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Ration Now or Ration Later: Endogenous Contractual Choice in Participative Budgeting

Fri, October 2, 4:30 to 6:00pm, TBA

Abstract

There is an extensive literature on participative budgeting studying situations where subordinates are better informed of project attributes than superiors. This paper reports on an experiment that adds to this literature by examining a superior’s choice between a budget contract that has a binding maximum funding limit (a “rationing” contract) and a budget contract where the superior can use ex post discretion to deny funding without the power of ex ante commitment (a “review” contract). Assuming only selfish motives, the rationing contract should be optimal from the superior’s perspective, while the review contract should result in the subordinate acquiring all the surplus. However, prior research has found that when a superior chooses between a review contract and a “trust” contract (wherein all subordinate requests are guaranteed to be funded), the review contract performs almost as well as the theoretical predictions for the rationing contract. The results from this experiment put prior findings into perspective. While superiors fail to achieve theorized earnings, the rationing contract does significantly better from the superior’s perspective than the review contract. We conclude that while the review contract may signal a superior’s commitment to enforce norms when chosen over the trust contract, it simply serves as a less powerful tool in controlling slack when chosen over the rationing contract.

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