Van der Stede, Wim

Van der Stede, Wim A.

LSE Research Online

Reducing budget slack may lead managers to focus on theshort term blogs.lse.ac.uk /businessreview/2016/06/06/reducing-budget-slack-may-lead-managers-to-focus-on-the-short-term/Every time I see corporate accounting irregularities in the news I recall how a key finding in my doctoral researchsome time ago has remained relevant. The research showed support for a spillover effect between slack resourcesand managerial time horizon. Kind of like a ‘whack-a-mole’ effect. Slack refers to securing more resources (such asduring an organization’s annual budgeting process) than are strictly necessary. The research suggested that tryingto reduce slack may rear its head elsewhere; that is, in the form of greater myopic decision making.But there were also two other factors (and inevitably many others, but unmeasured ones) in play: past performanceand competitive strategy. The results indicated that businesses that either pursue a differentiation strategy or havebeen more profitable tend to be subject to looser controls, which was associated with more slack as well as agreater tendency for managers to think long-term.This suggest an interesting tension. When does the comfort of good performance and success become socomfortable that it squanders resources or erodes the firm’s competitive edge, but equally, when does cutting anyslack become so constraining that it erodes the necessary long-term orientation for sustainable competitiveviability?1/3Tight budgets, slack and myopiaA tight budget-control style is one in which managers are evaluated primarily on whether or not they achieve theirbudget, usually expressed in terms of a profit target. When evaluated in this way, managers are held fullyaccountable for their performance as measured by the budget. This implies that salary, resources and careerprospects become highly, if not fully, dependent on the managers’ ability to meet the budget. Managers who misstheir target face the prospect of interventions by their senior management, the loss of organizational resources,the loss of bonuses, and ultimately the loss of their job. Under such pressure, managers may look for ways toprotect themselves from the downside of missing budget targets by way of, for example, negotiating moreachievable targets (ie, ‘padding the budget’ or ‘slack creation’) or by focusing on business matters that improvecurrent period performance even if possibly harmful long-term for the business (ie, ‘myopia’ or short-termmanagerial orientation).It is important to emphasize, however, that one must be careful to consign slack and decisions that improve short-term performance as unequivocally ‘dysfunctional’ or 'bad'. Not all cuts are 'myopic', nor is all 'slack' a waste.Slack sometimes has beneficial effects (eg, to pursue strategies that require innovation and experimentation) andsome seemingly short-term management decisions can help both short-term and long-term results (eg, scrappingprojects with dubious fortunes that ‘cut the loss’ rather than jeopardize competitiveness).To add complication, cutting slack can be good (when the extra resources indicate inefficiencies or ‘empirebuilding’), but not always (when the slack allows experimentation and provides some wiggle room for innovation andflexible responses and agility). Equally, cutting R&D is not always ‘bad’—it is only ‘myopic’ when it is done to boostshort-term earnings while shortchanging long-term value, but when it rids the firm of dud projects, it is good in boththe short and long term. But the important result in my study was that I found slack and managerial short-termorientation to be negatively related, indicating that when slack was reduced, managers tended to be more short-termoriented.Importantly, past performance appeared not to be an innocent bystander: business units that were more profitableenjoyed looser controls, which provided more leeway for slack creation which, in turn, tended to reduce thepressure for short-term results. A virtuous circle, until of course there is “not enough” pressure.But it is the vicious circle of “too much” pressure that can be more easily imagined, although it is usually not spotteduntil it is too late. This has been shown in a string of scandals in Japanese corporations of late that have beenattributed to “overly aggressive targets”.Let’s focus on one of these scandal-ridden cases, Toshiba, where CEO Hisao Tanaka stepped down in late July afteran inquiry uncovered that the company had inflated its profits in one of Japan’s biggest accounting scandals. But formy purposes, it is the following that is intriguing. As the FT reported: while Mr Tanaka may not have givensubordinates instructions to cook the books, it seemingly was the firm’s culture spanning three generations of chiefexecutives to “exert pressure on employees to meet aggressive, short-term profit targets,” where the “top-downpressure to meet increasingly unrealistic targets escalated as earnings deteriorated in the wake of the globalfinancial crisis and the 2011 earthquake and Fukushima nuclear accident.”This suggests pressure all around, from deteriorating past performance and from higher up — no slack and nowiggle room, and much else besides (such as weak corporate governance and a deferential organizational culture).How much can one squeeze? Clearly there is a limit where cutting slack, finding inefficiencies or profits to reportturns into cooking the books – hardly good decision making and certainly not viable long-term.To provide another context as an illustration of the tension, private equity can also have the good effect of cuttingslack — to hold executives’ feet to the fire to ‘sweat assets’. But the trick is to keep those feet close enough, yet notso close that those holding their feet to the fire end up burning their fingers.♣♣♣2/3Notes:This post is based on the author’s PhD dissertation, “The relationship between two consequences ofbudgetary controls: budgetary slack creation and managerial short-term orientation,” in Accounting,Organizations and Society, 25(6) 2000, 609-622.The post gives the views of its authors, not the position of LSE Business Review or the London School ofEconomics.Featured image credit: viZZZual.com CC-BY-2.0Before commenting, please read our Comment PolicyWim A Van der Stede  is the CIMA Professor of Accounting and Financial Management and Head ofthe LSE’s Department of Accounting. His research interests pertain broadly to the study ofmanagement control systems; ie, the study of performance targets and the budgeting processesused to set them; performance measurement and evaluation; and incentive systems that relateperformance evaluations to the provision of rewards. He tweets at @stede_w.  3/3

Reducing budget slack may lead managers to focus on the short term

Abstract

Similar works

Full text

Available Versions

LSE Research Online