THE EFFECT OF BUSINESS UNIT STRATEGY AND …



Budgetary slack and its antecedents

Does manager’s power distance matter?

By

Fuad & Arifin Sabeni

Abstract

Studies have provided insights on control systems, but results have not developed into a widely accepted theory of management control in explaining the antecedents of budgetary slack. This study attempts to answer the peculiarities and anomalies shown by prior researches by examining direct effect of diversification, business unit strategy on budgetary slack, or passing through the intervening variables, budget emphasis and incentive systems. Manager’s power distance was postulated to affect the extent of the relationship between the rigidity of budget emphasis and budgetary slack.

A hundred and one responses from the independent-subsidiaries companies were gathered and then analyzed by Structural Equation Modeling set up in Lisrel 8.5 and moderated regression analysis with dummy variable. The study found that while both diversification and business unit strategy significantly affect budgetary slack and indirectly through budget emphasis, incentive system insignificantly affects the presence of budgetary slack. Surprisingly, the results suggest that the relationship between budget emphasis and budgetary slack is negative and stronger for managers with low power distance than for managers with high power distance, as opposed to the positive interactions hypothesized that high power distance managers react favorably to the high emphasis on meeting the budget rather than managers with low power distance.

Key words: budgetary slack, power distance, business unit strategy, diversification

I. Introduction

The budgetary control systems have been examined widely by many researchers for almost five decades. One of important areas has been focused on supervisory style, which has been used to evaluate subordinate’s performance relying on budgetary information. It was first pioneered by Hopwood’s (1972) seminal paper, where recent budgeting literature has shown great interest in understanding possible effects of budgetary control styles.

Later, Most of prior empirical evidences generally maintained that the incidence of dysfunctional behavior is affected by the tightness of budgetary controls; which is the condition when employees, mostly at the management organization levels, are evaluated primarily on whether or not they achieved their budget. It implies, therefore, all aspects of job prospects and facilities strongly depend on the managers’ ability to attain the budget target. Managers who miss the targets may face the prospect of interventions by upper management, the loss of organizational resources, the loss of annual bonuses/incentives, and worst, perhaps, the loss of their job (Merchant & Manzoni, 1989). Under these circumstances, managers may look for ways to protect themselves from the downside risk of missing budget targets and the stigma normally (Stede 2000).

However, since corporate may not have all specific and wide information about the operation of their subsidiaries, as is the case of the more diversified firms (Campbell et al. 1995), the business units (BU) managers may react unfavorably to the target determined by the corporate by underestimating their “real performance” to easily achieve the budget target. In addition, the budget target determined by the corporate may not as precise as the less diversified firms, and hence, budgetary slack is presented. In order to minimize the existence of budgetary slack, according to agency literature, corporate are likely to provide the great extent of incentive to their subordinates.

Nevertheless, even if corporate managers were able to detect slack, they may actually tolerate slack in business unit budgets as a conscious strategy to reduce information overload at the top (Galbraith 1973). More slack reduces the chance of a target being missed; and, the fewer the exceptions that need to be investigated, the less the overload on the top. Rather than investing in “high-cost” information systems, corporate tend to let this slack exist in their business units.

On the other hand, budgetary slack can also be explained by the uncertainty involved in a particular industry facing different business unit strategy. Bourgeois (1981) concluded that slack may be required to successfully pursue competitive strategy that requires a high degree of flexibility to respond effectively to changes in the environment (e.g. Porter’s differentiation and/or Miles and Snow’s prospector). Langfield-Smith (1997) moreover found that the way in which business units competes in their markets influence the design of management control systems.

Nevertheless, the results of this research have been inconclusive in some cases. Simons (1987, 1988), for instance, found that prospectors emphasize rigid budgetary controls to a greater extent than defenders. These findings contrast with the “popular views” (e.g. Govindrajan (1988), Govindrajan and Fisher (1990)), maintaining that innovation and differentiation (which is the case of differentiated companies) is best achieved in organizations that minimize formal controls (i.e. low budget emphasis). Moreover, the management accounting literature has maintained that the way in which a business unit competes in its market also influences the design of the management control system (Langfield-Smith 1997)

Therefore, those kinds of strategies that pursued by the business unit may also influence the extent of slack. Organization theory has suggested that slack may be needed to successfully pursue competitive strategies that require a high degree of flexibility to respond effectively to changes in the environment (Bourgeois 1981). Hence, business unit strategy is expected to be an important factor for explaining the presence of slack in business unit budgets. Again, the results have been inconclusive or in some cases, contradictory (for example, please compare, Miller and Friesen 1982; Simons 1987; Kaplan 1990; Govindarajan 1988).

With respect to the existence of national culture (power distance) that was developed by Hofstede (1980) to moderate the relationship between budget emphasis and budgetary slack is likely to exist. Power distance, that was defined as “the difference between the extent to which the superior (in this case corporate) can determine the behavior of subordinate (business unit managers)” (Hofstede 1980, p. 98; emphasize added), relates to favorably/unfavorably reaction to a high/low budget emphasis in a high/low manager’s power distance. The favorably (unfavorably) reaction indicates the lower (higher) extent of manager’s intention to create budgetary slack.

Although Chenhall (2003), quoting Hofstede (1980), argued that national culture differs in particular cultural characteristics, preliminary test of this study showed that each individual have “wide variance” of score based on the Hofstede’s questionnaires. Therefore, we believe that the study of national culture have not always to compare the behavior of managers in various countries as the contingent factors. Instead, national culture measures can be adopted in the setting of specific country as well.[1]

It is interesting therefore, to contribute to the accounting literature by advancing “the paths” of determinants of budgetary slack that might have not been examined by prior researchers, in some specific ways: 1) Indonesia as the third world countries and “western” countries have shown contrasted value (Noesjirwan 1977, p. 357) and national culture (Hofstede 1985). Particularly, no research has been done in Indonesia that uses this measure as moderating variable to examine the variables hypothesized. 2) This research hopefully will be an advance solution for providing the “generally accepted results” pertaining the antecedents of budgetary slack.

This main purpose of this study is to determine the situational, as well as firm’s administrative systems antecedents in the presence of budgetary slack. Contingent argument will also be examined by the moderating role of power distance in the relationship between budget emphasis and budgetary slack.

The remainder of the study is organized as follows. The next section develops in more detail the hypotheses formulation and then followed by methodology of the study in Section III. Results are reported in Section IV while limitations and avenues for further research are discussed in the final Section.

II. Hypothesis Development

Corporate diversification is defined as the extent to which a firm is simultaneously active in “distinct” businesses (Pitts and Hopkins 1982) and a means by which a firm expands from its core business into other product markets (Andrews 1980; Gluck 1985). There are many advantages that a firm can get by doing diversification. Diversification can improve debt capacity, reduces the chances of bankruptcy by going into new product/markets (Higgins and Schall 1975; Lewellen 1971). Skill developed in one business transferred to other businesses, can also increase labor and capital productivity. A diversified firm can transfer funds from a cash surplus unit to a cash deficit unit without taxes of transaction costs (Bhide 1993).

The type (i.e. outcomes, use or usefulness) of management control systems implemented over business units may be affected by the extent of diversification. In-line with prior researches, more diverse firms may influence the ability of the corporate to detect the budgetary slack in their business units. Corporate managers in the diversified firms are less familiar with the operations of the distinct business (Campbell et al. 1995). Therefore, corporate managers are at disadvantage to detect slack. Moreover, as previously stated, some corporate tend to let slack exist in their business unit to control the information-processing need by corporate management (Galbraith 1973). Therefore, we posit that:

H1: more diversified firms experienced more budgetary slack in their business units.

In accordance with the above preposition, diversification leads to an increase in the capacity of information processing by the corporate. This would make the corporate almost impossible to use direct informal interventions in business unit operations as a tool of control. In fact, much of the control in diversified firms will be achieved through financial-results or budgetary controls (Salter 1973; Berg 1969). Fortunately, monitoring financial results requires less intimate knowledge of the activities of the various business units, which is an advantage issue for more diversified firms.

Moreover, in accordance with H1 above, since corporate managers in diversified firms lack specific operation knowledge about the various activities of their business units, it is expected that they will emphasize accounting-based budget performance. In other words, most interactions between corporate and business unit managers of diversified firms are likely to evolve mainly from budget-related issues, as opposed to the operational details of the business.

H2 : more diversified firms put more emphasis on budget target.

Furthermore, agency theory predicts that incentives should be most intense when business unit managers are able to respond to them (Milgrom and Roberts 1992). Business unit managers in diversified firms are likely to have discretion about more aspects of their work, and hence, have greater marginal impact on performance (Bruns and Waterhouse 1975). In the other hand, principal (corporate manager) wanted the agent (business unit manager) to provide high effort. Since effort is unobservable (Dirsmith 1998), incentives were provided for business managers to motivate them to behave in a manner consistent with the corporate interests.

Moreover, as previously stated in H2, corporate managers in diversified firms primarily monitor outcome-based budget results without getting involved in, and having a great understanding of, the business unit operations as such. Agency theory once again suggests that formal monitoring of outcome-based performance and incentives are complementary. Thus, we expect that the greater autonomy of business unit managers and the greater reliance on outcome-based budgetary controls in diversified firms is associated with a higher percentage variable compensation.

H3: diversified firms tend to intensively give a larger extent of both business unit and corporate performance-based incentive

There are two typologies that were used widely by behavioral-based budgetary accounting researchers to measure business unit strategy; which are Porter’s (1980) Cost-leadership/Differentiator and Miles and Snow (1978) Defender/Prospector. Both are assumed to be similar since they have the “same sense of market oriented”. Cost-leadership and defenders for instance, they focus on achieving a low cost position relative to competitors and therefore pursue cost reduction, exploit economies of scale and produce undifferentiated product. On the other hand, differentiators and prospectors actively engage in market and product development. Often, they create something that is perceived by the customer as unique by pursuing superior product features, product innovation, customer service, brand image, etc.

Govindrajan (1984, 1986, 1988) reconciled the Hopwood (1973) and Otley’s (1978) results relating to performance, argued that defenders face relatively low environmental uncertainty[2] rather than prospectors. He argued that differentiators/prospectors face relatively more uncertainty than cost-leaders/defenders because they have broad product lines, engage in produuct innovation, deal with products that have not yet crystallized, etc. Cost-leaders/defenders, in contrast, keep their essentially undifferentiated product offerings relatively stable over time (Fisher and Govindrajan 1993, Govindrajan 1986, 1988). Hence, the reliance on formal accounting-based budgetary controls is less suitable and they will also require a higher degree of flexibility to respond effectively to changes in the environment. Bourgeois (1981) and Cyert and March (1963) suggested the slack creation to hedge against uncertainty, which provide a cushion to support the exploitation of market opportunities and a source of funds to experiment with product innovation.

In addition, both defender and prospector also typically operate in dissimilar settings that may affect the ability of corporate management to detect slack. Merchant (1985b) argued that the ability to set accurate budget and to measure performance precisely, which is likely to be the case for cost-leaders/defenders, provides the opportunity to prevent the introduction of slack. On the other hand, corporate management may not wish to reduce slack in the differentiators/prospectors business units, where if they do, it would chokes innovation and prevents managers from exploring new market opportunities (Stede 2001). Therefore we conclude that

H4: differentiators/prospectors have more budget slack than cost leaders/defenders.

Prior research has not produced conclusive evidence on the relationship between management control systems and competitive strategy (Langfield- Smith 1997). For instance, Simons (1987, 1988) found that prospectors emphasize rigid budgetary controls to a greater extent than defenders, which conflicts with the widely held view that innovation and differentiation are best achieved in organizations that minimize formal controls. However, Govindrajan (1988) and Govindrajan and Fisher (1990) maintained that prospectors tend to set tight budgets.

Nevertheless, many strong evidences have suggested that cost-leadership/defenders (CL/DEF) will emphasize cost control, trend monitoring and efficiency, whereas differentiatiors/prospectors (DIF/PRO) are likely to rely on scanning the environment for new opportunities, comprehensive planning, and the adoption of relatively subjective performance measures. Accounting controls (budget) in general tend not to be associated with innovation; hence, differentiators/prospectors will make limited use of budgetary controls, where it chokes innovation and experimentations, although they will be important in the case of defenders.

H5: differentiators/prospectors put less emphasis on meeting the budget than cost leaders/ defenders.

With respect to the incentive system, managers in charge of DIF/PRO businesses are likely to receive a lower portion of their salary tied to accounting-based budgetary performance because of the uncertainty involved in pursuing DIF/PRO strategies. For example, engaging in product and market innovation may require investments that decrease current-period accounting profits despite their potential to generate substantial, but uncertain, future earnings. Incentives contingent on accounting-based measures may therefore discourage managers from undertaking such investments.

Since the critical success factors underlying DIF/PRO strategies tend to be long-term in nature and more difficult to quantify, incentives tied to accounting-based budgetary performance become less suitable because they potentially encourage managers to be myopic in their decisions (Baber et al. 1996; Clinch 1991). Similarly, if accounting-based measures of performance are a less adequate reflection of the managers’ actions in DIF/PRO units than in CL/DEF units, it is expected that incentive payments to managers in DIF/PRO units will be conditioned on subjective performance evaluations by corporate management to a greater extent than in CL/DEF units (Bushman et al. 1995). Collectively, this suggests that:

H6: incentives for managers in charge of differentiation/prospector business units are less intensive compared to incentives for managers in charge of cost leader/defender business units.

The presence of slack in business unit budgets is affected by the design of the budgetary control and incentive system, either because these systems produce pressures on business unit managers and/or affect the likelihood that slack is detected (Merchant 1985a). A strong (if not exclusive) emphasis on budgetary performance should provide clear guidance to managers as to what is considered important. Controls can also diminish the intentions of managers to create slack in their business unit budgets.

H7: tight budgetary controls are negatively associated with slack

Incentives can be considered using the theory of operant conditioning as well as the other motivation theories (e.g., agency, expectancy, equity and goal setting). Operant conditioning theory suggests that an individual’s behavior will be modified by the rewards or punishments that occur as a result of some action or failure to act on the part of the individual. Holding business unit managers responsible for clearly defined results areas, adequate monitoring of performance in these areas, and providing compensation for good results, generally is viewed in the (economics-based) accounting literature as an effective way to stimulate goal-directed management behavior. A high percentage variable compensation should increase the likelihood that bonus amounts are significant enough for managers to influence their behavior.

H8: business unit performance-based incentives are negatively associated with slack.

Recent management accounting studies incorporating some or all of Hofstede’s dimensions of national culture are mostly applied in the area of behavioral researches. It was pioneered by Chow et al. (1991) who found the insignificant relation between individualism and performance by controlling team pay, and then followed by numerous researchers such as Harrison (1992, 1993), O’Connor (1995), Lal et al. (1996), Nicholson et al. (1997), etc. Although they were a sign of the widening area in the behavioral accounting research, but many of them revealed the contradictory results. For example, while Chow et al. (1996) examined the effect of three Hofstede’s national culture dimensions (Individualism, Power distance and uncertainty avoidance) on the relationship between control system tightness, procedural controls, and centralized directives and found the significant ones, Harrison (1992) showed the contradictory results. Oddly, both used the same measurement and samples; which were Anglo-American managers and Singaporean manager.

We, however, postulate that a significant interaction of power distance in mediating the relation between budget emphasis and budgetary slack is likely to happen. Subordinates or managers are likely to react favorably to a high budget emphasis evaluative style in a high power distance society because a preference for a non-consultative, decisive leadership style in high power distance societies is also likely to produce a preference for high RAPM (reliance on accounting performance measure) in evaluative style (Harrison 1993, p. 322). A favorable subordinate’s reaction to a performance evaluative style is likely to be associated with less slack in achieving the budget target. In contrary, subordinates in low power distance societies are likely to “react favorably to a low budget emphasis evaluative style because this style provides the opportunity for subordinates to be consulted” (Lau et al. 1997, p. 179). With low budget emphasis, greater reliance will be placed on non accounting performance measures. As non accounting performance measures are likely to be more subjective and applied in more flexible measures than accounting performance measures, there is likely to be a greater need for consultations between superiors and subordinates. Therefore, hypothesis 9 is stated as:

H9: the interaction term between budget emphasis and budgetary slack is determined by power distance.

Figure I: Conceptual Framework

[pic]III. Method

3.1. The sample

Pilot study was conducted to the 34 respondents that represent the sample by conducted interview to ensure feasibility, understandability and clarity of the questions. However, there were many revisions suggested; and the most significant revision made was the omission[3] of one of Hofstede’s (1980) power distance constructs no C.12[4] (see Hofstede 1980, p.120), since respondents did not clearly understand the meaning after it was translated into Indonesian according to the methodological sequences. (Please refer to footnote 3).

We examine both the subsidiaries from both go public and non go public parents. This study identified 246 firms from 36 parents of manufacturing public listed firms and randomly allocated 500 questionnaires to them; Another 200 questionnaires were allocated to the non go public subsidiaries. Companies with less than 100 companies were not expected to have clearly defined areas of responsibility to which managers could be appointed (Dunk 1993), so they are not included in the study. Chosen managers were until three levels below the top management in order to hinder the bias results, because commonly, higher incentives are given to the middle-high level managers.

Sampling was restricted to managers of budget-related functional area; that is, managers that were responsible in attaining the budget target. A questionnaire[5] was attached to a cover letter explaining the purpose of the study and assuring anonymity was mailed (and e-mailed) to the managers. A reply-paid self-addressed envelope was also attached to the cover letter requesting the participants to return the completed questionnaires directly to the researcher. We received 45 and 56 usable responses from subsidiaries of go-public and non-go public firms, respectively.

Although prior researchers concluded that the subsidiaries of non-go public and go-public firms might have different characteristics based on their ownership and equity financing (Singh, 1995), test for equality of variances and means showed no differences between those different characteristics (all variables exceed the threshold level of observed probability 0.1). Therefore, this study inherently found no problem.

3.2. Measurement of Variables

Corporate diversification was measured by the number of separate entities in each company as a proxy for the degree of diversification at the highest organizational level. Budget emphasis was measured by the questionnaire survey consist of 7 items that scores from 1 (definitely false) to 5 (true) adopted from Stede’s (2000, 2001) published researches. The higher the score, the more achieving the budget is emphasized, and hence the tighter the budgetary control process is perceived to be. The construct reliability of budget emphasis was 0.752. A complete questionnaire is presented in the appendix A.

A budget contains slack if the business unit manager has intentionally set his/her budget target lower than his/her honest forecast about the future so that the budget becomes easier to achieve (Lukka 1988). The slack measurement consists of 5 items (items 1-4, using 5 items Likert’s scale, and item 5 is fully anchored question asking whether the budget is very easy to attain until impossible to attain). The construct reliability was 0.837

Incentives were measured using two aspects of monetary incentives. First, we asked respondents to indicate the percentage of their compensation that is performance-dependent. Second, we asked respondents to indicate the percentage of their bonus that depends on total corporate performance v. their own business unit performance (Gupta and Govindarajan 1986). The average of these measures was employed to determine the extent of incentive systems based on the performance of corporate, as well as their business units.

Business strategy as Govindrajan and Fisher (1990), using Porter’s (1980) Low cost – Differentiation and Miles and Snow’s (1978) Defender-Prospector were used in this study. The business unit managers were asked to position their business unit relative to competitors (on a seven-point scale from significantly lower to higher) in terms of Product selling price; R&D expenditures; Product quality; Brand image; and Product features. The higher score indicates that the business units operate in differentiation/prospector strategy, while vice versa; the lower score proves that the business units run in cost-leadership/defender strategy. The reliability was 0.716

Power distance was measured by a nine-item instrument developed by Hofstede (1980). At present, it is the only available instrument for measuring power distance. “This instrument was based on subordinates’ perceptions of whether their peers are afraid to disagree with their superiors, as well as their peers’ perceptions of and preferences for their superiors’ decision making styles”. (Lau et al. 1997. p. 183). Power Distance Index (PDI) was not adopted as many prior researchers did, as the nine-items of PD’s construct used in this study would be more precisely explain the extent of power distance (Hofstede 1980, p. 109).

Table 1: Descriptive Statistics

|Variable |N |Actual Range |Theoretical Range | |

| | |Min |Max |Min |Max |Mean(() |Std.Dev (() |

|STRATEGY |101 |5 |25 |5 |25 |18.861 |3.867 |

|DIVRSFTCN |101 |2 |19 |0 |( |5.663 |4.641 |

|INCENTIVE |101 |0 |0.3 |0 |( |0.101 |0.074 |

|EMPHASIS |101 |7 |35 |7 |35 |27.316 |5.434 |

|BDGSLACK |101 |7 |25 |5 |25 |20.158 |4.706 |

|Pow Dist |101 |14 |37 |8 |40 |27.435 |5.034 |

(: Unidentified

IV. Results and Discussion

H1 to H8 were analyzed by Structural Equation Modeling in LISREL 8.05 Simplis. Despite the model were threaten as the observed variables, rather than the latent variables (unobserved variables), this is the common method in a behavioral-based accounting research (Stede 2001; De ruyter and Wetzels 1999). In fact, this test produced a better confirmation about factor dimensions and the causality relationship between those factors. Nevertheless, H9 was analyzed by moderated regression analysis. Therefore, we assumed that there is no other antecedent (i.e. diversification and strategy) affecting the extent of budget emphasis and budgetary slack. In other words, budget emphasis, power distance (moderating variable) and budgetary slack are independent and dependent variables, respectively, using dummy (dichotomous variable). The purpose of this method is to figure out the role of managers’ power distance in the relationship between the rigidity of budget and the likelihood of managers to create budgetary slack, without be affected by other determinants of budgetary slack.

Table 2

Correlations

| |Strategy |Slack |Emphasis |Diversification | Incentive |

|

|Slack |.609** | | | | |

|

|Emphasis |-.238* |-.305** | | | |

|

|Diversification |.219* |.395** |.120 | | |

|

|Incentive |-.087 |-.158 |.085 |.105 | |

|

|PD |-0.168 |-0.179 |0.221* |-0.048 |-0.047 |

|Notes: N=101; **p < 0.01; * p < 0.05 (one-tail)

Table 2 reports the correlation between variables. While business unit strategy and budgetary emphasis seems to negatively correlated, Differentiators/Prospectors experience more slack in their budgetary outcome. The tight budgetary controls also seem to have less slack in their budgets. Incentive system and other variables, surprisingly, seem do not significantly correlated in the predicted directions. Diversified companies do not put more emphasis on their budgets, although they have more slack in their budgets, indicating lack of operational knowledge about the various activities of their business units.

Table 3 reports the output of a structural equation model. The structural equation model tests the hypothesized relationships with all variables entered simultaneously in the model. The purpose of this multivariate analysis is to test whether the one to one correlations reported in Table 2 hold significant in the presence of other intervening variables. In other words, it tests whether corporate diversification and business unit strategy, respectively, have a direct effect on budgetary slack or whether this effect is (in part) attributable to how rigidly the control system is implemented and/or how the incentive system is designed.

The structural model was set up in LISREL 8.05 Simplis. Because of sample size limitations, all variables in the model were treated as the observed variables (by using the aggregate scale for each construct) and not as latent variables with multiple indicators. Model fit is adequate: ((2 is insignificant (p = 0.66); the comparative fit index (CFI=1.00) exceeds 0.9. Further methodologies details are provided in the footnotes to table 3.

Table 3

Structural Equation Modeling Results

| |Path from |…to |( |Sig. |

|H1 |Diversification |Slack |0.337 |0.000 |

|H2 |Diversification |Emphasis |0.212 |0.064 |

|H3 |Diversification |Incentive |0.002 |0.198 |

|H4 |Strategy |Slack |0.574 |0.000 |

|H5 |Strategy |emphasis |-0.390 |0.004 |

|H6 |Strategy |incentive |-0.002 |0.253 |

|H7 |Emphasis |Slack |-0.192 |0.002 |

|H8 |Incentive |Slack |-8.338 |0.061 |

Notes: a. This study contained both the univariate and multivariate outliers. However, this study did not attempt to delete ones, because outliers must be viewed within the context of the analysis and should be evaluated by the types of information they provide. In addition, Hair et al. (1995) mentioned that “outliers should be retained to ensure generalizability to the entire population… (p. 66)”

b. Model fit is very good: ((2 = 0.193; root mean square error of approximation = 0.000; adjusted goodness of fit index (AGFI) is 0.988, above the recommended acceptance level (0.90); normed fit index (NFI) is 0.998; comparative fit index (CFI) is 1.000 proving the perfect fit (Arbuckle and Wothke 1999), which is above a common recommended value 0.90 (Hair et al. 1995)

The results showed, as hypothesized, as the number of subsidiaries controlled by the corporate is increasing, the extent of budgetary slack could be higher indeed. (H1; p= 0.00; (=0.3371). Following Galbraith’s (1973) model in which corporate management deals with the overload information processed, corporate management can either increase the capacity to handle more information, or reduce the amount of information. However, since investing in information systems is a high cost investment, corporate tends to let the slack exist in their business units. Moreover, it is more likely that more diversified corporate are less familiar with the operations of their businesses, which make them at a disadvantage to uncover slack (Onsi 1973).

Therefore, much of the control in diversified firms will be achieved through financial results-oriented or budgetary controls (Merchant 1981, Salter 1973, Berg 1969), as shown by significant effect on diversification to the budget emphasis (H2: p= 0.064; (=0.212) at the moderate cut-off (i.e. 7 per cent). Monitoring financial results requires less intimate knowledge of the activities of the various business units and simplifies top management information processing (Hill and Hoskisson 1987). Nevertheless, more diversified firms are not likely to give higher incentive to their business units manager (H3: p=0.198; (=0.002). Since business unit managers may underestimate their productive capabilities, the reliance on performance-based incentive was not the only option the corporate has. Instead, as has been argued by stewardship theorists (e.g., Donaldson and Davis 1989, 1991, 1994; Fox and Hamilton 1994; Donaldson 1990), agency theory may not work well on upper level management; where they were the sample of this study. Instead, higher order needs (growth, achievement, and self-actualization) are more determined by the corporate rather than lower order/economic needs (e.g. physiological, security, economic) as the motivation drivers for their managers.

The success factors underlying DIF/PRO strategies tend to be of a long term nature and difficult to quantify, which not only make reliance on formal accounting-based budgetary controls less suitable, but also requires a higher degree of flexibility to respond effectively to changes in the environment. Differentiators seem to induce more slack in their budget, while cost-leadership companies, in contrast, tend to produce less slack (H4: p=0.000; (=0.5745). In addition, Differentiators seem do not put higher pressure to attain the budgetary targets, as to be the case of cost-leadership companies (H5= 0.0045; (=-0.3904). However, differentiators do not give more incentive to their managers (H6) because the differentiated company’s ability to satisfy a customer need in a way that its competitors can not means that it can charge the premium price (p=0.2531; (= -0.0022). The ability to increase revenues by charging premium prices (rather than by reducing costs like the cost-leadership) allows the corporate to gain above-average profits. Hence, incentive in charge of differentiation/prospector business units is more intensive rather than in cost-leaders/defender business units.

We also found that rigid budgetary controls should increase the likelihood that slack gets detected (Williamson 1967), and therefore, curtailed (H7: p= 0.0026; (=-0.1920). In addition, we also found that there is a negative effect between incentives and budgetary slack at 10 per cent cut-off (H8: p=0.0617; (=-8.3382). As previously stated, assuming that managers seek to maximize personal income, high business unit performance will be pursued since it translates directly into higher personal income. This, however, reduces the propensity of BU managers to build slack (Milgrom and Roberts 1992).

Does managers’ power distance matter?

H9 implies that manager’s power distance moderates the relation between budget emphasis and budgetary slack. In other words, power distance and the rigidity of the budget interact to influence the extent of budgetary slack. If the interaction is significant, it would mean that the relations between the management control feature and budgetary slack is stronger for managers with high power distance than for managers with low power distance. To test the hypothesis, we divided the sample into high power distance and low power distance based on the mean score. The hypothesis was tested using the following regression equation:

Y = a0 + a1X1 + a2X2 + a3X1X2 (1)

Y = budgetary slack

X1 = budget emphasis

X2 = manager’s power distance (0 for low power distance and 1 for high power distance)

Using the value of power distance = 1, and 0, equation (1) can be reconstructed for managers with high and low power distance respectively as presented below:

For low managers power distance: Y = a0 + X1 (2)

For high managers power distance: Y = (a0 + a2) + (a1 + a3) X1 (3)

H9 posits that there is a significant interaction between budget emphasis and manager’s power distance affecting budgetary slack. To support the hypothesis, a3 in equation (1) must be significant and positive. However, this study found the significant one, but the negative sign was not expected as displayed in table 3. It can be observed from the table that the interaction term is negative and significant (p < 0.011). The model explains 25.4 per cent of the variance (adj. R2 = 0.164, F = 6.350, p < 0.01)

Table 4: Moderated Regression Results

|Variables |Coefficient |Coefficient value (() |T-stat value |Sig. p. |

|X1 budget emphasis |A1 |-0.069 |-0.646 |0.520 |

|X2 manager’s PD |A2 |10.884 |2.307 |0.023 |

|X3 interaction term |A3 |-0.436 |-2.588 |0.011 |

|Constant |A0 |22.830 |8.042 |0.000 |

|Notes: Adj. R2 = 0.164; F = 6.350; p < 0.001 |

To present more clearly the difference in the slope of the relationship between budget emphasis and budgetary slack with respect to the low and high power distance, the values from table III for the relevant coefficient in equation (1) are inserted to obtain equation (2) and (3)

For low manager’s power distance Y = 22.830 – 0.069BE (2a)

And

For high manager’s power distance Y = 33.674 – 0.505BE (3a)

The results clearly indicate that the relationship between budget emphasis and budgetary slack is negative and stronger for managers with low power distance (PD) than for managers with high power distance. A comparison of the regression coefficient of budget emphasis in equation (2a) and (3a) indicates that a unit decrease in budget emphasis has at least a seven-fold effect on the extent of budgetary slack for managers with high PD than for managers with low PD (see figure).

Figure 2: Relationship between budgetary slack and budget emphasis: low and high manager’s power distance

Budget emphasis

Surprisingly, although the moderating effect of power distance is significant, the negative sign is not expected. It means, therefore, business unit managers with high power distance tend to react favorably to a low budget emphasis evaluative style in achieving the budget target rather than managers with lower power distance. Since the satisfaction of managers with directive or persuasive superior is large for managers with high power distance (Hofsede 1980) greater reliance will be placed on non-accounting performance measures in the low budget emphasis

5. Limitations and Avenues for Further Research

This study carries several inherent limitations. Since the very low response rate, totally 11.25%, the question arises as to whether the responses obtained are representative of the population. The use of questionnaire also introduces the possibility that the respondents may place a different interpretation on the questions than did the researchers. Efforts were made to overcome this limitation, which was by conducting the pilot study. In addition, there are some determinants of budgetary slack which are not included in the study. Budgetary slack may actually be influenced by other variables than those considered in the study. Therefore, conclusions can be made only with respect to those situational factors and firm’s administrative systems.

Market intensity may affect the extent of accounting control and the intentions of manager to create slack in their business unit budgets, as well as the external forces of industry (i.e., porter’s five forces). Further study can also incorporate other measures of incentives such as group-based incentive Vs tournament-based incentive suggested by Drake et al. (1999), compensation level and/or compensation change (Ke et. al. 1999), or use of long term incentives (Merchant 1995). By overcoming the data difficulty, organizational systems variables can also be proxied by use of non-financial performance measures that have been done by Perera et al. (1997)

The role of national culture can also be extended by incorporating other dimensions of national culture such as individualism, uncertainty avoidance, or masculinity; or perhaps, by combining the national and organizational culture would clearly determine the “true effect” of cultures in each variable hypothesized. Further research can also change the business unit strategy’s scale. The dichotomous variable may be better, as this dummy variable can precisely determine the exact threshold value of differentiator/prospectors and cost-leadership/defender companies based on its median or mean value.

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Appendix

Instruments assessing manager’s power distance

Every individual have its own culture which is a set of values that might be expected or implicitly required of members of that organization. The following statements listed below are values that have been found prevalent in different individuals.

Please place one number (i.e. 1, 2, 3, 4, 5) against each of the following eight items to indicate the extent of your individual’s power distance

|1 |2 |3 |4 |5 |

|Not at all |To a slight extent |To a moderate extent |To a great extent |To a very great extent |

|(1) |Employees lose respect for a consultative |1 |2 |3 |4 |5 |

| |manager | | | | | |

|(2) |A good manager gives detailed instructions |1 |2 |3 |4 |5 |

|(3) |My manager is not concerned with helping get |1 |2 |3 |4 |5 |

| |ahead | | | | | |

|(4) |An employee should not ask for a salary |1 |2 |3 |4 |5 |

| |increase | | | | | |

|(5) |Employees in industry should participate more |1 |2 |3 |4 |5 |

| |in the decisions taken by management | | | | | |

|(6) |The average human being has an inherent |1 |2 |3 |4 |5 |

| |dislike of work and will avoid it if he can | | | | | |

|(7) |Most employees want to make a real |1 |2 |3 |4 |5 |

| |contribution to the success of it | | | | | |

|(8) |By and large, companies change their practises|1 |2 |3 |4 |5 |

| |much too often | | | | | |

Business Unit Strategy

Please position your business unit relative to competitors

|1 |2 |3 |4 |5 |

|Lowest |lower |Not bad |higher |highest |

|(1) |Product selling prices |1 |2 |3 |4 |5 |

|(2) |Product quality |1 |2 |3 |4 |5 |

|(3) |Brand image |1 |2 |3 |4 |5 |

|(4) |R&D expenditures |1 |2 |3 |4 |5 |

|(5) |Product features |1 |2 |3 |4 |5 |

Budget emphasis

A high emphasis on meeting the budget is the condition when subordinate managers are evaluated primarily on whether or not they achieve their budget. This instruments measure the rigidity of budget emphasis

|1 |2 |3 |4 |5 |

|Definitely false |False |Neutral |True |Definitely |

| | | | |true |

|(1) |I am constantly reminded by the corporate parent of the need to |1 |2 |3 |4 |5 |

| |meet budget targets | | | | | |

|(2) |Corporate superiors judge my performance predominantly on the |1 |2 |3 |4 |5 |

| |basis of attaining budget goals | | | | | |

|(3) |Control over my business is achieved by the corporate parent |1 |2 |3 |4 |5 |

| |principally by monitoring whether my budget is on target | | | | | |

|(4) |In the eyes of my corporate superiors, achieving the budget is an|1 |2 |3 |4 |5 |

| |accurate reflection of whether I am succeeding in my business | | | | | |

|(5) |Not achieving my budget has a strong impact on how my performance|1 |2 |3 |4 |5 |

| |is rated by my corporate superiors | | | | | |

|(6) |My promotion prospects depend heavily on my ability to meet the |1 |2 |3 |4 |5 |

| |budget | | | | | |

|(7) |In the eyes of my corporate superiors, not achieving the budget |1 |2 |3 |4 |5 |

| |reflects poor performance | | | | | |

Budgetary slack

This instruments measure whether you as the business unit managers intentionally set your budget target lower than your honest forecast about the future so that the budget becomes easier to achieve.

|1 |2 |3 |4 |5 |

|Definitely false |False |Neutral |True |Definitely true |

|(1) |Succeed to submit budgets that are easily attainable |1 |2 |3 |4 |5 |

|(2) |Budget targets induce high productivity in my business unit |1 |2 |3 |4 |5 |

|(3) |Budget targets require costs to be managed carefully in my |1 |2 |3 |4 |5 |

| |business unit | | | | | |

|(4) |Budget targets have not caused me to be particularly concerned |1 |2 |3 |4 |5 |

| |with improving efficiency in my business unit | | | | | |

|(5) |How do you judge your business units’ budget target? (please circle one) | | | | | |

| |very easy to attain | | | | | |

| |attainable with reasonable effort | | | | | |

| |attainable with considerable effort | | | | | |

| |practically unattainable | | | | | |

| |impossible to atttain | | | | | |

-----------------------

[1] Frucot and Shearon (1991) for instance, they examined the effect of manager’s power distance and uncertainty avoidance on the budgetary participation, performance, job satisfaction and locus of control to 83 Mexican managers.

[2] He defined environmental uncertainty as the unpredictability of the actions of customers, suppliers, competitors and regulatory groups.

[3] Modification of construct is common in behavioral-based accounting research. Budgetary participation construct developed by Milani (1975) has been revised significantly by Pope and Otley (1996). Furthermore, Brownell (1982, 1983) and harrison also made changes in job satisfaction’s widely-used questionnaires developed by Weiss et al. (1967).

[4] “There are few qualities in a man more admirable tha dedication and loyalty to his company”

[5] The questionnaires were initially developed in English by prior researchers, then translated into Indonesian and back-translated into English by different individuals. The original and back-translated versions were compared. The Indonesian version was then revised based on the detected differences, then translated back into English and again compared to the original English version. There were many remaining differences had to be resolved to finalize the Indonesian version.

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Budget Emphasis

Slack

Incentive

Strategy

PD

Diversification

High PD

Low PD

Budgetary

Slack

H1

H2

H3

H4

H5

H6

H7

H8

H9

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