Collusion in Capital Budgeting Process

Abstract

In response to the ever present concern about manager’s honest reporting and the need to control budgetary slack, a number of management control mechanisms have been proposed. Classical agency literature focuses on analytical solutions to identify the “best” mechanism to control this agency problem. However, experimental management accounting research has shown that individuals do not behave as opportunistically as predicted by the agency model. We empirically test one of the proposed control mechanisms in the agency literature – contracts – under different organizational conditions (ethical environment, collusion). Our results indicate that managers report most honestly under a slack contract with a guaranteed transfer of funds. However, managers did not respond to ethical environment manipulations but, did respond to the collusion treatment. Interestingly, this response is in the opposite direction from that predicted. Our results raise important questions for managers attempting to address agency questions.

Keywords: Collusion, Capital Budgeting, Ethics

JEL Classification: C70, M40