Uncertainty and Information Asymmetry in Budget Negotiations

Abstract

Participative budgeting processes are an important element of management control systems in many firms. The literature on participative budgeting has studied the role of information asymmetry. However, prior contributions do not differentiate between superior uncertainty about future profitability arising from information asymmetry between the superior and the subordinate (one-sided uncertainty) and superior uncertainty arising from a volatile environment in which even the subordinate does not know the future profitability (common uncertainty). While both kinds of superior uncertainty are equivalent from an economic perspective as the superior cannot expect the subordinate to convey private information under a slack-inducing bonus scheme, they may strongly differ with regard the psychological factors affecting behavior in these settings. We conduct a laboratory experiment to disentangle these effects. We find that the psychological effect, but not the economic effect, increases conflict in budget negotiations and hurts performance. Specifically, initial negotiation positions are more distant under one-sided than under common uncertainty, because superiors are more contending when information is asymmetric. As a consequence, negotiation failures are more frequent. Furthermore, when setting budgets following negotiation disagreement, we find that superiors account for the risk of losing the subordinate’s motivation under common uncertainty but not under one-sided uncertainty. Finally, after controlling for financial incentives, subordinates’ negative performance reactions to negotiation disagreement is particularly large under one-sided uncertainty.