The Effect of Endogenous Contract Selection on Budgetary Slack: An Experimental Examination of Trust, Distrust, and Trustworthiness

47 Pages Posted: 7 Mar 2016 Last revised: 6 Apr 2017

See all articles by Jeremy Douthit

Jeremy Douthit

University of Arizona - Dhaliwal-Reidy School of Accountancy

Steven T. Schwartz

SUNY at Binghamton - School of Management

Douglas E. Stevens

Georgia State University - Robinson College of Business

Richard A. Young

Ohio State University (OSU) - Department of Accounting & Management Information Systems

Date Written: January 10, 2017

Abstract

We examine the effect of endogenous contract selection on budgetary slack using two slack-inducing contracts found in the literature: a trust contract where the superior must accept the subordinate’s budget and a discretion contract where the superior can accept or reject the budget. Because neither contract incorporates a formal control for budgetary slack, we apply insights from both agency theory and social norm theory to develop our theoretical expectations. We hypothesize and find that budgetary slack is lower for both contracts when they are endogenously selected by the superior than when they are exogenously assigned. Consistent with our theoretical expectations, exit questionnaire responses suggest that selecting a trust contract signals trust and expectations of trustworthiness whereas selecting a discretion contract signals distrust and an increased willingness to enforce trustworthiness by rejecting unreasonable budgets. Signaling distrust, however, appears optimal for superiors in our budgeting setting. In particular, far more superiors select the discretion contract under endogenous contract selection and doing so yields the efficiency of the optimal hurdle contract prescribed under traditional agency assumptions.

Keywords: endogenous contract selection, trust, distrust, trustworthiness

JEL Classification: C91, D83, M40

Suggested Citation

Douthit, Jeremy and Schwartz, Steven T. and Stevens, Douglas E. and Young, Richard A., The Effect of Endogenous Contract Selection on Budgetary Slack: An Experimental Examination of Trust, Distrust, and Trustworthiness (January 10, 2017). Available at SSRN: https://ssrn.com/abstract=2742353 or http://dx.doi.org/10.2139/ssrn.2742353

Jeremy Douthit

University of Arizona - Dhaliwal-Reidy School of Accountancy ( email )

Tucson, AZ 85721
United States

Steven T. Schwartz

SUNY at Binghamton - School of Management ( email )

Binghamton, NY 13902-6015
United States
607-777-2102 (Phone)

Douglas E. Stevens (Contact Author)

Georgia State University - Robinson College of Business ( email )

P.O. Box 4050
Atlanta, GA 30303-3083
United States
404-413-7212 (Phone)
404-413-7203 (Fax)

HOME PAGE: http://robinson.gsu.edu/profile/douglas-e-stevens/

Richard A. Young

Ohio State University (OSU) - Department of Accounting & Management Information Systems ( email )

2100 Neil Avenue
Columbus, OH 43210
United States
614-292-0889 (Phone)
614-292-2118 (Fax)

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