Flattening the Organization: The Effect of Organizational Reporting Structure on Budgeting Effectiveness

Abstract

This study investigates whether increasing a superior's span of control reduces the effectiveness of capital budgeting in eliciting truthful reports. We conduct an experiment based on a modification of the capital budgeting setting described by Antle and Eppen (1985). This modification incorporates the notion that the superior's utility for wealth increases at a decreasing rate, as well as the recent empirical evidence that individuals have utility for enforcing social norms. Specifically, we assume the superior is willing to incur a cost in order to punish a subordinate who she believes is incorporating excess slack in his budget, thereby violating a social norm. These theoretical refinements lead to the prediction that as the span of control increases, superiors will be more willing to reject project proposals with high budgeted costs. We further predict that subordinates under an expanded span of control will anticipate the superiors' increased "toughness," and will respond by reducing their budgetary slack. We conduct an experiment to test these predictions. The experimental results are consistent with our theory. That is, as the span of control is increased, superiors show a greater willingness to reject projects for which they believe slack is excessive, and subordinates respond by reducing slack. The net result of these two effects is that as the span of control is increased, superiors earn more profit per subordinate. Thus, our study suggests that increasing the span of control can improve the effectiveness of the budgeting process, which is an important component of most firms' control environments. Although prior research has generally assumed that increasing the span of control weakens the control environment, our study demonstrates that increasing the span of control can actually strengthen it.

JEL Classification: M40, M46, G31, G34, L23