Budgetary Participation and Management Earnings Forecasts

This study examines whether and how budgetary participation practices affect top managers’ earnings forecasts. Previous research indicates that subordinate managers participating in the budgetary process may try to “play games” and underestimate budgeted revenues or overestimate budgeted costs to make budgeted targets easier to achieve, misleading top managers about the company’s true profit potential. In this study, we use management earnings forecasts released by top managers as a proxy variable for top managers’ future earnings estimation and test our research model empirically using data collected through a mail questionnaire survey and archival data of Japanese listed firms. We find that budget participation is positively associated with management forecast pessimism and that the positive association between budget participation and management forecast pessimism is stronger for firms in which the pay-performance sensitivity of subordinate managers is higher. These results suggest that budget participation practices introduce biases in top managers’ estimation of future performance