When the action of subordinate needs to be confirmed by the superior and may also be reviewed by the superior it is known as?

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Volume 78, October 2019, 101057

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Participative budgeting, where the superior incorporates the subordinate in the budgeting process to capitalize on the subordinate's private information, is common in practice (Libby & Lindsay, 2010). Despite its potential benefits, participative budgeting introduces agency costs due to the divergent incentives of superiors and subordinates. Prior research examines the ability of formal and informal controls to limit these costs given the traditional agency incentives in the superior-subordinate relationship (Brown, Evans, & Moser, 2009). However, this research does not consider contextual aspects pertaining to the hierarchical agency relationship itself, despite the critique that there is more to agency relationships than just the structure of incentives (Indjejikian, 1999). This study examines the effect of a prominent aspect of these relationships – subordinate perceptions of the superior's role legitimacy1 – on misreporting.

Perceptions within the superior-subordinate relationship are relevant in participative budgeting for three primary reasons. First, the presence of, and information asymmetry between, hierarchical levels are antecedent to participative budgeting (Shields & Shields, 1998). While firms may redefine the relationship (Tobak, 2016), a commonality is that this relationship is not between equals (Koeppel, 2003). Second, perceptions of the superior vary across firms and subordinates, even when not aligned with reality (Duttge, 2010). Third, participative budgeting is built on trust, as the superior is vulnerable to subordinates (Douthit, Schwartz, Stevens, & Young, 2019) and perceptions of others are essential in trust-based settings (Hardin, 2002). Thus, we expect perceptions of the superior to have a behavioral impact in participative budgeting.

Specifically, we consider the effect of subordinates' perceptions of the superior's role legitimacy on misreporting. Subordinates' perceptions about how legitimate the superior is in her role can come from many sources, such as the fairness of the process used to place the superior in the role, word-of-mouth, and direct observation (Manzoni & Barsoux, 2009). Business articles, practitioner articles, and popular books all discuss the trials of, and solutions for, dealing with bosses who are perceived as illegitimate or incompetent (e.g., Gallo, 2011; Griswold, 2013; Harvard Business Review, 2016; Hoover, 2011; Manzoni & Barsoux, 2009; Ryan, 2015; Scott, 2005). They argue that perceptions of superior role illegitimacy can harm working relationships, hamper productivity, and cause dysfunction. However, they largely ignore the potential gains from perceptions of superior role legitimacy. These gains are particularly important in participative budgeting as the agency costs that arise from the information asymmetry are assumed to severely limit participative budgeting's benefit to firm profitability, absent a counteracting force. While agency theory assumes that the superior possesses the property rights associated with production assets, including the rights to profits from these assets (Eisenhardt, 1989; Hart, 1995; Segal & Whinston, 2012), these rights are not fully enforceable absent complete contracts. In this study, we develop theory based on social norms that predicts that perceptions of a superior's role legitimacy can increase adherence to property rights norms and decrease slack.

Economics research finds that individuals weigh property rights in deciding how much to cede to another party when bargaining (Hoffman, McCabe, Shachat, & Smith, 1994; Hoffman & Spitzer, 1985). However, these studies consider peer bargaining over known endowments, rather than a veiled production surplus with unequal parties. Given the important differences caused by a hierarchical agency setting with information asymmetry, we incorporate research on norm activation (Bicchieri, 2006) and authority from property rights (Easton, 1958; Tyler, 1990) in our theory. We predict that perceptions of role legitimacy are an important determinant of budgetary slack in a hierarchical agency setting. Specifically, perceptions of superior role legitimacy increase subordinate concerns for a property rights norm, in lieu of self-interest, and decrease slack. This norm-based theory also suggests a focus on establishing role legitimacy, representing a shift in focus from the peer bargaining research in economics and the prevailing practitioner literature that focuses almost exclusively on avoiding role illegitimacy.

We test our theory using a participative budgeting experiment based on Evans, Hannan, Krishnan, and Moser (2001) in which a superior funds a project overseen by a subordinate. Subordinates report a cost budget to the superior and the superior funds the subordinate based on the reported budget. The superior gets the profit above the reported cost and the subordinate retains any slack (reported less actual cost). We manipulate role legitimacy by manipulating the method of assigning participants to their roles. Prior to role assignment, participants perform a real-effort task. In the Legitimate (Illegitimate) treatment, performance outcomes in the top (bottom) half of a session lead to a superior role and outcomes in the bottom (top) half lead to a subordinate role. In the Legitimate (Illegitimate) treatment, the role assignment supports (violates) the hierarchical nature of the agency relationship and its implicit property rights norm, which in turn supports (violates) the superior's claim to profits. Finally, we conduct a treatment with Random role assignment to serve as a neutral benchmark.

Results support our theory. Slack is lower with Legitimate roles than with Illegitimate roles. Further, Legitimate roles decrease slack compared to the benchmark (Random) treatment. These results suggest that role legitimacy is an important behavioral determinant of slack. However, inconsistent with concerns raised about the negative effects of role illegitimacy in practitioner literature (e.g., Manzoni & Barsoux, 2009) and peer bargaining economics results (e.g., Cherry, Frykblom, & Shogren, 2002; Oxoby & Spraggon, 2008), we do not observe a statistically significant difference in slack between Illegitimate and Random roles.

The method of role assignment is one aspect of role legitimacy and other aspects of the experimental setting could affect perceived role legitimacy and misreporting. Thus, we conduct two supplemental experiments to examine if our results are sensitive to 1) the use of contextualized role and task descriptions and 2) the relative payoffs (i.e., a setting where the superior is guaranteed at least as much as the subordinate). The results of these experiments generally suggest that Legitimate roles reduce slack, supporting that role legitimacy is an important behavioral control in hierarchical agency settings. However, we still fail to document a statistically significant difference in slack between Illegitimate and Random roles in either experiment or in analyzing the data from all three experiments at once. As discussed in Section 5, the shortcomings to these alternative designs harm theory testing and vindicates prior research's reliance on similar parameters with contextualized descriptions.

The contextual descriptions and parameters of our main experiment mirror the extant experimental research in participative budgeting (e.g., Church, Hannan, & Kuang, 2012; Evans et al., 2001; Rankin, Schwartz, & Young, 2008), whereas our additional conditions reflect adaptations to the basic design. As such, our results have methodological implications. Our results suggest that Random roles violate a behaviorally important assumption of the agency setting (that the superior is a claimant to profits). We provide a simple method to support perceptions of superiors’ rights to profits without losing randomization.

Our results also add to our understanding of the determinants of budgetary misreporting. Firms benefit from reducing managerial misreporting. We find that perceptions of the superior as a rightful claimant of profits, from role legitimacy, reduce slack. Firms can observe perceptions of a superior's role legitimacy by monitoring sentiments towards the superior via surveys and employee reviews. Our results suggest firms may gain from increased use of such surveys, as well as 360 evaluations and exit interviews. Understanding these perceptions can allow firms to increase efficiency by better matching their control system with their culture of legitimacy. Firms would be wise to also focus on the benefits from increased perceptions of role legitimacy, as role legitimacy is a basis for property rights norms that are less likely to exist under neutral perceptions and that reduce budgetary slack.

We also contribute to agency theory. In agency settings, a superior contracts with a subordinate to act on behalf of the superior who is the claimant of any surplus (Sprinkle & Williamson, 2007). As in prior studies, we capture the monetary incentives of the agency setting. However, our results bolster claims that agency relationships are more than just the structure of payoffs (Indjejikian, 1999). We find that perceptions of the superior as a rightful claimant are important for a behavioral understanding of the agency setting. This supports the incorporation of behavioral aspects into agency models (e.g., Stevens & Thevaranjan, 2010). We introduce evidence that property rights norms can reduce agency costs in hierarchical agency settings.

Our result that property rights norms, from role legitimacy, affect behavior is novel compared to research on property rights in peer bargaining and highlights the importance of our examination of property rights in a hierarchical agency setting. The dependent variables of these peer bargaining studies focus exclusively on fairness, whereas honesty is a major factor in budgetary reporting (Blay, Douthit, & Fulmer, 2019; Douthit & Stevens, 2015; Rankin et al., 2008). It is not obvious that fairness-based results directly transfer into ethical settings (Hoffman & Spitzer, 1985, p. 262), especially as fairness and honesty norms can interact (Douthit & Stevens, 2015). The importance of social norms in participative budgeting leads to our theory and predictions about role legitimacy. Failure to observe a robust result for role illegitimacy in line with the peer bargaining research is likely due to our setting's ethical concerns (honesty) and the hierarchical agency relationship implied by our setting's context and payoff structure. Neither party creates the surplus in our setting, as in Oxoby and Spraggon (2008). Instead, we test if role legitimacy supports one role's implicit property rights. Oxoby and Spraggon find results that suggest role legitimacy reduces slack. However, their result may be a function of the receiver (superior) earning a bigger endowment to be split, which is starkly distinct from earning a role that is vulnerable to the self-interest of the other party. Thus, our results extend the importance of property rights into agency settings and provide a caveat to the results on peer bargaining.

A hierarchical relationship with information asymmetry is an antecedent of participative budgeting (Shields & Shields, 1998). Subordinates in decentralized firms are closer to operations and have better information about costs than do superiors. Thus, superiors may elect to use the subordinate's input when setting budgets. Agency theory provides a framework for examining the conflicts from information asymmetry and divergent goals in hierarchies that arise when subordinates are involved in the

Our experiment entails a real-effort task followed by a participative budgeting task. The budgeting task is adapted from prior research (e.g., Evans et al., 2001; Rankin et al., 2008) and the agency model in Antle and Eppen (1985). Participants take the role of either a subordinate (“manager”) or superior (“owner”). The superior funds a project and is the residual claimant of profits. The subordinate provides a budget to the superior for the project's costs. It is common knowledge that the

Participants answered PEQ items on a 7-point Likert as comprehension and manipulation checks. Responses are compared to the neutral response of 4. Participants correctly identified that they were re-matched each period, subordinates could report any cost, superiors never knew the actual cost, subordinates always received a salary, if their role was based on performance, and if their role was based on high performance.11

Our main experiment uses the parameters and role/task descriptions typical in the extant participative budgeting literature. Contrary to the common concern in the practitioner literature regarding the dysfunction of role illegitimacy, our results do not document a significant increase in slack from role illegitimacy but do show some potential efficiency gains from role legitimacy, compared to a neutral baseline. This suggests that the extant participative budgeting research may often fail to

Our theory and results suggest that the negative effects of role illegitimacy, which prior literature laments, is at best incomplete. Our study suggests that there is also damage caused by the absence of role legitimacy or, said differently, role legitimacy has positive effects for the firm. Our theory of property rights norms suggests that role legitimacy counteracts subordinate self-interest. Our results extend property rights theory by considering its effect in hierarchical agency settings

Available upon request from the authors.

The authors are grateful to Amanda Beck, Mandy Cheng, Willie Choi, Jace Garrett, Lynn Hannan, Glenn Harrison, Ranjani Krishnan (editor), Marlys Lipe, Michael Paz, Bernd Reichert, Casey Rowe, Karl Schuhmacher, Matthew Sooy, Bill Tayler, Todd Thornock, Kristy Towry, Huaxiang Yin, participants at the 2015 Global Management Accounting Research Symposium, the 2015 AAA Annual Meeting, the 2015 ABO Midyear Meeting, the 2016 MAS Midyear Meeting, University of Arizona, and two anonymous reviewers for

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