The Effect of Budget Culture on Target Ratcheting: An Empirical Research Based on Management Forecasts

Abstract

Managers often use current budget variances when setting subordinates' subsequent budgetary targets. However, this type of target setting practice generates “ratchet effect” problems. In order to mitigate the ratchet effect, managers intentionally conduct “commitment”: they increase achievability of subordinates' targets by making them less challenging. The purpose of this study is to examine the impact of the firm-specific factors on commitment. Based on the argument of “budget culture” and its four constructs: budget firmness, target difficulty, management attention, and reward link, we use them as firm-specific factors and empirically investigate their effect on commitment. Our findings indicate that the three constructs other than “reward link” affect commitment, suggesting that the managers deal with the ratchet effect by setting subordinates' targets in consideration of characteristics of budgetary culture.