When Opportunism Mitigates Over-Expectations - Budgeting Biases and Profit Expectations


We examine how biases in the information provided by lower-level employees affect the forecasts of senior management of their firm’s future performance. Our findings imply that senior management does not adjust for systematic distortions in employee-generated data in budgets. Using a unique and proprietary data set of senior managements' non-public profit expectations from 2013 to 2019, we find an increase of importance in budget-based performance evaluation for lower-level employees by one standard deviation is associated with underestimating future profit by 21.8%. Interestingly, this downward bias partially corrects for the otherwise, on average, too high profit expectations. We find only partial support for the association of resource allocation with overestimating future profits. We also show that senior managements' expectation bias has economic consequences- a one percent increase in absolute expectation bias reduces firms' efficiency in labor and asset allocation by 0.6 and 1.7 basis points, respectively.

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Felix Fritsch
Felix Fritsch
Assistant Professor in Accounting & Taxation

I am an Assistant Professor at the University of Mannheim, Business School specializing in data science and empirical accounting research.