Budgeting Biases and Profit Expectations

Abstract

We examine whether the use of budgetary information for performance evaluation and resource allocation is associated with systematic biases in the forecasts of senior executives of their firm’s future performance. Using a unique and proprietary data set of senior executives’ non-public profit expectations from 2013 to 2019, we find that an increase of importance in budget-based performance evaluation for subordinates is associated with underestimating future profit. This indicates that senior executives do not fully adjust for distortions in employee-generated information to budgets. Our results also suggest that this downward bias in budgets partially corrects for the otherwise, on average, too high profit expectations. We find partial support for the association of resource allocation with overestimating future profits.