How the Budgeting Tail Wags the Corporate Dog
- By
- January 23, 2024
- CBR - Finance
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As fundamental as they are to running a business, corporate budgets can lead to a significant amount of waste, according to Arizona State’s Paul H. Décaire and Denis Sosyura. When managers with a looming year-end budget surplus go on a spending spree before the money disappears, the results tend to be lower sales and weaker margins, the researchers find, drawing on the Nielsen and NielsenIQ data sets at Chicago Booth’s Kilts Center for Marketing.
At big companies, top executives delegate responsibility for day-to-day operating and investment decisions to lower-level managers. To keep spending from going off the rails, they impose a set of simple rules with predetermined limits in round figures and rigid deadlines for completing outlays. At the end of the fiscal year, unspent funds go back into the corporate treasury. But putting budgets on autopilot in this way erodes investment efficiency, limits strategic behavior, and promotes wasteful spending, Décaire and Sosyura find.
The researchers focused on advertising outlays by American companies, which amount to more than the businesses spend on research and development. They analyzed daily Nielsen Ad Intel Data on advertising spending totaling $400 billion across 3.4 million itemized expenditures by 347 publicly traded companies from 2010 through 2019. They compared those data with NielsenIQ Retail Scanner Data, namely consumer purchases of 4.5 million products in 100 billion transactions at grocery and drugstores.
Use it or lose it
Rather than letting an advertising budget go unspent, managers with a surplus tended to raise spending sharply in the month before the end of the fiscal year.
Managers, they find, spent significantly more in the four weeks before budgets were reset, typically at the end of a fiscal year. For managers running a surplus, average expenditures that month spiked 44 percent. For those who had already run through their budgets, spending was slashed.
The spike in spending before budget deadlines was associated with a decline in investment efficiency, generating less than a dollar of sales per a dollar of investment, according to the study. Ad projects that were paid for during that last month with excess funds generated 62 percent less revenue, were 39 percent less efficient, and cost 52 percent more to reach the same number of potential customers, compared with other projects led by the same manager earlier in the same year, the researchers find.
The effects were stronger at companies with more layers between senior executives and mid-level managers and those with a higher ratio of subordinates to executives, they find. They were also stronger at organizations where internal monitoring was lax, perhaps because the CEO was approaching retirement, served on multiple external boards, or owned few shares of the company.
Paul H. Décaire and Denis Sosyura, “On a Spending Spree: The Real Effects of Heuristics in Managerial Budgets,” Working paper, November 2022.
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