In What Ways Can the Budgeting Process Create Incentives for Unethical Behavior?

A successful budget is one supported by the management team and perceived by all employees as a tool for meeting goals, not as a pressure device. While there’s no denying that an annual budget is critical to meeting long-term financial goals, policies and procedures that create pressure can incentivize unethical behaviors, such as changing or concealing important information, padding and end-of-year spending that decrease its effectiveness.

For many businesses, the budgeting process involves managers from every department. Although participative budgeting gives department heads a voice in developing the budget, the emphasis is on meeting broad objectives, not individual department needs or goals. Collaborative cooperation, which often involves sacrifices or cutbacks in some departments to provide more money for other departments, can become an incentive to inflate an initial budget request. In general, the objective is to get the budget allocation the department really requires.

Business rules that evaluate managerial performance mainly on how well a department functions within its annual budget can lead to unethical behaviors. The issue often relates to sacrificing long-terms goals to meet short-term performance objectives. For example, a production manager might decide to substitute lower-quality – and lower-cost – materials to stay within the budget, cut some employees' weekly work hours or delay preventive maintenance. While these actions might improve short-term budget performance, each can also have negative long-term effects.

Using overly optimistic forecasts or broad industry statistics to create a business budget not only can result in errors and inaccuracies but also can create pressures that lead to unethical behaviors in both managers and employees. This can be especially troublesome if upper-level management expectations to achieve forecast earnings increase pressures. Potential behaviors might include cutting corners, taking shortcuts, falsifying documentation, such as by hiding losses, and relaxing safety compliance guidelines.

An inflexible budgeting process that has a definite start-and-stop point can lead to unethical behaviors that occur regularly at the end of each fiscal year. Most often, a “use it or lose it” philosophy or an expectation that a surplus in one year will result in a lower allocation the next year leads to end-of-year spending. Regardless of whether this spending reflects true business needs, it most often does not reflect what is in the budget.