Organizational Theory Perspectives on Budgets (exam question by Keith Rollag)
Most modern organizations have budgets. In this paper I will explain the pervasiveness of budgeting from four theoretical perspectives -- institutional, resource dependency, transaction-cost, and Marxist.
Institutional Perspectives on Budgets
According to institutional isomorphism (Dimaggio & Powell, 1983), budgeting diffused via three mechanisms. Under mimetic diffusion, organizations adopt budgets because they observe that other groups become more financially confident and successful with a systematic budgeting process.
As budgeting became more popular, there were coercive pressures to adopt budgets. Stockholders who demand sound financial management may expect yearly budgets for key activities. Philanthropic organizations will scrutinize budgets of charitable organizations to ensure future contributions are spent wisely. Employees expect formal budgets to remain confident that money is available for salaries and important projects.
Finally, accountants and financial managers hired by firms bring normative pressures to adopt standardized budget practices. Budgeting is a logical extension of credit-debit accounting principles and is taught in every business school.
Budgets have also become a "rational myth" for modern organizations. According to Meyer & Rowan, the adoption of these myths is often ceremonial (Meyer & Rowan, 1977). Budgets necessary for legitimacy can be de-coupled from daily operations. Money may be transferred from one budget category to another to cover over-spending. Often there are little pressures to maintain budgeted spending levels once it has been developed. Uncle Sam's Bakery is a perfect example of budgets as yearly ceremony.
Resource Dependency Perspective on Budgets
Budgets are pervasive in organizations because they help clarify internal resource dependencies. Often the hierarchy of budgets reveal organizational priorities and dependencies better than formal organizational charts. The approved budget can also represent a "rationalized" statement of purpose for the coming year understood by both employees and outsiders.
More importantly, budgets are important tools of power (Pfeffer, 1992). Since departments are usually dependent on budgets for general operations, those who control budgeting control resources. Budget planners and approvers can exploit these asymmetric dependencies to accumulate power. External groups can also exert internal influence by reviewing and/or approving yearly budgets. The budget planning process at a given level is often a zero-sum game where politics and influence is most evident.
Budgets are also useful control mechanisms because there are more flexible than contracts. Unlike contracts, you can quickly change a budget to affect a sub-group's activity.
Transaction-Cost Perspective on Budgets
From a transaction-cost perspective (Williamson, 1975), budgets are ubiquitous because they help regulate the internal market. A good budget can lower internal transaction costs by minimizing uncertainties, hindering opportunism, and mediating internal disputes.
Organizational involvement in budget preparation can help clarify future transactions between sub-groups. For example, defining advertising budgets for each product line helps the marketing department plan activities more efficiently. Carefully scrutinized budgets and spending limits can reduce the potential of opportunism. Budgets can also be used to mediate disputes between organizational members by defining the priorities and boundaries of organizational action.
As also stated in the resource dependency perspective, budgets are not contracts. They offer the normative advantages of external contracts with the flexibility of future modification.
Critical Marxist Perspective on Budgets
From a Marxist perspective, budgets are an insidious tool used by capitalists to rationally justify the subjugation of the working class. Budget limits are prepared after guaranteeing profits and surplus value for company owners. Management then uses a budget to mask this embezzlement and build consent and compliance from labor. Yearly budgets are management experiments to help capitalists set labor wages as low as possible without instilling labor unrest.
Management involvement in budget preparation also diffuses responsibility
for capitalistic action. Managers can lay off workers and absolve responsibility
by "blaming it on the budget". Once again, budgets are not contracts,
and can also be changed whenever profits are threatened. Finally, budgets
exploit the "tyranny of numbers", hiding the domination of labor
in statistics and graphs.