LITERATURE REVIEW
2.5 Organizational Theory Perspectives on Budgets
Most modern organizations have budgets. In this section we will explain the pervasiveness of budgeting from four theoretical perspectives: institutional, resource dependency, transaction-cost, and Marxist.
2.5.1 Institutional Perspectives on Budgets
For over two decades a set of management techniques and practices, mostly associated with market and private-for-profit sectors, have been used to reform administration and management in government in a variety of countries. According to institutional isomorphism (Powell, 1983), budgeting is 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. The past decade has seen the application of some of these practices in some developing and transitional economies. The organizational reform trends have been driven by a combination of factors, not one of which can be said to be responsible for driving reforms on its own.
As budgeting became a lot more fashionable, there has been powerful pressure to adopt budgets. Stockholders who demand sound money management might expect yearly budgets for key activities. Philanthropic organizations can scrutinize the budgets
of charitable organizations to confirm future contributions as units spent, showing wisdom. Workers expect formal budgets to stay assured that money is out there for salaries and vital concerns.
Finally, government accountants and finance managers employed by government agencies bring normative pressures to adopt standardized budget practices.
Budgeting may be a logical extension of credit-debit accounting principles. Budgets have conjointly become a "rational myth" for contemporary organizations (Rowan, 1977). Budgets necessary for legitimacy are de-coupled from daily operations. Cash is also transferred from one budget class to a different one to hide over-spending.
Typically there is very little pressure to keep up budgeted payment levels once they’ve been developed. Uncle Sam's store may be an excellent example of budgets as a yearly ceremony.
2.5.2 Resource Dependency Perspective on Budgets
Government budgets are pervasive in public organizations because they help clarify internal resource dependencies. Often the hierarchy of budgets reveals 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 central and local government.
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 any given level is often a zero-sum game where politics and influence are most evident. Budgets are also useful control mechanisms because they are more flexible than contracts. Unlike contracts, you can quickly change a budget to affect a sub-group's activity. From a resource-based view, the transformation of a public organization can be viewed as follows:
1) Economic and fiscal pressure on government, which was experienced in most developed countries in the 70s and early 80s, occurred more fiercely in developing countries in Africa and Asia, and more recently, in the Asian “Tiger”
economies. The causes of fiscal stress are massive public-sector deficits, external trade imbalances and growing indebtedness, especially in developing countries where there was a major driver for restructuring the public sector, rethinking together with a reshaping of the government’s role. Issues of downsizing, privatization and contracting out gained prominence as methods of controlling fiscal deficits and restructuring the public sector.
2) On the aspect of public attitudes, criticisms increased (especially by public choice theorists) over the ineffectiveness and inefficiency of delivering public services through bureaucratic agency arrangements, together with the realization of the need to search for alternatives. The old public administration was seen as too slow, driven by rules instead of performance, inefficient and unresponsive to users.
3) The resurgence of new right politics in the late 70s and 80s that were pro-market and pro-private sector, such as NPM, had ideological underpinnings, challenging the post-war consensus on a welfare state that was unsustainable.
4) A proliferation of management ideas was generated, packaged and marketed by international management consultants, who often acted as advisers on the reformation of governments around the world.
5) In the case of most developing and transitional countries, an additional factor driving NPM-type reforms has been donor advocacy and lending conditions of international financial institutions, notably the IMF and the World Bank, with the adoption of a more pro-market and pro-private sector with a stance on structural adjustment programs.
6) The spread of global markets, especially those that are related to financial integration and liberalization and the resultant competition, are forcing the public sector in most countries to reshape themselves to keep pace with the emerging global economy and modern information technology. These are changing conventional ideas concerning the public sector.
7) The growth and use of new information technology has also provided impetus for some of the changes. Some aspects of the NPM reforms, such as performance management, executive agencies and management decentralization of public services, have been facilitated by the development of information technology that allows for indirect monitoring and control of performance.
Several theories have provided the theoretical underpinnings of NPM and have helped shape NPM ideas. Public choice and principal-agent theories are the two most prominent theories.
2.5.3 Stake Holders’ Theory
The definition of Stake Holders’ Theory (Clarkson, 1994) states that a firm could be a system of stake holders in operation at intervals. The massive system of the host society gives the mandatory legal and market infrastructure needed for companies’
activities. The aim of the firm is to make wealth or price for its stake holders by changing their stakes into smart services, as supported by Blair (1995, p. 322), who proposed that the products’ administrators and management ought to be increasing total wealth creation by the firm, this is the key to adhering to and reinforcing their voices.
Consistent budgeting to supply funds is significant to important stockholders.
Porter (1992, pp. 16-17) suggested to North American manufacturers that they ought to encourage board illustrations. Porter (1992) conjointly suggested that corporations get future house owners and offer them an instantaneous voice in governance.
All these recommendations could help to establish business alliances, trade related networks and strategic associations. Hollingsworth and (Lindberg, 1985) noted that they had not evolved as much in the United States as they had in continental Europe and Japan. In other words, Porter is suggesting that competitiveness can be improved by using all four instrumental modes for governing transactions rather than just markets and hierarchy. This supports the need to expand the theory of the firm, as suggested by (Turnbull, 1994).
In large enterprises a high degree of detailed budget planning is considered an important influence. Drilling overall budget problems down to the lowest hierarchical level requiress detailed analysis and consumes large quantities of human and monetary resources, moreover, wasteful resource consumption occurs every time negotiating partners loop through the planning cycle until they finally approve the annual operating budget. Large firms usually commit 75 to 95 percent of their total controlling capacity to operational planning during the time they are engaged in budget preparations (Kopp
& Leyk, 2004). Unfortunately, top management seldom considers the high cost involved, relative to the manager’s benefit derived from such detailed instruments. It is
no wonder, then, that cost, product and strategic control often gets little attention in the process.
2.5.4 Principal-agent Theory
Principal-agent Theory argues that the public (as principals), on whose behalf politicians and bureaucrats (as agents) are supposed to govern, is unable to hold the latter accountable because of insufficient information (information asymmetry), incompleteness of the contracts of employment, and the problems of monitoring behavior (Walsh, 1995; Lane, 1995). The public sector underperforms because state officials pursue their own narrow self-interests rather than the public interest. It is difficult to extract accountability and good performance from public servants (agents) because of the monopoly characteristics of public services, imperfect information about the services, the abilities and interests of public employees, and the huge transaction costs that would be involved in efforts to write and monitor complete contracts. One solution to the problem of the public sector is to expose public services to greater competition.
The result of the above drivers for change is that the role and institutional character of the state has been under increasing pressure to be more market-oriented and management-oriented, with emphasis on ‘doing more with less.’ The traditional model of agencies and delivery of public services, based on the principles of bureaucratic hierarchy, planning, centralization, direct control and self- sufficiency, is being replaced by a ‘new public management’ (NPM) model.
2.5.5 Agency Budgeting
Incrementalism literature focuses on the relationship between core budgetary institutions, spending agencies, Ministries of Finance and the legislature, by largely ignoring what goes on inside spending agencies during the budget process. When behavioral studies are undertaken in the private sector, they can provide some insight into this aspect of budgeting. One of the key issues that they explore is the degree of centralization with responsibility for budgeting and its implications for budgetary outcomes and performance. Chandra (1999) distinguishes four agency approaches to budgeting that involve authoritative budgeting. Authoritative budgeting centralizes
responsibility of budgeting in the hands of a senior manager who imposes final departmental allocations with consultative budgeting in which budget allocations are discussed with department staff; the decisions, on the other hand, are made by senior managers. Participatory budgeting, in which agency budgets are defined bottom-up on the basis of departmental budgets and negotiated budgets, performs the preparation of departmental budgets on the basis of limits agreed to by both departmental and senior managers.
There is an argument that more participatory methods improve staff motivation, whereas authoritative approaches, although effective in cutting costs, tend to provoke conflict and may undermine performance. This is partly because less participatory forms of budgeting tend to underestimate the resources needed to fulfil the department’s functions or meet its targets (Nouri & Parker, 1998). Senior managers and budget departments are poorly informed regarding the resources required to deliver a given level of services and, besides, will tend to underestimate budgetary requirements of subordinate institutions systematically as a means of achieving cost reduction goals.
Inevitably, this decreases efficiency.
In the public sector, particularly in developing countries, authoritative approaches to budgeting have tended to predominate as departmental budgets are often prepared and managed by a centralized finance and administrative department covering the whole agency. In some cases, managers may not even know the resources that are available, they merely submit requisitions that are either approved or rejected. In recent years, many countries have sought to improve motivation and efficiency by decentralizing responsibility for budgetary management with government agencies down to the field delivery units. Results have usually been positive, although in some cases, the scope for managers to realize these benefits have been limited by the persistence of centralized controls on recruitment and procurement of supplies
2.5.6 Public Expenditure Management (PEM)
The meaning and role of public expenditure management to perform the roles assigned to it by its people and the government needs, among other things, to:
1) Collect resources from the economy, in a sufficient and appropriate manner; and
2) Allocate and use those resources responsively, efficiently and effectively. The national budget is the main instrument through which these transactions are planned and carried out. Public expenditure management (PEM) pertains only to items.
Public expenditure management (PEM) is instrumental in nature. There is an important distinction between the expenditure policy question of “what” is to be done, and the expenditure management question of “how” it is to be done. It is true that attempts to set overly rigid boundaries between policy and implementation tend to lead eventually to unrealistic policies, ad hoc implementation and, over time, both bad policy and bad implementation. However, the distinction between the soundness of PEM procedures and processes and the goals that they are meant to achieve remains very important. Among other things, the mechanisms, techniques, skills, and data required for good PEM are different from those needed to formulate good policy. The analysis and discussion herein is generally applicable regardless of the strategic priorities and policy choices of the government in question.
The general agreement is that budget and public financial management reforms are designed to accomplish one (or more) of three basic goals or outcomes, which are these following subjects:
1) Establishing aggregate fiscal discipline;
2) Enhancing the efficiency of resource allocations; and
3) Improving operational efficiency in the use of budgeted resources.
These goals are often presented as PEM progress levels, and often inform the sequencing of budget and PEM reform programs. In reality, experience shows that there is no critical sequence of reforms between these three PEM goals. The real issue with reform sequencing is not about which level to pursue first, but about paying adequate attention to getting the basics right.