The Revelation Principle in Budget Setting Kentville Orchards grows and sells a wide variety of fruits. Norm Wilson, the vice president-

controller of Kentville Orchards, is responsible for all aspects of budgeting and forecasting in the firm. Norm has become both disillusioned and dissatisfied with the traditional approach that Kentville Orchards has taken to budgeting. Norm summarized his concerns as follows:

The traditional approach, where we set budget objectives and then evaluate performance relative to those objectives, is not working well. First, the budget is focusing attention on the wrong things. The managers are interested in making shortrun profit as large as possible and are not doing things to improve long-run profitability. Second, I do not think that the model of evaluating performance based on profits has the scope to evaluate the jobs that the managers are doing. Their jobs are much more complicated than a simple profit measure implies, and we need a more accurate picture of how well they are doing. Finally, the existing system is motivating the managers to build slack into both their standards and performance targets so that they can make budget and earn bonuses. As a result, our forecasting system is unable to predict either sales levels_ or input usage accurately.

Norm went on to indicate that he was considering recommending to the senior management committee at Kentville Orchards that the current budgeting system be replaced with a new system using participative budgeting techniques. Specifically, the new system would require that the objectives for each management job in the organization be defined relative to the organization's strategic goals by negotiations between the job's incumbent and the incumbent's supervisor. From these general objectives, specific performance objectives would be set for each job each year through negotiations between the incumbent and the incumbent's supervisor. The objectives would be multidimensional and would include performance objectives for all attributes of the job that are considered important.

The annual evaluation would reflect two dimensions of performance appraisal.

First, the incumbent would be evaluated for innovation in developing ways of carrying out assigned responsibilities. Second, the incumbent's performance would be evaluated relative to the targets that were negotiated with the supervisor. Norm summarized his feelings as follows:

The only thing that is holding me back is that I do not think that the proposed changes go far enough. The proposed system deals with the problem of inadequate performance measurement but still provides managers with incentives to understate their potential, since their performance will be evaluated relative to the targets that each manager negotiates with his supervisor. Moreover, the planned system, like the old system, still has the aspect of checking up on people rather than relying on them to do their jobs. Perhaps we should go even further and implement the proposed system but evaluate managers only on their ability to be innovative in undertaking the tasks that they have been assigned. If they are not evaluated relative to the-targets that they set jointly with their supervisors, they will be motivated not to understate their potential. The bottom line is that I think that we should get rid of the concept of standards altogether, irrespective of who sets the standards. As a result of eliminating the concept of standards, the budget will serve to communicate and coordinate rather than be a threat and a means of checking up on the managers.

Required Evaluate the initial proposal for the revision of the budgeting system as well as the proposal that would eliminate the use of standards.