The Behavioral Effect of Cost Targets on Managerial Cost Reporting Honesty
This study investigates whether firm communication of non-contractual targets motivates managers to report their private information more honestly and, thus, improves the firm’s well-being. Specifically, I investigate how the level of a specific cost target affects reporting honesty. Drawing on economic and psychology theory, I predict there is an inverted-U relationship between the level of the specific cost target and managerial honesty. I conduct an experiment in which specific cost targets are manipulated at four levels (none, low, moderate, and high). Results support the predicted relationship because participants’ report more honestly overall when they are provided moderate cost targets. Further, honesty is the same regardless of whether the firm provides no specific target, a low target, or a high target. Thus, while moderate cost targets improve the firm’s well-being; the firm is never worse off providing a specific, non-contractual cost target to its managers. These findings suggest firms should not hesitate to communicate their specific cost preferences to their managers. The results of this study have implications for the design and use of management control systems by providing insights on how firms can increase managerial reporting honesty without incurring the costs associated with more formal mechanisms.