On the Optimality of Participatory Budgeting

This paper complements the ongoing empirical discussion surrounding participative budgeting by comparing its economic merits relative to a top-down budgeting alternative. We analyze a screening model of participative budgeting where the subordinate uses the budgeting mechanism to relay private information to his superior, in addition to a signaling model of top-down budgeting where the superior similarly relays private information to the subordinate. In the presence of sufficient ex-ante environmental uncertainty, private interim information availability or both, we find that participative budgeting dominates the more centralized, top-down budgeting counterpart. Contrary to common belief, we find that the agency costs associated with participative budgeting largely persist under top-down budgeting. Consequently, the superior’s payoff peaks at boundary levels of informational asymmetry whereas the subordinate’s payoff displays unimodality over information asymmetry, regardless of the budgeting mechanism in use. Lastly, we provide empirical interpretations of our results relating the firm’s choice of budgeting mechanism to budget-emphasis, budgetary slack and incentive strength.