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Strategic Reputation Building and Norm Enforcement: An Experimental Study in a Capital Budgeting Setting

This experimental study investigates the effects of the superiors’ and the subordinates’ abilities to build reputations on ex post controls in capital budgeting. Investigating reputational aspects is particularly important in the context of capital budgeting as there is strong evidence that norms and norm enforcement affect superior and subordinate behavior in this setting. This means that both the willingness to conduct ex post controls and the control intensity might crucially depend on the reputation building abilities of superiors and subordinates. In particular, both the subordinate reputation as a “norm violating subordinate” as well as the intention to strategically build a reputation as a “norm enforcing superior” to prevent future slack creation might be strong triggers of ex post controls. However, there is no or little evidence so far that superiors or subordinates (successfully) build reputations in capital budgeting and that counterparts react to these reputations. This is surprising given the high relevance of norm enforcement and its potential interaction with reputations as well as the high importance of reputation as an (auxiliary) control mechanism in many other settings. The findings of our experimental study indicate that both the superiors’ control willingness and their control intensity depend on the superiors’ and the subordinates’ abilities to build reputations. The results show that both the non-monetary motive of norm enforcement as well as the monetary motivation of self-interested superiors to build reputations as norm enforcing superiors strongly influence decisions to conduct ex post control. Moreover, we find that ex post controls like internal audits are particularly useful in disciplining slack creation when reputational mechanisms are relevant. This contributes to the literature in several important ways: First, we add to the evidence on the role of reputations in capital budgeting and contribute to solve conflicting evidence as to the importance of reputations in capital budgeting. Second, our results contribute to explain how different superior motivations to conduct controls affect their control willingness and the control intensity which contributes to explain the way controls are conducted. Finally, our findings add to the growing literature on the effects of socially-mediated controls and norm enforcing motives in management control processes. Our results imply that reputational considerations may represent an important (auxiliary) control mechanism for capital budgeting.