Capital rationing, competition, and misrepresentation in budget forecasts

In this study, we ask: how does the intensity of internal competition for resources affect the communication of private information in an organization? Although competition between different divisions or units for resources is pervasive in many organizations, much of the accounting literature examines non-competitive resource allocation and thus does not provide guidance on this point. To address this question, we conduct an experiment in which a principal allocates capital among three agents, who can each propose a single project. In the high (medium, low) competition condition, principals have sufficient funds to accept only one (only two, all three) projects. We test three competing predictions based on prior literature: (1) Agents will make maximum credible misrepresentations under both medium and high competition, in order to maximize their chance of receiving capital. (2) Agents will weigh the disutility of misrepresentation against the expected utility of receiving project funding, resulting in more misrepresentation at medium than at high levels of competition, because the probability of receiving funding is lower in high competition. (3) Misrepresentation will be highest in high competition, because agents will interpret the high-competition setting as one in which misrepresentation is most necessary to win funding and most socially appropriate. Consistent with the second prediction, misrepresentation is highest in medium competition. These results suggest that a medium level of competition is a less favorable setting for voluntary information-sharing than either uncompetitive or high competition settings, and therefore costly formal enforcement mechanisms such as post-audits are likely to be more valuable in medium-competition settings.