The Competitive Strategy of Enterprise,Budgetary Slack and Enterprise Value

Abstract. Budget management plays an important role in the control of the management of all types of enterprises. In this study， we conduct research based on the contingency theory， using the budget data of Shanghai a-share listed companies in China from 2008 to 2011. our research shows that， companies who take differentiation competitive strategy have a higher degree of budgetary slack than those who take cost leadership strategy； In terms of the overall sample， there is a negative correlation between enterprise value and its degree of budgetary slack； For those who take differentiated strategy， appropriate budget slack is beneficial to the development of the enterprise.

Key words： corporate competitive strategy； contingency theory； budgetary slack； enterprise value.

1. Introduction

In the 1920s， companies such as DuPont and General Motors brought budget into business management for the first time， which can help enterprises plan internal production capacity， coordinate distribution of benefits among all levels of management， enhance the rationality of enterprise resource allocation and adapt to the external market environment. Having been developed up to now，budget management has been widely recognized by enterprises （Mao，Zhu，2009）. However，the problem called budgetary slack has not been solved properly. For the pros and cons of budgetary slack， foreign researchers mainly used the agency theory or contingency theory to effectively explain. Agency theory holds that budgetary slack is intentional interference whose budget target is lower than the desired level （Chow，1991）； Out of self-interest， managers make irrational allocation of enterprise resource， which causes operating inefficiencies and eventually leads to the reduction of enterprise value； However， contingency theory holds that when the uncertainty of the external environment faced by enterprises is high or what enterprises take is such strategy as differentiation strategy or offensive strategy， which requires high flexibility in order to respond effectively to environmental changes， then enterprises need to establish a degree of budgetary slack to ease the impact brought by external uncertainties， providing a buffer to solve the conflict between budget target and actual situation， which can help enterprises grasp the opportunity to develop new markets and provide a source of funding for their product innovation experiment（Bourgeois，1981；Cyert & March，1963）. Therefore， enterprises taking the differentiation strategy or competitive strategy need greater flexibility in budget so that they can make an effective response to environmental changes， which increases the subordinate’s tendency to create budgetary slack.

Studies of budgetary slack in China mainly focused on its influencing factors， which was more committed to the inspection agency theory and rarely involved the relationship between corporate strategy and budgetary slack. There were also some scholars involved in the study of the economic consequences caused by budgetary slack， but all are limited to investigating the budgetary slack‘s impact on corporate performance manifested in the form of indicators like ROA/ROE. This paper introduces the concept of enterprise value， and using the data of listed companies in China with empirical research methods， conducts in-depth discussions about the impact of competitive strategy and budgetary slack on the enterprise value.

2. THEORETICAL ANALYSIS AND HYPOTHESIS

As is known to all， different strategic choices mean different risks that organizations should be faced with， and then varying degrees of budgetary slack will occur in order to resist risks during budgeting process. The differentiation strategy means differentiating product or service provided by a company from others， forming something unique in the scope of whole industry. But this strategy may result in exclusivity to some extent. Sometimes it contradicts with the goal of trying to hold a larger market share as well， because the number of customers who need this unique product is limited； Furthermore， activities engaged in differentiation are always costly because of the high expenses for research and development and marketing. Based on these two points， companies that adopt the differentiation strategy have to confront with a great deal of uncertainty about revenue and cost when they launch a new product. And budgetary slack will be able to provide a buffer when the enterprise meets an unexpected condition， so that the enterprise can continue to operate smoothly. Therefore， managers need to establish appropriate budgetary slack. Meanwhile， cost leadership strategy has relatively fixed products and production patterns， whose central idea is only to maintain its low-cost competitive advantage in the case of quality assurance and withstand the confrontation from existing rivals and new entrants. Hence there should be strict budget to avoid meaningless waste of resources. Therefore， we put forward hypothesis1：

H1： Compared to those that adapt the cost leadership strategy， companies who take the differentiation strategy own a higher degree of budgetary slack.

Because the execution of China's board of supervisors system and the system of independent directors is not thorough， its effect is worse than the mature operation in Western companies， which may lead to ineffective supervision of the internal operation in the company and further increase the degree of information asymmetry. When the shareholding structure of one listed company is relatively concentrated， the largest shareholder will have a strong control over the company. And taking into account the inadequate supervision， there would be more opportunity to expand budgetary slack during the preparation of budget. Therefore， we propose hypothesis2：

H2： The degree of budgetary slack is positively correlated to that of ownership concentration of listed companies

Agency theory holds that there is always difficult to reconcile the contradictions due to the distribution of interests between the principal and the agent， so the information asymmetry between them makes the budgeting process has become a game. Broad standards of budgetary control also result in the lack of objectivity and impartiality， which hampers the correct variance analysis of the corporate income and cost and is easy to misjudge the true operating capacity， and then affects the efficiency of the business. Besides， those enterprises with the problem of budgetary slack will consume additional resources and their allocation of resources will seriously disorder. Contingency Theory argues that an appropriately flexible budget can be used to match with the flexible enterprise competitive strategy or mitigate the impact of external uncertainties， which is beneficial to the enterprise. Hence the following hypothesis：

H3： Enterprise value is negatively correlated with the degree of budgetary slack.

Differentiation strategy is more flexible when faced with either the internal management or the market competition. Loose allocation of resources can help enterprise cope with risks and compensate for errors in a timely manner. And lower budget targets make managers seldom take the risk to complete performance under a highly uncertain case so that it can make sure the company will not be in trouble because of adventure and upgrade the overall performance. On the Contrary， the most important thing of the cost leadership strategy is to reduce costs， enhance management efficiency， develop internal potential， implement saving ideological， form a competitive advantage and create enterprise value. Hence the following hypothesis：

H4： For the company that adopts the differentiation strategy， its enterprise value is positively correlated with the degree of budgetary slack.

H5： For the company that adopts the cost leadership strategy， there is no significant relationship between its enterprise value and the degree of budgetary slack.

3. RESEARCH DESIGN

（1） Sample selection and data sources

This paper selects A-share companies with health management （i.e.， non-ST and * ST） in Shanghai Stock Market from 2008 to 2011， excluding financial stocks， as the study sample. Budget data come from new business plans disclosed by the board in annual reports of listed companies. But because the disclosure of this kind of information is voluntary， disclosure standards of each company are inconsistent. Table 1 shows the situation of budget data.

As is shown in the Table1， most of the listed companies which disclose budget data voluntarily will disclose their operating income. And as to indicators of cost/expense， we find that some listed companies disclose individual index but others disclose the sum， so the standard can’t be unified. Therefore， in order to ensure the consistency of the measure of budget slack variables， we take the operating income index as our basis for calculating， and ultimately get 504 effective samples total.

The data in this paper are from open channels， mainly from CSMAR series database， Shanghai Stock Exchange website， etc.

（2） Research model and variable description

Firstly， H1 and H2 in this paper are used to study the relationship between the selection of enterprise competitive strategy and budgetary slack， so we build model①：

Slack=α0+β1Strategy+β2Percent+β3Size+β4Situation +∑γiYeari + ε

The dependent variable Slack stands for the degree of budgetary slack in a company. The greater Slack’s value is， the more relaxed the budget is. Using the research made by Pan Fei & Cheng Ming （2007） for reference and taking companies in the same industry as the basis for comparison， we denote the calculating formula of budget slack as follows：

Slack = 1 - [（In* - In-1） / In-1 - In-1^]

In this formula， In* represents the budgeted amount of the main business revenue in the first n years disclosed by the annual report of a listed company； In-1 represents the actual amount of the main business revenue in the first n-1 years； And In-1^ represents the growth rate of the average main business revenue of the whole industry in the first n-1 years. The meaning of this formula is to calculate the difference between the planned growth rate of the enterprise’s main business revenue and that of the industry average in base period， and then to take advantage of the average growth rate of the industry to control the influence of the performance level of overall industry on that of sample enterprise. The smaller the difference is， the more relaxed the budget is. So we use the natural number 1 minus the aforementioned difference to represent the budget slack.

Explanatory variables include Strategy and Percent.

Strategy represents the competitive strategy of an enterprise， which we choose book value ratio （market price per share / net assets per share） to measure based on existing research. If the book value of a company is relatively large， it means the enterprise has adopted the differentiation strategy. Conversely， cost leadership strategy. According to H1， its expected sign is positive.

Percent represents the ownership concentration， indicated by the stake of the largest shareholder of the listed company. According to H2， its expected sign is positive.

Control variables of the model include Size， Situation and Year.

Size indicates the enterprise’s scale， using the natural logarithm of the company's total assets to illustrate.

Situation represents the asset-liability ratio of sample enterprises， reflecting their operating status. When one enterprise goes into financial distress， the manager may not have confidence to accomplish a relatively strict budget target， causing a tendency to exacerbate the budgetary slack and damaging the enterprise value. Hence the expected sign is negative.

Year is a dummy variable， representing annual control variable. It is a macroscopic control for the selected data. Because we choose four years’ data as research samples， so the model includes 3 annual dummy variables.

ε represents the residuals.

Secondly， in order to test the impact of the budget relaxation on the enterprise value， we create model ②：

Valuen=α0+β1Slack+β2Valuen-1+β3Strategy+β4Percent+β4Strategy×Slack+β5Size

+β6Situation +∑γiYeari+ε

The dependent variable Value represents the enterprise value. We use indicators like EPS or ROE to measure the accounting performance of enterprises and the Tobin's Q ratio to measure the estimate of the market value of a company’s stock.

Valuen-1 is the control variable， saying the enterprise value of listed companies in the previous year. Here drawing on the study of Said （2003）， we take the data of the previous year as the control variable.

Strategy×Slack is an interactive variable， discussing the interaction of the budgetary slack and the competitive strategy to the enterprise value. According to H4 and H5， its expected sign should be positive if the enterprise takes differentiation strategy while negative if cost leadership strategy.

In addition， the rest of variables have the same meaning with those in model①.

4. REGRESSION RESULTS AND ANALYSIS

（1） Descriptive statistics

Based on the method to selecting the data of budgetary slack mentioned above， we get the data of the listed companies in China from 2008 to 2011 as follows：

As we can see from the table2， the population mean of slack is 1.011434 and its median is 1.065858. So it is easy to know that the growth rate of the budgeted value of the main business revenue in more than 50% of all the samples is lower than actual average level of industry， which to a certain extent shows that in China budgetary slack is widespread in listed companies that disclose budget information voluntarily. In addition， compared with other years， the degree of budgetary slack is especially low in 2009. The global financial crisis broke out in 2008.

（2） Regression test

Fitting the model with SPSS software， the result of regression is showed in table3.

Comment： *， **， *** Significant at the levels of 0.10， 0.05， and 0.01， respectively， the same as the following tables.

As is shown in the table3， the variable that represents the competitive strategy of enterprise is one of the important influence factors of the budgetary slack. The differentiation strategy increases the degree of budgetary slack with a significant level of 10%， which validates H1. In order to cope with the market competition well and optimize the implementation of their strategies， companies that take differentiation strategy have motivation to improve the degree of budgetary slack. Of course， we know that the influence of the competitive strategy is embodied in all aspects of a company and because our study only use a single index to measure the strategy， with a certain degree of bias， then the results of the research and the significance level may be affected. As for the variable saying the shareholding concentration， although its sign is positive as expected， the result was not significant， which means H2 has not been confirmed. This may be due to the check and balance from the remaining top five or top ten shareholders to the largest shareholder. So the largest shareholder can't fully pass on its own goals to the listed company， which can reflect its own will by the listed company. Meanwhile， budget data are announced in the report of the board and the divergence caused by agency problems between the owners and operators of the enterprise has existed for a long time， which could also be the reason for no significant correlation between the ownership concentration of listed companies and budgetary slack.

We test the influence of the company competitive strategy and budgetary slack on the enterprise value. The result of regression is showed in table4， table5 and table6.

The table4， table5 and table6， respectively， takes EPS， ROE and Tobin's Q value to measure the enterprise value. Regression results of Table 4 and table 5 are basically consistent， which indicates that the accounting performance and the degree of budgetary slack present obvious negative correlation， with significant level at 10% for EPS model and 5% for ROE model. The result is consistent with H3 in this paper. Thus it can be seen that principal–agent problem does generate agency costs. In order to reduce the risk of being unable to reach the budget goal， managers have to modify， decorate， cut， and exaggerate the information that should be reported. What’s more， due to reasons of time， space， professional level and channels of information， etc. the corresponding upper management has no way of learning the personal information owned by the subordinate， or even knowing the existence of information asymmetry， they can not obtain the accurate budget data and related information as well， which will cause the agent infringing the interest of the client and then reduce the enterprise value. However， in the Tobin's Q model， Tobin’s Q value is positively correlated with the degree of budgetary slack， which is inconsistent with the expectation. The reason may be that companies with budgetary slack give external people an illusion that they have a high degree of completion of their budget， which can prove that they run very efficient operations and they are worth the investment. And then with the market prices of their stocks surging， Tobin’s Q value will also rise. In table5 and table6， the enterprise value variable and the enterprise competitive strategy variable have significant positive correlation. It means that the performance of Chinese listed companies which prefer differentiation strategy is better than others. This should be due to the listed company belonging to large companies in the industry， for which only to reduce costs can not bring enough profit. Developing the company's unique products， opening up new markets and to finding new opportunities， is the right way to improve the enterprise value.

The table7 and table8， respectively， is the regression result of the companies with differentiation strategy and cost leadership strategy.

As we can see from the table7， when taking the differentiation strategy， EPS in the EPS model has no significant relationship with the degree of budgetary slack（Slack）， while the ROE and Tobin’s Q value is positively correlated with the degree of budgetary slack（Slack）， respectively. And these three variables of enterprise value are significantly positively correlated with the interactive variable of the budgetary slack and the competitive strategy（Strategy×Slack）， which shows that the contingency theory has powerful explanation for companies with differentiation strategy and proves H4. If the enterprise wants to take the differentiation strategy， it should guarantee enough measures to confront the uncertainty so as to make sure that the enterprise can handle a butcher's cleaver skillfully in the changeable environment and establish its own unique advantages. Of course， the degree of budgetary slack should be hold well. Otherwise， it will only cause employee laches and provide a elastic space of covering up mistakes or not working hard to the budget executors， which can hinder the enterprise from achieving the real purpose of budget management.

In the table8， it can be found that both the degree of budgetary slack（Slack） and the interactive variable of the competitive strategy and the budgetary slack（Strategy×Slack） present no significant correlation with the variables of enterprise value， which proves H5. It is worth noting that although it’s not significant， the symbol of the variable Slack is negative， which to a certain extent shows that for companies with cost leadership strategy， the agency theory has more explanatory power than the contingency theory. In a word， the agency problem is still a big problem which should be solved urgently by enterprises.

5. CONCLUSIONS

This paper focuses on studying the influence of the competitive strategy and budgetary slack on enterprise value. According to the statistical analysis of the data collected from A-share companies in Shanghai from 2008 to 2011， we find that budgetary slack is almost ubiquitous in the budgeting process of listed companies in China； Different competitive strategies have different affects on the budgetary slack and the differentiation strategy will make the degree of budgetary slack increase； The reason why the budgetary slack reduces the value of enterprises to a great extent is because of the influence of agency problems； Fractional analysis finds that contingency theory is also applicable and for companies which take differentiation strategy， moderate budgetary slack will be beneficial to the enterprise value； But when it comes to those companies that take cost leadership strategy， budgetary slack may be generated by the agency problem or just a means to cope with uncertainty. Moreover， there is no systematic relationship between enterprise value and budgetary slack， so we can’t draw firm conclusions. The research above show that we should not identify whether it is exactly harmful or beneficial when studying budgetary slack， and we must combine the specific circumstances of the company （e.g.， to match the degree of budgetary slack with the competitive strategy） so that the reasonable budget management system and budget target can be formulated， which will have a positive impact on the overall value of the company.

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