Budgeting Revisited: Cracks in the Foundation of Bank Performance Management

By Max, Mitchell | The Journal of Bank Cost & Management Accounting, January 1, 2002 | Go to article overview

Budgeting Revisited: Cracks in the Foundation of Bank Performance Management


Max, Mitchell, The Journal of Bank Cost & Management Accounting


Banks are investing heavily in replacing, overhauling and improving their performance management systems and infrastructures. Literature and case studies are replete with examples of Shareholder Value solutions, Balanced Scorecards, Enterprise Planning, and forecasting techniques. Each of these tools clings desperately to an underlying foundational assumption: If management sets short-term targets for its employees, measures their performance against these targets and rewards them for achieving these targets, then the overall performance of the bank will be enhanced and the interest of shareholders will be maximized.

To support this approach, management philosophy in the modern bank continues to focus on empowering employees at all levels in the organization-divisions, business units, service centers and front line staff-by giving them, to varying degrees, responsibility and tools to both satisfy customers and achieve the bank's goals. Performance Management systems support this empowerment by allowing management to articulate its goals and provide a measurement mechanism whereby performance against these goals can be tracked and feedback provided. Almost universally, budgets are used as the basis for short-term target-setting and measurement.

New research has begun to indicate that cracks are forming in the foundation of this performance management philosophy.1 The budget process, once viewed as the stabilizing force in a coherent management control system, is under attack. Called the "bane of corporate America" by GE's Jack Welch, "a tool of repression" by Chrysler's Bob Lutz, and generally despised as a hated evil by most executives, the budget remains a grudgingly-accepted annual ordeal filling the management agenda between summer and Christmas. Over the past decade, consultants, software vendors and organizations have worked to make the process simpler, faster, less painful, more integrated with management reporting tools, and more technologically enabled.

Yet these changes ignore the fatal flaw: budgeting represents the essence of a 1950's-style command and control structure which is wholly inconsistent with the empowerment goals management seeks. Despite the intention to empower employees, the budget effectively reasserts the notion of central control in the bank, building frustration and stifling entrepreneurial spirit at the front lines.

Recently, researchers and leading organizations have begun a search to better understand the flaws in budgeting in the context of current performance management processes, and to look for significantly improved budgeting practices world-- wide. This writer's focus is in applying these findings to the financial services industry. The significant flaws in the application of budgeting in modern banks can be grouped into three categories: cultural, strategic, and financial.

Cultural: At the heart of the performance management process, the budget represents a fixed performance contract. Budgets are negotiated, agreement is reached, resources are committed and subordinates ultimately report to managers on their ability to achieve the commitments promised. Managers have come to know the game well: achievement of targets is expected and rewarded, over-achievement is modestly rewarded in short-term and generally results in a `raising of the bar' in the future, and non achievement of targets is severely punished. These effects are accentuated when compensation and other incentives are tied to achievement of budget targets. (The `pay for performance' model remains highly entrenched in most banks, despite persistent research which finds that "individual incentive pay, in reality, undermines performance-of both the individual and the organization(2).")

Thus, the cost of failure is perceived as significantly greater than the benefit of over-achievement. The dysfunctional behaviors resulting from this conclusion have been well-documented, and indeed most readers will recognize these patterns - some to a greater degree than others - from their own organizational experience. …

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