1. Analysis of Budget Process at Citibank Direction and control of Citibank’s international branches are conducted via two formal management processes. Each year, top management sets sovereign risk limits for its independent branches based on proposals by country managers. Country managers may choose to operate with self-imposed limits below this upper guideline. Following, there is the budget setting process, where headquarters only provides administrative guidelines but not specific targets, with operating managers being responsible for budgets for the following year. Indonesia often set their targets above these long-term goals.
Performance is measured and compared against the budget each month, and a new forecast, which will be reviewed by the division manager, is drawn up each quarter for the remainder of the year.
This structure of bottom-up budgeting is appropriate for a decentralized firm like Citibank. This is evident from the freedom Mr Mistri has over Indonesia’s operations and the different business segments and divisions, as shown in Exhibit 2 & 3. Such a participative process is likely to increase management commitment to achieve the targets since country managers are responsible for influencing their own targets.
More importantly, country managers know the local business environment and culture better than group managers, therefore their targets are likely to be more accurate and realistic.
Furthermore, bottom-up budgeting is a form of action control while the frequent reviews of the budgets serves as preaction review. Both facilitate information sharing within the organisation, with long-term strategic goals of the firm being communicated downwards and local business potentials and risks conveyed upwards via the budgets and forecasts. They also encourage managers to think further ahead about what they want to achieve in the near future.
However, Citibank’s budgeting process appears to have an imbalanced focus with most of the emphasis placed only on financial measures. Although these measures can be easily obtained and are inexpensive because they are by-products of the accounting system, it does not fully represent all aspects of the organization’s strategies and goals. Instead, the budget could be restructured to include other non-financial aspects such as customer satisfaction and employee morale to obtain a balance, which will be vital towards the long term success of Citibank.
None of Citibank’s budget items extend beyond the next year; instead there is an emphasis on a fixed short horizon. This can result in managers developing a myopic focus instead of measuring the fulfilment of Citibank’s long-term goals or the local government’s societal expectations. Myopia is aggravated by the monthly performance reviews which reveals the focus on short term goals. Citibank should look at its budget with a longer horizon.
Moreover, the budgeting process in Citibank appears to be tedious and too time-consuming. The requirement for operating managers to conduct discussions and forecast all the line items shown on the submission form seems to take up significant time and effort. Such a process could be costly for the firm in terms of opportunity costs related to unnecessary time and resources spent. The benefits of such a tedious budgeting process must be high enough to justify the related costs.
Also, there seems to be no connection and a mismatch between the two management processes. It is only reasonable that these two processes should go hand in hand as higher returns may only be possible with a higher risk appetite. However, increase in profit goals is not matched by an increase in risk tolerance (sovereign risk limit). Moreover, sovereign risk limits is set yearly but not adjusted when budgets are revised each quarter. Citibank should consider allowing country/division managers to adjust risk limits to match any revisions in budgets during the year.
Use of the Budget for Performance Evaluation of Managers Performance is monitored every month against budgets, and incentive compensation for managers were linked to budget-related performance. Incentive compensation could range up to approximately 70% of base salary although awards of 30-35% were more typical. Assignment of bonuses were based approximately 30% on corporate performance and 70% on individual performance, primarily performance related to forecast.
This emphasizes results accountability as it involves rewarding the managers for generating good results that are aligned to the budgets. As such, it influences actions because it causes employees to be concerned about the consequences of the actions they take. However, the contradiction in this is that while these managers will not be constrained in what actions they can take to achieve their goals, they are also empowered to take whatever actions they believe will best produce these desired results. Hence, it is highly dependent on personnel controls with regards to the managers hired.
Provided that budgets were adequately set with appropriately extent of goal difficulty, these budgets act as results controls and affects a manager’s motivation since the targets are linked to performance evaluations and compensation. Furthermore, it is beneficial that manager’s compensation is tied directly to both individual(70%) and corporate performance(30%), allowing a larger perspective to be considered. Differentiation of base earnings from extraordinary earnings for which managers are not held accountable for is in line with the controllability principle. This is vital because setting performance targets to attain for each measure allows the managers to assess their performance and also get rewarded, encouraging behaviors that lead to desired results. As such, this will promise manager rewards that provide the most powerful motivational effects in the most cost effective ways possible.
However, performance evaluations based on budgeted information is backward looking (extrapolating past trends) while it is best that the evaluations be forward looking. It should be evaluated based on the future cash flow/profits that can be brought to the firm instead of historical performance to promote a higher performance in the future.
Furthermore, as their compensation is tied to meeting targets, it might promote game-playing and politics. As for Citibank, their culture encourages aggressive mark-ups to budget with managers constantly setting challenging budgets. For Mr Mistri, he will feel the extra pressure since the aggressive targets can barely be met with the deteriorating conditions in Indonesia.
In conclusion, the current budget and performance evaluation system, which is mainly bottom up with top down guidance, matches the decentralized structure of Citibank. Although there seems to be trade-offs and problems with Citibank’s current bottom up budgeting system, there is no perfect budget system to optimally serve all the different purposes of budgeting. What Citibank can do is to put in place measures to minimize some of these shortcomings.
2. Are managers at Citibank committed to achieving budget targets?
Yes, managers are committed as a result of their freedom to set their own budgets subject to guidelines provided by top management.
Mr Mistri can choose to operate with a self imposed sovereign risk limit which is lower than the one approved by the New York Headquarter if he thinks that the one set by the top management is too aggressive. The fact that he has control over this means that he will be less pressurised to set unrealistic goals or engage in budget slacks. These will garner higher commitment from managers since the budgets set are not restrictive and offer flexibility to managers according to the business conditions.
The commitment to achieve targets is augmented as incentive compensation for managers is linked to budget-related performance. Thus they will work towards getting more incentives for themselves through surpassing the budgeted forecast. On the other hand, the amount of commitment may be limited by the constant revision of budgets each quarter. Managers may be less motivated to hit their budget target if they know that those targets can be revised lower in the next quarter if performance was unsatisfactory. In addition, the frequent changes may make managers unfocused and reduce their motivation to work towards the goals set.
If so, are the budget targets too challenging?
The targets may prove to be too challenging. This can be shown by the fact that although incentive compensation could range up to 70% of base salary, awards of 30-35% were more typical, implying that it may be difficult to surpass the budgeted levels. Furthermore, Mr Mistri felt that the increased profit goal by $500K to $1mil set by Mr Gibson is too much as the budget he submitted is already very aggressive, judging by the bleak short term outlook due to the decrease in oil prices. This is supported by the self-imposed sovereign risk limit that Mr Mistri is operating at in order to minimise his exposure which will reduce the likelihood of the firm achieving higher returns due to the lower risk.
We also doubt the achievability of the budget set. Though the forecasts and budgets are set by the operating managers themselves, we have to take into consideration Citibank’s risk-taking culture. While challenging targets induce motivation, the aggressive year-on-year increase in targets might prove to be detrimental to the achievement of the firm’s strategic objectives. Firstly, this is especially so when targets are not adjusted in times of bad macroeconomic conditions. With the incentive compensation for managers linked to budget-related performance, it seems that managers might be motivated to set unrealistic targets and employ excessively risky methods to accomplish them. Such a system would eventually serve to promote short-term gains at the expense of long-term losses for the organisation. In addition, the practice of comparing actual performance to budgeted amount monthly is too short termed and may render managers to become myopic. This may encourage managers to engage in gamesmanship such as earnings management, manipulating data to receive additional bonuses especially towards the end of a quarter.
Is there any evidence of budget gaming?
Yes, there is evidence of budget gaming. The main reason Mr Mistri used to justify his less than ideal budget (as compared to Mr Gibson’s) is likely to be false and there are unhealthy motivations for him to engage in such behaviour.
Mr Mistri justified his budget by claiming that the Indonesian economy had slipped into a recession when oil prices decreased significantly. This is supported by the fact that Citibank’s Indonesian operations growth paralleled that of the Indonesian economy. However, evidence in Exhibit 4 suggests otherwise, revealing both the net and inflation-adjusted GDP of Indonesia to be increasing steadily over time. Even in 1983, GDP increased 5%. Moreover, a fall in oil prices will not necessarily lead to a recession. As such, Mr Mistri’s concerns are unlikely to be true and a simple check by the group managers would have allowed this to be uncovered. Moreover, even though Indonesia’s economy is highly dependent on oil prices, a fall in oil prices is also likely to affect Citibank’s other operations in different regions. The group managers will probably have considered this effect when setting the $4mil profit goal for South East Asia.
In our opinion, Mr Mistri is likely to be acting as a Sandbagger. By presenting less ambitious budgets, there will be higher likelihood of positive variances in actual performance. Given that compensation is tied to budget-related performance, such gaming behavior will probably increase Mr Mistri’s bonuses and salary.
Another motive for budget gaming could be to cover up the ongoing high staff turnover problem with the bad economic conditions. Mr Mistri just lost his chief of staff and two senior officers, and is concerned with constraints to growth due to his lack of experienced staff. This could in turn affect his bonus and salary. Since managers are not accountable for extraordinary earnings or losses at Citibank, by blaming the external economy (recession) for a less aggressive budget rather than on internal problems, his bonuses will not be affected.
Furthermore, Mr Minstri has the freedom to operate at a sovereign risk limit lower than the group’s since country managers are given substantial autonomy in deciding their country’s budget and risk limits. He is likely to be able to get away with a less than optimal budget if his group manager trusts him. This way, his budget gaming behavior will escape the suspicions of Mr Gibson and other group/division managers.