Opening the black box: Does target setting lead employees to engage in unethical behavior for the organization?

Abstract

Companies often attempt to manage their earnings, which is generally considered as unethical behavior that negatively affects earnings quality. In recent years, the incidence of real activity-based manipulation (RM), a form of earnings management, has increased. Unlike accrual-based manipulation, RM requires cooperation between top management and frontline employees. However, previous research has not clarified how top managers lead subordinates to engage in RM. The concept of unethical pro-organizational behavior (UPB) may be useful in clarifying this point. This is because RM can be considered as a form of UPB for employees. Therefore, this study analyzes the relationship between budget target setting, which is an important management element in almost all companies, and employees’ willingness to engage in UPB (WUPB). For this analysis, we use data from a web-based survey of 450 employees in the marketing and sales departments of Japanese companies. Our multivariate regression analysis shows that the relationship between the difficulty of budget targets and WUPB is nonlinear and that WUPB is greatest for so-called stretch targets, which are generally somewhat difficult to achieve. Moreover, WUPB is greater when budget targets are more flexible. These results suggest that earnings management may not only be a consequence of direct actions aimed at it, but also a result of the process of setting and achieving targets. This study may provide insights to bridge the gap between research and practice on earnings management.