Mood and honesty in budget reporting

Abstract

In this paper, I investigate whether the honesty of managers’ budget reporting depends on the state of their mood. The results from a laboratory experiment demonstrate that managers in a positive mood report their budgets more honestly than managers in a negative mood. Attaining a neutral mood state, however, does not increase honesty sufficiently to balance out the effects of a negative mood state. The hedonic contingency theory suggests that the cognitive process underlying a display of higher honesty when the manager is in a positive mood stems from the manager’s desire to maintain this mood by reporting the budget more truthfully. The results of supplemental analyses show that the effect of the manager’s mood on honesty remains stable over multiple reporting periods. By examining the expected firm profits, I reveal that a contract based on the assumption that a manager will be honest is more beneficial than a truth-inducing contract derived from economic theory. If the manager is in a more positive mood, this relative advantage increases due to the effect of mood on honesty.