Budget ratcheting and performance

Abstract

This chapter demonstrates (1) divergence between spending based upon a budget ratcheting model and a benchmark spending model, (2) that this divergence affects organizational performance, and (3) that internal benchmarking enables unit-to-unit performance comparisons, despite claims of organizational or unit uniqueness. We contrast two spending models to examine whether the divergence, or cost estimation gap, affects operating performance across inpatient (n=4,536) and outpatient departments (n=8,438) in 23 U.S. Army hospitals. Using a fixed-effects panel data methodology for fiscal years 2004–2006, we find that unit managers’ spending in this setting is more closely approximated by budget ratcheting. Using multiple performance metrics measured via a DuPont-like decomposition, we find that, within a specified range, operating performance generally improves as resources become constrained. Outside that range, however, we find nonlinear performance effects that approximate a quadratic loss function. Our benchmark model enables clinical department comparisons while controlling for facility, clinical specialty, and case mix severity. The resulting departmental comparability facilitates identification and communication of best practices across the entire Army hospital system. These results should be of interest to corporate executives, government officials, and agency managers who have responsibility for establishing funding mechanisms that include performance-based components.

Citation

Callahan, C.M., Waymire, T.R. and West, T.D. (2011), "Budget ratcheting and performance", Epstein, M.J. and Lee, J.Y. (Ed.) Advances in Management Accounting (Advances in Management Accounting, Vol. 19), Emerald Group Publishing Limited, Leeds, pp. 23-53. https://doi.org/10.1108/S1474-7871(2011)0000019008