Budget Ratcheting and Debtholders’ Monitoring: Evidence from Private Colleges and Universities

Abstract

This study examines whether budget ratcheting occurs in Japanese private colleges and universities (PC&Us) and how debtholders affect it. We predict that managers of Japanese PC&Us have incentives to increase their budgets in order to enhance their reputation from internal stakeholders; moreover, most of their stakeholders are less likely to strictly monitor the manager’s behavior, which creates the opportunity for budget ratcheting. First, we find that the budget for program expense increases associated with prior year overspending is larger than for decreases associated with underspending of the same amount, consistent with the budget ratcheting hypothesis. Second, we also find that the extent of budget ratcheting is less pronounced in PC&Us with debtholders and earnings losses, suggesting that debtholders such as banks monitor budgetary practices. This study contributes to the budget ratcheting literature by adding new findings on the budget ratcheting practices of nonprofit organizations, namely, PC&Us.