Ending Wasteful Year-End Spending: On Optimal Budget Rules in Organizations

What can organizations do to minimize wasteful year-end spending? I introduce a two-period model to derive optimal budget roll-over and audit rules. A principal tasks an agent with using a budget to fulfill the organization's spending needs, which are private information of the agent. The agent can misuse funds for private benefit. The optimal rules allow the agent to roll-over a share of the unused funds, but not necessarily the full share, and in most cases to audit only sufficiently large spending. The optimal audit rule can change once fund roll-over is allowed. Strategically underfunding the agent can be optimal.