First Session - iuc.bwl.uni-muenchen.de · The basic control problem … " Management control is...

Management Control Systems

First Session

Prof. Dr. Kai Sandner

LMU München

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Formal Aspects I

!  Lecturer: Prof. Dr. Kai Sandner [email protected] Room 521, Ludwigstraße 28 RG Consultation-hour: upon agreement

!  Lecturer: Debbie Claassen [email protected] Room 524, Ludwigstraße 28 RG Consultation-hour: upon agreement

Please consider that you can choose between courses „Management Control Systems“ and „Economics of Accounting“, but you cannot combine them.

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Formal Aspects II

Registration

!  Registration is mandatory for participation in the course

!  Registration deadline: October, 16th 2015, 12:00

!  E-mail to [email protected], including !  last name, first name !  matriculation number and !  three preferences for presentation topics

!  Participation is mandatory after registration !  The final allocation of participants to presentation topics is made after registration, depending on the exact number of students

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Main references

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Main References:

! Merchant, K. A. and Van der Stede, W. A., Management Control Systems, FT Prentice Hall, 2012 (third edition).

! Anthony R. N. and Govindarajan V., Management Control Systems, McGraw Hill, 2007 (twelfth edition).

! Rothaermel, F. T., Strategic Management, McGraw-Hill Irwin, 2013.

Further references:

! Davila, T., Epstein, M. J. and Shelton, R. D., Making Innovation Work, Pearson Education, Inc. publishing as FT press, 2013.

! Homburg, C., Schäfer, H. and Schneider, J., Sales Excellence, Gabler Publishing, Wiesbaden, 2006 (fourth edition).

! Kaplan, S. K. and Norton, N. P., The Balanced Scorecard – Translating Strategy into Action, Boston, 1996.

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Grading

! Final exam composed of

1.  Written test at the end of the term

!  Questions concerning the lecture material (~50 %) !  Response to a case following case work in class (~50 %) !  February, 4th 2016 at 2pm at S 007 (Schellingstr. 3)

2.  Presentation and participation in the seminar

!  Syllabus contains presentation dates and case study assignments

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1.  Management Control and Management Control Systems

Agenda

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Two main objectives of this course

1.  Knowledge on management control systems

2.  Transfer/Application to case studies

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Essence of management control (I)

Financial Accounting Management Accounting

focuses on external reporting that is directed by authoritative guidelines

measures and reports financial and as well as other types of information that are intended primarily to assist managers in fulfilling the goals of the organization

measures and reports (mainly) financial information related to the organization‘s acquisition and consumption of resources

Cost Accounting

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Essence of management control (II)

Management accounting and control

Management control

• The process by which management:

•  ensures that people in the organization carry out organizational objectives and strategies;

•  encourages, enables, or, sometimes “forces” employees to act in the organization’s best interest.

• Management control includes all the devices/mechanisms managers use to ensure that the behavior of employees is consistent with the organization’s objectives and strategies.

Management Accounting

enables

Cockpit

Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007

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Management Control…

Management control is about encouraging PEOPLE to take desirable actions,

i.e., it guards against the possibilities that employees will do something the organization does not want them to do, or, fail to do something they should do.

Hence, management control has a BEHAVIORAL ORIENTATION !

If all personnel could always be relied on to do what is best for the organization, there would be no need for a management control system.


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Relevance of management control

Individual target orientation

Like this?

Strategy-related, communicated,

coordinated target orientation

Or like this?

Behavior without management control in place.

Impact of management control on individual / business unit behavior

Ideal situation with management control mechanisms in place.

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Function and benefit of Management Control

"  Purpose / function …

–  get done what management wants to be done;

–  influence behavior in desirable ways.

"  Benefit …

–  increased probability that the organization’s objectives will be achieved.


Example

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Management and its components …

"  Management

–  the process of organizing resources and directing activities for the purpose of organizational objectives.

"  Process-breakdown …

–  Objective setting: What goals do we want to achieve?

–  Strategy formulation: How are we going to realize these goals?

–  Control: Are we on track in realizing these goals?


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Objective setting …

"  Objectives are …

–  a necessary prerequisite for any purposeful activity.

"  Without objectives it is impossible …

–  to assess whether the employees’ actions are purposive;

–  to make claims about an organization’s success.

"  Objectives can be …

–  financial versus non-financial;

–  quantified, explicit versus implicit;

–  economic, social, environmental, societal.


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Strategy formulation …

"  An organization must select any of innumerable ways of seeking to attain its objectives.

"  Strategies define how organizations should use their resources to meet their objectives.

"  Hence, strategies put constraints on employees to focus activities on what the organization does best or areas where it has an advantage over competitors.


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Control …

"  Strategic control …

–  Is our strategy (still) valid?

–  Strategy revision?

"  Management control …

–  Are our employees likely to behave appropriately? (design)

"  Do they understand what we expect of them?

"  Will they work consistently hard and try to do what is expected of them?

"  Are they capable of doing what is expected of them?

–  Do our employees behave as expected? (execution)


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Planning and control …

!  predominantly external focus; !  predominantly top management

responsibility; !  sometimes very unsystematic,

implicit and/or emergent.

!  predominantly internal focus; !  relevant for every superior-

subordinate relationship; !  more systematic and rhythmic.

OBJECTIVE SETTING

PLANNING

Strategy Formulation

Strategic Control

CONTROL

Strategy Implementation

Management Control


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The planning / control cycle …

Goals

Strategy Formulation

Strategy Implementation

" Objective setting: What goals do we want to achieve?

" Strategy formulation: How are we going to realize these goals? Are we on track realizing our goals?

" Strategy implementation: With what means are we implementing the chosen strategy?


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The basic control problem …

"  Management control is about encouraging PEOPLE to take desirable actions,

–  i.e., it guards against the possibilities that employees will do something the organization does not want them to do or, fail to do something they should do.

"  Hence, management control has a …

–  … BEHAVIORAL ORIENTATION !

"  If all personnel could always be relied on to do what is best for the organization, there would be no need for a management control system.


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Recall that …

"  Management Control is about taking steps to help ensure that the employees do what is best for the organization.

"  Three issues …

–  Do they understand what we expect of them …

"  Lack of direction

–  Will they work consistently hard and try to do what is expected of them …

"  Lack of motivation

–  Are they capable of doing what is expected of them …

"  Personal limitations


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Lack of direction …

"  Employees do not know what the organization wants from them.

"  When this lack of direction occurs, the likelihood of the desired behaviors occurring is obviously small.

Remedy: COMMUNICATION + REINFORCEMENT !


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Motivational problems …

"  When employees ‘choose’ not to perform as their organization would like them to perform.

"  Because …

–  Lack of goal congruence

Individual goals do not coincide with organizational goals.

–  Self-interested behavior

Generally, individuals are prone to being ‘lazy’ … e.g., take long lunches, overspend on things that make life more pleasant, use of sick leaves

when not sick, etc.


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Personal limitations …

"  Sometimes, people are ‘unable’ to do a good job because of certain personal limitations they have.

"  Some examples / causes:

–  Lack of requisite knowledge, training, experience;

–  Employees are promoted above their level of competence;

–  Some jobs are not designed properly; etc.

"  Remedies:

–  Training;

–  Job assignment / promotion;

–  Job design.


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Management control is more than …

"  A simple cybernetic control system involving a single feedback loop, like a thermostat …

–  Detectors # measure performance;

–  Assessors # compare with pre-set standard;

–  Effectors # take corrective action.

"  Many controls don’t focus on measured performance …

–  e.g., direct supervision, employee hiring standards, codes of conduct.

"  Many controls are proactive rather than reactive …

–  i.e., they are designed to prevent control problems before the organization suffers any adverse effects on performance.


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Control and ‘good’ control …

"  Again, management controls include all the devices managers use to ensure that the behaviors and decisions of people are consistent with the organization’s objectives and strategies.

"  ‘GOOD CONTROL’ is said to take place when there is …

–  a ‘high’ probability that the firm’s objectives will be achieved;

–  a ‘low’ probability that major unpleasant surprises will occur.

"  Therefore, controls must be:

–  Future-orientated ;

–  Objectives-driven ;

–  Economically desirable.


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Control alternatives …

the actions taken

the results produced

the types of people employed and their shared values and norms


Action Controls

Results Controls

People Controls

Or any combination

!  Control Problem Avoidance or


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Action controls …

"  Ensure that employees perform (or do not perform) certain actions known to be beneficial (or harmful) to the organization.

"  Prevention / detection

Most action controls are aimed at preventing undesirable behaviors.


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Effectiveness of action controls …

"  They are usable and effective only when managers:

–  Know what actions are desirable …

Difficult in highly complex and uncertain task environments. (e.g., research engineers or top-level managers)

–  Have the ability to make sure that the desirable actions occur …


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Action controls (I): Behavioral constraints

"  Physical constraints

–  e.g., passwords, limited access to areas where valuable inventories or sensitive information are kept, magnetic identification card readers …

"  Administrative constraints

–  Restriction of decision-making authority, e.g., lower-level managers are only allowed to have expenditures up to a certain limit.

–  Separation of duties.


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Action controls (II): Preaction reviews

"  Scrutiny of action plans, budgets.

–  Review / modification / approval

–  Can potentially address all three control problems:

"  Alleviate lack of direction;

"  Provide motivation;

"  Mitigate personal limitations.


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Action controls (III): Action accountability

"  Holding employees accountable for the actions they take.

"  It requires:

–  Defining what actions are (un)acceptable;

–  Communicating these definitions to employees;

–  Observing or otherwise tracking what happens;

–  [Rewarding good actions, or] punishing actions that deviate.

"  Mode of implementation:

–  e.g., work rules, policies and procedures, codes of conduct.


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Pros and cons of action controls

PROS CONS

"  The most direct form of control.

"  Tend to lead to documentation of the accumulation of knowledge as to what works best.

–  Organizational memory

"  An efficient way of coordination:

–  i.e., they increase the predictability of actions and reduce the amount of inter-organizational information flows to achieve a coordinated effort.

"  Only for highly routinized jobs.

"  May discourage …

–  Creativity;

–  Innovation;

–  Adaptation.

"  Sometimes very costly.


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the actions taken




Action Controls

Results Controls

People Controls

Or any combination


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Results controls …

"  It involves rewarding individuals for generating good results, or punishing them for poor results.

Results accountability

"  It influences ACTIONS because it causes employees to be concerned about the CONSEQUENCES of the actions they take.

However, the employees’ actions are not constrained; on the contrary, employees

are empowered to take whatever actions they believe will best produce the

desired results.


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Elements …

"  Defining the performance dimensions …

–  What you measure is what you get; hence

–  If not congruent with the organization’s objectives the controls will actually encourage employees to do the wrong things,

"  Measuring performance on these dimensions … –  Objective: Financial: market-based (e.g., stock price) or accounting-based (e.g., return on assets)

Non-Financial: e.g., market share, customer loyality

–  Subjective: e.g., managerial characteristics (‘being a team player’)

"  Setting performance targets …

–  Motivational effects + allow to interpret (own) performance.

"  Providing rewards or punishments …

–  Salary increases, bonuses, promotions, job security, recognition, etc. Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007

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Conditions …

"  Results controls work best only when ALL of the following three conditions are present:

–  Superiors / managers must know what results are desired in the areas being controlled;

–  The individuals whose behaviors are being controlled must have significant influence on the results in the desired performance dimensions;

–  Superiors / managers must be able to measure the results effectively.


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Ability to influence results …

"  The person whose behaviors are controlled must be able to affect the results in a material way in a given time span.

–  Controllability Principle:

"A man should be held accountable for only that which he alone can control." (Dalton, 1971)

"The controllability principle states that the manager of a responsibility center should be assigned responsibility only for revenues, costs, or investments controlled by responsibility center personnel." (Atkinson / Kaplan / Young, 2003)

"  Results controls are useful only to the extent that they provide information about the desirability of the actions that were taken.

–  If the results are totally uncontrollable, the controls will tell us nothing about the actions that were taken:

"  Good actions will not necessarily produce good results;

"  Bad actions may similarily be obscured.


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Ability to influence results …

"  The person whose behaviors are controlled must be able to affect the results in a material way in a given time span.

Controllability principle

!  “A man should be held accountable for only that which he alone can control.” (Dalton 1971)

!  „[T]he manager of a responsibility center should be assigned responsibility only for revenues, costs, or investment controlled by responsibility center personnel.“ (Atkinson / Kaplan / Young 2003)

Sources that contribute to a lack of control over results and lead to subsequent violations of the controllability principle (Ronen/Livingstone 1975, Kaplan/Atkinson 1999, Merchant / Van der Stede 2003, Giraud et al. 2008):

A) Horizontal interdependencies (decisions made by other managers)

B) Vertical / hierarchical interdependencies (decisions made at a higher hierarchical level)

C) Uncontrollable factors external to the company (economic and competitive factors, acts of nature, etc.)

“…one possible interpretation (…) is that the controllability principle does not fit in with the context in which firms operate today.” (Giraud et al. 2004, similar: Hirst 1983, Merchant 1998, Hartmann 2000)

But: The “principle is rarely followed in practice” (Simons 2007) and thus appears to be “paradoxical” (Hartmann 2000)

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Ability to measure results effectively …

"  The ‘effectiveness’ of results measures must be judged by their …

–  Ability to evoke the desired behaviors.

"  Results measures should be;

–  Precise;

–  Objective;

–  Timely;

–  Understandable.


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Pros and cons of results controls

PROS CONS

"  Behavior can be influenced while allowing significant autonomy.

"  They yield greater employee commitment and motivation.

"  They are often inexpensive.

–  e.g., performance measures are often collected for reasons not directly related to management control.

"  Often less than perfect indicators of whether good actions have been taken.

"  They shift risk to employees (because of uncontrollable factors). Hence, they often require a risk premium for risk averse employees.


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the actions taken




Action Controls

Results Controls

People Controls

Or any combination


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People controls …

"  People controls ensure that employees …

–  Will control their own behaviors

"  Personnel control

"  Self-monitoring

–  Will control each others’ behaviors

"  Cultural controls

"  Mutual-monitoring

"  People controls are part of virtually every management control system + becoming more important in …

–  "flatter and leaner organizations with empowered employees”


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Personnel controls …

"  Personnel controls build on employees’ natural tendencies to control themselves, because most people …

–  Have a conscience that leads them to do what is right;

–  Find self-satisfaction when they do a good job and see their organization succeed.

"  Labels …

–  Self-control;

–  Intrinsic motivation;

–  Ethics and morality;

–  Trust and atmosphere;

–  Loyalty.


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Methods to implement personnel controls …

"  Generally, it is about …

–  “…finding the right people, giving them a good work environment and the necessary resources…”

"  Selection and placement

–  Finding the right people to do a particular job.

"  Training

–  Give employees a greater sense of professionalism;

–  Create interest in the job by helping employees to understand their job better.

"  Job design + provision of necessary resources

–  So that motivated and qualified employees have a high probability of success (e.g., equipment, staff support, freedom from interruption, etc.)


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Cultural controls …

"  Cultural controls or mutual-monitoring tap into social pressure and group norms and values.

"  Cultural controls are effective because members of a group have emotional ties to one another.

"  Cultures are built on shared …

–  Traditions ;

–  Norms ;

–  Beliefs ;

–  Ideologies ;

–  Attitudes ;

–  Ways of behaving, etc. .


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Five ways to shape culture … (I)

"  Codes of conduct

–  Codes of ethics, corporate credos, mission statements, etc.;

–  Formal written documents with broad statements of corporate values, commitments to stakeholders, and the ways in which top management would like the firm to function.

"  Group based rewards

–  e.g., bonus, profit-sharing, employee ownership of company stock;

–  Cultural controls rather than results controls because the link between individual performance and rewards is weak.


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Five ways to shape culture … (II)

"  Intra-organizational transfers

–  Improve the socialization of individuals in an organization;

–  Improve identification with the organization as a whole as opposed to subunit identification.

"  Physical and social arrangements

–  e.g., office plans, interior decor, dress codes and vocabulary, etc.

"  Tone at the top

–  Top management statements must be consistent with the culture they are trying to create and importantly, their behaviors should be consistent with their statements.


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Summary people controls

"  People controls …

–  Must always be relied on to a certain extent;

–  Have relatively few harmful side-effects;

–  Involve relatively low out-of-pocket costs.

"  However, it is rare that people controls will be sufficient. In most cases, it is necessary to supplement them with …

–  Action controls;

–  Results controls.

"  Maybe, you just shouldn’t put all your trust in people !?


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Control and ‘Good’ control …

"  ‘GOOD CONTROL’ is said to take place when there is …

–  a ‘high’ probability that the firm’s objectives will be achieved;

–  a ‘low’ probability that major unpleasant surprises will occur.

"  Hence, the benefit of a control system can be expressed in terms of the amount of control achieved.

"  In this respect, tight control is ‘good’ because it provides a high degree of certainty that people will act as the organization wishes (assuming away harmful side-effects …)


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Control alternatives (Cont.)

Depending on:

Ability to measure results on important performance dimensions

Knowledge of which specific

actions are desirable

High Low Poor

Excellent

People Control (e.g. research lab)

Action Control (e.g. large projects)

Results Control (e.g. movie director,

entity manager)

Results Control

Action Control and/or

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Management Control System (MCS)

Defining Management Control System (MCS):

MCS is a broad term encompassing all elements of formal and informal (e.g., clan controls) management control

Individual target orientation

Like this?

Strategy-related, communicated,

coordinated target orientation

Or like this?

Company target

Impact of management control on individual / business unit behavior

Source: see for this Chenhal 2003, p. 129.

End of session

First Session - iuc.bwl.uni-muenchen.de · The basic control problem … " Management control is...

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