Management Control Systems Chapter 4: Control Tightness (or Looseness) Merchant and Van der Stede: Management Control Systems © Pearson Education Limited 2003

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 … ).

Tight action controls … (I) Behavioral constraints Physical constraints Extra protection usually costs more. Administrative constraints Restricting decision making to higher organizational levels provides tighter controls if: Higher-level personnel can be expected to make more reliable decisions; Those who do not have authority cannot violate the constraints. Preaction reviews Become tighter if the reviews are frequent, detailed, and performed by diligent, knowledgeable persons.

Tight action controls … (II) Action Accountability The amount of tightness of control generated by action accountability depends on: The definition of (un)desirable actions Definitions must be specific, yet complete; e.g., “act professionally” vs. “obtain three competing bids before releasing a purchase order” Definitions must be understood and accepted. The effectiveness of the action-tracking system Employees should feel that their actions are noticed, and noticed relatively quickly. The reinforcement provided i.e., the significance of the rewards or punishments.

The achievement of tight results controls depends on: (I) The definitions of the desired results areas The performance measures The reinforcements provided Congruence Choosing measurable performance dimensions that reflect an organization’s “true” objectives; e.g., # visitors for the success of a museum? # of patents for the success of R&D-departments? Annual profits for a firm with significant growth prospects? Specificity Disaggregation + quantification; e.g., “keep customers happy” vs. “less than 1 pct. customer complaints.”

The achievement of tight results controls depends on: (II) The definitions of the desired results areas Congruence Specificity Communication and internalization Depends on: qualification of the personnel involved; the amount of participation allowed in the goal-setting process; the perceived degree of controllability; and, the reasonableness of the goals. Completeness What you measure is what you get ! Hence, when the defined results areas are incomplete, performance in the unmeasured areas is likely to slip.

The achievement of tight results controls depends on: (III) The performance measures precision (cf., amount of “noise”) objectivity (cf., freedom of “bias”) timeliness Refers to the time lag between the individual's performance and the measurement of results. understandability What are we held accountable for? How can the measure be affected? The reinforcements provided Links between results and rewards should be: Direct: i.e., no ambiguity or buffers; Definite: i.e., no excuses.

Tight people controls … The tightness of personnel controls depends a great deal on the overlap between individual and organizational objectives: the larger the overlap, the lesser the perceived tightness Selection, training and job design are methods to implement personnel controls Cultural controls are often more powerful + stable Strong company cultures.

Control combinations ... In order to achieve tighter control, managers often use multiple forms of controls which can either reinforce each other or overlap ... The aim is: to achieve (tighter) control over all the factors critical to the entity’s success; or, to obtain a high degree of assurance that employees will behave as the organization wishes.

Management Control Systems Chapter 5: Direct & Indirect Control Costs Merchant and Van der Stede: Management Control Systems © Pearson Education Limited 2003

Cost of control ... Benefit of controls Costs of controls A higher probability that people will both work hard and direct their energies to serve the organization’s interests. Costs of controls Direct out-of-pocket costs Easy to quantify: cost of cash bonuses, internal audit staffs, etc.; Difficult to quantify: time spend on planning and budgeting activities, on pre-action reviews, etc. Harmful side-effects Behavioral displacement Gamesmanship Operating delays Negative attitudes.

Behavioral displacement ... Behavioral displacement occurs when the control system produces / encourages behaviors that are not consistent with the organization’s objectives. With results controls, it occurs when the results measures are incongruent with the organization’s true objectives; because … Poor understanding of the desired results: unwillingness to adapt production schedules to profitable rush orders sales volumes instead of profits, etc. Over-quantification: focus solely on quantifiable measures “Intangibles” are often overlooked. With action controls, it comes in the form of ... Means-ends inversion Employees are induced to pay more attention to what they do and lose sight of what they try to accomplish. Rigid, non-adaptive, bureaucratic behavior

Gamesmanship ... Refers to the actions managers take to improve their performance indicators without producing any positive economic effects. Two main alternatives Creation of slack resources Consumption of assets in excess of what is required; Slack can reduce manager tension and stimulate innovation; However, it causes inefficient resource allocation; Depends on information asymmetry, measurement precision, and degree of subordinate participation in setting performance targets. Data manipulation Trying to “look good” by fudging the control indicators; Falsification, i.e., reporting erroneous data; Data management, i.e., any action to change the reported result: Through accounting methods (e.g., reserves, write-offs) Through operating methods (e.g., delaying expenses).

Operating delays ... Mostly associated with action controls, notably, delays caused by: Pre-action reviews; Behavioral constraints. Bureaucratic organizations. When fast action is important, operational delays can be quite costly.

Negative attitudes ... Job tension, conflict, frustration, resistance, etc. Are often coincident with many harmful behaviors, such as, gaming, lack of effort, absenteeism, turnover, etc. Action controls often “annoy” professionals, but also lower-level personnel … Sometimes difficult to avoid: e.g., it is difficult for people to enjoy following a strict set of procedures for a long period of time ... Results controls ... Lack of employee commitment to the performance targets; targets are too difficult, not meaningful, not controllable. Performance evaluations are perceived as being unfair; The controls are implemented in a people-insensitive, non- supportive way.

Keep a behavioral focus ... There is no one best form of control ... What works best in one company (or area within a company), may not work in another ... e.g., accounting personnel vs. design engineers. Therefore, it is important to keep the focus on the people involved, because … It is their responses that will determine the success or failure of the control system ! The benefits of controls are derived only from their impacts on behaviors !

Management Control Systems Chapter 6: Designing and Evaluating MCS Merchant and Van der Stede: Management Control Systems © Pearson Education Limited 2003

Designing control systems ... Two basic questions: What is desired ? What is likely to happen ? If what is likely is different from what is desired, then two basic MCS-design questions must be addressed: What controls should be used ? How tightly should each be applied ?

What is desired ? Start from objectives and strategies ... They should be important guides to the actions that are expected, especially if they are specific … e.g., “Become a leader in the industry ” vs. “15% ROI and 20% sales growth.” Identify the key actions (KA) i.e., actions that must be performed to provide the greatest probability of success. Identify the key results (KR) i.e., the few key areas where things must go right for the business to flourish.

What is likely ? Three questions: Do employees understand what they are expected to do (key actions) or to accomplish (key results)? lack of direction Are they properly motivated? lack of motivation Are they able to fulfil their desired roles? personal limitations The discrepancy between what is desired and what is likely will determine the choice and the tightness of the management control systems.

Choice of controls ... The different types of controls (action, results and people controls) are not equally effective at addressing each of the control problems. Lack of direction Personal limitations motivation Results accountability Action controls - Behavioral constraints - Preaction reviews - Action accountability People controls - Selection / placement - Training - Provision of resources - Strong culture - Group-based rewards 

Start with 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 !?

Pros and cons of action controls ... 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, and adaptation. May cause sloppiness. May cause negative attitudes. e.g., little opportunity for creativity and self- actualization. Sometimes very costly e.g., preaction reviews

Pros and cons of results controls ... 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. Sometimes conflicting functions: Motivation to achieve targets should be “challenging”; Communication among entities targets should be slightly conservative.

Choice of control tightness ... What are the potential benefits of tight controls? In any organization, tight control is most beneficial over areas most critical to the organization’s success. What are the costs? Are any harmful side-effects likely?

Control system change ... As firms grow, their controls evolve, usually towards … Increased formalization of procedures ... for action accountability purposes; and/or Development of more elaborate information systems ... for results control purposes.

Keep a behavioral focus ... There is no one best form of control ... What works best in one company (or area within a company), may not work in another ... e.g., accounting personnel vs. design engineers. Therefore, it is important to keep the focus on the people involved, because … It is their responses that will determine the success or failure of the control system ! The benefits of controls are derived only from their impacts on behaviors!

Overview ... ? Can people be avoided? (e.g., automation, centralization) Control-problem avoidance Can you rely on people involved? Can you make people reliable? Have knowledge about what specific actions are desirable? Able to assess whether specific action was taken? results are desirable? Able to measure results? Yes No Action controls People controls Results controls ?

Depending on ... Action Control Results Control People Control Ability to measure results on important performance dimensions Knowledge of which specific actions are desirable High Low Excellent Poor Action Control and/or Results Control (e.g., large projects) (e.g., movie director, SBU-manager) People Control (e.g., research lab)

Cases Disctech, Inc. (p.207 ff.): Airtex Aviation (p. 238 ff.): What went wrong? What shoud Bill Winslow do to restore confidence at Disctech and prevent similar occurrences in the future? Airtex Aviation (p. 238 ff.): Did Airtex need a nes control system at the time of the takeover? Evaluate the control system that Frank and Ted implemented. Should anything be done differently?