Management Control Systems Summary

- 4 hours exam
- Basis for the exam: lecture slides, textbook and additional literature
- The lecture slides guide you through the textbook and additional literature.
- Focus: not the cases (even if you can use these as examples), but the body of
theoretical/ conceptual knowledge you gained during the lectures
- Questions are provided by all lecturers
- 2 pages are provided for answering the questions (provide guidance regarding the
extent of your answer)
- Please be clear and precise!
- 3 different types of questions: discussion, knowledge, consulting (the following
examples are examples from former exams)

Chapter 1

Why is management control important?

Management Control Systems (MCS) Refers to the set of procedures and

processes that managers and other participants use in order to help ensure the
achievement of their goals of their organizations, and it encompasses formal control
as well as informal personal and social controls.

Formal MCS consist of purposefully designed, information based and explicit

sets of structures, routines and processes that help managers to ensure that their
organizations strategies and plans are carried out or, if conditions warrant, that they
are modified.

Four types of Strategy / Structure / Control

Defender Maintain position in carefully chosen, narrow product-market

domain
Centralized functional organization
Efficiency focus, detailed and tight control

Prospector Create turbulence by continually bringing new products to the

market
Organic management arrangements, divisional organization
Effectiveness focus accenting innovation, entrepreneurial efforts, self-
evaluation at
lower levels

Analyzer Highly selective, copies successful innovations in dynamic domain

Dual cores: Centralized functional for stable domain, organic for its
dynamic sphere
Tight controls/ efficiency focus for stable domain; looser control/
effectiveness focus for
dynamic sphere

Reactor Well-defined but obsolete strategy, running blind

Politics and careerism dominate authority and responsibility
Mainly bookkeeping system

Strategy and control as linear process (critique)

The assumption is: rational decision by actors who act appropriately and efficient
in every situation
Strategy: Straightforward, top-down. Linear process

- Rational calculative understanding of control

- Similar linearity of control process
- Purpose of MC: provide direction/ask for appropriate behavior, avoid drift, aim at
alignment, optimal allocation of resources, task differentiation, reliability, timeliness,
service
Defining management control systems
The formal, information based routines and procedures used by managers to
maintain [diagnostic] or alter [interactive] patterns in organizational activities.
Shows importance of the responsible use of formal systems (classical control
and change)

Critical function MCS

Management control failures can lead to large financial losses, reputation damage,
and possibly even to organization failure.

Management control includes all the devices or systems managers use to ensure
that the behaviors and decisions of their employees are consistent with the
organizations objectives and strategies. These systems are referred to as
Management Control Systems.

Management Control Systems influence employees behaviors in desirable ways,

and consequently, increase the probability that the organization will achieve its
goals.

Function of MCS to influence behaviors in desirable ways

Benefit of MCS increased probability that the organizations objectives will be
achieved.

Objective settings
Knowledge of objectives is a prerequisite for the design of any MCS and, indeed,
forany purposeful activities.

Strategy formation
Having set the fi rms strategic intentions or objectives, strategies then defi ne how
organizations should use their resources to meet these objectives.

All the planning in areas as diverse as marketing, branding, fi nancing and training,
is designed around [our] objective as are [our] incentive [systems]. We have a
detailed road map, but it starts with a simple vision that everyone can understand
and buy into. Everything else we do comes on the back of those goals. In effect, we
can reverse engineer the business to those objectives.

Strategies emerge from a series of interactions between management, employees,

and the environment; from decisions made spontaneously; and from local
experimentation designed to learn what activities lead to the greatest success.

The formal strategic statements make it easier for management both to identify the
feasible management control alternatives and to implement them effectively. The
management controls can be targeted to the organizations critical success factors,
such as
- Developing new products
- Keeping costs down, or growing market share, rather than aiming more generally
at improving profitability in otherwise largely unspecified ways.

Managing director of Bank of Scotland:

I have seen businesses with 400-page documents outlining their strategy and its
clear they should have spent less time outlining the vision and more time thinking
about how they will deliver on it. You can have the best vision in the world but if you
cant put it into effect, you are wasting your time.

Strategic control involves managers addressing the question: Is our strategy

valid? Or, more appropriately in changing environments, they ask: Is our strategy
still valid, and if not, how should it be changed? All firms must be concerned with
strategic control issues, but the concern that a strategy may have become obsolete
is obviously greater in firms operating in more dynamic environments

Management control focuses on execution, and it involves addressing the

general question:
Are our employees likely to behave appropriately? This question can be
decomposed into several parts. First, do our employees understand what we expect
of them? Second, will they work consistently hard and try to do what is ex pected of
them; that is, will they pursue the organizations objectives in line with the
strategy? Third, are they capable of doing a good job? Finally, if the answer to any
of these questions is negative, what can be done to solve the management control
problems? All organizations who must rely on their employees to accomplish
organizational objectives must deal with these basic management control issues.
The tools for addressing strategic and management control issues are quite
different.
Managers addressing strategic control issues have a focus primarily external to the
organization; they examine the industry and their organizations place in it. They
contemplate how the organization, with its particular combination of strengths,
weaknesses, opportunities, and threats, can compete with the other firms in its
industry. Managers addressing management control issues, on the other hand, have
primarily an internal focus; they reflect how they can influence employees
behaviors in desired ways.

Bank of Scotland Corporate, proffers:

If you dont have [a strategy] but you know how to deliver, you might still make it.
Success in business is 25% strategy but 75% execution.

Management control involves managers taking steps to help ensure that the
employees do what is best for the organization. This is an important purpose
because it is people in the organization who make things happen. Management
controls are necessary to guard against the possibilities that people will do
something the organization does not want them to do, or fail to do something they
should do.

Need for MCS

The causes of the needs for control can be classified into three main categories:
- Lack of direction
- Motivational problems
- Personal limitations

Lack of direction
Some employees perform inadequately simply because they do not know what the
organization wants from them. When this lack of direction occurs, the likelihood of
the desired behaviors occurring will be haphazard. Thus, one function of
management control involves informing employees as to how they can direct their
contributions to the fulfillment of organizational objectives.

Motivational problems
Even when employees understand what is expected of them, some do not perform
as the organization expects because of motivational problems. Motivational
problems are common because individual and organizational objectives do not
naturally coincide individuals are self-interested.

Personal limitations
The final behavioral problem that MCSs must address occurs where employees who
know what is expected of them, and who may be highly motivated to perform well,
are simply unable to perform well because of any of a number of other limitations.
Some of these limitations are person-specific. They may be caused by a lack of
aptitude, training, experience, stamina, or knowledge for the tasks at hand. An
example is the too-common situation where employees are promoted above their
level of competence. When employees are over their heads, problems are nearly
inevitable. Sometimes jobs just are not designed properly, causing even the most
physically fit and apt employees to get tired or stressed leading to on-the-job
accidents and decision errors.

Good Management Control

Good control means that management can be reasonably confident that no major
unpleasant surprises will occur.

Control loss
The cost of not having a perfect control system can be called a control loss. It is the
difference between the performance that is theoretically possible given the strategy
selected and the performance that can be reasonably expected with the MCSs in
place.

Optimal control
Optimal control can be said to have been achieved if the control losses are
expected to be smaller than the cost of imple menting more con trols. Because of
control costs, perfect control is rarely the optimal outcome; what is optimal is
control that is good enough at a reasonable cost. The benchmark therefore is
adequate control rather than perfect control.

Avoidance means eliminating the possibility that the control problems will occur.

Activity elimination
Managers can sometimes avoid the control problems associated with a particular
entity or activity by turning over the potential risks, and the associated profits, to a
third party through such mechanisms as subcontracts, licensing agreements, or
divestment. This form of avoidance is called activity elimination.

The economics-based literature that focuses on whether specific activities

(transactions) can be controlled more effectively through markets or through
organizational hierarchies
is known as transaction cost economics.
Automation is a second avoidance possibility. Managers can sometimes use
computers, robots, expert systems, and other means of automation to reduce their
organizations exposure to some control problems. These automated devices can be
set to behave appropriately, and, when they are operating properly, they usually
perform more consistently than do humans.

Centralization of decision-making is a third avoidance possibility, which is a key

element of almost all organizations MCSs. High degrees of centralization, where all
the key decisions are made at top management levels, are common in small
businesses, particularly when they are run by the founder or owner.

When decisions are decentralized, results controls need to be in place to hold the
managers who enjoy the decision authority accountable for the results of their
decisions.

Subject of control:

Result control
Identification of what is a good result (= crucial)

Action control
Sets constraints for beneficial/ against harmful behavior

works effective, if:

(1) Awareness / clarity of wished actions (by analysing existing patterns or good
practices)
(2) Ability to observe that desired actions are taken (precise, objective, timeliness,
understandability)

Personnel control
Support of self-monitoring | Clarify expectations

Cultural control
Functions of organizational cultures
From an organizational point of view:
- Coordinating effect on behavior, substitute for other coordination and control
mechanism
- Motivation/ demotivation
- Building of team-spirit, employee retention, also for prospective employees
From an employee point of view:
- Orientation though reduction of complexity and insecurity for the single employee
- Stability, identification, sense making
Chapter 16
The effects of environmental uncertainty, organizational strategy and
multinationality on management control systems

Situational factors
Because the range of organizational settings is large, many relevant situational
factors exist. Examples of factors that affect one or more MCS choices include
differences in aspects of national culture; differences in the structure, stability, size,
growth, competition, and regulation of the industry or market; differences in aspects
of the ownership, size, strategy, and culture of the organization; differences in
production or service process complexity, technology, interdependence, or
routineness; and differences in management and employee experience, skills, and
training.

three important situational factors:

(1) Environmental uncertainty
(2) Organizational strategy
(3) Multinationality.

Environmental uncertainty refers to the broad set of factors that, individually and
collectively, make it difficult or impossible to predict the future in a given area.
Uncertainty can stem from changes (or potential changes) in natural conditions (e.g.
weather), the political and economic climate, or the actions of competitors,
customers, suppliers (including labor), and regulators. Uncertainty is higher where
the pace of technological change is higher. Uncertainty is also generally higher the
farther one tries to look into the future. Thus, uncertainty is higher in organizations
where the natural business cycle the lag between investment and the payoff from
that investment is longer.

An organizations corporate strategy determines what businesses it wants to be

in and how resources should be allocated among those businesses. One way of
viewing corporate strategies is to array them along a continuum from related to
unrelated diversification. Firms pursuing related diversification do not stray far from
their core business. They diversify in order to exploit economies of scope
stemming from relationships among their entities (business units). Firms pursuing
unrelated diversification are not concerned with restricting their focus to their core
business.

Business strategy, also sometimes called competitive strategy, defines how a firm
or entity within the firm (often called a strategic business unit) chooses to compete
in its industry and tries to achieve a competitive advantage relative to its
competitors. The strategy literature distinguishes two primary competitive
strategies: cost leadership and differentiation.9 A cost leadership strategy involves
offerings of relatively standardized, undifferentiated products; vigorous pursuit of
cost reductions; generation of volume to exploit economies of scale and to move
down the learning curve; acquisition of process engineering skills; and, as much as
possible, establishment of a routinized task environment. A differentiation strategy
involves the creation of a product or service that customers perceive as uniquely
differentiated from competitors offerings.

Multinational organizations (MNOs), those that operate in more than one country,
must understand how they must adapt their management practices, including
management control practices, to make them work in each of their international
locations. MNOs have many similarities with large domestic organizations in that
they are usually characterized by a high degree of decentralized decision making
and by management control through financial results controls. That said, controlling
MNOs is often more difficult than is controlling domestic organizations because
MNOs face a multidimensional organizational problem: they are organized not
only by function and/or product line, but also by geography.

Lecture 2
Chapters 2, 3, 4, 5, 6

Results control
Pay-for-performance is a prominent example of Result Control because it involves
rewarding employees for generating good results.
Identifying what are good results, as we will see, is crucial. The recent financial
crisis has thrown pay-for-performance, especially in banks, into sharp relief, where
rather than producing good results, pay-for-performance systems were said to have
bred bonus cultures of greed and short-termism.

Results controls create meritocracies. In meritocracies, the rewards are given to the
most talented and hardest working employees, rather than those with the longest
tenure or the right social connections. The combinations of rewards linked to results
inform or remind employees as to what result areas are important and motivate
them to produce the results the organization rewards.

Results controls influence actions or decisions because they cause employees to be

concerned about the consequences of their actions or decisions.

The organization does not dictate to employees what actions or decisions they
should take;
instead employees are empowered to take those actions or decisions they
believe will best produce the desired results.
Results controls also encourage employees to discover and develop their talents
and to get placed into jobs in which they will be able to perform well.

Result control not effective in every situation:

They are effective only where the desired results can be clearly defined and
adequately measured by the organization, and where the measured results can be
sufficiently controlled by the employee.

Results controls also can be particularly effective in addressing motivational

problems.
The implementation of results controls involves four steps:
- (1) defining the dimension(s) on which results are desired
- (2) measuring performance in the chosen dimensions
- (3) setting performance targets for employees to attain for each of the measures
- (4) providing rewards for target attainment to encourage the behaviors that will
lead to the desired results. Whereas these steps are easy to list, executing them
effectively can be challenging.

Performance targets are another important results control element because they
affect behavior in two ways. First, they improve motiva tion by providing clear goals
for employees to strive for.

Second, performance targets allow employees to assess their performance. People

do not respond to feedback unless they are able to interpret it, and a key part of
interpretation involves comparing actual performance relative to target.

Rewards or incentives are the final element of a results control system. The rewards
included in incentive contracts can be in the form of anything employees value,
such as salary increases, bonuses, promotions, job security, job assignments,
training opportunities, freedom, recognition, and power. Punishments are the
opposite of rewards. They are things employees dislike, such as demotions,
supervisor disapproval, failure to earn rewards that colleagues manage to earn or,
at the extreme, the threat of dismissal.

Effectiveness of Result Control

All need to be present:
1. organizations can determine what results are desired in the areas being
controlled;
2. the employees whose behaviors are being controlled have significant influence on
the results for which they are being held accountable; and
3. organizations can measure the results effectively.

An objective measure should be taken to mean here that it is not influenced by

personal feelings or interpretations
Timeliness refers to the lag between the employees performance and the
measurement of results

Two aspects of understandability are important. First, the employees whose

behaviors are being controlled must understand what they are being held
accountable for. This requires communication. Training, which is a form of
communication, may also be necessary if, for ex ample, employees are to be held
accountable for achieving goals expressed in new and different terms, such as when
an organization shifts its measurement focus from accounting income to, say,
economic value added.
Second, employees must understand what they must do to influence the measure,
at least in broad terms. For example, purchasing managers who are held
accountable for lowering the costs of purchased materials will not be successful
until they develop strategies for accomplishing this goal, such as improving
negotiations with vendors, increasing competition among vendors, or working with
engineering personnel to redesign certain parts.

Finally, measures should be cost efficient. A measure might have all of the above
qualities yet be too expensive to develop or use (e.g. when it involves third-party
surveys of customers, say, to collect the data), meaning that the costs exceed the
benefits.
Chapter 3
Action, personnel and cultural controls
Action controls involves ensuring that employees per form (do not perform)
certain actions known to be beneficial (harmful) to the organization.
They are feasible only when managers know what actions are (un)desirable and
have the ability to ensure that the (un)desirable actions (do not) occur.

Personnel controls are designed to make it more likely that employees will
perform the desired tasks satisfactorily on their own because the employees are
experienced, honest, and hard working, and derive a sense of self-realization and
satisfaction from performing tasks well.

Cultural controls exist to shape organizational behavioral norms and to

encourage employees to monitor and influence each others behaviors.

Action controls are the most direct form of management control because they
involve taking steps to ensure that employees act in the organizations best interest
by making their actions themselves the focus of control. Action controls take any of
four basic forms:
- Behavioral constraints
- Preaction reviews
- Action account ability
- Redundancy.

Behavioral constraints are a negative or, as the word suggests, a constraining

form of action control. They make it impossible, or at least more difficult, for
employees to do things that should not be done.

Preaction reviews involve the scrutiny of the action plans of the employees being
controlled. Reviewers can approve or disapprove the proposed actions, ask for
modifications, or ask for a more carefully considered plan before granting final
approval.

Action accountability involves holding employees accountable for the actions they
take. The implementation of action accountability controls requires: (1) defining
what actions are acceptable or un acceptable; (2) communicating those definitions
to employees; (3) observing or otherwise tracking what happens; and (4) rewarding
good actions or punishing actions that deviate from the acceptable.

Action controls work because, like the other types of controls, they address one
or more of the three basic control problems.

Personnel controls
Personnel controls build on employees natural tendencies to control or motivate
themselves.

First, some personnel controls help clarify expectations. They help ensure that each
employee understands what the organization wants.

Some personnel controls help ensure that each employee is able to do a good job;
that they have all the capabilities (e.g. experience, intelligence) and resources (e.g.
information and time) needed to do the job.

Personnel controls increase the likelihood that each employee will engage in self-
monitoring. Self-monitoring is an innate force that pushes most employees to want
to do a good job, to be naturally committed.

Personnel controls can be implemented through

(1) selection and placement
(2) training
(3) job design and resourcing.
In other words, finding the right people to do a particular job, training them, and
giving them both a good work environment and the necessary resources is likely to
increase the probability that the job will be done properly.

Selection and placement

But beyond screening new employees to mitigate security issues, organizations
primarily focus on matching job requirements with job applicants skills.

Training can provide useful information about what actions or results are
expected and how the assigned tasks can be best performed. Training can also have
positive motivational effects because employees can be given a greater sense of
professionalism, and they are often more interested in performing well in jobs they
understand better.

Cultural Controls
Cultural controls are designed to encourage mutual monitoring; a powerful form of
group pressure on individuals who deviate from group norms and values. Cultural
controls are most effective where members of a group have social or emotional ties
to one another.
- Codes of conduct
- Group rewards

The best chance to create a strong culture, however, seems to be early in an

organizations life when a founder can imbue the organization with a distinctive
culture.50 Cultural controls often have the advantage of being relatively
unobtrusive. Employees may not even think of the shared norms or the way we do
things around here as being part of the control system. As such, organizational
cultures can substitute for other formal types of controls.

The concept of tight control can certainly be applied to results controls. Tight results
controls might involve detailed (often line-by-line) and frequent (monthly or even
weekly) budget reviews of performance as well as lucrative incentives.
Diagnostic Control Systems
Purpose: Direction to achieve goals
Goal: No surprises
Fixed targets
Strategy as: Target

Interactive Control Systems

Purpose: Stimulate innovation, learning
Goal: Creative search
Targets: Constantly re-estimated
Strategy as: Vision (emergent approach)

Preaction reviews Tight preaction reviews of this kind involve formal scrutiny of
business plans and requests for capital by experts in staff positions, such as in the
Finance Division, and multiple levels of management, including top management.
Actions to avoid the problem

Tight-loose control
- Tight on objectives but loose on procedures (result control)
- Tight controls for some, few key actions or results
- Successful innovating companies have a mix of tight and loose controls

Lecture 3

Centralized organization
- The decision making and the direction of the company is concentrated at a high
level in a management hierarchy.
- A centralized structure can ensure a lower risk of leakage of confidential
information.
- Allows a faster, easier to undertake organizationwide activities.
- Extremely efficient regarding business decisions, but suffer from the negative
effects of bureaucracy.

Decentralized organization
- Rely on a team environment at different levels in the business.
- Decision making authority in lower-level managers or other employees.
- Autonomy to make decisions by different individuals with a variety of expertise
and knowledge.
- Struggle when multiple individuals have different opinions on a particular business
decision.

Decentralization delegating authority to subordinates for most decisions while

maintaining control over essential company wide matters.

Pros
- Flexibility and rapid response to change
- Management development
- Initiative
- Decisions close to facts
- Simplicity

Cons
- Coordination problems
- Unused competence
- Excess administration
- Lack of management competence

Advantages of Financial Results Control Systems

- Financial objectives are dominant in for-profit organizations.
- Financial measures provide a summary measure of performance.
- Most financial measures are relatively precise and objective.
- The cost of implementing financial results controls is often small relative to that of
other forms of management control.
Responsibility Centers They are identifiable segments within a company for which
individual managers have accepted authority and accountability. Responsibility
centers define exactly what assets and activities each manager is responsible for.

Four types of responsibility centers

Revenue centers
Responsibility for generating revenue (financial measure of the output) Example:
Sales managers.

Profit centers
Responsibility for some measure of profits (Revenues Costs).

Cost centers
Responsibility for some elements of costs (financial measure of the input).

Investment centers
Responsibility for Return on Investment (ROI) (ROE, ROCE, RONA, ROTC) in a unit.

Transfer pricing
- Sourcing decision: Should the good/ service be purchased outside or inside the
company?
- Transfer price decision: If inside, for what price should it be purchased?

Positive incentives rewards Things employees value.

Negative incentives punishments Things employees like to avoid.

Individuals tend to be more strongly motivated by the potential of earning rewards

than by the fear of punishment.
Purposes of incentives-performance dependent rewards
They provide three types of management control benefits:
- Informational (inform and remind employees of the importance of often-competing
results areas, e.g. cost, quality, etc)
- Motivational (employees need incentives to exert the extra effort required to
perform tasks well)
- Attraction and retention (use compensation packages to attract and retain a higher
quality set of employees)

Monetary incentives Money is an important form of reward that is linked to

performance:
- Salary increases
- Short-term incentives Based on the performance in the current year or less.
- Long-term incentives Based on the performance measured over periods greater
than 1 year and often related to the companys stock price.

Criteria for evaluating incentive systems

- Rewards should be timely
The discount rate employees apply to delayed rewards seems to be far greater than
the time value of money.

- Rewards should be durable

Rewards have greater value if the good feelings generated by the granting of a
reward are long-lasting, i.e., if employees remember them.

- Rewards should be reversible

To be able to correct mistakes of performance evaluations.
Promotions, for instance, are difficult to reverse.

- Rewards should be cost efficient

To stimulate the desired motivation at minimal cost.

Include intrinsic value

daily available
precise, accurate
objective
understandable
Types of uncontrollable factors:

1) Interdependencies

- Pooled interdependencies
e.g. entities use common resources or resources pools

- Sequential interdependencies
Outputs of one entity are the inputs of another entity (e.g. suppliers, deep vertical
integration)

- Reciprocal interdependencies
Bi-directional sequential interdependencies (e.g. transfer prices)

- Interventions from higher-level management

e.g. employ a person!, change supplier!, satisfy this customer!

2) Acts of nature, acts of man or political acts of parliament

(e.g. hurricanes, earth quakes, war, trade hinders) Unpredictable and
unreasonably events by natural or other forces over which employees have no
control Large, unexpected, one-off and totally uncontrollable

3) Economic and competitive factors

(e.g. inflation, currency, price war, financial crisis) Consumer demand and product
prices (e.g. competitor actions, changing consumer tastes, changing laws) Costs
of doing business (e.g. supply and demand of raw materials, labor and capital taxes)

Lecture 5
Corporate governance, important control-related roles, and ethics

Auditors
- Internal auditors are employees of the company who are auditing. They are known
as the eyes and ears of management.

- Internal auditors report to its audit committee and/or directors. They help to
design the companys organizing systems and help develop specific risk
management policies.

- External auditors are independent of management. They are employed by

professional service firms with no business ties to the auditee except performance
of the audit and a few advisory services (e.g. tax).

- External auditors report to the companys shareholders. They provide their

experienced opinion on the truthfulness of the companys financial statements and
perform work on a test basis to monitor systems in place.

Common audit types

The mechanisms and techniques are the same for all types of audits. However, the
motivations and end results are different.
The most common types of audits that serves diverse control purposes:

- Financial audits: Independent, external auditors give opinion on the financial

statements prepared by management and check if they are appropriate with
accounting standards.

- Compliance audits: Complying of activities or results with laws, rules, procedures

and administrative policies of various authorities. Both external and internal
auditors perform compliance-type audits. - -

- Performance audits: Provide an overall evaluation of the general performance or

the performance of an activity, function, entity, or company and its management.
Performed by broad-scope internal auditors or external auditors in a consulting role.

An audit is performed by an outside party

A control is exercised by an internal party
A control provides assurance to management
An audit provides assurance to outside investors.

Ethics
Ethics is the field of study that is used to prescribe morally acceptable behavior.
difficult subject for many managers to understand.
- When designing and using MCSs, managers should have a basic understanding of
ethics.
- Ethics is a field that provide methods that help to distinguish between right and
wrong and determine rules and guidance to individuals and groups.
- Ethical behaviors and value-maximizing behavior are not equivalent.

- Utilitarianism: Using this model, the rightness of actions is judged on the basis of
their consequences.
- Rights and duties: Every individual has certain moral entitlements in virtue of their
being human(e.g. rights to dignity, respect and freedom).
- Justice/fairness: People should be treated the same except when they are different
in relevant ways.
- Virtues: Examples of virtues are integrity, loyalty, and courage. They provide
guidance as to what is the right thing to do They are an element of personnel or
cultural control.

Common management control-related ethical issues

- The ethics of creating budget slack:

Negotiation processes between the budgeters and their higher-ups concerning
performance targets used at managerial levels, provide opportunities for those
proposing their budget to game the process.

- The ethics of managing earnings: Data manipulation problem, any action that
changes reported earnings (income statement or balance sheet item).

- The ethics of responding to flawed control indicators:

When the targets and prescriptions are not defined properly, they can motivate
behaviors that employees know are not in the organizations best interest.

- The ethics of using control indicators that are too good:

When controls are too tight or oppressive, they include unintended and /or
undesirable consequences, such as jobrelated tension and stress-related health
complaints.
Questions exam

Question 1

A) What are the potential challenges of business codes?

they are to some extent principle-based rather than merely rule based.
that employee misconduct arises because their companys code of conduct is not
taken seriously.32

The survey also indicates that the three most common drivers for code adoption are
to comply with legal requirements; to create a shared company culture; and to
protect or improve the corporate reputation.

The most commonly cited values embedded in the codes are integrity, teamwork,
respect, innovation, and client focus. The codes are most often directed at
employees; corporate responsibilities to shareholders are discussed in less than half
of the codes. More than 70% of the codes discuss the responsibilities of employees
regarding confidential information, accuracy of reporting (fraud), protection of
corporate property, and dealing with gifts and entertainment. Finally, most codes
contain a combination of principles and rules: 13% of the codes are principle-based,
35% are rule-based; the other 52% are a mix of the two.

B) Why is it difficult to implement an effective code of conduct?

Some codes of conduct fail because they are not supported by strong leadership
and proper tone from the top.

Top managers do not always appear committed to them, or worse, set bad
examples themselves through inappropriate conduct.

Question 2
The controllability issue:
A) Describe the controllability principle and the underlying logic

Organizations that hold employees accountable for uncontrollable factors bear

the costs of doing so because the vast majority of employees are risk averse; that
is, employees prefer that their perform ance-contingent rewards stem directly from
their efforts and not be affected by the vagaries of uncontrollables.

B) Three types of uncontrollable factors

Types of uncontrollable factors:

1) Interdependencies
- Pooled interdependencies
e.g. entities use common resources or resources pools

- Sequential interdependencies
Outputs of one entity are the inputs of another entity (e.g. suppliers, deep vertical
integration)

- Reciprocal interdependencies
Bi-directional sequential interdependencies (e.g. transfer prices)

- Interventions from higher-level management

e.g. employ a person!, change supplier!, satisfy this customer!

2) Acts of nature, acts of man or political acts of parliament

(e.g. hurricanes, earth quakes, war, trade hinders) Unpredictable and
unreasonably events by natural or other forces over which employees have no
control Large, unexpected, one-off and totally uncontrollable

3) Economic and competitive factors

(e.g. inflation, currency, price war, financial crisis) Consumer demand and product
prices (e.g. competitor actions, changing consumer tastes, changing laws) Costs
of doing business (e.g. supply and demand of raw materials, labor and capital taxes)

C) How can you control distorting effects of uncontrollable factors before a

performance measurement period starts?

Before the measurement period begins, they can define the results measures to
include only those items that employees can control or at least significantly
influence. Two primary methods can be employed to control for uncontrollables
before the measurement period: purchasing insurance and design of responsibility
structures.

C) How can you control distorting effects of uncontrollable factors after a

performance measurement period starts?

After the measurement period has ended, they can calculate (or estimate) and
adjust for the effects of any remaining uncontrollable factors using techniques such
as variance analysis, flexible budgeting, relative performance evaluations, or
subjective performance assessments.

This can sometimes be done objectively (through numerical calculation) using

variance analysis, flexible performance standards or relative performance
evaluations. Alternatively, it can be done subjectively through exercising evaluator
judgment. There are benefits and costs to each approach.
A variance analysis is a systematic analysis designed to explain how and why two
numbers are different.

Question 3
A) Three main purposes why companies implement planning and budgeting
systems?
Planning that is, decision making in advance. Employees tend to become
preoccupied quite naturally with their seemingly urgent, day-to-day exigencies.

Coordination The planning and budgeting processes force the sharing of in

formation across the organization. The processes involve a top-down
communication of organizational objectives and priorities, as well as bottom-up
communication of opportunities, resource needs, constraints and risks.

Motivation The plans and budgets become targets that affect manager
motivation because the targets are linked to performance evaluations and, in turn,
various organizational rewards.

B) Drawbacks
It is costly
Top management is visually attached to it which can cause employees to be
resistant and generate bad attitudes.

Alternative
Integrate a balance scorecard which will reflect finance, market, operations, and
people and organization.

C) While setting financial performance targets, the achievability in an important

issue to consider. Explain the relationships between performance targets and the
motivation of employees.

The plans and budgets become targets that affect manager motivation because the
targets are linked to performance evaluations and, in turn, various organizational
rewards.

Question 3
Finance ROI
A) ROI measures can create a suboptimization problem by encouraging managers to
make investments that make their divisions look good even though those
investments are not in the best interest of the corporation.

Congruence means that the performance of the actions defined in the control
system will indeed lead to the achievement of the true organizational objectives.

Alternative financial performance measure. Which one to solve sub-optimalization?

Summary measures I would suggest reflect the aggregate or bottom-line impacts
of multiple performance areas

In discretionary cost centers (sometimes called managed cost centers), such as

research and development departments and administrative departments (e.g.
personnel, purchasing, accounting, estates), the outputs produced are difficult to
value in monetary terms. In addition, the relationship between inputs and outputs is
not well known. Thus, evaluations
of discretionary cost center managers performances often have a large subjective
component to them. Control is usually exercised by ensuring that the discretionary
cost center adheres to a budgeted level of expenditures while successfully
accomplishing the tasks assigned to it.