Management Control Introduction and Theory PDF

Management Control Prof. Dr. Matthias Sohn Professur für Controlling  Chapter I: Introduction and Theory Management and Control Lecture 1 Learning Goals What is management control? How is it related to the management process? Why do organizations need management control?...

Management Control Prof. Dr. Matthias Sohn Professur für Controlling  Chapter I: Introduction and Theory Management and Control Lecture 1 Learning Goals What is management control? How is it related to the management process? Why do organizations need management control? What are the key theoretical foundations in management control research?  Overview Management and control Accounting and control Causes of management control problems How economics, psychology, and sociology theory informs management control 5 Management and Control 6  Management and Control “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.” (Merchant & van der Stede, 2017) “Management control systems are a combination of control practices designed and implemented by top managers to increase the probability that lower-level managers and employees will behave in ways consistent with the organization’s mission, goals and strategies.” (Hartmann et al., 2020) 7  Management and Control Credit Suisse Strategic mission (CS, 2021) The Credit Suisse Group purpose is at the core of everything we do. It underpins the value we create and has powered our progress for more than 160 years. It captures the essence of 'why' we exist as an organization. It motivates us when we come to work every day and serves as our North Star when we make decisions. Ultimately, it serves to define who we are and what we should be doing for our employees, clients and stakeholders. A revised code of conduct aligned to our new cultural values is available here: credit-suisse.com/codeofconduct Credit Suisse’s Group strategy has a clear focus on strengthening and simplifying the integrated model and investing in sustainable growth, while placing risk management at the very core of the Bank. With a global business and regional structure, Credit Suisse strengthens cross-divisional collaboration within the Bank to promote sustainable growth and economic profit. We serve our clients through four divisions: Wealth Management, Investment Bank, Swiss Bank and Asset Management. The global divisions are complemented by four strong regions: Switzerland, EMEA, APAC and Americas. This approach is reinforcing the integrated model with global businesses and strong regional client accountability. Credit Suisse continues to lead the bank and our clients into a sustainable future. The bank will build on its provision of sustainable investment solutions to clients through its ESG product offering and will be partnering with corporate clients to finance their sustainable transition. 8  Management and Control Credit Suisse example Our values (CS, 2021) Inclusion Inclusion builds an organization where everyone can thrive. Having a diverse workforce and inclusive culture is quite simply the right thing to do for our people and society. […] Meritocracy At Credit Suisse, we believe in meritocracy: an environment where people achieve success based on what they do – and not because of their background or connections. […] Partnership We believe in the power of partnership to achieve common goals. It means interacting in partnership with clients, suppliers and the communities in which we operate, to build lasting value. […] Accountability We are accountable to many stakeholders including shareholders, clients, regulators, society more broadly and of course each other. […] Client focus We are here to build lasting value for our clients with care and entrepreneurial spirit. Whatever our role, our client focus defines how well we deliver on our purpose. […] Trust Trust is hard to earn and easy to lose. Clients trust us with their financial assets and we in turn trust our clients and other counterparties to honor their agreements with us. […] 9  Management and Control Common Control Failures in the Banking and Insurance Sector Aggressive sales-based tactics (misseling financial services) Large financial losses Manipulation of interest rates (LIBOR) Reputation damage “Rogue trades” Possibly even Anti-money-laundering violations organizational failure 10  Management and Control “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.” (Merchant & van der Stede, 2017) “Management control systems are a combination of control practices designed and implemented by top managers to increase the probability that lower-level managers and employees will behave in ways consistent with the organization’s mission, goals and strategies.” (Hartmann et al., 2020) Management Processes of organizing Control resources and directing Backbone/end of the activities for the purpose of management process. achieving organizational objectives. 11  Management and Control Functions Resources Processes Product (or service) People Objective setting development Operations Money Strategy formulation Marketing/sales Machines Management control Finance Information Primary management Major types of resources Separates the management functions of the value that support management functions along a process chain. functions. involving objective setting, strategy formulation, and management control. 12  Management and Control Objective setting Objectives formalize organizational financial and non-financial goals. What is the purpose of the organization and for whom does it exist? Strategy formulation A strategy guides employees in pursuing their organization’s objectives. Formal strategies are often developed through systematic planning process. Strategic visions also come about through dynamic organizational processes. How does the organization reach its various goals? Management Control Management control focusses on the execution of strategy. 1. Do employees understand what firms expect of them? 2. Will employees work hard and try to do what is expected of them? 3. Are employees capable of doing what is expected of them? 13  Management and Control Old, Narrow View of MC Cybernetic or regulating system involving a single feedback loop. Old,Narrow view of MC goal control manager decisions results 14  Management and Control Broader View of MC Management control can be understood as a part of the overall managerial function: planning, organizing, staffing, leading, controlling. Focus on encouraging, enabling, or forcing employees to act in the organisation’s best interest. Management control is an active part in the target setting and strategy formulation process. Management controls are proactive rather than reactive. 15  Management and Control Broader View of MC goal control manager decisions results Examples: Staffing Development Culture building 16  Management and Control Broader View of MC goal control manager decisions results Examples: Delegation of authority Delegation of responsibility Prescribing behaviors 17  Management and Control Broader View of MC goal control manager decisions results Examples: Stating performance targets Linking performance to rewards Linking performance to promotion 18  Management and Control Organizational Goals - the Stakeholder vs Shareholder View of the Organisation Shareholder The “. Milton.. main owners there Friedman objective concern ishave one viewand 1970 the for ofonly legal managers a company one power social and is totoclose responsibility the give management down return theon ofcompany. business the control owners’ [. is.creating.] investments. to usevalue its resources for the owners. and engage in activities designed to increase profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception and fraud.” Stakeholder Input A ““… broad achievement R. Wecompany main Edward traditional defined from strategic concern Freeman all has view of “stakeholder” models the sense afor a number most corporation’s management 2002; as ofimportant the “any of 2020 in firm equally group apurpose”. put isstakeholders balancing or important tooindividual much “ the emphasis objectives. are that demands crucial canonaffect for from shareholders theor the company’s is affected stakeholders. to the survival. byexclusion the of other stakeholders who deserve consideration and to whom managers have obligations. […] managers also have duties to these other groups.” Shareholder view Stakeholder view The owners have the legal power to close down A company has a number of equally important the company. objectives. The main objective of a company is to give Input from all the most important stakeholders return on the owners’ investments. are crucial for the company’s survival. The main concern for managers and the A main concern for management is balancing the management control is creating value for the demands from the stakeholders. owners. “… traditional models of the firm put too much “... there is one and only one social responsibility of emphasis on shareholders to the exclusion of other business [...] to use its resources and engage in stakeholders who deserve consideration and to activities designed to increase profits so long as it whom managers have obligations. […] managers stays within the rules of the game, which is to say, also have duties to these other groups.” engages in open and free competition without deception and fraud.” “ We defined “stakeholder” in a Milton Friedman 1970 broad strategic sense as “any group or individual that can affect or is affected by the achievement of a corporation’s purpose”. “ 19 R. Edward Freeman 2002; 2020  Management and Control Organizational Goals - the Stakeholder versus Long-Term Shareholder versus Short-Term Shareholder View of the Organisation Organisation goals: Short-term Long-term shareholder view shareholder view Stakeholder view For whom does the The present owners The present and future All stakeholders organization exist? owners Time horizon Short Long Long Short-term profitability Long-term profitability Survival Main goal Mainly financial Financial and non- Financial and non- Performance measures financial financial Importance of Very high (present) High (all) High (all) shareholders Importance of other Rather low Rather high High stakeholders 20  Management and Control Stakeholder Theory of the Firm (Freeman 2010) Government Competitors Customers Shareholders Firm Suppliers Employees Civil society 21  Management and Control Stakeholder Theory of the Firm (Freeman 2010) Government Competitors Owners: high profitability and low risk Shareholders Customers Firm Suppliers Employees Customers: market share, customer satisfaction, market image Civil society Employees: employee satisfaction and competence Suppliers: price, quality, timely deliveries, good relationships Lenders: solvency, liquidity, good relationships Society: law-abiding, good ethics, CSR 22 corporation social responsibility  Management and Control Companies’ Sustainability Strategy and the Integration into Corporate Strategy 24% … not integrated 30% … integrated 40% 76% Ø since: 5.2 years 71% of large companies have a sustainability 30% Ø since: strategy, while only 15% of small companies do. 5.8 years Successful companies are significantly more likely … present … not present … not present, but planned to have a sustainability strategy, with 42% having one compared to 17% in less successful companies. 23 WHU Controller Panel 2022  Management and Control Technology Market Regulation - Innovation in product and processes - Rising power of Customer/Society - Carbon Emissions, Human rights - Big Data, AI, Social media - Changing demograpics of Investors - Globalization, Standardization Sustainability Targets Organizational Structure Performance Incentives measures Sustainability Performance Investors and 24 Sustainability Reporting other Stakeholders  Management and Control The collection of control mechanisms that are used to implement organizational goals and strategy is generally referred to as a management control package or a management control system (MCS). Management controls are typically categorized as – Formal vs. informal controls (Govindarajan & Anthony 1998) – Input, throughput, and output controls (Hartmann et al. 2020) – Results, action, cultural, and personnel controls (Merchant & van der Stede 2017) A major purpose of this lecture is to describe the factors affecting management control choice decisions and the effects on the employees and the organization when different choices are made. 25 Accounting and Control 26 Accounting and Control Management Management Control Management Accounting Accounting 27 Accounting and Control Management Control can be Understood as an Activity that uses Management Accounting Information Reasons for a strong connection Scorecard between management accounting and keeping management control: The importance of money as the overall measure of organizational Attention performance. The general importance of the directing organization’s overall accounting system to satisfy the information needs of the organization’s stakeholders. Problem solving 28  Q1: Why do organizations need management control systems? Why don’t employees naturally work in the best interest of the organization? 29  Why do organizations need Management Control Systems? - Causes of management control problems 30  Causes of management control problems Decentralization Knowledge Goal congruence Lack of resources Decentralized Decentralized Decentralized managers do not managers do not managers do not automatically automatically agree automatically have the understand the goals with organizational resources needed to and strategies goals and strategies act with organizational developed by higher developed by higher- goals and strategies level managers, nor level managers. developed by higher- how they can level managers. contribute to these goals and strategies. 31  Causes of management control problems Lack of Direction A study of 414 World-at- University Staff survey KPMG Survey Evidence Work members in mostly (2016) managerial positions 55% of the sample 81% believe that senior ½ of the employees respondents had a lack of management in their responded affirmatively to understanding of the organisations understand the question whether standards that apply to the value drivers. ”they had a clear their jobs. 46% say that middle understanding of the management purposes and objectives understands these of the [university]”. drivers. 13% believe non- management employees understand them. Organisational goals are NOT cascading down. 32  Causes of management control problems Motivational Problems Individual and organizational objectives do not naturally coincide (individuals are self-interested). MCSs can be employed to motivate positive or productive behaviors. Motivation should be the primary focus of effective MCSs. Personal Limitations May be caused by lack of aptitude, training, experience, stamina, or knowledge for the tasks at hand. Employees are boundedly rational. 33  Fraud and Corruption Total losses of around Organizations lose 5% Average loss per case $3.6 billion. of revenue to fraud. at around $1,780,000. Nearly half of the cases 42% of frauds were Corruption was the occurred due to lack of detected by tips (mostly most common scheme internal controls (29%) from employees). in every global region. or override of existing controls (20%). 34 Occupational Fraud Survey 2022  Top-down and bottom-up roles of management control Origin of the need for management Top-down role of management Bottom-up role of management control systems control systems control systems 1. Lower-level managers and Explain mission, goals strategies. Report on goal archievement; provide employees may not automatically Support coordination across business input when goals are unrealistic. understand the mission, goals and functions at decentralized level. Enable coordination and cooperation strategies of the organization, nor how with other decentralized units. they can contribute to them. 2. Lower-level managers and Motivate lower-level managers and Facilitate top managers to benefit employees may not atomatically employees to strive for the from the specialized skills and agree with the organizational mission, organizational mission, goals and knowledge of lower-level managers goals and strategies. strategies. and employees 3. Lower-level managers and Resource allocation, develop personal Enable lower-level managers to employees may not have the skills of lower-level managers and acquire the support and recources to resources needed to act according to employees. execute their responsibilities the organizational mission, goals and strategies. 35 How Economics, Psychology, and Sociology theory informs management control 36  Behavioral Theories The Standard Economic Model of Human Behavior The rational human actor makes deliberate choices to maximize utility (expressed in monetary terms). People give their time and efforts to an organization to get money (maximize their utility). Behavioral Economics People show irrational behaviours systematically that can be modelled and predicted. When designing control systems, organizations need to consider these systematic biases. 37  Behavioral Theories Agency Theory (Jensen & Meckling 1976) Principal employs an agent to perform tasks on their behalf. Agency problems:  Adverse selection: One party in a transaction possesses more information than the other and uses that information advantageously to the detriment of the less-informed party.  Moral hazard: One party takes excessive risks because they are protected from the consequences, because of contractual arrangements. Principal employs accountable to on behalf of Agent to perform Task 38  Behavioral Theories Prospect Theory (Kahneman &Tversky 2013) Losses loom larger than gains. People overestimate the likelihood of events with a very small probability. Theoretical foundation of the endowment effect. 39  Behavioral Theories Sociological Model of Human Behavior People are members of various groups in which certain rules and patterns of behavior exist. Groups have rituals and conventions that shape individual judgments. “Individual” preferences (in terms of utility) are largely shaped by the environment. Very important for MCS is the differentiation between formal and informal power in organizations. 40  Behavioral Theories The Psychological Model of Human Behavior Human behavior is driven by a multitude of beliefs and desires that originate from genetic, cognitive, and social “heterogeneity”. Greatly helps us in understanding human motivation, i.e., the direction of effort, the amount of effort, and the persistence of efforts towards goals. 41  Behavioral Theories Important Psychological Theories that inform Management Control 1. Theory of bounded rationality (Simon 1990) Individuals have limited computational and motivational resources. 2. Goal setting theory (Locke & Latham 2006) Individuals are motivated by clear and challenging goals. 3. Self-determination theory (Deci & Ryan 2012) Extrinsic vs. intrinsic rewards (labor ipse voluptas). 4. Theories on stable values and traits (Roccas et al. 2002) Individuals hold a set of stable values that shape behaviours in organizations. 42  Behavioral Theories Models of Human Behaviour – an Overview Economic model Psychological model Sociological model Control is about: Agency problems Behaviour Behaviour of groups Control serves: Contracting Motivation The structures that create power, identity and cultue Key control issue: Indicators to measure System to motivate Optimal distribution of value ceation managers power such that individual are enabled Model of man: Self-interested utility Social creature with Culturally raised an maximizer various “needs“ educated group member Focus lies with: The superior‘s problem Managers‘ behavioural Managers‘ identity, of control patterns values and norms Good control Measure and reward Everything to motivate Support managers‘ practice: value creation managers identity, values and norms Motivation: Implied in utility function A complex issue Drives are determined by background and group needs 43  Behavioral Theories Management Control and Human Behavior – Some Principles Managers and employees should be motivated Management control systems should by goals defined by top management. motivate managers and employees Managers and employees should be motivated by the incentives they get for their efforts. Management control systems should Managers and employees should be encouraged to learn and innovate. consider managerial and employee Managers and employees’ implicit knowledge abilities and inabilities should be encouraged and trained. Culture matters significantly for the design and Management control systems should effectiveness of management control systems. support a caring and ethical environment 44  Summary Management – processes of organizing resources and directing activities for the purpose of achieving organizational objectives. 1. Objective setting 2. Strategy formulation (defines how organizations should use their resources to meet the objectives) 3. Management control (internally focused on execution) Management Control System (MCS) – combination of various control mechanisms. Causes for need of control is decentralization, which comes with: 1. Lack of direction 2. Motivational problems 3. Personal limitations Management Control research and practice is heavily informed by theories from Psychology, Economics, and Sociology. 45  Business Case Study I - Strategic Mission Statements and their Implications for Management Control - SNCF vs. Trenitalia vs. DB 46  Railroad Case 20.7€ Billion revenue 13.7€ Billion revenue 56.3€ Billion revenue 276271 employees 85361 employees 338000 employees 30000 km railway 27227 km railway 33400 km railway network network network 47  Railroad Case SNCF Our values SNCF is on the move. Our mission, our goals and the tools we use to achieve them aren’t frozen in time—we constantly adapt them to meet the needs of our stakeholders. What endures is our corporate DNA—the core values that unite the men and women of the five companies that belong to SNCF Group. By 2030 we plan to be a world-class champion of sustainable mobility for both passengers and freight, with rail as our core business and France as our touchstone country. In 2020, we adopted Tous SNCF (“All SNCF”), a 10-year strategic plan that created the structure and interim targets we need to get there. Tous SNCF is built on 4 pillars: putting people at the heart of everything we do expanding our role as a force for regional development and vitality helping to make the ecological transition a reality leading the European market in digital mobility Commitment We’re proud to serve the public. Day in and day out, we work hard for our customers and for regional communities across France, and we’re always ready to step up in challenging situations. Efficiency Every day, we harness our combined skills and expertise to operate over 15,000 trains. Because mobility is essential—and because we believe in using taxpayer money wisely—continuous improvement is an imperative for each of us as we do our work. Openness At SNCF, we believe that diversity is a powerful asset, which is why we listen closely to the needs and expectations of our customers, our partners and our fellow citizens. We’re curious. We’re alert to our changing society. And we’re constantly looking for new ideas that will move us forward. 48  Railroad Case Trenitalia Trenitalia, a wholly owned subsidiary of FS Italiane SpA, has among its objectives to guarantee the country a range of quality services, capable of satisfying, nationally and in Europe, the mobility needs of travelers, committing itself to make the industrial structure more and more modern and functional and to direct the company towards objectives of technological development and cost-efficient turnover, working to compete, with loyalty and professionalism. At the basis of its mission, Trenitalia places service safety, quality, workers' health, environmental protection as essential conditions, and considers the centrality of customer relations as the way to achieve stable competitive advantage and create shareholder value. Committed to meeting customer needs and market demands, Trenitalia's entire organization ensures ever-higher safety standards and implements development and modernization plans while respecting social and environmental sustainability. Much of the know-how of 160 years of Italian Railways history has flowed into Trenitalia: an invaluable heritage that, now free from rigidity and constraints, is daily enriched with new knowledge and skills as a driver for operations, in terms of methods, tools and guidelines. Trenitalia intends to position itself among the main players in the European rail transport market and it is in this perspective that in the coming years it is necessary to pursue, the following strategic objectives: Consolidation in Italy: presiding over the national market share of mobility services; Expansion in Europe: entry into new profitable markets thanks to the capacity available as a result of the deliveries of the new HS fleet; Modal integration of mobility services; Consolidation in Italy and development in Europe in rail transport; Growth in "road" activities in Italy; Renew fleets (trains and buses) for Local Public Transport. 49  Railroad Case Deutsche Bahn Our inner ambition is to ensure that Germany has a strong rail system (“Strong Rail”). Building a strong rail system will help our country to overcome existential challenges: For the climate. No other motorized transport today is as climate-friendly as the rail system. In addition, no other means of transport is as electromobile – and therefore as low in greenhouse gases and pollutants – as rail, which holds the largest market share of e-mobility in Germany. No other mass transport can achieve a 100% share of renewable energies as quickly – by 2038, we will have converted our traction current in Germany to 100% ecopower. A strong rail system is therefore an essential prerequisite for meeting the climate protection targets of the Federal Government and the EU, because a reduction in emissions in the transport sector cannot be achieved without a massive shift in the mode of transport towards the climate-friendly rail system. Strong Rail is a crucial beacon of hope for our climate. In concrete terms, the shift in the mode of transport and other climate protection measures through Strong Rail means: annual savings of up to 10.5 million tons of CO₂ per year in the transport sector in Germany. For people. By 2050, almost 85% of the population of Germany is expected to live in metropolitan areas, compared to about 75% in the early 2020s. A consequence: the growing amount of passenger and freight transport will present our cities and metropolitan areas with even more logistical, social and ecological challenges than they currently face. The situation is different in many rural areas. Here, one of the key challenges is preserving individual mobility. In the future, a strong rail system can continue to enable vibrant, urban coexistence and the accessibility of rural regions, because it will enable real mobility and allow travel time to be used in a variety of ways, without wasting valuable hours in our days. In concrete terms, a strong rail system for people means a doubling of passenger numbers in rail passenger transport and thus five million fewer car journeys and 14,000 fewer air journeys in Germany per day. The five million car trips a day correspond to about half of all daily shopping trips made by car. In the case of air travel, every sixth domestic flight would be replaced. 50  Railroad Case Deutsche Bahn For the economy. Demand for freight transport is expected to continue to grow steadily in the coming decades. At the same time, commutes between metropolitan areas and surrounding regions as well as increasing flexibility in terms of workplaces and working hours will lead to higher demand on work-related mobility. With a strong rail system, this rising volume of traffic can be overcome, enabling environmentally friendly economic growth. A strong rail system is therefore a crucial competitive factor for Germany’s future economic success. It secures Germany’s position as a leading exporting nation. With it, we are competing for the most modern transport logistics, and developing decisive technological stimuli for the future. In concrete terms, Strong Rail for the economy means: growth in the modal share of rail freight transport from 18% in the early 2020s to 25%. This corresponds to about 13 million fewer truck journeys per year on German roads. For Europe. Germany has a special responsibility for the future of Europe. As well as being the most populous country, it is also the geographic and economic heart of the continent. This role means Germany must be the pioneer and set the precedent for advancing European objectives. Climate protection, jobs, economic growth, social prosperity: much depends on Germany’s and Europe’s transport routes remaining future-proof. Strong Rail is the necessary link between East and West, and North and South. It is not only an important instrument for cultural understanding between the individual countries, it is also a decisive factor for the joint achievement of the set goals. In concrete terms, Strong Rail for Europe means: working together to realize a European network. 51  Railroad Case Questions 1. How concretely are the strategic goals and corporate values specified in the mission statements? Do the mission statements specify for whom the organization exists (i.e., stakeholders)? 2. Do the mission statements contain any information on what measurable output variables can be used for control purposes? If not, can you think of any ways to operationalize/measure the strategic goals mentioned in the mission statements? 3. Do the mission statements specify the targets, i.e., what should be achieved and in which time frame? 52  Literature Deci, E. L., & Ryan, R. M. (2012). Self-determination theory. In P. A. M. Van Lange, A. W. Kruglanski, & E. T. Higgins (Eds.), Handbook of theories of social psychology (pp. 416–436). Sage Publications Ltd. Freeman, R. E. (2010). Strategic management: A stakeholder approach. Cambridge university press. Friedman (1970). The social responsibility of business is to increase its profits. New York Times Magazine. Govindarajan, V., & Anthony, R. N. (1998). Management control systems. Irwin McGraw-Hill. Hopwood, A. G. (1976). Accounting and human behaviour. Prentice Hall. Hartmann, F., Kraus, K., Nilsson, G. Anthony, R. & Govindarajan, V., (2020). Management Control Systems: European Edition. McGraw Hill. Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305-360. Kahneman, D., & Tversky, A. (2013). Prospect theory: An analysis of decision under risk. In Handbook of the fundamentals of financial decision making: Part I (pp. 99-127). Locke, E. A., & Latham, G. P. (2012). Goal setting theory. In Motivation: Theory and research (pp. 23-40). Routledge. Merchant, K. A., & Van der Stede, W. A. (2007). Management control systems: performance measurement, evaluation and incentives. Pearson education. Roccas, S., Sagiv, L., Schwartz, S. H., & Knafo, A. (2002). The big five personality factors and personal values. Personality and social psychology bulletin, 28(6), 789-801. Roemer, J. E. (1996). Theories of distributive justice. Harvard University Press. 53 Simon, H. A. (1990). Bounded rationality. In Utility and probability (pp. 15-18). Palgrave Macmillan, London. Management Control Prof. Dr. Matthias Sohn Professur für Controlling  Chapter I: Introduction and Theory  Cultural Controls and the Evaluation of Control Systems Lecture 3 Learning Goals What are personnel and cultural controls ? How do these more informal controls address the control problems? What types of costs do management control systems produce? How should organizations make control choices?  Overview Personnel controls Cultural controls Personnel/cultural controls and the control problems Effectiveness of personnel/cultural controls Control costs Choice of controls Maintaining good control 5 Personnel Controls 6  Personnel controls Personnel Control Builds on Employees’ Natural Tendencies to Control or Motivate Themselves. Serve three purposes: 1. Clarify expectations. 2. Ensure that each employee can do a good job. 3. Self-monitoring Personnel controls can be implemented through: 1. Selection and placement 2. Training 3. Job design and resourcing 7  Personnel controls Selection and Training Job design and placement provision of necessary resources Screening new employees What actions or results are => matching job expected? Employees need a particular requirements with job How can the assigned tasks set of resources available to applicant’s skills. be performed? them in order to do a good Can have positive job: motivational effects, greater  Information sense of professionalism.  Equipment  Supplies  Staff support  Decision aids or freedom from interruption 8 Cultural Controls 9  Cultural controls Cultural controls are established to encourage mutual monitoring among individuals in organizations. Powerful form of group pressure on individuals who deviate from group norms and values. Cultures are built on shared traditions, norms, beliefs, values, ideologies, attitudes, and ways of behaving. Embodied in written and unwritten rules. Remain relatively fixed over time. Benefits of direction and cohesiveness. 10  Cultural controls Cultural Controls Value-based Clan Controls Controls Symbol- based Controls 11 Q1: How can organizations shape their culture? 12  Cultural controls Codes of Conduct Most organizations above minimal size attempt to shape their organizational culture through:  Codes of conduct  Vision  Codes of ethics  Management philosophy  Statements of mission Broad, general statements of organizational values, commitments to stakeholders. Effective codes aim to shape a shared company culture and to protect or improve the organization’s reputation. 13  Cultural controls Group Rewards Incentive plans based on collective achievement can come in many forms:  Bonus  Profit sharing  Gain sharing plans Provide compensation based on overall company or entity (rather than individual) performance. Encourage broad employee ownership of company stocks. Create a culture of “ownership” and “engagement”. 14  Cultural controls Other Approaches to Shape Organizational Culture Intra- Setting the organizational Physical Social Managers as proper tone at transfers or arrangements arrangements role models employee rotation the top Statements should Creating a Help transmit be consistent with culture of Office plans Dress codes the type of culture culture they are trying to integrity in create organizations Actions and Institutionalized behaviors should Architecture habits be consistent with their statements Interior design Behaviors 15  Cultural controls 23% Transparency and 56% open information exchange 21% Corporate culture Moderately pronounce 19% 35% 50% Less pronounced 23% 58% 15% Very pronounced Constructive critique and Goal orientation and the power of the better argument accountability 16 WHU Controller Panel 2022  Cultural controls “How strongly is sustainability integrated in your corporate culture?” Less strongly Rather strongly Small companies (34%) perceive a sustainability culture 35% 12% as less important, while only 26% 18% of large companies see sustainability as less significant 22% within their corporate culture. A sustainability culture is firmly 18% established in companies that have a sustainability strategy or 13% have even established a dedicated sustainability 10% department. 9% 2% 1 2 3 4 5 6 7 Not at all Very strong 17 WHU Controller Panel 2022 Personnel/Cultural Controls and the Control Problems 18  Personnel/cultural controls and the control problems Control Problems Addressed of Effecting Personnel and Cultural Controls Lack of direction Motivational problems Personal limitations Ways of effecting personnel controls Selection and placement x x x Training x x Job design and provision of x necessary resources Ways of effecting cultural controls Codes of conduct x x Group based rewards x x x Intra-organizational transfers x x Physical arrangements x Tone at the top x 19 Effectiveness of Personnel & Cultural Controls 20  Effectiveness of personnel/ cultural controls All organizations rely to some extent on their employees to guide and motivate themselves Culture – Hard to imitate. – Differentiate organizations from their competitors. – Distinctive advantages over results and action controls. – Usable to some extent in almost every setting ”We consider hiring the most important decision we can make. We hire the smartest, most inspired people we can find, give them the resources they need, then get out of their way.” – William Cronk 21  Effectiveness of personnel/ cultural controls The best chance to create a strong culture: – Early in organization's life. – Founder can imbue the organization with a distinctive culture. 22  Effectiveness of personnel/ cultural controls A global survey of more than 1,800 CEOs and CFOs shows: Culture is important at firm. more than 90% Culture is among top5 things that make the company valuable. 78% Believe improving firm’s corporate culture would improve 92% firm’s value. Corporate culture is exactly where it needs to be (potency & only 15% insufficiency). More then 50% of executives said corporate culture influences:  Productivity  The value of the firm  Creativity  Growth rate  Profitability 23 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2805602 Control Costs 24  Control costs Monetary Costs include all the out-of-pocket, monetary costs required to design and implement the MCS Easy to identify: – Costs of paying cash bonuses (arising from incentive compensation for results control) – Costs of maintaining an internal audit (ensuring compliance with action-control prescriptions) Can only be estimated: – Time employees spend in planning and budgeting activities or preaction reviews. 25  Control costs Behavioral Displacement MCS produces, and actually encourages, behaviors that are not consistent with the organization’s objective. Produced by Results Controls when an organization defines sets of results that are incongruent with the organization’s ”true” objectives. Produced by Action Controls through means-ends inversion: employees pay attention to what they do (the means) while losing sight of what they are to accomplish (the ends). 26  Control costs Gamesmanship Actions that employees take to improve their performance indicators without producing any positive effects for the organization Produced by Results Controls when managers or employees fudge data, report false information, engage in corporate window-dressing etc. due to information asymmetry in a principal- agent relationship. Operating Delays Arising from approvals requiring multiple signatures from managers at various levels in the hierarchy. 27  Control costs Data Manipulation Involves fudging the control indicators through: Falsification:  reporting erroneous data (data are changed). Data management:  any action undertaken to change the reported results (such as sales numbers or profits).  Through either accounting or operating means. Accounting methods:  use of the flexibility available in either the selection of accounting methods or the application of those methods, to ”manage earnings”. Operating methods  Try to delay the timing of discretionary expenditures (such as maintenance).  Affect the size and/or timing of cash flows 28  Control costs Negative Attitudes Job tension Conflict Frustration Resistance Produced by Results Controls when employees are not committed to targets they consider too difficult, not meaningful, not controllable, or imprudent. Produced by Action Controls as preaction reviews can be frustrating if the employees being reviewed do not perceive the reviews as serving a useful purpose. 29  Control costs Control Types and Possible Harmful Side Effects Behavioral Operating Negative Type of control Gamesmanship displacement delays attitudes Results controls Results accountability x x x Action controls x Behavioral constraints x x Preaction reviews x x Action accountability x x x Redundancy x Personnel/cultural controls Selection and placement x Training x Provision of necessary resources Creation of a strong x organizational culture 30 Group-based rewards x Choice of Controls 31  Choice of controls Control Types and Control Problems Control problems Control types Lack of direction Motivational problems Personal limitations Results controls Results accountability x x Acton controls Behavioral constraints x Preaction reviews x x x Action accountability x x x Redundancy x Personnel/cultural controls Selection and placement x x x Training x x Provision of necessary x resources Creation of a strong x x organizational culture Group-based rewards x x 32  Choice of controls Personnel/Cultural Controls as an Initial Consideration Managers should start by considering how adequate personnel or cultural controls will be. – Worthy of first consideration. – Relatively few harmful side effects. – Relatively low out-of-pocket costs. Culture was considered one central reason for the calamity in the financial services sector following the 2009 financial crisis. Necessary to supplement personnel/cultural controls with controls over actions, results, or both. 33  Summary Personnel and cultural controls: – Self- and mutual monitoring – Encouraged in a number of ways: Personnel and cultural controls, sometimes referred to as soft controls, have become more important in recent years Training Provision of Job design necessary Group rewards resources Codes of conduct No one form of control is optimal in all circumstances. Keep the focus on the people involved, because their responses will determine the success or failure of the MCS. The benefits of management control are derived only from their impacts on behaviors. 35  Literature Hartmann, F., Kraus, K., Nilsson, G. Anthony, R. & Govindarajan, V., (2020). Management Control Systems: European Edition. McGraw Hill. Merchant, K. A., & Van der Stede, W. A. (2007). Management control systems: performance measurement, evaluation and incentives. Pearson education. 37 Management Control Prof. Dr. Matthias Sohn Professur für Controlling  Chapter I: Introduction and Theory Results and Action Controls Lecture 2 Learning Goals What are results controls and why are they so prevalent in practice? What makes results controls effective? How do organizations implement actions controls? What makes action control effective? What control problems do results and action controls target?  Overview Results controls in practice Prevalence of results controls Results controls & the control problems Elements of results control Action controls and the control problems Prevention vs. Detection Conditions determining the effectiveness of action controls 5 Results Controls in Practice 6  Results controls in practice Results control involves identifying good results, setting the right targets, and rewarding employees for generating good results. Widely used, even increasingly in the non-profit sector. Results controls establish Meritocracies: most talented and honest-working employees are rewarded. Industries ”Workers can earn more than their bosses and high-school-educated farm boys from Kansas can rise faster than Ivy League MBAs and end up running multibillion-dollar divisions” - Charles Koch 7 Results controls in practice Cause employees to be concerned about the consequences of their actions or decisions. Organizations do not dictate to employees what actions or decisions they should take. Employees are empowered to take those actions or decisions they believe will best produce the desired results. Employees are encouraged to discover and develop their talents. Do not operate in isolation. Cannot be used in every situation. 8 Prevalence of Results Controls & Decentralization 9  Prevalence of results control Philosophy of decentralization at General Motors Results controls under Alfred Sloan’s leadership were built on a return-on-investment performance measure to: – control the behaviours of employees with decision authority. – encourage an entrepreneurial thinking and allowing employees to use their knowledge to reach a set of targets. Example: Sanofi Decentralized disease-based units, each with its own departments for R&D, regulatory affairs, marketing, and sales. Purpose: Identify promising drugs more quickly and weed out failures before spending large amounts of money. “Performance culture” that encourages both operating discipline and greater responsiveness to local business needs. 10 Q1: What are the problems with decentralization combined with results controls? 11  Prevalence of results control Problems of decentralization: – loss of economies of scale  increased costs and inefficiencies  inconsistencies and complexity ”…creates more opportunities for corruption by increasing the number of decision makers with the power to exploit decision-making process for personal gain” (Merchant and Van der Stede, 2017) 12  Prevalence of results control Example: Carrefour in China Local managers are empowered to take charge of virtually all aspects of running their stores. ?