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Unformatted text preview: 2. Types of controls, control system costs
Reasons for implementing control systems: –To Influence Behavior –Goal Congruence: Individual Vs. Organization –Increase Motivation
Underlying theories: Underlying –Agency theory –Expectancy theory –Equity theory
Bus 424 second lecture presentation 1 Agency Theory Agency
– P-A relationship in which P assigns responsibility to A P-A and A is contracted to work on behalf of P and – Problems in P-A relationship
» Information Asymmetry » Agents’ actions are unobservable or costly » Self interest individuals (maximizing own wealth) » Dislike work – Control mechanisms: monitoring or incentive Control compensation compensation Bus 424 second lecture presentation 2 The Principal-Agent Model
External Factors Accounting Top Management
Pays Manager on the Basis of the Performance Report Uncertainty Prepare Performance Report Outcome of manager’s decision and effort Risk Aversion Decision Making Effort Receives Pay
3 Bus 424 second lecture presentation Manager Expectancy theory: • People are motivated to get the rewards that People they desire and prevent the penalties that they wish to avoid. wish • To motivate people to behave in a particular To way, employment contract must contain two things: things: 1. Provide rewards that are desirable 2. Provide a high probability that efforts 2. will lead to performance and, in turn, rewards rewards
Bus 424 second lecture presentation 4 •Expectancy theory: Effort Performance Rewards Intrinsic/Extrinsic Expectancy or subjective probability Expectancy or subjective probability Bus 424 second lecture presentation 5 Inputs: Outputs: •Time, efforts, loyalty, hard work, Love, Intimacy, Security, Esteem, Equity theory: commitment, ability, adaptability, Salary, Employee Benefit, Expenses, flexibility, tolerance, determination, Recognition, Reputation, • Perceptions of fair/unfair distributions of resources enthusiasm, personal sacrifice Responsibility within interpersonal relationships
Individual’s Outputs Individual’s own inputs = Relational partner’s Outputs Relational partner’s inputs • Perceived under or overrewarded will experience distress, leading to efforts to restore equity within the relationship • No need for equal outcomes nor equal inputs • Implications for management compensation system?
Bus 424 second lecture presentation 6 Limitations:
– – – – Corporate citizenship Not for profit organization (make a difference) Values and core beliefs Pride and accomplishment Purpose of MCS: Goal Congruence: consistency between Purpose self-interest and organizational goal self-interest Bus 424 second lecture presentation 7 Factors that influence goal congruence:
– Informal Factors
» External value: work ethic (loyalty, diligence, social value) » Internal value: History and top management leadership style (common Internal belief, attitudes, norms, relationships, assumptions) – Formal Factors:
» Rules: Job descriptions, manuals, SOP, etc » MCS Bus 424 second lecture presentation 8 Types of controls Goals Strategy CPV Operating Activities Input Process
Bus 424 second lecture presentation Result/Output
9 Results controls Involves rewarding individuals for generating Involves good results (or punishing them for poor results). good
» Results accountability It influences actions because it causes employees It actions to be concerned about the consequences of the consequences actions they take. actions
» However, employees’ actions are not constrained; However, not » On the contrary, employees are empowered to On empowered take whatever actions they believe will best produce the desired results. produce Bus 424 second lecture presentation 10 Performance Measurement Performance Framework Framework
1. What counts, gets measured 4. What gets rewarded, really count Competitive Strategy 2. What gets measured, gets done 3. What gets done, gets rewarded Bus 424 second lecture presentation 11
11 Elements of Result Control Defining the performance dimensions
» What you measure is what you get; hence, » If not congruent with the organization’s objectives, the controls will actually If encourage employees to do the wrong things! encourage Measuring performance on these dimensions
» Objective Objective » Subjective: managerial characteristics (e.g., critical thinking, being a team Subjective: player) player) Financial: market-based (e.g., stock price) or accounting-based (e.g., ROA) Non-financial (e.g., market share, customer turnover, customer satisfaction) Setting performance targets
» Motivational effects Providing rewards (or punishments)
» Monetary and non-monetary lecture presentation Bus 424 second
12 Conditions Results controls work best only when all of Results all the following three conditions are present: the three – Superiors/managers must know what results are desired in the Superiors/managers areas being controlled. areas – The individuals whose behaviors are being controlled must have The significant influence on the results in the desired performance dimensions. dimensions. – Superiors/managers must be able to measure the results Superiors/managers effectively. effectively.
Bus 424 second lecture presentation 13 Ability to influence results The person whose behaviors are controlled must be able to affect The the results in a material way in a given time span. the » Controllability principle Results controls are useful only to the extent that they provide Results information about the desirability of the actions that were taken. information » If the results are totally uncontrollable, the controls tell us nothing about the actions that were taken: Good actions will not necessarily produce good results; Bad actions may similarly be obscured. Bus 424 second lecture presentation 14 Ability to measure results effectively The “effectiveness” of results measures must be judged by their » Ability to evoke the desired behaviors Results measures should be:
» Precise; » Objective; » Timely; » Understandable.
Bus 424 second lecture presentation 15 Pros and cons of results controls
PRO CON Behavior can be influenced while allowing significant while autonomy. autonomy. They yield greater employee They commitment and motivation. commitment 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 Often whether good actions have been taken. whether They shift risk to employees (because They risk of uncontrollable factors). Hence, they of often require a risk premium for risk risk averse employees. averse Sometimes conflicting functions: – Motivation to achieve » targets should be “challenging” – Communication among entities among » targets should be slightly targets conservative conservative
16 Bus 424 second lecture presentation Action controls Ensure that employees perform (or do not perform) Ensure certain actions known to be beneficial (or harmful) certain to the organization. Prevention/detection
– Most action controls are aimed at preventing undesirable behaviors. Bus 424 second lecture presentation 17 Effectiveness of action controls They are usable and effective only when managers: – Know what actions are desirable » Difficult in highly complex and uncertain task environments. (e.g. research engineers or top-level managers) – Have the ability to make sure that the desirable actions Have occur occur » e.g., Effectiveness of organizational procedures e.g.,
Bus 424 second lecture presentation 18 Behavioral constraints Physical
– Locks, passwords, and limited access. Administrative
– Restriction of decision-making authority; – Separation of duties. Bus 424 second lecture presentation 19 Preaction reviews Scrutiny of action plans, investment Scrutiny proposals, budgets. proposals, – Review and approval. Bus 424 second lecture presentation 20 Action accountability Holding employees accountable for the actions they take. It requires: » Defining what actions are (un)acceptable Defining » Communicating these definitions to employees Communicating e.g., work rules, policies and procedures, codes of e.g., conduct conduct » Observing or otherwise tracking what happens Observing Direct observation/supervision Periodic tracking (e.g. “mystery shoppers”) Evidence of actions taken (e.g. activity reports) » Rewarding good actions, or punishing actions that deviate. deviate. Bus 424 second lecture presentation 21 Redundancy Assigning more people (or machines) to a task than necessary.
– e.g., backup people/computing facilities Bus 424 second lecture presentation 22 Pros and cons of action controls
PRO CON The most direct form of control Tend to lead to documentation of the accumulation of knowledge as to of what works best. what – 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, May innovation, and adaptation innovation, May cause sloppiness May cause negative attitudes – e.g., little opportunity for creativity and selfactualization Sometimes very costly Bus 424 second lecture presentation 23 Personnel/cultural controls People controls ensure that employees – Will control their own behaviors Personnel control Self-monitoring – Will control each others’ behaviors Cultural controls Mutual-monitoring People controls are part of virtually every management control People system and becoming more important in “flatter and leaner system flatter organizations with empowered employees.” organizations
Bus 424 second lecture presentation 24 Personnel controls Personnel controls build on employees’ natural tendencies to control themselves, because most people themselves, – have a conscience that leads them to do what is right; – find self-satisfaction when they do a good job and see their find organization succeed. organization Labels – Self-control – Intrinsic motivation – Ethics and morality – Trust and atmosphere – Loyalty
Bus 424 second lecture presentation 25 Implementing personnel controls Generally, it is about
“finding the right people, giving them a good finding work environment and the necessary resources” Selection and placement
» Finding the right people to do a particular job. Training
» Give employees a greater sense of professionalism; » Create interest in the job by helping employees to understand their job better. Job design and provision of necessary resources
» So that motivated and qualified employees have a high probability of success (e.g. equipment, staff support, freedom from interruption, etc.)
Bus 424 second lecture presentation 26 Cultural controls Cultural controls or mutual-monitoring tap into social pressure and group norms and values. group Cultural controls are effective because members of a group have emotional ties to one another. of emotional Cultures are built on shared – traditions – norms – beliefs – ideologies – attitudes – ways of behaving
Bus 424 second lecture presentation 27 Five ways to shape culture Codes of conduct
» Codes of ethics, corporate credos, mission statements, etc. » Formal written documents with broad statements of corporate values, commitments to stakeholders, and the ways in which top management would like the firm to function. » Fundamental guiding principles of the company. Group-based rewards
» e.g., bonus, profit-sharing, employee ownership of company stock; » Cultural controls rather than results controls because the link between results individual performance and rewards is weak. individual Bus 424 second lecture presentation 28 Five ways to shape culture Five (Continued) Intra-organizational transfers
» Improve the socialization of individuals in an organization and inhibit the formation of incompatible goals and perspectives; » Improve identification with the organization as a whole as opposed to subunit identification. Physical and social arrangements
» e.g., office plans, interior decor, dress codes and vocabulary, etc. Tone at the top
» Top management statements must be consistent with the culture they are trying to create, and importantly, their behaviors should be consistent with their statements.
Bus 424 second lecture presentation 29 Start with people controls People controls
» Must always be relied on to a certain extent » Have relatively few harmful side-effects » Involve relatively low out-of-pocket costs However, it is rare that people controls will be sufficient. In most cases, it is necessary to supplement them with
» action controls » results controls Maybe, you just shouldn’t put all your trust in people !?
Bus 424 second lecture presentation 30 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. In this respect, tight control is “good” because it In tight provides a high degree of certainty that people will provides act as the organization wishes (assuming away act harmful side-effects). harmful
Bus 424 second lecture presentation 31 Tight action controls Behavioral constraints – Physical
» Extra protection usually costs more. – Administrative
» 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.
Bus 424 second lecture presentation 32 Tight action controls (Continued) Action Accountability – The amount of tightness of control generated by action The accountability depends on: accountability » 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. Employees should feel that their actions are noticed, and noticed relatively quickly. i.e., the significance of the rewards or punishments.
Bus 424 second lecture presentation 33 » The effectiveness of the action-tracking system » The reinforcement provided Tight results controls The achievement of tight results controls depends on: – The definitions of the desired results areas » Congruence and completeness Choosing measurable performance dimensions that reflect an organization’s “true” objectives; e.g., Number of visitors for the success of a museum? e.g., Number Number of patents for the success of R&D-departments? Number Annual profits for a firm with significant growth prospects? Annual » Specificity Disaggregation and quantification; e.g., “keep customers happy” vs. “less than 1 pct. customer complaints.”
Bus 424 second lecture presentation 34 Tight results controls (Continued)
– The performance measures precision (amount of “noise”) objectivity (freedom of “bias”) timeliness (“lag” between occurrence and timeliness measurement) measurement) Understandability – The reinforcements provided » Are the links between results and rewards: Direct (no ambiguity) Definite (no excuses)
Bus 424 second lecture presentation 35 Tight people controls The tightness of personnel controls depends The personnel a great deal on the overlap between individual and organizational objectives. individual
» Selection and training ? Cultural controls are often more powerful and stable and
» Strong company cultures.
Bus 424 second lecture presentation 36 Control combinations
In order to achieve tighter control, managers often In use multiple forms of controls which can either multiple reinforce each other or overlap. reinforce overlap The aim is: – to achieve (tighter) control over all the factors critical to all to to the entity’s success; or, – to obtain a high degree of assurance that employees to high will behave as the organization wishes. will
Bus 424 second lecture presentation 37 Cost of control Benefit of controls – A higher probability that people will both work hard and direct higher their energies to serve the organization’s interests. their Costs of controls – Direct out-of-pocket costs » Easy to quantify: cost of cash bonuses, internal audit staffs » Difficult to quantify: time spend on planning and budgeting Difficult activities, on pre-action reviews, etc. activities, – Harmful side-effects – Behavioral displacement – Gamesmanship – Operating delays – Negativeus 424 second lecture presentation B attitudes 38 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 With results incongruent with the organization’s true objectives; because incongruent true » Poor understanding of the desired results » Over-quantification “Intangibles” are often overlooked. With action controls, it comes in the form of With action » Means-ends inversion Employees are induced to pay more attention to what Behavioral displacement they do and lose sight of what they try to accomplish. » Rigid, non-adaptive, bureaucratic behavior Bus 424 second lecture presentation 39 Gamesmanship Refers to the actions managers take to improve their performance Refers indicators without producing any positive economic effects. indicators Creation of slack resources » Consumption of assets in excess of what is required. Consumption » Slack can reduce manager tension and stimulate innovation; reduce stimulate However, it causes inefficient resource allocation. inefficient Data manipulation » Trying to “look good” by fudging the control indicators. Trying » Falsification, i.e., reporting erroneous data. Falsification » Data management, i.e., any action to change the reported Data i.e., result: result: Through accounting methods (e.g. reserves, write-offs); Through accounting Through operating methods (e.g. delaying expenses). Through operating
Bus 424 second lecture presentation 40 Operating delays Mostly associated with action controls, Mostly action notably, delays caused by: » Lengthy review processes » Cumbersome authorization layers » Bureaucratic organizations. When fast action is important, operational delays can be quite costly.
Bus 424 second lecture presentation 41 Negative attitudes Job tension, conflict, frustration, resistance
» Often coincident with many harmful behaviors such Often coincident as, gaming, lack of effort, absenteeism, and turnover. Action controls often “annoy” employees
» It is difficult for people to enjoy following a strict set of It procedures for a long period of time. procedures Results controls
» Lack of employee commitment to the performance targets: Lack to targets are too difficult, not meaningful, not controllable. » Performance evaluations are perceived as being unfair. Performance unfair
Bus 424 second lecture presentation 42 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!
Bus 424 second lecture presentation 43 ...
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This note was uploaded on 05/23/2010 for the course BUS 424 taught by Professor Joe during the Spring '10 term at Skidmore.
- Spring '10