Management Control System

Management and control

Chapter 1

 

Management relates to the process of organizing resources and directing activities for the purpose of achieving organizational objectives; consist of 4 phases:

  1. planning
    • mission; reason of company’s existence
    • vision; what to do to reach the mission
    • objective
    • strategy; Corporate S.(expansion/ shutdown/ no change)

Business unit S. (Differentiation, cost leadership, focus)

Operational S. (mktg, finance, HR, R&D)

  1. organizing
    • organization structure
    • amount of resources
    • task
    • Standard Operation Procedure
  2. leading
    • Implementation
  3. controlling
    • Performance Evaluation
    • Actual-Target comparison

 

Management process:

  1. Objective setting; important for design of management control system; doesn’t have to be quantified, needn’t be financial, must be understood by the employees
  2. Strategy formulation; define how organizations must use their resources to meet their objectives, can be formulated thru SWOT analysis, it emerged from the interaction between management, employees and environment
  3. Strategic control; to see whether the company’s strategy should be changed, considering the environment, competition and other factors; primarily focused on external (SWOT factors)
  4. Management control; to ensure the employees (behavior) do the best for the company, so that they understand company’s expectation, implement the company’s strategy as intended, capable to do their job, actions taken to solve management problems

 

Causes of management control problems:

  1. Lack of direction: causes employee to behave inversely to the desired behavior. Employees must be informed on how to maximize their contribution to the fulfillment of company’s objectives
  2. Motivational problems: employees are reluctant to give 100% effort, because individual and company goal don’t naturally coincide
  3. personal limitation: caused by lack of knowledge, training, experience, or jobs that are not designed properly

 

Characteristics of good management control:

Good management control: management are confident that no major unpleasant surprise will occur, but still allows probability of failure because perfect control is rare and the control loss(cost of not having perfect control) must be achieved to reach optimal control (cost of implementing more control > control loss)

  • future oriented (no unpleasant surprises in future)
  • objective driven (objective represents what the organization seeks)

 

Control problem avoidance:

activity elimination; potential risk in particular activity can be turned over to 3rd party (Subcontract, licensing agreements, divestment)

Automation; automated devices can be set to behave consistently in accordance to the company’s wants (lower inaccuracy, inconsistency, lack of motivation, unlike human) but maybe costly and lack of feasibility

Centralization; centralization in decision making of key risk areas is needed (Mergers and divestment)

Risk sharing; to limit loss; thru insurance

 

Chapter 2: Result control

 

Result control:

Rewarding for good result (meritocracies), punishing for bad results

Reminds employees of the consequences of actions taken

Employees are empowered to take any actions, not dictated by the company

Cannot be used in every situation, effective only where the desired result areas can be controlled (to a considerable extent) by the employees whose actions are being influenced and where the controllable result areas can be measured effectively

Preventive type control, effective in addressing motivational problems, personal limitation problems

 

Steps in result control:

  1. defining performance dimensions

“what you measure is what u get”; goals and measurement are the factors that shape up the employees’ mind of what is important, therefore it must be clear

  1. measuring performance

measurement is done in a specific period

  1. setting performance targets

affect behavior in 2: stimulate action and motivation; allow employee to self evaluation

  1. providing rewards/punishments

extrinsic(bonus, promotions) / intrinsic(self-esteem)

 

conditions determining the effectiveness of result controls:

ü  knowledge of desired results

must be communicated effectively to employees, result desirabilityàmore of the quality represented by the result measure is preferred to less, everything else being equal

ü  ability to influence desired results (controllability)

person whose behavior are being controlled must be able to affect the result in a material way in a given timespan; a manager only accountable for mistakes made under his control

result control will not be effective where the result that can be measured are either not controllable or largely uncontrollable

ü  ability to measure controllable results effectively

to judge the effectiveness of result measures is ability to evoke the right behaviors. To evoke right behaviors, result measures should be:

  1. precise

hi precision = small dispersion of results given by independent measurers =give good evaluation

  1. objective

freedom of bias; objective evaluation can be done by people who are independent of the process(personnel on controller’s staff); independent people (auditor)

  1. timely

timeliness: lag between the employees’ performance and the measurement of results; good for 2 reasons: employees need consistent, a short term pressures to perform well; it increases the value of interventions that might be necessary

  1. understandable

employee w/controlled behavior must understand his accountability and what he must do to influence the measure. E.g: customer service employee must understand what the their customers value (cust. Satisfaction)

 

Chapter 3: action, personnel and cultural controls

 

Action control involves taking steps to ensure that employees act in the organization’s best interest by making their actions themselves the focus of control

 

Forms of action controls:

  • behavioral constraints

it is a negative form of action control, it is divided into 2 kinds: physical constraints(locks on desks, passwords, access limit to certain areas) and administrative constraintsàlimit on employees’ ability to perform all/ a portion of a specific act; low grade manager can only approve $1000 expenditures, while med-grade manager can approve $10000 expenditure

another admin consàseparation of duties; different person for positions that closely related(checks receiver must be separated from the accountant who entries tha account receivable ledger)

  • preaction reviews

scrutiny of the action plans of the employees being controlled (approval/checking made by the supervisors about certain proposals)

  • action accountability

holding employees accountable for the actions they take. Its implementation requires:

    1. defining of actions which is good/bad
    2. communicating the definitions to employees
    3. observing / tracking what happens
    4. rewarding/punishing the actions
  • redundancy

assigning more employees / machines to a task than is strictly necessary, or at least having backup employees / machines available, can also be seen as a control because it increases the probability that a task will be satisfactorily accomplished.

 

Action controls and the control problems

Types of action controls Lack of direction Motivational problems Personal limitations
Behavioral constraints   X  
Preaction review X X X
Action accountability X X X
redundancy   X X

 

Prevention vs detection

Detection type action controls are used after the occurrence of the behavior

 

Examples:

Type of action controls Prevention Detection
Behavioral constraints Locks on valuable assets, separation on duties N/A
Preaction reviews Expenditure approvals budget reviews N/A
Action accountability Prespecified policies linked to expectations of rewards and punishments Compliance-oriented internal audits, cash reconciliations
Redundancy Assigning multiple people to an important task N/A

 

Conditions determining the effectiveness of action controls:

  • managers know what actions are desirable/undesirable

knowledge of the desired actions can be discovered in 2 ways:

    1. analyzing the actions/results patterns in a specific situations / similar situations over time to learn what actions produce the best results
    2. information from others(consultants) esp, for strategic decisions
  • managers are able to ensure that the desirable actions occur (or that the undesirable actions do not occur)

the effectiveness of the behavioral constraints and preaction reviews varies directly with the reliability of the physical devices / administrative procedures the organization has in place to ensure that the desired actions are taken.

action tracking often provides a significant challenge that must be faced in making action-accountability controls effective. The criteria that should be used to judge are: precision, objectivity, timeliness, understandability.

The action control system is not perfect, and to make it near perfect, it needs much cost, therefore some managers use personal and culture controls to fill in the gaps. These controls help employees  to control their own behaviors.

 

Personnel controls

It builds on employees’ natural tendencies to control and/ or motivate themselves. It serves any of 3 basic purposes:

  1. clarify expectationsàhelp ensure employees understands what the organization wants
  2. help ensure that the employees are able to do a good job(have the capability; experience, intelligence and resources)
  3. increase the likelihood that each employee will engage in self-monitoring

Self-monitoring is the naturally present force that pushes most employees to want to do a good job, to be naturally committed to the organization’s goals. It is also effective because most people have a conscience that leads them to do what is right and able to derive positive feelings of self-respect and self-satisfactions when they do a good job and see the organization succeeds

 

3 major methods of implementing personnel controls:

  1. selection and placement of employees

Finding the right people to do a right job and giving them a good work-environment and the necessary resources can obviously increase the profitability that a job will be done properly

  1. Training

Training can provide useful information about what results and actions expected and how the assigned task can be best performed (2 methods: on the job training and class training), also it can 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

  1. Job design and provision of necessary resources

A well designed job allows motivated and qualified employees a high probability of succeed

 

Cultural controls

Cultural controls are designed to encourage mutual monitoring, a powerful for m of group pressure on individuals who deviate from the group norms and values; it is most effective where members of a group have emotional ties to one another.

Cultures are built on shared traditions, norms, beliefs, values, ideologies, attitudes, ways of behaving. Organizational cultures remain relatively fixed over time , even while their strategies, tactics, and goals necessarily adapt to changing business conditions.

 

5 important methods in shaping culture , and thus effecting cultural controls:

  1. codes of conduct

the codes of conduct provide broad, general statements of corporate values, commitments to stake holders, and the ways in which top management would like the organization to function.

These codes are designed to help the employees to understand what behaviors are expected even in the absence of a specific rule or principle.

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

  1. group-based rewards

In group-based rewards, the link between individual efforts and the result being rewarded is weak , perhaps near 0. Thus , communication of expectations and mutual monitoring are the primary forces in group rewards.

The use of group reward also reduces measurement cost because each individual’s unique contribution to overall performance doesn’t have to be measured.

  1. intraorganizational transfers (employee rotation)

transfers tend to improve the socialization of the employees throughout the organization and thereby inhibit the formation of incompatible goals and perspectives

  1. physical and social arrangements

physical arrangements, such as office plans, architecture, and interior décor and social arrangements, such as dress codes and vocabulary can also shape the organizational culture

  1. tone at top

top level managers must be consistent with the type of culture they try to create, and their behavior must be in accordance with their statements

 

 

personnel/cultural controls and the control problems

 

  Lack of direction Motivational problems Personal limitations
Ways of effecting personnel controls      
Selection

X

X

X

Training

X

X

Job design and provision of necessary resources

 

 

X

Ways of effecting cultural controls

Codes of conduct

X

X

Group-based rewards

X

X

X

Intraorganizational transfers

X

X

Physical arrangements

X

Ton at the top

X

 

The effectiveness of personnel/cultural controls

These controls are adaptable. All managers rely to some extent on their employees guiding and motivating themselves.

Cultural controls often have the advantage of being relatively unobtrusive

Personnel and cultural controls have several important advantages over results and action controls:

  • usable to some extent in almost every setting
  • cost lower
  • produce fewer harmful side-effects

But the degree to which personnel/cultural controls are effective may vary significantly across individuals, groups, and societies. Some people are more honest, more strongly related

 

Control tightness / looseness

The achievement of tight result control depends on characteristics of  the definitions of the desired result areas, the performance measures, and the reinforcements provided

  • definitions of desired results

a tight management control must have the results which have dimensions that congruent with the true organizational objectives; the performance target must be specific; feedback in short time increments the desired results  must be effectively communicated and internalized by those whose behaviors are being controlled; and if result controls are exclusively in a given performance , the measures must be complete

  • measurement of performance

a result control system that is used to apply tight control requires excellence in all of these measurements qualities(precise, objective, timely, understandable)

  • rewards / punishments

result controls are likely to be tighter if rewards and punishments that are significant to the employees involved are directly and definitely linked to the accomplishment of the desired results

direct linkàresult translate automatically into rewards/ punishments w/o no buffers and ambiguity

definite link between results and rewardsà no excuses are tolerated

 

tight action controls

action control system can only be considered tight if it is highly likely that employees will engage consistently in all of the actions critical to the operation’s success and not take harmful actions.

  • Behavioral controls

 

Physical (locks, electronic security) and administrative can produce a tight control in some areas of organization. In general, administrative control such as, restriction of decision making to a higher level management provides tighter control: if the higher level management can produce more reliable decision; if it can be guaranteed that the ones without authority cannot violate the decisions that have been established

  • Preaction reviews

If the reviews are frequent, detailed, and performed by diligent, knowledgeable people, then the reviews can be considered tight. Preaction reviews are typically tight in areas involving large allocations because many investments are not easily reversible and can affect the success/failure of the business.

But reviews done by the top management doesn’t mean that the preaction review is tight, because sometimes the top management doesn’t have time and it can merely rubberstamp them

  • Action accountability

The amount of control generated by action accountability control depends on the characteristics of the definitions of desirable actions, the effectiveness of the action-tracking system and the reinforcement provided

To be considered tight, the definition of actions must be congruent, specific, well communicated and complete.

Detailed audits and constant direct supervision are some examples of tight action tracking system.

Control can be made tighter by making the rewards/punishment more significant for the employee affected. But different individual may react variably to identical rewards.

 

Tight personnel/cultural controls

these controls can only effect companies with strong culture  because cultural involves a set of shared beliefs and values that employees use to guide behavior. Most personnel/culture controls are unstable. They can break down quickly if demands, opportunities, or needs to change, and they provide little or no warning of failure

 

multiple controls

to tighten controls, managers often use multiple forms of controls. The controls can either reinforce each other or overlap, thus filling in gaps so that they, in combination can provide tight control over all the factors critical to the organization’s success

 

summary of tight controls:

Type of control What makes it tight
Results/ action accountability Definition of desired actions/results:

  • Congruent with the true organizational skills
  • Specific
  • Effectively communicated and internalized
  • Complete (if accountability emphasized)

 

Measurement of results / tracking of actions:

  • Congruent
  • Precise
  • Objective
  • Timely
  • Understandable

 

Rewards / punishments:

  • Significant to person involved
  • Direct and definite link to results or actions

 

Behavioral constraints Reliable

Restrictive

Preaction reviews Frequent

Detailed

Performed by informed persons

Personnel/cultural controls Certainty and stability of knowledge linking personnel/culture

Characteristics with desired actions

 

 

 

Chapter 5

 

Cost of control

  • Benefit of controls

Increase the probability that people will work hard and direct their energies to serve the organization’s interest

  • Cost of control

Direct out of the pocket cost

    1. easy to quantify: cost of cash bonuses; internal audit staff
    2. difficult 2 quantify: time spent on planning & budgeting activities + preaction control

 

harmful side-effects

  1. behavioral displacement
    • occurs when the control system produce behaviors that aren’t consistent w/ organization’s objectives
    • w/ result control, it occurs when the result measures are incongruent w/ organization’s true objectives because of:

ü  poor understanding of desired results; e.g: trailer decided to monitor the number of trailers its sales people sold, as a result, the sales increases, but many of the sales were made to poor credit risk, so the sales lot is quickly filled up w/ overpriced trade-ins

ü  over quantification (2nd major cause of displacement in result control); e.g: tendency to concentrate on matters that are concrete & quantifiable, rather than intangible concepts that may be even more important

Solution: find acceptable quantified indicators of intangible concepts that may be missing in order to alleviate the problem for which result control are being criticized

    • w/ action controls, it comes in form of:
  • means-end inversion: pay more attention to what they do (means) & lose sight of what they are to accomplish (the ends)

e.g: managers w/ low limit of capital expenditure authority only invest in small investments, which creates small return which is also not optimal

  • rigid, non adaptive, bureaucratic behavior, not creative
    • w/ personnel/culture controls:

Strong culture can also cause displacement where the behavioral norms that groups use to               guide the behaviors of their members, or the measures used to provide group-based            rewards, aren’t totally in line with what the organization desires

The solution to the behavioral displacement problems:

    • prompt & accurate recognition problem & diagnosing of problems are the keys to solution
    • the processes require thinking about whether there’s a difference between what employees are supposed to do & what the control system motivate them to do

 

  1. gamesmanship
  1. are actions managers take to improve their performance indicators without producing any positive economic effect
  2.  creation of slack resources: consumption of organizational resources by employees in excess of what is required, usually happened in the management level, in tight control, therefore, they try to lower the target budget

The + side of slack: reduce manager tension, increase organizational resilience to change;

stimulate innovation

the – side: inefficient allocation of resources, information distortion, lower performance

c.     Data manipulation( happens in accountability type control system): fudging control         indicators; falsification; data management (action changing reported result; sales, D/E ratio) while providing no real harm to the organization

 

  1. operating delays

ü  cause by limiting access to a stockroom; requiring passwords

ü  action control often “annoy” professional, but also lower level personnel

  1. negative attitudes
    • job tension, conflict, frustration, resistance

 

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