MANAGEMENT Control in Non Profit Organizations A nonprofit organization is defined as an organization that does not have owners who

profit when revenues exceed expenses. A nonprofit organization operates in the interests of society. It does not participate in the equity markets since it has no shareholders. The sources of funds for nonprofit organizations are contributions, grants, and operating surplus. The activities of a nonprofit organization uphold the organizations stated mission, which describes the nature of its contribution to society; profits do not form a part of its mission. Most nonprofit organizations provide services. They are run professionally, by managers who develop objectives, strategies and budgets. Performance reviews are conducted for the employees and they are suitably rewarded. Controlling employees, systems and processes in a nonprofit organization is different from controlling them in profit seeking organizations MISSION OF NONPROFIT ORGANIZATIONS The major difference between profit seeking and nonprofit organizations is their mission. The mission of an organization is explained in its mission statement. A mission statement is a written statement of purpose that can be used to initiate, evaluate and refine all organizational activities. According to Peter Drucker, a mission statement should state the following: Opportunities that an organization can exploit or needs that it can meet Strengths of an organization Beliefs of members of the organization A mission statement serves as a road map that guides an organization to success. Many organizations recognize the need to have a mission statement and to put this powerful tool into action -- especially nonprofit organizations that sincerely attempt to provide quality services. The basic problem that most nonprofit organizations face is that they find it difficult to measure the success of their mission. But, contemporary research indicates that this can be done. For this purpose, they need first to define their mission clearly. Nonprofit organizations have three options to help determine the organizations success in terms of its mission. First, the organization can define its mission narrowly so that progress can be measured easily. Second, it can invest in research to show how its activities help in achieving the objectives stated in its mission. Third, it can develop micro-level goals that if achieved, imply success on a bigger scale. Though there is no perceived difference between nonprofit and not-for-profit organizations, the legal definition differentiates between the two. Not-forprofit refers to an activity, for example, a hobby (like fishing). "Nonprofit"

refers to an organization established for purposes other than profit-making. For example, a "nonprofit" organization can be an association of people who like fishing. KEY CHARACTERISTICS OF NONPROFIT ORGANIZATIONS After studying a number of nonprofit organizations, seven key characteristics of these organizations have been identified: Atmosphere of scarcity Bias towards informality, participation and consensus Dual bottom lines: mission and financial Difficulty in assessing program outcomes Governing board with both overview and supporting roles Mixed skill levels of staff Participation of volunteers Atmosphere of Scarcity There are factual and perceptual components to scarcity in nonprofit organizations. Most nonprofit leaders are severely constrained by lack of resources. In addition, many nonprofit organizations rely on altruism. As a result, they often have underdeveloped infrastructures. Bias towards Informality, Participation and Consensus Nonprofit organizations are characterized by informality, participation and consensus. They give less importance to hierarchy. Taken too far, informality can limit the appropriate exercise of authority, over-participation can inhibit appropriate division of labor, and the tendency toward consensus can bog down decision making. Dual Bottom Lines: Mission and Financial Tension between mission and financial results is fundamental for nonprofit organizations. (One can debate to what extent this is unique. For-profit organizations have increasingly focused on the importance of mission, relative to the priority of return on investment. Governmental organizations have increasingly focused on the importance of mission relative to the priority of political impact). Internally, the tension between bottom lines influences many strategic decisions as well as the sense of how well the organization is doing at all operational levels. Externally, some stakeholders of a nonprofit organization care about both bottom lines (funders, competitors and regulators) while some stakeholders care primarily about mission (clients and community). The complexity of dual bottom lines figures in many consulting engagements. Difficulty in Assessing Program Outcomes Most nonprofit organizations have limited capacity for program evaluation.

This is caused partly by the absence of standardized program outcomes in most fields. In childcare for example, standards for adult-child ratios exist, but little is standardized in terms of the quality of care delivered. Similarly, arts groups, advocacy organizations, mental health agencies and community development corporations face substantial challenges in measuring their effectiveness. Furthermore, most nonprofit organizations do not have the benefit of unambiguous market feedback to let them know how well they are serving their clients. Nonprofit organizations exist because neither the market nor government is providing the service; most are funded in part or completely by sources other than the direct beneficiaries of their work. Thus, assessing cost-effectiveness and comparing alternative actions is difficult. Also, different individuals may make different assumptions about the relationship between cost and effectiveness. Some groups essentially ignore the issue assuming their efforts are as effective as they can be. Governing Board with both Overview and Supporting Roles The governing board of a nonprofit organization has dual roles: it is responsible for ensuring that the public interest is served by the organization, and, -- unlike private sector boards of directors or government boards and commissions -- is expected to help the organization to be successful. The first role is analogous to protecting the interest of stockholders or voters. The second role complicates the distinction between governance and management because, in this role, board members do staff-like work. As helpers, board members may raise funds, send mailings, paint buildings, or do the bookkeeping. This can lead to confusion about when, and how, it is appropriate for board members to be involved in initiatives at work. Furthermore, board members are often not experts in either nonprofit management or in the organization's field of service. They may either be unprepared to make decisions, or may give up their authority inappropriately to staff. Mixed Skill Levels of Staff The individuals passion for the mission, the limited financial resources of the organization, and a shallow pool of candidates often result in nonprofit organizations hiring managers with limited management training and program staff with little program experience. Though the staff is often composed of professionals (e.g. social workers, artists and scientists), since most organizations are small, there is seldom much internal capacity to provide training for staff for the particular roles they are playing. Participation of Volunteers Many nonprofit organizations rely on the active participation of volunteers.

Members of the Board of Directors are normally not paid for their work, and individuals contribute considerable time and effort in delivering services and providing administrative support. The contribution that volunteers make to the nonprofit sector is significant; indeed without volunteerism, many needed social services would not be available to the public. However, volunteers usually have to juggle multiple commitments, and the relative priority they assign to their volunteer job may have to be balanced with their paid job, family responsibilities, and other volunteer commitments. Board meetings are therefore often held in the evenings or on weekends. Finally, there may be resentment on the part of certain volunteers that some people are being paid for work that they are doing for free, and the feeling that everyone should be volunteering. DESIGNING CONTROL SYSTEMS FOR NONPROFIT ORGANIZATIONS Designing a control system for a profit seeking organization is different from designing a control system for nonprofit organizations. Some of the reasons are: Absence of profit measure. This makes performance evaluation difficult. Separate tax and legal status. Nonprofit organizations are exempted from taxation and there are no shareholders. Most nonprofit organizations provide services rather than products. It is difficult to measure the quality and quantity of service. Fragmented governance due to numerous sources of influence. Excessive constraints in terms of usage of funds. Differences in senior management. Traditionally nonprofit organizations have had poor management controls because the management consisted of professionals like teachers, priests, doctors, etc. These professionals tended to give greater importance to professional goals and did not give requisite value to managerial skills. EMPLOYEE CHARACTERISTICS AND ORGANIZATIONAL CULTURE Employees of a nonprofit organization are different from employees of a profit seeking organization. This can have positive or negative implications for organizational control. Control problems are usually aggravated when employees of nonprofit organizations compare themselves with the employees of profit seeking organizations. For example, compensation of employees in nonprofit organizations is usually not competitive when compared to compensation in profit seeking organizations. A positive aspect for control, seen in nonprofit organizations, is employee commitment. Because of the nature of work, which is quite often philanthropic in nature, employees find it

easier to identify themselves with the organization and its goals. High commitment minimizes control problems that may arise due to lack of motivation and direction. Cultural characteristics of profit seeking and nonprofit organizations also differ. Nonprofit organizations which are dominated by professionals, have little regard for management control systems. These people prefer to concentrate on their profession and undermine the value of MCS. Because of poor compensation, nonprofit organizations do not attract the best of managerial talent too. Absence of performance measurement methods compounds this problem. This leads to a culture in which there may be poor coordination and lack of trust among employees. Rewards Generally, employees working in profit seeking organizations get better compensation and rewards when compared to employees in nonprofit organizations. In nonprofit organizations, employees feel rewarded when they achieve the goals which form a part of the mission statement of the organization. For example, employees of a nonprofit organization that is working towards preventing the spread of AIDS will feel rewarded when the rate at which the disease is spreading decreases. As financial rewards are negligible in nonprofit organizations, achieving the goals in the mission statement keeps employees motivated. However, there are exceptions to this generalization. In certain nonprofit organizations like universities and research organizations, employee compensation is better than in private sector companies. Performance Measurement Measuring performance of nonprofit organizations is difficult and arduous because most nonprofit organizations provide services which are measured in qualitative terms rather than quantitative terms. Without a quantifiable performance indicator, it is difficult: to measure organizational performance in light of the overall goals and to use results control at the broad organizational level; to analyze the benefits of alternative courses of action to decentralize the organization and hold sub-unit managers responsible for specific areas of performance; and to compare the performance of sub-units which are performing dissimilar activities. It has been observed that many nonprofit organizations, irrespective of their mission, scope and needs, design three types of performance metrics. They are:

 Success in mobilizing resources Effectiveness of staff on the job Progress in fulfilling the mission The way these metrics can be applied differs from organization to organization. For example, for a museum, the performance of its staff will be rated on basis of the number of people who visited the museum. Of these three metrics, the first two are easy to develop but measuring the success of a nonprofit organization in terms of the achievement of its mission, is difficult. Fund Accounting Fund accounting is an accounting system used by many nonprofit organizations. In this system, accounts are kept separately for several funds, each of which is self-balancing, with the sum of debit balances equaling the sum of credit balances. Most nonprofit organizations have: (1) a general fund or operating fund, which corresponds to the set of operating accounts; (2) a plant fund and an endowment fund, which account for contributed capital assets and equities and (3) a variety of other funds for special purposes. Programming and Budget Preparation Compared to a typical business, programming is a more important and time consuming process in a nonprofit organization, where a decision has to be made on how best to allocate limited resources to worthwhile activities. Nonprofit organizations have to work within their budgets and cannot exceed the set monetary limits because they do not market their services to increase their revenues. They limit their expenditure and aim to break even at the estimated amount of revenue. Hence, the budget is a very important management control tool for a nonprofit organization.

MANAGEMENT CONTOL IN SERVICE ORGANISATIONS Over the years, the industrial landscape has changed drastically. Initially, the focus was mainly on the manufacturing sector but during the later half of the 20th century the focus shifted to the service sector. In the US only, growth of employment in the service sector during the 1980s, was twice as much as the growth of employment in the manufacturing sector. Control in service organizations is different from control in manufacturing organizations due to the following reasons: Absence of inventory buffer Difficulty in controlling quality

 Multi Unit organization Manufacturing organizations maintain an inventory of goods in order to tackle sales fluctuations in future. This does not hold true for service organizations. They cannot store their services. For example, the airplane seat, hotel room, or the service of professionals like lawyers, physicians cannot be stored. Moreover, many service organizations have a fixed cost in the short run which cannot be reduced. For example, a hotel cannot reduce its fixed costs by closing down some of its rooms. Thus, service organizations have to match their current capacity with demand. Organizations match their current capacity with demand in two ways. The first way is to stimulate demand in the off peak seasons by increasing marketing activities and decreasing prices. For example the airlines and hotels offer heavy discounts during the off-season to increase demand. Secondly, companies can also try to right-size their workforce according to the anticipated demand. The products of a manufacturing company should be inspected for quality before they are released in the market, but this cannot be done in case of a service organization's products. The quality of the products offered by service organizations cannot be judged until it is rendered to the customer. Also, the judgments regarding the quality of the product are often subjective. The management of a restaurant may judge the quality of the food and approve of it, but customer satisfaction also depends on how the food is served. Service organizations operate through many small units set-up in different locations. These units act as individual profit centers for the service organizations. Fast-food companies, gasoline stations and auto rental companies are some of the examples of such service organizations. The units of a service organization are either wholly owned or franchised. Most of these units are similar in size and operations and hence provide a basis for analyzing budgets and evaluating performance. The information generated from such an analysis can be used to distinguish the high performing units from the low performing units. CONTROL IN PROFESSIONAL ORGANIZATIONS Service organizations can be categorized into professional organizations, healthcare organizations, financial services organizations, etc. The characteristics of these service organizations differ from each other and hence the control systems also differ. We will first discuss the characteristics of professional organizations and their implications for control systems. Principles of Management Control Systems

Characteristics of Professional Organizations Organizations that provide specialized professional services are called professional organizations. They include law firms, consulting firms, engineering firms, sports organizations and so on. These organizations possess special characteristics like the following: Small size Labor intensiveness Different objectives and goals Difficulty in measuring output Different marketing strategies Small size Most professional organizations are relatively small in size and operate in a single location, with the exception of some law and accounting firms. Senior management personally monitors and motivates their subordinates. This brings down the need for sophisticated control systems. Even though professional organizations are small, they still need to prepare budgets, compare the budgeted and actual performance, and compensate employees on the basis of their performance. Labor intensiveness Professional organizations are labor intensive, and they employ individuals who are specialists in respective fields. Professionals who are also managers prefer working independently rather than in teams. Professionals are the most valuable asset of an organization. Due to this, some management thinkers advocate the idea that these professionals should be valued highly and their value highly included in the company's balance sheet. A system called human resource accounting was developed by Likert for valuing the professionals but very few companies used it. Different objectives and goals The goal of a manufacturing organization is to earn a satisfactory return on the assets it employed. As most assets are tangible, they appear in the balance sheet. In professional organizations, as most assets assume the form of the employees' skills it is difficult for the company to set for itself a goal in terms of returns on assets employed. The financial goal of professional organizations is to provide satisfactory compensation to its employees. Another goal of professional service organizations is to increase their sizes and networks. Difficulty in measuring output The output of manufacturing organizations can be measured in terms of units, tons, gallons, etc. but this method cannot be applied to professional organizations. For example, the output of a physician, can be measured in

terms of number of patients treated, but one cannot measure whether the service provided by the physician satisfied the patient. In some cases, the revenues earned indicate the measure of output, but only in terms of quantity. In a professional service organization, the non-repetitive nature of work compounds the problem of measuring output. Since no two professionals work in the same way, it is difficult to set standards in terms of the time spent for a task and the way in which the task is performed. Different marketing strategy In manufacturing companies, production and marketing activities are clearly demarcated. But no such demarcation is done in professional organizations. These organizations do not market themselves openly. It is done through the use of articles, personal and professional contacts, speeches etc. An auditing firm may market itself through the articles written by its auditors (on contemporary issues) or through the marketing activities done by professionals who spend much of their time working for clients. Thus, it becomes difficult to identify a single employee who is responsible for promoting the organization. Control Systems in Professional Organizations The most important aspects of management control systems in professional organizations are: Pricing Strategic planning and budgeting Control of operations Performance measurement and appraisal Pricing Most professional firms determine the price of their services in a traditional manner. If the professional service offered is dependent on time, then the fee is fixed on the basis of time spent on the service. Investment banking is an exception to this. In case of investment banking, the service charge is determined on the basis of monetary size of the securities issue. Prices of services offered differ from profession to profession. The prices are high for accountants and physicians compared to research scientists, for instance. Strategic planning and budgeting Manufacturing organizations have better strategic planning systems when compared to professional organizations of similar size. One of the main reasons for this could be that professional organizations do not need such a system. Strategic planning is important for manufacturing organizations because any commitment relating to the procurement of plant and equipment does effect its capacity and expenditures for years, and such effects are

irreversible. In professional organizations, the main assets are people and changes in the size and composition of the staff are irreversible and easier to make. The strategic plan of a professional organization is not as comprehensive as that of a manufacturing organization. It is mainly a longrange staffing plan and does not cover other functions. Control of operations Scheduling the working hours of employees is one of the most important aspects of controlling the operations in professional organizations. The billed time ratio, that is the ratio of hours billed to total professional hours available, should be analyzed thoroughly. Idle time should be minimized and appropriate rates should be used for billing engagements. Performance measurement and appraisal In professional organizations, it is easy to analyze the performance of employees at the top most and the lowest hierarchical level, but it is difficult to analyze the performance of employees who are placed somewhere between the two extremes. The main reason for this is the absence of objective criteria for performance appraisal. But there are exceptions to this too. For example, the performance of an investment analyst can be appraised by comparing his recommendations and the market behavior of securities. In many cases, performance appraisal depends on human judgment. An employees performance may be judged by his superiors, peers, subordinates and clients. Professional organizations use a formal performance appraisal system numerical ratings of specified performance attributes. These ratings are used as deciding factors for wage hikes and promotions. CONTROL IN GOVERNMENT ORGANIZATIONS Government bodies too, are service organizations and except for those performing business- like activities, they are nonprofit organizations. In addition to the characteristics of service organizations discussed above, government organizations also have some special characteristics. These are: Political influences Public information Attitude towards clients Management compensation Political Influences Government organizations work under high political pressure. Politically elected officials often exert pressure on managers which, in turn, inhibits managers from taking sound decisions. For example, managers may have to favor certain suppliers.

Public Information Government organizations are under the constant vigil of the press and the public. In a democratic society, the public assumes that it has the right to know everything about government organizations. Due to exaggeration by the media, at times, even minor issues appear to be major ones. Therefore, to discourage unfavorable media coverage, managers in government organizations exercise greater control on their tasks and try to limit the outflow of sensitive information about the company that flows through the formal management control systems. Attitude towards Clients The main source of revenues for many profit-oriented and non-profit companies is their clients. The principal source of revenues for government organizations is the general public. In case of profit-seeking organizations, more clients mean more revenues. Every client that is added to the portfolio of the company brings in additional profits. But for government organizations, an increase in the client base is a burden. For example, one may draw a comparison between government hospitals and private hospitals. An increase in the number of patients visiting private hospitals result in additional revenues, whereas in case of government hospitals, it may result in deterioration of the quality of service. Management Compensation Managers working in profit-seeking organizations are better paid when compared to their counterparts in government organizations. This is because legislators are influenced by the populist perception that one person is as good as another. Due to this the best managers do not prefer to work in government organizations. There is, however, an exception to this. University faculty and scientists in certain government organizations are paid as highly as managers in profit- seeking organizations. CONTROL SYSTEMS IN GOVERNMENT ORGANIZATIONS The two most important elements of the control system in government organizations are: Strategic planning Performance measurement Strategic Planning Strategic planning is of great importance in government organizations. The objective of strategic planning is to allocate resources judiciously. Governments employ the benefit/cost analysis method to make strategic decisions. Political pressure often influences managers decisions.

Performance Measurement Income is the difference between revenues and expenses. Expenses can be measured accurately in government organizations as well as private organizations. However, the revenue of government organizations is not just a measure of its monetary output. Therefore, governments have developed nonmonetary indicators for performance measurement. These measures can be classified in various ways. On the basis of the purpose of measurement, they are classified as (1) results measures, (2) process measures, and (3) social indicators. A results measure, also known as outcome measure, measures the output that is supposedly related to the organizations objectives. Some examples are, the number of students graduating from high school, the number of miles of road completed, the number of timely arrivals of planes at airports, etc. However, these do not represent an exact measure of output. For example, the number of graduates does not provide any information about the quality of education the students have received. A process measure relates to an activity carried on by the organization, for example, the number of livestock that are inspected in a week, the number of purchase orders issued in a day, the amount of data fed into a computer in an hour, etc. Process measures are used to measure current, short-run performance. As there is a close causal relationship between inputs (i.e., costs) and the process measure, the latter are easier to interpret than results measures. Process measures what was done, and not whether what was done helped the organization achieve its objectives. Thus, process measures relate to efficiency, not to effectiveness. In contrast to results measures, which are ends-oriented, process measures are means-oriented. A social indicator is a broad measure of output, which reflects the overall achievement of the organization. As social indicators are affected by external forces, they are at best only a rough indication of the organization's accomplishments of the organization. For example, although life expectancy indicates the effectiveness of a countrys healthcare system, it is also affected by the standard of living and the dietary and smoking habits of people, and other external causes. Social indicators are useful in long-range analyses of strategic problems. The use of social indicators is limited in day-to-day management, since they are very nebulous, difficult to obtain on a current basis, little affected by current efforts, and greatly affected by external factors.

CONTROL IN FINANCIAL SERVICE ORGANIZATIONS Financial service companies are involved in the business of managing money. They may act as intermediaries-they may take money from depositors and lend it to individuals or companies, risk shifters (commercial banks)-they may earn money in the form of premiums and invest it accept the risk such as damages to property or death (insurance companies) and traders i.e. buying and selling securities (securities firms). In this section, we will study the characteristics of commercial banks, insurance companies and securities firms and the role they play in management control. General Characteristics of Commercial Banks Commercial banks receive cash deposits from people and pay them interest on the deposited amount. They also lend money in the form of loans and charge a rate of interest on these loans. The difference between the interest paid on deposits and the interest obtained on loans constitutes the banks revenue. Regulatory Capital In most countries there is a central bank that regulates the money lending operations of commercial banks. For example, in India, the Reserve Bank of India (RBI) is the regulatory body. It controls the money-lending operations through cash reserve ratio. Similarly in the US, the Federal Bank is the regulatory body for the commercial banks. New Products Apart from accepting money in the form of deposit and giving for loans, banks generate income through other financial products and services. Some of the services which earn them substantial revenue are banks get substantial revenues are credit card fees, accounting services for companies, payroll services, foreign exchange services and so on. The service fees charged by banks help them in increasing their revenues. Banks are exposed to three types of risks: Credit risk, i.e., the risk of loaned money not being repaid Interest rate risk, i.e., the fluctuations in interest rate that is spread between rates paid on deposits and rates earned on loans. Transaction risk, i.e., the risk of theft, embezzlement and numerical errors in the processing of transactions. This risk can be greatly minimized by an effective internal audit and control system. Management Control Implications Commercial banks establish a number of branches that function as individual profit centers. These branches need to be controlled. Some of the important

control issues are: Interest rates Loan losses Transfer pricing Expenses Joint revenues Interest rates One of the most important aspects of banking which needs to be controlled is the interest rate exposure. Interest rate exposure is the difference between interest-sensitive assets and interest-sensitive liabilities of the bank. Interest sensitive assets of a bank are the loans on which the bank earns interest, and interest-sensitive liabilities are the deposits on which the bank pays interests. Traditionally, interest rate exposure was managed by buying or selling securities, or by increasing or decreasing the amount of loans. But with the increase in new and complex financial transaction like futures, options, floors, swaps etc., it has become difficult to exercise greater control over interest rates. The control system is responsible for communicating the prevalent rate of interest to the employees responsible for investment decisions. Control system should also see to it that managers adhere to the prevalent interest rates. Loan losses In several cases, banks suffer huge losses because customers do not pay back the loans. The reasons for their not paying back the loans could be numerous and varied. Also this shows the banks incompetence or ethical management. The internal auditors, bank examiners and external auditors should constantly maintain a vigil on the banks loan portfolio. Transfer pricing Banks set up a number of branches for the convenience of their customers. The activities of these branches are coordinated and controlled by the headquarters. The headquarters play a vital role in solving problems related to transfer pricing of money. Over a period of time, the branches of the bank may become loan-heavy that is their loans may exceed their deposits while some may become deposit-heavy. The headquarters try to maintain a balance between deposits and loans through intra-branch transfer of money. Branches that are deposit-heavy extend financial help to branches that are loan-heavy and, in the process, charge a transfer price for the amount of money being transferred. The profitability of a bank cannot be assessed unless transfer price is determined fairly. If the transfer price is low then the profitability of

loan heavy branches will be overstated, and if the transfer price is too high, then the profitability of deposit-heavy branches will be overstated. Expenses Banks face several problems in controlling their expenses. Unlike manufacturing organizations, most of the expenses of a bank pertain to the personnel. Back-office expenses of a bank can be budgeted and controlled but allocating common costs to all activities is difficult. Joint revenues A banks customers carry out transactions in different branches of the bank, depending on their convenience. Employees in one branch are often reluctant to provide service to the customers of another branch and feel unrewarded when they have to do so. They feel that they do not gain anything by providing service to customers of another branch. In this situation it is the responsibility of the top management of the bank to convey to the employees of all the branches that it is necessary for them to strengthen customer relationships through excellent customer service in order to achieve longterm success. Basle Committee Principles on Banking In 1975, the Basle Committee on Banking Supervision, a committee of banking supervisory authorities, was set up by the Central-Bank governors from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, Netherlands, Sweden, Switzerland, United Kingdom and the United States. The Basle Committee laid down certain principles for better control and governance in banks. These principles pertain to supervision, policies and procedures, measuring and monitoring systems, internal controls and information for supervisory authorities. The role of the board and senior management Principle 1 In order to carry out their responsibilities, the board of directors of a bank should approve strategies and policies with respect to interest rate risk management and ensure that the senior management takes the necessary steps to minimize these risks. The board of directors should be kept informed about interest rate risk exposure of the bank, for the above said purpose. Principle 2 The senior management must ensure that the structure of the bank's business and the level of interest rate risk it assumes are effectively managed, that appropriate policies and procedures are established to control and limit these risks, and that resources are available for evaluating and controlling interest rate risk.

Principle 3 Banks should clearly define the individuals and/or committees responsible for managing interest rate risk and ensure adequate distinction of duties in key elements of the risk management process to avoid potential conflicts of interest. Functions such as risk measurement, monitoring and control with clearly defined duties that are sufficiently independent from position-taking functions of the bank and which report risk exposures directly to the senior management and the board of directors are quiet essential. Larger or more complex banks should have a designated independent unit responsible for the design and administration of functions like interest rate risk measurement, monitoring and control. Policies and procedures Principle 4 It is essential that banks interest rate risk policies and procedures be clearly defined and that their nature and complexity of their activities remains consistent. These policies should be applied on a consolidated basis and, as appropriate, at the level of individual affiliates, especially when recognizing legal distinctions and possible obstacles to cash movements among affiliates. Principle 5 It is important that banks identify risks accompanying new products and activities and ensure these are subject to adequate procedures and controls before being introduced or undertaken. Major hedging or risk management initiatives should be approved in advance by the Board or by the committee set up for this purpose. Measurement and monitoring system Principle 6 It is essential that banks have interest rate risk measurement systems that capture all material sources of interest rate risk and that assess the effect of interest rate changes in ways that are consistent with the scope of their activities. The assumptions that the system is based on should be clearly understood by risk managers and the bank's management. Principle 7 Banks must determine and enforce operating limits and other practices that restrict their exposures within limits, so that these confirm to their internal policies. Principle 8 Banks should analyze their vulnerability to loss under stressful market conditions, including the breakdown of key assumptions, and ponder the results when establishing and reviewing their policies and determining limits

for interest rate risks. Principle 9 Banks must have adequate information systems for measuring, monitoring, controlling and reporting interest rate exposures. Reports must be provided on a timely basis to the board of directors, the senior management and, when required to individual business line managers. Internal controls Principle 10 Banks must have an adequate system of internal controls over their interest rate risk management process. A fundamental component of the internal control system involves regular independent reviews and evaluations of the effectiveness of the system and, when required ensuring that the internal control system has been appropriately revised. The results of such reviews should be passed on to the concerned supervisory authorities. Information for supervisory authorities Principle 11 The supervisory authorities should obtain from banks sufficient and timely information for evaluating the levels of interest rate risk. This information should include the range of maturities and currencies in each bank's portfolio, including off-balance sheet items, and other relevant factors such as the distinction between trading and non-trading activities. General Characteristics of Insurance Companies Insurance companies are of two types: life and casualty. A life insurance company collects premiums from policyholders, invests these premiums, and pays a specified amount to the beneficiary on the death of the policyholder. While term insurance offers a person insurance coverage for a limited number of years in the policy holders life; whole life insurance provides coverage for the insured person until his death. Usually, whole life insurance policies include an investment feature, that is, a part of the premium is devoted to building up the policys cash value. Cash is paid regularly over a specified period in the annuity version of such a policy. A casualty company collects premiums, invests them, and makes payments to policyholders for specified losses -- losses to property caused by fire, theft, accidents, or other causes, or losses to individuals caused by malpractice, negligence, illness, accidents, and so on. Casualty policies usually provide short- term coverage not exceeding three years. While some policies pay for claims made during this period, others pay for losses incurred during the period, even though the claims are made later. Usually, insurance policies are sold by agents, some of whom are independent,

and work for several companies while some others are employed only by a single company. The income of both the types of agents is a specified percentage of premium earned from the policies they sell. Through branch offices, insurance companies exercise some control over the agents' activities. Management control implications A major problem in the management control system of insurance companies is that profits from current policy sales cannot be determined until the next few years. This is especially true in case of life insurance companies. Though premiums are determined on the basis of the best estimate of the inflows and outflows associated with the policy, they may turn out to have been wide off the mark. While profitability cannot be ascertained until the final payment has been made, it may not be possible for the management to wait that long in order to make control decisions, as it would require information immediately. Insurance managers pay considerable attention to the controlling of expenditure unlike investment bankers. Product pricing A typical insurance company offers dozens of products and the price (i.e., the policy premium) of a given product varies in many respects for different customers. For example, the age of the insured person and, hence, his or her life expectancy, health, smoking habits, and, in some cases, gender, are taken into account to determine the premium. A tentative premium is determined by actuaries, and the final premium is a reflection of feedback from the marketing people about the attractiveness of the policy and their respective premiums offered by the competitors. Because of the importance of determining the premium, the performance of each actuary and the accuracy of and promptness in collecting huge data to furnish current information to the actuaries, is closely observed by the senior management. Is the calculated premium out of line with those of competitors, and if so, why? Is the actuary making use of the updated information? Is the calculation overly conservative or overly liberal? By answering these questions the senior management can analyze whether the actuary is furnishing current information into its data. Sales performance There is a wide variation in the actual profitability of various types of insurance policies, partly because of adjustments made in the actuarial calculation for fixing the premium, and partly because subsequent developments made the assumptions included in the actuarial calculation unrealistic. Although management would like the sales organization to concentrate on products that are actually the most profitable, it is difficult to

calculate the current profitability of various policies, and to communicate this information to the sales organization. Therefore, there is a tendency to focus on the sales volume, rather than on profitability. Therefore the agents commissions are hence based on the first-year or early year premiums, or on the face amount of policies written. Such appraisal methods are used in appraising the performance of branches. Computer programs are being increasingly used to help agents compute the actual profitability of various types of policies. Expense control As is done in industrial companies, expenses are controlled through programs and budgets in insurance industries. Productivity measures are used to control clerical and other repetitive operations. The activities of claims adjustors are carefully monitored, although judgments about their performance are somewhat subjective. Control of investing As in other financial services organizations, managing the investment function is important in insurance companies. Traditionally, insurance companies offered conservative investment policies, partly due to the influence of regulatory agencies. In the recent years, insurance companies have also made inroads into direct placement of loans, and investments in real estate and other commercial ventures. This shift involves an increase in risk, and requires a different approach to investment activities the control system of insurance companies is similar to that of other financial services organizations. CONTROL IN SECURITIES FIRMS Firms that deal with shares or securities are called securities firms and include investment bankers, securities traders, securities brokers and dealers, fund managers (investment, mutual, and pension funds), and investment advisors. Best known examples of investment bankers are J.P.Morgan, Drexel and Company, and Kuhn Loeb and Company. The management of the investment portfolio of individuals and companies was done by bank trust departments of the banks. The attitude of bank trust departments towards fiduciary responsibility resulted in an overemphasis on safe investments. This reduced the role of bank trust departments thus reducing their returns. Between 1975 and 1985, commercial banks lost one third of their business. Many traditional investment bankers expanded their services which now included all forms of securities underwriting, trading, and investment

counseling. Many of them set up branches to offer services to individual investors, including relatively small investors. Firms that specialized in providing expert advice about investment were also set up. The 1970s saw a proliferation of all types of mutual funds and an increasing fraction of securities issues were absorbed by pension funds. The result of all these developments was increased competition among securities firms and reduction in their profit margins. In course of time, financing became more complicated. A variety of issues with different risk / reward characteristics were invented. These were an addition to the already existing issues of long-term debt, preferred stock, and common stock. Foreign investors became an important source of funds. The execution of complicated decision rules for buying and selling huge quantities of securities in a matter of minutes (in some cases, seconds) was made possible through computer programs. Management Control Implications The characteristics of securities firms are different from those of other financial service organizations. These include: 1) The importance of customer relationships 2) Stars and team-work 3) The need of rapid information flow 4) Focus on short-term performance Customer relationships The products of securities firms are intangible, and it is difficult to measure their quality. The skills of the firms professionals contribute to the quality of its products in a big way. The quality of these products is difficult to measure as compared to the tangible goods. Earlier, firms could count upon, at least, a group of customers who stayed with the firm for a considerable period of time, but current trends show that customers are now much more aware and switch to another firm when they feel that the latter offers the products of the same quality at a better price. Customers opinions about the employees with whom they interact directly primarily determine their attitude towards the firm. Therefore, the management tries to find out what customers opinions are, and how well (and also how often) an employee interacts with a customer, especially with a potential customer. Most firms, therefore, require their employees to fill out call reports for every customer contact. These, at least, serve the purpose of measuring the quantity of an employees efforts. Stars and teamwork Decisions about buying or selling securities, or recommendations for

corporate financing involving huge amounts of money, are made by a few senior employees in securities firms. These senior professional are called 'stars' and constitute a firms most valuable assets. Because of the dominance of stars, there are relatively fewer levels in the organizational structure of securities firms. The relationship between superiors and subordinates are typically unstructured and informal. Loose control is, therefore, appropriate in such an environment. Firms acquiring such organizations experience difficulties in adapting their management control systems. Securities traders rely upon the advice of research people and others who have knowledge about securities or industries. These informal, though important relationships are in contrast to the relationships that exist between production departments and support departments in a manufacturing company. In a manufacturing company, production supervisors who need to get some work done by the maintenance departments, fill out a work request form, and wait for the work to be done. In a securities firm, paperwork is minimal, and responses to requests are often immediate. Need for rapid flow of information Many securities are listed in all the three stock exchanges-London, Tokyo and New York, which are located in three different time zones. Therefore, in a large securities firm, business takes place 24 hours a day, with responsibility passing from London to New York to Tokyo stock exchanges, as each market closes. Each trader maintains a book displaying the firms position in each security for which the trader is responsible, and in the buying and selling orders that are to be executed. Computers providing information about worldwide developments that might affect prices are also set up. Securities and commodity market prices are affected due to developments within minutes of their occurrence. Investment bankers also require current and complete information about everything that has a bearing on the deals in which they are involved at present or may be involved in the future. The information systems of these firms must, therefore, fulfill the following requirements: (a) Signal flash news separately, differentiating it from the routine news. (b) Transform mountains of data into meaningful information. Develop comparable data from raw data most importantly, provide accurate data. Development and maintenance of information systems in securities firms is, therefore, an important function. Focus on short run performance

The purchase of a growth stock today may produce satisfactory results three years later, or may never pay off at all. In other words, it may not be possible to observe the actual soundness of investment decisions made today, but only after the elapse of a considerable amount of time. In spite of this, securities firms, with some important exceptions, have a tendency to focus on short-run performance, and by 'short-run' they mean the current quarter. The reason for emphasis on short-term performance is that no one knows what the distant future if like, but also because it has become more of a tradition to have a short-run emphasis. Investors tend to rely on information about current performance, and performance in the recent past, of the securities firms they have hired to manage their funds. Data about the firms performance over 5-10 years may not be a valid basis for judging its overall performance or the performance of a specific fund that the firm manages, because the decisions of the firms stars, who probably were not with the firm over the past few years, heavily influence the performance of a securities firm. Japanese firms, on the other hand, tend to pay more attention to the long term performance. Although many people are convinced that the American emphasis on short-run performance has serious adverse economic consequences, no one seems to be able to change this emphasis. Measuring financial performance Measurement of the financial performance of securities firms and of managers, accounts executives, and others within the firm who trade or deal with customers tends to be primarily in terms of revenue and secondarily in terms of gross profit (the difference between revenue and direct expenses). Account executives commissions are based on the revenue or gross profit from the transactions with their customers. Bonuses are based on the firms fee for the service, and partly on the judgment of the senior management. These comprise the compensation given to investment banking professionals. Securities firms do not make much use of the profit center idea, nor do they do detailed cost accounting. This is partly because, unlike law or accounting firms, which charge fees according to the actual hours spent on the assignment, securities firms generally charge a fee that is a certain percentage of the total amount involved in the deal. Therefore, the need to collect costs by assignments in case of securities firms is much less when compared to other firms. The informal exchange of advice and other assistance that occurs in securities firms is another reason for the lack of detailed cost accounting in such firms. It is much more difficult to measure the cost of this assistance to the recipient then

to measure the cost of a maintenance work order in a factory. A third reason for the absence of detailed cost accounting in securities firms is that expenses are relatively unimportant. The direct expense (i.e., the transaction cost) of a securities trade is small, and a deal that generates many millions of rupees in fees may cost only a few hundred thousand rupees in terms of direct cost. Nevertheless, although the relative amount may not be huge, every rupee of legitimately saved expenses increases the net income by that amount.