Chapter 1; the control function of management Management and control Management control failures can lead to large financial

losses, reputation damage, and possibly even to organizational failure. However, having more controls in place doesnt always guarantee better controls. ts widely accepted that good MC!s are important. Management control in common use does not only focus on measured performance. "hey focus instead on encouraging, enabling or forcing employees to act in the organizations best interest. Management control includes all the devices or systems managers use to ensure that the behaviors and decisions of the employees are consistent with the organizations ob#ectives and strategies. $esigned properly, MC!s influence employees% behavior in desirable ways and conse&uently increase the probability that the organization will achieve its goals. 'unction; to influence behaviors in desirable ways (enefit; the increased probability that the organizations ob#ectives will be achieved. Management and control Management control is the bac) end of the management process. Management *ll definitions of management relate to the processes of organizing resources and directing activities for the purpose of achieving organizational ob#ectives. + Management functions of the value chain every management school offers courses focused on only ,part of- one of these primary management functions + Ma#or types of resources management schools offers courses organized using this classification + Management processes; the management functions along a process involving ob#ective setting, strategy formulation and management control. Objective setting .nowledge of ob#ectives is a prere&uisite,vereiste- for the design of any MC! and for any purposeful activities. /mployees must have a basic understanding of what the organization is trying to accomplish. 0rganizations develop e1plicit or implicit compromise mechanisms to resolve conflicts among sta)eholders and reach some level of agreement about the ob#ectives they will pursue ,nastreven-. Strategy formulation Having set the firms strategic intentions or ob#ectives, strategies then define how organizations should use their resources to meet these ob#ectives. Ma#or elements of these organizations strategies emerge from a series of interactions between management, employees and the environment; from decisions made spontaneously; and from local e1perimentation designed to learn what activities lead to the greatest success. 'or purposes of designing MC!s it is useful to have strategies that are as specific and detailed as possible, if those strategies can be )ept current. Management control versus strategic control Strategic control involves managers addressing the &uestion2 s our strategy valid3 *ll firms must be concerned ,bewust zi#n van- with strategic control issues, but the concern ,bewustzi#n- that a strategy may have become obsolete

,verouderd- is obviously greater in firms operating in more dynamic environments. Management control focuses on e1ecution ,uitvoering- and it involves addressing the general &uestion2 are our employees li)ely to behave appropriately3 1. $o our employees understand what we e1pect from them 4. 5ill they wor) consistently hard and try to do what is e1pected of them3 6. *re they capable of doing a good #ob3 7. f the answers to any of these &uestions is negative, what can be done to solve the management control problems3 Managers addressing strategic control issues have a focus primarily e1ternal to the organization. Managers addressing management control issues have primarily an internal focus. Management control versus strategic control /1ternal versus internal. Behavioral emphasis Management control involves managers ta)ing steps to help ensure that the employees do what is best for the organization. MC are necessary to guard ,bewa)en- against the possibilities that people will do something the organization doesnt want them to do, or fail to do something they should do. f all employees could always be relied on to do what is best for the organization, there would be no need for an MC!. Causes of management control problems 5hat is it about the employees on whom the organization must rely that creates the need to implement MC!s3 5hich behavioral problems must MC!s address3 Lack of direction; !ome employees perform inade&uately simply because they do not )now what the organization wants from them. MC should involve ,gepaard gaan metinforming employees as to how they can direct their contributions ,bi#drage- to the fulfillment of organizational ob#ectives. Motivational problems Motivational problems are common ,gemeenschappeli#)- because individual and organizational ob#ectives do not naturally coincide ,samenvallen-. !tatistics suggests that it should not be ta)en for granted that employees will always, and automatically, act with the best interest of their organizations in mind, and that because of this issue, the costs to organizations, whether e1plicit or implicit are nontrivial ,aanzienli#)-. /mployees tend to overspend on things that ma)e their lives more pleasant, such as on office accoutrements and other per)s. n addition to focusing on how MC!s can be used to avoid or mitigate these negative and dysfunctional behaviors, this boo)s emphasis is also, even primarily, on how MC!s can be employed to motivate positive or productive behaviors. "he role of MC!s in motivating employees to perform to their best abilities involves, among other sub#ects, the study of incentives in a results control conte1t. Personal limitations

"his problem occurs where employees who )now what is e1pected of them, and who may be highly motivated to perform well, are simply unable to perform well, because of any of a number of limitations. *ll individuals, even intelligent, well+ trained, and e1perienced ones, face limitations in their abilities to perceive new problems, to remember important facts, and to process information properly. !ometimes training can be used to reduce the severity of these limitations, but in most situations multiple biases and limitations remain. "hese problems reduce the probability that employees will ma)e the correct decisions or that they will correctly assess the problems about which decisions should be made. *ll that is re&uired to call for the necessity of effective MC!s, is that at least one of these problems occurs, which will almost inevitably ,onvermi#deli#)- be the case in comple1 organization as the above arguments and e1amples have suggested. 0ver)oepelende 8robleem MC naam 9ac) of direction !ome employees perform nvolve informing inade&uately simply because employees as to how they do not )now what the they can direct their organization wants from them. contributions to the fulfillment of the organizational ob#ectives Motivational individual and organizational how MC!s can be problems ob#ectives do not naturally employed to motivate coincide ,!amenvallenpositive or productive behaviors 8ersonnel /mployees are unable to do limitation their #obs Characteristics of good MC "o have a high probability of success, organizations must maintain good management control. :ood control means that management can be reasonably confident ,vertrouwen- that no ma#or unpleasant surprises will occur. (ut even good MC still allows for some probability of failure because perfect control doesnt e1ist. "he cost of not having a perfect control system can be called a control loss. 0ptimal control can be said to have been achieved if the control losses are e1pected to be smaller than the cost of implementing more controls. "he benchmar) therefore is ade&uate control. *ssessing whether good control has been achieved must be future+oriented and ob#ectives+driven. 'uture+oriented because the goals is to have no unpleasant surprises in the future. 0b#ectives+driven because the ob#ectives represent what the organization see)s to attain. 5hether good control is achieved is difficult and sub#ective. $ifficult because the ade&uacy of MC must be measured against a future that is difficult to predict. :ood control is also not established over an activity or entity with multiple ob#ectives unless performance on all significant dimensions has been considered. Control problem avoidance *voidance means eliminating the possibility that the control problems will occur. ctivity elimination "urning over potential ris)s, and the associated profits, to a third party through such mechanisms as subcontracts, licensing agreements or divestment. 5hen

managers do not wish to avoid completely an area that they cannot control well, they are wise at least to limit their investment, and hence their ris)s, in that area. "he economic+based literature that focuses on whether specific activities can be controlled more effectively through mar)ets or through organizational hierarchies is )nown as transaction cost economics. "he fact that all organizations of any size struggle with MC issues is testament to the limitations of arms+length, mar)et+based transactions with entities e1ternal to the firm to solve all control problems satisfactorily. utomation Managers can sometimes use computers, robots, e1pert systems, and other means of automation to reduce their organizations e1posure to some control problems. Computer eliminates the human problems of inaccuracy, inconsistency and lac) of motivation. *utomation can provide only a partial control solution at best; + 'easibility ,haalbaarheid+ Cost + ;eplace some control problems Centrali!ation Centralization is a )ey element of almost all organizations MC!s. Centralization e1ists to some e1tent in all organizations, as well as at all levels of management within organizations, as managers tend to reserve for themselves many of the most critical decisions that fall within their authority. "isk sharing !haring ris)s with outside entities can bound the losses that could be incurred by inappropriate employee behaviors. + nsurance + <oint venture "hese avoidance alternatives are often an effective partial solution to many of the control problems managers face. Control alternatives 'or the control problems that cannot be avoided, and those for which decisions have been made not to avoid, managers must implement one or more control mechanisms that are generally called management controls. MC!s vary considerably among organizations and among entities or decision areas of any single organization. Managers control choices are not random. "hey are based on many factors. * ma#or purpose of this boo) is to describe the factors affecting MC choice decisions and the effects on the employees and the organization when different choices are made.

Chapter 4; results controls 5ith the use of results control it is crucial to be clear in what are good results. ;esults control create meritocracies. n meritocracies, the rewards are given to the most talented and hardest wor)ing employees, rather than those with the longest tenure or the right social connections. ;esults controls influence actions or decisions because they cause employees to be concerned about the conse&uences of their actions or decisions. /mployees are empowered to ta)e those actions or decisions they believe will best produce the desired results. ;esults controls also encourage employees to discover and develop their talents. 5ell+designed results control systems can help produce the results desired. Prevalence #ge!ag$ of results controls ;esults controls are commonly used for controlling the behaviors of employees at many organizational levels, those with decision authority. ;esults controls are consistent with, and even necessary for, the implementation of decentralized forms of organization with largely autonomous entities or responsibility centers. Managers will act in an entrepreneurial manner necessary to thrive in competitive environments not only if they are sub#ected to the same mar)et forces and pressures that drive independent entrepreneurs, but also if they are promised commensurate,evenredig- rewards for the ris) they bear from doing so. $ecentralization, or delegation of decision rights to managers, and the design of incentive systems to motivate these managers to generate the desired results are two critical organizational design choices in a results+control conte1t2 they are part of what organizational theorists call the organizational architecture. 0rganizational choices about decentralization and incentive systems should be made #ointly, and that concentrating on one element to the e1clusion of the other will lead to poorly designed organizations. ;esults control need not to be limited to management levels only. 5hereas decentralization in an effective way to empower employees in a results+ control conte1t, there can, and even should, be limits to empowerment in certain circumstances. "esults controls and the control problems 5ell+defined results inform employees as to what is e1pected of them and encourages them to do what they can to produce the desired results. alleviate ,=erlichten- a potential lac) of direction. ;esults control also can be particularly effective in addressing motivational problems. 'inally, results control also can mitigate personal limitations. ;esults control typically promise rewards for good performers, they can help organizations to attract and retain employees who are confident about their abilities. nvestigating and intervening ,ingri#pen- when performance is deviating from e1pectations is the essence of a management+by+e1ception approach to management, which is in common use in large organization. %lements Of "esults Control Defining performance dimensions $efining the right performance dimensions is challenging and involves balancing an organization responsibilities to all of their sta)eholders, including owners, debt holders, employees, suppliers, customers and the society at large . Critical to choose performance measures that are congruent or aligned with the chosen performance dimensions because the goals that are set and the measurements that are made will shape employees views of what is important.

Measuring performance Measurement is a critical element of a results control system. "he ob#ect of measurement is typically the performance of an organizational entity or an employee in a specific time period. 8erformance measurement ,8m- typically vary across organizational levels. "he variation in the use of financial and operational pm between higher+ and lower+level management creates a hinge in the management hierarchy. f managers identify more than one result measure for a given employee, they must attach weightings to each measure so that the #udgments about performance in each result area can be aggregated not an overall evaluation. "he weightings can also be multiplicative. Setting performance targets 8erformance targets are another important results control element because they affect behavior in two ways; 1. "he improve motivation by providing clear goals for employees to strive for. 4. 8erformance targets allow employees to assess their performance. 'ailure to achieve the targets signals a need for improvement. Providing Rewards ;ewards or incentives are the final element of a results control system. "hey can be in the form of anything employees value, such as salary increases, bonuses, promotions, #ob security, #ob assignments, training opportunities, freedom, recognition and power. 8unishments are the opposite of rewards. 0rganization can derive motivational value from lin)ing any of these valued rewards to results that employees can influence. n entities where performance is mediocre ,matig- or poor, they can threaten to reduce the decision authority and power managers derive from managing their entities or decline to fund proposed pro#ects. ;esults measures can provide a positive motivational impact even if no rewards are e1plicitly lin)ed to results measures. 8eople often derive their own internally generated intrinsic rewards through a sense of accomplishment for achieving the desired results. "he motivational strength of any of the e1trinsic or intrinsic rewards can be understood in terms of several motivation theories that have been developed and studied for nearly >? years. + /1pectancy theory; individuals motivational force, or effort, is a function of; o "heir e1pectancies or their belief that certain outcomes will results from their behavior o "heir valences or the strength of their preference for those outcomes. 0rganizations should promise their employees the rewards that provide the most powerful motivational effects in the most cost effective way possible. (ut tailoring ,aanpassen- rewards to individuals or small groups within a large organization is not easy to accomplish. * tailored system will li)ely be comple1 and costly to administer. Conditions determining the effectiveness of results control ;esults controls wor) best only when all of the following conditions are present. 1. 0rganizations can determine what results are desired in the areas being controlled. 'or results control to wor), organization must )now what results are desired in the areas they wish to control, and they must communicate

the desired results effectively to the employees wor)ing in those areas. Results desirability means that more of the &uality represented by the results measure is preferred to less, everything else being e&ual. "he disaggregation of overall organizational ob#ectives into specific e1pectations for all employees lower in the hierarchy is often difficult. f the wrong results areas are chose, or if the right areas are chosen but given the wrong weightings, the combination of results measures will not be congruent with the organizations intended ob#ectives. @sing an incongruent set of results measures may then result in motivating employees to ta)e the wrong actions. 4. "he employees whose behaviors are being controlled have significant influence on the results for which they are being held accountable. /mployees whose behaviors are being controlled must be able to affect the results in a material way in a given time period Controllability principle. "he main rationale behind this principle is that results measures are useful only to the e1tent that they provide information about the desirability of the actions or decisions that were ta)en. n most organizational situations numerous uncontrollable or partially uncontrollable factors affect the measures used to evaluate performance. "he uncontrollable influences hinder efforts to use results measures for control purposes. n situations where many, large uncontrollable influences affect the available results measures, results control is not effective. 6. 0rganization can measure the results effectively. *bility to measure the controllable results effectively is the final constraint limiting the feasibility ,haalbaarheid- of results control. "he )ey criterion that should be used to #udge the effectiveness of results measures is the ability to evo)e ,oproepen- the desired behaviors. "o evo)e,oproepen- the right behaviors, in addition to being congruent and controllable, results measures should be; a. 8recision. Measurement accuracy refers to the degree of closeness of measurements of a &uantity to its actual value. 8recision is the degree to which repeated measurements under similar conditions show the same result; if they do, the measurements can be said to be reliable. *ccuracy describes the closeness of arrows ,measurements- to the target ,true value-. 5hen all arrows are grouped tightly together, the cluster of arrows ,measurement- is considered precise since they all struc) close to the same spot, even if not necessarily near the bulls eye. 9ac) of precision is an undesirable &uality for a results measure to have. 8recision therefore is an important &uality because without it the measure loses much of its information value. b. 0b#ectivity. *n ob#ective measure should be ta)en to mean here that it is not influenced by personal feelings or interpretations. :ood measures for control purposes therefore should be both precise ,;eliable- and ob#ective ,unbiased-. Measurement ob#ectivity can increased by i. Have the measuring done by people independent of the process ii. Have the measurements verified by independent parties c. "imeliness refers to the lag between the employees performance and the measurement of results ,and the provision of rewards based on these results-. "imeliness is important for two reasons; i. Motivational. /mployees need repeated performance pressure to perform at their best.

ii. "imeliness increases the value of interventions ,ingri#pen, tussen)omst-that might be necessary. f significant problems e1ist but the performance measures are not timely, it might not be possible to intervene to fi1 the problems before they cause ,more- harm. d. @nderstandability. "wo aspects are important. i. "he employees whose behaviors are being controlled must understand what they are being held accountable for. "his re&uires communication ,and maybe trainingii. /mployees must understand what they must do to influence the measure, at least in broad terms. 5hen employees understand what a measure represents, they are empowered to wor) out what they can do to influence it. e. Cost efficiency. * measure might have all of the above &ualities yet be too e1pensive to develop or use.

Chapter 6; *ction, 8ersonnel and Cultural Controls 0rganizations can supplement or replace results controls with other forms of control that aim to ma)e it more li)ely that employees will act in the organizations best interest. *ction controls involve ensuring that employees perform or do not perform certain actions )nown to be beneficial or harmful to the organization. "hey are feasible ,haalbaar- only when managers )now what actions are ,un-desirable and have the ability to ensure that the ,un-desirable actions ,do not- occur. 8ersonnel controls are designed to ma)e it more li)ely that employees will perform the desired tas)s satisfactorily on their own because the employees are e1perienced, honest, and hard wor)ing, and derive a sense of self+realization and satisfaction from performing tas)s well. Cultural controls e1ist to shape organizational behavioral norms and to encourage employees to monitor and influence each others behavior. ction controls *ction controls are the most direct form of management control because they involve ta)ing steps to ensure that employees act in the organizations best interest by ma)ing their actions themselves the focus of control. !o the focus is on the actionA Behavioral constraints (ehavioral constraints are a %negative or, as the word suggests, a %constraining ,beper)te- form of action control. "hey ma)e it impossible for employees to do thing that shouldnt be done. + 8hysical constraints; loc)s on des)s etc. 8hysical constraints are important in more everyday settings. + *dministrative constraints; they can be used to place limits on an employees ability to perform all or a portion of specific tas)s or actions. o !eparation of duties. (rea)ing up the tas)s necessary for the accomplishment of certain sensitive duties. Ma)ing it difficult for one person to complete the entire tas) on their own. !eparation of duties is one of the basic re&uirements of what is )nown as internal control which is the control+oriented term used by the auditing profession. + 8o)a+yo)es. Combination of physical and administrative constraints. ts a step built into a process to prevent deviation from the correct order of steps. Certain steps must be complete, before we can go further to another step. Preaction revie&s 8reaction reviews involve the scrutiny of the action plans of the employees being controlled. ;eviewers can approve or disapprove the proposed actions, as) for modifications, or as) for a more carefully considered plan before granting final approval. ction accountability *ction accountability involves holding employees accountable for the action they ta)e. 1. $efining what actions are acceptable or unacceptable. 4. Communication those definitions to employees a. *dministrative. "hey include the use of wor) rules, policies and procedures, contract provisions and company codes of conduct.

b. socially 6. 0bserving or otherwise trac)ing what happens a. $irect supervision or monitoring b. Mystery shoppers c. /1amine evidence 7. ;ewarding good actions or punishing actions that deviate from acceptable. Mostly action controls are more lin)ed with punishing than rewarding !ometimes the actions desired are not communicated e1plicitly at all, for e1ample in cases were a professional #udgment is involved. "edundancy#overtolligheid$ "his involves assigning more employees to a tas) than is strictly necessary. t increases the probability that a tas) will be satisfactorily completed. ction controls and the control problems *ction control wor)s, because they address one or more of the three basic control problems ,9ac) of direction, motivational problems and 8ersonal limitations-. + (ehavioral constraints are primarily effective in eliminating motivational problems. + 8reaction reviews can address all three of the control problems. (ecause they often involve communication to the employees about what is desired, they can help alleviate a lac) of direction. "hey can also provide motivation, as the threat ,bedreiging- of an impending review of an employees actions usually prompts e1tra care in the preparation of an e1penditure proposal, a budget or an action plan. 8reaction reviews also mitigate the potentially costly effects of the personal limitations, since a good reviewer can add e1pertise if it is needed. + *ction accountability controls can also address all of the control problems. + ;edundancy is relatively limited in its application. t is primarily effective in helping to accomplish a particular tas) if there is some doubt as to whether the employee assigned to the tas) is either motivated to perform the tas) satisfactorily or capable in doing so. Prevention versus detection *ction controls can also be usefully classified according to whether they serve to prevent or to detect undesirable behaviors. Controls that prevent the undesired actions from occurring are, when effective, the most powerful form of control because the costs and harm stemming from the undesirable behavior will be avoided. $etection+type action controls are applied after the occurrence of the behavior. Conditions determining the effectiveness of action controls *ction controls are effective only when both of the following conditions e1ist 1. 0rganizations can determine what actions are ,un-desirable. 9ac) of )nowledge as to what actions are desirable is the constraint ,beper)ingthat most severely limits the use of action controls. "he definitions of preferred actions in highly comple1 and uncertain tas) environments often is incomplete or imprecise. .nowledge of the desired actions can be discovered or learned in two ways; a. *nalyzing the action patterns ,patronen- in a specific situation or similar situations over time to learn what actions produce the best results. b. (e informed by others, especially for strategic decisions.

t is important that the actions for which employees are to be held accountable are in fact, the actions that will lead to the highest probability of accomplishment of one or more of the organizations goals. 4. 0rganizations are able to ensure that the ,un-desirable actions ,do notoccur. .nowing what actions are desirable is not sufficient by itself to ensure good control; organizations must have some ability to ensure or observe that the desired actions are ta)en. a. "he effectiveness of the behavioral constraints and 8reaction reviews varies directly with the reliability of the physical devices or administrative procedures the organization has in place to ensure that the ,un-desired actions are ,not- ta)en. b. *ction trac)ing often provides a significant challenge that must be faced in ma)ing action accountability controls effective. "he criteria that should be used to #udge whether the action trac)ing is effective are; i. 8recision refers to the amount of error in the indicators used to tell what actions have ta)en place. ii. 0b#ectivity, or freedom from bias, is a concern because reports of actions prepared by those whose actions are being controlled cannot necessarily be relied upon. 5ithout ob#ectivity, management cannot be sure whether the action reports reflect the actual actions ta)en, and the reports lose their value for control purposes. iii. "imeliness in trac)ing actions also is important. f the trac)ing is not timely, interventions are not possible before harm is done. Much of the motivational effect of the feedbac) is lost when the trac)ing is significantly delayed. iv. @nderstandability and consistently acting in full compliance with the detailed rules and regulations contained in procedures handboo)s, is obviously much more challenging. mplementing action controls where one of these action+trac)ing &ualities cannot be achieved will lead to some undesirable effects. Personnel controls 8ersonnel controls build on employees natural tendencies to control or motivate themselves. 1. !ome personnel controls help clarify e1pectations. "hey help ensure that each employee understands what the organization wants. 4. !ome personnel controls help ensure that each employee is able to do a good #ob. 6. !ome personnel controls increase the li)elihood that each employee will engage in self+monitoring. Self-monitoring is an innate force that pushes most employees to want to do a good #ob, to be naturally committed. 8ersonnel controls can be implemented through 1. !election and placement. 0rganization devote considerable time and effort to employee selection and placement. /mployee selection often involves reference chec)s on new employees, which many organizations have stepped up in recent years in response to the heightened worries over wor)place security. 0rganization primarily focus on matching #ob re&uirements with #ob applicants s)ills. 4. "raining. "raining is another common way to increase the li)elihood that employees do a good #ob. "raining can provide useful information about what actions or results are e1pected and how the assigned tas)s can be

performed. Much training ta)es place informally, such as through employee mentoring. 6. <ob design and resourcing. *nother way to help employees act aptly is simply to ma)e sure that the #ob is designed to allow motivated and &ualified employees a high probability of success. n larger organizations particularly, there is a strong need for transfer of information among organizational entities so that the coordination of well?timed, efficient actions and decision is maintained. Cultural controls Cultural controls are designed to encourage mutual monitoring; a powerful form of group pressure on individuals who deviate from group norms and values. Cultural control are most effective where members of a group have social or emotional ties to one another. Cultures are built on shared traditions, norms, beliefs, valued, ideologies, attitudes and ways of behaving. "he cultural norms are embodied in written and unwritten rules that govern employees behaviors. 0rganizational cultures can be shaped in many way; + 5ords + Codes of conduct. Most organization above minimal size attempt to shape their organizationl culture through what are )nown as codes of conduct. "hese formal, written documents, provide broad, general statements of organizational values, commitments to sta)eholders, and the ways in which management would li)e the organization to function. "o be effective, the messages included in these statements should be reinforced through formal training sessions and through informal discussions or mentoring meeting among employees and their superiors. "he three common drivers for code adoption are to comply with legal re&uirements; to create a shared company culture; and to protect or improve the corporate reputation. + :roup rewards. 8roviding rewards or incentives based on collective achievement also encourages cultural control. !uch incentive plans based on collective achievement can come in many forms. /vidence suggest that group+based incentive plans create a cultural of %ownership and %engagement to the mutual benefit of organizations and their employees. 5ith group rewards, the lin) between individual efforts and the results being rewarded is wea), or at least wea)ened. Motivation to achieve the rewards is not among the primary forces affected by group rewards; instead communication of e1pectations and mutual monitoring are. :roup rewards can encourage teamwor), on+the+#ob training of new employees and the creation of peer pressure on individual employees to e1ert themselves for the good of the group. pen boo! management " #M$. "he goal of 0(M is to create a clear line of sight between each employees actionsBdecisions and company financial performance, thereby instilling an incentive for the employees to behave in the companys best interest and to ma)e useful suggestions for improvement. :roup rewards essentially delegate the monitoring of employees behaviors to employees co+ wor)ers C essence of mutual monitoring + ntra+organizational transfers or employee rotation help transmit culture by improving the socialization of employees throughout the organization, giving them a better appreciation of the problems faced by different parts of the organization, and inhibiting the formation of incompatible goals and perspectives.

+ +

8hysical arrangements, such as office plans, architecture, and interior dDcor, and social arrangement, such as dress codes, institutionalized habits, behaviors, and vocabulary. "one at the top. "heir statements should be consistent with the type of culture they are trying to create and importantly, their actions and behaviors should be consistent with their statements.

Personnel' cultural controls and the control problems 8ersonnelBcultural controls are capable of addressing all of the control problems although not each type of control in this category is effective at addressing each type of problem. %ffectiveness of personnel'cultural controls *ll organizations rely ,vertrouwen- to some e1tent ,omvang- on their employees to guide and motivate themselves. Cultural controls can also, by themselves, dominate a control system. 8ersonnelB cultural controls can have distinctive advantages over results and action controls. "hey are usable to some e1tent in almost every settings; their cost is often lower than more obtrusive forms of controls; and they might produce fewer harmful side effects. "he degree to which personnelBcultural controls are effective can vary significantly across individuals, groups, communities, and societies. !ome people are more honest than others, and some communities and societies have stronger emotional ties among their members. Cultures that are %too strong can also be a disadvantage, especially when they need changing.

Chapter 7; Control !ystem "ightness "he benefit ,winst- of any MC! is derived ,volgt uit- from the increase in the li)elihood ,waarschi#nli#)heid- that the organizational ob#ectives will be achieved relative to what could be e1pected if the MC! were not in place. =oordeel is de waarschi#nli#)heid dat een doel wordt behaald in vergeli#)ing met de afwezigheid van een MC!. "ighter MC!s should provide ,zorgen voor- more assurance ,ze)erheid- that employees will act in the organizations best interest. /ffective implementation of tight control re&uires that management has a good understanding of how one or more of the control ob#ects ,results, actions, and personnelBculture- relate and contribute ,bi#dragen- to the overall organization ob#ectives. (ight results controls; "he achievement of tight result control depends on characteristics of the definition of the desired result areas, the performance measures and the reinforcement or incentives provided. + Congruence ,samenhang-; Congruence is one of the main determinants ,bepalende factor- of the effectiveness of results controls. "herefore, the true ob#ectives need to be well understood. 5at is het doel, in hoeverre is het doel te berei)en met dit control mechanisme3 5here ob#ectives are not clear, congruence becomes a limiting problem. f the chosen measurable performance dimensions are not good indicators of the organizations true ob#ectives, then the results control system cannot be tight, regardless of any of the other system characteristics. !pecificity; "he degree of tightness of results control also depends on having performance e1pectations described in specific terms. Control in difficult+to+measure areas can be tightened by disaggregating ,uitsplitsingthe global performance area into its various components. Eonetheless, specificity of e1pectations is one of the elements necessary for the implementation of tight results controls. Communication and internalization; 'or results controls to be tight, performance targets must also be communicated effectively and internalized ,zi#n doorgedrongen- by those charged with their accomplishment ,prestatie-. "he degree to which goals are understood and internalized is affected by many factors. Completeness; Completeness is the final re&uirement for tight results controls. "he result areas defined in the MC! include all the areas in which the organization desires good performance and for which the employees involved can have some impact. ;esults control systems should capture, as completely as possible, all information about employees effects on firm value, weighted properly, so that employees efforts are appropriately balanced across the multiple dimensions of their #ob. 5hen the results controls are incomplete, other types of control, including action and personnelBcultural controls, should be designed to try to fill the void left by the incomplete results control.

Performance measurement "ight results control also depends on the ade&uacy of the performance measures that are use. + ncentives; results controls are li)ely to be tighter if meaningful rewards are directly and definitely lin)ed to the accomplishment of the desired results. * direct lin) means that the accomplishment of results translates

e1plicitly and unambiguously into rewards. * definite lin) between results and rewards means that no e1cuses are tolerated (ight action controls *ction control systems should be considered tight only if it is highly li)ely that employees will engage consistently in all of the actions critical to the operations success and will not engage in harmful actions. !o the more unli)ely it is that an employee can harm the results, the more tight a control.

Behavioral constraints + *dministrative constraints. ;estricting decision authority to higher organizational levels provides tighter control if it can be assumed that higher+level personnel will ma)e more reliable decisions than lower+level personnel. o !eparation of duties between two employees ma)es the occurrence of harmful activity less li)ely because one person cannot accomplish the entire undesirable tas). Critical assumption here is that those who do not have authority for certain actions or decisions cannot violate the constraints that have been established. Preaction revie&s 8reaction reviews can ma)e MC!s tight if the reviews are fre&uent, detailed, and performed by diligent, )nowledgeable reviewers. "he e1tent to which organizations tighten their controls also often varies with their fortunes. ction accountability "he amount of control generated by action accountability controls depends on characteristics of the definitions of desirable actions, the effectiveness of the action+trac)ing system and the reinforcements provided. + $efinitions of actions. "o achieve tight action accountability , the definitions of actions must be congruent, specific, well communicated and complete. ,see tight results controlCongruence means that the performance of the actions defined in the control system will indeed lead to the achievement of the true organizational ob#ectives. t can be affected by ma)ing the definitions of actions specific in the form of wor) rules or policies. "ight action controls depends on the understanding and acceptance of the wor) rules, policies or guidance by those whose behaviors are being controlled. *ction controls are not effective in all circumstances, such as in situations where the desired actions cannot be defined nearly completely because the tas)s are comple1 and re&uire considerable discretion or creativity. + *ction trac)ing. Control in an action accountability control system can also be made tighter by improving the effectiveness of the action+trac)ing system. o Constant direct supervision o $etailed audits of action reports + *ction reinforcement. Control can made tighter by ma)ing the rewards or punishments more significant to the employees affected. !ignificance varies directly with the size of the reinforcement. 8unishments are common in action control settings because they often involve employee violations ,schending- of rules and procedures. ;einforcement is significant because for e1ample pilots are threatened with severe penalties, including

loss of profession, not to mention the fear for loss of life when accidents do happen. 'or action accountability to be tight, all of the elements of the action control must be properly designed. "hey can help prevent the dissipation ,verspilling- of value the company may have otherwise generated, and they can, hopefully, prevent ma#or losses that might arise from corruption scandals or accidents. "here is no reason why control of computer+based transactions cannot be tight, even tighter that paper+ based transactions, but due to system comple1ity, companies do not always fully understand the control ris)s involved. (ight personnel'cultural controls "ight personnelBcultural controls can also e1ist in for+profit business. "he degree of control provided by personnelBcultural controls is less than tight. 'actors such as education, e1perience, and personality cannot always predict future performance. Cultural controls on the other hand are often more stable. 0rganizational cultures can be strong because they derive from deeply held and widely shared beliefs and values. /1cept for companies with strong cultures, tight control probably cannot be affected with the use of personnelBcultural controls alone. Conclusion *n important characteristic of MC!s is their degree of tightness. "ight controls2 * high degree of assurance that employees will behave in the organizations best interest. "o tighten controls organizations must often rely on multiple forms of controls and align them with one another. 0rganizations sometimes deliberately choose to loosen their controls.

Chapter >; Control system costs MC!s provide one primary benefit2 a higher probability that employees will pursue organizational ob#ectives. )irect costs "he direct costs of an MC! include all the out+of+poc)ets, monetary costs re&uired to design and implement the MC!. Many organizations often are unaware of, or do not bother to calculate accurately the size of, all of these direct costs. *ndirect costs Challenging as estimating the direct costs of control may be, they can be dwarfed ,overschaduwd- by indirect costs of control caused by any of a number of harmful side effects; + (ehavioral displacement ,gedragsverplaatsing- is a common MC!+related side effect that can e1pose organizations to significant indirect costs. t occurs when the MC! produces, and actually encourages, behaviors that are not consistent with the organizations ob#ectives. o (ehavioral displacement and results controls. n a results control system, behavioral displacement occurs when an organization defines sets of results measures that are incongruent with the organizations %true ob#ectives. ncongruence arises because organizations focus on easily &uantifiable results that lead them to incompletely capture all of the desired results. /1ample; City officials wanted to tac)le overtime in their garbage collection service, they offered the garbage collectors an incentive scheme where they would be paid full time even if they reported bac) early. t wor)edA :arbage collectors came bac) consistently early and received full pay for the shift. $espite this good effect on overtime reduction, however, there was an increase in preventable traffic accidents, missed pic)+ups of garbage, and truc)s filled over the legal weight limit. $e )osten zi#n dan dus de )osten van het ongelu), de gemiste pic)+ups etc. * ma#or cause of the incompleteness in results control systems is a tendency to concentrate on results areas that are concrete and easily &uantifiable, rather than intangible and difficult to &uantify, despite their importance for organizational success. !olution2 find or develop indicators of the results areas that may be missing. "here is also a ever+present tendency that &uantified measures will be overused. "hey try to want what they can measure, instead of measure what they want. ts the other way around. o (ehavioral displacement and action controls. 0ne form of action control+related displacement is often referred to as means-ends inversion, meaning that employees pay attention to what they do ,the means- while losing sight of what they are to accomplish ,the ends-. !ometimes action control+related displacement occurs simply because the defined actions are incongruent. (ecause they promote compliant yet rigid, non+adaptive behaviors, a pathology commonly associated with bureaucratic organization. *ction controls and bureaucratization can be good in stable environments with considerable centralized )nowledge about &hat actions are desired because they help establish compliant, reliable,

and efficient wor) routines. n changing environments, however, they may hinder the needed change that is re&uired to stay competitive. o (ehavioral displacement and personnelBcultural controls. t can arise from recruiting the wrong type of employees or from providing insufficient training. !trong cultures can also cause displacement when the behavioral norms that groups use to guide the behaviors of their members, or the measures used to provide group rewards, are not in line with what organization desires. :amesmanship; we use this term to refer generally to the actions that employees ta)e to improve their performance indicators without producing any positive economic effects for the organization. o Creation of slac) resources ; !lac) involves the consumption of organizational resources by employees in e1cess of ,buiten datwhat is re&uired. "he propensity ,neiging- to create slac) often ta)es place when tight results controls are in use that is, when employees, mostly at management levels, are evaluated primarily on whether or not they achieve their budget targets. (udget slac) protects the managers against unforeseen contingencies and improves the probability that the budget target will be met. n most situations, slac) is nearly impossible to prevent. "heoretically, slac) is feasible ,mogeli#)- only where there is information asymmetry, where superiors have less+than+complete )nowledge about what can be accomplished in a given area, and where subordinates are allowed to participate in setting the performance targets for that areas. o $ata manipulation. $ata manipulation involves fudging the control indicators. 'alsification involves reporting erroneous data, meaning that the data are changed. $ata management involves any action underta)e to change the reported results, while providing no real economic advantages to the organization and, sometimes, even causing harm. $ata management can be accomplished through either accounting or operating means. %ccounting methods of data management involve an intervention ,ingri#pen- in the measurement process. perating methods of data management involve the altering ,wi#ziging- of operating decisions. Manipulation is a serious problem because it can render an entire control system ineffective. "he effects of manipulation can also go far beyond the MC! because it affects the accuracy of an organizations information system. $espite the costs, data manipulation schemes are often fostered by e1cessive short+term performance pressures and inade&uate controls to prevent the dysfunctional side+effects. /vidence indicates that detection of performance manipulation and misrepresentations of financial reports in on the rise. 0perating delays; 0perating delays often are an unavoidable conse&uence of the 8reaction review types of action controls and some of the forms of behavioral constraints. 0bviously, where fast action is important, as it is in many competitive mar)ets, decision delays can be &uite costly. $elays are a ma#or reason for the negative connotation associated with the word %bureaucracy. Eegative attitudes. "he cause of negative attitudes may be precipitated by a large number of factors such as economic conditions, organization structure, and administrative processes, alone or in combination. o Eegative attributes produced by results control.

0ne cause of negative attitudes arises from a lac) of employee commitment ,verplichting- to the performance targets defined in the results control system. Eegative attitudes may also stem from problems in the measurement system. t is common to hear managers complain that their performance evaluation are not fair because they are being held accountable for things they have little or not control. ;ewards that are not perceived to be e&uitable ,billi#)-, and perhaps most forms of punishment tend to produce negative attitudes. /ven target setting and evaluation processes themselves may produce negative attitudes particularly when they are implemented with people+insensitive non+supportive leadership styles. *ttitudes are important MC! outcomes to monitor not only because they have their own value as indicators of employee welfare, but also because the presence of these negative attitudes may indicate the propensity to engage in any of a number of harmful behaviors, such as data manipulation or other forms of gamesmanship, withdrawal or even sabotage. Eegative attitudes produced by action controls. Most people, particularly professionals, react negatively to the use of action controls. 8reaction reviews can be particularly frustrating if the employees being reviewed do not perceive the reviews as serving a useful purpose. *ction control may also annoy lower+level personnel.

Conclusion "he implementation of virtually all controls re&uires companies to incur some direct, out+of+poc)et costs. (ut sometimes those direct costs are dwarfed ,overschaduwd- by the indirect costs caused by any of a number of harmful side effects. 1. "he harmful side effects are not uni&ue to one form of control. 4. !ome of the control types have negative side effect that are largely unavoidable. 6. "he li)elihood of severe harmful side effects is greatest when there is either a failure to satisfy one or more of the desirable design criteria or a misfit between the choice of type,s- of control and the situation. 7. 5hen controls have design imperfections or when they are inappropriately used, the tighter the controls are applied, the greater are both the li)elihood and the severity of harmful sight effects. 5hat ma)es dealing with these potential side effects difficult is that there is not always a simple one+to+one relationship between the control type and the effect. 'urthermore the e1istence of the side effects is often difficult to detect.

Chapter F; $esigning and /valuating MC! * general framewor) that can be used to design MC!s or to improve those already in use. +hat is desired, nd &hat is likely, MC!s cannot be designed or evaluated without an understanding of what it is the organization wants the employees to do. 0b#ectives, and, more importantly, strategies, that are derived from a good understanding of the organizations ob#ectives often proved important guides to the actions that are e1pected. Eot only must organizations determine what is desired, they also need to try to assess what is li)ely to happen. Choice of controls "he specific set of management controls to be selected from the feasible alternatives should be those that will provide the greatest net benefits. 1. 8ersonnelBcultural controls as an initial consideration. Managers should start by considering whether personnel or cultural controls will be sufficient, because they have relative few harmful side+effects. 8ersonnelBcultural controls are sufficient only if employees understand what is re&uired in their particular roles, are capable of performing well, are supported by the re&uisite organizational structures and systems, and are motivated to perform well without additional reinforcements provided by the organization. .nowing the limitations of personnelBcultural controls, choices among the various forms of action and results control should depend on the particular advantages and disadvantages each has in the specific setting in &uestion. 4. *dvantages and disadvantages of action controls. a. *dvantages i. 8erhaps the most significant advantage of action controls is that they are the most direct form of control. ii. *ction controls tend to lead to documentation of the accumulation of )nowledge as to what wor)s best. iii. *ction controls, particularly in the form of policies and procedures, also are an efficient way to aid organizational coordination. b. $isadvantages i. 'easibility limitation ,haalbaarheid beper)ing-. /1cellent )nowledge of what actions are desirable e1ists only for highly routinized #obs. ii. Most action controls also often discourage creativity, innovation, and adaptation. /mployees often react to action controls by becoming passive. iii. *ction accountability, in particular, can cause,veroorza)ensloppiness ,slordigheid-. /mployees who are accustomed to operating with a stable set of wor) rules are prone to cut corners. iv. *ction controls often cause negative attitudes. !ome, perhaps even most, people are not happy operating under them. v. !ome action controls, particularly those that re&uire preaction reviews are costly. 6. *dvantages and disadvantages of results controls a. *dvantages

i. 'easibility ,haalbaarheid-. ;esults controls can provide effective control even where )nowledge as to what actions are desirable is lac)ing. ii. /mployee behavior can be influenced even while the employees are allowed significant autonomy. iii. 0n+the+#ob training. /mployees learn by doing and by ma)ing mista)es. iv. ne1pensive. b. $isadvantages i. ;esults measures usually provide less than perfect indications whether good action had been ta)en when the measures fail to meet one or more of the &ualities of good measures. ii. 5hen results are affected by anything other than employees own s)ills and efforts, as they almost always are, results control impose ris) on the employees. iii. mpossible to optimize the performance targets set as part of result control system. "he targets are often as)ed to fulfill multiple importation control function. 1. Motivation to achieve 4. 8lanning iv. *side from the difficulty involved in setting the right target for the right performance area, the measures themselves can be conflicting and certainly overwhelming, when they are ,toonumerous. v. Eot all employees li)e being empowered to produce results as they best see fit. Choice of Control (ightness 5hat are the potential benefits of tight controls3 5hat are the costs3 *nd are any harmful side effects li)ely3 n any organization, tight control is most beneficial over the areas most critical to the organizations success. .i#)en naar delen die het belangri#)st zi#n voor het succes van de organisatie. "he critical success factor vary widely across organizations. "he potential benefits of tight controls also tend to be higher when performance is poor. +hat are the costs involved, !ome forms of control are costly to implement in tight form. "ight results control might re&uire e1tensive studies to gather useful performance standards, or they might re&uire sophisticated information systems to collect and analyze all the re&uired performance data. re any harmful side effects likely, *ll the conditions necessary to ma)e a type of control feasible ,haalbaar-, such as )nowledge about how the control ob#ect relates to the desired ends, may not be present. Harmful side effects are li)ely if the control is implemented, especially if the control is implemented in tight form. Eeither action nor results control can be said to be clearly effective, and the implementation of either in tight form is li)ely to cause problems. "ight action controls would li)ely cause behavioral displacement and stifle creativity. "ight results controls would li)ely cause problems to select the right results measures and set ade&uately challenging targets, both of which are difficult in rapidly changing environmental conditions. Simultaneous tight-loose controls

MC!s can be considered loose in that they allow, and even encourage,aanmoedigen-, autonomy, entrepreneurship and innovation. (ut these same control systems can also be called tight because the people in the company share a set of rigid values. MC!s in these organizations are dominated by personnel or cultural control; or they can be said to be tight on ob#ectives and core values, but loose on procedures. t may be possible to approach a similar type of simultaneous tight and loose controls even where a strong culture does not e1ist. "his can be accomplished by using tight controls over the few )ey actions or results that have the greatest potential impact on the success of the organization. More control should be e1ercised over strategically important areas than over minor areas, regardless of how easy it is to control the latter. dapting to change Most organizations emphasize one form of management control at a given point in time, but they often change their emphasis from one form to another as their needs, capabilities and environment change. n addition to growth, many other situational factors cause organization to adapt their management control systems to their changing environments. .eeping a behavioral focus 5hat ma)es the analysis of management control so difficult is that their benefits and side effects are dependent on how employees will react to the controls that are being considered. Eo one form of control is optimal in all circumstances. However it is still important to )eep the focus on the people involved because it is their responses that will determine the success or failure of the MC!s. "he benefits of management controls are derived only from their impacts on behaviors. Maintaining good control/ "he causes of the problems these companies have faced are often divers. 0ne cause is an imperfect understanding of the setting andBor the effect of the management controls in that setting. *nother cause is managements inclination to sub#ugate the implementation of management controls to other, often more pressing, business demands. Criticisms should be made carefully. 5hile many organizations may have face MC! wea)nesses of various magnitudes, )nowing what should be criticized is not unproblematic. Criticisms of MC!s must be made with caution.

Chapter G; ncentive systems. 1. 8erformance definition 4. Measurements 6. 0ne of the primary principles of effective management is that rewards should be the third thing you wor) on. "he third ma#or element of financial results control systems deals with the provision of organizational rewards. "hey follow performance definition clear and unambiguous articulation of what needs to be done. ncentive systems tie ,verbinden- rewards ,andBor punishments- to the performance evaluations. ncentive systems are important because they reinforce ,verster)en- the definitions of the desired result areas and motivate employees to achieve and e1ceed the performance targets. ncentives refer primarily to things that employees value positive. 8unishments manifest themselves commonly through an absence of positive rewards. Purpose of incentives 8erformance+dependent rewards, or incentives, provide the impetus ,impuls- for the alignment ,in overeenstemming brengen- of employees natural self+interest with the organizations ob#ectives. + nformational; the rewards attract employees attention and inform or remind them of the relative importance of often+competing results areas, such as cost, &uality, customer service, asset management and growth. effort-directing purpose + Motivational. !ome employees need incentives to e1ert the e1tra effort re&uired to perform tas)s well; that is, to wor) hard, do a good #ob, and succeed. effort-inducing purpose + *ttraction and retention ,behoud- of personnel . 8erformance+dependent rewards are an important part of many employees total compensation pac)age. + ncentive systems also serve several non+control purposes. ncentive systems that are performance+dependent ma)e compensation more variable with firm performance. ncentive system design can also affect a firms ta1 payments. :overnment regulations also affect compensation arrangement in organization, thus driving another important concern of incentive system design. Control and non+control purposes of incentive systems can, and must, sometimes be traded off against each other. Monetary incentives Money is an important form of reward that is often lin)ed to performance, particularly at management levels in organization. + !alary increases can be seen as an incentive when at least some portion of the total raise consists of merit+based increases. !alary increases can be seen as an incentive when they are e1pected to be %earned through performance of the ac&uisition of s)ills that promise improved performance in future periods. + !hort+term incentives. Many organizations, especially those beyond minimal size in the commercial sector, but also increasingly those in the not+for+profit sector, in a growing number of countries, use short+term incentives, which include bonuses, commissions, and piece+rate payments. "he primary rationale for variable pay is to differentiate pay; that is, to provide rewards in accordance with an employees contributions to the

organization. !hort+term incentives typically provide cash payments based on performance measured over periods of one year or less. @sually in additions to financial measures of performance, annual incentive plans can also include bonus payments contingent on achievements in nonfinancial performance areas. 9ong+term incentive awards are based on performance measured over periods greater than one year. "heir principal ob#ective is to reward employees for their role in creating long+term value. 9ong+term incentive awards often are restricted ,beper)t- to relatively high levels of management based on the argument that e1ecutive decision ma)ing at these levels most directly impacts the long+term success of the organization. o !toc) option plans give employees the right to purchase a set number of shares of company stoc) at a set price during a specified period of time. 5hile employees might desire stoc) options because of the size of the potential gains, stoc) options also have several attractive features for the granting firms. 'rom an incentive perspective, employees only benefit when the stoc) prices goes up, so stoc) options motivate employees to increase their companys stoc) price. 'inally, vesting schedules coupled with service+based restrictions that cause employees to forfeit unvested options when they level the firm are believed to both enhance employees long+ term focus on the business as well as retention. $isadvantages; !toc) option grants represent a potential future issuance of shares, which creates dilution ,=erdunning- and puts a downward pressure on stoc) prices. !toc) options also sometimes motivate managers to underta)e ris)ier business strategies because the managers are rewarded for gains but not penalized for losses. o ;estricted stoc) plans. /mployees eligible ,geschi)t- for restricted stoc) do not have to spend cash to ac&uire the stoc), but selling the stoc) that they are given is restricted for a specified period of time and is contingent upon continued employment. "his plan are less ris)ier than stoc) options. o 8erformance stoc) or option plans. "o eliminate the giveaway perception of restricted stoc) and accentuate pay+for+performance, some firms have resorted ,gevlucht- to performance awards by ma)ing their stoc) grants contingent on the achievement of stoc) of non+stoc) goals over a multi+year performance period.

*ncentive system design + ncentive formula; "he types of rewards provided and the bases on which they are awarded are commonly communicated to the incentive plan participant by means of an incentive formula and described in an incentive contract that might be written in great detail. Contract terms can be left implicit for a number of reasons. t may be difficult to describe the bases for the rewards andBor their weighting from a large set of evaluation criteria prior to the performance period. "he use of sub#ectivity in contracting can affect employee ris). t can decrease ris) if it allows ad#ustments for the effect of factors that are outside the employees control. (ut the use of sub#ectivity can also increase employee ris). o mplicit contract. /mployees bear the ris) that their evaluators might evaluate them on different bases than that they were assuming when they made their decisions.

f employees do not trust their evaluators to ma)e informed and unbiased performance assessments, they can result in employee frustration, de+motivation and friction. o 5hen evaluations are sub#ective, employees may attempt to inappropriately influence their evaluator for better evaluations. !hape of the incentive function. 5hen rewarded promises are formulaic, the lin) between rewards and the bases on which they are awarded is often determined by a rewards+results or incentives+performance function. *t profit center levels, most firms set a lower cutoff or threshold in their short+term incentive contracts. !ize of incentive pay. (ecause employees almost invariably value money, a significant proportion variable pay should motivate them to achieve the performance goals. "he most important consideration to the high use of variable pay is that if performance is not totally controllable by the employees, then the incentive system inevitably ,ongeschi)t- imposes ris) on them. "herefore employees want to be compensated. o

Criteria for evaluating incentive systems "o evaluate an incentive system, one can consider the following criteria. 1. "he rewards should be valued. ;ewards that have no value will not provide motivations. (ut it is possible that rewards tastes vary across individuals. ;eward tastes also vary across countries due to many factors, including culture, stage of economic development and differences in ta1 and regulation. 4. "he rewards should be large enough to have impact . f rewards that are valued are provided in trivial amounts, the effect can be counterproductive. 6. ;ewards should be understandable . /mployees should understand both the reasons for and the value of the rewards. 7. ;ewards should be timely. $elay in providing rewards after the performance is said to dilute their motivational effects. >. "he effects of the rewards should be durable . ;ewards have greater value if the good feelings generated by the granting of a reward are long lasting. F. ;ewards should be reversible. 8erformance evaluators often ma)e mista)es, and some reward decisions are more difficult to correct than others. H. ;ewards should be cost efficient . ncentives should achieve the desired motivation at minimal cost. Monetary incentives and the evaluation criteria. Monetary rewards can have potent impacts on employees behaviors, because virtually everyone values money. However, the observation that employees almost without e1ception value money does not necessarily imply that higher incentives will necessarily lead to higher performance. "here is an inverse @+ shaped relationship between effort levels and incentive intensity, indicating that ever higher incentives may actually result in a decline in performance. !ome forms of monetary rewards have been said to have %too much impact ,stoc) options-. ncentive contracts are sometimes &uite comple1 or even ambiguous, and because performance+related feedbac) is incomplete or biased, employees often fail to understand the reasons why they are given the rewards. Monetary rewards vary in their timeliness. 8iece+rates used in some production settings are possibility the timeliest. *nother way to possibly mitigate the short+ term focus of some incentive systems while circumventing the %mental discount

cost of deferred payments would be to consider ris)+ad#usted measures as the basis for bonus determination. Most monetary rewards, particularly small ones, are not durable. $urability ,$uurzaamheid- can perhaps be improved if the award is given but restricted for a period of time. Monetary rewards also vary in their reversibility. (onus awards are reversible ,om)eerbaar- because they are typically contingent on performance in a single period. !alary increases, on the other hand provide an almost guaranteed annuity. 'inally, monetary rewards tend to be e1pensive. "he value provided to the employees is a direct cost to the firm. "itles, recognition, interesting #ob assignments etc are much less e1pensive. Critics have argued that the high pay for, say, top e1ecutives is driven more by an ideology called the %talent myth rather than by a reality that a small group of select employees who ma)e a huge impact on their companies success are hard to replace. *lthough monetary rewards do not satisfy all the evaluation criteria e&ually well, the criteria are not all e&ually important either. 0roup "e&ards "eam or group rewards have advantages; + :roup rewards often do not provide direct and strong incentive effects. + :roup rewards also create the potential for free rider effects. + 0ne prominent form of group rewards, provide direct incentives only for the small number of managers at the very top of publicly held firms who presumably can influence their firms stoc) price in a meaningful way. (ut, group rewards can produce a beneficial form of cultural control. "eam members may monitor and sanction each others behaviors and produce improved results. !ome firms have used group rewards very effectively over long periods of time. Conclusion ncentives are an important part of the results+control arrangements used to direct influence employees behaviors. ncentive contracts design presents problems that are far larger than #ust the choice of rewards. 8erhaps, the safest advice that can be proffered ,aangeboden- is that incentives should be sufficiently meaningful to offset other motives employees have to act in way that are contrary to the organizations best interests, but the rewards should not be greater than those necessary to provide the needed motivation. Many incentive systems have unintended conse&uences that can actually destroy value, such as by encouraging results that ma1imize incentive pay in the short term while #eopardizing the long+run viability of the organization.

Chapter 16; Corporate :overnance and (oard of $irectors Corporate governance refers to the sets of mechanisms and processes that help ensure that companies are directed and managed to create value for their owners while concurrently fulfilling responsibilities to other sta)eholders. Corporate governance practices in all countries are influenced by what is thought to be best practice. However, )nowledge of what constitutes ,vormt- best practice either in general or in any specific setting, is incomplete and uncertain. n the meantime, regulations are fre&uently changing, and corporation must do the best they can in environments that are often dynamic. Corporate governance systems and MC! are ine1tricably ,onlosma)eli#)- lin)ed. *n MC!s focus ta)es the perspective of top management and as)s what can be done to ensure the proper behaviors of employees in the organization. "he corporate governance focus is on controlling the behaviors of top management, and also, although less directly, those of all the other employees in the firm. Changes in corporate governance mechanisms and practices will usually have direct and immediate effects on MC! practices and their effectiveness. Corporate :overnance effectiveness MC! practices and their

La&s and "egulations Corporations are legal entities. "hey are sub#ect to the laws and regulations of the government #urisdiction in which they operate and those of the stoc) mar)ets on which their shares are traded. + %nglo-%merican system; focuses on the primacy of shareholders as the beneficiaries of fiduciary duties. "he legal systems in the @! creates a fiduciary obligation ,vertrouwensverplichting- for managers and directors to act in the best interest of shareholders. "he primary goal is to ma1imize the value of the corporation. "he @! Congress passed the !ecurities *ct of 1G66 and 1G67 that, among other things, created the !ecurities and /1change Commission ,!/C-, the agency that is primarily responsible for enforcements ,ten uitvoerlegging van-of @! federal securities laws. "hese acts re&uire that publicly traded corporations disclose certain types of information on a regular basis to the !/C and to the companys shareholders. + Continental &uropean'(apanese system) has a broader concern also for the rights of the other sta)eholders. "he Continental /uropeanB <apanese system of governance is aimed at ensuring that the corporation is managed for the good of the enterprise, its multiple sta)eholders, and the society at large. 0ne important effect of this legal difference is in the composition of the boards of directors. "wo+tier versus one+tier. ;egardless of their home country, all corporations are bound by the rules and regulations of the stoc) e1change on which their shares are traded. 0verall, corporations are sub#ect to a comple1 array of laws and regulations designed to direct and constrain their activities. (he Sarbanes-O1ley ct of 2332 !arbanes+01ley imposed new re&uirements on corporations listed in the @nited !tates and their auditors. "he e1plicit goal of !01 was to improve the transparency, timeliness, and &uality of financial reporting. + /1ternal auditing industry, which was formerly self+regulated, became highly regulated by the federal government.

"he members of the audit committees of companies board of directors are re&uired to be independent and financially literate. + !enior company managers, usually the C/0 and C'0, are re&uired to certify that they had reviewed their companys &uarterly and annual financial statements. + "he internal control+related section of the *ct ,section 7?7-. !ection 7?7 mandated an evaluation of the effectiveness of a companys internal controls by both management and the companys e1ternal auditor and formal written opinions about the effectiveness of those controls. :ood internal controls were said to be good business practice. :ood controls help to ensure fair and accurate financial reporting, to ensure that managers would have good information with which to ma)e their business decisions and they helped reduce the incidence of fraud and loss of assets. Companies have no obligation to disclose the e1istence of any deficiency less severe than a material wea)ness, although they and their auditors are re&uired to evaluate them to determine whether they could result in a material wea)ness. !01 has had significant effects on the activities and responsibilities of all those in financial reporting+ and control+related roles. Board of )irectors n publicly traded companies, shareholders typically diversify their ris)s and own a portfolio of shares in numerous firms. !hareholders collectively delegate their authority to monitor managements actions to a board of directors ,(o$-. (o$ have a fiduciary duty to foster the long+term success of the corporation for the benefit of shareholders, and also sometimes for debt+holders. + $uty of care; duty to ma)eBdelegate decisions in an informed way + $uty of loyalty; duty to advance corporate over personal interests + $uty of good faith; duty to be faithful and devoted to the interest of the corporation and its shareholders. + $uty not to %waste; duty to avoid deliberate destruction of shareholder value. n court cases involving all but the duty of loyalty, directors are somewhat protected by the business #udgment rule. "his rule is a legal presumption that a corporate fiduciary has endeavored ,getracht- in good faith to e1ercise care in the corporations interest. C vermoeden dat de director handelt ten behoeve van de onderneming. "he (o$ is responsible for the selection and evaluation of the corporations C/0 and they also must ensure the &uality of senior management. "hey have two main control responsibilities; + !afeguard the e&uity investors interests + 8rotect the interests of other corporate sta)eholders. *mong other things they help to ensure fair financial reporting, fair compensation, fair competition, protection of the environment, and proper conduct of business by the corporation overall. t is widely believed that a ma#ority of board members should be independent of management. 0bviously, incentives are important and especially the ways in which the incentive plans are set by a presumably independent board. t is also obvious that board members must be competent and must be able to devote the needed time to the role. (ut a firm should be concerned about their boards. n the meantime, board members have to do the best #ob they can. + Comply with relevant law and regulations

+ +

"ry to follow what they believe to be best practice. nvolve #udgment.

(oards put in place a number of structures and processes that enable them to carry out their responsibilities effectively. udit committees *udit committees provide independent oversight over companies financial reporting processes, internal controls, and independent auditors. *udit committees are re&uired to be comprised of outside or independent directors with a further re&uirement that they be financially literate. *n audit committees charter typically specifies the scope of the committees responsibility and how it carries out those responsibilities. *udit committees also establish procedures for handling complaints regarding accounting, auditing, and internal control matters. "hey are also typically responsible for the appointment, compensation, retention and oversight of the wor) of the e1ternal auditors. "he e1ternal auditors discuss and address the &uality, not #ust the acceptability of the companys accounting principles with the audit committee. *udit committees are intended to be informed, vigilant, and effective overseers of their companies financial reporting processes and internal control systems. n the financial reporting area, audit committees provide assurance that the companys financial disclosures are reasonable and accurate. n the corporate governance area, audit committees provide assurance that the corporation is in compliance with pertinent laws and regulations, is conducting its affairs ethically, and is maintaining effective controls against fraud and employee conflicts of interest. n the corporate control area, audit committees monitor the companys management and internal control systems that are designed to safeguard assets and employ them to achieve established goals and ob#ectives. *udit committees therefore hire the companys e1ternal auditors and monitor their performance. *udit committees must rely on the resources and support of other groups within the organization, and particularly the internal auditing function. ndependence from management, in both fact and appearance, is one essential, and in many countries a legally re&uired, characteristic of an audit committee. 5hen independence is lac)ing, employees and auditors will be reluctant to bring serious problems to the committees attention, and the committees effectiveness will be severely undermined. "he financial crisis of 4??I caused many audit committees to broaden their charters to include a focus on oversight of managements ris) management practices, broadly defined. Compensation committees "he rules of some stoc) e1changes re&uire listed companies to have compensation of top e1ecutives approved ,goedge)eurd- by a ma#ority of independent directors compensation committee. Compensation committees deal with issues related to the compensation and benefits provided to employees, and particularly top e1ecutives. Compensation committees have fiduciary responsibilities for ensuring that the companys e1ecutive compensation programs are fair and appropriate to attract, retain, and motivate managers and that they are reasonable in view of company economics and the relevant practices of comparable companies. "hey typically rely on the companys human resource function for staff support. "hey often employ outside consultants to provide data or e1pertise that the company does not have internally. Much criticism is currently being directed at compensation committees. Much of this criticism stems from the large compensation, severance andBor retirement pac)ages that have been offered to top e1ecutives. Much of the criticism is

leveled at board who seem either unwilling or powerless to rein in the pay of their e1ecutives. 0ther criticisms are more concerned with the wea) lin)s in many companies between rewards and controllable performance. !ome e1perts are predicting that compensation and the functioning of compensation committees will be the ne1t area for additional regulation in the corporate governance area.

Chapter 17; Controllers and *uditors. ts about the roles and challenges of personnel in two important corporate governance+and management control system+related roles that both re&uire financial measurement e1pertise2 controller and auditors. 0ne role is management service, which involves helping line managers with their decision+ ma)ing and control functions, to help create firm value. "he other role is oversight, which involves ensuring that the actions of everyone in the organization, and especially the managers, are legal, ethical, and in the best interest of the organization and its owners. /1ternal auditors provide an important independent chec) on managers financial reporting, disclosure, and internal control practices. Controllers "he finance and accounting functions in a corporation are typically managed by a person with the title of chief financial officer ,C'0- or vice president finance ,=8 'inance-. "he current crisis may have strengthened ,verster)t- the importance of the financial e1ecutives management service role ,the management service role involves helping line managers with their decision+ma)ing and control functions-. "he C'0 has two different functions; controller and treasurer. "he controller function deals primarily with financial record )eeping, reporting and control. "he treasury function deals primarily with raising and managing capital. Controllers play )ey roles in line management and in the design and operation of a management control system ,management service role and oversight role-. "hey have become more and more highly involved in helping managers ma)e good business decisions ,management service-. (ut being highly involved in management decision ma)ing is not the only role controllers must play; they are also their entitys %chief accountant. "hey establish and maintain internal control systems that help ensure both the reliability of information and the protection of the companys assets ,oversight role-. "he controller might also supervise the internal audit and management information system functions. Controllers must stay appropriately independent of their entitys managers. "hey have a fiduciary responsibility to ensure that the information reported from their entity is accurate and that the entitys internal control systems are ade&uate. "hey have a management oversight responsibility to inform others in that organization if individuals in their entity are violating laws or ethical norms. Corporate controllers may tend to put ,de neiging hebben-the interests of their corporate management, with whom they are closely connected as a management team, before the interest of the shareowners and other sta)eholders. "o maintain the integrity of the controllers role, firms can and probably should implement several additional safeguards to ensure that controllers fulfill their management oversight and fiduciary duties effectively. + *udit committees or board of directors and internal auditors can be used to oversee the controller function. + Controller behaviors can be shaped through personnel or cultural controls, such as selection and training. 8ersonal codes can add weight to the fiduciary responsibility of controllers who are also C8*s. "raining programs can be used to remind controllers of their multiple responsibilities and to give them the interpersonal s)ills useful in maintaining the proper balance between their management service versus management oversight and fiduciary roles. + $esigning incentive systems that do not create temptation. + !ome firms have found that solid+line reporting in the controllers organization is effective for controlling entity controllers activities. n this

controllership structure, the corporate controller determines the entitys controllers tas) priorities and performance evaluation. !olid+line reporting is designed to reduce the emotional attachment between entity controllers and the local entitys management to which they are assigned. "he most important role of controllers is to protect the corporations assets and to ensure that financial reports are accurate. /vidence suggests that changing the controllers reporting relationship does alter ,wi#zigen- entity controllers #ob priorities and loyalties. (ut designing an effective controllership function is both difficult and important. *uditors 4unctional audit; a public accounting firm e1presses an opinion about the fairness of presentation of a companys financial statements. (a1 audit; government auditors test to see if ta1payers have followed the laws and reported ta1able income truthfully. %1ternal financial audit; e1press an opinion on the effectiveness of a companys system of internal controls. %udits *n audit can be defined as a systematic process of 1. 0b#ectively obtaining ,ver)ri#ging- and evaluating evidence regarding ob#ects of importance 4. <udging the degree of correspondence between those ob#ects and certain criteria 6. Communicating the results to relevant users. !ystematic process is used to connote the fact that audits are not done randomly. "hey involve an orderly se&uence of interrelated steps. 1. 8lanning phase 4. 0btaining and evaluating evidence. "his process is ob#ective because auditors are independent of those being audited. /vidence gathering can be done by observation, interviews, reviews of reports, re+computations, confirmations and analyses. $ifferences in the ob#ects of importance provide the ma#or reason for the varied labels being put on different types of audits. a. Compliance audits are designed to test for compliance with rules about behavior or results. b. Mar)eting audits focus on the effectiveness and efficiency of the mar)eting function c. 'inancial statement audits proved a basis for the e1ternal audits. 6. <udgment 7. Communicating the results to relevant users. "he auditor is assuming responsibility for the opinion, with the ris) of economic or reputation loss if the opinion is subse&uently determined to be less than correct. &*ternal and internal auditors /1ternal auditors are independent of management because they are employed by professional service firms with no business ties to the auditee e1cept performance of the audit and, perhaps, a few ancillary advisory series. nternal auditors are employees of the company they are auditing. "he breadth of the charter is one of the ma#or determinants of the size of the staff. nternal auditors functions fre&uently turn to sub#ect matter e1perts to assist in audit coverage re&uiring deeper )nowledge of the specific business, process, or function.

"he internal audit function operates in a staff capacity and almost always reports high in the organization, at least to the corporate controller. Common audit types Mechanics and techni&ues are basically the same among all types of audits, but the motivations and end results are different. + n a financial audit, independent, e1ternal auditors are as)ed to e1press an opinion as to whether the financial statements prepared by management are fairly presented in accordance with applicable accounting standards. "he guidelines that e1ternal auditors must follow performing an audit in the @! are )nown as :**!. 'inancial audits essentially provide a tool by which outside regulators can enforce standards for the preparation and presentation of accounting information to interested parties who are outside the organization. + n a compliance audit, the auditors are as)ed to e1press an opinion as to whether actual activities or results are in compliance with the established standards, rules and regulations. (oth internal and e1ternal auditors perform compliance+type audits. + 8erformance audits, which go by various names such as operational audits, management auditors or strategic audits are used to provide an overall evaluation of the general performance or some specific aspect of the performance of an activity, function, entity or company and its management. *n important part of performance audits often involves defining the criteria in more specific terms. 8erformance auditors usually also produce an important by+product through identifying areas for improvement. +he value of audits 1. "he audit report adds credibility to the information provided to user groups. *s a by+product of this evaluation process, auditors often provide what can be an e&ually valuable benefit through identifying areas for improvement and providing specific recommendations where practices need to be redressed or issues need to be addressed. 4. "he second benefit of audits is provided not by the audit itself but by the anticipation of an audit. .nowing that an audit will or might ta)e place can have strong motivational effects of the individuals involved to conform to the standards they recon the auditors will use in their evaluation. *udits are not e&ually valuable in all situations. 0ne factor that affects the potential value of an audit is the importance of the area to be audited. *udits are also potentially more valuable if the probability is high that either the established criteria are not being met or would not be met in the absence of the audit. *udits can be valuable tools in many management control situations. *uditors can serve as the %eyes and ears of management in assessing what is happening within the organization, and they can also share their e1pertise by providing recommendations for improvement. *udits are designed to serve the interests of those outsiders, although the auditors may provide some observations of use to management. 5here audits are feasible ,uitvoerbaar-, they can be an important alternative or supplement to other management control mechanisms, such as direct supervision or incentives. *udits can test whether the desired behaviors were in fact ta)en, and they often have powerful influences on behavior at acceptable cost. (ut audits have limitations.

"hey are done only on a periodic basis and thus provide little protection against problems occurring in the interim e1cept to the e1tent that they provide a deterrent effect. + *udits also can create negative reactions, such as defensiveness, especially when individuals feel their integrity is &uestioned or their autonomy is #eopardized ,in gevaar gebracht-. + *udits can be costly + *udits can assess only the past *udits are invaluable in many situations and have li)ely increased in importance following the financial and economic crisis. "he elevation of the role of auditors implies that business+aware auditors will face similar role duality, and possibly role conflicts as controllers do in the e1ecution of their management service vs. oversight roles.

Chapter 1>; Management Control+related /thical ssues /thics is the field of study that is used to prescribe morally acceptable behavior . ts systematic nature goes beyond what even thoughtful people do in ma)ing sense of their own and others moral e1periences. /thics is important for managers involved with MC!s because ethical principles can provide a useful guide for defining how employees should behave. f good ethics can be encouraged in an organization, they can substitute for, or augment, actions or results control. /thics is difficult to understand; 1. Many managers basic discipline training is in economics or business. /thics, however, provides alternative assumptions about how people should and do behave. /thical behavior and value+ma1imizing behavior are not e&uivalent ,geli#)waardig-. t is the struggles between being selfish and doing %what is right that provides the most interesting and important ethical issues that we must consider. "he potential for personal sacrifice while acting ethically is reflected in many codes of professional conduct. (ut when are the ethical principles so important that one must consider other than self+interest or ones organizations best interest3 (he importance of good ethical analysis "o control unethical behaviors within an organization, managers need perceptive ethical reasoning s)ills. Managers need moral e1pertise to ma)e good ethical #udgments. Managers who are ignorant about ethics can ma)e any of a number of mista)es that can lead to high probabilities of unethical behaviors within their organization. 1. "hey can sometimes fail to recognize ethical issues when they arise. 4. /thical issues often are addressed with amateurish rules ,%always tell the truth, %do not harm etc.- !uch simple, conscience+based rules only wor) when the values of the person invo)ing the rule are shared by the others who are or might be affected. &thical models "he first challenge in adapting ethical thin)ing to managerial settings is in recognizing the e1istence of the ethical issues that do or might e1ist. ,ormative models of behavior; ethics is about how action affect the interests of other people. + @tilitarianism; @sing the utilitarianism ,conse&uentialism- model, the rightness of actions is #udged on the basis of their conse&uences. *n action is morally right if it ma1imizes the total of good in the world. %"he greatest good for the greatest number of people. o $isadvantages; Juantifying %net good is difficult because the benefits of some actions or decisions ,#ob satisfaction, freedom from stress etc.- are difficult to measure, aggregate and compare across individuals. @tilitarian+type reasoning ma)es it easy to sacrifice the welfare of a few individuals from the benefit of others. + ;ights and duties. "he rights and duties model maintains that every individual has certain moral entitlements in virtue of their being human. Commonly cited basic right in most modern societies include the rights to dignity, respect and freedom. ;ight and duties need to be mutually

observed by those participating in the group to which those right and duties apply. o $isadvantages; t is sometimes difficult to get agreement as to what right different individuals or groups of individuals should have. <ustice fairness; "he #ustice and fairness model maintains that people should be treated the same e1cept when they are different in relevant ways. Having a fair process, such as in evaluating employee performance, depends on such things as impartiality and consistency. o $isadvantages; (ut people differ in many ways, and determining which of these differences should be considered relevant is a core issue that must be dealt with in applying the #usticeBfairness model. t is easy to ignore effects on both aggregate social welfare and specific individuals. =irtues; 8rominent e1amples of virtues are integrity, loyalty and courage. ndividuals with integrity have the intent to do what is ethically right without regard to self+interest. ntegrity has many components, including honesty, fairness, and conscientiousness. 9oyalty is faithfulness to ones allegiances ,trouw-. Courage is the strength to stand firm in the face of difficulty or pressure. =irtues are often reflected in both professional and corporate codes of conduct. =irtues provide their own intrinsic rewards. (ut, not all employees in organizations should be ta)en as virtuous prima facie, which is why other forms of controls are necessary. =irtues fill in the gaps and provide guidance as to what is the right thing to do. "hey are an element of personnel or cultural control. o $isadvantages; "he list of potential virtues is long t is not obvious which set of virtues should be applied in any given setting. *nd some characteristics considered virtues can actually impede ethical behavior. t is also difficult to )now whether particular virtues e1ist in any individuals, how to develop virtues in individuals and groups of individuals, and how to recognize when day+to+day pressures are eroding the virtues.

%nalyzing ethical issues 5here the ethics of an action is in &uestion, individuals should structure their situational analysis by using a proper reasoning or decision model. 1. Clarify the facts 4. $efine the ethical issue 6. !pecify the alternatives 7. Compare values and alternatives >. *ssess the conse&uences F. Ma)e a decision t is important to recognize that different people can consider identical situations and reach different conclusions even after structuring their decision processes e&ually carefully and thoroughly. +hy do people behave ethically "here are some people who unscrupulously act as bad apples.

0thers are merely morally disengaged or ignorant 0thers who recognize ethical issues develop rationalizations to #ustify their possibly unethical behaviors. !ome people who )now they are doing something wrong are not able to stop because they lac) moral courage. Moral courage is the strength to do the right thing despite fear of the conse&uences.

Some common management control-related ethical issues Many ethical issues arise in the conte1t of MC!s. + +he &thics of creating budget slac!) May performance targets are negotiated between the budgeters and their higher+ups. Eegotiation processes provide opportunities for those proposing their budget to %game the process; to distort their positions in order to be given more easily achievable targets against which they subse&uently will be evaluated and on the basis of which they typically stand to earn performance+contingent rewards sandbagging or creating slac! . 5hen employees create slac) they are e1ploiting their position of superiors )nowledge about their entity prospects. Creating budget slac) can be deemed in violation of several of the obligations listed in the !tatement of /thical 8rofessional 8ractice from the *ssociation for *ccountants and 'inancial 8rofessional in (usiness o Slac! creation is unethical. *nalysis from the tenets of utilitarianism also suggests that slac) creation constitutes an ethical issues. /mployees creating budget slac) will benefit personally from it. (udgets containing slac) are often less than optimally motivating. !lac) creation also can be deemed less than correct from the standpoint of the users of the budget submissions as they will rely on the information in the budget to ma)e investments, resource allocation, and performance evaluation decisions that will become distorted. o Slac! creation is ethical. !ome arguments can be raised to support the position that slac) creation is ethical, or at least can be seen as #ustifiable. Creating slac) is a rational response within a result control system. "hey do not view slac) as a distortion but as a means of protecting themselves from the downside ris)s of an uncertain future. "his protection of ris) is particularly valuable in firms that treat the budget forecast as %hard promises from the budgetee to the corporation with little or no tolerance for missed targets or %under+performance with possible dismissal as a conse&uence when it occurs. (udget slac) is sometimes necessary to address the imbalance of power that is inherent in a hierarchical organization. Managers who defend the creation of slac) also often point out that it is an accepted practice in their organizations budget negotiating process. n many organizations, superiors may actually encourage their subordinates to create slac), because they also benefit from it. "he superiors targets are usually consolidations of the targets of their subordinates. +he ethics of management earnings. * common form of manipulation is earnings management, which includes any action that changes reported earnings, while providing nor real economic advantages to the organization and actually causing harm. "o (oost earnings, !mooth earnings or to ;educe earnings. o &arnings management is unethical

Most of the action are not apparent to either e1ternal or internal users of '! or the reported information more generically 8rofessional managers and accountants can be said to have a duty to disclose fairly presented information "he rewards earned from managing earnings are not fair when the reported performance is only cosmetic, not real. o &arnings management is ethical. Managers might argue to be ta)ing these actions merely to protect themselves from rigid, unfair performance evaluations. "hey might also be ta)ing action that ma)e it unnecessary for them to ta)e other possibly more damaging actions. Curiously, most people #udge accounting methods of managing earnings more harshly than operating methods even though the purposes of the two earnings management methods are identical, and the economic effect of the operating methods are typically far more costly to the firm. %ccounting methods of managing earnings involve the selection of accounting methods and the fle1ibility in applying those methods to affect reported earnings. perating methods of managing earnings involve the altering of actual operating decisions. !everal situational factors are li)ely to influence #udgments as to whether earnings management actions are deemed ,un-ethical. 1. "he direction of the manipulation 4. "he size of the effect 6. "he timing 7. "he method used >. "he managers intent regarding the informativeness of the numbers F. "he clarity of the rules prohibiting the action H. "he degree of repetition. +he ethics of responding to flawed control indicators. Myopia occurs when companies place a high emphasis on the achievement of short+term profit targets, even though some profit+increasing activities may diminish shareholder value in the long run. 5hen there is a conflict of interest ,following flawed control indicators or the companys best interest-, most employees will choose to follow the rules of the reward system, perhaps while lobbying to get the measures changed. +he ethics of using control indicators that are -too good.. *nother ethical issue relates to the use of control indicators that are %too good. 'or e1ample too tight control systems. "here is a fine line between the employers right to monitor and the employees rights to autonomy, privacy, or freedom from oppressive controls that suggest they are wor)ing in electronic sweatshops. Clearly what is acceptable to some is not acceptable to others, and views may differ across ,national- cultures. 5hen controls are %too good or %too tight they are li)ely to induce unintended andBor undesirable conse&uences. "his may be especially true for action controls. (ut results controls can also be %too tight in that they induce myopia and pressures for earnings management.

Spreading good ethics &ithin an organi!ation /thical progress within an organization typically proceeds in stages. 1. n an early stage, the organization becomes an e1tension of the founder or the top management group. Management acts as a role model. 4. n a later stage of development, organization predominantly use action accountability+type of controls. "he rules clarify the meaning of good

ethics, ma)e it clear that ethical behavior is valued, and provide guidance to employees to thin) through ethical issues. 6. *fter the rules are communicated, the organization ta)es steps to ensure that its employees follow the rules, for e1ample by signing a statement certifying that they understand and will abide by the rules. However, even the best laid out codes of conduct and signed employee certification statements may not be sufficient. t is obvious that merely having a set of ethical standards and rules and ta)ing steps to ensures that employees have read them is not sufficient. "op management must set a credible %tone at the top and they must endeavor to maintain a good internal MC! so that potential violators )now that there is a good chance that they will be caught. "one at the top can be an effective form of cultural control when it is consistent, and supervision and mutual monitoring can be effective when given teeth in an otherwise trusting organization climate. @nder effective corporate cultures, ethical behaviors are %shaped rather than merely %enforced from time to time, often after a ma#or violation has occurred and damage has been done.

Chapter 1F; "he effects of environmental uncertainty, organizational strategy and multinationality on MC! "here is no universally best MC! that applies to all situations in any organization much less all organizations. %nvironmental uncertainty /nvironmental uncertainty refers to the broad set of factors that, individually and collectively, ma)e it difficult or impossible to predict the future in a given area. + Changes in natural conditions + 8olitical and economic climate + *ctions of competitors, customers, suppliers and regulators. @ncertainty has some potent effects on MC!s. *ction controls are effective only if there is )nowledge as to which actions are desirable and if those actions are consistently desirable. 5hen action controls are deemed infeasible or impractical, manager generally tend to place a higher reliance on results controls. ;esults controls can be used even in highly uncertain settings. However, uncertainty ma)es result controls more difficult in use as well. 1. ;esult controls are not effective when employees do not understand how to generate the desired results. 4. /ven when employees )now how to respond, result controls will not be optimally effective unless properly challenging performance targets are set. 6. @ncertainty combined with the use of results controls causes employees to bear ris). 7. High uncertainty tends to have some broad effects on organizations structures and decision+ma)ing and communication patterns, and these effects increase the comple1ity of the management ris). @ncertainty is not only prevalent in many contemporaneous manufacturing environments; it also is a significant situational factor that affects MC! design in many other organizations, such as professional service firms that provide legal, accounting, business consulting or financial services, where coordination and )nowledge integration is critical for effective service delivery. Organi!ational strategy Corporate strategy *n organizations corporate strategy determines what businesses it wants to be in and how resources should be allocated among those businesses. 0ne way of viewing corporate strategy is to array them along a continuum from related to unrelated diversification. 'irms pursuing related diversification do not stray far ,dwalen af- from their %core business. "hey diversify in order to e1ploit economies of scope stemming from relationships among their entities. 'irms pursuing unrelated diversification are not concerned with restricting their focus to their core business. "hey pursue a portfolio of unrelated businesses to e1ploit internal capital mar)et benefits that stem from internal decision ma)ers relative information advantages for resource allocations compared to e1ternal capital mar)ets. *n important distinguishing characteristic of firms that are diversified into related businesses is high interdependence among their business units. "hey design their MC!s to ta)e advantage of this interdependent to e1ploit synergies and reap economies of scope. "o signal that cooperation among entities is important, related+diversified firms are more li)ely to use incentive compensation systems that base some portion of business unit managers bonuses on the performance

of the ne1t higher+level entity in the organization, which may be a division, region, business group or the entire company. *n important distinguishing characteristic of firms that are diversified into unrelated business relatively high information asymmetry between corporate and business unit management as corporate managers are unable to remain well informed about all the developments in all of their diverse business units operating areas. Corporate managers can reduce their information processing re&uirements by pushing the locus of decision ma)ing lower in the organization. "he corporate managers will also tend to #udge the performance of the diverse business units ob#ectively and award formula bonuses based on what they monitor. n such firms there is a higher level of autonomy. (ut if the autonomy is combined with the use of less+than+perfect financial measures, the business unit mangers are li)ely to engage in some dysfunctional behaviors. (ecause business units of unrelated diversified corporations have few operational synergies and are essentially autonomous, corporate performance is a noisy measure that provides relatively little information about any individual business unit managers action. #usiness strategy (usiness strategy ,competitive strategy- defines how a firm or entity within the firm chooses to compete in its industry and tries to achieve a competitive advantage relative to its competitors. * cost leadership strategy involves offerings of relatively standardize, undifferentiated products; vigorous pursuit of cost reductions; generation of volume to e1ploit economies of scale and to move down the learning curve; ac&uisition of process engineering s)ills; and, as much as possible, establishment of a routinized tas) environment. * differentiation strategy involves the creation of a product or service that customers perceive as uni&uely differentiated from competitors offerings. ;egardless of the chosen focus, a li)ely re&uirement is intensive coordination and collaboration across a broad array of employees and organizational entities. *nother feature of differentiation initiatives is that they often re&uire substantial time to translate into financial results, as it involves prospecting new mar)ets andBor developing new product of services. "he impact of whatever strategy that has been selected on one more MC! characteristics. !o+called contingency logic maintains ,onderhoudt- not only that competitive strategy should drive the design of MC!s, but also, and more importantly, that organizational effectiveness depends on the e1tent to which bot are aligned, that is, on the e1tent to which the MC!s %fit the competitive strategy. MC!s moet zich aanpassen aan strategy. (usiness endeavoring to be cost leaders, and those defending e1isting businesses, will tend to control their employees behaviors through relatively tight, formal financial controls and standardizing operating procedures designed to ma1imize efficiently. Conversely, businesses competing on the basis of differentiation, and those prospecting for new mar)ets, would tend to have a more informal control system, a participative decision+ma)ing environment, and incentive systems that include growth, measure either in financial or unit terms, or any of a number of forward+ loo)ing, nonfinancial performance indicators, such as product innovation mar)et development, andBor customer service. Multinationality Multinational organizations ,ME0s- must understand how they must adapt their management practices, to ma)e them wor) in each of their international locations. ME0s are characterized by a high degree of decentralized decision

ma)ing and by management control through financial results controls. "hey are organized not only by function andBor product line, but also by geography. "he geography dimension re&uires managers to be sensitive to each of the national cultures in which they operate. ,ational culture !ome of the effects, benefits, and costs of management controls are universal because, people in all countries have similar physiological needs and desires for achievement and financial strategy. 0ne important set of factors with potentially important influences on MC!s can be e1plained under the rubric of national culture/ the collective programming of the mind that distinguishes the members of one group or society from another. t can be argued that people from different national cultures are li)ely to have different preferences for, and reactions to, management controls because control problems are behavioral problems. "hus, an important factor that contributes to the effectiveness of MC!s is whether the employees perceive them as culturally appropriate; that is, whether they suit the shared values maintained by the society in which they operate. + "he individualism dimension of national culture relates to individuals self concept; that is, whether individuals see themselves primarily as an individual or as part of a group. + "he power distance dimension relates to the e1tent to which members of a society accept that institutional or organizational power is distributed une&ually. 8eople who are high in power distance are li)ely to prefer, or at least more li)ely to accept greater centralization of decision authority and less participation in decision processes. + ndividuals who score high in uncertainty avoidance feel uncomfortable when the situation they face is ambiguous. 8eople in high uncertainty avoidance are li)ely to want to avoid or reduce ris) and ambiguity. + "he masculinity dimensions relates to the preference for achievement, assertiveness, and material success, as opposed to an emphasis on relationships, modesty, and the &uality of life. /mployees desire for achievement and competition in masculine cultures may be conducive to an effective use of relative performance evaluations where employees performances are directly compared, and, hence competing with one another. Managers running a business for the benefit of many sta)eholders, and not primarily its shareholders, will ma)e different decisions. 0ocal institutions 0ne set of institutional factors with potentially important MC! implications are those descriptive of the financial mar)ets in various countries, their importance in raising capital and the e1tent of disclosures and types of information they demand. "he &uality of the re&uired disclosures of information by publicly traded firms also varies across countries, in part because of differences in the organization and regulation of their auditing. "he strength of regulation, auditing, and enforcement also may affect managers abilities and propensities to engage in earnings management. Differences in local business environments (usiness environments also differ significantly across countries. 1ncertainty

Country+specific environmental uncertainty can be cause by many things; military conflicts, )idnappings, terrorism, and e1tortion threats can create ma#or security problems. :overnment interventions also affect business ris). :overnments have, to a greater or lesser e1tent, powers that enable them to serve certain ob#ectives. "hese powers can have ma#or effects on the value of companies assets and the e1pected return on those assets. n general, in nations where the governments have greater powers and tend to use them more fre&uently, business ris) is higher. However, governments can also cat to lower business ris). Company growth patterns also can affect ris) through their influence on organizational learning. Managers of ME0s have one important MC!+related advantage over their domestic counterparts2 they are able to learn more &uic)ly and more thoroughly about potentially desirable practices used in foreign countries. 2nflation nflation is another environmental factor that differs significantly across countries. nflation, and fluctuation in inflation, which affect the relative values of currencies, create financial ris). High inflation affects the congruence of financial measurement systems. t can lead to the adoption of some form of inflation accounting which involves either the e1pressing of accounts and '! in terms of real amounts or e1pressing all assets and liabilities at current values.

+alent 0rganizations operating in developing countries often face limited availability of s)illed and educated personnel. 5hen employees are not highly educated, decision ma)ing structures are usually more centralized, and MC!s tend to be more focused on action controls rather than result controls. 5hen personnel mobility is low, there is less need for implementing long+term incentive plan that motivate managers both to thin) long+term and to stay with the firm to earn their rewards. 3oreign currency translation ME0s also face currency e1change and translation problems. ME0s bear economic ris) caused by fluctuating currency values. "he values of foreign investments appreciate or depreciate base on the relative values of the home and foreign currencies. !ome ME0s evaluate managers of their foreign entities in terms of results measured in home+country currency. *s such, it is natural for corporate management to want to encourage entity managers to ta)e actions to increase profits denominated in the currency of the parent company. f the foreign currency is appreciating relative to the home currency, foreign entities can comfortably earn the target rate of return or show impressive sales gains even though they may not be performing near the potential that is offered by foreign mar)et opportunity. /valuating managers of foreign entities in terms of the amount of home?country currency they earn sub#ects those managers to foreign currency translation ris). "he most important control decision in this area, however, is whether to hold managers accountable for foreign e1change gains and losses, thus sub#ecting them to foreign currency translation ris). 0ne could argue that entity managers who can influence the amount of the foreign e1change gains or losses should bear the foreign e1change ris). f corporate

managers decide that the managers of their foreign entities should not bear the foreign e1change ris), they can instead use any of four essentially identical methods. 1. /valuate the manager in terms of local currency profits as compared to local currency plan or budget 4. "reat the foreign e1change gains or loss as %below the income+statement line for which the manager is held accountable 6. /valuate the manager in terms of profits measured in home currency, but calculate a %foreign e1change variance and treat it as uncontrollable. 7. ;e+e1press the home currency budget for the entity in local currency using the end+of+year, not beginning+of+the+year, e1change rate or some average for the period. "his procedure creates a budget that %fle1es with e1change rates.