Management Control Systems (2nd Edition)

Fundamentals of Management Control : Overview

Management control systems are essential in situations where managers and employees do not have a clear idea of what is expected of them; where they have a fair idea of what is expected but do not feel motivated toward performance; or where, in spite of knowledge of expectations and sufficient motivation for performance, managers and/or employees fail to perform.

According to Norbert Weiner, "cybernetics is the study of the entire field of control and communication theory, whether in the machine or the animal." The basic control process based on the cybernetic approach comprises the following steps: determining areas to control, establishing standards, measuring performance, comparing performance against standards, rewarding good performance and/or taking corrective action when necessary, and adjusting standards and measures when necessary.

Management by Objectives (MBO), a concept propounded by Peter F. Drucker in 1954, is a specific application of the cybernetic process of management control. In MBO, goals/objectives (which should be Specific, Measurable, Achievable, Realistic, and Time-Specific) are set jointly by the supervisor and the subordinate. The MBO process consists of six steps: developing overall organizational objectives in key result areas; establishing specific goals for sub-units and individuals; formulating action plans while identifying possible problem areas; implementing self-direction and self-control among managers and subordinates; conducting a periodic review of plans; and appraising the performance of subordinates while allowing them sufficient autonomy to implement plans. Some of the limitations of MBO arise due to a lack of understanding of the philosophy of self-direction and self-control, the absence of adequate guidelines for performance, and the absence of verifiable goals against which performance may be measured.

The Committee of Sponsoring Organizations of the Treadway Commission (COSO) has discussed the objectives of management controls under three heads: effectiveness and efficiency of business operations; reliability of financial reporting; and compliance with the applicable regulatory and legal framework.

An effective organization is able to achieve its purpose and goals. Efficiency of an organization is its ability to achieve outcomes by utilizing the minimum resources. Financial reporting should have the characteristics of understandability, relevance, and materiality, and should be prepared in conformity with the generally accepted accounting principles. The compliance objective addresses regulatory issues (legal and other compliance requirements). Organizations should at least conform to regulatory standards of what should be done or not done and aim at setting higher ethical standards for themselves.

Experts have classified management controls based on the object of control, the extent of formalization of control, and the time of implementation of controls. Based on the object of control, management controls have been classified into action controls, results controls, and personnel/cultural controls. Action controls are aimed directly at the actions which take place at different levels of an organization. These can be further classified into behavioral restrictions, pre-action appraisal, and action accountability. Results controls focus on the consequences of actions taken rather than on the actions themselves. Personnel/cultural controls influence the people and the organizational culture, with the expectation that the right people in the right culture will perform the right actions that will ultimately yield the desired results.

Management controls can be classified into formal controls and informal controls based on the extent of formalization of control, while based on the time of implementation of controls, they can be classified into open loop controls and closed loop controls. Closed loop control mechanisms are further classified into feedback (follow-up) control and feedforward (anticipatory) control.

Different contextual factors influence the design and use of management control systems. These factors include: the nature and purpose of the organization; organization structure and size; national culture; corporate strategy and organizational diversification; competitive strategy; managerial styles; organizational slack; stakeholder expectations and controls; and organizational life cycle. The nature and purpose of an organization, that is, whether it is a for-profit or a non-profit organization has a major impact on management control systems. The aspects in which non-profit organizations differ from for profit organizations include measurement of the profitability and utilization of profits.

The organization structure establishes the formal pattern of job roles and responsibilities that individual employees and groups have to undertake, and the hierarchical structure and reporting relationships. The size of the organization influences the nature of controls such as rules, documentation of information, creation of specialized role functions, and a higher degree of decentralization. The management control system of any organization is influenced by the national culture of the country in which it operates. Geert Hofstede identified four dimensions along which national cultures vary. The dimensions are: power distance (acceptance of hierarchical levels); uncertainty avoidance (avoiding risk and ambiguity); individualism/collectivism (people's preference to work as individuals or in a team); and masculinity (competitive spirit, independent thinking, assertiveness)/femininity (interdependence, nurturing nature). To achieve goal congruence between the goals of the organization and those of individual strategic business units, it is necessary that the management control system has a good fit with the corporate strategy. Management controls also differ depending on the type of diversification - related or unrelated. The choice of generic competitive strategy - overall cost leadership, differentiation, or focus - also influences the management control system.

Managerial styles (autocratic or democratic, permissive or directive) play an important role in influencing the behavior of the employees in an organization and thus the design and implementation of control systems.

Organizational slack refers to that capacity in an organization which is in surplus of what is required for normal operations. It may be created voluntarily or involuntarily and may be good or bad for the organization.

Stakeholders (investors, employees and managers, suppliers, customers, community, government, etc.) are defined as individuals or groups of people who are impacted by or who impact the activities and operations of the organization. It is necessary for organizations to consider what the stakeholders want while designing their management control systems.

Chapter 1 : Overview