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Management Control Systems
Performance Measurement, Evaluation, and Incentives
4th edition
Section 1
The control function of
management
Chapter 1
Management and control

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Management control
• The process by which management
– … ensures that people in the organization carry out
organizational objectives and strategies
– … encourages, enables, or, sometimes “forces”
employees to act in the organization’s best
interests
• Management control includes all the
devices/mechanisms managers use to ensure that
the behavior of employees is consistent with the
organization’s objectives and strategies

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Function and benefit
• Purpose/function
– Get done what management wants done
– Influence behavior in desirable ways
• Benefit
– Increased probability that the organization’s
objectives will be achieved

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Let’s take a step back to
consider…Agency Theory…….
 Used to understand relationships whereby a principal
employs the services of, and delegates the decision
making authority to, an agent.
 Because the principal does not constantly see what the
agent is doing (information asymmetry), this can create
an opportunity for the agent to act against the best
interests of the principal if they have an incentive to do
so (moral hazard).
 It is important to note that agency theory is based on
assumptions regarding human behaviour which are
questionable, see later slide and later weeks.
4

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Agency Theory
 There are 3 agency ‘costs’
– Monitoring costs: incurred by the principal, (e.g. internal
and external auditing), passed onto agent (e.g. through a
reduced salary, this is known as ‘price protection’)
– Bonding costs: agents perceive that they can save more
in monitoring costs by incurring some bonding costs in
which they demonstrate their commitment to the principal
(e.g. agreeing to performance related pay)
– Residual loss: Despite the control provided by monitoring
and bonding, some information asymmetry will remain,
meaning some agents will still perform some actions
against a principal’s best interests
– For example, in a manager – employee situation,
employees may take ‘sickies’ off work, steal from
inventory, work lazily or not tell their boss the truth
5

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Owner–Manager Agency
Relationships
 Agency theory identifies a number of problems that
can exist between managers and owners.
 Contracts and accounting information can be used
to ‘bond’ the interests of owners and managers
(bonding costs)
 Addresses 3 specific problems
– Horizon problem
– Risk aversion
– Dividend retention.
6

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Management and its components
Strategy Formulation
Management Control
Objective Setting

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Objective setting
• Objectives are a necessary prerequisite for any
purposeful activities
• Without objectives, it is impossible …
– to assess whether the employees’ actions are
purposive;
– to make claims about an organization’s success.
• Objectives can be:
– financial vs. non-financial
– quantified, explicit vs. implicit
– economic, social, environmental, or societal

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Strategy formulation
• An organization must select any of innumerable
ways of seeking to attain its objectives
• Strategies define how organizations should use
their resources to meet their objectives
• Hence, strategies include placing constraints on /
providing incentives for employees to focus
activities on what the organization does best or
areas where it has an advantage over
competitors

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Taking another step back…lets
think a little more about strategy
1) What do we really mean by ‘strategy’?
2) Think of an example of a company strategy?

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What do we really mean by ‘Strategy’?
11
A plan of action designed by top
management to realise the long-term vision /
objectives for the whole business.
Example:
Aldi has a cost leadership strategy (sourcing the
cheapest products and other inputs) to increase
market share.

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12
Delving even deeper into ‘strategy’…
 From the Greek word ‘Strategos’, meaning ‘The art of
the general (leader)’
 One definition in an organisational context is:
The pattern or plan that integrates an organisation’s major
goals, policies, and actions into a cohesive whole. A
strategy is based on internal competences and
shortcomings, anticipated changes in the environment, and
contingent moves by intelligent opponents. (Quinn &
Mintzberg,1995)
 Strategy is long term generally > 5 years.

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Strategy Concepts
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Vision
Mission
Objectives
Strategy
Desired future state or aspiration of the
organisation.
Long term.
RSPCA : To be the leading authority in animal care
and protection
Defines the purpose and boundaries of the
organisation.
5 to 20 years.
RSPCA : To Prevent cruelty to animals by actively
promoting their care and protection
Specifies how the organisation will achieve
objectives (and thereby mission and vision)
1 to 5 years.
Specific statement of what the organisation aims to
achieve.
RSPCA : See: https://kb.rspca.org.au/knowledge-
base/rspca-australia-mission-statement-vision-and-
objectives/

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14
3 Levels of Strategy (for profit making
businesses)
• Corporate strategy
– Which businesses to operate in, acquire and divest
– How best to structure and finance the organisation
– Often influenced by the expectations of major shareholders
• Business (or competitive) strategy
– The way a business competes within its chosen market
– Distinct business strategies for each business unit
• Strategy implementation (functional strategy)
– Planning and managing the implementation of the strategy
– For example - new structures, systems, processes, marketing
approaches, human resource management policies

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Identify the level of strategy for the
scenarios listed below and explain the
reason:
1. Woolworths closing the Master's business.
2. Wesfarmers selling the Coles' business
3. Aldi store layout change.
4. JB Hi fi lowering prices.
15

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16
1. Woolworths closing Master's business.
Corporate
2. Wesfarmers separated Coles business
Corporate
3. Aldi store layout change – Business/
Functional
4. JB Hi fi lowering prices. Business

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Key questions with regards to
employees and strategy
implementation
• Are our employees likely to behave
appropriately?
– Do they understand what we expect of them?
– Will they work consistently hard and try to do what
is expected of them?
– Are they capable of doing what is expected of
them?

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The basic control problem
• Management control is about encouraging
PEOPLE to take desirable actions
– That is, it guards against the possibilities that
employees will do something the organization does not
want them to do, or, fail to do something they should do
• Hence, management control has a …
… BEHAVIORAL ORIENTATION
• If all personnel could always be relied on to do what
is best for the organization, there would be no need
for a management control system

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Basic control issues
• Three issues
– Do employees understand what we expect of
them?
 Lack of direction
– Will they work consistently hard and try to do what
is expected of them?
 Lack of motivation
– Are they capable of doing what is expected of
them?
 Personal limitations

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Lack of direction
• Employees may not know what the organisation
wants from them
• When this lack of direction occurs, the likelihood
of the desired behaviors occurring is small
COMMUNICATION + REINFORCEMENT

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Motivational problems
• When employees “choose” not to perform as their
organization would have them perform
– Lack of goal congruence
 Individual goals do not coincide with organizational goals
– Self-interested behavior
 Some believe* that individuals are prone to being “lazy” …
– For example, take long lunches, overspend on things that
make life more pleasant, use of sick leave when not sick,
etc.
 More extreme examples of motivational problems:
– Employee crime (fraud and theft)
* I am not sure I believe this as much as the textbook authors do….more on
this later in the course!

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Personal limitations
• Sometimes, people are “unable” to do a good job
because of certain personal limitations they have
• Some examples/causes:
– lack of requisite knowledge, training, and experience
– employees are promoted above their level of
competence
– some jobs are not designed properly etc.
TRAINING
JOB ASSIGNMENT/PROMOTION
JOB DESIGN

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However …
• Management controls do not always involve a simple
cybernetic system like a thermostat
– Detector measure performance
– Assessor compare with pre-set standard
– Effector  take corrective action
• Many controls don’t focus on measured performance
– For example, direct supervision, employee hiring standards,
and codes of conduct
• Many controls are proactive rather than reactive
– That is, they are designed to prevent control problems
before the organization suffers any adverse effects on
performance

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Control alternatives
• Control problem avoidance
• Management control systems
– Action controls
– Results controls
– People controls

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Control problem avoidance
• Activity elimination
– For example, subcontracts, licensing agreements, and
divestment
• Automation
– Computers/robots eliminate the human problems of
inaccuracy, inconsistency, and lack of motivation
– Only applicable for “programmable” decision situations
• Centralization
– Superiors reserve the most critical decisions for
themselves

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Control alternatives
• Controls can focus on:
– the actions taken
– the results produced
– the types of people
employed and their
shared values and
norms
Or any combination
ACTION CONTROLS
RESULTS CONTROLS
PEOPLE CONTROLS

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Overview
Can people be avoided?
(e.g., automation, centralization)
Control-problem
avoidance
Can you rely on people involved?
Can you make people reliable?
Have knowledge about what
specific actions are desirable?
Able to assess whether
specific action was taken?
Have knowledge about what
results are desirable? Able to measure results?
Yes
No
Yes
No
No
Action controls
People controls
Results controls
Yes
Yes
Yes
No
Yes
No
?
Yes