Merchant Van Der Stede

MANAGEMENT CONTROL SYSTEMS Performance Measurement, Evaluation and Incentives

Second Edition

Kenneth A, Merchant University of Southern California

Wim A. Van der Stede London School of Economics

Lffir Prentice Hall FINANCIAL Th,tES An impriil of P

Harlow, England . London

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eatson Education

New York . Boston . san Francisco . Toronlo

Sydney. Tokyo . Singapore. Hong Kong .Seoul. Taipei. New Delhi Cape Town . Madrid . Mexico City . Amsterdam ' Munich . Paris. Mian

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MANAGEMENT AND CONTROL

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organizations. Management contlol

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fianagemenr conrrol is a critical function

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In Aplil 2005, employees at the 75-year-old California-based not-for'-proirt Gemological Institute of America (GIA), the world's largest grader of diamonds, were accused of accepting bribes fi'om large diamond dealers to inflate diarnond grades. Large diamond

can lead to large financial losses, r'eputation damage, and possibly even to organizational failure. Here are some recent examples:

IYlfaitures

dealers rvouid submit proportionally high bids, often 20 to 30qa highel than prevailing bids fol lough stones. knowing that they would be able to sell these stones at a profit because they bribed GIA staff to get a higher-than-deserved grade. A small differ-ence in grade

can mean a huge difference in price, often hundreds of thousands of dollars on larger diamonds. The size of the blibes is unknown, but the probe into the allegations mentions cash, theatel tickets, and other gifts. What is known, however, is that the blibes gave the large dealers enough of a financial edge to control the market and reap excess profits. As such, the scandal reverberated thloughout the $80 billion diamond-jewelry industry around the world, as many customels overpaid for their diamor.rds and many diamond dealers, particularly srnaller ones, were forced to leave the industry or were considering it.'

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In 1995, venerable UK bank Baling Brothers, founded in 1817, declared bankruptcy. The bankruptcy was caused by losses on unautholized trades of futules contracts rnade by a Singapole-based trader named Nicholas Leeson. Betbre his trades were stopped, Leeson's losses totaled neariy $1.1 billion, more than t'"vice Baring Bank's capitaiization, A Bank of England investigation into the causes of the losses found major weaknesses in Baring's control systems, including lack of segregation of duties. lack of position limits, and confused lines of management responsibiiity.t When Baring failed, Leeson was two days sholt of reaching his twenty-eighth birthday .In2002, a simiiar case at Allied Irish Banks led to huge currency-trading losses at its Baltimole unit, Allfirst Financial. Lack of adequate risk controls and lack of independent confirmation of trades left the bank wide open to fi'audulentll, qengszled tradin-s losses of $691 miliion over a five-year period. The headline of The Wall Street Journal alticle suggested that "Lax Controls May Explain Trading Loss at

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Allied Irish."r In 2001 a keystloke error by an employee at Lehman Brothels Holdings, Inc. in London cost the firm $6 million in trading losses. The erlor changed a customer's f30 million stock sell order into one valued at about f300 million. Before the error was detected, stocks had fallen sharply, and Lehman was liable for the damages caused by the error'. The error was believed to be unintentional.r

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In 2002, a former National Atchives' empiol'ee admitted that he stole dozens of historical documents between 1996 and 1999 simply by putting them in his briefcase. The

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Management and Control

documents included auto-eraphed pictures of Apollo astronauts. plesidential paldons signed by Abraharn Lincoln, and slai,e tl'ade materials. u,hich he sold to collectors for more than $200,000. Investi_qators were tipped off to the theft when a t-ederal worker became suspicious of an itern offered for sale online. Clearly, the National Archives and Records Administration did not have good controls in piace.'

o In 2002, two clerical

workels at the Laguna Niguei. California-based service center of the US Immiglation and Naturalization Service (INS) were accnsed of destroying thousands of ir-nmiglation documents, includin-g visa applications, passports. and other papefs. According to the probe. tl.re clelks started shreddin-s unprocessed paperwork in early 2002 after an inventory revealed a processin-9 backlog of about 90,000 documents. A month later, in March 2002, the backlo-s was repor-ted to be zero. The shredding allegedly rvent on fbr about anothel'month to keep the backlog at zero, until INS officials discovered the shredding spree durin-e an evenin-e shift.6 This exanrple illustrates that money is not always the motive for wrongdoin-q.

The examples described above show the impofiance of having good management contlol systems (MCSs) and the types of problems - thefts, fi'auds. and unintentional errors - they can address. However, adding more controls does not aiways lead to better controi. Some MCSs in common use often stifle initiative, creativity, and innovation. Here is an example of a situation with a control-versus-initiative tensron: In 2003, the European Union's (EU) antifi'aud office discor,ered an allegedly "vast enterprise of looting" at Eurostat, the statistical service of the European Commission. The plobe focused on secret birnk accounts in which seniol mana_eers at Eurostat allegedly funneled an estimated €900,000 of EU taxpal,ers' cash to contractors, inchrding companies that they themselves had helped set up, by artificially inflating the value of the contracts or by creating fictitious contracts. Some noted that this rvas just a confirmation of the popular plejudice that tlie "BLr.rssels bureaucracy" is rife with col'ruption, lax financial controls, complacencv, and clonyisrn, a reputation that the European Commission had eamed in the late 1990s when several other con'uption scandals broke. Horvever, othels argued that it rvas not certain that the accounts set up by the Eurostat officials lvere used for the personal enrichment of those involved, at least not initially. They argued instead that these accounts may originally have been set up to give Eulostat a way to pay for Lesearch quickly without going through the Commission's cumbersome procedures. Ironicalll,, while the Cornmission has elaborate plocedules to prevent financial fraud. these plocedures may not only have ploved insufficient, they may actually have made the ploblem worse. Due to the tortuous fonn-filling that is required for fundin,e requests, the numbel of bureaucratic hoops fund requestels have to jump thlou_sh to get anything approved, and the notoriously slo,,r, delivery of the funds, comr.nission officials and staff may have got used to cutting corners and finding "creative" ways to speed up the plocess. But e\/en though there n.right be a strong suspicion that the seclet accounts $/ere at first intended to sele iegitimate purposes, they may have been abused as time went on. While the jury was out on the validity of the conjectures on each side of the argument, some argued that perhaps the most essential problem at the Commission was its lack of autlture of responsibilitl'.1

It is wideiy accepted that good MCSs are important. Understanding and comparing the views in the books and articles written on managernent control is difficult, holvever, becanse much of the MCS language is imprecise. The term "control," as it applies to a management function, does not have a universally accepted definition. An old, narrow view of an MCS is that of a simple cybernetic system involving a single feedback loop, analogous to a tlrermostat. Thermostats include a singie feedback loop: they lneasure the temperature, colnpare those rneasurements with the desired standarcl, and. if necessary, take a corrective action (turn on. or off. a fumace or air conditioner). In an MCS feedback

Management and control

loop, managers lleasure perfomtance, compal'e that lneasurement with a pleset performance standard, and, ifnecessary, take corrective actions. This book, however, like many other writings on management control, takes a broader view.8 It recognizes that many management controls in common use, such as direct supervision, employee-hiring standards, and codes of conduct, do not focus on measured perfonnance. They focus instead on encouraging, enabling. or, sometimes, forcing emplol,ees to act in the organization's best interest. This book also recognizes that solne nanagenrent controls arc proactire, rather than reactive. Ploactive means that the controls ale designed toprevent ploblerns before the organization suffers any adverse effects on perfolmance. Examples of proactive controls include planning processes, required expenditure approvals, computer passwords, and segregation of ernployees' duties. Management control, then, includes all the devices or systems managers use to ensure tliat the behaviors and decisions of theil employees ale consistent with the organization's objectives and strategies. The systems themselves al'e commonly referred to as the motlctgentent control st,.!/e,r?.t (MCSs), Desrgned properly, MCSs influence employees' behaviors in desirable ways and, consequently, increase the probability that the organization will achieve its goals. Thus, the primarylrnctiort of management control is to influence behaviors in desirable ways. The bene.fit of management control is the increased probability that the olganization's objectives will be achieved.

MANAGEMENT AND GONTROL Management control is the back end of the management process. This can be seen from the varior,rs ways in which the broad topic of management is disagglegated.e

Management The management literature includes many definitions of management. All relate to the processes of organizing resources and directing activities fol the purpose of achieving organizational objectives. Inevitably, those who study and teach management have broken the subject into smaller', more manageable elements. Table 1.1 shows the most prominent classification schemes. The first column identifies the basic management functions: product (or service) development, operations (manufacturing products or performing services), malketing/ sales (finding buyers and making sure the products and sen,ices fulfill customer needs), and finance (raising money). Virtually every managernent school offers courses focused on only one, or only part of one, of these management functions,

Tnsrr 1.1 Different ways of breaking down the broad area of management into smaller elements Functions

Besources

Processes

Product (or service) developmenl Operations Marketing/sales Finance

P6^^16

Objective setting Strategy lormulation Management control

Money Machines lniormation

So!rce K A Nlerchant Mode,nManagementConlrotSyslems:TexlandCases(UpperSadd'e River. NJ: PrenliceHall,1998), p

3

Chapter

1 Management and Control The second column of Table 1.1 identifies the major types of resources with which managers must wort: people, money, machines, and information. Management schools also offer collrses or-eanized using this classification. These courses are often called human resource mana-qement. accounting and finance, production, and informatiort systems, respectively. The term monogement corttrol appeal's in the thrrd column of Table 1.1, which separates the management functions along a proce.rs continuum involving objective setting, strategy formulation. and management control. Control is the back end of the management process. Many management courses, includin-s business policy, strategic management, and management control systems. fbcus on eiements of the mana-eement process. To focus on lnanagement control, we must distinguish it from obiective setting and strategy formulation.

0bjective setting Knorvled-ee of objectires is a necessary plerequisite for the design of any MCS and, indeed, for any purposeful activities. Objectives do not have to be quantified and do not have to be financial, such as 20o/o annual leturn on equity. A not-for-profit ol-ganization's primary objective might be to provide sJrelter tbl homeless people, for exampie. In any organization. however, employees must have some understanding of what the organization is trvin-e to accomplish. Othelwise no one could claim that any of the employees' actions are purposive, and no one could ever support a claim that the organization was s uccessful. In most organizations. the objectives at'e known. That is not to say that ali employees always agree unaninrously as to how to balance their or-sanizations' r'esponsibilities to all of theil stakeholders (including owners, debtors, employees. suppliers, customers, and the society at large). They ralely do. But earl1, in their histories, organizations develop complomise mechanisms to resolve conflicts among stakeholders and reach some level of agreement about the objectives thelr vTiil pLrrsue.

Strategy formulation Stt'ategies define how or'_eanizatious should use their resources to meet their objectives. We can vierv strategies as constraints that organizations place on their employees so that they will focus their activities on what their olganizations do best; particularly in areas where they have an advantage ovel their competitors. Well-conceived strategies, which result from analyzing the organizations'strengths and weaknesses in the malketplace, in successfully pursuing their olganizations' objectives.r0 -euide employees Strategies can be specified folmally or left lar-{el1, unspecified. Many organizations develop formal strategies through systematic, often elaborate, plannin.e processes (rvhich we discuss in Chapter 8). Othet' organizations do not have fonnal. u,t'itten stlategies: instead they try to respond to opporturities that present themselves.r' Major elements of these latter organizations' strategies emerge from a series of interactions between mana-qemert, employees, and the environntent; from decisions made spontaneously; and frorn local experimentation designed to learn u,hat activities lead to the greatest success. Nonetheless, if some decision-making consistency exists, a stl'ategy can be said to have been formed, regaldless of whethel managers planned ol e\/en intended that particulal consistency.

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Judging frorn employees' actions, it is sometirnes difficult to identify an organization's strategy. Spontaneous decisions sometirnes conflict dilectly with the organizations'

Management and control

rr-rfl]lrl stl'ategic statelnents, ltot because of mana-qement contlol probletns but because rhe ftrlntal stlategic statements have become obsolete and employees have decided to rrke rrctions that are better than the folnal strategy sLlggests. In the early 1980s, Intel's \rite(l plan was to be a major playel in rnerroLy chips (as rvell as n-ricroprocessors), but in 198-5 it exited frorn the dynarlic random access lnelnory (DRAM) business. Iu retfospect, Andy Grove, Intel's Chief Executive Officer' (CEO), observed that the compan\' \\'as "fooled by its orvn strate-qic rhetolic." Its marketin-e. pricing, and investment clecisiorrs as eally as 1983 made it clear that some key employees had made a decision ro letl'eat florn rneuror'1,chips.rr The point is that the actual strategy an organization euacts rnay be different tiorn its fonnal strategic statelnellts. Not eveu the rnost elaborate strate-qic visions and statenents ale cor.nplete to the point u hele they detail every desired action and contemplate s1,s11, possible contingetrcy. Ho'uveveL, fol purposes of designing N{CSs, it is r,rseful to have stlate-eies that are as specific and detailed as possible, if those strate-qies are well thou-ght out and can be kept cut'l'ent. The formai stlate-9ic statements make it easier for ilrana-qenent both to identify the feasible lnana,qenent control alternatives and to implement them effectively. The lranagelneltt controls can be targeted to the organization's critical success factors, such as developing new products, keeping costs down, or enhancing rnarket share, rather than aiming more generally at improvin_u profitability. Formal sfrate-9ic statements ale not r.nandator'5,for rlanagernent control purposes, hou,eveL. N4an1'organizatiotrs with lalgelll eurergent strate_sies have effective MCSs, aithough their control alternatives are often mole limited. Management control vs. strategic control

In the bloadest seuse. contLol

S),Stens can be viewed as having trvo basic functions: stlategic control and managernent contlol . Strategic cotttrol involves nanagers addressing the questiorr: Is onl strate-u1, valicl? Or', more applopriatell, in changing environments, they ask: ls or"rr stlategy still valid, and if not, how should it be changed? All firms rrust be concerned with stlategic control issues, but the concern that a strategy may have become obsolete is obviously greatet'in firms operating in more d),r.rarnic environments.'' Manctgentertt corttol involves addressing the -eeneral question: Are oul employees likely to bel.rave applopriatell,? Thls question can be decomposed into several parts. First. do oul emplo,vees undel'stand u,hat we expect of them? Second, rvill the1, work consistentiy hard and try to do what is expected of ther-n; that is, will they implement the orgauization's strategy as intended? Third, ale they capable of doing a good job? Finalll,, if the answer to any of these questions is no, what can be done to solve the managenent control ploblerns? All organizations who nrust lely on their employees to accomplish organizational objectives must deal u,ith these basic management control issues. The tools for addt'essing strategic and rnanagement control issues are quite different. Managers addlessin-s stretegi(' control issues have a focus prirnarily extelnal to the organization; they examine the industly and their or'-uanization's place in it. They thir* about horv the organization, with its pafiicular combination of strengths, weaknesses, opportunities, and limitations, can compete with the other fir'rls in its indnstry. Managers acldressirtg ntettctgetnetlt corttrol issues, on the other hand, have plimalily au intemal focus; they think about how they can influence enployees'behaviors in desired lvays. This book focuses on lnana-genent control. In nost cornpanies. focusing on irnpror,in-e MCSs wrll plovide hr-eher payoffs than will focusing on improving strategy. A Fortrttte studlr 5hsw.d that sevetr out of 10 CEOs who fail do so not because of bad strategy but because of bad executior-r.r5 Another study of Finrtncial Times 1,000 cornpanies

Chapter

1.

Management and Control 80o/o of directors thou-eht their compan), had the ri-qht strate-qies. but or-iy l4Vo thou-qht that theil companies were implementing the stlategies ,,r,eil.ro The tenns exectttiott and str(tteS!\, intplenrentatrori have the same meaning as mana-qement control the way

found that

that telm is used in this book.

From a lranagement control perspective, strategies should be viewed as useful, but not absolutely necessary, guides to the plopel design of an MCS. As lve show later, when stlategies are formuiated more clearl1,, more controi altematives become feasible. and it 1..-^'-'.. r',.i:- t. i-rll:rrert erch fbnr of management control effectivel;,. Managets :-..,.; i.1 ilc) oi controls u'ithout havin-e any clear strategk'5 1ll lllll1(1. Behavioral emphasis As mentioned eallier, nanagemeut contlol invoives managel's taking steps to help ensure that the eniplol,es5 do what is best for the or'-canization. This is an impol'tant function because it is people in the organization who make things happen, N4anagement controls al'e necessaty to guard against the possibilities that people will do something the organization does not want then to do or fail to do solnethin-q they should do. It makes little sense to talk about cost control, for example, without let-erence to people because costs do not control thernselves; people contlol them. Tliis behavioral orientation is not only an alea of agreement in the recent nanagement control literature; it also has long been recognized by lnanagers and controllers. For example, when Bill McElroy, fnance directol and boald mernber of the Toyota Motor Colporation of Australia, was asked what he would stLrdy if given the oppoltunity for some formal learning, he replied: I rvould like to know more abont psl,chology -in terms of why people ar'e the way they are and rvh1, they behave the way they behave. If I had studied this in my university days, I think I rvould have gained significant benetrts all the u,ay through nry career.'t

If all employees could always be relied on to do what is best for the organization, there would be no need fbr an MCS. But employees ale sonetimes unabie or unwilling to act in the organization's best interest, so nranagers must take steps to guard against the occulrence, and particularly the per'sistence, of undesir'able behaviors and to encourage desirable behaviors.

CAUSES OF MANAGEMENT CONTROL PROBLEMS Given the behavioral focus of contlols. the next logical question to ask is: What is it about the employees on whom the organization mnst rely that creates the need to implement MCSs? The causes of the needs for contlol can be classified into thlee main categories: lack of dilection, motivational problems, and personal limitations. Lack of direction Some employees perform poorly simply because they, do not know what the organization wants fi'om them. When this lock o.f clireclioru occurs. the likelhood of the desired

behaviors occurring is obviously smail. Thus, one fnnction of management control involves informing employees as to how they can maximize tl-reir contributions to the firlfilhnent of organizationai objectives.

Causes of management control problems

Lack of dilection is not a trivial issue in many organizations. For example. suwey evidence collected in 2005 by KPMG flom approxirnately 4,000 US enployees spanning all levels of job responsibility across a wide range of industries and olganizational sizes revealed that 557o of the sampie respondents had a lack of understandin-q of the standards that apply to theil jobs.rN Moreover', a 2004 study of 414 World-at-Work members in mostly managelial positions at large Norlh-Arnerican companies shorved that 81% of the respondents believe that senior lnanagers in their olganizations understaud the value drivers of theil business strategy; 46Vo say that middle managelnent undetstands these dlivels, but just 13oz'c believe uonfiranagement enployees understand them. This indicates that or'-eanizational goals are not cascacling down to all levels in the organization. And, while 79a/o of the respondeuts in this study beiieved tliat theil employees' goals are aligned with or-eanizational goals, 44Vo also stated that employees set goals based on their own views lather than dilection fi'om leadership.''

Motivational problems Even whele employees understand what they are expected to do, some choose not to perform as the organization would have thern perfotm because of ntotit,cttional problents. Motivational problems al'e comrr-ron because inclividual and organizational objectives do not naturaily coincide; individuals are self-interested.r0 Most, if not all. empioyees sometimes act in their o\\/n personal intelest at the expense of their organization's interest, Flederick Taylor. one of the n-rajor' figures in the scientiJic ntcutogetnent ntovenletlt that took place il the early-2Oth century wlote: "Hardly a competent workel can be found who does not devote a considerable amount of time to studying just how slowly he can work and still convince his employer that he is going at a good pace."2t Effot't aversiott and other seu-interestecl belnviors are still a problem today, however. For example, recent sun/ey evidence suggests that wasting, mismanag-

ing. falsifyin-e, stealing, and abusing organizational lesources, among other types of employee misconduct, ale prevalent in most organizations.:: Even ostensibly inconsequential forms of wasting time on the job can have high costs. Surflng the Intemet while on the job, for example, was estimated in 2001 to have cost US employers $63 billion per year." Extreme forms of employees' nisdirected behaviors, such as employee fraud, can have seveLe. detrimental impacts. includin-e deteriorated employee molale, impaired business relations, lost levenues from damaged reputations, investments in improving contlol procedures, legal fees and settlements of litigation, fines and penalties to regulatoly agencies. and losses from plummeting stock prices.r' While some of these impacts may seem far-fetched, they are not. One recent sun/ey of practice found that nearly three out of four employees leported that they had observed misconduct in theil olganizations in the prior l2-month period, with half of the lespondents stating that what they had observed could cause "a significant loss of public trust if discoverecl."r5 Focusing on employee flaud, a 1997 study by the Association of Certified Fraud Examiners estimated that the cost of workplace fraud in the US alone was $400 billion per year, or an average of $9 per day per employee tor the average compan1,.16 These losses were the equivalent of 6Vc of the total US gross domestic product. Similarly, a 2003 sur\/ey of executives from 459 US publicly held firms and govemment agencies shoq,ed that 36Vo of these organizations incured $1 million ol more in costs due to fraud.r? But small companies are also affected b), fraud; perhaps pl'oportionally even more in terms of the losses they incur because of it. Estimates by the Association of Certifled Flaud Examiners iu 1995 sug-eest that businesses with fewer than 100 employees that were victimized by

Chapter

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Management and Control

fiar.rd lost an avel'age of $120,000. an amount that sometimes threatens the life of these small or-eanizations. r8 These huge fraud costs can be traced back to hurnan weaknesses (and, probably, to the iack of effective MCSs). Brian McNally, the rnanager of the fashionable "44" r'estalrrant

in the Royaltorr Hotel in New Yolk, said, "Every single person in your restaurant is yoLr,"re Randolph D. Brock, president of Block International Security Corporation, estimatecl, more conservatively, that:

trying to steal fi'om

Between 10 and 20Vo of a companl,'e employees will steal anything tliat isn't nailed down. Another'2O% wiII never steal; the,v would sa1, i1 is morally wlong. The vast majolitS' of people are situationalll, honest; the1, lvsn', steal if there are plopel contlols.tt'

These estimates al'e consistent with research findin-gs and the sur\/eys of plactice.rl A special form of "stealin-e" occurs when employees manipulate their performance reports. either by falsifying the data ol by taking decisions that artificially boost perfolmance, with the intention of earning higher', but undeserved, per'fbrmance-dependent rewards. The surveys ofpractice invariably shorv that financiai repolting fraud has the hi,qhest cost per incident (u,ith cost estimates varying from anywhele between $10 and S100 million in sorne studies to as high as $250 rrillion per incident in othel studies), even though it occuls relatively infrequently.tt MCSs are obviously needed to plotect organizations a-eainst these behavicls. Employees, particularly marlagers, are also prone to rnake decisions that serve their' interests, but not those of their organization. They tend to overspend on things that make their lives more pleasant, such as on office accoutremeltts and other perks. They often engage in gamesnrcursftp such as "earnings management" to make their performance reports look good even when they knou, the actions they are taking have no economic value to the company and, in some cases, are actually harrnful. And they sometimes tend to be excessively risk averse and reluctant to make even good investments because of fear that if the investments do llot pay off, they may lose their job. We discuss these and related plobiems in detail in Chapter 5 and in the chaptels in Section IV of this book. But in addition to focusing on how MCSs can be employed to avoid ol mitigate these "negative" behaviors, this book's emphasis is also, even primaril),, on how MCSs can be employed to motivate "positive" behaviors; that is, hou, the), can encoul'age employees to work consistently hard to accomplish organizational objectives. The role of MCSs in

motivating employees to perform rr,,eli involves, among other subjects, the studlr ef irtcetttives (Chapter 9) in a results c'orttrol context, wlrich we introduce in Chapter 2. Personal limitations

The final behavioral problem that MCSs must address occurs where ernployees lvho know what is expected of them, and are highly motivated to pelforn weil, are simply unable to do a good job because of certain personal limitations. Man1, s1 15rre limitations are person-specific. They may be caused by a lack of requisite intelligence, trainin-e, experience, stamina. or knowled-ee fol the tasks at haud. An exarnple is the too-conmon situation where employees are promoted above their level of competence. When employees are "over theil heads," problems are nearly inevitable.

Another colnmon personal limitation is lack of knowledge or information. Many management control problerns occur because key personnel do not have the information necessary to do a good job. Management at American Bakeries desclibed the company as being in a "state of disarray" because of the absence of cliticai information about delivery routes, depots, bakeries, and divisions.rt Some major firms in the romance novel 10

Characteristics of good management control

publication industr'1, u'ere desclibed as being "out of control" because the key mana-qel's in the firn-rs did not have the ir-rtbtrnation uecessary to make good publication decisions, aud costly uristakes wele being urade.il Some jobs just are not desigued properly. These jobs ma)/ cause even the most physica111,61 people to get tired or stlessecl ar-rd, in turn, lead to on-the-job accidents and decision en'ol's. Son-re jobs require employees to perfolm duties or make judgments that e\fen the most talented amon_q us are unable to perfornr. A significaltt arld -erorvin-u body of psychological resealch has deu-ronstrated that all indivicluals - even vely intelli-eent, well-trained, experienced rndividuals - have solne sevel'e limitations on their abilities to pelceive new problems, to remember'important facts, and to pl'ocess infbmration propell1,.r5 In look-

ing at the future. it has been shorvn that people tend to overestimate the likelihood of commor-r e\1ents and events that have occurred relativell, recently (both of which ale easier' to lemember') as compared with relatively rare events and those that have not occumecl recentll,. Sometirnes trainin_q can be used to reduce the severity of these limittr-

tions, but in most situations nultiple biases and limitations renlain.i6 These lirnitations are a probiem because the1, 1s4r'r.. the probability that employees ivill rnake tlle cor'r'ect decisions 01'even that they will obsen,e the problems about rvhich decisions should be made. Researchels ale just beginning to explol'e the mauagemeut control implications of tliese lirnitations.''7 These tluee lnana-sement control probler.ns - lack of direction, motivational problems, and personal lirnitations - can obviously occur simultaneously and in any combination. An ernployee may not understand wirat is expected. n-tay not be motivated to pefibrni lvell, and may uot be capable of perfoming well even if slre both unclerstands what is bein-e asked for and is liighiy rnotivated to achieve it.

CHARACTERISTICS OF GOOD MANAGEMENT CONTROL To have a hi_sh probability of success, organizations urust maintain good management control. Goocl cotttt'ol means that management can be reasorabl)/ confident that no major' unpleasant surprises will occur, The label out of corttrol is used to describe a situation where thet'e is a high plobability of poor perfornance. either overall or in a specific performance area, despite having a leasonable stl'ategy in place. Good managerrent control stiil allorvs for some probabiiity of failure because perfect cortrol does not exisl except perhaps in vely unusual circumstances. Perfect control lvould require corlplete assurance that all physical contlol s),Stems are foolproof and all individuals on lvhom the organization must rely always act in the best way possible. Perfect control is obviousll, not a lealistic expectation because it is viltually irnpossible to instail MCSs so rveil designed that they guarantee goocl behaviors. Furthennore, as MCSs are costl1,, it is larely, if ever, cost effective to tly to irrplement enough controls e\/el] to approach perf'ect control. Tlre cost of not having a pet'fect controi systen'r can be called a c'ontt'ol io.ls. It is the diffelence between the performance that is theoretically possible given the strate-qy selected and the performance that can be reasonably expectecl with the MCSs in place. More or bettel MCSs shoLrld be irnplemented only if the amount by which they would leduce the contlol loss is greatel than their cost. Optinral c'orttrol can be said to have been achieved if the contlol losses are expected to be smaller than the cost of implementing rnore controls. Because of control costs. perfect cot.ttt'ol is rarely tl-re optimai outcome; what is optimal is control that is good enough at a reasonable cost. 11

Chapter 1 . Management and Control

Assessing whether good control has been achieved must be future-oriented and objectives-driven. It must be .firure-orienlerl because the goal is to have no unpleasant surprises in the future; the past is not relevant except as a -euide to the future. It must be

ob.jectit'es-ch'it,eli because the objectives l'epresent what the organization seeks to attain.s* Nonetheless, assessing whether good control has been achieved is difficult and subjective. It is difficult because the adequacy of management contl'ol must be measured against a future that can be very difficult to predict. Good control also is not established over an activity or entity with rnultiple objectives unless performance on c// significant dimensions has been consideled. As difficult as this assessment of management control is, however, it should be done because organizational success depends on a good MCS. Organizations that have not achieved good control, either because they have not implemented an MCS or because they have not implemented one well, are likely to face severe repercussions. As the examples plovided at the beginning of this chapter illustrate, they can suffer loss or impairment of assets, deficient l'evenues, excessive costs, inaccurate records and leports that can lead to poor decisions, legal sanctions, or' business intenuptions. At the extreme, if they do not control performance on one or more critical perfomance dimensions, these organizations can fail.

CONTROT PROBTEM AVOIDANCE Implementing some combination of the behavior-influencing devices commonly known as MCSs is not always the best way to achieve good control; sometimes the problems can be avoided. At'oiclance means eliminating the possibilitl, that the control problems will cause the organization harm. Organizations can never avoid all their control problems, but they can often avoid some of them by limiting exposure to certain types of problems and problem sources, or by reducin,e the maximum potential loss if the problems occur. Four prominent avoidance strategies are activity elimination, automation, centralization, and lisk sharing.

Activity elimination Managers can sometimes avoid the control problems associated with a pafiicular entity or activity by tuming over the potential risks, and the associated prolits, to a third party through such mechanisms as subcontracts, licensing agreements, or divestment. This form of avoidance can be called actrllrl' elinunatron. Managers who are not able to control certain activities, perhaps becanse they do not have the required lesources, because they do not have a good understanding of the required processes, or because they face legal or structural limitations, are those most likely to eliminate activities. General Motors (GM) turned its Clark, New Jelsey. roller bearing opelations over to the plant's ernployees. The plant had not performed rvithin limits acceptable to GM managers. The GM managers hoped that the emplol,ees would soon understand an important message that they had been unable to get them to understand - that productivity improvements were necessary for the plant to sun ive.se When managers do not wish to avoid completely an alea that they cannot control well, they ale wise at least to limit theil investments, and hence their risks, in that area. Chase Manhattan Bank was left with a potential $135 million after-tax write-off because of its involvement in the -government-securities lending business with Drysdale Govemment Securities. In retrospect, bank executives admitted they had not understood this business tz

Control problem avoidance

.,i.i1 its lisks ver1,

well and that they had not been wise to become so heavily involved iu avoidance of problems that might arise.

:,- Limiting risk is partial

The economics-oliented literature that focuses on wirether specific activities (transacnore effectively thlough ntarkets or throu-9h or-Qanizational ltier.,'t /iics is krrowr-t as trctttsctctiotl cost econoriirc's. A detailed exaurination of the theories -,nt1 evidence in this field of stud1, is outside the scope of this book.'' We just note that .ire fact that all olganizations of any size struggle with mana-eement control issues is tesinlent to the limitations of arms-length, market-based transactions r.vith entities extemal .tr the firm to solve all control problems satisfactorily. As such, olganizations will always .r.ri'e to rel1, on MCSs, which have been found to be effective in a br oad range of settings. The r,vorldwide glowth and success of lalge diversified organizations has depended to a irirge extent on -qood MCSs. .:ons ) can be controlled

Automation )trtontntiott is a second avoidance possibility. Mana-{ers can sometlmes use computers. lobots, expert systems, and other means of automation to reduce their organization's J\posule to sonle control ploblems. These automated devices can be set to behave appropliately, and u,hen they ale operating propelly. they usually perform rnole consistently than do hnmans. Computers eliminate the human problems of inaccurac),. inconsistency. lnd lack of motivation. Once progralnmed, computers are consistent in their treatments of tlansactions, and they never have dishonest or disloyal motivations. As techuolo-ey has advanced, organizations have substituted machines and expert \)'stems for people who have been perfonnin-e quite complex actions and making sophisticated judgments and decisions. In hospitals, artificial intelligence systems are rible to perform many of the tasks doctors and nurses previousll, had to perform. These s)'stems monitol the patients' conditions and tlends and alert the medical staff of possible ploblerns; they assist in making diagnoses; they order the needed drugs; and they check for potential dru-e interactions and allergic reactions.r2 These systems allow hospitiils to avoid one of the behavioral problems - the personal limitations of the rnedical staff. In the vast majority of situations, these systems are more likely than are the mernbers of the medical staff to recall all the details of evely condition. medication, and possible complications to initiate the propel lesponse. The system makes it more likely that no major, unpleasant surprises u,ill occur', in this case, avoidable medical elt'ors. Mrs. Fields' Cookies provides another good example of an MCS dominated by automation.| Ti-ris company is the largest retail operator of gourmet cookies through a franchise system with over 3,000 points-of-retail worldwide in over 30 countries, many of rvhich are located in shopping rnalls. The 8,000 stole-level emploi,ees are mostly young and irrexperienced. The company has a small headquarters staff. The Mrs. Fields' Cookies' MCS is built around a cornputer application that directs and assists the store rnanagers. The computer makes hourll' sales projectiorts and tells the - how nrany batches of cookies. of what t1rpe, and when. It gives the nranagers volume-increasing suggestions. If customer counts are down, it might su-sgest -eiving away cookie samples to shoppers in the mall. If customer counts are nomral but sales are down, it rtight present ideas for suggestive selling. The computer schedules the rnanagel's what to bake

It helps intewiew applicants by having applicants type answers to questions into the computer, and an expert system analyzes the responses. It assists rvith personnel administration by generating the personnel folder and remindin-s the manager of paper'work requirements. It helps with naintenance b1, making suggestions regarding repairs, and if the suggestions do not work, b1, preparing a wolk order and selecting a vendor. The crerv.

13

Chapter

1 Management and Control computer system is designed to make it possible tor even inexpelienced store managers to run their stores just as Debbi Fields, the successfnl founder of the company. woulcl. In most managerial situations. horveveL, automatiol'r can provide only a paftial control solution at best. One limitation is feasibili{r,. Hnmans have many talents - particularly those involving complex, intuitive judgments - that no machines ol decision models have been able to duplicate. A second limitation is cosr. Automation often requires major investments that may be justifiable only if improvements in productivity, as well as in control, ale forthcoming." Finaliy, automation may just leplace some contlol problems with others. Computel automation often increases control risks. The elimination of source documents can obscure the audit tlail; the concentration of information in one Iocation can increase security risks; and placin-e ,qreater reliance on computer programs can expose the company to the risks of progratnmel effors or fraud.

Centralization Cenn'ali:cttion of decision-making is a third avoidance possibility, and it can eveu be one of the centlal elements of an or'-eanization's MCS. Extrente forms of centralization in which all the key decisions are made at top management levels ale comlron in small businesses, particularly when the1, ale nrn "like a family store, with an iron _erip on authority" by a strong leader who is otlen the founder ol owneL.ts Stlong fomrs of centralization also exist in some Iarge businesses rvhose top managel's have repntations for bein-q "detail oriented." Data General Corporation's ex-president. Edson de Castro, maintained centralized control. A former lnana-qer in the {ilrn observed that "all the real decisions in that company go to one desk - de Castlo's."tt' Mr'. de Castro leserved the important, and sometimes the not-so-irnpoltant, decisions fbr himself because he apparently did uot tmst subordinates to take the propel actions. In so doing, he avoided some control ploblems. Some nranagers centralize decision-rnakin_s in some al'eas of theil organizations at specific points in their histories to implove conttol. N4any companies that became concemed about the multimillion dollar losses u'ith complex delivatives suffeled by Procter & Garnble, Gibson Greetings, Metallgesellschafi. and Oran-ue County California, to name a 1-ew, have responded by centlalizing lisk ntanasement activities. In the banking industry alone, Morgan Stanle1,. Citicorp, and Su'iss Bank are alnong the companies that have appointed corporate risk managers to pelform this important activity.rT Centralization exists to some extent at all levels 01'mana-eement. as managers tend to reserve for themselves many of the rnost critical decisions that fall within their autholity. In fact, one sttrdy found that (1) identification ofthe key'r'isk aleas, and (2) centralization of decision-rnaking in these areas ale charactelistics of the MCS used by "excellent" Canadian companies.*8 Common candidates fol centralization are decisions regardin-e rnajor acquisitions and divestments, major capital expenditLu'es, negotiation of pivotal sales contracts, organization changes, and hiring and fir'ing of executives. However, in most organizations of even rninimal size, it is not possible to centralize all critical activities, and other contlol soltttions are necessarl'7. Risk sharing

A final, paltial avoidance possibility is risk shalins. Sharin-s risks with outside entities can bound the losses that could be incurred by inapplopriate employee behaviors. Risk sharing can involve buying ittstu'curt'e to protect against celtain types of potentially large losses the organization rnight not be able to afford. N'Ianv companies pulchase fidelity 14

Control alternatives

in sensitive positions (such as bank tellers) to reduce the fitm's exposure, These insurance contracts pass at least a portion ofthe risk oflarge losses and errors to the insurance providers. Another way to share risks with an outside party is to enter into a joittt yenture agreement. This shares the risk with the joint venture partner. These avoidance altematives are often an effective partial solution to, or bounding of, many of the control ploblems managers face. It is larely possible to avoid all risks because firms are rewarded for bearing risk, but most firms use some forms of elimination, automation, centralization, and risk sharing in order to limit their exposure to the management control problems. bonds on employees

CONTROT ALTERNATIVES For the control problems that cannot be avoided, and those for which decisions have been made not to avoid, managers must implement one o[ more control mechanisms that are generally called nunagenrcnt cotltt'ols. The collection of control mechanisms that are used is generally referred to as a mqtngemetlt control D)stem (MCS). MCSs vary considerably among organizations and among entities or decision areas of any single company. Tables 1.2 and 1,3 show some of the controls used in a manufacturing Tnete 1.2 Examples of controls used in a manufacturing firm

1. The cash payment and cash receipt functions are segregated.

2. A check protector is used, and signature plates are kept under lock and key. 3. The accounting department matches invoices to receiving reporls or special authorizations prior

to

paymenr.

4. Checks are mailed by someone other than the person making out the check. 5. The accounting department malches invoices to copies of purchase orders. 6. The blank stock of checks is kept under lock and key.

7. lmprest accounting is used for payroll, 8. Bank reconciliations are to be accomplished by someone other than the one who writes checks

and

handles cash.

9. Surprise counts oi cash funds are conducted periodically. 10. Orders can be placed with approved vendors only, '1

1. All purchases must be made by the purchasing department.

Sourcet

KA

lvlerchant, Modern Management Conlrcl Systems: Text and Cases (Upper Saddle River, NJ: Prentice Hall, 1 998),

p

1

3

Tnetr 1.3 Examples of controls used in a computer facility

'I

Written standards exist for documentation of systems, operations, and administration.

2. Access to the computer system and all online data terminals is restricted at all times to authorized personnel only.

3,

Data are secured through tape file prolection rings, file labels, cryptographic protection, duplication procedures, and requirement of storage of duplicates at a remote site.

4.

Hardware controls include duplicate circuitry, dual reading, echo checks, preventive maintenance, and uninterruptible power systems.

5. Major risks are insured against.

6.

Backup systems and procedures are developed.

Soutce:K A. Merchant Moden Manegemenl Conlrcl Syslems: Texl and Cases\Upper Saddle River, NJ: Prenlice Hall, 1998), p.

14

1F

Chapter 1 . Management and Control

firm and a computer facility. respecfively. The MCSs of some organizations consist primarily of trying to hire people who can be relied upon to serve the organization well. Other or_sanizations provide modest performance-based incentives, and still others offer incentives that are hi-uhly leveraged. Some organizations base incentives on the accomplishment of tar-eets defined in terms of accounting numbers, others use nonfinancial measul'es of perfonnance, and still others evaluate performance only subjectively. Some organizations have elaborate sets of policies and procedures that they expect employees to follow, lvhereas others have no such procedures or they allow the procedures that were once in place to get out of date. Some organizations make extensive use of a lalge professional internal audit staff, while others do not have a separate intemal audit function. These are just examples. The distinctions that can be made among the MCSs in use are nun]erous.

Managers' control choices are not random. They are based on any of a numbet of factors. Some controls are not effective, or are not cost-effective, in certain situations. Some types of controls are better at addressing particular types of problems, and different organizations and different areas within each or-eanization often face quite different mixes of control problems. Some types of controls have some undesirable side effects that can be particularly dangelous in some settings. And some controls met'ely suit particular managels' styles better than others. A major purpose of this book is to describe the factols affecting management contlol choice decisions and the effects on the organization when better ol'worse choices are made.

OUTLINE OF THIS BOOK Tlie book discusses MCSs from sevelal different angles, each the focus of one major section of the book. Section II distinguishes controls based on the object of corttrol, which can focus on the results produced (results cotltrol), the actions taken (crctiort control), or the types of people employed and their shared norms and values (pet'sonrtel ctncl ctlttn'ctl control).re Chapters 2-6 in Section II discuss each of these forms of control, the outcomes they produce (which can be both positive and negative), and the factors that lead rnana-eers to choose one object of control ovel' allother. Section III focuses on the majot' elernents of firruncicrl results control ,t),JleillJ, an important type of results control in rvhich results are defined in financial terms. This section includes discussions of financial responsibility stluctules (Chapter 7), planning and budgeting systems (Chapter 8), and incentive compensation s)/stems (Chapter 9). Section IV discusses some major problems managers face r,vhen they use financiai results control systems and, particularly, the performance measurements that drive them. These problems include the tendency of accounting measul'es to cause managers to be excessivell, shofi-telm oriented (myopic), the tendency for return-on-investment measnres of performance to cause bad investment and perfomrance evaluation decisions, and the likelihood of negative behaviolal reactions from managers who are held accountable for factors over which they have less than complete control. Throu-ehout Chapters 10, 11, and 12, u,e also discuss several approaches organizations can rely orr to mitigate these problems. Section V of the book discusses sonre key olganizational control roles, including those of contlollers, auditors, and audit committees of the board of directors. It also discusses lecent deveiopments in corpolate govemallce, as well as common control-reiated ethical issues and how to analyze them. 16

Notes

The final sectiou of the book, Section VI, discusses some of the contextual factors that have significant effects on either the choices of MCSs or their effectiveness in specilic settings. Chapter' 16 discusses the effects of thlee of the uost important factors that cause control systems to be different: environnental uncettainty, organizational strategy, and multinationatity, Chapter 17 focuses on some control problerns unique to not-for'-profi1 organizations.

Notes

tr4 E. Porter.

A. Zinimerman and A.

Raghavan. "Diarnond Group Widens Probe of Bribe Char-ees." Tlte Wall Sn eet Jottrral (Malch 8, 2006), p. B 1. 2. "Report of the Board of Banking Supervision Inquirl' into the Circumstances of tlre Collapse of Balirrgs," Bank o.f Englatrd (Ju11' 18, 1995). 3 C. Karnrin and G. Fields. "Lax Contlols May Explain Trading Loss at Allied h'ish," The \|'all Street Jourtnl (March 8. 10021. p. A8. 4. ''Keystroke Errol Causes Tum-roil in UK N4arket," Ifte l4/ctll Sn'eer Journctl (May 16,2001), p. Cl4 5. "Man Adn.rits Theft fi'orn US Archives," The Los Artgeles frrras (lt4arch 14, 2002), p. ,\21. 6. lvl Molin, "Tivo Accused of INS Shreddin-u Sptee," Tlte Los Angeles files (Jat.ruary 31,2003), p. 85

1.

7. "The Road to Perdition." Tlte Ecortonist (July

Pless. 1985).

11. See H. Nfintzberg. "Clafting Strategy," Hartctrd Busiiress Ralierr,. 65, no. 4 (Jul1,-{u-ou51 1987), pp. 66-75. 12. H. Mintzberg, "The Strateg)' Concept I: Five Ps for Strate-sy," Ctlifornia Managemertt Reviev', 30, no. I (Fall 1987), pp. 11-24 13. R. Henkoff. "Horv to Plan lor 1995," Forturte (December 31, 1990), p. 76.

I4.

24,

Stotegic Renetrol (Boston, MA: Harvard Bustttess

Acarlen4' o.f Managentent Ret'iev', 12, no I (1987), pp. 91-103; and J H. Holovitz, "Stlategic Control: A

15. 16. 17.

Pitrnan, 1985).

9. Some key leferences in the area of olganizations

The strate-qic control task has been discussed b1', among others. I. Tavakoli and K. J. Perks, "The Development of a Strategic Control Systern tbr the Managetneut of Strategic Change." Strategic Clrctnge,10, no. 5 (August 2001), pp. 29'r,-305; M. Goold, "Stlategic Control in the Decentralized Fir:m." Sloart X4anagentettt Relie\',

32, no. 2 (Winter 1991), pp. 69-81; J. F. Preble, "Torvards a Comprehensive System of Strategic Corrtlol." Jortrttctl of Mcrrtogentent Stu(lies, 29, no. 4 (July 1992), pp. 391-409; G. Schreyogg and H Steinmann, "sttategic Control: A New Perspective,"

2003). p. 39. 8. See. fol exarnple, R. Simons. Levers of Control Hott Mattaget s Use Irrnot'cttit'e Contol Sls/ents to Drire

Scliool Press, 1995); R. Simons, Pet.fonttctrtce Merrsut emeti ancl Control Slstents Jor Intplententittg StrateSy (Upper Saddle River, NJ: Prentice Hall. 2000): D. J. Galloway, "Control Models in Perspective." Irttetttal Auditor,51, r'Lo. 6 (December' 1994). pp. 46-52; E. G. Flarnholtz. T. K. Das and A. Tsui, "Toward an Inte,erative Frarneu,ork of Organizational Contro1," Accottntittg, Ot gctni:cttiorts ctrtcl Society, 10, no. 1 (Januar'1, 1985), pp. 35-50; and K. A. Merchant. Cotttrol irr Bttsirtess Organi--atiotts (Marshfield, N{A:

Contpetitive Aclvantttge: Creatitrg cttttl York: The Flee

Sustainirtg, Superior PetJot nrutlce (Neu'

and

Neq,Task for Top Management," Long Range P[nrtttirtg. 12 (Jnne 1919), pp.2-1. R. Charan and G. Colvin, "Why CEOs Fail," Fortune, 139, no. 12 (June 21, 191)9). Businessballs,corn ivebsite. W. Birkett, "The Changing Role of the CFO: An Irltervie\\, u'ith Bill McEh'o),," A \/iew oJ Torttorrov' The Seniot Fittcttttial OJficet in tlte Year 2005 (New York: Intelnational Federation of Accountants, 1995). KPMG 200512006 Integri4' Srrr.r'e,r' (KPMG LLP, 200s).

marlagement include: H. Mintzberg. Structtrre irt Fives' D e s i g n i n g EJfe c: r i v e O r g o r i : a t i o s, 2nu edtt (En-uleri'ood

18.

Cliffs, NJ: Prentice Hall, 1992)l H. Mintzberg. f/re Structuting of Organizatiorrs (Engleu'ood Clitfs, NJ: Prentice Hall, 1979): and H. Mintzberg, ldirtt:berg on

i9. Wolld-at-Wolk, Sibson, and Synygy, The Stare

rt

Mattagenrert (Nerv York: The Free Press, 1989). 10. Some key references in the area of stlategic nlal1a-qement include: R. M. Grant. Corttentporars' Sucttegt Analtsis, 5'r' edn (Oxford: Blackwell, 200,1); H. Mintzberg, J. B. Lampel, J. B. Quinn and S. Ghoshal, The Sn'arcgt Process.4'r' edn (Engleu,ood Clifts, NJ:

E. Polter, Cotttpettttt'e Sn'nteg,r', Techrtiques fot Artctlt':ing Industries ancl Conuetitors (Ne,'v York: The Free Pless. 1980); and

Prerrtice Hall,2003); Ir4.

oJ

Pe'rformance ll4artagenrett (Survey Report, August 2004); and J. Kochanski aud A. Sorensen, "Managing Perforrnance Management," Workspatr (September' 2005), pp.

2l-6.

20. Man5, managentent accountittg and management control textbooks refel to lttck of goal ('ongrue]t('e as a problem category rvhich subsumes both lack -9eneral of direction and lack of rnotivatiort. 21. F. Taylor', The Prirtciples o.f Scietttifit'Mctttogienrent (New Yolk: Harper, I929). 22. KPI,IG 200512006 lttegt'i.r'Sirn'e,i' (KPMG LLP, 2005). 11

Chapter

1

Management and Control

23. S. PlLritt. "Are E,rnployees Wastrng Time Orrline?'' PCIUot'ld Colr (August 2. 2001). 24. Prit'ewaterhouseCooners 2005 Globctl Econonttt Crinte Survet' (PricewatethouseCoopels LLP. 2005). 25. KPMG 2005t2006 Integrin'Srrr ler' (KPMG LLP. 2005). 26. l. T. We]rls. Occttttcrtiottal Fratrd trrtcl Abuse (Association of Certified Fraud Exauriners, 1997). 21 . KPMG 2003 Fraud Srrn'e,r' (KPMG LLP. 2003). 28. J. R. Ernshwiller, "Small Business is the Bi_egest Victim of Theft by Ernployees, Sulvey Shorvs." I/rr, Wnll Srreet Jr,urrral (October 2, 1995), p B2.

29.

K. B.

Leu,is. "Thou Better Not Steal,'' Forbes

(Novernber 1 , 1994), p. 110.

30.

D. Gillmor'. "Crinre Is

31.

Btrsiness," Bostr,tu Globe, Febrrrary 15, 1983, p. 47. M. Liprrran. Steulittg How Anterit'o's Etrytlot'ee.s

Headed Up

- And

So

Is

tre

Steulirtg Tlteir Contparties BIirtd (Nerv York: Harper's Magazine Press. 1973); PricewoterlnuseCoopers 2005

Global Ecottotttic Crinte Srl'r'e,t (PlicervateLhouseCoopels LLP, 2005); KPMG 200512006 Ittregrirv Srrt e_r (KPN4G LLP. 2005): KPI,IG 2003 Fraud Sttt'et' (KPMG LLP. 2003). 32. PricevaterltotseCoopet's 2005 Global Et'ott,ttttit' Crinte Sun'et' (Pricewaterhousecoopers LLP. 2005): ard KPMG 2003 Fratrd Srrr le-r (KPMG LLP. 2003). 33 "Anrelican Bakeries: A Nerv Chef Cleans Up the Kitchen," Brr.rilres.r W'r,al (June 27, 1983), p. 52. 34. "Why Book Publishers Are No Longer in Love with Rornance Novels." Busittess lTeeA (Decenrber 5, 1983). p,157. 35. Seminal ref'elences are R. E. Nisbett and L. Ross. Hnttcrtt Inlerettce' Strategies cutcl Slrortt'orttirtgs of Socittl Jutlgntent (Englervood Clifft, NJ: Prentice-Hall, 1980); R. E. Nisbett and L. Ross. Tlte Per.sott and tlte Situcttiorr (Nerv York: McGlaiv-Hill, 1991); and D. Kahne rnan and A. Tvetsky. "Plospect Theory: An Analysis of Decisions Under Risk." Ecottorrtett'ictt. 11 (1919), pp. 313-27. See also R. H. Ashton and A. H. Ashton. .lutlgnrertt atrl D eci s i o n-M ctki t g Resea rch i rt Accttu ttt i n g a ncl Audi|i rt g (Cambridge Selies on Judgrnent and Decision Makin-e. Carnblidge Univelsity Press, 1995); R H. Ashton. Htrrttatr Ittfortttatiort P rocessirtg itt Ac'coutttittg, Studies in Accounting Research no l7 (Sarasota. FL: Amelican Accorrnting Association, 1982): R. Libby. Act'outtrirtg artcl Huntcttr Irt.fortrntiott Ptor;essittg: T!teot v crrttl Appliccttions (Englewood CtitTs, NJ: Prentice-Hall, 198 I ); A. Tvelsky and D, Kahneman, "Advances in Prospecl Theoly: Cumulative Repr:eseutation of Uucertainty," t

Jourrrql o/Rr.rA urrcl Utttettctinn', 5 (1992), pp.297323; and D. Kahneman, "A Pelspective on Judgment and Choice: ivlapping Bounded Rationality.'' ,{rrtet tr'en Pst'cltoktgist,58, no. 9 (2003), pp. 691-120. 36. M. H. Bazerman, Jrrtlgnteur irt Nlartctgeriul Decisiott Making.6'n edn (Nes, Yolk: John Wiley & Sons, 2005).

37. S. L. Sclrneider, Entergittg

(td

Decisiou

Re secu't'lt

Pet qtectit es ort .ltrclgutettt (Camblidge Series on Judgrnent

alld Decision Making, Cambudge Universitl, 18

Pless.

38

2003): and R. H. Ashton and A. H. Ashton. .luclgntcttt and Decisiort-NIakirtg Re.scarclt itt Accoutttirtg crtrcl Auditittg (Canrbridge Series on Judgment and Decision Nlaking, Canrbridge Urrivelsitl, Press, 1995), Confusion has long reigned as to how to use the terms objectitas and goals. In this book. objectives ret'er to

bload things tl-re or-eanization \\,auts to achieve, such as ''be a leader in the infblrnatioll sel'\,ices indnstry " Goals refer to specific thin-es the or-uauization \\'auts to achieve in a specifiecl tirne period. such as "earln a2O7c retullr on net assets in the corning 1'ear'." Objectives ale relativell, stable, Goals rnay clrange every plannine peliod. 39 A. Sloan, "Go Forth and Conlpete." Forhes (Novenrbet' 23. 1981), pp.41.-2. 40 J. Salarnon, "Horv Nerv Yolk Bank Got Itself Entangled in Drysdale's Dealings." Tlte lI;ull Srret't Jourttol (Itne I l. 1982), p. A1. 4l Olivel Willianrson is _geneLally lecognized as the nlost pronrinent theoretical contl'ibutol' in the area of tlansaction cost econorlics. FoL an overvierv of this litelature. see O. E. Williamsor-r, "Tlansaction Cost Econornics." irr R. Schmalensee and R. Willig (eds). Hartdbook oJ

Irrclrtstrictl Et'otrcntics (Neu, York: North Holland. 1989), ChapteL 3l and O. E. Williarnsor.r, "Tlansaction Cost Econourics: Hon, ir WoLks: Whele it is Headed." De Ecottotttist. 146. no. 3 (1998). pp. 23--58. +L S. Oliver. "Take Trvo Aspirin: rhe Compulel Will Call in the Moruin_s.'' Fot'bes (N4arch 14. 1994). pp. 1 l0-11. +J This exanrple is taken flonr T. Richman. ''N{r's. Fields' Secret Irrgredient." /iir'. (October 19871. pp. 61-72. See also S. H. Haeckei aud R. L. Nolan. "Mana-eing

by Wite." Hcttt'arcl Brrsilcss Rc,r'1crr,,71. no.5 (Septeniber-October 1993). pp. 122-31. 44

See.

tbr example. C. Olnstein. "Hospital

Heeds

Doctors; Strspends Use of Sotirvare." Tlte Los Artgeles

Iirras

(January 22.2003), p.

Bl.

NlLrfson. "Amerada Hess Chief Keeps Controls Tiglrt, Emphasizes Nlarketin_s." The lYall Street Jout-tnl (Janualy I I, 1983). p. l. 46 "Data GeneraI's N{ana-eement Tlouble," Brtsiness 11/eek (Febnrary 9. l98l). p.58. "Managin-e Risk." Brrsirrcss lI/eek (October 31. 1994), p 92. 48 T. Carvsey, G. Deszca and H. D. Tetl|, ilIutta,qenctil Cortn'ol St's/ents irt E.rc'cllcttt Cqnatlion Conrpctniet. i\,lana-Rernert Accounting Issues Paper #5 (Hamilton. ON: The Society of iVlanagetneut Accountants of

S.

Canada. i994). 19 This fi'arnewolk rvas discussed b1, W. Ouchi,

"A

Con-

ceptual Flarnes,ork fbl the Design of Organizational Contlol Mechanisnts." ful ct tta g e nr e rt St' i e nc e, 25. no. 9 (S€ptenrber 1979), pp. 833-48. It rvas elaborated on by K. A. Merchant. Coutt'ol irt Business Or.z,ani:tttiotts (Cambrid-ue, IVIA: Ballin-ser'. 1985). Section II of this book presents a rehned and expanded discussion of this fiamervork.

RESULTS CONTROLS

asked to think about powerful wa1's to influence behavior in organizations, most Ipeople would ptobably think first about pay for pet'fotmauce. And, no doubt, pay for pelformance is an effecti\re motivator. For example, at Thor Industries, the world's

ff

largest recreational vehicle manufacturer, Wade Thompson, the CEO, attributes much of the company'S succesS to its compensatiotr s),stem. Among other things, the company

of each division's pretax profits with the division managers, because, \{r. Thompson explained, "I want every one of olu' company heads to feel like it is their business, in their control. If they don't perform, they don't get paid very much. If they shales 15olc

do, thele is no cap to what they can make."r Pay for perfotmance is a prominent example of a type of control that can be called results control because it involves re'v\i arding employees for generating good t'esltlts. But the lewards that can be usefull;' linked to results -eo fal beyond monetarl' ssm-

pensation. As Vicky Wright, managing directol' at the Hay Group, a personnel and compensation consultancy firm, put it: The companies on the Most Aclmired list [a list of cornpanies produced annually by FortLtne) have chief executives who undelstand what perfolmance measurement is all about. It's about leaming how to motivate people - how to link tliose performance measures to rewards.2

Other rewards that can be linked usefully to measured perfonnance include job security, prornotions, autonom)/, and recognition.' Results controls create meritoct'acies.In meritocracies, the rewards are given to the most talented and hardest working employees, rather than those with the longest tenure or the right social connections. The combinations of rewards linked to results inform or remind employees as to what result areas are imporlant and motivate them to produce the results the organrzation rewalds. Results controls influence actions becattse they cause employees to be concerned about lhe consequences of the actions they take. The organization does not dictate to employees what actions they should take; instead employees ate enlpoy,ered to take those actions they believe will best produce the desired results. Results controls also encoutage emplol'ees to discover and develop their talents and to get placed into jobs in which they will be able to perform well. For all these reasons, a well-designed results control system should help produce the desired results.

There are many examples of dlamatic perfomance improvements following the introduction of anew results control system. In 1995. US West Communications Group implemented a pay-for-pelformance system that promised sales reps compensatlon increases of 20Vo or lnore if they met peformance goals. In the following three years, revenues per emplol,ee had increased by 4lVo,] This is consistent with a meta-analytic 25

Chapter 2. Besults Controls

review of 45 field and laboratory research studies on the use of incentives to motivate pelformance, which found that the overall avera-qe effect of all incentive prograrns in all work settings and on all work tasks was a22Vc gain in perfot'mance' Like all othel forms of controls, however, results controls cannot be used in every situation. They are effective only where the desiled result aleas can be contlolled (to a considerable extent) by the employee(s) whose actions are being influenced and where the controllable result areas can be measuled effectively.6

PREVALENCE OF RESULTS CONTROTS Results controls ale courmonly used for controlling the behaviors of employees at many organizational levels. They ale a necessary element in the employee entpov'ennett approach to rnanagement, which became a major mauagement trend startin-e in the 1990s.7 Results controls are particularly dominant as a means of controlling tlie behaviors of professional entployees; those rvith decisiort ctuthority, like managers. Reengineering guru Michael Hammer even defines a professional as "someone who is responsible for' achieving a result rather than [for] performin-e a task."o Results controls are consistent with, and even necessary for, the implementation of decentralized forms of organization with largely, autonomous entities ol responsibility centers (which we discuss in more detail in Chapter 7). Fol example. business pioneer' Alfied P. Sloan observed that he sought a way to exelcise effective control over the vvhole corporation yet maintain a philosophy of clecentralization.' At General Motors (and numerous other companies that followed), the solution under Sloan's leadership and beyond was tesnlts controls built on a retuln-on-investment (ROI) performance measure. By using this type of control systeln, corporate management could review and jud-ee the effectiveness of the various olganizational entities while leaving the actual execution of operations to people lesponsible tbr the perfbrmance of those entities; the

entlty managers. DuPont, Menill Lynch, Boeing, Coca-Cola, Alcoa, and Snnrise Medical are among the many cornpanies that have gone through the process of instituting rnore decentralized forms of organization with a concurrent increased emphasis on results control. In 1993, DuPont's CEO teplaced a complex management hierarchy by sptitting the compan)/ into 21 strategic business units (SBUs), each of which opel'ates as a free standing unit. The SBU managers wel'e given greater responsibilit;, und asked to be more entrepreneurial and more customer-focused. They u,ere aiso asked to bear more risk, because a lar-ee portion of SBU managers' compensation was based on SBU performance (sales and profrtability). The managers noticed the change. For exarnple. one SBU managel said, "When I joined DuPont [2 I 1'ears ago], if you kept )/our l-lose clean a1d worked hard, yott could work as long as you wanted. [But today] job security depends on resuits."'0 The change was perceived as being successful: A Brrslness Weck article noted that, "The ima-ee of DuPont has morphed fi'om giant sloth to gazelle."rl In 2003 and 2004. Merill Lynch placed a new emphasis on financial results. Thel, 6su.,1 billions of dollars of central adrninistrative costs into their business units' profit-and-loss statements, used perlormance talgets and metrics to inclease operatiltg discipline. and rcinforced the chan-qes with more transparent. more luclative perfomrancedependent bonuses. About this process, Ahrnass Fakahany, Merrill's CFO, said, "Once accoLrntability of the fully integrated P&L was in place, people started to make tradeoffs."

Managers started paying more attention to their technolo-ey bud-eet, and the business units were pushed towards more outsollrcing. Now, Mr, Fakahany continued, "A famill, 26

Prevalence of results controls

culture has been replaced by a perfonnance culture with operating discipline and a sense of nrgenc1,."rr Phil Conclit, Boeing's CEO, sirnilarly derided the family culture in his company, which was all "about seniority, not performance. In a family cultule, you never throw out a bad performer." Among the first changes he made after assuming the CEO offrce was to change Boeing's paternalistic culture into one focused on accountability for performance.'t Improvements were almost immediately apparent. Coca-Cola's plesident explained his company's inteut in decentralizing as follows: We're giving our division mana-qers alonnd the world a lot of authority, atrd we't'e holding them responsible. We're going to reu,ard thern for rneeting objectlves that thel' have agleed to. If the1, meer them, rhe1,'r's going to have rnoney jingiing in theil pocket; if they dou't, somebody else u,ill be given that opportunitl'." Paul H. O'Neill. Alcoa's chaiman. said: We cannot succeed if we persist in our use of the traditional command-and-contlol system of rnanagement where many thousands of people believe their only responsibility is to do what they are told to do.r5

And Richard H. Chandler', CEO of Sunrise Medical, a medical products company headquartered in Carlsbad, California, defended his company's decentralized olganization ancl lucrative performance-based bonuses as an effort to "replicate the entrepreneurial model" within a multifaceted corporation. He said, People want to be relvalded based on theil own effolts. [Without divisional accountability] you end up with a system like the US Post Office. There's no incentive [for wolkels to excel].'n

Indeed, many conlpanies have found that managers will act in the entrepleneurial nanner necessal'y to thlive in fast-moving markets only if they are subjected to the sarne market forces and pressures that drive independent entrepl'eneul's and if they are promised commensurate rewards for the risk they must bear, Thus, decentralization or the delegation of authority ol decision rights to managers, on the one hand, and the design of incentit'e s-l)'s/eir?s to ensule that these managers do not

misuse their discretion and are appropriately rewarded commensurate with the risk they bear, on the other hand, are two critical organizarional design choices in a resultscontrol context, Both decisions are part of what some olganizational theorists refer to as orgctnizcttional erc'hitectu'e. This litelatule maintains that both orgauizational choices ale linked and that concentt'ating on one element to the exclusion of the othel leads to poorly designed organizations; in other words, decisions about decentralization and iucentive systems should be made jorrrrly'. Fulther', this literature argues that a firm's choice of the organizational architecture is context-specific', depending ou factors such as the market structure, the or-eanization's strategy, the ploduction or sel'vice process, and the extent of information asynmetry, Factors identifled as supporting decentralization include mole

local information, constrained upper nanagement time, greater need for training of lower-level managers, feasible incentive costs, productiou or service processes that require little coordination across olganizafional units, and low levels of centralized information needed for local units to function.rT (We discuss the influence of contextual factors on MCS design in more detail in ChapteL 16.) At middle organizational levels, results controls ale often irnplernented under the framer.vork of a martctgentenf -b1'-objecrn,es (MBO) system. In its most basic fotm, MBO is: process u,heleby the superiol and subor:dinate mallagers of an organization jointly identify common goals, define each emplo1'ee's rnajor areas of responsibilities in terms of the results

A

21

Chapter

2

Results Controls

expected of thern. and use these rneasuLes as guides for operating the unit and contribution of each of its rnembels,rv

asse.ssin_g the

Results controls can also be emphasized down to the lowest ievels in the organization, as many companies have done with good effects. In a survey of mid-sized nanufacturers (with annual sales between $10 million and $500 million) sponsored by professional service firm Grant Thornton, 80% of the l'espondents repofied they were working on programs to give their workels mole power and responsibility on the shop floor'.re For example, it is common for delivery personnel to be paid on a commission basis. At the Frito-Lay division of Pepsi Coia, deliverymen receive only a small weekly salary but are paid a 107c commission on all the chips they sell. Studies have found that this system encourages them to serve the company's interest better: the drivers do not merely deliver the chips; they also "stop to talk with sttpermarket managers, an-eling for an extra

foot of shelf space."ro Porsche, the German automobile manufacturer'. and Cleveland-based Lincoln Electric Company are among the compar-ries that use results controls down to the lowest organizational levels in their manufacturing areas. Porsche, which is known for high-quality products, enters the name of the worker who installs each majol engine component in the engine's log so if a fault (a result) appears later, it can be ttaced back to the person responsible.rr Lincoln Electric provides wa-qes based solely on piecervork for most factory jobs and lucrative perfbrmance-based bonuses that can rnore than double an employee's pay.2r This incentive system has cleated such high procil-rctivity that some of the industry giants (Genelal Electlic, Westinghouse) found it difficult to compete in Lincoln's line of business (arc welding) and exited from the market.r3 A Business \Ueek article observed that "in its reclusive, iconoclastic way, Lincoln Electric remains one of the best-managed companies in the United States and is probably as good as anything across the Pacific."1 And even though Lincoln's legenclarl, Incentit,e Perf'orntanc'e S_),s/ent has essentialll, r.tnu n"O the same since it was installed in 1934, the company is still acclaimed for its systems and perfom-rance today, such as in a recent book titled The Modern Firm.'5 Frattchisirtg is another approach for implementin-e results controls. With franchising, business ownership, with all of its risks and lewards, is passed to a franchisee. So are the decision rights, although these are constl'ained by the franchise contract to ensure that franchisees do not deviate from the franchise concept. For example, McDonald's hambulger franchisees mnst offer Big Mucs, lvhich are an important element of the menu concept used around the u,orld. But the control advantage of franchising is that franchisers can spread the use of their concept and earn fees and royalties with minimum control risk because franchisees' r'ewards stem directly fiom the profits they earn. The rewards motivate the franchisees to be hardwolking, efficient, r'esponsive to ctlstomers, and entrepreneurial.

RESULTS CONTROTS AND THE CONTROL PROBLEMS Results controls are preventive-type controls that can address each of the majot cate-eories of control problems. Well-definecl results inform employees as to u'hat is expected of them and encourages them do what they can to produce the desired results. In this way, the results controls alleviate a potential lack of direction' probResults controls also are often particularly effective in addressing motivational contlols lesults tlle Iems. Even without upper-level manager supervision or intervention, 28

Elements of results controls

induce employees to behave so as to lrraximize their chances of ploducing the results the organization desires. This desirable motivational outcome occurs because the olganizarions' desired results are also. not coincidentally, those that will maximize the employees' own pelsonal rewards. And results controls also carr address pelsonal limitation problems. Because results controls usually promise high rervalds for good performels, use of results controls can help lirms attract and retain employees who are confident about their abilities.26 And lesults controls can encourage all employees to address their limitations and to develop their talents to position thenselves to earn the results-dependent rewards. The perfonr-rance ureasut'es that al'e a part of the results controls also provide some nonmotivational, detection-type control benefits of a c1'bernetic (feedback) nature, as was rlentioned in Chapter 1. The results measures help managers answer questions about how various strategies, organizational entities, and employees are perfotming. If performance fails to meet expectations, managers can consider chan-ees of the strategies, the managers, or the operational processes.=t Investigating and intervening only when pelfonnance is lagging is the essence of a ntanagenrcnt-b\,-esception approach to management, which is widell, u5e6.

ETEMENTS OF RESUTTS CONTROLS The implementation of results contfols requires four steps: (l) defining the dimension(s) on which resr,rlts are desired (or not desired), such as profitability, customer satisfaction, or product defects; (2) measuring perfolmance on these dimensions; (3) setting performance targets for employees to strive for; and (4) providing lewards to encourage the behaviors that will lead to the desiled results. Each of these steps has pitfalls.

Defining performance dimensions Defining the right performance dimensions is critical because the goals that are set and the measurements that are made shape employees' views of what is important. Or, in the terms of a '*,r,idely known business adage: "What )i ou measure is what you get." What is wonisome is that employees work to improve the areas that are measuLed regardless of v'ltefher or not tlte nteasrtrentent clintensions are cleJtned correctl\,.If the measurement dimensions are not defined conectll,; that is, if the1, al'e not congruent with the olganization's objectives or agreed-upon strategies, the results contlols will actually encourage employees to do the wrong things. We discuss this probleni further in Chapters 5, 10, and 1 1.

Measuring perfolmance Measurerneut, which involves the assignment of numbers to objects, is a critical element of a results control system. The object of importance is the perfbrmance of an employee (or a group of employees) in a specific time period. Many different results measures can be linked to rewards. Many objective financial measures, such as net inconre. eamings per shale, alld leturn on assets. are in common use. So are some nonfinancial measures, such as market share, growth (in units), customer satisfaction (as measured, for example, by repeat sales or a mailed survey), and the tirnely accomplishnent of certain tasks. Some measurements involve subjective judgments. Evaluators may be asked to judge whether a manager is "being a team 29

Chapter

2

BesLrlts Controls

player" or "developing employees effectivell," and to record their judgrnents on a crlrde, oldinal measurer.nent scale (e.-s. frorn I (unsatisfactory) to 3 (excellent)). The measures used tl,pically vary across or-eanizational levels. At hi,sher organizational levels, most of the key results linked to reu,ards are defined in financial terms. The measures ma)/ be either market-based pertonnance indicators (such as stock price or returns) ol accounting plofits or 1'eturns (such as return on equity). Lower-level rnanagers. ou the other hand, are typically evaluated in tenns of operational data that are lrtore controllable at the local level. The key result areas for a lnana-qer in charge of a tnanufacturir-s site, fol example. rnight be a combination of efficiency (such as labor hours per units produced), inventory contlol (such as days sales on hand), quality (such as avelage number of defects per unit produced). delively time (such as the percentage of orders shipped on time). and batch setup time. The lack of symrnetr'), in the nses of financial and opelational performance measures between top mana_qetnent anci iower-level management creates a critical pivotal point in the management hieralchy, which is sornetitnes called a hinge or linkin-e pin.tt At some critical middle organizational level, often a pl'ofit center levei. managers must tt'anslate financial goais iuto opelational _eoals. These managel's'goals are primarily defined in financial terms. so their communications rvith theil superiols are primarily in financial terms. But because their subordinates' -qoals are primarily opelational, their downward communications ale primalily in operational terms. If mana-qers identify mole than one resnlt lleasule fol a given entployee, they must attach lelative inportance wei_uhtings to each lneasure so that the judgments about perfolnlnance in each |esuit area can be a-eg|e-eated into an overall evaluation. The weightings can be additive. For example .60c/c of the overall evaluation is based on return on assets and 40c/c is based on saies growtll. The wei-ehtin-qs can also be multiplicative' For example, Browning-Fenis Industries multiplies a score on achievement of profit and levenue goals by a score assessecl based on enviLonrnental lesponsibility.r') If the environmental lesponsibility score is less than 107c,the multiplier is zelo, and so is the resulting bonns. Sornetirnes. organizations make the weightin-es of perfomance lneasures explicit to the emplo)/ees, as in the examples just presented. Often, however, the weightings are partially ol totally implicit. sr-rch as rvhen the perfonnance evaluations are doue subjectively. Leaving the weighting implicit blurs the commnnication to employees about rvhat results are important. Employees ale left to infer what results will most affect their over'all evaluations. We discuss the causes and effects of performance evaiuation explicitness (i.e. objectivefformulaic vs. subjective/discretionary) further in Chaptels 9 and 12.

Setting pedormance targets Pertbnnance targets, or standalds, are another important results control systern element. In a lesults contlol system, tal'_sets should be specified fot'every perforrnance dimension that is measured. Perfornance tar_sets aff'ect behavior in two basic ways. First, they stimulate action

(inrplove motivation) by providing conscious goals for employees to strive for. Most people pref'er to be given a specific target to shoot for', rather than merely being ,eiven vague statements like "do the best yon can" or "rvork at a reasonable pace."r0 Second, pelforrnance talgets allow employees to interplet theit'olrt perfbrmauce. People do not lespond to feedback unless they are able to intet'pret it, and a key palt of interpretation involves comparing actual performance lvith the predetetmined perfbrmatrce targets.'' The targets distinguish strong from poor perfot'mance. Failure to achieve the tar,qets 30

Elements of results controls

provides managels with a signal that they should probably chan-ee their actions. We discuss perfonnance targets and target setting processes in mole detail in Chapter 8.

Providing rewards Rewards or incentit,es are the final important elernent of a results control system. The rewards included in incentive contracts can be in the form of anything employees value, such as salary increases, bonuses, promotions, job security, job assignments, training opportunities. freedom. recognition, and power. Punishments are the opposite of rewards. Thel, 219 things employees dislike, such as demotions. supelvisor disapploval, failure to get lewatds eamed by peers or. at the extlelne, the threat of dismissal, Organizations can derive motivational value from linking any of these valued rewards

to results that employees can influence. For example, organizations can use any of

a

number of e-rtt'insic rev'qrcls. They can grant additional monetary rewards, such as in the form of cash or stock. They can use non-monetary rewards, such as by glarrting high performing employees public recognition and additional decision authority. Alternatively, in entities where perfomrance is mediocre or pool', they can threaten to reduce the decision authority and powel managers derive from rnanagirrg their entities by lefusing to fund ideas for expenditures. Results measures can provide a positive motivational impact even if no rewards are explicitly linked to results tneasures. People often derive theil orvn internally-generated ittrinsic rev,arcls through a sense of accomplishment for achievin-s the desired results. For example, when William J. Bratton became the New York City Police Cornmissioner in January 1994, he gave department pelsonnel one clear. simple goal: cut crime,sr

(Previously the thinking had been that crime was due to societal factors beyond the department's control, so the police were largely measured by how quickly they responded to emelgency calls.) He also implemented a results corrtrol system. He decentralized the department by giving the 76 precinct commanders the authority to make most of the key decisions in their police stations. including the light to set pe1'sonnel schedules, and he started collecting and leporting crime data daily. Even though Commissioner Bratton legally couid not award good performers with pay raises or merit bonuses, the system was tremendously successful. In 1994, majol felonies in New York fell by 12%, and in the first three quartel's of 1995, thel, fs11 another 18% below 1994 levels. This success clearly was not attributable to pay for performance in the strictest sense; it was instead due, at least in part, to providing officers with clear goals and empowering them to go about lighting crime. Seeing the r'esults of theil initiatives gave police officers a sense of accomplishment, and thus, an intrinsic motivation to perform well. The motivational strength of any of the extrinsic or intrinsic rewards can be under'stood in tenns of several motivation theories that have been developed, such as expectoncv theorl'. Expectancy theory postulates that individuals' motivational force, or effolt, is a function of (l) their expectattcies or their belief that certain outcomes will tesult frorn their behavior (e.g. a bonus for increased effort); and (2) their valence.s or the strengtlr of their pleference for those outcomes, The ralence of a bonus, however, is not always restricted to its monetary value, it also nray have yalettc'e in securing other valued items. such as status and prestige.'r Organizations should promise their ernployees the rewards that provide the most powerful motivational effects in the most cost effective way possible, But the motivational effects of the various rewatd forms can vary widely depending on individuals'personal tastes and circumstances. Some peopie are greatly interested in immediate cash awards, whereas others al'e more interested in increasin-e their retirement benefits, increasing their 31

Chaoter 2 . Besults Controls

autonolny, or improving their promotion possibilities. Rewald tastes also vary acl'oss countries for a number of reasons, including diffelences in cultr.rres and income tax laws. However, if organizations can tailor their reward packages to theil employees' individual preferences, they can provide meaningful tewalds in a cost efficient manner'. But tailoring rewards to individuais or small groups within a large olganization is not easy to accomplish. A tailoled system will likely be complex and costly to administer. But when poorly done, it can easily lead to employee perceptions of unfaimess and potentially have the opposite effects of those intended: demotivation and poor employee morale. In Chapter 9 we discuss issues related to choices of incentives in more detail.

CONDITIONS DETERMINING THE EFFECTIVENESS OF RESULTS CONTROTS Although they are an important form of control in many organizations, results controls cannot always be used effectively. They work best only when a// of the following conditions are present: 1. organizations can determine what results are desired in the areas bein-e contlolled;

2. the employees rvhose behaviors are being controlled have significant influence on the results for which they are being held accountable: and 3. organizations can measure the lesults effectively.

Knowledge of desired results For results contlols to work, organizations lnust know what results are desired in the aleas they wish to control, and they must communicate those desiles effectively to the employees working in those areas. Resrr/ts clesirabilin' means that more of the qLrality represented by the resuhs measure is preferred to less, evelything else being equal. At a general level, most people agree that the primary objective of for'-profit organizations is to maximize shareholder (or owner) value.! It does not follow, however, that because this overall objective is known, the desired lesults are then also known at all intermediate and lower levels in the organization. The disaggregation of overall organizational objectives into specific expectations for all employees lower in the hierarchy, is otien difficult. Different needs and tradeoffs may be present in different parts of the organization.

For example, purchasing lnanagers create value by plocuring good-quality, low-cost materials when needed. These three result areas (quality, cost, and schedule) can often be traded off against each other. and the overall organizational objective to maximize shareholder value does not provide much help in making these tradeoffs. The irnpot'tance of each of these result areas may vary over time and among parts of the organization depending on differing needs and strategies. For example, a company (or entity) short of cash ma1, want to minimize the amount of inventory on hand, which may make scheduling the dominant consideration. A company (or entity) with a cost leadership strategy may want to emphasize the cost considelations. And a company (or entity) with products with a quality image or differentiation strategy may emphasize meeting or exceeding the speciflcations of the materials being purchased. Thus, to ensure proper purchasing manager behaviols, the importance orderin-es ol weightings of these three resnlt areas must be made clear. If the wrong lesult areas are chosen, or if the right areas ale chosen but given the \\i rong importance weightings, the combination of results measures is not corrgrrrent with 32

Conditions deternrining effectiveness

:_lmization's true objectives.35 Using an incongl'uent set of results measures will ,.r r.notivate ernployees to take the wlong actlons.

llility

to influence desired results (controllabilityl

.r'iond condition that is necessar)i for lesults controls to be effective is that the :.iovees Lvhose behaviors are being controlled must be able to affect the lesults il a ,.:r'ial way in a given time period. This controllabiliS' pt'inciple is one of the centrai - :rs of responsibility accounting (u,hich we discuss in more detail in Chapters 7 and - Hele are some representative expressious of this perennial principle: It is alrnost a self-evident proposition that, in appraising the perforrnance of divisional :rqerneut, no account should be taken

\

manager

ilr olable

man-

of lnattel's outside the division's coutrol.t6

is not norrnally held accountable fol unfavorable outconres or cledited with if they, are cleally dLre to causes not under tris control.r?

ones

The main lationale behind the controllability principle is that results measures ale to the extent that they provide information about the desirability of the that were taken. If a results area is totaily uncontrollable, the results measures -:.-tions :eveal nothin-q about what actions were taken. Paltial controllability makes it difficult to rnt-er frorn the lesults measures whether ol not good actions \ /ere taken. In most organizational situations, of course, nurlerous uncontrollable or paltially Lrncontrollable factols affect the lreasures used to evaluate perfomance. These unconrlollable influences hinder efforts to use results measures for control purposes, If the eft-ects of the uncontlollable factors cannot be sorted out and eliminated, often all rhat car be measured is a broad band within which perforrnance probabll, Iies. rather tl.ran a precise lrreasure of performance. In this case, it becornes difficuit to detemine rvhether the results achieved are due to the actions taken or to uncontrollable factols. Good actions will not necessarily produce good results. Bad actions may siurilarly ...efr.rl only

be obscured.

In situations rvhere urany, large uncontrollable influences affect the availabie results lneasures, results control is not effective. Managers cannot be lelieved of their responsibility to respond to relevant environmental factors, but jf these factors are difficult to

separate from the results measures, results controls do not provide good infbrmation either for evaluating perfolmance or for motivating good behaviors. We discuss the methods or-eanizatior-rs use to cope with uncontrollable factors in lesults control systelns in rnore detail in Chapter' 12.

Ability to measure controllable results effectively

Ability to measule the controllable results effectivell, is the final constraint liuriting

the

feasibiiity of lesults contlols, Often the controllable results the or-ganization truly desires, and the employee involved can affect, cannot be measured effectively. Measurement itself is lareiy the problem; in virtually all situations sontethittg can be nreasuled as, by definition, measurement requires onl1, that numbers be assigned to events or objects. But sonretimes the key results areas cannot be measured e.ffectfteh'. The key cliterion that should be used to judge the effectiveness of results measures is the ability to evoke the desired behaviors. If a measure evokes the right behaviors in a -eiven situation, then it is a good control measure. If it does not, it is a bad one, even if the measure acculately reflects the quantity it purpolts to lepresent. To evoke the right behaviors, in addition to being con-sruent, results measures should be (1) plecise, 33

Chapter 2 . Results Controls

If any of these rneasurement qualities effective in evoking the desired behaviors. cannot be achieved. results control will not be (2) objective, (3) timely, and (4) understandable.

Precision

Measurernenl precision refers to the amount of t'andomness in the measure. For plecision to be high, the dispersion amon-q the values placed on a -9iven result by multiple independent measurements must be small. For example, if l0 independent measurements show that the quantity being measured is exactly 120.3, then the measure is precise. If one can conclude only that the quantity is between 100 and 130, the measure is less precise. Some aspects of perfonnance (such as social responsibility, pelsonnel developrnent) ale difficult, ol'even irlpossible, to measure precisely. Precision is an inportant quality because without it the measure loses rnuch of its information value. Imprecise measules inct'ease the risk of misevaluating performance. En'rployees wili react ne_eatively to the inequities that will inevitably arise when equally good pertormances al'e rated differently. 0biectivity Ob.lectit,itt,, which means fieedom frorn bias, is another desirable measurelrent quality. Measulement objectivity is low (i.e. the possibility of biases is high) where either the choice of measurement rules or the actual measuring is done by the persons whose pelfomances are being evaluated. Low objectivity is likely, for exampie, where performance is self-reported or where evaluatees are allowed considelable discletion in the choice of measnrement methods, such as is true to some extent with the measurement of accounting income. There are two main altematives to inclease measurement objectivity. The first altemative is to have the measuring done by people independent of the plocess. such as by pelsonnel in the controller's depaltment. The second alteurative is to have the measulements verified by independent palties, such as auditols. Timeliness

Tintelirtess refers to the lag between the employee's pelformance and the measulement of results (and the provision of reu'ards). Tirneliness is an important measurement quality for trvo reasons. The first is motivational. Employees need consistent, short-tern performance pressure to perfom at their best. The pressure helps ensule that the employees do not becorne complacent, sloppy, ol wasteful. Measures, and thus rewards, that are delayed for significant peliods of time lose most of their motivational impact. Shorl-telm pl'essure can also stimulate creativity by increasing the likelihood that employees will be stimulated to searcl.r for new and better ways of improving results. A second advantage is that timeliness increases the value of interventions that might be necessary. If significant problems exist but the perfomance measllres ale not timely, it might not be possible to intelvene to flx the ploblems before they cause seveLe harm. Understandability

Two aspects of unclerstanclabiliry,are important, Filst, the employees whose behaviors are being controlled must undelstand what they are being held accountable for. This requires communication. Training, which is a fonn of communication, may also be necessary if, for example, employees are to be held accountabie for achieving goals expressed in new and different terms, such as rvhen an organization shifts its measurement focus from accounting income to, say, economic value added. 3+

N

otes

S:cond, employees must uudelstand what they must do to influence the measul'e, at

: ,.t in bload terms. Fol exarnple, purchasing managel's who ale held accountable for '.erin-u the costs of pnrchased materials will not be successful until they develop strat-'--.:: fol accomplishing this goal, such as imploving neqotiatious r.r,ith vendols, incleas: competition anong vendors, or u,orking with en-eineerin_e personnel to ledesign -:':.titin pat'ts. Simiiat'ly, employees who ale held accountable for custorner satisfaction . i.t Lrnderstand rvhat theif cr-lstolneLs value and what the1, g2rl do to affect it. In tnost situations, understandability is not a limiting factor. When employees -.;1e rstand what a measure l'epresents. they rvill fi-9ure out what they can do to influence In fact, this is one of tl-re advantages of results controls: control can be achieved -eood ,ihout knorvin-q exactly horv employees will produce the results. \ltrn1, rlsurules cannot be classified as either cleally effective ol clealll, ineffective. lriierent tradeoffs arnong the evaluation criteria create some advantages and disadvant.:_:.\. Fol' example, measul'es can often be made lnore collgluent, contlollable. precise. - ,ul objective if tin-reliness is corrpromised. Thus, in assessing the efi'ectiveness of results I lilsures, many difficult jud-ements are often uecessary. These judgtnents are discussed . nrore detail throughout several chapters of this book.

CONCLUSION :ris chapter described an important torn of control, results control, which is used at :t,trtv levels in most olganizations, Results cor.rtlois al'e an indilect form of control :-citllse they do not focus explicitly on the employees'actions. However, this indilect-

:s\ provides some important advantages. Results controls can often be effective when . is t'tot clear what behaviols are most desirable. In addition, results coutrols can yield :.',od contLol u,hile allowing the emplol,ees whose behaviors are being contlolled hi-gh .,-rtollorl!, Manl,people, pafiicularly those highel in the or_qanizational hierarchy, value : .sh autonoml' and respond Lvell to it. Hi_eh antonomy often breeds innovation. Results controls are not effective in every situation, however. Failule to satisfy all -ree effectiveness conditions knowledge of the desiled results, ability,to affect the --.::iled leslrlts, and ability [o measure controllable results effectivell, - r,vill render.results ,'DIrtl'ols impotent. It will also probably, precipitate any of a number of dysfunctional side .'ltects, man1, sf which are discussed in later chapters. Results controls usually are the major element of the MCS used in all but the snallest rrganizations. However, r'esults controls often are supplemented by action and person:-.:l/cultural controls, which we discuss in the next chaptel.

Notes J. Fahey. "Lord of the Rigs." FolDes (March 29,2004),

Forttne (October 2, 2000).

5. S. J. Condll', R. E. Clark and H. D. Stolovitch, "The Effects of Incentives on Workplace Performance: A Meta-Analytic Revieu' of Research Studies,"

See. for example, S. L. Rynes, B. Gerhar-t and K. A. N4inette. "The Lnpoltance of Paf in Enrployee Motivalion: Disclepancies betu,een What People Sa1, ur.,,l

Perforntorrce Intprot'entattt Quarterl\'. 16. no. 3 (2003), pp. 46-63. For exarnples of en-rpirical resealch studies on the eft'ects of incentives on pelforntance. see R. D. Banker. S. Y. Lee. G. Potter and D. Srinivasan. "An

p. 68. "Measulin_s People Porver'."

p.

l

186.

What Thel, Do." Hunrutt Resourge tr4attctgeltert. 13. no. 4 (Winter 2004): pp. 381-94. C. Palmer.i, "A Gazelle. nor a Godzilla." Fot'bes (September 21. 1998), p. 64,

Empirical Analy,sis

of

Continuin-9 Improverlents

Follou,in-e tlie Implementation of a Perfolmance-Based Cornperrsation Plan." Joru nct I oJ' At'r'o un t i n,e, nncl Ecottotrtits. 30. no. 3 (December' 2000). pp. 315 50: and 35

Chapter 2 . Results Controls

R. D. Banker'. S. Y, Lee and G, Potter, "A Fielci Study ol the Impact of a Perlblmance-Based Incentive Plan,'' Jourtul of Accouttting ctttd Ecottotttics, 21, no. 3 (Aplil

6.

1996), pp. t95-226. As an exarnple of ser,eral lesults control issues that can arise rvlien these conditions al'e not rret. see S. Kerr.

"The Best-Laid Incentive Plans," Hnrlnrd

see.

tbr exanrple, K. H. Blanchald. J. P. Carlos and W. A. Randolplr. Tlrc 3 Kets to Errtltorrerntelrt (San Francisco, CA: Benett-Koehlel Publishels. 1999): B. Manville and J. Ober', "Beyond Ernpowelment: Building a Company of Citizens," Haryortl Brr.iirre.ss Reyielr,8l. no. I (Jarruary 2003), pp. 48-56; and D. E. Bou,en and E. E. Larvler'. "The Empowerment of Service Workels: What. Why. Horv. and When," Slotttr Monagentent Rerie\,, 33, no. 3 (Spring 1992), pp. 3 l-9. Fol a l'ecent enrpirical resealch study irl this alea. see S. E. Seibelt. S. R. Silvel and W. A. Randolph, "Taking Enrpowennent to the Next Level: A Multiple-Level Model of Emporverment, Pedbmance, ancl Satisfaction," A caclerny of Marr agentett Jourrnl,47, no 3 (June 2004), pp. 332-49. Fol a theoretical snrd1, on the f'easibility artd limitatious of ernpo'nvemrerrt and decentralization. see G. Baker. R Gibbons and K. J. N4urphy, "Blinging the Malket Inside the Firm," Alrelic'att Etottonric Ret'iev,9l. no. 2 (May 2001), pp.2l2-18. 8. M. Hanrrner. Beyottcl Rcertg,itteerittg Hov tlrc Prot'e ssCertterecl Orgutti:cttiou is Cltougirtg Our lVot'k arul Otrt ln'cs (Nerv Yolk: Harper Business, 1996). 9. A. P. Sloan, Ml Years v'itlt Getreral Motot's (Nerv York: Doubleday, 1964). 10. J. Weber', "For DuPont, Christmas in Aplil," Business

(April24,

1995).

p.

130.

11. Ibid.. p. 129. 12. "Radical Surgerl, Saved Melrill." F irruncial lirrres (July 2,2004), p. 8, 13. K. Labich, "Boeing Finally Hatches a Plan," Fortarc

(Malch 1, 1999), p.

102

14. Don Keough quoted in J. Huey. "New Top Executives Shake up Old Order at Soft-Drink Giant," The l4lall Street Jourtml(November 6, 1981), p. 17. 15. D. Milbank, "Changes at Alcoa Point Up Challenges and Benefits of Decentralized Authority," The \Uull Street Jourrrctl (November'7, 1991), p. B7. 16. R. H. Chandler', qr-roted in T. Petluno. "Sunlise Scam Thlorvs Light on Incentive Pa1, Proglams," Tlte Los

lrires (January

Angele,s

15, 1996), p. D3.

17. J. Brickley, C. Srnith and J. Zimmerman, Mtrnagerial Econontics ancl Ot'gotti:ntiortal Arcltite.'rrrl'e (Boston. MA: McGrarv-Hill Ilvin, 2001); D. A. Nadler, M. S. Gerstein and R. B. Sharv, Or'.gali--otion(tl Arcltitecture: Desigrts for Cltaugiug Ot'gcrtti:rttiotts (Nerv York: Jossey-Bass: 1992); and P. Milgrom and J. Roberts, Ec otton

t i

c

s,

O t' gct

t t

izct

ti

on

an

tl M

Cliffs, NJ: Prentice Hall, 1992). 36

a

r t ct

g

e

ing. 1965). pp. 55-6. See also H Levinson, "Managemerlt b)' Whose Objectives." Hotyarcl Busittes.s Retiey,. 81, no I (JanuaLy 2003), pp. 101-17. 19 "Employee Autonomy Results in Enhanced Profitability." Martufactming & Distribution Issttes,7 (Suntmer

Bustttess

Retietr, 81, no. I (Januar1, 2OO3), pp. 21-40 7. Fol references on the empowerment movement

Week

l8 G. Odiorne, Monagentartt-bt-Objectites: A St'stent ttf Matragenrertt Laaclcrship (Behnont, CA: Pitman Leam-

rnerrl (Englervood

1996). pp.3-4. 20 J. Guyon. "The Public Doesn't Get a Better Potato Chip rvittrout a Bit of Pain." The IUall Street Jotu'rrnl (March 25, 1983), 1.

p

21. "Autontaking on a Human Scale." 1982), pp. 89-93. 22

Foltrlia (April

5.

N. Fast and N. Belg, "The Lincoln Electrrc Conrparry," Case no. 9-376-028 (Bosron. MA: HBS Case Services. 1975); and M Mrowca, "Ohio Firm Relies on Incentive-Pay System to Motivate Workers See

and Maintain Products," Tlte lI/oll Street.Iournal (August 12, 1983). p.23. 23

"Lincoln Electric: Whele People Are Never Let Go," i"irrre (June I8. 2001), p. 40.

24. "This Is the Answer." Brrsrness l4!eek, Jll1, 5,

1982,

pp. 50-2. 25. J. Roberts. Tlte Moclertt Finn. Organi:ational Desigrt fot Pe(brntartce arrcl Grottlt (New York. Oxforcl Universit), Press, 2004). 26. A. Arya and B. Mittendorf, "Offering Stock Options to Gauge Nlana_sel'ial Talent," Journol oJ Accourttittg cutcl Ecouornit s, 40, no. 1-3 (Decernber 2005), pp. 189210. 27. D, Campbell, S. Datar, S. L. Kulp and V. G. Narayanan, "The Strategic Infonnation Content of Non-Financial Perfolrnance IVIeasules." Wot king Paper (Harvard Business School. 2006). 28. K. J. Euske. M. J.. Lebas and C. J. McNair', "Pelfolmarrce Measurement in an International Setting," &,[arragenrctlt Accourttittg Researclr, 4 (1993) pp. 275 -99. 29. Institute of Managelrent Accountants. Implententing Corporote Ertirorttrrcntal Strategies, Statement of Management Accounting no. 4W (Montvale. NJ: Institute of Managemenr Accountanrs, July 31. 1995). 30. E. A. Locke and G. P. Lathan, A Theorr of Goal Setting ancl Task Pet'forntartce (Englervood Cliffs. NJ: Prentice Hall. 1990): G. P. Latham, "The Motivational Benefits of Goal-Setting," Acatlenty of Managenrcnrt Erecutire, 18, no.4 (Novernber 2004). pp. 126-9 andE. A. Locke and G. P. Latham, "Building a Placticalll, Useful Theory of Goal Setting and Task Motivation: A 35-year Odyssey," Antericctrt Psl,t'ltologisr, 57 (2002), pp. 705-

t7.

31. K. A. Merchant. Returdittg Results Motit'ating Profit Center Matwgels (Boston. MA: Harvard Busuress School Press, 1989).

32. E. Lesly,

"A

Sat'er

New York Cit),," 6,,rt,,"rs Week

(Decembel I l. 1995). p. 81. 33. V. H. Vloonr, l'l/ork and Motilnliorr (New York: Wiley. 1964).

ACTION, PERSONNEL, AND CULTURAL CO

NTROLS

p

esults controls are not the only form of controls. Organizations can suppletnent or t'esults controls with other forms of controls that serve the same purposes; that is, to make it more likely that employees will act in the organization's best interest.

I\replace

One such important category of controls, actiotr cotttrols, involves ensuring that employees petform (do not perform) certain actions known to be beneficial (harmful) to the organizalion. Although action controls are commonly used in organizations, they are not effective in every situation. They are feasible onl1, y,1l.n managers knou, what actions are (un)desirable and have the ability to ensure that the (un)desirable actions (do not) occur. Another control category, personnel controls, are designed to make it mole iikely that employees will perform the desired tasks satisfactorlly on their ov,rt because, for example, the employees are experienced, honest, and hard working. A flnal category of contr.ols is called cLtltLu'al controls. Cultural contlols exist to shape organizational behavioral nolms and to encourage employees to monitor and influence each other''s behaviors, Action, personnel, and cultural controls are a part of virtually every MCS. In sorne organizations, they at'e so important they can be said to be the dominant fon11 of control.

ACTION CONTROLS Action controls are the most direct form of management control because they involve taking steps to ensule that employees act in the organization's best interest by making their actions themselves the focus of control. Action controls take any of four basic forms: behavioral constraints, preaction leviews, action accountability. and redundancy.

Behavioral constra ints Behavioral constraints are a negative form of action control, They make it impossible, or at least nore difficult, for employees to do things that should not be done. The constraints can be applied physically or adminisrrarively. Most companies use multiple forms of p/r,r,sical constrcurzts, including locks on clesks. computer passu'ords, and limits on access to areas lvhere valuable inventories and sensitive information are kept. Some behavioral constraint devices are technically sophisticated and often expensive, such as magnetic identiflcation card readels ancl fingerprilt or eyeball pattern readers. In situations u,here a high degree of control is desired, such 76

Action controls

as in facilities where radioactive materials al'e processed, secret service agencies whele classified information is gathered, or casino count l'ooms whele cash is handled, the

benefits of such sophisticated contt'ols may outweigh their costs. Aclntirtistratit,e constroints can also be used to place limits on an ernplol,ee's abilities to perform all or a portion of specific acts. One common form of administtative control involves the restriction of clecision-making authority. Managers at a low organizational level may be aliowed to approve expenditures of up to $ 1,000; those at a higher level up to $5,000, and so on. Above those limits, the pulchasing department is instructed not to place the order. The senior managers who restrict the decision-making authority in this way al'e trying to minimize the risk that untrained or uninformed employees will make

major mistakes. Another common form of administrative control is generaily referred to as separation o.f cluties. This involves dividing up the tasks necessaly for the accomplishment of certain sensitive duties, thus making it impossible, or at least difflcult, fot one pelSon to complete certain tasks alone. Separation of duties comes in rnany forms. One common example involves n-raking sure the employee who makes the payment entries in the accounts receivable ledger is not the employee who receives the checks. If an employee who is diverting company checks to a personal account only has the payment-entry duties; that is, opening the mail and listing, endorsing, and totaling incoming checks, custonrers rvill eventually complain about being dunned for amounts they had already paid. But a person with both check-receiving and payment-entry duties could divert the checks and cover the action by making fictitious entries of returns of goods or, perhaps, price adjustments. Separation of duties is described by auditors as one of the basic requirenrents of what they call good internol control . The effectiveness of separation of duties is limited, however, in that it does not plevent negative actions produced by collusiott between two or more employees, such as those with the check-receiving and payment-entry duties. Although collusion requires devious employees to reveal their bad iutentions to other employees whom they seek to engage in the scheme, 63Vo of the respondents in the KPMG 2003 Froucl Srn,e-v indicated that fraud in their organizations took place in this way, either by collusion between employees and third parties (489a) or by collusion among employees or management themselves (157o).1 Sometimes physical and administrative constraints can be combined into what has been labeled as poka-.tokes that ale designed to make a process ol system/oolproof.l A poka-yoke is a step built into a process to prevent deviation from the correct order of steps; that is, where a certain action must be completed before the next step can be performed. A simple mechanical poka-yoke example is the inclusion of a switch in the door of a rlicrowave oven so that the oven cannot be operated with the door open.

Similar mistake-preventing poka-yokes can also be built into sorne production and administrative processes. For example, some airlines have recently switched to laptops in the cockpit to repiace manual preflight calculations that were elror-prone. The software is idiot-proof as it does not slip up on the math and flashes a waming if a seriously wrong number is entered, such as a 10-ton mistake in the weight of the plane or fuel load.3 Similarly, it mi,eht be possible to have a signature-verifying computer generate the paperwork necessary for making a cash distribution only after all the approvals for that distribution have been secured.

It is often difficult to make behavioral constraints foolproof, especially when the organization is dealing with disloyal, deceitful employees. For example, despite teasonable safeguards, a fonner secretary at Bear Stearns, a global investuent firm, used disappear-ine ink to write checks that her boss requested. After the manager signed the checks, she 77

Chapter

3 Action,

Personnel, and Cultural Controls

wouid elase the name of the payee and rewrite the checks for cash. In hel eight rnonths

with the firm. she made more than $800.000 vanish from her boss's bank accounts.t Preaction reviews Preqctiort reyiews involve the scrutiny of the action plans of the employees bein,q controlled. Reviewers can approve or disapprove the proposed actions, ask for modifications, or ask for a more carefirlly considered plan before granting final approval. A common form of preaction leview takes place during planning and budgeting plocesses characterized by multiple levels of reviews of planned actions and budgets at consecutively higher organizational levels. We discuss the plannin,e and budgeting process in more detail in Chapter 8. Action accountability Actiott accoruttctbilin'involves holding emplol,ees accountable for the actions they take. The implementation of action accountability controls requiles; (1) defining what actions ale acceptable or nnacceptable, (2) communicating those definitions to employees, (3) observing 01' othelwise tlacking what happens, and (4) rewardin-e good actions or punishing actions that deviate from the acceptable. The actions for which employees are to be heid accountable can be communicated either administlatively or socially. Aclnirtistrcttile modes of communication include the use of work rules, policies and procedures, contract plovisions. and company codes of conduct, It is common in chains of fast-food franchises, such as McDonald's, to prescribe and communicate in writing, and clalify and reinforce through trailin-q, how virtually evelything should be done, including how to handle cash, how to hire personnel, where to buy supplies, and what temperature to keep the oil while cooking fries.' Similarly, nurses use preoperatit'e checklisrs to help ensure that they prepare patients thoroughly fbr surgery. These checklists remincl them to check on the patient's allergies, ciru-q-takin-s history, and time of last meal. Department store personnel also colnrnonly have sets of procedures they are expected to tbllow. At a lar-ue retailer', store managers are rebuked if empty merchandise cartons are not broken do'*,n before they are sent to the trash loom because ernployees could use the cartons to steal merchandise.6 The desired actions do not have to be communicated in written form, however. They can be communicated face-to-face in rneetings or in private. Fol example, Andrew Grove, Intel's fonner chief executive officer' (CEO), reco-enized that to keep "his genelals and troops malching in the same direction requires constant cajoling and quarreling up and down the ranks."l Sometimes the actions desired afe not comrnunicated explicitly at all. In many operational audits, post audits of capital investment decisions, and peer leviews of auditors, lawyers, doctoLs, and managers, irdividuals are heid accountable for their actions that involve pt'oJessiortctl juclgntent. The desilability of the actions of professionals generally cannot be clearly delineated in advance. Nonetheless, these individuals are held accountable for their actions under the premise that they should act professionally. Although action accountability controls are most ef'fective if the desired actions are well communicated, cornmunication is not sufficient by itself to make these controls effective. The affected individuals must understand rvhat is lequired and feel reasonably sure that their actions will be noticed and rewarded or punished in some significaut way. Actions can be tracked in several ways, Employee actions can be obsen,ed directiy and neariy continuously as is done by direct supervisols on ptoduction lines. They can 78

Action controls and the control problems

be tracked periodically, such as retail stoles do when they use nD'ster-y shoppers to critique the service provided by store clerks.s They can also be tracked by examining evidence of actions taken, such as activity reports or expense documentation. Auditors, particularly internal auditols. spend much of their time examining evidence about compliance with preestablished action standards. Action accountability is usually implemented with negative reinforcements. That is, the actions defined are more often linked with punishments than with rewards. Steelmaker Nucol links se'r,eral contract eleurents to actions as palt of the production wolkforce's incentive compensation agreement. Anyone late for a shift loses a day's bonus, and anyone rvho misses a shift loses the bonus for the week.e At Home Depot, managers are required to use an in-house personnel-screening system when hiring new emplo;,sss. But recently five managers failed to use the system, and they u'ere fired.Io

Redundancy Reclundartcy, which involves assigning more employees (or machines) to a task than is strictly necessary, or at least having backup employees (or machines) available, also can be considered an action control because it increases the probability that a task will be satisfactorily accomplished. Redundancy is common in computer facilities, seculity functions, and other critical operations. However', it is larely used in other areas because it is expensive. Fulther, assigning more than one employee to the same task usually lesults in conflict, fi'ustration, and/ol boredom.

ACTION CONTROTS AND THE CONTROL PROBTEMS Action controls work because, like the other types of controls, they address one or more of the thlee basic control problems. Table 3.1 shows the types of problems addressed by each of the action controls. Behavioral constraints are primarily effective in eliminating motivational problems. Employees who might be tempted to engage in undesirable behaviors can be prevented from doing so. Preaction reviews can address all three of the control problems. Because they often involve communications to the employees about what is desired, they can help alleviate a lack of direction. They can also provide motivation, as the threat of an impending review of an employee's actions usually prompts extra care in the preparation of an

Tnarr 3.1 Control problems addressed by each of the action control types Control problem Type of action control Behavioral constraints Preaction reviews Action accountability Elar{r rndennrr Sourcq K.

A

Lack of direction

Motivational oroblems

Personal limitations

X X

X

X

X

X

X

lvlerchant, Modern Managemenl Contral Syslems: Texl and Cases (Upper Saddle Fliver, NJ: Prenlice Hall. 1 998),

p

30

7A

Chapter

3 Action,

Personnel, and Cultural Controls

expenditure ploposal, a budget, or an action plan. Preaction reviews also mitigate the potentially costly effects of the personal limitations. since a good reviewel can add expertise if it is needed. The revieu,s can prevent mistakes or other harmful actions from happening.

Action accountability controls can also address all of the control problems. The prescriptions ofdesired actions can help provide direction and alleviate the types ofpersonal limitations due to inadequate skills or experience. And the rewards or punishments help provide motivation. Redundancy is relativeiy Iimited in its application. It is primarily effective in helping to accomplish a particular task if there is some doubt as to whether the employee assigned to the task is either motivated to perform the task satisfactorily or capable of doing so.

PREVENTION VERSUS DETECTION Action controls can also be usefully classified according to whether they serve

ro pre\tetlt

or to detect undesirable behaviors. This distinction is important because controls that prevent the undesired enors and irreguladties flom occurrin,q are, when they are effective, the most powerful form of control because rtone of the costs of the undesirable behaviors will be incuued. Detection-type action controls diffel frorn prevention-type controls in that they are applied after the occurrence of the behavior. Still, they can be effective if the detection is made in a timely manner and if the detection results in a cessation of the

behavior and a comection of the effects of the harmful actions. Also, the promise of prompt detection of harmful actions is itself preventative; it discourages individuals from purposefully engaging in such behaviols. Most action controls are aimed at preventing undesirable behaviors. The exception is action-accountability controls. Although action-accountability controls are designed to motivate employees to behave appropriately, it cannot be verified whether the appropriate actions were taken until evidence of the actions is gathered. Hou,ever', if the evidence gathering is concurrent with the activity, as it is with direct supervision, then action accountabilitl, control can approach the desired state of prevention of undesired actions. Table 3.2 shows examples of common forms of action controls classified according to rvhether their purpose is to prevent or detect problems.

Tner 3.2 Examples of action controls classified by purpose Control purpose Type of action control

Prevention

Detection

Behavioral constraints

Locks on valuable assets Separalion oJ duties

N/A

Preaction reviews

Expenditure approvals Budget reviews

N/A

Action accountability

Prespecified policies linked to expectations of rewards and punishments

Compliance-oriented internal audits Cash reconciliations Peer reviews

Redundancy

Assigning multiple people to an important task

N/A

Source:K A l,4erchant, Modern Managemenl Conlrcl Syslems: Text and Cases (Opper Saddle River, NJ: Prentice Hall, 1998), p,

80

31

Conditions d eterminino

CONDITIONS DETERMINING THE EFFECTIVENESS ACTION CONTROLS

eff

e

ctiveness

OF

Action controls cannot be used effectively in every situation. They are effective only when both of the following conditions exist, at least to some extent: 1. organizations can determine what actions are (un)desirable; and 2. organizations are able to ensure that the (un)desirable actions (do not) occur.

Knowledge of desired actions Lack of knowledge

as to what actions are desirable is the constraint that most limits the use of action controls. This knowledge is often difficuit to obtain. Although it may be easy

to define relatively completely the actions required of employees on a production line, the deflnitions of preferred actions in highly complex and uncertain task environrnents, such as those of salespeople, research engineers, or top-level managers, cannot be as complete or precise. Most organizations do not have a good idea as to how employees in these roles should best spend their time.

Knowiedge of the desired actions can be discovered or leamed in either of trvo basic ways. One is by analyzing the actions/results pattems in a specific situation or similar situations over time to leam what actions produce the best results. For example, (mortgage)

loan approval decisions aLe now highly structured. Over tirne, lenders obser"ve which bonowels are likely to fail their loan payments. In so doing, they can develop a loan approval protocol, delegate the decision to lower-level employees, and control employee behaviors by monitoring their adherence to the desired decision protocol. Another way organizafions can leam which actions are desirable is to be informed by others, especially for strategic decisions. Indeed, this is a major role played by consultants who have detailed knowledge of best practices. It is important that the actions for which employees are to be held accountable be, in fact, the actions that will lead to the highest probability of accomplishment of one or more of the or-eanization's goals, or at least the proper implementation of the strategy that

is being followed. As with results controls, many organizations have actually found themselves holding employees accountable for taking the v,rong actions. We discuss this problem in detail in Chapter 5.

Ability to ensure that desired actions are taken Knowing what actions are desilable is not enough to ensure good control; organizations must have some ability to ensure or obsen,e that the desired actions are taken. This ability varies widely among the different action controls. The effectiveness of the beltat,iot'al constraints and preaction ret,ievts 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) taken. In many cases, these devices and procedures are not effective. For example, a rogue currency trader at Allfirst Financial, who had lost about $700 million in foreign exchange trading, was said to have "targeted every control point in the system and systematically found a way atound them," When called aside by managers for going over his trading limits, the trader complained that the computerized risk-monitorin-e system he used to check his risk exposure duling the day was too cumbersome. He got away with it.rL ro cover up his losses, the trader allegedly started selling bogus option contracts. This practice was not detected in 81

Chapter

3 Action,

Personnel, and Cultural Controls

a timely manner either, in part, because the responsibility fol the monitoring and reporting of the trader's foreign-exchan-ee risks was,eiven to a junior', relatively inexperienced, staff mernber,rr At Lelrman Brothers. a star stockbroker rnana,ged to keep a pelsonal computer on his office desk, despite rules prohibiting this practice, and allegedly despite the fact that some senior executives were awal'e of it. The blokel used his personal computer, rather than a Lehrnan office computer, to create fake account statements rvith inflated stock prices. He then divelted the leal account statements to post-office boxes that he controlled, rather than to his clients who instead leceived the phony statements he generated. Clients say the brokel forged their autholizations to send their statements to the postoffice boxes. What's more, the broker supervised the compliartce staff whose job it was to help police the office brokers. Over a l5-year period. this bloker stole $125 n-rillion flom his unsuspecting customers.'l Exarnples such as these are consistent rvith the findin-ss of the KPMG 2003 Frqucl Srrl'r'e-r'. In this survey,39Vc of the respondents stated that the frauds in their or'-ganizations occuned because of poor itrternal cottil'ols, many of which fall into our categor)/ of behat,ioral cottstraints, and 3lVo because of ntattagentettt ot'erride of internal controls.r+ Action tracking often provides a significant challenge that must be faced in making ac'tiott ctc'coutttctbilin' controls effective. Even where employees' actions cannot be observed directly, usually some actions can be tracked. But this tlacking is not always effective. The cliteria that should be used to jud-ee '"vhethel the action tlacking is eff-ective at'e plecision, objectivity, tirneliness. and understandabiliti, (as we also discLrssed in Chapter 2 in a results control context). If any of these measurernent qualities cannot be achieved, action accountabiliti' control rvill not be effective in evoking the desired

behaviors.

Precision refers to the amount of enor in the indicatols used to tell what actions have If action trackin-e involves direct supervision, can the snpelvisors accurately distinguish good fi'om bad actions? 11' action tracking involves exanrination of transaction records. do those records reliably tell whethel the ploper actions u,ere taken? For example. an initiative aimed at tlacking rvhether salespeople spend enough time on market development activities, as opposed to direct sales activities, is doomed to fail until precise definitions can be developed as to rvhich actions tall into each of these taken place.

two

areas.

Auother precision failure of an action control is the US Foreign Corrupt Practices Act. This act was intendecl to rnake bribes to foreign officials ille-eal, but it allowed.facilitatitrg ltatntettts to Iower'-level officials. The distinction betrveen bribes and facilitating pelntetlts was not made clear, however. The va-sueness of this law has caused rnuch concern among corporate officials who cannot be snre that their real-time interpretations of the act would match those rlade by independent observers (such as a jury) at a latel date.r-' Precision problems also limit the effectiveness of many organizations' codes

of conduct. Olt.jectit,itt'. or freedorn from bias, is a concern because repol'ts of actions plepaled by those whose actions are being controlled camot necessarily be relied upon. Project- and sales-orier.rted pelsonnel are tiequently asked to prepare self-r'eports of horv they spend their tine. Lr most cases. these l'epol'ts ale precise, as the allocatious ma1, be in units of time as small as by the miuute. But the reports are not obiective. If the pelsonnel involved want to obscnre the true time patterns, perhaps to co\i er a bad perfomnance or to allow some personal time, it is relativell, eas1, fbr them to report that most of theil time was spent on productive activities. Most companies use direct supervisors and internal auditors to provide objectivity checks on such reports. Without objectivity, management 82

Personnel controls

cannot be sure whethel the action l'eports reflect the actual actions taken, and the reports lose their value fol control pulposes. Timeliness in tracking actions is important. If the trackin-e is not timely, interventions are not possible before harm is done. Further, much of the motivational effect of the feedback and rewards is lost when the tlacking is significantly delal'ed, Finally, it is important that the actions for q,hich individuals are to be held accountable be uttderstatdable. Employees can easily understald prescriptions to "show up to work on time" or "don't steal." But undet'standability does become a problem where the action is defined in aggregate tetms and the individuals involved do not understancl everything irnplied b), the aggregate prescriptions. For exarnple, auditors who are held accoultable for "testing an accounts receivable balance" may not understand that their tests will be ;udged based on the satisfactory accomplishment of a series of generally accepted steps, including inspections of documentation, confirmations, computations, reconciliations of general-ledger balances, and clelical checks. If the employees do not understand the detailed procedures, the overall behavioral effect rvill be unsatisfactory even though the a-qgregate action is defined con-ectly and the tracking of whether or not the steps have been performed adequately can be done precisely. objectively, and on a rimely basis. Implementing action controls where one of these action-tracking qualities cannot be achieved will lead to some undesirable effects. These, too, are discussed in Chapter 5. Like results control systems. action control systems usually cannot be made nearpetfect, or at least they are prohibitively expensive to make near-perfect. As a consequence, organizations use personnel and cultural controls to help fill in some gaps. These controls motivate employees to control their own behaviors (by means of personnel c'ontrols) or to conh'ol each other's behaviors (by means of cultural controls).t6

PERSONNEL CONTROTS Personnel controls build on ernployees' natural tendencies to control and/or motivate themselves. Pet'sonnel controls serve any of three basic purposes. First, some of them clarify expectations. They help ensure that each employee understands what the organization wants. Second, some of them help ensure that each employee is able to do a good job; that they have all the capabilities (e.g. experience, intelligence) and resources (e.g' information and time) needed to do a job. And third, some of the personnel -eood controls increase the likelihood that each employee will engage in self-monitoring. Self-ntoniton ng is the naturally present force that pushes most employees to want to do a good job, to be naturally committed to the organization's goals. Self-monitoring is effective both because most people have a conscience that leads them to do what is right and are able to derive positive feelings of self-respect and self-satisfaction when they do a good job and see their olganization succeed. The phenomena under.lying selfmonitoring have been discussed in the management literature under a variety of labels, including self-control, intrinsic ntotit'ation, ethics ancl ntoraliA,, tntst, and loyalrt,.

Some organizations rely heavily on personnel controls. For example, John McConnell, chairman of columbus, ohio-based worthington Industries, a superior peformel in the steel processing industry, said, "You have to trust the wolkforce. If you don't, you've done a bad job."r7 Trust is a substitute for other, more fomal forms of control. worthington Industries does not have time clocks or plant supervlsors. Three major methods of implementing personnel controls are through (1) selection and placement of employees, (2) training, and (3) job design and provision of necessary resources. 83

Chapter 3 .Action, Personnel, and Cultural Controls

Selection and Placement

Finding the right people to do a particular job and giving them both a good work envlronment and the necessary resources can obviously increase the probability that a job will be done properly. Organizations devote considerable time and effort to employee selection and placement, and a large literature describes how these tasks should best be accomplished. Much of this literature describes possible predictors of success, such as education, experience, past successes, and personality and social skills.rR

Employee selection often involves refelence checks on new employees,le which many organizations haye stepped up in response to the heightened wonies over workplace security.rO But beyond screening new employees to mitigate security issues, organizations primarily focus on matching job requirements with job applicants' skills. For example, Horne Depot has an in-house computer system that contains the names of prescreened candidates who have the right skills and experience. This allows managers to find qualified candidates quickly when the need arises. But the automated system also provides cues about what interview questions to ask, what answers to listen for, and even what advice to give the interviewees.rr More exotic employee-seiection techniques have also been developed and used. Some organizations have lesofted to analyzing potential employees' handwriting or using polygraph tests ro rry to weed out high-risk individuals. Dell Computer, General Electric, Motorola, and other companies require job candidates to undergo lengthy interviews with outside human resource service providers, or to take paper-and-pencil tests, or both. While these evaluations are expensive, their cost is far less than the costs associated with hiring someone who is a "poor fit" with the company.rr

Training Training is another common way to help ensure that employees do a good job. Training can provide useful information about what actions or results are expected and how the assigned tasks can best be pelformed. It can also have positive motivational effects because employees can be given a greater sense of professionalism, and they are often more interested in performing well in jobs they understand better. Many organizations use formal training programs. such as in classroom settings, to improve the skills of their personnel. The Los Angeles Unified School District warlted to decentralize and give school principals more decision-making authority. District managers concluded, however, that the principals would not know how to use their increased authority. They decided to put the principals through a formal mini-MBA program to teach them how to improve the educational process and manage school costs. The principals attended classes over an 18-month period and several follow-up workshops. The program was judged -so successful that it was expanded to the San Francisco Bay area and the East Coast." Much training takes place infotmally, such as through employee mentoring. Jerry Reinsdorf, a successful entrepreneur and owner/chairman of the Chicago White Sox basebail club, noted the importance of his role as a mentor: My management style is to hire good people and develop a relationship with them sothat95Va of the time they'll knor,v what decision I'd make and go ahead without askiug me.2l

His control system could be described as being dominated by selection training. 84

and

Cultural controls

Job design and provision of necessary resources Another way to help ernployees act appropriately is siniply to make sure that the job is desi-ened to allow motivated and qualified employees a high probability of success. Some olganizations do not give all their employees a chance to succeed. Some jobs are too complex. Salespeople may be assigned too many accounts to handle effectively. Ernployees also need a particular set of resources available to them in order to do a good job. Resource needs are highly job-specific, but they can include such iterns as information, equipment, supplies, staff suppolt, decision aids, or freedom from intenuption. In larger or-eanizations, pafiicularly, there is a strong need for tlansfer of information among organizational entities so that the coordination of lvell-timed, efficient actions and decisions is maintained.

CULTURAL CONTROTS Culttrral cotttt'ols are designed to encourage mutual monitoring; a powerful form of group pressure on individuals who deviate from gloup norms and values. Cultulal contlols are most effective where rnembers of a group have emotional ties to one another. Iu some collectivist cultules, such as Japan, incentives to avoid anything that would disglace oneself and one's famill' are paramount. Similarly, in many communities, such as the Hasidic Jewish community in New Yolk City, and in many countries, notably those in Southeast Asia, many business deals are sealed by verbal agl'eement only. The communities' social and moral pressures are stronger than legal contracts. But strong cultural controls produced by mutual-monitoring processes also exist within single organizations. Cultures are built on shared traditions, norms, beliefs, values, ideologies, attitudes, and u,ays of behaving.25 Olganizational cultrlres remain relatively fixed over time, even while goals and stlategies necessarily adapt to changing business conditions.26 The cultural nonns are embodied in written and unwritten rules that govenr employees' behaviors. To understand an organizalion's culture, ask long-time employees questions like: What are you proud of around here? What does it take to get ahead? How do you stay out of trouble? If a strong organizational culture exists, the vast majority of long-time employees will have consistent answers to these questions even when the answers are not written down. When that is the case. strong, functional organizational cultures pronpt employees to wolk together in a synergistic fashion. Managers attempt to create and shape organizational cultures in many ways, both in words and by example. Codes of conduct and group rewards are among the most important methods of shaping culture, and thus effecting cultural controls. Other approaches include intraorganizational tlansfers, physical and social anangements, and tone at the top. Godes ol conduct

Most organizations above minimal size attempt to shape their organizational culture through what are knorvn, variously, as codes of conduct, codes of ethics, organizational credos, or statements of mission, vision, or management philosophy.rT These formal, written documents provide broad, general statements of organizational values, commitments to stakeholders, and the ways in which management would like the organization to function. Each of these codes or statements is designed to help employees understand what behaviol's are expected even in the absence of a specific rule or principle. These statements may include important messages about dedication to quality or customer 85

Chapter 3 . Action, Personnel, and Cultural Controls

satisfaction, fair treatment of staff and suppliers, employee safety, innovation, risk taking, adherence to ethical principies, open communications, and willingness to change. For maximum effect. the messages included in these statements should be reinforced throu_eh formal training sessions, or at least through some discussions among employees

and their superiors. The vadous codes and statements differ considerably in form. As an example, Figure 3.1 shows the code of conduct nsed at Provident Mutual, which includes a general policy and guidance on specific issues. Provident's general policy statement is aimed at influencing the organization's culture. But the code _qoes on to provide behavioral guidance on specific issues. The detailed behavioral prescriptions provide action accountabrlity control because emplolrgs5 who violate these prescriptions will be reprimanded. One survey of 264 companies (707c from the US, and the rest from Europe, Canada, and Mexico) found that 84Vo of the US respondents and 58Vo of the non-US respondents have a code of conduct.rS The codes are drafted, most commonly, by top management, the corporate iegal department and, to a lesser extent, the board of directors. This survey showed that where codes exist, the vast majority of them define "fundamental guidin-q

plinciples of the company." The only specific issties cited by 507o or mole of the

Frcunr

3.1 Code of Conduct of the Provident Mutual 0rganization

General Policy The Provident Mutual organization is committed to achieving high standards of business and personal ethics for itself and its personnel, Through performance in accordance with these standards, the Organization and all its employees will merit and enjoy the respect of the public, the business community, policyholders, customers, and regulatory authorities It is the personal responsibility of all employees to acquaint themselves with the legal and policy standards and restrictions applicable to their assigned duties and responsibilities, and to conduct themselves accordingly. Over and above the strictly legal aspects involved, all company personnel are expected to observe high standards of business and personal ethics in the discharge of their assigned responsibilities,

Employee Conduct Each member of the Organization must avoid any action, relationship or situation which could jeopardize or impair the confidence or respect in which the Organization is held by its customers and the general public, or which appears to be contrary to the interests of Provident Mutual or its policyholders. Employees shall comply fully with all applicable statutes and regulations. Willful and knowing disregard ot the law may result in severe penalties to the Organization ln its many business activities, Provident Mutual and its affiliated companies engage in vigorous, tair and ethical competition. Discussions and agreements with competitors concerning pricing or other competitive policies and practices are strictly prohibited.

86

Conflict of Interest Provident Mutual annually circulates a policy statement of Conflicts of Interest. The basic policy states that every employee must avoid any interest that conflicts with the interests of Provident Mutual. The document provides detailed examples and explanations of situations and types of transactions which can give rise to conllicts of interest, In order to implement the conJlict of interest policy of Provident Mutual, all o{ficers and other a{fected persons are required to submit annually a completed disclosure statement to the Chairman and Chief Executive Officer of Provident Mutual. Each affiliated comoanv has a similar requrrement,

Gifts to or by Employees Employees may not give or receive anything of more than token value to or from any individual or organization with whom Provident Mutual or its affiliates does business, or who is seeking to do business with Provident Mutual or its affiliates. "Token" is defined as havinq a value of $50

or less Certain business courtesies, such as payment for a lunch or dinner in connection with a business meeting, normally would not be a gift within the contexl of this policy However, such activity shall be limited in frequency. Employees shall endeavor to avoid any situation where a gift or activity might appear to iniluence business judgment or relationships. Any question as to whether a gift might appear to be improper or questionable shall be addressed in writing, with a statement of all relevant facts, to the office of the General Counsel.

Cultural controls Frcunr Po

I

3.1 continued

itical Contri butions

No funds or assets of the Company shall be used for federal, state or local political campaign contributions. These prohibitions cover not only direct contributions but also indirect assistance or supDort of candidates or political parties through purchase of tickets to special dinners or other fund raising events or the furnishing of any other goods, services or equipment to political parties or committees, No funds or assets of the Company shall be used directly or indirectly for political contributions outside the United States, even where permitted by applicable law, without the prior written approval of the Chief Executive Officer or General Counsel,

The above prohibitions apply only to the direct or indirect use of corporate funds or assets for polltical purposes and are, of course, not jntended to discourage employees from making personal contributions to the candidates, parties or commiltees of their choice, through the Company's Political Action Committee. Under no circumstances shall employees be reimbursed in any way for personal contributions

Confidential lnlormation and lnsider Trading Employees frequently have access to confidential information concerning the Organization's business and the businesses ol present and prospective customers, policyholders and other employees. Safeguarding confidential information is essential to the conduct of our business. Caution and discretion must be exercised in the use of such information, which should be shared only with those who have a clear and legitimate need and right to know No employee shall disclose confidential information ot any type, to anyone, except persons within the employee's company who need to know. Information regardrng a customer may not be released to third parties, government, or other organizations, without the consent of the customer unless required by law.

Any requests for information arising through a legal process (e.9. subpoena or court order) must f irst be referred to the office ol the General Counsel before the release of information and belore the client is conlacted. Selling or acquiring stocks, securities or other investments, on the basis of non-public information is prohibited Securities include stocks. bonds, notes, debentures, or any other interests, instruments, documents or rights which represent securities. Questions concerning the definition of non-public information or a security shall be referred to the office oI the General Counsel before anv transaclions are underlaken.

Source:

KA

Service and Customer Concerns The foundation of the Organization is to provide high quality service to our existing and prospective customers Each company endeavors to give prompt, courteous and accurate response to inquiries and complaints received from customers. When appropriate ad.iustments are warranted, employees will make them promptly and courteously, Equally important, we seek to add or improve policies, procedures and products that contribute to customer satisfaction.

lntegrlty of Records and Compliance with Accounting Procedures Accuracy and reliability in the preparation of all business records is mandated by law. lt is of critical importance to the corporate decision-making process and to the proper discharge of Provident Mutual's financial, legal and reporting obligations. Ail business records, expense accounts, vouchers, bills, payroll and service records and other reports are to be prepared with care and honesty. False or misleading entries are not permilted in the books and records of Provident Mutual or any affiliated company. All corporate funds and assets are to be recorded in accordance with applicable corporate procedures. Compliance with accounting procedures and internal control procedures is required at all times. lt is the responsibility of all employees to ensure that both the letter and the spirit of corporate accounting and inlernal control procedures are strictly adhered to at all times They should advise the responsible person in their department of any shorlcomings they observe in such procedures.

Administration of the Code Employees are encouraged to seek guidance regarding application or interpretation of this Code of Conduct and are expected to cooperate fully in any investigation of a potential violation. The statements set forth in this Code of Conduct are intended as guidelines for employees. Routine questions of interpretation regarding the Code shall be directed to the employee's supervisory otficer. and if necessary, relerred to the oflice of the General Counsel. lf any employee belreves the code may have been violated, the matter shall prompily be reported to the Director of Internal Audit. Violations of the Code of Conduct may be disciplined by the Organization, up to and including dismissal. However, the Code of Conduct does not set forth all of the reasons or situations in which employees may be disciplined.

The Code of Conduct is not an employment contract, and the Organization may at any time modify the provisions of this Code of Conduct as it deems appropriate.

l'.4erchant Moden Managemenl Controt Syslems: Texl and Cases lupper Saddle River, NJ: prenlice Hall

1

998), pp I 26-7

87

Chapter

3 Action,

Personnel, and Cultural Controls

companies deal with purchasing gLridehnes (56%) and security of proprietar)' information (53%). Other statenents commonly included relate to responsibilities regarding

the environment, marketing' product safetl" workplace safety, and conlidentiality of employee records. The surve), also found that the codes are dynamic documents: 597o hacl been changed lvithin the three years prior to the survey. The most frequent reasons fo1change were specific incidents either within the cornpany or the industry, new leadership, new Ialvs, or a change in business strategy. Most organizations flnd that the adoption of codes stimulates ciiscussion as to what constitutes clesirable behavior and forces development of a cousensus. The adoption of writteu cocles also enhances comrrunication of expectations and the Ieasons for the expectations. One study found that pressule to achieve perfotmance tal'gets was greatest in companies witl-r forn-ral codes of conduct. But this perhaps only indicates that the performance plessures create a need for the codes:re consistent with findin-ss that "pl'essure to clo whatever it takes to meet business tar-qets" is the most common drivel of employee miscondr-tct.3o

Do codes of conduct u,ork? The evidence is equivocal. One sulvey found that employees who work fol companies with codes of ethics were much more likely to rate the commitment to ethical conduct by others in their'fitm as "about light." They were also as much as 88% more iikely to rate their f,rm's fulfillment of its ethical obligations as "exceptional."-t' However, a study that compared 202 firrns with codes of conduct with 104 firms without codes found that those with codes were just as Ikell' to be convicted of illegal acts as those without thent.rr Moreover, as many as 527o of the 4,056 employees lecently sun,eyed tnthe KPMG 200512006 Integt'ih' Srn't'e-l'believe that the fact that "their company's code of conduct is not taken seriously" was a root cause of ernployee misconduct.rr Some codes of conduct indeed fail becar.rse they are not supported by stron-q leadership and ploper torte Jront the top. Top managers do not always appear committed to then. or worse, set bad examples themselves throngh inappropriate conduct, One stt"rdy founcl that one fourth of the codes of conduct sttidied were clorntan l, meaning that employees perceived the codes as simply public relations and not something to be taken seriously." Perhaps a case in point. Enron managers were proud of theil company's code of ethics, but it failed to prevent the majot problems that led to the company's batrkluptcl'.r5

Group rewards

Providing rewarcls based on collective achievement also encoura-ses cultural control. Reward plans based on collective achievement come itt rnany forms. Common examples are bonus, proflt-shaling, or gain-sharing plans that plovide compensation based on cor'porate or entity perfonnance in terms of accor,tnting returns, proflts, ot' cost reductions. Encouraging broad employee ownelship of company stock, with effective colporate commnnications to keep employees infonned and enthusiastic, encourages ali employees to think like owners. Research evidence shows that such plans work, seemingiy because they create an ownelship culture.r6 A leview of 70 studies done over the past 25 years found that botl-r erlployee ownership and profit-sharing programs improved employee productivity, company performauce, ancl cotnpany sumivol'rates.rt Gloup rervards are discussed here as a type of cultural control rather than as a tesults conrrol (as r,ve discuss in Chapter 9) because they are quite different in chalacter fiom rervalcls given for iudividual accomplishment. With group l'ewards, the link between individual efforts and the results being lewarded is weak, perhaps near zero for most

88

Cultural controls

-.oups other than small work teams. Thus, motivation to achieve the rewards is not .::rong the primary forces affected by group rewards; instead communication of -'\pectations and mutual monitoling (social control) at'e. Gloup rewards, however, can ork, even in cor.rntlies iike the US with a culture oriented towards individualism and :rsonal accountability. Evidence suggests that group rewards can have a positive effect on motivation and -:r'fonnance.r' Gloup rewards can encoulage teamwork, on-the-job training of new crkers by rnore experienced ones, and tl-re creation of peer pressure on individual r:.rU)loyees to exelt themselves for the good of the group. Panhandle Eastem Corporation, ,. natlu'al gas company, installed a _eain-sharing plan that called for all employees to -:ceive a borus if corporate earnings exceeded $2 per share. Tliis gloup-pelformance '.rur created a cost-cutting cultule throughout the organization and turned "employees :rnr top to bottorn . . . into cost-cutting vigilantes."3e \4ichael Armstrong, then-chairman of Hughes Electronics, used group incentives to -:rrurge his cornpany's culture. Before Annstrong, Hughes'culture was a regimented, rp-heavy hier archy that: . . . rnirrored its miiitary clients. Managers had iittle accountability. And the engineers'cultule reu,arded those who came up with the most sophisticated inventions - whether or not the rnarket rvanted them.ro

irr change the culture, Armstron-e instituted a new bonus program for all employees with ':tvments based on the profits of their business unit, He required that engineers attend -rance classes, and he opened the company's books for all employees to see the results .i their efforts. Steven Dorfman, then-president of Hughes' Satellite unit said, "Now. :\.el'yone [is] walking the floors talkin-s about leturl on net assets."rr Other evidence of the success of group rewards comes from the litet'ature that describes

.ornpanies'experiences with plograms known as open book ntarngentent (OBM), of '. hich group rewards are an important ingredient. The goal of an OBM program is to cre-:te a cleal line of sight between each employee's actions and corporate financial perform,'.trce and an incentive for the employees to behave in the corporation's best interest and -r'r lr?k€ useful suggestions for improvement. OBM programs involve: (1) regular sharrrs of the con'rpany's financial information and any other information that will help the ;n.rployees work together with managenent towards organizational success; (2) training, :o that employees undelstand both what that information means and how they them.elves can contribute to company performance; (3) rewards linked to company perform.rnce; and (4) if necessary, a cultural change away fi'om a top-dorvn culture to ensure :hat employee ideas are both encouraged and considered fairly. Most commonly, OBM .ncentives involve tying a portion of each employee's compensation to key coryorate inaucial indicators, usually in the fom of an employee stock ownership plan (ESOP) oL .r profit-shaling plan. The earliest program given the OBM label was that implemented at the Springfield Remanulacturing Company in the early 1980s.4t This program was credited with tuming rround a near-failing company. The idea has spread and the business literature now coniains a number of examples explaining how OBM programs have yielded significant :nrplovements in productivity and profits.'l In conclusion, group rewards essentially delegate the monitoring of employees' activities to employees' coworkers. This is the essence of mutual monitoring. Managers know iheir ,eroup rewards are working u,hen they hear hard working employees urying on their collea_eues ivith statements like, "You're hurting my profit sharing."

'luggish

89

Chapter 3 . Action, Personnel, and Cultural Controls

Other approaches to shape 0rganizational culture Other common approaches to shape organizational culture include intraorganizational transfers, physical and social arran-qements, and tone at the top. Introorgarizational trctnsfers or entplo:'ee rotcttiott help transmit culture by improving the socialization of employees throughout the organization, giving thern a better appreciation of the problems faced by different parts of the olganization, and inhibiting the formation of incompatible goals and perspectives. Transfels also potentially rnitigate employee fraud by preventing employees frorr becoming "too" familiar with certain entities, activities, colleagues. and/or trausactions.rl Pln,sical on'ongenletlts, such as offlce plans. architecture, and interiol decor, and social anangements, such as dress codes and vocabulary, can also help shape organizational culture, Some organizations, such as technology fimrs in the Silicon Valley, have created informal cultures, with open office anangements and casual dress codes that deliver messages about the importance of innovation and employee equalitl,. At Disneyland, ernployees are called cctst ntentbet's; being on the job is being onstage (off the job is offitage): a work shift is a petforntortce: and a job description is a scril:t. This vocabulary, which is imparted imrnediately on joining the company and is reinforced through training, separates Disney employees from the rest of the world, brings them closer to-eether, and reminds them that they are pelfomers rvhose job is to help fulfill the company's mission: to make people happy. The largest Japanese flrms find it easier to uraintair.r a strong culture because they tend to retain tlrcir entplol'ees for long periods of time, until lecently often an entire lifetime. This stability in the employee base increases the hornogeneity of perspectives in the organization. The errployees become socializecl to their organization's values and its "walr of doing things." Finally, management can shape culture by setting the proper totrc ot the top. Their statements should be consistent with the type of culture they are trying to cleate and, importantly, theil behaviors should be consistent with their statenlents. Managers selve as role models and ale often cited as a determining factor in creating a culture of integrity

in theil organizations.at Management cannot say one thing and do another. Management sometimes sets the v'rcng tone by not responding appropliately to matters brought to their attention, sucir as ethics concerns or reports of malpractice. All too common, wltistle blotvers (ernployees rvho draw attention to suspected malpractice) ale ignored, such as Sherron Watkins was initially at Enron.*o To correct such a situation, Abbey National, a Blitish bank, set the right tone by producing a booklet about whistle blowin-e and by providing contacts inside and outside the firm fbr employees who ale concemed about malpractice.rT In so doing. management set the tone that honesty and integrity are valued and rer.varded by the organization. Several studies, hor.r,ever, paint a rather gioomy pictule of tone at the top. Fol example, a study by the Treadway Commission that exarnined acconnting scandals that brought dou,n companies tound that fraud started at the too in7jc/c of the cases.r*

PERSONNEL/CULTURAL CONTROLS AND THE CONTROL PROBLEMS As a group, the personnel/cultural controls are capable of addtessing all of the control problems although, as shown in Table 3.3, not each type of control is useful in addressing each type of problem. The lack-of-direction problem can be minimized, for example, 90

Effectiveness of personnel/cultural controls

3.3 Control problems addressed by the various ways of effecting personnel and cultural controls

TneLt

Lack of direction

Motivational proDtems

Personal limitations

Ways of eflecling personnel controls Selection and placement

X

Training Job design and provision of necessary resources

X X

Ways of elfecting cultural controls Codes of conduct Group-based rewards Intraorganizational transfers Physical arrangements Tone at the top

X X X X

Source:K A lvlerchant ModenlvlanagementControl

Sysfems:TextandCases\tJpperSaddleRiver.NJ: prenticeHall. lgg8),p

130

by hirin-e expelienced personnei. by providing training programs, or by assigning new personnel to work groups that will provide good direction. The motivational problems, which ma1, be minirnal in organizations with strong cultures, can be minimized in other organizations by hiring highly motivated people or by assigning people to work groups that will tend to make them adjust to group nolms. Personal linitations can also be reduced through one or rnore types of personnel controls, parlicularly selection, training, and provision of necessarv resources.

EFFECTIVEN ESS

O

F PERS ON N Et/CU LTU RAt CO NTRO tS

Personnel/cuitural controls are adaptable. All organizations rely to some extent on their employees to guide and motivate themselves. Even in plisons whele administrators face general inmate hostility and have few cor.rtlol options available other than physical constraints, administratol's screen inmates so as to not assign dangerous inrnates to high-risk jobs, such as in a machine shop. Some corporate control systems are dominated by personnel controls. William F. Cronk, president of Dreyer's Grand Ice Cream, said, "We consider hiring the most impoltant decision we can make. We hire the smartest. most inspired people we can find, give them the resources they need, then get out of their way."re Cultulal controls can also, by themselves, dominate a control system. The best chance to create a strong culture, however, seems to be early in an or-eanization's life when a founder can imbue the organization with a distinctive culture.50 But stron-q leaders and mana-eement policies added latel in an organization's history also can have an impact. Regardless of the difficultS, in implementing them, cultural controls should sel've some positive purpose in e\/ery organization.

Cultural controls often have the advantage of being relatively unobtrusive. The limits of acceptable behaviors may be prescribed in terms as simple as "the way we do things around here." The people whose actions are being controlled may not even think of the shared norrns as being part of the MCS. As such, organizational cultules (shared values)

can substitute for other fonnal tvpes of controls. Or. as Peters and Waterman observed: q1

Chapter

3

Action, Personnel, and Cultural Controls

"the stronger the culture . . . the less need thele is for policy nanuals, olganization charts. or detailed procedures and rules,"sl Personnel/cultural controls thus have several important advantages over results and action controls. They are usable to some extent in almost every setting; their cost is often lower than more obtn-rsive forms of controls; and they usually produce fewer hannful side effects. Personnel/cultural controls perhaps even make good "economic sense" as some recent evidence suggests that "itpa,l,s to be nice to employees."5r In an 800-store study, Sears, the giant US retailer, found that if employee attitudes (such as about workload and trearment by bosses) improve by 5Vo, customer satisfaction will jump by | .37o, driving a half percentage point increase in revenues.''3 This lo-eic is echoed by Elizabeth Rose, vice president at Northem Telecom of Toronto, Canada, tvho states that "they came up with conclusive evidence that improving employee satisfaction will satisfl, customers better and, in turn, improve financial results "5r At the Raleigh, North Calolina-based SAS Institute, the world's largest privately held software company, cofounder and chairman James H. Goodnight says that "he likes happy people." He instills employee loyalty with an unusual anay of perks for his 2,700

headquarter employees, such as profit-sharing; a fi'ee health clinic; daycare centers; private offlces for everyone; flexible 35-hour weeks; free sodas, ftesh fruit, and pastries in the coffee-break rooms; and even a pianist in the subsidized lunch and rect'eation room. SAS'5 tuntover late has been about 47o for years, conpaled to an industry average of about 20Vo. Stanford University professol Jeffrey Pfeffel concluded, "The roughly $50 million per year that SAS saves with its low turnover pays for all the family-friendly stuff. And, while the free company clinic costs $1 million per year to oDerate. that is $500,000 less than what it would cost the compan)/ if employees were

triated elsewhere."55 But, the degree to which personnel/cultural controls are effective can var)/ significantly across individuals, groups, and societies. Some people are mol'e honest than others, and some groups and societies have stronger emotional ties amon-9 their members.

c0Nctusl0N In this chapter we provided an overview of the most direct type of controls, ctction cotttrols, which take any of several different forms: behavioral constraints. pleaction reviews, action accountability, and redundancy. Action controis are the rnost dilect type of management control because they ensure the proper behaviors of the people on whom the organization must rely by focusing directly on their actions. We also described personnel and cultru'ctl corttrols, which managers implement to encourage either or both of two positive forces that are normally pt'esent in organizations: self- and mutual-monitoring. These forces can be encouraged in a number of ways. including effective personnel selection and placement, training, job design atld provision of necessary resources, cocles of conduct, group rewards, intra-organizational transfers, physical and social arrangements, and tone at the top. Personnel and cultural controls, which are sometimes referred to as sol controls. have become more important in recent years. Organizations have become flatter and leaner. Managels have wider spans of control and elaborate hierarchies and systems of action controls (bureaucracies) have been dismantled and replaced with empowered employees' In this environment, shared organizational values have become a lrlore important tool for ensuring that everyone is acting in the organization's best interest. 92

Notes

i'lotes '

. KPMG 2003 Fraud Sin

L

er' (KPMG LLP, 2003). D. Ster,r,art and R. Chase, il[istake-Pt ooJtrtg: De sigttittg Errors Out (Poltland. OR: Productivitl, Press. 1995). Pokct:oke is the Japanese ternt for .foolproof. It *,as introduced to the managernent litelature b), the Japan-

Lerers

ese qua1it1, gur-u, Sigeo Shingo.

Cortn'ol ,9-r,,rlclrs to Driye Strotegic Renev'al (Boston,

-r. S. Carey and D. Michaels. "At Sorne Air-lines, Laptops Replace Pilots' 'Blain Bags','' The Woll Stt.eet Jout nal (Malch 26, 2002), p. B 1. l, "Beal Stearns Ex-Staffer Pleads Guiltl, Ts 1.pitlt funds rn Check Scheme." Tlte lVall Street Jomnal, (Februaly 26,2002), p. Cl4. 5 ''Menrorable Memo: McDonald's Sends Operations to War on Fries," I/re Woll Street .Iourncrl Intercrt-tite Edirion (December 18, 1997). 5 V. Govindalajan and J. G. San Miguel, "Sears, Roebuck aucl Co. (C): The Internal Audit Function," Case uo. 9-179-125 (Boston: HBS Case Sen,ices. 1979)

I R. 3,

Henkoff,

"Hou,to PIan for

1995," Forrttne

(Decernber 31, 1990), p. 74. S. Leung, "McDonald's Asks Myster.y Shoppers What Ails Sales: Undercover Customers to Rate Service and Food Quality." The Wall Sil eet Journal (December. 17,

2001), p.

Bl

9 F. K. Iverson, "Effective Leader.ship:

The Key

is

Simplicity," rn Y. K. Hsetty and V. M. Buehler (eds). Tlte Quest .for Cotnpetitir,ene,rs (Ner.v York: euorum,

0

199 I ).

C. Daniels. "To Hire a Lumber Exper-t, Click Here," Forturte (April 3, 2000), p. 268. .1. A Galloni and M. R. Sesit, "Allfirst Officials Raised Concern about Trader in a 1999 Merno," The Watt Streer Jorrntctl (Feblualy 25 , 2002), p. C 1 6. and M. R. Sesir. "Controls at Allied L.ish's

'1, A, Galloni

Alllirst Likely Failed in Imporranr Wa1,s," The lVatt

Stt'eet

i3.

Journal (Febluarl, 20. 2002), p.

C

1 .

C. Gaspalino and S. Claig, "Lehman Broker in Alleged Swindle Also Supen,ised the Compliance Officer." I/re

Wall Sneet Jounlol (Februar;, 20,2002). p. Cl; and C. Gasparino. ''Rogue Broker. Costs Lehrnan. Coiven a Bundle; Re,sulatol's Pt'ess Firns to Pay up to Sl00 Million to Investors Wlio Were Gruttadauria Victinrs.'' The V'all Srreet.lournal (December 4,2002), p. C1.

+. KPMG 2003 Fraud.Srrn.a.r, (KPMG LLP. 2003). 15. See R. N. Hoit and R. E. Fincher, "The For-ei-sn Conupt Plactices Act," F inancial Attalt'.sts Joru-rtal, 3j (MarchApril 1981): pp. 73-6: and L. Landr.o, .'Analysis of ITT's Report Shorvs Pr-oblems in Halting euestionable Foleign Payments." Tlrc Vlall Street Journal (June 3, 1982), p. ?7. 16. MCSs dominated b1, personnel and cultural contr.ols have been called ot grutic (as opposed to nrcchanistic) b), BLrrns and Stalker': a professional bureatrcrac\. (as opposed to a rtmthirte bureattctctcti) by Mintzber.g; and belief s.t'.rrel/r.r (as opposed to dia,qnostit' c,otttrol

slsteirrs) by Simons. See T. Burns and G. M. Stalker. Tlte Matrtgentetrt of Intlot'aliorr (London: Tavistock. 1961); H. Mintzbelg, The Structut'ing of Organi:atiorts (Engleu,ood Cliffs, NJ: Prentice-Hall, 1979); R. Srrrons,

of Cottilol: Hou' Managets Use

Intk-^,atie

MA: Harvard Business School Pless, 1995);

R

and

Sirnons, Petfornrurtce Measurentertt and Ccntrol

5-1,s/errs

for

Inrplententing

Stt

oteg\' (Upper Saddle

River, NJ: Plentice Hall, 2000). 17. H. Rudnitskl,, "You Have to Tlust the Wolk Force," Forbes (Itrly i9, 1993), p. 78. 18. See. fol example. B. D. Smart. How Leading Contpanies IYin bt Hiriug, Cooching attd Keeping the Best People (Nett, York: Portfolio Haldcover, Penguin Group USA,2005): and M. T. Brannick and E. L. Levine, Job At,zh'sis. Methods, Researclt, and Applications for Hurnotr Resource Marrugentertt in the New Millettttiunt (Thousand Oaks. CA: Sage Publicarions, 2002). 19. KPX,IG 2003 Fraud Srrn,e,r. (KPMG LLP, 2003). 20. See J. S. Lublin, "Check. Please." The Wall Sn-eer .lour rtctl (March 11, 2002). p. R11; A Davis, "Employers Dig Deep Into Workers' Pasts, Citing Tenolisrn Feals." Zte lI/all Street Jouructl (March 12, 2002), p. A1. 21. C. Daniels. "To Hire a Lumber Expert, Click Here." Fortutte (April 3. 2000), pp. 261-10. 22. C. Daniels, "Does This Man Need a Shrink" Fortune (February 5. 2001). pp,205-1. 23. R. Wartzrnan. "School Inc.: Principals Taught to Act Like CEOs." The Wttll Street .lournal (Octobel 16, 1996). p. CAl. 21. "Jeny Reinsdorf Pulls a Double Play in Chicago," Busirtess WeeA' (October 10, 1983), p. 53. 25. An extensi\/e literatur-e exists on the benefits and methods of shaping corporate cultules See R. M. Kilmann, Martctgitrg Betond the Quick Fn (San Francisco, CA: Jossey-Bass. 1989); R. H. Kilmann and M. J. Saxton

(eds), Gaittirtg Control oJ the Corporcrte Culture (San Flancisco. CA: Jossey-Bass, 198-5); E. H. Schein, Orgctrti:atiortctl Cultute ancl Leoclersltip: A Dvranttc l/ieu' (Sar Francisco, CA: Jossey-Bass, 1985); and R. E. Walton, "Toward a Strategy of Eliciting Employee Commitment Based on Policies of Mutuality," in R. E. Walton and P. R. Lawlence (eds), HRM Tt ends atrd Cltrtllenges (Boston, MA: Harvar-d Business School Pless. i985). pp. 35-65. 26. J. C, Collins and J. I. Porras. Built to Last; successJul Habits of \tisionary Contpctnies (Nerv York: Harper Business. i994).

27. The Conference Boarrl, Corporate Ethics prartices (Nerv Yolk: The Cont-erence Board. Inc., 1992). 28. The Conference Board. Corporute Ethics Prauic.es (Nerv Yor'k: The Confelence Board. Inc., 1992). The plevalence of codes of conduct reported in this study is 93

Chapter

3,Action, Personnel, and Cultural Controls

consistent with that reported in a difi-erent and rnore recent sanrple of firnrs fi the KPlvlG 200512006 Irtregi'lt1'

29. A.

9111'1,s,t

I.

pp.2l-1;

(KPMG LLP. 2005).

irtg

Rich, C. S. Snrith and P. H. Mihalek. "Are

A. Adelson. "Casual, Worker-Friendly, and a Moneymaker. Too," Tlte Nev York Tintes (June 30, 1996), p. F8l and J. P. Schuster. J. Carpenter and M. P. Kane, Tlte Poter o.f' Open-Book Matragenent (New York:

Corporate Codes of Conduct Eft'ective?," Matngenrettt Accourttirtg (1990), pp. 34-5.

30. KPMG 200512006 Integritt Srn'e,v (KPMG LLP. 2005).

31. "Employees Say 32.

It's Hard to be Ethical in

Some Organizations." Internal Aucliror (Febluary 1995), p. 9. See R. Berenbeim. "An Outbleak of Ethics." Acr.oss tlrc Board (May 1988), pp. 15-19.

33. KPMG 200512006 lrttegritt' .!rl.r'c.r' (KPMG LLP,

John

2005 ).

46. M, Swartz and S, Watkins. Potet Fctilure:Tlrc Insicle Stort oJ the Collapse of Enron (Neu, York, Doubledal,. 2004).

34. S. Landekich, Corporare Codes of Cottclrtct: Art Exanitntiort atrcl Intplenrcntation Guide (Montvale, NJ: National Association of Accountants, 1989). 35, "Why Honesty Is the Best Policy: Corporate Deceit Is a Slippery Slope." A Survey of Mana_eentent. The Ecoirorrrisl (Malch 9,2002), pp. 9-13. 36. C. Rosen, J. Case and M. Staubus, Equirt': lVln' Employee Ownership is Gootl Jbr Busittess (Boston.

47 "Why Honestl, Is the Best Policl,: Corporare Deceit Is a Stippery Slope," A Sulvey of iVlana_sement, The Ecottontist (March 9, 2002), pp. 9-13.

48. H. W. Jenkins, "One More Dilty Job fol Accountants: Take the Blanre." Tlte \l'ull Street Jountal (March 20, 2002).p A23. 49. Quoted in D. Fer'-euson. "Do Enrlepreneurial Companies Lose Their Innovative Spalk as Thev Grorv

MA: Harvard Business School Press, 2005). 37. J. R. Blasi, D. Kruse and A. Bernstein, In tlte Cotnparty oJ Orners. The Trust ctbotrt Stock Optiotts (ctnd Wl:'l. Even, Enrylotee Should Hat'e fftarrrJ (Neiv York: Basic

Employees into Cost-Cutting Vigilantes," Tlte Wall Street Jourrrul (September 29, 1995), p.

Bl

40. E. Schine, L. Armstrong and K. Kenvin, "Liftoff: Michael Amstrong Has Made Hughes an Electronics and Telecom Contendet'," Business Week (Aprll 22, 1996), p. r42. 41. E. Schine, L. Armstrong and K. Kerwin, "Liftoff: Michael Armstrong Has Made Hughes an Electronrcs and Telecom Contender." Brtsirtess Week (Aprtl 22. 1996D, p. r42. 42. J. Stack, The Great Game of Busirrcss (New York:

43.

94

Doubleday, 1992). See C. Lee, "Open Book Management," Trctitrirtg (Jttly 1994), pp, 66-80; J. Fierman. "Winning Ideas from

M.

Wolk is Clouded by Picketing and Employee Complaints; No Longer the Underdos," The Wctll Sn eet Jourttal (July I 1, 2003), p. Al: E. H. Schein. "The Role of the Founder in ttre Creation of Olganizational Culand Hard

Kruse, "Plofit Shalin-e and Productivity:

Microecononric Eviclence from the United States." ilre, Economic Jout ttctl (January 1992), pp.24-36. 39. E. Nelson, "Gas Company's Gain-Sharin-s Plan Turns

Cttl Business (Fall 1995). p. 12. Trottnran, "New Atrnosphere: Inside Southrvest Aillines. Storied Cultule Feels Stlains; Spirit of Fun Lar-eer?"

-50.

Books. 2003).

D. L.

Wiley. 1996).

44. KPMG I99B Frautl Srrr le,r (KPNIG LLP, 1999). 45. KPMG 200512006 Itrtegrirr Srur,er, (KPMG LLP,

2005).

38.

6, 1995), J. Case, Open-Book Mcutagettrent;Tlte ConBtrsittess Reyolution (Ne'uv Yolk: Haqper, 1995);

Mavelick lt{anagels." Fotttttte (FeblLrary

ture," Orgatti:otionel D\'nonrics. l2 (Summel 1983). pp. 13-28. 51. T. J. Peters and R. H. Waterman. Irt Seatclt of E.rce Ilenc'e (Nerv York: Harper & Rorv, 1982). p. 75. 52. "Cornpanies Are Finding It Really Pa1,s ro Be Nice to Ernployees," Tlte lYall Streer Jountql (July 22, 1998). 53. A. J. Rucci, S. P. Kirn and R. T. Quinn, "The Enrployee-Custolrler-Pl'ofit Chain at Sears.'' Hctnard

54

Brrsirress Review (January-FebruaLy, 1998), pp. 8297. "Companies Are Finding It Really Pays to Be Nice

to Errployees," The Wall Steet Jottrnal (Ittly l

55.

22,

998).

T. D.

Schellhardt.

"An Idyllic Workplace under a

Tycoon's Thumb." Tlte Wall Street Journql (November

23.1998).