Effective Management Control Theory and Practice by Eric G. Flamholtz
Effective Management Control Theory and Practice by Eric G. Flamholtz
Effective Management Control Theory and Practice by Eric G. Flamholtz
CONTROL:
Theory and Practice
EFFECTIVE MANAGEMENT CONTROL:
Theory and Practice
by
Eric G. F1amholtz
"
~.
Flarnholtz, Eric.
Effective management control : theory and practice / Eric. G.
Flamholtz.
p. cm.
Includes bibliographical references and index.
Chapter 1
Chapter 2
Chapter 3
Chapter 4
ChapterS
Chapter 6
Chapter 7
Chapter 8
Chapter 9
This monograph deals with a critical but relatively neglected misunderstood aspect of
organizational effectiveness: The process of controlling the behavior of people in
organizations. Our overall purpose is to provide a framework to assist practicing
managers as well as academics to understand the nature, role, features, and functioning
of organizational control and cor.trol systems in organizations.
The basic objective of this study is to take some steps towards the development of a
more comprehensive framework for understanding, designing, and managing control
systems. The monograph is a hybrid of a treatise and a text and is intended for
practicing managers as well as for students of management.
The monograph begins with a chapter dealing with the nature and role of
organizational control. Chapter two presents a framework for understanding the nature
of organizational control, and identifies the three principal parts ofan organizational
control system: 1) The core control system, 2) The organization's structure, and 3) The
organization's culture. The core control system consists, in turn, of a series of
"components": a planning sub-system, a measurement and feedback sub-system, an
evaluation sub-system, and a reward sub-system.
Chapters three through six deal with each of these components of the core control
system. Each examines the role of these components ofa core control system as part
of an overall organizational control system per se. Chapter seven examines the role
of organizational structure and culture in control.
Chapter eight examines the role of the firm's accounting system as a control system.
Accounting is often thought of as a control system but, as shown in this monograph,
it can not function independently as a control system. It needs to be connected with
other parts of the overall control system in order to function effectively as a control
mechanism. Accordingly, chapter eight examines the extent to which accounting can
function as a control system and what needs to be done in order to make it part of an
effective system of organizational control.
In the final chapter of the monograph (chapter nine), we turn our attention to the issues
involving the overall design of effective control systems in organizations. The design
of an effective control system for an organization is a critical issue. If there is too little
control, an organization can drift into chaos, and, in turn, fail. For example, Osborne
Computers did not have an adequate control system over its finances and
manufacturing costs and went bankrupt. On the contrary, if an organization develops
xiv Preface
an organi:zational control system with too great a degree of control, then innovation and
entrepreneurship can be significantly suppressed. This has been the problem of a
nwnber of major organizational bureaucracies including: AT & T, IBM, and General
Motors. Thus, the issue of organizational control and the design of an optimal control
system is essential for long-term organizational effectiveness. The chapter presents a
framework to facilitate the design and evaluation of control systems. It also presents
some examples and a mini-case study to illustrate the practical issues involved.
This monograph is intended for a dual audience. It is intended for both practicing
managers as well as students of the practice of management. Accordingly, it attempts
to strike a balance between providing a relatively straight-forward and understandable
text, together with certain conceptual or academic perspectives that are necessary both
to the practicing manager as well as to the scholar. The balance between these two
audiences is not always easy to reach, and the reader is asked to bear with the author
in this respect. At times, the franlework may be too "academic" for the practicing
manager, while simultaneously it may be too "practical" for the research scholar.
Wherever feasible, I have oriented text towards the practicing manager, with chapter
endnotes being directed towards the research component of this audience. However,
in certain instances, I have chosen to briefly summarize selected research studies which
I think are of particular relevance to dle practicing manager. Similarly, certain portions
of the monograph are necessarily technical in nature. In order to fulfill its objective of
providing a comprehensive framework that can be used by practicing managers, I have
chosen to summarize certain teclmical information, especially with respect to
evaluation systems, that is also treated in certain texts. The basic rationale is that I
wanted this monograph to be a "stand alone managerial tool" for all those who might
chose to use it.
In brief, I hope that dle practicing manager will pardon me when the discussion
becomes too academic or theoretical, and that the research scholar will pardon me
when the discussion becomes too much like a text for the practicing manager. Taken
as a whole, I believe iliat boili audiences will find value in the monograph.
The bottom line is that the monograph's intent is to contribute to our understanding of
how to achieve the optimal degree of control in organizations by designing and using
control systems as an effective managerial tool. To accomplish this, we need to
understand what control is, what a control system is, how the key components of a
control system function, and how to design, manage, and redesign actual organizational
control systems. This monograph provides a conceptual framework to facilitate this
understanding. This franlework should be useful to academics by providing an
integrated approach to control systems issues and problems. It should be useful to
practicing managers by providing a lens through which to analyze control systems in
their own organizations.
1
THE NATURE AND ROLE OF
ORGANIZATIONAL CONTROL
To help gain control over the behavior of people in formal organizations, most
enterprises use a combination of techniques including personal supervision, rules,
standard operating procedures, job desc:riptions, budgets, accounting measurements,
and performance appraisal systems. Taken together, these techniques are part of an
invisible yet very real system: The organizational control system.
Control plays a major part in the management of an enterprise, but unlike machines,
equipment, finances, and people its role is often hidden from view. When we examine
an organization's structure, we see it in the form of an "organizational chart."
Unfortunately, there is nothing like this to help us visualize an organization's control
systems. Thus organizational control and organizational control systems are
ubiquitous but difficult to visualize; they are pervasive yet tenuous; they are invisible,
but have a significant impact on people's behavior.
This book deals with organizational control: its nature, role, functioning, and effects.
It develops the concept of control as well as the notion of a control system. It also
considers the relation between control and human behavior in organizations. It
examines the elements of an organizational control system as well as the process of
designing such systems. The basic purpose of this book is to examine this relatively
neglected but indispensable aspect of management, and show how organizational
control systems can play an important role as a component of the overall management
process.
2 The Nature and Role of Organizational Control
2. Why are organizational control and organizational control systems necessary for
effective organizational performance?
5. How can (and should) organizations design control systems which influence
behavior in desired ways?
The remainder of this chapter shall focus upon the first question above, while the other
issues will be examined in subsequent chapters.
The term "control" is typically used in a variety of ways. I In this book, our concern is
with organizational control, which is the process of controlling or influencing the
behavior of people as members of a formal organization to increase the likelihood that
they will achieve organizational goals. 2
There are four critical dimension of this concept of control: 1) it is oriented to goals;
2) it relates to a lack of goal congruence; 3) it refers to a process; and 4) it is
probabilistic. These features shall be examined in turn.
The concept of control used here is based upon the idea that the purpose or raison
d'etre of control is to assist the organization in achieving its "goals." As used here, the
term "goals" refers to those things which the organizational seeks to attain.3 An
organization's goals may be the goal's of an individual entrepreneur or CEO; they may
be the goals of a committee or set of committees. There may even be goals that are not
chosen by the organization, but merely imposed upon it by an external group or
authority. Regardless of the source of its goals, all control systems must be goal-
oriented.
Effective Management Control: Theory and Practice 3
We also assume that the goals of the organization are not necessarily the same goals
of all of the entity's individual or group members. The larger the organization, the less
likely the goals of all of its members are to be congruent. For an organization to
function effectively, it would be ideal if all members shared the same goals. This
idealized state of total goal congruence, or an identity between the goals of all
organization members and the organization as a whole, is shown in Figure 1-1.
Unfortunately, the state of total goal congruence is rarely, if ever, attained, except
perhaps in a one-person firm where the owner is the only employee. More typically,
there is a partial sharing of goals between organizational members and the entity. This
is shown schematically in Figure 1-2. The amount or area of congruence is represented
by cross-hatching.
Control is a Process
This concept of control views it as an ongoing process. Control is dynamic and not
static. It must adjust to changes in goals over time.
Although there are techniques of control, they are merely components of the control
process which is intended to increase the degree of goal congruence.
Control is Probabilistic
From a practical perspective, the aim of a control system is to maximize the likelihood
that people will behave in ways which are consistent with organizational objectives.
No system can guarantee that this will occur all of the time. This means that control
is probabilistic rather than deterministic.
Individual
Goals =
Organizational
Goals
Figure 1-1
Schematic of Total Goal Congruence
Figure 1-2
Schematic of Partial Goal Congruence
Effective Management Control: Theory and Practice 5
For some, the connotative meaning of control is positive. It suggests an idea of "being
in control," a sense of order. For others, the notion of control has negative
connotations. It implies that people are controlled or manipulated.
As we shall see, control is a tool, like hammer or a computer, and it is required for
effective organizational performance. At this point, it should be merely noted that the
concept of control is not merely technical, but has psychological overtones as well.
The larger the number of people in an organization, the greater the need for some form
of organizational control mechanism. In relatively small entrepreneurial organizations,
"control" is experienced by the entrepreneur who can see what is happening on a day-
to-day basis and make personal interventions. In large, complex enterprises, such as
ffiM, AT&T, and General Motors, more complex, formal mechanisms of control must
be designed and used. However, these formal control systems must be designed with
care in order to achieve the optimal degree of control; one which is neither too loose
(which may lead to chaos), or too tight (which may lead to stifling bureaucracy).
Functions of Control
Next, control systems must coordinate the efforts of several different parts of an
organization. Even when people are trying to act in the organizations' best interests,
they may find themselves working at cross-purposes. For example, a sales unit may
want to offer a customer expedited delivClY to make a sale, while from manufacturing's
perspective, this may mean a "rush order" which disrupts carefully designed production
schedules and causes inefficiency.
The third task of a control system is to provide information about the results of
operation, and people's performance. This information allows the organization to
6 The Nature and Role of Organizational Control
Focus on Goals
Coordination
In larger, more complex organizations, the problem of coordination may be much more
than trivial. In firms such as General Electric with several different businesses,
operating in several different nations, the effort required simply for coordination may
be quite substantial.
Another reason for control systems is to permit the decentralization of day to day
operations while simultaneously assuring that organizational objectives are achieved.
This need has been recognized since the early portion of the twentieth century. A
classic example of tlllS purpose of control is described by Alfred P. Sloan as part of his
experience in managing General Motors as a national corporation during the 1930s.
Sloan stated tlmt tlle firm had established techniques of control over individual matters
such as cost, inventory and production, but the fundamental issue of how to achieve
optimal control remained:
The basic strategy was to permit managers to run their day to day operations as they
wished, while evaluating the results of their decisions and actions in terms of the
criterion of rate of return on investment. This permitted managers a great deal of
autonomy, while still allowing top management to control the goals of the operating
executives. It thus optimized, rather than either maximized or minimized, the degree
of control.
The issue of how to optimize control (that is, to simultaneously permit managers
sufficient autonomy while maintaining overall control) is of widespread significance.
Historically, some firms such as lIT (International Telephone and Telegraph) under
the leadership of Harold Geneen resolved it by developing highly centralized control
systems, while others equally large firms (such as Beatrice Foods under William
Karnes) are able to run $8 billion organizations with a staff of 100 people or less.
Implementation of Planning
Control over an organization can be exercised through many mediums. A manager can
exercise control by means of his or her personal supervision, leadership and
involvement in day to day activities. Techniques such as job descriptions, rules and
standard operating procedures can also be used. Budgets, performance appraisal
systems, and incentive compensation plans are also commonly employed in attempts
to control behavior.
Taken together, we might wish to call all of these things a "control system." Yet as we
shall see in Chapter 2, the mere existence of an ad hoc collection of techniques control
does not comprise a true control system.
8 The Nature and Role of Organizational Control
How does control differ from control systems? Control is a generic process. It can be
exercised either by: 1) supervision, 2) leadership, 3) an ad hoc collection of control
mechanisms which have not been designed explicitly to articulate with one another for
the purpose of control, as shown in Figure 1-3.
Personal Impersonal
Control Control
2 4
Formal
PLANNED Leadership Control
System
1 3
Figure 1-3
Typology of Control
The process of supervision refers to the day to day scheduling, observation, and
oversight of work. We use the term supervision if the process through which this
occurs is ad hoc or intermittent rather than planned.
Although it may not be thought of as a method of control as such by the managers who
practice it, nevertheless the ad hoc supervisory method is an implicit control strategy.
It is shown in Figure 1-3 as an unplanned method of personal control.
The process ofleadership refers to the use offonnal (appointed) leaders to perfonn
several responsibilities in order to inHuence the behavior of people to achieve
organizational goals. Just as supervision, leadership is a personal method of control.
Leadership differs from supervision in that there are an explicit, predefined set of
processes which leaders are expected to use to influence the behavior of people who
are their subordinates. The leader is expected to set performance goals, help facilitate
work, stimulate group interaction and communications as well as to provide
performance feedback, personal support and recognition. These are just some of the
most common leadership functions.
There are many different theories ofleadership, which prescribe what functions leaders
should perfonn and how these functions ought to be perfonned. 6 In brief, leadership
is a planned method of personal control.
Some of the most common techniques of control have been noted above: job
descriptions, rules, standard operating procedures, appraisal systems, budgets, etc. It
is very common for such techniques to be used in organizations on a piecemeal basis.
They are typically added one-at-a-time as the organization grows and experiences
greater need for control.
Although this is a realistic and practIcal way to increase control, the principal
disadvantage of the ad hoc method of control is that the collection of control
techniques used have not been designed as a system. Thus individual techniques may
actually work at cross-purposes; or, even more significantly, important aspects of
organizational perfonnance may not be adequately controlled. For example, one of the
current problems facing U. S. automotive companies is a comparative disadvantage in
product quality vis !! vis Japanese and West German companies. Automobiles
produced by Japanese and West Gennan companies are perceived by the U.S.
10 The Nature and Role of Organizational Control
consumers as superior in terms of certain aspects of product quality, i.e., "fits and
finishes." U.S. automotive companies have always had systems for quality control
and inspections. Nevertheless, the overall control system does not appear to have
placed sufficient emphasis upon quality to satisfY consumer tastes and preferences. It
is possible that the quality control systems used by automotive companies worked at
cross purposed with the firm's unwritten control system: its culture. An automobile
worker at one major company described the changing philosophy as follows:
We used to be told: "if you can get it to run out the door, we can sell it." But
now we know that that's bad business in the long run. Today, everything is
quality, quality, quality.
Thus, in this example, it is clear that historically inadequate control was exercised over
product quality. However, it is not clear whether the problem was that the quality
control techniques were working at cross-purposes with the firm's culture, whether the
control mechanisms were simply not functioning, or whether the control techniques
were actually operating in accord with the company's objectives.
In brief, control techniques are an unplanned method of impersonal control. The term
"impersonal control" is used to refer to control by means of systems and procedures
rather than through personal efforts.
The term control system has been defined above. It refers to a set of processes and
techniques which have been designed explicitly as a system to influence the behavior
of people. It is a planned method of impersonal control.
All organizations need control; but not all organizations require control systems. The
four different methods of control are each appropriate under different circumstances,
or stages of an organization's development. 7 We can identifY or define four stages of
organizational growth, at which, different methods of control are appropriate.
Stage II. The next stage typically requires more fomlalleadership and certain control
techniques. Fonllal goal setting sessions, regular staff meetings, reports, budgets,
Effective Management Control: Theory and Practice 11
Stage III Once a firm has sales in excess of$50 million, it is increasingly difficult to
achieve effective control without a formal control system. Of course, there are many
examples of successful of even much greater size which do not have well designed,
effectively functioning control systems. Those firms do, however, pay a price for the
lack of such systems. The price may be concealed, and exist only as an opportunity
cost. Nevertheless, it is real.
Stage IV. In large, multi-billion dollar enterprises, the control systems required may
be quite complex, and component parts may not set well with each other. In some
instances, the cost of an inadequate control system can be very great and only observed
in a catastrophic situation. For example, a large well-known firm that suddenly incurs
huge losses and finds itself out of control after years of profitability and benevolent
neglect. The costs of ineffective control can be hidden by other positive factors, and
may reveal themselves only after deterioration in other areas.
In brief, all organizations do not require the same method of control. The specific
method of required control depends upon the stage of development of a firm and
especially its size. The larger the firm, the greater the need for planned and formal
methods of control. Similarly, within organizations the smaller the unit to be
controlled, the less the need for planned, formal methods.
CONCLUSION
This chapter has examined the nature and role of organizational control. It has also
identified different methods of control, and distinguished between control and a control
system. 8
Except for very small organizations, the need for control is ubiquitous. Ail
organizations require control systems. These systems may be difficult to visualize, but
they are real nonetheless. In chapter two, we shall provide a framework that helps
make an "invisible" control system mon: tangible.
12 The Nature and Role of Organizational Control
ENDNOTES
1. The literature on control is quite diverse, but can be categorized as comprising three different
perspectives: the sociological, the administrative, and the psychological. For a review of the
academic literature from these three perspectives, see F1amholtz, Das, and Tsui (1985). Also
see K.A. Merchant, Control in Business Organizations, Boston, Pitman Publishing, Inc., 1985.
2. For alternative conceptualizations of control, see: Weber (1947), Thompson (1967), Perrow
(1977). Ouchi (1977); Birnberg and Snodgrass (1988); Gupta and Govindarajan (1991).
3. Empirical research on the relationship of goals and performance standards as components of a
control system may be found in the organizational psychology literature (Ivancevich, 1976,
1977; Kim and Hammer, 1976; Latham and Yuki, 1975; Locke, 1968; Terborg, 1976; Matsui
et ai, 1987; Mitchell and Silver, 1990; Kernan and Lord, 1990; Wright, 1990; Weingart, 1992;
Meyer and Gettatly, 1988; Earley et aI., 1989; Gettatly and Meyer, 1992).
4. Alfred P. Sloan, My Years With General Motors, New York: MacFadden-Bartell, 1965.
5. This is a constitutive or conceptual definition of an organizational control system. In Chapter 2,
we shaIl define a control system in operational terms; that is, in terms of the operational
subsystems which comprise the process and mechanisms of control.
6. For further discussion of leadership theories, see for example B.M. Bass, Leadership and
Performance Beyond Expectations, (New York: Free Press, 1985); W. Bennis and B. Nanus,
Leaders, (New York: Harper & Row, 1985); J.A. Conger, The Charismatic Leader, (San
Francisco: Jossey-Bass, 1989); J.P. Kotter, The Leadership Factor, (New York: Free Press,
1988); H. Mintzberg, The Nature of Managerial Work, (New York: Harper & Row, 1973);
Bennis, On Becoming a Leader, (Reading Mass., Addison-Wesley, 1989); and T.J. Peters and
R.H. Waterman Jr., In Search of Excellence, (New York: Harper & Row, 1982); R.P. Vecchio,
"Situational Leadership Theory: An Examination of a Prescriptive Theory", Journal of Applied
Psychology, 1987, 72,3,444-451; Kozlowki and M.L. Doherty, "Integration of Climate and
Leadership: Examination of a Neglected Issue", Journal of Applied Psychology, 1989, 74:4,546-
553.
7. For further discussion of the stages of organizational growth as weIl as the nature of control
required at each stage, see E.G. Flamholtz, Growing Pains: How to Make The Transition From
Entrepreneurship to a ProfessionaIly Managed Firm, (San Francisco, CA: Jossey-Bass
Publishers, Inc., 1990). It should be noted that the four stages of organizational control systems
described her differ from those described in Growing Pains... to some extent.
8. This chapter constitutes a behaviorally based approach to organizational control. For other
approaches, see Eisenhardt, K.M., "Control: Organizational and Economic Approaches,"
Management Science, Vol. 31, pp. 134-149 (1985); Williamson, D.E., The Economic
Institutions of Capitalism. New York: Free Press, 1985; and EgelhofI; W.G., "Organizing The
Multinational Enterprise: An Information Processing Perspective," Cambridge, MA: Ballinger,
1988.
Effective Management Control: Theory and Practice 13
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14 The Nature and Role of Organizational Control
Organizational control systems (or, for brevity, "Control Systems") are not visible to
the naked eyes of observers in an organization. Yet they are not metaphysical; they are
real and permeate an organization.
Control systems are not easily seen or perceived by observers because they comprise
a complex set of on-going organizational processes: the budgeting process, strategic
planning, measurement and performance evaluation, the compensation system, and so
on.
This model can be used as a framework for both describing an organizations' control
system as well as to evaluate its functioning and effectiveness. Once we have
presented the framework, we shall illustrate its practical application by describing and
evaluating an actual control system of a medium-sized residential real estate firm.
ORGANIZATIONAL ENVIRONMENT
Figure 2-1
Schematic Representation of an Organizational Control System
Effective Management Control: Theory and Practice 17
The innennost circle comprises the "core control system." This is a cybernetic
structure consisting of four subsystems (planning, operations, measurement, and
evaluation-reward) which are articulated (linked) by feedback and feed-forward loops.
The middle circle comprises the organization's structure: its set of rules and their
interrelationships. The outer circle represents the organization's culture: its value
system, beliefs, assumptions; the patterned ways of thinking which are characteristic
of the entity. Those three elements of the control system are bounded by the
organization's environment. We shall examine each part of a control system,
beginning with the core control system.
Planning, which can itself be defined in many ways, is basically the process of deciding
about the objectives and goals of an org~mization (and/or its members) as well as the
means to attain those objectives goals. 12 "Organizational goals," according to Hall "are
the desired ends or states of affairs for whose achievement system policies are
committed and resources allocated."13 In this context, the tenn "objectives" refers to
relatively broad statements about things an organization wishes to achieve in a given
"perfonnance area" (markets, products, personnel, financial results, etc.). "Goals"
represent the quantitative level of aspiration sought to be attained for a given objective.
For example, the financial objective for Pepsico may be "to earn a satisfactory return
upon net assets employed in the business," while its goal or standard of perfonnance
for a given year might be "18% pretax ROL" The role of the planning subsystem in
control is considered further in chapter 3.
Operations, or dle operational subsystem refers to the on-going system for perfonning
the functions required for day-to-day organizational activities. These are the
responsibilities and activities specified in organizational roles.
18 Organizational Control Systems: A Framework
Evaluation-Reward
System
Rewards
Planning
System
1-1 Objectives
1-2 Goals
4-1 Corrective
Feedback
Measurement System
Figure 2-2
Schematic Model of The Core Control System
Effective Management Control: Theory and Practice 19
Measurement performs a dual function as part of a control system. One function is that
numbers generated may be used to monitor the extent to which goals and standards
have been achieved, so that organizational members may be provided corrective and/or
evaluative feedback. This is termed the "output function" of measurement. The second
function of measurement related not to the nwnbers produced by measurement
operations, but rather to the phenomena caused by the act or process of measurement
~ se. The very fact that something is tlte subject of measurement tends to influence
the behavior of people in organizations. 14 Thus the mediwn of measurement itself a
stimulus. This is termed the "process function" of measurement. The role of
measurement in control is examined in more depth in Chapter four.
Feedback consists of information about operations and their results. There are two
types of feedback: I) corrective and 2) evaluative. Corrective feedback is simply
information about the performance of the operational system which is designed to help
adjust operations in order to improve performance. Evaluative feedback is information
about how well the operational system lis doing. It provides a basis for performance
evaluation as well as the administration of rewards. The role offeedback in control
will be examined in greater depth in Chapter 4, together with the role of measurement.
20 Organizational Control Systems: A Framework
To illustrate the framework for core control system, we will examine the application
of the model in a manufacturing plant. As seen in Figure 2-3, the plant has five key
result areas: production volume, quality, safety, energy utilization, and scrap. All of
these key result areas are different in nature. Production volume is something that can
be easily quantified. Energy utilization and scrap can also be measured but in a
different way. Quality and safety require still a different type of measurement.
The company has established goals for each of these five key result areas, as listed in
the column titled "This Year's Goals." The firm also shows last year's actual
performance in the next column. In addition, this year's performance is tracked on a
monthly basis in the adjacent columns.
Virtually any company or any unit of a company can use a format similar to that shown
in Figure 2-3 to apply the control model to its operations. This approach can be useful
for the company as a whole, a division, a department, or even an individual such as a
salesperson. Indeed, I observed an example of the application of this framework on
a visit to China in 1983 in a chemical plant located in the city of Shanghai. The plant
manager was using a blackboard to list the key result areas, current performance goals,
prior year's actual performance, and historical best performance, as well as to track the
actual performance of tlle plant to date. Whenever an employee walked past the
blackboard, he or she got a quick glimpse at how the plant was performing to date.
AltllOUgh the four basic elements of the core control systems must be present for the
system to function fully, it is possible to find in actual organizational settings different
configurations of one or more of the system's elements. For example, it is possible to
observe a "control system" that consists merely of a planning system with little else.
In such situations measurements may be available only at year end and thus are not
available for periodic assessment of performance on a real time basis. On the contrary,
performance measurement systems may be found in situations without any formal
system for planning and goal-setting. In these situations, it is not possible to evaluate
actual perfonnance in relation to plans or budgets.
'T1 m
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w
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CD
8. :::I
!!.
This Last This Year's Performance
0
'" 0
Year's Year's ~
-
:::I
Kev Result Areas Goals Actual Jan. Feb. Mar. Apr. May June July AIIjt. Sep. Oct. Nov. D<c. "g.
.. I. Production
Volume
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4. Energy :::I
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22 Organizational Control Systems: A Framework
The second component of the overall control system shown previously in Figure 2-1
is organizational structure. As Otley and Berry state: "Indeed, organization can itself
be view to CCH>perate in order to achieve purposes which require their joint actions. ,,15
Similarly, Etzioni states that "organizations theorists have argued that organization
structure is developed as a response to the problem of control. 16
In contrast with the core control system, organization structure is relatively static. It
represents a strategic responses to the requirements of markets, technology, and the
environment. 17 The role of organization structure in control of is described in Chapter
7.
Effective Management Control: Theory and Practice 23
Control Illustrative
Levels Configuration of
8
Control System Elements
Figure 2-4
Levels of Control Achieved by
Different Configurations of System Elements
24 Organizational Control Systems: A Framework
The tenn "culture" is subject to many different definitions and denotations. Kroeber
and Kluckholm devoted an entire book to a study of the history, definitions, and
properties of the nature of culture. 18 Elsewhere Kluckholm stated that: "Culture
consists in patterned ways of thinking, feeling and reacting, acquired and transmitted
mainly by symbols, constituting the distinctive achievement of human groups,
including their embodiments in artifacts; the essential core of culture consists of
traditional (i.e. historically derived and selected) ideas and especially their attached
values. ,,19 In an organizational context, Ouchi refers to culture as the broader values
and normative patterns which guide worker behavior, practices and policies. 20 In this
chapter, we shall refer to organization culture as the set of values, beliefs, and social
nonns which tend to be shared by its members and, in turn, tend to influence their
thoughts and actions.
Although culture is shown as the third circle in Figure 2-1, it is, in fact, the starting
point for the design of an organizational control system. In spite of the fact that it
changes slowly and typically with great difficulty, organizational culture ~ a variable 21 •
It is subject to design, and can be the product of management decision. For example,
in the early 1980s the Board of Directors of U.S. based RCA Corp. decided to replace
that company's president, Edgar H. Griffiths, with Thornton F. Bradshaw.
Accordingly to an analysis presented in Business Week. Bradshaw was chosen
explicitly to change RCAs culture. His task is to change the value system in the
company from on that stresses short-tenn projects and planning to long range goals.
Business Week quoted an unidentified "source close to the Board," as stating that
under Griffiths: "Long-range planning meant, 'What are we going to do after lunch'"
In addition, Bmdshaw "... must redirect the culture of the company from one based on
intense politicking to one that rewards perfonnance. ,,22 The role of organizational
culture in control is examined in greater depth in Chapter 7.
The control systems model presented above has two major, related uses:
1. It can be used to describe and understand the structure of the control systems in
actual operating organizations, and
2. It can be used to evaluate the functioning and effectiveness of such systems.
organizational structure is typically far more complex than can be reduced to such a
chart. Nevertheless, it does provide a first-approximation for describing an
organization.
Ifwe wish to get a picture of the structure of an organization's control system, we need
something comparable to an organization chart, which will specify the elements of the
control system and their interrelationships. For this purpose, we can develop
schematics such as those shown previously in Figure 2-1 to 2-3. We shall term these
"Control Systems Charts" because they diagram different aspects of an organization's
control systems.
Another related use of the model presented above is in evaluating the functioning and
effectiveness of the system in an organization. Using control systems charts we can
determine whether:
1. All three of the major elements of a control system have been sufficiently developed
(culture, structure, and the core control system);
2. All three of the major elements articulate with one another;
3. All the components of the core control system (planning, measurement, etc.) have
been developed sufficiently; and
4. All the components of the core control system articulate with each other.
Items 1 and 3 refer to the development of pieces of the control system, while items 2
and 4 relate to their articulations or parts of an integrated system.
In some cases, not all the required parts of a control system may be in place. In others,
all of the pieces may be present but may not articulate as a system with each other.
In this section we shall examine the control system of an actual company to illustrate
the practical use of tile model in describing and evaluating the system. The firm is a
medium-sized U. S. real estate company located in a large metropolitan area.
Description of Firm
The firm is a residential real estate company. It provides a full set of services
(brokerage, property management, leasing, etc.) to buyers of residential real estate
throughout a relatively large metropolitan area in a major U.S. city. The firm's
organizational structure is shown in Fib'Ufe 2-5.
26 Organizational Control Systems: A Framework
PRESIDENT &
I CEO I
I I I I
Property
Management Sales Mortgage Administration
and Leasing Depart- Department Department
Department ment
I
I I I I
Sales Sales Sales Sales
Branch Branch Branch Branch
Figure 2-5
Organizational Structure of Metropolitan
Residential Real Estate Firm
At the time of the study, the firm had 12 sales branches located through-out the
metropolitan area. Each branch was headed by a branch manager who was supposed
to be responsible for branch revenue and costs. Thus technically each branch
constituted a profit center. Branches typically had between 10-25 "sales associates"
(sales personnel) and 1-2 clerical personnel. The annual volume of residential real
estate sold was approximately $300 million.
Residential real estate finus in the U.S. are sales oriented. They tend to be
entrepreneurships begun by one or a few people who were initially successful sales-
persons themselves and founded their own companies because of available business.
Neither the owners or manager in residential real estate firms typically have formal
management training or managerial experience in other industries. Thus the culture
found in such firms may be characterized as a sales culture. Accordingly, the explicit
and implicit value system of the firnl emphasizes sales: "listing" of properties to be
sold and sales of properties. 23 The culture also states that sales is a "numbers game."
If you make so many calls, house showings, etc. you will get listings and sales, and,
in turn, earn income.
Effective Management Control: Theory and Practice 27
Branch managers tend almost exclusively to be former salespersons who have been
promoted. Few real estate firms have fonnal training programs for recently promoted
managers. They are expected to learn by doing the job.
Since the firms are entrepreneurial in style, there are not typically job descriptions for
branch manager, or if role descriptions exist, they tend to be vague. Accordingly, the
branch manager tends to define hislher own job and, not surprisingly, the notion of the
jobs often emphasize the sale component or things which support sales, rather than
such administrative matters as budgeting, planning, cost control, etc.
Branch managers receive a base compensation of "X" thousand dollars per month. In
addition, they receive an "override" of 1% of "Company Dollars," (Gross Commissions
income received by the firm less Salesperson's share).
The basic problem with respect to control in this firm is that branch managers paid
little or no attention to the budget or variances. They virtually ignored the income
statement. Stated simply, branch managers ignored variances, large or small. Many,
if not all, hardly looked at the budget or income statement.
The theoretical as well as practical managerial question underlying this behavior may
be stated quite simply: Why did the branch managers ignore the firm's income
statement and budget variances? To answer this question we shall draw upon the
meta-framework of control to examine the elements of culture, organizational structure,
and core control system. Taken together, an analysis of these elements explains the
very rational behavior of branch managers in ignoring income statements and budgets.
The firm's culture unintentionally mitigated against branch managers paying attention
to budgets, income statements, and, indeed, even profits; the culture emphasized
SALES in all capital letters. The explicit value system as well as the informal
socialization system all held the successful salesperson in high regard. This carried
over to successful branch managers; they were successful if they could attract,
motivate, and retain "top sales people."
The role of sales managers was a sales oriented role. In addition to the ability to
recruit and manage personnel, the sales managers must be knowledgeable about real
estate transactions both to train sales associates and to serve as a consultant on
complex transactions. Knowledge of accounting and budgetary controls skills are not
explicitly viewed as part of the role and, if present, are not highly valued.
28 Organizational Control Systems: A Framework
The firm's core control system was not explicitly designed as such. There is a plan
(budget), a measurement system (the accounting system), feedback (budget reports and
income statements), and an evaluation-reward system (performance appraisal and
compensation systems). However, these components or subsystems have not been
designed either: 1) explicitly to lead to emphasis on profits and attention to variances
from profit budgets, or 2) to articulate with one another in an integrated fashion. The
former problem concerns the purposes of the system, while the latter concerns the
system's architecture or structure.
In the language of the firm's culture, the branch managers do not perceive "ownership
of tile budget." It is not their budget, but top management's budget. There is also a
problem with the accounting system as it relates to providing information for real time
decisions and control. In a sales culture such as this, tile art of completing a contract
of sale is the major point of psychological closure for a salesperson and a branch
manager. From both a legal and accounting point of view, however, the transaction
is not completed (final) until the deal "closes" (that is, all tl1e conditions of tile
transactions have been satisfied and money and deeds to property are exchanged). The
"closing" may occur 30-60-90 days or more after the deal has been reached, and by this
time salespersons and branch managers are absorbed by other potential transactions.
To deal with tile uncertainty in realization of income, tl1e firnl's accounting system
either operates on a cash basis under which income is realized and commissions paid
when escrow closes, or on an accrual basis with an "allowance for cancellations" which
is similar but not identical to an allowance for uncollectables.
Thus there is a conflict between tl1e psychological mind set of branch managers with
respect to income "earned" and tl1e accounting definition of income earned as well as
the fmancial reporting of such income. This difference has led tl1e managers to reject
and ridicule accountants and accounting systems while still being forced to accept their
dictates. Consequently, the nwubers generated by the accounting system as reported
in Company income statements are viewed as irrelevant to managers for action taking
purposes. The nwubers affect the timing oftl1e managers compensation, but are not
seen as useful.
In addition, ilie most relevant nunlbers concern sales revenues not net profit, because
the compensation system provides for an override (bonus) based upon sales not branch
profits. This is congruent wiili the sales-oriented culture of the firm, ratl1er ilian
economic theory. It is an instance of what Kerr has referred to as "the folly of
rewarding A, while hoping for B. ,,24
Effective Management Control: Theory and Practice 29
The operation of the control system at this U.S. real estate company helps to illustrate
the usefulness of the mcx:lel presented above. First, the fIrm's control system cannot be
viewed merely as a set of control techniques such as budget or accounting
measurements and reports; these control mechanisms did not motivate and control the
behavior of the fIrm's managers.
The real control system must be view~:d as the combination of the firm's culture,
structure, budgetary planning, and accounting measurement system, as summarized in
Figure 2-6. A detailed description of the specific aspects of the fIrm's control system
is shown in Figure 2-7.
Organizational
Culture:
Entrepreneurial, Sales Culture
Organizational
Structure:
Branch Managers Role
Figure 2-6
Metropolitan Residential Real Estate Firm
Diagranunatic Description of Control System
30 Organizational Control Systems: A Framework
3.0 Core Control 3.1 The firm's core control system was not designed
System as such.
Figure 2-7
Metropolitan Residential Real Estate Firm Summary of Control System
Effective Management Control: Theory and Practice 31
Using the framework developed in this chapter, these two charts help to make the
finn's control system explicit. We can see that although the firm's president states that
its objective is to control profitability. the system actually focuses upon sales. Thus
it is quite natural for the branch managers to pay little or no attention to the budget or
variances.
If the firm wishes to change the behavior of its managers, it must revise its control
system. The finn's culture ought to be revised to focus upon profits rather than sales;
the organizational structure and managerial role needs to be revised, and, also, the core
control system. Chapter 9 shall deal with the process of making such changes in the
design of control systems.
CONCLUSION
This chapter has presented a framework for describing and analyzing an organization's
control system. The framework consists of three major parts: I) A core control
system, 2) Organizational structure, and 3) Organizational culture. The core control
system consists, in turn, of five basic organizational processes or components:
Planning, operations, measurement, feedback, and evaluation-reward. Each of these
components of the core control system are organizational systems per se.
The role of each of these major parts of a control system (the core control system,
structure, and culture) will be examined in the remaining chapters. First, we shall
examine the components of the core control system (chapters three through six). Then
we shall examine the role of structure and culture in organizational control (chapter
seven).
This chapter also illustrates the practical use of this framework into the context ofan
actual organization: It described the control problems of a residential real estate firm,
and illustrated how we can use the control systems franlework to understand why the
organization's control system is not effective in motivating it desired results.
32 Organizational Control Systems: A Framework
ENDNOTES
9. This chapter draws upon Eric G. Flamholtz, "Accounting, Budgeting, and Control Systems in
Their Organizational Context: Theoretical and Empirical Perspectives, Accounting,
Organizations and Society, Vol. 8, Number 2/3, 1983, pp. 153-169.
10. The model used in this chapter is adopted from E.G. Flamholtz, T.K. Das, and AS. Tsui,
"Toward and Integrative Framework of Organizational Control," Accounting, Organizations and
Society, Vol. I 0, No.1, 1985, pp. 35-50, which, in tum, was an elaboration and extension of a
previous model by E.G. Flamholtz, "Organizational Control Systems as a Managerial Tool,"
California Management Review, Vol. 22, No.2, Winter 1979, pp. 50-59.
11. Hofstede, G., "The Poverty of Management Control Philosophy," Academy of Management
Review, July 1978, pp. 450-461.
Otley, D.T. and Berry, AJ., "Control, Organizations and Accounting," Accounting,
Organizations and Society, Vol. 5, No.2, pp. 231-244.
Weiner, N., Cybernetics, Cambridge, MA: M.LT. Press, 1948.
12. The problem ofreification need not hinder us if we view the "organization" as a proprietorship,
dominant coalition, or institution comprised of individuals and groups.
13. Hall, F.S., "Organizational Goals: The Status of Theory and Research", in 1.L. Livingstone
(Ed.), Managerial Accounting: The Behavioral Foundations, Columbus, Ohio: Grid Publishing
Company, 1975, pp.1-32.
14. Cammann, C., "Effects of the Use of Control Systems," Accounting, Organizations and Society,
Vol. 1, No.4, 1976, pp. 301-314.
Flamholtz, E.G., "Toward A Psycho-Technical Systems Paradigm of Organizational
Measurement," Decision Sciences, January 1979, pp. 71-84.
Prakash, P. and Rappaport, A, "Information Inductance and Its Significance for Accounting,"
Accounting, Organizations and Society, 1977, pp. 29-38.
Williams, J.1. and C.R. Hinings, " A Note on Matching Control System Implications with
Organizational Characteristics: ZBB and MBO Revisited", Accounting, Organizations and
Society, 1988, pp. 191-200.
15. Otley, D.T. and Berry, A.1., "Control, Organizations and Accounting," Accounting,
Organizations and Society, Vol. 5, No.2, pp. 231-244.
16. Blau, P.N. and Scott, W., Formal Organizations, San Francisco: Chandler, 1962.
Etzioni, A, A Comparative Analysis of Complex Organizations, Glencoe, IL: Free Press, 1961.
Perrow, C., "The Bureaucratic Paradox, The Efficient Organization Centralizes in Order to
Decentralize," Organization Dvnamics, 1977, pp. 3-14.
Poole, M.S. and AH. Van De Ven, "Using Paradox to Build Management and Organization
Theories", Academy of Management Review, 1989, 14: 562-578.
17. Child, 1., "Organizational Growth," in S. Kerr (Ed.), Organizational Behavior, Columbus, Ohio:
Grid Publishing Company, Inc., 1979, Chapter 16, pp. 379-399.
Yasai-Ardekani, Masoud, "Effects of Environmental Scarcity and Munificence on the
Relationship of Context to Organizational Structure", Academy of Management Journal, 1989,
32: 131-156.
Keats, Barbara Wand Michael A Hit!, "Causal Model of Linkages Among Environmental
Dimensions and Macro Organizational Characteristics," Academy of Management Journal,
1988,31: 570-598.
Miller, Danny, Cornelia Droge, and Jean-Marie Toulouse, "Strategic Process and Content as
Mediators Between Organizational Conte,,"! and Structure", Academy of Management Journal,
1988, 544-569.
18. Kroeber, AL. and Kluckhohn, C., Culture: A critical Review of Concepts and Definitions, New
York: Vintage Books, 1952.
19. Kluckhohn, C., "The Study of Culture," in D. Lerner and H.D. Laswell (Eds.). the Policy
Sciences, Stanford, CA: Stanford University Press, 1951, pp. 86-101.
Effective Management Control: Theory and Practice 33
ENDNOTES
9. This chapter draws upon Eric G. Flamholtz, "Accounting, Budgeting, and Control Systems in
Their Organizational Context: Theoretical and Empirical Perspectives, Accounting,
Organizations and Society, Vol. 8, Number 2/3, 1983, pp. 153-169.
10. The model used in this chapter is adopted from E.G. Flamholtz, T.K. Das, and AS. Tsui,
"Toward and Integrative Framework of Organizational Control," Accounting, Organizations and
Society, Vol. 10, No.1, 1985, pp. 35-50, which, in turn, was an elaboration and extension ofa
previous model by E.G. Flamholtz, "Organizational Control Systems as a Managerial Tool,"
California Management Review, Vol. 22, No.2, Winter 1979, pp. 50-59.
11. Hofstede, G., "The Poverty of Management Control Philosophy," Academy of Management
Review, July 1978, pp. 450-461.
Otley, D.T. and Berry, AJ., "Control, Organizations and Accounting," Accounting,
Organizations and Society, Vol. 5, No.2, pp. 231-244.
Weiner, N., Cybernetics, Cambridge, MA: M.l.T. Press, 1948.
12. The problem ofreification need not hinder us if we view the "organization" as a proprietorship,
dominant coalition, or institution comprised of individuals and groups.
13. Hall, F.S., "Organizational Goals: The Status of Theory and Research", in J.L. Livingstone
(Ed.), Managerial Accounting: The Behavioral Foundations, Columbus, Ohio: Grid Publishing
Company, 1975, pp.l-32.
14. Cammann, C., "Effects of the Use of Control Systems," Accounting, Organizations and Society,
Vol. 1, No.4, 1976, pp. 301-314.
Flamholtz, E.G., "Toward A Psycho-Technical Systems Paradigm of Organizational
Measurement," Decision Sciences, January 1979, pp. 71-84.
Prakash, P. and Rappaport, A, "Information Inductance and Its Significance for Accounting,"
Accounting, Organizations and Society, 1977, pp. 29-38.
Williams, 1.1. and C.R. Hinings, " A Note on Matching Control System Implications with
Organizational Characteristics: ZBB and MBO Revisited", Accounting, Organizations and
Society, 1988, pp. 191-200.
15. Otley, D.T. and Berry, A.J., "Control, Organizations and Accounting," Accounting,
Organizations and Society, Vol. 5, No.2, pp. 231-244.
16. Blau, P.N. and Scott, W., Formal Organizations, San Francisco: Chandler, 1962.
Etzioni, A, A Comparative Analysis of Complex Organizations, Glencoe, IL: Free Press, 1961.
Perrow, C., "The Bureaucratic Paradox, The Efficient Organization Centralizes in Order to
Decentralize," Organization Dvnamics, 1977, pp. 3-14.
Poole, M.S. and AH. Van De Ven, "Using Paradox to Build Management and Organization
Theories", Academy of Management Review, 1989, 14: 562-578.
17. Child, 1., "Organizational Growth," in S. Kerr (Ed.), Organizational Behavior, Columbus, Ohio:
Grid Publishing Company, Inc., 1979, Chapter 16, pp. 379-399.
Yasai-Ardekani, Masoud, "Effects of Environmental Scarcity and Munificence on the
Relationship of Context to Organizational Structure", Academy of Management Journal, 1989,
32: 131-156.
Keats, Barbara Wand Michael A Hitt, "Causal Model of Linkages Among Environmental
Dimensions and Macro Organizational Characteristics," Academy of Management Journal,
1988, 31: 570-598.
Miller, Danny, Cornelia Droge, and Jean-Marie Toulouse, "Strategic Process and Content as
Mediators Between Organizational Contell:t and Structure", Academy of Management Journal,
1988, 544-569.
18. Kroeber, AL. and Kluckhohn, C., Culture: A critical Review of Concepts and Definitions, New
York: Vintage Books, 1952.
19. Kluckhohn, C., "The Study of Culture," in D. Lerner and H.D. Laswell (Eds.), the Policy
Sciences, Stanford, CA: Stanford University Press, 1951, pp. 86-101.
34 Organizational Control Systems: A Framework
20. Ouchi, W., "A Conceptual Framework for the Design of Organizational Control Mechanisms,"
Management Science, 1979, 25, pp. 833-847.
21. The following research looks at the process of changing organization culture:
Nahavandi, A and AR. Malekzadeh, " Acculturation in Mergers and Acquisitions", 1988,
Academy of Management Review, 13: 79-90.
Weiner, Y., "Forms of Value Systems: a Focus on Organizational Effectiveness and Cultural
Change and Maintenance", Academy of Management Review, 13: 534-545
Eisenhardt, K.M. and C.B. Schoonhoven,"Organizational Growth: Linking Founding Team,
Strategy, Environment, and Growth Among U.S. Semiconductor Ventures, 1978-1988",
Administrative Science Ouarterly, 35: 504-525.
The relationship between a culture and its subcultures is explored in S.A. Sackman's "Culture
and Subcultures: An Analysis of Organizational Knowledge", Administrative Science Ouarterly,
37: 140-161.
Measuring and comparing organization cultures is explored in G. Hofstede et al.'s "Measuring
Organizational Cultures: A Qualitative and Quantitative Study Across Twenty Cases",
Administrative Science Quarterly, 35: 286-305.
22. Business Week Start: "Why Griffiths is Out as RCA Chairman," Business Week, February 9,
1981, pp. 72-73.
23. A "listing" is a contract between the principal (property owner) and agent (broker for the latter)
to have exclusive rights to sell property.
24. Kerr, S., "On The Folly of Rewarding A, While Hoping For B," Academy of Management
Journal, December 1975, pp. 769-783.
Effective Management Control: Theory and Practice 35
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Blau, P.N. and Scott, W., Fonnal Organizations, San Francisco: Chandler, 1962.
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Child, J., "Organizational Growth," in S. Kerr (Ed.), Organizational Behavior, Columbus, Ohio: Grid
Publishing Co., Inc., 1979, Chapter 16, pp. 379-399.
Cammann, C., "Effects of the Use of Control Systems," Accounting. Organizations and Society, 1,4,
1976, pp. 301-314.
Egelhofl; W.G., Organizing the Multinational Enterprise: An Infonnation Processing Perspective,
Cambridge, MA: Ballinger, 1988.
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Eisenhardt, K.M. and C.B. Schoonhoven, "Organizational Growth: Linking Founding Team, Strategy,
Environment, and Growth Among U.S. Semiconductor Ventures, 1978-1988", Administrative Science
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Etzioni, A, A Comparative Analysis of Complex Organizations, Glencoe, IL: Free Press, 1961.
Flamholtz, E.G.,"Accounting, Budgeting, and Control Systems in Their Organizational Context:
Theoretical and Empirical Perspectives", Accounting, Organizations and Society
Flamholtz, E.G., "Organizational Control Systems as a Managerial Tool," California Management
Review, Vol. 22, No.2, Winter 1979, pp. 50-59.
Flamholtz, E.G., "Toward A Psycho-Technical Systems Paradigm of Organizational Measurement,"
Decision Sciences, January 1979, pp. 71-84.
Flamholtz, E.G., Das, T.K. and Tsui, A, "Towards an Integrative Theory of Organizational Control,"
Accounting, Organizations and Society, Vol. 10, No.1, 1985, pp. 35-50.
Govindarajan, V. and Gupta, AK., "Linking Control Systems to Business Unit Strategy: Impact on
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Hall, F.S., "Organizational Goals: The Status of Theory and Research," in J.L. Livingstone (Ed.),
Managerial Accounting: The Behavioral Foundations, Columbus, Ohio: Grid Publishing Co, 1975,
pp. 1-32.
HofStede, G., ''The Poverty of Management Control Philosophy," Academy of Management Review, July
1978, pp. 450-461.
Hofstede, G. B. Neuijen, D.D. Ohayv, and G. Sanders, "Measuring Organizational Cultures: A
Qualitative and Quanitative Study across Twenty Cases", Administrative Science Quarterly, 1990,
35:286-305.
Keats, Barbara W. and Michael A Hitt, "Causal Model of Linkages Among the Environmental
Dimensions and Macro Organizational Chara(teristics," Academy of Management Journal, 1988,31:
570-598.
Kerr, S., "On The Folly of Rewarding A, While Hoping For B," Academy of Management Journal,
December 1975, pp. 769-783.
Kluckhohn, C., "The Study of Culture," in D. Lerner and H.D. Laswell (Eds.), The Policy Sciences,
Stanford, CA: Stanford University Press, 1951, pp. 86-101.
Kroeber, AL. and Kluckhohn, C., Culture: A Critical Review of Concepts and Definitions, New York:
Vintage Books, 1952.
Martinez, J.1. and Jarillo, J.C., ''The Evolution of Research on Coordination Mechanisms in Multinational
Corporations," Journal oflnternational Business Studies, 1989.
Miller, Danny, Cornelia Droge, and Jean-Marie Toulouse, "Strategic Process and Content as Mediators
Between Organizational Conte1l.1 and Structure"" Academy of Management Journal, 1988,31 :544-569.
Nahavand~ A and AR. Malekzadeh, "Acculturation in Mergers and Acquisitions", 1988, Academy of
Management Review, 13: 79-90.
Otley, D.T. and Berry, AJ., "Control, Organizations and Accounting," Accounting, Organizations and
Society, 5,2, pp. 231-244.
36 Organizational Control Systems: A Framework
Ouchi, W., "A Conceptual Framework for the Design of Organizational Control Mechanisms,"
Management Science, 1979,25, pp. 833-847.
Perrow, C., "The Bureaucratic Paradox, The Efficient Organization Centralizes in Order to Decentralize,"
Organization Dynamics, 1977, pp. 3-14.
Poole, M.S. and A.H. Van De Ven, "Using Paradox to Build Management and Organization Theories",
Academy of Management Review, 1989, 14:562-568.
Prakash, P. and Rappaport, A., "Information Inductance and Its Significance for Accounting,"
Accounting. Organizations and Society, 1977, pp. 29-38.
Sackman, SA., "Culture and Subcultures: An Analysis of Organizational Knowledge", Administrative
Science Quarterly, 1992,37: 140-161.
Weiner, N., Cybernetics, Cambridge, MA: M.LT. Press, 1948.
Weiner, Y., "Forms of Value Systems: A Focus on Organizational Effectiveness and Cultural Change and
Maintenance", Academy of Management Review, 13: 534-545.
Williams, J.J. and C.R. Hinings, "A Note on Matching Control System Implications and Organizational
Characteristics: ZBB and MBO Revisited:, Accounting. Organizations and Society, 1988, pp 191-200.
Yasai-Ardekani, Masoud, "Effects of Environmental Scarcity and Muniference on the Relationship of
Context to Organizational Structure," Academy of Management Journal, 1989,32: 131-156.
3
THE ROLE OF PLANNING
IN CONTROL
In its broadest sense, "planning" is the process of deciding about the objectives of an
organization and the ways to attain those objectives. It involves analyzing an
organization's environment, assessing potential opportunities, fonnulating general
objectives and specific goals, as well as developing action plans to attain them.
Although many organizations develop plans, not all organizations which have them are
successful in their implementation. In many organizations, once plans are made, they
tend to gather dust and are not meaningful as a management tool. This problem
typically occurs because the planning system in an enterprise is seen as something
independent from the organization's control system. This suggests that we need to
understand the relationship between planning and control as a vehicle to better
implement an organization's plans.
There is also another reason for examining the relationship between planning and
control, and that is because planning plays a critical role in the process of
organizational control itself The planning system is itself an integral part of an overall
control system. In fact, it is the starting point for the entire control process.
This chapter, therefore, suggests the need to examine the symbiotic relationship
between planning and control. First we shall exanline the nature of planning per se,
as well as the components of the planning process. Then we will examine the
relationship between planning and control, and the role that planning plays as part of
a control system. An implicit assumption here is that planning is perhaps better
understood as a component of an overall control system, rather than as a stand alone
process per se.
An "action definition" (or operational definition) tells us not only what something is,
but how to do it. Defined in action-oriented temls, planning is the process of deciding
about the:
This definition treats planning as a set of four related steps. First, the organization's
mission must be defined. Next, the key result areas necessary to accomplish the
mission are developed. Then objectives and goals are established for each key result
area. Finally, action plans are developed for achieving each goal.
These four components of the planning system are shown schematically in Figure 3-1.
This section describes and illustrates the four components of a planning system:
mission, key result areas, objectives and goals, and action plans. Each component is
examined, in turn, below.
Mission
"To develop into the leading full service distributor of industrial abrasives in
the western United States by 1998."
This is a broad statement of what Industrial Abrasives, Inc. wants to achieve by the
end of a five year planning period.
Another example of a mission statement for a medium-sized residential real estate firm
is:
"To develop into a full service residential real estate company, providing
services throughout the northern part of the state. In order to become a full
service residential real estate firnl, we must add to the present service
capabilities in: guaranteed sales, condo-conversion, tract sales, investment
counseling, and primary mortgages."
This is a broad statement of what Industrial Abrasives, Inc. wants to achieve by the
end of a five year planning period.
Effective Management Control: Theory and Practice 39
MISSION
;
I
,
KEY RESULT AREAS
I
OBJECTIVES
I
;
GOALS
;
I
ACTION STEPS
I
1. Mission Broad statement of what the organization wants to
achieve during the planning period.
2. Key Result Areas These are the performance areas that are critical to
achieving the organization's mission.
Figure 3-1
Components of the Planning System
40 The Role of Planning in Control
Another example of a mission statement for a medium-sized residential real estate firm
is:
"To develop into a full service residential real estate company, providing
services throughout the northern part of the state. In order to become a full
service residential real estate firm, we must add to the present service
capabilities in: guaranteed sales, condo-conversion, tract sales, investment
counseling, and primary mortgages."
In fact, this was, during the 1980's, the actual mission of United Airlines (VAL),
which, briefly changed its name to Allegis to reflect this change before it reversed its
strategic direction. As part of its strategic plan, UAL had acquired hotels (The Westin
and Hilton International chains), a car rental company (Hertz), and had established its
own travel company.
Missions can be developed not only for an organization as a whole, but for specific
subunits as well. For example, the mission statement for the personnel department of
a bank with assets in excess of$1 billion is:
In brief, the mission statement is the starting point of the planning process.
Effective Management Control: Theory and Practice 41
Key result areas are areas of an organization's operation where perfonnance has a
critical impact upon the achievement of the overall mission. If performance in a key
result area is unsatisfactory, it will inhibit the organization from achieving its mission.
The specific key result areas vary from organization to organization and each firm must
identi1Y those which are relevant to its mission. In the industrial abrasives firm cited
above, there were five key result areas:
l. profitability,
2. fmancial planning,
3. management and organizational development,
4. physical plan and equipment, and
5. marketing capabilities.
In the residential real estate finn, key results were classified into two groups: I)
fmancial results, and 2) non-financial results. In the financial result area, there were
two major dimensions: 1) company profitability, and 2) profit contribution by
departments of the firm. In the non-financial area, there were five key result
dimensions:
1. company integration,
2. services offered,
3. personnel development,
4. administration of the firm, and
5. research.
The specific key result areas for a department, division, or other subunit of a firm will
differ from those of the overall entity. For example, the key result areas for the
personnel department of a bank were:
In brief, key result areas are an outgrowth of the mission, and vary from organization
to organization.
42 The Role of Planning in Control
Objectives are things which an organization or subunit wants to achieve in the long run
in each key result area. An objective is a relatively general statement of what is to be
achieved in an area, rather than a precise goal. Goals are specific things that the
organization wants to attain by a specified time. 25
In the area of profit, an objective may be "to earn a satisfactory return on investment."
A specific goal is: "To earn a minimum of 18% ROI before taxes in each operating
division.
Action Plans
Action plans specify activities or steps which must be performed to achieve a goal.
Although action plans are not necessary for all goals, these are useful for achieving
relatively complex projects or tasks.
Without a control process, planning is either less useful than it can be or completely
meaningless. Many corporate plans are developed and then placed in drawers or on
a shelf to gather dust. Little or no attention is paid to them, and they have no impact
on operations.
Effective Management Control: Theory and Practice 43
Just as planning is not likely to be effective without being linked to its other
components of the core control system, the core control system as a whole is not likely
to fimction well without these key planning components. The control process begins
with the planning process. The plan specifies the direction of what the organization
wants to achieve. It establishes a mission, key result areas, objectives, and goals.
Without these things, control is direction less.
The discussion above suggests that the optimal way of thinking about planning is that
it is an integral component of an organization's core control system. Since planning
is essential for control and since it does not function effectively in isolation, we must
treat it as a component of control rather than a stand alone system.
The specific steps in developing a plan are summarized in a flow diagram shown in
Figure 3-2. It shows that the development of a formal plan is a seven-step process:
beginning from the analysis and definition of a firm's business.
To illustrate the process and output of an organizational plan, we shall examine the
planning process ofa service company. The firm is the medium-sized residential real
estate company introduced in Chapter 2. We shall refer to this company as
"Metropolitan Realty, Inc."
By examining the step by step process of developing a plan for this company, we can
better appreciate the meaning of the components of a plan and the nature of the overall
44 The Role of Planning in Control
1.0
ANALYZE AND DEFINE
NATURE OF FIRM'S BUSINESS
2.0
ASSESS FUTURE
BUSINESS SITUATION
3.0
DEVELOP MISSION
FOR FIRM
~
4.0
IDENTIFY AND ANALYZE
KEY RESULT AREAS
t
5.0
DEVELOP OBJECTIVES, GOALS
AND TARGETS FOR
KEY RESULT AREAS
t
6.0
DEVELOP ACTION PLANS
t
7.0
DEVELOP
WRITTEN BUSINESS PLAN
Figure 3-2
Flow Diagram of Steps in the Planning
Effective Management Control: Theory and Practice 45
planning process. This, in turn, will provide a context for illustrating the role of
planning in control.
Concept of Business
As part of the annual planning process MRI identified the alternative concepts of
business to guide its operations. The purpose of developing a concept of the business
is to provide direction for corporate efforts and to identify or help create a market niche
or competitive difference for the company. The alternative concepts of the business are
shown in Figure 3-3 and described below.
This concept of the business (Concept A) sees MRI specializing in residential real
estate brokerage with some minimal level of support from other areas, which operate
independently. This is the fimI'S present strategy. Following this concept MRI would
add more brokerage offices and maintain otller functional areas of real estate at their
present levels.
Concept (B) would involve becoming a firm capable of serving all of a client's
residential real needs. It would involve: identifying the full set of services required in
residential real estate and building the capability of supplying those services.
An analysis of MRI's major competitors indicates tltat most of them are moving toward
full service residential real estate firms, with the exception of two major corporations.
1. More Offices
2. Mortgages
3. Leasing!Property Management
4. Special Projects
___ Services to
.....
be added
.......-1-_ Services to
be added
Figure 3-3
Alternative Concepts of Business
Effective Management Control: Theory and Practice 47
toward this type of business, at the present time revenues were not sufficient to allow
adoption of this concept.
In order to choose among these concepts at the Annual Review and Planning meeting,
a number of questions were analyzed such as those shown in Figure 3-4. It was
decided that for the next five years MRI should develop toward the concept of a full
service residential real estate firm.
Corporate Mission
Based upon our planning meeting, the mission ofMRI is to develop into a full service
residential real estate company, providing services throughout the northern part of the
state. In order to become a full service residential real estate company MRI must add
to its present services capability in the following areas: marketing, guaranteed sales,
cond<KOnversiol\ tract sales, investment counseling and sales, and primary mortgages.
Objectives
Over the next five years the objectives are to work toward the corporate mission of
becoming the leading full service residential real estate firm in the area. In order to do
this both financial and non-financial objectives were defined for the period 1991-1995,
as follows:
Financial Objectives
Non-Financial Objectives
Services - To review new and existing services in order to evaluate each and
recommend addition, deletion, or expansion of these services.
1.0 Analyze and Define 1.1 What is the nature of our business?
Nature of Firm's 1.1.1 Services
Business 1.1.2 Markets and customers
1.1.3 Competition
1.2 What is the firm's market niche and
competitive advantage?
1.2.1 Do we have a special niche in
the market?
1.2.2 What distinguishes us from our
competition?
2.0 Assess Future Business 2.1 What will our industry be like in five
Situation year?
2.1.1 Trends
2.1.2 Opportunities
2.1.3 Threats
4.0 Identify and Analyze 4.1 What must the firm do during the next
Key Result Areas five years to achieve its mission?
4.2 What are the Key Result Areas of the
business?
4.3 What are our current strengths and
limitations in each Key Result Area?
5.0 Develop Objectives and 5.1 What are our objectives in each area?
Goals for Key Result 5.2 What are our goals in each Key Result
Areas Area?
6.0 Develop Plans for 6.1 What are our priorities for developing
Implementing programs in various Key Result Areas?
Objectives and Goals 6.2 Who is responsible for developing
programs in each area?
6.3 What steps must be taken to achieve
objectives and goals in each result area?
Figure 3-4
Planning Steps and Related Issues
Effective Management Control: Theory and Practice 49
Goals
Financial Goals
Profit - To reach profit for 1993-1995 of 10% - minimum, 15% - most likely, and 20%
- ideal, of gross revenue, after all costs have been considered.
Costs - To establish a standard of costs per employee, both direct and non-direct, with
the minimum - $750, most likely - $850, and maximum - $1,000.
Non-Financial Goals
The preceding section has presented portions of a business plan for a company to
illustrate the nature and output of the planning process. As seen in the control systems
model in Chapter 2, planning is the first phase of the control process. It specifies what
the organization seeks to accomplish.
By specifYing the organization's direction, a focus for efforts is given. This in itself is
a form of control. However, the more specific statement of key result areas, objectives,
and goals increases the degree and effectiveness of control.
In brief, planning provides the targets for the operational system to achieve. Hence it
represents the beginning of the control process in organizations. A written business
plan, such as the one illustrated for Metropolitan Realty, Inc., helps facilitate the
planning aspect of the control process, by providing the objectives and goals against
which performance can be measured and evaluated.
Once the plan has been developed, we have established the mission the organization
seeks to attain as well as specific key result areas and related objectives and goals
which must be achieved. These provide focus for people's decisions and actions.
Effective Management Control: Theory and Practice 51
ENDNOTES
25. For more discussion on goals and objectives and their impact on performance, see:
Chesney, AA and EA Locke, 1991, "Relationships Among Goal Difficulty, Business
Strategies, and Performance on a Complex Management Simulation Task", Academy of
Management Journal, 34: 162-193.
Erez, M., P.C. Earley, and C.L. Hulin, 1985, "Impact of Participation on Goal Acceptance and
Performance: a Two-Step Model", Academy of Management Journal, 28: 50-66.
Earley, P.C., T. Connolly, and G. Ekegren, 1989, "Goals, Strategy Development, and Task
Performance: Some Limits on the Efficacy of Goal Setting", Journal of Applied Psychology, 74:
24-33.
26. For research on the relationship of goals and motivation see:
Shalley, C.E., G.R. Oldham, and J.F. Porac, 1987, "Effects of Goal Difficulty, Goal-Setting
Method, and Expected External Evaluation on Intrinsic Motivation", Academy of Management
Journal: 30: 553-563.
Shalley, C.E. and G.R. Oldham, 1985, "Effects of Goal Difficulty and Expected External
Evaluation on Intrinsic Motivation: A Laboratory Study", Academy of Management Journal: 28:
628-640.
Tubbs, M.E. and S.E. Ekeberg, 1991, "The Role ofintentions in Work Motivation: Implications
for Goal-Setting Theory and Research", Academy of Management Review, 16: 188-199.
Sullivan, 1., 1988, "Three Roles of Languagt: in Motivation Theory", Academy of Management
Review, 13, 104-115.
27. For research on the relationship between goals and control, see:
Green, S.E. and M.A Welsh, 1988, "Cybernetics and Dependence: Reframing the Control
Concept", Academy of Management Review, 13,287-301.
52 The Role of Planning in Control
REFERENCES
Chesney, AA and E.A. Locke, 1991, "Relationships Among Goal Difficulty, Business Strategies, and
Performance on a Complex Management Simulation Task", Academy of Management Journal, 34:
162-193.
Earley, P.C., T. Connolly, and G. Ekegren, 1989, "Goals, Strategy Development, and Task Performance:
Some Limits on the Efficacy of Goal Setting", Journal of Applied Psychology, 74: 24-33.
Erez, M., P.C. Earley, and C.L. Hulin, 1985, "Impact of Participation on Goal Acceptance and
Performance: a Two-Step Model", Academy of Management Journal, 28: 50-66.
Green, S.E. and M.A Welsh, 1988, "Cybernetics and Dependence: Reframing the Control Concept",
Academy of Management Review, 13,287-301.
Shalley, C.E. and G.R. Oldham, 1985, "Effects of Goal Difficulty and Expected External Evaluation on
Intrinsic Motivation: A Laboratory Study", Academy of Management Journal: 28: 628-640.
Shalley, C.E., G.R. Oldham, and J.F. Porac, 1987, "Effects of Goal Difficulty, Goal-Setting Method, and
Expected External Evaluation on Intrinsic Motivation", Academy of Management Journal: 30: 553-
563.
Sullivan, J., 1988, 'Three Roles of Language in Motivation Theory", Academy of Management Review,
13,104-115.
Tubbs, M.E. and S.E. Ekeberg, 1991, 'The Role of Intentions in Work Motivation: Implications for Goal-
Setting Theory and Research", Academy of Management Review, 16: 188-199.
4
THE ROLE OF MEASUREMENT
AND FEEDBACK IN CONTROL
This chapter examines the role of "measurement" and "feedback" in organizational
control. 28 We shall develop a framework for viewing the measurement and feedback
as components of a core control system from the perspective of attempts to influence
human behavior, rather than to merely represent things in numerical terms. The
framework is termed the "Psycho-Technical Systems" (or PTS) model of
measurement. 29
It is important to recognize that there are different concepts of the raison d'etre of
measurement. Three alternative concepts of the purpose of measurement are:
Each of these notions are examined below in the context of a discussion of the
prevailing measurement paradigm as we:ll as the PTS model.
Different interpretations can be made of the extent to which the raison d'etre underlying
the traditional paradigm is "measurement as an end in itself' or "measurement as a
means to an end." In physical science, we may be concerned with measuring some
phenomenon such as the speed oflight either as an end in itself simply because it is an
aspect of nature, or as a means toward some specified end. In effect, there is merely
a difference in the degree to which a purpose for the measurement has been specified,
and this may vary from a very tenuous specification to one that is much more precise.
Thus we can view these notions of raison d'etre as points on a continuum, rather than
as discrete classes, as shown in Figure 4-1.
In accounting in the U.S. prior to the 1960's, the prevailing measurement paradigm
treated accounting measurement between points (A) and (B) on the continuum shown
in Figure 4-1, that is, it tended to be viewed somewhere between an end in itself and
as a means to an end. More specifically, it was intended to represent economic
transactions per se rather than necessarily be useful for decisions. This is analogous
to the measurement of temperature in physical sciences. This can be used as a general
purpose measurement with specific uses unspecified, or for a very well defined
purpose.
This alternative concept of the role of measurement in organizations has been evolving
for many years; but it has neither been explicitly accepted as ilie basis of a new
paradigm of organizational measurement, nor has it been developed into a formal
model with premises, propositions, and criteria. In brief, a meta-theory of
measurement based upon the notion of behavioral influence does not yet exist.
In previous research, an attempt was made to formulate the basic ideas of the
alternative behavioral model of measurement. This meta-theory of measurement was
termed a "Psycho-technical Systems" (PTS) approach.34
Effective Management Control: Theory and Practice 55
Figure 4-1
Continuum of Notions of
Raison d'etre Underlying Measurement
The PTS model is based upon the notion that the principal difference between
measurement systems used in organizations ("organizational measurement systems")
and those developed for use in physical science is the degree to which the former are
intended to have functions other than merely representation of objects in numerical
terms. Organizational measurement systems are typically intended to perform a
representational function not as an end in itself, but rather, as a means of ultimately
influencing human behavior. This point is illustrated systematically in Figure 4-2. As
shown in Figure 4-2, both physical science and organizational measurement require
representation as well as direct behavioral effect. But they differ in the degree or
proportion of these desired properties.
The term "psycho-technical system" is used here to refer to any technology that is
intended to perfonn or effect certain predefined psychological (behavioral) functions.
The term "technology" as it is used here means something different from machine
technology. It is used in the sense propos1ed by Jaques Ellul and refers to any complex
of standardized means for attaining a predetermined result. 35 Thus, a psycho-technical
measurement system is intended to perform certain predefined psychological
(behavioral) functions through the process and output of measurement.
56 The Role of Measurement and Feedback in Control
Amount of
Representation
Required
Amount of
Direct Behaviorial
Effect Required
Physical Organizational
Science Management
Figure 4-2
Relation Between Amounts of Representation and
Direct Behavioral Effect Required on
Physical Science and Organizations
The PTS model is based on the notion that the principal purpose of measurement in
organizations is to influence human behavior. Under this model, behavior is the end
result of measurement. Accordingly, this presupposes that the designers of an
organizational measurement system have a concept of the desired behavioral outcomes
their systems are intended to produce. This requires, in turn, that the design of
organizational measurement systems must be based upon a blueprint of expected
behaviors. At present, we must admit that the technology to blueprint expected
behaviors form measurement systems is not well developed; this is an area for future
research.
Domains of Measurement
In the context of human organizations, there are three domains of measurements: (1)
the sender's behavior, (2) the receiver's behavior, and (3) the phenomenon being
measured. The "sender" refers to the person(s) required to measure some object or
phenomenon. The "receiver" refers to the person(s) who receive measurements. The
Effective Management Control: Theory and Practice 57
"phenomenon" being measured refers to the object to which the rules of measurement
are applied.
Prior research has not explicitly recognized and developed a total systems view of the
effects of the act of measurement; rather, recognition of its significance has been in bits
and pieces. For example, Prakash & Rappaport have examined the effects of the act
of measurement upon the information sender, but not upon the information receiver
or the phenomenon being measured itself. 36 In addition, most studies recognizing the
effects of the act of measurement upon receivers have viewed the phenomenon as an
aberration, rather than as a normal inherent part of the measurement process.
Elements of Measurement
A basic premise underlying the PTS framework is that there are two major elements
of measurement: (1) the numbers produced by a measurement system and (2) the act
or measurement itself.
The numbers produced by measurement are the outputs of the measurement system.
They are typically intended to provide information for decision-making or evaluation
(feedback). They are an important element, but not the only element, or measurement.
The second element of measurement is the process or act of measurement per se. The
very act of measuring some object or phenomenon may have certain functions in the
context of organizations.
Figure 4-3 shows schematically the relation between the domains and elements of
measurement. Under the PTS concept, we are concerned about a dual aspect of the
effect of measurement: (1) the effi~cts of the measurement process or act of
measurement upon the phenomenon measured per se and (2) the effects of the output
of the measurement system, the nwnbers produced, upon all three domains of
measurement.
Measurement Domains
Measurement
Elements Sender Receiver Phenomena
Measured
Output
Process
Figure 4-3
Relation Between Domains and Elements
Each of these two elements of measurement (process and output) have different
subfunctions. The process element of measurement (the act of measurement) perfonns
four basic functions: (1) the criterion function, (2) the catalyst function, (3) the set
function and (4) the motivational function. These four process functions of
measurement, shown schematically in Figure 4-4, are described in the subsequent
section. The output element of measurement (the numbers provided by measurement)
has two basic functions: (1) infonnation for decision making, and (2) infonnation for
feedback (evaluative feedback and corrective feedback). These two output functions
of measurement, shown schematically in Figure 4-4, are examined below.
Output
Measurement
I--"~I System Functions:
Numbers for
Decision.
Evaluation
(Feedback)
Process
Functions:
• Criterion
• Catalyst
• Set
• Motivational
Figure 4-4
Elements of Measurement
The role of the measurement system as a model of the decision maker's "world" may
be better appreciated by drawing upon th,e work of Piaget. In discussing Piaget's ideas,
Carroll states that: 38
"The unifYing theme in the work of Pia get is the gradual unfolding of the
individual's ability to construct an internal "model" of the universe around
him and to perform manipulations on that model so as to draw conclusions
about the probable past history of his environment as the probable results of
possible actions that could be taken upon that environment. The ability to do
this is the essence of all "thinking" in the non-trivial meaning of the term."
Thus, the measurement system provides an implicit model or set of criteria through
which the decision maker organizes thought.
The need for such structured thought is derived from limits on man's cognitive
60 The Role of Measurement and Feedback in Control
Another way oflooking at the criterion function is that it performs the "coding" process
described by Katz and Kahn. 40
We can illustrate the role of the criterion function in the context of human-resource
management, which, to a very great extent, consists of decision making. Management
continuously makes decisions involving the acquisition, development, allocation, and
compensation of human resources. For example, since people differ in such qualities
as intelligence, skills, motivation, and personality, management must decide what
qualities are desirable in people recruited into a fiml. It must also evaluate possible
job candidates and select people. Similarly, management must decide how to allocate
its existing people to roles. It must also decide if the firm should invest in specialized
training programs.
The development of Human Resource Accounting (HRA) measures is, in part, based
on the recognition of the need for such a criterion. 41 The criterion suggested by HRA
is a person's value to an organization. For example in Human-resource-acquisition
decisions, the criterion used in selecting people should be the expected value of people
to the organization. Similarly, in human-resource-development decisions, the criterion
should be the expected increase in human-resource value, as reflected in the return on
investment. In addition, in deciding whom to retain in layoff decisions, the criterion
should be the relative value of people to the enterprise. These examples are intended
to be illustrative and not exhaustive.
The catalyst function of the act of measurement is related to what Prakash and
Rappaport have tenned "infonnation inductance." As they state: "Information
inductance is the process whereby the behavior of an individual is affected by the
infonnation he is required to communicate. ,,43 Similarly, measurement serves as a
catalyst to cause an individual to consider the variables which are inputs to the
measurement process.
The effects of the catalyst function can be illustrated in the context of operational
budgeting. Budgets involve forecasts of future parameters (costs, revenues, production
rates, etc.). Consequently, there may be a great degree of certainty in the numbers
derived from the budgeting process. However, through the process of measuring the
parameters included in a budget, managers may be caused to consider the effects of
those variables. This is especially true for the case of multiplan (flexible) budgeting.
Thus the calculation or measurement of variables in a budget is a catalyst to systematic
operational planning.
be available, the probabilities that these people will occupy various positions, their
need for training and development to enhance promotability, their transferability, and
the likelihood that they will remain in the firm. Thus, in the measurement of human-
resource value, the numbers produced may not be as important as the process that must
be employed to derive those numbers. This suggests that subjectivity involved in
measuring such contrasts as human-resource value may not be a critical limitation; for
even though the numbers derived may be uncertain, the measurement process may
cause systematic planning to occur.
Although the process is not quite so direct, the act of measurement may lead to changes
in the direction of motivation. As Ridgeway states: "Even where performance
measures are instituted purely for purposes of information, they are probably
interpreted as definitions of the important aspects of their job or activity and hence
have important implications of the motivation of behavior. ,,46
The measurement process can also play a motivational role in the content of the
human-resource management process. For example, measures of human-resource
value may be used to motivate human-resource development and conservation. If the
value of hwnan resources under a manager's stewardship is measured, we anticipate
that the manager will pay attention to, and be concerned about, changes in human-
resource value. For example, if one factor used in evaluating the performance of
managing partners in local CPA firm offices is the change in human-resource value
attributable to development, we may expect that a greater degree of attention will be
devoted to the development process. The manager may begin to ask himself: "How
can I utilize this person in a way that will enhance his value to the firm?" Thus the
measurement process rather than the numbers per se influence the decisions of
managers in this situation.
The four process functions examined above are closely related. Intuitively, they may
be viewed as comprising two different dimensions. The first type of dimension (type
1) is the criterion function, and the second (type 2) is the other three functions:
catalyst, set, and motivational.
Type 1 is concerned with providing a focus for thought and analysis. Is provides and
operational goal to guide decisions. Typ(~ 2 are all concerned with different aspects of
influencing behavior. They may be viewed as different degrees of effect on behavior
as shown in Figure 4-5.
Type 1 Degree of
Process Process Function Effect on
FunctIons Descnphon BehaVlor
.
Figure 4-5
Degrees of Effect of
Type I Process Functions on Behavior
The traditional notion of "validity" refers to the extent a measurement represents what
it purports to represent. "Reliability" refers to the reproductability of the measurement.
Both of these constructs are representational constructs.
With a shift to a PTS concept of measurement based upon recognition of the functions
of the measurement process, the traditional criteria are insufficient (and perhaps
sometimes irrelevant). Instead, a different set of criteria are required which are based
upon the PTS view.
Two tentative PTS measurement criteria have been proposed which are relevant here:
(1) behavioral validity and (2) behavioral reliability.48 "Behavioral validity" refers to
the extent to which a measurement process leads to the behaviors it is intended to
produce. It does not concern itself with the issue of whether the measure represents the
object being measured in a valid way; but, rather, whether the intended effects (or
behaviors) occur. "Behavioral reliability" refers to the extent to which the behavioral
outcomes produced by the measurement process are consistently produced. It does not
concern itself with the representational reliability of measures. In principle, the
constructs of behavioral validity and reliability are independent. A measurement
system may lead to behaviors it purports to lead to, but do so unreliably. Alternatively,
it may lead to invalid (unintended) behaviors quite consistently.
A behaviorally valid measure is one that leads to intended consequences and the degree
of behavioral validity is the extent to which this occurs. For example, the behavioral
purpose of a measurement system may be to motivate managers to pay attention to
human resource development as well as to current productivity. It may not be possible
to develop a measure of personnel development with a high degree of representational
Effective Management Control: Theory and Practice 65
validity. Yet it may be possible to construct a measure that has behavioral validity,
because by simply measuring employee development in some manner decision-maker
may be motivated to increase it (the motivational function). The measure's behavioral
reliability is the extent to which it consistently produces concern for employee
development.
In brief, the basic argument here is that the different purposes of measurement require
different criteria. The weight placed upon behavioral criteria is greater than upon
representational criteria when the purpose of measurement is direct behavioral
influence, and vice versa. This is shown schematically in Figure 4-6.
Figure 4-6
Different Measurement Criteria Weights for
Different Measurement Purposes
The prior analysis of the subfunctions of the measurement process has been based on
the notion of measurement as a PTS. It has been proposed that the measurement
process has certain built-in psychological functions for decision makers.
Their responses to the question suggest that the very fact that "firm B" was measuring
investment in hwnan resources had an effect on the subjects' decision processes. It led
to different perceptions of the firms and their managements. Some of the subjects
specifically referred to hwnan resources as reasons for their judgments of management
and noted that the firm measuring human resources was "more progressive. "
As discussed in Chapter 3, there are two types of feedback infonnation: (1) corrective
feedback and (2) evaluative feedback. The fonner provides infonnation for the
adjustment of operations in order to confinn more closely to plan, while the latter
provides infonnation to be used in assessing the quality of perfonnance. This latter
function shall be examined in Chapter 5.
CONCLUSION
This chapter has examined the role of measurement and feedback in control. The
framework of measurement adopted here is based upon the notion that measurement
process is a "psycho-technical system," a technology designed to influence human
behavior, rather than merely a representational technology.
According to the PTS model, measurement has two basic elements: (1) the numbers
produced and (2) the act of measurement itself The numbers produced are the outputs
of the measurement system and perfonn two subfunctions: a) they provide infonnation
for decision-making, and b) feedback infonnation for perfonnance evaluation. The act
of measurement itself, tenned measurement's process function, perfonned four related
subfunctions; it serves as: a) a criterion for decision-making, b) a catalyst for
systematic planning, c) a way of influencing a decision-makers set, and d) a mechanism
for motivating attention to relevant perJunnance (or result) areas.
ENDNOTES
44. This research study suggests how the presence or absence of human-resource value (HRV)
measures can influence a decision maker's set. In this study, using a test-retest design, decision
makers were asked to choose between two individuals for ajob assignment (allocations) in a
CPA finn. In the first test, they were presented with traditional perfonnance appraisal data on
which to base decisions. The decision makers were also asked to indicate their reasons for their
choice. Their responses were content-analyzed and found to be primarily concerned with the
relative capabilities of value of the people to either (1) serve the finn's current needs or (2) serve
the needs of the client. They did not consider the needs of the individuals assigned or the effect
of the anticipated assignment on their value to the finn. In the second test, they were presented
with nonmonetary human-resource valuation data. Specifically, they received estimates of
assessments of the expected promotability of the staff and the probability that they would
remain in the finn. The rationale for these decisions was also content analyzed, and the results
indicated that a significantly greater percentage of the reasons concerned the effect of the job
assignment upon the individual's value to the finn than to either serve the finn's or client's
needs. The third retest presented the subj<:ct with monetary data about the individual's expected
value. The content analysis indicated a significant change in the set used to reach the decision.
In brief; the presence of the HRV measures stimulated a different way of thinking about the
decisions; there was a change in the proportion of people using each factor to select each staff
accountant for the job assignment from the: first to second to third tests.
45. Ijiri, Yuji, The Foundations of Accounting Measurement, Englewood Cliffs, NJ: Prentice-Hall,
Inc., 1967, p. 158.
46. Ridgeway, V.F., "Dysfunctional Consequences ofPerfonnance Measurements," Administrative
Science Ouarterly, September, 1956, p. 247.
47. Cammann, C., "The Impact ofa Feedback System on Managerial Attitudes and Perfonnance,"
Unpublished Ph.D. dissertation, Yale University, 1974.
48. Flamholtz, Eric, "Toward a Psycho-Technical Systems Paradigm of Organizational
Measurement," Decision Sciences, January, 1979, pp. 82-83.
49. McLuhan, M., Understanding Media: The: Extensions of Man, New York: McGraw-Hili Book
Company, 1964.
50. Schwan, E.S., "The Effects of Human Resource Accounting Data on Financial Decisions: An
Empirical Test," Accounting, Organizations and Society, 1976, pp. 219-238.
51. For a more detailed discussion of various aspects offeedback, see:
Ashford, SJ. and A.S. Tsui, 1991, "Self Regulation for Managerial Effectiveness: The Role of
Active Feedback Seeking", Academy of Management Journal, 34: 251-280.
Baron, Robert A., 1990, "Countering the Effects of Destructive Criticism: The Relative Efficacy
of Four Interventions", Journal of Applied Psychology, 75: 235-245.
Earley, P.C., G.B. Northcraft, C. Lee, T.R. Lituchy, 1990, "The Impact of Process and Outcome
Feedback on the Relation of Goal Setting to Task Perfonnance", Academy of Management
Journal, 33, 87-105.
Hedge, J.W. and M.J. Kavanagh, 1988, "Improving the Accuracy ofPerfonnance Evaluations:
Comparison of Three Methods ofPerfonnance Appraiser Training", Journal of Applied
Psychology, 73: 68-73.
Klein, 1.1., 1990, "Feasibility Theory: A Resource-Munificence Model of Work Motivation and
Behavior", Academy of Management Revi~ 15: 646-665.
Matsui, T., T. Kakuyama, and M.L.U. Onglato, 1987, "Effects of Goals and Feedback on
Perfonnance in Groups", Journal of Applied Psvchology, 72: 407-415.
Vance, R.J. and A. Colella, 1990, "Effects of Two Types of Feedback on Goal Acceptance and
Personal Goals, Journal of Applied Psychology, 75: 68-76.
70 The Role of Measurement and Feedback in Control
REFERENCES
Ashford, S.J. and AS. Tsui, 1991, "Self Regulation for Managerial Effectiveness: The Role of Active
Feedback Seeking", Academy of Management Journal, 34: 251-280.
Baron, RobertA, 1990, "Countering the Effects of Destructive Criticism: The Relative Efficacy of Four
Interventions", Journal of Applied Psychology, 75: 235-245.
Birnberg, J.G. and Snodgrass, C., "Culture and Control: A Field Study," Accounting, Organizations and
Society, Vol. 13, No.5, 1988, pp. 447-464.
Cammann, C., "The Impact of a Feedback System on Managerial Attitudes and Performance,"
Unpublished Ph.D. dissertation, Yale University, 1974.
Campbell, N.R., Foundations of Science, New York, NY: Dover Publications, 1957.
Carroll, J.B., Language and Thought, Englewood Cliffs, NJ: Prentice-Hall, Inc., 1964.
Earley, P.C., G.B. Northcraft, C. Lee, T.R. Lituchy, 1990, "The Impact of Process and Outcome
Feedback on the Relation of Goal Setting to Task Performance", Academy of Management Journal,
33,87-105.
Eisenhardt, K.M., "Control: Organizational and Economic Approaches," Management Science, Vol. 31,
1985, pp. 134-149.
Ellul, J., The Technological Society, New York: Alfred A Knop~ 1964.
Flamholtz, Eric, Growing Pains: How To Make The Transition From Entrepreneurship to a
Professionally Managed Firm, San Francisco, CA: Jossey-Bass Publishers, Inc., 1990.
FIamholtz, Eric, Human Resource Accounting, San Francisco, CA: Jossey-Bass Publishers, Inc., 1985.
Flamholtz, Eric, "Toward a Psycho-Technical Systems Paradigm of Organizational Measurement,"
Decision Sciences (January, 1979), pp. 71-84.
Gardner, W.R., "Attention: The Processing of Multiple Sources of Information," Handbook of
Perception, Vol. II: Psychophysical Judgement and Measurement, Edited by E. Carterette and M.
Friedman. New York: Academic Press, 1974, pp. 23-59.
Grove, H.T., Mock, J. and Ehrenreich, K., "A Review of HRA Measurement Systems from a
Measurement Theory Perspective," Accounting Organizations and Society, 1977, pp. 219-236.
Hedge, 1.W. and M.J. Kavanagh, 1988, "Improving the Accuracy of Performance Evaluations:
Comparison of Three Methods of Performance Appraiser Training", Journal of Applied Psychology,
73: 68-73.
Ijiri, Yuj~ Theory of Accounting Measurement, Studies in Accounting, Research No. 10, Sarasota, FL:
American Accounting Association, 1975.
Katz, D. & Kahn, R.L., The Social Psychology of Organizations, New York, NY: John Wiley and Sons,
1966.
Klein, 1.1., 1990, "Feasibility Theory: A Resource-Munificence Model of Work Motivation and
Behavior", Academy of Management Review, 15: 646-665.
Matsu~ T., T. Kakuyama, and M.L.U. Onglato, 1987, "Effects of Goals and Feedback on Performance
in Groups", Journal of Applied Psychology, 72: 407-415.
McLuhan, M., Understanding Media: The Extensions of Man, New York: McGraw-Hill Book
Company, 1964.
Mirvis, P.H. and Lawler, E.E., "Measuring the Financial Impact of Employee Attitudes," Journal of
Applied Psychology, Vol. 62, No.2, 1977, pp. 1-8.
Mock, T.J., Measurement and Accounting Information Criteria, Studies in Accounting, Research No. 13,
Sarasota, FL: American Accounting Association, 1976.
Prakash, P. and Rappaport, A, "Information Inductance and Its Significance For Accounting,
Accounting, Organizations and Society, 1977, pp. 29-38.
Ridgeway, V.F., "Dysfunctional Consequences of Performance Measurements," Administrative Science
Ouarterly, September, 1956, pp. 240-247.
Schwan, E.S., 'The Effects of Human Resource Accounting Data on Financial Decisions: An Empirical
Test," Accounting, Organizations and Society, 1976, pp. 219-238.
Stevens, S.S., "On The Theory of Scales of Measurement," Science, 1946, pp. 667-680.
Vance, R.1. and A Colella, 1990, "Effects of Two Types of Feedback on Goal Acceptance and Personal
Goals, Journal of Applied Psychology, 75: 68-76.
Williamson, O.E., The Economic Institutions of Capitalism, New York: Free Press, 1985.
5
THE ROLE OF EVALUATION IN
ORGANIZATIONAL CONTROL
The "evaluation and reward subsystem" refers to the component systems of the overall
core control systems (shown in Figure 2-2) which deals with the process of assessing
human performance and rewarding it. Th(: evaluation system concerns the assessment
of the quality of performance and provides the basis for administration of rewards.
Thus these two systems individually and in combination play a crucial role in the
overall process of organizational control. 52 Although the merging of the evaluation and
reward processes of an organization creates a system ~ se, we shall first examine
each of these two processes as independent systems.
This chapter exanlines the nature of the evaluation subsystem and several aspects of
its role in organizational control. We shall:
Thus this chapter shall examine what happens in the evaluation component of the
evaluation-reward system's box of the core control model shown in Figure 2-2.
To the extent that an organization's evaluations affect either a person's perceived self-
worth or rewards provided to the individual, the evaluation process becomes
inextricably linked to the ability of people to satisfY their needs. This means that
evaluation plays a critical role in both ~:x Ante and Ex Post control.
"Ex Ante control" refers to the process of influencing the behavior of people to achieve
organizational objectives before their behavior occurs. It is an attempt to motivate or
cause people to strive to achieve organizational goals before the fact of their actual
72 The Role of Evaluation Organizational Control
performance. "Ex Post control" refers to the process of influencing the behavior of
people to achieve organizational goals after behavior has occurred. It is an attempt to
influence a future set of actions by either reinforcing, failing to reinforce, or punishing
behavior or performance which has already occurred. The notion of Ex Ante control
is to influence the person's perceptions that his (her) effort will lead to outcomes
(evaluations) which will be instrumental for attaining other desired outcomes
(rewards). This suggests, in turn, that evaluation is inextricably related to reward
systems, as examined in the next chapter.
Given this background, an "evaluation system" may be defined as a set of methods and
processes designed to assess either some dimension of a person's contribution (present
or potential) to an organization or the value of an individual as a whole to the firm.
The evaluation system may isolate a particular dimension such as individual's
productivity or promotability, as is typically done in practice; or, it may attempt to
make an overall assessment of an individual's value to the firm. It should be noted that
the former approach has been the traditional practice of evaluation, while the latter is
the basis of the more recently developed field in Human Resource Accounting. 54
The planning process generates the Mission, Key Result Areas, Objectives, and Goals
Effective Management Control: Theory and Practice 73
which the organization seeks to attain. These must be the content which is in the
performance evaluation process.
By focusing upon certain things and de-emphasizing others, organizations can use the
evaluation process strategically to motivate people in desired directions. This specific
mechanism by which this is accomplished involves the use of Key Result Areas
(KRAs) in developing methods of evaluation.
METHODS OF EVALUATION
This section deals with the methods which may be used in evaluation. There are two
fundamental issues in selecting an evaluation method: (l) the source of the evaluation,
and (2) the technique or procedure by which the evaluation will be obtained.
Before examining these issues, we should consider the criteria to use to determine the
extent to which a method of evaluation is appropriate. Our culture is heavily
influenced by the value of "rationality." This, in turn, leads to a desire for objectivity
in decision-making. In order to achieve objectivity in decisions, presumably we need
objective information, including objective measurements. Thus, the ideal of an
evaluation method would be to have objective (i.e., independently verifiable)
measurements of performance or potential. Unfortunately, however, almost all
methods of evaluation presently devised arl~ based upon human judgment. As a result,
they are inherently subjective. This must be recognized in considering the methods
described below.
SOURCE OF EVALUATIONS
There are two basic types of evaluations: I) judgmental sources, and 2) organizational
measurements. Judgmental sources are the most commonly used. Basically, it
involves obtaining judgments of performance or potential from various people.
Another source is organizational measurements such as productivity or accounting
measurements.
There are strengths and limitations involved with using either judgments or
organizational measurements as sources. In principle, organizational measurements
are objective. However, tlley may not take into account all significant factors of a
person's performance and, therefore, may not be a valid index of performance. In
addition, since people tend to pay greater attention to aspects of performance which are
measured at the expense of aspects which are unmeasured, the use of measurements
may lead to unintended dysfunctional results. For example, if a CPA firm uses
chargeable hours (an organizational measurement) as the criterion for performance
evaluation, then senior auditors may devote their efforts to maximizing chargeable
74 The Role of Evaluation Organizational Control
Judgmental Evaluations
For these reasons, it may be useful to use multiple rather than single assessments. For
exanlple, in CPA fimlS evaluations ofperfornlance are typically made after each "job"
is completed. During the course of a year, a person is typically evaluated several times
by different supervisors. Although the rating of a single supervisor may not be valid,
the overall pattern of ratings provide an indication of performance and potential. The
use of multiple ratings also enable the organization to interpret the ratings of
evaluators who are known to be typically "difficult to please" or "easy."
Some firms use groups rather than merely a number of individuals to obtain
evaluations. TIle appraisal group may consist of a person's immediate supervisor as
well as other managers who have interacted with the individual. In some instances,
there may be an evaluation committee which will include people who do not have a
great deal offirsthand knowledge of people being evaluated. TIleir presence represents
a trade-off between objectivity and actual knowledge of performance and potential.
Effective Management Control: Theory and Practice 75
Multiple ratings are, however, not free from limitations. It is possible that a person
will acquire a "reputation" relatively early in his or her career. This may lead to the
person being highly sought after, which, in turn, tends to lead to good assigmnents.
This means that a person who makes a good first impression may continue to do so
because of future assigmnents. This is known as a "self-fulfilling prophecy."
Similarly, a person who does poorly at a relatively early stage may find himself
(herself) the victim of a negative self-fulfilling prophecy.
Although these sources have attractive aspects, they are also not free from defects. One
problem is that when peers rate each other there is the possibility for intentionally
biased evaluations. Good friends may give each other mutually high ratings. In
addition, if promotion and compensation decisions are based upon such ratings, a
certain degree of" gamesmanship" may aflect the evaluations provided. At times, the
people being rated may prefer supervisory to peer evaluations, which can lead to
resistance against the system.
Organizational Measurements
There is also a different type of source: of information for evaluation. These are
measurements which are routinely collected as part of the organizational management
information system. They include accounting, production, marketing and related
measurements. For example, the ratio of actual manufacturing cost to standard cost
is that is generated from the accounting system might be used to evaluate a foreman
and plant managers.
It should be noted that there are difficulties involved in using such measurements for
evaluation purposes. Differences in external factors such as unreliable sales forecasts
may lead to manufacturing inefficiencies that are not controllable by foremen or plant
managers, and yet influence the measurements by which they are evaluated. The age
of machinery may differ from one plant to another and cause differences in productivity
which are also uncontrollable. If a firm simply ranks plants and their managers using
measurements of production efficiency, it may be a spurious representation of actual
productivity. Thus, judgement is typically required in interpreting such measurements.
There are also many facets of performance which are important but not reflected in
organizational measurements. In an automotive dealership, for example, the number
of new and used cars sold and the dollar-value of parts are easily measured, but not the
development of mechanics or customer relations. Similarly, in an optical products
manufacturing company, production schedules may be achieved while labor relations
deteriorate.
We have examined the various sources of evaluations. Another important aspect of the
evaluation process concerns the development of evaluation methods per se.
Evaluations, as noted previously, are essentially nonmonetary measurements. In order
to understand the different types of evaluation methods, it is necessary to first examine
some fundamental aspects of measurement. For these aspects of measurement underlie
the differences between various approaches to evaluation.
Measurement Defined
Nominal Scale. The nominal scale is the most basic level of measurement. The
numbers assigned to objects in this scale do not have true significance; rather, they are
merely numerical labels which are intended for purposes of classification.
Ordinal Scale. The ordinal scale is the next higher level of measurement. The
numbers assigned according to the rules of ordinal measurement do have arithmetic
significance. The signify rank order.
The numbers assigned to indicate rank order may either be in ascending or descending
direction. For example, 1,2, ... , n, can represent the highest, next highest, and so on
to the smallest rank. Alternatively, it can represent the smallest, next smallest, and so
on to the nth or highest rank.
Interval Scale. The interval scale is the next highest level of measurement. The
numerals assigned according to rules of interval measurement have quantitative
significance in the ordinary sense of the Iterm. Thus the difference between a score of
8 assigned to person A and 10 assigned to person B is intended to represent the same
thing as the difference between a score of 4 assigned to person C and 6 assigned to
person D. TIle scale is intended, in other words, to represent an interval scale or level
of measurement.
Ratio Sca/e. The ratio scale is the highest level of measurement that can be achieved.
The nwneraIs assigned according to the rules of ratio measurement indicate the actual
amounts or magnitude of the property being measured. The ratio scale has an
empirical meaningful zero. This means that if an object has none of a property being
measured, it will be assigned the nunlber "zero." In addition, differences between
objects are measured in equivalent units as different points on the scale. This is the
sante property as in interval scales.
Because the ratio scale has an empirically meaningful zero point, it can express the
ratio between objects. Accordingly, ifone object has twice as much ofa property as
another object, it is assigned a nmnber twice as large.
Although there are many different techniques of evaluation, they basically can be
classified into three types: 1) rating methods, 2) comparison methods, and 3)
descriptive methods. TIle various tec1miques which are included in each of these three
categories are shown in Table 5-1.
These three categories of methods correspond very closely to three different scales or
levels of measurement. Rating methods are, or purport to be, interval measures.
Comparison methods are ordinal or rank order measures. Descriptive methods are
essentially nominal measures. Table 5-1 also indicates the level of measurement
achieved by each of the various tecImiques. The measurement aspects of these
methods are discussed further below.
Rating Methods
Typically, rating methods focus not only upon an overall measure of performance or
potential but upon their specific dimensions. Some of the aspects of performance
commonly rated are: knowledge of job; personal qualities such as social skills,
"dependability;" quantity of work; and quality of work. Some of the dimensions of
potential conmlOnly rated are leadership potential, initiative, and judgment.
Effective Management Control: Theory and Practice 79
I. Rating Methods
D. Sociometric OrdinallInterval
A. Checklists Nominal
B. Essay Nominal
The mting approach may be used in various formats. However, the basic characteristic
of all variations is that a set of attributes of a person are to be rated according to a
standardized scale. The number and type of attributes or characteristics may vary. In
addition, the set of numbers used in particular scales may vary form other scales.
However, for a given scale they are designed to differentiate the extent to which group
of people possess specified attributes.
Typically, some version of the "graphic rating scale" is used. For this technique, the
evaluator is presented with a graph or chart listing performance characteristics. He
(she) is asked to rate a person on these dimensions by placing a mark (a circle or
check) on a scale provided. The scale may be descriptive or numerical. One type of
descriptive scale uses words to rate performance such as: "always demonstrates good
judgment" to "always demonstrates poor judgment." Another descriptive scale uses
words such as "outstanding," "good," "satisfactory," "fair," and "poor." These
80 The Role of Evaluation Organizational Control
descriptive mtings are then assigned numbers in order to convert them into scores. The
verbal descriptions used are intended to represent equal distances or perfonnance
intervals. At a minimum, they are intended to represent "equal-appearing" intervals.
This is necessary to score the descriptive rating and use it in comparing individuals.
The rating scale used may also be numerical, which, by definition, does not require
scoring. 11te evaluator is presented a range of numbers to use in mting a person on a
set of dimensions. He (she) is instructed, for example, that "10" represents
"exceptional performance" while" 1" represents "extremely poor perfonnance. "
Figures 5-1 and 5-2 illustrate two mting forms which are used in a CPA firm. Figure
5-1 is a form used by supervisors to evaluate their subordinates, while Figure 5-2 is
used by the subordinates to evaluate their supervisors. These forms are examples of
the chart-type of rating approach.
Rating methods are commonly used in organizations. Their primary advantages are
that they are relatively easy to use as compared with other methods, that they tend to
have face-validity (they seem reasonable), and that they are relatively inexpensive to
use.
Comparison Methods
11te basic idea underlying the comparison method is that it is relatively "easier" for an
evaluator to rank people to the extent to which they possess a given characteristic than
to assign numerals to differentiate them. This means that the rankings derived are
thought to possess a greater degree of validity than the rating measurements. The
technical reason is that interval measurements (which mting scales purport to be) are
more difficult to achieve than ordinal measurements (ranking).
Simple Ranking. Under this method evaluators are merely asked to rank employees
from highest to lowest on some criterion or set of criteria. There are not instructions
as to how this mnking should be derived.
Figure 5-1
Audit Staff Evaluation Form
Instructions
A careful, honest, and impartial preparation of this form is a must Staff accountants are to be rated according to the standards of their
present experience !eve/.
This form should be completed before any assignment, including preliminary war/{, if ~ extends for one week or more.
Clarifying comments and recommendations must be insetted in the space provided on the reverse side for qualifteattons requiring
improvement.
Only the PERFORMANCE QUALIFICATIONS above must be diSCUssed with the staff accountant. Compliment on work well done and be
constructive in your suggestions in areas where improvement is required.
DO NO T discuss the nems on the reverse side with the staff accountant under any circumstances.
After the completion of this fonn and the discussion of the ijerns above with the staff accountant, forward this form to the partner in charge
of personnel in your offICe.
82 The Role of Evaluation Organizational Control
Figure 5-2
Supervisory Evaluation Fonn
$~; IAssistant
~ofCIient; R_ey;
~by: 10ai9;
l.nglll of AssIgnment: INumber SUpeMsed:
(Read Instructions Before Rating) CHECK APPLICABLE BOX
1, Planning
a, Presentation of a general overview of client's business
b, Presentation and discussion of prior yea(s workpapers
c. Conciseness and completeness of aud~ program
d. Defin~ion of areas of responsibility
e. Explanation of time budget
f. Delegation of responsibility (to provide a challenging leaming
expenence)
2. FieldWork
a. Introduction to client personnel
b. Introduction to client's records and procedures
c. Availability of supervisor
d. Willingness of supervisor to accept questions
e. Ability to communicate
f, Attentiveness to assistant's problems and needs
g. Allowed freedom of action
3. Review
a. Promptness In reviewing assistant's work
b. Promptness in feedbeck to assistant
c. Ability to communicate queries on assistant's work
d. Instructional att~ude toward the review process
4. Evaluation
a. Promptness In evaluating assistant's work
b. Objectivity in evaluating assistant's work
c. Instructional attitude toward the evaluation process
5. Professional Qualifications
1. Inquis~iveness
2. Creativeness
3. Apt~ude for aSSOCiating with people
4. Maintaining client relationships
5. ComprehenSion and interest in business of client
6. Interest in professional advancement
7. Advising superiors promptly of problems
8. Willingness to accept responsibility
9. Ability to accept responsibility
10. Ability to follow instructions
11. Effectiveness of expression - Oral
12. Effectiveness of expression - Written
Effective Management Control: Theory and Practice 83
6. Personal Qualifications
1 Appearance
2 Poise
3 Tact
4. Personality
5 Conduct
6. Cooperation - AppreciatIOn of mutuality of interests - personal and
company
7. Energy
8. Stability
9 Initiative
10. DeciSiveness
11. Judgement
12. Maturity
13. leadership
14. Integrity
15. Attrtude
16. Desirable self-confidence
17 Attrtude toward client & firm
Explanations
A. If I were to personally advise the supervisor on the areas in which he/she needs improvement, I would tell himlher .. _ _ _ _ __
B. I would [ask for] [accept] {prefer not] a future aSSignment with thiS supervisor
1. The staff member [is] [in not] now quahfied for heavier responsibilijles (this does not necessorily relate to promotion)
2. I would [ask for] [accept] {prefer not to have] this staff member in my engagement hereaner
3 In relation to this staff membe(s experience, the work assignment was [complex] [moderately difficuft] [rela~vely easy]
4. I [have] [have not] diSCUSsed thiS evaluahon WIth the staff member
5 The staff member's reaction to the discussion was [receptive] [indifferent] {antagomstlc]
Instrudions
A thoughtful, unbiased preparation of thiS form IS essential ThiS evaluation will serve as a means of obtaining Information to be
used In the development ot SUperviSOry skills
This form should be completed for any assIgnment that extends for one week or more It may be completed for assIgnments of
shorter duration at the dIscretIon of the staff assistant.
Upon completIon, this form is to be forwarded to the personnel partner The assistant should not discuss the evaluatlOl"l with the
SUpervisor.
84 The Role of Evaluation Organizational Control
people, the person with the highest value is selected followed by the person with the
lowest value, and so on alternating between the next highest and lowest. Research on
the reliability of this method has found it more reliable than the simple ranking
method. An illustrative alternation ranking worksheet used at an insurance company
is shown in Table 5-2. Its instructions are shown in Appendix 5-1.
Paired Comparisons. This is a method for deriving a ranking of people from a series
of comparisons of each individual with all other people in the group to be ranked. A
rank order may be derived from the paired comparisons by a simple scoring procedure.
This method becomes cumbersome when the number of people to be ranked exceeds
ten, because of the large number of pairs involved. It is typically implemented by
writing the names of pairs of individuals on file cards and presenting them to
evaluators one card at a time. Research on the reliability of the paired comparisons
method has found it more reliable than simple ranking and equally reliable to the
alternation ranking method.
Sociometric Ratings. This method is one that may be used with peers as the source
of evaluations. It is based upon group choice. One person is asked to choose one or
more other persons according to some criteria. The evaluators can be asked to use
rating scales to assess others. They can also be asked to rank others on criteria. If the
number to be ranked becomes too large, the method becomes quite cumbersome.
The purpose of the forced distribution is to overcome any tendency for evaluators to
eiilier be too lenient or too severe in their ratings. However, the technique leads to an
invalid assessment unless a group of individuals actually comprise a nOrnlal
distribution in performance or potential.
Descriptive Methods
The evaluator is presented both with sets of favorable and unfavorable items. The
statements in each set are intended to appear approximately equally favorable or
unfavorable, but they actually differ in the degree to which they have been found to be
predictors of effective or ineffective performance.
Essay Evaluation. TIus method of evaluation involves the use of an essay to describe
aspects of a person's performance. Typically, there is not a prescribed format. The
evaluator may be asked to describe a person's "strengths" and "limitations," or it may
be used without any guidelines.
The method is helpful in the development process, but it is not as useful as other
methods in providing a basis for administering reward systems. For it does not
provide a convenient basis for personnel comparisons.
The essay method may be used with virtually all sources of evaluation, including self-
assessments. However, its successful use requires evaluators with reasonable skill in
written communication. Another potential limitation is that the method may be costly
because of the time required to prepare evaluations. This may also lead to resistance
against its use by evaluators.
Critical Incidents. This method involves recording significant (or critical) incidents
of positive or negative performance as a basis for evaluation. It is related to the essay
method of evaluation, for it is intended to describe actual performance.
There are no guidelines or criteria for determining what constitutes a critical incident.
What is left to the evaluator's judgment, although a list of categories of job
requirements may be provided. For example, critical incidents may occur in customer
relations for salesmen, planning and decision-making managers, and in technical
problem solving for engineers.
However, the choice of incidents to record as critical is still subjective. Because the
method focuses upon actually observed behavior, it can be useful in the development
process. Unless the incidents relate to characteristics required for promotability, it may
not be particularly useful in promotion decisions.
The underlying concepts are that people prefer to be evaluated according to criteria
which they perceive are realistic and standards which they perceive are reasonably
attainable. Under this method, people participate in setting the goals and identifying
the criteria which will be used to evaluate them. Some of the results or goals on which
people will be evaluated may be measurable in quantitative terms (such as profit,
expenses, sales, or production volume), while others may be assessed qualitatively
(such as employee development, customer relations or a marketing plan).
The basic steps in this cycle of evaluation are: I) the evaluator and evaluatee mutually
decide upon the key objectives for the evaluatee; 2) they agree on the criteria or
measurements to be used in evaluating the achievement of performance objectives; 3)
after performance occurs, actual performance is assessed against planned performance;
and 4) objectives and criteria are revised for the future. In brief, this is both a
sequential and an interactive process.
Problems of Validity
The most common biases or errors which influence evaluations are: 1) the "halo
effect", 2) different standards used, 3) inflation of standards, 4) bias, 5) central
tendency, and 6) primary or recency of date. These are discussed below.
The Halo Effect. The so-called "halo effect" is the tendency for an evaluator to base
an assessment of all individual characteristics which are presumably independent of
each other on an overall impression of a person. For example, an individual who is
generally well regarded may be rated high on such unrelated characteristics as technical
skill, imagination and reliability. Another person, who is less well regarded, may be
evaluated low on all these dimension even though an "objective" assessment would
show that the latter person was more reliable than the former. Thus the halo effect is
a tendency to generalize from an overall positive or negative impression to a set of
specific traits or characteristics.
In general, the halo effect appears applicable to almost any method of evaluation,
because it influences an evaluator's perception of an individual. Given an overall
impression, the evaluator may be "set" to perceive certain things and filter out others
or to perceive behavior in ways which are colored by "the halo" a person has. Thus the
halo effect may influence the numbers assigned under rating methods, the ranks
assigned under comparison methods, and may even influence the descriptions used
under descriptive methods.
It is extremely difficult to deal with bias in evaluations. The descriptive methods offer
less overt chance to present biased evaluations, but bias can certainly influence
descriptive methods as well.
Problems of Reliability
Each of the evaluation methods described have strengths and limitations. They are
each capable offulfilling the functions of the evaluation process to different extents.
This section evaluates the evaluation methods. It summarizes their strengths and
limitations and examines the degree to which they fulfill various evaluation functions.
It also indicates some administrative problems with evaluation methods.
Summary of Limitations
Table 5-3 summarizes the extent to which various evaluation methods are subject to
problems of validity and reliability. Rating methods are subject to a high degree to
virtually alliintitations discussed. Yet they are the common evaluation methods used
90 The Role of Evaluation Organizational Control
because of their relatively low cost of administration and the convenience with which
they may be applied. Comparison methods are sensitive to different and inconsistent
standards as well as bias, but not to the halo effect, inflation of standards or central
tendency. Descriptive methods are subject to these limitations to varying degrees
depending upon their particular methods. However, the critical incident and evaluation
by objective methods are the least subject to these problems. Unfortunately, they are
the most complex and costly to administer.
Inflation Inconsistent
Halo Different of Central Application of
Methods Effect Standards Standards Bias Tendencv Standards
I. Rating Methods
In addition to the problems of evaluation methods ~ se, there are also difficulties
involved in administering the evaluation process as a whole. Two of the major
problems are union resistance to evaluations and individual resistance.
Unions may also retain some degree of control over the evaluation methods and
judgments. Some medlods may not be acceptable to unions. In addition, some union
contracts may require a review process for evaluations.
Individuals as well as unions may resist evaluations for a variety of reason. Where an
evaluation process results in criticism, people may, quite understandably, react
defensively. In addition, since some of the methods may be quite subjective, people
may simply not accept evaluations as valid. In some instances at least, they may be
correct.
Another major reason for the failure of people to accept evaluations is their role in
compensation and promotion decisions. Evaluations may play a critical role in a
person's career. Thus it is quite natural dmt people may feel threatened by evaluations.
The only response to such feelings is to develop an evaluation system which people
perceive as being realistic, valid and reliable.
In previous sections of this chapter we have examined the nature, functions, types, and
limitations of evaluation systems as independent operating systems. We must also
consider the functioning of evaluation systems as integral components of an
overall core control system -- as a part of a larger system.
Purpose
The system serves as a critical link between the measurement and reward systems.
The planning process generates the Mission, Key Result Areas, Objectives, and Goals
which the organization seeks to attain. These must be the content which is in the
perfonnance evaluation process.
By focusing upon certain things and de-emphasizing others, organizations can use the
evaluation process strategically to motivate people in desired directions. This specific
mechanism by which this is accomplished involves the use of Key Result Areas
(KRAs) in developing methods of evaluation.
The key to understanding dus apparent paradox is this: The effective or relative value
(as opposed to the nominal or absolute value) of a measurement depends upon the
organization's goals. If profit center "A" earned $10 million but was budgeted at $5
million, we may evaluate its perfomlance as superior. However, if profit center "B"
Effective Management Control: Theory and Practice 93
earned $10 million but was budgeted at $15 million, we might evaluate its
perfonnance as inferior.
In brief, not all equal nwnerical measurements are equal in substance. Some are more
(and some are less) equal than others.
A manufacturing plant may have goals of production volume, cost savings, product
quality, and safety. Yet the measurement systems and hence the data inputs toe the
evaluation's system may only focus upon production volwne and cost savings. This
situation can lead management to make decisions which appear to give good results
in the short term but are actually harmful in the long run.
SUMMARY
This chapter deals with the evaluation process. Evaluation refers to the methods
developed to evaluate the performance and potential of people as organizational
resources. Most evaluation methods involve some form of numerical measurement.
The overall purpose of evaluation is to provide an input to the process of measuring
individual and organizational perfomlance as a component of an overall control
system.
There are three basic types of evaluation methods: 1) rating methods, 2) comparison
methods, and 3) descriptive methods. These three categories correspond closely to
94 The Role of Evaluation Organizational Control
All types of evaluation methods are subject to a variety of limitations. The basic
problems may be viewed as either problems of I) validity or 2) reliability. The
specific difficulties include: The "halo effect", different standards, inflation of
standards, bias, central tendency, and primacy or recency of data. Each method of
evaluation suffers from these limitations to a different degree. For example, mting
scales are quite susceptible to the problem of central tendency, white comparison
methods and descriptive methods are not.
Please read these instructions carefully before completing the attached form.
Column 1 - Consider these individuals only with respect to their current positions.
Select the individual on the list who you feel has the highest value to the organization
at the present time. Write his name in the space provided in Column 1. From the
remaining names select the person who you feel is lowest in value to the organization
at this time. Alternately, continue selecting the next highest and next lowest names
remaining on the list. Indicate ties by placing the tied individuals' names in same
space in Column 1.
Column 2 - Now that you have completed Column 1, consider these same individuals
again. This time consider them with respect to both their current positions and the
future positions they might occupy over the next five years. Ignore the possibility of
the men leaving the company. Select the individual who you feel has the highest
potential value to the organization. From the remaining names select the person who
you feel has the lowest potential value to the organization. Alternately, continue
selecting the next highest and next lowest names remaining on the list. Indicate ties
by placing the tied individuals' names in the same space in Column 2.
Column 3 - Now that you have completed Column 2, consider these same individuals
again. This time consider them with respect to both their current positions and the
future positions they might occupy over the next five years; but do not ignore the
possibility of the men leaving the company. Select the individual who you feel has the
highest potential value to tbe organization. From the remaining names select the
person who you feel has the lowest potential value to the organization. Alternately,
continue selecting the next highest and next lowest names remaining on the list.
Indicate ties by placing the tied individuals' names in the same space in Column 3.
96 The Role of Evaluation Organizational Control
ENDNOTES
52. For an alternative concept of the economic approach to control, see Eisenhardt, K.M., "Control:
Organizational and Economic Approaches," Management Science, 1985, Vol. 31, pp. 134-149.
53. Ouchi, W., "A Conceptual Framework for the Design of Organizational Control Mechanisms,"
Management Science, 1979, pp. 833-847.
54. Flamholtz, E., Human Resource Accounting (San Francisco, CA: Jossey-Bass Publishers,
1985).
55. Stevens, S.S., "On the Theory of Scales of Measurement," Science, 103, No. 2684 (June 9,
1946), p.677.
56. Ibid.
Effective Management Control: Theory and Practice 97
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Firms", Administrative Sciences Quarterly, 1991,36,459-475.
Cleveland, IN., Murphy, K.R., and R.E. Williams, "Multiple Uses of Performance Appraisal: Prevalence
and Correlates", Journal of Applied Psychology, 1989,74, 130-135.
Earley, P.C., Connolly, T., and G. Ekegren, "Goals, Strategy Development and Task Performance: Some
Limits on the Efficacy of Goal Setting", Journal of Applied Psychology, 1989, 74, 34-33.
Earley, P.C., Northcraft, G.B., Lee, C., and Liturchy, T.R., "Impact of Process and Outcome Feedback
on the Relation of Goal Setting to Task Performance:, Academy of Management Journal. 1990,33,1,
87-105.
Eisenhardt, K.M., "Control: Organizational and Economic Approaches", Management Science, 1985,
31, 134-149.
Flamholtz, E., Human Resource Accounting, San Francisco, CA: Jossey Bass Publishers, 1985.
Geriinger, 1M. and Louis Hebert, "Measuring Performance in International Joint Ventures", Journal of
International Business Studies, 1989, 22, 2, pp. 248-263.
Hedge, J.W. and MJ. Kavanagh, " Improving the Accuracy of Performance Evaluations: Comparison
of Three Methods of Performance Appraiser Training", Journal of Applied Psychology, 1988, 73, 68-
73.
Konrad, A.M. and I Pfeffer, "Do You Get What You Deserve? Factors Affecting the Relationship
Between Productivity and Pay", Administrative Sciences Quarterly. 1991,35,258-280.
Lewin, D. and Mitchell, DJ.B, "Appraisal and Reward," Chapter 7 of Human Resource Management:
An Economic Approach, PWS - KentlWadsworth, forthcoming.
Liden, R.C., Mitchell, T.R., and C.E. Summer, "Top Level Management Priorities in Different Stages of
the Organizational Life Cycle," Academy of Management Journal. 1985,28,291-308.
Luckett, P.F. and M.K. Hirst, 'The Impact of Feedback on Inter-Rater Agreement Insight in Performance
Evaluation Decisions", Accounting. Organizations and Societv, 1989, 14, 379-389.
Matsui, T., Kakuyama, T., and M.L Uy Onglato, "Effects of Goals and Feedback on Performance in
Groups", Journal of Applied Psychology, 1987, 72, 3, 407-415.
Ouchi, W.,"A Conceptual Framework for the Design of Organizational Control Mechanisms",
Management Science, 1979,833-847.
Russell, JA, and DJ. Goode, "An Analysis of Managers' Reactions to Their Own Performance Appraisal
Feedback," Journal of Applied Psychology, 1988, 73, pp. 68-73,
Schmidt, F.r., Hunter, IE., Outerbridge, AN. and S. Gafl; "Joint Relation of Experience and Ability with
Job Performance: Test of Three Hypotheses", Journal of Applied Psychology, 1988,73, pp. 56-67.
Shoorman, F.D., "Escalation Bias in Performance Appraisals: An Unintended Consequence of Supervisor
in Hiring Decisions", Journal of Applied Psychology, 1988, 73, pp. 46-57
Snell, Scott A., "Control Theory in Strategic Human Resource Management: The Mediating Effect of
Administrative Infornlation", The Academy of Management Journal. 1992, 35, 2.
Stevens, S.S., "On the Theory of Scales ofMeasureJ1lent," Science, 103, No. 2684 (June 9, 1946), p. 677.
Zalesny, M.D., "Rater Confidence and Social Influence in Performance Appraisals", Journal of Applied
Psychology, 1990, 75, 3, 274-289.
6
THE ROLE OF REWARD SYSTEMS
IN CONTROL
This chapter examines the nature of organinltional reward systems and their role in the
core control system. The chapter focuses upon four basic questions:
If properly designed, reward systems can lead to desirable behavior for a firm. If
incorrectly designed or administered, reward systems can lead to the gradual deteriora-
tion of an organization if not its abrupt demise.
This section presents an overview of the concepts and ideas underlying reward systems.
This will serve as a basis for understanding their functioning and role as a component
of organizational control systems.
Concept of Rewards
The basic idea to bear in mind is that reward systems are intended to motivate certain
kinds of behaviors and to reinforce their occurrence. This means that the outcomes
provided by the reward system must be positively valued by the person; if they are not
valued, then they are not rewards. The outcomes may either be the inherent result of
the person's own behavior, such as a feeling of accomplishment, or external to the
100 The Role of Reward Systems in Control
Types of Rewards
There are various types of "rewards" offered to members by organizations. There are
"psychic," "financial," "intrinsic," "extrinsic," "nonmonetary," "monetary," and "social
rewards."
Financial (Monetary) Rewards. Rewards that fall into this category are the most
common medium of organizational motivation an reinforcement. They include wages
and salaries as well as other aspects of compensation (bonuses, benefits, etc.).
Psychic Rewards. The tenn "psychic rewards" refers to the psychological experience
of satisfaction derived by people from a variety of organizational rewards --
nonmonetary as well as monetary. An individual may derive psychic rewards (satisfac-
tion) from promotions, favorable perfonnance evaluations, verbal recognition,
organizational prerogatives (such as a "special" parking space, office, etc.), or other
rewards. The magnitude of the psychic reward is not necessarily a linear relation to the
dollar-value of the reward. For example, an individual may derive a certain amount
of satisfaction from a $1,000 raise, but not necessarily find as much satisfaction (it
may be either more or less) from a $2,000 increase at a different point in time.
Intrinsic Rewards. TIus tenn refers to desirable outcomes which are the inherent result
of a person's own behavior, such as enjoyment of a task. For example, a research
chemist may derive intrinsic satisfaction from the act of research ~ se, a nurse may
derive satisfaction from helping people, or a chef may derive satisfaction from seeing
(or tasting) his (her) creations.
Extrinsic Rewards. These are rewards provided not only by the person himself but by
others. TIley may include external evidence of recognition of accomplishment such as
promotions, perfonnance evaluations, and salary increases.
Social Rewards. TIlese are rewards not provided by the organization ~ se, but which
accrue to an individual because of his (her) membership in a finn. For example,
certain organizations have considerable prestige, and members may derive "reflected
Effective Management Control: Theory and Practice 101
This discussion of the different types of rewards suggests that rewards may either be
intangible or tangible. They may be tangible rewards such as salary increases or
promotions, or intangible such as the satisfaction a person experiences from a
"positive" performance evaluation. It should noted that even intangible rewards such
as performance evaluations may also be valued by individuals as evidence of future
tangible rewards. Stated differently, a series of positive performance evaluations may
be perceived as leading to a very tangible salary increase or to a promotion.
Rewards also provide the Ex Post source of reinforcement for people. Once people
have expended energy based upon the expectation that they will be rewarded, the actual
distribution of the rewards serves to reinforce the same behavior in subsequent time
periods.
In brief, rewards are the component of an organizational control system which activates
or energizes people's behavior. The planning component designs the desired direction
of the behavior. The measurement component provides information about that
behavior and input to the performance evaluation process which, in turn, provides the
basis for administration of rewards. However, the rewards themselves are what people
actually seek in exchange for their behavior.
Tangible rewards are provided by both (1) the compensation-reward system, and (2)
the promotion-reward system. Intangible rewards, such as recognition, and evidence
offuture tangible rewards are provided by the evaluation system.
102 The Role of Reward Systems in Control
The role of the evaluation system as a component of a control system was described
in Chapter 5. In brief, evaluation directs (motivates) attention to the relevant
performance criteria. It also provides feedback on performance as a basis for either
reinforcing or modifying it. Evaluation provides intangible rewards of recognition
which are highly valued in our achievement-oriented society. The remainder of this
chapter will focus upon compensation and promotional systems as rewards.
In many societies, including our own, the symbolic value of money leads to psychic
satisfactions for a person. This means that a person may use money as a generalized
satisfier for esteem, social and, and self-actualization needs. A person may use money
income as a measure of his (or her) self-worth. In addition, income often has the
potential for people to satisfy social needs, through the prestige it affords.
Thus, money has utility for people to satisfy needs. Its utility is psychological
(symbolic) as well as economic. As a result, money, or more accurately, the
opportunity to obtain money, is a powerful incentive to human behavior. This suggests
that compensation functions as a reward because of the utility of money.
The value of money and, in turn, compensation to a person is subjective. This means
that different people may "value" the same amount of money differently, because the
same number of dollars may have a different utility for them. The same person may
also value a given quantity of money differently at different times.
Effective Management Control: Theory and Practice 103
This means that although money may serve as a reward, it cannot be used as the only
reward. In addition, it cannot be expected to function as a reward at all stages of a
person's career.
One important implication for the management of human resources of the subjective
value of compensation is that the same increments of income will produce different
motivational responses from different people and from the same people at different
times. This means that compensation decisions for groups such as factory workers,
engineers, and managers may have to take a variety of diverse factors into account.
Similarly, even decisions for a specific group such as managers may have to take into
account differences in the value of compensation. For example, young M.B.A.'s
typically want high pay and are less concerned about security and retirement benefits,
while older managers are more concerned about security and retirement than current
income.
Ifa person fails to conform to group norms, then the result can be criticism, ridicule,
or ostracism. Thus individuals must make decisions concerning the value of
compensation and the cost (and probability) of social disapproval.
Marginal
Utility
of
Money
Low High
Money (Amount)
Figure 6-1
Hypothesized Subjective Value of Money
Several theories have been proposed which suggest that people seek a "just" or
"equitable" return for their contributions of services on a job. The basic idea
underlying such theories is that compensation which is either greater than or less than
that which is perceived by the recipient to be equitable results in dissatisfaction. This
is analogous to the oft-quoted union demand for "a fair day's pay for a fair day's work."
Summary
The value of money as a motivator for any person is subjective. It depends upon
individual (personal), group, and organizational factors. Different people have a
different utility for money, and its utility may also differ for the same person at different
Effective Management Control: Theory and Practice 105
times.
The previous section has explained why and how compensation serves as a reward.
This section deals with the strategic use of compensation as a reward. more
specifically, it suggests how to use compensation as a reward in a core control system.
First we shall examine the nature of compensation, per se, and then we will discuss the
strategic use of compensation, per se.
Nature of Compensation
"Compensation" may be defined as the fmancial rewards paid to people for services
rendered to an organization. Although it is typically paid in money, it may also be paid
in the form of goods and services.
There are two basic forms of compensation, commonly known as "wages" and
"salaries." The term "wages" refers to compensation paid on an hourly, daily, or piece-
work basis. It is generally used for compensating manual labor. The term "salaries"
refers to compensation paid for a period of a week, month, or longer duration. It is
generally used to compensate clerical of managerial employees.
The difference between wages and salaries is related to the different functions of
compensation. Some suggest that salaries are paid for services requiring special
training or abilities. Yet a machine operator may be highly skilled and receive an
hourly wage paid on a daily basis, while and office clerk may be relatively unskilled
and receive a "salary." Similarly, a salesman may have considerable skill and be
compensated by commission (a form of piece work), while someone of equivalent (or
less) skill may receive a salary. Thus the rationale for using wages for one type of
employee and salaries for another is not solely attributable to the variable of skill.
A major factor explaining choice of wages or salaries depends upon the nature of the
work performed and, in turn, the extent to which it is feasible to measure units of
services rendered. For some jobs, such as certain factory workers, salesmen, or typists,
it is possible to measure (i.e., count) the units of services (production) rendered. For
others, such as managers or secretaries, it is virtually impossible to measure all aspects
of work performed. Thus different modes of compensation have developed to deal with
this difference.
quantity-based compensation. The fonner involves payment for specified time periods:
hour, day, week, month, year, etc. The latter involves payment for the units of service
rendered (number of telephone calls made, rooms painted, circuits wired, etc.).
Compensation Strategy
The key principal underlying compensation ought to be, "form follows function." This
means that the method of compensation and the elements of the compensation plan
should be designed in such a way as to optimize the probability that people will
behave in desired ways. Although this seems logical and, perhaps, even obvious, it id
not found often enough in actual compensation systems. To implement this principal,
compensation systems must be geared toward optimizing the performance of people
on their own and the organization's Key Result Areas. This means that compensation
should be directed to the MAXIMUM extent feasible toward people to be concerned
about achieving the mission and goals developed in the plan of their strategic business
unit. This is done by linking rewards to the achievement of the plan.
PROMOTION-REWARD SYSTEMS
In the previous portion of this chapter we have described the nature and methods of the
compensation-reward system. This section focuses upon another major element of the
overall organizational reward system -- the promotion reward system.
It should be noted at the outset that neither theory nor practice is as well developed for
the promotion-reward system as for the compensation or evaluation reward system.
Unlike compensation decisions, promotion decisions typically occur as a by-product
of the selection process to fill job vacancies. Consequently, many organizations do
little or no formal planning of the promotion process; rather, it just happens. Just as
practice in this area is not well developed, theory about promotion as a reward is rather
sparse.
The purpose of this section is to outline the rationale for promotion as a reward. It
also will describe some guidelines for using promotion-reward system as a component
of a core control system.
Effective Management Control: Theory and Practice 107
Promotion as a Reward
How does a promotion operate as a reward? In other words, what makes a promotion
attractive to people and motivates them to behave in ways which may help achieve it?
Although the term "promotion" has been defined in many different ways, it basically
refers to a person's movement from one position level in a job hierarchy to another of
higher rank. The increase in rank may be attributable to increases in skill,
responsibility or even some artificial or illusory factor. For example, a promotion may
consist of movement from the position of machinist to foreman, from salesman to
sales manager, from vice president to president. ll1ese promotions may reflect real
differences in function performed. However, there are also "nominal" promotions,
which merely use job titles to reflect artificial distinctions between positions. For
example, in one insurance company a promotion from claims investigator to claims
adjuster did not reflect any real difference in function; rather, it merely reflected the
amount of time a person was with the firm. Similarly, the titles assistant engineer,
engineer, and senior engineer may reflect only artificial differences. They are used, as
explained subsequently, to provide the illusion of promotion because of its power as
a motivator. There are also promotions which reflect differences in attainment and
imply differences in skill rather than differences in function. In colleges and
universities, for example, promotion from assistant to associate to full professor is
intended to be a recognition of such achievement differences.
Ability to SatisfY Various Needs. The power of promotion as a reward is derived from
its attractiveness to satisfY a variety of needs for an individual. Promotion ~ se has
important symbolic value for people in our society. It represents an increase in status
in one's organization, which, in turn, may confer social as well as organizational
prestige. Promotion also represents "recognition," that is, formal acknowledgment by
an organization of a person's increased value to the enterprise. Thus it is a vehicle for
people to satisfY their self-esteem needs.
Promotion also has power to help satisfY self-actualization needs. The increase in rank
may provide the opportunity for a person to exercise latent abilities, to assume higher
levels of responsibility. It may provide, in other words, the opportunity for people to
more fully become what they are capable of becoming.
In addition to its power in satisfYing such higher level needs, promotion also indirectly
enables a person to increase satisfaction of physiological and perhaps even safety
needs. Typically, an increase in compensation accompanies a promotion -- at least it
tends to correlate with genuine and not artificial promotions. This means that
promotion not only has values of its own but also the values of compensation as a
reward.
different for different people and for the same person at different times. Many people
in our society are highly achievement-oriented. For them, promotion is a valued
reward. For others, who may have a somewhat lower need for achievement and who
value other variables such as security or social relations, a promotion may have less
value or even a negative value (or cost).
There are a variety of reasons why people do not always value promotions. For
example, a salesman in a automotive dealership may earn more than the sales manager.
The latter may have greater job security, but this may be less important to the salesmen
who values money ~ se. Indeed, this problem commonly plagues a variety of
companies who find salesmen unreceptive to "promotions" to sales managers where
they may actually earn less. A factory worker may not wish promotion to foreman
because he will no longer be able to associate with his peers (that is, be "one of the
boys"). In addition, he may be concerned about a loss of union protection, if foremen
are not part of the bargaining unit, and loss of seniority rights, in case of layoff. An
engineer who is highly oriented to the teclmical side of his job may not desire to be
promoted to engineering manager because it will take him away from the work he truly
enjoys. Another person may not wish a promotion because it involves a geographical
change. As the nunlber of two-career families (husband and wife) increases, such
geographical changes become quite complex for people.
This means tllat people are directing long-term energies on such career goals. Thus
promotion is a complementary part of the overall organizational reward system. It is
the ingredient for long-tenn motivation.
Effective Management Control: Theory and Practice 109
Organizations follow different strategies to this issue. Some, like IBM and DuPont,
tend to hire only at relatively low-level entry positions and promote people from within
to fill higher job level vacancies. 57 The rationale for this policy is that (1) it serves as
a motivator to personnel who have the opportunity for promotion, and (2) it insures
that people will be fanliliar with the organization and not just a particular type of
function (i.e., controllership) when they occupy higher level jobs. Such organizations
believe that it is often quite risky to hire from the outside to fill high-level positions.
For example, several years ago one of the "Big 3" automotive manufacturers hired an
Executive Vice President from one of its competitors to become its President. A few
years later, that person left the firnl. The problem was that it is difficult to "transplant"
such an important "organ" as a chief executive from one body to another without the
risk of "rejection." Of course, many other firms believe strongly in the virtues of hiring
from the outside, and there have been many successful transplants. For example, some
personnel executives in the banking industry believe that the officer-level position in
their organizations are relatively homogeneous across most comparably-sized banks.
Thus they may recruit for such positions from the outside. However, from the point
of view of the promotion-reward system, a policy of internal recruitment is a powerful
motivator.
Another major factor involved in the system's design is the identification of promotion
channels. At an elementary level, the promotion channels may be identified by
reference to an organization chart. However, the development of people may require
promotion paths that do not correspond to movement from foreman to assistant plant
manager to plant manager. Rather, it may involve movement from plant manager to
assistant personnel director to some job title in sales in order to develop broad
knowledge of a business.
110 The Role of Reward Systems in Control
A third element of the promotion-reward system is the methods and procedures used
for assessment and selection of people. It is important to distinguish between the
methods and procedures used for (1) unionized personnel and (2) nonunion personnel.
The promotion methods, procedures, and criteria for unionized employees may be
relatively spelled out in collective bargaining agreements. Unions tend to want
seniority as the primary, if not the sole, criterion for promotion decisions. It is an
objective criterion, and seniority (length of service) is presumed to correlate with
experience and skill. In addition, unions typically may file a grievance and submit a
promotion decision to arbitration if they disagree with management's choice. For
nonunionized personnel, promotion typically occurs as a by-product of the human
resource planning, acquisition and allocation process.
The ultimate step in designing this system is the promotion decision-making process
~ se. This ranges from a very informal, almost casual process to a very structured,
sometimes ritualized process. In some organizations a group of executives virtually
decide promotion during luncheon conversations, while in others openings may be
posted and "bids" (applications) requested.
Promotions are a valuable reward, and they can be used strategically as a component
of a reward system. The key to the effective use of promotion as a strategic reward
relates to the ability of promotions to send a "signal" or "message" throughout the
organization.
This chapter has described two major components of the overall human resource
reward system: the compensation and promotion reward systems. Together with the
evaluation system, these reward systems provide the mechanism by which
organizations motivate and reinforce people toward joining, retaining membership,
developing their skills, and perfonning their roles.
The three systems complement one another. They serve different types of functions and
emphasize different time periods. Compensation plays a greater role in attracting
human resources than promotion or evaluation (the latter is irrelevant at that point).
Promotion and, perhaps to a lesser extent, compensation play major roles in helping
to maintain people in the organization. Evaluation is the most immediate system
influencing perfonnance, but it is only instrumental for the individual who desires
either compensation or promotion.
Evaluation is typically the reward system that can provide the most immediate
feedback and reinforcement for people. Compensation may be used for both short-tenn
and long-tenn motivation and reinforcement. Promotion tends to be a medium-tenn
to long-tenn motivator.
The differential functions and time horizons of these systems suggest that they must be
integrated into an "effective" overall reward system in a particular organization -- one
that motivates behavior congruent with organizational goals and individual needs.
A reward system will typically produce the behavior it has been designed to produce,
whether or not these programmed results were the behaviors it was intended to
112 The Role of Reward Systems in Control
Another major problem with reward systems is that if they are not properly designed,
they will lead to short-term thinking rather than a long-term orientation. This is a
major difficulty with reward systems.
SUMMARY
This chapter has focused upon the reward system as a whole and the compensation and
promotion reward subsystems. A reward system is a management control subsystem
designed to motivate people toward the achievement of organizational goals.
"Rewards" are the desirable outcomes or returns to a person, provided by himself and
others. Rewards are subjective. Whether an "object" (tangible or intangible) is a
reward is determined by a person's needs and perception. There are three major types
of human resource reward systems: (I) evaluation, (2) compensation, and (3)
promotion.
Compensation functions as a reward because it has the ability to lead to people's need
satisfaction. It has the ability to satisfy needs not only as a medium of exchange to
acquire goods and services but also for its symbolic values. It is viewed as evidence
of achievement and worth to an organization and society. The value of compensation
to an individual is subjective and has personal, group and organizational determinants.
TIlere are two major fonns of compensation: wages, which are based on hourly work
and tend to be paid for manual labor, and salaries, which tend to be paid for periods
of one week or longer and are generally used to compensate clerical or managerial
personnel.
Promotion functions as a reward because it has the power to satisfy a variety of human
needs. Promotion has considerable symbolic value in our society because it represents
an increase in status. It represents recognition of an increase in a person's value to an
enterprise. Since it is typically accompanied by an increase in compensation, it also
has the power to help satisfy physiological and safety needs. Just as compensation,
promotion has a subjective value. Because they recognize the power of promotion as
a motivator in an achievement-oriented society, some organizations use "artificial
promotions," that is, they create artificial job grade distinctions and/or inflated job
titles. TIle theory and practice of promotion-reward systems is not yet well-developed.
In many organizations the promotion process tends to occur as a by-product of the need
to fill job vacancies. there are four basic aspects of the design ofa promotion-reward
system: (1) formulating promotion policies, (2) identifying promotion channels, (3)
developing procedures for assessment and selection, and (4) tile promotion decision
Effective Management Control: Theory and Practice 113
~ se. Because of the subjective nature of the promotion decision, great care must be
exercised to insure that decisions are valid.
Both compensation and promotion can be used strategically as part of a control system.
Compensation can be used to channel people's efforts toward the organization's overall
mission and/or specific Key Result Areas, objectives, and goals. Promotion decisions
send "messages" throughout the organization concerning who and what is valued.
This, in turn, creates corporate role models. Management can use promotions to create
the appropriate role models to strategically focus people on the things it values.
114 The Role of Reward Systems In Control
ENDNOTES
57. The appointment of Louis Gerstner, Jr. as IBM's Chairman in 1993 from RJR Nabisco is a
notable exception, and may signal a change in future corporate practices in this regard.
58. Kerr, S. "On the Folly of Rewarding A, While Hoping for B," Academy of Management
Journal, 1975, Vol. 18, pp. 769-783.
Effective Management Control: Theory and Practice 115
REFERENCES
Conlon, EdwardJ. and Parks, J.M., "Effects of Monitoring and Tradition on Compensation
Arrangements: An Experiment with Principal-Agent Dyads", Academy of Management Journal, 1990,
33,603-633.
Cowherd, D.W. and D. I. Levine, "Product Quality and Pay Equity Between Lower-Level Employees and
Top Management: An Investigation of Distributive Justice Theory", Administrative Sciences Quarterly,
1992,37,2, 302-321. Gerlinger, J.M. and L. Hebert, "Measuring Performance in International Joint
Ventures", Journal ofInternational Business Studies, 1991,22,249-263.
Gerhart, B., and G.!. Milkovitch, "Organizational Differences in Managerial Compensation and Financial
Performance", Academy of Management Journal, 1990,33,663-691.
Gomez-Meija, L.R., Tosi, H., and T. Hinkin, "Managerial Control, Performance, and Executive
Compensation, Academy of Management Journal, 1987, 30, 51-70.
Harder, 1.W., "Play for Pay: Effects of Inequity in a Pay-For-Performance Context", Administrative
Sciences Ouarterly, 1992,37,2,321-335.
Kerr, J.L., "Diversification Strategies and Managerial Rewards: An Empirical Study", Academy of
Management Journal, 1985, 28, 155-169.
Kerr, S . , "On the Folly of Rewarding A, While Hoping for B," Academy of Management Journal, 1975,
Vol. 18,769-783.
Konrad A.M. and 1. Pfeffer, "Do You Get What You Deserve? Factors Affecting the Relationship
Between Productivity and Pay", Administrative Sciences Quarterly, 1990,35, 258-280.
Micell~ M.P., Jung, I., Near, 1.P.M. and Greenberger, D.B., "Predictors and Outcomes of Reactions to
Pay-For-Performance Plans", Journal of Applied Psychology, 1990,75,2,508-521 .
Pierce, 1.L. Stevenson. W.B., and James L. Perry, "Managerial Compensation Based on Organizational
Performance: A Time Series Analysis of the Effects of Merit Pay", Academy of Management Journal,
1985, 28, 261-278.
Tosi, H.L. and Gomez-Meija, L., "The Decoupling of CEO Pay and Performance: An Agency Theory
Perspective", Administrative Sciences Quarterly, 1989, 34, 2, 252-278.
Townsend, A.M., K.D. Scott, and S.E. Markham, "An Examination of Country and Culture-Based
Differences in Compensation Practices", Journal oflnternational Business Studies, 1990, 667-678.
Williams, M.L. and G.F. Dreher, "Compensation System Attributes and Applicant Pool Characteristics",
Academy of Management Journal, 35, 1992.
Zenger, T.R., "Why Do Employers Only Reward Extreme Performance? Examining the Relationships
Among Performance, Pay and Turnover", Administrative Sciences Quarterly, 1992, 37, 2, 198-219.
7
THE ROLE OF ORGANIZATIONAL
STRUCTURE AND CULTURE
IN CONTROL
The model of an organizational control system presented in Chapter 2 (Figure 2-1)
included three parts: 1) the core control system59, 2) organizational structure60 , and 3)
organizational culture61 • The components of the core control system have been
examined in Chapters 3-6. This chapter deals with the role or organizational structure
and culture in control. It also suggests the relationship between structure and culture
and the core control systems.
As used in this context, the term "organizational structure" refers to the patterned
relationships among the roles people occupy in a formal organization. 62 "Roles," in
turn, are sets of behaviors expected to be performed by an incumbent.
Stated differently, roles refer to the jobs people occupy in organization, and to the sets
of behavioral requirements expected to be performed by people in those jobs. An
organization's structure refers to the pattern of arrangements of the sets of jobs
comprising the organization. Thus there are two major elements of structure: 1) roles,
and 2) their patterned arrangement in relation to one another.
Through the process of specifYing what Key Result Areas ought to be in a given role,
the role itself serves as a "goal" or standard against which a person's actual behavior
can be monitored (or measured), evaluated, and rewarded.
118 The Role of Organizational Structure and Culture in Control
Control Function of the Arrangement of Roles. The pattern by which roles are
arranged in relation to one another also performs a control function. Roles can be
arranged in a large variety of patterns and structures. The patterns can vary from
relatively flat organizational hierarchies, as illustrated in Figure 7-1, to relatively tall
structures, as shown in Figure 7-2.
One factor dmt may lead to dle choice of a flat or tall structure is simply the size of an
organization. The greater the number of people involved, the greater the need for
intermediate levels of management to achieve correlation and control. Management
theory has developed notions such as "span of control" to refer to this aspect of
organizational structure.
PRESIDENT
I I I I
Inside Outside Purchasing Warehouse
Sales Sales Agent Accounting Personnel
Figure 7-1
Illustration of Flat Organization Structure
(recruitment, training, sales, record keeping, and inventory control) rather than profit
responsibility. The rationale is that tht:re are corporate level experts who can best
make decisions which are then implemented by lower level managers.
PRESIDENT
Controller
Effective Management Control: Theory and Practice 121
As used in this context, the term "organizational culture" refers to the system of values,
attitudes, and beliefs which prevail within an organization and (explicitly or implicitly)
tend to govern the behavior ofpeople. 63 Culture represents written as well as unwritten
rules of conduct. It deals with what behavior is expected and what is taboo.
122 The Role of Organizational Structure and Culture in Control
All organizations have a culture, though it may be implicit rather than explicit, and
though it may be invisible to non-members. A firm's culture is very real and it must
be viewed as a major part of an organization's overall control system.
The three major elements of an organization's culture are values, beliefs and norms.
The nature of each variable is described below.
Values. The term "values" refers to the things which the organization's members seek
to attain or feel represent the organization. For example, an organization that wants
to attain a reputation as the preeminent professional advertising agency, or the "Rolls
Royce of consulting firms" is defining itself in a very particular way. Such values
govern behavior in a variety of ways. For example, one may hear that the statement
in a firm: "We don't do business that way; or "that wouldn't fit our image;" referring
II
Most firms have a self-concept which reflects their values. A firm of Certified Public
Accountants may see itself as a group of "high quality technically-oriented
professionals" or as a group of "good business people." A consumer electronics firm
may see itselfas a group of hard -driving innovative entrepreneurs, who are willing to
assume substantial risks. Another firm in the same industry may view itself as serious,
conservative and solido-unwilling to take unnecessary risks.
Belieft. In brief, a finn's self concept study typically represents its values, or what it
is trying to become. Values are accompanied by attitudes and beliefs. One firm may
believe in planning as a way of life and develop short term and long term plans.
Another finn may believe in continuing management education and development and
growing its managers from within. Another may believe that management
development is a waste of money, and that if good managers are needed they can be
hired. One finn may believe that it must continually innovate new products, while
another may believe the pioneers are "people with arrows in their back."
These differences in beliefs are real, if intangible, but they help shape how people in
an organization perceive events and design actions. Stated differently, this element of
culture influences a manager's set. By simultaneously prescribing "how we do things
at IBM Corporation" and influencing how managers perceive things, an organization's
belief systems can playa powerful role in controlling behavior. For example, in
residential real estate firms, one of the unwritten values is: "Thou shalt always be
optimistic. " If someone is pessimistic in a meeting, that person is likely to be the
object of peer pressure to change his or her view. This may take the form of comments
such as: "You're not being very optimistic," or "don't you have faith in your ability to
get the job done?"
Effective Management Control: Theory and Practice 123
At both companies in the examples above:, the norm serves an identical purpose, even
though the norms themselves differ. Specifically, each company's norms for dress are
intended to buttress the company's values, they way in which people think about
themselves.
Although all corporation' have cultures, just as all people have personalities, not all
corporations "manage" their culture. By managing its culture, an organization can
strategically use it as a component of an overall control system.
The first step in managing corporate culture us to assess what it actually is. Many
companies (such as Johnson & Johnson) have "Corporate Credos" which specifY their
desired culture. However, the actual culture may not coincide with the intended or
desired culture. For exanlple, an organization may specifY that customer satisfaction
is the highest priority while in the actual culture, there may be an indifference or even
a subtle contempt for customers. Similarly, the stated culture may emphasize
motivation, product quality, and the notion that" people are our most valuable asset,"
while the actual culture may be quite indifferent to these values.
Management can influence the actual culture by strategically using the organizational
reward system, as described in chapter six. The key point is that culture can and does
influence the behavior if people in an organization on a daily basis as well as a long
term basis.
A firm's culture does not, cannot, and should not exist independently from the other
dimensions of its control system. All of the three elements (the core control system,
structure, and culture) interact with one another.
124 The Role of Organizational Structure and Culture in Control
To function effectively, all of the firm's three elements of control should operate in
concert. This suggests that the three elements ought to be designed as a total system.
or a series of interconnected subsystems.
From a normative perspective, the design of the culture variable ought to come first:
what the organization values and seeks to become is of paramount importance. The
organizational structure ought to be designed in order to help implement the firm's
value system, and finally the core-control system ought to be designed to implement
the desired culture and structure.
Unfortunately, actual life does not always operate as theory would suggest. More
typically, culture is the variable that is recognized last, not first, and any changes
required must then be made in previously existing organizational structure and core-
control systems.
We shall deal with the design and redesign of actual systems of organizational control
and selected examples of the types of problems caused when the three elements of
control are not congruent in Chapter 9.
Effective Management Control: Theory and Practice 125
ENDNOTES
59. See Alexander (1991) and Dermer (1987) for other examinations of the role of organizational
control systems.
60. For additional information on organizational structure see Bhambri and Sonnenfeld (1988),
Capon et al. (1987), Miller et al. (1988), Hoskisson (1987), Shenkar and Ronen (1987), Yasai-
Ardekani (1989) and Keats & Hitt (1988).
61. For other discussions on organizational culture see Eisenhardt and Schoonhoven (1990) and
Osborn and Baughn (1990).
62. For further discussion organizational structure as a management tool, see Eric G. Flamholtz,
Growing Pains: How to Make the Transition from an Entrepreneurship to a Professionally
Managed Firm. (Jossey-Bass Publishers, Inc., 1990), pp.l84-21 1.
63. For further discussion of organizational culture, see llii4. pp.289-318.
126 The Role of Organizational Structure and Culture in Control
REFERENCES
Alexander, lA, "Adaptive Change in Corporate Control Practices", Academy of Management Journal,
1991,34:2,251-280.
Bhambri, A, and H. Sonnenfeld, "Organization Structure and Corporate Social Performance: A Field
Study in Two Contrasting Industries", Academy of Management Journal, 1988,31:3,642-662.
Capon, AN., Christodoulou, C., Farley, J.U., and H.M. Hubert, "Comparative Analysis of the Strategy
and Structure of U.S. and Australian Corporations, Journal ofInternational Business Studies, 1987,
18:1,51-74.
Covaleski, M. and M. Aiken, "Accounting and Theories of Organizations: Some Preliminary
Considerations", Accounting. Organizations and Societv, 1991, 11 :4/5, 297-320.
Dent, J.F., "Accounting and Organizational Cultures: A Field Study of the Emergence of a New
Organizational Reality, Accounting, Organizations and Societv, 1991, 16:8, 705-732.
Dermer, J., "Control and Organizational Order", Accounting, Organizational and Society, 1987,13:1,
25-36.
Eisenhardt, K.M. and C.B. Schoon hoven, "Organizational Growth: Linking Founding Team, Strategy,
Environment and Growth Among U.S. Semiconductor Ventures, 1978-1988", Administrative Sciences
Quarterly, 1990,35, 504-520.
F1amholtz, E. Growing Pains: How to Make the Transition from an Entrepreneurship to an
Professionally Managed Firm, Jossey-Bass Publishers, Inc., 1990.
Hoskisson, R.E., "Multidivisional Structure and Performance: The Contingency of Diversification
Strategy", Academy of Management Journal, 1987,30:2, 625-644.
Keats, B.W. and M.A Hitt, "Causal Model of Linkages Among Environmental Dimensions, Macro
Organizational Characteristics", Academy of Management Journal, 1988,31:3,570-598.
Miller, D., Droge, C., and J. Toulouse, "Strategic Process and Content as Mediators between
Organizational Context and Structure", Academy of Management Journal, 1988,31 :3,544-569.
Osborn, R.N. and C.C. Baughn, "Forms oflnterorganizational Governance for Multinational Alliances",
Academy of Management Journal, 1990, 33:2, 503-519.
Shenkar, O. and S. Ronen, "Structure and Importance of Work Goals Among Managers in the People's
Republic of China", Academy of Management Journal, 1987,30:3, 564-576.
Yasai-Ardekan~ M., "Effects of Environmental Scarcity and Munificence on the Relationship of Context
to Organizational Structure", Academy of Management Journal, 1989,32: 1, 131-156.
8
THE ROLE OF ACCOUNTING SYSTEMS
IN ORGANIZATIONAL CONTROL
Accounting is a system designed to measure, aggregate, and transmit ftnancial data for
a variety of managerial purposes. In most organizations, the accounting system is an
integral part of the overall core control system because of its measurement capability
and the need for measures to facilitate control.
In addition to the role that accounting plays in the overall core control system, certain
managerial accounting systems (i.e., budgetary systems) may function as if they were
control systems per se. When an accounting system functions as though it were a
control system, we may term it as "accounting control system." Accordingly, this
section examines the nature of the accowlting control system and how it operates as a
component of the overall organizational control system. It also examines the principle
types of accounting control systems.
There are three principal types of accounting control systems: 1) budget control
systems, 2) responsibility accounting systems, and 3) standard cost-variance control
systems. Each of these systems is described below.
128 The Role of Organizational Structure and Culture in Control
The budgetary control system consists of a process and a set of budget reports. The
process is the method by which the set of numbers comprising a budget are derived.
It may range from a highly participative process ofjoint decision-making to a relatively
autocratic or directive process in which a budget is imposed.
Types of Budgets
A fixed budget is an estimate of some items (sales, costs, etc.) under a single
assumption about its level of activity. For example, an automobile manufacturer may
assume that it will produce 800,000 passenger cars during a given year, and budget its
costs based upon that estimate. Unfortunately, under a fixed budget the attainability
of goals becomes meaningless as soon as the actual operating level varies from the
level assumed. A flexible budget is a set of budgets, with each prepared under a
different assunled level of activity. For example, the automobile manufacturer might
prepare production cost budgets under assumptions of minimum, most likely, and
maximum units of sales. The flexible budget would then provide a meaningful
standard under each possible level of operation, rather than a single hypothetical level.
Once formulated, the budget represents the plans and goals which the organization
hopes individuals and groups will achieve. There are three basic budgetary control
issues which our knowledge of human behavior can help us resolve:
Individuals pursuing what is best for their own needs may not accept the budget as a
goal. They may not perceive that achieving the budget will lead to satisfaction of their
goals. For an individual to be motivated to achieve the budget, he of she must, flrst,
perceive that the achievement of the budget is instrumental for the attainment of some
desired outcome or set of outcomes, and, second, place a positive value on those
outcomes. Thus the acceptance of the budget as an individual's goal is a question of
personal rationality.
Similarly, groups mayor may not accept a budget as a goal. Subgroup loyalty may
lead to conflict between the goal of a group and the organization as a whole. Such
conflict may be manifest not in the rejection of the budget as a goal per se, but in
intergroup conflict and competition for budget resources. For example, Division A
may compete with Division B to maximize its share of the budget pie, rather than to
obtain a budget that would merely be sufficient to satisfy its needs. This may be quite
rational from the vantage point of Division A's personnel, because their performance
will depend upon the resources available to them including "slack." A great deal of
political behavior may result from this motivation, causing intergroup competition.
achieve.
The organization wants people to accept budgets as their levels of aspiration. The
degree to which this will occur depends upon the perceived degree of difficulty of the
budget, whether it is perceived as realistic and attainable, and the perceived relation
ofperfonnance to organizational rewards.
The primary issue ofleadership or management style involved here concerns the degree
of participation of people responsible for achieving the budget in the establishment of
budgeted standards. There is a great deal of research which suggests that participation
leads to greater commitment to organizational goals.
Although it is clear that the desire for participation in decisions depends upon
personality and not all individuals desire to participate, it is possible hat participation
in the budgetary process can serve as a method of helping to induce internalization of
a budget. However, it should also be noted that if the process is more than a pseudo
or spurious process, then standards ultimately set may not necessarily be identical to
what the organization might set in the absence of participation. For example, some
organizations budget costs by merely issuing notices that budgets will be X per cent
Effective Management Control: Theory and Practice 131
more or less than the prior year. The percentage change does not necessarily come
from a participative budgeting process.
Some activities may be included in a budget which are not truly subject to the control
of the person responsible for the budget. One accounting practice is to "allocate"
(distribute by means of cost accounting methods) the costs of common of joint
activities to individual units which are thought to benefit indirectly. For example,
costs of corpomte headquarters may be allocated to divisions, or costs of the personnel
fimctions may be allocated to other departments. From the perspective of management
control, this practice is not beneficial. Such costs are not subject to control of the
organizational unit to which they are allocated, and if this is not recognized it can have
dysfunctional (adverse) results. Managers may begin to question the validity of the
budgetary control system, or may be misled by the nwnbers in the budget reports.
Another reason why not all variances ought to be investigated involves materiality. It
is not possible to a general criterion or cutoff for insignificant versus significant
variances. This depends upon the nature of the industry and the item. For example,
a 1% ( or possibly less) variance in materials cost in the tobacco industry may be very
significant, while a 5% of even 10% variance in labor colt in the petro-chemical
industry may be insignificant. Nevertheless, some criterion must be developed that is
valid for the particular situation.
In general, only controllable activities in the budget ought you be used as the bases for
evaluation and reinforcement of budget performance. If an individual does not
perceive that performance is controllable, then, in terms of expectancy theory, the
person's perception that effort will lead to performance will be decreased.
RESPONSIBILITY ACCOUNTING
There are two major types of cost centers: 1) Engineered Cost Centers and 2)
Discretionary Cost Centers. The fonner is a cost center in which it is possible to
utilize industrial engineering to detennine what costs ought to be ("standard costs")
under specified operating conditions. In such centers, such as certain manufacturing
organizations, these standard costs can b(! used for control, as examined below In the
latter, it is not possible to detennine what costs should be and there is no obvious
relationship between inputs and outputs. Costs are thus subject to management's
judgement or discretion. Hence the nanle "discretionary costs centers."
A standard cost-variance control system involves the process of detennining what costs
ought to be under specified operating conditions, using the cost derived as a standard
and goal of perfonnance, measuring actual perfonnance, and evaluating actual
perfonnance vis a vis the standard cost. A standard cost-variance control system is
closely related to a budgetary control system. Both include goals, standards, and
measures, but not rewards. Similarly, while both are not technically total control
systems, they operate with the effect of control systems because variances are used in
perfonnance evaluation.
A standard cost is a calculation of what <;osts for an activity or item ought to be under
predetennined operating conditions. It is then a nonnative or hypothetical cost. As
the title implies, it is intended as a standard for evaluating the efficiency of operations.
engineering methods are used, detailed analyses are made of the tasks which must be
perfonned to provide a service of produce a good, their optimal or "standard" sequence
and duration id specified as will as materials required (if any), and the cost of the direct
labor and materials as will as overhead (indirect materials, labor, and services) is
calculated. Alternately, accounting records may be used to determine what an activity
or product has cost historically and this historical cost may be employed as a standard.
Types of Variances
Several different types of variances may be calculated under a standard costing system.
The basic variances are shown in sununary in Figure 8-1.
There are two basic classes of variances: I) acquisition cost variances refer to the
variances between the standard cost of acquiring cost variances refer to the variances
between the standard cost of acquiring an input for operations (labor, material for
overhead) and the actual cost incurred. As seen in Figure 8-1, the acquisition cost
variance for materials is called a "price variance." For example, if the standard price
of a raw material used in manufacturing chemicals is .20 pound, and the actual cost
is.22 per pound, a price variance will be incurred that is measured by multiplying the
differential cost (.22 - .20 =.02) by the nwnber of pounds of the material that are
purchased. If 100,000 pounds ore purchased, the materials price variance is $2,000.
Similarly, acquisition cost variances may be calculated for labor and overhead, though
different labels are used to denote them. Utilization colt variances refer to the
variances between the standard cost of using an input in an operation to produce a
good or service and the actual cost incurred. 65
Acquisition Cost
Variances Price Variance Rate Variance SEending Variance
Utilization Quantity Efficiency Efficiency Variance
Variances Variance Variance Volwne Variance
Figure 8-1
Sunmlary of Basic Variances
In general, the basic issue involving the control of human behavior with standard costs
are quite similar to those concerning budgetary control. The four primary issues are:
Effective Management Control: Theory and Practice 135
In many respects standard costs variance controls operate in the same ways as
budgetary controls. Accordingly, to avoid repetition, this section will emphasize those
aspects which are relatively unique to standard costing.
Standard Costs as Goals and Standards. The idea underlying standard costing as a
control tool is very consistent with the overall notion of organizational control. By
definition, the purpose of standard costs is to serve as a goal to motivate cost control
as well as a specific standard of perfonllance against that goal.
Just as in the case of budgets, neither individuals nor groups will necessarily accept
cost control as their goals. There are four basic prerequisites for a "behaviorally
sound" control system: 1) standards must be established in a way that people accept
them as realistic rather than arbitrary; 2) people must feel that they have some
influence in establishing their own goalls; 3) people must feel that they will not be
unfairly censured for "nornml" of chance variation in perfornlance; and 4) feedback on
perfornlance must be for both correction as well as evaluation.
The process of establishing standards can playa crucial role in the degree to which
they are accepted as realistic and attainable. The traditional methods of establishing
standard costs (engineering and accounting estimates), described above, do not
typically provide an opportunity for individuals to participate in their development.
Yet participation is a major managerial strategy designed to lead to commitment to
organizational goals and standards. l1lUs we must recognize the built in conflict
between what is psychologically necessary in order to have people internalize goals
136 The Role of Organizational Structure and Culture in Control
and the way in which standard costs are established in most organizations. This
suggests the need for some mechanism to permit people to participate in setting
standards. In many industries, unions negotiate work standards with management and
indirectly serve the function of legitimizing standards.
CONCLUSION
This chapter has examined the nature of accounting control teclmiques and their role
as part of the overall organizational control systems. Budgetary systems, responsibility
accounting systems, and standard cost systems all function, to some extent, as
accounting control systems. However, from a tecImical standpoint, they are not fully
control systems. Nevertheless, accounting systems can serve a significant role as part
of an overall control system.
Effective Management Control: Theory and Practice 137
ENDNOTES
REFERENCES
Birnberg, J.G. and C. Snodgrass, "Culture and Control: A Field Study", Accounting, Organizations and
Society, 1988, 13:5, 447-464.
Buckley, J.W. and K. Lightner, Essentials of Accounting. (Encino, CA: Dickenson Publishing Co.,
1975).
Daley, L., Jiambalvo, J., Sundem, G., and Y. Kondo, "Attitudes Toward Financial Control Systems in
the U.S. and Japan", Journal ofInternational Business Studies, 1985,16:3,91-110.
Dent, J.F., "Accounting and Organizational Cultures: A Field Study of the Emergence of a New
Organizational Reality", Accounting. Organizations and Society, 1991, 16:82,705-732.
Flamholtz, E., Human Resource Accounting, (San Francisco, CA: Jossey-Bass Publishers, Inc., 1985).
Jones, C.S., "The Attitudes of Owner-Managers Towards Accounting Control Systems Following
Management Buyout", Accounting. Organizations and Society, 1992, 17:2, 151-168.
Kerr, S., "On the Folly of Rewarding A, While Hoping for B," Academy of Management Journal,
(December, 1975), pp. 769-783.
Lawler, E.E. and J.G. Rhode, Information and Control in Organizations, (Pacific Palisades, CA:
Goodyear Publishing Co., 1976).
Merchant, K.A., "The Effects of Financial Controls on Data Manipulation and Management Myopia",
Accounting. Organizations and Society. 1990. 15:4,297-314.
9
THE DESIGN A.ND EVALUATION OF
EFFECTIVE CONTROL SYSTEMS
Previous chapters have been concerned with the nature and role of organizational
control, the effects of control on behavior, the elements of an overall control system,
and the accounting-<:ontrol system as a component of the overall organizational control
system. This final chapter deals with some aspects of the design and evaluation of
control systems in organizations. Specillcally, it focuses upon the criteria which can
be used to guide the development on evaJiuation of an existing control system. It also
examines the adverse or dysfunctional ~:ffects of control systems that have not been
effectively designed. Finally, we shall examine selected examples of control systems
in order to illustrate their strengths and weaknesses. In brief, the overall objective of
the chapter is to provide a framework that can be useful in the design and evaluation
of control systems in order to enhance their effectiveness.
By definition, the ultimate criterion of an dfective control system is the extent to which
it increases the probability that people will behave in ways that lead to the attainment
of organizational objectives. Thus, since the objective of a control system is to
promote goal congruence, an identity between the goals of organizational members
(individuals as well as groups) and the: organization as a whole, the criterion of an
effective control system is the extent to ~hich it creates goals congruence. If a control
system does not lead to goal congruence, it is not effective. Alternatively, if a control
system sometimes leads to goal congruence but sometimes leads to goal conflict, it is
also ineffective, or at least less effectiv~: than might be desired.
To achieve overall goal congruence, a control system must also satisfY certain
penultimate and instrumental criteria:
1. To what extent does the system set:k to control all relevant goals or aspects of
perfonnance?
2. To what extent does the system lead to behaviors to which it is intended to (or
purports to) lead? and
3. To what extent does the system consistently lead to the same behaviors?
The llrst of these criteria may be viewed as a penultimate goal or criterion of control
systems, while the second and third are instrumental criteria. This is shown
schematically in Figure 9-1.
140 The Design and Evaluation of Effective Control Systems
Instrumental
Criteria
Ultimate
Penultimate Criterion
Behavioral
Validitv
Behavioral Goal
Comprehensiveness Congruence
Behavioral
Reliabilitv
Figure 9-1
Criteria of Effective Control Systems
Behavioral Comprehensiveness
To be effective, a control system must identifY all relevant behaviors or goals which
are required by the organization. This is tenned "behavioral comprehensiveness." If
the system does not identifY all relevant goals and seek to control them, then people
may simply channel their efforts toward some other direction. For example, a
wliversity may desire to achieve both the goals of research and education, but may only
have a control system that deals with the goal of research. Thus the system monitors
and rewards research while hoping for attention to education as well.
Behavioral Validity
This construct refers to the extent to which an organizational control system leads to
behaviors to which it purports to lead (intended behavior). For example, a control
system may be desired to motivate attention to achieving a budgeted profit and
personnel development. If the system leads to these behaviors that are in conflict with
Effective Management Control: Theory and Practice 141
The concept of "behavioral validity" is based upon the recognition that the purpose of
a control system is to influence human behavior. This notion has important and
somewhat subtle implications for tile design of control systems. For example, assume
that a CEO (chief executive officer) wants to motivate his or her line management to
devote efforts toward tile development of personnel and especially to develop their own
successors. The CEO might state at an annual management meeting: "One of our
goals is developing people and because it is one of our goals we will measure the
change in value of people by using Human Resource Accounting. 66 We will also take
this factor into account in our appraisal of managerial performance. "
In effect, tile CEO of this company has dlescribed a key result area (Human Resource
Development) and an implicit core control system, with the components of planning
(goals), measurement, and evaluation-reward. If this "system" is successful in leading
to increased personnel development, tllen we say it has "behavioral validity," even if
the "system" ~ se is vague, ambiguous, and not well defined.
In practice, however, tllis type of infomlal or implicit core control system may lead
some managers to develop people while not motivating others to do so. This refers to
the control system's consistency or reliability, as defined below.
Behavioral Reliability
This is the extent to which a control system repeatedly produces the same behaviors
regardless of whether tllese behaviors are intended or unintended. A control system
which produces the same behavior in all managers or the same behavior in the same
manager over different times is tenlled behaviorally reliable or consistent.
Behavioral reliability is more likely to occur when tlte control system has been
specified to a greater extent than in the example of the CEO's comments at an annual
management meeting.
Behavioral reliability is different from and is not sufficient witltout behavioral validity.
A control system may have a high degree of behavioral reliability, but it may lead
consistently to unintended, dysfunctional behaviors.
Goal Displacement
This involves a lack of goal congrucnce: creatcd by motivation to achieve some goals
sought by tile organization at tile expense of otller intended goals. Goal displacement
may be caused by several tllings, including 1) suboptimization, 2) selective attention
142 The Design and Evaluation of Effective Control Systems
Similarly, the sales manager of an automobile dealership, who was rewarded based
upon sales but was not responsible for costs, unreasonably increased expenditures for
advertising even though it was unprofitable for the dealership to do so.
application forms, counseling them, and referring them to jobs. To control the
interviewers, the agency monitored the number of interviews conducted. The effect of
this control system was to motivate the interviewers to pay attention to the instrumental
goals (i.e., numbers of interviews), while neglecting the overall (but unmeasured) goal
of placing people injobs.
Measurement
This involves a lack of goal congruence created by motivation to "look good" in terms
of the measures used in control systems, even though no real benefit has derived to the
organization. It involves playing "the nunlbers game" and manipulating the measures
used by a control system. There are two primary types of measurementship: I)
smoothing and 2) falsification.
The preceding section has presented a set of criteria for designing and evaluating
effective control systems and discussed the problems caused by ineffective control
systems. In this next section, we shall examine selected examples of control systems
in order to illustrate some of their strengths and weaknesses as well as some of the
problems typically observed in actual systems of organizational control.
Each of these types of situations shall be described in order to examine their effects on
144 The Design and Evaluation of Effective Control Systems
organizational control.
There are many firms which operate without a formal control system as it has been
described in this book. Typically such firms are relatively small (sales less than $10
million). However, occasionally even large firms have not developed formal control
systems. Such firms will have elements of a control system but not a complete system.
In this section, we shall examine one relatively small firm that operates without a
formal control system and explain why this was so and describe the regretting
difficulties.
Nature ofthe Firm. TIle finn in question was an industrial abrasives distributor. The
finn distributed a full set of industrial abrasive products to industrial firms which use
the products in their own manufacturing process. We shall term this firm "Industrial
Abrasives, Inc."
Industrial Abrasives, Inc. had its major facility located in a large metropolitan city in
the U.S. TIle finn also had one satellite branch office in another major city. The firm's
sales volume exceeded $12 million annually, and the finn employed approximately 75
persons.
Firm's Culture. Structure, and Accounting System. Although the firm had been
founded more than twenty years prior to this study, for most of its history it had
remained relatively small in temlS of sales volume and personnel. During the past few
years, the finn had experienced rapid growth in sales volume attributable to favorable
economic conditions, its full range of products, sales force, and ability to meet
customer service requirements. During a three year period the firm increased in size
from $3 Yz million to more than $12 million.
The firm was owned by a single family, and three family members (a father and two
sons) ran the firm along with other family members. As typical in firms of this size,
responsibilities were not formally defined and tended to be overlapping.
The finn had been successful, at least in part, because of competitively priced products
and skill at selling by family members and the sales staff. None of the members of the
family as well as virtually all other "managers" had been formally trained in
management. The fiml did have a "Controller," who was a CPA.
The Accounting System and Organization Control. The firm did not have any formal
system of management control as it has been defined in this monograph. As an
organizational function, "control" was exercised by the personal involvement offamily
members in the day-to-day activities of the firm, rather than through formal planning,
Effective Management Control: Theory and Practice 145
measurement, perfonnance appraisal and n:ward systems. In this respect, the ftrm was
probably quite typical of most organizations with its type of history: rapid growth as
an entrepreneurship.
The fum's accounting system produced an annual income statement and balance sheet.
An illustrative income statement is showlll in Exhibit 9-1 to indicate the format used;
the numbers have been eliminated. These ftnancial statements were prepared at the end
of each year to determine the ftrm's yCluly income and ftnancial position both for
ownership and tax purposes; but they were not used otherwise in day-to-day
management ofdle business.
As seen in Exhibit 9-1, the income statement format is very simple. Expenses are
listed alphabetically rather than by functional categories (selling, administrative,
warehouse, etc.). Although the ftnn has fOlllr different product lines, there is no attempt
at product line profttability analysis, and this did not occur in any other way in the
ftrm. Indeed, management did not know what the relative product line profttability
was except in terms of "gross margin": selling price less direct materials costs. In
neither this income statement nor any supplementary analysis was there any attempt
to classifY costs as "ftxed or variable, controllable or uncontrollable." As noted above,
the income statement was prepared annually and, therefore was not available for
periodic monitoring during the year. In addition there was no budget or proftt plan.
Thus, there was neidler an attempt to s,et proftt goals nor to assess the variance of
actual proftt in relation to goals.
In brief, there was not a fonnal system or control in this ftrm, an the accounting system
did not perform any of the control functions ordinarily associated with it. Indeed, the
ftrm's ftnancial statements were virtually ignored except to detenuine whether or not
a proftt had been made.
If this organization's ftnn were merely an illustration of an isolated ftrm that lacked
sophisticated management, it would be of little signiftcance. However, this ftrm is a
classic illustration of an entrepreneurship that has experienced rapid growth and has
not yet responded to its changed circwnstances. Rather than being a-typical, it is the
prototype of a great many successful ftrms of its size in a variety of industries. As
such, it suggests signiftcant insights for our understanding of the actual role (or more
properly, lack of a role) that accounting plays in its organizational context in a great
many ftrms.
Impact ofCulture Upon Utilization ofAccounting and Control. What explains the
ftrm's lack of fomlal organizational control system as well as its failure to use
accounting information to facilitate organizational control? The key is in the
organization's culture.
Exhibit 9-1 Industrial Abrasives, Inc.: Income Statement Before Income Taxes
Sales
Cost of Goods Sold
OPERATING EXPENSES:
Advertising
Bad Debt Provision
Car Expense
Conullissions
Contributions
Data Processing Service
Depreciation
Entertainment
Freight Out
Insurance - Officer's Life
Insurance - General
Insurance - Group
Interest
Medical and Dental
Office Expense
Postage
Professional Fees
Profit Sharing
Rent
Repairs and Maintenance
Salaries - Officers, Manager
Salaries - Office
Salaries - Sales
Salaries - Warehouse
Shipping Supplies
Taxes - Payroll
Taxes and Licenses
Telephone
Travel
Utilities
operational things very well: buy product, sell it, deliver it, and service customers.
Personal attention to the business and an open-ended commitment by family members
and many employees made the firm prosper and grow. However, the frrm lacked a
professional management orientation. It did no formal planning, and there was not
even informal long range planning; rath(~r, the frrm reacted to changing events and
circumstances. Organizational roles were not defined explicitly. People did what work
had to be done. There was no budget, but the controller paid attention to cash flow.
Because the firm was growing, sales revenues were sufficient to cover expenses, and
the firm had a line of credit sufficient to (:over short-term cash requirements.
The firm was sales and product-oriented. Its owners were skilled in personal selling
and because of good interpersonal skills th,ey were also able to maintain relations with
suppliers. If expenses had to be increased, the culture responded, explicitly and
implicitly, by saying "So we'll have to go out and get some more business." Indeed,
when a profit budget had been prepared for the first time, and the president was
advised of a projected loss the possibility of personnel layoffs was proposed. The
president responded: "Why don't we just go out and get some more business."
Although this response was quite typical, it was not appropriate to the current
economic environment.
Consequences of Lack of Control System. What were the consequences of the lack
ofa formal control system for this firm? For most of its history, the firm was able to
operate profitably without a formal control system, but there was an opportunity cost.
As the firm began to increase its sales revenues rapidly, profits remained surprisingly
level. In effect, the firm had increased its volume but had not increased profitability
correspondingly. The cost of a lack of a formal control system was less profit than the
firm ought to have earned.
As long as market conditions were good, the problem of lack of control remained an
opportunity cost and hence was intangible. However, the firm began to feel the effects
ofa wide-spread economic decline in the U.S. and, for the first time, as stated above,
fuced a projected loss. At this point, the firm had already begun to try and develop a
formal control system but it was too lat(~, and the cost of not having moved quickly
enough to accommodate changed needs was now more severe.
Conclusions. As illustrated by this firm's history, formal control systems are not
always essential to a firm's profitability and survival. However, after a certain size is
reached ($10 million or more in sales), the lack of a formal control system can become
an acute problem.
There are many firms which do have formal control systems but which have systems
dealing with only some of the organization's key result areas. The problems
148 The Design and Evaluation of Effective Control Systems
encountered by such finns are different from those experienced by firms with no formal
control system. This section describes an example of a firm that has a formal control
system which leads to selective attention to organizational goals because of the failure
to include all relevant key result areas. This type of problem is especially important
today in U.S. organizations.
The plant is treated as a cost center and has a standard cost system used in connection
with cost control. Top management states that the key areas of concern for plant
management are: cost control, product quality, timeliness of product delivery, and
safety.
The fiml has a fornlal system of planning and control, and year-end bonuses are paid
for achieving manufacturing efficiency ratings.
Problems with Control System. There has been increasing evidence of customer
dissatisfaction during the past few years. The firm's sales force reports customer
complaints about product quality and missed delivery dates. Sales personnel also
complain that plant personnel are no sufficiently sensitive to customer needs, and that
there is an unwillingness to modifY production schedules to accommodate large rush
orders. Plant personnel encounter tllat they are evaluated upon plan efficiency
measures derived from the standard costing system and they are just doing what the
firm wants them to do -- be as efficient as possible.
AnalySiS ofControl Problems. The key problems facing this firm are suboptimization
and goal displacement. The plant is optimizing its manufacturing efficiency
measurements because the control system is effective in motivating the behavior it is
designed to produce. However, other important but uncontrolled variables are not
receiving sufficient attention including product quality and timeliness of delivery. This
occurs because the fonnal control system is limited to financial variables and does not
include these other factors.
This plant is a classic illustration of the problems facing a great many U.S.
manufacturing firms, caused by ineffectively designed core control systems. The
solution is to correct the system to increase the degree of behavioral
comprehensiveness so that all key result variables are under control.
Problems When Culture and Core Control Systems Are Not Synchronized
Our final example concerns the problems caused when an organization's culture and
its core control system are not sufficiently synchronized. Stated differently, what
happens when there is an inconsistency between what the organization's culture says
Effective Management Control: Theory and Practice 149
it wants and what is motivated and rewarded by the core control system?
This type of problem is common even in relatively large, well-managed firms. Our
example is drawn from a professional service firm.
Problems 0/ Partial Control in a CPA Firm. This firm is a major international firm
of Certified Public Accountants (CPAs). It provides a wide variety of audit, tax, and
consulting services for clients. The fiml is professionally managed and profitable. It
has a strategic plan, and a fomlal control system.
The basic control problem experienced by the firm is in the "Huntan Resources" key
result area. The Huntan Resources area is an explicit part of the firm's strategic plan
and there are specific goals in the firm's strategic plan dealing with the recruitment,
development, and retention of people.
The control problem facing the firm is that its huntan resource goals are not being
fulfilled. The major explanation for this problem is that the firm's formal control
system is not sufficiently synchronized with its culture.
Analysis o/Control Problem. This firm has a formal organizational control system.
The firm has an annual planning process ilnd sets goals for all relevant key result areas.
The firm also has an evaluation process which purports to assess partner performance
in all key areas, including the huntan resources area.
The six key result areas in which partners are evaluated are: I) Client relations, 2)
Development and motivation of others, 3) Practice development, 4) Practice
management. 5) Self-development, and 6) Technical effectiveness. These areas purport
to represent the finn's value system, its culture.
On paper, all of these key result areas are equally important. However, the real value
system of the finn is reflected in tlle administration of the partner evaluation process.
In this process, what gets measured and rewarded gets attention paid by partners. In
terms of the firm's culture, if no one gets "gigged" (penalized) for not developing
people or not developing practice, then sufficient motivation will not be focused upon
these variables.
In brief, the firm says it wants personnd development, but it does not reward people
for personnel development and it does not punish (gig) people for failing to develop
people. The finn says it wants technical effectiveness and it rewards partners (through
compensation and promotion) for technical effectiveness, while punishing people for
inadequate technical effectiveness. Thus it is not surprising that the firm is perceived
as teclmically effective but inadequate in its development and retention of people.
This is another example that the prOCt:ss of organizational control is not magical or
150 The Design and Evaluation of Effective Control Systems
mysterious. The control system does what it is "told" to do. It produces the behavior
it is designed to produce even if this differs from what top management says it wants.
The previous section of this chapter has examined selected problems of control systems
which are commonly observed in actual organizations. In this fmal section, we shall
examine an example of the overall core control system. Our purpose is to present a
"mini" case study of the issue, involving the effective functioning of a core control
system.
The original location ofthe firm was a single store in a major metropolitan area in a
large western state. The firm emphasized a variety of competitive aspects, including
the use of original equipment, materials, competitive prices, rapid service, quality of
installation. and field service by means of radio dispatched trucks. As the firm began
to grow, it targeted new geographical markets. By 1986 the firm had organized a
franchise operation. and had established ten locations throughout the state. Each of the
franchises is organized with a branch manager, a number of installation technicians,
and an administrative assistant. The administrative assistant's function is critical to
the effectiveness of the operation of the branch since they had the primary contact with
the customer, and are required to relay most of the critical information concerning sales
and or repairs. TIle installation and repair teclmicians are also critical to the effective
operation of the firm. Incorrect installation or faulty repair creates significant customer
ill will and substantial cost to the company. The "branch manager" is actually an
owner/operator, who has an investment in the franchise. Depending upon the size of
the branch the branch manager may also function simultaneously as an
installer/technician or even as a sales person. Some of dIe larger branches, there may
be one or more full time sales personnel.
By 1989, the firm had grown to approximately $25 million in annual revenue. The
firm was growing at an average rate of 22 percent a year, and because of rapid growth
both in ternlS of dIe number of branch operations, as well as in the total volume of
sales there had been relatively little time to develop the infrastructure of the
Effective Management Control: Theory and Practice 151
organization.
Certain aspects of the Superior Alann lcontrol systems were more developed than
others. The company had developed a relatively sophisticated strategic planning
process. The flrm had been involved in numerous formal planning exercises over
several years since its inception. The planning meetings involved a considerable
amount of discussion generating ideas concerning problems facing the company,
identifYing alternatives, assessing the strengths and limitations, searching for
information that was relevant, and formulating a broad concept of where the flrm
wanted to go. These sessions were the basis for the flrm's decision to franchise, for
example. One problem with the planning process was, according to the firm's
administrative staff as well as the branch managers, that it did not tend to result in a
set of specific goals and objectives for thle firm, or a set of priorities to guide them in
carrying out there overall efforts. The frequent complaint was that many of the plans
that were originally made at the beginning of the planning year tend to become
"bumped" by more immediate problems handed down by top management. The
introduction of unplanned projects, or cris(:s which tended to emerge, resulted in shifts
in the focus of energy, and would result in neglect of many of the projects which had
been originally agreed to at the beginning of the year. There was a sense that the firm
was making progress, but that a great deal of the progress was in an ad hoc, or piece
meal basis. The bottom line was that many of the participants in the planning process
sessions expressed uncertainty about how the content of the meetings would be
translated into action.
Although the overall planning process was extensive, there had never been a formal
consideration of what the company's ki!y result areas ought to be. Accordingly,
although the branch managers and in tum installation technicians understood in general
what their role was, there was not a specific set of key result areas for which they were
held accountable. Similarly, there were not a specific set of goals or objectives for
which they were held accountable.
Another problem with the firm's control system related to the nature of its objectives
and goals. Although most of the fIrms obje:ctives and goals were not measurable, a few
were quantiflable. Another problem was: that the level of performance expected was
unrealistic. For example, the times which were available as "standard times" for
installation were thought by all but a few of the most talented and experienced
installation technicians to be unrealistic. As a result, many of the employees found the
standards to be demoralizing. Moreover, the enforcement of the standard was
relatively uneven. Some branch managers tended to stick to standards and to evaluate
installation technicians negatively whenl~ver their performance was below standard,
which was quite frequently. Other branch managers, who recognized the standards
were not wholly realistic, tended to ignore them.
152 The Design and Evaluation of Effective Control Systems
One strength of the measurement system of the firm was that it was organized on a
"responsibility accounting basis." This meant that the firm had good information
concerning the profitability of each individual branch. At each branch, the company
ilad institutionalized a monthly financial review of the data. The representative of the
home office met with the branch manager and examined the monthly financial report.
They also discussed issues involving branch performances on such key factors as
market share. Within each branch, however, the process of performance review was
relatively uneven. Other than examination of overall bottom line profitability, there
did not tend to be a review of performance in key result areas which supported that
profitability. Discussions of "problems" would occur as they emerged. There was no
systematic attempt to identifY the critical success factors of the branch, to measure the
branches performance in each one of those factors, and to examine it in depth. With
respect to performance appraisals of each employee, there was an uneven emphasis by
the different branch managers on evaluation of their subordinates. While it was
company policy that employees were to be reviewed based on their performance on a
yearly basis, some individuals indicated that over two years had passed since their last
review. They also reported that feedback on their performance ranged from some very
specific, constructive criticisms, to more global assessments of their performance.
Many individuals indicated that they were not really sure how they were being
evaluated by their managers, or either whether they were valued or not valued by their
managers. One stated, " well, I'm still here, so I must be doing okay."
At this stage of the finn's development there was not a well designed compensation
program. The administration of compensation increases was on an ad hoc basis.
Some individuals had not received a salary increase in more than two years. There
were no specific guidelines for salary increases that would be allocated in relationship
to different levels of performance, such as excellent performance, good performance,
or satisfactory perfonnance. Individuals reported that they did not have a clear idea as
to how increases in their compensation would result based upon different levels of
perfornlance.
An analysis of our description of the control system at Superior Alarm in the last
section indicates that there are a nwnber of problems in the design of that system.
There are problems both in the individual components of the control system, as well
as in the overall integration of the system. In this section, we shall examine some of
those problems and make suggestions about how they can be improved.
Goals and Objectives. As described in Chapter 3, objectives and goals are the output
of the finn's planning system. The companies strategic planning system should result
in a statement of its mission, its key result areas, its objectives, and goals. In the case
of Superior Alarm, the planning system is not functioning as well as it needs to provide
a foundation for a effective control system. The basic problem with the planning
Effective Management Control: Theory and Practice 153
process at Superior Alarm is that it is not producing a well defined statement of key
result areas. The key result areas are necessary to provide an overall focus for the
branch manager, and in turn the installation technicians and the administrative
assistants. Once the key result areas for each branch are identified and defmed, then
it is necessary to further improve the planning process at Superior Alarm by generating
a set of objectives and relationships to each key result area. The next step is to
generate goals which, by definition, are specific, measurable and time dated in
relationship to each objective. These steps will help overcome the problems faced by
branch managers, installation technicians, and administrative personnel. To help avoid
the problem of setting unrealistic goals, the branch manager, installation technicians,
and administrative personnel, should participate in the process of setting these goals.
It is particularly important that great care be devoted to insuring that the goals are
measurable, specific, and time dated. Otherwise, they did not provide and effective
basis as a comparison with actual perfOlmance.
The company will need to do an analysis of each of its key result areas in order to
insure that measurements are available to assess performance on each of these key
factors. The measurements do not all have to be in dollar ternlS. Some can be in
monetary terms, other can be in non-monetary terms. Some measurements can even
be what may be characterized as "go/no go" measurements. This means that a manager
can do an informal rating of whether something has happened or not happened. For
example we might be able to assess the level of customer service by the number of
written complaints or letters of praise received. Ultimately, the home office might
conduct a telephone sanlple of customers and have the interviewer generate a
judgement as to whether the service provided was "satisfactory or unsatisfactory." By
then tabulating the nwnber of satisfactory versus unsatisfactory responses, we can
generate a "measurement" of branch perfonnance in this key result area.
Rewards. A significant problem with the firnl's control system is the lack of linkage
between objectives, goals, measurements and rewards. The firm's compensation
system does not appear to be linked to its objectives and goals. Individuals do not
perceive that they are rewarded based upon their ability to achieve goals and
objectives. Since people do not perceive a clear linkage between goals and objectives
and compensation, there is unlikely to be: a great deal of "ownership" of the goals and
objectives. People may very well be motivated, but the firm's reward system is not
either enhancing or channeling their motivation directly toward the goals and
objectives that the branch seeks to attain.
154 The Design and Evaluation of Effective Control Systems
To improve its control system, the firm will have to do an analysis of its overall
compensation system. To be effective the compensation system should ideally provide
incentive for an individual to achieve the goals and objectives that the organization
wants to attain. An increasing number of entrepreneurial firms are relying on
compensation systems which have a significant component based upon incentive
compensation. In such circumstances, people are generally provided a base salary
which is relatively competitive, and then opportunities for substantial increases in
compensation linked to the achievement of individual and company objective and
goals. Wherever feasible, a company should attempt to tie incentive compensation to
measurable factors. However, even where this is not feasible, if management can
identitY the key factors it wishes people to focus upon, and indicate how incentive
compensation will be based upon those factors, it will result in enhanced motivation
of performance.
CONCLUSION
The design and evaluation of organizational control systems is a complex and difficult
process. Yet it is possible to design effective systems of control, ones which cause
people to behave in ways which are consistent with organizational objectives.
The failure to properly design a control system can lead to major problems in an
organization or even to organizational failure. Although the state of the art of
organizational control theory requires further development, this monograph has
presented the basic concepts, theory, and research findings relevant to an understanding
of control systems as well as a conceptual framework to facilitate their design,
evaluation, and improvement.
ENDNOTES
66. See Eric F1amholtz, Human Resources Accounting, (Jossey-Bass Publishers, Inc., 1985).
67. Ibid.
156 The Design and Evaluation of Effective Control Systems
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INDEX
Note: Page numbers in italics refer to figures; page numbers followed by t
indicate tables.