Summary Management Control and Cost Management
Management Control (part 1) (~40% exam)
Module 1 : Introduction to management control
- Big challenge: strategy execution
o #1 challenge for CEOs around the world (Asia, Europe, US)
o Approximately, 2/3 to 3/4 of large organizations struggle to implement their
strategies
▪ Because it is about people: people make things happen
▪ "Execution is the result of thousands of decisions made every day by
employees acting according to the information they have and their own self-
interest"
▪ Understanding, predicting, and influencing human behaviour = difficult
- Management Control: influencing employees to make decisions that allow for
implementation of organizational strategies and achievement of goals
o Management control systems: all tools, devices, and systems that managers put in
place to influence employees’ behaviours and align them with organizational goals
and strategies
▪ Examples: budgeting systems, performance measurement & compensation
systems, planning systems, reporting system
o Key functions of management:
▪ Objective setting: what does the organization want to achieve?
▪ Strategy formulation: how to use resources to meet the objectives?
▪ Management control: strategy execution with the behavioural focus
• Do employees act in line with the organizational strategy to achieve
organizational objectives
▪ -> These functions are interrelated and inform each other
▪ -> Strategy is not just something top management designs and then hands
over. What people do every day—shaped by management control systems—
can also influence how strategy evolves.
o Causes of control problems: not behaving in way company wants
▪ Lack of direction: Employees don't know/understand what the organization
wants from them
• Solution: clarify expectations, make clear how they contribute, make
job more meaningful , help to move in right direction
▪ Motivational problems: employees' interests are not always aligned with the
organizational ones (similar terms: conflict of interests, goal incongruence)
• Solution: incentives
▪ Personal limitations: lack of ability to perform, cognitive limit (limited
capability to process information properly)
• Solutions more about training, help develop skills to allow them to
do job better, also selection of fitting people, job design
1
,- Agency theory:
o Principal-agent relation: settings in which one party (the principal) hires another
party (the agent) to perform a task on her/his behalf
o Assumptions:
▪ Agency problem: agent pursues their self-interest instead of the principal’s
interest →difference in goals
▪ Often information asymmetry between principal and agent (eg ability,
environment, quality of work, time it takes, price of different paints, …)
▪ Agent and principal are cognitively limited: bounded rationality
• They are rational given the information they have, but this
information is not perfect
• Eg limited time: not access to all information, you cannot process all
information
▪ Agent and principal can have different levels of risk aversion
• Agent may take more risk than principal would like eg or other way
around
o Agency problem exists in all organizations and in all cooperative efforts, at every level
of management in firms, universities, mutual companies, cooperatives, governmental
authorities and bureaus, and unions
o Agency problem causes agency costs
▪ = all costs principal must bear by assigning a task to an agent
▪ 1) Costs of managing the principal-agent relation: monitoring, making a
contract, information search, incentives, …
▪ 2) Agent uses the principal’s resources in their own interest
o Agency problems:
▪ Goal incongruence: agents maximize their utility, not the principal’s
▪ Hidden information (asymmetry)-> Adverse selection
• Prior to contracting , agents have better private information than
principals
o (eg candidate for job exaggerates, sick people seek health
insurance, …)
• Solutions: pre-contract investigation, post-contract penalties (if
something wrong)
▪ Hidden action -> Moral hazard
• After contracting , agents have an incentive to deviate because the
principal cannot readily observe their actions (hidden action or
hidden information) (e.g., shirking on job)
• Solutions: monitoring, target setting, performance-based incentives
▪ Employee theft:
• Employees use firm resources for unauthorized purposes (pure risk)
• Solutions: Buy fidelity bond (insurance pays if employee steals
something, eg cashiers), monitoring, inventory control, installing
whistle blowing systems, etc
2
, ▪ Empire-building: accumulating power
• Managers seek to manage a larger number of employees/funds to
increase their own job security or compensation without benefiting
the company
• Solutions: Modify incentive contracts, benchmarking of CEO pay, etc
▪ Horizon problem:
• Agents expecting to leave the firm place less weight on the long-term
interests of the firm
o Focus on short-run actions = myopic behavior
• Solutions: Long term incentives (eg stock options), bonus bank (part
of bonus is banked/deferred, you get it if you keep performing),
monitoring, etc.
Example Horizon problem: -Manager expects to retire in 3 years
-Compensation: fixed salary + 5% of division’s profits
-He can spend $100,000 on process improvements this
year + next year -> cost savings of $150,000 for each of the
following 4 years
However, he will reject the project because accepting
would reduce his total bonus (even though good project)
▪ Key control problem in teams: free-rider problem
• Individuals form teams (firms) because they can produce more in a
team compared to doing alone (positive synergy). However, team
production can create control problems.
• Agents are likely to shirk (=avoid responsibility) because their
individual efforts are not directly observable to the principal
o The principal only observes the total output
• Solutions: peer monitoring, between-group competition (based on
research reduces free riding, individual members start caring more),
cultural control (more informal, free riding = socially sanctioned (eg
people don’t want to be your friend))
o Typical organization loses 5% of rev due to fraud
▪ Control failure can be costly (can threaten a firm survival, lead to
reputational damage, financial loss, organizational failure) →not just about
reaching goals
- Designing control systems:
o Avoiding control problems:
▪ Activity elimination: subcontracting activities that can create control
problems to an external party: use of cloud services so that data security and
protection would be provided and controlled by another company
▪ Automation: using robots, computers, and expert systems to eliminate
human problems of inaccuracy, inconsistency, or lack of motivation
▪ Centralization: eliminate the possibility that lower-level employees make
decisions that are not in the best interest of the organization
▪ Risk sharing: buying insurance against certain large losses that an
organization may face. For example, purchasing fidelity bonds on employees
in sensitive positions (such as bank tellers) to reduce firms' exposure to
control problem
3
, Module 2: Introduction to management accounting and cost management important
- Accounting: ‘language of business’ to know
o We understand, assess, and communicate about business with accounting difference
o Accounting: recording, analysing, summarizing, and reporting business between 2
transactions mainly in the financial terms domains
o Accounting system: a particular way a company does accounting!
Financial accounting Management accounting
Goal: Provide information about how firm is Help make better decisions (pricing,
doing for financial accounting and tax make or buy, investment/closure in
purposes (Sometimes for executive region or product, accept/reject
compensation) special orders,..)
Reports External for external agents (e.g., Internal reports for managers
and their suppliers, clients, banks, analysts,
audience: shareholders, investors)
Regulations Guided by prescribed accounting Organization-specific, customized,
principles. It is compulsory for all with some legal restrictions, but no
organizations. regulation
(eg IFRS: mandates firms to disclose
information about their segments
(geographic region and/or product level)
= segmental reporting)
Horizon Provides information about the past Reports historical and current
period information and provides information
on expected future performance and
activities
(budget information, sales targets, goals to
achieve, results of variance analyses,
customer satisfaction, safety measures,
cost information to marketing & sales
managers for pricing and profitability
analysis)
Reporting Annual reporting (semi-annual and Variable reporting interval: monthly,
frequency quarterly reports also exist in some weekly, hourly, ad-hoc analysis…
companies)
2 different What is required for tax reporting may 2 key roles (!): “very
systems: not be the best information we need for - Decision-facilitating role: Provision import
purposes (internal) decision making of information to reduce pre-decision
ant”
are not Avoiding disclosure of strategic uncertainty/make better decision
always information; proprietary costs (don't →Aim: to improve employees’
aligned want to give too much information, not knowledge so that they can make
sensitive information bcs competitors organizationally desirable judgments
also have access to financial reports) -Decision-influencing role (control):
Eg BMW discloses segments based on Use of information to motivate
product and not on region because they employees and align their interests
want to protect from competitors , their with those of the firm
competitive advantage → Aim : to influence (control)
employee behaviour
4
Management Control (part 1) (~40% exam)
Module 1 : Introduction to management control
- Big challenge: strategy execution
o #1 challenge for CEOs around the world (Asia, Europe, US)
o Approximately, 2/3 to 3/4 of large organizations struggle to implement their
strategies
▪ Because it is about people: people make things happen
▪ "Execution is the result of thousands of decisions made every day by
employees acting according to the information they have and their own self-
interest"
▪ Understanding, predicting, and influencing human behaviour = difficult
- Management Control: influencing employees to make decisions that allow for
implementation of organizational strategies and achievement of goals
o Management control systems: all tools, devices, and systems that managers put in
place to influence employees’ behaviours and align them with organizational goals
and strategies
▪ Examples: budgeting systems, performance measurement & compensation
systems, planning systems, reporting system
o Key functions of management:
▪ Objective setting: what does the organization want to achieve?
▪ Strategy formulation: how to use resources to meet the objectives?
▪ Management control: strategy execution with the behavioural focus
• Do employees act in line with the organizational strategy to achieve
organizational objectives
▪ -> These functions are interrelated and inform each other
▪ -> Strategy is not just something top management designs and then hands
over. What people do every day—shaped by management control systems—
can also influence how strategy evolves.
o Causes of control problems: not behaving in way company wants
▪ Lack of direction: Employees don't know/understand what the organization
wants from them
• Solution: clarify expectations, make clear how they contribute, make
job more meaningful , help to move in right direction
▪ Motivational problems: employees' interests are not always aligned with the
organizational ones (similar terms: conflict of interests, goal incongruence)
• Solution: incentives
▪ Personal limitations: lack of ability to perform, cognitive limit (limited
capability to process information properly)
• Solutions more about training, help develop skills to allow them to
do job better, also selection of fitting people, job design
1
,- Agency theory:
o Principal-agent relation: settings in which one party (the principal) hires another
party (the agent) to perform a task on her/his behalf
o Assumptions:
▪ Agency problem: agent pursues their self-interest instead of the principal’s
interest →difference in goals
▪ Often information asymmetry between principal and agent (eg ability,
environment, quality of work, time it takes, price of different paints, …)
▪ Agent and principal are cognitively limited: bounded rationality
• They are rational given the information they have, but this
information is not perfect
• Eg limited time: not access to all information, you cannot process all
information
▪ Agent and principal can have different levels of risk aversion
• Agent may take more risk than principal would like eg or other way
around
o Agency problem exists in all organizations and in all cooperative efforts, at every level
of management in firms, universities, mutual companies, cooperatives, governmental
authorities and bureaus, and unions
o Agency problem causes agency costs
▪ = all costs principal must bear by assigning a task to an agent
▪ 1) Costs of managing the principal-agent relation: monitoring, making a
contract, information search, incentives, …
▪ 2) Agent uses the principal’s resources in their own interest
o Agency problems:
▪ Goal incongruence: agents maximize their utility, not the principal’s
▪ Hidden information (asymmetry)-> Adverse selection
• Prior to contracting , agents have better private information than
principals
o (eg candidate for job exaggerates, sick people seek health
insurance, …)
• Solutions: pre-contract investigation, post-contract penalties (if
something wrong)
▪ Hidden action -> Moral hazard
• After contracting , agents have an incentive to deviate because the
principal cannot readily observe their actions (hidden action or
hidden information) (e.g., shirking on job)
• Solutions: monitoring, target setting, performance-based incentives
▪ Employee theft:
• Employees use firm resources for unauthorized purposes (pure risk)
• Solutions: Buy fidelity bond (insurance pays if employee steals
something, eg cashiers), monitoring, inventory control, installing
whistle blowing systems, etc
2
, ▪ Empire-building: accumulating power
• Managers seek to manage a larger number of employees/funds to
increase their own job security or compensation without benefiting
the company
• Solutions: Modify incentive contracts, benchmarking of CEO pay, etc
▪ Horizon problem:
• Agents expecting to leave the firm place less weight on the long-term
interests of the firm
o Focus on short-run actions = myopic behavior
• Solutions: Long term incentives (eg stock options), bonus bank (part
of bonus is banked/deferred, you get it if you keep performing),
monitoring, etc.
Example Horizon problem: -Manager expects to retire in 3 years
-Compensation: fixed salary + 5% of division’s profits
-He can spend $100,000 on process improvements this
year + next year -> cost savings of $150,000 for each of the
following 4 years
However, he will reject the project because accepting
would reduce his total bonus (even though good project)
▪ Key control problem in teams: free-rider problem
• Individuals form teams (firms) because they can produce more in a
team compared to doing alone (positive synergy). However, team
production can create control problems.
• Agents are likely to shirk (=avoid responsibility) because their
individual efforts are not directly observable to the principal
o The principal only observes the total output
• Solutions: peer monitoring, between-group competition (based on
research reduces free riding, individual members start caring more),
cultural control (more informal, free riding = socially sanctioned (eg
people don’t want to be your friend))
o Typical organization loses 5% of rev due to fraud
▪ Control failure can be costly (can threaten a firm survival, lead to
reputational damage, financial loss, organizational failure) →not just about
reaching goals
- Designing control systems:
o Avoiding control problems:
▪ Activity elimination: subcontracting activities that can create control
problems to an external party: use of cloud services so that data security and
protection would be provided and controlled by another company
▪ Automation: using robots, computers, and expert systems to eliminate
human problems of inaccuracy, inconsistency, or lack of motivation
▪ Centralization: eliminate the possibility that lower-level employees make
decisions that are not in the best interest of the organization
▪ Risk sharing: buying insurance against certain large losses that an
organization may face. For example, purchasing fidelity bonds on employees
in sensitive positions (such as bank tellers) to reduce firms' exposure to
control problem
3
, Module 2: Introduction to management accounting and cost management important
- Accounting: ‘language of business’ to know
o We understand, assess, and communicate about business with accounting difference
o Accounting: recording, analysing, summarizing, and reporting business between 2
transactions mainly in the financial terms domains
o Accounting system: a particular way a company does accounting!
Financial accounting Management accounting
Goal: Provide information about how firm is Help make better decisions (pricing,
doing for financial accounting and tax make or buy, investment/closure in
purposes (Sometimes for executive region or product, accept/reject
compensation) special orders,..)
Reports External for external agents (e.g., Internal reports for managers
and their suppliers, clients, banks, analysts,
audience: shareholders, investors)
Regulations Guided by prescribed accounting Organization-specific, customized,
principles. It is compulsory for all with some legal restrictions, but no
organizations. regulation
(eg IFRS: mandates firms to disclose
information about their segments
(geographic region and/or product level)
= segmental reporting)
Horizon Provides information about the past Reports historical and current
period information and provides information
on expected future performance and
activities
(budget information, sales targets, goals to
achieve, results of variance analyses,
customer satisfaction, safety measures,
cost information to marketing & sales
managers for pricing and profitability
analysis)
Reporting Annual reporting (semi-annual and Variable reporting interval: monthly,
frequency quarterly reports also exist in some weekly, hourly, ad-hoc analysis…
companies)
2 different What is required for tax reporting may 2 key roles (!): “very
systems: not be the best information we need for - Decision-facilitating role: Provision import
purposes (internal) decision making of information to reduce pre-decision
ant”
are not Avoiding disclosure of strategic uncertainty/make better decision
always information; proprietary costs (don't →Aim: to improve employees’
aligned want to give too much information, not knowledge so that they can make
sensitive information bcs competitors organizationally desirable judgments
also have access to financial reports) -Decision-influencing role (control):
Eg BMW discloses segments based on Use of information to motivate
product and not on region because they employees and align their interests
want to protect from competitors , their with those of the firm
competitive advantage → Aim : to influence (control)
employee behaviour
4
