Creating dynamic tensions through a balanced use of management control systems

This paper explores how organisations balance controlling and enabling uses of management control systems (MCS), and how this balance facilitates the creation of dynamic tensions and unique organisational capabilities. By employing Simons’ (1995) levers of control framework in a case study setting, the paper investigates the challenges faced by senior managers when they use MCS simultaneously to direct and empower. The findings indicate a number of factors – internal consistency, logical progression, historical tendency, dominance, and suppression – that impact the capacity of organisations to balance different uses of MCS. The interactive lever of control also plays a significant role in achieving and sustaining a balance between controlling and enabling uses of MCS, and its impact on the other levers is seen to constitute a unique organisational capability in its own right. The findings from this study offer an elaboration of how dynamic tensions are created through managers’ attempts to balance controlling and enabling uses of MCS.     

Inexperienced investors and bubbles

We use mutual fund manager data from the technology bubble to examine the hypothesis that inexperienced investors play a role in the formation of asset price bubbles. Using age as a proxy for managers’ investment experience, we find that around the peak of the technology bubble, mutual funds run by younger managers are more heavily invested in technology stocks, relative to their style benchmarks, than their older colleagues. Furthermore, young managers, but not old managers, exhibit trend-chasing behavior in their technology stock investments. As a result, young managers increase their technology holdings during the run-up, and decrease them during the downturn. Both results are in line with the behavior of inexperienced investors in experimental asset markets. The economic significance of young managers’ actions is amplified by large inflows into their funds prior to the peak in technology stock prices.     

Application of the controllability principle and managerial performance: The role of role perceptions

The controllability principle stipulates that the evaluation of a manager should be based only on elements that are under the manager's control. Arguments for and against its application are theoretically well understood, but empirical evidence based on the evaluation of the perceptions of managers and their implications for managerial performance is scarce. By empirically analyzing the effects on managerial performance, this paper explores managers’ responses to the application of the controllability principle. We draw on role theory and analyze how role ambiguity and role conflict mediate this basic relationship. Moreover, we test whether application of the controllability principle equally affects role perceptions of top-level managers and those of lower and middle-level managers. Empirical analysis of survey responses from 440 managers reveals that role perceptions completely mediate the effect of application of the controllability principle on managerial performance. This effect is insignificant in the group of top-level managers, who appear to cope with uncontrollable factors more effectively.     

The role of performance measurement and evaluation in building organizational capabilities and performance

This study examines the processes through which the availability of broad-based strategically relevant performance information impacts on the performance outcomes of organizations. We explore the role of evaluation mechanisms in influencing managers’ use of broad-based performance measurement information for feedback and feed-forward control. We hypothesize that these resultant decision-making patterns impact the exploitation and identification of strategic capabilities within an organization and in turn organizational performance. Using a structural equation model, we find support for a model in which the degree of commonality between measures identified as decision-facilitating and decision-influencing is significantly associated with the use of decision-facilitating measures for both feedback and feed-forward control. In turn, the extent to which decision-facilitating measures are actually used by strategic business unit managers impacts on the strategic capabilities of the organization and subsequently its performance. Overall the results suggest that to encourage managers to use the multiple financial and non-financial performance indicators increasingly incorporated in contemporary performance measurement systems it is imperative that performance evaluation schemes are also designed to reflect these measures. To the extent performance evaluation schemes do not reflect such decision-facilitating measures it is less likely managers will use these indicators to effectively manage performance. The resultant performance implications for the organization arise from the impact of these decision effects on the exploitation of existing capabilities and the search for and identification of new strategic opportunities.     

Global equity fund performance, portfolio concentration, and the fundamental law of active management

This paper investigates the relation between portfolio concentration and the performance of global equity funds. Concentrated funds with higher levels of tracking error display better performance than their more broadly diversified counterparts. We show that the observed relation between portfolio concentration and performance is mostly driven by the breadth of the underlying fund strategies; not just by fund managers’ willingness to take big bets. Our results indicate that when investors strive to select the best-performing funds, they should not only consider fund managers’ tracking-error levels. More important is that they take into account the extent to which fund managers carefully allocate their risk budget across multiple investment strategies and have concentrated holdings in multiple market segments simultaneously.     

Analyst coverage and earnings management

What is the role of information intermediaries in corporate governance? This paper examines equity analysts’ influence on managers’ earnings management decisions. Do analysts serve as external monitors to managers, or do they put excessive pressure on managers? Using multiple measures of earnings management, I find that firms followed by more analysts manage their earnings less. To address the potential endogeneity problem of analyst coverage, I use two instrumental variables based on change in broker size and on firm's inclusion in the Standard & Poor's 500 index, and I find that the results are robust. Finally, given the number of covering analysts, analysts from top brokers and more experienced analysts have stronger effects against earnings management.     

The effect of cost management knowledge on the relationship between budgetary participation and managerial performance

This study investigates the relationship between budget participation (BP), cost management knowledge and managerial performance. It draws on relevant previous research in the theory of work performance and accounting to formulate the research questions. Eighty-three managers from Finnish companies participated in the study. Data were collected from the managers using a mail questionnaire. The results indicate that managers’ cost management knowledge, and especially the balanced perspective of cost management knowledge, moderates the effect of BP on self-perception of managerial performance. It was specifically found that the effect of BP on perceived managerial performance becomes more positive when managers’ cost management knowledge increases. High perception of managerial performance is obtained when both the BP and managers’ cost management knowledge are high. Our results suggest that organizations should improve the cost management knowledge of managers who participate in the budgeting process.     

Revisiting mutual fund performance evaluation

Mutual fund manager excess performance should be measured relative to their self-reported benchmark rather than the return of a passive portfolio with the same risk characteristics. Ignoring the self-reported benchmark results in different measurement of stock selection and timing components of excess performance. We revisit baseline empirical evidence fund performance evaluation utilizing stock selection and timing measures that incorporate the self-reported benchmark. We introduce a new factor exposure based approach for measuring the – static and dynamic – timing capabilities of mutual fund managers. We overall conclude that current studies are likely to be misstating skill because they ignore the managers’ self-reported benchmark in the performance evaluation process.     

The strategic competence of accountants and middle managers in budget making

This paper aims to advance the notion of the “situated functionality of numbers” (Ahrens & Chapman, 2007) by investigating the practical knowledge of strategy which shapes the calculations performed by accountants and middle managers when they are making a budget. It proposes an in-depth investigation of the budgeting conversations collected during an extensive field study in a large construction firm that had undertaken a new partnership strategy. Drawing on a conversation analytical approach, it identifies three micro-practices of calculation constitutive of the accountants’ and middle managers’ strategic competence: invoking the usefulness of numbers to activate local projects; constructing the acceptability of numbers to report them to external partners; authorising the plausibility of numbers to reconcile local contingencies and global coherence. The paper then explores how accountants and middle managers come to a mutual understanding of their respective accountabilities when they perform their strategic competence. It ends by discussing the unintended consequences of these transformations in their professional roles.     

Do changes in audit actions and attitudes consistent with increased auditor scepticism deter aggressive earnings management? An experimental investigation

Audits are claimed to not only enhance the detection of fraud but also the deterrence of fraud. This study examines whether different audit procedures and attitudes conveyed to management deter aggressive earnings management that may be fraudulent, and whether such different procedures and attitudes conveyed influence managers’ perceptions about the ethicality of any anticipated earnings management. In an experiment with 171 senior corporate managers, we find that compared to the condition where the audit proceeds the same as last year, managers anticipate that there would be less earnings management when the nature of evidence collected has increased probative value; and when the auditor conveys a more sceptical attitude via more critical inquiry combined with either an increase in the evidence extent (increased sample size) or the nature of the evidence. However, this reduction in anticipated earnings management is not found with either the increased extent of evidence collected alone or more critical inquiry alone, suggesting that a combination of action and attitude changes compared to a change in either action alone or attitude alone better signals to managers the heightened scepticism that enhances the effectiveness of auditor deterrence. We also find, after controlling for the underlying ethical disposition of managers, that the different audit procedures and attitudes conveyed to management affect managers’ perceptions of the ethicality of anticipated earnings management. Interestingly, the conditions that engender greater earnings management also paradoxically increase managers’ perceived unethicality of the anticipated earnings management. Together these findings have implications for how different changes in audit approaches may result in differential managerial responses about their intention to commit fraud and its appropriateness. This study is one of the first papers to provide experimental empirical evidence that specific audit actions conveying heightened scepticism have significant influence on managerial judgments and behaviours with respect to committing aggressive earnings management.     

Debt and managerial rents in a real-options model of the firm

We present a theory of capital investment and debt and equity financing in a real-options model of a public corporation. The theory assumes that managers maximize the present value of their future compensation (managerial rents), subject to constraints imposed by outside shareholders’ property rights to the firm's assets. Absent bankruptcy costs, managers follow an optimal debt policy that generates efficient investment and disinvestment. We show how bankruptcy costs can distort both investment and disinvestment. We also show how managers’ personal wealth constraints can lead to delayed investment and increased reliance on debt financing. Changes in cash flow can cause changes in investment by tightening or loosening the wealth constraints. Firms with weaker investor protection adopt higher debt levels.     

Accounting information and managerial work

Despite calls to link management accounting more closely to management (Jonsson, 1998), much is still to be learned about the role of accounting information in managerial work. This lack of progress stems partly from a failure to incorporate in research efforts the findings regarding the nature of managerial work, as well as inadequate attention devoted to the detailed practices through which accounting information is actually used by managers in their work. In this paper I draw on prior research to develop a series of propositions focused on three primary insights into how and why managers use accounting information in their work. First, managers primarily use accounting information to develop knowledge of their work environment rather than as an input into specific decision-making scenarios. In this role, accounting information can help managers to develop knowledge to prepare for unknown future decisions and activities. Second, as accounting information is just one part of the wider information set that managers use to perform their work, it is imperative to consider its strengths and weaknesses not in isolation but relative to other sources of information at a manager’s disposal. Third, as managers interact with information and other managers utilising primarily verbal forms of communication, it is through talk rather than through written reports that accounting information becomes implicated in managerial work. These insights have important implications for how managers use accounting information, and, in particular, require reconsideration of the types accounting information that managers find, or could find, helpful. The paper also considers how existing experimental and field-based methods could fruitfully be adapted to focus on the detailed activities through which managers engage with accounting information.     

A note on work-related values, budget emphasis and managers’ organisational commitment

Managers’ work-related values (WRVs) have important implications for designing appropriate management accounting systems (MAS) in organisations. This paper examines the effect of the interaction between managers’ WRV for innovation and budget emphasis (an integral part of MAS) on their organisational commitment. The sample consisted of 109 managers from production, marketing and support departments within Australian manufacturing firms. Hypotheses were tested using both quantitative and qualitative data collected by a questionnaire survey and post-survey interviews. The results indicate that the adoption of low budget emphasis led to high organisational commitment when managers’ WRV for innovation was high, but not when managers’ WRV for innovation was low. The results also indicate that marketing managers held higher WRV for innovation than production managers. The post-survey interviews provide further insight into how a more customer- and competitor-focused subculture of marketing managers and a more technical- and efficiency-focused subculture of production managers may promote the difference in their WRV for innovation, and affect their attitudes towards budget emphasis. The findings of the study have implications for design of performance evaluation systems for managers in functionally differentiated organisations.     

An investigation of how the informal communication of firm preferences influences managerial honesty

This study investigates the effectiveness of informal firm communication at motivating managerial honesty. Specifically, it focuses on the effectiveness of informal cost targets, which communicate firms’ specific cost preferences to managers without tying managers’ compensation to reporting costs that meet those targets. I develop predictions about how the tightness of an informal cost target influences the effect that a cost target has on managers’ reporting honesty. Using an experimental setting, I examine three levels of target tightness—loose, moderate, and tight—within a uniformly distributed cost range and where participants’ financial incentives are to ignore the cost target and fully misreport their cost information. I find that both moderate and loose cost targets, on average, increase honesty relative to when the firm does not communicate a specific target or it communicates a tight target. Tight targets have no significant effect, positive or negative, on honesty. Whereas prior research focuses only on the potential benefits of firms communicating their general preferences, my study provides important insights regarding the potential incremental effectiveness of communicating specific preferences.     

Subjective adjustments to objective performance measures: The influence of prior performance

This field study examines whether and how supervisors’ subjective adjustments to objective performance measures are influenced by their prior subjective evaluations of employees. Evaluations were determined entirely subjectively in the sample internal audit organization in 2005. In 2006, the organization introduced a pay-for-performance incentive plan that established four objective measures of audit manager performance. Then, knowing the challenges of objectively measuring manager performance, the organization gave supervisors the discretion, mandate, and training to subjectively adjust each of the objective measures when performance as indicated on the individual measures misrepresented managers’ true performance.     

Shared interest and honesty in budget reporting

This study uses two experiments to investigate the honesty of managers’ budget reports when the financial benefit resulting from budgetary slack is shared by the manager and other non-reporting employees. Drawing on moral disengagement theory, we predict that the shared interest in slack creation makes misreporting more self-justifiable to the manager and, therefore, leads to lower honesty. Consistent with our prediction, the results of our first experiment show that managers report less honestly when the benefit of slack is shared than when it is not shared, regardless of whether others are aware of the misreporting. Our second experiment investigates whether the preferences of the beneficiaries of the slack affect managers’ honesty. We predict that managers’ honesty will be improved when the beneficiaries of the slack have a known, higher-order preference for truthful reporting. Consistent with our prediction, the results show that managers report more honestly when other employees have a known preference for honesty than otherwise. The implications of our findings for management accounting research and practice are discussed.     

Internal auditors’ use of interpersonal likability,arguments, and accounting information in a corporate governance setting

Internal auditors play an important role in influencing managers’ judgments. Yet, the practitioner literature indicates that, because internal audit lacks the client services incentives of external audit, internal auditors often adopt a “policeman approach” that can lead to negative interpersonal relationships with managers. We investigate three variables fundamental to internal auditors’ ability to influence managers: (1) internal auditors’ interpersonal likability, (2) the information used to support their positions, and (3) whether they present that information in a thematically organized argument. We find that managers agree more with an internal auditor who is both likable and uses a thematically organized argument. We find further that this joint effect occurs regardless of whether the internal auditor’s information is relatively supportive or unsupportive of his position. Overall, our theory and findings suggest that an internal auditor can achieve agreement from managers on important corporate governance issues with this fairly straightforward presentation tactic, even when the underlying information is relatively unsupportive and managers otherwise tend not to agree with the internal auditor’s position. Our study contributes to accounting, psychology, and writing and discourse theories with new evidence of the effects of an argument structure (holding the underlying information constant) on users’ judgments, and how those effects depend on the likability of the source of information. Our findings have important implications for internal auditors, managers, external auditors, and others interested in corporate governance.     

Environmental uncertainty and managers’ use of discretionary accruals

Although an organization’s environmental uncertainty may induce greater variability in reported earnings, managers have incentives to reduce this variability. The flexibility accorded by generally accepted accounting principles (GAAP) provides managers the means to accomplish this via exercising discretion in recognizing accounting accruals. Thus, we examine the relation between managers’ use of discretionary accruals and environmental uncertainty. Overall, evidence suggests managers use discretionary accruals to reduce the variability in reported earnings more when firms operate in high uncertainty.     

Goliath Corporation: An instructional case in transfer pricing policy

This case illustrates some of the issues associated with setting firms’ transfer pricing policies. The simulation requires students to assume the roles of top management and divisional management for Goliath Corporation in negotiating transfer prices. The student playing the role of top management first selects a transfer pricing policy from four possible mechanisms: market-based, cost-based, negotiated, and dual-pricing. Given the top manager’s policy choice, divisional managers are then constrained to use that policy as they decide whether to purchase internally or externally based on their respective negotiations. In each negotiation, there is an ex ante best decision for Goliath as a whole. The case is thus useful in demonstrating how managers’ transfer price policy choices can lead to bad sourcing decisions.     

Managerial incentives for discretionary disclosure: evidence from management leveraged buyouts

Managers in management leveraged buyout (MBO) firms prefer to purchase their firms at a low offer price. This motive gives them a clear incentive to make pessimistic discretionary disclosures. Using a sample of press releases, I find that managers involved in their firms’ MBO selectively release negative disclosures to denigrate their firm just before the MBO transaction when compared with prior period: they issue more bad news disclosures and more pessimistic quotes. Additionally, they issue less optimistic quotes, fewer good news disclosures, less positive earnings forecasts, and they manage earnings downwards. I control for factors that may not be caused by managers’ purchase motives by comparing the MBO sample with a third-party leveraged buyout sample where management is not involved in the buyout and with a performance-matched control sample. I find that the disclosure of MBO firms becomes significantly more pessimistic than the leveraged buyout firms where management is not involved in the transaction and significantly more pessimistic than the performance-matched control sample.