Module 1

Introduction to management control

Learning objectives
After reading this chapter, you should be able to:
1. Explain why organizations have a need for management control systems to attain
their objectives.
2. Explain why organizations have a need for management control systems to execute
their strategies.
3. Explain why organizations have a need for management control systems to keep
managerial actions and decisions on track.
4. Discuss the reasons why managers do not automatically behave in line with
organizational objectives.
5. Explain the differences between the top-down function of management control and
the bottom-up function of management control.

Real world vignette: Functional and dysfunctional decision making

In a feature article in Der Spiegel, Jerome Kerviel of Société Générale was asked to explain his
behaviour following the discovery of his alleged malpractices. The following are excerpts from
that interview.
‘Jerome Kerviel has been called the biggest gambler of all time. The 33-year-old Frenchman
established positions worth up to €50 billion in bets on the development of the German stock
market. At first, he earned billions in profits for his employer, Société Générale, but then he
began losing and became a symbol of the financial crisis. At the beginning of October [2010],
he was sentenced to five years in jail, two of them suspended. He was also ordered to pay
damages of €4.9 billion. The judge ruled that he had fraudulently manipulated his computer
and concealed his trades from his colleagues with offsetting transactions. Kerviel has
appealed. He claims to only have used methods that he learned as an employee of Société
Générale.
[…]
Kerviel: In the process, I didn’t make a penny, I didn’t enrich myself personally and I didn’t
commit any fraud. I only wanted to be a good employee who generated as much profit as
possible for his employer. I was merely a small cog in the machine – and now I’m suddenly
supposedly the main person responsible for the financial crisis.
SPIEGEL: In 2005, you were promoted to a position as a junior trader and quickly began to
distinguish yourself. How did you accomplish that?
Kerviel: I specialized in German stocks. After a few months, I took my first position, on Allianz
stock, betting on a fall in the market. At first, I was in the red. But, then, the attacks on
London’s subways caused stock prices to collapse. The bank reaped €500,000 in profits from
my transaction.
SPIEGEL: How did your superiors react?
Kerviel: When I spoke with my supervisor about the deal over lunch, there was a bit of a
scolding: As a trader with only six months on the job, I wasn’t supposed to take those kinds of
positions. Still, right after that, he praised me and increased my freedom to make speculative
 deals from €2 million to €5 million. That is typical for the contradictory world of the trading
room: Risk limits were exceeded on a daily basis. The bosses knew that, but there were never
any admonishments.
SPIEGEL: But even with €2 million or €5 million to gamble with, you still weren’t satisfied for
long.
Kerviel: I continued to raise my stake higher and higher after noticing that my superiors would
cover up for me out of their own self-interest and for the benefit of the bank. In late 2006, I
established a major short position on the DAX, Germany’s stock index, worth several billion
euros, which I sold off for a €20 million profit in February 2007. Since the transaction with the
Allianz stocks, none of my superiors had taken me to task again. I was making consistently
large profits. Within three years, my bosses had raised my targets by 1,700 percent. That
shows that they knew exactly what was going on. […]’1

Introduction

T heOrganizations
goal of management control systems is to implement organizational strategies.
that are able to efficiently meet their strategic objectives are the best
performers in the long run. Management control, therefore, directly concerns
organizational performance and one of its challenges is, indeed, to increase the organization’s
long-term performance. Management control systems consist of the various ways in which the
organization’s top management team attempt to enhance the organization’s performance in
line with strategic objectives. Such typical control system elements include strategic planning;
budgeting; resource allocation; performance measurement, evaluation and reward;
responsibility centre allocation; and transfer pricing. These elements should work together to
ensure that the organization meets its desired performance levels. Understanding why
management control is an essential function of management, and how typical elements of
management control systems go together is important to be able to build a viable management
control system.
Throughout this book, we define management control as the systematic process by which
the organization’s higher-level managers influence the organization’s lower-level managers to
implement the organization’s strategies. Thus, our mission is to understand how the
organization’s senior management should design and use tools and techniques, such as the
ones we mentioned, to ascertain that its lower-level managers behave in line with
organizational objectives. The organization’s higher-level managers can be addressed by
various terms such as ‘top management team’ or ‘senior management’ as we used before. In the
remainder, however, we often refer to these managers as ‘the board’ of the organization.
When presenting management control as an issue of higher-level and lower-level managers,
we emphasize that management control is about decentralized organizations. The distinction
between higher and lower levels of managers within an organization is, in fact, crucial for our
understanding of the organization’s need for management control. The essence of a
decentralized organization is that not all the power to make decisions that affect the future of
the organization resides at the highest level in the organization. Some of this power is shared
with lower-level managers. Decentralization is the single most important reason why
organizations need to implement management control systems. As, in decentralized
organizations, lower-level managers have the authority to take decisions on their own, such
organizations specifically need the formal mechanisms and routines that facilitate goal sharing
and cooperation between the organization’s participants. Without them, organizations may go
astray and fail in achieving their objectives. The case of Société Générale described at the start
of this chapter functions as a warning to us about the importance of such mechanisms.
 Indeed, although the failure of companies is often due to a mix of external and internal
circumstances, in many cases companies’ failures can be directly attributed to the lack of
appropriate management control. This means that these failures could have been avoided by
the proper design and use of management control systems. Understanding the nature of these
failures, therefore, helps us to understand better where management control systems fail, and
what potential weak spots they have. In the USA, companies such as Tyco, WorldCom and
Enron have become well known for their management control failures. And although in these
cases external auditors were blamed for their alleged failure to correct the companies’
misdoings, a large part of the reason for their demise was the lapse in internal controls to keep
managerial behaviour on track. In some of these cases, chief executive officer (CEO) and top
management compensation was so heavily tied to stock options that executives were
motivated to manipulate the financial figures to stimulate the short-term stock price. This is an
important fact to establish, because rewarding executives with stock options was commonly
seen as a way to make executives think and act in line with the interests of shareholders. The
reverse can happen, as these cases illustrate, and we need to understand why. In Europe,
companies such as Parmalat and Ahold are known for similar problems. In 2003, Parmalat, an
Italian producer of milk and other dairy products, went into bankruptcy after following a
strategy of aggressive growth for several years. Although financial statements had shown good
performance, fraudulent activities had covered up a significant lack of cash flow that almost
forced the company out of existence.2 The damage to the firm’s structure, employees and
outside activities, such as the sponsorship of Parma Football Club, was enormous. As a result,
the Italian government passed legislation to help Parmalat to recover, making it the worldwide
company it is today. Ahold is a Dutch multinational company that is active mainly in retailing
through operating chains of supermarkets. Similarly, a strong growth strategy, involving many
international takeovers in Sweden, the USA and elsewhere, was followed by the near collapse
of the firm in 2003.3 The attention these firms paid to pleasing the stakeholders by achieving
pre-set performance targets resulted in executive behaviour that eventually went against
stakeholder interests. Performance pressure may incentivize executives to commit fraud in
reporting performance levels that have no economic substance. If it is coupled with an
organizational culture of improving reported performance by every means possible, failure is
likely to happen some day. Although management control applies to all managers in the firm,
we should not forget that sometimes failures of the management control system result in
wrong behaviour of individuals. If these individuals have significant discretionary power, the
effects of such failures can still be great. In the financial industry, several examples exist in
which individual traders have brought their firm to the brink of collapse. In most cases, they
were disguising the high risks that were in fact associated with the financial performance they
achieved. In a classic case from 1995, an individual trader, Nick Leeson of the Singapore branch
of Barings bank, managed to bring the bank close to bankruptcy. Barings bank was taken over
by ING bank in 1995 for the symbolic sum of £1, and after a couple of years the name Barings
ceased to exist as an independent organization. A combination of much freedom to act, good
performance in the past and an ability to hide losses and risks associated with his portfolio
caused a tremendous failure. Management controls that were supposed to motivate this trader
to enhance the bank’s performance did not prevent and possibly even encouraged the risk-
seeking behaviour that became clear once it was too late. In France, Société Générale also
reported billions of losses after one of its traders, Jerome Kerviel, took tremendous risks in his
hedging strategies. Although these cases themselves do not inform us about the generality of
these kinds of problem, it is logical to assume that the problems that surface in this way are
only a small subset of all prevalent management control problems in today’s organizations. As
an illustration of this possibility, it is important to note that Jerome Kerviel argued that the
kind of behaviour he showed was normal. The financial crisis that afflicted international
financial markets for many years since it began in 2008, and which continued in the worldwide
economic crisis which followed it, attests to the possibility of this being at least partly true.
Small and centralized organizations, consisting of only a few people, face a smaller challenge
of ensuring that decentralized management behaves in line with organizational objectives, and
have little need for the systematic, complex and costly design of management control systems
that we present and discuss in this book. Smaller firms, by definition, employ fewer people,
such that communication between the top management team and the rest of the organization
is more direct than in big firms, and will remain more informal.
One way to explain the difference in need for management control between a small
organization and a larger organization is by showing how the potential need for information
increases rapidly with organization size. This is illustrated in Exhibit 1.1. The upper part of
Exhibit 1.1 shows a relatively small organization, which consists of a board and three
decentralized units. These units represent departments or working units under the
responsibility of a manager. This organization has 6 possible communication channels between
those units, which are depicted in grey. In the lower part of this exhibit, the organization
consists of 22 units, one board and 21 decentralized units. This organization has 231 potential
communication channels. Some of these channels, but not all, are also depicted in grey.

EXHIBIT 1.1 Firm size and information flows

In contrast, large and decentralized organizations cannot do without formal management

control systems. Large firms that strive to maximize their value on behalf of their shareholders
are the organizations that are the most in need of informing their decentralized managers
about the strategic goals and associated actions that will satisfy their owners. If the senior
managers fail to implement the appropriate management controls, lower-level managers will
simply not have a clear sense of what decisions to take, what results to achieve and where to
lead the people and how to use the resources under their responsibility. We call this the top-
down role of management control systems. This is illustrated in Exhibit 1.2. This exhibit
illustrates how the formal organization of communication channels between hierarchically
organized units reduces the number of such channels.

EXHIBIT 1.2 Top-down role of management control

 Reversely, without appropriate management controls, senior managers will not have a clear
sense of what decisions lower-level managers are taking, what results they are achieving and
where they are leading the people and using the resources under their responsibility. We call
this the bottom-up role of management control systems. This is illustrated in Exhibit 1.3.

EXHIBIT 1.3 Bottom-up role of management control

Management control: role and position

W hen
we define management control as the systematic process by which the organization’s
higher-level managers influence the organization’s lower-level managers to implement
the organization’s strategies, we assume that lower managers in the organization do not
automatically perform such actions. Indeed, decentralization causes a number of reasons why
lower-level managers do not automatically perform in line with the organization’s overall
objectives. Let us try to understand why by discussing three reasons that hinder automatic
organizational goal achievement by decentralized managers.
1 Decentralized managers do not automatically understand the goals and strategies developed by
higher-level managers, nor how they can contribute to these goals and strategies.
An important first reason for the need of management control in decentralized
organizations is that lower-level managers need to become aware of how they can contribute
to the achievement of organizational goals and strategies. This is not a trivial issue, because
organizational goals are typically defined at the organizational level rather than the managerial
level and, therefore, are not immediately meaningful to lower-level managers. For example, a
common goal for an organization is to earn a certain amount of profit. But when the
organization aims to achieve a certain amount of yearly profit, this does not mean that
individual managers automatically understand how this profit should be achieved. Take the
example of a sales manager. Should a sales manager increase the selling price and, therefore,
try to earn more contribution margin? Or should the selling price be lowered, such that the
sales volume goes up resulting in a higher profit? And should profit only be high this year, or
should the sales manager also pay attention to next year’s profit levels? If so, that probably
means that the manager should think just as hard about keeping customers as about
maximizing profit this year. This relatively simple example shows that even if an organizational
goal is relatively easy to measure, as is the case with organizational profit, such a goal needs to
be operationalized to inform individual managers about the required direction of their efforts
and decisions. In reality, however, organizations often have goals that are even less easily
measurable than profit. For such goals, the need for operationalization is even bigger. Firms
that are owned by external shareholders, for example, often state their goals in terms of
maximizing shareholder value. This means that they want to earn a profit in excess of a
minimum return to their owners. Not-for-profit organizations typically have goals defined in
terms of delivering maximum quality services to a variety of external stakeholders, subject to
the available funding. In such cases, the need to provide lower-level managers with a clear
direction for their efforts and decisions is even greater.
An important first function of management control is its top-down function to provide
lower-level managers with a clear sense of direction that helps them take actions, make
decisions and achieve results that help the organization to achieve its overall goals. Bottom-up,
management control should inform higher-level managers about the progress of decentralized
managers in their efforts to achieve organizational objectives.
2 Decentralized managers do not automatically agree with organizational goals and strategies
developed by higher-level managers.
A second reason for the need of management control in decentralized organizations is that
lower-level managers are not automatically motivated to achieve the organization’s goals. This
can be the case even if such organizational goals are operationalized and clearly communicated
to these managers. Such motivation may be lacking because managers have private goals that
are incompatible with the goals of the organization. Private goals include goals that managers
try to achieve out of self-interest, and that lead to the consumption of organizational resources
for private reasons. Examples of such dysfunctional consumption are managers’ inclination to
increase holiday and leisure time, or simply the overconsumption of the organization’s internal
goods and services. More importantly, however, managers may have private goals that they try
to achieve out of a genuine interest in the organization’s well-being. Such managers may even
disagree with the ways in which higher-level managers formulate goals and strategies. Such
disagreement is likely to occur, because decentralized managers often have better information
about the local conditions of the firm. For example, a sales manager is often better informed
about local market conditions than higher-level managers in the firm. Lower-level managers
also often have more specialized skills than higher-level managers. Sales managers typically
have more commercial skills than higher-level general management. Note that benefiting from
local information and from specialized managerial skills are two important reasons why
organizations decide to decentralize in the first place.
An important second function of management controls is their top-down function to
motivate lower-level managers to take actions, make decisions and achieve results that help
the organization achieve its overall goals. Bottom-up, management control should facilitate
higher-level managers to benefit from the specialized skills and knowledge of decentralized
managers.
3 Decentralized managers do not automatically have the resources needed to act with
organizational goals and strategies developed by higher-level managers.
 A third reason for the need of management control in decentralized organizations is that
lower-level managers are not automatically able to achieve the organization’s goals. This can
be the case even if such organizational goals are operationalized and clearly communicated
and if managers feel motivated to achieve them. To act in line with organizational strategies,
managers need both personal skills and monetary and physical organizational resources. While
obvious, the lack of personal skills is sometimes hard to detect, as decentralized managers may
often find excuses for their poor performance. They may do so by pointing at others or by using
external circumstances to explain their failure to make an organizational contribution. Sales
managers may, for example, blame the general economic situation for disappointing sales
levels, rather than their lack of commercial skills. They may also blame the production
managers for a lack of product quality that reflects in dissatisfied customers. The provision of
sufficient monetary and physical organizational resources to decentralized managers is also a
challenge for most organizations. It is clear that such resources are necessary conditions for
decentralized managers to take purposeful actions. However, as resources are costly, it is
crucial that the provision of resources results in a sufficient return. This is, of course, not easily
established a priori.
An important third function of management control is its top-down function to ensure that
decentralized managers have the skills and the organizational resources they need to perform
in line with organizational objectives. Bottom-up, management control should enable lower-
level managers to acquire the support to develop their skills as well as the organizational
resources to execute their responsibilities.
In summary, management control can best be seen as performing various functions in
reaction to the organization’s need for control. This central reason for management control is
summarized in Exhibit 1.4. The exhibit also includes some examples of top-down and bottom-
up control elements.

EXHIBIT 1.4 Top-down and bottom-up functions of management control

It is important to realize that when organizations decentralize, they create managerial

challenges that need to be addressed through the proper design of management controls. In a
sense, there can be no decentralization without control. A well-designed organization,
therefore, is aware of the benefits of decentralized operations as well as the costs of installing
the right management controls. In the later chapters on forms of decentralization this issue is
explored at length. Some summarize this explanation of management control as a way for top
management to ensure the obedience of lower-level managers and other employees. Such
observers of the management control function of management argue that control is meant to
increase the power of top management at the cost of the power of employees at lower levels in
the organization. Typically, control systems are seen as structural devices to ‘check’ what
people are doing, to coerce them into cooperation, or to force them to do things they would
never do of their own free will. While such critical views are important, they should not be
taken as a critique of the view of management control outlined above. Indeed, if organizations
are to profit from the skills, motivation and commitment of their full working staff,
management control should be exercised to maintain or enhance the skill set, job motivation
and organizational commitment that employees aim to contribute to the organization. This
supportive, enabling and empowering side of management control is the explicit subject of the
further elaboration of management control in practice in later chapters.

Comparing management control and general management

Management control is an organizational phenomenon that affects all managers within the
organization. It is useful to consider that control is often regarded as a basic managerial
function, alongside other managerial functions that are typically labelled planning, organizing,
leading and staffing. Those managerial functions refer to the kind of decisions made and
actions that managers typically take. These functions particularly aim to describe the purpose
of those managerial decisions.
The planning function of managers concerns the decisions that managers need to make
about what the organizational participants need to do in the future. This includes making
decisions themselves, such as investment decisions, and making plans that may guide the
actions of others.
The organizing function of management concerns the use of physical, human and financial
resources in such a way that the plans can become operational, and the planned actions can be
taken.
The staffing function of management concerns the managerial responsibility to ensure that
the organization employs the right people to perform the actions. Although this is part of the
general organizing function, denoting staffing as a separate responsibility emphasizes the
importance of human resources for organizations.
The leading function of management concerns the managerial function of ensuring that the
plans and planned activities are followed by organizational participants. This typically requires
leadership and motivational activities by managers.
Finally, the controlling function of management suggests the importance of establishing
whether the actions and activities are performed according to plan. One purpose of
management is to check, ex post, whether these plans have made sufficient progress.
It is important to acknowledge that all management typologies, such as this particular one,
are made from a certain perspective. Here the perspective is to provide a comprehensive
description of the purpose of management by referring to managerial responsibilities and
activities that serve this overall purpose. However, these broad classes of managerial functions
do not explain the exact activities that managers perform, and the processes that they are
involved in. It rather presents managers’ roles as a set of distinct, rather than continuous,
responsibilities. Other typologies of management, therefore, line up with the various roles that
managers play such as the informational role, the leadership role and the decisional role. In
addition to these typologies of the functions and roles of management, alternative managerial
typologies stress the basic skills of managers, and for example aim to describe what makes a
manager a ‘good’ manager. Such skills include the informational skills that managers need to
communicate well with other organizational participants, the technical skills that managers
need to supervise specific organizational areas, such as production, marketing or accounting,
and managers’ coordination skills to make the people under their responsibility work together
to profit from the synergy of their joint efforts. Note that each of these typologies of
management offers a description of the different aspects of management, and each typology is
in fact an answer to a different question one may have about the importance of management.
Such answers are needed because the term ‘management’ is in itself rather opaque. It is often
forgotten that in many language areas, the term ‘manager’ does not even have a good direct
translation. This is not merely because the English term ‘management’, once developed, has
been immediately adopted in those language areas, but rather because countries differ in the
extent to which management has traditionally been seen as a separate organizational role for
organizational participants, which requires a separate set of skills, to be applied in
distinguished functions. Even if in those language areas organizations existed and exist in
which people were occupied with planning, organizing and staffing, these functions were
considered as the integral responsibility of the professional worker, who was often labelled the
‘master’ of a certain trade. They were not seen as a separate set of functions for a separate set
of people. Even today, some people feel uneasy with the term ‘management’ and they
sometimes use the term ‘managerialism’ when they critically evaluate the dominance of the
idea that management is a separable set of activities. As we see later in this book, the use of
managerial terminology in the not-for-profit sector still lags behind the use of similar terms in
the profit-oriented firms.
So why do we devote such attention to this discussion of the term ‘management’ and its
meaning? It is because a closer look at the managerial functions reveals that all these functions,
roles and skills are important for management control. Let us look again at the managerial
functions. Their relevance for management control is most obvious for the control function of
management, but also the other functions reflect that managers are responsible for
implementing the organization’s strategies. However, when we discuss management control,
we are not just interested in the way in which individual managers decide and act, but rather
how managers across levels cooperate. For this reason management control goes beyond the
individual managerial functions we have just discussed. It does so in three ways. First,
management control is the systematic process by which the organization’s higher-level
managers influence the organization’s lower-level managers. This means that management
control integrates the various managerial functions in such a way that these functions in
conjunction help the organization to realize its strategies. It is this orchestration of managerial
functions that is the core challenge of management control systems. Second, management
control is about different layers in the organizational hierarchy. It is not just about performing
well in line with organizational strategies at one level in the organization. Rather, management
control connects different hierarchical levels to help the organization to realize its strategies.
This is another challenge beyond the challenge of just good management for the individual
manager. Third, management control is not just about managerial decisions and actions; it is
about the tools and techniques that managers apply in their execution of management control.
It is the tools and techniques that facilitate both managers’ top-down management control
activities and their bottom-up management control activities. Traditionally, the tools and
techniques that managers use for these roles are part of the management accounting system of
the organization. We devote some attention to the relationship between management
accounting and management control in the following section.

Comparing management control and management accounting

According to the most influential definitions given by professionals, management accounting is
the process of preparation, interpretation and communication of performance information to
management. Managers constantly need this information to know what is going on in the
organization, to identify areas of potential improvement and to support decision making. These
functions are summarized in the threefold typology of scorecard keeping, attention directing
and problem solving functions of management accounting.4 Historically, management
accounting originates in cost accounting. This partly explains management accounting’s
dominant reliance on the preparation, interpretation and communication of financial
information. Typical cost accounting tools that management could use to keep score, direct
attention and solve problems are variance analysis and budgeting. Many of these tools still play
a vital role in today’s organizations, even if the total management accounting repertoire of
tools and techniques is under constant development and improvement. The persistence of the
relevance of financial information for management control, however, can be explained by at
least two reasons. One reason is the importance of money as the overall measure of
organizational performance. A second reason is the general importance of the organization’s
overall accounting system to satisfy the information needs of the organization’s stakeholders.
It is this financial focus of the organization’s most important stakeholders that causes
management accounting tools to play an important role in management control. Whether these
stakeholders are owners who expect a sound return on their investment, or governments and
foundations that aim to provide good services at low cost to their stakeholders, monetary value
is often the single most important metric to express organizational performance. Accounting is
the language developed to report about the production and consumption of monetary values
throughout the organization. This is why many of the tools and techniques developed in the
field of management accounting play a vital role in management control. Techniques, such as
budgeting, resource allocation, the calculation of various financial performance measures and
traditional cost analysis, enable managers to exchange information about the organization’s
strategies between hierarchical levels, to coordinate actions between managers across
functions and to formulate motivating strategic targets. Despite the continued importance of
the financial management accounting tools, management accountants increasingly realize that
organizations cannot be managed by financial information alone. They understand that by
acknowledging that accounting is a language, it suffers from some inherent lingual limitations.
This literally means that it is sometimes difficult to express organizational goals, and the
actions needed to achieve them, in accounting terms such as costs, revenues and profits. One of
the most important limitations is that even if accounting profit is considered an important goal
for organizations, it is not necessarily the ultimate goal. For not-for-profit organizations this is
obvious, but firms often define their goals in terms of the creation of shareholder value. This is
a more complicated concept, which requires additional metrics over the ones developed within
the traditional management accounting framework. While we devote considerable attention to
the importance of financial management accounting information for management control in
later chapters in this book, we also illustrate where the strict focus on financial goals and
metrics, such as profit, may lead to situations of poor management control. Indeed, many of the
severe management control problems in the firms and banks that we referred to earlier in this
chapter can be understood by the imperfections of accounting returns to report the riskiness of
the performance levels achieved. In such situations, organizations should learn how to use
additional, sometimes non-financial, information to implement their strategies.

Human behaviour in organizations

M anagement
control is about influencing the behaviour of humans in organizations in such a
way that this behaviour becomes goal-congruent. Goal-congruent behaviour is behaviour
that helps the organization to implement its strategies and to reach its goals. Clearly, the
behaviours of Jerome Kerviel and Nick Leeson were not helping their organizations to reach its
objectives, but the dysfunctional nature of these behaviours was only discovered when it was
already too late. So, while easily defined conceptually, in reality goal-congruent behaviour is
hard to obtain and assess in a timely manner. This is the case for at least three reasons. First, as
we have seen, managers may deviate from the organization’s strategies because they do not
understand those strategies, do not support those strategies, or simply lack the resources to
accomplish the organization’s strategies. This, as we mentioned, creates the need for top-down
management control. Second, the concept of goal-congruent behaviour, logical as it may seem,
is problematic in itself as it is not always a priori clear which behaviour is goal-congruent and
which behaviour is not. Managerial actions and decisions are taken at a certain moment, but
their consequences may appear months or years later. Samsung’s decision to move into the
market of Smartphones seems utterly goal-congruent in view of the success of this business
line in the early years of the 2010 decade. But the challenge for management control is to be
able to assess and influence the decision at the moment it is taken. Nokia’s decision to
cooperate with Microsoft by installing Windows mobile software on its new line of mobile
phones is another example of such a decision, which was taken in 2011, but for which the true
outcomes were unknown at the time of decision making. Thus, there is a timing problem when
we try to control human behaviour in such a way that it is goal-congruent. For most important
decisions it is true that at the moment the decision is taken, we can never be sure that the
decision actually is goal-congruent. Goal congruence is something that can be judged only later.
In all cases, management control should at the very least safeguard the organization against
behaviour that is congruent a priori. Many of the behaviours associated with the (near)
collapse of the firms we mentioned in the previous section seem to fall into this category.
Finding out which behaviour is assumed as incongruent is difficult for yet another reason. This
reason relates to the freedom we provide to lower-level managers to make decisions to help
the organizations achieve their strategic goals. Managers are deliberately given this freedom,
as higher-level managers hope to profit from lower-level managers. This is especially
important in companies that rely on the creativity and entrepreneurship of their employees.
For example, consider the view on management in a firm such as the one presented by Google
seen in the following example.
Example: Management control concerns the ways in which organizations ensure that their management behaves in line with
organizational objectives. As organizations differ in the objectives they seek to attain, they also differ in the ways in which they
control the behaviour of their managers and employees. Google is one of the companies that is well known for its focus on
organizational culture to influence and stimulate managerial behaviour in the right direction. Thriving on creativity of its
employees, it applies a combination of organizational arrangements that include performance measurement, project
management and typical cultural instruments to obtain goal-oriented behaviour. This is well illustrated by the following
excerpt from Google’s public information:

‘Google culture
Google culture revolves around our mission: to organize the world’s information and make it universally accessible and useful.
Googlers are proud of this mission and work to better serve our users each and every day. Googlers are passionate and
dedicated individuals who really want to make a difference in the world. When you give smart people space to innovate, you
unleash the power of imagination, ideas and connectivity to change the world for the better. This ethos embodies the essence
of Google culture.

Project-Based Work
Despite our size and expansion, Google still maintains a start-up culture. Google is not a conventional corporation, and our
workdays are not the typical 9 to 5. Our work is project-based, meaning that Googlers focus on specific projects and goals
every quarter. If you happen to be hitting your project out of the park, then you might feel the need to come in to work a bit
later the next day! There would be no retribution – Googlers are passionate and self-motivated, and Google trusts them to
make responsible decisions.

Transparency and Openness

Googlers live and breathe a culture of openness. Our commitment to innovation depends on everyone being comfortable
sharing ideas and opinions. The ability to challenge or discuss a company decision is never more than an open door,
whiteboard, email, hallway or microphone away. We highly value rigorous debate, and value all Googlers’ input in company
decisions. One example is our weekly company all-hands meeting – known as TGIF – where Googlers can ask their questions
directly to Larry Page and Sergey Brin from an open mic. Googlers also have the opportunity to develop 20% Projects, where
they take 20% of their work time to work on projects that they’re personally passionate about. There are many examples of
20% projects that lead to meaningful impact on the company, such as Gmail.’5

We have addressed this issue before as the bottom-up role of management control systems.
Third, and much related to the previous two reasons, even if the need for management control
is clear, and management control has become a part of the managerial task, good management
control is quite a challenge for those managers exercising it. It requires that, throughout the
organizational hierarchy, managers understand what the organizational strategies require
them to do, and are able to inform the organizational participants under their supervision
about those strategies in a way that increases goal congruence. This often implies that goals
higher up in the organization need to be translated into goals lower down in the organization.
Goals higher up in the organization are often abstract, financial and longer term. However,
goals at lower levels in the organization need to be concrete, operational and short term to
help managers understand what actions they should take, to motivate managers to make the
right decisions and to be able to establish that managers are displaying the right behaviours.
In the remainder of this section we explore the importance of these three crucial
considerations in exercising management control and obtaining goal-congruent behaviour in
organizations. These are exactly the challenges we face in exercising management control.
Goal-congruent behaviour should be achieved in situations in which managers may not
understand the organization’s strategies, may not be motivated to pursue these strategies or
lack the skills and resources to accomplish the strategies. This provides management with a
challenge to explain the organizational strategies, and to motivate and empower lower-level
managers. The question ‘What behaviour is goal-congruent?’ can often not be answered a
priori, because the outcomes of managerial decisions and actions often appear only after a
considerable amount of time. This may be especially true for actions and decisions that
originate in managers’ creative freedom. This provides management with a challenge to
balance between rigidity and flexibility in executing management control. Goal-congruent
behaviour, therefore, in summary, requires sequential translation of goals that are relatively
abstract, financial and longer term into goals that are relatively concrete, operational and short
term. This provides management with a challenge to ascertain that no translation errors are
made. The challenges lies in ensuring that lower-level managers understand the strategies, are
motivated and empowered to pursue them, and are given sufficient freedom to make them use
their creativity to help the organization reach its objectives. In the remainder of this section,
we explore some of the drivers of human behaviour that we need to understand in order to
exercise management control. In particular, we elaborate on the idea of goal congruence as the
objective for management control, and how it relates to management motivation and
managerial decision making. This analysis shows the complexities that organizations face
when designing management control systems, which is the topic of the next chapter. The
central purpose of a management control system is to ensure a high level of called ‘goal
congruence’. When we consider how to obtain goal congruence, it is useful to consider that in a
goal-congruent process, the actions people are led to take in accordance with their perceived
self-interest are also in the best interest of the organization. Obviously, in our imperfect world,
perfect congruence between individual goals and organizational goals does not exist. One
reason is that individual organizational participants may want as much compensation as they
can get while the organization maintains that salaries can go only so high without adversely
affecting profits. A second reason is that management control is costly. It does not pay off for
the organization as a whole to invest more resources into obtaining goal-congruent behaviour
if the benefits of goal-congruent behaviour do not outweigh the costs. This is why an adequate
control system will at least not encourage individuals to act against the best interests of the
organization. For example, if the system emphasizes cost reduction and a manager responds by
reducing costs at the expense of adequate quality or reduces costs in his or her own unit by
imposing a more than offsetting increase on another unit, the manager has been motivated, but
in the wrong direction. In evaluating any management control practice, it is, therefore,
important to understand some essential features of managerial motivation.
Trying to understand managerial motivation in full is not an easy task, as the multitude of
existing theories on human motivation amply illustrate. However, it is important that
management control is based on principles of human motivation that appear to be generally
valid, and to point to motivational pitfalls that should be avoided in the exercise of
management control. Without aiming for a complete overview, the following principles of
human motivation deserve to be followed when designing and using management control
systems in organizations. In our discussion we introduce the principle, explain its validity, but
will also point to conditions in which the motivational principle loses its validity and
applicability. This latter set of insights is important, because organizations’ failures that can be
attributed to defective management controls in organizations can often be traced back either
to a poor understanding of what makes managers prefer certain courses of actions over others,
or to a lack of understanding about the conditional nature of human motivation. It is useful to
distinguish between three sources of managerial motivation. These are listed first and then
discussed in some detail.
1. Managers are motivated by goals that they are asked to achieve.
2. Managers are motivated by rewards that they may get from their efforts.
3. Managers are motivated by the social context in which they work.

Managers are motivated by the goals that they are asked to achieve
One of the most effective ways in which managers can be motivated is by providing them with
goals to be achieved. To understand why this is the case, we need to understand better what
we mean by human motivation. Motivation is a combination of the effort, direction and
persistence.
Effort is the amount of time and energy that humans expend in performing a certain activity.
This energy can be physical or cognitive, but in all cases reflects the value that people are
willing to invest in a certain course of action. Generally, effort levels increase when humans are
confronted with a goal that is clear, not too distant, and the achievement of which is considered
an accomplishment. Direction of effort is almost as important as the level of effort, because
expending effort in the wrong direction is at best equal to not expending effort, but may in fact
work against the organization’s objectives. When the traders in Barings bank and Société
Générale were aiming for high returns of their portfolios, they were expending effort, but in the
wrong direction, because they were not considering the riskiness of their overall portfolios.
Persistence relates to the duration of effort and is an important condition for effort to be
expended until the organizational objective is reached. Organizations do not need short-term
explosions of managerial motivation, but rather the longer-term devotion to a certain course of
action. They also need managers not to give up at the first signs of potential failure but to push
on. Giving people goals that are set in time helps them to expend their effort over longer
periods.
Important limitations to the motivational effects of goals exist, however, that are mostly
related to failure to meet the conditions under which goals are seen as a way to reach a
valuable result. Sometimes, goals can be seen as a threat, and not meeting the goal as a failure
even if the performance level was still sufficient. Goals may also lack the clarity to provide a
sense of direction, especially when multiple goals should be achieved at the same time, or a
goal that is clear by itself needs to be achieved in a turbulent environment. Also, perception
and communication affect the working of goal setting.
In working towards the goals of the organization, operating managers must know what
these goals are and what actions they are supposed to take to achieve them. They receive this
information through various channels, both formal (e.g. budgets and other official documents)
and informal (e.g. conversations). Despite this range of channels, it is not always clear what
senior management wants done. An organization is a complicated entity, and the actions that
should be taken by any one part to further the common goals cannot be stated with absolute
clarity even in the best of circumstances.
Moreover, the messages received from different sources may conflict with one another, or
be subject to differing interpretations. For example, the budget mechanism may convey the
impression that managers are supposed to aim for the highest profits possible in a given year,
whereas senior management does not actually want them to skimp on maintenance or
employee training as such actions, although increasing current profits, might reduce future
profitability.
Overall, therefore, while goal setting is an important tool in management control, its use
should be done with care and its effectiveness should always be judged based on the
managerial function and the circumstances that affect this function. Although goal setting may
be an important part of good management control, management control is more than goal
setting.

Managers are motivated by the rewards that they may get from their
efforts
Although, according to some, money is the root of all evil, in reality money plays a crucial
instrumental role in our society to get things done. This is most obvious in market transactions,
in which goods are transferred between transacting partners in exchange for money, and in the
delivery of services. A crucial characteristic of market transactions is that the amount of money
paid for a good or service holds a more or less direct relationship with the quantity or quality
of the good or service provided. In firms and other types of organization, the relationship
between the services provided by employees and the monetary reward that these employees
get in return is less clear, and, in fact, subject to various rules and regulations. Such
relationships may theoretically range from fixed pay arrangements, in which employees get
paid a fixed amount of money regardless of the actual goods and services they provide, to
arrangements in which pay varies with goods and services delivered. Such arrangements are
typically known as performance-related rewarding systems. In reality, most organizations
have pay systems that fall somewhere in the middle. This depends on various institutional
settings, as labour laws, trade unions and professional organizations have various levels of
influence on the type of contracts between organizations and their employees in different
countries. These differences, which are clearly present between the USA, Europe and Asia,
determine the possibilities of arranging for optimal reward structures for employees.
Managers, who are the main focus of this text, are of course just a subset of all employees, but
because of their typically higher positions in firms, they are normally less protected by labour
laws that put restrictions on labour contracts. For management levels, we therefore observe a
higher variation in reward structures between organizations and managerial functions, and
managers are therefore generally eligible for more pay-related reward policies. Despite the
omnipresence of pay-for-performance schemes, there is not yet a generally satisfactory answer
to the question of whether variable pay ‘works’.6 Whether it is the bonus arrangements in the
financial industry that brought serious trouble for Barings bank, Société Générale and many
other banks during the financial crisis of 2008, pay-for-performance schemes are often
criticized for having led managers to make the wrong decisions and take the wrong actions.
One reason is that variable rewards have the tendency to lose their attraction over time, as
they are regarded by the manager as part of the fixed salary. Another reason is that when
rewards are linked to goal achievement, they may lead to internal competition within the
organization, which destroys cooperation and overall performance. A third reason is that
because good performance often shows up much later than the decision that causes this good
performance, it is very difficult to design reward structures that motivate managers to make
good decisions. Often such reward structures, in fact, only motivate managers to enhance
short-term performance, which may go against the longer-term strategies of the firm. One
advantage of variable reward schemes is that they allow organizations to control their labour
costs, as these costs go up and down with the organizations’ overall performance. This,
however, is not an advantage in terms of the motivation function that such systems may have.
Although reward policies may be an important part of good management control, management
control is more than rewarding.
Managers are motivated by the social context in which they work
It is important for the designers of formal systems to take into account the informal processes,
such as work ethic, management style and culture, in organizations because successful
implementation of organizational strategies requires appropriate informal processes that, in
totality, create the social context in which managers take actions and make decisions. They
consist of both external and internal factors.
External factors are norms of desirable behaviour that exist in the society of which the
organization is a part. These norms include a set of attitudes, often collectively referred to as
the work ethic, which is manifested in employees’ loyalty to the organization, their diligence,
spirit and pride in doing a good job (rather than just putting in time). Some of these attitudes
are local; that is, specific to the city or region in which the organization does its work. In
encouraging companies to locate in their city or state, chambers of commerce and other
promotional organizations often claim that their locality has a loyal, diligent workforce. Other
attitudes and norms are industry-specific. The railroad industry, for example, has norms that
are different from those of the airline industry.
In today’s electronic industry, the eye often is on zones of remarkable industrial renewal;
for example, on Silicon Valley. This is a stretch of northern California about 30 miles long and
10 miles wide. It is one of the major sources of new business creation and wealth in the US
economy. Silicon Valley attracts people with certain common characteristics: an
entrepreneurial spirit, a zest for hard work, high ambition and a preference for informal work
settings. Over the last 60 years, Silicon Valley has created companies such as Hewlett-Packard,
Microsoft, Apple Computer, Sun Microsystems, Oracle, Cisco Systems and Intel. Even after the
most recent boom-and-bust cycle, the old-line companies and the ‘dot com’ survivors have kept
up Silicon Valley’s reputation as the centre of technology innovation. The famous German
sociologist, Max Weber, explained the capitalist working spirit in the Western world pointing
at the values within traditional Protestant theology. Still others argue that cultural values are
national; some countries, such as India and China, have a reputation for excellent work ethics.
In Europe and the USA, the positive work ethics are sometimes considered to stem from the
puritan values of Protestantism.7 Other studies have defined culture as the collective mental
programming of the human mind that distinguishes one group of people from another.8 They
suggest a big impact of culture on various business processes, as well as the shape of national
institutions such as labour unions and trade unions. Such organizations that act in the interest
of employees have a big, even if declining, influence on organizations’ policies and the relative
power of top management and lower-level employees.9 Interesting in this respect is also the
existence of large cultural differences between the organizations’ institutional and political
environments such as measured by the Corruption Perceptions Index (CPI).10 This index ranks
the perceived corruption of a country’s public sector, and is based on a combination of surveys
and assessments of corruption among the public.
Inside the organization, these sources of cultural norms blend to form norms of acceptable,
desirable and sometimes laudable behaviour among management and all other employees.
They are often addressed with such general labels as organizational culture, management style
or tone-at-the-top. Although these labels lack the precision needed to discuss them in depth,
we devote some attention in the next chapter to such factors. Cultural norms are extremely
important for at least three reasons. First, they may explain why two organizations, with
identical formal management control systems, may vary in terms of actual control. Second,
culture can explain why organizations are hard to change. Attempts to change practices almost
always meet with resistance, and the larger and more mature the organization, the greater the
resistance is. Part of this is due to the fact that organizations have informal lines of
communication that do not correspond with the lines on an organization chart. Such charts
depict the formal relationships; that is, the official authority and responsibilities of each
manager. The chart may show, for example, that the production manager of Division A reports
to the general manager of Division A. But in the course of fulfilling his or her responsibilities,
the production manager of Division A actually communicates with many other people in the
organization, as well as with other managers, support units, the headquarters staff and people
who are simply friends and acquaintances. This is graphically illustrated in Exhibit 1.5.

EXHIBIT 1.5 Formal and informal communication

In extreme situations, the production manager, with all these other communication sources
available, may not pay adequate attention to messages received from the general manager; this
is especially likely to occur when the production manager is evaluated on production efficiency
rather than on overall performance. The realities of the management control process cannot be
understood without recognizing the importance of the relationships that constitute the
informal organization.
Third, the culture of an organization is not just a factor that is present in the organization,
and which we need to take as it comes. Culture can also be changed, and, therefore, can be
made a tool of management control that helps organizations to achieve their objectives. This
requires, however, that we understand more fully what we mean by ‘organizational culture’
and to delineate it from other meanings of culture; for example, to describe differences
between countries and nations. The following examples of culture description in various
organizations at least attest to the importance that organizations attach to culture.
Example: The importance of organizational culture to the well-being of organizations and their performance, as well as that of
their managers and employees, cannot be underestimated. But the same can almost be said about the complexity of this
concept, and management ‘thinkers’ often underestimate this complexity.11 Culture is a concept heavily studied in the field of
sociology and anthropology, in which it is usually associated with the dynamic and evolving characteristics of groups of people.
Cultures manifest themselves through shared language, rituals and symbols. In organizations, culture is seen as a powerful
way to make people work together. Below you will find examples of how firms describe the importance of organizational
culture in their corporate communication. These examples probably demonstrate in particular how the firm likes its culture to
be seen by others. For example, the cultural characteristics that Jerome Kerviel related to in explaining his behaviour in Société
Générale are typically hidden rather than disclosed. Yet, these statements are at least partly informative about some of the
actual cultural characteristics of the organization that communicates them.

Siemens Annual Report (2012):

‘Employees – The source of our strength
We’re mastering the major challenges of our time, continuously breaking new ground and making technology history. But
these achievements are only possible because we have outstanding employees who – through their expertise, abilities and
dedication – have made our Company the global powerhouse that it is today. That’s why lifelong learning, continuous personal
development and the fostering of diversity and employee commitment are the foundations of our employee and management
culture.
Siemens is only as strong as its employees. We expect outstanding performance from our people. In return, we support
them in unleashing their full potential.’12

Volvo Corporate Communication (2013)

‘The Volvo Way is the lively dialogue between leaders, within teams, and among colleagues around the world. This is the way
we conduct business and deliver results. This is how we partner with customers and suppliers, how we work and change, and
how we build the future together.
 […]
“Our culture is how we work together with energy, passion and respect for the individual. It is about involvement, open
dialogue and feedback. It is about teamwork, diversity, and leadership. It is how we build trust, focus on customers and drive
change.”
“Passion is an intense emotion, yet this is how it feels to be deeply committed and engaged. Here we can bring our hearts
and minds to work.”
“We care about people. We acknowledge and appreciate each other. We treat every individual with respect.”
“We are empowered. Every colleague participates in setting goals and in meeting commitments. Every individual
contributes by working together with others towards common business goals.”’13

Beiersdorf Annual Report (2012): Our Employees & Our Values

‘Beiersdorf’s success has many faces. Our dedicated employees and unique corporate culture are our most important assets.
Beiersdorf employs some 17,000 people at over 150 affiliates worldwide. Each and every one of them contributes to the
company’s success and continuing development. To ensure that this remains the case, we aim to focus even more on our values
in the future – openness, trust, international orientation, and a sincere and straightforward corporate culture in which
teamwork and, above all, mutual respect are of central importance.

Courage and Openness

Courage, openness, and determination are key factors for growth in a dynamic market. This is why we aim to motivate our
employees to improve their performance every day by giving them challenging tasks and plenty of individual responsibility.

Flexibility and Speed

New technologies, new products, and getting ideas to market more quickly are vital – as is always making sure you are that
little bit faster than the competition. Beiersdorf offers its employees lean structures, flat hierarchies, and flexibility, letting
them turn their passion and creativity into successful innovations and developments – and to bring them to market.14

Responsibility and Teamwork

For over 130 years, our corporate culture has encouraged our employees to champion their own ideas and convictions and to
take responsibility for themselves and their teams. At Beiersdorf, the suggestions and decisions of each and every employee
help contribute to the company’s success.

Transcending Boundaries and Borders

Beiersdorf is growing globally. Our brands are at home in the truest sense of the word in over 150 countries. For example,
NIVEA – the company’s core brand – is seen as a local product in a large number of countries. We will successfully continue on
this course in the coming years by investing further in internationalizing the company – and in our employees.’