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Comprehensive summary Management Control Systems
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Summary of 31 pages for the course Management Control Systems at UVT
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Management Control Systems 2014Lecture 1: Setting the Stage
When you look at an entrepreneur, there is a direct relationship between effort and the money
he/she receives. That is the reason they often work a lot.
When the business grows, the entrepreneur can decide to hire employees. Employees are paid a
fixed wage and the entrepreneur cannot always monitor his employees. Because of the fixed wage,
there is no relationship between the effort the employee supplies and the money the employee
receives. How many hours will the employee work? In general, less hours than the entrepreneur (i.e.
the gap).
Goal of this course study how MCS can decrease (or increase) the size of the gap.
An agency relationship is any situation in which one individual (the agent or employee) acts on behalf
of another individual (the principal or business man) and is supposed to advance the principal’s goals.
The moral hazard problem (the gap) arises when the agent and the principal have different
objectives and when the principal cannot easily determine whether the agent’s actions are being
taken in pursuit of the principal’s goals because constantly monitoring the agent is impossible or too
costly and because the principal does not have enough knowledge.
Employees does not always act in the best interest off the firm because they are self-interested.
Examples: every employee tries to find out how slowly he can work and still convince his employer
that he is going at a good pace / CEO can earn a bonus when firm profit is higher than X, but a R&D
investment will increase future profits.
Main assumption of traditional economic theory: individuals are perfectly rational and always act
self-interested. But, employees are less self-interested than traditional economic theory predicts and
they exhibit social preferences.
In this course we study the tension between ‘self-interest’ and ‘social preferences’. The consequence
of social preferences is that people sometimes act in the best interest of the firm without the
implementation of the typical management control systems (monitoring systems, performance-
based contracts, possibility of promotion). Even worse: implementation of MCS can crowd out social
preferences and lead to a worse situation than without MCS. The trick is to know when you can rely
on social preferences to reduce ‘the gap’ and when you need to introduce ‘hard’ MCS.
Another reason that employees, managers and CEOs not always act in the best interest of the firm is
because they are subject to the typical human biases
Anchoring (example: first two digits of passport number/ANR then bid on a bottle of wine).
It seems that employees and managers are heavily influenced by certain numbers such as the cutoff
point for their bonus. In order to meet this cutoff point they will do actions that are not in the best
interest of the firm.
, Common versus unique measures (example: one common and two unique performance
measures, people will rely on the common measure). We will study how evaluation of
employees happens and how, for instance, the use of the balanced scorecard as an
evaluation tool can increase the moral hazard problem.
Overconfidence
Our starting point is the moral hazard problem. Employees and managers do not always work in the
best interest of the firm because they are self-interested (but not always) and because they are
biased (but not always).
MCS are often used to reduce the gap, but can also crowd out social preferences and introduce
biases (and thus increase the gap).
Goal of this course: give more insights into when MCS will decrease or increase the gap.
Management control addresses the general question: are our employees likely to behave
appropriately? Internal focus.
The difference with strategic control:
Strategic control addresses the question: is the strategy valid, and if not, how should it be changed?
External focus how can the firm with its particular strengths, weaknesses, opportunities and
limitations compete with other firms?
Strategy Management Control Performance.
It seems that making sure that employees execute your strategy is one of the biggest problems.
Developing appropriate management control systems can make your company a leader.
A MCS is everything that firms can use to induce their employees to act in the best interest of the
firm.
Hard incentive-based compensation, employee selection and monitoring systems.
Soft leadership, social norms, honor codes.
Everyone is/will be subject to MCS because all companies evaluate their employees on a regular
(yearly bonus) or irregular (promotion decision) basis and all companies want that their employees
work harder.
Example: university (principal) and students (agents). Government funds universities based on the
number of students that graduate within a certain period of time. University wants that students
graduate as quick as possible but students have different reasons to not graduate as quickly as
possible (the gap). Decision principal: BSA, harde knip.
Lecture 2: Theory, Methodology and Professional Skills
A theory is an integration of observations that provides an adequate explanation of human behavior
(inductive thinking and the researcher should develop a helicopter-view).
A good theory must also suggest new hypotheses that are capable of being tested empirically
(deductive thinking and a researcher should be willing to admit errors in his earlier thinking.
Observations formulation of a theory testing the theory by developing hypotheses hypothesis
refuted / hypothesis confirmed formulation of a theory.
, A theory is a system of ideas to explain a class (or classes) of phenomena and consists of:
Concepts (e.g. self-interest).
A set of assumptions (e.g. human beings are self-interested).
Logically interconnected statements that relate these concepts to each other (hypotheses)
(e.g. if it is impossible to be detected, human beings will steal money).
A theory must answer all the common questions:
Who? What? (concepts)
When? Where? (scope)
How? Why? (assumptions)
Would? Should? Could? (hypotheses)
Theories are important for practitioners because they help you to see through ill-structured or
unstructured problems, they help you to develop adequate solutions for problems you come across
in practice and they help you to convince others of the solutions you have developed.
Practitioners should use the theories (mix theoretical background and practical work
experience) rather than develop them (task of a researcher).
The ultimate goal of our education is to enable you to solve problems that you will encounter as a
practitioner. Method 1: going with you through all the practical situations you will encounter as a
practitioner (no time for that, impossible to predict all practical situations and quickly outdated
advice). Therefore, we use method 2: providing you with a framework by teaching theories (theories
serve as a framework, quite resistant to change and you can adapt it to your particular situation).
To analyze the manager-employee relationship in this course, we borrow insights from economic
theories (such as agency theory) and psychological theories (such as social comparison theory).
Although they both try to explain human behavior, economic and psychological theory seem to
contradict with each other.
More and more, psychological evidence is used as a source of inspiration for developing the
assumptions of economic theories. Example: behavioral theory is proposed as an alternative for
‘traditional’ agency theory.
Behavioral economics improves the assumptions underlying economic theory and can lead to a
reunification of economics and psychology, it implies moving from theorizing about how people
should behave to how people do behave and it provides a more realistic and thoughtful basis for
making economic policy.
In order to test hypotheses, one can use different research methods such as experiments, field
studies, experiments and archival data. Every research method has its own vaue. The research
methods differs with regarding to:
External validity: the extent to which the results can be generalized across variations in
people, settings, outcomes and times. Is sample reflective for the whole population?
Internal validity: the extent to which we can accurately infer that the independent variable
caused the effect observed on the dependent variable. Does x leads to y, or is there another
explanation?
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