Course : F0942 Management Control System

Year
: 2013-2014

Using Financial Results Controls in the

Presence of Uncontrollable Factors

Slide 12.3

Chapter 12:
Using Financial Results Controls in
the Presence of Uncontrollable Factors

Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition Pearson Education Limited 2007

Slide 12.4

Controllability principle

Employees should be held accountable only for that

which they alone can control; or,

Employees should be held accountable only for that

over which they have significant influence.

Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition Pearson Education Limited 2007

Slide 12.5

Rationale

Uncontrollable factors distort performance

measures and evaluations.

Uncontrollable business risks are best borne by

shareholders (who are better able to diversify the
risks).
If managers bear the risk:
They must be compensated for it.
They may engage in undesirable actions to protect themselves
from the risks (e.g., by engaging in gameplaying or by
becoming excessively risk averse).

Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition Pearson Education Limited 2007

Slide 12.6

Choices that must be made include

Purpose(s) for which adjustments are made?

Salary raises
Incentive pay (short-term, long-term)
Job retention

Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition Pearson Education Limited 2007

Slide 12.7

Choices that must be made include ( Continued)

Types of uncontrollables for which adjustments

are made?
Economic and competitive factors
Acts of nature
Interdependencies
i.e., uncontrollables due to decisions made by personnel
in other parts of the organization, such as higher
organizational levels or other organizational entities.

Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition Pearson Education Limited 2007

Slide 12.8

Choices that must be made include ( Continued)

Who makes the adjustments?

Immediate superior
Upper management
(Compensation committee of the) Board of Directors
Done automatically by predetermined formulae/rules

Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition Pearson Education Limited 2007

Slide 12.9

Choices that must be made include ( Continued)

Which method to use to make the adjustments?

Variance analysis
Flexible performance targets (e.g. flexed budgets)
Relative performance evaluations
Subjective judgments

Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition Pearson Education Limited 2007

Slide 12.10

Other choices

Should the adjustments be total or partial?

Should the adjustments be for negative

uncontrollable factors only (i.e. bad luck),
or should adjustments be made in either direction,
both positive and negative?

Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition Pearson Education Limited 2007

Slide 12.11

How to decide?

Costs vs. benefits:

For some types of adjustments, the benefits clearly
outweigh the costs:
Factor is totally uncontrollable
Manager is not expected to respond to the factor
The effect of the uncontrollable factor can be
calculated objectively

Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition Pearson Education Limited 2007

Slide 12.12

How to decide? (Continued)

The benefits of making adjustments are:

More accurate performance evaluations
Less manager frustration; better motivation
Better decision making; less noise in the performance
measures
Lower compensation costs
(in the long run less risk, less turnover)

Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition Pearson Education Limited 2007

Slide 12.13

How to decide? (Continued)

What if the company wants the managers to

respond to an uncontrollable factor?
Should not buffer them completely from the effects
Consider partial adjustment

Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition Pearson Education Limited 2007

Slide 12.14

How to decide? (Continued)

What if the effect of the uncontrollable factor can

only be estimated?
Subjectivity enters in
Subjectivity introduces another form of risk;
that of evaluation bias

Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition Pearson Education Limited 2007

Slide 12.15

How to decide? (Continued)

What if the factor is only partially uncontrollable?

Consider not making adjustments:
Performance measures provide some information
about managers performance.
Consideration of adjustments leads to the creation
of an excuse culture.
Managers are prone to make excuses instead
of addressing their problems.
Costly in terms of management time involved to
investigate the claims and determine appropriate
adjustments.

Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition Pearson Education Limited 2007

Slide 12.16

How to decide? (Continued)

If adjustments are made where they should not

be made:
Bad decisions; managers fail to consider relevant
factors in their decision making.
Shareholders lose as managers are given undeserved
rewards.

Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition Pearson Education Limited 2007

Slide 12.17

Summary

Consider costs and benefits of making

adjustments
Benefits exceed costs if:
Factor is clearly uncontrollable and do not want
managers to respond (they have no influence)
Subjectivity can be avoided (or is tolerated)
In all other cases, use adjustments sparingly

Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition Pearson Education Limited 2007