CHAPTER 5 – CONTROL SYSTEM COSTS

Managers are willing to incur sometimes significant direct, out-of-pocket costs to try to obtain this
benefit. But managers must also consider some other, indirect costs that can be many times greater
than the direct costs.

A. DIRECT COSTS

The direct costs of a MCS include all the out-of-pocket, monetary costs required to design and
implement the MCS. Some direct costs, such as the costs of paying cash bonuses (arising from incentive
compensation for results control ) or the costs of maintaining an internal audit staff (needed to ensure
compliance with action-control prescriptions) are relatively easy to identify.

Many organizations often are unaware of, or do not bother to calculate accurately the size of, all of
these direct costs. But all that is required for our purposes is to acknowledge that these costs are not
trivial and, thus, should be put against the benefits that MCSs have or are expected to have.

B. INDIRECT COSTS

Challenging as estimating the direct costs of control may be, they can be dwarfed by indirect costs of
control caused by any of a number of harmful side effects, including behavioral displacement,
gamesmanship, operating delays, and negative attitudes, as the example above illustrates and which we
discuss further below.

1. Behavioral displacement

Behavioral displacement is a common MCS-related side effect that can expose organizations to
significant indirect costs; it occurs when the MCS produces, and actually encourages, behaviors that are
not consistent with the organization’s objectives.

Behavioral Displacement and Results Controls

In a results-control system, behavioral displacement occurs when an organization defines sets of results
measures that are incongruent with the organization’s “true” objectives.

Behavioral Displacement and Action Controls

Behavioral displacement can also occur with action controls. One form of action control-related
displacement is often referred to as means-ends inversion, meaning that employees pay attention to
what they do (the means) while losing sight of what they are to accomplish (the ends).

Sometimes action control-related displacement occurs simply because the defined actions are
incongruent. As with results controls, this problem arises in an action-accountability context.

Some action controls cause behavioral displacement because they promote compliant yet rigid, non-
adaptive behaviors, a pathology commonly associated with bureaucratic organizations.
Behavioral Displacement and Personnel/Cultural Controls

Behavioral displacement can also occur with personnel/cultural controls. It can arise from recruiting the
wrong type of employees or providing insufficient training, and when personnel/ cultural controls are
implemented in the wrong setting, they will be rendered ineffective and encourage unintended
behaviors.

2. Gamesmanship

We use the term gamesmanship to refer generally to the actions that employees take to improve their
performance indicators without producing any positive effects for the organization. Gamesmanship is a
common harmful side effect faced in situations where accountability forms of control, either results or
actions accountability, are used. We discuss two major forms of gamesmanship: slack creation and data
manipulation.

Creation of Slack Resources

Slack involves the consumption of organizational resources by employees in excess of what is required
to meet organizational objectives. The propensity to create slack often takes place when tight results
controls are in use; that is, when employees, mostly at management levels, are evaluated primarily on
whether or not they achieve their budget targets. Managers who miss their target face the prospect of
interventions in their jobs, the loss of organizational resources, the loss of annual bonuses and pay
raises, and sometimes even the loss of their job.

Under these circumstances, managers may look for ways to protect themselves from the downside risk
of missing budget targets and the stigma attached to underachievers.

Data Manipulation

Data manipulation involves fudging the control indicators. It comes in two basic forms: falsification and
data management. Falsification involves reporting erroneous data, meaning that the data are changed.
Data management involves any action undertaken to change the reported results (such as sales
numbers or profits) while providing no real economic advantage to the organization and, sometimes,
even causing harm. Data management actions are typically undertaken to make performance look
better, such as to achieve a budget target or to increase stock price.

Data management can be accomplished through either accounting or operating means. Accounting
methods of data management involve an intervention in the measurement process. Individuals engaging
in accounting methods of data management sometimes violate accounting rules; more frequently, they
use the flexibility available in either the selection of accounting methods or the application of those
methods, or both, to “manage earnings,” as it is often called.

Operating methods of data management involve the altering of operating decisions. To boost earnings
in the current period, managers can, say, try to delay the timing of discretionary expenditures (such as
maintenance) and/or try to accelerate sales.
 3. Operating Delays

Operating delays often are an unavoidable consequence of the preaction review types of action controls
and some of the forms of behavioral constraints. Delays such as those caused by limiting access to a
stockroom or requiring the typing of a password before using a computer system are usually minor and
are inevitable (although they can be made more effective and less timewasting or cumbersome through
the use of technology, such as touch IDs or retina-recognition systems).

4. Negative attitudes

Management controls can also cause negative attitudes, including job tension, conflict, frustration and
resistance. Such attitudes are important not only because they are indicators of employee welfare, but
also because they are often coincident with other behaviors that can be harmful, such as gameplaying,
lack of effort, absenteeism and turnover.

Negative Attitudes Produced by Results Controls

Results controls can produce negative attitudes. One cause of negative attitudes arises from a lack of
employee commitment to the performance targets defined in the results-control system.

Negative attitudes may also stem from problems in the measurement system. It is common for
managers to complain that their performance evaluations are not fair because they are being held
accountable for things over which they have little or no control.

Negative Attitudes Produced by Action Controls

Most people, particularly professionals, react negatively to the use of action controls. Preaction reviews
can be particularly frustrating if the employees being reviewed do not perceive the reviews as serving a
useful purpose.

C. ADAPTATION COSTS

In addition to direct and indirect costs, further costs related to running effective MCSs may arise from
the need to adapt MCSs to the context in which they operate, which is particularly pertinent when
operating multinationally, and which we will use as the case in point here. But adaptation costs are also
incurred when firms adapt their MCSs across different strategic business units (SBUs) or across different
business or product/service lines because these have adopted different business unit or competitive
strategies. Regardless, adaptations to local circumstances can be costly, and firms may prefer to
standardize their systems rather than to adapt them.

Adapting MCSs is particularly challenging in multinational environments. Managers of multinational

organizations (MNOs) almost invariably face high information asymmetry between themselves and
personnel in the foreign locations. The foreign personnel have specialized knowledge about their
environments (such as about local norms, tastes, regulations, and business risks).

1. National culture
Some of the effects, benefits, and costs of management controls are universal because, at a certain basic
level, people in all countries have similar physiological needs and desires, say, for achievement and
financial security. One important set of factors with potentially important influences on MCSs can be
explained under the rubric of national culture. National culture has been defined as “the collective
programming of the mind that distinguishes the members of one group or society from another.”

An important factor that contributes to the effectiveness of MCSs is whether the employees perceive
them as culturally appropriate; that is, whether they suit the shared values maintained by the society in
which they operate. When groups of employees perceive things differently, or react to things differently,
different control choices may have to be made.

2. Local institutions

Corporate governance regulations, employment law, and contract law, as well as banking systems and
governance interventions, also vary significantly across nations. Just as with national culture, such
institutional factors can influence both the design and effects of an organization’s MCS. For example,
organizations in countries with strong labor unions may find it difficult to provide incentive pay as unions
often prefer seniority-based pay systems.

3. Differences in local business environments

Business environments also differ significantly across countries. Elements of these environments can
affect environmental uncertainty, inflation, and the availability of qualified personnel. Each of these
factors, and many others in this realm, has MCS implications.

4. Foreign currency translation

MNOs also face currency exchange and translation problems. At first glance, it is not obvious that results
controls in MNOs should be complicated by the fact that the firms’ profits are earned in multiple
currencies. Results controls over foreign entities can be implemented using the same practices
employed in most domestic firms, by comparing performance measured in terms of the local currency
with a pre-set plan also expressed in the local currency. However, MNOs bear economic risk caused by
fluctuating currency values. The values of foreign investments appreciate or depreciate based on the
relative values of the home and foreign currencies