Management control systems
Aan het eind van blok graag deze summary in chat zetten met alle learning
goals (uit de lecture slides) en vragen of hij er een goede samenvatting van
kan maken voor mijn tentamen. Hij hoeft niet ingekort te worden, maar alle
informatie moet er gewoon helder en compleet in staan. Er moet geen
dubbele info in staan. Make sure to put together any duplicate information, to
include answers on all learning objectives, without changing the summary too
much.
Lectures + video’s!!
Four lectures requiring active participation: make summary, handout, discuss
in class
Lecture 1: setting the stage
The agency problem: principle vs. agent. One wants profit (principal), the other does not
care (agent). Balancing decision facilitating (internal information system) and decision
influencing (moral hazard, adverse selection). There is a gap: when the organization grows,
the gap becomes bigger between principal and agent.
Decision facilitating – guide decision making: Google employees speak the language of
data as part of their culture. In Google, the aim is that all decisions are based on data,
analytics and scientific experimentation.
Decision influencing – attract talent, offer incentives: compensation for Google
emplooyees, they get a fixed salary and variable bonus. Perks for employees like free meals
and snacks in the office.
When incentives are not aligned > decision influencing. Adverse selection, moral hazard
(hidden information, hidden action).
When incentives are aligned > decision facilitating. Info provision such that people take better
decisions.
Adverse selection: according to contracting theory, this term is used to categorize
principal-agent models in which an agent has private information already before a contract
is written. For example, a worker may know his effort costs before an employer makes a
contract offer. Example with student and university contract (1000,- if you get average of
75% or otherwise donate 400 yourself), students are more likely to sign if they think they
can achieve the target. This leads to selection effect: attract highly skilled students.
Moral hazard
- Hidden information: used for principle-agent models where there is often symmetric
information at the time of contracting. The agent can become privately informed
, after the contract or has information that the principal is not aware of at the time.
The local business unit has hidden information compared to the shareholders.
- Hidden action: symmetric information at time of contraction, the entrepreneur
cannot perfectly monitor the agent efforts. The agent is working less, or spends
some of his time idle. Therefore, moral hazard leads to hidden action. It arises
because effort of employee is costly, monitoring them is costly, principal does not
always have enough knowledge. Time theft is a big problem nowadays because of the
internet, losing money and productivity annually.
Decision facilitating: principal and agent incentives could be aligned, but the information
is not there. Decision facilitating role of accounting. What information should we provide to
ensure that employees make decisions that add value to the company? Accounting can help:
provide information to reduce pre-decision uncertainty. Aim: to improve employees
knowledge so they can make organizationally desirable judgements.
Management control = ways to reduce the gap and mitigate the agency problem.
A management control system is everything that a company can use to induce their
employees to act in the best interest of the firm. Management control systems that we focus
on int his course can range from: soft and behavioral (leadership, social norms, honoring
codes) to hard and economic (inventive-based compensation, employee selection,
monitoring systems).
Everyone will be subject to management control systems: all companies evaluate their
employees on a regular or irregular basis. All companies want their employees to work
harder. Even students are subject to management control systems.
Strategy > management control > performance. Making sure that employees execute your
strategy is one of the bigger problems. Developing appropriate management control
systems can make your company a leader.
Management control and the type of agent
Ecomonists have characterized agents as lazy, self-interested and fully rational. A lot of
behavior is rooted in humans: we do not always act optimal, we want to be liked, we have
the need to compare ourselves, we have cognitive limitations. If we know what people care
about or make mistakes about, we can make accounting relevant again. Management
control can make a difference.
The characterization of the agent: employees are lazy? Or can they be intrinsically
motivated by their job design? A lot of employees love their job and do their job not because
they have to but because it gives them feelings of competence, relatedness and autonomy.
This makes them intrinsically motivated to exert effort in order to advance the firm’s goals.
Video article 1: agency problems
Decision influencing: incentive issue (misalignment of incentives) > adverse selection,
moral hazard, hidden action or hidden information = agent and principle don’t have the
same incentives.
,Decision facilitating: informational issue (incentives are aligned) > nudging, right
decisions, predecision, information = the incentives are aligned, but the agent does not
have the right information.
Adverse selection: agent has private information already before a contract is written, e.g.
they know they can reach a target so they buy, or they know how much time will go into
something so they sign the contract cause its beneficial for them. By writing a good
contract, you can attract the right people > attract smart people by letting them sign a
contract where you get 1000,- if you reach 75% average = selection effect.
Example of general electric: forced ranking system, performance against peers, low
performance (10%) are kicked out.
Types of information: management accounting
- Incentive contracts with employees that stipulate performance levels > ability?
- Relative performance systems; compare performance against peers > competitive?
- Bonus contracts, variable pay (more risk) vs fixed pay (less risk) > risk taking people?
- Set targets for financial and non-financial performance > long term focus?
- Deferred compensation plans > people that do not want to go for immediate results
Moral hazard (hidden information) = symmetric information at time of contracting,
agent may become privately informed after the contract is written.
E.g. taxi drivers driving an extra round or longer route to let you pay more, because you
have no idea what the right route is. Or, managers can misuse their information, setting a
target lower than necessary because they know they can reach and will reach they bonus.
Moral hazard (hidden action) = symmetric information at time of contracting leads to
agent working less, as their efforts are not perfectly monitored and contracts are imperfect
(fixed wage). There is a gap between employee and employer: providing effort is costly for
employee, monitoring employees is costly, the principal does not have enough knowledge
(on how much time the employee should actually be working on something).
E.g. an employee is paid a fixed wage, so no matter how hard they work, they always get the
same pay. Therefore, they don’t work that hard or slow down their effort.
Performance measurement systems can avoid this and cause people to work harder. If
you pay them fixed wage + bonus, people will try to reach that bonus.
How do you avoid this? Management control systems. Types of
information/monitoring:
- Monitoring systems by peers
- Internal control procedures
- Video surveillance
- Increased documentation, supervision authority
- Allocation of decision rights
Decision facilitating: principal and agent incentives could be aligned. So there is no
agency problem. But, the information is not there: decision facilitating role of accounting.
, What information should we provide to employees in order to ensure that employees make
the right decisions that add value to the company?
Decision facilitating role = provision of information to reduce pre-decision uncertainty.
Aim: to improve employees’ knowledge, so that they can make organizationally desirable
judgements.
Video article 2: characterization of the agent
Types of agents
- Homo economicus: always rational, always focused on money as an incentive
- Agent driven by other things.
1. Are employees fully self interested > Social motives exist! People are either pro
social, individualists, or competitors. Why is this important? Many people reveal
information honestly, people care about fairness.
2. People are not always rational > People are biased. They anchor on information,
e.g. certain numbers. Performance measures are numbers, or pricing information are
numbers, so they focus a lot on that. If people start from a different anchoring point,
they make different decision compared to people who have better information.
Therefore, management accounting is very important, because people count on
these numbers.
3. Employees are lazy > But people can be intrinsically motivated. A lot of
employees love their job and do they job not because they have to but because it
gives them feelings of competence, relatedness and autonomy. A lot of people are
intrinsically motivated to exert effort in order to advance the firm’s goal.
So, we know that employees are not always lazy, that they do have social preferences and
they are boundedly rational. Management control systems are needed based on the most
accurate characterization of the agent, otherwise management control systems can increase
(rather than decrease) the gap.
If you don’t recognize the different types of agents, and think people are always the same,
you might increase the gap of the agency problem. Incentives can backfire.
Hard vs soft control systems
- Economics (hard): incentive-based compensation, employee selection or monitoring
systems
- Behavioral (soft): leadership, social norms, and honor codes
Lecture 2: performance measures
Video article 1: delegation and performance measures
This paper is about the moral hazard problem: the principal wants profit, but he needs
to ask the question whether he can delegate the decision to people lower in the
Aan het eind van blok graag deze summary in chat zetten met alle learning
goals (uit de lecture slides) en vragen of hij er een goede samenvatting van
kan maken voor mijn tentamen. Hij hoeft niet ingekort te worden, maar alle
informatie moet er gewoon helder en compleet in staan. Er moet geen
dubbele info in staan. Make sure to put together any duplicate information, to
include answers on all learning objectives, without changing the summary too
much.
Lectures + video’s!!
Four lectures requiring active participation: make summary, handout, discuss
in class
Lecture 1: setting the stage
The agency problem: principle vs. agent. One wants profit (principal), the other does not
care (agent). Balancing decision facilitating (internal information system) and decision
influencing (moral hazard, adverse selection). There is a gap: when the organization grows,
the gap becomes bigger between principal and agent.
Decision facilitating – guide decision making: Google employees speak the language of
data as part of their culture. In Google, the aim is that all decisions are based on data,
analytics and scientific experimentation.
Decision influencing – attract talent, offer incentives: compensation for Google
emplooyees, they get a fixed salary and variable bonus. Perks for employees like free meals
and snacks in the office.
When incentives are not aligned > decision influencing. Adverse selection, moral hazard
(hidden information, hidden action).
When incentives are aligned > decision facilitating. Info provision such that people take better
decisions.
Adverse selection: according to contracting theory, this term is used to categorize
principal-agent models in which an agent has private information already before a contract
is written. For example, a worker may know his effort costs before an employer makes a
contract offer. Example with student and university contract (1000,- if you get average of
75% or otherwise donate 400 yourself), students are more likely to sign if they think they
can achieve the target. This leads to selection effect: attract highly skilled students.
Moral hazard
- Hidden information: used for principle-agent models where there is often symmetric
information at the time of contracting. The agent can become privately informed
, after the contract or has information that the principal is not aware of at the time.
The local business unit has hidden information compared to the shareholders.
- Hidden action: symmetric information at time of contraction, the entrepreneur
cannot perfectly monitor the agent efforts. The agent is working less, or spends
some of his time idle. Therefore, moral hazard leads to hidden action. It arises
because effort of employee is costly, monitoring them is costly, principal does not
always have enough knowledge. Time theft is a big problem nowadays because of the
internet, losing money and productivity annually.
Decision facilitating: principal and agent incentives could be aligned, but the information
is not there. Decision facilitating role of accounting. What information should we provide to
ensure that employees make decisions that add value to the company? Accounting can help:
provide information to reduce pre-decision uncertainty. Aim: to improve employees
knowledge so they can make organizationally desirable judgements.
Management control = ways to reduce the gap and mitigate the agency problem.
A management control system is everything that a company can use to induce their
employees to act in the best interest of the firm. Management control systems that we focus
on int his course can range from: soft and behavioral (leadership, social norms, honoring
codes) to hard and economic (inventive-based compensation, employee selection,
monitoring systems).
Everyone will be subject to management control systems: all companies evaluate their
employees on a regular or irregular basis. All companies want their employees to work
harder. Even students are subject to management control systems.
Strategy > management control > performance. Making sure that employees execute your
strategy is one of the bigger problems. Developing appropriate management control
systems can make your company a leader.
Management control and the type of agent
Ecomonists have characterized agents as lazy, self-interested and fully rational. A lot of
behavior is rooted in humans: we do not always act optimal, we want to be liked, we have
the need to compare ourselves, we have cognitive limitations. If we know what people care
about or make mistakes about, we can make accounting relevant again. Management
control can make a difference.
The characterization of the agent: employees are lazy? Or can they be intrinsically
motivated by their job design? A lot of employees love their job and do their job not because
they have to but because it gives them feelings of competence, relatedness and autonomy.
This makes them intrinsically motivated to exert effort in order to advance the firm’s goals.
Video article 1: agency problems
Decision influencing: incentive issue (misalignment of incentives) > adverse selection,
moral hazard, hidden action or hidden information = agent and principle don’t have the
same incentives.
,Decision facilitating: informational issue (incentives are aligned) > nudging, right
decisions, predecision, information = the incentives are aligned, but the agent does not
have the right information.
Adverse selection: agent has private information already before a contract is written, e.g.
they know they can reach a target so they buy, or they know how much time will go into
something so they sign the contract cause its beneficial for them. By writing a good
contract, you can attract the right people > attract smart people by letting them sign a
contract where you get 1000,- if you reach 75% average = selection effect.
Example of general electric: forced ranking system, performance against peers, low
performance (10%) are kicked out.
Types of information: management accounting
- Incentive contracts with employees that stipulate performance levels > ability?
- Relative performance systems; compare performance against peers > competitive?
- Bonus contracts, variable pay (more risk) vs fixed pay (less risk) > risk taking people?
- Set targets for financial and non-financial performance > long term focus?
- Deferred compensation plans > people that do not want to go for immediate results
Moral hazard (hidden information) = symmetric information at time of contracting,
agent may become privately informed after the contract is written.
E.g. taxi drivers driving an extra round or longer route to let you pay more, because you
have no idea what the right route is. Or, managers can misuse their information, setting a
target lower than necessary because they know they can reach and will reach they bonus.
Moral hazard (hidden action) = symmetric information at time of contracting leads to
agent working less, as their efforts are not perfectly monitored and contracts are imperfect
(fixed wage). There is a gap between employee and employer: providing effort is costly for
employee, monitoring employees is costly, the principal does not have enough knowledge
(on how much time the employee should actually be working on something).
E.g. an employee is paid a fixed wage, so no matter how hard they work, they always get the
same pay. Therefore, they don’t work that hard or slow down their effort.
Performance measurement systems can avoid this and cause people to work harder. If
you pay them fixed wage + bonus, people will try to reach that bonus.
How do you avoid this? Management control systems. Types of
information/monitoring:
- Monitoring systems by peers
- Internal control procedures
- Video surveillance
- Increased documentation, supervision authority
- Allocation of decision rights
Decision facilitating: principal and agent incentives could be aligned. So there is no
agency problem. But, the information is not there: decision facilitating role of accounting.
, What information should we provide to employees in order to ensure that employees make
the right decisions that add value to the company?
Decision facilitating role = provision of information to reduce pre-decision uncertainty.
Aim: to improve employees’ knowledge, so that they can make organizationally desirable
judgements.
Video article 2: characterization of the agent
Types of agents
- Homo economicus: always rational, always focused on money as an incentive
- Agent driven by other things.
1. Are employees fully self interested > Social motives exist! People are either pro
social, individualists, or competitors. Why is this important? Many people reveal
information honestly, people care about fairness.
2. People are not always rational > People are biased. They anchor on information,
e.g. certain numbers. Performance measures are numbers, or pricing information are
numbers, so they focus a lot on that. If people start from a different anchoring point,
they make different decision compared to people who have better information.
Therefore, management accounting is very important, because people count on
these numbers.
3. Employees are lazy > But people can be intrinsically motivated. A lot of
employees love their job and do they job not because they have to but because it
gives them feelings of competence, relatedness and autonomy. A lot of people are
intrinsically motivated to exert effort in order to advance the firm’s goal.
So, we know that employees are not always lazy, that they do have social preferences and
they are boundedly rational. Management control systems are needed based on the most
accurate characterization of the agent, otherwise management control systems can increase
(rather than decrease) the gap.
If you don’t recognize the different types of agents, and think people are always the same,
you might increase the gap of the agency problem. Incentives can backfire.
Hard vs soft control systems
- Economics (hard): incentive-based compensation, employee selection or monitoring
systems
- Behavioral (soft): leadership, social norms, and honor codes
Lecture 2: performance measures
Video article 1: delegation and performance measures
This paper is about the moral hazard problem: the principal wants profit, but he needs
to ask the question whether he can delegate the decision to people lower in the
