Controlling in Organizations

1. Controlling in Organizations Chapter 10

2. Learning Goals • Explain the foundations of control 2. Identify the six phases of the corrective control model 3. Describe the primary methods of organizational control 4. Explain key corporate governance issues and control mechanisms

3. Foundations of Control • Processes for ensuring that behaviors and decisions conform to an organization’s standards and legal requirements, including its rules, policies, procedures, and goals • How controls and planning support each other • Controls help ensure that decisions, actions, and results are consistent with plans • Controls help maintain or redirect actual behaviors and results toward those desired in plans • Controls help provide essential information needed to plan • Plans indicate the purposes to be served by controls

4. Preventive Controls • Mechanisms intended to reduce the likelihood of an unwanted event and thereby minimize the need for corrective action • A few forms: • Rules and regulations • Standards • Recruitment and selection procedures • Training and development programs

5. Corrective Controls • Corrective Controls • Mechanisms intended to reduce or eliminate unwanted behaviors or results and thereby return the situation to conformity with the organization’s regulations and standards • A few forms: • Direct supervision and feedback • Disciplinary action • Procedures for reporting misconduct • Monthly or even daily financial reports

6. Examples of Sources and Types of Control Source of Control Preventive Corrective Stakeholders Maintaining quotas for hiring personnel in protected class Changing recruitment policies to attract qualified personnel Organization Using budgets to guide expenditures Disciplining an employee for violating a “No Smoking” safety regulation in a hazardous area (continued)

7. Examples of Sources and Types of Control (cont'd) Source of Control Preventive Corrective Group Advising a new employee about the group’s norm in relation to expected level of output Harassing and socially isolating a worker who doesn’t conform to group norms Individual Deciding to skip lunch in order to complete a project on time Revising a report you have written because you are dissatisfied with it

8. Linkage to Strategic Goals for Effectiveness Objective controls To AchieveStrategicGoals Acceptable controls Complete controls Timely controls

9. How Much Organizational Control? • Core questions • For what desired behaviors and results should organizational controls be developed? 2. What are the costs and benefits of the organizational controls required to achieve the desired behaviors and results? 3. What are the costs and benefits of utilizing alternative controls; such as self-managed teams, informal peer control, or individual self-control?

10. Cost-Benefit Model of Organizational Control(adapted from Figure 10.1)

11. Internal Control • A process—effected by an organization’s board of directors, management, and other personnel—designed to provide reasonable assurance regarding the achievement of goals in the various categories • Major categories of internal control • Effectiveness and efficiency of operations • Reliability of financial reporting • Compliance with applicable laws and regulations

12. Interrelated Components and Layers of Internal Control Control Environment Risk Assessment Control Activities Information and Communication Monitoring Internal Control

13. Snapshot “Fundamentally, control existsonly to mitigate risk. So every internalcontrol framework has to start with a systematic approach to identifying risk…Look at some of the major recent corporate failures. Where did the problems fundamentally arise? They occurred primarily because of breakdowns in thecontrol environment.” Larry Rittenberg, Chairman, COSO—Committee of Sponsoring Organizations of the Treadway Commission

14. Limitations of internal control • Cannot change a bad manager into a good one • External influences may be beyond management’s control • Judgments may be faulty • May be circumvented by collusion of two or more employees • Management can override the control system

15. Corrective Control Model • Define theSystem 2. Identify KeyCharacteristics 3. SetStandards 4. CollectInformation If okaycontinue 5. MakeComparisons 6. Diagnoseand CorrectProblems If deviations

16. Snapshot “Many large companies suffer the ravages of fiefdoms, turf wars and bureaucracy. It’s a problem that begins when individuals, groups, or divisions try to protect their turfs, reshaping their environments to gain as much control as possible…Ultimately, fiefdoms lose their ability to act consistently on behalf of the greater good of the company.” Robert J. Herbold, Former Chief Operating Officer of Microsoft, and author of The Fiefdom Syndrome

17. Primary Organizational Control Methods(adapted from Figure 10.3) Mechanistic And Organic Control Automation- Based Control Market Control Organizational Control Financial and Accounting Controls

18. Mechanistic and Organic Control Methods Mechanistic Control Methods Organic Control Methods • Use of detailed rules andprocedures wheneverpossible • Top-down authority, withemphasis on positionalpower • Activity-based jobdescriptions that prescribeday-to-day behaviors • Use of detailed rules andprocedures only whennecessary • Flexible authority, withemphasis on expert powerand networks of influence • Results-based jobdescriptions that emphasizegoals to be achieved (continued)

19. Mechanistic and Organic Control Methods (cont'd) Mechanistic Control Methods Organic Control Methods • Emphasis on extrinsicrewards (wages, pensions,status symbols) • Distrust of teams, based onan assumption that teamgoals conflict withorganizational goals • Emphasis on both extrinsicand intrinsic rewards(meaningful work) • Use of team, based on anassumption that team goalsand norms assist inachieving organizationalgoals

20. Market Controls • The collection and evaluation of data related to sales, prices, costs, and profits for guiding decisions and evaluating results • Market controls require: • The costs of the resources used in producing outputs to be measured monetarily • The value of the goods and services produced to be defined clearly and priced monetarily • The prices of the goods and services produced to be set competitively

21. Financial Controls • Mechanisms for preventing or correcting the misuse and misallocation of resources, especially monetary resources • Comparative financial control: evaluation of a firm’s financial condition for two or more time periods • Ratio analysis: selecting two significant figures (or a combination of a number of figures), expressing their relationship as a fraction or percent, and comparingthe value for two or more periods of time • Example: return on investment (ROI) ratio is net profit before tax divided by net worth and is a measure of the efficiency of total assets in generating net profits

22. Financial Controls • Budgetary control:the process of monitoring,comparing, and evaluating actual expenditurelevels in various categories in relation to budgetedamounts, and making changes as needed during the budget time period • Purposes of budgeting • Help in planning work effectively • Assist in allocating resources • Aid in controlling and monitoring resource utilization during the budget period

23. Financial Controls Common Types of Budgets in a Business Sales budget Capital budget Materials budget Research anddevelopment budget Labor budget Cash budget

24. Activity-Based Costing Model(adapted from Figure 10.4) Cost View Resources Resource Cost Assignment Process View Input Information Activities Performance Evaluation Activity Cost Assignment Goods And Services

25. Automation-Based Controls • Automation:the use of self-regulating devices and processes that operate independently of people • Machine control:utilizes self-regulating instruments or devices to prevent and correct deviations from preset standards • In continuous process or robotic operations, machines control other machines

26. Corporate Governance? What is Corporate Governance? • The pattern of relations and controls between the stockholders, the board of directors, and the top management of a company • Expectations: set by the organization through policies, procedures, practices and guidelines • Communication: makes sure that expectations are understood throughout the organization, and that there is proper training • Accountability: holds people accountable for meeting the expectations that have been set

27. Corporate Governance: A Sample ofKey Terms and Elements Bylaws Annualreport andAnnualmeeting Board ofdirectors Proxystatement Annual meeting

28. External Control Mechanisms Laws and regulatory agencies Possibility of being acquired Lawsuits by stakeholders Proxy statements: voting by shareholders

29. Sarbanes-Oxley Act • Eleven major sections dealing with such issues as: • Auditor independence 2. Corporate responsibility 3. Enhanced financial disclosures 4. Conflicts of interest 5. Corporate accountability

30. Sarbanes-Oxley Act • Certification: requires CEOs and CEOs of publicly traded companies to personally “testify”/sign that valid financial accounting processes have been established and used • Auditability: requires companies to develop and publish internal processes so that outsiders can confirm the existence of appropriate controls • Disclosure: companies must report financial results and material changes in corporate financial condition or operations “on a rapid and current basis” • Criminal accountability • Whistle-blower protection

31. Internal Control Mechanisms • Independent Boards of directors • Compensation contracts that attempt to align the interests of top executives with those of stockholders • Corporate bylaws that set ground rules for the responsibilities of top executives and board members • Evaluation of CEO by the Board • Strategic allocation of corporate resources by Board • Exercise of fiduciary responsibility and control by the Board