Advanced Management

Accounting

Strategic Control System –

Incentive System
 What is control?
• Control, in a broader sense, is making sure that the actual
behaviours (of individual, groups, organisations as well as
other ‘things’) are in line with the ideals (standards,
objectives, norms, values & beliefs, rituals and so on).
• So, two fundamental elements in conceptualising control are:

Actual
Ideals
behaviour

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 What is control?
• What does this “making sure” include? Or, in other words,
what one should do to ‘make sure’ this match between
ideals and actual behaviours.
– Goal setting (knowing the ideal). This also include knowing what
the environment demands from the organisation.
– Performance measurement (measuring the actual behaviour).
– Comparisons and judgements (comparing actual with the ideal
and making judgements about actual behaviours and also the
ideals).
– Corrective actions: decision-making, communication and
implementation (including rewarding and punishments) to
correct the deviations between ideal and actual behaviours.
Three dimensions of human behaviour
• Rational economic behaviour: maximising
economic rewards
• Psychological/cognitive behaviour: achieving a
psychological equilibrium – mental
consistency and human motivation.
• Political behaviour: discipline, power, control
and resistance.
 Economic-rational assumptions of
human behaviour
• Utility maximisers
• Opportunistic, work and risk aversive
• Rationality, and unlimited cognitive capacity in
decision choice (in some economic theories,
especially in agency model)
• Imperfect knowledge and bounded-rationality
(in some other economic theories, example
transaction cost economics).
 Economic-rational assumptions of
organisational configurations
• Organisations are programmable entities.
• Programming/configurational objective is to
maximise profits/shareholders’ wealth.
• Organisational objective of profit maximisation
contradicts with individual employees’ utility
maximisation objectives and behavioural
conditions of opportunism and work/risk
aversion.
• However, Nash equilibrium (a win-win situation)
can be achieved though properly devised control
and incentive devices.
Optimum level of performance target:
classical agency-theory model?
Expected payoff

Agent’s expected income

Expected payoff and agent’s expected income

R2
R2 = Maximum level of
return for principal.
R1 = Principal’s return when
there is no performance
R1 based incentives for agent

Basic wage with no performance based incentives

B opt Agent’s risk and effort

Optimum level which (level of budget difficulty)
Maximises principal’s
return
Behavioural challenge of management
control: economic rational model
• Setting proper levels of difficulty in
performance targets so that profit
maximisation objective can be achieved. That
is deciding the appropriate level of risk,
rewards and performance targets to be
achieved (these are the elements of a
performance-based contract).
 Key psychological assumptions of
human behaviour
• Human beings are boundedly rational. Their
rationality is bounded by lack of perfect
information, cognitive limitations of information
processing, and emotionality.
• They are satisfying rather than maximising.
• Individuals seek a state of internal equilibrium,
which is often called mental consistency. This
means an individuals mental states such as
attitudes, beliefs, and preferences etc. fit
together harmoniously without conflicts.
 Rewards
Extrinsic Intrinsic
• Provided by the • Self-provided by individuals
organization to the • Examples
employee – Satisfaction for a job well
• Examples done
– Cash bonus – Satisfaction provided by the
– Stock options scope of the job
– Public recognition – Satisfaction provided by the
opportunity for advancement

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 Effective Reward Systems
• An effective reward system motivates an employee to
act in the organization's best interests
• If the reward system is based on extrinsic rewards the
employee must
– Understand clearly what is rewarded
– Have the authority to affect what is rewarded
– Value what is rewarded

Notes: incentive compensation systems work best in

organisations in which employees have the skill and authority
to react to conditions and make decision.
 Case Study
Citibank: Performance Evaluation
1. Find type of rewards discussed in case study.
2. What are the areas covered in measuring
manager’s performance?
3. Identify why has Citibank introduced a
Performance Scorecard?
4. If you were Lisa, what evaluation would you
give to James in his overall performance
rating?
THANK YOU
 Q2: What are the areas covered in
measuring manager’s performance?
The implemented performance scorecard specifies
goals and measures manager’s performance in 6
areas:
• Financial measures
• Strategy implementation
• Customer satisfaction
• Control measures
• People
• Standards
 Q3: Identify why has Citibank
introduced a Performance Scorecard?
• Citibank was a niche player and was to provide
high level of services to customers
• Only financial measures were the poor vehicle
to communicate the high service strategy
• Broader view of business and focus on all the
dimensions for long term success
• Reflection of Customer Satisfaction as a key
differentiator
Q4: If you were Lisa, what evaluation would you
give to James in his overall performance rating?
No. Areas Scores
1 Financial measures Above Par
2 Strategy implementation Par
3 Control measures Above Par
4 People Above Par
5 Standards Above Par
6 Customer Satisfaction Below Par

Practical Constraints faced by James McGaran

1. Diverse set of customers.

2. The branch that was handled by James was the largest and
toughest branch in the division.
3. Had a demanding clientele and challenging competition.
 Final Evaluation Rating for James
• Overall Evaluation: Above Par
• This is the first year the balanced scorecard was
implemented. It will take sometime to insure that all the
areas are measured appropriately
• He has done exceptionally well across the scorecard and he
is consciously making efforts to over come the issues in
customer evaluation rating
• Management should also have a look on James’ peer group
ratings to ensure customer satisfaction is fair indicator
which can be linked to overall performance
• Lets not forget the parameters which are beyond branch’s
control are also detrimental for customer satisfaction score.