Accounting for Management Control

Category: Accounting

Critical review of recent literature, which evaluate the effectiveness of different approaches to the design and management of a performance measurement and reward system as a part of organisation wide system of management control.


Over the past 20 years, changes in technology and competitive conditions have dramatically altered the conditions of business operations. Many mangers of the companies realised that new tools for measurement performance are required. The challenge rose due to the fact that the traditional financial performance measurement did not capture all of the customers' demands (Otley, 1999). In order to overcome the limitations of financial indicators, the need arises to complement them with a monitoring of non-financial indicators such as quality, flexibility, value and so on -which, given their very nature, seem to be more appropriate, to follow operations closely and in real time, thus making it possible to carry out revisions and corrections as needed (Azofa 2003). Therefore, effective performance measurement is a vital ingredient in ensuring the successful implementation of an organisation's strategy. A performance measurement system that enables it to meet the customers' demands successfully is essential as it helps ensure that decision-making at strategic and operational level is better informed and more effective (CIMA). Hence there are several factors that a performance measurement system might need to contain in order to be in assistance of the managers to overcome their day to day management issues. It must be integrated with the overall strategy of the business, to be a system of feedback and review, to be comprehensive, and measures need to be fair and achievable (CIMA). In order to solve these issues mentioned above, academics and practitioners have developed two approaches. The stakeholder approach which is linked to corporate strategy to supplement traditional financial measures and the shareholder approach which is based on residual income concept (Otley, 1999). Both of these approaches have plenty of tools for measuring the performance. This paper will focus on most popular example of each, the balanced scorecard (BSC) for the stakeholder approach and economic value added (EVA) for shareholder approach. The objectives of this paper are to evaluate the effectiveness of these different approaches and to indentify how these methods are linked to the reward system of organisations and where are the gaps between academic studies and professional practice.

Shareholder and Stakeholder approaches

The main difference between stakeholder and shareholder dimensions performance is that stakeholder approaches involve a number of measures, both financial and non-financial, whereas shareholder approaches focus on one financial metric (Otley, 1999). In practice we can see overlaps between stakeholder and shareholder approaches to measuring and managing performance.

Stakeholder perspective

Stakeholder perspective argues that companies compete in many dimensions whose evaluation cannot be confine to narrow financial indicators (Otley, 1999). In other words, if the firms relay only on financial performance this might be an incorrect politics because nowadays companies are more oriented in establishing good employee relationship and customer satisfaction. Thus, a new non-financial measurement strategy is needed to be developed in order to meet these requirements.

Shareholder perspectives

The main principle underlying shareholder perspectives of measurement is that the measuring and rewarding activities that create shareholder value will ultimately lead to shareholder wealth (Otley, 1999). All of these shareholders perspectives are based on value-based management programs which involve residual income metrics as a key performance measurement and compensation to the achievement (Coper, 2001).

Balance Scorecard

The balanced scorecard (BSC) is probably the most widely known multidimensional framework adopted by organisations in the quest for improved corporate performance (Otley, 1999). Over the years the impact of the new technologies over the business and economies has increased dramatically. From this perspective the BSC has been improved during the years in order to match the demands of the changing competitive environment. The first generation BSCS were focused on measurement, combining financial and non-financial strategic measures. The second generation developed linkages between the dimensions by using cause-and-effect chains to link strategic objective to drivers. The third generation completes the transformation to a strategic management system (Speckbacher, et al., 2003). In the early 1990s the balance score card was proposed as a framework to provide a structure for related sets of organisational performance measures (Kaplan and Norton, 1996a).The idea of the creation was to overcome some imperfections in previous traditional approaches. The main purpose was to transform the vision of an organisation strategy into measurable objectives with meaning for practitioners.

The main difference between BSC and the other approaches is that it links together the four perspectives measurement in casual chain (Kaplan and Norton, 1996a). Put it in different way, the BSC approach provides a close link between cause and effect into organisation. These measurement areas of activity that may be critical to nearly all organizations and all levels within organizations are as follows:

* Investing in learning and growth capabilities

In the learning and growth perspective "managers define the employee capabilities and skills, technology and corporate climate needed to support a strategy" (Kaplan and Norton 2001a). On average, employees with higher skills and knowledge are compensated with higher salaries and employee benefits (Milkovich and Newman 2002). Therefore, in general the people with higher skills and knowledge are directly associated with both higher levels of product introductions and customer satisfaction. Subsequently, this leads to better financial performance and company reputation.

* Improving efficiency of internal processes

A generic view of the internal business process perspective encompasses the entire internal value chain, which Kaplan and Norton (2001a) decompose into four processes common to all firms: innovation, customer management, operational, and regulatory and environmental. . Finally, measures are used to determine whether the firm is a good corporate citizen in the regulatory and environmental process. The outcomes of the internal business process perspective facilitate achievement of customer objectives.

* Providing customer value

Customer perspective is focused on the external environment and allows firms to understand, discover, and emphasize customer needs. The customer perspective identifies outcome measures that will facilitate the achievement of the organization's financial objectives (Kaplan and Norton 1996).

* Increasing financial success

The financial perspective contains outcome measures that result from achievement of objectives in the previous perspectives. Therefore, managers should be aware that, they need to improve shareholder value through a revenue growth strategy, a productivity strategy or a mix of the two (Kaplan and Norton 2001a).

The conclusion one can be drawn from these point is that there is a positive relation between financial outcomes and both customer satisfaction and product introductions. Providing this casual chain (Kaplan and Norton, 1996a) made attempt to indentify how the effectiveness and efficiency can be improved in an organisation in order to meet the final agenda, which in this case is maximising the financial performance. Moreover, the chain can be seen as a useful tool for performance measurement that hence, is related to the reward scheme of the organisation. Thus, Kaplan and Norton (1996c) assert that not only does the BSC embody or help create organizational strategy and knowledge, but also the BSC itself effectively communicates strategy and knowledge.If the BSC does articulate organizational knowledge and strategy in a superior manner, then i t may be a source of competitive advantage, at least until all competitors use it equally well.


There are a considerable amount of papers that provide arguments which focus attention on that the BSC is not fully developed and there are many areas where the system could be improved in order to be useful tool in the professional practice.


To be effective, BSC measures should be accurate, objective, and verifiable. Otherwise, measures will not reflect performance and may be manipulated, or managers could in good faith achieve good measured performance but cause the organization harm. If managers can achieve good measured performance by cheating the BSC, then the system quickly will lose credibility and desired motivational effect. Furthermore, the set of BSC measures should completely describe the organisation's critical performance variables, but should be limited in number to keep the measurement system cognitively and administratively simple. An exhaustive set of performance measures may accurately reflect the complexity of the organisation's tasks, but too many measures may be distracting, confusing, and costly to administer (Malina and Seltho, 2001). This indicates that poorly designed and implemented features of the BSC can do harm to the communication and control of strategy (Malina and Seltho, 2001).

In a paper, which appeared in Management Accounting Research in 2000, (Nørreklit, 2000) explored the nature of cause-and-effect relationships in the BSC. Amongst other things, she pointed out that time lags are not well understood or modelled within the BSC. Furthermore, the directions of causality are not always clear, and the linkages between the different perspectives may be non-linear. In addition, there was only limited empirical evidence for the casual relationships assumed in Kaplan and Norton's portrayal of the BSC. Nørreklit also argued that Kaplan and Norton confuse cause-and-effect relationships with both logical relationships and means-ends (also called, finality) relationships (see also Nørreklit and Mitchell, 2007). Nørreklit pointed out that, in cause-and-effect relationships, the events are logically independent and can only be inferred empirically. The evidence leads one to believe that despite the fact that BSC is far more superior instrument for performance measurement it requires time and empirical evidence to underpin the theory of Kaplan and Norton. In practice, users of BSC simply have a belief in the relationship between measures rather than testing and indentify the nature of actual relationship.

The Implementation of BSC meets a serial of practical issues. First, organisations are focused to build an operational tool rather than following the concept of BSC. Second, measuring the effects of complex activities is a problem; since it is difficult and almost impossible to establish performance measurement for activities that organisation does not have experience. Third, performance measurement and evaluation will always be partly subjective and to some extent depend on intuition of the top management, because both past results and the impact of future opportunities should form part of the performance picture (Happer, Scapenns and Northcott).

Many researchers which have researched the BSC have their limitations regarding the time frame of their investigation, because BSC is a relatively new approach and there is still need for further, more detailed, research in order to become a tool for measurement performance that always works and managers can rely on it. Moreover, there is no proof whether the BSC when it is implemented to organisation strategy and structure provides the information which managers will need for their evaluation. From this perspective, the BSC should be adjusted for every company in order to be implemented successfully and provide effectiveness by improving the financial performance of the company.

BSC and reward system

Bonuses based solely on profits and other financial accounting numbers have been criticised for encouraging managers to sacrifice long-run performance to increase short-term financial results, and thereby maximize their bonuses. To overcome the short-run orientation of accounting-based reward systems, many firms are implementing compensation plans that supplement financial metrics with additional measures in order to assess performance dimensions that are not captured in short-term financial results (Happer, Scapenns and Northcott).

The reward structure is concerned with motivating towards achieving the performance targets set. It involves clarity- where the company strategy is introduced and understood by the employees. Moreover, It considers motivation- where the targets set by the managers are tied to rewards and in this way the contribution and commitment of the employees is greater. Furthermore, the controllability is vital factor -where people are responsible only for what they can control and they should be reward only for the results of their efforts.


As is well known, most measures of financial performance, such as profit or return on investment, suffer from inherent defects that may cause dysfunctional decision-making on the part of managers. EVA, which is defined as accounting profit less a charge for capital employed, is claimed to be less problematic in this respect (Otley, 1999). The EVA concept extends the traditional residual income measure by adjusting the financial performance. Adjustments are made to the operating profit in order to replace historical accounting data (Otley, 1999). From this perspective EVA model has been proposed as better measure than a traditional ratios to assess corporate performance and shareholder wealth creation The EVA framework is constructed from the value-based management approach, which basically is a return to economic values in assessing the performance of the firms (CIMA). The EVA system is designed to provide a single value-based measure that can be used to evaluate business strategies, value acquisitions, evaluate investment projects, and set managerial performance targets, measure performance and pay bonuses (Otley, 1999).

Two key claims have been made about using EVA as a performance measure:

Eva is a better predictor of stock market returns that traditional accounting earnings.

A performance measurement and reward scheme based on EVA will provide higher rates of return for shareholders than conventional rewards systems based on earnings per share and other popular financial measures (Hopper et al. 2007).

The Wallace (1997) study demonstrated that companies adopting EVA and RI in compensation schemes tended to generate higher levels of residual income than companies which do not use this method by improving operating efficiency, disposing of selected assets, and repurchasing more shares. All this actions are consistent with shareholder wealth creation. Moreover, Wallace (1997) found out that, relative to control firms using traditional accounting methods, firms that adopted EVA-like performance metric (i) increase their disposal of assets and decrease new investments, (ii) increase their payouts to shareholders trough share repurchase and (iii) used their assets more intensively. In addition (Hopper et al. (2007) suggest that firms that decentralise decision rights over asset levels may benefit from using EVA, because EVA motivates managers to consider not only revenues and costs, but also the opportunity cost of capital associated with initiatives to increase profitability.

The CIMA research, however, identified a number of problems and challenges associated with VBM adoption reported by the companies involved. These were: _ Behavioural difficulties, such as getting managers to understand the new measures, avoiding perverse short-termist behaviour and complexity. _ Technical difficulties, including getting the right data, volatility in WACC, the reliability of assumptions used. _ Organisational difficulties, such as overcoming internal resistance, particularly with City analysts retaining a focus on accounting-based information, the significant effort and time required for implementation and

ensuring that implementation proceeds sufficiently quickly to maintain momentum. As mentioned above, there is much evidence to suggest that to be successful implemented EVA model there is a need for change in company culture. (CIMA) There are also a number of problems with using valuebased measures as a basis of an investment decision based on the problem of having to make arbitrary adjustments to standard accounting numbers. Stern and Stewart's EVA model suggests up to 164 adjustments to accounting data to ensure against manipulation and arbitrariness (CIMA). Critics have pointed out that these adjustments are both time-consuming and costly and many are based on decisions that are as subjective as the original accountant's numbers (CIMA).

EVA model can be seen from many scholars as one of the most accurate approach which underpins the shareholder approach. Despite the fact that the model is far more upgraded and developed than other models such as ROI ROCE and RI there is still room for development. Not only is it requires a great number of adjustment in order to work but in many cases the model does not provide accurate information. Moreover, the model is likely to be manipulated by the manager with intention to provide reasonable results which might satisfy the shareholders.