You are on page 1of 15





Although the research on current management accounting practices and MCS has been
comprehensive, their empirical evidence has almost totally been based on data from larger
companies or their sub-units. Small business studies have been rare – at least based on their
number of published studies – as pointed out by e.g. McMahon (2001), Mitchell and Reid
(2000), Luft and Shields (2003) and Reid and Smith (2002). The mainstream of the research in
MA seems to concentrate on the middle range of organizational size (Luft and Shields 2003).
Typically, if small firms have been included in these studies, and for example, not been
discarded as outliers, researchers seem rather to have been more interested in the effects of size
variation within larger organizations or between size groups of firms (i.e. small, medium and
large) than in the small businesses as such or possible variation among firms in this size group
(Chenhall2003, Luft & Shields 2003, Mitchell & Reid 2000).

Nevertheless, some studies on MCS in small businesses have been conducted, but the
designs and focuses of these undertakings have varied . For example, Reid and Smith (2000,
2002, see also Nayak and Greenfield 1994) have studied the use of management accounting
techniques of small UK micro firms with less than ten employees; Gul (1991) has revealed the
interaction effect of MCS and perceived environmental uncertainty on managerial performance
in small firms; Laitinen (2002) has examined MA and its change in small Finnish technology
companies; Moores and Yuen (2001) have approached the use of management accounting
systems in life-cycle configurations of Australian clothing and footwear firms, albeit using a
sample including also larger firms; and McMahon (2001) has analyzed the relation between
financial reporting practices, business growth and performance among Australian manufacturing
small and medium-sized firms.

Despite a small number of the small business studies in MA, for example, Hicks (1999),
Laitinen (1996) and Mitchell and Reid (2000) have stated that modern management accounting
practices and sophisticated systems might also be useful for small businesses. Furthermore,
although small firms may have different needs than large companies, there is also some
promising empirical evidence, for example, on the possibilities of the Balanced Scorecard as an
efficient management tool for small businesses as well (Chow et al. 1997, Kaplan& Norton
2001c, 369-370). In addition, like Laitinen (1996) and Mitchell and Reid(2000) have stressed,
practices and systems should not be somehow down sized copies of the ones used in large
companies. Contradictory, practices and system sought to be tailored to fit the needs of small
businesses and their managing directors (see also Nordberg, 1997). However, what are these
needs? How should the practices and systems be adapted for these firms? Research evidence on
the above questions, the current state and nature of small business management accounting
practices and their associations with contextual factors like the environment, strategies,
organizational characteristics, as well as the role an owner-manager plays in these relationships
is very limited (e.g. Chenhall 2003, McMahon and Stanger 1995, Reid and Smith 2000, see also
Ittner and Larcker 2001). For example, we do not know very well the answers to such questions
– How widely are new ideas and innovations of Management Accounting already in use in the
small business sector or are they at all?
– What kind of information do managing directors in small firms prefer and use to pursue
strategies and strategic priorities of their businesses?
– What are the main factors influencing the designs and use of Management Control System
(MCS) in small firms, and how do these factors possibly influence MCS?
– To what extent are the empirical research results based on large companies on the design and
use of MCS consistent with those based on small businesses?
– Is the possible use of MCS related to firm performance of small firms?

Most executives agree that there is no magic formula……or one right measure…….for
evaluating business performance. Therefore, in an effort to capture the essence of business
performance, many companies are creating new performance measurement systems that include
a broad range of financial and nonfinancial measures,(Bonnie P. Stivers et al 1998).

The accounting perspective claims that the headquarters increase the intensity of
Management Control System (MCS) after the performance has worsened in order to adjust for
deviations from planned strategy and operations (Drury 2000; Anthony and Govindarajan 2001).
On the other hand, an intensified (MCS) assures achieving planned goals and objectives
(Egelhoff 1988; Harzing 1999). These two streams in the scientific research make the
explanation of the relationship between Management Control Systems (MCS) and performance
extremely difficult. Additionally, the data for measuring success of the influences of MCS on the
performance has still to be provided (Epstein and Manzoni 2002).

The last trends, including integrated measures (e.g. Kaplan and Norton Balanced Scorecard),
suggest for evaluating various management controls. However, the integrated measures make
comparisons between companies difficult (Epstein and Manzoni 2002).

Integrity is the most important precondition for the smooth functioning of organizations
because it strengthens stakeholder confidence, reduces external regulations, reduces conflicts &
enhances cooperation with stakeholder (Kaptein and Wempe,2002; Pearson,1995; Shaw,1997;
Hill,1990; Schwartz and Gibb,1999; Williamson,1993)

Research that consider the possible effect of Integrity on the relationship between
management control systems and organizational performance of small firms is rare, for that
reason this study tends to analysis the effect of integrity in the relationship between management
control system and organizational performance of small firms in South Sulawesi, Indonesia.

Purpose of the study

This study will investigates the use of MCS practices and information in the field of MA in
small firms. More specifically, this study will focuses on the effect of integrity on the
relationships between the use of MCS practices and information, and contextual factors of small
firms (strategy, environment, and organizational structure) as well as their impact on small firms‟
organizational performance. Moreover, this study concentrates on the organizational level of
small firms in the identification of possible causal relationships between variables.
Contingency theoretical management accounting research has tried to explain over the past
decades how the designs and effectiveness of MCS depend on contextual factors such as

organizational size and structure, environment, strategy, technology and culture (e.g. Chapman
1997, Chenhall 2003, Fisher 1995, 1998,Langfield-Smith 1997, Luft and Shields 2003, for
discussions and reviews).

Respectively, the contingency theoretical paradigm of MA states that a better match or fit
between the factors or circumstances of a firm and its MCS leads an organization to better
decision-making, which in turn will assist it in achieving improved organizational performance
(for reviews, see e.g. Chapman 1997,Chenhall 2003, Fisher 1995, 1998, Luft and Shields 2003).

In practice, also a misfit can occur, for example, due to the response time needed to adapt
and react for the MCS when one or more contextual factors have changed (Donaldson 2001, Luft
and Shields 2003). This all implies that contingencies are variables that are moderating or
conditioning the relationship between characteristics of an organization and its effectiveness or
performance (Donaldson 2001). Furthermore, it is also widely discussed and approved that the
approach to the nature of the fit shapes the theory development, collection of data and statistical
analysis of the research when a contingency theoretical framework is applied in MCS research.
(Chenhall 2003, Donaldson 2001, Gerdin and Greve2004, Hartmann and Moers 1999, 2003,
Ittner and Larcker 2001, Luft and Shields2003, Selto et al. 1995, see also Baron and Kenny
1986, Drazin and Vande Ven 1985, Venkatraman 1989).

On the other hand, the contingency-theoretical research on MA and MCS has also been
criticized. It has been argued that the research stream suffers, for example, from the lack of clear
definitions of variables and control system boundaries, from the lack of a sound and consistent
use of contingency theory as well as from the under specification of the research models and
poor methodology applied in the empirical studies (see e.g. Fisher 1995, 1998, Otley 1980,
Langfield-Smith 1997, also Hartmann & Moers 2003). Furthermore, these kinds of shortcomings
in the research stream complicate the interpretations and comparisons of results.

This study falls in the contingency style of the MCS research stream that is based on an
assumption of disequilibrium at the organization level, i.e. firms perform differently because
some are using MCS that is optimal for them and some are not (Donaldson 2001, Luft & Shields

2003). Thus, firm performance conceptualized here as organizational performance is an outcome
variable in the study. According to the classificatory framework of Gerdin & Greve (2004) the
form of fit in this study can be illustrated as a contingency variant of the Cartesian approach.
That approach proposes a fit as a continuum with a possibility of various degrees of fit when
performance is included as a dependent variable (also see Gerdin 2005 and Donaldson 2001,
Fisher 1995, 1998). Additionally, due to the small number of previous MCS studies in the small
business context, this explorative study applies a broad mediation approach to fit in the causal
modeling. On the other hand, according to Baron & Kenny (1986), if preferred, this kind of a
broad approach may later be followed by a narrower approach to fits by examining interaction
effects of variables.

Framework of the study

The hypothesis developments of the study are based on the prior relevant literature and
empirical studies conducted, in the main, in large organizations. Although the study relies on a
cross-sectional design, in addition, an attempt towards a longer term or dynamic approach is
intertwined into the investigation. This is possible when the data contains information on both
realized and intended strategies as well as on organization performance of small businesses
before and after the survey. The incorporation of performance information both before and after
the time of the survey will strengthen the causal inferences regarding how the contextual factors
together with MCS affect organization performance of firms (Donaldson 2001). This diachronic
approach will offer more reliable insights into the effects of contingency fit on performance, i.e.
possible lagging and leading effects of MCS and multiple contingencies. Thus, the time frame of
the study design allows examinations of bidirectional causal effects between variables. In the
study two theoretical models with different time intervals and directionality between the
variables will be tested using data on small firm businesses. Due to many causal paths and
mediation fits proposed between variables, a statistical method of structural equation modeling
(SEM) is applied, which allows simultaneous examination of the many paths and effects in the
theoretical models of the study.

The framework for the study is illustrated in Fig. 1. This framework will be more detailed
discussions on the theoretical background for the framework, possible bidirectionality of the
causal effects depending on the time frame, and finally to developments of hypotheses for the
causal models to be examined in this study. Nevertheless, a brief explanation of the framework is
provided next.

Strategy Integrity

b d Organization
Environment MCS


Fig. 1 Framework of the study

Overall, this study will draws on a broad approach to MCS implying that MCS convey
useful information to assist managers in their decision making to achieve desired organizational
outcomes or goals efficiently (Anthony & Govindarajan 2001,Chenhall 2003, Langfield-Smith

1997, Otley 1994, 1999, 2001, Simons 1995,2000). The expression of “useful information”
refers to various needs of managers and further to different designs of MCS depending on the
desired goals.
First, in the field of MA the linkage of strategy with MCS has often been examined
incorporating the effects of environmental uncertainty in the study, and in practice, almost
entirely using larger firm samples (e.g. Langfield-Smith 1997, for a review). It is stated that
firms pursuing the generic business strategies like prospector (Miles & Snow 1978),
differentiation (Porter 1980, 1985), entrepreneurial (Miller & Friesen 1982) or build (Gupta &
Govindarajan 1982, 1984a, 1984b) are more likely using more external, non-financial, and
futureoriented, i.e. broad scope, MCS information than firms focusing on the “opposite” types of
strategies (e.g. Baines & Langfield-Smith 2003, Chenhall & Morris 1986, Chong & Chong 1997,
also Langfield-Smith 1997, and reviews therein, Shank & Govindarajan 1993, 93-99). These
latter types of firms tend to use more traditional or narrow scope MCS information. This effect
of strategy on the use of MCS is depicted with an arrow labelled as „a‟ from Strategy to MCS in
Fig. 1. Nevertheless, on the other hand, it has also been stated that MCS already being used by
firms may also affect their choices of future strategies (e.g. Gray 1990, Otley 1999). Thus, if a
different time frame were applied, the direction of the path might also be opposite to the one
shown in Fig. 1.
Second, it has widely been acknowledged that the more uncertain the external environment
of organizations the more organizations prefer and use externally focused, non-financial and
future-oriented management accounting information to confront the unpredictable changes in
their environment (Chenhall & Morris 1986, Gul 1991, Gul & Chia 1994, Chong & Chong 1997,
Gordon & Narayanan 1994, see also Gordon & Miller 1976, Govindarajan 1984, Hoque 2005).
Hence, increasing environmental uncertainty can be stated to feed organizational dependence on
more strategic-oriented management accounting information and use of more sophisticated
MCS. Consequently, lower environmental uncertainty is related to the use of more internally
focused, financial and historically oriented information (ibid.), i.e. a more operational type of
management accounting information and traditional MCS. This kind of relationship from
Environment to MCS is described with an arrow labelled as „b‟ in Fig. 1. In doing so,
environmental uncertainty actually becomes an intervening variable between strategy and MCS
in the causal framework of the study.

Third, decades ago Chandler (1962) presented that strategy contingency shapes the
structure of organizations, that is, diversifying leads the organization to adopt a divisional
structure in order to overcome crises of poor performance. Furthermore, according to the
contingency theory of organization, divisionalization relates to the practical way the work and
management is decentralized for top managers (Donaldson 2001). On the other hand, the theory
of upper echelons based on the introduction of Hambrick & Mason (1984) states that the use of
top management teams as a part of an organization structure influences the development of a
firm and its strategic priorities (see Carpenter et al. 2004, for a comprehensive literature review).
Additionally, Berry (1998) has found empirical evidence that growing small high tech
companies with multi-disciplinary teams use more formal strategic planning than small firms
without such managerial teams. Nevertheless, following the reasoning provided first above, in
Fig. 1 the arrow labeled as „c‟ describes the effects of management team as part of
Organizational Structure and respectively on MCS.
Fourth, following the discussions about MCS presented above, the use of appropriate MCS
fitting strategies, environmenr and organization stucture of firms should assist firms to be more
successful in their effectiveness or performance. The relationship between MCS and organization
performance moderating by integrity is described in Fig. 1 by an arrow labelled as „d‟ from MCS
to Performance.
In addition to the research purpose described above, the survey of this study also serves as
an instrument for collecting data on the adoption rates and use of MCS practices and information
in small firms. Besides the theoretical models and their empirical testing, the more practical
research questions to be explored are as follows:
1. Do small businesses use other practices and information of MCS besides the statutory annual
accounts and financial reports? If so, what kind of MCS practices and information are the firms
applying and how systematically is the information used?
In other words, the aim is to find out how widely both traditional and new, more advanced
management accounting practices and information, typically included in the area of modern
MCS of larger organizations, have diffused in the use of small businesses and how deeply they
have penetrated into the practices of those firms.
2. Do small growth-oriented firms use more comprehensive MCS practices and information than
firms without such a clear growth orientation?

3. Does the use of MCS or particular dimensions of MCS lead to better organizational
performance of small firms?
4. Is the possible use of more advanced MCS practices and information in connection with the
intended strategy of the small firm?
5. Do small firms have special needs for changes in their MCS?

Rationale for the study

Although the result of researches between (Drury 2000; Anthony and Govindarajan 2001)
and (Egelhoff 1988; Harzing 1999) are contrary and make the explanation of the relationship
between management control system (MCS) and performance extremely difficult, but definitely,
the research of Chandler and Hanks (1993) offers an advantage in the use of performance
measures. It suggests that the use of subjective measures of firm performance (relative to
competitors) are particularly useful in studying emerging business, and that these measures
correlate with the objective measures with a high degree of reliability. Such measures were
successfully applied by luo and Peng (1999), who measured performance with manager‟s
perceptions on four factors concerning the competitive position of a company and managers‟
satisfaction about the company operations.

The rationale for this study is to determine whether integrity have moderating effect on
the relationship between management control system (the external environment, organizational
structure and strategy dymensions) and the organizational performance of small firms.

Key Constructs for this Study

The definition of MCS has evolved over the years from one focusing on the provision of
more formal, financially quantifiable information to assist managerial decision making to one
that embraces a much broader scope of information. This includes external information related to
markets, customers, competitors, non-financial information related to production processes,
predictive information and a board array of decision support mechanisms, and informal personal
and social controls.

While such a valid measure would enhance consistency between studies, a difficulty exists in
the dynamic nature of MCS practices. MCS that are valid today may lose validity as they evolve
through time. Certainly, because of advances in information technology (IT) software, some type
of balanced scorecards being employed today are more comprehensive and strategic in nature
than those being used 5 years ago.

Without accommodating changes in contemporary control systems, concepts and measures of

MCS are unlikely to address pertinent, contemporary issues. A research climate that encouraged
the development of valid concepts and measures of MCS would have to recognize the need for
modification to incorporate the evolution of MCS.

Contingency-based studies have examined MCS as both dependent and independent

variables. To examine fit between MCS and context, some commentators have claimed that the
outcome variables should be some dimensions of desired organizational or managerial
performance (Otley,1980; Otley and Wilkinson, 1998). Good fit means enhanced performance,
while poor fit implies diminished performance. It is noteworthy that performance has been
included as an independent variable explaining some characteristics of MCS.

This study pertains to the integrity context of organizations and more significantly, to
relationships between management control system (the external environment, organizational
structure and strategy dimensions) and performance of small firms.


From MCS research, evidence suggests links between strategy and cost control and to
formality of performance evaluation. The studies are focused on strategy at the strategic business
unit level, rather than corporate or functional levels. Most of studies explore the association
between MCS and strategic typologies. Concerning performance measurement, build compared
to harvest strategies, which involve low specialization and difficulty in measuring outcomes, suit
more subjective and long-term controls e.g (Govindarajan and Gupta, 1985).

Strategies characterized by conservatism, defender orientations and cost leaderships are more
associated with formal, traditional MCS focused on cost control, specific operating goals and

budgets and rigid budget controls, than entrepreneurial, build and product differentiation

The external environment

The external environment is a powerful contextual variable that is at foundation of
contingency-based research. Perhaps the most widely researched aspect of the environment is
uncertainty. Early contingency research in organization design focused on the effect of
uncertainty on organizational structure. Example include Burns and Stalker (1961), Galbraith
(1973), Lawrence and Lorsch (1967) and Perrow (1970). The importance of uncertainty as a
fundamental variable in MCS contingency-based research has been stressed recently by
Chapman (1977) and Hartmann (2000). Both reinterpret aspects of MCS research by examining
the impact of environment uncertainty.

The more uncertain the external environment the more open and externally focused the
MCS. The more hostile and turbulent the external environment the greater the reliance on formal
controls and an emphasis on traditional budgets. Where MCS focused on tight financial controls
are used in uncertain external environments they will be used together with an emphasis on
flexible, interpersonal interactions

Organizational Structure

Organizational structure is about the formal specification of different roles for organizational
members, or task for groups. To ensure that the activities of the organization are carried out.
Structural arrangenments influence the efficiency of work, the motivation of individuals,
information flows and controlsystems and can help shape the future of organization. There have
been various definitions of organizational structure. An important distinction is the difference
between the outcomes of structure and the structural mechanism.

Lawrence and Lorsch (1967) refer to structure, generically, as the way in which the
organization is differentiated and integrated. Burns and Stalker (1961) discuss structure,
generically, in term of mechanistic and organic approaches.

Large organizations with sophisticated technologies and high diversity that have more
decentralized structure are associated with more formal, traditional MCS (e.g. budgets, formal

communications). Decentralization is associated with the MCS characteristics of aggregation and
integration. Organic organizational structures are associated with perceptions that future oriented
MCS are more useful, and with the effective implementation of activity analysis and activity-cost

Integrity of Organization

Integrity of Organisation is reflected in the formulation and implementation of its code of

ethics, clients‟ charter, and system or work procedures, as well as compliance with best practices.
The organisation‟s code of ethics is constantly reiterated, internalized and upheld by members of
organisation intil it becomes second nature, and ultimately transforms into the culture for the
organization as a whole. (National Integrity Plan of The Government of Malaysia 2004)

Integrity is an excellent quality that exist in individuals and it is based on ethics and the
relations of ethics in daily actions We need integrity in everything that we do (Megat Najmuddin
Khas,President MICG,2006)

Integrity could become our standard for corporate conduct becouse it is closely tied
to the implicit issue raised by both the critic‟s disdain for corporations and the supporter‟s
disappointment in corporate scandals : the issue of trust. If people have integrity, then we can
usually trust them. If we could design corporations with integrity, people could trust them too.
They could work in them and with them to develop a viable future for us and for our children.
(Marvin T. Brown., “Corporate Integrity”, Rethinking Organizational Ethics and Leadership,
Combridge University Press, 2005)

Organizational Performance
The traditional management accounting literature advocates the use of organizational
performance measures in evaluating managerial performance. Many writers (e.g. Anthony,
1965; Merchant, 1998) argue that organizational performance measures communicate financial
objectives, provide an overall summary of performance, do not require top management
involvement in operating decisions taken at business units, can play a diagnostic role in deciding

whether or not to continue with current strategies and do not require additional costs in order to
prepare them since they are already available for external financial reporting purposes.

Although the traditional management accounting literature advocates the use of

organizational performance measure many writers attribute many problems to use of
organizational performance measures. Eccles and Pyburn (1992) argue that organizational
performance measures are „lagging indicators‟ since they determine the outcomes of
management‟s actions after a time period. Therefore, it is difficult to establish a relationship
between managers‟ action and the report financial result.

Most executives agree that there is no magic formula……or one right measure…….for
evaluating business performance. Therefore, In an effort to capture the essence of business
performance, many companies are creating new performance measurement systems that include
a broad range of financial and nonfinancial measures.(Bonnie P. Stivers et al 1998)

The present study will focusing to organizational performance measures of small firms.

Statement of the Problem

Although the result of researches between (Drury 2000; Anthony and Govindarajan 2001)
and (Egelhoff 1988; Harzing 1999) are contrary and make the explanation of the relationship
between management control system (MCS) and performance extremely difficult, but definitely,
the research of Chandler and Hanks (1993) offers an advantage in the use of performance
measures. To offset partially this limitation, therefore, the current study examines the integrity as
moderating variable that may influence those relationships between management control system
(MCS) and organizational performance of small firms.

Research Question

Based on an extensive literature review, this study addresses research question on whether
the integrity variable has significant moderating effects that influence the relationship between
management control system (MCS) and organizational performance. So, this study addresses one
primary research question “Does the integrity variable moderate the effect of the relationship
between management control system (MCS) and organizational performance ?


Research question was then formulated into the following null hypotheses :

H 1. : All dimension of management control system (MCS) does not lead to increase
organizational performance of small firms
H 2 : Integrity does not moderate the effect of external environment on organizational

performance of Small firms

H 3: Integrity does not moderate the effect of organization structure on organizational

performance of Small firms.

H 4: Integrity does not moderate the effect of business strategy on organizational performance

of Small firms.

Research Methodology and Analysis

Indonesia, mainly South Sulawesi will choose as the site of the research because it differs
business atmosphere and culturally with other region (provinsi) and the participating small firms
will be select primarily from among data of Dinas Koperasi dan Usaha Kecil dan Menengah. A
field study approach with questionnaire process will use in the study. This approach will conduct
by using multiple instruments, all of which had been previously tested and will back translating
for this study.