Slide 12.

Chapter 12:
Using Financial Results Controls in
the Presence of Uncontrollable
Factors

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012

Slide 12.2

Controllability principle

Employees should be held accountable only for that

which they alone can control; or,

Employees should be held accountable only for that

over which they have significant influence?

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012

Slide 12.3

Rationale

Uncontrollable factors distort performance measures

and evaluations

Uncontrollable risks are best borne by shareholders

(who are better able to diversify them)
If managers bear the risk:
They must be compensated for it
They may engage in undesirable actions to protect
themselves from the risks

For example, by engaging in gameplaying behaviors

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012

Slide 12.4

Considerations

Purpose(s) for which adjustments for

uncontrollables are made?
Salary raises
Incentive pay (short-term, long-term)
Job retention

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012

Slide 12.5

Considerations (continued)

Types of uncontrollables for which adjustments

are made?
Acts of nature (force majeure)
Economic, competitive factors
Interdependencies
Uncontrollables due to decisions made by personnel in
other parts of the organization, such as at higher levels
or in other entities

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012

Slide 12.6

Considerations (continued)

Who makes the adjustments?

Immediate superior
Upper management
(Compensation committee of the) Board of Directors
Done automatically by predetermined formulae/rules

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012

Slide 12.7

Considerations (continued)

Which method to use to make the adjustments?

Variance analysis
Flexible performance targets (e.g., flexed budgets)
Relative performance evaluations (RPE)
Subjective judgments

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012

Slide 12.8

Other choices

Should the adjustments be total or partial?

Should the adjustments be for negative

uncontrollable factors only (i.e., bad luck),
or should adjustments be made in either direction,
both positive and negative?

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012

Slide 12.9

How to decide?

Costs vs. benefits

For some types of adjustments, the benefits clearly
outweigh the costs
Factor is totally uncontrollable
Manager is not expected to respond to the factor
The effect of the uncontrollable factor can be
calculated objectively

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012

Slide 12.10

How to decide? (continued)

Benefits of making adjustments

More accurate performance evaluations
Less manager frustration; better motivation
Better decision-making; less noise in the
performance measures
Lower compensation costs
(in the long run less risk, less turnover)

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012

Slide 12.11

How to decide? (continued)

What if the company wants the managers to

respond to an uncontrollable factor?
Should not buffer them completely from the effects
Consider partial adjustment

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012

Slide 12.12

How to decide? (continued)

What if the effect of the uncontrollable

factor can only be estimated?
Enter subjectivity
Subjectivity introduces another form of risk
evaluation bias

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012

Slide 12.13

How to decide? (continued)

What if the factor is only partially uncontrollable?

Consider not making adjustments
Performance measures provide some information
about managers performance
Consideration of adjustments leads to the creation
of an excuse culture

Managers are prone to make excuses instead of

addressing the problems

Costly in terms of management time involved to

investigate the claims and determine appropriate
adjustments

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012

Slide 12.14

How to decide? (continued)

If adjustments are made, where they should

not be made
Bad decisions; managers fail to consider
relevant factors in their decision making
Shareholders lose as managers are given
undeserved rewards

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012

Slide 12.15

Summary

Consider costs and benefits of making

adjustments
Benefits exceed costs if:
Factor is clearly uncontrollable and if the firm
does not want managers to respond (they have
no influence)
Subjectivity can be avoided (or is tolerated)
In all other cases, use adjustments sparingly

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012