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Abstract:
This paper illustrates how a company can use its performance measurement system to i) evaluate its operating strategy, ii) identify potential problems with its strategy, and iii) devise plans to mitigate these problems. Kaplan and Norton (1992) define strategy as a set of hypotheses linking non-financial measures to future value through a series of cause-and-effect relationships. Using data from a convenience store chain, we demonstrate how performance measures and the links between the measures can be used to identify potential problems with the firm's operating strategy. Furthermore, we explore whether the performance measurement system can highlight the causes of these problems and identify possible solutions. While preliminary tests indicate no significant direct relationship between non-financial measures of strategy implementation and the firm's financial performance, detailed analysis reveals that financial performance is associated with the interaction of measures of strategy implementation and employee skills. Financial performance also directly relates to employee skills and store location proxies. We find that the firm's strategy positively (negatively) impacts financial performance in stores with high (low) employee skill levels. Thus, a poor fit between strategy and capabilities primarily caused the ineffectiveness of the strategy. These findings highlight the importance of conditioning the formulation and implementation of a firm's strategy on its core competencies. More importantly, we demonstrate that performance measurement systems can be used to monitor, analyze, and revise a firm's strategy.

Performance Measurement, Balanced Scorecard, Control System, Non-financial Measures, Business Strategy

Abstract:
The recent series of corporate scandals have resulted in an unprecedented crisis in accounting. Investors have lost faith in financial statements on the assumption that cooking the books has become a routine practice in corporate America. Restoring the credibility of financial reporting is clearly an urgent priority as indicated by the passage of the Sarbanes/Oxley Act that mandates that CEOs personally certify to the accuracy of their firm's financial statements. The approach being contemplated by the accounting profession itself is a shift away from the rules-based approach to financial accounting standards used by GAAP towards the principles-based approach of International Accounting Standards. Both these initiatives draw attention to the fact that accounting standards are only useful and effective if they are actually implemented by firms in the way they were intended to be by the standard setter. In other words, the need to ensure implementation of accounting standards by managers who have an incentive to beat analysts' earnings forecasts means that accounting standards have a management control component to them. In this paper we put forward an ex-post perspective on accounting standard implementation that places the problem clearly within the domain of control theory. In turn, that implies that standard setters can make use of the powerful tools that control theory provides to ensure compliance by management, the four levers of control: belief, boundary, diagnostic and interactive control systems. Our control perspective provides new insights into accounting standards setting, including the need for both belief and boundary controls rather than the reliance on one alone. Potentially of even greater significance is the implication our management control perspective has on the Sarbanes/Oxley Act's Section 404 requirement for management and auditor assurance on the effectiveness of the firm's internal controls over financial reporting. A management control perspective can provide a much-needed framework within which the COSO standards can be applied, avoiding an excessive focus on the existence and documentation of controls rather than on their efficacy.

Accounting standard setting, Rules versus Principles, Sarbanes Oxley Act, Section 404, Management Control Systems

Abstract:
Many companies operate units that are dispersed across different types of markets, serving significantly diverging customer bases. Such dispersion is likely to compromise headquarters' ability to control local managers' behavior and satisfy the needs of different customer types. In this study we find that market-type dispersion is an important determinant of the delegation of decision rights and the provision of incentives. Using a sample of convenience store chains, we show that market-type dispersion is positively associated with the degree of franchising at the chain level as well as the probability of franchising a given store within a chain. Our results are robust to alternative definitions of market-type dispersion and to other determinants of franchising such as the stores' geographic dispersion. Additional analyses suggest that chains that do not franchise cope with market-type dispersion by decentralizing operations from headquarters to their stores and providing their store managers higher variable pay.

Control Systems, Franchising, Agency Costs, Market Dispersion, Retailing

Abstract:
We examine the effects of adverse selection and agency costs on the structure of the consideration offered in an acquisition. Specifically we investigate factors affecting the benefits arising from use of earnouts. We find that when targets have greater private information, consideration is more likely to be based on the future performance of the target. We also find an earnout is more likely to be used in an acquisition if the target is a smaller, private company in a different industry than the acquirer. In addition, earnouts are more likely to be used when fewer acquisitions take place within an industry and when targets are service companies or companies with more unrecorded assets. Finally, we compare the use of earnouts with the use of stock and find that financing considerations are a more important factor in the use of stock.

mergers and acquisitions, adverse selection, agency costs

Abstract:
We examine the effects of adverse selection and agency costs on the structure of the consideration offered in an acquisition. Specifically, we investigate factors affecting the benefits arising from use of earnouts. We find that when targets have greater private information, consideration is more likely to be used in an acquisition if the target is a smaller, private company in a different industry than the acquirer. In addition, earnouts are more likely to be used when fewer acquisitions take place within an industry and when targets are service companies or companies with more unrecorded assets. Finally, we compare the use of earnouts with the use of stock and find that financing considerations are a more important factor in the use of stock.

mergers and acquisitions, adverse selection, agency costs

Abstract:
There has been increasing interest in firms in which workers strongly identify with their firm's success. It would seem apparent that such identification by workers should be considered as an integral element of the firm's control systems. However, much of the literature on the myriad forms of firm culture has focussed on its symbolic and psychological characteristics as opposed to its economic consequences. As a result many economists, and the mangers who design control systems, have chose to concentrate on such "hard" controls as pay-for-performance and not on how worker identification with the firm can alleviate control problems. In this paper we use analytic models to study the control implications of high commitment human resource systems where workers identify with the success of their firm. We show that such identification can help alleviate control problems by encouraging information sharing, even when that is at the expense of worker slack.

adverse selection, monetary and non-monetary compensation, firm culture, worker behavior

Abstract:
In light of recent changes limiting auditors' legal liabilities, we examine the role of audit reputation on the interaction between the auditor and the manager whose actions he is attesting to. This contrasts with the literature that analyses how the firm's owner uses auditor reputation as a means of signalling to external constituencies. One of the roles of auditing is the production of information that facilitates contracting between the firm's owner and its managers. Management typically has an incentive to bias reports in its own favor. This creates a demand for confirmation of the financial reports provided by managers. An auditor can provide such a confirmation, but only if the auditor himself is induced to work hard and report truthfully. We show that reputation formation by the auditor serves as a substitute for costly contracting, monitoring, and litigation by the owner. By deterring misreporting, reputation reduces the inherent risk of the audit, allowing the auditor to cut back on substantive testing without increasing the probability of biased reports. The presence of audit institutions that promote and facilitate the building of auditor reputations mitigate both the auditor's and the manager's moral hazard on actions and reports. This role of reputation has implications for auditor legal liability, because the need for penalties is tempered by the auditor's desire to maintain a reputation.

Abstract:
We use a model of information asymmetry and rent seeking to understand why management control becomes easier when a firm makes improvements that are translated into increasing sales. We show that increases in market share can lead to better information sharing if (1) workers make continuous improvements and (2) workers feel that they stand to share in the resulting expected changes in output, either monetarily or non-monetarily. In these circumstances the worker may reveal true productivity, trading off the reduced rents against the benefits of higher sales. This is an outcome not possible if the only control systems available to the firm are "sticks" such as outsourcing or shutting down. An element of a "carrot" however, reduces control problems when it is recognized that workers value monetary and non-monetary aspects of their job such as lifetime employment, reduced fear of layoffs and pride and job satisfaction in working for a more successful company.

Abstract:
We examine the effects of moral hazard and adverse selection on the structure of the consideration offered in an acquisition. Specifically, we investigate factors affecting the occurrence of earnouts, finding that when targets have greater private information, consideration is more likely to be based on the future performance of the target. We find an earnout is more likely to be used in an acquisition if the target is a smaller, private company in a different industry and country than the acquirer. Earnouts are also more likely to be used when fewer acquisitions take place within an industry.

Abstract:
The need for businesses to react quickly to increased competition, continuously improve quality and provide total customer satisfaction has caused firms to reject the traditional "command and control" management style which is now widely condemned as being too rigid and not motivating information gathering and sophisticated thought by workers. Hoping instead, to institute a pro-active approach to experimentation, data-gathering, improved understanding of their own work environment and hence, improved and timely decision-making, firms are empowering their workers. As the TQM literature argues, the learning by doing that empowerment allows can also be leveraged by firms into improved quality. However, the inherent lack of control in this approach can reduce the benefits of empowerment if workers make use of their newly acquired informational advantages and lack of supervision to generate slack instead of profits. In this paper we examine what empowerment means and the control problems that arise as a result. We find that empowerment is most likely to be beneficial if accompanied by strong control systems. In particular, we suggest that Just In Time is a means of successfully controlling empowerment because JIT shortens feedback loops and provides process information in real time to managers. Empirical evidence from a unique dataset supports our conclusions about the benefits of JIT as a control mechanism for empowerment.