Question

Is it possible for management control systems to contribute to unethical or fraudulent behavior? Explain and give examples.

Answer 1

Management control is important for organizations because failures in management control can lead to large financial losses, reputation damage, and possibly even to organizational failure.

Despite the importance of having good management control systems (MCSs), management critics have argued that adding controls does not always lead to better control and that the MCSs in common use cause managers to be excessively short-term oriented or are prone to stifle creativity and initiative.

An old narrow view of a MCS is that of a simple cybernetic (regulating) system, involving a single feedback loop (thermostat). This book takes a broader view and recognizes that some management controls are proactive rather than reactive. Proactive means that the controls are designed to prevent problems before the organization suffers any adverse effects on performance. The benefit of management control is that the probability that the firm’s goals will be achieved increases.

Causes of management control problems

The causes can be classified into three main categories:

1. Lack of direction

   1. Employees do not know what the organization wants from them.

2. Motivational problems

   1. Individual and organizational objectives do not naturally coincide: individuals are self-interested.

   2. Employee fraud and theft are the most extreme examples of motivational problems.

3. Personal limitations

   1. They may be caused by a lack of requisite intelligence, training, experience, stamina, or knowledge for the task at hand.

   2. Some jobs are not designed properly.

Why do people behave unethically?

There are four basic reasons:

1. Some people are just basically dishonest.

2. Moral disengagement: no foundation in ethics.

3. Some people who recognize ethical issues develop rationalizations to justify their perhaps unethical behaviors.

4. Some people who are well trained in ethics and who know they are doing something wrong are not able to stop because they lack moral courage; the strength to do the right thing despite fear of the consequences.

Some common management control-related ethical issues

Four common management control-related ethical issues:

• Creating budgetary slack:

Managers negotiate about performance targets and they want to distort their positions in order to be given more easily achievable targets. Managers at all levels of the organization negotiate for slack in their budgets, and everyone is aware of the behavioral norm.

• The ethics of managing earnings

Any action that changes reported earnings while providing no real economic advantage to the organization and, sometimes, actually causing harm. They are designed to:

• Boost earnings

• Smooth earnings: to give the impression of higher earnings predictability and, hence, lower corporate risk.

• Reduce earnings: save profits for a future period when they might be needed or to lower the stock price to facilitate a management buyout.

Unethical because:

• Most of the actions are not apparent to either external or internal users of financial statements. Those engaging in earnings management may be deriving personal advantage through deception.

• Many people believe that professional managers and accountants have a duty to disclose fairly presented information.

• Distortions can be interpreted as not being consistent with managers’ and accountants’ integrity obligations to be honest, fair and truthful.

• The rewards earned from managing earnings are not fair when the reported performance is only cosmetic, not real.

• The ethics of responding to flawed control indicators

When the targets and prescriptions are not defined properly, they can actually motivate behaviors that employees know are not in the organization’s best interest.

• The ethics of using control indicators that are ‘too good’