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Journal of Management Control

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17-02-2024 | Original Paper

A theory of management control packages and organizational identity

Author: Toshiaki Wakabayashi

Published in: Journal of Management Control | Issue 4/2023

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Abstract

This study aims to present the conditions under which an organization should use effort standards in addition to performance evaluations for management control. This study uses a mathematical model and focuses on the identities of organizational members and standard-setting cost. This study obtains the following results: First, when an organization uses the effort standard in addition to performance evaluations for management control, it must set relatively high standards at a sufficient cost. Second, the relationship between identity and the principal’s expected utility is U-shaped; in some cases, the principal’s expected utility decreases as identity increases. Third, setting the standard only controls are never optimal. This study contributes additional findings to previous research regarding the role of identity in management control. Moreover, this study has implications for management control packages. From the perspective of increasing the expected utility of the principal, the base of the control package may be accounting control using performance evaluations, and social control using identity may be additional and extended rather than parallel to it.

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A control package is a set of multiple MC elements that are used in an organization; the combination can be interdependent (Bedford, 2020; Van der Kolk, 2019) or selected and integrated from a wide variety of control methods to achieve the same objective defined as a thing (Abernethy & Chua, 1996).

Empirical studies include Bedford and Malmi (2015), Bedford et al. (2016), Bedford (2020), Malmi and Brown (2008), Sandelin (2008), and van Veen-Dirks et al. (2021). Relevant studies using mathematical models, for example, Indjejikian and Matĕjka (2012), analyze the substitutability and complementarity of multiple control systems of accounting decentralization, operational decentralization, and performance evaluation; Manthei et al. (2023) analyze the complementarity and substitutability of information in management control systems. Furthermore, Stevens and Thevaranjan (2010) analyze the choice of control systems.

For example, Ouchi (1979) divides cases into knowledge of the transformation process and the ability to measure output, and Merchant (1982) divides cases into the ability to measure performance and the ability to specify desirable actions. Both note that the applicable control method may differ in each case.

In the conceptual study, we also compared each control system’s advantages and disadvantages to deduce the superiority or inferiority of each control system. However, analytical modeling can even provide specific thresholds regarding the conditions for using different control systems under explicit assumptions, and we can further explain the mechanism. Many economic factors are determined by other economic factors. Making accurate inferences about such complex situations is difficult without making explicit assumptions. In addition, analytical modeling can sometimes yield economic counter-intuition results. For example, this study shows that the relationship between identity and the principal’s expected utility is U-shaped. However, we can only obtain this result or explain its validity with analytical modeling.

Behavioral contract theory is the field that relaxes the assumptions of standard contract theory by introducing ideas from behavioral economics (Itoh, 2004; Kőszegi, 2014).

Identity has various meanings in academic research and popular usage in other fields such as sociology and psychology; this study follows the definition used in identity economics pioneered by Akerlof and Kranton (2000). It is a form of social control.

This is similar to the conclusion of Akerlof and Kranton (2005). However, this study depicts a more detailed mechanism and argues that a threshold exists for the level of identity in the choice of whether to use identity utility and it is affected by uncertainty.

Reverse functionality refers to cases where the principal’s expected utility decreases in the agent’s identity. In other words, it refers to the case where identity harms the MC.

In addition to high-tech companies, consulting firms systematically engage in efforts to influence employee behavior through identity (Akerlof & Kranton, 2010; Alvesson & Robertson, 2006; Ravasi & Phillips, 2011).

Casadesus-Masanell (2004) also analyzes models that assume exogenous norms where the variable of how much the agent cares about the norm is endogenous.

Using a laboratory experiment, Brüggen et al. (2018) demonstrate that providing both an input and output target on a routine task leads to greater creative task performance relative to providing one or none of these targets. The input target is the effort standard in this study.

According to Akerlof and Kranton (2010), Goldman Sachs has clearly stated its business principles. Another good example is Johnson and Johnson’s Our Credo.

For example, managers would not have considered sustainable development goals in 20th-century codes of conduct. Additionally, from the 1960s to the 1980s in Japan, catching up economically with advanced Western countries took precedence over individual human rights and cultural life. While Japan achieved economic success by doing so, the code of conduct set up and taken for granted by management is no longer appropriate.

In Shang et al. (2020), transparency refers to whether a colleague’s performance is observable in a relative performance evaluation. However, when transparency is present, colleague performance is a definite value in performance measures. When transparency is absent, colleague performance is also a random variable in performance measures.

For example, Hillman et al. (2008, p. 443) argue that “the more strongly individuals are aware of the organization, the more they will work for it.” Similarly, Akerlof and Kranton (2005, p. 11) state that “employees who perceive themselves as insiders in the organization need few financial incentives to do their jobs well.”

Efforts that deviate from the effort standard by falling short of it are, for example, shirking. Conversely, efforts that deviate from the effort standard by exceeding it are, for example, voluntarily working late at night or on holidays even though it is not recommended from the perspective of the employee’s health, or performing quality control checks that exceed the effort standard at the employee’s own discretion. This study assumes that the agent feels a sense of guilt for wasting management resources.

The model in this study means that the agent is effort averse, and the principal compensates the agent through rewards for the costs incurred from exerting effort because of the more significant psychological costs incurred if the agent does not make an effort to reach the standard. There is room to explain any variable that fits into the setting of such a model in terms other than identity. It should be noted, however, that identity also differs from the concept of intrinsic motivation. While intrinsically motivated agents derive pleasure from performing a job, agents motivated by identity preferences do not necessarily enjoy performing the activity itself; instead, they are motivated by a sense of duty or obligation to the organization.

Akerlof and Kranton (2005) also discuss when investment in identity is viable. However, this investment cost includes the cost of increasing \(\theta\) or going from \(\theta = 0\) to \(\theta > 0\) in this study. This study distinguishes between such a cost and the cost of setting the standard (\(\delta {s}^{2}/2\)) and does not consider the cost of increasing identity.

It may appear that \({\theta \left(s-e\right)}^{2}/2\) is taken into account as a cost of effort standard-setting; however, this is not a cost of effort standard-setting but a cost of effort exerting.

If the model in this study were a multi-period model, communication costs would occur in each period. Indeed, Honryo (2018), in analyzing dynamic models in negotiations, treats communication costs as recurring. Similarly, when considered to be reputational or litigation risks, they are also recurring.

Merchant and Manzoni (1989) have found that principals set goals at levels significantly more attainable (i.e., with a higher probability of achievement) than the goal-setting theory predicts.

This is a somewhat unusual situation; however, the larger the standard, the more likely it is to be in such an unusual situation, which explains why the cost is convex in relation to the strength of the standard.

Proofs of the lemmas and propositions are presented in the Appendix A. Although \(\alpha\) is not explicitly stated in each lemma, fixed salary \(\alpha\) is adjusted so that the participation constraint binds, assuming that the agent’s reservation utility is -1, that is, the reservation certainty equivalence is zero.

Equation (5) defines \({R}_{e}\), which is the best response of the agent to the decisions made by the principal, not the equilibrium itself. We distinguish this from Lemma 2, which implies subgame-perfect equilibrium obtained by solving the dynamic game backward.

The derivation of Eq. (6) is as follows. The cost borne by the principal is \(w+\delta {s}^{2}/2\), of which \(w=\alpha +\beta e={e}^{2}/2+{\theta \left(s-e\right)}^{2}/2+r{\beta }^{2}{\sigma }^{2}/2\) using the fact that the IR condition is satisfied by the equal. We substitute the best response \(e={R}_{e}\), obtained in Eq. (5), for this.

Abernethy et al. (2022) empirically demonstrate this.

The proof is explained in Appendix B.

Proposition 2(ii) shows that \(s^{\dag }\) decreases in the identity. Moreover, \(\partial^{2} s^{\dag } /\partial \theta^{2} = - 2\delta \left( {1 + \delta } \right)/\left( {\delta + \theta + \delta \theta } \right)^{3}\); therefore, \(s^{\dag }\) is a concave function of the identity.

LEN is an acronym for the model’s characteristics: Linear compensation, Exponential utility function, and Normal distribution of performance indicators (Lambert, 2001).

The result of Lemma 5 is \({EU}_{P}^{NC}=0\); therefore, Proposition 3 excludes this for comparison.

Even if the deviation costs function is \(\theta \left|s-e\right|\) as opposed to \(\theta {\left(s-e\right)}^{2}/2\) in Eq. (1), it is satisfied, within the range that \(\theta\) can take, that standard setting becomes desirable when \(\theta\) is higher than the threshold level and the standard is relatively high.

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Title: A theory of management control packages and organizational identity
Author: Toshiaki Wakabayashi
Publication date: 17-02-2024
Publisher: Springer Berlin Heidelberg
Published in: Journal of Management Control / Issue 4/2023
Print ISSN: 2191-4761
Electronic ISSN: 2191-477X
DOI: https://doi.org/10.1007/s00187-024-00366-5

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