The effect of organizational culture on performance measurement

Amsterdam Business School

The Effect of Organizational Culture on Performance Measurement

MSc Accountancy & Control, specialization Control

Faculty of Economics and Business, University of Amsterdam Supervisor: dr. ir. S.P. van Triest

Name: C.P. van Waegeningh Student number: 10526161 Date: 17-08-2015

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Statement of Originality

This document is written by student C.P. van Waegeningh who declares to take full responsibility for the contents of this document. I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.

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Abstract

This paper sought to better understand the effect of organizational culture on performance measurement. Results were drawn from a survey among 122 business-unit managers. The Competing Values Framework of Kimberly and Quinn (1984) was used determine organizational culture. Performance measurement was operationalized using the four perspectives of the Balanced Scorecard (Kaplan and Norton, 1992). Hypotheses were tested using a multiple regression analyses and control variables were included for factors that are theoretically known to influence the design of performance measurement. Although the results show evidence for a relation between organizational culture and performance measures in the customer and learning and growth perspective, no evidence is found that organizational culture unambiguously effects performance measurement.

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Table of Contents

1 Introduction ... 5

2 Literature review ... 8

2.1 Management control systems ... 8

2.1.1 Agency theory ... 8

2.1.2 Merchant and van der Stede: social, action and results controls ... 11

2.1.3 Simons: levers of control ... 13

2.2 Performance measurement ... 15

2.2.1 Balanced Scorecard ... 15

2.3 Why firms use different MCS: Contingency theory ... 19

2.3.1 Contingency theory ... 20

2.3.2 Control variables ... 20

2.4 Culture as a contingency factor ... 22

2.4.1 National culture ... 22

2.4.2 Organizational culture ... 23

2.4.3 Competing Values Framework ... 24

3 Hypotheses development ... 29

4 Research methodology ... 31

4.1 Data collection and sample ... 31

4.2 Measurement of constructs ... 32

4.2.1 Independent variables: organizational culture ... 32

4.2.2 Dependent variable: performance measures ... 34

4.2.3 Control variables ... 34 4.3 Research model ... 38 5 Results ... 40 5.1 Descriptive statistics ... 40 5.2 Correlation ... 42 5.3 Main findings ... 42 5.3.1 Independent variables ... 44 5.3.2 Control variables ... 46

6 Conclusion and discussion ... 48

6.1 Conclusion ... 48

6.2 Theoretical and practical implications ... 50

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7 References ... 52 8 Appendices ... 57

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Introduction

Traditionally a management control system (hereafter MCS) has been defined as formal, information-based routines and procedures, used by managers to maintain or alter patterns in organizational activities (Simons, 1987a, 1994). However, in today’s dynamic environment organizations need to adapt in order to achieve organizational goals (Chenhall, 2003; Henri, 2006). Simons (1995) states that the primary function of a MCS is promoting initiative in a controlled way, by enabling employee initiative where possible, without exposing the organization to excessive risks that can harm its integrity or financial health. Therefore scientists agree that offering flexibility and being in control fulfil an equally important role in the design of a MCS. An organization’s MCS design is influenced by internal and external factors (Ittner & Larcker, 2001; Ittner, Larcker, & Meyer, 2003), it therefore appears in different forms, extends to every organizational level and is unique to every organization (Shields, Deng, & Kato, 2000).

Performance measurement fulfils an important role within an MCS as it is a tool to objectively assess the progress in reaching desired goals. There are numerous forms of performance measures, which make it challenging for managers to implement an effective performance measurement system. A model that is widely used in the selection and implementation of performance measures is the Balanced Scorecard (BSC) of Kaplan and Norton (1992), which allows managers to assess the organization from four different views. The BSC approaches the organization from the learning and growth perspective, an internal process perspective, a customer perspective and a financial perspective. As performance measures have great impact on the organization and its operations they are subject to extensive research in organizational science. Developments in technology, strategic risk management and administrative innovations make them subject to continuous change. It is therefore important to continue to investigate performance measures and the variables that influence them in their contemporary setting (Chenhall, 2003).

Chenhall (2003) reviewed studies relating organizational context to MCS design spanning two decades. He identified culture as a variable that is often investigated in relation to MCS design. Culture is a broad concept that is both difficult to define and difficult to operationalize. There are two different forms of culture that influence an organization’s MCS, national culture and organizational culture. As research primarily focusses on national

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culture, organizational culture is overlooked. Nevertheless, studies on organizational culture are encouraged as it may dominate national culture in an organizational setting (Chenhall, 2003). Organizational culture represents the system of ideals and beliefs that holds the organization together. It is mostly measured by means of the Competing Values Framework by Quinn and Rohrbaugh (1983) and Kimberly and Quinn (1984). They identify two main dimensions of organizational culture. The first dimension is organizational structure which reflects a flexibility dominant type (hereafter flexibility dominant) or control dominant type (hereafter control dominant). The second dimension is organizational focus which reflects an internal dominant type (hereafter internal dominant) or an external dominant type (hereafter external dominant).

Henri (2006) investigated the relationship between performance measures and the flexibility/control dimension of organizational culture. He focused on two attributes of performance measurement systems, diversity of measurement and nature of use. Henri (2006) found that organizations with a flexibility dominant culture used performance measures to focus attention and support strategic decisions, as well as to use more performance measures, to a greater extent than organizations reflecting a control dominant culture.

Most studies focus on the relationship between MCSs and national culture (Awasthi, Chow, & Wu, 1998; Chow, Lindquist, & Wu, 2001). This may be explained by the ongoing globalization. However, in order to explain organizational structure, effects of both internal and external culture have to be taken into account (Williams & van Triest, 2009). It is important to find a balance between national and organizational culture in organizational system design. And although organizational culture is subordinated in organizational research, it might well be of greater importance than national culture in MCS design (Chenhall, 2003).

Building on Henri’s (2006) findings, this paper investigates the effect of organizational culture on the use of specific types of performance measures. Specifically, I look at the use of measures in the four categories of the Balanced Scorecard (Kaplan and Norton, 1992), and investigate whether the two dimensions of organizational culture suggested by both Quinn

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and Rohrbaugh (1983) and Kimberly and Quinn (1984) impact the weight of each category in measuring managerial performance.

This paper expects control dominant firms to place more emphasis on both financial and process measures. Secondly flexibility dominant firms are expected to be associated with customer and learning and growth measures. Furthermore external dominant firms are expected to place more emphasis on financial measures and customer measures. Finally internal dominant firms however are predicted to place more emphasis on process measures and learning and growth measures.

To answer the research question, this paper conducts quantitative research. Data is collected from a survey held among 121 managers in different organizations. Apart from culture there are other factors that are theoretically expected to influence the use of performance measures, such as industry, size, technology, structure and strategy (Chenhall, 2003). These variables are controlled for.

As opposed to national culture (Chow e.a., 2001; Chow, Shields, & Wu, 1999; Wim A. Van Der Stede, 2003), there is little research on the effects of organizational culture (Chenhall, 2003). Prior studies concerning organizational culture focused on one of the competing values used to measure this phenome (Henri, 2006). This research contributes to existing literature, as to the best of my knowledge there are no prior studies that take the two competing values of organizational culture into account. From a social point of view this research can explain which to consider when designing a MCS. Furthermore, it can help senior management to determine effective performance measures that are in line with their organizational structure.

The remainder of this paper is divided into five sections. First I will review the existing literature about the purpose of MCS and its underlying theories. This is followed by existing perceptions of culture and models that are used to conceptualize this subject. In the third section the research question will be divided into hypotheses. The next two sections will discuss the research method and the research findings. The final chapter will discuss the conclusions and provide recommendations for future research.

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Literature review

This chapter describes the literature that forms the theoretical framework of this thesis. Paragraph 4.1 discusses theories that form our current perception of MCS. I start with describing the agency theory, which provides the theoretical lens through which we understand how managers react to the use of performance measures and control systems. This is followed by the approaches of various researchers in conceptualizing MCS. Section 4.2 uses the agency theory to explain why organizations use different MCS. Subsequently the chapter describes the different roles of culture as contingency factor in MCS design. It recapitulates the findings of Chenhall (2003) and explains the differences between national and organizational culture. The next section illustrates the theory related to organizational culture and finishes by illustrating the “Competing Values Framework” of Kimberly and Quinn.

2.1

Management control systems

The agency theory (Jensen and Meckling, 1976) states that an organization consists of multiple social contracts between principals (e.g. shareholder or manager) and agents (e.g. executive or employee). The principal delegates decision rights to the agent to perform decision-making on his behalf. The fundament of the agency theory is the assumption that there is an information asymmetry between the principal and the agent. This asymmetry causes problems (agency problems); the cost related to resolving these problems are called agency costs.

One assumption in this theory is that happiness increases when someone gets what he desires. Therefore individuals act in self-interest, trying to maximize their utility. This leads to two phenomena which in organizational literature are known as adverse selection and moral hazard. Adverse selection, or the hidden information problem, occurs because a principal is unable to select the best agent for a certain operation in advance, without making (adverse selection) costs. The moral hazard, or the hidden action problem, comprises the difference in risk preferences (risk-loving versus risk-averse) between agent and principal. An agent may benefit from a favorable outcome (e.g. bonus or promotion); an unfavorable outcome however may not directly damage the agent. If merely the principal suffers from unfavorable outcomes, the risk of opportunistic behavior by the agent

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increases. This results in the agent having a more risk-loving attitude than the principal. This is emphasized by the principal’s inability to observe the agent’s efforts and actions once he is hired. The costs involved in this situation are known as moral hazard costs (Arrow, 1971). A special type of asymmetric information is impacted information, which is related to in-depth knowledge about the specifics of the operation. In order to assess the work performed by the agent a principal must gather knowledge. It is very difficult and costly to acquire the information that is necessary to achieve information parity. Costs involved in transferring knowledge from the agent to the principal are known as knowledge transfer costs (hereafter KTC). As the knowledge intensity of the firm increases, so do KTC as it is harder to obtain and master the knowledge and evaluate the actions (Keller & Yeaple, 2013). Although in practice this will often be less unruly, agents driven by self-interest could exploit information asymmetry by withholding or manipulating information. Due to the lack of information parity and KTC a principal cannot observe the agent’s actions perfectly or without making extra costs.

Both parties address the agency problem, albeit in different ways. The agent tries to convince the principal of her or his competence by communicating former education and job experience (signaling). In this way the agent bears some of the adverse selection costs. The principle tries to mitigate the risks relating to the moral hazard and impacted information. This situation is created when the agent shares in the risks and the principal provides

incentives to share in the profits. In this way the principal brings the agent’s interest more in line with his own (goal congruence). The ultimate goal of an incentive scheme is to reach total goal congruence between the principal and the agent. However, an agent may be unable or unwilling to act in the principal’s best interest (Merchant, 1982). A MCS helps a principal to achieve organizational goals by influencing the behavior of the agent. The agency problem is visualized in

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Figure 1: Agency problem

2.1.2 Merchant and van der Stede: social, action and results controls

A MCS can consist of many different forms of controls (e.g. performance measures, targets, incentives, procedures). Scientists categorize them in different ways. Merchant and Van der Stede (2003) distinguish three categories: social controls, action controls and result controls. Social controls can be divided into personnel controls and cultural controls. Personnel controls start with the selection and recruitment of personnel. The first aim of personnel controls is to define the employer’s expectations by ensuring that employees are aware of the organizational goals. Secondly the employer selects employees that have the right capabilities and resources needed to do job. Finally these controls can increase the likelihood that employees will engage in self-monitoring, assuming that they generally want to do what is right. Personnel controls are implemented through selection and placement (e.g. based on education, experience, personality and social skills), by training, job design and resourcing. Effective personnel controls focus on finding the right people for a particular job. This includes training them and creating the proper work environment with the necessary resources and a clear, manageable task (Merchant and Van der Stede, 2003). Cultural controls are a form of mutual monitoring within a population. It can be shaped in words, behavior and beliefs (e.g. codes of conduct, tone at the top and corporate mission). These controls are built on norms, beliefs and shared traditions and result in a powerful form of group pressure on individuals who deviate from group norms and values.

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Action controls ensure that employees (do not) act in ways that are beneficial (harmful) to the organization. There are four basic forms of action controls; behavioral constraints, preaction reviews, action accountability and redundancy. Behavioral constraints concern the discouragement of actions that are not in line with organizational goals. Preaction reviews occur in a situation in which a manager reviews and approves the plans or actions that employees are considering. Action accountability is holding employees accountable for the actions that are taken. Redundancy involves bringing in additional resources to increase the possibility of completing a task.

Results controls are an indirect form of control. They do not dictate actions or decisions employees have to take, but empower them to take those actions and decisions they believe will best produce the desired results. Well-designed results control systems can help accomplish the desired goals. Results controls involve giving employees an incentive for generating good results. This incentive can be a reward. They can be tied to monetary rewards like a wage raise or a bonus and non-monetary rewards like promotions, autonomy, recognition and job security. However results measures can provide a positive motivational impact even if no rewards are explicitly linked to results measures. A sense of accomplishment for achieving the desired results can generate intrinsic rewards. Besides rewards, incentives can be given by punishment like demotions, supervisor disapproval, exclusion of rewards or the threat of dismissal. It promotes the results the organization rewards. It encourages people to develop their talents and get placed into jobs in which they are able to perform well. Motivational effects of the various rewards can vary widely, depending on individuals’ personal tastes and circumstances and differences in culture and local (tax) laws. In order to achieve the most powerful motivational effect in a cost effective manner, a reward system must be tailored to a specific (individual) situation.

Results controls have certain preventive type benefits. First they inform employees about what is expected of them. Secondly they encourage employees to reach the desired goals, and finally they attract, contract and retain employees that are confident about their abilities. Furthermore results controls provide ways to detect and react to deviations from expected outcomes. These are non-motivational, detection-type control benefits and offer feedback (management-by-exception). Results controls are particularly used for employees who are responsible for achieving a result rather than performing a task. Therefore this type

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of controls start at functions with decision making authority, at the management level. From there they can be driven down to lower levels in the organization. Results controls are necessary for the implementation of decentralized forms of organization with largely autonomous entities. Because rewards are given to the most talented and hardest working employees, they primarily assess individual talent and performance and thus create meritocracies. Other types of control are needed to increase the probability that employees act in the organization’s best interest.

2.1.3 Simons: levers of control

Organizations face a fundamental challenge in finding the balance between flexibility and control. In the mid-19th century control was exercised by ordering tasks and monitoring performance by constant surveillance. This type of control is still effective when standardization is critical for efficiency, the risk of theft of assets is high, or quality and safety are essential for performance. Today’s organizations must however seek opportunities and respond to customer demands in order to remain competitive, in which they rely on employee initiative. Nonetheless, by empowering employees and enabling employee initiative, a business can expose itself to excessive risk and offer space for behavior that can inflict damage to a company’s integrity. Therefore managers must encourage employees to initiate process improvements and respond to customer needs in a controlled way (Simons, 1995). Simons (1995) describes four levers of control, which allows management to offer a path for initiative while monitoring the realization of strategic goals and contributing to a proactive response to organizational and environmental developments.

Diagnostic control systems enable managers to monitor critical performance outcomes. By setting future goals, such a system can be seen as a management dashboard. It concerns setting future goals, allowing managers to keep track of progress and keep critical performance variables within pre-set limits. Managers use this control system to periodically monitor goals and measure progress. The output can be compared with pre-set standards of performance, and the feedback allows managers to take action to match future goals more closely. Diagnostic control systems ensure important goals are being achieved efficiently and effectively and make constant monitoring superfluous.

Beliefs systems enable managers to communicate core values. It empowers employees and encourages the search for new opportunities by communicating core values and

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inspiring all participants to commit to the organization’s purpose. People have an urge to contribute. In order for employees to contribute to the organization, they have to understand its purpose. The purpose is to inspire and promote commitment to an organization’s core values. They are concise, value laden and inspirational. A beliefs system concerns deeply rooted values that focus employees’ attention on the level of performance the organization strives for. They communicate how individuals are expected to manage both internal and external relationships. Beliefs systems can be a powerful lever of control when managers live up to those systems in their daily conduct. The tone at the top is of utmost importance to demonstrate to employees that the beliefs represent deeply rooted values. In large decentralized organizations without formal beliefs system employees might find it hard to have a clear and consistent understanding of the core values and their place within the business, and assumptions are made about what constitutes acceptable behavior. Effective managers inspire people throughout their organizations by actively communicating core values and missions. Beliefs systems can inspire employees to search for innovation and create value in new ways. This control system builds on the assumption that in general employees want to do what is ethically right. However the urge to perform may tempt employees to bend the rules.

Boundary systems set the rules of the game and identify actions that must be avoided. They define the borders within which one must act. In contrast to diagnostic control systems and beliefs systems, boundary systems make use of “the power of negative thinking” as Simons (1995) calls it, by stating negative terms or minimum standards. For example, by implementing standard operating procedures, an organization dictates people what to do. Therefore this control system may suppress initiative and innovation. In order to promote entrepreneurship, a manager is better off telling the employees what not to do rather than telling them what to do. The effectiveness of a boundary system depends on the type of organization. “[Boundary systems] are the organization’s brakes. Every business needs them, and, like racing cars, the fastest and most performance-oriented companies need the best brakes.” (Simons 1995). Boundary systems become more important when the organization’s reputation is built on trust and when they become more decentralized. Telling employees what not to do allows them to take initiative, but within clearly defined limits. Powerful control is implemented by combining the beliefs and boundary systems. Managers set a goal

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within certain boundaries by establishing direction, and by motivating and inspiring staff, whilst protecting the organization against potentially damaging opportunistic behavior (Simons, 1995).

Interactive controls emerge when senior management has regular personal contact with employees about emerging threats and opportunities. This form of control easily takes place in small entities but becomes harder when organizations grow larger. Interactive controls are essential as it a way of sharing emerging information and harnessing the creativity that often leads to new products, line extensions, processes and even markets. And as diagnostic control systems only highlight deviations from an expected result, new formal systems must be created to share information. Interactive control systems differ from diagnostic control systems in four ways. First they focus on constantly changing information that top-level managers have selected as potentially strategic. Second, due to the relevance of the information, frequent and regular attention is needed from managers at all levels of the organization. Third, as the name implies, interactive control systems are a multidirectional form of communication. Face-to-face meetings between principal and agent are needed to interpret and discuss the data properly. And finally, these control systems stimulate an ongoing debate about data, assumptions and action plans. Interactive control systems focus organizational attention and learning on key strategic uncertainties, and allow managers to become regularly and personally involved in the decision-making of subordinates. They enable them to get an overall view of the organization and still receive specific information about threats and opportunities which allow them to act proactively. Furthermore, by selecting specific controls to invest time and attention in face-to-face meetings, a manager sends a signal to the organization about what is important. It is important to find a balance in using all four levers of control as all are equally important and they reinforce each other (Simons, 1995).

2.2

Performance measurement

2.2.1 Balanced Scorecard

In the industrial era financial performance measures like profit, EBITDA, economic value added and return on investment offered sufficient information for optimization and responding to existing challenges. However, as complexity and competitiveness increased, the use of merely financial performance measures turned out to have its limitations (Ittner

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e.a., 2003). First financial performance measures are mainly backward-looking as they show the results of actions that have already taken place. Furthermore, financial measures are called “myopic performance measures” as they do not fully reflect the economic consequences of the agent’s actions (Feltham & Xie, 1994). Most actions do not immediately result in improved financial performances, in fact essential activities may initially lower results, as investments in for example products and personnel may be needed to ensure future financial benefits. Therefore financial measures are unable to reflect value-creating actions and thus promote short-term investment decisions. One way of dealing with ‘myopia’ is to supplement financial measures with measures that focus on the future effects. Operational measures are said to be drivers of future performance (Luft & Shields, 2001; Nagar & Rajan, 2001). Furthermore, measures on customer satisfaction, internal company processes and the organization’s innovation and improvement activities are necessary to measure innovation, skills and competencies (Scott & Tiessen, 1999).

Kaplan and Norton (Kaplan & Norton, 1992) developed the Balanced Scorecard (BSC), a model based on empirical research that consists of both financial and non-financial measures. Kaplan and Norton (1993) state that organizations need customized performance measures to fit their mission, strategy, technology and culture. The BSC gives managers a more holistic view on organizational performance and triggers them to act in line with organizational strategy. First it combines backward-looking financial measures and operational measures, which are drivers for future financial performance. This encourages managers to achieve future goals without making trade-offs among key success factors. It thereby functions as the cornerstone of a company’s current and future success (Kaplan & Norton, 1993). Secondly the BSC lets senior management formulate performance measures that are in line with its strategy and let them disaggregate vertically to lower organizational levels. This ensures that all organizational levels support the strategic goals. The use of different types of performance measures is efficient for incentive purposes (Feltham & Xie, 1994). The BSC is a model for determining the most important parts of a business in a structured manner. It demands that managers assess an organization from four different perspectives, the customer perspective, internal process perspective, a learning perspective and a financial perspective.

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The BSC is not a universal blueprint that can be applied to all organizations or industries. It is a customized model, based on how the organization distinguishes itself from its competitors. Senior management translates competitive demands and strategic goals into concrete measurable parameters. It functions as a communication channel for senior management to communicate relevant performance measures to internal stakeholders like employees and managers, as well as communicate core values to external stakeholders like customers and investors. The BSC combines four seemingly different elements into a single management report. Measures of each type can be disaggregated horizontally from manager to employee and vertically across departments. This allows both managers and employees to focus on indicators that are congruent with organizational goals, and to align them with the organization’s vision.

2.2.1.1 Customer perspective

In the customer perspective, senior management translates the general mission statement on customer service into specific measures that reflect factors that matter to customers. Customer concerns are divided into four categories: time, quality, performance and service. Each of these categories should be translated into performance measures that help to meet customer demands or create value to the customer. The customer perspective represents external measures (Kaplan and Norton, 1996). Although the data to measure performance may be internally available, organizations mostly rely on external data (Kaplan & Norton, 1992). Firstly because indicators in this perspective have a certain degree of subjectivity (e.g. customer satisfaction, customer loyalty and meeting customer needs). Secondly, even if measures can be determined objectively (e.g. response time, on-time-delivery) clients can value them differently. To meet customers’ expectations, companies are forced to view performance through their customers’ eyes (Kaplan and Norton 1992). Therefore the performance measurement in the customer perspective is associated with flexibility and adaptability.

2.2.1.2 Internal business perspective

The internal business perspective concerns measures that reflect the performance of the organization’s primary activities. Measures in this perspective are called process measures as they can relate to processes, procedures and decision-making. In order to determine relevant and effective process measures, senior management begins with identifying the

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core activities, after which they define goals that are in line with their strategy (e.g. operational excellence, cost reduction or existing (after-sales) service to customers). The internal business perspective represents internal measures (Kaplan and Norton, 1996). Managers focus on activities within the organization such as the production process, delivery of products or serving the customer. Performance measurement is associated with stability and control. Organizations attempts to excel in the activities that define their primary process. Whether it is producing at the lowest costs or delivering the best service, a company tries to distinguish itself from competitors by mastering its core business. Excellent performance results in a higher productivity or efficiency.

2.2.1.3 Learning and growth perspective

The learning and growth perspective concerns measures that reflect the performance of innovating activities. These are important for future performance as steady levels of efficiency and productivity are no longer sufficient for organizational success. Long-term effects of improvement do not show up in the short-run, therefore the absence of these measures may result in a lack of ownership. The evaluation on merely short-term financial measures makes it difficult to sustain investments that are needed to improve the productivity or quality of performance. Kaplan (1996) defined three principal categories for the learning and growth perspective: staff capabilities, information systems capabilities and motivation, empowerment and alignment. The learning and growth perspective represents internal measures (Kaplan, 1996). It concerns improvements of internal activities, the development of new products or services, and the innovation and improvement of existing products or services. (Front-line) employees are considered to be the most important factor in initiating innovation (Kaplan, 1996). A climate of motivation, empowerment and acknowledgement is needed to initiate innovation and maintain initiative. The performance measurement in the learning and growth perspective is therefore associated with flexibility, affiliation and attachment.

2.2.1.4 Financial perspective

Financial measures are criticized because of their short-term, backward-looking focus and their inadequacy to reflect value-creating actions. However, not all long-term strategies are profitable strategies. Organizations cannot avoid the use of financial performance measures in determining their current financial position and judging the result of prior decisions.

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Moreover, they are a way of uniformly evaluating the organization’s performance. Kaplan and Norton (1992) identify three themes within the financial perspective; revenue growth, cost reduction or productivity improvement, and asset utilization. The financial perspective represents external measures (Kaplan and Norton, 1996, Ittner Larcker, Meyer 2003). This is explained from a shareholders’ point of view. Whether the shareholder is an investor at the stock market or the government, management is held accountable for the invested capital. Capital invested in the business is seen as an exogenous value provided by shareholders. Senior management use these financial performance measures for accountability. Performance measurement in the financial perspective is associated with effectiveness, optimization and efficiency. Financial measures may concern increasing the market share, reducing costs, utilizing fixed assets, or increasing shareholders’ value.

The balanced scorecard emphasizes that financial and nonfinancial measures must be part of the information system for employees at all levels of the organization. Front-line employees must understand the financial consequences of their decisions and actions. Senior executives must understand the drivers of long-term financial success. This can be achieved by deriving performance measures from the organization’s mission and strategy and top-down disaggregating them to the work-floor. Measures that are implemented using the BSC represent a balance between external measures for shareholders and customers and internal measures of critical business processes, innovation, learning and growth. Furthermore managers should keep the balance in mind between objective and easily quantifiable measures and subjective performance drivers.

2.3

Why firms use different MCS: Contingency theory

This subchapter starts by describing the contingency theory in detail and explaining why organizations use different MCS designs and performance measures to cope with the agency dilemma. The following sections build on a paper of Chenhall (2003), who reviewed contingency-based studies on the effectiveness of MCSs in an organizational context. Based on studies spanning two decades he identified six variables that were often investigated in relation to the design of MCSs. This paragraph discusses prior research on these six variables and how they are expected to affect MCS design.

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2.3.1 Contingency theory

The contingency theory states “one size does not fit all”. In other words, there is not one perfect blueprint that can be used by every organization to ensure effectiveness. It is built on the assumption that organizations must change to adapt to their environment, to be more specific, organizations try to “fit” their environment. In this theory environment must be interpreted in its broadest sense. The environment exists of all stakeholders, such as customers, suppliers, competitors, shareholders, government, employees, management and the community. A better fit results in increased performance. A misfit will be punished by market forces and decrease performance. In relation to MCS design, an organization strives for a fit between its controls and its environment.

2.3.2 Control variables

According to the contingency theory there are many factors that influence an organizations’ structure, including MCS design. There are six variables that are often investigated in relation to the design of MCSs, and culture is one of them (Chenhall, 2003). The other variables that are theoretically known to influence MCS design are: size, organizational structure, strategy, environment and technology. The influence of these variables should be recognized when developing the research method.

2.3.2.1 Size

Although revenue, profits or market share can be used to measure the size of an organization, more often the number of employees is used to operationalize its size. The increasing size of an organization decreases the span of control and thus makes managers implement more sophisticated controls to ensure that organizational goals are reached. Therefore the number of employees is seen as a more reliable measure, i.e. mostly the number of fulltime-equivalents (FTE) when taking into account the part-time rate.

2.3.2.2 Environment

The environment forms the foundation of contingency-based research (Chenhall, 2003). It is considered to be one of the most influential factors of MCS design and is therefore studied extensively (Hartmann, 2000). Environment consists of different elements, such as uncertainty, complexity, dynamism and controllability and equivocality. However uncertainty is a factor that is (expected to be most) often used as attribute of environment (Chapman, 1997; Chenhall, 2003; Hartmann, 2000). It is important to distinguish between uncertainty and risk or complexity (Chapman, 1997; Chenhall, 2003). Uncertainty differs

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from risk because it is often not predictable and probabilities cannot be attached. However, complexity may be inevitable due to a variety of possible reactions to external events, although these events may be far from unexpected (Chapman, 1997). In examining the influence of environment, uncertainty can operationalized using the predictability of various aspects of the environment, such as the industrial, economic, competitive, and customer environment (Gordon & Narayanan, 1984).

2.3.2.3 Structure

Organizational structure concerns the specification of roles for organizational members (Chenhall, 2003). Decision rights form an essential part of the formal power managers need in carrying out their role. Decision rights can be divided into five categories relating to strategy, marketing, investment, human resources and decisions regarding the internal process. (Abernethy, Bouwens, & van Lent, 2004; Gordon & Narayanan, 1984)

2.3.2.4 Strategy

Strategy is a leading factor in organization design. A MCS can be used to implement and monitor strategy in the organization. Organizational strategy influences the design of a MCS (Chenhall, 2003). Researchers recognize that most organizations do not pursue one strategy out of two extremes as was formerly thought (Porter, 1985), but rather find an optimal mix of different strategies (Chenhall, 2003; Chenhall & Langfield-Smith, 1998). There are however three generic notions of strategy which organizations can emphasize, cost-leadership, customer service and flexibility (Chenhall & Langfield-Smith, 1998; Dekker, Groot, & Schoute, 2012). A cost-leadership strategy focusses on offering products and services at low cost by optimizing internal processes and an efficient use of resources. Firms pursuing a customer service strategy aim at timely delivery, reliable and high-quality products and services. The main focus of organizations that follow a flexibility strategy is to develop and introduce innovative products and the ability to change or adjust to external developments.

2.3.2.5 Technology

In relation to MCS design, technology refers to the primary activities within organizations to create value. This includes hardware, materials, people, software and knowledge (Chenhall, 2003). These activities form an important factor in the design of a MCS. Competitors naturally have many technologies in common. On a higher level this can be operationalized

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by determining the main industry in which organizations are active. There are six main industries in which an organization is often categorized. The first group, which includes for example agriculture, hunting, forestry, fishing, mining or quarrying. The second category is manufacturing, which concern activities such as the manufacturing of products, distributing electricity, gas and water supply or construction. The third group provides services, which can be divided into commercial services (e.g. trade, rental, transport, storage, IT and communications), professional services (advisory, engineering, legal and auditing services) and financial intermediation (banks, insurances and pension funds). The final category is the non-profit sector, which concerns activities such as education, health care, social work and governing.

2.4

Culture as a contingency factor

Culture is a broad concept, in organizational theory there is no single definition for culture that all scientist agree on. This paper follows Zammuto and Krakower (1991) in defining culture as the patterns of values and ideas in organizations that shape human behaviour and its artefacts (as cited by Bhimani, 2003). Culture is identified as a factor that influences MCS design (Chenhall, 2003). This relationship can be explained from a sociological perspective. The proposition is that different populations, whether within nations or organizations, possess particular cultural characteristics. This makes individuals respond differently to MCSs. Ongoing globalization will intensify interaction between populations. Therefore organizations should increasingly consider culture in the development of an effective MCS. This might explain why culture is subject to extensive research (Chow e.a., 1999; W.A. van der Stede, 2003). Nevertheless, research on culture still is in an exploratory phase (Chenhall, 2003). Chenhall (2003) mentions two forms of culture that are studied in organizational theory, national culture and organizational culture.

2.4.1 National culture

Most research is focused on national culture, such as (i) its relation with control system characteristics (Harrison, 1993), (ii) the impact of national and organizational culture on decentralization (Williams & van Triest, 2009) (iii) MCS as a whole (Dent, 1991, Sunder, 2002), (v) and the impact on budget participation (Merchant, Chow, & Wu, 1995). Studies on this subject mostly build on Hofstede’s (1983) perception of culture. He defines culture as “[…] that part of conditioning that we share with other members of our nation, region, or

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group but not with members of other nations, regions, or groups.” (Hofstede, 1983). Hofstede’s dimensions of culture let the user place countries on the scale of five opposite values. These are individualism vs collectivism, large vs small power distance, strong or weak uncertainty avoidance, masculinity vs femininity, and long- vs short-term orientation (Hofstede, 1984). Although virtually all studies in this subject use Hofstede’s dimensions of culture, little consensus can be drawn. This is partly explained by the inconsistent use of the theoretical framework and little overlap between studies. The result is that few comparisons and generalizations can be made. Some scientists therefore argue that Hofstede’s dimensions represent a restricted view of culture (Chenhall, 2003).

2.4.2 Organizational culture

Chenhall (2003) concludes his findings on culture by suggesting that organizational culture may have greater impact on organizational structure than national culture. Therefore he stresses the need for continuous research on organizational culture. Organizational culture is the shared values and norms inherent within a firm. It can be seen as a leadership tool where leaders identify their personal philosophies and translate them in organizational values and practices. The importance of organizational culture is emphasized by Kimberly & Quinn (1984), stating that the character of organizational development is powerfully shaped by choices made about ideology, organizing, planning, learning, external relations with constituents, stakeholder influence and membership definition. As organizations possess particular cultural characteristics, it can be expected that individuals from within these cultures respond in different ways to MCS design.

Organizational culture is important, as managers need to express their philosophy and harmonize this with corporate rules and beliefs (Deal and Kennedy, 1982). Furthermore, by recognizing the existing culture, managers can increase acceptance of organizational changes by putting them into perspective with common practices and beliefs. Therefore managers must develop organizational culture along with organizational changes. Culture can be institutionalized in three ways. First through rewarding practices and activities that are consistent with desired values. Second by staffing key positions with individuals who have a clear cultural bias. And finally by developing new cultural norms in formal training events (Kimberly & Quinn, 1984 p260).

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However, according to Rousseau (1990) scientists neither disagreeon the definition nor on the implementation of culture, but rather on how it is operationalized. For instance, some state that culture is only conceptualized as a set of isolated characteristics to suit the methodological and scientific needs of the research community (Chenhall, 2003). In some papers organizational culture is operationalized as the shared values that interact with an organization’s structures and control systems to produce behavioral norms (Uttal and Fierman, 1983). This research however follows the assumption that it is not a different set of values which give rise to a different organizational culture, but rather a varying emphasis on a limited set of values prevalent within the larger society (Henri, 2006; Bhimani, 2003).

Organizational culture has been criticized as conceptually weak since it has been defined in many ways and each definition focusses on a different aspect or other level of abstraction (Cai, 2008) . Schein (1985) for example, formulates three levels of culture. First the visible organizational structures, secondly publically communicated values and finally unconscious beliefs and perceptions. Buono and Bowditch (1989) on the other hand only identify two levels: objective organizational culture, which refers to artefacts and physical settings, and subjective organizational culture, which refers to patterns of belief, assumptions and expectations shared by the organization’s members. However, in a complex field with as little consensus as culture, scientists need a polyphonic view that allows them to create a basis of shared understanding to build on (Martin, 1995). The Competing Values Framework (Kimberly and Quinn, 1984) meets this criterion as it was based on a study among 52 experts in organizational theory (Quinn and Rohrbaugh, 1983). This framework approached organizational culture form a high level of abstraction. Therefore this study uses the Competing Values Framework to determine the role of organizational culture.

2.4.3 Competing Values Framework

Initially driven by the statement of Goodman and Pennings (1977) that every firm strives for organizational effectiveness, Quinn and Rohrbaugh (1983) developed a framework for organizational analysis, based on grounded theory. Research among academics on variables that influence organizational effectiveness resulted in a three-dimensional model with competing values. Although organizations may differ enormously in terms of their dominant values, there are common value dimensions that run through most organizations (Howard,

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1998). Kimberly and Quinn (1984) stated that the two key dimensions enabled the categorization of organizations based on organizational focus and organizational structure.

The first dimension, organizational focus, consists of the competing values internal vs external focus. The second dimension, organizational structure, is flexible vs control structure. This results in four different cultures and four different organizational forms. Kimberly and Quinn (1984) used this competing values approach to develop the Competing Values Framework (CVM), in which an organizational focus and structure result in four quadrants, each corresponding a cultural type; group culture, developmental culture, hierarchical culture and rational culture. In order to be effective each cultural type needs a different approach in compliance, motivation, leadership, decision making, effectiveness values and organizational form.

Kimberly and Quinn (1984) find that organizations reflecting a group culture have an internal organizational focus and a flexible organizational structure. Compliance flows from trust, tradition and long-term commitment to the system. Individuals value attachment, affiliation or membership. Leaders are participative and supportive, showing consideration and facilitating interaction. Decision-making can be slow in order to be supported by all the members of the system. The effective organization places an emphasis on the development of human resources.

Organizations that reflect a hierarchical culture have an internal organizational focus and an organizational structure that reflects control. Compliance flows from formally stated roles and is reinforced by rules and regulations as well as surveillance and enforcement. Individuals value security and order. Leaders should be conservative and cautious, primarily providing expertise and ensuring the maintenance of the basic structure. Decision makers should proceed slowly, objectively documenting the process, thus ensuring the accountability of the outcome. The effective organization emphasizes stability and control.

When an organization reflects the developmental culture it has an external organizational focus and its organizational strategy is flexibility. Compliance flows from importance or ideological appeal of the task that is being undertaken. It is believed that individuals need growth, stimulation, and variety. Leaders should be inventive and risk-taking, paying particular attention to envisioning new possibilities and acquiring additional

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resources, visibility, legitimacy and external support. Decision makers should proceed rapidly, making the most legitimate decision, later adapting the conclusions as more information is collected or as external conditions change and demands are altered. It is assumed that effective organizations emphasize growth and resource acquisition.

Organizations that reflect a rational culture have an external organizational focus and an organizational structure that reflects control. Compliance flows from formal contracting, is achieved if individual objectives are clarified and rewarded on achievement. An individual’s primary need is to demonstrate competence and experience the successful achievement of predetermined ends. Leaders are goal-oriented, constantly providing structure and encouraging productivity. Decisions are made with reasonable haste, making logical, efficient decisions which are conclusive, decisive and final. Effective organizations place emphasis on planning, productivity and efficiency. Table 1 summarizes the organizational cultures and the corresponding organizational forms.

group culture hierarchical culture developmental culture rational culture

compliance affiliation rules ideology contract

motivation attachment security growth competence

leadership concerned,

supportive

conservative, cautious

inventive, risk-taking directive,

goal-oriented

decision making participation,

support documentation, accountability adaptability, external legitimacy efficiency, conclusiveness effectiveness values development of

human resources

stability, control growth, resource

acquisition

productivity, efficiency

organizational form clan hierarchy adhocracy market

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Quinn and Rohrbaugh (1983) mention that the Competing Values Framework is a combination of seemingly contradictory or incongruous concepts. Certain pairs of concepts are at opposite locations, but this does not require them to be empirical opposites or mutually exclusive. Different employee groups can subscribe to different organizational cultural values (Bhimani, 2003). No organization is likely to reflect only one culture but rather has some aspects of all four types (Kimberly and Quinn, 1984). Some values however are more dominant than others. As Quinn (1988) states “Real organizations do not fall neatly into one or the other of these four models. In fact, the models do not contain organizations; organizations contain the models, all of them. In every organization all four models exist.” Figure 2 visualizes the four organizational cultures and their corresponding organizational forms and visualizes how organizations can be placed in this model.

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The lack of consensus in defining, modelling and operationalizing organizational culture is one of the reasons why research in this field has provided mixed results (Chenhall, 2003). Chenhall suggests the use of the CVM for investigating organizational culture, this model is used more often (Bhimani, 2003; Henri, 2006). Henri (2006) investigated the impact of flexible and control dominant firms on their performance measurement systems. A part of this research focused on the diversity of measurement. He underlined the importance of both financial and non-financial measures and used the four dimensions of the balanced scorecard as a framework.

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3

Hypotheses development

This section builds on the theory described in the previous chapter to develop hypotheses for answering the research question. This research studies the effect of the two dimensions of organizational culture as identified in the Competing Values Framework on performance measures in the perspective of the Balanced Scorecard.

By using the performance measures related to the perspective of the balanced scorecard, this research primarily uses result controls in determining the influence of culture on performance measurement. For several reasons, this research does not consider other forms of controls. First they form a minor part of the control system as personnel control primarily focus on the recruitment of personnel. Secondly, social controls, specifically cultural controls, are hard to measure objectively.

Following Henri (2006, p 79), control values refer to predictability, stability, formality, rigidity and conformity. In firms with a control dominant structure senior management tends to implement rules and procedures in order to ensure efficiency and standardization. There is little room for exceptions. Managers focus on stability, security, order, routine, and standardization. Performance measures in both the financial and the internal business perspective result in productivity, efficiency, stability and control. It is expected that firms dominated by an emphasis on control are affiliated with financial and process measures. Therefore the following two hypotheses are formulated:

H1: Control dominant firms place more emphasis on financial measures H2: Control dominant firms place more emphasis on process measures

Firms with a mostly flexible structure value spontaneity, change, openness, adaptability and responsiveness. The flexible structure promotes initiative, innovation, customer service and teamwork. Performance measures in the customer and learning and growth perspective are affiliated with flexibility, adaptability, affiliation and attachment. Performance measures in the learning and growth perspective pursue initiative, employee satisfaction, retention and productivity (Kaplan & Norton, 2007). It is expected that flexibility dominant firms are

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affiliated with customer and learning and growth measures. This results in the following hypothesis:

H3: Flexibility dominant firms place more emphasis on customer measures

H4: Flexibility dominant firms place more emphasis on learning & growth measures

External oriented firms focus on their shareholders and their customers. Shareholders are primarily interested in the financial performance of the firm. Measures for performance are therefore the share price, EBITDA, dividend, debt ratio and the cash flow. Firms that focus on customers are trying to meet their demand. These organizations adapt when external conditions change. Performance is measured using the market share, customer satisfaction and customer loyalty. The abovementioned performance measures concern the customer and the financial perspectives. Therefore it is expected that external dominant firms make use of financial and customer measures. This results in the following hypotheses:

H5: External dominant firms place more emphasis on financial measures H6: External dominant firms place more emphasis on customer measures

Organizations that are more internally oriented will focus on their employees and their primary processes. When focussing on employees firms are concerned with the development of human resources, innovation and sickness. The performance is measure by absence figures, educationdegrees and employee satisfaction. The primary processes are affected by utilization, the improvement of internal processes, and the maintenance of the internal structure. Performance is measured by efficiency rates, utilization figures and stock levels. These performance measures concern the process and the learning and growth perspective. Therefor it is expected that internal dominant firms use process and learning and growth measures.

H7: Internal dominant firms place more emphasis on process measures

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4

Research methodology

This chapter illustrates the research method that is used in this study. The first paragraph describes the method that was used to collect the data and the sample characteristics. The next section explains how the constructs of consecutively, the independent variables the dependent variable and the control variables are built. Finally this chapter describes the research method.

4.1

Data collection and sample

This is a quantitative research to the effect of organizational culture on performance measurement. A survey was held amongst business-unit managers to collect the relevant data. There were no selection criteria for the branch or firm the respondents worked in. However, in order to participate managers had to meet certain criteria. To ensure the managers were subject to a formal MCS, participants had to be in charge of an operational department and manage at least 20 FTE. Furthermore all selected managers had direct customer/client contact and have decisive decision rights. Of the 122 surveys that were received, 23 were removed from the sample. Nine surveys were deleted from the data because the sum of the questions relating to organizational culture (question 39-42, questions 43-46, questions 47-50 or question 51-54), did not equal 100%. Fourteen surveys were deleted from the data because the sum of the questions relating to types of performance measurement (questions 70-77), did not equal 100%. The average age of the 99 remaining managers is 47 year (MEAN = 47.55; SD = 8.716). On average they manage 68 FTE (MEAN = 67.65: SD = 80.8). A manager works on average nine years in the business unit (MEAN 8.96; SD = 8.719) and 6 years in the current position (MEAN = 5.83; SD = 5.459). The respondents were active in the non-profit sector (40), professional services (30), manufacturing (13), commercial services (12) and financial intermediation (4). None of the managers were primarily active in the extraction industry. A detailed overview of the BU primary industries is presented in Appendix 8.

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4.2

Measurement of constructs

Theory tells us that apart from culture there are five other variables that are often investigated in relation with the design of MCSs. The factors that are considered in this model are the environment, technology, size, structure and strategy (Chenhall, 2003). These factors are known to influence MCS design and thus should be controlled for to eliminate their effect on performance measurement design. As described in the previous paragraph, this sample consists of 99 surveys after corrections for missing values. Using Green’s (1991) rule-of-thumb for medium effect-size studies, this sample permits the use of six control variables. The next sections explain how the constructs were built and operationalized in the survey. The survey questions that were used in this study and the constructs they relate to are illustrated in

Appendix 1.

4.2.1 Independent variables: organizational culture

Studies in the field of organizational culture have to build on similar research methods in order to make comparisons and develop generalizations (Chenhall, 2003). This research conceptualized organizational culture by using the Competing Values Framework of Kimberly and Quinn (1984). This research builds on the same theoretical framework that was used in prior research on organizational culture (Henri, 2006; Bhimani, 2003; Zammuto and Krakower, 1991). The questionnaire that was used is developed at the National Center for Higher Education Management System (Krakower and Niwa, 1985). The validity of this instrument was demonstrated and used in other studies (Henri, 2006; Bhimani, 2003; Zammuto and Krakower, 1991). In the survey respondents were asked to distribute 100 points among four statements, depending on how well the description represents the dimensions of culture. The four dimensions are represented by the business-unit’s character, the business-unit leader, the cohesion and emphasis within the business-unit. The four statements each represent one of the organizational cultures. Business-unit A representing a group culture, business-unit B representing a developmental culture, business-unit C representing a hierarchical culture and business-unit D representing a rational culture.

The organizational culture construct in this survey serves two goals. The first goal is to determine the business-unit’s position on the flexibility/control continuum (structure dominant-type score). This forms the foundation for answering hypothesis 1, 2, 3 and 4. The

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second goal is to determine the business-unit’s position on the internal/external continuum (focus dominant-type score). This forms the foundation for answering hypothesis 5, 6, 7 and 8. Four steps are taken to determine both dominant-type scores. First the data was considered reliable using Cronbach’s Alpha for the four questions of each culture types. The reliability statistics of culture type scores are presented in Appendix 2. Second the culture-type scores are compiled. This is the average value each culture-culture-type obtained in the four questions. This is measured using the following formulas:

= + + + = !+ + "+ # $% &$%& = + + + % = #+ '+ !+

The second step is to compute the value scores of each of the four competing values, this is measured using the following formulas:

() * +%,% % - = ( + )

() & = ( % + $% &$%& )

() % = ( $% &$%& + )

() + = ( + % )

Finally the dominant type score is obtained by subtracting a value-score from its competing value-score, this is measured using the following formulas:

0 12 ) 34 = (() * +%,% % -− () & )

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The structure dominant-type score and the focus dominant-type score can be interpreted as follows. A positive structure (focus) dominant-type score represents a firm that is flexible (internal) dominant. Higher scores represent a more flexible (internal) dominant business-unit. A negative structure (focus) dominant-type score represents a firm that is control (external) dominant. The lower the score, the more control (external) dominant the structure (focus) of the business-unit. Appendix 3 represents an illustration of the dominant-type scores.

4.2.2 Dependent variable: performance measures

The four perspectives of the BSC are used to conceptualize performance measurement. As described in paragraph 2.2.1 these perspectives are learning and growth, customer, internal business and financial. Building on prior surveys, this survey used a set of financial and non-financial performance measures (Abernethy e.a., 2004; Bouwens & Lent, 2007). Respondents were asked to indicate how much weight their superior placed on each measure when evaluating their performance. The weight was set in percentages, the sum of the weight being 100 %. The questionnaire is presented in Appendix 1. The list consisted of four financial performance measures (FPM) that are used to operationalize measures in the financial perspective. The customer, internal business and learning and growth perspectives are operationalized by respectively, customer measures (NFPM_C), process measures (NFPM_P) and learning and growth measures ((NFPM_L). This results in the following formulas. 789:; = ' 789:_< = 789:= = 89: = !+ + #+ 4.2.3 Control variables

The control variable size is operationalized as the number of FTE that is managed by the business-unit manager. Performance measures can be expected to be mainly influenced by the size of the whole organization, rather than the size of the business unit. This research however, focusses on the manager and the size of the corresponding business-unit. Culture on organizational level is the dominant cultural values that business-units within the same organization have in common. However the population of one business-unit can be seen as a