Lessor firms : management control system design

Lessor Firms: Management Control System Design

Name: Nicholas Anthony Student number: 11390018

Thesis supervisor: Sander van Triest Date: 25 June 2017

Word count: 17,106

MSc Accountancy & Control, specialization Control

Statement of Originality

This document is written by student Nicholas Anthony 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.

Abstract

This paper is a qualitative study that provides insight into the design of management control systems (“MCS”) in lessor firms. Lessor firms are an interesting type of firm because they do not fit within the within the bounds of financial services firms or typical goods or services trading firms. For example, due to the physical asset owned by a lessor being placed under the control of a lessee, moral hazard exists in the relationship between lessor and lessee. As a result, the MCS must guide the employees of a lessor to manage the moral hazard while also achieving the firm’s objectives.

In order to gather data for this paper, I conducted interviews with four employees from two lessor firms (eight interviews in total): an aircraft engine lessor and a commercial property lessor. I observed that lease managers at lessor firms have four key roles: sales, project management, customer relationship management and asset management. The asset management aspect is relatively unique to lessor firms when compared to a financial services firm, because it requires a focus on technical rather than financial knowledge.

Based on this exploratory research, I was able to make three key findings regarding MCS design in lessor firms. The first key finding is that there is a focus on input control for employees with respect to the recruitment of lease managers and the low strength of incentives relative to base salary in rewarding performance. The second key finding is that decision-making power is typically centralised in relation to decisions to lease an asset to a customer or add an asset to the lease pool, however this centralisation is perceived as enabling the lease managers in their role. The third key finding is that although financial measures are prevalent at the firm-wide level, these measures are translated through the organisation to being mostly non-financial performance measures for the performance evaluation of the individual lease managers. Moreover, there is evidence to suggest that the nature of asset being dealt with by the lessor firm has an effect on the MCS design.

Contents

1 Introduction ... 5

1.1 Lessor firm business model ... 6

1.2 Defining a lessor ... 8

2 Literature Review ... 11

2.1 Emphasis on financial measures ... 11

2.2 A system of management control ... 12

3 Research Methodology ... 14

3.1 Qualitative study ... 14

3.2 The subject lessor firms... 14

3.3 Interviews ... 15

3.4 Interview design ... 17

3.5 Interview questions ... 18

4 Discussion ... 20

4.1 Summary of Findings ... 20

4.2 Research setting: The environment of a lessor firm ... 24

4.3 The role of lease managers... 26

4.4 Centralised control ... 30

4.5 Financial focus ... 34

4.6 Impact of the asset type and the lease terms ... 35

4.7 Limitations... 37

5 Conclusion ... 38

References ... 39

1 Introduction

In a world of increasing capital efficiency, it has become commonplace for firms to focus their capital investment on what they consider to be their core competencies, in order to achieve a competitive advantage in the marketplace (Prahalad and Hamel, 1990). Indeed, a firm can require an asset as part of its broader operations, but the ownership of that asset itself will not necessarily form part of the firm’s core competencies. As a result of narrowing their focus to only core competencies within the broader operations, firms often form strategic alliances (Nooteboom et al., 1997). An example of such strategic alliances is the leasing of assets.

Leasing arrangements are increasingly becoming the norm; the first independent leasing company was established in the U.S.A. in 1952 and this expanded to lease companies being established in over eighty countries in the 1990s (Canadian Finance & Leasing Association, 2010). It would appear that “if you can purchase an asset, you can probably lease it” (Berk & DeMarzo, 2017). For example, commercial airlines require aircraft to provide their transportation service but in 2016 only 61% of in-service global fleet of western-built commercial aircraft are owned by the airlines themselves. In fact, the ratio of leased aircraft has increased consistently since 1970 (Airfinance Annual 2016/2017). This suggests that rather than devoting limited financial resources to the capital intensive business of aircraft ownership, airlines are instead choosing to focus resources on a narrower core competency, namely airline operations and are relying on strategic alliances through lease arrangements in order to carry out their broader operations. Langfield-Smith and Smith (2003) describes outsourcing agreements as a form of strategic alliance, which is a comparable concept except in leasing the ownership of the asset is outsourced. Leasing therefore enables firms to acquire certain assets without an initial large capital expenditure and the potential need to finance the outlay (Berk & DeMarzo, 2017). Consequently, this has created a role within the relevant markets for firms with complementary core competencies of asset ownership and management. For the lessee the decision may be broader than financial and may extend into operational factors such as the flexibility of only having an asset for a set period of time. While leasing arrangements may be a financial solution for the lessee firm, the effect of this is that the lessor firm stands to derive a passive income stream.

Lease arrangements from the lessor perspective culminate with interesting considerations for design of an MCS. In the instance of a financial services firm, a typical loan transaction begins with a cash outflow to the customer followed by periodic cash inflows for interest and loan repayments which concludes when the balance is repaid. However a lease transaction begins with a physical asset being transferred to the customer followed by cash inflows for lease payments and concludes

when the asset is returned to the lessor. Whilst creditworthiness of the customer would be a decision parameter in both scenarios, the decision parameters are impacted by a physical asset forming part of the transaction. One aspect is the moral hazard caused by information asymmetry in the relationship (Holstrom, 1980) whereby the lessor owns the asset but cannot fully directly observe the treatment of the asset by the lessee who is in control of the asset. There is a mismatch in the horizon for responsibility because at the end of the lease term the lessee gives the asset back to the lessor but the condition, and hence value, of the asset means there is an incentive for the lessee to not take the same level of care over the asset as if it were their own. An aspect of the lessor’s MCS is that it must guide employees to safeguard the value of the assets of the lessor. There is a large body of literature regarding MCS within settings traditionally considered to be well suited to accounting-based controls, such as a manufacturing setting (Abernethy & Brownell, 1997). There is also a growing body of literature regarding MCS within non-traditional environments, such as audit firms (see Gendron & Spira, 2009) and research and development (see Abernethy & Brownell, 1997). MCS research is extending into fast developing industries and practices, for example outsourcing (Langfield-Smith and Smith, 2003), but despite the increasing prevalence of asset leasing, there is a gap in the existing body of literature in relation to MCS design in this field. Furthermore, although there is a significant amount of research regarding leases, this is largely from a finance perspective, such as the “lease or buy” decision (see Schall, 1974). Moreover, the existing body of research is largely focused on the interests and considerations of the lessee, rather than the lessor. It is, however, the lessor that is making the capital intensive investment and whose income stream is dependent on the proper acquisition and management of the asset. My thesis will provide an in-depth analysis of MCS design in lessor firms. This study will provide a valuable source of knowledge regarding MCS in a type of firm where, to the best of my knowledge, previous literature does not.

1.1 Lessor firm business model

The operations of a lessor firm determine the applicable management control system. The diverse range of lessor firms is due to the relevant characteristics of the operations, such as the asset being leased, varying lease durations and overall business strategies. These characteristics will be discussed in more depth in the context of the two lessor firms that form the case study for this thesis. The two firms that are the subjects of my research are referred to as “Engine Lessor” and

Engine Lessor operates in the aircraft engine lease industry, specifically the short to medium term aero engine lease market. Engine Lessor is a subsidiary of a larger group of companies and its financial results are therefore reported and assessed within the group. Certain policy and procedural influences extend from the group level, rather than being designed and implemented at subsidiary level. An additional aspect of Engine Lessor is that it doesn’t always own the relevant assets that it leases, rather it leases the engine from a third party and then sub-leases the engine to a customer at a higher rate in order to make its profit margin.

For Engine Lessor, the initiation of new leases is linked to three key drivers. The first is customer-initiated, that is, an airline has a specific need for a particular engine type for a particular duration. In this circumstance the lessor firm is providing a service element: if it doesn’t have an asset in its lease pool it will search the market for an appropriate asset that it can lease and then sub-lease to the customer. The second driver is market-based. If another lessor firm offers an engine to the market, Engine Lessor will make an assessment of whether it can make a profit on the leasing arrangement. A key factor in this decision is the customer demand for the particular engine type and the market rate at which this can be agreed. The duration of the lease with the third party has to be equal to or longer than the sub-lease period and may involve multiple sub-leases (including to multiple customers) to cover the head lease period. Any period of time in which the engine is not utilized by a sub-lease arrangement is at the expense of the lessor firm. The third driver is the existing pool of assets that the lessor firm owns. In economic terms, the engine purchase decision is a sunk cost. Therefore the expansion or reduction of the leasing pool must be carefully evaluated in terms of changing market forces, including customers, competitors and innovation.

Fig. 1 The capital purchase cycle

Fig. 2 The property lease relationship

Lessor Firm Market

Information on assets available for purchase Assessment of asset and offer

Acceptance of terms and purchase

Property Owner

Right to occupy the property

Fig. 3 The extended lease chain

The second sample firm that is the subject of this research, referred to as Property Lessor, is a property trust, which is an investment vehicle whereby investors purchase “units” (an equity investment similar to a share) in the firm and derive an income from trust distributions (comparable to a dividend from a share), as well as potential capital gains from appreciation of the value of the unit itself. Property Lessor has its securities listed on the stock exchange, so the units are a liquid asset and its perceived performance will be reflected in the price of the units. Property Lessor owns real estate assets from which it derives rental income, which funds the distributions to investors.

Property Lessor specifically invests in pubs, which are venues that sell meals, alcohol and often have poker machines (also known as slot machines or gambling machines). The objective of Property Lessor is to maximize the long-term income and capital returns for its unitholders, and its investment profile is conservative. The reason for this is that rental income is underpinned by long-term leases with strong contracted rental growth. Although Property Lessor does not actively trade assets, it considers relevant assets for sale on the property market for potential purchase and evaluates its own existing portfolio of freehold interests for potential sale. These assessments are carried out against the firm’s investment criteria, which specifies the investment profile of assets in metrics such as yield and remaining lease duration. Assets are leased out on long-term contracts, usually of 10 years or more, and it is rare that a property becomes vacant. As such, the most common activity for growth is assessing assets as potential additions to the portfolio.

1.2 Defining a lessor

A lessor’s operations can be defined within the existing constructs of management accounting literature, specifically three parameters: the good/service distinction, the type of employees and the performance measurement of the underlying work. A lessor’s operation is not easily classified in terms of a good or service because it possesses elements of both. While the underlying asset of the lease is tangible, the “right to use” the relevant asset is intangible. Furthermore, there may be service elements. For example, if a customer wanted to lease a particular aircraft engine type, the

Asset Owner (Head Lessor)

Lessor Firm (Head Lessee/

Sub-Lessor)

Customer (Sub-Lessee)

Right to re-assign

use of asset _{Right to use asset}

lessor might set out to procure the particular asset for the lease agreement. There has been limited research aimed at systematically investigating the design of MCSs in service organisations (Auzair & Langfield-Smith, 2005). Research by Cobb et al (1995) supports the view that although intangible, financial products can be viewed in a similar context to the production and sale of manufactured products. However, this research also emphasises the difficulty in accurately measuring costs of delivering these “products” and subsequent profitability.

Although lessor firms often transact with assets which are associated with manual labour, the environment of lessor firms should be considered “white collar”. By “white collar”, I refer to workers who principally perform tasks of an administrative, professional or managerial nature, usually in an office environment. Baik et al. (2016) studied white collar managers and defined this term as

“non-executive employees with significant managerial or professional expertise who serve in functions without specific responsibility for either generating sales or the overall performance of a major organizational unit, such as a division or the entire firm”. While I agree with definition provided by Baik et al, it should be noted that the

foregoing definition refers to white collar managers (a subset of white collar workers), for whom appropriate performance measures were limited. In contrast, the type of employee in the lessor context may differ because the nature of work may involve specific responsibility and performance measures. Management control of white collar workers is interesting given the likely differences with blue collar workers, which are studied in traditional MCS research (see Ouchi, 1979). Finally, the relevant consideration is financial transactions in the context of leasing. The broadest definition of financial transaction captures any transaction in which money is exchanged. Within this framework, I emphasise the close proximity between operations and the financial measurement of outcomes.

A lease agreement typically involves periodic payments by the lessee in exchange for right to use an asset, so for the lessor there is an easily measurable financial outcome in respect of the revenue earned. However, the income side in isolation does not create goal congruence with the creation of firm value. This is because there needs to be an allocation of resources consumed in generating the income. Common accounting based-measures can include profit, Return of Assets, Return on Investment, Residual income or an adaptation of Economic Value Added. In the scenario where a lessor acts as an intermediary (namely whereby it does not own the asset but leases then sub-leases to the client), there will be a lease fee which is a readily identifiable direct cost. Where an asset is owned by the lessor, the cost may be represented by depreciation plus an allocation of the cost of financing the asset and an expected return from the capital allocation to that asset. While

there may be other important performance measures that are non-financial, the key point I make is that financial measurements are readily available in a lessor firm.

This financial focus flows further into the procurement aspect of the lessor’s business, namely where a lessor acquires an asset through purchase or lease. Asset purchasing decisions focus on forecasting future cash flows, which is more prominent in a lessor environment where there is likely to be an active market for similar lease assets. A lessor firm must manage a “lease pool”, also referred to as a “portfolio”, which is the collection of assets it has available for leases to customers so the utilisation rate of the lease pool, meaning the proportion of assets within the pool that are leased to a customer and earning revenue at a given time, is a key concept. Dealing in high quality assets is paramount for a lessor, as quality translates into a secure future income stream in terms of high utilisation and high overall financial returns. The importance of the secure income stream is that idle assets, which are not leased out and hence earning not revenue, erode profitability and can thus be likened to unused capacity. There is also much literature focusing on capital asset pricing models (see Gordan, 1974) and while this a relevant aspect, it is only part of the management control system surrounding asset acquisition decision-making. Indeed, asset acquisition decisions for lessors are complex and critical as they relate to and the implications of these decisions have long-term effects on management, strategy and profitability of a lessor firm. Management control refers to the processes by which management ensures that employees carry out the firm’s objectives and strategies (Merchant and Van der Stede, 2012). Effectively, if the workload in a firm is too large for one person, this will necessitate delegation. However, with delegation comes the challenge of ensuring that other individuals are acting in the best interests of the firm. In the context of lessor firms, the control choices are largely unstudied and prior knowledge is not necessarily transferable. Therefore the design of the lessor firm’s Management Control System (MCS) is a compelling issue.

2 Literature Review

My literature review is divided into two propositions identified from prior literature. These were not intended to limit the open-minded acquisition of data via exploratory interviews, but rather to inform and provide structure to the interviews and subsequent analysis.

2.1 Emphasis on financial measures

The International Accounting Standard 17 defines a lease as “an agreement whereby the lessor conveys to

the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time”. A

lease is therefore a financial transaction by which the lessor is assigning the right to use an asset to another party in exchange for compensation. There is limited accounting literature in respect of management control systems in predominantly financial arrangements (or the financial sector more broadly). As a result, I have developed my theory based on other transferrable contexts. Prior research has observed that there is a basic set of management controls that are adopted by almost all firms to enable planning and support basic operations of a firm (Sandino, 2007). Within a retail context, it was observed in a study of early stage firms that basic controls included budgets, pricing controls and inventory controls. This finding is transferable to other contexts, and accordingly a similar basic set of controls is applicable in the lessor context. For a lessor firm, with similarities to financial services firms, basic financial controls such as a budget for planning and target purposes should be anticipated (it should be noted that budgeting will be specifically considered in more detail in Proposition 2). In the banking sector, research by Soin et al (2002) demonstrated that activity-based costing, a control traditionally considered to be suited to a manufacturing environment could be institutionalized in a banking context.

A study by Ittner, Larcker and Meyer (2003) in the context of a financial services firm considered subjective weighting in a balanced scorecard bonus plan and found that the most weight was allocated to financial measures. In this context, the weight on objective, financial measures are expected to decrease as the noisiness increases. Although this study considered financial and non-financial measurement from an enabling perspective whereas I am looking at non-financial measurement from a boundary control perspective, the interplay of noisiness and financial measures is pertinent. Specifically, firms in the financial sector rate the reporting, compliance, control, and risk role more important than those in other industries (Chang, Ittner and Paz, 2014) and this could reflect a heightened consciousness toward financials.

Agency theory is based on a principle-agent relationship and an assumed likelihood of conflicting goals, hence the need for mechanisms to limit an agents self-serving behaviour (Eisenhardt, 1989).

This leads to the concept of goal congruence, which is the degree to which the employee behaviour elicited by the control is aligned with organizational goals. Firms design their MCS to maximize goal congruence (Cugueró-Escofet and Rosanas, 2012). Given the operational level decision has such a directly measurable financial, it is conceivable that financial measures could form a part of a quality control process as a result of the high congruence to an overarching financial target. Although I do not anticipate a focus on results controls (see proposition 2), where results controls are used I expect there to be a central focus on financial measurement. As the essence of the operation is of a financial nature this should be reflected in performance evaluation processes.

Proposition 1: Lessor firms use mostly financial measures for results controls at an operational level as a focal point of their MCS design.

2.2 A system of management control

There are several well-known frameworks for management control systems within firms. I have selected two which I will use as a lens to analyse the MCS of lessor firms: Ouchi (1979) and Merchant and van der Stede (2012). These two frameworks are not entirely independent of one another in some aspects, but work well in conjunction to provide a broad overview.

Ouchi (1979) developed a conceptual framework for organizational control based in a parts distribution division of a company. This setting has clearly observable functions. Although this is unlike the setting of a lessor firm, the MCS mechanisms identified in the study are broadly applicable. Ouchi’s framework focused on three key mechanisms: markets, bureaucracies and clans. The use of competitive market mechanisms results in a focus on outcomes rather than process. This is an efficient mechanism, however due to the relatively low volume of transactions in the sample lessor firms, I expect the lack of necessity for market mechanisms will lead to a greater focus on other mechanisms. Bureaucratic mechanisms involve surveillance and direction of employee actions. This direction is often in the form of rules that contain the information required for carrying out the tasks. Although not strictly applicable, in the context of low transaction volume with high consequence, direct monitoring and rules can be implemented to constrain the actions of employees. Clan mechanisms are the informal social structures that contribute to control. Through shared values these can correct ambiguity or complexity that the other two mechanisms are incapable of controlling. I have no definitive expectation relating to clan mechanisms and note that such mechanisms are determined by cultural and societal influences.

Merchant and Van der Stede (2012) developed a framework that considers MCS mechanisms in terms of results controls, action controls and social controls (consisting of personnel and cultural). Results controls, similar to Ouchi’s market mechanisms, are focused on good results that can empower employees to deliver as they see fit. Action controls can be likened to Ouchi’s bureaucratic mechanisms and involve direct management control. The four basic forms of action controls in this framework are behavioural constraints, pre-action reviews, action accountability and redundancy. This framework provides greater depth, and I expect in the context that pre-action reviews specifically will be prominent due to the nature of tasks. Social controls are similar to Ouchi’s clan mechanisms, but specifically include sub-elements of selection and placement, training and job design, which I expect to have some level of significance. Non-financial controls, especially personnel forms of control, contribute to organization effectiveness, particularly where task characteristics are not well suited to the use of accounting-based controls (Abernethy, 1997). Merchant and van der Stede propose the conditions that will give rise to a certain control type under their framework. When the outcomes of actions are easily measured and the desired actions are known, it is expected that either results controls or actions controls could be used. If the outcome is not readily measured, then the emphasis is likely to be on action controls. This could be implemented through procedures that keep decisions within a strict scope.

Ferreira and Otley (2009) developed a framework for management control systems, however this does not provide a normative position as to what mechanisms would be implemented in a specific context so it does not contribute to developing my theory. I do however agree with the authors that they provide a “useful research tool”, which I elaborate on in my Research Methodology section.

3 Research Methodology

3.1 Qualitative study

This thesis aims to provide an in-depth analysis of how lessor firms design their management control systems. Given the limited pre-existing academic knowledge relating to lessor firms, a qualitative approach was the most appropriate method to conduct the required research. The two sample lessor firms, Engine Lessor and Property Lessor, whose leasing activities are described in Section 1 above, each gave me access to key personnel for the purpose of my thesis. These firms have a commonality that their business models concern high-value assets and a relatively low transaction volume, so making the right decisions is critical to success. The counter case would be a business model that has high volumes of low-value transactions per individual asset in relative terms, for example a car leasing business. While I considered including such a counter case, I consider it would not add any value to my objective of analysing MCSs for lessor firms, as the volume of transactions at such a firm would likely dilute the importance of controls within the decision-making process for asset acquisitions into the lease pool. Moreover, the two sample lessor firms I selected will provide a valuable insight to MSCs for lessor firms on a globally diverse level, as they operate in completely different industries and in different countries and hence their objectives and market influences are very different.

Due to the close access I was granted to key personnel at the two sample lessor firms, anonymity was an important factor in ensuring that potentially commercially sensitive issues could still be addressed and included in my assessment. Furthermore, details of a firm’s strategy, commercial drivers and other sensitive operational considerations are typically not available to the general public, so through providing anonymity I hoped to reduce barriers and encourage more open dialogue about the internal workings of the firms.

The Discussion section includes a Summary of Findings which aims to increase the transparency and contribute to the confirmability of this thesis. Although complete objectivity in this type of research is not possible (Bryman, 2008), relevant quotes from transcribed interviews have been provided in the Discussion section with the intention of validating the notion of good faith in interpretation of results.

3.2 The subject lessor firms

Engine Lessor is a subsidiary of a German aircraft engine MRO (maintenance, repair and overhaul) group of companies, which leases aircraft engines to airlines on short (less than 12 months) and

medium term leases (1 – 5 years). Engine Lessor has a second operation in the business of buying aircraft engines then overhauling or selling piece parts, however my focus is solely on the leasing aspects of the business conducted by the firm.

At any time Engine Lessor is managing a lease pool of 40 – 50 aircraft engines. As set out in Section 1, it does not necessarily own the engines that it leases to customers, rather in some instances it acts as an intermediary whereby the firm leases in an engine from a head lessor and then sub-leases out the engine to the airline. In relation to certain assets, Engine Lessor therefore does not invest capital in the engine, but its profit is based on the margin between the rate at which it can lease the asset and the revenue earned from the sub-lease. Typically the inbound lease is longer in duration than an outward lease, which exposes the firm to idle-time risk in which the engine is being paid for under the head lease, but is sub-leased and hence not earning revenue. Property Lessor is an Australian real estate investment trust that owns a portfolio of pub freeholds (also called land and buildings), which it leases to tenants who operate the pubs. It is listed on the stock exchange in Australia and, as is required for a self-managing publicly traded trust, it holds an Australian Financial Services License. The lease terms are typically an initial term of at least 10 years, and the lease contracts usually include extension options that are exercisable by the lessee (also referred to as the tenant). It is uncommon for the assets that are subject to the long-term leases to be unutilized. Furthermore, although Property Lessor regularly assesses property market listings for new assets for purchase, it is rare that an asset meets the firm’s strict investment criteria. When acquiring assets, the firm generally seeks to acquire property with an existing lease in place, which allows it to acquire both the property and the lease.

3.3 Interviews

Semi-structured interviews were conducted in order to gather data from key employees within lessor firms. Interviews were the chosen method for my research as this format allowed me to gain significant and detailed insight into how the firms design and tailor their MCS and further enabled me to probe deeper into the responses provided by interviewees. With very little prior research in this area, conducting interviews in real-time was a high priority and an invaluable opportunity. Interviewees were selected with the concept of triangulation whereby more than one source of data is used to explain the phenomena. From each firm there are two interviewees from top management, a managing director and a senior finance employee, and two leases managers. This design was intended to gather data from two of the firm’s top management, who design and implement the MCS, in order to compare and validate data. The other interviews were with two

lease managers, who are subjected to the MCS, and data could be compared to increase the credibility of my research. The interviewee selection was also intended to improve the fairness as an aspect of authenticity (Bryman, 2008) to represent the viewpoint of different individuals in the research setting fairly.

The interviews were conducted in person where possible, or by video chat (Skype or Facetime) when face-to-face contact was not practical due to logistical considerations. Specifically, all interviews for Engine Lessor were conducted in person, but video chat was used for all interviewees from Property Lessor because the firm is located outside of Europe. I do not consider there was any significant difference in the quality or depth of the interviews conducted with Engine Lessor and Property Lessor, as video chat still enables the reading of body language and non-verbal communication.

I had a target duration of 45 minutes per interview, however this was intended to be flexible and adaptable depending on the interviewee and the data available. As can be seen in the below table, only two of the interviews were shorter than 45 minutes and two exceeded one hour. There is no readily apparent relationship between the medium used for the interview and the duration of the interview. On average, the duration was 52 minutes for the four face-to-face interviews and 51 minutes for the four video chat interviews. Based on my experience conducting these interviews, I did not associate any variability in individual interview duration with to the medium used. All interviews were voice recorded and later transcribed for analytical purposes. An audit trail has been retained with all recordings and transcripts are kept in an accessible manner to contribute to the dependability (Bryman, 2008) of this thesis. Closed captioning was not required because the framework applied (described in Section 3.4 Interview design) in design of the semi-structured component of the interviews allowed easier identification of key themes.

The below table lists the interviewees, their position within the firm, and other relevant details of each interview:

Firm Interviewee Interviewee Position Method Interview date Duration

A A1 Chief Executive

Officer

Face-to-face 24 May 2017 36 minutes

A A2 Chief Financial

Officer

Face-to-face 17 May 2017 46 minutes

A A3 Lease Manager Face-to-face 19 April 2017 49 minutes

A A4 Lease Manager Face-to-face 12 May 2017 1 hour 18

minutes

B B1 Chief Executive

Officer

Skype 20 April 2017 & 21 April 2017

1 hour 2 minutes (38 & 24 minutes)

B B2 Finance Manager Skype 8 May 2017 51 minutes

B B3 National Property

Manager

Facetime 23 May 2017 48 minutes

B B4 Facilities Manager Skype 18 May 2017 43 minutes

3.4 Interview design

In designing my semi-structured approach, I heavily utilised the questions developed in the framework of Ferreira and Otley (2009) for the structured component. I agree with the authors that the framework provides a “useful research tool”, and I found that the twelve question framework structures this research in a logical manner. I overlaid the sequence of adapted questions from the framework and noted specific areas I wanted to discuss with each interviewee. For example, when discussing performance evaluation at various levels, I specifically wanted to discuss objectivity versus subjectivity, individual targets versus collective targets, and the frequency of evaluations. I found that the data collection process enabled me to achieve this objective, as I was able to take data obtained from one interviewee and seek additional perspectives and input. For example, in relation to the interviews conducted with Property Lessor I was able to utilise data collected in

earlier interviews to provide specific examples of controls when seeking processes in place to ensure that strategies are carried out.

The interviewees I selected were intentionally selected from two distinct organizational levels. In order to promote more fluid conversation, I adapted the questions to be more suitable to the employee’s role. The first group of interviewees are those high in the managerial hierarchy or in the finance/controlling function. The questions directed to individuals in this group were focused more on the intended design and implementation of the control system and how design decisions suit a lessor firm. The data that I anticipated would be particularly valuable related to factors such processes for communicating the mission to managers, the adaption of strategies and plans for managers and key success factors. I anticipated that those interviewees at the lower levels (which I refer to as lease managers) may not be completely aware of the control environment in which they operate. Nonetheless I was open to the possibility that interesting differences in perception could arise between the two groups in terms of why controls suit or don’t suit a lessor firm. From this group I was anticipating interesting data relating to evaluation, reward and information flows.

3.5 Interview questions

All questions were ultimately intended to the gather data as to “why” the specific management control system was designed and implemented at the lessor firm and also to enable me to make credible deductions and identify possible causes of differences. For example, differences between the firms’ MCSs could relate to the to the firm’s strategy, the asset being dealt with, the duration of lease contracts or the external environment.

The introductory questions sought to gain an overall picture of the business. Within this, it was anticipated that the response may extend past the parameters of lease business, but would ultimately be used to gain an understanding of the operations and subsequently isolate the boundaries of the lease operations as much as possible. A starting point was to clarify the business cycles for lease operations and the different ways lease decisions and asset purchase or sale decisions are made.

 Q1: Overview of the business in terms of history, strategy and operations  Q2: Description of the business cycles for a leases and/or leased assets

The topics of the questions relating to management control system design were based on the Ferreira and Otley (2009) framework.

 Q4: Organisational structure and links to the vision, mission and key success factors  Q5: Processes in place to ensure strategies and plans are carried out

 Q6: Key performance measures used to monitor and evaluate the success of the business toward its key success factors, strategies and plans

 Q7: Setting performance targets

 Q8: Processes are in place for evaluating performance at individual, group or organisational level

 Q9: Rewards gained by achieving performance targets (or penalties by failing to achieve them? (financial and/or non-financial)

 Q10: Key controls in place to ensure leasing decisions maximise value for the business  Q11: Changes in controls due to changes in the dynamics of the organization and its

4 Discussion

Given that the exploratory nature of this research paper, much of the below discussion is focused on findings beyond the key propositions. This section sets out a summary of the interviewees’ responses to the structured questions that formed the basis of the interviews, considers the environment of the lessor firm, and the role of lease managers. It then provides a response to the initial propositions derived from the literature review, namely “Centralised control” and “Financial

focus”. The remaining sections discuss other key themes that arose from the analysis of my data,

namely the impact of the asset type and the applicable lease. Finally, it identifies a number of limitations of this research paper.

4.1 Summary of Findings

The below summary of findings is arranged according to the interview questions, which were derived from the Ferreira & Otley (2009) framework. The summary of findings has been categorised in the below table according to the best fit within the wider framework of topics, rather than in relation to the specific question put to the interviewee. A more detailed description of findings can be found in the Appendix.

Engine Lessor Property Lessor

Communication of vision, mission and key success factors

 Key objectives are visible on the walls of the office.

 Firm-wide meetings twice each year.  An annual “OP Booklet” (Operating Plan

Booklet) is distributed to lease managers.

 Emphasis on informal communication due to the small number of employees.

Organisational structure and links to the vision, mission and key success factors

 Firm is supported by a small finance team and a small legal team.

 Ten lease managers who report to either the head of the sales or the head of the technical.

 Two lease managers who report directly to the Managing Director.

 Small accounting team

 Maintains a minimal workforce by having a low number of customers who are high quality (financially sound) tenants

 Flat management structure to enhance efficiency in a highly competitive and time-sensitive setting.

 The board of directors are very involved in the business.

Processes in place to ensure strategies and plans are carried out

 Input control for personnel involving selection criteria based on sharing the core values of the firm, most notably entrepreneurism.

 Key success factors are devised into milestones for the team and individual performance targets.

 Weekly team meetings aim to ensure a constant and open flow of communication and information between lease managers.  Standardised template for the assessment

of a proposed new lease, which the lease managers must complete. The Managing Director or Chief Financial Officer must approve the completed template before a lease contract can be offered to a customer.

 A “delegation of authority matrix” is in place which is a policy that limits the amount that any single employee can approve for expenditure. The board of directors is required to approve any purchase of a new asset.

 The lease managers maintain a pipeline of capital expenditure items with a five year horizon. Expenditure should not exceed the designated budget.

 Job descriptions for the lease managers define the responsibilities of this position.  KPIs are reviewed and set annually to

guide behaviour not provided in the job descriptions.

Key performance measures are used to monitor and evaluate the success of the business toward its key success factors, strategies and plans

Firm level

 Firm performance is evaluated on a monthly basis.

 The most important metrics for the lease department are financial measures. Monthly reporting includes measures for sales, costs, gross profit and EBIT.

 When making decisions about individual leases, the key metrics used are revenue, EBIT and EBIT margin.

Firm level

 The key measures are distributions (the equivalent of a dividend but from a trust) and distribution growth (which is attribute of a publicly listed firm).

 Revenue is highly predictable given long term leases and rent escalations are set out in the lease contract.

 The other firm-wide primary metrics relate to capital structure.

 When deciding to purchase an asset for the lease pool there is a free cash flow and NPV analysis.

 “Utilisation” is a non-financial measure which refers to the number of engines in the asset pool that are leased each month.  “Win rate” is another non-financial

measure which is the ratio of enquiries against materialised new lease agreements. Individual

 Lease managers receive targets in relation to aspects such as volume, new product development, sourcing and professional development.

 The majority of these targets are measured in non-financial terms.

Individual level

 Annual performance review process incorporates specific aspects of the overall requirements of the company within individual goals of lease managers.

 Lease managers are not responsible for revenue because they have no control over this aspect.

Setting performance targets

 Performance targets are set by the top management.

 Emphasis on flexibility rather than a static plan. This allows the firm to follow opportunities in the dynamic market.  Top management perceives targets are set

as achievable

 These targets are achievable but also set reasonably strong growth rates.

 Target setting is implemented from the top down because the distribution expectation is set by the market.

 The lease managers are given their performance targets by top management.  Target difficulty is set in an achievable

range

Processes are in place for evaluating performance at individual, group and organisational level

 Board of directors meet to evaluate performance three times each year.

 Monthly meeting of the board of directors.  Annual performance appraisals for the

 Top management evaluate firm performance monthly.

 Formal feedback discussions with lease managers occur twice each year.

Financial and/or non-financial rewards gained by achieving performance targets (or penalties for failure to achieve targets)

 Lease managers are able to earn bonuses for meeting or exceeding performance targets.

 The availability and scope of such incentives depends on the individual contract and role within the firm.

 Bonuses to lease managers are entirely discretionary, rather than contractual.  The amount of the bonus relative to the

lease manager’s base salary is not high

Key controls in place to ensure leasing decisions maximise value for the business

 Business case templates used for the assessment of new leases transparently calculates the contribution of the target asset to the overall group result.

 The template assists lease managers to assess and prepare their business case and requires the collection of all documentation which acts to mitigate risk.

 The “delegation authority matrix” is a policy that ensures that decisions can only be made by employees within a particular role and with a commensurate level of responsibility

 The board of directors ensure that all due diligence processes for asset acquisitions have been carried out and that any actions of this nature are within the strategic scope of the firm.

Changes in controls due to changes in the dynamics of the organization and its environment

 Expanding rapidly with respect to revenue and employee numbers and therefore the MCS is not static.

 The business is mostly consistent in its operations and control environment.

4.2 Research setting: The environment of a lessor firm

The first theme identified in this exploratory research is the environment of the lessor firm. This is a broad theme in which lessor firms will be differentiated from other types of businesses. Specifically, the MCS environment of a lessor firm will be differentiated from that of financial services firms, which in turn will introduce the research setting.

The structure of loan/lease arrangements for banks and lessor firms may appear, at a superficial level, to be similar. Specifically, a loan arrangement involves the loan of a sum of money for which interest is payable for the duration of the loan period, upon which the principal sum of the loan is repaid. Similarly, a lease arrangement involves the lease of an asset, for which payments are made for the duration of the lease, upon which the asset is returned to the lessor firm. Moreover, in both scenarios, the specific characteristics of the customer determine the terms of the loan/lease arrangements. In spite of these superficial similarities between these types of businesses, the characteristics of MCS in lessor firms are very different to those of banks. The underlying reasons for these differences is considered below.

Banks are not required to perform job costing for external reporting purposes, and furthermore, the concept of a product in banking is not easily defined. As a result, financial services firms generally don’t have a thorough understanding of profitability in respect of customers and products due to the proportionately large process costs (Soin et al, 2002). In contrast, the product for lessor firms is well-defined: lessor firms deal with limited types of assets and each lease agreement is a product. The costs of a lessor firm are more easily attributable to products because of the direct costs incurred and the low volume of transactions. This is most straightforward in circumstances in which a lessor firm both leases and subsequently sub-leases the assets in the lease pool because the difference in amount between these two leasing arrangements is the profit margin. It is also to the case, however, that even an owned asset by the lessor firm could have a cost of capital calculated to represent profitability. While Soin et al (2002) focused on a cost centre, Cobb at al (1995) considered on the management accounting system in a division of a bank with a fee-earning business. Cobb et al (1995) observed that, within this environment, there was an increased presence and influence of accountants and management information. Similarly, the strong influence of accounting staff was evident in the sample lessor firms, however the use of financial measures was different. For example, the banks appear to use profit by product and risk ratio calculations, while the sample lessor firms are more focused on EBIT margins at a portfolio-wide level.

A lessor firm’s “lease pool” is the pool of assets that a lessor firm has under its control for the purpose of being leased out for the lessor’s financial gain. A lessor firm must therefore prudently manage its lease pool to maximise firm value. This includes careful consideration of its competitors and market environment, not only in respect of entering into leasing arrangements in respect of assets in the lease pool, but also in relation to purchasing or leasing assets for inclusion in the lease pool and selling (removing) assets from the lease pool. Property Lessor is frequently assessing assets for acquisition within a strict and fixed time frame, between when assets are announced as being on the market and the closing of bids. The dynamic nature of the external environment creates a need for constant communication and coordination within the lessor firm. An example from Engine Lessor is when various lease managers are working together or in parallel in order to find a customer for a particular engine that is coming to the end of its current lease term. This must be carefully coordinated so that a new lease can be commenced as soon as possible after the end of the previous lease period.

Management of the lease pool, specifically for a measurement such as utilisation, is indicative of a service characteristic because unused capacity cannot be stored (Lovelock and Gummeson, 2004). As a result, lease payments are forgone when an asset is not leased to customer. The particular market is also relevant to the management of a lease pool. For example, Property Lessor operates at 100% utilisation, however Engine Lessor makes lease pool decisions for the inverse trade-off between having engines idle to be available for customers as needed and having minimal engines not earning lease revenue.

From the perspective of the lessee, the key interest in a lease arrangement is the use of the asset in the operations of the business. From the perspective of the lessor, however, it is necessary to efficiently and effectively managing a pool of lease assets in a manner that both maximises revenue and safeguards the value of the assets. Therefore KPIs of lessor firms often focus on the utilisation rate of the lease pool from an efficiency perspective because it reflects performance in management of the lease pool. The safeguarding of asset value is more difficult to measure because it is often long-term in nature so is subjective in measurement. It is therefore essential that a lessor firm has a comprehensive knowledge of the particular asset and the market(s) relevant to those assets. An interviewee from Engine Lessor described leases within the aircraft engine industry as becoming increasingly more of a “commodity product”, meaning that there are increasing numbers of lessors and lessees in the market who are transacting at greater volumes. This in turn causes an active market with visible prices to evolve. The Managing Director of Engine Lessor emphasises the notion of an active market:

“We are positioning ourselves in short term leasing which is a supply and demand market. So that means if there are any issues causing high demands… I have to spot that trend earlier than my peers and position myself. So it’s all about spotting trends in the market and then ride the cycles.”

In response to a competitive market, there has been an increasing amount of innovation in the form of product development. Engine lessor companies take measures to differentiate themselves from competitors and market themselves as a “lessor with flavour”. An example of innovative product development is the “green time” concept, in which an engine with limited life remaining is purchased from an airline, repaired to align the remaining life of the major components and then leased to a customer on a short-term basis. This dynamic operating environment creates challenges in MCS design, specifically in relation to managing risk.

The sample firms used for this research both emphasise that flat management structures and open communication channels are a conscious choice of MCS design. Although not a unique concept, this is derived from a desire to be swift in responding to opportunities in the market. This finding is consistent with Abernethy and Lillis (1995) position, which describes flat management structures as designed to “encourage integrative problem solving, fast response (by reducing bureaucratic barriers) and

spontaneity”.

4.3 The role of lease managers

The key employees subject to the MCS are collectively referred to in this paper as “lease managers”. It is therefore useful to define the meaning of this term, the aspects of the role and the characteristics of employees within this role. These culmination of these factors appear to result in an emphasis on personnel controls.

The two samples firms studied for this research paper adopt different roles and divisions of responsibilities. In this paper, “lease manager” refers to an employee whose primary function relates to operational aspects of leasing, who is not in an overarching management role nor are they support personnel such as finance or legal services.

The role of lease managers can be broad and varied, encompassing one or more of the following aspects (which are discussed in detail in this section): sales, project management, customer relationship management and asset management. My research further indicated that while finance is not part of the role of the lease manager, elements of finance can be found within the sales and project management aspects. The key oversight and responsibility for the finance function is retained by the finance department and Chief Financial Officers. With respect to the sales component of this role, a lease manager is expected to know basic financial metrics such as revenue

and margin, however (within the sample firms) the lease managers do not have the authority to make financial decisions, such as purchasing assets or offering leases to customers. Project management broadly refers to achieving the outcome of a particular project or objective set by the lessor firm. Project management includes the responsibility for liaising with the finance and accounting functions in order to receive the necessary approvals. Asset management refers to responsibility for the physical condition of the asset and involves specialist technical knowledge about the asset such as technical knowledge.

The Managing Director of Engine Lessor specifically states that during the recruitment process, he looks for “complementary skills sets” with respect to the existing team members. He acknowledged that a suitable candidate may not have every skill, however Engine Lessor will subsequently train employees to enhance and development their knowledge base. This approach is confirmed by one of the lease managers from Engine Lessor, who described himself as "not a specialist" in any one aspect, rather he likens himself to a manager of projects.

Munns and Bjeirmiof (1996) defined project management as controlling the objectives in achievement of a project. They further defined project defined as “a specific objective, which involves a

series of activities and tasks which consume resources”. Furthermore they noted that characteristics of a

project include set parameters in which a project should be achieved, such as defined start and end times. These characteristics are, however, more fluid in lessor firms because leases are relatively dynamic.

For Engine Lessor, the boundaries of a project can be difficult to define as it could include the entire process or a significant part of the process, for example redelivery of an engine. Lease managers at Engine Lessor follow the entire process from initial lead or request for proposal, to delivery of the engine to the customer, and finally to the redelivery inspection of the engine’s condition and the conclusion of the agreement. Lease managers must liaise with the internal legal department to ensure the lease contract meets the required specifications (which are intended to minimise risk), as well as liaise with the customer.

Similar project management responsibilities are allocated to lease managers at Property Lessor. Lease managers are responsible for managing capital improvements to the properties as well as maintenance activities, such as sourcing and coordinating tradespeople and ensuring work carried out meets specifications. The Managing Director of Engine Lessor provides the following observation in relation to a lease manager’s role:

“I want entrepreneurs and that means you need to command the entire value chain. I think that means you are solely responsible to source your engine, you’re solely responsible to lease in the engine if we do not own

it ourselves, you have to remarket that engine, you have to make sure that the contract is negotiated and signed, you need to ensure payment, and you need to ensure end of lease. I want people who are generalists and command each set in the entire process”

“It is a project because you need to manage the finance, you need manage the legal, you need to manage the technical team so it’s not a coincidence that half the team has been trained in project management and the next half will be trained in the second half [of the year]”

The role of lease managers at Property Lessor does not include the sales aspect. This is because the firm operates at full asset utilisation with long-term leases in place, and the arrangement of a new lease is therefore not a regular requirement. In contrast, Engine Lessor deals largely in a market for short-term leases, which is driven by supply and demand trends. Effective MCS design is crucial to achieving favourable outcomes for a sales function, and a control environment with both high formal and informal controls leads to better sales performance outcomes than combinations where one or both is low (Cravens et al, 2004). Although the lease manager role at Engine Lessor is never purely a sales role, there is a strong emphasis on both the informal (being professional and cultural controls) and the formal (being the output and process controls). At Engine Lessor, sales meetings occur weekly and updates on the progress of all leases are provided and assessed, so that the lease managers receive direction for prioritisation. Official financial results are prepared by finance on a monthly basis, however the financial implications of new leases are also informally communicated to the team. Due to the opportunity and uncertainty faced in such a dynamic environment, it is expressly communicated that lease managers are expected to bring an “entrepreneurial spirit” to the workplace. From a MCS design perspective, the entrepreneurial nature of an employee is identified at the selection stage for prospective employees and subsequently developed by the firm’s internal culture.

The aspect of customer relationship management and asset management are often interrelated. This is due to the nature of the asset lease agreement, which requires the asset to be in the possession of the customer. At both the Engine Lessor and Property Lessor firms, there are employees who have a specialist focus on the asset management aspect. Despite this, one of the unavoidable risks facing a lessor arises from the lack of agency and control, namely the ownership of an asset but not having custody of it or direct supervision over its usage.

Within the constructs of lease contracts, the life and condition of the asset are affected by the conduct of the lessee. Although the lessee is financially motivated not to spend any more on the asset than contractually required, given the horizon differential between the lessee’s use period and the asset’s lifespan, the lessor firm needs employees protecting its interest in the asset. A lessor

firm therefore needs its employees to manage and be responsible for the asset in order to ensure that the lessee is fulfilling their obligations under the lease agreement. In the similar strategic alliance of outsourcing, Langfield-Smith and Smith (2003) found trust-based pattern of control emerged. In the context of leasing, however, I identified a focus on bureaucratic controls, mostly in the form of extensive legal contracting and involvement of legal specialists from both sides. This appears to assist in the customer relationship management because it defines the responsibilities of the parties and provides a degree of certainty.

The lease manager at Engine Lessor is responsible for receiving monthly reports from the customer, including details of the engine such as the number of hours of flight time, the number of cycles (i.e. take-off and landing) and replacement of parts. When the customer receives an engine, it carries out a technical inspection to ensure the function is within specification. An end of lease inspection is carried out by the lessor to ensure the asset has not been damaged due to action or inaction of the lessee. At Property Lessor, the two lease managers are both property specialists with knowledge in real estate and technical knowledge of facility maintenance. Every property is inspected at least annually to ensure the tenant is keeping up with their maintenance obligations pursuant to the lease contract. A lease manager at Property Lessor observed, in respect to maintenance inspections, that: “In terms of meeting their lease obligations, that’s where a lot of it falls back

to me”. It should be noted, however, that certain consequences for failure to abide by the terms of

the lease agreement (such as the issue of a notice of breach) requires escalation to the Managing Director.

The range of responsibilities that fall within the role of the lease manager appears to manifest in a strong focus on personnel controls. This is consistent with a finding by Abernethy & Brownell (1997) that personnel control contribute to organisational performance, when accounting based-controls are not suitable. Within this context, the sales aspect of a lease manager’s role would typically be suitable for accounting controls, however project management, customer relationship management and asset management are more difficult to measure in financial terms. Property Lessor does monitor the expenditure on capital additions and maintenance relative to a budget, however the emphasis is on the efficiency of this expenditure, whereby the long-term value in the property is maintained.

Indeed, direct monitoring would not be suitable for the type of work being performed at the lessor firms. Rather, as the Managing Director of Engine Lessor observed “to build a structure we have a goal

commitment of the people where you have the entrepreneurial spirit”. This concept of entrepreneurial spirit is

pursue opportunities in line with the firm’s strategic goals. The Managing Director of Engine Lessor further expressed the view that combining this entrepreneurship with clear goals and employee buy-in leads to enhanced employee performance. Although this should not be considered unique to lessor firms (or to apply to all lessor firms), the principle of an input control for employee selection where employee tasks are diverse and not directly observable is relevant. This is consistent with findings of Campbell (2012), that managing inputs can be more effective than controlling outputs, such as contractual incentive arrangements for employees. The strength of incentives for lease managers at both sample lessor firms was observed to be low relative to base salary.

As noted by top management at the sample lessor firms, the nature of the work carried out by lease managers means that the management of employees in these roles does present some challenges. Specifically, lease managers often do not have a comprehensive understanding of the business as a whole and therefore require KPIs for alignment with business objectives. For example, Engine Lessor uses KPIs for strategic alignment, such as new product development to support the firm’s strategy as an innovative lessor firm. Furthermore, although lease managers are not expected to fully understand the strategy of the business, there is a strong emphasis on ensuring that they understand their contribution to it. In relation to the communication of strategy, the Managing Director of Property Lessor observed: “There are concepts in there that several of our team don’t

understand or wouldn’t understand at first pass. Continuing to reinforce those messages and help them understand but mostly putting their roles in that context”. An example of this is Property Lessor aiming to maximize

the value of its property portfolio. Property Lessor identified that the lease managers are the most suitable employees for the identification of unique growth opportunities, such as the development or subdivision of existing properties.

4.4 Centralised control

Decision-making control is often centralised in circumstances where managers want to make the most critical decisions within their realm of responsibility and authority (Merchant and Van der Stede, 2012). There are two possible explanations for decentralisation of decision-making control. The first is that organisations may be too large or geographically dispersed for core employees or top management to make all decisions. The second is that there may be difficulty in transmitting all relevant information to the decision-makers (Atkinson et al, 2012).

My research suggests that the MCS at lessor firms is designed to retain decision-making power at the level of top management. As set out above, the role of a lease manager is broad and includes