The influence of the Dutch financial supervision act
A case-study at a Dutch financial service provider
Master of Science Accountancy and Control (control track)
Name: K.E. Oosterling Student number: 0420298 Master thesis
Supervisor: Rui J. Oliveira Vieira Date: 27-08-2014
Abstract
The past few decades the financial markets around the world have been subject to change. As a result, in response to these changes, financial market supervision needed to be adjusted as well. On January first 2007 the Dutch Financial Supervision took effect, a two pillar model of financial supervision. The Dutch Central Bank is responsible for prudential supervision, and the Authority Financial Market is responsible for conduct of business supervision. The Dutch Financial Supervision Act has an important influence on a financial organization. This research focuses on the influence of the Dutch Financial Supervision Act on the performance management system of a supplier of consumer loans. A case-study is performed to study the effects in practice. The framework of Ferreira and Otley is used to create a comprehensive view of the performance management system of a supplier of consumer loans. The objective was to detect changes in the performance management system as a result of the implementation of the Dutch Financial Supervision Act.
Table of contents
Abstract………...2
1 Introduction ... 4
2 Literature review performance management system ... 6
3 Overview Dutch financial sector ... 19
3.1 Financial market regulation and supervision ... 19
3.2 The Dutch Financial Supervision Act ... 22
3.3 Consumer loans suppliers ... 25
4 Methodology ... 27 4.1 Case-study research ... 27 4.2 Case-study at Company X ... 28 4.3 Research design ... 29 5 Overview Company X ... 31 6 Findings ... 34 7 Discussion ... 48 8 Conclusion ... 53 9 Bibliography ... 55
Appendix 1A Overview question model Ferreira and Otley (2009) ... 63
1 Introduction
“Consumers need to feel confident that financial institutions work in a honest and truthful way” (Hoogervorst, 2008, P.2). The past decades the financial supervision across Europe has been subject of change. There are several reasons for this change, one important reason is increasing integration of financial markets, which can be partially explained by the introduction of the Euro. Another reason is the increasing overlap between the different financial institutions (Wymeersch, 2007).
There are several objectives of financial supervision and regulation. According to Di Giorgio and Di Noia (2003, p. 6), “Economic regulation aims at correction market imperfections and unfair distribution of the resources, while pursuing three general objectives: stability, equity in the distribution of resources and efficiency”. Across Europe several different models for financial market regulation and supervision are used. The past few years these models have also been subject of change, due to developments across the financial market (Lumpkin, 2002). Several of these models will be discussed in the next section.
On January first 2007 the Dutch Financial Supervision Act took effect. The aim of the Dutch Financial Supervision Act is to replace the different supervision acts of the multiple financial market sectors, and combine them to one supervision act for entire financial market sector. According to this act the Dutch National Bank (DNB) is responsible for prudential supervision and the Authority for the Financial Markets (AFM) is responsible for the market conduct supervision of the different financial institutions of the financial market (website AFM, 2012).
The Dutch Financial Supervision Act applies to several financial market sectors including banks, insurance companies, pensions funds, and suppliers of consumer loans. In the past the supervision of the market for consumer loans was documented in the Dutch Financial Service Provider Act. Since 2007 The Dutch Financial Supervision Act applies to the consumer loans market, which has several important implications for the entire market (website AFM, 2012).
An important implication of the Dutch Financial Supervision Act is that all organizations who offer consumer loans need to have a license approved by the DNB or AFM. One of the objectives of The Dutch Financial Supervision Act is to protect consumers. With regard to the market for consumer loans this has important consequences for several aspects of the market. Due to the implementation of the Dutch Financial Supervision Act they experience increased regulation, codes of conduct relating to the protection of consumers, and transparency
requirements regarding their cost structure, and laws concerning their reward structure (website AFM, 2012).
The influence of the implementation of the Dutch Financial Supervision Act on suppliers of consumer loans provide an interesting research field, because the new laws and rules, the increased form of regulation, and the increased significance of compliance influence the performance of the organization. It would be interesting to see how these factors, that have a great influence on organizational performance, influence the performance management system of an organization. Also because there is a research gap regarding to the subject of performance management systems (Pinheiro de Lima et al. 2013). This research could provide insight in the use of a performance management system in practice and the influence of external factors such as the implementation of a new supervision act. The main research question is: how did the performance management system used by a supplier of consumer loans change after the implementation of the Dutch Financial Supervision Act?
In order to answer this question a case-study is undertaken at a supplier of consumer loans. Particularly interesting is that this supplier strongly aspires is to comply to the rules of the Dutch Financial Supervision Act, and tries to implement new rules before they are obliged to by the Dutch Financial Supervision Act. The main aim of this research is, studying the changes in the performance management system of the supplier of consumer loans since the implementation of the Dutch Financial Supervision Act, and to discover to what extent the Dutch Financial Supervision Act is translated to the Performance Management System. For this research the framework developed by Ferreira and Otley (2009) is used. This framework is chosen, because it provides a comprehensive view of the performance management system used by the organization.
The remainder of the paper is structured as followed: section two provides a literature review, section three describes the research methodology used, followed by section four which provides an overview of the organization studied, section five presents the findings of the research, which is followed by section six with the discussion and conclusion.
2 Literature review performance management system
Traditionally, organizations used accounting measures and data when measuring organizational performance, until, as a result of developments and organizational changes, these seemed to become insufficient and the demand for different types of performance measurement increased (Nudurupati et al., 2011). Otley (1994) describes several environmental factors that influenced organizations the past few decades. These factors include: social changes, political changes, globalization, technical changes, shrinkage of business units, and the formation of alliances. Not only did these factors influence the organizations in general it also influenced their business process and inevitably the management control process within the organization.
Already in 1972 Hopwood focused his research on the appropriateness of accounting data when measuring performance. Lebas (1995) emphasizes the importance of defining organizational performance as part of the performance measurement process. Furthermore, he concludes that performance measurement is not an isolated process within the organization, but it is interrelated with the management process. Multiple authors, including Otley (1994), Nita (2008), and Adler (2011) consider the work of Anthony (1965) to be vital in the development of the concept of management control. Antony (1965) defined management control as “the process,
by which managers assure, that resources are obtained and used effectively and efficiently in the accomplishment of the organizations objectives” (p. 17).
Ouchi (1979) conducted further research on the concept of management control and developed a framework for the design of the organizational control mechanisms. According to Ouchi (1977) as a result of organizational growth, organizations should accommodate their control mechanisms accordingly to ensure the obtainment of the desired results and to monitor behavior, while considering the hierarchical levels within the organization. The framework developed by Ouchi (1979) provides three types of control mechanisms, targeting the alignment of the organizational objectives with the objectives of the individuals within the organization. Malmi and Brown (2008) developed a conceptual framework for a management control package, where they distinguish five types of controls: planning controls, cybernetic controls, reward/compensation controls, administrative controls, and cultural controls. Their motivation for their research is the lack consensus in the literature when defining management control, and the limited amount of research of management control systems.
Emerging from the literature is the shift in focus from performance measurement to performance management. Nita (2008) explores the development of the performance management process and signals the need for organizations to look further than the management
control process and pay attention to the entire performance management process, which he considers to be a prerequisite for the successful evolvement of strategy of the organization. According to Aguinis (2009, p. 2) performance management is “a continuous process of identifying,
measuring, and developing the performance of individuals and teams and aligning performance with the strategic goals of the organization”.
Langfield-Smith (1997) examines the literature regarding the coherence between management control systems and strategy. Her research shows, that the quantity of literature is limited, though she underlines the possible importance of employee involvement with strategy. In addition to the role of employees with strategy, the literature indicates that the involvement of employees with the performance management process could also improve organizational performance (Gruman and Saks (2011); de Leeuw and van den Berg (2011)).
The management information system serves an important purpose in the performance management process as it should contain information necessary for decision making and control (Nudurupati et al. 2011). Performance measures could provide a useful source of information, as they should put forward the strength and weaknesses of the organizational performance (Grafton et al. 2010). Organizations have several possibilities to present information. One of the possibilities is the use of dashboards, which according to Yigitbasioglu and Velcu (2012) could provide an opportunity to make information more accessible for people within the organization. According to Aguilar (2003) the performance management process could be very useful when implementing the strategy throughout the organization. Aguilar (2003) identifies 5 performance management dimensions that he considers to be critical for maximizing the organizational value, and achieve the goals of the organizations including: strategic planning, performance measurement, integrated business planning, management reporting, and organizational culture and reward system. Otley (1999) proposes a performance management framework which focusses around 5 questions regarding several elements of the organization, whose answers develop and change over time, together with the organization. These questions later became part of the performance management system model developed by Ferreira and Otley (2009).
Performance management system models have been part of the organizational performance research stream for the past few decades. While quite some research is dedicated to the performance management system and its different components, there still is a research gap in relation to the subject. Furthermore, so far research has failed to develop an generally accepted definition of the concept (Pinheiro de Lima et al. 2013). Adler (2011) developed a framework
which connects the performance management system to the strategy of the organization, while emphasizing the role of external factors, which are a component of the model. According to Adler, the performance management system should be adjusted to the strategy of the organization, as he emphasizes the substantial influence of the strategy on the entire organization and its processes.
The lack of consensus in the literature is also mentioned by Franco and Bourne(2003). They also urge on the lack of empirical research regarding performance management systems. Both Nilsson and Kald (2002) and Busco et al. (2008) research the use of performance management systems in practice. Nilsson and Kald (2002) focusses on the interactive and diagnostic use of the performance management systems, and the design of the overall performance management system. The main focus of their research is on the Nordic regions of Europe. Busco et al. (2008) perform a case-study at Nestlé waters to explore the role of the performance management system after a change of strategy. The study specifically focusses on the integrating strategy Nestle was in the process of adopting.
Ferreira and Otley (2009) developed a framework which aims to create a comprehensive view of the performance management system used by an organization. They have developed questions relating to twelve different elements and processes within the organization relating to the performance management system including: vision and mission, key success factors, organizational structure, strategies and plans, key performance measures, target setting, performance evaluation, reward system, information flows, systems and networks, PMSs use, PMSs change, and strength and coherence.
Figure 3 shows the Performance Management Systems model developed by Ferreira and Otley. By studying these twelve elements, answering the corresponding questions, and studying the interaction between the different elements, the performance management system used by an organization can be surveyed . These twelve elements will be further explained below. An overview of the accompanying questions, and the questions developed for this research is given in appendix 1A and appendix 1B.
Figure 3 (Ferreira and Otley, 2009, p.268)
The first element of the framework, vision and mission is concerned with the vision and mission of an organization and how they are communicated throughout the organization. According to Johnson et al. (2005, p. 13) the mission contains “the overriding purpose of the
organization in line with the values or expectations of stakeholders” and the vision describes “the desired future state: the aspiration of the organization”.
According to David (1989), the mission describes the “organizations reason for being”. After the determination of the mission, the mission should be communicated to the different stakeholders, which, for example can be achieved through the development and issuance of a mission statement (David, 1989, Klemm et al., 1991, Bart et al., 2001). The mission statement can either serve an external purpose or an internal purpose, in which it can be used to communicate the mission to the employees and by that motivate the employees and become part of the organizational culture (Klemm et al., 1991).
The development and communication of a clear organizational mission can contribute to the a alignment of short-term and long-term organizational goals (David, 1989). According to Bart et al. (2001) the development and communication of the organizational mission provides an opportunity to control employee behaviour, by motivating them to serve to organizational mission. According to their research a strong organizational mission contributes to the chance an employee will succeed in serving the organizational mission.
Looking at the literature concerning the vision of an organization the majority sees the vision as part of the organizational plan to the future (El-Namaki, 1992, Collins and Porras, 1996). El-Namaki (1992, p. 27) identifies several conditions required for a vision to be accurate, including: “be realistic and feasible, and clear; provide a challenge for the whole organization; mirror the goals
and aspirations of the constituents; able to focus the attention with respect to scope and time; translatable into goals and strategies, endorsed and frequently articulated by top management.” According to Sadri and Lees
(2001), strong communication of the organizational vision is essential to its effectiveness.
According to Collins and Porras (1996) a vision should not only have a long-term focus, and be clearly described, it also should incorporate the organizations core values and core purpose, the core ideology. The core values and core purpose focus on the fundamental values and purpose of the organization and should be incorporated when deciding over the future. The core ideology focuses on the people within the organization, who are essential when realising the vision of the organization.
The second element of the framework, focusses on the identification of the key success factors. Key success factors, also called critical success factors in the literature (Clarke, 1999), are “for any business the limited number of areas in which results if they are satisfactory, will ensure successful
competitive performance for the organization. They are the few key areas where things must go right for the business to flourish” (Rockart, 1979, p. 85).
The identification of the key success factors can serve several purposes within the organization. By putting the focus on the successful areas of the organization, the key success factors could provide useful insight in the information needs of the senior management regarding to several processes within the organization including: strategic planning, strategy development, performance measurement and control. The key success factors could play an important role in the strategy of an organization (Leidecker and Bruno, 1984).
The importance of key success factors in the strategic process of an organization is emphasised by several authors. The main purpose of the key success factors is the identification of areas where the organization could be successful. According to Ragone (1997), an organization should carefully identify, asses, and monitor the key success factors, in order to be successful at the chosen strategy. The identification of the key success factors provides an opportunity to identify the organizations strengths and weaknesses and the threats and opportunities in the organizations environment, whih are essential when developing the organizations strategy (Leidecker and Bruno, 1984).
The third element of the framework is organization structure. The structure of the organization plays an important role in several processes and components within the organization, including the strategic process, and the control process. Several models regarding organization structure have been developed and discussed in the literature (Dalton et al. 1980). Child (1973) developed a model of organization structure whereby the size of the organization and subsequently organizational complexity and bureaucratic control, are crucial determinants of the organizational structure. Pugh et al. (1968) identify, in an attempt to measure differences in organizational structure across organizations, six dimensions of organizational structure: specialization, standardization, formalization, centralization, configuration, and flexibility, whereby the dimensions are based on several features of the organization.
Three of the dimensions are also used by Frederickson (1986). Frederickson (1986) examines the relationship between the strategic decision process within an organization and the organizational structure. The dimensions used by Frederickson are: centralization, whereby the organizational structure is based on the assignment of authority and decision making, formalization, whereby the organizational structure is based on presence of rules and procedures and, complexity, whereby the organizational structure is based on presence of interrelated parts within the organization.
The research shows that the different dimensions of organizational structure, influence strategic decision making process. The different dimensions of organizational structure, place the authority and decision making rights with different people in the organization, and follow a different structure. As a result different goals are pursued, and what is considered as important might differ. Also there could be a discrepancy in the level of involvement across the organization, as a result the level of influence people have on the strategic decision making process, which is also depended on the organizational structure (Frederickson 1986).
An important process in the organization is control. As described by Flamholtz et al. (1985), organizations should increase the likelihood that the goals of the individuals within the organization are equal to the goals of the organization, by developing adequate control mechanisms. The framework developed by Flamholtz et al. (1985) considers the organizational structure part of the control context. The organizational structure by itself could directly or indirectly serve as a control mechanism as a result of its design. The relationship between the organizational structure and control is also described by Ouchi (1977), who concludes that the organizational structure is related to organizational control.
The fourth element of the framework is strategies and plans. There are several definitions of strategy in the literature (Dent, 1990). According to Chandler (1962, p. 13) strategy is “the determination of the basic long term goals and objectives of an enterprise and the adoption of courses of action and the allocation of resources necessary for carrying out these goals”. The development of the organizational strategy starts with the people within the organization (Johnson, 1992). The top management is responsible for the strategic planning process, identifying the goals of the organization, and develop plans to achieve those goals (Daft and Macintosh, 1984).
Frederickson (1986) identifies six factors that are critical in the strategic decision process: process initiation, role of goals, means ends relationship, explanation of strategic action, comprehensiveness in decision making, and comprehensiveness in integrating decisions. An organization faces changes in their environment over time, which could create new opportunities for the organization, it is up to the people within the organization to translate these opportunities into adequate strategies (Johnson, 1992).
The management control system plays an important role in the strategic process both in the initiation process as well as in the monitoring process (Daft and Macintosh, 1984; Simons 1991; Otley 1999). According to Simons (1991), the control system can help the management decide if the strategic goals are achieved by providing the tools to evaluate organizational performance in comparison with the strategic goals, as well as highlighting areas were new strategic possibilities arise. Daft and Macintosh (1984) describe the relation between strategy and control as well. They consider the strategic process and the control process to be interrelated. The strategic process influences the control process by setting standard needed to achieve the goals of the organization, while the control process provides an opportunity to communicate the strategy throughout the organization and evaluate performance compared to the strategy.
The fifth element of the framework is key performance measures. The next step in the framework follows from the previous four elements and is used in the organization to “evaluate
success in achieving their objectives, KSFs, strategies and plans” (Ferreira and Otley, 2009, p. 271). The
past few decades many organizations faced multiple changes in their environment, which influenced the organizations in several ways. The new business environment created opportunities for new strategies, which in turn required adjustments to the way organizations measured the performance. One important consequence was the development and implementation of non-financial performance measures. To facilitate these changes in strategy and performance measurement the information system required adjustments (Eccles, 1991).
Neeley et al. (1997) developed a framework, called the performance measure record sheet, which could support organizations when developing and implementing performance measures. “The framework consists of ten elements: title, purpose, relates to, target, formula, frequency, who
measures, source of data, who acts on the data, what do they do, notes and comments” p. 1136. According to
the authors, identification of these elements could encourage the development of suitable performance measures.
Non-financial performance measures have been subject of discussion in the literature. Ittner and Larcker (1998) found evidence that measuring customer satisfaction could be beneficial for internal performance measurement purposes. Non-financial performance measures are also a component of Rangone’s (1997) fuzzy linguistic framework. The linguistic framework aims to show the effectiveness of the organization as a result of the relationship between the strategy of the organization, the key success factors, and the key performance measures, both financial and non-financial.
The sixth element of the framework is target setting. The target setting process is part of the control system of an organization and serves several purposes within the organization, including: planning purposes, control purposes, evaluation purposes, and motivation purposes (Merchant and Manzoni, 1989). There are several stages in the target setting process and the responsibility of target setting could be assigned to different people within the organization.
One of the possibilities for an organization is to engage in a participative budgeting process. According to Shields and Shields (1998, p. 48) participative budgeting is “a process in
which a manager is involved with and has influence on the determination of his or her budget”. There are
several reasons why an organization could decide to follow a participative budgeting process, including organizational structure, environmental uncertainty, employee motivation, value attainment, and information asymmetry between a superior and a subordinate (Shields and Shields, 1998). An organization could also reduce information asymmetry by increasing organizational trust (Dirks and Ferrin, 2001).
One subject that has been discussed extensively in the literature is target achievability. Setting the target at the appropriate level is an important aspect of the target setting process. Merchant and Manzoni (1989), extensively discuss the trade-off organizations face when deciding either to develop high achievable targets or low achievable targets, and the motivation behind their choice, which according to their research, could vary from increasing the likelihood to receive a bonus, credibility, and increasing profit, depending on the level of management in charge of the decision.
Target achievability is also researched by Fisher et al. (2003). When measuring individual performance is difficult, organizations could decide to focus on the results of the entire group or department instead. Group performance convenes several control issues including the free-rider problem. Fisher et al. (2003) research the influence of performance based contract on group performance, while taking the level of achievability in consideration.
The seventh element of the framework is performance evaluation. Measuring organizational performance could serve several purposes including: evaluation purposes, control purposes, budgeting purposes, motivational purposes, learning purposes, and improvement purposes. Measuring organizational performance is essential in evaluating how the organization is progressing towards its goals, but measuring organizational performance is only useful when the results subsequently lead to the necessary actions to improve organizational performance (Behn, 2003).
Traditionally financial accounting data have been the main source for performance measurement. According to Hopwood (1972) accounting data serves multiple purposes within the organization and as a result, will not always necessarily be most suitable for performance measurement and evaluation. In an attempt to influence the outcome of performance measures, accounting data could be subject to manipulation, and consequently negatively influence organizational performance. The main aim of Hopwood’s (1972) research is to discover the influence of evaluation style on organizational behavior regarding performance evaluation measures.
While performance measures based on financial accounting data are mostly objective, subjective performance measures have been widely discussed in the literature and have become part of the organizational performance evaluation process. According to Prendergast and Topel (1993) subjectivity in performance evaluation is inevitable, as a result of the human involvement in the evaluation process. Due to the human evolvement, organizations have to be aware of the possibility of bias in the evaluation process as a result of personal preferences and relationships within the organization. In addition they consider subjective performance measures a necessity since not all performance is objectively measurable.
Subjective performance measurement is also subject of the research of Dess and Robinson (1984) and Dawes (1999) who both examine the correlation between subjective and objective performance measures. Govindarajan (1984) studies the influence of environmental uncertainty on the usage of subjective performance measures, and concludes that they are positively related. While both objective and subjective performance measures could have a
positive influence on performance evaluation it is important to find a balance between these measures in order to achieve the optimal result (Ittner et al. 2003).
The eight element of the framework is reward systems. Ferreira and Otley (2009) consider both financial and non-financial rewards as part of the reward structure. Rewarding desired behaviour and discouraging undesired behaviour is key to a sound rewarding system, but is not as straightforward in practice as it might seem (Kerr, 1975). In exploring literature regarding the influence of human resource management on organizational performance Hiltrop (1996), concludes that there is strong evidence that human resource management could have a positive influence on employee behaviour.
According to Katz (1964) employee behaviour and motivation is of great importance to an organization for several reasons, including ensuring low employee turnover, reliability, and encouraging innovations. Through employee rewarding organizations could encourage desired behaviour and increase motivation, whereby there is a distinction between individual rewards, and system rewards, which does not depend on individual performance. According to Brownell (1982) the influence an employee has on the performance he is rewarded for is positively related to the effectiveness of that reward on employee motivation.
Through the reward system organizations try to positively influence employee performance and ultimately maximize organizational performance (Katz 1964). As discussed in the previous section non-financial performance measures have become more important in organizational performance measurement, and subsequently in the reward systems. Both Banker et al. (2000) and Said et al. (2003) examine the influence of non-financial performance measures on performance based contracts.
The ninth element of the framework is Information flows, systems, and networks. Organizations generate and use an on-going flow of information. The key issue is to ensure that the information generated is useful for organizational purposes (Daft and Lengel, 1986). As stated by Granlund and Mauritsten (2003) the past decades were characterized by multiple developments in information technology, including the development of systems such as enterprise resource planning systems (ERP), which could have a beneficial influence on
organizational progresses. They also emphasize the role of accounting information systems in the management control process.
According to Lebas (1995) organizations should, when developing their performance management system, have a clear understanding what they want to measure and why they want to measure it. This, in turn is based on the relationship between the organizational objectives and actual performance. According to Eccles (1991) the development of new information technology
and the development of non-financial performance measures such as customer satisfaction have an important influence of the information architecture of and organization. Information architecture includes: “categories of information needed to manage a company’s businesses, the methods the company uses to generate this information and the rules regulation its flow” (Eccles, 1991, p. 133).
Both Chenhall and Morris (1986) and Daft and Lengel (1986) developed a model to provide better understanding of information requirements within organizations. Chenhall and Morris (1986) develop a model which explores the relationship between organizational factors, including decentralization, perceived environmental uncertainty, and organizational interdependence and information characteristic, including scope, timeliness, aggregation, and integration. Daft en Lengel (1986) developed a model which examines the influence of uncertainty and equivocality on information requirements within the organization, including the organizational structure and the available technology.
The tenth element of the framework is PMSs use. According to Ferreira and Otley (2009) there isn’t a generally accepted consensus in the literature regarding the use of the performance management system measures and information generated by the system. Chenhall and Langfield-Smith (2007) explore the choice and design of performance measures. They make a distinction between cybernetic controls and strategic controls and also make a differentiation between financial and non-financial measures.
The performance management system affects the entire organization. Research on control mechanism affecting the management has been done for instance by Coughlan and Schmidt (1985). They examine the control mechanisms affecting top management, specifically, mechanisms available to the board of directors to align the goals of the top management and the shareholders to reduce the agency problem, which according to Coughlan and Schmidt results predominantly from information asymmetry between the top managers and the board of directors. Their evidence suggests that depending management compensation on the stock price of an organization could provide a relevant control mechanism.
Neely et al. (1995) consider performance measurement as a process or metric to quantify effectiveness and efficiency of an organization. They identify three levels of performance management: at individual level, at performance management system level, and at environmental level, whereby they make a distinction between internal organizational environment and the external organizational environment. Ouchi (1979) identifies 3 mechanisms that should contribute to the process of aligning organizational goals and employee goals: market mechanisms, which are inevitably present, bureaucratic mechanisms, which are developed and
implemented by the organization, and clan mechanisms, which are part of the informal structure and the organizational culture.
Like Chenhall and Langfield-Smith (2007), Langfield-Smith (1997) makes a distinction between formal controls, including feed forward controls and informal controls which show, as stated by Langfield-Smith (1997) similarities to clan mechanisms developed by Ouchi (1979). Langfield-Smith (1997) examines the importance of management control systems in regards to corporate strategy. She also pays attention to interactive controls and diagnostic controls, developed by Simons (1995), which was also mentioned by Ferreira and Otley (2009).
The eleventh element in the framework is PMSs change. According to Cheng et al. (2007) the performance management system plays a dual role in organizational change. While it could facilitate changes within the organization, it also affects the organization when the system itself is subject of change. Their case-study underlines the importance of management and employee commitment to change, in order to guarantee its success. To stay successful organizations should continuously accommodate to their changing environment. The ability of an organization to adapt to these changes provides a foundation for organizational learning (Fiol and Lyles, 1985), whereby the performance management system is highly involved (Atkinson et al. 1997).
According to Burns and Scapens (2000) organization are a collection of rules and routines. The model developed by Burns and Scapens (2000) sees accounting change as a process of the emergence of new rules, which lead to new routines within the organization, influenced by old routines. After time these new routines become institutionalized and part of the organization. The model of Burns and Scapens (2000) has been an important component of the research of Lukka (2007), who examines management accounting change and stability. In addition to the model of Burns and Scapens (2000), Lukka (2007) considers the presence of loose coupling within the organization a important factor for the occurance of accounting change and stability at the same time.
The twelfth element of the framework is strength and coherence, and intends to explore the strength and coherence between the previous eleven elements of the framework (Ferreira and Otley 2009). There are findings in the literature that describe these relationships between the different elements of the framework. Van der Stede et al. (2006) discuss the performance alignment process between strategy, performance measurement and ultimately organizational performance. This is supported by evidence resulting from their research.
Sandelin (2008) performs a case study, which explores the control packages used in high growth organizations. The evidence supports the view that the effectiveness of the control
package is dependent on the consistency between the different components of the management control package, which accentuates the relationship between the different elements of the system. The breakdown/ aggregation model developed by Berrah and Clivillé (2007) also remarks on the relationship between different elements in the performance management cycle. They consider identification of the relationship between the different elements as an important but difficult process.
Finally, as also mentioned by Ferreira and Otley (2007) a description of the strength and coherence between a performance management system is developed by Chenhall (2003) who considers the management control system as a possibility to “consider multiple stakeholders; measure
efficiency, effectiveness and equity; capture financial and non-financial outcomes; provide vertical links between strategy and operations and horizontal links across the value chain; provide information on how the organization relates to its external environment and its ability to adapt” (p. 136), compared to the organizational goals.
Broadbent and Laughlin (2007) use the model of Ferreira and Otley (2009) as the basic assumption of the model they develop. Particular attention is given to the last four elements of the framework, the external factors, which they regard as the underlying principles when answering the first eight questions. Though, they support the opinion that the questions related the last four elements of the framework developed by, could be improved by providing better guidelines regarding the questions. Broadbent and Laughlin (2007) consider the model developed by Ferreira and Otley (2009) to be very useful when establishing the performance management system used by an organization.
3 Overview Dutch financial sector
To develop a better perspective of financial market regulation and supervision, and to get a better understanding of the Dutch Financial Supervision Act, this section will discuss financial market regulation and supervision in general and the Dutch Financial Supervision act in specific.
3.1 Financial market regulation and supervision
Over the past decades several countries have changed the regulation and supervision of their financial market. There are several explanations for this changes including: the emergence of a financial crisis, institutional changes, and market integration (Lumpkin, 2002; Čihák and Podpiera, 2008). According to Begg (2009) the financial crisis of 2007 posed a serious threat on the financial stability across different countries in Europe, as it uncovered several limitations and weaknesses in financial market regulation and supervision across Europe, which resulted in an increased demand for changes in the regulation and supervision of the financial market.
Traditionally the financial market consisted of three main financial institutions: banks, insurance companies, and securities firms, all with their own separate market. Over de past few decades these financial institutions have become more and more integrated (Lumpkin, 2002; Čihák and Podpiera, 2008). Providing products and services originally offered by other types of financial institutions, created new growth opportunities for financial institutions. The tendency to diversify to different types of products and services was reinforced by the increasing globalization during the past decades. While the opportunity to diversify is valuable to financial institutions, it increases competition among the financial institutions, and makes the process of regulating and supervising the financial markets more complicated. This is reinforced by the increased complexity of the financial products and services (Di Giorgio and Di Noia, 2002; Lumpkin, 2002).
The entire financial market consist of many different financial organizations, with different business goals, different products and services, legal structures, and of a different size. Governments have different approaches to supervise financial institutions. These approaches divide financial institutions into different categories, based on different features of the financial institution, which depend on the approach chosen. We can distinguish the institutional approach, the functional approach, and the integrated approach (Lumpkin, 2002; Wymeersch, 2007).
The institutional approach, also called the three pillar approach, is the most traditional approach. As previously mentioned, the financial market originally consisted of three types of financial institutions: banks, insurance companies, and securities funds, all with their own types
of business, and legal form. With the institutional approach the supervision is based on the legal form of the financial institution. The supervision is assigned to an agency that is solely responsible for one type of financial institution. Which resulted in the appointment of three separate agencies: one responsible for the supervision of banks, one responsible for the supervision of insurance companies, and one responsible for the supervision of securities funds, all with their own rules regarding the supervision of the financial institution. Originally the agencies were responsible for the prudential supervision, later conduct of business supervision was also added (Lumpkin, 2002; Wymeersch, 2007).
The institutional approach is still used worldwide, but the developments in the financial market have consequences that should be considered. An important development is the tendency of financial institutions to diversify. Financial institutions started to provide products and services originally offered by other types of financial institutions, with a different legal form, while still being under the supervision of the same agency they were assigned to when the financial institution was established. As a result financial institutions who sell the same products, but have different legal form, are subject to different supervision rules. Combined with the increased competition in the financial market, this imposes serious consequences for the financial institutions (Lumpkin, 2002; Wymeersch, 2007).
The functional approach ignores the legal form of the financial institution, and instead bases the supervision approach on the main business goals of a financial institution. Several agencies might be formed, based on different business goals, such as banking, insurance, and trade of securities. The agencies are responsible for the development of their rules of supervision, and a clear distinction should be made between agencies responsible for the prudential supervision, and agencies responsible for conduct of business supervision (Lumpkin, 2002; Wymeersch, 2007).
As a result of the diversification strategy, financial institutions might pursue several goals at once, and might be subject to the supervision of several agencies at the same time. An advantage of this approach is that all financial institution pursuing the same business goal are subject to the same supervision rules. However the rules and responsibilities of the different agencies should be clearly defined, to prevent overlap between the different agencies. An example of a functional approach is the twin peaks model. Whereby the prudential supervision and conduct of business supervision of all the financial institutions are assigned to two different agencies. One agency responsible for the prudential supervision and the other agency responsible
for the conduct of business supervision. The twin peaks model will be further explained in the next paragraph (Lumpkin, 2002; Wymeersch, 2007).
The integrated approach results from the diversification tendency of the financial institutions. The integrated approach aims to combine all the different forms of supervision required for the products and services an financial institution sells, but also takes the legal form of the financial institution into account. Although this approach is still in development, there is a reasonable chance it will become adopted more often due to the developments in the financial market (Wymeersch, 2007).
Financial market regulation and supervision serves several objectives. One objective is to create macro-economic stability. The main aim of creating macro-economic stability is to protect the economy for financial crises. By implementing different forms of controls, often executed by the central bank., the government attempts to ensure that financial market performs at an optimal level. Another objective is to create micro-stability, which aims, through different rules and controls, to ensure that all financial institutions are stable at individual level. Finally, another objective is conduct of business supervision, through which the transparency of financial institutions is raised, and by doing so, the government strives to ensure safe practices from the financial organisations (Di Giorgio and Di Noia, 2002; Herring and Carmassi, 2008).
To meet the objectives of financial supervision Wymeersch (2007) identifies three main types of supervision: prudential supervision, conduct of business supervision, and oversight supervision. Prudential supervision aims to ensure the solvency of financial institutions. Conduct of business supervision strives for honest and safe practices from the financial institutions, and finally oversight supervision, executed by the central bank, aims to ensure the stability of the entire financial market.
The responsibility of the execution of the prudential supervision and conduct of business supervision is dependent on the institutional structure a country seeks to follow. The institutional structure of a county is “related to the number and structure of agencies responsible for the regulation and supervision of financial institutions and markets which includes the role of the central bank in this area” (Llewellyn, 2006, p. 4).
Both prudential supervision and conduct of business supervision are key to the functioning of the financial market. According to Mishkin (2001) prudential supervision should protect clients of financial institutions by restricting information asymmetry between financial institutions and their clients, and protect them from insolvency of the financial institutions. Conduct of business supervision is aimed at protecting clients from unfair business of a financial
institution. By monitoring financial institutions and setting up rules regarding disclosure, fair practice of the financial institution should be ensured (Herring and Carmassi, 2008).
According to Llewellyn (2006) countries have to make the crucial decision whether the supervision is executed by the central bank, or a separate agency and if both prudential supervision ad conduct of business supervision can be executed by the same institution. Llewellyn makes a distinction between integrated agencies, where there is one single agency responsible for the prudential supervision of all the financial firms, and unified agencies, where both prudential supervision and conduct of business supervision of all the financial firms is executed by one agency.
Across the world several models of financial market supervision have been adopted, and sometimes already have been abandoned due to new developments or changes. The model used for supervision depends on the public authorities of the county it is implemented in, and on the approach they seek to follow. The role of supervisor often is assigned to the central bank and often an independent special financial supervision authority. There are four main models of supervision: based on the sector, based on the objective, based on the function, and combined as a single regulator (Herring and Carmassi, 2008). The model applied in the Netherlands will be furthermore discussed in the next section.
3.2 The Dutch Financial Supervision Act
On January first 2007 the Dutch Financial Supervision Act took effect. The aim of the Dutch Financial Supervision Act was to replace the different supervision acts of the multiple financial market sectors, and combine them to one supervision act for entire financial market sector. As a result of developments in the Dutch financial market, the Dutch government adopted a new model of financial supervision (website AFM, 2012).
As mentioned in the previous section there are several approaches of financial market supervision. The past decade the Dutch financial market, and accordingly the financial supervision has evolved over time. Traditionally the Dutch financial market consisted of three financial sectors: the banking sector, the pension and insurance sector, and the securities sector. They were supervised according to the institutional approach, whereby the supervision was assigned to three different agencies, one for each financial sector, and all with their own rules. The banking sector was supervised by the Dutch National Bank (DNB), the pension and insurance sector was supervised by the Pensions and Insurance boards (PVK), and the security sector was supervised by the Securities Board (STE) (Van Lelyveld and Schilder, 2003). Figure 1 provides an overview of Dutch supervision model based on the sector.
Figure 1: Stylized structure of the Dutch financial supervision based on the sector
Sourcce: Kremers et al. (2003, p. 226)
As a result of developments in the financial market the Dutch financial supervision model was adjusted in 1990. One important development in the financial market, which had a strong influence on the financial market supervision, was the establishment of financial conglomerates. According to Van Lelyveld and Schilder (2002, p. 3) “financial conglomerates are groups that combine banking, securities, and insurance activities within one organization”. Financial conglomerates could be operating internationally.
In 1990 the Dutch National Bank and the Pensions and Insurance Boards developed a protocol to coordinate the supervision of financial conglomerates specialized in banking or insurance activities. Rules were developed concerning group solvency reports, risk concentration, and intra group transactions. In 1999 more adjustments were made with the development of the Board of Financial Supervisors (BFS), which was responsible for the coordination of rules that applied to all financial institutions, regardless of the sector (Lelyveld and Schilder, 2002; Lumpkin, 2002; Wymeersch, 2007). According to Dierick (2004), the Netherlands were one of the first countries to transfer the supervision of insurance companies to the central bank. This could be explained by the presence of a substantial amount of insurance orientated financial conglomerates, who have a significant influence on the Dutch financial market.
In 2002 the transfer was made to the functional approach, when the prudential supervision of the financial market was assigned to both the Dutch National Bank, and the pensions and insurance boards (PVK). The conduct of business supervision of the financial market was assigned to the securities board (STE), which was reclassified as the Authority
Financial Market (AFM). The Board of Financial Supervisors (BFS) remained responsible for coordination of rules concerning the overall market (Lelyveld and Schilder, 2002; Lumpkin 2002).
In 2007 the twin peak model of financial market supervision was introduced, an integrated supervision model. In 2007 the prudential supervision of the entire financial market was assigned to the Dutch National Bank, and the conduct of business supervision of the financial market was assigned to the Authority Financial Market (Herring and Carmassi, 2008). Herring and Carmassi (2008) identify three reasons for the implementation of an integrated supervision model, such as the twin peak model. First, the developments in the financial markets, such as diversification, creates gaps in the traditional institutional approach of supervision. Second, as mentioned before, as a result of the institutional approach, different rules might apply to one product, depending on the legal form of the financial institution. As a result regulatory arbitrage might occur. The third reason is the possibility that a new approach could increase the efficiency of the financial supervision, by preventing overlaps in the supervision rules. Figure 2 provides an overview of the Dutch twin peak model of financial supervision.
Figure 2: Dutch twin peak model of financial supervision
Source: Kremers et al., 2003, p. 226)
The past few decades the Dutch financial market super approach has evolved. According to Kremers et al. (2003, p. 227) “The underlying principle is that market developments should be accompanied as much as possible, while at the same time maintaining the effectiveness and efficiency of the objectives of financial supervision. The authors claim that supervision agencies should enable financial agencies to develop, and adjust the financial supervision accordingly, while striving for most efficient and effective supervision possible.
According to Llewellyn (2006) an important advantage of the twin peak model is the separation of prudential supervision and conduct of business supervision. By assigning prudential supervision and conduct of business supervision to two separate agencies there is no longer the possibility that preference is given to one type of supervision As mentioned in the previous section, prudential supervision is meant to ensure the solvability of the financial institutions, and to construct a stable financial market. Market conduct supervision is aimed at ensuring a sound, transparent market, and to protect the clients of the financial institution. Protection of the clients is an important aspect of the Dutch Financial Supervision Law, and will be further discussed in the next section (Bouwman and Westerlaak, 2008).
3.3 Consumer loans suppliers
The Dutch financial market consists of several different types of financial institutions, with combinations of different products and services. These include banks, insurance companies, pension funds, and so on. In the interest of this research in this chapter the market for consumer loans will be further explained. The market for consumer loans consists of different suppliers, including banks and intermediaries. There are several forms of consumer loans: personal loan, continuous credit, card credit and overdraft.
Before the introduction of the Dutch Financial Supervision act the laws, rules and supervision of this sector were registered in the Dutch Financial Service Provider Act. The implementation of the new law had an important effect on the suppliers of consumer loans. New, stricter laws, and rules were applied, which also were a result of developments in the market for consumer loans (website AFM, 2012).
As previously explained, the Authority Financial Market (AFM) is responsible for the conduct of business supervision of the Dutch financial market. The Dutch Financial Supervision Act replaced eight prior supervision laws, concerning different financial organizations within the financial market. The Dutch Financial Supervision Act brought together all the different laws, rules, and forms of financial supervision and replaced them with one universal law, applying to all the financial institutions (website AFM, 2012). According to the AFM website (2012) the aim of the Dutch Financial Supervision Law is to create “a targeted, market orientated, and transparent law for the financial markets”.
As a result of the Dutch Financial Supervision Act all financial service providers, including suppliers of consumer loans should obtain a license from the AFM, independent of the form of the financial institution. In order to obtain a license the financial service provider should comply to the rules and standards set by the AFM. In addition, the AFM oversees if the
consumer loan supplier complies to all the laws and rules of the Dutch Financial Supervision Act after the consumer loans supplier receives a license. Another responsibility of the AFM is to ensure that consumers receive honest, and right information from the consumer loan supplier. Consumer protection and transparency of the consumer loan supplier are important goals of the AFM (website AFM, 2012).
The laws and regulations applicable to consumer loan suppliers are registered in the Dutch Financial Supervision Act, Besluit Gedragstoezicht Financiële ondernemingen (BGFo), and in
Nadere Regelingen gedragstoezicht financiële ondernemingen (NRgfo). According to the AFM (AFM
Website, 2012), there are four provisions that are of significance importance to the suppliers of consumer loans: the obligation to obtain a license from the AFM, the responsible loan standard, information transparency, and the reward structure.
The Dutch Financial Supervision Act, contains laws and rules concerning the overall supervision of the financial market. The Besluit Gedragstoezicht Financiële ondernemingen (BGFo), contains laws and rules that are more organization specific including legal provisions concerning the competencies of the employees, reliability, business integrity, and procedures regarding complaints. The Nadere Regelingen gedragstoezicht financiële ondernemingen (NRgfo) focuses more on information transparency, as it includes laws and rules concerning the disclosure of pre-contractual information, and the “financiële bijsluiter”, which provides information regarding costs, returns, and risk of the financial product (website AFM, 2012; website http://www.overheid.nl, 2012)
An important aspect of the Dutch Financial Supervision Act is the responsible loan standard. According to the Authority Financial Market (website AFM, 2012), suppliers of consumer loans should prevent over lending by consumers. In order to prevent over lending three trade organizations The Nederlandse vereniging van Banken (NVB), the Vereniging van
Financieringsondernemingen in Nederland (VFN) and the Nederlandse Thuiswinkel Organisatie (NTO)
have developed two codes of conduct, concerning the responsible loan standard.
The first code of conduct, the code of conduct of the VFN applies to all the different types of consumer loans. The second code of conduct, from the NTO applies to only one specific type of consumer loan. Suppliers of consumer loans could decide to join a trade organization and use their code of conduct, or develop and use their own code of conduct, in that case the Authority Financial Market monitors if the code of conduct protects the consumers from over lending, and if the loan standards are according to the responsible loans standard (website AFM, 2012).
4 Methodology
This section describes the methodology used for the research. The first subsection describes case-study research in general, and why this research method was chosen for this research, the second subsection gives a brief description of the organization where the case study was undertaken, the third subsection gives a description of the research framework used for this study. The fourth subsection describes how the case-study research was designed.
4.1 Case-study research
For this research a case-study at a Dutch supplier of consumer loans is performed. According to Yin (2009, p.18) a case-study is “an empirical inquiry that investigates a contemporary phenomenon within its real-life context, especially when the boundaries between phenomenon and context are not clearly evident”. Furthermore, Ryan et al. (2002, p. 143) who consider that case studies “offer us the possibility of understanding the nature of accounting practice; both in terms of the
techniques, procedures, systems etc. which are used and the way in which they are used”
Ryan et al. (2002) and Scapens (1990) identify five different types of case-studies in accounting research: descriptive, illustrative, experimental, exploratory, and explanatory. Descriptive case-studies focus on describing events within its context, the objective is to describe accounting practices currently used. Illustrative case-studies can be used when illustrating innovative practices developed by a company. Experimental case-studies are used to test and examine new ideas within the management accounting practice. Exploratory case-studies give the possibility to explore the reasons why certain accounting practices are used. And explanatory case-studies aim to explain why some accounting practices are used.
Case-study research is a process that evolves over time. Ryan et al. (2002) and Scapens (1990) identify six main steps in case-study research: preparation, which includes the development of the research questions, collecting evidence, assessing evidence, identifying and explaining patterns, theory development, and report writing. The collection of evidence is an important aspect of case-study research. There are several sources of evidence including: documents, archival records, interviews, direct observation, participant observation, and physical artifacts (Yin, 2009). According to Yin (2009) when conducting an case-study the researcher should ensure triangulation of information by using multiple sources of evidence. By using multiple sources of evidence the accuracy of the case-study could by increased.
After the implementation of the Dutch Financial Supervision act, suppliers of consumer loans were subject of new laws and rules, and an increased forms of regulation. As stated in the previous section two important consequences of the Dutch Financial Supervision act are the development of the responsible loan standard, and the requirement to make their reward-structure visible to their clients. The responsible loan standard directly influences the production of the supplier of consumer loans, as it prescribes to whom they are allowed to sell a loan. The transparency requirement makes it easier for consumers to compare the different suppliers of consumer loans, and increase the competition on the market.
The implantation of the Dutch Financial Supervision act influences the way in which suppliers of consumer loans conduct their business, and as a result influences their performance. According to Scapens (1990) case-studies provide a good opportunity to create an understanding of the use of management accounting in practices. According to Yin (2009), a case-study is appropriate when the research focus on the explanation of how or why in a particular situation.
This research focuses on how the performance management system of a supplier of consumer loans has changed as a result of the implantation of the Dutch Financial Supervision act. It aims to describe the main changes in the performance management system as a result of the implementation of the Dutch Financial Supervision Act. In order to answer the main research question: how has the performance management system changed after the implementation of the Dutch Financial Supervision Act?, an descriptive case-study is conducted at Company X, a supplier of consumer loans.
4.2 Case-study at Company X
In order to answer my research question I will perform a case-study at Company X. Company X is an issuer of consumer loan. Company X is the competence centre of four financial service providers operating under four different labels: Company F, Company G, Company H, and Company I. Their main objective is to provide loans to consumers.
Company X is an issuer of consumer loans in the Netherlands and has between 100 and 200 employees. Consistent with other financial institutions, Company X is covered by the Dutch Financial supervision act. The main objective of Company X is to become the largest issuer of consumer loans, while also meeting the requirements of the Dutch Financial Supervision Act. Since the introduction of the financial supervision act Company X strives to become a precursor in compliance to all the rules of the Dutch Financial supervision act, and is involved with the development of new rules of the Dutch Financial supervision act.
As seen in the previous section, consumer protection is an important part of the Dutch Financial Supervision Act, which is expressed by the responsible loan standard, the transparency requirement, and rules concerning the reward structure. All of these measures have an important impact on the performance of a provider of consumer loans. This might be even more significant for Company X, since compliance to the supervision act is an important part of their mission. The aim of this research is to study how the performance management system used by Company X has changed after the implementation of the Dutch Financial Supervision Act, and to see how the aim to comply to the rules of the Dutch Financial Supervision Act is translated to the performance management system.
The reason Company X is chosen for this research is, because of their image within the market. Company X has the image to be a reliable organization that takes an advanced position regarding the compliance with the laws and rules developed by the AFM. It would be interesting to see how an organization with this image operates in practice. This research focuses on the main objectives of the Company X, and the translation of these objectives to the performance management system, while taking the compliance to the Dutch Financial Supervision act into account.
4.3 Research design
As previously explained, the main aim of the research is to study the changes in the performance management system used by Company X as a result of the implementation of the Dutch Financial Supervision Act. In order to get a comprehensive view of the performance management system used by Company X, and the changes it might have experienced, the framework developed by Ferreira and Otley (2009), which is explained in de second chapter, is used.
As described in the previous section the research was conducted at Company X, a supplier of consumer loans. The research the first contact with the organization was May 2011 and the actual research was conducted in June 2012. Meetings were held with different members of the organization, in order to develop an understanding of the performance management system of Company X, and the changes that resulted due to the implementation of the Dutch Financial Supervision Act.
The research is based on six semi-structured interviews with different members in the organization, and the study of documents, and archival data, including posters, strategy cards, KPI dashboards, and management reports. The interviews were held with six members of the organization. Five members were head of their department, one member was team leader of the
department. All the interviewees were involved with the performance evaluation process of the employees of their department.
The questions, based on the framework of Ferreira and Otley, and disclosed in appendix 1B of this thesis, were posed to the head of the finance and control department, the head of the operational risk & compliance department, the head of the sales department, the head of the sales and support department, the team leader of the acceptance & contract intake department, and the head of the collections department. The members were chosen, based on their position, and their knowledge of performance evaluation and the Dutch Financial Supervision Act. A number of six interviewees was chosen based on the people who were available for the interviews, and to get a reflection of the business cycle within Company X.
All the interviews were recorded and full transcribed, also notes were taken during interviews, and the interviewees were asked to bring relevant documents. The interviews lasted between 30 and 75 minutes. The head of the finance and control department assisted collecting general information about the organization. After the transcription the interviews were analysed and the documents studied, to answer the research questions and the questions relating to the model of Ferreira and Otley (2009). Special attention was given to the differences and similarities in the data, in order to ensure reliability and validity. Table 1 provides an overview of the interviews.
Interviewee Position Length of the interview
1 The head of the finance and control
department
75 minutes
2 The head of the operational risk &
compliance department
65 minutes
3 The head of the sales department 59 minutes
4 The head of the sales and support
department
30 minutes
5 The team leader of the acceptance &
contract intake department
41 minutes
6 The head of collections department 36 minutes
