Management review within organizations Identifying factors that influence the effectiveness of management review

Identifying factors that influence the effectiveness of management review

Master thesis Bart Bults

University of Groningen

Faculty of Economics and Business

Msc Business Administration

Specialization: Organizational and Management Control

June 2010

Name: Bart Bults

Abstract

Organizations nowadays are encountering increasing control costs. This increase is caused by stricter policies with regards to internal control that organizations implement. This recent trend is caused by the large accounting scandals that have become public in recent years. Due to these scandals, both governments and organizations have acknowledged the need for stricter policies with regards to internal control at organizations. Although these stricter policies will do organizations more good than harm, organizations are now faced with a significant increase in control costs. Albert Heijn, a retailer based in the Netherlands, was just like a lot of other organizations searching for possibilities to cut these costs. AH came up with the concept of management review, by delegating internal financial guidelines from upper management to lower management, AH hoped that control activities could be integrated in the daily activities of the lower management.

One significant problems arises with the application of management review. It undermines the concept of segregation of duties which in most cases have been implemented or made more strict as a reaction to the stricter legislation. Therefore, monitoring activities from the upper management and internal and external auditing departments have to increase. Whether monitoring is possible within a certain situation is dependent on the fact what type of control system is applied within an organization. Next to that, the state of certain contingency variables, like those identified by Fisher(1998) have an influence on the effectiveness of management review. When an organization like AH wants to apply management review, there should be an analyses of all the relevant factors and a trade-off between positive and negative consequences of applying management review should be made.

Key words

Table of content:

2. Principal-agent theory in comparison to management review ...11

2.1 The management review tool...11

2.2 Theoretic background of principal-agent model...13

2.3 Management review in relationship to principal-agent theory ...16

3. Contingency based research in comparison to management review ...20

3.1 Theoretic background of contingency-based research ...22

3.2 Relevant contingency variables in comparison to management review ...23

4. The application of management review at Albert Heijn BV...31

4.1 Description of the case organization Albert Heijn BV ...31

4.2 The application of management review at Albert Heijn ...32

4.3 The environmental context Albert Heijn operates in ...33

4.4 Type of control system at Albert Heijn ...35

5. Application of management review at Albert Heijn in comparison to the findings within the academic literature ...37

6. Conclusion...39

6.1 To what extent can organizations apply management review ...39

6.2 Discussion...41

6.3 Recommendations for further research ...42

1. Introduction

The economic world today has been shocked with a lot of scandals regarding accounting issues. These scandals has resulted in an increased amount of regulation and monitoring by governments and other over spanning organizations. The SOx 404 act of 2002 is one example of this. This act has been implemented in the US en is mostly based on increased

responsibility for external auditors. Most European countries have implemented policies based on the SOx act. Because of this increased responsibility, external and internal auditing activities have increased significantly within organizations. Especially those organizations which are listed on the different stock exchanges have felt the pain cost-wise. This is because these organizations have to be in compliance with the increased amount of rules that are required for being listed on a stock exchange. (Elder, 2006) Because of the increased amount of rules and activities an organization is confronted with, an organizations costs for

monitoring and compliance have increased significantly.

Because of this, organizations are looking into ways of decreasing their costs for monitoring and compliance. The increased costs of these activities have also been a problem at Albert Heijn B.V. I have followed an internship of six months at Albert Heijn B.V. at their headquarters in Zaandam, The Netherlands. In an attempt to cut the costs, AH has hired an external accounting firm to find ways to cut these costs.

This external accounting firm came with a concept they called Management Review. Management Review is mostly based on what is known in the academic literature as delegating financial control guidelines to lower management layers. Within AH, the internal control activities are carried out by a separate internal control department. This internal control department rapports directly to the higher management which in their turn

1.1 Subject of research

A few reasons why organizations delegate responsibilities are: information overload at the top, need for responsiveness to local conditions and a stimulus for motivation down the hierarchy. (Baliga, 1984) By delegating the internal financial control guidelines from the internal control department and the upper management to lower management layers an organization makes those managers responsible for the activities they are daily encountered with. This has some great advantages which ultimately will have to lead to cost reduction. By applying management review, the internal control department can disappear or at least be reduced in size. Another big advantage is that managers have to control those activities within their own department. So by doing their daily activities they can detect control issues and directly intervene or communicate these problems to higher management. Therefore control issues are sooner detected and dealt with, before they can do greater harm.

But of course there are some disadvantages to management review. The biggest issue is with segregation of duties. Within every organization, segregation of duties is important to prevent control issues like fraud and mismanagement. (Burch, 2008) But management review gives responsibility to managers to control their own activities. So there should be some kind of monitoring by a second party to make sure that the managers don’t abuse their

responsibilities.

Control issues like fraud and mismanagement are related to the principal-agent problem that is mentioned a lot in today’s scientific literature. The current principal-agent theory is highly connected with management review. In order for a principal to make sure that an agent does what the principal wants, there should be some kind of incentive for that agent to act in that way. (Callen, 2008) By delegating financial control guidelines from upper management to lower management, upper management should make sure that lower management acts in the best interest of the higher management. This will have big implications for higher

management because in most cases the complete incentive scheme for lower management has to be changed. When management review is applied, lower management receives the

responsibility to test those activities for which they are responsible. Therefore, the opportunity for lower management to commit fraud and mismanagement is much higher. So the current incentive schemes would probably have to be adjusted to this new responsibility for lower management. Next to that, higher management has to increase their monitoring activities over the lower management and this can be very costly as management time is very scarce.

1.2 Theoretic background

When we look at the introduction and the subject of research, a definition of the main scientific concepts used is in order.

First of all management review, with management review we are not talking about delegating the complete control structure of an organization. Management review is a control tool that’s designed to give managers the responsibility to test internal financial control guidelines that they are daily encountered with. When organizations don’t delegate these financial control guidelines, the responsibility to test these guidelines lies with the upper management and the internal control department. Delegating this responsibility to lower management layers gives managers the opportunity to integrate these control activities in their daily operations. When management review is applied lower management receives the responsibility to execute the internal financial control guidelines. Higher management then becomes responsible for monitoring the execution of this responsibility instead of executing it. So it’s merely a tool to support an organizations management control system. Thereby achieving a decrease in the total amount an organization spends on internal controls and delegating responsibility to the persons that are the best positioned within an organization to execute this responsibility. Within the case organization of Albert Heijn BV, responsibility for mostly internal financial control guidelines have been delegated. Mostly focusing on financial checks and balances to spot discrepancies within their financial system. Within AH these guidelines are rules and policies mostly based on the SOx legislation and there to prevent fraud and mismanagement. For every guideline it is determined within what timeframe the guideline should be tested and what actions should be taken when discrepancies are detected. By delegating internal financial control guidelines from higher management to lower management, these managers can achieve the organizational objectives in a more efficient way. This will lead to a significant cost reduction of the internal and external control costs. (Geuzebroek&Klumper, 2008) Second of all, principal-agent theory will be discussed. In the case of management review, higher management can be seen as the principal and lower management can be seen as the agent. When management review is applied, the principal delegates financial control guidelines to the agent. So when management review is applied, the agent receives more responsibilities and power. But the principal wants the agent to act in a way that is

agent will have a lot more information and knowledge about certain processes. For a principal there a different ways of controlling an agent. A principal can increase the amount of

monitoring of the agent, set up a third party to monitor the agent that will communicate with the principal or an agent should be rewarded for acting in the interest of the principal. (Callen, 2008)

When we look at management review, we have to look at contingency variables that influence the effectiveness of management review. Management review is a tool that supports the management control system, and an organization always want to have a fit between its contingency variables and its management control system. A management control system provides information to managers and thereby helping managers to make better informed decisions in both their daily activities as well as in their strategy formulation and strategy execution. When there is a good fit between the contingency variables and the management control system, it will be easier for an organization to achieve its goals and targets. (Chenhall, 2003) Management review is a tool to increase the effectiveness of the management control systems and therefore there should also be a good fit between the contingency variables and the management review tool. This knowledge is formulated within the contingency theory. There are quite a few contingency variables, but authors like Chenhall and Fisher have specifically looked into variables that influence management control systems. Next to that, when Fisher identified and defined the relevant contingency variables, he focused on a managerial level within organizations. Because management review is in most cases applied on a managerial level, the contingency variables selected by Fisher (1998) will be leading in this research. The contingency variables used by Fisher are: uncertainty, technology and interdependence, industry and firm variables, competitive strategy and mission and observable factors.

Last, we will be looking at the different management layers that exist within organizations. There are basically three main management layers, top, middle and lower management. With regards to management review, I will be looking at the delegation of financial control

Lower management is beneath middle management and has at least one hierarchical level beneath them. (Staehle, 1992)

1.3 Research questions

So Albert Heijn is applying management review. And some advantages and disadvantages regarding management review have been mentioned before. But every organization is different and this means that a certain theory or strategy can work for one organization but doesn’t work for another organization. There are different contingency variables that influence the effectiveness of management review.

So the main research question of this thesis is:

 To what extent can management review be applied given the context an organization

operates in?

Based on this research question four sub research questions have been formulated that answer different parts of the main research question:

1) How does the current literature about principal-agent theory inform us about management review within organizations?

2) Which contingency variables influence the effectiveness of management review within an organization?

3) How did Albert Heijn BV apply management review within their organization? 4) How does the current control literature about management review compare to the

case of Albert Heijn BV, what are the similarities, what are the differences and what implications do these findings have?

1.4 Research methodology

This research will be based on a literature study and on a case study. The required literature will be collected through the different sources that are available to all students. The thesis will be based on a review of the available literature on the different subjects but will be

supplemented with empirical data. The empirical data will be gathered through the internship at Albert Heijn BV. During this five month internship at Albert Heijn BV I was closely involved and partially responsible for the daily activities regarding management review. Through the execution of these activities I came in contact with the people that were working with management review on a daily basis and through this contact I have collected a lot of their experiences working with management review. Next to that, data has been collected from the people that were responsible for the design and application of management review at Albert Heijn BV, mostly through e-mail correspondence with those people. So no structured interviews have been taken but the data has been collected through social interactions and e-mail correspondence with the people that are involved with management review at Albert Heijn BV.

2. Principal-agent theory in comparison to management review

In this chapter we will discuss management review in relation to all the current knowledge and theory that is available about principal-agent relationships. A short description of management review has been given in chapter 1.2 but a further detailed description will be given in the first part of this chapter. In the second part of this chapter the focus will lie on the theoretic background of principal-agent theory. Principal-agent theory is the main theory for determining whether management review can be effective within an organization. The following part of this chapter will pay attention on how we can use the knowledge of

principal-agent theory in determining the effectiveness of management review. In this part of the chapter potential problems of management review are identified and potential solutions are discussed. But also the advantages of management review will be discussed, and how these can be best achieved by an organizations.

2.1 The management review tool

Figure 1 and 2 (see next pages) are a schematic presentation of the different parties that play a role in controlling an organization. Every bloc represents a different party within an organization and every arrow displays a flow of information from one party to another party. Red arrows are information flows that go up an organization and green arrows are flows that come down in an organizational hierarchy.

If we look at figure 2 we can see that the department management collects controlling information directly from the department and has the authority to directly take some corrective action. Next to taking corrective action the department management will communicate their information and corrective actions to the external controllers and the higher management. The higher management will also receive information from the external controller about the control status of department A and based on this may take further action the increase controllability of department A.

So in figure 1 it takes a lot longer for information to travel from department A up to higher management and then back from higher management to department A than in figure 2. So if higher management wants to take corrective action on the basis of this information the big time gap between detection and corrective action can cause a problem to cause a lot of harm to the organization. This gap is only a small problem in figure 2 because department

management can take direct corrective action. Next to that, the time it takes for the

information to reach higher management is smaller because department management directly communicates with higher management and there is no internal controller to slow

communication down. (van de Berghe, 2005)

Figure 2:

2.2 Theoretic background of principal-agent model

The principal-agent relationship is relevant within every organization. Within every organization there is a relationship between for example its owner and an employees or a manager and his subordinates. So the knowledge and theories gathered about principal-agent relationships are relevant for all organizations.

The principal-agent model discusses two parties, a principal and an agent. The principal is a person that is higher ranking within an organization than the agent. So the principal could be the manager that has the responsibility over a group of people, the agents. Because the principal and the agent are two different entities they will probably have different goals and objectives. The challenge for the principal lies in making the goals and objectives of the agent congruent with those of the principal. When the principal can achieve this the performance outcome of the agent will probably be beneficial for the principal. Within this model, the goals and objectives of the top management of an organization are passed from the top, down to all the underlying layers of an organization through the different principal-agent

relationships that are effective between all these layers. So if all the principal-agent

relationships are effective, everybody within the organization will have the same goals and objectives. (Callen, 2008)

There are different ways for a principal to direct an agent in the right way. Callen (2008), is talking about the incentives-actions-performance linkage. Callen discusses the sequential

relationship between incentives, actions and performance. Callen stated that if principals implement the right incentives for agents, these incentives will lead to certain actions executed by the agents and these actions will lead to the performance that is wanted by the principals. These incentives can be very broad, not only focusing on direct monetary rewards but also on softer incentives like job security and promotions. (Callen, 2008)

But for a principal to determine whether an agent has to be awarded for his performance some kind of monitoring and auditing has to be executed. Monitoring and auditing is a very

important for a principal because in most principal-agent relationships there is some kind of information asymmetry between both parties. (Strausz, 1997) This information asymmetry is caused by the fact that the agent has all the information about his own actions and following performance but the principal is not directly involved in the daily activities of the agent and because of that has less information than the agent. So the principal has to execute some kind of monitoring or auditing to gather information about the performance of the agent to make a valid and complete assessment of the agents performance. Strausz says: ‘Monitoring and auditing serve the same goal but are certainly not the same. Monitoring is checking on the agent while he is performing his task. This is in contrast to auditing, which takes place after the agent has chosen his actions.’ (Strausz, 1997) Within the current principal-agent theory, monitoring an agents activity by a principal is one of the internal control mechanisms designed to address the agency problem. (Walsh, 1990)

So were monitoring focuses on the actions of the agent, auditing focuses on the performance that’s followed by these actions executed by the agent. For a principal it’s preferred to focus on monitoring, because checking on the agent while he is performing these actions gives the principal the option to intervene and direct the agent in the right way. Whereas auditing is executed after the actions of the agent have been taken and does not give the principal the option to intervene and maybe prevent some undesirable outcomes of these actions. Incentive schemes designed for the agents should suite whether a principal can perform some kind of monitoring or that a principal can only audit the performance of the agent. When monitoring is possible the incentive scheme should focus on rewarding the right actions, when monitoring is not possible the incentive scheme should focus on rewarding the right performance of the agent. But focusing only on performance may lead to certain actions taken by the agent to achieve this performance that may harm an organization. Therefore auditing shouldn’t only focus on the performance but also on the actions that an agent toke to achieve this

Control systems implemented by organizations can be categorized in different types. The type of control system that is dominant in an organization can have a great influence on the different principal-agent relationships that exist within an organization. Most of all, the type of control systems determines how a principal tries to control an agent. Ouchi (1979), has identified three different types of organizational control systems: market, bureaucratic and clan control. The characteristics of an organization, identified by Ouchi (1979), determine which type of control system is best suited for an organization. The type of control system that is then implemented within an organization has a great deal of influence on how the principal tries to make the objectives of the agent congruent with those of the principal. When a principal has knowledge of the transformation process, he can focus on controlling the agent by monitoring his actions. The principal can set the incentives for the agent in a way that he will carry out the correct actions and that the principal can monitor these actions. If a principal has the ability to measure the output of an agent but doesn’t has much knowledge of the transformation process, he can focus on monitoring the output of the agent. In this case the principal focuses on the performance of the agent and not on the action the agent toke to come to this performance. If a principal doesn´t have the ability to measure the output and doesn´t have a lot of knowledge of the transformation process then the principal has to focus on clan control. This means that the principal can’t directly monitor the agent but has to transfer the attitudes, values and beliefs of an organization to the agent to make sure that his objectives become congruent with those of the organization. It typically takes more time before goal congruence is achieved than via direct forms of monitoring but when congruence is achieved it requires less time for the principal to monitor. (Ouchi, 1979)

2.3 Management review in relationship to principal-agent theory

Delegating financial control guidelines from the principal to the agent has a number of advantages. One of these advantages is that the agent receives the responsibility to control those activities an agent daily encounters. A principals time is in general scarce, and is divided in a lot of different activities. (Berghe, 2005) Because of this, a principal can’t be closely involved with the operational level of an organization for which he is responsible. This is in contrast with the agent, because the agent has a lower position within an

organization than a principal, the focus of the agent can be more on the operational level of the organization. Because of this fact, an agent in most cases will have more information of the operational level and will know better how to respond when certain control issues are detected. So not only is it preferable for an organization to delegate financial control guidelines from a principal to the agent, an agent must also have the authority to undertake action when a control issue is detected. This has the advantage that control issues are sooner detected and that these issues are sooner corrected, so that no further damage to the

organization can occur. Another advantage of delegating financial control guidelines from the principal to the agent is that the scarce time of the principal isn’t used up as much by control activities. This responsibility now is with the agent, and the agents time is usually a lot less scarce then that of the principal. The agent would also be controlling by doing his daily activities, so this responsibility wouldn’t cost an agent that much time in comparison to a principal. (Geuzebroek&Klumper, 2008)

One big problem with management review from a principal to an agent is that most

review can be implemented by organizations to minimize these costs, but goes directly against the principles of segregation of duties.

A way of undermining this problem is to increase the monitoring activities of the principal. As we discussed earlier, principals are usually higher management and their time is scarce and therefore expensive. So increasing their monitoring activities will lead to a certain cost

increase, as well as a increase of opportunity costs because higher management could deploy their scarce time in other areas to create value there. (Berghe, 2005) An organization will not implement management review if it will not lead to some kind of cost reduction, so the increase in monitoring costs for the principal may not out weight the lower costs for internal and external control activities. Because management review is a relative new concept within organizations only a few studies focusing on the implementation and consequences of

management review have been executed. Some early studies with a few case study’s do show that management review can reduce the internal and external control costs up to 50 percent. (Geuzebroek&Klumper, 2008) Mostly achieved by integrating management control within the daily operations of the lower management and thereby decreasing the amount of internal and external control activities. Not only, will too much monitoring be costly for an organization, it also will stifle the agents entrepreneurship and thereby influencing the organizations

performance negatively. (Berghe, 2005)

Another problem with delegating financial control guidelines from the principal to the agent is that the current incentive schemes for the agents may not be appropriate for the new situation. Incentive schemes that focus only on evaluating the performance of an agent are really not applicable for a situation where an agent controls his own activities. There is a great risk that managers will resort to forms of gaming and fraud to achieve a certain output that is required by the incentive scheme he operates under. As stated before the amount of monitoring by the higher management and external controllers should be increased when this is the case. The increased amount of monitoring should prevent the agents to achieve the goals stated by the organization in any other way then is beneficiary for the organization.

As stated before, Ouchi has defined three types of organizational control: action, output and clan control. These three types of organizational control and their influence on the

principal can monitor the agents actions correctly and intervene while the agent is performing these actions. But when the incentive scheme for the agent is correctly designed, it should make sure that the agents goals and objectives will be in line with those of the organization because the agent will then be awarded for executing the actions that are desired by the organization. Monitoring activities can then be brought to a bare minimum.

When higher management doesn’t have sufficient knowledge of the transformation process to monitor the agents actions but can measure the agents output, then higher management can focus on output control. In this case management review can’t be effectively applied. Because only the output of the agents is measured and not the actions that have been taken to achieve this output, there is a strong incentive for the agents to conduct mismanagement, gaming and fraud to achieve the desired output. Because the principals delegate financial control guidelines to the agents and there is no monitoring by the principals possible, applying management review can lead to undesired actions by the agents.

When higher management can’t achieve some kind of knowledge of the transformation process and there is no possibility for the higher management to monitor the actions of the agents, organizations should focus on clan control. When an organization has implemented clan control then management review can be applied. In this case there is also the risk for mismanagement, gaming and fraud due to lack of monitoring. But because of the application of clan control the agents will internalize the organizations values, attitudes and beliefs. Next to that, there will be a lot of interaction between the agents and the principals because clan control is a very informal type of control. (Ouchi, 1979) So there will be a lot of indirect monitoring of the principal, not focusing on the actions of the agents but just transferring the goals and objectives of the organization to the agent. This will lead to goal congruency between the agents and the principals and reduces to chance that agents will undertake actions that are harmful for the organization.

So we can conclude that when an organization wants to implement some kind of management review, the different principal-agent relationships that exist within an organization have to be taken in consideration. On basis of Ouchi’s research, organizations should determine whether a certain principal-agent relationship is suitable for management review. As discussed above some principal-agent relationships will not be suitable for management review and

organizations can focus on rewarding actions or performance and should make sure that principals have an incentive to monitor agents and that agents have an incentive to act in congruence with the organizational goals and objectives.

Table 1:

Organizational characteristic

State Control type Increase of monitoring costs when management review is applied

Ability to measure output No Action control Medium Knowledge of the transformation process Yes Ability to measure output Yes Output control High Knowledge of the transformation process No Ability to measure output

No Clan control Low

Knowledge of the transformation process

Figure 3: 0 1 2 3 4 5 6 7 8 9 10 Total control costs with action control Total control costs with output control Total control costs with clan control No management review applied Management review applied

(The data on the vertical scale is not based on scientific data but merely there to display the development of the costs.)

Table 1 is based on the findings discussed above. As discussed earlier, organizations will only implement management review if this will lead to a certain reduction in costs. The application of management review can lead to a 50 percent reduction of internal and external control costs. (Geuzebroek&Klumper, 2008) The total control costs consist of all the internal and external control activities that are undertaken within an organization, and also the monitoring costs from the upper management are included within these costs. The application of

management review will lead to an increase in monitoring costs due to the fact that

3. Contingency based research in comparison to management

review

With the knowledge about management review and principal-agent theory we can look at the different contingency variables that influence principal-agent relationships and therefore the effectiveness of management review. In the first part of this chapter we will pay attention to the theoretic background of contingency-based research in comparison to management review. We will pay attention to the existing knowledge about contingency-based research and how this relates to management review and the principal-agent model. In the second part of this chapter we will focus on the implications that contingency-based research has on the effectiveness of management review. Focusing on how the different contingency variables influence the effectiveness of management review. We will pay attention to which

contingency variables influence the effectiveness of management review and how strong this influence is. Next to that we will discuss what type of control system an organization should have given the influence of the contingency variables.

3.1 Theoretic background of contingency-based research

Management review is a tool to delegate financial control guidelines within an organization. Contingency variables influence the effectiveness of organizations and the tools that these organizations apply. So when organizations want to apply management review, certain changes to the organization are made, so contingency-based research is very relevant theory when making these changes. Based on the research of Fisher (1998), certain contingency variables have been identified that are relevant in comparison to management review. The research of Fisher specifically focuses on the influence of certain contingency variables on the effectiveness of an organizational control system. Therefore his research and identification of contingency variables is very relevant for this research. Fisher has identified the following contingency variables: uncertainty, technology and interdependence, industry and firm variables, competitive strategy and mission and observable factors. According to the theory of contingency-based research, the effectiveness of an organizational control system will be influenced by the context the control system operates in. So the contingency variables that are mentioned by for example Fisher should be taken into account when designing a

organizational control system. So when certain changes to this system are made, like

As Chenhall (2003) states it: ‘Good fit means enhanced performance, while poor fit means diminished performance.’ Once a good fit has been made this does not mean that this fit will be effective over a longer period of time. Organizational learning occurs over time and this process will change an organization. As an organization changes and with that the

organizational control system, the fit between the organizational control system and its context will fade away. Because of organizational learning, an organizations strategy will change over time. Because strategy is a contingency variable that influences the effectiveness of an organizational control system, adjustments have to be made to achieve a continues fit. (Fisher, 1998)

Within the current contingency theory there is a strong consensus about the need for a fit between a management control system and the context it operates in. But there are a lot of differences between different authors about the relevant contingency variables and the relationships between these contingency variables. As stated by Fisher (1998): ‘Trade-offs between the conflicting contingencies must be considered in designing the control systems.’ Also the definition of the different contingency variables varies between different authors. The work of Fisher (1998), has been chosen as leading because he based his work on a lot of existing contingency theory and because he has chosen to define his contingency variables on basis of relevance to management control systems. In the next part of this chapter we will focus on the relevant contingency variables and describe their definition.

3.2 Relevant contingency variables in comparison to management review

The first contingency variable that we will focus on are observable factors. As stated by Fisher (1998): ‘Observability of behavior or outcomes implies that control can be placed only on variables that are observable by an evaluator.’ These variables have been identified and defined by Thompson (1967) and by Ouchi (1977) as: knowledge of the transformation process and ability to measure output. Because these variables and their influence on management review have already been discussed in great detail in chapter 2 no further attention will be paid on the matter in this chapter.

Environmental uncertainty is one of the most important contingency variables. As stated by Chenhall (2003): ‘The environment uncertainty is a powerful contingency variable that is at the foundation of contingency-based research.’ The degree of environmental uncertainty is determined by, if probabilities can be assigned to certain situations and whether all the relevant elements in the environment can be identified. The degree of environmental uncertainty is determined by a number of underlying variables that can be captured by

dichotomies like: static vs. dynamic, simple vs. complex and calm vs. turbulent. Relationships that an organization has with its customers, suppliers and governmental agencies also

influence the environmental uncertainty.

Because task uncertainty can be linked to what Ouchi called, knowledge of the transformation process, this chapter will not further focus on this part of uncertainty because a detailed description of this variable has been given in chapter 2. Environmental uncertainty also has a significant influence on the effectiveness of management review and will be discussed next. When environmental uncertainty is high there is a need for a more open and externally focused management control system. (Chenhall, 2003) When environmental uncertainty is high due to a high dynamic, there is a need for the collection of timely market information and timely actions required on the basis of this information. So when environmental

uncertainty is high for an organization then management review can be a very effective tool. Because financial control guidelines are delegated to lower management layers, the

responsibility to detected changes in the environment and act accordingly lie with the people that are daily encountering environmental entities. When environmental uncertainty is high, changes within the external environment occur very rapidly and lower management layers are the first to encounter these changes through their daily activities. So when lower management execute their delegated activities they can detected changes in the external environment and can act to make the proper corrections if needed. So when environmental uncertainty is caused by a high complexity, then management review can be a very effective tool. Because lower management has in most cases far more specialized information about their specific work area then higher management. Delegating financial control guidelines from higher to lower management gives the responsibility to those people with the most knowledge about an specific area. This will lead to lower management making better informed decisions because they have the time and resources to interpret complex information about the external

layer to lower management layers. So there is a fit between the need for decentralization and management review. When uncertainty is high, decentralization and the need for specialized market information makes it harder for principals to monitor the actions of the agents when management review has been applied. So when organizations want to apply management review when uncertainty is high, an organization should have clan control to make sure that management review is effective. When uncertainty is low, there is much less decentralization and need for specialized market information, so it becomes much easier for the principal to monitor the agent when management review is applied. In this case organizations will focus more on action control so applying management review in this case will be effective.

Technology and interdependence is the next contingency variable we will focus on. As stated by Chenhall (2003): ‘Technology refers to how the organizations work processes operate (the way tasks transform inputs into outputs) and includes hardware, materials, software and knowledge. The degree of technology is determined by the complexity of the work processes, with large batch, mass, process and small-batch production representing increasing levels of complexity. Interdependence is also a part of a firms technology. Perrow (1967) defined three types of interdependence with an increasing demand for coordination: pooled, sequential and reciprocal. As the complexity of the work processes increase so does the demand for a more informal control system. As the complexity of the work processes increases it becomes harder for higher management to have knowledge of the transformation process and to apply some kind of action control. Because of the high complexity, the principal has not much knowledge of the transformation process and can therefore probably not monitor whether the agent executes the right actions. In this case, management review can better not be applied unless an organization has clan control as its organizational control type. (Ouchi, 1979) In this case, the need for monitoring by the principal is much smaller and there is a fit with the demand for a more informal control system. When an organizations has a output or action control system and complexity is high, the need for monitoring will be too high when management review is applied. When complexity is low, higher management will have much more knowledge about the transformation process and higher management can focus action control. In this case management review can also be applied effectively.

both. When management review is applied in this case, there should be clan control

implemented within the organization. Clan control will lead to the principal interacting with the agent and thereby communicating with the agent about current activities and

developments. Then management review is complementary with the organizational needs when interdependencies are high.

control system and tasks will become more standardized and specialized. In this case, organizations will apply action control and management review can be effectively applied. Next to the industry variables are the firm contingency variables. These consist of structure, size and diversification. Diversification can be described as the level of diversity in an organizations product line and/or structure. (Fisher, 1998) An organizations structure can be categorized into a multi-divisional structure or a functional structure. (Fisher, 1998) The leading variable here is size, when the size of an organization increases the structure and degree of diversification also change. When an organizations size increases, the structure of an organization in most cases changes from a functional structure to a multi-divisional

structure. (Chenhall, 2003) An increase in size will also lead a higher degree of diversification because of the development of new products and new structures. When an organization increases in size there is increase in formalization of procedures and specialization of functions. Large organizations also tend to have a more divisionalized structure making departments within these divisions smaller and easier to control. (Fisher, 1998) So when an organization has a large size, it’s relative easy for higher management to monitor lower management actions and output. So management review can be very effective in this case. Especially because organizations tend to implement a multi-divisional structure when higher management wants lower management to have the freedom to respond to local conditions. Applying management review in this case gives lower management this freedom. Within large organizations there aren’t any obstacles for an organization to focus on either clan or action control. But in most cases organizations will focus on action control because all the tasks are highly specialized and standardized and therefore monitoring by the principal is relative easy. For smaller organizations delegating financial control guidelines is not so effective within an action control type. Because of the functional structure and a decrease in formalization and specialization, monitoring of lower management is going to be very hard and probably not cost effective. So in this case management review can only be applied if an organization has a clan control type.

specialization of tasks and ´hard´ performance measurement systems. Therefore applying management review within these organizations can be very effective. Because of the fact that task are specialized and the performance measurement system focuses mostly on actions and output, output and action control can be very easy executed by higher management. Next to that, an effective implementation of management review will lead to a significant reduction in the total control costs and will therefore fit with the focus on controlling the costs.

Organizations that have a prospector type of strategy will focus on informal communication, a ‘softer’ performance management system and a control system that signals when innovation is needed because of fallen productivity and efficiency. In this case, management review can also be effective. When management review is applied, lower management layers get the responsibility to detect gaps in the organizations control system. These gaps can be caused by fallen productivity or efficiency or by changes in the external environment of the

organization. Because lower management is closer to the core activities of the organization and has more knowledge about the core activities, these gaps will be sooner detected and the cause will sooner be identified then when management review isn’t applied. When

management review is applied, higher management has a responsibility to monitor the different agents actions and output. Due to this responsibility, the amount of informal communication between lower and higher management will increase significantly. This increase, matches with the demand for more informal communication within prospector type strategies. Monitoring activities will take up more time because tasks are not as much specialized as in defender type strategies. But because there is no real cost focus within prospector type strategies this fact will not be decisive in the decision to apply management review. Because tasks are less specialized within prospector type of strategies, organizations will focus on clan control and management review can be applied effectively.

In the following table the findings discussed in this chapter have been schematically displayed.

Table 2:

Contingency variable State of variable

Management review effective?

Preferred type of control system

Uncertainty High Yes Clan control

Low Yes Action control

Technology and interdependence

Complex Yes Clan control

In complex Yes Action control Industry, firm and unit

variables

High competition

Yes Clan control

Low competition

Yes Action control

Competitive strategy and mission

Defender Yes Action control

Prospector Yes Clan control Observable factors Behavior/action Yes Action control

Output No Output control

Neither action or output

Yes Clan control

4. The application of management review at Albert Heijn BV

In this chapter there will be paid attention to how Albert Heijn BV(AH) applied management review within their own organization. In the fifth chapter the focus will lie on the fact if the findings discussed in the first two chapters of this research are congruent with the case of AH. In this chapter, a description of the case organization will be given and the context that AH operates in will be discussed in order for us to determine which specific contingency variables AH encounters. Next to that, attention will be paid to how AH applied management review, focusing on to what extent AH has chosen to apply management review. So focusing on how wide within the organization did AH apply management review and how many financial control guidelines have been delegated. We will also focus on the type of control system AH has, to determine whether this is congruent with the application of management review.

4.1 Description of the case organization Albert Heijn BV

Albert Heijn BV was founded in 1887 and has over the years become the biggest retailer of groceries in the Netherlands. AH is currently the market leader with a market share of 31.3 percent in a market that’s dominated by a few big players. AH’s core business is still food retail but non-food activities have also become part of Ahold, which is the holding that is owner of AH. Although Ahold has also acquired a lot of international activities over the years, AH is still the biggest company within the holding. AH has more than 800 stores located in the Netherlands and for the year 2009 these stores produced a net sales of 9.8 billion euro’s. Next to that, AH employs more than 80.000 people and is constantly looking to increase its market share by aggressively cutting prices to attract new customers and searching for new markets to enter.

Organizations are willing to allocate more resources to internal and external auditing in order to prevent similar scandals happening at their organizations which cause much bigger harm to an organization than the increase in costs that these activities demand. AH operates in a market where competition has become pretty intense over the years and keeping the same margins on its operations has become more and more difficult. Therefore, AH is looking for ways to cut costs where this is possible. With the application of management review, AH is hoping to decrease the total control costs without diminishing the quality of the internal and external control.

4.2 The application of management review at Albert Heijn

As stated before, AH is an enormous organization, with a lot of sub organizations and different activities. Before AH will apply management review on a broad basis within its organization a few departments have been chosen to test the effectiveness of management review. As discussed before, within AH management review focuses on the delegation of internal financial control guidelines and can therefore not be applied within every part of the organization. Because internal financial control guidelines will simply not be executed in every part of an organization, especially in lower parts of an organization. In the case of AH, management review was first applied in 2007 within a few departments, namely finance, human resource and the legal department. By applying management review within these departments AH could monitor the effectiveness of management review in a timely and accurate fashion because these were relative small departments that were all allocated within the headquarters of AH. But these departments have important functions within the

organization so the effectiveness of management review could be tested with some important internal financial guidelines. When the application of management review would be a success within these departments, management review could be further applied on a broader basis within the organization.

Before AH applied management review within these departments, a broad risk analyses has been made to identify certain risk area’s and problems that may be caused by the application of management review. One of the issues that arose was with segregation of duties. As mentioned before, segregation of duties has an important function within organizations and applying management review can undermine this function. This issue was detected by AH and actions were taken to prevent fraud and mismanagement as a consequence of the

sure the new roles and responsibilities were clear. Most of all, AH made certain that higher management and internal and external auditing departments received a more monitoring role as to an executing role of internal financial guidelines (different roles have been discussed in chapter 1.2). Next to that AH made sure that they supported the people that were executing the internal financial guidelines so that the quality of the output of the internal financial guidelines was up to a certain standard.

4.3 The environmental context Albert Heijn operates in

In the third chapter, contingency variables that are relevant to the implementation of management review have been discussed. Attention has been paid to what contingency variables are relevant and what the influence of these variables would be on the effectiveness of management review within an organization. It’s a fact that AH has applied management review within some parts of their organization and has the intention to apply management review on a broader level. By determining the state of the contingency variables for AH, we can determine whether the findings discussed earlier are congruent with the case of AH. The implications of the state of the contingency variables based on the findings of the literature on the case of AH will be discussed in chapter five.

The first contingency variable that will be discussed is uncertainty. As discussed earlier, uncertainty is caused by two sources, namely task and environmental uncertainty. In the case of AH we can determine that the uncertainty level isn’t that high because AH operates in a relative stable market with very few competitors and a market were big opportunities don’t occur in a rapid fashion. Next to that, because AH has focused on the same core business for over decades, the tasks required to complete the core business of AH are relatively specialized and standardized and it’s clear what outcome a certain task will have. So concluding, task and environmental uncertainty are low for AH.

The third contingency variable are industry and firm variables. Industry variables consist of concentration ratio and barriers of entry. For the market that AH operates in it’s very difficult for a new competitor to enter. There are huge economies of scale, mostly caused by the a discount organizations receive when buying in bulk. Only competitor that are operational within other countries can enter the market because they already can buy in bulk because of their own operations. But these parties will probably have to acquire a party that is already operational within the Netherlands to get access to the right selling locations. Although it’s hard for new competitors to enter the market, the competition between the existing players has been pretty fierce the last few years. The existing four/five competitors all have significant resources resulting in aggressive marketing and smaller margins. So competition is high for AH, despite the barriers to entry.

Size is one of the firm variables and AH can certainly be seen as a large organization.

Although AH is large in size, its structure is still a functional one, every function is carried out on one or a few locations and there are no division containing a cluster of functions that focus on a specific area or product. Also there is no real need for a divisionalized structure because the degree of diversification is low for AH. AH is a retailer that focuses on food products supplemented with a much smaller non-food product line. But these products are homogenous and can be seen as one category and there are very few innovations in the products that AH offers, so AH isn’t very diversified in the products they offer.

The fourth contingency variable is strategy and mission. AH’s strategy can very clearly be classified as a defender type of strategy. Focusing on cost control, defending its current market share and making entry by new competitors very hard. AH is not focusing on the development of new products and markets and is mainly focusing on keeping current profit margins on a healthy level.

The fifth contingency variable are observable factors, focusing on the possibility to monitor output and/or actions. For AH, as for every organization, this variable isn’t consistent throughout the entire organization. Because the possibility for management to monitor the actions and/or output of the people that they are responsible for, differs across the

the organization. Management also has knowledge of the actions required because these have not really changed over the years as AH hasn’t made any major innovations that require new tasks. As we go down within the organization, monitoring of output becomes easier because tasks here get more specialized and standardized. This makes it easier for management to measure a tangible output that can be assigned to a single person. Within these parts of the organization, monitoring actions is also still possible, because management will also have knowledge of these specialized and standardized tasks. Where monitoring will focus on in these parts is determined by which type of control system is best suited for the entire organization.

In the following table, the contingency variables and the state of these variables for the case of AH will be displayed.

Table 3:

Contingency variable State of variable at AH

Uncertainty Low

Technology and interdependence In complex Industry and firm variables High competition Strategy and mission Defender

Observable factors Action/behavior

4.4 Type of control system at Albert Heijn

As stated in chapter 2 and 3 of this research, it’s very important for an organization to make sure that the type of control system an organization has, will allow effective application of management review. As described by Ouchi, there are three types of control systems: action, output and clan control. Each type of control systems differentiates in the way that controls are designed and monitoring of these controls occurs. Organizations can monitor through actions or output of its employee’s, or through interacting and sharing beliefs and values with its employee’s.

headquarters are from such nature that the output of these tasks is very hard to measure. Therefore making output control not a relevant option. Next to that, AH doesn’t apply some type of clan control. There are no signs that AH undertakes any actions that come with the application of clan control. There is a strong control structure in place, that has its basis in the fact that roles and responsibilities within the control structure are made clear through

5. Application of management review at Albert Heijn in

comparison to the findings within the academic literature

In chapters 2 and 3, we have discussed what is known within the current control literature about the application of management review within organizations. In chapter 4, the application of management review within AH as one specific case organization has been discussed. With the findings that are discussed in these chapter we can determine whether the findings of the case are congruent with those of the control literature. In this chapter we will strongly focus on what differences exist and if these differences will lead to certain problems for AH or that there are other variables that are relevant but haven’t been discussed in this research.

In the parts of the organization where AH has applied management review, an action control system is present. As discussed in table 2, a specific state of a contingency variable has a preferred type of control system. When look at the state of the contingency variables for AH, it can be concluded that for four of the five variables, action control is the preferred type of control system. The contingency variables: uncertainty, technology and interdependence, competitive strategy and mission and observable factors, are in the right state for action control to be the preferred type of control system when management review is applied. Only for the state of the industry and firm variables is clan control the preferred type of control system because AH is encountering significant competition.

make monitoring of actions really hard. So for organizations that apply management review in this case this could lead to certain costs because an organization will respond slower to actions of the competitors and because fraud and mismanagement is possible within the research and development activities due to lack of proper monitoring. Every organization has to determine whether these potential costs outweigh the positive effects of applying

management review.

For the case of AH, the high competition doesn’t come from the development of new products or markets. This is because the market that AH operates on, is a relative stable market and there is no real total revenue growth for the market that can be captured by new markets or products. The high competition is caused by the fact that the competitors all apply aggressive marketing tactics and price setting. Because of this, within AH there is a real need for quick responses and flexibility. But when management review is applied there is a need for extra monitoring activities and these will have a negative effect on this need for quick responses and flexibility. AH has to determine what the height of these costs are and whether these are less than the total cost reduction of the total control costs when management review is

6. Conclusion

In this part, the main research question will be answered. The main research question is: To what extent can management review be applied given the context an organization operates in? The research question will be answered on the basis of the information that has been

discussed in the previous chapters. In these chapters different parts of the research question have been answered and when combined, the conclusions mentioned in these chapters will give an answer to main research question. Next to that, a discussion about the research

methodology and findings of this paper and some recommendation for further research will be given.

6.1 To what extent can organizations apply management review

For organizations, the increasing amount of total control costs is the main reason to apply management review. But management review is not a tool that an organization can apply without careful planning. There are quite a lot of factors that influence the effectiveness of management review. The effectiveness of management review is determined by the fact whether the application of management review decreases the total control costs more than what the increase in monitoring costs for an organization is. Due to that fact that the application of management review undermines the principle of segregation of duties, an increase of monitoring costs will occur within organizations to prevent fraud and

mismanagement. The factors identified in this paper determine whether management review can effectively be applied within an organization.

Every organization has to determine within which part of its organization, management review possible can be applied. When we look at the case company, management review was initially applied within three departments with the intent to test the effectiveness of

want to apply management review, an organization will have to determine the state of factors that have been identified in this study to determine whether management review can

effectively be applied.

Organizations have to check whether there is congruence between the state of the contingency factors and the type of control system that is applied within the organization. As identified by Ouchi(1979), organizations can have three types of control systems: output, action or clan control. All three types of control system focus differ in the way that employees or monitored and how these employees or rewarded. Ouchi determined two organizational characteristics that can help organizations to determine what type of control system has to most fit with the organization (see table 1, page 19). As discussed earlier, when an organization apply output control then management review can’t be applied. The fact that there is no monitoring of the actions of the agents in a direct or indirect way makes the risk for fraud and mismanagement to high. When organizations apply action or clan control this risk is counter with the fact that agents can be monitored when management review is applied.

The state of the contingency variables, which the type of control system is a part of, are also a factor in the effectiveness of management review. As summarized in table 2(page 28), the state of a certain variable requires a specific type of control system when management review is applied. As an organization can only apply one type of control system, certain trade-offs and decisions has to be made. Organizations will have to determine which contingency variables are congruent with the current control system and which variables are not. Then an organization has to determine what the negative consequences are due to the fact that there is no congruence between certain contingency variables and the control type when management review is applied. An example of such a trade-off decision has been given in chapter 5 where the case of AH was discussed. Organizations will have to look at the extra costs that applying management review cause when there is no complete congruence between the state of the contingency variables and the type of control system.

When organizations are faced with quite a few differences between the state of certain

costly and in most cases the control system should be a starting point for organizations and not the state of the contingency variables.

So it’s quite clear that management review can’t be applied within an organization without a careful assessment of a lot of factors. Management review isn’t a tool that every organization can apply to decrease their total control costs. An organization has to consider its current type of control system, the state of the contingency variables and the effect of applying

management review under these conditions. Even when these conditions make to application of management review possible. Every organization still has to make a certain trade-off and the main focus should lie on the cost effect that the applying management review has. So the extent to what management review can be applied within organizations is limited. Not every organization is suited to apply management review, and even if an organization is, then differences within the organization make application within the entire organization very difficult.

6.2 Discussion and limitations

This paper is based on a literature study supplemented with data collected within one case organization. Before certain scientific findings can be applied on a broad scale, these findings should be tested within a broad array of case organizations. Because this paper has only focused on one case organization, the findings in this paper may very well not be relevant for other organizations. Organizations operate on different markets and therefore the contingency variables that organization encounter differ across these markets. The contingency variables that AH encounters may very well differ from those of an organization that operates in a completely different market or even location/country. Therefore the findings discussed in these paper can’t be generalized for other organizations until these findings have been tested within other case organizations that operate on different markets.

relationships have also not been discussed in this paper. So there are other relevant variables and relationships that have not been discussed but that should be taken into account when applying management review.

Last, the cost effect of management review will be discussed. As mentioned earlier, the application of management review as determined at the case of AH can reduce internal and external control costs up to 50 percent. (Geuzebroek&Klumper, 2008) But this has been concluded on the basis of one case organization. Next to that, this conclusion has been made on the basis of a very short period of research, so the full cost effects of management review have not yet been identified. This paper only focused on the effects of management review on the monitoring costs and treated all three the management control systems equally when it came to the reduction of the total control costs. But of course the cost effect of management review will certainly differ across different control systems.

6.3 Recommendations for further research

Based on what has been said in the discussion, some recommendations for further research will be given next.

This paper has focused on a relative new scientific concept. Parts of the principle of management review is have been mentioned in current academic literature but the concept discussed in this paper has found its origin at the case company AH. So there is enough room for further studies related to the principle of management review. First of all, this paper only focuses on one case organization. Further research should focus on multiple case

organizations that operate within different markets and within different countries. Research should further focus on the positive and negative effects of management review. Most of all, a quantitative case study to the cost effects of management review should be performed,

thereby determining what the exact effect of management review is on total control costs and monitoring costs.