THE INFLUENCE OF THE EXTERNAL ENVIRONMENT ON THE DESIGN OF MANAGAMENT ACCOUNTING SYSTEMS AND ENTERPRISE RISK MANAGEMENT

THE INFLUENCE OF THE EXTERNAL

ENVIRONMENT ON THE DESIGN OF

MANAGAMENT ACCOUNTING SYSTEMS

AND ENTERPRISE RISK MANAGEMENT

A STUDY ON AFRICAN AND EUROPEAN FINANCIAL

INSTITUTIONS

Co – Assessor: Prof. A. Rehman Abbasi Date: 20th June2017

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ABSTRACT

As a contribution to literature on management accounting and risk management, this study investigates the influence of the external environment on the design of MAS and ERM in African and European financial institutions. Using a cross-sectional research method, the findings of the study revealed that the influence of the external environment on the design of MAS and ERM in African and European financial institutions is dynamic and mostly depends on the level of economic development. Economic development, in turn, defines the external environmental factors that have direct influence on the design of MAS and ERM in financial institutions. These external environmental factors include: foreign capital, domestic and international regulations, type of financing systems and circumstances in which MAS are used (i.e.; the organization’s strategy, current and historical state of the economic, internal and external stakeholder information needs, competitive landscape, accounting profession and education, information availability, policy conflicts, technological infrastructure, geo-politics, counter party credit ratings; and cybercrime security). Moreover, organizational perceived environmental uncertainty was revealed to have an indirect influence on the design of MAS and a direct influence on management information and ERM in both African and European financial institutions. The difference in level of economic development between Africa and Europe determines the difference in magnitude of influence of the formerly mentioned factors on the design of MAS and ERM in African and European financial institutions. Furthermore, the findings of this study also reveal MAS and ERM to be interrelated as they are both dynamically designed to complement all organizational functionalities by providing information for strategic management decision making, control and planning, as well as being used to facilitate internal and external reporting.

Key words: external environment, management control systems, management accounting systems, enterprise risk management, financial institutions, contingency theory.

Acknowledgment

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Table of Contents

1. Introduction ... 4

2. Literature review ... 7

2.1 Contingency view on the design of MAS and ERM ... 7

2.2 The influence of other external environmental factors on the design of MAS and ERM ... 9

3. Management control systems ... 12

3.1. The design of management accounting systems (MAS) ... 12

3.2. Risk management ... 14

3.2.1. ERM sophistication ... 15

3.3. The interrelationship between MAS and ERM ... 16

4. Methodology ... 17

4.1 Research population ... 17

4.2 Method of data collection ... 17

4.3 Method of data analysis ... 18

5. Results ... 18

5.1 African financial institutions ... 18

5.2. European financial institutions ... 22

6 Discussion and conclusion ... 26

6.1. Main discussion and conclusion ... 27

6.2. Contribution to literature ... 29

6.3. Practical implications ... 30

6.4. Limitations of the study ... 31

6.5. Future research ... 32

7 References ... 33

8 Appendices ... 38

8.1 Appendix 1: Distribution of interview respondents ... 38

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1. Introduction

In a future that is characterized by uncertainties, the pursuit of security, profit and competitive strategies have become closely intertwined with the constant quest for organizational control (Bartholomew, 2014; Abernethy & Lillis, 1995; Brickley et al., 1997). Consequently, organizations implement management control systems, namely management accounting systems (MAS) and enterprise risk management (ERM), that are aligned with organizational strategies to help ensure the availability of sophisticated management information and risk governance. This in turn facilitates the ability for management to make informed decisions during periods of uncertainty (Rezaee, 2005; Cole, 1998).

Irrespective of numerous literature on the roles of management accounting in regard to their individual characteristics (Siegel & Sorensen, 1999), the role’s functionality (Koontz & O'Donnell, 1974), and its evolving nature (Bhimani & Bromwich, 2009) the practice of management accounting continues to be a subject of debate as its boundaries have expanded into other organizational dimensions (Roslender, 1995; Lord, 1996; Roslender & Hart, 2002). For example, Bhimani and Bromwich (2010) argue that the evolving management accounting role is inextricably interdependent with strategy, change management, risk analysis and corporate governance. Moreover, Bhimani (2009) also asserts that it is becoming decreasingly relevant to distinguish between what constitutes management accounting control and risk management as both pertain to the utilization of effective controls. Therefore, management accounting, risk management and corporate governance are increasingly becoming intertwined and inextricable interdependent. This is reason being that these dimensions complement effective decision making, control and planning (Mikes, 2006; Woods, 2008; Gordon et al., 1984). Nonetheless, Soin and Collier (2013) argue that there is little understanding about the interrelation between risk management, management accounting and control practices, thus make a clear call for research to investigate this.

5 interesting but also insightful. Additionally, as Lebedev (2014, 2015) argues that accounting research in developing economies is still in search for an identity, the African context provides a vibrant environment to further expand on the existing body of accounting and risk management literature in emerging economies.

In contrast to Africa, Europe’s economy is highly developed with a vast network of companies selling complex financial products and services to local and international clients. Therefore, it is necessary for European financial institution to employ systems and processes that can sustain complex and dynamic business operations. Even though there is significant literature investigating the use of modern MAS and ERM in European organizations (i.e.; Braam & Nijssen, 2004; Shields, 1998; Tillema, 2005; Dekker & Smidt, 2003; Bouwens & Abernethy, 2000; Agbejule, 2005, 2007; Florio & Leoni, 2016; Bertinetti et al., 2013), this is not the case for African organizations. Also, as far as the financial services industry is concerned, this literature is not strictly limited to Europe’s financial institutions. Therefore, in an attempt to close the gap in the available literature between the African and European markets, I am interested in carrying out an empirically study on the influence of external environment on the design of MAS and ERM in African and European financial institution, including the interrelationship between these systems.

The following main research question was formulated:

“What is the influence of the external environment on the design of MAS and ERM in African and European financial institutions?”

To provide guidance in answering the research question, the following sub-questions were designed:

(i) “What factors in the external environment influence the design of MAS and ERM in African and European financial institution, and to what extent are these factors different or similar in each setting?” (ii) “How is the design of MAS and ERM practices interrelated in African and European financial institutions?”

6 environmental factors that influence the design of MAS in the African and European financial institutions. Secondly, this study explores the similarities and differences that could exist between the design of MAS and ERM, and the interrelation between these systems in both the African and European contexts. Lastly, with the help of research findings, this study provides evidence from a contingency perspective whether the design of MAS and ERM adopted by financial institutions is dependent on factors within an organization’s external environment, which will also help to broaden the understanding of the variations in the design of MAS and ERM in both Africa and Europe. The findings of this investigation reveal that the influence of the external environment on the design of MAS and ERM in African and European financial institutions is dynamic and mostly depends on the level of economic development. In turn, economic development defines the external environmental factors that consequently directly influence the design of MAS and ERM in financial institutions. These external environmental factors include: foreign capital, domestic and international regulations, type of financing systems and circumstances in which MAS are used (i.e.; the organization’s strategy, current and historical state of the economic, internal and external stakeholder information needs, competitive landscape, accounting profession and education, legal system, technological infrastructure, geo-politics, counter party credit ratings, and cybercrime security). The external environmental factor of organizational perceived environmental uncertainty was revealed to have an indirect influence on the design of MAS, but a direct influence on management information and ERM. The difference in level of economic development between Africa and Europe defines the difference in magnitude of influence of the formerly mentioned factors on the design of MAS and ERM in African and European financial institutions. Additionally, the findings of this study reveal MAS and ERM in African and European financial institutions to be interrelated as they are both dynamically designed to complement all organizational functionalities by providing information for strategic management decision making, control and planning, as well as being used to facilitate internal and external reporting.

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2. Literature review

Regardless of the standardized aspect attached to regulatory guidelines of global best practices, literature on contingency theory and management control systems suggests that the efficiency of these systems is contingent upon certain characteristics of the organization and its environments (Waterhouse & Tiessen, 1978; Agbejule, 2007). However, to the best of my knowledge, there has not yet been any exploratory research investigating this theoretical argument in different jurisdictions. Driven by the fact that the continental jurisdictions of Africa and Europe are economically, socially and culturally distinctive, relating to the contingency theory, the objective of this study is thus to investigate the influence of external environment on the design of MAS and ERM, as well as the interrelationship of these systems as illustrated in the diagram below.

Figure 2.1: The influence of the external environment on the design of MAS and ERM

This section of the report proceeds to provide a description of the contingency view on the design of MAS and ERM, which, together with other literature that follow in the sub-section, makes assumptions on the influence of the external environmental factors on the design of MAS and ERM in African and European financial institutions.

2.1 Contingency view on the design of MAS and ERM

8 On the other hand, research about ERM assert that the relation between ERM and firm performance is contingent upon the appropriate match between ERM and factors affecting an organization’s business: environmental uncertainty, industry competition, firm size, firm complexity, and board of directors’ monitoring (Gordon et al., 2009). This research is consistent with the contingency based-research on MAS, as it reiterates that there is no universally accepted ERM approach but rather an exclusive one (Gordon & Miller, 1976; Gordon & Narayanan, 1984; Chenhall & Morris, 1986; Chenhall, 2003). By adopting this view, this study proposes to focus on one contingency variable, namely the external environment. The external environment is regarded as the foundation of contingency-based research with its most commonly researched aspect being uncertainty and its effect on organizations (Burns & Stalker, 1961).

Uncertainty has been ascribed to be one of the most important variables in the MAS-performance relationship (Chenhall, 2003), with most of the studies specifically focusing on environmental uncertainty (Daft & Lengel, 1986). In literature, environmental uncertainty is defined in terms of perceived environmental uncertainty (PEU), with the aim being to elaborate on an individual’s perception rather than objective reality when relating to the external environment (Andesto, 2016; Agbejule, 2005; Milliken, 1995; Tymon et al., 1998). Additionally, PEU is reported as being a variable that influences the design, use and impact of control systems through its attention to and use of information (Agbejule, 2005; Gul & Chia, 1994). Reflecting on contingency-based research, is it suggested that when PEU is high, making use of reports from MAS can help managers reduce uncertainty and improve managerial decision making (Gul & Chia, 1994). This research suggests as well that information from MAS is also used for risk assessment processes whereby organizations are able to cope with environmental uncertainty.

In regard to risk management, environmental uncertainty creates business challenges for organizations due to the increasing unpredictability of future events that might affect operations. In this sense, Gordon, Loeb and Tseng (2009) state that “…the risks associated with a firm, and the appropriate response to such risks, will likely vary depending on the environmental uncertainty confronting the firm.” These authors further state that an ERM system, which is a subset of an organization’s management control system, is intended to identify and manage uncertain future events that may affect organizational performance.

9 assumption is made that there are other factors that could influence the design of MAS and ERM in African and European financial institutions which is addressed in the following paragraphs.

2.2

The influence of other external environmental factors on the design of MAS and

ERM

2.2.1 African financial institutions

Africa is a continent made up of 54 economically and culturally diverse countries (UNPF, 2016). The diversification of African countries is further reflected in their financial systems that include central banks, deposit-taking banks, and non-bank institutions, such as stock markets, fixed income markets, insurance markets, and microfinance institutions (Allen et al., 2011). Economic growth within African countries has mainly been driven by payoffs to years of economic and financial sector reforms, as a result of becoming increasingly integrated into the global economy (Allen et al., 2011). The side effects to this are financial risks, such as the impact of global financial crises, which can devastate economic effects for countries with weak macroeconomic fundamentals (Schmuler, 2004). Moreover, the impact of unfavorable factors such as environmental degradation1, climate change, political instability, conflicts, and weak governance, legislation and regulations are also stated as being a threat to Africa’s domestic political and social stability (Evenett, 2000; Schmuler, 2004), which consequently create an uncertain business environment. To help alleviate this, and also maintain a balance between economic growth and international environmental, political and trade commitments, African governments have enforced legislations of trade and financial liberalization of the domestic financial sector and capital account, (Evenett, 2000; Zagha & Nankani, 2005). These legislations are in form of deregulation, privatization, advances in technology and sound corporate governance to avoid financial crises or make crises less risky (Schmuler, 2004). Based on this, the assumption is that these domestic legislations influence the design of MAS and ERM within African financial institutions. In addition, it is also likely that international and domestic accounting regulatory bodies such as the International Association of Practicing Accountants, International Federation of Accountants, Pan African Federation of Accountants, and Committee of Sponsoring Organizations of the Tradeway Commission also influence the design of MAS and ERM in African financial institutions. These regulatory bodies design accounting and risk management guidelines that help to promote corporate governance, control and reporting, as well as ethical behavior. The inference is that following these guidelines supports African countries’ transition into attractive foreign investment destinations, in addition to further being integrated into the global financial market. On another note, Albu and Albu (2012) report that the adoption and use of management accounting techniques in

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10 developing countries are mostly associated with the presence of foreign capital and organizational size, excluding factors such as the environment and competition. Presence of foreign capital can drive economic development, whereby appropriate systems have to be in place to sustain and safeguard complex business transactions which motivates my hypothesis that the design of MAS and ERM in African financial institutions is influenced by foreign capital.

2.2.2 The European financial institutions

The European Union (EU) consists of 28 member states with a partnership that represents a unique form of cooperation (Archick, 2017). The EU has helped to promote peace, stability, economic prosperity throughout the European continent. Nonetheless, EU member states are economically diverse, with one common currency, and financial systems that are linked and integrated into the global financial market (Pace, 2016). These financial systems fall under the European Monetary System which is monitored by the European Central Bank (ECB). In principle, the ECB complements the jurisdiction’s structural policy, banks, financial intermediaries (i.e., insurance corporations and pension funds) as well as non-bank and non-insurance financial intermediaries2 (ECB, 2015).

In 2009, the EU was confronted with a financial and sovereign debt crisis which led to enhanced regulatory and supervisory measures to strengthen economic governance. An example of such regulatory and supervisory measures as Schaub (2005) reports, is the design of management accounting practices that are highly influenced by international regulatory accounting bodies such as International Association of Practicing Accountants and the European Accounting Association. These regulatory bodies have objectives to promote ethical behavior, raise the quality of accounting practices and create harmonization of accounting standards.

Moreover, Doupnik and Perera (2015) assert that there are two important factors driving differences in accounting systems and the compliance function in western countries which are stated to be the nature of culture and type of financing system adopted. Without considering culture, as it is a broad and complex concept to generically define, the type of financing system could influence the design of MAS in European financial institutions. There are two types of financing systems identified in Europe’s business environment: financing from creditors and investors versus equity financing (Doupnik & Perera, 2015). Providers of both financing have the need to monitor the performance of companies they supply capital to, as well as the magnitude of incentives they receive. In order to

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11 fulfill this need, companies design their accounting systems to help them to produce information that meets the information needs of investors. Providing such information can create investor confidence which could further result in the availability of more capital.

Furthermore, literature on MAS in Europe mostly based on the contingency theory perspective that generally states that the design of MAS is dependent on the circumstances in which these systems are being used. These literature generally mention the following circumstantial factors to be determinants of the design of MAS: accounting innovations and trends, regulations, the importance of the financial objectives, interactions between organizations and organizational parts, visibility of the operating tasks, complexity of the operating tasks, dynamism of the environment in which the operating tasks are undertaken, significance of the financial consequences, clarity of the financial consequences (Tillema, 2005), cost reduction (Dekker & Smidt, 2003), capital and size (Albu & Albu, 2012), and business process modeling (Pinayiotou & Tatsiopoulos, 2012). Since the above stated literature is quite abstract and not specific to the financial industry, with the help of interviews, this study investigates whether this literature is generalisable towards Europe’s financial institutions.

Similar to the African context, it is further assumed that ERM practices in European financial institutions are to some extent influenced by guidelines from regulatory bodies with the objective to promote the use of ERM as a value-contributing best practice in corporate governance (Whitman, 2015).

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Figure2.2: Factors that influence the design of MAS and ERM in African and European financial institutions

Having listed numerous assumptions of the external environmental factors that could influence the design of MAS and ERM in African and European financial institutions, this report proceeds to provide a brief description of the design of effective MAS and ERM as portrayed in literature.

3. Management control systems

Management control systems (MCS) are defined as a collection or set of controls and control systems that may include accounting controls (i.e. budgets), administrative controls (i.e. governance systems) and socially based controls (i.e. values and culture). These controls are simultaneously used to facilitate management decision making and at the same time help to align employee activities with the achievement of organizational goals (Abernethy and Chua, 1996; Otley, 1980; Simons, 1995). Irrespective of the different types of MCS, in keeping with the topic of this research, this section of the report proceeds to briefly and exclusively describe the design of effective MAS and ERM.

3.1. The design of management accounting systems (MAS)

13 environment (Ajibolade, 2013). These variables are: the level of detail provided (scope), aggregation and integration, and frequency of reporting (timeliness) (Chenhall & Morris, 1986; Gordon & Narayanan, 1984; Gordon & Miller, 1976). The report proceeds to briefly explain these four variables. Scope of MAS

MAS are viewed as a continuum with information of a narrow scope at one end and information with a broad scope at the other end. Bouwens and Abernethy (2000) characterize information with a narrow scope as linked to traditional accounting systems. The reasoning being that traditional accounting systems are typically limited to providing information that is internally focused, financial, and historically-based information. On the other hand, information on the broad-scope of the continuum is information that is not only linked to traditional accounting systems, but is also externally focused, non-financial, and future-orientated.

Aggregation and integration of MAS

The aggregated dimension of MAS provides a summary of information produced by an organization’s functional areas (Chenhall & Morris, 1986). Since this information is aggregated at the functional level, it provides managers with knowledge about the outcomes of decisions made in other departments (Bouwens & Abernethy, 2000). Given that the aggregated dimension of MAS provides condensed information that can quickly be processed, the overall amount of information that can be administered within a given time is increased. Consequently, the potential for sub-optimal decision making owing to information overload is reduced (Acko, 1967).

14 Frequency of reporting (timeliness)

Bouwens and Abernethy (2000) conceptualize timeliness into two sub-dimensions, namely, frequency of reporting and speed of reporting. They define frequency as how often information is provided to managers, and speed as the time lag between when a manager requests information and when it is made available. When information is provided frequently, and when there is little delay between when an event occurs and when information concerning this event is provided to managers, MAS are considered to be high on the timely dimension. Galbraith (1973) argues that in instances where MAS are not considered to be high on the timely dimension, an organization can increase the decision-makers’ information processing capacity through the introduction of more sophisticated information systems that can partly fill this gap. In doing so, sophisticated information systems facilitate the co-ordination of activities among interdependent departments, which reflect the integration dimension of MAS (Gordon & Miller, 1976). To this end, Riahi-Belkaoui (2002) concludes that “… MAS do not only include accounting aspects but also aspects of organization, decision-making, behavior and strategy.” Other researchers argue that MAS adopted by financial institutions should provide information relating to compliance issues and also make available necessary information for appropriate disclosure of regulatory reports and other required financial statements (Siti, Che & Wan, 2014).

Notwithstanding, post 1995, the emphasis of MA was on value at risk in the strategic processes (National Award for Management Accounting, 2011). This thus suggests that efficient reporting is unattainable without an integrated information system comprising of management accounting practices and risk management. Having provided a brief explanation about the design of effective MAS, the next section addresses the design of effective ERM.

3.2. Risk management

Power (2007) argues that since the 1990s the transformation in risk-based internal control systems has been driven by developments in corporate governance, whereby internal control has been re-defined to cover controls relating to financial accounting, regulatory compliance matters and business operations. ERM has emerged as a significant category for rethinking the organization of risk management activities and practices (Beasley et al., 2006; Pagach & Warr, 2011).

15 increasingly seen as a source of competitive advantage since it is broad in scope and does not limit consideration to the specific items a regulator may require (Platt, 2004). Consequently, ERM is moving away from the “silo” approach of managing different risks within an organization, to increasingly being referred to as “strategic risk management”, “integrated or “holistic risk management” (Liebenberg & Hoyt, 2003) in which strategic, operational, reporting and compliance risks are addressed simultaneously (COSO, 2004). Organizations can therefore use ERM to manage risks (Banham, 2004), which results in an increased ability for top management to better identify, evaluate and mitigate the portfolio of risks they are confronted with (Beasley et al., 2005).

In his article, Bessis (2002) classifies the major risks faced by financial institutions as being credit, market, interest rate, liquidity and operational risks. In relation to this, Siti, Che and Wan (2014) state that for compliance purposes, risk management systems are essential for internal use in financial institutions as they ensure organizational safety and soundness, including that of the whole financial system in general. Moreover, Aebi et al. (2012) argue that although most banks still emphasize asset growth and a reduction of operational costs as the main contributors to profitability, risk management plays an important role by exercising the support/control function in financial institutions. Financial institutions are required to have robust risk management systems (Bank Negara Malaysia, 2008), which invites the question of what entails a robust risk management system in a financial institution? The report tries to answer this question by addressing ERM sophistication.

3.2.1. ERM sophistication

An organization’s ERM sophistication encompasses components of corporate governance, risk management, risk assessment frequency, depth and methodology (Florio & Leoni, 2016). With the help of these components, one is able to obtain an overview of an organization’s ERM operational mechanisms as well as the extent of implementation of these systems. To address the operating aspects of ERM implementation in an organization, of the five components of ERM sophistication, this study will only focus on the process of risk assessment (COSO, 2012) which is made up of the following three main characteristics:

The frequency of risk assessment (timing)

16 Depth

This characteristic of risk assessment refers to the organizational level at which risk is identified, assessed and monitored. COSO (2012) recommends organizations to execute risk identification and assessment at the corporate and business unit level, as well as to organize risks by category and sub-category. Previous research has reported that a deeper risk assessment is essential to achieve ERM effectiveness for complex organizations as it enables them to prevent specific risks (Florio & Leoni, 2016). Additionally, Farrell & Gallagher (2014) state that risk monitoring by business units is the most effective way to uncover and track risks.

Methodology

The methodology applied to risk assessment can be executed using either qualitative and quantitative information or one of the two. COSO (2012) recommends organizations to perform quantitative analysis on the most important risks after an initial qualitative risk screening. Multiple researchers (Collier et al., 2007; Soin, 2005; Williamson, 2004) have proposed that management accounting practices support risk management and control by quantifying objectives, estimating consequences of potential outcomes from risk events, analyzing cost and benefits of risk management processes, or comparing actual performance to risks faced by organizations. In doing so, MAS play important roles in risk measurement in areas such as risk aggregation, risk reporting and risk communication by providing information for risk measurement and indicators in performance management so that corrective action can be taken to minimize or eliminate risks within an organization in a timely manner (Siti, Che & Wan, 2014). It is likely that this requires MAS that are broad in scope and timely, especially at a time of crisis (Mikes, 2006), integrated (Kopp, 2005), aggregated (Bouwens & Abernethy, 2000; Choe, 1998), and also external, future and non-financial oriented (Siti, Che & Wan, 2014). Therefore, management accounting and risk management are expected to complement each other and aid enterprise-wide decision making. But how is this interrelationship defined? The report proceeds to answer this question.

3.3. The interrelationship between MAS and ERM

17 performance (Beasley et al., 2006). Moreover, both MAS and ERM are oriented towards the future as they are both strategic in nature, i.e. ERM is intended to identify and manage uncertain future events that may affect organizational performance and MAS include accounting, organizational, decision-making, behavioral and strategical aspects; and use information of a broad scope which is timely, aggregated and integrated to reduce uncertainty concerning the feasibility of achieving objectives. This study aims to investigate whether this literature holds for MAS and ERM employed at African and European financial institutions. In the following section gives an explanation of the research method applied.

4. Methodology

As previously mentioned, the objective of this research is to investigate the influence of the external environment on the design of MAS and ERM in African and European financial institutions, the interrelationship between these systems in the context of the formerly mentioned jurisdictions. In doing this, this study will be contributing to the literature on management accounting and risk management. The following paragraphs describe the research method that was adopted to help achieve this objective.

4.1 Research population

This study’s population consists of financial institutions including; banks, financial administrative companies, and one insurance company. A total of 11 respondents working at African and European financial institutions were interviewed, please refer to appendix 8.1. The distribution of the respondents includes six management accountants and five risk officers with at least five years working experience. The majority of respondents were randomly selected based on their LinkedIn profiles while the others were recommended.

4.2 Method of data collection

18 complements this study, but to also give it direction. With the communication process, data was collected with the help of structured and semi-structured interviews via telephone and Skype calls as well as via email. This helped to facilitate description and exploration of the topic of this study (Blumber et al., 2014). Moreover, a particular set of open-end questions for each research variable was designed, please refer to the interview guide in appendix 8.2.

4.3 Method of data analysis

With the guidance of the literature summarized above the research questions were created. To facilitate systematic analysis of the data collected, all interviews were recorded and transcribed. Also, secondary information obtained from annual reports were added to the interview transcripts in order to create a general document for all textual data. In order to systematically order the data, a coding procedure was applied to categorize and combine the data into themes (Blumber et al., 2014). Thereafter, passages addressing a particular theme were assigned a particular code label, a procedure which helped to create groupings of passages with each passage representing one theme that is linked to a particular interview question. Each theme, together with its codes and passages was individually analyzed to retrieve relevant information on the influence of each external environmental factor on the design of MAS and ERM in African and European financial institutions, including the interrelationship between these two systems as can be seen in the Results section.

5. Results

The following paragraphs present the findings of the study collected from respondents working at both African and European financial institutions. The Results section is structured as follows: first, an overview of the external factors that influence the design of MAS and ERM in each jurisdiction is given continued by the interrelationship between these systems, starting with Africa then followed by Europe.

5.1 African financial institutions

19 borrower. Additionally, the findings of the study further revealed that African financial institutions are also confronted with market risks or financial risks: money laundering risks, foreign exchange risk and interest rate risk, commodity price risk, and non-financial risks such as contract risk, political risk, legal risk, reputation risk, regulatory risk, environmental and social risks. Collectively, these types of risks can be a source of considerable uncertainty for financial institutions in Africa. Moreover, the findings of the study revealed that the effect of risks has a direct effect on the type of management information produced by MAS, but an indirect effect on the design of MAS themselves. Nonetheless, these risks have to be governed and the process of governing risks at African financial institutions entails having sound risk management frameworks, processes and systems that are run by both qualitative and quantitative data, and are also independent of the organization’s other businesses and operations. In particular, African financial institutions consider it to be very important to have ERM in place as it helps the organization to prevent making losses as well as exposing itself to significant risks that could impair the existence of the business. When asked to define ERM, respondent MA 1-Africa mentioned the following:

Domestic and international regulations

The findings of the study revealed that the African financial institutions that are integrated into the global economy have to base their ERM on both domestic and international regulations on global best practices such as money laundering, combating financing of terrorism, environmental issues and international regulation. Moreover, African financial institutions that are not integrated into the global economy and/or have offices in various locations are also forced to adopt ERM global best practices in order to be seen as credible organizations. As stated by respondent RO 2-Africa:

20 financial institutions to be seen as credible businesses and hence attract more capital. As explained by respondent RO 3-Africa:

Similar to ERM, the design of management accounting practices in African financial institutions was said to be greatly influenced by domestic and international regulatory standards. For example, domestic regulators try to set standards that are in line with requirements set by international regulators, capital adequacy ratios in Basel II, and Basel III, to manage operational risks. So, African financial institutions basically design their MAS in order to meet such requirements.

Foreign capital (FDI)

The interviews conducted for this research revealed that the external environmental factor of foreign capital also has an influence on the design of MAS and ERM in African financial institutions. For example, some African financial institutions receive foreign capital investments from regional and western countries, while in other cases it is common practice for foreign banks to buy shares in local banks. Therefore, African financial institutions are pressured to meet investors’ information needs and credibility expectations. Consequently, African financial institutions design their MAS and ERM to alleviate this pressure. As previously stated, this in turn helps African financial institutions to establish credibility and hence attract more capital.

Circumstances in which MAS are used

21 That being said, the scale of MAS differed in every African financial institution considered for this study. This difference is mainly determined by the organizational strategy. Nonetheless, since these financial institutions require a complete insight into their customers and businesses, they normally employ a central system that gives a consolidated picture by feeding off all of the other systems. As described by respondent MA 1-Africa:

Consistent with literature of the three characteristics of effective MAS, the findings of this study further revealed the design of MAS in African financial to encompass broad scope information that is aggregated, integrated and timely. As outlined by respondent MA 1-Africa:

22 management procedure of these financial institutions follows the standard format of the ERM assessment process as published by COSO (2012), thus, risk identification, assessment, mitigation, monitoring and reporting.

The interrelationship between MAS and ERM

Both management accountants and risk officers at African financial institutions referred to the employment of MAS and ERM systems to be very important. This is because both systems complement each other and are in line with organizational strategies and risk appetite. Both of these systems help African financial institutions to make effective management decisions. For example, MAS provide a single source of credible information that can be used both for management decision making as well as risk management. For these companies, it is extremely important to have management accounts that are adjusted to the organization’s risk appetite. Moreover, it is a regulatory requirement for an organization’s management accounting information and risk management assessment processes to be consistent with each other. This requirement has been driven by the Basel committee on banking supervision that has introduced a standard that ensures consistency and that the management of risk information is streamlined within financial institutions. African financial institutions acknowledged to abiding by regulatory standards such as Basel I, II and III.

5.2. European financial institutions

23 organization’s actual risk profile in relation of its overall risk appetite. The risk governance frameworks, systems, processes and people are all designed in such a way that they are line with the organization’s strategy. Risk management at European financial institutions is dynamic and follows the standard format of the COSO (2012) risk assessment procedure, namely risk identification, assessment and control, monitoring and reporting, however, at different degrees of intensity. The difference in degrees of intensity is defined by the organization’s strategy, types of systems in place, importance of risk to the organization, the likelihood that the risk materializes, and information needs of internal and external stakeholders. With regard to MAS and environmental uncertainty, European financial institutions design their MAS in such a way that they are able to produce management (accounting) information that can be used to run organizational businesses, make strategic plans and measure performance. As explained by respondent MA 5-Europe:

Given the complex nature of financial products and services provided by European financial institutions, these companies have different systems for different sectors of the organization, that are centralized into one major system from which entity-wide information can be retrieved for internal and external reporting purposes. Moreover, some European financial institutions use third-party tools to facilitate external reporting.

Domestic and international regulations

24 Financing systems

It was revealed that given the fact that some European financial institutions are dependent on both public and private financing, they have to meet investor information needs and certain regulatory requirements. In both cases, the meeting of investor information needs and regulatory requirements such as overview of the return on equity, business forecasts, capital requirements, credit ratings and risk management governance translates into an influence on the design of MAS and ERM. These systems are designed in such a way that they produce information that meets investor information needs and regulatory requirements. European financial institutions benefit as they are then seen as sustainable businesses. Respondent MA 4-Europe mentioned the following as an example to illustrate how MAS are designed to provide management information to meet investor information needs:

Circumstances in which MAS are used

25 information from MAS is used by European financial institutions for management decision making, internal and external reporting to stakeholders as well as risk management.

The interrelationship between MAS and ERM

26 The table below provides a summary of the findings from the executed interviews as described above. As can be seen, the table further illustrates external environmental factors that have a direct and indirect influence on the design of MAS and ERM in African and European financial institutions.

Figure 5.1: Results of the influence of the external environment on the design of MAS and ERM in African and European financial institutions

6 Discussion and conclusion

27

6.1. Main discussion and conclusion

As previously explained, studies on management control systems have defined environmental uncertainty in terms of perceived environmental uncertainty (PEU) with aim to elaborate on an individual’s perception rather than the objective reality when relating to the external environment (Andesto, 2016; Agbejule, 2005; Milliken, 1995; Tymon et al., 1998). However, findings of this study reveal the opposite to be true as they illustrate that perceived environmental uncertainty in financial institutions, regardless of the location, is mostly determined by risks that confront an organization’s infrastructure, both financial and non-financial risks. This means that the objective reality of the external environment defines PEU at financial institutions. Nonetheless, it was further revealed that even though financial and non-financial risks are significant factors that determine organizational PEU for financial institutions, they do not have direct influence on the design of MAS but instead on management information and ERM. The reason for this being that these systems are specifically designed to absorb shocks from financial and non-financial risks that can be estimated based on historical data. Thus to some extent the findings are at the same time in line with earlier stated literature that argues that PEU influences the design, use and impact of control systems through its attention to and use of information (Agbejule, 2005; Gul & Chia, 1994).

Secondly, driven by international regulatory guidelines, African and European financial institutions that are listed on foreign stock markets and participate in offshore businesses are required to design their MAS and ERM in accordance with domestic and international regulations. It is also important to note that domestic regulations are designed in such a way that they closely reflect international regulatory standards of global best practices which is consistent with the earlier made assumptions that illustrates the impact of regulations on ERM practices (Whitman, 2015; Paape & Spekle, 2012), and the design of MAS (Tillema, 2005). Thus, confirming generalisability of this literature regardless of the fact that the formerly mentioned literature was not specifically directed towards financial institutions. Specific to Africa, financial institutions that strictly operate in the local market are predominantly exposed to domestic regulations and hence design their MAS in such a way that they produce information that meets domestic regulatory reporting requirements that, to some extent, reflect international regulations. At the same time, African financial institutions also abide by international regulations of money laundering and ERM. By meeting regulatory requirements, African and European financial institutions are perceived to be credible businesses.

28 institutions is dynamic and mostly depends on circumstantial factors that are defined by the level of economic development. These include complexity of financial products and services, organization’s strategy, current and historical state of the economic, stakeholder information needs, competitive landscape, accounting profession and education, information availability, policy conflicts, technological infrastructure, geo-politics, counter party credit ratings, and cybercrime security. The difference in level of economic development between Africa and Europe determines the difference in magnitude of influence of the formerly mentioned factors, with factors such as accounting profession and education, information availability and policy conflicts having significant influence on the design of MAS in African financial institutions. On the other hand, the complexity of financial products and services, technical advancement and cybercrime security are larger influencing factors on the design of MAS in European financial institutions than their counterparts in Africa. For example, the ING Bank uses tools with visual analytic capabilities to complement portfolio risk management. Nonetheless, taken together, these findings are to some extent consistent with the earlier stated literature on the circumstantial factors that influence the design of MAS in European organizations: accounting innovations and trends, regulations, the importance of the financial objectives, interactions between organizations and organizational parts, visibility of the operating tasks, complexity of the operating tasks, dynamism of the environment in which the operating tasks are undertaken, significance of the financial consequences, clarity of the financial consequences (Tillema, 2005), cost reduction (Dekker & Smidt, 2003), capital and size (Albu & Albu, 2012) and business process modeling (Pinayiotou & Tatsiopoulos, 2012).

29 In conclusion, the external environment influences the design of MAS and ERM in African and European financial institutions in a dynamic manner that mostly depends on the level of economic development. Economic development, in turn, defines the external environmental factors that influence the design of MAS and ERM in financial institutions regardless of the location. Example of these factors include foreign capital, domestic and international regulations, type of financing systems and circumstances in which MAS are used (i.e.; the organization’s strategy, current and historical state of the economic, internal and external stakeholder information needs, competitive landscape, accounting profession and education, information availability, policy conflicts, technological infrastructure, geo-politics, counter party credit ratings, and cybercrime security). The external environmental factor of organizational perceived environmental uncertainty was revealed to have an indirect influence on the design of MAS, but a direct influence on management information and ERM in African and European financial institutions. Nonetheless, the difference in level of economic development between Africa and Europe determines the difference in magnitude of influence of the formerly mentioned factors. In comparison to European financial institution, together with the circumstances in which MAS are used, foreign capital, domestic regulations, accounting profession and education, information availability as well as policy conflicts have significant influence on the design of MAS and ERM in African financial institutions. And in contrast to African financial institutions, domestic and international regulations, financing system influence the design of MAS and ERM, with circumstances in which MAS are used, namely, complexity of financial products and services, technological infrastructure and cybercrime security predominately influence the design of MAS in European financial institutions. Even so, regardless of the location, the design of MAS and ERM is mainly influenced by two external environmental factors: regulations and stakeholders (i.e.; shareholders, investors and customers). Additionally, according to the findings of this study, MAS and ERM employed at African and European financial institutions are interrelated. This is based on the fact that both MCS are dynamically designed to complement all organizational functionalities by providing information for strategic management decision making, control and planning, as well as being used to facilitate internal and external reporting.

6.2. Contribution to literature

30 in markets that they operate in. Regardless of this, the findings reveal that organizational PEU does not have a direct influence on the design of MAS but instead on management information and ERM. For starters, with regard to financial institutions, this empirical finding disqualifies the generalizability of literature that states that PEU elaborates on an individual’s perception rather than the objective reality when relating to the external environment (Andesto, 2016; Agbejule, 2005; Milliken, 1995; Tymon et al., 1998). Also, this empirical finding are in accordance with literature that argues that PEU influences the design, use and impact of control systems through its attention to and use of information (Agbejule, 2005; Gul & Chia, 1994). Taken together, the empirical finding supports arguments from the contingency-based view on MCS that suggests that the efficiency of these systems is contingent upon certain characteristics of the organization and its environments (Waterhouse & Tiessen, 1978; Agbejule, 2007; Chenhall, 2003; Gordon et al., 2009). Companies adapt their systems, processes and manpower to their specific environment(s). Nonetheless, for financial institutions in particular, the contingency-based view might not fully count as these institutions are mostly governed by regulatory requirements of global best practices.

Furthermore, this research contributes to management accounting and risk management literature that take into account the African element by arguing that MAS and ERM are crucial MCS in financial institutions. In these institutions, MAS and ERM are dynamically designed to complement all organizational functionalities by providing information for strategic management decision making, control and planning, as well as being used to facilitate internal and external reporting. In this way, management is better positions to make effective decisions that are not only fundamentally valuable to the organization, but are also streamlined with organizational objectives. However, for this to be achieved, both MAS and ERM have to be place as they complement each other. These findings of the study are consistent with earlier mentioned evidence from literature that states that MAS and ERM are integral to decision making, planning and control in an organization, and enhancing organizational performance (Mikes, 2006; Woods, 2008). Additionally, these findings of the study also answer the call in literature to investigate the interrelation between risk, risk management, management accounting and control practices (Soin & Collier, 2013).

6.3. Practical implications

31 reporting and social costs for various organizations. For developing jurisdictions such as Africa, this represents significant challenges. Therefore, I propose for African countries, including the region’s financial institutions to implement a centralized financial system that designs regulatory requirements that are specific to the region’s economic, environmental and social spectrum. Moreover, to promote integration into the global financial markets, this centralized financial system should of course be in line with regulations produced by western regulators such as the ECB. However, in a region where high bureaucracy and corruption are common practices, it cannot be assumed that establishing a centralized financial system will be successful. This is given the fact that Africa does not have a strong formal information structure or business environment. In addition, there is almost no common union between African countries and resourceful governments to sustain a strong continental financial system.

On another note, regardless of the harmonized approach by the ECB to regulate European financial institutions, in the ING Bank annual report (2016), it is argued that such efforts have not been completely effective. This is due to the fact that the regulatory landscape is continuously changing. This continuous change has brought about an increase in the amount of new regulations that lack clarity around reforms of regulatory requirements and are inconsiderate of environmental factors such as competitive and technological advancement. Moreover, the continuous change in Europe’s regulatory landscape has also led to rising regulatory costs and lack of coordination among regulators which has led to a sustained unlevel playing field among European financial institutions. Together with the change in the competitive landscape, this has generated uncertainty for European financial institutions to operate efficiently. To alleviate this, I recommend the ECB to create regulations that take into account changes in environmental factors that influence financial institutions’ operations, including their systems (i.e. MAS and ERM), people and processes. However, considering the contingency based view, this might not be successful given the fact that each financial institution is confronted by environmental factors specific to its environment.

6.4. Limitations of the study

32 questionnaire. In addition, some candidates that I approached were not willing to help out in fear of the consequences of participation and having busy schedules. For the remaining few that were still interested, it was challenging to arrange meetings with them given their busy schedules. For example, some interviews sessions were scheduled during respondents` free time or during weekends or evenings. In addition, of the respondents that were willing to help, some were not willing to open discussion or answering some questions due to company policy on information confidentiality. This influenced the amount of information that I collected whereby it was challenging to fully achieve the objective of this study. All of this restricted my initial plan to interview more than ten people which consequently meant that I had to modify my research plan. Most respondents requested to have the research questions sent to them before the interview sessions which proved challenging in getting the right information as the respondents would take liberties in how they wanted to answer the questions. In some cases the respondents had limited knowledge about the topics being asked so they were not able to answer the research question(s). This limited the appropriate use of the interview sessions as there were instances where I had to contact some the respondents again so that they could clarify of certain aspects that were specifically directed to my research which was also an inconvenience to them.

Finally, given the fact that most African financial institutions operate in an environment characterized by information business operations, another limitation of this study was accessing additional information about these financial institutions such as annual reports.

6.5. Future research

33 and ERM. Therefore, future research to investigate the design of MAS and ERM in financial institutions while considering all of the formerly mentioned contingency variables is recommended. Lastly, future research should also be specifically designed from an economic perspective as this determines the existence of financial institutions and the employment of management control systems such as MAS and ERM.

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