Accounting control systems and business strategy: An empirical analysis

Accounting Organizations andSociety, Vol. 12, No. 4, pp. 357-374, 1987. Printed in Great Britain

ACCOUNTING

0361-3682/87 $0.00+.00 Pergamon Journals Ltd.

CONTROL SYSTEMS AND BUSINESS STRATEGY: AN EMPIRICAL ANALYSIS*

ROBERT SIMONS Harvard Business School

Abstract

Accounting theoreticians have argued that control systems should be modified in accordance with the business strategy of a firm. This study tests this hypothesis by examining differences in accounting control system attributes between two groups of firms following distinctly different strategies. Interview data and questionnaire data are used to provide evidence of the ways in which firms align their control systems and strategy. In addition, preliminary evidence is discussed which suggests a relationship between accounting control systems, business strategy and firm performance.

This r e s e a r c h investigates the r e l a t i o n s h i p bet w e e n b u s i n e s s strategy a n d a c c o u n t i n g b a s e d c o n t r o l systems. U n d e r a c o n t i n g e n c y v i e w of o r g a n i z a t i o n design, it has b e e n p r o p o s e d that a c c o u n t i n g c o n t r o l systems s h o u l d b e d e s i g n e d specifically to suit the b u s i n e s s strategy of the firm (Otley, 1980; D e r m e r , 1977). However, aside from the n o w w e l l - a c c e p t e d link b e t w e e n an organization's strategy a n d its s t r u c t u r e (Galbraith & Nathanson, 1979; Rumelt, 1974; Chann o n , 1973; Chandler, 1962), little e m p i r i c a l evid e n c e exists i n s u p p o r t of this claim. T w o e m p i r i c a l studies in the o r g a n i z a t i o n t h e o r y l i t e r a t u r e p o i n t to the p o t e n t i a l import a n c e of u n d e r s t a n d i n g the r e l a t i o n s h i p b e t w e e n strategy a n d c o n t r o l systems as a p r e r e q u i s i t e to t h e d e v e l o p m e n t of g e n e r a l t h e o r i e s c o n c e r n i n g a c c o u n t i n g c o n t r o l systems i n c o m p l e x organizations. In the m o s t r e c e n t of these studies, Miller & Friesen ( 1 9 8 2 ) s o u g h t to u n d e r s t a n d the relat i o n s h i p b e t w e e n p r o d u c t i n n o v a t i o n a n d or-

ganizational variables, i n c l u d i n g the use of control systems. A n u m b e r of p r e v i o u s studies had a t t e m p t e d to test Burns & Stalker's ( 1961 ) conc l u s i o n that u n s t r u c t u r e d , o r g a n i c organizations w i t h m i n i m a l formal c o n t r o l s w e r e best suited to a strategy of i n n o v a t i o n ; h o w e v e r , results from these studies w e r e i n c o n c l u s i v e (Rogers & Shoemaker, 1 9 7 1 , p p . 350--376; Kimberly, 1981, p. 89). In a t t e m p t i n g to r e c o n c i l e these differences, Miller & Friesen's r e s e a r c h r e v e a l e d that c o n t r o l l i n g for the strategy of the firm is critical to u n d e r s t a n d i n g the r e l a t i o n s h i p b e t w e e n control a n d i n n o v a t i o n . T h e y found, for example, that e n t r e p r e n e u r i a l firms p u r s u i n g a strategy of continual product market development used c o n t r o l systems as a m e a n s of m o n i t o r i n g inn o v a t i v e excess; c o n t r o l was therefore negatively c o r r e l a t e d w i t h f i r m i n n o v a t i o n . H o w e v e r , for firms i n their sample following a c o n s e r v a t i v e strategy, these same systems a l l o w e d m a n a g e r s to b e c o m e aware of p o t e n t i a l areas of o p p o r t u n ity a n d were, accordingly, positively associated

*This paper has benefitted from the suggestions of colleagues at the Facultyof Management,McGiUUniversityand at Harvard Business School. I am especially grateful to Haim Falk, Robert Kaplan, Harvey Mann, Danny Miller, Henry Mintzberg, and Morty Yalovsky.Perceptive comments have also been provided by Shahid Ansari,V. Govindarajan,Norman Macintosh,John Waterhouse and two anonymous reviewers. Funding for the research was provided by the Quebec Order of Chartered Accountants and the Division of Research of Harvard Business School. 357

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w i t h firm innovation. A s t u d y b y Khandwalla ( 1 9 7 2 ) also suggests the p o t e n t i a l for e x p l o r i n g relationships bet w e e n firm strategies a n d c o n t r o l systems. I n this research, data o n the use of n i n e categories of sophisticated c o n t r o l s w e r e g a t h e r e d from 92 Canadian m a n u f a c t u r i n g firms. 1 T h e m a j o r conc l u s i o n of the s t u d y was that i n c r e a s e d c o m p e t i tion, n o t a b l y p r o d u c t c o m p e t i t i o n , r e s u l t e d in i n c r e a s e d use of sophisticated c o n t r o l procedures. Khandwalla c o n c l u d e d that these types of firms, e n g a g e d i n c o n t i n u a l p r o d u c t developm e n t a n d the search for n e w m a r k e t segments, b e c a m e differentiated a n d r e q u i r e d elaborate c o n t r o l s for p u r p o s e s of i n t e g r a t i o n ( L a w r e n c e & Lorsch, 1967). T h e r e l a t i o n s h i p b e t w e e n strategy and o n e att r i b u t e of control, the m a n a g e m e n t r e w a r d system, has b e e n the s u b j e c t of limited empirical testing b y a c c o u n t a n t s . Vancil ( 19 79, p. 2 9 2 ) has s h o w n that an organization's e v a l u a t i o n a n d rew a r d systems are usually tied to its c o n t r o l systems. Managers often r e c e i v e at least s o m e of their r e m u n e r a t i o n as a f u n c t i o n of c o n t r o l syst e m m e a s u r e s (e,g. b u d g e t targets, profit c e n t e r results), and it has b e e n argued that r e m u n e r a t i o n packages for m a n a g e r s s h o u l d b e adapted to a n organization's strategy (Salter, 1973). Govindarajan & G u p t a ( 1 9 8 5 ) tested this hypothesis a n d c o n c l u d e d that p e r c e i v e d organizational p e r f o r m a n c e was higher w h e n r e m u n e r a t i o n p r o c e d u r e s ( d i s c r e t i o n a r y vs f o r m u l a - b a s e d ) w e r e c o r r e c t l y m a t c h e d to organizational strategies. T h e studies r e p o r t e d above are suggestive of a

p o t e n t i a l l y i m p o r t a n t relationship b e t w e e n control systems and firm strategy. However, since the studies b y Miller & Friesen ( 1 9 8 2 ) a n d Khandwalla ( 19 7 2 ) w e r e each part of a larger research series, they are of l i m i t e d value to the q u e s t i o n s p o s e d b y a c c o u n t a n t s : c o n t r o l was m e a s u r e d , in each case, as a single variable in a m u c h larger set of organizational, e n v i r o n m e n t a l a n d strategic variables. Thus, the n a t u r e of the relationship b e t w e e n c o n t r o l attributes a n d b u s i n e s s strategy r e m a i n s largely untested.

RESEARCH DESIGN This r e s e a r c h was d e s i g n e d to d e t e r m i n e the n a t u r e a n d e x t e n t of differences i n the c o n t r o l systems of firms w h i c h follow different b u s i n e s s strategies. 2 Thus, the relationship b e t w e e n t w o classes of variables - - c o n t r o l system attributes a n d b u s i n e s s strategies - - is the focus of this research.

Control system attributes In this study, c o n t r o l systems refer to form a l i z e d procedures a n d systems that use inform a t i o n to m a i n t a i n or alterpatterns in organiz a t i o n a l activity. W i t h i n the d o m a i n of interest i m p l i e d b y this d e f i n i t i o n are p l a n n i n g systems, r e p o r t i n g systems, a n d m o n i t o r i n g p r o c e d u r e s w h i c h are based o n i n f o r m a t i o n use; e x c l u d e d ( s o m e w h a t arbitrarily) from this analysis are informal c o n t r o l m e c h a n i s m s such as social and cultural c o n t r o l (Jaeger, 1983). A c c o u n t a n t s have b e c o m e i n t e r e s t e d in un-

t Khandwalla'scontrol procedures were: ( 1) standard costing and variance analysis,(2) marginalcosting, ( 3) flexiblebudgeting, ( 4 ) internal auditin~ ( 5 ) operational auditing by outside auditors, ( 6 ) capital budgeting techniques, ( 7 ) statisticalquality control, (8) inventory control and production scheduling by operations research techniques, and (9) systematic managerial performance evaluation. z The hypothesis and methods of this study, which relate control system attributes to business strategy, are developed and stated in a functionalist perspective (Burrell & Morgan, 1979, pp. 164--184). For example, statistical tests are performed under the assumption that, when certain organizational attributes are beneficial to the strategic success of a set of firms, the use of these attributes by firms in the set will be more prevalent. It is often convenient, therefore, to imply causality, i.e. strategic needs determine control system design; however, causality is a matter of expositional convenienceand cannot be imputed from the results of this study. Moreover, the emerging literature on organizationalmyth and ceremony (e.g. Meyer, 1986; Dirsmith, 1986; Meyer & Rowan, 1977) suggests that formal structures such as control systems may be created and elaborated to support institutional myths. This research was not designed to investigate these effects, e.g. potential differences between reported control system structures and the structures actually in use.

ACCOUNTINGCONTROLSYSTEMSAND BUSINESSSTRATEGY:AN EMPIRICALANALYSIS derstanding the relationship b e t w e e n control system design and organizational variables such as size, technology and environment. A review of the typological literature c o n c e r n e d with control system design suggests that certain attributes of control systems are amenable to design choice. Studies by Merchant (1984, 1981), Macintosh (1981), Gordon et al. (1978), Tushman & Nadler (1978), Ansari (1977), Gordon & Miller (1976), Mintzberg (1975), Bruns & Waterhouse (1975), Gorry & Scott Morton ( 1971 ) and Anthony ( 1 9 6 5 ) address the structural attributes of planning and control systems and suggest possible design modifications contingent u p o n the context of their use. Examples of control system attributes include tightness of budget goals, use of cost control, frequency of reporting and intensity of monitoring performance results. The next section of the p a p e r outlines the methods employed to categorize control system attributes for this study. Strategy Strategy researchers such as Mintzberg (1973), Utterback & Abernathy (1975), Miller & Friesen (1978), Miles & Snow ( 1 9 7 8 ) and Porter (1985, 1980) have sought to understand the type of strategy followed by firms in relation to other variables relevant to organizational success. In these studies generic and recurring strategies have b e e n identified by studying a large n u m b e r of firms in a variety of industries. The Miles & Snow ( 1 9 7 8 ) typology used in this study is based on field research in four industries: college t e x t b o o k publishing, electronics, food processing, and health care. The key dimension of the Miles & Snow typology is the rate at which the organization changes its products or markets. Miles & Snow identified three successful, generic strategies which they labeled Prospector, Defender, and Analyzer. Defenders operate in relatively stable p r o d u c t areas, offer m o r e limited products than competitors, and c o m p e t e through cost leadership, quality, and service. They engage in little product/market development. Prospectors, on the other hand, c o m p e t e through n e w products and market development.

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Product lines change o v e r time and this type of firm is constantly seeking n e w market opportunities. Analyzers are an intermediate hybrid, combining parts of b o t h Defender and Prospector strategies. The Miles & Snow typology was chosen in this study for two reasons. First, it is well d o c u m e n t e d and representative of the current strategy content literature. The Prospector and Defender type firms identified by Miles & Snow exhibit similar characteristics to strategy archetypes identified in other studies including entrepreneurial and planning m o d e firms (Mintzberg, 1973), performance maximizing and cost minimizing firms (Utterbeck & Abernathy, 1975), and innovators and dominant firms (Miller & Friesen, 1978). Moreover, Miles & Snow are clear in their statement that the control system of a firm should be congruent with its strategy. Second, the typology has b e e n independently tested in subsequent studies (Hambrick, 1983; Snow & Hambrick, 1980; Hambrick, 1979) and found to be a useful means of classifying generic strategies across diverse industries. Most strategic typologies are grounded in the belief that firms following different strategies can prosper in most industries by properly aligning their internal characteristics with their market niche position (Galbraith & Nathanson, 1979). In this view, firms have freedom of choice in choosing their strategies: for example, Miles & Snow ( 1 9 7 8 ) and Snow & Hambrick ( 1 9 8 0 ) b o t h state that Prospectors and Defenders will perform equaUy well in most industries if the strategy is well i m p l e m e n t e d and internal structures are consistent. This view, however, is not universally shared; others believe that optimal strategy is situationally determined. Andrews ( 1 9 7 1 ) and Porter (1980), for example, argue that firms should match their business strategy to their industry environment, with highly dynamic industries requiring m o r e innovative strategies (i.e. Prospector strategies) and less dynamic industries being associated with m o r e traditional (i.e. Defender) strategies. Since the firms in this study include a wide variety of industries (the selection process is explained in the next section), a variable for in-

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dustry dynamism was included in the analysis as another indicator of business strategy. If strategy and industry environment are related, the inclusion of this variable is expected to increase the predictive accuracy of the model.

Hypothesis This study is designed to use the Miles & Snow strategy typology as a vehicle to build on the generalized findings of KhandwaUa ( 1 9 7 2 ) and Miller & Friesen ( 1 9 8 2 ) to investigate from an accounting perspective which specific attributes of control system design differ with a firm's strategy. Miles & Snow suggest that successful firms must ensure that their administrative systems, notably their control systems, a r e properly and differentially designed to take account of their strategy. They argue that Defenders will emphasize cost control, trend monitoring and efficiency rather than scanning the environment for new opportunities. Prospectors, by contrast, will use comprehensive planning and measure performance more subjectively. It seems reasonable to anticipate that Defenders will place heavier reliance on formal accounting procedures, especially those directed to cost control, while Prospectors will de-emphasize accounting controls in general, placing greater emphasis on fostering individual creativity and innovation. This view is in accord with the belief that innovation (in this case product/ market innovation) and administrative control is incompatible (Thompson, 1965). However, the few studies which have focused on the relationship between control systems and innovation (Kamm, 1980; Miller & Friesen, 1982) have concluded that the relationship between administrative control and innovation needs to be clarified in the light of evidence that adminstrative controls can be associated with more rather than less innovative behavior. Other studies have also found that firms facing uncertain environments use sophisticated controls to a high extent (Lawrence & Lorsch, 1967; Khandwalla, 1972; Tushman & Nadler, 1978, Simons, 1987). Since theory in this area is not well developed, it is premature to specify apriori h o w account-

ing control systems are expected to differ according to the strategy pursued by the firm. Rather, any differences in attributes between Prospector and Defender firms which cause rejection of the null hypothesis in a two-tail test can be examined to provide initial evidence concerning the relative impact of strategy on accounting control systems. H0 (Null form). Control system attributes do not differ between Prospectorfirms and Defenderfirms. Underlying most accounting research is the assumption that control system design contributes to the successful operation and profitability of the firm (Merchant & Simons, 1986). In the context of this study, limited preliminary evidence was examined to determine if a relationship exists between economic performance, control system attributes and strategy. If successful implementation of Defender and Prospector strategies requires different control systems, then the correlations between control system attributes and economic performance should be different for Defender firms and Prospector firms. The examination of this relationship was not statistically tested due to small sample sizes; rather differences in correlations between Prospector and Defender firms are used to interpret and discuss interview data gathered as part of the study. Finally, since the size of a firm has been shown to affect the way in which control systems are utilized (Merchant, 1981; Bruns & Waterhouse, 1975), the sample for this study was split based on size to create two subsamples of firms. Data analysis was conducted tbr the sample as a whole and separately for each subsample. METHOD The hypothesis was tested using both interview data and a binary logistic regression model with strategy type as the criterion variable and control system attributes as predictors. AdditionaUy, profit performance data were correlated with control system attributes for Prospector and Defender firms. The following section describes these procedures.

ACCOUNTINGCONTROLSYSTEMSAND BUSINESSSTRATEGY:AN EMPIRICALANALYSIS

Sample selection S n o w & H a m b r i c k ( 1 9 8 0 ) identify four m e t h o d s of classifying firms into g r o u p s b y strategy: investigator inference, self-typing b y s u b j e c t firm, e x t e r n a l assessments b y experts, a n d the use of o b j e c t i v e indicators. An e x t e r n a l assessment m e t h o d b a s e d o n the ratings of experts i n each i n d u s t r y was c h o s e n as the p r i m a r y classification d e v i c e for this s t u d y d u e to c e r t a i n advantages: the m e t h o d allows for large sample sizes, it utilizes the i n f o r m e d ratings of impartial experts, a n d it is well suited to identifying realized, as o p p o s e d to i n t e n d e d , strategies. 3 Disadvantages to this m e t h o d relate to the possibility that raters m a y possess l i m i t e d k n o w l e d g e c o n c e r n i n g a large array of organizations. As S n o w & H a m b r i c k ( 1 9 8 0 ) p o i n t out, this disadvantage can b e o v e r c o m e b y c o n s t r a i n i n g the g e o g r a p h i c p r o x i m i t y of firms to b e rated, tailoring q u e s t i o n s to i n d u s t r i e s in w h i c h the rater is well versed, a n d selecting o n l y firms w h e r e agr e e m e n t a m o n g raters as to the classification is high. All of these c o n t r o l p r o c e d u r e s w e r e foll o w e d in this study. In addition, the p e r c e p t i o n s of e x e c u t i v e s c o n c e r n i n g the strategy of their o w n firm (i.e. self-typing) w e r e u s e d as a s e c o n d classification d e v i c e to cross validate the external assessment. Based o n four digit Standard I n d u s t r y Classific a t i o n Codes, a list was c o m p i l e d of 261 Canadian m a n u f a c t u r i n g firms in 38 industries in southern Ontario and Quebec. A questionnaire was sent to the c h i e f e x e c u t i v e officer of each firm. 4 T h e q u e s t i o n n a i r e c o n t a i n e d the o n e paragraph d e s c r i p t i o n u s e d b y S n o w & Hrebiniak ( 1 9 8 0 ) to categorize P r o s p e c t o r s a n d Defenders. I n addition, a list of those firms in the same i n d u s t r y as that of the r e c i p i e n t was prov i d e d w i t h the r e q u e s t that the r e s p o n d e n t indi-

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cate if any ( o r n o n e ) of the firms o n the list, inc l u d i n g his own, c o u l d b e classified as e i t h e r Type A ( D e f e n d e r ) or T y p e B ( P r o s p e c t o r ) . T h e w o r d s D e f e n d e r and P r o s p e c t o r w e r e carefully o m i t t e d from b o t h the i n s t r u c t i o n s a n d strategy descriptions, a n d the i n s t r u c t i o n s clearly stated that n e i t h e r type necessarily r e p r e s e n t e d g o o d or p o o r strategic behavior. A total of 171 firms ( 6 6 % ) c o m p l e t e d a n d ret u r n e d the q u e s t i o n n a i r e . A firm was a d m i t t e d to the sample as either a D e f e n d e r or P r o s p e c t o r w h e n m o r e t h a n two-thirds of the r e s p o n d e n t s w i t h i n its i n d u s t r y agreed o n the classification. However, if the r e s p o n d i n g e x e c u t i v e from any firm disagreed w i t h the e x t e r n a l c o n s e n s u s conc e r n i n g his o w n firm, that firm was d r o p p e d from f u r t h e r analysis. Following this p r o c e d u r e , a total of 62 Defenders a n d 46 Prospectors w e r e identified s p a n n i n g 28 industries. T h e m e a n agr e e m e n t a m o n g r e s p o n d e n t s as to the final rating c a t e g o r y for the 108 firms selected was 85.7% i n d i c a t i n g a high level of c o n f i d e n c e that the firm was c o n s i s t e n t l y r e g a r d e d w i t h i n its industry as either a D e f e n d e r or Prospector. Since the categories of D e f e n d e r a n d P r o s p e c t o r are n o t exhaustive w i t h i n the Miles & S n o w typology, b u t r a t h e r c h o s e n to m a x i m i z e b e t w e e n g r o u p variance, it is n o t u n e x p e c t e d that these proced u r e s s h o u l d yield o n l y 108 firms from an initial set of 261. 5 Of the 108 firms identified as Prosp e c t o r s or Defenders, 76 agreed to p r o v i d e data for the s t u d y ( T a b l e 1 ).

Interviews I n t e r v i e w s w e r e c o n d u c t e d w i t h s e n i o r general m a n a g e r s ( u s u a l l y the c h i e f o p e r a t i n g ofricer of the strategic b u s i n e s s u n i t ) in twelve rand o m l y s e l e c t e d firms c h o s e n for i n c l u s i o n i n the

3See Mintzberg (1978) for a discussion of intended, emergent and realized strategies. 4A firm is defined in this discussion as the strategic business unit (SBU)which operates primarily in the 4 digit SIC industry classificationused in the sample selection. Of the sample SBUs,85% were distinct legal entities and 15% were autonomous divisions of diversified,multidivisional companies. 5The remaining categories of the typology are Analyzer- - an intermediate position between Prospector and Defender-- and Reactor - - an unsuccessful firm which fails to follow one of the other three successful strategies. In the questionnaire, these firms are captured by the category, "fitsneither type" for firmswhich are neither distinct Prospectors nor distinct Defenders.

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ROBERT SIMONS TABLE 1. Sample by industry n

Industry Industrial chemicals Pharmaceuticals Tires Footwear Elevators Computers Television sets Phonograph records Signaltransmission equipment Aircraft Industrial controls Medical supplies Toys and games Preserved foods Baked goods Chocolate Liquor Furniture Greeting cards Total

Prospectors

Defenders

3 3 1 2 1 1 1 3 2 1 1 1 2 2 2 2 1 1 2

5 1 2 4 2 3 1 4 2 2 1 1 5 3 1 2 2 1 2

32

44

s a m p l e ( s i x D e f e n d e r s and six P r o s p e c t o r s ) . 6 T h e i n t e r v i e w l e n g t h w a s t w o to t h r e e h o u r s a n d discussions were tape recorded. The purpose of t h e i n t e r v i e w s w a s threefold: first, to i n d e p e n d e n t l y assess t h e a c c u r a c y o f t h e s t r a t e g y classification; s e c o n d , to g a t h e r i n p u t for t h e d e s i g n o f t h e q u e s t i o n n a i r e to b e u s e d in c o l l e c t i n g d a t a a n d testing h y p o t h e s e s r e l e v a n t to c o n t r o l syst e m a t t r i b u t e s f r o m t h e larger p o p u l a t i o n o f firms; a n d third, to o b t a i n i n t e r v i e w d a t a to aid in t h e analysis o f differences in t h e u s e o f c o n t r o l s b e t w e e n D e f e n d e r a n d P r o s p e c t o r firms. T h e int e r v i e w s f o c u s e d o n t h e strategies f o l l o w e d b y t h e firm a n d o n t h e use o f c o n t r o l s y s t e m s w i t h i n t h e firm. In all t w e l v e cases, s e m i - s t r u c t u r e d discussions c o n f i r m e d t h e i n d e p e n d e n t , p r i o r assessm e n t b y i n d u s t r y e x e c u t i v e s o f t h e firm's strategy as e i t h e r a P r o s p e c t o r o r Defender, t h e r e b y a d d i n g f u r t h e r validity to t h e s a m p l e s e l e c t i o n p r o c e d u r e . For e x a m p l e , t h e f o l l o w i n g

r e m a r k s w e r e m a d e b y s e n i o r m a n a g e r s o f firms classified as Defenders: "one o f o u r o b j e c t i v e s is to b e l o w c o s t p r o d u c e r in t h e industry; w e are a l e a d e r in p r o d u c t i v i t y " ( f o o d m a n u f a c t u r e r ) ; " t h e r e is n o q u e s t i o n a b o u t it for us, efficiency o f o p e r a t i o n s is t h e m o s t i m p o r t a n t t h i n g as far as relative w e i g h t s b e t w e e n i n n o v a t i o n a n d effic i e n c y ( a v i a t i o n p r o d u c t s m a n u f a c t u r e r ) ; "cost is o u r p r i m e c o n s i d e r a t i o n , a n d w e ' l l d o everyt h i n g to m i n i m i z e t h o s e costs" ( d r u g manufacturer). By contrast, e x e c u t i v e s o f firms classified as P r o s p e c t o r s stated, " w e are high p r i c e d in t e r m s o f o u r p r o d u c t s , so that if w e d o n ' t have any n e w p r o d u c t i n n o v a t i o n s o u r m a r k e t will q u i c k l y b e lost b y v i r t u e o f l o w p r i c e d c o m p e t i t o r s c o m i n g a n d taking o u r m a r k e t share away. P r o d u c t innov a t i o n is p r o b a b l y t h e singular m o s t i m p o r t a n t a s p e c t o f o u r business" ( d r u g m a n u f a c t u r e r ) ; '~¢e c o n s c i o u s l y d e c i d e d that w e are n o t g o i n g to c o m p e t e o n price, w e a r e g o i n g to c o m p e t e o n fashion and style" ( s h o e m a n u f a c t u r e r ) .

Measures Scale q u e s t i o n s for control s y s t e m attributes w e r e d e v e l o p e d in t h r e e steps. First, r e f e r e n c e was m a d e to c o n t r o l t y p o l o g i e s w h i c h p r e d i c t d i f f e r e n c e s in c o n t r o l s y s t e m d e s i g n a c r o s s differ e n t o r g a n i z a t i o n a l t y p e s ( G o r r y & Scott Morton, 1971; G o r d o n et al., 1978; Ansari, 1977; G o r d o n & Miller, 1976; Macintosh, 1981; Mintzberg, 1975; T u s h m a n & Nadler, 1978). Second, t h e i n t e r v i e w data s u p p l i e d b y s e n i o r m a n a g e r s w e r e a n a l y z e d for c o n t r o l a t t r i b u t e s w h i c h t h e m a n a g e r s c o n s i d e r e d i m p o r t a n t to t h e p e r f o r m a n c e o f t h e i r firm. Third, w h e n e v e r possible, q u e s t i o n s w e r e a d o p t e d f r o m previo u s l y v a l i d a t e d s o u r c e s (e.g. Khandwalla, 1972, 1977). Q u e s t i o n n a i r e s w e r e t h e n e d i t e d for amb i g u i t y b y t h r e e faculty colleagues. Q u e s t i o n s w e r e f u r t h e r r e f i n e d b y p r e t e s t i n g t h e questionn a i r e w i t h s e n i o r m a n a g e r s and c h i e f financial ofricers in t w e n t y firms n o t i n c l u d e d in t h e s t u d y and soliciting their comments concerning a p p l i c a b i l i t y and clarity.

6 These firms were subsequently included in statistical data analyses. To ensure no contamination of the data, the control questionnaire was completed by a senior manager not present at the interview.

ACCOUNTINGCONTROL SYSTEMSAND BUSINESSSTRATEGY:AN EMPIRICALANALYSIS Based o n t h e s e p r o c e d u r e s , 33 a n c h o r e d s e v e n - p o i n t Likert-type scales w e r e s e l e c t e d to collect data concerning accounting and control a t t r i b u t e s o f t h e s e l e c t e d firms. T h e q u e s t i o n s foc u s e d o n d i v e r s e a s p e c t s o f a firm's a c c o u n t i n g c o n t r o l s y s t e m s i n c l u d i n g planning, b u d g e t i n g , c o s t analysis, a n d r e m u n e r a t i o n t e c h n i q u e s ( a n a b b r e v i a t e d v e r s i o n o f t h e q u e s t i o n n a i r e is p r e s e n t e d in t h e A p p e n d i x ) . Fully c o m p l e t e d questionnaires were received from senior managers in 76 firms that a g r e e d to p a r t i c i p a t e in t h e study. R e s p o n d e n t s , w h o h a d b e e n a s s o c i a t e d w i t h t h e i r b u s i n e s s an a v e r a g e o f 12 years, c o m p r i s e d b o t h s e n i o r o p e r a t i n g officers a n d s e n i o r financial officers. N i n e p e r c e n t o f r e s p o n d e n t s w e r e CEOs; 65% r e p o r t e d d i r e c t l y to t h e CEO; 26% w e r e t w o o r m o r e levels b e l o w t h e CEO. To e n s u r e that r e s p o n d e n t s u n d e r s t o o d b o t h t h e i n s t r u c t i o n s a n d t h e scale questions, e a c h res p o n d e n t w a s c o n t a c t e d b y t e l e p h o n e in t h e week following their receipt of the questionnaire, at w h i c h t i m e any n e c e s s a r y clarification was provided. F a c t o r analysis w a s p e r f o r m e d to e x p l a i n t h e c o r r e l a t i o n s a m o n g t h e 33 s c a l e d c o n t r o l s y s t e m variables. After an e x a m i n a t i o n o f f a c t o r solutions w i t h e i g e n v a l u e s > 1, t e n factors w e r e ret a i n e d w h i c h a c c o u n t e d for 75.2% o f t h e variance. To i m p r o v e i n t e r p r e t a b i l i t y , t h e factor solution was rotated using the varimax orthogonal m e t h o d ( G r e e n , 1978, p. 377); t h e r e s u l t i n g factor loadings and percent of variance explained b y e a c h o f t h e factors are s h o w n in T a b l e 2. T h e f a c t o r s c o r e s c o m p u t e d for e a c h firm a c r o s s t h e s e t e n factors w e r e u s e d as t h e i n d e p e n d e n t variables o f t h e statistical analysis ( f o r a discuss i o n o f this p r o c e d u r e , s e e G r e e n , 1978). Based o n t h e scales c o n t a i n e d in t h e q u e s t i o n naire, t h e t e n factors m a y b e d e s c r i b e d as follows: 1. Tight b u d g e t goals - - e x t e n t to w h i c h m e e t i n g tight b u d g e t targets is e m p h a s i z e d . 2. E x t e r n a l s c a n n i n g - - e x t e n t to w h i c h d a t a o n e x t e r n a l e v e n t s are i n c l u d e d in c o n t r o l information. 3. Results m o n i t o r i n g - - e x t e n t t o w h i c h managers monitor interperiod budget and perf o r m a n c e results.

363

4. Cost c o n t r o l - - e x t e n t to w h i c h c o s t analysis t e c h n i q u e s and c o n t r o l s are used. 5. F o r e c a s t d a t a - - t h e e x t e n t to w h i c h forecast d a t a is i n c l u d e d in c o n t r o l r e p o r t s . 6. Goals r e l a t e d to o u t p u t effectiveness - k n o w l e d g e a n d i m p o r t a n c e o f factors r e l a t e d to product output. 7. R e p o r t i n g f r e q u e n c y - - f r e q u e n c y o f issuing c o n t r o l r e p o r t s . 8. F o r m u l a - b a s e d b o n u s r e m u n e r a t i o n - - ext e n t to w h i c h b o n u s r e m u n e r a t i o n is e s t a b l i s h e d by formula based on achieving budget targets r a t h e r t h a n d i s c r e t i o n a r y . A s s o c i a t e d w i t h lack o f e x t r a n e o u s d a t a in c o n t r o l r e p o r t s . 9. T a i l o r e d c o n t r o l s y s t e m s - - e x t e n t to w h i c h c o n t r o l s y s t e m s are t a i l o r e d to dep a r t m e n t a l c i r c u m s t a n c e s a n d needs. A s s o c i a t e d w i t h high level o f detail in c o n t r o l r e p o r t s . 10. C o n t r o l s y s t e m c h a n g e a b i l i t y - - freq u e n c y o f c h a n g e in c o n t r o l s y s t e m s and i m p o r t a n c e o f e m p l o y i n g informal c o m m u n i c a t i o n to t r a n s m i t c o n t r o l information. Industry dynamism, the e n v i r o n m e n t a l varia b l e u s e d in this study, w a s t a k e n f r o m KhandwaUa ( 1 9 7 7 , pp. 6 4 1 - 6 4 2 ) a n d is similar to that e m p l o y e d b y Miller & F r i e s e n ( 1 9 8 4 ) to measure environmental dynamism. Calculated as t h e m e a n o f t w o s e v e n - p o i n t , a n c h o r e d , Likert-type scales ( C r o n b a c h ' s 0t= 0.74), indust r y d y n a m i s m is d e f i n e d as t h e e x t e n t o f c h a n g e a n d u n p r e d i c t a b i l i t y in t h e t e c h n i c a l a n d e c o n omic dimensions of the industry environment. Profitability w a s m e a s u r e d as t h e m e a n t h r e e y e a r r e t u r n o n i n v e s t m e n t ( R O I ) for t h e r e p o r t ing b u s i n e s s unit. R e p o r t e d ROI figures w e r e c h e c k e d against p u b l i s h e d financial s t a t e m e n t s w h e r e p o s s i b l e a n d f o u n d to b e substantially accurate. T h e m e d i a n t h r e e y e a r ROI for s a m p l e firms w a s 16.7% w i t h a r a n g e o f - 6 . 0 % to 46.3%. W h i l e ROI is an i m p e r f e c t m e a s u r e o f firm p e r f o r m a n c e , a n d c o n c l u s i o n s m u s t t h e r e fore b e tentative, this analysis is u s e d to m o t i v a t e discussions concerning the possible relationship b e t w e e n firm p e r f o r m a n c e a n d strategy. ANALYSIS The major hypothesis of the study concerning

364

ROBERT SIMONS TABLE 2. Factor loadings - - control attributes

Factor description and variables (loading > 0.50)

Loading

Percentage of variance explained

FI

F2

F3

/74

F5

F6

F7

F8

F9

F10

25.7

Tight budget goals (Q 32)* Tightness of budgetary goals (Q 23) Importance of meeting buget targets (Q 25) Accuracy of budget targets (Q 8) Use of summary measures of departmental performance (Q 24) Importance of achieving operating efficiencies

0.81 0.60 0.56 0.55 0.51

External scanning (Q 1) Use of planning manuals (Q 15) Inclusion of external data in control reports (Q 11) Comparison of performance results against competitors

0.65 0.63 0.60

Results monitoring (Q 21 ) Trends in performance results closely monitored (Q 12) Provision ofwritten explanation for variances (Q 23 ) Importance of meeting budget targets

0.67 0.58 0.54

Cost control (Q 4) Use of cost centers ( Q 2) Extent of cost control through variance analysis (Q 18 ) Monitoring of all tasks by control systems

0.70 0.52 0.52

Forecast data (Q 6) Inclusion of forecast data in control reports

0.57

Goals related to output effectiveness (Q 17 ) Importance of effectiveness goals related to product output (Q 16 ) Knowledge of business operations

0.76 0.55

Reporting frequency (Q 27 ) Frequency ofissuing control reports

0.67

Formula-based bonus remuneration (Q 28) Bonus remuneration based on objective formula related to budget targets (Q 20 ) Data included in control reports only if frequently used

0.71 0.52

Tailored control systems (Q 29 ) Control systems tailored to circumstances (Q 26 ) Control reports highly detailed

0.78 0.50

Control system changeability (Q 31) Frequent change in control systems in past 5 yrs (Q 22) Informal communication important in supplying control information

0.54 0.53

*See Appendix for abbreviated research questionnaire.

8.6

7.2

6.3

5.4

5.3

4.8

4.2

4.0

3.6

ACCOUNTING CONTROL SYSTEMSAND BUSINESSSTRATEGY:AN EMPIRICAL ANALYSIS the existence of control system differences between Prospectors and Defenders was tested using a logit model of the form

In

P = /30 + /31F1 + . - . 1--P

+ /31o/71o + /311D + E

w h e r e P is t h e p r o b a b i l i t y t h a t t h e f i r m is a P r o s p e c t o r , ( 1 - P ) is t h e p r o b a b i l i t y t h a t t h e f i r m is a Defender, F i (i = 1..... 10) are factor scores of c o n t r o l s y s t e m a t t r i b u t e s , a n d D is i n d u s t r y d y n a m i s m . /30 t o / 3 t l a r e p a r a m e t e r s t o b e estimated. The logit model postulates that the binary dependent variable (coded 0 for Defenders or 1 for P r o s p e c t o r s ) is d r a w n f r o m l o g i s t i c c u m u l a t i v e function distributions with selection probabilities conditioned on the observed values of the independent variables. 7 Thus, the null hypothesis that control system attributes do not differ between Prospector and Defender firms can be

365

r e j e c t e d if t h e / 3 c o e f f i c i e n t s o f t h e f a c t o r s c o r e s in the estimated model are significantly different f r o m 0. T h e g o o d n e s s o f fit a s s o c i a t e d w i t h t h e model can be assessed in the usual manner by u s i n g a l a t e n t R z s t a t i s t i c ( S c h l a i f e r , 1 9 8 1 , p. 2 3 4 ) a n d a d d i t i o n a l l y b y l o o k i n g a t t h e differences between the observed frequencies in the P r o s p e c t o r a n d D e f e n d e r c a t e g o r i e s a n d t h e estimated frequencies obtained from the logit m o d e l ( P i n d y c k & R u b i n f i e l d , 1 9 8 1 , p. 2 9 3 ) . The null hypothesis states that control system attributes do not differ systematically between P r o s p e c t o r f i r m s a n d D e f e n d e r firms. T h i s h y p o thesis was tested using a logit model for n = 76 (32 Prospectors, 44 Defenders) firms which p r o v i d e d full d a t a sets. T h e d e p e n d e n t v a r i a b l e was coded 0 for Defender firms and 1 for Prospector firms so that, in interpreting the results, a h i g h s c o r e o n a v a r i a b l e w i t h a n e g a t i v e coefficient in the model predicts a Defender and a h i g h s c o r e o n a v a r i a b l e w i t h a p o s i t i v e coeffi-

TABLE 3. Logit results for Prospector/Defender classification model with retained variables significant at 0.05 level (two-tail) All firms ( n = 76): Prospector/Defender = - 0.46 + 0.81 tight budget goals + 0.76 cost around - 0.49 formula based bonus + 0.91 tailored control systems R 2 = 0.35 % of firms correctly classified (p = 0.05) = 70% X2 = 15.86 (p < 0.005) Firms with 250 to 600 employees ( n = 39); Prospector/Defender = - 4.41 + 1.37 output goals - 1.15 formula based bonus + 1.92 tailored control systems + 0.80 industry dynamism R2=

0.59 % of firms correctly classified (p = 0.05) = 80% X2 = 14.38 (p < 0.005) Firms with more than 600 employees ( n = 37): Prospector/Defender = - 0.08 + 0.83 tight budget goals - 1.43 output goals + 1.54 tailored control systems + 1.03 control system charge R 2 = 0.44 % of firms correctly classified (p = 0.05) = 81% X2 = 14.45 (p < 0.005)

7 See Pindyck & Rubinfeld ( 1981 ) for a discussion of the logit model; see Schlaifer ( 1981 ) for a description of the logit computer program used. Discriminant analysis is another means to test hypotheses with binary dependent variables. The advantage of logit analysis is that unlike discriminant analysis, it requires no assumption that the independent variables are normally distributed.

366

ROBERTSIMONS

c i e n t p r e d i c t s a Prospector. T h e best e q u a t i o n was estimated b y a stepwise d e l e t i o n of nonsignificant variables u n t i l all r e t a i n e d (factor s c o r e ) c o n t r o l attribute variables in the r e d u c e d m o d e l w e r e significant. As s h o w n in Table 3, the m o d e l is significant w i t h an R 2 = 0.35. Further, the e x p l a n a t o r y acc u r a c y of the m o d e l was tested. T h e p r o b a b i l i t y that the firm is a D e f e n d e r or a P r o s p e c t o r was c o m p u t e d for each o b s e r v a t i o n i n the sample, and a cross t a b u l a t i o n of o b s e r v e d versus pred i c t e d values of Y ( b a s e d o n p r e d i c t i n g Y = 1 if P > 0 . 5 ) w a s calculated. T h e fraction of c o r r e c t a n d i n c o r r e c t p r e d i c t i o n s was cross t a b u l a t e d a n d a X2 statistic was c o m p u t e d . 8 Using this procedure, the m o d e l c o r r e c t l y classified 70% (X 2 = 1 5 . 8 6 ; P < 0 . 0 0 5 ) of firms i n the sample. This p r o c e d u r e was r e p e a t e d for t w o subsampies of firms split b y size: ( 1 ) 39 firms w i t h 2 5 0 6 0 0 e m p l o y e e s a n d ( 2 ) 37 firms w i t h m o r e t h a n 6 0 0 employees. Splitting the sample b y size imp r o v e d b o t h the classification a c c u r a c y and the variance e x p l a i n e d b y the model. R 2 i n c r e a s e d to 0.59 for smaller firms a n d 0.44 for larger firms; classification a c c u r a c y i m p r o v e d w i t h 80% of smaller firms c o r r e c t l y classified and 81% of larger firms c o r r e c t l y classified. G i v e n the m o d e r a t e l y h i g h R 2 a n d e x p l a n a t o r y a c c u r a c y of the model, the null hypothesis c a n be r e j e c t e d in favor of the alternate hypothesis that c o n t r o l system attributes do i n d e e d differ b e t w e e n these strategic groups.

Correlation a n d interview data The s e c o n d stage of the analysis c o n s i d e r e d c o r r e l a t i o n and i n t e r v i e w data. Table 4 shows the c o r r e l a t i o n s b e t w e e n ROI and the t e n factors r e p r e s e n t i n g a c c o u n t i n g c o n t r o l system attrib u t e s for the full sample a n d for subsamples of D e f e n d e r and P r o s p e c t o r firms. D u e to small sample sizes, these c o r r e l a t i o n s m u s t r e m a i n tentative. However, an e x a m i n a t i o n of the correlations c a n b e used to motivate a discussion of in-

t e r v i e w data w h i c h illustrates h o w c o n t r o l systems are u s e d in P r o s p e c t o r and D e f e n d e r firms.

Goals a n d Monitoring Tight b u d g e t goals (F1) appear to b e associated w i t h firm p e r f o r m a n c e for all firms exc e p t larger Defenders ( r = 0.47 for Prospectors a n d r = 0.37 for small Defenders). Budget pressure was m e n t i o n e d as a positive force in s e v e n of the firms i n t e r v i e w e d . T h e p r e s i d e n t of an aviation m a n u f a c t u r e r ( D e f e n d e r ) r e p o r t e d that o n c e the b u d g e t was established, he w o u l d chall e n g e his managers to b e a t it b y 10%. A d r u g m a n u f a c t u r e r ( D e f e n d e r ) r e p o r t e d u s i n g internal targets to do b e t t e r t h a n b u d g e t performance. In this firm, "the i n t e r n a l targets are real o p e r a t i o n a l plans, n o t a political d o c u m e n t like the b u d g e t w h i c h is sent to head office." Additionally, s o m e firms r e p o r t e d u s i n g i n t e r n a l c o m p e t i t i o n s to e n g e n d e r tight b u d g e t targets like the general m a n a g e r of a leading p h o n o g raph r e c o r d m a n u f a c t u r e r ( P r o s p e c t o r ) : We circulate all our managers' budgets and actual reports as well as national figures to all managers. It is an aid. He can use it in his own management because he can see the figures, not only his own but national as well. He can mea. sure himself againsthis colleagues so there is a little bit of a competitive spirit, a rather healthy one. I encourage these managers to talk to each other because it is much better if they create their own pressure than if others create it for them. The relationship b e t w e e n ROI a n d the establ i s h m e n t of goals related to o u t p u t effectiveness (F6) a n d the m o n i t o r i n g of results (F3) differed for Prospectors a n d Defenders. For b o t h large and small Prospectors, s t r o n g o u t p u t goals and results m o n i t o r i n g are positively associated with ROI; for large Defenders only, the relationship b e t w e e n ROI and these factors is negative. Interviews suggest that P r o s p e c t o r firms are ext r e m e l y active in m o n i t o r i n g deviations from b u d g e t t h r o u g h e x c e p t i o n r e p o r t s and m o n t h l y reviews. Moreover, P r o s p e c t o r firms m o r e fre-

8 However, measures calculated on the ability to predict retrospectively tend to be biased upward since they are based on predictions for the observations to which the model was fitted. Also,the robustness of these statistics depends on the extent to which the distribution of sample observations corresponds to the distribution ofX's in the population from which the sam. ple was drawn.

ACCOUNTING

CONTROL

SYSTEMS AND BUSINESS STRATEGY: AN EMPIRICAL

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ANALYSIS

367

368

ROBERTSIMONS

quently required quarterly and monthly updates of budget targets (even though the formal budget was often not revised). Prospector firms also frequently required operating managers to supply variance information as compared to Defender firms where staff accountants from head office were more often charged with gathering and reporting variance information. It is not clear why large Defenders exhibited a negative relationship between ROI and output goals and results monitoring. Additional research may provide clues as to other mechanisms used by Defenders to achieve desired results.

External scanning and forecast data External scanning (F2) does not appear to be associated with ROI in the statistical analysis or to differ among Prospector and Defender firms. The interviews suggest that scanning tends to be informal, relying on salesmen's reports, attendance at conventions and trade shows, trade journals, purchases of industry surveys (e.g. drug industry), and the use of government statistical data. However, the Prospector firms did appear somewhat more aggressive in their scanning of competitor activities including photographing of equipment at trade shows (aircraft manufacturer), using full time employees to track government legislation (drug manufacturer), and the use of spies in competitors' factories (fashion shoe manufacturer). In support of arguments made by Gordon & Miller (1976), the incorporation of forecast data in control reports (F 5) appears to be related to performance for both large and small Prospectors but not for Defenders. This was reflected in the interviews in a number of ways. First, Prospectors reported considerable attention to developing strategic plans from the bottom-up to satisfy a stated need for environmental information (e.g. computer manufacturer, pharmaceutical company). In contrast, Defenders often alluded to a planning cycle dependent on the downward communication of goals set by top management (aluminium manufacturer, computer manufacturer, food manufacturer) or to a lack of long term planning (generic drug man-

ufacturer, surgical dressing firm). Second, Prospectors reported a strong reliance on qualitative forecast information as in this valve manufacturer, "We use a five-year strategic plan which is prepared bottom up by each of the company's profit centers and presented at head office. Plans are developed during a lengthy series of meetings with divisions, group V.P.'s and the Executive Committee. Plans include new products, markets, and strategies; efficiency is not an issue." Finally, both types of firms (Prospectors and Defenders) reported using scenarios. However, Defender scenarios tended to be more focused, often developed in relation to "baseline business of proven record and then a separate analysis of growth opportunities" (aviation equipment manufacturer). Prospector scenarios were often less structured and more based on "stargazing" (in the terms of the vice president of the fashion shoe manufacturer) for purposes of speculation concerning future products and markets.

Remuneration The questionnaire data regarding the calculation of bonus remuneration (F a) suggest that Defender firms provide bonuses based on achieving predetermined budget targets to a greater extent than Prospector firms. Due to the inherent stability of their strategy, Defenders are perhaps better able than Prospectors to quantify performance criteria and therefore utilize formula-based plans [for a more complete discussion of the relationship between performance appraisal, strategy, and environmental uncertainty, see Govindarajan ( 1 9 8 4 ) and Govindarajan & Gupta (1985)]. Two aspects of remuneration which were evident in the interviews but not in the statistical data were the relative size of performance bonuses and the number of people affected. Managers in Prospector firms typically reported bonuses comprising 50% or more of total remuneration and bonuses going down five or more levels in the organization. Defenders typically reported bonuses of 25% or less of total remuneration and bonuses were often confined to top managers.

ACCOUNTINGCONTROL SYSTEMSAND BUSINESSSTRATEGY:AN EMPIRICALANALYSIS

Tailoring o f control systems T a b l e 3 i n d i c a t e s that P r o s p e c t o r firms g e n e r ally c u s t o m tailor t h e i r c o n t r o l s y s t e m s to u s e r s ' n e e d s to a g r e a t e r e x t e n t t h a n D e f e n d e r firms (/79). This finding is in a c c o r d w i t h t h e a r g u m e n t o f G o r d o n & Miller ( 1 9 7 6 ) that firms w h i c h c o m p e t e t h r o u g h n e w p r o d u c t s a n d m a r k e t dev e l o p m e n t s s h o u l d tailor t h e i r a c c o u n t i n g a n d c o n t r o l s y s t e m s to a c c o m m o d a t e local needs. H o w e v e r , t h e r e g r e s s i o n w i t h ROI ( T a b l e 4 ) reveals that, for P r o s p e c t o r firms only, t h e r e is a n e g a t i v e r e l a t i o n s h i p b e t w e e n ROI a n d s y s t e m tailoring. An e x p l a n a t i o n for this r e v e r s a l m a y b e that successful p r o s p e c t o r firms, in assigning h i g h p r i o r i t y to b u d g e t targets, w o r k to e n s u r e that t h e s y s t e m is c o n s i s t e n t in p r o v i d i n g s e n i o r m a n a g e r s w i t h c o m p a r a t i v e b u s i n e s s u n i t inform a t i o n for r e v i e w a n d appraisal [see, for example, Vancil's ( 1 9 8 2 ) d e s c r i p t i o n o f p r o c e d u r e s in use at G e n e r a l Electric to m a i n t a i n internal administrative consistency]. R e l a t e d to this o b s e r v a t i o n is t h e fact that large P r o s p e c t o r firms r e p o r t e d a r e l a t i o n s h i p between performance and reporting frequency (F7) r e i n f o r c i n g t h e s p e c u l a t i o n m a d e a b o v e that P r o s p e c t o r firms h a v e a s p e c i a l n e e d to t r a n s m i t e n v i r o n m e n t a l i n f o r m a t i o n to s e n i o r managers. T h e i n t e r v i e w s suggest that t h e m a n n e r in w h i c h c o n t r o l s y s t e m s a r e c e n t r a l i z e d m a y differ a m o n g P r o s p e c t o r a n d D e f e n d e r firms. F o r example, a g e n e r i c d r u g m a n u f a c t u r e r classified as a D e f e n d e r r e p o r t e d , " T h e y ( h e a d office acc o u n t i n g ) tell us a l m o s t t o t h e l e t t e r h o w t h e y w o u l d like to s e e t h e r e p o r t a n d w e m a k e it t h e w a y t h e y w a n t it." By contrast, a d i r e c t c o m p e t i t o r , classified as a P r o s p e c t o r , r e p o r t e d tailoring its c o n t r o l r e p o r t s , "The k i n d o f inform a t i o n y o u h a v e is u s u a l l y u n i q u e to y o u r business r a t h e r t h a n different t y p e s o f all kinds o f b u s i n e s s e s that w e ' r e in." H o w e v e r , for this firm, centralization of reporting was handled through a local finance g r o u p : Our local finance group has a hand in every aspect of our operation. They report to corporate, but they are here to help the marketing people, operations people, purchas-

369

ing people, and personnel people in the various aspects of the company and it keeps control on the financial aspects of what is happening in the organization.

Control system changeability T w o variables e x h i b i t e d h i g h l o a d i n g o n a fact o r l a b e l l e d c o n t r o l s y s t e m changeability: freq u e n c y o f c o n t r o l s y s t e m c h a n g e and i m p o r t a n c e o f informal c o m m u n i c a t i o n s in s u p p l y i n g c o n t r o l information. This factor was p o s i t i v e l y a s s o c i a t e d w i t h ROI for large P r o s p e c t o r s a n d n e g a t i v e l y a s s o c i a t e d for large Defenders. This is c o n s i s t e n t w i t h t h e D e f e n d e r ' s n e e d to m a i n t a i n stability in its i n t e r n a l p r o c e d u r e s (Miles & Snow, 1 9 7 8 ) a n d G o r d o n & Miller's ( 1 9 7 6 ) pred i c t i o n that firms facing h e t e r o g e n e o u s and dyn a m i c e n v i r o n m e n t will m o d i f y t h e i r i n t e r n a l s y s t e m s f r e q u e n t l y to a d a p t to c h a n g i n g circ u m s t a n c e s . F o r this l a t t e r g r o u p o f firms, informal c o n t r o l c o m m u n i c a t i o n is e s p e c i a l l y imp o r t a n t g i v e n t h e n e e d to r e s p o n d q u i c k l y to env i r o n m e n t a l cues.

Cost control A negative relationship between cost control and firm p e r f o r m a n c e for P r o s p e c t o r s suggests that t h e s e firms focus t h e i r c o n t r o l efforts o n areas o t h e r t h a n c o s t c o n t r o l (e.g. f o r e c a s t i n g a n d b u d g e t i n g ) . H o w e v e r , t h e lack o f signific a n c e for D e f e n d e r s of factors r e l a t i n g to c o s t c o n t r o l is surprising. Miles & S n o w ( 1 9 7 8 ) maintain that t h e d i s t i n c t i v e c o m p e t e n c e o f Defend e r s r e q u i r e s t h e m to p a y e x t r e m e l y careful att e n t i o n to c o s t i n f o r m a t i o n to m a i n t a i n t h e i r s t r a t e g i c advantage. This lack o f significance m a y b e d u e to t h e validity o f T h o m p s o n ' s ( 1 9 6 7 ) arg u m e n t that m a n u f a c t u r i n g firms a t t e m p t to seal a n d buffer t h e i r p r o d u c t i o n c o r e s f r o m environm e n t a l t u r b u l e n c e : i n t e r n a l stability is d e s i r a b l e for all firms s i n c e it allows s t a n d a r d i z a t i o n a n d i n c r e a s e d o p e r a t i n g efficiencies. This supposition was largely c o r r o b o r a t e d 9 b y Hayes' ( 1 9 7 7 ) a c c o u n t i n g s t u d y w h i c h c o n c l u d e d that p r o d u c tion departments were relatively independent of o t h e r o r g a n i z a t i o n a l s u b u n i t s and, a c c o r d i n g l y , w e r e e v a l u a t e d using i n t e r n a l l y d e v e l o p e d meas u r e s w i t h o u t m u c h r e g a r d to s u b u n i t inter-

9 But see also Tiessen & Waterhouse's (1978) critique of the robustness of Hayes' results.

370

ROBERTSIMONS

dependence. By implication, aspects of control systems which focus on internal operating efficiencies should not differ systematically between Prospector and Defender firms. In any event, the use of cost and production data in achieving firm strategies is an area worthy of further study.

Industry dynamism Miles & Snow ( 1 9 7 8 ) and Snow & Hrebiniak ( 1 9 8 0 ) agree that Prospectors and Defenders will perform equally well in most industries if the strategy is well implemented and internal structures are consistent. Hambrick (1983), however, found that Prospectors outperform Defenders in industries which are innovative and dynamic; Hambrick argues that this is due to their superior adaptability in these industries. The present study supports this latter view: results in Table 4 show that industry dynamism is positively related to ROI for Prospectors and negatively associated with ROI for Defenders. This result indicates that firms do well to match their business strategy to their industry environment, a position advocated by Andrews ( 1 9 7 1 ) and Porter (1980).

CONCLUSION Accountants have been aware for some time that control systems are used by managers to guide in the formulation and implementation of objectives (Anthony, 1965). Strategy researchers have further proposed that control systems are used in different ways depending on the strategy of the firm (Miller & Friesen, 1978; Miles & Snow, 1978; Porter, 1980). However, this assertion has been untested in respect of the specific control variables of interest to accountants. The evidence from this study suggests that firms following different strategies do indeed employ accounting control systems in different ways an~d offers some preliminary conclusions concerning the attributes which may differ according to strategy. The two strategic firm types identified for this research, Prospector and Defender, appear to be

valid and commonly occurring strategies. In addition to their original identification and validation (Miles & Snow, 1978; Hambrick, 1979, 1983; Snow & Hrebriniak, 1980), Prospector and Defender firms are similar to strategic types identified in other empirical studies (Mintzberg, 1973; Utterback & Abernathy, 1975; Miller & Friesen, 1978; Porter, 1980). This study considers control attributes which differ between Prospectors and Defenders and provides preliminary evidence concerning the relative importance of control systems in the two types of firms. High performing Prospector firms seem to attach a great deal of importance to forecast data in control systems, setting tight budget goals, and monitoring outputs carefully. For Prospectors, cost control is reduced. In addition, large firms appear to emphasize frequent reporting and the use of uniform control systems which are modified when necessary. Defenders, particularly large firms, appear to use their control systems less intensively. In fact, negative relationships were noted between performance and attributes such as tight budget goals and output monitoring. Defenders emphasized bonus remuneration based on the achievement of budget targets and tended to have little change in their control systems. These observations are in accordance with a number of previous studies. Tushman & Nadler (1978), following Ashby's ( 1 9 5 6 ) notion of requisite variety, argue that organizations facing high uncertainty will utilize their control systems to a high degree. Khandwalla ( 1 9 7 2 ) concluded that firms engaged in continual product development and the search for new market segments b e c o m e differentiated and require elaborate controls, including budgeting techniques, for purposes of integration. Kamm ( 1 9 8 0 ) found, in a study of companies matched by industry, that control was tightest in companies which were perceived to have the highest level of product/market innovation. Simons (in press ) concluded that firms operating in uncertain environments employ control processes which are highly interactive and require the ongoing attention of operating managers. Understanding the link between strategy and

ACCOUNTING CONTROL SYSTEMSAND BUSINESSSTRATEGY:AN EMPIRICALANALYSIS c o n t r o l a p p e a r s t o b e i m p o r t a n t ; as a first step, a significant challenge remains to gather more first h a n d d a t a c o n c e r n i n g t h e e v o l u t i o n a n d c h o i c e o f c o n t r o l p r o c e s s e s in f i r m s f o l l o w i n g d i f f e r e n t strategies. F u t u r e r e s e a r c h m a y b e a b l e to uncover the complex relationship between s p e c i f i c a c c o u n t i n g c o n t r o l s y s t e m s (e.g. c o s t accounting systems, budgeting systems, responsibility r e p o r t i n g s y s t e m s ) , t h e v a r i e t y o f business strategies used by organizations, and the

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a c h i e v e m e n t o f o r g a n i z a t i o n a l goals. As t h e v i c e p r e s i d e n t o f an i n n o v a t i v e p h a r m a c e u t i c a l c o m pany concluded, "we have an inordinately complex control system because of the great number o f p e o p l e t h a t h a v e t o b e i n v o l v e d in t h e d e c i sion. Y o u h a v e t o h a v e p e o p l e o n b o a r d , o t h e r w i s e y o u a r e n o t g o i n g to g e t t h e s u p p o r t . T h e c u r s e o f t o o m u c h c o m p l e x i t y is t h e b l e s s i n g o f having people with you".

BIBLIOGRAPHY Andrews, K. R., The Concept of Corporate Strategy ( Homewood, IL: Dow Jones-Irwin, 1971 ). Ansari, S. L., An Integrated Approach to Control System Design, Accounting Organizations and Society (1977) pp. 101-112. Anthony, R. N., Planning and Control Systems: A Framework for Analysis (Boston: Division of Research, Graduate School of Business Administration, Harvard University, 1965). Ashby, W., An Introduction to Cybernetics (New York: John Wiley, 1956). Bruns, W. J. & Waterhouse, J. H., Budgetary Control and Organization Structure,Journal of Accounting Research (Autumn 1975) pp. 177--203. Burrell, G. & Morgan, G., Sociological Paradigms and Organisationai Analysis (London: Heinemann, 1979). Bums, T. & Stalker, G. M., The Management oflnnovation (London: Tavistock, 1961 ). Chandler, A. D., Jr., Strategy and Structure (Cambridge, MA: MIT Press, 1962). Channon, D. K., The Strategy and Structure of British Enterprise (Boston: Division of Research, Graduate School of Business Administration, Harvard University, 1973). Dermer, J., Management Planning and Control Systems ( Homewood, IL: Irwin, 1977 ). Dirsmith, M. W., Discussion of"Social Environments and Organizational Accounting", Accounting Organizations and Society (1986) pp. 357-367. Galbralth, J. R. & Nathanson, D. A., The Role of Organizational Structure and Process in Strategy Implementation, in Schendel, D. E. and Hofer, C. W. (eds), Strategic Management pp. 249-284 (Boston: Little, Brown, 1979). Gordon, L. A., Larcker, D. F. & Tuggle, F. D., Strategic Decision Processes and the Design of Accounting Information Systems: Conceptual Linkages, Accounting Organizations and Society (1978) pp. 203- 13. Gordon, L. A. & Miller, D. A., Contingency Framework for the Design of Accounting Information Systems, Accounting Organizations and Society (1976) pp. 59-69. Gorry, G. A. & Scott Morton, M. S., A Framework for Management Information Systems, Sloan ManagementReview(Fall 1971), pp. 55-70. Govindarajan, V. & Gupta, A. K., Linking Control Systems to Business Unit Strategy: Impact on Performance, Accounting Organizations and Society (1985) pp. 51-66. Govindarajan, V., Appropriateness of Accounting Data in Performance Evaluation: An Empirical Examinaation of Environmental Uncertainty as an Intervening Variable. Accounting Organizations and Society (1984) pp. 125-136. Green, P. E.,Analyzing Multivariate Data (Hinsdale, IL: Dryden Press, 1978). Hambrick, D. C., Some Tests of the Effectiveness and Functional Attributes of Miles and Snow's Strategic Types, Academy of Management Journal ( 1983 ) pp. 5-26. Hambrick, D. C., Environmental Scanning, Organizational Strategy, and Executive Roles: A Study in Three Industries, Unpublished doctoral dissertation, Pennsylvania State University, 1979. Hayes, D. C., The Contingency Theory of Managerial Accounting, The Accounting Review (April 1977 ) pp. 530--533. Jaeger, A, The Transfer of Organizational Culture Overseas: An Approach to Control in the Multinational

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Corporation,Journal of International Business Studies (Fall 1983) pp. 91-114. Kamm, J. B., The Balance of Innovative Behavior and Control in New Product Development, Unpublished doctoral dissertation, Graduate School of Business Administration, Harvard University, 1980. Khandwalla, P. N., The Effect of Different Types of Competition on the Use of Management Controls, Journal of Accounting Research (Autumn 1972) pp. 275-285. KhandwaUa, P. N., TheDesign of Organizations (New York: HarcourtBrace Jovanovich, 1977). Kimberly, J. R., Managerial Innovation, in Nystrom, P. C. and Starbuck, W. H. (eds)Handbook of Organ izationalDesign 1, pp. 84-104. (Oxford: Oxford University Press, 1981). Lawrence, P. R. & Lorsch, J. W., Organization and Environment (Homewood, IL: Irwin, 1967). Macintosh, N. B., A Contextual Model of Information Systems, Accounting, Organizations and Society (1981), pp. 39--53. Merchant, K. A., The Design of the Corporate Budgeting System: Influences on Managerial Performance and Behavior, The Accounting Review (October 1981 ) pp. 813-829. Merchant, K. A., Influences on Departmental Budgeting: An Empirical Examination of a Contingency Model, Accounting Organizations and Society (1984) pp. 291-307. Merchant, K. A. & Simons, R., Research on Control in Complex Organizations: An Overview, Journal of Accounting Literature (1986) pp. 183-203. Meyer, J., Social Environments and Organizational Accounting, Accounting Organizations and Society (1986) pp. 345-356. Meyer, J. W. & Rowan, B., Institutionalized Organizations: Formal Structure as Myth and Ceremony, American Journal of Sociology (1977) pp. 340-363. Miles, R. E. & Snow, C. C., Organizational Strategy, Structure, and Process ( New York: McGraw Hill, 1978 ). Miller, D. & Friesen, P. H., Archetypes of Strategy Formulatinns,ManagementScience (1978) pp. 937-948. Miller, D. & Friesen, P. H., Innovation in Conservative and Entrepreneurial Firms, Strategic Management Journal (1982 ) pp. 1-27. Miller, D. & Friesen, P. H., Organizations: A Quantum View (Englewood Cliffs, NJ: Prentice Hall, 1984). Mintzberg, H., Strategy Making in Three Modes, California Management Review (Winter 1973) pp. 44--53. Mintzberg, H., Impediments of the Use of Management Information (New York: National Association of Accountants, 1975). Mintzberg, H., Patterns in Strategy Formation, Management Science (1978) pp. 934--948. Otley, D. T., The Contingency Theory of Management Accounting: Achievement and Prognosis, Accounting Organizations and Society (1980) pp. 431-428. Pindyck, P~ S. & Rubinfeld, D. L.,Econometric Models and Economic Forecasts (New York: McGraw-Hill, 1981). Porter, M. E., Competitive Strategy (New York: The Free Press, 1980). Porter, M. E., Competitive Advantage: Creating and Sustaining Superior Performance (New York: The Free Press, 1985). Rogers, E. M. & Shoemaker, F., Communication of Innovations: A Cross Cultural Approach (New York: Free Press, 1971 ). Rumelt, R. P., Strategy, Structure and Economic Performance (Boston: Division of Research, Graduate School of Business Administration, Harvard University, 1974). Salter, M., Tailor Incentive Compensation to Strategy, Harvard Business Review (1973), pp. 94-102. Schlaifer, IL, User's Guide to theAQD Collection, 8th edn (Boston: Harvard Business School, 1981 ). Simons, R., Planning, Control, and Uncertainty: A Process View, in Bruns, W. J. and Kaplan, R. S. (eds) Accounting and Management Field Study Perspectives (Boston: Harvard Business School Press, forthcoming). Snow, C. C. & Hambrick, D. C., Measuring Organizational Strategies: Some Theoretical and Methodological Problems, Academy of Management Review ( 1980 ) pp. 527-538. Snow, C. C. Hrebiniak, L. G., Strategy, Distinctive Competence, and Organizational Performance, Administrative Science Quarterly (June 1980) pp. 317-336. TJaompson, J. D., Organizations in Action (New York: McGraw Hill, 1967). Thompson, V. A., Bureaucracy and Innovation, Administrative Science Quarterly (1965) pp. 1-20. Tiessen, P. & Waterhouse, J. H., The Contingency Theory of Managerial Accounting: A Comment, The Accounting Review (1978) pp. 523-529. Tushman, M. L. & Nadler, D. A., Information Processing as an Integrating Concept in Organizational Design, Academy of Management Review (July 1978) pp. 613--624.

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Utterback, J. M. & Abernathy, W.J., A Dynamic Model of Process and Product Innovation, Omega ( 1 9 7 5 ) pp. 639-656. Vancil, R. F., Decentralization: Managerial A m b i g u i t y by Design (Homewood, IL: Dow Jones-Irwin, 1979). Vancil, R. F.,Implementing Strategy: The Role o f Top Management, Course Module and Teacher's Manual, ( Boston: Division of Research, Harvard Business School, 1982).

APPENDIX. ABBREVIATED RESEARCH QUESTIONNAIRE Notes: ( 1 ) Original questions were presented using anchored seven point Likert-type scales in the following format: Planning Manuals: Not used at all 1 2

3

4 5 Used occasionally

6

7

Used to a great extent

( 2 ) Some scales reversed for purposes of analysis. To w h a t e x t e n t are the f o l l o w i n g used in y o u r business? Response anchors Not used Used Used to a at all occasionally great extent Q Q Q Q Q

1. 2. 3. 4. 5.

Planning manuals. Cost control of operations by analyzing the variance of actual costs from standard costs. Internal audit groups in checking financial information systems and reports. Cost centers. Profit centers.

H o w m u c h o f the f o l l o w i n g ~ypes o f data are included in periodic p l a n n i n g or control reports p r o v i d e d to m i d d l e a n d senior m a n a g e m e n t (e.g., d e p a r t m e n t head a n d above)? Response anchors None Q Q Q Q

Moderate a m o u n t

A great a m o u n t

6. Forecast data prepared by analysts (e.g. market demand, technological improvements, g o v e r n m e n t regulation, competitor actions). 7. Formal plans f o r p o t e n t i a l products and/or markets (i.e. products and markets outside the organization's current area of activity). 8. Overall, s u m m a r y measures of departmental performance. 9. Probability estimates (e.g. reports o f " w o r s e case, probable, best case").

To w h a t e x t e n t are the f o l l o w i n g statements true? Response anchors Never Occasionally Always Q 10. Management control reports relate outputs p r o d u c e d with inputs c o n s u m e d (e.Fy costs per unit, output per m a n hour, space utilization by product). Q 11. Overall performance in any period is evaluated by comparing o u r results with those of competitors in our industry. Q 12. Written explanations are provided to managers in budget reports for changes b e t w e e n current year results and the results of previous years. Q 13. Data included in control reports are very precise. Q 14. Control reports contain data w h i c h are not useful or only occasionally useful to management. Q 15. External data (e.g. trade ass•ciati•n rep•rts• industry deve••pments) are inc•uded in m a n a g e m e n t c•ntr•• systems. Please indicate the extent o f y o u r a g r e e m e n t or disagreement w i t h the f o l l o w i n g statements: Response anchors Strongly Agree No Opinion Strongly Disagree Q 16. Thepr•cess•esbywhich•rganizati•nalinputs(i.e.•nancial•material'andhuman)aretransf•rmedint••rganizati•na• o u t p u t s (i.e. products or services) are well u n d e r s t o o d throughout the organization. Q 17. The m a i n criterion of success throughout this organization is providing products in desired quantity or quality.

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Q 18. Control systems monitor virtually all tasks in the organization. Q 19. The control system provides the flexibility for managers to respond to new, uncontemplated opportunities. Q 20. New information categories are included in control reports only if they can be justified as being of repeated value to users. Q 21. The trend between last period's actual results and the results of the current period is monitored closely by senior managers. H o w important are the following activities in y o u r organization? Response anchors Not important Somewhat important

Extremely important

Q 22. Informal communications (e.g. meetings, inter-personal contracts) in supplying control information to senior managers. Q 23. Meeting budget targets. Q 24. Achievement of operating eificiencies (i.e. maximum output for given levels of inputs). Please rate the following planning and control system variables Q 25. Accuracy of predetermined performance standards for organizational subunits (e.g. budget targets for task groups, departments, divisions).

Not at all accurate

Fairly accurate

Extremely accurate

Q 26. Amount of detail included in control reports received by senior managers. Aggregated; e.g shown with summaries only

Fairly detailed

Highly detailed; e.g. breakdown by department operating unit, task

Q 27. Frequency of reporting control information to senior managers e.g., reports showing deviations from plans. Very frequently daily

Monthly

Very infrequently, quarterly or longer

Q 28. Usual basis for awarding performance or bonus remuneration to senior managers. Discretionary; based on personal assessment of superiors

Intermediate

Very objective; based on meeting budget or other quantitative target

Q 29. Tailoring of management control systems to suit differing individual and departmental needs. Not tailored at all; consistent throughout organization

Somewhat tailored

Highly tailored to circumstances

Q 30. Emphasis on adherence to rules, policies, or plans. Always disregarded

Sometimes disregarded

Always followed

Q 31. Changes in control systems during last five years. A great deal of change and evolution

Occasional change

Stable; no change

Q 32. Tightness of budgetary goals affecting senior managers. Very tight

Moderate

Q 33. Participation in budget preparation: No participation; Executives discuss with responsible executives others before deciding make budget decisions using existing information

Very loose Decisions made by management groups or committees after full discussion - decision by consensus or vote