Chhillar - Management Control Systems and Corporate Governance A Theoretical Review
Chhillar - Management Control Systems and Corporate Governance A Theoretical Review
CORPORATE GOVERNANCE:
A THEORETICAL REVIEW
Palka Chhillar1
Pradip Banerjee2
1
Institute for Financial Management and Research, India
2
Indian Institute of Management, India
ABSTRACT
This study presents a systematic review of research on the relationships
between various management control system (MCS) components as a
package with corporate governance and on their impact on organizational
performance. The motivation for the study originates from the past studies
who suggested a dearth of research on the configuration and inter-linkages
among all components of MCS package: cultural control, planning,
cybernetic control, reward and compensation, and administrative control.
A thematic approach is followed to conduct a systematic literature review.
The review builds upon existing literature and contributes toward identifying
research gaps, which may contribute to the existing body of knowledge
through theory building and empirical testing.
Keywords: management control systems, corporate governance,
organizational performance, cybernetic control, administrative controls,
rewards and compensation, cultural control, planning
INTRODUCTION
Management control philosophy and corporate governance (CG) are
related to the sharing of power among stakeholders and the protection of
shareholders interests. CG mechanism includes overseeing the activities
of the board of directors and the auditing committee, and ensuring the
integrity of the financial reporting process. Conversely, management control
THEORETICAL BACKGROUND
The objective of MCS is to alter and influence employee behavior toward the
achievement of organizational objectives. Positivist agency theory identifies
the need for governance mechanisms in the principalagent relationship,
which limits the self-serving behavior of agents (Eisenhardt, 1989). The
principalagent literature on the agency model emphasizes the need for
and the requirement of managerial accounting policies and procedures,
such as budgeting, performance measures, and monitoring (Baiman, 1990).
The link between management accounting and agency theory originates
from the information economics literature (Lambert, 2006), in which the
author suggests that management accounting is a domain that focuses on
the performance measurement and information issues in the organization.
Contingency theory (Lawrence & Lorsch, 1967) provides a common ground
for the two constructs under discussion, namely, MCS and CG. Contingency
theory asserts that designing the CG system has no best way. The design
of governance structures is contingent upon the external environment and
context, such as national, industrial, and organizational level disparities
(Huse, 2005). Contingency theory suggests that control systems are
dependent on the organizational setting and concludes that a better match
between the two can improve organizational performance (Fisher, 1998).
Studies on the linkages between contingency-based research and MCS
extensively have examined the influence of contextual variables, such as
the nature of the environment, technology, size, structure, strategy, and
national culture in contemporary settings (Chenhall, 2003; Fauzi, Hussain, &
Mahoney, 2011). Therefore, agency theory and contingency theory provide
a common thread between the two constructs under study.
The main focus of the systematic review is the control and governance
mechanisms, which are internal to organizations. Distinct themes are
identified within the scope of topic, and the thematic approach is followed
to conduct the systematic literature review process, which integrates
theoretical and empirical literature (Cronin, Ryan, & Coughlan, 2008). The
major search strategy includes conventional subject or keyword searching
combined with journal hand-searching and reference list checking. Table
1 in Annexure I presents the broad themes of the literature review along
with the constructs.
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among parties in the contract gives rise to the need for having a governance
mechanism to address the conflicts.
The corporate world and researchers often focus on CG models and
mechanisms that can prevail in various economies for decades. CG
mechanism varies a great deal around the world depending upon the
micro and macro-economic variables and institutional and political setups.
Therefore, different countries have adopted various models of CG, which
lead to the enforcement of different CG codes, to promote fair dealings and
communicating quality information to investors. The distinction between
the two types of financial systems, the market capital-dominated and bankdominated, indicates that two types of distinct CG models exist: the AngloSaxon type of CG system and the GermanJapanese type of CG system.
The models represent two extremes of the continuum with a stakeholder
model, which is the internal control exercised by the various stakeholders,
such as creditors, bankers, and employees, and the stockholder model,
which is the external control exercised by the stockholders in the firm.
The Anglo-Saxon type, capital market, or stockholder model (Jeffers,
2005) of governance mechanism is prevalent in the United States and the
United Kingdom. These countries have a long tradition and history of
democracy and capitalism, which in turn promotes private ownerships in
business. In the stockholder model, firms work toward the maximization
of the shareholders wealth, and the main dimension of analyzing the firm
performance is its market value (Jeffers, 2005). Another CG model is the
German-Japanese model, bank-based model, or stakeholder model
(Jeffers, 2005), which is prevalent in Germany and continental Europe. In
the German society, the emphasis is on the shareholder value maximization
and the costs and benefits that accrue to the society out of the operations
of a corporate house.
Researchers consider the governance mechanism to be classified into two
categories: mechanisms internal to the firm and mechanisms external to
the firm (Gillan, 2006). Internal mechanisms include the composition of
the board of directors (Nikolic & Erk, 2011), board structures (Jensen,
1993), managerial incentives (Tuschke & Gerard Sanders, 2003), and
capital structure (Porta, Lopez-de-Silanes, & Shleifer, 1999). External
control mechanisms include legal and regulatory mechanism (Lazarides
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& Drimpetas, 2010) and financial systems (Anderson & Gupta, 2009).
The CG models adopted in various countries over decades are different in
various dimensions, such as board structure and ownership patterns, due to
the unique set of socio-economic, cultural, legal, and political dimension
of the countries.
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Second, the review suggests that MCS and CG share the common objective
of directing the employees and managers behavior to motivate them toward
organizational goals and minimize the rent-seeking behavior among them.
MCS and CG, as concepts, are intertwined, and a dearth in the literature
on the direction of the causality of relationship exists. The review proposes
to test the direction of causality of the relationship between governance
and control mechanisms. The causal relationship can be argued in both
directions. Good governance mechanism leads to robust control systems, or
the presence of robust control mechanisms leads to the better governance of
firms. The research can be further extended to explore the characteristics of
MCS in the context of two governance models lying on the extreme sides
of the continuum focusing on the compositions of internal control systems
in different governance mechanisms.
Finally, considering the individual components of the MCS package, the
critical review of the literature suggests that a scope for research on the
relationship between corporate culture and CG exists. Studies on culture
and governance focus mostly on national and industrial cultures, which
show a gap in the relationship between organizational culture and CG that
can be explored. The relationship between planning as a control mechanism
and CG is also relatively unexplored. In the literature on individual control
mechanisms, studies on the direction of causality between executive
compensation and firm performance are also sparse, and thus researchers
are motivated to explore the area further.
Several limitations of the study must be acknowledged. The review focuses
on internal governance mechanisms given that MCS pertains to control
systems, which are internal to organizations rather than external. Both CG
and MCS concepts under review are complex in nature, and thus they give
rise to definitional problems. The review is based on particular frameworks
given by Malmi and Brown (2008) for MCS and Gillan (2006) for CG. The
frameworks are chosen because they are the most comprehensive and cover
maximum dimensions pertaining to the constructs. The review identifies
research gaps and adds to the existing body of the knowledge through theory
building and empirical testing.
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APPENDIX 1
Broad Themes of the Literature Review and their Constructs
S. No.
Broad Themes
1.
Constructs
Cultural control
Planning
Cybernetic control
Reward and compensation
Administrative control
2.
Composition of board
Board structure
Managerial Incentives
Capital structure
3.
Accounting-based measures
Market/valuation based
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