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Internal Controls, Decentralization, and Performance

Performance Measurement and Management Control: The Relevance of Performance Measurement and Management Control Research

ISBN: 978-1-78756-470-1, eISBN: 978-1-78756-469-5

Publication date: 4 October 2018

Abstract

Internal control mechanisms are fundamental to organizational governance; particularly, to the agency relationship associated with decentralization of decision rights. Management accounting and organizational literatures provide conflicting predictions on the association between decentralization and internal controls, with some research arguing that internal controls be tightened to mitigate the risks associated with greater decentralization of decision rights while other work avers that tighter internal controls defeat the purposes of decentralization. In this chapter, we argue that managers choose these two organizational design variables jointly. Capitalizing on a unique database of control practices in the purchasing and payment process within the procurement function, this chapter examines the relationship between control tightness – a critical characteristic of internal controls – and decentralization. Using a simultaneous equation model, the study finds that decentralization and internal control design are endogenously determined. Tight control is negatively associated with the level of decentralization, while decentralization has a positive effect on the tightness of control. These results reconcile the apparently contradictory results relating these two variables. The chapter also finds that decentralization and tight control mechanisms operate both independently and synergistically to improve performance.

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Acknowledgements

Acknowledgments

The authors would like to thank David Bedford of the University of Technology Sydney, Roland Spekle of Nyenrode University, and others at the 9th Conference on Performance Measurement and Management Control for their helpful comments. We also extend special thanks to Jack Zhang (PhD student) and Professors Jared Jennigs and Kimball Chapman of Washington University in St. Louis for their beneficial insights on the chapter. Finally, we thank the anonymous reviewers and Frank Verbeeten, Sally Widener, and Marc Epstein for their valuable comments and guidance.

Citation

Davila, A., Gupta, M. and Palmer, R.J. (2018), "Internal Controls, Decentralization, and Performance", Epstein, M.J., Verbeeten, F.H.M. and Widener, S.K. (Ed.) Performance Measurement and Management Control: The Relevance of Performance Measurement and Management Control Research (Studies in Managerial and Financial Accounting, Vol. 33), Emerald Publishing Limited, Leeds, pp. 39-64. https://doi.org/10.1108/S1479-351220180000033003

Publisher

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Emerald Publishing Limited