Accounting cues bolster or bust restructuring efforts

January 17, 2007

Any parent who has ever withheld an allowance until beds have been made and trash cans have been dragged to the curb knows this truth: If you want kids to do something well, you need to delineate tasks and reward them accordingly.

What works on the home front works in the corporate world, too. And, since top executives can't stand in the kitchen, hands on hips, directing actions precisely, they can use another form of action measurement. It's called accounting.

As it turns out, accounting practices can influence behavior that aids or thwarts organizational efforts to get the job done. This is especially true if the job is change. So says research conducted by Casey Rowe, an assistant professor of accounting at the W. P. Carey School of Business.

Change to spare

Rowe teamed with colleagues Jacob G. Birnberg from the University of Pittsburgh and Michael D. Shields of Michigan State University to analyze how accounting practices influenced corporate managers at Convair, which was formerly a San Diego-based division of defense conglomerate, General Dynamics Corp. Specifically, the team examined change efforts and employee reactions at the aerospace company between 1986 and 1994.

Those were tough years for Convair. Just about everyone in the corporate world was out to cut costs in the lean-and-mean 80s. On top of that, the Cold War between the United States and Soviet Union subsided; the Berlin Wall tumbled in 1989; and the Soviet Union itself dissolved in 1991. Such developments were good news for world peace, but bad news for a defense contractor.  

What did Convair's corporate chieftains do? They aimed to change.

Companies change in one of two speeds, Rowe says. Transformations may be slow and methodical through continuous-improvement initiatives. Or, they can be a whirlwind rollercoaster ride that managers know as "restructuring."

In continuous-improvement efforts, "all the cost-center managers improve their own parts of the organization, and they do it without regard to what other managers are doing," Rowe explains. Individual department performance is what gets measured, monitored and rewarded.

Restructuring is a whole different animal," Rowe adds. For one thing, it typically follows a crisis. For example, a regulatory change could require major corporate overhauls. A rival's innovation could leave corporate leaders spitting out the competitor's dust. Or, as in Convair's case, a 40-year-old military standoff that fueled defense spending could simply end.

According to Wikipedia, the online encyclopedia, restructuring "generally involves selling off portions of the company and making severe staff reductions." It's painful.

The turmoil that spawns corporate restructuring comes on quickly and creates rapid change. Hence, massive reengineering generally doesn't last very long. Rowe and his colleagues call such reorganizations "discontinuous" change.

Rowe also notes that, rather than taking place within individual responsibility centers, such as purchasing or marketing, discontinuous process improvements involve coordinating change across departmental boundaries, which requires cooperation between managers. That's where accounting comes into play.

"Companies generally don't perform as well as expected through restructuring," Rowe says, and his research helps explain why. "If you don't change your accounting system to motivate the right kind of behavior -- cooperative versus competitive -- managers won't trust each other, and they don't reveal the information necessary to improve the performance of the company as a whole."

In other words, managers won't speak up when restructuring and reengineering streamlines processes enough to eliminate inefficiencies, including headcount.

To motivate cooperation, you have to change the nature of your accounting practices, Rowe maintains. He adds: "The accounting that works well through continuous change works badly with discontinuous change."

 Adding it up

 The researchers considered different aspects of accounting and compared how well these components mesh or conflict with corporate goals during various improvement efforts.

 The team examined responsibility accounting. This, says Rowe, is essentially a map that links organizational strategies and structures. On the one hand, responsibility accounting seeks to measure performance and hold managers accountable for their actions. On the other hand, responsibility accounting structures the relationship between managers across the organization. 

Traditional responsibility accounting views responsibility centers -- things such as departments and divisions -- as "separable." However, when discontinuous change happens, accountability becomes blurry because managers are working in teams that cross department lines.

 "At the time you're doing discontinuous change, it becomes impractical to measure each manager separately, because they're working so hard together to rebalance all the resources," Rowe says. "You can only effectively measure the process as a whole," a situation that Rowe calls "inseparable measurability." As a consequence, individual accountability is blurred.

 Although competitive behavior works well when measurability is separable, it backfires when measurability becomes inseparable. Cooperation is needed.

 Enter the relational role of responsibility accounting. In this regard responsibility accounting frames (or reframes) the relationship between the managers. A social science term, relational framing explains how unspoken signals prompt people to understand their social situations and, therefore, affect personal behavior.

According to Rowe responsibility accounting is a boundary management tool that can be designed (redesigned) to promote managerial competition or cooperation.

For example, providing managers with separate reports that only provide information about their area of responsibility suggests a competitive individual frame. In contrast, 'opening the books' and sharing accounting information about broader parts of the organization implies a cooperative group frame. According to the researchers, framing managers as individuals works fine with continuous-improvement efforts, but it falls short during periods of companywide restructuring.

These factors -- separable versus inseparable measurement, as well as competitive versus cooperative accounting boundaries -- became part of a model Rowe and his colleagues used to analyze how accounting affects process change. They evaluated separate periods of change at Convair, and their findings suggest that corporate managers really do follow the money -- or at least the accounting of it.

Friendly fire

Between 1984 and 1987, legislation broke up Convair's monopoly on two cruise-missile product lines; 35 percent of the company's Department of Defense contracts changed from being billable on a cost-plus basis to being fixed-price contracts; and the company lost contracts due to high prices, which reflected high internal costs.

The company chose to address these challenges with a continuous-improvement initiative, and thus began period one of the change-filled eras Rowe et al. studied.

During this time, central managers evaluated subordinates separately, and competition between departments ruled the day. In fact, around 200 initiatives surfaced throughout the company's various responsibility centers, and these proposals vied for acceptance from the company chiefs.

Meanwhile, accounting followed the company's functional hierarchy: Reports went only to the managers responsible for a given area, and those reports contained "department-specific" information, making it hard for managers to comment on other areas' initiatives effectively. It was every manager for him- or herself.

But, it worked reasonably well during continuous change, the researchers found. Cost savings ranged from $7 million to $18 million per year.

Cooperation and sharing among managers wasn't tip-top, and it didn't need to be. That's because both accounting measures and process improvements focused on individual responsibility centers.

Mixed signals

This wasn't the case in period two, the time between November 1989 and July 1991. Then, Convair was in a life-and-death battle for business, because the Department of Defense had cut demand for cruise missiles by 50 percent, and the agency intended to give all orders to the lowest bidder. On top of that, commercial aircraft sales, another moneymaker for the company, had taken a 50 percent dive. The result? Convair's top-tier managers decided it was time to restructure.

First, the company hired consultants to analyze processes and their costs. Then, massive employee training followed. Folks learned to participate in cross-functional teams.

That led to inseparable measurement of responsibility centers' performance. But, even though change efforts looked beyond departmental divisions, competitive accounting boundaries remained. Managers were uncooperative. No one wanted to give up information that would shrink his or her fiefdom in the corporate empire.

This is due, in the researchers' view, to the relationship between responsibility centers. Previously, managers of differing functional areas competed with each other for resources and rewards. That didn't change in period two, and it should have, Rowe says.

"In our model, the way to mitigate uncooperative behavior is to change responsibility-center boundaries from being focused on individual managers to being focused on groups of managers," he says. "The senior managers didn't do that, and consistent with our model, performance was low."

One problem is that resources are power, and managers don't want to give it up, Rowe says. This is particularly true when managers suspect that other managers will keep such information close to their vests.

That changed in period three, when the organization changed responsibility-center boundaries by using accounting to "reframe" the relationship between managers.

In period three, restructuring, or discontinuous change, continued. Accounting focused on activity-based costing that followed processes beyond traditional department boundaries. Managers worked in cross-functional teams extending outside their own functional areas.

What differentiated the work performed in period three was relational reframing that helped managers understand they were being viewed as a cross-functional team, and they were being measured as such. Accountants provided group-level reports, and everyone involved got copies of the same report, not different reports for different departments, as in the past. In addition, company accountants translated all the accounting jargon that had stymied managers in days gone by, making reports accessible to all managers involved.

Although none of the managers had worked closely together before, they now participated in face-to-face meetings, which further reinforced a team orientation.

In contrast to periods one and two, managers openly revealed private knowledge during period three, sharing information about how cost savings might accrue from specific actions. That enabled the company to reorganize more effectively. And that is no small feat.

Rowe's investigation follows a long line of research indicating that restructuring generally fails to deliver the cost benefits and profitability top managers seek to achieve through it. One such study comes under review in a paper co-authored by Philip Regier, the W. P. Carey School's executive dean. Its findings conclude that "the average effect of restructurings on post-restructure firm performance is significantly negative."

Rowe and his team feel they may understand why this is so. They believe that during restructuring accounting should be used to promote cooperation and teamwork, not competition. At the same time, accounting measures should reflect the organizational changes top managers want to see.

With the proper accounting, corporate bosses can keep an eye on how well others handle their new relationships and restructuring chores. That, you might say, provides the "allowance" rewarding good efforts.

Bottom Line

  • Responsibility accounting is a boundary management tool that motivates managerial competition or cooperation.
  • Although competition is normally beneficial, restructuring and reengineering efforts demand managerial cooperation.
  • Traditional responsibility accounting systems reinforce departmental borders and impede restructuring because they promote competition at a time when cooperation, open communication, and cross-functional teamwork is needed.
  • Thus, when organizations ebb and flow through periods of continuous and discontinuous change, accounting systems need to be changed to motivate competition or cooperation as appropriate.