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Allowance for failure: reducing dysfunctional behavior by innovating accountability practices

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Abstract

A common theme in current corporate governance is to increase managers’ accountability. In contrast, this paper emphasizes the need for less accountability in certain situations and consequently introduces the concept of “allowance for failure”. This concept refers to the style in which the decision maker’s environment—such as capital market, corporate governance, and management control system—deals with potential failures (e.g., project or investment failures). The argument that allowance for failure is important is illustrated by the example of failing projects, drawing on the escalation of commitment literature. It is hypothesized that allowance for failure indirectly reduces project escalation, i.e., the continuation of a failing project. The relationship is mediated by managers’ perceived threat in case of project failure. In addition, the paper suggests that capital market orientation increases managers’ perceived threat in the case of project failure and thus indirectly increases project escalation. Cross-sectional survey data were collected to test these hypotheses. The results from 320 failed projects under the responsibility of top-level managers support the hypothesized effects. Cross-validation with 109 projects terminated by lower-level managers and 133 projects terminated by company owners shows consistent results. The study’s findings highlight the importance of carefully analyzing potential consequences of promoting capital market orientation. More important, the study indicates a need for innovative accountability practices that expand allowance for failure to avoid dysfunctional consequences for decision-making, especially if strong capital market orientation is prevalent.

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Notes

  1. Both listed and unlisted companies were addressed for this study (cp. Aerts 2005). The reason for this choice was to get sufficient variance in the variables of interest, especially concerning the variable “capital market orientation”. If all companies in the sample had an extremely high value on “capital market orientation”, it would be very difficult to find correlations with other variables. In an extreme case, if all companies had the highest value on capital market orientation, this would be a constant and not a variable. In this extreme scenario, it would not be possible to detect any significant correlations. In other words, variance in the variables of interest is a required prerequisite for the analysis and a broad sample increases the variance. Furthermore, although it can be assumed that listed companies have a stronger capital market orientation, unlisted companies can rely on the capital market as well. For instance, they may be subsidiaries of listed companies, they may intend to pursue an IPO in the future, they may issue bonds, they may use or strive for venture capital, and they may raise long-term loans from banks. Even “small businesses rely on financial institutions for over a quarter of their total financing. In contrast to conventional wisdom, this is true even for the smallest small firms” (Berger and Udell 2002, p. F36). If none of these arguments applied, the respondent could choose the answer option “not correct at all” when asked for the intensity of capital market orientation of their company (see “Appendix”).

  2. In previous research, similar items have also been used to capture involvement (Biyalogorsky et al. 2006) and need for self-justification (Steinkühler et al. 2013), which are conceptually very close to perceived threat in case of project failure.

  3. However, one might also have expected to find a significant effect of capital market orientation, because increasing pressures from the capital markets lead to “a reconfiguration and rearrangement of forms of management accounting, management control, management information systems, operational control, and so on” (Hopwood 2008, p. 10). Management accounting and control systems thereby provide the means to pass capital market pressures down to managers on different hierarchical levels (Fligstein 1990; Vollmer 2003). These pressures reshape organizations (Zorn et al. 2006) and are reflected by performance evaluation systems, bonuses and payments (Healy and Wahlen 1999), and dismissals (Mian 2001). As such, financial discipline is not only imposed on top-level managers; rather, “the number of involved individuals is much greater than many would suspect. This deep programming of corporate/individual wealth harmony is an essential element in the construction of a culture of performance. In these plans, a heavy reliance on financial accounting measures is typical” (Radcliffe et al. 2001, p. 150).

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Acknowledgments

The author would like to thank Joan Luft, Wim A. Van der Stede, Jürgen Weber, Utz Schäffer, Erik Strauß, Florian Herschung, Sigrid Gschmack, Maximilian Margolin, Mary A. Malina, participants of the Management Accounting Section Research and Case Conference 2010 and workshop participants at London School of Economics 2008, WHU-Otto Beisheim School of Management 2008, and University of Innsbruck 2009.

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    Matthias D. Mahlendorf

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Mahlendorf, M.D. Allowance for failure: reducing dysfunctional behavior by innovating accountability practices. J Manag Gov 19, 655–686 (2015). https://doi.org/10.1007/s10997-013-9276-3

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