Related Literature and Hypotheses

502 There has been a considerable interest in the study of the relationship between strategy, MCS and performance. Previous research in this area can be categorized into three main streams. First, studies that investigate the impact of strategy on MCS Quanttrone Hopper, 2005; Langfield-Smith, 1997; Abernethy Lillis, 1995; Abernethy Guthrie, 1994; Dent, 1990; Simons 1987. This stream of research considers MCSs as strategy implementation systems. The basic argument is that MCS should be designed to support a firm‘s chosen strategy to gain competitive advantage and superior performance. Quattrone Hopper 2005, for example, proposed that different strategies will lead to different configurations, implementations, and usage of management control systems. Other authors suggest that prospector and defender strategies require quite different design and use of MCA e.g., Abernethy Lillis, 1995; Abernethy Guthrie, 1994; Langfield-Smith, 1997, Simons, 1987. Miles and Snow 1978, for example, found that a particular configuration of task technology, structure, and process is adopted by firms to match their strategy. In their study, they found that firms that adopt a defender strategy tend to adopt a functional structure with high formalization to support their capability to operate efficiently. In contrast, firms that adopt a prospector strategy tend to adopt low formalization to support their ability to create new product and exploit market opportunities. For firms that adopt an analyzer strategy, they tend to adopt a functional structure characterized by fluid product-market group to balance the pressure for innovation and efficiency. A second stream of research examines the influence of MCS on strategy Chenhall Euske, 2007; Chenhall, 2005; Bisbe Otley, 2004; Marginson, 2002; Dent, 1991. This stream of research considers MCS as systems that are used by management to formulate a firm‘s strategy. Chenhall and Euske β007, for example, investigated the role of activity based cost management ABCM in a strategic change process. Based on their study in an Australian and a US military organization, they found that information generated from the ABCM systems is used by the organizations 503 to influence the planned organizational change. Naranjo-Gil and Hartmann 2007 conducted a survey of 103 Spanish public hospitals. They found that top management team use management accounting systems for strategic change. Based on a longitudinal study of a public sector entity spanning five years, Kober, Ng and Paul 2007 found that management control systems help to facilitate a change in strategy for their sample organizations. In a similar vein, Dent 1991 found that railway organizations used MCS to change their strategic orientation from a government dependent to a business oriented strategy. A third stream of research investigates the impact of aligning strategy and MCS on performance e.g., Sandino, 2007; Ittner, Larcker, Randall, 2003; Simons, 1987. This perspective is based on the premise that strategy-MCS fit is achieved when the characteristics of a business strategy and control systems are joined together in a particular configuration to achieve completeness in a description of a social system Van de Ven, 1979. As such, the performance effects of misfits should reflect the simultaneous and holistic pattern of inter-linkages between strategy and control systems Venkatraman and Prescott, 1990. Despite its intuitive appeal, previous studies investigating the effects of strategy-MCS misfits have reported weak and often contradictory results e.g, Ittner, Larker Randall, 2003; Sandino, 2007; Simons, 1987. Several authors have suggested that the link between strategy, MCS and performance is not fully understood Chapman, 2005; Skaerbaek Tryggestad, 2009. Ittner, Larcker Randall, 2003 investigated whether firm performance is positively associated with the extent to which management control systems are aligned with the firm‘s strategy. Based on a survey of US financial services firms, they found little support that deviation from the ―ideal‖ profile negatively affect performance. Sandino 2007 used a sample of US retailer to investigate the impact of strategy-MCS fit on performance. She employed four types of MCS: basic MCS focus 504 on planning, setting standards and establishing the basic operations, cost MCS emphasize on enhancing operating efficiencies and minimizing costs, revenue MCS use to foster growth and customer responsiveness, and risk MCS focus on reducing risks and protecting assets integrity. She reported that firms that match their MCS with their intended strategy outperform those that reveal a strategy-MCS mismatch. Based on a sample of 76 firms, Simons 1987 reported that the use of tight budget goals and forecast data in control reports was positively related to performance for prospectors but not for defenders. However, the establishment of goals related to outputs and close monitoring of results were positively related to performance for prospectors but negatively related to performance for defenders. He concluded that intensive use of financial control systems is more effective for prospectors than defenders. Some researchers have argued that the conceptual notion of strategy-MCS misfits is only understood implicitly rather than in explicit functional forms e.g., Venkatraman Prescott, 1990; Scherer, 1980. Venkatraman and Prescott 1990 argued that previous research has used phrases like ―matched with‖, ―contingent upon‖ or ―congruent with‖ without necessarily providing precise guidelines for translating such phrases into the operational domain of empirical research and statistical tests. As such, there is a lack of general consensus regarding the conceptualization of misfits and its related empirical tests. We conceptualize strate gy based on εiles and Snow‘s 1978 generic strategy taxonomy which provides the richest portrayal of organizational arrangements associated with particular strategies Dent, 1990. This typology is unique because it views the organization as a complete and integrated system in dynamic interaction with its environment McDaniel and Kolari, 1987. Miles and Snow 1978 argued that prospector, defender, and analyzer are all viable strategies. The key dimension underlying this typology is the organization‘s response to changing environmental 505 conditions. According to Miles and Snow, defenders have narrow product-market domains and tend not to search outside their domains for new opportunities. Prospectors continually reach for market opportunities and tend to be creators of change in the industry. Analyzers are a mixture of both, operating in perhaps one relatively stable and one changing product-market domain. εCS are conceptualized based on Van de Ven and Ferry‘s 1980 and Drazin and Van de Ven‘s 1985 notion of organizational process or control. We focus on control systems that have been used in the accounting literature namely performance evaluation, compensation, communication, conflict resolution, commitment, and product and market policy e.g., Selto, Renner and Young, 1995; Gresov, 1989. This study uses the holistic perspective 64 to determine the misfits between business strategy and MCS e.g., Van de Ven, 1979; Selto, Renner Young, 1995 and investigates the performance implications of the misfits. Ittner Larker 2001 proposed that one key element in studying strategy and MCS is to identify the specific factors that do in fact lead to value creation. One way to identify the factors that contribute to value creation in the strategy-MCS study is to investigate the specific control systems that contribute positively to performance given a specific type of strategy. Following Venkatraman and Prescott 1990, we obtain a profile of control systems dimension for a set of high performing firms adopting a specific strategy. Any deviations from this profile will have negative performance implications. The ideal profile can be derived either theoretically or empirically Van de Ven and Drazin, 1985. The test for performance implication of the misfit between strategy and control system is provided by correlating the misfit with performance. A negative and significant negative correlation between misfit and performance will support the proposition that misfits negatively affect performance. 64 Most early studies used selections and interactions method to define misfits. These two approaches, however, have been criticized for their inability to measure the alignment of the whole systems e.g., Selto, Renner Young, 1995; Van de Ven and Drazin, 1985. 506 Following a contingency theory, we hypothesize that firms that reveal a fit between strategy and MCS is more effective than those that do not achieve such fit Lawrence Lorsch, 1969. The more a firm deviates from the ideal profile, the lower will be its performance Drazin and Van de Ven, 1985 since fit between strategy and control systems will reinforce competitiveness leading to superior performance McDaniel and Kolari, 1987. However, the misfit between strategy and control systems will affect performance negatively only if the firm deviates from the ideal in terms of the critical control systems. Specifically, the following hypotheses will be tested: H1a: A misfit between business strategy and the critical control systems will have a negative and significant impact on financial performance. H1a: A misfit between business strategy and the critical control systems will have a negative and significant impact on non financial performance. Venkatraman and Prescott, 1990 proposed that while the negative and significant correlation between misfits and performance support the notion that aligning MCS with strategy positively affects performance, it only serves as a necessary but not sufficient condition to argue convincingly for the strong relationship between misfits and performance. This is because the power of the test is unknown. To address this concern, Venkatraman and Prescott 1990 suggest developing a baseline profile using variables that were not significantly related to performance in each type of strategy. The baseline profile reflects a model where firms use control systems that are not critical in affecting the firms‘ performance. We expect that the relationship between the misfits in the baseline profile will not be significantly different from zero. Specifically, the following hypotheses will be tested: H2a: A misfit between business strategy and the non critical control systems will not have a significant impact on financial performance H2a: A misfit between business strategy and the non critical control systems will not have a significant impact on non financial performance 507 We also expect that the magnitude of the correlation between misfits and performance for critical MCS will be significantly more negative than the magnitude of the correlation between misfits and performance for non critical MCS. Specifically, the following hypotheses will be tested: H3a: The correlations between misfits and financial performance for critical MCS are significantly more negative than the correlations between misfits and financial performance for non-critical MCS. H3a: The correlations between misfits and non-financial performance for critical MCS are significantly more negative than the correlations between misfits and non-financial performance for non-critical MCS.

3. Research Method

3.1. Sample selection To test the hypotheses developed in the previous section, a single industry was selected to minimize the environmental heterogeneity Moers and Yuen, 2001. Data were collected from bank executives directors and divisional managers through a mail survey. 65 We contacted the senior management of all commercial banks in Indonesia that have retail banking operations asking their willingness to participate in our study. After obtaining approval from the senior management, we ask them to nominate a director in their unit who is responsible for its retail banking operations. We need to have respondents who are the policy makers since the questioners are related to the firm‘s strategic policies. The initial contact resulted in 150 respondents interested in this study. We sent the following materials to each respondent: a letter explaining the purpose of the study, the questionnaire, and a self addressed, stamped return envelope. To ensure that the materials reach the intended respondent, we sent the 65 A pilot study was conducted before the survey was sent to the respondents. We used five bank officers to review the questionnaires. The main purpose of this pilot study is to investigate the degree of understanding and clarity of the questionnaire. As a result, some minor modifications were made to the questionnaire. 508 materials through a well-established courier company. We received 125 questionnaires representing 88.3 response rate. Sixteen respondents were excluded from further analyses because the respondents do not have a retail banking operations 66 eleven responses and do not answer all the required questions five responses. Our final sample consists of 109 banks. 3.2. Constructs and their measures Strategy Business strategy defines how a firm chooses to compete in its industry and tries to achieve a competitive advantage relative to its competitors Merchant and Van der Stede, 2007. Andrews 1980 argued that a clearly defined business strategy helps a firm allocates its resources to convert distinct competences into competitive advantage. Miles and Snow 1978 proposed three successful organizational strategies: defenders, prospectors, and analyzers. 67 Defenders focus on their niche market and emphasize on high product quality and services James Hatten, 1995. Defenders tend to have a narrow product lines and are less involved in product or market development Langfield-Smith, 1997. The critical success factors for defenders are stable product and services, high product quality and services on existing products and low prices Miles and Snow, 1978. Prospectors strive to take advantage of market opportunities by producing new products and services and are rewarded by their ability to charge premium prices for their innovative products and services. The critical success factors for prospectors are innovative products and services, broad range of products and services and quick response to changing business environment. Analyzers are characterized by their ability to take advantage of the strengths of both the defenders and the prospectors. The key success factors for analyzers are ability to 66 These respondents work either work for foreign banks or joint-venture that are not allowed to have retail businesses. 67 The forth type of strategy is reactor. However, since reactor is considered an unsuccessful type of strategy see for example Shortell and Zajac, 1990; Langfield-Smith, 1997, it is not discussed and used in this paper.