Management control systems and innovation strategies in business-incubated start-ups

Abstract

We respond to recent calls for a better understanding of the effects of management control systems (MCS) in small start-ups. Using a sample of business-incubated start-ups, we examine the performance effects of the alignment between MCS and innovation strategies. Regression analyses show higher performance when financial (non-financial) MCS are associated with an emphasis on exploratory (exploitative) innovation strategies. Overall, this study contributes to understanding the contingent effects of MCS and innovation strategies in business-incubated start-ups, as well as the consequences for their outcome and survival.

Keywords:

• management control systems
• incubated start-ups
• business incubators
• innovation
• strategy

JEL:

• codes: M13 new firms
• start-ups
• M41 accounting

Acknowledgements

We have benefited from comments and suggestions from the editor (Frank Hartmann), two anonymous reviewers, Mercedes Barrachina (discussant), Salvador Carmona (discussant), Beatriz Garcia, Gerhard Speckbacher (discussant), Frank Verbeeten (discussant) and seminar and conference participants at the 42nd EAA Annual Congress in Paphos (2019), the 11th New Directions in Management Accounting Conference in Brussels (2018), the Workshop on Accounting and Management Control 'Memorial Raymond Konopka' (2019, 2017 and 2015), VI Research Forum on Challenges in Management Accounting and Control (2019), the IV Iberian Conference on Entrepreneurship (CIEM) in Pontevedra (2014), University of Burgos and University of Chile. We are grateful for the support of the INCYDE Foundation in conducting the study. We also acknowledge financial contribution from the FUNCAS Foundation (EF001-2018), the Santander Financial Institute (2020), the Spanish Ministry of Science and Innovation (PID2019-104163RA-I00), the Spanish Ministry of Education and Science (ECO2016-77579-C3-3-P), Catedra UAM-Auditores Madrid, the Spanish Ministry of Science, Innovation and Universities (CAS18/00374), and the Madrid Government (within the framework of the multi-year agreement with the Universidad Autónoma de Madrid on Line 3: Excellence for University Staff - PRICIT). This paper is based on the dissertation work of Raul Gonzalez-Castro at the Universidad Autonoma de Madrid. We are also grateful to the dissertation committee: Leandro Cañibano, Beatriz Garcia, and David Naranjo.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1 The possibilities for small firms to adopt MCS can be restricted by strictly constrained monetary resources and managerial financial literacy (Perren and Grant 2000, Lavia López and Hiebl 2015).

2 Previous literature shows that venture-capital-backed firms adopt MCS induced by investors, who aim to safeguard their specific investments (Gomez-Mejia et al. 1990, Wijbenga et al. 2007). Agency problems can arise when the entrepreneurial firm’s management has more or better information than the venture capitalist (asymmetric information). As a venture–capital-backed firm tends to have short-term and efficiency-oriented investors (Gomez-Mejia et al. 1990), they usually promote the adoption of more financially focused MCS. Hence, contrary to the broad support offered by incubators, venture-capital-backed firms provide a very specific support to new ventures in terms of financial control and monitoring (see Chen 2009). In this sense, the focus of previous studies is different from ours.

3 Following Simons (1995) we define MCS as the set of formal processes, procedures, and routines used by management to achieve organisational goals. Previous research has shown that incubators invest strongly in creating a controlled environment by monitoring and assisting incubated start-ups in planning and control activities (Baraldi and Havendid 2016). This is expected since the low survival rate among start-ups is regularly attributed to the scarce attention paid or the improper development of these management functions (Peters et al. 2004). In this regard, ‘business support services provided by incubator management can help bridge the traditional market failure in the provision of business support services to the small business market’ (EU 2002, p. 51). Thus, incubated start-ups are different from other small firms in that they are assisted in the adoption and use of MCS and are more aware of the importance of these practices for firm survival.

4 McAdam and McAdam (2008, pp. 287–8) show the example of an incubated start-up that is in a critical stage of securing funding from external investors. Managers of the incubated start-up talk about the support they received by saying ‘We turned to the MGT [incubator] team who have been great in helping us during this awful time’ […] ‘The management team [of the incubator] set up a meeting with X [investors] which was great as this is all new to us and we have heard some scary stories, they helped us prepare for the meeting and kept us right on all the legal jargon.’

5 As an example, suppose that an incubated start-up is negotiating a sales contract with a retailer or wholesaler that has the bargaining power. The retailer or wholesaler will adjust and reduce the margins and will demand product availability. Thus, this small supplier, the incubated start-up, is constrained by limited resources, yet often faces stringent and unpredictable demands from larger buyers who have been known to exploit their market power. As described in Malagueño et al. (2019, p. 418), the suppliers ‘can find themselves over-stretched and exposed, as they seek to satisfy their key customers for little or no marginal return on their investments and efforts.’ The decision-making by the firm will be very different in an incubated/non-incubated setting (ceteris paribus, assuming two firms of the same size or age): managers of the incubated start-ups will make, a priori, better decisions, due to the advice of the incubator (support in reading financial data and forecasts, ameliorating the uncertainty of the decision).

6 These stages have been labelled differently in prior work, but they converge in nature, being the choice more semantic than substantive. In our study, we choose this classification for its recent application in start-ups (Fisher et al. 2016).

7 Lavia López and Hiebl (2015) argue that, commonly, small start-ups make a very limited and mostly ceremonial use of MCS that are put in place mainly to conform to larger partners or to provide information for external stakeholders (e.g. banks, investors, retailers or wholesalers).

8 As we noted in Section 2.2.1, small early-stage non-incubated start-ups have scarce resources and they are usually highly dependent on the owners’ skills and time, and cash and financial management is just one of their responsibilities (Howorth and Westhead 2003). Consequently, those start-ups commonly struggle with the tasks that involve starting a business and do not formalise financial MCS.

9 Start-ups following exploratory innovation strategies often have limited collateral value (De Maeseneire and Claeys 2012). This strategy repeatedly involves sunk costs with little or no salvage value at the initial stage, like market and industry analysis, market surveys, or legal consulting services for new products.

10 At the time of our study, about 53% of the entrepreneurs in our setting were previously unemployed, 17% had quit their previous employment to start their own business project, while 7% were self-employed entrepreneurs. The remaining 23% correspond to other profiles (Spanish Chamber of Commerce 2016).

11 Examples of start-ups in our sample include a start-up offering an optimised technical maintenance service for wind turbines and an APP development start-up experimenting with quality monitoring and process management.

12 The services offered by incubators have evolved during the last six decades. According to Bruneel et al. (2012), first generation incubators provided infrastructure (office space and shared resources). The second generation added coaching and training support. The third generation provides access to technological, professional and financial networks.

13 ATA carnet is a certificate that authorises transitory tax-free international operations of goods.

14 We offered instructions to the incubator managers in order to allow them to resolve specific questions regarding the content of the survey. Additionally, incubator managers were in contact with a member of the research team who oversaw the distribution of questionnaires and data collection.

15 We excluded eight questionnaires with multiple missing values (mainly on MCS and firm performance) in order to avoid any artificial increase in the analysed effects (Hair et al. 2010).

16 We follow the definition of Davila et al. (2009a, p. 344), where ‘formalized is defined as having documented a process and / or periodically and purposefully executing the process.’

17 We compute each individual control systems as a sum of both respective items.

18 To assure our proxy for operating budgets and variances is capturing cash control, we searched for additional evidence in our sample. We follow Howorth and Westhead (2003) and looked at proxies for better cash control. Our sample was divided into high and low scores for operating budgets and variances (above and below the median). We observe that the subsample of start-ups with high score presents a better liquidity ratio (2.50 on average) and has a lower payment period to creditors (51.43 days on average) when compared with the subsample of start-ups with low operating budget and variance scores (1.56 and 71.14 days, respectively). Overall, this descriptive evidence confirms the role of the operating budgets as a mechanism for cash control in incubated start-ups.

19 Consistent with Bedford (2015) and Jansen et al. (2006), this item is removed from the analysis due to the low communality. Bedford (2015) and Jansen et al. (2006) explain that low-cost strategy represents a different concern to exploitative innovation strategy. Exploratory factor analysis results displayed in the Appendix show that the 10-item load was as expected in two factors representing the exploitative and exploratory innovation strategies, except for the low-cost item.

20 According to Spanish commercial regulation (Art. 365 del Reglamento del Registro Mercantil) firms following the simplest legal form, like most firms in our sample, are not required to register accounts. This restricts our possibility of collecting objective secondary data on firm performance.

21 As an additional test, we also include in our model the interaction term financial MCS x non-financial MCS. Results show qualitative similar effects in testing our hypotheses. Financial MCS x non-financial MCS term shows a non-significant effect on firm performance (β = 0.087, p > 0.10).

22 The two highest correlations are between (i) financial and non-financial MCS and (ii) exploratory and exploitative innovation strategies. While this would be natural as, for example, innovation leads to more innovation (Bierly III and Daly 2007, Geerts et al 2018), it does open up concerns about multicollinearity. Thus, orthogonalised estimates of the interaction terms were included to reduce potential multicollinearity. We calculate and report variance inflation factors (VIF) for all independent variables, being in the 2.187–6.330 range, well below the threshold of 10 (Hair et al. 2010). We also account for, as untabulated tests, results using non-orthogonalised terms. These results reveal qualitative similar effects, however, with VIF values slightly above 10.

23 As a robustness check, we replicated our analysis using an adjusted measure of performance. Due to potential endogeneity concerns, and following Bisbe and Otley (2004), the two innovation-related items were excluded from the performance construct (‘sales growth of new markets’ and ‘sales growth of existing markets’). The three remaining items showed appropriate loadings and composite reliability (loadings range = 0.753–0.889; eigenvalue = 2.110; variance explained = 70.236%; Cronbach Alpha = 0.694; KMO = 0.658). Untabulated regression results report a positive and significant effect of the interactions to test H1a and H2a (β = 0.326, p < 0.10 for financial MCS x exploratory innovation strategy; and β = 0.507, p < 0.01 for non-financial MCS x exploitative innovation strategy), and non-significant (negative) effects when analyse H1b and H2b (β = −0.152, p > 0.10 for financial MCS x exploitative innovation strategy; and β = −0.448, p < 0.01 for non-financial MCS x exploratory innovation strategy). For comparability, we opt to use the original scale of Bedford (2015) in our main results. Due to the potential concerns about the relevance of the item ‘profitability’ for early-stage start-ups, we re-run our regressions by eliminating this item from the construct firm performance. Results remain qualitatively similar (β = 0.521, p < 0.01 for financial MCS x exploratory innovation strategy; β = 0.698, p < 0.01 for non-financial MCS x exploitative innovation strategy; β = −0.170, p > 0.10 for financial MCS x exploitative innovation strategy; and β = −0.530, p < 0.01 for non-financial MCS x exploratory innovation strategy). We thank an anonymous reviewer for making this point.