THE ACCOUNTING REVIEW

Vol. 82, No. 4

2007
pp. 907–937

Management Control Systems in

Early-Stage Startup Companies
Antonio Davila
IESE Business School
George Foster
Stanford University
ABSTRACT: This paper uses a multi-method, multi-case field research design to study
the evolving portfolio of the management control systems (MCSs) of 78 early-stage
startup companies. We examine 46 individual systems from eight different MCS cate-
gories—financial planning, financial evaluation, human resource planning, human re-
source evaluation, strategic planning, product development, sales / marketing, and part-
nerships. We report analysis of the following: (1) The speed of adoption of financial
planning and financial evaluation systems in relation to six other MCS categories. These
systems are considered key MCSs associated with management accounting. We find
financial planning to be the most widely adopted MCS category at an early stage,
followed by the human resource planning and strategic planning categories. Financial
evaluation systems are typically adopted at a later stage. (2) Variables associated with
the rate of adoption of MCSs. Our results indicate that number of employees, presence
of venture capital, international operations, and time to revenue are positively associ-
ated with the rate of adoption. Furthermore, the rate of adoption simultaneously affects
company size. (3) CEO turnover and the rate of adoption of MCSs. We find that CEOs
who have adopted fewer MCSs have shorter tenures. This is consistent with the hy-
pothesized difference between entrepreneurs and managers. Overall, the evidence
strongly supports the relevance of MCSs to the growth of early-stage startup
companies.
Keywords: management accounting; management control systems; entrepreneurship;
growth companies; startup companies.

We greatly appreciate the support of CES co-directors Professors Irv Grousbeck, Charles Holloway, and Garth
Saloner and CES program directors Mary Burnham and Linda Wells. We are also very grateful for the support of
the people who assisted us on this project: Jakub Wilsz, Jennifer van Steele, Aimee Noelle Swanson, Christopher
Armstrong, Jan Chong, Merle Ederhof, and Ravi Sarin. The paper has benefited from the comments of participants
at the University of Washington, the AAA Management Accounting Section meetings in Tampa 2006, Washington
University, and especially from two anonymous reviewers. This paper was funded by the Center for Entrepreneurial
Studies (CES), Graduate School of Business.
Editor’s note: This paper was accepted by Dan Dhaliwal.
Submitted: October 2005
Accepted: December 2006

907
908 Davila and Foster

I. INTRODUCTION

E
arly-stage companies start with an open slate as regards management control systems
(MCSs). This paper examines the evolving portfolio of MCSs in the following eight
categories for 78 early-stage startup companies—financial planning, financial eval-
uation, human resource planning, human resource evaluation, strategic planning, product
development, sales/marketing, and partnerships. We build on the findings in Davila and
Foster (2005) that examined the speed of adoption of individual systems in two of these
eight MCS categories—financial planning and financial evaluation. Each of the individual
systems examined in Davila and Foster (2005) fall under what many view as the domain
of management accounting, e.g., operating budgets and routine analysis of financial per-
formance against targets. This extension paper examines 46 individual systems across the
above eight MCS categories. An important finding is that financial planning and financial
evaluation, both typically associated with management accounting categories, include in-
dividual systems that have well above-average early adoption by the 78 startup companies
in our research. The voluntary early adoption of these individual management accounting-
based systems indicate that these systems pass a market test as regards their ‘‘perceived
value’’ compared to many other individual MCSs.
Management control systems—defined as ‘‘formal, information-based routines and pro-
cedures managers use to maintain or alter patterns in organizational activities’’ (Simons
1995, 5)—are important tools to professionalize a company. They are a subset of organi-
zational routines (Nelson and Winter 1982; Zollo and Winter 2002) whose key character-
istics include being recurrent, formalized, and information-based. MCSs help managers
leverage their attention, liberate them from decisions that can be delegated and controlled
by exception, and supply information when the informal network is overloaded.
The study of MCSs has mostly focused on cross-sectional variation in large established
firms (Cardinal 2001; Chenhall 2003); it is only recently that empirical evidence on their
emergence in early-stage startup firms is accumulating (Davila 2005; Davila and Foster
2005; Sandino 2007; Cardinal et al. 2004). These recent studies have examined factors
associated with cross-sectional variation on the time-to-adoption of particular management
control systems and how this timing varies with the strategy of startups. However, they
only look at a subset of these systems and, more importantly, they address to a limited
extent the issue of the relevance of MCSs to successfully deal with early-stage company
growth.
We examine the evolution of 78 early-stage startup companies from their founding.
Our research addresses three questions: (1) How fast do early-stage startup companies adopt
financial planning and evaluation systems vis-à-vis other management control systems? (2)
What variables are associated with the rate of adoption of these systems? (3) Does the rate
of adoption of management control systems affect CEO rotation? We collect field research
data using a multi-method, multi-case research design. The proprietary nature of the data
and the detail needed to address the research questions demanded the design of tailored
data collection instruments. For each company in our sample, we triangulate information
from public sources, three questionnaires to three different managers, and three semi-
structured interviews with each manager.
This paper contributes to the literature in four distinct ways. First, we provide detailed
descriptive statistics on the adoption of 46 different MCSs. Second, we provide empirical
evidence on the simultaneous association between the evolution of MCSs and company
size, measured by the number of employees. This finding is consistent with the observation
that company growth requires the management infrastructure that these systems provide, as
well as the reverse that systems are a consequence of growth. Third, the entrepreneurship

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Management Control Systems in Early-Stage Startup Companies 909

literature has documented an association between startup company growth and the replace-
ment of the original CEO (Chandler and Jansen 1992; Willard et al. 1992). The proposed
explanation for this empirical regularity is that the psychological characteristics of entre-
preneurs are such that while they enjoy the fluidity of new ventures, they dislike the for-
mality required for growth. We document an association between the level of MCSs’ adop-
tion and the likelihood of CEO turnover. CEOs who adopt fewer MCSs are replaced sooner;
this is consistent with certain founders having difficulties in moving from an entrepreneurial
to a managerial role—as measured by the level of adoption of a set of managerial tools—
and being replaced.

II. MCSs’ ADOPTION AND EARLY-STAGE COMPANY GROWTH

Three lines of research are relevant to this research. The first—applicable to the re-
search question addressed in Section V on the impact of management control systems on
startup company growth—examines the adoption of a subset of management control sys-
tems (MCSs) in startup companies. The second documents the frequent replacement of the
founder as CEO in startup companies—informative to the research question in Section VI
on the relevance of MCSs’ adoption to CEO rotation. The third looks at the determinants
of growth in startup companies.

MCSs Adoption and Company Growth

MCSs have been argued to facilitate growth (Simons 1995; Flamholtz and Randle
2000). They are adopted to overcome the limitations of informal management styles that
require constant personal interaction. The need for these systems has been argued from
agency and information-processing perspectives, which are the main roles of MCSs
(Baiman 1982; Narayanan and Davila 1998). As companies grow, direct observation of the
agents’ effort—the main control approach in the absence of systems—becomes too costly
and motivation and monitoring have to happen through the design of appropriate MCSs.
Company growth also affects the ability to move information to the right decision makers.
Without formal systems, the number of interactions required to move information around
the company increases exponentially with the number of employees. Communication be-
comes too costly if MCSs are not implemented. These arguments propose the size of the
company (in particular, number of employees) as a relevant variable in explaining the
phenomenon.
The adoption of MCSs in startup companies is potentially an important stage in their
growth. For the most part, the empirical findings on this question have focused on particular
types of systems. Baron et al. (1996, 1999) examine the adoption of human resource (HR)
management systems in startup firms. Their objective is to understand the impact of the
founder’s mental model of human resource relationships on the speed of adoption of these
systems. Company size is significant in explaining speed of adoption in 17 out of 25 HR
policies and in explaining the number of systems adopted at the end of the first year.
Hellmann and Puri (2002) find that venture-backed firms are faster at adopting HR policies
and stock-option compensation plans. Davila (2005) finds that size, CEO transition, and
presence of venture capital are associated with the adoption of HR systems.
Moores and Yuen (2001) map the type of management accounting systems throughout
the lifecycle of firms. In particular, they identify the transition from birth to growth as the
point at which these systems are formalized. Granlund and Taipaleenmaki (2005) study
management accounting systems in eight new economy firms. These authors provide some
evidence on the sequencing of adoption of accounting systems. They find that budgeting is
the first to be used; additional accounting systems are present only in firms with a strong

The Accounting Review, July 2007

910 Davila and Foster

belief about their future success. Davila and Foster (2005) examine the adoption of man-
agement accounting systems and of budgets in particular. They find that size, the presence
of VC funding, CEO experience, and how the CEO interprets management accounting
systems are associated with faster adoption of operating budgets. They also provide de-
scriptive statistics on sequencing, and report that budgets are the first managerial accounting
system adopted. They further find an association between the adoption of operating budgets
and company growth. Sandino (2007) studies the adoption of an extended set of manage-
ment accounting systems in a sample of 97 young U.S. retailers. She finds that almost all
of these firms adopt a basic set of managerial accounting systems including budgets, pricing
systems, and inventory control. But they differ in the adoption of more advanced systems;
firms following a cost strategy add managerial tools focused on enhancing efficiencies; in
contrast, firms following a differentiation strategy adopt tools to gather customer informa-
tion. One case study (Cardinal et al. 2004) describes the evolution of control systems,
interpreted to include informal as well as formal processes, in moving a company through
its crucial early stages. This qualitative study is the first one that looks at a broad range of
control mechanisms.
CEO Rotation and MCSs
A second research stream—summarized in the following quote, ‘‘[founders] are prob-
ably unsuited to be managers’’ (Greiner 1998, 61)—is relevant to this paper. The maintained
assumption is that the founder ‘‘needs and values creative expression and is easily bored
by familiar territory’’ (Rubenson and Gupta 1996, 25). However, evidence consistent with
this assumption has barely started to emerge. Willard et al. (1992) do not find support for
founders underperforming compared to non-founding CEOs. Fiet and Busenitz (1997) relate
the likelihood of top management dismissal with sales underperformance, smaller boards,
and the presence of venture capitalists on the board. Hellmann and Puri (2002) find that
venture capitalists are faster at replacing the CEO with an outsider. Wasserman (2003) also
finds that turnover of founders is associated with venture capital and with completing
product development. This evidence reveals a pattern of founders’ turnover, but does not
address the maintained assumption that most entrepreneurs do not transition well to the
managerial role that CEOs of larger firms have to fulfill.
High-Growth and Low-Growth Determinants
The third line of research relevant to this study focuses on explaining what differentiates
high-growth from low-growth startups. Most of this research is based on empirical obser-
vation and has evolved around four main themes: management characteristics, competitive
strategy, competitive environment, and funding.1 For instance, Keeley and Roure (1990)
identify the completeness of the founding team, technical superiority, product development
time, and buyer concentration as associated with value creation in venture-backed startups.
Feeser and Willard (1990) report that success is associated with top management’s ‘‘sen-
sitivity to opportunity.’’ Similarly, Siegel et al. (1993) identify management’s industry ex-
perience and its ability to stay focused as separating high-growth and low-growth young
companies. Ciavarella et al. (2004) find that two (out of five) personality traits—
conscientiousness and openness to experience—are associated with company survival.2 Ev-
idence on the potential role of MCSs is sparse but tends in the expected direction. Reid

1
An emerging research thrust associated with startup growth focuses on valuation of these pre-IPO companies
(Hand 2005; Armstrong et al. 2005).
2
In this rich stream of research, see also Ibrahim and Goodwin (1986), Cooper et al. (1994); Herron and Robinson
(1993), and Stuart and Abetti (1987).

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Management Control Systems in Early-Stage Startup Companies 911

and Smith (2000) use a sample of 150 small and medium Scottish firms to examine variables
associated with performance (measured as a combination of employee growth, profitability,
and productivity). Their ordered logit specification (they group the firms into three per-
formance groups) includes 20 variables capturing different aspects of the management team
and organization. They find that management characteristics are nonsignificant or have a
negative impact on performance except for ‘‘pursuit of high return on investment’’; however
‘‘forward planning’’ and ‘‘organization and systems’’ have a positive effect. Barringer et al.
(2005) content-analyze the narrative case studies for 50 high-growth and 50 slow-growth
firms. Based on an extensive literature review, they base their analysis on four broad topics:
founder characteristics, firm attributes (e.g., vision, planning, commitment to growth), busi-
ness practices (e.g., product superiority, innovation), and HR practices. They conclude that
high-growth companies: have founders with more experience, better education, and higher
motivation; demonstrate stronger commitment to growth and alliances; show deeper cus-
tomer understanding; and emphasize training, employee development, and financial incen-
tives. Davila et al. (2003) report significant growth around venture capital funding events.

III. COMPANY SAMPLE AND MCSs EXAMINED

The sampling process is described in Davila and Foster (2005), as well as the sample
of 78 companies, including 48 information technology (IT) companies, 12 biotech com-
panies, and 18 others. Prior to launching the research, we met five financial managers with
experience in early growth companies (all of them with multiple company experience).
After understanding the purpose of the research, these managers suggested companies of a
size and age that would best fulfill the research needs. The sample selection required the
companies to have between 50 and 150 employees at the sampling date, be less than 10
years old, and be independent. We adopted a multi-method, multi-case field research design.
Information was collected from public sources such as company web pages and press
releases from Lexis-Nexis. We also collected data using questionnaires filled out by three
senior managers at each company—the CEO, CFO/financial manager, and the business
development/marketing manager.
The questionnaire captured quantifiable information about the company including its
financial and funding history as well as the dates in which particular MCSs were formalized.
Semi-structured interviews were conducted with each of these three managers. Each inter-
view relied on a detailed protocol to insure that the main topics were systematically covered
during the conversation. The semi-structured nature of the interview gave flexibility to query
the interviewer when clarification of particular practices was required (Marshall and
Rossman 1995). Interviews, lasting about an hour with two researchers present, were taped
and then transcribed. The interview was also instrumental in clarifying and triangulating
the answers to the questionnaire (Jick 1979). Rich descriptions of each company’s history
gave a detailed context in which to understand why systems were adopted. During the
interviews, we did not ask respondents directly about ‘‘intangible’’ variables such as com-
pany culture, which might vary depending on the respondent’s background or bias regarding
‘‘acceptable practices.’’ Rather, we inferred these variables from the interviewees’ descrip-
tions of their experiences (Seidman 1998).3 Finally, we chose a multi-case field design to
gather a large enough sample to go beyond company-specific experiences and examine
whether the findings could be generalized through statistical validation.

3
The questionnaires and interview protocols are available from the authors.

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912 Davila and Foster

The information was triangulated in various ways. Financial and funding information
was compared with information independently collected by Venture One and Venture Ec-
onomics.4 The date of adoption of a subsample of MCSs was asked in two different ques-
tionnaires. In both of these triangulation efforts, the kappa statistic of inter-rater agreement
was highly significant.
Table 1 provides descriptive statistics on the sample. CEO’s have mean work experience
of 18 years with the 25th percentile at 12 years. Most firms have not yet reached profita-
bility, again reflecting the bias toward venture-capital based technology firms in the early
years (see Armstrong et al. 2006). The mean number of rounds of venture capital financing
is 3.43. Sixty of the 78 companies received financing from venture capitalists.
We asked respondents about the date of adoption of 46 individual systems from eight
general categories of systems:5 (1) Financial Planning (three individual systems); (2) Fi-
nancial Evaluation (six systems); (3) Human Resource Planning (seven systems); (4) Human
Resource Evaluation (four systems); (5) Strategic Planning (five systems); (6) Product De-
velopment Management (seven systems); (7) Sales/Marketing Management (ten systems);
and (8) Partnership Management (four systems).6 Founding date (date the company was
legally established) was obtained from the CFO questionnaire and contrasted to the date
reported in Venture One. In all cases but one, the dates were comparable; in this one case
we contrasted the information with the CFO and used his reported date. The founding date
was used to calculate the age of the company when each system was adopted. Management
accounting systems fall into the first two categories:

TABLE 1
Descriptive Statistics on Sample of Companies

Mean Std. Dev. Q1 Median Q3

Number of CEOs 1.65 0.78 1 1 2
Years of Total Experience of CEOa 18.42 8.48 12 20 25
Age of the Company 5.47 2.44 3 5 7
Number of Employeesb 118 62 71 113 155
Revenues (‘000)c 10,923 11,853 2,437 7,300 15,000
Income (‘000)c ⫺9,455 15,668 ⫺12,469 ⫺4,700 29
Number of VC Rounds 3.43 1.78 2 3 5
Valuation (millions)d 168.6 229.6 21.5 67.25 192.7
a
Estimated for all CEOs in the sample.
b
Number of employees is calculated at the peak of each company’s size.
c
Revenues and income are for the last year of data available.
d
Valuation statistics are for the largest valuation round available.

4
Both firms are public data sources that collect funding information for startup companies. In some cases, they
also report financial statement information.
5
The systems were identified from various sources specific to each function, often from textbooks in the field.
For instance, financial planning and evaluation were identified after examining several of the most popular
managerial accounting textbooks (such as Horngren et al. 2006); human resource planning and evaluation were
identified from the Baron et al. (1996, 1999) study on the HR models in startup firms. In addition, the list of
systems was validated with the five managers we interviewed in the research planning stage.
6
These systems are not intended to be an exhaustive list, but capture the main ones within each category. To
further examine the adequacy of these eight groups we run an exploratory factor analysis with varimax rotation
on the time-to-adoption of the 46 systems; the various systems loaded into factors that closely mapped into the
categories defined.

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Management Control Systems in Early-Stage Startup Companies 913

● Financial Planning—operating budget; cash flow projections; sales projections

● Financial Evaluation—capital investment approval procedures; operating expenses
approval procedures; routine analysis of financial performance against target; product
profitability analysis; customer profitability analysis; customer acquisition cost
analysis.
These two categories include nine of the 46 individual control systems examined in
our research.
Interviews and questionnaires have certain limitations. There is no guarantee that the
data fully reflects reality. Respondents may be subject to recall bias or to their image of
the history of the company. We seek to mitigate this limitation by asking several respon-
dents, asking about various dimensions of the variables of interest, and mainly inquiring
about their experiences while minimizing their personal assessments. We also contrast their
responses to publicly available sources of data when available.

IV. MCSs EVOLUTION FOR 46 INDIVIDUAL SYSTEMS AND

EIGHT CATEGORIES
Table 2 reports the percentage adoption of each of the 46 individual systems by the
end of Year 1 through Year 5. Figure 1 (Panel A) presents a summary of the 46 systems
for the eight MCS categories. Each individual system within each category is equally
weighted in Figure 1 and the average adoption of systems is computed for the end of Year
1 through Year 5. Several patterns are observable in Table 2 and Figure 1 (Panel A). First,
Financial Planning systems (comprising operating budgets, cash flow projections, and sales
projections) are consistently the most frequently adopted category across all eight MCS
categories. Second, the three most widely adopted MCS categories in the early years since
founding of a company all involve planning—financial planning, strategic planning, and
human resource planning.7 Third, the importance of the financial evaluation and human
resource evaluation categories is lower than the three planning categories in the first three
years, but increase in importance in Years 4 and 5. Fourth, the sales/marketing and part-
nership categories have lower adoption than other categories across each of the first five
years since company founding.
Figure 1 (Panel A) plots the evolution of MCS categories by year since company
founding for the 78 companies in our sample. These companies differ greatly in their
increase (and decrease) in headcount over time. Figure 2 (Panel A) plots the evolution of
MCS categories by headcount (less than 10 employees, less than 20 employees,...,less than
150 employees). There is a rapid buildup of systems, especially up to the 100-employees
company size. The Financial Planning category has the highest percentage adoption at all
company size levels examined in Figure 2 (Panel A).
Table 3 (Panel A) looks at the category mix of the ten most frequently adopted indi-
vidual systems each year. The early dominance of planning systems (financial, HR, and
strategy) is reinforced in this ‘‘top ten’’ systems analysis. In each of Years 1 to 3, systems
from the three planning categories comprise at least 80 percent of the top ten systems. By
Years 4 and 5, the mix of the top ten individual systems has broadened to include systems
from both the Financial Evaluation category (capital investment approval procedures, op-
erating expenses approval procedures, and routine analysis of financial performance against
target) and the human resource evaluation category (written performance evaluation reports,

7
This finding is consistent with traditional control systems theory where planning comes first followed by eval-
uation and corrective actions (Ashby 1960; Anthony 1965).

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The Accounting Review, July 2007

914
TABLE 2
MCS Adoption Percentage by Year since Company Founding for 46 Individual Systems in Eight Categories: Full Sample of 78 Companies

Percentage of companies having adopted the system by the end of: Year 1 Year 2 Year 3 Year 4 Year 5
Financial Planning Operating budget 18% 41% 57% 72% 80%
Cash flow projections 18 39 54 72 77
Sales projections 14 32 49 68 74
Financial Evaluation Capital investment approval procedures 13 28 43 59 77
Operating expenses approval procedures 13 24 39 53 67
Routine analysis of financial performance against target 10 27 43 53 67
Product profitability analysis 4 14 20 21 30
Customer profitability analysis 6 14 16 19 27
Customer acquisition costs analysis 6 8 10 12 18
Human Resource Planning Core values 22 31 40 53 59
Mission statement 18 32 45 58 66
Organizational chart 18 41 60 65 70
Codes of conduct 15 26 31 39 47
Written job descriptions 13 31 46 56 64
Orientation program from new employees 13 25 43 55 58
Company-wide newsletter 3 10 18 27 36
Human Resource Evaluation Written performance objectives for managers 12 24 39 56 63
Written performance evaluation reports 12 25 49 64 69
Linking compensation to performance 12 22 45 56 66
Individual incentive programs 7 13 31 41 52
Strategic Planning Definition of strategic (nonfinancial) milestones 16 37 54 61 75
Customer development plan (plan to develop market) 16 29 40 52 63
Headcount / human capital development plan 16 32 42 53 58

Davila and Foster

Product portfolio plan (plan about future products) 13 25 36 50 61
Investment budget 10 31 42 50 53
(continued on next page)
 Management Control Systems in Early-Stage Startup Companies
TABLE 2 (continued)

Product Development Management Project milestones 14 29 40 45 51

Product concept testing process 9 18 19 24 26
Reports comparing actual progress to plan 8 19 30 37 45
Project selection process 8 15 25 31 36
Product portfolio roadmap 6 15 26 29 36
Budget for development projects 6 18 30 35 41
Project team composition guidelines 5 14 17 19 21
Sales / Marketing Management Sales targets for salespeople 8 12 34 44 49
Market research projects 6 10 17 24 26
Sales force compensation system 6 10 32 44 47
Sales force hiring and firing policies 5 10 19 23 22
Reports on open sales 4 6 22 33 38
Customer satisfaction feedback 4 9 14 23 27
Sales process manual 3 4 9 15 18
Sales force training program 1 3 18 25 29
Marketing collaboration policies 1 3 6 12 14
Customer relationship management system 1 8 12 23 29
Partnership Management Partnership development plan 5 8 16 23 25
The Accounting Review, July 2007

Policy for partnerships 3 6 13 17 19

Partnership milestones 1 5 13 16 19
Partner monitoring systems 1 5 14 17 21
For each system, we asked respondents for the date when the system was adopted. The questions’ instructions were: ‘‘For each system below, please indicate when
your company formalized it; formalized is defined as having documented a process and / or periodically and purposefully executing the process.’’

915
916 Davila and Foster

written performance objectives for managers, and linking compensation to performance).

The percentage adoption of the two management accounting system categories in the top
ten increases over time as individual systems from the Financial Evaluation category enter
the ‘‘Top Ten’’:

FIGURE 1
Early-Stage Company Evolution of Management Control Systems:
Cumulative Intensity of Adoption over Time (Years Since Founding)

Panel A: Full Sample

100%

90%

80%

70%
In te n s ity (%)

60%

50%

40%

30%

20%

10%

0%
1 2 3 4 5
A g e (Y e a r s S in c e F o u n d in g )

Panel B: Venture Capital-Backed Company Sample

100%

90%

80%

70%
In te n s ity (%)

60%

50%

40%

30%

20%

10%

0%
1 2 3 4 5
A g e (Y e a r s S in c e F o u n d in g )

(continued on next page)

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Management Control Systems in Early-Stage Startup Companies 917

FIGURE 1 (continued)
Panel C: Non-Venture Capital-Backed Company Sample

100%

90%

80%

70%
I n te n s ity (%)

60%

50%

40%

30%

20%

10%

0%
1 2 3 4 5
A g e ( Y e a r s S in c e F o u n d in g )

Key:

F in an cial P lan n in g H R P lan n in g St rat egic P lan n in g Sales /Mark et in g

F in an cial E v alu at io n H R E v alu at io n P ro d u ct D ev elo p m en t P art n ers h ip s

Each individual system within each category in Table 2 is equally weighted. The percentage of systems adopted
in each category is plotted over time since company founding.

Year 1 Year 2 Year 3 Year 4 Year 5

Financial Planning 20.0% 30.0% 30.0% 27.3% 27.3%
Financial Evaluation 0.0 0.0 0.0 9.1 27.3
Total 20.0% 30.0% 30.0% 36.4% 54.6%

The Sales/Marketing and Partnership categories have no individual systems represented in

the ‘‘Top Ten’’ in Years 1 to 5.

Influence of Venture Capital Financing

The advent of venture capital financing has been found by prior research to speed up
the professionalization of management systems (see Section II). The 78 companies in this
research include 60 with venture capital (VC) financing and 18 with no venture-capital
(non-VC) financing. Several issues can be probed with these two subsamples. One issue is
whether VC-backed companies adopt more systems at an earlier stage. Figures 1 and 2
(Panel B for VC-backed companies and Panel C for non-VC-backed companies) highlight
the buildup of the MCSs in the eight categories over time and over company size levels.
The general pattern in both Figures 1 and 2 indicates that VC-backed companies build up

The Accounting Review, July 2007

918 Davila and Foster

their systems much faster, and to a larger extent.8 From the interviews, we identified three
main reasons why there is such a disparity between VC-backed and non-VC-backed firms.
First, VC-backed companies grow much faster than the non-VC companies and the demand

FIGURE 2
Early-Stage Company Evolution of Management Control Systems:
Cumulative Intensity of Adoption for Company-Size (Number of Employees)

Panel A: Full Sample

100%

90%

80%

70%
I n te n s ity (%)

60%

50%

40%

30%

20%

10%

0%
<10 <20 <30 <40 <50 <60 <70 <80 <90 <100 <110 <120 <130 <140 <150
S iz e (N u m b e r o f E m p lo y e e s )

Panel B: Venture Capital-Backed Company Sample

100%

90%

80%

70%
I n te n s ity (%)

60%

50%

40%

30%

20%

10%

0%
< 10 < 20 < 30 < 40 < 50 < 60 < 70 < 80 < 90 < 100 < 110 < 120 < 130 < 140 < 150
S iz e (N u m b e r o f E m p lo y e e s )

(continued on next page)

8
VC-backed companies are defined as those that receive venture capital funding at some point during their lives.
Some of the VC-backed companies may not have received this funding in the early years.

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Management Control Systems in Early-Stage Startup Companies 919

FIGURE 2 (continued)
Panel C: Non-Venture Capital-Backed Company Sample

100%

90%

80%

70%
I n te n s ity (%)

60%

50%

40%

30%

20%

10%

0%
<10 <20 <30 <40 <50 <60 <70 <80 <90 < 100 < 110 < 120 < 130 < 140 < 150
S iz e (N u m b e r o f E m p lo y e e s )

Key:

F in an cial P lan n in g H R P lan n in g St rat egic P lan n in g Sales /Mark et in g

F in an cial E v alu at io n H R E v alu at io n P ro d u ct D ev elo p m en t P art n ers h ip s

Each individual system within each category in Table 2 is equally weighted. The percentage of systems adopted
in each category is plotted over the size measured as number of employees.

for MCSs is higher—slower growth firms can adopt informal working practices over time
but VC-backed firms do not have the time to search and find these informal practices.
Second, the need for venture capital is characteristic of companies that are cash flow neg-
ative earlier in their lives. Financial planning facilitates companies that are cash-constrained
making good use of cash and negotiating a new round of funding with enough time for the
negotiation process. Third, as illustrated in the quotes in the Appendix, venture capitalists
‘‘impose’’ some of those systems—mainly in financial planning and evaluation and strategic
planning—and other times they bring them into the company through the hiring of key
managers.
The pattern for non-VC-backed companies indicates that financial planning does not
dominate the adoption of systems as much as in VC-backed firms, and HR planning, stra-
tegic planning, and HR evaluation come in earlier than financial planning as far as Year 4.
The later adoption of financial-planning systems (Figure 1, Panel C versus Figure 1, Panel
B) together with these systems being the most frequently adopted in companies with more
than 30 employees (Figure 2, Panel C) suggests that the delay in adoption documented in
Figure 1, Panel C may be associated with non-VC-backed companies growing more slowly.
There is also a difference in the mix of MCS category adoption between the VC-backed
companies and the non-VC-backed companies. Table 3 (Panels B and C) presents the top
ten individual systems adoption mix for these two subsamples. The VC-backed companies,

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920 Davila and Foster

TABLE 3
MCS Category Percentage Composition of ‘‘Top Ten’’ Most Adopted Individual Systems:
Full Sample of 78 Companies

Year 1 Year 2 Year 3 Year 4 Year 5

Panel A: All Companies
Financial Planning 20.0% 30.0% 30.0% 27.3% 27.3%
Financial Evaluation 0.0 0.0 0.0 9.1 27.3
Human Resource Planning 40.0 40.0 40.0 27.3 18.2
Human Resource Evaluation 0.0 0.0 20.0 27.3 18.2
Strategic Planning 30.0 30.0 10.0 9.1 9.1
Product Development Management 10.0 0.0 0.0 0.0 0.0
Sales / Marketing Management 0.0 0.0 0.0 0.0 0.0
Partnership Management 0.0 0.0 0.0 0.0 0.0

Panel B: VC-Backed Companies

Financial Planning 30.0 30.0 30.0 27.3 30.0
Financial Evaluation 20.0 0.0 10.0 27.3 30.0
Human Resource Planning 20.0 30.0 20.0 18.2 10.0
Human Resource Evaluation 0.0 0.0 10.0 9.1 10.0
Strategic Planning 20.0 30.0 30.0 18.2 20.0
Product Development Management 10.0 10.0 0.0 0.0 0.0
Sales / Marketing Management 0.0 0.0 0.0 0.0 0.0
Partnership Management 0.0 0.0 0.0 0.0 0.0

Panel C: Non-VC-Backed Companies

Financial Planning 0.0 10.0 8.3 20.0 20.0
Financial Evaluation 0.0 0.0 0.0 0.0 13.3
Human Resource Planning 54.5 60.0 50.0 40.0 33.3
Human Resource Evaluation 27.3 20.0 25.0 30.0 20.0
Strategic Planning 18.2 10.0 16.7 10.0 13.3
Product Development Management 0.0 0.0 0.0 0.0 0.0
Sales / Marketing Management 0.0 0.0 0.0 0.0 0.0
Partnership Management 0.0 0.0 0.0 0.0 0.0
For each year, we rank the 46 systems from the most adopted to the least adopted system and identify the top
ten systems. The table reports the percentage of systems within each category that made it into these top ten
systems.

on balance, have a higher percentage of the top ten systems in the Financial Planning and
Financial Evaluation categories than do the non-VC-backed companies. Using the percent-
ages in Table 3, the combined percentages of these two management accounting categories
across the two subsamples are:

Year 1 Year 2 Year 3 Year 4 Year 5

VC Companies 50.0% 30.0% 40.0% 54.6% 60.0%
Non-VC Companies 0.0% 10.0% 8.3% 20.0% 20.0%

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Management Control Systems in Early-Stage Startup Companies 921

There are several possible explanations for VC-backed firms giving higher priority to
the Financial Planning and Financial Evaluation categories. One explanation is that venture
capitalists come with much experience about management challenges in successfully grow-
ing early-stage companies. This extensive experience leads them to give higher emphasis
to adopting management accounting type systems in the early phases of a company’s
growth. Another explanation is that VC-backed firms typically require multiple rounds of
private finance before they are cash-flow positive. Early-stage companies that are cash-flow
negative may well require more careful monitoring of financial aspects of their business
compared to companies not so constrained financially. A third explanation is that entrepre-
neurs of VC-backed companies wish to achieve positive cash-flow/profitability at the ear-
liest possible stage (say, to avoid subsequent equity ownership dilution) and view financial
planning/financial evaluation MCSs as a key tool in this objective.9
Many companies receive Series A venture capital funding when they are in an early
formative stage with limited buildup of their MCS portfolio. Figure 3 and Table 4 highlight
the dramatic impact of VC funding. Companies receiving Series A venture capital funding
already have higher adoption of MCSs than non-VC funded companies of comparable age
or headcount. However, between Series A and Series B there is a quantum buildup in the
MCSs of these companies. This buildup in MCSs from Series A to B occurs in a short
time-frame. For 43 (27) out of the 46 MCSs, there is a 50 percent (100 percent) or higher
increase in adoption between the Series A to Series B funding. The mean (median) time
from company formation to Series A is 2.1 years (1.5 years), from Series A to Series B
1.28 years (1 year), from Series B to Series C 1.40 years (1 year), and from Series C to
Series D 1.39 years (1 year).

V. MCS ADOPTION AND COMPANY GROWTH

An important need for MCSs comes from the coordination and monitoring costs that
increase as the complexity of the company (and in particular the complexity associated
with a growing number of employees) increases. Small companies typically do not need
these systems and empirical evidence has found strong evidence for company size being
associated with the adoption of these management systems (see Baron et al. 1996; Davila
2005; and Section IV of this paper).10 They are adopted to overcome the limitations of
informal management styles that require constant personal interaction. As a manager in our
sample described it: ‘‘We had management by personality and it became evident that that
wouldn’t scale. We figured our personalities can go through one floor and two walls. After
that management by personality doesn’t work anymore.’’ This section probes the hypothesis
of a positive relationship between MCS intensity and company growth. MCS intensity is
computed in a two-stage process. First we compute the MCS category intensity as the
percentage of individual systems adopted in each of the eight categories for each year.

9
We also examined whether the pattern of adoption was different among different VC categories. In particular,
we identified VC firms among the top 10 and top 20 in number of deals from Venture One over the period in
which the firms in the sample received venture funding; we then compared time-to-adoption for each of the 46
systems between startups funded by VC firms in these two groups and the rest of the VC-backed companies.
Only ‘‘marketing collaboration policies’’ (shorter for top VC startups) and ‘‘company-wide newsletter’’ (shorter
for non-top VC startups) were significant at the 10 percent level (two-tailed).
10
An alternative role of MCS is to prevent company failure due to a major catastrophe that was not adequately
controlled for through MCS. Addressing this alternative role of MCS requires a different research design where
company failure is the dependent variable.

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922 Davila and Foster

FIGURE 3
Early-Stage Company Evolution of Management Control Systems:
Cumulative Intensity of Adoption by Venture Capital Funding Round

100%

90%

80%

70%

60%
Intensity (%)

50%

40%

30%

20%

10%

0%
VC Round A VC Round B VC Round C VC Round D

Key:

F in an cial P lan n in g H R P lan n ing St rat egic P lan n in g Sales /Market in g

F in an cial Ev alu at io n H R E v alu at io n P ro d u ct D ev elo p m en t P art n ers h ip s

Each individual system within each category in Table 2 is equally weighted. The percentage of systems adopted
in each category is plotted for companies going through the different rounds of funding.

Then, overall systems’ intensity is calculated as the equal-weighted sum of the eight inten-
sities.11 Company growth is measured by number of employees at the end of each year.
Figure 4 provides initial evidence on the relationship between company size and MCS
intensity. It plots the average company size over time for three portfolios. Portfolio 1 is
formed with the companies in the highest third in terms of systems’ intensity in Year 2.
Portfolio 2 is formed with the medium-intensity companies, and Portfolio 3 is formed with
the third of companies with lowest intensity in Year 2. The plot suggests an association
between intensity in Year 2 and company size over time. Means and medians tests between

11
Each MCS category intensity measure varies from 0 (for a company year that adopts none of the individual
systems in that category) to 1 (for a company year that adopts all of the individual systems in that category).

The Accounting Review, July 2007

 Management Control Systems in Early-Stage Startup Companies
TABLE 4
MCS Adoption Percentage by Round of Venture Capital Financing for 46 Individual Systems in Eight Categories:
Sample of 60 Venture-Finance Companiesa

Percentage of companies having adopted the system by the end of: Round A Round B Round C Round D
Financial planning Cash flow projections 35% 78% 90% 86%
Operating budget 31 78 88 90
Sales projections 31 69 88 90
Financial evaluation Capital investment approval procedures 25 55 80 86
Operating expenses approval procedures 24 51 78 81
Routine analysis of financial performance against target 18 49 83 86
Customer acquisition costs analysis 11 14 23 29
Customer profitability analysis 11 14 20 33
Product profitability analysis 9 18 30 33
Human resource planning Core values 31 48 58 58
Mission statement 31 48 63 63
Organizational chart 31 69 82 79
Codes of conduct 22 44 47 63
Written job descriptions 26 54 63 58
Orientation program from new employees 26 44 61 79
Company-wide newsletter 7 21 32 42
Human resource evaluation Written performance objectives for managers 26 48 61 53
The Accounting Review, July 2007

Written performance evaluation reports 26 52 71 79

Linking compensation to performance 22 42 58 68
Individual incentive programs 17 31 47 63
Strategic planning Definition of strategic (nonfinancial) milestones 33 63 76 84
Customer development plan 28 48 61 74
Headcount / human capital development plan 28 54 66 74
Product portfolio plan (plan about future products) 26 52 63 79
Investment budget 22 52 63 53
(continued on next page)

923
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924
TABLE 4 (continued)

Percentage of companies having adopted the system by the end of: Round A Round B Round C Round D
Product development management Project milestones 25% 40% 60% 57%
Product concept testing process 17 26 33 39
Reports comparing actual progress to plan 15 34 49 57
Project selection process 12 30 40 39
Product portfolio roadmap 12 28 40 43
Budget for development projects 12 28 47 48
Project team composition guidelines 10 19 21 22
Sales / marketing management Sales targets for salespeople 13 28 49 48
Market research projects 12 19 26 17
Sales force compensation system 15 30 49 43
Sales force hiring and firing policies 8 15 19 17
Reports on open sales 12 17 33 35
Customer satisfaction feedback 7 17 23 17
Sales process manual 8 8 14 13
Sales force training program 7 17 30 30
Marketing collaboration policies 5 8 9 13
Customer relationship management system 5 11 16 26
Partnership management Partnership development plan 7 17 33 35
Policy for partnerships 3 15 30 22
Partnership milestones 2 15 28 22
Partner monitoring systems 2 15 28 22
a
60 firms in the sample had Round A, 53 had a Round B, 43 had a Round C, and 23 had a Round D. The declines in percent usage in some systems are due to
declines in the sample rather than those specific systems being abandoned.

Davila and Foster

Management Control Systems in Early-Stage Startup Companies 925

FIGURE 4
Management Control Systems’ Intensity and Employee Growth

160

140

120

100
Employees

80

60

40

20

0
1 2 3 4 5
Age (Years Since Founding)

Highest Intensity Mid Intensity Lowest Intensity

This figure plots average company size over time for three portfolios. Each company in the sample is assigned
to one of the portfolios according to its systems’ intensity in its second year of existence. Each portfolio has an
equal number of firms. Portfolio (1) is formed with the 33 percent of companies with highest intensity, portfolio
(3) is formed with the 33 percent of companies with lowest intensity, and portfolio (2) is made up of the rest of
firms.

the various portfolios are significant from Year 2 onward. Similar results are obtained if
the portfolios are formed in Year 1 or Year 3.12
In addition to company size being a driver of the MCS intensity, the prior literature
has argued that growth itself is possible only if these systems are in place.13 In other words,
these systems provide the management infrastructure required to scale up the business
model.
These arguments suggest that the relationship between company size and the intensity
of MCSs goes both ways. We model the endogeneity of these two variables using a si-
multaneous equations model. The first equation uses number of employees as proxy for
company size. The second equation uses MCS intensity as a measure of rate of adoption:

12
We also used cluster analysis to group firms based on their patterns of adoption of the 46 systems. Clustering
the firms into three groups and plotting growth for each of the groups led to graphs very similar to the one
reported in Figure 4.
13
Greiner (1998), in a well-know article on company growth, described the need for systems as the ‘‘control
revolution’’ required for companies to continue on its growth path.

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926 Davila and Foster

Employees ⫽ f(MCS intensity, control variables); (1)

MCS Intensity ⫽ f(employees, control variables). (2)

To ensure identification of the system of equations, both equations require additional

variables. In addition to MCS intensity, we include two additional variables in the first
equation—revenues and cumulative funding—that arguably impact company growth. In
equilibrium, companies will hire the number of employees required to satisfy demand for
the company products. We use revenues to proxy for demand in the company’s product
market. Market demand is assumed to be driven by customer needs, an exogenous variable
that affects number of employees. In other words, the company hires more employees to
satisfy this latent demand (exogenous to the company). In addition to external demand,
growth may come from the need to develop technology, products, and markets. We proxy
this internal demand for growth using the cumulative funding that a company has received.14
External funding depends on the attractiveness of the company’s business model, which is
exogenous to the current size of the company. These two variables impact MCS intensity
through their effect on number of employees—the hypothesized driver of MCS needs—as
captured in the second equation.15
In addition to number of employees, our second equation includes the following vari-
ables. It has been argued that venture capitalists professionalize the companies that they
fund faster (Hellmann and Puri 2002; Davila and Foster 2005; and Section IV of this paper).
While size of VC funding is expected to positively impact the number of employees (Equa-
tion (1)), prior findings (Davila and Foster 2005) suggest that the presence of venture capital
(regardless of the funding amount) affects certain MCSs, regardless of size.16 We include
a dummy variable that takes a value of 1 for those company-years in which the company
has venture capital investors. CEOs with more experience are more likely to have been
exposed to MCSs and therefore be knowledgeable about their benefits and costs. If, on
average, the adoption of these systems trails behind company needs, then we expect CEO
experience to accelerate their adoption.17 We also include a dummy variable that takes

14
We asked the CFO of each company to provide a financial history of the company with the dates of funds
inflow—in most cases venture capital investments, the amount invested, and company valuation. This information
was contrasted with Venture One and Venture Economics data. In most cases, both sources provided the same
information; when in conflict, we reconfirmed the data with the CFO. Also from the CFO we gathered the
revenue history of the firm since founding.
15
As in any field research study, it is difficult to identify exogenous variables because in companies many variables
often move together. The underlying assumption to treating revenues as exogenous is that the company is
somehow behaving optimally and it has the people it needs to be able to serve up to the last marginally profitable
sale. Thus, if a potential profitable market for the company increases, then it will hire the people it needs to
satisfy this new level of revenues. In other words, companies can quickly adjust its employees to reach the
optimal level of revenues; if companies stay in the transition period (unable to hire enough people to meet
demand) for long periods of time, then the assumption is weak. Similarly, cumulative funding can be argued to
also affect MCS intensity. The assumption behind our model is that it is not as much the total dollars invested
that drives MCS as the presence of professional investors (this is why we have the variable ‘‘venture backed’’
in the second equation). This two-equation simultaneous model addresses the endogeneity problem to the extent
we believe it can be addressed. However, the test rests on the validity of the arguments behind treating certain
variables as exogenous. To check the robustness of the results we run different models of this two-equation
model such as dropping some of the variables (revenues, industry dummies, time-to-revenue, or international).
The relationship between employees and MCS intensity remained significant in these robustness tests.
16
The presence of venture capital is associated with the quality of the business model, which is exogenous to our
model.
17
The underlying assumption is that CEO experience impacts number of employees through his or her likelihood
of adopting MCS.

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Management Control Systems in Early-Stage Startup Companies 927

the value of 1 if the original CEO has been replaced.18,19 Entrepreneurs may have a hard
time transitioning into a manager’s mindset (Chandler and Jansen 1992; Willard et al. 1992).
While many managers rely on MCSs, some entrepreneurs perceive them as killing the
entrepreneurial spirit. Therefore, we expect this CEO replacement variable to have a positive
effect (Davila and Foster 2005). We also include a dummy variable that takes a value of 1
if the company is beyond the pre-revenue stage. We expect pre-revenue stage companies
to require fewer systems.20 We also control for the potential complexity that having inter-
national operations brings to a company’s needs for MCSs. This variable takes the value
of 1 for those years in which the company had international activities. The Appendix
provides quotes from the research interviews that illustrate the potential relevance of these
variables to explain MCS intensity. Finally, we control for industry.21,22
Table 5 reports Pearson and Spearman correlations. Variables are significantly corre-
lated. In particular, MCS intensity and employees are highly associated. The pattern of both
types of correlations is similar, indicating that Pearson correlations are not driven by ex-
treme observations.
We examined the simultaneous equation model for the possibility of auto-correlated
error terms. We found this to be a problem in Equation (2), and model the error term using
a first order auto-correlation model. In addition to the information technology (IT) industry,
we further control company attributes using a random-effects model. We ran a Hausman
test comparing the more efficient random-effects model with a fixed-effect model and did
not reject the equality of coefficients.
Our final specification is:

Employees ⫽ ␣0 ⫹ ␣1 MCS Intensity ⫹ ␣2 Revenues (1)

⫹ ␣3 ln (Cumulative Funding) ⫹ ε;

MCS Intensity ⫽ ␤0 ⫹ ␤1 Employees ⫹ ␤2 VC-Backed ⫹ ␤3 CEO Experience

⫹ ␤4 Founder Replaced ⫹ ␤5 Post-Revenue ⫹ ␤6 International
⫹ ␤7 IT Industry ⫹ ε(AR1). (2)

Table 6 reports the results. The coefficient on MCS intensity (␣1) is positively associated
with employee growth. This is consistent with the predicted relevance of these systems to
the growth of startup firms. Revenues (␣2) and cumulative funding (␣3) are also positive
and significant. These findings are consistent with external demand and the availability of
resources to meet internal needs for employees being associated with company growth.

18
We collected the CEO history from the CEO questionnaire where we asked for the dates in which a new person
was appointed CEO and this person’s years of experience and whether the experience was with startup firms.
We contrasted this information during the CEO’s and business development manager’s interviews.
19
CEO replacement may be driven by the lack of MCS intensity and then this variable is endogenous to the model
we are estimating. We ran the same model without CEO replacement and the inferences remained unchanged.
20
Pre-revenue stage is driven by whether the technology has moved to a commercial product. While the quality
of MCS in product development may have an effect on the pre-revenue stage, we are assuming that the effect
is small and that the pre-revenue stage is determined by factors unrelated to size or MCS intensity. The low
adoption of product development MCS in the early years suggests that the assumption is likely to be valid.
Moreover, the first commercial product is often brought to the market by a small team.
21
Wooldridge (2005) describes the criteria for selecting the independent, exogenous variables.
22
We include a control for industry in the second equation rather than the first because revenues and funding are
likely to capture the differences in growth across industries. None of the exogenous variables is likely to capture
the effect of industry. For instance, the fact that IT firms may need to hire a much larger sales force than
biotechnology or other industries is not captured by the exogenous variables.

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The Accounting Review, July 2007

928
TABLE 5
Correlation Table

Number MCS
of Systems’ Ln(Cumulative CEO VC- CEO Time to International Biotech
Employees Intensity Revenues Funding) Experience Backed Replaced Revenue Operations Industry
Number of Employees 0.38*** 0.50*** 0.43*** 0.46***
MCS Systems’ Intensity 0.44*** 0.10* 0.45*** 0.16***
Revenues 0.60*** 0.23*** 0.15*** 0.11*
Ln(Cumulative Funding) 0.55*** 0.47*** 0.19*** 0.23***
CEO Experience 0.15** 0.16*** ⫺0.03 0.25***
Venture Capital Backed 0.37*** 0.22*** ⫺0.11** 0.29*** 0.37***
Founder Replaced 0.37*** 0.34*** 0.17*** 0.30*** 0.39*** 0.29***
Time to Revenue 0.65*** 0.04 0.50*** 0.06 0.42*** 0.27*** 0.25***
International Operations 0.38*** 0.51*** 0.18*** 0.24*** 0.27*** 0.21*** 0.45*** 0.21***
Biotech Industry 0.00 ⫺0.02 ⫺0.10** 0.28*** ⫺0.01 0.17*** 0.07* 0.00 0.00
IT Industry ⫺0.03 0.15*** ⫺0.12** 0.06 0.07 0.07 0.01 ⫺0.04 0.05 ⫺0.65***

*, **, *** Indicates significance at 10 percent, 5 percent, and 1 percent levels, respectively.
The upper triangle reports Pearson correlation and the lower triangle reports Spearman correlation. Pearson correlations are not reported for dummy variables.

Davila and Foster

Management Control Systems in Early-Stage Startup Companies 929

TABLE 6
Firm Growth and Management Control Systems’ Intensity

Equation 1: Employees
Constant ⫺87.54**
(⫺2.55)
MCS Intensity 30.38**
(3.70)
Revenues 0.002***
(6.68)
Ln(Cumulative Funding) 62.52***
(3.91)
Chi-square 196.67***
Overall R2 0.36

Equation 2: MCS Intensity

Constant ⫺0.81**
(⫺2.50)
Employees 0.006***
(3.97)
Venture Capital Backed 0.247*
(1.79)
CEO Experience 0.004
(0.50)
Founder Replaced 0.053
(0.45)
Time to Revenue 0.246**
(1.97)
International Operations 0.416***
(4.09)
Biotech Industry ⫺0.218
(⫺0.67)
IT Industry 0.181
(0.52)
Chi-square 90.28***
Number of observations 264
*, **, *** Indicates significance at the 10 percent, 5 percent, and 1 percent levels, respectively.
z-stat in parenthesis.
The table reports iterative, random effects simultaneous equations model estimation.
Employees ⫽ number of employees at the end of each year;
MCS Intensity ⫽ sum of the percentage of systems adopted within each type of management
control system;
Venture Capital Backed ⫽ value of 1 for those company-years in which the company had venture
capital in its equity, and 0 otherwise;
CEO Experience ⫽ years of experience of the CEO when (s)he became CEO;
Founder Replaced ⫽ dummy variable that takes value of 1 for company-years in which the CEO
is not the founding CEO;
Time to Revenue ⫽ dummy variable that takes value of 1 for company-years beyond the pre-
revenue stage;
International Operations ⫽ value of 1 if the company has international activities, and 0 otherwise; and
IT Industry and Biotech Industry ⫽ dummy variables that take value of 1 for those firms in the IT or biotech
sector.

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930 Davila and Foster

In Equation (2), the number of employees (␤1) is significantly associated with MCS
intensity. This finding is consistent with predictions and with previous empirical evidence
that identified company size as a relevant variable to explain the adoption of MCS. The
coefficient on the presence of venture capital (␤2) is positive and significant, consistent with
this type of capital bringing ‘‘professional’’ systems to companies. Also companies beyond
the pre-revenue stage (␤5) and with international activities (␤6) are positively associated
with the intensity of MCSs.23
In summary, the findings are consistent with company growth and MCSs being inter-
related. These systems are needed to provide the management infrastructure that supports
growth beyond the informal stage; simultaneously, these systems are needed only if growth
exists. The results in Table 6 establish association but not causality. The current research
design is consistent with two (not necessarily inconsistent) hypotheses—(1) that an increase
in MCS intensity facilitates future company growth, and (2) that managers anticipate future
growth and increase MCS intensity to enable them to ‘‘manage that growth.’’24

VI. PERFORMANCE IMPLICATIONS: CEO ROTATION AND MCSs

The replacement of entrepreneurs at the CEO position has been frequently associated
with the difficulty such individuals experience in transitioning into a manager’s mindset
(Chandler and Jansen 1992; Willard et al. 1992). A powerful indicator of this transition is
the adoption of MCSs. Figure 5 provides descriptive evidence relevant to this question. We
classified firms into three groups according to MCS intensity in Year 1 from high to medium
and low intensity. For each group we estimated the proportion of founders that were re-
placed during the years for which we have data. Panel A in Figure 5 reports these propor-
tions. We reclassified firms into groups in Year 2 (Panel B) and again in Year 3 (Panel C).
Figure 5 suggests an association between MCS intensity and founder’s replacement as CEO.
Given the survival nature of the data, we use a Cox specification model and report
hazard ratios. Table 7 examines this same question in a multivariate setting. We examine
two different models. The dependent variable in the first model is the time since founding
to the replacement of the founder as CEO. The dependent variable in the second one is the
time to replacement of a CEO from his or her hiring date regardless of whether this person
was a member of the founding team. The second model takes advantage of the additional
information in our database about CEO tenure beyond the founding CEO.
If MCS intensity is associated with an entrepreneur (or CEO in the expanded model)
being able to transition into a managerial role, then we expect intensity to be associated
with longer tenure. In addition, we control for the number of employees, industry, CEO
experience and whether this experience is in startup firms, as well as whether the firm is
VC-backed. Employees capture the potential effect of company performance—more suc-
cessful CEOs may build their companies faster and have longer tenures. Industry reflects
the different time frames across industries, with information technology having a faster
ramp-up than biotechnology. Prior research suggests that venture capitalists are faster at
replacing the founder as CEO (Hellmann and Puri 2002). Finally CEO experience, and
whether this experience was gained in startup companies, control for the background of

23
We examined the late adoption of sales management systems. As expected, we found that sales management
intensity was associated with whether the firm had reached the selling stage (time-to-revenue variable). Size
(number of employees) and the information technology dummy were also significant.
24
One venture capitalist who commented on the research argued that in a narrow sense Table 4 did establish
causality. He noted that venture funding facilitated growth after each funding round and that Table 4 highlighted
the quantum increase in MCSs Series B that venture capitalists required before the new venture money was
invested.

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Management Control Systems in Early-Stage Startup Companies 931

FIGURE 5
CEO Turnover and Management Control Systems’ Intensity
Panel A: CEO Turnover and Management Control Systems’ Intensity—Year 1

60 %
Percentage of founders replaced from CEO position

50 %

40 %

30 %

20 %

10%

0%
Group 1 (highest intensity) Group 2 Group 3 (lowest intensity)

Panel B: CEO Turnover and Management Control Systems’ Intensity—Year 2

60 %
Percentage of founders replaced from CEO position

50 %

40 %

30 %

20 %

10%

0%
Group 1 (highest intensity) Group 2 Group 3 (lowest intensity)

(continued on next page)

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932 Davila and Foster

FIGURE 5 (continued)
Panel C: CEO Turnover and Management Control Systems’ Intensity—Year 3

60 %
Percentage of founders replaced from CEO position

50 %

40 %

30 %

20 %

10%

0%
Group 1 (highest intensity) Group 2 Group 3 (lowest intensity)

These figures plot the percentage of founders replaced from the CEO position per level of management control
systems’ intensity. Firms were grouped into three portfolios from highest to lowest intensity in Year 1 (Panel A),
Year 2 (Panel B), and Year 3 (Panel C). The y-axis is the percentage of founders replaced and the x-axis are the
three portfolios from highest (group 1) to lowest intensity (group 3).

the CEO. CEOs with more experience and with startup experience are likely to better
understand what needs to be done to grow the company.
Table 7 reports the hazard ratios. MCS intensity is significant and associated with longer
tenure in both models in Table 7.25 The coefficient for information technology is larger than
1 and significant, indicating that tenure in this industry is shorter. Company size is signif-
icant and greater than 1 in the second model but not in the first. This result is consistent
with shorter tenures in larger companies. CEO experience in startups is significant in the
first model (founder model), with prior startup experience being associated with shorter
tenures. However, this result is after controlling for startup experience and CEO experience.

25
The literature has put forward the argument that founders are replaced because they are unable to transition
from an entrepreneurial to a managerial mindset (see Section II). Our results are consistent with this argument.
An alternative argument is that the founder knows that s / he is going to be replaced and under-invests in MCS,
knowing that those systems benefit the long term of the company and not the short term (for which s / he is
accountable) and that the new CEO will introduce them.

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Management Control Systems in Early-Stage Startup Companies 933

TABLE 7
Management Control Systems’ Intensity and CEO Rotation

Time to Replacing Time to

Founder as CEO CEO Replacement
Hazard Ratio z-statistic Hazard Ratio z-statistic
MCS Intensity 0.365*** ⫺2.77 0.393** ⫺2.37
IT Industry 3.311** 2.37 3.897** 2.28
Number of Employees 1.007 1.62 1.010** 2.24
Venture Capital Backed 2.301 1.53 1.669 0.83
CEO Experience (Years) 1.020 0.67 0.994 ⫺0.24
CEO Startup Experience 0.002*** ⫺2.98 1.480 0.40
Startup Experience * CEO Years 1.354*** 3.77 0.929 ⫺1.28
of Experience
Number of Observations 201 272
Number of Subjects 52 80
Chi-square 43.24*** 13.09**
*, **, *** Indicates significance at the 10 percent, 5 percent, and 1 percent levels, respectively.
The table presents results for a Cox regression model with right censoring and time-varying covariates of CEO
tenure. A coefficient of 1 indicates that the variable has no influence on the time to the event, a coefficient less
(more) than 1 indicates that the variable is associated with longer (shorter) time to the event.
MCS Intensity ⫽ sum of the percentage of systems adopted within each type of management control
system;
Number of Employees ⫽ number of employees at the end of each year;
Venture Capital Backed ⫽ value of 1 for those company-years in which the company had venture capital in its
equity, and 0 otherwise;
CEO Experience ⫽ years of experience of the CEO when (s)he became CEO;
CEO Startup Experience ⫽ dummy variable coded 1 if the CEO has experience in startups or small firms; and
IT Industry ⫽ dummy variable that takes value of 1 for those firms in the IT sector.

This latter interaction variable is associated with longer tenure.26 Thus, CEO experience in
startup companies increases the likelihood of longer tenures.27

VII. CONCLUSIONS
An informal approach to managing organizations becomes harder when they grow
beyond a certain size. At this point, the adoption of MCSs becomes important to provide
the management infrastructure required to scale-up the organization. Modeling this transi-
tion point as a system of simultaneous equations, we find that the adoption of MCSs is
positively associated with company size and, simultaneously, company size is associated
with the presence of these systems. This evidence indicates that growth and the adoption
of management systems reinforce each other as companies transition through their first

26
These results are robust to using lagged MCS intensity, which captures the potential endogeneity of MCS
intensity and the presence of a new CEO in the last period of a spell (endogeneity that may emerge if new
CEOs quickly build up systems after they join the company). They are also robust to including alternative
measures of performance, such as change in number of employees in the period, or revenues. Finally, the
coefficient on a dummy variable for the year of a founder’s replacement and the year after is significant in a
regression of change in MCS intensity against change in employees, employees, and this dummy variable.
27
As an additional test, we added to the model reported in Table 7 another variable: change in MCS intensity.
The idea behind this variable is that CEOs who are building up the systems are less likely to be replaced. The
variable is significant at the 10 percent level (and larger than 1) for founders and not significant for CEOs in
general.

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934 Davila and Foster

‘‘growth crisis.’’ We also find evidence informative to the empirical regularity found in
early-stage startup firms where founders are replaced as CEOs more often than expected.
We find that CEOs with lower adoption of MCSs are more likely to be replaced. Overall,
the evidence supports the relevance of these systems to the growth of startup firms beyond
their initial stage.
The financial planning MCS category is typically the first and most widely one adopted
by the startup companies examined. Three individual systems relate to financial planning—
operating budgets, cash flow projections, and sales projections. Individual human resource
planning and strategic planning systems are also among the first and most widely adopted
MCSs, e.g., core values, organization charts, definition of strategic milestones, and
headcount/human capital development budgets. Progressively over the third to the fifth
years since founding, there is a sizable buildup in both financial evaluation and human
resource evaluation MCSs. The financial evaluation systems that have widespread adoption
in the first six years are capital investment approval procedures, operating expenses approval
procedures, and routine analysis of financial performance against target.
The evidence in this paper can be extended in several ways. We treat MCSs in a
dichotomous way—the company either has or has not adopted them. Future research could
examine potential variation in the quality or depth of individual systems or individual
categories adopted. During the data collection research phase it was not unusual to hear
descriptions of these systems evolving from fairly straightforward systems to more sophis-
ticated ones. Future research could quantify such depth or quality of system adoption.
Our research highlights the importance of venture capital (VC) to understanding the
adoption of MCS. It is relevant in terms of the adoption pattern (Figures 1 and 2 showing
higher adoption in VC-backed companies) and to explain MCS intensity and the adoption
of planning systems. Future work may examine the adoption of MCS in these non-VC-
backed companies to understand whether there are different patterns of adoption. Because
of the small sample size of this type of company and the large contrast between VC-backed
and non-VC-backed companies, this question is not addressed in this research.
Another important extension of this research has to do with the sequencing of MCS
adoption. Theory suggests that planning systems should be adopted before evaluation sys-
tems are. However, theory is silent about which systems come first and whether the adoption
of certain systems is conditional on having other systems in place. In preliminary results
comparing financial, strategic, and human resource (HR) planning (not reported), we find
that HR and strategic planning complement each other—the presence of one is associated
with a higher likelihood of adopting the second. In contrast, the adoption of financial
planning systems is associated with longer adoption times for HR and strategic planning.
Future research can develop arguments on how the adoption of these systems should be
sequenced, and then to empirically examine this question.
An alternative role of MCS is to control risks and avoid major catastrophes that may
lead to company failure. This study does not address this question, but gathering empirical
evidence on whether MCSs can assist managers to avoid failure through their role as risk
monitoring devices is an important line for future research.28
The role of key individuals/players in building the MCS portfolio of companies is an
important but little-researched topic. For instance, it was common during interviews to have

28
Also, preliminary evidence (not reported) suggests that the presence of MCS may be related to the value that
venture capitalists put on a startup company. Future research could address this additional piece of evidence on
the relevance of MCS to performance.

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Management Control Systems in Early-Stage Startup Companies 935

descriptions of specific MCS adoption being associated with the hiring of a particular
manager—the idea of ‘‘import in’’ knowledge. Related to this issue is the role of ‘‘third
parties’’ in guiding MCS adoption decisions. Early-stage companies adopting product de-
velopment MCSs sometimes referred to the ‘‘requirements’’ of third parties (such co-
product developers, like Intel) or research/marketing partners (such as pharmaceutical
companies) when explaining why specific MCSs were implemented. Venture capitalists
represent a key third-party in our sample, as is evidenced by the greater emphasis placed
on management accounting MCSs (both financial planning and financial evaluation) in VC-
financed companies compared to non-VC-financed companies. Venture capitalists have vast
experience with many early-stage startups and have high incentives to understand factors
that increase the likelihood of company success. Management accounting and other MCS
choices appear to be influenced by such third parties to a greater degree than has been
previously recognized as early-stage companies build up their MCS portfolios.

APPENDIX
Illustrative Quotes for Variables Potentially Affecting Management Control Systems’ Intensity

Variable Illustrative Quotes

Number of ‘‘I think the systems are more important in the scaling period because what works
Employees for 20 people won’t work for 50 or 200 people, in terms of communication,
decision making, etc. So you need the systems to formalize and structure it
more.’’
‘‘It definitely happened to us, when you couldn’t fit everyone into one space and
the dynamic shifts and communication get a lot harder.’’
Venture- ‘‘[These systems] were put in through a combination of the then Chief Financial
Backed Officer as well as the minimum expectations set by the VCs. So the board itself
had a very strong hand in terms of what minimum it was prepared to accept.’’
‘‘I just find that you can’t get hurt by over-reporting to the board. And reporting
early.’’ (The board had various venture capitalists on it.)
Managers’ ‘‘I think some of it is just something that I’ve learned or I’ve developed over the
Experience years from experience, things that work.’’
‘‘He came from McKinsey and he was a very process-oriented guy. So that’s when
the process began, I would say.’’
‘‘Some systems expertise you import when you import the right people.’’
Founder ‘‘Originally the sales organization was run by one of our founders who was a very,
Replaced very young guy like 22 at the time or something. But he just didn’t have a lot of
experience running this type of organization and putting this kind of system in
place. And then eventually we ended up having an experienced VP of sales and
marketing join who then implemented kind of his vision of things.’’
Pre-Revenue ‘‘So there is a clear need for a formalized policy on communicating with each
Stage other. And also because we are getting closer to commercialization, there is a
need to have a better understanding of our cost structure, which needs a very
formalized approach.’’
‘‘There’s no need to do a product profitability report because we’re not shipping
product.’’
‘‘So one of our biggest weaknesses was lack of marketing information and
marketing analysis, the problem was that we didn’t have the reporting tools.’’

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936 Davila and Foster

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