Early Warning Systems: A Risk of Increasing Managerial Myopia?

The Italian legislator has recently approved a new Insolvency and Crisis Code (Legislative Decree 14/2019), introducing a compulsory Early Warning System to detect occurring crises. The new provisions are in accordance with the EU policies that require Member States to develop national insolvency frameworks, which force enterprises in financial difficulties to restructure at an early stage of the crisis (EU Directive COM(2016) 723). The aim of the new rules is to prevent, as far as possible, insolvencies, and therefore to maximise the total value to creditors, employees, owners, and the economy as a whole. Since the new rules imply more encompassing responsibilities for corporate supervisory bodies, these provisions are generally perceived as having the ability to induce a significant impact on Italian SMEs’ management control systems. This is certainly to be welcomed, because this is an area where there is still room for much-needed improvements. Nevertheless, some concerns should also be expressed. As a matter of fact, possible misunderstandings and misuses of different sets of control could derive from this new focus on early warning indicators. Notably, a bureaucratic and formal approach in the design and use of companies’ control structure could prevail, since generally, among practitioners, there is not enough knowledge and understanding of the rationale of management control systems. Different kinds of control, such as post-action controls, steering controls, and yes-no controls, could therefore be confused, with an almost assured negative effect on firm’s ability to pursue its strategic aims. Another area of potential misconstruction could arise from the confusion between managerial control systems on one hand, and internal auditing on the other: their roles and aims should be clearly understood and kept separated, although within an integrated framework. This distinction is of a paramount importance because, with the new law, the monitoring of the occurring crisis is no longer a responsibility of the sole directors, but it involves other subjects: the board of statutory auditors (or the single statutory auditor). These subjects will therefore have a set of incentives that make them focus all their attention on avoiding insolvency risks, with no or little interest in the pursuing of long-term goals, possibly leading to short-termism and a lack of strategic action. Early warning indicators are certainly useful, as they can be employed both as a diagnostic form of control, and as a strategic tool to detect in advance the evolutions of the environment and the competitive arena. Clearly, different sets of parameters should be adopted in the two instances, and, more importantly, different logics and ways of interpreting them. Regrettably, the new rules concerning early detection of crises could determine a too narrow focus on the short term, therefore causing managerial myopia. Building on previous literature, this article aims to develop a set of indications that could lead to a better understanding of the purposes and rationales of different kinds of managerial controls, and therefore to help practitioners to design their managerial control systems in a more informed and balanced way.