Internal Control Systems and the Performance of Agricultural Small Medium Enterprises in Eastern Uganda. A Case Of Mbale District

TABLE OF CONTENT

TABLE OF CONTENT

LIST OF TABLES

LIST OF FIGURES

LIST OF ABBREVIATIONS

ACKNOWLEDGEMENT

ABSTRACT

INTRODUCTION

1.1 Introduction
1.2 Background to the Study
1.2.1 The historical background
1.2.2 Theoretical background
1.2.3 The conceptual background
1.2.4 The contextual background
1.3 Statement of the problem
1.4 Purpose of the study
1.5 Objectives of the study
1.6 Research Questions
1.7 Hypotheses of the study
1.8 Conceptual Framework
1.9 Significance of the study
1.10 Justification of the study
1.11 Scope of the study
1.12 Operational definitions

CHAPTER TWO
LITERATURE REVIEW
2.1 Introduction
2.2 Theoretical review
2.3 Conceptual Review
2.4 Control systems and the performance of agricultural SMEs
2.4.1 Assets control and performance of SMEs
2.4.2 Financial control and performance of SMEs
2.4.3 Compliance control and performance of SMEs
2.5 Summary of the literature review

CHAPTER THREE
METHODOLOGY
3.1 Introduction
3.2 Research Design
3.3 Study Population
3.4 Determination of the Sample size
3.5 Sampling techniques and procedure
3.6 Data Collection Methods
3.6.1 Questionnaires survey
3.6.2 Interviews
3.6.3 Documentary review
3.7 Data collection instruments
3.7.1 Self-administered questionnaire
3.7.2 Interview guide
3.7.3 Documentary checklist
3.8 Validity of data collection instruments
3.9 Reliability
3.10 Procedure of Data Collection
3.11 Data Analysis
3.11.1 Quantitative data analysis
3.11.2 Qualitative data analysis
3.12 Ethical considerations

CHAPTER FOUR
PRESENTATION, ANALYSIS AND INTERPRETATION OF FINDINGS
4.0 Introduction
4.1 Response rate
4.2 The socio-demographic characteristics of respondents
4.2.1 Distribution of respondents according to gender
4.2.2 Age bracket of the respondents
4.2.3 Education level of the respondents
4.3 Internal Control System and performance of agricultural SMEs in Mbale District
4.3.1 How does asset control contribute to the performance of agricultural SME’s in Mbale District?
4.3.2 What is the relationship between financial control and performance of agricultural SME’s in Mbale District?
4.3.3 How does compliance control contribute to the performance of Agricultural SME’s in Mbale District?
4.3.4 What is the relationship between internal control systems and Agricultural SME performance in Mbale District?
4.4 Multiple Regressions for internal control system variables within Agricultural SMEs in Mbale District
4.4.1 How does asset control contribute to the performance of Agricultural SMEs in Mbale District?
4.4.2 What is the relationship between financial control and performance of Agricultural SMEs in Mbale District?
4.4.3 How does compliance contribute to the performance of Agricultural SMEs in Mbale District?

CHAPTER FIVE
SUMMARY, DISCUSSION, CONCLUSION AND RECOMMENDATIONS
5.1 Introduction
5.1.1 The extent to which assets control predicts the performance of agricultural SMEs in Mbale district
5.1.2 The extent to which financial control predicts the performance of Agricultural SMEs in Mbale District
5.1.3 The extent to which compliance control and performance of Agricultural SMEs in Mbale District
5.2 Discussion of major findings
5.2.1 Asset control and Performance
5.2.2 Financial control and Performance
5.2.3 Compliance control and Performance
5.3 Conclusion of the study
5.3.1 The relationship between asset control and performance
5.3.2 The relationship between financial controls and performance
5.3.3 The relationship between compliance control and performance
5.3.4 The relationship between internal control systems and performance
5.4 Recommendations
5.4.1 Asset control and performance
5.4.2 Financial control and performance
5.4.3 Compliance and performance
5.5 Limitations of the study
5.6 Contributions of the study
5.7 Areas recommended for further research

References

APPENDICES
APPENDIX 1: INTRODUCTION LETTER
APPENDIX 2: SELF-ADMINISTERED QUESTIONNAIRE
APPENDIX 3: INTERVIEW GUIDE
APPENDIX 4: DOCUMENTARY CHECK LIST

LIST OF TABLES

Table 1: Distribution of respondents of the study

Table 2: Results of validity analysis

Table 3: Results of reliability analysis

Table 4: Response rates

Table 5: Age brackets of respondents

Table 6: Education levels of respondents

Table 7: Assets control and SME performance

Table 8: Financial control and SME performance

Table 9: Compliance control and SME performance

Table 10: Summary internal control systems and SME performance

Table 11: Multiple regression results of assets control on SME performance

Table 12: Multiple regression results of financial control on SME performance

Table 13: Multiple regression results of compliance control on SME performance

LIST OF FIGURES

Figure 1: The conceptual framework diagram

Figure 2: Gender of respondents

Figure 3: Age brackets of respondents

Figure 4: Education levels of respondents

LIST OF ABBREVIATIONS

Abbildung in dieser Leseprobe nicht enthalten

ACKNOWLEDGEMENT

To my supervisors Mr. Mugambe Paddy, Doctor Keefa Kiwanuka Professor Benon Basheka and Ms. Pross N. Oluka, I am greatly indebted to you. I will always remember you for your constructive criticism and professional guidance and for being there for me through different stages of my research

I would like to thank UMI Consultants especially those from the department of Economics and Managerial Sciences for their continued guidance during my study, special attention of Professor Benon Basheka, Ms. Pross N. Oluka, Mr. Kiwanuka Michael, Dr. Stella Kyohairwe and Dr. Maria Balifaijo for their expertise and guidance and professional delivery and transfer of knowledge to adult learners

I must thank my class mates at MBA 3, particularly Kanyoola Moses, Brenda Nziabake, Natukunda Rebecca, Were Jackson, Karibwije Chris, Akiru Josephine, Kanyago Anne and Kakai Lydia. Your additional teachings and support inspired me to complete this course.

Special thanks go to, my wife Sarah, my children Brent, Sean and Carlos who tried to understand and support me during my academic endeavors. I must appreciate my late parents (Rutebuka John Baptiste and N.Ngirimana Alodia) for inspiring me at a tender age in how to pursue and not giving up on education.

I pray for God’s blessings to you all.

ABSTRACT

This study aimed at establishing the contribution of internal control systems towards the performance of agricultural SMEs in Eastern Uganda, with a case study of SMEs in Mbale district. The study objectives were (i) To examine the extent to which assets controls predict the performance of agricultural SMEs in Mbale district; (ii) To establish the extent to which financial controls predict the performance of agricultural SMEs in Mbale district; (iii) To assess the extent to which compliance controls predict the performance of agricultural SMEs in Mbale district; The study was conducted through a case study on agricultural SMEs in Mbale District. The results of multiple regression analysis between assets control and SME performance noted an adjusted R2 value of 0.194 implying that generally 19% of total variability in SME performance is explained by assets control mechanisms; while the analysis between financial control and SME performance showed an adjusted R2 value of 0.097 implying that generally 9.7% of total variability in SME performance is explained by financial control mechanisms and an adjusted R2 value of 0.131 between compliance control and SME performance implying that generally 13.1% of total variability in SME performance is explained by compliance control mechanisms. The conclusion was that generally, there is a weak positive correlation between internal control systems and the performance of Agricultural SMEs in Eastern Uganda. The weak prediction reflects the reality that there were other factors that influenced the performance of agricultural SMEs in Eastern Uganda. The study recommends additional research on the relationship between Informational Technology, agricultural mechanization, stability and availability of markets, participative management and agricultural SME performance.

CHAPTER ONE INTRODUCTION

1.1 Introduction

This study investigated the relationship between internal control systems and performance of agricultural SMEs in Eastern Uganda; a case study of Mbale District. In this study, internal control systems, the independent variable was measured by the indicators assets control, financial control, and compliance control. The performance of Small and Medium Enterprises as a dependent variable was measured by the indicators financial performance, and product market performance.

This chapter presents information related to this topic in the following sections: background of the study, statement of the problem, purpose of the study, objectives of the study, research question, research hypotheses, conceptual framework, significance of the study, justification of the study, scope of the study, and operational definitions.

1.2 Background to the Study

1.2.1 The historical background

Internal controls in organizations have existed from ancient times. In Hellenistic Egypt, there was a dual administration with a set of bureaucrats charged with collecting taxes and another charged with supervision for purposes of internal controls. In the ancient Republic of China, the “Jiancha Yuan or Control Yuan” was one of the agencies that monitored the other branches of Government for purposes of internal controls (Papadopoulou, 2010) and (Yuan, 2009).

The history and evolution of the concept of internal controls in the contemporary times have largely been influenced by events and developments in the USA and the UK. The concept of internal control was first officially defined in 1949 by the American Institute of Accountants. Since then, the definition and concept of internal controls have been the subject of debate. Different interest groups have had diverse perceptions but agreed that internal controls improve financial reporting and are beneficial to capital providers and other stakeholders Chye (2007) citing Deumes (2000).

In the UK, the collapses of Bank of Credit and Commerce and the Maxwell Empire in 1991 sparked widespread concern that led to the creation of the Cadbury Committee that recommended listed companies to report on the effectiveness of financial control, while the Rutteman Committee provided guidance on how the board should review and report. Legislations issued after the Cadbury Committee such as the Hempel Committee, the combined code, as well as the Turnbull Committee have reiterated their recommendations in support of internal control Chye (2007).

In the USA, successively the Cohen Commission 1978, the Securities and Exchange Commission, the US congressman Ron Wyden of the House Oversight and Investigations Sub-Committee, the Federal Deposit Insurance Corporation of the Tread way Commission, the Public Oversight Board and more recently the Sarbanes – Oxley Act of 2002 have recommended the strengthening of internal controls (Spira& Gowthorpe, 2008).

In the Sub-Sahara African context, the importance of internal controls was perhaps highlighted by the introduction of Structural Adjustments Programs (SAPs) recommended by the International Monetary Fund (IMF) as far as policy and budget reforms in the public service were concerned (Noorbakhsh& Poloni, 1999). The internal controls within these economies focused on control mechanisms aimed at stabilizing the fiscal policy and environment. SAPs in Uganda commenced in 1987.

Uganda’s economy remains heavily dependent on the agricultural sector. In 2008/2009, the agricultural sector contributed 90% of total export earnings, generated 23.7% of Gross Domestic Product (GDP), and directly or indirectly provided livelihoods for about 90% of the population. However, small-scale agro-enterprises who use rudimentary technology and are largely engaged in non-market production are responsible for most of the agricultural production. The country faces a shortage of entrepreneurship skills and successful models of commercialized agriculture (Kraybill& Kidoidoi, 2009).

Eyaa& Ntayi (2010) observed that poor performance and subsequent high rate of collapse is far superior to the rate of success among all SMEs. Among the biggest contributors of these failures is believed to be poor management. Management implies many functions including controlling. The inadequate internal control mechanisms may not only lead to poor performance of an SME but also to total collapse. The next section enlightens on the theoretical rationalization of the role of internal controls in relation to SME performance.

1.2.2 Theoretical background

Cybernetics (theory of Communication and Control) by Norbert Weiner in 1948 asserts that entropy is very common in systems and its increase causes systems to become less organized and eventually malfunction as long as there are no means of control that force a system to maintain the structure. Malik (2004) from the holistic system-oriented standpoint criticizes pure shareholder value orientation and education programs in business administration and argues that applying the laws, models and methods of management cybernetics, enables an organization to function more effective and efficiently.

The main weakness of cybernetics is that the position of the observer of the system (e.g. the organization) pre-defines how the system is observed. This problem of placing the observer in the center became the Achilles' heel of cybernetics, with the result that its wide acceptance and use have declined over time, so much that today it has limited application in organizational and management sciences.

The COSO model of internal control in organizations is another important control model. State of New York Comptroller (2010) says that the integrated internal control framework is made of five interrelated elements as identified by COSO; fostering a favourable control environment, conducting risk assessment, designing and implementing control activities in the form of policies and procedures, providing for effective communication throughout the organization, and conducting ongoing monitoring of the effectiveness of control-related policies and procedures.

However, Amundo& Inanga (2009) through their study on evaluation of internal control systems in Uganda contest that the COSO framework approach may be relevant to larger organizations, yet inappropriate for smaller ones due to costs and operational complexity.

In this study, the Agency Theory was used to describe, predict and explain the phenomenon of internal control, as a function of management, and its perceived contribution towards the performance of small and medium agricultural enterprises. According to the Agency Theory, internal controls established by both management and administration of a firm are one of many mechanisms used to address the agency problem (Kevan, Jensen& Jeff, 2003). Furthermore, research has proven that internal controls reduce agency costs (Barefield, Claver & O’Keefe, 1993).

The Agency Theory is about the separation between ownership and control. One person (the Principal) engages another person (the Agent) to perform duties. An agency problem arises if the cooperative behavior, which would maximize the group’s welfare, is not consistent with each individual’s self-interest. Because owners of resources will have less information than those who manage the resources, these agents may take advantage of the situation for their own benefit. As a result, different contracting agreements and controls need to be designed in order to mitigate agency-related problems (Arwinge, 2013).

Benisiu& Hangula (2011) citing Sykuta& Chaddad (1999) while reviewing theory, practice, and dynamics of agricultural cooperatives in Namibia, noted that the Agency Theory is relevant to the institutional structure of agricultural enterprises because it explains how employed agents in agri-business may not act in the best interests of cooperative owners hence the need for internal control mechanisms as suggested in the model.

Rost, Inauen, Osterloh, & Frey (2010) also studied organizations and the success of their longevity in the guidance of the agency theory and concluded that longevity success in organizations is attributed to an appropriate governance structure that relies strongly on internal control mechanisms, as suggested in the agency theory. The next section identifies a conceptual setting on which the study of a relationship between internal controls and SMEs was modeled.

1.2.3 The conceptual background

Internal controls are procedures put in place by firms’ owners, executives, managers and staff to ensure efficient and effective operations of activities so as to meet the firms’ objectives. Internal controls also help the auditors and evaluators to assess the business risks, minimize loss and maximize wealth. Research has proven that there is a strong relationship between weak internal controls and perpetuation of fraud in organizations. Arsenault (2008) found that good internal controls provide a working environment in which good employees are not tempted to do something they would not ordinarily do.

There are various approaches to analyzing the competence of internal control systems. The Application Control Approach promoted by Namiri& Stojanovic (2012) presents a novel view on the modeling and implementation of internal control in the business process. The main idea in this view is the introduction of a semantic layer in which the process instances are interpreted according to given control statements, without changing the original (business goal driven) business process. The COSO interpretation of internal controls, on the other hand, notes that internal controls systems consist of five interrelated components namely: Control Environment, Risk Assessment, Control Activities, Information, and Communication, as well as Monitoring (Schneider& Becker, 2011).

Amundo& Inanga (2009) through their study on evaluation of internal control systems in Uganda contest that the COSO framework approach may be relevant to larger organizations, yet inappropriate for smaller ones due to costs and operational complexity.

In this study, the concept of internal control systems with more relevant variables was adopted from CPA Australia (2008) that suggested four broad areas that may constitute SMEs internal control systems notably mechanisms for controlling all assets, a sound financial system, a keen interest in compliance with the environment, legal and regulatory systems, as well as supervisory management. However, the study concentrated on the three areas (assets control, finance control, and compliance control) within the milieu of agricultural SMEs in Mbale as contextualized below.

1.2.4 The contextual background

Mbale is a district in Eastern Uganda that was named after the 3rd largest town in Uganda after Kampala and Mbarara (UN HABBITAT, 2011). Mbale district is bordered by Sironko (North), Bududa (Northeast), Manafwa (Southeast) Tororo (South), Butaleja (Southwest) and Budaka in the west. The primary economic activity in the district is agriculture and some of the main crops are coffee, beans, matooke, maize, onions, potatoes, carrots and sweet potatoes (Escudero-Pascual & Barthilson, 2007).

According to UN HABITAT (2011), in the 1970s, Mbale was an economically vibrant and strong town with the coffee industry as its main economic base, supplemented by cotton, and some inflows of various foodstuffs which were coming from Northern Uganda via railway line. Mbale town is fairly well connected in terms of transport. It is a major business hub in the region and trades with Kenya, Sudan, and Tanzania. The town is served by a total of over 100 kilometers of tarmac and earth roads. Mbale is the nodal center for the Mbale-Kampala highway via Tororo town through Tirinyi road. It also connects this region of Uganda via the Soroti highway.

In the context of agricultural SMEs, lack of appropriate finance at reasonable costs to support their operations has continuously affected their investment and production levels and hence lowered their return on investment. (DEMIS Consults Limited, 2010). CARD UGANDA (2012) reports that 70% of commercial banks in the region still perceived agribusinesses as low-income earners lagging in development ladders, with low profits therefore not worth of financial services as they are a potential liability. In the same report, agriculture finance service providers also highlighted that there is up to 17% loan defaulting among agribusinesses, which highlights poor performance among agricultural SMEs. This situation represents the major ingredient of the problem of SMEs in Mbale District as specified in the statement of the problem.

1.3 Statement of the problem

Teketel& Belhanu (2009) quoting Wai (2008) noted that although the importance of an internal control system is widely acknowledged among large companies, an efficient system of internal control is typically said to be absent or not strong in most SMEs in general.

Mbale district is famously known for its many agro-based small enterprises that have earned it respect in the economy of Uganda. Mbale was referred to as the food basket of Eastern Uganda (Mafabi, August 2007) and (People and Language Detail Report 2004). A number of organizations such as National Agricultural Research Organization (NARO), National Agricultural Advisory Services (NAADS) have made numerous interventions to strengthen agricultural enterprises in Mbale (Bagamba, Kikulwe, Tushemereirwe, Ngambeki, Muhangi, Kagezi, & Ragama, 2006 quoting Nangoti, Kayobyo & Rees, 2004). Additionally, financial institutions have invested in training owners and managers of agri-businesses in Mbale in effective record keeping and internal control and creating market linkages with the aim of boosting Agribusiness performance and maintaining Mbale as the food basket.

Despite these interventions, agricultural enterprises have been performing below expectations over a period of time. For example; to date, Bugisu Cooperative Union is perceived as not being creditworthy, its sales capacity dropped from 10,000 metric tons in 1980’s to 2,000 metric tons annually, employing only around 50 people from 1000 in the 1980’s (Kwapong, 2012). This trend may be attributed to structure and management as affirmed by Bukenya& Kinatta (2011) as the major reason for below expected performance among SMEs.

If this situation prevails, issues such as food insecurity and unemployment could soon throw the eastern region and the whole country into chaos that may result in serious economic and political uncertainties for the economy (DEMIS Consults Limited, 2010). It is for this reason that the researcher set out to find out the effect of internal controls on the performance of agricultural SMEs.

1.4 Purpose of the study

This study aimed at establishing the contribution of internal control systems towards the performance of agricultural SMEs in Eastern Uganda, with a case study of SMEs in Mbale district.

1.5 Objectives of the study

This study was guided by the following objectives:

1. To examine the extent to which assets control predicts the performance of agricultural SMEs in Mbale district;
2. To establish the extent to which financial control predicts the performance of agricultural SMEs in Mbale district;
3. To assess the extent to which compliance control predicts the performance of agricultural SMEs in Mbale district;

1.6 Research Questions

This research sought to answer the following questions:

1. How does assets control contribute to the performance of agricultural SMEs in Mbale district?
2. What is the relationship between financial control and performance of agricultural SMEs in Mbale district?
3. How does compliance control contribute to the performance of agricultural SMEs in Mbale district?

1.7 Hypotheses of the study

This study tested the hypotheses listed below:

There is a positive relationship between assets control and the performance of agricultural SMEs in Mbale district;

There is a positive relationship between financial control and the performance of agricultural SMEs in Mbale district;

There is a positive relationship between compliance control and the performance of agricultural SMEs in Mbale district.

1.8 Conceptual Framework

Figure 1: The conceptual framework diagram

Abbildung in dieser Leseprobe nicht enthalten

Source: Developed by the researcher, based on the literature of CPA Australia (2008), Internal controls for small business.

The conceptual framework is composed of the independent variable internal control systems with three constructs—assets control, financial control, and compliance control, and the dependent variable SME performance with two constructs-financial performance and product market performance. The framework suggests that the levels of assets control, financial control, and compliance control positively influence the performance of agricultural SMEs in Mbale District. The implication is that adequate assets control, financial control and compliance control bring about the efficient generation of profits, return on assets, and return on investment, sales and market shares among agricultural SMEs in Mbale District.

1.9 Significance of the study

This study highlights the importance of having a sound internal control system in SMEs and its major roles. This study emphasized on the fact that lack of appreciation of the value of effective internal control in agricultural SMEs will continue to cause poor performance. Therefore, by establishing the extent to which a sound internal control system may contribute to improved performance of SMEs, this study adds value to the efforts of having an efficient agricultural SME sector in Uganda.

This research provides the SME managers, researchers, and readers in general with knowledge of agricultural SMEs operations in Uganda; make available to Uganda policy makers, Ministry of Trade and Investments, information about current trends in the SME sector, which information helps in the improvement of the National SME policy and guidance in different areas of operations. The study findings also inform the National Agricultural Advisory Center Uganda and other agriculture programs on the status of agri-business performance in the country for better future planning. It is expected to stimulate further research on appropriate support programs and activities by the Ministry of Trade and Industry, to create more opportunities for the SME sector in Uganda.

The study helps the researcher to gain an in-depth discovery of the subject of internal control systems in relations with agricultural Small and Medium Organization.

1.10 Justification of the study

Amundo & Inanga (2009) points out that a proactive approach to the problems of SMEs failure require a critical analysis of existing internal control structures in organizations to determine their capacity to ensure that organizations’ activities are carried out in accordance with established goals, policies and procedures. This makes this study relevant in Uganda.

Furthermore, during the opening of the 5th Session of the 7th Uganda Parliament on June 7, 2005 the President of Uganda noted that the growth of SME sector is important as a tool for transitions in economic activity from agricultural sector to the industrial sector. Thus SMEs should be assisted to create and enhance efficient units that could support the policy of employment creation and “Bona bagagawale” program. That makes this study necessary because results from it will provide important support information for the support of SMEs.

Tushabomwe-Kazooba (2006) noted that Small businesses in Uganda are faced with a number of challenges that lead to business failure. Studies like this aimed at identifying and finding solutions to those problems faced by SMEs in Uganda so as to reduce on their failure rate. World Bank (2013) also recommends that support for agro-enterprises can be important to introduce innovation in the agriculture sector and to help establish new enterprise profitability, productivity and sustainability of agricultural sector. Kwapong& Korugyendo (2010) argue that the development of agricultural enterprises in Uganda is limited by inadequate research. This

Justifies the study through identifying the various problems faced by agricultural enterprises and finding solutions to such problems.

1.11 Scope of the study

Time scope

The study was conducted in July 2014 for a period of 4 weeks through a case study.

Conceptual scope

This study analyzed the relationship between internal control systems and performance of SMEs. The study endeavored to evaluate the relationship between specific control system components (Assets control, finance control and compliance control) and SME performance in terms of financial performance, and product market performance.

Geographical scope

The study was done on 124 SMEs’ Operations Officers, Finance Managers and other staff members of 12 registered SMEs, selected from Mbale Municipal Council and the neighborhoods.

1.12 Operational definitions

Control: This is the process of regulating agricultural SME’s activities so that actual performance conforms to expected standards and goals and ensures that necessary corrective action is taken.

System: An organized set of ideas and theories that guide a particular way of handling work processes including information sharing within an agricultural SME.

Performance: How well or badly an agricultural SME is meeting its obligations and competing on the market.

Small Enterprise: company or business organization whose primary goal is the creation of wealth and achieving financial profits, employing maximum 50 people, annual sales/revenue turnover of maximum 360 million shillings and total assets of maximum 360 million.

Medium Enterprise: company or business organization whose primary goal is the creation of wealth and achieving financial profits, employing more than 50 people, annual sales/revenue turnover of more than 360 million shillings and total assets of more than 360 million.

Agricultural SME: Any business falling under the definitions of a small or medium enterprise (As given above), engaged in the producing operations of a farm, or the manufacture and distribution of farm equipment, or supply, processing, storage and distribution of farm commodities.

In the subsequent paragraphs of the second chapter, the Agency Theory and concept identified to model the investigation of a relationship between internal controls and the performance of agricultural SMEs were analyzed in details. Previews related studies also were consulted in the quest to discover possible gaps, getting necessary information and ensure no duplication of work.

CHAPTER TWO LITERATURE REVIEW

2.1 Introduction

This chapter discussed the literature of internal control systems and the performance of agricultural SMEs in Uganda, with the case study of SMEs in Mbale district. The purpose of this study was to understand the contribution of internal control systems to the overall performance of SMEs in Uganda. The review was conceptualized under the objectives of the study and focuses mainly on assets control, financial control, as well as compliance control and how they affect the performance of SMEs.

2.2 Theoretical review

Modern Control theories in management originate from Cybernetics (theory of Communication and Control) by Norbert Weiner in 1948. McGarry (2008) observes that Cybernetics asserts that entropy is very common in systems and its increase causes systems to become less organized and eventually malfunction as long as there are no means of control that force a system to maintain the structure. Malik (2004) from the holistic system-oriented standpoint criticizes pure shareholder value orientation and education programs in business administration and argues that applying the laws, models and methods of management cybernetics, enables an organization to function more effective and efficiently.

The main weakness of cybernetics is that the position of the observer of the system (e.g. the organization) pre-defines how the system is observed. This problem of placing the observer in the center became the Achilles' heel of cybernetics, with the result that its wide acceptance and use have declined over time so that today it has limited application in organizational and management sciences.

The COSO model of internal control in organizations is another important control model. DiNapoli (2010) analyzes that the integrated internal control framework is made of five interrelated elements as identified by COSO; fostering a favourable control environment, conducting risk assessment, designing and implementing control activities in the form of policies and procedures, providing for effective communication throughout the organization, and conducting ongoing monitoring of the effectiveness of control-related policies and procedures.

However, Amundo& Inanga (2009) through their study on evaluation of internal control systems in Uganda contest that the COSO framework approach may be relevant to larger organizations, yet inappropriate for smaller ones due to costs and operational complexity.

Perhaps, the Agency Theory has a better set of concepts that relate to smaller organizational performance and control mechanisms. The Agency theory attempts to explain a relationship in which one party (the principal) delegates work to another (Agent) who performs the work according to a mutually agreed contract, yet both parties are self-interested with incongruent goals. The Agency Theory explains that an agent relationship is a contract under which one or more persons (the Principal) engage another person (s) (the Agent) to perform some service on their behalf, which involves delegating some decision-making authority to the Agent (Devos, Landeghem & Deschoolmeester, 2008).

Jensen & Meckling (1976) argue that if both parties to the relationship are utility maximizers, there is good reason to believe that the agent will not always act in the best interest of the principle. To counteract this, the Theory suggests among many solutions that information be treated as a commodity whereby it has a cost and it can be purchased. This gives an important role to formal systems such as budgeting, Management by Objectives, and Boards of Directors as the informal systems such as managerial supervision. The implication is that organization can invest in systems in order to control agent opportunism (Eisenhardt, 1989).

In this study, the Agency Theory assisted in explaining organizational control mechanisms that take into consideration risk behavior, information irregularities, and goal differences in order to determine how control orientation affects firm performance. The Agency Theory helped the study to explain the implied causes of poor performance among small agricultural enterprises and whether or not control mechanisms prevent those causes. The Agency theory was also used to predict how instituted internal control mechanisms serve to enhance information asymmetry thereby minimizing the agency costs incurred in solving the agency problem. This is so because according to the Agency Theory, those internal control mechanisms enable timely disclosure of vital information about the performance of a firm. Once the principal obtains vital information about the performance of his/her firm, the subsequent costs of mitigating the agency problem are considerably reduced (Shapiro, 2005).

Gomes-Mejia, Larraza-Kintana & Makri (2003) used the Agency Theory in research on the mechanisms used by owners to align Executives interests with those of the organization. The conclusion was that the best way of aligning employees’ interests with those of the principal is through formal monitoring and only when the cost of monitoring is high should a company consider alternatives to formal monitoring. However, in the case of the Executives, formal monitoring was found to be impossible, therefore executive compensation was highly recommended. Internal control systems in the context of the Agency Theory in this study was best conceptualized as assets control, financial control, and compliance control variable indicators, developed in the paragraphs below.

2.3 Conceptual Review

This study was conceptualized on the basis of two major notions explicitly “SMEs performance” as a dependent variable and “internal control systems” which is an independent variable. Firm performance is one of the major apprehensions of business owners. When a business is performing well and even beyond the expected, the owners find a reason to keep investing in it. Richard, Devinney, Yip & Johnson (2009) provide the most appropriate definition of performance for this study. Bin Dost, Ahmed, Shafi & Shaheem (2011) citing Richard et al. (2009) informs that organizational performance can be measured through three basic outcomes which are financial performance, product market performance, and return on investment. Based on the recommendations of the above scholars, this study investigated agricultural SMEs performance in terms of financial performance (profits, return on assets, and return on investment), and product market performance (sales, and market shares).

CPA Australia (2008) suggests four broad areas that may constitute SMEs internal control systems notably mechanisms for controlling all assets, a sound financial system, a keen interest in compliance with the environment, legal and regulatory systems, as well as supervisory and management.

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