What Is an External Control? Definition and Examples
Updated October 18, 2022
For businesses to function successfully, they require different types of controls and regulations to manage their operations and establish consistent standards. External controls are one aspect of governing an organization that all managers, business leaders and professionals within an industry consider when making choices about company policies and procedures. Learning about what external control is and how it influences business operations is useful for anyone interested in a leadership position or a role in a regulatory agency.
In this article, we review what external controls are, describe their importance, share how they work in different industries and share several examples to explain the concept.
What is an external control?
An external control is any sort of influence from outside of an organization that affects how it operates. External controls specifically focus on regulating on a company's governance policies, such as hiring policies and safety procedures. They include direct rules, such as government regulations, and indirect pressure, such as scrutiny from the media. An external control can change a business's internal policies, encourage an organization to comply with industry practices or influence the relationship between a company and its business partners.
Internal vs. external controls
Internal and external controls both influence the way a company regulates its business practices. Internal controls are the steps an organization takes to manage its own operations and create consistent outcomes in the workplace. These can include overall company values and best practices for accomplishing goals. For example, a company that values environmental sustainability uses that characteristic as an internal control when choosing business partners, suppliers and production methods.
Some internal controls are based on external controls. For example, if the government passes a law setting limits on certain financial transactions, a company may proactively hire an internal auditor to review its financial policies.
Why are external controls important?
External controls are important because they ensure that organizations are accountable for their actions and meet a certain standard of behavior. In several industries, external controls ensure that businesses provide employees with a healthy work environment and give consumers access to high-quality products. Here are some of the key reasons external controls exist:
Creating consistent industry standards: External controls strive to apply the same standard of performance and operational behavior for all businesses within an industry. They ensure that all companies in the same sector follow the same rules and use similar governance practices.
Improving work conditions: By adhering to external controls, organizations uphold conditions for their employees and regularly strive to improve the quality of life for their team members. External controls such as labor laws and federal regulations ensure that employees have access to safe conditions in the workplace.
Promoting transparency: Many external controls focus on transparency regarding how organizations operate and require companies to share information about their policies and governance. This gives consumers and members of the public details about the products and services they purchase.
Upholding corporate responsibility: External controls encourage organizations to be more responsible about how their operations influence their community and environment. This can lead to more inclusive hiring practices, more sustainable manufacturing procedures and other long-term operational benefits.
Who uses external controls?
Managers and business leaders use external controls to construct and update policies on their team. External controls are also important for anyone who works in a compliance role, because compliance professionals need to understand all relevant laws and regulations when determining if their team, department or project meets all necessary requirements. You can use external controls in any industry, but they're particularly important for professionals in these fields:
Finance and accounting
Human resources and labor
Construction and manufacturing
Healthcare and pharmaceuticals
You may also consider working in the field of regulatory affairs, where you create the external controls that influence how businesses operate. Both the people who create regulations and those who uphold internal compliance to external controls have important roles in creating industries with high standards for consumers and professionals.
Examples of external controls
Here are several types of external controls with an explanation of each:
One of the most direct types of external controls is government regulations and laws that influence how companies can operate. They're also highly effective because they have immediate consequences for businesses that don't comply. When an organization doesn't follow a government regulation for business operations, it may need to pay an expensive fine or follow an operational penalty. Government regulations cover any aspect of organizational governance, from employment practices to how the company advertises its products. Some examples of external government controls include:
Laws limiting the locations where oil companies can extract resources
Regulations regarding how companies can use and share data from customers
Tax code explaining how much businesses owe on different types of company earnings
Standards within an industry are another type of external control. Professional organizations can set their own regulations and expectations for how companies and professionals operate to achieve respect and renown in their industry. Some professional organizations have additional requirements and expectations for members to join, which raises the standard for success in that field. Industry groups may also lobby for laws and rules to change or create public pressure for certain companies to change their internal governance structures.
When companies release information, such as yearly financial reports, this information can act as an external control. Even the knowledge that information is eventually going to be public can encourage company leaders to make more responsible, ethical choices about their business. This can include sharing information within the company, submitting details to shareholders or releasing reports to the public. For example, some government regulations require businesses to release certain financial information to the public to uphold financial accountability.
Changes in leadership
If one company purchases another, a merger occurs or a business simply hires a new person in a leadership position, this can increase awareness of the organization's internal governance structure. In especially large, public companies, a change in leadership can also attract attention from the public and media to the company's business practices. Before a change in leadership, current company leaders may make adjustments to the governance structure to improve compliance or simply make the business more organized for the successor.
External controls can occur between business partners and departments through external audits. One company may hire an external auditor to review the business practices of a potential business partner before agreeing to a business relationship. This type of external control is common between retailers and suppliers or companies that want to ensure that they're doing business with companies that have ethical and sustainable governance practices.
Public perception and media coverage can also influence an organization's internal policies and operational procedures. Investigative journalists may report on an issue within a company and use pressure from the public to encourage company leaders to change their policies. Social values and changing opinions can also cause businesses to adapt their values and adjust their practices so they can appeal to their target audience.
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