Transferability of Chinese Human Resource Management Practices in Bangladesh: A Case Study

Academy of Taiwan Business Management Review 1

Relationship of Osmosis: Rise of Emirates, The Airline and Dubai, The City

Dr. Achinto Roy, Deakin University, Australia

ABSTRACT A relationship of economic osmosis is noticed between an airline and the country whose flag it

flies. Economic impact studies prepared by government organisations and airline managements usually point out the economic benefits of setting up a new airline or flying a new route. These benefits arise for the airline’s home base by way of greater connectivity with the world and include a number of tangibles such as growth in tourism, increase in retail revenue from transit passengers, access to cargo transport for importers and exporters, employment opportunities and a host of indirect benefits that the local populace can gain from exposure to other countries and cultures. One also notices two very important intangibles associated with an airline and the nation of origin- national pride and national security. This paper analyses the remarkable success story of mutual growth shared by Emirates, the airline and Dubai, the city, over the past twenty-five years and the opportunities that the success of this duo signifies for others in the region.

INTRODUCTION Success or failure of a nation’s flag carrier is usually perceived as an issue of national pride. This

is perhaps one of the key reasons why many governments in different parts of the world have undertaken government bailout of national flag carriers from financial crisis and near bankruptcy. Coupled with the much publicised national pride exists the underlying issue of self-interest in keeping alive the airline that flies the national flag. Primarily, it is to provide the nation access to global business opportunities and stimulate internal economic growth as well as to prevent foreign airlines from gaining uncontrolled access to one’s home skies. Regardless of these objectives, the airline industry is a rigorously competitive arena where Darwin’s law of survival of the fittest operates with a vengeance and consistent commercial success year after year of operation is never assured.

During the past decade, under competitive pressures, the airline industry witnessed the introduction of budget, no frills airlines in every major continent of the world including the Middle-East. In this competitive scenario, the growth and consistent profitability of Emirates as a full service premium airline is a remarkable success story built on a relationship of osmosis between Dubai, the city and Emirates, the airline; made possible by the vision of a dedicated management team that continues to work with the airline even after a quarter of a century.1

Today, Emirates is a global airline of repute flying a very young fleet of 1472 aircraft to over 100 destinations in all six continents and Dubai a much visited transit cum tourist destination. The Emirates- Dubai combination represents the growth opportunities for an airline-transit hub osmosis strategy which both Qatar Airways and Etihad Airways in the region are attempting to emulate. The Emirates-Dubai story also represents the many challenges that one faces in the airline industry, especially when one poses a serious competitive threat to other established players on their home territory. This paper analyses the Emirates and Dubai duo as an excellent case study of a small airline and a port city that grew into a global airline-transit hub combine of significance in 25 years. The geographical location of Dubai has helped Emirates create a global air transit hub from where one can fly to all six continents non-stop. The first section of this paper traces the history and rise of Emirates, followed by an analysis of the success factors behind Emirates and the relationship of osmosis with Dubai in section two. The third section discusses some of the challenges that Emirates has encountered followed by the concluding section that briefly touches on what the future may hold for airline-transit hubs in the region.

FORMATION AND RISE OF EMIRATES It all started when Gulf Air, the then leading airline in the middle-east decided to cut back its

services to and from Dubai International Airport where 25 other airlines operated. Gulf Air did this largely because it felt that it was acting as a feeder airline for other rival airlines operating out of Dubai airport to European destinations, thus aiding and benefiting its own competition. Gulf Air was owned by a consortium of four nations, namely, Abu Dhabi, Bahrain (headquarters), Sultanate of Oman and Qatar. Gulf Air’s decision to withdraw its services from Dubai acted as a catalyst for the 1 Emirates started out in 1985 and still have with them Maurice Flanagan, KBE as founding CEO (now the Executive Vice

Chairman), Tim Clark (now President) and HH Sheikh Ahmed Bin Saeed Al Maktoum, Chairman of Emirates. 2 Emirates to hire 700 pilots over next 18 months, Gulf News, 4 June,2010 at http://gulfnews.com/business/

aviation/emirates-to-hire-700-pilots-over-next-18-months-1.636488 accessed on 14/01/11

2 Academy of Taiwan Business Management Review

creation of Emirates as it prompted Dubai’s ruler to back the launching of a Dubai based airline. Emirates, the airline, was thus born in 1985 with a capital of USD 10 million and two wet leased aircraft, namely a Boeing 737, an Airbus 300 B4 leased from Pakistan International Airlines and another two Boeing 727s loaned by Dubai’s royal family from Dubai Air wing. The airlines’ maiden flight, EK 600 took off on 25th October, 1985 from Dubai to Karachi, Pakistan but Emirates was forced to fly 80 of its staff incognito in order to cover up a dismal sale of tickets and avoid a public relations disaster.3 The airline initially operated flights to three destinations, namely Karachi, Bombay (now Mumbai) and New Delhi. During its first year of operation, Emirates carried 260,000 passengers and 10,000 tons of freight taking away business from its rival Gulf Air whose revenues dropped by 30%.4 Emirates posted a modest profit in its very first year of operations and decided to expand and invest in infrastructure.

The following year, Emirates posted a loss due to investments in infrastructure but grew its flight network to Amman, Colombo, Cairo and Dhaka. 5 In 1987, Emirates took delivery of its first purchased aircraft from Airbus fitted to its own specifications designed to enhance passenger comfort and deliver a superior customer flying experience over its rivals.6 Consistent increases in revenue, profits, passengers flown and cargo carried, occurred over the next few years. Emirates doubled the number of destinations flown to, every year between the years 1989 and 1991 (Monteiro, 2005:37). Thus, within six years of operation, Emirates was flying via Dubai 25000 passengers per week to 23 destinations and had acquired nine aircraft.7

Both Kuwait wars in 1990 and 1991 provided an opportunity for Emirates to go against the industry trend. Every other airline had grounded or reduced flights in the region, while some regional airlines suffered losses as a result. Emirates continued to fly retaining 90% of its services except for a few hours in 1991 when the liberation war for Kuwait began.8 The airline continued to make profits throughout these times when others suffered losses and expanded by placing orders for seven Boeing 777s (Birtles, 1998:75) in 1991.

Later in 1992, Emirates acquired an exclusive terminal for its use at Dubai International airport and became the first airline to order a USD 20 million full flight simulator from Airbus for training purposes. The airline also introduced some notable industry firsts in the areas of customer service in order to achieve superior service in the field over its rivals. In flight personal video systems for passengers in all classes, telecommunications in all three classes and on flight fax facility were introduced. Perhaps in recognition of superior customer service and innovative facilities provided by Emirates, the airline won the “Executive Travel Airline of the year” award in 1994. This was very encouraging for Emirates as it meant recognition in the business class passenger segment was a landmark achievement as no other Middle-Eastern airline had received this award before.

Celebrating its 10th anniversary in business, Emirates acquired the Emirates Aviation College, previously owned by the Dubai Civil Aviation Authority, and expanded its services to Africa by flying to Johannesburg and Nairobi in addition to 34 other destinations in Europe, Far East and the Middle-East.9 By 1998, Emirates had flown 3.7 million passengers, increased its capacity by 26% over previous years and carried 200,000 tonnes of cargo, largely using Dubai as the transit point. In recognition of its superior customer service and innovative approach to service delivery, the airline was voted as the ‘World’s Best Airline’ at the OAG awards.10

In 2001, Emirates placed the largest order for aircraft in the history of the aviation industry. The airline ordered 58 new aircraft (mix of Airbus and Boeings) at a contract price of USD 15 billion.11 This was followed in 2005 by the largest ever order for Boeing 777s worth USD 9.7 billion for 42 aircraft12 and a historic civil aviation order for 120 Airbus A350s, 11 A380s and 12 Boeing 777- 300ERs in November 2007 estimated to be worth USD 34.9 billion per list prices.

Simultaneously, the Emirates-Dubai combination sought recognition in global markets not only through the introduction of new destinations via Dubai but also brand associations with high profile international events through sponsorships. Currently, some prominent sponsorship associations are: FIFA World Cup, Rugby Union World Cup 2011, ICC World Cup 2011, Cricket Australia, Emirates Team New Zealand, 15 International Golf Tournaments, equestrian events such as the Melbourne Cup, Singapore Derby and the Dubai World Cup, Auto racing, Tennis, Arts and Culture.13

3 http://www.theemiratesgroup.com/english/our-company/our-history.aspx#y1985 accessed on 8/01/11 4 http://www.referenceforbusiness.com/history2/10/The-Emirates-Group.htmlReference for Business accessed on 7/01/11 5 http://www.theemiratesgroup.com/english/our-company/our-history.aspx#y1959 accessed on 8/01/11 6 Ibid. 7 Ibid. 8 Ibid 9 http://www.theemiratesgroup.com/english/our-company/our-history.aspx#y1985 accessed on 17/01/11 10 Ibid 11 http://www.emirates.com/english/about/about_emirates.aspx accessed on 14/01/11 12 Ibid 13 http://www.emirates.com/english/about/sponsorships/sponsorships.aspx accessed on 14/01/11


Currently, Emirates flies 1118 flights per week out of Dubai to all six continents14 and is considered amongst the top ten airlines15 in the world. The airline has won over 400 awards16 during the past 25 years and is amongst the most awarded airlines on a number of counts by a range of rating agencies. The airline has a fleet of 14717 aircraft flying to over 100 destinations in 60 countries, employing 30,000 people of 100 different nationalities. For the year ended March 31, 2010, Emirates earned a net income of USD 964 million18 with annual revenues of over USD 6 billion. In 2010, Emirates carried 27.5 million passengers with 78% percent seat load factor.19 The airline is reported to be the fastest growing airline in the world today20 and has grown at an average rate of 20% for some years returning profits every year since its inception except for a financial loss in 1986. The global financial crisis appears to have had very little impact on either its ambitions or financial performance beating the global aviation industry trend where a number of international airlines such as Lufthansa and British Airways are losing money and curtailing operations.

DUBAI AND EMIRATES:A RELATIONSHIP OF ECONOMIC OSMOSIS Perhaps national pride prompted Dubai to launch Emirates when Gulf Air withdrew services but

this had an economic logic of ensuring that Dubai’s trade links with the world did not suffer. Taking into consideration the relationship between Dubai the city state and Emirates the airline, the success of Emirates as a global and a consistently profitable airline can be attributed to a great extent to its location in Dubai, among other factors. The airline has adopted the hub and spoke strategy with Dubai as the central hub where all flights arrive and disembark passengers and then those passengers catch flights to go their respective destinations or spend a few days exploring Dubai before they again fly out to their actual destination. The hub and spoke strategy, if executed correctly, has the potential to bring in tourism and retail spending at the central hub i.e. Dubai in this case.

The downside to this strategy is the amount of aircraft waiting time for the airline (can lead to increase in airport ground costs and lower aircraft utilization rates as most airports have night restrictions on flying in) due to delay in the arrival of connecting flights. This is a significant disadvantage as aircraft utilization rates can be lower pushing up operational costs as compared to a point to point flight (directly flying to the destination without a change-over to another flight). However, in case of Emirates, the airline also achieved one of the highest aircraft utilization rates in the industry at 18 hours per day as there are no night flight restrictions at Dubai International airport, thus overcoming the only major disadvantage of the hub and spoke strategy. Currently Emirates flies non-stop to all six continents from a single hub, i.e. Dubai demonstrating successful of the hub and spoke strategy to grow the duo of Dubai and Emirates.

Paul Griffiths, CEO of Dubai Airports believes that Dubai has a number of distinct advantages that will ensure Dubai International airport’s growth in the future (and thus the growth of Emirates). According to Griffiths, “Dubai’s location, which puts it just four hours flying time from one-third of the world’s population and 12 hours from 80 per cent of the population; an open skies policy that welcomes competition, top notch infrastructure and compelling tourist attractions”21 will help both keep growing. Thus, Dubai as the central hub for the airline has undoubtedly helped Emirates expand air services to areas of heavy passenger traffic in Asia, Europe and Africa as well as launch onward connections to United States and far off destinations such as Australia and New Zealand. The phenomenal growth of Emirates has created a relationship of osmosis between the airline and the continuous expansion of airport facilities at Dubai. Brand Emirates is also linked to “brand Dubai” as a tourism destination. Dubai boasts of the world’s largest duty free shopping and an unsurpassable retail experience, among other attractions. In addition, the airline has one of the youngest fleet of wide bodied, long haul aircraft that can carry up to 500 passengers contributing to a lower per passenger-per mile costs with a very healthy 78% seat loading factor (seat occupancy). Emirates enjoys access to exclusive parking and maintenance facilities at its own terminals at Dubai Airport. The airline significantly benefits from Dubai being a tax free emirate and a place where trade unionism is not permitted- all of which contribute to the airlines profitability.

14 http://www.emirates.com/english/about/about_emirates.aspx accessed on 14/01/11 15 http://www.worldairlineawards.com/main/2010Awards.htm accessed on 14/01/11 16 A list of all awards that Emirates has received can be accessed at http://www.emirates.com/english/about/awards/awards.

aspx (accessed on 17/01/11 17 Emirates to hire 700 pilots over next 18 months, Gulf News, 4 June,2010 at http://gulfnews.com/business/aviation/

emirates-to-hire-700-pilots-over-next-18-months-1.636488 accessed on 14/01/11 18 Emirates Annual Profit to beat last year’s CEO says (update 1), 7 June 2010 at http://www.businessweek.com/news/

2010-06-07/emirates-annual-profit-to-beat-last-year-s-ceo-says-update1-.html accessed on 14/01/11 19 ‘Rulers of the New Silk Road’, The Economist, 3 June, 2010 from http://www.economist.com/node/16271573 accessed

on 12/01/11 20 There are several other airlines who claim to be the fastest growing airlines in the world such as Etihad Airways, Qatar

Airways, Easy Jet and Ryan Air. 21 “Dubai International on course to become fastest growing major international airport” http://www.dubaiairport.com/

DubaiAirports/English/Media+Center/Press+Release/DANews13Jan10.htm accessed on 13/01/11


Dubai, too, benefits from the presence of Emirates in a big way. In 2008, Dubai International airport was refurbished and a new Terminal was opened for the exclusive use of Emirates. This contributed to 9.2% growth in passenger traffic during 200922 at Dubai International airport contrary to the downtrend in passenger traffic elsewhere due to the global financial crisis. The airline’s promotion of Dubai as not just a stopover point but also a holiday destination through its “Discover Dubai” promotions further contributed to this growth. If one reviews growth in passenger capacity of Dubai airport since 1974 to 2010, one notices an unrelenting growth and a positive correlation between the growth of Dubai airport passenger capacity and Emirates’ expansion of services.23

In 2010, Dubai opened the first phase of a second international airport i.e. Dubai World Central-Al Maktoum International airport. When both international airports in Dubai start operating by 2012, Dubai will have the capacity to handle more than 90 million passengers. This shall exceed the combined capacities of London’s Heathrow and Paris’s Charles De Gaulle airports. In 2010, Dubai International airport experienced a 15% growth of transit traffic passing through Dubai. The airport authorities expect to receive 4 million passengers every month in 201124. Therefore, Dubai already competes very successfully with rival transit hubs such as Singapore, Bangkok, Kuala Lumpur and Seoul and is likely to challenge other transit hubs in Europe especially in case of travellers flying to USA or Latin America from Asia and Australasia.

THE CHALLENGES Emirates faced some challenging times after September 11, 2001. With the downtrend in global

air travel, rising security costs many major airlines faced financial trouble. Swiss Air closed business while three major US airlines (Delta, United and US Airways) reduced staff and faced near bankruptcy. British Airways launched a major cost cutting initiative while Air France and Lufthansa scaled down their growth prospects (Monteiro, 2005: 39). Most airlines started reducing employees, cutting down operational costs and routes; but Emirates decided to do take steps contrary to the norm of announcing redundancies. HH Sheik Ahmed sent out an email to all Emirates employees telling them (as cited in Monteiro, 2005: 39) “We are a family, and I want to address you as the head of the family. I want to reassure you that your safety and well-being is our paramount concern. My message is that this is the time to prove that Emirates Group really is the best multinational team in the travel business. Show respect to each other, and we will emerge an even stronger team.” The airline industry had barely emerged from the aftermath of September 11, when it was again hit by a substantial increase in oil prices in 2004 and once again in 2008-9 by the global financial crisis. The last decade has been the most challenging for the airline industry worldwide. It is estimated that post 9/11 worldwide the airline industry has lost around USD 50 billion (Falconer 2010). Contrast this depressing scenario with the phenomenal growth of Emirates, the airline and passenger traffic at Dubai during the same period. Essentially, it speaks of the airline’s ability to overcome challenges thrown by shifting conditions in the global business environment. Although Emirates has overcome the hurdles experienced by the airline industry in the past decade, it still faces challenges in expanding operations. In recent times Emirates has faced opposition in expanding its network to Canada and obtaining landing slots at the new airport in Berlin, Germany. Canadian newspapers have reported that Emirates was in negotiations with Air Canada during 2006 to fly into Toronto and other Canadian airports but business terms did not work out between the two airlines.25 Possibly, as a result, the present Canadian government has denied Emirates landing rights for additional flights that Emirates had proposed for Canada.26 In Germany, Lufthansa has accused Emirates of gaining an unfair advantage in its services to Germany stating that Emirates flies into four German cities while Lufthansa flies to only one city i.e. Dubai. Lufthansa has also approached the German government to deny additional landing slots to Emirates at the new airport in Berlin approaching completion.27

22 “Dubai International on course to become fastest growing major international airport” http://www.dubaiairport.com/

DubaiAirports/English/Media+Center/Press+Release/DANews13Jan10.htm accessed on 13/01/11 23 “Dubai International celebrates 50 years of growth: Airport transformed from humble airstrip to leading global aviation

hub” at http://www.dubaiairport.com/DubaiAirports/English/Media+Center/Press+Release/Dubai+International+ Celebrates+50+years+of+Growth.htm accessed on 17/01/11

24 Dubai International’s traffic surges 15% in November at http://www.dubaiairport.com/DubaiAirports/English/Media+ Center/Press+Release/Dubai+International+passenger+traffic+surges+15+per+cent+in+November.htm accessed on 18/01/11

25 ‘Air Canada proposed Emirates deal in 2006:documents’ at http://www.theglobeandmail.com/news/politics/air-canada-proposed-emirates-deal-in-2006-documents/article1868756/ accessed on 18/01/11

26 ‘Air Canada proposed Emirates deal in 2006: documents at http://www.theglobeandmail.com/news/politics/air-canada-proposed-emirates-deal-in-2006-documents/article1868756/

27 ‘Emirates fires at Lufthansa in battle over Berlin slots’ , at http://www.thenational.ae/business/aviation/emirates-fires-at-lufthansa-in-battle-over-berlin-slots accessed on 18/01/11


EMIRATES AND DUBAI:FLYING INTO THE FUTUE The airline industry in the Middle East has two entrants who are working towards emulating the

Emirates-Dubai success story, namely Etihad Airways from neighbouring Abu Dhabi as the central hub and Qatar Airways from Doha, Qatar as the central hub. All three airlines have ordered large numbers of aircraft from both Boeing and Airbus at a point in time when most airlines are not placing large orders. In 2008, Abu Dhabi’s Etihad Airways placed a massive order of 205 aircraft worth USD 43 billion at list prices with Boeing and Airbus,28 while Qatar Airways had 140 aircraft on order in 2007.29 Emirates also are not lagging behind these two. In June 2010 the airline ordered additional 32 Airbus A 380s at a cost of USD 11.5 billion making it the single largest order ever for that aircraft.30 Again in July 2010 at the Farnborough Air show, UK, Emirates placed orders for 40 new Boeing 777s at a cost of USD 9 billion. This turned out to be the single largest order at the show where the combined dollar value of all orders amounted to USD 25 billion.31 Between the three airlines, the next decade will see an addition of substantial number of aircraft. Assuming that some of those will be used to replace old aircraft in case of Emirates, the region will have still added substantial capacity.

Coupled with these massive orders for aircraft, if one reviews the airport expansion plans and developments taking place in Abu Dhabi, Dubai and Qatar, a very interesting picture emerges. For instance, a new airport is being built in Doha to ultimately handle 50 million passengers, two million tonnes of cargo and 320,000 landings and takeoffs each year from 2015 onwards.32 Add to this the developments at Dubai and Abu Dhabi and one can visualise the Middle-East as the ultimate central hub for all air travellers crossing the date line from either side. As a result, Europe may lose its importance as a transit hub for air travel to North America in particular.

All these developments certainly augur well for the region. However, the outcomes will also depend on how competition evolves in the region and whether each of these three airlines and their respective central hubs reach a certain level of resource similarity. If they do reach similar levels of resources then applying the logic in Chen (1996) firms with high degree of resource similarity will engage in similar competitive actions. Likewise market commonality as defined in Chen (1996) will also apply in this case. It will also have a significant bearing on the intensity of rivalry and therefore the nature of competitive actions these airlines will engage in. Since all three airlines will be catering to common markets at a certain point in time and all three will have similar resource capabilities, it is expected that they will not compete with each other but end up cooperating with each other.

REFERENCES Birtles, P. (1998:75) Boeing 777: Jetliner for a New Century, MBI Publishing Co., USA. Chen, M. (1996), Competitor Analysis and Inter-firm rivalry: Towards a theoretical integration, Academy of Management Review, 21: 100-134. Falconer, T. (2010) Emirates’ Airlines Profits soars, Wall Street Journal, November 1, 2010 Monteiro, F. (2005) Hub of the World, Business Strategy Review: Spring 2005, pp.35-40

28http://www.etihadairways.com/sites/etihad/ae/en/aboutetihad/mediacenter/newslisting/newsdetails/Pages/Etihadplacesor

derforupto205aircraft.aspx accessed on 18/01/11 29 http://www.qatarairways.com/global/en/our-fleet.html accessed on 18/01/11 30 http://gulfnews.com/business/aviation/emirates-stuns-industry-with-11-5b-a380-order-1.638357 accessed on 18/01/11 31 http://www.economist.com/node/16634898?story_id=16634898 accessed on 9/01/11 31 http://www.airport-technology.com/projects/doha accessed on 18/01/11


Do Managerial Characteristics Promote Export Development? A Case of Manufacturing Small and Medium Enterprises in Indonesia

Rita R. Pidani, Amir Mahmood and Frank Agbola

Newcastle Business School, Faculty of Business and Law The University of Newcastle, Australia

ABSTRACT This paper examines the extent to which the managerial characteristics of small and

medium-sized enterprises (SMEs) in the manufacturing sector impact on export development in Indonesia. Utilising descriptive and inferential statistics techniques, we find that differences exist between exporting and non-exporting firms in relation to the managerial characteristics of education level, foreign language ability and international business experience. The findings indicate that a manager’s educational attainment, foreign language skills, and international business experience have a significant impact on the export development of the firm. The implication of the findings is that the Indonesian government should pursue policies aimed at encouraging training and improving language skills of managers, as well as promoting international business experience of managers, as these policies are capable of enhancing the export competitiveness of manufacturing small and medium enterprises in Indonesia

INTRODUCTION In the last two decades small and medium-sized enterprises have played a critical role as an

engine of growth in both developed and developing countries. SMEs productive capacity contributes to increased exports, they serve as subcontractors for a variety of input utilised by large-scale businesses and provide a source of innovation. Their ability to adapt quickly to changes and to identify market niches has placed them in a key position within the labour market. Their flexibility to the shifting economic structure of a country has also allowed them to play a major role in removing regional and sector imbalances in the economy. An economy that meets the needs of its SMEs enhances the chances of job growth which then translates into a vibrant economy (Urata, 2002; UNESCAP, 2009). In particular, in developing countries, where large government enterprises are downsizing in response to the changing global economy (WTO, 2009), the creation of a healthy business environment to help support small and medium businesses will, in turn, help with the retention of skilled workers. It is, therefore, pertinent to understand the operation of SMEs and establish effective support systems to help boost growth within these enterprises.

In Indonesia, the SMEs’ role in economic and social development has been a subject of empirical research (see for example, Soesastro and Basri, 2005; Tambunan, 2007; Wengel and Rodrigues, 2006; Thee, 2006). Their importance is often associated with the government’s efforts to eliminate the imbalances caused by the uneven process of development between urban and rural areas. Although the majority of Indonesian small enterprises do not evolve from small to medium to large enterprises (Liedholm and Mead, 1999), most SMEs have achieved considerable growth while maintaining their size thus retaining their fairly stable share of employment during volatile economic periods (Wengel and Rodriguez, 2006). Despite the domination of large enterprises (hereafter LEs) in the past, the recent priority of Indonesian government policies has shifted to that of SMEs due to the growing evidence of the importance of SMEs as a source of income and employment and their ability to serve as a catalyst to reduce poverty as well as the trade deficit in the country.

According to the Indonesian Ministry of Co-operative and SMEs (hereafter MOCSME), the contribution of SMEs (excluding micro-enterprises) to the total GDP was nearly 25 per cent in 2010 (MOCSME, 2012). The number of persons employed by SMEs stood at around 6.4 million which was almost three times larger than that of large enterprises (hereafter LEs) in the same year. The contribution of SMEs to export was estimated to be 15 per cent compared to 84 per cent of LEs in 2010 (MOCSME, 2012). The narrowing gap between SMEs and LEs’ contributions to GDP and export shares is seen as both a threat and an opportunity by exporters and non-exporters alike. The Indonesian government through its MOCSME and National Agency for Export Development (hereafter NAFED) has introduced various schemes and programs aimed at increasing SMEs’ export performance in the global market. These initiatives are expected to also scaffold the Indonesian government trade policy reforms that are aimed at transforming the government’s import-substituting pattern of industrialisation during the oil boom era of the 1970s to an export-oriented one today (Thee, 2006).

Arguably, a shift from reliance on the oil and gas sectors to other sectors of the economy, particularly the manufacturing sector, would create confidence among entrepreneurs and investors thereby stimulating non-oil exports to offset the decline in tax revenue derived from oil exports. To most Indonesian SMEs, however, achieving productivity and export operation remain challenging tasks and their realization, to a large degree, falls back on the characteristics of individual firm.


Studies of SMEs and their problems have concluded that both managerial and organisational physiognomies of SMEs require identification and quantification in order to address their difficulties and weaknesses in order to close the productivity gap between themselves and larger businesses and to equip corporate and public policy makers with strategic information in formulating and implementing effective promotion programs.

The purpose of this study is to identify the characteristics of Indonesian SMEs and assess their importance, particularly in the manufacturing industry. The rest of the paper is divided into three sections. The next section provides an overview of recent developments of Indonesian manufacturing SMEs. This is followed by a discussion of the managerial characteristics of SME manufacturers and how this impacts on export development in Indonesia. Finally, we summarise key findings of the study and make some policy recommendations for improving export competitiveness of SME manufacturers in Indonesia.

SMALL AND MEDIUM ENTERPRISES IN INDONESIA: AN OVERVIEW The roles of SMEs in the Indonesian economy are aligned with the primary goal of addressing

unemployment and income inequality. Recent statistics from the Ministry of Cooperative and Small and Medium Enterprises in Indonesia has shown that small enterprise establishments, including micro enterprises, amounted to 47,007,000 units in 2005, and increased by 14 per cent to 53,781,000 units in 2010 (MOCSME, 2012) (see Table 1). This strong growth has provided a positive impact on employment opportunities especially for women and the young. According to MOCSME (2012), the number of people employed in SMEs is larger than the number employed in large enterprises. In 2000, for example, SMEs’ contribution was 5,169,329 employed persons. This number increased by 24 per cent or 6,387,016 people in 2010, In contrast to the number employed in large enterprises which only increased by 6 per cent and absorbed 2,839,711 people in 2010.

Table 1: Total Units of Enterprises by Size (by Employment Category in Thousand), 2005-2010 Size Category 2005 2006 2007 2008 2009 2010

MSEsa 47,007 48,985 50,108 51,369 52,723 53,781 MEsb 35.5 36.8 38.3 39.7 41.1 42.6 LEsc 6.8 4.6 4,5 4.7 4.7 4,8

Notes: a= Micro and Small enterprises; b = Medium enterprises; c = Large enterprises. Source: MOCSME (2012).

Table 1 illustrates the dominance of SMEs in the Indonesian industrial structure. SMEs share of the number of establishments consistently stood at more than ninety per cent during 2005-2010. Their larger share of employment and larger number of establishments has also been significant in improving their share of trade in the economy. According to the Indonesian Ministry of Industry and Trade (hereafter MIT), SMEs’ trade value had increased by an average of five per cent during the same period (MIT, 2011).

Although SMEs employ a large number of people in Indonesia, their low productivity compared to that of large enterprises poses a great challenge to the industry. It is estimated that labour productivity by large enterprises is about five times that of SMEs in Indonesia, thus demonstrating a considerable gap in productivity across enterprises on the basis of size (MOCSME, 2009). In response to this productivity gap, the Indonesian “New Order Era” government has implemented various schemes aimed at providing assistance to SMEs to overcome the constraints faced by the industry, the most notable being access to finance and poor managerial and marketing skills of SMEs. As well, attention is being paid to the low level of technology adoption and innovation by SMEs (Thee, 2006). These government initiatives are expected to boost SMEs’ productivity, create employment and redistribute income throughout the nation-states (Hill, 2001). It is important to note that most of these assistance programs have undergone a series of reviews given that they have often failed to achieve the intended outcomes. Thee (2006) attributes the failure of government programs to the lack of coordination between agencies in charge of SME programs, poor program design, and inadequate monitoring and evaluation. In 1990, as part of the reform process in response to a high default rate (which was more than 27 per cent) and debt collection problems, the financial assistance programs introduced by the Indonesian government, such as the Kredit Industri Kecil (KIK) or Credit for Small Investment and Kredit Modal Kerja Permanen (KMKP) or Credit for Permanent Working Capital, were replaced by non-subsidised KUK (Credit for Small Business) (Thee, 2006).

Despite the unsatisfactory outcomes of assistance programs and the outstanding growth of large-scale manufacturing in exports, the role of SMEs remains crucial for sustaining the economic growth and development of economies in the developing world. One of the key reasons for the continued policy focus on SMEs is their ability to exploit market niches that are not in the commercial interest or are not within the technological interest of larger firms (Hill, 1995b). Another reason for an emphasis on SMEs is their low import requirements and less reliance on formal credit (Wengel and Rodriguez, 2006). The clustering feature of manufacturing SMEs, particularly in densely populated regions, such as Java, a region which has the highest concentration of SMEs in Indonesia, has enabled the sector to exploit agglomeration economies (Berry et al., 2001).


In recent times, the Indonesian government’s demand-driven and export market-oriented policy has enhanced the export performance of SMEs. Although there are still a number of internal factors that complicate the economic reforms in the SME sector, the schemes introduced by the Indonesian government aimed at stimulating further entry and participation of SMEs in the export market, has pushed the SMEs in Indonesia to the international stage and enabled greater competitiveness. In the last two decades, the world has witnessed massive growth in global trade from a mere forty billion US dollars in 1945 to more than twelve trillion in 2009 (WTO, 2010). This growth, and more recently the volatile global economy, necessitates an understanding of the managerial characteristics of manufacturing SMEs, and how these characteristics can be enhanced to achieve greater export competitiveness of SMEs in Indonesia. This study seeks to achieve this by investigating interrelationships between managerial characteristics and export development of manufacturing SMEs in Indonesia.

METHOD Participants and Procedure

For the purpose of this study, companies were chosen based on a list compiled by the Indonesian National Agency for Export Development Program (NAFED) in 2007 and the 2007 Indonesian Yellow Pages. Any duplication in the listings was noted and deleted to avoid double counting and to arrive at a complete list of SMEs from three selected industries. The sample population in this study consists of small and medium sized firms dealing in exportable manufactured products. The three types of industries examined are garments and footwear, furniture and wood products. The main reason for targeting these industries is because most of the small and medium sized firms involved in exporting in Indonesia fall under these three industries (Berry et al. 2001). These industries can also be generalized as light industries or consumer goods industries which can offer a better platform for export initiation, particularly in the context of developing countries (Ibeh and Young, 2001; Tybout, 2000; and Wade, 2003). A questionnaire was administered in early 2008. Given that there were 816 registered SMEs in Indonesia in these categories, utilising Cochran’s (1963) method, the sufficient sample size was estimated to be 261. Based on this estimate, this study aimed at interviewing 262 exporting and non-exporting firms. However, due to a non-response rate which was about 54.6 per cent in this case, of the 435 invited exporters and non-exporters, only 204 of them agreed to participate in the survey. Ultimately, the study consisted of a sample of 197 manufacturing SMEs in Indonesia, after discarding 7 incomplete questionnaires. The above non-response rate is consistent with personally administered questionnaires that range between 60 and 50 per cent (Groves, 1989; Ornstein, 1998; Massey et al. 1997). Analysis

To understand the importance and characteristics of Indonesian SMEs, we used descriptive and inferential statistics to describe the distribution of the data in the study. By using graphical analysis we present a quantitative description of a set of observations that highlight the characteristics of managers in manufacturing SMEs and their interrelationships with export development in Indonesia. For testing significant differences between the groups, we used the implied correlation matrix. In this study, we investigated the significant differences that exist between exporters and non-exporters and across different sub-sectors and levels of export development using crosstab, chi-square test, the t-test and Mann-Whitney U test. We also performed the Levene test for equality of variances to ensure that homogeneity of variance assumption was not violated.

RESULTS Sub-sector Characteristics of Manufacturing SMEs

The sub-sector shares of manufacturing SMEs in Indonesia are reported in Figure 1. Of the 197 firms surveyed, 80 firms or 41 per cent are from furniture and wood products, 60 firms or 30 per cent are from garments, and 57 firms or 29 per cent belong to the footwear sub-sector. SMEs from furniture and wood products were apparently more willing to participate in the survey compared to garment and footwear which led to its larger sample composition than the other two sub-sectors.

Figure 1: Sub-sector Distribution of Manufacturing SMEs in Indonesia

Source: Derived from survey data.


Export development within each of the sub-sectors in the manufacturing industry is shown in Figure 2. Figure 2 shows that the majority of exporters are in the furniture and wood products sub-sector. Most of the non-exporters are in the garment and footwear sub-sectors. The furniture and wood products subsectors experienced a strong revival in the 1970s and rapidly penetrated the global market during the 1980s and 1990s, leading to an intense process of local industrial expansion, a strengthening of inter-firm relationships of production, increasing sales and an outsourcing of skilled carving work within SMEs clusters. Thus, although furniture and wood product exports experienced a decline by the late 1990s as more countries entered into this promising and profitable area of trade, this sector is still able to maintain its export share. Various government schemes aimed at promoting value-added exports of furniture and wood products have developed this sector’s capability of attracting investment to itself as well as to the relatively unregulated forest sector. This in turn has also encouraged the use of non-wood materials and other alternative materials from waste wood or plantation crops (IMI, 2009). Therefore, although timber supply from clearing of conversion forests is scheduled to decline markedly by 2010 (FAO 1998; ITTO, 1997), the furniture and wood products sub-sector will still be able to accommodate to market conditions by improving quality control and superior design; meeting international environment standards; and enhancing its marketing effort in international markets (Aswicahyono & Hill, 2004). Furthermore, despite the fierce competition from countries such as China, Malaysia and Vietnam, Indonesian furniture and wood products are able to maintain their competitive characteristics by producing tropical hard-wood products with unique carving designs (IMI, 2009).

Figure 2: Manufacturing SMEs by Sub-sector and Share of Export Development (Frequency Distribution)


The share of exports of the garment sub-sector in the survey stood at 5.1 per cent. The textile and garment industry as a whole used to be the single leading foreign exchange earner in non-oil and gas exports, reaching US$6.5 billion in 1997, a tremendous increase from US$559 million in 1985 (MIT, 2009). Since the early 1990s, about 16 per cent of the total value of Indonesian manufacturing exports came from the clothing and garment sector. In 2000, the textile and garment industry achieved a record US$8.2 billion in exports (MIT, 2009). This made Indonesia 10th among the garment and textile producing countries. In 2003, Indonesia earned US$7.03 billion from exporting textile and textile products but its rank slipped to 17th and accounted for only 2.15 per cent of the US$500 billion global garment trade (Business News, 2006). Although the garment sub-sector has existed downstream of the textile industry for longer than the wood and furniture sub-sector has existed, in recent years it has been experiencing declines in exports due to the increasing international competition from countries such as India, China, Pakistan, Bangladesh and even from neighbouring ASEAN countries. Coupled with this, following the Asian financial crisis in 1997, there has been a decline in capital investment in the garment sub-sector, (Akatiga, 2007). Nevertheless, during the period 2000-2005, despite fierce international competition, exports from the garment sub-sector grew steadily by the first half of 2006 by 0.82 per cent (Akatiga, 2007).

The share of exports of the footwear sub-sector was only 6.1 per cent (see Figure 2). Exports of footwear grew in the late 1980s but declined following the financial crisis of 1997, peaking at $US2.2 billion in 1996 (IMI, 2007). Following the Asian financial crisis, exports declined dramatically with Indonesia’s ranking slipping from 3 to 10, being squeezed by major competitors such as China, India, and Vietnam. Despite this loss in competitiveness, the growth experienced in the global footwear market has meant that there is a potential for Indonesia to regain the competitive edge it achieved prior to the crisis of 1997. This sub-sector is expected to catch-up as Indonesia’s economy improves. Since 2007, foreign companies have been returning to Indonesia due to increasing competitiveness of labour costs and skills (MIT, 2009).

The Pearson Chi-Square (χ2) test for independence was carried out to find out whether the sub-sector and export development level had a relationship that could be used to explain the distribution above. Prior to performing each test, the underlying assumptions of the test were


investigated. A contingency table generated by SPSS fulfilled the following conditions: (1) Each observation is independent of all the others (that is each subject contributes data to only one cell). Therefore, the sum of all cell frequencies in the table must be the same as the number of subjects in the sample; (2) No more than 20 per cent of the expected counts are less than 5 and all individual expected counts are 1 or greater (Yates, Moore, and McCabe, 1999). Following the test for independence and given the calculated value of χ2 (2, N = 197) = 56.40 and a p-value of 0.000 which is less than the critical value of 0.05, the study rejects the null hypothesis and concludes that there is a significant relationship between the sub-sector and the level of export development, at the 5% significance level. Managerial Characteristics of Manufacturing SMEs in Indonesia

Age of the Manager This study examines demographic or objective managerial characteristics instead of

subjective, psychological attributes of management to explain the physiognomies of the firm. The management characteristics are: (a) age; (b) level of education; (c) overseas experience; and (d) foreign language proficiency. Figure 3 shows that the majority of managers or owners in both exporting and non-exporting firms are in a relatively mature age group. About 73.6 per cent of respondents are aged 31 to 50 years. Some 15 per cent of sample firms are managed or owned by people over 50. This pattern holds at the sub-sector level for both exporting and non-exporting firms. This pattern is supported by Mann-Whitney U test which determines an insignificant difference between exporting and non-exporting manufacturers in terms of their owners/managers’ age (z=score = -0.754 and p-value = 0.451). Exporting and non-exporting firms were found to have relatively equal mean ranks in their owners/managers’ age. These findings suggest that in the context of Indonesia, the average age of the entrepreneur does not significantly determine their tolerance toward challenges and risks of export endeavours. The results, then, fail to provide support for previous empirical research findings (Leonidou et al. 1998; Ross, 1989; Tseng and Yu; 1991; Ursic and Czinkota, 1989) suggesting the age of the entrepreneur as a determinant of export involvement.

Figure 3: Manufacturing SMEs by Sub-sector, Export Development and Managerial Age (Frequency Distribution)


Level of Education The investigation of the highest level of education achieved by owners/managers is presented

in Figure 4. These results show that the majority of respondents, regardless of their level of export development, held a diploma or bachelor degree as their highest level of education (58 per cent). About 12 per cent had achieved Master and PhD level and the other 30 per cent had finished elementary or high school as their highest level. Exporters are more prominent than non-exporters at the higher education levels. The findings at the sub-sector level show a relatively similar distribution, in that firms of all sub-sectors were most numerous at the diploma and bachelor degree level of education. None of the non-exporters owners/managers from wood products, however, had a Masters or PhD. The findings from the Mann-Whitney U test support a significant difference between exporters and non-exporters in relation to the owners/managers’ education level as z-score = -3.357 and p-value = 0.001. The mean rank of exporters’ education (mean rank = 109.80) is found to be significantly higher than that of non-exporters (mean rank = 85.62). Hence, firms with significantly better educated work forces would be likely to have greater commitment to exporting and increased ability to understand and anticipate foreign markets’ settings. These findings are consistent with Berry and Levy’s study in Berry and Nugent (1999). They conducted fieldwork in Java among garment, wooden furniture and rattan SMEs exporters and found SMEs exporters to be fairly well educated in comparison with SME entrepreneurs in general. The complexity and accuracy needed for dealing with export documentation and bureaucracy requires managers who are not only well educated but also able to understand the


operation and tackle the mechanics of exporting. While the role of education in export planning and performance has been extensively discussed elsewhere (Samiee and Walters, 1999; Axinn, 1988; Reid, 1983; Simpson and Kujawa, 1974) the present findings have strengthened the importance of knowledge acquisition in reducing the risk perceived by the individual (Gray, 1997) which in turn promotes a more open-minded and interested evaluation of the benefits and disadvantages of exporting (Garnier, 1982). Figure 4: Manufacturing SMEs by Sub-sector, Export Development and Managerial Education

(Frequency Distribution)

Notes: 1 = owners/managers without education; 2 = owners/managers with elementary and secondary education; 3

= owners/managers with diploma and bachelor education; 4 = owners/managers with master and doctoral education (Suarez-ortega and Alamo-vera’s (2005) study).

Source: Derived from survey data. Experience Abroad

Experience abroad refers to the owners/managers’ previous opportunities to live, work or study abroad. Every respondent was asked a series of questions which were not necessarily mutually exclusive, so an affirmative response to one or several of the statements (“I was born overseas”; “my parents were born abroad”; “I have lived/worked abroad for some time”; and “I have received some/all of my education abroad”), was treated as a single affirmative response. The findings reveal that 85 per cent of the sample had not had any previous international exposure (see Figure 5). The Mann-Whitney U test was conducted to find out whether there was a significant difference between those exporters and non-exporters who had had international experience and the results indicate that the mean rank of exporters’ international experience (mean rank = 104.38) was significantly higher than that of non-exporters (mean rank = 92.34) at the 5 per cent significance level. The results indicated a z-score of -2.402 and p-value of 0.016. These results reinforce previous empirical findings suggesting that decision makers of exporting firms are likely to have spent part of their lives abroad (Boatler, 1994; Garnier, 1982). Experience outside the country can facilitate the chance for them to build contacts or networks that can be used to exploit international market opportunities more than for those who do not have such connections.

Figure 5: Manufacturing SMEs by Sub-sector, Export Development and Managerial International Experience (Frequency Distribution)

Source of data: Derived from the survey. Foreign Language Proficiency

The study collected data on the number of foreign languages in which the owners of the firms were proficient. Most of the owners or 62.5 per cent of the sample indicated that they were proficient in at least one foreign language, usually English which is the common business language of Indonesia. Along with English, 2 per cent of respondents indicated that they were proficient in Italian, 4 per cent in German, and 3.5 per cent in each of French and Dutch. Figure 6


shows that the majority of respondents (42 per cent) indicate they have a fair level of proficiency in English; 12.5 per cent did not know how to speak English at all; and only 6.5 per cent report an excellent ability to converse in this language. Generally, exporters claimed greater English language proficiency, that is, fair to excellent, than did non-exporters. as the proficiency level advances from a fair to an excellent level. The Mann-Whitney U test results suggest that exporting managers speak significantly better English than their non-exporting counterparts (z-score = -4.544, p-value = 0.000). The mean rank of exporters’ proficiency level (mean rank = 114.80) was higher than that of non-exporters (79.43). These significant results imply a positive link between the language skills of the manager and the firm’s export development level. Pertaining to the data, foreign language proficiency is not only useful in securing business transactions, but it is also helpful in improving managers’ cultural understanding of overseas markets. The communication breakdown identified in about a quarter of the total respondents could lead to a failure to adapt to individual foreign markets’ specifications and requirements. Figure 6: Manufacturing SMEs by Sub-sector, Export Development and Managerial English

Language Proficiency (Frequency Distribution)

Notes: 1 = not proficient at all; 2 = poorly proficient; 3 = fairly proficient; 4 = good proficiency in English;

excellent proficiency in English (Suarez-ortega and Alamo-vera’s study (2005). Source: Derived from survey data.

CONCLUSION This study contributes to the literature on exporting by examining the managerial characteristics

of small and medium manufacturing enterprises in Indonesia. By using cross sectional data collected via survey questionnaire, the results indicate that managerial education level, international experience, and foreign language proficiency are key determinants of an SME pursuing an export-oriented strategy. Contrary to expectation, the age of a manager does not impact on the ability of a manufacturing SME to become an exporter. The results emphasize that managerial skill development is a key to achieving export development. Although formal education generally improves the managerial skill base, the results of this study indicate that knowledge of a foreign language serves as a catalyst for encouraging export development of manufacturing SMEs in Indonesia. This finding suggests that, in addition to the governmental mandate of a Year 9 educational qualification for all managers, there is the need for the Indonesian government to implement policies aimed at encouraging managers of SMEs to pursue further education. This can be achieved by the government implementing tax incentives by which managers who undertake further education and training could claim the cost of the education from the government. Furthermore, as being able to speak a foreign language is found to be key in enhancing the ability of a manager to engage in export activities, this suggests the need for the Indonesian government to encourage managers of exporting firms to learn a foreign language to enhance their negotiation skills and thereby promote export development. This could be achieved by the Indonesian government implementing assistance schemes aimed at managers upgrading their English and other foreign languages skills. We find that the more internationally experienced a manager is the more likely it is that he will adopt an export development strategy. These findings highlight the need for the Indonesian government to encourage and subsidize business-related foreign trips and trade shows, or stage such trade shows domestically. Such programs are capable of creating market opportunities and they generate self-confidence in SME managers to embark on an export drive. This in turn will encourage innovation and product development for the export market. Clearly, the results of this study provide some empirical evidence in support of the generally held view of the growing importance of managerial characteristics in influencing export development. The results highlight the need for pursuing greater public-private partnership aimed at enhancing managerial knowledge, skills and competencies to encourage experiential learning thereby creating the ability to enhance export development of manufacturing SMEs in Indonesia.


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Importance of Total Quality Management and Leadership Communication to Enhance Islamic Quality at Malaysian Civil Service

Assoc. Prof. Dr. Raja Roslan Raja Abd. Rahman ,Dr. Kalthom Husain,Hassan Adnan

Mohamad Zahir Zainudin,Juan Rizal Sa’ari,Norazlina Mohd. Darus,Norwatee Abd. Rahman Universiti Teknikal Maaysia Melaka,Malaysia

ABSTRACT In the leadership communication styles, most of the middle management positions such as

managers, assistant managers and those at executives’ level are practicing good leadership communication via enhancing the Islamic quality at Malaysian Public Service. A two-way communication does exist among the staff especially in meetings, discussions and working in team. A good leadership communication among the staff and their involvement are important in Malaysian Civil Service in order to achieve the total quality management objective. Reason being is that the leadership communication is the most important tool and vital part in all organisational operations. Leadership communication could be the basis for understanding, cooperation, teamwork and positive action, which without it such goals would be undermined at Malaysian Civil Service. Two-way communication gives more opportunities to the staff to be involved in discussions and meetings which create the spirit of togetherness in the organisation. The Total Quality Management (TQM) has positively affected job satisfaction, the employees' ability to work together, improve the staff work and builds leadership communication at Malaysian Public Service. Obviously, provide a significance relationship between leadership communication and quality management in Islamic perspectives on job satisfaction among the staff at Malaysian Public Service. Keywords : Total Quality Management, Leadership, Leadership Communication, Job Satisfaction,

Malaysian Public Service.

INTRODUCTION The Malaysian Public Service formerly known as the Malayan Civil Service (MCS) has assumed

a significant key role in the economic and social development of the country. Shaped by the country’s historical development and its social and political institutions, the Malaysian Public Service has had a remarkably interesting record. During the pre-independent period, the British introduced structures and practices to help provide various basic services to the public in order to maintain law and order which were aligned to the economic and political activities of the time. Those structures and practices set the foundation of the Malayan Civil Service (www.pmo.gov.my/ksn/?frontpage/content/1995/2015).

With the aim of progressing towards self-determination after independence, the Malaysian Public Service has undergone many changes to re-orientate and evolve into a civil service structure that is relevant and progressive through the introduction of planned improvements and innovations to cope with the developments at that time as well as future needs. To date, the Malaysian Public service has staff strength of 1.2 million employees covering 28 schemes of service including the Federal Public Service, the State Public Services, the Joint Public Services, the Education Service, the Judiciary, the Legal Service, the Police and Armed Forces (Tan Sri Datuk Haji Arshad, 2008).

Since independence the Malaysian public service has assumed a multitude of roles in meeting the needs and expectations of the public and other stakeholders. The public service, with the strength of 1.2 million members, has assumed the roles of negotiator, controller and facilitator. In addition, it has also become the pace setter and the change agent for the country. In assuming these roles the public service needs to perform numerous duties which include delivering services, handling public interest, ensuring public security and safety, and community programmes (Wan Mansor Abdullah, 2005).

Significantly the Malaysian Civil Service has over the years carved its name and is recognised as one of the best in the regions. It is credited for playing a key role in Malaysia’s development and modernisation. Generally, the governmental efforts made during the past decades, have produced favourable impacts in improving governance and the quality of services in the public sector.

In its efforts to meet the expectations of both the National Vision Policy and the National Mission spanning from 2001 to 2020, the Malaysian Public Service continues to redefine itself in these challenging times. Through the various tag lines such as “No Wrong Door Policy”, “Business is not as Usual” and the creation of PEMUDAH for improving public service delivery system by reducing bureaucratic obstacles and providing productive, creative and innovative services, it aspires to become a strong partner with the different sectors in creating wealth for the nation. All in all the Public Service has sought to be world-class and meet international benchmarks of performance and excellence Dato’ Seri Syed Hamid, 2008)


PROBLEM STATEMENT Leadership is the most important part of management. Leadership is stirring people so that they

are moved from within. It is stating goals that excite [people] and lift their sights. It is setting the personal example, putting enthusiasm into the operation, and communicating with workers both ways, listening as well as talking at Malaysian Civil Service. Leadership is a rewarding merit and penalizing demerit, honestly and fairly. It is the right combination of these [qualities] that will lead people to do the work that makes a business successful because they want to [Goble, 1972]. Leaders must understand the difference between leadership and authority. Authority is delegated from those above in the chain of command, whereas leadership is earned from those below and from peers [Rosenblatt et. al, 1982]. In an organization, the utopian situation is for the individual who has been delegated the leadership role from higher authorities to be leadership role from those below and from peers. Above all, leadership is a position of servant hood [DePree, 1992]. The Japanese leader recognizes that rank does not confer privileges, but that rank entails responsibilities [Drucker, 1992].

Leadership is one of the most important aspects in our life cycle. As we all noticed that leadership communication is used in all elements at Malaysian Civil Service for example economic, social, political, management, marketing, and many others. In leadership it consists all the needs to manage your worker or your subordinates in an organization. Here the quality and leadership move together towards their goals. For the past thousands years, philosophers, historian and social scientist contemplated the phenomenon of leadership and their quality. The Ohio States of University have made a research on this case since the past 40 years. This lead to understanding of leadership and the quality as a set of behavior.

Leadership in quality at Malaysian Civil Service means that all the decision makers (leader) turn to identify and define the skills and the abilities critical effectiveness at all level in a quality organization. The importance of this concept is to translate these criteria along with the other quality principles and practices into a set of leadership competencies. This is useful in selecting development and rewarding in quality organization. It involves all the quality principles (the collective capacity of the organization) and leadership practice (individual skill required for leadership success like communication) at Malaysian Civil Service. So, the research question in this study were: What is the importance of leadership the approaches of leadership at Malaysian Civil Service, Why the effective communication skills and quality in islamic management importance at Malaysian Civil Service, What is importance of Total Quality Management (TQM) and Leadership Communication at Malaysian Civil Service, How the behaviour and attitude modification at Malaysian Civil Service, and What are the Levels of Leadership Communication from the Islamic Perspective at Malaysian Civil Service?

OBJECTIVES 3.1 To understand the importance of leadership at Malaysian Civil Service. 3.2 To determine the approaches of leadership at Malaysian Civil Service. 3.3 To understand the importance of effective communication skills at Malaysian Civil Service. 3.4 To know the quality in islamic management at Malaysian Civil Service. 3.5 To understand the importance of Total Quality Management (TQM) at Malaysian Civil Service. 3.6 To know the importance of Leadership Communication at Malaysian Civil Service. 3.7 To understand the behaviour and attitude modification at Malaysian Civil Service. 3.8 To know the Levels of Leadership Communication at Malaysian Civil Service. 3.9 To understand the Leadership Communication from the Islamic Perspective at Malaysian Civil

Service. LITERATURE REVIEW

Leadership Leadership is the heart and soul of an organization at Malaysian Civil Service. No one really

manages an organization by shuffling numbers or rearranging organizational charts. What is really managed in an organization is people! Leadership is the ability to inspire people to work together as a team to achieve common objectives. People want to follow an effective leader [Geneen, 1984). No leader can prove to a board of director show much leadership contributes to the bottom line in the success of an organization at Malaysian Civil Service. However, leadership is, no doubt, the single most important ingredient in organizational management, and good leadership which inspires people to excel contributes as much as 80-90 per cent to an organization’s success [Geneen, 1984]. This leadership can be exercised only through quality communication [Well and Spinks, 1992]. Leaders are people who are able to express themselves fully; they know what they want, why they want it, and more important, how to communicate what they want to others to gain co-operation and support [Bennis, 1989)]. Total Quality Management

An emerging school of management thought today is the total quality management (TQM) approach, emphasizing vision- and value driven leadership. This approach holds that an


organization elevates “customer focus” to a major element of its strategy. It presumes that all people in an organization should strive constantly for the highest quality productivity possible [Well and Spinks, 1992]. All employees must be dedicated to this commitment to excellence effort, and more important, senior management must lead this quality effort [Walton, 1990]. The concentration is on performing the best job possible on the first attempt and on working with any project as a team until a high quality result is accomplished.

Total Quality Management can be defined as a meeting and striving to exceed the requirements of the customers at Malaysian Civil Service. Another definition is providing the customer with quality products and services at the right time and at the right place. According to Adnan (1996), TQM is not a program, it is a transformational process of bringing positive change that is a positive organizational change for:

a. Excellent performance b. Comprehensive and balanced human development. c. Everybody in the organization doing the right thing rightly. d. Customer both external and internal is satisfied, confident and loyal.

To produce a quality service requires a quality process at Malaysian Civil Service. A quality process can be defined as service delivery operation that utilize such as accepted TQM processes as employee empowerment, employee education and training, solicitation of employee suggestions for improvement, utilization of teams for problem solving and for getting work done, utilization of the latest information and communication technology, utilization of concurrent engineering where appropriate, development of focused units, focus on cycle time minimization, constant search for productivity improvements, and other aspects of TQM (Pegels, 1995). Effective Communication

Most leaders do not communicate effectively. They typically underestimate the importance of communication to their success. Consequently, they often fail to communicate passionately their vision, goals and expectations, elicit and act upon employee input, consistently share information with employees, maintain sufficient information exchange with peers, customers and other stakeholders, and regularly reinforce the goals and employees’ achievements at Malaysian Civil Service. As a result, employees frequently feel uninvolved and uninspired. They are unlikely to commit fully to their leader, to key goals, or to their organization. Productivity and retention suffer, and customer loyalty weakens. Islamic Quality Management

Islamic values provide a conducive framework for Quality Management with appropriate techniques, approaches and management ethics. The Islamic concept of brotherhood and sisterhood to each other is well defined. The distinction of race, colour, tribe, caste and language are not valid criteria for superiority for it is quality behaviour that matters at Malaysian Civil Service.

All people are entitled to an ethically right behaviour irrespective of distinctions of caste, creed, race and geographical locations. This has positive implications on attitudes towards one another and this motivating factor of musawat (equality) given by Islam impacts a strong sense of responsibility and belongingness. And this feeling further fosters a culture and incentives for continuous improvement and commitment to work at Malaysian Civil Service. Islam considers work as ibadah (deed). Leadership Communication

Leadership communication consist of those messages from leaders that are rooted in the values and culture of an organization and are of significant importance to key stakeholders, such as employees, customers, strategic partners, shareholders, and the media at Malaysian Civil Service. These messages affect the vision, mission, and transformation of an organization. The chief intention of a leadership message is to build trust between the leader and her or his constituency at Malaysian Civil Service. According to Baldoni (2003), traits of leadership communication reflect :

i. Significance. Messages are about big isues that reflect the present and future of the organization (e.g.; people, performance, product, and services)

ii. Values. Message reflect vision, mission, and culture. iii. Consistency. Message exemplify stated values and behaviors. iv. Cadence. Messages occur with regularity and frequency.

In its simplest form, leadership communication is communication that flows from the leadership perspective. It is grounded in the character of the leader as well as the values of the organization. It is an expression of culture as well as an indicator of the climate, likes openness, integrity, and honesty at Malaysian Civil Service. Leadership communications emerge from organizational culture and values as from the values of the leader. Their ultimate aim is to build, or continue to build, a relationship between leader and follower. The purpose of leadership communication is to build (or establish) trust between leader and follower. This trust is essential to leader’s credibility at Malaysian Civil Service.

There are many purposes and types of leadership communication. According Baldoni (2003), each of the emerges from a leadership action that is communicated from the point of view of leader,


such as on doing what is beneficial for the organization and the people in it. Leadership communications are designed to engage the listener, gain commitment, and ultimately create a bond of trust between leader and follower. They also do something more such as drive results, enabling leader and follower to work together more efficiently because they understand the issues and know what has to be done to accomplish their goals at Malaysian Civil Service.

METHODOLOGY Qualitative Research

In defining the qualitative research, Creswell (1998, 2007) argued that it is an inquiry process of understanding based on distinct methodological traditions of inquiry that explore a social or human problem in the natural setting. While, on the other hand Ghosh and Chopra (2003) defined qualitative data as the form of descriptive accounts of observations. In real sense, qualitative research is used to gain deeper understanding of the research concern, thus it is common in social and behavioral sciences as well as among researchers interested to understand human behaviors and functions (Ghauri & Grǿnhaug, 2005). Qualitative methods, indeed allow researchers to explore and probe deeply into attitudes towards research issue; hence it is quite suitable for studying organization, groups and individuals.

According to Myers (2009), qualitative research is good for exploratory research, when the particular topic is new and there is not much previously published research on that topic. Researcher also added that studying any specific subject in depth, qualitative research is the best. The most common forms of qualitative research methods include such as participant observation, interview, and focus group discussion used in the literature (Myers, 2009). According to Lincoln and Guba (1985), qualitative method is appropriate to gain a ‘rich’ understanding of a phenomenon. In the present study, researcher used interview method because this technique allows participants to describe their perceptions, and also allow the researcher to question the participants directly about how they understand their decision. Salkind (1997) argued that interviews are helpful to get information that might otherwise be difficult to come by, including first-hand knowledge of people’s feelings and perceptions. Thus, this study has been designed as library research approach to understand the importance of total quality management and leadership communication to enhance islamic quality at Malaysian Civil Service.

FINDINGS Importance of Leadership at Malaysian Civil Service

Leaders understand that people is the most important component in an organization at Malaysian Civil Service. To make people feel as though they are accomplishing something and not just “putting in time”, a leader must work with people and not against them. A leader needs to create an image which excites people and which inspires excitement at work [Goble, 1972]. Delegating responsibility is as important a gift to followers as it is central to employee participation [DePree, 1992]. Since the beginning of time, people have been trying to determine whether one best approach to leadership exists. The best approach appears to vary by culture and environment, but agreement exists on some basic concepts. Leadership is a major component of the nation’s economic system and its society. Quality leadership leads to greater productivity, which in turn produces a higher standard of living for the nation’s population.

What is really managed in an organization is people! Leadership is the ability to inspire people to work together as a team to achieve common objectives. Explores on several approaches to leadership include the trait approach, the style approach, the effectiveness versus efficiency approach, the contingency approach, the power approach, the function approach, the competence approach, and the TQM approach. In addition, the role of leadership in behaviour and attitude modification and the different leadership tasks of upper-level, middle-level, and lower level leaders are looked at in Malaysian Civil Service. Approaches to Leadership at Malaysian Civil Service

Although organizational communication consists of issuing orders and giving instructions, to some extent, people must not think of leadership as “driving” employees to perform given tasks at Malaysian Civil Service. In today’s world, successful executives inspire, not force, their employees. Quality communication is the avenue by which leaders clarify their visions and foster participative management within the organization [DePree, 1992 ]. Some approaches to describing leadership are [Well and Spinks, 1992]: the trait approach; the style approach; and the effectiveness versus efficiency approach; (1) the contingency approach; (2) the power approach; (3) the function approach; (4) the competence approach; (5) the total quality management approach.

Trait approach The trait approach explaining leadership assumes that leaders are born, not made. Some people,

because of their charisma and other personality traits, seem to be natural born leaders whom others will follow automatically. People possessing charismatic traits need to learn to use and develop those


leadership traits consciously. Attempts to isolate leadership traits, however, have established that many successful leaders do not possess a common body of personality traits which explain their leadership abilities at Malaysian Civil Service. In fact, many great leaders of the past seem to have had different personality traits. Quality leadership depends neither on charisma nor on personality traits. Dwight Eisenhower, George Marshall (originator of the Marshall Plan), and Harry Truman were quality leaders, yet none possessed charisma [Well and Spinks, 1992]. Style pproach

The style approach assumes use of leadership styles ranging from authoritarian to democratic, including several points in between. The authoritarian leader makes decisions and proclaims these downward to employees. However, the democratic leader encourages group decision making at Malaysian Civil Service. Between these two extremes can be found several leadership styles which use varying degrees of authority. All leaders, in actuality, use various styles under differing circumstances. One is simply dominant, or frequently used [Well and Spinks, 1992]. Effectiveness versus Efficiency Approach

Some authorities consider leadership from the standpoint of focusing on effectiveness as opposed to efficiency. The effective leader achieves desired results, whereas the efficient leader produces a large output from a given input at Malaysian Civil Service. For example, a project manager concludes a project by delivering its product on time and on budget. A manager of an operating arm of a company might produce half again the raw product of a peer business unit elsewhere in the organization, thereby increasing profitability [Well and Spinks, 1992]. Contingency Approach

The contingency approach to explaining why some leaders emerge successful contends that the style of effective leadership is contingent on the nature of the situation at hand at Malaysian Civil Service. This theory assumes that when circumstances are highly favourable or highly unfavourable, an authoritarian leader is more successful. However, when circumstances are neither highly favourable nor highly unfavourable or when a mixture of favourable and unfavourable circumstances exists, a democratic leader tends to be more successful [Well and Spinks, 1992]. Power Approach

Leadership can also be described as the exercising of various kinds of power at Malaysian Civil Service. Reward power is the power of the leader to bestow tangible rewards on followers. Coercive power is the power to punish, such as the power to fire, demote, transfer, assign undesirable tasks, and withhold desirable outcomes.

Legitimate power is the power associated with the individual’s position in the organizational hierarchy and not necessarily with the individual per se. Expert power refers to the extent to which followers perceive the leader to possess certain knowledge and abilities and to possess the capability to use these towards desired outcomes [Well and Spinks, 1992]. Function Approach

The function approach to explaining leadership views leadership as the cumulative performance of many functions, including motivating personnel, creating favorable public relations, or developing plans at Malaysian Civil Service. Leadership ability is assumed to be the capability to perform certain functions well. One leader may perform all the necessary leadership functions in a given situation, or many leaders may perform various functions [Well and Spinks, 1992]. Competence Approach

Another strategy to interpreting leadership is the competence approach, including a scribing the phenomenon of leadership to the exercise of competence at Malaysian Civil Service. Bennis [1989] conducted a two-year study to isolate the basic competences of leaders. He undertook the study of leadership assuming it is the central ingredient to the way progress is created and to the way organizations develop and survive. After interviewing 90 leaders, five major competences slowly emerged as significant. Management of attention is the ability of leaders to get others to listen to their intentions and to get others to focus on their visions and their agendas. This ability engenders reciprocity; that is, it also enables leaders to focus their attention on others. Management of meaning is the ability of leaders to convey their goals, desires, objectives to others clearly, effectively, and meaningfully using both words and symbols.

Management of trust requires that leaders remain constant in their views and that they have commitment, integrity, reliability, stability, and predictability as these qualities so strongly affect followers at Malaysian Civil Service. Trust is developed overtime through repeated interactions, A leader’s actions and a leader’s professed beliefs must be congruent, as consistency is necessary for trust to develop [Drucker, 1992]. Management of self recognizes that most leaders have strong egos, high self-regard, and high regard for others. At an early age these leaders knew their strengths, and throughout the years they continued to nurture these strengths. “The Wallenda factor” is a term used to mean that successful leaders always look for challenges; they concentrate on succeeding and not on failing; they enjoy taking calculated risks [Bennis, 1984].


Total Quality Management Approach For TQM to be successful, its results should include delighted customers, empowered

employees, higher revenues, and lower costs at Malaysian Civil Service. Rewards are structured to benefit quality performance rather than quantity of output [Well and Spinks, 1992]. What part does quality communication play in the overall quality picture? TQM clearly emphasizes quality of products and services [Thurow, 1992]; but, what about the quality of communication? Communication is the lubricant used to turn the wheels in any leadership role. Perhaps, the term “Big Q” couldbe a label for the enlarged scope of managing for quality, including quality of communication. If this were the case, benchmarking techniques could be used for measuring a company’s communication processes against those communication processes used at Malaysian Civil Service renowned as leaders in their own communication functions. In addition to the leadership approaches described above, other approaches to leadership have been described in management literature.

The Importance of Effective Communication Skills at Malaysian Civil Service Managers are likely to spend most of their time engaged directly in some form of

communication process. Diwan (1990) have done a research on how managers spend their time. It was established that on average the 160 managers in her sample spent two-thirds of their time working with other people. The rest of their time was mainly engaged in preparing information reports. It seems reasonable to assume that most managers spend the bulk of their working day in some type of communication activity at Malaysian Civil Service.

Even the 33 managers in the sample in "backroom"-type jobs spent about half of their time working with other people. This may be through attendance at meetings, the giving and receiving of instructions, discussions with colleagues and contact with customers or suppliers. Such contact may be face to face or over the telephone or a combination of both at Malaysian Civil Service. Obviously, communication is important to the business organization. According to one generally accepted estimate, between 40 and 60 percent of the work time spent in a typical manufacturing plant involves some phase of communication. Some employees spend much more of their time communicating. In fact, the higher up the organization structure the employee is, the more communicating he or she is likely to do. Typically, top executives spend from 75 to 95 percent of their time communication (Diwan, 1990).

Communication is also important in the strategy implementation like quality management. For successful strategy implementation, employees should create an environment where open and honest dialogue and communication on strategies issues and changes can take place (Carpenter, 1986). Additionally, top management has to regularly review with the departmental and divisional heads, the long-range plans and the resource requirements of these plans so as to avoid production delays at Malaysian Civil Service. This helps to improve the effectiveness of these plans being implemented. Alexander (1985) and Reed and Burkley (1988) recommended a two way communication feedback that permits questions from affected employees about the formulated strategy. Quality in Islamic Management at Malaysian Civil Service

The implication of this concept is that work comprises the intention, prayer, profession, action, reaction and behaviour of the people performing it. However, the result comes from Allah. Being Muslim, one has to accept it whether positive or negative, because the will of Allah will prevail at the end (Khaliq, 1996). For Muslims, any work can be ibadah given that requirement such as good intention, permissible, profession, serious efforts, surrendering to Allah's will, be met during and after its performance at Malaysian Civil Service.

Islam considers quality as a process of bringing positive changes for excellent performance in daily life. Its final objective is to improve quality living of man. An organization without quality will perish. Every task should be done to the level of excellence at Malaysian Civil Service. This culture of excellence if we are able to practice in our daily life will bring a result in a quality society. The Prophet Muhammad SAW advised the Muslims to work hard. It was reported that the Prophet to have said; "The best income is that which is earned honestly by the hard working labourer." (Majma al-Zawaid)

He also reminded the Muslims to be confident in carrying out their work. It was reported that the Prophet to have said; "Ask Allah to help you and not fell incapable, for nothing is impossible." (Sahih Muslim)

In Islam, quality is more important than quantity. Small quantity of performance may be has a good quality in value or vice versa. In addition, poor quality performance may bring about adverse outcome at Malaysian Civil Service. For example, sawm or fasting has been made obligatory for Muslims (Al-Quran, 2:183). The sawm becomes useless when it is not of good in quality. It was reported that the Prophet to have said ; “ Many fasting people get nothing from fasting except hunger and many of those who offer salah (prayer) by night get nothing from it except the discomfort of staying a wake."(Ibn Majah)

Thus, in Islam, quality is more important than quantity. But it does not mean that quantity doesn't count at Malaysian Civil Service.


The Importance of Total Quality Management (TQM) at Malaysian Civil Service TQM is customer and market driven. To ensure this, the most common practice under this

system is the company registration. This has been done under the prevention based ISO 9000 Quality Assurance (QA) management systems. In the Japanese case, the Deming Prize, in the USA, the Malcolm Baldridge National Quality Award, are basically instituted to reward excellence in Quality Management. SIRIM's Mark of Quality and Quality Improvement Certificate also seek to reward Malaysians for excellence in performance and Quality Management (Khaliq, 1996). In Malaysia, the Prime Minister's Quality Award, introduced on 9 November 1990, is designed to encourage progress in this direction. This award is intended to be the highest national award to recognize agencies in the private, public and social sectors for quality performance. Winning the award is a prestigious accomplishment, as the Prime Minister's Quality Award is a symbol of the highest achievement of quality, productivity and excellence at Malaysian Civil Service.

TQM emphasizes employee as the most important resource of the organization. It is a system that decentralized the power to all employees to take responsibility for improving quality within organization (Luthans, 1995). TQM practices improves the level of job involvement, job satisfaction and commitment to organization (Poister and Harris, 1997). The studies showed that TQM practices are producing changes in employee activities and attitude. Butler (1996) found that middle managers from organizations that practice some level of TQM feel less frustration in their work and closer to top management.

The purpose of TQM is to improve the performance of business. In order to achieve that purpose, TQM is broken down into eight critical components, namely, employee involvement, training, supplier quality management, customer focus, quality measurement, quality leadership, quality policies and process improvement (Anshutz, 1995).

Employees who dedicate their efforts to achieve a high level of quality products or service will be affected most directly and immediately after the implementation of TQM at Malaysian Civil Service. Purcell and Hutchinson (1996) found that middle managers from the organizations that implement TQM feel less frustration in their work and closer to top management. The Importance of Leadership Communication at Malaysian Civil Service

Leadership communication is a style, communication strategy and method used by the leader in the organization such as meeting, supervision, advice, instruction and exhortation (Tubbs and Moss, 1980). Effective leadership by definition requires effective leadership communication. Effective leaders are those who inspire others to make a full and willing commitment to the organization's goals and the process of quality management. To accomplish this, managers must communicate with employees about the organization's goals and how accomplishing these goals will, in turn, help employees accomplish their own personal goals at Malaysian Civil Service.

To be effective leader, managers should be aware of both formal and informal communication systems within an organization. Formal communication involves a form of letters, meeting, report and conferences. While informal communication occurs when where people come together because they labor in the same organizational unit or division or because they are members of a project at Malaysian Civil Service. Sometimes it also occurs when people sit together in the cafeteria and attend the family day of the organization. Managers also should aware of both internal and external communication. External communication may include in press release and marketing strategies. In other side, internal communication is directed to the stakeholders in the organization (Harris, 1989).

Not surprisingly, leadership communications among the managers influence the productivity and job satisfaction of the employees. Based on the research done by Hain and Widsery (1973) on an automobile company, found that the quality of communication of supervisors in this company has a high correlation with the employees' performance. One of the elements of the effective leadership is leadership communication. Effective leadership has been linked with job satisfaction and employee performance. Employee will perform a job well if their managers have good leadership communication. Moreover, it is to ensure that the leadership communication adheres strongly to the Islamic perspective. It also to remind that the quality management will not achieve the objective without the effective leadership communication among the staff at Malaysian Civil Service.

Leadership communication among the staffs in organization has an influence on the implementation of quality management at Malaysian Civil Service. Thus, the effective leadership communication will be the result of effectiveness in quality management. On the other hand, ineffective leadership communication will make the quality management to break down. Those who are involved in quality management should have a good leadership communication. In addition, good leadership communication among the staffs will lead them to achieve the objective of quality management at Malaysian Civil Service. The good relationship between the top management and the staff will enhance the job satisfaction and leads the successful in implementation of TQM. Leadership communication message do one or more of the following (Baldoni, 2003) :

i. Affirm organizational vision and mission. These messages let people know where the organization is headed and what it stands for


ii. Drive transformational initiative (change). These messages get people prepared to do things differently and give the reasons why.

iii. Issue a call to action. These messages galvanize people to rally behind and be initiative. They tell people what to do and how to do it.

iv. Reinforce organizational capability. These messages underscore the company’s strengths and are designed to make people feel good about the organization for which the work.

v. Create an environment in which motivation can occur. These messages provide reasons why things are done and create a path of success, such as more competitive organization, more opportunities for promotion, or increased compensation.

vi. Promote a product or service (and affirm its link to the organization’s vision, mission, and values). These messages place what organization produces within the mission, culture, and values of the organization, like creating products that improve people’s life.

Behaviour and Attitude Modification at Malaysian Civil Service In mastering the role of leadership, leaders must discern between behaviour modification and

attitude modification at Malaysian Civil Service. Behaviour modification implies that people change their outward actions, while their attitudes, beliefs, feelings, and opinions remain the same. Attitude modification implies that followers change their inward thinking; hence, their attitudes, feelings, and opinions are brought into line with those of the leader. It is clear that attitude modification is more important to effect lasting change than behaviour modification [Well and Spinks, 1992].

Influence Quality leadership results in influence at Malaysian Civil Service. What leaders are

communicates influence perhaps more persuasively than what leaders say or do [Covey, 991]. Seldom are most leaders in today’s complex organizations in positions to exercise, by force, absolute controls over people or activities to achieve their goals and objectives. Instead, leaders exercise influence on the thinking of employees obtaining their co-operation in successful goal-oriented activities. This influence canonly result from quality communication by leaders [Well and Spinks, 1992]. Motivation

The ability to motivate is a highly desirable quality in a leader at Malaysian Civil Service. What makes some people better motivators than others? Motivation requires an understanding of human behaviour and the components which form such behaviour, such as perception, attitude, and personality. Motivation is an understanding of why people behave as they do, coupled with a process of persuading or influencing individuals to behave in ways which will satisfy certain needs [Rosemblatt et.al, 1982]. Why are people motivated to accomplish tasks for the organization? The truth is that no one single factor motivates all the people all the time. In addition, different people are motivated by different things at any onetime [Cohen, 1990]. However, all behaviour is motivated, no matter what the factors are. Individuals need reasons for what they do and for how they do it. Quality leadership provides these reasons which motivate employees to behave in ways beneficial to the organization [Well and Spinks, 1992]. To motivate employees towards quality productivity, measurable goals must be set with input from employees. If no goals are set or if employees do not have input in formulating goals, employees are often not motivated to complete the tasks successfully. Perhaps, they do not realize the importance and value of the tasks [Well and Spinks, 1992].

A need for trust between leaders and employees is essential for continued quality performance [Bennis,1989]. Without trust, most motivational attempts will not be successful because these attempts will be perceived as manipulative. Leaders who use constructive criticism must first establish the respect and acceptance of their employees through teamwork. Trust is the conviction that leaders mean what they say. It is also the belief in something old-fashioned called “integrity” [Drucker, 1992]. Trust is built over a period of time through quality communication which is constant and reliable [Well and Spinks, 1992]. Trust is the emotional glue which binds followers and leaders together [Bennis and Nanus, 1985]; quality communication heralds trust.

The ability to listen is a quality communication tool employed in the motivational process at Malaysian Civil Service. A leader who listens encourages upward communication. Just as an open door policy fosters two-way communication, two way communication builds teamwork, encourages feedback, and promotes productivity [Well and Spinks, 1992]. Employees want to feel as though they are integral parts of the organization. For example, delegating responsibilities contributes to worker motivation, not because workers desire power, but because they enjoy the satisfaction which comes from successfully carrying out their responsibilities in the context of a larger community of fellow workers at Malaysian Civil Service.

Levels of Leadership Communication What constitutes effective leadership communication differs somewhat depending on whether

the leader is a part of upper, middle, or lower level management [Well and Spinks, 1992].


Upper Level Leadership Communication Upper level leaders make decisions, and they make these quickly. These leaders must make

sure they are receiving an adequate and accurate flow of upward communication, so that they see the organization’s operations as a whole and make plans and decisions accordingly. Upper-level leaders cannot concern themselves with every small detail and problem which arises; they involve their employees through empowerment. For example at Malaysian Civil Service, the upper-level leader who becomes excessively involved will be unduly busy.

Meanwhile, the organization wanders since no one is dealing with the larger issues of setting goals and charting a course for the enterprise at Malaysian Civil Service. The first communication imperative for upper level leadership is to develop sound policies, describe and carry out plans, and make decisions. The second imperative is to make sure that quality communication networks are functioning properly. An imperative less commonly discussed is to consider the non-verbal communicators which will accompany messages. Non-verbal communicators include everything from voice tone and facial expressions to the overall perception others develop of the organization. The effective leader uses this input to communicate the message, policy, or directive of doing what was planned. The final imperative of an effective leader is to evaluate the communication, to assess its effectiveness, and to make any necessary changes a base for further decisions at Malaysian Civil Service. Middle Level Leadership Communication

Many middle level leaders state that they feel caught in the middle. On the one hand, they owe loyalty to upper level leaders, and they must work for the success of decisions, plans, and policies of those leaders at Malaysian Civil Service. On the other hand, middle level leaders are viewed by lower level employees as their sole representatives in dealing with the administration. In this dual role, middle level leaders must represent upper level administration by instituting, communicating, and carrying out policies, while keeping the best interests of lower level employees in mind. Middle level leaders gather information from lower level leaders and communicate this information upward. The gathering of good, valid information from below depends on a climate of trust and openness conducive to developing quality communication networks at Malaysian Civil Service. Lower Level Leadership Communication

Lower level leaders face a situation similar to that faced by middle level leaders at Malaysian Civil Service. They also have a duty to carry out policies, strategies, orders, and instructions from above. Meanwhile, they have responsibilities to work for the best interests of the employees beneath them. Communication at this level, however, consists more of giving instructions and is suing orders than that at upper levels. The plans lower level leaders implement are tactical. Also, communication at this level is often directed towards employees who practice particular skills or crafts. These workers often view their goals, objectives, and futures as being more closely aligned with performance of their crafts than with performance in their employer’s at Malaysian Civil Service context.

A unique feature of lower level leaders is that they truly comprise the front lines of management in creating an effective workplace at Malaysian Civil Service. They deal with workers, workers’ organizations, customers, and clients. Lowe level leaders even see the public on a day-today basis. Therefore, quality communication at this leadership level is crucial, as results of quality communication should deliver delighted customers and empowered employees to management’s bottom line at Malaysian Civil Service.

Leadership Communication from the Islamic Perspective Communication is the important activity in the organization. According to Zaiko and Dance

(1965), managers in the organizations in USA used about 85% to 90% from their working time to communicate. Barnard (1938) said the executive in the organization has to build and maintain the effective formal communication system.

Today, at Malaysian Civil Service, the executives have to attend training programs in order to make sure they can communicate effectively with their subordinates. Not surprisingly, skill in communication is one of the conditions for promotion in the organization. Dennis (1975) had identified several characteristics of good leadership communication. Among them are:

a. Executives give a chance to their subordinates to communicate with them. b. Executives encourage their subordinates to inform to them if they are facing a problem and try

to overcome the problem. c.Executives give a lot of information needed by the subordinates. d. Executives will be fair to any suggestions made by the subordinates.

Mohd. Yusuf (1998) said that communication is one of the important aspects in Islam especially in our daily life. Allah said; " Read: In the name of thy Lord who create. Create man from a clot" (Al-Alaq: 1-2)

" And there may spring from you a nation who invite to godness, and enjoin right conduct and forbid indecency. Such are they who are successful"(Ali Imran: 104)


But, according to Islam, if someone is good in leadership communication but on the other side poor in akhlak, he or she cannot be considered as a good leader. Thus, Islam gives a guideline to be a good leader. A leader should maintain a good relationship with Allah s.w.t. Allah said; " I created the jinn and humankind only that they might worship me" (Al-Zhariyat: 56)

Islam also provides the principles of the communication. Islam encourages us to communicate with a gentle word.

Allah said;" Go, thou and thy brother, with my tokens, and be not faint in remembrance of me. Go both of you, unto Pharaoh. Lo! He hath transgressed (the bounds). And speak unto him a gentle word, that peradventure he may heed or fear."(Thoha: 42-43)

CONCLUSION Communicating the leadership message over and over again in many different circumstances lets

employees come to better understanding of what the leader wants, what the organization needs, and how they fit into the picture. In time, leader and followers form solidarity that is rooted in mutual respect at Malaysian Civil Service. When that occurs, leader and followers can pursue organizational goals united in purpose and bonded in mutual trust.

According Baldoni (2003), the chief aim of organizational communications is to ensure that everyone understands both the external and internal issues facing the organization and what individuals must do to contribute to the organizational success. Communication belongs to everyone in the organization and it is not a functional responsibility limited to marketing, public relations, or human resources. Communication must become a core competency and responsibility of everyone within the organization at Malaysian Civil Service.

Quality management provides the umbrella under which everyone in the organization can strive to create internal and external customer satisfaction. Its practices result in increased employees' job satisfaction, lead staff to improve their work performance and encourages employees' participation and commitment at Malaysian Civil Service. Employees' satisfaction is vital at current management and key to success for the particular organization. Staff are committed to their work. Accepting a position in organization is considered as involving oneself in a binding aqd (contract) to fulfill it to the best at ability and quality. To maintain the quality, staff usually makes a continuous improvement of their job.

Progress has been made in improving the quality of products and services in organizations, but this progress has been limited. As organizations strive to achieve quality in relationships, both inter- and intra-organizational, they increase their abilities to survive in a global economy at Malaysian Civil Service. The global economy contains most of the opportunities for the 2000 sand beyond. Leadership is the heart and soul of organizations, and quality communication is the avenue by which leaders clarify their visions and foster participative management within organizations, no matter which approach best describes their leadership styles. In mastering the role of leadership, leaders must strive for attitude modification in their followers to effect lasting change. Attitudes, feelings, and opinions of employees must be in sync with those of their leaders. To accomplish this lasting change, trust must be established between leaders and employees, and quality communication plays an important role in initiating and maintaining this trust. Quality leadership can be exercised only through quality communication at all levels –upper, middle, lower – in organizations. If quality communication is in place, the organization will achieve delighted customers, empowered employees, higher revenues, and lower costs at Malaysian Civil Service.

According to the Kaizen approach, staff are responsible for participating in Kaizen suggestions, engaging in continuous self improvement activities and continually enhancing job skills through education and training. Kaizen is the name given by the Japanese to the concept incremental improvement. The improvement aspect of Kaizen refers to both people and process. The concept of empowerment allows staff to solve their own problems. They are free to use their own minds, creativity to solve a particular problems or in making a decisions. The rationale of empowerment is that it represents the way to bring the creativity and initiative of the best employees to bear on improving company's competitiveness. Creative thinking and initiative from as many as possible will increase the likelihood of better ideas, better decisions, better quality, better productivity and competitiveness at Malaysian Civil Service.

Johnson (1991) describes the rationale for teamwork as follows. First, two or more heads are better then one. Second, the whole (the team) is greater than the sum of its parts (individual members). Third, people in teams get to know each other, build trust, and as a result, want to help each other. Finally, teamwork promotes better communication. Information should be shared freely inside of the teamwork and outside of it at Malaysian Civil Service. Education and training are fundamental to quality management because they represent the best way to improve people on a continual basis. According to Scholtes (1992), in quality organization, everyone is constantly learning. Management encourages employees to constantly elevate their level of technical skill and professional expertise.

In Islam, quality management is not only to produce quality products or services, but also important in obligatory ibadah such as solat. Quality assurance in solat has to occur before, during and after the solat., All the conditions need to be fulfilled first before performing the solat. During the solat,


concentration or solemnity will ensure all the pillars have been followed. Upon completion, the solat will be checked or evaluated as to whether all pillars and conditions had been observed. Thus, quality management is not practiced in the organization alone, but also in the daily life. Islam emphasizes very much on team spirit which is the element in teamwork at Malaysian Civil Service. To exemplify this from the Islamic perspective, is the congregational prayers. From this exercise, respect and obedience to leaders can be gleaned. Each person has various idea and opinion. Combined together, it will achieve what the organization aims to enhance Islamic quality at Malaysian Civil Service.

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How Good Is Your Organisational Knowledge?

Fawzy Soliman,UTS Business School,University of Technology, Australia

ABSTRACT Knowledge management has been widely recognised as an essential tool in managing

organisations. Good knowledge management programs or tools impact positively on the performance of the organisation and therefore, the goodness and usefulness of knowledge management is a competitive advantage. This means organisations must carefully evaluate the knowledge management programs and/or tools. This requires assessment of knowledge itself. In other words good strategies must be based on good knowledge and the inverse is true, i.e. poor or incomplete knowledge could results in poor or defective strategies.

The success of innovative organizations today is often a result of good knowledge and skills applied by their professional and technical employees. Effective management of such a work force has become one of the most critical problems faced by organizations in both the private and public sectors. This should be translated into good assessment and examination of knowledge so that its management can focus on achieving the organizational objectives.

The paper shows that a method for assessing the attributes of knowledge encompasses nine important characteristics of knowledge. The nine characteristics of knowledge are shown to be:

1. Timeliness of knowledge; 2. Currency of knowledge; 3. Relevance of knowledge; 4. Authority for obtaining knowledge; 5. Purpose of knowledge; 6. Importance of knowledge; 7. Accessibility of staff to knowledge; 8. Applicability of knowledge, and 9. Suitability of knowledge to the application.

Keywords: Knowledge Management, Knowledge Characteristics, Assessment of Knowledge.

INTRODUCTION A large body of literature in business, management and organisational studies, points to the link

between successful management of organisational intellectual assets and improvement in performance. In other words, successful knowledge management has become a key organisational imperative. The most important component in knowledge management programs is knowledge itself. Enterprises can benefit from understanding the nature and location of their knowledge resources while carefully dipping their toes into the pool of innovative knowledge management (KM) technologies.

Knowledge may be defined as what makes personal, organizational, and societal intelligent behaviour possible. The two knowledge-related aspects that are vital for the viability and success of a business may be grouped under:

1. Knowledge assets: Knowledge assets may be also referred to as Intellectual Assets which are the valuable knowledge available to be used or exploited by the organisation or the individuals. This knowledge must be nurtured, preserved, and used to the largest extent possible by both individuals and organizations.

2. Knowledge-related processes: These processes are usually found within organisations for the purpose of creating, building, compiling, organising, transforming, transferring, pooling, applying and safeguarding knowledge. These processes must be carefully and explicitly managed in all areas affected. Knowledge must be managed effectively to ensure that the basic objectives of organizations and

individuals are attained to the greatest extent possible. In this context, knowledge management in organizations must be considered from three perspectives with different aims and purposes, these perspectives are:

1. Business Perspective: In this perspective the management should focus on why, where, and to what extent the organisation must invest in or exploit knowledge. Knowledge is required for the development of strategies, products and services, alliances, acquisitions. An example would be corporate strategy, which is made possible by better knowledge management. Planning and creating new products usually relies on better knowledge. Knowledge management is also necessary for directing the business to create, deploy and exploit knowledge assets and if necessary, create joint ventures to facilitate knowledge exploitation.

2. Management Perspective: In this perspective the management should focus on determining, organizing, directing, and monitoring knowledge-related activities required to achieve the desired


business strategies and objectives. Knowledge is needed to create knowledge about creation, acquisition, retention, transfer and usage of knowledge. Knowledge management is necessary to monitor processes and create policies and practices needed to determine required knowledge related activities.

3. Operational Perspective: In this perspective the management should focus on applying the expertise to conduct explicit knowledge-related work and tasks. Knowledge is needed to conduct a survey of knowledge status to determine the available knowledge needed to build human resources further. Knowledge management is needed to conduct better training, better R&D and establish a better pool of knowledge and systems. It is clear from discussion that knowledge and in particular knowledge management must receive

the appropriate attention and analysis from researchers and business management. The first ever published work about knowledge is found in the book titled “The Concept of

Mind” by Ryle (1949). Ryle introduced the concepts of know-how and know-that – or sometimes referred to them as know-what. Polanyi (1966) suggested that there are two major types of knowledge and named them tacit and explicit knowledge. Few years later, Von Hippel (1987) defined information trading as “the willingness of employees working in different firms – even direct competitors – to exchange information informally”. Von Hippel (1987) work defined knowledge transfer as a “process through which one network member is affected by the experience of another”. Further work by Bartley (1987) proposes that “individuals interact with each other and share their knowledge (on the unknown and unfathomable object-product) in a process to create not-yet-existing knowledge about the already existing products, as well as creating new products”.

It should be noted that the work of Polanyi (1966), Von Hippel (1987) and Bartley (1987) received little attention from the management of organisations until later in the beginning of 1990s.

During the end of 1980s sluggish business activities forced many Multi National Enterprises MNEs to downsize and retrench portions of their work force. These negative business sentiments fuelled a huge major stock market crash and forced organisations to rethink their strategies. Accordingly, two important business and management concepts were born about the beginning of 1990s; namely the Business Process Re-Engineering concept (Hammer, 1990; Davenport and Short, 1990; Hammer and Champ, 1991) and the Knowledge Management concept (Nonaka, 1990 and Nonaka, 1991).

The work by Nonaka (1990) elaborated on tacit and explicit knowledge further: Explicit Knowledge is captured in databases, customer files, software, manuals, and so on, and

can be referred to as “structural” capital. Tacit Knowledge, on the other hand, may reside in the minds of the company’s employees,

suppliers, and customers, and is also known as human capital. Human and structural capitals make up the intellectual capital of the organisation.

Ever since the first published work on knowledge management by Nonaka (1990), interests in the topic grow strongly and knowledge management has come to be a formal discipline in many teaching and research institutions. For instant Vincenti (1990) identified a number of categories that are of limited use in developing and improving knowledge management activities.

THE RISE OF KNOWLEDGE MANAGEMENT Many authors believe that the knowledge management field was born about the year 1990

immediately after the release of Nonaka’s book “A Theory of Organisational Knowledge Creation” (Nonaka, 1990). The book has sparked a stream of work on the topic starting with the work of Cohen and Levinthal (1990) who examined the absorptive capacity of the individual to analyse the knowledge received. Further work by Nonaka (1991) provided further analyses of different types of knowledge and gave some examples of knowledge forms that include tacit and explicit knowledge. Nonaka’s (1991) work introduced the most popular theory in knowledge management “Theory of Organisational Knowledge Creation”. Further work by Kogut and Zander (1992) has shown that the popularity of knowledge management is due to its positive impact on organisations' competitive advantages. Furthermore, Kogut and Zander (1992) proposed that the creation of new knowledge resulting from individuals’ interaction should be combined and/or exchanged with other's knowledge in order to be meaningful to the organisation.

Further work by Nonaka (1994) proposed that the organisation should pay attention to knowledge processes and the way new knowledge is created. According to Nonaka (1994), knowledge is perceived differently when it is moved from one context to the other, therefore, there must be a match between recipient's situation and perspectives and the knowledge received. Further work by Bohn (1994) suggest that knowledge creation within organisations is an endless process that starts at the individual level and expands to other sections, departments, divisions, and even beyond organisation boundaries. Nonaka’s work was the first to highlight the possibility of finding mismatches among and between knowledge entities during the knowledge transformation process.


Although Nonaka’s work has sparked a debate and alerted the scientific community that knowledge mismatches could exist, it did not provide an approach to identifying the various types of mismatches, nor did it propose a way to find the sources of those knowledge mismatches.

Further interest in the topic was made by Nonaka and Takeuchi (1995) who proposed that explicit knowledge is easy to articulate, capture and distribute in different formats while tacit knowledge is unspoken and hidden. Nonaka and Takeuchi (1995) further argued that there are four modes of knowledge conversion, these are externalisation, internalisation, socialisation and combination and that the enterprise needs to plan for each conversion mode when adopting a knowledge management program. At that time the Nonaka and Takeuchi (1995) theory of knowledge creation has become the most popular theory of knowledge creation which is also known as the SECI (Socialization, Externalization, Combination, and Internalization) model. The theory acknowledges that knowledge is created through four conversion modes of tacit and explicit knowledge. The modes are:

1. The first mode converts tacit knowledge to tacit knowledge and is known as socialisation. This is done through sharing similar experiences between individuals.

2. The second mode converts explicit knowledge to explicit knowledge, and that is combination. In this mode new knowledge is created through sorting, adding, re-categorizing, and re-contextualizing existing knowledge.

3. The third mode converts tacit knowledge to explicit knowledge is called externalisation. Through this mode, an individual's knowledge is transformed into a more understandable form by others in the group, and thus employed to create new knowledge.

4. The fourth mode converts explicit knowledge to tacit knowledge is identified as internalisation. It is a requirement to realise the knowledge related to an individual within the knowledge of the organisation. Knowledge in this stage is applied practically to create new organisation's routines. This wave of renewed interest in knowledge management was further enhanced by a number of

articles dealing with the five most important functions of knowledge management; namely Create, Capture, Organise, Access and Use of Knowledge (Soliman and Spooner 2000). For example, Coombs and Hull (1998) attempted to describe the field of knowledge management and the practice of knowledge within organisations under the following three headings:

1. Knowledge processing: This group of knowledge management activities is concerned with the generation, transfer, utilisation, identification, capture/retrieval, format and codification of knowledge.

2. Knowledge domains: This group is concerned with the classification of knowledge. For example factors affecting knowledge acquisition in the following areas differ considerably: internal and external knowledge, technical knowledge, product knowledge, process knowledge and project knowledge.

3. Knowledge formality: This group is concerned with the format of knowledge. For example the format of formal knowledge differs quite substantially from the format of informal knowledge. Similarly, time, location, dependency and technology used all have different formats for creating, capturing, organising, accessing and sharing knowledge. According to Soliman et. al. (1999b) the processes of managing knowledge in organisations are

the means by which value is added to raw-knowledge (inputs) which in turn is used to create processed-knowledge (outputs) that eventually add value to clients. The specifics of this will of course vary substantially across industries, however in general, there are four primary processes for handling resources knowledge, which are common across most organisations; namely: 1) Adding value to information, 2) Capturing and sharing knowledge, 3) Creating or generating knowledge and 4) Utilising knowledge.

In addition to the above four primary knowledge management processes, organisations must also have in place additional processes for organising and accessing knowledge. For instance when knowledge can be codified it must be organised in a way for others to find and recognise its relevance. It is only when the information is understandable, relevant and useable that it can be converted to knowledge and acted upon. This means knowledge should be assessed and evaluated before it is used.

Despite the benefits that organizational units will obtain from knowledge management and despite the wide spread popularity of knowledge management, no work was conducted for evaluating knowledge or at least identifying factors that influence decisions to choose or prefer knowledge entities over others. While researchers and strategists were able to distinguish between strategies, they lacked similar abilities in differentiating between good or useful knowledge from defective or poor or unhelpful knowledge until the end of 1990s.

Soliman and Spooner's (2000) work on evaluation of strategies revealed that poor knowledge or defective knowledge could contribute to the failure of some strategies. The Soliman and Spooner work further identified a relationship between poor or defective knowledge and poor or unachievable strategy. In that regard, Soliman and Spooner (2000) compared intended strategies with realized strategies and found that there is mismatch between the knowledge needed for the intended strategy and the knowledge associated with the realized strategy.


They referred to this knowledge mismatch as knowledge gaps and referred to the discrepancies between the intended strategy and the realized strategy as a strategic gap. They also found that the strategic gaps correspond to knowledge gaps which they identified as mismatch between knowledge need for intended strategy and knowledge associated with the realized strategy. They further used forward mapping techniques (Soliman, 1998) to identify what organisations can do, and sued the backward mapping to identify what organisations must know.

Forward mapping identifies the difference between what an organisation can and must do and highlights the strategic deficiencies of the organisation. Equally true, backward mapping identifies the knowledge gaps and what employees know against what they should know to overcome existing knowledge deficiencies.

The Soliman and Spooner (2000) work has sparked interest in the topic of knowledge gaps as discussed below:

Campos and Sanchez (2003) have shown that complex knowledge management systems may lead to intensive knowledge spirals. However, they failed to point out that both knowledge loops and knowledge spirals could lead to knowledge gaps and this in turn could result in strategic gaps. Campos and Sanchez’s work was limited and could not be generalized to cover relationships' knowledge gaps and strategic gaps in organizations.

Further work by Maier and Remus (2003) has shown that most organizations improve their knowledge management initiatives by linking to business strategies and in doing so, organizations may be overlooking the existence of knowledge gaps and hence strategic gaps. Maier and Remus failed to recognize that the organizational performance may be related to the existence of knowledge gaps.

Other work by Snyman and Kruger (2004) emphasized the interdependency between strategic management and knowledge management. However their work does not address the real issue which is the mismatch between knowledge strategy and business strategy and whether organisations could improve performance by eliminating or neutralising the effect of strategic gaps through identification of knowledge gaps.

Hellstrom and Husted (2004) have presented the finding of a focus group's study in a university setting, showing that knowledge mapping could be a useful tool in knowledge management. However, the findings are limited to an educational environment and there is no evidence that the finding could be generalized and related to the development of business strategies and the process of knowledge mapping in identifying knowledge gaps, and hence strategic gaps, in organizations.

Smith, (2004) pointed out to the relationship between knowledge management strategy and internal competitive strategies. Smith also reported the findings of a study of three organizations based on the grounded theory approach. Smith’s findings are limited to internal competitive strategies and lack the generalization to identify how the weaknesses in the relationship could be attributed to the existence of knowledge gaps that could lead to gaps in the organization’s internal competitive strategies.

Neef, (2005) reported that many organizations use a combination of knowledge and risk management to boost performance. Neef overlooked that knowledge gaps and strategic gaps may lead to further risks and in turn adversely affect the performance of organizations.

Nielsen, (2005) summarized the evolution of strategic management and knowledge management in contemporary business perspectives. Even though Nielson’s work pointed out to the significance of the linkage between strategic management and knowledge management, Nielsen failed to address the weaknesses of the linkage and in particular the existence of strategic gaps and knowledge gaps in global organizations. Nielsen also failed to highlight how such strategic gaps and knowledge gaps could impact adversely on each other.

Mehrez (2010) applied the Soliman and Spooner approach to identify factors leading to failure of some industrial applications known for being of high quality. In fact Mehrez's (2010) work pointed to the existence of quality gaps in some of the well known quality programs. The problem remains as to how one distinguishes between good knowledge and less useful knowledge.

ATTRIBUTES AND CHARACTERISTICS OF KNOWLEDGE As enterprises are continually challenged to perform better and go further than their competitors,

they should be viewing their collective knowledge as a key competitive tool from which innovation and competitive advantages can emerge. Soliman et. al. (1999) noted that when enterprises attempt to define their existing knowledge management activities, they become in a position to identify areas for potential improvement, which could yield competitive advantages. Equally correct, management should be able to identify areas of weakness that could hinder the organisational effort to achieve or sustain competitive advantages. From the above discussion, knowledge gaps could be one such weakness that hinders or obstructs organisational progress.

Given that knowledge management is considered a key competitive advantage, efforts must be directed towards identifying and segmenting knowledge so that management can determine which knowledge is useful and which knowledge is inappropriate or unwanted.


According to Mockler (1998), Knowledge-Based Systems should have the following seven characteristics:

1. Contain symbolic programming and reasoning capabilities. 2. Contain a knowledge base about a specific decision domain or situation that is in large measure

distinct from the inference mechanism. 3. Contain an inference engine, or inferential reasoning capability, that is in large measure distinct

from the knowledge base. 4. Can handle uncertain, unknown, and conflicting data. 5. Allow a programmer or user to modify segments of programs relatively easily. 6. Have a facility to explain their advice or reasoning process. 7. Use if-then rules (heuristic’s) extensively, but not necessarily exclusively.

Moreover, while decentralised enterprises may know where the bulk of their knowledge resides, the problem becomes disseminating that knowledge to the people who need it. It may need sorting or screening so that the appropriate knowledge is delivered timely and in the acceptable forms. Soliman and Youssef (2003) pointed out that characteristics for information critical to knowledge management should have seven characteristics; namely Accuracy and precision; Timeliness and currency; Relevance; Conciseness; Completeness; Good presentation; and Cost-effectiveness.

However for Knowledge to be useful and appropriate it must encompass the following characteristics:

Accuracy Accuracy of knowledge is difficult to measure but it is possible to judge the knowledge against

already perceived knowledge. The degree of closeness of the knowledge of interest to the perceived knowledge may reflect confidence in the knowledge used which in turn may reflect its actual (true) value. Reproducibility and repeatability of knowledge could be dependant on other characteristics. Accuracy is the degree of veracity while in some contexts precision may mean the degree of reproducibility, Accuracy could refer to reliability, truthfulness, and correctness of the knowledge content such as:

1. Where does the knowledge come from? 2. Could the knowledge be supported by evidence? 3. Could the knowledge be verified by others? 4. Does the language or tone seem biased and free of emotion?

Timeliness and currency Timeliness of knowledge is necessary to avoid making decisions that are out of date and hence

harm the organisation's progress. Therefore one essential qualification of knowledge is that it must be current. Currency of knowledge means that it is possible to determine:

1. When was the knowledge obtained? 2. Has the knowledge been revised or updated? 3. Is the knowledge current or out-of-date for the topic?

Relevance of Knowledge: A number of authors have indicated a direct association between relevance and organisational

impacts. This means knowledge relevance could be evaluated in terms of ease-of-use, functionality, reliability, flexibility, portability, integration, and importance. Organisational impacts should be determined by the quality of the work environment and job performance. The importance of relevance of knowledge could be determined by the following questions:

1. Does the knowledge relate to the topic? 2. Who are the intended users of the knowledge? 3. Is the knowledge at an appropriate level, i.e. not too elementary or advanced for employees’

usage? Authority

Authority of knowledge means a determination where the knowledge comes from so that its integrity and reality could be established. The source of the knowledge could be determined by knowing:

1. Who is the author/publisher/source/sponsor of the knowledge? 2. Are the author’s credentials or organizational affiliations given? 3. What are the author’s qualifications to produce or handle the knowledge?

Purpose The purpose of the knowledge usage or acquisition or transmission or sharing is necessary to

be established. In this regards the purpose of knowledge could be a critical factors in determining its integrity and hence the intended purpose should be determined though:

1. What is the purpose of the knowledge? to inform? teach? sell? entertain? persuade? 2. Do the authors/sponsors make their intentions or purpose clear? 3. Is the knowledge fact? opinion? propaganda? 4. Does the point of view appear objective and impartial? 5. Are there political, ideological, cultural, religious, institutional, or personal biases?


Importance Importance of knowledge encompasses whether the characteristic of knowledge under

consideration can be controlled within the organization, whether it focuses on a key management issue, whether it addresses a real-world problem, and whether it is timely. Based on these criteria, important is that which meets the needs of organisation by addressing a real world problem in a timely manner, and in such a way that it can act as the starting point for providing an eventual solution. Accessibility

Accessibility of knowledge encompasses whether the knowledge is understandable. Substantial evidence suggests that if managers perceive knowledge as being difficult to understand, it loses its usefulness. Furthermore, accessibility of knowledge encompasses whether the knowledge is understandable, readable, and focuses on achieving the desired outcome for the organisation. Applicability

Applicability of knowledge encompasses whether the knowledge is complete, whether it provides guidance and/or direction. Many projects lack, for example, detailed insights into how to use knowledge provided. This may be due to inapplicability of the knowledge. Furthermore, applicability of knowledge encompasses whether the published knowledge is complete, whether it provides guidance and/or direction, and whether it provides concrete recommendations for appropriate action. Even if managers believe that the knowledge is important, they may not be able to apply it. Suitability

Suitability of knowledge encompasses whether the knowledge deemed to be important to the organisation and suitable for meeting its needs, can be further elaborated to assist the organisation achieving its strategic objectives. It is envisaged that applicability and suitability of knowledge may be interrelated. If knowledge is deemed to be important to the organisation and suitable for meeting the needs of practice, the knowledge could be further enhanced to be made more suitable for its intended usage.

It is important to mention that Soliman and Youssef (2003) pointed out that the purpose of the critical information for knowledge management is to: create efficient operations; provide control; measure performance, compare results with the standards and take corrective action if necessary. Therefore the above knowledge characteristics provide a safety net for the array of benefits obtainable from good knowledge management. In other words, enterprises need to enhance their efficiency and effectiveness with the aid of good knowledge management that creates opportunities to reduce and eliminate non-value-adding work.

CONCLUSIONS Knowledge management has been widely recognised as an essential tool in managing

organisations. Good knowledge management programs or tools impact positively on the performance of the organisation and therefore, the goodness and usefulness of knowledge management is a competitive advantage. This means organisations must carefully evaluate the knowledge management programs and/or tools. This requires assessment of knowledge itself. In other words good strategies must be based on good knowledge and the inverse is true, i.e. poor or incomplete knowledge could results in poor or defective strategies.

Therefore a method for assessing the attribute of knowledge is required. In this chapter nine important characteristics of knowledge are highlighted. The nine characteristics of knowledge are:

1. Timeliness of knowledge; 2. Currency of knowledge; 3. Relevance of knowledge; 4. Authority for obtaining knowledge; 5. Purpose of knowledge; 6. Importance of knowledge; 7. Accessibility of staff to knowledge; 8. Applicability of knowledge, and 9. Suitability of knowledge to the application.

The success of innovative organizations today is often a result of good knowledge and skills applied by their professional and technical employees. Effective management of such a work force has become one of the most critical problems faced by organizations in both the private and public sectors. This should be translated into good assessment and examination of knowledge so that its management can focus on achieving the organizational objectives.


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Transferability of Chinese Human Resource Management Practices in Bangladesh: A Case Study

Dr. Md. Khasro Miah, Associate Professor, School of Business, North South University, Dhaka,

Bangladesh. Md. Faisal Ibne Wali, Lecturer, School of Business, North South University, Dhaka,

Bangladesh

ABSTRACT In this study, we have addressed the key issue of how Chinese multinational corporations

(MNCs) operating and dominating Chinese human resource management (HRM) practices in the same cultural setting of Bangladesh. The core finding of this study revealed that in order to encourage and retain talented employees, Chinese MNCs applied home country HRM practices especially “Confucius values,” “Guanxi” through ethnocentric approach to operate business in Bangladesh. In addition, significant differences in HRM practices across studied firms between two countries have been discovered. One of the extensive findings in this case study shows that Chinese MNCs applied conservative HRM practices for Bangladeshis subsidiaries. Finally, this study will assist to understand how Chinese HRM practices can be useful in the Bangladeshi business environment and how Chinese MNCs can help Bangladeshi corporate culture to further develop competitive advantages through effective HRM practices. KeyWords:Chinese and Bangladesh HRM practices, Cross-cultural and Convergence-Divergence

Issue, Chinese MNCs, Bangladeshi Local firms, Confucius values and Guanxi.

INTRODUCTION There have been long concerns for multinational corporations (MNCs) regarding subsidiaries’

Human Resources Management (HRM) practices and effects on the overall performance of the organization. MNCs want to gain competitive advantages from lower labor cost and locational advantages from its subsidiaries, but one of the main challenges for subsidiaries is to develop HRM practices based on comprehensive sophisticated HR practices (Miah and Bird 2007). MNCs develop HRM practices for subsidiaries based on home country and Host County’s environment in order to mitigate differences between two cultures. Regarding South Asia’s traditional and autocratic leadership practices, MNCs are more concern as modern HRM practices views these practices less productive and effective for most organizations (Habibullah, 1974; Miah, 2000; Miah et al. 2003).

Bangladesh is strategically located in emerging South Asian markets (Abdullah et al. 2011) and has already adopted best policies in South Asia to attract Foreign Direct Investment (FDI) (Rahman et al. 2011). JP Morgan and Goldman Sachs have highlighted Bangladesh in “Frontier Five” and “Next Eleven” respectively (Abdullah et al. 2011). Many Chinese MNCs have already started operating in Bangladesh to gain competitive advantages in the global arena. One of the main reasons of China’s dominance in the world economy is evolved from the capacity and capability to up hold Chinese traditions with unique blend of modernization. The strong economic prospects of China powered expansion of commercial relationship with other countries worldwide (Goodman and Segal, 1998) along with having membership of World Trade Organization (WTO) (China and the WTO 1999).

Development of an instrument to assess business strategy orientation is warranted and may provide foreign investors and non-Chinese managers with potentially useful tool for evaluating business strategy (Nie, 2005). In this study, emphasis had been given to identify different Chinese HRM practices taken by Chinese MNCs in Bangladesh. It is important to identify as some MNCs subsidiaries prefer to transfer home country’s HRM practices where as some MNCs believe locally developed HRM practices (Bird et al. 1999). The main objectives of the study are to understand Chinese HR practices by Chinese MNCs in Bangladesh and to find out ways to transfer stronger sides of Chinese HRM practices into Bangladeshi organizations to gain more competitive advantage in global business environment. This study is significant as it will broaden the perspective of Bangladeshi HRM practices by analyzing how Chinese MNCs are applying Chinese HRM practices according to a particular culture in Bangladesh.

HOME COUNTRY HUMAN RESOURCE MANAGEMENT PRACTICES The work culture of China is strongly influenced by certain traditional Chinese cultural values

like ‘guanxi’ (Wright et al. 2002) ‘face’ ‘harmonious relationships’ and ‘Confucian HRM’(Warner 2010). These values focus on harmonious relationships between the employers, employees and government (Benson et al. 2000; Vanhonacker, 2004). In China HRM practices are largely based on relationships (Goodall and Warner, 1997). Even Government encourages more labor intensive production by providing financial incentives to the employers if companies employ surplus workers (Verma and Zhiming, 1995; Glover and Siu, 2000). However, the concept of job for life tradition may be diminishing but still has significant place in Chinese psyche and HRM practices.


In addition, centralized decision making and recognition of hierarchy (Sudhir, 1993) is also another practice originated from Confucius beliefs that encourages respecting seniors. Chinese employees are group orientation (Bond, 1991) and tend to remain as part of a group, team or unit. In order to distinguish between insiders and outsiders, China has developed distinct characteristics among themselves due to collectivist culture. The concept of guanxi or personal relation is dealt in the organizations with mutual favors and string pulling between organizations and authorities (Xin & Pearce, 1996).

HOST COUNTRY HUMAN RESOURCE MANAGEMENT PRACTICES Managers and scholars agreed on the fact that HRM practices have significant impact on

organizations productivity, performance (Arthur, 1994; Huselid, 1995; Ichniowski et al. 1997; Katou and Budhwar, 2007; Miah and Bird 2007). Recent studies on Bangladeshi HRM practices revealed that in order to have stronger employees’ commitment towards organizations performance, HRM practices play significant roles (Billah and Islam, 2009; Billah, et al. 2009). Bangladeshi organizations also proved that HRM practices have significant positive relation with firms’ performances (Islam and Siengthai 2010). Another independent research revealed that financial reward policy places the most significant effect on employees’ performance followed by diversified workforce culture (Rahman et al. 2011).

For optimum organizational performance, HRM practices need to be coordinated with long term goals of the organization. There has been a long debate in Bangladesh regarding integration of HRM practices with organization’s overall objective. Even ten years back, a study shown that out of ninety two medium and large enterprises in capital Dhaka, 62% of surveyed organization had formal HR or IR department (Moyeen and Huq 2001). The growth of HR practices in Bangladesh was highly influenced by different factors including owners’ education, government regulations, presence of visionary owners in different sectors, presence of MNCs and employees relations. A study has also revealed similar findings on relevant factors that influenced the development of HRM practices in Bangladesh (Absar et al. 2010).

The rapid pace of globalization of markets in recent decade has added new dimensions to the HRM practices to create competitive organization. It is argued that the fundamental concept of becoming effective corporations has a symbiotic relationship with society, and has responsibilities toward society beyond profit maximization (Amaeshi et al. 2006). Bangladeshi HRM practices have significant impact on employees’ loyalty and commitment towards organizations (Haque & Azim 2008).

METHODOLOGY In this study, influence of Comparative HRM practices, HRM activities in Chinese MNCs and

Bangladeshi local companies have been analyzed. We have decided to adopt a qualitative approach to our research strategy. Researchers have contended that quantitative research methods may hold some merit with respect to presuming real time information on different HRM practices in MNCs subsidiaries. However, for the purpose of understanding and comprehending the expansion process and dynamic nature of international human resource management (IHRM) practices, such as demonstration of historical and longitudinal information, characteristic of quantitative methods would have provided little help. This may be attributed to limited capacity of quantitative approaches to take into account the overall context.

Therefore, in regard to IHRM practices which involve a variety of employees and various organizational cultural effects, a more appropriate approach seem to be the qualitative one. Moreover, according to Martin and Beaumont (1999), quantitative methods were considered to lack the robustness to provide comprehensive and convincing descriptions of HRM development processes, and instead advocated thorough qualitative case studies to unearth the insights of HRM development processes in MNCs. In this study, independent opinion or plain information would not be able to elucidate without case study method. It provided scope to understand behavior of decision makers and highlight the historical practices.

Five Chinese MNCs and five Local companies were selected for the study. In order to properly contrast findings, we considered equivalence of research methods and research formalities at the data collection stage. Moreover, to take into account the process dynamics of gradual evolution of Chinese MNCs and local companies HRM practices, we collected retrospective and real-time data.

To facilitate data collection for this study, the authors focused on Primary data collection and Secondary data collection. In primary data gathering, the authors collected data using methods such as interviews and structured questionnaire. In this case study a comprehensive structured questionnaire related to Chinese MNCs and Bangladeshi local companies HRM practices was developed. Next, our team personally interviewed HRM managers, administration managers and senior HRM official at each of the selected Companies in Bangladesh, to get valuable information. First day, interviews were focused on the prevalent HRM officials in each organization. Discussion on the entire questionnaire, with companies’ top executives, allowed getting their response about the theme. In some areas related to basic HRM practices, some organizations’ top executives were


hesitant to respond very frankly. However, the authors personally paid visits throughout the week days, to accumulate among the companies’ corporate and factory offices and observed company officials and HRM activities, towards end of the year 2011. To enrich the study Efforts were made to get the best ideas that helped in understanding the companies’ HRM policies and practices. After scrutinizing data, we personally re-examined all Companies corporate offices for gathering additional information about HRM practices of two different types of companies in Bangladesh.

In addition, all interviews were tape recorded on-site coupled with written notes taken of the discussion. After returning from interview sites, recorded conversation were transcribed and translated immediately. Thereafter, all interview transcripts were shown to the interviewees for verification. Based on our theoretical assumptions, we categorized our data in distinct groups such as related to HRM issues, production integration issues, IHRM policy orientation issues especially Confucianism and Guanxy philosophy, and convergence and divergence issues.

All interview data was transcribed in the form of narrative stories. We made use of the “meaning reduction approach” to dissect appropriate codes in order to generate themes pertaining to the research questions. After decoding all the interviews, we reviewed the narratives and compared and contrasted the facts of all ten cases. Firstly, we looked for patterns and links in individual cases and consequently explained with interrelated evidence within and across cases. We were able to develop a general explanation of cause-effect relationship of IHRM practices for each individual case by making use of the data contained in the multiple case studies. Prior conceptualization of Chinese MNCs and local HRM practices helped us explain the narrative link between two different types of organization working in the same cultural setting in Bangladesh. We tried to employ the relevant codes to rearrange the evidence into categories that would be helpful for the comparison of evidence within and between cases, while explaining the pervasiveness of two social phenomena— fundamental differentiation among the organizational practices and into two country organizations. To support and clarify the study findings, we developed a summary table to demonstrate the similarities and differences among the cases.

Table 1: Background information of the sampled data from Chinese MNCs (Joint Ventures/Subsidiaries) and Bangladeshi Local Firms

Criteria Bangladeshi Companies

Company A Company B Company C Company D Company E

Main products & services Banking Services

Ready Made Garments

Banking Services

Brokerage Services

ATM Network Solutions

Establishment year 1993 2002 1992 1997 2000 No. of employees 2500 1500 1100 128 200

% of foreign capital N/A N/A N/A N/A N/A

No. of foreign expertise 3 2 0 1 0

Total assets in USD $ N/A US$ 15.00 million

US$799.29 million

US$ 41.01 million

US$ 3.28 million

% of sales in domestic market 90% Only By

Products 95% 95% 100%

% of sales in foreign market 10% 99% <5 % 5% Not Applicable

Average age (years) 34+ 27+ 32+ 25 + 27 + Average education Bachelor Bachelor Masters Bachelor Bachelor

Average monthly salary (BDT) 28000 20,000 28000 23,000 28,000

Number of strike day Zero Zero Zero Zero Zero Business growth 20% 20% 56% 78 6.09

Employee turnover rate Minimal Not Given Minimal <5% 1%


Criteria

Chinese MNCs in Bangladesh Company A Company A Company A Company A Company A

Main products & services Telecom Solution Provider

Telecom Solution Provider




Establishment year 2001 2001 2001 2001 2001 No. of employees 1500 1500 1500 1500 1500

% of foreign capital 80% 80% 80% 80% 80%

No. of foreign expertise 25 25 25 25 25

Total assets in USD $ Not Given

Not Given

Not Given

Not Given

Not Given

% of sales in domestic market 25% 25% 25% 25% 25%

% of sales in foreign market 75% 75% 75% 75% 75%

Average age (years) 29 + 29 + 29 + 29 + 29 + Average education Bachelor Bachelor Bachelor Bachelor Bachelor

Average monthly salary (BDT) 28,000+ 28,000+ 28,000+ 28,000+ 28,000+

Number of strike day Zero Zero Zero Zero Zero Business growth 35% 35% 35% 35% 35%

Employee turnover rate Not Given Not Given Not Given Not Given Not Given

RESULTS Recruitment and selection

Bangladeshi organizations follow more structured recruitment and selection process than Chinese MNCs in Bangladesh. From job advertisement to written test, most of the Bangladeshi organizations are following formal and structured process, unlike Chinese MNCs. Chinese MNCs are providing more emphasis on structured interview process as they are more reluctant in initial stages of recruitment and selection process. Both country origin organizations are considering negotiation stage very importantly.


Table 2: Comparison of the HRM Practices between Chinese MNCs (Subsidiaries/Joint Ventures) and Bangladeshi Local Firms

Criteria Bangladeshi Companies

Company A Company B Company C Company D Company E

Recruitment & Selection Process

Job advertisement Semi -formal Highly formal Formal Formal and

informal Informal

Screening Structured Structured Structured Occasionally Occasionally

Written Test Formal Formal Formal Occasionally Never

Interview Unstructured Structured Semistructured

Highly structured

HighlyStructured

Medical Test Not required Essential Essential Not required Not required

Negotiation Moderate High High Moderate High

Referral Preferred Minimal For TopManagement Minimal High

Similar industryCandidates

Highly preferred Preferred Preferred Highly

preferred Highly

preferred

Training and Development

Criteria Yearly all employees

Incumbent’s need

Incumbent’s need

Monthly all employees Job need

Venue In house In house In house, home and

abroad In house

In house, home and

abroad

Type Job requirement

Dept's need

Depends on posts.

Incumbent’s Need

Dept's requirement

Trainer In house and outsourced Outsourced In house and

outsourced In house and outsourced Outsourced

Promotion System

Basis Viva Performance Job knowledge Viva Credibility

Issued by Department Department Department and HR

Department and HR

Department and HR

Performance Appraisal

System

Frequency Annually Annually Bi-annually Annually Annually

Criteria Leadership KPI driven Customers’evaluation KPI driven KPI driven

Appraised by Dept Dept 3600 Dept & HR Dept & HR

Criteria

Chinese MNCs in Bangladesh Company A Company B Company C Company D Company E

Recruitment & Selection Process

Job advertisement Formal Highly formal Semi-formal Formal Informal

Screening Semi-structured Highly Structured Semi-structured Highly Structured Moderate

Written Test Never Never Never Never Occasionally

Interview Semi structured Highly Structured Structured Highly Structured Structured

Medical Test Not required Not required Not required Essential Not required

Negotiation High High Moderate Moderate Moderate Referral Highly Preferred Preferred Highly Preferred Preferred Preferred

Similar industry Candidates

Expatriate preferred


Expatriate highly preferred

Expatriate highly preferred


Training and Development

Criteria Dept’s need basis Need basis Need basis Monthly all

employees Monthly all employees

Venue In house, home and abroad In house In house, home

and abroad In house, home

and abroad In house, home

and abroad

Type Dept's need Need basis On the Job Dept.’s basis On the job

Trainer In house and outsourced Outsourced In house and

outsourced In house and outsourced

In house and outsourced

Promotion System

Basis Seniority Seniority Seniority Seniority Performance

Issued by Department and HR Department Department

and HR Department

and HR Department

and HR

Performance Appraisal

System

Frequency Bi-annually Annually Annually Annually Monthly Criteria Sales Volume KPI driven KPI driven Expertise KPI driven

Appraised by Dept & HR Department Dept & HR Dept & HR Dept & HR


The study observed that, Chinese MNCs prefer more referral candidates than Bangladeshi firms. Best practice in Chinese MNCs in Bangladesh is to “prefer referral candidates” for recruitment and selection process that indicate traditional Chinese value of ‘guanxi’ (Hwang, 1987; Luo, 1997; Tsang, 1998; Wong and Chan, 1999; Yang, 1994, 2002; Lu, 2012). Even to hire candidates from host country national, Chinese MNCs prefer reciprocity and personalize candidates based on Confusion value (Redding, 2002; Child and Warner, 2003; Law and Jones, 2009; Warner 2010). Study also revealed that, all the Chinese MNCs in Bangladesh preferred Chinese expatriates from the similar industry rather than local experts from similar Bangladeshi industry.

Chinese MNCs ethnocentric staffing approach is evident form Chinese MNCs in Bangladesh. Overtime, Chinese MNCs realized that the successes of overseas subsidiaries are largely depending on correct selection of staffs; hence more emphases have been given to technical and managerial capabilities rather than other individual competencies (Shen and Edwards 2004). Chinese MNCs in Bangladesh prefer Chinese employee in the top management who has been working for the organization in host country or other country. These five Chinese MNCs in Bangladesh are having seventy two foreign expatriates whereas in the Bangladeshi organizations in the similar industry are having only six expatriates. A possible explanation of this approach could be rewarding the follower of “guanxi” model from China and inside the organization. Training and development

According to Chinese MNCs in Bangladesh, training is an integral part of the businesses to achieve their business objectives. Chinese MNCs in Bangladesh are arranging training on monthly basis, based on departments’ need and even to refresh learning from previous trainings. Whereas in contradiction, Shen and Darby (2006) revealed that Chinese MNCs provide limited international training to other nationals. Chinese Company A, D and E provide more training to employees as the nature of the business require more technical understanding and customization of product and services.

In order to ensure effective and advanced training, four Chinese MNCs in Bangladesh send expats and host country origin employees to foreign training centers especially in China. In order to provide world class training, China has developed training and development infrastructure in China and Chinese corporations are getting benefit and creating competitive advantage (Warner, 2011). Competitive training infrastructure, cost and technical understanding of Chinese know-how are the reasons to send employees in China. Another reason for foreign training in China is ethnocentric approach of Chinese MNCs business model that supports Shen and Darby’s (2006) findings.

Bangladeshi companies are providing training on need basis, derived by the incumbent or department. Only company D provides training on monthly basis as stock market is very volatile and dynamic. In order to remain competitive service provider in the market, Company D continuously needs to update employees on new market trends and practices. Bangladeshi company C and E are determined to provide better training and even send employees abroad to get the best possible training. Company A, C and D are having in-house trainer in order to ensure immediate response to training need. On the job training is the preferable way of serving training needs for Bangladeshi companies A, C and D. Study revealed that, only company D provides option to incumbents to come up with own training need unlike other four companies where department heads decides the need for training. Promotion system

Chinese MNCs in Bangladesh provide more emphasis on seniority while promoting employees. Performance is ranked as next important factor for being promotion. Chinese company A, B, C and D explained that during recruitment technical knowhow and managerial capabilities are judged. So, unless significant differences in performance are found, senior employee will be preferred for next promotion over junior employee’s performance. Findings indicate that promotion criteria of Chinese MNCs in Bangladesh are based on Confucian values. “Societal order” of Confucian value relates to HRM in terms of keeping harmony at work and another value “Control” relates to HRM in terms of having effective leadership in the organization (Warner, 2010). It is evident from the study that Chinese MNCs in Bangladesh are also maintaining Confucian values during promotion.

On the other hand, performance, job knowledge, credibility and viva are basis for promotion in Bangladeshi organizations. Each company developed its own basis for promotion rather than having a common set of basis for all organizations. Bangladeshi organizations have linked promotion with the overall business objectives and performance. If an employee is performing well, established credibility and in viva incumbent has shown long-term commitment towards the organization, than only promotion is given. Long-term commitment in Bangladeshi organization is important to prevent job hopping. Performance appraisal system

All the Chinese MNCs in Bangladesh supported that performance appraisal is an integrated and important part of the organization. However, in Chinese company B, C and D, performance appraisal takes place only once in a year. In Chinese company A and E, bi-annual and monthly


performance appraisal are taken place respectively that indicates commitment and importance on performance appraisal system. Bi-annual and monthly appraisals provide feedback to employees to improve performance. Unlike Chinese company A and E, other three companies do not provide feedback to employees. Similar evidence has been revealed from another study where most of the Chinese companies hardly provide feedback to its employees (Shen, 2007).

The criteria for performance appraisal in all the Chinese MNCs in Bangladesh are based on short-term goals. Except Chinese company D, other Chinese companies A, B, C and E have set Key Performance Indicators (KPI) and Sales volume as appraisal criteria. Incumbents are appraised by both department’s head and HR department that ensures organizational hierarchy and control and established HR departments authority in the organization. Application of Confucian values like hierarchy and control (Warner, 2010) are evident from this appraisal system.

Bangladeshi organizations are following annual performance appraisal system except Bangladeshi company C that follows bi-annual performance appraisal system. As a result, proper and timely feedbacks to employees are not ensured. Throughout the year, if an employee loses its track on KPIs, than it is not possible for the employees to meet objectives at the end of year which affects the overall performance of the organization. A study by (Absar et al. 2010) has revealed that even in Bangladeshi organizations, performance appraisal and compensation is highly correlated than other relevant factors.

KPI, Leadership and customers’ evaluation are the criteria on which Bangladeshi organizations prefers to evaluate its employees. Leadership criteria have been set by Bangladeshi financial service organization ‘A’ which is more appropriate in Bangladeshi context. Among financial service providers, Bangladeshi company A is performing better than C where the leadership criteria played a vital role rather than short term KPI driven criteria by Bangladeshi company C. However, in terms of appraisal, Bangladeshi company C has adopted 3600 performance appraisal system. Even other Bangladeshi and Chinese MNCs in Bangladesh have not yet adopted the technique. Other Bangladeshi firms B, D and E needs to more effective appraisal system to enhance firms overall performance. A research by Islam and Siengthai (2010) has also revealed a positive relationship between performance appraisal and firms’ performance in the context of Bangladesh.

LESSON FROM CHINESE MNCs’ IN BANGLADESH HRM PRACTICES FOR BANGLADESHI ORGANIZATION

Policy lessons for companies To improve the efficiency of Bangladeshi organizations, some of the Chinese HRM practices

can be adopted based on our case study. First the talent acquisition process, as the success of an organisation hinges on the output of its human workforce. Secondly, the performance management of the selected workforce in regards to the strategy of the organisation. Result suggests that organisations that have successfully implemented performance management system are delivering significant benefits including productivity improvements, organisational improvements, enhanced strategic capabilities etc. Bangladeshi company A is practicing the Confucian value of Control or leadership (Warner 2010) in performance appraisal process and already proved as an effective tool.

Selected workforce should have been given a clear idea of on what management wants from them and how they will be rewarded and compensated. The workforce and trainers should also undergo periodic training and development. Chinese counterpart Company E conducts regular training on monthly basis for all the employees of the organization and created competitive workforce. Besides, Chinese MNCs in Bangladesh are very particular about ensuring training providers themselves are aptly knowledgeable and educated. In addition, training can be applied for IT applications like customer relationship management, product data management, financial management, asset management, etc. and indicate that only the best workforces get the maximum benefits from new technologies (Richard et al. 2008).

In addition, corporate culture is also a determining factor for an effective organisation. In Bangladeshi traditionally hierarchical society, seniors are hardly questioned. There is also a tendency in the employees to shun responsibilities. This implies that the few individuals at the top of the management have to waste valuable time. This practice results in the loss of creative energy for both the subordinates and the ones trying to micro manage.

However, organizations will be benefited by filtering out some HRM practices in the Chinese organizations that do not match with the Bangladesh corporate culture. In China, political influences are a major problem for the organizations. If this is allowed in Bangladeshi organizations, employees will put less concentration on work and more on stakeholder management and develop rapport with influential people. China has a tradition of giving authority to person who is aged or elderly with experience. But this comes in straight contradiction if we look the working nature of other MNCs in Bangladesh. Talents should be empowered irrespective of age.

Another problem is related to Personal Relation or ‘Guanxi’ and harmony. As per the modern business ethics, no employee should have any personal relationship with any other peers in any


organization (Xin and Pearce, 1996). There is an existence of Guanxi in Bangladesh mostly in traditional Bangladeshi organizations but employees should be judged on their work, merits and performances. Otherwise, the concept of talent attraction and retention will become ineffective. Policy lessons for the government

The government should ensure implementation of best model for ensuring effectiveness in companies in Bangladesh. While the majority of corporate issues might be solved at the company level but monitoring and enforcing laws related to labor issues, environment protection, and health and safety are urgent issues to strengthen neo-protectionism in the global trade arena in the near future. Government must establish a standard policy and procedures for local and multinational organizations. Rules and regulations that affect HR strategies must be carried out in a proper way to develop and adopt new laws and regulations to ensure job security as well as introduce in incentive in the form promotion/financial benefits. Regulatory clarity must be developed for MNCs that are working in our country along with HRM standards.

CONCLUSION China has achieved a great position in the global market through astute use of workforce.

Unique HRM practices have helped China’s productivity to increase significantly. The Bangladeshi organizations have a great deal to learn from China. By learning and implementing these practices, Bangladesh can build HRM systems ensuring sustainability and competitive advantage for the company. Hence current recommendations for Bangladeshi companies will be: Develop HRM practices as functionality for the company with the support of information technology in order to communicate a message of positive transformation to the employees that shapes the desirable organizational culture and aids sustainable competitive advantage for the company.

In order to implement the recommended strategies discussed earlier, Bangladeshi company must go through certain phases like talent hunting, training & development, reward & compensation, job security, performance management and maintaining industrial relations etc. In this age of technology, the functions of HRM have been strategized; it is the time to back it up with Information Technology. The typical organizational culture of a Bangladeshi company is to have a tall structure with highly formal relationships among employees. However, the scenario is changing in Bangladeshi organizations. With the entrance of the MNCs, a great deal of change has been noticed as foreign companies have been practicing home cultural mix with host countries culture that has created a new culture among MNCS.

Finally we have also focused on how the Bangladeshi Organizations can actually learn greatly from the Chinese culture. Bangladesh’s economy is also changing and this country also attracts many foreign MNCs. Bangladesh and China also has a common competitive advantage of cheap and available workforce. However, Bangladesh should learn how to optimize the use of available workforce by training them into skilled resource in order to maintain sustainable competitive advantage.

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The Effects of Atmospherics on Buying Intentions through Retail Benefaction:An Application of Utilitarian Dimensions and the Theory

of Planned Behavior to Patronage Intentions

Dr.Makarand Upadhyaya, Dr.Ali Medabesh Jazan University

Saudi Arabia.

ABSTRACT As in physical environments, one of the most important research topics is related to the effects of

the characteristics of these new interactive virtual environments on different dimensions of human behaviour. This is particularly relevant in the case of consumer shopping environment in which a service process takes place, has a paramount influence in re-assuring the customer and eventually enabling him or her in comprehending the experiential outcomes of purchase and consumption. The paper investigates the impact of retailscape (retail servicescape) on behavioral intentions of customers in the retail industry. The servicescape framework in this paper is based on selected aspects of Bitner’s (1992) servicescape framework and Wakefield and Blodgett’s (1994) model. Five servicescape dimensions have been identified, viz. ambient conditions, spatial layout, functionality, spatial signs, symbols and artifacts and cleanliness. The paper studies the impact of these dimensions on the perceived quality of the servicescape and on the shoppers’ desire to stay in the retail store. Factor Analysis is performed using SPSS 16. Multiple regression is employed to study the relationship between service dimensions and perceived service quality and perceived service quality and satisfaction and satisfaction and desire to stay. The study strongly supports that spatial layout and ambient conditions bear the strongest relationship with the perceived quality of the servicescape. These two dimensions make statistically unique contribution to the prediction of perceived servicescape quality. Keywords: servicescape, environmental dimensions, perceived quality, behavioral intentions

INTRODUCTION The influence of the environment on behavior has long been acknowledged by landscapers,

architects, interior designers, retailers, and environmental psychologists. Theoretical and empirical data from environmental psychology research suggests that customer reactions to the physical environment (also known as atmospherics’ or ‘SERVICESCAPE’) may be more emotional than cognitive, particularly when hedonic consumption is involved. While consumption of many types of service is driven primarily by utilitarian (functional) purposes, such as fast food drive-through services, consumption of leisure services (e.g., dining at an upscale restaurant) is also driven by hedonic(emotional) motives. Hedonic consumption is more than just perceived quality of the service being offered (e.g., whether a meal was delivered quickly), influencing whether consumers are satisfied with the service experience. One of the main reasons customers seek out hedonic consumption is to experience pleasure and excitement. Previous research indicates that the degree of pleasure (e.g., unhappy-happy) and arousal (e.g., excited calm) that customers experience during hedonic consumption may be a major determinant of their satisfaction and subsequent behavior such as repatronage and positive word-of-mouth. The atmosphere or the physical environment is important because it can either enhance or suppress these emotions.

REVIEW OF LITERATURE Physical environment is inevitably a means of influencing behaviors and creating an image,

especially for service businesses such as hotels, restaurants, professional offices, banks, retail stores, and hospitals (Baker 1987; Bitner 1986; Kotler 1973; Shostack 1977; Zeithaml, Parasuraman, and Berry 1985). Bitner and Bernard (1981) defined servicescape as “the environment in which the service is assembled and in which the seller and customer interact, combined with tangible commodities that facilitate performance or communication of the service”. McComish and Quester et al. (2007), consider servicescape to be a set of physical environment of the service setting which has an influential role on the consumer’s buying experience. Services are characterized by simultaneity, that is, simultaneous production and consumption, and hence more often than not a consumer is in the service factory where ambience adds to or detracts from his total experience of the received service. Physical surroundings are, in general, more important in service settings because customers as well as employees often experience the firm's facility. The lack of intangibility puts an absolute dependence on physical environment for gathering pre purchase cues on the quality and credibility of the firm’s offerings (Berry and Clark 1986; Shostack 1977). The physical environment especially abounds in such cues (Rapoport 1982) and exerts a profound influence in communicating the firm's image and purpose to its customers and prospects. Michaelle (1996) considered the service


environment or servicescape as a composition of aesthetic design, functional design, and social elements. Ambient or aesthetic design elements are “intangible background conditions that tend to affect the senses and in some cases may have a relatively subconscious effect” on the customer. Bitner (1990) proposed that physical setting also influences customer’s ultimate satisfaction with the service experience. Services typically require a direct interaction between customers and employees and hence the organization's environment should support the needs and preferences of both service employees and customers simultaneously. Employees too are influenced by a conducive physical setting and demonstrate higher productivity, morale, motivation and work place satisfaction (Becker 1981; Davis 1984; Wineman 1986). Servicescapes, though an important ingredient of the service offering, differ in its management and planning depending on the level of interaction that customers have with the facility. Bitner proposed a continuum where the left extreme represents a state of high customer involvement and the right extreme represents negligible customer involvement. For instance, in "self-service" organizations very few employees are present and the customer activity is very high, to the extent that he is practically a co-producer. At the other extreme lie the fully automated services, that is, the "remote service" where there is little or no customer involvement in the servicescape and sometimes even little employee involvement too. Between the two extremes are positioned the "interpersonal services". In these organizations, both customers and employees are present and performing actions within the servicescape. The relative level of involvement of customers and employees determines whose needs should be consulted in the design of the environment. In interpersonal servicescapes, special consideration must be given to the effects of the physical environment on the nature and quality of the social interaction between and among customers and employees (Bitner, 1992). Whether customers, employees, or both are present within the servicescape also determines the types of objectives a firm might expect to accomplish through use of its physical environment. In self-service settings, the creative use of physical design could support particular positioning and segmentation strategies and enhance specific marketing objectives, such as customer satisfaction and attraction. At the other extreme, for remote services, organizational objectives such as employee satisfaction, motivation, and operational efficiency could be the primary goals in physical setting design, because few customers would ever see or experience the firm's physical setting. For interpersonal services, both organizational and marketing objectives could potentially be targeted through careful design of the servicescape. Even marketing goals such as relationship building (Crosby, Evans, and Cowles 1990) could be influenced by the design of the physical setting.

Servicescape Models Wakefield and Blodgett (1994)

Wakefield and Blodgett (1994) proposed a servicescape framework that has five environmental dimensions viz. layout accessibility, facility aesthetics, seating comfort, electronic equipment displays and facility cleanliness. These five dimensions impact the perceived quality of the servicescape and consequently the satisfaction with servicescape. This in turn has a bearing on the patronage intentions and the desire to stay at the facility. Hence, the longer one spends in a facility, the greater the likelihood that the perceived quality of the servicescape will play an important role in determining satisfaction with the service. Physical surroundings thus play a role similar to a physical good’s packaging in that it basically communicates an image of what is included in the service.

Figure 1:

Source: Wakefield, K.L. and Blogett, J.G. (1996), “The effect of the servicescape on customers’ behavioral intentions in

leisure service settings”, Journal of Services Marketing, Vol.10 No.6, pp.46.


Bitner’s Model (1992) Bitner (1992) proposed a framework for explaining what behaviors can servicescape

influence and how and why should the service environment be planned to achieve the pertinent objectives that the organization has assumed for itself. Bitner’s framework suggests that both employees and customers are impacted cognitively, emotionally and behaviorally by the servicescapes in which they deliver and receive services respectively. These internal responses to the environment influence the behavior of customers and employees and these behaviors in turn affect social interactions between and among customers and employees. The model shares striking similarities with other models (e.g., Mehrabian and Russell 1974), but it is unique because the Mehrabian and Russell model focuses on emotional responses only whereas Bitner’s model encompasses cognitive and behavioral dimensions too.

Dimensions of Servicescape Dimensions of servicescape include all the objective physical factors that can produce a

possible approach effect for both customers and employees alike. There could be an infinite list of such factors- lighting, color, signage, textures, quality of materials, style of furnishings, layout, wall decor, temperature, and so on. Review of literature as well as significant research in this field by Bitner (1982) suggests three important aspects of servicescape as (See Figure 2)

1) Ambient Conditions (e.g. temperature, air quality, noise, music, odor, etc.) 2) Spatial layout and functionality (e.g. layout, equipment, furnishings, etc.) 3) Signs, Symbols and Artifacts (e.g. signage, personal artifacts, style of décor, etc.) According to

environmental psychologists, people respond to their environments in a comprehensive and holistic manner. That is, though individuals perceive discrete stimuli, it is the total configuration of stimuli that determines their responses to the environment (Bell, Fisher, and Loomis 1978; Holahan 1982; Ittelson et al. 1974). Hence, though the dimensions of the environment are defined independently here, it is important to recognize that they are perceived by employees and customers as a holistic pattern of interdependent stimuli.

Ambient Conditions Several authors have identified ambient conditions as a factor that affects perceptions of and

human responses to the environment (Darley and Gilbert 1985; Russell and Snodgrass 1987; Sundstrom and Sundstrom 1986). Ambient conditions affect the five senses and thus help in sensory branding of the service organization. Typically, ambient conditions include lighting, smell, temperature, noise and music. For example, in studies of restaurants and supermarkets, it has been illustrated that music tempo can affect pace of shopping, length of stay, and amount of money spent (Milliman 1982, 1986). Sometimes, these dimensions are not distinctly palpable, but yet have immense effect on customers and employees who spend a significant time at the service factory. Spatial layout and functionality

Spatial layout refers to size, shape, arrangement and spatial relationships among machinery, equipments, and furnishings. Functionality refers to the ability of the same items to facilitate performance and the accomplishment of goals of the customer, as service encounter environments are functional environment. Spatial layout and functionality are essentially important for self-service organizations where the customer is almost a co-producer and hence needs to be facilitated in the accomplishment of his goals of visiting the service organization. Signs, Symbols and Artifacts

Signs, symbols and artifacts are potent means of communicating the image of a service organization. Signages are explicit communicators and may include labels of departments, name plates, identity cards, directional material-arrows, and also rules of expected behavior-no smoking, danger zone, adults must accompany children, silence etc. Other elements in the environment, though not strong communicators, also convey a meaning and status. Quality of materials used in construction, artwork, presence of certificates and photographs on walls, floor coverings and personal objects displayed in the environment can all communicate symbolic meaning and create an overall aesthetic impression. Signs, symbols, and artifacts are particularly important in forming first impressions, for communicating new service concepts, for repositioning a service and in highly competitive industries where customers are looking for cues to differentiate the organization.


Figure 2:Servicescape Framework

Source: Adapted from Bitner’s (1992) Framework for Understanding Environment-user Relationship in Service

Organizations. Behavioral Responses to Servicescape Dimensions

The dimensions of organization’s servicescape influence important customer and employee behaviors. Mehrabian and Russell (1974) propose that individuals respond by exhibiting two general and contrasting forms of behavior-approach and avoidance. Approach behaviors include all positive responses towards a place-desire to stay, associate, affiliate, explore and work. Avoidance behaviors are just the opposite and include a desire not to stay, associate, affiliate, explore and work. In a study of consumers in retail environments, Donovan and Rossiter (1982) found that approach behaviors in a retail setting include a feeling of achievement by shopping, repatronage, expressions of commitment, attraction and friendliness toward others, spending money, spending time in browsing and exploration of the store. Milliman (1982, 1986) found that the tempo of background music can affect traffic flow and gross receipts in supermarket and restaurant settings. Each individual visits a retail outlet with a purpose and the physical setting of the outlet must help him in achieving what he had planned. For example, a shopper to a retail store must be able to locate the merchandize that he had planned to purchase, the signages should enable him to procure his stuff, the music, sound, acoustics, lighting and smell should be emotionally encouraging to instill in him a desire to stay for long. This is how a well planned retail servicescape assists a shopper to accomplish the purpose for which he has visited the store. Obviously, retail stores strive to cultivate positive (approach) behaviors and deter negative (avoidance) behaviors and at the same time enable customers and employees to carry achieve their desired outcomes. Besides affecting individual behaviors, servicescapes act as facilitators in increasing the quality of interaction between employees and customers, most importantly in interpersonal services. Bennett and Bennett (1970) state that "all social interaction is affected by the physical container in which it occurs." This physical container is aptly the servicescape that affects the duration of interaction and actual progression of events. Forgas (1979) suggests that environmental variables such as propinquity, seating arrangements, size, and flexibility can define the possibilities and limits of social episodes, such as those between and among customers and employees.

One of the challenges in designing environments to enhance individual approach behaviors and encourage the appropriate social interactions is that optimal design for one person or group may not be the optimal design for others (Baker, Berry, and Parasuraman 1988). Similarly, an environment that is conducive to an employee's individual work needs may not enhance the employee's ability to converse and interact interpersonally with customers. Theoretical Framework

The servicescape framework in this paper is based on selected aspects of Bitner’s (1992) servicescape framework (see figure2) with reference to Wakefield and Blodgett’s (1994) model (see figure1) in studying the effect on customers’ behavioral intentions in retail. Five servicescape factors applied to a retail store include (1) ambient conditions, (2) spatial layout, (3) functionality, (4) signs, symbols and artifacts, (5) cleanliness. The effects of these dimensions on perceived servicescape quality were examined. Based on this, it is hypothesized that:

H1: Ambient conditions affect the perceived quality of servicescape; H2: Spatial layout affects perceived quality of servicescape; H3: Functionality affects the perceived quality of servicescape; H4: Spatial signs, symbols and artifacts affect the perceived quality of servicescape; H5: Cleanliness affects the perceived quality of servicescape; H6:The perceived quality of servicescape has a positive effect on satisfaction with the

servicescape; H7: Satisfaction with the servicescape has a positive effect on the shoppers’ desire to stay in the

retail store; The hypothesized model is shown in Figure 3


Figure 3:Hypothesized Model

Source: Developed for research

RESEARCH DESIGN Methodology

The research methodology applied in this study consisted of three stages: • a literature review; • a qualitative exploration consisting of in-depth interviews and focus groups; and • a quantitative descriptive survey of consumers. Preliminary Study-Exploratory Stage of research

Since there is a dearth of research on retail servicescape, especially in India, an exploratory research should first be used (Cooper and Schindler 2001; Zikmund 1997) to identify relevant issues, to gather ideas and insights and then to develop the hypotheses for later testing (Churchill and Iacobucci 2002). This study is a preliminary step to gain a more rigorous and adequate understanding of issues related to retail servicescape in the explanatory stage (Zikmund 1997). This allowed the development of a preliminary model of the impact of a various variables on consumers’ attitudes toward retail servicescape. Participants

300 participants were randomly selected for the study. The respondents were essentially consumers of a selected retail stores in Jaipur. Each respondent was administered a structured questionnaire comprising 30 variables. Sampling procedure employed was Convenience Sampling (Non-probability Sampling) Measurement Instrument

A structured questionnaire was developed based on the literature review and exploratory studies- in-depth interviews and focus groups. The design and administration of the questionnaire followed six steps which were adapted from Churchill (1979) Frazer and Lawley (2000) and Kinnear and Taylor (1996).The questionnaire consisted of 30-items to be rated on a 10 point Likert-type scale, ranging from 1 (probably very untrue)-10 (probably very true) . Data Analysis

A Factor Analysis was performed on 30 variables using SPSS 16. Basic Assumptions

Two statistics on the SPSS output that permit us look at some of the basic assumptions. • Kaiser-Meyer-Olkin Measure of sampling adequacy • Bartlett's Test of sphericity Kaiser-Meyer-Olkin Measure of sampling adequacy

This measure generally indicates whether or not the variables can be grouped into a smaller set of underlying factors. It is a measure of whether the distribution of values is adequate for conducting factor analysis. A measure > .9 is marvelous, >8 is meritorious, > .7 is middling, >.6 is mediocre, > .4 is miserable and <. 4 is unacceptable. Thus, high values (close to 1.0) generally indicate that a factor analysis may be useful with your data. If the value is less than .40, the results of the factor analysis probably will not be very useful. Bartlett's Test of sphericity

This is a measure of the multivariate normality of the set of distributions. It also tests whether the correlation matrix is an identity matrix because factor analysis would be meaningless with an identity matrix. A significance value of < .4 indicates that these data do NOT produce an identity matrix (or differ significantly from identity) and are thus approximately multivariate normal and acceptable for factor analysis.

In the study, Kaiser-Meyer-Olkin measure for sampling adequacy yielded a value of .83. Bartlett’s Test of Sphericity gave a value of .03.

TABLE 1 Kaiser-Meyer-Olkin measure of Sampling Adequacy 0.83Bartlett’s Test of Sphericity 0.03


Both the measures indicate that the sample of the study reported here was adequate. So, clearly our data support the use of factor analysis and suggest that the data may be grouped into a smaller set of underlying factors. Factor Analysis

Using Kaiser’s criterion, 6 components with eigen value of 1 or more are selected. These 6 components account for 74.035 % of the total variance. Air Quality, with loadings to 2 factors greater than 0.5, is considered as cross-loaded and therefore deleted. Of all the 30 statements in the questionnaire, 28 statements with factor loadings greater than 0.5 are selected for subsequent analysis.

Each of the items in for the 6 factors extracted is presented in Table2, with their respective loadings and mean scores. Factor means indicates respondents’ attitude towards different dimensions of servicescape. As shown in Table 2, the five items in descending order of means score were as follows:

Spatial Layout (5.34), Signages (5.05), Ambient Conditions (4.96), Cleanliness (4.60), Facilities and artifacts (4.34) and Functionality (3.78)

Factor 1, Ambient Conditions, consisted of six items (alpha=0.890) and explained 47.894% of the variance. The mean score is 5.05, which is the second highest score. This factor reveals whether the retail store has pleasant lighting (4.98), appropriate background music and sound (5.20), appropriate temperature (5.34), pleasant odor (4.58), and overall comfortable ambient conditions (5.24), and adequate lighting (4.96).

Factor 2, Cleanliness, consisted of six items (alpha=0.921) and explained 7.106% of the variance. The mean score is 4.60, which is the fourth highest score. The six items are: overall very clean facility (4.58), clean walkways and exits (4.49), clean food zone (4.19), clean aisles (4.60), dust free furniture and fixtures (4.86) and products neatly arranged and displayed (4.92).

Factor 3, Signage, consisted of four items (alpha=0.948) and explained 5.955% of the variance. The mean score is 4.96, which is the third highest score among the six dimensions. These four items are related to the signage in the facility, namely, signage helps in locating merchandise(5.10), signage is big and distinct (5.02), sufficient signages (5.00) and signages are easy to comprehend (4.72).

Factor 4, Spatial Layout, consisted of four items (alpha=0.911) and explained 5.281% of the variance. It is the most satisfactory factor. The mean score is 5.34, which is the highest score among the six dimensions. It measures whether the store has a good parking (5.43), good interiors (5.27) and customer friendly layout (5.54) in the facility, as well as its aisles for easy movement of shoppers (5.11).

Factor 5, Facilities and Artifacts, consisted of five items (alpha=0.855) and explained 4.003% of the variance. The mean score is 4.34, which is the fifth highest score. The five items are: clean washrooms (3.94), sufficient drinking water fountains (4.59), aesthetically decorated facility (4.55), adequate seating space (4.15) and availability of kidzone (4.71).

Factor 6, Functionality, consisted of 3 items (alpha=0.769) and explained 3.796% of the variance. The mean score of 3.78 is the lowest among the six dimensions which is the least satisfactory factor. The three items are: high performance electronic equipments (3.56), fast billing (3.32) and fast location of needed merchandise. (4.45).


TABLE 2:Factor Extraction for Servicescape No. Factors Loading Mean Factor Mean

FACTOR 1 AMBIENT CONDITIONS The facility has pleasant lighting 0.770 4.98 The background music/sound is pleasant 0.760 5.20 The temperature in the facility is appropriate 0.743 5.34 5.05 (II) The lighting is adequate 0.739 4.96 The facility has a pleasant odor 0.656 4.58 The overall ambient conditions make a comfortable stay 0.635 5.24 FACTOR 2 CLEANLINESS The facility is overall very clean 0.828 4.58 The walkways and exits are clean 0.822 4.49 The food zone is clean 0.803 4.19 The aisles are clean 0.632 4.60 4.60 (IV) The furniture and fixtures are dust free 0.623 4.86 The products are neatly arranged and displayed 0.586 4.92 FACTOR 3 SIGNAGES The signages help in locating merchandise 0.737 5.10 The signage is adequately big and distinct 0.736 5.02 4.96 (III) There are sufficient signages in the facility 0.710 5.00 The signages in the facility are easy to comprehend 0.692 4.72 FACTOR 4 SPATIAL LAYOUT Facility layout has a good parking .821 5.43 Facility has good interiors .745 5.27 5.34 (I) Facility has a customer friendly layout .733 5.54 Facility layout has aisles to facilitate easy movement of shoppers .634 5.11 FACTOR 5 FACILITIES AND ARTIFACTS Facility has clean washrooms 0.803 3.94 Facility has sufficient drinking water fountains 0.633 4.59 Facility is aesthetically decorated 0.576 4.55 Facility has adequate seating space 0.564 4.15 4.34 (V) Facility has a kid zone with babysitting service 0.502 4.71 FACTOR 6 FUNCTIONALITY Facility offers high performing electronic equipments 0.817 3.56 3.78 (VI) Equipments provide for fast billing 0.797 3.32 Technology enables a fast location of needed merchandise 0.554 4.45

Table 3:Total Variance Explained Component Initial Eigenvalues Extraction Sums of Squared Loadings

Total % of Variance Cumulative % Total % of Variance Cumulative %1 14.368 47.894 47.894 14.368 47.894 47.8942 2.312 7.106 55.000 2.312 7.106 55.0003 1.787 5.955 60.955 1.787 5.955 60.9554 1.584 5.281 66.236 1.584 5.281 66.2365 1.201 4.003 70.239 1.201 4.003 70.2396 1.139 3.796 74.035 1.139 3.796 74.0357 .855 2.849 76.884 8 .780 2.598 79.482 9 .673 2.244 81.727 10 .629 2.097 83.824 11 .596 1.986 85.810 12 .486 1.620 87.431 13 .473 1.577 89.008 14 .407 1.358 90.366 15 .383 1.276 91.642 16 .347 1.157 92.799 17 .308 1.025 93.824 18 .267 .891 94.715 19 .244 .813 95.528 20 .234 .778 96.306 21 .188 .627 96.934 22 .167 .558 97.491 23 .152 .506 97.998 24 .131 .437 98.435 25 .112 .374 98.809 26 .101 .336 99.145 27 .091 .304 99.449 28 .080 .265 99.714 29 .068 .226 99.940 30 .018 .060 100.000

Extraction Method: Principal Component Analysis

Table 4:Rotated Component Matrix


1 2 3 4 5 6 Unpleasant Lighting 0.770 A Background Music and Sound 0.760 .317 .345 A Temperature 0.743 .341 Inadequate Lighting 0.739 .325 A Pleasant Odor 0.656 A_Air Quality 0.635 .509 A Overall .544 .331 .396 C_Overall 0.828 C_ Walkways and Exits .302 0.822 C_Foodzone 0.803 .353 C_Aisles 0.632 .305 C_Furnitures and Fixtures .314 0.623 .325 .337 C_Product Displays 0.586 .434 .336 S_Ability to help in locating .343 0.737 S_Big and Distinct 0.736 S_Sufficient Signages 0.710 S_Easy to comprehend .307 .316 0.692 SL_ parking .821 SL_interiors .745 SL_customer friendly .316 .733 SL_easy traffic .311 .405 .634 F1_wash rooms 0.803 F1 _drinking water .423 0.633 F1 _decorated .455 0.576 F1_seating space .351 0.564 F1_kidzone .303 .318 .346 0.502 F1_smoking zone .307 .497 .325 F2_equipments 0.817 F2_fast billing 0.797 F2_ location friendly .304 .393 0.554

Extraction Method: Principal Component Analysis Rotation Method: Varimax with Kaiser Normalization, Rotation converged in 9 iterations

Table 5:Reliability Test Reliability test was applied to each construct in order to verify their reliability for further analysis. A measure of >.7 for all the dimensions (Table 5) make them reliable and internally consistent and thus eligible for further analysis.

Component Cronbach’s Alpha No. of items Ambient Conditions .890 6Cleanliness .921 6Signages .948 4Spatial Layout .911 4Facilities and Artifacts .855 5Functionality .769 3

Multiple Regression The relationship among the six servicescape dimensions, perceived servicescape quality,

satisfaction and desire to stay was analyzed by standard multiple regression. I Relationship between Servicescape Dimensions and Perceived Quality

The six servicescape dimensions explained 62.7 % of the total variance in the dependent variable of overall perceived servicescape quality (Adjusted R Square =0.627). Thus the relationship between servicescape dimensions and perceived quality is strong. To compare the contribution of each servicescape dimensions in forming customers’ perceived servicescape quality, we refer to the Standardized Bata Coefficient. As shown in Table 6 below, the largest beta value is 0.362, which is for Layout, which is closely followed by Ambient conditions (Beta = 0.353). It shows that Layout and Ambient conditions have strongest relationships with perceived quality of servicescape. Moreover, among the 6 dimensions, only Layout (Sig. = 0.000) and Ambient conditions (Sig. = 0.000) were significant (Sig. <0.05), indicating that these 2 dimensions are making statistically unique contribution to the prediction of perceived servicescape quality. Therefore, only H1 and H2 are supported. Table 6:Relationship among Six Servicescape Dimensions and Perceived Servicescape Quality

Dimensions B Beta Sig. Functionality 0.116 0.105 0.126 Layout 0.336 0.362 0.000* Signage 0.115 0.128 0.101 Ambient Conditions 0.382 0.353 0.000* General facilities and artifacts -0.109 -0.113 0.117 Cleanliness 0.087 0.103 0.061 Adjusted R Square = 0.627 *p<0.050

Relationship between Perceived Quality and Satisfaction


The result of regression reveals that satisfaction with the servicescape is positively influenced by perceived quality (Beta = 0.848, Sig. = 0.000). 71.7% of the total variance in visitors’ satisfaction can be explained by their perceived quality (Adjusted R Square =0.717). H6 is supported.

Table 7 a:Model Summary b

Model R R Square Adjusted R Square Std. Error of Estimate 1 .848a .719 .717 .60779

a. Predictors: (Constant), Perceived Quality b. Dependent Variable: Satisfaction

Table 7b:ANOVA b

Model Sum of Squares df Mean Square F Sig.

1 Regression Residual

Total

164.402 64.278

228.680

1 174 175

164.402 .369 445.036 .000a

a. Predictors: (Constant), Perceived Quality b. Dependent Variable: Satisfaction

Table 7c:Coefficients(a) Model Unstandardized Coefficients

B Std. ErrorStandardized Coefficients Beta

T Sig.

1(Constant) Perceived Quality

.537 .217

.915 .043 .848 2.470 21.096

.014

.000

a Dependent Variable: Satisfaction. Relationship between satisfaction and desire to stay

In testing H7, the predictive power of satisfaction in desire to stay, the Standardized Beta Coefficient was found to be 0.835 (Sig. =0.000), indicating that satisfaction and desire to stay are positively related and the relationship is strong. H7 is therefore supported. With Adjusted R Square of 0.695, satisfaction explained 69.5% of visitors’ desire to stay longer.

Table 8a:Model Summary

Model R R Square Adjusted R Square Std. Error of the Estimate 1 .835a .696 .695 .62590

a. Predictors: (Constant), Satisfaction b. Dependent Variable: Desire to Stay

Table 8b:ANOVA

Model Sum of Squares df Mean Square F Sig. 1 Regression

Residual

Total

156.381

68.164

224.544

1

174

175

156.381

.392 399.190 .000a

a. Predictors: (Constant), Satisfaction b. Dependent Variable: Desire to Stay

Table 8c:Coefficients (a) Model Unstandardized Coefficients Standardized Coefficients

Beta t Sig.

B Std. Error

1(Constant) Satisfaction

.584

.827 .213.041 .835

2.742 19.980

.007

.000 a Dependent Variable: Desire to Stay

CONCLUSIONS AND RECOMMENDATIONS Having run factor analysis, it was observed that the five dimensions chosen in the original model

are amenable to be split into six, as signages stood out quite conspicuously from its original dimension of signs, symbols and artifacts. The six dimensions are ranked as follows (in descending order of ranking)

1. Spatial Layout 2. Ambient Conditions 3. Signages 4. Cleanliness 5. Facilities and Artifacts 6. Functionality

The store needs to make significant investment in increasing its functionality. The facility should offer high performing equipments that enable fast billing and fast location of needed merchandise.


Facilities are artifacts need to be improved, with an urgent provision of clean wash rooms. Mean score on this item (3.94) is much less than the factor means (4.34).

The study strongly supports that spatial layout and ambient conditions bear the strongest relationship with the perceived quality of the servicescape. These two dimensions make statistically unique contribution to the prediction of perceived servicescape quality.

Results of regression reveal that satisfaction with the servicescape is positively influenced by perceived quality of the servicescape. Satisfaction and shoppers’ desire to stay are positively related and the relationship is strong.

The servicescape thus encourages the target customers to enter the service environment in the first place, and to retain them subsequently. Well designed servicescpaes thus provide substantial tangible cues for re-assuring, facilitating purchase and ensuring repeat business.

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Measuring and Recognizing the Value of Purchased Goodwill: A Note on Market Value Measurement Method

Indra Abeysekera

University of Wollongong, Australia

ABSTRACT Through a review of literature and with conceptual underpinnings, this paper demonstrates that

relying on the market value measurement method to ascertain value of purchased goodwill does not contribute to more accurate value of the financial worth of the firm.It argues that the use of market value for the measurement of purchased goodwill for recognition in financial statements is a mere artifact and a response to the contemporary paradigm rather than a measure of the accurate financial worth of purchased goodwill. It demonstrates the need to seek a measurement method that does not impose a transaction as a necessary precondition for ascertaining the financial value of goodwill. Keywords: goodwill, market value, measurement, recognition

INTRODUCTION Purchased goodwill is a topic worthy of investigation to enhance the transparency of financial

worth of assets in financial reporting, helping users to make better-informed decisions about resource allocation (Masters-Stout et al., 2008). Purchased goodwill that generally does not appear on individual entities financial statements is a highlight in the group balance sheet. Two problems have confronted the accounting profession in accurately measuring the financial worth of firms: (a) the difficulty of identifying the value of discrete items recognized in financial statements, and (b) dealing with changes in the value of such items after their recognition in financial statements. Amongst the most difficult item being the accounting for goodwill as discrete items and dealing with the changes in the value of goodwill. Accounting researchers have devised various measurement methods to deal with the problem of measuring goodwill (Gynther, 2001; Hughes, 1982). However, the measurement methods in general constitute the least explored area in the International Accounting Standards Board (IASB) framework. The market value, a fair value (paragraph 32 of IFRS 3), is central to determining the value of purchased goodwill in contemporary accounting standards (IAS 36, 2008; IFRS 3, 2008).

Restricting the discussion to purchased goodwill only, this paper argues that relying on the market value measurement method to ascertain the value of purchased goodwill does not contribute to measuring more accurately the financial worth of the firm in financial statements. To substantiate, Section 2 outlines how reliance on transactions to measure and recognize purchased goodwill hinders accurate determination of the financial worth of goodwill. Section 3 examines the market value method for measuring the financial worth of purchased goodwill. Section 4 outlines how relying on the market value measurement method to value the purchased goodwill and its recognition in group financial statements have facilitated the establishment of a classification that does not necessarily reflect the financial worth of purchased goodwill.

ESTABLISHINGA CLASSIFICATION THROUGH RECOGNITION RESPONDING TO THE CONTEMPORARY PARADIGM

The recognition of assets begins with satisfaction of the criteria for the definition of an asset in the conceptual framework of accounting, followed by the measurement of its value due to a past transaction or event. However, purchased goodwill challenges this stereotypical sequence. First, unlike direct measurement, firms’ measure purchased goodwill indirectly, in relation to the market value of the identifiable net assets value of an entity. Second, unlike measuring a single asset, firms measure and recognize goodwill as a composite asset. Recognition of purchased goodwill therefore becomes a vessel that contains measurement errors of other assets.1 Although the accounting standards require the distinguishing of other assets from purchased goodwill on the basis that they are identifiable and measurable, those accounting standards apply diverse measurement methods to assets, and often the differences in measurement methods used for recognition of identifiable assets arise from whether similar assets are exchanged in a liquid market or not, as if the identifiable assets will be liquidated in the market place. In such measurement methods, the liquidation of identifiable assets is not required, but is rather a necessary condition of identifiable assets, identified as exchangeability.

1Errors in measuring acquired goodwill as a residual could include overpayments by the acquirer and errors in measuring and recognizing fair values of identifiable assets acquired and liabilities assumed (IFRS 3, 2008). A parent entity may overpay to acquire a subsidiary merely to gain control over it (Weston and Halpern, 1983), or to offer shares of the parent entity that the parent entity believes to be overvalued (Mayers and Majluf, 1984), and a parent entity may attempt to manipulate its share price upwards during the bidding process to gain control over the a subsidiary entity (Erickson and Wang, 1999).


Although the pooling of interest method has been replaced by the purchase accounting method, giving rise to recognition of goodwill in group financial statements around the world, the purchase accounting method still leaves the profession far from being able to state the accurate value of purchased goodwill. Rather, it has resulted in an exercise of seeking verification by reference to figures stated in the group balance sheet. The market value as an indirect measurement method of purchased goodwill allows the creation of a classification through verification with reference to the market, leading to the new label called goodwill included through purchase accounting in group accounts. Verification of accounting numbers is dependant on the ability to identify them either individually or collectively, and is the reason why purchased goodwill represents a ‘collection’ of assets, because when treated thus they are identifiable for verification as an accounting number.

Although the conceptual framework of accounting does not advocate a preferred measurement method, for assets the revisions to the contemporary accounting standards tend to favor the market value of measurement method with exchangeability as a necessary condition. This method is portrayed as displaying objectivity of measurement, and hence objectivity of recognition. Objectivity and accuracy of measuring financial worth are nevertheless two different attributes of measurement that lead to the recognition of identifiable assets in the financial statements. Objectivity of measurement may not necessarily lead to accuracy of measurement of financial worth, and vice versa. Less than fully efficient market measure assets with incomplete information, leading to measurement errors and financial statements reproduce these measurement errors through recognition. Firms’ measure purchased goodwill in relation to the market value of the identifiable net assets value of the firm. The market value in a less than fully efficient market becomes a contributor of errors in the measurement and recognition of purchased goodwill. The individual asset measurement value representing the identifiable net assets value similarly becomes a contributor of errors.

Purchased goodwill is recognized in group accounts due to a business combination on the basis that it is brought into being by the combination of two entities. However, the parent entity pays for purchased goodwill in the subsidiary at the date of acquisition. The purchased goodwill therefore resides in the subsidiary entity, and if group accounts are prepared at the date of acquisition, the group recognizes purchased goodwill in its accounts because the parent entity paid for that purchased goodwill in the subsidiary entity. Thus the purchased goodwill has not arisen due to synergy, as there has been scarcely any time for the new business combination to create any financial value for the goodwill. Therefore the argument that purchased goodwill is a result of synergy is contestable. The entity which recognizes the purchased goodwill, due to synergy or lack of synergy, depends on the entity controlling that goodwill. In a business combination there are three entities: two legal entities—the parent and subsidiary entities—and a fictitious entity from a legal perspective, the group. The purchased goodwill exists in the subsidiary entity prior to the business combination, and is the reason why the parent entity decided to pay an excess for it as an asset. If the purchased goodwill existed prior to the business combination, the subsidiary entity then controlled purchased goodwill prior to the parent entity gaining control over the subsidiary. However, the subsidiary entity cannot recognize purchased goodwill, because there has been no transaction to bridge the gap between the market value of identifiable net assets and the market value of the subsidiary entity. Yet the absence of a transaction does not alter the composition of goodwill or the fact that it exists in the subsidiary. It also does not alter the fact that the subsidiary entity controls the purchased goodwill. Inasmuch as the subsidiary entity recognizes other assets, it must then surely recognize purchased goodwill that it controls, but the absence of a transaction precludes such recognition.

When a parent entity gains control over the assets of a subsidiary entity, the parent entity recognizes its control over the assets of the subsidiary entity. The parent entity shows that control not by recognizing individual assets in its financial statements, but by substituting a single label covering all the assets, called investment in the subsidiary entity. This label disguises the fact that the control by the parent entity of the subsidiary entity’s assets creates a new classification of financial reporting communication. According to Grojer (2001), the purpose of categorizing accounting elements (i.e. assets, liabilities, equity, revenue, and expenses) in financial statements is to communicate a classification that purports to be objective.

If a transaction were a necessary condition then the parent entity would recognize purchased goodwill, as it could identify and differentiate identifiable assets from unidentifiable assets. The accounting regulation mediates the recognition of purchased goodwill by the way it mandates the entity having control over such goodwill, and by the way it foresees the establishment of classification through the process of labeling accounting elements for interpretation. The category used for presenting financial information about purchased goodwill therefore is different among subsidiary entity, parent entity and the group. Had measurement using market value to establish verification of accounting numbers been employed, then all three entities would be in a position to recognize purchased goodwill. The subsidiary could measure goodwill as the difference between the market value and fair value of identifiable net assets at the time of reporting. The parent entity could dichotomize investment in the subsidiary as investment in identifiable net assets and purchased goodwill, in its recognition in financial statements. Additionally, the parent entity could recognize its


own goodwill using the same criteria applied in measuring goodwill of the subsidiary entity. But it is the group that recognizes goodwill as a residual in the business combination. The classification of the accounting regulation is therefore that purchased goodwill becomes a seriously measurable asset in business combinations only. Thus a conception of organizational reality shapes organizational participants’ views about organizational functioning and financial discourse. The group, a fictitious construct with no legal personality, recognizes purchased goodwill originating elsewhere in an entity with a legal personality.

The Financial Accounting Standards Board (FASB) examined two methods of accounting for business combinations, namely the purchase method and the pooling of interest method, and then issued a special report stating that the existence of the two methods to account for identical transactions can lead to firms managing accounting for the transaction with the method that produces desirable results for them (FASB, 1997). Evidence suggests that under the pooling of interest method, firms are prepared to make a significant wealth transfer to target shareholders. Firms prefer using the pooling of interest method to report higher earnings, avoiding amortization and depreciation expenses that otherwise reduce earnings (Ayerset al., 2002; Weber, 2004); managers, deriving benefits from stock-based compensation, may act opportunistically to structure acquisitions to increase earnings (Aboody et al., 2000; Robinson and Shane, 1990).2 The preference for the purchase accounting method appeared as an acknowledgement of the financial worth of goodwill, but it is merely a shift from no verification of purchased goodwill to verification of purchased goodwill with reference to the market. Guthrie and Petty (2000) point out that firms are sold at prices different from their market price prior to initiation of their sale, and this fact challenges the validity of recognition of the financial worth of purchased goodwill based on market value, as the residual between market value of the subsidiary entity and fair value of its net identifiable assets when the cash generating unit is the entire entity. The value of goodwill after accounting for the business combination can increase over time, and whether to attribute an increase (or decrease) in the value of goodwill to synergy (or problems) of the business combination is a grey area. The issue is whether the change in goodwill is attributable to the business combination. None of the three entities (parent, subsidiary entity or group) recognizes an increase in the financial value of goodwill on the basis that entities cannot link that increase to identifiable transactions or events. The accounting regulation does not deny the increase in the financial worth of goodwill, but the rules for goodwill interpretation facilitate re-classification. Lack of recognition of any increase in the financial worth of purchased goodwill challenges the regulator’s approach of recognizing purchased goodwill as the difference between the market price of the subsidiary entity and market value of identifiable net assets, especially where firms can establish market value through a liquid share price. In one context, the financial worth of the purchased goodwill is hidden (in the parent entity), whereas in the other context it is disclosed (in the group entity) in the financial statement. Consistent with the accounting framework, the parent entity has an opportunity to recognize the purchased goodwill of the subsidiary entity in its own financial statements, as the purchaser of goodwill resulting from a past transaction, but does not do so. Further, the conceptualization of goodwill drives the recognition of purchased goodwill in business combination with the entity and parent-entity concept of consolidation and the proprietary entity concept of consolidation, resulting in recognition of two different amounts of the same purchased goodwill.

The classification of purchased goodwill is manifested in three different ways. First, it establishes goodwill as an asset that is objectively measurable with reference to market value. Second, a transaction is a prerequisite for recognition of purchased goodwill. Third, the conceptualization of purchased goodwill determines its recognition, that is, whether it should be embedded in another asset or shown separately. The three different ways of manifesting classification are independent of ascertaining the financial worth of purchased goodwill, but they determine the world view communicated to stakeholders through recognition or non-recognition of purchased goodwill. Surveying four Western countries (Great Britain, the U.S., Germany and France), Ding et al. (2007) argue that over the past century the treatment of purchased goodwill has moved from a stakeholder model (an era dominated by family-owned entities) to a shareholder model (an era where ownership of firms is dominated by non-family shareholder owners). This trend may have contributed to the present movement towards objective verification of purchased goodwill in relation to the marketplace, due to the greater proportion of non-family shareholders in listed firms and the devolving public accountability demanded from the accounting profession. As an example of Kuhn’s (1996) conception of paradigm shift, the stakeholder model displayed anomalies in the treatment of purchased goodwill in the shareholder dominated environment, and a shift was required to appear objective to shareholders and investors, where market values were a better proposition.

2However, there is evidence indicating that the pooling criteria under APB Opinion No. 16 have been manipulated by firms to avoid amortization of goodwill (Robinson and Shane, 1990). Discussion of the implications of amortization of acquired goodwill is beyond the scope of this paper.


PURCHASED GOODWILL RECOGNITION AND MEASURING THE NATURE OF GOODWILL

The role of financial statements has been to recognize identifiable assets in a transaction, either through direct or indirect measurement. Purchased goodwill is recognized in group financial statements for the same reason, because group financial statements can refer to a transaction that took place to show all possible net assets of two entities (i.e. the parent and subsidiary entities) in a single financial statement. That is a plausible reason why the acquired entity (i.e. the subsidiary entity) does not recognize purchased goodwill in its financial statement—there is no transaction by which to refer to it directly or indirectly. If financial statements represent transaction-based items only, then purchased goodwill has little place in single legal entities in the business combination. Even when purchased goodwill is recognized because it is triggered by a transaction, the financial statement does not reveal the composition of the bundle of assets within it, and that bundle remains a mystery. Whether a firm should identify any asset individually or collectively is irrelevant to the transaction-based financial statement; the only necessary condition is a transaction, and for purchased goodwill, the transaction becomes the verification for measurement referenced to market value. If a firm has a transaction involving an asset (individual or collective), that asset is a given a label (i.e. ‘goodwill’ or any other) to display in the body of the financial statement. The labels have little to do with the financial worth of assets but they are assigned to build a classification into the financial statement.

Hence, in the context of business combination, the problem with recognition of purchased goodwill relates to imposition of the necessary condition of a transaction for it to be recognized as an item in financial statements. Measurement methods that require a transaction as a precondition for measurement do not measure purchased goodwill in a single entity, but in the group entity only. This is the reason that historical cost and market-selling price accounting do not recognize purchased goodwill as an asset in a single entity, only in a group entity. Further, when a business combination acquires purchased goodwill by virtue of a transaction, that purchased goodwill relates to a bundle of assets that are individually unidentifiable, and the transaction model has little capacity to untangle the bundle and recognize those assets separately. All the above measurement methods entail the bold assumption that purchased goodwill can be measured in a similar manner to measuring identifiable tangible and identifiable intangible assets. But this assumption ignores the fact that purchased goodwill is an unidentifiable bundle, albeit a real one. All this time, an assumption is made that purchased goodwill comprises a bundle of assets, and that there are no liabilities involved. When there is a drop in the value of purchased goodwill, it is attributed to the drop in value of the bundle of assets. However, the bundle of purchased goodwill can comprise both assets and liabilities. For instance, if an acquirer purchases a firm for a value less than its fair value of identifiable net assets, the discount on goodwill (or negative goodwill) should be attributable to unidentifiable non-tangible liabilities, because the unidentifiable ‘assets’ have a negative value, and assets do not generate negative net cash flows. The concept of purchased goodwill as comprising assets only is more for convenience of fitting into a mathematical equation than warranted by evidence-based research.

MARKET VALUVE AS A MEASUREMENT METHOD Purchased goodwill comprises a bundle of unidentifiable non-tangibles which partly represents

the financial value of a firm (Basis for Conclusions 10, 2008). Purchased goodwill exists because there is a set of assets that are present in the firm. These additional assets include the knowledge of staff, the educational qualifications of staff, corporate reputation, customer loyalty, and distribution channels. The sum of these assets comprises goodwill. Assets have financial value that brings future economic benefits to the firm, such as rights to future economic benefits, or the potential for such economic benefits (Chauvin and Hirschey, 1994; French et al., 1965). The recognition of purchased goodwill has value relevance to investors (Amir et al., 1993; Bugeja and Gallery, 2006; Godfrey and Koh, 2001; Gynther, 1969), but investors experience difficulty in understanding the implications of goodwill accounting (Duvall et al., 1992).

Purchased goodwill exists before a firm, part of a firm, or an asset is sold as unpurchased goodwill, and not recognized prior to the sale transaction. Firms recognize goodwill only after purchasing another firm or part of another firm or an asset. If the purchased goodwill originates in a subsidiary entity in a business combination, then the subsidiary controls the purchased goodwill, although the purchased goodwill is not recognized in its financial statement. The reason for non-recognition is the absence of a past event or past transaction. If goodwill is measurable in relation to the market value of the subsidiary entity at the date of acquisition for a business combination, then the subsidiary entity could measure the purchased goodwill using the same approach for recognition. The conceptual framework of accounting further supports the view that ownership of an asset is not conclusive for recognition of that asset, but helps to support its case. If so, the subsidiary entity is more qualified than the parent entity or the group entity to recognize its own goodwill (purchased by


the parent entity) as the difference between the market value and the net book value of assets in the subsidiary.

When examining measurement methods for purchased goodwill, a pertinent question is whether the method measures the essential qualities or character of goodwill accurately without errors. The composition of purchased goodwill is such that it requires measurement of a bundle of heterogeneous assets rather than of a single, homogeneous asset. Determining the financial worth of purchased goodwill using market value can be approached via two perspectives3: (a) determining the market value of the firm’s assets other than purchased goodwill and subtracting them from the market value of the firm to ascertain the value of the purchased goodwill (i.e. purchased goodwill as a residual value), or (b) ascertaining the value of purchased goodwill in its own right; however the consequences of each these two perspectives are different.

Although market price is conceptually appealing as a way of measuring purchased goodwill, it has three problems. The first is the inability to calculate directly the net present value of all assets of the acquired firm. The composition of goodwill is such that it is difficult to identify the assets comprising it, and hence it is difficult to measure them as single assets. Thus, a compromise is struck to measure purchased goodwill as a residual bundle of assets - the difference between the market value of the acquired firm and the net present value of its identifiable assets.

The second problem is the assumption that the earning potential of each asset is equal, thus applying the same discount rate to all assets, being aware that some assets have a higher earning potential and others a lower earning potential than the uniform discount rate. These differences in earning potential that can exist among assets that belong to purchased goodwill, intangible assets and tangible assets. The errors in earning potential give rise to errors in identifiable assets, and since purchased goodwill (i.e. unidentifiable assets) becomes the difference between market value and the net present value of identifiable assets (erroneously valued), the errors in valuation become embedded in purchased goodwill as the residual valuation. Additionally, human intervention by setting market values on identifiable net assets to reduce purchased goodwill that may later dilute earnings, is unavoidable (Schocker et al., 1994).

The third problem is the assumption that the market value represents the net present value of the firm, i.e. the financial worth of the firm, and if that were correct, the financial value of the firm should not change with the vagaries of market volatility. Other forces, not all of which are controllable by the acquired firm, affect the financial worth of the firm. Changes in uncontrollable forces such as inflation, customer preferences and the regulatory environment change the financial worth of the firm. In short, the firm operates in a contingent, semi-efficient market, and errors in valuing the financial worth of the acquired firm hence become embedded in the purchased goodwill of the firm. In other words, the market price measurement method reinforces the ‘excess profit concept’ (Salop, 1979), and the purchased goodwill is an asset that gives rise to profits that are in excess of what the acquired firm could earn from its identifiable assets, although this contention is disputed by some (Ritter and Wells, 2006).

Bryer (1995), referring to the Marxian tradition, argues that the underlying reality of profits is surplus value for unpaid labor time, and any distortion may well be in the collective interests of the capital providers. Purchased goodwill is a purchase of surplus future profits and is no different from tangible assets. The Marxian tradition, however, disregards the fact that goodwill is a composite heterogeneous asset, and hence has a less regard for the composition of purchased goodwill. According to the conceptual framework of accounting, market value originates when an asset is exchangeable—but that is not possible with goodwill as it is not separately identifiable for sale (Scheutze, 2004), and this argument has been used to assert that purchased goodwill is not an asset. However, the purchased goodwill could remain within a firm, and not necessarily be sold or exchanged to generate future economic benefits.

According to the continuously contemporary accounting proposed as a workable solution to the problems of market value measurement method, firms should state all assets at their cash amount or cash equivalent upon sale.4 It has been suggested that the current selling price be verified by auditors for accuracy (Chambers, 1976; Clarke and Dean, 2007). Continuously contemporary accounting by implication eliminates the necessity to reverse intra-group transactions and fair value adjustments to assets and liabilities of the subsidiary entity in the preparation of consolidated financial statements by restating assets at the current selling price of both parent entity and subsidiary entity. However, it does not attempt to address measurement of the future financial worth of assets in the firm. Further, it 3The IASB definition of fair value is “the amount for which an asset could be exchanged, or a liability settled, between knowledgeable willing parties in an arm’s length transaction”. Upon investigating fair value accounting for investment property (IAS 40), it was found that there is considerable misunderstanding about the application of fair value in practice, with firms using open market value, market value for existing use, most likely value, and most probable price (IVSC, 2007).

4Bloom (2008) proposes an additional financial statement called a market capitalization statement as a way of applying continuously contemporary accounting, and also recognizing the current level of information relating to goodwill in the financial statement of listed firms. This approach relies on market value and calculation of goodwill as a residual.


restricts the measurement to financial exit value rather than financial worth, assuming that all assets will have accurate market selling prices. Such a notion becomes less feasible for firms located in developing countries that have imperfect markets and for assets held by the public sector.

It is futile to claim that purchased goodwill must be exchangeable for cash, because that necessarily equates financial value to an exchange value.5 This necessary exchange value concept can be traced back to transaction-based accounting, in which a transaction is a necessary condition for recognizing items in financial statements, a necessary condition for financial value. To transact an asset, it needs to be identifiable, and identifiability becomes a precondition for measuring the financial worth of the asset in its own right. Further, exchangeability is not an attribute noted in the conceptual framework of accounting in the measurement of financial worth. Nevertheless, the concept of exchangeability is inconsistent with the composition of goodwill, being a bundle of unidentifiable non-tangibles contributing to the financial value of a firm.

There is evidence, however, to suggest that the indirectly calculated figure for purchased goodwill as a residual includes other unidentifiable assets and liabilities for following five reasons. First, investors have not perfected the valuation of assets including purchased goodwill in the market (Lev et al., 2005), with the result that firms are often bought at prices far exceeding market capitalisation (Guthrie and Petty, 2000). Second, the financial, social and political environment of a country influences the market value of a firm. For instance, the market value of a firm in an emerging economy may be different from that of a similar firm in a developed economy. Research demonstrates that among stock markets in developed economies that have strong public investor property rights there is a higher firm-specific market value (Morck et al., 2000). Third, both the psychology of the share market and forecasts of a company’s financial potential above and beyond its regular business contribute to the market value of a firm (Tissen et al., 2000). Fourth, the use of market value to measure the identifiable net assets of an entity relates to present financial benefits under a ceasing concern. Fifth, the concept of a cash-generating unit to measure goodwill as a residual suffers from ambiguity in relation to the determination of the business segment and the method employed to determine recoverable value (Carlin et al., 2007).

Seeking a measurement method that does not impose a transaction as a necessary precondition for ascertaining the financial value of purchased goodwill deserves consideration as an alternative to measurement methods that rely on a transaction or an event to assign a value to purchased goodwill. This paper, through examination of measurement methods of purchased goodwill, has prompted two research propositions. Firstly, future research can examine the use of the market value measurement method of purchased goodwill and its influence on the control of labor in achieving financial goals of firms. Ezzamel and Hart (1987, p. 107) suggest that the role of accounting in organizational control is little understood, although Marx’s analysis of capitalist labor processes challenges that view (Bryer, 2006). Secondly, future research can engage in the debate about internally generated goodwill where Bryer (1995) argues that capitalizing internally generated goodwill is capitalizing fictitious capital, an approach consistent with the contemporary accounting standard on the treatment of goodwill. The Marxian tradition, however, demonstrates a contradiction here. When an acquirer entity pays excess capital to acquire goodwill which is internally generated by an acquired entity, it is treated as productive capital. On the other hand, when the acquired entity has generated a market price in excess of its fair value of net assets after acquisition, it is treated as fictitious capital. The Marxian argument is extended to counter the notion of productive capital, as firms incur expenditure to generate surplus profits in a period, not to ‘purchase’ expected surplus profits. The Marxian tradition takes the position that expenditure cannot produce or ‘purchase’ expected surplus profits and must be consumed in the period in which it is incurred. This argument becomes inconsistent when applied to purchased goodwill because it is the expenditure of the acquired entity that has produced or ‘purchased’ expected surplus profits giving rise to purchased goodwill, for which the acquiring entity has paid.

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Political Influence in Management of and Regulation the Financial Sector in Kenya Perspectives from Financial Institution in Kisii County

Dr. Charles Kombo Okioga, Kisii University College Kenya

ABSTRACT The financial system is a nerve centre of economic development of any country. It provides the

important service of financial intermediation that largely entails enabling surplus spending units to save and deficit spending units to raise fund for investment and consumption. The financial system comprises of four segments that provide distinct service including banking, insurance, pensions and equity and long term bonds. Each segment is regulated by a statutory body with a mandate to promote orderly growth and development of financial markets. The oversight function of each of the regulator is also focused on identifying and taking measures to mitigate potential weaknesses and downside risks in the relevant financial market segment. Each financial sector regulators collects data and other relevant information to monitor and evaluate performance, soundness and stability of their respective licensees and market segments as well as the overall stability of the system. Politics has an influence on the financial sector legislation on the rules that govern the sector. The study undertook to study the perception of people of Kisii County on the influence of political activities on the financial sector in Kenya. Keywords: Finance sector, Executive, Regulation

BACKGROUND OF THE STUDY The financial sector in Kenya comprises of Banking, Insurance, Capital Markets and Pension

Funds. Other parts of the sector include Quasi-Banking composed of Savings and Credit Cooperative Societies (SACCOs), Microfinance institutions (MFIs), Building Societies, Development Finance Institutions (DFIs) and informal financial services such as Rotating Savings and Credit Associations (ROSCAs).( Mwega, F.M. 2003) Currently, the financial sector contributes about 4 per cent to GDP and provides assets equivalent to about 40 per cent of GDP. Overall, the sector is characterized by low penetration and limited supply of long-term finance. However, there is considerable potential to improve the depth and breadth of the sector to make Kenya a globally competitive financial hub, serving a large part of the Eastern and Southern Africa region of Africa. This will involve developing a vibrant and stable financial system to mobilize savings, and to allocate these resources more efficiently in the economy( Mwega,F.M, 2003)

According to Kablan, S. ( 2007) the role of the financial institutions is to mobilize savings and allocate them to those in need of funds. They do this by providing brokerage and asset transformation services. As brokers, financial institutions act as agents for savers and issuers of debt and equity instruments by providing information and transaction services. As asset transformers, financial institutions offer liquidity, maturity and size intermediation. (Kablan, S. 2007) The existence of financial institutions clearly encourages a higher level of savings and investment and ultimately a higher rate of economic growth. Many financial institutions provide specialized services to the economy. Banks, for example, provide payment services and provide a transmission mechanism for monetary policy; pension funds and insurance companies spread incomes over the lifetimes; mutual funds and unit trusts provide a mechanism for pooling small savings into large pools of capital while securities firms have specialized in providing risk management instruments. Failure to provide these services can be costly to the economy since efficient financial services are a necessary condition for sustainable economic growth.

Kamau (2009) observes that the aftermath of the 2008 global financial and economic crises was a wakeup call for financial sector regulators and governments worldwide to enhance transparency and accountability of financial intermediation and ensure financial soundness and stability. The Kenya‘s financial system has previously experienced risks emanating from poor corporate governance; weak risk-management frameworks; competition and globalization, including cross border trade risks; rapid technological innovations, mainly product development, delivery channels and methodologies; and from socio-economic shocks. Besides addressing these risks, the joint financial sector regulators platform sought to accelerate the process of deepening the financial system by promoting the good governance by the political class in the legislation of rules and laws to foster financial access and inclusion( Kamau, 2009)

Kenya depicted strong macroeconomic environment in 2010 with GDP growth rate accelerating to 5.6% up from 2.6% in 2009. Both Inflation and short term money market interest rates were low and stable within single digits, and broad monetary and fiscal aggregates were within respective targets. Overall public and publicly guaranteed debt was sustainable under the standard thresholds, with government borrowing costs relatively low due to low interest rates regime. The financial landscape also improved in 2010, with strong capital flows into emerging & developing economies


and risk appetite in developed economies observed, implying investor’s interest in taking more risky assets that offer better return ( Oloo, M. 2010)

Funding pressures also reappeared, but there were limited financial market spillovers to other countries due to the intervening policy actions that managed to keep the financial turmoil and its real effects contained in the periphery of the country resulting in only a modest drag on the global recovery. The limited financial spillovers observed across the financial markets and regional economies, as well as the appropriate policy responses by IMF to limit contagion and financial turmoil to the Greek crisis, mitigated negative impact on the global recovery in the second half of 2010. ( World Bank,2010) The first round of crisis response policy measures in May 2010, focused on financial assistance to Greece from the Euro zone leaders and the IMF, paired with austerity measures and reforms implemented by the Greek government. Central banks also played a role in providing liquidity in the region. The policy measures were aimed to prevent a disorderly Greek default, to restore debt sustainability in Greece, and to prevent the spread of the crisis to other Euro zone countries and the global economy( World Bank, 2010)

According to Mwega, F. M ( 2003) a stable financial system requires adequate macroeconomic stability this can only be possible through legislation by the political class (Executive), characterized by stable employment, stable prices and high growth prospects. High unemployment and economic stagnation have negative effects on financial stability through accelerated credit risk perceptions and constrained debt servicing capacity by borrowers. Other macroeconomic indicators were fairly stable. ( Mwega, F.M, 2003) There are however threats emanating from inflation and foreign exchange rates as well as slowdown in economic recovery of Kenya‘s major trading partners. In addition, rising international crude oil prices is likely to dampen economic recovery.

Mutuku, N. (2008) observes that the volatile consumer prices affect disposable incomes and fixed income markets, thus escalating real debt burdens. Volatile exchange rate impacts negatively on potential foreign investors, worsens external debt service and increases import bill, making a country uncompetitive as an investment destination. Increasing domestic prices of food caused by delayed and insufficient rain may also pose a threat to growth prospects with possible negative effects on stability and this has been aggravated by influx of refugees from Somali another drought afflicted country in the Horn of Africa region. Growth prospects may also be dampened by domestic power rationing, currently targeting manufacturing firms.

PROBLEM STATEMENT The challenge for political leaders who are policy makers in translating the broad principles into laws, regulations, and enforcement measures that are effective in the financial sector regulation. The priorities and practical implementation vary widely according to the country’s political class interest and the stage of financial sector development, financial inclusion goals, regulatory capacity, consumers’ experience using formal finance, and consumer culture. The wholesale adoption of laws and regulations from elsewhere is rarely appropriate due to differing cultural, legal, and economic contexts. The capacity of the government as a regulator in question to implement and supervise the financial sector is critical. Many countries with large underserved markets still struggle with adequate prudential oversight of financial institutions. When regulatory capacity is limited, a focus on consumer protection divert resources from other essential functions hence the need to conduct a research to establish the political influence on the financial sector regulation in Kenya.

LITERATURE REVIEW Political influence on Financial Sector Policy making

Kenya prospects in the financial sector regulation are contingent on the behaviour of policymakers. Indeed, there is need for better regulation that can readily identify emerging vulnerabilities; properly price risks and strengthen incentives for prudent behaviour. It is tempting after the financial crisis to call for more regulation, but there should be emphasis on better regulation by building strong institutions.( Mutuku, N. 2008) The Operationalisation of Credit Referencing Mechanism which was operationalised on 2nd February 2009. This facilitates the sharing of credit information by institutions licensed under the Banking Act. This link allows the industry to build information capital that is critical in the credit market. The Licensing of Deposit Taking Microfinance Institutions (Mutuku, N. 2008) The Microfinance Act was operationalised effective May 2008. Currently, one institution has been licensed and eight applications for license are being processed. With the unique business models of microfinance institutions mainly targeted at the lower end of the market, bringing them under the purview of the Central Bank will not only give them a legal basis in dealing with depositors but will also boost access to formal financial services by the populace. Deposit Taking Microfinance Institutions are free to be community-based or nationwide (Oloo, M. 2010)

The World Bank report (2010) observes that the National Payments System sits at the centre of the financial system. It is imperative that payments systems are secure and efficient. The Central


Bank continues with its initiatives to modernize the national payments system. Accordingly, from 1 October 2009, value capping was effected with all payments above Kshs.1 million being made through the Real Time Gross Settlement System (RTGS). This initiative enhanced the security and efficiency of high value payments. The celebrated MPESA falls under this category of reforms. As we have seen this market unfolding, MPESA account holders have soared to 9 million, total transactions surpassed Ksh.48 billion a month (or averaging Ksh.1.6 billion a day) and agents increased to 17,000 in the last 3 years. Negative Political influence on the financial sector Regulation

Leigthner, J. & Knox, L. (2008) Lack of transparence by the political class has the direct costs of corruption such as bribery for a banking license, this remain a deterrent to potential investors in the financial sector. Corruption is a major impediment both for existing businesses and those seeking to establish new businesses. According to The Global Competitiveness Report 2007–2008, corruption remains the largest obstacle in doing business. Further, the capacity of public institutions to facilitate corporate performance is ranked as weak, with a score of 3.5 on a scale of 1 to 7. At present there is a somewhat pointless debate about Kenya’s constitutional review and the effectiveness of oversight institutions such as the Capital Markets Authority. The Oversight institutions such as the CMA, the central bank and the Kenya Anti-Corruption Commission would be effective in ensuring good corporate governance without undue influence from an overbearing executive. The executive powers greatly compromise the effectiveness of the oversight institutions. The KACC, for example, a supposedly independent institution, has to depend on the director of public prosecution’s decision as to which cases to prosecute. The Kenyan constitution grants the director of presidential appointee, the president’s influence on prosecution is not hard to see (Kamau, A.W 2009).

The central bank’s independence came to the spotlight with claims of corruption by a former deputy governor, Jacinta Mwatela. Mwatela claimed that her redeployment to the Ministry of Northern Kenya was a cover-up in connection with corruption surrounding the award of a currency printing tender to the De la Rue Company. Short of this devolution of power, all attempts to govern Kenya’s financial sector effectively will routinely be rendered futile by the executive (Kamau, A.W. 2009)

In August 2008 the attorney general (who is part of the executive) withdrew a case involving a former Euro Bank employee, Peter Fernandez, whom the KACC had accused of wrong doing within the bank. If excessive presidential power is reclaimed and returned to the judiciary, justice will be served (Kamau, A.W. 2009).

Figure 1:Conceptual Framework for political institutional analysis

Source:Researcher’s own conceptualization

Political influence on Finance sector efficient Regulation Kamau, A.W (2009) argues that the engagement at the local level in Kenya presents problems

as there has been a continuous process of centralization of power since independence and concentration of powers in the Presidency Finding ways to support people’s participation in public affairs at the local level, in the absence of a decentralization reform, is a key challenge for development partners. The deliberate weakening of control institutions, such as the judiciary and the auditor general, and of systems of financial management. Increasingly, the Presidency took on extra powers, while the checks were weakened. This was a deliberate strategy to maintain control and to ensure that the President could maneuvers as he wished, unencumbered by external controls. This led to a weakening of state institutions, which were increasingly seen as serving the country’s elite rather than the people. (Kamau, A.W. 2009) The source of political patronage was found in the sale


of parastatals, and increasingly large schemes of grand corruption in public procurement and financial management.

Increased competition and efficiency of the financial sector contribute to greater financial stability, product innovation, and access by households and firms to financial services, which in turn can improve the prospects for economic growth, it is therefore important to identify the kind of reforms and environments that may help to promote competition and efficiency in the financial system in Kenya. However, there is concern that the recent reforms, particularly the consolidation within the banking system, may have resulted in a sound but uncompetitive system that could fail to deliver on greater access and financial deepening, even though profits may go up (Oloo, M 2010).

In the early 1980s, Kenya's financial sector was highly repressed, the financial system was characterized by interest rate restrictions, domestic credit controls, high reserve requirements, segmented financial markets, underdeveloped money and capital markets, and exchange rate and international capital controls ( Kamau,2009) Kenya undertook financial sector reforms from the late 1980s. The financial reforms were aimed at liberalizing interest rates, reducing controls on credit, enhancing competition and efficiency and productivity gains in the financial system. Furthermore, the reforms were directed towards strengthening the central bank's supervisory framework and improving the effectiveness of monetary policy through greater reliance on market forces.

The restructuring of financial institutions, usually undertaken after a banking crisis. The country experienced a banking crisis in 1986 when a number of ‘specified’ non-bank financial institutions (NBFIs) and a small commercial bank collapsed. Consequently, eight financial institutions were taken over and merged into a state bank in 1989 the Consolidated Bank of Kenya (CBK). The initial capital requirements for setting up financial institutions were increased both for commercial banks and ‘specified’ NBFIs. In addition, the cash ratio was reintroduced to moderate excess liquidity within commercial banks (Mutuku, N. 2008)

The second banking crisis occurred in 1998, when five banking institutions were placed under statutory management (Kamau, 2009) the bank failures were attributed to high non-performing loans. Following this crisis, the CBK put several measures to foster a sound and stable banking system. The Banking Act was also amended to give the CBK more powers to enforce banking laws and regulations, including the power to levy monetary penalties for non-compliance. A substantial number of mergers and acquisitions have taken place in the banking sector in Kenya, partly occasioned by the need to meet the increasing minimum core capital requirements and to enhance the institution's market share in the local banking industry (Kamau, 2009) Between 1994 and 2005 there were 20 successful mergers, with the number increasing to 26 by 2007, with one merger in 2008.

The country now has banks that own insurance companies, some have set up insurance agencies to push forward their concept of bank-assurance; others own stock brokerage firms (e.g. Cooperative Bank of Kenya) or are in the process of acquiring or establishing one in-house (e.g. Equity Bank). Hence there have been increased synergies between the banking, insurance and securities sectors with removal of regulatory barriers between the different segments of the financial sector. Given the convergence and consolidation of the financial services, some players have called for the establishment of an overall services regulatory authority (World Bank, 2010)

Financial sector reforms have strengthened Kenya's banking sector in the last decade or so, in terms of product offerings and service quality, stability and profitability (Kamau, 2009). Some micro-finance institutions like K-Rep Bank and Equity Bank have emerged, targeting the small-scale borrowers. Equity Bank, which converted to a commercial bank in 2004, had over 2 million customers in 2008, more than 35 per cent of the entire industry. During this period, only two banks have been put under CBK statutory management (Prudential Bank and Charterhouse Bank), in comparison to the 1980s and early 1990s when a large number of banks collapsed. The banking system therefore seems poised to withstand the global financial and economic crisis, unless overcome by pure contagion, as the fundamentals seem quite sound (Mwega, F.M.2003)

RESEARCH METHODOLOGY This study was as assessment of political influence on the finance sector management and

regulation, perspectives form Kisii County. The research partly involved a complete survey of the entire financial institution in Kisii town. The respondents to participate in the research were selected using the random sampling procedure. Financial institutions were selected randomly in Kisii town from which 50 financial institution employees and 100 respondents from the customers were selected. This consequently ended up with 150 respondents selected. The sample of 50 respondents was chosen for the study, according to Mugenda& Mugenda (1999) a sample of 30% is representative.

A questionnaire was used to collect data from the respondents in Kisii town. The questionnaires were filled as the researcher waited to reduce non-response rates. The study incorporated data analysis tools, which included descriptive and inferential statistics to analyze the data collected. Likert scale was used to identify the degree of importance of each factor. Chi- square test was used to establish the relationship between the political influence and finance sector regulation.


RESEARCH RESULTS AND DISCUSSION This section deals with data analysis and interpretations of research findings. The data in this

study was summarized and presented in the form of tables, frequencies, percentages, mean scores and standard deviations

Descriptive Analysis As per the response rate analysis, out of the 50 questionnaires that were issued to the

respondents, 48 which translate to 93% were returned, while 2 which translate to 7% were not returned. The 7% consist of respondents who were on leave and could not be contacted during the time of questionnaire collection. 93% represent a high response rate. The questionnaires were given to employees in the financial institutions and customers in respective financial institution. Gender analysis indicates that 61% of the respondents were male, while 39% were female. This shows that most of the respondents who participated in the study were male. An analysis of the highest education levels attained by the respondents shows that 21% had acquired diploma, 43% bachelor’s degree while 36% had masters. These shows that majority had at least bachelors degree thus had an understanding of their work and related issues. Regarding work experience 22% of the respondents had worked with their institutions for less than five years. 39% had worked for 5-10 years, 32% for 10-15 years and 7% for 15 years and above. Majority therefore had been in their financial institutions for 5-10 years which is a period enough to understand the individual firms and the finance industry. The first step in analyzing the data was through descriptive measures, which was done using Microsoft Excel.

Table 1: Descriptive Statistics .

Mean Std. deviation Political influence 12.9333 21.94800

Finance market performance 0.1845 0.16028 . Note. Source: Research data.

The average value of political influence on the regulation and management of the financial sector had a mean of 12.93 and a standard deviation of 21.95 while finance market performance had a mean of 0.1845 with a standard deviation of 0.161. There is very high variability in both political influence and finance market performance among the finance institutions as shown by their standard deviation values

Table 2:model Summary Model Summary . R R square Adjusted R square Std.error of

Change statistics . R square change Fchange df1 df2 Sig.F Change

0.527(a) 0.278 0.275 18.68179 0.278 114.690 1 298 0.000 Note. Predictors: (Constant), Finance market performance. Source: Research data.

Analysis in Table 2 shows that the coefficient of determination the percentage variation in the dependent variable being explained by the changes in the independent variables) R2 equals 0.278, that is, financial market performance explain 27.8% of political regulation and management for financial institutions leaving 72.2% unexplained. The P-value of 0.000 (less than 0.05) implies that the model of political influence is significant at the 5% level of significance.

Table 3:ANOVA analysis ANOVA .

Sum of squares DF Mean square F Sig. Regression 40,027.940 1 40,027.940 114.690 0.000 (a) Residual 104,004.726 298 349.009 Total 144,032.667 299

Notes. Predictors:constant, finance Market Performance. Dependent variable: Political influence. Source: Research data.

ANOVA findings (P-value of 0.00) in Table 3 show that there is correlation between the predictor’s variables market performance and response variable political influence. The study used regression analysis to find the association between financial market performance and political influence forecasting model was developed and tested for accuracy in obtaining predictions. The finding of the study indicated that the model was moderately significant. This is demonstrated in the part of the analysis where R2 for the association was 27.8%. The results obtained from the regression model show that there is an effect of political influence on market performance on reasonable level with 27.8% possibility of political influence in predicting the variance in financial market performance.

Table 4:Coefficient of Regression Coefficients of Regression Equation .

Unstandardized coefficients Standardized coefficients T Sig. B Std. error Beta

Constant 26.251 1.646 15.947 0.000 Political influence -72.189 6.741 -0.527 -10.709 0.000 Notes. Dependent variable: Political influence. Source: research data.

As shown in Table 4, the established simple linear regression equation becomes:


Y = 26.25 – 72.19X where: Constant = 26.25, shows that at zero value of political influence for all financial institutions, political influence takes the value 26.25. X1= -72.19, shows that one unit change in political influence results in 72.19 units decrease in financial market. Political influence is also linearly related with financial market performance as shown, its P-value of 0.00 which is less than 0.05.

SUMMARY, CONCLUSION AND RECOMMENDATIONS This section presents the summary of the research findings on the political influence on the

finance sector regulation in Kenya, perspectives from financial institutions in Kisii County; the conclusion drawn from the summary findings; recommendations and suggestions for further research.

This study makes several contributions on ongoing concern of financial market regulators and government regarding the low level of knowledge/financial literacy among individual investors. Second, this is the only study which we are aware of which has demonstrated that the enduring involvement with financial institutions mediates the relationship between political influence and investor knowledge. Overall, the study enhances our understanding of the influence of political Legislation on financial institutions and enduring involvement with finance product development.

The findings of the study have implication for the policy decisions. Governments and regulatory agencies across the globe are highly concerned with the low level of financial literacy among investors. They are constantly focusing on making the information that are relevant to their investment decision accessible to average investor. These rules and additional rules are directly aimed at reducing the ambiguity surrounding investment in the market place. However, availability of information will only provide an opportunity for the investor to acquire and process that information; however lack of investment knowledge among investors will dampen the spirit of providing information to investors to make intelligent investment decision.

The effectiveness of the information related to investment products available in the public domain will remain low until unless investor’s knowledge of investment product is increased. The study suggests significant linkage of political knowledge and financial institution products. Hence policy makers should promote financial education program delineating the importance of investment product for investors’ long term financial well being and retirement needs. This can be done through extensive financial education program starting from primary school level. Further extensive campaign to educate investors about the impact of poor political decisions on financial planning is likely to increase level of less enduring involvement. Future research is required to throw light on the above finding. However based on the findings of this study, it can be concluded that level of enduring involvement with product will vary across investors based on their level of legislation. Hence it is not unexpected that the effectiveness of financial education program will vary among investors based on their own political inclination. This may explain the large variability in the effectiveness of financial decision. This suggests that there will be difference in the level of knowledge of individual investors, influenced by government legislation mediated through enduring involvement with products. To meet the information need of those investors, who are less knowledgeable, regulatory bodies are required to follow a differential reporting requirement considering the specific information need of low knowledgeable investors.

This will make sure that investors are making intelligent/informed choice, specifically low knowledgeable investors. This needs changes in the existing policy use of information by potential investors. Hence existing reporting required by these regulatory bodies does not adequately support the investment decision made by low knowledgeable investors of regulatory bodies across the globe and other regulatory body across the globe makes decision about required reporting information based on assumptions regarding the homogeneous

Further research In future research should also be done to explore the role of enduring involvement of low

education on politicians and the legislation of financial institution. This will help government and regulators to provide education and assistance to the investor. Due to the drastic growth in the investment products, there is an increasing demand for product information from investors. However due to the cognitive limitation of the human, policies aimed at increasing information may not improve the quality of investment decision based by individual investors. Researcher should explore the mediating role of enduring involvement on the nature of information looked by investors. This will help regulatory bodies to adequately support the investment decision by providing relevant information to various categories of investors

REFERENCES Aikaeli, J. (2007), ‘Efficiency and the Problem of Excess Liquidity in Commercial Banks in Tanzania’, PhD thesis submitted to the University of Dar es Salaam.


Baumol, W., J. Panzar and R. Willig (1982), Contestable Markets and the Theory of Industry Structure, Harcourt Brace Jovanovich, San Diego, CA. Bresnahan, T.F. (1989), ‘Empirical Studies of Industries with Market Power’, in R.Schmalensee And R.Willig (eds.), Handbook of Industrial Organization, Vol. 2, North-Holland, Amsterdam, pp. 1011–57. Brownbridge, M. and C. Harvey (1998), Banking in Africa, Africa World Press, Trenton. Buchs, T., and J. Mathisen (2005), ‘Competition and Efficiency in Banking: Behavioral Evidence From Ghana’, IMF Working Paper No. 05/17. CBK (2003), the Payment System in Kenya. Hauner, D. and Peiris, D.J (2005), ‘Bank Efficiency and Competition in Low-Income Countries: The Case of Uganda’, International Monetary Fund Working Paper WP/05/240. Kablan, S. (2007), ‘Measuring Bank Efficiency in Developing Countries: The Case of WAEMU’,Paper presented an African Economic Research Consortium Workshop, May. Kamau, A.W. (2009), ‘Efficiency in the Banking Sector: An Empirical Investigation of Commercial Banks in Kenya’, PhD thesis submitted to the University of Nairobi. Kasekende, L., K. Mlambo, V. Murinde and T. Zhan (2009), ‘Measuring the Competitiveness of The Financial Services Sector: What Are the Lessons for African Economies?’ African Development Bank, framework paper. Kubo, K. (2006), ‘the Degree of Competition in the Thai Banking Industry before and after the East Asian Crisis’, Institute of Developing Economies, Discussion Paper No. 56. Leigthner, J. and L. Knox (2008), the Impact of Financial Liberalization on the Performance of Thai banks, Journal of Economics and Business, Vol. 50, No. 2, pp. 115–31. Mutuku, N. (2008), ‘The Case for Consolidated Financial Sector Regulation in Kenya’, Mwega, F.M. (2003), ‘Financial Sector Reforms in Eastern and Southern Africa’, in T.Mkandawire and C. C.Soludo (eds.), African Voices on Structural Adjustment: A Companion to Our Continent, Our Future. Africa World Press, Trenton, NJ. Oloo, M. (2010), the Banking Survey, Kenya. Think Business Ltd. World Bank (2010), Adjustment in Africa: Reforms, Results and the Road Ahead, World Bank Policy Research Report, Oxford University Press, New York.


Effect of European Debt Crisis Spillover on Currency Options Pricing

Ariful Hoque, Murdoch University, Australia

ABSTRACT Two major currencies, the Australian dollar (AUD) and Japanese yen (JPY), have recently

appreciated as concerns around European debt have pushed investors into safe-haven currencies. Speculators have taken advantage of this upward price movement by holding AUD and JPY options contracts. However, such a heavy demand for AUD and JPY options increases the possibility of them being mispriced. Of particular concern are the active foreign exchange (FX) participants who hedge their funds to avoid risks against price changes, for they suffer financial losses when options are mispriced. This study examines the shock of large budget deficits in Europe on AUD and JPY options market efficiency that leads to options price accuracy. In the literature, the no-arbitrage strategy-based put-call parity (PCP) relationship is employed for options pricing analysis. The transaction cost (TC) plays a significant role in the determination of the arbitrage profit amount due to violations of PCP. Since transaction cost estimation is a challenging issue, bid-ask spread is used for the proxy of TC. We develop a new approach to analyse options pricing accuracy based on options moneyness. This approach overcomes the critical TC estimation issue for arbitrage profit opportunity under the PCP test in order to confirm whether options are priced correctly. AUD and JPY options with three of their different strike prices are included as a sample in this study. The regression analysis and Wald test results indicate that, on average, both sample currency options have been priced efficiently during the European debt crisis spillover. The findings of this study are useful for various FX market participants who manage foreseeable financial risks by holding AUD and JPY options contracts. Keywords:European Budget Deficit, Currency Options, Put-Call Parity, Serial Correlation, ARCH,

GARCH, Wald Test

INTRODUCTION In January 2010, a European Union (EU) report condemned "severe irregularities" in Greek

accounting procedures. Greece's 2009 budget deficit was revised upwards to 12.7%, from 3.7%, more than four times the maximum allowed by EU rules (see the Europe Crisis Timeline). The European debt crisis pushed investors into safe-haven currencies, and, subsequently, the AUD and JPY have appreciated. The upward price movement of the AUD and JPY has attracted currency speculators to make a profit by holding AUD and JPY options contracts. This practice has increased the demand for AUD and JPY options and has led to their mispricing. This study analyses the effect of the European debt crisis spillover on AUD and JPY options pricing accuracy.

The PCP relationship is widely accepted in concluding whether or not the options market is efficient—that is, if options are priced correctly. The PCP is a no-arbitrage relationship that must be satisfied to prevent arbitrage profit opportunities. Giddy (1983) and Grabbe (1983) were among the first to design the PCP relationship for foreign currency options, doing so by using the PCP theorem that was developed by Stoll (1969) for equities. To examine the possibility of arbitrage profit opportunity, several studies conducted PCP tests without allowing for transaction costs (see, for example, Trippi, 1977, Chiras and Manaster, 1978, Shastri and Tandon, 1985, Bodurtha and Courtadon, 1986). In general, the PCP test results did not support that the options were priced efficiently.

A systematic treatment of the transaction costs (TC) facing traders in the organised options market can be seen in the work of Phillips and Smith (1980). They considered explicit costs, in the form of commission and other fees, and implicit costs, such as bid-ask spreads in options pricing. They found that the larger the TC, the wider is the band within which options prices can swing without creating arbitrage opportunities. Additionally, Keim (1989) as well as Yadav and Pope (1990) took into account 1 per cent as an average bid-ask spread in their PCP tests. Subsequently, Puttonen (1993) considered 2 per cent of the bid-ask spread for the Helsinki Stock Exchange. Furthermore, Nisbet (1992) identified that the PCP violation in the presence of only bid-ask spreads almost disappeared when commission was included with bid-ask spreads, whereas Chateauneuf et al. (1996) pointed out that bid-ask spreads differ from the traditional formalization of proportional TC. Brunetti and Torricelli (2005) suggested that other types of costs (e.g., clearing fees, short selling costs, and so on), in addition to bid-ask spreads, should be considered and that commissions should include more precise information about the TC.

For German mark exchange options market efficiency, El-Mekkaoui and Flood (1998) conducted PCP tests in the presence of transaction costs using intra-daily data. They used a 0.0625 per cent TC, as Surajaras and Sweeney (1992) suggested in their study. However, Rhee and Chang (1992) used a TC of 0.0409 per cent for the German mark. Mittnik and Rieken (2000) analysed the informational efficiency of the German DAX-index options market in the presence of TC. In their studies, a fee of 0.40 DEM per contract and 0.1 per cent of the index value represented the trading costs.


After reviewing the literature, we find a number of weaknesses in the PCP tests for options market efficiency that were to confirm options pricing accuracy: (1) insignificant arbitrage profit due to PCP violation also indicates that the options market is not efficient; (2) significant arbitrage profit gets insignificant in the presence of TC; (3) standard TC is not easy to determine, since it varies across markets and currencies. This study provides an econometric approach, where arbitrage profit due to PCP violation in the presence or absence of TC or TC estimation is not an issue. The proposed model is based on the options price and its relationship to moneyness. The overall test results confirm that, on average, the AUD and JPY options are priced efficiently. The paper is organized as follows: section 2 gives the research methodology and data; section 3 discusses the regression results of the empirical analysis; and, finally, section 4 concludes the paper.

METHODOLOGY AND DATA In this section, the methodology design is based on the relationship between options price and

moneyness. Options in-the-money (ITM) and out-of-the-money (OTM) moneyness describes profit and loss, respectively, for their immediate exercise. Consequently, the call (put) option should be sold at a higher price than that of the put (call) option when call (put) and put (call) is traded ITM and OTM, respectively. Using this options market trading mechanism, we have developed an econometric model, as shown in equation (1),

(1) where, C, P, S, X, R and T, represent call price, put price, spot price, strike price, domestic risk-free interest rate, and time to maturity, respectively. Equation (1) shows that the call and put price difference is related to their moneyness return. Now, we consider that and

and rearrange the equation (1) to develop the regression equation (2), as follows: . (2)

Under the null hypothesis, coefficients α0 and α1 in equation (2) should be 0 and 1, respectively, to conclude that the call and put options are priced efficiently. We address the unit root issue for the Yt and Xt series, because Hoque et al. (2008) found that strike price, spot price, and interest rate are non-stationary; otherwise, the OLS estimates are likely to be spurious. We also accommodated potential autocorrelation and conditional heteroscedasticity for equation (2) so that the results would lead to unbiased and consistent inferences for α0 and α1.

The options pricing analysis is conducted for options on the AUD and JPY. Since the EU Monetary Affairs commissioner stated that June 2011 may the “beginning of the end” of the crisis (see the Europe Crisis Timeline), this study includes the put-call pairs of the sample currencies from 26 June 2011 to 25 May 2012. The contract size is 10,000 and 100,000 for Australian dollar and Japanese yen, respectively. These options mature on the third Friday of each month. The data set also consists of daily closing spot prices and daily US dollar risk-free interest rates for the sample period. All of these data are obtained from Datastream.

EMPIRICAL ANALYSIS The empirical analysis started with a unit root test for the sample data series. The standard

Augmented Dickey-Fuller (ADF) and Phillips-Perron (PP) tests were employed to identify the presence of the unit root in the Y and X data series of equation 2. The ADF test accommodates serial correlation and time trends by explicitly specifying the autocorrelation structure. The PP test accommodates heteroscedasticity and autocorrelation using the non-parametric method. Philips and Perron (1988) argue that the PP test has a stronger power than ADF under a wide range of circumstances. The ADF and PP unit root test was run on levels of the Y and X data series; the test results are given in Table 1. The t-statistics for all strike prices of Y and X data series failed to reject the null hypothesis of the unit root at any level of significance under both ADF and PP tests. These results mean that the Y and X variables are not stationary for each of their strike price data sets.

Table 1: Unit Root Test on the Variable Level Strike price Yt Xt

ADF PP ADF PP Panel A: Australian dollar

100 -2.136340 -2.333664 -1.561362 -1.662863 105 -2.144441 -2.338793 -1.561362 -1.662863 110 -2.148149 -2.353818 -1.561362 -1.662863

Panel B: Japanese Yen110 -1.477727 -1.571650 -0.967763 -0.967763 120 -1.588102 -1.500039 -0.967763 -0.967763 130 -1.556636 -1.490483 -0.967763 -0.967763

Notes: The T-statistic critical values for the ADF and PP tests are -3.457061, -2.873190 and -2.573054 at the 1%, 5% and 10% level of significance respectively.


Next, the ADF and PP unit root tests were run following the first difference in the Y and X series to ensure that the data set used for the regression analysis was stationary; otherwise, the OLS estimates were likely to be spurious. The test results are presented in Table 2. For all sample data series, the reported t-statistics in Table 2 rejected the null hypothesis of the unit root test at less than a 1 per cent level of significance.

Table 2: Unit Root Test on First Difference of the variables Strike price Yt Xt

ADF PP ADF PP Panel A: Australian dollar

100 -16.10532 -16.10311 -15.43636 -15.43630 105 -9.654514 -16.16440 -15.43636 -15.43630 110 -15.91690 -15.92216 -15.43636 -15.43630

Panel B: Japanese Yen110 -18.26909 -18.27683 -16.73489 -16.73489 120 -16.95964 -16.97582 -16.73489 -16.73489 130 -16.40610 -16.42502 -16.73489 -16.73489

Notes: See notes of Table 1 Finally, the regression analysis was conducted for the first difference in the Y and X data series, as

done with equation (2) by accommodating the serial correlation and ARCH effects; the results are given in Table 3. To detect the possible presence of serial correlation problems and ARCH effects, LM (Lagrange multiplier) tests were employed. For each currency, the regression analysis was performed for three sets of data with different strike prices. The A and B panels provide the regression results for options on the Australian dollar and Japanese yen, respectively. In columns 5 and 6, the P-values for the F-statistic under LM tests indicate that the data failed to reject the null hypothesis of no serial correlation and ARCH in the residual for all sample currencies. Next, we examined the values of the intercepts, as reported in column 2. The null hypothesis, H0: , cannot be rejected at any standard significant level, indicating that the intercepts are not statistically different from 0 in all cases except for the Japanese yen strike price of 110. However, the values of the intercepts in column 2 are negligible. Finally, we looked at the slope coefficient ( ) with its standard error (std. error) in the parentheses, as reported in column 3 of Table 3. The estimates of are statistically different from 0 for all cases.

Table 3: Regression Test Results Strike price

Intercept

(std. error) Slope

(std. error) Serial Correlation Test Heteroskedasticity Test

ARMA F-statistic(P-value) GARCH F-statistic

(P-value) Panel A: Australian Dollar

100 0.00033 (1.04E-05)

0.9823(0.0089)

(2,2) 0.8232(0.4403)

(2,1) 0.0010 (0.9747)

105 0.00032 (7.99E-06)

0.9810(0.0076)

(2,2) 0.6748(0.5102)

(6,0) 0.7622 (0.7827)

110 0.00033

(1.02E-05) 0.9797

(0.0091) (3,3) 0.1676

(0.8458) (6,0) 0.02271

(0.8803)

Panel B: Japanese Yen110

4.72E-05 (0.00023)

1.0776(0.0438)

(1,1) 0.5682(0.5673)

(2,2) 0.5843 (0.4454)

120

0.00016 (4.01E-05)

1.0260(0.0135)

(2,2) 0.0335(0.9672)

(2,0) 0.0413 (0.8392)

130

0.00019 (1.87E-05)

0.9818(0.0096)

(2,2) 0.1717(0.8423)

(1,1) 0.2105 (0.6468)

The null hypothesis (H0: ) test results are given in Table 4. The regression results for the slopes from Table 3 are reproduced in Table 4 with the standard errors (std. error) under T-tests. The std. errors are given in parentheses next to the estimated coefficients. The high values of R2 in the last column of Table 4 indicate a good fit of the regression line for all data sets of both currency options. In column 2, the T-test reveals that the null hypothesis, H0: , cannot be rejected at any standard level of significance.

To obtain a precise significance level, a Wald test was conducted, and the results are presented in column 3. Under the Wald test, the P-values next to the F-statistic in parentheses indicate that the null hypothesis, H0: , cannot be rejected at the 5, 1, and 3 per cent levels of significance for the Australian dollar options strike prices of 100, 105, and 110, respectively. For the Japanese yen, the null hypothesis, H0: , cannot be rejected at the 8, 5, and 6 per cent levels of significance for the strike prices of 110, 120, and 130, respectively. Since higher values of significance levels narrow the band to reject the null hypothesis, JPY options are priced more efficiently than those of AUD.


Table 4: Analysis of Equality of Slope Coefficient to 1 Strike price

T-tests

Coefficient (Std. error)Wald tests

F-statistic (P-value) R2 Panel A: Australian Dollar

100 0.9823 (0.0089) 3.92244 (0.0488) 0.7746 105 0.9810 (0.0076) 6.3190 (0.0126) 0.7694 110 0.9797 (0.0091) 4.9867 (0.0265) 0.7771

Panel B: Japanese Yen110 1.0776 (0.0438) 3.1326 (0.0780) 0.7838 120 1.0260 (0.0135) 3.7341 (0.0545) 0.9219 130 0.9818 (0.0096) 3.5601 (0.0604) 0.9478

CONCLUSION The recent European debt crisis has pushed investors into safe-haven currencies. Consequently,

the Australian dollar (AUD) and Japanese yen (JPY) have appreciated, which has attracted speculators taking advantage of upward price movement to make a profit by holding AUD and JPY options contracts. This practice has also created a heavy demand for AUD and JPY options, thus increasing the possibility of them being mispriced. Active foreign exchange (FX) market participants who use the currency options to avoid risk, protecting themselves against price changes, will suffer financial losses when options are mispriced. This study examined the impact of large budget deficits in Europe on AUD and JPY options price accuracy. The purpose of this study was to determine whether the FX risk management tool currency options market is functioning efficiently in the Australian and Japanese financial markets during the European debt crisis spillover.

In this study, a new econometric approach is introduced to overcome the following two major drawbacks of standard put-call parity (PCP) tests for options pricing efficiency: (1) they are critical for determining the attractive arbitrage profit amount due to violations of the PCP relationship, and (2) these present a challenge to estimating the standard transaction costs. The econometric model was developed based on the options price and moneyness relationship. If options provide profit and loss for their immediate exercise, the options’ moneyness is described as in-the-money (ITM) and out-of-the-money (OTM), respectively. For this instance, the call (put) option should be sold with a higher price than that of the put (call) option if call (put) and put (call) are traded ITM and OTM, respectively. Our approach mainly adapted the options market trading mechanism to examine whether or not the difference of call and put options is equal to their moneyness return. If the price difference and the return are equal, we can conclude that options have a correct price.

To justify our conclusion, the regression analysis was conducted by taking unit root issues into account; otherwise, the OLS estimates were likely to have been spurious. We also accommodated potential autocorrelation and conditional heteroscedasticity to obtain unbiased and consistent inferences for both intercepts and slopes. Furthermore, the Wald test was employed to obtain a precise significance level, because slope is equal to 1 statistically. For each sample currency, the regression analysis was performed for three sets of data with different strike prices. Wald test results for the AUD options showed that the slope is equal to 1 at the 5, 1, and 3 per cent levels of significance for strike prices of 100, 105, and 110, respectively. Similarly, for the JPY options with strike prices of 110, 120, and 130, the slope was equal to 1 at the 8, 5, and 6 per cent levels of significance, respectively. The overall empirical analysis indicates that, on average, the AUD and JPY options are well priced. Further, the higher significance level for JPY indicates that JPY options are priced more efficiently than those of the AUD. The findings of this study offer valuable insight for FX market participants holding AUD and JPY options contracts in order for them to manage their projected financial risk.

REFERENCES Bodurtha, J. N., and Courtadon, G. R. (1986). "Efficiency tests of the foreign currency options market. "The Journal of Finance 41: 323-330. Brunetti, M., and Torricelli, C. (2005). "Put-call parity and cross-markets efficiency in the index options markets: evidence from the Italian market." International Review of Financial Analysis, 14: 508-532. Chateauneuf, A. , Kast, R., and Lapied, A. (1996). "Choquet pricing for financial markets with frictions." Mathematical Finance 6,: 151-162. Chiras, D., and Manaster, S. (1978). "The information content of option prices and a test of market efficiency." Journal of Financial Economics 6: 213-234. El-Mekkaoui, M., and Flood, M. D. (1998). "Put-call parity revisited: intra daily tests in the foreign currency options market." Journal of International Financial Markets, Institutions and Money 8: 357-376.


Europe Crisis Timeline: Maastricht to Papandreou – Bloomberg (http://www.bloomberg.com/ news/2011-11-07/europe-timeline-maastricht-to-papandreou.html Giddy, I. H. (1983). "Foreign exchange options." The Journal of Futures Markets 3(2): 143-166. Grabbe, J. O. (1983). "The pricing of call and put options on foreign exchange." Journal of International Money and Finance 2: 239-253. Hoque, A., Chan, F., and Manzur, M. (2008). "Efficiency of the Foreign Currency Options Market."Global Finance Journal 19: 157-170. Keim, D. (1989). "Trading patterns. Bid-ask spreads, and estimated security returns: the case of common stocks at the calendar turning points." Journal of Financial Economics(25): 75-97. Mittnik, S., and Rieken, S. (2000b). "Put-call parity and the informational efficiency of the German DAX-index options market." International Review of Financial Analysis 9: 259-279. Nisbet, M. (1992). "Put-call parity theory and an empirical test of the efficiency of the London traded options market." Journal of Banking and Finance 16: 381-403. Phillips, P., and Perron, P. (1998), Testing for a unit root in time series regression, BiometriKa, 75, 335-346. Phillips, S. M., and Smith, C. W. (1980). "Trading costs for listed options." Journal of Financial Economics 8: 179-201. Puttonen, V. (1993). "Boundary conditions for index options: evidence for the Finnish market." The Journal of Futures Markets 13: 545-562. Rhee, S. G., and Chang, R. (1992). "Intra-day arbitrage operations in foreign exchange and eurocurrency markets." Journal of Finance 47: 363-379. Shastri, K., and Tandon, K. (1985). "Arbitrage tests of the efficiency of the foreign currency options market." Journal of International Money and Finance 4: 455-468. Stoll, H. R. (1969). "The relationship between put and call option prices." Journal of Finance 24: 801-824. Surajaras, P., and Sweeney, R. (1992). Profit-making speculation in Foreign exchange markets, Westview press, Boulder, CO. Trippi, R. (1977). "A test of option market efficiency using a random-walk valuation model." Journal of Economics and Business 29: 93-98. Yadav, P. K., and Pope, P. F. (1990). "Stock index futures arbitrage: international evidence." The Journal of Futures Markets(10): 573-603.


Outsourcing Relationships in not–for–Profit Superannuation Funds in Australia: Survey Evidence

Sarath Delpachitra, Flinders University, Australia

Deborah Ralston,Monash University, Melbourne, Australia Guneratne Wickremasinghe*,Victoria University, Australia

ABSTRACT This paper reports the results of a survey on the nature of investment management outsourcing

relationships in not-for-profit superannuation funds in Australia. The survey dealt with provider relationships with asset consultants, investment managers and custodians of twenty-six not-for-profit superannuation funds. The results indicate that superannuation funds enjoy strong relationships with their investment outsourcing partners, asset consultants, investment managers and custodians. This is evidenced by relatively high levels of trust, business understanding and the level of commitment between funds and investment outsourcing providers. Further, the survey identified three key attributes that have a major bearing on the success of the relationships between funds and investment outsourcing providers: the length of the relationship, whether the relationship is largely a partnership or it is a transactional relationship and monitoring costs. In terms of overall satisfaction with the relationship, asset consultants are rated most highly followed by custodians and then investment managers. Keywords:Not-for-profit superannuation funds, outsourcing relationships, investment managers,

industry funds, asset consultant

INTRODUCTION Outsourcing in the financial services sector has accelerated over past decades due to rapid

developments in information and communication technologies. Growth in this business model provides an interesting contrast to more traditional economic theory which suggests that firms should consolidate on achieving economies of scale and scope in the process of business development.

Outsourcing allows firms to focus on “core” business rather than investing to improve “non-core business”. Through outsourcing, firms have been increasingly shifting specific components of their business processes from a ‘hierarchical’ mode towards a ‘market’ mode of governance. By contracting out some activities to a third-party provider, firms are handing over the operations that are sometimes historically costly to maintain or where they do not have sufficient resources or expertise to maintain them in-house. Such shifts have created opportunities to transform fixed costs to variable costs. It is possibly for this reason that outsourcing has become so widespread amongst superannuation funds in Australia.

Outsourcing in financial institutions can, however, impose a significant set of accountability and risks issues for management. As the Federal Reserve Bank of New York (1999) and the Bank of International Settlements (2005) point out, while outsourcing means that direct managerial responsibility for the activity is transferred to a third party provider, accountability for the function is retained by the financial institution. In maintaining accountability, risks are incurred by the financial institution and need to be effectively managed.

In Australia requirements for the management of outsourcing risks in banks are contained in Registrable Superannuation Entities (RSEs) in the Superannuation Industry (Supervision) Act 1993 and Regulations1. Treatment of outsourcing risks is seen to be harmonised for banks and RSEs under the proposed Prudential Standards for Superannuation. These Prudential Standards are likely therefore to cover the need for a formal outsourcing policy and risks management strategy, minimum requirements for outsourcing agreements, and due diligence and on-going monitoring requirements. As APRA (2011) points out in its Discussion Paper where superannuation funds are concerned more attention will be paid in these standards to aspects of outsourcing with related parties than is the case with banks, given the extent and prevalence of outsourcing to related parties in the superannuation industry and the resulting potential for increased risks.

Outsourcing to related parties increases risks in super funds in terms of concentration, contagion and conflicts of interest. Management of service-provider conflicts requires that fund trustees impose governance practices, which ensure alignment of process with beneficiaries’ interests and compliance with the fiduciary’s duty of loyalty. Oversight of the selection of outsourcing providers, contract requirements, alignment of incentives with beneficiaries’ goals, the monitoring of conflicts and enforcement of standards are critical aspects (Hawley, Johnson and Waitzer, 2011). Where a fund trustee also sits on the board of a service provider, the pressure to achieve corporate goals may directly conflict with the duty to beneficiaries.

This paper examines the nature of outsourcing relationships in Australian not-for-profit superannuation funds. Drawing on prior literature, the study reports a survey of 26 superannuation


funds and their relationships with providers of investment outsourcing services, namely asset consultants, investment managers and custodians.

RATIONALE FOR OUTSOURCING The literature related to outsourcing draws from two main disciplines, strategic management and

the theory of economics (see Lee et al., 2000). The strategic management perspective explains the concept of outsourcing using resource-based theory and resources-dependency theory. According to the resource-based theory, a lack of internal physical, human and organizational capital capability drives the firm to look for external service providers. Similarly, the resources-dependency theory supports the proposition that outsourcing gives the firm an opportunity to take advantage of available external specialists to sustain a competitive advantage and maximize the productivity and efficiency of internal processes.

In contrast, economic theory explains the concept of outsourcing from a number of perspectives. First, the theory of comparative advantage emphasises the gains from specialization. In other words, firms should procure some of their inputs externally if they do not have sufficient specialised skills in-house. It also suggests that by outsourcing firms will be able to increase economies of scale and scope by cutting costs and utilizing resources more efficiently. Furthermore, transaction theory and agency cost theory have also been used to explain the concept of outsourcing.

Transaction cost theory suggests that by adopting an outsourcing relationship firms will be able to reduce transaction costs (and production costs), thereby achieving cost efficiency. Furthermore, as said before, outsourcing provides opportunities for firms to restructure costs by transforming some of its fixed costs to variable costs. Similarly, agency cost theory emphasises the application and advantages of a principal-agent relationship with the expectation that both principal and agent have a sound understanding of their relationship and obligations. Thus principal-agent theory emphasises that agents (the outsourcing provider in this case) will act in the best interests of the principal and use the provider’s specific skills in delivering comparatively low cost value, thereby improving cost efficiency and reducing risks exposure. Both transaction cost and the agency cost theories emphasise that outsourcing leads to administrative, scale and pure technical efficiencies in the production/delivery processes.

Despite the advantages of outsourcing there are many issues that have been raised in the literature. These issues cover the problems related to acquisition, motivation (in-source or outsource), scope, performance (in terms of investment and as well as product), the nature of contacts and partnerships.

RISKS IN OUTSOURCING The joint forum of the Basel Committee on Banking Supervision has identified a number of types

of risks present in financial services outsourcing. These risks include strategic risks, reputation risks, compliance risks, operational risks, exit strategy risks, counterparty risks, country risks, contractual risks, access risks and concentration and systematic risks.2

First, strategic risks will occur if the outsourcing provider conducts activities on its own behalf compromising strategic goals of the firm or if the firm fails to implement appropriate oversight of the outsource provider or if there are insufficient experienced personnel in-house to oversee the outsourcing provider. This may lead to a breach of trust, business understanding and functional and dysfunctional conflicts.

Second, reputation risks can arise through poor service quality and adoption of investment strategies that are inconsistent with the firm’s objectives (and the objectives of the members of the firms). In addition, practices of the outsourcing provider may not comply with the ethical standards of the firm. Third, compliance risks can arise through inadequate compliance and control measures on the part of the outsourcing provider. These may lead to non-compliance with general prudential and consumer-protection standards.

Fourth, if the firm is not sufficiently experienced in the overall process of outsourcing there may not be an appropriate exit strategy from the relationship. This may arise from over-reliance on the outsourcing provider or a lack of relevant employees (and skills) within the firm itself which could hinder bringing back the activities in-house.

Finally these risks may also lead to concentration and systemic risks creating a significant risk exposure to the outsourcing provider, lack of control over the outsourcing provider by the firm and ultimately systemic risks to the superannuation industry as a whole. In order to mitigate the above risks, there should be a strong relationship between the firm and its outsource providers.

OUTSOURCING IN AUSTRALIAN SUPERANNUATION FUNDS Australian superannuation funds tend to outsource a large number of functions. A recent study by

Lui and Arnold (2010a) of 115 funds with assets in excess of $200m examined the use of outsourcing


for actuarial services, administration, asset consulting, auditing, custody, legal services, sales and marketing and investment management, legal services, sales and marketing (see figure 1).

Each of the 115 respondents outsourced at least one function, and nearly two-thirds outsourced six or more. Not-for-profit funds were more likely to outsource than retail funds do, which are more likely to use affiliate service providers. Figure 1 depicts the nominal and effective extent of outsourcing in non-for-profit and retail funds where the effective level of outsourcing refers to arrangements with independent service providers.

Figure 1: Nominal and Effective Outsourcing by Fund Type – All Functions

Source: Liu and Arnold, (2010a), p. 3

In another study, Liu and Arnold (2010b) conclude that, while the motivation of not-for-profit funds to outsource is largely driven by functionality and/or cost efficiency amongst retail funds which tend to outsource to affiliates which is an integral part of their revenue models.

The effective level of outsourcing of the three investment functions of asset consulting, investment management and custody, which are the subject of this paper, appears to be considerably greater amongst not-for-profit funds. Of the 84 not-for-profit funds surveyed, 95 per cent outsourced the asset consulting or allocation function, with the vast majority (72) using the services of only one provider. Similarly, 71 per cent outsourced their custody function, and almost all used only one provider for this function.

By contrast, funds had multiple relationships with investment managers. As shown in table 1, 92 per cent of the not-for-profit respondents who reported outsourcing the investment management function used multiple providers and almost half used more than 10 investment managers.

Table 1: Investment Management – Number of Service Providers Number of service providers 1 2-4 5-10 11-37 Did Not Report Total

Number of respondents 6 12 23 32 10 83 Source: Liu and Arnold (2010a)

As this survey of 115 funds demonstrates, outsourcing in the superannuation industry is widespread and, as a consequence, selecting, monitoring, and managing service providers have become major functions of trustees, and the remuneration of service providers has become a major cost for funds.

METHODOLOGY A survey examining the nature of investment management outsourcing relationships was

distributed through the Australian Industry Superannuation Trustees (AIST) to all affiliated 84 not-for-profit funds. The six-page survey comprised three sections dealing with provider relationships with asset consultants, investment managers and custodians. A final section gathered data on the demographics of the funds.

In each of the sections relating to service providers for asset consulting, investment management and custody, respondents were asked to identify key aspects of their relationship with their main service provider in terms of the length of the relationship, whether the relations were transactional or partnership in nature (on a five-point scale), and how many staff were involved in the function, both in the fund itself and within the service provider. Participants were then asked to indicate their response on a five-point scale to statements concerning, firstly, trust, business understanding, and risks and benefit sharing, secondly, functional and dysfunctional conflict, and commitment, and thirdly, strategic, economic and technological benefits. In addition respondents were asked a small number of


subsidiary questions in each section relating to how they perceive the success of that outsourcing relationship and other matters directly related to that type of service.

The survey was distributed in October 2010 and followed up with telephone calls. A total of 26 responses were received, giving a response rate of 31 per cent. Of the 26 funds that responded, 18 were industry funds, seven were public/corporate funds and one identified it as a “system” fund. The funds ranged from small (6) with less than 10 employees, to medium (13) with employees between 11 and 49, and large (6) with more than 50 employees. In terms of funds under management, 13 had between $1 and $3 billion, and 12 had more than $3 billion. Geographically the majority of funds (13) was from Victoria, 7 from New South Wales, 2 from South Australia and one each from Western Australia, the ACT and the Northern Territory. Over 80 per cent of those completing the survey were either CEOs or CIOs (One respondent didn’t wish to disclose his position)

RESULTS In this section results of the survey are examined for each of the investment service providers.

The pattern of the type and length of relationship varies across the three types of outsourcing providers as follows (note figures may not add up to 100% due to multiple responses).

Table 2: Average length and nature of outsourcing relationship (%) Length of relationship Partly or largely partnership 1 - 5 yrs 5 – 10 yrs > 10 yrs Asset Consultants 50 50 0 85 Investment managers 37.5 50.0 12.5 50 Custodians 11.5 34.6 46.2 37.5

Relationships between funds and asset consultants tend to be long term, with half being over five years and of a partnership nature for the vast majority (85 per cent). The relationship between a fund and its key investment manager also tends to be long-term with 62 per cent being in a relationship longer than five years and being evenly divided between a partnership and transactional-type relationship.

Relationships between funds and custodians tend to be very long term, with 81 per cent reporting relationships of more than 5 years and with half of those relationships being for more than 10 years. Only around one third of respondents (38 per cent) report this as being a partnership style relationship.

Relative numbers of staff engaged in a particular function is used as a proxy for assessing monitoring costs. If the fund has fewer staff than those of the service provider, or in other words the service provider is “resource rich”, the monitoring costs are generally assumed to be higher (BIS, 2005). If the fund has greater capacity within the organisation than the service provider does, monitoring cost are assumed to be lower regardless of the levels of difference in expertise.

Trust Funds were asked nine questions related to the trust between funds and investment outsourcing

providers. Answers to these questions were rated on a five-point scale ranging from 1 for strongly disagree to 5 for strongly agree. The results are shown in Table 3.

Table 3: Trust Asset

ConsultantsInvestment managers Custodians

1. The provider has the required expertise to perform jobs effectively. 4.30 4.45 4.202. The provider has high integrity. 4.30 4.00 4.803 The provider has been open in dealing with us. 4.23 4.00 4.004. The provider makes credible promises. 3.90 3.79 3.805. The provider does not make false claims. 4.15 4.04 4.006. The provider is honest about problems that arise. 3.96 3.87 3.907. The provider can be relied upon. 4.19 4.08 3.908. The provider is sincere. 4.15 3.92 3.959. The provider demonstrates high ethical standards in dealing with us. 4.23 4.00 3.90

Average 4.16 4.02 4.05Overall there appears to be a high level of trust among funds and all three types of service

providers, with this being slightly higher for asset consultants. There is a particularly a high level of confidence in the service providers’ expertise and ability to perform their jobs effectively, with integrity and openness in dealings. Across all three service provider groups, it is notable that custodians are rated a very high in relation to their integrity. Business Understanding　

Respondents were asked to gauge the business understanding of investment outsourcing providers by ranking responses to six questions on a five-point scale from 1 for strongly disagree to 5 for strongly agree. The results are shown in Table 4.

Whilst mutual business understanding in general is not as high as the level of trust between funds and service providers, overall respondents indicate a reasonably high level of agreement to the statements above. This is especially so for asset consultants.


Table 4: Business Understanding Asset

Consultants Investment managers Custodians

1. We and the provider understand each other’s business processes. 4.07 3.56 3.902. We and the provider are clear about each other’s business objectives. 4.11 3.78 3.803. We and the provider agree upon each other’s roles in the outsourcing

relationship. 4.03 4.31 4.10 4. We and the provider have jointly developed visions in the outsourcing

relationship, making goals explicit. 3.65 3.65 3.70 5. We and the provider take into account the goals to be achieved by each other

in the outsourcing relationship. 3.77 3.60 3.50 6. We and the provider understand each other’s business policies. 3.73 3.17 3.60

Average 3.89 3.68 3.77There is a markedly lower level of understanding of business policies, however, between funds

and investment managers (Q.6). Analysis of these responses indicates that monitoring costs may be an important factor. When funds have higher monitoring costs, that is, a smaller number of staff than that of the investment manager, they are more likely to disagree that they and the investment manager understand each other’s business policies (80 v. 38 per cent).

Responses in relation to custodians are lowest with respect to understanding each other’s goals and business policies. In this case the length and nature of relationship is important. Respondents in a relationship of 10 years or more are more likely to agree that they and their custodian take into account the goals to be achieved by each other in the outsourcing relationship than those with a shorter relationship (67 v. 27 per cent). Similarly, funds in mostly a partnership relationship with their provider are more likely to agree that they take into account the goals to be achieved in the relationship than are those in mostly a transactional relationship (63 v. 40 per cent). Benefits and Risks Sharing

Respondents were asked to gauge the perceived benefits and risks-sharing with investment outsourcing providers by ranking responses to five questions on a five-point scale from 1 for strongly disagree to 5 for strongly agree. The results are shown in Table 5.

Table 5: Benefits and Risks Sharing Asset


1. Guidelines are established in the outsourcing relationship to ensure fairness for both parties. 3.76 3.73 3.70

2. We and the provider have collective responsibility for benefits and risks resulted from the joint business processes. 3.23 2.91 3.20

3. We and the provider agree on rules that constitute equal treatment underthe outsourcing relationship – the profit and loss are incurred equally by both parties. 2.96 2.73 2.73

4. The outsourcing contract is structured according to equity – we and the provider profit and loss from the outsourcing relationship in proportion to what we invest. 2.73 2.60 2.73

5. The benefits received by both parties are commensurate with the risks borne by each party in the outsourcing relationship. 3.03 2.60 2.95

Average 3.14 2.91 3.06Reponses to questions on sharing of benefits and risks indicate lower levels of agreement than

for either trust or business understanding. Once again asset consultants achieved the highest average score, followed by custodians and then investment managers. Asset consultants

The length of relationship between funds and asset consultants has a direct bearing on the perception of how benefits and risks are shared. Respondents who have a relationship longer than five years are more likely to agree that they and their asset consultants benefit and lose from the outsourcing relationship in proportion to what they invest than are those with a shorter relationship (77 v. 29 per cent). Investment managers

The type of relationship and monitoring costs affect the perception of how benefits and risks are shared between funds and investment managers.

Respondents who have mostly a partnership relationship with their investment manager are more likely to agree that rules foster equal treatment under the outsourcing relationship to ensure that profit and loss are incurred equally than are those in a mostly transactional relationship (67 v. 36 per cent). Similarly those in a partnership relationship are also more likely to agree that each party’s benefits and losses from the relationship are in proportion to what they invest (67 v. 27 per cent). Further, two-thirds of respondents in a mostly partnership relationship with their investment manager agree that the outsourcing contract is structured according to equity while the same proportion of such respondents agree that the benefits are commensurate with the risks from each party.

Where monitoring costs are concerned, respondents from funds with a smaller number of staff than the those of investment manager, that is higher monitoring costs, are more likely to disagree that they and the investment manager profit and loose from the relationship in proportion to what they invest than are those in a transactional relationship (60 v. 38 per cent).


Custodians The length of relationship is important, with respondents from funds in a relationship of less

than 10 years with their custodian being more likely to disagree that they have a collective responsibility for benefits and risks resulting from joint business processes (82 v. 33 per cent). Dysfunctional conflict

A conflict can arise from differences in focus and the objectives of the organisation, from interpersonal relationships or from the way in which strategies and business plans are implemented. In the case of functional conflict the parties may use the disagreement to clarify issues and continue to support goals, strategies and implementation plans to improve organisational performance. Dysfunctional conflict, on the other hand, will destroy or hinder the desired performance objectives of the relationship.

Respondents were asked to gauge the level of dysfunctional conflict between funds and investment outsourcing providers by ranking responses to six questions on a five-point scale from 1 for strongly disagree to 5 for strongly agree. The results are shown in Table 6. Dysfunctional conflict is lowest in relationships between funds and asset consultants, followed by investment managers and highest for custodians.

Table 6: Dysfunctional Conflict Asset


1. Disagreements we have with the provider in the outsourcing relationship create anger. 2.38 2.69 2.95 2. Disagreements we have with the provider in the outsourcing relationship are

resolved through the use of pressure or intimidation. 1.69 2.13 2.26

3. Disagreements between us and the provider in the outsourcing relationship create tension. 2.96 3.13 3.21

4. Cohesiveness between us and the provider in the outsourcing relationship is reduced because of disagreements. 2.50 2.82 2.91

5 Disagreements in the outsourcing relationship impede the communications between us and the provider. 2.53 2.78 2.82

6. Discontent with each other results from having disagreements in the outsourcing relationship. 2.60 2.69 3.10

Average 2.44 2.71 2.88 Asset consultants

All of the respondents rejected the proposition that pressure or intimidation is used to resolve disagreements between the fund and the asset consultant. However, where respondents are engaged with asset consultants in a mostly transactional relationship they are far more likely than those in a mostly partnership relationship (68 v. 0 per cent) to feel that disagreements create anger. Two thirds of respondents in mostly transactional types of relationships with their asset consultants confirmed that disagreements in the outsourcing relationship impede communication. This suggests that those who are in transactional relationships with their asset consultants are more likely to have a dysfunctional relationship. Investment managers

Monitoring costs are once again an important point of differentiation for relationships with investment managers. Where monitoring costs are low and funds have a larger number of staff than that of the investment manager, respondents are less likely to agree that disagreements in the outsourcing relationship create tension (39 v. 71per cent). The type of relationship also has a bearing on dysfunctional conflict. Respondents in mostly partnership relationships with their investment managers are less likely to agree that disagreements in the outsourcing relationship cause tension (27 v. 67 per cent). Respondents in a relationship of less than 5 years are less likely to agree that discontent results from having disagreements in the outsourcing relationship than are those in longer relationships (27 v. 63 per cent). Respondents in a mostly partnership relationship with their investment manager are less likely to agree that discontent results from disagreements in the outsourcing relationship (18 v. 58 per cent). Custodians

There is a higher level of dysfunctional conflict amongst funds and custodians as most of the respondents agree that disagreements with the custodian create anger, cause discontent and reduce cohesiveness in the outsourcing relationship. Most respondents are neutral when asked if the disagreements in the outsourcing relationship impede the communications between them and the provider. However, most respondents disagree that disagreements with the custodian are resolved through the use of pressure or intimidation. The length and type of relationship and monitoring costs all have an impact on the level of dysfunction. Respondents from funds who have been in a relationship for less than 10 years with the custodian are less likely to disagree that disagreements create tensions (36 v. 58 per cent). Monitoring costs also have a bearing. Respondents with lower monitoring costs, that is with a larger number of staff than the custodian, are more likely to disagree that disagreements in the outsourcing relationship create tension (63 v. 31per cent). Respondents in


mostly a partnership relationship with their custodian are less likely to disagree that tension is created through disagreements than those in a mostly transactional relationship (25 v. 60 per cent). Functional conflict

Respondents were asked to gauge the level of functional conflict between funds and investment outsourcing providers by ranking responses to six questions on a five-point scale from 1 for strongly disagree to 5 for strongly agree. The results are shown in Table 7. Functional conflict is more evident than dysfunctional conflict and is highest amongst asset consultants, followed by custodians and then investment managers.

Table 7: Functional Conflict Asset


1. Disagreements between us and the provider in the outsourcing relationship are solved amicably. 4.03 3.90 3.80

2. Disagreements we have with the provider in the outsourcing relationship ultimately increase both parties’ productivity. 3.40 3.13 3.43

3. We and the provider strive to find a solution that is good for all when disagreements arise in the outsourcing relationship. 3.80 3.82 3.70

4. Disagreements we have with the provider in the outsourcing relationship generate new ideas. 3.50 3.04 3.00

5. Disagreements we have with the provider in the outsourcing relationship providea medium through which problems can be aired and tension released. 3.53 3.30 3.84

6. We and our provider better understand each other after having disagreements in the outsourcing relationship. 3.57 3.47 3.21


There is strong evidence of functional conflict occurring in the outsourcing partnership with asset consultants. Indeed, all of the respondents accepted that disagreements with the consultant in the outsourcing relationship generate new ideas and that they and the consultants better understand each other after having disagreements. Most of the respondents confirmed that disagreements between them and the consultant were solved amicably and that they both strived to find a solution that was good for all.

The level of functional conflict is influenced by type and length of relationship and monitoring costs. Respondents who have been in a relationship with their asset consultant for less than 5 years or more are more likely to agree that disagreements in the outsourcing relationship increase both parties’ productivity (62 v. 31 per cent). Respondents that have a larger number of staff from their own organization, and therefore lower monitoring costs are more likely to agree that disagreements provide a medium through which problems can be aired and tension released (83 v. 40 per cent). Respondents in a mostly partnership relationship with their consultant are more likely to agree that disagreements provide a medium through which problems can be aired and tension released (75 v. 45 per cent).

All of the respondents agree that they and the consultant provide consistent input to the outsourcing relationship, perform pre-specified agreements in the outsourcing relationship and provide adequate pre-specified support to each other in the outsourcing relationship. All of the respondents also agree that an environment that would encourage continued effective exchange in the outsourcing relationship is fostered. Most of the respondents agree that they and the consultant are committed to and intend to maintain the outsourcing relationship. Investment managers

All of the respondents agree that disagreements with the investment manager in the outsourcing relationship are solved amicably and that they and the investment manager strive to find a solution that is good for all. Most of the respondents agree that disagreements with the investment manager in the outsourcing relationship ultimately increase both parties’ productivity and that the disagreements provide a medium through which problems can be aired and tension released. Most of the respondents are neutral when asked if the disagreements with the investment manager in the outsourcing relationship generate new ideas.

Respondents with high monitoring costs, that is, a smaller number of staff from their own organization, are less likely to agree that they and the investment manager better understand each other after having disagreements in the outsourcing relationship (14 v. 69 per cent). Custodians

Most of the respondents agree that disagreements with the provider in the outsourcing relationship are solved amicably and that they and the provider better understand each other after having disagreements. Most of the respondents also agree that they and the provider strive to find a solution that is good for all when disagreements arise in the outsourcing relationship. Most of the respondents are neutral when asked if disagreements with the provider in the outsourcing relationship generate new ideas.

Respondents with mostly partnership relationships with their custodian are more likely to disagree that disagreements with the provider in the outsourcing relationship ultimately increase


both parties’ productivity than are those in a mostly transactional relationship (61 v. 25 per cent). Respondents with high monitoring costs, that is a smaller number of staff from their own organization, are more likely to disagree that disagreements can be used to air problems and release tension (77 v. 25 per cent). Commitment

Respondents were asked to gauge the level of commitment between funds and investment outsourcing providers by ranking responses to six questions on a five-point scale from 1 for strongly disagree to 5 for strongly agree. The results are shown in Table 8. In terms of commitment, asset consultants receive the highest rating, followed by custodians and then investment managers.

Table 8: Commitment Asset


1. We and the provider provide consistent input to the outsourcing relationship. 3.96 3.50 4.002. We and the provider perform pre-specified agreements in the outsourcing relationship. 3.88 3.83 3.953. We and the provider provide adequate pre-specified support to each other in the

outsourcing relationship. 3.92 3.62 3.78

4. An environment that would encourage continued effective exchange in the outsourcingrelationship is fostered. 4.03 3.75 3.69

5. The outsourcing relationship is something we and the provider are committed to. 4.07 4.08 3.876. We and the provider intend to maintain the outsourcing relationship. 3.96 4.00 3.87


All of the respondents agree that they and the provider provide consistent input, perform pre-specified agreements and provide adequate pre-specified support to each other in the outsourcing relationship. Most of the respondents agree that an environment that would encourage continued effective exchange in the outsourcing relationship is fostered. Most of the respondents also agree that they and the provider are committed to and intend to maintain the outsourcing relationship. Investment managers

Most of the respondents agree that they and the investment manager perform pre-specified tasks and provide adequate pre-specified support to each other in the outsourcing relationship. Most of the respondents agree that they and the investment manager are committed to and intend to maintain the outsourcing relationship. Most of the respondents also agree that an environment that encourages continued effective exchange in the outsourcing relationship is fostered. Respondents with high monitoring costs, who have a smaller number of staff than their investment manager, are less likely to agree that they and their investment manager provide consistent input to the relationship (14 v. 62 per cent). Respondents in a mostly partnership relationship with their investment manager are more likely to agree that they and their manager provide consistent input to their outsourcing relationship (67 v. 33 per cent). Custodians

All of the respondents agree that they and the provider provide consistent input, perform pre-specified agreements and provide adequate pre-specified support to each other in the outsourcing relationship. Most of the respondents agree that an environment that would encourage continued effective exchange in the outsourcing relationship is fostered. Most of the respondents also agree that they and the provider are committed to and intend to maintain the outsourcing relationship. Strategic benefits of the relationship

Respondents were asked to gauge the level of strategic benefits achieved from the relationship with the investment outsourcing providers by ranking responses to five questions on a five-point scale from 1 for strongly disagree to 5 for strongly agree. The results are shown in Table 9. Strategic benefits from the relationship are highest amongst asset consultants followed by investment managers and custodians. Asset consultants

All of the respondents agree that they are able to focus their business efforts on core business issues. Most of the respondents agree that they are able to focus available in-house talent on activities that promote competitiveness and have acquired the ability to enhance competitive advantage. Also, most of the respondents agree that their responsiveness to the business environment has been increased and that their resources can be allocated for more strategic use in the organization. Investment managers

All of the respondents agree that they are able to focus their business efforts on core business issues and that their resources can be allocated for more strategic use in the organization. All of the respondents also agree that they are able to focus on available investment management talent on activities that promote competitiveness. Most of the respondents agree that they have acquired the ability to enhance competitive advantage. Respondents who have a relationship of less than 5 years and who have a mostly transactional relationship with their investment manager are more likely to disagree that their responsiveness to the business environment has been increased (78 v. 40 per cent). Respondents in a


mostly partnership relationship are more likely to agree that their responsiveness to the business environment has been increased than those in a transactional relationship (67 v. 42 per cent).

Table 9: Strategic benefits of the relationship Asset


1. We are able to focus our business efforts on core business issues. 3.80 3.82 3.912. We are able to focus available Investment Management talent on activities that

promote competitiveness. 3.76 3.60 3.60

3. We have acquired the ability to enhance competitive advantage. 3.73 3.29 3.214. Our responsiveness to the business environment has been increased. 3.73 3.40 3.525. Our resources can be allocated for more strategic use in the organisation. 3.92 3.83 3.65

Average 3.79 3.59 3.58 Custodians

Most of the respondents agree that they are able to focus their business efforts on core business issues. Most of the respondents also agree that they are able to focus available in-house talent on activities that promote competitiveness, have acquired the ability to enhance competitive advantage and can allocate their resources to more strategic use in the organization. Respondents with low monitoring costs, that is, a larger number of staff from their own organization, are more likely to disagree that their responsiveness to the business environment has been increased (63 v. 31 per cent). Economic benefits of the relationship

Respondents were asked to gauge the level of economic benefits achieved from the relationship with the investment outsourcing providers by ranking responses to eight questions on a five-point scale from 1 for strongly disagree to 5 for strongly agree. The results are shown in Table 10. Relationships with custodians are seen to achieve the highest economic benefits, followed by investment managers and then asset consultants. Asset consultants

Most respondents agree that the cost of hiring, training and retaining professional staff have been reduced, existing in-house specialists are able to focus on what they need to do and the productivity of in-house staff has increased. Also, most of the respondents agree that the quality of investment strategy and asset allocation services have improved that translates into cost savings. Most of the respondents were neutral when asked if the cost of hardware and software maintenance have been minimized. Respondents in relationships of more than 5 years with their consultant are less likely to agree that overhead expenses associated with investment strategy and asset allocation have been reduced compared with those who have relationships shorter than 5 years (23 v. 69 per cent). Respondents who have low monitoring costs, that is, a larger number of staff from their own organization, are less likely to agree that cost uncertainties have been mitigated (33 v. 60 per cent). Respondents in a mostly transactional relationship with their asset consultant are less likely to agree that cost uncertainties associated with investment strategy and asset allocation have been mitigated than those in mostly partnership relationships (25 v. 59 per cent). Investment managers

All respondents agree that existing in-house specialists are able to focus on what they need to do. Most of the respondents agree that the costs of hardware maintenance have been minimized and overhead expenses associated with investment management have been reduced. Most of the respondents also agree that the quality of investment management services has improved and that the productivity of investment management staff has increased.

Respondents with low monitoring costs, that is, a larger number of staff from their own organization, are more likely to disagree that the costs of hiring, training and retaining in-house professionals have been reduced (75 v. 31 per cent). Respondents in mostly partnership relationships with their investment manager are more likely to disagree that the costs of software maintenance have been minimized (67 v. 42 per cent).

Table 10: Economic benefits of the relationship Asset


1. Costs of hiring, training and retaining Investment Management professionals havebeen reduced. 3.23 3.50 3.60

2. Existing Investment Management specialists are able to focus on what they needto do. 3.88 3.90 3.95

3. Costs of hardware maintenance have been minimised. 2.96 3.80 3.564. Costs of software maintenance have been minimised. 3.03 3.45 3.565. Overhead expenses associated with Investment Management have been reduced. 3.38 3.20 3.306 Costs uncertainties associated with Investment Management have been mitigated. 3.38 3.40 3.477. Quality of Investment Management services has improved, which translates into

costs savings. 3.73 3.70 3.69

8. Productivity of Investment Management staff has increased. 3.69 3.66 3.58Average 3.41 3.58 3.59


Custodians Most of the respondents agree that costs of hiring, training and retaining in-house professionals

have been reduced and that existing in-house specialists are able to focus on what they need to do. Most of the respondents also agree that overhead expenses associated with custodial services have been reduced, cost uncertainties associated with custodial services have been mitigated and that the quality of custodial services has improved. Respondents with mostly partnership relationships with their custodian are less likely to disagree that the costs of hardware maintenance have been minimized than are those in a transactional relationship (13 v. 60 per cent). Respondents in mostly partnership relationships with their custodian are more likely to agree that the productivity of investment management staff has increased than are those in transactional relationships (77 v. 40 per cent). Technological benefits of the relationship

Respondents were asked to gauge the level of technological benefits achieved from the relationship with the investment outsourcing providers by ranking responses to three questions on a five-point scale from 1 for strongly disagree to 5 for strongly agree. The results are shown in Table 11. Relationships with asset consultants are perceived to offer the greatest technological benefits, followed by custodians and are lowest from relationships with investment managers.

Table 11: Technological benefits of the relationship Asset

ConsultantsInvestment managers Custodians

1. Risks associated with technological obsolescence due to dynamic changes inInvestment Management have been reduced or eliminated. 4.57 3.32 3.79

2. We have increased access to key Investment Management expertise. 4.07 4.18 4.003. We have increased access to key Investment Management infrastructure. 3.88 3.72 3.91


Most of the respondents agree that they have increased access to key investment strategy and asset allocation expertise and infrastructure. Also, most of the respondents agree that risks associated with technological obsolescence due to dynamic changes in investment strategy and asset allocation have been reduce or eliminated. Investment managers

All respondents agree that they have increased access to key investment management expertise. Most of the respondents agree that they have increased access to key investment management infrastructure. Respondents with higher monitoring costs, that is, a smaller number of staff than their investment manager, are more likely to disagree that the risks associated with technological obsolescence have been reduced or eliminated (64 v. 29 per cent). Respondents with a mostly partnership relationship are more likely to agree that risks associated with technological obsolescence due to dynamic changes in investment management have been reduced or eliminated than those in a transactional relationship (67 v. 40 per cent). Custodians

Most of the respondents agree that the risks associated with technological obsolescence due to dynamic changes in custodial services have been reduced or eliminated. Most of the respondents also agree that they have increased access to key custodial services expertise and infrastructure. Other issues Asset consultants

A number of additional questions were asked to explore other factors impacting on the relationship between the funds and their asset consultants. These included ownership of the asset allocation decision, pressure on fees and performance management. Most of the respondents rate the tension between board and consultant on who ‘owns’ the final asset allocation decisions as low. Interestingly, respondents who have a relationship with their consultant for less than 5 years are far more likely to rate the fee pressure on consultants as low than are those in relationships for more than 5 years (62 v. 15 per cent). Most of the respondents report that the in-house staff members are responsible for performance measurement of the consultant’s role. Investment managers

Most of the respondents provide a satisfactory rating for the value of money paid to investment managers with an active management style. Custodians

Respondents were asked to rate their degree of satisfaction with aspects of the service provided by custodians such as access to data, fee structure, performance measurement and time and accurate reporting. Most of the respondents provide a high rating for access to data in the outsourcing relationship with the custodial services provider. Most of the respondents rated their custodial services provider a satisfactory rating for the fee structure. With regard to performance measurements, 58 per cent of respondents in a relationship of 10 years or more rated the performance of their custodian as high, on the other hand, 67 per cent of respondents in a relationship of less than 10 years rated the performance of their custodian as poor. Respondents in a


relationship of 10 years or more give their custodial services provider a higher rating for timely and accurate reporting than those in a relationship of less than 10 years (58 v. 23 per cent). Overall success of the relationship

Respondents displayed quite divergent views when asked about the overall success of the relationship, as shown in Table 12.

Table 12: Overall success of the outsourcing relationship (%) Relationship Very poor Poor Satisfactory High Very High

Asset consultants 8 39 35 20 Investment managers 54 42 4

Custodians 4 12 35 39 4 The majority of funds rated the success of their relationship with asset consultants as high or

very high, but two funds (8 per cent) felt it to be poor. There is a greater commonality of views with respect to investment managers where only one fund rated the success of the relationship as very high, but almost half thought it to be high and the majority rated the relationship as satisfactory. Views on the relationship with custodians were the most diverse. Overall success was seen to be high or very high by 42 per cent of respondents, 35 per cent found it to be satisfactory, and three funds rated the overall success of the relationship with custodians as poor or very poor.

CONCLUSION As this survey highlights, superannuation funds enjoy strong relationships with their investment

outsourcing partners, asset consultants, investment managers and custodians as evidenced by relatively high levels of trust, business understanding and commitment. There are three key attributes that have a major bearing on the success of the relationship between funds and investment outsourcing providers: the length of the relationship, whether it is largely a partnership or the relationship is transactional and monitoring costs.

Whilst there is a relatively high level of trust across all providers, this is most evident with asset consultants, where 85 per cent of respondents indicating that their fund has a strong partnership relationship with the asset consultant. This may well explain why asset consultants receive the highest ratings from funds with respect to trust, business understanding, benefit and risks sharing, and commitment. Funds have the lowest level of dysfunctional conflict with asset consultants, and it is notable that funds rate their relationships with asset consultants highest for strategic and technological benefits. Those funds which are in a largely transactional relationship with their asset consultant, however, are far more likely to feel that disagreements create anger, and are less likely to agree that costs associated with investment strategy and asset allocation are mitigated due to the asset consultant.

The length of relationship also has an impact. Relationships with asset consultant tend to be shorter on average than with other investment outsourcing service providers. Those with relationships of more than five years are more likely to believe that the partners benefit and lose in proportion to what they invest and are also more likely to agree that overhead expenses associated with investment strategy and asset allocation have been reduced.

Respondents rated their relationship with their largest active investment manager as having the lowest levels of trust, business understanding, benefit and risks sharing, and commitment of all three investment outsourcing service providers. Funds have their highest level of functional conflict with their investment managers, but only a moderate level of dysfunctional conflict.

Both type of relationships and monitoring costs have a bearing on the success of the relationship between funds and investment managers. The relationship with a fund’s largest active investment manager is described as mostly a partnership in nature by 50 per cent of respondents. Funds with a partnership relationship with low monitoring costs rate their relationships with investment managers more highly. Outsourcing to investment managers is seen to provide economic benefits in the relationship with funds.

While only 38 per cent of funds rate their relationship with their custodian as being mostly a partnership in nature and almost half of respondents have been in the relationship for more than 10 years. Funds rate custodians most highly in terms of business understanding, and in the sharing of benefits and risks. While custodians have the highest level of dysfunctional conflict with funds, they also have the highest level of functional conflict, suggesting that while conflict is not infrequent, it is, for the most part, solved amicably. As with investment managers, funds see themselves gaining most in terms of economic, rather than strategic or technological benefits, from their relationship with custodians. In terms of overall satisfaction with the relationship, asset consultants are rated most highly followed by custodians and then investment managers.

REFERENCES APRA 2011 Discussion Paper Prudential Standards for Superannuation, 28 September.


BIS, 2005, The Joint Forum on Outsourcing in Financial Services, Basel Committee on Banking Proceedings, Bank for International Settlements, Basel, Switzerland, February. ECB, 2004, European Central Bank Outsourcing Survey, European Central Bank www.ecb.int/ (Accessed 20/05/2011). Gartner Group, "The Economics of IT Services and Outsourcing in Europe", 18 March 2003. Huynh J., Chi-way M. Q., K. R., Pi, S., 2000, The Evolution of Outsourcing Research: What is the Next Issue? Proceedings of 33rd Hawaii International Conference on System Sciences, IEEE, Hawaii Hawley J., Johnson K. and Waitzer E., 2011, Reclaiming Fiduciary Duty, Rotman International Journal of Pension Management, Vol. 4, No. 2, 4-16. Lee J, and Kim Y., 1999, Effect of partnership Quality on IT Outsourcing Success: Conceptual Framework and Empirical Validation, Journal of Management Information Systems, Vol. 14, No. 4, 29-61. Liu, K. and Arnold, B. R., 2010a, APRA Working Paper, Australian superannuation – the outsourcing landscape, 12 July, Australian Prudential Regulation Authority, Sydney. Liu, K. and Arnold, B. R., 2010b, APRA Working Paper, Australian superannuation outsourcing– fees, related parties and concentrated markets, 12 July, Australian Prudential Regulation Authority, Sydney. Nomura Research (NR) 2006, Fund Management Outsourcing by Investment Trusts, Vol. 3, Nomura Research Institute Ltd. Japan. The Bank of International Settlements (2005), Outsourcing Financial Services, Joint Forum, Basel Committee on Banking Supervision, Basel, Switzerland. The Federal Reserve Bank of New York (2000), Research and Market Analysis Group, New York * Corresponding author, Email: [email protected] Tel: +613 9919 1477, Fax: +613 9919 4901. 1These requirements are contained in ss. 29H and 29P of the Superannuation Industry (Supervision) Act 1993 and r.4.16 of SIS Regulations. 2For further information see BIS, 2005 pages 11-12


Impact of Accruals Quality on the Equity Risk Premium in Iran

Mahdi Salehi ,Ferdowsi University of Mashhad, Iran Mohammad Reza Shoorvarzy and Fatemeh Sepehri, Islamic Azad University, Nyshabour, Iran

ABSTRACT Investors believe accrual quality is defined as close of earning to the cash. Therefore, poor

quality of accruals causes increased uncertainty of information and it will lead to rise of investment’s risk. Thus, this study investigated relation between accruals quality and equity risk premium according to three potential factors of Fama and French (1993): 1- equity risk premium 2- size 3- rate of book value to market value. Following, 73 companies listed in Tehran Stock Exchange during 2005-2010 for hypothesis testing used time series data and two-stage cross-sectional regressions (2SCAR). The result of the study indicates that there is not significant relationship between accrual quality and equity risk premium. Keywords:Earning Management, Investment, Accrual Quality, Equity Risk Premium, Discretionary

Accrual

INTRODUCTION This study examines the association between accrual quality and equity risk premium. Accrual

quality is an issue of increasing importance to investors especially after recent financial scandals and crises. Furthermore, measuring accruals quality has developed in during decades. Literature suggests that managers will manipulate accruals opportunistically and it will lead to decline earnings quality. Scholars have defined discretionary accruals differently (DeAngelo et al. 1994; Jones 1991). Believed that higher quality accruals lead to reduce develop a measure reflecting variation of accruals that are not mapped into cash flows and uncertainty of predicting cash flows. Theoretical studies show that high accruals quality reduces cost of capital may be originated from the effect of reduced information asymmetry and reduced information uncertainty. Generally, findings indicate that reduction of information uncertainty (i.e. improved precision) reduces estimation risk and it will lead to reduces cost of capital. Some studies also suggest that better disclosure quality reduces information asymmetry, which decreases cost of capital. On the other hand, other studies argue that information asymmetry cannot be priced in a rational expectations setting and the effect of information asymmetry can be diversified away (Lambert et al., 2008; Hughes et al., 2007).

Accruals Quality Accruals are used to adjust cash flows such that earnings reflect the performance of the firm.

Dechow and Dichev (2002) argued that the role of accruals is to “shift or adjust the recognition of cash flows over time so that the adjusted numbers (earnings) better measure firm performance”. When a firm makes a sale, there is no difference between whether the firm gets cash at the time of in the future (adjusting for time value) or the firm gets the cash the sale from a performance standpoint. Although, there is uncertainty inherent when cash will be collected in the future because the exact amount of cash that will be collected is unknown. This uncertainty affords managers opportunities to manipulate earnings (Dechow and Dichev 2002; Healy and Wahlen 1999). Model of Dechow and Dichev (2002) assume that accruals are created in one-year reverse in the next year. As a result, the accruals (or the change in non-cash working capital) for the current period can be expressed as a linear function of current, lag, and lead cash flows. Equity Risk Premium

The equity risk premium is defined as the reward that investors require to accept the uncertain outcomes associated with owning equity securities. The equity risk premium is measured as the extra return that equity holders expect to achieve over risk-free assets on average. Moreover, the equity risk premium is a key element in many costs of equity models. Fama-French three factor model all require an equity risk premium to compute a cost of equity. The higher the equity risk premium the higher the cost of equity.

LITERATURE REVIEW Making investment decisions is based on the information that is disclosed, manipulating accruals

by earnings management is led to the lack of transparency and integrity of financial reports. Thus, raise uncertainty and ambiguity in the perspective of suppliers and increase the risk of investing in the profit firms. Rising in capital risk will lead to increase risk of potential investors and eventually, higher expected rate is for compensating accepted risk. The results of the last two decades in developed countries suggests that variables such as size, rate of earnings to share price, rate of cash flow operation to price, rate of book value to equity, accrual have the most share in capital assets pricing model. Following Francis et al., (2005) innate component reflects the intrinsic features of a firm related to information uncertainty while the discretionary component represents noise or firms’ opportunistic choices to either fool the market or to reveal private information (Francis et al., 2005).


Decision about investment is made by information which is disclosed, manipulating in accrual quality lead to lack of transparency and integrity of financial reports and also lead to higher risk in mind of suppliers and increases risk in profit firms. Higher risk lead to risk premium of potential investors and finally they demand for higher expected return to compensate their risk (Wei, 2008). Results of research in developed in recent decades indicate that variables like size, rate of earnings to price, rate of book value to equity, accrual and its component has the most share in explaining returns on the capital asset pricing model. These can lead to deformities market and accrual is one of factors can lead to create of deformities in risk and return (Kothari, 2001).

Fama and French (1993) investigated the relation between accruals and information risk. In time series regression, return of companies on another three factors such as: rate of book value to market value and equity risk premium. Their result shows that there is a significant and positive correlation between accruals and the three factors. Francis and et al., (2005) expressed if we have lower accrual quality, we will have higher cost of debt and capital. Following, low quality of accruals will lead to increase ambiguous information and increase of investment. Chan et al (2006), examined accruals related to future stock returns. They believed that companies who have higher accruals in the period following the reporting of financial reporting, they will have lower return of stock. Ogneva (2008) investigates the relationship between stock returns and accruals quality and the results show a significant association between the quality of accruals and future stock returns. Poor accrual quality firms have significantly higher returns, however, significantly lower returns during down markets. There is a significant interaction effect between the value premium and accrual quality, which only exhibits in the down markets (Chicherea et al., 2012). Yee (2006) presents an analytical model to indicate that effect of earnings quality on cost of capital cannot be significant in the absence of fundamental risk. In addition, he demonstrated that earnings quality affects the equity premium by magnifying fundamental risk. Chen et al (2008) provide empirical evidence that the pricing effect of accounting quality on the cost of capital increases with fundamental risk. These studies evoke the idea that accounting quality is associated with a firm’s fundamental risk and that the pricing effect of accounting quality on the cost of capital may stem from fundamental risk and its related information risk captured by accounting quality.

Core et al., (2008) paid attention to previous research of Francis et al., and their result show that accrual quality cannot be a factor of priced risk and it indicates that accrual quality and risk factors cannot be effective factor for predicting risk premium. Gray et al., (2009) investigate accrual quality, informational risk and capital cost in Australian market. They used research of Francis et al., by accrual quality as replace of risk. The results indicate that accrual quality impact on capital cost; however, there are notable differences. In addition, accrual quality as risk factor is valuable. Mashrwala (2010) Investigated accrual quality and return in months of the year. The results show that relation between accrual and return is stronger in January and first 5 days of trading, the effect of accruals quality on stock return is observed. Lobo et al., (2012) illustrated that lower accrual quality provide opportunity of personal information for analysts and it can be concluded that low accruals quality is more specialized information.

METHODOLOGY Based on all that has been said, we investigated the relation between accrual quality and equity

risk premium. Empirical result of Biddle (1995) and Francis (2003) show that investors compare to other factor of performance have more dependent on earnings. Moreover, Fama and French (1993) illustrated that accrual quality and other factors of risk (market premium risk, size and rate of book value to market value) are important and accrual quality can be priced risk factor.

The research is inductive and correlative and is conducted on companies listed in Tehran Stock Exchange and our sample includes 73 companies which were operating in the primary market between 2005and 2010.

The entities should be listed before 2004. Date financial firms should lead to the end of March each year. The entities should be activated during 2005 to 2010. The entities should not change their financial periods. The entities’ availability of information is required.

Hypotheses: According to the research the hypotheses arise:

H1: There is a significant relationship between accrual quality and equity risk premium. Independent Variable:

Accrual Quality: In this study, measurement of accruals based on the modified model Dechow and (2002)

Dichev that link current accruals to cash flows from operations in the last period, current, and future. TCA j ,t =β0,j + β1,j CFOj,t-1 + β2,j CFOj,t + β3,j CFOj,t+1 + β4,j ΔRevj,t + β5,,j PPEj,t +uj,t

TCA j ,t= Total current accrual is calculated by The difference between current assets except cash and current liabilities except short-term debt in between year of t and t-1. Residuals of the


regression indicates accrual and standard deviation of the residuals shows a measure of accruals that higher accrual is defined as lower quality.

TCA = (ΔCA - ΔCASH) - (ΔCL - ΔSTDEBT) ΔCA: changes in current assets ΔCASH: changes in cash ΔCL: Changes in Liabilities ΔSTDEBT: Changes in short term debt CFOj t: Cash flow from operations divided by average total assets ΔRev: change in net revenue PPE: Gross value of property, machinery and equipment

Dependent Variable: Risk Premium: Equity risk premium is calculated by Gordon’s model (1962):

RPit = E(Rit -RFt) RPit = Risk premium in t year ERit= Expected rate in t year RFt= Free risk in t year Controlling Variables: Market Factor:

Ri–Rf = risk premium for company i; SMB = Size factor risk. Expected return of a portfolio of small stocks minus the expected return on portfolio of big stocks; and,

Value factor:

HML = Distress factor risk where distress is measured by book equity divided by market equity. Expected return of a portfolio of high book-to-market stocks minus the expected return of a portfolio of low book-to-market stocks

The equity risk premium is one of three components in the Fama-French three factor model. These three factors include a size factor, a distress factor and a market risk factor (the equity risk premium) S/L= Companies that are small in size and have lower ratio of book value to market value S/M= Companies that are small in size and have middle ratio of book value to market value S/H= Companies that are small in size and have higher ratio of book value to market value B/L= Companies that are big in size and have lower ratio of book value to market value B/M= Companies that are big in size and have middle ratio of book value to market value B/H= Companies that are small in size and have higher ratio of book value to market value Two-stage cross-sectional regressions (2SCSR):

Now, the study should be tested whether the accounting quality factor is a priced risk factor using a 2SCSR? Where excess returns are regressed on risk factor betas. Following asset-pricing literature, our tests examine whether AQ is a priced risk factor after controlling for the three Fama and French (1993) factors (the market risk premium (RM–RF), size (SMB), and book-to-market. In the first stage, we estimate multivariate betas from a single time-series regression of excess returns for a firm or a portfolio of firms (Rq - RF) on the contemporaneous returns to the Fama–French factors and the accounting quality factor:

For example, when we add the AQfactor to the Fama–French model, the multivariate betas are estimated using the following time-series regression:

We compute standard errors from monthly cross-sectional regressions using the Fama and

MacBeth (1973) procedure to mitigate concerns about cross-sectional dependence in the data. Because betas in the second-stage regressions are estimated betas (and not true betas), they may suffer from an error-in-variables problem:

For performing multiple regression analysis, we used backward method in SPSS. Backward method starts with a model containing all the explanatory variables and eliminates variables one by one, at each stage choosing the variable for exclusion as the one leading to the smallest decrease in the regression sum of squares. An F-type statistic is used to judge when further exclusions would represent a significant deterioration in the model.

It is noteworthy that the first stage of the model is done for each company in the specified period and after computing bi for each company, regression coefficients are computed. Second stage is general regression model, and for hypothesis testing, we fit the general regression model. In this model indicates the relationship between independent and dependent variables. Results of the


fitted regression model are shown in Table 1. It shows that about 9.20% of the variation in equity risk premium is explained by the model.

Table1: Summary of cross-sectional simple regression model Model Correlation coefficient Coefficient of determination Adjusted coefficient of determination

First stage 0.320 0.103 0.093 Second stage 0.320 0.102 0.095 Third stage 0.311 0.097 0.092 Final stage 0.303 0.092 0.089

Table 1 show that SPSS has fitted the regression model four times, so that in the fourth stage by eliminating no significant variables, the adjusted coefficient of determination obtained as 0.089. In the first stage all explanatory variables contributed in the model. In the second stage variable b3.HML and in the third stage variable b2.SMB was eliminated. In Table 2 results of analysis of variance, for testing that all coefficients are equal to zero, are shown. It shows that the significance level is equal to 0.000 so we conclude the fitted model is significant and we can use the independent variables in the model for predicting the risk.

The p-value for the null hypothesis (H 0= 0) which indicates the lack of any relation between

the Impact of Accruals Quality on the Equity Risk Premium is less than 0.05. Therefore, the null hypothesis is rejected with a certainty of 95%. Accordingly, there is a significant relation between accruals quality and equity risk premium.

Table 2:Coefficients Sig F-value Mean sum of squaresR- squared.f Factor

0.000 36.629 1214.9081214.9081 Regression

33.16812039.367363 Error 13254.775364 Total

Table 3:Portfolio time-series regressions Standard Error T-valueSigCoefficientPrimary model

0.303 2.8910.0040.876Intercept 0.047 6.1140.0000.288b1.RM - RF 0.044 1.3540.1770.059b2.SMB 0.025 -0.2950.768-0.007b3.HML 0.019 1.6650.0970.032b4.AQfactor

T-test was used for independent groups in order to test the equality of average and the following results were obtained:

Table 4. Coefficient in final model

Sig Std. ErrorT- valueCoefficientFinal Model 0.005 0.3022.80.845Intercept 0.000 0.0416.0520.247RM - RF

The following model is proposed to predict and provide future researchers:

The aim of this study investigates relation of accrual quality and equity risk premium. After calculating accrual quality by standard deviation of residual of regression (1) during 2005-2010.Finally, the null hypothesis is rejected with a certainty of 95%. Accordingly, there is a significant relation between accrual quality and equity risk premium

CONCLUSION The main objective of this research was investigating the impact of accrual quality on equity risk

premium in regarding to three controlling factors: Market risk premium, size and ratio of book value to market value. However, accrual quality is the main factor for evaluating the quality of accruals and the other factors are used for reaching final results. Due to manipulation of accruals quality may affect earnings, thus, by increasing accrual, earnings will drop and shareholders may react by increasing risk premium. Hence, it is expected, there is a significant relationship between risk premium and accrual. Investors and other capital market players, such as analysts, evaluators, and makers require the information to make the right investment decisions. Furthermore, their main source of information is financial reporting and quality of accruals is measure of financial reporting. Investors and other groups’ above mentioned using accounting information to estimate the risk and return and results of this study indicates that investors do not pay attention to accounting information as one of the main sources of risk. Accordingly, there is a significant relation between accruals quality and equity risk premium.

The results of this is study is consistent of Core and et al., (2008) they used the quality of accruals as a proxy for information risk which is not priced and can not only affect the premium risk of company. On the other hand, the result of the study is inconsistent by studies of Francis et al (2005) and Fama and French (1993), they suggested that accruals quality is a priced risk factor and it can be


explained by increase of stock return relative to risk-free rate of return. In addition, there is positive and significant correlation between factors of accrual quality.

REFERENCES Biddle, G., G. Seow, and A. Siegel, (1995), "Relative versus incremental information gontent", Contemporary Accounting Research, Vol. 12, pp.1-23. Chan, K., L. Chan, N. Jegadeesh, and J. Lakonishok, (2006), " Earnings quality and stock returns", Journal of Business, 79(3), pp. 1041-1082. Chichernea, D., Holder, A., Wei, J (2012), "Connecting the dots: the accruals quality premium vs the value premium", Managerial Finance, Vol. 38(12):1106-1133 Core, J., W. Guay, and R. Verdi, (2008), "Is accruals quality a priced risk factor?", Journal of Accounting and Economics, 47, pp. 2-22. DeAngelo, H, L. DeAngelo, and D. J. Skinner. (1994). "Accounting Choice in Troubl Companies". Journal of Accounting and Economics 17: 113-143. Dechow, p., and I. Dichev, (2002), "The quality of accrual estimation errors", The Accounting Review, 77, pp. 35-59. Fama, E. F., and K. R. French, (1993), "Common risk factors in returns stock and bonds",Journal of Financial Economics, 33, pp. 3-56. Francis, J., and L. Vincent, (2003), "The relative and incremental explanatory power of earning and olternative performance measure for returns", Accounting Research, 20, pp. 121-164. Francis, J., P. Lafond, P. Olsson, and K. Schipper, (2005), "The market pricing of accruals quality", Journal of Accounting and Economics, 39, pp. 259-327. Gordon, M (1962): The Investment, Financing, and Valuation of the Corporation. Irwin, Homewood, IL. Gray, p., P. Koh, and Y. Tong,(2009), "Accruals quality information risk and cost of capital: Evidence form Anstralia", Journal of Business Finance and Accounting, 36, pp. 51-72. Healy, P. M., and J. M. Wahlen. (1999). "A Review of the Earnings Management Literature and Its Implications for Standard Setting". Accounting Horizons 13 (4):365-383. Hughes, J. S., L. Jing, and J. Liu. (2007). "Information Asymmetry, Diversification, and Cost of Capital". Accounting Review 82 (3):705-729. Jones, J, (1991), "Earning Management during Import Relief Investigation", Journal of Accounting Research, Vol 29 (2): 193-228 Kothari, s., (2001), ”Capital market research in accounting", Journal of Accounting and Economics, 31, pp.105-231. Lambert, R., C. Leuz, and R. E. Verrecchia. (2007). "Information Asymmetry, Information Precision, and the Cost of Capital", Working Paper, University of Pennsylvania. Lobo, G. J., M. Song, and M. Stanford, (2012), "Accruals quality and analyst coverage", Journal of Banking and Finance, 36, pp. 497-508. Mashrwala, C. A., (2010), "The pricing of accruals quality: January vs. the rest of the year ", Available at: http: //www.ssrn.com. Ogneva, M., (2008), "Accruals quality and expected returns: the importance of controlling for cash flow shocks" Working paper, Stanford University. Wei, K. C. J., and F. Xie, (2008), "Accruals capital investments and stock returns", Financial Analysts Journal, 64, pp. 34-44.


Emerging Market Mutual Funds: Recent Trends in Performance, Expenses, Composition and Growth

William J. Bertin, Laurie Prather and Li-Anne Woo

Bond University, Gold Coast Australia

ABSTRACT Emerging market mutual funds are a rapidly growing mutual fund category. This growth is most

likely due to their impressive realized returns, although their returns may be quite volatile. This study reports on emerging market mutual funds’ characteristics and performance relative to domestic and international equity mutual funds and also details the significant growth in these funds. We further consider the investment allocations of the three categories of funds among developing versus mature markets. Our results suggest that the superior performance of emerging market mutual funds more than adequately compensates for their higher risk, and thus provides a sound justification for their rapid growth in recent years. Keywords: mutual fund, emerging markets

INTRODUCTION Over the past decade the mutual fund industry has experienced significant developments

including the rapid growth of emerging market mutual funds. These funds primarily invest in the equity of firms operating in emerging market economies, thus giving investors the opportunity to share in the substantial returns that emerging markets may provide. In addition to the possibilities of high returns, emerging market funds may create further benefits, if the correlation of their returns with domestic equity returns is relatively low. The possibility of diversification coupled with the potential for high returns, make emerging market mutual funds an attractive investment indeed, as suggested by their rapid growth rate.

Some earlier studies have explored emerging market and international mutual fund growth in the 1990s; however, our study is the first to provide a detailed update of emerging market mutual fund growth over the most recent decade. This time period is important to examine since the number and size of emerging market mutual funds have increased significantly during that decade. Thus the results presented here provide the relevant financial data for emerging market mutual funds. The same financial data for domestic equity and international funds is also compiled on an annual basis over the period 1998 through 2008. This allows for a direct comparison of the emerging market mutual funds with the domestic equity and international funds over that period. In addition, we review the diversification arguments for emerging market mutual funds in comparison to domestic equity mutual funds as well as international funds.

Some researchers have questioned the traditional diversification arguments proposed for emerging market investments in terms of whether or not such investments actually provide the promised diversification benefits (See, for example, Antoniou, Olusi, and Paudyal (2006), Butler and Joaquin, (2001)). The non-traditional arguments are supported by the premise that investors may be able to replicate the benefits of international diversification by a proper selection across various securities including cross-listed stocks, domestic portfolios of multinational firms, and certain industrial sectors. In addition, finding low correlations in emerging markets may be a challenging task, especially during market downturns and financial crises.

Our analyses of emerging market funds along with the domestic and international equity funds serve to explore the various characteristics of these funds including their performance, expenses and growth. This naturally provides a basis for comparisons and contrasts among these different fund types. Further discussion of our results pertains to fund risk factors, return measurements, relative sizes and overall ratings, as well as loads, fees and turnover. Finally, we address the compositions of the various fund categories in terms of their proportional investments in developing versus mature markets.

The remainder of the paper proceeds as follows. Section 2 provides a review of the literature and a discussion of growth trends in the emerging market mutual funds compared to domestic and international equity funds. Section 3 presents the data and descriptive statistics of those three fund groups with a special emphasis on the emerging market funds. Section 4 presents the data and discussion regarding fund composition. Section 5 presents a summary of results and conclusions.

LITERATURE REVIEW Over the past decade, the literature on emerging market funds and their performance has been

developing rapidly, and despite the short history of such funds, the literature is relatively extensive covering a broad range of emerging market topics. Much of the early works treat emerging market funds within the broader context of international diversification. For example, Kaminsky, Lyons and Schmukler (2001) in an overview of emerging market fund investments provide the details on


international mutual funds investing in emerging markets and also note their trends over time, including crises periods. Their analysis of U.S.-based emerging market funds, however, is relatively brief with early growth data from the 1990s. Some of the other broad studies on emerging market funds and international diversification include Charitou, Makris and Nishiotis’ (2006) study of closed-end emerging market funds, Opiela (2007) on global investing and Patro’s (2005, 2006) studies on fund premiums and flows in emerging markets. Eun, Janakiramanan and Senbet (2002) also examine the premiums/discounts of country funds under segmented emerging markets.

Much more focused are those studies that examine emerging market fund activity in specific countries including Swinkels (2008) on Poland; İmişiker and Özlale (2008) on Turkey; Muga, Rodriguez and Santamaria (2007) on Mexico, and Moss, Ramachandran and Standley (2007) on Africa. While these country specific studies typically examine the performance of emerging market funds and fund managers within those countries, much of the recent literature addresses the topic of emerging market fund performance from a global market perspective. Gottesman and Morey (2007) examine the typical fund attributes (i.e. size, turnover, tenure, etc.) that impact performance and find that for emerging market funds only the expense ratio is useful in predicting performance. Addressing the issue of persistence, Huij and Post (2008) find that emerging market funds display stronger performance persistence than U.S. funds, which is consistent with the view that emerging markets are less efficient than developed markets. In two related earlier pieces, Kaminsky, Lyons and Schmukler (2004) report that trading activities at both the fund manager and investor levels cause international funds to engage in momentum trading, while Parvez, Gangopadhyay and Nanda (2001) find that emerging market fund performance is positively related to a restrictive monetary policy as set by the Federal Reserve. Finally, in a comprehensive study of the U.S.-based emerging market bond funds, Polwitoon and Tawatnuntachai (2008) document that emerging market bond fund performance is superior to both domestic and global bond funds in terms of total and risk-adjusted returns.

The behavior of emerging market funds has also been addressed in some of the earlier literature on the topic. In two related pieces Borensztein and Gelos (2001, 2003) firstly find moderate evidence of herding with such behaviour more prevalent in large emerging markets, and secondly when exploring the fund redemption behaviour of international investors, that such redemptions can directly lead to financial shocks across countries. Considering investment allocations by actively managed U.S. funds, Aggarwal, Klapper and Wysocki (2005) find that such investments are more heavily weighted toward open emerging markets with stronger shareholder rights, legal frameworks and accounting policies.

Our study adds to this emerging market literature by updating the growth of emerging market funds through 2008, and thus essentially extends some of these earlier works. Beyond that update of growth, we also report on a variety of fund characteristics over the time of our study period, 1998-2008, and note comparisons of emerging market funds to domestic and international groupings of funds. Our findings suggest that the rapid growth of emerging market funds is well justified by their superior performance. In spite of their somewhat higher risk in comparison to domestic and international equity funds, emerging market funds with their higher returns over time provide more than adequate compensation for the risk involved, and this makes these funds a highly desirable investment alternative.

Growth Trends in Emerging Market Funds and Domestic Equity Funds As indicated in the previous literature review, Kaminsky, Lyons and Schmukler (2001) have

documented the early growth of emerging market funds over the 1991-1998 period. Our findings suggest that this trend continues over our 1998-2008 study period with the exception of the year 2008.1 Morningstar Principia Mutual Funds Advanced (MS) reported performance information in 1998 for 83 distinct emerging market funds accounting for approximately $13.1 billion in mutual fund assets. By the end of 2007, the number of distinct emerging market funds had grown to 108 offerings with approximately $129.69 billion in total assets. This increase represents a 25.8% annual growth rate in emerging market funds’ assets over this ten-year period. In contrast, the growth of domestic equity funds was more moderate from 1,632 to 2,842 funds (with assets increasing from $1.76 trillion to $3.90 trillion) over the 1998-2007 period. This increase suggests an 8.28% annual growth rate in assets, which is less than one-third that of the emerging market funds over the same period.

The observed growth differential may be due to various factors including the potential for high performance from emerging market funds and increased demand created by that performance among investors. This of course leads to an increased flow of funds to the emerging funds as quality investments. Additionally, mutual fund companies may initiate new emerging market offerings or expand upon existing offerings (or in some cases proliferate their offerings to compete for fund flows) as they attempt to meet this increased demand. Investors may have a common perception that one must have exposure to the emerging markets for high growth in the future, and emerging market funds can quickly provide this desired exposure.

1 Although our study period runs through 2008, the financial crisis in that final year resulted in some abnormally low year

end valuations, thus much of the following growth analysis focuses on 2007 as the end period.


DATA AND FUND CHARACTERISTICS The data source used to gather fund information is the Morningstar Principia Mutual Funds

Advanced. To analyse this information, we compare a sample of emerging market funds to two groups of equity funds: 1) a broad group of domestic equity funds and 2) a group of international equity funds. Our comparisons focus upon fund size, composition, performance including return and risk measures, cost measures including expense ratios, as well as the all important Morningstar rating. Table 1 presents some of this descriptive information for the three fund groups. As previously noted, growth in the emerging market funds is again apparent as evidenced by the increase in total assets (nearly a tenfold increase over the period 1998 through 2007).

When comparing the emerging market funds to the domestic equity and international equity groups, a number of unique features of the emerging funds become apparent. In particular, the market capitalization figures from Table 1 indicate that emerging market funds are substantially smaller than the other fund groups. On a percentage basis, this could be contributing to their higher annual total asset growth (an approximate 26% annual growth rate in contrast to 8% growth in domestic equity funds and 16% growth for the international equity group over 1998 through 2007). Clearly, the increased demand for emerging market funds coupled with higher flows into these funds are impacting this growth differential. In addition, the strong performance prospects of the emerging market funds are also contributing factors to their growth. In terms of holdings as indicated by the lower geometric average market capitalization measure, Table 1 further suggests that EM funds hold more investments in smaller companies than the other two equity groups. This market capitalization figure, however, has been increasing substantially in the past few years for emerging market funds, and also noteworthy is the fact that the international funds have surpassed the domestic equity funds in terms of market capitalization.

Table 1:Portfolio characteristics and performance variables this table includes the descriptive statistics on the size, returns, and risk variables for domestic, international,

and emerging market equity funds from 1998-2008 (figures are averages unless otherwise noted). 1998 1999 2000 Domestic International Emerging Domestic International Emerging Domestic International Emerging Total Assets** $1.76 (tril) $324.2 (bil) $13.1 (bil) $2.45 (tril) $512 (bil) $21.3 (bil) $2.25 (tril) $447.2 (bil) $13.6 (bil)Geo Avg Mkt Cap(mil)* $17,720 $11,895 $2,284 $33,467 $22,557 $4,647 $30,331 $20,855 $4,688 σ (3-yr)(%) 22.04 19.11 26.10 27.38 26.37 34.28 27.64 25.71 32.78 3-yr. Mean Return*** 18.93 7.65 -8.70 25.61 17.42 3.38 12.56 10.01 -3.90 MS rating (3-yr.) 3.04 3.23 1.92 3.17 3.25 2.00 3.20 3.31 1.89 Beta 0.98 0.79 1.26 0.91 0.77 1.19 0.99 0.81 1.23

2001 2002 2003 Domestic International Emerging Domestic International Emerging Domestic International Emerging Total Assets** $1.98(tril) $348.3(bil) $12.2(bil) $1.61(tril) $293.4(bil) $12.90(bil) $2.14(tril) $399.9(bil) $25(bil) Geo Avg Mkt Cap(mil)* $24,852 $17,773 $4,252 $18,649 $15,321 $4,906 $18,480 $15,260 $4,283 σ (3-yr)(%) 25.16 22.94 30.91 21.16 16.98 21.26 20.49 19.23 25.31 3-yr. Mean Return*** 4.42 0.51 5.45 -11.28 -16.27 -13.45 -1.91 -0.89 13.64 MS rating (3-yr.) 3.16 3.15 2.93 3.06 3.05 3.11 3.05 3.07 3.10 Beta 0.98 0.85 1.17 0.95 0.73 0.91 0.99 0.87 1.01

2004 2005 2006 Domestic International Emerging Domestic International Emerging Domestic International Emerging Total Assets** $2.45(tril) $559.5(bil) $37.4(bil) $3.17(tril) $821.6(bil) $65.8(bil) $3.56(tril) $1.1(tril) $52.82(bil)Geo Avg Mkt Cap(mil)* $19,054 $16,832 $5,613 $19,548 $18,922 $8,193 $21,331 $21,511 $10,115 σ (3-yr)(%) 17.47 17.93 20.87 11.96 12.72 16.27 10.35 11.37 17.11 3-yr. Mean Return*** 4.95 12.82 21.56 17.23 24.53 37.09 10.69 -3.50 29.08 MS rating (3-yr.) 3.06 3.08 3.15 3.01 3.02 3.10 2.99 3.01 2.94 Beta 0.96 0.94 1.01 1.13 0.96 1.19 1.27 1.06 1.60

2007 2008 Domestic International Emerging Domestic International Emerging Total Assets** $3.9(tril) $1.43(tril) $129.69(bil) $2.35(tril) $765.24(bil) $64.5(bil) Geo Avg Mkt Cap(mil)* $24,632 $27,135 $17,478 $17,193 $19,442 $11,575 σ (3-yr)(%) 10.09 12.07 18.37 18.14 21.31 27.78 3-yr. Mean Return*** 8.69 18.41 33.79 -9.15 -7.76 -5.78 MS rating (3-yr.) 3.00 2.98 3.13 3.04 3.05 3.16 Beta 1.08 1.11 1.65 1.07 1.05 1.43 * This figure represents the median market capitalization in millions from 1998-2002 and then geometric average market

capitalization thereafter.


** Total assets consider all multi-class funds within each group. Results in the remainder of the paper consider only funds with distinct portfolios.

*** For all funds, returns are net of asset-based expenses and fees. The standard deviation measures from Table 1 indicate that the returns of emerging market funds

are more volatile, but their three year mean returns are also higher than those of the other two fund groups since 2003. The emerging market funds’ double digit returns from 2003 – 2007 are quite impressive and undoubtedly have lead to the rapid growth in these funds over this period. The higher risk of the emerging funds is also evident when comparing their betas to the two comparison fund groups. For every year displayed in Table 1, the emerging market funds’ betas consistently exceed the betas of the other groups. However, when overall performance is measured by their Morningstar rating, the emerging funds appear to be stronger in recent years. In particular, while their average rating was substantially lower during the 1998 – 2000 period, it has been at least comparable to and even higher than the domestic and international funds rating since that time. The higher Morningstar rating for the emerging market funds suggests that their higher risk is more than compensated for by their higher returns.

Table 2 reports the expense and activity variables (loads and fees, expense ratios and portfolio turnover) for our sample of domestic, international, and emerging market funds. Clearly indicated is the fact that in terms of front end and deferred loads, as well as the marketing or 12b-1 fees, the emerging market funds consistently have lower fees and loads for all years examined. With regard to expense ratios, however, the opposite conclusion may be drawn. This is evident in the expense ratios of the emerging market funds being the highest of the three fund categories with the exceptions of the years 2006 and 2008. This result may be expected, given that the costs of trading in emerging markets is likely to be higher than trading costs in the developed markets. When examining fund turnover, a somewhat mixed result seems to emerge. Although the emerging market funds exhibit slightly higher turnover in the early part of the study period (1999 – 2003), this percentage has since been gradually declining and is thus becoming comparable to the turnover of the other two fund groups. With regards to turnover, it is noteworthy that the international funds are consistently lower suggesting that they place a stronger emphasis on a buy and hold strategy when compared to domestic and/or emerging market funds. The lower turnover is consistent with the lower expense ratios for the international funds, especially during the 2004-2008 period.

Table 2:Portfolio expense and activity variables this table includes the descriptive statistics on loads, fees, expenses, and turnover variables for domestic, international, and emerging market equity funds from 1998-2008 (figures are averages unless otherwise

noted). 1998 1999 2000 Domestic International Emerging Domestic International Emerging Domestic International Emerging Front-end Fees (%) 1.27 1.37 1.06 1.27 1.35 1.10 1.25 1.34 1.08 Deferred Load (%) 0.98 1.06 0.93 1.01 1.09 0.93 1.01 1.06 0.88 12b-1 Fees (%) 0.40 0.43 0.37 0.39 0.43 0.37 0.39 0.43 0.37 Expense Ratio (%) 1.28 1.59 1.80 1.25 1.61 1.88 1.24 1.59 1.82 Turnover (%) 87 75 85 93 85 109 100 90 111

2001 2002 2003 Domestic International Emerging Domestic International Emerging Domestic International Emerging Front-end Fees (%) 1.21 1.31 1.07 1.19 1.26 1.08 1.12 1.19 1.00 Deferred Load (%) 1.02 1.10 0.89 1.04 1.08 0.82 0.97 1.02 0.84 12b-1 Fees (%) 0.41 0.45 0.38 0.43 0.45 0.36 0.42 0.44 0.38 Expense Ratio (%) 1.25 1.51 1.78 1.29 1.60 1.82 1.38 1.60 1.75 Turnover (%) 105 98 112 101 101 102 102 93 104

2004 2005 2006 Domestic International Emerging Domestic International Emerging Domestic International Emerging Front-end Fees (%) 1.10 1.13 0.97 0.90 0.91 0.79 0.88 0.90 0.83 Deferred Load (%) 0.95 0.97 0.81 0.76 0.79 0.69 0.70 0.79 0.65 12b-1 Fees (%) 0.42 0.44 0.38 0.39 0.41 0.36 0.37 0.41 0.36 Expense Ratio (%) 1.33 1.50 1.75 1.29 1.42 1.64 2.12 1.58 1.89 Turnover (%) 93 84 93 86 78 84 84 76 78

2007 2008 Domestic International Emerging Domestic International Emerging Front-end Fees (%) 0.85 0.86 0.79 0.84 0.85 0.76 Deferred Load (%) 0.62 0.73 0.66 0.57 0.67 0.56 12b-1 Fees (%) 0.35 0.38 0.35 0.34 0.37 0.33 Expense Ratio (%) 1.53 1.55 1.78 1.97 1.58 1.67 Turnover (%) 84 67 83 95 70 75


FUND COMPOSITION In addition to fund characteristics, our analysis also considers the three fund categories

examined in terms of their relative portfolio holdings. In particular, we assess their holdings with regard to the amount of investment funds allocated to developing markets versus mature market.

Table 3 provides the year by year details of these holdings, and some notable trends may be observed. Consistent with expectations, the US domestic equity funds have been and continue to be primarily invested in mature markets with very little allocation to developing markets. Similarly, the international funds also focus on mature market investments, although to a slightly lesser degree than the US domestic equity funds. The emerging market funds are the ones that demonstrate the greatest variation in their fund allocations across the developing and mature markets. While the emerging market funds have minimum holdings in the domestic US market (with that allocation becoming even smaller during the study period), they have significantly decreased their holdings in developing markets and simultaneously increased their holdings in mature international markets in recent years. Emerging market funds’ composition prior to 2004 was primarily in developing markets with only three to fourteen percent of holdings in mature markets. This composition has changed significantly since 2004. For example, starting in 2004 through the next five years, emerging market fund composition has averaged approximately 39 percent in mature markets, which is roughly four times their average mature market holdings in the pre-2004 period.

Table 3: Percentage of fund assets allocated to developing markets, mature markets and US stock (or non-US stock for the domestic market) for domestic,international, and emerging market equity funds from 1999-2008*

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 US Domestic Funds

% Developing Markets 0.5 0.6 0.6 0.5 0.8 0.6 0.7 0.9 1.2 1.0 % Mature Markets 99.1 98.6 98.1 99.1 98.8 99.4 99.3 99.1 98.8 99.0 % Non-US Stock 4.5 4.4 4.0 3.6 4.3 4.8 5.5 6.0 6.6 5.7

Emerging Market Funds % Developing Markets 92.9 90.0 87.2 86.1 85.0 60.0 58.0 56.3 63.3 69.6

% Mature Markets 4.2 3.3 3.8 12.4 13.3 40.0 42.0 43.7 36.7 30.4 % US Stock 2.4 5.2 6.4 1.6 0.9 1.9 0.5 0.6 0.7 0.7

International Funds % Developing Markets 8.3 8.4 7.9 9.1 10.1 5.3 5.3 5.7 8.1 7.5

% Mature Markets 90.0 88.0 87.7 90.6 88.8 94.6 94.7 94.3 91.9 92.5 % US Stock 2.1 3.7 4.3 1.4 1.1 1.2 0.7 1.1 1.1 1.1

* 1998 is not included in the table since Morningstar did not provide the mature market/developing market breakdown until 1999.

SUMMARY AND CONCLUSIONS This study analyzes emerging market mutual funds along with domestic and international equity

funds in terms of the various fund characteristics including their performance, expenses, composition, and growth. We add to the emerging market literature by updating the growth of emerging market funds through 2008, thus extending some of the earlier works. In addition to the growth update, we also report on a variety of fund characteristics over our study period, and note comparisons of emerging market funds to domestic and international groupings of funds. Our findings suggest that the rapid growth of emerging market funds is justified by their superior performance. In spite of their somewhat higher risk in comparison to domestic and international equity funds, emerging market funds with their higher returns over time provide more than adequate compensation for the risk involved, and this makes these funds a highly desirable investment alternative.

REFERENCES Aggarwal, R., Klapper, L, and Wysocki, P.D, 2005. Portfolio preferences of foreign institutional investors, Journal of Banking & Finance, 29, 2919–2946. Antoniou, A, Olusi, O. and Paudyal, K., 2006. Why Diversify Internationally When Domestic Diversification Provides Similar Benefits? Available at SSRN: 936637. Baker, H. K, Haslem, J, Smith, D M, 2008: Performance and Characteristics of Actively Managed Institutional Equity Mutual Funds, University of Maryland working paper. Borensztein, E.R and Gelos, R.G, 2003. Leaders and followers: emerging market fund behavior during tranquil and turbulent times, Emerging Markets Review, 4, 25-38.


Borensztein, E.R and Gelos, R.G, 2001: A Panic-Prone Pack ? The Behaviour of Emerging Market Mutual Funds, International Monetary Fund working paper 00/198. Butler, K. C. and Joaquin, D. C. 2001, Are the Gains from International Portfolio Diversification Exaggerated? The Influence of Downside Risk in Bear Markets, EFMA 2002 London Meetings, SSRN: 221992. Chan-Lau, J A, 2004: Pension Funds and Emerging Markets, International Monetary Fund; The Fletcher School of Law and Diplomacy working paper Charitou, A, Makris, A and Nishiotis, G, 2006. Closed-End Country Funds and International Diversification. Multinational Finance Journal, 10, 251-276. Eun, C. S, Janakiramanan, S and Senbet, L. W, 2002. The pricing of emerging market country funds, Journal of International Money and Finance, 21, 833-855. Fletcher, J and Marshall, A, 2005. An empirical examination of the benefits of international diversification, Journal of International Financial Markets, Institutions and Money, 15, 455-468. Gottesman, A and Morey M.R, 2007: Predicting Emerging Market Mutual Fund Performance, Journal of Investing, 16, 111-122. Huij, J and Post T, 2008: On the Performance of Emerging Market Equity Mutual Funds, Joint Research Kaminsky, G., Lyons, R. K and Schmukler, S. L., 2001. Mutual fund investment in emerging markets: an overview, World Bank Economic Review, 15, 2, 315-340. Kaminsky, G., Lyons, R. K and Schmukler, S. L., 2004, Managers, investors, and crises: mutual fund strategies in emerging markets, Journal of International Economics, 64, 113-134. Moss T, Ramachandran, V and Standley, S, 2007: Why Doesn’t Africa Get More Equity Investment? Frontier Stock Markets, Firm Size and Asset Allocations of Global Emerging Market Funds, The Center for Global Development working paper. Muga, L, Rodriguez, A., and Santamaria, R, 2007. Persistence in Mutual Funds in Latin American Emerging Markets: The Case of Mexico, Journal of Emerging Market Finance, 6, 1-37. İmişiker S. and Özlale Ü, 2008. Assessing Selectivity and Market Timing Performance of Mutual Funds for an Emerging Market: The Case of Turkey, Emerging Markets Finance and Trade, 44, 87-99. Ong, L.L, and Sy, A 2004: The Role of Mature Market Mutual Funds in Emerging Markets: Myth or Mayhem?, International Monetary Fund working paper. Opiela, N, 2007. Global Investing: Are We There Yet? Journal of Financial Planning, 20, 24-35. Parvez, A, Gangopadhyay, P, Nanda, S, 2001: Performance of Emerging Market Mutual Funds And U.S. Monetary Policy, University of North Florida working paper. Patro, D.K, 2005. Stock Market Liberalization and Emerging Market Country Fund Premiums, Chicago Journal of Business, 78, 135-168. Patro, D.K, 2006: International Mutual Fund Flows, Office of the Comptroller of the Currency working paper. Polwitoon, S and Tawatnuntachai , O, 2008. Emerging Market Bond Funds: A Comprehensive Analysis. Financial Review, 43, 51-84. Swinkels, L, 2008: Performance evaluation of Polish mutual fund managers, Erasmus University Rotterdam working paper.


Current State and Future Prospects of Mobile Money in Somalia: A Structural Equation Modeling Approach

Osman Sayid and Abdelghani Echchabi, International Islamic University Malaysia, Malaysia

ABSTRACT The main purpose of this paper is to study the perception and willingness of Somali customers to

adopt mobile money, based on an upgraded version of technology acceptance model. The questionnaire used in this study was distributed to 100 Somali customers, and the data gathered were then analysed using multiple regression and one sample t-test. The results indicate that perceived ease of use has a significant positive influence on the perceived usefulness of mobile money. Moreover, perceived usefulness and security were found to have a significant positive influence on attitude. Finally, social influence together with perceived usefulness both have significant positive influence on the Somali customers’ intention to adopt mobile money. This is one of the first studies to be conducted on mobile money in Somalia, the study uses an upgraded version of technology acceptance model and it reports significant findings based on this approach.

INTRODUCTION Following the collapse of central government led by President Siyad Barre in 1991, the financial

system has been destroyed including the Central Bank of Somalia and the entire banking system in Somalia (Siad Barre’s Fall Blamed for Somalia’s Collapse into Civil War: 2011). However, In December 2006, the Central Bank was able to reopen its offices in Mogadishu and Baidoa after 18years out of the service to keep government annual budget and to pay its salaries (African Development Bank, 2010).

Even though, the central bank seems to be inactive and there is a long way to go to regain its power and control on economy and monetary policies in the country. Therefore, the Money Transfer Companies (Hawaleh System) have arisen with the hope to fulfil this gap and deliver some of basic banking services. As a result, Hawaleh System becomes the major financial institutions in the country due to their faster and cheap service charges, growing public trust and the reliability on its service and due to having agencies across the world, which are handling up to $1.6 billion in remittance annually to the home land (CIA wold fact-book statistics, 2012).

The role of the Hawaleh system is not ended with transferring money from overseas to back home, but it plays important role in trade and local investment financing since there is no investment and commercial banks in Somalia. Moreover, the Hawaleh system acts as a saving bank by accepting the public deposits in its current and saving accounts (Abdusalam, 2002).

On the other hand, one of successful histories in Somalia is the telecommunication sector that was developed by private companies. These private companies provide affordable fixed-line, mobile phone and internet services in every major city in Somalia with a lowest international calling rates and high quality, which are not available in many parts in the continent (Istanbul Conference on Somalia, 2010).

Due to having access and rapid growing of telecommunication, Hormuud Telecom in Mugdisho, Golis Telecom in Bossaso and Telesom in Hargeisa have introduced a mobile money (M-money thereafter) service in the first time in 2009, which is known as Zaad or Sahal financial Service allowing customers using their mobile phone to transfer money, to pay bills and to purchase goods and services.

Within a very short period, this product becomes more popular in the Somalis community from Ras kamboni to Rascaseyr due to its reducing risk of carrying cash around and eliminating the need to use money transfer companies to transfer money within the country. However, Al-Shabab rejected Zaad or Sahal financial service arguing that this will lead the economy to fall in hands of international corporations and bankers, elimination of local currency (So.Sh) in circulation, the hawaleh system to be destroyed. Therefore, the Zaad or Sahal financial service was suspended in South Somalia, in the area where Hormuud Telecom is operating, while Zaad and Sahal financial service is operating effectively in Puntiland and Somaliland states because there two states are not under the control of Al-Shabab which banned Zaad and Sahal services.

Even though, Zaad or Sahal financial service is partially banned, but it remains to be one of the interesting innovations in both the telecom and hawaleh industries in Somalia. It may increase competitiveness between these two industries especially in a country like Somalia, where it could be a difficult to introduce the ATM (Automatic Teller Machine) in the public place due to security issues. Hence, this paper attempts to examine the Somali customers’ perception and willingness to adopt the two main M-money services in Somalia i.e. Zaad and Sahal.

After this brief introduction, the next section will present an overview on the adoption of M-money in different countries, using different approaches. The methodology employed in this study, the profile analysis as well as the results and discussion will then be presented sequentially.


LITERATURE REVIEW At the most basic level, M-money is the provision of financial services through a mobile device.

This broad definition encompasses a range of services, including payments, finance, and banking. In practice, a variety of means can be used such as sending text messages to transfer value or accessing bank account details via the mobile internet. Special “contactless” technologies are available that allow phones to transfer money to contactless cash registers (Donovan, 2012).

M-money is an emerging facet of electronic banking that, unlike traditional financial services, which offer very limited functions, is a potential platform for automated banking and other financial services. It is a wireless service delivery channel that offers additional value for customers by providing “anytime, anywhere” access to financial services (Lee and Chung, 2009).

Several studies have examined the attitude and/or intention to adopt M-money services in different countries. Daud, Kassim, Said and Noor (2011) examined the critical success factors influencing the adoption of M-money in Malaysia using technology acceptance model (TAM). The authors found that perceived usefulness, perceived credibility and awareness have significant effect on user’s attitude and subsequently influence the intention toward using M-money. A similar study was conducted by Cheah, Teo, Sim, Oon, and Tan (2011), and found that factors such as perceived usefulness, perceived ease of use, relative advantages and personal innovativeness were positively related to the intention to adopt M-money. In the same context Riquelme and Rios (2010) found that usefulness, social norms and social risk, are the factors that influence the intention to adopt M-money in Singapore.

Similarly, Bankole, Bankole and Brown (2011) investigated M-money adoption in Nigeria. The authors used both questionnaires and interviews for data collection. Their results showed that culture is the most important factor influencing M-money adoption behaviour in Nigeria.

In another context, Suoranta (2003) examined M-money adoption in Finland and found that relative advantage, compatibility, communication and trialability are the most important factors in explaining consumers’ behaviour. Similarly, Wessels and Drennan (2010) studied M-money adoption in the Australian context, they found that perceived usefulness, perceived risk, cost and compatibility are affecting consumer acceptance of M-money.

Lee, Lee and Kim (2007) examined the factors that influence adoption of M-money in South Korea using TAM. The authors found that the financial-performance risk dimension is the most salient concern for this sample and its context. Similarly, Gu, Lee and Suh (2009) explored the adoption of M-money in South Korea, based on TAM model. The study found that self-efficiency was the strongest antecedent of perceived ease-of-use, which directly and indirectly affected behavioural intention through perceived usefulness in M-money. A similar study was also conducted by Lee, Park, Chung and Blakeney (2011), and found that connectivity influences perceived ease of use directly. In addition, perceived monetary value has a significant effect on perceived usefulness, inferring MFS is not only useful for a firm, but also is useful from a time and monetary value standpoint. Personal innovativeness significantly influences perceived ease-of-use, so innovative users can take advantage of MFS more frequently. Absorptive capacity also directly affects usage intention. Finally, perceived task technology, versus a task characteristic view, significantly influences perceived usefulness.

Furthermore, Brown, Cajee, Davies, and Stroebel (2003) investigated the predictors of M-money adoption in South Africa. Factors identified included relative advantage, trialability, and consumer banking needs, with perceived risk having a major negative influence.

On the other hand, Cruz, Neto, Munoz-Gallego and Laukkanen (2010) examined the adoption of M-money in Brazil. Perception of cost, risk, low perceived relative advantage and complexity were revealed to be the main reasons behind the use of the service. A similar study was conducted by Puschel, Mazzon and Hernandez (2010).

In another context, Koenig-Lewis, Palmer and Moll (2010) investigated the factors that influence M-money adoption in Germany using TAM. The results of the study indicated that compatibility, perceived usefulness, and risk are significant indicators for the adoption of M-money services in Germany.

The above studies are based on different models including theory of reasoned action (TRA), theory of planned behaviour (TPB), decomposed theory of planned behaviour (DTPB), innovations diffusion theory (IDT) and technology acceptance model (TAM), among others. Among the above models, TAM has been chosen mainly because its basis represents an important theoretical contribution towards the understanding of M-money acceptance and behaviour (Malhotra and Galletta, 1999). TAM developed by Davis (1989) postulates that perceived ease of use has a positive influence on perceived usefulness. Furthermore, perceived usefulness and perceived ease of use have a positive influence on attitude. In addition, perceived usefulness and attitude both have a positive influence on the behavioural intention. Based on the proposed model, the following hypotheses were developed:

H1: Perceived ease of use has a positive influence on the perceived usefulness of M-money. H2: Perceived ease of use has a positive influence on the attitude towards M-money. H3: Perceived usefulness has a positive influence on the attitude towards M-money. H4: Perceived usefulness has a positive influence on the Intention to adopt M-money.


H5: Attitude has a positive influence on the intention to adopt M-money. Figure 1: Research model

METHODOLOGY The current study is conducted in the context of Somalia. Hence, 100 self administered

questionnaires were distributed to Somali customers by well trained research assistants. The questionnaire was constructed of two main parts. The first part is meant to collect information about the four constructs of TAM. The measurement for these two section was made on a five points likert scale (1 = Strongly Disagree and 5 = Strongly Agree). The second part gathered the demographic information of the respondents for subsequent comparative analysis.

The questionnaire was made in English and was subsequently translated into Somali language and distributed as such, since Somali is the main language in the country and most Somali people can speak Somali. The data analysis was done through one sample t-test and multiple regression analysis. It is worth mentioning that the analysis was done through SPSS 18 software.

The demographic data shown in Table 1 below indicates that 56 per cent of the respondents are male, while 44 per cent are female. 58 per cent of them are married, 34 per cent are single, while the remaining 8 per cent are divorced or widowed.

With regards to the age distribution, 42 per cent are between 20 and 30 years old, 35 per cent are between 31 and 40, 19 per cent are between 41 and 50 years old, and 4 per cent are above 50, while none of the respondents is below 20 years old. In terms of level of education, 56 per cent of the respondents are holding Bachelor’s degree, 23 per cent are holding high school certificate, while 21 per cent are holding Master’s degree.

Table 1: Descriptive statistics Percent

Gender Male 56Female 44

Age

Below 20 020-30 4231-40 3541-50 19Above 50 4

Education level High School 23Bachelors 56Master 21

Marital status Single 34Married 58Divorced/Widowed 8

Employment status

Student 4Public sector 25Retired 3Academicians 20NGO 26Private sector 22

Monthly salary

Less than USD200 22USD200-USD400 35USD401-USD600 30USD601-USD800 10USD801-USD1000 1USD1001-USD1200 1More than USD1200 1

Perceived Ease Of Use

Perceived Usefulness

Attitude Adoption Intention


Regarding the employment status, 26 per cent are working with nongovernmental organisations (NGO), 25 per cent are attached to the public sector, 22 per cent are working in the private sector, 20 per cent are academicians, 4 per cent are retired, while the remaining 3 per cent are students. Likewise, 35 per cent of the respondents have a salary between 200 and 400 US Dollars, 30 per cent earn a salary between 401 and 600 US Dollars, 22 per cent earn less than 200 US Dollars, while 10 per cent make a monthly salary between 601 and 800 US Dollars.

RESULTS The results indicate that the perceived ease of use has a significant positive influence on the

perceived usefulness of M-money. This supports hypothesis 1 initially claiming that the perceived ease of use of the m-money has a positive influence on its perceived usefulness. This is compatible with Davies (1989).

Moreover, the results also suggest that the perceived ease of use has no significant effect on the attitude towards M-money. This rejects hypothesis 2 stating that the perceived ease of use of m-money has a positive influence on attitude. This contradicts with Davies (1989).

At the meantime, perceived usefulness was also found to have a significant positive influence on attitude, which supports hypothesis 3 and which is in line with Davies (1989). In addition, perceived usefulness of M-money was found to have a significant positive influence on the intention to adopt it. Hence, hypothesis 4 was supported. This is in line with Davies (1989). However, hypothesis 5 was rejected because attitude does not have any influence on intention to adopt M-money. This contradicts with Davies (1989).

Figure 2: Summary of significant paths

In order to examine the attitude and willingness of the Somali customers to adopt Islamic

banking services, a one sample t-test is conducted for the both variables i.e. attitude and intention and their various items. By setting the test value as 3, the results show that all the items are significant at 95% confidence level for attitude, which shows that the Somali customers are willing to adopt Islamic banking services.

Table 2: One sample t-test for Attitude

Test Value = 3

T df Sig. (2-tailed) Mean Difference 95% Confidence Interval of the DifferenceLower Upper

Attitude 7.546 99 .000 .47000 .3464 .5936 AT1 12.753 99 .000 1.18000 .9964 1.3636 AT2 5.014 99 .000 .36000 .2175 .5025 AT3 8.132 99 .000 .58000 .4385 .7215

With regards to the intention to adopt M-money, the results indicate that overall the customers are willing to adopt it. Nevertheless, items 1 and 2 do not significantly differ from the test value. This indicates that though the customers are ready to adopt M-money in the future, they are not willing to do so in the short run.

Table 3: One sample t-test for Intention

Test Value = 3

T Df Sig. (2-tailed) Mean Difference 95% Confidence Interval of the DifferenceLower Upper

Intention 2.400 99 .018 .19667 .0341 .3592 INT1 .541 99 .590 .06000 -.1599 .2799 INT2 1.452 99 .150 .14000 -.0513 .3313 INT3 9.507 99 .000 1.02000 .8071 1.2329 INT4 11.413 99 .000 1.00000 .8261 1.1739 INT5 2.832 99 .006 .39000 .1167 .6633

DISCUSSION AND CONCLUSION The study initially aimed at examining the attitude and willingness of Somali customers to adopt

mobile money. Specifically, the study attempted to investigate the factors that may lead the Somali

Perceived Ease Of Use

Perceived Usefulness

Attitude Adoption Intention


customers to adopt M-money, by using technology acceptance model. Overall, the findings provide evidence on the suitability and reliability of the model used in the Somali m-money context.

The results show that the Somali customers are willing to adopt m-money. Furthermore, the results indicate that perceived ease of use has a significant positive influence on the perceived usefulness of M-money. Moreover, perceived usefulness was found to have a significant positive influence on attitude and intention to adopt M-money in Somalia. As such, the Somali banks and authorities have interest in highlighting this quality of m-money, and also keeping the customers informed about the measures put forward to further facilitate its use.

The findings of the study have important implications, for decision makers, policy makers as well as to the body of knowledge. In fact, this is one of the first studies that examined the prospects and opportunities of m-money, by using technology acceptance model. This enriches the literature on m-money by extending it to a different context. Moreover, the findings will give hindsight to the policy makers and decision makers that attempt to provide and enhance m-money in Somalia and similar countries.

The researchers that are aiming to undertake studies in this area are advised to take into account some additional variables, such as government contribution and credibility, etc. in order to provide more comprehensive results. Additionally, the future studies should be directed to some other countries, that still did not introduce m-money or those that have already introduced it, and it is still underused.

REFERENCES Abdusalam, O. (2012). A report on supporting systems and procedures for the effective regulation and monitoring of Somali remittance companies (Hawala). Online version http://mirror.undp.org/somalia/ remittance/ssp-hawala.pdf accessed on May 27. Bankole, F. O., Bankole, O. O., & Brown, I. (2011). Mobile banking adoption in Nigeria. The Electronic Journal on Information Systems in Developing Countries , 47(2), 1-23. Brown, I., Cajee, Z., Davies, D., & Stroebel, S. (2003). Cell phone banking: predictors of adoption in South Africa-an exploratory study. International Journal of Information Management, 23, 381-394. Cheah, C. M., Teo, A. C., Sim, J. J., Oon, K. H., & Tan, B. I. (2011). Factors affecting Malaysian mobile banking adoption: An empirical analysis. International Journal of Network and Mobile Technologies, 2(3), 149-160. Cruz, P., Neto, L.B.F., Gallego, P.M., & LaukkaNen, T. (2010). Mobile banking rollout in emerging markets: evidence from Brazil. International Journal of Bank Marketing, 28(5), 342-371. Daud, N. M., Kassim, N. E., Said, W. S., & Noor, M. M. (2011). Determining critical success factors of mobile banking adoption in Malaysia. Australian Journal of Basic and Applied Sciences, 5(9), 252-265. Davies, F.D. (1989). Perceived usefulness, perceived ease of use, and user acceptance of information technology. MIS quarterly, 13(3), 319-340. Gu, J.G., Lee, S.C., & Suh, Y.H. (2009). Determinants of behavioural intention to mobile banking. Expert Systems with Applications: An International Journal, 36, 11605-11616. Istanbul Conference on Somalia, (2010). Draft discussion paper for Round Table “Telecommunications”. Accessed on 21 – 23 May 2012. Koenig-Lewis, N., Pamler, A., & Moll, A. (2010). Predicting young consumers’ take up of mobile banking services. International Journal of Bank Marketing, 28(5), 410-432. Lee, K. S., Lee, H. S., & Kim, S. Y. (2007). Factors influencing the adoption behaviour of mobile banking: A South Korean perspective. Journal of Internet Banking and Commerce, 12(2), 1-9. Lee, K.C., & Chung, N. (2009). Understanding factors affecting trust in and satisfaction with mobile banking in Korea: a modified DeLone and McLean’s model perspective. Interacting with Computers, 21(5/6), 385-92. Malhotra, Y., & Galletta, D. F. (1999). Extending the technology acceptance model to account for social influence: Theoretical bases and empirical validation. Proceedings of the 32nd Hawaii International Conference on System Sciences, 1999. Mvunganyi, J. (2011). Siad Barre’s Fall Blamed for Somalia’s Collapse into Civil War. Voice of America. Online version http://www.voanews.com/english/news accessed 01 February, 2011.


Puschel, J., Mazzon, J.A., & Hernandez, J.M.C. (2010). Mobile banking: proposition of an integrated adoption intention framework. International Journal of Bank Marketing, 28(5), 389-409. Riquelme, H.E., & Rios, R.E. (2010). The moderating effect of gender in the adoption of mobile banking. International Journal of Bank Marketing, 28(5), 328-341. Suoranta, M. (2003). Adoption of mobile banking in Finland. Unpublished Master thesis, University of Jyvaskyla, Jyvaskyla. Wessels, L., & Drennan, J. (2010). An investigation of consumer acceptance of M-banking. International Journal of Bank Marketing, 28(7), 547-568.


An Empirical Analysis of Stock Price Synchronicity in Emerging and Developed Economies

Dr Sarod Khandaker, Swinburne University of Technology,Australia

ABSTRACT The paper examine the stock markets of 41 countries over a 10 year period from January 1996 to

December 2005 using the classical stock synchronicity measure developed by Morck et al. (2000). The study finds evidence that stock markets in emerging economies are more synchronous than in developed financial market. In separate panel data analysis there is evidence that countries with higher stock synchronicity have higher levels of inflation and lower levels of government accountability and corporate transparency. It is also apparent that in civil law countries stock synchronicity is more closely associated with the level of corporate governance than is apparent in common law countries.

INTRODUCTION It is often argued in the finance literature that stock prices in emerging economies are more

synchronised over time than those in developed economies. This is not only because developed economies have higher GDP per capita. It appears that there are several other factors which directly or indirectly affect the capital markets of developed economies such as, low corruption rates, strong investor protection, political stability and low inflation. Morck et al.(2000) argue that stock prices in economies with high per capita gross domestic product (GDP) move in a relatively unsynchronized manner over time in contrast to stock prices in low per capita GDP economies. They argue that low GDP per capita economies tend to be undiversified which makes firm level earnings highly correlated. Further, Morck et al. (2000) argue that low GDP per capita economies often cannot provide proper protection of property rights for investors.Thus, there should be a tendency for share prices in emerging economies to display a greater level of synchronicity than would be evident in developed economies.Further, a measure of stock synchronicity should capture the tendency of share market prices to move in the same direction over a particular period of time, in this case, in a given week.

Morck et al.(2000) propose two models to measure stock return synchronicity over a particular period of time.The first model is the classical approach using all available firms in the share market for a particular period of time. This captures the level of firm specific information that is reflected in individual firm share prices. The second model captures the broad market wide movements of share prices relative to a share market index over a particular period and is often referred to as the R-square measure of synchronicity.This paper analyse market wide share price movement using the classical synchronicity measures.1

This paper is divided into six sections. In the next section (section two), I review some of the more recent literature relevant analysis of share price synchronicity.In section three, the paper discuss the basic measures of stock return synchronicity developed by Morck et al.(2000) and also describe the data that is used in analysis.Section four provides descriptive statistics and Section five reports the results from panel analysis.The paper discusses these results in Section 6 and reports the conclusions of the analysis in Section 7.

LITERATURE REVIEW Synchronicity refers to the tendency for the stocks in a share market to move in the same direction.

The stock co-movement direction could be upwards or downwards depending upon the trend in the market. It is argued that stock prices in poor economies are more synchronized over time than those in rich economies. However, finding a definition of stock market synchronicity is not an easy task. Roll (1988) argues that stock market synchronicity depends on the relative amounts of firm-level and market-wide information capitalized into stock prices. In addition, Morck et al.(2000) suggest that stock prices in high per capita GDP economies move in a relatively unsynchronized manner. In contrast, stock prices in low per capita GDP economies tend to move up or down together.So we might define synchronicity as co-movement of stocks in a share market over a particular period of time.

Measuring stock synchronicity is a difficult task because this involves analysis of market wide share price co-movement. For example, the New-York stock Exchange (NYSE) has approximately 4,0492 firms listed. To estimate the classical stock synchronicity measure for the NYSE, it is necessary to collect each firm week observation for a relatively long period of time, in this case 10 years. This includes about 2 million firm week observations.Morck et al.(2000) use biweekly return data to measure stock return synchronicity for 40 countries around the world, including 15,920 firms.They use data from 1993 to 1995 for time series analysis and from 1995 data for cross sectional analysis.

1 There is little published in the literature using this approach. 2 According to DataStream database on July 28, 2006.


Morck et al.(2000) find that stock price synchronicity is negatively correlated with country geographical size and positively correlated with GDP growth and earning co-movements. They argue that a “Small Country Effect” causes the higher stock price co-movement found in smaller countries.It is suggested that highly diversified conglomerate3 companies account for a large fraction of stock market value and that widespread inter-corporate ownership might cause firm share prices to move together.This finding is further supported by Levine and Zervos (1998) who argue smaller countries often have unstructured financial markets leading to lower financial growth, compared to developed financial markets.Morck et al.(2000) use three good governance indices proposed by La-Porta et al. (1998) for cross sectional analysis which were government corruption, risk of expropriation by the government and risk of government repudiation of contracts.Jin and Mayers (2004)examine the link between measures of corporate transparency and the R-square based measure of stock synchronicity. They find that in a more transparent environment, proportionately more firm-specific information is revealed to outside investors. As a result, market-wide information explains a smaller proportion of the individual firm return variation, resulting in lower levels of synchronization and a lower average R-square for the market.

Li et al.(2003) argue that individual stocks are becoming more synchronous for the average country in their sample. They examine the Canadian stock market and compare this with the share markets of Mexico and the East Asia4. They find that Canadian stocks move less synchronously than Mexican stocks. They also find that when Canada entered into the free trade agreement with the US, its stocks exhibited a permanent increase in firm-specific variation, thus decreasing price synchronicity, because of increased market openness in the US market. In contrast, when Mexico entered into NAFTA (with the U.S.) its stocks exhibited a strong temporary increase in stock price synchronicity. They argued that developed economies like Canada, with well-developed institutions tend to exhibit permanent increases in firm-specific stock return variation on announcement of market wide information, whereas emerging economies tend to exhibit a temporary increase in share price co-movement. In addition, they find evidence of similar types of temporary stock price co-movement in the East Asian financial markets with economic liberalization.

Skaife et al. (2005) use the R-square synchronicity measure to conduct several analyses using data from the six largest equity markets in the world5.There is considerable variation in the results.For example, they find lower R-square values are associated with more informative prices in Australia while higher R-square values are associated with more informative prices in Germany, Japan and the U.S.A. In addition, they observe a statistically significant association between future earnings and returns, conditional on R-square values in France and the U.K. They argue that there are significant differences in voluntary information flows, ownership structure, trading activity, and market frictions across countries and this affects the price formation process in these markets.

Skaife et al. (2005) also examine the relation between the R-square measure of stock synchronicity and analyst forecast errors. They find evidence of a positive relation between analyst forecast error and R-square stock synchronicity in Australia, France, Germany, the UK and the USA. The only exception is Japan. However, they find evidence that firms with higher R-square values have lower analyst forecast error, which contradicts the findings of Li et al. (2003). Further, Skaife et al. (2005) examine the correlation between synchronicity measures and proxy firm informativeness variables that are reflected in stock prices 6 . They find some correlations between R-square synchronicity measures and information proxies across the countries that are inconsistent with their priors.Thus, there is evidence of country variation in explanatory models relying on the R-square synchronicity measure.

At a more general level, Longin and Solnik (1995) find evidence that correlation increases over time and large stocks tend to drive these correlations. They argue that international market correlation is higher when stock markets are volatile, especially in bear markets.They find that growing political, economic and financial market integration affects international financial market co-movement, as more integrated economies are influenced by global market factors. Indeed, it is suggested that removal of international investment barriers 7 may affect the level of international market co-movements that is observed in the markets. It is suggested, though, that larger stocks may move in the same direction with macroeconomic announcements, which has been shown to contain information relevant to both intra and inter day share market returns.

Wurgler (2000) proposes that capital flow is more responsive to value added in countries where firm-specific variation is a greater part of the total variation of individual stock returns. He suggests 3 A group of diverse companies run as a single organization. 4 Li et al. (2003) used R-square synchronicity measures for their cross sectional analysis. 5Skaife et al (2005) used the six largest equity markets in the world for their R-square synchronicity analysis. Their sample countries were Australia, France, Germany, Japan, the U.K., and the U.S.A.

6 The proxy firm informative variables include quality of firm information flows, firm size, turnover and industry regulation.

7 Such of these barriers are financial barrier, political barrier and the legal barrier.


that capital moves faster to higher value uses where stock prices move less synchronously. Thus, stock synchronicity is higher in low GDP economies than in high GDP economies.

Nguyen and Aman (2006) observe that corporate governance mechanisms are positively correlated with higher stock price valuation and market valuation in the Japanese stock market. They construct three critical dimensions for governance indices, board structure, ownership composition and disclosure policy. They suggest that, ownership structure is one of the most important factors in determining firm performance. Further, they argue that accounting transparency has a positive effect on a firm’s market valuation.

Overall, the empirical studies provide evidence that stock market synchronicity, generally based on the R-square measure, is higher in emerging economies than the developed economies. Little research is evident based on the first of the synchronicity measures recommended by Morck et al. (2000), the classical synchronicity model. This paper provides some insight into the behaviour of this alternative measure of stock market synchronicity.

RESEARCH METHODOLOGY AND DATA Classical Synchronicity Measure

This study uses the Classical Synchronicity Measure for stock synchronicity analysis, developed by Morck et al.(2000). The following equation illustrates the Classical Synchronicity measure.

[ ]downjt

upjt

downjt

upjt

jt nnnnMAX

f+

=,

(1) Here, jtf is the net change in price (whether up or down) of the stock of country j in month t .

upjtn is the number of the stocks in country j whose prices rise in month t and

downjtn is the number

of stocks whose prices fall.This measure has a maximum of 1.0 for markets where the share prices are perfectly synchronized and a minimum of 0.5 where there is an equal number of rises and falls over the period, consistent with a market where prices are not synchronized.This measure focuses synchronicity evident in the market as a whole for one period rather than on individual shares, which is captured by the R-square measure of synchronicity. Trade Openness

The study uses a trade openness measure for the stock market synchronicity analysis. Morck et al.(2000) argue that more open economies exhibit a lower level of stock synchronicity than less open economies. They also find that emerging countries tend to have less open economic policy than the developed countries; especially communist-states8. Trade openness is measured as follows (Li et al., 2003)

[ ]⎟⎟⎟

⎠

⎞

⎜⎜⎜

⎝

⎛−−=∑

nnt

nt

nt

nt

GDPGDP

GDPI

OpennessTrade 1

(2) Here ntI is the total imports of country n in year t and ntGDP is the gross domestic product

(GDP) for country n for the same period. ∑

nntGDP

is the aggregate GDP of the world at period t . Given a single country world, the value of the openness measure is I/GDP and this approaches zero for a closed economy and a value of one for more open economy. For a small closed economy in a multi-country world, the openness measure is approaches negative one, while for a small open economy the measure approaches zero.

It should be noted that it is possible to have a positive trade openness measure for entrepôtcountries. 9 The study uses two year average trade openness measures for cross sectional analysis. However, the sample country trade openness measure is always negative, except for Singapore and Hong-Kong. This result is consistent with Li et al (2003) who argue that Singapore and Hong-Kong are the most important entrepôt states in the world at present. Li et al.(2003) also propose that trade openness provides a direct measure of openness for individual country stock markets, tending to reflect the value of stocks that can be purchased by foreign investors as a percentage of total domestic market capitalization. Stock Return Data

The study analyses stock market data from 41 different countries. This includes 34 emerging markets and 7 developed economies. The emerging markets are taken from different geographical locations. The main criteria for selecting emerging markets include geographical location, legal origin,

8 This argument is further supported by La-Porta et al.(1998), who suggest that post-communist countries provide very little protection to shareholders.

9 An entrepôt (from the French "warehouse") is a trading post where merchandise can be imported and exported without paying import duties, often at a profit.(http://en.wikipedia.org/wiki/Entrep%C3%B4t)


size of the equity market and the availability of data from DataStream. The data span the period from January 1996 to December 2005. The study uses both live stocks and dead stocks to minimize survivorship bias problems. Further, full period data is divided into five sub-periods which are 1996-97, 1998-99, 2000-01, 2002-03 and 2004-05. The study uses weekly stock return data and the final dataset includes approximately 20.8 million weekly observations for 40,014 firms across the world.

This study divides emerging economies into three basic categories, e.g.English based common law countries; French and German based civil law countries and the former communist states. Developed economies are not classified into any specific legal origin. This study allocates all seven (7) developed economies into a single category. However, in emerging economies Zimbabwe requires some special consideration. According to the CIA (2007) website the Zimbabwe10 legal system is a mixture of Roman-Dutch law and English based common law. Further, Zimbabwe modified the criminal law code to a common criminal law code which replaced the Roman-Dutch criminal law system. As a result Zimbabwe legal origin is classified as a Common law based legal system.

The study uses 12 emerging countries of English based common law origin, 19 emerging countries of French or German based civil law origin, 3 countries of post communist origin and the 7 developed countries. There are only three post communist countries due to a lack of reliable data for other countries that fall within this classification. The study relies on DataStream in general though Yahoo finance is used to fill gaps where necessary. Other variables used in panel data analysis

Two corporate governance indicators used for panel data analysis (regulatory control and voice & accountability). These governance indicators reflect the statistical compilation of responses concerning the quality of governance and these indicators are measured in units ranging from -2.5 to +2.5. The higher values correspond with better governance outcomes and lower values correspond with poor governance outcomes. In addition the corporate transparency index (CPI), country geographical size, a trade openness measure, GDP per capita and an inflation index are also included in panel data analysis.

Country geographical size is collected from the CIA11 world factbook website and GDP per capita and inflation rate are collected from the World Bank12 database. Further, the trade openness measure is calculated using the Li et al. (2003) trade openness approach, which was discussed in the research methodology section. The corruption index was collected from the transparency international database13.

DESCRIPTIVE ANALYSIS Table 1 illustrates classical stock synchronicity descriptive statistics for the 41 countries. It is

found the countries with highest stock price synchronicity for the full period are China Ecuador, Malaysia and Turkey. In contrast, Germany and Australia exhibit the lowest stock price synchronicity during this period. The average synchronicity measure for the developed economies is 62 percent and for the emerging countries is 67 percent. However, Japan is the only country with high levels of stock synchronicity amongst the developed nations during this period consistent with the findings of Morck et al.(2000).

10 The CIA website access date 25/02/2005. (https://www.cia.gov/library/publications/the-world-factbook/geos/zi.html) 11https://www.cia.gov/library/publications/the-world-factbook/ 12 http://www.worldbank.org/ 13 http://www.transparency.org/


Table 1:Descriptive Statistics for Stock Return Synchronicity of 41 Countries Country Name Mean Median Standard Deviation

Argentina 0.69 0.68 0.11Australia 0.58 0.56 0.07

Bangladesh 0.68 0.68 0.12Brazil 0.64 0.64 0.09Chile 0.65 0.64 0.09China 0.73 0.74 0.13

Columbia 0.66 0.65 0.11Cyprus 0.69 0.67 0.12

Czech Republic 0.61 0.59 0.08Ecuador 0.75 0.71 0.18Egypt 0.65 0.65 0.10France 0.61 0.60 0.08

Germany 0.59 0.58 0.06Greece 0.72 0.71 0.13

Hong-Kong 0.65 0.63 0.10Hungary 0.65 0.64 0.10

India 0.65 0.65 0.10Indonesia 0.68 0.67 0.11

Japan 0.67 0.66 0.11Kenya 0.61 0.59 0.09Korea 0.68 0.66 0.11

Malaysia 0.73 0.71 0.13Mexico 0.66 0.65 0.10

New-Zealand 0.62 0.60 0.09Pakistan 0.67 0.66 0.10

Peru 0.65 0.65 0.09Philippines 0.65 0.64 0.10

Poland 0.66 0.63 0.12Portugal 0.63 0.62 0.09Russia 0.70 0.69 0.12

South-Africa 0.60 0.59 0.07Singapore 0.69 0.67 0.12

Spain 0.66 0.64 0.10Sri-Lanka 0.67 0.65 0.11Taiwan 0.69 0.68 0.13

Thailand 0.66 0.66 0.10Turkey 0.75 0.75 0.13

UK 0.63 0.62 0.09USA 0.63 0.62 0.09

Venezuela 0.67 0.65 0.12Zimbabwe 0.67 0.64 0.11

Total average 0.66Developed country average 0.62Emerging country average 0.67

The legal origin descriptive statistics reported in table 2 show that post communist countries exhibit higher levels of synchronicity on average, than the common law countries group and the civil law country group. Common law countries exhibit the lowest level of stock synchronicity during the observation period.

Table2:Descriptive Statistics for Stock Return Synchronicity Legal Origin Group Name No of Countries Mean Synchronicity

Common law Country Group 12 66 percent Civil law country Group 19 67 percent

Post communist country group 3 69 percent Developed country group 7 62 percent

Figure 1 shows the variation in stock return synchronicity evident for Australia, China and the USA given a 10 week moving average from January 1996 to December 2005. Stock synchronicity for the Chinese market is more synchronous than for the Australian and the USA stock markets. However, Australian stock markets exhibit the lowest level of stock synchronicity during this observation period.


Figure 1: The graph shows US, Australian and Chinese stock market synchronicity for 1996-2005.

The Study graphs 10-week moving average synchronicity for these stock markets. It is found that

Australian stock synchronicity is about 58% in an average week, which is lower than the USA (63 percent) and China (73 percent). It is found that Chinese stock markets move more synchronously than the developed markets. The study is consistent with Morck et al.(2000)

In addition, the study finds a significant mean difference in synchronicity measure between the emerging country and the developed country groups at α 0.01 level ( =3.606) .Correlations coefficients calculated between the independent variables by sub-periods are given in table 3.

Table3:Correlation-Coefficient between the Explanatory Variables in Five Sub-Periods Here, Control is the regulatory control, Corruption is the corruption index produce by transparency

international, GDP is the gross domestic product per capita, Inflation is the inflation rate of a country, Trade is the trade openness measure, Account is the voice and accountability index and Size is the geographical size of a country. Values with the bold letter indicates the significant level at the 5 percent and values with bold letter including star ‘*’ indicates significant at the 10 percent level.

Panel A--1996-97 Sync Inflation Control Account GDP Corruption Size

Inflation 0.156 Control -0.601 -0.466 Accountability -0.637 -0.377 0.798 GDP -0.553 -0.145 0.726 0.680 Corruption -0.596 -0.214 0.880 0.681 0.870 Size 0.201 -0.049 -0.136 -0.190 0.002 -0.083 Trade -0.111 0.320 0.236 -0.139 0.124 0.292(*) -0.218

Panel B--1998-99 Sync Inflation Control Account GDP Corruption Size

Inflation 0.335 Control -0.108 -0.410 Accountability -0.407 -0.447 0.615 GDP -0.302(*) -0.389 0.680 0.608 Corruption -0.284 -0.469 0.843 0.641 0.807 Size 0.008 0.215 -0.245 -0.107 -0.014 -0.120 Trade 0.313 -0.164 0.449 0.006 0.243 0.403 -0.209

Panel C--2000-01 Sync Inflation Control Account GDP Corruption Size Inflation 0.367 Control -0.175 -0.513 Accountability -0.284(*) -0.320 0.636 GDP -0.289(*) -0.280(*) 0.651 0.553 Corruption -0.328 -0.318(*) 0.830 0.638 0.804 Size -0.075 0.013 -0.286(*) -0.108 -0.001 -0.096 Trade 0.110 -0.138 0.476 0.006 0.290 0.411 -0.225


Panel D--2002-03 Sync Inflation Control Account GDP Corruption Size Inflation 0.113 Control -0.366 -0.439 Accountability -0.507 -0.401 0.871 GDP -0.308(*) -0.168 0.757 0.697 Corruption -0.383 -0.235 0.895 0.731 0.835 Size 0.018 -0.034 -0.130 -0.156 -0.003 -0.064 Trade 0.064 0.009 0.376 0.051 0.239 0.392 -0.208

Panel E--2004-05 Sync Inflation Control Account GDP Corruption Size Inflation 0.156 Control -0.601 -0.466 Accountability -0.637 -0.377 0.798 GDP -0.553 -0.145 0.726 0.680 Corruption -0.596 -0.214 0.880 0.681 0.870 Size 0.201 -0.049 -0.136 -0.190 0.002 -0.083 Trade -0.111 0.320 0.236 -0.139 0.124 0.292(*) -0.218

PANEL DATA ANALYSIS This section focuses on possible explanations for cross-sectional variation in synchronicity at the

country level. The Model

The study uses the following model to explain stock return synchronicity. ititititititititit TRSIZEGDPCPINVCRCSYNC εβββββββα ++++++++= 7654321 (3)

Where for each country i in year t itSYNC represents stock return synchronicity and α is a constant. itRC is the regulatory control index, itVC is the voice and accountability index, itIN is the inflation rate, itCP is the corruption perception index, itGDP is the gross domestic product per capita, itTR is the trade openness measure, itSIZE is geographical size and itε is the error term. The natural log of geographical size is used to minimize the impact of skewness in this variable. Panel Analysis

The study uses white adjusted standard errors in a fixed effect model for panel analysis. Table 4 illustrates analysis for all countries, developed countries and emerging countries. The thesis uses 41 sample countries for the analysis with 34 of them being emerging countries.

Table4:Fixed Effect Panel Analysis Variables All Countries Developed Countries Emerging Countries Control 0.0160 0.0095 0.0097 (3.83) (1.83) (1.98) [0.00] [0.08] [0.05] Corruption -0.0079 0.0095 -0.0032 (-5.48) (31.25) (-1.21) [0.00] [0.00] [0.23] GDP 0.00 0.00 0.00 (1.62) (1.04) (1.77) [0.11] [0.31] [0.08] Inflation 0.0002 -0.0027 0.0002 (1.15) (-0.81) (1.18) [0.25] [0.42] [0.24] Trade -0.0126 0.0479 -0.0173 (-1.18) (0.56) (-1.32) [0.24] [0.58] [0.19] Accountability -0.0238 -0.1268 -0.0213 (-6.39) (-3.09) (-6.45) [0.00] [0.01] [0.00] Log (Size) -0.0038 -0.0036 -0.0004 (-3.45) (-1.10) (-0.35) [0.00] [0.28] [0.73] R-square 0.269 0.614 0.128


The panel of this table contains estimates of: ititititititititit TRSIZEGDPCPINVCRCSYNC εβββββββα ++++++++= 7654321

where SYNC, the dependent variable, is the classical stock synchronicity measure and α is a constant. Control (RC) is regulatory control index, Corruption (CP) is the corruption index produced by Transparency International, GDP is gross domestic product per capita / 10,000, Inflation (IN) is a country’s inflation rate, Trade (TR) is the trade openness measure, Accountability (VC) is the voice and accountability index and Size (SIZE) is the natural log of the geographical size of a country.

Two values are reported below the estimated coefficient. The first in the parenthesis is the t statistics using white adjusted standard errors and the second in the brackets is the P value for the statistics.

The country corruption index is negatively correlated with synchronicity at the one percent significance level for the all country group and positively correlated for the developed country group. However, this effect is insignificant for the emerging country group, though the corruption index is negatively correlated with synchronicity in this case. In addition, inclusion of Singapore, South-Korea and Hong-Kong in the emerging country sample could exacerbate the problem, as the corruption index is quite high (low corruption) for these countries. To check the impact of these countries the analysis is repeated without Singapore, Hong-Kong and South Korea for the all country group and the emerging country group. The result of this analysis is provided in table 5.

Table5:Panel Data Analysis without Singapore, South-Korea and Hong-Kong All Countries Emerging Countries

Control 0.01872 0.01087 (3.73) (2.14) [0.00] [0.03] Corruption -0.00884 -0.00470 (-5.25) (-1.54) [0.00] [0.13] GDP 0.00000 0.00000 (1.85) (1.69) [0.07] [0.09] Inflation 0.00017 0.00015 (1.00) (0.88) [0.32] [0.38] Trade 0.00199 0.00763 (0.14) (0.32) [0.89] [0.75] Accountability -0.02585 -0.02578 (-5.90) (-7.20) [0.00] [0.00] Log(Size) -0.00335 0.00042 (-2.35) (0.24) [0.02] [0.81] R-squared 0.283 0.149

The study compares the all country group and the emerging country group, excluding Singapore, Hong-Kong and South-Korea


where SYNC, the dependent variable, is the classical stock synchronicity measure and α is a constant. Control (RC) is regulatory control index, Corruption (CP) is the corruption index produced by Transparency International, GDP is gross domestic product per capita / 10,000, Inflation (IN) is a country’s inflation rate, Trade (TR) is the trade openness measure, Accountability (VC) is the voice and accountability index and Size (SIZE) is the natural log of the geographical size of a country.

Two values are reported below the estimated coefficient. The first in parenthesis is the t statistic using white adjusted standard errors and the second, in brackets, is the P value for the statistic.

It is often argued that high inflation is bad for the real market economy and that synchronicity is positively correlated with inflation (Morck et al., 2000). Inflation is positively correlated with stock synchronicity for the all country group and for the emerging country group, but the effect is statistically insignificant. It is found that while a few emerging countries (Singapore, Taiwan, and Argentina) exhibit low inflation rates during the sample period the remaining emerging countries exhibit higher inflation.


The voice and accountability variable is negatively correlated with stock synchronicity at the one percent significance level for the all country group, the developed country and the emerging country group. Voice and accountability is one of the most important corporate governance mechanisms identified in the panel analysis. The World-Bank produces six good governance indicators in three clusters and three are used for measuring the good governance system. Voice and accountability and political stability are included in the first of the three clusters. The World-Bank states that the voice and accountability indicators include various aspects of civil rights, political rights and independence of public and private media. This provides a measure of the legal environment and enforcement quality of a country. Morck et al.(2000) argue that synchronicity is higher for the countries that do not respect private property rights and that have less enforcement quality in their legal system. This argument is further supported by Roll (1988). It is argued that strong civil and property rights produce lower levels of stock synchronicity.

Surprisingly, regulatory control exhibits a positive correlation with stock return synchronicity at the one percent significance level for the all country group and at the five percent significance level for the emerging country group. It was predicted that regulatory control and voice and accountability would have the same impact on stock synchronicity. However, it is found that some of the emerging countries in the sample exhibit strong positive regulatory control systems (examples include Poland, Malaysia and Singapore) during the observation period, while these countries exhibit higher stock market co-movement in the same period. This may explain the reason for positive correlation between regulatory control and stock price co-movement in the panel analysis.

The natural log of geographical size is used to control for country size. It is found that geographical size of the country is negatively correlated with stock synchronicity at the one percent significance level for the all country group but the effect disappears for the developed country and emerging country groups. Emerging countries generally have small geographical size (except for China, India and Brazil) while developed countries are generally larger in size. This is consistent with the argument that geographical size becomes statistically significant between groups rather than within groups. Panel Data Analysis: Legal Origin Effects

Separate analysis is also conducted for groups based on legal origin (common law countries and civil law countries) to check for variation across legal groups (table 6). Post-communist countries are not analysed separately due to small sample size.

Table6:Panel Data Analysis between the Legal Origin Groups Common Law Countries Civil law Countries Control -0.0103 0.0185 (-0.75) (1.82) [0.46] [0.07]Corruption -0.0011 -0.0135 (-0.30) (-2.69) [0.77] [0.01]GDP 0.0000 0.0000 (-0.33) (0.87) [0.75] [0.39]Inflation -0.0001 0.001 (-1.69) (3.98) [0.10] [0.00]Trade 0.0551 -0.1064 (2.12) (-3.52) [0.04] [0.00]Accountability -0.0094 -0.0129 (-1.98) (-1.69) [0.05] [0.09]Log(Size) 0.0001 -0.0125 (0.06) (-4.07) [0.95] [0.00]R-square 0.3905 0.4693

The study compares the common law country group and the civil law country group. The Post-communist countries are not analysed separately due to small sample size.


where SYNC, the dependent variable, is the stock synchronicity measure and α is a constant. Control (RC) is regulatory control index, Corruption (CP) is the corruption index produced by Transparency International, GDP is gross domestic product per capita / 10,000, Inflation (IN) is a country’s


inflation rate, Trade (TR) is the trade openness measure, Accountability (VC) is the voice and accountability index and Size (SIZE) is the natural log of the geographical size of a country. Two values are reported below the estimated coefficient. The first in parenthesis is the t statistic using white adjusted standard errors and the second, in brackets, is the P value for the statistic.

It is found that inflation and accountability in common law countries is negatively correlated with stock synchronicity at the 10 percent significance level. Trade openness is positively correlated with synchronicity at the 5 percent level.In contrast, accountability is negatively correlated with stock synchronicity at the 10 percent significance level and trade openness, geographical size and corruption are negatively correlated at the one percent significance level for the civil law country group. There is evidence that, civil law country stock synchronicity is mainly driven by weak corporate governance systems and high inflation, whereas the effect is less significant for the common law countries. Additionally, the trade openness measure has the same effect for both the common law country and the civil law country group.

Regulatory control is positively correlated with stock synchronicity at the 10 percent level for civil law countries. This may be due to the weak regulatory control systems apparent in the emerging civil law country group (La-Porta et al., 1998, La-Porta et al., 1997). However, this effect is insignificant for common law countries.

DISCUSSION The study focuses on the largely ignored classical synchronicity measure in analysis of country

stock market synchronicity.It is found that emerging economies exhibit greater levels of stock synchronicity over the study period.Indeed, stock synchronicity for developed economies averages 62 percent, whereas emerging countries exhibit higher average stock synchronicity (66 percent) and the difference is statistically significant.

Further, synchronicity is lower in more transparent economies than in less transparent economies (examples include Australia, UK, France and Germany). These developed economies have low corruption rates and rank higher in terms of voice and accountability measures. In contrast, the Japanese stock market exhibits high stock return synchronicity relative to the other developed countries. This result is consistent with Morck et al.(2000) who also note the high Japanese stock market synchronicity.

There is evidence that stock price synchronicity is associated with country legal origin. Post communist countries exhibit higher stock synchronicity than common law and civil law origin countries. However, the sample size for the post communist country group is small and China exhibits the highest stock return synchronicity from the post communist countries (73 percent). Ex-communist countries like Poland, that are reforming their economic system, exhibited lower levels of stock synchronization in recent years relative to the early 90s. Further, civil law origin country stock synchronicity is associated with corruption rate, inflation, country size and accountability, whereas common law country synchronicity is mainly associated with inflation and accountability. It is found that stock synchronicity is negatively correlated with country geographical size, consistent with Morck et al.(2000), which suggest large countries like the USA, Australia and Mexico exhibit lower stock price co-movement than small countries like Singapore and Ecuador. In addition, there is evidence that higher synchronicity is associated with higher inflation rates (examples include Ecuador, Russia, Turkey and Argentina).

Finally, corporate governance mechanisms are negatively correlated with stock synchronicity for the all country group as well as the emerging economy group. Countries with poor corporate governance systems often exhibit higher levels of stock synchronicity (examples include Turkey, Ecuador and China) and this finding is consistent with Morck et al.(2000).

CONCLUSION This study presents empirical analysis of the classical measure of stock return synchronicity. It is

found that China (73 percent), Malaysia (73 percent) and Turkey (75 percent) exhibit the highest stock synchronicity during the study period while the developed countries average 62 percent.

In panel data analysis the study finds that corruption is negatively correlated with stock price synchronicity. This suggests that economies with higher levels of corruption exhibit higher stock return synchronicity than less corrupt economies and these results are consistent with Morck et al.(2000). There is evidence that country stock synchronicity is associated with higher inflation rates. High inflation economies such as Turkey exhibit higher synchronicity during the study period.

In contrast, low inflation economies, such as Australia and Germany exhibit low levels of stock return synchronicity. The study also finds that voice and accountability has a strong impact on country stock co-movement. This paper uses the voice and accountability index as a measure of the quality of law enforcement and civil rights and finds negative correlation with stock synchronicity. There is evidence that countries that are highly accountable with respect to civil and private property rights rank higher in the accountability index and exhibit lower stock synchronicity while countries that do not respect the private property rights and civil rights rank lower in accountability index and exhibit


higher stock synchronicity. Finally, the trade openness measure is negatively correlated with the classical synchronicity measure for civil law countries though the effect is insignificant for the common law country group.

REFERENCES CIA 2007. World Factbook. Periodical World Factbook. Volume, Pages DOI: Electronic Resource Number Durnev, A., Morck, R., Yeung, B. and Zarowin, P. 2003. "Does Greater firm-specific Return Variation Mean More or Less Informed Stock Pricing?" Journal of Accounting Research. 41 (5): pp. 797-836. Jin, L. and Mayers, S. 2004. "R Square Around the World: New Theory and New Tests." Journal of Financial Economics. 58 (1): pp. 215-260. La-Porta, P., Lopez, F. S., Andrei, S. and Robert, V. W. 1998. "Law and Finance." The Journal of Political Economy. 106 (6): pp. 1113-1155. La-Porta, P., Lopez, S. F., Shleifer, A. and Vishny, R. 1997. "Legal determinants of external finance." Journal of Finance. 52 (3): pp. 1131–1150. Levine, R. and Zervos, S. 1998. "Stock Markets, Banks, and Economic growth." American Economic Review. 88 (3): pp. 537-558. Li, K., Morck, R., Yang, F. and Yeung, B., 2003, "Time varying synchronicity in individual stock returns: a cross-country evidence." University of Alberta Business School. Longin, F. and Solnik, B. 1995. "Is the correlation in international equity returns constant: 1960-1990?" Journal of International Money and Finance. 14 (1): pp. 3-26. Morck, R., Yeung, B. and Yu, W. 2000. "The information content of stock markets: why do emerging markets have synchronous stock price movements?" Journal of Financial Economics. 58 (1): pp. 215-260. Nguyen, P. and Aman, H., 2006, "Corporate Governance and Stock Performance of Japanese Firms." Social Science Research Network. Roll, R. 1988. "R²." Journal of Finance. 43 pp. 541-566. Skaife, A. H., Gassen, J. and La.Ford, R., 2005, "Does stock price synchronicity represent firm-specific information? The international evidence." MIT Sloan Working Paper., 4551-05. Wurgler, J. 2000. "Financial Markets and the allocation of Capital." Journal of Financial Economics. 58 (1-2): pp. 187-214.


The Adoption of Discrete Payback of Dividend Reinvestment to Shareholders Wealth

DevinagaRasiah

Multimedia University (Melaka Campus) Malaysia

ABSTRACT Normally dividend reinvestment planshelp shareholders to reinvest variable amounts in a

company over the life of a long-term investment. In a reinvestment plan, generally all shareholders can purchase shares or even fractions of shares.Instead of giving their shareholder quarterly dividends check.This method provides a cost effective way to save our money and to put it to good use rather than spending the money it. Many of these programs allow dividends to be reinvested for no transaction fee and share can be bought at a lower price. The advantages from being offered or enrolled into DRIP (Get more stock than cash) may outweigh its drawbacks. However, it is always best for amateur individual investors to think twice. Keywords: Dividend Reinvestment, Corporations, investors, risk, dividends.

INTRODUCTION Dividend Reinvestment Programs (DRIPs) had been around since the 1950’s as indicated by

Cherin and Hanson, (1995) and it had been gaining popularity since then. According to Berry (2000), “today over 1800 companies and most Fortune 500 firms offer DRIPs with approximately five million investors in them”. Large companies offer automatic dividend reinvestment plans (DRIPS) to stockholders. Instead of receiving a cash dividend payment the stockholder receives additional shares of stock. Where the company can either buy the shares on the open market or issue the shares to the stockholder. At this juncture the primary focus of stock investing is on gaining money through the increase in the value of stocks over time due to market demand. While demand determines whether stock prices go up over time, some companies make periodic payments to stockholders called dividends, which offer an additional way to earn a return.

Wilson, B. (1982) indicated that in the era of globalization, we cannot escape from the evolution of dividend reinvestment plans. Baker and Meeks (1990) voiced that the evolution of dividend reinvestment plans: 1968-1988. Dividend Reinvest plans was highly demanded.Researchers such as Baker &Seippel (1980), Chan, McColough&Skully (1995),Boyes and Kramer (1982) explained in 1982 that individuals may use dividend reinvestment plans to achieve significant tax saving.In another study Chen (2009) wrote about the reversal of return and dividend growth predictability. He showed that lack of dividend growth predictability stemmed from how the dividend growth was constructed.However, despite all the merits from enrolling into this plan, there are some problems as well. Researchers such as Oden, D.H., & Williams, J.R. (1997), and Thorp (2007) have given a few deterrents that could be noted from participating in this program. We would elaborate more about their points in the literature review of the topic of discussion in this report.

In this study the names of the commercial banks will not be disclosed. Different steps of the process will be examined to study the detailed methodology taken to manage the disbursement of the dividend reinvestment.

The objective of the study is toreview the adoption discrete payback of dividend reinvestment to shareholders wealth and to show mathematically an analysis between a normal dividend payout and what happens when 95% of the share holder opts to reinvest.

LITERATURE REVIEW According to Steinbart and Swanson (1998) Dividend Reinvestment Plansare an enormous

instrument for lasting investors. When enough money is accrued, additional shares are routinely purchased, simply reinvest the dividends. Investors can acquire shares of stock at zero cost by using the interest of dividend reinvestment plan s. Furthermore, Baker and Seippel ( 1981)stated that when taking out a mutual fund be sure to check the reinvestment optionon the application form, as investors may ask intentional contributions to buy in additional shares of a particular company. Chan, McColough and Skully (2007) announced that dividendreinvestmentplanspermitall existing shareholderstoreinvest their dividend in the company,typicallyit is done with reduced cost to market price and no transaction cost, else alternately, the fraction contributed by shareholders’ dividendsinfurthercompanyshares. In another study by Lee (2010) indicated that a continuous free cash flow is provided by a huge proportion of high quality dividend-paying stocks which is benefit to owner. A continuous cash flow companies frequently enlarge their dividends from time to time to attract more investors. Therefore, during good or bad period, a dividend keeps coming in as long as the company grows and remains financially sound.


Why firms offer dividend reinvestment Plan There are many reasons for corporations to allow their investors to subscribe for dividend

reinvestment plans.A study conducted by Larkin, Lee and Wane (2005) fromFayetteville State University shows that many researchers such as Baker and Seippel (1980), Carlson (1992), Davey (1976), Fox (1981), Hagaman (1992), Pettway and Malone (1973), and Rodgers (1980) hadconducted similar research ondividend reinvestment plan s by the firms because of its economic motivations to the firm offered by dividend reinvestment plan s.(Larkin, Lee and Wane, 2005).According to Carlson (1992), dividend reinvestment plans are employed by firms to enable existing shareholders had bought additional shares from the firm and by doing this there did not pay the broker for his associated services. Furthermore, Burns (1994)mentioned that through open enrollment in dividend reinvestment plans, shareholders who did initial investments subsequently did not have to pay for brokerage charges.

Boehm, T.P., & De Gennaro, R.P. (2007) had indicated that there are number of the advantages in Dividend Reinvestment Plans and in the Shareholder Investment Plans for Shareholders, Real Estate Investment Trusts and Economy by Landy (1996). In a study conducted by Scholes and Wolfson (1989) indicated that the decentralized investment banking had made iteasy for strategies to be designed to distribute shares in the market and tocapture discounts. Schneid (1981) came out with a packaging combining the dividend-reinvestment and stock-purchase plans which allow stockholders to take up part of the underwriting fees by offerings newshares and tosave sponsoring firms by some of the usual underwriting costs.

The large revenue earned by the strategies raises serious questions about reasons many eligible shareholders who were eligible did not participate in their discount plans and as such making the firms to take a longer period to raise their targeted capital.In another study by Todd and Domian (1997) showed their participation rates of Dividend reinvestment plan which contrasted the differences between utility and non-utility firms. Likewise, it had been found by Chiang, Frankfurter and Kosedag (2004) that approximately fifty firms had allowed open enrollment in their dividend reinvestment plan s in 2004. With this benefit that investors can gain from participating in dividend reinvestment plans, companies that offer dividend reinvestment plans which improved stockholder relations, as shareholders who enroll in this plan had managed to increase their share holding at a reduced cost. (Larkin, Lee and Wane, 2005) In other words, greater loyalty among shareholders had reduced the risk of an undesirable takeover. (Cherin and Hanson,1955).

Steinbartand Swanson (1998) analyzed that firms which subsequently experience significant decrease shares number held per shareholder implement no-load Dividend reinvestment plan s. Thus, no-load Dividend reinvestment plan s does appear to be successful in broadening as a base of company’s stockholder. Saporoschennko (1998) argued the efficiency and the contribution of dividend reinvestment to their Industrial value firm.

There are some theories related to the dividend reinvestment plan indeed. First of all, it is the success of the dividend portfolios which automatically creates dividend stock portfolios which suit different people lifestyles and the situations by asking their users to select a portfolio type they like. Then, it comes to monthly dividend collection. Founder of Street.com developed a brand new system to help reschedule dividend checks to ensure investors can receive income in the mail in each and every month of the year. The exclusive tool searches a database of dividend stocks, and it matches up with shares that pay their dividends in the corresponding months preset.

Figure 1:The benefits of Dividend Reinvestment Plans

Source:Dividend Reinvestment Plans (DRIPS) and Their Benefits by Dave Scott on September 13, 2012

Excess Return .Net Dave Scott (2012) indicated that classically, with DRIPs, individual DRIP investor have very

little money to buy even a single share. Under the DRIP, the management brings together all the company dividends with other DRIP investors. Dave Scott (2012) highlighted that the company uses the total to buy the company shares. This is then allocated by fractional shares based on each investor’s dividend contribution.

Disadvantages of Offering Dividend Reinvestment Programs (DRIPs)


The benefits that firms gain from offering DRIPs may outweigh these several disadvantages. Furthermore, the merits gained from establishing this plan exceed the benefits that have to be forgone from offering common stock to the public. (Roden and Stripling, 1996) However, firms should be aware of the adverse consequences that may occur from implementing DRIPs.

Cherin and Hanson (1995) remarked that the costs to start-up and maintain DRIPs may discourage firms from introducing DRIPs to their investors. They further explained that firms not only have to endure the great start-up costs but also the annual administration expenses annually. The researchers also stressed that companies have to incur the costs of educating the investors when a DRIP is initiated. Other researchers such as Skully (1982), Davey (1976) and Carlson (1992) also stated that “there are high costs associated with initiated, administering, and maintaining DRIPs. (as cited in Larkin, Lee and Wane, 2005) Chan, McColough and Skully (1992) also commented that all stockholders of the firm have to pay for the costs of implementing and administrating DRIPs, but only those who participate in the plans would be benefited; hence, non-participants actually subsidize DRIPs although they do not register to enroll in them. Non-participants are therefore discriminated against in the form of high expenses on DRIPs. (Cherin and Hanson, 1995)

Other than that, Cherin and Hanson (1995) stated that firms would risk of having injured shareholder relations if they offer DRIPs. They elaborated that DRIPs might wound relationship with their shareholders by causing them unable to receive cash dividends when they need them. Moreover, they added that DRIPs may seem to be only suitable for long-term investors, and this may provoke unfavorable conflicts between participants and non-participants of DRIPs. Cherin and Hanson (1995) also believed that it is also possible that record-keeping errors would be made through DRIPs, and thus hurting the relationship between companies and investors.Moreover, Myers and Majluf (1984) indicated that the firm’s decision to seek for equity financing through DRIPs may deliver negative information regarding the corporation to the public. According to them, the reason for the possible bad publicity is the fact that usually firm’s management would only issue new equity when they feel that the price of the shares are too high.

THE MODEL USED FOR SHARE ENTITLEMENT The shareholder by electing to participate in the Dividend Reinvestment Plan receives a notice of

election where by the shareholder can then reinvests the electable portion.The electableportion shows the number of new shares are allotted and issued to the participating shareholder who wants to reinvest either the whole or, part of the electable portion of their newshares. This is then calculated in accordance with the following formula:

S = D x E x N VORN = S X D V Where: S = New Shares to be allotted and issued as fully paid-up to the elected participants notified by

the Notice of Election. D = Participating Shareholder holding shares at the Close of books and Date upon Notice of

Election relates. E =Electable Portion where the Board has determined that may be reinvested in New Shares. N = Size of Electable Portion chosen to be reinvested in New Shares. V = Issue Price, which, for the purpose of the Dividend Reinvestment Plan. As theMalaysian ringgitis determined by the Board of the company which is based on the

adjusted Weighted Average Price for the five market working days immediately prior to a fixing of the price date.Next, the applicant receives a discount of not more than 10%. The Volume-Weighted Average Price (VWAP) is the average price weighted by volume. Subsequently, the Volume - Weighted Average Price will be equals to the dollar value of all the trading periods. This is then divided by the total trading volume for the current day. Subsequently, the calculationstarts, when trading opens until it closes.However, this is good for the current trading day and the intraday periods only. Consequently, the data is used in the calculationof thevolume-weighted average price.The volume-weighted average price is the adjusted ex-dividend before the aforementioned discount before securing the Issue Price. At this juncture, the issue price may not be less than the par value of organizations s’shares at the material time.

The rest of the study looks at the process flow as to how the ORGA had planned their process flow for the dividend reinvestment plan to be carried out smoothly.


FINDINGS AND DISCUSSION Fig1:The process Flow chart

ORGANISATION A A brief process flow chart in relation to how the Dividend Reinvestment Plan is intended

to be administered is shown below

Step 1 ORG A. declares Dividend Reinvestment Plan

As per Notice of Election to Shareholders

Step 2 To vote to reinvest into new shares

Step 3 Shareholders fill up and return forms.

Step 4 ORG A. to make payment of the net payment from the Dividend Payment Account

Step 5 For Shareholders who applied the Reinvestment Option, cash in respect of the Electable Portion, reinvested, will be

reassigned to a share subscription account and the new shares being verified.

Step 6 ORG A to allot and credit New Shares into the Central Depository System accounts of Shareholders who exercised their

Reinvestment Option Assuming the dividend reinvestment plan (DRP) showed that 95% of shareholders opted to

reinvest their dividends; the beneficiaries are actually the company shareholders who choose to receive their dividends in cash.The company dividend yield remained attractive at 5.5% p.a. and the growth potential of their shareholding had improved from 3.75% to 8.06% p.a.

Analysis of an organization (ORG A)‘s dividend reinvestment plan SENARIO A

Case of normal dividend reinvestment plan of a hypothetical company The ORGAhadintroduced its Dividend Reinvestment Plan for the final dividend for the

financial year June 2010, and the interim and final dividends for the company for financial year June 2011.Under the Dividend Reinvestment plan, shareholders of the company had the option of reinvesting their selected portion into ORGA shares at a discount up to 10%.The reinvestment rates of the company have been quite good around 80%, 92% and 88% respectively i.e. a company average of about 95% of shareholders choose to reinvest their dividends.The economy was stable in the country, and the investors were given dividends payout e.g. financial year 2010 and 2011 were 79% and 76% respectively.

Assuming a case a normal company dividend payout, it is assumed that the ORGA’s return on equity was 14% in 2011, and with the company dividend reinvestment plan of 76%.

Maximum asset growth potential of (1-76%) x 14% = 3.36% p.a. This would be because that the company asset growth was coupled to the increase in equity

via the lowest amount capital adequacy ratio.Assuming also that the company’s earnings growth was coupled to asset growth, earnings per share, growth potential would be limited to 3.36% p.a.

For the current year 2012, ORGA’s PER of 12.5 x, earnings yield = 1/PER = 7.3% p.a. and a Dividend per share of 76% translates into net dividend yield = Dividend Payout Ratio x EY = 76% x 7.3% = 5.5% p.a. So a shareholder receives net dividend yield of 5.5% p.a. and earnings per share growth of

3.36% p.a. SENARIO B

Case when 95% of shareholders from ORGA opt to reinvest? New shares issued = dividend entitlement/adjusted share price

= (95% x 76% x net profit)/ (95% x (share price – gross dividend per share)) Assuming the new shares is issued at the maximum 10% discount to market price adjusted for

the gross dividend. So the company new shares issued were; = (76% x net profit)/ (share price – (share price x net dividend yield /0.76)) = (76% x net profit)/ (share price x (1-5.5%/0.76)) = (76% x net profit)/ (share price x 0.93).


Consider the percentage increase in company new shares = company new shares issued/issued shares

= 76% x net profit/ (share price x 0.93)/issued shares = 76%/0.93 x (net profit/issued shares)/share price = 0.817 x Earning per Share /share price = 0.817 x EY = 0.817 x 7.3% = 5.96%.

Earnings growth = retained portion of return of equity = ((1-DPR) + 95% x DPR) x Return- on- Equity = (24% + (95% x 76%)) x 15% = 14.5% p.a. As such the earnings per share growth for the new share issue was; = 1.145/1.0596 = 8.06% p.a.

Assuming the company shareholder reinvests his dividend. He will then notice his shares multiply by; (Percentage increase in new shares) / (percentage of shares owned by him) = 5.96%/95% = 6.3%. Considering this his share of net profit increases by: (Percentage increase in shares owned by him) x (diluted Earnings per Share growth) = 1.063 x 1.086 = 15.44%. So the shareholder whoever opts to reinvest his dividend receives Dividend Yield of zero and

Earnings Per Share growth of 15.44% p.a. Whereas the shareholder opted to receive his dividend in cash, only will receive a dividend yield of 5.5% p.a. and Earning per Share growth of 8.06% p.a.The proposed dividend reinvestment plan is good because there is greater flexibility in the investors’ investment objectives, such as the choice of receiving cash or reinvesting in the company with additional shares without any related cost.

CONCLUSION Dividend reinvestment plans were served positively in the existing market. Essentially, the return

of dividend reinvestment plan outweighs the disadvantages, depending on investors’ situation. The fact that investors can constantly raise the holding in an organization’s ordinary stock without spending money out of investors pocket is an attractive way to invest. In due course, the number of shares of stock that investor possessed will noticeably be enlarged, and all investors had to do was to choose dividends reinvested in the companies.

In conclusion, dividend reinvestments have served a useful function in Malaysian providing organizations a comparatively inexpensive source of equity finance and also providing shareholders higher dividend payouts. With many Malaysian investors partaking, the strategy of dividend reinvestment plan will persist to be a major source of new equity capital for Malaysian organizations.Essentially, depending on investors’ situation,the return of Dividend reinvestment plan outweighs the disadvantages. Thus, allowing the investors raise their holding in a company’s stock with not much money in investor’s pocket. Over time, the ordinarystock that the investor has would have increased substantially in the companies.

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Castro, B. (2008), Dividend Reinvestment Plans: A Leveraged Investing Alternative. Chan, K., McColough, D.W., &Skully, M.T. (1995) Dividend Reinvestment Plans in Australia. Global Finance Journal, 6 (1), 79-99. Cherin, A.C., & Hanson, R.C. (1995), Dividend Reinvestment Plans: A review of the literature. Financial Markets, Institutions and Instruments, 4, 59-73. Chiang, K., Frankfurter, G.M., &Kosedag, M. (2004), Explanatory Analyses of Dividend Reinvestment Plans and some Comparisons [ElectronicVersion]. International Review of Financial Analysis, 14 (2005) 570-586. Dahlke, G. (2005), Dividend Reinvestment Plans: Investing on Automatic Pilot. Dave Scott ( 2012 ) Dividend Reinvestment Plans (DRIPS) and Their Benefits by Dave Scott on September 13, 2012 Excess Return .Net Davey, P.J. (1976), Dividend Reinvestment Programs New York: Conference Boards, No. 699. Finnerty, J.D. (1989), New issue dividend reinvestment plans and the cost of equity capital. Journal of Business Research, 18, 127 – 139. Larkin, P., Lee, B., & Wane, A. (2005), Repurchase Dividend Reinvestment Plans (Repurchase Dividend Reinvestment plan S). Journal of Business of Economics Research, 3 (10) 55 - 62. Lee. K. F (2010) The Information Content of Dividend Policy on Future, Earnings in Australia: A VECM Approach International Research Journal of Finance and Economics, ISSN 1450-2887 Issue 49 (2010), © EuroJournals Publishing, Inc. 2010 Myers, S.C., &Majluf, N. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics, 13, 187 – 221. Oden, D.H., & Williams, J.R. (1997), Investment Opportunities Through Dividend Reinvestment Plans [Electronic Version]. The CPA Journal. Retrieved 28 July 2010 Pettway& Malone, 1973. R.H. Pettway and R.P. Malone, Automatic previous term Dividend Reinvestment next term Plans of Nonfinancial Corporations. Financial Management 2 (1973), pp. 11–18 (Winter) . Full Text via Cross Ref Roden, F. & Stripling, T. (1996) Dividend Reinvestment Plans as Efficient Methods of Raising Equity Financing. Review of Financial Economics 5, 91 – 100. Saporoschenko, A. (1996), DRIP’s agency and capital structure issues. Working paper: University of South Carolina, June, 19-21. Scholes, M.S., &Wolfson, M.A. (1989) Decentralized investment banking: The case of discount dividend-reinvestment and stock-purchase plans. Journal of Financial Economics, 17, 7 – 35. Skully, M.T. (1982), Dividend Reinvestment Plans: their development and operation in Australia and the United States, Melbourne; Committee for the Economic Development of Australia. Thorp, W.A. (2007), Dividend Reinvestment Plans: Value Investing With a Dividend Boost. AA11 Journal, 24 – 27. SteinbartP. J; Zane Swanson(1998) 'No-load' dividend reinvestment plans ,Review of Financial Economics 1998;7(2):121-141. Todd, J.M., &Domian, D.L. (1997), Participation Rates of Dividend Reinvestment Plans: Differences Between Utility and Nonutility Firms. Review of Financial Economics, 6 (2), 121 – 135. Wilson, B. (1982), Reinvesting Dividends: A Way to Revitalize Your Company. Financial Executive, 50 (December): 38 – 44.


Importance of Internet Financial Reporting Disclosures – Perception of lenders in Malaysia

Ramaiyer Subramanian1, Jayalakshmy Ramachandran2, David Tong Yoon Kin3

ABSTRACT Rapid use of technology has prompted companies to disclose financial and non-financial

information about companies using internet. While most developed countries have resorted to internet financial reporting, Malaysia is seen to be lagging behind. In its endeavour to be technologically savvy, we contribute by stating that internet financial reporting will be embraced by the stakeholders, especially the lenders. However the acceptability of the information depends upon the quality of information disseminated through the net. While it is accepted that more information could be shared at less costs, lenders seem to be interested in non-conventional value added information. Incidentally, the most important contribution to this research is that lenders are not keen on audit assurance reports as they do not perceive audit assurance reports to be value added in decision making process. This sends an important message to the auditors that lenders are probably losing confidence in audit assurance reports possibly due to the past business failures, where the professional auditors were seen to be complementing the failure process. We strongly recommend that use of professionalism, professional knowledge and diligence in the audit process while bearing in mind that auditors report to the shareholders must be on the top agenda of the auditors to build back the cracking image.

INTRODUCTION The objective of corporate financial reporting is to provide information that is useful to present,

past and future investors, creditors and others in making investment, credit and similar decisions (IFRS 14). Corporate financial reporting is the common source of information for all stakeholders for decision making (Botosan, 1997). To make decisions, financial information should be easily understood by the users. To understand the information, accurate reporting is vital to the society (Coffin, 2000). However, as per the current reporting practice considerable differences exist in the quantity and quality of information provided by different entities. Internet Financial Reporting is a new path in information dissemination. It is slowly replacing the traditional print media. Companies present their financial and other information on their web sites. Large companies were pre-dominant in embarking on internet financial reporting, however the rapidity of the technological development has witnessed even the medium and small organizations following suit (Holm, 2002). Regrettably, regulatory bodies do not govern the disclosure of financial information on web sites by the companies, which has led to information asymmetry. While information is required for decision making, too much unregulated information could lead to befuddling the shareholders. This was witnessed since the collapse of Enron followed by the collapse of a number of gigantic corporations. As a result many lenders and shareholders have lost faith in the reports provided by companies. Financial reporting practice on the web site is still novel and companies in Malaysia are developing their reporting practices attempting to catch up with international businesses. In Malaysia about 95 per cent of listed companies are having hyperlink to their web sites through Bursa Malaysia5. Internet is thus seen as a way of providing more information with cost efficiencies. Victoria et. al. (2000), claims that by providing more information voluntarily companies are able to reduce the agency costs6. However the reliability of the unregulated information would be questionable. In this research we study the lenders’ perception on the importance of information disclosed on internet. We believe that the corporate collapses of the recent years including the subprime crisis have caused a lot of financial distress to financial institutions due to lending habits. We deliberate that the lenders base their preliminary decisions on the information disclosed by the companies whether through internet or through traditional methods. Hence it is important to identify the perception of the lenders on the importance of internet based financial and audit assurance information. Remaining sections of this paper are structured as background, literature review, research methodology and hypothesis development, analysis and discussion of findings and conclusions with limitations.

1 Corresponding author, Lecturer, Faculty of Business and Law, Multimedia University, Malaysia 2 Asst. Professor, Nottingham University Business School, Seminyih, Malaysia 3 Sr.Lecturer, Faculty of Business & Law, Multimedia University, Melaka Campus, Melaka, Malaysia. 4 IFRS International Financial Reporting Standards 5 Bursa Malaysia is the Malaysian Stock exchange which was previously known as the Kuala Lumpur Stock Exchange. 6 Agency cost is an economic concept which explains the loss to the stakeholders due to poor decision made by the managers. It also explains the cost incurred by companies due to information asymmetry.


BACKGROUND AND RELATED RESEARCH Terminologies used

Internet Financial Reporting Internet Financial Reporting is the public reporting of operating and financial data by a

business enterprise by the World Wide Web or related Internet-based communications medium (Lymer et al., 1999). Statutory disclosures

Statutory disclosures in accounting are disclosures made by companies as provided by the statute which includes financial statements and non-financial information7. Voluntary disclosures

Voluntary disclosures in accounting are disclosures other than statutory information which are provided by companies for the benefit of the stakeholders and are disclosed at the discretion of the management (Mechael et al., 2002). Audit assurance

Audit assurance report provided by the professional independent auditors assuring the fairness in presentation of financial statements provided by the management. Largely it is assumed that most stakeholders rely on this report prior to making decisions. However, some studies have advocated that the audit assurance information has no effect on the investment decisions nor in extending financial facilities (Johl et al., 2007).

Theoretical and historical development of Internet financial reporting Access to financial statements of companies is primarily through published annual financial

statements, which is mandatory for all companies. Corporate social responsibilities8, on the other hand, demand that the stakeholders be supplemented with additional information to assist in decision making. In the past, researchers have used a number of theories to explain the motivation to disclose additional information, most of who have focused on agency theory 9 . The onus was on the management to disclose any information perceived to be auxiliary. This led most organisations to disclose voluntary information over and above the mandatory requirements. Consequently it was seen that the cost of disseminating information through traditional sources increased gradually leading to negative cost effectiveness and environmental impact due to print media. An alternative source of reducing cost was the use of internet to disseminate information. Allam and Lymer (2003), purport that internet financial reporting began gaining importance during the late 90s, a year after global corporates used internet for advertising purposes. The benefits of internet financial reporting have been repeatedly examined and documented by various researchers. It is presumed that stakeholders will use web sites to supplement their information prior to decision making. The major benefits include cost efficiencies, increased information dissemination, borderless information access, reduced time for information distribution, communicating with prospective stakeholders and supplementing traditional information. The principles of economic effects on internet financial reporting remain unaffected claimed Shapiro & Hal, (1999). However, a different theory was provided by Gallaugher et. al (2001) that web was costly to produce and relatively cheaper to reproduce. Lymer et. al.(1999); Wagenhofer, (2003); and DiPiazza et. al.(2002) asserted that transactions, disclosure and information obtaining costs can be reduced through web while Davis et. al., (2002) asserted that the incremental cost for companies having a web presence would be minimal. Ever since its introduction in the late 90s, Internet financial reporting has grown rapidly. Most developed countries like United States of America and European countries have adopted internet fully for reporting purposes (Debreceny & Gray 1996, Lymer et al., 1999, Craven & Marston, 1999) while developing countries like Malaysia and Indonesia have adopted internet partially for reporting purposes (Noor & Mahamad, 2000; Salleh at el., 2002; Khadaroo, 2005; Abdul Hamid, 2005). It was contended that in Malaysia, companies did not use the government provided incentives to upgrade their infrastructure of technology (Aziz et. al. 2011). Xiao et al., (2004) advocated the difficulties faced by the stakeholders in using internet financial reporting. The authors also commented that the quality of information disseminated on internet required improvement. Companies with good quality financial reporting have more liquidity position in the capital market by raising capital easily in the capital market, shares are traded frequently, and also reduce the cost of capital. The most trusted quality information by most stakeholders is the Audit assurance reports provided by the independent auditors. In Kuwait users attach more importance to independent verification and strongly agreed that the auditor’s report forms an important part of

7 Statutory disclosures are not defined and the meaning has been derived from observation 8 Corporate social responsibility is understood as the moral obligation of the management towards the stakeholders and the society at large.

9 Agency theory is the theory that explains the relationship between a principal and the agent. In financial reporting managers are agents of the shareholders who are the Principal and it is assumed that the managers would make decisions which are in the best interest of the shareholders


annual report (Naser et al., 2003). Baker et al., (2005) opined that in Malaysia majority of the loan officers regarded the audit report as ‘important’ particularly in lending decisions. In this research study we regard that the lenders would find statutory, voluntary and audit assurance information disseminated through internet much useful for decision making. We thereby gather the perception of the lenders on the usefulness of information dispersed through internet. This will not only contribute towards agency theory, stakeholder theory10 and legitimacy theory11 but also provide insights on lender’s expectation prior to considering companies for lending activities.

LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT Internet has played a very important role in financial reporting activities with many countries

using internet as cost cutting strategies. It has also become popular among academic researchers claimed Haniffa and Rashid (2004). Kelton (2006) contributes that web based reporting with hyperlinks can assist with information search leading to verification of audited financial statement. The potential investors can move away from the traditional concept of relying on audited financial information to make decisions. Transparency of information, wider reach, effective communication tool, timely reporting and value added information are some of the core benefits of internet in attracting and satisfying stakeholders (Gorgan and Gorgan, 2010; Lamani and Cepani, 2011). Petravick and Gillet (1998) emphasised that around 80 per cent of the fortune 500 companies released their financial information on internet immediately along with announcements in other media. 94 per cent of the companies listed in HongKong stock Exchange had implemented internet financial reporting by 2003 (Poon and Li, 2003). A comparative study between Croatian and Slovene companies revealed that Croatian companies lag behind in terms of disclosing voluntary disclosures using internet (Pervan 2006). 80 per cent of the banks and insurance firms in Albania used websites to disclose financial information (Lamani and Cepani, 2011). About 84 per cent of companies listed in Amman Stock exchange have websites and disclosed statutory information on websites (Sakarneh, 2011). Alias et al. (2009) indicated that 89 percent of the 100 companies sampled had disclosed information on the web of which only 52% made full disclosures while khan and Ismail (2011) developed checklists of items that the financial statement users would prefer to look at while reading financial statements on the internet. While the world is rushing towards technological development, the use of internet to disseminate information is still unsatisfactory in Malaysia claimed Alais (2009) and more could be done to regulate Internet financial disclosures in order to achieve Malaysia’s vision of a developed nation by 2020 (Alarussi and Hanefah, 2011). It can consequently be evidenced that despite rapid growth in technology and adoption of technology by both developed and developing nations, Malaysia is yet to embrace the technology fully. Researchers in the past have emphasized a lot on determinants of Internet financial reporting and the extent of disclosures. Internet financial reporting is not mandatory in Malaysia claimed Haniffa and Rashind (2004) even though companies with specified characteristics like bigger firm, highly levered, growth potentials, foreign shares and high shareholder concentration do tend to disclose voluntary information on the net. Disclosing more information on the internet helps to reduce the disclosure costs, however for the benefit to be perceived by the companies, the management must disclose more quality information which can be fairly standardized (Wagenhofer, 2003). Yet London’s FTSE-350 companies’ reporting characteristics indicated that companies with high environmental impact disclose more on their website while leverage and ownership concentration had negative association (Damaso and Lourenco, 2011). Webb and Sharma (2010) assert that lending decisions are affected by financial reporting credibility. Auditor’s reports and opinion are most sought information by lenders in commercial market apart from fundamental financial statements, Cash flow statements and voluntary disclosures (Libby, 1979; Jones and Widjaja, 1998; Guillamon 2003; Stainbank and Peebles 2006) with particular importance associated with qualified audit reports( Andreas, 2007). The chairman’s statement or report according to Clarke and Murray (2000) conveys important information about the company’s functions and increases the shareholders’ confidence while Al-Razeen and Karbhari (2004) insist that the directors’ personal information and directors’ report are thoroughly followed and read by stakeholders. The financial scams of the recent years have focused a lot on the borrowing tendencies of the companies leading the companies to bankruptcy. It is thus in the interest of this research to identify the perceptions of the lenders on their views of internet financial reporting prior to making decisions. In Malaysia the lenders treat audit assurance information as very important particularly when they make lending decisions (Baker et al. 2005) while in Kuwait, stakeholders do not consider audit information as important (Naser et al., 2003). Brammer and Pavelin (2006) observed that the absence of disclosure leads to stakeholders’ assumption of the worst financial situation and non-financial information as voluntary information is an important factor for decision making (Dyckman et al, 1978). Hand and Green (2011) ascertain that accounting 10 Stakeholder theory suggests that in order to be successful in business it has to create value for customers, suppliers, employees, communities and financiers.

11 Legitimacy theory emphasizes that actions of the companies are appropriate or desirable within certain socially constructed system of norms, values, beliefs and definitions (Suchman, 1995)


information is important since it is used by stakeholders particularly analysts who maximize their utility from the financial statements. Users of financial statements evaluate the financial statements of companies to determine liquidity, leverage, asset activity, profitability, and performance (Jooste, 2006). The annual report is regarded as the main medium by which companies disseminate information to the external users (Firth, 1979; Botosan, 1997; Epstein and Pava, 1993, as cited by Al-Razeen and Karbhari, 2004). Disclosure differences exist among each element of mandatory disclosure and all annual reports do not contain all mandatory disclosures (Roger Hussey (2000). Accordingly twelve statutory financial items (Annexure I) were included in this research under statutory information. A firm’s mandatory disclosures play a key role in determining their voluntary disclosure policies (Einhorn, 2005). The Financial Accounting Standard Board (FASB, 2000) described ‘voluntary disclosures as information primarily outside of the financial statement that are not explicitly required by accounting rules or standards”. Therefore voluntary disclosure includes accounting and other information relevant to the needs of various stakeholders (Meek et. al.,1995). Information other than statutory financial information disseminated on internet is deemed to be voluntary disclosure. Web sites are weak in voluntary disclosure claimed Adsu and Kosedag (2006). The results of the firm are likely to reflect the outcome of a whole bundle of voluntary disclosures provided by the firm (Lang and Lundholm, 1993). The absence of disclosure leads to investors’ assumption of the worst financial situation of the firm and will bid down the stocks (Cormier and Magnan, 2003 as cited by Stephen Brammer and Stephen Pavelin, 2006). Consequently, based on previous studies, this research study used fourteen items representing voluntary information to find out the importance of information and the relationships between the predictor and criterion. Based on the brief literature discussion we have identified and classified the financial information content into three elements ie., the statutory information consisting of mandatory financial statements and disclosures, voluntary information consisting of any information disclosed by the companies based on the management discretion and Audit assurance information which are generally used to evaluate the strength and weaknesses of the financial statements. We also develop a framework based on model used by Barsky et. al. (1999). While Barsky et. al. (1999) used the model to explain stakeholder expectation, we use the model to explain the lenders’ perceptions since past researchers deliberate that lenders depend on financial information and audit assurance before they make lending decisions.

Figure 1:Research model: Illustration of the perception of lenders on the importance of statutory disclosure, voluntary disclosure and audit assurance via internet.

Independent variables Dependent variable

Based on research literatures we develop two null hypotheses to find the relationship between the financial and non-financial information and audit assurance information disseminated on internet and the perception of lenders on the importance of internet financial reporting disclosure. H01 There is no significant relationship between internet financial reporting information disseminated

by companies and perceived importance of information to lenders. H02 There is no significant relationship between dissemination of audit assurance information on web

sites of companies and perceived importance of information to lenders. Furthering on the methodology, we used survey questionnaires with five-point Likert scale to

determine the perceptions of the lenders. We used snowball sampling. Snowball sampling is commonly used when it is difficult to identify member of the desired population (Mark et al., 2003). Questionnaires were distributed among bankers in Malaysia. A total 113 responses out of 150 distributed questionnaires were received providing 75.3% response rate. Reliability and validity tests were carried out and the results were satisfactory. The survey instrument had twenty six items measuring ‘statutory and voluntary financial information’. Eight items were used to measure audit assurance and ten items were used to measure ‘perception of lenders’ were used. Correlation test was carried out to find out the correlation among different attributes. High correlation items were dropped resulting into twenty-five items used for factor analysis. Further reduction in the items resulted from low factor loading.

Statutory disclosure on internet

Voluntary disclosure on internet

Audit assurance on internet

Perceived importance of information to lenders


Test results of demographic information Table 1:Demographic profiles of lenders Gender N % Cumulative %

Male 71 62.8 62.8Female 42 37.2 100Total 113 100Age

Below 20 years 0 0.0 020 -35 47 41.7 41.736-50 50 44.1 85.851-65 16 14.2 100

Above 65 years 0 0. 100Total 113 100

Education Secondary School 23 20.3 20.3University Degree 55 48.7 69.0

Post graduate 16 14.2 83.2Professional exam 16 14.2 97.4

Other exams 3 2.6 100Total 113 100

Experience Less than 1 year 3 2.6 5.6

1 – 5 years 29 25.7 31.36 -10 years 25 22.1 53.4

Over 10 years 56 49.6 100 113 100

Total 113 100Table 1 shows the demographic information of the lenders. More responses were received from

male than female with the highest response rate from the age group between 36 years and 50 years. Table 2:Descriptive analysis - Financial information items

Mean Std. Deviation Skewness kurtosisc1 4.3628 .64173 -.709 .501c2 4.3805 .65898 -.596 -.639c3 4.2389 .67181 -.323 -.788c4 3.9735 .68739 .034 -.850c5 3.7080 .70307 .479 -.875c6 3.4602 .84553 -.144 -.156c7 3.5752 .91423 -.262 -.392c8 4.1858 .66209 -.410 .076c9 3.9292 .78736 -.656 .985

c10 3.6814 .78223 -.282 -.209c11 3.3540 .86520 -.253 -.077c12 3.8142 .67545 .242 -.802c13 3.9469 .75405 -.802 1.664c14 3.9469 .66602 .059 -.709c15 3.8407 .76259 -.705 1.265c16 3.9204 .85713 -.711 .551c17 3.9204 .81440 -.357 -.396c18 3.9558 .78364 -.488 .006c19 3.7434 .77665 -.331 -.123c20 3.6903 .78011 -.082 -.401c21 4.0177 .71940 -.026 -1.043c22 3.7522 .87148 -.317 -.512c23 3.6460 .87546 -.377 -.480c24 3.3982 .91163 -.232 -.267c25 3.6372 .89704 -.422 -.184c26 3.8761 .73354 -.078 -.520


Table 3: Cronbach’s alpha for financial statement, corporate governance, corporate information, internal report and audit assurance

Dimensions items Cronbach’s alpha Financial statement 2 .829 Corporate governance 5 .834 Corporate information 4 .766 Internal reports 3 .681 Audit assurance 4 .798

Table 4: KMO, Factor loading and eigenvalues for financial statement, corporate governance, corporate information, internal Report, audit assurance and Perceived importance of information to lenders

Dimensions KMO Loading Eigenvalues Financial statement .500 >.893 59.58 Corporate governance .795 >.645 60.37 Corporate information .696 >.683 59.17 Internal reports .633 >.602 61.22 Audit assurance .757 >.724 62.31 Perceived importance of information to lenders .758 >.707 56.32

About 77 per cent of the respondents had either a university degree or were professionally qualified and 50 percent of the respondents had more than 10 years’ work experience. This statistics enhances the credibility of the data received emphasizing on the maturity levels and the technological expertise or savvies of the respondents. Normality test result in Table 2 measuring skewness and kurtosis revealed a normal distribution of the data. Figure 2, histogram shows the graphical representation of normal data distribution. The mean score, as seen from Table 2, ranged between 3.39 and 4.3 and standard deviation between 0.641 and 0.914. Factor analysis was used to test the validity of statutory and non-statutory information, audit assurance and Perceived importance of information disclosed on internet to lenders. The Cronbach’s Alpha results as can be evident from Table 3 ranged between 0.681 and 0.834. The Kaiser-Meyer-Olkin (KMO) measure of sampling adequacy and Bartlett’sTest of Sphericity were used to find out the appropriateness of information for factor analysis. The results of KMO, factor loading and eigenvalues for all dimensions including dependent variable are given in Table 4 and can be observed to be within acceptable levels. Regression Test Results H01 There is no significant relationship between internet financial reporting information

disseminated by companies and perceived importance of information to lenders. Table 5: Regression results between internet financial reporting information and Perceived

importance of information to lenders R .425 R square .180 Adj.R square .142 Std error of the estimates .92627142Sig .001 F- value 4.708 Df 5

The results of the regression model as stated in Table 5 revealed a positive relationship between the internet financial information disclosure and the perceived importance of information to lenders (R= 0 .425, R square = 0.18, p-value <.001 ). Given the statistical significance and positive direction of this relationship it could be established that there is a significant positive relationship between internet financial reporting information disclosure and perceived importance of information to the lenders. The t-value indicated that financial statement, corporate governance and corporate information have a significant (p-value <.0.05) influence on the lenders perception. Therefore we reject the null hypothesis (H01) and claim that the alternative hypothesis is supported. Table 6:Coefficient results of internet financial reporting information and Perceived importance of

information to lenders ( Dependent variable: Perceived importance of information to lenders)

The coefficient results of financial information indicated that out of five predictors only three predictors, namely Corporate governance, Corporate information and Financial statements have

Model Unstandardized Coefficients Standardized Coefficients

t Sig.B Std. Error Beta

1

(Constant) -9.151E-17 .087 .000 1.000Corporate governance .211 .088 .211 2.383 .019Corporate information .289 .090 .289 3.219 .002Financial statement .258 .093 .258 2.772 .007Audit assurance -.144 .102 -.144 -1.422 .158


significant influence (p-value 0.019, 0.002 and 0.007 respectively) on the criterion. In other words corporate information like financial highlights, business review and information, share price movement and information and management announcements also influence lenders’ decisions as much as the traditional financial statement like the income statement and cash flow statement or the corporate governance reports like the Board of directors, their reports, their profile, their statutory duties and chairman’s statement. This implies that lenders expect more quality corporate information than merely reading the standardized statutory information. H02 There is no significant relationship between dissemination of audit assurance information on

web sites of companies and perceived importance of information to lenders. Table 7:Correlation between audit assurance and Perceived importance of information to lenders

PIIL d3 d4 d5 d6PIIL 1 d3 .167 1d4 -.035 .513** 1d5 -.078 .434** .571** 1d6 .049 .383** .451** .584** 1

To test the second null hypothesis, correlation test was used to find out the correlation between the audit assurance and the perceived importance of information to lenders. Contrary to that witnessed in the previous research, the correlation matrix results indicated that correlation was not significant between the predictor ‘audit assurance information’ and criterion ‘perceived importance to lenders’ resulting in acceptance of null hypothesis. Most researches in the past conveyed the message that it was important to have audit assurance information prior to making lending decisions. Baker et al., (2005) study in Malaysia found that the majority of the loan officers regarded the audit report as ‘important’ particularly in lending decisions. In Kuwait users attached more importance to independent verification and strongly agreed that the auditor’s report forms an important part of annual report (Naser et al., 2003). To further verify the correlation analysis results, a simple linear regression analysis was also carried out.

Table 8:Regression results between audit assurance and Perceived importance of information to lenders R .270 R Square .073 Adj.R square .039 Std error of the estimates .9804 Sig > 0.05 F value 2.126

The result indicates no significant relationship between audit assurance and the perceived importance of information to lenders (p-value >0.05). Therefore the null hypothesis is supported. This is an important finding which gives a warning that the lenders are probably losing their confidence on the audit assurance information. This could be detrimental to the interest of the profession itself. It also gives signal that the profession must act immediately to intensify their integrity and build back the down trodden image.

DISCUSSION AND CONCLUSION Earlier research studies investigated the determinants of internet financial reporting, while in this study we analysed the importance of information disclosed on internet to the lenders group. The measurable variables were selected on macro level of financial information which is generally published in the annual reports. Contrasting the past studies, this research revealed that audit assurance statements were not perceived important by lenders in making decisions. It was also observed that the lenders are drifting towards self-evident quality information rather than doting on the conventional financial information like the Balance sheet and Cash flows which can be easily manipulated. Major corporate failures like that of Enron, Worldcom, Lehman Brothers and Washington Mutual etc., in recent years have proven time and again the way in which financial statements could be created and maintained for years without being able to raise red flags on timely basis. It was also witnessed in the past that professional auditors are capable of compromising their integrity in order to maintain the client and client confidence. We thereby infer that unless the professional auditors are willing to act more diligently, without fear or favour, the lenders or other stakeholders would be unwilling to make good use of audit report. This compliments the concept of agency theory claiming that employing auditors to provide ‘true and fair’ audit report would remain as additional cost for the principals than a value added cost. The benefit would be reaped only by the agents, in this study, managers of companies. Earlier study by Haniffa and Cooke, (2000) acknowledge that financial information, statutory as well as voluntary; influence the lenders in their decisions. We extend this finding by stating that financial information, statutory and voluntary, disseminated on the internet by companies are perceived to be important by the lenders with special regards given for quality corporate information alongside the conventional statements and the corporate governance statements. Out rightly audit assurance statements have no influence on lenders’


decisions. Our recommendation, particularly to the auditors is to regain public confidence by acting diligently. Use of professional expertise and professional knowledge must be maintained. The top of the line principle should be that the auditors must not express any opinion on the financial position of an entity if the auditor is not satisfied with the evidences and explanations provided by the client. Auditors are independent legal third parties who are qualified to make an opinion and who have the onus to report to the shareholders and the other stakeholders. Despite these recommendations we reserve that this study is conducted in Malaysia and the sample size is small, as such the result may not be appropriate to be generalized over a wider population. Thereby, this research opens up prospects for future research by suggesting that the study be extended to a wider population within Malaysia. To give better insights into the validity of this study a cross country research could be undertaken to identify if perceptions differ. On the front of technological development we suggest that more information could be effectively disseminated through internet and since we observe a trend shifting towards quality financial information, use of internet will prove to be efficient and cost effective. This, in turn, would promote ‘Legitimacy theory’ where by managers will be witnessed performing socially desired actions in achieving the corporate objectives while ensuring going concern of the businesses. As much as the past researches have prompted the use of internet for more quality information, this research backs up the findings of the past researchers.

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An Examination Of Randomness Properties of 3-Digit Fibonacci Numbers Utilizing Traditional Randomness Tests

Fatollah Salimian, Associate Professor,Jerome J. DeRidder, Professor

Franklin P. Perdue School of Business Salisbury University

USA

ABSTRACT A myriad of scientific inquiries use random numbers as the basis or groundwork of their

investigation for seeking information about different subject matters. The results of these studies are expected to be unbiased discoveries or revision of theories or facts. Computer algorithms usually are not capable of generating random numbers. These algorithms generally produce “pseudo random numbers” that almost have all properties of real random numbers. This paper will examine the notion that random numbers used in some research studies may not be truly random.

We have demonstrated that although Fibonacci numbers are generally regarded as pseudo random numbers, they do not pass the classical tests of randomness. It is worthy of note that passing these tests per se, may not be sufficient to ascertain that the generated numbers are in fact random. To achieve this objective, a set of 1500 three digit numbers of the Fibonacci series were chosen. These numbers were tested for randomness using One Digit Frequency Test, newly proposed two and Three Digit Frequency Tests, Serial Test, Runs Test, Poker Test, and Significant Serial Correlation Test.

Despite favorable results gained by utilizing these conventional methods, it was found that the generated numbers grossly lack randomness.

INTRODUCTION Although everyone has an intuitive notion of what randomness is, no one has yet defined the

concept of randomness acceptable to all academicians. However, many mathematicians have tried to define randomness and random sampling numbers.

One author tries to explain randomness as a method of choice which lacks aim or purpose and another defines randomness when there are no patterns associated with the selection of numbers. Another suggestion states that randomness is present when selection of series of numbers or objects requires no specific pattern of choice.

Maybe randomness is most acceptably defined to be “Every selection of (m) objects from (n) objects is equally probable.” In a special case where m = 1 and n is digits 0 through 9, chances of choosing any digit according to this definition is 1/10. Defining (n) the same and letting (m) be equal to 3, randomness requires that any set of the form (n1, n2, n3) are different. For example, (1, 2, 8) and (1, 8, 2) are different since they are ordered differently.

Regardless of the process of randomness generation, it is impossible to consider or assign an origin to the generation of random numbers. Thus sequences of numbers generated by various mathematical procedures are called “Pseudo-random numbers.”

The method which we selected to generate the so called “Pseudo-random numbers” is by the utilization of “Fibonacci Series.” The beginning of Fibonacci numbers dates back to the year 1212 and to a person by the name of “Leonardo of Pisa”. He wrote a book called Liber Abaci and described the process of generation of what we call “Fibonacci Numbers” today.

The Fibonacci numbers have become quite special to many mathematicians for two reasons. One is that it has a characteristic of appearing in unexpected places in natural phenomena and second is that no knowledge beyond simple mathematics is needed to understand this sequence.

The first and second elements of Fibonacci series is one. And simply other elements will be generated by adding the two previous elements. In other words

FNn = FNn-1 + FNn-2 Where,

FNn is the nth element of the series FNn-1 is the (n-1)th element of the series, and FNn-2 is the (n-2)th element of the series.

Table 1 shows the first 30 Fibonacci Numbers. Table 1: The first 30 numbers of the Fibonacci Series

FN1 FN2 FN3 FN4 FN5 FN6 FN7 FN8 FN9 FN10 1 1 2 3 5 8 13 21 34 55




Following are some of the properties of a Fibonacci series: 1.The square of any F-number is equal to the product of the two F-numbers on each side plus or

minus one. Or: (FNn)2 = (FNn-1) (FNn+1) + 1 For example: 342 = (21) (55) + 1 = 1155 +1 = 1156 212 = (13) (34) – 1 = 442 – 1 = 441

2.For any four consecutive F-numbers FNn, FNn+1, FNn+2, FNn+3, the following formula holds: (FNn)(FNn+3) = FNn+2

2 - FNn+12

For example, for the numbers 13, 21, 34, 55 (13) (55) = 342 – 212 = 1156 – 441 = 715

3.The sequence of the last digit number of Fibonacci series repeats in a period of sixty (60). The last two-digit number repeats in a period of (60(5) = 300. The periodic cycle for the last three-digit number is (5) (300) = 1500. 15000 or (10) (1500) is the repeating cycle for the last four-digit number, and (102) (1500) for the last five-digit number, and (10n) (1500) is the repeating cycle for the last (n+3)-digit number.

4.Perhaps the most remarkable property of this series is that the ratio of two consecutive numbers is alternatively greater or smaller than the golden mean, and as the series continues, the ratio approaches the golden ratio of (1+√5)/2 = 1.61803. Therefore one can find (FNn+1) approximately by multiplying (FNn) by (1+√5)/2 when n is large.

For the purpose of this study, we generated 1500 F-numbers, beginning with 001 and subjected the last three digits of these numbers to some conventional tests of randomness. It is important to note that since we are only dealing with the last three digits, and not the whole F-numbers, the 1500 numbers used in the study do not have the cyclical properties mentioned above.

METHODOLOGY In the introductory section, we stated the objective of this research. We also presented some of the

properties of Fibonacci numbers. In order to generate these numbers, which would be tested for randomness, we designed a visual basic program that could generate numbers up to 1000 digits. However, we should mention that the dimension of the program could not have been expanded to generate a greater number of digits. Taking into consideration our objective and limitations, we selected the last three digits of Fibonacci numbers starting with the first number in the series to the 1500th number which we call the 1st and 1500th Fibonacci numbers. Furthermore, the program was written in such a way that any other digits besides the last three digits on the right could not have been observed. It is also necessary to note that our sample of 1500 numbers is a complete cycle of three digit F-Numbers.

In pursuing our goal, we subjected our sample to seven different tests of randomness. These tests consist of: Frequency test, Serial test, Runs test, Poker test, and Significant Correlation test. Before giving the description and the results of these tests for the subject matter, we digress for a moment to talk about the level of significance. In light of the fact that our sample consists of 4500 digits and that constitutes a large sample, we decided that α = 0.05 is appropriate for all the tests.

ONE DIGIT (MONOBIT) FREQUENCY TEST This test states that one should count the frequency of occurrence of digits from zero to nine in

the entire sample. That is to say how many zeros, ones, twos, etc., are in the sample. After doing so we find the computed Chi-square by the following equation:

Χ2 = (ν + 1) / N Σ [Ni –N/ (ν + 1)] 2 Where:

ν = degrees of freedom. Ν = sample size = 4500. Νi = observed frequency of digit “i” in the sample. Table 2 below, shows the observed and expected frequencies for the generated 4500 digits:

Table 2:Chi-Square table demonstrating observed and expected frequencies of the digits Digits Observed Frequencies Expected Frequencies

0 412 4501 488 4502 412 4503 488 4504 412 4505 488 4506 412 4507 488 4508 412 4509 488 450

Total 4500 4500


In this case the results showed that computed Chi-square was 32.08 (p-value = 0.000192205). Since the 95 percent critical Chi-square with 9 degrees of freedom is 16.919, we reject the notion of randomness. It is interesting to note that observed frequencies of all even digits and all odd digits were all equal to 412 and 488 respectively.

TWO DIGIT FREQUENCY TEST The purpose of this test is to see if all the possible two digit numbers appear as the last two digits

of our generated numbers. Furthermore, all observed two digits have an equal chance of being observed. A full cycle of last two digits comprising of 300 consecutively generated numbers were chosen. The results are tabulated in Table 3.

Table 3: Frequencies of appearance of the last 2 digits The last two digits ending with

0 1 2 3 4 5 6 7 8 9

0 2 6 2 2 2 6 2 2 2 61 2 2 2 6 2 2 2 6 2 2

The 2 2 6 2 2 2 6 2 2 2 6Last 3 2 2 2 6 2 2 2 6 2 2two 4 2 6 2 2 2 6 2 2 2 6digits 5 2 2 2 6 2 2 2 6 2 2

beginning 6 2 6 2 2 2 6 2 2 2 6with 7 2 2 2 6 2 2 2 6 2 2

8 2 6 2 2 2 6 2 2 2 69 2 2 2 6 2 2 2 6 2 2

As we can see in Table 3, 01 appears 6 times as the last two digits of the 300 consecutively generated numbers and 62 appears only 2 times in the same position. We notice that all 100 possible numbers appear at least once, although the series has a tendency to produce odd numbers more frequently (odd-oriented series.)

THREE DIGIT FREQUENCY TEST The purpose of this test is to see if all the possible 3 digit numbers appear as the last three digits of

our generated numbers. 1500 consecutively generated numbers were chosen (a full cycle for 3 digits). The results were disappointing since many numbers of our population of 1000 were not seen as the last three digits. For example, our generated numbers could never end with 102 0r 100, 300, 702… and in fact more than 200 numbers out of 1000 total number of population elements were never observed.

It goes without saying that since the results of this test for the last three digits were unfavorable, it will be so for the last (n+3) digits (where n is a non-negative integer) and we can conclude that our generated numbers by no means are random.

SERIAL TEST This test looks at the frequency with which a digit (i) is followed by one of digit (j). This means

that since our digits are from zero to nine, each time we look at a digit say zero, we observe how many times it was followed by another zero, by ones, by twos, etc. We do this for all the digits. After doing so, the following formula is used to complete a preliminary Chi-square. Χ2 = (ν + 1)2 / N * Σ Σ[Nij –N/ (ν + 1)2]2

Where: ν = degrees of freedom. Ν = sample size = 4500. Νij = observed frequency of digit “ij” in the sample.

To find computed Chi-square for this test we take the difference of this preliminary and frequency test’s Chi-square and compare it with critical Chi-square with 72 degrees of freedom (since ν2 – ν = 81-9 =72.) If computed Chi-square is less than theoretical Chi-square the notion of randomness will not be rejected.

After conducting this test, the results showed that computed Chi-square was greater than the theoretical Chi-square (0.05 level of significance), which were 104.7115 and 93.186 respectively (p-value = 0.007133) . The conclusion of this test would be that the generated numbers do not have random distribution.


RUNS TEST This test looks at each digit individually. In our case our sample consisted of 4500 numbers

which were arranged in 1500 rows each having three digits (three columns). The test runs up and down the columns and counts the number of ascending and descending changes among the numbers. For example, taking the first column, it identifies an ascending group of digits until the time that the next digit is smaller than the previous one. This is a change and the test considers this as a run. The opposite case is that it looks at the descending digits and when the next digit is greater than the previous one, again it is considered as a run. The test is using the following equations to determine the Z statistics which must be compared to the theoretical Z:

E(R) = 1/3 (2N-1) Σ (R) = 1/90 (16N-29) Z = (R-E(R))/σ(R)

Where, E(R) = expected number of runs N = sample size = 4500 σ(R) = standard deviation of runs

The results of the test on our data showed that computed Z = -0.73. Comparing this value with the 95 percent theoretical Z of 1.96 indicates that our data are indeed randomly distributed.

POKER TEST This test considers all the poker hands that can be arranged by our three digit numbers and the

probabilities associated with any of these poker arrangements. After doing so, the Chi-square is computed and compared to theoretical Chi-square. Consequently, the randomness of the numbers is evaluated in the light of comparing the Chi-squares.

Given our three digit numbers, we could arrange 3 possible hands which are: 1. Three of a kind (AAA) 2. One pair (AAB) 3. Bust (ABC)

The results of the poker test showed our sample is random. This decision was based upon the fact that at0.05 level of significance with 3-1 = 2 degrees of freedom the computed Chi-square was 15.5724, whereas the critical Chi-square is 18.307.

SIGNIFICANT SERIAL CORRELATION TEST The purpose of this test is to investigate whether there is a significant serial correlation among

the generated numbers when different lags are considered. In order to conduct this test, we selected all 1500 three digit F-numbers and arranged them sequentially with 9 different lags in 10 consecutive columns. Based on the analysis of the Serial Correlation Matrix shown below (Table 4), at 0.05 level of significance, no significant serial correlation was observed.

Table 4: Serial Correlation Coefficient Matrix with Lags

Original Lag 1 Lag 2 Lag 3 Lag 4 Lag 5 Lag 6 Lag 7 Lag 8 Lag 9Original 1Lag 1 ‐0.0157 1Lag 2 ‐0.0178 ‐0.016 1Lag 3 ‐0.0098 ‐0.0139 ‐0.01203 1Lag 4 0.0513 ‐0.0099 ‐0.01405 ‐0.008 1Lag 5 ‐0.0078 0.05526 ‐0.00597 ‐0.0141 ‐0.004 1Lag 6 ‐0.0178 ‐0.0079 0.05519 ‐0.002 ‐0.0141 ‐3E‐05 1Lag 7 ‐0.0038 ‐0.0139 ‐0.00397 0.05518 0.00202 ‐0.0141 0.00398 1Lag 8 0.0027 ‐0.0039 ‐0.01395 ‐1E‐05 0.0552 0.006 ‐0.014 0.0079 1Lag 9 0.0022 0.00658 3.7E‐05 ‐0.0139 0.00394 0.0553 0.00995 ‐0.0139 0.01187 1

CONCLUSION As it was stated earlier, randomness is present when there is equal probability for each element of

the population to be observed. If the population is defined to be three digit random generated numbers, definition of randomness implies that the probability of observing 411 or 034 or any other three digit number should be the same and equal to 0.001.


We demonstrated that perhaps some mathematical algorithms can be used to generate random numbers. When the series of generated numbers produce repeating cycles (such as Fibonacci numbers), they may pass some conventional tests of randomness but may lack some elements of randomness. There seems to be a need for a robust test to examine if all elements of the population have a chance to be selected.

REFERENCES Conway, J. and Guy, R. (1996), Fibonacci Numbers, In The Book of Numbers, New York: Springer-Verlag, pp. 110-119. Finch, S. R. (2003), The Golden Mean, §1.2 in Mathematical Constants. Cambridge, England: Cambridge University Press, pp. 5-12. Marsaglia, G. and Zaman, A., (1995), Some very-long-period portable random number generators, Computers in Physics, 8 pp. 117–121. Pappas, T. Anatomy (1989), The Joy of Mathematics, San Carlos, CA: Wide World Pub., Tetra, pp. 31-37. Ram, R. Fibonacci Formulae, http://users.tellurian.net/hsejar/maths/fibonacci/. Wikipedia, Fibonacci number, http://en.wikipedia.org/wiki/Fibonacci_number Wikipedia, Randomness tests, http://en.wikipedia.org/wiki/Randomness_tests


A Study on the Development of Cloud Database for the Aged People’s Leisure Activities in Taipei City – The Verification of Lifestyles,

Demands and Impediments to Leisure Activities

San-Chuan Cheng, Office of Physical Education, Ming Chuan University,Taiwan Meng-Yuau Sung, Office of Physical Education, National Chin-Yi University of Technology,Taiwan

ABSTRACT Facing the structure of ageing population, it has become a worth-concerning and discussing issue

to promote the quality of life and the life quality of metropolitan aged people in Taiwan. Furthermore, Cloud Computing is considered an important development in Information Technology in Taiwan that the verification of the correlations with leisure and the development of relevant leisure indicators also require active exploration. Based on the theoretical structure of Lifestyles, Demands for Leisure Activities, and Impediments to Leisure Activities, statistic analyses are utilized for verifying the correlations among them and for establishing the preliminary model of Cloud Database for middle-aged and aged people’ Leisure Activities. Total 980 senior citizens aged 60 and above in Da-an Park, National Taiwan University track and field, Tien-mu Park, Chiang Kai-Shek Memorial hall, National Dr. Sun Yat-sen memorial Hall, Youth Park, and 228 Peace Memorial Park in Taipei City are selected as the research subjects for questionnaire survey. Having deducted invalid ones, total 637 copies were retrieved, with the retrieval rate 75.2%. The research findings show that Lifestyles would affect Demands for Leisure Activities of the aged people in metropolis Taipei, but negatively affect Impediments to Leisure Activities. In this case, Lifestyles need to be promoted for establishing and developing Cloud Database for senior citizens’ Leisure Activities and the indicators. Ke words: Cloud Database, Internet, Technological Management, Information Technology, Ageing

INTRODUCTION Research background

Ageing is a special development of population in developing countries because of the dropping birth and death rate (Department of Statistics, Ministry of the Interior, 2010). According to the statistics, senior citizens aged 60 and above increased 2.86 million, from 1.99 million in 1990, 2.34 million in 1995, 3.5 million in 2000, 4.06 million in 2005, to 4.86 in 2009 (National Statistics, R.O.C., 2010). Besides, the death rate is decreasing every year and the average life is increasing because of the progress of medical technology and public health. The birth population in Taiwan decreased 0.13 million, from 0.321 million in 1991, 0.329 million in 1995, 0.305 million in 2000, 0.205 million in 2005, to 0.191 million in 2009 (National Statistics, R.O.C., 2010). Such phenomena of ageing and decreasing birth rate hav rapidly changed the structure of population in the past twenty years that Taiwan has become the structure of ageing society. When facing the problems resulted form the ageing society, social, family, economic, and physical problems for aged people are the new issues for present government organizations, groups, research institutes, and families. Hsu (2001), Hsu (2002), Kao (2004), Tsai (2006), Chiang (2007) pointed out six dimensions for the demands of aged people, including Health and Medical Treatment, Economic Security, Education and Leisure, Living and Nursing, Psychological Adaptation, and Social Adaptation. Having the aged group as the research subject, this study aims to discuss the dimension of Education and Leisure and to propose specific suggestions. Furthermore, the number of long-term care and nursing home for senior citizens appears the most in Taipei County, where Taipei City is ranked on the top with 84.3％ utilization (Department of Statistics, Ministry of the Interior, 2010). This study therefore tends to discuss the present situation of aged people in metropolis Taipei for the reference of relative units.

The booming of Information Technology in the 21st century allows the research on various fields being largely improved. Countries have made efforts on internationalization and modernization in order to promote the competitiveness. Cloud Computing is a new computing method based on the isomeric and autonomous services on the Internet to provide individuals and enterprises with on-demand computing. In other words, Cloud Computing automatically divides the large and complicated computing process into several smaller sub-processes through the Internet, and has the large server-based computer cluster to proceed distributed computing and parallel computing analyses. Such processed results are further transmitted back to Cloud Client who is not necessary to learn the professional knowledge of Cloud technology and infrastructure. With Cloud Computing, Web Service Providers could process millions or trillions of data in few seconds that it presents various powerful network services as a super computer. For this reason, it is a critical development for Information Technology in Taiwan to establish Cloud Leisure Activities in the ageing and recreational society. The development of Information Technology in recent years has improved the research on various fields. In such a knowledge economic and digital economic era, it


is inevitable widely to utilize Information Technology. As a result, a rapid response to changes and continuous innovation for new performance in the new age are required for adapting to the impact and challenge from technology knowledge (Lin, 2003). In this case, knowledge could change the economic structure in such a high-technology competitive age that people could merely control the trend by mastering in Information Technology. Well utilizing new technology information is the key to promote work efficiency (Hwang, 1999). Hwang (1999) classified the application of Information Technology into 1.Efficiency, 2.Effectiveness, and 3.Transformation. Apparently, Information Technology presents great effects on the modern society. The rapid development and the substitution of Information Technology have resulted in the structural regeneration of society, economy, and culture. Such a digital trend also affects the leisure education context (Hwang, 2004).

Kelly (1955) regarded Lifestyles as a structural system of cognition, as everyone had the specific Lifestyles that each group had the specific Lifestyles. Research on Lifestyles tended to find the common dimensions for a group so as to understand the group and further predict the possible behaviors. Lazer (1963) defined Lifestyles as a systematic concept which was the feature in a certain society or a certain group. Different from other societies or groups, such features were specifically presented on a dynamic model. Lifestyles were the combination of culture, value, population statistics variables, social status, reference group, family, personality, motivation, cognition, learning, and marketing. Hawkins, Best and Coney (2001) indicated that Lifestyles referred to a person’s living being deeply affected by culture, value, population statistics variables, social status, reference group, family, personality, motivation, cognition, learning, and marketing, and further influencing consumers’ Behavioral Decision Process, from which consumers received experiences and formed individual unique Psychological Factor (Charters & Ali-Knight, 2002). Lin (1994) concluded the dimensions for Lifestyles of the elderly from their leisure activities, namely Proactivity, Generally Satisfactory, Conservative and Cautious, Anxiety, and Family Orientation. With Factor Analysis, Chen (1995) discovered eight factors in Lifestyles, including Concern about Society, Value Family, Social Contact, Routine Life, Science of thought, Pecuniary Value, Outdoor Activity, and Satisfaction with Current Situation. Kao (2004) divided Lifestyles of the elderly into Family Style, Social Style, and Working Style, in which Family was the core that their lifestyles tended to the combination of Family Style and Other Styles. In conclusion, Lifestyles could be applied to understanding the behaviors and characters of different groups and reflecting the external behaviors from the internal characters that it could analyze the interactions between a person and the environment.

Lavery (1975) pointed out three demands for Leisure Demands. 1. Effective Demand referred to the demands people willing to and capable of acquiring and the leisure activities they could directly proceed. 2. Deferred Demand referred to the demands people willing to and capable of acquiring, but not able to participate in activities, and the activities they could not participate in because of insufficient facilities or knowledge. 3. Potential Demand referred to the demands people willing to but not capable of acquiring and the leisure activities they could not participate in unless individual impediments (such as money, time, health) were improved. Iso-Ahola, in the hierarchy of needs, considered that Leisure Demands were satisfied through leisure activities when people required certain demands. Researchers used to request the participants for listing the reasons (Leisure Demands), the leisure activities they participated in, and the importance of such activities that it was regarded as expressive Leisure Demands (Crawford & Godbey, 1987). Chang (1995), Tseng (1996), and Tsai (2007) indicated that aged people interacted with each other based on the relevant benefits (making friends, killing time, looking for happiness, being emphasized, gaining health). Proctor (1962) discovered the correlations between age, educational background, gender, occupation, social status, income, personality trait, marital status, life cycle of family and the participation in leisure (Boothby, Tungatt, & Townsend, 1981; Francken & van Raaij, 1981). Those researchers considered that demographic variables and Lifestyles were the key factors in Leisure Impediments. Based on Attribution Theory, Iso-Ahola (1985) mentioned that the perceived impediments could be acquired from the perceived degree of freedom, where perceived freedom referred to an individual could select the things he desired to do (Siegenthaler & O’Dell, 2000). In addition to the trait of participants and the impediments to participation, Jackson (1983) also concerned about the factors in impediments to pleasure when participating in leisure activities. Goodale & Witt (1989), on the other hand, concerned about the differences in the sense of pleasure when participating in the same activities with the same time. Such researchers not only covered the effects on participation and the frequency of participation in the definition of Leisure Impediments, but also contained the psychological factors of participation, demands, or control of leisure. Chiang (2007) pointed out the correlations between senior citizens’ selections and gender, age, income, marital status, employment, and educational background. Mutcheler and Burr (1991) found the effects of Social Impediments and Self-Impediments on senior citizens’ decision for participation.

To sum up, Taiwan is facing the major change in total population and the structure that the impact on present social policy and insurance is a critical issue for concern and discussions. Consequently, the relations between aged people and leisure should be taken into account, looked for, and analyzed in the leisure era so as to verify and improve the physical and mental problems of


domestic aged people, to develop the application of Information Technology, to reduce the pressure of social cost, and to enhance the wellness of aged people. Research questions

Based on the theories of Lifestyles, Leisure Demands, and Leisure Impediments, this study tends to discuss the present situation of aged people in metropolis Taipei and the correlations, expecting to propose a model related to aged people’s Lifestyles, Leisure Demands, and Leisure Impediments for the reference of future policies and strategies. The researched questions are listed as follows. (1)The present population background of aged people in metropolis Taipei. (2)The relations among Lifestyles, Leisure Demands, and Leisure Impediments of aged people in

metropolis Taipei. Research hypotheses

According to the above statements, the following hypotheses are proposed. (1) Lifestyles would affect Leisure Demands of aged people in metropolis Taipei. (2) Lifestyles would affect Leisure Impediments of aged people in metropolis Taipei. (3) Leisure Demands would affect Leisure Impediments of aged people in metropolis Taipei. Research area and restriction

Da-an Park, National Taiwan University track and field, Tien-mu Park, Chiang Kai-Shek Memorial hall, National Dr. Sun Yat-sen memorial Hall, Youth Park, and 228 Peace Memorial Park in metropolis Taipei were selected as the research areas. The results were restricted by several explanations because of different culture and policies in various metropolitan resulting in distinct situations, results, and explanations.

RESEARCH METHOD Research framework

Based on the research on Lifestyles, Leisure Demands, and Leisure Impediments, the following hypotheses and framework are proposed. H1: Lifestyles would affect Leisure Demands of aged people in metropolis Taipei. H2: Lifestyles would affect Leisure Impediments of aged people in metropolis Taipei. H3: Leisure Demands would affect Leisure Impediments of aged people in metropolis Taipei.

Fig 1:Research framework

Research subjects The research was preceded in between March 1-7, 2010. Senior citizens aged 60 and above

proceeding leisure activities in the parks and leisure sites in metropolis Taipei were selected as the research subjects. Based on representatives of samples, the research team proceeded stratified sampling at Da-an Park, National Taiwan University track and field, Tien-mu Park, Chiang Kai-Shek Memorial hall, National Dr. Sun Yat-sen memorial Hall, Youth Park, and 228 Peace Memorial Park (Table 1). The questionnaire survey was preceded at the time periods of 6-10.30am and 4-7.30pm for a week. Representative sites for leisure activities in metropolis Taipei were collected samples. Total 980 samples were distributed the questionnaire and 846 copies were collected, with the retrieval rate 86.3%. Having deducted invalid ones, total 637 copies were valid, with the retrieval rate 75.2%. The population was the aged people in metropolis Taipei. With the restrictions of precision and reliability, it applied the conservative method that .05α = , .05CP = was the conditions for .5p = formula (Rea & Parker, 1997). The acquired number of samples

2(1 )Z p p

nCp

α⎡ ⎤−= ⎢ ⎥⎢ ⎥⎣ ⎦

H3

H2

Lifestyles

Leisure Demands

Leisure Impediments

H1


n: number of sample Cp: maximal allowable error P: parent group ratio Z: standard normal value under the reliability α

With calculations, the required number of samples was 385 copies. Chiu (2004) suggested that the number of samples was better above 400 when proceeding statistic analyses with Structural Equation Modeling. For this reason, 980 samples were selected from the population for questionnaire distribution.

Table 1:Population sampling for aged people’ leisure in metropolis Taipei Involved sites Collected

questionnaireRetrieval

rateValid

questionnaire Valid

retrieval rateDa-an Park 130 copies 92.8％ 97 copies 74.6％National Taiwan University track and field 126 copies 90.0％ 100 copies 79.3％Tien-mu Park 121 copies 86.4％ 68 copies 56.1％Chiang Kai-Shek Memorial hall 119 copies 85.0％ 92 copies 77.3％National Dr. Sun Yat-sen memorial Hall 109 copies 77.8％ 78 copies 71.5％Youth Park 113 copies 80.7％ 99 copies 87.6％228 Peace Memorial Park 128 copies 92.1％ 103 copies 80.4％

Total 846 copies 86.3％ 637 copies 75.2％ *10 copies were distributed every morning and afternoon; each area was distributed 140 copies. According to the sample characteristics, most people who participated in leisure activities were

females (59%), aged 65-70 (39%), graduated from junior high schools (63%), married (38%), not living with children (48%), unemployed (73%), presently or used to working as public functionary (39%), and with average monthly income NT$20,000 and below (44%). From the above sample composition, most research subjects were aged 65-75 (73%) that was similar to the groups in the past research. Research tools

The questionnaire contained Demands for leisure activities, Impediments to leisure activities, and Lifestyles, where Demands for leisure activities were composed of seven sub-scales of Physiology, Psychology, Interpersonal Interaction, Ego, Society, Entertainment, and Value, with the α reliability .76; Impediments to Leisure Activities were composed of Live Impediments, Self-Impediments, and Activity Impediments, with α reliability .71; and Lifestyles were composed of Ego-styles, Lifestyles, and Social styles, with α reliability .71. The scales were scored with Likert 5-point scale, in which 1 (Extremely disagree) ~ 5 (Extremely agree) were selected. The major theory was based on the research of Shih (2009), Lin, Hsu & Hwang (2009), Chang (2009), Hwang (2009), Chou & Hsiao (2009), Cheng, Tsai & Cheng (2009), and Lee & Chen (2010). Furthermore, with SPSS for Windows 12.0 and LISREL 8.72, α=.05 was regarded as the significance for statistic analyses. According to the research purpose, this study applied the suggestions of Hair, Anderson, Tatham, and Black (1998) to evaluating the full model fit with measure of absolute fit, incremental fit measures, and parsimonious fit measure. In this case, GFI>.90, AGFI>.90, and RMSEA<.08 were the indicators of absolute fit for the theoretical model; NFI, NNFI, and CFI above .90 was the indicators of incremental fit; and, CN>=200 was the indicator of parsimonious fit. Table 2:The observation indicators and the measurement of latent variables for the lifestyles and

leisure models of aged people in metropolis Taipei Code Variable Type of

variableNo. of

question M SD Cronbach α

Impediments to Leisure Activities Latent variables X1 Live Impediments Measured variable 3 3.70 1.28 .71X2 Self-Impediments Measured variable 3 3.90 1.11 X3 Activity Impediments Measured variable 3 3.00 1.37

Demands for Leisure Activities Latent variables Y1 Physiology Measured variable 3 3.37 1.29 .76Y2 Psychology Measured variable 3 3.60 1.40 Y3 Interpersonal Interaction Measured variable 3 3.59 1.35 Y4 Ego Measured variable 3 2.69 1.30 Y5 Society Measured variable 3 2.63 1.19 Y6 Entertainment Measured variable 3 3.59 1.38 Y7 Value Measured variable 3 3.39 1.32

Lifestyles Latent variables Y8 Ego-styles Measured variable 3 3.14 1.36 .71Y9 Lifestyles Measured variable 3 2.67 1.24 Y10 Social styles Measured variable 3 4.01 1.17 Compilation of scales

The scales for the questionnaire were based on theories, and Confirmatory Factor Analysis was directly applied to measuring the reliability and validity. In terms of reliability test, composite


reliability was utilized. From Table 3, the composite reliability of the factors was larger than the acceptance .6, showing the favorable reliability of the factors (Bogozzi & Yi, 1998). Both convergent validity and discriminate validity were utilized for validity. Convergent validity applied the suggestions of Anderson and Gerbing (1988) that the reflected factor coefficient of measured variables should achieve the statistic significance (p<.05). Discriminate validity was tested by the model of the relevant setting between two factors being 1.00 and Chi-Square differences in freedom estimate among all factors. When Chi-Square difference achieved significance (p<.05), the two factors could be discriminated. Moreover, it was tested whether the confidence interval (positive and negative standard errors) of the estimate between two factors contained 1.00. If so, the two factors were the same; or, they could be discriminated (Anderson & Gerbing, 1988).

Table 3:Confirmatory Factor Analysis among factors Factor Composite

reliability Standardized

λ t Average VariancesExtracted

Impediments to Leisure Activities Live Impediments .76 .67-.76 13.80*-14.32* .45-.57Self-Impediments .61 .55-.77 11.14*-12.32* .30-.60Activity Impediments .75 .65-.77 13.15*-13.45* .42-.59Demands for Leisure Activities Physiology .73 .66-.73 11.96*-12.00* .44-.53Psychology .87 .76-.78 16.74*-16.82* .58-.61Interpersonal Interaction .86 .73-.76 14.73*-14.81* .53-.58Ego .77 .69-.75 13.81*-14.09* .47-.56Society .62 .52-.79 10.39*-10.66* .27-.63Entertainment .88 .73-.81 16.32*-17.44* .53-.65Value .78 .66-.80 13.59*-13.96* .44-.65Lifestyles Ego-styles .77 .67-.77 13.18*-13.36* .45-.59Lifestyles .64 .49-.80 13.12*-13.36* .24-.64Social styles .85 .73-.75 14.41*-12.49* .53-.57

*p<.05 From Table 3, the factors of measured variables achieved significance that they corresponded to

the requirements for convergent validity. From Table 4, Chi-Square differences of Demands for Leisure Activities, Impediments to Leisure Activities, and Lifestyles achieved significance (p<.05) that there were differences between the model of relevant setting between two factors being 1.00 and all latent freedom estimates. In other words, the correlations among factors could be discriminated that discriminate validity was supported. Besides, none of the confidence interval in the three brackets contained 1.00 that discriminate validity existed in between the factors (Yeh, Hwang & Lin, 2007).

Table 4:Correlations and discriminate validity Factor Type Demands for

Leisure ActivitiesImpediments to

Leisure Activities

Impediments to Leisure Activities Correlation value -.57 Chi-Square Test 4943.57**

Confidence interval 【.82；.91】

Lifestyles Correlation value .21 -.36 Chi-Square Test 5435.35** 4577.52**

Confidence interval 【.81；.90】【.79；.91】 *p<.05

ANALYSES AND DISCUSSIONS Referring to the method of Roberts, Varki, and Brodie (2003), the dimensions of Demands for

Leisure Activities, Impediments to Leisure Activities, and Lifestyles were reduced from the quadratic model to the first-order model so as to simplify the model and to have better fitness. After Confirmatory Factor Analysis, such a method calculated the average scores of measured variables in each factor for the single measure of the factors (Anderson & Gerbing, 1988); then, the model was further constructed based on the theory.

Construction of leisure model for aged people in metropolis Taipei Structural Equation Modeling (SEM), composed of structural model and measurement model,

was utilized for analyzing the covariation among variables. Structural model was applied to describing the relationship among latent variables, while measurement model was to describe the relationship between latent variables and measured variables. This study applied two stages to constructing the causality model of traveling purpose. Confirmatory Factor Analysis was utilized for evaluating the appropriateness of measurement model in the first stage, while the model was constructed in the second stage.

Measurement model analysis A measurement model with ideal fit should correspond to the following conditions. (1) Each

factor loading should achieve statistic significance; and, (2) Composite reliability (CR) of latent


variables should reach .60 (Hatcher, 1994; Lee & Scott, 2006). Each measured variable in this study exceeded the critical t value 2.56, showing that the parameters achieved the significance .01 and all factor loadings achieved the statistic significance (Table 1). Apparently, the measured variables could reflect the responding latent variables. Structural model analysis

Full model-fit evaluation The indicators for full model-fit presented χ2=165.42(df=62), RMSEA=.05 and

RMR=.075<.08, and NFI=.90, NNFI=.91, CFI=.93, GFI=.96, AGFI=.95 >.90, χ2 / df=2.67 < 3 that the model was acceptable. Linear structural relationship analysis

The research outcomes showed that Lifestyles would significantly and positively affect Leisure Demands, but negatively affect Impediments to Leisure Activities. The direct effect of Lifestyles on Leisure Demands appeared 1.18, and the direct effect on Impediments to Leisure Activities presented -1.5 (Fig. 2).

Fig 2:Effect model of Lifestyles, Leisure Demands, and Leisure Impediments

1ξ

1η 2η

Note: Factor loadings in the figure were the quadratic factor loadings, and the values were larger than .3.

Discussions Correlation Analysis of Lifestyles toward Leisure Demands

The research outcomes showed the positive effects of Lifestyles on Leisure Demands, which supported the hypothesis H1. With further analyses, aged people in metropolis Taipei appeared the most perception on Ego-styles (factor loadings .48) in Lifestyles, and the least on Lifestyles (factor loadings .38, t=6.99). The results were different from the research outcomes of Lin (1994), Chang (1995), and Chiang (2007), possibly because aged people in metropolis Taipei perceived the most of Ego-styles as they were affected the participation in leisure activities by individual personality, interests, and mood. Besides, senior citizens aged 65 and above in metropolis Taipei might have retired or prepare for retirement that personal affairs were reduced and free time was increased. They therefore had more time and options for leisure activities. Demands for Leisure Activities presented significantly positive effects on Lifestyles. Such a result also corresponded to the research outcomes of Chang (1995) and Chiang (2007).

In Demands for Leisure Activities, aged people in metropolis Taipei appeared the least perception on Entertainment (path coefficient .41, t=6.94) and Interpersonal Interaction (factor loadings .37, t=6.48). It was assumed that the elderly in Taipei City preceded leisure activities because they would like to be with family and friends and interact with them. They therefore presented the most perception on entertainment and Interpersonal Interaction. On the contrary, aged people in metropolis Taipei had reduced the living pressure when retiring that psychological perception was the least. Correlation Analysis of Lifestyles toward Impediments to Leisure Activities

The research outcomes showed the positive effects of Lifestyles on Impediments to Leisure Activities that the hypothesis H2 was supported. With further analyses, aged people in metropolis


Taipei presented the most perception on Self-Impediments (factor loadings .48, t=8.00) in Impediments to Leisure Activities, but the least on Activity Impediments (factor loadings .38, t=7.06). It was assumed that aged people in metropolis Taipei might be hindered Demands for leisure activities because of the past experiences in leisure activities, individual personality, or being introverted. They therefore appeared the most perception on Self-Impediments. Moreover, a lot of leisure sites (parks or sports centers for citizens) have been built in Taipei metropolitan in recent years. The facilities and environmental security have been largely emphasized that aged people in metropolis could precede leisure activities in such secure environments. The perception of impediments to activities was therefore reduced.

Aged people in metropolis Taipei displayed the most perception on Ego-styles (factor loadings .48) in Lifestyles, and the least on Lifestyles (factor loadings .38, t=6.99). Such results were different from the research outcomes of Lin (1994), Chang (1995), and Chiang (2007), possibly because aged people in metropolis Taipei perceived the most of Ego-styles as they were affected the participation in leisure activities by individual personality, interests, and mood. Besides, senior citizens aged 65 and above in metropolis Taipei might have retired or prepare for retirement that personal affairs were reduced and free time was increased. They therefore had more time and options for leisure activities that they had the least perception on Lifestyles. Correlation Analysis of Leisure Demands toward Impediments to Leisure Activities

The research outcomes did not show significant correlations between living demands and Impediments to Leisure Activities that the hypothesis H3 was not supported. With further analyses, the full model fit was within the acceptable range that it presented certain explanations. From the model path in Fig. 2, Impediments to Leisure Activities revealed remarkably negative effects on Demands for Leisure Activities. The result corresponded to the viewpoint of Crawford et al. (1991) and Siegenthaler & O’Dell (2000) that the increase of Impediments to Leisure Activities would affect individual motivation and Demands for leisure activities. For aged people, it also corresponded to the idea of Chen (1995) and Chang & Kao (2001) that aged people’s demands for activities was closely related to live impediments. Impediments to Leisure Activities therefore appeared negative effects on Demands for Leisure Activities of aged people. Besides, the significantly negative effects of Impediments to Leisure Activities on Lifestyles corresponded to the research outcomes of Hsu (2002) and Kao (2004).

CONCLUSIONS AND SUGGESTIONS Conclusions

This study mainly contributed to proposing the lifestyles and leisure model for aged people in metropolis Taipei and to verifying the relations among Leisure Demands, Impediments to Leisure Activities, and Lifestyles with Structural Equation Modeling. The research outcomes showed that aged people’s lifestyles and leisure model in metropolis Taipei achieved fitness. Besides, composite reliability, convergent validity, and discriminate validity for testing the reliability and validity also achieved certain standard that the questionnaire was reliable and could effectively measure Demands for Leisure Activities, Impediments to Leisure Activities, and Lifestyles of aged people in metropolis Taipei and the relations. From the structural model of aged people’s Lifestyles and leisure in metropolis Taipei, Lifestyles would affect Demands for Leisure Activities but negatively affect Impediments to Leisure Activities of aged people in metropolis Taipei. As a consequence, Lifestyles of senior citizens in metropolis Taipei should be promoted for constructing and developing Cloud Database for the leisure activities and the indicators. Suggestions

From the research, it was found that the pursuit of psychological satisfaction and stable emotion were the essentials for individual life, in addition to physiological satisfaction. Psychological satisfaction and stable emotion refer to the interpersonal interactions of an individual with the society, family, work, and living. Aged people appear the same. In the research findings, metropolitan aged people presented high self-awareness that they focused a lot on themselves. It was assumed that the rapid development of metropolis caused the change of social organizations, family, and environmental styles that more live impediments were generated from the environmental change, influencing the behavioral model of aged people. For this reason, relative units should pay attention to Leisure Impediments and Lifestyles of aged people and enhance the application Cloud Database for leisure activities and the standard of behavioral algorithm when planning relevant leisure policies, strategies, and activities for metropolitan aged people and constructing Cloud Database for aged people’s leisure activities in metropolis Taipei. The following suggestions are further proposed.

Widely establish investigation organizations for aged people’s leisure and master in the leisure environment and lifestyles of metropolitan aged people. The proportion of ageing population is increasing that it has become an important concern for the relative sectors. According to the data in administrative organizations and international organizations, the development Cloud Database for aged people’s leisure activities has become a


trend that investigation organizations for aged people’s leisure could be widely established in order to promote the leisure skills, application capabilities, and environmental construction of metropolitan aged people. Moreover, mastering in the lifestyles of aged people could reduce life impediments, promote leisure participation, enhance wellness, and finally achieve the objective of constructing Cloud Database for aged people’s leisure activities. Increase the experts in the application of Information Technology for aged people’s leisure, and promote the overall development of metropolitan aged people. The professional courses, instructional services, and relative development of Information Technology application for aged people’s leisure depend on the investment and development of the experts to enhance the development and learning of Information Technology. Universities of the Third Age in France establish the relevant information instructions to cultivate the talents; Universities of Technology in Japan promote and train the relevant professional talents; and experts in different fields in UK collaboratively develop relative training courses. Accordingly, domestic policies and regulations in the application of Information Technology for aged people’s leisure should be actively developed so as to enhance the quality of life of metropolitan aged people and the demands for social policies. Establish standard courses for aged people’s leisure education to enhance the leisure skills and knowledge of metropolitan aged people. According to international journals of elderly education (Journal of Aging and Physical Activity, Age and Aging, Canadian Journal on Aging, Indian Journal of Gerontology), courses in leisure education for senior citizens aim to enhance individuals acquiring the best strategies of leisure skills and knowledge, to learn new knowledge, travel learning, service orientation, exploration courses, and health courses from leisure, to guide aged people to high quality of life and life quality, to reduce leisure impediments, and to promote the motivation, opportunities, and demands for leisure participation. Domestic leisure education organizations should have strategic alliance with international elderly organizations to promote leisure education. Ageing is a trend in the society. Particularly, Taiwan and Republic of Portugal are the last two countries who have not stopped the ageing speed. In this case, domestic Information Technology organizations for aged people’s leisure should actively cooperate with international associations of senior citizens, international alliance of the elderly, and European learning network for senior citizens, enhance the cooperative plans and exchange, and research and develop more Information Technology policies and strategies for aged people’s leisure so as to promote the application Cloud Database for leisure activities and to correspond to the quality of life of aged people.

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