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CIMA Financial Management

Would the Balanced Scorecard have helped?

Miss Archchana Vekneswaran - 12501207

Individual Assignment Accounting and Management Control Systems


Date of Submission: 4th March, 2013

Submitted in partial fulfillment for the degree of Bachelor of Arts (Hons) Sustainable Performance Management

Word Count: 2193

CIMA Financial Management | March 2013

Would the Balanced Scorecard have helped?


By: Archchana Vekneswaran

Balanced Scorecard - one of the versatile models could have helped the global organizations
such as HSBC and Barclays to avoid recent scandals and to drive towards corporate targets with enhanced controls and sustainable performance management solutions.

Overview

ue to significant changes in technology and product proliferation (Wongrassamme et al, 2003, p.14), companies started to evolve from being domestic to multinationals and into

global corporations (Dyment, 1987, p.20). During this process they had to find ways to achieve sustainable competitive advantages in the volatile market by establishing proactive internal controls and continuous performance improvements to suit the changes in each strategic business units across national borders to match the global strategy (Wongrassamme et al, 2003, Lee & Colbert, 1997 and Dyment, 1987). BBC (2012) reported that a number of scandals have engulfed the global financial system and various banking institutions are under investigations and scrutiny by regulators. As Merchant & Van der Stede (2007, p.3) and Dyment (1987, p.20) argue, failed management controls could bring in collateral damages like reputation risks and bankruptcy. Therefore companies had to invest in methods which could provide higher return on investment (Ghalayini and Noble, 1990 cited in Wongrassamme et al, 2003, p.14). One such model is Kaplan and Nortons Balanced Scorecard (BSC) which celebrates its 20th anniversary. The following article discusses about the model and the part it could have played in mitigating recent banking scandals.

Balanced Scorecard Model


In their multi company study in 90s, Kaplan and Norton introduced balanced perspective to performance management by introducing their popular model BSC (Fig 1 & 2) for the companies of the information age (Kaplan and Norton, 2001, p.2) where performance could be measured through leading and lagging indicators. They argued that focusing mainly on financial targets was encouraging

short termism while hindering the future earning potential of those companies hence becoming obsolete (Kaplan and Norton, 2001, p.2). Furthermore, they stated that by having a balanced view would provide instrumentation to achieve competitive advantage and thereby navigate towards strategic objectives (Kaplan and Norton, 2001, p.3).
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Figure 1: Balanced Scorecard Model Source: Kaplan and Norton (1992, p.9) cited in Google Images (2012)

Figure 2: Critical Dimensions of BSC Source: Kaplan and Norton (1994) cited in Davies (2007, p.2)

The BSC model is being used by 70% of the companies worldwide (Hickman, 2012) including 50% of fortune 1000 firms (Davies, 2007, p.1). According to Hickman (2012), The key to its longevity and popularity has been its ability to adapt and provide solutions to changes in the broader economy. However, the benefits could only be achieved on the basis of what is it used for, how well are they designed and how well were they been applied into the business (2GC Limited, 2008, p.2). Global firms find it difficult to implement sound internal control and performance measures. Such issues and how BSC could address these issues are discussed below.
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Difficulties in establishing effective controls and performance management in global organizations


Maznevski et al (2007) exhibited four main complexities that lead to these control PM issues in global firms: Diversity

Global organization such as HSBC and Barclays face diversity from internal and external sources where the management finds it difficult to manage each business unit in the similar way. From the internal perspective, due to internationalization management of HR pool has to be unique (Maznevski et al., 2007, p.1). Moreover, the ways in which each business unit achieves it financial or corporate targets are different. There could be complexities in integrating managing different management systems. External environment imposes diversity in terms of heterogenic customer requirements and variation on stakeholder claims, diverse political, legal and technological environment and varying degrees of competitor strategies (Maznevski et al., 2007, p.1). Devising management controls while absorbing the diversities is difficult and the factors are volatile in nature. Interdependence

When the companies operate across borders interdependence increases to a greater extent where each and every aspect of the business becomes related (Maznevski et al., 2007, p.2). Value webs have replaced the value chains and other aspects of the business such as reputation, financial flow, top management and corporate governance issues have reached their maximum while erasing the boundaries of a company (Maznevski et al., 2007, p.2). Furthermore these issues increase the reliance on each other and exposed companies such as HSBC to issues on frictions, negative trends, loss in share price etc imposing difficulties in managing the companies in effective manner (Maznevski et al., 2007, p.2.). Ambiguity

Maznevski et al (2007, p.2) says The business world today is characterized by too much information with less clarity on how to interpret and apply insights. Diversity in financial standards along with studies surveys, scenarios etc. becoming less reliable due to volatile business world, made the numeric figures and business forecasts ambiguous due to uncertainties (Maznevski et al., 2007, p.2.). It is also found that many companies find it difficult to identify the
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CIMA Financial Management | March 2013

core value drivers of their existence making the cause effect relationships less useful (Maznevski et al., 2007, p.2.). Flux

If the managers find ways to resolve above issues, the situation of business could change on the very next day where the solution becomes outdated (Maznevski et al., 2007, p.2.). Companies have to have ongoing monitoring process to continuously devise strategies to match the existing control gap in organizations. Lack of credibility

Supervisors of global workforce find it difficult to monitor all the staff to measure the performance. Lack of knowledge, expertise, and understanding of the global context and poor credibility of the feedback has diluted the effectiveness of PM (Rowley and Poon, 2009, p.1). Furthermore, employees have to report to various superiors such as headquarters, country manager, regional manager etc. has increased the challenges (Rowley and Poon, 2009, p.1). Standardization of PM and national culture in workplace

Many organizations tries to standardize the PM systems across countries where the effectiveness could be influenced by factors such as cultural differences, institutional isomorphism, global integration V global adaptation, risk attitude etc. which questions the effectiveness of standardized PM solutions (Rowley and Poon, 2009, p.2). Above factors form the reasons behind why an effective control and PM system couldnt be established in global organizations like recent banking scandals. Could BSC have help to manage the above issues while avoiding the scandals if it was implemented in the above banks? The following section analyses tries to answer the above question.

Recent Banking Scandals and Failed Controls A Recap


Money Laundering and Terrorist Financing HSBC The global banking giant HSBC is operating since 1865, with 89 million customers across 85 countries (Dailymail, 2012). Today, a bank with such a long history has failed to maintain sufficient Anti Money Laundering (AML) controls indicating insufficient awareness over the ethical and lawful transactions (HK company law blog, 2013).
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As per the Homeland Securities and Government Affairs (2012), HSBC compliance culture has been pervasively polluted for a long time and analysts propose that HSBC is too large to manage in an effective manner (HK company law blog, 2013). The US Senate Committee reports that HSBC was guilty on following grounds:

Figure 3 : HSBC Scandals Source: Compiled by Author based on US Senate Committee Repot (2012)

Due to above scandals HSBC was imposed with fines worth $2 billion, and a downgrade on standards and poor outlook (BBC, 2012). It should be noted that having a proper AML program incorporating AML internal controls, AML compliance officer, AML training and independent testing on the AML programs effectiveness would have prevented the bank from facing legal consequences (US Senate, 2012). Financial Crisis Inquiry Commission (FCIC) strongly believes that the crisis was mainly due to human mistakes, misjudgments and misdeeds that resulted in systemic failures (Sathye, 2012).

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Manipulation of LIBOR Barclays With over 300 years of history of banking (Barclays, 2012), Barclays was one of worlds renowned brands of all time. However, the corporate image was tarnished by consequences of recent LIBOR rate rigging scandal and socked with $453 million to UK and USA regulators (Business times, 2012). It was proved that the bank was involved in producing false reports to manipulate the interest rate (LIBOR) to increase its profits in collusion with some other top banking firms (Business times, 2012). LIBOR rate was used to set transactions worth $300 trillion (BBC, 2012). Hence, the rate should have been backed by hard data on market factors instead of falsified assumptions. But poor accountability

framework of Barclays lead the traders find loopholes in the systems and to fix the rates in
Figure 4: Barclays LIBOR rate rigging Source: Bloomberg cited in BBC (2012)

collusion with traders of other banks (Financial times, 2012) during 2008 at the verge of

financial crisis (Fig 4). The governor of Bank of England says, The idea that one can base the future calculation of LIBOR on the idea that 'my word is my LIBOR' is now dead (BBC, 2012) as regulators have restored rigid monitoring process over banks.

BSC Would it have helped to address these challenges?


BSC would have definitely helped to mitigate most of the control and performance measures related issues and thrive toward long term sustainability in the markets in which they operate. Initially author wishes to highlight how BSC could have addressed the challenges mentioned above in implementing sound internal control and performance management solutions in global firms.

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Diversity Management (DM)

According to Schmidt (2012), DM involves the consideration and appreciation of diversity as well as the active use and promotion of diversity to increase the economic success. This helps to match the differences and similarities in terms of strategic objectives of the company. Inclusion of diversity in mission statement was highly appreciated by global work force and has resulted in reduced absenteeism motivation and productivity (Schmidt, 2012). Few questions that could become BSC controls related to DM are as follows (Schmidt, 2012): Financial perspective: What are the costs of non- introduction of DM measures? Customer perspective: How many diverse customer groups does the company serve? Process perspective: What % does diversity contributes in profit generation and cost cutting? Staff and innovation perspective: How diversity has improved the productivity? How many new innovations were proposed by diverse work teams? Proactive promotions and cultural diversity appreciation has improved the learning and sharing among heterogeneous groups and lead to innovations (Schmidt, 2012). It has helped many global firms to address complex problems. But BSC alone would not ensure diversity but it should be jointly used with other comprehensive DM models such as outcome mapping (Schmidt, 2012). Internal Benchmarking (IB)

It is identified that interdependence of business units has imposed significant challenges. One best way in which BSC could help global firms to resolve the challenge is by carrying out internal benchmarking practices where one subsidiary in one destination is compared against the best subsidiary of the specific global company. This balanced review on performance would highlight the issues in subsidiaries and would help to decide solutions to be implemented to reduce or avoid the existing issue in the subsidiary. For example, banking industry in Sri Lanka is heavily regulated and monitored by Central Bank of Sri Lanka. So, HSBC USA could benchmark its statutory controls against HSBC Sri Lanka. Addressing ambiguity and flux

BSC could be implemented along with IT solutions which could be regularly updated with external environment factors which could affect the performance of the global company. In this way BSC could have helped to endure that the information is up to date and makes the forecasts,
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controls and PM more reliable and less ambiguous. This BSC model could help to arrive at cause and effect relationships which would help to identify the issues behind BSC perspectives and to make informed decisions based on reliable sources. Better PM feedback and learning

BSC helps the top level managers to identify how they could address the challenges enforced by external environment. If a company couldnt achieve its established targets then BSC requires top management to look in the organizations resources and capabilities and establish necessary measures to suit the new strategies. This process would act as a feedback loop to support decision making at all levels (Procurement Executives Association, n.d). It is essential to be noted that HSBC was using BSC to measure the performance of the senior management says HSBC sustainability report 2007 which is known as an executive BSC which is only a part of establishing a complete BSC program (Creamer and Freund, 2010, p.366). However BSC program was not in place at Barclays. BSC could have helped in following ways in avoiding banking scandals: Positive change in management focus HSBC and Barclays evaded most of the mandatory regulatory requirements due to short term focus of the management to earn quick profits. Bruce (2012, p.18) states that corporate leaders like a politician, see them in power for a shorter period of time and tries to focus on initiatives that gives short term profits rather than sustainable longer term profitability. BSC encourages management to switch focus on long term strategic objectives rather than shorter time horizon. BSC has strategy at its core and could have helped the banks to focus on future rather than today. Establishment of performance culture A common criticism over the banking scandals is that the corporate culture is polluted to a greater extent. BSC would support the management to enhance a strategy oriented performance culture throughout its operations. Treanor (2004) says that banks could deploy diverse rewards systems whereas sales were the only angle of HSBC. When BSC implemented,
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The beauty of BSC is that the act of measurement forces somewhat vague and ambiguous concepts such as culture to be defined precisely Kaplan and Norton (2004)

CIMA Financial Management | March 2013

US and European subsidiaries would change their focus to other strategic indicators their respective business (Mooraj et al, 1999, p.483) rather than short term preferences. This attitude could have been changed by performance driven culture imposed by BSC. Due to the switch in culture, the attitude towards innovation, collaboration and teamwork, rewards and incentives, risk attitudes etc would change favourably and align employee performance to strategy of the banks. Enhanced performance management BSC would have helped to move from performance measurement to performance management (Procurement Executives Association, n.d). Senior management would get involved in the process of developing PM systems which are linked to companys achievement of four key perspectives as per BSC and strategy at the end. Employees would get better understanding on what they should and should not do to reach the set targets. Employees who reached the target could be awarded with monitory or non-monitory rewards as token of appreciation. By this the rewards would be aligned to the overall strategy of the banks. BSC would also improve the accountability of the staff as they gain a sense of ownership when individual attainment of target helps the organization in achieving the corporate targets. However, the individual should have required skills and should be given with necessary authority to perform their targets to remain accountable. In the context of HSBC, certain compliance division consisted of inexperienced divisional heads and staff without authorities to handle their duties (US Senate, 2012) which indicate that HR policies should be adjusted first to reap the benefits of accountability. Better control environment Both companies under review has suffered poor control environment as indicated by the failed controls. BSC consists of 3 control mechanisms which help the management to keep track of the day to day operation of the banks as indicated in Fig 5 below. Interactive control systems enable the management to conduct 3600 feedback control over the activities and to interact with the related parties such as customers and staff to ensure controls are in place and to make necessary changes (Mooraj et al., 1999, p.486). If this was in place HSBC could have avoided terrorist financing activities and Barclays could have mitigated risks of falsified reports used for rate rigging.
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Diagnosis lagging controls would have helped to trace whether necessary objectives were reached as expected without any irregularities. This might have helped to trace financing activities from Mexican HSBC and analyze into sources to avoid money laundering. Boundary controls ensures that all the employees are very familiar with the intended objectives and vision of the banks which could have eliminated the sub optimization due to selfinterest prioritized over the companys strategies especially in the case of Barclays wh ere traders acted in misconduct to raise their bonuses through rate rigging mechanisms.

Figure 5: Control systems of BSC Adopted from Mooraj et al (1999, p.486)

Key Performance Indicators (KPI) and internal audit BSC could act as a system to generate key performance indicators and ratios while balancing the four perspectives of corporate strategy (Kagermann et al, 2008, p.527). In this case BSC would assist in developing KPIs relating to AML controls and other general banking initiatives. It was found that HSBC has AML issues in terms of dysfunctional systems, 17,000 unattended risk alerts, inadequate staffing in compliance division, improper risk assessment techniques and lost suspicious activity reports (US Senate, 2012). In that case, learning and growth perspective would help to attain long term organisational growth through three sources such as people, systems and procedures (Business Excellence, 2013). To overcome AML deficiencies re-skilling of employees, investing in IT solutions and improving the organisational procedures would have helped to close the gaps in controls (Business Excellence, 2013).
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Criteria Staff training

Indicator Amount of training on AML No

KPI of

Description

training This is a legal requirement

sessions

Compliance

Reports to authorities

No of reports

Preparation authorities prosecution

of and

reports reports

to

governing leading to

Management of AML effectiveness

Comparison of Number of updates Qualitative reports and numeric assessments AML controls and checking on has to be conducted AML effectiveness
Table 1: KPIs for AML controls Source: Adopted from Schoenbein et al (2001)

per reqirement

Due to comprehensive nature and integration of qualitative measures, BSC could accelerate KPI based internal audit (Kagermann et al, 2008, p.528). Internal audit is one of the statutory requirements for any registered company which indicates that KPI based internal control issues could have been tracked in the case of banking scandals. Enhanced risk management It is visible that poor risk management in the organizations has also lead the companies towards legal consequences due to events such as negligence of alerts, knowingly producing false reports, poor client checks which lead to drug money laundering disputes and evading laws and regulations etc. BSC would have helped the top management to develop strategic maps where each input, process and outcomes of every move of the company is clearly defined (Frigo, 2012, p.52). Then the management could be able to identify strategic risks associated with each and every component after which these risks elements could be placed in a 2X2 risk map by giving scale based on likelihood and severity (Frigo, 2012, p.53). By this management could identify and devise plans to mitigate the risks. The above control could have enhanced the control environment of the banks under review and would have satisfied one of the requirements of Sarbanes Oxley Act USA by ensuring a sound control environment which would have mitigated certain control issues.

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BSC as a self-diagnosis tool accompanied by strategic maps treats risk management as senior managements responsibility rather than compartmentalizing risk areas into functional categories (Frigo, 2012, p.53). This practice would have enhanced comprehensive integrated process of risk management process (Frigo, 2012, p.53) across the organization and to establish sophisticated risk control to avoid irregularities and to protect the corporate reputation.

Benefits vs. Limitations of BSC


Some additional benefits of adopting BSC as control and performance measurement tool are discussed below: BSC requires active involvement of the users throughout its designing process which makes the framework more comprehensive (2GC Limited, 2008, p.2) thus would improve stakeholder confidence due to transparency in reporting and would also improve the corporate governance dimension (BSC Institute, 2012, p.1). Due to immense competition in todays business world, it is essential for a company to focus and invest in intangible intellectual sources such as research and development, IT technology, branding and persuasive marketing initiatives (Pandey, 2005, p.64). As BSCs leading indicators provide logic to achieve these intellectual assets it would help the banks drive towards the future and sustain in their respective markets (Pandey, 2005, p.65). BSC links three leading indicators which are hard to manipulate due to intangible nature and day to day monitoring hels to avoid window dressing. Having analyzed the benefits of the model, it should also be noted that the model consists of certain limitations which has to be considered. 1. Requires change management BSC implementation process is a transformational change initiative where long term commitment has to be required in terms of generating metrics to measure performance. Employees have to be educated and should be trained to adapt to BSC environment. This is timely and expensive (Murphy and Gould, 2005, p.24). Employee resistance to such significant change by which their performance are going to monitored, conflicts within the organizations which might end up conflict of interest dilemma.

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2. Key personnel change would question the sustainability BSC requires significant involvement from the top management when implementing and reporting the findings. Key personnel would also determine underlying principle and how the performance is going to be managed (Murphy and Gould, 2005, p.25). If there are any changes in the top management, BSC initiatives can falter if the new management has totally different view on performance evaluation. So it is essential to ensure that the new management is not deviating from companys original initiatives towards BSC (Murphy and Gould, 2005, p.25). 3. Inward Focused It should also be noted that inward focused measure (Murphy and Gould, 2005, p.26). It avoids integrating changes in the external environment such as in SWOT or PESTEL measures. 4. Difficulties in establishing linkages Another criticism on the BSC is that it is difficult to establish linkages between the four perspectives put forward by Kaplan and Norton (Murphy and Gould, 2005, p.25). There could be unidentified time lags between the actions taken and results generated while trying to create linkage between financial and non-financial measures and this would be pointless when devising decisions (Murphy and Gould, 2005, p. 25). 5. Other limitations Most organizations try to implement BSC simply because their competitors are doing it. This would erode the popularity of the model because every company is unique and requires well built in performance metrics. Furthermore, if departments (marketing, HR etc.) are allowed to devise their own BSC measures based on what they know well it would lead to lack of goal congruence as the measures would not lead the overall company towards the corporate strategy but only the departments to reach individual targets. It is evident that BSC could act as a useful tool if carefully devised. However, global firms face tremendous pressures and complexities in implementing such sound measures to control the performance and to keep the company on the path to reach the corporate objective.

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Recommendations
In order to attain the benefits from BSC author recommends global firms to adapt to risk based IT driven BSC systems in their operations. This BSC is also known as 4th generation BSC (Tomura, 2006) which integrates internal control requirements per regulations such as Sarbanes Oxley Act in USA, with risk elements by operating on IT platform (Fig 6). As discussed above BSC would be a solution for most of the control and performance management concern of global firms.

Figure 6: 4th Generation Balances Score Card Source: Tomura (2006)

As per the above diagram, the integration of internal control and risk would help the global organizations to address statutory as well as internal requirements where as usual BSC itself helps to reach PM targets. KRI and KCI could be established with owners and could act as an effective tool in internal audit programs and to trace the accountability of any failed control. This could also act as an effective communication medium with stakeholders to ensure that company has been undertaking regular internal control reviews which enhance transparency (Tomura, 2006). Integration of risk aspects to the traditional BSC would enhance the detection and rectification of risk due to the use of IT software (Tomura, 2006). Preventive measures taken

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to control the irregularities would lead to Kaizen for the next period due to step by step improvement in organisational performance (Tomura, 2006). It should be noted that in order reach the benefits of successful BSC there are certain prerequisites that the global firms should consider. Initially the top management should have wide knowledge on the reason why they are implementing BSC and they should be committed throughout the process (Pandey, 2005, p.63). This would act as a cultural control where the management gives the impression that it is committed for better performance. Next the companies should be able to identify what are the critical success factors (CSF) that drive the organizations success and clearly define metrics to suit each factor (Pandey, 2005). A best example could be Toyota which drives through quality in each of its operations (Maznevski et al., 2007, p.4). Companies should also have a sophisticated tracking system to measure the performance and to enhance controls. If these prerequisites were met implementing BSC would drive the company towards success. As global companies are subject to complexities due to borderless operations, author recommends if possible the management structure could be decentralized to a certain extent where the country managers would have the autonomy to devise BSC measures that best suits the nations conditions while countrys managers performance could be measured by regional headquarters. In the case of Barclays and HSBC, quick profit motive has hindered the performance of the companies. As per Tilley (2012, p.65), individual bonuses should be paid in equities and placed into their pensions.. Executive incentive schemes that encouraged excessive risk taking and short term gains directly contributed to the economic crisis. It is essential that the remuneration packages should be linked performance based on BSC to avoid short termism (Pandey, 2005, p.63). Apart from the additions to the conventional BSC model, global firms and especially the banks should give more attention towards their recruitment policies. This is because in order maintain good code of conduct and performance culture exceptional professionalism is required. Even a very sound control could be evaded by collusion between individuals or institutions such as in the case of rate rigging scandal where Barclays collided with several other firms to manipulate the LIBOR rate. However, Barclays has decided to recruit based on good citizenship tests and decided to redesign their compensation policies by basing them on BSC where
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performance would be measured through reputation and business conduct test and client satisfaction ratings (telegraph, 2012). This should be welcomed and sustained in future. Individuals should also be given necessary authority to be accountable for their duties. Failed controls in the banking scandals were due to intentional fraudulent activities. In order overcome this, anti fraud culture should be promoted with sound anti-fraud controls such as segregation of duties, authorization, physical controls etc. These measures could also be integrated into BSC framework and could be monitored on a daily basis. It should also be encouraged to nurture whistleblowers to fight irregularities by rewarding them appropriately (Bartram, 2012, p.36). Mystery shoppers could also be established confidentially to check the vigilance of the front end officers. However, it is worth mentioning that the regulatory bodies were not efficient and vigilant enough to track the loopholes in their operations and regulations. So, the governments of respective countries should carryout robust restructuring to their usual monitoring process to avoid any further scandals and financial crisis which has a chain effect on all over the world.

Conclusion
As per Treanor (2012), "Capital requirements, loan ratios, buffers, and ring-fencing are important but not sufficient to restore confidence in our banking system. We also need a fresh approach from the banks themselves. One such reform is BSC which ensure sound internal controls aimed at long term corporate targets and performance measures. It was identified that this 20 year old model holds greater insights which with slight modifications could be adopted by any firm to retain its market position. It would have definitely been able to play a vital role in avoiding certain global banking scandal issues.

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AMCS Unit Assessment - MMU