Chinese Busssines Review

Chinese Business Review
Volume 10, Number 11, November 2011 (Serial Number 101)
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Chinese
Business Review
Volume 10, Number 11, November 2011 (Serial Number 101)
Contents
Financial Forum
Effectiveness of the Global Banking System in 2010: A Data Envelopment Analysis Approach 961
Ngo Dang-Thanh
Application of Pareto Distribution in Wage Models 974
Diana Bílková
The Chaotic Monopoly Price Growth Model 985
Vesna D. Jablanovic
Marketing
Analysis of the Relationship Between Perceived Security and Customer
Trust and Loyalty in Online Shopping 990
Nihan Özgüven
Industrial Economics
Growth Potential and Profitability Analysis of Insurance Companies in the Republic of Serbia 998
Dragana Ikonić, Nina Arsić, Snežana Milošević
Regional Economics
Sustainable Consumption and Production in the Baltic Sea Region 1009
Janis Brizga, Dzintra Atstaja, Dzineta Dimante
Enterprise Management
Motifs and Impediments for the Harmonization of Accounting Regulations
for Small and Medium-Sized Companies in the EU 1021
Tamara Cirkveni
Change of Management Values in Estonian Business Life in 2007-2009 1028
Anu Virovere, Mari Meel, Eneken Titov
Public Economics
The Impact of Tax Policies on Taxpayers Budget in Terms of Risk, Sensitivity and Volatility 1043
Boloş Marcel Ioan, Otgon Cristian Ioan, Pop Răzvan Valentin
Interactions Between Knowledge Sharing and Organizational Citizenship Behavior 1061
Yavuz Demirel, Zeliha Seçkin, Mehmet Faruk Özçınar
Social Economics
Enhancing Organization’s Performance Through Effective Vision and Mission 1071
Ben E. Akpoyomare Oghojafor, Olufemi O. Olayemi, Patrick S. Okonji, James. U. Okolie
Determinants of Female Employment Rate in the European Union 1076
Irena Spasenoska, Merale Fetahu-Vehapi
Chinese Business Review, ISSN 1537-1506
November 2011, Vol. 10, No. 11, 961-973
Effectiveness of the Global Banking System in 2010:

A Data Envelopment Analysis Approach∗
Ngo Dang-Thanh
University of Economics and Business (Vietnam National University), Hanoi, Vietnam
Massey University, Palmerston North, New Zealand
The current crisis has revealed the weaknesses of the global financial in general and its banking system in particular,
and puts forward a requirement for assessing the effectiveness and stability of the banking sectors across countries.
Based on available data from 64 countries over the world, the author tried to evaluate the effectiveness of the
banking sectors in those countries through the view point of the data envelopment analysis approach to define how
the global banking systems is under the effect of the current crisis. Findings from the research showed that banking
systems in advanced economies are still more effective than in developing countries. Moreover, it explained the
effect of the current financial crisis, the role of public finance (and the government), and the development of the
(privately) commercial banks to the effectiveness of the banking sectors. The research also explained some
determinants that can affect the effectiveness of the banking system, including inflation, bank concentration, and
level of economic development.
Keywords: data envelopment analysis, effectiveness, efficiency, banking, cross countries
Introduction
Because of the important role of the banking and financial system in the rapid development of new industrial
economies (NIEs) in the 1960s-1970s, there were renewed interests in the relationship between financial and
economic growth. Schumpeter (1911) argued that the role of financial intermediaries in savings mobilization,
projects evaluation and selection, risk management, entrepreneurs monitor, and facilitating transactions is
important to technological innovation and economic growth. Following this argument, many other leading
economists continuing emphasized the positively essential role of the financial sector in economic development,
including Goldsmith (1969), Shaw (1973), McKinnon (1973), King and Levine (1993a, 1993b).
Banks are the core of the financial system. They accept deposits from savers and lend them to borrowers.
∗
Acknowledgement: The author would like to offer special thanks to Professor David Tripe at Centre for Banking studies,
Massey University, New Zealand for his supports, encouragement and useful comments. The author also thanks participants at the
18th Annual Global Finance Conference in Bangkok, Thailand, April 2011 for their constructive comments and feedback to
improve the quality of the paper. The usual disclaimer applies.
Ngo Dang-Thanh, Ph.D. candidate, Lecturer, Faculty of Political Economy, University of Economics and Business (Vietnam
National University), Centre for Banking Studies, Massey University.
Correspondence concerning this article should be addressed to Ngo Dang-Thanh, Faculty of Political Economy, University of
Economics and Business (Vietnam National University). E-mail: ndthanhf@yahoo.com.
962 EFFECTIVENESS OF THE GLOBAL BANKING SYSTEM IN 2010
They hold liquid reserves which allowing predictable withdrawal demand. They issue liabilities which are more
liquid than the deposits. They also reduce (or some times eliminate) the need of self-finance (Bencivenga &
Smith, 1991, p. 195). Banks hold an important role within the financial system, and to some certain level,
researching the banking system therefore means researching the financial system.
Started from the bankruptcy of the Northern Rock Bank in the UK (2008, February), however, the global
financial crisis and its heavily impacts have put researchers and policy makers under the requirement of
re-assessment and re-evaluation the stability and performance of the global financial and banking system1.
A firm is effective when it reaches its target outputs. Similarly, a banking system is defined as effectiveness
if it can fulfill its missions of providing banking services and monitoring the stability of the system. Meanwhile,
if banking systems are set under similar conditions of macro- and micro-economic, the level of outcomes that a
banking system can provide (in term of services and stability) is indeed its efficiency. In this sense, the problem
of calculating effectiveness of banking systems all over the world becomes the problem of evaluating its
efficiency with a (dummy) similar and equal input. This research is trying to define the effectiveness of the global
banking system in 2010 through analysing cross-country data observed from 64 countries, using the data
envelopment analysis (DEA) approach. The remainder of this paper is organized as follows. Section 2 gives some
reviews on efficiency and effectiveness evaluation in the banking sector using DEA approach. Section 3 explains
the methodologies and technical will be applied in the research. Section 4 shows empirical results and section 5
concludes.
Literature Review
To evaluate the efficiency of a set of firms (or banks), the most popular approaches are ratio analysis,
parametric analysis and nonparametric analysis (the latter two methods belongs to the X-efficiency approach).
While ratio analysis focuses on ratios between two variables (of inputs or outputs) to define the productivity and
efficiency, X-efficiency analysis evaluates the efficiency of a bank through a multi-variables aspect.
DEA is a popular nonparametric method applied in evaluating efficiency in finance and banking area. After
Farrell (1957) laid the foundation for a new approach in evaluating efficiency and productivity at micro-level,
Charnes, Cooper and Rhodes (1978) and then Banker, Charnes and Cooper (1984) developed the CCR and
BCC-DEA model, respectively, to evaluate the (relative) efficiencies of the researched decision making units
(DMUs). Since then, DEA was increasingly applied in efficiency evaluation, especially in social sciences2.
There are a limited number of researches using DEA to examine banking performance at cross-country level.
A study in 1997 showed that out of 130 studies on banking performance and efficiency, only six were focused on
comparing the efficiency level of banking systems across countries (Berger & Humphrey, 1997, pp. 182-184). As
shown in Table 1, all three DEA studies were using small sample data at institutional (bank) level to define the
benchmark frontier, hence, the global banking system was left untouched.
In the 2000s, further studies which used common frontier approach were developed by add in the model
1
According to Science Direct, since 2010, there are more than 2,200 journal articles regarding banking performance after the
crisis of 2007-2008 (Retrieved December 20, 2010, from http://www.sciencedirect.com).
2
Recent study of Avkiran (2010) showed that there are more than 170 articles using DEA as a main methodology to analyse the
efficiency of banks and banks branches, including Sherman and Gold (1985), Peristiani (1997), Schaffnit, Rosen and Paradi
(1997), and Pastor, Knox Lovell and Tulkens (2006).
EFFECTIVENESS OF THE GLOBAL BANKING SYSTEM IN 2010 963
some environmental/controllable variables such as banking market conditions or market structure and regulation
(Kwan, 2003; Lozano-Vivas, Pastor, & Hasan, 2001; Maudos, Pastor, Perez, & Quesada, 2002; Sathye, 2005).
However, as they are also mainly focused on institutional level data while macro-environment is different from
country to country, they ignored that banks which are efficient in this country may not performance well if they
run as foreign-owned banks in other countries (Berger, 2007, p. 125). Hence, while trying to examine the whole
banking systems across countries, this study attempts to overcome the above problem.
Table 1
Studies on Banking Performance at Cross-Country Level (Prior to 1997)
Authors (date) Method used Countries included Institution
Berg, Forsund, Hjalmarsson, &
Data envelopment analysis Norway, Sweden, Finland Bank
Suominen (1993)
Fecher & Pestieau (1993) Distribution free approach 11 OECD countries Financial service
Bergendahl (1995) Mixed optimal strategy Norway, Sweden, Finland, Denmark Bank
Ruthenberg & Elias (1996) Thick frontier approach 15 developed countries Bank
Bukh, Berg, & Forsund (1995) Data envelopment analysis Norway, Sweden, Finland, Denmark Bank
J. Pastor, Perez, & Quesada (1997) Data envelopment analysis 08 developed countries Bank
Note. Source: Berger and Humphrey (1997).
As DEA evaluates the efficiency of each DMU based on the optimal multipliers (or weights) of inputs and
outputs factors, it allows us to examine the effectiveness of a banking system by looking at the achievements of
the banking sector, including both quantity (assets, deposits, credits, etc.) and quality (overhead cost,
nonperforming loans, frequency of bank crises, etc.) factors of commercial banks in the economy3. They are
chosen following 122 variables represent the stability of the global financial system (WEF, 2010, Appendix A).
However, since DEA treats those factors dynamically (meaning each country can have its own preference on
them), to be understandable in evaluating and comparing the effectiveness of the banking systems between
countries, a common preference (or common set of weights) for the above analyzed factors is required. Therefore,
in this research, the DEA model will be divided into three stages, in which the first stage conducts a dynamic
DEA model (DSW model) to define the relatively efficiencies of the banking systems from these 64 countries;
the second stage examines the determinants affecting that efficiencies (Tobit model); and the third stage defines
the common set of weights for those analyzed factors (CSW model) in order to conduct the final banking
effectiveness scores.
Technical Methodologies
In the first step, DSW model is produced to calculate the maximum effectiveness scores that each country
can achieve with the observed (achievement) factors. Mahlberg and Obersteiner (2001) and Depotis (2004)
developed an input-oriented DEA-like model which treats all factors as outputs, while input is a dummy variable
(values equal to 1 for all countries). Therefore, the DSW model in this research is in fact a
constant-returns-to-scale (CRS) and input-oriented DEA model. For an evaluated country j0-th, its efficiency
score (DSWj0) can be expressed by the following non-negative linear problem:
3
It is important to notice that these factors are outcomes that a banking system is aiming for; hence, the DEA model in this paper
will use them all as output variables.
DSWj0 = max
∑u y
m mj 0
(1)
∑v x
k kj 0
Subject to:
∑u m ymj ≤ ∑ vk xkj , 1 ≤ j ≤ n
∑v x = 1
k kj
∑u = 1 m
um ≥ 0
xj = 1 {all original input values are assumed to be equal to 1}
where:
um: weight of m-th output factor;
vk: weight of k-th input factor;
xkj: k-th input of j-th country, k = 1;
ymj: m-th output of j-th country;
n: number of countries;
m: number of factors.
Due to the fact that some countries can have the same scores in this DSW model, a super efficiency DEA
model (Zhu, 2001) is also ran to determine the ranking order of the researched countries, makes it easier to
compare the effectiveness’s of the banking systems between countries.
In the next step, a Tobit regression (for more details, see Tobin, 1958) is used to determine the factors
affecting the country’s banking efficiencies (Tobit model). Since the CSW scores are bounded between 0 to 1,
non-censored regression models could be biased (Fethi & Pasiouras, 2010), while Tobit regression is justify as in
equation (2). Variables used in this model are ones that mainly related to the financial efficient of a banking
system at micro-level and are expressed in Table 2.
EF = α + β1*CONC + β2*ROA + β3*ROE + β4*CIR + β5*INF
+ β6*CTA + β7*NIM + β8*CII + β9*GROUP (2)
Table 2
Variables of the Tobit Model
Variables Definition
EF CSW-DEA scores.
CONC Bank concentration (assets of three largest banks as a share of assets of all commercial banks).
ROA Bank’s average return on assets (Net income/Total assets).
ROE Bank’s average return on equity (Net income/Total equity).
CIR Bank’s cost to income ratio (Total costs as a share of total income of all commercial banks).
INF Inflation, consumer prices (annual %).
CTA Bank’s capital to assets ratio (ratio of bank capital and reserves to total assets).
NIM Net interest margin of banks (value of bank’s net interest revenue as a share of its interest-bearing assets).
Depth of credit information index (measures rules and practices affecting the coverage, scope and accessibility of
CII
credit information).
Dummy variable of income group (equals to 0 if country belongs to lower income, 1 if middle income, and 2 if high
GROUP
income group).
The last step is to define the optimal common set of weights which should be used for compare and ranking
countries based on their banking systems’ effectiveness. It is done by applying the CSW model. It is believed that
the efficient frontier found in the DSW model in the first step is the “best practice frontier” (Grosskopf &
Valdmanis, 1987; Schaffnit, Rosen, & Paradi, 1997); hence, the optimal common weight set will be the one that
get every countries’ performances closest to that frontier. There are several ways to define that common set of
weights is based on this idea. While imposing bounds for factor weights, Roll and Golany (1993) found out that
the common set of weights can be defined by maximizing the average efficiency of all DMUs or maximizing the
number of efficient DMUs. Kao and Hung (2005) applied a compromise solution approach to minimize the total
squared distances between the optimal objective values (found by DEA) and the common weighted values (found
by using common set of weights). Jahanshahloo, Memariani, Lotfi and Rezai (2005) applied the multiple
objective programming approach to simultaneously maximize the performance scores to get it closes to the “best
practice frontier”. Liu and Peng (2008) applied the common weights analysis to minimize the vertical and
horizontal virtual gaps between the benchmark line (slope equals to 1.0, or performance scores equal to 1.0) and
the coordinate of common weighted DMUs. In this paper, we modified the model of Kao and Hung (2005) into a
minimum distance efficiencies model, in which the common set of weights can be defined as the one minimizing
the total distances between optimal efficiencies (DSW scores) and common weighted scores (CSW scores) of all
DMUs, under the condition that each DMU’s efficiency cannot exceed its DSW efficiency4. To understand the
role of each factor in CSW scores, another condition was added where the total sum of weights is equal to 1 (or
100%). The country’s banking effectiveness scores will be constructed based on that CSW scores and findings
from the super efficiency DEA results in the previous step. This CSW model can be expressed as a
non-negatively linear problem as follows:
(
min ∑ e*j − e j ) (3)
Subject to:
e*j = DSWj
ej =
∑u ym mj
,1≤j≤n
∑v x k kj
e j ≤ e*j
∑v x = 1
k kj
∑u = 1 m
um ≥ 0.015
xj = 1 {all original input values are assumed to be equal to 1}
where:
um: weight of m-th factor;
ymj: m-th factor of j-th country;
4
This constrain makes these distances non-negative, hence, they can be used directly rather than the squared distances.
5
Mahlberg and Obersteiner (2001) found that restriction weights with lower bound of 0.01 steered a middle course between too
strong predetermination and too large flexibility.
n: number of countries;
m: number of factors.
The final effectiveness scores will then be calculated following this equation:
ES j = ∑u CSW
m ymj (4)
where:
ESj: Effectiveness score of country j-th;
umCSW: Common weight of factor m-th;
ymj: Value of factor m-th of country j-th.
Empirical Results
In the first stage, countries and factors are collected from the database of Beck, Demirgüç-Kunt and Levine
(2000), Laeven and Valencia (2010), the World Bank (World Development Indicator, Global Development
Financial, and Doing Business databases), the International Monetary Fund (IMF, 2010), the Consultative Group
to Assist the Poor (CGAP, 2010) and Annual Reports from Central Banks of such researched countries. Ten
factors6 are included in this research, covering both quantitative (the first 5 factors) and qualitative (the last 5
factors) aspect of the banking sectors (see Table 3). It is important to notice that the last 3 factors are undesirable
factors (as they have negative effect to the banking effectiveness), hence, they was transformed into desirable
ones through the linear monotone decreasing transformation method7.
Table 3
Descriptive Statistics of Factors
Standard Standard
Factors Mean Minimum Maximum
error deviation
Commercial banks’ assets/GDP 0.74 0.06 0.48 0.09 2.42
Domestic credit provided by banking sector (% of GDP) 80.21 8.74 69.92 -11.17 379.30
Commercial banks' deposits/GDP 0.60 0.04 0.36 0.12 1.80
Number of ATMs per 100,000 people 28.27 4.87 38.96 0.06 236.07
Number of branches per 100,000 people 11.47 1.23 9.86 0.53 45.60
Private credit bureau coverage (% of adults) 36.72 4.38 35.03 0 100
Public credit bureau coverage (% of adults) 8.24 1.60 12.76 0 48.50
Banks' overhead costs/Total assets 0.22 0.01 0.05 0 0.26
Nonperforming loans ratios of commercial banks 17.39 0.78 6.23 0 22.80
Frequency of banking crises 2.92 0.09 0.72 0 4.00
Note. Data of the last three variables are already transformed.
As mentioned in section 3, those factors will be treated as output variables, while a dummy-input (equals to
1) will be set for the whole 64 countries. The DSW model then produces an effective frontier built from 25
countries, while the other 39 are ineffective (see Appendix A Table A2).
Within the ineffective ones, none of them is developed countries, suggesting that the banking systems in
6
According to Dyson et al. (2001, p. 248) and Avkiran (2001, p. 68), one rule of thumb in using DEA is that the sample size has
to be at least 3 times bigger than the number of total inputs and outputs to overcome the discrimination problem. As we have 64
samples over 10 variables, hence, this research is justified.
7
In this method, the transformed values will be calculated by the difference between a proper translation vector w with the
original values of those undesirable factors. For more details, see Seiford and Zhu (2002) and Fare and Grosskopf (2004).
advanced economies still run better than in developing countries although they had to bear stronger effect from
the current crisis. This can be explained by the difference between projected values and original values of these
factors (in percentage of original values), in which the biggest differences are mainly for quantity factors, except
for the case of private credit bureau coverage. The results show that, major weaknesses of ineffective countries in
banking system development are the ATM network, bank deposits to GDP, private credit coverage, bank assets,
and bank’s domestic credits. Those are the disadvantage of developing countries as they are still on their way
developing their financial and banking systems (see Table 4).
Table 4
Differences Between Projected and Original Values for Inefficient Countries
Total differences
Factors
In value In percentage of original value
Commercial banks’ assets/GDP 21.72 45.56
Domestic credit provided by banking sector (% of GDP) 2,338 45.55
Commercial banks’ deposits/GDP 21.67 56.44
Number of ATMs per 100,000 people 1,373 75.88
Number of branches per 100,000 people 379.4 51.7
Private credit bureau coverage (% of adults) 1,230 52.34
Public credit bureau coverage (% of adults) 56.46 10.71
Banks’ overhead costs/Total assets 0.741 5.376
Nonperforming loans ratios of commercial banks 80.16 7.201
Frequency of banking crises 21.68 11.59
Average 552.3 36.24
In the second stage, the results from Tobit model show the relation between the banking systems’
effectiveness and various variables such as inflation level of the economy, income group that the country belongs
to, concentration of the banking system, etc., as summarized in Figure 1. It is obvious that higher inflation,
banking concentration, and bank’s cost-income ratio can reduce the effectiveness of the banking sector
(respectively significant at 1, 5 and 10 percent), while the high level of economic development (improving to
higher income group) can help increase the effectiveness of the banking system (5% significant level).
Figure 1. Determinants of the global banking effectiveness.

In the last stage, solving the non-linear problem of the CSW model (equation (3)) helped us defining a
common set weight for the ten factors of every country in the research (see Table 5). Noticeably, important
factors which strongly affect the performance of the banking sector in those countries are non-performing loans
ratio (79.49%), public credit bureau coverage (10.47%), and number of branches per 100,000 people (3.03%).
The other factors only keep minimum role (1% weight) in the final results. It shows that the effectiveness of the
banking sector is mainly affected by the damage of the global crisis, the (financial) public policy of the
government, and the development of the commercial bank system of each country respectively. It also suggests
that the quality of the banking sector is now becoming more important than the quantity aspect, not only for
countries with developed banking systems but for developing countries as well. Thus, country which focuses on
improving the quality of its banking sector can have higher effectiveness and is more stable.
Table 5
Common Set of Weights for the Effectiveness Scores
Factors Weight
Commercial banks’ assets/GDP 1.00
Domestic credit provided by banking sector (% of GDP) 1.00
Commercial banks’ deposits/GDP 1.00
Number of ATMs per 100,000 people 1.00
Number of branches per 100,000 people 3.03
Private credit bureau coverage (% of adults) 1.00
Public credit bureau coverage (% of adults) 10.47
Banks’ overhead costs/Total assets 1.00
Nonperforming loans ratios of commercial banks 79.49
Frequency of banking crises 1.00
By applying this common set of weights, the effectiveness scores of country’s banking systems can be
calculated and countries can be ranked as in Table 6. Since non-performing loans ratio became the most
important factor, countries having problems with NPLs became less efficient and ranked bottom in the list,
including even Denmark and New Zealand.
Table 6
The Global Banking Effectiveness in 2010
Rank Country Effectiveness score Rank Country Effectiveness score
1 Japan 23.231 33 Kuwait 17.606
2 Canada 23.231 34 Venezuela, RB 17.556
3 Chile 23.231 35 Moldova 17.504
4 Malaysia 22.275 36 Lithuania 17.394
5 Australia 22.177 37 Bolivia 17.333
6 Switzerland 22.079 38 Croatia 17.307
7 United States 22.037 39 Uganda 16.947
8 Bulgaria 21.755 40 Jordan 16.891
9 Argentina 21.671 41 Mozambique 16.853
10 Ecuador 21.461 42 Poland 16.771
11 Costa Rica 21.421 43 Colombia 16.770
12 United Kingdom 21.415 44 Armenia 16.276
(Table 6 continued)
Rank Country Effectiveness score Rank Country Effectiveness score
13 Korea, Rep. 21.066 45 Thailand 16.203
14 Sweden 21.060 46 Russian Federation 16.066
15 Brazil 20.968 47 Georgia 15.859
16 El Salvador 20.232 48 Morocco 15.475
17 Dominican Republic 20.070 49 Kazakhstan 15.288
18 Peru 19.907 50 Albania 15.116
19 Israel 19.735 51 Yemen, Rep. 14.566
20 Guatemala 19.626 52 Nigeria 14.202
21 Singapore 19.326 53 Kenya 11.871
22 Estonia 19.276 54 Bangladesh 10.486
23 Panama 19.085 55 Tunisia 9.696
24 Indonesia 18.993 56 Romania 9.442
25 Turkey 18.749 57 Egypt, Arab Rep. 8.051
26 South Africa 18.538 58 Mauritius 7.601
27 Czech Republic 18.302 59 Denmark 6.519
28 Hungary 18.233 60 New Zealand 5.338
29 Saudi Arabia 18.045 61 Vietnam 4.841
30 India 17.921 62 Angola 4.761
31 Macedonia, FYR 17.842 63 Botswana 0.662
32 Slovak Republic 17.750 64 Sierra Leone 0.203
Conclusions
Using data from 64 countries in the world, this research applied the data envelopment analysis (DEA) to
evaluate the effectiveness of banking systems in the World in 2010. The research was divided into three steps, in
which the first stage applied data envelopment analysis method to build a common frontier for these 64 countries;
the second step detected the determinants of the banking sector’s effective; and the last step defined a common set
of weights for analyzing factors helping in ranking the effectiveness of the global banking system in 2010.
The research evaluated the effectiveness of the global banking systems using a dummy input and ten outputs
to create a common frontier for the whole banking systems of 64 countries (while previous studies used
institutional level data of smaller sample size); and after that building a common set of weights to calculate the
effectiveness scores of the global banking system, applied to the DEA method. This proposes an interesting
function for using DEA in examining the effectiveness (and efficiency) in the banking sector.
Findings from the research showed that banking systems in advanced economies are still more effective than
in developing countries. Reasons seem to be related to the development of the banking sector in quantity (number
of bank branches) and more importantly in quality aspects (including the NPL ratio, public credit bureau coverage,
bank concentration, bank’s capital, and cost-income ratio). It is also included the effect of economic development,
expresses through level of income (group) and inflation rates. These results partly explained the effect of the
current financial crisis to the banking sector, the role of public finance (and the government) in this kind of
situation, and the important role of developing commercial banking system to its efficiency and effectiveness.
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Appendix A
Table A1
Countries’ Data
Country y1 y2 y3 y4 y5 y6 y7 y8 y9 y10
Albania 0.77 66.88 0.74 2.37 2.11 0.00 9.90 0.24 16.70 3.00
Angola 0.24 9.34 0.24 9.58 0.60 0.00 2.50 0.23 5.34 4.00
Argentina 0.18 24.47 0.20 14.91 10.01 100.00 34.30 0.18 20.60 0.00
Armenia 0.20 16.66 0.12 1.37 7.59 34.50 4.40 0.22 18.90 3.00
Australia 1.29 143.75 1.14 64.18 29.86 100.00 0.00 0.24 22.80 4.00
Bangladesh 0.54 59.38 0.51 0.06 4.47 0.00 0.90 0.24 12.10 3.00
Bolivia 0.32 55.24 0.38 4.80 1.53 33.90 11.60 0.21 19.00 2.00
Botswana 0.19 -11.17 0.58 9.00 3.77 51.90 0.00 0.22 0.00 4.00
Brazil 0.91 117.85 0.66 17.82 14.59 59.20 23.70 0.14 20.20 2.00
Bulgaria 0.85 66.74 0.77 29.79 13.87 6.20 34.80 0.25 20.90 3.00
Canada 1.40 178.07 1.04 135.23 45.60 100.00 0.00 0.24 22.20 4.00
Chile 0.78 115.92 0.55 24.03 9.39 33.90 32.90 0.23 22.30 2.00
Colombia 0.51 43.26 0.22 9.60 8.74 60.50 0.00 0.21 19.30 2.00
Costa Rica 0.49 53.90 0.25 12.83 9.59 56.00 24.30 0.15 21.80 2.00
Croatia 0.90 75.09 0.77 40.10 23.36 77.00 0.00 0.24 18.40 3.00
Czech Republic 0.67 57.98 0.62 19.57 11.15 73.10 4.90 0.24 20.00 3.00
Denmark 2.42 211.45 0.72 52.39 37.63 5.20 0.00 0.23 3.30 3.00
(Table A1 continued)
Country y1 y2 y3 y4 y5 y6 y7 y8 y9 y10
Dominican Republic 0.22 39.06 0.21 15.08 6.00 46.10 29.70 0.13 19.80 3.00
Ecuador 0.28 19.76 0.28 6.32 9.30 46.00 37.20 0.22 20.80 2.00
Egypt, Arab Rep. 0.56 77.70 0.75 1.78 3.62 8.20 2.50 0.22 8.50 3.00
El Salvador 0.42 49.94 0.42 11.07 4.62 94.60 21.00 0.23 20.50 3.00
Estonia 1.18 97.26 0.48 57.70 15.19 20.60 0.00 0.17 21.40 3.00
Georgia 0.40 32.87 0.22 1.17 3.14 12.20 0.00 0.18 19.20 3.00
Guatemala 0.44 40.11 0.37 20.20 10.12 28.40 16.90 0.01 20.90 4.00
Hungary 0.90 80.70 0.50 29.40 28.25 10.30 0.00 0.00 20.30 2.00
India 0.69 68.35 0.70 7.29 10.64 10.20 0.00 0.24 21.00 3.00
Indonesia 0.29 36.75 0.33 4.84 8.44 0.00 22.00 0.23 20.10 3.00
Israel 0.95 82.16 0.87 18.81 14.74 89.80 0.00 0.24 21.80 3.00
Japan 1.48 379.30 1.80 113.75 9.98 76.20 0.00 0.25 21.60 3.00
Jordan 1.29 114.92 1.09 9.38 10.02 0.00 1.00 0.24 19.10 3.00
Kazakhstan 0.89 33.51 0.39 7.01 2.47 29.50 0.00 0.23 18.20 3.00
Kenya 0.29 40.09 0.29 0.99 1.38 2.30 0.00 0.21 14.30 2.00
Korea, Rep. 1.21 112.32 0.59 90.03 13.40 93.80 0.00 0.25 22.20 3.00
Kuwait 0.81 74.92 0.71 19.69 8.27 30.40 0.00 0.23 20.20 3.00
Lithuania 0.73 64.37 0.36 28.78 3.39 18.40 12.10 0.24 18.70 3.00
Macedonia, FYR 0.55 42.70 0.56 49.97 26.79 0.00 28.10 0.22 16.50 3.00
Malaysia 0.99 115.54 1.09 16.44 9.80 82.00 48.50 0.24 18.50 3.00
Mauritius 0.88 111.78 0.86 22.04 11.92 0.00 36.80 0.24 2.50 4.00
Moldova 0.49 39.76 0.45 236.07 10.07 0.00 0.00 0.21 18.10 4.00
Morocco 0.91 95.54 0.94 9.68 15.80 14.00 0.00 0.25 17.30 3.00
Mozambique 0.22 14.14 0.29 4.90 2.92 0.00 2.30 0.20 20.50 3.00
New Zealand 1.55 156.45 0.96 50.36 28.04 100.00 0.00 0.25 1.70 4.00
Nigeria 0.45 26.73 0.26 18.63 6.42 0.00 0.00 0.23 17.00 3.00
Panama 0.86 85.41 0.88 16.19 12.87 45.90 0.00 0.19 21.60 3.00
Peru 0.21 18.51 0.26 5.85 4.17 31.80 23.00 0.23 21.10 3.00
Poland 0.55 60.06 0.42 17.31 8.17 68.30 0.00 0.24 18.90 3.00
Romania 0.52 40.91 0.32 12.47 13.76 30.20 5.70 0.18 9.50 3.00
Russian Federation 0.49 26.03 0.36 6.28 2.24 14.30 0.00 0.18 19.50 2.00
Saudi Arabia 0.55 9.42 0.53 14.70 5.36 17.90 0.00 0.25 21.90 4.00
Sierra Leone 0.09 7.35 0.15 1.14 2.76 0.00 0.00 0.16 0.00 3.00
Singapore 1.10 79.17 1.18 37.93 9.13 40.30 0.00 0.26 21.90 4.00
Slovak Republic 0.55 53.80 0.49 29.21 10.28 44.00 1.40 0.24 20.10 3.00
South Africa 0.95 215.47 0.67 17.50 5.99 54.70 0.00 0.22 19.40 4.00
Sweden 1.40 133.43 0.57 29.56 21.80 100.00 0.00 0.25 22.30 2.00
Switzerland 1.89 180.59 1.31 70.60 37.99 22.50 0.00 0.23 22.80 3.00
Thailand 0.84 145.65 0.79 17.05 7.18 32.90 0.00 0.24 17.60 2.00
Tunisia 0.62 72.04 0.52 17.69 15.51 0.00 19.90 0.24 7.80 3.00
Turkey 0.51 52.54 0.42 18.00 8.50 42.90 15.90 0.22 19.70 2.00
Uganda 0.22 11.45 0.20 0.70 0.53 0.00 0.00 0.20 21.10 3.00
United Kingdom 2.08 211.35 1.71 42.45 18.35 100.00 0.00 0.25 21.70 3.00
United States 0.73 271.64 0.83 120.94 30.86 100.00 0.00 0.22 20.30 2.00
Venezuela, RB 0.38 20.49 0.39 16.60 4.41 0.00 0.00 0.21 21.40 3.00
Vietnam 1.24 94.99 0.93 15.36 3.42 0.00 19.00 0.25 2.00 3.00
Yemen, Rep. 0.13 11.29 0.21 2.75 1.97 0.00 0.20 0.25 18.00 3.00
Note. y1, y2,..., y10 are respectively referred to ten factors in Table 3.
Table A2
Dynamic DEA Efficiencies
Rank Country DSW score Rank Country DSW score
1 Moldova 1.000 33 Thailand 0.961
2 Malaysia 1.000 34 India 0.957
3 Japan 1.000 35 Dominican Republic 0.955
4 Canada 1.000 36 Croatia 0.951
5 United Kingdom 1.000 37 Panama 0.947
6 Denmark 1.000 38 Czech Republic 0.947
7 Mauritius 1.000 39 Lithuania 0.944
8 Argentina 1.000 40 Estonia 0.939
9 Switzerland 1.000 41 Venezuela, RB 0.939
10 United States 1.000 42 Poland 0.938
11 Chile 1.000 43 Indonesia 0.937
12 Guatemala 1.000 44 Jordan 0.935
13 Singapore 1.000 45 Albania 0.931
14 Macedonia, FYR 1.000 46 Brazil 0.930
15 South Africa 1.000 47 Slovak Republic 0.929
16 New Zealand 1.000 48 Uganda 0.925
17 Australia 1.000 49 Bangladesh 0.920
18 Bulgaria 1.000 50 Kuwait 0.912
19 Vietnam 1.000 51 Turkey 0.904
20 Sweden 1.000 52 Mozambique 0.901
21 Korea, Rep. 1.000 53 Kazakhstan 0.893
22 El Salvador 1.000 54 Nigeria 0.893
23 Botswana 1.000 55 Hungary 0.890
24 Saudi Arabia 1.000 56 Armenia 0.870
25 Angola 1.000 57 Bolivia 0.867
26 Ecuador 0.985 58 Egypt, Arab Rep. 0.863
27 Yemen, Rep. 0.984 59 Russian Federation 0.855
28 Costa Rica 0.980 60 Colombia 0.846
29 Morocco 0.972 61 Georgia 0.842
30 Tunisia 0.970 62 Kenya 0.813
31 Peru 0.969 63 Romania 0.750
32 Israel 0.965 64 Sierra Leone 0.750
Note. First 25 countries are ranked based on super-efficiency DEA results.
November 2011, Vol. 10, No. 11, 974-984
Application of Pareto Distribution in Wage Models∗
Diana Bílková
University of Economics in Prague, Prague, Czech Republic
This paper deals with the use of Pareto distribution in models of wage distribution. Pareto distribution cannot
generally be used as a model of the whole wage distribution, but only as a model for the distribution of higher or of
the highest wages. It is usually about wages higher than the median. The parameter b is called the Pareto coefficient
and it is often used as a characteristic of differentiation of fifty percent of the highest wages. Pareto distribution is
so much the more applicable model of a specific wage distribution, the more specific differentiation of fifty percent
of the highest wages will resemble to differentiation that is expected by Pareto distribution. Pareto distribution
assumes a differentiation of wages, in which the following ratios are the same: ratio of the upper quartile to the
median; ratio of the eighth decile to the sixth decile; ratio of the ninth decile to the eighth decile. This finding may
serve as one of the empirical criterions for assessing, whether Pareto distribution is a suitable or less suitable model
of a particular wage distribution. If we find only small differences between the ratios of these quantiles in a specific
wage distribution, Pareto distribution is a good model of a specific wage distribution. Approximation of a specific
wage distribution by Pareto distribution will be less suitable or even unsuitable when more expressive differences
of mentioned ratios. If we choose Pareto distribution as a model of a specific wage distribution, we must reckon
with the fact that the model is always only an approximation. It will describe only approximately the actual wage
distribution and the relationships in the model will only partially reflect the relationships in a specific wage
distribution.
Keywords: Pareto distribution, Pareto coefficient, estimation methods for parameters, least squares method, wage
distributions
Pareto Distribution
The question of income and wage distributions and their models is quite extensively treated in the statistical
literature (Bartošová, 2006; Bartošová & Bína, 2009; Bílková, 2007; Dutta, Sefton, & Weale, 2001; Majumder &
Chakravarty, 1990; McDonald & Snooks, 1985; McDonald, 1984; McDonald & Butler, 1987).
∗
Acknowledgment: The paper was supported by grant project IGS 24/2010 called “Analysis of the Development of Income
Distribution in the Czech Republic Since 1990 to the Financial Crisis and Comparison of This Development With the
Development of the Income Distribution in Times of Financial Crisis, According to Sociological Groups, Gender, Age, Education,
Profession Field and Region” from the University of Economics in Prague.
Diana Bílková, Ing./Dr., Department of Statistics and Probability, Faculty of Informatics and Statistics, University of Economics
in Prague.
Correspondence concerning this article should be addressed to Diana Bílková, Department of Statistics and Probability, Faculty
of Informatics and Statistics, University of Economics in Prague, Sq. W. Churchill 1938/4, Prague 3, Czech Republic, post code:
130 67. E-mail: bilkova@vse.cz.
APPLICATION OF PARETO DISTRIBUTION IN WAGE MODELS 975
Pareto distribution is usually used as a model of the distribution of the largest wages, not for the whole wage
distribution. In this article, we will consider using the Pareto distribution to model wages higher than median.
The 100·P% quantile of the wage distribution will be denoted by xP, 0 < P < 1. This value represents the upper
bound of 100·P% lowest wages and also the lower bound of 100(1 – P) % highest wages. A particular quantile
(denoted as xP0) which will be the lower bound of some small number of the highest wages is usually set to be the
maximum wage. If the following formula (1) holds for any quantile xP, the wage distribution is Pareto distribution.
b
x P0 ⎛ 1− P ⎞
=⎜ ⎟ (1)
xP ⎝ 1 − P0 ⎠
The parameter b of the Pareto distribution (1) is called the Pareto coefficient. It can be used as a
characteristic of differentiation of 50% highest wages.
We will now consider a pair of quantiles xP1 and xP2, P1 < P2. It follows from equation (1) that:
b
x P0 ⎛ 1 − P1 ⎞
= ⎜⎜ ⎟
⎟ (2)
x P1 ⎝ 1 − P 0⎠
and
b
x P0 ⎛ 1 − P2 ⎞
= ⎜⎜ ⎟
⎟ (3)
x P2 ⎝ 1 − P0 ⎠
From what we can derive for the rate of xP2 to xP1 that:
b
x P2 ⎛ 1 − P1 ⎞
=⎜ ⎟ (4)
x P1 ⎝ 1 − P2 ⎠
The rate xx P 2 is an increasing function of the Pareto coefficient b. If the rate of quantiles increases, the
P1
relative differentiation of wages increases too. If only absolute differences between quantiles increase, only the
absolute differentiation of wages increases.
It follows from the equation (1) that once the values xP0 and b are chosen, we can determine the quantile xP
for any chosen P or the other way around for any value xP we can find the corresponding value of P. In the first
case, it is advantageous to write the equation (1) as:
x P0
xP = b
⎛ 1− P ⎞ (5)
⎜ ⎟
⎜1 − P ⎟
⎝ 0⎠
or after logarithmic transformation as:
log xP = log xP0 − b [log (1 - P) - log (1 − P0)] (6)
in the second case:

x P0
1 − P = (1 − P0) b (7)
xP
976 APPLICATION OF PARETO DISTRIBUTION IN WAGE MODELS
or after logarithmic transformation as:

1
log (1 − P) = log (1 − P 0) + (log x P − log x P) (8)
b 0
The equations (2)-(4) will after logarithmic transformation have the following forms:
x P0
log
x P1
b= (9)
1 − P1
log
1 − P0
x P2
log
x P1
b= (10)
1 − P1
log
1 − P2
It follows from the equation (9) that instead of the Pareto coefficient b we can use any other quantile xP1 of
the Pareto distribution and it follows from the equation (10) that the Pareto coefficient b can be calculated using
any known quantiles xP1 and xP2. Then we can also determine the value xP0 using the formulas:
b
⎛ 1 − P1 ⎞
x P 0 = x P1 ⎜⎜ ⎟,
⎟ (11)
⎝ 1 − P0 ⎠
b
⎛ 1 − P2 ⎞
x P 0 = x P 2 ⎜⎜ ⎟
⎟ (12)
⎝ 1 − P 0 ⎠
The model characterized with the relationship (1) will be practically applicable if the following is known:
• The value of the quantile that characterizes the assumed wage maximum and the value of the Pareto
coefficient b;
• The value of the quantile that characterizes the assumed wage maximum and the value of any other quantile;
• The values of any two quantiles of the Pareto distribution.
Any two quantiles can be written as xP and xP+k, where 0 < k < 1 – P . Using the equation (4), we can derive
for the rate of these two quantiles:
b
x P + k ⎛⎜ 1 − P ⎞⎟
=⎜ ⎟ (13)
xP ⎝1 − P − k ⎠
The rate (13) will be equal for such pairs of quantiles for which the following formula holds:
1− P
= c, (14)
1− P − k
where c is a constant, i.e., the rate will be the same for all pairs of quantiles for which:
c −1
k= (1 − P) (15)
c
We will use the constant c = 2 in equation (15) and we will choose gradually P = 0.5; 0.6; 0.8. Then using the
equation (13) we can show the equality of rates of some frequently used quantiles:
x 0.75 = x 0.8 = x 0.9

(16)
x 0.5 x 0.6 x 0.8
From the relationship (16) we can conclude that Pareto distribution assumes such a wage differentiation for
which the rate of the upper quartile to median is the same as:
• The rate of the 8th to the 6th decile;
• And as the rate of the 9th to the 8th decile.
If in a particular case, the observed differences of the rates of the above mentioned quantiles are negligible,
Pareto distribution will be an appropriate model of the considered wage distribution. In the case, the differences
are quite material, the approximation of the considered wage distribution with Pareto distribution will be more or
less inappropriate. More about the theory of Pareto distribution is described in statistical literature (Forbes, Evans,
Hastings, & Peacock, 2011; Johnson, Kotz, & Balakrishnan, 1994; Kleiber & Kotz, 2003; Krishnamoorthy,
2006).
Parameter Estimates
If the Pareto distribution is chosen as a model for a particular distribution we have to keep in mind that this
model is only an approximation. The wage distribution will be only approximated and the relations derived from
the model will also hold for the “true distribution” only approximately. Which relations will hold more precisely
and for which the precision will be lower will be mostly dependent on the method of parameter estimates.
There are many possibilities to choose from. In the following text the quantiles of Pareto distribution will be
denoted as xP and the quantiles of the observed wage distribution will be denoted as yP.
First we need to decide which quantile to choose as xP0. It this article we will assume that xP0 = x0.99. From
the equation (1) we can see that the considered Pareto distribution will be defined by the equation:
b
x 0.99 = ⎛ 1 − P ⎞ (17)
⎜ ⎟
x P ⎝ 0.01 ⎠
Then we need to determine the value x0.99 and the value of the Pareto coefficient b. Because it is necessary to
estimate the values of two parameters we need to choose two equations to estimate from.
A natural choice is the equation xP0 = yP0; that is in our case x0.99 = y0.99. As the other equation we set a
quantile xP1 equal to the corresponding observed quantile, i.e., xP1 = yP1. In this case, the parameters of the model
will be:
x P0 = y P0 (18)
and using equation (9):

y P0
log
y P1
b= (19)
1 − P1
log
1 − P0
We can get different modifications using different choice of the maximum wage and the second quantile. If we
use equation x0.99 = y0.99 and we use the median in the second equation, i.e., x0.5 = y0.5 we get a model with
parameters:
x 0.99 = y 0.99 (20)
y 0.99
log
y 0.5
b= (21)
0.5
log
0.01
Another possibility is setting any two quantiles of the model equal to the quantiles of the observed distribution:
x P1 = y P1 (22)
x P2 = y P2 (23)
Using the formula (10), we get the following parameter estimates:

y
log P 2
y P1
b= (24)
1 − P1
log
1 − P2
and from equations (11) and (12) we get:
b b
⎛ 1 − P1 ⎞ ⎛ 1 − P2 ⎞
x P 0 = y P1 ⎜ ⎟ = y P2 ⎜ ⎟ (25)
⎝ 1 − P0 ⎠ ⎝ 1 − P0 ⎠
With this alternative we can also get numerous modifications depending on the choice of quantiles yP1 and
yP2 that are used.
The third possibility is based on the request that xP0 = yP0 and that the rate of some other two quantiles of the
Pareto distribution xP2/xP1 is equal to the rate yP2/yP1 of correspoding quantiles of the wage distribution observed.
In this case we will estimate the parameters using equation (10):
x P0 = y P0 (26)
y P2
log
y P1
b= (27)
1 − P1
log
1 − P2
In this case, notwithstanding that xP2/xP1 = yP2/yP1 holds, the equality of quantiles itself, xP1 ≠ yP1 and xP2 ≠ yP2,
does not hold. In this case, we can also arrive to numerous modifications depending on what maximum wage is
chosen and what quantiles yP1 and yP2 are chosen.
For all of the above methods the equality of two characteristics of the model and the observed distribution
was required. There are also different approaches to the parameter estimates.
The least squares method is frequently used for the Pareto distribution parameter estimates as well. We will
consider the following quantiles of the observed wage distribution yP1, yP2, …, yPk and corresponding quantiles of the
Pareto distribution xP1, xP2, …, xPk. The model distribution will be most precise when the sum of squared differences:
− x P i) 2
k
∑ ( yP (28)
i =1 i
is minimized. In this case closed formula solution does not exist. Therefore sum of squared differences of
logarithms of quantiles is often considered:
k 2
∑ (log y P − log x Pi) (29)
i =1 i
Minimizing the objective function (29), it is possible to derive the following estimates:
k 1 − P0 k k 1 − P0
k ∑ log y log − ∑ log y P ∑ log
i =1 Pi
1 − P i i =1 i i =1 1 − Pi
b= 2 (30)
k 1 − P0 ⎛k 1 − P0 ⎞
k ∑ log 2 − ⎜ ∑ log ⎟
i =1 1 − Pi ⎝ i =1 1 − P i ⎠
k 1 − P0
k ∑ log
∑ log y
Pi i = 1 1 − Pi (31)
log x P0 = i =1 −b
k k
In the case we use this estimating method, it is needed to keep in mind that the equality of model quantiles
and observed quantiles is not guaranteed for any P. Again we can arrive to different results depending on what
quantiles yP1, yP2, …, yPk are used for the calculations. Furthermore the parameter estimates also depend on the
choice of the maximum wage.
Characteristics of the Appropriateness of the Pareto Distribution

For the application of Pareto distribution as a model of the wage distribution, it is crucial that the model fits
the observed distribution as close as possible. It is important that the observed relative frequencies in particular
wage intervals are as close to the theoretical probabilities assigned to these intervals by the model as possible.
It is needed to note that the same parameter estimation method does not always lead to the best results. It is
of particular importance in “what direction” is the observed wage distribution different from Pareto distribution.
Pareto distribution assumes such wage differentiation that the relations (16) hold. With real data we can
encounter many different situations:
y 0.75 y 0.8 y 0.9
< < (32)
y 0.5 y 0.6 y 0.8
y 0.75 y 0.8 y 0.9
> > (33)
y 0.5 y 0.6 y 0.8
y 0.75 y 0.9 y 0.8
< < (34)
y 0.5 y 0.8 y 0.6
y 0.75 y 0.9 y 0.8
> > (35)
y 0.5 y 0.8 y 0.6
y 0.8 y 0.75 y 0.9
< < (36)
y 0.6 y 0.5 y 0.8
y 0.8 y 0.75 y 0.9

> > (37)
y 0.6 y 0.5 y 0.8
It follows from equations (32)-(37) that the observed distributions will more or less systematically differ
from the Pareto distribution. In the case of equation (32) the differentiation of the observed wage distribution is
higher; in the case of equation (33) the differentiation will be lower than in the case of Pareto distribution. Some
bias occurs in cases equations (34)-(37) as well (but cannot be so specified). Systematical bias should be a signal
for potential adjustment of the model which could be based for example on adding one or more parameters into
the model. These adjustments usually lead to more complicated models. Therefore, the above mentioned bias is
often neglected and simple models are preferred even though they lead to some bias.
Wage Distribution of Males and Females in the Czech Republic in 2001-2008

The data used in this article is the gross monthly wage of male and female in CZK in the Czech Republic in
the years 2001-2008. Data were sorted in the table of interval distribution with opened lower and upper bound in
the lowest and highest interval respectively. The source is the web page of the Czech statistical office. The
following quantiles were calculated (see Table 1).
Table 1
Median y0.50 (in CZK), 6th Decile y0.60 (in CZK), Upper Quartile y0.75 (in CZK), 8th Decile y0.80 (in CZK), 9th
Decile y0.90 (in CZK) a 99th Percentile y0.99 (in CZK) of Gross Monthly Wages in the Czech Republic in the Years
2001-2008 (Total and Split up to Male and Female Separated)
Year y0.50 y0.60 y0.75 y0.80 y0.90 y0.99
Total 2001 12,502 14,042 16,987 18,254 23,319 44,921
2002 15,545 17,125 20,215 22,193 27,754 47,172
2003 16,735 18,458 22,224 23,797 29,590 47,719
2004 17,709 19,557 23,077 24,849 31,082 56,369
2005 18,597 20,566 24,470 26,328 33,292 56,852
2006 19,514 21,564 25,675 27,693 35,230 57,326
2007 20,987 23,227 27,590 29,900 37,892 66,395
2008 22,310 24,696 29,553 31,769 40,541 68,828
Males 2001 14,152 15,781 19,037 20,697 26,264 46,781
2002 16,985 18,667 22,604 24,199 31,101 48,047
2003 18,240 20,116 24,145 26,041 34,564 48,417
2004 19,344 21,321 25,306 27,286 34,819 57,514
2005 20,281 22,446 26,822 28,989 37,211 57,808
2006 21,199 23,460 28,090 30,525 39,381 58,104
2007 22,933 25,366 30,284 32,663 42,815 70,522
2008 24,498 27,115 32,343 35,105 46,375 72,338
Females 2001 10,770 12,187 14,655 15,700 18,904 37,526
2002 13,746 15,181 17,727 18,903 23,291 43,339
2003 14,831 16,453 19,281 20,628 24,637 44,883
2004 15,642 17,303 20,293 21,560 25,776 50,776
2005 16,454 18,211 21,426 22,804 27,503 52,508
2006 17,311 19,202 22,530 23,966 29,082 54,054
2007 18,390 20,392 24,024 25,924 31,338 58,649
2008 19,399 21,600 25,558 27,215 33,405 63,628
From Table 2, we can see that, with the exception of male in the year 2003, 2007 and 2008, all other wage
distributions have lower differentiation than Pareto distribution. The systematical error occurred also in the case
of male in the year 2003, 2007 and 2008. It follows from the empirical criterion (16) and from Table 2 that in all
cases the differences between the rates of the considered quantiles are negligible and therefore Pareto distribution
can be used as the model of the distribution.
The 99th percentile will be considered as a characteristic of the maximum wage. The parameters of the
Pareto distribution are estimated using the above described methods.
First we consider the conditions xP0 = yP0 a xP1 = yP1 and we chose median as the second quantile, i.e.,
x0.99 = y0.99 and x0.5 = y0.5. We estimate the parameter b using the formula (21). The summary of the parameter
estimates is in Table 3.
Table 2
The Rates of Quantiles y75/y50, y80/y60 and y90/y80 of the Wage Distributions in the Years 2001-2008 and Its
Relations
y 0.75 y 0.80 y 0.90
Year Relations between quantile rates
y 0.50 y 0.60 y 0.80
Total 2001 1.358815 1.299910 1.277456 (21.2)
2002 1.300422 1.295897 1.250612 (21.2)
2003 1.327994 1.289216 1.243457 (21.2)
2004 1.303112 1.270608 1.250812 (21.2)
2005 1.315815 1.280162 1.264514 (21.2)
2006 1.315734 1.284213 1.272161 (21.2)
2007 1.314623 1.287295 1.267291 (21.2)
2008 1.324653 1.286403 1.276118 (21.2)
Males 2001 1.345148 1.311556 1.268936 (21.2)
2002 1.330847 1.296386 1.285203 (21.2)
2003 1.323680 1.294561 1.327273 (21.5)
2004 1.308222 1.279734 1.276084 (21.2)
2005 1.322543 1.291532 1.283632 (21.2)
2006 1.325086 1.301135 1.290146 (21.2)
2007 1.320542 1.287669 1.310810 (21.4)
2008 1.320230 1.294671 1.321037 (21.5)
Females 2001 1.360723 1.288227 1.204113 (21.2)
2002 1.289624 1.245137 1.232163 (21.2)
2003 1.300019 1.253747 1.194319 (21.2)
2004 1.297375 1.246052 1.195526 (21.2)
2005 1.302189 1.252237 1.206076 (21.2)
2006 1.301488 1.248134 1.213470 (21.2)
2007 1.306362 1.271283 1.208841 (21.2)
2008 1.317491 1.259954 1.227448 (21.2)
Next we apply the conditions xP1 = yP1 and xP2 = yP2 and we choose 6th and 9th decile for yP1 and yP2. We use
the formulas (24) and (25) to estimate the parameters. The summary of the parameter estimates is in Table 3.
Parameters of the Pareto distribution can also be estimated using the equations xP0 = yP0 and xP2/xP1 = yP2/yP1.
We choose the 9th and 6th decile in the rate yP2/yP1. In this case we use the relations (26) and (27) to estimate the
parameters. The summary of the parameter estimates is also in Table 3.
Table 3
Estimated Parameters of Pareto Distribution for Different Choices of the Estimation Equations
Equations used
x 0.9 = y 0.9
x0.99 = y0.99, x0.5 = y0.5 x0.6 = y0.6, x0.9 = y0.9 x0.99 = y 0.99,
x 0.6 y 0.6
Parameter estimates Parameter estimates Parameter estimates
Year xP0 b xP0 b xP0 b
Total 2001 44,921 0.326952 54,143 0.365843 44,921 0.365843
2002 47,172 0.283758 61,890 0.348293 47,172 0.348293
2003 47,719 0.267846 64,800 0.340425 47,719 0.340425
2004 56,369 0.295969 67,096 0.334192 56,369 0.334192
2005 56,852 0.299456 74,095 0.347455 56,852 0.347455
2006 57,326 0.275468 79,614 0.354083 57,326 0.354083
2007 66,395 0.294405 85,426 0.353045 66,395 0.353045
2008 68,828 0.287978 92,352 0.357552 68,828 0.357552
Males 2001 46,781 0.305624 61,207 0.367449 46,781 0.367449
2002 48,047 0.265814 72,613 0.368246 48,047 0.368246
2003 48,417 0.249540 84,934 0.390464 48,417 0.390464
2004 57,514 0.278536 78,632 0.353784 57,514 0.353784
2005 57,808 0.267749 86,165 0.364658 57,808 0.364658
2006 58,104 0.257739 93,098 0.373653 58,104 0.373653
2007 70,522 0.287153 102,142 0.377610 70,522 0.377610
2008 72,338 0.276777 113,087 0.387128 72,338 0.387128
Females 2001 37,526 0.319087 39,196 0.316679 37,526 0.316679
2002 43,339 0.293539 47,418 0.308749 43,339 0.308749
2003 44,883 0.283055 48,172 0.291217 44,883 0.291217
2004 50,776 0.300989 49,971 0.287505 50,776 0.287505
2005 52,508 0.296625 54,551 0.297414 52,508 0.297414
2006 54,054 0.291062 57,954 0.299456 54,054 0.299456
2007 58,649 0.296461 63,977 0.309955 58,649 0.309955
2008 63,628 0.303636 68,917 0.314516 63,628 0.314516
In the end we also estimate the parameters of the Pareto distribution using the least squares method. We use
the relations (30) and (31). In this method, we choose 5th, 6th, 7th, 8th and 9th deciles of the observed wage
distribution, i.e., k = 5. Parameters estimated using the least squares method are summarized in Table 4.
Table 4
Parameters Estimated Using the Least Squares Method
Parameter estimates
Year Total Males Females
xP0 b xP0 b xP0 b
2001 56.562 0.379911 63.774 0.379912 42.520 0.341047
2002 64.026 0.358469 73.770 0.372825 49.188 0.320682
2003 67.219 0.351034 85.080 0.391617 51.125 0.309187
2004 69.311 0.344615 80.310 0.360986 52.763 0.303849
2005 76.310 0.356935 88.251 0.372535 57.413 0.312826
2006 81.721 0.362626 95.225 0.381012 60.917 0.315022
2007 88.022 0.362359 103.405 0.383183 67.572 0.325878
2008 94.849 0.366387 114.131 0.391293 72.463 0.330659
The values of the sum of absolute differences of observed and theoretical absolute frequencies of all
intervals calculated for all cases considered wage distributions are in Table 5. In the case of the theoretical
frequencies at first we determined theoretical probabilities using the formula (8). From these, we determined
theoretical absolute frequencies.
Table 5
Sums of the Absolute Differences of the Observed and Theoretical Frequencies
Equations used
x0.99 = y0.99
Year x0.99 = y0.99 x0.6 = y0.6 x 0.9 = y 0.9 Least squares method
x0.5 = y0.5 x0.9 = y0.9
x 0.6 y 0.6
Total 2001 37,459 23,255 85,795 23,859
2002 51,358 27,327 171,404 31,658
2003 73,388 36,520 204,535 39,722
2004 103,625 64,422 249,348 66,249
2005 167,946 69,930 353,661 68,679
2006 157,094 68,849 426,442 69,104
2007 268,740 260,786 322,437 262,224
2008 282,396 253,373 372,117 257,050
Males 2001 20,603 10,089 56,291 9,959
2002 33,576 19,711 111,796 20,298
2003 47,909 23,576 96,863 23,747
2004 60,241 32,457 178,858 33,076
2005 81,505 35,349 220,276 36,321
2006 96,789 37,737 250,764 37,653
2007 140,965 138,678 202,143 139,428
2008 135,960 133,953 173,262 135,089
Females 2001 24,256 23,926 23,687 21,270
2002 23,697 16,716 42,148 18,595
2003 37,215 30,902 40,237 30,011
2004 45,429 41,416 45,460 40,957
2005 51,793 41,615 52,493 41,449
2006 58,014 41,137 74,302 41,812
2007 138,241 128,854 150,258 127,313
2008 140,955 132,125 155,071 131,224
Conclusions
The appropriateness of particular modifications of the Pareto distribution can be evaluated comparing the
theoretic and empirical frequencies. It is possible to compare both the absolute and relative differences between
the theoretic and observed empirical distributions. In this article we used the absolute differences. The values
sums these differences are in Table 5. The values seem to be relatively high. The question of appropriateness of a
given theoretic wage distribution in the case of large samples was described in statistical literature (Bílková,
2007). Some more general conclusions can be made from the values of the absolute differences of observed and
theoretic distributions.
With the exception of the wage distribution of women in 2001, the worst results are achieved using the
equation x0.99 = y0.99 and setting the ratio of other two quantiles of the Pareto distribution x0.9/x0.6 equal to the ratio
y0.9/y0.6 of the corresponding empirical quantiles. This fact is less obvious for female distribution and most
obvious for total distribution. This is also due to the larger sample size of the total sample (in comparison with the
sample size of the sub-groups of male and female). Again with the exception of the wage distribution of women
in 2001 the second worst model is the estimate based on the equations x0.99 = y0.99 and x0.5 = y0.5. This fact is again
less obvious for female distribution and most obvious for total distribution. In the case of the wage distribution of
women in 2001, the worst estimate is based on the equations x0.99 = y0.99 and x0.5 = y0.5. In the case of the total
group is the third worst (second best) method the least squares method (with the exception of 2005). The best
results are achieved with the method based on the equations x0.6 = y0.6 and x0.9 = y0.9. In the case of the total wage
distribution in 2005 is the third worst method based on the equations x0.6 = y0.6 and x0.9 = y0.9 and the best method
is the least squares method. In the case of the wage distribution of male (with the exception of the years 2001 and
2006), the third worst (second best) results are again achieved using the least squares method. The best results are
achieved with the method based on the equations x0.6 = y0.6 and x0.9 = y0.9. In the years 2001 and 2006 (set of men)
is the third worst method the method based on the equations x0.6 = y0.6 and x0.9 = y0.9 and the best is the least
squares method. In the case of the female group (with the exception of the years 2001, 2002 and 2006) is the third
worst (second best) method based on the equations x0.6 = y0.6 and x0.9 = y0.9 and the most precise results are
achieved with the least squares method. In the years 2001, 2003, 2004 and 2005 was for the group of women the
most precise the least squares method. The very best method for the group of male in 2001 was the least squares
method. In this case other methods had much higher values of the above mentioned sum of absolute differences.
From the above described comparison, it is obvious that the simplest parameter estimating methods can be
in the case of the Pareto distribution competing with more advanced methods.
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November 2011, Vol. 10, No. 11, 985-989
The Chaotic Monopoly Price Growth Model
Vesna D. Jablanovic
University of Belgrade, Belgrade, Serbia
Deterministic chaos refers to an irregular or chaotic motion that is generated by nonlinear systems. The chaotic
behavior is not to quantum-mechanical-like uncertainty. Chaos theory is used to prove that erratic and chaotic
fluctuations can indeed arise in completely deterministic models. Chaotic systems exhibit a sensitive dependence
on initial conditions. Seemingly insignificant changes in the initial conditions produce large differences in
outcomes. To maximize profit, the monopolist must first determine its costs and the characteristics of market
demand. Given this knowledge, the monopoly firm must then decide how much to produce. The monopoly firm can
determine price, and the quantity it will sell at that price follows from the market demand curve. The basic aim of
this paper is to construct a relatively simple chaotic growth model of the monopoly price that is capable of
generating stable equilibria, cycles, or chaos. A key hypothesis of this work is based on the idea that the coefficient,
⎡ e b ⎤
π = ⎢ ⎥ plays a crucial role in explaining local stability of the monopoly price, where,
⎣ m (α − 1 ) ( e + 1 ) ⎦
b—the coefficient of the marginal cost function of the monopoly firm, m—the coefficient of the inverse demand
function, e—the coefficient of the price elasticity of the monopoly demand, α—the coefficient.
Keywords: monopoly, price, chaos
Introduction
Chaos theory attempts to reveal structure in unpredictable dynamic systems. It is important to construct
deterministic, nonlinear economic dynamic models that elucidate irregular, unpredictable economic behavior.
Deterministic chaos refers to irregular or chaotic motion that is generated by nonlinear systems evolving
according to dynamical laws that uniquely determine the state of the system at all times from the knowledge of
the system’s previous history. Chaos embodies three important principles: (1) extreme sensitivity to initial
conditions; (2) cause and effect are not proportional; and (3) nonlinearity.
Chaos theory can explain effectively unpredictable economic long time behavior arising in a deterministic
dynamical system because of sensitivity to initial conditions. A deterministic dynamical system is perfectly
predictable given perfect knowledge of the initial condition, and is in practice always predictable in the short term.
The key to long-term unpredictability is a property known as sensitivity to (or sensitive dependence on) initial
conditions.
Chaos theory started with Lorenz’s (1963) discovery of complex dynamics arising from three nonlinear
Vesna D. Jablanovic, Associate Professor of Eonomics, Faculty of Agriculture, University of Belgrade.

Correspondence about this article should be sent to Vesna D. Jablanovic, Vinogradski venac 20, 11000 Belgrade, Serbia. E-mail:
vesnajab@ptt.rs.
986 THE CHAOTIC MONOPOLY PRICE GROWTH MODEL
differential equations leading to turbulence in the weather system. Li and Yorke (1975) discovered that the
simple logistic curve can exibit very complex behavior. Further, May (1976) described chaos in population
biology. Chaos theory has been applied in economics by Benhabib and Day (1981, 1982), Day (1982, 1983,
1997), Grandmont (1985), Goodwin (1990), Medio (1993, 1996), Lorenz (1993), Jablanovic (2010, 2011),
among many others.
The basic aim of this paper is to provide a relatively simple chaotic the monopoly price growth model that is
capable of generating stable equilibria, cycles, or chaos.
A Simple Chaotic Price Growth Model of a Profit-Maximizing Monopoly

In the model of a profit-maximizing monopoly, take the inverse demand function:
Pt = n – mQt (1)
Where P—monopoly price; Q—monopoly output; n, m—coefficients of the inverse demand function.
Further, suppose the quadratic marginal-cost function for a monopoly is:
MCt = a + bQt + cQt2 (2)
MC—marginal cost; Q—monopoly output ; a, b, c—coefficients of the quadratic marginal-cost function.
Marginal revenue is:
⎡ ⎛ 1 ⎞⎤
MR t = Pt ⎢1 + ⎜ ⎟ ⎥ (3)
⎣ ⎝ e ⎠⎦
MR—marginal revenue; P—monopoly price; e—the coefficient of the price elasticity of demand.
A monopoly firm maximizes profit by producing the quantity at which marginal revenue equals marginal
cost. Thus the profit-maximizing condition is that:
MRt = MCt (4)
Further,
MCt+1 = MCt + ΔMC (5)
Or
MCt+1 = MCt + αMCt+1 (6)
i.e.,
(1-α ) MCt+1 = MCt (7)
Thus, the chaotic model of the profit-maximizing monopoly is presented by the equations (1)-(4) and (7).
Where: Q—output of the monopoly firm; MC—marginal cost; MR—marginal revenue; P—monopoly price;
e—the coefficient of the price elasticity of demand; n, m—coefficients of the inverse demand function; a, b,
c—coefficients of the quadratic marginal-cost function.
Firstly, it is supposed that a = 0 and n = 0.
By substitution one derives:
Pt + 1 =
eb
Pt − 2
ec
Pt 2 (8)
m (α − 1 ) ( e + 1 ) m (α − 1 ) ( e + 1 )
Further, it is assumed that the monopoly price is restricted by its maximal value in its time series. This
premise requires a modification of the growth law. Now, the monopoly price growth rate depends on the current
size of the monopoly price, P, relative to its maximal size in its time series Pm. We introduce p as p = P/Pm. Thus,
p ranges between 0 and 1. Again we index p by t, i.e., write pt to refer to the size at time steps t = 0, 1, 2, 3, ....
Now, growth rate of the monopoly price is measured as:
THE CHAOTIC MONOPOLY PRICE GROWTH MODEL 987
eb ec 2 (9)
p t +1 = pt − 2 pt
m (α − 1 ) (e + 1 ) m (α − 1 ) (e + 1 )
This model given by equation (9) is called the logistic model. For most choices of b, c, m, and e, there is no
explicit solution for equation (9). Namely, knowing b, c, m, and e and measuring p0 would not sufficient to
predict pt for any point in time, as it was previously possible. This is at the heart of the presence of chaos in
deterministic feedback processes. Lorenz (1963) discovered this effect—the lack of predictability in
deterministic systems. Sensitive dependence on initial conditions is one of the central ingredients of what is
called deterministic chaos.
This kind of difference equation (9) can lead to a very interesting dynamic behavior, such as cycles that
repeat themselves every two or more periods, and even chaos, in which there is no apparent regularity in the
behavior of pt. This difference in equation (9) will possess a chaotic region. Two properties of the chaotic
solution are important: firstly, given a starting point p0 the solution is highly sensitive to variations of the
parameters b, c, m, and e; secondly, given the parameters b, c, m, and e the solution is highly sensitive to
variations of the initial point p0 . In both cases the two solutions are for the first few periods rather close to each
other, but later on they behave in a chaotic manner.
Logistic Equation
The logistic map is often cited as an example of how complex, chaotic behavior can arise from very simple
non-linear dynamical equations. The logistic model was originally introduced as a demographic model by Pierre
François Verhulst. It is possible to show that iteration process for the logistic equation:
zt+1 = πzt(1 - zt), π∈[ 0 ,4], zt∈[0 ,1] (10)
is equivalent to the iteration of growth model (9) when we use the following identification:
ec
zt = pt (11)
ebm
and
⎡ e b ⎤
π = ⎢ ⎥ (12)
⎣ m (α − 1 )(e + 1 ) ⎦
Using equation (9) and equation (11) we obtain:
⎛ ec ⎞ ⎛ ec ⎞ ⎡⎛ eb ⎞ ⎛ ec ⎞ 2⎤
z t +1 = ⎜ ⎟ p t +1 = ⎜ ⎟ ⎢ ⎜⎜ ⎟⎟ p t − ⎜⎜ 2 ⎟⎟ p t ⎥
⎝ebm⎠ ⎝ebm ⎠ ⎢⎣ ⎝ m (α − 1 ) ( e + 1 ) ⎠ ⎝ m (α − 1 ) ( e + 1 ) ⎠ ⎥⎦
⎛ ec ⎞ ⎛ e2 c2 ⎞
=⎜ ⎟p − ⎜ ⎟p 2
⎜ 2 ⎟ t ⎜ 3 ⎟ t
⎝ m (α − 1) (e + 1) ⎠ ⎝ e bm (α − 1) (e + 1) ⎠
On the other hand, using equations (10)-(12) we obtain:
⎛ eb ⎞⎛ e c ⎞ ⎡ ⎛ e c ⎞ ⎤
zt +1 = π zt (1 − zt ) = ⎜⎜ ⎟⎜
⎟ ⎟ pt ⎢1 − ⎜ ⎟ pt ⎥
⎝ m (α − 1) ( e + 1) ⎠ ⎝ e b m ⎠ ⎣ ⎝ e b m ⎠ ⎦
⎛ e c ⎞ ⎛ e2 c2 ⎞ 2
= ⎜⎜ 2 ⎟⎟ p t − ⎜⎜ ⎟⎟ p t
⎝ m (α − 1 ) ( e + 1 ) ⎠ ⎝ e b m (α − 1 ) ( e + 1 ) ⎠
3
988 THE CHAOTIC MONOPOLY PRICE GROWTH MODEL
Thus, we have that iterating p t +1 = eb ec

pt − 2 p t 2 is really the same as
m (α − 1 ) ( e + 1 ) m (α − 1 ) ( e + 1 )
iterating zt+1 = πzt(1 - zt ) using z t = p t and π = ⎡⎢ ⎤ .
ec e b
⎥
eb m ⎣ m ( α − 1 ) ( e + 1 ) ⎦
It is important because the dynamic properties of the logistic equation (10) have been widely analyzed (Li &
Yorke, 1975; May, 1976).
It is obtained that:
(1) For parameter values 0 < π < 1 all solutions will converge to z = 0;
(2) For 1 < π < 3.57, there exist fixed points the number of which depends on π;
(3) For 1 < π < 2, all solutions monotnically increase to z = (π - 1)/π;
(4) For 2 < π < 3, fluctuations will converge to z = (π - 1)/π;
(5) For 3 < π < 4, all solutions will continously fluctuate;
(6) For 3.57 < π < 4, the solution become “chaotic” wihch means that there exist a totally aperiodic solution
or periodic solutions with a very large, complicated period. This means that the path of zt fluctuates in an
apparently random fashion over time, not settling down into any regular pattern whatsoever.
Conclusion
This paper suggests conclusion for the use of the simple chaotic model of a profit—maximizing monopoly
in predicting the fluctuations of the monopoly price. The model (9) has to rely on specified parameters b, c, m,
and e, and initial value of the monopoly price, p0. But even slight deviations from the values of parameters
parameters b, c, m, and e and initial value of the monopoly price, show the difficulty of predicting a long-term
behavior of the monopoly price, p0.
A key hypothesis of this work is based on the idea that the coefficient plays a crucial role in explaining local
stability of the monopoly price:
⎡ eb ⎤
π =⎢ ⎥
⎣ m (α − 1)( e + 1) ⎦
where b is the coefficient of the marginal cost function of the monopoly firm, m is the coefficient of the inverse
demand function, e is the coefficient of the price elasticity of monopoly’s demand, α is the coefficient.
The quadratic form of the marginal cost function of the monopoly firm is important ingredient of the
presented chaotic monopoly price growth model (9).
References
Benhabib, J., & Day, R. H. (1981). Rational choice and erratic behaviour. Review of Economic Studies, 48, 459-471.
Benhabib, J., & Day, R. H. (1982). Characterization of erratic dynamics in the overlapping generation model. Journal of Economic
Dynamics and Control, 4, 37-55.
Benhabib, J., & Nishimura, K. (1985). Competitive equilibrium cycles. Journal of Economic Theory, 35, 284-306.
Day, R. H. (1982). Irregular growth cycles. American Economic Review, 72, 406-414.
Day, R. H. (1983). The emergence of chaos from classica economic growth. Quarterly Journal of Economics, 98, 200-213.
Day, R. H. (1997). Complex economic dynamics volume I: An introduction to dynamical systems and market mechanism. In
Discrete Dynamics in Nature and Society (pp. 177-178), 1. MIT Press.
Gandolfo, G. (2009). Economic dynamics (4th ed.). Berlin: Springer-Verlag.
THE CHAOTIC MONOPOLY PRICE GROWTH MODEL 989
Goodwin, R. M. (1990). Chaotic economic dynamics. Oxford: Clarendon Press.

Grandmont, J. M. (1985). On enodgenous competitive business cycles. Econometrica, 53, 994-1045.
Jablanović, V. (2010). Chaotic population growth. Belgrade: Cigoja.
Jablanović, V. (2011). The chaotic saving growth model: G 7. Chinese Business Review, 10(5), 317-327.
Li, T., & Yorke, J. (1975). Period three implies chaos. American Mathematical Monthly, 8, 985-992.
Lorenz, E. N. (1963). Deterministic nonperiodic flow. Journal of Atmospheric Sciences, 20, 130-141.
Lorenz, H. W. (1993). Nonlinear dynamical economics and chaotic motion (2nd ed.). Heidelberg: Springer-Verlag.
May, R. M. (1976). Mathematical models with very complicated dynamics. Nature, 261, 459-467.
Medio, A. (1993). Chaotic dynamics: Theory and applications to economics. Cambridge: Cambridge University Press.
Medio, A. (1996). Chaotic dynamics. Theory and applications to economics. De Economist, 144(4), 695-698.
Peitgen, H. O., Jürgens, H., & Saupe, D. (1992). Chaos and fractals-new frontiers of science. New York: Springer-Verlag.
Rössler, O. E. (1976). An equation for continuous chaos. Physics Letters A, 57, 397-398.
Tu, P. N. V. (1994). Dynamical systems. Verlag: Springer.
November 2011, Vol. 10, No. 11, 990-997
Analysis of the Relationship Between Perceived Security

and Customer Trust and Loyalty in Online Shopping
Nihan Özgüven
Dokuz Eylul University, Izmir, Turkey
Advancements in the internet technology triggered a line of developments in the field of marketing. As an
alternative to the conventional shopping, online shopping over the internet has gained substantial share of retail
market. Customers get used to this new shopping venue and nowadays prefer it more and more according to the
researchers, ten percent of the global population now uses internet for shopping. In this research, the author
explored the relationship between the security measures implemented by a company, very active in the online
shopping domain, and the customer trust and loyalty on the online services provided by this company. Findings of
this research are based on survey data analyzed in SPSS. This research supports the existence of a relationship
between the security of a company’s website and customer trust and loyalty on the online services of this company.
When the perception of security measures improves, customer trust and loyalty increases accordingly.
Keywords: customers, customer trust, perceived security, loyalty, online shopping, websites
Introduction
Today’s companies have to take advantage of the opportunities offered by the internet in order to be one step
ahead of its competitors. Leaving aside the traditional shopping, they need to differentiate themselves via this
modern communication channel as online shopping emerges as a new domain.
However, customers are confused with the increasing numbers of websites day by day. In this context,
companies have to generate publicity, create user blogs and provide the most honest information about their
products and services in order to shine out among the realm of websites. Only then, they can attract the attention
and interest of the customers, according to Faks (2008).
Only after companies fully meet the customers’ needs and expectations, customer trust starts to build-up,
according to Ural (2009). Online shopping turnover is increasing year by year, and the main drivers of this
increase include the form of payment options offered to ease up the process and value-added services provided to
increase the customer satisfaction. With these advancements, online shopping today has reached about four times
the size of the traditional shopping for certain goods and services.
Today, from the electronic goods to car rentals to all kinds of sports materials, a wide range of goods and
Nihan Özgüven, Ph.D., Department of Business Administration, Dokuz Eylul University.

Correspondence about this article should be sent to Nihan Özgüven, Dokuz Eylul University, Faculty of Economics and
Administrative Sciences, Department of Business Administration, Dokuzcesmeler Campus, 35160, Buca-Izmir/Turkey. E-mail:
nozguven@hotmail.com.
PERCEIVED SECURITY AND CUSTOMER TRUST AND LOYALTY 991
services can be purchased over the internet. Traditional retail companies are under continuous pressure of
pleasing their customers and following the advancements in business to maintain their position in the market.
From this perspective, easy and secure online payment applications facilitate the everyday business of these
companies. A list of companies, including banks and credit card companies, have lost market share in this
dynamic era as they failed to carry over the customer loyalty, brand awareness and thereby, the share of mind
they used to own to the online media. Even if these companies make online payment available, their brands can
get lost among numerous e-wallets. In particular, credit card and payment companies remain behind the
competition when the customer accounts are linked directly to e-wallets.
In the study, the literature reviewed is primarily about online shopping and its effects on the perceived
reliability, and the trust and loyalty variables are explained and the relationship between these variables and
online shopping are revealed.
Literature Overview
In the study which researched the impact of customer trust on e-commerce, Kim, Chung and Lee (2011)
concluded that internet security measures have positive impact on customer trust and no impact on transportation
costs while customer satisfaction has positive impact on trust and commitment. Bellman, Lohse and Johnson
(1999) explored the relationship between customers’ demographic characteristics, personality traits and attitude
towards online shopping; they identified that customer lifestyle is effective on attitude towards online shopping
and customers with time limitations tend to do more online shopping. Separately, Jarvenpaa, Tractinsky and
Vitale (2000) explored the setup of online shopping website and company reputation in relation to risk perception,
customer trust and attitude and demand; they emphasized that there is a positive relationship between company
reputation and consumer trust and as trust improves, risk perception decreases.
Ou, SIA and Banerjee (2007) explored the Chinese market and identified the mistrust in the websites, lack of
regulatory framework and limited product offer as the reasons behind the slow development of online shopping
over there. Teo (2002) examined customer attitude towards online shopping and Internet and concluded that
companies do not encourage customers to shop online and customers do not embrace the idea of online shopping.
In addition, he emphasized that customers do use internet to collect information, rather than shopping.
Perceived Security, Trust and Loyalty

In the online shopping domain, website security is important for the sense of trust and loyalty. The security
of the website is essential to attract customer traffic and this is only possible with the security measures put in
place.
Perceived security. Security is the fundamental concern of the customers who want to shop over the
internet, according to Suh and Han (2003). Failure to put in place adequate security measures that assure the
confidentiality of the customer data is the major barrier in front of the e-commerce development, according to
Furnell and Karweni (1999). In the online shopping domain, perceived security depends on the reliability of the
payment methods as well as the data transmission and storage. In other words, perceived security is the customer
perception on the quality of tools and processes used for personal information transmission and storage,
according to Kolsaker and Payne (2002).
992 PERCEIVED SECURITY AND CUSTOMER TRUST AND LOYALTY
Trust. In the online shopping, companies with online sales services thorough their websites focus on the
customer trust and online purchasing experience. In traditional shopping, customer trust depends on the
salesperson and company image whereas in online shopping, it depends on the reaction of buyers, their
e-commerce experience and purchasing style, according to Kim, Ferriand and Rao (2008). Trust is a relationship
of exchange between the uncertainty, sensitivity and commitment, according to Jarvenpaa, Noam, and Vitale
(2000). Trust is also considered in connection with the communication, commitment, satisfaction and
relationship marketing theories, according to Flavian and Guinaliu (2006).
Loyalty. Loyalty in online shopping means customers continuing to shop at a website that they have
shopped before and recommending it to their friends, according to Cyr (2008). Loyalty is a result of consistent
satisfaction the customer gets from a product or service the purchases for himself and his family, according to
Assael (1990) loyalty is also defined as a “saturation in satisfaction”, according to Altıntas (2000) to develop
loyal customers, companies create online virtual communities; by focusing on online virtual communities, they
both gain potential customers and retain the existing ones, according to Kim, Lee, and Hiemstra (2004, p. 343).
Methodology
As part of this study, a questionnaire was prepared, collected data were analyzed using SPSS 16 program
and the results were interpreted. Studies of Chen (2006), Kim, Chung and Lee (2011), Wu and Chang (2003)
were used as references while preparing the basic scale expressions in the survey form.
Objective of the study. This research aims to understand the relationship between perceived security and
customer trust and loyalty towards online shopping and different websites. The study covers online shopping
customers in Turkey.
Findings of the study. Findings of the research, as the outcome of the analysis conducted, are shown below.
Reliability of the scale statements has been also analyzed.
As the result of reliability analysis, the overall average of the scale statements is found as 2.8670 and the
correlation between questions is 0.4501. These findings show that the correlation between questions is low. The
analysis of the reliability value is obtained as 0.8986 accordingly, indicating a high reliable scale (0.80 < α <1).
Table 1 shows the demographic characteristics of people who filled in the questionnaire.
Among the participants of this survey, 42% were female and 58% were male. According to the data
collected, the larger portion of the survey respondents were male and men use online shopping more. The
distribution of respondents by age groups are as follows: 33% of respondents are aged 18-25 years, 23% are aged
26-35 years, 21% are aged 36-45 years, 8% are aged 46-55 years, 8% are aged 56-65 years and 7% are more than
65 years old. According to these findings, most respondents are aged 18-25 years and young. This is a
well-expected finding as younger people use the Internet more frequently. Seven percent of survey respondents
are primary school graduates, 7% are secondary school graduates, 22% are middle school graduates, 13% are
associate degree graduates, 40% have undergraduate and 11% have graduate degrees. Accordingly, most
respondents have a graduate degree which indicates that online shoppers have relatively high levels of education.
Sixty percent of respondents are married and 40% of them are unmarried. Among the respondents of survey, 3%
earn 500-1,000 TL, 14% earn 1,001-1,500 TL and 1,501-2,000 TL, 9%, earn 2,001-2,500 TL, 15% earn
2,501-3,000 TL, 18% earn 3,001-3,500 TL, 8% earn 3,501-4,000 TL, 9% earn 4,001-4,500 TL, 4% earn
4,501-5,000 TL and 6% earn 5,001 TL or more than on monthly basis. This finding shows that the majority of the
respondents in the range of 3,001-3,500 TL income level have a high level of income compared to the overall
country average. Six percent of the surveyed work in public sector, 19% of them work in private sector, 5% are
housewives, 8% are retired, 12% of them are students, 32% are self-employed and 13% are trader. Most of the
participants are self-employed.
Table 1
Demographic Characteristics
Frequency % Occupation Frequency %
Gender
female 175 42.16 Businessman, top executive 24 5.78
male 240 57.84 Public sector worker 25 6.03
Age Private sector worker 80 19.28
18-25 135 32.53 housewife 20 4.81
26-35 95 22.89 Retired 31 7.47
36-45 85 20.49 Student 50 12.05
46-55 35 8.43 Self-employment 134 32.29
56-65 35 8.43 Tradesman 51 12.29
65 and more 30 7.23 Revenue
Education 500-1,000 13 3.1
primary 30 7.23 1,001-1,500 56 13.5
secondary 30 7.23 1,501-2,000 58 14.0
collage 90 21.68 2,001-2,500 38 9.2
two-year degree 55 13.25 2,501-3,000 61 14.7
university 165 39.76 3,001-3,500 75 18.1
master degree 45 10.85 3,501-4,000 32 7.7
Marital status 4,001-4,500 38 9.2
married 250 60.24 4,501-5,000 17 4.1
single 165 39.76 5,001- and more 27 6.5
Total 415 100 Total 415 100
Table 2
Results of Factor Analysis
Factors definitions Trust Perceived security Loyalty
G1 0.604
G2 0.779
G3 0.748
S1 0.753
S2 0.683
S3 0.733
S4 0.637
B1 0.882
B2 0.874
B3 0.888
B4 0.823
As shown in Table 2, the first factor, trust has 3; the second factor, perceived security has 4 and the last
factor, loyalty has 4 questions. Factor loadings of the questions for the first factor are between 0.604 and 0.779;
for the second factor are between 0.637 and 0.753 and for the third factor are between 0.888 and 0.823. All factor
load values high. The first factor explains 30.566% of the total variance, the second factor explains 23.747% and
the third factor explains 25.277% of the total variance. According to the obtained findings, the first factor, trust is
more explanatory than the other factors.
Table 3 shows the correlation between the scale dimensions.
Table 3
The Correlation on the Scale Dimensions
Trust Perceived security Loyalty
Trust Pearson correlation 1 0.715 0.637
Sig. (2-tailed) 0.000 0.000
No. 415 415 415
Perceived security Pearson correlation 0.715 1 0.871
Sig. (2-tailed) 0.000 0.000
No. 415 415 415
Loyalty Pearson correlation 0.637 0.871 1
Sig. (2-tailed) 0.000 0.000
No. 415 415 415
There is a strong direct correlation between trust, perceived security and loyalty dimensions.
Table 4
T-test Results of the Scale on the Statements
Definitions No. Mean Std. deviation Std. error mean
Trust
The web sites which provides online shopping are honest 415 2.7590 1.00470 0.04932
The web sites that offer online shopping are reliable 415 2.7012 0.94146 0.04621
Web sites are safe 415 2.7060 0.93784 0.04604
Perceived security
The web site which I give credit card number to get my product, is safe 415 2.8627 1.08031 0.05303
In general, making online payment is risk-free 415 2.6747 1.05533 0.05180
Online sales firms, honest about my personal data is kept private 415 2.9012 0.98901 0.04855
Online sales firms offer a guarantee of confidentiality in all matters 415 2.9205 1.02667 0.05040
Loyalty
Web sites easy to think that the process of purchasing 415 3.6241 1.03951 0.05103
I would recommend to friends online shopping 415 3.3446 1.15859 0.05687
I prefer online shopping and traditional shopping methods 415 2.6096 1.16590 0.05723
Most of my purchases are in online shopping 415 2.4337 1.06767 0.05241
When the scale expressions are evaluated in 5-point Likert scale, response 3 means that customers are
undecided on this specific point. Accordingly, test value was taken as 3. In Table 3, the average values of the
scale are given. If the average value of the expressions is more than 3, then it means that the respondents agree.
However, when the t values in Table 4 interpreted together with the values in Table 5, respondents do agree in the
statements 8 and 9. These statements are as follows: “I think the online purchasing process is easy” and “I would
recommend online shopping to my friends”. Respondents do not agree on the other statements about perceived
security and trust. The two expressions respondents agree are about with loyalty. Accordingly, it can be
concluded that respondents are more loyal to the online shopping than the average.
Table 5
Levels of Significance on the Statements of Scale
Test value = 3
95% trust interval of the difference
t df Sig. (2-tailed) Mean difference
Lower Upper
G1 -4.886 414 0.000 -0.2410 -0.3379 -0.1440
G2 -6.465 414 0.000 -0.2988 -0.3896 -0.2080
G3 -6.386 414 0.000 -0.2940 -0.3845 -0.2035
S1 -2.590 414 0.010 -0.1373 -0.2416 -0.0331
S2 -6.279 414 0.000 -0.3253 -0.4271 -0.2235
S3 -2.035 414 0.042 -0.0988 -0.1942 -0.0034
S4 -1.578 414 0.115 -0.0795 -0.1786 0.0195
B1 12.231 414 0.000 0.6241 0.5238 0.7244
B2 6.059 414 0.000 0.3446 0.2328 0.4564
B3 -6.821 414 0.000 -0.3904 -0.5029 -0.2779
B4 -10.805 414 0.000 -0.5663 -0.6693 -0.4632
In this study, the following hypotheses are formed to explore the relationship between perceived security for
online shopping, customer trust and loyalty.
H1: There is a relationship between trust and perceived security;
H2: There is a relationship between trust and loyalty;
H3: There is a relationship between perceived security and loyalty.
When the hypotheses were tested with regression analysis, the relationship between trust and perceived
security was found to be statistically significant (p < 0.05). The relationship between trust and perceived security
is a very strong and positive one (r = 0.890). In addition, the correlation coefficient (r2) was calculated as 0.792,
which means that 79.2% of the variation in trust depends on the perceived security. As the perceived security of
online shopping improves, customer loyalty increases. Hypothesis H1 is accepted.
The relationship between trust and loyalty was significant (p < 0.05). The relationship between trust and
loyalty is a positive one (r = 0.737). However, the correlation coefficient (r2) was calculated as 0.543; i.e., 54%
trust variability depends on the loyalty. H2 hypothesis was also accepted. Customer loyalty in online shopping
increases in line with the trust.
The relationship between perceived security and loyalty variables found to be significant (p < 0.05). There is
a positive relationship between perceived security and loyalty (r = 0.871). In addition, the correlation coefficient
(r2) was found to be 0.75, i.e., 75% of variation in the loyalty depends on the perceived security. Accordingly,
customer trust towards online shopping depends on perceived security and trust leads to loyalty.
In the online shopping domain, website security measures improve customer trust and this trust results in a
customer loyalty.
Results
This study considered three factors associated with online shopping: perceived security, trust and loyalty.
Respondents of the study questionnaire in general argued that the websites have not taken adequate security
measures and thereby, they do not have trust in online shopping. However, customer trust and loyalty are very
important in online shopping, and customers do continue to shop at the websites which they have shopped before
and recognized as trustable.
Following conclusions are derived with hypothesis testing in this study; as a company’s perceived security
of online shopping site increases, also does the customer trust. With increasing level of customer trust in online
shopping, loyalty also increases. All in all, customer loyalty depends on the security measures provided by online
shopping websites; these measures improve the perceived security and consumer trust, which in return increases
the loyalty.
Discussion
In recent times, online shopping is more and more gaining edge towards the traditional shopping. As of
today, approximately one-tenth of the world’s population buys and sells over the internet. Customers purchase
more books, video games and plane or bus ticket over the internet than they do over the counter.
To succeed in online shopping, companies have to own a website which carries certain features. For instance,
the website should be simple but eye-catching, easy to access and navigate through. All in all, perceived security
of the website is fundamental as it directly affects the consumer trust and loyalty. Customers need to disclose
sensitive information, such as personal and financial information, while shopping online; accordingly, companies
should to take stringent security measures to ensure the confidentially of disclosed information, especially in their
payment processing systems in use.
Businesses should clearly treat security as a priority as consumer trust is the key to success. Customers, not
surprisingly, prefer to only trustable website. In recent years, among the multiplying number of companies with
online sales services, the ones that have invested more on security measures attracted more costumer interest.
The navigation functionality metric, comprised of operational efficiency, the speedy transmission of words
and images, and modern technology, has a significantly positive effect on a site’s perceived trustworthiness and
reliability. Security also had a significantly positive influence on satisfaction. These and other relationships have
been tested in previous studies and our findings are consistent with other reports (Kim & Lim, 2005; Shankar,
Urban, & Sultan, 2002; Suh & Han, 2003). Our findings indicate that increasing customer trust in online
shopping results in increased loyalty.
Findings of this study are consistent with the prior researches, such as Kim and Lim (2005); Shankar, Urban
and Sultan (2002); Suh and Han (2003), which have explored the relationship between security and loyalty;
depending on the security measures provided by online shopping websites, customers become more loyal to the
site.
Limitations and Future Research

This study has a few limitations that need to be pointed out and recognized when interpreting the results.
One obvious limitation is that the study covers customers using the online shopping in one province of Turkey.
However, to reach all customers nationwide who shop online would necessitate a larger budget, more staff and
longer time—all of which could not be afforded due to the economical constraints. Convenience sampling
method was applied; 450 survey forms were distributed and recollected in the scope of the study—out of which,
35 of them were missing or filled in with contradictory and erroneous information; these were excluded from the
scope of research. The final number of valid responses was 415.
Another potential limitation is the use of behavioral intention to measure the behavioral component of
attitude. In addition, this research only explored the customers in Turkey, and future studies can be performed in
other countries to compare similarities and variations among different countries. Such reviews and summaries
provide a solid foundation on which we, as researchers, can build future studies.
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November 2011, Vol. 10, No. 11, 998-1008
Growth Potential and Profitability Analysis of Insurance

Companies in the Republic of Serbia
Dragana Ikonić, Nina Arsić

Higher School of Professional Business Studies, Novi Sad, Republic of Serbia
Snežana Milošević
Economic and Trade High School, Senta, Republic of Serbia
Economically developed countries hold much of its total wealth as financial savings, and they should faster
experience higher rates of overall economic growth in the long run. Given the level of income made by economic
entities and according to such correlation, their propensity to save can be generated. As a clear reflection of the
development of the financial sector, insurance companies as financial intermediaries, through the mobilization of
savings, contribute to the development of the entire financial sector. Analyzing the performance of insurance
companies in Serbia, CARMEL method will be applied, which includes indicators for the presentation of
quantitative criteria for the purpose of monitoring and analyzing the profitability of insurance companies consisting
of a model that is the current methodology of the MMF. In addition to traditional financial instruments, derivative
securities are traded in financial markets, promoting the development of financial markets, such as options, which
are generators of potential growth of profitability. The aim of this paper is to show the growth potential of
profitability in insurance companies, as well as decreasing risks which are connected to the business activities by
the use of options.
Keywords: growth, profitability, insurance companies, options
Growth Potential of Insurance Sector

The Development of Insurance Sector
As far as modestly developed Serbia’s insurance market is concerned, the premium from credit portfolio of
insurance is insignificant because credit insurance is widespread among developed economies. The consequences
of global financial crisis that are largely seen in our country are characterized by limited supply of capital, more
expensive loans and decreased demand. With the present problem of getting receivables, it is clear that there are no
signs of developing credit insurance sector in Serbia. From the perspective of financial markets, insurance
companies and pension funds play the significant role as institutional investors in various securities. So with these
Dragana Ikonić, MA of Economics, Research Associate, Higher School of Professional Business Studies.
Nina Arsić, MA of Law, Research Associate, Higher School of Professional Business Studies.
Snežana Milošević, MA of Economics, Professor, Economic and Trade High School.
Correspondence concerning this article should be addressed to Dragana Ikonić, Vladimira Perica Valtera 4, 21000 Novi Sad,
Republic of Serbia. E-mail: dragana_ikonic@yahoo.com.
GROWTH POTENTIAL AND PROFITABILITY ANALYSIS OF INSURANCE COMPANIES 999
investments, they enable a significant and major increase in the liquidity of the market, as well as its overall
performance. Sales of insurance policies to residents and businesses represent and create a long-term source of
funds. These activities can be used to purchase long-term financial instruments—stocks and bonds, and short-term
securities. The basic and the key form of insurance in developed countries, like the United States, is life insurance,
while in less developed countries like the Republic of Serbia non-life property insurance is dominant.
The banking sector dominates the financial market in Serbia and it is followed by the insurance sector. It
cannot be said about the fund industry which is just in the state of approximate trend. By the fact of delaying the
development of domestic investors created a significant gap, which was filled with foreign portfolio investors.
Regarding fund industry, the first and the crucial steps were made by voluntary private pension funds supervised
by the National Bank of Serbia (Ikonić, Arsić, & Milošević, 2011).
In the total assets of the financial sector in the year 2010, which amounted to 2,759 billion dinars, banks
accounted for 91.8% and the insurance company with 4.2%, as shown in Table 1 (National Bank of Serbia, 2010).
Table 1
The Share in the Total Financial Sector in Percent
Banks Leasing Insurance DPF
2008 2009 2010 2008 2009 2010 2008 2009 2010 2008 2009 2010
Total assets 89.3 90.8 91.8 6.2 4.7 3.6 4.3 4.2 4.2 0.2 0.3 0.4
Capital 93 92.1 92.5 1.4 1.9 1.5 5.6 6 6
Number of 72.2 72.5 71.8 1.2 1.1 1.1 26.2 25.9 26.8 0.5 0.4 0.3
employees
The structure and process of forming of financial institutions largely depend on the extent of development of
financial market. Apart from legal limitations, there are other factors influencing the development of financial
market, such as, political and economic conditions, currency stability, appropriate level of savings, etc..
Contemporary financial markets should have tendency to create business environment both for classic financial
institutions and for new ones, which will offer a wide selection of financial services.
It can be stated that insurance sector is inadequately developed in Serbia. Not only is the level of its
development below EU average, but there are also other indicators of development (the relationship between total
premium and gross national product, and total premium per capita).
By influencing the rise in the price of risk and fall in the investment income, financial crisis causes the need
for increasing the insurance premium. Figure 1 shows the development of insurance in some European countries,
which can be analyzed in terms of share of premium in gross national product (Swiss Re, Sigma No. 2/2005, No.
5/2006, No. 4/2007, No. 3/2008, No. 3/2009). In the period between 2004 and 2008, Serbia held the 62nd
position in the world, and comparing with the group in which it has been placed it can be concluded that Serbia
has the satisfactory position since the countries like Romania and Turkey are behind Serbia. Switzerland has the
highest percentage of share (with the tendency of decreasing the share), followed by Germany and Spain (Swiss
Re, Sigma No. 2/2005, No. 5/2006, No. 4/2007, No. 3/2008, No. 3/2009).
The information about total number of insurance companies states that there were 26 insurance companies
in the first quarter of 2010 (National Bank of Serbia, 2010). There are 22 companies involved into insurance
affairs, and only four companies have re-insurance services included (Law on Insurance, The Official Gazette of
1000 GROWTH POTENTIAL AND PROFITABILITY ANALYSIS OF INSURANCE COMPANIES
the Republic of Serbia, 2004). Among companies dealing with insurance, there are seven companies involved in
life insurance, nine companies working exclusively with non-life insurance, and there are six companies dealing
with both life and non-life insurance. Breakdown by ownership shows that 19 insurance companies were in
majority foreign and seven in majority domestic ownership as of 2009.
14
12
10
8 2008
2007
6
2006
2005
4
2004
2
Figure 1. The level of development of insurance in some European countries: The share of premium in GNP.
The sector grew at a much slower pace (16.5% in 2008 vs. 2.6% in 2009), but its overall performance may
be assessed as encouraging given the crisis environment. The total premium in 2007 ($ 44.8 billion) rose by 16.9%
compared to the premium in 2006, whereas the increase in the total premium in 2006 was 10.3% compared to
2005. If we observe the first quarters in the period between 2006 and 2010, the rise in premium can be noticed
(16%, 17.9%, 1.09%, and 2.41% respectively). Observing the changes of total premium in the period from 2005
to the first quarter of 2010, it can be concluded that it had the tendency of rise, which is seen in Figure 2 (National
Bank of Serbia, 2009).
Observing the premiums per capita in 2008 it can be seen in Figure 3 that Serbia holds 62nd position in the
world with $ 126.1, whereas the same indicator for EU-27 countries is $ 3,061. The UK holds the first place with
$ 6,858, followed by the Netherlands with $ 6,849 and Switzerland with $ 6,979.4. Hungary and Croatia are in
the 41st and 42nd position with the premiums per capita of $ 501.4 and $ 430.7 respectively, whereas Turkey
holds the 65th position with $ 116.1.
In the period between 2004 and 2008 Serbia on average holds the 65th position in the world with the
decreasing tendency of premium per capita. Turkey holds the 61st position on average with the average premium
per capita of $ 115 in the given period. Hungary and Croatia hold on average the 38th and 41st position with the
average premium per capita of $ 398 and $ 326 respectively. The Netherlands holds the 5th position with the
average premium of $ 4,855 per capita. The UK has the 1st place in the world, with the average premium of
$ 5,909 per capita (Swiss Re, Sigma No. 2/2005, No. 5/2006, No. 4/2007, No. 3/2008, No. 3/2009).
I II III IV
52.2 53.5
44.8
38.3
34.7 40.1 40.9

34.4
29.8
26.5 28.7 28.5
21.3 24.1
18.5 11.5 13.6 13.7 14.1
9.9
2005 2006 2007 2008 2009 2010
Figure 2. Quarterly movements in total premium (2005-2010) in billions of Serbian dinars (RSD).
100% 6,379
6,858 6,849 501 431 126 116
80%
7,114 5,741
6,263 492 371 111
60% 103
5,562
6,467 3,829 376 308 89
40% 5,558 77
4,599 3,741 334 275 79
20% 49
4,508 3,599 5,716 287 248 45 65
0%
United Netherlands Switzerland Hungary Croatia Serbia Turkey
Kingdom
2004 2005 2006 2007 2008
Figure 3. Premium per capita in European countries in dollars (2004-2008).
The development of insurance sector in its full potential would create a proper framework for appliance and
use of other financial instruments such as financial derivatives.
Options in the Function of Profitability Growth of Insurance Companies
The main role of creating products is protection against risk, or reduction and elimination of harmful
consequences of a financial risk. Traditionally, the public discourse on derivatives mentions hedging and
speculative activities as complementary concepts. Modern approaches do not place hedging in the foreground but
point out that derivative instruments are tools that should serve companies in a better assessment of financial risk,
and they undoubtedly contribute to the possibility of generating higher profitability. Financial derivatives are
controversial instruments for many reasons. First they are complex and thus seen as unclear to use, but where
theorists and practitioners agree on is the fact that their use is subject to their full understanding; otherwise, the
outcome is not certain.
If we take into consideration the degree of development of domestic financial markets, there is an obvious
significant lagging behind the international market of financial derivatives. During the last years, there has been
removal of a number of factors critical for this lag in the development of domestic financial market, but the
consequences of these factors still exist and can be felt. It is essential to have intense involvement of economy
and banks in international financial markets in order to achieve the development of financial derivatives market
in Serbia. Encounter between interest rates and exchange rates from foreign markets and local entities involved
in these flows will result in risks from international financial environment.
In order to protect themselves against currency and interest rate risk, domestic entities must know of
instruments, techniques and strategies of trading on uncertain foreign market derivatives. Positive legislation in
the Republic of Serbia provides enough space for the development of this market, but so far important results
have not been achieved in this segment. Experts say that there are many factors influencing the development of
derivative markets in our country. The most important factors are as follows: faster development of spot
financial markets, efficient protection of creditors’ rights, active role of government in this segment,
transformation of banks and economy and appropriate measures of monetary and fiscal policy. If the factors of
development of derivative markets are rapidly implemented and brought into effect, dynamics of financial
markets will be automatically more noticeable. There is no doubt that the current situation in our market cannot
be compared with the situation that existed just a decade before. In fact, long-term credit instruments lacked in
the market ten years ago, but today there are foreign currency savings bonds with long maturity, and the stock
market is much better organized (Skakavac, 2008). A similar development path as in developed markets is
expected and it will surely start with the classic futures forward contracts as the simplest financial derivative,
but later more sophisticated financial instruments will occur, such as options, futures and swaps.
It is possible to predict that the market of financial derivatives in our country at an early stage in its
development will have inter-bank character, with sporadic participation of some highly rated companies,
whereas the share of the corporate sector and the citizens can be expected with the institutionalization of the
clearing house and establishment of appropriate mechanisms to guarantee the performance of the contract.
A popular segment of the financial markets in the world is the market of financial derivatives. There are
trade operations with derivatives such as futures, options, forwards and swaps. The basic function of derivative
financial products is the protection from risk. The fact that applies to developed countries is that the number of
investors trading with options tends to increase in contrast to the total number of investors. It is believed that
there are significant opportunities to expand benefits and options for switching activity from over-the-counter
market to stock market. The volume of options trading at CBOE is shown in Table 2 (Retrieved from
www.cboe.com).
Table 2
The Volume of Options Trading at CBOE
2010 2009 2008
Shares 572,688,137 634,710,477 604,024,956
Indexes 269,989,511 222,787,514 259,499,726
Trading instruments 276,362,700 277,266,218 329,830,388
Total 1,119,040,348 1,134,764,209 1,193,355,070
Table 3
Global Options Markets
Volume traded Notional value Open interest Number of trades Option premium
Exchange (Nber of Contracts) (USD millions) (Nber of Contracts) (USD millions)
2009 2008 2009 2008 2009 2008 2009 2008 2009 2008
Americas
BM&FBOVESPA 546,547,550 350,046,283 931,053 855,086 7,299,503 2,847,679 14,842,470 11,877,646 28,676 21,956
Boston Options 137,784,626 177,600,467 24,902 44,463 NA NA 7,869,962 9,544,517 24,902 44,463
Exchange (2)
Buenos Aires SE 25,132,711 25,165,308 NA NA 747,190 344,528 535,375 578,555 241 339
Chicago Board 634,710,477 604,024,956 2,187,581 2,717,661 188,281,057 187,131,615 46,078,979 35,461,401 111,455 172,815
Options Exchange
(CBOE)
International 672,429,815 687,165,942 NA NA NA NA 44,122,185 NA NA NA
Securities
Exchange (ISE)
MexDer 345,718 585,037 73 154 3,960 17,486 3,288 6,104 NA NA
Montréal 14,507,261 14,633,599 76,246 73,732 1,547,120 1,453,365 839,596 765,794 2,060 3,182
Exchange(1)
NASDAQ OMX 426,245,722 537,954,692 NA 225,858 193,253,211 235,799,395 23,782,783 36,343,109 123,339 225,859
PHLX
NYSE Amex 170,978,207 121,342,636 NA NA NA NA NA NA NA NA
NYSE Arca 273,769,123 270,939,723 NA NA NA NA NA NA NA NA
Options
Asia Pacific
Australian 15,242,798 17,043,125 196,892 262,171 1,451,359 1,328,769 1,460,904 1,509,062 23,405 32,629
Securities
Exchange (Inc.
SFE) (4)
Hong Kong 41,863,995 48,038,651 127,339 168,772 3,836,130 3,978,418 NA NA 9,623 16,419
Exchanges (1)
Korea Exchange 982 21 0 0 0 0 21 19 0 0
National Stock 14,066,778 11,067,082 88,173 50,851 41,012 153,609 10,928,922 7,973,108 2,998 1,860
Exchange India
Osaka Securities 408,612 534,954 NA NA 20,897 86,764 78 601 110 134
Exchange
TAIFEX 8,240,390 872,880 14,824 5,319 2,584 574 110,547 29,666 19 13
Tokyo Stock 660,875 88,256 NA NA 102,789 44,628 NA NA 46 4
Exchange Group
Europe, Africa,
Middle East
Athens Derivatives 67,590 182,757 133 677 1,615 6,272 3,218 2,728 10 55
Exchange (3)
Borsa Italiana 20,462,240 20,056,426 71,873 112,613 2,719,744 2,748,370 459,087 545,541 NA NA
Eurex (1) 146,286,451 197,338,587 353,285 881,388 NA NA 2,822,091 2,814,787 NA NA
Johannesburg SE 15,670,869 19,591,351 NA NA 2,814,565 32,236,246 6,960 9,079 984 1,346
MEFF(1) 35,527,914 18,317,249 56,253 35,357 7,728,251 4,669,410 77,754 59,053 3,290 2,091
NASDAQ OMX 28,775,091 42,767,407 399,648 47,388 3 844 093 4,913,148 NA NA 1,873 2,866
Nordic Exchange
NYSE Liffe 141,604,421 142,684,583 325,405 461,824 32,661,287 33,374,165 3,407,139 3,676,891 24,969,263 39,222,710
(European markets)
(1) (5)
Oslo Børs 2,219,926 3,976,223 1,493 5,377 NA NA NA NA NA NA
Tel Aviv SE 321,735 0 1,200 0 23,192 0 5,165 0 84 0
Wiener Börse 474,697 848,021 596 3,946 70,363 78,631 14,290 17,510 55 163
Total 3,374,346,574 3,312,866,216
The largest volume of trading in global markets is conducted in CBOE Stock Exchange, (which is shown
in Table 3) with nearly one billion contracts in 2008 (Retrieved from www.world-exchanges.org), which is
ahead of other Asian and European stock markets. CBOE also had the largest number of trade operations as
well as the largest amount of premiums (Alijanović, Poklepović, & Šego, 2009). The prerequisites for the
survival of derivates market are transparency and regularity.
In order to provide the unique market at the level of the European Union, the latest framework for regulation
is Solvency II. This act will be applied in Serbia in 2012. Solvency II acknowledges the influence of all risks that
insurance companies face while determining the level of capital adequacy. For European insurers it is particularly
significant that Solvency II regulations will enable long-term sustainability of the insurance sector as a whole,
bearing in mind the key experience gained during the crisis. Solvency II will have a significant role in the field of
determining the adequacy and efficient allocation of capital, which has a direct influence on the reduction of costs
for the insured, better protection from failure because the capital is adapted to the appropriate risk and on the
promotion of good examples of risk management (Swiss Re, Sigma No. 4/2006).
Global structure of balance sheet of insurance companies in Serbia is not stable. One of disadvantages of
insurance companies is the fact that the value of fixed assets exceeds the value of working capital. Thus in 2008
and 2009 the value of fixed assets was about 35 and 41 billion dinars respectively, whereas the value of working
capital was about 20 and 22 billion dinars. The relationship between fixed assets and capital are similar in 2007,
2006 and 2005 (30.1: 24.7 bn dinars, 24.9: 20.9 bn dinars and 22.5: 17.6 bn respectively). Immobile assets in the
form of intangible assets show that it is difficult to make distinction between a non-insurance company and
insurance company, or in other words, insurance companies recognize only those funds that are easy to be dealt
with and are called approved funds. All these should be included in the balance sheets of insurance companies,
whereas the permanent assets should be excluded from the balance sheet and thus property part of the balance
sheet would be underrated (Ostojić, 2004). The above-mentioned problem and new institutional regional
decisions make insurance companies transfer to property and life insurance by high capital census and strict
division.
Despite the potential that financial derivatives (options) have, they are not used in the Republic of Serbia.
The reason is that financial markets and financial institutions are at a low level of development and that financial
derivatives still have only theoretical but not practical potential. The involvement in international financial flows
would create the need for using the options, and thus there will be their contribution to profitability growth of
appropriate insurance institutions.
An Overview of Determinants of Profitability of Insurance Companies

Theoretical and Practical Framework of the Analysis of Profitability Indicators
The National Bank of Serbia, as a regulatory body, set out six guidelines from the field of insurance, whose
aim is to protect the interests of the insured and insurance beneficiary, create trust of citizens in financial and
insurance sector in order to establish a safe and stable insurance market. These guidelines include different fields
necessary for business operations, supervision, reporting and development of corporative managing of insurance
companies. Their aim is to suggest a way of organizing and carrying out the business activities to insurers, so the
efficiency can be improved.
The National Bank of Serbia created the guidelines (Carmel indicators) following IMF methodology so the
performance assessment of insurance companies is not only standardized but simplified. They are criteria for
quantitative monitoring and analysis of financial stability of insurance companies. The indicators of capital
adequacy are the first to be applied in determining profitability of a certain insurance companies.
The analysis of indicators of capital adequacy shows how a certain insurance company is profitable.
Determining capital adequacy according to Carmel methods consists of the following subgroups of indicators:
C1: Self-insured retention premium/Total capital. This indicator measures the relationship between
self-insured retention premium and total capital of an insurance company. Self-insured retention premium is the
approximation of risks considered in insurance contracts by insurance companies involved in non-life insurance.
The significance of this premium is reflected in its capability to absorb inadequate price level of premiums and
potential unexpected damage covered by insurance. More precisely, self-insured retention premium measures the
insurance risk.
If the total value of this indicator is high, it can be concluded that the total capital is inadequate comparing to
taking risks considered in insurance contracts (which is measured by the level of premium). Conversely, a low
value after comparing self-insured retention premium and total capital brings to conclusion that capital resources
are not used properly or that the insurance company has problems and it cannot generate its portfolio.
C2: Total capital reduced by loss/Total assets. This indicator measures the relationship between the total
capital reduced by loss and total assets of the insurance company. This indicator measures the exposure of
insurance company to market, investment and credit risk. The low value of this indicator may point out to the
high exposure of the insurance company to these types of risks.
C3: Total capital reduced by loss/Technical reserve. If C3 indicator shows very high levels, there is
inadequacy of total capital compared to take risks according to insurance contracts (measured by the level of
technical reserve). The high level of indicators may signal a bad use of capital resources or failure to generate its
portfolio.
An insurance company is obliged to determine, at the end of accounting period, the technical reserve for
settling liabilities from insurance contracts (Law on Insurance “Official Gazette of RS”, No. 55/2004,
70/2004-red. and 61/2005.) and they serve for settling liabilities set forth in the issued insurance policies.
Technical reserve is generated from the technical premium funds. Their level is determined by actuarial methods
and it depends on future liabilities and structure of insurance portfolio.
In order to have more active insurance companies in financial market, there is an institutional framework
provided where free financial funds can be placed. According to the Law on Insurance there is a clear picture
what portion of technical reserve can be placed by insurance companies (Official Gazette of RS, No. 83/2005),
but not to cause non-liquidity problems.
C4: Collateral reserve/Solvency margin. This indicator shows the relationship between collateral reserve
and solvency margin. An insurance company in its business operations, i.e., settling its liabilities, does not use
premium gains or placement from invested funds. The reason for that is the difference in business operations
among insurance companies. That is why forming the reserve is necessary for the insurance companies. The
reserve is formed by taking financial funds from gains, premium and start-up capital.
Collateral reserve is a form of guarantee that the insurance company will settle liabilities on the basis of
insurance. It is the indicator of solvency. According to the Law on Insurance, collateral reserve must always be
higher than the calculated solvency margin. An insurance company must have collateral reserve or capital in
order to settle its liabilities. The insurance company is obliged to deposit and invest collateral reserve (Official
Gazette of RS, No. 83/2005) in accordance with the insurance rules and good business customs. Likewise, the
collateral reserve should be defined in the methods and amounts prescribed by the Law and with the aim of
keeping and protecting its real value.
An insurance company must provide prescribed solvency margin. The solvency margin represents the
quantitative indicator of solvency, i.e., the surplus of liquidity assets over the liabilities of the insurance company.
The level of collateral liquidity must be higher than established solvency margin, i.e., its amount cannot be less
than fixed assets. If there are variations, or in other words, if collateral reserve does not reach the amount of
calculated solvency margin, the insurance company shall launch the harmonization programme within 30 days
from the day of stating irregularities. Solvency margin is a guarantee that the liabilities of paying insured amount
and indemnities will be settled in case the insurance company has financial problems. Solvency margin also
represents the signal for supervisory board to take certain measures in case there are threats to solvency margin.
The analysis of profitability indicators brings to a clearer image of success of certain insurance companies.
More detailed analysis of this indicator into parts refers to successful business operations of insurance companies.
The necessary information is obtained from balance sheet, income statement and notes from financial reports as
well as from consultations from the heads of insurance companies. The notes for 2009 and 2008 at the example of
Dunav Insurance and DDOR Insurance will be presented hereinafter (see Table 4).
Table 4
Overview of Subgroups of Indicators for Dunav and DDOR Insurance
Amount in thousands
Group Indicator
2009 2008
C1 Self-insured retention premium/Total capital 122.1% 111.1%
C2 Total capital reduced by loss/Total assets 40.9% 40.7%
C3 Total capital reduced by loss/Technical reserve 81.1% 81.8%
C4 Collateral reserve/Solvency margin 329.4% 298.5%
By comprising the previously stated indicators of capital adequacy that have been practically applied, it can
be concluded that there are signs of success, i.e., profitability of the insurance companies. Namely, by analyzing
and interpretation of the capital adequacy indicators it is noticed that DDOR Insurance creates a lower level of
profitability compared to Dunav Insurance.
Conclusion
A strong competition among the business entities participating in the market is more and more present in our
region as well so the right observation and analysis of the business success is of paramount importance. The
reason for that lies in the need for better understanding of the current position and better design of future business
operations. Only companies that make right decisions are able to quick and efficient implement those decisions
and they are characterized as successful companies.
In the first parts of papers, we attempted to show development of the insurance sector in the Republic of
Serbia in comparison with other developed countries. Insurance is today one of the most profitable activities in
the economies of European countries, and such tendency is seen in Serbia. The results of the research in the first
part conclude that the insurance market in Serbia is among so-called developed markets with the chance to grow
and be more prosperous. The conclusion of the National Bank of Serbia is that the insurance market and the level
of its development are not at the satisfactory level. As indicators of the level of development of insurance market,
in the first part of the paper are given the following: the share of the premium in gross national product in the
period between 2004 and 2008, and here Serbia is on average at the 62nd position. Therefore it can be said that
Serbia is at the satisfactory level since Romania and Turkey are behind according to this ranking. The movement
of the total premium from 2005 to the first quarter of 2010 has been shown and it is seen that it had risen. The
premium per capita for the period between 2004 and 2008 has been observed, and here Serbia holds 65th place in
the world with rising tendency which is now $ 80 on average. For example, Hungary and Croatia hold 38th and
41st place respectively with the average premium per capita of $ 398 and $ 326 respectively in the given period.
Most reputable experts dealing with the analysis of business operations of insurance companies point out that
Serbia will, after overcoming the financial crisis, have an increase in the insurance premium that will exceed the
growth of the gross national product.
Developed financial markets show a tendency to increase the number of option contracts as well as other
financial instruments. Through greater regulation and transparency of capital market in the Republic of Serbia,
trading derivative securities, including options, should be introduced in the future and this introduction will be
beneficial to the growth of profitability of insurance companies. Also the introduction of options on our stock
exchange would be of great importance for capital market in Serbia because it would announce new possibilities
for placing the funds.
The results of the research in the latter part of the paper point out that an insurance company may achieve and
keep desirable level of profitability if it has an adequate level of capital. Transparency of business operations has
been promoted since annual reports of insurance companies are available to the public on the Internet. It has been
emphasized that this analysis is based on the indicators of CARMEL methods adapted to insurance companies. By
this method it is possible to increase the extent of transparency and comparability because the National Bank of
Serbia automatically takes all the indicators of CARMEL methodology into consideration. Within the analysis of
profitability the indicator of capital adequacy has been used and it is undoubtedly the essence of today’s business
operations of insurance companies because its function is to absorb the risks, create security for the insured and
provide the survival on the insurance market. The capital of insurance companies should satisfy internal capital
requirements as well as the requirements of regulatory bodies or ranking agencies. The above-mentioned
theoretical assumptions have been applied at the example of DDOR and Dunav Insurance.
Insurance companies thus will be able to utilize serious and scientifically based and practically proved ways
and to fulfil their inclination towards successful business operations in comparison with their rivals—now and in
the future.
References
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10, 123.
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November 2011, Vol. 10, No. 11, 1009-1020
Sustainable Consumption and Production

in the Baltic Sea Region
Janis Brizga
University of Latvia, Riga, Latvia
Dzintra Atstaja
BA School of Business and Finance, Riga, Latvia
Dzineta Dimante
University of Latvia, Riga, Latvia
Economic activity always has an impact on the environment, but the potential degree of this impact depends on
consumption and production patterns. The aim of this paper is to analyse the environmental and well being impacts
of consumption and production systems in Baltic Sea Region and draw conclusions about transferring of best
practises in Latvia. This study is based on indicator analyses, focusing on data of environmental impacts from
consumption and production in the region, and analyses drivers behind these impacts. The paper concludes two
trends—Scandinavian countries and Germany which have more advanced economies demonstrate much higher
ecoefficiency and environmental management practices compared to the new EU member states. The example of
the Baltic Sea region shows that high income levels and a stable development path in the old EU member states
provide grounds for technology advancement to reduce the environmental impact of production. However Baltic
States and Poland on average demonstrate much more sustainable consumption patterns. But the trends in these
countries are negative—they try to copy lifestyles and consumption patterns of more advanced economies with
higher ecological footprint. Challenge for Latvia is to improve its ecoefficiency but at the same time develop more
sustainable consumption patterns.
Keywords: Baltic Sea Region, economy, environmental impact, efficiency, environmental management,
sustainable consumption and production
Introduction
The purpose of this paper is to analyse the impact of economies in different stages of development on state
of the environment and well being of the population, using the example of the Baltic Sea Region (BSR) countries
and drawing conclusions about the possibilities of introducing best practises from the region in Latvia.
Janis Brizga, Ph.D. candidate, Department of Environmental Management, University of Latvia.

Dzintra Atstaja, Professor, Department of Entrepreneurship and IT, BA School of Business and Finance.
Dzineta Dimante, Ph.D. in Economics, Assistant Professor, The Chair of Economic Systems Management Theory and Methods,
University of Latvia.
Correspondence concerning this article should be addressed to Dzintra Atstaja, K.Valdemara Street 161-407; Riga, LV 1013,
Latvia. E-mail: dzintra.atstaja@ba.lv.
1010 SUSTAINABLE CONSUMPTION AND PRODUCTION IN THE BALTIC SEA REGION
The Baltic Sea Region is made up of nine countries and a number of metropolitan areas. The region
encompasses Estonia, Latvia, Lithuania (The Baltic States), Sweden, Denmark, Finland, Germany, Poland, and
North-West Russia, with St. Petersburg and Kaliningrad Oblast, the Russian exclave between Poland and
Lithuania (see Figure 1). All countries except Russia are members of the European Union. The paper examines
only those BSR countries which are EU member states—Denmark, Estonia, Finland, Germany, Latvia, Lithuania,
Poland and Sweden.
Figure 1. Map of Baltic Sea Region. Source: UNEP/GRID.
BSR is rich and diverse in ecosystems as well as in economic activities. It inhabits around 100 million
people and produces many services and industrial and agricultural goods. However consumption and production
patterns in the BSR have an increasing influence on global resources and ecosystems. The earth has entered into
a new epoch where humans constitute the dominant driver of change to the Earth System and abrupt global
environmental change can no longer be excluded (Rockström et al., 2009).
Current economic downturn in many Baltic Sea countries can be used as a starting point for making
considerable changes in these patterns, paying more attention to the environmental constraints, economic
efficiencies and social wellbeing. To ensure this kind of economic development or sustainable consumption and
production there are three types of strategy to apply (Shove, 2004; Sayfang & Paavola, 2007; Bauler et al., 2009;
Paredis, Crivits, Bauler, Mutombo, Boulanger, & Lefin, 2009): (1) Ecoefficiancy strategy aims to reduce the
intensity in materials (including the non-renewable sources of energy) throughout the life-cycle of products and
services; (2) Structural change strategy aims at changing supply side; and (3) Sufficiency strategy aims to
de-linking the product functions from the wellbeing they generate1.
1
Different authors use different terms for these strategies. For example, Sayfang and Paavola (2007) talks about market
(ecological modernization), hierarchical (systems of provision) and egalitarian (social marketing) approaches, Shove (2004)
proposes to focus on promoting efficiency, restructuring supply and restructuring demand, but Paredis et al. (2009) calls them
eco-efficiency, de-commodification and sufficiency strategies.
SUSTAINABLE CONSUMPTION AND PRODUCTION IN THE BALTIC SEA REGION 1011
There are many regional initiatives executing these strategies in the BSR and several intergovernmental
institutions like Council of the Baltic Sea States (Baltic 21), HELCOME and the EU strategy for the Baltic Sea
Region which amongst other things try to solve the conflicts arising between environmental protection, economic
development and social welfare. Most of these governmental and intergovernmental initiatives focus primary on
the efficiency strategy and use of economic instruments. These instruments are especially effective in
circumstances of market economy and influence producers’ possibilities and consumers’ behaviour in the market
(Central Intelligence Agency, 2008). Hoverer, this approach alone cannot deliver sustainable consumption and
production (Greening, Green, & Difiglio, 2000; Fuchs & Lorek, 2005; Rubik et al., 2009; Jackson, 2009), as it
does not take into account absolute numbers and scale and in many cases ignores possible rebound effects.
Assessing how green the economies of BSR are, we analyse data reflecting environmental impacts from
consumption and production in the region. There are many drivers behind these impacts and that’s why we used
variate of indicators which characterises these diverse relationships between divers, pressures and impacts on
environment and human prosperity.
Sustainable Consumption Patterns

BSR countries differ considerably according to the GDP per capita in comparison to industrially developed
countries and transition economies. Old EU member states weighted average GDP per capita in 2008 was around
31.8 thousand EUR in current prices with decrease in 2009 around 4.6 per cent. New EU member states or
transition countries weighted average GDP per capita in the same period was around 9.6 thousand EUR in current
prices with decrease around 15 per cent in 2009. So in 2009 average income difference between old and new
member states is 3.7 times. Household spending accounts for a significant proportion of GDP, averaging just
around 57 % in the BSR (Eurostat).
Also the inequality of income distribution reflected by Gini index is higher in transition economies (see
Table 2), which means that there is considerable share of people living in poverty. This causes a dilemma
between economic growth and environmental protection to be even more complicated.
Having different consumption patterns in various countries the environmental impact from consumption can
differ considerably. Food, housing and mobility are the three main consumption clusters with the highest
environmental impacts (Tukker et al., 2006; Lähteenoja & Lettenmeier, 2007; Moll & Watson, 2009). Household
expenditures are increasing not only in eastern countries of the BSR, but also in Scandinavia and Germany where
absolute per capita expenditures are 3 to 4 times higher than in Baltic States and Poland. In the time period
between 2002 and 2009 household expenditures increased by 6%, but the increase in the consumption clusters
with the highest environmental pressures (food, housing and mobility) in the same period was only 2.7% with the
highest increase in the Baltic States and Poland and some decrease in other BSR countries (Denmark and
Germany in this period has experienced decreasing household expenditures in these sectors).
Biggest environmental pressures related to the food consumption are linked with the consumption of
animal-based products. Meat consumption in the BSR is similar to the rest of EU, but households in Denmark,
Germany, Sweden and Poland consumes on average more meat products than consumers in the Baltic States (see
Figure 2).
There are significant differences in the transportation infrastructure and patterns in the BSR. Train network
is most developed in Sweden, Denmark and Germany and in these countries it represents 8%-9% of in total
inland passenger-km. Number of cars per household also differs significantly (see Figure 3). In those countries
with the highest number of cars per 1,000 inhabitants car travel also represents the higher share in total travel.
120
100
80
60
40
20
0
Germany Poland Estonia Lithuania
Denmark Sweden Finland Latvia
Figure 2. Consumption of meat per inhabitant (2007). Data: Eurostat.
550
Finland
Germany Lithuania
500
Denmark
Sweden
Cars per 1000 inhabitant
450 Poland
Estonia Latvia
400
R² = 0.2913778635
350
300
78 80 82 84 86 88 90 92
Car % in total inland passenger-km
Figure 3. Cars per 1,000 inhabitants and car share in total inland travel. Source: Eurostat.
Also final energy consumption by households differs very much in the Region. Most of the countries over
the last years have experienced slight increase in the total energy consumption (see Figure 4). But at the same
time electricity consumption has increased very rapidly, in Latvia by 50%. Main drivers of increasing electricity
consumption are growing number of appliances (e.g., freezers, washing machines, dishwashers, PCs and other
small appliances) utilized in households as well as increasing diversity of electricity use (not only for lighting,
food storage and entertainment, but also food preparation, air conditioning and hot water preparation).
Housing which represents significant share in the total household expenditures is also responsible for the
biggest share of total energy consumption (in Sweden 60%). BSR is experiencing several trends which facilitate
increasing energy consumption by housing sector. There is increasing number of dwellings, also the size of
dwellings is increasing over the years. But there are also positive trends. Rising energy prices, increasing taxes on
fossil fuels and information campaigns have shifted household energy consumption away from oil and coal to
other energy carriers—mostly biomass and natural gas, but also solar and wind energy is more and more available
and used by households.
1.2
0.8
toa per capita
2002
0.6
2008
0.4
0.2
0
Denmark Estonia Finland Germany Latvia Lithuania Poland Sweden
Figure 4. Household final energy consumption (toe). Source: Eurostat.
Sustainable Production Patterns

Economies of BSR countries which have not undergone the change of economic system have considerably
more developed production sector and are more advanced in technological development. These countries have
also succeeded to be the frontrunners in the development of ecotechnologies—Denmark is well known for its
cluster of wind power generator production, Germany—for developments in wind, solar and geothermal energy
production equipment and components, Sweden—for its use of hydro power and biomass for energy production.
Sweden is the first advanced western economy trying to become oil free for energy production until 2020 without
building a new generation of nuclear power stations.
Considering the great environmental impact of climate change, energy efficiency and the use of energy
resources with less or zero greenhouse gas emissions (GHG) are very important factors assessing economy’s
impact on the environment. Figure 5 shows that all BSR countries have improved their energy efficiency from
1996 until 2008. New EU member states have succeeded reductions by factor 2, but still their average energy
intensity is 2.7 times higher than in the old member states. This can be explained by advanced technologies of the
old member states and new member states’ bad heritage of energy inefficiency from Soviet times especially in the
housing sector. Denmark and Sweden has vast range of environmentally motivated subsidies besides the
traditional economic instruments—charges and taxes (European Environment Agency, 2010).
Not only the old EU member states but also Latvia has had a positive experience in using renewable resources
for energy production. Sweden, Latvia, Finland and Denmark have the biggest share of renewable resources in
total energy consumption (see Figure 6) and these countries have also the highest targets for 2020 set by EU
Directive on renewable energy. Finland, Sweden and Latvia are leaders in EU in biomass production per capita.
There is a continuous debate over economic and environmental impacts of biofuels. Mainly, because biofuel
production compete with food production and may cause an increase in fertiliser and pesticide use which have
adverse negatively effect on ecosystems and biodiversity. Use of renewable resources for energy production is a
very important factor for development of the local economy. The renewable energy sector provides jobs, reduces
transportation volumes, increases energy independence and for many countries improves import-export balance.
These benefits favour development of biofuel industry, but with great attention to sustainable practices and high
environmental standards. According to studies commissioned by the German Ministry of Environment, Germany
had 166 thousand jobs related to renewable energy in 2004 and estimated considerable increase in the future
(UNEP, 2008).
Figure 5. Energy intensity of the economy in BSR countries from 1996-2008 (kg of oil equivalent per 1000 Euro). Source: Eurostat.
Figure 6. Electricity generated from renewable sources in BSR countries from 1998-2010, % of gross electricity
consumption. Source: Eurostat.
To improve energy efficiency and increase the share of energy produced from renewable resources, new
member states should use EU Structural Fund financing and also revenues from Kyoto Protocol emission trading
system. As the restructuring of economies in transition countries has led to a sharp decrease in production sector
and improvement of technologies, the GHG reductions in three Baltic States are even bigger than countries have
committed by Kyoto Protocol (see Figure 7). Therefore the new member states are able to obtain assets from
emission trading and invest them in technologies for reduction of GHG emissions. For example, in 2009 and
2010 Ministry of the Environment of the Republic of Latvia organized contests for investments in energy
efficiency and technology development for 81 million EUR. There is a good cooperation between BSR countries
in joint implementation projects as well. The BSR as a testing ground was an early stage of the overall process of
following and implementation of the Kyoto Protocol.
Figure 7. GHG emissions in CO2 equivalent reductions in BSR countries 1990-2006. Source: United Nations
Framework Convention on Climate Change.
Technological improvements are of vital importance not only in energy use, emissions reduction but also in
saving other resource. These improvements in resource use can be obtained through reductions in material input,
minimisation of waste, reuse, recycling of waste and improved durability of goods. Figure 5 shows that waste
sorting and management system in the new member states has not been developed properly, because on average
in 2008 there is 3.6 times more waste landfilled per capita compared to old member states. Comparing municipal
waste created and landfilled from 2001 to 2008 old member states have landfilled on average 19 percent of their
municipal waste but new member states 79 percent. An analysis of reasons for such disparities revealed that old
member states have more developed waste management systems and also landfill charges are much higher
ranging from 30 to 100 EUR per ton of waste, while new member states have very low landfill charges, for
example, 4 EUR per tonne in Latvia. Estonia has managed to achieve a considerable reduction of municipal waste
landfilled from 95 % in 2000 to around 60 % in 2006 owing to landfilling cost increase by 700 percent. Since
2002 in Sweden and since 2005 in Germany it is not allowed to landfill the organic waste. The graphs in Figure 8
show that it has caused an obvious decrease in weight of lanfilled waste per person. EEA study finds that to be
effective landfill tax rates should be relatively high, although in Estonia rapid increases to a relatively low landfill
tax have achieved a similar effect (European Environment Agency, 2009).
These examples show that in BSR countries with higher per capita income levels using economic
instruments and technology advancements do reduce impact of their economy on the environment. Figure 9
shows the relation between GDP per capita (horizontal axis) and energy intensity (vertical axis) in 2007.
Coefficient of determination 0.8 shows that the exponential equation describes the relation between these factors
is quite close.
From green economics perspective it would be very important to strengthen cooperation between BSR
countries, facilitate technology transfer and share best environmental management practices to decouple growth
of transition economies and their impact on environment. As the Baltic Sea is one of the common goods of the
region and it suffers a lot from pollution caused by surrounding countries’ economies such common effort would
improve the well being of inhabitants of all BSR countries.
Figure 8. Municipal waste landfilled (kg per capita) in BSR countries 1997-2008. Source: Eurostat.
Figure 9. Relation between GDP per capita in current prices and energy intensity in BSR countries during 2003-2009.
Source: Eurostat.
Environmental data of BSR countries reveals that slower growth in transition economies has been beneficial
for some environmental issues, such as biodiversity and protected areas. According to Eurostat, Estonia has
highest percentage of areas protected for biodiversity—17 percent of its territory, Latvia has highest common
bird index 109.7 in comparison to 1990.
Many authors have stressed that there is a necessary drastic reduction of environmental impact of economic
activities to avoid the collapse of civilization and change should come from society by transforming dominant
cultural patterns, changing attitudes and behaviour (Assadourian, 2010; Jackson, 2009; Daly, 2008). Therefore
there is a need for transition not only economic sector and technologies, but also institutional framework which
should encourage prosperity also outside of the market and culture—social-psychological mindset should shift
towards less materialistic values and lifestyles.
While transition countries do not have enough capacity to develop new technologies for decoupling the
growth, they would need to pay more attention to education, awareness rising and promotion of green lifestyles.
In order to find out the real possibilities of involving society in the introduction of environment protection
activities and to clarify a real situation regarding society’s attitude towards environmental problems, we carried
out a survey of the entrepreneurs in Latvia, which could serve as an example for situation in the Eastern part of
the region.
Performance Indicators
To assess how a state of the environment, technological advancements and also public opinion have
contributed to the quality of life and wellbeing of the inhabitants in BSR countries, we use such well developed
indicators as Environmental Performance Index (EPI) and Happy Planet Index (HPI). Environmental
performance index was elaborated by a team of environmental experts at Yale University and Columbia
University. EPI ranks countries on their performance across 25 metrics aggregated into ten categories including:
environmental health, air quality, water resource management, biodiversity and habitat, forestry, fisheries,
agriculture, and climate change. Analysis of the policy drivers underlying the 2010 rankings suggests that income
is a major determinant of environmental success. At every level of development, however, some countries
achieve results that exceed what would be anticipated, demonstrating that policy choices also affect performance
(Yale Center for Environmental Law & Policy Yale University, 2010). Table 1 shows that in comparison to 163
countries all BSR countries occupy ranking in the first half while the old EU member states from BSR and Latvia
have higher scores. Owing to changes in the data and methods used in 2010, the results cannot be directly
compared to 2008.
Table 1
Environmental Performance Index Ranks and Scores for BSR Countries in 2008 and 2010
2010 2008
EPI rank EPI score EPI rank EPI score
Sweden 4 86 3 93.1
Finland 12 74.7 4 91.4
Germany 17 73.2 13 86.3
Latvia 21 72.5 8 88.8
Denmark 32 69.2 26 84.0
Lithuania 37 68.3 16 86.2
Estonia 57 63.8 19 85.2
Poland 63 63.1 43 80.5
Note. Source: EPI.
The Happy Planet Index (HPI) report identifies health and a positive experience of life as universal human
goals, and the natural resources that human systems depend upon as fundamental inputs. A successful society
is one that can support good lives that don’t cost the Earth. The HPI measures progress towards this target—the
ecological efficiency with which happy and healthy lives are supported (The New Economics Foundation,
2009).
HPI scores range from 0 to 100—with high scores only achievable by meeting all three targets embodied in
the index—high life expectancy, high life satisfaction, and a low ecological footprint. The ecological footprint
measures our use of ecological resources and represents the amount of biologically productive land and sea area
needed to regenerate the resources a human population consumes and to absorb and render harmless the
corresponding waste. The earth currently has just 1.8 global hectares available per person. From BSR countries
Lithuania and Latvia have the smallest ecological footprints but still they are almost twice as big as fair share for
each person on Earth. Estonia’s big footprint can be explained by the fact that it produces electricity from oil
shale which is very polluting (Streimikiene & Roos, 2009). Nevertheless, shorter life expectancy and lower life
satisfaction ranks new member states behind the old ones according to HPI.
Whilst the HPI confirms that the countries where people enjoy the happiest and healthiest lives are mostly
richer developed countries, it shows the unsustainable ecological price we pay. It also reveals some notable
exceptions—less wealthy countries, with significantly smaller ecological footprints per head, having high levels
of life expectancy and life satisfaction. In other words, it shows that a good life is possible without costing the
Earth (The New Economics Foundation, 2009).
In case of BSR only Denmark lags behind other old EU member states, but in overall higher life satisfaction
and life expectancy offsets drawback of bigger footprints and Germany, Sweden and Finland have better HPI
scores than transition countries (see Table 2).
Table 2
Performance Indicators of BSR Countries
Foot-print
Life satisfaction Life expectancy GDP per capita HDI Gini coefficient
Country (g ha/cap) HPI HPI rank
(0-10) (years) 2010 (EUR PPP) 2008 (2010) (2008)
2007
Germany 7.2 80.2 5.1 48.07 51 29,000 0.885 30
Sweden 7.9 81.3 5.9 47.99 53 30,700 0.885 24
Finland 8.0 80.1 6.2 47.23 59 29,300 0.871 26
Poland 6.5 76.0 4.3 42.75 77 14,100 0.795 32
Lithuania 5.8 72.1 4.7 40.90 86 15,500 0.783 34
Latvia 5.4 73.0 5.6 36.67 101 14,300 0.769 38
Denmark 8.1 78.7 8.3 35.47 105 30,100 0.866 25
Estonia 5.6 73.7 7.9 26.42 131 16,900 0.812 31
Note. Source: HPI, Eurostat.
Combining HPI, EPI, Human Development Index and Gini coefficient ranks, we conclude that Sweden has
achieved the best results from BSR, followed by Finland, Germany and Denmark. This shows that advancements
in technology, high income levels and well coordinated legislation base, use of economic instruments in old EU
member states have provided good results not only to inhabitants of these countries but also for the environmental
situation.
Conclusions
BSR countries can be considered as good perspective for implementation of green economics because of
considerable achievements in several countries of the region using renewable energy, improving technologies,
preserving environment, reducing inequality, improving well being. Although each country has its own traditions,
history, culture and politics, this diversity can be mutually beneficial in case of good cooperation.
In total the old EU member states from the BSR have managed to achieve better results in ecoefficiacy and
decoupling of resource consumption and pollution from economic growth. Energy intensity of economy, GHG
emission intensity of output and waste management measures are examples of this. The new member states and
whole region can benefit from technology transfer, knowledge sharing and other forms of partnership.
However old EU member state have much higher per capita consumption levels and this leads also to the
higher household direct and embedded energy consumption, waste generation and at the end higher ecological
footprint from consumption. But the trends in the new member states are alarming, as increasing income leads
towards higher resource consumption and pollution levels linked to the life cycle of the products and services.
The ecological situation in transition economies improved considerably when industry output reduced and
policy changed along with the collapse of the Soviet Union. EU accession process also contributed for better
environmental situation as EU Environmental standards and basic environmental management principles were
introduced.
High income, sophisticated environmental policies and technology advancements improve environmental
health, air quality, resource management, higher life satisfaction and life expectancy which offset drawbacks of
bigger consumption in the old EU member states and results in higher rankings in Environmental Performance
Index and Happy Planet Index with some exceptions.
Common resource—the Baltic Sea and good neighbouring relations serve as facilitators for active
cooperation in environmental issues in the region.
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November 2011, Vol. 10, No. 11, 1021-1027
Motifs and Impediments for the Harmonization

of Accounting Regulations for Small and
Medium-Sized Companies in the EU
Tamara Cirkveni
RRiF High School for Financial Management, Zagreb, Croatia
Small and medium-sized companies in most EU countries form a considerable share in the total number of
companies and are also an important development impeller of the entire economy. Therefore, one of the most
essential goals of accounting authorities in the EU is accomplishing the harmonization of accounting regulations
for these companies. In this paper, the author have discussed and explained the main motifs and impediments for
this harmonization. One of the main motifs is a big span and complexity of international standards of financial
reports which is allowed and even prescribed in many countries. Some of the main impediments are a lack of
uniformity as far as criteria for classification of small and medium-sized companies according to size are concerned
as well as the determining of limitations up to which the requirements in accounting standards for small and
medium-sized companies should be set.
Keywords: IFRS for SMEs, accounting regulation, small and medium sized entities, motifs, impediments
Introduction
Efforts to “harmonize” accounting around the world began even before the creation of the International
Accounting Standards Committee. Companies seeking capital outside of their home markets and investments
internationally faced increasing problems resulting from national differences in accounting measurement,
disclosure, and auditing (Choi, Frederick, Meek, & Gary, 2008). In the last thirty years, this process has been
mostly oriented on large entities. The bases of accounting regulation were made by the fourth and the seventh
directive of the EU. However, they failed to obtain a desirable and expected level of financial reporting
transparency and comparability.
The process of adoption of international financial reporting standards (IFRS) in both EU and non-EU
countries has created further bases for establishing accounting regulations, especially for well-rated entities. The
Regulation of the European Parliament and of the Council (1606/2002/EC dated July 19, 2002) (Retrieved July
20, 2010, from http://www.eur-lex.europa.eu) has had an important role in this process and it has also prescribed
a required application of the IFRS for all entities which are rated on the EU financial market and which have been
Tamara Cirkveni, MSEc, Economy Department, RRiF High School for Financial Management.
Correspondence concerning this article should be addressed to Tamara Cirkveni, Vlaška 68, 10 000 Zagreb, Croatia. E-mail:
tamara@rrif.hr.
1022 MOTIFS AND IMPEDIMENTS FOR THE HARMONIZATION
preparing consolidated financial reports since May 1, 2005. This requirement has substantially influenced the
acceptance of the IFRS as a frame of financial reporting for other (both well-rated and non-rated) entities in the
EU member states as well as in African and Asian countries. Although these EU and IFRS directives have played
a vital part in the establishment of the entire accounting regulation, their requirements are adjusted mostly for
large entities which manage a sufficient number of professional accountants and whose beneficiaries of financial
reports need more information about their management. The requirements for small and medium-sized entities,
which account for 95% (Klikovac, 2009) of all entities in most EU countries, were therefore placed in the
background, i.e., they were left to national accounting regulations. Due to those reasons, some countries accepted
the IFRS even for small and medium-sized entities (e.g., Malta, Cyprus), while other countries have created
national standards in order to reduce the requirements in the financial reporting for small and medium-sized
entities (e.g., Great Britain, Slovenia, Ireland, Sweden). Due to the fact that it is obvious that the IFRS are too
complicated to be applied for small and medium-sized entities, the motifs for the harmonization of the accounting
regulations for small and medium-sized entities in the EU are numerous. Seven years ago International
Accounting Standards Board (IASB) has therefore started creating global accounting standards for those entities
as a part of the project “International standards for small and medium-sized entities” (IFRS for SMEs). A lot of
problems occurred in that process, the most important were the lack of uniformity as far as criteria for
classification of small and medium-sized entities are concerned as well as the determining of limitations up to
which the requirements in accounting standards for small and medium-sized companies should be set.
Nevertheless, the IASB published the IFRS for SMEs in July 2009. Ultimately, the open question that still
remains to be answered is whether the European Commission will and in which scope adopt these standards as a
constituent part of accounting legal regime in the EU.
The Characteristics of Accounting Regulative in EU

The European Union (the EU) is a regional organization of European states through which its members
accomplish common goals such as well-balanced economic and social development, high rate of employment as
well as the protection of citizens’ rights and interests. Since January 1, 2007, the EU consists of 27 member states
with the population of approximately half a billion people (Retrieved July 20, 2010, from
http://www.entereurope.hr). The accounting legal regime in the EU is comprised of directives and regulations,
and regulatory bodies that regulate accounting at the EU level are: European Parliament, Council of the European
Union, European Commission, European Financial Reporting Advisory Group and Accounting Regulatory
Committee.
The accounting system of every EU member state as well as of those states which aspire to that status is
based on regulations and directives of the EU. Beside them, an important role is played by decisions,
recommendations and opinions which are passed by the EU legislation. Regulations which are passed at the EU
level are binding for application in all EU member states, i.e., individual adoption for their application is not
needed in the EU member states. At the EU level, several regulations of the European Parliament and of the
Council, as well as of the European Commission have been passed and are referred to the accounting regulative.
The regulation that defined the beginning of harmonization of the accounting regulative in the EU is the
Regulation of the European Parliament and of the Council (1606/2002/EC dated July 19, 2002). According to this
MOTIFS AND IMPEDIMENTS FOR THE HARMONIZATION 1023
regulation all entities which are rated in the financial market of the EU and which prepare consolidated financial
reports are bound to apply the IFRS since January 1, 2005.
The EU directives are adopted by the legislation of every member state. Although all EU member states are
bound to adopt the directives, it does not mean that the institutions within the member state have to comply with
the directives if their content is not prescribed by their legislature. The most important directives which edit
accounting area are the fourth and the seventh directive, as well as the directives which define the financial
reporting in the banks and insurance companies. The fourth directive has harmonized the appearance of balance,
as well as of the profit and loss account, and it has also defined the minimum of information that the notes to the
financial statements have to contain. An important base for the comparability of information in the financial
reporting has therefore been created. The seventh directive has defined the entities which should prepare the
consolidated financial reports and that has standardized the requirements which are referred to those reports.
However, the success of EU harmonization efforts has been debated. For example, member states generally did
not scrap their existing accounting rules when adopting EU directives. Another issue is the scope to which
member states enforced compliance with the directives (Walton, 2007).
The prerequisite for a complete acceptance and spread of the IFRS and which is published by the IASB was
made by the directive. Current application of the IFRS in the world shows that the IFRS are accepted world-wide,
that many countries use them as a basis for their national standards and that they are accepted by numerous
stock-markets and controllers which allow domestic or foreign entities to deliver the financial reports prepared
according to the IFRS (Choi, Frederick, Meek, & Gary, 2008). The application of the IFRS during the preparation
of consolidated financial reports for non-rated entities is allowed by/in the majority of EU member states. For the
individual financial reports of the EU member states, the application of the IFRS is somewhat different. Therefore,
in ten EU member states the use of IFRS is not allowed (e.g., Austria, Belgium, the Czech Republic, France etc.).
The above application suggests that in the majority of the EU states, IFRS are accepted when consolidated financial
reports are prepared, and to a lesser scope when individual financial reports for non-rated entities, i.e., for small and
medium-sized entities, are prepared.
The directive provides the member states to allow the application of the IFRS to the entities during the
preparation of the individual financial reports, as well as to entities which are not rated in the regulated capital
market (Tadijančević, 2005), i.e., small and medium-sized entities. Such a demand can be justified due to the fact
that the IFRS meet the requirements of the external users with the goal of truthful and fair display of properties,
management liabilities and results. However, the complexity of their requirements and solutions in some issues
are not appropriate for the usage in the small and medium-sized entities. Therefore, in the majority of countries
national legislature for the financial reporting of the small and medium-sized entities is applied. The countries
which possess prescribed standards for small and medium-sized entities, and the EU members are Great Britain
and Slovenia. Unlike the IFRS, the EU directives refer to all entities, even the small and medium-sized entities.
The essential role in the financial reporting of the small and medium-sized entities is played by the fourth
directive that beside the rules for the preparation and publication of the financial reports, recommends
abbreviated financial reporting for those entities. Unfortunately, that proposal was not sufficient for solving the
problem of financial reporting for small and medium-sized entities.
The Harmonization of Accounting Regulative for Small and Medium-Sized Entities

Small and medium-sized entities are an important promoter of the entire EU economics, and it is
understandable that for some time a question is asked whether it is needed and how to harmonize the accounting
regulative for those entities. Numerous accounting organizations have tried to answer these questions, but the
central role was held by the IASB which has recognized the complexity of the application of the complete IFRS
for small and medium-sized entities and which has also started the project to create the standards of financial
reporting for small and medium-sized entities. For the main motifs of this action, the IASB has, beside the
complexity of the IFRS, highlighted the fact that the adoption of global standards for small and medium-sized
entities is necessary due to better protection of foreign suppliers, foreign banks which grant them loans, and due
to foreign investors to whom the global accounting standards will ensure a desired compatibility (Retrieved July
18, 2010, from http://www.iasb.org). Despite all that, during the creation of global accounting standards there
were numerous obstacles which had to be overcome.
The basic problem which complicates the harmonization of financial reporting for small and medium-sized
entities is the criteria for classification of entities according to their size. It is enough just to be reminded that the
fourth directive, the European commission and the national legislature of EU member states prescribe different
amounts for the quantitative classification of entities (the sum of the balance sheet, total income, number of
employees). On the other hand, the IASB has, during the defining of the standards scope for small and
medium-sized entities, chosen the qualitative characteristics, i.e., the defining of the public liability during the
classification of small and medium-sized entities. The usage of different terminology which denotes the same
term (small and medium-sized entities) is equally indisputable. Besides, numerous authors as the main argument
against separation of financial report for small and medium-sized entities from the one for large entities state the
need for universality, comparability and reliability of the financial reports for all categories of entities. It is also
vital to take into account that in some countries (e.g., Germany) financial reports traditionally serve also for the
needs of informing and determining the profits (for distribution), and the IFRS are inappropriate for that function,
especially because they are not oriented towards the precautionary principle, whose goals are the maintenance of
capital and the protection of investors (2005).
In the process of harmonization of financial reporting an important role belongs to the IASB which has
already in 2001 with Standards Advisory Council (SAC) for the first time considered the need for creating
accounting standards for small and medium-sized entities, and two years later (i.e., 2003) it launched their
creation. In the process of developing the IFRS for SMEs, the IASB conducted an extensive world-wide debate.
Working group comprised of forty members—experts cooperated with the IASB on the structure and content of
the IFRS during different development stages. Standards draft was published in 2007 and it was translated into
five languages which contributed to the widening of the circle of experts involved in the debate1. It has also been
tested on more than 100 small entities in 20 countries resulting in a further simplification of standards.
Final version of the IFRS for SMEs was published in July 2009. The bottom line is that the SMEs standards
actually represent a shortened form of the IFRS (the scope is reduced for 90%). Certain requirements which are
considered inappropriate for the application in small and medium-sized entities are not contained in the IFRS for
1
Mrša, Josipa. Iz odbora za MRS-Objavljeni su IFRS-a za mala i srednje velika poduzeća. RRiF, 2009., br. 08/09., str. 49.
SMEs (see Table 1).
Table 1
IFRS Requirements Which Are Not Included in the IFRS for SMEs
IAS 33 Earnings per share
IAS 34 Intern in financial reporting
IFRS 5 Non-current assets held for sale and discontinued operations
Besides, in the IFRS for SMEs simpler variants are involved in subsequent valuation of tangible fixed assets
as well as simplified recognition and establishment of financial assets.
The recognition of tax assets and deferred tax liabilities is also simplified. The IFRS for SMEs consist of 35
sections and a glossary (Retrieved July 25, 2010, from http://www.iasb.org), and they should be applied by the
entities which do not have “public liability”.
Obstacles for a Possible Application of the IFRS for SMEs

Despite the fact that the IFRS for SMEs are supported by numerous international organizations, the EU
support is still debatable. In fact, in September 2007 Charlie McCreevy, the European Commissioner for Internal
Market and Services declared that the IFRS Draft for SMEs was not simplified enough to be appropriate for
application in most small and medium-sized entities. Due to these reasons numerous efforts were subsequently
made in order to simplify and adjust the accounting requirements according to the requirements of small and
medium-sized entities. The EU commission has decided to conduct a consulting research (Retrieved June 20,
2010, from http://www.ec.europa.eu/internal market/consultations/2009/ifrs for sme en.htm) about the need to
simplify the directives’ demands in order to create the basis for the application of the IFRS for SMEs. One of the
important questions of the research was to determine whether the IFRS for SMEs appropriate for the application
in the EU. The majority of respondents answered affirmatively (13 of 22 countries). The countries which support
the application of the IFRS for SMEs underline the enhanced comparability of information in financial reports
since the application of these standards, the attraction of foreign capital, and therefore the reduction of capital
expense due to application of universal accounting standards as main arguments for their application. On the
other hand, some respondents think that the IFRS for SMEs are too complex for application in small entities, i.e.,
that the consequence of the application of these standards will be contradictory due to high expenses of the
preparation for their application. An overview of the most important arguments for and against the application of
the IFRS for SMEs is shown in Table 2.
Table 2
An Overview of Arguments for and Against the Application of the IFRS for SMEs According to the Respondents
Arguments for IFRS for SMEs Arguments against IFRS for SMEs
enhanced harmonization and comparability of information in
the duplication of administrative burden for those entities
financial reports
the cohesion of accounting and tax regulative in some countries
reduced capital expenses
can result in double financial reporting
they are not useful to the entities which do business “locally” the
the usage of an “unique accounting language”
frequency of changes in the accounting regulative
Respondents also held a wide range of views on how to deal with incompatibilities between the Accounting
Directives and the IFRS for SMEs. Some countries implied that a mechanism should be formed which would
maintain the compatibility of accounting standards and directives and enable their alternations. Others suggested
that conflicts should be resolved on a case by case basis by national authorities, or that priorities should be
established in the framework of the Directives. Finally, some respondents considered that the IFRS for SMEs
should not be applied in case of incompatibility.
Due to all these reasons the European Financial Reporting Advisory (EFRAG) conducted a research
(Retrieved July 20, 2010, from http://www.efrag.org/newa/detail.asp?id=548) which was directed to analyse the
compatibility of the IFRS for SMEs and of the fourth and the seventh directives. The aim of this research was to
determine the areas of incompatibility of the IFRS for SMEs and of the directives. According to the conclusion of
the EFRAG the incompatibilities in the IFRS for SMEs are determined in numerous areas (see Figure 1).
Requirements for the IFRS for

SMEs which are incompatible
with the EU directives
1. The prohibition to present 4. The requirement to recognise immediately in

“extraordinary items”. profit or loss any negative goodwill.
2. The requirement to measure financial 5. The requirement to present the amount

instruments (non-basic financial instruments) at receivable from equity instruments issued
fair value. before the entity receives the cash as an offset to
equity and not as an asset.
3. The requirement to presume the useful life of 6. The prohibition to reverse an impairment loss
goodwill to be ten years if can’t be estimated recognised for goodwill.
reliably.
Figure 1. An overview of requirements for the IFRS for SMEs which are incompatible with the EU directives.
Data about the requirements for the modernization of the directives were gained due to the consultations
conducted by the EFRAG and IASB. Numerous interest groups consider that the directives should continue to be
the framework of the financial reporting in the EU and that they should prescribe the preparation of reports about
the money flow and minimal information which should be presented in the notes. Other interest groups intercede
for the making of directives which are drafted on the principles and not on the detailed elaboration of the financial
reports’ structure. When defining the value of the items which are shown in the financial reports, numerous
groups consider that the application of fair value method represents a great burden for small entities and that it is
in contradiction with the basic principle “think small first” on which reviewed assets should be based. In order to
enable quality accounting information, many who are involved think that the extraordinary items should again be
placed in the financial reporting frame. All the provided requirements refer to the need for further consultations
and debates in order to coordinate the directives’ prescriptions with the IFRS requirements and the IFRS for
SMEs requirements, all with the purpose of creating a unique accounting regulation for all entities.
Conclusion
Motifs for the harmonization of the accounting regulation for small and medium-sized entities are
multiplying due to the process of globalization. However, there are also many obstacles which have appeared in
this process. One of the obstacles is the acceptance of new solutions in the countries which have solved the
problem of the requirements’ scope in the IFRS by adopting national accounting standards for small or small and
medium-sized entities. Another obstacle is the act of defining the criteria for classification of small and
medium-sized entities, i.e., defining whether those are just the entities which do not have the public liability, as
the IASB suggests. The application of fair value and extraordinary items in the accounting standards for small
and medium-sized entities is also relevant in determining the requirements which are appropriate for the
application in these categories of entities. The determination of scope and limitations is a very complex work,
therefore it is not surprising that the process of adopting the IFRS-a for SMEs has lasted for seven years and that
it has not resulted in the standards whose requirements were entirely accepted by the European commission and
numerous interest groups which were involved in the debates related to the requirements of those standards. The
demand of coordination of the accounting regulations has imposed the demand of coordination of the IFRS for
SMEs with the directives whose prescriptions are based on the fundamental accounting principles which have
created the basis for the harmonization of the accounting regulation.
References
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from http://www.efrag.org/newa/detail.asp?id=548
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November 2011, Vol. 10, No. 11, 1028-1042
Change of Management Values in Estonian

Business Life in 2007-2009
Anu Virovere
Tallinn University of Technology, Tallinn, Estonia
Estonian Entrepreneurship University of Applied Sciences, Tallinn, Estonia
Mari Meel
Eneken Titov
Estonian Entrepreneurship University of Applied Sciences, Tallinn, Estonia
The paper deals with the change of management values in Estonian business life in the year of the rapid growth
(2007) as compared with the year of hard decline (2009). The hypothesis is set that company managers do not have
permanent values but they change accordingly to the change in economic conditions: in economical welfare
situations business-managers more eagerly take larger responsibilities on ethical and philantrophical stages but in
crisis only the lower stages (economical and legal ones) could be detained. In the paper, we firstly observe if values
change in general and secondly we study if our pre-stated hypothesis holds. As the research method we use the
method of critical incidents.
Keywords: core values, organizational values, economical crisis, sustainability, change of values
Introduction
In 2001, Drucker wrote:
The half century after the Second World War, the business corporation has brilliantly proved itself as an economic
organization. In the next society, the biggest challenge may be in its social legitimacy—its values, its mission, its vision.
The wave of distrust of business generated by the recent financial crisis has proved how right it was. (as cited in Paschek,
2009)
Importance of CSR
During the last decades, corporate social responsibility has become a more important topic in countries with
developed economies. Discussions about it intensified already in the end of the 1960s with the rise of Milton
Anu Virovere, Ph.D. candidate, Lecturer, Chair of Marketing, Tallinn University of Technology; Management Institute, Estonian
Entrepreneurship University of Applied Sciences.
Mari Meel, Ph.D., Associate Professor, Chair of Operations Management, Tallinn University of Technology.
Eneken Titov, Ph.D. candidate, Department of Business Administration, Tallinn University of Technology, Lecturer and
Director of studies in Management Institute, Estonian Entrepreneurship University of Applied Sciences.
Correspondence concerning this article should be addressed to Eneken Titov, Estonian Entrepreneurship University of Applied
Sciences, Suur-Sõjamäe 10a, Tallinn, 11415, Estonia. E-mail: eneken@eek.ee.
CHANGE OF MANAGEMENT VALUES IN ESTONIAN BUSINESS LIFE 1029
Friedman’s (1963, 1970) ideology: “There is one and only one social responsibility of business—to use its
resources and engage in activities designed to increase its profits so long as it stays within the rules of the game”.
In accordance to globalization and strengthening of citizenship movement the self-consciousness of societies has
risen and that has brought along the broadening of meaning of corporate social responsibility and also,
sustainability has gained the leading position. The issue of sustainability has also become important due to the
constant deterioration in environmental conditions and to the growth of exploitation of poor countries’ resources.
On the other hand, at international climate conferences, the views of wealthy and underdeveloped countries
often collide in the question of social responsibility towards nature: representatives of underdeveloped countries
declare that wealthy countries have higher responsibility and must bear higher costs in protection of environment,
while poor countries just cannot do it—they are not able to do more than stick to the basic survival game. The
authors of this article were fascinated with the thought, how suggestible and changing are people’s attitudes and
way of thinking towards the change of economic conditions, for example, does the economic crisis, growing
debt-load and poverty weaken the European Union’s usually heightened responsibility towards nature and
traditional efforts to lessen social inequity?
Importance of Values
Values are the ideas and beliefs that influence and direct our choices and actions (Gini, 2004). Values
perform three functions for individuals and organizations—to defend against perceived threats (defensive values),
to adjust to society (stabilizing values), and to foster movement toward self-actualization (growth values). All
these three types of values are necessary and leadership definitely carries an important role in supporting these
values and creating opportunities to do that (Hultman & Gellerman, 2002). Effective leadership is about finding
balance between economic success and well-being of your employees, and at the same time, it is about balance
between society and the owners’ demands. Therefore there are values by nature dynamic and influenced by
economic environment. Other authors have also drawn attention to the change of values, for example, professor
Lauristin (2008) has indicated the negative change of values in Estonian liberal society where borderless market
economy has turned into total sales ideology, democracy has turned into egoistic competition between political
parties and state-of-law has opened its doors to large-scale bureaucracy. Prevalently, Estonian manager’s
leadership style does not based on long-term management values. However, the enduring leadership is important
in order to assure the sustainability. Enduring leadership is leadership that outlasts and transcends the
individual—has been shown by research to be a predictor of long-term success (Moon, 2001).
Influence of crises to management. Today’s managers are under strong pressure, especially during the
economic crisis, because the rapid development of technology is forcing continuous change and new knowledge
economy requires people who are devoted to their work. This can be considered a conflict situation where
successful conflict management, turning the conflict into something productive, could help implement changes
faster. Empirical research in Estonian organizations indicates that the best predictors of attitude towards change
are ethical values and business ideological values (Alas, 2009). The ability to use crisis as a productive conflict
and to base on true business ideological values in practice, would enable the organization to do the right changes
as well as to be sustainable. To understand productive conflict we should consider conflict management strategies
because they strongly influence subsequent interactions and outcomes, and conflict issues because they impact on
1030 CHANGE OF MANAGEMENT VALUES IN ESTONIAN BUSINESS LIFE
conflicts management strategies through thoughts and feelings (De Dreu, 1997).
Conflict studies, carried out in Estonia show that Estonian leaders are lacking the knowledge of ethics and
the will to resolve conflicts and understand the usefulness of a good and motivating work atmosphere. They do
not realize that resolving conflicts and assisting the employees will be beneficial to the company and thereby
make a major contribution to a more positive environment at work which significantly improves the employees’
motivation and loyalty and the companies market position (Virovere, Kooskora, & Valler, 2002).
Influence of working environment to job satisfaction. During the time of fast changes every organization
needs creativity and innovation and the will of employees to go along with the changes. That means creating an
environment where creativity is made possible. Organizational culture and microclimate are directly influenced
by a manager’s leadership style and leadership values. Studies carried out in Estonia show that especially people
with an university education were most less satisfied with management and work satisfaction was the lowest
among employees who had worked for the company for four and five years (Alas, 2009). Based on these results,
it is possible to conclude that there is a lack of appreciation of the working environment and workers in Estonian
organization.
The Change of Management Values
In this article, we tried to follow, how has the economic crisis influence the attitudes and management values
of Estonian managers: Estonia’s relatively fast and successful emerge into West-European (capitalist) society has
often been explained by Estonian liberal-friedmanistic economic policy. After joining EU (in 2004) both the state
and society here have started to force the businesses towards broader social responsibility and triple-bottom-line
way of thinking is emerging. That means that a business (its management) should feel a broader responsibility
towards social and ecological environment than just a legal one. It is logical to assume that during fast economic
growth and relative wealth, the managers of companies were susceptible towards that new approach. But how are
things now when companies have to concentrate on survival?
Theory and Hypothesis

The Hypothesis
Traditionally, corporate social responsibility is divided into four stages (look for, e.g., Carroll & Buchholtz,
2009; Ferrell, 2008; Crane, 2010; etc.). Initially the model was proposed by Carroll soon in 1979 and advanced
later (1999, 2009). The stages are differentiated as the ground ones—economical and legal, and the upper
ones—ethical and philantrophical responsibilities. Logically, it could be supposed that in the situation of
economical welfare business-managers are more eager to take more larger responsibilities on ethical and
philantrophical stages and vice versa, in hard conditions of economical crisis it would be well enough if only the
lower stages could be detained: at times of economic decline companies do not have means for philantropic
causes and also in the case of ethical considerations it is observed that they would not cause additional expenses
to the company.
The Base of the Hypothesis
That hypothesis seems to be supported by several earlier researches about the behavior of international
organizations while locating territories of production. Reich (1992) shows that already since 1970s a trend is
emerging where multinational enterprises, which are operating in the conditions of severe global competition and
therefore are forced to innovate their production continuously keeping at the same time prices low, have nothing
to do but to organize their work in the way as by placing their innovative units (research and development) in
developed country, with highly educated and expensive work force, and their mass production in underdeveloped
countries where the cost of work is low (as usual the lower cost of work force is accompanied with poorer labor
conditions, absence of trade unions, lower safety protection etc.). This means that while locating their
organization they follow (in territorial sense) Carroll’s 4-level model, that higher-level responsibilities are
considered only in the economically developed mother country. In poor countries, where production units are
located, it is well if legal obligations are met at minimal range (according to the looser legislation base of
under-developed countries) and the goal is making maximum profit. Several researches show that this is a
continuous trend both in the US and EU. Also, it is mentioned that in the case of international competition it is
inevitable (for example, Meel & Saat, 2000). Crane (2010) shows that a growing number of multinationals as for
example major European brands (Adidas, Reebok, Marks and Spencer etc.) as well as high-profile US brands
(Disney, Levi’s, Nike, Wal-Mart etc.) are involved in these location-based ethical conflicts.
The influence of crisis to an organization. Talwar (2009) wrote also that, in an era of global transformation,
a narrow focus on strategies for enhancing profitability will no longer be sustainable, and organizations will need
to seriously address long-term geopolitical social issues to attain sustainability with the adoption of universally
acceptable ethical work standards. Practicing values is an important aspect for building a successful strategy and
corporate culture. Based on the banking crisis it is also possible to draw parallels between organizational values
and success. For example John Holland (2010) writes in his article that:
Top management weaknesses in the failing banks were important in undermining bank SCA and increasing relative
vulnerability to crisis. Top management weakened other key resources such as risk management skills at middle
management and operational levels by downplaying relevant knowledge. They appeared not to have had an explicit strategy
to develop human capital, structural capital and relational capital at all levels in the bank or how to use it to improve risk
control and intermediation. They downplayed ideas of adequate equity, and of sufficient cash. They sought to gain the
maximum benefits of leverage ignoring the impact on bank functions and risk exposure.
Values and Maslow’s Hierarchy. It can be logically assumed that the same tendency that works locally
(territorially) should work in the time dimension, according to the change of economic conditions. During
economic recession while most of any country’s population fall to lower levels of Maslow’s hierarchy of needs
(main problems are making a living, lack of jobs is increasing) fundamentalistic claims rise also in managerial
values: compared to developed societies only legal obligations are met, philantropic and ethical obligations will
be left waiting for better times. In order to manage economical crises, there is a need to actualize Maslow’s
hierarchy upper needs—self-actualization and commitment, which would help to manage changes in the
organization as well as to become innovative and sustainable. Based on the same logic, it can be assumed that
company managers do not have constant moral certainties or values, but they shift according to the changes of
economic conditions: During the good times, they tend to behave according to virtues—show up more caring,
respect, valuing the employees etc.. During the recession, employees are fired more easily, in communication
with the employees the managers are stricter, aggressive and autocratic. Only these values are considered that are
connected to the company’s economic success and sustainability.
Stability of values. On the other hand, researches that prove exactly the opposite (Collins, 2001) show that
not all managers let their moral values to be shaken by the outside environment. Especially in times of recession
like in 1929, just those companies that did not cross the line beyond their main values survived. Different
researches (Collins, 2003; Drucker, 1972) even prove that sticking to core values is the key issue in an
organization’s sustainability. In really remarkable companies change is a constant factor, but they distinguish
issues that should never be changed and those that should be opened to change. They distinguish their timeless
core values and constant mission (that should never change) from ways of action and business strategies that have
to be changed according to the changes in the world (Collins, 2003). Due to Fukuyama (2001), the sustainability
of an organization is directly linked to the question of core values, although we have shared values, they may not
yet produce social capital if the values are wrong. Profit orientation as a value has been replaced with a new value
of sustainability (Drucker, 2003). Also, a research by Wilson and Eilertsen about strategic planning and survival
during economic recession produced results that show the importance of core values. Although in 2009,
organizations have more focus on cash flow and liquidity than they did a year ago, managers are experiencing
greater internal pressures or conflicts inside the organization because of the changes in business environment,
leadership is using the situation to make difficult decisions, and there is more leadership steering than managers
had experienced in the past, despite these pressures, two-thirds of managers are convinced that their actions
during the crisis remain aligned with the values and vision of the organization (Wilson & Eilertsen, 2010).
The association between values and organization’s success has also been researched as an important aspect.
With reference to corporate ethical values, Hyman (1990) contendes that positive employee perception of top
management’s values and beliefs will lead to higher performance outcomes. Bergeron (2007) concludes that
individuals that perceive high congruity between an organization’s ethical values and their own will feel more
motivated. Schwepker (2003) suggests that congruity between the ethical values of an employee and their
organization will positively influence employee’s performance.
Flowingly we are trying to research how constant the organizations’ management values have been in
Estonia during the last abrupt changes in the economical environment: At first, we observe if values change in
general; as for second, we study if our pre-stated logical assumption holds—that while the economic situation
deteriorates drastically, the basis of management values change and socially responsible and ethical behavior
receives less consideration.
Organizational Effectiveness vs. Values
One important aspect that draws attention to the importance of values in an organization is the connection
between organizational values and organization’s success. Several modern researchers have pointed out that the
constancy and direction of organizational values are some of the most important aspects to predict a company’s
success. For example, Kotter and Heskett have written in their book Corporate Culture and Performance, that
companies with strong adaptive cultures based on shared values outperformed other companies by a significant
margin. For example, they show how valuing interest groups influence success—companies that emphasized all
stakeholders—employees, customers and stockholders, and focused on leadership development, grew four times
faster than companies that did not. They also found that these companies had job creation rates seven times higher,
had stock prices that grew 12 time faster and profit performance that was 750 times higher than companies that did
not have shared values. Collins and Porras (2003) confirm the same tendency in their book Built to Last, where
they compared organizations with gyroscopes which keep the organizations in balance—the main values stay
changeless, but other organizational processes continue to change. They show that companies that consistently and
in long-term focused on building strong corporate cultures outperformed companies that did not by a factor of six
and outperformed the general stock market by a factor of fifteen. Beu, Buckley and Harvey (2003) set the
organizational values even on a higher position while they say that business, as a type of society, is possible only
within a certain social context of institutions, agreements, understandings and shared values.
Shared Values and Job Performance
In the case of value-based leadership, it has been discussed that in reality, all organizations are value-driven.
But what is important is the fact whether the values are conscious, shared and lived, or unconscious and
undiscussed. When values are unconscious and undiscussed, the culture of the organization usually reflects the
personality of the leader. Unless the organization has a very evolved leader, it is unlikely that there will be an
alignment between employees’ personal values and the leader’s values (Fitzgerald & Desjardins, 2004). At the
same time, a high consensus in followers’ perception of their leader does not assure that performance is in line
with company expectations. Consequently, it is proposed that high work values moderate the relationship
between consensus and performance (Schyns, 2006).
When values are conscious and discussed, it is likely that they are shared and lived. In this case, there is a
stronger possibility that that there is an alignment between employees’ personal values and the organization’s
values (Fitzgerald et al., 2004). Westerman and Cyr (2004) analyzed personality and work environment
congruence and found that value congruence was the best predictor of job satisfaction. Verquer, Beehr and
Wagner (2003) also found that value congruence and turnover intent are in strong positive correlation with each
other. One other important result was that when individuals’ values match those of their organization, they are
less likely to leave.
A whole theory has been created to explain the connections between organizational environment and the
individual (the person-environment fit theory), that assumes that individuals prefer an environment that possesses
characteristics (e.g., values, beliefs) that are similar to their own (Kroeger, 1995). The theory says that if people
fit well with an organization, they are likely to exhibit more positive attitudes and behaviors.
Leadership and Shared Values
Therefore it is important to understand while connecting values and organizational success to each other
whether the behavior of the organization is based only on the manager’s or the organizations shared values. It is
also important that the organizational values cannot be seen separately of leadership and management behavior.
Terrence Deal and Allan Kennedy found out that leaders should not hesitate to communicate their values widely
and advocate for them vigorously. They considered important that leaders create a guiding vision and shape
shared values. James MacGregor Burns believes that leaders should help followers reframe their understanding
of core values from self-interest to a broader view of the common good (Whitmire, 2005). Peter Drucker (2003)
wrote:
The leader is visible; he stands for the organization. He may be totally anonymous the moment he leaves that office and
steps into his car to drive home. But inside the organization, he or she is very visible, and this isn’t just true of the small and
local one, it is just as true of the big, national, or worldwide one. No matter that the rest of the organization doesn’t do it; the
leader not only represents what we are, but, above all, what we know we should be.
Also, Alas and Tuulik (2004) emphasized the importance of managers in strengthening the values and
believed that common values can be attained through improved training and improved management practices and
also by having the right leaders for the job.
We have no reason doubting the importance of behavior of managers in influencing the values of an
organization but more important become the question—how important are their actions in forming organization’s
values in the eyes of the managers themselves. For example, based on the research of McKinsey and Co in 2009
(763 executives who responded) two most important activities for managers were “leadership (shape and inspire
the actions of others) 49% of respondents and “direction” (capacity to articulate where the company is heading
and how to get there) 46 % of respondents, but activity “foster a shared understanding of values” was important
for only 8% of respondents. Researchers claim that ensuring shared values has become less important since the
economic crisis began, while the other two qualities have become more significant (Wartzman, 2009).
Therefore, of critical importance is how much do manager’s value spreading and following the
organizational values inside the organization. While getting over the crisis those organizations survive that have
kept to the same core values in the long run.
Consultant Kane (2009) has described how core values affect performance and managers definitely have an
important role in that process. She believes that: “Managers and others throughout the organization give priority
attention to what is stressed in the corporate values system and this in turn supports producing the priority results”.
If the employees have acknowledged the core values they make better decisions, because they are guided by their
perception of the shared values. Also, if employees share the values then they are more likely to recognize that they
are an important part of the organization. They are more motivated because life in the company has more meaning
for them. They work harder because they are dedicated to what is expressed in the organization’s core values.
Values Which Predict Success
Peters’ and Waterman’s seven values of excellence. Several authors have investigated which
organizational shared values predict success. Many researchers have been carried out where connections between
different shared values and organizational success have been investigated. Boxx, Odom and Dunn (1991) used
Peters’ and Waterman’s seven values of excellence, stated in 1982 (superior quality and service, innovation,
importance of people as individuals, importance of details of execution, communication, profit orientation, and
goal accomplishment) and analyzed their correlation to work satisfaction. Although positive correlation was
found among highway and transportation managers, the results can be generalized because later researches also
confirm correlations between values and work satisfaction.
Hultman’s 15 values. Hultman has brought out 15 values (self-directed learning, adapting to change,
balance, seeking opportunities in the midst of uncertainty, utilizing ability, distributing rewards fairly, finding
satisfaction in work, serving mutual interests, working as an owner, prizing wisdom, being authentic, seeking
truth, celebrating differences, accepting people and viewing people as ends in themselves), that in his opinion are
particularly relevant for success in this current business climate of global competition and instant communication.
Those values also happen to be humanistic values that foster wholeness and integration (Hultman & Gellerman,
2002). Hultman also stresses the importance of connection between organizational and individual values:
“Effective culture is one that successfully balances individual and organizational values, that is, walking the
tightrope to success” (Hultman & Gellerman, 2002). Based on research he also claims that profits are higher
when individual and organizational values are aligned. He writes that many organizational problems can be
traced back to people’s values (Hultman & Gellerman, 2002).
Risk-taking value and success. Organizational success has been also tied to risk-taking. Zukerman and
Kuhlman’s (2000) study show that generalized risk taking is related to scales for impulsive sensation seeking and
aggression. Logically, it could be guessed that risk-taking is rather positively connected to organization’s success
but based on several researches the connection seems to be indeed negative. Rauch and Frese (2002) show that
high risk-taking is negatively associated with business success, Estola (2004) found that risk-taking is a
contributory factor to the unethical in business. Based on theory another value that is negatively correlated to
organization’s success is concentrating of profit—Amos and Weathington found that there are general negative
connotations associated with organizations that individuals perceive as only valuing profit (Amos &
Weathington, 2008).
Ethical Values and Success
Correlations between ethical values and different constructs (devotion, work satisfaction) have been studied
relatively much also they have proven to have positive correlation with organization’s success. For example,
Hunt, Wood and Chonko (1989) discovered a positive association between corporate ethical values and
organizational commitment, Singhapakdi, Kraft, Vitell and Rallapalli (1995) proved that those employees who
exhibited a greater degree of belief in corporate ethical values placed more importance on ethical approaches and
social responsibility, thus leading to the overall increased effectiveness of the organization. In the next study
Singhapakdi, Rao and Vitell (1996) found that an organization that appears to have ethical values shared by its
employees is relying on the ethical reasoning of its decision makers.
DeGeorge ties organization’s success to ethical values more directly, assuming, based on the study, that the
freedom of business to make profit is limited by the values of fairness, equal opportunity, honesty and
truthfulness (DeGeorge, 1999) and therefore setting ethical values on the first place above all other values. Others
have also mentioned the importance of ethical values. Barnow, King and Krumina (2003) tied ethical behavior to
social capital, based on the fact that making human relations more ethical directly increases the value of social
capital. Alas and Tuulik (2004) develop the idea of importance of ethical values further, stressing organization’s
ethical competencies by which they mean a company’s ability to change its activities so they conform to a set of
ethical standards, and so, to manage its own values and commitments. Therefore, when an organization bases its
actions of ethical values they also appear in organizational behavior as ethical competencies and thereafter the
behavior of the organization as a whole influences the employees to work harder and finally the performance of
the organization rises.
In different researches especially one value has been demonstrated as an important ethical value, which is
fairness (Moorman, Niehoff, & Organ, 1993; Clemmer, 1993; Oliver & Swan, 1989). On one hand fairness is
important as an organization’s core value, but employee’s perception of how fairly he or she is treated can
become even more important. Perceived fairness is a key antecedent to commitment, job performance and job
satisfaction. The value of employee-centeredness can also be discussed through two aspects. The importance of
people as individuals’ value facet significantly related to job satisfaction. This circumstance indicates that
employees who perceive their organization as valuing employees as individuals report higher job satisfaction
(Amos & Weathington, 2008).
Research
Research Methodology
This research can be called critical discourse analysis (more information about this in Laherand, 2008, pp.
329-330, or Fairclough, 2002, pp. 91-116). The same principles have been used in other researches in Estonia by
Lauristin (2000)—investigating articles appearing in two newspapers during 10 years that were collected out of
certain two month issues of each year (Lauristin’s analysis is centered on typical metaphors that carry the means
of translating social changes).
In a similar way, we use documents, namely business magazine Director’s 2007 and 2009 issues as the
database for our qualitative study. In 2007, Estonian economy was in the phase of fast growth, quite fast inflation
accompanied that also. Wages (and prices) rose, there was lack of work force, not lack of work. It could be
guessed that in that kind of environment the managers of companies were considerate towards their employees
(valued them relatively highly) and acted also more broadly responsible towards other interest groups (taking
higher stages of model of Corporate Social Responsibility).
In 2009, Estonia was already in deep economic crisis, lack of work was serious, companies had hard time
selling their products both here and outside markets, several companies had gone into bankruptcy, both wages and
prices had stagnated—we guessed that in that kind of situation the values of entrepreneurs (in Estonia: managers of
companies but also co-owners) would comply with lower stages of model of Corporate Social Responsibility.
As it can be seen we used magazine articles in our study. The articles were interviews with managers of
companies—that kind of database can be named as documents. Hirsjärvi (2005) suggests data gathering method
based on documents, mostly along with other data gathering methods but it can be used as an independent method
also (Flick, 2006, pp. 245-246).
To ensure validity and reliability of our investigation we used Creswell’s (2003, pp. 196-197) proposed
researcher triangulation which means using different observers to discover or minimize mistakes that come from
the researcher’s person, like it was said above, we were reading the articles from business magazine director,
issues of 2007 and 2009. Each of them included about 10-30 business related articles that in our view represented
important values of that particular time in our business world. Two researchers read independently each article
and wrote down the values that the article carried. One hundred and fifty seven articles in 2007 issues were read
and 401 values were written down. One hundred and sixty five articles in 2009 issues were read and 340 values
were written down.
Next the discovered values were analyzed. Values inside the article that we agreed upon us added to the
database. If different values appeared, our third researcher read the article, too. If her opinion was the same as
either of the two others those values were added to the database, if not, then these values were not added. In 2007,
there were 27 and in 2009, 30 articles that did not show any clear values. The values added in the database were
analyzed and similar were gathered together. If necessary the same articles were re-read to make sure that
similarly named values would actually represent values with the same meaning. The results of research are shown
in the Appendix A.
Discussion
This research showed an important change of values in the period of 2007-2009 (see Appendix) that can be
described by Estonian economy reaching deep economic crisis, coming from very fast economic growth. That
was also accompanied by very fast growth of unemployment (the number of unemployed people doubled in a
year—2008 IV quarter, 53,500 people, and 2009 IV quarter, already 106,700 people. Estonian population is
approximately 1.3 mil). In the beginning of 2010, unemployment continued to rise. This has been the highest
level of unemployment in Estonia in 12 years (Toompark, 2010).
For many companies, it was more useful to go into bankruptcy than to continue working. In 2009 in Estonia
1,055 businesses and 14 non-profit organizations were estimated unable to pay their debt which meant that the
number of bankruptcies rose compared to 2008, 2.5 times, in numbers 623 companies. Statistics show that every
133th business, that is 0.75% of all businesses in Estonia went into bankruptcy (Karner, 2010).
Innovation and creativity. If we analyze the change of values (see Appendix A), then we can bring out
both important changes and also those values that were left at the same level and were mutually important both in
2007 and 2009. Innovation and creativity turned out to be very important. They are directly connected to fast
changes in the society and the need to stay in competition and keep up with the fast development in technology.
Innovativeness, creating something new is also named as most important by professor Lauristin (Raun,
2010), who states that these are the keys of bringing a country and an organization of the crisis. In her words, it is
clear that innovativeness is needed in Estonia, but it is another question if we can meet those needs. According to
our research, creativity and innovation are important values by the number of times they appeared, but their
change in time was not noted. If we talk about knowledge management as a management instrument in a modern
organization, innovation being presented as a value must be considered as an important issue, because the
innovation views and creativeness are the significant parts in process of knowledge management development.
Risk-taking. Economic crisis brings out the need to rising professionalism and risk-taking. If in economy
taking risks is seen as a possibility to achieve higher results, then this study also confirms that in difficult
economic conditions taking risks may mean ignoring ethical principles and laws. In order to use the risk to come
out of the crisis one must in full awareness use the principles of risk management. Risk management can thus be
defined as a systematic application of management practices to identifying, analyzing, treating, and monitoring
uncertainties to better advice crisis management (Robert & Lajtha, 2002).
The rise of professionalism and courage to risk as values and using knowledge management is connected to
the opportunity to use the situation for one’s own advantage, and therefore be more competitive in the market.
The point of view is the courageous survive. The crisis gives an extraordinary possibility to change both
organizations and economic structure. Managers who miss the opportunity to use the crisis for long-term changes
not only waste a good possibility, but also make re-appearance of other crises possible (George, 2010).
Teamwork. The possibility for long-term changes is connected to crisis management and knowledge
management. Knowledge management itself will not solve the problems. The active involvement of top
management and the board and the exercise of their power on these knowledge matters are vital. As knowledge is
vital the organizations need active teamwork by employees and management to implement changes. At the same
time, research showed that in times of crisis, the importance of teamwork as a value has diminished greatly.
Therefore, it is contradictory that knowledge management is important for coming out of the crisis but at the same
time Estonian managers do not value one of the main competencies of using it—teamwork. The reasons of lack of
teamwork can be uncertainty and fear of losing one’s job. Therefore, everybody is concerned about keeping the
status quo instead of actively searching for new opportunities. The same results are backed up by the fact that
communication as a value diminished because teamwork means communication. It is difficult to conceive of how
such learning, knowledge and regulation can control or change human nature, especially greed.
Motivation and valuing the employee. Analyzing these values that changed remarkably in negative
direction, motivation and valuing the employee must be pointed out. The diminishing of these values can be
explained by the fact that having a job became a value of its own during the time or crisis and being motivated
while having a job was elementary. Simply put it means that for employees the content of the job, job
environment, management activities and other factors that influence work motivation and satisfaction became
less important because lack of work-force that described the earlier period had been replaced by massive lack of
work. Changed economic conditions brought out sparingness and saving as values that represent in general the
whole operations of an organization—the main savings were made in employee wages (in 2009 III quarter,
Estonian average salary was 11,770 crowns. The drop in annual average salary was 5.9%. Still in 2008, the rise in
average salary was 14.8%, average salary began to drop in the I quarter of 2008 (Toompark, 2010)), number of
jobs, expenses on trainings and other employee-related costs. Because of that responsibility for the employees
diminished as the employers often felt they had power over them (many possible new employees around).
Although courage and risk as values appeared more often, it seems contradictory that aggressiveness and
competition diminished. This tendency can be explained by several cartel agreements occurring during these
times (Prangli, 2008).
Crisis management with full awareness. To use crisis as a possibility to develop and change economy, it is
necessary to use crisis management with full awareness. Crisis management is broader in scope and can be
defined as a set of ongoing and systematic processes for identifying, analyzing, and treating business crises by
applying management practices (Mitroff, 1994). Crisis management frameworks can be categorized according to
those that focus on why crises happen, which is termed operation-oriented frameworks, and those that focus on
how crises impact organizations and the tasks that need to be performed in order to lessen their impact, which is
termed process-oriented frameworks (Wang, 2009).
If we analyze the differences among negative values that appeared it shows that in the earlier period
overbuying and overbidding, brutality and shrewdness were condemned. But in 2009, more
organization-centered behaviors were brought out as negative values—too much profit-centeredness, lack of
mission, not trusting employees and too little creativity.
Results and Conclusion

In this paper, we researched the constancy of management values in times of economic crisis. We started out
with the hypothesis that in hard economic conditions less attention is paid to ethical values and economy-based
values will take their places. At the same time, several earlier researches made us doubt that hypothesis. They
said that those companies whose core values and mission stayed constant in long term survived any crisis better.
In this research we followed the change in management values in 2007 (time of rapid economic growth) and 2009
(deep crisis in economy).
Moorman points out that the most important value is fairness and it should even be one of the core values of
the organizations, but at the same time our research shows that the fairness as a value is decreased at the time of
crisis. Comparing the values discovered by our research to values brought out by Peters, Waterman and Hultman,
we can admit that four values of Peters et al. were also discovered in our study—superior quality and service,
innovation, importance of people as individuals, communication. But in our study communication and
importance of people diminish during the crisis. Other values, important by Peters et al.—importance of details of
execution and goal accomplishment did not show up as significant in our study. Comparing our results to
Hultman’s important values we can mention fairness and honesty, whereby the occurrence of honesty is
increased and occurrence of fairness is significantly decreased-it confirms the decrease of importance of ethical
values in the time of crisis.
The management values analysis 2007 versus 2009 shows a certain change in values but does not bring out
the need for knowledge management and learning as a value. Also Holland (2010) claims that knowledge and
lack of it was also deeply implicated in the crisis and in many of the above problems, and hence addressing these
issues will be part of the solution.
What are the conclusions of that research? We must admit that there has been an important shift among
management values in the period of 2007-2009. In the centre position, there is survival, not so much competition
but still sustainability is tied to innovation and creativity.
Sustainability in a society, in Estonian economy coming out of the economic crises means that our economic
structure also needs a change to be competitive. If Estonia has clearly approached the EU and developed
countries economies characteristics in some ways, then we cannot say that about our economic structure’s
dynamics unfortunately (Terk, 2007). James Collins and Jerry Porras of Stanford University (2003) found that
the main differences between the visionary companies (companies that survived the economic crisis) and the
control group with which they were compared were in their approach to values. All the visionary companies had
a powerful sense of their identity and what they wanted to achieve. Managers in global business can help their
firms to be successful and to minimize ethical conflict in several ways. The most important in sustainability of an
organization is that the core values stay the same.
Surviving is also connected to opposite values, saving and frugality on one side but also courage and risk on
the other. Diminishing competition seems illogical but it can be explained by making cartel agreements that
represents growth in unethical behavior. Cartel agreements are connected to the need to lessen the competition on
the market and therefore ensure the survival of your own organization but at the same time this activity shows
ignorance of ethical values. At the same time, other researches (Alas, 2009) show that having ethical values
present in the organization is an important prerequisite for employees to go along with changes.
As the research confirms the importance of ethical values like respect, valuing of employees, justice and
responsibility has diminished remarkably, the hypothesis that was set—in hard times economic concerns prevail
over ethical and philantropical ones—is proved right. At the same time the will of an organization to keep the
status quo and not to use the crisis as an opportunity for positive changes points out.
In conclusion, it can be said that the year 2007 is described by innovation and creativity, communication and
caring as values, also valuing the employee, stability and intentionality. In 2009 innovation, creativity and caring
remain important but ethical values as fairness, respect and valuing the employee lost their significance.
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Appendix A
carefulness 1 4
patience 2 2
economy 2 8
self-analyzing 3 0
risk-taking 3 15
quality 4 3
loyalty 4 4
frankness 4 0
self-confidence 4 7
respect 5 2
optimism 5 3
geniality 5 4
continuous learning 5 4
client orientation 5 8
flexibility 6 4
commitment 6 5
openness 7 1
teamwork 7 1
agressiveness 7 1
responsibility 7 2
accuracy 7 4
transparency 7 7
honesty 7 12
fairness 8 2
enterprisingness 8 7
vision 8 11
cooperation 8 12
motivation 9 3
decision-making ability 9 9
fixity of purpose 11 13
valuing the employee 12 2
stability 12 10
profesionalism 12 22
caring 17 18
efficiency 20 8
trust 21 20
communication 24 13
Innovation and creativity 28 23
0 10 20 30 40 50 60
2007 2009
Figure A1. Change of management values in Estonia in business life between 2007-2009, by the frequencies of the
occurrence of values.
November 2011, Vol. 10, No. 11, 1043-1060
The Impact of Tax Policies on Taxpayers Budget in

Terms of Risk, Sensitivity and Volatility
Boloş Marcel Ioan, Otgon Cristian Ioan, Pop Răzvan Valentin

University of Oradea, Oradea, Romania
Local and central governments are concerned to develop fiscal policies that are based on principles already enshrined
in the literature as the principle of equity and/or the principle of fiscal appropriateness. Beyond these principles, the
governments want to make sure that all taxpayers have the capacity to pay at maturity the tax debts owed to the
public budget. In crisis situations, as recent experience has shown, governments adopt fiscal policy measures, with
the sole purpose of procuring financial resources to cover the huge government budget deficits. In this situation, a
natural question arises: Do governments need, for the elaboration of their fiscal policy, an analysis that takes into
account the taxpayer’s budget? Or is it sufficient that they confine only to the theoretical principles enshrined in the
literature or the tax paying ability of the taxpayers? The answer can only be affirmative, because any taxpayer’s
budget is an inexhaustible source of resources for the public budgets. It is undisputed that in the taxpayer’s budget,
the tax expenditures coexist with other categories of expenditures such as consumption expenditures, durable
expenditures and public utilities expenditures. Each expenditure type is risk-bearing. To study the structure of budget
expenditures within the taxpayer, the authors suggest the use of three indicators innovative for the science of public
finance: the risk, the sensitivity coefficient and the coefficient of volatility. Depending on the values registered by the
three indicators of fiscal policies, expenditures can be classified as risky, volatile and sensitive which may lead to
risks of failure to collect the taxes and/or to tax evasion. Innovative for the science of public finances is that the
fundamentation of the fiscal policies is realized using the three indicators, the budget of the taxpayer and the
networking between the categories of expenditures that fall within its budget structure.
Keywords: fiscal policy, risk, volatility, sensitivity, taxpayer budget, expenditure
Introduction
Nowadays the local and central governments in Central and Eastern Europe are preoccupied to elaborate
measure plans which can lead to new sustainable economic development and also to get out of crisis. The
economic crisis has hit the national economies. The aggregate demand has been severely damaged. Companies
had to adjust their activities, many of which bankrupted. Along with these, budget deficits have appeared because
Boloş Marcel Ioan, Associate Professor, Department of Finance-Accounting, University of Oradea.

Otgon Cristian Ioan, Master, Department of Finance-Accounting, University of Oradea.
Pop Răzvan Valentin, Bachelor, Department of Finance-Accounting, University of Oradea.
Correspondence concerning this article should be addressed to Boloş Marcel Ioan, Oradea, Romania, Linistei street, 14, bl. PC 7,
ap. 3. E-mail: marcel_bolos@yahoo.com.
1044 THE IMPACT OF TAX POLICIES ON TAXPAYERS BUDGET
the national economies could not provide their financial resources in order to support the public expenditures. But
these budget deficits, some of them out of control, have given serious headaches to the local and public
governments. The measures taken to rationalize the public expenditures were quite unpopular. The salaries have
been considerably diminished, for example Romania has decreased the salaries by 25% and increased the
consumption taxes (VAT has increased in the majority of Central and Eastern Europe countries).
The IMF intervention was necessary in order to give “last resort” credits to avoid financial collapse or even
the default of states. For example, Greece borrowed 100 billion euro in order to avoid the financial difficulties
determined by the budget deficit financing, while Romania has contracted a credit worth 20 billion euro with the
same destination. Many of the rationalizing measures determined a series of fiscal innovations. Hungary, for
example, resorted to different taxation for banks and monopolies. And the examples can go on. Every country had
a specific strategy to get out of problems. The common point of these strategies was: rationalizing the public
expenditures, fiscal innovations, and financing budget deficits through capital infusions from IMF, EU, World
Bank or BERD.
A natural question arises: What was the cause of these excessive deficits acted like a real tsunami in times of
financial crisis? The answer is very simple. Influenced by the economic growth miracle Central and Eastern
Europe countries had increased the public expenditures that were not based on a sustainable economic growth.
The oversized expenditures were not matched by financial resources of the same level. The consequences did not
occur when the economic crisis started. This is how public debts have exponentially increased so the imminent
danger of this period, for the most of the Central and Eastern European countries, is a new type of crisis:
“sovereign debt crisis”.
The economic growth period in Central and Eastern Europe has brought a mentality change regarding the
consumer’s behavior. Until recently, it was impossible to overcome the CEE consumer’s behavior, whose golden
rule was that 35-45 years old consumers would buy durables from their savings. The American consumer’s
behavior, which resorts to credits to buy a house or a car, was now adapted. There are several implications
regarding this behavior, the consumer can enjoy his purchased goods without expecting to save the necessary
money. The workforce is permanently stimulated to seek new job opportunities in order to pay the credit annuity.
The economy is based on goods and services demand stimulated and supported by the banks through credits.
Changing mentality by resorting to credit in order to buy durable goods has determined the appearance of a
new category of expenditures. This refers to the expenditure with the credit annuity which is additional to the
already mentioned consumer expenditures, tax expenditures and public services expenditures.
A portfolio of consumer spending was formed, in which consumer goods spending has an important
percentage, approximately 60% (see Figure 1), followed by expenses for taxes and charges, that account for
15%-16%. What is noticeable in the consumer’s budget is that in the growth period, until the emergence of the
global economic crisis, there was a new type of expense, that of durable goods, with an average of 14% share in
the total budget, which confirms that, consumers have turned to loans to purchase durable goods and thereby
there was a change in lifestyle and consumption mentality generating a continuous improvement of living
conditions. Another important category of expenditure as a share of the consumer’s budget is the expenditure on
public services, about 15%, which has an upward trend in the period under review due to the rising prices of
public utilities (electricity, water, heat etc.).
TH
HE IMPACT OF
O TAX POL
LICIES ON TAXPAYERS
T BUDGET 1045
Each of the consumeer’s expenses generates a ceertain categorry of risk deterrmined mainlyy by the risk tthat the
spending wiill not take place. Each co
onsumer’s exppense from hiis/her budget has a certainn level of senssitivity
showing how
w it reacts whhen the consum
mer changes its ratio in the total expendiitures by one percent.
p Increases or
decreases foor a category oof expenditure for a short pperiod of timee are measured through vollatility. The riisk, the
sensitivity and
a the volatillity characteriize each categgory of the connsumer’s expense budget and
a central annd local
governmentts should be innterested in th
heir development in the conntext of fiscal policies
p whichh they developp.
Ex
xpenditure on coonsumer
go
oods/person
Ex
xpenditure on taaxes / person
Ex
xpenditure on loong term use goods
Ex
xpenditure on public services
Figure 1. T
The evolution off the percentagee of each type off expenditure in the whole portffolio.
State oof Knowledge

The sciientific literatture provides us several pappers regardingg the impact of
o fiscal policies on the ecoonomic
developmennt and people’s prosperity in
n order to findd the optimal fiscal policy.
One off the most reemarkable ressearches anallyzes the optimal tax poliicy in a moddel where firm
ms are
internationaally mobile (Joohannes & Cleemens, 2011),, showing thatt the optimal policy
p responsse to increasinng firm
mobility maay be taxation,, subsidization
n, or non-distoortion of the marginal
m invesstment, depennding on whethher the
mobile firm
ms are more or less profitablle than the aveerage firm in the
t economy.
Also, another
a importtant research in
i the field reffers to calculaating an optim
mal mix of wagge and bequesst taxes
with alternaative parameteer combination
ns (Grossmannn & Poutvaara, 2007). In alll cases, the opptimal wage ttax rate
is clearly higher
h than thhe optimal beequest tax raate, but the laatter is generrally positive when the reequired
governmentt revenue in thhe economy iss sufficiently hhigh.
The opptimal fiscal package sho
ould be timely, large, lassting, diversiffied, contingeent, collectivve, and
sustainable (Spilimbergo,
( , 2009): Timelly, because the need for actiion is immediate; large, beccause the curreent and
expected decrease in private demand iss exceptionallyy large; lastingg because the downturn willl last for som
me time;
diversified because
b of thee unusual degrree of uncertaiinty associated with any sin
ngle measure; contingent, bbecause
the need to reduce
r the perrceived probab
bility of anothher “Great Deppression” requ
uires a commiitment to do m
more, if
needed; collective, since each country that has fiscal space should contribute; and sustainable, so as not to lead to
a debt explosion and adverse reactions of financial markets.
Fiscal policy is also affecting the markets, the impact of fiscal policy from a different approach should be
taken into consideration, the appetite for fiscal discipline has been steadily declining among most industrial
countries (Ricardo, 2005). Even after controlling for cyclical effects, budgetary balances have been deteriorating
both in the US and in Europe. In Japan, a string of large fiscal imbalances has severely undermined the
sustainability of the fiscal stance.
In the past, fiscal profligacy would have been punished by markets with higher interest rates and, in some
cases, also exchange rate depreciation. This is another good reason to find a way to calculate the taxpayers
affordability.
Fiscal policy, the main instrument for the public authorities, has a great influence on economic cycles
(Lopez-Pinto, 2001). The conclusion of a research that takes into consideration the effects of fiscal policies on
capital accumulation and economic performance in a simple endogenous growth model with elastic labor supply
by focusing on the implementability of a competitive equilibrium with productive public spending and
distortionary taxation is that given a feasible exogenous fiscal policy, productive public spending can, at first,
lead to positive short-run and long-run growth in the unique competitive equilibrium (Hyun, 2009). However,
although strictly positive growth is possible in the short run, a Ramsey policy with productive public spending
does not implement positive capital accumulation in the long run. Also, the local indeterminacy of Ramsey
allocations, in conjunction with the global multiplicity, arises as an implementable competitive equilibrium with
Ramsey policies: namely, a continuum of transitional dynamics and multiple balanced growth paths.
Extending income tax cuts and reducing the growth rhythm of government spending (excluding Social
Security and Medicare), assuming that government expenditures are cut to avoid dramatic increases in
government consumption relative to GDP in comparison to historical norms, would increase investment,
employment, and output. However, postponing the implementation of tight spending controls would more than
offset the positive benefits of lower tax rates on the size of the economy and leave future generations with fewer
resources for private consumption and production (Diamond, 2005).
Volatility and Sensitivity Calculation in the Study of Fiscal

Policy Impact Over the Public Budget
As already seen, in the Central and Eastern Europe the taxpayers’ budget is characterized by a series of
features specific to the economic boom period, but also by the constraints determined by the well-known
financial crisis. As a consequence of economic boom met in the former communist countries but perhaps as a
result of changing attitude of taxpayers, a significant proportion of expenses is starting to be held by those for
durable goods. The latter takes the form of reimbursement credit rates and interest rates contracted by the
taxpayers from banks in order to buy houses or durable goods.
The volatility and sensitivity calculation in order to study the impact of fiscal policies over the taxpayer’s
budget involves a series of hypotheses which represent the base of calculation and have as a goal the analysis of
the inherent risk each expenditure category included in the taxpayers budget but also of the risk determined by the
variation of weight held by some expenditures in the total budget.
THE IMPACT OF TAX POLICIES ON TAXPAYERS BUDGET 1047
A natural question arises: What is the significance of total budget risk and how can this category of risk
affect the fiscal policies which the governments are elaborating in accordance with the national development
strategies?
There are several matters which we are trying to cover, supported not only by the theoretical formulations
which will be found in this research paper but also by the elaborated calculation of the volatility and sensitivity
within the study of fiscal policy.
In the terminology used in this research paper, global risk designates the risk that an expenditure, part of the
total taxpayers budget, cannot be realized due to lack of funding source or other endogenous or exogenous factors
which characterize the taxpayer’s behavior. The greater the risk, the higher the probability for an expenditure not
to be made. If this probability affects the tax expenditures the public budget can be put in difficulty on short and
medium term by the taxpayer’s risk of non-payment. As a consequence, fiscal policies make more sense if
analyzed from the perspective of the inherent risk of each category of expenditure which constitutes the
taxpayer’s budget and also from the perspective of sensitivity analysis determined by fiscal policies when they
produce an effect on the proportion of taxes in the taxpayer’s total budget.
In order to test the impact of fiscal policies over the taxpayer’s budget there were drawn a series of
hypotheses, which are the basis for the sensitivity and volatility calculation and are characteristic for any
consumer’s budget.
First hypothesis starts from the idea that each group of expenditures, no matter if they are consumption
expenditures (Chc ) , tax expenditures (Chimp,taxe ) , durable expenditures (Chbfi ) , or public utility expenditures
(Chup ) , registers expenditures growth rate between two consecutive periods, t respectively t , determined
0 1
according to a relation of the following form:
Ch t 1 − Ch t 0 (1)
R ch = × 100
Ch t 0
Any positive values of the expenditures growth rhythm may reveal the taxpayer’s propensity for a category
of expenditure and hence a sort of behavior which can be based on consumption expenditures and/or durable
expenditures, while the negative values signify a decreasing pace of allocating financial resources for that
category of expenditure. In any situation the taxpayer’s budget must be balanced, even if loans are contracted in
order to provide the budget balance.
The second hypothesis is based on the fact that the sum of weights of every category of expenditure in the
total budgets equals to one. It means that the taxpayer’s budget can be written as a sum of expenditures consisting
in consumer goods expenditures, tax expenditures, durable goods expenditures, public services expenditures,
according to the taxpayer’s budget equation of the form:
Bc = Chc + Chimp ,taxe + Chbfi + Chup (2)
If equation (2) is divided to taxpayer’s budget ( B c ) , it results a sum of weights in the total budget, formed
by the weight of consumption expenditures ( p c ) , the weight of tax expenditures ( p f ) , the weight of durable
expenditures ( p bfi ) and also the weight of public utility expenditures ( pup ) , according to the following
relation:
1 = pc + p f + pbfi + pup (3)
In order to substantiate the global risk of taxpayer’s budget, it is necessary to use a series of specific
indicators which start from the average rhythm of total expenditures growth which is registered by the taxpayer
−
( R ch ) and also from the variance of total expenditures which form the taxpayer’s budget structure (σ ch ) . The
average rhythm of total expenditures growth is obtained depending on the weight of expenditures specific to the
taxpayer’s behavior in his total budget ( p i ) and also on the average rhythm of specific expenditures between
−
two consecutive periods ( R Chi ). Also the variance of total expenditures which forms the taxpayer’s expenditure
structure is obtained depending on the weight ( pi ) of every category of specific expenditures, on the standard
deviation (the inherent risk of each category of specific expenditures in taxpayer’s budget), σ Chi
2
, and on the
covariance between two pairs of specific expenditures (σ c , f ) .
We, thus, obtained the global risk equations which characterize the taxpayer’s behavior. These equations are
at the base of the study of the impact that fiscal policies have over the consumption goods budget, tax budget,
durable goods budget and public utility budget and can be expressed as follows:
− _ _ _ _
RCh = pc × RC + p f × R f + pbfi × Rbfi + pup × Rup
σ Ch
2
= pc2 × σ C2 + p 2f × σ 2f + pbfi
2
× σ bfi
2
+ pup
2
× σ up
2
+ 2 pc p f σ Cf + 2 pc pbfiσ Cbfi + 2 pc pupσ Cup
(4)
2 p f pbfiσ fbfi + 2 p f pupσ fup + 2 pbfi pupσ bfiup
1 = pc + p f + pbfi + pup
The above equations can be rewritten in the following general form:
− 4 _
R Ch = ∑ pi × R Chi
i =1
4 4 4
σ Ch
2
= ∑ pi2 × σ Chi
2
+ 2∑∑ pi p j σ ij (5)
i =1 i =1 j =1
4
1 = ∑ pi
i =1
The study of fiscal policies’ impact over the taxpayer’s budget will be performed by measuring the
sensitivity of consumer’s global risk (σ Ch ) according to the changes in the tax expenditure weight ( p c ) ,
according to the expression:
∂σ Ch
γ = (6)
∂p c
In order to determine the sensitivity coefficient ( γ ), it is necessary to establish the final form of consumer’s
global risk based on the general risk equation depending on expenditure’s weight of consumption goods, durable
goods, taxes and public services and also the specific risk determined through the medium of standard deviation
(σ Chi
2
) for each expenditure categories:
σ C2 h = p c ( p c σ 2
c + p fσ cf + p b fi σ c b fi + p upσ cup )+
p f ( p fσ 2
+ p cσ + p b fi σ + p upσ )+
f cf fb f i fu p
(7)
p b f i ( p b fi σ 2
b fi + p cσ c b fi + p fσ fb fi + p upσ b f iu p )+
p up ( p upσ 2
up + p cσ cup + p fσ fu p + p b fi σ b fiu p )
The analysis of the expression of the consumer’s global risk equation (5) from above reveals that global risk
is depends on expenditures weight in the taxpayer’s total budget ( pi ) and the risk specific to each expenditure
category related to the taxpayer’s total budget (σ iCh ) , which leads to the global risk evaluation of the form:
σ Ch
2
= pcσ CCh + p f σ fCh + pbfiσ bfiCh + pupσ upCh (8)
In these conditions and taking into account the possible changes in the tax expenditures, the sensitivity
coefficient shall be determined starting from expression (6):
∂( pcσ CCh + p f σ fCh + pbfiσ bfiCh + pupσ upCh ) 1 ⎛ ∂σ CCh ∂σ fCh ∂σ ∂σ ⎞

γ= = ⎜ pc + pf + pbfi bfiCh + pup upCh ⎟
∂pc 2σ Ch ⎝ ∂pc ∂pc ∂pc ∂pc ⎠ (9)
1 1
=
2σ Ch
( pcσ CC + p f σ fC + pbfiσ bfiC + pupσ upC ) =
2σ Ch
(σ CCh + σ CCh )
The final form of the sensitivity coefficient which will be used in the analysis of the impact of fiscal policies
over the taxpayer’s budget is given by a relation of the form:
σ CCh
γC = (10)
σ Ch
The expression (10) provides a major advantage because the sensitivity analysis of central and local
governments fiscal policies can be made taking into account the taxpayer’s global risk which consider every
expenditure categories specific to the taxpayer’s needs for either consumption or durable goods.
In order to measure the taxpayer’s global risk there shall be used the taxpayer’s budget equations written in
a matrix form, using the variance-covariance matrix ( Ω n × m ) and the column vector of every expenditure weights
in the taxpayer’s budget ( p T ) which in a simplified form can be written as:
i
⎛ σ CCh ⎞ ⎛ σ ccσ cf σ cbfiσ cup ⎞ ⎛ pc ⎞

⎜ ⎟ ⎜ ⎟ ⎜ ⎟
⎜ σ fCh ⎟ ⎜ σ fcσ ff σ fbfiσ fup ⎟ ⎜ pf ⎟
⎜σ ⎟ = ⎜σ σ σ σ ⎟×⎜ pbfi ⎟
(11)
⎜ bfiCh
⎟ ⎜ bfic bfif bfibfi bfiup
⎟ ⎜ ⎟
⎜σ ⎟ ⎜σ σ σ σ ⎟ ⎜ pup ⎟⎠
⎝ upCh ⎠ ⎝ upc upf upbfi upup ⎠ ⎝
With these calculation judgments, the sensitivity coefficient can be determined for each expenditure
category which is part of the taxpayer’s budget, in order to measure the risk specific to each expenditure category,
compared to taxpayer’s global risk. In contradistinction to the inherent risk also specific to each expenditure
category, which is related to the values registered by each expenditure category in a previous period of time and is
determined by the standard deviation, the sensitivity coefficient is influenced also by the covariance between the
expenditure pairs which are part of the taxpayer’s portfolio.
High values of sensitivity coefficient, specific to the tax expenditures, determined above, will indicate an
increased level of risk of these expenditure categories not to be paid in time, while low values of this coefficient
can be an expression of a high potential of financial resources, which can be fructified by the governments
through additional revenues for the public budgets.
The sensitivity coefficient is highly dependent on two specific notions, which are innovative for the public
finance domain, namely the expenditure risk and taxpayer’s global risk. Explained in simple terms, the
expenditure risk appoints the risk that an expenditure is not made by the taxpayer due to: lack of financial
resources, taxpayer’s specific behavior etc.. For public budgets, the taxpayer’s risk of tax expenditure is
equivalent to the risk of not collecting the tax revenues. If this risk is amplified by a certain intensity of financial
crisis, the probability that the public budget shall register deficits or liquidity crisis is quite high.
The risk of a specific expenditure relative to the taxpayer’s total budget is the second form of the specific
risk for each expenditure category which is a part of taxpayer’s total budget. The advantage of studying this form
of risk is that it depends on the intensity of the connections between a studied expenditure and the other categories
of expenditure. These connections are studied through the statistical covariance and indicate the “behavior” of a
certain expenditure category as compared to the taxpayer’s total expenditures. The major advantage of this
category of risk is given by the fact that, by the help of covariance, one can study the way a certain category of
expenditure behaves as compared to the other expenditure categories.
As regards the taxpayer’s global risk, it offers information related to the taxpayer’s risk of not his budget.
When taxpayer’s budget is risky, the central and local fiscal policies are more exposed to the risk of not collecting
the tax debts. That is why a fundamental element, even strategic, in the substantiation of fiscal policies, will be
the very intensity of the global risk of the taxpayer’s budget in order to detect in due time potential risks of not
realizing the planned budget.
It can be noticed that taxpayer’s global risk is a homogeneos function that depends on the weight vector
(p ,p
c f , pbfi , pup ) , which means that the Euler formula can be applied and the taxpayer’s global risk equation
can be rewritten as:
∂σCCh ∂σ fCh ∂σbfiCh ∂σupCh ∂σ ∂σ ∂σ ∂σ

σCh = pc + pf + pbfi + pup == pc Ch + p f Ch + pbfi Ch + pup Ch (12)
∂pc ∂p f ∂pbfi ∂pup ∂pc ∂p f ∂pbfi ∂pup
Taking into account the sensitivity coefficient established through expression (9) the taxpayer’s global risk
can be written depending on the coefficients (γ i ) and the weights of specific expenditures in the taxpayer’s
total budget ( p ) , in the following formula:
i
σ Ch = γ c pc + γ f p f + γ bfi pbfi + γ up pup (13)
If expression (8) is divided by σ Ch and the sensitivity coefficient is replaced with the ratio between the risk
specific to each category of expenditure (σ ) and the taxpayer’s global risk (σ Ch ) , a new form of taxpayer’s
iCh
global risk is obtained:
σ CCh σ fCh σ bfiCh σ upCh
1 = pc + p + p + p (14)
σ Ch
2 f
σ Ch
2 bfi
σ Ch
2 up
σ Ch
2
The coefficients in expression (14) are called volatility coefficients and are determined as a ratio between
the specific risk of a certain risk category in the total budget (σ iCh ) and the standard deviation of taxpayer’s
expenditures (σ Ch ) according to the relation:
2
σ iCh
βi = (15)
σ Ch
2
The volatility coefficients determined for each expenditure category which is part of the taxpayer’s budget
offer information related to the risk of alterations in the level (value) registered for an expenditure in a short
period of time. High values of the volatility coefficient will reflect a high risk for a category of expenditure that is
part of the taxpayer’s budget, which can modify its value in a short period of time, while the low (diminished)
values of volatility coefficients reveal a low risk and thus a low probability that a category of expenditure, that is
comprised in the taxpayer’s structure, could modify its value in a short period of time.
Sensitivity and volatility are two coefficients which provide the local and central governments with
information regarding the taxpayer’s risk of not paying his taxes. This category of risk is extremely important for
every government that is substantiating its fiscal policy. If the taxpayer is registering high sensitivity coefficients
then the fiscal policy turns to be quite risky.
Types of Fiscal Policies Established With Respect to the Taxpayer’s Risk

The calculations, the hypotheses, and the rules exposed above lead to the conclusion that every fiscal policy
made by central or local governments has to be substantiated not only on the affordability of taxpayers but also on
the risk of not paying. This risk occurs because the taxpayer doesn’t finance sole a category of expenditure that
regards the taxes. The latter is added to by the consumption goods, durable goods, public utility expenditures
which represent nothing more than expenditures for meeting the needs of a regular taxpayer. This way, the
taxpayer is acting in the market, in his bivalent nature from two points of view, as a consumer and as a taxpayer.
The constraints resulted from financing the expenditures are limited to the taxpayer’s income over a certain
period of time. These constraints often generate the occurrence of risk of non-payment as the income growing
speed is inferior to the expenditure growing speed.
There are three categories of indicators which are at the basis of fiscal policy substantiation depending on
the risk which appears in the taxpayer’s budget. The indicators result from the above hypotheses and calculations,
and they are: the inherent risk of an expenditure category, the sensitivity coefficient and the volatility coefficient
of expenditures which are part of taxpayer’s budget structure.
The inherent risk of each expenditure category, determined by the standard deviation, offer the local and
central governments information related to the taxpayer’s risk of not paying. The higher the values of this risk, the
more intense the risk of not paying is acting. The major disadvantage of this indicator is the fact that it doesn’t
take into consideration other expenditure categories which are part of taxpayer’s budget and moreover it does not
measure the specific risk for each expenditure relative to the total budget.
In order to offer complete information about the taxpayer’s risk, which local and central governments cannot
neglect, there were introduced two specific notions regarding the global risk and the specific risk for each
category of expenditure part of taxpayer’s budget. The global risk, as shown before, represents that certain
category which can help in obtaining information related to the probability of the taxpayer’s budget to collapse.
The specific risk of an expenditure category provides information about the “behaviour” of this expenditure as
compared to the other ones which compose the taxpayer’s budget. Regardless of the calculation and the
interpretation of the indicators related to the taxpayer’s risk, these indicators can succesfully be used with success
in the sensitivity and volatility calculation of the coefficients, used by the local and central governments for fiscal
policy substantiation. While the sensitivity coefficients contribute to testing the way a expenditure category
behaves relative to the taxpayer’s total budget when a percent of the weight of these expenditures in the total
budget changes, the volatility coefficient provides information about the probability of an expenditure to change
in a short period of time.

Depending on the values which are registered by the inherent risk of expenditures and the values of
sensitivity and volatility coefficients for these expenditures, we can distinguish the particularities of the types of
fiscal policies.
(1) If σ f ≥ (σ c ,bfi ,up ) ,
2 2
γ f ≥ ( γ c ,bfi ,up ) , β f ≥ ( β c , b fi , u p ) , the fiscal policy is risky and unstable and the fiscal
expenditures are volatile in comparison with the other expenditures. The volatility is high. The risk of not
collecting the fiscal debts is maximum. The government has to review the fiscal policy to monitor and control the
risk of not collecting the tax debts.
(2) If σ 2
f ≥ (σ c2 , b fi , u p ) , γ f ≤ ( γ c , b fi , u p ) , β f ≥ ( β c , b fi , u p ) , the fiscal policy is also risky, stable, with high
volatility. The tax expenditures behave quite well as compared to the other expenditures due to the low level of
sensitivity. The risk of not collecting the tax debts is high. Volatility registers high levels. The government’s
fiscal policy has to be monitored because there is a perspective of increasing tax expenditures on short term.
(3) If σ
2
f ≥ (σ c2 , bfi , up ) , γ f ≤ ( γ c , bfi , up ) , β f ≥ ( β c , bfi , up ) , the fiscal policy is risky, stable, with low
volatility. Regarding the global risk, tax expenditures behave quite well as compared with the other expenditures.
The risk of not collecting the tax debts is in acceptable limits. Volatility is low. The government’s fiscal policy
has to be monitored from the perspective of the evolution of the inherent risk of tax expenditures.
(4) If σ 2f ≥ (σ c2 , b fi , u p ) , γ f ≤ ( γ c , b fi , u p ) , β f ≥ ( β c , bfi , up ) , the fiscal policy is also risky, unstable, but with
low volatility. The tax expenditures are extremely sensitive in report to the other expenditures which means that
an increase by one percent in tax expenditure is answered by an increase in the global risk. The volatility is quite
low; yet, the risk of not collecting the tax debts stays high.
(5) If σ f ≥ (σ c , bfi ,up ) , γ f ≤ ( γ c , bfi , up ) , β f ≥ ( β c , bfi , up ) , the fiscal policy is characterized by a
2 2
diminished risk, unstable and highly volatile. There is a problem in these situations due to the unstable
characteristic of fiscality. It is possible that for short-term periods of time the tax expenditures register high
values, due to the high volatility. The risk of not collecting the tax debts can be a major problem when the tax
expenditures grow.
(6) If σ 2
f ≥ (σ c2 , b fi , u p ) , γ f ≤ ( γ c , b fi , u p ) , β f ≥ ( β c , b fi , u p ) , the risk of fiscal policy is still diminished, the
fiscal policy is stable due to the low level of sensitivity and high volatility. The behaviour of tax expenditures
compared with the other expenditures is good due to the low sensitivity. Volatility is high. The fiscal policy has
great chances to be succesfully implemented even if there is a perspective of increasing tax expenditures for
short-time periods.
(
(7) If σ f ≥ σ c , bfi ,up ,
2 2
) γ f ≤ ( γ c,bfi ,up ) , β f ≥ ( βc,bfi ,up ) , the fiscal policy risk is also diminished, but the
fiscal policy is stable, due to low level of sensitivity which tax expenditures register. The volatility is low. The
behaviour of tax expenditures as compared to the other expenditures is good with respect to the taxpayer’s global
risk. It’s the type of fiscal policy with the greatest sensitivity and volatility indicators, with great chances to be
succesfully implemented, and a low risk of not collecting the tax debts.
(
(8) If σ f ≥ σ c , bfi ,up ,
2 2
) γ f ≤ ( γ c,bfi ,up ) , β f ≥ ( βc,bfi ,up ) , the risk of fiscal policy is low and unstable. The
volatility is also low. The tax expenditures behave rather undesirably as compared with the other expenditures,
due to high level of sensitivity. There is a risk of not collecting the tax debts when the weight of tax expenditures
in the taxpayer’s total budget changes.
The combination between risk, sensitivity and volatility coefficients, offer the governments further
information in order to substantiate their fiscal policies, so that the risk of not collecting the tax debts could be
controled. It is noticeable the fact that the risk, the sensitivity and the volatility of fiscal policies could not always
register values which can be framed in the eight fiscal policy typologies. In these situations the values of the
indicators should be analyzed in correlation with the values obtained for each expenditure category which is part
of taxpayer’s total budget. The combination between sensitivity and volatility coefficients is also useful to detect
the tax evasion which can be active in the circumstances when the risk is high and the sensitivity and the volatility
levels are high as well.
Nowadays, the risk of not collecting the tax debts and tax evasion are major concerns for the local and
central governments all over the world. There is a question which has to be answered: To what extent do fiscal
policies need to be reviewed in order to keep the taxpayer’s fiscal comfort? It is a question and also a research
subject which will be treated in our future research activities.
Testing the Types of Fiscal Policies for the Taxpayers From Central and Eastern Europe
In order to test the impact of fiscal policies over the taxpayer’s budget, the expenditures of the taxpayer were
grouped in four major categories, namely the consumption expenditures, tax expenditures, durables expenditures,
and public utility expenditures. The database of this analysis is made of information provided by the national
institutes of statistics. The calculation of risk, sensitivity coefficient and volatility coefficient can be applied for
each series of data constituted with the purpose of analyzing the sustainability of local and central government’s
fiscal policies.
The first indicator calculated was the growth in the rate of expenditures between two consecutive periods, the
time slot for the analysis being 2008-2010. The results are presented in Appendix A. It is noticeable that the most
spectacular growth rhythm was registered by the durables, which after an ascending trend in 2008-2009 it is start to
register a decrease in the late 2010. The consumers abandoned the idea of buying durables as a result of the fact
that the consumer’s income was constant, in the analyzed period, with a slight decrease. The durables were a
disposable variable as their income was diminished. The general characteristic of growth rhythms, in periods of
economic crisis, for the analyzed expenditure categories was the emergence, as an increasing rhythm was followed
by a descendent evolution, even for short period of time. Regarding the public utility expenditures they had an
increasing trend due to the fact that in Central and Eastern Europe the prices of public utilities are established in
monopoly conditions. An emergence of fiscal expenditures was observed in the period analyzed and that was due
to increased tax rates, as a last resort solution to avoid financial collapse or excessive budget deficits.
The risk of expenditures is the second indicator which has been calculated and analyzed for each
expenditure category that was part of taxpayer’s budget. The less risky expenditure turns out to be the
consumption expenditures, which are the most significant part of the total budget. The reason is that in the
analyzed period the consumption expenditures are almost constant and the growth rhythms of this type of
expenditures registered the same trend. The durables expenditures proved to be extremely risky because, besides
the fluctuant growth rhytms, they have registered high values of risk (in quarter IV σ b fi = 4, 2 9 3 .0 4 2 0 9 ).
2
The situation is explained by the fact that during economic boom, the population resorted to credits to
purchase durables, and then the economic crisis changed the behaviour of the consumer who abandoned the idea
of buying durables, because it was the only disposable type of expenditure. Regarding the tax expenditures they
registered high values of risk especially in the last period analyzed (year 2010). The tax expenditures were ranked
in the third place after durable expenditures and public utility expenditures. The risk evolution for each
expenditure is presented in Figure 3.
80
60
40
20
0
1 2 3 4 5 6 7 8 9 10 11
-20
-40
Growth rhythm for consumer expenditure Growth rhythm for taxes expenditure
Growth rhythm for durables expenditure Growth rhythm for public utility expenditure
Total expenditure
Figure 2. The growth rythm of consume expenditure (% from a trimester to another).
900 5000
800 4500
700 4000
3500
600
3000
500
2500
400
2000
300
1500
200 1000
100 500
0 0
1 2 3 4 5 6 7 8 9 10 11
The risk for all expenditures

The risk for the consumer expenditure
The risk for the taxes expenditure
The risk for the public utility expenditure
The risk for the durables expenditure (represented on the secondary axis)
Figure 3. The evolution of the risks for each expenditure (% from a trimester to another).
The sensitivity and volatility coefficients for each expenditure category are the third category of indicators
analyzed, the values of which are presented in Table 1.
Table 1
The Situation of Sensitivity and Volatility Coefficents for Each Expenditure Category
Specification Risk at the level of period Sensitivity at the level of period Volatility at the level of period
Total expenditures 22.0287846
Consumption expenditures 20.87507 0.10530504 0.00079995
Tax expenditures 116.6408 0.25906198 0.00196797
Durables expenditures 597.26563 0.53432052 0.00405898
Public utilities expenditures 248.107557 0.10131246 0.00076962
The most sensitive expenditures for the period analyzed remained the durable expenditures. The calculation
leads us to the conclusion that a one percent change in the weight of durables expenditures determines an increase
of 0.53% in the global risk of the taxpayers budget. The weight of tax expenditures in the total budget will itself
determine an increase of the global risk of 0.25%. Finally, the sensitivity calculation shows that even if public
utility expenditures are quite risky, they behave better compared to the other expenditures due to low level of
sensitivity which is registered in the analyzed period.
The volatility coefficient registered the highest values for the durable expenditures. It means that the probability
of changing the values of durables expenditures in the total budget is very high. The hypothesis of this change in
value is confirmed by the emergent growth rate which was registered during the analyzed period (2008-2010).
The tax expenditures register quite high levels in what volatility is regarded after durables expenditures. Any
increase of tax expenditures will have consequences in the volatility of this type of expenditure. The causes for a
high volatility can be many. One of them can be the stagnation or even the reduction of the income which
taxpayers earn during the analyzed period.
The consumption expenditures remained the less volatile. The explanation consists in the low level of risk
which consumption expenditures registered but also in the low level of sensitivity registered as compared to the
other expenditure categories.
The general characteristic of Eastern Europe fiscal policies related to the taxpayer’s total budget is that it
was quite risky registering the third highest level of risk, after durable expenditures and public utility
expenditures. The volatility is quite high which means that any modification of tax expenditure weight in the total
budget becomes risky. Central and local governments must be prudent in the elaboration of fiscal policies to
avoid the risk of not collecting the tax debts or the phenomena of tax evasion which can manifest among the
taxpayers. Besides the high sensitivity of fiscal policies, Eastern Europe registers an interesting particularity
determined by the high volatility of tax expenditures. This means that the latter are likely to change their values
on short-term. Any modification of fiscality as a weight in taxpayer’s budget is followed by a certain response
which can manifest under the form of not collecting the tax debts as they were projected. The greatest constraint
regarding fiscality is manifest when the income evolution is flat or decreasing especially in the time of economic
crisis. The influence of income stagnation on the fiscal risk and on sensitivity and volatility of risk with the tax
expenditures is a future reseach direction which shall be explored within further research activities.
From the perspective of risk, sensitivity, volatility the tax expenditures were analyzed on their structure. In
order to perform this analysis tax expenditures were grouped in four major subgroups, namely, wage tax
expenditures, pension contribution expenditures, health contribution expenditures and unemployment
expenditures. The results are presented in Table 2.
Table 2
Risk, Sensitivity and Volatility Calculation for Eastern Europe Tax Expenditures
Specification Risk at the level of period Sensitivity at the level of period Volatility at the level of period
Tax expenditure 11.65603
Wage tax expenditure 18.5823 0.3962421 0.0108352
Pension contribution expenditure 8.781152 0.2362452 0.0064601
Health contribution expenditure 12.16907 0.3200744 0.0087524
Unemployment expenditure 10.97704 0.0474382 0.0012972
The most risky expenditures remained the wage tax expenditures with a level of risk of σ s2 = 18 . 5823 ,
which simultaneously register the highest levels of sensitivity, γ s = 0 . 3962421 , and respectively of volatility,
β s = 0 . 0108352 . This means that any modification in central government’s fiscal policy, in the sense of a
transition from a fiscal policy based on flat tax to a fiscal policy based on progressive tax may lead to a great risk
of not collecting the tax debts. Also a high risk level was registered by the health contribution expenditures. The
level of sensitivity and volatility of this subcategory makes the modification of weight in the total budget lead to
a risk of not collecting the specific tax debts owed to the social security budget.
The structural analysis of tax expenditure structure based on risk, sensitivity and volatility coefficients
provides the governments with additional regarding the most sensitive, risky and volatile expenditure, so that
they could be more cautious in the elaboration of fiscal policies.
Conclusions, Future Research Directions

The fiscal policy of central and local governments should not be based only on equity principles and/or
fiscal rightness. It is not sufficient to produce a fair wealth taxation or a fair taxation of the work and of the capital
if these are not accompanied by a detailed analysis of taxpayer’s budget. And this budget has a series of
constraints determined by the income level which taxpayers register and also by the behaviour of the taxpayer
acting as a consumer on the products and services market.
Each expenditure category is included in the taxpayer’s budget regardless of its nature: consumption
expenditures, durables expenditures, tax expenditures and/or public utility expenditures registering a certain level
of risk. This risk can be manifested under two forms: when the taxpayer involves in the expenditure and the
public budget collects the tax debts or on contrary when the taxpayer does not make the whole expenditure in
which case the tax debts register an increasing trend. The measurement of each expenditure risk was performed
using the standard deviation, and the results obtained in the analysis period 2008-2010 lead to the hypothesis that
the riskiest category of expenditure remains the durables expenditure followed by the public utility expenditures.
On the third place as size, it turns out to come the tax expenditures, that register a risk of σ 2f = 116 . 6408
which implies that Eastern Europe countries must be cautious in the elaboration of fiscal policies, because there is
a risk for taxes not to be collected totally at their maturity.
This form of risk measurement is not sufficient, because the expenditure categories are interdependent. The
measurement of the interdependency between the expenditure categories leads to another indicator for the
analysis of the fiscal policies, known as sensitivity coefficient. The indicator whose formula was calculated in
this research paper measures the risk of an expenditure category relative to the total taxpayer’s budget when there
is a modification of one percent in the weight of a expenditure category. The more sensitive an expenditure
category is, the higher is the risk not to make that expenditure. In the period analyzed, tax expenditures registered
a sensitivity value of γ f = 0.25906198 which leads to the hypothesis that any modification by one percent of tax
expenditures determines a taxpayer’s global risk increased by 0.25%. By size the tax expenditures are ranked in
the second position, in what sensitivity is concerned after durables expenditures.
The last indicator analyzed and determined for the fiscal policies was the volatility coefficient. This
measures the probability that an expenditure included in the taxpayer’s budget modifies its value in a short period
of time. From the perspective of volatility, the tax expenditures were ranked on the second position after durable
expenditures with a coefficient, β f = 0 . 00196797 .
The general conclusion is that Eastern Europe’s fiscal policies were pretty risky from the perspective of
taxpayer’s budget. The sensitivity, quite high, makes the fiscal policies elaborated be really hard to implement
especially if they lead to increased tax rates. At the same time, volatility shows an increase in tax expenditures on
short-term caused especially by the stagnation or even reduction of taxpayer’s income.
The risk, the sensitivity and the volatility of tax expenditures in relation with the taxpayer’s budget provide
complete information for local and central governments related to the fiscal policies elaborated. The successful
implementation of a fiscal policy also depends on the value of these indicators. In order to avoid the risk of not
collecting the tax debts and the phenomena of tax evasion the governments have to monitor the value of these
indicators so that avoiding measures can be taken by the central and local governments.
If the fiscal policy is risky the analysis can be continued through the calculation of risk, sensitivity and
volatility for each expenditure category which is part of the fiscal policy. To perform this type of factorial
analysis, the tax expenditures were grouped in wage tax expenditures, pension contribution expenditures, health
contribution expenditures and unemployment expenditures. The calculation leads to the hypothesis that the
riskiest expenditure category is wage tax registering a risk σ s2 = 18.5823, a sensitivity coefficient γ s = 0.396242
and a volatility coefficient β s = 0 .108352 . High values of risk, sensitivity and volatility can, as we mentioned,
cause difficulties to the change in fiscal policies of central governments given by the transition from a taxation
mechanism based on flat tax to a taxation mechanism based on progressive taxes.
Regardless of the information provided to the central and local governments, through the calculation of risk,
sensitivity coefficient, volatility coefficient, there still stays as a future research direction, the study of fiscal
policy boundaries and the impact of stagnating or reducted incomes on the risk of not collecting the tax debts. An
important direction of research is represented by the calculation of expenditure efficiency frontier included in the
taxpayer’s budget having as a starting point the calculation hypothesis for the Markowitz efficiency frontier for
financial markets.
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Appendix A: Monetary Units
Table A1
The Values for Expenditure and Revenues in the Period 2008-2010, for Each Trimester
Monthly total Expenditure on Expenditure on Total Total
Expenditure on Expenditure on
expenditure/ consumer long term use revenues/ revenues/
taxes/person public services
person goods/person goods household person
2008 Trimester 1 619.28 391.49062 106.597011 31.1447107 90.047658 1,647.73 612.679969
2008 Trimester 2 624.38 413.737662 107.684998 36.1634542 66.7938851 1,753.88 650.92733
2008 Trimester 3 698.21 463.725684 120.354962 41.1354959 72.9938577 1,889.2 732.521246
2008 Trimester 4 714.58 462.812093 121.130079 39.8469388 90.7908891 1,969.77 733.133801
2009 Trimester 1 686.58 452.160111 90.7902656 41.6719515 101.957672 1,895.66 728.744019
2009 Trimester 2 707.3 484.39481 95.2171555 46.8613622 80.826672 2,033.66 781.276258
2009 Trimester 3 686.97 484.125755 85.0959617 36.3065675 81.4417158 1,977.71 773.415139
2009 Trimester 4 738.25 490.88497 90.2727726 62.1956405 94.8966171 1,986.13 767.687698
2010 Trimester 1 714.39 464.577994 96.9219384 46.0314147 106.858653 2,000.34 776.968021
2010 Trimester 2 698.21 484.174605 81.8401709 44.0594211 88.1358028 2,038.37 791.481469
2010 Trimester 3 698.21 488.330541 75.8511141 43.0818505 90.9464945 1,955.03 773.356994
2010 Trimester 4 730.21 504.908211 80.1776807 44.6267907 100.497318 1,954.98 770.438742
Table A2
The Growth Rhythm From a Trimester to Another, for Each Expenditure
Growth rhythm for Growth rhythm for taxes Growth rhythm for Growth rhythm for
consumer expenditure expenditure durables expenditure public utility expenditure
Trimester 2/1 2008 5.68265016 1.02065437 16.1142723 -25.82385
Trimester 3/2 2008 12.0820574 11.765765 13.748802 9.2822458
Trimester 4/3 2008 -0.19701107 0.6440255 -3.1324701 24.381547
Trimester 1 2009/4 2008 -2.30157824 -25.0472992 4.58005748 12.299453
Trimester 2/1 2009 7.12904538 4.87595212 12.4530062 -20.72527
Trimester 3/2 2009 -0.05554461 -10.6295906 -22.5234485 0.7609417
Trimester 4/3 2009 1.39616921 6.0834978 71.3068595 16.520896
Trimester 1 2010/4 2009 -5.35909174 7.36563813 -25.9893228 12.605334
Trimester 2/1 2010 4.21815313 -15.5607365 -4.28401691 -17.52114
Trimester 3/2 2010 0.85835473 -7.31799153 -2.21875498 3.1890465
Trimester 4/3 2010 3.39476415 5.70402503 3.58605794 10.501585
Table A3
The Growth Rhythm From a Trimester to Another, for Each Type of Expenditure on Taxes
Growth rhythm for Growth rhythm for Growth rhythm for pension Growth rhythm for
tax expenditure wage tax expenditure contribution expenditure unemployment expenditure
Trimester 2/1 2008 5.68265016 1.02065437 16.1142723 -25.82385
Trimester 3/2 2008 12.0820574 11.765765 13.748802 9.2822458
Trimester 4/3 2008 -0.19701107 0.6440255 -3.1324701 24.381547
Trimester 1 2009/4 2008 -2.30157824 -25.0472992 4.58005748 12.299453
Trimester 2/1 2009 7.12904538 4.87595212 12.4530062 -20.72527
Trimester 3/2 2009 -0.05554461 -10.6295906 -22.5234485 0.7609417
Trimester 4/3 2009 1.39616921 6.0834978 71.3068595 16.520896
Trimester 1 2010/4 2009 -5.35909174 7.36563813 -25.9893228 12.605334
Trimester 2/1 2010 4.21815313 -15.5607365 -4.28401691 -17.52114
Trimester 3/2 2010 0.85835473 -7.31799153 -2.21875498 3.1890465
Trimester 4/3 2010 3.39476415 5.70402503 3.58605794 10.501585
Table A4
The Risks Calculated for Each Type of Expenditure, in the Analyzed Period
The risk for the total The risk for expenditure on The risk for expenditure The risk for expenditure The risk for expenditure
expenditure / person consumer goods/person on taxes/person on long term use goods on public services
22.0287846 20.87507 116.6408 597.26563 248.107557
Table A5
The Sensitivity Calculated for Each Type of Expenditure, in the Analyzed Period
The sensitivity for expenditure The sensitivity for The sensitivity for expenditure on The sensitivity for expenditure
on consumer goods/person expenditure on taxes/person long term use goods on public services
0.105305042 0.25906198 0.53432052 0.10131246
Table A6
The Volatility Calculated for Each Type of Expenditure, in the Analyzed Period
The volatility for expenditure The volatility for expenditure The volatility for expenditure on The volatility for expenditure
on consumer goods/person on taxes / person long term use goods on public services
0.105305042 0.25906198 0.53432052 0.10131246
Table A7
The Values for Each Type of Expenditure on Taxes in the Period 2008-2010, for Each Trimester
Expenditure on taxes Expenditure on Health insurance State social insurance Unemployment fund
/person wage tax contribution contribution expenses
2008 Trimester 2 602.64 236.51 143.29 208.09 14.75
2008 Trimester 3 632.69 256.49 141.43 219.81 14.96
2008 Trimester 4 660.12 272.78 142.41 230.2 14.73
2009 Trimester 1 659.46 270.33 139.68 235.02 14.43
2009 Trimester 2 703.97 287.04 146.53 255.61 14.79
2009 Trimester 3 696.55 284.05 144.93 252.6 14.97
2009 Trimester 4 695.62 284.4 143.67 253.27 14.28
2010 Trimester 1 692.97 285.27 141.63 251.88 14.19
2010 Trimester 2 691.49 283.15 141.02 252.83 14.49
2010 Trimester 3 661.35 268.38 133.93 245.48 13.56
2010 Trimester 4 670.04 272.23 135.83 248.26 13.72
Table A8
The Risks Calculated for Each Type of Expenditure on Taxes, in the Analyzed Period
The risk for expenditure The risk for expenditure The risk for health The risk for state social The risk for unemployment
on taxes / person on wage tax insurance contribution insurance contribution fund expenses
11.65603 18.5823 8.781152 12.16907 10.97704
Table A9
The Sensitivity Calculated for Each Type of Expenditure on Taxes, in the Analyzed Period
The sensitivity for The sensitivity for health The sensitivity for state social The sensitivity for
expenditure on wage tax insurance contribution insurance contribution unemployment fund expenses
0.3962421 0.2362452 0.3200744 0.0474382
Table A10
The Volatility Calculated for Each Type of Expenditure on Taxes, in the Analyzed Period
The volatility for The volatility for health The volatility for state social The volatility for unemployment
expenditure on wage tax insurance contribution insurance contribution fund expenses
0.0108352 0.0064601 0.0087524 0.0012972
November 2011, Vol. 10, No. 11, 1061-1070
Interactions Between Knowledge Sharing and

Organizational Citizenship Behavior
Yavuz Demirel, Zeliha Seçkin, Mehmet Faruk Özçınar

Aksaray University, Aksaray, Turkey
Recently, researches toward the social and psychological structure of organizations have proliferated observably.
As the quality and quantity of these studies improve, the value of such issues gets more manifest. In this context,
efforts toward making employees’ knowledge, which is an indispensable value for organizations, accessible and
efforts to make it available for work processes and social relations extend new behavioral patterns. Organizational
citizenship behavior is an example of such patterns. This paper attempts to explain and discuss interactions between
organizational citizenship behavior and knowledge sharing, which is reasoned to have a defining role over it, and to
draw attention on the issue. Organizational knowledge sharing, the factors influential on it, and the relationships
between the antecedents of organizational citizenship behavior and knowledge sharing are being dwelled upon
conceptually.
Keywords: knowledge, knowledge sharing, organizational citizenship behavior
Introduction
The key capital and locomotive power of organizations is “human”, which is a social being. Thus, the
existence of workers who have adopted the organization’s values, who see the organization’s purposes as their
own purposes, and who make an effort more than expected in the organization with willingness is becoming more
important for the organizations, so that they can carry out their activities and achieve their goals. When the
studies on organizations conducted in recent years are looked at, it will stand out that interest in psycho-social
issues, which were formerly going unnoticed though they are crucial for organizations, has grown. An
outstanding example of such issues is organizational citizenship behavior. Organizational citizenship behavior
involves the organization members’ behaviors that include positive actions. In other words, it is the behaviors of
the workers that are demonstrated voluntarily without any expectations and beneficial for the organization.
Findings of studies on the subject have revealed that workers who tend to demonstrate organizational citizenship
Yavuz Demirel, Ph.D., Associate Professor, Department of Business Administration, Faculty of Economics and Administrative
Sciences, Aksaray University.
Zeliha Seçkin, Ph.D., Assistant Professor, Department of Administrative and Economical Programs, Ortaköy School of
Vocational Studies, Aksaray University.
Mehmet Faruk Özçınar, Ph.D., Assistant Professor, Department of Public Administration, Faculty of Economics and
Administrative Sciences, Aksaray University.
Correspondence concerning this article should be addressed to Yavuz Demirel, Aksaray University, Faculty of Economics and
Administrative Sciences Department of Business Administration, 68100 Aksaray/Turkey. E-mail: ydemirel75@gmail.com.
1062 KNOWLEDGE SHARING AND ORGANIZATIONAL CITIZENSHIP BEHAVIOR
behavior are more efficient and productive, prone to teamwork, enthusiastic for full participation and
knowledge-sharing, and have higher levels of loyalty and responsibility.
In order for the workers to demonstrate organizational citizenship behavior, it seems necessary to build a
culture of communication, trust and knowledge sharing. Organizational citizenship behavior and knowledge
sharing are not expected to meet the prospects in a working atmosphere where suspicion and uncertainty reign.
The sense of organizational citizenship behavior can be positive or negative, depending on the workers’
perceptions of organizational knowledge sharing. The positive perception among the workers that knowledge
sharing is supposed to generate is an important factor for determining the tendency of the workers toward
organizational citizenship behavior. Consequently, this study grounds on the principle that workers cannot be
forced, but they can share knowledge depending on behaviors that are not pre-defined, and it is beneficial for the
social system of the organization. The conceptual relationship and interaction between organizational knowledge
sharing and organizational citizenship behavior is analyzed in detail.
Organizational Knowledge Sharing: Concept and Content

Knowledge, which has become the most powerful tool for surplus value, produces more value when it is
shared. This fact has caused the “Knowledge is power” (Liao, Chang, Cheng, & Kuo, 2004, p. 24) aphorism of
Bacon to be moved one step further as “Knowledge sharing is power” (Gurteen, 1999, p. 3). In this respect, it can
be pronounced that knowledge is doubtlessly among the most strategic and important resources for organizations
(Fei & Chen, 2007, p. 2), and not simply a rhetorical expression. Knowledge sharing functions as a fundamental
element that contributes to the competitive power of the organization in the global market, improves
management-worker relations, and increases the performances of the employees. Consequently, as long as
knowledge is shared in an organization, that organization will gain competitive advantage. Sharing requires the
circulation of knowledge. The boundaries of this circulation are drawn not only by technology, but also
depending on the behavioral factors of the employees (Liao et al., 2004, pp. 24-25). The view of Cheah and his
colleagues (2009, p. 1423) that knowledge sharing is an activity and knowledge is transmitted by this action
corresponds to the studies of Liao and his colleagues. Takeuchi (1995) also considers the production of
knowledge as a process and emphasizes that production of knowledge cannot take place without the individuals
by drawing attention to the importance of individuals in this process, and he points to the importance of
knowledge sharing in enabling organizational effectiveness. According to Lin (2008, p. 241), whereas
knowledge sharing improves the competitive power of an organization, the lack of knowledge sharing can cause
serious trouble for the organization. Active knowledge sharing is related to how willing and prone to sharing
knowledge the employees are (Fei & Chen, 2007, p. 3) and how enthusiastic they are (Vries & Hooff, 2006,
p. 116). The development of knowledge sharing arises from the active external relations among the employees,
shareholders, intermediates and customers and it is transformed to organizational strategies that will enable to
organization to gain competitive power in the future. However, Batt has reached the conclusion that an
organization cannot compel the employees to share tacit knowledge. Nevertheless, it is indispensable for the
knowledge managers to put forward incentives and rewards that will encourage the employees to contribute to
knowledge sharing and the information pool. According to Gagne (2009), knowledge sharing is a process when
the employees exchange knowledge and produce new knowledge. However, the fact that organizational
KNOWLEDGE SHARING AND ORGANIZATIONAL CITIZENSHIP BEHAVIOR 1063
knowledge sharing generates value requires the reproduction of knowledge at personal and organizational levels.
Considering this fact, it is necessary for the managers to set up systems that will motivate the employees to share
knowledge positively and willingly. The result of this motivation is related to how important the employees
consider knowledge sharing with a personal or collective purpose (Gagne, 2009, p. 572). In other words,
individuals or groups need to share knowledge with each other through cooperation and therefore gain mutual
benefits. In their study, Small and Sage (2005/2006) offer three explanations for the dilemma of why employees
tend to/need to share knowledge in spite of the fact that they will lose power and profit: gaining knowledge,
reusing knowledge and the aspiration to produce knowledge.
Although knowledge sharing creates personal and organizational value, it may not always occur in an ideal
way for every organization. It must not be ignored that there are factors of secondary importance in the resolution
of the mentioned conflict. The term knowledge sharing also represents a dilemma between personal benefit and
organizational benefit. In terms of organizational benefit, knowledge sharing is indispensable whereas it can be
seen as a behavior that can cause negative effects for the individual. Knowledge sharing will increase the
possibility of an individual or a group to provide benefits to another individual or group that will become a rival
in the future. Therefore, organizations that foresee the fact that individuals will avoid knowledge sharing,
introduce certain systems of incentives and rewards in order to prevent this and to ensure knowledge sharing in
the organization (Liao et al., 2004, p. 25). These systems of incentives and rewards should not be considered
different from technological tools in terms of overcoming the dilemma between personal and organizational
benefits. Knowledge sharing is also related to the degree of trust among the shareholders. As Bratianu and Orzea
(2010, p. 108) indicated, most people will avoid their knowledge and experience when they do not have a certain
degree of trust for their interlocutors. When people share a certain piece of knowledge, they need to be assured
that it will not be misused. In this case, we can say that knowledge sharing, and flow and transfer of knowledge
will occur more frequently in organizations and working units where there is high level of sense of trust. In this
respect, plenty of research that supports the relationship between trust and knowledge sharing has been carried
out (Nita, 2008, p. 16; Yücel & Samancı, 2009, pp. 116-117). It must not be forgotten that when people believe
that knowledge is the source of power and prestige, knowledge sharing will cause the individuals to be afraid to
lose power and therefore it will negatively affect knowledge sharing. Moreover, individuals will think that a
decline in their power and status will cause their perceived value in the organization to decrease and they will fear
becoming expendable. Studies that have been carried out so far confirm that knowledge sharing provides benefit
for everyone except the one who shares the knowledge. This, therefore, means a decrease in the personal value of
the individual who contributes. Riege (2005, p. 23-25) considers the problem of knowledge sharing that is
assumed to arise from various reasons as an “obstacle” and suggests three dimensions of the concept which are
personal, organizational and technological. Knowledge sharing obstacles at employee and individual level are the
lack of communication and social bonds among the employees, differences in national culture, too much
emphasis on the position, lack of time and trust. On the other hand, obstacles at organizational level are economic
capacity, lack of background and resources, lack of formal and informal meeting places, inconvenient physical
environment. Technological obstacles are insufficient or no technological devices, the fact that these devices are
not used for the purpose of sharing knowledge among the employees and not being able to follow technological
advancements. In addition to these factors, difficulty to transform personal knowledge into organizational
knowledge represents another important obstacle in knowledge sharing. Kankanhalli, Tan and Wei (2005)
suggests that transforming personal knowledge into organizational knowledge can be difficult in the following
ways:
• Discouraging organizational climate and the motivational lack of the individuals;
• Tensions that may occur between efficient and inefficient knowledge cycles in different organizational
levels;
• Compulsion in codification;
• Difficulties in the relationships.
According to Chow and his colleagues (2008), the effectiveness of knowledge sharing for the employees
and the organization depends on organizational culture, performance evaluation, reward system and the use of
information technologies. When we focus on the production and sharing forms of knowledge through the
interaction between explicit and implicit knowledge, we come across four possible processes:
• Socialization: Sharing of tacit knowledge among individuals;
• Externalization: The appreciation of tacit knowledge and its transformation into easily understandable
forms;
• Internalization: Transformation of explicit knowledge into tacit knowledge;
• Combination: Placing explicit knowledge into more complex explicit knowledge sets.
As tacit knowledge becomes explicit knowledge and creates surplus value, knowledge sharing becomes
more important for the organization and individuals.
Organizational Citizenship Behavior Concept, Its Dimensions

and Its Importance for Organizations
The highly competitive environment urges organizations to search for new ways of gaining sustainable
competitive advantage. After it was found out that technological-, structural- and capital-based assets are
insufficient for getting the desired result, attention was drawn to human factor. However, it is not enough for the
employees to carry out the defined role requirements in order to gain sustainable competitive advantage. In this
respect, organizational citizenship behavior (OCB), which is believed to increase the performance of the
employees, and therefore the organization, is among the leading issues that draws the most attention in the fields
of organizational psychology, organizational behavior and human resources. Although the term is attributed to
Barnard (1938) and Katz (1964) (Tayyab, 2005, p. 49; Organ et al., 2006, pp. 44-51; Sezgin, 2005, p. 320; Farh,
Zhong, & Organ, 2004, p. 241), it became popular in the literature through the papers of Organ and Bateman in
the “42nd National Management Conference” in 1982 and their studies afterwards (Podsakoff, Mackenzie,
Paine, & Bachrach, 2000, p. 513; Karaaslan, Ergün, & Kulaklıoğlu, 2009, p. 138). Barnard called attention to the
willingness of the employees to contribute to the organization with their efforts, and Katz put emphasis on the
importance of extra role behaviors that were neither considered compulsory by the managers nor predefined. The
well accepted definition of OCB is attributed to Organ (Yener & Akyol, 2009, p. 258). According to Organ
(1988), OCB is “the voluntary behaviors of the individual that are not directly and clearly defined by the formal
reward system of the organization, but help the organization work effectively and efficiently as a whole”.
Knowsky and Pugh (1994) define the term as the voluntary behaviors of the employees that are independent from
the formal reward system and beyond the role definitions. According to the definition of Blakely (2003), OCB is
a pattern of behaviors that are different from the technical efforts required by the job and add surplus value to the
activities related to the work being done in psycho-social terms. Van Dyne and his colleagues (1995) define OCB
as voluntary behaviors that go beyond defined job expectations and performed with the intention to provide
benefit for the organization. Briefly, OCB involves all the positive voluntary actions of the employees that are
related to the behaviors of the organization members and are performed for the benefit of the organization.
(Jahangir, Akbar, & Haq, 2004, p. 76).
It is possible to evaluate the work attitudes of the employees in terms of OCB in two dimensions. The
cognitive dimension that is towards the features of the attitude object and affective dimension that is towards the
attitude object. Both dimensions are known to affect OCB in a positive way. When it is considered that OCB
depends on the desires, voluntary efforts and sincere actions, it will be better understood how important
individuals act “voluntarily” affectively and cognitively. In other words, individuals do not act in this way due to
professional duties (Sezgin, 2005, p. 320). Therefore, in the case of a performance evaluation of the employees, a
two-dimensional process will need to be taken into consideration: In-role and extra-role performance. In-role
performance involves behaviors that employees are expected to perform by the organization, that exist in their
formal job descriptions and that are directly or indirectly related to the mission of the organization. Extra-role
behavior, on the other hand, involves behaviors that support the organization but do not exist in the job
description of the employees, and behaviors that are voluntary, and different from the job role. Examples of these
behaviors are cooperation among the employees, voluntarily undertaking extra responsibility, orientation of the
new employees, willingness to help others succeed in their work, and doing more work than they are required by
the job (Bergeron, 2007, p. 1078; Chen & Chıu, 2009, p. 476; Zellars, Teper, & Duffy, 2002, p. 1068). These
behaviors include positive and voluntary behaviors as they are independent from the formal reward system and
their repudiation is not subject to a penal enforcement (Çetin, 2004, p. 128; Acar, 2006, p. 3; Finkelstein, 2006,
p. 604). The definition of organizational citizenship behavior by Organ (1988) involves a structure consisting of
the components below (Schlecter & Engelbrecht, 2006, p. 3; Karaaslan et al., 2009, pp. 138-139).
• These behaviors go beyond the job requirements and formal job descriptions of the employees. They are out
of the formal roles of the employees;
• These behaviors are voluntary by nature and employees decide to demonstrate these behaviors willingly.
Thus, employees cannot be forced to perform these actions by the organization;
• These behaviors depend on the voluntary preferences of the employees as they are not defined by the formal
reward system or the structure of the organization. Employees do not expect to get a reward in return for their
extra efforts. Besides, they are not to be penalized because of the roles and behaviors that they do not perform in
terms of OCB;
• OCB is the whole set of behaviors that contribute to the employees and the organization.
In many studies on organizational citizenship behavior, there are differences among the numbers and
classifications of the dimensions related to this behavior. Smith and his colleagues (1983) mention two
dimensions related to OCB that they call altruism and generalized compliance (conscientiousness). Graham
(1991), on the other hand, divides these dimensions into three, which are obedience, loyalty, and participation.
While Williams and Anderson (1991) considered OCB in individual and organizational levels, Podsakoff and his
colleagues (2000) and Karaaslan and his colleagues (2009) considered OCB in seven dimensions. On the other
hand, Organ (1988) mentions five dimensions. Although there are various dimensions in the literature suggested
by the researchers, Organ’s five-dimensional classification is the fundamental one. These five dimensions are
altruism, conscientiousness, courtesy, civic virtue and sportsmanship (Kays, 2001, p. 104; Tayyab, 2005, p. 51,
Boiral, 2009, p. 224; Çetin, 2004, p. 19; Bolat & Bolat, 2008, p. 79).
Altruism
It involves attitudes and behaviors that are related to helping other workers overcome the problems they
encounter and contribute voluntarily to their performances and activities in this way. When an employee
voluntarily helps another employee complete his/her work and succeed in an activity he/she cannot overcome,
that is altruism. These behaviors that are intended to increase the performance of the colleagues also contribute to
group efficiency and to the fulfillment of organizational goals thanks to the cooperative effect. Although altruism
represents the individual efforts of the employees, it provides benefit for the organization on the whole.
Conscientiousness
It expresses the fact that the employees in an organization go beyond the requirements of their formal duties
and roles and willingly contribute to the functioning of the organization as a whole. Behaviors such as the
attendance of the employees to work, using time of work efficiently and effectively, performing work-oriented
and target-oriented actions that require effort, abiding by the formal rules, protecting the resources of the
organization, making suggestions that solve problems, etc., can be listed as examples of conscientiousness.
Courtesy
Courtesy involves the conscious behaviors of the employees that are preventive against the problems that
may arise in the organization. In this respect, courtesy points to the fact that employees must act thoughtfully and
carefully before performing actions that will affect the work they are doing and they must determine the
problematic points beforehand and make the necessary efforts for resolution. It emphasizes the fact the
employees need to act responsibly before performing actions that will affect their work. Courtesy-based
informing and voluntary participation in efforts of knowledge sharing can be considered as an example in this
respect. The dimension of courtesy, which contributes to the development of cooperation awareness among the
employees, also has an effect on establishing the positive communication necessary for cooperation.
Conscientiousness involves behaviors that are intended to prevent organizational problems.
Civic Virtue
It is the behaviors that are intended to protect the benefit of the organization at utmost level. It refers to the
highest level of active participation in the organizational life. It involves the behaviors in terms of voluntary
participation in organizational activities. Civic virtue also reflects a situation where commitment and interest in
the organization is at the highest level. Behaviors such as actively contributing to the resolution of the problems
by voluntarily participating in management, expressing ideas about the strategy that the organization should
follow, voluntarily supporting the action of converting the threats for the organization into opportunities,
performing actions and practices that will benefit the company can be considered relevant to civic virtue.
Voluntary behaviors such as taking part in the social activities in the organization can be shown as an example of
the civic virtue dimension of OCB. Being sensitive to the change occurring in the atmosphere of the organization
and developing positive reactions, accessing knowledge and being willing to share this knowledge with
colleagues also are involved in civic virtue dimension.
Sportsmanship
Sportsmanship involves behaviors such as being sensitive to the inconveniences, constraints and extra
efforts caused by job requirements and process, not complaining about the job and other employees, protecting
the positive attitude against negative occurrences, tolerating those who have different ideas, willingness to
participating in group work, etc.. They are behaviors that require the skill of internalizing the understanding of
not minding problems too much. Trying to avoid possible tensions in the organization can be considered an
example of behaviors involved in sportsmanship.
Considering the dimensions representing OCB, it is understood that these behaviors depend on
“willingness”, which emphasizes the preferences of employees concerning OCB. Studies dealing with the effect
of the state of mind and personality traits of the individuals on their preferences have been carried out. According
to what Messer and White (2006, p. 67) cite from George, Carlson and their friends Isen and Daubman, it was
found out that there was a positive correlation between the positive state of mind of the employees and altruism,
and the employees were more willing to fulfill the formal and extra role requirements. Koys (2001) draws
attention the fact that there are strong correlations between each dimension of organizational citizenship behavior
and customer satisfaction. Besides, when the employees have strong organizational citizenship behaviors, the
manager will be able to allow time for more important issues (Koys, 2001, p. 104; Bateman & Organ, 1983, p.
588).
The Relationship Between Knowledge Sharing and Organizational Citizenship Behavior

These two terms have been the subject of the scores of diverse studies in the literature. The interest in the
issue is growing particularly because of the fact that both terms occur as a result of interactions among the
employees and they increase the performance. Whether organizations can achieve sustainable competitive
advantage depends on the precondition that they must attain their defined performance/success aims. When the
organizations achieve this, the need for the behaviors as part of OCB arises. In this respect, it is obvious that
knowledge sharing will have a positive effect on the organizational performance directly or indirectly due to its
definition. As Hendriks (1999, pp. 91-100) states, knowledge sharing is a very significant channel for
transforming personal knowledge to a strategic source for the organization. Many studies are carried out without
the need to explain the necessity and importance of knowledge sharing for an organization. However, it must be
accepted that knowledge sharing is not a behavior that can easily be accomplished. Therefore, the ways of
ensuring that the employees share knowledge have been studied. Ipe (2003) indicates that many researchers have
handled the motivation for knowledge sharing as a function of reciprocity. Li and his colleagues (2010), who
have made a recent study on this issue, have approached the issue on a cultural level and have focused on whether
the organizational climate is suitable for knowledge sharing or not. This study focuses on OCB, which is a
variable that must be considered to be relevant to the organizational climate and atmosphere. Naturally, neither
knowledge sharing nor OCB is a phenomenon that is equally available in every organization. Thus, whether the
level of OCB varies depending on the pervasiveness of knowledge sharing is a meaningful research subject.
When the relationship between organizational citizenship behavior and trust within the organization (Wech, 2002,
p. 354) is considered, naturally it will be assumed that there is a relationship between OCB and knowledge
sharing. Connelly and Kelloway have found out that social interaction reinforces the perception of knowledge
sharing culture but technology does not have such an effect, in their study where they evaluated various factors
that possibly impinge on the perceptions of knowledge sharing culture in an organization (Connelly & Kelloway,
2003, p. 298).
This finding show that not material factors but social and psychological factors and human relations are
decisive in accomplishing knowledge sharing. OCB is a significant topic to be evaluated in this respect. There are
studies, though in limited numbers, that measures the relationship between the two terms. Mogotsi (2009, p. 136)
has reached the conclusion that there is a positive correlation between knowledge sharing and OCB and has
reached the inference that knowledge sharing is a type of OCB. Connelly and Keloway (2003, p. 294) even
concluded that knowledge sharing and OCB are similar behaviors. Lin (2008, pp. 242-243) has put forward the
positive correlation between knowledge sharing and the dimensions of OCB in his research. Lin states that
knowledge sharing is affected by altruism, conscientiousness, courtesy, civic virtue and sportsmanship, which are
the dimensions of OCB, and discusses the relationship between these dimensions and knowledge sharing.
Nevertheless, in such a case where knowledge sharing is the defined policy of the organization and it is included
in the reward system (Sezgin, 2005, p. 320), there can be a difference in terms of the voluntary OCB actions of
the employer. Much as the view that OCB must be supported by the reward system is emphasized, this situation
bears the possibility of a conflict about OCB. Including actions of OCB in the reward system will not be in
accordance with the understanding of “not being included in the reward system” which forms the essence of this
behavior. In that case, whether employees perform actions of OCB for reward or for the sake of OCB spirit will
need to be discussed. Furthermore, including OCB in the reward system will make the separation between these
two terms more ambiguous.
Conclusion
For a better comprehension of the relationship between OCB and knowledge sharing, it needs to be probed
in terms of the dimensions of OCB, because all behaviors performed as a part of OCB require putting knowledge
sharing into practice. Voluntary behaviors representing examples of “altruism” such as contributing to
overcoming hard work or taking part in group work cannot be performed without knowledge sharing. Behaviors
in terms of “conscientiousness” such as making constructive suggestions in order to solve problems will not be
yielded without knowledge sharing. For behaviors representing “courtesy” such as informing the relevant people,
cooperating with other employees to take place, knowledge sharing is essential. “Civic virtue”, which involves
behaviors intended for protecting the benefits of the organization at the highest level, also requires highest
participation in organizational life. Boosting knowledge sharing is the way to ensure them at the top level.
Developing knowledge sharing among employees in order to ensure active participation for the benefit of the
organization is one of the fundamental requirements. “Sportsmanship”, on the other hand, involves the behaviors
intended for being sensitive to the inconveniences, constraints and extra efforts that may result from the
professional processes, and avoiding organizational conflicts that may arise. In order to produce resolutions to
these problems, employees need to make knowledge sharing common and functional.
Organizational knowledge sharing is a considerably important element in terms of ensuring cooperation
among employees, developing awareness for taking responsibility, and enhancing the commitment toward the
values of the organization. As knowledge sharing becomes common in an organization, manifestation of
organizational citizenship behaviors by employees can be expected to increase. In fact, considering the two terms
as interlocked to each other will be a better approach. In other words, in organizations where OCB is common,
actions as part of knowledge sharing will most probably be common, too.
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Journal of Applied Psychology, 87(6), 1068-1076.
November 2011, Vol. 10, No. 11, 1071-1075
Enhancing Organization’s Performance Through

Effective Vision and Mission
Ben E. Akpoyomare Oghojafor, Olufemi O. Olayemi, Patrick S. Okonji

University of Lagos, Akoka Yaba-Lagos, Nigeria
James U. Okolie
Lagos State University, Ojoo-lagos, Nigeria
Organizations, no matter their kinds, are established to serve specific societal needs. The success of an organization
depends on its ability to direct the energies of its members in effectively serving these needs. The primary motive
for the existence of any organization is often expressed in its mission. It is heartwarming that most Nigerian
organizations (profit and non-profit alike) have mission statements conspicuously displayed in their front offices.
However, the efficacies of these mission statements in securing the needed employees support and commitment
have not being fully investigated within the Nigerian context. The authors used structured questionnaires to elicit
required responses from respondents’ employees of various Nigerian organizations. It was affirmed that the
statements of properly formulated and communicated missions are potent tools in the hands of management in
unleashing employees’ commitment and improving organizational performance. It was recommended that Nigeria
organizations should move beyond the use of mission statements as mere “slogans” and open up employees’ “eyes”
to see how their daily tasks and roles as enshrined in the vision and mission can move the organization towards the
attainment of its objectives.
Keywords: vision, mission, commitment, performance, objectives
Introduction
For over a decade now, corporate Nigeria suddenly woke up to the fact that the formulation of vision and
mission usually compressed in statements is a sure building block for effective management of organizations.
Expectedly, corporate front offices were and still filled with various sorts of statements purporting to be mission
and vision statements. Lately, the non-profit organizations especially the churches have followed suit. While this
realization is a welcomed development. There is a debate as to whether, and if these statements have actually
improved organizational performance within Nigeria. This study was carried out to ascertain the extent to which
effective vision and mission statements could help improve managerial performance and organization prosperity.
Ben E. Akpoyomare Oghojafor, Ph.D., Professor and Dean, Faculty of Business Administration, University of Lagos.
Olufemi O. Olayemi, Ph.D. candidate, Lecturer, Department of Business Administration, University of Lagos.
Patrick S. Okonji, Ph.D. candidate, Lecturer, Department of Business Administration, University of Lagos.
James U. Okolie, Lecturer, Department of Accounting and Finance, Faculty of Management Sciences, Lagos State University.
Correspondence concerning this article should be addressed to Olufemi O. Olayemi, Department of Business Administration,
University of Lagos, Akoka Yaba-Lagos, Nigeria. E-mail: femolayemi1@yahoo.com.
1072 ENHANCING ORGANIZATION’S PERFORMANCE
Specifically, the study focused on:

(1) Determining the extent of corporate awareness of vision and mission relevance in the effective
management of organization;
(2) Ascertaining the efficacy of visions and mission so formulated by Nigerian managers in improving
organizational performance.
Literature Review and Theoretical Framework

A vision is a realistic, credible and attractive future for an organization (Nanus, 1997). For Thornberry
(1997), vision is a picture or view of the future, something not yet real but imaging. What the organization could
and should look like, partly analytical and partly emotional. According to Dess, Lumpkin and Eisner (2007),
statements of vision tend to be quite broad and can be described as a goal that represents an inspiring, over
arching and emotionally driven situation. Vision statements tend to be quite enduring and seldom changes.
Hay and Williamson (1999) posit that an effective vision must possess both the external and internal
dimensions. The external dimension is a shared view within the organization of what are the market, customers,
competitors, industry and likely macroeconomic impacts on the market. While the internal dimension is the
shared organizational beliefs and values. It is through this that meaning is created throughout the organization
about what it is that the organization does—and from here other strategic actions are taken such as the
development of the mission, plans, objectives and budgets.
For Nutt and Backoff (1997) visions can be crafted in three different ways:
(1) Leader—Dominated approach—In this approach, the founder or chief executive officer formulates the
vision for the organization;
(2) Pump—Priming approach—This is an improved method under which the leader or CEO provides
visionary ideas on which selected employee, will work on to fashion out a vision statement;
(3) Facilitation approach—This is a participatory approach under which a wide range of people are engaged
in a process of developing and articulating a vision. The leader/CEO merely acts as a facilitator that guides the
vision formulation process.
According to Mishe (2000), the most effective visions share six essential qualities. The visions are:
(1) Vission communicates a sense of direction. All organizations need a sense of direction, a goal and
guide to a future state of existence;
(2) Vision establishes a context for operating the enterprise. Contexts help to define and classify the
environment in which the leader and the organization operate;
(3) Vision describes a future condition. Effective visions provide a future—state and condition that
represents a “better” state than the ones of the past and that exists in the present;
(4) Vision motivates people. Leaders understand that effective and meaningful visions provide a high
value proposition to others. Those visions that appeal to the instincts, needs and intelligence of people and
touch their “soul” serve as a basis for systematic acceptance and motivation;
(5) Inspires people to work toward a common state and a set of goals;
(6) Serves as a centering point for organizational behaviour and performance. Visions provide a central
point for focusing the resources of the organization, developing strategy and measuring progress towards the
ENHANCING ORGANIZATION’S PERFORMANCE 1073
vision.
Nutt and Backoff (1997), posit that for a vision to enhance organizational performance it must possess the
following generic features:
(1) Possibility—It should entail innovative possibilities for dramatic organizational performance;
(2) Desirability—It should draw upon shared organizational norms and values about the way things should
be done;
(3) Actionability—A vision should provide a motivation for people to take actions that are relevant to them;
(4) Articulation—The vision should possess an image that is powerful enough to communicate clearly a
picture of where the organization is headed.
For Jick (2001), vision should be clear and concise, memorable, exciting and inspiring, challenging,
centered on excellence, both stable and flexible and achievable and tangible. According to Daft (2008), the
mission describes the organization’s values, aspirations and reason for being. Formal mission statements are a
broadly shared definition of purpose . A mission statement answers the following questions, what is our business,
i.e., who are our customers and which of their needs are we seeking to serve? Given the dynamic nature of the
external environment, a market-focused mission and strategy may not provide the stability and consistency of
direction needed as a foundation for long term strategy (Grant, 2000).
For Bateman and Snell (2007) the mission statement is a clear and concise expression of basic purpose of the
organization. It describes what the organization does, who it does it for, its basic product or service and its values.
Oghojafor (2006) defined mission statement as that which reveals the long-term vision of an organization in
terms of what it wants to be and whom it wants to serve. It describes the organizational purpose, customers,
products or services, markets, philosophy and basic technology.
David and David (2003) posit that a well-defined mission statement can enhance employee’s motivation and
organizational performance. The purpose of the mission statement is to inspire, its credibility lies in the
significance and scope of the problems and needs it has identified (Ragan, 2004).
According to King and Cleland (1978), the objectives of a company mission are:
• To ensure unanimity of purpose within the organization;
• To provide a basis for motivating the use of organizational resources;
• To establish a general tune or organizational climate to suggest a business like operations;
• To develop a basis or standard for allocating organizational resources;
• To serve as a focal point for those who can identify with organization’s purpose and direction and to deter
those who can not do so from participating further in it is activities;
• To facilitate the translation of objectives and goals into work structures involving the assignment of tasks to
responsible elements with in the organization;
• To specify organizational purpose and the translation of these purposes into goals in such a way that cost,
time, and performance parameters can be assessed and controlled.
All told, an organization without a clear mission statement tends to have its short-term actions
counter-productive to its long-run purpose. It should be carefully prepared and should always be subject to
revision so that it can meet major environmental changes to enable it stand the test of time (Oghojafor, 2006).
1074 ENHANCING ORGANIZATION’S PERFORMANCE
Methodology
One hundred and twenty questionnaires were administered to respondents out of which 83 were completely
filled and returned. Thus, the sample of the study consists of 83 respondents. These were made up of employees
of three companies (two in manufacturing and one in the service sector) and part time students of the Masters
degree program in the department of Business Administration, University of Lagos (who were employees of
different companies with in Lagos and its environments). These were selected through the use of systematic
random sampling procedures.
Measures and Analysis

Structured questionnaires consisted of 15 items describing the benefits of vision and mission to an
organization and its employees was employed. This was measured along a five-point Likert scale of “Strongly
agree”, “Agree”, “Undecided”, “Disagree” and “Strongly disagree”. A content analysis revealed that four main
benefits of vision and mission were recurring. Thereafter, the respondents were asked to rank these four benefits
in order of importance. The result of the ranking is shown in Table 1.
Table 1
The Result of the Ranking
Opinions Rank 1(%) Rank 2(%) Rank 3(%) Rank 4(%) Total
Organizational focus 55 (67) 12 (14) 10 (12) 6 (7) 83 (100)
Employee motivation 42 (51) 20 (24) 13 (16) 8 (9) 83 (100)
Public image 25 (30) 34 (41) 15 (18) 9 (11) 83 (100)
Co-ordination 28 (35) 30 (36) 10 (12) 12 (15) 83 (100)
Note. Source: Author’s Survey Instrument (2010).
Findings, Conclusion and Recommendations

Respondents were unanimous in their agreement that effective vision and mission have great potential in
improving organizational performance. This is because vision and mission statements provide a sense of
direction for the organization and channel employee’s behaviour towards this direction. Employee’s motivation
is greatly improved since “the knowledge of where one is heading seems to make the journey easier”. Besides,
vision and mission statements tend to improve the public image of an organization as well as aid coordination of
organizational activities.
However, it is regrettable that vision and mission statements in most Nigerian organizations are mere
“slogans” which are used as public relation tools to deceive stakeholders into believing that the management is
competent. These statements do not guide managerial decisions and actions since management does not match
“actions with words”. Besides, most organization’s vision and mision statements are vague and management
sometimes failled to sufficiently explain the meaning and import of them to lower level employees. The result is
that most employees do not understand how their daily activities contribute to the attainment of the vision and
mission for the organization. Most organization’s vision and mission statements were manifestations of the
“bandwagon effects”. They were simply formulated to meet the vague and not reflecting on the environments of
the organizations concerned.
ENHANCING ORGANIZATION’S PERFORMANCE 1075
Given that vision and mission statements are sine quo non for better management and improved
organization performance, it is recommended that top management should formulate them based on
environmental realities and where possible in consultation with the rank and file in the organization. It is
suggested that all employees should be properly educated on the primary role of these statements and how each
member’s activities contribute towards the realization of the vision and mission of the organization.
Management’s commitment to the vision and mission should be unwavering. This should be manifested in
matching actions with the vision and mission statements. Above all, vision and mission statements are starting
points in the strategic management process thus its effectiveness will depend on how well the other stages in the
strategic management have been mplemented or carried out.
References
Bateman, T. S., & Snell, S. D. (2007). Management: Leading and collaborating in a competitive world (7th ed.). Biston: Mc
Graw-Hall: Irwin.
Daft, R. C. (2008). Management 3rd Australia: Thomson.
David, F. R. (2003). It is time to re-draft your mission statement. Journal of Business Strategy, 1-2, 11-14.
Dess, G. G., Lumpkin, G. T., & Eisner, A. B. (2007). Strategic management: Text and cases. Boston: McGraw-Hill/Irwin.
Grant, R. M. (2000). Concepts, techniques, applications (3rd ed.). Massachusetts: Blackwell Publishers.
Jick, J. P. (2001). Vision is 10%, implementation is the rest. Harvard Business Review, 11(4), 36-38.
Jick, T. D., & Peciperl, M. A. (2003). Managing change: Case and concepts. New York: McGraw-Hill Higher Education.
King, W. R., & Cleland, D. (1978). Strategic planning and policy. New York: Van Reinhold.
Mishe, M. A. (2000). Strategic renewal: Becoming a high-performance organization. New Jersey: Prentice Hall.
Nanus, B. (1992). Visionary leadership: Creating a compelling sense of direction for your organization. San Francisco, C.A.:
Jossy-Boss Publishers.
Nutt, P. C., & Backoff, R. W. (1997). Crafting vision. Journal of Management Inquiry, 6(4), 308-328.
Oghojafor, B. E. A. (2006). Essentials of business policy. Lagos: Ababa Press.
Rangan, V. K. (2004, March). Lofty mission, down-to-earth plans. Harvard Business Review, 112-119.
Thornbarry, N. (1997). A view about vision. European Management Journal, 15(1), 23-34.
Trichy, N., & Devannna, M. (1986). The transformational leader. New York: John Wiley.
November 2011, Vol. 10, No. 11, 1076-1090
Determinants of Female Employment

Rate in the European Union
Irena Spasenoska, Merale Fetahu-Vehapi

State University of Tetovo, Tetovo, FYR of Macedonia
The aim of this paper is to provide a clear insight about the determinants of female employment rate in the
European Union where we have used panel data analyses of 27 countries members of the European Union from
1995 till 2009. Applying dynamic modeling, i.e, generalized method of moments (GMM) econometrics findings
have driven us to system estimated model where the following institutional variables have been tested: maternity
leave, child care facilities, college education, fertility rate, GDP growth, female unemployment rate and part-time
employment. We expect these variables to have a positive impact on the female employment rate except for the
female unemployment rate and maternity leave.
Keywords: female employment rate, European Union, dynamic panel data analysis
Overall Lisbon Strategy

Confronted with globalization and the challenges of a new knowledge-driven economy, the European
Council held on March 23-24, 2000 in Lisbon came to an agreement for a new strategic goal for the European
Union to become the most competitive and dynamic knowledge-based economy in the world capable of
sustainable economic growth with more and better jobs and greater social cohesion. Achieving this goal required
an overall strategy aimed at:
 Preparing the transition to a knowledge-based economy and society by better policies for the information
society and R&D, as well as by stepping up the process of structural reform for competitiveness and innovation
and by completing the internal market;
 Modernizing the European social model, investing in people and combating social exclusion;
 Sustaining the healthy economic outlook and favorable growth prospects by applying an appropriate
macro-economic policy mix.
Among the goals for modernizing the European Social Model by investing in people and building unactive
welfare system was creation of more and better jobs for Europe as well as substantial reduction of unemployment
(Retrieved from http://www.europa.eu, summary of legislations). Hence, the European Council considered that
the overall aim was to raise the employment rate from an average of 61% in 2000 to as close as possible to 70%
Irena Spasenoska, Msc., teaching assistant at Faculty of Economics, State University of Tetovo.
Merale Fetahu-Vehapi, Msc., teaching assistant at Faculty of Economics, State University of Tetovo.
Correspondence concerning this article should be addressed to Irena Spasenoska, Braka Miladinovi br.312 3/12 1200 Tetovo, R.
Macedonia. E-mail: spasenoskairena@yahoo.com.
DETERMINANTS OF FEMALE EMPLOYMENT RATE IN THE EUROPEAN UNION 1077
by 2010 and to increase the percentage of women in employment from an average of 51% in 2000 to more than 60%
by 2010. The new goal required member states to consider setting national targets for an increased employment
rate, which it was argued by enlarging the labor force would reinforce the sustainability of social protection
systems. In addition to the 2010 Lisbon targets, the Stockholm Europen Council of 2001 set intermediate targets
for employment rates in the EU in 2005 of 67% overall and 57% for women. It also set a new target for raising the
average EU employment rate for older men and women (aged 55-64) to 50% by 2010 (Retrieved from
http://www.europa.eu, summary of legislations).
Progress of Total and Female Employment Rate After the Lisbon Strategy
The progress towards the Lisbon employment targets of overall employment (70%), female employment
(60%) and employment of older man and women (50%) can be seen in Table 1.
Table 1
Progress of Total and Female Employment Rate From 2000 to 2009 in Percentages
Employment rate % Employment rate Female employment rate GDP growth percentage
EU overall 55-64 years old % overall 15-64 years old change in previous year
Benchmark 70% (2010 target, 50% (2010 target, 60% (2010, Lisbon Base line scenario of 3% per
Lisbon summit) Stockholm summit) summit) annum, Lisbon summit
1997 60.7 36.4 50.8 2.5
2000 63.4 37.5 54.1 3.9
2001 64.1 38.4 55.0 1.9
2002 64.2 39.8 55.6 1.2
2003 64.5 41.5 56.2 1.2
2004 64.8 42.3 57.0 2.3
2005 65.4 44.2 57.8 1.8
2006 66.2 45.3 58.8 2.9
2007 67.0 46.5 59.7 2.7
2008 67.3 47.4 60.4 0.6
2009 64.6 46.0 58.6 2.5
Notes. The employment rate is calculated by dividing the number of persons aged 15 to 64 in employment by the total population of
the same age group. The indicator is based on the EU Labour Force Survey. The survey covers the entire population living in private
households and excludes those in collective households such as boarding houses, halls of residence and hospitals. Employed
population consists of those persons who during the reference week did any work for pay or profit for at least one hour, or were not
working but had jobs from which they were temporarily absent. Source: EUROSTAT—European Commission Statistics.
First three years of the decade after the launch of the Lisbon strategy were characterized with only a
moderate growth in employment. The slowdown which began in the first half of 2001 and saw growth reached a
standstill by the last quarter of 2002, followed by only a very moderate recovery over the course of 2003. With
nearly zero growth in 2003 the progress towards the Lisbon 2010 target of 70% overall employment had came to
a standstill. By 2003, it became clear that the EU was going to miss the intermediate employment rate target for
2005 although the employment rate target for women still remained in reach. In 2006, 13 member states have
meet the 2010 employment target for women including for the first time Cyprus, Germany, Latvia and Lithuania.
Since 2000, large increases have been achieved in Cyprus, Estonia, Greece, Latvia and Italy where rates have
risen by around 5 percentage points and Spain with 12 percentage points. Greece and Italy were still far from the
1078 DETERMINANTS OF FEMALE EMPLOYMENT RATE IN THE EUROPEAN UNION
target. Total employment continued to expand in the EU in 2008. However, the rise was not uniform with respect
to gender, age and type of employment The EU employment rate, i.e., the share of the population aged 15-64
years (the working-age population) in employment, amounted to 65.9% in 2008, up 0.5 percentage points
compared with 2007. The growth rate for female employment was almost three times that for male employment.
In 2008, the employment rate of women aged 15-64 amounted to 59% , while for man it was almost 73%. In 2009,
the employment rate for persons aged 15-64 was above 70% while in all member states the male employment rate
was higher than the female employment in 2009 except for Lithuania where the female rate was 1 percentage
point higher for men. Estonia and Finland have recorded the smallest difference between male and female
employment rates while Malta, Greece and Italy recorded the greatest.
The aim of the empirical testing in this study is to capture the common institutional determinants of female
employment rate by employing the generalized method of moments (GMM) proposed by Arellano-Bond (1991)
and Arellano-Bover (1995)/Blundell-Bond (1998). We have considered dynamic model estimation as a more
appropriate approach because of the possibility to capture the costly sluggish adjustment of employment as well
as the effect of persistence captured by adding a lagged dependent variable. Moreover, we were also interested
whether there will be a change in the sings in front of the coefficients especially for fertility rate and maternity
leave which traditionally have been taken as factors that negatively influence female employment rate. The
contribution of this analysis can be seen in a manner that highlights the relationship and significance of the
institutional variable towards improvement of the social and welfare system across countries members of the
European Union as the backbone for supporting female in perusing carriers and higher employment.
The study is organized as follows. In the next section, we provide a brief yet detail insight to literature
review for each variable included in the research. Empirical specification diagnostics and results are given in the
third section followed by the fourth where we discuss our findings and conclusion.
Literature Review and Variable Description

In general there are two main approaches employed across studies of female employment across countries.
The first approach examines the level of female employment itself, focusing on the labour force participation rate
and the number of hours worked such as part-time to full-time category. The second approach explores the
determinants of female employment. While the determinants selected for analysis vary from study to study, they
may include one or more of the following three types of variables: (1) individual level (micro variables, such as
number of children in household); (2) institutional level (macro) variables, such as the size of the welfare state;
and (3) a combination of individual and institutional level variables (Warnecke, 2008). While single-country
level studies use micro-level variables, macro-level variables focus on family policies as diverse social, political,
institutional and cultural constraints of the average female participation rate. In the following we have provided a
brief literature review by analyzing the institutional level (macro) variables used in this study.
Maternity Leave
Parental leave policies support new parents usually in two complementary ways: by guaranteeing
job-protected leave and by offering financial support during that leave. The aim of benefits is to subsidize the
child care provided by the mother while job protection aims to ensure continuity of women’s careers in the labor
market. Most of the literature has found that more generous parental leave mandates tends to delay women’s
return to work. However, evidence of the relationship between duration of leave and women’s labor market
outcomes is mixed.
Job protected leave mandates are expected to increase women’s employment and earnings by encouraging
job continuity after birth. Yet, prolonged periods of absence from the workplace might lead to loss of specific and
general human capital and weaker labor market prospects after returning to work (Voicu & Hielke, 2003). Hence
previous employers, while obliged to re-employ mothers when they return to work after the baby break, may
either remunerate them relatively worser than their colleagues or may dismiss or layoff re-entered women with a
higher probability as soon as the job protection period upon re-entry has run out (Lalive, Schlosser, &
Zweimuller, 2009). Ruhm (1998) compares employment rates and wages of men and women using panel data
from European countries, and finds that longer leave mandates are associated with higher female employment but
lower relative wages. Ejrnaes and Kunze (2006) investigate the role of parental leave on the family wage gap
using administrative data for Germany and exploiting exogenous variation in the length of parental leave
generated by policy changes in the German system. The authors found that longer parental leave duration leads to
detrimental effects on employment and wages. In contrast, Schonberg and Ludsteck (2008) study the same
reforms and found only minor effects on employment rates and a mixed effect on wages. In our analysis
maternity leave is defined as the number of paid weeks a woman is entitled in case of normal birth (International
Social Comparison Database).
Child Care Facilities
Theories about child care (e.g., Andersson, Duvander, & Hank, 2004; Rindfuss & Brewster, 1996) include
four dimensions of child care: availability, quality, cost, and acceptability. In our case, we are testing the impact
of the availability upon female employment rate. Availability is the degree to which a family has ready access to
the needed child care—This might include not only convenient geographical location but also the availability of
slots for the right age range and the right time of day (Rachel, 2001). Our measure of availability is the
participation rate of 4 years old children in pre-school education. This indicator presents the percentage of the 4
years old who are enrolled in education-oriented pre-primary institutions which provide education-oriented care
for young children. They can either be schools or non-school settings, which generally come under authorities or
ministries other than those responsible for education. As such it is a measure of utilization rather than capacity.
When estimating the child care effect on female employment rate, we have considered possible simultaneity
that gives rise to endogeneity in women’s decision to work and in the decision to use institutional child care.
According to Coneus, Goeggel and Muehler (2009) the decision to use child care outside the home is strongly
connected to mothers’ decision to work after child birth and vice versa. They provide evidence on the
determinants of institutional child care use addressing the endogeneity of mothers’ labour supply by applying an
instrumental variable approach. Based on the German Socioeconomic Panel from 1989 to 2006 they have shown
the children have a higher probability to attend institutional care if their mothers increase their actual weekly
working time. On the other hand, limited availability in the form of limited slots and hours a facility can remain
open limits compatibility with the mother’s working hours. Kreynfeld and Hank (2000) have found that due to the
very limited opening hours mothers using child care may not even be able to work part time and must seek
additional forms of child care, which are rarely available. Greater availability of child care it is associated
positively with female’s employment (Van Dijk & Siegers, 1996). Therefore, a positive sign is expected in front
of the coefficient (Eurostat Database).
Fertility Rate
The fertility rate is defined as the mean number of live children born to a women during her lifetime.
Traditionally, a high fertility rate has a negative impact upon female employment. However, recent studies have
shown that the current relationship between female employment rate and fertility rate is somewhat ambiguous
and has been undergoing constant change in recent years. Due to institutional changes in form of subsidies, child
care programs, possibility of part-time working and unemployment rates might have changed the sign in past
decades (DelBoca & Saures, 2007). The correlation between fertility and female employment across developed
countries was negative, significant and quite stable during the 1970s and up to the early 1980s. However, by the
late 1980s, the correlation had become positive and equally significant (Ahn & Mira, 2002). The reversal of the
sign occurred simultaneously with the emergence of a high and persistent unemployment rate, increasing
dispersion in the availability of part-time jobs, child care availability and job protection provided by paid
maternity leave. Where the unemployment rate is high, women are less likely to leave the labor market,
knowing that it may be more difficult to reenter later due to the scarcity of jobs (Del Boca, 2003). Additionally,
when there is greater insecurity in the labor market, parents may be more reluctant to have children because of
the fear of not having enough income to support their potential children (Del Bono, 2002). The greater
availability of part-time job opportunities within a country reduces the opportunity cost of having children, as
mothers will be less likely to give up their jobs to raise their children. In a carefully conducted empirical study
based on provincial-level Italian panel data, Del Boca (2002) documents that availability of child care and
part-time work increases both the probability of working and having a child. Many researchers have suggested
the increasing availability of market child care as a possible explanation for the recent fertility upswing in some
developed countries. Moreover, countries with longer maternity leave programs have significantly higher
fertility rates than countries with shorter maternity leave policies. Based on a cross-sectional time-series data for
the European Union, DiCioccio and Wunnava (2008) found that neither female education nor increased
employment were significant in determining fertility and vice versa.
When estimating the fertility effect on female employment, it is important to recognize the mutual
dependence between the labour supply of married women and fertility, i.e., the endogeneity in either life cycle
models or static models of female labour supply. Even though children can be exogenous to the hours of work
decision for married women, according to Xie (1997), children are endogenous to the female participation
decision where children under six have dramatic negative impact on female employment. However, based on the
findings that government regulations and job protection has mitigated the effect of fertility upon employment rate,
we might expect downsizing of the negative effect upon employment or even an insignificancy of the coefficient
(World Bank Database).
College Education
In order to estimate the effect of education upon female employment, the percentage of graduated females
with tertiary education is used, irrespective of fields of education such as mathematics, science, computing,
engineering, manufacturing and construction. Greater levels of educational attainment theoretically afford
females a greater range of employment possibilities and a greater choice of superior (more “desirable”)
employment, e.g., higher paying jobs, thereby creating an incentive to enter the labour force. Therefore we can
expect a positive relationship between the percentage of female population with college education and female
employment (Gerner & Zick, 1983; Rextorat, 1990; Miller & Xiao, 1999; World Bank Database).
Female Unemployment Rate
The female unemployed rate is female unemployed persons as a percentage of the female labour force based
on International Labour Office definition. Unemployed persons comprise persons aged 15 to 74 who are without
work and have been actively seeking work. This variable captures the labour market conditions and the
expectation of obtaining gainful employment. Unfavorable market conditions, i.e., a high female unemployment
rate negatively influences the female employment rate, therefore we can expect a negative sign in front of the
coefficient (Eurostat Database).
Female Part-Time Employment
Female part-time employment is defined as the percentage of total female employment. The rise in female
participation has occurred hand-in-hand with an increase in the part-time rate in many countries. While the
causality is not clear between the decision to participate into the labour market and the choice of working
part-time, the rising proportion of women willing to join the labour markets, mostly explained by rising levels of
education, contributed to the development of part-time employment. Sociological and cultural reasons, such as
the separation of tasks within the household and the family model, combined with institutional reasons (e.g., the
lack of childcare facilities) explain in part why women are more inclined to work part-time than men. For
instance, a “male breadwinner” model of family encourages women to work part-time rather than full-time
(Fagan & O’Reilly, 1998). According to Budelmeyer, Mourre and Ward (2008), part-time work creates an
opportunity for women to combine taking care of their children with market work. Therefore a positive sign is
expected (Eurostat Database).
Growth of GDP per Capita
This is defined as the annual percentage growth per capita. According to the Neoclassical Endogenous
Growth theory, the rate of growth is endogenous in a sense that is driven by the rate of growth of the labour force
i.e., employment and the technological change (Setterfield, 2009). At the same time, a higher employment rate
implies an unambiguous increase in GDP per capita with no negative implications for long-run productivity
growth in the existing workforce (Carone, Denis, Morrow, Mourre, & Roger, 2006). The growth rate in labour
productivity is the most important determinant of the growth of GDP per capita as it accounts for at least half of
GDP per capita growth in most OECD countries. Greater labour utilization is the factor that can make an
important contribution to GDP growth by providing a significant boost to the annual growth. It is expected a
positive sign in front of the coefficient (World Bank Database) describes the relative judgment of oneself in
comparison with others. Overprecision is “excessive certainty regarding the accuracy of one’s beliefs” (Moore &
Healy, 2008, p. 4). Overconfidence has been observed in social judgments, self-predictions, and professional
predictions, in retrospective as well as prospective judgments (Allwood & Granhag, 1999; Dunning, Griffin,
Milojkovic, & Ross, 1990; Lichtenstein & Fischhoff, 1977; Paese & Feuer, 1991; Vallone, Griffin, Lin, & Ross,
1990; Von Winterfeldt & Edwards, 1986). With regard to confidence judgments about achieving future goals,
this calibration deficit implies that decision makers systematically overestimate their capacity to reach stated
goals.
Empirical Specification
Descriptive Statistics and Model Specification
In this chapter, we test the significance of selected institutional variables on a county’s female employment
rate by conducting a first-order dynamic panel estimation. Dynamic panel estimation has been used since static
modeling of an employment equation may lead to problems. According to Lachenmaier and Rottmann (2007),
the high cost of hiring and firing are a well-known argument for costly employment adjustment, especially in
European economies. If a firm faces these high costs, the actual employment will deviate from the equilibrium
level in the short run. The short-run dynamics compound the influences from adjustment costs, expectation
formation and decision processes. Therefore, a dynamic panel data model is considered in order to model the
sluggish adjustment.
Dynamic panel models estimate the effects on some observed outcome of other variables of interest, which
may be exogenous or potentially endogenous, conditional on both unobserved individual heterogeneity and one
or more lags of the dependent variable1. In our case apart from the dependent variable, female employment rate,
three individual variables were taken as endogenous variable: fertility rate, GDP per capita and childcare
facilities. To get consistent estimates in the presence of lags of the dependent variable we employ the generalized
method of moments (GMM)2 proposed by Arellano-Bond (1991) and Arellano-Bover (1995)/Blundell-Bond
(1998) introduced also by Roodman (2006). Applying GMM we account for the potential endogeneity arising
from the lagged dependent variable as well as three above mentioned variables. Using the appropriate
instruments for the endogenous variables one can overcome the endogeneity problem although using lags two
and deeper for the endogenous variable in the GMM-style and all regressors included in the RE increases the
number of instruments and too many instruments “can overfit endogenous variables” (Roodman, 2006, p. 13).
According to Roodman (2006) dynamic panel estimation is a proper approach for situations with few time
periods, say ≤ 15, and many cross-section units where the number of units is far greater than the number of time
periods. However, in our case we are going to use a panel data with relatively long time period and considerably
small number of cross-sections, i.e., 25 out of 27 EU countries for 13 years starting from 1995. In panels where T
is large, the dynamic panel bias becomes small and a more straightforward fixed effect estimator works. However,
large bias has been found even for T = 30 and our data has a considerably smaller time dimension than this. At the
same time, the number of instruments in difference and system GMM tends to explode with T. If N is small, the
cluster-robust standard errors and the Arellano-Bond autocorrelation test may become variables (Geoff Pugh,
1
The basic characteristics of the linear dynamic panel model are displayed in the following equation:
Yit = βYi,t-1 + (αi + ࣟit). It is a first-order dynamic panel model, because the explanatory variables on the right-hand side include
the first lag of the dependent variable (Yi,t-1) where the group-specific random effect (αi) control for all unobserved effects on the
dependent variable that are unique to the country and do not vary over time, i.e., captures specific ignorance about country i and
an error that varies all over countries and time (ࣟit) capturing the general ignorance of the determinants of Yit.
2
GMM is a general method of estimating population parameters from a data sample. GMM assumes population conditions
expressed in terms of expectations, i.e., E(ࣟt, xt) = 0 which is a restriction on the covariance between the error term and the
independent variable known as conditions. GMM dynamic panel estimation allows use of set of instruments per variable within
the data which give a great possibility for resolving endogeneity problems within the model.
2009). Despite the expected problems, we continue to investigate dynamic model out of economic reasons
explained at the beginning of the chapter. Hence this chapter should be seen in terms of illustrating an approach
that may be more appropriate for data set with a larger cross-section dimension.
Female employment ratei,t = f(em_ratei,t-1, matleavei,t, chcarei,t, fertratei,t, educ i,t unemrate i,t
part_emi,t, GDPi,t, time dummy, error term)
The chosen variables in the model given above have been considered in the literature as possible
determinants of the female employment rate. The dependent variable is the female employment rate which is
females in employment as a percentage of the total female population over 15 years age and up to 64 years age
(Eurostat Database).
In order to obtain more valid result we have included time dummy variables in the model which will capture
and place the effect of universal shocks (business cycle effects, demand shock, etc.) from the idiosyncratic error
term in to the systematic part of the model. According to Roodman (2006), contemporaneous correlation, as a
result of universal time-related shocks, can cause cross-individual correlation in the error term which may give
biased estimates and the addition of such time dummies may lessen or remove such correlation.
The abbreviation used in the regressions as well as brief summary statistics are given in Table 2.
Table 2
Descriptive Statistics
Variables Abbreviation Standard deviation Mean value Min. Max.
Maternity leave matleave 8.50 19.41 13 52
Child care facilities chcare 19.63 78.07 29.7 100
Fertility rate fertrate 0.24 1.48 1.09 2.13
College education educ 10.56 25.89 2.8 54.2
Female unemployment rate unemrate 4.75 9.23 2.2 30.8
Part-time employment rate part-em 16.14 23.43 2.7 75.2
Female employment rate em_rate 9.40 55.86 31.6 74.3
Growth in GDP per capita GDP 2.37 3.47 -4.58 12.23
Empirical Results
In order to estimate the significance of female employment rate determinates, we have considered dynamic
model estimation as a more appropriate approach since dynamic estimation gives us the possibility to model the
costly sluggish adjustments of employment.
According to Peseran, Smith and Im (1996), pervasive slope heterogeneity is often evidence in panel-time
series for groups such as countries, regions, industries and firms. In such panels inclusion of lagged dependent
variable in conventional FE and RE model could lead to biased and inconsistent estimates (Peseran & Smith,
1995). Secondly, in RE estimation, the lagged dependent variable is correlated with the compound error term.
Because the compound error term has a time invariant component, it influences the dependent variable in each
period and hence, must be correlated with lagged values of the dependent variable which conflicts with the basic
assumption of linear regression (Creen, 2003). In our case, the error component regression model controls for
unobservable characteristics such as tradition, employer preferences, i.e., stereotyping, prejudice, work-life
balance policies and so on. According to the literature, there is a high possibility for these to be correlated with
some of the independent variables in the employment rate, e.g., in highly traditional counties, where the
bread-winner model is dominant there is higher possibility of a higher fertility rate and less possibility of
supporting the female partner to enter the working market and to enroll tertiary education.
There are two partial solutions for situations where we have slope heterogeneity and an error component
correlation. One is a group—mean regression which involves reducing panel to a cross section and the second is
estimating purely static panel, both eliminating dynamics. However, omitting dynamics and estimating a static
model in presence of a dynamic relationship entail serious misspecification as well as bias and inconsistent
estimates (Bond, 2002a). The importance of modeling dynamics has been strongly emphasized by Green (2008),
according to whom, inclusion of lagged variable brings entire history in the right-hand-side of the equation, so
that any measured influence is conditional on this history where any impact of the independent variables
represents effect of new information. Therefore, in order to get consistent estimates in presence of lags of the
dependent variable we employ the generalized method of moments (GMM) proposed by Arellano-Bond (1991)
and Arellano-Bover (1995)/Blundell-Bond (1998), and developed in Roodman (2006).
In the GMM approach, apart from the dependent variable three other variables were classified as
endogenous: childcare, fertility rate and GDP per capita. However, we have to be aware that classifying these
variables as endogenous makes the use of this estimation procedure problematic given our data set since applying
more endogenous variables create more instruments, thereby causing bias and inefficient estimates.
When analyzing cross-sectional data with slightly longer time series, difference estimation is considered as a
more suitable approach. However, according to the obtained results when comparing both difference and system
estimation, in our case the system approach appears as more appropriate. Examining the diagnostic statistics (m1
+ m2 statistics as well Sargan test), in the system estimated model there is 1st-order serial correlation and there is
No 2nd order serial correlation while Sargan test p = 0.2050. On the other hand, diagnostic testing of the Arellano
and Bond Difference estimation, indicated weak instruments since Sarnan test p = 1.000 while m1 + m2 statistics
suggested presence of 1st order serial correlation well as 2nd order serial correlation. On the bases of diagnostic
testing, the system estimated model is going to be used as it is preferred over the difference model. The obtained
results are given in Table 3. When we look at statistics of significance in the difference estimated model, all of the
coefficients are statistically, individually insignificant at the conventional 5% critical level. Compared to the
difference estimated model, the system estimated model has the same statistics as significant, with the exception
for three variables: em_rate(lagged), GDP and unemrate.
Before the interpretation of the system GMM estimation, two tests for instrumental validity have been used:
(1) test for first and second order serial correlation among the residuals (m1 and m2 statistics); and (2) the Sargan
test of over-identifying restrictions. Arrelano and Bond’s (1991) GMM estimation require E[Δࣟit, Δࣟi,t-2] = 0, i.e.,
no second-order serial correlation in the error term of the first differenced equation, where m2 statistics test the
maintained hypothesis (Ho) in the equation above. The m1 statistics has a subsidiary role by providing
information on the robustness of m2 statistics. The m2 statistics is unreliable, i.e., it may fail to reject, if the error
term in levels follows a random walk. Thus, if there is first order serial correlation in the first differenced error
term where 0 < p < 1, the random walk in the first order errors is excluded. Therefore, the m1 and m2 statistics
require first order serial correlation and No. second order serial correlation.
According to the first way of testing instrumental validity, i.e., test for first and second order of serial
correlation among the residuals, in all cases the t-statistics for m2 we accept the null of No. 2nd order
autocorrelation in the differenced error terms. At the same time we do reject the null of m1 statistics for 1st order
autocorrelation in the differenced error terms.
Table 3
Comparison Between System and Difference Estimated Models
Models
Variables System
Difference
Dependent variable: dynamic
dynamic panel-data estimation
Em_rate panel-data estimation
Independent variables:
Constant 11.51 45.95
Standard Errors; t-statistics (2.595); (4.43) (30.72); (1.50)
Em_rate(lagged) 0.84 0.57
chcare -0.003 0.05
Standard Errors; t-statistics (0.01); (-0.32) (0.039); (0.17)
fertrate -0.05 2.43
Standard Errors; t-statistics (0.883); (-0.06) (1.811); (1.34)
matleave -0.05 -1.41
Standard Errors; t-statistics (0.027); (-1.72) (1.36); (-1.04)
educ 0.006 0.03
unemrate -0.20 -0.11
Standard Errors; t-statistics (0.039); (-5.16) (0.14); (-0.81)
Part_em 0.02 -0.07
Standard Errors; t-statistics (0.015); (1.63) (0.17); (-0.39)
GDP 0.20 0.15
m1 -2.28 -0.54
pr > z (0.20) (0.59)
m2 1.15 0.19
pr > z (0.25) (0.85)
Sargan/Hansen test 130.41 7.888
Prob > chi2 (0.2050) (1.000)
Wald test
Prob > chi2 2,345.45 5,062.50
If TS > CV → Reject Ho: the independent variables are jointly zero. (0.000) (0.000)
Table 4
Interpretation of Diagnostic Tests for Arrelano and Bover System GMM
Models 1. Arellano-Bover 2. Arellano-Bover 3. Arellano-Bover 4. Arellano-Bover
dynamic panel-data dynamic panel-data dynamic panel-data dynamic panel-Data
estimation estimation estimation estimation
Diagnostic 3th lag in level and 4th lag in level and 3th
tests 2nd lag in level and
1st lag in levels 2nd lag differences lag differences
1st lag difference
(1 more instrument) (2 more instruments)
Number of instruments 183(Max) 86(Min) 111 135
m1 2.3167 -1.9278 2.271 -2.2837
Pr > z (0.0205) (0.0539) (1.1937) (0.0224)
m2 0.1061 1.6056 0.2326 1.1487
Pr > z (0.2687) (0.1084) (0.0231) (0.2507)
Sargan/Hansen test 181.61 7.88 116.7 130.41
Prob > chi2 (0.1928) (1.000) (0.0563) (0.2050)
Concerning the Sargan/Hansen test, as second test for instrument validity, too low and two high p-values can
be indicative of weak instruments (Roodman, 2007). Also there is the problem of “to many” instruments where
the Sargan test grows weaker the more instruments were tested and we unable to reject the null of instrument
validity. In this case, p values obtained in most of the cases were above the apparently very high rule of thumb a
threshold of p = 0.25. According to the statistics presented in the table only the forth case of estimation provided
p value near to the rule of thumb suggested by Rodman, p = 0.2050. Even we do accept the null of valid
instruments we still had to deal with the problem of two many instruments given that there are only 23 groups in
our data set. As discussed too many instruments can overfit endogenous variables and fail to expunge their
endogenous components. In our case the number of instruments is massively over the number of cross-section.
There are two options in trying to deal with this problem: limiting the lags used in the GMM-style instruments or
using command for collapsing instruments available in xtabond2. In this analysis the second approach has been
conducted. The number of instruments are reported in Table 4, first row.
There is no clear guidance from the literature on how many instruments are “too many” (Roodman, 2009),
although > xtabond2 < does give a warning when the number of instruments is larger than the number of
cross-sectional units. One of the ways to limit the instrument count is by collapsing them, i.e., creating
instruments for each variable only. Namely, when we “collapse” an instrument set, we create not a whole matrix
of instruments but a single column vector of instruments, which means that there is only one instrument for all
time periods (Pugh, 2004). At the same time there has been a growing evidence that that panel data is likely to
exhibit cross-sectional dependence which may arise due to spatial dependencies, economic distances, common
shocks thereby causing errors to be “correlated across the entire cross section” (Sarfidis et al., 2006). The
evidence of 2nd—no order serial correlation might imply possibility of no heterogeneous error cross sectional
dependence.
Table 5
The Difference in Hansen Test (≡ C-statistics)
C-statistics Chi2 P-values Ho: instrument validity
2 2
Hansen test of over-identified restriction Chi = 4.52 Prob > chi = 1.000 Not rejected
Difference in Hansen test of exogeneity of instruments Chi2 = 5.17 Prob > chi2 = 0.819 Not rejected
Comparison of both tests Chi2 = 0.65 Prob > chi2 = 1.000 Not rejected
Note. The p-values given above were compared to the conservative threshold suggested by Roodman (2007 and 2009) which is
p = 0.25.
According to the statistics presented in Table 5, in our preferred model the system GMM instruments for
levels are valid, in which case we can accept the “steady-state” assumption required for system estimation and
there is no undue problem with cross-sectional dependence. However, the number of instruments still remained
high and above the number of cross-sectional groups, i.e., 48.
Despite the fact that we did not have 1st order correlation and have 2nd order correlation, at the same time
valid instruments (Sargan/Hansen) we cannot say that this is a sensible model. The number of instruments
remained high which overfit the number of instruments and bias the results. At the conventional 5% critical value,
almost all of the coefficients were statistically individually insignificant. Apart from the coefficient of the lagged
dependent variable and two other variables, i.e., tertiary education and GDP growth are significant at 10% level.
All of the signs in front of the coefficients are as expected, i.e., there is high level of persistency between lagged
dependent variable and dependent variable in level as well as a negative relationship between female employment
rate and increase in female unemployment, long maternity leave and high fertility rate.
Table 6
Interpretation of the System Model
Regressors Coefficient with robust SE Economic interpretation
Employment rate (lagged) 0.96* On average, the female employment rate in current period is estimated to
be 0.96% of the employment rate in the last period (t-1), ceteris paribus
(high level of persistency).
Child care facilities 0.07 On average, 1% point increase of 4 years old in pre-school education in
current period, gives 0.07% point increase in the percentage of female
employment ceteris paribus.
Fertility rate -7.55 On average, increase average of birth rates in current period, will
decrease the employment rate by 7.55%, ceteris paribus.
Maternity leave -0.0013 On average, 1 week increase in maternity leave in the current period will
give 0.0013% point decrease in the percentage of employment rate,
ceteris paribus.
Education 0.11** On average, 1% point increase in the female tertiary graduates will give
0.11% point increase in the female employment rate, ceteris paribus.
On average, 1% point increase in the female unemployment rate will
Female unemployment rate -0.04
give 0.04% point decrease in the female employment rate, ceteris
paribus.
On average, 1% point increase in the female part-time employment will
Part-time employment 0.05
give 0.05% point increase in the female employment rate, ceteris
paribus.
GDP 0.23* On average, 1% point increase in the GDP growth will give 0.23% point
increase in the female employment rate, ceteris paribus.
Constant term 3.71 The constant term has no theoretical meaning.
Notes. * Significant at 10% level; ** Significant at 5% level; Coefficients without asterisk are statistically insignificant.
Conclusion
In this paper, we have investigated the question what determines female employment rates in the European
Union where a sample of 27 countries has been analyzed over a time period of 14 years from 1995. Because of
the costly sluggish adjustments of employment we have specified a dynamic model where system GMM model
appeared as more suitable compared to the difference model. At the same, we have to be aware that our data set
has a considerable lack of cross-sections. Moreover, the number of instruments were increasing enormously over
the number of observation even though we tried to reduce them. Nevertheless, results from our study have been
supported by vast number of empirical research in the literature. At the same time, the choice of variables
incorporated in the model was based on theory and empirical investigations where the chosen variables were
suggested as possible determinants of female employment rate. The main findings can be summarized as follows:
The coefficient estimators for tertiary education and GDP growth per capita were found to be significant at
10 percent level while lagged female employment rate had coefficient estimator significant at the 5 percent
level. The significance as well as the positive sign in front of these coefficients are as expected. According to
our results, the current employment rate is highly influenced by the previous year employment rate. Past research
on female employment has repeatedly shown that persistence is an important aspect of the female employment,
while first-order dependence the most important factor in explaining persistence in female labor supply behavior
(Heckman & Willis, 1977; Nakamura & Nakamura, 1985; Eckstein & Wolpin, 1989). Persistence in
employment may be due to state dependence which arises from human capital accumulation or the costs of
searching for job which in turn may be influenced by social policies such as employment regulations and the
availability of child care. Tertiary education raises the utility of working full-time and lowers the utilities
associate with part-time work and no work. Our results have indicated that 1% point increase in the female
tertiary graduates will give 0.11% point increase in the female employment rate, other things being constant,
while a 1% point increase in the GDP growth will give 0.23% point increase in the female employment rate,
ceteris paribus.
Contrary to our expectations, the rest of coefficients are statistically individually insignificant at both 5%
and 10% level in our estimates. Maternity leave that guarantees a (post-leave) right to return to work is an
important component of family policies. However, even though many analyses have revealed that job-protected
leave can increase the time mothers spend at home with their infants and also the likelihood they return to their
pre birth employer, women’s employment opportunities decline with the time away from work. Our analysis
results suggest that the length of maternity leave has negative impact on female employment where for every
one week increase in the length on maternity leave, female employment rate is expect to decrease by 0.013%.
On the other hand, high part-time employment rate has a positive impact on employment. For every percentage
point increase in the percent of working women who work part-time, female employment rate is expected to
increase by 0.05. High level of education, sociological and cultural reasons as well as increase in the fertility rate
and number of children per family, have increased the need for working part-time instead of working full-time so
as to reconcile professional and family life. Limited availability of part-time employment and the limited
availability of affordable child care services increase the costs of working for mothers, making it difficult to
participate in the labour market.
Other social factors do seem to negatively contribute to countries’ employment rates. The influence of
current labour market conditions and the responsiveness of women to those conditions are relatively strong.
Women’s responses to labour market conditions are normally found to be sensitive to changes in the
unemployment rate. Namely, high unemployment within a country has a negative effect upon female
employment rates. Our results suggest that a percentage point increase in a country’s unemployment rate will
decrease its employment rate by 0.04. Moreover, women in their mid-20s facing a tight labor market and
worsening economic conditions (i.e., high unemployment) tend to restrict their fertility below their ideal level,
even though this phenomenon seems to be much weaker if they were employed in a stable public sector job,
(Adsera, 2006). Concerning fertility rate effect on female employment our analysis has revealed a negative
relationship, as expected. Namely, a percentage increase in the average births, will decrease the employment rate
by 7.55%, other things being equal. However, many researchers have indicated that the female employment rate
and fertility decisions are both affected by similar forces. The decisions to work and have a child are positively
influenced by the available supply of public child care as well as the availability of part time jobs. Many
researchers have indicated that by increasing the flexibility of employment relationships, more women would
find it attractive to enter into the market. As suggested by feminist observers (e.g., Folbre, 1997, 2001), countries
that facilitated combining the worker and mother roles have higher fertility and higher female employment rates
where a major institutional influence is the availability and acceptability of child care centers. According to our
research, on average, 1% point increase of 4 years old in pre-school education in current period, gives 0.07%
point increase in the percentage of female employment.
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Chinese Business Review

Volume 10, Number 11, November 2011 (Serial Number 101)

David Publishing Company

Aims and Scope:

Editorial Board Members:

Abstracted / Indexed in:

Effectiveness of the Global Banking System in 2010:

Keywords: data envelopment analysis, effectiveness, efficiency, banking, cross countries

Figure 1. Determinants of the global banking effectiveness.

Socio-Economic Planing Sciences, 35, 57-80.

Application of Pareto Distribution in Wage Models∗

or after logarithmic transformation as:

log xP = log xP0 − b [log (1 - P) - log (1 − P0)] (6)

in the second case:

or after logarithmic transformation as:

x 0.75 = x 0.8 = x 0.9

and using equation (9):

Using the formula (10), we get the following parameter estimates:

Characteristics of the Appropriateness of the Pareto Distribution

y 0.8 y 0.75 y 0.9

Wage Distribution of Males and Females in the Czech Republic in 2001-2008

The Chaotic Monopoly Price Growth Model

Keywords: monopoly, price, chaos

Vesna D. Jablanovic, Associate Professor of Eonomics, Faculty of Agriculture, University of Belgrade.

A Simple Chaotic Price Growth Model of a Profit-Maximizing Monopoly

Thus, we have that iterating p t +1 = eb ec

Goodwin, R. M. (1990). Chaotic economic dynamics. Oxford: Clarendon Press.

Analysis of the Relationship Between Perceived Security

Nihan Özgüven, Ph.D., Department of Business Administration, Dokuz Eylul University.

Perceived Security, Trust and Loyalty

Limitations and Future Research

Growth Potential and Profitability Analysis of Insurance

Dragana Ikonić, Nina Arsić

Keywords: growth, profitability, insurance companies, options

Growth Potential of Insurance Sector

34.7 40.1 40.9

2005 2006 2007 2008 2009 2010

Figure 3. Premium per capita in European countries in dollars (2004-2008).

An Overview of Determinants of Profitability of Insurance Companies

National Bank of Serbia. (2010). Insurance sector in Serbia—First quarter report.

Sustainable Consumption and Production

Janis Brizga, Ph.D. candidate, Department of Environmental Management, University of Latvia.

Figure 1. Map of Baltic Sea Region. Source: UNEP/GRID.

Sustainable Consumption Patterns

Figure 4. Household final energy consumption (toe). Source: Eurostat.

Sustainable Production Patterns

Motifs and Impediments for the Harmonization

The Characteristics of Accounting Regulative in EU

The Harmonization of Accounting Regulative for Small and Medium-Sized Entities

SMEs (see Table 1).

Obstacles for a Possible Application of the IFRS for SMEs

Requirements for the IFRS for

1. The prohibition to present 4. The requirement to recognise immediately in

2. The requirement to measure financial 5. The requirement to present the amount

Change of Management Values in Estonian

Theory and Hypothesis

Results and Conclusion

of Marketing, 53, 79-90.

The Impact of Tax Policies on Taxpayers Budget in

Boloş Marcel Ioan, Otgon Cristian Ioan, Pop Răzvan Valentin

Keywords: fiscal policy, risk, volatility, sensitivity, taxpayer budget, expenditure

Boloş Marcel Ioan, Associate Professor, Department of Finance-Accounting, University of Oradea.

State oof Knowledge