Professional Documents
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Ugc Net Management Syllabus
Ugc Net Management Syllabus
MANAGEMENT]
Contents
Instructions.................................................................................................................4
Organizational behavior...........................................................................................18
Management Thoughts.............................................................................................49
Human resource management.................................................................................51
Business statistics....................................................................................................55
Marketing environment and environment scanning.................................................62
Corporate Strategy...................................................................................................67
Values and ethics in management...........................................................................94
Corporate governance............................................................................................122
Fundamental and Ethics Theories of Corporate Governance..........................122
Production management........................................................................................142
Financial management...........................................................................................157
Different types of transactions in the Foreign Exchange Market....................157
Risk management...........................................................................................181
Cash management.................................................................................................188
Cash management services generally offered................................................188
Inventory................................................................................................................190
Inventory Management..................................................................................190
Business inventory.........................................................................................191
The reasons for keeping stock.....................................................................191
Special terms used in dealing with inventory..............................................192
Typology......................................................................................................192
Inventory examples.....................................................................................192
Principle of inventory proportionality..............................................................193
Purpose.......................................................................................................193
Applications.................................................................................................194
Roots...........................................................................................................194
High-level inventory management.................................................................194
Accounting for inventory................................................................................196
Role of inventory accounting.......................................................................197
FIFO vs. LIFO accounting.............................................................................197
Standard cost accounting............................................................................198
Theory of constraints cost accounting.........................................................198
National accounts...........................................................................................198
Distressed inventory.......................................................................................199
Inventory credit..............................................................................................199
Cash conversion cycle............................................................................................201
Definition........................................................................................................201
[edit] Derivation..........................................................................................201
Question bank........................................................................................................205
Job enrichment.......................................................................................................230
Contents.........................................................................................................231
[edit] Techniques............................................................................................231
What are Management Information Systems?................................................232
Advantages & Disadvantages Of Information Management Systems.....................238
Advantages.....................................................................................................238
Better Planning and Control............................................................................239
Aid Decision Making.......................................................................................239
Disadvantages................................................................................................239
Constant Monitoring Issues............................................................................239
Instructions
(i) The Test will consist of three papers. All the three papers will be held on 26th December,
2010 in two separate sessions as under:
Paper-I shall be of general nature, intended to assess the teaching/research aptitude of the
candidate. It will primarily be designed to test reasoning ability, comprehension, divergent
thinking and general awareness of the candidate. UGC has decided to provide choice to the
candidates from the December 2009 UGC-NET onwards. Sixty (60) multiple choice questions of
two marks each will be given, out of which the candidate would be required to answer any fifty
(50). In the event of the candidate attempting more than fifty questions, the first fifty questions
attempted by the candidate would be evaluated.
Paper-II shall consist of questions based on the subject selected by the candidate. Each of these
papers will consist of a Test Booklet containing 50 compulsory objective type questions of two
marks each.
The candidate will have to mark the responses for questions of Paper-I and Paper-II on the
Optical Mark Reader (OMR) sheet provided along with the Test Booklet. The detailed
instructions for filling up the OMR Sheet will be sent to the candidate along with the Admit
Card.
Paper-III will consist of only descriptive questions from the subject selected by the candidate.
The candidate will be required to attempt questions in the space provided in the Test Booklet.
The structure of Paper-III has been revised from June, 2010 UGC-NET and is available on the
UGC website www.ugc.ac.in.
Paper-III will be evaluated only for those candidates who are able to secure the minimum
qualifying marks in Paper-I and Paper-II, as per the table given in the following:
OBC/PH/VH 35 35 90 (45 %)
SC/ST 35 35 80 (40 %)
However, the final qualifying criteria for Junior Research Fellowship (JRF) and Eligibility for
Lectureship shall be decided by UGC before declaration of result.
(ii) For Visually Handicapped (VH) candidates thirty minutes’ extra time shall be provided
separately for paper-I and Paper-II. For paper-III, forty five minutes’ extra time shall be
provided. They will also be provided the services of a scribe who would be a graduate in a
subject other than that of the candidate. Those Physically Handicapped (PH) candidates who
are not in a position to write in their own hand-writing can also avail these services by making
prior request (at least one week before the date of UGC-NET) in writing to the Co-ordinator of
the test centre. Extra time and facility of scribe would not be provided to other Physically
Handicapped candidates.
(iii) Syllabus of Test: Syllabi for all NET subjects can be downloaded from the UGC Website
www.ugc.ac.in and are also available in the libraries of all Indian universities. UGC will not send
the syllabus to individual candidates.
(iv) In Paper III, candidate has the option to answer either in Hindi or in English in all
subjects except the languages where the candidate is required to write in the concerned
language only. In case of Computer Science & Applications, Electronic Science and
Environmental Sciences, the question papers have to be answered in English only.
(v) In case of any discrepancy found in the English and Hindi versions, the
questions in English version shall be taken as final.
Section-3: Nine questions may be asked across the syllabus. The questions will be
definitional or seeking particular information and are to be answered in up to 50
words each. For Science subjects as mentioned in Section-1, short
numerical/computational problems may be considered. Each question will carry
10 marks (9Q X 10 M =90 Marks). There should be no internal choice. The
questions in this section should be numbered 6 to 14.
Section-4: It requires the candidates to answer questions from a given text of around 200-300
words taken from the works of a known thinker/author. Five carefully considered
specific questions are to be asked on the given text, requiring an answer in up to
30 words each. This section carries 5 questions of 5 marks each (5Q X 5M =25
Marks). In the case of science subjects, a theoretical/ numerical problem may be
set. These questions are meant to test critical thinking ability to comprehend and
apply knowledge one possess. Question in this section should be numbered as 15
to 19.
1. Writing skills matter a lot in the NET Examination. Most of the candidates appearing for the
NET examination have a lot of knowledge, but lack writing skills. You should be able to present
all the information/knowledge in a coherent and logical manner, as expected by the examiner.
For example: Quoting with facts and substantiating your answer with related concepts and
emphasizing your point of view.
3. Prepare a standard answer to the question papers of the previous years. This will also make
your task easy at the UGC examination.
4. Do Not miss the concepts. Questions asked are of the Masters level examination. Sometimes
the questions are ‘conceptual’ in nature, aimed at testing the comprehension levels of the basic
concepts.
5. Get a list of standard textbooks from the successful candidates, or other sources and also
selective good notes. The right choice of reading material is important and crucial. You should
not read all types of books as told by others
6. While studying for the subjects, keep in mind that there is no scope for selective studies in
UGC. The whole syllabus must be covered thoroughly. Equal stress and weight should be given
all the sections of the syllabus.
7. Note that in the ultimate analysis both subjects carry exactly the same amount of maximum
marks.
8. Go through the unsolved papers of the previous papers and solve them to stimulate the
atmosphere of the examination.
9. Stick to the time frame. Speed is the very essence of this examination. Hence, time
management assumes crucial importance.
10. For developing the writing skills, keep writing model answers while preparing for the NET
examination. This helps get into the habit of writing under time pressure in the Mains
examination.
11. Try not to exceed the word limit, as far as possible. Sticking to the word limit that will save
time. Besides, the numbers of marks you achieve are not going to increase even if you exceed the
word limit. It’s the quality that matters not the quantity.
12. Highlight the important points which are important.
13. Follow paragraph writing rather than essay form. A new point should start with a new
paragraph.
14. If the question needs answer in point format give it a bullet format.
16. Give space and divide it by a dividing line between two questions.
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Unit 1
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managerial economics-demand analysis
production function
cost-output relations
market structures
pricing theories
advertising
macro-economics
national income concept
infrastructure-management and policy
business environment
capital budgeting
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Unit 2
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the concept and significance of organisational behaviour-skills and role in an organisation-
classical, neo-classical and modern theories of organisational structure- organisational design-
understanding and managing individual behaviour personality-perception-values-attitudes-
learning-motivation.
Understanding and managing group behaviour, processes-Inter-personal and group dynamics-
communication-leadership-managing cange-managing conflicts. Organisational development
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Unit 3
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Concepts and perspectives of HRM,HRM in changing environment, Human resource planning-
objectives, process and techniques.
Job analysis- job description
Select human resources
Induction, training and development
Exit policy and implications
performance appraisal and evaluation
Wage determination
Industrial relations and trade unions
Dispute resolution and grievance management
Labour welfare and social security measures
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Unit 4
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financial management-nature and scope
valuation concepts and valuation of securities
Capital budgeting decision-risk analysis
Capital structure and cost of capital
Dividend policies-determinants
Long term and short term financing instruments
mergers and acquisitions
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Unit 5
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Marketing environment and environment scanning, marketing information systems and
marketing research, understanding consumer and industrial markets, demand measurement and
forecasting, market segmentation-targeting and positioning, product decisions,product mix,
product life cycle, new product development, branding and packaging, pricing methods and
strategies.
Promotion decisions-promotion mix, advertising, personal selling, channel management, vertical
marketing system, evaluation and control of marketing effort, marketing of service, customer
relation management,
Uses of internet as a marketing medium- other related issues like branding, market development,
advertising and retailing on the net.
New issues in marketing.
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Unit 6
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Role and scope of production management, facility location, layout planning and analysis,
production planning and control- production process analysis, demand forecasting for operations,
determinant of product mix, production scheduling, work measurement, time and motion study,
statistical quality control.
role and scope of operations research, linear programming, sensitivity analysis, transportation
model, inventory control, queuing theory, decision theory, markov analysis, PERT/CPM
*****************
Unit 7
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Probability theory, probability distribution-binomial, poission, normal and exponential,
correlation and regression analysis, sampling theory, sampling distribution, tests of hypothesis,
large and small samples, t, z, f, chi-square tests.
use of computers in managerial applications, technological issues and data processing in
organisations.
Information systems, MIS and decision making, system analysis and design, trends in
information technology,Internet and internet-based applications.
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Unit 8
*****************
Concept of corporate strategy, component of strategy formulation, Ansoff's growth vector, BCG
model, Porter's generic strategies, competitor analyis, strategic dimensions and group mapping,
industry analysis, strategies in industry evolution, fragmentation, maturity and
decline,competitive strategy and corporate strategy, transnationalisation of world
economy,managing cultural diversity, global entry strategies, globalisation of financial system
and services, managing international business, competitive advantage of nations, RTP and WTO
*****************
Unit 9
*****************
Concepts- types, characterstics, motivation, competencies and its development, innovation and
entrepreneurship, small business-concepts
Government policy for promotion of small and tiny enterprises, process of business opportunity
identification, detailed business plan preparation, managing small enterprises, planning for
growth, sickness in small enterprises, rehabilitation of sick enterprises,
Intrapreneurship(organisational entrepreneurship).
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Unit 10
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Ethics and management systems, ethical issues and analysis in management, value based
organisations, personal framework for ethical choices, ethical pressure on individuals in
organisations, gender issues, ecological consciousness, environmental ethics, social
responsibilities of business, corporate governance and ethics.
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Elective-I
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Career planning and development-concept of career; career planning and development methods.
Compensation and benefits- job evaluation techniques; wage and salary administration; fringe
benefits; human resource records and audit.
Employee discipline –importance; causes and forms; disciplinary action; domestic enquiry.
Grievance management- importance; process and practices; employee welfare and social security
measures.
Trade union- importance of unionism; union leadership; national trade union movement
Industrial democracy and employee participation- need for industrial democracy; pre-requisite
for industrial democracy; employee participation –objectives; forms of employee participation.
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Elective-II
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Marketing-Concepts; Nature and scope; Marketing myopia; Marketing mix; Different
environments and their influences on marketing; understanding the customer and competition.
Role and relevance of Segmentation and positioning; Static and dynamic understanding of BCG
matrix and Product Life Cycle; Brands-Meaning and role; Brand building strategies; Share
increase strategies.
Different tools used in sales promotion and their specific advantages and limitations
Distribution channel hierarchy; role of each member in the channel; Analysis of businesss
potential and evaluation of performance of the channel members
Wholesaling and retailing- Different formats and the strength of each one; Emerging issues in
different formats of retailing in India
Marketing research- Sources of information; Data collection; Basic tools used in data analysis;
structuring a research report
Consumer behavior theories and models and their specific relevance to marketing managers
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Elective-III
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Nature and scope of financial management
valuation concepts-risk and return, valuation of securities, pricing theories- capital asset pricing
model and arbitrage pricing theory
Understanding financial statements and analysis thereof
Capital budgeting decision, risk analysis in capital budgeting and long-term sources of finance
Capital structure- theories and factors, cost of capital
Dividend policies -theories and determinants
Working capital management-determinants and financing, cash management,inventory
management, receivables management
Elements of derivatives
Corporate risk management
mergers and acquisitions
International financial management
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Elective-IV
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India’s foreign Trade and Policy; Export promotion policies; Trade agreements with other
countries; Policy and performance o Export zones and Export-oriented unit; Export incentives.
WTO and Multilateral trade agreements pertaining to trade in goods; trade in services and
TRIPS; Multilateral environment agreements(MEAs); International Trade Blocks- NAFTA,
ASEAN, SAARC, EU, WTO and Dispute Settlement Mechanism.
Managerial economics
Definition of managerial economics
Nature and characteristics of managerial economics
Scope of managerial economics
Difference between managerial economics and economics
Economic tools used in managerial economics
Decision criteria
Demand analysis
Demand curve
Demand schedule
Elasticity of demand
Demand forecasting
In the figure above the average and marginal cost curves have been drawn. It
will be seen that so long as the average cost is falling, marginal cost is less than
average cost. In the same way when average cost is rising marginal cost is
above the average cost.
The marginal average relation is mathematical Seller Seller Buyer Buyer
truism which is correct in all the conditions. We entry numbe entry numbe
can understand it easily with the help of an barrier r barrier r
example. Suppose in a cricket match the
batting average of a batsman is 60 in the first
innings. If Market structure
Market structure
Macro-Economics
Macro-economics is also known as the theory of income and employment or
simply income analysis. It is concerned with the problems of unemployment,
economic fluctuations, inflation or deflation, international trade and economic
growth.
Limitations of Macro-economics:-
1 Fallacy of compositions
2 To regard the aggregate as homogeneous
3 Aggregate variables may not be important necessarily
4 Indiscriminate use of Macro-economics misleading
5 Statistical and conceptual difficulties
Capital Budgeting
Meaning
BUSINESS CYCLE
Business Cycle refers to fluctuations in economic activity. It is also known as the
economic cycle. The Business Cycle has four distinct phases that revolve around
its long-tern growth trend.
1. Peak/boom
2. Recession
3. Trough
4. Recovery
Let's briefly discuss each phase now:
1. Peak/Boom: This is the stage when the business activity is at its
maximum, although this level of activity is temporary.
2. Recession: After operating at maximum activity, the business goes into
the recession phase. This phase witnesses a decrease in total output,
employment and trade. Recession may last for about 6 months or more.
3. Trough: At this stage, output and employment are at their lowest. This is
also referred to as the stage of depression. This stage may be short term
or may be long term depending on circumstances and market conditions.
4. Recovery: The recovery stage, as the name suggests is the rise in output,
employment and trade after the depression stage. The employment levels
increase till maximum employment is reached.
These stages are often depicted as a graph. The graph would look like a wave.
The peak of the wave is the boom phase, the decreasing slope is recession, the
rock bottom of the wave is the trough/depression, and recovery phase is shown
as the increasing slope after the trough. The vertical axis measures real output
and the horizontal axis measures time.
Organizational behavior
*************
Personality
Determinants of personality
Personality and behavior
Organisational applications of personality
Personality:-
Personality theories:-
Psychoanalytic theory:-
The ID
The Id, The Ego and The super Ego are the parts of the personality.
The Ego
The Ego keeps the Id in check through the realities of the external environment
through intellect and reason.
Socio-psychological theory
Social variables and not the biological instincts, are the important determinant in
shaping personality. There is an interaction between the society and the
individual.
Trait theory
The trait approach to personality is one of the major theoretical areas in the
study of personality. The trait theory suggests that individual personalities are
composed broad dispositions. Consider how you would describe the personality
of a close friend. Chances are that you would list a number of traits, such as
outgoing, kind and even-tempered. A trait can be thought of as a relatively
stable characteristic that causes individuals to behave in certain ways.
* Cardinal Traits: Traits that dominate an individual’s whole life, often to the
point that the person becomes known specifically for these traits. People with
such personalities often become so known for these traits that their names are
often synonymous with these qualities. Consider the origin and meaning of the
following descriptive terms: Freudian, Machiavellian, narcissism, Don Juan,
Christ-like, etc. Allport suggested that cardinal traits are rare and tend to develop
later in life.
* Central Traits: These are the general characteristics that form the basic
foundations of personality. These central traits, while not as dominating as
cardinal traits, are the major characteristics you might use to describe another
person. Terms such as intelligent, honest, shy and anxious are considered
central traits.
* Secondary Traits: These are the traits that are sometimes related to
attitudes or preferences and often appear only in certain situations or under
specific circumstances. Some examples would be getting anxious when speaking
to a group or impatient while waiting in line.
Trait theorist Raymond Cattell reduced the number of main personality traits
from Allport’s initial list of over 4,000 down to 171,3 mostly by eliminating
uncommon traits and combining common characteristics. Next, Cattell rated a
large sample of individuals for these 171 different traits. Then, using a statistical
technique known as factor analysis, he identified closely related terms and
eventually reduced his list to just 16 key personality traits. According to Cattell,
these 16 traits are the source of all human personality. He also developed one of
the most widely used personality assessments known as the Sixteen Personality
Factor Questionnaire (16PF).
1. Introversion/Extraversion:
2. Neuroticism/Emotional Stability:
3. Psychoticism:
Later, after studying individuals suffering from mental illness, Eysenck added
a personality dimension he called psychoticism to his trait theory. Individuals
who are high on this trait tend to have difficulty dealing with reality and may be
antisocial, hostile, non-empathetic and manipulative.4
Both Cattell’s and Eysenck’s theory have been the subject of considerable
research, which has led some theorists to believe that Cattell focused on too
many traits, while Eysenck focused on too few. As a result, a new trait theory
often referred to as the "Big Five" theory emerged. This five-factor model of
personality represents five core traits that interact to form human personality.5
While researchers often disagree about the exact labels for each dimension, the
following are described most commonly:
1. Extraversion
2. Agreeableness
3. Conscientiousness
4. Neuroticism
5. Openness
Self theory
Self-concept: The composite of ideas, feelings, and attitudes that a person has
about his or her own identity, worth, capabilities, and limitations. A person’s self
concept gives him sense of meaningfulness and consistency.
Self-image: A person's self image is the mental picture, generally of a kind that
is quite resistant to change, that depicts not only details that are potentially
available to objective investigation by others (height, weight, hair color, gender,
I.Q. score, etc.), but also items that have been learned by that person about
himself or herself, either from personal experiences or by internalizing the
judgments of others.
Ideal-self: The ideal self denotes the way one would like to be.
Determinants of personality
Biologica
l factor
Cultural
factors
Personality and behavior
Self-concept is the way individuals define themselves as to who they are and
derive their sense of identity. Self-esteem denotes the extent to which they
consistently regard themselves as capable, successful, important and worthy
individual.
Need pattern
Locus of control means whether people believe that they are in control of
events or events control them.
Type A people always feel a sense of time urgency, are highly achievement-
oriented, exhibit a competitive drive and are impatient when their work is slowed
down for any reason.
Type B people are easy going, do not have urgency for time and do not
experience the competitive drive.
Tolerance of ambiguity
Work-ethics orientation
*************
Perception
Perception is defined as a process by which individuals organize and interpret their sensory
impressions in order to give meaning to their environment.
perceptual process
Perceptual selectivity
Perceptual organization
Interpersonal perception
Managerial application of perception
*************
Attitudes
Attitude is the persistent tendency to feel and behave in a favourable or unfavourable way
towards some object, person or idea.
Concepts of attitudes
Attitudes and values
Theories of attitude formation
Factors in attitude formation
Attitude measurement
Attitude change
Methods of attitude change
*************
Values
Values are global beliefs that guide actions and judgment across a variety of situations.
Values and attitudes
*************
Learning
Learning theories
conditioning theories
Cognitive learning theory
Social learning theory
Integrating various learning theories
Reinforcement
Types of reinforcement
Administering reinforcement
*************
Organizational behavior modification
*************
Motivation
Motivation refers to the way in which urges, drives, desires, aspirations, striving
or need direct, control or explain the behavior of human beings.
Motivation
The term ‘motivation’ comes from the Latin ‘movere’ which means ‘to move’.
Motivation as the base-building block of human action has been studied
extensively. Studies on motivation broadly refer to two areas:
The concept “motive” refers to the purpose underlying all goal directed actions.
All motives, however, may not be equally important to the context of goal. Some
actions arise from biological or physiological needs, over which people do not
have much control. Such motives are common to the entire animal kingdom. But
there are certain crucial and other higher order needs which are common to
human beings. The distinctly human motives are largely unrelated to biological
and survival needs. These are related to feelings of self esteem, competency,
social acceptance, etc.
Motivation Process
Motivation of inner
state (feedback)
1. Needs or expectation
2. Behavior
3. Goal, and
4. Some form of feedback
Achievement motivation
• Attitudes involve social judgments. They are either for, or against, pro,
or con, positive, or negative; however, it is possible to be ambivalent
about the attitudinal object and have a mix of positive and negative
feelings and thoughts about it.
• Attitudes involve a readiness (or predisposition) to respond; however, for a
variety of reasons we don’t always act on our attitudes.
• Attitudes vary along dimensions of strength and accessibility. Strong
attitudes are very important to the individual and tend to be durable and
have a powerful impact on behavior, whereas weak attitudes are not very
important and have little impact. Accessible attitudes come to mind
quickly, whereas other attitudes may rarely be noticed.
• Attitudes tend to be stable over time, but a number of factors can cause
attitudes to change.
• Stereotypes are widely held beliefs that people have certain
characteristics because of their membership in a particular group.
• A prejudice is an arbitrary belief, or feeling, directed toward a group of
people or its individual members. Prejudices can be either positive or
negative; however, the term is usually used to refer to a negative attitude
held toward members of a group. Prejudice may lead to discrimination,
which involves behaving differently, usually unfairly, toward the members
of a group.
Below is an article that I worked on with a group for a college class I took
recently.
There are also multiattribute attitude models. The first one is the attitude toward
an object model. This is when one’s attitude toward a product or brand is a
function of the presence, or absence, and evaluation of certain product-specific
beliefs and/or attitudes. The second is the attitude toward behavior model. This
is when the individual’s attitude toward behaving or acting with respect to an
object rather than the attitude toward the object itself seem to correspond more
closely to actual behavior than does the attitude toward object model. The
theory of reasoned action model is a comprehensive integration of attitude
components designed to lead to both better explanation and better predictions
of behavior. It incorporates subjective norms that influence intention. This
assesses normative beliefs attributed to others and motivation to comply with
others.
Two last models were formed to look at consumers’ attitudes from a different
perspective. There is the theory of trying-to-consume model, which reflects
instances in which the action or outcome is not certain but instead reflects the
consumer’s attempts to consume. And our final model is the attitude toward the
ad model in which the consumer sees an ad and forms certain feelings and
judgments as a result of the ad. These feelings and judgments in turn affect the
consumer’s attitude toward the ad and beliefs about the brand. Then these two
things combined influence his or her attitude toward the brand.
Attitudes are learned. This learning process is the shift from having no attitude
about a product to having an attitude. For example, new technology is always
coming out, and until something is invented we have no attitudes toward it. An
attitude can follow the purchase or consumption of a product or it can come
before the purchase, perhaps from something as simple as viewing an
advertisement for that product. Things that may influence one’s attitude are
personal experience, influence of family and friends, direct marketing, mass
media, and the Internet. Attitudes that have been formed from direct
experiences are more confidently held, and therefore stronger, than attitudes
formed from an indirect experience. As we discussed in class, a consumer’s
personality will have an effect on how they perceive an advertisement. People
with a high need for cognition enjoy lots of product information, whereas those
low in need for cognition respond better to celebrities or attractive models.
Consumers’ attitudes can be changed, however. There are five methods for
attempting to alter the attitudes of consumers. They are: (1) Changing the
consumer’s basic motivational function (2) associating the product with an
admired group or event (3) resolving two conflicting attitudes (4) altering
components of the multiattribute model and (5) changing consumer beliefs
about competitors’ brands.
Attitude Formation / Change: Functional Approach to Change
The functional approach to changing attitudes says that there are four
classifications of attitudes. They are the utilitarian function, the ego defensive
function, the value-expressive function, and the knowledge function. The
utilitarian function is when an attitude is held due to the brand’s utility. A way to
change this attitude is to show the utility or purpose of the brand that they might
not have considered. The next is the ego-defensive function which expresses
people’s desire to protect their self-image. Showing how a product can boost
people’s self esteem and feelings of self doubt is one way of changing their
attitude in this situation.
There is also the idea of combining several of the above functions to appeal to
different groups of people who may use the same product but for different
reasons.
Showing consumers that their negative attitude toward a product, brand, etc. is
not in conflict with another attitude, may make them inclined to change their
negative opinion of the brand. This is just one more way of changing consumers’
attitudes.
Now that we have discussed how attitudes are formed and how they can be
altered, we will go into how attitudes affect the actions that consumers take, or
vice versa. Consumers’ behavior can either precede or follow their attitude
formation.
Two explanations as to why behavior may precede attitude formation are the
cognitive dissonance theory and the attribution theory. The cognitive dissonance
theory is the discomfort or dissonance that occurs when a consumer holds
conflicting thoughts about a belief or an attitude object. An example would be a
post-purchase dissonance, where the consumer thinks about the unique, positive
qualities of the brands that they did not select. An ad may help to assure the
consumer that they made the right decision and ease this dissonance. The
attribution theory explains how people assign blame or credit to events on the
basis of either their behavior or the behavior of others. They may ask themselves
why they made a decision. The process of making inferences is a major part of
attitude formation and change.
There are different perspectives on the attribution theory, which include self-
perception theory, attributions toward others, attributions toward things, and
how we test our attributions.
Attributions towards others and attributions towards things are the opinions
people have of things which they come into contact with. For example, when
talking to a salesperson at a store, a consumer will try to determine if the
salesperson is knowledge, trustworthy, and reliable. The same can be said of
attributions towards things. Consumers will judge a product’s performance and
form attributes in an attempt to find out why the product meets or fails to meet
their expectations.
________________________________________
________________________________________
As familiar and rational as the functional hierarchy may be, there are distinct
disadvantages to blindly applying the same form of organization to all purposeful
groups. To understand the problem, begin by observing that different groups
wish to achieve different outcomes. Second, observe that different groups have
different members, and that each group possesses a different culture. These
differences in desired outcomes, and in people, should alert us to the danger of
assuming there is any single best way of organizing. To be complete, however,
also observe that different groups will likely choose different methods through
which they will achieve their purpose. Service groups will choose different
methods than manufacturing groups, and both will choose different methods
than groups whose purpose is primarily social. One structure cannot possibly fit
all.
Organizing on Purpose
The purpose for which a group exists should be the foundation for everything its
members do — including the choice of an appropriate way to organize. The idea
is to create a way of organizing that best suits the purpose to be accomplished,
regardless of the way in which other, dissimilar groups are organized.
Only when there are close similarities in desired outcomes, culture, and methods
should the basic form of one organization be applied to another. And even then,
only with careful fine tuning. The danger is that the patterns of activity that help
one group to be successful may be dysfunctional for another group, and actually
inhibit group effectiveness. To optimize effectiveness, the form of organization
must be matched to the purpose it seeks to achieve.
Exercising Choice
There are four basic issues which may be involved in a conflict. These are:-
(1) Facts- Conflicts may occur because of disagreement that the persons have
over the definition of a problem, relevant facts related to the problem, or
their authority and power.
(2) Goals- Sometimes, there may be disagreement over the goals which two
parties want to achieve. The relationship between goals of the parties may
be viewed as incompatible with the result that one goal may be achieved
at the cost of the other.
(3) Methods- Even if goals are perceived to be the same, there may be
difference over the methods, procedures, strategies, tactics, etc. through
which goals may be achieved.
(4) Values- There may be differences over the value-ethical standards,
considerations for fairness, justice etc. These differences are of more
intrinsic nature in persons and may affect the choice of goals or methods
of achieving those.
Types of conflict:-
1. Survey feedback
2. Process Consultation
3. sensitivity Training
4. The Managerial grid
5. Goal setting and Planning
6. Team Building and management by objectives
7. Job enrichment, changes in organizational structure and participative
management and Quality circles, ISO, TQM
Goal setting and planning : Each division in an organization sets the goals or
formulates the plans for profitability. These goals are sent to the top
management which in turn sends them back to the divisions after modification .
A set of organization goals thus emerge there after.
Fourth phase is concerned with the creation of a strategic model for the
organization where Chief Executives and their immediate subordinates
participate in this activity.
Sixth Phase is concerned with the critical evaluation of the model and making
necessary adjustment for successful implementation.
Job enrichment is currently practiced all over the world. It is based on the
assumption in order to motivate workers, job itself must provide opportunities for
achievement, recognition, responsibility, advancement and growth. The basic
idea is to restore to jobs the elements of interest that were taken away. In a job
enrichment program the worker decides how the job is performed, planned and
controlled and makes more decisions concerning the entire process.
Organizational Development
Organizational Structures
Organizational Development Cycles
Diagnosis and Intervention Strategies:
Team Building
Goal Setting
Survey Feedback
Strategic Planning
Sensitivity Training (T-Groups)
Grid Training
Organizational Culture within Organizational Development
International Culture and Organizational Development
Organizational Development in Response to Technological Change
Organizational development
Burke (1982) defined organizational development (OD) as "a planned process of change in an
organization's culture through the utilization of behaviourial science, technology, research
and theory." It refers to the management of change and the development of human resources.
It is a response to change (Bennis, 1969). OD is a complex educational strategy intended to
change the beliefs, attitudes, values and structure of the organization so that the organization
can better adapt to new technologies, markets and challenges.
A variety of forces cause changes in the modern organization (Hellriegel, Slocum and
Woodman, 1983). Some of these are:
• technological change;
• the knowledge explosion;
• product and service obsolescence; and
• social change.
Environment, resources and technology perform a decisive role in determining organizational
policies. If any one of these determinants changes, the policies need to be re-examined to
determine if a different organizational design would be better suited.
Approaches to OD
The major schools of thought in OD are considered in the following paragraphs.
Group Dynamics
This is a historical and traditional method of OD based on the assumption that OD activities
are process consultation (Albrecht, 1983). In this approach, an expert works at a small-group
level, using group methods, sensitivity training and other related approaches.
The Behaviour Modification School
The 'be-mod' school of OD (based on the various works of Skinner) attempts to rearrange the
reward system in the organization so as to strengthen selected 'target' behaviour on the part of
employees.
The Systems Approach
This approach aims at enhancing the overall effectiveness of the organization. The system
can be defined as having:
• some components that comprise it;
• functions and processes performed by various components;
• relationship among the components that make them a system; and
• an organizational principle, which gives the system a purpose.
This approach is based on the assumption that an organization is composed of four
interlocking systems (Albrecht, 1983), namely:
• a technical system, referring to the elements, activities and relationships that make up the
primary productive axis of the organization. It includes physical facilities, machinery, special
equipment, work processes, work methods, work procedures, work-oriented information and
various means of handling;
• a social system, referring to the people in the organization and the activities in which they
are engaged. It includes the intra-group roles and relationships, the form of power hierarchy,
values and norms for behaviour in the organization, and the reward and punishment
processes;
• an administrative system, which refers to the policies, procedures, instructions, reports, etc.,
which are required to operate the organization. It also includes those who operate the
technical and administrative systems; and
• a strategic system, which is the steering function of the organization. Its components
include the management team from the chief executive down to the lowest supervisor, the
chain of command, reporting relationships, and the power values of the leaders of the
organization. It also includes plans, the planning process and the procedures used in
governing the organization and adapting it to changing needs.
The systems approach has four sequential stages: assessment, problem solving,
implementation and evaluation.
The Socio-Technical Approach
The socio-technical approach views an organization (Pasmore, 1988) as made up of people (a
social system and a technical system) producing goods or services valued by customers (who
are part of the external environment).
The social system uses tools, techniques, and knowledge. The technical system produces
goods and services which are valued by customers in the external environment.
The Environment Approach
The environment is an agent of change. Environmental changes are the primary incitement
and stimulus for organizational betterment. The socio-technical arrangements in the
organization must change according to changes in the environment. The environment can
change in both predictable and unpredictable ways. The external environment can be
relatively stable or rapidly changing.
Thus, the environment, the technical system and the social system are three basic elements
which play a crucial role in any organization's design, re-design or development. The
efficiency and effectiveness of the organization depend upon the equilibrium between the
needs of these determinant elements.
The OD process
The OD process entails various activities at different levels in the organization. Through
these activities, interventions are made in the ongoing organization to change the structure,
processes, behaviour or values of individuals and groups. Golembiewski, Prochl and Sink
(1981) categorized these interventions under eight headings:
• Process Analysis Activities, referring to applications of behaviourial science perspectives to
fathom complete and dynamic situations;
• Skill-building Activities, involving various designs for eliciting behaviours in congruence
with OD values. This includes giving and receiving feedback, listening, and settling conflicts;
• Diagnostic Activities, including process analysis to generate data through interviews,
psychological instruments or opinion surveys;
• Coaching or Counselling Activities to help in resolving conflicts through third-party
consultation;
• Team Building Activities, enhancing the efficiency and effectiveness of task groups;
• Inter-group Activities, attempting to create effective and satisfying linkages between two or
more task groups or departments in the organization;
• Techno-Structural Activities, aiming at building need-fulfilling roles, jobs and structures;
and
• System-Building or System-Renewal Activities, seeking exhaustive changes in a large
organization's climate and values using combinations of the various OD interventions listed
above.
Socio-technical systems approach for organization re-design
Socio-technical systems design is better suited to meet the requirements of a changing
external environment in comparison with traditional designs. It endeavours to re-design the
organization's structure, processes and functions to create a balance between the organization
and its changing external environment. It could involve the following steps (Foster, 1967;
Cummings, 1976; Pasmore, 1988):
• defining the scope of the system to be re-designed;
• defining the environmental demands;
• evolving a vision statement;
• enlightening organizational members;
• developing the change structure;
• conducting socio-technical analysis;
• preparing re-design proposals;
• implementing recommended changes; and
• evaluating the changes or re-design.
OD techniques
Techniques used for OD are considered below.
Sensitivity training
This has many applications and is still used widely, even though new techniques have
emerged (Lewin, 1981). Sensitivity training (Benny, Bradford and Lippitt, 1964) basically
aims at:
• growth in effective membership;
• developing ability to learn;
• stimulating to give help; and
• developing insights to be sensitive to group processes.
These process variables - in a systems sense - interact and are interdependent.
Grid Training
Blake and Mouton’s Managerial Grid
The treatment of task orientation and people orientation as two independent dimensions was a
major step in leadership studies. Many of the leadership studies conducted in the 1950s at the
University of Michigan and the Ohio State University focused on these two dimensions.
Building on the work of the researchers at these Universities, Robert Blake and Jane Mouton
(1960s) proposed a graphic portrayal of leadership styles through a managerial grid
(sometimes called leadership grid). The grid depicted two dimensions of leader behavior,
concern for people (accommodating people’s needs and giving them priority) on y-axis and
concern for production (keeping tight schedules) on x-axis, with each dimension ranging
from low (1) to high (9), thus creating 81 different positions in which the leader’s style may
fall.
Concern for People
• Reducing involvement and terminating This is the mutual agreement to cease the
consultation.
Third Party
The third-party peace-making technique attempts to settle inter-personal and inter-group
conflicts using modern concepts and methods of conflict management. This technique
analyses the processes involved, discerns the problem on the basis of the analysis, and
suitably manages the conflict situation.
Team building
Team building has been considered the most popular OD technique in recent years, so much
so that it has replaced sensitivity training. It aims at improving overall performance, tends to
be more task-oriented, and can be used with family groups (members from the same unit) as
well as special groups (such as task forces, committees and inter-departmental groups).
There are five major elements involved in team building (French and Bell, 1978):
• problem solving, decision making, role clarification and goal setting for accomplishing the
assigned tasks;
• building and maintaining effective inter-personal relationships;
• understanding and managing group processes and culture;
• role analysis techniques for role clarification and definition; and
• role negotiation techniques.
Transactional Analysis
Transactional analysis is widely used by management practitioners to analyse group
dynamics and inter-personal communications. It deals with aspects of identity, maturation,
insight and awareness (Berne, 1964). As a tool for OD, it attempts to help people understand
their egos - both their own and those of others - to allow them to interact in a more
meaningful manner with one another (Huse, 1975). It attempts to identify peoples' dominant
ego states and help people understand and analyse their transactions with others. It is quite
effective if applied in the early stage of the diagnostic phase.
Team Building
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Work focus
Managers are paid to get things done (they are subordinates too), often within
tight constraints of time and money. They thus naturally pass on this work focus
to their subordinates.
Seek comfort
An interesting research finding about managers is that they tend to come from
stable home backgrounds and led relatively normal and comfortable lives. This
leads them to be relatively risk-averse and they will seek to avoid conflict where
possible. In terms of people, they generally like to run a 'happy ship'.
Leaders do not have subordinates - at least not when they are leading. Many
organizational leaders do have subordinates, but only because they are also
managers. But when they want to lead, they have to give up formal authoritarian
control, because to lead is to have followers, and following is always a voluntary
activity.
Telling people what to do does not inspire them to follow you. You have to appeal
to them, showing how following them will lead to their hearts' desire. They must
want to follow you enough to stop what they are doing and perhaps walk into
danger and situations that they would not normally consider risking.
Leaders with a stronger charisma find it easier to attract people to their cause.
As a part of their persuasion they typically promise transformational benefits,
such that their followers will not just receive extrinsic rewards but will somehow
become better people.
People focus
Although many leaders have a charismatic style to some extent, this does not
require a loud personality. They are always good with people, and quiet styles
that give credit to others (and takes blame on themselves) are very effective at
creating the loyalty that great leaders engender.
Although leaders are good with people, this does not mean they are friendly with
them. In order to keep the mystique of leadership, they often retain a degree of
separation and aloofness.
This does not mean that leaders do not pay attention to tasks - in fact they are
often very achievement-focused. What they do realize, however, is the
importance of enthusing others to work towards their vision.
Seek risk
A surprising number of these leaders had some form of handicap in their lives
which they had to overcome. Some had traumatic childhoods, some had
problems such as dyslexia, others were shorter than average. This perhaps
taught them the independence of mind that is needed to go out on a limb and
not worry about what others are thinking about you.
In summary
This table summarizes the above (and more) and gives a sense of the differences
between being a leader and being a manager. This is, of course, an illustrative
characterization, and there is a whole spectrum between either ends of these
scales along which each role can range. And many people lead and manage at
the same time, and so may display a combination of behaviors.
Rensis Likert
Dr. Rensis Likert has conducted much research on human behavior within
organizations, particularly in the industrial situation.
The form of the organization which will make greatest use of the human
capacity, Likert contends, is;
Management Styles
The exploitive - authoritative system, where decisions are imposed on
subordinates, where motivation is characterized by threats, where high levels of
management have great responsibilities but lower levels have virtually none,
where there is very little communication and no joint teamwork.
This fourth system is the one which is the ideal for the profit oriented and
human-concerned organization, and Likert says (The Human Organization,
Mcgraw Hill, 1967) that all organizations should adopt this system. Clearly, the
changes involved may be painful and long-winded, but it is necessary if one is to
achieve the maximum rewards for the organization.
• Employees must be seen as people who have their own needs, desires and
values and their self-worth must be maintained or enhanced.
• Supportive relationships must exist within each work group. These are
characterized not by actual support, but by mutual respect.
The work groups which form the nuclei of the participative group system, are
characterized by the group dynamics:
• The members of the group are loyal to it and to each other since they
have a high degree of mutual trust.
• The norms, values and goals of the group are an expression of the values
and needs of its members.
• The members perform a "linking-pin" function and try to keep the goals of
the different groups to which they belong in harmony with each other.
Management Thoughts
There are a few people in every age who produce new, paradigm-shifting ideas.
Sometimes these ideas don't catch on right away, but as time passes, their worth
becomes more evident. The art of management is an old one, but it was a fairly
static one until about 150 years ago, when changes in technology, e.g. railroads
and telegraph, changed our economy quite dramatically, and at the same time
changed the discipline of management. We don't really have much perspective
yet. Without it, it's hard to say what ideas will endure, and who the real pioneers
will turn out to be. But, guessing, here are some of the people in our
management heroes gallery.
* George Box
* Philip Crosby
* W. Edwards Deming
* John Dewey
* Fredrick Herzberg
Kaoru Ishikawa
Kaoru Ishikawa wanted to change the way people think about work. He urged managers to
resist becoming content with merely improving a product's quality, insisting that quality
improvement can always go one step further. His notion of company-wide quality control
called for continued customer service. This meant that a customer would continue receiving
service even after receiving the product. This service would extend across the company itself
in all levels of management, and even beyond the company to the everyday lives of those
involved. According to Ishikawa, quality improvement is a continuous process, and it can
always be taken one step further.
With his cause and effect diagram (also called the "Ishikawa" or "fishbone" diagram) this
management leader made significant and specific advancements in quality improvement.
With the use of this new diagram, the user can see all possible causes of a result, and
hopefully find the root of process imperfections. By pinpointing root problems, this diagram
provides quality improvement from the "bottom up." Dr. W. Edwards Deming --one of
Isikawa's colleagues -- adopted this diagram and used it to teach Total Quality Control in
Japan as early as World War II. Both Ishikawa and Deming use this diagram as one the first
tools in the quality management process.
Ishikawa also showed the importance of the seven quality tools: control chart, run chart,
histogram, scatter diagram, Pareto chart, and flowchart. Additionally, Ishikawa explored the
concept of quality circles-- a Japanese philosophy which he drew from obscurity into world
wide acceptance. .Ishikawa believed in the importance of support and leadership from top
level management. He continually urged top level executives to take quality control courses,
knowing that without the support of the management, these programs would ultimately fail.
He stressed that it would take firm commitment from the entire hierarchy of employees to
reach the company's potential for success. Another area of quality improvement that Ishikawa
emphasized is quality throughout a product's life cycle -- not just during production.
Although he believed strongly in creating standards, he felt that standards were like
continuous quality improvement programs -- they too should be constantly evaluated and
changed. Standards are not the ultimate source of decision making; customer satisfaction is.
He wanted managers to consistently meet consumer needs; from these needs, all other
decisions should stem. Besides his own developments, Ishikawa drew and expounded on
principles from other quality gurus, including those of one man in particular: W. Edwards
Deming, creator of the Plan-Do-Check-Act model. Ishikawa expanded Deming's four steps
into the following six:
• Determine goals and targets.
• Determine methods of reaching goals.
• Engage in education and training.
• Implement work.
• Check the effects of implementation.
• Take appropriate action.
* Joseph M. Juran
* Kurt Lewin
* Lawrence D. Miles
* Alex Osborne
* Walter Shewhart
* Genichi Taguchi
* J. Edgar Thomson
Human resource management
The maternity Benefit Act, 1961: Maternity benefit is “an indemnity for the
loss of wages incurred by a woman who voluntarily before child-birth and
compulsorily thereafter abstains from work in the interest of the child and
herself”. The I.L.O. Maternity Protection Conventions of 1919 was revised in
various details in 1952.
(a) Enable the women employee to abstain from work during the 6 weeks
preceding the expected date of her confinement;
(b) Oblige her to abstain from work during the 6 weeks following her
confinement;
(c) Provide her, with free attendance by a doctor or certified mid-wife;
(d) Provide her out of public funds or by means of insurance, with a cash
benefit sufficient for the full and healthy maintenance of herself and child
during the said period of abstention from work;
(e) Prohibit her dismissal during the said periods or a subsequent period o
sickness; and
(f) Enable her to suckle her baby twice a day during working hours.
According to the Industrial Disputes Act, 1947, industrial disputes mean any
dispute or difference between employers and employees, or between employers
and workmen, or between workmen and workmen, which is connected with the
employment or non-employment or with the conditions of labor of any person.
Causes of dispute:
1 Wages
2 Union rivalry
3 Political interference
4 Unfair labor practices
5 Multiplicity of labour law
6 Others: Industrial relation managers stoke the fire and then try to
extinguish it- all to justify their own existence in organization.
Methods of resolving dispute;
1 Collective bargaining
2 Code of discipline
3 Grievance procedure
4 Arbitration
5 Conciliation
6 Adjudication
7 Consultative machinery
According to Arthur James Todd,” Labour welfare means anything done for the
comfort and improvement, intellectual or social, of the employee over and above
the wages paid which is not a necessity of the Industry.”
Labour welfare:
Social security:
The term social security originated n U.S.A. In 1935, the Social Security Act was
passed there and Social Security Board was established to govern and
administer the scheme of
• unemployment,
• sickness and
• old-age insurance.
Though social security program differ from country to country, they have three
characteristics in common
There are several Acts and Schemes which provide security to the workers.
According to Prof. Watson, the law of return to a variable factor is “when total
output o production of a commodity is increased by adding units of variable
inputs while the quantities of other inputs are held constant, then increase in
total production becomes, after some point, smaller and smaller.
Probability measures provide the decision-maker with the means for quantifying
the uncertainties which affect the choices of appropriate actions. Understanding
probability and taking decision after understanding it minimizes the risk.
Priori approach assumes that all the possible outcomes of an experiment are
mutually exclusive and equally likely.
The word equally likely conveys the motion of equally probable, and mutually
exclusively means of one event occurs the other event will not occur.
• The exponential pdf has no shape parameter, as it has only one shape.
• The exponential pdf is always convex and is stretched to the right as λ decreases in
value.
• The value of the pdf function is always equal to the value of λ at T = 0 (or T = γ).
• The location parameter, γ, if positive, shifts the beginning of the distribution by a
distance of γ to the right of the origin, signifying that the chance failures start to occur
only after γ hours of operation, and cannot occur before this time.
The following notation is helpful, when we talk about the Poisson distribution.
• e: A constant equal to approximately 2.71828. (Actually, e is the base of
the natural logarithm system.)
• μ: The mean number of successes that occur in a specified region.
• x: The actual number of successes that occur in a specified region.
• P(x; μ): The Poisson probability that exactly x successes occur in a
Poisson experiment, when the mean number of successes is μ.
Poisson Distribution
A Poisson random variable is the number of successes that result from a Poisson
experiment. The probability distribution of a Poisson random variable is called a Poisson
distribution.
Given the mean number of successes (μ) that occur in a specified region, we can compute the
Poisson probability based on the following formula:
Poisson Formula. Suppose we conduct a Poisson experiment, in which the
average number of successes within a given region is μ. Then, the Poisson
probability is:
The average number of homes sold by the Acme Realty company is 2 homes per day. What is
the probability that exactly 3 homes will be sold tomorrow?
Solution: This is a Poisson experiment in which we know the following:
• μ = 2; since 2 homes are sold per day, on average.
• x = 3; since we want to find the likelihood that 3 homes will be sold
tomorrow.
• e = 2.71828; since e is a constant equal to approximately 2.71828.
We plug these values into the Poisson formula as follows:
P(x; μ) = (e-μ) (μx) / x!
P(3; 2) = (2.71828-2) (23) / 3!
P(3; 2) = (0.13534) (8) / 6
P(3; 2) = 0.180
Thus, the probability of selling 3 homes tomorrow is 0.180 .
A cumulative Poisson probability refers to the probability that the Poisson random variable
is greater than some specified lower limit and less than some specified upper limit.
Example 1
Suppose the average number of lions seen on a 1-day safari is 5. What is the probability that
tourists will see fewer than four lions on the next 1-day safari?
Solution: This is a Poisson experiment in which we know the following:
• μ = 5; since 5 lions are seen per safari, on average.
• x = 0, 1, 2, or 3; since we want to find the likelihood that tourists will see
fewer than 4 lions; that is, we want the probability that they will see 0, 1,
2, or 3 lions.
• e = 2.71828; since e is a constant equal to approximately 2.71828.
To solve this problem, we need to find the probability that tourists will see 0, 1, 2, or 3 lions.
Thus, we need to calculate the sum of four probabilities: P(0; 5) + P(1; 5) + P(2; 5) + P(3; 5).
To compute this sum, we use the Poisson formula:
P(x < 3, 5) = P(0; 5) + P(1; 5) + P(2; 5) + P(3; 5)
P(x < 3, 5) = [ (e-5)(50) / 0! ] + [ (e-5)(51) / 1! ] + [ (e-5)(52) / 2! ] + [ (e-5)(53) / 3! ]
P(x < 3, 5) = [ (0.006738)(1) / 1 ] + [ (0.006738)(5) / 1 ] + [ (0.006738)(25) / 2 ] +
[ (0.006738)(125) / 6 ]
P(x < 3, 5) = [ 0.0067 ] + [ 0.03369 ] + [ 0.084224 ] + [ 0.140375 ]
P(x < 3, 5) = 0.2650
Thus, the probability of seeing at no more than 3 lions is 0.2650.
The weekly wages of 2000 workers in a factory is normally distributed with a mean of
Rs. 200 and a standard deviation of Rs. 20.
Estimate the lowest weekly wages at the 200 highest paid workers and the highest wages
of 200 lowest paid workers.
[Given phi(1.28)=0.09]
Marketing environment and environment scanning
As regards the environment that is specific to the given business, the firm
studies:
Benefits:
1 In marketing planning
2 In marketing implementation
3 In marketing control
Periodic reports
Triggered reports
Demand reports
Plan reports
Specialized databases
➢ Customer database
➢ Marketing intelligence
➢ Data mining and data warehousing
1 Bachelor Young, single, not living at home, few financial burdens, fashion
stage opinion leaders. Recreation oriented. Buy; basic home
equipments, furniture, cars, equipments for the mating game
vacations.
2 Newly Young, no children, highest purchase rate and highest purchase of
married durables: Cars, appliances, furniture, vacations
couples
3 Full nest I Youngest child under six, home purchasing at peak, liquid assets
low, interested in new products, advertised products. Buy:
Washers, dryers, TV, baby food, chest rub and cough medicines,
vitamins, dolls, wagons, sleds,skates
4 Full nest Youngest child six or over, financial position better. Less
II influenced by advertising. Buy large-size packages, multiple-unit
deals. Buy: Manifolds, cleaning materials, bicycles,music lessons,
pianos
5 Full nest Older married couples with dependent children. Financial position
III still better. Some children get jobs. Hard to influence with
advertising. High average purchase of durables: new, more
tasteful, furniture, auto travel, unnecessary appliances, boats,
dental services, magazines
8 Solitary In labour force, Income still good but likely to sell home
survivor I
9 Solitary Retired. Same medical and product needs as other retired group;
survivor drastic cut in income, special need for attention, affection and
II security
Marketing research
Research on competition
Research on distribution
Research on price
What is a service?
Kotler and Bloom defined service as “ A service is any act or performance that
one party can offer to another that is essentially intangible and does not result in
the ownership of anything. Its production may or may not be tied to a physical
product.”
• Intangibility: Refers to the aspect not associated with any physical form or
characteristics. It is very much, pronounced in the pure service elements
like the lecture given by a professor.
• Inseparability: It means that the production and consumption of the
service are inextricably interwined. Hence, the consumer’s presence is in
most cases necessary at the time of production. Goods are usually
purchased, sold and consumed; whereas, services are usually sold and
then produced and consumed.
• Heterogeneity: The services offered are not similar all the time to all the
customers. This feature of service is called “ Heterogenity”. The quality of
a service depends on the person, who provides the service, or the time,
when provided. Even though standard systems may be used to handle a
flight reservation, book a car for service, each “unit” of service differs from
other “units”.
• Perishability: This means that the service “units” cannot be stocked. If a
seat is unfilled when the plane leaves or the play starts, it cannot be
stored and sold next day or next week; that revenue is lost forever.
1 Tangible Intangible
2 Homogeneous Heterogeneous
This process is effective for developing all types of business, and delivers business growth
via:
• new products or services to existing customers,
• existing products or services to new customers, or
• new products or services to new customers.
Market development process:
1. Establish market development aims and targets.
2. Identify target market(s), sectors and niches.
3. Assess your existing sales organisation and develop it as necessary.
4. Source/utilise a suitable prospect database - ensure data is clean and up
to date, and strategic decision-makers are identified.
5. Develop and agree your strategic proposition(s) - with reference to USP's,
UPB's, competitors, positioning, product mix, margins, etc.
6. Design your communication(s) and method(s) to generate enquiries.
7. Design your response and sales processes and establish or provide
required capabilities.
8. Design and provide your required monitoring, measurement and reporting
systems.
9. Implement your sales development activity and reinforce it through
coaching, training, meetings, executive endorsement, etc.
10.Follow-up the activity: coach as required, review, monitor, seek customer
and prospect feedback (successful and unsuccessful) and report on
performance.
11.Make changes and improvements and continue your activity at the
appropriate stage.
Growth Strategies:
One of the objectives of the firms is to continuously increase their sales and
profit. At some point of time, a firm faces a situation that the expected sales and
profit from its existing business do not reach the desired levels. The firms need
to adopt suitable strategies to fill this strategic gap. The firms can adopt three
possible approaches:
You need to run faster and faster to remain at the same place
H. Igor Ansoff first published the now well-known vector matrix or product-matrix
in the Harvard Business review in Sep/ Oct edition of 1957. The matrix also
appeared in the book written later by Ansoff and published in 1965- corporate
strategy. Although the matrix was published a long time ago, it still remains one
of the most popular matrices and is used to identify the basic alternative
strategies, which are options for a firm wanting to grow.
Ansoff developed the matrix out of his realization that a firm needs a well-
defined scope and growth direction. For most companies growth is often the
perquisite for survival.
Ansoff felt that many of the theorists had too broad a concept of business and
that the traditional identification of a firm with a particular industry had become
too narrow. This was because many firms acquired a diverse range of products
through policies of vertical and horizontal integration to protect their existing
markets, and also through new product development, done to exploit
technological innovations and to develop new market with opportunities to
growth.
Existing
Market penetration New
Product development
strategy strategy
Existing
Market
New
This grid may be also used to make an analysis of the marketing personality/
outlook of the individual/ firm
a. Maintain or increase its share of the current market with current products.
b. Secure dominance of growth markets.
c. Restructure a mature market by driving out competitors.
d. Increase usage by existing customer.
a. Growth - new products and new markets should be selected which offer
prospects for growth, which the existing product market mix does not.
b. Investing surplus – funds not required for other expansion needs: but the
funds could be returned to shareholders.
c. The firms strengths matches the opportunity if – outstanding new products
have been developed by the company’s research and development department.
The profit opportunities from diversification are high.
Related diversification
Horizontal integration refers to ‘development into activities which are
competitive with or directly complementary to a company’s present activities.’
Sony with its playstation started to compete in computer games.
a. Risk spreading – entering new products into new markets offers protection
against failure of current products and markets.
b. High profit opportunities – Ability to move into high growth profitable
industries especially important if current industry is in decline.
c. Escape – from the present business if competition is too hot!
d. Better access to capital markets.
e. No other way to grow – expansion in the existing industry might lead to
monopoly and government investigation
f. Use surplus cash
g. Exploit under-utilized resources
h. Obtain cash or other financial advantages
i. Use a company’s image reputation in one market to build products and
services in another market.
Product strategies
Marketing strategies which are based on the product element are called product
strategies. Product strategies are of two types:-
Product modification
Product elimination
Diversification
Stages
ch Profit
ar
Strategic thrust
ac
te Customer targets
ris Competition
tic
Differential
s
advantage
Stages
Ma Product
rk
Price
eti
ng Promotion
Mi
x Advertising
focus
distribution
Products
Immobile
Existing Immobile
Existing
non-innovative innovative
mobile Immobile
Market
non-innovative innovative
Existing
New
BCG Model
Market Share
Porter’s Generic
Strategies
Industry Analysis
Competitive strategy
Grand strategies
Stability strategies
Expansion strategies
Retrenchment strategies
Combination strategies
Corporate restructuring
The Uruguay round of trade negotiations, after more than seven years of
deliberation was wrapped uo on 14th Dec, 1993 and was formalized by more than
120 countries on April 15, 1994. WTO came into existence on Jan 1, 1995.
Functions:
Agreement on agriculture:
Balanced Scorecard
The balanced scorecard has evolved from its early use as a simple performance
measurement framework to a full strategic planning and management system.
The “new” balanced scorecard transforms an organization’s strategic plan from
an attractive but passive document into the "marching orders" for the
organization on a daily basis. It provides a framework that not only provides
performance measurements, but helps planners identify what should be done
and measured. It enables executives to truly execute their strategies.
Kaplan and Norton describe the innovation of the balanced scorecard as follows:
Adapted from Robert S. Kaplan and David P. Norton, “Using the Balanced
Scorecard as a Strategic Management System,” Harvard Business Review
(January-February 1996): 76.
Perspectives
The balanced scorecard suggests that we view the organization from four
perspectives, and to develop metrics, collect data and analyze it relative to each
of these perspectives:
Kaplan and Norton emphasize that 'learning' is more than 'training'; it also
includes things like mentors and tutors within the organization, as well as that
ease of communication among workers that allows them to readily get help on a
problem when it is needed. It also includes technological tools; what the Baldrige
criteria call "high performance work systems."
Strategy Mapping
Strategy maps are communication tools used to tell a story of how value is
created for the organization. They show a logical, step-by-step connection
between strategic objectives (shown as ovals on the map) in the form of a cause-
and-effect chain. Generally speaking, improving performance in the objectives
found in the Learning & Growth perspective (the bottom row) enables the
organization to improve its Internal Process perspective Objectives (the next row
up), which in turn enables the organization to create desirable results in the
Customer and Financial perspectives (the top two rows).
Corporate level
strategies
Retrenchment Combination
Stability Expansion
Types of merger
Fragmentation Stage
Advantage
Target Scope
Focus Focus
Narrow Strategy Strategy
(Market Segment) (low cost) (differentiation)
Differentiation Strategy
A differentiation strategy calls for the development of a product or service that offers
unique attributes that are valued by customers and that customers perceive to be
better than or different from the products of the competition. The value added by the
uniqueness of the product may allow the firm to charge a premium price for it. The
firm hopes that the higher price will more than cover the extra costs incurred in
offering the unique product. Because of the product's unique attributes, if suppliers
increase their prices the firm may be able to pass along the costs to its customers
who cannot find substitute products easily.
Firms that succeed in a differentiation strategy often have the following internal
strengths:
• Access to leading scientific research.
• Highly skilled and creative product development team.
• Strong sales team with the ability to successfully communicate the perceived
strengths of the product.
• Corporate reputation for quality and innovation.
The risks associated with a differentiation strategy include imitation by competitors
and changes in customer tastes. Additionally, various firms pursuing focus strategies
may be able to achieve even greater differentiation in their market segments.
Focus Strategy
The focus strategy concentrates on a narrow segment and within that segment
attempts to achieve either a cost advantage or differentiation. The premise is that the
needs of the group can be better serviced by focusing entirely on it. A firm using a
focus strategy often enjoys a high degree of customer loyalty, and this entrenched
loyalty discourages other firms from competing directly.
Because of their narrow market focus, firms pursuing a focus strategy have lower
volumes and therefore less bargaining power with their suppliers. However, firms
pursuing a differentiation-focused strategy may be able to pass higher costs on to
customers since close substitute products do not exist.
Firms that succeed in a focus strategy are able to tailor a broad range of product
development strengths to a relatively narrow market segment that they know very
well.
Some risks of focus strategies include imitation and changes in the target segments.
Furthermore, it may be fairly easy for a broad-market cost leader to adapt its product
in order to compete directly. Finally, other focusers may be able to carve out sub-
segments that they can serve even better.
Generic Strategies
Industry
Force Cost
Differentiation Focus
Leadership
Minister of Italy Mr. Renatto Rugaro is its present Director General. Four Deputy
Director General are also elected to assist the Director General.
Like GATT, WTO’s headquarter is also at Geneva. According to the latest WTO
report (WTR-2003), at the end of April 2003, 146 countries were the members of
WTO. WTO increased the present membership of WTO to 151.
Objectives of WTO
1. To improve standard o living of people in the member countries.
2. To ensure full employment and broad increase in effective demand.
3. To enlarge production
4. To enlarge trade of goods.
5. To enlarge production with trade of services.
6. To ensure optimum utilization of world resources.
7. To accept the concept of sustainable development
8. To protect environment
Function of WTO
1. To provide facilities or implementation administration and operation of
multilateral and bilateral agreements of the world trade.
2. To provide a platform to member countries to decide future strategies
related to trade and tariff.
3. To administer the rules and process related to dispute settlement
4. To implement rules and provisions realted to trade policy preview
mechanism
5. To assist IMF and IBRD for establishing coherence in universal economic
policy determination.
6. To ensure the optimum use of world resources
7. To accept the concept of sustainable development
8. To protect environment
9. To ensure optimum utilization of world resources
10.To enlarge production
11.To enlarge trade or services
WTO agreements
The main WTO agreements can be divided into the following categories:
1. Agreement on agriculture: This provides a framework for the long-term
Values and ethics in management
Morality, is defined as the customary, sociolegal practices and activities that are
considered importantly right and wrong; the rules that governs these activities;
and the values that are embedded, fostered, or perused by those conventional,
sociolegal activities and practices.
Teleological ethics theories maintain that good ends and/or results determine the
ethical values of action.
• Individual character
• Work character
• Professional character
• Personal improvement
• Organizational ethics
• Extra- organizational ethics
There are many ethical decisions that human beings make with respect to the
environment. For example:
Is it right for humans to knowingly cause the extinction of a species for the
convenience of humanity?
versus what is good for the environment. In other words, the consensus must be
that there should be a hierarchy of interests-one which places environmental and
sustainability concerns at the peak. "The claim is that the various benefits and
harms of development are incommensurable and not easily weighed, involving
differences between global and local goods-the benefits of selling wood fiber for
local populations versus the possible global benefits of a potential cure for
cancer or a contribution to the reduction in greenhouse gases...Whose interests
count for more?" (Light 2002). In short, the interests of the global good should
always outweigh those of the short-term monetary or other gains produced by
unethical or unsustainable practices and leadership decisions. Leaders in both
business and civil society have focused too much on the friction between them
and not enough on the points of intersection. The mutual dependence of
corporations and society implies that "both business decisions and social policies
must follow the principle of shared value. That is, choices must benefit both
sides. If either a business or a society pursues policies that benefit its interests at
the expense of the other, it will find itself on a dangerous path (Porter 2006).
There are various approaches to solving the organizational (and for that matter,
national and international) problems surrounding effective and environmentally
ethical leadership. The main issue is, however, a lack of coherent ideology
surrounding organizational and corporate responses-even if the desire to be
more aware of environmental ethics matters exists. For example, according to a
survey conducted in December of 2006, "198 medium-sized to large
multinationals found that most said they lacked an active approach to
developing new business opportunities arising from meeting citizenship and
sustainability needs" (Marshall 2007). In order to remedy this crisis, many larger
organizations hired corporate responsibility officers to monitor such things as
environmental ethics. These individuals were charged with the task of reviewing
and analyzing current policy and practices to ensure that the highest ethical
standards were being met in a way that was conducive to the organization's
mission statement, budget, and overall corporate culture. In short, one approach
to solving the ethical demands that increasingly valued by both the public and
investors is to ensure corporate responsibility through the hiring of an outside
consultant. With larger organizations understanding the value of environmental
ethical responsibility, it is natural to assume that smaller entities will take notice
and follow suit.
Being an effective and responsible corporate leader is not simply something that
is an issue in the organizational context, but it extends to the community level as
well. Consider the case of Detroit and its rapidly dwindling reserve of natural
areas and resources. In Detroit, an urban ecosystem analysis undertaken by
American Forests revealed how land cover changes over the past 11 years have
affected environmental quality in a nine-county area of southeast Michigan.
"From 1991 to 2002 that region's open space declined by 10 percent while urban
areas increased dramatically-21 percent. As a result, the region lost $1 billion in
stormwater management services with a corresponding decline in water quality"
(Kollin 2006). "The companies were rated on their ability to provide good jobs for
employees, environmental sustainability, and healthy community relations"
(Mirren 2006).
A. Gender mainstreaming is not a dead end strategy. But it is not always fully
understood and implemented in the right way.
* There is confusion about concepts: “gender” and “women”. However, one does
not exclude the other. The use depends on the context. “Gender” is most
fruitfully used as an adjective, not a noun, in concepts like “gender equality” and
“gender analysis”. “Women” (and girls) are essential actors and target groups in
relation to gender equality. It is important to analyse issues so that gender
differences and disparities appear and women are visible in relation to men.
* There is also confusion about goals and means. The goal is gender equality and
women’s empowerment. To achieve the goal, different strategies and actions are
needed according to circumstances. Polarisation of approaches does not work. A
main strategy is gender mainstreaming of all policies, programmes and projects.
But “women must not be lost in the mainstream, or malestream!”. Targeted
women-specific policies, programmes and projects are necessary to strengthen
the status of women and promote mainstreaming. In any case, there must be
specialist support, institutional mechanisms and accountability.
* Agencies have chosen different bases for their action: human rights or
efficiency considerations. In fact, it is not a question of either/or. The human
rights basis is more fundamental, but is not always made explicit and in some
organisations it is not well understood or appreciated. The emphasis will vary
from one organisation to the other, but it is important to realise that the
promotion of gender equality implies a social transformation in society in
addition to more effective economic development and poverty reduction.
G. Gender units. To promote gender equality, funds and competent staff are
required. Corporate gender units are necessary. Regarding the level, resources
and institutional placement of the gender units, the key objective is maximum
and timely access to key corporate strategic processes and high-level
management. There must be a critical mass of staff resources/gender specialists
kept together and then ideally additional fulltime specialists in other units and
decentralized offices. There should be allocation of adequate resources and a
match of expectations and resources expressed in clear terms of reference of
catalytic functions of the gender unit
I. Networks. Networks and alliances are important within the organisation and
outside. Internally, ownership should be shared with both women and men, and
between Headquarters and the field. Externally collaboration should be
established with governments, civil society and other UN organisations. Links
should be established and support provided for women’s organisations and
groups, keeping in mind the character of the different groups and organisations.
It is also important to collaborate with business and professional organizations,
employers and trade unions, social and cultural associations, youth clubs etc.
L. Mottos:
“Whatever works, do it” (don’t be hung up in dogmatic approaches or language)
“Be persistent (things are never fast and easy), passionate (both competence
and involvement are needed) and keep a sense of humour (there are many
perspectives and ways of thinking)”
“Don’t compromise your dignity” (there are limits to what a gender focal point
can or should do)
“Damned if you do, damned if you don’t” (there are rarely simple
solutions)“Don’t reinvent the wheel, there are so many wheels” (learn from the
experiences of others)
“The more you advance, the more remains to be done” (new opportunities entail
new challenges)
Pune: Women occupy just about 5% positions on the boards of director of Indian
firms listed on the Bombay Stock Exchange. The revelation, which comes amid
The study-a first of its kind in India and second in Asia- note that only 59 (5.3%)
of the 1,112 directors of companies that form the elite BSE-100 group are
women. These directorships are held by 48 different women, the study said.
The percentage compares unfavorably with Canada, where women hold 15% of
directorships, the United States (14.5%), the United Kingdom(12.2%),
Hongkong(8.9%) and Australia(8.3%).
The findings also reveal that 12 companies on the BSE-100 have more than one
female director, 7 companies have female executive directors and 2.5% of all
executive director roles are held by women. Less than half of the companies-only
46%- have women on their boards.
Of all the appointments made in 2010 (as of May 2010), 4.9% were women. Two
companies –Jindal Steel& Power ltd. Have women as chairpersons and two of the
countries most significant banks-ICICI Bank and Axis Bank- have female CEOs.
The report includes a ‘Women on Boards League Table” which ranks companies
listed on the BSE-100 in terms of the gender diversity of their boards, with those
with the highest percentage o women on their boards appearing at the top. At
the top of the list is JSW Steel Limited, which has three women (23.1%) on its
board of 13. Oracle Financial Services Software is second with two
women(22.2%) on its board of nine and Piramal Healthcare is third with 20%
female board directors.
“ We hope that this research will act as a catalyst for discussion in and amongst
corporate India on the need for greater gender diversity at senior levels,” said
Shalini Mahtani, co-author of the report and Founder of Community Business.
“Our aspiration is that in time we will have a true meritocracy in corporate India,
allowing each person, regardless of gender or background, to achieve their full
potential.”
Jemila Samerin
Prime minister Manmohan singh has described the historic women’s reservation
bill as a “giant step” towards the empowerment of women and a “celebration of
womanhood.” The passing of the bill in the Rajya Sabha is a momentous, heart
warming step for India; also an inspirational trendsetter for women’s
empowerment in the entire region.
The movement for women’s right has broken many a fetter, but it has also
forged new ones. Women today are the striking power, a great contributor to
many working sectors, ready to accept challenges. But do we ever recognize
what boundaries they are being forced to cross?
The sexual laws and moral standards have always been stricter for women. The
female body was regarded down the ages as a mere vessel for the male creative
fluids. Women were the soil in which men planted their seeds. This perception
was also reflected in religious beliefs. Women were stripped of their creative role
and burdened with the responsibility for the Original Sin. The Ten
Commandments list wives among a man’s possessions. Not surprisingly,
therefore, in a traditional Jewish prayer men implored God, “Let not my offspring
be a girl, for very wretched is the life of woman.” And they gladly repeated every
day: “Blessed be Thou, O Lord our God, for not making me a woman.”
The sacred texts of every major religion enshrines the subjugation of women
through myth (Eve causing “the fall of man”) or through code (the Shariah that
values a woman’s testimony as half that of a man and authorizes a man to beat
and whip his wife to keep her obedient to him).
Apostle Paul made it clear that the head of the woman is the man, For the man is
not of the woman; but the woman of the man. And if they will learn anything, let
them ask their husbands at home: or it is a shame for women to speak in the
church.
Christianity excluded women from priesthood and other church offices. At the
same time, they were also expected to remain subservient to men at home. In all
societies, the obvious biological difference between men and women is used as a
justification for forcing them into different social roles which limit and shape their
attitudes and behavior. A woman, in addition to being a female, must be
feminine. Sexual oppression, no matter how harsh or unjustified, has never
lacked rationalization. These may range from simple religious dogmas to
sophisticated pseudo-scientific theories. For over a hundred years, the old form
of marriage, based on the Bible, “till death do us part,” has been denounced as
an institution that stands for the sovereignty of the man over the woman, of her
complete submission to his whims and commands, and absolute dependence on
his name and support. In addition, women are generally exploited by the media.
They become like goods which are sold and bought. For instance, in
advertisements we usually see women presenting products; but unfortunately,
their bodies are used to attract consumers.
Break barriers.
The problem that confronts us today is how to be one’s self and yet be in
oneness with others, to feel deeply with all human beings and still retain one’s
own characteristic qualities. The modern woman would be enabled to blossom in
true sense- with full respect for her personality; all artificial barriers should be
broken, and the road towards grater freedom cleared of every trace of centuries
of submission and slavery
Ethics the Framework for success: while some ethical decisions are
simply a matter of right vs. wrong, the tough ethical decisions are right
vs. right.
Instead, companies must ask the following question: "Have we replaced our
underlying business theme of 'succeeding at all costs' with 'succeeding only the
right way'?" An ethical culture can ensure success by establishing appropriate
expectations using proper guidelines, thus preventing the need or desire to be
involved in any questionable business practices. Ultimately, success is about
keeping your word, and companies that live up to their promises are successful.
While it's true that some businesses hold themselves to a higher ethical
standard, not all companies operate in an ethical environment. Financial
decisions often are made without considering the ethical implications.When
companies don't hold themselves to high ethical standards, the impact
reverberates throughout the financial markets. Companies are destroyed, jobs
are lost, and retirement savings are decimated. One of the government's
reactions to corporate wrongdoing was enactment of the Sarbanes-Oxley Act of
2002 (SOX). But as Gary Smith, CEO of CIENA, characterized it in the October 20,
2003, edition of USA Today, SOX was "'chemotherapy' to prevent the cancer
from recurring after cutting out corporate tumors at Enron,WorldCom, and
elsewhere."
Ensuring that an effective ethical culture exists in an organization isn't only a key
factor in preventing the kinds of losses brought about by corporate frauds and
avoiding the need for costly, burdensome legislation, but it can also enhance a
company's reputation, improve morale, and even increase sales. This article
examines top management's role in building an ethically minded culture, steps
for making sound choices, and examples of ethical issues.
One company that provides a prime example of making good ethical decisions is
Johnson & Johnson. In 1982, James Burke, then CEO, faced an ethical dilemma.
The company experienced a major crisis when some of its Extra-Strength Tylenol
capsules were found laced with cyanide. Faced with a difficult decision, Burke
turned to Johnson & Johnson's credo: "We believe our first responsibility is to
doctors, nurses, and patients, to mothers and fathers and all others who use our
products and services." He ignored the immediate short-term financial
implication and adhered to the attitude of "doing the right thing," ordering the
recall of more than 31 million bottles at a cost of more than $100 million. This
action set a new standard for crisis management. As a result of these events, the
company developed the tamper-proof seal and gained even more market share
and customer loyalty than it had before the incident.
To make choices like Burke requires individuals to take the steps listed in "A
Framework for Thinking Ethically" from the Markkula Center for Applied Ethics at
Santa Clara University (www.scu.edu/ethics):
[ILLUSTRATION OMITTED]
While companies will inevitably face difficult situations, their ability to make
ethical decisions must not be compromised for any reason. Consider Exxon, for
example. This company refused to accept responsibility for the Valdez accident,
and their attempt to blame state and federal officials for delays in containing the
spill damaged their reputation. Even today the name Exxon is synonymous with
environmental catastrophe. Due to ineffective communication from Exxon, the
public questioned their credibility and truthfulness. According to Jennifer Hogue
in "What is Crisis Management?" (http://iml.jou.ufl.edu/
projects/Spring01/Hogue/crisismanagement.html), a survey conducted by Porter
Novelli several years after the accident found that 54% of respondents were still
less likely to buy Exxon products.
Employees would benefit individually from this mindset during their careers by
adhering to high ethical standards. Companies must build a strong ethical
framework to withstand attacks from the public through frivolous lawsuits,
competition's claims of wrongdoing, and any fraud attempted by their
employees. Positive public perception is vital to success in the marketplace,
which is protected by ethical behavior just as Daniel protected himself from his
enemies by remaining faithful to his high moral standards.
* It is right to find out all you can about your competitor's costs and price
structures--and right to obtain information only through proper channels;
* It is right to throw the book at good employees who make dumb decisions that
endanger the firm--and right to have enough compassion to mitigate the
punishment and give them another chance.
* It is right to protect the endangered spotted owl in the old-growth forests of the
American Northwest--and right to provide jobs to loggers.
DIFFICULT CHOICES
Every day, management decisions affect individuals, families, and even nations.
Before making a final decision, the goal should be to completely consider the
ethical implications, including the immediate financial impact as well as the
lasting consequences. If the organization's climate is to not permit wrongdoing of
any kind, then employees are more likely to work harder for the company's
common good. Ethical decision making safeguards an enterprise's future.
Ethics is a topic at IMA's Annual Conference, June 14-18, 2008, in Tampa, Fla. For
information, visit www.imaconference.org.
****************************************
Thinking Ethically:
A Framework for Moral Decision Making
Moral issues greet us each morning in the newspaper, confront us in the memos
on our desks, nag us from our children's soccer fields, and bid us good night on
the evening news. We are bombarded daily with questions about the justice of
our foreign policy, the morality of medical technologies that can prolong our
lives, the rights of the homeless, the fairness of our children's teachers to the
diverse students in their classrooms.
Dealing with these moral issues is often perplexing. How, exactly, should we
think through an ethical issue? What questions should we ask? What factors
should we consider?
The first step in analyzing moral issues is obvious but not always easy: Get the
facts. Some moral issues create controversies simply because we do not bother
to check the facts. This first step, although obvious, is also among the most
important and the most frequently overlooked.
But having the facts is not enough. Facts by themselves only tell us what is; they
do not tell us what ought to be. In addition to getting the facts, resolving an
ethical issue also requires an appeal to values. Philosophers have developed five
different approaches to values to deal with moral issues.
To analyze an issue using the utilitarian approach, we first identify the various
courses of action available to us. Second, we ask who will be affected by each
action and what benefits or harms will be derived from each. And third, we
choose the action that will produce the greatest benefits and the least harm. The
ethical action is the one that provides the greatest good for the greatest number.
Of course, many different, but related, rights exist besides this basic one. These
other rights (an incomplete list below) can be thought of as different aspects of
the basic right to be treated as we choose.
• The right to the truth: We have a right to be told the truth and to be
informed about matters that significantly affect our choices.
• The right of privacy: We have the right to do, believe, and say whatever
we choose in our personal lives so long as we do not violate the rights of
others.
• The right not to be injured: We have the right not to be harmed or injured
unless we freely and knowingly do something to deserve punishment or
we freely and knowingly choose to risk such injuries.
• The right to what is agreed: We have a right to what has been promised by
those with whom we have freely entered into a contract or agreement.
Favoritism gives benefits to some people without a justifiable reason for singling
them out; discrimination imposes burdens on people who are no different from
those on whom burdens are not imposed. Both favoritism and discrimination are
unjust and wrong.
The common good is a notion that originated more than 2,000 years ago in the
writings of Plato, Aristotle, and Cicero. More recently, contemporary ethicist John
Rawls defined the common good as "certain general conditions that are...equally
to everyone's advantage."
In this approach, we focus on ensuring that the social policies, social systems,
institutions, and environments on which we depend are beneficial to all.
Examples of goods common to all include affordable health care, effective public
safety, peace among nations, a just legal system, and an unpolluted
environment.
Appeals to the common good urge us to view ourselves as members of the same
community, reflecting on broad questions concerning the kind of society we want
to become and how we are to achieve that society. While respecting and valuing
the freedom of individuals to pursue their own goals, the common-good
approach challenges us also to recognize and further those goals we share in
common.
Virtues are attitudes or character traits that enable us to be and to act in ways
that develop our highest potential. They enable us to pursue the ideals we have
adopted. Honesty, courage, compassion, generosity, fidelity, integrity, fairness,
self-control, and prudence are all examples of virtues.
Virtues are like habits; that is, once acquired, they become characteristic of a
person. Moreover, a person who has developed virtues will be naturally disposed
to act in ways consistent with moral principles. The virtuous person is the ethical
person.
In dealing with an ethical problem using the virtue approach, we might ask, What
kind of person should I be? What will promote the development of character
within myself and my community?
• What benefits and what harms will each course of action produce, and
which alternative will lead to the best overall consequences?
• What moral rights do the affected parties have, and which course of action
best respects those rights?
• Which course of action treats everyone the same, except where there is a
morally justifiable reason not to, and does not show favoritism or
discrimination?
This article updates several previous pieces from Issues in Ethics by Manuel
Velasquez - Dirksen Professor of Business Ethics at Santa Clara University and
former Center director - and Claire Andre, associate Center director. "Thinking
Ethically" is based on a framework developed by the authors in collaboration
with Center Director Thomas Shanks, S.J., Presidential Professor of Ethics and the
Common Good Michael J. Meyer, and others. The framework is used as the basis
for many programs and presentations at the Markkula Center for Applied Ethics.
*********************
ABSTRACT
This study aims at testing the influence of ethical pressure, professional
expectation in stress and job quality via moderators of time pressure and self
esteem. Accountants in Thailand are the sample. The results show that ethical
pressure and professional expectation have positive and significant association
with stress. In addition, stress is positively and significantly related to job quality.
these findings provide some initial empirical support for suggests need for
additional investigation of factors that influence an accountant's stress and for
further investigation into the effect of ethical pressure, professional expectation
on job quality. Therefore, contributions and suggestion are also provided for
further research.
1. INTRODUCTION
The rapid acceleration of the global economic system, world trade and free
markets continue to expand organizations seek new business opportunities to
enhance their competitiveness. Organizations focus to improve services,
enhance product quality and improve production efficiency. The significant
influence of business activities on accountant professionalism is interesting. It is
commonly accepted that accounting information is used to manage business.
Accountants cannot escape involvement in this undertaking. Accounting
professionals are generally perceived by the public. The characteristics of a
professional, which include the presence of a systematic body of the skills
required for practice, the sanction of the community in the form of formal
credentials and licensing, recognition by the general public of profession
authority over the knowledge and skills in the field, a regulative code of ethics
and a professional culture with a language, symbols and norm of its own.
In this study and attend to test the effect of ethical pressure, and professional
expectation are independent variables, job quality is dependent variable, stress
is mediating variable, time pressure, and self esteem are moderator variable, as
shown in Figure 1.
[FIGURE 1 OMITTED]
Shafer (2002) and Aranya and Ferris (1984) found that accountants employed in
industry did in fact experience higher levels of organizational-professional
conflict than those employed in public accounting. Perceived ethical conflicts can
lead to dysfunctional organizational outcomes such as lower organizational
outcomes such as lower organizational commitment and higher turnover
intentions (Shafer, 2002; Schwepker, 1999). Thus ethical pressure is an
important factor to impact an accountant's stress. This implies that if there is
high ethical pressure it may also have great stress. This leads to the following
hypotheses:
H1a: The accountants with higher ethical pressure will have greater stress.
Brierley (1999) and Lachman & Aranya (1986b) described that the realization of
professional expectations has been measured in research of accountants by
assessing the discrepancy between responses to questions about "how much
should there be" and "how much is there now", on aspects of professional
values, such as the autonomy to act according to professional judgment and
responsibility to clients. Thus in this study, Professional expectation refers to the
perceptions of public about professionalism, independence, self improvement,
commitment to learning, responsibility, skill with accountant's practice.
H1b: The accountants with higher professional expectation will have greater
stress.
2.3 Stress
Tulen and Neidermeyer (2004) and Sullivan and Baghat (1992) reviewed four
possible scenarios regarding stress and performance: stress may increase
performance, stress may decrease performance, stress may have no effect on
performance, and the relationship between stress and performance may
represent an inverted-U. Their findings supported a negative relationship
between stress and performance. Tulen and Neidermeyer (2004) and Rabinowitz
and Stumpf (1987) described that there is a positive relationship between stress
and job performance. Thus, stress may be closely related to job quality. This
leads to the following hypotheses:
H2a: Accountants with the greater stress will have greater job quality.
Time budget pressure refers to the pervasive constraint on resources that can be
allocated to accomplish a job (DeZoort and Lord, 1997). It is the perception of
unreasonable deadlines and time demands.
H1c: The accountants with the higher time pressure will potentially have greater
positive relationship between ethical pressure and stress.
H1d: The accountants with the higher time pressure will potentially have greater
positive relationship between professional expectation and stress.
2.5 Self-esteem
Self-esteem refers to as the extent that employees feel valued and taken
seriously (LeRouge, et al., 2006). It significantly moderates the relationship
between role stress fit and job satisfaction. In order to examine the effects of
self-esteem on job quality, self-esteem thus may be related to job quality.
H2b: Accountants with the higher self esteem will potentially have greater
positive relationship between stress and job quality.
3. RESEARCH METHODS
Later, 600 questionnaires were sent to accounting manager firms to provide data
for this study via mail. After two weeks 152 questionnaires were received. There
were 33 questionnaires that could not be sent to receivers and these were
returned. However, 2 received questionnaires were incomplete, and were not
included in the data analysis. This resulted in 100 usable responses or a
response rate of 26%.
3.4 Measure
All variables in Table1 use the 5-point Likert scale and show numbers of items in
order to tap each variable. Five-point Likert scale ranging from strongly disagree
(score one) to strongly agree (scored five) were used to measure all variable.
Next, respondents were asked to indicate ethical pressure, professional
expectation, stress, time pressure, self esteem, and job quality.
Table 3 shows the results of regression analysis to inference H1a, H1b, H1c, H1d
that is measured via user information satisfaction and monitoring items,
moderated by time pressure. The results indicate that in Model 3 of regression
equation consisting of ethical pressure, and professional expectation as
independent variables, and stress as dependent variable, there is a significant
and positive association between ethical pressure and stress (b =. 048; p>.05);
therefore, H1a is supported. Likewise, the relationship between professional
expectation and stress is significant and positive (b = .381; p<.01), which is
consistent with H1b.
The results of Model 1 presents according to Model 2 that the linkage between
ethical pressure and stress, and the linkage among ethical pressure, professional
expectation and stress are positive and significant. Indeed, Model 3 is added
moderator variable. Finding shows not significant relationship between
interaction of ethical pressure and time pressure with stress (b =. 052; p>.95).
Other interactions are not significant. Therefore, H1c and H1d are not supported.
This study helps accountants identify and explain key components that may
influence to accountants' stress. Accountants should be continuously training in
order to continuously maintain knowledge and increase skills and ethics that
reduce accountants' stress. Accountants should provide other factors to support
job quality including the good staff, the greater time-management, the
appropriate accounting work scope, the character and number of work when suit
to accountant's capability. An important point is accountant's professional ethic
behavior that he or she should care for acting to professions and users.
Consequently, reducing accountant's stress and job quality are needed for
businesses and managers.
6. CONCLUSION
Our expectations regarding perceptions of accountant's stress were confirmed.
Both ethical pressure and professional expectation have a direct positively
influence on stress and stress has a direct positively influence on job quality. In
hypotheses testing professional expectation is more a superior variable than
ethical pressure in all relational. But interactions of moderator have not
association. Our results suggest that it would be prudent for firm managers to
focus their stress-reduction strategy upon accountant.
Who were the "bad" guys? According to group consensus, corporations that
manufacture weapons (which helped the United States defeat Iraq in the Gulf
War), refine oil (for planes and cars) or, the worst of all offenses, test their
ingredients according to accepted international standards to ensure the safety of
consumers.
The good guys? Many of the companies cited by my lunch companions pay their
workers near-minimum wage, are strongly anti-union, have an unhappy
workforce, and/or make luxury products at pricey premiums. No matter that in
marketing their products these ethical business superstars frequently confuse
their intentions and reputations with their not-so-lustrous corporate actions.
While reflecting on my inability to make any headway with this table of social
visionaries, my thoughts turned to Mark Twain, always a good source for irony in
the midst of hubris. "The secret of success is honesty and fair dealing," he once
said. "If you can fake these, you've got it made."
The sobering reality is that the socially responsible business movement may
promote corporate behavior that is neither progressive nor particularly ethical.
Business ethics is based on broad principles of integrity and fairness and focuses
on internal stakeholder issues such as product quality, customer satisfaction,
employee wages and benefits, and local community and environmental
responsibilities?issues that a company can actually influence.
The corporate responsibility movement, on the other hand, has come to elevate
a social and political agenda that draws on notions of liberal propriety and
correctness that date to the 1960s. Truisms of social responsibility include the
embrace of environmentalism, antiwar pacificism, human rights, animal rights,
sexual rights, women's rights, and other -isms that few disagree about in
principle. For instance, military production and animal testing are negative
screens while the use of "natural" products or campaigning for Third World rights
demonstrates a higher ethical standard. Academics, the media, and social
investment firms have uncritically promoted these fashionable standards.
The most highly touted solution to U.S. manufacturers' sourcing of goods from
low-wage countries?corporate codes of conduct on sourcing?frequently ends up
doing far more harm than good. As well-meaning as these codes and mission
statements purport to be, promises that companies cannot hope to implement?
or that cause more harm than good if they are implemented?divert attention
from the need for structural changes in the relationship between consuming
nations and raw material suppliers. The real benefits of many well-publicized
codes have gone to the companies who are embarrassed into drafting them, not
the people they were designed to help.
Starbucks
Take Starbucks, the boutique Seattle-based coffee retailer, as an example. To
earn enough to afford a pound of Starbucks' coffee, a Guatemalan worker would
have to pick 500 pounds of beans, about five days of work. As you choke on your
scone, note that this story has a twist: in a glittering ceremony in New York
recently, Starbucks was awarded the International Human Rights Award by the
Council on Economic Priorities (CEP) at its annual "Corporate Conscience" awards
ceremony.
How does a company under attack for exploiting cheap, foreign labor by activist,
environmental, and church groups become the belle of the socially responsible
ball? During 1994, Starbucks suffered embarrassing grassroots protests because
it sourced beans from export houses that paid Guatemalan workers below a
living daily wage, about $2.50 a day. The company is no worse than the average
wholesaler, but it has a better-than-average reputation as a new-breed, values-
driven corporation. So when protesters leafleted Starbucks stores and targeted
its annual meeting, a peace plan was offered. Last year, Starbucks became the
first company in the agricultural commodities sector to announce a "framework"
for a code of conduct.
But according to Alice Tepper Marlin, CEP's executive director, the mission
statement alone was enough to earn Starbucks its honor. How has Starbucks
enforced its code? "We've done nothing yet," acknowledges Olsen. "It's a slow,
incremental process." Very incremental. Starbucks' promised review of
plantation conditions is being carried out by the Guatemalan coffee growers
association, the very organization accused of perpetuating the low wages. First
condemned for labor practices it could not hope to change, Starbucks is now
praised for actions it has not yet taken.
What can Starbucks accomplish with its code, putting aside its obvious goal of
quieting protests? "Codes are a start," says Eric Hahn of the US/Guatemala Labor
Education Project. "But only if it's part of a bigger strategy of industry
monitoring, which is one of the few tools available in an international,
deregulated economy. Otherwise it's just a balm to consumers."
This is not to suggest that codes are entirely meaningless. As Kathie Lee Gifford
has learned, promises focus attention. But solutions rest with accountability, and
there doesn't appear to be any here. Starbucks has no practical ability to
oversee conditions and says it cannot risk punishing violators.
Even the bugaboo of child labor is more complicated than it seems. Honduran
adolescents are legally allowed to work at 14 with parental permission, and most
are desperate to help their families. The frenzy sparked by the Gifford spectacle
has led to the dismissal of hundreds of legally hired adolescents. Rather than
returning to school, which is not an option for most families who cannot afford to
feed and clothe their children, adolescents buy documents to work at even lower
pay or in some cases peddle their bodies. When confronted with the
consequences of their highpowered campaign, the New York labor group offered
little solace: "Obviously, this is not what we wanted to happen."
Although many clothing companies, such as Nike, KMart, JC Penney, and Reebok,
have rushed to pass sourcing codes, few make the effort to examine the
complexity of these issues. Of the high-profile retailers, Levi Strauss and The Gap
have distinguished themselves by devoting considerable resources to identifying
the first link in the supply chain (the shops that supply their suppliers) and
bringing direct pressure to establish minimum wage standards and working
conditions.
Celebrating "good intentions" when complex social problems are at issue and not
understood goes to the heart of the corporate ethics conundrum. Rewarding
noble posturing also obscures meaningful progress by "messier" companies.
While many highly praised "New Age" firms have been found lacking in critical
areas of accountability and honesty of marketing, some of yesterday's most
vilified companies have quietly moved to the forefront of corporate
responsibility. Despite their regular appearances on "dishonorable" lists,
controversial multinationals such as Monsanto, DuPont, or Gillette offer fair
wages and benefits, have launched impressive affirmative action practices, are
addressing complicated environmental issues, actively engage their community
responsibilities, give many millions of dollars to charity, and sell quality,
competitively priced products and services.
When comparing these environmental and social reforms with the cosmetic code
at Starbucks or other boutique retailers, one has to wonder how they rack up so
many "good business" honors. A more basic question is why do so many "socially
responsible" awards go to companies that sell commodity goods to affluent
consumers at eyepopping prices?Starbucks, for example, where mark-ups
exceed 1,000 percent?
When asked why Starbucks was honored, CEP's Marlin says, "We want to reward
positive role models." Dare one suggest that CEP should have waited until
Starbucks did more than pass a "framework for a code of conduct," as admirably
symbolic as it may be? According to Starbucks, its code has had no effect on the
way it does business in Guatemala or dozens of other countries.
Awarding "A"s for visionary rhetoric shifts focus away from corporate governance
and behavior to the nevernever-land of good intentions. It's a dangerous trend
that companies promote Thoreau-like mission statements without organizational
commitments to implement those ideals. Character demonstrated by actions, not
by intentions, is the only reliable measure of corporate ethics.
Our first articles describe the steps taken by the chemical industry and one of its
member firms, Velsicol Chemical Corporation, to become accountable to local
communities and to the environment. Then David Mager draws from 20 years of
experience to tell how socially and environmentally responsible behavior benefits
the bottom line.
Richard Adams' description of the new retail chain he has founded, Out of this
World, illustrates how it is possible to incorporate the means for corporate
accountability to multiple stakeholders into the design and operation of a
company.
We conclude with two articles that examine the principal avenues owners can
take to influence corporate behavior in a positive direction: ethical investing and
pension fund activism.
The corporate world cannot be divided easily into "good guys" and "evil
companies." Companies are dysfunctional families writ large. Mistakes,
sometimes whoppers, are built into life, including the life of corporations. Self-
scrutiny and accountability are essential. The measure of a company's integrity
is not how loudlyit beats its own breast, or whether it blunders, but its respect for
its stakeholders and its responsiveness to problems.
1
"In Honduras, 'Sweatshops' Can Look Like Progress." New York Times, July 18,
1996, p. A1.
Step three: Identify and rank the key values and principles
Step ten: Submit cases to your ethical review team or board regularly for review
• Circumstances impact upon the problem definition (for whom does the
problem exist? What is the setting?)
Corporate governance is a broad term that has to do with the manner in which
the rights and responsibilities are shared among owners, managers and
shareholders of a given company.
In essence, the exact structure of the corporate governance will determine what
rights, responsibilities, and privileges are extended to each of the corporate
participants, and to what degree each participant may enjoy those rights.
Generally, the foundation for any system of corporate governance will be
determined by several factors, all of which help to form the final form of
governing the company.
Within any corporation, the structure of corporate governance begins with laws
that impact the operation of any company within the area of jurisdiction.
Companies cannot legally operate without a corporate structure that meets the
minimum requirements set by the appropriate government jurisdiction. All
founding documents of the company must comply with these laws in order to be
granted the privilege of incorporation. In many jurisdictions, these documents
are required by law to contain at least the seeds of how the company will be
structured to allow the creation of a balance of power within the corporation.
Much of the basis for corporate governance is found in the documents that must
be prepared and approved before incorporation can take place. These
documents help to form the basis for the final expression of the balance of power
between shareholders, stakeholders, management, and the board of directors.
The bylaws, articles of incorporation, and the company charter will all include
details that determine who has what authority in the decision making process of
the company.
Along with the laws of the land and the founding documents, corporate
governance is further refined by the drafting of formal policies that not only
recognize the assignment of powers in accordance to the bylaws and corporate
charter, but also help to further define how those powers may be employed. This
helps to allow the company some degree of flexibility in maintaining a balance of
power as the company grows, without undermining the rights and privileges
inherent in each type of corporate participation.
Introduction
Corporations have become a powerful and dominant institution. They have reached to every
corner of the globe in various sizes, capabilities and influences. Their governance has
influenced economies and various aspects of social landscape. Shareholders are seen to be
losing trust and market value has been tremendously affected. Moreover with the emergence
of globalization, there is greater deterritorialization and less of governmental control, which
results is a greater need for accountability (Crane and Matten, 2007). Hence, corporate
governance has become an important factor in managing organizations in the current global
and complex environment. In order to understand corporate governance, it is important to
highlight its definition. Even though, there is no single accepted definition of corporate
governance but it can be defined as a set of processes and structures for controlling and
directing an organization. It constitutes a set of rules, which governs the relationships
between management, shareholders and stakeholders (Ching et al, 2006). The term “corporate
governance” has a clear origin from a Greek word, “kyberman” meaning to steer, guide or
govern.
From a Greek word, it moved over to Latin, where it was known as “gubernare” and the
French version of “governer” . It could also mean the process of decision-making and the
process by which decisions may be implemented. Henceforth, corporate governance has
much a different meaning to different organizations (Abu-Tapanjeh, 2008). In recent years,
with much corporate failures, the countenance of corporate has been scared.
Corporate governance includes all types of firms and its definitions could extend to cover all
of
the economic and non-economic activities. Literatures in corporate governance provide some
form of
meaning on governance, but fall short in its precise meaning of governance. Such ambiguity
emerges
in words like control, regulate, manage, govern and governance. Owing to such ambiguity,
there are
many interpretations. It may be important to consider the influences a firm has or affected by
in order
to grasp a better understanding of governance. Owing to vast influential factors, proposed
models of
corporate governance can be flawed as each social scientist is forming their own scope and
concerns.
Hence, this article reviews various fundamental theories underlining corporate governance.
These
theories range from the agency theory and expanded into stewardship theory, stakeholder
theory,
resource dependency theory, transaction cost theory, political theory and ethics related
theories such as
business ethics theory, virtue ethics theory, feminists ethics theory, discourse theory and
postmodernism ethics theory.
Fundamental Corporate Governance Theories
Agency Theory
Agency theory having its roots in economic theory was exposited by Alchian and Demsetz
(1972) and further developed by Jensen and Meckling (1976). Agency theory is defined as
“the relationship between the principals, such as shareholders and agents such as the
company executives and managers”.
In this theory, shareholders who are the owners or principals of the company, hires the agents
to perform work. Principals delegate the running of business to the directors or managers,
who are the shareholder’s agents (Clarke, 2004). Indeed, Daily et al (2003) argued that two
factors can influence the prominence of agency theory. First, the theory is conceptually and
simple theory that reduces the corporation to two participants of managers and shareholders.
Second, agency theory suggests that employees or managers in organizations can be self-
interested.
The agency theory shareholders expect the agents to act and make decisions in the principal’s
interest. On the contrary, the agent may not necessarily make decisions in the best interests of
the principals (Padilla, 2000). Such a problem was first highlighted by Adam Smith in the
18th century and subsequently explored by Ross (1973) and the first detailed description of
agency theory was presented by Jensen and Meckling (1976). Indeed, the notion of problems
arising from the separation of ownership and control in agency theory has been confirmed by
Davis, Schoorman and Donaldson (1997).
In agency theory, the agent may be succumbed to self-interest, opportunistic behavior and
falling short of congruence between the aspirations of the principal and the agent’s pursuits.
Even the understanding of risk defers in its approach. Although with such setbacks, agency
theory was introduced basically as a separation of ownership and control (Bhimani, 2008).
Holmstrom and Milgrom (1994) argued that instead of providing fluctuating incentive
payments, the agents will only focus on projects that have a high return and have a fixed
wage without any incentive component. Although this will provide a fair assessment, but it
does not eradicate or even minimize corporate misconduct. Here, the positivist approach is
used where the agents are controlled by principal-made rules, with the aim of maximizing
shareholders value. Hence, a more individualistic view is applied in this theory (Clarke,
2004). Indeed, agency theory can be employed to explore the relationship between
the ownership and management structure. However, where there is a separation, the agency
model can be applied to align the goals of the management with that of the owners. Due to
the fact that in a family firm, the management comprises of family members, hence the
agency cost would be minimal as any firm’s performance does not really affect the firm
performance (Eisenhardt, 1989). The model of an employee portrayed in the agency theory is
more of a self-interested, individualistic and are bounded
rationality where rewards and punishments seem to take priority (Jensen & Meckling, 1976).
This
theory prescribes that people or employees are held accountable in their tasks and
responsibilities.
Employees must constitute a good governance structure rather than just providing the need of
shareholders, which maybe challenging the governance structure.
Figure 1: The Agency Model
Self
interest
Self
interest
Performs
Hires & delegate
Principals Agents
2.2. Stewardship Theory
Stewardship theory has its roots from psychology and sociology and is defined by Davis,
Schoorman & Donaldson (1997) as “a steward protects and maximises shareholders wealth
through firm performance, because by so doing, the steward’s utility functions are
maximised”. In this perspective, stewards are company executives and managers working for
the shareholders, protects and make profits for the shareholders. Unlike agency theory,
stewardship theory stresses not on the perspective of individualism (Donaldson & Davis,
1991), but rather on the role of top management being as stewards,
integrating their goals as part of the organization. The stewardship perspective suggests that
stewards
are satisfied and motivated when organizational success is attained.
Agyris (1973) argues agency theory looks at an employee or people as an economic being,
which suppresses an individual’s own aspirations. However, stewardship theory recognizes
the
importance of structures that empower the steward and offers maximum autonomy built on
trust
(Donaldson and Davis, 1991). It stresses on the position of employees or executives to act
more
autonomously so that the shareholders’ returns are maximized. Indeed, this can minimize the
costs
aimed at monitoring and controlling behaviours (Davis, Schoorman & Donaldson, 1997).
On the other end, Daly et al. (2003) argued that in order to protect their reputations as
decision
makers in organizations, executives and directors are inclined to operate the firm to maximize
financial
performance as well as shareholders’ profits. In this sense, it is believed that the firm’s
performance
can directly impact perceptions of their individual performance. Indeed, Fama (1980) contend
that
executives and directors are also managing their careers in order to be seen as effective
stewards of
their organization, whilst, Shleifer and Vishny (1997) insists that managers return finance to
investors
to establish a good reputation so that that can re-enter the market for future finance.
Stewardship model
can have linking or resemblance in countries like Japan, where the Japanese worker assumes
the role of
stewards and takes ownership of their jobs and work at them diligently.
Moreover, stewardship theory suggests unifying the role of the CEO and the chairman so as
to
reduce agency costs and to have greater role as stewards in the organization. It was evident
that there
would be better safeguarding of the interest of the shareholders. It was empirically found that
the
returns have improved by having both these theories combined rather than separated
(Donaldson and
Davis, 1991).
Middle Eastern Finance and Economics - Issue 4 (2009) 91
Figure 2: The Stewardship Model
Intrinsic and
extrinsic
motivation
Shareholders’
profits and
returns
Protects and maximise
shareholders wealth
Empower and
trust
Shareholders Stewards
2.3. Stakeholder Theory
Stakeholder theory was embedded in the management discipline in 1970 and gradually
developed by Freeman (1984) incorporating corporate accountability to a broad range of
stakeholders. Wheeler et al,
(2002) argued that stakeholder theory derived from a combination of the sociological and
organizational disciplines. Indeed, stakeholder theory is less of a formal unified theory and
more of a
broad research tradition, incorporating philosophy, ethics, political theory, economics, law
and
organizational science.
Stakeholder theory can be defined as “any group or individual who can affect or is affected
by
the achievement of the organization’s objectives”. Unlike agency theory in which the
managers are
working and serving for the stakeholders, stakeholder theorists suggest that managers in
organizations
have a network of relationships to serve – this include the suppliers, employees and business
partners.
And it was argued that this group of network is important other than owner-manager-
employee
relationship as in agency theory (Freeman, 1999). On the other end, Sundaram & Inkpen
(2004)
contend that stakeholder theory attempts to address the group of stakeholder deserving and
requiring
management’s attention. Whilst, Donaldson & Preston (1995) claimed that all groups
participate in a
business to obtain benefits. Nevertheless, Clarkson (1995) suggested that the firm is a system,
where
there are stakeholders and the purpose of the organization is to create wealth for its
stakeholders.
Freeman (1984) contends that the network of relationships with many groups can affect
decision making processes as stakeholder theory is concerned with the nature of these
relationships in
terms of both processes and outcomes for the firm and its stakeholders. Donaldson & Preston
(1995)
argued that this theory focuses on managerial decision making and interests of all
stakeholders have
intrinsic value, and no sets of interests is assumed to dominate the others.
92 Middle Eastern Finance and Economics - Issue 4 (2009)
Figure 3: The Stakeholder Model (Donaldson and Preston, 1995)
Government
Investors
Political
Groups
Supplier
Trade
Associations
Customers
Communities
Employees
FIRM
2.4. Resource Dependency Theory
Whilst, the stakeholder theory focuses on relationships with many groups for individual
benefits,
resource dependency theory concentrates on the role of board directors in providing access to
resources
needed by the firm. Hillman, Canella and Paetzold (2000) contend that resource dependency
theory
focuses on the role that directors play in providing or securing essential resources to an
organization
through their linkages to the external environment. Indeed, Johnson et al, (1996) concurs that
resource
dependency theorists provide focus on the appointment of representatives of independent
organizations
as a means for gaining access in resources critical to firm success. For example, outside
directors who
are partners to a law firm provide legal advice, either in board meetings or in private
communication
with the firm executives that may otherwise be more costly for the firm to secure.
It has been argued that the provision of resources enhances organizational functioning, firm’s
performance and its survival (Daily et al, 2003). According to Hillman, Canella and Paetzold
(2000)
that directors bring resources to the firm, such as information, skills, access to key
constituents such as
suppliers, buyers, public policy makers, social groups as well as legitimacy. Directors can be
classified
into four categories of insiders, business experts, support specialists and community
influentials. First,
the insiders are current and former executives of the firm and they provide expertise in
specific areas
such as finance and law on the firm itself as well as general strategy and direction. Second,
the
business experts are current, former senior executives and directors of other large for-profit
firms and
they provide expertise on business strategy, decision making and problem solving. Third, the
support
specialists are the lawyers, bankers, insurance company representatives and public relations
experts
and these specialists provide support in their individual specialized field. Finally, the
community
influentials are the political leaders, university faculty, members of clergy, leaders of social
or
community organizations.
2.5. Transaction Cost Theory
Transaction cost theory was first initiated by Cyert and March (1963) and later theoretical
described
and exposed by Williamson (1996). Transaction cost theory was an interdisciplinary alliance
of law,
economics and organizations. This theory attempts to view the firm as an organization
comprising
people with different views and objectives. The underlying assumption of transaction theory
is that
firms have become so large they in effect substitute for the market in determining the
allocation of
resources. In other words, the organization and structure of a firm can determine price and
production.
The unit of analysis in transaction cost theory is the transaction. Therefore, the combination
of people
with transaction suggests that transaction cost theory managers are opportunists and arrange
firms’
transactions to their interests (Williamson, 1996).
Middle Eastern Finance and Economics - Issue 4 (2009) 93
2.6. Political Theory
Political theory brings the approach of developing voting support from shareholders, rather
by
purchasing voting power. Hence having a political influence in corporate governance may
direct
corporate governance within the organization. Public interest is much reserved as the
government
participates in corporate decision making, taking into consideration cultural challenges
(Pound,
1993). The political model highlights the allocation of corporate power, profits and privileges
are
determined via the governments’ favor. The political model of corporate governance can
have an
immense influence on governance developments. Over the last decades, the government of a
country
has been seen to have a strong political influence on firms. As a result, there is an entrance of
politics
into the governance structure or firms’ mechanism (Hawley and Williams, 1996).
Invest
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or
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Time Warner president and CEO Jeffrey Bewkes accepted a position of duality
when he took on the role of chairman of the board of the company in January
2009.
Appointing a CEO's successor gets a little more complicated when the chief executive officer
is also a member of the board of directors. Let's examine how muddled up things can get in
this case.
So we know that shareholders elect a board of directors for a company, and that board in turn
elects the CEO. But we've also learned that in some cases, a CEO can be a member of the
board itself. In fact, he or she can simultaneously hold the position of chairman of the board
and CEO. Those who study corporate governance call this situation CEO duality.
As you might expect, duality is controversial. Even theorists who strive to find the best ways
of managing a company are split about the issue. Two schools of thought represent the
different arguments. Advocates of agency theory argue that the positions of CEO and
chairman should be separate. They say that a single officer who holds both positions creates a
conflict of interest that could negatively affect the interests of the shareholders. Why? Well,
in this situation, the CEO/chairman is be able to direct board meetings and isn't restrained
from acting in his or her own self-interest when a separate chairman isn't there to look out for
shareholders. This very powerful CEO would therefore generally weaken the oversight power
that boards hold -- in other words, there wouldn't be a solid system of checks and balances.
And it's not just an issue of power for the acting CEO/chairman. CEO duality can also
complicate the already frustrating issue of CEO succession. In some cases, a CEO/chairman
may choose to retire as CEO, but keep his or her role as the chairman. Although this splits up
the roles, which appeases agency theorists somewhat, it nonetheless puts the new CEO in a
difficult position. The chairman is bound to question some of the new changes put in place,
and the board as a whole might take sides with the chairman whom they trust and have a
history with [source: Lavelle]. This conflict of interest would make it difficult for the new
CEO to institute any changes, as the power and influence still remains with the former CEO.
If that's agency theory, what does the opposing side argue?
CEO Duality and Stewardship Theory
Breaking Barriers
In the United States, the positions of CEO and board members have been
dominated historically by white males, but this is slowly changing. Now, about
14.5 percent of Fortune 500 companies have female CEOs [source: Shambaugh].
Women and minorities also make up about 11 percent of board members in
corporations [source: Kidder].
CEO duality is a pretty hot debate. While advocates of agency theory believe that little good
can come from a CEO who serves simultaneously as chairman of the board of directors, there
is another side to the argument. Those who support stewardship theory maintain that when
one person holds both roles, he or she is able to act more efficiently and effectively. Holding
dual roles as CEO/chairman creates unity across the company's managers and board of
directors, which ultimately allows the CEO to serve the shareholders even better.
Unfortunately, studies on the different situations (companies that have duality and those who
do not) haven't been able to come up with a clear answer on which is better for running a
company [source: Crane]. Studies seem to indicate that duality doesn't have a direct
correlation to how well a company performs. One might assume that without a separate
chairman to oversee the CEO, the environment is ripe for corruption. However, many are
surprised to learn that even in the high-profile corporate scandals of Enron and WorldCom,
which centered around CEO corruption, the companies didn't have a duality structure [source:
Knowledge@Wharton].
This last fact is even more intriguing when you consider that most CEOs of big companies in
the United States also act as the chairman. About 80 percent of the big corporations in the
United States have a system of duality [source: Alvarez]. The same isn't true in Europe,
however. There, duality is either not permitted or, as in the U.K., not very common [source:
Huse].
Up until now, we haven't discussed what is actually the most hot-button issue regarding
CEOs: salary. We'll get to that next.
CEO Salaries
We all know that our boss makes more money than we do -- but finding out just how much
more can be shocking and often hard to swallow. Chief executive officers (CEOs) obviously
get paid handsomely (for the most part). But how much is too much? CEO pay is always
controversial -- especially when the CEOs are getting perks at a time when the company isn't
doing well.
Looking at how much modern CEOs get paid, you may think that they get to decide their own
salary. But this isn't allowed in public companies. Boards of directors have that responsibility,
and this is a harder task than you might expect. Pay too much and the board risks not only
marring the public image of the company, but also squandering corporate funds. Pay too little
and the board won't be able to attract or retain talented executives who are sought after in a
competitive market.
It's such a difficult decision that boards often designate a compensation committee made up
typically of two to five board members to determine how much to pay a CEO. Regulations
stipulate that the members of this committee can't be current employees of the company
(inside directors), which would cause a conflict of interest. Although private companies aren't
required to follow such regulations, many do anyway [source: Smith].
Compensation committees often consider the advice of internal executives, but they also
recruit outside consultants to help them determine an appropriate salary for the company's
CEO. The committees strive to design an appropriate philosophy for compensating the CEO
in a way that motivates performance. After the committee makes its recommendations, the
board can decide whether or not to approve them. In the United States, Securities and
Exchange Commission (SEC) regulations require that committees explain the reasons for
their decision to shareholders in a released statement [source: Smith].
There's at least one CEO who makes less than minimum wage -- kind of. Find out who on the
next page.
CEO Perks
Loss of Loyalty
Although it used to be customary for upper-management employees to stick with
a single company for much of their lives, this tradition changed in the 1980s.
Since then, executives have been more willing to switch companies for better
offers. This trend has contributed to higher salaries for executives as companies
make bids for the best candidates on the job market [source:
Knowledge@Wharton].
Steve Jobs, the CEO of Apple whose health we discussed on a previous page, is a pretty
notable exception when it comes to high CEO salaries. Apple pays him $1 a year. You read
that right: a single dollar. But don't feel too badly for him; he actually takes home a whole lot
more than that and is reportedly worth billions [source: Knowledge@Wharton]. That's
because in lieu of a traditional paycheck, Jobs receives stock options that allow him to cash in
on the success of the company.
As Jobs' case clearly illustrates, CEO compensation is more than just salary. Actually, most
top earners receive the bulk of their take-home pay from stock options. Larry Ellison, CEO of
Oracle Corporation and the top-paid CEO of 2007, received a cool $182 million in stock
options and a mere million from his salary [source: DeCarlo]. In addition to stock options,
CEOs often get hefty bonuses, privileges to use company-paid perks (like private jets) and
large contributions to their retirement plans. And although this is great news for CEOs, it
gives researchers quite a headache. Because compensation takes so many forms, those who
want to analyze, compare and determine CEO compensation find it a daunting task.
Overall, it's important to take sensationalized reports of a CEO's high salary with a grain of
salt. It can be difficult to estimate his or her value to a company and to guess the various
factors that go into the board's difficult decision of determining salary.
If you want more on the spoken and unspoken rules that govern a company, browse the links
on the next page.
How CEOs Work
If you're too intimidated to ask him or her personally, this article will tell you
what a CEO does. See more pictures of corporate life.
You've heard about his private jet, fancy mansion and sports car collection -- not to mention
the cutthroat business practices that helped him attain all these things. He's the CEO of your
company, and you're probably lucky if he knows your name.
Well, this is the stereotypical portrait of a CEO, anyway. In reality, yours might be a nice,
down-to-earth guy, or he may be a she. Regardless, CEOs have a reputation for living
luxuriously, having keen business minds and striking fear into the hearts of employees
whenever they happen to drop in.
In corporate culture, a chief executive officer, or CEO, is the big boss. CEOs may not do the
nitty-gritty hirings and firings themselves, but they run the show. They're in charge of setting
strategy, company goals and making the high-end decisions. Because this is a big job, they
delegate many of their powers to other executives. Employees can question a CEO's
judgment, but only at their own risk. That's not to say CEOs are untouchable or have
unchecked power. Although he or she may be top dog in the office, the CEO must answer to
a board of directors.
Nevertheless, the power associated with the position often generates suspicion and
controversy. When a company is suffering through a tough quarter and sends word to its
employees that there won't be any Christmas bonus this year, it certainly looks bad to see a
CEO take an increase in salary and fly off on vacation in the company jet. It's also suspicious
when a company's CEO serves simultaneously as chairman of the board of directors. What's
more, the position draws heightened scrutiny these days after such corporate scandals as
Enron exposed CEOs abusing their power.
Before we delve into these and other controversies that swarm around CEOs, we need to
understand what these officers do. It can be difficult to define a CEO's responsibilities due to
the fact that every company's CEO is different. Because they hold the top internal position in
a corporation, CEOs get to decide which duties they want to take on personally and which
they want to delegate. And because every corporation has its own culture and various
industries operate on different corporate structures, we'll have to look at the role from a
general perspective. Let's start with a brief overview of how corporations work.
Corporate Structure: Board of Directors
Have you ever tried to understand the ranks of executives in a company only to get lost in
acronyms and jargon? You're not alone; the balance of power in the corporate world can be
confusing even to those entrenched in it. But don't dismay: We'll walk you through the basic
corporate structure.
Just like many governments, corporations have a system of checks and balances so that not
too much power is centered in one person or group. In companies, the structure is set up to
separate powers of ownership and management. This wasn't always the case. Before the
Industrial Revolution in the 19th century, companies were typically family-run and very
small by today's standards. But eventually, powered by machines and advanced efficiency,
individual companies grew exponentially. Soon after came the dawn of public ownership of
companies, which helped fund these gargantuan institutions.
When various shareholders have partial ownership of a company, they want to make sure
whoever's running the show is looking out for their best interests. This is what a board of
directors is for. The board represents the shareholders and other stakeholders (those who
have a vested interest in the company). The board of directors doesn't run the company itself,
but it oversees those who do.
In a public company, the shareholders elect the members of a board of directors. The board is
headed by a chairman and contains other directors, the number of which varies from
company to company. Directors can be either inside directors or outside directors. Inside
directors are those who are also managers in the company or happen to be major
shareholders. Outside directors, on the other hand, don't have a role in the company. They
typically have experience in the industry (or might even be chief executive officers of other
companies), which allows them to make informed decisions about the business. Some have
memberships on multiple boards.
While inside directors can share their unique insight from an internal perspective, outside
directors are considered unbiased. Both kinds of directors have the same general
responsibilities on a board. Directors oversee the management of the company collectively by
approving strategies and budgets. They may not meet regularly, and the influence they truly
wield over management can depend on the dynamics and atmosphere of the company.
Corporate Structure: Company Management Ladder
Private Matters
Today, even if a corporation is private and isn't publicly traded, laws and
regulations usually require it to have a board of directors that looks out for the
interests of owners and various stakeholders, such as the local community.
However, the board of a private company has fewer oversight rules and
regulations to follow. Many private companies also have CEOs, though not all of
them do.
A CEO must make the important high-end decisions for the company.
Putting aside the vague language, what does a chief executive officer (CEO) do, exactly?
All CEOs are responsible for determining the overall strategy of a company. For example, the
CEO of a car company would have to decide whether to focus on building large SUVs for the
family and adventurer demographic or to jump on the latest green trend and build vehicles
with more efficient gas mileage, instead. The CEO of a company that makes computers might
decide whether to cut prices to be more competitive in the consumer market or to hire more
engineers so that the company can make a better computer.
The CEO's day-to-day duties may depend on the size of the company he or she oversees. In a
big company, setting the strategy in all departments and for all facets of the industry can be a
full-time job. This is why you never see CEOs of large corporations stepping into the
warehouse and helping to get orders through (except, perhaps, in photo ops). In smaller
companies and start-ups, things are usually different. A CEO who was also the founder of the
company and is struggling to make it grow probably has a more hands-on role. He or she is
more likely to step into any role necessary to get the job done. And, of course, the daily
responsibilities of a CEO may also vary across industries.
Even though they can delegate power, CEOs are ultimately responsible for everything related
to management, such as operations and financial matters. This means that the chief operating
officer (COO) and chief financial officer (CFO) report directly to the CEO. As we've
mentioned, since the board of directors chooses the CEO, the CEO must, in turn, report to the
board.
Depending on how involved the board chooses to be, it can take a backseat to the CEO's
vision and decisions. Or, the board could opt to take a more direct role and charge the CEO
with carrying out its plans. The CEO's personality is a major factor in determining his or her
relationship with the board. In general, CEOs tend to have domineering, arresting
personalities that can help them wield power over a board. But because the board has the
power to choose and remove the CEO, there's always that check on power that can reign in a
CEO's behavior.
More CEO Responsibilities
Regardless of whether it's a big or small company that he or she oversees, the CEO is usually
instrumental in setting the tone for an organization. CEOs are able to use their power and
method of leadership in a way that motivates employees. For instance, if employees get the
impression that their CEO is working as hard as they do and that he or she really appreciates
their hard work, this can elicit loyalty from all levels of employees. But the CEO doesn't
always set a positive tone; his or her behavior can discourage employees as easily as it
bolsters their morale. If a CEO comes across as unattached to the company's employees and
flies off frequently on exotic vacations, employees may not feel compelled to work hard for
him or her.
Many people assume that because of their heavy responsibilities, CEOs are especially prone
to stress-related health problems. According to some research, however, those in mid-level
management are more likely to develop health problems than those who work at higher levels
of the corporate ladder [source: Quick]. So it would seem that more responsibility doesn't
necessarily equate to more stress. However, some argue that top-ranking CEOs are able to
avoid job stress by dodging responsibility. When a company's performance takes a dive,
CEOs may try to pass the buck down to lower executives. Although this is just one possible
explanation for why CEOs wouldn't be as stressed as some of those managers to whom they
delegate power, shirking responsibility has shown to be an unwise business tactic. According
to some studies of Fortune 500 companies, when high-level executives take the blame for
slumps, it's more likely to result in improved performance from the employees [source:
Pfeffer]. Other studies confirm that even in hypothetical situations, employees are more likely
to approve of and respect executives who shoulder the blame for unfavorable events [source:
Pfeffer].
Because CEOs are so vital to the success, identity and tone of a company, controversy always
lurks around the corner when the top dog retires, as we'll see next.
The Problem of Losing a CEO
Car accidents, heart attacks, cancer. As much as we hate to think about it, no one lives
forever. If a CEO is truly successful, he or she won't outlive the corporation itself. And,
CEOs may also choose to leave the company suddenly to go another organization, to pursue
other exploits or retire. Of course, the board can always fire the CEO as well.
Whatever the cause, when a company loses a CEO, it can be like the frenzy of a chicken
running around with its head cut off. That's because of the problem of CEO succession -- in
other words, deciding who will be a suitable replacement. Just as monarchies have struggled
historically with the death of a king who has no strong or obvious successor, so must
companies struggle with the departure of a CEO. If companies aren't careful, what plays out
is the stuff of Shakespearean drama. In fact, in the 2000 motion picture release of
Shakespeare's "Hamlet," which deals with problems of royal succession, filmmaker Michael
Almereyda modernized the plot to revolve around the death of a CEO in place of a king.
So why is naming a new CEO such a big deal? Why does the media rush to the scene when
Steve Jobs, the CEO of Apple, so much as sneezes? Basically, it's because of the reasons we
laid out on the last page -- the CEO is the lifeblood of a company. He or she sets the direction
of a corporation, and shareholders don't want to hold on to the stock of a directionless
company for long. Jobs himself is a great example of this because many credit him with
saving Apple from the brink of bankruptcy and subsequently raising it to enormous success.
Without him, some fear the company might sink yet again. To see evidence of how much a
company hinges on its CEO, note how Apple's shares dipped at the mere rumor of Jobs'
remission into ill health [source: Reuters]. In January 2009, news surfaced of Steve Jobs
taking a leave of absence from his position at Apple. The announcement was enough to
institute a temporary halt on the trading of Apple stock. To calm investors, Jobs appointed
COO Tim Cook to take over daily operations for him during his leave.
CEO Succession
Layout Planning
The most popular layout for complex systems is the SPINE LAYOUT. Examples are shown in
the following figure.
The spine defines a central channel of material flow for the entire facility. Each department
branches out of this central core. Ideally, each department has its own input/output area along the
spine. This departmental point of usage concept reduces material flow.
We shall now look at some details of how to locate departments along a spine to optimize the
flow of materials. Let us first try to see if we can evaluate whether there is a dominant flow
pattern in a manufacturing system or not.
We define the weight of the cost of moving material between departments i and j as:
wij = fij.hij
Given the values of all the wij's, one measure of flow dominance is the coefficient of variation,
defined as:
Clearly, f=0 implies that there is no significant variation of flow volumes between different pairs
of departments. In such cases, almost any solution for layouts will be close to optimal.
Similarly, if f is large (>2), it implies that some flows in the system are very low, while others
are extremely dominant. This is typical for assembly lines types of systems. It is easy to design
the layout for such systems (Why?).
However, if the value of f is close to 1, then it is difficult to see dominant flows, and other
techniques of layout design need to be employed.
One such technique is the manual design methodology developed by Muther, called:
Systematic Layout Planning
Department Total
Closeness
Rating
SR 9+3+9+3+81
= 105
PC 9+0+1+1+27
= 38
PS 58
IC 39
XT 35
AT 165
In the above, the X-ratings were ignored in order to allow each department to have a fair
chance in placement in the initial design of the layout. The real value of this rating will be
used later, when we put some effort into modification on the first-guess solution.
Forming the first guess solution (greedy algorithm):
Step 1. Notice that AT has the highest rating, and so is placed in the center of the layout
(why ?)
Step 2. The next highest ranked department is SR, which may be placed adjacent to AT
due to their mutual A-rating. We put it on top of AT.
Step 3. Next up is PS, which should go adjacent to AT (since V(AT,PS) is the highest
rated closeness value for PS.
Step 4. Next comes XT, which should be close to PS.
Step 5. Next is IC, which should be close to AT and is placed below it.
Step 6. Finally, we have PC, which must stay away from PS.
Using these directions, we have a first attempt at the layout as follows:
Notice the odd shape of the final layout. This does not matter, since we still have not
considered the relative sizes of the departments. But before considering that, we must
also attempt to improve upon our greedy solution.
One heuristic to do so is called the 2-Opt method. A k-opt method is said to have
converged when any switching between k variables (in this case, locations of
departments) cannot improve upon the objective (in our case, minimization of the total
MH cost).
The 2-Opt procedure to improve on the greedy solution is pretty straightforward, and
described rather well in your text (Askin and Standridge, pp 219). In summary, it is a hill-
climbing heuristic, in which, starting from the initial solution, at each step we compute
the reduction (if any) in cost associated with switching the positions of each pair of
departments.
The pair which yields the maximum reduction in costs (steepest local benefit) is selected
at this step. The switch is made, and the procedure continues, until at some stage, we are
unable to find any pair-switch which improves on the MH cost.
In the above, the MH cost associated with any pair of departments is often based on the
estimated MH cost factor, wij that we computed earlier, multiplied by an estimate of the
distance between the two cells.
1. The normative decision theory looks for criteria of rational deciding and wants to give
assistance for the question, how one is to decide in a given situation reasonably. In addition it
must meet some simplifying model acceptance, then it must proceed for example from the axiom
of the of the Entscheiders.
2. The decision theory concerns itself with the supply from procedures to the precipitation of
rational and practicable decisions.
3. The descriptive decision theory examines against it empirically the question how decisions
in the reality are actually made.
The basic model (normative) of the decision theory consists of the decision field and the target
system. The decision field contains the activity space (quantity of the possible action
alternatives), the Zustandsraum (quantity of the possible environmental conditions) and a result
function, which assign a value to each combination of action and condition. A frequent problem
is that the true environmental condition does not admit is. Here one speaks of uncertainty,
contrary to the situation of the security, in which the environmental condition admits is. The
uncertainty situation can be arranged into
With a decision under risk expectancy values can be calculated over all possible consequences of
each individual decision, while with a decision under uncertainty and/or is used the principle is
not possible by the insufficient reason/Indifferenzprinzip, which assigns the same probability to
each option. On the basis of such probability evaluations a determination of the expectancy value
can be made also under uncertainty
(In or multi-level) the decision-making process with the different consequences can be plotted as
decision tree.
The decision theory is not applicable, if the entrepreneur and/or manager lets this competition
likewise flow competed with a rationally acting opponent (a competitor about) to which into his
decision. This can do also with the help of the probability calculation alone is not no more
illustrated, since the behavior of the opponent is not deterministically however not coincidental.
In such a case the game theory is used.
The decision theory is used recently also with the evaluation of investments. Under the name
material option is used the decision tree procedure (and/or options) for it to be able to decide the
value of flexibility concerning decisions - i.e. the option (at a later time) - to judge.
OPERATIONS SCHEDULING
Scheduling pertains to establishing both the timing and use of resources within an organization.
Under the operations function (both manufacturing and services), scheduling relates to use of
equipment and facilities, the scheduling of human activities, and receipt of materials.
While issues relating to facility location and plant and equipment acquisition are considered long
term and aggregate planning is considered intermediate term, operations scheduling is considered
to be a short-term issue. As such, in the decision-making hierarchy, scheduling is usually the
final step in the transformation process before the actual output (e.g., finished goods) is
produced. Consequently, scheduling decisions are made within the constraints established by
these longer-term decisions. Generally, scheduling objectives deals with tradeoffs among
conflicting goals for efficient utilization of labor and equipment, lead time, inventory levels, and
processing times.
Byron Finch notes that effective scheduling has recently increased in importance. This increase
is due in part to the popularity of lean manufacturing and just-in-time. The resulting drop in
inventory levels and subsequent increased replenishment frequency has greatly increased the
probability of the occurrence of stock-outs. In addition, the Internet has increased pressure to
schedule effectively. "Business to customer" (B2C) and "business to business" (B2B)
relationships have drastically reduced the time needed to compare prices, check product
availability, make the purchase, etc. Such instantaneous transactions have increased the
expectations of customers, thereby, making effective scheduling a key to customer satisfaction. It
is noteworthy that there are over 100 software scheduling packages that can perform schedule
evaluation, schedule generation, and automated scheduling. However, their results can often be
improved through a human scheduler's judgment and experience.
There are two general approaches to scheduling: forward scheduling and backward scheduling.
As long as the concepts are applied properly, the choice of methods is not significant. In fact, if
process lead times (move, queue and setup times) add to the job lead time and process time is
assumed to occur at the end of process time, then forward scheduling and backward scheduling
yield the same result. With forward scheduling, the scheduler selects a planned order release date
and schedules all activities from this point forward in time.
With backward scheduling, the scheduler begins with a planned receipt date or due date and
moves backward in time, according to the required processing times, until he or she reaches the
point where the order will be released.
Of course there are other variables to consider other than due dates or shipping dates. Other
factors which directly impact the scheduling process include: the types of jobs to be processed
and the different resources that can process each, process routings, processing times, setup times,
changeover times, resource availability, number of shifts, downtime, and planned maintenance.
LOADING
Loading involves assigning jobs to work centers and to various machines in the work centers. If
a job can be processed on only one machine, no difficulty is presented. However, if a job can be
loaded on multiple work centers or machines, and there are multiple jobs to process, the
assignment process becomes more complicated. The scheduler needs some way to assign jobs to
the centers in such a way that processing and setups are minimized along with idle time and
throughput time.
Two approaches are used for loading work centers: infinite loading and finite loading. With
infinite loading jobs are assigned to work centers without regard for capacity of the work center.
Priority rules are appropriate for use under the infinite loading approach. Jobs are loaded at work
centers according to the chosen priority rule. This is known as vertical loading.
Finite loading projects the actual start and stop times of each job at each work center. Finite
loading considers the capacity of each work center and compares the processing time so that
process time does not exceed capacity. With finite loading the scheduler loads the job that has
the highest priority on all work centers it will require. Then the job with the next highest priority
is loaded on all required work centers, and so on. This process is referred to as horizontal
loading. The scheduler using finite loading can then project the number of hours each work
center will operate. A drawback of horizontal loading is that jobs may be kept waiting at a work
center, even though the work center is idle. This happens when a higher priority job is expected
to arrive shortly. The work center is kept idle so that it will be ready to process the higher
priority job as soon as it arrives. With vertical loading the work center would be fully loaded. Of
course, this would mean that a higher priority job would then have to wait to be processed since
the work center was already busy. The scheduler will have to weigh the relative costs of keeping
higher priority jobs waiting, the cost of idle work centers, the number of jobs and work centers,
and the potential for disruptions, new jobs and cancellations.
If the firm has limited capacity (e.g., already running three shifts), finite loading would be
appropriate since it reflects an upper limit on capacity. If infinite loading is used, capacity may
have to be increased through overtime, subcontracting, or expansion, or work may have to be
shifted to other periods or machines.
SEQUENCING
Sequencing is concerned with determining the order in which jobs are processed. Not only must
the order be determined for processing jobs at work centers but also for work processed at
individual work stations. When work centers are heavily loaded and lengthy jobs are involved,
the situation can become complicated. The order of processing can be crucial when it comes to
the cost of waiting to be processed and the cost of idle time at work centers.
There are a number of priority rules or heuristics that can be used to select the order of jobs
waiting for processing. Some well known ones are presented in a list adapted from Vollmann,
Berry, Whybark, and Jacobs (2005):
• Random (R). Pick any job in the queue with equal probability. This rule is often used as a
benchmark for other rules.
• First come/first served (FC/FS). This rule is sometimes deemed to be fair since jobs are
processed in the order in which they arrive.
• Shortest processing time (SPT). The job with the shortest processing time requirement
goes first. This rule tends to reduce work-in-process inventory, average throughput time,
and average job lateness.
• Earliest due date (EDD). The job with the earliest due date goes first. This seems to work
well if the firm performance is judged by job lateness.
• Critical ratio (CR). To use this rule one must calculate a priority index using the formula
(due date–now)/(lead time remaining). This rule is widely used in practice.
• Least work remaining (LWR). An extension of SPT, this rule dictates that work be
scheduled according to the processing time remaining before the job is considered to be
complete. The less work remaining in a job, the earlier it is in the production schedule.
• Fewest operations remaining (FOR). This rule is another variant of SPT; it sequences
jobs based on the number of successive operations remaining until the job is considered
complete. The fewer operations that remain, the earlier the job is scheduled.
• Slack time (ST). This rule is a variant of EDD; it utilizes a variable known as slack. Slack
is computed by subtracting the sum of setup and processing times from the time
remaining until the job's due date. Jobs are run in order of the smallest amount of slack.
• Slack time per operation (ST/O). This is a variant of ST. The slack time is divided by the
number of operations remaining until the job is complete with the smallest values being
scheduled first.
• Next queue (NQ). NQ is based on machine utilization. The idea is to consider queues
(waiting lines) at each of the succeeding work centers at which the jobs will go. One then
selects the job for processing that is going to the smallest queue, measured either in hours
or jobs.
• Least setup (LSU). This rule maximizes utilization. The process calls for scheduling first
the job that minimizes changeover time on a given machine.
These rules assume that setup time and setup cost are independent of the processing sequence.
However, this is not always the case. Jobs that require similar setups can reduce setup times if
sequenced back to back. In addition to this assumption, the priority rules also assume that setup
time and processing times are deterministic and not variable, there will be no interruptions in
processing, the set of jobs is known, no new jobs arrive after processing begins, and no jobs are
canceled. While little of this is true in practice, it does make the scheduling problem manageable.
GANTT CHARTS
Gantt charts are named for Henry Gantt, a management pioneer of the early 1900s. He proposed
the use of a visual aid for loading and scheduling. Appropriately, this visual aid is known as a
Gantt chart. This Gantt chart is used to organize and clarify actual or intended use of resources
within a time framework. Generally, time is represented horizontally with scheduled resources
listed vertically. Managers are able to use the Gantt chart to make trial-and-error schedules to get
some sense of the impact of different arrangements.
There are a number of different types of Gantt charts, but the most common ones, and the ones
most appropriate to our discussion, are the load chart and schedule chart. A load chart displays
the loading and idle times for machines or departments; this shows when certain jobs are
scheduled to start and finish and where idle time can be expected. This can help the scheduler
redo loading assignments for better utilization of the work centers. A schedule chart is used to
monitor job progress. On this type of Gantt chart, the vertical axis shows the orders or jobs in
progress while the horizontal axis represents time. A quick glance at the chart reveals which jobs
are on schedule and which jobs are on time.
Gantt charts are the most widely used scheduling tools. However, they do have some limitations.
The chart must be repeatedly updated to keep it current. Also, the chart does not directly reveal
costs of alternate loadings nor does it consider that processing times may vary among work
centers.
SCHEDULING SERVICE OPERATIONS
The scheduling of services often encounters problems not seen in manufacturing. Much of this is
due to the nature of service, i.e., the intangibility of services and the inability to inventory or
store services and the fact that demand for services is usually random. Random demand makes
the scheduling of labor extremely difficult as seen in restaurants, movie theaters, and amusement
parks. Since customers don't like to wait, labor must be scheduled so that customer wait is
minimized. This sometimes requires the use of queuing theory or waiting line theory. Queuing
theory uses estimate arrival rates and service rates to calculate an optimum staffing plan. In
addition, flexibility can often be built into the service operation through the use of casual labor,
on-call employees, and cross-training.
Scheduling of services can also be complicated when it is necessary to coordinate and schedule
more than one resource. For example, when hospitals schedule surgery, not only is the
scheduling of surgeons involved but also the scheduling of operating room facilities, support
staff, and special equipment. Along with the scheduling of classes, universities must also
schedule faculty, classrooms, labs, audiovisual and computer equipment, and students. To further
complicate matters, cancellations are also common and can add further disruption and confusion
to the scheduling process.
Instead of scheduling labor, service firms frequently try to facilitate their service operations by
scheduling demand. This is done through the use of appointment systems and reservations.
Frank and Lillian Gilbreth
Experimental Technique
Work simplification strategies can be traced back to the work of the Gilbreths, whose methods
were quite sophisticated. For example, they weren't satisfied with simply saying that a person
"moved the hand," so they broke down this action into 17 separate units of motion. They called
each motion a "therblig," which is "Gilbreth" spelled backward (the "th" is transposed for easier
pronunciation).
They also invented a microchronometer to study work motion. This is a clock capable of
recording time to the 1/2000th of a second. By placing the clock in the field of the picture, they
could break movements down into very small units of time. Henry Gantt, the originator of the
Gantt Chart, was a contemporary of the Gilbreths, who used a Gantt Chart to demonstrate
graphically the various pieces of a larger task.
The Gilbreths' discoveries about workplace efficiency were not limited to the need to increase
output. They were also interested in how workers could reduce fatigue. From this industrial
psychology perspective, they advanced ideas about how best to train and develop workers.
Tactics like job rotation and finding work best suited for a worker's natural skills and abilities
developed from the Gilbreths' extensive experiments.
Key Points
While you may not have known the names Frank and Lillian Gilbreth before reading this article,
their contribution to the advancement of management science and modern management theory
was significant. Today, we're very familiar with the idea of workplace efficiency – no one argues
with its importance. We can thank pioneers in the management science movement, like the
Gilbreths, for this knowledge.
Financial management
2.Profit Maximization has to defined after taking into account many things like:
Wealth is equal to the the difference between gross present worth of some
decision or course of action and the investment required to achieve the
expected benefits.
Gross present worth involves the capitalised value of the expected benefits.This
value is discounted a some rate,this rate depends on the certainty or uncertainty
factor of the expected benefits.
The Wealth Maximization approach is concerned with the amount of cash flow
generated by a course of action rather than the profits.
Any course of action that has net present worth above zero or in other
words,creates wealth should be selected.
The financial management come a long way by shifting its focus from traditional
approach to modern approach. The modern approach focuses on wealth
maximization rather than profit maximization. This gives a longer term horizon
for assessment, making way for sustainable performance by businesses.
Giving priority to value creation, managers have now shifted from traditional
approach to modern approach of financial management that focuses on wealth
maximization. This leads to better and true evaluation of business. For e.g.,
under wealth maximization, more importance is given to cash flows rather than
profitability. As it is said that profit is a relative term, it can be a figure in some
currency, it can be in percentage etc. For e.g. a profit of say $10,000 cannot be
judged as good or bad for a business, till it is compared with investment, sales
etc. Similarly, duration of earning the profit is also important i.e. whether it is
earned in short term or long term.
In wealth maximization, major emphasizes is on cash flows rather than profit. So,
to evaluate various alternatives for decision making, cash flows are taken under
consideration. For e.g. to measure the worth of a project, criteria like: “ present
value of its cash inflow – present value of cash outflows” (net present value) is
taken. This approach considers cash flows rather than profits into consideration
and also use discounting technique to find out worth of a project. Thus,
maximization of wealth approach believes that money has time value.
An obvious question that arises now is that how can we measure wealth. Well, a
basic principle is that ultimately wealth maximization should be discovered in
increased net worth or value of business. So, to measure the same, value of
business is said to be a function of two factors - earnings per share and
capitalization rate. And it can be measured by adopting following relation:
***********************
Borrowing funds to increase capital investment with the hope that the business
will be able to generate returns in excess of the interest charges.
Course 2: Capital Budgeting Analysis
As part of the CFA® exam review courses that he teaches, Bill covers the area of
risk analysis in capital budgeting. His experience in developing mathematical
models for Monte Carlo simulation fit naturally into this very important area of
corporate decision-making.
In discussing the capital budgeting techniques, we have so far assumed that the
proposed investment projects do not involve any risk. This assumption was
made simply to facilitate the understanding of the capital budgeting techniques.
In real world situation, however, the firm in general and its investment projects
in particular are exposed to different of risk. What is risk? How can risk be
measured and analyzed in the investment decisions?
Nature of risk
Risk exists because of the inability of the decision maker to make perfect
forecasts. Forecasts cannot be made with perfection or certainty since the future
events on which they depend are uncertain. An investment is not risky if, we can
specify a unique sequence of cash flows for it. But whole trouble is that cash
flows cannot be forecast accurately, and alternative sequences of cash flows can
occur depending on the future events. Thus, risk arises in investment evaluation
because we cannot anticipate the occurrence of the possible future events with
certainty and consequently, cannot, make are correct prediction about the cash
flow sequence. To illustrate, let us suppose that a firm is considering a proposal
to commit its funds in a machine, which will help to produce a new product. The
demand for this product may be very sensitive to the general economic
conditions. It may be very high under favorable economic conditions and very
low under unfavorable economic conditions. Thus, the investment would be
profitable in the former situation and unprofitable in the later case. But, it is
quite difficult to predict the future state of economic conditions, uncertainty
about the cash flows associated with the investment derives
Industry factors
This category of events may affect all companies in an industry. For example,
companies in an industry would be affected by the industrial relations in the
industry, by innovations, by change in material cost etc.
Company factors
This category of events may affect only a company. The change in management,
strike in the company, a natural disaster such as flood or fire may affect directly
a particular company
• Profitability index
• Equivalent annuity
Besides these methods, other methods that are used include Return on
Investment (ROI), Accounting Rate of Return (ARR), Discounted Payback Period
and Payback Period.
The different types of risks that are faced by entrepreneurs regarding capital
budgeting are the following:
• Corporate risk
• International risk
• Stand-alone risk
• Competitive risk
• Market risk
Sensitivity Analysis:
Hillier Model:
In particular situations, the anticipated NPV and the standard deviation of NPV
can be incurred with the help of analytical derivation. This was first realized by
F.S. Hillier. There are situations where correlation between cash flows is either
complete or nonexistent.
Decision Tree Analysis: The principal steps of decision tree analysis are the
definition of the decision tree and the assessment of the alternatives.
Corporate Risk Analysis: Corporate risk analysis focuses on the analysis of risk
that may influence the project in terms of the entire cash flow of the firm. The
corporate risk of a project refers to its share of the total risk of a company.
Selection of project under risk: This involves procedures such as payback period
requirement, risk adjusted discount rate, judgmental evaluation and certainty
equivalent method.
Practical Risk Analysis: The techniques involved include the Acceptable Overall
Certainty Index, Margin of Safety in Cost Figures, Conservative Revenue
Estimation, Flexible Investment Yardsticks and Judgment on Three Point
Estimates.
In our previous example (Example 6), we used the cost of capital for discounting
cash flows. Our example involved the replacement of equipment and carried a
low level of risk since the expected outcome was reasonably certain. Suppose
we have a project involving a new product line. Would we still use our cost of
capital to discount these cash flows? The answer is no since this project could
have a much wider variation in outcomes. We can adjust for higher levels of risk
by increasing the discount rate. A higher discount rate reflects a higher rate of
return that we require whenever we have higher levels of risk.
Another way to adjust for risk is to understand the impact of risk on outcomes.
Sensitivity Analysis and Simulation can be used to measure how changes to a
project affect the outcome. Sensitivity analysis is used to determine the change
in Net Present Value given a change in a specific variable, such as estimated
project revenues. Simulation allows us to simulate the results of a project for a
given distribution of variables. Both sensitivity analysis and simulation require a
definition of all relevant variables associated with the project. It should be noted
that sensitivity analysis is much easier to implement since sophisticated
computer models are usually required for simulation.
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International Projects
Post Analysis
One of the most important steps in capital budgeting analysis is to follow-up and
compare your estimates to actual results. This post analysis or review can help
identify bias and errors within the overall process. A formal tracking system of
capital projects also keeps everyone honest. For example, if you were to
announce to everyone that actual results will be tracked during the life of the
project, you may find that people who submit estimates will be more careful. The
purpose of post analysis and tracking is to collect information that will lead to
improvements within the capital budgeting process.
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Course Summary
The long-term investments we make today determines the value we will have
tomorrow. Therefore, capital budgeting analysis is critical to creating value
within financial management. And the only certainty within capital budgeting is
uncertainty. Therefore, one of the biggest challenges in capital budgeting is to
manage uncertainty. We deal with uncertainty through a three-stage process:
Sensitivity Analysis
• Analysis of the impact of the change in each of the variables on the project’s
NPV.
Simulation Analysis
Sensitivity and scenario analyses are quite useful to understand the uncertainty
of the investment projects. But both Approaches suffer from certain weaknesses.
As we have discusses, they do not consider the interactions between variables
and also, they do not reflect on the probability of the changes in variables.
The Monte carol simulation or simple the simulation analysis considers the
interactions among variables and probability of the change in variables. It does
not given the probability distribution of NPV. The simulation analysis is an
extension of scenario analysis. In simulation analysis a computer generates a
very large number of scenarios according to the probability distributions of the
variables. The simulation analysis involves the following steps:
• First, you should identify variables that influence cash inflows and outflows. For
example, when a firm introduces a new product in the market these variables
are initial investment, market size, market growth, market share, price, variable
costs, fixed costs fixed costs, product life cycle, and terminal value.
• Second specify the formulas that relate variables. For example, revenue
depends on by sales volume and price: sales volume is given by market size,
market share and market growth. Similarly, operating expenses depend on
production, sales and variable and fixed costs.
• Third, indicate the probability distribution for each variable. Some variables will
have more uncertainty than others. For example, it is quite difficult to predict or
market growth with confidence.
Simulation analysis is a very useful technique for risk analysis. Unfortunately. Its
practical use is limited because of a number of shortcomings. First the model
becomes quite complex to use because the variables are interrelated with each
other and each variable depends on its value in the precious periods as well.
Identifying all possible relationships and estimating as well as expensive.
Second, the model helps in generating a probability distribution of the project’s
NPVs. But it does not indicate whether or not the project should be accepted.
Third, simulation analysis, like sensitivity or scenario analysis, considers the risk
of any project in isolation of other projects. We know that if we consider the
portfolio of projects, the unsystematic risk can be diversified. A risky project may
have a negative correlation with the firm’s other projects, and therefore
accepting the project may reduce the overall risk of the firm.
INTERNATIONAL FINANCE
Different types of transactions in the Foreign Exchange
Market
Spot and Forward Exchanges
Spot Market:
The term spot exchange refers to the class of foreign exchange transaction which requires the
immediate delivery or exchange of currencies on the spot. In practice the settlement takes
place within two days in most markets. The rate of exchange effective for the spot transaction
is known as the spot rate and the market for such transactions is known as the spot market.
Forward Market:
The forward transactions is an agreement between two parties, requiring the delivery at some
specified future date of a specified amount of foreign currency by one of the parties, against
payment in domestic currency be the other party, at the price agreed upon in the contract. The
rate of exchange applicable to the forward contract is called the forward exchange rate and
the market for forward transactions is known as the forward market.
The foreign exchange regulations of various countries generally regulate the forward
exchange transactions with a view to curbing speculation in the foreign exchanges market. In
India, for example, commercial banks are permitted to offer forward cover only with respect
to genuine export and import transactions. Forward exchange facilities, obviously, are of
immense help to exporters and importers as they can cover the risks arising out of exchange
rate fluctuations be entering into an appropriate forward exchange contract. With reference to
its relationship with spot rate, the forward rate may be at par, discount or premium. If the
forward exchange rate quoted is exact equivalent to the spot rate at the time of making the
contract the forward exchange rate is said to be at par.
The forward rate for a currency, say the dollar, is said to be at premium with respect to the
spot rate when one dollar buys more units of another currency, say rupee, in the forward than
in the spot rate on a per annum basis.
The forward rate for a currency, say the dollar, is said to be at discount with respect to the
spot rate when one dollar buys fewer rupees in the forward than in the spot market. The
discount is also usually expressed as a percentage deviation from the spot rate on a per
annum basis.
The forward exchange rate is determined mostly be the demand for and supply of forward
exchange. Naturally when the demand for forward exchange exceeds its supply, the forward
rate will be quoted at a premium and conversely, when the supply of forward exchange
exceeds the demand for it, the rate will be quoted at discount. When the supply is equivalent
to the demand for forward exchange, the forward rate will tend to be at par.
Futures
While a focus contract is similar to a forward contract, there are several differences between
them. While a forward contract is tailor made for the client be his international bank, a future
contract has standardized features the contract size and maturity dates are standardized.
Futures cab traded only on an organized exchange and they are traded competitively.
Margins are not required in respect of a forward contract but margins are required of all
participants in the futures market an initial margin must be deposited into a collateral account
to establish a futures position.
Options
While the forward or futures contract protects the purchaser of the contract fro m the adverse
exchange rate movements, it eliminates the possibility of gaining a windfall profit from
favorable exchange rate movement. An option is a contract or financial instrument that gives
holder the right, but not the obligation, to sell or buy a given quantity of an asset as a
specified price at a specified future date. An option to buy the underlying asset is known as a
call option and an option to sell the underlying asset is known as a put option. Buying or
selling the underlying asset via the option is known as exercising the option. The stated price
paid (or received) is known as the exercise or striking price. The buyer of an option is known
as the long and the seller of an option is known as the writer of the option, or the short. The
price for the option is known as premium.
Types of options: With reference to their exercise characteristics, there are two types of
options, American and European. A European option cab is exercised only at the maturity or
expiration date of the contract, whereas an American option can be exercised at any time
during the contract.
Swap operation
Commercial banks who conduct forward exchange business may resort to a swap operation
to adjust their fund position. The term swap means simultaneous sale of spot currency for the
forward purchase of the same currency or the purchase of spot for the forward sale of the
same currency. The spot is swapped against forward. Operations consisting of a simultaneous
sale or purchase of spot currency accompanies by a purchase or sale, respectively of the same
currency for forward delivery are technically known as swaps or double deals as the spot
currency is swapped against forward.
Arbitrage
Arbitrage is the simultaneous buying and selling of foreign currencies with intention of
making profits from the difference between the exchange rate prevailing at the same time in
different markets.
Foreign exchange
exposure
Hedging
through invoice
currency
Positive Negati Asset Operatin
ve g
Hedging
through invoice
currency
• Hedging via lead and lag: Another operational technique the firm
can use to reduce transaction exposure is leading and lagging
foreign currency receipts and payments.
Lead means to pay or collect early, where as
Lag means to pay or collect late.
The firm would like to lead soft currency receivables and lag hard
currency receivables to avoid the loss from depreciation of the soft
currency and benefit from the appreciation of the hard currency. For the
same reason, the firm will attempt to lead the hard currency payables
and lag soft currency payables. To the extent that the firm can effectively
implement the Lead/Lag strategy, the transaction exposure the firm faces
can be reduced.
2. Translation Exposure (Accounting Exposures)
Translation exposure is defined as the likely increase or decrease in the parent company’s net
worth caused by a change in exchange rates since last translation. This arises when an asset
or liability is valued at the current rate. No exposure arises in respect of assets/liabilities
valued at historical rate, as they are not affected by exchange rate differences. Translation
exposure is measured as the net of the foreign currency denominated assets and liabilities
valued at current rates of exchange. If exposed assets exceed the exposed liabilities, the
concern has a ‘positive’ or ‘long’ or ‘asset’ translation exposure, and exposure is equivalent
to the net value. If the exposed liabilities exceed the exposed assets and results in ‘negative’
or ‘short’ or ‘liabilities’ translation exposure to the extent of the net difference.
Translation exposure arises from the need to “translate” foreign currency assets or liabilities
into the home currency for the purpose of finalizing the accounts for any given period.
A typical example of translation exposure is the treatment of foreign currency borrowings.
Consider that a company has borrowed dollars to finance the import of capital goods worth
$10000. When the import materialized the exchange rate was say Rs 30 per dollar. The
imported fixed asset was therefore capitalized in the books of the company for Rs 300000.
In the ordinary course and assuming no change in the exchange rate the company would have
provided depreciation on the asset valued at Rs 300000 for finalizing its accounts for the year
in which the asset was purchased. If at the time of finalization of the accounts the exchange
rate has moved to say Rs 35 per dollar, the dollar loan has to be translated involving
translation loss of Rs50000. The book value of the asset thus becomes 350000 and
consequently higher depreciation has to be provided thus reducing the net profit.
Thus, Translation loss or gain is measured by the difference between the value of assets and
liabilities at the historical rate and current rate. A company which has a positive exposure
will have translation gains if the current rate for the foreign currency is higher than the
historic rate. In the same situation, a company with negative exposure will post translation
loss. The position will be reversed if the currency rate for foreign currency is lesser than its
historic rate of exchange. The translation gain/loss is shown as a separate component of the
shareholders’ equity in the balance-sheet. It does not affect the current earnings of the
company.
3. Economic Exposure
Economic exposure can be defined as the extent to which the value of the firm would be
affected by unanticipated changes in exchange rates. An economic exposure is more a
managerial concept than an accounting concept. A company can have an economic exposure
to say Yen: Rupee rates even if it does not have any transaction or translation exposure in the
Japanese currency.
This would be the case for example, when the company’s competitors are using Japanese
imports. If the Yen weekends the company loses its competitiveness (vice-versa is also
possible). The company’s competitor uses the cheap imports and can have competitive edge
over the company in terms of his cost cutting. Therefore the company’s exposed to Japanese
Yen in an indirect way.
In simple words, economic exposure to an exchange rate is the risk that a change in the rate
affects the company’s competitive position in the market and hence, indirectly the bottom-
line. Broadly speaking, economic exposure affects the profitability over a longer time span
than transaction and even translation exposure. Under the Indian exchange control, while
translation and transaction exposures can be hedged, economic exposure cannot be hedged.
Economic exposure consists of mainly two types of exposures.
• Asset exposure
• Operating exposure
Exposure to currency risk can be properly measured by the sensitivities of (1) the future
home currency values of the firm’s assets (and liabilities) (2) the firm’s operating cash flows
to random changes in exchange rates.
Asset exposure: Let us discuss the case of asset exposure. For convenience, assume that
dollar inflation is non random. Then, from the perspective of the U.S. firm that owns an asset
in Britain, the exposure can be measured by the coefficient ‘b’ in regressing the dollar value
‘P’ of the British asset on the dollar/pound exchange rate ‘S’.
P=a+b*S+e
Where ‘a’ is the regression constant and ‘e’ is the random error term with mean zero, P =
SP*, where P* is the local currency (pound) price of asset. It is obvious from the above
equation that the regression coefficient ‘b’ measures the sensitivity of the dollar value of
asset (P) to the exchange rate (S). If the regression coefficient is zero, the dollar value of the
asset is independent of exchange rate movement, implying no exposure. On the basis of
above analysis, one can say that exposure is the regression coefficient. Statistically, the
exposure coefficient, ‘b’, is defined as follows:
b = Cov (P,S)/ Var (S)
Where Cov (P,S) is the covariance between the dollar value of the asset and the exchange
rate, and Var (S) is the variance of the exchange rate.
Next, we show how to apply the exposure measurement technique using numerical examples.
Suppose that a U.S. firm has an asset in Britain whose local currency price is random. For
simplicity, let us assume that there are three states of the world, with each state equally likely
to occur. The future local currency price of this British asset as well as the future exchange
rate will be determined, depending on the realized state of the world.
Operating exposure: Operating exposure can be defined as “the extent to which the firm’s
operating cash flows would be affected by random changes in exchange rates”. Operating
exposure may affect in two different ways to the firm, viz., competitive effect and
conversion effect. Adverse exchange rate change increase cost of import which makes firm’s
product costly thus firm’s position becomes less competitive, which is competitive effect.
Adverse exchange rate change may reduce value of receivable to the exporting firm which is
called conversion effect.
Some strategy to manage operating exposure
• Selecting low cost production sites: When the domestic
currency is strong or expected to become strong, eroding the
competitive position of the firm, it can choose to locate production
facilities in a foreign country where costs are low due to either the
undervalued currency or under priced factors of production.
Recently, Japanese car makers, including Nissan and Toyota, have
been increasingly shifting production to U.S. manufacturing
facilities in order to mitigate the negative effect of the strong yen
on U.S. sales. German car makers such as Daimler Benz and BMW
also decided to establish manufacturing facilities in the U.S. for the
same reason. Also, the firm can choose to establish and maintain
production facilities in multiple countries to deal with the effect of
exchange rate changes. Consider Nissan, which has manufacturing
facilities in the U.S. and Mexico, as well as in Japan. Multiple
manufacturing sites provide Nissan with great deal of flexibility
regarding where to produce, given the prevailing exchange rates.
When the yen appreciated substantially against the dollar, the
Mexican peso depreciated against the dollar in recent years. Under
this sort of exchange rate development, Nissan may choose to
increase production in the U.S. and especially in Mexico, in order to
serve the U.S. market. This is, in fact, how Nissan has reacted to
the rising yen in recent years. Maintaining multiple manufacturing
sites, however, may prevent the firm from taking advantage of
economies of scale, raising its cost of production. The resultant
higher cost can partially offset the advantages of maintaining
multiple production sites.
• Flexible sourcing policy: Even if the firm manufacturing facilities
only in the domestic country, it can substantially lessen the effect
of exchange rate changes by sourcing from where input costs are
low. Facing the strong yen in recent years, many Japanese firms are
adopting the same practice. It is well known that Japanese
manufacturers, especially in the car and consumer electronics
industries, depend heavily on parts and intermediate products from
such low cost countries as Thailand, Malaysia, and China. Flexible
sourcing need not be confined just to materials and parts. Firms can
also hire low cost guest workers from foreign countries instead of
high cost domestic workers in order to be competitive.
• Diversification of the market: Another way of dealing with
exchange exposure is to diversify the market for the firm’s products
as much as possible. Suppose that GE is selling power generators in
Mexico as well as Germany. Reduced sales in Mexico due to the
dollar appreciation against the peso can be compensated by
increased sales in Germany due to dollar depreciation against the
euro. As a result, GE’s overall cash flows will be much more stable
than would be the case if GE sold only in one foreign market, either
Mexico or Germany. As long as exchange rates do not always move
in the same direction, the firm can stabilize its operating cash flow
by diversifying its export market.
• R&D efforts and product differentiation: Investment in R&D
activities can allow the firm to maintain and strengthen its
competitive position in the face of adverse exchange rate
movements. Successful R&D efforts allow the firm to cut costs and
enhance productivity. In addition, R&D efforts can lead to the
introduction of new and unique products for which competitors offer
no close substitutes. Since the demand for unique products tend to
be highly inelastic, the firm would be less exposed to exchange risk.
At the same time, the firm can strive to create a perception among
consumers that its product is indeed different from those offered by
competitors. This helps firm to pass-through any adverse effect of
exchange rate on to the customers.
• Financial hedging: While not a substitute for the long-term,
financial hedging can be used to stabilize the firm’s cash flow. For
example, the firm can lend or borrow foreign currencies as a long
term basis. Or, the firm can use currency forward of options
contracts and roll them over if necessary.
Related posts:
1. Foreign Exchange Risk
2. Economics of the Foreign Exchange Market
3. Settlement of Transactions in Foreign Exchange Markets
4. Flexible v/s fixed foreign exchange rates
5. Official actions to influence foreign exchange rates
6. Management of Foreign Exchange Risks
7. Role of FEDAI in Foreign Exchange
8. Foreign Exchange Management Policy in India
9. Different types of transactions in the Foreign Exchange Market
10.Merchant Rate and Exchange Margin in Foreign Exchange Markets
Capital Asset Pricing Model and Arbitrage Pricing Theory
The three portfolios we looked at in Topic 2 helped down the foundation for
many of the asset pricing models commonly used in the financial industry today.
Two of such models are the capital asset pricing model (CAPM) and the arbitrage
pricing theory (APT). We will focus first on the capital asset pricing model for two
reasons: (i) many of you have seen the CAPM in an introductory finance course,
and (ii) the approach the CAPM takes to estimate the risk of a portfolio is very
similar to the approach of the third portfolio we analyzed in Topic 2.
Before we look at how the CAPM can be used to price a portfolio (or an
investment), it is important for you to understand that it is after all a theoretical
model, which means that it is based on an idealistic investment environment
different from the real world. Despite its “simplistic” assumptions about the
investment environment, the CAPM still serves as a valuable tool in
understanding the relationship between the risk and return.
The following are the assumptions of the CAPM. Briefly explain what each
assumption means.
(c) Investors have access to all investments and have access to unlimited
borrowing and lending opportunities at the risk-free rate
In Topic 2, we know that when you have access to all the different investments
available in the financial market, the “best place” you can be is on the capital
market line (CML). Portfolios that are located on this line will provide you the
best (or optimal) combination of risk and return. As a result, the CML is a good
measure for the relationship between risk and return. Just in case you forgot, the
CML is represented by the following formula:
E (rm ) − rrf
E (r p ) = rrf + σ p
rm
What is the similarity and difference between the CAPM and the CML in
measuring the relationship between risk and return? We need to first re-arrange
the formula (which is presented below) for the CML before we will address the
question.
σp
E (r p ) = rrf +
σm
[ E (r
m ) − rrf ]
[
E (r p ) = rrf + β p E (rm ) − rrf ]
What about the differences between the CML and the CAPM? Can you tell what
are the two differences between the CML and CAPM?
2. , and SML
The CAPM, Beta (i.e.
Now that we know more about the similarities and differences between the CML
and the CAPM, we need to go back and look at some of the details related to the
CAPM.
Even though the formula presented earlier for the CAPM is for a portfolio, the
formula can easily be modified to determine the return of a single investment as
follows:
[
E (ri ) = rrf + β i E (rm ) − rrf ]
Since the risk-free rate and the market return should be the same for every
investment in the financial market, the only thing that is different from
investment to investment is the beta of the investment. As a result, we can
claim that the only driving force behind the determination of an investment’s
return is its beta.
What is the beta? It represents an investment’s non-diversifiable risk (and not its
total risk) relative to the market risk. In other words, the beta of an investment
measures the co-movement of the investment’s expected return with the
market’s expected return. The formula of an investment’s beta is as follows:
ρ im σ i
βi =
σm
where
im = correlation between investment i’s return and the market’s return
i = investment i’s non-diversifiable risk
m = market risk
We know the CAPM can be easily modified to determine the expected return of
either a portfolio or an individual investment. The only difference between the
two is the beta: beta of a portfolio and beta of an individual investment. What is
the relationship between the two? The beta of a portfolio is simply the weighted
average of the betas of the investments included in the portfolio. The formula for
the beta of a portfolio is as follows:
β p = ∑ wi β i
Just as in the case with the capital allocation line, we can also represent the
CAPM in a graphical manner. The straight line that represents the relationship
between risk and return (according to the CAPM) is known as the security market
line (SML).
E(ri) A SML
E(rm)
B
rrf
βi
1.0
The security market line will help you determine if an investment is correctly
price. In other words, help you determine if the investment is offering a return
that is appropriate for its level of risk (as measured by the beta). If an
investment’s return falls on the SML, the investment is considered to be
correctly price because the expected return of the investment matches the one
according to the CAPM (based on for its beta). However, if the expected return of
the investment differs from the one as “predicted” by the CAPM, the investment
is considered to be either underpriced or overpriced. The difference between the
investment’s actual expected return and its fair return (as dictated by the CAPM)
is known as the investment’s alpha (i.e.
).
Let’s analyze the two investments A and B as depicted in the graph above.
Based on your analysis, what can you say about the two investments?
(a) Investment A
(b) Investment B
Since the driving force behind the CAPM in determining the return of an
investment is its beta, it is important that you know the process commonly
adopted to estimate the beta of an investment. Before we can proceed with the
discussion on how to estimate beta, you need to first understand that we cannot
implement the CAPM in the real world as it is because of two main issues. First,
the CAPM assumes that the market portfolio (which includes all investments in
the financial market) is available to all investors. Second, it focuses on the
expected return of an investment.
Index model
To apply the CAPM in the real world, we need to use the index model, which
addresses the above two issues as follows:
(a) The index model uses a proxy such as a market index (e.g. S&P 500) to
represents a more relevant market portfolio (and the market risk).
(b) The index model uses realized returns (rather than expected returns,
which are not easily observable).
However, since we are using the index model (i.e. using realized returns), the
regression model will look as follows:
One thing that is crucial to remember is that because of the setup of the
regression model, the excess returns of the investment have to be on the y-axis
and the excess returns of the market index have to be on the x-axis.
Once you have the excess returns of the investment and the market index
plotted as above, you want to find a straight line that “best fit” the data as
presented in the graph below:
What does it mean to have a straight line that “best fit” the data points?
The straight line, which “best fit” the data points, is known as the security
characteristic line (SCL). Once again, a straight line is determined by its y-
intercept and its slope. How do you determine the y-intercept and the slope of
the SCL? You can do so by performing a regression analysis using any statistical
packages or Microsoft Excel.
Although the Capital Asset Pricing Model is the most popular tool among many of
the investors and investment analysts, it does have its problems. We know the
CAPM uses 3 variables to determine the expected return of an asset: the risk-
free rate, the expected return of the market portfolio, and the beta of the asset.
An error in the estimation of any of these variables might lead to a wrong
recommendation or investment decision. The following are some of the sources
of error in estimating the 3 variables for the CAPM:
(b) We know there are many representations (or proxies) for the market,
which means that there are many choices to represent the market
portfolio: the Dow Jones Industrial Average, the S&P 500 index, the NYSE
Composite index, etc. Each of these choices will provide a different
estimate for the market return. Just as in the case of the risk-free asset,
the choice of the representation for the market portfolio will affect an
investor’s investment decisions.
(c) It has been proven empirically that the beta of an investment is unstable
over time. In other words, the value of the beta of an investment changes
over time. This could be due to changes in the company’s management,
its financing policy, etc. In addition, the estimates for the beta of a
particular investment vary among analysts and publications for several
reasons:
(i) The proxy for the market can be different among analysts and
publications. For example, one analyst might be using the Value
Line index (which contains 1700 stocks), while another analyst
might be using the S&P 500 index.
(ii) The time period used in estimating the beta of a stock can be
different among analysts and publications. For example, the beta
of an investment estimated using 5 years of return will differ from
the one estimated using 10 years of return.
(iii)The intervals of the measurement of the returns will also affect the
estimates of the betas. For example, a beta estimated with weekly
returns will differ from the one estimated with monthly returns.
The major criticism of the CAPM is that it uses only a single factor in determining
the return of a portfolio, namely the beta of the portfolio. In other words, the
non-diversifiable risk of the portfolio (in relation to the market risk) is the sole
determinant of its return. No other factors will have any effect on the portfolio’s
return.
To address this criticism of the CAPM, a new model has been developed based
on the arbitrage pricing theory (APT). Similar to the CAPM, the APT assumes that
there is a relationship between the risk and return of a portfolio. However,
compared to the CAPM, the APT has fewer assumptions. The following
assumptions are required for the CAPM but not for the APT:
The APT is based on the concept of arbitrage (or law of one price), which states
that any two identical investments cannot be sold at a different price. In other
words, the theory states that market forces will adjust to eliminate any arbitrage
opportunities, where a zero investment portfolio can be created to yield a risk-
free profit.
The key thing you need to understand is that, unlike the CAPM, the APT does not
assume that the market risk is the only factor that influences the return of a
portfolio. The APT recognizes that several other factors (or risks) can influence
the return of a portfolio.
The APT preserves the linear relationship between risk and return of the CAPM
but abandons the single measure of risk by the beta of the portfolio. The APT
model is a multiple factor model, which uses factors such as the inflation rate,
the growth rate of the economy, the slope of the yield curve, etc. in addition to
the beta of the portfolio in determining the return of the portfolio. Keep in mind
that just as in the case with the CAPM, the APT can also be modified to
determine the return of an individual investment. The formula of the APT can be
presented as follows:
[ ] [ ] [
E (ri ) = rrf + β 1 E (r1 ) − rrf + β 2 E (r2 ) − rrf + ... + β n E (rn ) − rrf ]
The problem with the APT is that the factors are not well-specified ex-ante. Some
research had been conducted to determine the appropriate factors that should
be included in the model. However, there is no consensus on what the factors
should be. One study suggested that the factors that should be included are
changes in expected inflation, unanticipated changes in inflation, unanticipated
changes in industrial production, unanticipated changes in the default risk-
premium, and unanticipated changes in the term structure of interest rates. On
the other hand, another study suggested that the factors should be default risk,
the term structure of interest rates, inflation or deflation, the long-run expected
growth rate of profits for the economy, and residual market risk.
What does this all means to an investor like you? Should you use the CAPM or
the APT? The key thing you need to remember is that neither of the theories
dominates the other one. The APT is more general because it does not require as
many assumptions as the CAPM. However, the CAPM is more general because it
applies to all individual investments without reservation (whereas the APT works
better with well-diversified portfolio).
where
• E(rj) is the risky asset's expected return,
• RPk is the risk premium of the factor,
• rf is the risk-free rate,
• Fk is the macroeconomic factor,
• bjk is the sensitivity of the asset to factor k, also called factor loading,
• and εj is the risky asset's idiosyncratic random shock with mean zero.
That is, the uncertain return of an asset j is a linear relationship among n factors.
Additionally, every factor is also considered to be a random variable with mean zero.
Note that there are some assumptions and requirements that have to be fulfilled for the latter
to be correct:
There must be perfect competition in the market, and the total number of factors may never
surpass the total number of assets (in order to avoid the problem of matrix singularity),
Arbitrage and the APT
Arbitrage is the practice of taking advantage of a state of imbalance between two (or possibly
more) markets and thereby making a risk free profit; see Rational pricing.
Arbitrage in expectations
The APT describes the mechanism whereby arbitrage by investors will bring an asset which
is mispriced, according to the APT model, back into line with its expected price. Note that
under true arbitrage, the investor locks-in a guaranteed payoff, whereas under APT arbitrage
as described below, the investor locks-in a positive expected payoff. The APT thus assumes
"arbitrage in expectations" - i.e. that arbitrage by investors will bring asset prices back into
line with the returns expected by the model portfolio theory.
Arbitrage mechanics
In the APT context, arbitrage consists of trading in two assets – with at least one being
mispriced. The arbitrageur sells the asset which is relatively too expensive and uses the
proceeds to buy one which is relatively too cheap.
Under the APT, an asset is mispriced if its current price diverges from the price predicted by
the model. The asset price today should equal the sum of all future cash flows discounted at
the APT rate, where the expected return of the asset is a linear function of various factors,
and sensitivity to changes in each factor is represented by a factor-specific beta coefficient.
A correctly priced asset here may be in fact a synthetic asset - a portfolio consisting of other
correctly priced assets. This portfolio has the same exposure to each of the macroeconomic
factors as the mispriced asset. The arbitrageur creates the portfolio by identifying x correctly
priced assets (one per factor plus one) and then weighting the assets such that portfolio beta
per factor is the same as for the mispriced asset.
When the investor is long the asset and short the portfolio (or vice versa) he has created a
position which has a positive expected return (the difference between asset return and
portfolio return) and which has a net-zero exposure to any macroeconomic factor and is
therefore risk free (other than for firm specific risk). The arbitrageur is thus in a position to
make a risk free profit:
Where today's price is too low:
The implication is that at the end of the period the portfolio would have
appreciated at the rate implied by the APT, whereas the mispriced asset would
have appreciated at more than this rate. The arbitrageur could therefore:
Today:
1 short sell the portfolio
2 buy the mispriced-asset with the proceeds.
At the end of the period:
1 sell the mispriced asset
2 use the proceeds to buy back the portfolio
3 pocket the difference.
Where today's price is too high:
The implication is that at the end of the period the portfolio would have
appreciated at the rate implied by the APT, whereas the mispriced asset would
have appreciated at less than this rate. The arbitrageur could therefore:
Today:
1 short sell the mispriced-asset
2 buy the portfolio with the proceeds.
At the end of the period:
1 sell the portfolio
2 use the proceeds to buy back the mispriced-asset
3 pocket the difference.
Relationship with the capital asset pricing model
The APT along with the capital asset pricing model (CAPM) is one of two influential
theories on asset pricing. The APT differs from the CAPM in that it is less restrictive in its
assumptions. It allows for an explanatory (as opposed to statistical) model of asset returns. It
assumes that each investor will hold a unique portfolio with its own particular array of betas,
as opposed to the identical "market portfolio". In some ways, the CAPM can be considered a
"special case" of the APT in that the securities market line represents a single-factor model of
the asset price, where Beta is exposed to changes in value of the Market.
Additionally, the APT can be seen as a "supply side" model, since its beta coefficients reflect
the sensitivity of the underlying asset to economic factors. Thus, factor shocks would cause
structural changes in the asset's expected return, or in the case of stocks, in the firm's
profitability.
On the other side, the capital asset pricing model is considered a "demand side" model. Its
results, although similar to those in the APT, arise from a maximization problem of each
investor's utility function, and from the resulting market equilibrium (investors are
considered to be the "consumers" of the assets).
Using the APT
Identifying the factors
As with the CAPM, the factor-specific Betas are found via a linear regression of historical
security returns on the factor in question. Unlike the CAPM, the APT, however, does not
itself reveal the identity of its priced factors - the number and nature of these factors is likely
to change over time and between economies. As a result, this issue is essentially empirical in
nature. Several a priori guidelines as to the characteristics required of potential factors are,
however, suggested:
1. their impact on asset prices manifests in their unexpected movements
2. they should represent undiversifiable influences (these are, clearly, more
likely to be macroeconomic rather than firm-specific in nature)
3. timely and accurate information on these variables is required
4. the relationship should be theoretically justifiable on economic grounds
Chen, Roll and Ross identified the following macro-economic factors as significant in
explaining security returns:
• surprises in inflation;
• surprises in GNP as indicted by an industrial production index;
• surprises in investor confidence due to changes in default premium in
corporate bonds;
• surprise shifts in the yield curve.
As a practical matter, indices or spot or futures market prices may be used in place of macro-
economic factors, which are reported at low frequency (e.g. monthly) and often with
significant estimation errors. Market indices are sometimes derived by means of factor
analysis. More direct "indices" that might be used are:
• short term interest rates;
• the difference in long-term and short term interest rates;
• a diversified stock index such as the S&P 500 or NYSE Composite Index;
• oil prices
• gold or other precious metal prices
• Currency exchange rates
What is Capital Asset Pricing Model? Discuss its assumptions
The NOI approach implies that (i) whatever may be the change in
capital structure the overall value of the firm is not affected. Thus the
overall value of the firm is independent of the degree of leverage in
capital structure. (ii) Similarly the overall cost of capital is not affected
by any change in the degree of leverage in capital structure. The
overall cost of capital is independent of leverage.
If the cost of debt is less than that of equity capital the overall cost of
capital must decrease with the increase in debts whereas it is assumed
under this method that overall cost of capital is unaffected and hence
it remains constant irrespective of the change in the ratio of debts to
equity capital. How can this assumption be justified? The advocates of
this method are of the opinion that the degree of risk of business
increases with the increase in the amount of debts. Consequently the
rate of equity over investment in equity shares thus on the one hand
cost of capital decreases with the increase in the volume of debts; on
the other hand cost of equity capital increases to the same extent.
Hence the benefit of leverage is wiped out and overall cost of capital
remains at the same level as before. Let us illustrate this point.
To put the same in other words there are two parts of the cost of
capital. One is the explicit cost which is expressed in terms of interest
charges on debentures. The other is implicit cost which refers to the
increase in the rate of equity capitalization resulting from the increase
in risk of business due to higher level of debts.
Speculation
Economist Keynes described this reason for holding cash as creating the ability
for a firm to take advantage of special opportunities that if acted upon quickly
will favor the firm. An example of this would be purchasing extra inventory at a
discount that is greater than the carrying costs of holding the inventory.
Precaution
Transaction
Float
Float is defined as the difference between the book balance and the bank
balance of an account. For example, assume that you go to the bank and
open a checking account with $500. You receive no interest on the $500
and pay no fee to have the account.
Now assume that you receive your water bill in the mail and that it is for
$100. You write a check for $100 and mail it to the water company. At the
time you write the $100 check you also record the payment in your bank
register. Your bank register reflects the book value of the checking account.
The check will literally be "in the mail" for a few days before it is received
by the water company and may go several more days before the water
company cashes it.
The time between the moment you write the check and the time the bank
cashes the check there is a difference in your book balance and the balance
the bank lists for your checking account. That difference is float. This float
can be managed. If you know that the bank will not learn about your check
for five days, you could take the $100 and invest it in a savings account at
the bank for the five days and then place it back into your checking account
"just in time" to cover the $100 check.
Bo
ok
Time Bal Bank Balance
an
ce
$5
Time 0 (make deposit)
00
Time 1 (write $100 $500
$4
check) $500
00
Time 2 (bank receives $400
$4
check)
00
Float is calculated by subtracting the book balance from the bank balance.
Firms can manage cash in virtually all areas of operations that involve the use of
cash. The goal is to receive cash as soon as possible while at the same time
waiting to pay out cash as long as possible. Below are several examples of how
firms are able to do this.
Here a firm already is holding the cash so the goal is to maximize the benefits
from holding it and wait to pay out the cash being held until the last possible
moment. Previously there was a discussion on Float which includes an example
based on a checking account. That example is expanded here.
Assume that rather than investing $500 in a checking account that does not pay
any interest, you invest that $500 in liquid investments. Further assume that the
bank believes you to be a low credit risk and allows you to maintain a balance of
$0 in your checking account.
This allows you to write a $100 check to the water company and then transfer
funds from your investment to the checking account in a "just in time" (JIT)
fashion. By employing this JIT system you are able to draw interest on the entire
$500 up until you need the $100 to pay the water company. Firms often have
policies similar to this one to allow them to maximize idle cash.
Sales
The goal for cash management here is to shorten the amount of time before the
cash is received. Firms that make sales on credit are able to decrease the
amount of time that their customers wait until they pay the firm by offering
discounts.
For example, credit sales are often made with terms such as 3/10 net 60. The
first part of the sales term "3/10" means that if the customer pays for the sale
within 10 days they will receive a 3% discount on the sale. The remainder of the
sales term, "net 60," means that the bill is due within 60 days. By offering an
inducement, the 3% discount in this case, firms are able to cause their
customers to pay off their bills early. This results in the firm receiving the cash
earlier.
Inventory
The goal here is to put off the payment of cash for as long as possible and to
manage the cash being held. By using a JIT inventory system, a firm is able to
avoid paying for the inventory until it is needed while also avoiding carrying
costs on the inventory. JIT is a system where raw materials are purchased and
received just in time, as they are needed in the production lines of a firm.
3. Ratios give false result, if they are calculated from incorrect accounting data.
4. Ratios are calculated on the basis of past data. Therefore, they do not provide
complete information for future forecasting.
Many things can impact the calculation of ratios and make comparisons
difficult. The limitations include:
The common size ratio for each line on the financial statement is calculated as
follows:
Item of
Interest
Common Size
Ratio =
Reference
Item
Inventory
The following example income statement shows both the dollar amounts and the
common size ratios:
Common-Size
Income
Income
Statement
Statement
For the balance sheet, the common size percentages are referenced to the total
assets. The following sample balance sheet shows both the dollar amounts and
the common size ratios:
Common-
Balance Size
Sheet Balance
Sheet
ASSETS
The ratios in common size statements tend to have less variation than the
absolute values themselves, and trends in the ratios can reveal important
changes in the business. Historical comparisons can be made in a time-series
analysis to identify such trends.
Common size statements also can be used to compare the firm to other firms.
Limitations
Features
Function
Benefits
Significance
Expert Insight
Derivative
Derivatives are financial contracts, or financial instruments, whose values are derived from
the value of something else (known as the underlying).
The underlying on which a derivative is based can be an asset (e.g., commodities, equities
(stocks), residential mortgages, commercial real estate, loans, bonds), an index (e.g., interest
rates, exchange rates, stock market indices, consumer price index (CPI) — see inflation
derivatives), or other items (e.g., weather conditions, or other derivatives). Credit derivatives
are based on loans, bonds or other forms of credit.
The main types of derivatives are forwards, futures, options, and swaps.
Derivatives can be used to mitigate the risk of economic loss arising from changes in the
value of the underlying. This activity is known as hedging. Alternatively, derivatives can be
used by investors to increase the profit arising if the value of the underlying moves in the
direction they expect. This activity is known as speculation.
Because the value of a derivative is contingent on the value of the underlying, the notional
value of derivatives is recorded off the balance sheet of an institution, although the market
value of derivatives is recorded on the balance sheet.
Uses
Hedging
Derivatives allow risk about the value of the underlying asset to be transferred from one
party to another. For example, a wheat farmer and a miller could sign a futures contract to
exchange a specified amount of cash for a specified amount of wheat in the future. Both
parties have reduced a future risk: for the wheat farmer, the uncertainty of the price, and for
the miller, the availability of wheat. However, there is still the risk that no wheat will be
available due to causes unspecified by the contract, like the weather, or that one party will
renege on the contract. Although a third party, called a clearing house, insures a futures
contract, not all derivatives are insured against counterparty risk.
From another perspective, the farmer and the miller both reduce a risk and acquire a risk
when they sign the futures contract: The farmer reduces the risk that the price of wheat will
fall below the price specified in the contract and acquires the risk that the price of wheat will
rise above the price specified in the contract (thereby losing additional income that he could
have earned). The miller, on the other hand, acquires the risk that the price of wheat will fall
below the price specified in the contract (thereby paying more in the future than he otherwise
would) and reduces the risk that the price of wheat will rise above the price specified in the
contract. In this sense, one party is the insurer (risk taker) for one type of risk, and the
counterparty is the insurer (risk taker) for another type of risk.
Hedging also occurs when an individual or institution buys an asset (like a commodity, a
bond that has coupon payments, a stock that pays dividends, and so on) and sells it using a
futures contract. The individual or institution has access to the asset for a specified amount of
time, and then can sell it in the future at a specified price according to the futures contract. Of
course, this allows the individual or institution the benefit of holding the asset while reducing
the risk that the future selling price will deviate unexpectedly from the market's current
assessment of the future value of the asset.
Speculation and arbitrage
Derivatives can be used to acquire risk, rather than to insure or hedge against risk. Thus,
some individuals and institutions will enter into a derivative contract to speculate on the
value of the underlying asset, betting that the party seeking insurance will be wrong about the
future value of the underlying asset. Speculators will want to be able to buy an asset in the
future at a low price according to a derivative contract when the future market price is high,
or to sell an asset in the future at a high price according to a derivative contract when the
future market price is low.
Individuals and institutions may also look for arbitrage opportunities, as when the current
buying price of an asset falls below the price specified in a futures contract to sell the asset.
Speculative trading in derivatives gained a great deal of notoriety in 1995 when Nick Leeson,
a trader at Barings Bank, made poor and unauthorized investments in futures contracts.
Through a combination of poor judgment, lack of oversight by the bank's management and
by regulators, and unfortunate events like the Kobe earthquake, Leeson incurred a $1.3
billion loss that bankrupted the centuries-old institution.[1]
Types of derivatives
OTC and exchange-traded
Broadly speaking there are two distinct groups of derivative contracts, which are
distinguished by the way they are traded in market:
• Over-the-counter (OTC) derivatives are contracts that are
traded (and privately negotiated) directly between two parties,
without going through an exchange or other intermediary. Products
such as swaps, forward rate agreements, and exotic options are
almost always traded in this way. The OTC derivative market is the
largest market for derivatives, and is largely unregulated with
respect to disclosure of information between the parties, since the
OTC market is made up of banks and other highly sophisticated
parties, such as hedge funds. Reporting of OTC amounts are
difficult because trades can occur in private, without activity being
visible on any exchange. According to the Bank for International
Settlements, the total outstanding notional amount is $684 trillion
(as of June 2008)[2]. Of this total notional amount, 67% are interest
rate contracts, 8% are credit default swaps (CDS), 9% are foreign
exchange contracts, 2% are commodity contracts, 1% are equity
contracts, and 12% are other. Because OTC derivatives are not
traded on an exchange, there is no central counterparty. Therefore,
they are subject to counterparty risk, like an ordinary contract,
since each counterparty relies on the other to perform.
• Exchange-traded derivatives (ETD) are those derivatives
products that are traded via specialized derivatives exchanges or
other exchanges. A derivatives exchange acts as an intermediary to
all related transactions, and takes Initial margin from both sides of
the trade to act as a guarantee. The world's largest[3] derivatives
exchanges (by number of transactions) are the Korea Exchange
(which lists KOSPI Index Futures & Options), Eurex (which lists a
wide range of European products such as interest rate & index
products), and CME Group (made up of the 2007 merger of the
Chicago Mercantile Exchange and the Chicago Board of Trade and
the 2008 acquisition of the New York Mercantile Exchange).
According to BIS, the combined turnover in the world's derivatives
exchanges totalled USD 344 trillion during Q4 2005. Some types of
derivative instruments also may trade on traditional exchanges. For
instance, hybrid instruments such as convertible bonds and/or
convertible preferred may be listed on stock or bond exchanges.
Also, warrants (or "rights") may be listed on equity exchanges.
Performance Rights, Cash xPRTs and various other instruments that
essentially consist of a complex set of options bundled into a simple
package are routinely listed on equity exchanges. Like other
derivatives, these publicly traded derivatives provide investors
access to risk/reward and volatility characteristics that, while
related to an underlying commodity, nonetheless are distinctive.
Common derivative contract types
There are three major classes of derivatives:
1. Futures/Forwards are contracts to buy or sell an asset on or before
a future date at a price specified today. A futures contract differs
from a forward contract in that the futures contract is a
standardized contract written by a clearing house that operates an
exchange where the contract can be bought and sold, while a
forward contract is a non-standardized contract written by the
parties themselves.
2. Options are contracts that give the owner the right, but not the
obligation, to buy (in the case of a call option) or sell (in the case of
a put option) an asset. The price at which the sale takes place is
known as the strike price, and is specified at the time the parties
enter into the option. The option contract also specifies a maturity
date. In the case of a European option, the owner has the right to
require the sale to take place on (but not before) the maturity date;
in the case of an American option, the owner can require the sale to
take place at any time up to the maturity date. If the owner of the
contract exercises this right, the counterparty has the obligation to
carry out the transaction.
3. Swaps are contracts to exchange cash (flows) on or before a
specified future date based on the underlying value of
currencies/exchange rates, bonds/interest rates, commodities,
stocks or other assets.
More complex derivatives can be created by combining the elements of these basic types. For
example, the holder of a swaption has the right, but not the obligation, to enter into a swap on
or before a specified future date.
Examples
Some common examples of these derivatives are:
CONTRACT TYPES
UNDERLYI
Exchang Exchang
NG OTC OTC OTC
e-traded e-traded
swap forward option
futures options
Option on
DJIA
DJIA Index
Index
future
Equity future Equity Back-to-
Option on n/a
Index NASDAQ swap back
NASDAQ
Index
Index
future
future
Option on Interest
Eurodolla Eurodollar Forward rate cap
Interes
Money r future future rate and floor
t rate
market Euribor Option on agreemen Swaption
swap
future Euribor t Basis
future swap
Repurchas
Option on Total
Bond e Bond
Bonds Bond return
future agreemen option
future swap
t
Credit Credit
Credit n/a n/a default n/a default
swap option
Cash flow
The payments between the parties may be determined by:
• the price of some other, independently traded asset in the future
(e.g., a common stock);
• the level of an independently determined index (e.g., a stock
market index or heating-degree-days);
• the occurrence of some well-specified event (e.g., a company
defaulting);
• an interest rate;
• an exchange rate;
• or some other factor.
Some derivatives are the right to buy or sell the underlying security or commodity at some
point in the future for a predetermined price. If the price of the underlying security or
commodity moves into the right direction, the owner of the derivative makes money;
otherwise, they lose money or the derivative becomes worthless. Depending on the terms of
the contract, the potential gain or loss on a derivative can be much higher than if they had
traded the underlying security or commodity directly.
Valuation
Total world derivatives from 1998-2007[4] compared to total world wealth in the
year 2000[citation needed]
Definitions
• Bilateral netting: A legally enforceable arrangement between a
bank and a counter-party that creates a single legal obligation
covering all included individual contracts. This means that a bank’s
obligation, in the event of the default or insolvency of one of the
parties, would be the net sum of all positive and negative fair
values of contracts included in the bilateral netting arrangement.
• Credit derivative: A contract that transfers credit risk from a
protection buyer to a credit protection seller. Credit derivative
products can take many forms, such as credit default swaps, credit
linked notes and total return swaps.
• Derivative: A financial contract whose value is derived from the
performance of assets, interest rates, currency exchange rates, or
indexes. Derivative transactions include a wide assortment of
financial contracts including structured debt obligations and
deposits, swaps, futures, options, caps, floors, collars, forwards and
various combinations thereof.
• Exchange-traded derivative contracts: Standardized derivative
contracts (e.g. futures contracts and options) that are transacted on
an organized futures exchange.
• Gross negative fair value: The sum of the fair values of contracts
where the bank owes money to its counter-parties, without taking
into account netting. This represents the maximum losses the
bank’s counter-parties would incur if the bank defaults and there is
no netting of contracts, and no bank collateral was held by the
counter-parties.
• Gross positive fair value: The sum total of the fair values of
contracts where the bank is owed money by its counter-parties,
without taking into account netting. This represents the maximum
losses a bank could incur if all its counter-parties default and there
is no netting of contracts, and the bank holds no counter-party
collateral.
• High-risk mortgage securities: Securities where the price or
expected average life is highly sensitive to interest rate changes, as
determined by the FFIEC policy statement on high-risk mortgage
securities.
• Notional amount: The nominal or face amount that is used to
calculate payments made on swaps and other risk management
products. This amount generally does not change hands and is thus
referred to as notional.
• Over-the-counter (OTC) derivative contracts : Privately negotiated
derivative contracts that are transacted off organized futures
exchanges.
• Structured notes: Non-mortgage-backed debt securities, whose
cash flow characteristics depend on one or more indices and/or
have embedded forwards or options.
• Total risk-based capital: The sum of tier 1 plus tier 2 capital. Tier 1
capital consists of common shareholders equity, perpetual
preferred shareholders equity with non-cumulative dividends,
retained earnings, and minority interests in the equity accounts of
consolidated subsidiaries. Tier 2 capital consists of subordinated
debt, intermediate-term preferred stock, cumulative and long-term
preferred stock, and a portion of a bank’s allowance for loan and
lease losses.
Risk management
The broad parameters of risk management function should cover:
Accurate and timely credit grading is one of the basic components of risk
management.
Credit risk
Credit risk is defined as the possibility of losses associated with diminution in the
credit quality of borrowers or counterparties.
Market risk
Operational risk
New techniques for assessing and managing these risks all focused on their impact on market
value.
• Market risk, by definition, is risk due to uncertainty in future market values.
• New credit risk models assessed potential defaults or credit deteriorations in terms of
their mark-to-market impact.
• Operational risk was also assessed in terms of its actual or potential direct costs.
Such techniques proved effective on bank trading floors, where market values were readily
available. Extending them to other parts of the bank, or even to non-financial corporations,
proved problematic. This was the realm of book value accounting. Market values were
difficult or impossible to secure for items such as private equity, pension liabilities, factory
equipment, intellectual property or natural resource reserves.
Corporate risk management emerged as a catch-all phrase for practices that serve to optimize
risk taking in a context of book value accounting. Generally, this includes risks of non-
financial corporations, but also those of business lines of financial institutions that are not
engaged in trading or investment management. Risks vary from one corporation to the next,
depending on such factors as size, industry, diversity of business lines, sources of capital, etc.
Practices that are appropriate for one corporation are inappropriate for another. For this
reason, corporate risk management is a more elusive notion than is financial risk
management. It encompasses a variety of techniques drawn from both FRM and ALM.
Corporations pick and choose from these, adapting techniques to suit their own needs. This
article is an overview.
Corporate Risk Management
In a corporate setting, the familiar division of risks into market, credit and operational risks
breaks down.
Of these, credit risk poses the least challenges. To the extent that corporations take credit
risk (some take a lot; others take little), new and traditional techniques of credit risk
management are easily adapted.
Operational risk largely doesn't apply to corporations. It includes such factors as model risk
or back office errors. Some aspects do affect corporations—such as fraud or natural
disasters—but corporations have been addressing these with internal
audit, facilities management and legal departments for decades. Also,
corporations face risks that are akin to the operational risk of financial institutions but are
unique to their own business lines. An airline is exposed to risks due to weather, equipment
failure and terrorism. A power generator faces the risk that a generating plant may go down
for unscheduled maintenance. In corporate risk management, these risks—those that
overlap with the operational risks of financial firms and those that are akin
to such operational risks but are unique to non-financial firms—are called
operations risks.
The real challenge of corporate risk management is those risks that are akin to market risk
but aren't market risk. An oil company holds oil reserves. Their "value" fluctuates with the
market price of oil, but what does this mean? The oil reserves don't have a market value. A
chain of restaurants is thriving. Its restaurants are "valuable," but it is impossible to assign
them market values. Something that doesn't have a market value doesn't pose market risk.
This is almost a tautology. Such risks are business risks as opposed to market risks.
In the realm of corporate risk management, we abandon the division of risks into market,
credit and operational risks and replace it with a new categorization:
Corporate risk
• Those that address business risks from a book value standpoint, modifying or
adapting techniques of FRM and ALM as appropriate.
Both approaches are discussed below.
Economic Value
Techniques of the first form focus on a concept called economic value. This is a vague notion
that generalizes the concept of market value. If a market value exists for an asset, then that
market value is the asset's economic value. If a market value doesn't exist, then economic
value is the "intrinsic value" of the asset—what the market value of the asset
would be, if it had a market value.
Economic values can be assigned in two ways.
• One is to start with accounting metrics of value and make suitable adjustments, so
they are more reflective of some intrinsic value. This is the approach employed with
economic value added (EVA) analyses.
• The other approach is to construct some model to predict what value the asset might
command, if a liquid market existed for it. In this respect, a derogatory name for
economic value is mark-to-model value.
Once some means has been established for assigning economic values, these are treated like
market values. Standard techniques of financial risk management—such as value-at-
risk (VaR) or economic capital allocation—are then applied.
This economic approach to managing business risk is applicable if most of a firm's balance
sheet can be marked to market. Economic values then only need to be assigned to a few
items in order for techniques of FRM to be applied firm wide. An example would be a
commodity wholesaler. Most of its balance sheet comprises physical and forward positions in
commodities, which can be mostly marked to market.
More controversial has been the use of economic valuations in power and natural gas
markets. The actual energies trade and, for the most part, can be marked to market. However,
producers also hold significant investments in plants and equipment—and these cannot
be marked to market. Suppose some energy trades spot and forward out
three years. An asset that produces the energy has an expected life of 50
years, which means that an economic value for the asset must reflect a hypothetical 50-year
forward curve. The forward curve doesn't exist, so a model must construct one.
Consequently, assigned economic values are highly dependent on assumptions. Often, they
are arbitrary.
In this context, it isn't enough to assign economic values. VaR analyses require standard
deviations and correlations as well. Assigning these to 50-year forward prices that are
themselves hypothetical is essentially meaningless—yet, those standard deviations
and correlations determine the reported VaR.
These dubious techniques were widely (but not universally) adopted by US energy merchants
in the late 1990s and early 2000s. The most publicized of these was Enron Corp., which went
beyond using economic values for internal reporting and incorporated them into its financial
reporting to investors. The 2001 bankruptcy of Enron and subsequent revelations of fraud
tainted mark-to-model techniques.
Book Value
The second approach to addressing business risk starts by defining risks that are meaningful
in the context of book value accounting.
Most typical of these are:
• Earnings risk, which is risk due to uncertainty in future reported earnings, and
• Cash flow risk, which is risk due to uncertainty in future reported cash flows.
Of the two, earnings risk is more akin to market risk. Yet, it avoids the arbitrary assumptions
of economic valuations. A firm's accounting earnings are a well defined notion. A problem
with looking at earnings risk is that earnings are, well, non-economic. Earnings may be
suggestive of economic value, but they can be misleading and are often easy to manipulate.
A firm can report high earnings while its long term franchise is eroded away by lack of
investment or competing technologies. Financial transactions can boost short-term earnings
at the expense of long-term earnings. After all, traditional techniques of ALM focus on
earnings, and their shortcomings remain today.
Cash flow risk is less akin to market risk. It relates more to liquidity than the value of a firm,
but this is only partly true. As anyone who has ever worked with distressed firms can attest,
"cash is king." When a firm gets into difficulty, earnings and market values don't pay the
bills. Cash flow is the life blood of a firm. However, as with earnings risk, cash flow risk
offers only an imperfect picture of a firm's business risk. Cash flows can also be manipulated,
and steady cash flows may hide corporate decline.
Techniques for managing earnings risk and cash flow risk draw heavily on techniques of
ALM—especially scenario analysis and simulation analysis. They also
adapt techniques of FRM. In this context, value-at-risk (VaR) becomes
earnings-at-risk (EaR) or cash-flow-at-risk (CFaR). For example, EaR might be
reported as the 10% quantile of this quarter's earnings (which is the same as the 90% quantile
of reported loss, multiplied by minus one).
The actual calculations of EaR or CFaR differ from those for VaR. These are long-term risk
metrics, with horizons of three months or a year. VaR is routinely calculated over a one-day
horizon. Also, EaR and CFaR are driven by rules of accounting while VaR is driven by
financial engineering principles. Typically, EaR or CFaR are calculated by first performing a
simulation analysis. That generates a probability distribution for the period's earnings or cash
flow, which is then used to value the desired metric of EaR or CFaR.
One decision that needs to be made with EaR or CFaR is whether to use a constant or
contracting horizon. If management wants an EaR analysis for quarterly earnings, should the
analysis actually assess risk to the current quarter's earnings? If that is the case, the horizon
will start at three months on the first day of the quarter and gradually shrink to zero by the
end of the quarter. The alternative is to use a constant three-month horizon. After the first day
of the quarter, results will no longer apply to that quarter's actual earnings, but to some
hypothetical earnings over a shifting three-month horizon. Both approaches are used. The
advantage of a contracting horizon is that it addresses an actual concern of management—
will we hit our earnings target this quarter? A disadvantage is that the risk metric keeps
changing—if reported EaR declines over a week, does this mean that actual risk has declined,
or does it simply reflect a shortened horizon?
Conclusion
While the two approaches to business risk management—that based on economic value and
that based on book value—are philosophically different, they can complement each other.
Some firms use them side-by-side to assess different aspects of business risk.
This article has focused on the unique challenges of corporate risk management. There is
much else about corporate risk management that overlaps with financial risk management—
the need for a risk management function, the role of corporate culture, technology issues,
independence, etc. See the article Financial Risk Management for a discussion of these and
other topics.
Corporate Risk Management
Listed below are brief tips that may be helpful as an overview and guidelines for risk
management activities. If there are questions on these risk management highlights or if more
detailed information is needed, please contact Risk Limited directly.
Risk is everywhere. Success in business often comes down to recognizing and managing
possible risks associated with potential opportunities and returns. The types of risks faced in
most businesses are quite varied and far ranging. Risks typically include both financial and
physical categories. Types of risk include sometimes apparent hazards, such as safety and
health risks associated with operations, as well as financial risks from exposures to market
price volatility, counter party credit defaults, and legal liabilities. Some risks are intuitively
obvious; unfortunately, many are not. Risk categories include: Market, Credit, Legal,
Regulatory, Political, Operational, Strategic, Reputational, Event, Country and Model Risks.
So first identify possible risks throughout your business.
Interactions and correlations of risks are a key element of which to be aware in identifying,
quantifying and mitigating risks. For example, exposure to credit risks may also affect
market price risks, whereas operational risks such as fraud may create legal and reputational
risks. Recognition that risks interact between business activities is one of the basis for the
'enterprise-wide risk management' approach now widely practiced by leading companies.
Things change, and so do risks. Market conditions and volatility levels change, financial
strength of counter parties change, physical environments change, geopolitical situations
change, and on-and-on. And these changes can be rather sudden, or they can be creeping and
hidden. Exposures to risks that result from business activities may also change. Effective risk
management requires that one reevaluate risks on an ongoing basis, and processes such as a
RiskAudit ® should be built into the corporate risk management framework to assess both
current and projected risk exposures. Forecasting future exposures is necessary since hedge
decisions are based on projected risk levels.
Effective risk management also requires considerable expertise and resources, from basic risk
control, compliance and governance activities, through advanced quantitative risk analysis.
The costs for these resources are usually not cheap, but as has been proven repeatedly by
high-profile business failures, the cost of losses due to risk management weaknesses or lapses
can be catastrophically high. Investment in risk management capabilities for most businesses
has a high payoff. Due to the potentially extreme cost of mistakes, risk managers should be
especially well trained.
Transferring risks through hedge transactions or other activities is often an effective and
advisable risk management technique, but risk mitigation strategy may largely depend on the
hedge costs. Risk mitigation strategies also depend on the capacity of the firm to sustain risks
and possible losses. Trading activities that are truly for hedging should not be avoided due to
concern that trading could be misconstrued as 'speculative'; however, various hedge
instruments may not have the same cost effectiveness or appropriateness for every company
and environment.
4. Reduce exposure
Risk management does not equate to risk aversion; however, decisions driven by risk/reward
assessments usually have a higher probability of successful outcomes. A consideration in
such risk-based business decision-making should also be the capacity of the firm to sustain
risks. As in the well developed finance field of portfolio theory (which in general terms
focuses on how investors can best balance risks and rewards in constructing investment
portfolios), business decisions based on risk/reward balance should optimize returns.
A key value of quantitative risk measures is to highlight significant changes in risk levels.
Although opinions may differ on the optimal methodology for some valuation metrics,
significant changes or trends in risk metrics, such as Value-at-Risk measures, can provide a
key signal to management. Best practices designs of management reporting 'dashboards'
provide this risk monitoring capability, also showing segment reporting and consolidation to
reflect correlations such as offsets in price risks between markets.
Educate the organization in practical aspects of risk management, and that especially
includes the most senior business executives and the corporate board of directors. Risk
management responsibilities should be clear. Whether it is intuitive actions based on
experience and expertise in risk management or whether it is a result of institutionalized risk
policies and procedures, effective risk management is typically a key factor in successful
businesses. Training and building awareness can lead to a risk management culture that will
drive business success.
Cash management
In United States banking, cash management, or treasury management, is a marketing term
for certain services offered primarily to larger business customers. It may be used to describe
all bank accounts (such as checking accounts) provided to businesses of a certain size, but it
is more often used to describe specific services such as cash concentration, zero balance
accounting, and automated clearing house facilities. Sometimes, private banking customers
are given cash management services.
Cash management services generally offered
The following is a list of services generally offered by banks and utilised by larger businesses
and corporations:
• Account Reconcilement Services: Balancing a checkbook can be
a difficult process for a very large business, since it issues so many
checks it can take a lot of human monitoring to understand which
checks have not cleared and therefore what the company's true
balance is. To address this, banks have developed a system which
allows companies to upload a list of all the checks that they issue
on a daily basis, so that at the end of the month the bank
statement will show not only which checks have cleared, but also
which have not. More recently, banks have used this system to
prevent checks from being fraudulently cashed if they are not on
the list, a process known as positive pay.
• Advanced Web Services: Most banks have an Internet-based
system which is more advanced than the one available to
consumers. This enables managers to create and authorize special
internal logon credentials, allowing employees to send wires and
access other cash management features normally not found on the
consumer web site.
• Armored Car Services (Cash Collection Services): Large
retailers who collect a great deal of cash may have the bank pick
this cash up via an armored car company, instead of asking its
employees to deposit the cash.
• Automated Clearing House: services are usually offered by the
cash management division of a bank. The Automated Clearing
House is an electronic system used to transfer funds between
banks. Companies use this to pay others, especially employees (this
is how direct deposit works). Certain companies also use it to
collect funds from customers (this is generally how automatic
payment plans work). This system is criticized by some consumer
advocacy groups, because under this system banks assume that
the company initiating the debit is correct until proven otherwise.
• Balance Reporting Services: Corporate clients who actively
manage their cash balances usually subscribe to secure web-based
reporting of their account and transaction information at their lead
bank. These sophisticated compilations of banking activity may
include balances in foreign currencies, as well as those at other
banks. They include information on cash positions as well as 'float'
(e.g., checks in the process of collection). Finally, they offer
transaction-specific details on all forms of payment activity,
including deposits, checks, wire transfers in and out, ACH
(automated clearinghouse debits and credits), investments, etc.
• Cash Concentration Services: Large or national chain retailers
often are in areas where their primary bank does not have
branches. Therefore, they open bank accounts at various local
banks in the area. To prevent funds in these accounts from being
idle and not earning sufficient interest, many of these companies
have an agreement set with their primary bank, whereby their
primary bank uses the Automated Clearing House to electronically
"pull" the money from these banks into a single interest-bearing
bank account.
• Lockbox - Retail: services: Often companies (such as utilities)
which receive a large number of payments via checks in the mail
have the bank set up a post office box for them, open their mail,
and deposit any checks found. This is referred to as a "lockbox"
service.
• Lockbox - Wholesale: services: are for companies with small
numbers of payments, sometimes with detailed requirements for
processing. This might be a company like a dentist's office or small
manufacturing company.
• Positive Pay: Positive pay is a service whereby the company
electronically shares its check register of all written checks with the
bank. The bank therefore will only pay checks listed in that register,
with exactly the same specifications as listed in the register
(amount, payee, serial number, etc.). This system dramatically
reduces check fraud.
• Reverse Positive Pay: Reverse positive pay is similar to positive
pay, but the process is reversed, with the company, not the bank,
maintaining the list of checks issued. When checks are presented
for payment and clear through the Federal Reserve System, the
Federal Reserve prepares a file of the checks' account numbers,
serial numbers, and dollar amounts and sends the file to the bank.
In reverse positive pay, the bank sends that file to the company,
where the company compares the information to its internal
records. The company lets the bank know which checks match its
internal information, and the bank pays those items. The bank then
researches the checks that do not match, corrects any misreads or
encoding errors, and determines if any items are fraudulent. The
bank pays only "true" exceptions, that is, those that can be
reconciled with the company's files.
• Sweep accounts: are typically offered by the cash management
division of a bank. Under this system, excess funds from a
company's bank accounts are automatically moved into a money
market mutual fund overnight, and then moved back the next
morning. This allows them to earn interest overnight. This is the
primary use of money market mutual funds.
• Zero Balance Accounting: can be thought of as somewhat of a
hack. Companies with large numbers of stores or locations can very
often be confused if all those stores are depositing into a single
bank account. Traditionally, it would be impossible to know which
deposits were from which stores without seeking to view images of
those deposits. To help correct this problem, banks developed a
system where each store is given their own bank account, but all
the money deposited into the individual store accounts are
automatically moved or swept into the company's main bank
account. This allows the company to look at individual statements
for each store. U.S. banks are almost all converting their systems so
that companies can tell which store made a particular deposit,
even if these deposits are all deposited into a single account.
Therefore, zero balance accounting is being used less frequently.
• Wire Transfer: A wire transfer is an electronic transfer of funds.
Wire transfers can be done by a simple bank account transfer, or by
a transfer of cash at a cash office. Bank wire transfers are often the
most expedient method for transferring funds between bank
accounts. A bank wire transfer is a message to the receiving bank
requesting them to effect payment in accordance with the
instructions given. The message also includes settlement
instructions. The actual wire transfer itself is virtually
instantaneous, requiring no longer for transmission than a
telephone call.
• Controlled Disbursement: This is another product offered by
banks under Cash Management Services. The bank provides a daily
report, typically early in the day, that provides the amount of
disbursements that will be charged to the customer's account. This
early knowledge of daily funds requirement allows the customer to
invest any surplus in intraday investment opportunities, typically
money market investments. This is different from delayed
disbursements, where payments are issued through a remote
branch of a bank and customer is able to delay the payment due to
increased float time.
In the past, other services have been offered the usefulness of which has diminished with the
rise of the Internet. For example, companies could have daily faxes of their most recent
transactions or be sent CD-ROMs of images of their cashed checks.
Cash management services can be costly but usually the cost to a company is outweighed by
the benefits: cost savings, accuracy, efficiencies, etc.
INVENTORY
Inventory means goods and materials, or those goods and materials themselves, held
available in stock by a business. This word is also used for a list of the contents of a
household and for a list for testamentary purposes of the possessions of someone who has
died. In accounting, inventory is considered an asset.
In business management, inventory consists of a list of goods and materials held available in
stock.
Inventory Management
Inventory refers to the stock of resources, that possess economic value, held by an
organization at any point of time. These resource stocks can be manpower, machines, capital
goods or materials at various stages.
Inventory management is primarily about specifying the size and placement of stocked
goods. Inventory management is required at different locations within a facility or within
multiple locations of a supply network to protect the regular and planned course of
production against the random disturbance of running out of materials or goods. The scope of
inventory management also concerns the fine lines between replenishment lead time,
carrying costs of inventory, asset management, inventory forecasting, inventory valuation,
inventory visibility, future inventory price forecasting, physical inventory, available physical
space for inventory, quality management, replenishment, returns and defective goods and
demand forecasting. Balancing these competing requirements leads to optimal inventory
levels, which is an on-going process as the business needs shift and react to the wider
environment.
Inventory management involves a retailer seeking to acquire and maintain a proper
merchandise assortment while ordering, shipping, handling, and related costs are kept in
check.
Systems and processes that identify inventory requirements, set targets, provide
replenishment techniques and report actual and projected inventory status.
Handles all functions related to the tracking and management of material. This would include
the monitoring of material moved into and out of stockroom locations and the reconciling of
the inventory balances. Also may include ABC analysis, lot tracking, cycle counting support
etc.
Management of the inventories, with the primary objective of determining/controlling stock
levels within the physical distribution function to balance the need for product availability
against the need for minimizing stock holding and handling costs. See inventory
proportionality.
Business inventory
The reasons for keeping stock
There are three basic reasons for keeping an inventory:
1. Time - The time lags present in the supply chain, from supplier to
user at every stage, requires that you maintain certain amounts of
inventory to use in this "lead time."
2. Uncertainty - Inventories are maintained as buffers to meet
uncertainties in demand, supply and movements of goods.
3. Economies of scale - Ideal condition of "one unit at a time at a place
where a user needs it, when he needs it" principle tends to incur
lots of costs in terms of logistics. So bulk buying, movement and
storing brings in economies of scale, thus inventory.
All these stock reasons can apply to any owner or product stage.
• Buffer stock is held in individual workstations against the
possibility that the upstream workstation may be a little delayed in
long setup or change over time. This stock is then used while that
changeover is happening. This stock can be eliminated by tools like
SMED.
These classifications apply along the whole Supply chain, not just within a facility or plant.
Where these stocks contain the same or similar items, it is often the work practice to hold all
these stocks mixed together before or after the sub-process to which they relate. This
'reduces' costs. Because they are mixed up together there is no visual reminder to operators of
the adjacent sub-processes or line management of the stock, which is due to a particular
cause and should be a particular individual's responsibility with inevitable consequences.
Some plants have centralized stock holding across sub-processes, which makes the situation
even more acute.
Special terms used in dealing with inventory
• Stock Keeping Unit (SKU) is a unique combination of all the
components that are assembled into the purchasable item.
Therefore, any change in the packaging or product is a new SKU.
This level of detailed specification assists in managing inventory.
• Stockout means running out of the inventory of an SKU.[1]
• "New old stock" (sometimes abbreviated NOS) is a term used in
business to refer to merchandise being offered for sale that was
manufactured long ago but that has never been used. Such
merchandise may not be produced anymore, and the new old stock
may represent the only market source of a particular item at the
present time.
Typology
1. Buffer/safety stock
2. Cycle stock (Used in batch processes, it is the available inventory,
excluding buffer stock)
3. De-coupling (Buffer stock that is held by both the supplier and the
user)
4. Anticipation stock (Building up extra stock for periods of increased
demand - e.g. ice cream for summer)
5. Pipeline stock (Goods still in transit or in the process of distribution -
have left the factory but not arrived at the customer yet)
Inventory examples
While accountants often discuss inventory in terms of goods for sale, organizations -
manufacturers, service-providers and not-for-profits - also have inventories (fixtures,
furniture, supplies, ...) that they do not intend to sell. Manufacturers', distributors', and
wholesalers' inventory tends to cluster in warehouses. Retailers' inventory may exist in a
warehouse or in a shop or store accessible to customers. Inventories not intended for sale to
customers or to clients may be held in any premises an organization uses. Stock ties up cash
and, if uncontrolled, it will be impossible to know the actual level of stocks and therefore
impossible to control them.
While the reasons for holding stock were covered earlier, most manufacturing organizations
usually divide their "goods for sale" inventory into:
• Raw materials - materials and components scheduled for use in
making a product.
• Work in process, WIP - materials and components that have begun
their transformation to finished goods.
• Finished goods - goods ready for sale to customers.
• Goods for resale - returned goods that are salable.
For example:
Manufacturing
A canned food manufacturer's materials inventory includes the ingredients to form the foods
to be canned, empty cans and their lids (or coils of steel or aluminum for constructing those
components), labels, and anything else (solder, glue, ...) that will form part of a finished can.
The firm's work in process includes those materials from the time of release to the work floor
until they become complete and ready for sale to wholesale or retail customers. This may be
vats of prepared food, filled cans not yet labeled or sub-assemblies of food components. It
may also include finished cans that are not yet packaged into cartons or pallets. Its finished
good inventory consists of all the filled and labeled cans of food in its warehouse that it has
manufactured and wishes to sell to food distributors (wholesalers), to grocery stores
(retailers), and even perhaps to consumers through arrangements like factory stores and
outlet centers.
Examples of case studies are very revealing, and consistently show that the improvement of
inventory management has two parts: the capability of the organisation to manage inventory,
and the way in which it chooses to do so. For example, a company may wish to install a
complex inventory system, but unless there is a good understanding of the role of inventory
and its perameters, and an effective business process to support that, the system cannot bring
the necessary benefits to the organisation in isolation.
Typical Inventory Management techniques include Pareto Curve ABC Classification[2] and
Economic Order Quantity Management. A more sophisticated method takes these two
techniques further, combining certain aspects of each to create The K Curve Methodology[3].
A case study of k-curve[4] benefits to one company shows a successful implementation.
Unnecessary inventory adds enormously to the working capital tied up in the business, as
well as the complexity of the supply chain. Reduction and elimination of these inventory
'wait' states is a key concept in Lean[5]. Too big an inventory reduction too quickly can cause
a business to be anorexic. There are well-proven processes and techniques to assist in
inventory planning and strategy, both at the business overview and part number level. Many
of the big MRP/and ERP systems do not offer the necessary inventory planning tools within
their integrated planning applications.
Principle of inventory proportionality
Purpose
Inventory proportionality is the goal of demand-driven inventory management. The primary
optimal outcome is to have the same number of days' (or hours', etc.) worth of inventory on
hand across all products so that the time of runout of all products would be simultaneous. In
such a case, there is no "excess inventory," that is, inventory that would be left over of
another product when the first product runs out. Excess inventory is sub-optimal because the
money spent to obtain it could have been utilized better elsewhere, i.e. to the product that just
ran out.
The secondary goal of inventory proportionality is inventory minimization. By integrating
accurate demand forecasting with inventory management, replenishment inventories can be
scheduled to arrive just in time to replenish the product destined to run out first, while at the
same time balancing out the inventory supply of all products to make their inventories more
proportional, and thereby closer to achieving the primary goal. Accurate demand forecasting
also allows the desired inventory proportions to be dynamic by determining expected sales
out into the future; this allows for inventory to be in proportion to expected short-term sales
or consumption rather than to past averages, a much more accurate and optimal outcome.
Integrating demand forecasting into inventory management in this way also allows for the
prediction of the "can fit" point when inventory storage is limited on a per-product basis.
Applications
The technique of inventory proportionality is most appropriate for inventories that remain
unseen by the consumer. As opposed to "keep full" systems where a retail consumer would
like to see full shelves of the product they are buying so as not to think they are buying
something old, unwanted or stale; and differentiated from the "trigger point" systems where
product is reordered when it hits a certain level; inventory proportionality is used effectively
by just-in-time manufacturing processes and retail applications where the product is hidden
from view.
One early example of inventory proportionality used in a retail application in the United
States is for motor fuel. Motor fuel (e.g. gasoline) is generally stored in underground storage
tanks. The motorists do not know whether they are buying gasoline off the top or bottom of
the tank, nor need they care. Additionally, these storage tanks have a maximum capacity and
cannot be overfilled. Finally, the product is expensive. Inventory proportionality is used to
balance the inventories of the different grades of motor fuel, each stored in dedicated tanks,
in proportion to the sales of each grade. Excess inventory is not seen or valued by the
consumer, so it is simply cash sunk (literally) into the ground. Inventory proportionality
minimizes the amount of excess inventory carried in underground storage tanks. This
application for motor fuel was first developed and implemented by Petrolsoft Corporation in
1990 for Chevron Products Company. Most major oil companies use such systems today.[6]
Roots
The use of inventory proportionality in the United States is thought to have been inspired by
Japanese just-in-time parts inventory management made famous by Toyota Motors in the
1980s.[3]
High-level inventory management
It seems that around 1880[7] there was a change in manufacturing practice from companies
with relatively homogeneous lines of products to vertically integrated companies with
unprecedented diversity in processes and products. Those companies (especially in
metalworking) attempted to achieve success through economies of scope - the gains of
jointly producing two or more products in one facility. The managers now needed
information on the effect of product-mix decisions on overall profits and therefore needed
accurate product-cost information. A variety of attempts to achieve this were unsuccessful
due to the huge overhead of the information processing of the time. However, the burgeoning
need for financial reporting after 1900 created unavoidable pressure for financial accounting
of stock and the management need to cost manage products became overshadowed. In
particular, it was the need for audited accounts that sealed the fate of managerial cost
accounting. The dominance of financial reporting accounting over management accounting
remains to this day with few exceptions, and the financial reporting definitions of 'cost' have
distorted effective management 'cost' accounting since that time. This is particularly true of
inventory.
Hence, high-level financial inventory has these two basic formulas, which relate to the
accounting period:
1. Cost of Beginning Inventory at the start of the period + inventory
purchases within the period + cost of production within the period
= cost of goods available
2. Cost of goods available − cost of ending inventory at the end of the
period = cost of goods sold
The benefit of these formulae is that the first absorbs all overheads of production and raw
material costs into a value of inventory for reporting. The second formula then creates the
new start point for the next period and gives a figure to be subtracted from the sales price to
determine some form of sales-margin figure.
Manufacturing management is more interested in inventory turnover ratio or average days to
sell inventory since it tells them something about relative inventory levels.
Inventory turnover ratio (also known as inventory turns) = cost of goods
sold / Average Inventory = Cost of Goods Sold / ((Beginning Inventory +
Ending Inventory) / 2)
The foundation behind account receivables is your policies and procedures for sales.
For example, do you have a credit policy?
When and how do you evaluate a customer for credit?
If you look at past payment histories, you should be able to ascertain who should get credit
and who shouldn't.
Additionally, you need to establish sales terms.
For example, is it beneficial to offer discounts to speed-up cash collections?
What is the industry standard for sales terms?
There are several questions that have to be answered in building the foundation for managing
accounts receivables.
A system must be in place to track accounts receivables. This will include balance forwards,
listing of all open invoices, and generation of monthly statements to customers.
An aging of receivables will be used to collect overdue accounts. You must act quickly to
collect overdue accounts. Start by making phone calls followed by letters to upper-level
managers for the Customer. Try to negotiate settlement payments, such as installments or
asset donations. If your collection efforts fail, you may want to use a collection agency.
Also remember that the collection process is the art of knowing the customer. A
psychological understanding of the customer gives you insights into what buttons to push in
collecting the account. One of the biggest mistakes made in the collection process is a "sticks
only" approach. For some customers, using a carrot can work wonders in collecting the
overdue account. For example, in one case the company mailed a set of football tickets to a
customer with a friendly note and within weeks, they received full payment of the
outstanding account.
MEASUREMENT
Measurement is another component within account receivable management. Traditional
ratios, such as turnover will measure how many times you were able to convert receivables
over into cash.
Example: Monthly sales were $ 50,000, the beginning monthly balance for receivables was $
70,000 and the ending monthly balance was $ 90,000. The turnover ratio is:
.625 ($ 50,000 / (($70,000 + $ 90,000)/2)). Annual turnover is .625 x 360 / 30 or 7.5 times. If
you divide 360 (bankers year) by 7.5, you get 48 days on average to collect your account
receivables. You can also measure your investment in receivables. This calculation is based
on the number of days it takes you to collect receivables and the amount of credit sales.
Example: Annual credit sales are $ 100,000. Your invoice terms are net 30 days. On average,
most accounts are 13 days past due. Your investment in accounts receivable is:
(30 + 13) / 365 x $ 100,000 or $ 11,781.
Example: Average monthly sales are $ 10,000. On average, accounts receivable are paid 60
days after the sales date. The product costs are 50% of sales and inventory-carrying costs are
10% of sales. Your investment in accounts receivable is:
2 months x $ 10,000 = $ 20,000 of sales x .60 = $ 18,000.
Measurements may need to be modified to account for wide fluctuations within the sales
cycle. The use of weights can help ensure comparable measurements.
Example: Weighted Average Days to Pay = Sum of ((Date Paid - Due Date) x Amount
Paid) / Total Payments
Example: Best Possible Days Outstanding = (Current A/R x # of Days in Period) / Credit
Sales for Period
Receivable Management also involves the use of specialist. After-all, you need to spend most
of your time trying to lower your losses and not trying to collect overdue accounts. A wide
range of specialist can help:
Credit Sales /
COGS / 365
365 COGS / 365
Derivation
Cashflows insufficient. The term "cash conversion cycle" refers to the timespan between a
firm's disbursing and collecting cash. However, the CCC cannot be directly observed in
cashflows, because these are also influenced by investment and financing activities; it must
be derived from Statement of Financial Position data associated with the firm's operations.
Equation describes retailer. Although the term "cash conversion cycle" technically applies
to a firm in any industry, the equation is generically formulated to apply specifically to a
retailer. Since a retailer's operations consist in buying and selling inventory, the equation
models the time between
(1) disbursing cash to satisfy the accounts payable created by sale of a
unit of inventory, and
In calculating each of these three constituent Conversion Cycles, we use the equation TIME
=LEVEL/RATE (since each interval roughly equals the TIME needed for its LEVEL to be
achieved at its corresponding RATE).
• We estimate its LEVEL "during the period in question" as the
average of its levels in the two balance-sheets that surround the
period: (Lt1+Lt2)/2.
• To estimate its RATE, we note that Accounts Receivable grows only
when revenue is accrued; and Inventory shrinks and Accounts
Payable grows by an amount equal to the COGS expense (in the
long run, since COGS actually accrues sometime after the inventory
delivery, when the customers acquire it).
• Payables conversion period: Rate = [inventory increase +
COGS], since these are the items for the period that can increase
"trade accounts payables," i.e. the ones that grew its inventory.
NOTICE that we make an exception when calculating this interval:
although we use a period average for the LEVEL of inventory, we also
consider any increase in inventory as contributing to its RATE of change.
This is because the purpose of the CCC is to measure the effects of
inventory growth on cash outlays. If inventory grew during the period, we
want to know about it.
• Inventory conversion period: Rate = COGS, since this is the item
that (eventually) shrinks inventory.
• Receivables conversion period: Rate = revenue, since this is the
item that can grow receivables (sales).
Inventory
Account
receivable
Cash
conversion
cycle
Accounts Cash
payable
Restrictive trade practices
The term restrictive trade practice is used for any strategy used by producers to
restrict competition within a given market. Collusion resulting in the formation of
a cartel is one such practice. Other practices that fall short of the formation of a
cartel but are nonetheless against the public interest and illegal include: (a) the
setting of minimum prices; (b) agreements to share markets; (c) the refusal to
supply retailers that stock the products of other competitors; (d) setting different
prices for different buyers (discriminatory pricing); (e) exchanging information.
The aim of restrictive practices is to raise prices and restrict output to the
benefit of the companies practicing them.
Monopolies and Restrictive Trade Practices Commission (MRTPC)
An important organ of the Department of Company Affairs is the Monopolies and Restrictive
Trade Practices Commission (MRTP Commission) a quasi-judicial body. The MRTP
Commission established under Section 5 of the Monopolies and Restrictive Trade Practices
Act, 1969, discharge functions as per the provisions of the Act. The main function of the
MRTP Commission is to enquire into and take appropriate action in respect of unfair trade
practices and restrictive trade practices. In regard to monopolistic trade practices the
Commission is empowered under section 10(b) to inquire into such practices (i) upon a
reference made to it by the Central Government or (ii) upon its own knowledge or
information and submit its findings to Central Government for further action.
Question bank
Mangement paper-ll
Note: This paper contains fifty (50) multiple-choice questions, each carrying two
(2) marks. Attmpt all of them.
Define oligopoly and explain price rigidity under oligopoly in terms of Kinked
demand curve
Distinguish between micro and macro environments and explain the relationship
between the two.
What are the factors guiding the activities of corporate social responsibility?
“The short-run cost curves are derived from production function”, Evaluate
What is Business Cycle and what are the different phases of Business Cycle?
Organizational Behavior:-
How can the divorce of planning and doing improve the productivity and
effectiveness of work/
Do you think in the light of the Hawthorne experiment that there exists a
relationship between working conditions and productivity/
Atttitude is more important than working condition. Discuss the above statement
in the light of Hwthorne experiment.
Compare and contrast the contribution of F.W.Taylor with that of Elton Mayo.
Selection tests reveal more but that is suggested. They conceal less but that is
vital”Critically evaluate the statement.
What is potential appraisal? How does it differ from Performance appraisal?
Discuss.
Explain Victor Vroom’s Expectancy theory and point out its limitations
Determine the job suitability of the people who have high need for power
Why do some of the people avoid the pain of being rejected by a social group?
The tendency to feel rejection as an acute pain may have developed in humans
as a defensive mechanism for the species, she said.
"Because we have such a long time as infants and need to be taken care of, it is
really important that we stay close to the social group. If we don't we're not
going to survive," said Eisenberger.
"The hypothesis is that the social attachment system that makes sure we don't
stray too far from the group piggybacked onto the pain system to help our
species survive."
Just as an infant may learn to avoid fire by first being burned, humans may learn
to stick together because rejection causes distress in the pain center of the
brain, said Eisenberger.
"If it hurts to be separated from other people, then it will prevent us from
straying too far from the social group," she said.
Social Groups
A social group consists of two or more people who interact with one another and who
recognize themselves as a distinct social unit. The definition is simple enough, but it has
significant implications. Frequent interaction leads people to share values and beliefs. This
similarity and the interaction cause them to identify with one another. Identification and
attachment, in turn, stimulate more frequent and intense interaction. Each group maintains
solidarity with all to other groups and other types of social systems.
Groups are among the most stable and enduring of social units. They are important both to
their members and to the society at large. Through encouraging regular and predictable
behavior, groups form the foundation upon which society rests. Thus, a family, a village, a
political party a trade union is all social groups. These, it should be noted are different from
social classes, status groups or crowds, which not only lack structure but whose members are
less aware or even unaware of the existence of the group. These have been called quasi-
groups or groupings. Nevertheless, the distinction between social groups and quasi-groups is
fluid and variable since quasi-groups very often give rise to social groups, as for example,
social classes give rise to political parties.
Primary Groups
If all groups are important to their members and to society, some groups are more important
than others. Early in the twentieth century, Charles H. Cooley gave the name, primary
groups, to those groups that he said are characterized by intimate face-to-face association and
those are fundamental in the development and continued adjustment of their members. He
identified three basic primary groups, the family, the child's play group, and the
neighborhoods or community among adults. These groups, he said, are almost universal in all
societies; they give to people their earliest and most complete experiences of social unity;
they are instrumental in the development of the social life; and they promote the integration
of their members in the larger society. Since Cooley wrote, over 65 years ago, life in the
United States has become much more urban, complex, and impersonal, and the family play
group and neighborhood have become less dominant features of the social order.
Secondary Groups
Largeness of the size: Secondary groups are relatively larger in size. City, nation, political
parties, trade unions and corporations, international associations are bigger in size. They may
have thousands and lakhs of members. There may not be any limit to the membership in the
case of some secondary groups.
No physical basis: Secondary groups are not characterized by physical proximity. Many
secondary groups are not limited to any definite area. There are some secondary groups like
the Rotary Club and Lions Club which are international in character. The members of such
groups are scattered over a vast area.
Specific ends or interest: Secondary groups are formed for the realization of some specific
interests or ends. They are called special interest groups. Members are interested in the
groups because they have specific ends to aim at. Indirect communication: Contacts and
communications in the case of secondary groups are mostly indirect. Mass media of
communication such as radio, telephone, television, newspaper, movies, magazines and post
and telegraph are resorted to by the members to have communication.
Communication may not be quick and effective even. Impersonal nature of social
relationships in secondary groups is both the cause and the effect of indirect communication.
Nature of group control: Informal means of social control are less effective in regulating
the relations of members. Moral control is only secondary. Formal means of social control
such as law, legislation, police, court etc are made of to control the behavior of members.
The behavior of the people is largely influenced and controlled by public opinion,
propaganda, rule of law and political ideologies. Group structure: The secondary group has a
formal structure. A formal authority is set up with designated powers and a clear-cut division
of labor in which the function of each is specified in relation to the function of all. Secondary
groups are mostly organized groups. Different statuses and roles that the members assume
are specified. Distinctions based on caste, colour, religion, class, language etc are less rigid
and there is greater tolerance towards other people or groups.
Reference Groups
According to Merton reference groups are those groups which are the referring points of the
individuals, towards which he is oriented and which influences his opinion, tendency and
behaviour.The individual is surrounded by countless reference groups. Both the memberships
and inner groups and non memberships and outer groups may be reference groups.
Discuss the measures taken by government for the promotion of small and tiny
enterprises in the wake of globalization?
HRM:-
Rate buster: An employee who is highly productive and exceeds the formally
agreed rate of output for the particular task. Whilst this is advantageous for
management, rate-busters are usually disliked by their colleagues because their
action provides managers with the excuse to raise the rate of output for all the
other employees. Typically, there is informal social regulation of work in most
workgroups where rate-busting is deemed antisocial behaviour and potential
rate-busters are brought into line by their work colleagues through a mixture of
persuasion and coercion.
Define ‘Selection’.
Finance:-
Explain briefly:
State the method of risk analysis with reference to capital budgeting decision
What is working capital? How would you assess the working capital
requirement of a firm?
Explain the concept and measurement of risk and return of single asset and
a portfolio.
What is the relationship between an investor’s required rate of return and the
value of a security? Explain with example
Discuss the purpose of the statements of changes in financial position when
prepared on working capital basis and cash basis
How is cost of debt similar to cost of preference capital/ Descibe the uses and
limitations of cost of capital to a financial manager.
What are the basic financial derivatives? Describe the function of economic
nature as performed by participants in derivative market.
What are the different conflicting views on capital structure? Describe the
Modiglianni and Miller theory on relationship between capital structure and
value of firm.
The final implication of both Walter-model and Gordon-model are same for
dividend distribution” Discuss and comment.
Proper financial analysis can provide early warning signals about the health
of the organization.” Elaborate.
What are the two important characteristics of current assets? State their
implications for Working Capital Management
“Reducing rate of interest on loans and debts has led to debt restructuring”
Explain this in the context of rising rate of inflation and cost of capital of the
firm.
How are the values of perpetual bonds and preference shares determined?
Bring out the similarity of this process with that used to value a zero growth
share
Discuss the process for calculating the cost of retained earnings. Also bring
out the theoretical and practical difficulties associated with this calculation.
Explain the relationship between capital structure and value of the firm.
Borrowing funds to increase capital investment with the hope that the
business will be able to generate returns in excess of the interest charges.
***************************************
Economic condition
Return of P 55 50 60 70
Ltd. stock
Return of Q 75 65 50 40
Ltd. stock
Rs.500 in the equity stock of P Ltd and Rs.500 in the equity stock of Q Ltd;
Rs.700 in the equity stock of P Ltd and Rs.300 in the equity stock of Q Ltd
In what different ways are the investment, financing and dividend decisions
interrelated? Give arguments in support of the position that dividends are
relevant to stock valuation and that dividend policy is an active decision
variable.
Explain briefly the factors which are influencing dividend policy of a company
****************************************
Briefly explain why one prefer NPV method over the IRR method as project
evaluation technique
Define ‘Capital Budgeting’ and discuss its features
Under what conditions do the NPV and IRR methods conflict? Which of these
two methods should be used to take capital budgeting decision under such
conflicting situation/
Comapre the NPVmethod with the IRR method. What are the steps involved
in the calculation of IRR in the case of uneven cash inflows?
Explain the criterion for judging the acceptability of investments when benefit
–cost ration is used. What is the B/C ration of an investment when its NPV is
zero?
******************************************
What is the basic purpose of holding inventory? Describe the risk-return trade
offs associated with inventory management.
What are the costs associated with inventory management? Illustrate the use
of Economic Order Quantity
Briefly explain the concept of factor productivity, factor intensity and returns
to scale under production analysis.
What is linear programming problem and what are its components? Discuss the
scope and role of linear programming in solving management problems.
Discuss the different types of variations in the manufacturing purpose. How does
SQC help to identify different types of variations?
What is System Life Cycle? What are the important steps involved in the system
analysis? Illustrate your answer with reference to a real life situation.
Operations:-
Describe the North West Corner Rule for solving a transportation problem.
Briefly describe the principles propounded by Frank Gilberth for improving the
work efficiency.
Identify management thinker of your interest and compare his contributions with
the any of the above mentioned thinkers
Critically analyse the issue covered in the last three Ministerial conference of
world trade organization.
Statistics:-
The weekly wages of 2000 workers in the factory is normally distributed with a
mean of Rs. 200 and a standard deviation of Rs. 20. Estimate the lowest weekly
wages of the 200 highest paid workers and the highest weekly wages of 200
lowest paid workers (given hi(1.28) =0.90)
Explain the terms Lead time, re-order point, stock-out cast and set-up cast in
inventory management
Discuss the concept of operating profit. How is it different from net profit/
What is dividend growth model approach to the cost of equity ? Discuss its
rationale.
What is the funds flow statement based on working capital concept? What
purpose does it serve?
Discuss the methods for ranking investment proposals. What are the methods
commonly used for incorporating risk in capital budgeting decisions?
State derivation of cost of debt adapting both book-value and market value
approach
Explain generic strategies. How these strategies can be used to gain competitive
advantage/
Distinguish between complete enumeration and sample survey. What are the
advantages of sampling over complete enumeration. Describe in brief different
sampling methods.
List out ‘Hygiene factors’ and ‘motivators’ of the Hertzberg’s Two Factor Theory
Describe in brief the steps involved in designing the data base for an
information system of the Mangement Department of your University/Institute.
What is the structural analysis of Industry? How Porter’s five force model can be
used in industry analysis?
Define chi-square. Cite some statistical problems where you can apply chi
square for testing hypothesis.
What are the challenges before the Human Resource Mangement in India?
What do you mean by ‘marketing” and how does it differ for “Selling”?
Discuss briefly the basic steps to be followed in developing PERT programme for
a project.
1 10 15 90
2 12 14 108
Test whether the sample come from the same normal population at 5% level of
significance.
{given:}
What is a ‘Data Flow Diagram (DFD) and a Data Dictionary? Draw a DFD for
payroll processing of an organization
Explain the BCG matrix. Bring out its usefulness in corporate level strategy
formulation.
In what ways have the functions of Human Resource Manager changed in the
post globalistion scenario
Define branding
Give the classical and frequency definition of probability. What are the
objections raised in these definitions?
Write down the Normal Distribution unction and the characteristics of the Normal
Probability Curve
Why has strategic management become so important to today’s business
organizations
Where and under what conditions did Elton Mayo conduct his experiments/
Strategy:-
Define the ‘PEST’ analysis and describe how to carry one out
Entrepreneurship:-
Economics:-
Corporate governance:-
Job enrichment
Job enrichment is an attempt to motivate employees by giving them the opportunity to use
the range of their abilities. It is an idea that was developed by the American psychologist
Frederick Hertzberg in the 1950s. It can be contrasted to job enlargement which simply
increases the number of tasks without changing the challenge. As such job enrichment has
been described as 'vertical loading' of a job, while job enlargement is 'horizontal loading'. An
enriched job should ideally contain:
• A range of tasks and challenges of varying difficulties (Physical or
Mental)
• A complete unit of work - a meaningful task
• Feedback, encouragement and communication
Contents
[hide]
• 1 Techniques
• 2 Literature
• 3 References
• 4 See also
[edit] Techniques
Job enrichment, as a managerial activity includes a three steps technique:[citation needed]
1. Turn employees' effort into performance:
• Ensuring that objectives are well-defined and understood by
everyone. The overall corporate mission statement should be
communicated to all. Individual's goals should also be clear. Each
employee should know exactly how he/she fits into the overall
process and be aware of how important their contributions are to
the organization and its customers.
• Providing adequate resources for each employee to perform well.
This includes support functions like information technology,
communication technology, and personnel training and
development.
• Creating a supportive corporate culture. This includes peer support
networks, supportive management, and removing elements that
foster mistrust and politicking.
• Free flow of information. Eliminate secrecy.
• Provide enough freedom to facilitate job excellence. Encourage and
reward employee initiative. Flextime or compressed hours could be
offered.
• Provide adequate recognition, appreciation, and other motivators.
• Provide skill improvement opportunities. This could include paid
education at universities or on the job training.
• Provide job variety. This can be done by job sharing or job rotation
programmes.
• It may be necessary to re-engineer the job process. This could
involve redesigning the physical facility, redesign processes,
change technologies, simplification of procedures, elimination of
repetitiveness, redesigning authority structures.
2. Link employees performance directly to reward:[citation needed]
• Clear definition of the reward is a must
• Explanation of the link between performance and reward is
important
• Make sure the employee gets the right reward if performs well
• If reward is not given, explanation is needed
3. Make sure the employee wants the reward. How to find out?[citation needed]
• Ask them
• Use surveys( checklist, listing, questions)
What are Management Information Systems?
Management information systems (MIS) are a combination of hardware and
software used to process information automatically. Commonly, MIS are used
within organizations to allow many individuals to access and modify information.
In most situations, the management information system mainly operates behind
the scenes, and the user community is rarely involved or even aware of the
processes that are handled by the system.
Management information systems typically have their own staff whose function
it is to maintain existing systems and implement new technologies within a
company. These positions are often highly specialized, allowing a team of people
to focus on different areas within the computer system. In recent years, colleges
and universities have begun offering entire programs devoted to management
information systems. In these programs, students learn how to manage large
interconnected computer systems and troubleshoot the automation of these
management information systems.
Many people use management information systems every day without thinking
about the actual system they are using. The individual will see a website and
enter information with the expectation that a specific action will happen; these
websites, just like the accounting systems used by large corporations, act as
management information systems to automate the process.
Definition: Management Information Systems (MIS) is the term given to the discipline
focused on the integration of computer systems with the aims and objectives on an
organisation.
The development and management of information technology tools assists executives and the
general workforce in performing any tasks related to the processing of information. MIS and
business systems are especially useful in the collation of business data and the production of
reports to be used as tools for decision making.
Applications of MIS
With computers being as ubiquitous as they are today,
there's hardly any large business that does not rely
extensively on their IT systems.
* Strategy Support
* Data Processing
Q2. In an examination 40% students fail in maths, 30% in English and 15% in
both. Find the pass percentage.
Q3. If the hands of a clock are in perpendicular position what will be the time
when they are in the 8-9 position?
Q4. In the figure OR and PR are radii of circles. The length of OP is 4. If OR=2,
what is PR?(PR is tangent to circle with centre O)
O P
F G
B C
A D
E H
A F
D