BER：Vol.3,No.2,December 2013,published

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Business and Economic Research

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2013, Vol. 3, No. 1

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Editorial Team

Editor-in-Chief

Dr. Sahar Bahmani, University of Wisconsin at Parkside, United States

Editorial Assistant

Daisy Young, Macrothink Institute, United States

Associate Editors

Dr Angela Wright, CIT, Ireland

Dr. Manuel Alejandro Cardenete, European Commission (JRC-IPTS), Spain

Dr. Judy Li, Lincoln University, New Zealand

Editorial Board

Ajmer Singh, Kurukshetra University, India

Andrea Morone, University Jaume I, Castellon, Spain & University of Bari "A.Moro", Italy

Angel Espiniella-Menendez, University of Oviedo, Spain

Annamaria Fiore, Regional Innovation and Technology Agency (ARTI), Italy

Antonio Ruiz-Porras, University of Guadalajara, CUCEA, Mexico

Dr. Armin J. Kammel, Danube University Krems, Austria

Bilal Khalaf Sakarneh, Isra University, Jordan

Bratu (Simionescu) Mihaela, Faculty of Cybernetics, Statistics and Economic Informatics,

Romania

Cosimo Magazzino, Roma Tre University/LUSPIO University, Italy

Prof Dr Eddie John Fisher, Universidad de Oriente, Santiago de Cuba, Cuba Univerzita

Palackeho, Olomouc, Czech Republic, United Kingdom

Dr. Ewa J. Kleczyk, TargetRx, Inc, United States

faris nasif ALShubiri, Amman Arab University - College of Business, Jordan

Frantisek Svoboda, Masaryk University, Czech Republic


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Grigorios L Kyriakopoulos, National Technical University of Athens (NTUA), Greece

Hazem Ali Marashdeh, Alhosn University, Jordan

Associate Professor Hengky Sumisto Halim, Universiti Utara Malaysia, Malaysia

Assoc. Prof Dr Izah Mohd Tahir, University Sultan Zainal Abidin, Malaysia

Kamran Mohamadkhani, Islamic Azad university, Tehran Science and Research branch, Iran,

Islamic Republic of

Dr Mohd Rizal Muwazir, University of Malaya, Malaysia

Dr. Mohammad Nurul Huda Mazumder, Multimedia University, Malaysia

Mohammad Reza Noruzi, Tarbiat Modarres University, Policy Making in Public Sector

Management, Iran

DR Motsomi Marobela, Department of Management, University of Botswana, Botswana

Dr Olubukunola Ranti Uwuigbe, Dept of Accounting, School of Business, Covenant

University, Nigeria

Professor Pacha Malyadri, Government Degree College, Osmania University, India

Dr. Ramil Maano Perez, Eastern Visayas State University, Philippines

Dr. Said Jaouadi, College of business and administration, Jazan University, Saudi Arabia

Dr Santosh Banadahally Manjegowda, Jain University, India

Prof. Shyamkumar D. Kalpande, MET's Institute of Engineering, BKC- Nashik, Pune

University, India

Dr. Socrates Ogalesco Ballais, Eastern Visayas State University, Philippines

Dr Uwalomwa Uwuigbe, Dept of Accounting, Covenant University


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www.macrothink.org/ber I

Contents

An Investigation of Visual Components of Packaging on Food Consumer Behavior

Golnesa Ahmadi, Hamid Reza Bahrami, Mona Ahani 1-11

Exchange Rate Impacts on Investment of Manufacturing Sectors in Iran

Mohammad Reza Lotfalipour, Maliheh Ashena, Maryam Zabihi 12-22

Private Returns to Education in Urban Cameroon

Christian Zamo Akono, Roger Tsafack Nanfosso 23-37

Success Factors of Entrepreneurs of Small and Medium Sized Enterprises: Evidence from Bangladesh

Mohammed S. Chowdhury, Zahurul Alam, Md. Ifttekhar Arif 38-52

The Impact of Overconfidence on Investors' Decisions

Boubaker Adel, Talbi Mariem 53-75

Determinants of Firm’s Financial Performance: An Empirical Study on Textile Sector of Pakistan

Ali Abbas, Zahid Bashir, Shahid Manzoor, Muhammad Nadeem Akram 76-86

English Language Skills Training: Theory and Practice-A Cuban Perspective

Eddie John Fisher, Jorge Luis Herrera Ochoa, Yoennis Diaz Moreno 87-106

Myths and Realities of Innovative China the Case of Haier Company

Farrukh Nawaz kayani, Saquib Yusaf Janjua, Mumtaz Ahmed, Babar Wasim 107-114

The Relationship between Macroeconomic Variables and Passenger Vehicle Sales in Malaysia

Fidlizan muhammad, Mohd Yahya Mohd Hussin, Azila Abdul Razak, Norimah Rambeli, Gan Pei Tha 115-126

From Cyber Bullying to Cyber Coping: The Misuse of Mobile Technology and Social Media and Their

Effects on People’s Lives

Eddie John Fisher 127-145

New Evidence from Assessing the Tobin Tax Effects on Exchange Stability and Trade

Said Jaouadi 146-155

Is It Possible to Create Goods from Thin Air Using Money and an Expenditure Multiplier?

Gennady Bilych 156-172

Total Reward Concept: A Key Motivational Tool For Corporate Ghana

Olivia Anku Tsede, Ernestina Kutin 173-182

Valuation of IPOs in India-An Empirical study

Sanjay Sehgal, Bhushan Kumar Sinha 183-204

Determinants of Profitability of Indigenous Chickens in Swaziland

Bongani J. Siyaya, Micah Bheki Masuku 205-217

Ownership Structure and Performance of the Listed Tunisian Companies

Habib Affes, Nourchéne Hamza Hakim 218-235

http://www.macrothink.org/journal/index.php/ber/article/view/3799/3254

















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Revisiting the Psychometric Properties of Market Orientation Framework in an

Emerging Economy: a Case-Study of Botswana’S Small Service Firms

Olumide Olasimbo Jaiyeoba 236-245

The Effects of Environmental Munificence and Market Orientation Dimensions

on Performance of Small Business Firms in Botswana

Olumide Olasimbo Jaiyeoba 246-254

Investment Strategies of Different Holding Periods: Evidence from Stock

Markets of Hong Kong, Korea, Shanghai, and Taiwan

Massoud Moslehpour, Munkh Ulzii Batmunkh 255-27




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An Investigation of Visual Components of Packaging

on Food Consumer Behavior

Golnesa Ahmadi

Department of Management, Naragh Branch

Islamic Azad University, Naragh, Iran

E-mail: [email protected]

Hamid Reza Bahrami

Department of Management, Naragh Branch



Mona Ahani (Corresponding author)

Department of Management, Young Researchers Club, Naragh Branch



Received: June 2, 2013 Accepted: June 16, 2013

doi:10.5296/ber.v3i2.3799 URL: http://dx.doi.org/10.5296/ber.v3i2.3799

Abstract

The present research is aimed to identify the effect of components of packaging on the behavior

of food consumers. In this respect, first a deep examination of literature and the internal and

external studies was performed in order to find out the fundamental basis for drawing out

necessary prerequisites of measuring effects of packaging components. Accordingly, product

package color, package design, and the size of the food package were identified as the

fundamental factors influencing the behavior of food consumers. Thus, the research

assumptions were regulated.


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One sample t-test was used to assess the assumptions. In order to analyze the view of

respondents based on gender, an independent two sample t- test was used, and in order to

analyze their views based on the level of education, income and age, a variation analysis test

was used. The results show that the color of packaging, size of packaging and design of

packaging have an influence (95% confidence) on the behavior of the consumer ranking the

effectiveness of individual aspects shows that the color of packaging has the highest effect on

the behavior of consumers.

Keywords: Consumer behavior, Packaging, Color, Design, Size

1. Introduction

The consumer and his satisfaction are the essential matters which can lead to the promotion of

an organization in the present competitive world. The importance of the consumer and his

satisfaction relate to global competition. Therefore it is important to consider what factors can

be effective more exactly and completely in increasing the satisfaction of the customers.

The role of packaging as a means of communication with the consumer and choosing

trademarks is growing constantly. In order to fulfill the communication goals, it is necessary

for the producers to acquire adequate information regarding the customer's psychology. On the

other hand, the behavior of the consumer has been a major issue of interest for the marketing

researchers during the last decades. Variation of consumer behavior is because of the effect of

different factors influencing the behavior and motivation of the person for purchase. The

existence of different groups of consumers for the markets of a single product indicates wide

differences. The consumer is considered today as the major key to the success or the failure of

a company.

Identification of these relations and examination of the role of different packaging components

in the behavior of the consumer will undoubtedly identify the strengths and the weaknesses of

the companies for entering into competitive markets. Therefore the essential question of the

present research is how the different aspects of product packaging influence the purchasing

behavior of the consumer. In another word, how the individual aspects of product packaging,

i.e color, design and the size of packaging influences the purchasing behavior of the consumer?

2. Literature

2.1 Consumer Behavior

Without knowing how the consumer behaves and without proper understanding of his behavior,

organizations can not take appropriate measures to meet the requirements and needs of the

consumer (Hawkins and Coney, 2010). The behavior of the consumer consists of knowledge

and emotions that people experience and the actions they perform during the process of

consumption. It also includes some elements of the environment that influence the knowledge,

emotions and behavior. Consumers have dynamic behavior since knowledge, thoughts,

emotions and the behavior of the consumer individually, and the target groups of consumers

and the society as a whole are changing constantly. The dynamic nature of the consumer

behavior makes the development of marketing strategies difficult. There are additional


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different definitions of the consumer behavior. For instance, American Marketing Association

defines consumer behavior as follows: "Dynamic interaction of influence, recognition,

behavior, and the environment that people exchange in their lives."

The behavior of a consumer consists of the interaction of thoughts, emotions, behavior, and the

environment. Therefore the marketing agents need to know for instance what products and

trademarks are meaningful for the consumer, how the consumer purchases, and what factors

influence purchase and consumption. In addition, the behavior of consumers includes the

interaction among humans. It means that the people give a valuable thing and take another

thing in return (Peter and C.Olson, 2009: 115).

2.2 Research Views about Consumer

Decision making view: This view suggests that the consumers are rational. When considering

the decision making view of purchase, we find that the consumers first find out a problem and

during some steps they try to solve it rationally. These steps include problem identification,

research, evaluation, choosing, and after -purchase evaluation.

Experimental view: The experimental view of the consumer purchase process suggests that the

consumers sometimes do not purchase based on rational decision making. Rather, they

sometimes purchase goods or services only for enjoyment, imagination, excitement, and

emotions.

Behavioral effect view: The behavioral effect occurs when strong environmental forces drive

the consumer to buy a product without strong pre -shaped emotions or beliefs. At this time, the

purchase results from the direct influence of behavior through environmental forces including

the means of sale promotion, cultural norms, physical environment or economic stresses

(Moon and Minor, 2003).

2.3 The reason for Studying Consumer Behavior

The development of research about consumer behavior results from a shift in marketing

philosophy from the tendency of production and product towards the tendency of sale and then

marketing. Additional factors contributing in the development of research about consumer

behavior includes: the higher rate of introducing new products, the lower product life –cycle,

increasing the movements of consumer support by private groups and public policy makers,

paying attention to environment and growth of service marketing (Golchinfar and Bakhtaee,

2007).

Table 1. Reasons for studying customer behavior; source: Moon & Minor, 2003, 28

Reasons for studying customer behavior

1- The basis for marketing management should be the analysis of consumer behavior.

This helps the managers in the following way:

A) Mixed design marketing

B) Market segmentation

C) Identifying the location and product differentiation

D) Improvement of environmental analysis


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E) Development of market research demands

2- Consumer behavior should play an important role in general policy making.

3- The study of consumer behavior transforms individual to a more efficient consumer.

4- The study of consumer behavior provides information about the consumption

behavior of human being.

The study of consumer behavior provides three types of information:

A) Consumer orientation

B) Realities about human behavior

C) Viewpoints which guide the process of thinking

2.4 Notion of Packaging

Product packaging is any kind of dish or package within which the product is offered for sale in

the market or by which the necessary information about the product is transferred to the

consumer (Roosta et al, 2009: 216). Packaging is described as a harmonic system in order to

prepare goods for transportation, distribution, storage, sale and consumption (Walter, 2005:

17).

2.5 Position of Packaging in Marketing

Packaging is an element mingled with marketing. It means every manager or marketing expert

or a person who wants to study in any way about an institution and its products, needs to study

and examine the different methods and kinds of product packaging of that institution and this

examination should be made in two areas of protection and information. Shape, color, design

and packaging are important elements in the examination of goods and a combination of these

elements constitutes the superficial shape of goods in the eyes of the consumer)Silaloy & Spice,

2004).

3. Research Objectives

The present research aims to investigate the relation between packaging components and

consumer behavior and to obtain the following objectives:

Primary objectives: recognition and determination of the relation between packaging

components and consumer behavior.

Secondary objectives:

1. recognition and determination of the relation between the color of packaging and

consumer behavior

2. recognition and determination of the relation between the design of packaging and

consumer behavior

3. recognition and determination of the relation between the size (volume) of

packaging and consumer behavior

4. Research Assumptions

Primary assumption: There is a meaningful relation between the components of packaging and

consumer behavior.


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Secondary assumptions:

There is a direct and meaningful relation between the color of packaging and

consumer behavior.

There is a direct and meaningful relation between the design of packaging and

consumer behavior.

There is an indirect and meaningful relation between the size (volume) of packaging

and consumer behavior.

5. Research Conceptual Model

Based on research conceptual framework, a research conceptual model can be offered. This

model shows the effect of an individual dimension of product packaging on consumer behavior.

Every dimension of product packaging, i.e color, size and design is considered an independent

variable. The conceptual model of research includes the primary variables and relations among

them shown in figure (1).

Figure 1. Research analytical model

6. Research Method

Since the present research aims primarily to identify the effect of every aspect of product

packaging on food consumer behavior, it can be said that the purpose of present research falls

in the domain of practical research. On the other hand, since the present research has used a

library study method as well as a field study methods like questionnaire, it can be said that the

nature and method of the present research is a descriptive-survey method.

The questionnaire used in this research includes two groups of general and specific questions.

General questions are about gender, age and level of education which constitute personal

specifications of the respondents. Specific questions include 19 items designed based on

assessment and evaluation of individual resumptions of the thesis. Likert scale was used for the

quantitative evaluation and scoring of the specific questions.

A statistical sample of the present research is obtained by the following formula:

Product

packaging

Color of packaging

Consumer

behavior Design of packaging

Size of packaging


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2

22

2

d

SZ

n

In which the major parameter to estimate is S2

which is the variance of the original sample. In

order to measure S2, a number of questionnaires were distributed and the variance of the

original sample was measured.

n = ( Z2

α /2 × S² ) / d2

Z α /2 = 1.96 → Z2

α /2 = 3.8416

d = 0.05

S² = 0.0732

n = (0.0732 × 3.8416)/0.0025 ≈ 112.482

Considering the result obtained, 110 individuals was determined as the sample volume .In

order to determine the validity of the questionnaire, the content needed validation. To do so, the

questionnaire was distributed among a group of experts, and professors of management and

behavior sciences, and then all of the deficiencies and ambiguities were removed. In order to

evaluate the reliability of the questionnaire, 15 questioners were distributed in a primary study

and the confidence correlation was measured based on Cronbach's alpha using SPSS statistical

software and the number 0.724 obtained which shows the reliability of a questionnaire.

6.1 Analysis of Data Relating to the General Specifications of Respondents

This part describes the data relating to general specifications of the respondents, i. e. gender,

age, level of education and income.

Gender: 49 individuals of the total respondents (62.7%) were female and 37.3 % were male.

Age: The respondents were classified into four groups according to their age. 47 respondents

were 30-40 years old. This number has the highest frequency with almost 43% of the total

respondents. 15 % of the sample (16 respondents) was 40-50 years old. 45 respondents were

below 30 years old and 2 respondents were 50 years old.

Education: 49 respondents with a bachelor's degree had the highest frequency. The individuals

with a diploma and below diploma constituted 12.7 % (41 respondents) of the sample. The

individuals with an A.M and higher degree (6 respondents) had the lowest frequency. 14

respondents had a technician degree.

Income: 37 respondents in the present research have a monthly income lower than 300

thousand Tomans1 which constitute almost 32% of the selected sample. 11 respondents (10%)

have an income of 300-400 thousand Tomans. The people with an income higher than 600

thousand Tomans (26 respondents) constituted 26% of the sample volume.

6.2 Research Assumptions Tests

First, research assumptions were tested using one sample t-test.

1. Iranian currency


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Assumption 1 test: The color of packaging influences food consumer behavior.

In order to test this assumption, H0 assumption is regulated in such a way that the color of

packaging has no effect on consumer behavior and H1 is considered the opposite assumption

and test claim. The statistical test assumptions are expressed as follows:

The results of assumption 1 test show that H0 is rejected at an error level of α=%5 and H1 is

accepted. Therefore, the color of packaging influences consumer behavior with 95%

confidence interval.

Table 2. One sample t-test of assumption 1

p Degree of freedom

t Average Assumption 1

0.000 109 17.944 3.956 Color of

packaging

Assumption 2 test: The size of packaging influences food consumer behavior.

In order to test this assumption, H0 is regulated in such a way that the size of packaging has no

effect on consumer behavior and H1 is considered the opposite assumption and test claim. The

statistical test assumptions are expressed as previous:

The results of assumption 2 test (table 3) show that H0 is rejected with 95% confidence and H1

is accepted. In another word, the color of packaging influences consumer behavior with 95%

confidence.


p Degree of

freedom t Average Assumption 2

0.000 109 18.164 3.941 Size of

packaging

Assumption 3 test: The design of packaging influences food consumer behavior.

In order to test this assumption, H0 is regulated in such a way that the design of packaging has

no effect on consumer behavior and H1 is considered the opposite assumption and the test claim.

The statistical test assumptions are expressed as follows:

Here again, based on the results of one sample t-test (table 4), H0 is rejected at an error level of

α= %5 and test claim is accepted. In another word, design of packaging influences consumer

behavior with 95% confidence.


p Degree of freedom

t Average

Assumption 3

0.000 109 6.503 3.487 Size of

packaging


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7. Research Findings

After analysis of research assumptions about gender, age, education, and income of

respondents, data obtained from the research was examined further.

Examination of respondents' views based on gender

In order to measure the meaningfulness of the difference of average scores of respondents,

views based on gender about the effect of packaging components on food consumer behavior,

an independent two-sample test was used. This test is used when the researcher deals with two

independent groups. The output of this test was examined based on variance sameness using

Levine’s test and through SPSS software.

In this test H0 assumption is regulated in such a way that there is no meaningful difference

between the average scores of male and female respondents and that H2 is the opposite

assumption. This is the statistical representation of this assumption, and is therefore based on

the results obtained from assumption tests. It can be said that both men and women believe that

color, design and size of packaging influences purchase behavior. The degree of influence is

also the same in the views of both men and women and no meaningful difference was seen.

Table 5. Data obtained from independent two-sample test based on gender

P F

Average scores

Women's views

Average score Men's views

Assumption

0.375 0.794 3.929 4.000 Color of product

0.232 1.445 3.507 3.455 Size of product

0.512 0.432 3.917 3.982 Design of product

Examination of respondents' views based on age

In order to measure the meaningfulness of the difference of respondents, views based on age,

single-agent variance analysis was used. This test is used for the analysis of more than two

independent groups. Statistical assumptions of the test were regulated in such a way that H0

assumption, that there is no meaningful difference in respondents, views based age, was

rejected when ji for at least one of the average scores and that H1 is the opposite

assumption.

Statistical representation of this assumption is as follows:

Based on findings and the calculated p-value, there is no meaningful difference in average

scores of respondents, views based on age about any research assumptions at P≤%5 among 4

different age groups. Therefore, the people's view in different age groups, about the influence

of packaging components on food consumers' behavior is the same with 95% confidence.


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Table 6. single-agent variance analysis for examination of respondents, view based on age

P F Assumption

0.980 0.062 Color of product

0.532 0.737 Size of product

0.599 0.627 Design of product

Examination of respondents' views based on academic paper

In order to measure the meaningfulness of the difference of respondents, views based on

academic paper, a single-agent variance analysis was used, since here again there are more than

two independent groups. A statistical test is regulated in such a way that in the H0 assumption,

there is no meaningful difference in respondents, views based on academic paper is rejected

when ji for at least one of the average scores and that H1 is the opposite assumption.

Statistical representation of this assumption is as follows:

Based on the findings of the tests and because the calculated P-value is always greater than the

error level, there is no reason to reject H0 about the effect of the color of the product on

purchase behavior. Therefore, there is no meaningful difference in respondents views based on

academic paper about the effect of the color of the product on purchase behavior among four

different groups. However there is a meaningful difference in the mean of respondents, views at

error level of 5% about the effect of size and design of the product on the purchase behavior of

consumers.

Table 7. single-agent variance analysis for examination of respondents,

view based on

academic paper

P F Assumption

0.100 2.136 Color of

product

0.045 2.779 Size of

product

0.035 2.967 Design of

product

Examination of respondents' views based income

In order to measure the meaningfulness of the difference of respondents, views based on

income, a single-agent variance analysis was used. Here again H0 assumption, that there is no

meaningful difference in respondents, views, is rejected when ji for at least one of the

average scores and that H1 is the opposite assumption. Statistical representation of this

assumption is as follows:


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Based on findings shown in table 8 and the calculated P-value, there is no meaningful

difference in the average scores of respondents, views based on income about the effect of color

and size of the product on behavior among 5 different groups. Therefore the views of people

with different incomes about color and size of product on consumer behavior is the same with

90% confidence). However, an error level of 1% and consequently 5% of the views of

respondents with different levels of income about the effect of product design on consumer

behavior is different.

Table 8. single-agent variance analysis for examination of respondents, view based on income

P F Assumption

0.267 1.321 Color of product

0.729 0.509 Size of product

0.000 5.929 Design of product

Ranking of criteria using Freidman test

Based on the output of the Freidman test, the color of packaging is the most important criterion

influencing the purchase decision of customers. The design of packaging and size of

packaging are the next preferences.

Table 9. Freidman test for the ranking of packaging criteria

Normalizes rank Friedman rank Criteria

0.368 2.21 Color of packaging

0.268 1.61 Size of packaging

0.363 2.18 Design of packaging

8. Conclusion and Suggestions

Based on the findings obtained from the theoretic and the field studies in the present research,

the following results and suggestions can be offered:

1- Since the color of packaging influences consumer behavior, food producing companies

should be more careful about the coloring of food packaging. More specifically,

customers in any gender, income and level of education believe that the packaging

color of the product influences the amount of product that will be purchased.

2- Findings of the research show that if the products are offered in smaller packages, the

tendency to buy the products increases. Food producing companies should know that

large and big packages make the process of purchase and transportation of the product

difficult. In addition, because foods have an expiration date, customers do not like

large packages of products.


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3- Design of packaging also influences food consumers, behavior. Food producers should

know that a beautiful package of food increases the appetite and desire to eat food and

persuades the customer to buy it. The packaging design of the product has a positive

effect on the buyer's taste. The design of the package has a direct effect on the prestige

of its contents and even on the confidence of the consumer.

References

Golchinfar, Shadi, Bakhtaei, & Amir. (2005). Internet; an efficient tool at the service of

propaganda, Daneshe Tablighat (knowledge of propaganda), monthly magazine, No 10.

Hawkins, D, Best, R., & Coney, K. (2010). Consumer Behavior: Building Marketing Strategy.

(9th.ed.). New York: McGraw-Hill.

Moon. C. G., & Minor, S. M., (2004). consumer behavior (first volume), Translation Abbas

Saleh Ardestani, Tehran: Asar Press, (Original publication year 1993).

Peter, P. C., & Olson , J. (2009). Consumer Behavior and Marketing Strategy. (7th.ed.). New

York: McGraw-Hill.

Roosta, Ahmad, Venus, Davar & Ebrahimi, Abdolhamid. (2007). Marketing management,

Tehran: Samt Press, Sixth edition.

Serka, Walter. (2005). Principles of packaging technology: recognition: A look at packaging

process, Packaging functions, graphic design, Translation: Hashem Habibi, Tehran: Hirad

Press, First edition.

Silayoi, P., & Speece, M. (2004). Packaging and purchase decisions: An exploratory study on

the impact of involvement level and time pressure, British Food Journal, 106(8), 607-628.

Copyright Disclaimer

Copyright reserved by the author(s).

This article is an open-access article distributed under the terms and conditions of the

Creative Commons Attribution license (http://creativecommons.org/licenses/by/3.0/).


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Exchange Rate Impacts on Investment of

Manufacturing Sectors in Iran

Mohammad Reza Lotfalipour

Professor of Economics, Department of Economics, Ferdowsi University of Mashhad


Maliheh Ashena

Ph. D student, Faculty of Economics, Tarbiat Modares University


Maryam Zabihi

M.A. in Economics, Ferdowsi University of Mashhad

E-mail:[email protected]

Received: May 23, 2013 Accepted: June 3, 2013


Abstract

As a major factor in the development process and economic policies evaluation, investment

and its growth rate have been considered in many studies. This paper examines the relationship

between changes in exchange rate and the investment of manufacturing sectors in Iran

during1995 to 2009 using the panel data approach. So, the annual data of manufacturing

sectors is used to examine the impact of real exchange rate fluctuations on industrial

investment. It is found a negative and statistically significant impact of real exchange rate

movements on manufacturing investment.

Keywords: Manufacturing sectors, Exchange rate, Panel Data, Iran.

JEL Classification: D51, E22, L52.


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1. Introduction

As a major factor in the development process and economic policies evaluation, investment

and its growth rate have been considered in many studies. Most of the previous studies

introduce increasing investment as the only way to reduce unemployment and increase

productivity. Iran as a developing economy is located in the course of economic growth and has

determined prospects of economic advancement. In order to meet the economic development

needs and to achieve progress of these measures, some necessary and effective tools must be

taken. This is achieved through the study of economic behavior, as well as social and

geography conditions of the society.

Investment in the industry sector is affected by factors such as value added, the amount of

banking facilities, costs of capital, crude oil revenue, exchange rate and economic growth.

Problems such as strong reliance on the oil revenues for buying machinery and raw materials,

the dominant role of government in economic management, shortage of liquidity, lack of

linkage between planning and executing of industrial development needs, exacerbates the

problems of the industry.

The increase of the secondary sector products and shift of resources from the primary to the

secondary sector may be considered as a driver of the development process. The manufactured

export increases income more than the primary products (Hausmann et al., 2005).

Over the past two decades many developed and developing countries have experienced

Changes in exchange rate. Baldwin and Krugman (1989) pointed the durable effects of major

exchange rates changes on international trade.

The economic approaches to exchange rate management have evolved over the past decades.

For adjusting an economy there are some instruments such as exchange rate that it has to be

considered in response to changes in factors affecting a country’s economic equilibrium.

The implications of exchange rate changes for the economy have been focused of empirical

studies in international economics. These studies examined the impact of exchange rate

increase or decrease on macroeconomic key factors.

Although there have been substantial currency fluctuations over the recent years, few studies

have been focused on examining exchange rate movements and manufacturing sector. This

paper investigates the relationship between exchange rate changes and the manufacturing

sector investment in Iran.

The paper is organized in four Sections. Section 2 summarizes theoretical framework and

reviews literature. Section 3 explains the methodology and empirical results. Section 4

represent conclusion.

2. Review of Literature

There are some theoretical arguments underlying the stimulating role of manufacturing sector

for economic development. The increase of the secondary sector products and moving

resources from the primary to the secondary sector may be considered as a driver of the


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development process.

Investment is a determinant factor of output level, productivity and growth. Changes in

exchange rate may cause changes in the profitability of production and investment incentives.

Exchange rate increase may increase the demand of domestic products and the cost of imported

capital and other imported inputs. It will cause investment increase only if the impact on

demand is more than the cost effect.

There are some factors affecting the optimal response of an industry investment policy to

exchange rate changes. It includes the reliance on imported inputs and the share of foreign sales

in total sales. If a firm is more dependent on imported inputs, there will be more variable costs

and less marginal value of capital. So a depreciation of exchange rate causes a reduction in the

level of industrial investment. By contrast, there will be increase in price competitiveness a

firm following an exchange rate appreciation. This is likely leads to an increase in the expected

value of capital and its level of investment.

Those sectors, in which output price is determined in the world markets, are likely to be more

sensitive to exchange rate movements. The manufacturing firms that rely on export and

imported inputs, the effect of currency valuation changes could be either positive or negative.

The choice of control variables is a crucial aspect of any empirical study of investment.

Demand-side explanatory variables (such as sales or output) and cost factors (such as the user

cost of capital or the price of oil) were employed by most studies.

Any changes in exchange rate has set of conflicting changes in foreign and domestic economy

so that its result can be positive or negative. Upcoming opportunities of liberalization of the

exchange rate in the industrial sector can be summarized as follows:

a. An increase in the exchange rate causes moving towards higher value-added products. The

point where is considered as a threat of exchange rate liberalization, may have a key role in the

industrial development of the country.

b. Iran's industry has the ability to produce foreign goods of the same quality. The liberalization

of exchange rates removes the need of high tariff walls for supporting of domestic products.

c. In recent years, many activities have done in order to reduce waste and unnecessary costs.

These removal costs and damages of industries cannot be overlooked. The lliberalization of the

exchange rate will follow decreasing waste and managing costs.

On the other hand, profitability is the most important factor of the private investment in the

industry sector. Increase of industry sector profitability will have the greatest impact on

investment of private sector. Profitability in the non-manufacturing and the speculation sectors

of the economy in some cases is also associated with various rents. Therefore, the owners of

capital will tend to invest in the non-manufacturing sectors that have more profitability, less

risk and more power of transferring the capital. Due to these issues, the exchange policy is one

of the policies affecting investment decisions. The exchange rate changes may affect

investment through increasing exports and increasing prices of imported capital goods and raw

materials. In addition, the feature of irreversibility and the delay of investment make investing


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decisions more sensitive to the real exchange rate fluctuations.

Developing countries, including Iran have experienced large fluctuations in their

macroeconomic variables such as growth, inflation, and exchange rates. The effects of these

fluctuations have discussed in various studies of growth, investment and trade.

The wage has important role in determination of investment while the wage itself is affected by

government expenditure policy. Alesina et al. (2002) presented evidence of a relationship

between investment and government expenditure, and between wages and government

expenditures.

The exchange rate has two opposing effects on manufacturing sales (both to the domestic and

the international markets). Based on the Krugman’s (1979) model and modified model from

Fung (2008), a depreciation of the home currency gives domestic industries a cost advantage

and their sales will rise. Afterward, entry of new firms may reduce the market share. It is more

likely that exports increases following home currency depreciation, but its effect on domestic

sales may be ambiguous, depending on the importance of new firm's entry. If there is

increasing returns to scale of production technology, productivity will move in the same

direction as total sales. Thus, the direction and magnitude of changes in exports and domestic

sales will affect not only total sales but also productivity and investment (Fung and Liu, 2009).

Some studies explored exchange rate and trade relation in terms of export or import (Bernard

and Jensen (2004) and Landon and Smith (2007)). Nouria et al. (2011) showed that during the

period 1991–2005 a number of countries have used undervaluation to foster the price

competitiveness of manufactured exports.

There is considerable emphasis on the study of pricing policies in response to changes in

exchange rate (Goldberg and Knetter, 1997). Some others study the impact of exchange rate

movements on the firm value (Jorion (1990), Bodnar and Gentry (1993), Clarida (1997), and

Bodnar, Dumas and Marston (1998), Harris (2001), Head and Ries (1999)).

The investigation of the exchange rate effects on investment decisions of manufacturing

industries in Colombia has emphasized the negative impact of exchange rate fluctuations on

the industrial sector (Kandilov and Leblebicioğlu, 2011). While studying industries investment

in Canada during 1981-1997 shows that it is not affected by the exchange rate changes

(Harchaoui, et al., 2005).

There are few researches focusing on the sensitivity of firms’ investment to changes in the

currency value (Goldberg (1993), Campa and Goldberg (1995), Campa and Goldberg (1999),

Forbs, 2002 Serven (2003), Fuentes (2006)). As the first contribution, Goldberg (1993)

indicates that currency appreciations led to different consequences on investment in various

periods. Campa and Goldberg (1999) showed that an exchange rate increase leads to

manufacturing investment decline in the US. Similarly, Forbes (2002) found that there is

slower growth in capital investment following exchange rate increase in commodity firms with

higher capital/ labour ratios.

Fung (2008) explored, both theoretically and empirically, the effects of the considerable


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appreciation of the Taiwanese currency, the New Taiwan dollar (the NT dollar), on both firm

turnover and production scale. The results of Fung and Liu (2009) indicated that the real

depreciation of the NT dollar led to an increase in exports, domestic sales, total sales,

value-added, and productivity. In addition, they found that there may be productivity

improvement induced by real currency depreciation a result of firm scale expansion.

Using an error correction methodology, the aggregate and sector-level investment equations for

a panel of 17 OECD countries was estimated by Landon and Smith (2009). It is found that real

currency depreciation may reduce aggregate investment and investment of nine sectors in the

short run. Furthermore, it causes reduction of aggregate investment in the long run. Kandilov

and Leblebicioğlu (2011) found a robust negative impact of exchange rate volatility on plant

investment.

Researches employing the data of the Iranian Manufacturing sectors includes Arman and

Ghorbani (2005), Lotfalipour and Razmara (2006), Khodaparast (2001) and ghetmiri (1996).

While there is some empirical literature on the impact of exchange rate on investment, there are

only a few studies that have considered the manufacturing subsectors. Moreover, most of the

studies are based on the data at the aggregated industry level. In this paper we analyze the

relationship between investment and exchange rate fluctuations using industrial subsectors

panel data.

3. Methodology and Empirical Results

The mentioned theoretical and empirical framework motivates studying investment and

exchange rate relationship, and it also highlights some other important factors of this

relationship. The goal of the paper is to estimate the impact of exchange rate changes on

investment, so we estimate a reduced form investment equation. The following baseline

dynamic specification (1) is estimated, which focuses on the main effect of exchange rate on

investment.

(1)

Where I is investment, EXR is exchange rate, W is real price of the non-tradable domestic input

and VA is value-added.

The model is estimated based on dynamic panel data using the generalized method of moments

estimator developed by Arellano and Bond (1991). In the considered equation, investment

interacts with the relevant industry-specific and time-varying explanatory variables. Therefore,

the estimated effect of the exchange rate on investment is allowed to vary over time for each

industry.

Providing a large number of point data, panel data approach allows for more powerful

statistical tests and normal distribution of test statistics. It can also take heterogeneity of each

cross-sectional unit into account, and give “more variability, less collinearity among variables,

more degrees of freedom, and more efficiency” (Baltagi, 2001).

),,),1(( VAWEXRIFI


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3.1. Panel Data Unit Root Tests

Studies on panel unit root tests include Hadri (2000), Maddala and Wu (1999), Levin et al.

(2002), Im et al. (2003). Among different panel unit root tests developed in the literature,

LLC test (Levin et al., 2002) and IPS test (Im et al., 2003) are the most popular and are based

on the ADF principle. However, the LLC test assumes homogeneity in the dynamics of the

autoregressive coefficients for all panel members. In contrast, the IPS test allows for

heterogeneity in these dynamics. IPS begins by specifying a separate ADF regression for each

cross section. The IPS test is based on the following model:

ip

j

itjtiijtiiiit yyy1

,1, (2)

where yit is the series for country i in the panel over period t, ρi is the number of lags selected

for the ADF regression and εit are independently and normally distributed random variables for

all i and t with zero means and finite heterogeneous variances.

IPS tests the null hypothesis of the unit root for each individual in the panel, that is,

.,0:0 iH i

LLC unit root test considers the coefficients of the autoregressive term as homogeneous across

all individual. So, LLC tests the null hypothesis that each individual in the panel has integrated

time series, that is .,0:0 iH i

Maddalaand Wu’s (1999) and Choi’s (2001) tests were developed to overcome the

shortcomings of the LLC and the IPS tests. They suggest panel unit root tests using a Fisher

statistic. Table 1 presents the test results of the panel level series including a constant term and

time trend.

Table 1. Panel unit root test results

variables LI LEXR LW LVA

Levin, Lin & Chu t. -5.22 (0.00) -6.41(0.00) -6.89 (0.00) -10.27 (0.00)

Im, Pesaran& Shin W-stat -2.19 (0.01) ........ -1.91 (0.02) -3.42 (0.00)

ADF – Fisher Chi-square 72.68 (0.00) 79.84 (0.00) 68.05 (0.02) 87.84 (0.00)

PP – Fisher Chi-square 147.53 (0.00) 150.65 (0.00) 92.75 (0.00) 95.50 (0.00)

Note: (a) Individual intercepts are included as exogenous variables in the test equations. Maximum lags are

selected based on the Schwarz Information Criterion. (b)Figures in brackets denote p-values.

The results of IPS, LLC and Fisher tests indicate that the panel level series are stationary.

Therefore, we have chosen to use the panel level series in the panel VAR analysis.

3.2. Empirical Results

In this section, the exchange rate effect on the investment of manufacturing sector is

investigated empirically. As Iran experienced large currency depreciations in the recent years,

it can be of great importance to policy makers to understand the exchange rate effects on

industry sector performance. In this paper, we employ manufacturing sector panel data of Iran


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to examine the impact on the manufacturing subsectors investment of the substantial real

depreciation of the exchange rate.

The empirical analysis has been conducted using data of 2-digit ISIC industries drawn from

statistical yearbook during 1995-2008. The data include information on exchange rate,

investment, domestic output and compensation of the non-tradable domestic input.

Employing industry-level data from the Iranian Manufacturing sector, we estimate a dynamic

investment equation using the system-GMM estimator developed by Arellano and Bover (1995)

and Blundell and Bond (1998).

The fixed effects in panel data permit us to account for heterogeneity of industries. Moreover,

panel data allows us to study dynamics for the individual industries. Hence, by including both

the individual-specific and the time-specific effects into the specification for panel data, a

larger portion of the omitted-variable bias can be eliminated.

The real exchange rate, EXR, is measured as domestic currency units per unit of foreign

currency. The theoretical investment equation includes real value-added, VA, and the real price

of the non-tradable domestic input, W. Industry-specific fixed effects, µ , are included in the

estimating equation to represent the determinants of investment that differ across industries,

but are constant through time. Incorporating the variables described above in the panel model,

Eq. (3) yields the estimable investment equation:

(3)

m

j

itijti

m

j

jjti

m

j

jjtijjti

m

j

jit LEXRLWLVALILI1

11,

1

4,

1

3,2,

1

11

Where i and t denote, respectively, industry i and time t, j is the lag length, μi is

industry-specific effects and εit is the disturbance terms. If the coefficient βi in equation (3) is

significantly different from zero, then that variable may be said to have impacts on investment.

This specification incorporates lags of investment, and the current value and some lags of all

the explanatory variables. We treat all of the industry specific variables as endogenous, and

use lagged values dated t−2 as the GMM-type instruments.

The optimal lag length in the VAR model based on the Schwarz Information Criterion (SIC) is

chosen two. Table 2 shows the results for estimating the model using GMM. The Sargan test is

a test on whether the instruments are valid (uncorrelated with the error term).

Table 2. Estimation results of the panel regression

Variables LI

LI(-1) -0.393(-4.617)

LI(-2) -0.183(-3.987)

LW 0.691(1.827)

LVA 0.208(0.555)

LEXR -0.568(-2.573)

LVA(-1) 0.313(5.456)

LEXR(-1) 0.474(1.779)

Sargan test (p-level) 9.35

Instrument rank 20

Figures in brackets denote t-statistics.


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Based on these results, we found a strong negative and statistically significant impact of real

exchange rate movements on plant investment. Based on the theoretical expectations, we

would expect exchange rate to have impact on investment and it is valid for selected industrial

subsectors. The test results suggest that the null hypothesis of coefficients insignificance is

rejected. It indicates that exchange rate and investment lags have negative and significant

impact. Since the real exchange rate is indicated as an indicator of competitiveness of domestic

goods relative to foreign goods, therefore fluctuations in the exchange rate reduce desire of

producers to investment.This result demonstrates that real depreciation of the home currency

has unfavorable effects on investment of industry sector. In terms of control variables, we find

an economically and statistically significant impact of value-added first lag on plant-level

investment. Furthermore, the price of non-tradable inputs is found to have no significant effect

on industrial investment.

4. Summary and Conclusion

Investment has important role in the determination of output changes, productivity and growth.

Changes in exchange rate can cause large fluctuations in the profitability of production and

investment incentives. As Iran had experienced large currency depreciations in the recent years,

it can be of great importance to policy makers to understand the exchange rate effects on

industry sector performance. In this paper, we used manufacturing annual data of Iran to

assess the impact of real exchange rate fluctuations on investment of manufacturing sectors.

We used the Iranian data of 2-digits industries from 1995 to 2009 and estimated a dynamic

investment equation using panel data model developed by Arellano and Bover (1995) and

Blundell and Bond (1998).

It is found a strong negative and statistically significant impact of real exchange rate

movements on plant investment. In light of these findings, the analysis incorporates real

value-added and the real price of the non-tradable domestic input as control variables in the

empirical equation. This avoids omitting potentially important variables, and allows for a

comparison of the relative roles of the output, the wage and the exchange rate as determinants

of investment.

Since the real exchange rate is indicated as an indicator of competitiveness of domestic goods

relative to foreign goods, therefore fluctuations in the exchange rate reduce the desire of

producers to invest. The government should try to stabilize the real exchange rate for

motivating investment in industry sector. Any change in price index causes the instability of

the real exchange rate, so government should implement appropriate policies to reduce the

volatility of commodity prices. The foreign exchange reserve is one of the means that the

government can use to control exchange rate supply and demand.

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Private Returns to Education in Urban Cameroon

Christian Zamo-Akono (Corresponding author)

Faculty of Economics and Management

University of Yaoundé II, Cameroon


Roger Tsafack Nanfosso

Faculty of Economics and Management

University of Yaoundé II, Cameroon

Received: May 12, 2013 Accepted: May 28, 2013


Abstract

Earlier studies on the impact of education on earnings highlighted a declining pattern of the

private returns in developing countries. However, recent research has argued that failing to

account for the segmented structure of the labour market could be misleading. This study

aims to estimate private returns to education in Cameroon, focusing on how they vary across

the different segments of the Cameroon labour market. The data used in this study are drawn

from the 2005 Employment and Informal Sector Survey, which is nationally representative

and comprehensive survey providing information over 8,540 households and 38,599

individuals around the country. The estimation of wage equations corrected from selectivity

bias reveals that there are convex rates of return to education in all the segments of the labour

market. As far as the private sector is concerned, it is found that those who graduated from

primary school earn no returns compared to those who never attended school. The fact that

only degrees are rewarded on the Cameroon labour market evidences the existence of a

sheepskin effect in Cameroon and may serve as a confirmation of the signalling role of

education in this context.

JEL Classification: I21, J31, J40

Keywords: Returns to education, Labour market sectors, Earnings.


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1. Introduction

1.1. Context

Following independence in 1960, Cameroon recorded tremendous economic growth. The

yearly average growth rate of per capita Gross Domestic Product (GDP) amounted to 4

percent during the period 1965-1976, 13 percent from 1977 to 1981, and 8 percent from 1982

to 1985. By 1985, Cameroon was ranked among the middle-income countries, according to

the World Bank taxonomy (De Monchy and Roubaud, 1991). During this “20-year golden

age”, the Government created many schools (primary and secondary) and instituted a

partially free primary and secondary education in order to ensure access to education. As one

of the crucial problems faced by Cameroon was the need for trained national cadres

(especially for senior positions in the civil service), policy-makers held the view that the

panacea would be for Government to create and run institutions of higher learning and thus

make provision for the acquisition of skills necessary for national development. Cameroon

created a variety of higher education institutions, among which one university and diverse

state-owned professional schoolsi. During this period, unemployment was not a big issue,

thanks to an ambitious development program of employment creation in the public sector,

recruitments in state-owned enterprises, and development projects. Graduates of professional

schools were assured of jobs in the public sector once admitted into the school; a practice that

skewed the Cameroon labour market towards the public sector.

From 1986 to 1994, Cameroon faced a deep-seated crisis which led to a decline of the GDP by

roughly six percent per annum between 1986 and 1993. Reforms engaged in order to comply

with its commitments with the International Monetary Fund and the World Bank consisted in

privatizing and restructuring public firms, dismissing in the public sector, suppressing civil

servant advantages, and almost a 50 percent cut in per capita income during 1992-1993 (World

Bank, 1996). The public sector, previously known as the main caterer in salaried and decent

jobs, witnessed a significant decline in its share of total employment. This shrinking public

sector employment, coupled with the incapacity of the private sector to absorb all the influx of

job searchers in the labour market, induced the rise of unemployment. In 1992, there were over

76,500 job seekers in Cameroon (Aming and Awung, 2005). Along with low paying and poor

working condition in both public and private sectors, many individuals were drained into the

informal sector of the labour market. With 85.9 percent of employed workers in 1996 and 90.4

percent in 2005 (National Institute of Statistics, 1996; 2005), the informal sector emerged as

the leading sector in terms of opportunities for employment. From 1995 onward, Cameroon

regained a steady growth path and an annual GDP growth rate of roughly 4.5 percent (Emini,

Cockburn, and Decaluwe, 2005). But despite the recovery, unemployment remained extremely

pronounced, especially in urban areas. The 2005 Employment and Informal Sector Survey

revealed that highest unemployment levels were observed in the two biggest agglomerations of

Cameroon were the unemployment rates are 14.7% and 12.5%, respectively for Yaoundé and

Douala.

Despite a decline in individuals’ employability due to the reduced capacity of the economy to

absorb all the graduates of the educational system, large amounts of resources are still being


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invested in education by both Cameroon Government and Cameroonians. The landmark

innovations of the 1993 reforms were the institution of a 50,000 CFA francs (CFAF)ii

registration fees for state-owned universities and the liberalization of the higher education

sector. Tuition fees in private-owned institutions involved in the tertiary education range from

CFAF650,000 to almost CFAF1,300,000 depending on the speciality chosen by the student

(Tsafack, 2006). At the same time, the demand for education has kept increasing. While the

Federal University started with a small enrolment of about 600 students, the student enrolment

increased substantially as time went on up to 7 000 in 1970, above 50 000 by 1992

(Tafah-Edokat, 1989). According to the National Institute of Statistics, the student enrolment in

State Universities and at the Catholic University of Central Africa (CUCA) was above 75 000

during the 2001-2002 academic year, 91 000 in 2004-2005, and above 105 000 during the

2005-2006 academic year. It thus becomes interesting to investigate whether Cameroon

educational system yields private returns that justify the resources invested in schooling. The

main objective of this study is to estimate the private returns to education Cameroon. The

outline of the paper is as follows. The next point reviews the literature, section two presents the

methodology and provides a brief description of the data used in the study. Section three

discusses the results and section four concludes.

1.2 Private Returns to Education in the Literature

According to the human capital theory, an individual’s optimal investment in human capital

calls for a consideration of both human and financial capacities, and the prospective utilization

of the capital that is being accumulated (Mincer and Polachek, 1974). Consequently, the

expectations regarding future family and market activities of individuals play an important role

in the determination of the levels and forms of human capital investment. To the extent that

labour market earnings are determined by the stock of human capital accumulated by

individuals, a sequence of positive net investments results in an earning power that grows over

the life cycle (Sackey, 2008). Consequently, educational attainments are thought to be a

plausible cause of earnings differential between individuals. These ideas have given foundation

to a huge number of studies on returns to schooling around the world.

Earlier studies were devoted to the analysis of the impact of length of schooling, labour market

experience, and school quality on earnings. Psacharopoulos (1994) made an extensive survey

of published studies on private returns to investments in education in many sub-Saharan

African countries. He observed a declining pattern of the returns to education over time and

found that the rate of return on primary education was 24 per cent, 18 per cent for secondary

education and 11 per cent for higher education; he concluded that investments in primary

education should be emphasized at the expense of higher education. These results were

challenged by Bennell (1996) who revealed theoretical and empirical shortcomings in studies

of individual rate of return to education in African countries. While undermining the credibility

of Psacharopoulos’ aggregate estimates for the continent as a whole, Bennell’s arguments led to

many other studies of sub-Saharan African countries who did not support Psacharopoulos’

result of consistently higher returns to primary education than either secondary or higher

education. For example, Manda and Bigsten (1998) and Liu (1998) analysed the impact of

educational expansion and returns to schooling in Kenya and found that private return to


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secondary and tertiary education were high, but close to zero for primary education. Examining

private returns to education in same country, Kimenyi et al. (2006) found that the returns to an

additional year of schooling increased from about 8% for primary school to 23% for secondary

school and then to 25% for university level of education. These results were confirmed in a

number of sub-Saharan Africa countries by Appleton et al (1999), Bigsten et al (2000), Schultz

(2004), and Aromolan (2004; 2006).

When it comes to the analysis of returns to schooling in Cameroon, there is relatively little

empirical evidence. Among known studies, only Tafah-Edokat (1998) found that primary

education gives the highest returns followed by secondary and tertiary education. He

concluded like Psacharopoulos (1994) that the investment in primary education should be

emphasized and that individuals willing to pursue further education should be made to bear a

higher proportion of the cost of such education. His results suffer from the fact that his sample

was mostly limited to civil servants. Although other studies find convex returns to education

(Lanot and Muller, 1997; Bigsten et. al., 2000; Aming and Awung, 2005; Ewoudou and

Vencatachellum, 2006), they do suffer from many shortcomings. The first one relates to the fact

that some of the samples were not representative of the urban population diversity. For example,

Bigsten et. al. (2000) worked on a sample of workers from 170 companies in the manufacturing

sector and could not inform about returns in the formal or informal non-manufacturing sectors.

While Lanot and Muller used data from a sample of 200 women in Yaoundé, Aming and

Awung’s results were based on the survey data collected in 1994 from rural and urban areas of

Mfoundi, Moungo, Mezam, Benoue, Nyong and Soo, five subdivisions of only four regions of

Cameroon. Second, results of some of these studies (principally Bigsten et. al., 2000; Aming

and Awung, 2005) may not be reliable as most of them failed to account for the most notable

characteristic of the Cameroon labour market that is, its structure in term of two homogeneous

sectors (public and formal private) and a heterogeneous informal sector. Factors determining

labour market decisions and outcomes are thought to be different from one sector to another

and failing to account for these differences may result in biased estimates of the returns to

education. Thus, this study advocates for an explicit modelling of the economic opportunities

available to job seekers and the correction of selectivity bias in wage equations.

2. Methodology.

2.1. Econometric Method

To ascertain the returns to education, we use the standard and widely applied earnings function

proposed by Mincer (1974). The methodology consists in estimating a semi-logarithmic

equation, where log wages lnW are explained by education and individual economic and

noneconomic characteristics X that is:

ij jijiiii XUnivSecondimW 3210 Prln (1)

with, 0 representing an intercept term, j an unknown parameter associated to variable Xj,


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and the random disturbance term.

Returns to education being dependent of the proportion of qualified individuals that are

applying for a job on the labour market (Angrist, 1995), the increasing production of high

skilled individuals in Cameroon is likely to have induced a filtering down process in which low

paying job attract overqualified individuals. In such a context and for a given labour market

experience, education may loose its explanatory power on the wages. Hypothesizing the

existence of a “parchment effect” on the Cameroon urban labour market, we include dummy

variables representing the highest degree obtained by an individual and obtain the following

second equation.

ij jijk kikiiii XDegreeUnivSecondimW

8

13210 Prln (2)

Due to the fact that wages are unobserved for individuals whose market pay is lower than their

reservation wage, the analysis of earnings is potentially affected by a non-random selection of

individuals into the labour market. In such a setting, earnings are jointly determined with

labour force participation and any analysis that ignores the process of labour force participation

is potentially subject to selection bias. To correct for such a bias, the two-step estimation

method developed by Lee (1983) and Trost and Lee (1984) is adopted. In the first stage, the

selection into the labour market is estimated. As far as the Cameroon labour market is

concerned, individuals face four mutually exclusive labour market outcomes: unemployed (l=0)

the reference group; employed in the public (including parastatal companies) sector (l=1), in

the private formal sector (l=2), and in the informal sector (l=3). The probability that individual

i has outcome l is given by a multinomial logit:

3

0

'' exp/expl ilill ZZp (3)

The choice of or selection into one of these sectors is thought to depend on a vector of

explanatory variables (Z) capturing an individual’s perceived net differentials in wages

between them, tastes and preferences, as well as human capital and other characteristics;

represents a vector of associated unknown parameters to estimate. From these estimates, we

construct the selection term (Mills’ ratio) for the alternative l as ilill ZZ '' / ;

being the normal density function and the normal distribution function. In the second

stage, the estimated l is included among the explanatory variables of the wage equations. The

implied sector wage equation 4 is estimated by OLS for l = 1; 2; 3.

ilj jijk kikiiii XDegreeUnivSecondimW

8

13210 Prln (4)

With this specification, we compute both total and marginal returns to education. Total return

to a given level of education (or degree) is defined as the mean difference between the wage of


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someone who achieved level j (obtained degree k) and the wage of the other one who didn’t go

to school (obtained any degree). It is given by:

exp 1level J jtr and deg exp 1ree K ktr .

Following Kimenyi et al. (2006), the marginal return to education was defined as returns that

accrue to an additional year of schooling. This value is computed by dividing the difference

between the coefficients of adjacent schooling levels (degrees) by their differences in years of

schooling. Letting R represent the rate of return and S the years of schooling, the rate of return

to an additional year of schooling for a given level and for a given degree are measured

respectively for the level of education and the highest degree as follows:

1-

1-

-

1--exp

JlevelJlevel

jj

JlevelSS

mr

and

1-degdeg

1-deg

-

1--exp

KreeKree

kkKree

SSmr

To determine the years of schooling (S), Sackey (2008) used the statutory number of years for

the completion of any given level of schooling, assuming a homogenous educational system.

As far as our study is concerned, there’s a need to point out that Cameroon educational system

is a mixture of the Anglophone and the Francophone systems which differ in some respects

especially on the statutory duration of studies in both the primary and secondary levels. For

instance in the Anglophone system, primary education lasts for seven years and leads to the

First School Leaving Certificate (FSLC). The first level of secondary education lasts for five

years and leads to the General Certificate of Education Ordinary level (GCE-OL) and higher

schools offer two-year courses leading to the GCE Advanced level (GCE-AL). As far as the

Francophone system is concerned, six years in primary education lead to the French version of

the FLSC, five more years in the first cycle of secondary education lead to the French GCE-OL,

and finally three years’ study in the upper secondary lead to the GCE-AL named

BACCALAURÉATiii

.Thus, to get to the tertiary level of education, the Anglophone system

involves a sequence of seven, five and two years, while the Francophone system requires a

sequence of six, four and three years. University level studies depict similar differences

between the facultiesiv

. Consequently, unlike Sackey (2008), our measure of the years of

schooling (S) must allow to account for both heterogeneities inside the system, grade repetition,

examination failures, and school dropout before stage completion. For these reasons, years of

schooling are derived from information on the highest class successfully completed by

attaching the modal number of years to educational levels and degrees.

2.2. Data Source

The data used in this study are drawn from the 2005 Employment and Informal Sector Survey

(EISS) which is a nationally representative and comprehensive survey providing information

over 8,540 households and 38,599 individuals around the country. Information covers

socioeconomic characteristics, employment status and characteristics, and some family

background indicators. Of particular interest is information on variables, which might permit

meaningful separations of the data by type-of-employment and labour market sector. The


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survey also includes information on the industry of employment and occupation and on a

variety of income sources, including weekly earnings and wages analyzed in this study. The

analysis of returns to education concentrates only of salaried workers. The rationale is that,

revenues generated from self-employed individuals’ activities do not simply remunerate labour,

but also capital. Considering the fact that there’s no information on how to dissociate these

components, it is better to exclude these individuals from the analysis. The sample used in this

study included only individuals in the working age group 15 to 65 years, who were full-time

employees, and lived in Cameroon urban areas. It consisted of 13,104 observations covering

individuals both in the public (871), private formal (898), informal (2458) sectors, as well as

unemployed (5420) ones. Sample modal numbers of years are 6, 9 and 16 respectively for those

who have the primary, the secondary and the tertiary levels of educationv. While considering

the highest degree obtained, we have 6 for the Primary school certificate (FLSC), 10 for the

first level secondary school diploma (GCE-OL), 12 for the PROBATION degree, 13 for the

GCE-AL, 15 for the BTS degree, 16 BACHELOR degree, 18 for the MASTER and upper

degrees (Master/PhD).

Table 1 presents means and standard deviations for the main variables of the study. As can be

seen on it, there are differences between those who are considered as having a given level of

education and the proportion of individuals having at least the lowest degree of this level. For

example, 52.9% of civil servants have the secondary level of education but only 46.5% hold at

least a GCE-OL. These differences are due to grade repetition, examination failures, and school

dropout before stage completion. Further, there are important differences in educational

attainment by sector of employment. While 88.6 % of individuals working in the public sector

have at least the secondary level of education, in the formal private and informal sectors the

analogous figures are, respectively, 78.9 % and 53.8 %. As far as degrees are concerned, the

proportions of individuals who hold a university degree are 40.3%, 18.9%, and 2.44%

respectively in the public, formal private and informal sectors. The higher proportion of

university graduates in civil servant jobs than in private sector ones is partly attributable to the

fact that access to many Government jobs require a higher education degree. Observed

differences in education are reflected in wage differences. Actually, sizeable earnings

differentials in favour of public sector employees relative to formal private and informal

sectors workers are found across labour market sectors. The average log(wage) is 11.65 in the

public sector, 11.279 in the formal private sector, and 10.253 in the informal sector. A group

mean comparisons tests reveals that public sector earnings are higher than both formal private

and informal sectors wages. The earnings gap in favour of the public sector may be either due

to higher economic returns to human capital in the public sector, or to differences in personal or

job characteristics (education, experience or occupations) between employees across the

labour market sectors. Consistent with the notion that rewards in the public sector are less

variable, the standard deviation of these variables is lower in the public than in the private

sector.


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Table 1. Sample characteristics for basic variables

Variables

Public sector Formal private sector Informal sector

Mean Standard

deviation

Mean Standard

deviation

Mean Standard

deviation

Education variables

Level of education

Primary school dummy

Secondary school dummy

Tertiary school dummy

Highest degree obtained

Primary school certificate

First Level Secondary school

diploma

Probation degree

High School certificate

BTS degree

Bachelor/Licence degree

Master and upper degrees

Years of schooling

Other variables

Log(wage)

Age

Experience

Monthly hours of work

Migration status

0.106

0.529

0.357

0.190

0.182

0.071

0.212

0.050

0.121

0.111

12.351

11.650

39.640

6.717

156.436

0.437

3.387

0.766

8.823

6.797

31.387

0.191

0.567

0.222

0.285

0.224

0.066

0.146

0.056

0.065

0.060

10.835

11.279

33.726

5.0634

202.841

0.197

4.025

0.863

9.493

5.580

64.462

0.393

0.502

0.036

0.491

0.131

0.042

0.040

0.006

0.013

0.005

6.739

10.253

26.879

3.093

184.019

0.077

3.806

0.774

9.399

4.360

87.006

3. Results and Discussion

Table 2 provides the results from estimating earnings functions for the public, formal private

and informal sectors in Cameroon for the two specifications under consideration. Globally, all

the wage equations are statistically significant with an R-squared which is around 34% in the

public sector, 40% in the formal private sector around 25% the informal sector; these statistics

means that the model is better fitted to explain wages of public and formal private sectors

workers. A first noteworthy result is that a large part of the variance of earnings reflects

unobservable factors that are not captured in the regression equations. Unlike Ewoudou and

Vencatachellum (2006) who got a significant selection term only in the public sector, the

sample selection correction terms are significant and negative for all the labour market sectors,

meaning that it is important in the case of Cameroon to explicitly model selection into

employment when estimating earning functions. If we hypothesize that people choose their

status of employment in a way which maximizes their earnings potential, then we should

observe positive selection. One interpretation of the negative selection into employee status is

therefore that there exist some unobserved factors that increase one’s probability to be

employed but also contribute to the likelihood that a person will earn a below average wage.


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Table 2. Estimated earnings coefficients.

Variables

Public sector Private sector Informal sector

1 2 1 2 1 2

Age

Experience

Experience squared

Monthly hours of

work

Migration status

Level of education

dummies

Primary school

dummy

Secondary school

dummy

Tertiary school

dummy

Highest degree

dummies

FLSC

GCE-OL

PROBATION

degree

GCE-AL

BTS degree

BACHELOR

degree

MASTER and upper

degrees

0.0242***

(6.26)

0.0183*

(1.67)

-0.0009**

(-1.98)

0.0017**

(2.21)

0.1895***

(4.54)

0.5597**

(2.01)

0.8776***

(3.16)

1.2694***

(4.21)

-1.1017**

(-2.13)

10.0179***

(16.32)

49.20

0.0000

0.0239***

(6.42)

0.0180*

(1.67)

-0.0008**

(-1.96)

0.0018**

(2.29)

0.1821***

(4.37)

0.2806

(0.91)

0.3927

(1.21)

0.5499

(1.56)

0.3794***

(2.38)

0.4765***

(2.79)

0.5142***

(2.80)

0.6493***

(3.76)

0.7724***

(3.55)

0.6746***

(3.37)

0.9252***

(4.73)

-0.8818*

(-1.73)

9.8414***

(16.28)

31.81

0.0000

0.0214***

(6.32)

0.0547***

(3.64)

-0.0018**

(-2.46)

0.0004

(1.09)

0.2245***

(3.42)

0.1657

(1.19)

0.4889***

(3.39)

1.1359***

(6.73)

-2.1987***

(-3.04)

11.1954***

(17.21)

53.88

0.0000

0.0195***

(5.99)

0.0547***

(3.59)

-0.0018***

(-2.38)

0.0005

(1.52)

0.1941***

(3.05)

0.0796

(0.53)

0.1769

(1.04)

0.1012

(0.46)

0.1358

(1.51)

0.3082***

(2.77)

0.4353***

(3.22)

0.5758***

(4.58)

1.0822***

(5.61)

0.8702***

(4.51)

1.4887***

(7.23)

-1.9442**

(-2.80)

11.0404***

(17.80)

35.67

0.0000

0.0219***

(9.08)

0.0396***

(4.26)

-0.0013***

(-3.14)

0.0021***

(9.36)

0.1092*

(1.96)

0.1588**

(2.03)

0.5646***

(6.55)

1.2189***

(7.27)

-1.1746***

(-3.75)

9.2179***

(49.39)

44.64

0.0000

0.0199***

(8.55)

0.0407***

(4.56)

-0.0013***

(-3.47)

0.0022***

(9.90)

0.1022*

(1.86)

0.1311

(1. 61)

0.4019***

(4.03)

0.2794

(0.96)

0.0390

(0.80)

0.2390***

(3.40)

0.3332***

(3.29)

0.3960***

(3.83)

0.5426

(1.43)

1.2524***

(4.18)

1.4090***

(4.08)

-1.1588***

(-3.78)

9.2614***

(51.43)

30.35

0.0000


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Selectivity term

Constant term

F( , )

Prob > chi2

R-squared

No. Observation

0.3380

859

0.3620

859

0.3797

874

0.4291

874

0.2325

1616

0.2607

1616

Note: Dependent variable: Log revenue; Dummies No-education, No-diploma, and Non-migrant are base

outcomes for Education level, Diploma and Migration status. Values within parentheses under estimators

represent t-Student. ***(**){*} significant at 1% (5%) {10%}.

Results show that the association between monthly wages and monthly working hours is

positive and significant in the public and informal sectors. There is a non-linear relationship

between earnings and experience is reflected in the coefficient on the experience variable

bearing a positive sign, while the experience squared variable has a negative sign. Following

Mincer’s (1974) and Card’s (1999) idea, one can interpret this result as an indication that

people increase their productivity while working through the learning by doing process an that

earnings increase with an increasing rate at the beginning of the carrier and with a decreasing

rate through the end of the carrier. One more year of experience increases log (wage) by about

1.81% in the public sector, 5.62% in the formal private sector, and 4.15% in the informal

sectorvi

. According to the microeconomic theory of migration, individuals’ migration decisions

are the outcome of human capital investment decisions (Sjaastad, 1962) and are aimed at

securing either jobs or better-paying jobs. This view was confirmed by Tsafack and Zamo

(2009) who gave evidence of significant wage differentials in favor of migrants in urban

Cameroon. This study does dive into that result by explicitly highlighting that returns to

migration are around 19.97% in the public sector, 21.42% in the formal private sector and

10.76% in the informal sector.

In line with findings in the literature, our results show that earnings rise with higher levels of

education. Taking the first specification and irrespective of the labour market sector, returns to

education are convex and the statistical significance becomes stronger with higher levels of

schooling. The profile of the convexity of the returns to education are close in magnitude to

what was estimated for Turkey in the informal sector (Tansel, 1999), for Cameroon private

sector (Ewoudou and Vencatachellum, 2006), and for Ghanaian male workers (Sackey, 2008).

As Benhayoun and Bazen (1995) observed in Morocco, the returns to the level of education are

overestimated when omitting the highest degree obtained by the individual. For instance,

returns to the tertiary level of education are lowered and become non significant in all the

labour market sectors. This result evidences the existence the of a sheepkin effect in the

Cameroon urban labour market, that is the fact that part of the returns to education is due to the

influence of degrees on wages. This may be interpreted as a confirmation of Arrow’s “filter

theory” according to which the main function of education is not to increase people’s

productivity, as postulated in the human capital theory, but to filter candidates with the most


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impressive characteristics.

Table 3 summarizes the private rates of return to education in the different labour market

sectors. It shows that returns to degrees obtained before university are greater in the public

sector. Monthly wages differentials between the omitted class of non-graduated and individual

with a GCE-Ordinary level are around 61.04% in the public sector, 36.09 in the formal private,

and 24.99% in the informal sectors. For those who hold a GCE-AL, the same wage differentials

are around 91.42% in the public sector, 77.85 in the formal private, and 48.58% in the informal

sectors. Thus, the major pattern that emerges from these results is that, it is more beneficial for

those with the secondary level of education to work in the sector formal (public or private) than

in informal sector. As far as university degrees are concerned, returns are greater in the private

sector. For instance, the BACHELOR degree raises wages by approximately 138.73 % in the

formal private sector and only by 96.32% in the public sector. It is worth nothing that university

degrees significantly affect pay in the informal sector. Still, coefficient estimates for different

degrees may not be reliable as there are very few observations in some of the cells. For instance,

there are only 15 observations in the informal sector for the Master and upper degrees.

Therefore, the results concerning informal sector wage equations should be interpreted

cautiously.

Table 3. Estimated return rates to degrees (second specification)

Variables

Public sector Private sector Informal sector

total marginal total marginal total marginal

FLSC

GCE-OL

PROBATION degree

GCE-AL

BTS degree

BACHELOR degree

MASTER and upper degrees

0.4614**

0.6104**

0.6723**

0.9142***

1.1649***

0.9632***

1.5223***

---

0.0254

0.0192

0.1446

0.0654

-0.0931

0.1423

0.1454

0.3609***

0.5454***

0.7785***

1.9511***

1.3873***

3.4313***

---

0.0470

0.0677

0.1508

0.3296

-0.1910

0.4280

0.0397

0.2499***

0.3954***

0.4858***

0.7204

2.4987***

3.0918***

---

0.0553

0.0493

0.0648

0.0789

1.0335

0.0847

Note: ***(**){*} significant at 1% (5%) {10%}.

Source: Author’s calculations based on Table 2.

In the Cameroon economy where the formal sector of the labour market is unable to grow at a

fast enough pace to absorb the ever rising labour force, competition for the limited formal

sector jobs is keen and people tend to invest more in education in order to get degrees that will

enable them to get better paid jobs. As one can observe on table 3, highest marginal rate of


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return to additional certificates are obtained in the formal private sector. Graduating from the

first level of the secondary education entails a marginal return of 2.54% for civil servants,

4.70% for formal private workers, and 5.53% for informal workers. Schooling two additional

years after the GCE-AL increases wages by 6.6.54% in the public sector and by 32.96% in the

formal private sector; the increase is not statistically significant in the informal sector. It is

worth mentioning that in the formal sector (public and private), returns to an additional year of

tertiary education once the BTS certificate is obtained are lower than returns to an additional

year after the GCE-AL. This result comes as an indication that holders of this vocational

certificate are worse-off working with a Bachelor degree. It may also be interpreted as a result

of the quadratic form of returns to additional years of schooling. The return to two additional

years of tertiary education once the Bachelor degree is obtained tends to be relatively high in

the formal private sector (42.80%) followed by the public sector (14.23%).

4. Conclusion

This study analyses the returns to education in Cameroon and uses the 2005 Employment and

Informal Sector Survey. Two sample selection corrected wage equations are estimated for each

labour market sector to check for a “parchment effect” in the urban Cameroon labour market.

In line with findings in the literature on sub-Saharan Africa, results show that earnings rise with

higher certificates in all sectors of employment. Completing a certificate is more beneficial

than completing one year of college without a credential; a GCE-OL degree is more valuable

than four years of college without the credential; the probation degree (Probatoire) increases

earnings by more than two years of college after the GCE-OL without the certificate. This

suggests that completing credentials is the wisest course for most individuals. Overall, returns

to education in the formal private sector are higher than returns to education both in the public

and informal sectors. Thus, it is more beneficial for those with high degrees to work in the

formal private sector.

As a policy prescription from these results, the fact that those who do not graduate from a

certain level of education cannot take advantage of the returns to this level calls for efforts to

reduce classes repeating and school drop outs; there’s a need to improve the internal efficiency

of the Cameroon education system. The decrease in the returns to schooling between the BTS

and the Bachelor degree provides some rationale for greater investment in schooling by private

economic agents, beyond the one year needed to obtain the Bachelor degree. Further, public

policies that enforce private initiative, in order to expand employment opportunities for

underprivileged and socially excluded groups, must be encouraged as they benefit the whole

society via the externalities of education.

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Endnotes

i The University of Yaoundé, the sole university at that time, compounded the faculty of Law and Economics,

the faculty of Arts and Social Sciences, and the faculty of Science. The Government also built professional and

technological schools in order to prepare graduates for immediate integration into the public service or

Government corporations. By 1967 other establishments were created and attached to the University of Yaoundé.

The principal ones are the University Centre for Health Sciences (CUSS), the Institut de l’Administration des

Entreprises (IAE), International School of Journalism (ESIJY), the Institute of International Relations (IRIC)


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and the National Advanced School of Engineering (ENSP). With the creation of these training capacities, the

nation was finally poised to tackle the broad strategic problems of development.

ii CFAF represents the monetary unit used in Cameroon and in the countries that are members of the Central

African Economic and Monetary Community. CFAF means Communauté Financière d’Afrique (that is African

Financial Community)

iii During the second year, students sit an exam to get the Probation Degree named “Probatoire” which allow

them sit the final exam of the secondary school, that is the Baccalauréat. Recall, the french name of the FLSC is

Certificat d’Etudes Primaires et Élémentaires (CEPE), while the GCA-OL is named Brevet d’Etudes du

Premier Cycle (BEPC).

iv Post secondary education is mainly provided by universities, specialized institutions and schools. University

level studies are sanctioned by a Diplôme d'Etudes Universitaires Générales (DEUG) after two years, a Bachelor

degree (also called Licence) one year after the DEUG a Maîtrise one year (in faculties of Economics and

Management and in Law) or two years (in faculties of Arts and Sciences) after the Licence, and a doctorate (3 to

5 years after the Diplôme d'Etudes Approfondies (DEA), generally obtained one year after the Maitrise).

v Note, sample mean numbers are very close to these statistics. For instance, we have 5.098, 9.917 and 15.824

respectively for those who have the primary, the secondary and the tertiary levels of education. As far as the

highest degree obtained is concerned, mean number of years of schooling are 7.640 for the FLSC/CEP degree,

10.621 for the GCE-OL/BEPC degree, 12.033 for the Probation degree, 13.364 for the GCE-AL/Bacalaureat

degree, 15.086 for the BTS degree, 16.115 for the Bachelor/Licence degree, 17.996 for the Master and uppers

degrees.

vi To compute these returns to experience, we used coefficients obtained in specification (2) and the formula

used to compute these return is exp 1j .






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Success Factors of Entrepreneurs of Small and Medium

Sized Enterprises: Evidence from Bangladesh

Mohammed S. Chowdhury

Touro College, Department of Business and Accounting, New York


Zahurul Alam

Department of Management Studies

University of Chittagong, Bangladesh


Md. Ifttekhar Arif

Lecturer, Institute of Education Research and Training

University of Chittagong , Bangladesh

Received: June 13, 2013 Accepted: June 30, 2013


Abstract

In order to assess the factors that affect the success of entrepreneurs of small and medium sized

enterprises of Bangladesh, survey data were collected from eighty entrepreneurs from the

southern region of Bangladesh selected through random sampling technique. Success factors

here refer to demographic characteristics and environmental factors that impede the business

success of entrepreneurs of small and medium-sized enterprises of Bangladesh. The results

indicate that that the success of the entrepreneurs was correlated to all independent variables in

the study and all hypotheses were supported. Lack of infrastructure, sound political

environment, access to market and capital were the major factors that positively hindered the

success of the entrepreneurs. Experience and education were positively correlated while age

was negatively correlated to success. The regression models fit for regression equations were

determined by F statistics. The models indicate positive and statistically significant

relationship. Altogether demographic variables explained 26.9% of the total variance in


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success while environmental variables explained 39.8% of the total variance in success.

Keywords: Entrepreneurship, Infrastructure, Environment, Success, Education, Experience

1. Introduction

There is a broad consensus that a vibrant SMEs (herein referred to as Small and medium-sized

enterprises) sector is one of the principal driving force in the development of a market economy

and vital for a healthy economy (Nafukho and Muya, 2010). The men and women who run

these enterprises are called entrepreneurs. Entrepreneurship is a company that undertakes new

arrangement to produce new products and services ( Schumpeter, 1934). It is a process of

innovation and creation with four dimensional elements –individual, organization,

environmental factors and process, with support from the government, education, and

constitution (Kuratko and Hodgetts, 2004). Historically, it is proven that that with each

economic downturn in both developed and developing countries, it is the entrepreneurial drive

and persistence that brings us back (Kuratko 2006). In this study, we focus on entrepreneurship

as it takes place in SMEs since the two are closely related and cannot be isolated from each

other.

Various types of SMEs such as village handicraft makers (weaving, embroidery etc), potteries,

dying, small machine shops, restaurants, knitting, small dairy process etc, are, therefore,

becoming increasingly important to economic development of developing nations. For

example between 1990 and 1995, an average of 84 out of 100 new jobs in the region were

generated by micro enterprises in Latin American countries. (Orlando & Pollock, 2000). In

Least Developed Countries (LDCs) in Asia small medium enterprises account for 80% of the

firms generating 80% employment and 40-70% of value added and in Bangladesh small

medium enterprises account for the majority of firms (87%) providing 80% of total

employment and contributing 15 percent to Gross Domestic Product (GDP) of the country

(Narain, 2003). It is generally recognized that six million SMEs (firms of less than 100

employees) of Bangladesh have a significant role in generating growth and jobs (ADB, 2004).

The country’s SMEs sector contributed up to 25% of Bangladesh’s gross domestic product,

about 40% of gross manufacturing output, 80% of industrial jobs, and around 25% of the total

labour force in 2003 (ADB, 2004), making the country's SMEs the largest business sector in the

economy of Bangladesh. The garment sector of Bangladesh alone directly employs 2.7

million people, including 1.25 million women and is the source of direct and indirect

employment for 10 million people (Levin, 1998 cited in Chowdhury, 2007).

1.1 Problem Statement

In Bangladesh, most SMEs operate along traditional lines in production and marketing. There

is a growing evidence in literature that the main problem for SMEs in developing countries is

not their small size but their isolation, which hinders access to markets, as well as to

information, finance and institutional support (Mead & Liedholm, 1998; Swierczek & Ha,

2003). A host of factors prevent them from realizing their full potential as entrepreneurs, where

they could make significant contribution to society. These factors relate to the characteristics of

entrepreneurs, psychological traits, finance, capitalization, marketing, technology, social


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network, gender, government policy issues, and management and performance of the firms.

While several of these challenges are in inherent to many countries, some of them are more

severe in South Asia, particularly Bangladesh. It is important that factors be identified that

affect the business success of the entrepreneurs in this country.

Research has shown that success is closely connected to education level (Staw 1991; Meng and

Liang, 1996), experience (Ziemmerer and Scarborough, 1998) and age (Sletten and Hulaas,

1998). Also, numerous studies (Chowdhury, 2007; Larsen and Lewis, 2007; McDowell, 1997;

Prahlad, 2004; Mintoo, 2006) have revealed the relationship of entrepreneurial success to

environmental factors such as political environment, government, infrastructure, technology

etc. Cooper (1985) reported three factors responsible for entrepreneurial development and

success at the grass root level. These are antecedent influences (background factors such as

family influence, skills and knowledge), the incubator organization (the nature of the

organization where the entrepreneurs were employed prior to starting their own business) and

environmental factors (e.g., infrastructure, political environment, access to capital, role of

government etc).

A closer look into such studies reveals that these environmental and demographic factors in

relationship to entrepreneurial success have received scant attention in Bangladesh. Moreover,

though the promotion of SMEs development has been a stated objective of successive

governments of Bangladesh since 1947, they have not been able to unleash entrepreneurial

talents and enhance their success to increase productivity throughout the economy (Chowdhury,

2007).

Built on theories and research on entrepreneurship, this study has attempted to capture the

essence of identification of factors affecting the business success of entrepreneurs of small and

medium sized enterprises. One of the major impacts of this study is that it will constitute an aid

to policy makers, researchers, academia, and the business community as well for improving the

performance of entrepreneurs of small and medium sized enterprises in this country. The

purpose of this study is, therefore, to determine factors affecting business success of small and

medium-scale entrepreneurs in Bangladesh that relate to demographic and environmental

variables (see figure 1) from Bangladesh context.

Research Question

To what extent do demographic factors affect business success of entrepreneurs in SMEs sector

of Bangladesh?

To what extent do environmental factors affect business success of entrepreneurs in SMEs

sector of Bangladesh?

Research Objectives:

To identify demographic factors that affect business success of entrepreneurs in SMEs sector of

Bangladesh

To identify the environmental factors that affect business success of entrepreneurs in SMEs

sector of Bangladesh


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It is argued that entrepreneurship is environmentally determined phenomenon (see McDowell,

1997, Prahalad, 2004, Quddus and Rashid (2000). Indarti, N and Langenberg, M ( 2005) also

reported external environment and demographic factors affecting SME business success.

The environmental constraints can make or mar entrepreneurial decision making. This

supports the thesis that ability to success is impaired by environmental constraints.

Demographically, age, gender, education, and work experience have been found to have impact

on entrepreneurial success. Educated people are creative and innovative and they are always

looking for something unique to fill a need or want (Ndubisi et al, 2003). The educated and

experienced women are more interested in becoming entrepreneurs than non-educated and

inexperienced women (Kavita , Anantharaman, and Jayasingam 2008). People between the

age of 25 and 44 are most likely to be involved in entrepreneurial activity ( Reynolds et al,

2000).

These demographic and environmental factors are considered for the theoretical framework of

our study based on suitability within Bangladesh context. Accordingly the study of key factors

affecting success of entrepreneurs in Bangladesh can be grouped into:

Demographic characteristics

Environmental elements

1.1.1 Theoretical Framework

These demographic and environmental factors are considered for the theoretical framework of

our study (see figure 1).

Figure 1. Theoretical Framework

Success

Demographic

characteristics:

Age

Education

Experience

Environmental

(contextual) variables

Marketing

Technology

Capital access

Infrastructure

Government

Political

Information access


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2. Literature Review

2.1 Business Success of Entrepreneur

Success refers to the achievement of goals and objectives in any sector of human life. Though,

in business, the concept of success generally refers to a firm’s financial performance, it has

been interpreted in many different ways (Foley and Green, 1989). Some authors defined

success from tangible (objective) points of view such as revenue or a firm’s growth, personal

wealth creation, profitability, turnover (Perren, 2000; Amrit et al 2000). Other studies (Watson

et al 1998; Taormina and Lao, 2007) associated entrepreneurial success with continued

business operations, operating for at least three years. Some other studies have interpreted the

success from intangible points of view where intangible assets (e.g., goodwill of firm) are

linked to key factors of success. Despite the fact that success has been widely studied topic in

the field of entrepreneurship, no consensus on what is understood by the success of the firm can

be found in the literature (Perez and Caninno, 2009). Our contention is that success is largely

determined by subjective perceptions of the entrepreneur regarding their success (Ibrahim and

Goodwin, 1986). This study, therefore, attempts to find out the relationship of success as

perceived by entrepreneurs to demographic and main environmental elements.

2.1.1 Demographic Characteristics

A wide range of studies (Muncuso, 1974; Cooper and Dunkelberg, 1987; Dolinsky et al 1993;

Gratner, 1989 ) profiling the demographic characteristics of entrepreneurs is evidenced in the

literature. A common trend in all of these studies has been the reliance on descriptive profiles of

demographic and personal characteristics, which are then often compared with results derived

from similar studies in different country settings. We propose, in this study, that education, age

and experience are important demographic factors from the context of Bangladesh. The

argument is that education and experience play a fundamental role in the process of economic

development of a developing country (Scott et al 1998). Future entrepreneurs tend to be

younger possessing stronger educational backgrounds and having less previous working

experience (Sletten and Hulaas, 1998). Skills and educational backgrounds of these

entrepreneurs are vital to the development of new businesses. Secondly, more and more men

and women are emerging as entrepreneurs in the economy of Bangladesh with less experience

and education (Chowdhury, 2011). Several other studies (Reynolds et al 2000; Kristiansen et

al 2003; Sinha, 1996) found a significant relationship between the age of entrepreneur and

business success.

Based on the above discussion on demographic characteristics of entrepreneurship proposed in

our theoretical framework, we hypothesize the following:

H1: There is a significant relationship between the age of entrepreneurs and business success.

H2: There is a significant relationship between education of the entrepreneurs and their

success.

H3: There is a significant relationship between work experience of the entrepreneurs and their

success


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2.1.1.1 Environmental Elements

A host of environmental factors (see figure 1) impede the success of small business in

Bangladesh. For example (Begum, 1993) reports lack of government efforts and incentives.

Several studies (Camp and Anderson, 2000; Chowdhury, 2007; McDowell, 1997) report

absence of adequate infrastructure facilities. Some study (Quddus and Rashid, 2000) reports

myriad of bureaucratic obstacles that entrepreneurs face in their quest to start a business. A host

of factors such as lack of long-term capital (Chowdhury and Amin, 2011), limited personal and

family savings (Mintoo, 2006), limited access to market (Keh, Nguyen and Ng, 2007; Mead

and Liedholm, 1998; Swierczek and Ha, 2003), technology (Gundry, Ben-Yoseph and Posig,

2002; Gibbons and O’Connor, 2003) and information (Singh and Krishna, 1994; Duh, 2003;

Kriestiansen, 2002) have been found to be impeding the success of entrepreneurs of small and

medium enterprises of Bangladesh. Personal and political enmity between political rivals,

frequent haratal (strikes), lack of respect for elementary principles of democratic governance

have become the principal characteristics of political system of the country (Chowdhury, 2007).

A series of prolonged haratal and labor unrest at garment factories affect the socio-economic

and political condition of the country. The average cost of haratal during 1990s to Bangladesh

economy was 3 to 4 per cent of GDP of the economy (UNDP, 2005)

The foregoing discussion reveals that the success of entrepreneurs is influenced by

environmental factors. The following hypotheses are, therefore, proposed on the

environmental variables stated in our theoretical framework.

H4: There is a significant relationship between market and the success of entrepreneurs

H5: There is a significant relationship between government support and the

success of entrepreneurs

H6: There is a significant relationship between access to capital and the

success of entrepreneurs.

H7: There is a significant relationship between technology and the success

of entrepreneurs.

H8: There is significant relationship between information access and the


H9: There is a significant relationship between infrastructures and the


H10: There is a significant relationship between political environment of the country and

the success of the entrepreneurs

3. Materials and Method

3.1 Sample

To achieve the objectives of this study a sample of eighty seven entrepreneurs was

conveniently chosen from southern region of Bangladesh. Convenience sampling was

employed because of the paucity of statistics on the target group. The questionnaires were

distributed to the entrepreneurs and in distributing the questionnaire “drop and collect”

procedure was chosen. The questionnaires were collected after a period of 30 days. Eighty


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entrepreneurs filled the questionnaire correctly. Therefore, only eighty entrepreneurs were

taken into consideration in the study. Enterprises taken up for the study were food, printing and

publication, wooden & steel furniture, boutiques, beauty parlors, handloom units, and nursing

homes. They were all SMEs with twenty or fewer employees. This is generally accepted

definition of SMEs for this study ( Ibrahim and Goodwin, 1986). Most entrepreneurs were

male (92%) and a vast majority of them (58%) had four years college degrees. Majority of

them fell in the age group of 31-40.

3.1.1 Instruments

The study relied primarily on the survey method. A survey instrument was developed to

capture the information relating to the research objectives. A structured questionnaire was

distributed to entrepreneurs. The resulting questionnaire comprised of demographic and

environmental information of the respondents and a set of items to measure business success.

3.1.1.1 Measurement of Variables

Subjective perceptions of the entrepreneurs regarding their success (dependent variable in this

study) have been used in our study rather than objective measures. This is in parallel with

previous studies (Perez and Canino, 2009; Wang and Ang, 2004). Subjective measures may

also reliably assess the success of business and may become best way to obtain information

that would otherwise be very difficult to gather (Perez and Canino, 2009). Five-point Likert

scale anchored by strongly disagrees and strongly agrees were applied to measure the

perceived success that comprised four items, trapped into one variable.. One typical item was: I

consider my business successful. Another item was: I consider my business growing.

Cronbach’s alpha of the items was .73.

Demographic and Environmental factors are independent variables in this study. As part of

capturing demographic information of the respondents, we have included only three

demographic characteristics: age, education, and experience. The three factors conform to the

suitability of Bangladesh situation. Cronbach’s alpha of the items was .71.

In regard to environmental variables, the respondents were asked to score the importance of

seven environmental factors on a scale anchored by very unimportant to very important. All

these factors relate to external environment that affect success of the entrepreneurs and

conforms to previous research (Indarti and Langenberg, 2005; Huggins, 2000) This part

consisted of 27 items, trapped into seven variables.

4. Results

4.1. Validity and Reliability of the Instrument

Table 1. Reliability test

No Variable No of items Cronbach’s alpha

1 Marketing 5 0.78

2 Technology 4 0.73

3 Information access 3 0.69


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4 Capital access 5 0.81

5 Government support 3 0.67

6 Political environment 4 0.71

7 Infrastructure 3 0.68

As seen in the table 1above each variable consisted of at least 4 items. The values of

Cronbach’s alpha are greater than 0.6 for each variable and hence considered acceptable

( Nunally, 1978). We conclude that the research instrument used in the study is valid and

reliable.

4.1.1 Data Analysis

To analyze data, descriptive statistics, correlation and regression analyses were used. Pearson

r is the most widely used bivariate correlation technique (Gall and Gall, 1996). Pearson’s

correlation measures both direction and extent of association between the variables. The

coefficient of correlation measure was, therefore, used to examine the relationship between the

success and demographic factors and between success and environmental factors. Two

regression equations were used to test our theoretical model. One for analyzing the direct

effects of seven environmental variables on success and another for doing the same for

demographic variables, aimed at determining the highest influence factor (s) of independent

variables on business success of entrepreneurs.

Table 2 presents correlation between success and demographic characteristics. Table 2

indicates that experience and education are positively correlated while age is negatively

correlated to business success.

Table 2. Correlation between success and demographic characteristics

Success Age Education Experience

Success 1 -.241* .255* .249*

Age -.2418 1 .212 -.237

Experience .255* -.212 1 -.322**

Education .249* -.237 -.322** 1

**Correlation is significant at the .01 level (2 –tailed)

*Correlation is significant at the .05 level ( 2 tailed)

Regression analysis results (see table 3) based on independent variables (demographic) depicts

that education and experience directly affect the success of entrepreneurs in Bangladesh, as

evidenced from greater t-value (t>2). Age factor has relatively less and negative influence on

success when compared to these two factors (t= -1.93). Altogether demographic variables

explained 26.9% of the total variance (adjusted r-square is .269).


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Table 3. Coefficient of determination between independent variables (demographic) and

dependent variable

Variable Beta Standard coefficient T-value Significance Mean SD

Success 6.41 000 4.7 .6825

Age -2.00 -1.938 .056 37. 6.301

Experience .293 2.868 .000 2.5 .5031

Education .348 3.329 .000 2.0 .5624

As regards to environmental variables, results (table 4) show that all the independent variables

are correlated to the entrepreneurial success.

Table 4. Inter-correlation between environmental variables and entrepreneurial success

Success Mkt Capital Infra Govt Tech

Polenv

Info

Success 1 .435** .256* .447** .288** .328** .406** .225*

Mkt .435** 1 -.073 .573** . 285* .283* .161 .277*

Capital .256* -.073 1 -,064 .204 .020 .018 .165

Infra .447** .573** -.064 1 .401** .314** .152 .352**

Govt .288** .285* .204 .401** 1 .475** .106 .305**

Tech .328** .283* .020 .314** .475** 1 .146 .396**

Politcal .406** .161 .018 .152 .106 .146 1 -.014

Info .225* .277* .165 .352** .305** .396** -.014 1

**Correaltion is significant at the .01 level ( 2 tailed)

* Correlation is significant at the .05 level ( 2 tailed)

Notes: *p <0.1, ** p <0.05

Mkt= Marketing, Infra= Infrastructure

Govt= Government; Info = Information access

Polenv= Political environment

Regression analysis results based on independent variables (environmental) show that (see

table 5) market, infrastructure, capital access, political environment, affected entrepreneurial

success significantly in positive directions as proved by the higher t (t>2) and beta for each of

them. Altogether, the independent variables (environmental) explained 39.8 % of the total

variance in success (adjusted R-square is .398)

Model summary:

Adjusted R-square .269

F 8.259

Significance 000


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Table 5. Coefficient of determination between independent variables (environmental) and

dependent variables

Variable Beta standard coefficient T-value Significance Mean Standard Deviation

Success -4.19 .000 11.45 3.84

Marketing 2.134** 2.134 .036 12.75 2.37

Capital access .294*** 3.177 .000 13.96 1.22

Infrastructure .263** 2.285 .025 12.56 3.43

Government support -.044 -.406 .686 8.42 4.66

Technology .161 1.514 .134 7.11 4.24

Political environment .304*** 3. 386 .000 4.88 .389

Information access -.027 -.262 .794 11.62 3.64

**p<0.05, *** p<0.001

5. Discussion

The main objective of this study has been to present a general model toward understanding the

dynamics of entrepreneurial success. We have developed the framework that included

demographic and environmental factors (see figure 1). The study supports the contention that

age, education and experience affect the success of entrepreneurs in Bangladesh. Several

studies (Scott, Rosa and Klandt, 1998; Reynolds et al 2000; Kriestiansen et al , 2003; Sinha,

1996) support this contention of our study. The study reveals that supportive environmental

factors may well be linked with the success of the entrepreneurs in Bangladesh. This study

clearly supports that volatile political environment, lack of access to capital, lack of

infrastructure and technology are the major constraints limiting the success of entrepreneurs in

Bangladesh. Entrepreneurs in all parts of the world seem to have a problem accessing capital,

securing financing, convincing bankers and obtaining bank loans or credit from suppliers.

This conforms to several studies around the world that have been carried out to throw light on

the challenges faced by entrepreneurs. For example, in South Asia, lack of access to capital

has been a primary obstacle for entrepreneurs, and recent research suggests it continues to be”

(Gundry, Ben-Yoseph and Posig, 2002). This could also include start-up financing and credit,

cash flow management in the early operations and financial planning. Research suggests that

the primary source of funding has been through family loans, personal savings, credit cards,

and home equity loans (Gundry, Ben-Yoseph and Posig, 2002).

6. Conclusion and Future Research

The challenges towards success of entrepreneurs of small and medium size enterprises have

depicted several key issues, relating to demographic and environmental factors. Despite

many barriers to success, a new entrepreneur class has arisen in the country taking on the

challenge to work in a competitive and complex economic and business environment. Not only

Model summary:

Adjusted R-square

.398: F value 8.448:

Significance 000


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have their entrepreneurship improved their living conditions and earned more respect in the

family and the society, but they are also contributing to business and export growth, supplies,

employment generation, productivity and skills development of the country. Therefore, there is

a need for a continuous and coherent focus on financing, advisory and work life balance for

enhancing entrepreneurship in Bangladesh. The country needs a frame for policy learning in

order to develop a proper policy mix towards promoting entrepreneurship.

A favorable political and economic climate is a pre-condition for the development of any

business in any country in this world. The entrepreneurs of Bangladesh must be recognized as

an important unit contributing to the economic growth of the country since small and medium

business sector is going to attract and create jobs for many more Bangladeshis. They must be

supported by the governmental organizations and their constraints must be recognized and a

structured and organized strategic plan put in place to help them overcome these limiting

factors. Bangladesh Government must come forward to enhance the entrepreneurial

capabilities of entrepreneurs through funding and skill development.

Future Research

The study has been able to explore a number of issues that require further investigation. Future

research should seek to investigate into the factors other than demographic and environmental

factors (e.g., entrepreneurs’ innovative behavior, personality traits) that affect the success and

growth of entrepreneurship in the country. Longitudinal data may reveal a trend in constraints

to entrepreneurship success that this study was not able to uncover. Such study will provide a

clearer picture of the antecedent's influence on entrepreneurial success. A combination of

survey and case study methods should be employed. The findings of such a study should assist

various actors to focus their efforts on the growth and success factors of SME sector of

Bangladesh.

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The Impact of Overconfidence on Investors' Decisions

Boubaker Adel, Talbi Mariem

International Finance Group Tunisia,

Faculty of Management and Economic Sciences of Tunis

Tunisia, El Manar University, Tunis Cedex, C. P. 2092, Tunisia

Received: June 20, 2013 Accepted: July 4, 2013


Abstract

The purpose of this paper is to study the impact of the bias of overconfidence on the

decisions of investors, specifically to evaluate the relationship between the bias, trading

volume and volatility. The empirical study on a sample of 27 companies listed on the stock

exchange in Tunis, observed over the period, which runs from 2002 until 2010.

The results we have achieved, through the application of tests and VAR modeling

ARMA-EGARCH indicate the importance of confidence bias in the analysis of

characteristics of the Tunisian financial market.

Keywords: Efficiency, Behavioral finance, Overconfidence, Stock returns, Trading volume,

Excess volatility, VAR, EGARCH

1. Introduction

The theory of efficiency is indeed one of the most controversial theories in economics and

finance theories. Despite the amplitude of empirical work to test the hypothesis of efficiency,

no obvious conclusion seems to be clear. This absence of unanimous results is certainly

related to the importance of efficiency in the financial theory.

The efficiency market hypothesis (EMH) requires the validation of a number of conditions:

the rationality of investors, the free flow of information, the market's atomicity and liquidity.

The good performance of financial markets is based on the validation of these five conditions,

but this one proves not easily applicable, due to some shortcomings related to investor

behavior.

According to the literature finding, the investors decisions are not perfectly rational, the EMH

is unable to explain certain anomalies detected on the financial market, This was the origin of

the emergence of a new research program "behavioral finance", this new current treats at the

same time psychology and finances, was able to focus on the behavior of investors in the


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financial market through different psychological biases among these biases, we find through

overconfidence as the choice of this bias seems very important in terms of choice of the

financial decisions.

The purpose of this paper is to analyze the impact of overconfidence bias on investor

decisions, in Tunis stock market through the use of data collected from the stock market of

Tunis (Tunis Stock Exchange).

First, we present the theoretical foundations of EMH by evaluating the size of the efficiency

of financial market based on the literature review, and its contribution in the field of modern

finance, as well as the recently observed anomalies in financial markets. That contributed to

devalue this current, which allowed the entry of a new current “behavioral finance”, in this

context, we recall the notion of overconfidence and its role occupied in the field of behavioral

finance, through a range of studies on this concept, while referring to the existing theoretical

and empirical literature and various reflections.

Second, we present the data collected from the stock market of Tunis and the methodology.

Finally, we present an empirical validation test which will be on the Tunisian context; we

tried to present the main results. The aim of our research is to detect the impact of

overconfidence on investors' decisions, based on different statistical tools.

1. 1 Literature Review

Before presenting the basic assumptions of the EMH, we have tried to present the definition

of the efficiency hypothesis as presented by Fama (1965), “an efficient market is a market

where all agents are rational whose price should reflect fully and instantly all the published

information on the market”, so investors will be able to tap instantly and adequately to the

occurrence of information for inclusion in the asset price, tell that four conditions.

The investor rationality: its rational expectation, that is to say that investors can maximize the

benefit they make for a given level of risk or minimize risk for a given gain level.

The free flow of information: All investors can simultaneously benefit from the same

information, in order to act immediately on the market under identical conditions.

The absence of transaction costs and tax: The investor is when the expected benefits

outweigh the transaction costs and tax as they can influence investor reaction and end

investors and atomicity liquidity.

This efficiency hypothesis was defined according to the first classification of Fama (1965) in

three forms: The weak form; where the information contained in past prices of the market is

fully reflected in asset prices. Therefore, during the titles reflect their historical, it is not

possible to take advantage of the information passed on a financial asset. The semi-strong

form; in which it is impossible to predict the future value of a share price based on historical

data and data publicly accessible, and the high form or any non-public information are

reflected in the course, so it is not possible for an investor to take advantage of inside

information, but this definition has been renewed by Fama (1991 ) and the weak form;


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becomes the test of predictability of returns which aims to analyze the returns rate ,

highlighting the unpredictability of these rates, the semi-strong form tests becomes event

studies with the aim to determine the speed of price adjustment to the announcement of new

information.

This efficiency concept is based upon two key assumptions: rationality: this hypothesis rests

on the notion of fundamental value that equals the present value of future dividends rationally

anticipated by the agents (Allais 1953). It also relies on the notion of homo economics, which

is based on the theory of expected utility, as the market is efficient, if asset prices which are

quoted is only based on rational expectations, as there are three types of rationality.

Procedural rationality or the agent is limited in its ability to collect and pay information

(Simon 1978), and instrumental rationality based on the choice of instrument in which the

individual adopts a utility maximizing behavior and late cognitive rationality which is stewed

for a match between the information received from agents and performances that make them

Walliser (1989). One can conclude that anticipation is called rational if it incorporates

optimally all available information at the level of financial market, the rationality of agents,

consists firstly in that the investor is able to formulate rational expectations and secondly to

maximize their expected utility. The second hypothesis embodies the arbitration, it is a

financial transaction that includes all positive flow with a non zero probability .This operation

is to conduct two simultaneous operations (buying and selling), on two assets with similar

characteristics that is to say substitutable at different prices, to end to make a profit with no

risk and no initial cash outlay. According to Ross (1976), founder of the first principle of

arbitration, this operation is based on the law of unique price, where two identical assets must

be negotiated at the same price, we can conclude that a market has an arbitrage opportunity if

given prices, it is possible to conduct an investment strategy based on a zero capital income

guarantees positive for all states of the world.

This notion of efficiency is still unable to explain certain anomalies detected on the financial

market as the anomaly is defined by Rabin and Thaler (2004), as "an empirical result difficult

to rationalize or require unrealistic assumptions to be explained".

Among these anomalies, we find the effect later this year or January effect, the effect of firm

size, the effect low price-earnings ratio, the weekend effect, the effect of end months, the

value effect, the momentum effect, and the phenomenon "data snooping". These anomalies

are regarded as evidence of market inefficiency, giving birth to a new trend; it is behavioral

finance, which challenges the fundamental assumptions of the theory of efficiency. This new

trend is based on two assumptions further that stand out significantly from the assumptions

that underlie the EMH.

The first is that some investors are not fully rational and their demand for financial assets at

risk is affected by their beliefs or emotions, which obviously are not fully justified by

economic "fundamentals".

These investors are called noises traders. The second assumption is that arbitration, an

activity which will deliver the second category of investors, who are themselves fully rational

activity is not without risk and whose effectiveness is therefore limited. It connects the


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current investor psychology to finance; it combines the results of experiments in cognitive

psychology to the concepts and principles of finance in order to decipher the anomalies at the

end to explain the irrational behavior of investors in the financial market.

One can conclude, therefore, the role occupied by the behavioral finance that is melted on

behavioral psychology and the existence of bias influencing the financial decisions taken, this

current is used to explain observed phenomena in the financial market as arbitrage

opportunities lasting, over or under-reaction courses, self -correlation of returns. It offers a

renewed vision of the issue of agents' behavior in financial markets by psychological biases

that are due to faulty reasoning or emotions that can lead investors to act irrationally in these

decisions especially in situations of uncertainty.

In this case the two psychologists Kahneman and Tversky (1979), conducted researches on

cognition investors it is made in, cognitive biases, feelings and attitudes, their behaviors in

total these biases increase when individuals form their beliefs and preferences, were

considered errors of decision making, such as a behavior adopted to face a situation resulting

from a weakness in the processing of an available information.

So we talk about behavioral biases that constitute a new pattern that complement the

traditional theory of finance, such as the presence of these biases is evidence of the

emergence of the irrationality that is related to the process of decision making. Among these

biases are found optimism bias, the representativeness algorithmic, conservatism or mental

affix, found through overconfidence which is based on our research, according to this aim,

investors tend to overestimate their private signals, that is to say, to have an exaggerated

confidence in their own skills as information is generated by their own thoughts and abilities,

among the consequences of this bias is the excessive transaction.

This bias is defined as behavior that the individual ignores errors or failures and therefore,

contributes to the creation of the illusion of control over events that led him to overestimate

these opportunities and these capabilities.

It always tends to overestimate his ability in different contexts; this bias has been highlighted

by all economic and financial studies which aim to provide a convincing explanation of

abnormal phenomena occurring in the market.

According to De Bondt and Thaler (1995), they found that: “overconfidence the result is the

strongest identified by psychological research that is to say, investors tend to overestimate the

probability of accuracy of their information, their successes and capabilities”.

According to Shiller (1997)," overconfidence is associated with people in their own

judgments, these individuals underestimate the margins of error likely to be committed”,

Odean (1998), which states that investors treat first information leading to biased choices,

they maintain their positions although they do not result in a profit that is to say: losing as to

maintain constant their level of confidence.

As to Barber and Odean (2001), they have identified that investor’s confidence prove their

pride in their beliefs and they ignore any belief from rational investors, it will be a difference


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of opinion and an increase in transaction volume.

Daniel and Al (2002), who showed, from their study that this bias is used to explain certain

anomalies, such as the reaction of stock prices.

According to Lovigne and Legros (2005), this bias is considered the source large volumes of

transaction; this bias can lead to problems and affects the volume of transaction, such

QUELA volatility of assets subject to such transactions and their yields

Stracca (2004), Bénabou and Tirole (2004) who argue that "This bias is the result of

self-attribution as describing individuals tend to attribute successes to their own judgments

while the failures are due to luck and external factors".

As to Broihanne, Merli and Roger (2004), this bias is considered that the search for

information by the private investor and grant him too much.

Chuang and Lee (2006), this bias does play down or weaken the investment risk that is to say,

leads agents to underestimate the level of risk of their investments and so on-hold portfolios

diversified.

Kumer (2006), which linked through to this uncertainty, whichever is higher, more investors

can make mistakes and exhibit increased overconfidence. There are also many new studies

that have been shown to measure this behavioral bias includes a title example.

As to Ronald Huisman, Nico L. Van Der Sar, Remco CJ Zwinkels (2012), they suggested a

new method for measuring investor confidence in using data to end well determined to make

their predictions on the stock market, they applied the estimation of Parkinson's which is

based on extremes around the prediction of action for deduct on investor confidence.

As the aim is to examine directly whether some investors are confident about their

predictions. This measure is based on the evaluation of Parkinson's volatility (Amsterdam

Exchange Index), the results show that some investors display a significant view that

confidence on the prediction of equity volatility is less than the implied volatility.

Other economic actors as Gerlinde Fellner, Sebastian Krügel (2011), who proposed a new

measure of this bias, which is captured as behavioral models, the reliability of signals, the

results and the importance of private information. The latter two have made a distinction

between the overestimation of the accuracy Knowledge of own predictability of a time series

and the overestimation of the predicted signals from three judgment tasks based on three

types of information: forecasts based on information that is not explicitly available , but that

external data is in memory, forecasts of a variable based on previous values of this variable

and the end of the forecast of a variable explicitly on information available on the value of

another variable.

Menkhoffa Lukas, Maik Schmelinga Ulrich Schmidtb, c, (2013), in their study, presented a

line-experience on overconfidence in the context of market funding. As the sample consists of

institutional investors, investment advisors and individual investors.

Each of them being registered users a great platform online data on market sentiment.


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Because of their record, several socio-economic characteristics of participants can be ordered

in their analysis. It turns out that there are stable differences in overconfidence among the

three groups of investors.

In addition, the investment experience has a significant impact on the degree of excess of

confidence that will surprisingly in reverse. Where these results have important implications

for the studies on the impact of the experience on the behavior of markets (financial).

According Dimitris Andriosopoulos has Kostas Andriosopoulos b Hafiz Hoque (2013), a

repurchase shares on the open market is not a commitment, and there is little evidence on

whether firms repurchase shares under. They showed that disclosure information and

overconfident CEOs are important determinants of the rate of completion of redemption

shares. In addition, they found that large companies that perform buyback programs for

further action, and have a reputation of completion, have higher completion rates.

Finally, they assessed whether other features of CEOs affect the completion of redemption

rates and find that companies with executives who hold external mandates can have a

mandate over as CEO are more likely to complete the repurchase programs. In sum, the

results suggest that there is a clear relationship between information disclosure, CEO

overconfidence and the completion of redemption rates.

Sanjay Deshmukh, Anand M. Goel b, Keith M. Howe (2013) developed a model of the

dynamic interaction between CEO overconfidence and dividend policy.

They found that the dividend level is about one sixth in low managed by leaders who are

more likely to be overconfident businesses. They attested that the reduction in dividends

associated with CEO overconfidence is greater in company’s opportunities for growth lower

and lower cash flows.

They also showed that the magnitude of a positive market reaction to the announcement of

increased dividends is higher for firms with greater uncertainty about CEO are confident.

To analyze the overconfidence hypothesis, we presented the relationships between the bias

and information (private-public).

According to Chuang and Lee (2006), the two types of information can generate volumes of

transaction and security prices under-react to the shock of public information and then reach

the equilibrium response. The transaction is generated by informed investors actively sharing

their private information.

The second linkage is the overconfidence and trading volume, as according to Statman, and

Thorly Vorkink (2004), this link is plausible because trading volumes are positively

correlated with over the months proceeding, such as increasing courses during a period,

causes an increase in the confidence of investors who are tempted to negotiate advantage of

the next period.

The third and last relation is defined as the ratio between the bias and volatility as according

Chaung and Lee (2006), the excessive trading in action on investor confidence contributes to


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excessive volatility. They concluded that the high level of market volatility is due to the

presence of excess investors and asymmetric effect of positive and negative signals on asset

returns, while showing that negative innovations on returns assets tend to increase volatility

more than positive.

2. Data and Methodology

2.1 Data

In terms of market capitalization, the Tunis stock market is considered to be close to the small

number of companies listed on them. As can be noted that it is dominated by companies in

the financial sector.

In our empirical study, we investigated the impact of this bias on investments decisions,

which aims to propose an empirical full implications study of the various hypothesis of

overconfidence by focusing on the overall behavior of investors. We had recourse to a

representative sample of the financial market consisting of 27 shares (AMEN BANK, ATB,

ATL, BH, BIAT , BNA, BT, CIL, ELECTROSTAR, GENERAL STORE, SFBT, SIAME,

SIMPAR, SIPHAT, SOTETEL, SOTRAPIL, SOTUVER, STAR STB STEQ, CST LEASING,

UBCI, UIB, AIR LIQUIDE CST, ALKIMIA, GSI, CST LAI) , The choice of the number of

companies is due to the data availability, this brings us back to consider all Tunisian shares

from 1 January 2002 to 31 December2010.

The actions in our sample must have information on stock prices, trading volume (turnover)

and market capitalization. In fact, we use daily data from Tunis Stock Market to build the

daily observations inspired by the famous research paper "investor overconfidence and

trading volume".

Statman Al, (2004) and Wen-Ichaung, Bong-Soo Lee (2006). We use turnover (turnover rate)

as a measure of volume of transactions. In fact the turnover rate may better reflect the reality

that direct employment of shares traded, given the variation of the outstanding securities of

the firm due, for example, to the capital increase.

2.2 Methodology

H1: Investors react over-confident after the shock of private information and under react after

the shock of Public Information: People tend to underestimate their disagreement errors by

making predictions; they give significant weight to their own forecasts relative to those of

other forecasters.

To test this hypothesis, we used the VAR model:

(1)

As: the detrended trading volume (measured by turnover), the stock return. εt private: the

private information shock, public εt: the public information shock. : For i, j = 1, 2 is the

polynomial operator in L such that:


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H2: Market gains prompting investors confident about negotiating aggressively in subsequent

periods:

This idea was highlighted by several studies, for example, Glaser and Weber (2004). This

gave the idea of the causal relationship between the asset returns and trading volume. The

vector auto-regression (VAR) is used to study the interaction of turnover and the time series

of returns for the end market has to prove that VT returns depend delayed:

(2)

: The detrended trading volume that measured by turnover or the turnover rate at time.

: The market return at time.

: The absolute value of broad market return at time t.

: Denotes the deviation of mean absolute cutting performance that is to say transverse

to the standard deviation time t yields. It is weighted by market value of securities, this

variable and the market return, is intended to explain the effect of the volatility time series. To

calculate the market return, we used stock market indices:

(3)

Stock prices generally are used on the closing price. For the average deviation of

cross-market:

(4)

With: (5)

: The (value-weighted) weight of stock i.

: The return on stock i, : the market-wide return.


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N: the total number of all action in the sample.

The trading volume is measured by turnover or the turnover rate is defined as follows:

(6)

H3: the excessive trading of shares on investor confidence contributes to excessive volatility:

The purpose of our third hypothesis is to prove that the transaction in excessive action of

confident investors contributes to excessive volatility. We shall, therefore, by the context

empirically that we can check whether the excessive volatility comes from the excessive

trading on investor confidence.

We begin by dividing the volume of transactions into two components: to model and predict

volatility. We applied the EGARCH model, to estimate this model, there are several steps.

The first part is to estimate the regression that breaks the VT in two parts, the first part

reflects the behavior of investors confident, presented by the delayed returns. The second part

captures the influence of other factors, the present model and the constant residual term.

(7)

= Overconfidence + not Overconfidence = E +NE (8)

: Variable market return.

: Variable trading volume.

Constant

Residual term.

Optimal number of lags to include in the model, determined by the information criteria.

Factors associated with past returns.

The residuals are defined as the component unrelated to over-confident investors and the

difference between transaction volume and the sum of constant terms means overconfidence

due to past asset returns (ECT).

The idea of decomposing the transaction volume in two parts, back to the fact that it can be

affected by several factors other than overconfidence. The number of delay (P) to be included


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will be determined using the criteria of Akaike and Schwartz. The selection procedure of the

order of representation is to estimate all models for an order from 0 to h (h being the

maximum allowable delay in economic theory or available data).

The number of delay p selected, will be one that minimizes the AIC or SC. We also take into

account changes in the value of log-likelihood since a slight improvement of this value shows

a further refinement of the model.

Test the effect of trust on the volatility of market returns: Estimated ARMA (p, q): checking

the stationary of the time series of returns, we allow the calculation of the conditional mean

of this series, for that the calculation requires the stationary of series. We can apply the

Box-Jenkins (1976) without estimating the conditional mean. Models ARMA (p, q)-specific

calculation of the conditional expectation is of a general ARMA (p, q).

(9)

They are therefore representative of a process generated by a combination of the values of

past and past errors. The orders p and q of ARMA model are determined from a series of

correlogram coefficients of auto-correlations (simple and partial), this by considering the

orders corresponding to the auto-correlations significantly different from zero.

After estimating the conditional expectation, it is wise to test the relationship between

overconfidence and the conditional volatility. In this case the EGARCH model is the primary

means used to model and predict this volatility, this model allows both devices to capture

shocks in the estimation of uncertainty and allows the treatment and the distinction of those

negative and positive shocks and that of the asymmetry of the reaction yields to the signs of

shock.

(10)

(11)

(12)

K: volatility parameter to capture the leverage effect, if k significant and negative; the

presence of asymmetry.

: Average conditional on date t on the set of past information.

: Residues from the equation of the conditional mean at time t.

ht: conditional volatility at time t.


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EC: the exchange part motivated by a feeling of confidence and outcome of this model.

NEC: Part exchange unrelated to past market returns and outcome of this model.

f 1: parameter measuring the recurrence relation between the conditional and the

unconditional prior period.

f 2: parameter measuring the recurrence relation between the conditional variance and that

of the previous period.

f 3: parameter measuring the effect of overconfidence on the conditional variance.

f 4: parameter measuring the effect of factors other than reliance on the conditional variance.

3. Results and Interpretations

Before analyzing the assumptions of this bias, we conducted preliminary tests to know the

stationary test as the stationary is a necessary condition in any procedure for estimating a

model to prove that this is representative of the studied phenomenon.

We used the Dickey and Fuller (ADF) that allows highlighting the character or not a

stationary series and taking into account the autocorrelation of a differentiated set via a

correction using the values delayed.

The Phillips Perron test (PP) which takes into account that errors may be heteroscedastic, the

second test is the normality test series where the descriptive analysis is based primarily on

analysis of two coefficients of flattening Kurtosis and asymmetric Skweness as normal for

the law, they are respectively 0 and 3.

Table1: Structure of descriptive statistic:

Following the analysis table of descriptive statistics, these two coefficients are different from

0 and 3; in addition to the Jarque-Berra statistics shows zero probability.

Hence the rejection of null hypothesis of normal distribution of the series. We can conclude

that all series of stock returns ( ); transaction volumes(Vit) per share which is measured by

turnover ( , deviation of the market ) (standard deviation of cross market

return), market return ( ) and total transaction volume (( ), do not follow the normal

distribution, with respect to the stationary test, all series are stationary, because they have

values of ADF and PP below the critical values shown directly by Eviews to seuils1%, 5%

and 10%.

For the variable ( ), we took the rate of stock returns of 27 companies in the form of a

single variable according to panel data, to facilitate and improve the empirical results, the

same approach to variable turnover ( . It is for this reason, the results of two


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Stationary tests (ADF and PP) give us important values for these two variables and Rit are

driven by two types of shocks that are distinguished by an identification restriction imposed

on the VAR model, used to capture the asymmetric effect of two types of information about ,

that is to say that private εt an impact on while εt public has no impact on which is mainly

due to the weight accorded by investors confident of their private information and insufficient

weight attached by public information. The estimation results of the VAR model, after

determining the optimal number of delay, within this framework, we chose the VAR (2),

because it minimizes the information criteria and maximizes the log likelihood.

Table1. Descriptive statistics

Variable

Vit

Mean 0.000225 0.000740 0.006591 0.000643 0.000489

Maximum 0.708972 0.659308 0.124085 0.036794 0.010646

Minimum -1.000 000 0.000 000 0.000644 -0.048805 1.73 E-0.5

Std.dev 0.021502 0.004703 0.004811 0.005220 0.000646

Skewness -15.53119 69.11747 10.69417 -0.167543 6.687332

Kurtosis 719.4974 7834.254 208.5473 13.31909 71.28012

Jarque-bera 1.28 E+09 1.53 E+11 3937957 9851.241 447394.3

Probability 0.000 000 0.000 000 0.000 000 0.000 000 0.000 000

Observation 59882 59882 2213 2213 2213

Table 2. Stationary daily series

Rit Vit Rmt MAD TURN G

calculated value critical value

with constant

(ADF)

-34.09566 -23.11026 -9.357873 -7.287366 -5.878762 1%: -3.430291

5%: -2.861398

10%:-2.566735

With constant

and

trend(ADF)

-34.09564 -23.19727 -9.562849 -7.337168 -8.171259 1%: -3.958187

5%: -3.409877

10%:-3.126647

with constant

(PP)

-252.2731 -302.1727 -38.10739 -46.37997 -47.27678 1%: -3.430290

5%: -2.861398

10%:-2.566734

With constant

and trend

(PP)

-252.2704 -301.3025 -37.99000 -46.15758 -44.74405 1%: -3.958186

5%: -3.409877

10%:-3.126647

H1: Investors reaction over-confident after the shock of private information and under


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reaction after the shock of Public Information:

Table 3. Criteria for choosing the optimal lag order of VAR model

delays Log-likelihood AIC SC

1 386030.3 -12.89412 -12.89322

2 386591.0 -12.91866 -12.91475

3 386273.0 -12.90455 -12.90245

4 386584.3 -12.91611 -12.91340

5 386588.9 -12.91743 -12.91412

6 386193 -12.9072 -12.89922

Following results show that has a positive and significantly different from 0 out

because the t statistic of student at a late and worth (5.11671) is greater than the

critical value which is about 1.96 at 5%, confirming the existence of a positive relationship

between two variables and .

Table 4. Estimation results of the VAR model (2)

Rate of stock returns Turnover

Rit (-1) 0.043134

(0.00409)

[10,5410]**

0.004931

(0.00096)

[5.11671]**

Rit (-2) 0.023819

(0.00378)

[6.29749]**

0.001360

(0.00089)

[1.52643]

Turnover (-1) 0.133293

(0.01735)

[7.68414]**

0.081175

(0.00408)

[19.8717]**

Turnover (-2) 0.126329

(0.01735)

[7.28214]**

0.068893

(0.00409)

[16.8638]**

Confidence level: 1 %(*); 5 %(**); 10 %(***)

These results are improved by impultionel response functions; these functions trace the effect

of a shock, a standard deviation of an innovation current and future value of endogenous

variables.

According to the analysis of pattern of these functions, has a null response during the

first period after following a shock to and then increases during the second and third


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period and then return to balance during the fourth period by a correction process. Same

response to after the shock of , we can conclude that is induced by investors who

actively sharing their private information and heterogeneous interpretations of public

information on investors to conduct trading volumes, that is to say ,it has an impact on

investor confidence and trading activity on the posterior.

Figure 1. Schematic of impulse response functions

H2: market gains prompting investors confident about negotiating aggressively in subsequent

periods:

The results of the VAR model, after determining the optimal number of delay in this case is

chosen, the VAR model of order 3 that minimizes the information criteria and maximizes the

log likelihood.

Table 5. Criteria for choosing the optimal lag order of VAR model

delays Log-likelihood AIC SC

1 30434.43 -27.56903 -27.53804

2 30385.85 -27.59187 -27.53752

3 30465.02 -27.74146 -27.65340

4 30402.02 -27.73122 -27.64006

Estimation results show that in a positive and significantly different from zero as

t-statistic student at a delay of 1 and worth (2.25253) is greater than the critical value which is

about 1.96 at 5% level, where at one level of delay can positively influence the.

Table 6. Estimation results of the VAR model (3)

Turnover amount Market efficiency amount

(-1) 0.005528

(0.00245)

0.190599

(0.02161)


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[2.25253]** [8.81869]**

(-2) 0.002403

(0.00249)

[0.96428]

0.055655

(0.02195)

[2.53544]**

(-3) -0.000956

(0.00245)

[-0.38974]

-0.022543

(0.02161)

[-1.04327]

TURN (-1) 0.162365

(0.02001)

[8.11327]**

0.312264

(0.17624)

[1.77180]

TURN (-2) 0.089578

(0.02016)

[4.44362]**

0.264244

(0.17753)

[1.48844]

TURN (-3) 0.102762

(0.02068)

[4.97027]**

0.398886

(0.18208)

[2.19071]**

Confidence level: 1 %(*); 5 %(**); 10 %(***)

It was applied as the test of Granger causality to test the causal link between the two variables.

Similarly the results of causality prove the existence of dual or causal relationship retroactive

(feedback) between the two variables for the probability that does not cause is

inversely .is very low hence the second hypothesis is verified.

Table 7. Results of Granger Causality test.

Null Hypothesis Observation F-Statistic Prob.

Does not Granger Cause 2213

4.42230 0.0121

Does not Granger Cause. 3.78730 0.0228

H3: the excessive trading of shares on investor confidence contributes to excessive volatility:

Following the estimation of regression which breaks down the transaction volume in two

parts, we have noticed that all the coefficients are significant in terms of t-statistics in terms

of probability; this shows the dependence of of the previous period.

Table8. Decomposition of trading volume

coefficient Std error t-statistics Probability

C 0.000483 1.38 E-05 35.3113 0.0000

Rm (-1) 0.009709 0.002623 3.701321 0.0002

F-Statistics 13.69973 Probability 0.000220


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Significant coefficients in term t-statistic and probability are considered. The lag order chosen

for the estimation of our model is equal to 1. This order is selected, while setting a range of

maximum delay and estimates the model parameters using the method of ordinary least

squares.

The β coefficient has a positive and significant value since the t-statistic is equal to

3.701321> 1.96 for a significance level of 5%, which asserts the dependence of trading

volume market performance in the previous period. The significance of the coefficient C is of

the order (0.000483) may also assert that relationship.

The next step is to estimate the conditional expectation, that is to say, to calculate the

conditional mean return series to select the orders of AR and MA parts from correlograms

coefficients series (for Both kinds of simple and partial autocorrelation).

This step is followed by a validation process using a test on the estimated coefficients (which

must be significantly different from zero), and another on residues that informs us about the

fact that the estimated residuals follow a process white noise (absence of auto-correlation).

The choice of the most appropriate model is based also on the criteria of information that

tends to minimize AIC, SC and HQ criteria and maximize the log-likelihood slight

improvement, since this value reflects a further refinement of the model.

a) Test on the coefficients:

the analysis of these correlograms allows the identification of order p = 1, and an order q = 2,

this result provides three processes (AR ( 1), MA (2) and ARMA (1,2)), the next step is to

perform a test on the coefficients by parameter estimation, due to this estimate, two processes

namely AR (1) and MA (2), are candidates for applying the following test, when the process

ARMA (1,2) is rejected as non has a significance level of one of these coefficients.

The estimation results of three AR (1), MA (2) and ARMA (1, 2).

Table 9. Estimation Results of AR (1)

statistics coefficient t-statistics Probability

C 0.000639 4.620501 0.0000

AR (1) 0.217221 10.47350 0.0000

AIC -7.719279

SC -7.714133

HQ -7.717399

LM 8558.821

Particularly, the constant C is significantly different from zero (4.620501> 1.96) similarly for

the coefficient AR (1) such that (10.47350>1.96). This model is a candidate for the

application of tests on the residue of this process.


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Table 10. Estimation results of MA (2)


C 0.000643 4.543234 0.0000

MA (1) 0.207374 9.809473 0.0000

MA (2) 0.102048 4.827188 0.0000

AIC -7.722277

SC -7.714561

HQ -7.719459

LM 8567.005

This model is also to keep because of the significance of the coefficients. Specifically the

three coefficients are significantly different from zero and then they check the t-statistics

greater than 1.96, it is candidate for the verification of other tests.

Table 11. Estimation results for ARMA (1, 2)


C 0.000639 4.426216 0.0000

AR (1) 0.209915 1.057080 0.2906

MA (1) -0.004132 -0.0020812 0.9834

MA (2) 0.058827 1.281476 0.2002

AIC -7.721229

SC -7.710938

HQ -7.717470

LM 8562.983

In contrast to the two processes previously estimated, the ARMA (1, 2) has a non-significance

level of coefficients, this appeared in coefficient of the MA (1) that negative one hand. On the

other hand it gives off a t-statistic less than 1.96 (-0.0020812).

This process is therefore, to reject the point of no significance and the negativity of one of

these coefficients. This leads us to consider only two processes for the following tests, the AR

(1) and MA (2).

b) Tests on the residuals:

*Autocorrelation test:

After removal of the ARMA (1,2) model, we proceed to consider the autocorrelation of errors

of the above process from their simple and partial patterns. For this, we uses has the

Box-Pierce is based on two hypotheses: H0: 1= 2=… k=

H1: there is at least one significantly different from zero i

To perform this test, called the Q statistic is given by:

(13)


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With n: number of observations and k²: coefficient of order k of the estimated residuals.

The verification of the autocorrelation is a comparison of the Q statistic to the value

displayed on the table ² (k). Therefore it retains H0 (no self-correlation) if and only if this

statistic is less than the value of ² a likelihood for fixed risk.

Selected processes will be validated by another test or test on residuals autocorrelation of

errors of two AR (1) and MA (2), following the analysis of correlograms of these two

processes, the AR (1 ) is not a good model because it presents at two types of auto correlation,

not significant (probability less than (0.05)) hence the rejection of the null hypothesis in favor

of the presence autocorrelation, while for MA (2), the above probability (0.05) from which

the acceptance of the null hypothesis (no autocorrelation).

c) Heteroscedasticity test:

The detection of heteroscedasticity of residuals is an essential step in determining the most

appropriate model to study the relationship between the volume of transaction to

overconfidence and excessive volatility.

There are a multitude of tests for heteroscedasticity, such as, Goldfold and Quandt test white

of Haravey and ARCH test, which has been frequently used in the treatment of financial time

series. This test is to perform an autoregressive regression of squared residuals on q delays

0+ (14)

With:

: Refers to residues from the ARMA (p, q), the assumptions of this test are as follows:

H0: homoscedasticity = 1 and q = 0

H1: there is at least one significantly different from zero coefficients.

To conduct this test, the test statistic TR ² is used with T denotes the number of observations

of the residual series and R ² is the coefficient of determination of autoregressive regression.

Under H0 the statistic TR² the law (q). Especially if TR² �² (q), we accept the

homoscedasticity hypothesis (H0).

The last test is a test of heteroscedasticity (test ARCH) which is to study the heteroscedastic

conditional variance observed from the correlogram of squared residuals from the MA (2).

The results show that the probabilities are lower (0.05) where the rejection of the null

hypothesis of homoscedasticity which confirms the existence of ARCH effect.

The ARCH test performed on our series residual gives us the following results:


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Table 12. ARCH –LM test

F-statistic 449.5125 Prob. F(1,2215) 0.0000

Obs*R-squared 374.0156 Prob. Chi-Square(1) 0.0000

We notice from the results found that the probability associated with the statistic TR ² is equal

to 0.0000, which is strictly less than 0.05. Over all t-statistics are greater than 1.96 which

confirms the existence of ARCH effect. There by verifying the heteroscedasticity of residuals

MA (2).

The next step is to estimate the E-GARCH model that presents our third relationship. In this

context, there are more than a candidate model to form the volatility, we chose MA

(2)-EGARCH (3, 3) that minimizes the information criteria and maximizes the log likelihood.

Table 13. Criteria for choosing the optimal lag order (MA-EGARCH) (p, q)

criteria AIC SC HQ LM

MA(2)-EGARCH (1,1) -8.029431 -8.011428 -8.022855 8911.639

MA(2)-EGARCH(1,2) -8.028754 -8.008179 -8.021239 8911.888

MA(2)-EGARCH(1,3) -8.027870 -8.004723 -8.019415 8911.907

MA(2)-EGARCH(2,1) -8.028531 -8.007956 -8.021016 8911.641

MA(2)-EGARCH(2,2) -8.029711 -8.006564 -8.021256 8913.949

MA(2)-EGARCH(2,3) -8.029179 -8.003460 -8. 019785 8914.359

MA(2)-EGARCH(3,1) -8.027731 -8.004585 -8. 019277 8911.754

MA(2)-EGARCH(3,2) -8.028951 -8.003233 -8. 019557 8914.107

MA(2)-EGARCH(3,3) -8.038903 -8.010613 -8.028570 8926.144

The last step is to introduce the two components extracted from the estimated turnover based

Rmt. These two f3 and f4 are components which respectively reflect the effect of the

component related to the excess of confidence and independent of the overconfidence. F3

which is of the order (0.977556) is greater than that F4 is the order (0.089576) where the

positive effect of the bias of overconfidence on the volatility of returns which confirms our

third hypothesis.

Table 14. Results from the introduction of overconfidence:

coefficient Statistics Std-error Z-statistic

W -0.543801 0.293611 -1.852112

F1 0.618981 0.468294 1.321778

F2 0.753497 0.124786 6.037762

F3 0.977556 0.380914 2.015036

F4 0.089576 0.054050 1.657258

K 0.019701 0.053554 0.367868


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4. Conclusions

The purpose of this article was to shed light on the phenomenon of overconfidence observed

in financial markets. Our research work was divided into three sections.

The first section has sought to present the main foundations of the theory of efficient

financial markets as developed by the traditional theory based on the fact that people operate

in the financial markets have rational behavior and prices at all times reflect all available

information.

For this, several limitations have come to question this theory and have concluded that the

inability of the traditional theory to reveal any anomalies in the financial market, we then

oriented to the study of a new approach "finance behavior "that has developed from work in

cognitive psychology that proposes to integrate not perfectly rational behavior in

decision-making by investors.

The main promoters of this current Kahneman and Tversky (1979) who questioned the

rational behavior of agents in favor of a psychological behavior by focusing on the

relationship between psychology and finance, involving the psychology of investor in making

its financial decision.

The idea comes from the presence of several biases that affect the rationality of investors and

produce several anomalies such as excessive trading volume and excess volatility, we find

among these biases through overconfidence, which is considered as an explanation important

for several anomalies in financial markets.

This bias has formed a subject of several studies of economic and financial cost of its

importance in decision-making of investors; this bias is defined as the overstatement of

earnings and consolidated under estimate its error. The second section was devoted to the

presentation of data collected from the stock market of Tunis, and the methodology (models,

variables).

The last section provides our empirical investigation that focused on the study of the impact

of overconfidence on investors' decisions on three assumptions, through the examination of a

part of the relationship between trading volume and performance track to evaluate the

responses asymmetry caused by striking information (private-public), on the other hand, the

relationship between transaction volume and performance of the market through

overconfidence and its role in generating the volatility of the Tunisian financial market.

In the analysis of the hypothesis of overconfidence we are interested in 27 Tunisian

companies over the period January 2002 to December 2010 by a preliminary statistical

analysis of time series of returns, turnover and the deviation of the market.

We proceed by studying the first hypothesis using the vector autoregressive model and

impulse response functions, allowed us to identify that investors over-react on confidence

after the shock of private information and under- react after the shock of Public Information.

In the second case, the Granger causality test, allowed us to identify the performance gains

market lead investors to negotiate over-confident in a more aggressive in previous periods


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this test shows a retroactive reaction in both directions.

The last assumption states that the volume of transactions of intensive investors and the

increased confidence on the conditional volatility of the securities through the use of

MA-EGARCH model seems most appropriate to explain this phenomenon.

Within this framework through overconfidence reflects the excessive volatility of conditional

market return given the significance and importance of the coefficient and component related

to this bias. This result allowed us to verify the third hypothesis. The obtained results indicate

the importance of bias on confidence in the analysis of the specificities of the Tunisian

financial market.

At the end, we believe that this work has some limitations, in effect, using daily data, for

example, carries the effects of day of the week where the importance of considering other

frequencies such as weekly that might give more meaningful results.

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7-36.






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Determinants of Firm’s Financial Performance: An

Empirical Study on Textile Sector of Pakistan

Ali Abbas (Corresponding Author)

Hailey College of Commerce, University of the Punjab Lahore, Pakistan

Tel: 92-333-897-4480 E-mail: [email protected]

Zahid Bashir

Faculty of Finance at School of Business, Economics & Management Sciences

Imperial College of Business Studies Lahore, Pakistan


Shahid Manzoor

Hailey College of Commerce, University of the Punjab Lahore, Pakistan


Muhammad Nadeem Akram

Mezan Bank, Quaid-e-Azam Industrial Estate Branch Lahore, Pakistan


Received: July 5, 2013 Accepted: July 18, 2013


Abstract

The current study aims to find out the determinants significantly affecting the firm’s financial

performance in textile sector of Pakistan for the period 2005-2010. The researcher used

panel/longitudinal data set which are created with the help of State Bank of Pakistan’s annual

publication named as “Financial statement analysis of companies (non-financial) listed in KSE

for the period 2005 to 2010 which is available at www.sbp.org.pk online. The researcher used

one-way fixed effect model due the presence of cross-sectional fixed effect in the regression


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results. The dependent variable was profitability as a measure of firm’s financial performance

while the independent variables were leverage, growth, firm’s size, risk, tax, tangibility,

liquidity and non-debt tax shield. The firm’s performance in textile sector is significantly

affected by Short term leverage, Size, risk, tax and non-debt tax shield while taking long term

leverage as first independent variable, the leverage becomes insignificant along with tax factor.

The textile sector should consider the above said factors because these factors significantly

increasing or decreasing firm’s financial performance. The findings of the current research are

limited and applicable to non-financial sector of Pakistan only. It is not applicable to financial

sector due to their difference of capital structure. In addition, the researcher used ROI as

measure of firm’s financial performance while the future research can have ROA, ROE, EPS

etc as firm’s financial performance.

Keywords: Firm’s performance, Textile sector, Return on Investment

1. Introduction

There are a total number of 411 firms in non-financial sector of Pakistan which is subdivided

into 12 sectors while Textile sector is the largest and the first sector which comprise of a total

number of 164 firms which covers 40% of the overall non-financial sector of Pakistan. The

researcher used the financial data of 139 firms of textile sector because the remaining firms

missed some of the financial records required for analysis. The textile sector represent a large

part of the non-financial sector of Pakistan, the financial performance of this sector may

influence the performance of the other sectors. The basic and fundamental duty of every

financial manager is to maximize the shareholder’s wealth and to increase firm’s value which is

possible when the firm’s financial performance can be increased. The researcher’s aim during

this research is to identify the number of factor that determines the firm’s financial

performance. The previous studies conducted on firm’s performance indicates that a large

number of factors affect significantly the firm’s performance. David Durand (1952) presented

different theories for starting the argument on firm’s value. David Durand (1952) presented

first theory with the name of Net Income (NI) approach, then after wards he presented Net

Operating income approach and finally traditional approach to justify his opinion. He was of

the view that increasing leverage can increase firm’s performance but he could not provide the

operational justification to validate his point of view. Modigliani and Miller (1958) in their

theses revealed it is not mandatory that a firm using leverage or not can have difference in their

value. For the validity of their research they presented an operational justification with the

name of arbitrage process. The arbitrage process states that investor purchases shares or make

investment at low prices and sales their investment or shares at high prices simultaneously in

different markets. Modigliani and Miller (1963) also found that debt provide the tax shield

advantage in the form of interest. A lot of studies afterwards reveal that corporate financial

performance or firm’s performance influenced by a number of factors that should keep in mind

while making financial decision to increase a firm’s performance. The researcher used the

framework of Zeitun and Tian (1997). They used leverage, growth, size, tax, risk and

tangibility to see their effect on corporate performance of Jordan non-financial sector. The

researcher extended the regression model by including liquidity and non-debt tax shield

(depreciation) to make this study more comprehensive.


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1.1 Significance of the Study

Textile sector is the largest industry in Pakistan. It consist of 164 firms which includes 145

firms related to spinning, weaving and finishing while 6 firms consist of made up textiles

articles and the remaining 13 firms are related to other textiles items. From the last many years,

Pakistani textile industry is facing a large number of crises due to continuous load-shedding

from the last many years. A large number of firms in this sector have closed their operations

because without electricity it is not possible to produce any product in textile sector. The

remaining firms are forced to take loan for their survival in order to use generator or private

electricity resources which are much costly. It has increased debt financing trend in this sector

and the firm’s performance is affected largely by this trend. APTMA has requested to

Government of Pakistan to take some serious steps in order to rescue the textile industry for

possible survival by controlling the problem of electricity and restructuring the outstanding

loans. In this way PICIC commercial bank was previously establish to provide loan both short

term and long term according to this sector need and recently NIB bank has been established

for this purpose.

1.2 Objective of the Study

The Textile Sector covers 40% of non-financial industry in Pakistan. It can influence the

performance of other sectors by its financial decision making and actions thereof. The

researcher aims to explore the factors that determine firm’s performance in textile sector of

Pakistan so that the financial performance can be groomed in overall non-financial sector of

Pakistan. The researcher’s objective is to find out the different factors which are significantly

affecting firm’s performance in textile sector of Pakistan for the period 2005-2010.

1.3 Research Questions

The researcher wants to explore the current study with reference to the following research

questions:

What factors are significantly impacting the firm’s performance in textile industry of Pakistan?

Do the observed factors also consistent with the previous researcher’s findings.


A large number of previous studies relating to firm’s performance or sometimes corporate

performance has identified a number of factors that empirically and even significantly affecting

the firm’s performance. There are a little number of research findings available in Pakistani

context relating to firm’s performance however the foreign researchers has done a lot in this

context. The researcher used the framework of Zeitun and Tian (2007) with the extension in

their regression model by adding liquidity and non-debt tax shield and applied this regression

model simultaneously on textile and food sectors of Pakistan. The findings of Zeitun and Tian

(2007) indicated that leverage has a significant and negative relationship with firm’s

performance. They used leverage, growth, size, tax, risk and tangibility as independent variable

to see their effect on firm’s performance. They concluded that firm’s size and tax have positive

and significant relationship with firm’s performance while risk and tangibility have negative


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and significant relationship with firm’s performance. Memon, Bhutto and Abbas (2010)

concluded in their study of capital structure and firm’s performance on textile sector that the

companies in this sector are performance below optimum level of capital structure and also fail

to achieve the economies of scale. Nosa and Ose (2010) found that effective funding required

for the growth and development of the corporations in Nigeria. They suggested enhancing the

regulatory framework for increasing the firm’s performance by focusing on risk management

and corporate governance. Onaolapo and Kajola (2010) found a significant and negative

relationship between debt ratio and firm’s financial performance. The study conducted by

Krishnan and Moyer (1997) found a negative and significant relationship between leverage and

firm’s performance while other factors affecting firm’s performance positively includes size,

growth, tax and risk. Jensen and Meckling (1976) found two types of agency cost; agency cost

of equity holders and agency cost of debt holders. They concluded that a conflict of interest

arises between the management and the shareholders when management take decision against

the interest of shareholders and another conflict arises when the shareholder act against the

interest of debt holders. William (1987) found that decision for high leverage by the

management decreases the conflict between management and shareholders. The leverage can

work as disciplinary device that controls the management from wasting their firm’s resources

according to Grossman and Hart (1982). The researcher in the current study used short term as

well as long term debts as proxy for leverage and also the other factors like growth, size, tax,

risk, tangibility, liquidity and non-debt tax shield for measuring their impact on firm’s financial

performance in textile as well as food sector comparatively for the period 2005-2010.

3. Data and Methodology

3.1 Data and Source

The type of data is panel/longitudinal and has been created from the State Bank of Pakistan’s

annual publication “Financial Statement Analysis of companies (non-financial) listed in

Karachi Stock Exchange for the period 2005-2010”. This statement contains the 6 years

financial figures of 12 different sectors relating to non-financial industry having 411 firms in

total and available online at www.sbp.org.pk while the researcher selected the Textile sector

because it covers the greatest part of overall population of non-financial industry in Pakistan.

The sample consists of 139 companies from textile sector of Pakistan. The findings of the

current study is applicable on all sectors of non-financial industry of Pakistan as the sample

selected covers 4.0% approximately of the whole population of non-financial industry.

It is not applicable on financial industry like banks and insurance sector as their capital

structure is entirely different from non-financial sector.

3.2 Econometric Regression Model

For regression analysis of Panel data, there are three methods available for their regression like

fixed effect, Random effect and constant coefficient regression model. The choice between

fixed effect and random effect is finalized by hausman specification test (1978) while the

choice between random effect and constant coefficient model is finalized by Lagrange

multiplier test. As there is a large number of companies in the current study while the time


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period is small so the data type is short panel according to Baltagi (2005). The researcher

expects a cross sectional fixed effect with constant in the current study and developed the

following regression model for the estimation of current study:

Yit = α1+ + β1(LV)it + β2(GR)it + β3(SZ)it + β4(RK)it + β5(TX)it

+β6(TN)it + β7(LQ)it + β8(ND)it + + Uit

Where

Yit = Firm’s Financial Performance over time. This variable is indicated by Return on

Investment (ROI)

α1+ = Constant coefficient including cross sectional fixed effect

β1 – β8 = Regression coefficients for measuring independent variables

LV = Leverage

GR = Growth

SZ = Size

RK = Risk

TX = Tax

TN = Tangibility

LQ = Liquidity

ND = Non-debt Tax shield

+ Uit = Error component showing unobserved factor

3.3 Variables and Hypothesis Development

The previous studies have shown a number of proxies for measuring firm’s financial

performance like ROA, ROE, Tobin’s Q, EPS and ROI. Some of these variable required

current market data like Tobin’s Q. The researcher in the current study used Return on asset

(ROI) as dependent variable for measuring firm’s financial performance while the independent

variables includes short term and long term leverage, growth, firm’s size, risk, tax, tangibility

of fixed assets, liquidity and non-debt tax shield (depreciation).

The description of each variable and their expected signs are given below in the following


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table:

Table 1. Explanation of Dependent and Independent variables and Expected signs

Dependent Variable

ROI EBIT/Total Assets

Independent Variables

Variables Description Expected Signs

Leverage Short term debt/Total assets, Long term debt/Total Assets Negative

Growth Δ Total Assets/ Total Assets Positive

Size Natural Log of Total Sales Positive

Risk EBIT/Earning after interest and Tax Positive

Tax Current year’s Tax/Earnings before Tax Positive

Tangibility Fixed Assets/Total Assets Positive

Liquidity Current Assets/Current Liabilities Positive

NDTS EBIT + Depreciation/Total Assets Positive

On the basis of above table the relationships between dependent and independent variables

have been developed in the following hypothesis:

H1: Leverage (short & long term) should have a negative impact on firm’s performance.

H2: Growth should have a positive impact on firm’s performance.

H3: Firm’s size should have a positive impact on firm’s performance.

H4: There should be a positive relationship between risk and firm’s performance.

H5: There should be a positive relationship between tax and firm’s performance

H6: Tangibility should have a positive relationship with firm’s performance.

H7: Liquidity should have a positive relationship with firm’s performance.

H8: There is a positive relationship between Non-debt tax shield and firm’s performance.

4. Regression Analysis and Discussion on Findings

The researcher used STATA 11 software for the regression analysis of the current study. The

dependent variable is firm’s performance measure ROI while the independent variables

includes Leverage (short, long), Growth, Size, Risk, Tax, Tangibility, Liquidity and Non-debt

tax shield. The descriptive statistics showing mean, standard deviation, minimum and

maximum values of textile sector indicated in table 2 while correlation matrix of textile sector

is indicated in table 3. The regression result using one-way fixed effect model is indicated in

table 4. The presence of fixed cross sectional effect is evidenced by the significant results of

hausman test which validate the name of this model as one way-fixed effect model according to

Baltagi (2005).

Table 2. Descriptive Statistics

Variables Mean SD Min Max

Return on Investment (ROI) .0231793 .1554565 -1.71287 1.736175

Short term Leverage (S-Lev) .5139861 .2567038 .0085605 2.546073

Long term Leverage (L-Lev) .2236888 .2091147 0 1.730722


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Growth (GR) .0337597 .2263425 -2.86857 .9645731

Firm’s Size (SZ) 13.88058 1.417079 7.34601 17.26663

Risk (RK) 1.388222 4.136975 -42.9379 73.95914

Tax (TX) .8204285 13.75174 -58.7819 381.2666

Tangibility (TN) .9245616 .4761682 0 5.93239

Liquidity (LQ) 1.045564 1.070488 .04 10.55

Non-debt Tax shield (ND) .1021373 .5978221 -10.9418 5.070107

The above table 2 indicates the descriptive statistics like Mean, Standard deviation, Min and

Maximum of Firm’s performance (ROI) and other firm’s specific factors like Leverage,

Growth, Size, Risk, Tax, Tangibility, Liquidity and Non-debt tax shield (Depreciation) during

the period 2005-2010 for Textile sector of Pakistan. The above table indicates that short term

leverage has an average (mean) value as 51% in textile sector’s firm’s performance

approximately, while long term leverage showing (mean) value as 22% in Textile sector. The

firm’s Size in Textile sector on average (mean) value showing 139%.

Table 3. Correlation Matrix for Textile Sector

ROI S-LV L-LV GR SZ RK TX TN LQ ND

ROI 1.000

S-LV -0.056 1.000

L-LV -0.132 -0.079 1.000

GR 0.089 -0.109 -0.108 1.000

SZ 0.137 -0.194 -0.129 0.223 1.000

RK 0.057 0.003 -0.030 0.002 0.063 1.000

TX -0.003 0.026 -0.013 -0.003 -0.018 -0.007 1.000

TN -0.106 0.264 0.262 -0.277 -0.413 -0.041 -0.000 1.000

LQ 0.039 -0.204 -0.121 -0.015 0.051 0.029 -0.036 -0.101 1.000

ND 0.705 -0.044 -0.092 0.060 0.053 0.017 -0.609 -0.045 0.045 1.000

The above table 4.2 indicates the correlation matrix of dependent and independent variables

in textile sector of Pakistan for the period 2005-2010. It indicates that short term and long

term leverage including tax and tangibility having negative correlation with firm’s

performance while growth, size, risk, liquidity and non-debt tax shield having positive

correlation with firm’s performance in textile sector of Pakistan. The highest correlation is

indicated between non-debt tax shield and firm’s performance as 0.71 approximately

according to the above table.

Table 4. Regression Results – One way fixed effect regression model Dependent Variable =

Firm’s Performance (ROI)

Independent Variables 1st Model (β1=S-LV) 2nd Model (β1=L-LV)

Coefficients P-values Coefficients P-values

Leverage (S-Lev,

L-Lev)

-.0315

93

**

0.026

.01988

23

0.2

21

Growth (GR) -0.014

184

0.2

39

-.0124

429

0.3

02

Firm’s Size (SZ) .01869

4

*0.

000

.01889

60

*0.000

Risk (RK) .00142

3

**

0.023

.00144

25

**0.021


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Tax (TX) .00775

3

*0.

000

.00779

07

*0.

000

Tangibility (TN) -.0072

14

0.5

11

-.0116

991

0.2

98

Liquidity (LQ) -.0007

47

0.8

43

-.0002

636

0.9

44

Non-debt Tax shield

(ND)

.29488

3

*0.

000

.29660

95

*0.

000

Constant -.2505

96

0.0

01

-.2707

327

0.0

00

Number of

Observations

=834 =834

No of Groups =139 =139

Overall Model

Fitness

F(8,687)=325.51 F(8,687)=323.44

Prob>F = 0.0000 Prob>F=0.0000

R2 (Within) =0.7913 =0.7902

R2 (Between) =0.7833 =0.7926

R2 (Overall) =0.7847 =0.7866

F-test that all u-i=0 F(138,687)=1.57 F(138,687)=1.54

Prob>F=0.0001 Prob>F=0.0003

Hausman test Prob>Chi2=0.000 Prob>Chi2=0.007

Note: The current table is generated by the output STATA 11 regression

result

*significant at 1% level, **significant at 5% level, ***significant at 10%

level

The above table 4.3 indicates results of one-ways fixed effect regression model estimation. The

overall model is statistically fit and significant in both sectors. It indicates that short term

leverage is significant at 5% level in textile sector and showing negative relationship with

firm’s performance and accepts the 1st hypothesis. The negative relation between leverage and

firm’s performance is also consistent with the following researchers like Krisnan and Moyer

(1997), Onaolapo and kajola (2010), Memon, Bhutto and Abbas (2010) and Zeitun and Tian

(2007). It indicates that firm’s performance in textile sector is significantly influenced by short

term debts. Growth is not significant at any level and showing negative relationship which

rejects the 2nd

hypothesis. However the negative relationship between growth and firm’s

performance is consistent with the similar findings of previous researchers Zeitun and Tian

(2007) while the other researchers like Krishnan and Moyer (1997), Onaolapo and Kajola

(2010), Memon, Bhutto and Abbas (2010) found positive relationship between firm’s

performance and growth. Firm’s size is significant @1% level and accepts the 3rd

hypothesis.

This positive relationship is consistent with the following researchers like Onaolapo and

Kajola (2010), Krishnan and Moyer (1997) and Zeitun and Tian (2007). It indicates that firm’s

size increases firm’s performance in textile sector of Pakistan. Risk is significant at 5% level in

textile sector. It is showing positive relationship which accepts 4th

hypothesis. This positive

relationship between risk and firm’s performance is also consistent with the previous

researchers who found the same relationship like Memon, Bhutto and Abbas (2010) and

Krishnan and Moyer (1997). It indicates that more risky firms tend to perform well in textile

sector of Pakistan. Tax is significant at 1% level in textile sector and accepts 5th

hypothesis it is

also consistent with the similar findings by Krishnan and Moyer (1997), Memon, Bhutto and


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Abbas (2010) and Zeitun and Tian (2007). Tangibility is not significant at any level in textile

sector. It means that tangibility does not play a significant role for firm’s performance in textile

sector. Liquidity is not significant at any level in both sectors. It has negative relationship with

firm’s performance in textile sector that rejects the 7th

hypothesis. The non-debt-tax shield

(depreciation) is significant at 1% level with positive relationship and accepts 8th

hypothesis. It

means that non-debt tax shield plays an important and significant role for increasing firm’s

performance in textile sector of Pakistan.

5. Conclusion and Recommendations

The current study concluded that firm’s performance in textile sector of Pakistan is

significantly affected by Short term leverage, size, risk, tax and non-debt tax shield. The

Researchers recommends that the textile sector of Pakistan should make its financial decision

taking into consideration of the above said factors because textile sector is the largest sector in

Pakistan for non-financial industry and it is considered as benchmark for other sectors in

Pakistan. The Findings of the researcher are also consistent with the previous researchers. The

Textile sector should preferably decrease their short term debt financing as it will decrease

firm’s financial performance while all other sector may increase it. The firm should use less

short term debt as it neither provide tax shield advantage and not also cheap as long term debt

financing.

6. Policy Implications

The current research findings empirically implies that the companies in textile sector of

Pakistan has to make their policies by considering short term leverage, firm’s size, financial

risk, tax provision and non-debt tax shield (depreciation) in order to strengthen their

performance. Short term leverage decreases performance significantly so the firms should

avoid short term leverage while all other factors increases firm’s performance in textile sector

of Pakistan.

7. Limitations and Suggestions

The current study is limited and applicable to non-financial industry of Pakistan only. It is not

applicable to financial sector as their capital structure is entirely different from non-financial

sector. The researcher used book value measure for dependent and independent variables. The

future research on firm’s performance may be made through market value measures like

Tobin’s Q etc. The future research may also be conducted on financial sector using the same

models and variables.

References

Baltagi, Badi, H., (2005), “Econometric analysis of Panel data, 3rd

edition”, John wiley and

sons Ltd.

Campbell, A., (2007), “Introduction to Econometrics”, MIT.

Financial statement analysis of Non-financial companies listed in Karachi Stock Exchange for


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the period 2005-2010, Statistic and DWH department, State Bank of Pakistan.

Jensen, Meckling (1986), Agency cost of Free Cash Flows, Corporate Finance and Takeovers,

American Economic Review, Issue 76, PP 323-329.

Krishnan and Moyer (1997), Performance, Capital Structure and Home Country: An analysis

of Asian Countries, Global Finance Journal, Issue 8(1), PP 129-143.

Memon, Bhutto and Abbas, (2010), Capital Structure and firm’s performance: A case of Textile

sector of Pakistan, Asian Journal of Business and Management Sciences, Vol 1, issue 9, PP

9-15.

Modigliani, F., & Miller, M., (1958), The Cost of Capital, Corporation Finance and the theory

of investment, The American Economic Review, Vol 48, Issue 3, 261-297.

Nosa, & Ose, (2010), Capital Structure and Corporate Performance in Nigeria: An empirical

investigation, Journal Of Management Sciences, Vol 1, Issue 1, 43-52.

Onaolapo, & Kajola (2010), “ Capital structure and Firm’s Performance: Evidence from

Nigeria”, European Journal of Economics, Finance and Administration Sciences, Issue 25,

70-82.

Park. (2009), Linear regression models for panel data using SAS, STATA, LIMDEP and SPSS,

Indiana University.

Pratheepkanth, P., (2011), Capital Structure and Financial performance: Evidence from

Selected Business Companies from Colombo Stock Exchange Srilanka, International Referred

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Scott, D. E., (1972), Evidence on the Importance of Financial Structure, Journal of Finance

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Shah, S.M., & Amir (2007), The Determinants of Corporate Debt Policy, Pre and Post

Financial Market Reforms: A case from Textile Industry of Pakistan, The Pakistan

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Williamson, O., (1988), Corporate Finance and Corporate Governance, Journal of Finance,

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Panel Data of emerging market, a case of Jordan, Corporate Ownership and Control, Vol 6,

Issue 4, 96-114.






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English Language Skills Training: Theory and

Practice-A Cuban Perspective

Eddie Fisher

Faculty of Social Sciences, Universidad de Oriente, Santiago de Cuba, Cuba


Jorge Luis Herrera Ochoa, Yoennis Diaz Moreno

Faculty of Humanities, Universidad de Oriente, Santiago de Cuba

Received: August 8, 2013 Accepted: August 26, 2013


Abstract

The ability to teach foreign languages effectively has become an increasingly important skill

to develop and improve the language proficiency of students. Teachers need to develop and

apply proactive and positive attitudes to foster new levels of foreign language learning within

their students. Teaching, on its own, is not a panacea for success. This paper investigates how

teachers at the Universidad de Oriente (UO) in Santiago de Cuba search for and apply

innovative ways of teaching foreign languages to their students within current boundaries.

The results from this research show that there is a positive relationship between the level of

proficiency in a foreign language and the methods and approaches teachers apply to keep

students motivated and interested in the subject matter. The literature review from this study

provided supportive evidence which was strengthened with insights from face to face

interviews and a focus group meeting. The outcomes confirmed that students, who are

exposed regularly to practical and diverse teaching methods, are more likely to exceed the

expected foreign language proficiency levels set by the UO‟s quality standards.

Keywords: English language teaching, Content and Language Integrated Learning (CLIL),

Communications, Psychology, Language Teachers

1. Introduction

1.1 Introduction

Being able to communicate in a language other than one‟s own native language has become

paramount not only in business but also in people‟s private lives. Many businesses operate in


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more than one country and people travel across the world to experience the different cultures

of other people. Being able to communicate in another language brings people much closer

together and much faster. Language teaching plays a vital role in developing and fostering

people with the necessary attitude, motivation and driving force to become proficient in

another language. This is not an easy task. Every person is different and responds in a

different way to language teaching approaches and methods. Language teachers need to keep

themselves informed of new technological advances, for example, to improve the effective

and efficient means of teaching a foreign language to students. Some countries have been

more exposed to the need to learn other languages depending on their geographical position

and their economic situation, such as tourism being a major income provider. Europe, for

example, has a long tradition of language teaching and language learning. Most European

nations are close to each other or they are bi-or multi-lingual themselves such as Belgium or

Switzerland. The need to communicate with one another across languages is therefore an old

and obvious one.

Much of today‟s business discussions and negotiations are conducted primarily in English

and many tourists use English as a common means to communicate with others in countries

such as Cuba, Spain and Italy. The learning and teaching of foreign languages such as English,

Spanish and German is of enormous importance across the world. It appears that publications

on language teaching have often been seen as the lowest step of a staircase according to

Appel (1995). At the top there is theory and as one walks down, the lower steps become more

and more practical until class room interaction is reached. Practical applications in many and

varied forms are what makes successful language teaching today. As knowledge methods of

how to teach languages increase, so does the effectiveness of the end results. It appears that

an emphasis on how languages are taught does not necessarily combine with changes in

practice. Some teachers have shown a strong resistance to educational change. This has often

been the subject of complaint. Some scholars such as Appel and Celik suggest that language

teaching practice has been going on as if advances in research had never happened. The

attitudes and associated behaviors of language teachers and Heads of Language Schools are

of paramount importance. It is here where fundamental positive steps forward can be

achieved.

One such forward-thinking institution is the Faculty of Humanities at the Universidad de

Oriente (UO) in Santiago de Cuba. Language teachers of foreign languages such as English

and German regularly review contemporary literature to keep up to date with the latest

thinking in foreign language teaching methods. In addition, they conduct research via the

Internet and by contacting language teaching institutions outside of Cuba to gather

knowledge to make informed decisions to improve their own language teaching approaches.

The UO currently teaches topics such as British and American History and Literature so that

students learn about a new topic whilst at the same time improving their practical language

skills, including linguistics and semantics.

Students have workshops and exams that provide opportunities to recycle the newly-gained

knowledge. Early indications show that students perform better when the passing on of

knowledge is approached in such a way that the level of motivation within students is


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increased noticeably and significantly. There is clear evidence that students enjoy and benefit

from visits by foreign scholars who share their knowledge and experience in the appropriate

language. These encounters are landmark points for the students as part of their training and

development plan within the UO and their later professional/working life. For example,

recent encounters at the UO included presentations and interactive class room discussions

about topical business issues such as Conflict Management, Team Building and Effective

Communications. These sessions are very intense and provide superior levels of learning over

a much shorter period of time compared to regular classroom teaching. The use of equipment

is limited to available resources but this does in no way limit the positive and proactive spirit

of the teachers and the learners of new languages.

This research presents the outcomes of a study that investigated the close relationships

between attitudes, behaviors and teaching competencies of foreign language teachers at the

UO in Santiago de Cuba, how the students benefit from their proactive and forward-thinking

teaching approaches and what the benefits are to the students in terms of increased levels of

language proficiencies (Fig. 1).

Language Teachers Language Students Language Proficiency

Figure 1 The Relationship between Language Teachers, Language Students and Language

Proficiency

1.2 Literature Review

According to Doernyei (2009), it will not come as a surprise to hear that language is a part of

psychology. The reason for this is that language is not just a communications code or a

cognitive linguistic system. Language is at the centre of everything human beings do, from the

most prosaic to the most profound. It is the basic ingredient of virtually every social situation.

Lightbown and Spada (2006) suggest that the acquisition of language is one of the most

impressive and fascinating aspects of human development. It appears that the two fields of

psychology and linguistics had the potential during the 1960s to work much closer together.

In contrast, Segalowitz (2001) considers that this opportunity never materialized. Segalowitz

takes the grim view that “The sad truth is that many psychologists interested in language have

not kept up with recent developments in linguistics and it would also seem that many linguists

are not aware of what is happening in psychology, especially in cognitive psychology and

Positive Attitude Positive/Proactive Thinking Topics of Interest Motivates/Directs Brings together Theory, Practice and Context

Benefit from new ways of teaching/learning Become comfortable in unfamiliar territories Their needs are met Well prepared for the „real world‟

In Depth Highly Confident Any Time, any Place Professional Recognized High Demand


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cognitive neuropsychology” (p.4). According to Doernyei linguists and psychologists have

looked at the same phenomenon from different perspectives. Accordingly, for example,

teachers of languages tend to concentrate more on the descriptive rules and patterns of the

language system such as grammar. Doernyei suggests that psychologists, on the other hand,

focus more on the mental processes and structures whereby people understand, produce,

remember, store and acquire the actual language.

Belyayev (1965) considers that students who learn a foreign language must by force of

necessity learn to think in that language. Consequently, the whole process of language teaching

is to be envisaged as the switching of the student‟s thinking from one language to another.

Belyayev asserts, based on some research, that once students have mastered a foreign language,

the learner does not need to revert back to his native language to use the resources of that

tongue. The learner has acquired the ability to think directly in the new foreign language he/she

has learned. According to Belyayev (1969), based on some further research, language teachers

have an important role to play in the effective teaching of foreign languages. Belyayev

considers that thinking in a foreign language reveals specific characteristics and presents

certain distinctive features in relation to thinking in the native language. This is why language

teachers need to master the art and means of communication in a foreign language so that the

language student evolves a different way of thinking. Belyayev did not elaborate on what he

meant by “thinking”. Littlewood (1981) considered earlier that communicative activities are

paramount to the successful learning of another language. He defines communicative learning

as an activity whereby the student engages in activities with the main purpose of

communicating meanings effectively to another student or the teacher. Littlewood suggests a

number of contributions that communicative activities can make to language learning. For

example, whole task practice is a structured approach in order to suit the learner‟s level of

ability. This integrates all of what has been learned so far. Littlewood asserts that learners want

to participate more in communications with others and are therefore more motivated to learn

much faster. The actual use of the new language is also an important part of the total learning

process. Natural learning is a result of applying, for example, in conversations what has been

learned. Communicative activities create environments that support the individual in their

efforts to learn.

Lynch (1996) suggests that it is important that teachers observe how foreign language students

succeed or fail in their efforts to communicate in the classroom or language laboratory. It can

help them to intervene to make learners‟ use of the foreign language more effective. Teachers

should never be afraid to search for new teaching techniques and approaches to improve the

effectiveness of language teaching. Some methods may well work better in some settings such

as rural schools or Universities but of paramount importance is to have the right attitude to at

least try some new way of teaching.

Teachers should always try out something themselves so they can use this practical experience

to argue in favor of any desired approach changes. Lynch points out that students should be

encouraged to interact through classroom tasks such as presentations and group exercises by

using the traditional language skills of listening, reading, speaking and writing.

Comprehension plays an important role in the development of the foreign language learners‟


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competence in that language. As part of the teaching process, teachers of foreign languages

must develop the active listening skills of students. To become competent in another language

involves much more than just recognizing what is being said. Comprehension is multi-layered

and requires or allows interpretation at different levels. When people, for example, listen to

their own language, they often go beyond the input in many ways. This is where language

schools can provide learners with appropriate help. Research has shown that low-level learners

tend not to use the effective listening strategies that they would apply in their first language.

Lynch quotes Krashen (1985) who argues that under suitable affective conditions such as

positive feelings and motivation, language learners will use some parts of this input not only to

comprehend the current message but also to pick up new items of grammar and vocabulary and

to improve their fluency in speaking. Interactive negotiations are an effective route to improve

language proficiency. Lynch considers that language teachers play a vital role in the effective

teaching of foreign languages to students. Teachers, based on years of practical class room

experience, recognize the important link between comprehension and progress in a foreign

language and then design classroom teaching appropriately. This includes the effective

utilization of tools such as the language laboratory and inviting native English speakers to

interact with students. Krashen reports that it is the teacher‟s personal style that makes a

fundamental difference how students pick up language skills, for example, by how they ask

questions. This has a major impact on how students learn. Krashen asserts that those teachers‟

abilities to close the gap between the students‟ perception what the teachers are trying to focus

on and what they actually are focusing their attention on is of paramount importance to the

effective teaching of a foreign language. The authors, based on years of practical classroom

teaching in foreign languages, suggest that regular interactions with native speakers of

languages provide students with opportunities to acquire and use, for example, new vocabulary,

grammar and contemporary expressions and phrases in the relatively safe environment of the

classroom. Native speakers of languages must modify their speech content to ensure that the

messages sent are received as intended.

According to House (2008), language is the most important means of communicating, of

transmitting information and providing human bonding. It is a person‟s prime means of

acquiring knowledge of the world, of transmitting mental representations and making them

public and inter-subjectively accessible. House considers that language per se has an influence

on its speakers‟ thinking, their world view and behavior. This is in contrast of the view that

language “reflects” the culture of a social group. House suggests that some people have

acquired language proficiency in more than one language.

This is the kind of person who has been exposed to, for example, the language intricacies of his

own native tongue and those of another language. Such a person has the potential to develop

“his or her own third way, based on the combined knowledge and experience of more than one

native language” (p.19). This puts students into a precarious position but ultimately one of

enrichment. Such experiences offer the intercultural speakers deeper insights and

understanding in both cultures (own and learned). It appears that English is the preferred option

for linguistic unity, allowing people from different first language backgrounds to communicate

(Soler, 2008). As a consequence, nearly all Europeans, irrespective of social class, are provided


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with instructions in English. The language is also accepted as an international or global

language. It should be noted that the following statements are not questioned and some are

perhaps the fundamental reason why so many students across the world study English at

University level:

-English is the language spoken by more non-native speakers than native speakers

-English is the language to have access to journals and conferences

-English is the dominant language in publishing

-English is used when the content of courses, manuals and software have a bilingual or

trilingual pattern

-Multinationals are set up in Europe and irrespective of their location, English is the working

language

-English language education is compulsory in most schools

House suggests that when English is used in mutually occurring contexts, then the outcome

will be much stronger and more relevant for its intended use. Frydryclova Klimova (2012)

reports that the European Union (EU) emphasizes that Content and Integrated Language

Learning (CLIL) in which pupils learn a subject through the medium of a foreign language, has

a major contribution to make to the Union‟s language learning goals. It can provide effective

opportunities for pupils to use their new language skills now rather than learn them now for use

later. It opens doors on languages for a broader range of learners, nurturing self-confidence in

young learners and those who have not responded well to formal language instruction in

general education. It provides exposure to the language without requiring extra time in the

curriculum which can be of particular interest in vocational settings. The introduction of CLIL

approaches into an institution can be facilitated by the presence of trained teachers who are

native speakers of the vehicular language. The authors consider in this context that the example

of the EU is relevant to this research as many languages are spoken within the current member

states of the EU. The combined learning knowledge and experiences from Europe are relevant

and should be taken into consideration as it is suggested that these can be applied universally,

subject to local prevailing cultural differences.

Hismanoglu and Hismanoglu (2011) consider that, based on the constructivist theory of

learning and communicative language teaching methodology, the task-based viewpoint of

language teaching has emerged in response to some constraints of the traditional Presentation,

Practice and Performance (PPP) approach (Ellis, 2003; Long and Crookes, 1991).

It has the significant meaning that language learning is a developmental process enhancing

communication and social interaction rather than a product internalized by practicing language

items, and that learners master the target language more powerfully when being exposed to

meaningful task-based activities in a natural way. It was in the 1980s that this viewpoint of

language learning gave rise to the popularity of various task-based approaches (Breen, 1987;

Candlin and Murphy, 1987; Nunan, 1989; Prabhu, 1987). Moreover, during the 1990s, it

developed into a comprehensive structure for the communicative classroom where learners did


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task-based activities via cycles of pre-task preparation, task performance, and post-task

feedback via language focus (Skehan, 1996). According to Ellis (2003) task-based language

teaching has been re-investigated recently from a variety of perspectives covering oral

performance, writing performance and performance assessment.

Celik (2013) holds the view that course instructors across a wide range of disciplines such as

language teaching, have implemented computer-based learning resources such as online

discussion boards. Celik suggests that the benefits of implementing an online discussion board

in teaching have been well-documented and that an investigation into the social aspects of

online learning environments is still needed in order to develop a deeper understanding of how

group dynamics affect the overall learning experience. Celik conducted a related action

research project that explored the perceptions of graduate students concerning the use of an

online discussion board that revealed that positive group dynamics appeared to be prevalent in

the discussion. In contrast, the perception of the individual class members did not always agree

with this view. The authors consider that that outcomes of Celik‟s discussion board project

could be of value to students with disparate levels of knowledge of a foreign language as the

cumulative learning effect would be of benefit to students, irrespective of their levels of

proficiency.

The literature review from this research suggests that there is a gap between contemporary

language teaching approaches and methods and what language teachers could achieve if they

adopted new and different approaches to develop the language proficiencies of their students.

Established subject matter experts consider that it is the appropriate application of different

language teaching approaches and methods that can make it possible for language teachers to

improve the foreign language proficiency levels of their students significantly.

1.3 Main Research Questions/Hypotheses

The following research questions were constructed:

1. What is the value of presenting topics of interest by visiting native English language

practitioners who use contemporary English that is used in business and academic

environments?

2. What is the value to English language teachers of conducting regular research in order to

keep abreast of the latest thinking in language teaching approaches and methods?

3. Does the power distance between English language teachers and their students affect the

quality and proficiency levels of the learning?

The following hypotheses were constructed:

H1: English language students improve their English language proficiency substantially if they

interact regularly with business people and academics whose native language is English

H2: English language teachers improve the quality of their teaching in the classroom for the

benefits of students if they develop a positive and proactive attitude towards contemporary

foreign language teaching methods and tools


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H3: English language teachers who give students the freedom to learn and practice using their

own chosen topics are increasing students‟ self-confidence and speaking abilities of speaking

in the foreign language substantially

2. Research Methodology

2.1 Method

The authors applied a constructivist interpretivist research approach within a

phenomenological research paradigm. They considered that this was most appropriate in order

to make a valid and reliable contribution to knowledge. The outcome of this research is

applicable to both academics and practitioners. The aim and purpose of this research, in line

with the research questions and hypotheses from Section 1.3, are to suggest what makes an

effective and efficient language teacher based on the work that has already been done at the UO

in Santiago de Cuba and what is planned in future. It is important that foreign language

teachers can experience new approaches and methods themselves to confirm that these are

valid and reliable. The authors consider that the change in expectations to develop new tools

and techniques for teaching foreign languages (Section 1.1) is the likely reason why foreign

language teachers are under increasing pressures to respond to these new demands in a

proactive and positive manner. Thirteen final year undergraduate students from the Faculty of

Humanities and thirty-three undergraduate students from the Faculty of Social Sciences of the

Universidad de Oriente (UO) in Santiago de Cuba were interviewed by the authors during face

to face and focus group meetings. The authors who have over 50 years of theoretical and

practical work experience were acting as participatory observers to facilitate this research. The

interviews were conducted in early 2013 in Santiago and recorded verbatim to ensure that all

responses were captured correctly, including meaning as intended. Interviews were

semi-structured. Participants‟ ages ranged from 19 years to 24 years and they had between

three and four years of practical work experience of applying foreign language skills acting as

translators and interpreters. The participants were asked for their insights to answer the main

research questions from Section 1.3, using their own theoretical and practical experiences from

the past and the present.

Table 1 is a summary of the questions that were asked during the face to face and focus group

meetings. The first objective of the face to face interviews was to review the outcome of the

literature review and confirm whether the research data from the literature review was relevant

and admissible as evidence for this research. The second objective was to consider how

language teachers need to apply these kills in a practical way in classroom situations and to

confirm what makes an effective foreign language teacher. The purpose of the focus group was

to review the contributions the individuals made during the face to face meetings, in a group

environment, to check whether these findings, together with the outcome from the literature

review, could be verified and improved. The focus group reviewed and checked the findings

from the literature review and the face to face interviews and made final recommendations that

would be of practical value to suggest what makes an effective foreign language teacher and

what the associated teaching approaches and methods are.

Table 1. Research Questionnaire: Practical Language Skills Teaching


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1. What is your definition of Language Skills Teaching?

2. What are the aspects you associate with effective language skills teaching?

3. What is your view on the claim that the concept of practical language skills teaching is a desirable and

effective methodology?

4. What potential problems do you associate with practical language skills teaching?

5. What are your personal practical experiences with practical Language Skills Teaching -give some real

life/practical examples/feedback on the course

Why did it work for you?

Why did it not work for you?

2.2 Data Collection, Interpretation and Triangulation

The authors applied three methods to collect relevant research data to answer the main research

questions and hypotheses from Section 1.3: a review of the literature (Section 1.2), face to face

interviews (Section 3.1) and a focus group meeting (Section 3.2), within the context of a

phenomenological research paradigm and an associated constructivist interpretivist research

approach. The authors were thus able to get closer to the subject matter under investigation.

They have added their own interpretations of what makes an effective foreign language teacher

and associated teaching approaches and methods, in their role as participant observers. This

research approach allowed for the collection of different perceptions of the phenomena under

investigation. All research data was collected over a period of three months. The authors

applied triangulation as a means to use a combination of different methods in order to reduce

reliance on a single research method and to ensure that the use of all data was consistent and

coherent.

3. Results

3.1 Face to Face Interviews

Thirteen final year undergraduate English language students and their teachers from the

Faculty of Humanities placed a high importance on the attitude and abilities of foreign

language teachers to make language teaching in the classroom and laboratory interesting and

exciting. They considered that it is not the syllabus in itself that will lead to the successful

teaching of foreign languages but how teachers interpret the syllabus and how they consider

and develop new methods of effective teaching. To have detailed knowledge of a subject matter

such as English language is no panacea for success. It is the teachers‟ personal ability to engage

with language students in an interesting, motivational and exciting way that will make all the

difference. The authors, based on many years of practical language teaching in classrooms,

consider that students learn much better if different teaching approaches are applied as this

allows different levels of immersion in the language. The students considered that the four

linguistic skills of reading, writing, listening and speaking are still valid but that it is the

practical application of these that will make a substantial contribution how quickly and how

effectively students learn foreign languages. All participants insisted that real names should be

used to give this research authenticity. Individual interviews were conducted with the students


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who considered what they associate with effective language skills teaching and what effective

teaching methods should be applied to improve the long-term proficiency in a foreign language

such as English:

1. What is your definition of Language Skills Teaching? “It means teaching the language by

dividing the teaching process into the different skills of the language: reading, writing,

listening and speaking” (Yeynier; Anelis). “The teaching of language skills is the implicit

teaching of separate language skills in order to help the student achieve the proper competence

in the language” (Maikel). “Language skills teaching is the teaching of a foreign language

dividing the content into the four linguistic skills and at the same time combining it into one

major skill or competence” (Clara). “It is about the teaching of a foreign language in respect of

the language‟s idiosyncrasies through the methods of reading, writing, speaking, listening and

other sub skills” (Manuel).

2. What are the aspects you associate with effective language skills teaching? “Teaching

language skills in an effective way requires teaching the content the students actually need at

the time and thus motivate them to study the language in an accurate way” (Lianne).” To teach

language skills effectively the teacher must be well prepared in the proper methodology to

teach each of the skills separately and all in tandem. Besides, a key factor is the inclusion of

real life situations in the teaching learning process2 (Alberto).” A skilled language teacher

should combine all the content of the four skills so that the students learn the four skills in

tandem and thus develop the required language competence” (Roberquis).” An efficient and

proficient teacher would integrate the content of the four skills in his/her lectures and would

also raise students‟ awareness of the importance of the four linguistic skills as well as provide a

positive feedback”(Fernando).

3. What is your view on the claim that the concept of practical language skills teaching is a

desirable and effective methodology? “The concept of practical language skills teaching is

quite relevant in the training of language students. Students will get the language and the

culture of the source language as well” (Fernando). “It is so because it enables teachers to

prioritize the elements of language skills they would like to concentrate on” (Lisbet). “It is

effective for people above a basic level and a faster way to learn the language for immigrants or

academic applicants” (Manuel).

4. What potential problems do you associate with practical language skills teaching? “The

potential problem would be for beginner learners; this approach is more suitable for

intermediate and advanced students who have more background to acquire vocabulary and

grammar rules in this way” (Yeynier).

“Using the practical language skills teaching approach would probably be a problem for it

alone would not cover all the aspects that the students need to properly learn a language

“ (Lianne). “Practical language-skills teaching should not present problems but with the

grading of the content to be taught which should be suited to the student‟s needs “(Maikel).

“Practical language skills teaching should not be used on its own. It should be combined with


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other methods to achieve the required level of competence “(Fernando).

5. What are your personal practical experiences with practical Language Skills Teaching -give

some real life/practical examples/feedback on courses you attended. Why did it work for you?

Why did it not work for you? “Personally, I have noticed that it is much easier to learn this way,

for instance, when I was a student, I spent two years studying English language and then during

the third year we had lectures about British history where I learned new historical facts but at

the same time you unconsciously learn new grammar rules and vocabulary along with the

pronunciation and contextual usage of the words; that is what makes it work, it is easier to

remember grammar rules and vocabulary in this way than it would be learning random words

and rules “ (Yeynier). “In my experience practical language skills teaching is quite useful. It is

easier to practice what you have learned when you practice it in that way. This kind of

knowledge is easier to remember and closer to real life situations “(Lianne). “Practical

language skills teaching has proved relevant to me because my students seem to enjoy it more

and at the same time they remember the things learned more easily, which makes it a win-win

situation for both students and teachers “ (Daniel). “The concept of practical language skills

teaching has always been useful to me but combining it with other methods. I have always used

to support the rest of the classes and it has had excellent results for me when I take other

subjects, somehow related to the content of the semester, and use them in practical language

skills lessons” (Fernando). “I have worked with videos and I have integrated the other skills

with them. The course helped a lot. I was great to realize that what I have been doing for a few

years was not crazy at all “(Lisbet).

The authors assert that the contributions from the community of practice have been invaluable

to the drive to answer the main research questions and hypotheses from Section 1.4. All

students have been engaged in applying their acquired English language skills during

simultaneous translation sessions during academic and business presentations held at the UO

over a period of time. This provided them with valuable opportunities to apply in real life what

they learned in the classroom and language laboratory environments and to validate and review

the English language teaching approaches currently employed at the UO. These insights have

strengthened the presentation of the qualitative data from this research and provided important

inputs to the presentation of the analysis and interpretation to emphasize the qualitative nature

and to the constructivist interpretivist research approach of this current research. The inputs

from the community of practice and the authors‟ own extensive experiences have provided

important insights and contributions to develop and suggest what the effective approaches and

effective English language teaching skills are within a proactive thinking and acting language

department at the UO in Santiago de Cuba.

3.2 Focus Group Meeting

This focus group was made up of the same thirteen final year undergraduate students from the

Faculty of Social Sciences at the UO that were interviewed individually during the face to face

interviews. Attendees were familiar with best practice in English language teaching. This was

reinforced by the authors through a series of short presentations prior to the start of the formal

discussions to set the scene for the focus group meeting. The focus group checked and


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validated the reliability of the research data from the literature review and the face to face

interviews. The focus group confirmed that the research data from the literature review was

consistent and admissible. The focus group associated the infusion of presentations from a

native English speaker with improving language skills in a number of areas. They felt that a

regular exposure to native English speakers, for example, enhances their vocabulary in topical

areas such as Project Management, Intercultural Communications and Negotiation and

Persuasion. This learning is reinforced by drawing on the practical knowledge and experience

of guest speakers. They suggest that topical presentations by external native English speakers

should be incorporated into English language degree program syllabuses. It should be noted

that this applies equally to all other language programs at the UO. The same research questions

from the face to face interviews were used in the focus group meeting:

1. What is your definition of Language Skills Teaching? “The teaching of language skills

means teaching a foreign language in an organized way by dividing the content into the four

linguistic skills of listening, speaking, reading and writing” (Jorge, Yoennis). “Language skills

teaching is the teaching of a foreign language dividing the content into the four linguistic skills,

and at the same time combining it into one major skill or competence” (Clara).

2. What are the aspects you associate with effective language skills teaching? “An effective

language skills teaching would include all the skills not only in a theoretical way but also in a

practical and contextual way” (Yeynier). “In order to teach language skills effectively the

teacher must reach a synergy between the four skills making the content as close to real life as

possible, so that the boundary between each skill is nearly imperceptible” (Jorge, Yoennis). “To

teach the four skills in a proper way the teacher must grade the data according to the level and

needs of the students, keep the students‟ attention focused on the subject matter and encourage

the students to further their studies by means of positive feedback” (Daniel).

3. What is your view on the claim that the concept of practical language skills teaching is a

desirable and effective methodology? “In my opinion practical language skills teaching is

indeed a desirable and viable way to teach a language because the learners acquire knowledge

in a more ample and contextual way- for example, they learn new vocabulary and grammar in a

given context which makes it easier to remember and put into practice later” (Yeynier).

“Practical language teaching is a good approach both for the student and the teacher because it

implies teaching vocabulary and grammar rules without directly focusing on them” (Jorge,

Yoennis). “The practical teaching of a language is a very effective method for it involves being

more interactive and at the same time teaching more than just language” (Alberto). “The

teaching of practical language skills is very useful. It combines all the skills into one and

soothes the teaching learning process. It is also a powerful source of motivation” (Maikel).

“Teaching language skills in a practical way is a good approach because it actually combines

the language skills with other areas of expertise and thus enhances the professional profile of

the student” (Roberquis). “It is very good for ESL students because it shows them that they can

learn from any topic involving real life situations including the language” (Clara).

4. What potential problems do you associate with practical language skills teaching? “The

problem of practical language teaching is that it should always be addressed to intermediate


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and advanced students. It should also include topics of interests to them. Otherwise it turns

difficult to create the proper learning environment. It should also be mixed with traditional

teaching styles because alone it does not meet all the students‟ needs” (Jorge, Yoennis). “A

potential problem would be adjusting the content to be taught to students‟ proficiency levels

of the foreign language, for example, giving a lecture about advanced mechanics to beginner

students would not be accurate and would probably de-motivate the students” (Alberto). “A

potential problem with practical language skills teaching would be the topic. The topic should

fit the students‟ needs and interests as interesting topics would add value to the effective

teaching of foreign languages” (Daniel). “A poor attention to language structure which is the

key for the complete assimilation of linguistic competence” (Manuel).

5. What are your personal practical experiences with practical Language Skills Teaching

-give some real life/practical examples/feedback on the course. Why did it work for you?

Why did it not work for you? “Practical language teaching really works. For me the clearest

example occurred when I was a student. I spend a year studying English at the university and

then went to Canada for a training course of a month. The way I see it, I learned more language

in that month than I did in one year studying at the university. In one month I experienced

the context and the motivation to learn more very strongly.” (Anelis). “Practical language

teaching has always worked for me. I have been a teacher for more than 20 years and I have

always included this approach on my courses, not alone though. Students tend to learn easily

with this approach for it motivates them more than the traditional approaches, and also they get

to learn a language but also a new topic of interest that serves their professional profile” (Jorge,

Yoennis).

6. “Practical/contextual language skills teaching for me is the best from the students‟ point of

view. My students always ask for this kind of class because it is more motivational for them and

also it is easier for them to remember what they have learned as it is more easily associated to

real life situations than, say, a purely grammar lesson” (Alberto). “In my experience practical

language skills teaching is a powerful tool to support the teaching-learning process. A good

example is the course we have just attended. We have learned a lot about new subject matters,

for example, management, and at the same time we have learned a lot about the language such

as vocabulary, use in context, pronunciation and the general culture of the language” (Maikel).

“This course we have just received is the proof of the relevance of practical language skills

teaching. We have learned many new things about the English language in context and at the

same time we have learned about topics that are new to us and are useful” (Roberquis).

The focus group members identified that effective language teaching skills and the methods of

teaching language teachers apply will lead to improved language proficiency levels of students,

particularly at intermediate and advanced levels. They consider that knowledge of the words

and vocabulary of a language on its own does not increase the proficiency levels of language

students in that particular language. They suggest that the attitude of the teacher how they wish

to pass on their extensive knowledge and practical experiences of a particular language are of

paramount importance. For example, a good and competent car driver is more likely to teach

someone else how to drive with competence if they have the right positive attitude towards

teaching others how to become a good driver. In addition, language teachers need to consider


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new ways of passing on their knowledge and experience to others in such a way that students

feel compelled to learn more and to drive themselves for higher levels of language

proficiencies that they thought they could never achieve. Table 2 is a summary of the

application and rankings of the examined language teaching skills set. Results from this

research suggest that language teachers who adopt and apply these skills are more likely to

increase the language proficiency levels of their students.

Table 2: Application and Ranking of the examined Language Teaching Skills Set

Skills Set Application Ranking

Practical

Language

Teaching

It is imperative that the right content is taught in

language classes and the language laboratory

There is a relationship between the attitude,

behavior and the competence of the foreign

language teacher and the effectiveness of the

teaching itself

Real life situations should be included in the foreign

language teaching syllabus to prepare students for

real life situations.

Some skills such as reading or listening to a foreign

language need to be taught on their own and at

other times all four skills (reading, writing, listening

and speaking) need to be taught simultaneously.

Positive reinforcements and regular feedback are

the trademarks of an effective foreign language

teacher

It is important to keep informed of the latest

thinking in foreign language teaching including new

approaches and methods.

It is important to understand that theory, practice

and context are important to the effective teaching

of foreign languages

It is important that foreign language teachers create

synergy in the classroom or laboratory by sharing

knowledge and experience consistently

Identified by all parties as being

important *

Considered by all parties to be highly

important. Members of the focus group

suggest that this is an integral part of

being an effective foreign language

teacher *

Considered important by the literature

review.

Identified by all parties to be highly

important *

Considered important by all parties *

Identified by all parties as being highly

important.*

Considered important by the face to face

interviews and the focus group meeting

Considered important by the literature


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review and face to face interviews.

*Literature review, face to face interviews and focus group meeting

It appears, based on the strength of evidence from the results of this research, that the language

teaching skills of language teachers can be improved in a number of ways:

Develop „Can Do‟ attitudes within students and drive them to higher language proficiency

levels

Turn any negative attitudes towards more in depth learning into positive ones by selling the

students the benefits for doing so

Convince students to try new ways of learning in both familiar and unfamiliar territories by

changing their mind sets to put efforts where the greatest achievements can be made (*see

below for an explanation of this 80/20 rule by Pareto, adopted by Koch, 1988)

Search for new established or untried methods of teaching language skills, adopt/ adapt these

and then make them fit for purpose for the UO

Invite more native language speakers from Universities and the Business World to improve the

language proficiency levels of students in order to get them ready for the world that exists

outside of the safe environment of the UO

Visit language teaching facilities in other countries and prepare proposals how to introduce

new language teaching methods into the UO within current guidelines and budget limitations

*Koch (1998) suggests that the approach developed by the Italian economist and sociologist

Vilifredo Pareto should be applied to become more effective and efficient in whatever people

undertake to do. Koch questions the need to spend equal time on all work activities. To achieve,

for example, higher levels of language proficiency, one should put one‟s efforts where the

greatest achievements can be delivered. Koch suggests that 80% of what is important can be

achieved with only 20% of effort (Fig.2).

Input

Inputs Outputs

Causes Consequences

Effort Results

20 %

% 80%


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Figure 2. The 80/20 Principle adapted from Koch (1998)

4. Discussion

The outcome of the literature review confirms that the ability to teach foreign languages on its

own is not sufficient to increase the language proficiency levels of students and to maintain

high levels of interest within students to immerse themselves more in foreign languages. It

appears that students learn more effectively when a good learning climate has been created by

their teachers in the classroom or language laboratory. The provision of “safe” working

environments is vital as this enables students to practice and perfect their language skills. The

most effective environments are those where making mistakes is considered to be a learning

experience. The outcome from the face to face interviews and the focus group meeting

provides new insights into what good language teaching looks like. Students at the UO benefit

from being given some level of autonomy by their teachers to express themselves freely and

being able to critically review the language teaching processes. Based on the strength of

evidence from interviews, participants in the research consider that it is this level of personal

involvement that increases motivation levels within students significantly.

Students and teachers would benefit from regular interactions with, for example, native English

speakers who come from a variety of backgrounds such as business, education and non-profit

organizations. This provides opportunities to learn new words and phrases but also to engage

interactively, in another language, with subject matter experts who can share current best

business practice across a number of industries. Students would be able to increase their

knowledge how a business functions and operates. This will help them in their later life or

career by being able to understand the perspectives of others better and gaining a deeper

understanding of “where others are coming from or what is of value to others”. In this respect,

practice makes not only perfect but also helps to become a better translator or interpreter.

Knowing the words of another language such as English is considered not sufficient. Attaching

more meaning to words and expressions is far more effective and allows language students to

become more proficient in new languages much faster and with better results. The UO is

including translation and interpretation in its language teaching syllabus. Both are related to

and dependent on psychological aspects. The UO is endeavoring to excel in these areas with a

view to raise the language proficiency levels of its students whilst at the same time aiming to

close the gap between linguists and psychologists (Section 1.2) for the benefit of foreign

language teachers and students. This is encouraging.

The three hypotheses of this research are supported by strength of evidence from the literature

review, face to face interviews and the focus group meeting (see Table 3 for a summary of the

results), namely:

H1: English language students improve their English language proficiency substantially if they


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interact regularly with business people and academics whose native language is English. This

hypothesis holds true. High levels of exposure to native English or other language speakers will

increase foreign language proficiency levels in accordance with the levels of exposure to the

foreign language. Language schools should consider adopting this approach.

H2: English language teachers improve the quality of their teaching in the classroom for the

benefits of students if they develop a positive and proactive attitude towards contemporary

foreign language teaching methods and tools. This is a valid premise. The latest thinking in

language teaching is based on years of research and feedback from practitioners in the field.

Language teachers and language schools need to keep themselves abreast of new developments

in this area and consider these for use in the classroom or language laboratory.

H3: English language teachers who give students the freedom to learn and practice using their

own chosen topics are increasing students‟ self-confidence and speaking abilities of speaking

in the foreign language substantially. This is a true hypothesis. Teachers who give students

freedom to choose their own topics increase their motivation levels significantly which leads to

higher levels of language proficiency.

Table 3. Hypotheses and Research Questions: Summary of Results

Hypothesis Related Research Question(s) Results

H1: English language students

improve their English language

proficiency substantially if they

interact regularly with business

people and academics whose

native language is English.

1. What is the value of presenting

topics of interest by visiting

native English language

practitioners who use

contemporary English that is used

in business and academic

environments?

3. Does the power distance

between English language

teachers and their students affect

the quality and proficiency levels

of the learning?

The evaluation of the literature made

positive contributions to determine

whether exposure, for example, to

native English speakers would

enhance language proficiency to the

desired level. The face to face

interviews and focus group meeting

concluded that students who interact

regularly with business and

academics are more likely to develop

stronger language proficiency levels.

They will also increase their

understanding how businesses across

a number of industries function and

operate.

H2: English language teachers

improve the quality of their

teaching in the classroom for the

benefits of students if they

develop a positive and proactive

attitude towards contemporary

foreign language teaching

methods and tools.

2. What is the value to English

language teachers of conducting

regular research in order to keep

abreast of the latest thinking in

language teaching approaches and

methods?

3. Does the power distance

between English language

teachers and their students affect

the quality and proficiency levels

of the learning?

The literature provided some valid

and reliable evidence that suggests

that English language teachers who

are striving to keep abreast of the

latest thinking in foreign language

teaching, are improving the language

efficiency of their students. The

outputs from the face to face

interviews and the focus group

meeting strengthened the findings

from the literature review.


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H3: English language teachers

who give students the freedom to

learn and practice using their own

chosen topics are increasing

students‟ self-confidence and

speaking abilities of speaking in

the foreign language substantially.

3. Do proactive and interactive

presentations in native English

improve the language skills of

students or do these divert from

the syllabus?

5. What is the value of regular

research to keep abreast of the

latest thinking in language

teaching approaches and

methods?

The literature is positively

conclusive that students would

benefit from being given the

freedom to choose their own topics,

for example, for discussion in the

classroom, as this increases their

motivation level significantly.

5. Conclusions

The Faculty of Humanities at the UO has created an inclusive and participatory language

learning environment in which students can apply, try, bring together and evaluate their

knowledge of foreign languages in a safe and realistic real life setting. Academic staff and

foreign language teachers are continuously striving to improve ways of teaching their students

languages such as contemporary English. It is highly commendable, given the financial and

resource constraints, that new research is planned in order to enhance the effectiveness of

language teaching. The positive, proactive and “can do” attitudes of language teachers are of

paramount importance. These are the driving forces behind motivating and keeping students

interested in trying out new approaches to learning a foreign language. Tools and techniques

are important, too, and latest technological developments should be considered for use in the

classroom and language laboratory, depending on prevailing local circumstances. Teachers will

engage more in trying to close the gap between the perspectives of linguists and psychologists

for the benefit of those who are going to learn languages. It is anticipated that teachers will

become more actively engaged by conducting more teacher-initiated research into teaching

methods and practices by, for example, spending more time in language learning facilities in

other countries such as Belgium. The UO has recently engaged in some collaborative work

with Flemish Universities in Belgium. Language teachers will attend workshops on current

innovative teaching techniques including e-learning and other computer-based teaching

methodologies.

A language laboratory will be created (language self access resource centre) for students to use

current proactive and interactive techniques. Native English speakers are interacting with

teachers and students in areas such as teaching and researching. There is conclusive evidence

from the literature review, face to face interviews and the focus group meeting that language

teaching skills and methods, when applied appropriately, can improve the people skills of

language students as well as improve their self confidence levels, as shown by this study. One

of the planned objectives is to teach English to all academic staff at the UO thus enhancing the

professional profiles of all UO personnel. Insights and subject matter knowledge from a larger

sample of students and practitioners of other Universities, including those in other countries,

would have provided richer and diverse research data to address the research scope in more

depth and universally. It is confirmed that the research scope from Section 1.3 has been


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answered and that all three hypotheses hold true and are valid in the context of this research.

The authors suggest that more research and practical work needs to be conducted to close the

perspective gap between linguists and psychologists in order to bring the two parties much

closer together. New research should be considered in the area of developing multi-lingual and

intercultural competence and their relationship.

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Littlewood, W. (1981). Communicative Language Teaching-An Introduction, Twelfth Printing

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Language Use and Language Learning, Springer






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Myths and Realities of Innovative China the Case of

Haier Company

Farrukh Nawaz Kayani (Corresponding author)

Assistant Professor, Department of Management Sciences

COMSATS Institute of Information Technology, Islamabad


Saquib Yusaf Janjua


COMSATS Institute of Information Technology, Islamabad


Babar Wasim


COMSATS Institute of Information Technology, Wah


Received: July 6, 2013 Accepted: July 19, 2013


Abstract

It is well recognized phenomenon that innovations are a strategic weapon for economic growth

and have played an important role in industrialization process of developing countries. Because

of the conventional thought that China produces sub-standard goods; the term innovative

China sounds like a myth. In reality China has made tremendous progress in producing

innovated goods. To support this view, in this paper, we have thoroughly discussed the case of

Haier Company. Haier is one of the very successful stories of Chinese companies which

absorbed the foreign technology and climbed up the technological ladder. This case of Haier


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supports our notion of innovation philosophy behind success of world renown Chinese

companies.

Keywords: China, Innovation, Case Study, Developing Countries, Haier

1. Introduction

The enormous growth of Chines economy in last of couple of decades have grasped

attention of academicians and practitioners. They are curious to understand the reasons and

factors behind this formidable growth and progress of Chinese companies. In 1978, the

Chinese government decided to move away from Soviet-style economic policies in order to

gradually reform the economy towards free market principles. In this regard, Chinese

government encouraged import substitution strategies to export promotion policies. They

established Social Economic Zones (SEZs) to attract foreign direct investments and

facilitated domestic firms. Social Economic Zones are geographically separate small areas of

a country where governments provide special fiscal and financial incentives to foreign and

domestic firms for boosting the exports.

Developing countries offer various kinds of incentive packages to attract Multinational

Corporations (MNCs) from developed countries. These incentives are usually divided into

“soft” and “hard” ones (Kusago and Tzannatos, 1998). Wong (1987) mentioned that countries

establish SEZs for employment creation, technology up-grading and foreign exchange

earnings. SEZs as a means of attracting foreign investment and technology along with

promoting Chinese exports. By granting special investment incentives to foreign investors, it

was hoped that an export-oriented industrial base might be created in the SEZs via foreign

capital and technology. Many of these privileges were also extended to domestic firms to

encourage their participation in the SEZs and thereby increase their contact with foreign

technology and managerial skills.

Aggarwal (2007) has discussed three aspects of SEZs i.e. employment generation, human

capital development and technology up gradation. Each aspect exerts two types of effects i.e.

direct and indirect. For instance, the employment would be directly generated when the SEZs

would hire labor. The indirect employment would be generated through the demand for

complementary goods. Similarly, the skill formation effect operates directly when they

acquire the skills by working in the SEZs. The spillover effects would take place through the

movement of workers to domestic firms. The SEZs would also result into technology transfer

to domestic firms.

Johanson and Vahlne (2003, 2001, 1977) stated that with the increasing internationalization,

lots of businesses are emerging on the globe. For firms, to survive and to earn a leading role in

the fierce global competitive landscape, unremitting innovations are of immense importance. A

number of studies in international business field show that the internationalization of a firm is

an incremental process, that is, a firm should gradually increase its international involvement.

There are several theories that focus on internationalization process of a firm on “its gradual

acquisition, integration and uses of knowledge about foreign markets and operations and on its

successively increasing commitment to foreign markets”.


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Haier is the single most extensive producer of exhaustive family machines in China. It has

developed from minor undertaking to being one of the advancing family apparatuses of China.

The philosophy of expansion and internalization of Haier is based on innovation. The paper

deliberates on success story of Haier i.e. one the leading Chinese company presence all over the

globe. The rest of the paper critically analyzes and discusses the developments and strategy of

Haier that make him successful in global competitive environment.

2. Haier’s Historical Development

Haier group started to work in 1992 by renaming the Qingdao Refrigerator plant which was

shaped in 1984. In 1984 an organization together with Liebherr was created following a

watchful assessment of 32 potential agreeable confederates. Haier transported in Liebherr's

four-star fridge processing innovation and gear to China. Liebherr had 70 years of interaction

in generating brilliant fridges. The Chinese features were a few star advances and

obsolete-formed with a solidifying ability of – 12 degree Celsius. The solidifying ability of

Liebherr's four-star innovation was – 18 degree Celsius. Haier ended up being the just Chinese

ensemble to give four-star refrigerator mechanics following the partnership with Liebherr.

Following collusion, Haier sent above and beyond 40 of its beat engineers and managers to

Liebherr. Liebherr authenticated to be a truly fruitful teaching establishment for Haier's beat

R&D talents. They concentrated on the growth of four-star refrigerator, and possibly aced the

crux innovative aptitudes needed for improving progressed fridges. In 1985, a year following it

permitted Liebherr's engineering, Haier was fit to present its first four-star icebox in the

Chinese business. This feature immediately secured Haier as the advancing refrigerator maker

in China. The figure 1, shows tremendous growth of Haier from 2008-2012 in terms of revenue

and net income.

Source: http://markets.ft.com/

Figure 1. Revenue over the time and Net Income over the time (2008-2012)

The overall sale pattern of Haier Electronics Company, for the years 2008 to 2012 is provided

along with forecasted sale in the same year as well as for the years 2013 and 2014, is provided

in Figure 2. There is upward trend which shows an increase in sales. The forecast till year

2012 is very close to the actual sale, which shows the accuracy of the forecast sales. For the

subsequent years after the year 2012, we can expect the same pattern of the Haier’s sales.


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Source: http://www.4-traders.com/

Figure 2. Actual vs Forecasted Annual Sales (2007-2015)

Haier, today makes about 15,100 feature mixed bags in 96 item lines. Over the period of time,

Haier has not just upgraded the value but added objective and innovative proficiencies as well.

In 1993, nine years following its establishment, Haier was certain enough to start a worldwide

operations. The role of present CEO of Haier in upgrading the quality of products is obvious.

His order of destruction of 76 defective refrigerators was a symbolic step of moving towards

quality production.

In 2003, the Haier brand topped all Chinese trademarks in a nationwide survey. The Chinese

Fortune Magazine (issue 8/2004) appraised Haier the second in their catalogue of most

obviously appreciated ensembles in China. In this rating Haier was observed as number one in

the fields of administration display, development capacity and social obligation. In 2004, Haier

was distinguished as one of the World's 100 Most Recognizable Brands in a worldwide name

mark post altered by the World Brand Laboratory 10.

As per 2006 Euro-monitor statistics on outfit bargains, Haier has the most extensive planet

business sector mark impart for fridges, and it is the fourth right around the worldwide white

merchandise makers. Among 2003 and 2006, Haier ranked first in terms of the most part

initiative right around terrain Chinese ensembles in the Wall Street Journal Asia's anniversary

study of Asia's 200 Most Admired Companies. In 2008, Haier ranked 13th on Forbes'

Reputation Institute Global 200 record. In addition in the same year, Haier ranked first around

Chinese endeavors on the Financial Times record of the most exceptionally regarded

worldwide teams (Duysters et al., 2010). This short article thoroughly discusses the historical

development, diversification process and globalization strategies of Haier Company in China.

3. The Process of Haier’s Diversification

In 1991, Haier started to diversify. Haier also started to produce air-conditioners and freezers

besides refrigerators. Haier took three years to establish repute in these two industries. In 1991,

the sales and profits of Haier were RMB 724 million and RMB 31.2 million respectively.

Whereas in 1994, Haier’s sales and profits had grown to RMB 2.56 billion and to RMB 200

million respectively. Subsequently, Haier developed washing machines, microwave ovens and


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water heaters. In 1997, Haier entered into the production of black household appliances. Table

1 summarizes the processes of Haier’s diversification over the time.

Table 1. The Stages of Haier’s Diversification

Stage Period Diversification

Area Procedure

1 1984-Dec 1991 Refrigerators Imported refrigerator technology from Liebherr

Company of Germany.

2 Dec. 1991- Jul.1995 Freezers

Air-conditioners

Acquired Qingdao Freezer General Plant and Qingdao

Air-conditioner Plant.

3 July.1995-Aug.1995

Washing machines

Microwave ovens

Water Heaters

Acquired Red Star Electric Appliance Factory and

established a joint venture with Laiyang of Shandong

Household Appliance General Plant.

4 Sept. 1997 Black household

Appliances

Established a joint venture with West Lake of Hangzhou

Electric Group.

5 1998 Knowledge sectors Formed technology cooperation with many external

organizations

Source: Sun (2002) Yan and Hu (2001) and Duysters et al.(2010)

With the idea of “customers as the foundation of growth”, Haier furnishes a one-stop star aid to

its clients. In a joint review directed by the China Consumer Association and the China

Enterprise Research Centre of Tsinghua University on China's domesticated sturdy items for

2003 and 2004, eight of Haier's feature classifications were ranked No. 1 for client fulfillment

and for the most part fulfillment. Notwithstanding excellent home apparatuses, Haier is

additionally centered on offering greatest-of-breed aid answers to its clients. Haier's aid

framework runs all through the preparation method from item plan, preparation, assembling, to

pre-deal, under deals and following deals fix. Inasmuch as 2002, Haier has efficaciously

secured an arrangement of over 5,000 household pro aid suppliers to transport auspicious redid

utility.

4. Internationalization Strategies

Haier is the first Chinese firm to buy a fridge production line in the European Household

apparatus segment. It made the first European acquisition in 2001 by getting refrigerator

manufacturing plant in Italy. The reason for this acquisition is to enhance range and production

capacity. Haier has several abroad modern points of production and sales in the United States,

Pakistan and Jordan. In particular, it has 30 abroad plants and 58,800 deals executors

worldwide. It sends out its items to more than 130 nations in Europe, Asia, Middle East and

North America. The predominant production plant of Haier was in Yugoslavia under a joint

venture with a neighborhood community. Haier is transforming coolers, freezers, clothes

washers, dishwashers, microwave broilers and modest machines for the European business. In


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Asia, it has engaged in the business sectors of Indonesia, Philippine, Malaysia, United Arab

Emirates, Algeria, Bangladesh and Iran through joint ventures. Table 2 below shows the

foreign operations of Haier internationally.

Table 2. Foreign Operations of Haier

North America Europe South Asia ASEAN Middle East Africa

USA Germany India Thailand Jordan Tunisia

Italy Pakistan Indonesia Nigeria

Holland Bangladesh Philippines Egypt

Denmark Sri Lanka Malaysia Algeria

Romania South Africa

Ukraine

Haier has devised a few guidelines for its globalization policy. Under this guideline, one-third

of its features are both handled and sold in its home nation and the other on one-third of the

items are handled in home nation but sold abroad, and rest of the items are both handled and

sold abroad. In worldwide extension procedure, Haier's method is to move from challenge to

simplicity i.e. dropping in additional propelled business sectors first. It is vital to drop in the

more progressed businesses first with a specific end goal, which is to increase more brand

recognition.

In the European Union, Haier entered in the German business sector first. Germany is

recognized as a troublesome business sector to enter in. Scrutinize systems possess a foremost

place in the development and innovative advancements of any immovable. In this respect Haier

has engaged in accommodating scrutinize systems with acclaimed unfamiliar firms. The

proposed helpful systems furnish Haier qualified information about global slants in innovation

improvement. Haier's worldwide mechanics cooperation compass Tokyo, Los Angeles,

Montreal, Lyons, Seoul, Sydney and Amsterdam. The accommodating associates of Haier

incorporate Toshiba, Mitsubishi, ESS, Philips, Metz and Lucent.

5. Discussion

Haier’s success lies in the careful positioning of the products rather than only selling its

products at the lowest possible prices. The products that accommodate the local specificities

were made along with the identification of the niche markets. They are a lot of examples where

Haier’s products accommodated the local requirements. In Indonesia, Haier presented power

saving adaptable-voltage apparatuses due to nation's capacity deficiencies and voltage

variances. Haier presented a fridge with fold-out table in United States so as to target the

scholars who are residing in dorms. Similarly in Pakistan, they modify their cooling machines

to make them adaptable and efficient to extreme weather and electricity load shedding.

In China, Haier advanced a clothes washer that washes both the garments and vegetables. This

model is offered to target the people of country territories. In France and Italy, Haier first sold

out the iceboxes in light of strategic explanation. As the ventilation system business sector

being comparatively a brand new mark was not imperative. The different item lines for


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example iceboxes and clothes washers were presented later following making its mark. Haier

additionally presented brand new classes of products similarly as wine cellar room for

American market. Initially, Haier confronted great challenge in influencing the clients

regarding the handiness of this feature but later on this item has a tremendous demand in the

American businesses. In nutshell, the secret of great success of Chines company lies in its

innovation philosophy and localization strategy of product features and branding compaign.

6. Conclusion

The products of Haier are sold in over 100 nations. The sales of Haier's production are about

RMB 118 billion and it employees more than 50,000 workers across the world. Haier with its

innovation spirit is a pioneer of Chinese enterprises globalization and brand building. It has

emerged into a hefty multinational corporation, and it keeps on expanding its business in China

as well as in abroad, such as North America, Europe, and Asia. Over the passage of time, Haier

has advanced a noteworthy international R&D system. The ambitiousness of Haier’s plan is

reflected in its innovation target: two successful intellectual patent applications every work

day that dispel the image of substandard products and reverse re engineering approach of

Chinese business counterparts.

References

Aggarwal, A. (2007). Impact of Social Economic Zones on Employment, Poverty and Human

Development Indian Council for Research on International Economic Relations,Working

Paper No 194.

Duysters, G., Jo, J., Charmianne, L., & Yu, J. (2010). “Internationalization and Technological

Catching up of Emerging Multinationals: A Comparative Case Study of China’s Haier Group”,

Industrial and Corporate Change, 18(2), 325-349. http://dx.doi.org/10.1093/icc/dtp006

Johanson, J., & Vahlne, J. E. (1977). The Internationalization Process of the Firm: A Model of

Knowledge Development and Increasing Foreign Market Commitments, Journal Of

International Business Studies, 8(1), 32-44. http://dx.doi.org/10.1057/palgrave.jibs.8490676

Johanson, J., & Vahlne, J. E. (2001). “The Mechanism of Internationalization”, International

Market Review, 7(4), 11-24.

Johanson, J., & Vahlne, J. E. (2003). “Business Relationship Learning and Commitment in the

Internationalization Process”, Journal of International Entrepreneurship, 1, 83-101.

http://dx.doi.org/10.1023/A:1023219207042

Kusago, T, & Tzannatos Z. (1998). Export Processing Zones: A Review in need of Update,

Social Protection Discussion Paper No 9802.

Sun, J. (2002). The Company Strategy of Haier, The Enterprise Management Press, China:

Beijing.

Yan, J., & Hu, H. (2001), China’s Haier. Hainan of China Press: Haikou.


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The Relationship between Macroeconomic Variables

and Passenger Vehicle Sales in Malaysia

Fidlizan Muhammad (corresponding author)

Department of Economics, Faculty of Management and Economics

Universiti Pendidikan Sultan Idris, Perak, Malaysia


Mohd Yahya Mohd Hussin




Azila Abdul Razak




Norimah Rambeli




Gan Pei Tha





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Received: January 10, 2013 Accepted: February 2, 2013


Abstract

This study aims to analyze the long-term relationship and causal relationship between

macroeconomic variables and passenger vehicle sales in Malaysia. In this study, the monthly

time series data from April; 2004 to December; 2010 is used. To achieve the objectives, the

Vector Autoregressive (VAR) estimation method is applied. Results show that there is no

significant long-term equilibrium relationship between sales of passenger vehicles with

macroeconomic variables. For the short term, only significant IPI variable affects the growth of

passenger vehicle sales in Malaysia.

Keywords: Passenger Vehicle Sales, Macroeconomic, VAR

1. Introduction

Passenger vehicle is a part of the important transportation to the world now. It serves in smooth

mobility of people and goods from one destination to another destination. Through efficient

transportation infrastructure, economic activities involving local and foreign business can be

conducted quickly and minimize the financial cost. According to Abu-Eisheh and Mannering

(2002), the demand for vehicles will determine the pattern of travel, tourism, road design and

housing. Therefore, transportation is an important factor for economic development of a

country today.

In addition, according to Sean et al. (2003), the hierarchical position of the demand for vehicles

comes second after the property demand among the people in the United States. This scenario

occurs in many countries of the world including Malaysia. This can be proven by two

circumstances. Firstly, the ratio of bank loans especially for car loan until 2010 which

represents 13.3% of the total loan amount, demonstrates a double increase as compared to 6.7%

in 1996 (BNM, 2010). Secondly, the total number of vehicles sold in the market in Malaysia

has shown an increase of 262% or an average of 12% per annum for the period from 1990 to

2011. The increase in car sales is as shown in Figure 1.

Figure 1: Passenger Vehicle Sales in Malaysia (1990-2011).


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Source: Malaysian Automotive Association (MAA)

Figure 1 shows the total vehicle sales in 1990 amounted to 165,861 units, later it increased to

343,173 units in 2000. Total sales continually increased from year to year. In 2011, the number

of vehicles sold amounted to 600,123 units. Although the figure of vehicle sales indicated an

increase as a whole, it was also affected by the current economic situation. The economic crisis

in Asia in 1997/98 for instance, also gave negative implications on Malaysia's vehicle sales

which had decreased by 60% than the previous year.

Due to the fluctuations that occur in the economy, it also has implications for the economic

growth. This is because, the automotive sector in Malaysia is the sector that has contributed

significantly to the economic policy changes in Malaysia, particularly in achieving the

economic status of high-income by 2020. The sector has accounted for 11% to 13% of

economic value added to the manufacturing industry. In addition, the number of employment in

the automotive sector has also nearly doubled in a decade from 2000 to 2009. (NPC, 2009; Wad

and Govindaraju, 2011). During the economic crisis in the United States in 2008, the Malaysian

government has established the Automotive Development Fund totaling to RM200 million to

consolidate and rationalize the PROTON vendor system for the purpose of promoting exports

and financing the easy loan scheme to vendors. Besides that, the scrapping scheme for vehicle

over the age of 10 years was also implemented to promote car sales (Annual Report of the

Malaysian Economy 2009/2010,p.14).

Over the factor of vehicle importance in daily business facilities for the community and also the

country's economic growth, the study focuses on the macro analysis of relevant variables that

affect the total passenger vehicles sales in the long term and short term.

The writing of this study is arranged as follows. The second section describes the literature

review related to the topic of study, followed by a description of the data and research

methodology in the third and the fourth. In the fifth part, the findings will be discussed and the

conclusion of the study is discussed in the sixth.


Studies on the relationship between macroeconomic variables vehicle sales are very limited.

However, there are few studies that have examined the impact of oil prices on car sales.

According to Hamilton (1988) and Pindyck and Rotemberg (1984), the increase in the oil

prices has increased the cost of operation for some durable goods. This will directly affect the

demand for goods and investment, particularly for the automotive sector.

This study is supported by Lee and Ni (2002) research, that involves 14 industrial countries.

They have seen the impact of oil prices through two aspects of supply and demand. On the

supply side, it appears that the oil based manufacturing industry have been affected by the

rising of oil prices as compared to other industries. Among the identified industries affected by

these changes is the automotive industry. On the demand side, rising oil prices and their impact

on production has resulted in inflation. This situation indirectly causes reduced consumer real

income which will eventually reduce the demand for vehicle.


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The study by Barber et al. (1999) also examined the relationship between oil prices and foreign

exchange rates on the sale of vehicles manufactured by the United States and Japan. The study

found that both variables are significant to the sale of vehicles produced. However, it was

found that the rise in oil prices gave more negative implications to the U.S. car production than

the Japanese production. Justification to this situation is based on the focus of the automotive

manufacturing market. The target of manufacturers in the United States is to produce vehicles

in the luxury category as opposed to Japanese manufacturers. This situation has given market

advantage (market gains) to Japanese manufacturers. Despite of the rising oil prices and

affecting the demand, the impact suffered by the Japanese manufacturers is smaller.

The finding of this study is in line with Duncan (1980) who found that the increase in oil prices

results in an increasing demand for small-sized vehicles that use less fuel. A study by

Shahabudin (2009) through regression analysis using macroeconomic variables and monetary

aggregates found that all the variables are significantly influenced by either vehicle sales of

locally produced vehicles and imported. However, the findings of this analysis have serial

correlation problems that stir the model consistency.

A study by Ludvigson (1998) is more focused on the impact of monetary policy on the sale of

vehicles proxied by bank loan supply for automobile loans. The increase in interest rates was

found to have negative implications. This is because the ability of banks to provide more loan

offers was reduced due to the change in monetary policy.

A study by Dargay and Gately (1999) on the impact of income on car ownership in 26 countries

for the period 1960 to 1992 found that, estimation of vehicle ownership for the past two

decades through 2015 is high for low-income countries. Whereas, for the countries of China,

India and Pakistan, the ownership of the vehicle doubled in line with the growth in per capita

income.

In Dargay’s study (2001) in the UK using data from the Family Expenditure Surveys 1970 and

1995, found that the ownership of the vehicle increases if income is also increased. However,

this situation is not consistent in the event of a decline in income. This condition is associated

with a person's behavior and the difficulty to change as the vehicle is now becomes a necessity

in life.

In Malaysia, studies analyzing the relationship between vehicle sales with macroeconomic

variables using econometric approach are also very limited. Many previous studies conducted

were more focused on qualitative discussion regarding the development of the automotive

sector in Malaysia. As an example in Ward and Govindaraju (2011) and Mohd Rosli (2006).

Therefore, this study can be considered as a preliminary study aimed to explore the extent of

these macroeconomic variables relating to the sales of passenger vehicles, particularly in

Malaysia. Given no specific studies done to examine this relationship, the objective of this

study is looking at the long-term equilibrium relationship and the Granger causal relationship

between sales of passenger vehicles with macroeconomic variables in Malaysia.

3. Description of Data

In this study, five variables are used for the analysis section. Definitions for each of the


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variables used are outlined in Table 1

Table 1. Definition of research variables

No Variable Description Source

1 Sales of passenger

vehicles (CAR)

CAR is the number of passenger vehicles sold in

Malaysia

MAA, UPE

2 Consumer Price

Index (CPI)

CPI is used as a proxy to the inflation BNM

3 Index of Industrial

Production (IPP)

IPP is used as a proxy to the Gross domestic product

(GDP)

BNM

4 Oil Price

(OIL)

OIL is used as a proxy to the oil price sold at gas stations

in Malaysia. the price is based on car oil of RON92

(currently RON95)

Ministry of Commerce

and Consumer Affairs

5 Monetary Policy

Rate (ONR) ONR is used as a proxy for the country's monetary

policy. This rate determines the interest rate of loans

offered by banking institutions.

BNM

In this study, the time series of monthly data from April 2004 to December of 2010 is used. The

choice of this period is based on the availability of the monthly vehicle sales data reported by

the Economic Planning Unit, Malaysia. For the purpose of analysis, the CAR, CPI and IPI

variables are transformed in log form. Regression model for this study is based on the model of

aggregate demand vehicles. This model has been applied in the study of Duncan (1980),

Shahabudin (2009) and Lee and Ni (2002). Regression models to examine the relationship can

be summarized as follows:

CAR =f {CPI, IPP, OIL, ONR} (1)

Model in equation (1) is regressed in log-linear form which is written as follows:

tttttt LNONRLNOILLNIPPLNCPILNCAR 4321 (2)

Based on the standard VAR estimation method, the model of the above equation containing

these five variables can be rewritten as follows:

5

4

3

2

1

1

1

1

1

1

5

4

3

2

1

)(

et

et

et

et

et

ONR

OIL

IPP

CPI

CAR

LR

A

A

A

A

A

ONR

OIL

IPP

tCPI

t

t

t

t

t

t

t

t

tCAR

(3)

Where R is a 5 x 5 matrix polynomial estimator parameters, (L) is the lag operator, A is the

intercept and et is the Gaussian error vector with zero mean and variance matrix Ω.



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For the purpose of analyzing the long term and short term causal relationship between the

passenger vehicle sales variable and the macroeconomic variables, the method of vector

autocorrelation (VAR) was applied. To get the good results of the analysis, the standard

procedure of time series data analysis was conducted.

Stationarity test of variables series using the Augmented Dickey-Fuller (ADF) and

Phillips-Perron (PP) was conducted as the first step to find out whether all study variables have

the same degree of integration or different. Degree of integration is essential to enable further

analysis to be undertaken. In addition, the same level of integration also shows the possibility

of long-term causal relationship, known as cointegration.

The next step is to determine the appropriate lag before applying model-based cointegration

method of Johansen (1988) and Johansen and Juselius (1990) or to simplify the J & J. To ensure

that the selected lag is appropriate, the test of the VAR unit stability was implemented. The

next step is the cointegration analysis based on the J & J method called Multivariate Johansen

Test. This method aims to ensure that the relationship of the series of variables studied exist in

the long term. The determination of the existence of this relationship is seen on the significant

value for the two types of statistical value which is the Trace statistical value and Eigen

maximum value.

To obtain the mutual relationship between the variables that is known as the causal short-term

relationship, the method of vector error correction model-VECM was applied. This method can

describe the variables analyzed whether it is exogenous or otherwise.

5. Result of Empirical Analysis

Discussion on the data analysis results obtained based on the VAR testing procedures initiated

by the unit root test analysis results, followed by cointegration test and ended with a vector

error correction model.

5.1 Stationarity Test

Stationarity analysis or also known as integration test was done to investigate the stationarity

degree of each variable. It should be done in advance to avoid the occurrence of spurious

regression problem. This study requires the same degree of immobilization for each time series

as it is a prerequisite in cointegration analysis and Granger causal VECM version.

Table 2 shows the results of the analysis of stationarity tests using ADF and PP. Based on Table

2, it appears that all variables in the study had the same integration or stationarity level of I (1).

Table 2. Unit Root Test

Variable ADF (level)

ADF (First differentiation)

PP (level)

PP (First differentiation)

CAR 0.3103 -9.6479* 0.3815 -17.1546* CPI 2.3495 -5.4047* 3.0213 -5.3991* IPP 1.0726 -2.0174* 0.4660 -20.8352* OIL 0.2423 -7.8217* 0.2423 -7.8259* ONR -0.3147 -4.5939* -0.2537 -4.5760*


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* Significant at 1% significance level.

5.2 Lags Selection

Based on the method of estimation of vector autoregressive (VAR), the selection of the

correct lag is important to ensure that the findings reflect the real economic situation and in

line with economic theory and econometrics (Ibrahim, 2007)

Table 2. Lags Test

Lags Final Prediction Error

(FPE)

Akaike Information Criterion

(AIC)

Schwarz Information Criterion

(SIC)

0 2.59e-10 -7.8858 -7.7336

1 1.50e-14 -17.6453 -16.7322*

2 7.05e-15* -18.4063* -16.7321

3 8.50e-15 -18.2040 -15.8052

* show the lags selected by the criteria are based on the minimum value

Based on Table 3, criteria of Final Prediction Error (FPE) and the Akaike Information Criterion

(AIC) suggest that the selected lags are lags 2, while the Schwarz Information Criterion (SIC)

was chosen based on the lags of 1 to the smallest value for each criterion. However, this study

will only be using the Akaike Information Criterion (AIC) in selecting the lag of lags 2. The

selection of lags that uses these criteria in previous studies is the same as the study by Adam

and George (2008) and Yusoff et al. (2006). Therefore, the lag two (2) will be used to test the

cointegration and vector error correction model (VECM).

5.3 The VAR Stability Test

Among the important features in VAR analysis is the VAR (p) – variable that can produce a

stable process. Stable VAR process is important because it produces an efficient model in terms

of analysis of variance, covariance and also the beginning of the analysis period. VAR stability

is achieved if the value of the modulus obtained is less than one. If VAR is not stable, the

solution can be done is to reduce the time lags (Charemza and Deadman 1997, Gujarati 2003).

Results of this analysis are shown in Table 4.

Table 4. VAR Unit Polynomial Stability Test

Unit Modulus

0.995051 0.995051

0.845294 - 0.091717i 0.850256

0.845294 + 0.091717i 0.850256

0.540139 - 0.407871i 0.676837

0.540139 + 0.407871i 0.676837

0.670566 0.670566

-0.494558 - 0.203829i 0.534915

-0.494558 + 0.203829i 0.534915

-0.339778 0.339778

0.184408 0.184408

Based on Table 4, it was found that the modulus obtained is smaller than one. This shows that


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the analysis is stable. Therefore, the selected lag two (2) is sufficient.

5.4 Cointegration Analysis

Based on the findings of the analysis shown in Table 2 showing that the series of variables have

the same degree of integration, the cointegration test was implemented. This test result analysis

is shown in Table 5.

Table 5. Cointegration Test

Model Null Hypothesis Trace Statistics

Critical Value

(5%)

Maximum Eigen

Statistics

Critical Value

(5%)

Lag : 2# r ≤ 0 96.0375* 69.8188 40.5145* 33.8768

r ≤ 1 55.5230* 47.8651 32.9616* 27.5843

r ≤ 2 22.5614 29.7907 16.3253 21.1316

r ≤ 3 6.2360 15.4947 6.0497 14.2646


critical value is obtained from Osterwald-Lenum (1992)

# Lags is based on AIC value

Based on Table 5, it is found that there are at least two cointegration relationship obtained. This

shows that there are two equations that may be developed in the long term. Based on the results

of this cointegration, long-term relationship that has been transformed in the form of the

normal equations for passenger vehicle sales in Malaysia with macroeconomic variables can be

written as shown in Table 6.

Table 6. Cointegration Relationship

Dependent variable (LNCAR) Independent Variable

LNCPI LNIPP OIL ONR C

Coefficient - 0.0452 0.7089 -0.1065 -0.1266 -7.8915

s.e value (0.8207) (0.5747) (0.1563) (0.0640)


Based on Table 6, it appears that CPI, OIL and ONR variables are negatively related, while the

IPPs are not. Although, these variables are in line with the theory and also with the findings of

previous studies, but it is not significant. The question now is, does the passenger vehicle sales

variable is the independent variable (exogenous) or dependent (endogenous)? To answer this

question, the method of vector error correction model (VECM) is applied.

5.5 Analysis of Vector Error Correction Models (VECM)

Based on the cointegration test shown in Table 6, it is proven that the existence of a long-term

relationship between the variables-variables in the study is of the same degree of integration.

Hence, the term of error correction (ECT) should be included in the model before testing the

Granger causal relationship can be carried out. Engle and Granger (1987) and Toda and Phillips

(1993) argue that the failure to take into account the error correction term (ECT) will result in

the test conducted produces specification error model (model misspecification). Therefore, the

Granger causality test should be expected in the vector error correction model (VECM) version

and the results are shown in Table 7.


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Table 7. Vector Error Correction Model (VECM) test

Dependent Variables Independent Variable

Chi-Square Value (Wald test)

t- statistics value

LNCPI LNIPP OIL ONR

LNCAR Ect-1

LNCPI 0.0541 3.6518 0.7249 0.7299 0.0046(0.0067)

LNIPP 6.5342** 12.7820* 0.0658 2.8863 -0.0959*(0.0511)

OIL 4.0849 0.8742 0.9681 3.4444 -0.0730(0.0408)

ONR 10.6819* 0.8019 3.9030 1.1005 -0.1859(0.1463)

LNCAR

2.5426 8.8054** 1.3943 0.1230 -0.5659*(0.1413)

*,**,*** Signficant at significance level of 1, 5 and 10 %

( ) s.e value

Based on Table 7, long-term Granger causal relationship can be seen on the ECT-1 for each

variable. Based on the VECM test results, it is found that the ECT-1 CAR and IPI variables are

significant. This variable indicates that the CPI, the IPI, OIL and ONR are long-term Granger

causal to CAR, while the CPI, ONR, CAR OIL are for the IPP variable.

The result from the ECT value on the CAR variable in particular clearly shows that the CAR

variable in the equation carries the error correction burden of scattered short-term balance to

strike a balance in the long term. This suggests that the CAR variable is endogenous variables

in the study model. Coefficient ECT-1 also reflects the speed of adjustment to achieve a

balance in the long-term in which the value is -0.5659 that means as much as 56.59 percent of

the adjustment is done during the lags two to achieve long-term equilibrium.

From Table 8 also, a short-term causal relationship is obtained based on the Wald test. Test

results reveal that the CPI is a short-term causes of the IPP, and OPR, while the OIL is the

short-term cause to IPPs. For CAR variables, only the IPI is found to have a short-term

relationship.

Overall, the direction design of Granger causal short-term relationship can be summarized as

shown in Figure 2 below.

Figure 2. Causal Relationship

OIL

ONR

CPI

IPP CAR

Indicator:

One way relationship two way relationship


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Based on Figure 2, it can be concluded that there are two pathways that affect auto sales in

Malaysia in the short term. The first route is OIL-IPP-CAR, while the second path is the

CPI-IPI-CAR. From the first line, it is in line with the findings of previous studies that found

that changes in oil prices will affect the demand for cars. This can be attributed to the net

income of users will be affected in the event of rising oil prices. Apart from the oil price factor,

the increase in overall inflation will also affect the consumer income. Thus, the main factor

affecting the automotive sales in Malaysia is the income. For that reason, factors that can affect

this income will directly affect the automotive sales.

6. Conclusion

This paper analyzes the relationship between macroeconomic variables with auto sales in

Malaysia for the period of 2004: M4 to 2010 : M12 by using the VAR method. From the

analysis results obtained, it appears that there are two pathways that influence the sales of

passenger vehicles in Malaysia, which are the CPI variables to the IPP and secondly the OIL

variables to the IPP. Shocks that occurr on IPP variables are found to affect the sales of

passenger vehicles in Malaysia. This indicates that the sale is dependent on the economic level

which is a proxy for the measurement of consumer income. Good income position will affect

positively to the increasing demand for passenger vehicle sales in Malaysia. Therefore, to

improve the automotive sector in Malaysia, the government should ensure that the level of

income of the users in Malaysia to remain strong and not be adversely affected by factors such

as rising prices, oil and so on.

7. Acknowledgements

The research is financed by Internal Short-Term Grant by RMIC-UPSI, Perak, Malaysia.

For ASEAN automotive relationship already published in IOSR Journal of Business and

Management (IOSRJBM), Vol. 2, Issue 1 (July-Aug 2012).

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October 2006.






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From Cyber Bullying to Cyber Coping: The Misuse of

Mobile Technology and Social Media and Their Effects

on People‟s Lives

Eddie Fisher (Corresponding author)

Faculty of Social Sciences, Universidad de Oriente, Santiago de Cuba, Cuba

Univerzita Palackeho, Olomouc, Czech Republic, 8 Kendal, Swindon,

Wiltshire, SN5 8HW, United Kingdom


Received: August 27, 2013 Accepted: September 17, 2013


Abstract

The ability to deal and cope with cyber bullying attacks is becoming increasingly important to

children and young people in the United Kingdom although this phenomenon appears to be

acute in many other countries, too. This paper investigates and provides a deeper understanding

of what the effects of cyber bullying have on people‟s lives. The results show that there is a

relationship between an increase in access to digital technology and the methods cyber bullies

apply to threaten, harass, humiliate and embarrass people. Results suggest that parents,

teachers, employers and owners of social media sites are not educating and coaching young

people sufficiently so that these can stay safe in a world of texting, twittering and social

networking. The research suggests a number of practical solutions such as incentivized

schemes and engaging young people in cyber bullying awareness focus groups. It is anticipated

that this will help young people to develop their own levels of responsibilities to make

informed decisions what is safe for them to access, view and act upon.

Keywords: Cyber bullying, Mobile phone technology, E-Safety, Social networks, Attitude and

behavior

1. Introduction

1.1 Introduction

It appears that the misuse of mobile technology and social media networks is becoming


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epidemic not just in the United Kingdom but also in other countries such as the United States. A

few years ago words such as “cyber bullying” or “e-safety” would not have meant much to

most people. Today these words appear to have become part of people‟s everyday vocabulary.

The meaning of these words is clear to most people but not everyone understands what the

consequences are to people‟s lives who are, for example, cyber bullied. According to Giant

(2013) the explosion of twentieth-century technology has been unprecedented and most people

cannot remember a time when this technology did not exist. Mobile technology allows people

to communicate with each other at any time anywhere in the world. It is possible to send

pictures and video clips to friends and family at the click of a button. This revolution has

changed people‟s lives irreversibly. The vast majority of children and young people own a

computer and mobile phone which gives them unlimited access to information and allows them

to share this information with others across the globe (Rogers, 2010). Older people perhaps

have developed a sense of caution not to trust technology blindly. In contrast, younger people

do not have this balanced view. They were born and are brought up in a world that is full of

technology that forms a substantial part of their everyday lives. It appears that the technology

has become a right to most young people. This explains why the technology is used extensively

throughout their daily lives, exceeding the uses of most adults by a substantial margin. With the

right to have and use this technology also come responsibilities such as how to use the

technology responsibly and in such a way that no direct or indirect harm is caused to other

people. This is the theory but reality looks different. Access to the new technology has led to an

increase in misuse or abuse of this technology leading to many incidents of threatening,

harassing, embarrassing and humiliating behaviors and actions. Cases of so-called cyber

bullying have become proportionately sophisticated as access to the new technology has grown.

Predators can target their selected audience quite easily and with hardly any effort and at very

low cost if any. The misuse of mobile technology and social media has become a concern of

parents, social psychologists and authorities including schools, colleges and universities. The

aim and objectives of this research are to investigate the current status of the misuse of mobile

technology and social media in the UK and some other countries. The research will suggest

practical mitigations to try and help young people to move from cyber bullying to cyber coping

(Figure1). The article further aims to promote the responsibilities of safe and acceptable use of

these and to mitigate the risks of misuse whether at work, in schools or at home, and the role

social psychology needs to play to achieve the desired outcomes.

Cyber Bullying Social Psychology Cyber Coping

Figure 1 From Cyber Bullying to Cyber Coping

Threaten

Harass

Humiliate/Denigrate

Embarrass

Blackmail

Flaming/Exclusion

Educate

Self-Confidence

Attitude/Behavior

Real/Cyber Worlds

Online Protocols

Influencing/Persuasion

Being in Control

Shrug off Attacks

ICT Astute

Respect for Others

Face to Face Comms

Know who to Trust


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1.2 Literature Review

1.2.1 Misuse of Mobile Technology and Cyber Bullying

According to some recent research by Giant (2013), it is difficult for people to conceptualize

what the Internet and related technologies actually represent. It is therefore more difficult for

people to rely on their intuitions and common sense to navigate through the maze of technology.

Common sense usually develops a degree of maturity and a sense of individual responsibility.

A moral appreciation of right and wrong also falls into this category. These qualities are

generally linked to age and children/young people are not expected to hold the same degree of

maturity, responsibility and moral values as the adults around them. Experience does matter in

this context. With so many people having access to the Internet and associated mobile

technologies, it is perhaps too late to pretend that this technology does not exist. The time has

come to make explicit not just the benefits of the new technology but also the risks associated

with it. This should also include the related responsibilities to keep everyone safe and ensure

people‟s well-being in both the real and the “virtual” world. Giant suggests that the issue of

cyber bullying is only as old as the technologies used to hurt and denigrate others. The research

and study of cyber bullying is still growing but perhaps not as fast as the phenomenon itself.

Giant quotes Belsey (2004, p.1) who defines cyber bullying as a phenomenon that

“…..involves the use of information and communication technologies to support deliberate,

repeated and hostile behavior by an individual or group that is intended to harm others”. Giant

points out further that any technology can be used for both positive and negative effects but the

extremes to which mobile phones, online platforms and other forms of technology are abused

to bully others, often leaves,for example, parents, youths and teachers astounded.

Giant suggests that there are seven forms of cyber bullying:

1. Flaming: sending angry, rude, vulgar messages directed at a person or persons

privately or to an online group

2. Harassment: repeatedly sending a person offensive messages

3. Denigration: sending/posting rumors, harmful, untrue information about a person to

others

4. Cyber stalking: harassment that includes threats of harm or is highly intimidating

5. Impersonation or masquerading: to be another person and posting/sending material

online to make them look bad

6. Outing or trickery: tricking a person into sending information (secrets, embarrassing

information) that can be used to send to others online

7. Exclusion: excluding someone purposefully from an online group, for example, an IM

or BBM list

Source: Willard (2007)


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Giant (p.23) considers that “It is widely understood that face to face communication is

conducted not only through the spoken word but through tone, intonation, body language and

other non-verbal cues that alert participants to potential discrepancies, incongruencies or

dangers. Virtual communication often asks participants to make a judgment about the content

by relying solely upon the words with which they are presented. This can be particularly

difficult for children and young people with less maturity, awareness of risk and connection

with their intuition or an inner sense of right and wrong”. Different types of technology such as

text and instant messaging, E-mail and online chat rooms are often used as a method of

harassment, discrimination and bullying of others. Giant considers that some form of

harassment or cyber bullying maybe deemed to be a criminal offence as far as adults are

concerned. This consideration is particularly relevant in the context of this research as many

cyber bullying offences are committed by those who are over 18 years of age. Giant suggests

that there is a difference in opinion among researchers whether cyber bullying is a phenomenon

that is perpetrated by and affects more girls than boys. Both sexes are using the technology and

can, therefore, also experience cyber bullying, and both could be just as likely to commit it. It

appears that girls are more likely to be involved in cyber bullying.

According to Lenhart (2007) and Smith et al (2008), this is perhaps due to the increased

likelihood of girls utilizing relationally aggressive tactics which can be suitably employed

online. This includes isolation, rumor and gossip spreading and otherwise damaging and

manipulating relationships to gain power and control. Hinduja and Patchin (2009) found that

girls engaged in cyber bullying for longer than boys, and employed different tactics, including

taking pictures of victims and posting them online.

The Kaiser Foundation in the United States (2010) reports that young people 8-18 years old

spend more than seven and a half hours each day using some form of media or technology,

including TV, games consoles or a computer. This does not include the 90 minutes or so each

day that young people spend texting or talking on the phone. Except time spent sleeping or at

school, this means that young people spend every possible moment using some form of

technology. This raises the possibilities and potential for bullying, access to inappropriate

content, unsafe conduct and general health and social risks related to technological over-use.

The Pew Research Centre (2010) in the United States found that ¾ of teens now have a mobile

phone, with as many as 58% of 12-year olds owning a phone, up from just 18% of such teens as

recent as 2004. Researchers found that 93% of both teens and adults aged 12-29 years of age go

online, compared to only 74% of all adults. A study conducted by the international consumer

research specialist Intersperience (2012) declared that 65% of the approximate 32 million

Smartphone users in the United Kingdom would declare themselves to be “lost” without their

phone. An Ofcom (2011) report that specifically studied the use of technology, suggests that

81% of Smartphone users have their phones switched on all of the time, even when they are in

bed, with 40% of teens admitting to using their Smartphone after it woke them. An earlier study

conducted by Ofcom (2010) found that young people between 5-15 years of age:

1. Only 1% of 12-15 year olds in the United Kingdom do not have access to the Internet

at home


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2. Half of 5-7 year olds (49%), 2/3 of 8-11year olds (67%) and ¾ of 12-15 year olds

(77%) have a TV in their bedroom

3. 85% of parents trust their children to use the Internet safely

4. Only 34% of parents whose children are aged 12-15, are likely to be concerned about

Internet content

A study conducted by Carnegie Mellon University concluded that Internet use leads to small

but statistically significant increases in misery and loneliness and a decline in overall

psychological well-being (De Angelis, 2000). With this increasing use of the Internet and

related technologies in children as young as two years old, there is a debate among

psychologists as to the prevalence of a psychological disorder associated with online use.

Labeled by some as Internet Addiction Disorder (Goldberg, 1996), studies suggest that the

growth of addictive behavior is typical among heavy Internet users (Greenfield, 1999; Young,

1998).

“The web filtering standard set by Becta (2012, p.1) should be considered as the technical

minimum threshold for safe Internet access for children and staff in education as no other

implementable standard currently exists”. Becta sets an accreditation standard for filtering

products or services, including a need for the product or service to block 100% of illegal

material identified by the Internet Watch Foundation (CAIC) List. The software should be able

to block approximately 90% of inappropriate Internet content in categories such as violence,

race hate material, illegal drug taking and criminal skill/activity.

From June 2012, Ofsted (2012), the UK school inspection authority, will feature e-safety and

cyber bullying as part of school inspection criteria. The aim is to ensure that students not only

feel safe at school but also understand how to keep themselves and others safe.

Rogers (2010) suggests that mobile technology and access to social networks gives young

people almost unlimited access to information. This positive side is overshadowed by a darker

side. The misuse of technology to threaten, harass, humiliate and embarrass victims is defined

as “cyber bullying”. Particularly young people are affected by this approach of psychological

attacks.

Rogers considers that cyber bullying is just as unacceptable as physical bullying, leaving

emotional rather than physical scars. The emotional damage is not tangible so victims are often

left with a feeling that there is no safe place to escape to and that they cannot trust anyone

anymore. Young people need to be encouraged and made feel comfortable to talk about how

they use the Internet and their mobile phones. Victims need the language to be able to express

what has happened to them, to know that it is wrong and to be able to tell someone they can

trust. This is now of widespread concern how children and young people can stay safe in a

texting, twittering and social networking world. Rogers considers that cyber bullying is

different from ordinary bullying in a number of ways. The bullies can keep a safe distance

between themselves and their victims. They maintain anonymity. There are no feelings of guilt

or empathy. Cyber bullying can take place 24 hours a day, seven days a week. Table 1 is a

summary of the most common used cyber bullying methods. Rogers suggests that it is also


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important for parents to encourage young people to keep detailed records of any offending

material or communication, as this could be used later on in court or by some service providers

to make their sites/services safer. It is important to guide young people to deal with “real

world” issues in the “real world” and not to get side-tracked into cyber land. Young people

should accept only friends from the real world as friends on social networks such as My Space

and Twitter. Rogers suggests that parents should be particularly aware of changes in attitudes

and behaviors of young people such as being upset after using the Internet or making adverse

comments about friends or observing changes in their relationships with friends.

Fisher and Gonzalez (2013) suggest that contextual performance such as parents helping their

children, teachers helping their students and employers helping their employees, is increasing

in importance in today‟s social environments. Parents, teachers and employers not only have to

deliver their social responsibilities but should also work together as a team to create social

opportunities that foster responsible individual and group attitudes and behaviors that

strengthen the cyber coping capabilities of young people. An essential tool to achieve these

goals is the ability to influence and persuade others.

Bhat et al (2011) suggest that cyber bullying or bullying using information and

communications technology becomes more and more widespread. The Asian region accounts

for one of the highest regions in the world as far as mobile phone and Internet users are

concerned. It appears that students in particular experience cyber bullying which in turn leads

to several detrimental psychosocial effects that detract from their ability to be successful in

school. In some instances, student suicides have been linked to cyber bullying goals. The

outcome of their research suggests a number of ways of reducing cyber bullying and other

harmful uses. This includes the sharing of knowledge about media literacy elements such as the

definition of cyber bullying and behavioral examples of types of actions that constitute cyber

bullying, knowledge and understanding of the types of ICT used to cyber bully, the roles in

cyber bullying including that of active cyber bully, secondary cyber bully, observer and target,

what actions each one can take to prevent cyber bullying and the specific actions students

should take if they are cyber bullied. Some of these actions could be taking screen shots,

printing evidence, speaking to trusted adults, not retaliating as this often escalates the cyber

bullying and what the clear consequences are for those who engage in cyber bullying.

These initiatives are targeted at teachers and students as Bhat et al consider that students cannot

achieve improvements on their own. Parents are a key element of media literacy initiatives.

Parents provide and pay for computers, Internet connections, and cell phones and should

acknowledge that it is a parental responsibility to teach children how to use these powerful

forms of communication in an ethical and safe manner. Parents need to know and understand

that with children who are minors, they can be held accountable for the actions of their

children.

In contrast, Klick et al (2012) suggest, based on some research they conducted in the United

States, that mobile technology has made a significant positive contribution to people‟s lives

and they link mobile phone use to a historic drop in the crime rate and urges

policymakers to encourage individuals to carry their cell phones with them as a way to


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further deter crime. Klick et al report a novel contributing factor to help explain the

remarkable crime decline of the 1990s, when crime rates dropped by about a third

across all crime categories. Mobile phones allow for quicker reporting of crimes and

in some cases real time communication of details about the crime and the criminal.

The perceived risk of apprehension could increase among motivated offenders when

they notice potential targets are carrying a mobile phone. As technology has improved

to allow the transmission of photographic images, identification, apprehension,

prosecution and conviction all presumably become even more likely.

Jones and Mayo (2013) consider whether electronic media such as smart phones,

iPods, computers and tablets are contributing to society’s growing physical

estrangement. Jones and Mayo argue that the reverse is true. People who use social

media sites such as Facebook are also the most sociable people in real life. Social

media actually creates more opportunities for meeting up. It allows people to be more

spontaneous and creates more face to face socialization, not less. People prefer to

belong to communities irrespective of whether these are online or physical such as the

village shop or local Post Office. If people find value in social relationships, then being

a member of a social media community such as Facebook ranks much higher

provided that it reflects people’s values and beliefs appropriately.

Table 1. Summary of Common Cyber bullying Methods (Source: Rogers, 2010)

Cyber bullying Method Details

Text Messages Takes the form of messages that are threatening, offensive or persistent

Picture/Video clip via

Mobile Phone Cameras

Clear images are captured to make the victim feel threatened or embarrassed.

Random physical assaults are filmed and shared.

Mobile Phone Calls Bullies bombard victims with silent or persistent calls and abusive messages or

steal the phone and harass others, causing the victim to appear responsible for the

call

E-mails Multiple E-mail accounts make it easy to send threatening or bullying E-mails

using a pseudonym or somebody else‟s name

Chat rooms Can be a good and safe way to communicate for young provided security measures

are in place. Can easily become a forum for menacing and targeting people

Instant Messaging (IM) Once messages are posted, they are in “cyber land”. Things can get out of hand

and can include groups of people ganging up on one target

Social Networking Sites Can be misused without appropriate security settings. Easy to spread rumor and

gossip. Children often accept strangers as “friends” and give access to personal

information. It is possible to cyber target by posing as someone else. Bullies can

retain anonymity and stalk their victims

Websites Bullies can set up defamatory blogs or create personal websites featuring their

victim. They can set up online polling sites asking an unlimited number of

questions about the victim


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1.2.2 Media Reports/Studies and Court Room Cases

Media Reports/Studies:

Daniel Perry (17 years old): Sky News reports on 18 August 2013 that police are investigating

claims that a teenage boy killed himself after being targeted by online blackmailers. He is

thought to have fallen victim of to a scam where Internet users are lured into online chats and

then blackmailed. It is believed that he thought he was talking to a girl of similar age in the US

state of Illinois for several months through Skype and other websites. It appears that he killed

himself on 15 July 2013 when he was told by the blackmailers that the conversations he had

with the girl would be shared with his family and friends unless he paid up.

The Huffington Post reports on 18 August 2013 that Sergeant Jeremy Scott, a serving police

officer who posted an offensive message online following Baroness Thatcher‟s death, has

resigned. He is understood to have written on social networking website Twitter that he hoped

that Baroness Thatcher‟s death was “painful and degrading”. His resignation was accepted by

Scotland Yard with immediate effect.

His resignation comes after figures from Scotland Yard revealed that three police officers have

been sacked for misusing social media over the past five years. Allegations linked to the use of

sites including Facebook and Twitter have been recorded against 75 Metropolitan police

officers since 2009, with 38 of the claims substantiated.

BBC West reported in July 2013 that Ben Townsend, 25 years old, received a fine of £1000 by

a local court and a life time ban by Cheltenham Football Club for racially abusing two

footballers on Twitter. The offence took place in May 2013 after a football match between

Northampton Town FC and Cheltenham Town FC. Responses from other Twitter users alerted

the police who tracked him down and arrested him.

Another offender, Swansea student Liam Stacey, was jailed in 2012 for making racist remarks

about another footballer on a social media site. These examples should be tough lessons for the

users of social media that the law still applies online. On 16 June 2013 Sky News reported that

the first juror to be prosecuted for contempt of court using the Internet has been jailed after her

online activities led to a retrial in a multi-million pound drugs case. Joanne Fraill was

sentenced to 8 months prison.

Court Room Cases:

The researcher engaged in practical field research, by attending public hearings at a Swindon

Magistrates Court over a prolonged period of time (October 2012 to August 2013), capturing

extensive relevant research data to act as supportive evidence. The court cases listed below

involved incidents of theft, fraud, domestic violence, drug dealing and grievous bodily harm

(GBH). The statistical analysis of the research sample suggests that more than 70% of court

cases involve the misuse of mobile phones or social media networks. Of the actual cases where

the misuse of mobile or social media technology was evident, approximately 55% of cases

ended up in domestic violence or physical assaults. 45% of cases resulted in drug

dealings/abuse and mental/physical threats (Table 2).


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Table 2. Statistical Analysis of Observed Court Cases/Trials October 2012 to August 2013

Type of Case/Trial Number of Cases/Trials Percentage of Total Number

Irrelevant:

Traffic Violations 15 10

Theft 15 10

Fraud 10 7

Total: Relevant: 40 27%

Domestic Violence 30 20

GBH 30 20

Drug Abuse/Dealing 20 13

Threats 30 20

Total: 110 73%

1. Young man aged 24 years of age splits up with his girl friend. She continues to hassle

him by sending text messages to his mobile. He cannot cope and decides to sleep in

his car in a public car park. Consumed food and alcohol in the car and turned on the

engine during the night to keep warm. A routine police patrol leads to his arrest for

being drunk in charge of a motor vehicle. He loses his driving license for 12 months.

2. A young couple splits up. He meets her sometime later and takes her mobile phone to

check text messages and detailed call records as he suspects that this all happened

because of her new boy friend. He then sends threatening messages/makes threatening

calls to her new boy friend. He was issued with a community order for 80 hours of

community work.

3. A well-known drug dealer uses the Blackberry Messaging (BBM) facility on his

mobile phone to discuss with his friends the details of a new drug delivery. He gets

arrested during a routine check of his car (some drugs found) and the Police

confiscate and analyze call and text details from his mobile phone which includes

details of his „conference calls‟ with his friends. The case in currently pending and

will almost certainly lead to a custodial sentence for this drug dealer.

4. Young man relaxes at home and has some alcoholic drinks. Receives compromising

text messages from his girl friend who thinks he is cheating on her. He wants to sort

this out immediately and drives his car to see her but is stopped by Police for erratic

driving and is convicted of drunk driving. He loses his license for 12 months.

5. Young man receives threatening text messages on his mobile. Replies go backwards

and forwards, ultimately leading to a visit to the other person‟s home where the young

man commits aggravated bodily harm. He is found guilty and a suspended custodial

sentence is awarded plus 60 hours of unpaid community work.


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1.3 Knowledge Gap

The literature review from this current research has confirmed that there is a need to develop

and train young people much more and using a different approach in the safe and appropriate

use of mobile technology, such as texting and picture/video sending, and associated social

media sites such as Facebook and Twitter. Established subject matter experts suggest that

increasing awareness levels and providing guidelines for young people in how to use mobile

technology and media sites are adequate activities to help young people stay safe in today‟s

texting, twittering and social networking world. Reality appears to differ. Recent incidents

(Section 1.2) suggest that the existing training and guidance that is provided to young people is

not working effectively and that perhaps a different approach needs to be developed and

implemented that closes this gap.

Young people who are emotionally disturbed and affected by, for example, adverse comments

made about their appearance on a social media site, are unlikely to make good use of any social

media site‟s help and support tool or ask parents or trusted friends for help and advice. They

appear not to be in control of themselves anymore and this leads to irrational and uncontrolled

responses to these cyber bullying attacks. The practical insights from solicitors and district

judges from face to face meetings together with the suggested views of the researcher will help

to close the knowledge gap.

1.4 Main Research Questions/Hypotheses

The main research questions for this research are:

1. How widespread is cyber bullying really? Are the effects as serious as is reported by the

media?

2. What practical and workable solutions can be developed to improve and increase the e-safety

of young people?

3. Does a potential shortcoming exist between the existing e-safety training and guidance that

is provided by education authorities, parents and employers?

4. How can the contributions to knowledge from this research be practically applied to help

young and mature people to cope better with incidents of cyber bullying or mobile technology

abuse?

The following hypotheses were constructed:

H1: The increased use of mobile phones and its technology leads to higher/lower levels of

criminal activities. There is a proportionate relationship between the use of mobile technology

and social media and an increase in domestic violence/aggravated bodily harm (GBH)

H2: Mobile phone operators and providers of social media sites are discharging their social

responsibilities of educating young people more in the safe use of the technologies and

associated applications

H3: People are using mobile technology and social media as a substitute for face to face


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communications. This affects the ability to socialize and develop interpersonal relationships

adversely

H4: Parents, teachers and employers are failing in their duty of care to take ownership of

providing young people with practical advice that is fit for purpose for the intended audience.

Incentive schemes could improve this situation


2.1 Method

The researcher considered that a qualitative research approach was most appropriate for this

research and therefore applied a constructivist interpretivist research approach within a

phenomenological research paradigm. He considered that this was most appropriate and

defendable in order to make a valid and reliable contribution to knowledge. In addition, some

quantitative research approach was used to capture relevant statistical information from the

court cases and to strengthen the resulting conclusions drawn from this evidence. The outcome

of this research is applicable to both academics and practitioners. The aim and purpose of this

research is to suggest new practical approaches to combat cyber bullying and misuse of mobile

technology amongst primarily young people and how these should be applied to make them

work effectively. As such, it is important that, for example, parents and teachers experience the

new approaches themselves to confirm that these are valid and reliable. The researcher

suggests that an increase in the use and abuse of mobile technology and associated social media

sites (Section 1.1) has necessitated the need for this research and to propose more effective

solutions to develop e-safety in young people. Two solicitors from a local law firm in Swindon

and twelve district judges and other solicitors from the Swindon Magistrates Court were

interviewed by the researcher during face to face and ad hoc interviews. The interviews were

conducted between October 2012 and August 2013 and recorded verbatim to ensure that all

responses were captured correctly, including meaning as intended. Interviews were

semi-structured. Participants‟ ages ranged from 35 years to 55 years and they had between ten

and thirty years of practical work experience. The participants were asked what their

experiences were with cyber bullying and misuse of mobile technology in court cases and to

provide appropriate details to support their statements subject to data protection limitations.

The researcher then focused his attention on capturing what the participants considered to be

the main applications of cyber bullying and misuse of mobile technology and what the

participants considered to be practical approaches to mitigate or eliminate the effects of these

phenomena on young people.

2.2 Data Collection, Interpretation and Triangulation

The researcher considered three methods to collect relevant research data to answer the main

research questions and hypotheses from Section 1.4: a review of the literature, relevant media

reports/studies, court room cases (Section 1.2) and face to face interviews (Section 3.1), within

the context of a phenomenological research paradigm and an associated constructivist

interpretivist research approach. The researcher, in his role as participant observer, added his

contributions of what he considers are practical and effective means to reduce or eliminate the


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effects cyber bullying attacks have on young people in order to obtain different perceptions of

the phenomena under investigation. Data was collected over different time frames and from

different sources.

The researcher applied triangulation as a means to use a combination of different methods in

order to reduce reliance on a single method.

3. Results

3.1 Face to Face Interviews

Two local solicitors from a local law firm were interviewed by the researcher to collect further

evidence and to capture the insights of the solicitors based on their practical experiences as law

practitioners. In addition, twelve ad hoc and planned interviews took place before and after

actual court hearings with district judges and other solicitors at Swindon Magistrates Court.

These short interviews typically lasted 30 minutes. The purpose of these interviews was to

gather additional relevant and reliable information from law practitioners. The research

materials used were a semi-structured questionnaire with open-ended questions for the face to

face interviews. Further open-ended questions were used during these semi-structured

meetings to elicit further data from the participants, for use in the triangulation of the collected

data. The participants in the research were given details of the purpose of the research. The

researcher asked all participants to give open and honest answers that were based on, for

example, what the participants had actually done and how they had done it. Where participants

strayed from this path, the researcher quickly pulled interviewees back onto the right track. The

planned interview lasted around three hours. All interviews took place in appropriate meeting

room surroundings to put the participants at ease and to create a relaxed atmosphere that aided

a genuine participation. The law practice solicitors (Rob and Chris) considered that mobile

technology is increasingly being misused by drug dealers to target their existing and potential

new audiences via applications such as texting, Blackberry Messaging (BBM) and social

media such as Twitter and Facebook. The number of court cases where defendants are

convicted of crimes due to the misuse of mobile technology and social media is on the increase.

People‟s phone numbers, their names and other personal details such as home address are often

quoted in these types of communications which are then easy to obtain by the Police and the

Courts. Police now have access to much improved technology that allows for faster and more

accurate retrieval of appropriate data that can then be used in the Court Room, for example, to

convict the guilty party or parties very effectively. Forensic Telecommunications Services

(FTS) in the UK can retrieve data and images from any mobile device up to 12 months since the

data and images have been deleted and provide the Police with detailed accounts which are

admissible as evidence in court. Rob and Chris reported that iphones are increasingly used to

show inappropriate material to very young children. Predators encourage young girls on Skype

to commit to do inappropriate sexual activities. The number of offenders in this respect is on

the increase and Rob and Chris have recently been engaged in a larger number of cases than,

for example, compared to 5 years ago. It is suggested that most young people between the ages

of 14 and 24 live their lives through the use of mobile technology and social media. Mobile

technology and social media have been seen to be the catalyst of new crimes. Rob and Chris


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suggest that young people need to be educated much earlier (Age 8 onwards) in the appropriate

use of mobile technology and social media.

The interviewed district judges and other solicitors suggest that there has been a substantial

increase in court cases in the United Kingdom where incidents of aggravated and grievous

bodily harm are directly attributable to the incorrect/misuse of mobile technology or social

media sites.

This includes text messaging, phone calls and sites such as Facebook and Twitter. The police

are providing increasing levels of evidence such as details of SMSs and MMSs. They consider

that this situation is becoming epidemic, judging by the number of cases involved. They

suggest that this could be as high as 2/3 of all court cases. As technology improves further, new

opportunities will open up for criminals and cyber bullies to look for new ways of making this

work for their intended purposes. Cyberspace and Satellite services will enhance the

availability of what has been communicated and when, by whom and how. This issue is live

and it is necessary to take proactive action to provide much stronger and relevant help and

support to young people (Table 3). They suggest that young people aged 8 years of age and

over need to be educated in a number of ways such as age dependant training films, posters in

schools, colleges and Universities and regular class room sessions with practical exercises that

address both the bullied and the bully so that young people can see both perspectives. They

consider that mobile phone operators and owners of social media sites also need to take more

proactive social responsibilities by developing positive attitudes and solutions to reduce cyber

bullying and mobile phone misuse substantially.

Table 3. How to Improve E-Safety-Application and Ranking of the Considered Solutions

Skills Application Ranking

Building

Self-Confidence

and becoming

“Cyber Coping”

Developing an ability to say “No” and ignoring acts

of cyber bullying will develop higher levels of

self-confidence in emotionally unstable youngsters

There is a relationship between the attitude people

hold towards what others stand for and how they

respect them. People must not be used as a means to

an end. All communications must be genuine and

authentic. Showing empathy and sincerity are the

building blocks of authentic interpersonal

relationships

Young people need to learn not to copy others who do

engage in undesirable activities such as cyber

bullying by following their own values and beliefs of

what is right and wrong and what is acceptable and

unacceptable behavior towards others

Considered important by the

literature review and face to face

interviews

Considered by all parties to be

highly important. Young people

who develop the right attitude

will be less likely to engage in

cyber bullying and mobile

misuse activities *


literature review and the face to

face interviews. Young people

should not follow the “herd

instinct” but decide for

themselves by considering, for


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Young people need to acquire more in depth

knowledge of the concepts of influencing and

persuading as these are the skills of effective cyber

bullies. Appearing to be trustworthy, self-confident

and secure are the traits of effective

influencers/persuaders who then misuse these skills

to their advantage by cyber bullying others

successfully.

Developing a better understanding of the impacts the

misuse of mobile technology and social media sites

have on society will help young people to see the

much wider picture of the negative effects these

concepts have on business in general and the

economy

example, the consequences of

their actions and the effects these

could have on others

Identified by all parties to be

highly important *


literature review and face to face

interviews

*Literature review, face to face interviews and media reports/studies

4. Discussion

The evidence from the literature review, face to face meetings with law professionals, media

reports and actual court room cases suggests that there is a link between the increasing use of

mobile technology and social media websites and increased levels of associated crimes. This is

not limited to committing crimes that affect the other person(s). Recent suicide cases such as

Hannah Smith (2013, aged 14) and Daniel Perry (2013, aged 17) suggest that young people are

not sufficiently informed and trained how to deal and cope with the social pressures they are

placed under by cyber bullies such as threatening behaviors and malicious rumors. They may

not be aware of and appreciate the consequences the various forms of cyber bullying can have

on the lives of other people, irrespective of the victim‟s age. Older people can be emotionally

unstable or uninformed and fall victim to cyber bullying, too. There is no panacea for all-round

success to stop cyber bullying and the misuse of mobile technology and social media sites but it

is important to take more proactive actions to alleviate the problem as much as is practically

and realistically possible. Actions speak louder than words and it is the responsibility of parents,

teachers, employers and mobile services operators/owners of social media sites to increase the

e-safety of young people. E-safety needs to start at home. Parents need to spend more quality

time with their children to explain the various forms of cyber bullying in detail. They should

then use real life examples to show their children what it feels like to be cyber bullied by

another person and what the consequences are. Young people need to experience what it “feels

like” to be cyber bullied.


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Parents need to encourage their children (aged 8 and above) to report and talk about cases of

cyber bullying and incentivize them to do so willingly. They need to change their children‟s

attitude to feel good about the reporting of incidents and reward this behavior with gifts

appropriate to the age of the young person. Young people should adopt that asking for help is

considered to be a strength and not a weakness. This whole approach could achieve desired

repeat behaviors and have a knock-on effect on other parents and their children. Teachers need

to work closely with parents to ensure that there is a consistent and co-operative approach

between them (one version of the truth) and that young people are getting the message that

cyber bullying is unacceptable. Teachers could set up focus groups that address cyber bullying

and the misuse of mobile technology and then share the work of these groups during school

assembly, on specifically designed posters that appeal to young people and by sending out

regular “Cyber Coping” bulletins. Mobile phone operators and owners of social media sites

need to provide more practical advice to users such as what forms of misuse exist, what the

effects are on the victims and what the legal implications are for those who cyber bully others.

Cyber bullying can affect how people perform at work and directly affect a company‟s

reputation which in turn can lead to loss of business, customers and profit. Employers should

make it clear to employees that cyber bullying is not an acceptable behavior and that proven

cases will lead to dismissal and/or prosecution. Help should be offered to employees who are

victims of cyber bullying through professional coaching services. Human Resources (HR)

need to ensure that this is reflected in company HR policies. The four hypotheses of this

research are supported by strength of evidence from the literature review, face to face

interviews, media reports/studies and court room cases (see Table 4 for a summary of the

results), namely:

H1: The increased use of mobile phones and its technology leads to higher/lower levels of

criminal activities. There is a proportionate relationship between the use of mobile technology

and social media and an increase in domestic violence/aggravated bodily harm (GBH). This

premise holds true. Although some evidence suggests that the wider availability of mobile

phones has made some contribution towards reducing potential crimes, mobile phone misuse

and social media abuse crime rates in the United Kingdom have increased in recent years. This

includes cases of domestic violence and GBH

H2: Mobile phone operators and providers of social media sites are discharging their social

responsibilities of educating young people more in the safe use of the technologies and

associated applications. This hypothesis is valid. There is sufficient evidence from the

outcomes of this research that suggests that mobile phone operators and owners of social media

sites are not committed to engage in devising and implementing e-safety improvement

programs for young people

H3: People are using mobile technology and social media as a substitute for face to face

communications. This affects the ability to socialize and develop interpersonal relationships

adversely. This is a valid hypothesis. Young people are spending more of their time on the

phone and using social media sites to communicate with each other.

It appears that face to face communications are no longer the preferred method of


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communicating with each other

H4: Parents, teachers and employers are failing in their duty of care to take ownership of

providing young people with practical advice that is fit for purpose for the intended audience.

Incentive schemes could improve this situation. This premise holds true.

These groups are not sufficiently engaged in proving young people with appropriate practical

advice and support to cope with incidents of cyber bullying and mobile technology better and

more effectively. Awards and incentivized schemes to achieve good repeat behaviors would

make a major contribution to improve the identified shortfall

Table 4. Hypotheses and Research Questions: Summary of Results

Hypothesis Related Research Question(s) Results

H1: The increased use of mobile

phones and its technology leads to

higher/lower levels of criminal

activities. There is a proportionate

relationship between the use of

mobile technology and social

media and an increase in domestic

violence/aggravated bodily harm

(GBH)

1. How widespread is cyber

bullying really? Are the effects as

serious as is reported by the

media?

2. What practical and workable

solutions can be developed to

improve and increase the e-safety

of young people?

The evaluation of the literature was

positive but not conclusive to

determine what needs to be done

practically. The face to face

interviews and media reports

concluded that parents, teachers and

employers need to focus their efforts

more on those identified as being

vulnerable whilst at the same time

provide in depth coaching for the

wider community

H2: Mobile phone operators and

providers of social media sites are

discharging their social

responsibilities of educating

young people more in the safe use

of the technologies and associated

applications

3. Does a potential short coming

exist between the existing

e-safety training and guidance

that is provided by education

authorities, parents and

employers?

4. How can the contributions to

knowledge from this research be

practically applied to help young

and mature people to cope better

with incidents of cyber bullying

or mobile technology abuse?

The literature was not positively

conclusive and did not provide

sufficient valid and reliable evidence

that suggests that this is the case.

Inputs from the face to face

interviews and court cases suggest

that the providers of such services

are not seen to be engaging in

activities that lead to a reduction in

cyber bullying and mobile phone

misuse

H3: People are using mobile

technology and social media as a

substitute for face to face

communications. This affects the

ability to socialize and develop

interpersonal relationships

adversely




of young people?

4. How can the contributions to

knowledge from this research be

practically applied to help young

The literature is positively

conclusive that young people in

particular are not communicating

directly with each other anymore.

This has been supported by evidence

from the court room cases and

reports/studies by the media.


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and mature people to cope better

with incidents of cyber bullying

or mobile technology abuse?

H4: Parents, teachers and

employers are failing in their duty

of care to take ownership of

providing young people with

practical advice that is fit for

purpose for the intended audience.

Incentive schemes could improve

this situation




of young people?

3. Does a potential shortcoming

exist between the existing

e-safety training and guidance

that is provided by education

authorities, parents and

employers?

The evaluation of the literature was

positive but not conclusive. The face

to face interviews and inputs from

the media studies/reports and court

room cases suggest that these groups

do not focus their attention and are

not sufficiently engaged and

committed to reduce or eliminate

cyber bullying and mobile phone

abuse amongst people of all ages

(but particularly the young and

inexperienced)

5. Conclusions

The technological revolution has changed people‟s lives forever and irreversibly. With the

considered right to have access to and being able to use this technology when and where people

want, come social responsibilities. Digital communication has grown much faster than people

of all ages have been able to catch up with. Technology is increasingly misused to threaten,

harass and embarrass victims and methods known as cyber bullying have become more

sophisticated and widespread. By working in partnership and driving each other to succeed,

parents, teachers, employers and mobile phone operators/owners of social media sites can

reduce and alleviate risks of misuse, promote responsibilities and foster positive attitudes and

behaviors in younger and more mature people. Young people have a very short attention span

so it will be important to concentrate efforts where the greatest achievements can be realized in

the shortest period of time. It is encouraging that the Office for Standards and Education and

Children‟s Services and Skills (Ofsted) in the United Kingdom has included e-safety and cyber

bullying as part of school inspection criteria since June 2012. No empirical data is available yet

that could provide evidence of how successful this initiative has been at the end of its first year.

Combating the misuse of mobile technology and social media sites is a long journey and many

steps need to be taken to complete it. The research was limited to a relatively small number of

district judges and solicitors from the Magistrates Court in Swindon. Insights and subject

matter knowledge from a larger sample of law professionals would have provided richer and

diverse research data to address the research scope in more depth and universally. Further

research should be conducted to assess and confirm the actual cost to the economy of the

effects of cyber bullying such as loss of income to employers, employing more counselors in

educational establishments and the need for additional law professionals. It is confirmed that

the research scope from Section 1.4 has been answered and that all four hypotheses hold true

and are valid in the context of this research.


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New Evidence from Assessing the Tobin Tax Effects on

Exchange Stability and Trade

Dr. Said Jaouadi

Dept. of Finance and Banking, Jazan University

PO Box 114, Jazan, KSA

Tel: 966-7321-4436 E-mail: [email protected]

Received: June 28, 2013 Accepted: July 17, 2013


Abstract

The paper attempted to find out the economic effects of setting up a tax on currency

transactions. Professor James Tobin was the first to propose the particular taxation to reduce

the exchange volatility. Many authors interested by the Tobin tax topic, raised many statements

against implementing such tax, they argued that it should tend to raise the fluctuations of

exchanges rates, and in return, finish by harming the international trade.

In the empirical investigation of the paper, we carried out an econometric modeling focused on

data about exchange rate volatility, international trade. To explore the effects of the Tobin tax

on exchange volatility and international trade, we calculated the currency transactions costs

according to a new methodology, covering the period 1990 – 2011, and finding out the effects

of the taxation on the exchange market of these countries: United Kingdom, Japan and

Germany.

The empirical investigation underlines two major findings, which allow us to reinforce

establishing the tax on currency transactions, proposed by Professor James Tobin. The model

puts emphasis on the decreasing effect of the Tobin tax on exchange volatility, it enabled us to

infer that the currency taxation is contributing to improve the exchange rates stability.

According to the estimation findings, the currency tax has positive impact on foreign trade, this

evidence authorized us to denote that the Tobin tax tends to promote international trade

transactions.

Keywords: Tobin tax, Speculation, Trade volume, Volatility, Transactions costs, Foreign

currency tax, Exchange market, Foreign exchange.


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1. Introduction

In 1972, Professor James Tobin suggested in conference at Princeton to set up a tax equal to 1%

on every currency transaction. For the author, applying tax on exchange market will have the

same impact of throwing sand in the wheels of international finance, to reduce the speculation

and in return the exchange market volatility.

In recent years, the Tobin tax topics were widely broached as critical question in international

debates, imposing a tax on currency transactions should generate several benefits. The

proposal of James Tobin was primarily targeting to reinforce the exchange markets stability.

Although, during the last few years, many NGO contributed to diffuse the Tobin tax principle

in the media and hereby, they facilitated the advertisement for the topic and created widespread

for the tax proposal in international meetings. The prime interesting output of the Tobin tax

project relies on the huge revenues generated from the taxation, which should help poor

countries in eradicating poverty, according to theses NGO.

The Tobin tax becomes the prime issue of the bulk of debates in economic reviews and

academic journals, because of its positive economic effects cited above. The focus of the

international comunityon the Tobin tax issue made the Tobin proposal a pivotal question to

fight poverty in developing countries, like promoted by several NGO.

2. Literature review

In economic theory, carrying out a tax on currency transactions seems a difficult task without

agreement of the bulk of the developed countries. Therefore, many authors elaborated other

variants of the Tobin tax. The preliminary assessment of their theoretical development were

encouraging to establish such tax.

2.1 The new Variants of Tobin Tax

In fact, to apply a tax on currency transactions, we pointed out several difficulties that thwart

implementation such taxation. Many authors contributed to develop flexible forms of the Tobin

tax and to find solutions to some obstacles that could make the overwhelming Tobin tax project

impossible to set up.

2.1.1 The Variant of Spahn

According to Spahn (1995), carrying out a tax on currency transactions could face several

problems to come through, the author argued that: “analysis has shown that the Tobin tax as

originally proposed is not viable and should be laid aside for good.”

For Spahn, the major obstacle thwarting the Tobin tax project, remains in the distinction

between normal liquidity and speculative trading in exchange market, the author stresses1: “It

is virtually impossible to distinguish between normal liquidity trading and speculative noise

trading.” In the sum, the author puts emphasis on carrying out a tax on currency transactions

could be harmful with high rate and ineffective with low rate.

1Spahn, P. B. 1995. “International financial flows and transactions taxes: Survey and options.” IMF working paper

WP/95/60.


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To avoid this problem, Spahn proposed to impose a tax on currency transactions with double

items: low fix rate for normal currency transactions, and high variable rate solely applied in

period of speculative noise trading.

2.1.2 The proposal of Eichengreen et al

According to Eichengreen et al2, exchange volatility is the direct result of speculative

transactions in currency market, the authors attributed crucial role for banks to reduce the

speculative trading volume. They suggested that banks should make special deposits without

interest returns on the monetary authorities, the amount of deposit will depend on the volume

of exchange transactions of short run.

With the new financial rule advanced by Eichengreen et al, it should virtually eliminate the

speculative transactions on the currency market.

2.1.3 The variant of Schmidt

According to Schmidt, the Tobin taxation is a partial solution to avoid international financial

crises, through limiting speculative transactions on currency markets.

The author argued that currency markets are decentralized, unregulated and moving, so any

country attempting to apply the Tobin tax, will push the transactions of its currency to be made

on offshore markets.

To thwart this weakness, the author suggested the importance of establishing the taxation on

major developed countries, to avoid concurrence among countries and the tax revenues should

be retrieved on the place of the currency transaction.

2.2 The Tobin Tax and its Effect on Currency Volatility

In economic literature, there are many theoretical essays founded to explore the relationship

between taxing the currency transactions and the exchange volatility.

Introducing these theoretical developments remains quite important to illustrate the importance

of this taxation in the international finance, we can sum up the effects of implementing the

Tobin tax into two major statements:

2.2.1 Stabilizing the Speculators Expectations

It seems crucial to describe the stabilizer effect provided by implementing the Tobin tax,

because, it should eliminate the opportunities to generate profits from speculative trading,

through the deviations registered in the exchange rates market.

The stabilizer effect becomes more effective when the tax value is high, so we can argue that

affecting the speculators expectations has major role to alter the decisions of noise trading on

the currency market.

Reducing the speculator activities on currency markets should decrease the possibility of

2Eichengreen B., Wyplosz C. and Tobin J. 1993. “Two cases of sand in the wheels of international finance”, Economic

journal, volume 13.


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currency crisis creation, and avoid the crisis contagion effects among countries. The

speculators plaid guilty in many papers for the advent of several crises. According to Taketa

(2003): “it is quite important to investigate how such speculators can affect the market during

contagious currency crisis.”

2.2.2 The Negative Impact on the Currency Market Liquidity:

Fixing the amount of the tax on currency transactions should reduce the liquidity in the

currency market and in return, it could harm the market efficiency. The lack of liquidity due to

the Tobin taxation could arise preliminary fluctuations, and finish by increasing the currency

volatility.

In several surveys, some authors stressed that there is no link between liquidity of currency

market and the stability of exchange rates. Because of the simple reason that the rise of

liquidity in the currency market in recent years, did not reduced the number of financial crises.

According to (Bernardos, 2009)3: “the creation of the first real estate bubble was mainly driven

by great liquidity at global scale between 2001 and 2005.”

2.2.3 Assumptions

Setting up a tax on currency transactions should arise directly the currency transactions costs.

So, finding out the effect of these costs on exchange volatility and international trade, allows us

to examine the effect of Tobin tax on volatility and foreign trade.

3. Empirical Evidence

3.1 The Aliber Model

The examination of the effects of the Tobin taxation on currency market was primarily

concerned through many papers and surveys, many authors attempted to explore the real

impact of the taxation on exchange volatility and international trade.

3.1.1 The Model Presentation

In 2001, Aliber et al4 carried out an empirical model to analyze the effect of a tax on currency

transactions on the exchange volatility and the international trade. The authors put forward

their model according to the following introduction:

(1)

(2)

Where and are error terms. Volatility represents the difference of exchange rate between

two years.

3Bernardos G. 2009. “The rise and fall of the first global real estate bubble”, paradigmes issue n°2, June 2009, p99 – p106. 4Aliber R. Z., Bhagwan C. and Yan S. 2001. “Some evidence that a Tobin tax on foreign exchange transactions may increase

volatility”, European Finance Review, 7, pp. 481-510, 2003.


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The variable “Cost” makes up the cost of currency transactions in the exchange market, the

examination of its impact, thoroughly points up the effect of Tobin tax, due to the relevant

positive relationship between the taxation and the transactions costs.

For the variable “Trade”, it makes up the volume of transactions of futures, the variable

indicates the number of long term transactions in the currency market, and in return, it reflects

the volume of transactions of international trade. The sample of the empirical investigation

conducted by Aliber et al (2001) includes 4 developing countries: USA, Japan, Germany and

UK.

3.1.2 The Methodology

In economic literature, we assume that costs depend on the difference between the two terms of

equilibrium in the market. Therefore, there is margin between supply and demand, which

makes up the transaction costs of the market.

For Aliber et al, the currency market is considered in equilibrium if we reach the equality of the

terms of the arbitration operation, following the presentation below:

(3)

Where: i and i* are the domestic and the international interest rate.

F is the exchange rate future and S is the exchange rate spot.

Making the logarithm of (3), it provides

(4)

Making the difference between two periods T1 and T2, it gives

(5)

We can sum up the relation in

(6)

We finish by finding

(7)

For the authors, the difference between the two terms of the equation, represents the cost of

currency transactions on the market.

Therefore, the authors make the covariance of the difference between the two terms of the

equality (7), using the following formula:


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(8)

3.2 The New Approach

In this paper, we used another approach to calculate the costs of currency transactions. We

considered another equilibrium condition, particularly distinct than the relationship adopted by

Aliber et al (2001) focused on the arbitration operation, between the future rate and spot rate.

3.2.1 The Methodology

In the current paper, we conducted our empirical investigation focusing on the equality of

Fisher. The latter resumed the equilibrium relationship between the real interest rates between

the country and international interest rate. According to Fisher, countries using their production

factors intensively, have the same development, in return we should finish by getting equality

of their real interest rates.

The Fisher equality of real interest rates among countries is made up as following

iD = i* (9)

Where iD the domestic real interest rate and i* the international real interest rate. The nominal

returns of interest rates are roughly equal to the real interest rate minus the price level, which

give

ID - PD = I* - P* (10)

Where: PD the domestic price index, P* the international price index, ID the domestic nominal

interest rate, and I* the international nominal interest rate.

We Finished by founding:

ID - I* = PD - P* (11)

We can sum up the Fisher relationship, as compensating the variation of nominal interest rate

by variation in the price index.

From equation (11), we can calculate the costs of currency transactions from the value of the

difference between the two terms of this equality, as done by Aliber et al (2001).

(12)

From the equation 12, we can determine the cost of currency transactions by calculating the

covariance:

(13)


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3.2.2 The Data

In the current paper, we used data about the exchange rate to calculate volatility, and the real

and nominal interest rates and the exports and imports as shares of GDP, as variable reflecting

the international trade. We collected the data from the database of the World Bank, World

Development Indicators 2013. The sample of the elaborated survey is covering the period 1990

– 2011. We estimated our model using the method of ordinal least squares (OLS), for panel of

three developed countries: Japan, Germany and Great Britain.

3.3 Comparing the Results of the Two Approaches

The model estimation authorized us to explore the effect of Tobin tax on volatility and

international trade. We put forward the results in table 1 and table 2, to compare between the

two approaches of costs calculations.

Table 1. The effect of the Tobin tax on the exchange rates volatility.

The results of Aliber et al The results of the new approach

countries Great Britain Germany Japan Great Britain Germany Japan

Constant -- -- -- -0.004

(-0.54)

0.5

(2.63)

-9.03

(-0.84)

Transactions costs 12.1**

(2.24)

2.76

(0.53)

16.8***

(3.25)

0.09**

(2.5)

-0.36**

(-2.53)

6.77

(0.68)

Exchange volatility t-1 0.55***

(10.94)

0.46***

(8.4)

0.36***

(6.24)

0.2

(1)

-0.14

(-0.65)

0.23

(0.87)

R2 31% 21.3% 18.5% 30.4% 27.4% 12.8%

For the results of the effect of setting up Tobin tax on the international trade, they are

summarized in the Table 2.

Table 2. The effect of the Tobin tax on international trade.

The results of Aliber et al The result of the new approach

countries United Kingdom Germany Japan United Kingdom Germany Japan

Constant -- -- -- -0.14

(-0.1)

39.5**

(2.53)

-3.97

(-1.39)

Transactions costs -1.27***

(-3.56)

-1.86*

(-1.82)

-2.44***

(-3.66)

1.3

(0.97)

-27.4**

(-2.41)

4.83*

(1.79)

Exchange volatility 0.11***

(3.55)

0.49***

(4.54)

0.371***

(5.19)

17.3

(1.17)

-12.2

(-0.79)

0.06

(0.93)

International trade t-1 0.78***

(23.31)

0.85***

(30.01)

0.78***

(22.46)

-0.25

(-1.13)

-0.27

(-1.09)

-0.29

(-1.25)

R2 73.3% 80.8% 72.2% 18.2% 28.1% 24.8%


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According to Aliber et al, it seems that establishing a tax on currency transactions tends to raise

the exchange volatility and to reduce the international trade for countries applying this tax.

These effects remain statistically significant at 5% at the most cases for the sample of the

estimation. Therefore, the authors argued that applying the Tobin tax on currency markets has

destabilizing effect by rising the exchange volatility for countries, and finish by harming the

international trade value.

In table 1, all the R2 of the models are weak, including the results of Aliber et al, therefore, the

models elaborated did not explain the reality because of the sensitivity of the volatility concept.

For which many econometric models and methods are developed, we can cite the examples of:

ARCH, GARCH, EGARCH, FIGARCH…

Although, according to the new approach adopted to calculate the currency costs, we found that

establishing tax on currency transactions tends to reduce the exchange rates volatility. So

imposing the Tobin tax could potentially stabilize the fluctuations of the exchange rates in the

market. The statement is consolidated by (Erturk, 2013)5, the author emphasizes: “the core

issue remains the contention that a small transactions tax would stabilize international currency

markets by reducing volatility.”

According to the tables, with the new approach of cost calculation, we found that for Germany,

the cost transactions tend to reduce the volatility of the exchange rate. This result allows us to

infer that establishing the Tobin tax could contribute to reduce the fluctuations of the exchange

rate, according to (Palley, 2003)6: “the tax would reduce volatility, in turn reducing the

volatility risk…”

For Japan, it seems that setting up a tax on currency transactions tends to raise the international

trade. We could explain the result by focusing on the effect of the Tobin tax on the expectations

of speculators, the tax contribute to reduce the opportunities to generate profits from

fluctuations of the exchange rate among countries. The benefic effect of Tobin tax when

targeting the international trade depends on the level of the tax compared to the costs supported

by traders. (Dodd, 2003)7 highlights: “the Tobin tax is small relative to the lower cost

advantages of trading in the US over countries and this small tax would not there overwhelm

these cost advantages.”

4. Conclusion

This paper finished by providing new evidences in favor of fixing the Tobin tax in the financial

world economy. Through the empirical investigation, the survey call into question the

evidences found by many authors about the rise of volatility of exchange rates related to

applying tax on currency transactions and about harming the international trade.

The Tobin tax remains promoting project and its harmful effects identified in the paper of

Aliber et al, remain limited after altering the methodology of currency costs calculations,

5Erturk K. A. 2013. “On the Tobin tax”, Department of economics, University of Utah. 6Palley T. I. 2003. « the economic case of the Tobin tax », debating the Tobin tax, new rules for Global finance, Washington

DC. 7Dodd R. 2003. « Lessons for Tobin tax advocates: the politics of policy and the economics market micro-structure »,

Derivatives study center.


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which represent the major empirical effort exerted in this paper.

The current paper attempted to sum up the effects of posing a Tobin tax in economic literature

and provided new findings. The last should consolidate adopting such tax, because it could

reduce volatility of exchange and improve the transactions of international trade. Primarily,

many countries like Chili and Malaysia begun establishing variant to this tax in their exchange

market and they reached significant economic effects, in favor of reinforcing the financial

market stability and the international trade.

The results provided by this paper lead to infer that the Tobin tax could be an effective tool to

reduce the exchange rates volatility and to promote the international trade. Given the threats of

exchange instability, it seems reasonable to reinforce taxation on currency transactions, to

promote exchange operations of international trade and to avoid the consequences of financial

crises.

Eventually, the current paper is contributing to rehabilitate the Tobin tax proposal and to

reinforce the hope to establish it. Recently, many NGO are encouraging the currency taxation.

The economic effects of the tax argued by Professor James Tobin are not the major motivation

of many international organizations. But, the huge volume of tax revenues has seduced many

authors and NGO, it could serve to eradicate poverty in developing countries.

References

Aliber R. Z., Bhagwan C. and Yan S. (2001). Some evidence that a Tobin tax on foreign

exchange transactions may increase volatility, European Finance Review, 7, 481-510, 2003.

Bernardos G. (2009). The rise and fall of the first global real estate bubble, paradigmes issue

n°2, June 2009, 99-106.

Eichengreen B., Wyplosz C., & Tobin J. (1993). Two cases of sand in the wheels of

international finance, Economic journal, volume 13.

Erturk K. A. (2013). On the Tobin tax, Department of economics, University of Utah.

Frenkel J. (1977). Transactions costs and interest arbitrage: tranquil versus turbulent periods,

journal of political economy, vol 85.

Palley T. I. (2003). The economic case of the Tobin tax », debating the Tobin tax, new rules for

Global finance, Washington DC.

Riggs A. R., & Velk T. (1999). The Tobin tax: a bad idea whose time has passed, Policy

options.

Rodney S. (1999). A feasible foreign exchange transactions tax, Research Associate The North

South Institute.

Rodney S. (2000). Is the Tobin tax practicable?, international development research center

government of Canada, June 2000.

Shi K. (2008). Entry cost, Tobin tax, and noise trading in the foreign exchange market, Hong


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Kong University of science and technology, Simon Fraser University.

Singh J., & Yadav P. (2011). Tobin tax and its applicability in India, international journal of

multidisciplinary research, vol.1 issue 7.

Spahn P. B. (1996). La taxe Tobin et la stabilité des taux des changes, FMI, Finance et

Développement.

Spahn, P. B. (1995). International financial flows and transactions taxes: Survey and options.

IMF workingpaper WP/95/60.

Stotsky J. (1996). Pourquoi une taxe Tobin double est vouée à l’échec ? Finance &

Développement, Juin 1996.

Taketa K. (2003). A large speculator in contagious currency crises: a single « George Soros »

makes countries more vulnerable to crises, but mitigates contagion, Department of Economics,

University of Wisconsin-Madison.



This article is an open-access article distributed under the terms and conditions of the Creative

Commons Attribution license (http://creativecommons.org/licenses/by/3.0/).


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Is It Possible to Create Goods from Thin Air Using

Money and an Expenditure Multiplier?

Gennady Bilych

Dept. of Management, UPEC Corporation, Belgorod

20 Popova str., 308000, Belgorod, Russia


Received: September 29, 2013 Accepted: October 15, 2013


Abstract

Most sensible people will not think to dispute the fact that any active government monetary

policy that has no solid theoretical or empirical grounding should be thought of as an

irresponsible experiment with completely unpredictable consequences for the economy.

However, as surprising as it may be, this is exactly the policy in use today in many countries all

over the world in the hope of overcoming the crisis and reviving national economies. The

results of empirical studies on the effects of a certain amount of money on economic growth are

rather contradictory and do not allow us to definitively evaluate the effectiveness of

government intervention. The Keynes Theory, which for a long time served as scientific proof

of the entry of the government to a market, has been the object of fierce criticism for the last 40

years. Little is left of the proud status it once enjoyed. Many economists are still only willing to

support Keynes when he states that under certain circumstances, an unexpected increase in the

money supply may have a positive effect on the function of the economy. Author argues that

such attempts to refute the neutrality of money are theoretically unfounded and contradict

empirical data and additional money in a crisis is more likely to be a poison rather than a cure.

Keywords: Money, Monetary Policy, Multiplier, Keynes Theory, Economic Growth

1. Introduction. Scientists and Engineers

Mankiw (2006) rightly noted that there are two types of economists: engineers and scientists.

The engineers address the important practical issues. Their efforts are primarily aimed at

improving the function of the economy. They are in a constant struggle against unemployment,

crises, inflation and other market imperfections. Most macroeconomists are, of course,

engineers, or in any case strive to be. Engineers often become advisers to politicians and


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sometimes become politicians themselves; they occupy positions in commissions, committees

and working groups. They write speeches and develop programmes for current and future

presidents and prime ministers. They have a high level of authority and they are in demand. In

my opinion, however, the close link between engineers and politicians has now become a major

problem for society. The problem lies in the fact that engineers have now come to depend on

politicians to the same extent that politicians depend on them. Today, the level of prestige of

macroeconomics as a profession largely depends on the level of interest of politicians towards

engineers. This dependency is, of course, rather dangerous; the danger has to do with the fact

that very many politicians and state officials have a vested interest in expanding their influence

over the economic life of society. The prestige of their profession is, to a significant extent,

determined by the size of the budget they manage. This is why politicians usually have a highly

sympathetic attitude towards any theories that justify government intervention. I am by no

means judging certain individuals, but it cannot be denied that a situation such as this is far

from ideal.

Mankiw believes that scientists have a different objective – to understand how the world is

built, how the market system works. Scientists are mainly focused on microeconomic issues.

Their choice is easily explained. Economic scientists believe that in order to understand

macroeconomic issues we have to thoroughly study the mechanism of interaction of individual

economic agents and only then can we move on to discussing the function of the economy as a

whole. The relationship between these two types of economists has never been simple.

Engineers criticise scientists for ignoring the interest towards real markets and for attempting

to create their own theories on very dubious grounds. Engineers believe that there are no ideal

markets, no perfect competition and no balance in real life, and if there are they are very rare,

an exception. We live in a world of imbalance and imperfect competition, therefore all

microeconomic theories are invalid. What is proposed instead? Even less realistic grounds for

forming theories: money illusion, liquidity preference and animal spirits (Keynes, 1973;

Krugman, 2008; Skidelsky, 2009; Akerlof and Shiller, 2009). For some reason it is also thought

that some people are not subject to all these preferences and illusions, therefore only they are

able to think sensibly and advise the rest. Naturally engineers believe that they are the only

ones who are capable of doing this, which I personally doubt, given the confusion that prevails

in the macroeconomic environment every time there is a crisis. These strange grounds are not

only used to develop theories, but also serve as a basis for practical steps taken towards

improving the function of the economic markets. The results of these practical steps usually

seem less than convincing. Most macroeconomic theories do not even stand up to basic

empirical tests. Furthermore, many theories contradict not only microeconomic foundations of

science, but also plain common sense. For some reason, however, this does not concern

engineers in the least and does not prevent them from bringing their dubious ideas to life. There

is no need to recall what came out of the realisation of the ideas of one of the first economic

engineers in history. Fortunately Marx was not a practising engineer, but unfortunately he did

have many practising followers. Thanks to their efforts and advice, economies in many

countries were put back hundreds of years, to the Middle Ages. Marx’s preaching on the

immorality of the free market became so deeply ingrained in people that even today certain

rather well-respected economists attempt to use them as scientific arguments (Akerlof and


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Shiller, 2009; Sandel, 2012; Skidelsky, 2009). All of their moral limitations of the free market

that they tirelessly state are in fact absolutely immoral from the point of view of those who are

affected by such limitations. It is not only economic engineers who are responsible for this

situation; microeconomic scientists, too, are responsible. Today much depends on the

viewpoint of scientists, their voice is important in discussions of practical issues associated

with attempts to regulate the economy. How actively and successfully they defend their views

will have a great impact not only on the future of our science and the authority of economists,

but also on the level of people’s wellbeing. In order to win over people’s minds and

demonstrate that they, the scientists, are right, they do not need to create complicated, obscure

theories, filling them with endless mathematical equations. Very often, using only common

sense and the simplest truths, success can be achieved and dubious economic experiments can

be avoided. Today the circumstances are such that scientists have now become the only force

that is able to and must stand up against the dangerous tandem of engineers and politicians.

This paper does not set out to do much. I would simply like to try to analyse the influence of an

increase in the money supply on inflation, employment and economic growth and also discuss

the function of the multiplier mechanism. For this purpose I will critically examine currently

existing microeconomic grounds for the lack of neutrality of money. The influence of an

amount of money on business activity and the function of the multiplier are used by many

economists in order to justify intervention in the economy with the aim of correcting what they

believe to be imperfections in the function of the free market. I will primarily be interested in

the response and actions of economic agents and which macroeconomic effects these actions

bring about. The analysis will be based solely on simple ideas and arguments that nobody can

refute and also common sense.

2. Literature Survey. Inflation, Employment and Economic Growth

As stated by Lucas (2009), the matter of the effect of an amount of money on economic activity

has been given so much attention and so much has been written about it that one could assume

that the issue had long since been resolved. However, this is not the case. The issue was not

resolved during the times of Keynes, nor in the 1970s, nor the 1990s and today there is still no

satisfactory answer to the question. Now almost all economists, with few exceptions (for

example Akerlof and Shiller, 2009), are only willing to unconditionally support the claim that

money is neutral in the long term. In this case there is a rare unanimity. There have never been

any serious theoretical and empirical objections to this claim. It is enough to recall the

respected and credible work of McCandless and Weber (1995), which gives a correlation

between the increase in the monetary base and inflation and also between the increase in the

monetary base and the actual production output during different time intervals in a large sample

of 116 countries. The result, especially for large time intervals, is consistent with the

quantitative theory of money. Inflation rises in the same proportion as the amount of money

and the actual production output does not depend at all on the increase of the money supply.

The short-term effect of the increase in an amount of money is far from obvious. According to

data from McCandless and Weber (1995), in the short term, with a moderate increase in the

money supply, there is a rather large range of values for inflation and production. This fact


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alone does not say much. When looking at the influence of money on the economy, it is

important to remember that money can only have an effect on certain economic parameters

when it is really involved in the process of market exchange. When additional money appears

in an economy, economic agents need time to make a decision on how to use it. This means that

money does not start to actively participate in market exchange processes right away. Briefly

speaking, this can be expressed as follows: money cannot instantly be absorbed into an

economy as there are transaction costs of exchange. Therefore there is nothing surprising about

the uncertainty of the results of the short-term effects of money. Furthermore, in the late 1960s,

thanks to the efforts of Friedman (1968) and Phelps (1968), insight was given into the causes of

the uncertainty associated with the consequences of the short-term effects of money and

reasonable doubts were expressed regarding the effectiveness of the countercyclical monetary

policy carried out by the authorities. It became clear that the short-term effect of money on real

economic indicators depends on the predictability of the actions of the authorities. A rational

and informed economic agent would not immediately increase output in response to an

increase in prices of their own products. Only people with limited information who are

suffering from monetary illusion would act in accordance with the wishes of regulatory bodies.

This approach seriously undermined the theoretical foundations of economic regulation, which

is why many economic engineers rushed to defend their ideas. The struggle continues to this

day with mixed success.

It must be recognised that the empirical studies available today do not allow us to give a

definitive answer to the question of the short-term effect of money on economic activity. In a

sample of 100 countries from 1960 to 1990, Barro (1995) discovered a weak negative

relationship between inflation and economic growth. Barro and Sala-I-Martin (2004) confirm

this conclusion also noting a significant inhibitory effect of high inflation on output growth.

Fischer (1993) suggests that high inflation lowers labour productivity growth rates. Some

authors (Rindyck and Solimano, 1993) believe that high inflation has a negative effect,

especially on making investment decisions. It also inevitably raises a question: what level of

inflation should be considered high and what happens in the event of a moderate increase in an

amount of money? Ghosh (1997) defined the threshold value of inflation having a positive

impact on growth as 10% per year. Fischer (1996) believes that the threshold is in the region of

15% and Sarel (1996) is certain that inflation of less than 8% is harmless and has no significant

effect on the economy. Many economists believe that the threshold value of inflation depends

on the particular economic features of a country. Khan, Senhadji and Smith (2001) suggest that

the threshold value of inflation for developed countries is in the region of 1% and for

developing countries – in the region of 11%, and with lower values of inflation they were not

able to define the relationship between growth and inflation. The empirical results of studies

for 42 economies conducted by Lopez and Mignon (2011) give threshold values of 2.7% and

17.5% respectively; with inflation below the threshold values, a very weak relationship is

observed between the increase in the monetary base and the growth in the economy.

The issue of the influence of inflation on employment also lacks clarity. Lucas (2009), using

the results of Stockman (1996), rightly notes that just because there is a Phillips Curve in

certain short periods of time, we should not draw hasty conclusions on the positive effects of


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inflation on employment. If we look at long periods of time, we can easily be clear that periods

of a positive slope in the Phillips Curve are inevitably followed by periods of a negative slope

and vice versa. This is confirmed by the results of numerous studies. Some of them indicate a

positive link between inflation and employment (for example: Caporale and Skare, 2011),

others do not agree (for example: Hooker, 2002).

What conclusion can be drawn from all this? At present there are no arguments in favour of the

positive influence of moderate and high inflation in the long term. Furthermore, all researchers

note the unambiguously harmful effects of high inflation. In the short term the situation is not

entirely clear, some researchers confirm the positive effect of money, others reject this effect. It

is surprising that this has no effect on the activity of regulatory authorities and monetary

authorities who persist in trying to influence market processes, despite the very dubious end

results of their activity. This is just like trying to embark on a round-the-world trip with a

newly-built ship full of passengers that nobody has checked is seaworthy against the advice of

the ship’s engineers.

The mechanism of the expenditure multiplier has received extremely widespread coverage in

economic literature (Blaug, 1993; Benassy, 2007; Corsetti, Meier and Muller, 2012; Giles,

2012; Romer, 2012), and practically in every macroeconomic textbook there is a whole section

on the wonderful way in which it works (for example: Mankiw, 2007). A great deal of scientific

work is currently devoted to discussing the values of the multiplier for different economies and

markets and also explaining the reasons for its volatile character. The reality of the multiplier

effect is not really disputed by anyone, although there are certain doubts regarding its fantastic

capabilities (Moore, 1994; Hazlitt, 1959; Stoddard, 2010; Barro, 2009). This is strange and

surprising if you consider the improbable and unrealistic consequences that it could potentially

have. For example, you could very well have a situation where the increase in output and profit

of a certain company could be many times greater than initial investments. This unusual

situation should be the rule for large vertically-integrated companies. Indeed, if a certain

subdivision of a company decides to invest a certain amount of funds into expanding

production and increasing profit, this should automatically increase profits and production in

all other subdivisions. Consequently, regardless of the desires, abilities and efforts, the

productivity of labour in all subdivisions will increase by itself. A fantastic result! What more

does one need to be happy! Another example, any dictator can easily create conditions in a

country whereby the multiplier will be infinite, or in any case will reach a very high value. The

prosperity and success of the country will be guaranteed. Of course such assumptions have no

common sense; neither do they have any sense of history of how a certain family dispute could

provoke a real business crisis in a small town or how the broken windows of a shop and the

window of your neighbour are able to cause an economic boom. These light-hearted tales are

clearly only included in textbooks to cheer up students studying the multiplier effect

(McConnell and Brue, 2005). At the same time, these stories should sow seeds of doubt and

encourage microeconomists comprehensively analyse such strange inventions of

macroeconomists as the multiplier or the effect of money on economic activity. I will try to

follow this advice and analyse the behaviour of rational and irrational people in response to the

appearance of additional money in an economy.


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3. The Models of Production of Goods from Thin Air

3.1 Money and Economic Growth

It may seem surprising, but today, in order to theoretically justify the lack of neutrality of

money in the short term, economists usually use the same arguments used by David Hume

([1752], 1970) in his time. His explanations sound so common, natural and convincing that

they have long since been taken as self-evident and banal truths. However, nothing is as simple

as it seems at first glance. A more detailed analysis inevitably points to a number of errors,

inaccuracies and contradictions that Hume overlooks in justifying the short-term effect of

money.

Hume states that the main cause of the short-term effect of an additional amount of money on

output is its unequal distribution among the population. If one night by some miracle five

pounds lands in the pocket of every person in the United Kingdom, this will have no effect on

the wellbeing of the population. All goods will increase in price in accordance with the quantity

theory of money. Speaking in modern terms, these people in the United Kingdom should have

no monetary illusion; they have enough information in order to respond rationally to such an

event. However, Hume believes that everything changes if not all people in the United

Kingdom, but only a certain group of producers receive a certain amount of additional money.

They will be able to hire additional workers who will not even think of asking for a higher wage.

These workers will produce an additional amount of goods. Even at this stage of reasoning a

number of questions arise. Firstly, why is Hume so certain that there is always involuntary

unemployment? On what grounds? Secondly, if producers seek to expand production, this

means that their activity is bringing profit and has done so in the past. Therefore it is entirely

unclear why they did not try to hire additional workers before. An expansion of production

would enable them to increase their profits. What prevented them from doing this? In this case

a lack of funds cannot be a comprehensive explanation for the passivity of entrepreneurs.

Producers could take out a loan and pay it off using the profit they have. If the rates are too high

for them they are still able to fund the gradual expansion of production using existing profits.

What fundamental change did money have? It is not clear. Thirdly, Hume’s model assumes that

there is not only involuntary unemployment, but also unlimited economic opportunities to

produce any capital goods. This is how it must be because in order to expand production an

additional amount of material resources and raw materials are always needed. If the additional

demand increases the prices for a certain raw material, this has a negative effect on the activity

of all enterprises that use the raw material. Enterprises that have not received any benefit from

the expansion of the money supply will be forced to reduce output, which is further evidence

against the positive effects of an increase in an amount of money.

As it goes on there are more and more questions and less and less clear answers. According to

Hume, after a certain period of time, people going to the market discover that goods are sold at

the same price as before, but they return with more goods of a better quality for their family.

The farmer and the gardener, convinced that all their goods are being sold, try to increase

production. Very strange conclusions. As mentioned before, salaries remain the same, prices

for goods have not changed, but for some unknown reason people are able to buy more


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products of a better quality. How can this be? An increase in production caused by an increase

in employment, if this happens at all, will be compensated by an increase in demand from new

workers. Their incomes will be exactly equal to the value of the additionally produced goods.

The production of goods and services per UK resident will not change, therefore nobody will

come back from the market with more goods of a better quality. This is not possible, and

neither is the increase in demand for the goods of the farmers and gardeners. It may well be so

that new workers want to buy their goods, but goods produced by new workers will also have to

be purchased by somebody. Therefore the demand for the goods of the farmers and gardeners

will remain the same. There will be no economic boom. There may be a slight increase in

employment, but even this conclusion seems doubtful. Why did none of the producers or

traders see the opportunity for earning profit before the additional money arrived? What could

have prevented them from doing so? It is a well-known fact that an amount of money is in no

way connected to intelligence and the acuity of human vision, therefore there was nothing

preventing entrepreneurs from seeing an opportunity to increase their profits and expand

production before the money appeared. Following all of these arguments, we were only able to

conclude that an increase in an amount of money could have the same result as with no increase

in an amount of money. This is all that can be concluded from Hume’s explanations.

The starting point for Hume’s argument was the effect of money on the supply of goods and

services. The Keynes Theory is based on other conditions and focuses on demand. Let us

examine what this approach may change. Let us suppose that residents of the UK receive

additional money and they go off to the market. At that moment in time the amount of goods

and their price are the same. What then happens? There are two alternatives. If the prices

remain unchanged, a portion of the buyers will not have any goods because the amount of

money is greater than the total value of the goods. The buyers will have all the additional

money. In this case nothing in the economy will change because the previous amount of money

is involved in the process of exchange. This result is of no interest to us. What is more

interesting is the second version of the events whereby the increase in demand leads to an

increase in price. As a result, the residents who have suddenly become wealthier will purchase

more goods than before and the rest will be forced to reduce their consumption. However, what

is most important is that the earnings of producers will be higher than their costs and they will

receive profit. This means that Keynes’ dreams start to come true. Following his logic,

producers should immediately start investing their profit in the production of goods that are

becoming more expensive. This may happen, but I hope to demonstrate that this route will lead

to nothing but disappointment. Let us not forget that for consumers the increase in prices has

already become a reality, therefore it is most likely that in the future when making decisions

they will take this fact into consideration. If they demand an increase in wages they will put

possible investments under threat. Producers will not have funds left for investment and all

profit will go towards payment of compensation. This version of events will have no effect on

the growth of economic activity, therefore we will go on slightly different assumptions and we

will accept that most people suffer from a full range of all the possible Keynes diseases,

including monetary illusion. We will suppose that nobody will demand an increase in wages

and producers will continue to hire additional workers who will produce additional goods. We

are, of course, again forced to admit the existence of infinite economic opportunities for the


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production of any amount of resources and raw materials. Otherwise the additional demand for

resources and raw materials must inevitably increase the prices for them, which will have a

negative effect on the output of end goods and services in a country. However, even under these

imaginary conditions producers will be faced with very unfavourable events – prices of the

goods will start to go down. This will be inevitable because the amount of money will remain

unchanged, but the amount of goods will increase. Nobody will receive any additional profit; at

best producers will be able to only reimburse their expenses. The most optimistic outcome of

all this will be the production of a certain additional amount of consumer goods with a value

equal to the cost of the additionally hired workers. The income per resident of the country will

remain the same, employment may rise slightly. However, employment will only rise if a

number of not very plausible conditions are fulfilled: irrational behaviour, a lack of information,

involuntary unemployment, disregard of past experience, limitless production of capital goods

and many more. And even if all of these conditions are fulfilled, a rise in employment still

seems very doubtful. After an increase in production followed by a reduction in prices,

entrepreneurs will most likely try to somehow retain their profits. In order to do so they must

either lower wages, which Keynes believes is impossible, or dismiss some workers. This will

result in levels of output and employment returning to previous values.

Very often, followers of Keynes argue that real markets are different to markets invented by

microeconomists as some of the firms have unsold residual stock. In this case the appearance of

additional money will not lead to inflation, therefore the growth of the economy will not

depend on how rationally or irrationally consumers or producers behave. An increase in

demand will enable all residual stock to be sold and producers will respond to this by

increasing the number of staff and expanding production output. At first glance this is

wonderful; the markets receive a powerful positive impulse and there are no negative

consequences for the economy. Is this really the case? In my opinion it is not. Firstly, an

increase in goods reserves means that nobody needs the product at the offered price. The price

for the product is too high and it will only be purchased if its real value decreases. After the

appearance of additional money and an increase in demand, prices increase for all products

except for those that are available in abundance. Its relative value will decrease and only in this

case will it be sold. Secondly, there will be no increase in output. Producers of higher-priced

goods will not increase output for the reasons discussed above. If a producer who has sold all of

their goods reserves decides to increase their output, they will end up in the same situation that

they were in before. The demand for their products will remain the same, but the supply will

increase. The producer will again be faced with unsold residual stock or will have to reduce the

price of the products. They will not be able to lower the prices; on the contrary they will be

forced to increase prices because raw materials, machinery and labour costs will have become

more expensive due to the rise in prices, which happened because of an increase in the money

supply. In either case there will again be unsold residual stock and everything will revert back

to as before with just one difference: there will be higher prices on the market. One thing is

clear – an increase in the money supply under all of the possible scenarios of the development

of events cannot cause an increase in production output. Money can have no effect on the

existing level of GDP in a country.


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All of today’s misunderstandings regarding the possibility of the real effect of money on the

economy are to do with common misconceptions on the nature of economic growth. Modern

economic science considers investment to be a key factor of growth and nobody denies this.

However it is very important to understand and take on board when conducting any economic

policy that not all investments increase the production of goods and services. As can be seen

from the above examples, additional investments always require an additional amount of

capital resources and raw materials, which puts certain limitations on investment processes.

Investments enter into a competitive battle with one another for resources and economic

growth becomes dependent upon which methods of investment win the battle. Only the most

effective investments, which allow producers to receive the maximum amount of goods from

one resource unit, are conducted in a free market. These producers may offer the highest price

for the resources. The market sets the price for the resource and this price will be equal to the

average marginal product. The marginal product of the most efficient producers will be greater

than the average market marginal product and these companies will earn profit. In order to

further increase their income, successful companies will put their profit towards acquiring

additional resources and expanding output. The value of the additional product will equal the

profit obtained. This is why profit always turns into economic growth. This is why real market

signals, rather than artificially created signals are important for an economy to function

properly. This is why rational and informed producers and consumers, rather than individuals

with complicated illusions and preferences are needed for growth. By intervening, the

government creates false signals for market participants and profit may not go to the most

efficient producer, which takes resources away from this producer. Illusions always give rise to

illusions and artificial profit always gives rise to nominal economic growth rather than real

economic growth, or, in other words, inflation. Therefore artificial stimulation of the economy,

which is seen as a cure and which modern interpreters of Keynes (Krugman, 2008; Skidelsky,

2009) insist upon, more often than not leads to recession rather than recovery. This may be the

reason why economies sometimes have a very hard time during a crisis and take a long time to

recover.

At first glance, nothing is preventing producers from increasing the production of any capital

goods or raw materials if necessary. However, this is not the case; the production of capital

goods and end products may, at any given moment in time, come to an end because the

economy has one very important resource, the production of which cannot be increased –

people. A person’s productivity, not an amount of money, determines the level of output of

goods and services in any country and is a key driver of economic growth. The reluctance of

many economists to note this variable and include it in their models is entirely understandable

and is most likely due to the fact that labour productivity is in no way connected to the amount

of money in an economy. No governments or central banks are in a position to influence this

indicator, even with large sums of money. Money is entirely useless in a situation when more

goods have to be produced from a resource unit than were produced before. This requires

innovation implemented by entrepreneurs in order to increase their profit. Innovation does not

depend on money; therefore all attempts to stimulate an increase in production by injecting

cash into an economy are doomed to fail. A magical multiplier, which we will discuss later on,

cannot cause a rise in business activity because it is not able to alter the existing level of labour


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productivity. Productivity depends not on the efforts of the monetary authorities and theories of

macroeconomists, but on the level of development of science, technology, education and the

quality of control.

3.2 The Multiplier

The time has now come to discuss one of the most important inventions of economic engineers.

We are, of course, going to talk about the multiplier, which enables goods to miraculously be

produced from thin air. For this magic to take place, all you have to do is invest a certain sum of

money and a mysterious mechanism will be activated that will allow you to obtain much more

goods than any sensible person would expect. Prior to this invention, nobody would have

dreamed that there could be a situation where the value of additionally produced goods could

be many times greater than the amount of initial investment. In other words, the value of the

additionally produced goods can be many times higher than the costs. How is that for a miracle!

What an incredible return! And the higher the so-called propensity to consume, the greater

amount of products will be produced. It remains a mystery why this discovery was not taken

advantage of by many non-free countries. In these countries they know perfectly well how to

deal with various human propensities, including the propensity to consume, and guide them in

the right direction. Consequently, any dictator will easily be able to increase the expenses

multiplier to the highest values possible and turn the country into a paradise. However,

something invariably prevents dictators from turning Keynes’ dream into reality. Perhaps they

simply did not read textbooks on macroeconomics or missed the chapter on the multiplier. Let

us remind ourselves and them how the multiplier effect is described in modern textbooks (for

example: Mankiw, 2007). At the beginning of the chapter, authors usually put readers at ease,

stating that elementary mathematical knowledge that even a senior student at secondary school

would know is enough to understand the function of the multiplier. This is perfect because as

Coase (1988) once stated, if nonsense is too obvious people often try to express it using

complicated mathematical equations. This is followed by an example of the government

deciding to purchase new fighter planes worth $20 billion from Boeing, which causes a rise in

employment and profit for the contractor of the government order. Even a senior student at

secondary school may think to ask the reasonable question: where did the government get such

a large sum of money from? Did it reduce funding for education? Did it raise taxes? If it did,

then did employment and profits decrease in other industries of the economy? Usually

textbooks do not mention anything about this therefore we will assume that the government

simply printed the money. Let us continue. The increase in income of workers at Boeing raises

the demand for the goods and services of other companies. If the marginal propensity to

consume is ¾, the demand will increase by $15 billion. The increased incomes of workers of

these companies will raise the demand for production of other companies. A shrinking wave of

additional demand will appear in the economy, which will in the end lead to an increase in

combined demand of $80 billion. This is all very fascinating, but a very attentive secondary

school student may have certain doubts. How can it be so that the appearance of $20 billion in

an economy allows workers to acquire goods for $80 billion? This contradicts the rules of

elementary mathematics. Economic engineers will, of course, condescendingly explain to the

student that the expansion of production and the rise in employment happen gradually and the


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demand is transferred from one industry to the other not in an instant, but over a period of time.

However, the meticulous student may object: this means that growth in demand will inevitably

be followed by a decrease in demand and a rise in employment in one industry will lead to

redundancies in another. Consequently there can be no growth in demand of $80 billion. Indeed,

after workers at Boeing announce an additional demand of $15 billion for the goods of other

industries, the prices of these goods will increase and the additional profit will enable the

company’s management to hire additional staff who will produce additional products. But who

will buy them? Boeing’s workers will not be able to; they already spent the $15 billion. If the

government fails to quickly allocate $20 billion for the purchase of the fighter planes, nobody

will purchase the products of other industries. This will cause demand for goods to return to

previous values and all hired workers will lose their jobs. In order to sell additionally produced

goods, companies will be forced to lower goods output for a certain period of time. The GDP in

the country will remain the same. The economy will be hit by waves of employment followed

by redundancies and periods of profit will alternate with periods of losses. It may well be the

case this activity will bring more harm than good. One thing is clear, the prices for goods and

services will increase because the manufacturers of additional fighter planes need to eat, clothe

themselves and have a place to live.

In this dispute I am on the side of the secondary school student; I believe their arguments are

more consistent and logical. If we continue to believe in the wonderful capabilities of money,

we still have to explain how the appearance of $20 billion made it possible to purchase goods

for $80 billion. It is possible if $20 billion are spent over a certain period of time more than

once. However, it would be completely erroneous to argue that GDP had increased by $80

billion. Real or, more likely nominal GDP will only increase $20 billion. Textbook authors use

strange calculations; they add together the growth in GDP at different periods of time,

forgetting that growth in one industry is always followed by decline in another.

If the reader goes back to the very beginning of the aforementioned textbooks on

macroeconomics, he or she will certainly find a section on circular flow, which is directly

linked to the topic being discussed. The whole section together with the circular flow diagram

easily fits onto 1-2 pages and its contents rarely rouses much interest. It is important however

because it demonstrates that any income of individuals and firms is always at the expense of

other people and firms. If the income of certain companies increases, this means that the

expenses of other companies increase. An increase in income equals an increase in expenses.

Therefore, when prices for cars increase, at the same time the costs of transport companies

increases, which has a negative effect on the activity of companies that require transport

services, including the car manufacturers themselves. For the economy as a whole, the increase

in price does not change anything. An increase in production in one industry is compensated by

a decrease in another. Economic growth is not an increase in the value of goods and services;

on the contrary, it is a reduction. Only when prices for goods and services are lower than the

level of salaries will people be in a condition to obtain more of them. The ratio between product

prices and the cost of labour determines the level of economic well-being, therefore monetary

stimulation or burying bank notes in pits, as once recommended by Keynes, will not restore

growth. Growth can only be restored by increasing labour productivity which, fortunately or


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not, does not at all depend on the efforts of macroeconomic engineers and politicians.

4. Empirical Results

Fig.1 shows the changes in economic growth, inflation and unemployment in the US from

1965 to 2012.

0%

5%

10%

0%

5%

10%

0%

10%

5%

1970 1980 1990 2000 2010

Unemployment

Inflation

Economic Growth

Source: Bureau of Economic Analysis, U.S. Departament of Commerce.

Figure 1. Economic Growth, Inflation and Unemployment in the US (1965-2012).

Even a quick glance at the shape of the curves will reveal a very interesting feature: at certain

periods in time inflation and unemployment behave exactly as predicted by the classic Phillips

Curve. However, an unexpected fact is that this happens when economic growth is in decline.

At this time, when growth is slowing down and the economy is approaching another crisis,

inflation rises and unemployment decreases. This result seems strange because for most people

an increase in employment is always associated with a rise in economic activity. In order to

explain this phenomenon I will try to express certain concerns regarding the causes of cyclical

changes of GDP having refused to use Keynes’ numerous and dubious inventions. Surprisingly

this is not so difficult if we remain within the boundaries of classic theory rather than endlessly

searching for market imperfections. The only reasonable explanation for an increase in

production and consumption is an increase in labour productivity. In order to increase

production we have to somehow increase the production process or improve the management

of a company. These improvements are usually called innovation. A company that introduces

innovation has the capability of producing more products from one resource unit than other

companies. Consequently the difference between earnings and costs will be higher at that

company and this means that it will have higher profits. This company will become a

temporary monopoly continually increasing production and its market share. Naturally the

company will rapidly acquire followers, which will enable a greater amount of economic


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resources to be used in the most productive manner. During such periods, indicators for

economic growth in a country rise at a steady rate. In the US, for example, such periods were

observed in 1971-1973, 1975-1976, 1982-1984, 1992-1993, 1996-1999 and 2002-2004. Many

companies unable to introduce innovation into production are forced to reduce output or

terminate their activity. Unemployment may rise during these periods if the number of

redundancies at companies experiencing problems is not compensated by a rise in employment

at more successful companies. There are no objective reasons for a rise in inflation during

periods of heightened economic growth. Furthermore, the introduction of innovation creates

real conditions for lowering prices, which is also confirmed by the data presented in Fig. 1. At

the time when half of the country’s resources begin to be used in the most productive manner or,

in other words, half the companies introduce innovation, growth reaches its maximum values.

After this, economic growth in the country begins to decrease and the battle for resources

intensifies. Fewer resources are used non-productively, therefore companies have less and less

opportunities to obtain profit and expand output. The fierce competition for material and

human resources pushes prices up, therefore unemployment declines steadily and inflation

begins to rise. During periods of declining economic growth, which in the US economy took

place in 1965-1971, 1973-1975, 1978-1980, 1988-1991, 1999-2001, 2005-2008 we see a

classic Phillips Curve. During these years the profits of companies gradually go down and this

means that there is a great difference between the profits of companies when they receive loans

and when they return them. If in such a situation the managers of companies reassess their

capabilities, this may cause serious financial difficulties both for the companies themselves and

for the banks that are providing loans to them. During this period, active government

intervention in the form of a relaxation of the monetary policy is most likely to only make the

situation worse. A rise in inflation and a reduction in interest rates caused by an expansion of

the money supply will, of course, make repaying loans simpler, but at the same time this will

encourage less efficient production companies to use borrowed funds, which may cause serious

difficulties for the whole economy in the short term. During this period the future is rather

predictable. Companies have less and less opportunities to increase labour productivity and the

economy inevitably approaches the limit of its production capacity. Profits and economic

growth tend towards zero, which signifies the advent of an economic crisis. People will soon

rush to blame financial institutes and their managers of greed and dishonesty, producers of

being too presumptuous and consumers of behaving irrationally. Keynes’ followers will perk

up and with renewed energy begin to criticise the market system, demanding that control be

tightened and freedom limited. The governments will make new laws, introduce additional

taxes and begin to pour money into the economy. All of these actions will not give any positive

results because the economy has reached the limits of its production capacity and overcoming

these limits does not require heightened government control, but creative efforts of

entrepreneurs. Innovation is needed to get out of a crisis and this will certainly happen. It will

happen not through the efforts of economic engineers and politicians, but through people’s

natural pursuit of profit. Only the implementation of innovation, which increases labour

productivity, will enable entrepreneurs to earn profit again and bring the economy back on

course for the next business expansion. This is how it always has been and how it always will

be. This is how it was in the times when people hunted with wooden arrows and stone axes.


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This is how it was when the pharaohs and feudal lords ruled. This is how it was when the first

merchants and free peasants appeared. Of course, features of capitalism and the free market

system do not actually cause crises. Crises have always been as inevitable as the onset of winter

or summer. What can an active government monetary policy or fantastic inventions of

economic engineers do to change the situation? In the best case nothing and in the worst case

they may create additional problems. We can, of course, proudly argue and ramble on about the

highly important role of money in the economy. But show me on Fig. 1 the year when the work

of the monetary authorities gave a positive result and changed the function of the economic

markets for the better. In which year did adding money to the economy and rising inflation

overcome recession and encourage growth? I searched for a long time, but could not find the

answer.

5. Conclusion

A monetary policy conducted by the authorities must have solid theoretical and empirical

grounding; in any case it must be supported by the majority of actively working economists. If

these conditions are not fulfilled, any monetary policy should be regarded as dubious and an

irresponsible economic experiment. I may be mistaken in regard to the extent to which a

government’s monetary policy is supported by economists, but I am convinced that at present

there are not enough theoretical and empirical grounds for attempts to stimulate business

activity by expanding the money supply. Most empirical studies carried out over the last 40

years either reveal an inverse relationship between the increase of the money supply and the

value of economic growth, or they support the idea of the neutrality of money. Only a few

studies leave hope for a successful stimulating monetary policy.

Today there is little left of the former glory of the Keynes Theory, which for a long time served

as scientific evidence of the entry of a country to the free market. A significant number of

economists are still prepared to only support Keynes in as far as that only a poorly informed

individual suffering from monetary illusion could behave as the monetary authorities hope for.

As they see it, in response to the appearance of additional money in an economy, such an

individual will immediately attempt to increase production output. However, I believe that

these assumptions are completely unfounded and contain a serious logical error. In arguments

on the possibility of the positive influence of the expansion of the money supply, the fact is not

taken into consideration that any increase in income of certain economic agents is the same

increase in expenses for other economic agents. The income of people selling certain goods or

services is exactly equal to the expenses of the people who obtain these goods or services. The

expansion of demand of certain goods causes their price to rise, which increases the costs of the

people or firms consuming these goods. The possible increase in output of goods that have

risen in price is compensated by a reduction in the output of other goods. The economy does

not produce anything new; the loss of certain individuals is exactly equal to the losses of others.

This clearly demonstrates the circular flow diagram studied by all novice economists. Adding a

certain amount of money to the economy does not make it possible to change the existing level

of labour productivity, upon which the real output of goods and services in a country are

dependent. Naturally, for this very reason in the real world there is no multiplier effect allowing

us to magically increase GDP in a country to a value many times higher than an initial


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government investment. It is nice to dream that having spent $20 billion, we could produce

goods and services for $80 billion, but this is not possible. It is nice to imagine yourself being a

wonderful magician creating a wide range of goods from thin air, but even the most

distinguished politicians and economic engineers are not able to do this.

Today, the disappearance of money from models used by economists, which greatly surprised

and upset King (2002), in actual fact reflects the constantly rising doubts of economists of the

chances of successfully implementing an active monetary policy. Increasing numbers of

macroeconomists are coming to the conclusion that increasing the money supply only leads to

price increases and does not bring about any economic changes. It is not easy to give up the role

of ruler of destinies and go from being an irreplaceable engineer, fearlessly hurling hundreds of

billions of dollars into the fire of a crisis, to an ordinary scientist. It is even more difficult, but

sooner or later it will have to be admitted that over the last 70 years, not ordinary citizens, but

many former and currently active politicians and economic engineers have suffered from

monetary illusion and other Keynes diseases. This is not surprising. The sooner we admit this,

the more chances we will have to maintain economic freedoms and prevent the market from

turning into a lifeless desert with ‘no-entry’ signs dotted here and there and kilometre after

kilometre of barbed wire fences.

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Total Reward Concept: A Key Motivational Tool For

Corporate Ghana

Dr. Olivia Anku-Tsede

Organizational and Human Resource Department

University of Ghana Business School. P. O. Box LG 78, Legon-Accra, Ghana


Ernestina Kutin (Corresponding author)

P. O. Box CT 550, Cantonment- Accra, Ghana




Abstract

This paper examines the concept of total reward and its application in motivating employees in

Ghana. Total reward as an integral element of reward management is the combination of

financial and non-financial rewards given to employees in exchange for their efforts. The aim

of total reward is to maximize the combined impact of a wide range of reward elements on

motivation, commitment and job engagement. Hence, total reward embraces everything that

employees’ value in the employment relationship. In spite of the growing need to pay attention

to the concept of total reward, it appears most Ghanaian organisations place more emphasis on

traditional rewards that are typically extrinsic and financial in nature. Thus, most Ghanaian

organisations pay too much attention to financial rewards at the expense of non-financial

rewards. This paper thus examines existing literature on the concept of total reward to

determine whether the adoption of total reward strategy could be the answer to corporate

Ghana in its bid to obtain maximum efforts from employees.

Keywords: Total reward, Financial and non-financial rewards, Employee motivation, Ghana


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1. Introduction

The complexity of today’s business environment has imposed continually changing settings in

which organisations compete for survival. As a result, special emphasis is placed on acquiring

and retaining quality employees as this is seen as a key factor underpinning organisational

success. Although it takes a great deal of other resources to run a business, employees have

been identified as the most valued resource which determines the success of every business. As

Milkovich and Bondreau (1988) put it, ‘plant, equipment and financial assets are resources

required by firms but employees are particularly important’. Take away their creative minds

and organisations are just pile of papers, blocks and metals. Thus, the ability of organisations to

create a sustainable competitive advantage in today’s dynamic business environment depends

greatly on employees’ ideas and innovations, making them the most valuable assets in

organisational success. As rightly stated by Deeprose (1994), effective reward system

improves employee motivation and increases employee productivity which contributes to

better enhanced organisational performance. Hence, total reward which is a combination of

both financial and non-financial rewards to gain employee commitment cannot be

over-emphasised. The implementation of total reward strategy improves not only employees’

motivation, efficiency and performance but also their psychological contract and overall

organisational behaviours. Moreover, as organisational success is tied to people innovations,

rewards have become strategic which confirms why organisations whatever their size and

business orientation are looking for better ways to reward their employees for a sustainable

competitive advantage.

In view of these challenges, this paper seeks to examine how total reward management could

be used as a key motivational tool in Ghana.

2. Total Reward Concept

The concept of total reward has emerged quite recently and is exerting considerable influence

on reward management. Total reward as an integral element of reward management is the

combination of financial and non-financial rewards given to employees in exchange for their

efforts. Worldat Work (2006) defines total reward as all of the tools available to the employer

that is used to attract, motivate and retain employees and includes everything the employee

perceives to be of value resulting from the employment relationship. Thompson (2002) also

defines total reward to typically encompass not only traditional, quantifiable elements like pay

and benefits, but also more intangible elements such as scope to achieve and exercise

responsibility, career opportunities, learning and development, the intrinsic motivation

provided by the work itself and the quality of working life provided by the organisation. As

expressed by Lawler (2003), the greatest amount of motivation is present when employees

perform tasks that are both intrinsically and extrinsically rewarding. Total reward strategies are

vertically integrated with business strategies, but they are also horizontally integrated with

other HR strategies to achieve internal consistency. This view has been shared by Kaplan

(2007), who said that total reward is a holistic approach aligning with business strategy and

people strategy. This reward strategy brings about maximum return and builds up employment

brand, all of which create sustainable competitive advantage for organisations. The conceptual


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basis of total reward is that of bundling, so that different reward processes are interrelated,

complementary and mutually reinforcing (Armstrong, 2006).

The aim of total reward is to maximize the combined impact of a wide range of reward

elements on motivation, commitment and job engagement. Hence, total reward embraces

everything that employees value in the employment relationship. According to O’Neal (1998),

a total reward strategy is critical to addressing the issues created by recruitment and retention as

it creates a work experience that meets the needs of employees and encourages them to expend

more effort. The significance of total reward is creating a challenging work environment in

which individuals are able to use their abilities to do meaningful jobs for which they are shown

appreciation is likely to be a more certain way to enhance motivation (Pfeffer, 1998).

According to Armstrong (2006), the benefits of a total reward approach include a combined

effect of different types of rewards makes a deeper and long-lasting impact on the motivation

and commitment of employees. Also, the employment relationship created by a total reward

approach makes the maximum use of relational as well as transactional rewards and therefore

appeal more to employees. Besides, a system of total rewards allows flexibility to meet

individual needs as relational rewards binds employees more strongly to the organisation

because they answer those special individual needs. Relational rewards also deliver a positive

psychological contract and this can serve as a differentiator in the recruitment market which is

much more difficult to replicate than individual pay practices.

Hutcheson (2007) also stated that organisations that practices total reward strategy are able to

establish a distinctive set of rewards to support the institution’s employment brand and enables

the institution to attract and retain qualified workforce. According to him, it provides a

roadmap for the HR function to review and enrich the total rewards offerings and also provides

a clear and consistent communication device to remind employees of the full array of rewards.

Developing and implementing total reward strategy is a critical organisational intervention that

requires top management support. It is important for top management to develop strong

relationship between the organisation and employees to fulfil the continuous changing needs of

both parties as the employees are seen as principal source of the organisation’s competitive

advantage. Management should acknowledge the increasingly important role of reward

programmes in achieving business goal; thus ensuring that organisations deliver the right

amount and mix of rewards to the right people, at the right time, and for the right reasons.

Managers are also required to provide rewards that are valued, clearly linked to the desired

behaviours and perceived as fair and equitable ( Mullins, 2010). Top managers should not only

verbally advocate the strategy or merely mimic the reward systems of other organisations but

they should strive to get the right mix of financial and non-financial rewards to motivate their

workforce towards achieving their strategic goals. As Morris (2006) puts it, management must

deliberately create a customised total reward strategy to holistically create a program that best

fits their unique human capital and business strategies as this differentiates the organisation

from competitors. Management must also recognise the fact that involving employees in the

design of the total reward strategy increase their acceptance and commitment towards effective

implementation. It is also very critical for managers to consider their external environment and


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organisational culture when developing total reward strategy as well as equity in the

implementation of the strategy (Worldat Work, 2006).

A total reward strategy articulates in simple but powerful terms how organisations should

invest their resources, reinforce their core principles and values, and create competitive

advantage. According to Lawler (2003), an effective reward strategy should be designed to

motivate employees to perform and give them the power to influence their performance.

Wilson (1994) on the other hand, states that an effective reward strategy would impact

positively on behaviour when they are meaningful and valuable to employees based on the

organization’s objectives and attainable goals, open and well-communicated to all and not

based on competitive struggles within the workplace and balanced between extrinsic and

intrinsic rewards. The UK Cabinet Office (2007) outlines that in developing a total reward

strategy, organizations must build a good understanding of the organisation's strategy, goals,

capability to deliver and sustain changes in total reward practice and key measures of success.

They further posited that there must be an understanding of what motivates people, how they

contribute to organisational success, the competences and capabilities required, the values and

culture needed to secure high performance, the current HR strategy, the way key HR programs

are focused and how current total rewards are perceived by employees. After these, a set of

total reward programs, policies and practices could be developed for planned implementation.

In deciding which of the many rewards to incorporate in the total reward strategy, managers

must weigh the strengths and weaknesses of each reward as well as considering the kind of

synergies that can be generated by combining these rewards. Understanding the rewards

preferences and the value of rewards as perceived by the workforce helps organisations adjust

the reward elements to attract and retain the necessary skill mix (Morris, 2006).

Since the 1990s, various total reward models have been developed to motivate employees to

give thier best. While each approach presents a unique point of view, all the models seem to

recognise the importance of leveraging multiple rewards, HR practices and cultural dynamics

to satisfy and engage the best employees to contribute and improve business performance and

results. Some of these models include the World at Work Total Reward Model (World at Work,

2006; The UK Cabinet Office’s Pay and Workforce Reform Team (2007); and Armstrong’

Total Reward Model (2006).

The World at Work total reward model integrates five key elements, each of which includes

programmes and practices that collectively define an organisation's strategy to motivate and

retain talents required to achieve desired business results. These five key rewards elements are

compensation; benefits; work-life; performance and recognition; and development and career

opportunities. These components are not mutually exclusive and are not intended to represent

the ways that companies deploy programs and elements within them. This model recognizes

that total rewards operate in the context of overall business strategy, organizational culture, HR

strategy and external influences such as competition. Indeed, a company's exceptional culture

or external brand value may be considered a critical component of the total employment value

proposition. The backdrop of the World at Work model represents the external influences on a

business, such as regulatory issues; cultural influences and competition. An important

dimension of the model is the exchange relationship between the employer and employee


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where successful companies realise that productive employees create value for their

organizations in return for tangible and intangible value that enriches their lives.

The UK Cabinet Office’s Pay and Workforce Reform Team (2007), developed a Total Reward

Model that organisations especially public institutions can adopt to be able to attract, motivate

and retain the most sufficient and effective workforce.

The Armstrong Total Reward Model on the other hand combines the impact of two major

categories of reward: transactional rewards and relational rewards. The transactional rewards

are tangible rewards arising from transactions between the employer and employees

concerning pay and benefits. The relational rewards on the other hand, are intangible rewards

concerned with learning and development and work experience. According to Armstrong

(2006), pay and benefits; represent transactional rewards which are financial and extrinsic in

nature and are essential to recruit and retain staff but can easily be copied by competitors.

Conversely, relational rewards are non-financial and enhances the value of transactional

rewards.

According to Thompson (2002), an analysis of the various total reward models shows that

almost all these models have certain common characteristics. For instance, they all appear to be

holistic in nature. That is, they seem to address the entire employment value proposition using

an array of financial and non-financial rewards. These total reward models are often

programmed in such a way that they are tailored to suit an organisation's own culture, structure,

work process and business objectives. Simply put, these models are best fit.

They also seem to be strategic and integrative. This is because these total reward models align

all aspect of rewards to business strategy and are integrated with other HR policies and

practices. More importantly, the various components appear to complement each other.

Whilst the total reward models proposed by Thompson (2002), seem more people-centered,

thus recognise that employees are the key source of sustainable competitive advantage and

focus on what they value in the employment relationship, they also appear customised and

distinctive. They therefore identify flexible mix of rewards that offers choice and are better

designed to meet employees' needs. These models use diverse rewards to create a powerful and

competitive employer brand that serves to differentiate the organisation from its rivals.

Following from the above literature review, it appears financial rewards are just one part of a

reward package and may not be sufficient in motivating employees for best results. It also

suggests that for an effective and beneficial exchange between employer and employee to

occur, the organisation's reward system must be all embracing, taking into consideration both

financial and non-financial rewards. A total reward concept with an underlying holistic

approach, must thus be adopted to gain a sustainable competitive advantage.

3. The Ghanaian Situation

Many reasons have been attributed to the failure of some Ghanaian organisations in their bid to

achieve their goals. Common among them is low employee motivation due to poor reward

strategies that mostly concentrate on financial rewards (Gneezy, Meier & Rey-Biel, 2011).


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Most organisations in Ghana typically place more emphasis on traditional rewards that are

typically extrinsic and financial in nature in the bid to motivate the employees to achieve

competitive advantage. These managers often pay too much attention to financial rewards at

the expense of non-financial rewards such as work/life balance, employee recognition, job

enrichment, career development, job security, and sense of affiliation, which all bear relational

and personal orientation to the work itself. More often than not, these financial rewards are not

equitably distributed and consequently employees are discontented and dissatisfied (Fehr &

Fischbacher, 2004).

Also, pay increment initiated by most organisations do not produce corresponding rise in

productivity which makes managers frustrated and disillusioned. One other worrying trend

among most Ghanaian organisations is that employees do not seem to have a say in the

composition of their respective benefit packages. Thus, one-fits-all approach to reward

management mostly does not have the desired effect because of the uniqueness of employees’

needs and wants (Bahaudin & Shandana., 2010). Still more troublesome, is the realization

that the reward that effectively motivate some workers do not succeed with others. These result

in low productivity, high turnover, poor customer service, and labour unrest which all impact

unfavourably on organisational success (Armstrong, 2006). It is therefore important for

organisations to understand what motivates their employees and reward them appropriately.

Existing literature, suggests that the African worker is more interested in the financial reward

and may not be affected by the absence of non-financial reward. Perhaps, this may be attributed

to the biblical saying that money answers all things (Ecclesiastes 10:19), as well as the high

rate of poverty associated with African communities. According to Kanungo and Jaeger (1990),

the African worker is often portrayed as being content with just having employment of any

kind rather than facing the threat of hunger from unemployment. It is however suggested that

as much as the Ghanaian worker may be interested in getting a job in exchange for financial

gains for survival, it should be noted that financial rewards alone do not necessarily motivate

the worker in employment to give up his best. It is thus argued that even though financial

reward may entice a poverty stricken person to accept a job offer, it might not guarantee good

or adequate value from the worker. The worker may irrespective of the financial reward not

give his best. It is thus crucial for managers to note that employees can be well motivated to

work without being perceived as driven purely by financial rewards.

All these challenges call for an understanding of the strategies that will truly motivate

Ghanaian workers to expend more towards the achievement of organisational goals. A study

conducted by Neghandhi (1985), in six African countries with similar work ethics and

environment as Ghana revealed that, workers in Africa and those of other countries in Europe

and America, want not only financial rewards but also non-financial rewards such as

opportunities for advancement, fair treatment, better working conditions, challenging and

interesting jobs, autonomy on the job and responsibility.

Consequently, it is suggested that Ghanaian organisations do more to make the work

environment more challenging and interesting. Cognizant of this, managers in collaboration

with human resource departments could formulate and implement total reward strategies to


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ensure that both extrinsic and intrinsic motivational needs of their employees are well met.

Ghanaian organisations could also improve their reward strategies by configuring modern

rewards that embraces everything that employees’ value. This balanced approach is more likely

to drive employee commitment towards performance and effectively engage and retain vibrant

workforce. It appears this approach, if used in reward management, could create a win-win

exchange relationship between organisations and their employees as well as advance the

overall HR and business strategies. This is because, total reward concept seems to take into

account the needs of both the organisation and its employees as it integrates compensation with

work content/context and employee growth opportunities (Armstrong, 2006).

It is further suggested that Ghanaian managers could adopt the cafeteria approach in order to

obtain maximum efforts from workers. This is because the cafeteria approach allows

employees to choose what really matters to them. Employees are thus allowed a great deal of

choice as to how exactly their benefit package should be (Griffin, 1999). The overall value is

set by the employer, but it is for employees to choose for themselves what balance they wish to

strike between the different kinds of benefits (Torrington et al, 2005). Armstrong (2006) and

Griffin (1999) shared the same view when they stated that flexible benefit schemes allow

employees to decide within certain limits on the make-up of their benefit package according to

their needs.

There are a number of reasons for considering this cafeteria approach instead of the employee

benefit schemes which limits employees to certain limited benefits without any room for

choice. Griffin (1999) for example, mentions that the flexible schemes encourage employees to

stay in the organisation longer and even help attract new employees. One way of doing this,

could be in the form of creating forums where benefits offered by the organisation could be

discussed with employees taking into consideration the uniqueness of individual needs. Even

though the success of this approach may depend on the organisation’s ability to afford, it is

suggested that organisations ensure that the various reward components are internally equitable

and externally competitive. Corporate Ghana encourage or adopt open communication system

to ensure free information flow. Corporate intranet, HR circulars, unit meetings, and shared

folders could also be used for this purpose. Most importantly, reward policy could be

effectively communicated to all employees to inform them about the various reward packages

available to them and the basis for rewarding. Also, any changes to the policy should be

communicated to forestall any negative perceptions that may arise. This is likely to promote

equity, trust, and commitment (Armstrong, 2006).

Following from the above, it seems employee involvement is one key form of recognition and

as such should be encouraged and practiced. Managers should therefore create opportunities

for employees to participate in decision-making through meetings, workshops, and retreats. It

appears reward strategies are more likely to be accepted and therefore more effective if

employees who are affected by these decisions are allowed to make inputs to their design and

implementation. Recognition of employees’ efforts should thus be a deliberate strategic

exercise for managers. As part of their key performance areas, departmental heads and unit

supervisors who have direct contact with employees could continuously look for opportunities

to recognise and appreciate employees for good ideas and work well done (Wilson (1994).


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Having regard to the literature reviewed, it is suggested that the following could be adopted

as a means of appreciating employees for good work done and motivating them to do their

maximum best for the growth and development of the organisation:

i) Besides the normal best worker or long service awards, managers could introduce

employee of the month award partly nominated by fellow employees and management. One

simple but effective way of doing this is to publish the employee’s photo in the

organisation's newsletter or on notice boards.

ii) Cultivating a culture of caring by introducing personally signed birthday cards for

employees celebrating their birthdays and wedding anniversaries.

iii) Work well done or great ideas should be immediately acknowledged by way of

praise or a simple thank you or a visible hand shake preferably in the presence of others.

iv) Consistently giving positive feedback about their work and sharing positive

feedback from customers with employees. A constructive criticism is critical to the

employee’s continuance or improvement of work but managers and supervisors should not

dwell too much on negatives as this may kill creativity and innovativeness.

v) Corporate souvenirs such as T-shirts, diaries and calendars could be given to

employees once a year. The giving of these items could serve as a means of recognising

employees as part of the organisation, as well as advocates of the organisation’s identity and

reputation, which further creates a sense of belonging.

4. Conclusion

Following from the literature review and discussion above, it appears total reward strategy is a

powerful and useful tool for motivating employees to achieve higher performance. Ghanaian

organiations could utilise total reward strategy to stay ahead of competition as it establishes

distinctive set of rewards that serve as a differentiator in the recruitment market and may be

difficult for competitors to replicate. Further, it seems the combined effect of both financial and

non-financial rewards creates a deeper and long-lasting impact on employees’ performance and

commitment towards sustainable organisational success. Non-financial rewards therefore

appears to bind employees more strongly to the organisation as they deliver positive

psychological contract that meet those special individual needs.

Acknowledgement

The authors wish to thank the University of Ghana Business School for its assistance. The

authors accept full responsibility for this article.

References

Armstrong, M. (2006), A Handbook of Human Resource Management Practice. (10th

ed.),

Kogan Page Limited, London.

Bahaudin G. M. & Shandana S. (2010), An Equitable Total Rewards Approach to Pay for

Performance Management, Journal of Management Policy and Practice, 11(4), 111.


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Deeprose, D. (1994), How to Recognize and Reward Employees. AMACOM: New York, USA.

Ecclesiastes (1996), The Holy Bible, Ecclesiastes Chapter 10, Verse 19, King James Version,

Broadman & Holman Publishers.

Fehr, E., & Fischbacher, U. (2004), Social norms and human cooperation, Trends in

Cognitive Sciences, 8, 185-190.

Griffin, R. W. (1999). Management, 6th

ed., Houghton Mifflin Company, Boston, USA.

Hutcheson, K. (2007), The Complete Package, HR Horizons, 2(1), 1-5.

Kaplan, S. L. (2007), Business Strategy and Total Rewards, Benefit and Compensation Digest,

44(9), 12-19.

Kanungo, R. N. & Jaeger, A. M. (1990), Introduction: The Need for Indigenous Management

in Developing Countries. Routledge: London.

Lawler, E. E. (2003), Treat People Right. Jossey-Bass Inc: San Francisco, USA.

Milkovich, G. T., & Boudreau, J. W. (1988), Human Resource Management, (5th

Ed.). Business

Publications Inc.: Texas, USA.

Morris, I. (2006), The Future of Work: Total Reward Strategies and Canadian’s Aging

Workforce. Rogers Media Inc.: Toronto, Canada.

Mullins, L. J. (2010), Management and Organizational Behaviour, (9th

Ed.). Pearson

Education Limited: England.

Negandhi, A. R. (1985), Management in the third world, In P.Joynt & M.Warner (eds.),”

Managing in Different Cultures, Oslo, Universeitforlaget, (69-97).

O’Neil, S. (1998), The Phenomenon of Total Rewards, ACA Journal, 7(3), 8–12.

Pfeffer, J. (1998), The Human Equation: Building Profits By Putting People First. Harvard

Business School Press: Boston, USA.

Thompson, P. (2002), Total Reward. Chartered Institute of Personnel Development (CIPD):

London.

Torrington, D., et al (2005). Human Resource Management, 6th

ed., Pearson Education Limited,

England.

UK Cabinet Office (2007), Total Reward Strategy. Available at:

www.cabinetoffice.gov.uk/workforcematters

Gneezy, U., Meier, S., and Rey-Biel, P. (2011), When and Why Incentives (Don’t) Work to

Modify Behavior, Journal of Economic Perspectives, 25(4), 191–210.

Wilson, T. B. (1994), Innovative Reward Systems for the Changing Workplace. R. R.

Donnelley and Sons Company: USA.

http://www.cabinetoffice.gov.uk/workforcematters


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WorldatWork (2006), Total Rewards Concept and Model. Available at www.worldatwork.org.






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Valuation of IPOs in India-An Empirical study

Sanjay Sehgal

Professor, Department of Financial Studies, Faculty of Commerce & Business

University of Delhi, New Delhi, India

Bhushan Kumar Sinha (Corresponding author)

Department of Economic Affairs, Ministry of Finance

Government of India, New Delhi, India


Received: July21, 2013 Accepted: August 9, 2013


Abstract

In this paper, we examine two main propositions for Indian Equity Market: (i) important

factors that determine short-run underpricing of initial public offerings (IPOs) (ii) impact of

IPOs‟ mispricing on investment banks‟ reputation. Data is employed for 432 new IPO issues

for India from April, 2001 to December, 2011. We find that 5 variables i.e. number of times an

IPO issue subscribed, number of uses of IPOs‟ proceeds, Listing Delay, Industry PE ratio and

dummy for companies representing new economies are positively related to the short run initial

return on IPOs, while 4 variables, i.e. company size , investors‟ sentiment , investment banks‟

reputation defined in terms of share in IPO proceeds and dummy for private companies‟ IPOs

bear a negative relationship with initial return. The IPOs seems to be overpriced and the Indian

market takes about 6 months to fully incorporate information for discovering the fair value of

IPOs. Mispricing of IPOs seems to negatively impact the investment banks‟ reputation in the

next period. Our results are in conformity with the previous findings of developed market. The

findings of this research have strong implications for the policy makers, market intermediaries

as well as investors. The present study contributes to the capital market literature, especially for

emerging economies.

Keywords: IPO, Underpricing, Investment Banks, Investor‟s sentiment, Short-run initial

return


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1. Introduction

In 1980s and 1990s, there was an increasing realisation on the part of the policy planners that

an efficient and well developed capital market is essential for sustained growth in an emerging

market economy like India. The capital market fosters economic growth by promoting

channelisation of real savings for capital formation and raises productivity of investment by

improving allocation of investible funds. However, it is quality of the market which determines

effectiveness of this mechanism for capital flows. Accordingly, with the view to improve the

quality of the market in terms of its efficiency, transparency and price discovery process and

bringing the Indian capital market up to the international standards, a package of reforms

comprising of measures to liberalise, regulate and develop the Indian capital market have been

implemented since early 1990s. The reforms mainly covered areas like legislative framework,

trading mechanisms, institutional support, etc.

As a result of the reforms initiated by the Government of India, primary market (including

IPOs) started emerging as one of the major source of funds for Indian companies as well as an

important avenue for retail investors to channelise their savings for higher return. A perusal of

the trend in the Indian capital market shows that as a proportion of the total resources mobilised

through primary market, the share of IPOs went up from 15.9 per cent in FY 2001-02 to 48.7

per cent in 2004-05 and then declined marginally to 39.9 per cent before reaching the peak of

85.1per cent in 2006-07. Thereafter, it exhibited a sharp decline in the next two years before it

started rising again in 2009-10 and reached the level of 50.3% in 2010-11. No doubt, on

account of temporary phases of cyclical downturn due to domestic and international factors,

there may be fluctuating trends in the IPO market. However, keeping in view the requirements

of Indian corporates and the available sources of funding, IPOs segment will continue to

remain an important component of Indian capital market in the medium to long-term horizon.

As far as IPO market is concerned, the available IPO literature indicates that there are

significant underpricing of IPOs expressed in terms of positive abnormal returns measured

from either the opening or the closing price on the first day of trading versus the offer price of

IPOs in US and other international markets. In other words, there is a significant underpricing

of IPOs. A review of the existing literature on IPOs shows that a number of studies have

already been undertaken on underpricing of IPOs for developed capital markets as discussed in

section 2 of this study. It will be interesting to examine whether the underlying factors

identified in these studies also influence pricing behavior for IPOs in an emerging market like

India. Past studies have also shown that pricing of IPOs is always an issue and one needs to

analyse factors that determine the level of underpricing especially for an emerging market like

India. A review of studies on the subject reveals that no significant attempt has been made so

far in the direction of developing a model that explains the underpricing of Indian IPOs as

discussed in Section 2 of this study. Most of the studies on Indian IPOs have mainly focused on

testing various theoretical explanations/hypotheses explaining underpricing, identifying

determinants of IPO underpricing both in the short-run and long-term performance of IPOs,

comparative studies of underpricing under fixed price and book building method of allocation

of IPOs etc. Since IPOs are now a major source for investment especially by the Indian retail

investors, and have gradually emerged as one of the important source for raising fund in the


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Indian primary market, it is important that the pricing of IPOs truly reflects the intrinsic value

of the company. With strong market fundamentals and good prospect for growth, a sound

capital market with a transparent mechanism for price discovery process for IPOs will go a

long way in leveraging India‟s potential as a preferred destination for investment by both

domestic as well as international investors. Hence from the policy perspective, an attempt has

been made in this paper to develop a model for explaining the possible level of short run

underpricing in India.

Past studies also show that investment banks with high reputation tend to underprice IPOs to a

lesser degree as due diligence by highly reputed investment banks reflect less riskiness of an

issue among the investor community. By subscribing to an IPO, investors are taking a bet on

the reputation of investment banks that have managed/co-managed the issue and hence willing

to subscribe to the issue at a lesser discount. A logical corollary to this argument is that if the

pricing of the issue is not done accurately by an investment bank, the market may penalize

them in subsequent period, which could then be reflected in terms of decline in the market

share of investment banks for the period under reference. Accordingly, it is always in the

interest of investment banks to enforce underpricing equilibrium to the extent possible. Hence,

the hypothesis relating to IPO mispricing and its impact on investment banks‟ market share

needs to be tested in case of India so that policy changes with respect to the role of investment

banks, if any, could be suggested. An attempt has accordingly been also been made in this study

to examine the relationship between mispricing by an investment bank during a given period

and change in its market share in the subsequent period.

The study comprises of 7 sections, including the present one. Section 2 of this study provides

theoretical explanation and a brief review of studies undertaken on underpricing of IPOs, both

in the international as well as Indian context. While section 3 describes the details of the data

and their sources for the study, section 4 covers performance of the Indian IPOs market over the

study period. A detailed analysis of the factors influencing short term initial return on IPOs for

developing an underpricing model is covered in section 5 of this report. In section 6, of this

study examines the relationship between investment banks‟ reputation and underpricing of

Indian IPOs. Summary and concluding remarks are provided in section 7 of this study.

2. Review of Literature

Past international studies on short-run underpricing of IPOs show that these research mainly

focused on variables/parameters which could broadly be classified under 4 categories, i.e.,

company/issue specific parameters, industry specific parameters, market specific information

and country specific macro parameters. Beatty & Ritter (1985) in their study, inter alia,

postulated the hypothesis that greater is the ex-ante uncertainty, the higher was the expected

underpricing. The authors have used (i) the log (1+no. of uses of proceeds) listed in the

prospectus and (ii) inverse of gross proceeds as proxies for ex-ante uncertainties. Both these

variables are found to be positively related to the degree of underpricing. According to Karlis

(2000), IT and other new economy industries IPOs tend to be underpriced leading to higher

initial return. This is based on the argument that industry with shorter & less informative

history will be more underpriced because there is more uncertainty about the issuing firm.


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Kooli & Suret (2001) examined ex-ante uncertainty hypothesis, underwriter reputation

hypothesis and market climate hypothesis in the context of the Canadian IPO market for the

period 1991-1998. According to this study, a negative relationship existed between the level of

underpricing vis-à-vis ex-ante uncertainty (issue proceeds used as a proxy for ex-ante

uncertainty) and the reputation of the underwriter. The results are consistent with the findings

of Beatty and Ritter as former used gross proceeds instead of inverse of gross proceeds as in the

case of latter study. Kooli & Suret have further observed that the IPOs issued during an

upswing in the stock market experienced a higher underpricing than IPOs issued during a

falling market. Guner, Onder & Rhoades (2004) examined the relationship between reputation

of an underwriter and the initial-day IPO return in the emerging market of Turkey from January,

1993 to June, 1999. The authors used two reputation measures: the first measure assumed that

two underwriters with the highest number of IPOs managed or co-managed were the

prestigious underwriter and the rest are not. This variable measured the visibility of

underwriters in the IPO market. The second reputation variable was a proxy for the volumes of

IPO business (either in dollar amount or in number) lead or co-lead by an underwriter.

According to their model, a negative relationship between the initial day IPO returns and the

visibility measures was found. This indicated that since these underwriters were well known by

the investors, they underpriced IPOs to a lesser degree. On the other hand, initial day IPO

returns was found to be positively related to the volume of IPOs indicating that the more IPOs

an underwriter handled, the harder would be to sell the shares. Therefore, these underwriters

had to underprice the issues to a higher degree.

Procianoy and Cigerza (2007) in their comparative study of IPOs in emerging markets of

Brazil, India and China used multivariate linear regression model with a mix of variables

covering IPO specific information, market related factors and macro-parameters. The variables

used are offer size, Investment bank reputation, final offer price, market performance, dummy

for goods produced using high-tech content, interest rate, FDI, GDP, inflation, etc. In this study,

the authors found market performance (before and after the issue) and the high-tech dummy

were the only variables influencing short run initial return with acceptable statistical

significance at 10% or below. The independent variables used in the multivariate analysis of

the first day trading performance of the IPOs in the Brazilian Market between January, 2004 to

April, 2007 by Faria (2007) included age of the firm, ratio of primary offer size to the total offer

size and nine key ratios: sales, growth in sales, solvency, liquidity, fixed asset turnover, total

asset turnover, return on equity, return on assets and operation profit margin. The author

observed that out of all the above independent variables, only return on equity was statistically

significant with negative correlation with underpricing. While examining the determinants of

initial IPO performance in Hong Kong and Taiwan, Lin & Hsu (2008), inter alia, found that

„allotment ratio‟ of the subscribed shares (total IPO shares issued over the number of shares

subscribed by the participants applicants) was the most consistent determinant for IPO

underpricing in both the Hong Kong as well as Taiwanese market, thereby supporting Rock‟s

(1986) adverse selection theory of underpricing .

In the Indian context, Krishnamurti & Kumar (2002) in their study analysed 386 IPOs issued

between 1992 and 1994 on the Bombay Stock Exchange and documented time-lag between


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final allotment and listing as one of the important reasons for underpricing of IPOs in India as it

increased the perceived risk of the investors and hence they demanded more return. They also

suggested but not tested that there is higher IPOs underpricing in India because of the presence

of individual and small investors, who are less informed than the large investors. Presence of a

large number of uninformed investors would require the issuers to underprice their IPOs to a

large extent to induce these investors to invest in IPOs (Rock 1986). Ghosh (2002) in his study

examined the uncertainty and signalling models of underpricing in the Indian context over the

last decade. The empirical findings showed that there existed positive relationship between

IPO underpricing and ex-ante measures of risk proxies. The relationship between underpricing

and age of the company in a simple OLS framework showed that the age of the company could

not explain the variations in the initial returns. This could possibly due to the fact that since

most of the companies that tapped the capital market were young in terms of their age, it

seemed that the Indian investors did not frame their opinion about the viability of a corporate

from its age profile. Kumar (2007) analysed the short run and long run performance of Book

built IPOs in India by performing a cross sectional regression with the short run initial returns

as dependent variable and size (the natural log of the issue size), dummy for before market

conditions and quotient of offered price to the upper price as independent variables. From the

regression results it was observed that only offer price quotient was found to be significant and

the remaining variables were not statistically significant. Pandey & Vaidyanathan (December

2008) studied the underpricing of IPOs listed on National Stock Exchange during 2004 to 2006.

The multivariate regression analysis was based on factors like dummy for demand for the IPOs,

listing delay, issue size and marketing expenditure (in millions of rupees). The results of this

study showed that the coefficient of demand is positive and significant indicating more

underpricing if the issue is finally priced towards the higher end of the price band. Similarly,

the coefficient of listing delay had a significant positive relation with underpricing. Bansal &

Khanna (2012) inter-alia analysed the factors which affected the degree of underpricing after

the global economic crisis during 2008-11. The study found a negative relationship between

variables like number of shares offered, issue size and private IPOs vis-à-vis the level of

underpricing.

Prior studies in India have focused on a limited no of variables to explain IPO underpricing and

generally cover a time horizon of 4-5 years. In the present study, we employ a comprehensive

set of macro-economic, industry, market and company related factors that may influence the

level of underpricing in India. The study also covers a longer study period from April 2001 to

December, 2011. This study period has witnessed market upswings as well as downswings due

to domestic as well as international factors and therefore covers all phases of market cycle. In

addition, the study also examines the relationship between IPO pricing error and the

Investment bank reputation, an issue which has not been addressed so far in prior literature for

India. Hence the paper fills an important research gap in equity market literature.

3. Data and Their Sources

Data for companies issuing IPOs from March, 2000 to December, 2011, have been obtained

from Prime Database, an organisation dedicated to the primary capital market covering fund

raising by the Indian corporate sector and the Government through equity, debt or


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securitisation, in India or abroad. Information obtained from the Prime Database covers

opening and closing date of issue, price band, offer price, employees share, date of listing,

closing price at the end of 1st day, 7th day, 1 month, 3 months, 6 months, details of the lead

manager/co-manager, industry/sector, uses, etc. The details of income of the company, industry

P/E ratio, date of certificate of incorporation, etc. are taken from the draft prospectus filed by

each of these issuing companies with Securities and Exchange Board of India (SEBI), the

market regulator in India. However, since there are a lot of missing data in respect of the IPOs

issued between April, 2000 to March, 2001 especially in regard to the listing and closing price

details for different moments, the reference period for this study that has subsequently been

used is April, 2002 to December, 2011 thereby covering 432 IPO issues.

The details of GDP, Wholesale Price Index (WPI) and Index of Industrial Production (IIP) for

the reference period have been obtained from the Central Statistical Organisation (CSO),

Ministry of Statistics and Programme Implementation (www.mospi.nic.in) and the Department

of Industrial Policy and Promotion (DIP&P), Ministry of Commerce and Industry website

(www.dipp.nic.in). While WPI time series data has been used to calculate the time series data

on inflation, IIP series have been used to estimate the rate of growth of industry. The implicit

yield at cut-off price for the 91 days Treasury Bills in the last week of the month immediately

preceding the month in which offers for IPOs have been closed is obtained from RBI monthly

bulletin as provided on the central bank website (www.rbi.org.in). The T-Bill yield has been

used as proxy for opportunity cost of capital. The Put-Call ratio of NIFTY index option as a

proxy for investors‟ sentiment is sourced from National Stock Exchange (NSE).

4. Review and Performance of Indian IPOs Market over the Study Period

In this study, we estimate the short term initial return for the sample IPOs as the difference

between the first day closing price and offer price. The average short run initial return for all

the 432 IPOs from April, 2002 to December, 2011 is 24.93 per cent. The short-run initial return

has come down significantly over time as shown in prior research (see Table 1). According to

Kumar (2007), this decline is probably due to the introduction of book-building process, an

important change that the public issue process has witnessed from the early nineties to the

present day. According to Pandey & Vaidyanathan (2008), the reduction in underpricing could

also be attributed in part to the change in regulation whereby the allocation to informed

institutional investors was allowed.

Table 1. Short-run performance of Indian IPOs – A comparison with prior studies

Studies Period First Day Return (after Listing)

Kakati (1999) 1993-96 34.9% (un-annualised)

Krishnamurti and Kumar (2002) 1992-94 72.34% (un-annualised)

Jaitly and Sharma (2004) 1993-94 72% (un-annualised)

S S S Kumar (2007) 1999-2006 26.35% (un-annualised)

Present studies 2002-2012 ( up to Dec. 2011) 24.93% (un-annualised)


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The year-wise pattern of short-run Initial Return on Indian IPOs over the study period is

provided in Table 2. While the first day return is with respect to the offer price, return for

subsequent periods have been estimated with respect to the first day closing price of the IPO.

An analysis of the trend in initial return across short term and medium-term time horizon (up to

6 months period) indicates that the first day initial return which is highly positive at about

24.93 per cent for the first day becomes negative and is -1.21 per cent for the 6 month period

from the issue date, excluding the first day return. The trend is also in conformity with the

international findings that as time passes and more information becomes available, divergence

of opinion between optimistic and pessimistic investors will narrow down and consequently

price will drop in the market.

Table 2. Short-run & Medium-term return on IPOs

Year IRD1 IR 7D/

day 1 closing

IR 1 month/

day 1 closing

IR 3 months/

day1 closing

IR 6 months/

day 1 closing

2002-03 0.127 0.023 0.177 0.470 1.448

2003-04 0.527 0.045 0.016 -0.004 0.057

2004-05 0.458 0.008 0.029 0.172 0.420

2005-06 0.356 0.021 0.060 0.020 -0.005

2006-07 0.170 0.012 -0.016 0.081 0.138

2007-08 0.390 -0.029 -0.055 -0.097 -0.124

2008-09 0.122 -0.072 -0.192 -0.348 -0.357

2009-10 0.054 -0.017 -0.022 -0.09 -0.010

2010-11 0.157 -0.039 -0.094 -0.082 -0.148

2011-12

(up to Dec. 11) 0.013 -0.093 -0.173 -0.204 -0.215

Overall Return 0.249 -0.014 -0.033 -0.037 -0.012

IRD1-First day initial return (calculated w.r.t. offer price), IR7D-Seventh day return (calculated

w.r.t. first day closing price), IR1 month- return at the end of 1 month (calculated w.r.t. first day

closing price), IR3 months- return at the end of 3 months (calculated w.r.t. first day closing

price), IR 6months- return at the end of 6 months (calculated w.r.t. first day closing price)

A snapshot of the IPO activities during the reference period i.e. April 2002 to December 2011

in India is provided in the Table 3 of this study. It can be observed that the Indian market saw a

steady rise in terms of IPO issues up to 2007-08. Thereafter, the market started declining on

account of global economic crises. The effect of global economic slowdown was reflected in

terms of decline in the number of IPO issues which came to the market during 2008-09 and

2009-10. Then, there was a recovery period of one year when the number of IPO issues went up

to 52 in 2010-11. The subdued IPO market of 2011-12 thereafter could be regarded as the

fall-out of impact of Euro Zone crises on India growth story as reflected in terms of decline in


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IPO issues as shown in the table. It has also been observed that the Indian companies took

advantage of the bullish phase of the Indian capital market as the period of market upturn is

followed by high issue volumes in the market. In other words, when investors are

overoptimistic, firms respond by issuing equity in a window of opportunities. The average

issue size of Indian IPOs during the reference period increased from USD 35.77 million in

2002-03 to USD 145.22 million in 2004-05. It subsequently declined to USD 33.10 million in

2005-06 and exhibited a mixed trend thereafter before reaching a peak of USD 139.67 million

in 2010-11.

Table 3. IPO activities in India –An overview

Year Avg. Issue Size

(in USD mn#)

Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis Obs.

2002-03 35.77 0.128 0.022 0.404 -0.058 0.196 0.535 1.633 6

2003-04 37.86 0.528 0.312 1.791 -0.023 0.574 1.082 3.058 18

2004-05 145.22 0.458 0.322 2.097 -0.206 0.542 1.426 4.941 22

2005-06 33.10 0.356 0.258 2.582 -0.881 0.537 1.886 8.588 82

2006-07 72.24 0.170 0.013 2.303 -0.422 0.468 1.955 8.216 78

2007-08 122.10 0.390 0.237 2.863 -0.240 0.596 1.978 7.371 84

2008-09 20.70 0.122 -0.018 1.596 -0.672 0.557 1.276 4.025 22

2009-10 131.70 0.055 0.019 0.636 -0.372 0.247 0.515 3.015 39

2010-11 139.67 0.157 0.091 1.144 -0.529 0.344 0.824 3.483 52

20011-12

(up to Dec. 2011) 36.39 0.013 -0.137 1.535 -0.731 0.573 0.723 2.927 29

# Based on average annual exchange rates

5. Determinants of Short Run Underpricing of IPOs

Linear regression model (OLS framework) has been used in this study to identify variables that

may explain the level of underpricing. To start with, initial return (dependent variable) has been

regressed vis-à-vis 20 independent variables identified on the basis of the past research. Based

on the results of bivariate regression analysis, 13 variables are identified in the first stage as

variables significantly influencing short run initial return on Indian IPOs at 20 per cent level of

significance or below. Since there are prior results hypothesising and explaining the

relationship of the shortlisted variables vis-à-vis short run underpricing of IPOs including the

direction of relationship, one tail test has been applied to check the level of significance of the

short listed variables. The internal returns are then regressed on 13 variables identified at the

first stage within the framework of multivariate regression analysis. Pair-wise cross correlation

are estimated for sample independent variables to verify whether there is an overlap among the

13 factors identified at the first stage of regression analysis. Four variables, namely CDROI

(proxy for opportunity cost of capital), D1 (dummy for offer price), IGP (inverse of gross

proceeds), INF (inflation) have been dropped due to multicollinearity problem and 9 variables

are finally selected for underpricing model as discussed below. White test has been performed

on the residuals to check the presence of Heteroscedasticity in the cross-sectional model

suggested for predicting the possible level of underpricing. It is observed that no significant

Heteroscedasticity is present and hence the OLS estimation for the proposed model is

satisfactory.


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Based on past studies, it is observed that the variables affecting IPOs underpricing could

broadly be classified into the following four categories and the variables for the present study

have accordingly been selected as shown in Exhibit A:

Exhibit A. Sample Variables used for explaining IPO underpricing

A. Company/issue related variables

IGP Inverse of the Gross Proceeds -Gross Proceeds being defined as the total number of

shares issued multiplied by the final offer price.

Uses Log (1+no. of uses uses). No. of uses as indicated in the draft prospectus.

CS Proxy for Company size /IPO Deal Size – defined in terms of the log value of the

proceeds raised through the IPO route.

IRR Insider Retention – The proportion of issued stock retained by the original owners

and/or reserved for the employees of the company as indicated in the draft prospectus.

TS Times Subscribed-no of times an issue subscribed by all class of investors.

LD Listing Delay – Defined in terms of time lag between the closing date of the offer and

listing of the issue at the Stock Exchange.

Age Age of the Company-Log value of number of years calculated from the date of

certificate of incorporation of the company to the offer date of the issue.

Offer Price Dummy for Offer Price

D1 If the final offer price is nearer to the lower end of the price band of the IPO, the

dummy will take a value of 1 otherwise 0.

D2 If the final offer price is nearer to the upper end of the price band of the IPO, the

dummy will take a value of 1 otherwise 0.

Pvt. companies

IPO

D5 - for private companies IPO. It takes a value of 1 for the private company issuing IPO,

otherwise 0.

Income Total Income of the company – Log value of the total income of the company as

reported in the prospectus for the year immediately preceding the year in which IPO

was issued.

B. Industry specific information

Industry PE ratio Industry‟s Price to Earning (P/E) Ratio – Taken as the proxy for the overall growth

potential of the industry.

C. Market related information

Investor

sentiment

Proxy for Market Investment Sentiment –The put-call ratio of NIFTY index option

taken as proxy for investor‟s sentiment in the markets.

Market Climate D3 -Dummy for market performance: If the market return (return on NIFTY index)

during the month immediately preceding the date of issue of IPO is issued is greater than

the average of the last three months (including the immediate preceding month), then the

dummy variable takes a value of 1 otherwise 0.


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Cos representing

new economies

D4- Dummy for the companies representing new economy: Biotech, pharma, telecom

media, entertainment, IT/ ITES) takes a value of 1 otherwise 0.

IBRP

IBRI

Proxy for the Investment Bank Reputation – The proxy being defined in terms of share

of an underwriter in the value of IPO business (in rupee amount) during the reference

period.

Proxy for the Investment Bank Reputation – The proxy being defined in terms of share

in IPO business defined in terms of no. of issues

D. Country Specific Macro Variables

GDP Growth GDP annual growth

Net FII Net Foreign Institutional Investment (FIIs) Inflow – Net FIIs flows during the month

immediately preceding the month in which the IPOs are issued

Inflation Inflation – Change in Wholesale Price Index during the month immediately preceding the

month in which the IPOs are issued.

IIP Industrial Growth – Represented by the IIP figures released by the Ministry of

Statistics & Programme Implementation/ Department of Industrial Production and

Policy (DIP&P), Govt. of India during the month immediately preceding the month in

which the IPOs are issued

CDROI Proxy for opportunity cost of capital - The yearly effective rate in percentage points for

the 91 days Treasury Bills issued by the RBI on behalf of the Government of India in

the last week of the month immediately preceding the month in which the IPOs are

issue

The details methodology is described as follows. As a first step the short-run initial return (IR)

is regressed vis-à-vis each of the 20 variables one at a time (bivariate regression) to analyse

their significance in explaining the level of underpricing in Indian IPO market. The results of

the bivariate regression analysis are reported in Table 4 of this study.

Table 4. Results of Bivariate Regression Analysis

The Table below shows the result of the bivariate regression analysis with IR as the

dependent variables.

Variables Co-efficient (t statistics)

CDROI -0.029323(-1.515098*)

CS -0.130401(-3.567408*)

I_Sentiment -0.382349(-2.508626*)

IBRP -0.005595(-1.332057*)

IBRI 0.005123(0.734003)

IGP 0.063896

(3.585411*)

IIP 0.003436 (0.522147)

IPE 0.003618 (2.231194*)

Income -0.096729 (-0.417389)

Age 0.039093 (0.423853)


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Variables Co-efficient (t statistics)

TS 0.011147 (11.84548*)

USES 0.193183 (1.475995*)

LD 0.019239 (3.749942*)

Net _FII 8.98E-06 (0.642232)

INF -0.026800 (-2.793067*)

IIP 0.003436 (0.522147)

IRR 0.005035 (0.698123)

GDP_Growth -0.003452 (-0.178378)

D1 -0.295059 (-3.564244*)

D2 0.046116 (0.851441)

D3 0.005035 (0.698123)

D4 0.209422 (3.663342*)

D5 -0.190367 (-1.534628*)

IR- Initial Return; CDROI – interest rate expressed in terms of 91 days GoI T – bill, CS – Proxy

for company size defined in terms of log value of proceeds raised, I_Sentiment – investors

sentiment expressed in terms of put/call ratio, IBRP – proxy for investment bank reputation in

terms of proceeds raised ; IBRI - proxy for investment bank reputation in terms of no. of issues

managed/co-managed ; IGP – log value of inverse of gross proceeds, IPE – industry PE ratio,

Income – log value of total income of the company, Age – log value of the age of company

expressed in terms of no. of years, TS - time subscribed, Uses - Log (of 1 + no. of uses), LD –

Listing Delay, Net _FII - net foreign institutional inflows, INF – inflation, IIP- industrial

growth, IRR – insider retention by employees/ original owner, GDP_growth – annual growth

rate of GDP, D1 – dummy for final offer price in the lower end of the price band, D2 - dummy

for final offer price in the upper end of the price band, D3 – dummy for market performance,

D4 – dummy for companies representing new economy, D5 - dummy for private companies

IPO.

*Variables significant at 20% level and below (One tail test).

Based on the result of the bivariate regression analysis, all independent variables significant at

20% and below level are initially shortlisted in the first stage for multivariate regression

analysis. As mentioned above, since there are prior results hypothesising and explaining the

relationship of the shortlisted variables vis-à-vis short run underpricing alongwith the direction

of relationship, one tail test has been applied to test the level of significance. Based on these

criteria, the independent parameters which qualify for multivariate modelling exercise includes

Times Subscribed (TS), Company Size (CS), Listing Delay (LD), Interest Rate (CDROI), log

value of inverse of gross proceeds (IGP), USES, Put- Call ratio taken as proxy for I_Sentiment,

Inflation (INF), Industry PE ratio (IPE), Proxy for an Investment bank reputation in terms of

value of IPO business (IBRP), Dummies for (i) Offer Price (D1) (ii) companies representing

new economy (D4) and private companies IPOs (D5). The 13 variables identified at the first

stage as detailed above are then regressed vis-à-vis initial return within the framework of

multivariate regression analysis. It is then observed that factors like CDROI, D1, IGP, and INF,

become insignificant even at 20% level because of their multicollinearity with some of the

identified variables.


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Table 5. Pairwise correlation between pricing factors

CDROI CS D1 D4

I_SENTI

MENT IBRP IGP INF IPE D5 TS USES LD

CDROI 1 -0.07619 0.035123 -0.03149 0.191211 -0.05489 0.105696 0.286417 0.010925 0.092337 -0.05938 0.057765 -0.11019

CS -0.07619 1 0.071122 -0.11796 0.061239 0.001335 -0.9031 -0.0452 0.011149 -0.15396 0.143529 -0.16479 -0.22238

D1 0.035123 0.071122 1 -0.01247 0.044616 -0.00897 -0.11439 0.124261 0.08794 0.061748 -0.16094 0.027418 -0.20962

D4 -0.03149 -0.11796 -0.01247 1 -0.06675 0.060296 0.154566 -0.06811 0.033867 0.109231 0.16059 0.094776 0.045226

I_SENTIMENT 0.191211 0.061239 0.044616 -0.06675 1 -0.2312 -0.04551 0.045454 0.147312 0.211686 0.093207 0.219737 -0.03132

IBRP -0.05489 0.001335 -0.00897 0.060296 -0.2312 1 0.00071 -0.07864 -0.07873 -0.17035 -0.02393 -0.01026 0.071672

IGP 0.105696 -0.9031 -0.11439 0.154566 -0.04551 0.00071 1 0.062248 -0.02345 0.213153 -0.17522 0.184565 0.251051

INF 0.286417 -0.0452 0.124261 -0.06811 0.045454 -0.07864 0.062248 1 -0.04505 0.090511 -0.18164 -0.14042 -0.35234

IPE 0.010925 0.011149 0.08794 0.033867 0.147312 -0.07873 -0.02345 -0.04505 1 0.014994 0.101511 0.021046 0.108089

PVTIPO 0.092337 -0.15396 0.061748 0.109231 0.211686 -0.17035 0.213153 0.090511 0.014994 1 -0.0881 0.269157 -0.07596

TS -0.05938 0.143529 -0.16094 0.16059 0.093207 -0.02393 -0.17522 -0.18164 0.101511 -0.0881 1 -0.02164 0.024527

USES 0.057765 -0.16479 0.027418 0.094776 0.219737 -0.01026 0.184565 -0.14042 0.021046 0.269157 -0.02164 1 0.111024

LD -0.11019 -0.22238 -0.20962 0.045226 -0.03132 0.071672 0.251051 -0.35234 0.108089 -0.07596 0.024527 0.111024 1


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CDROI – interest rate expressed in terms of 91 days GoI T – bill, CS – Proxy for company size

defined in terms of log value of proceeds raised, D1 – dummy for final offer price in the lower

end of the price band D4 – dummy for companies representing new economy, I_Sentiment –

investors sentiment expressed in terms of put/call ratio, IBRP – proxy for investment bank

reputation in terms of proceeds, IGP-log value of inverse of gross proceeds, INF – inflation,

IPE – industry PE ratio, D5 - dummy for private companies IPO. TS - Times subscribed, Uses

- Log (of 1 + no. of uses), LD - Listing Delay.

After taking into consideration the pair-wise correlation as provided in Table 5 of this study and

further filtering of variables, the model becomes more robust with TS, CS, I_Sentiment,

Industry PE ratio, uses, D4 and D5 at 20 per cent level of significance and below. Thereafter,

variables relating to CDROI, D1, IBRP, IGP, INF, LD are added one at a time to see their likely

impact on the overall goodness of fit of the model. It is observed that after incorporating

CDROI, D1, IGP, INF, one at a time, there is no change in the statistical parameters of the

significant variables already present in the model as well as on the overall performance of the

model. As the significance of variables have been tested at 20% level and below (one tail test),

it is observed that when IBRP and LD with „t‟ value of -1.12 and 1.15 respectively are added to

the multivariate regression model, both the variables also exhibit significant relationship

vis-à-vis short run underpricing at 20% and below (one tail test). Further, overall of

performance of the model also improves in terms of explanatory power of the model. Apart

from these 9 significant factors, additional factor(s) do not contribute to augment the

explanatory power of the model. The final result of the multivariate regression analysis is

summarised in Table 6 of this study. The sign of the co-efficients of variables of this model are

also found to be in conformity with the findings of international/ Indian studies on underpricing

of IPOs. The detailed economic explanation of the relationship between the dependent and

independent variables of the model is as under:

Times Subscribed: It is observed that TS is the most important factor affecting short run

underpricing of IPOs. This variable is positively related with short run underpricing of IPOs

with a„t‟ value of 11.691. The TS ratio is regarded as one of the important indicator of

uncertainty in the literature on IPOs. Higher the extent to which an issue is subscribed higher is

the uncertainty about getting shares allotted in oversubscribed issues. Hence, a representative

investor will submit purchase order if more money is “left on the table” in the form of higher

discount resulting into higher underpricing.

Company Size: The variable CS representing company size is found to be negatively related to

short run underpricing with„t‟ value of -4.79. The negative relationship is explained by the facts

that large IPO offers in India are expected to have less initial underpricing because they tend to

be fairly priced and a less risky.

Investor Sentiment: The investor sentiment represented by the put-call ratio is negatively

related to the short run underpricing with a„t‟ value of -2.63. This relationship is explained by

the fact that a bearish trend in the stock market represented by high put call ratio results into

lower demand for IPOs and hence higher underpricing of IPOs.


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Uses: The log value of (1+ number of uses of IPO proceeds) listed in the prospectus have been

taken as one of the important proxy for ex-ante uncertainty for an IPO issue. The greater the

number of uses listed in the prospectus of a company, greater is the uncertainty about the end

utilization of the IPO proceeds. The investor view investment opportunities in such issues risky

and therefore demands a higher level of underpricing. Accordingly, the finding of this study is

in conformity with international findings with a„t‟ value of 1.81.

Listing Delay: The LD is positively related with short run underpricing with a„t‟ value of 1.74.

As there is a delay in listing of the issue, the market starts revising its expectation about the

company resulting into higher uncertainty and the investors accordingly demanding a higher

degree of underpricing.

Industry PE Ratio: The Industry PE ratio is considered to be one of the most important

indicators of the growth potential of an industry. The positive relationship between industry PE

ratio and short run underpricing with a„t‟ value of 1.63 could be explained in terms of the fact

that the investors are not very sure whether a company accessing the IPO market with a new

issue will be able to catch up with the pace of the growth of the industry/sector expressed in

terms of high PE ratio. To compensate for this uncertainty, the investors demand a higher

degree of underpricing of IPOs.

Investment Bank Reputation: The investment bank‟s reputation defined in terms of share in

the total value of IPO business managed or co-managed by an underwriter during a given

reference period is found to be negatively related with the degree of underpricing with a „t‟

value of -1.18. When IPOs are managed/underwritten by reputed investment banks, it gives

signal to the market that there has been a proper due diligence of these issues and hence their

pricing truly reflects the fundamentals of the companies. Investors are accordingly willing to

subscribe to these issues at lower discount. Hence, an investment banks with high reputation

will tend to underprice IPOs to a lesser degree. However, the impact of investment bank‟s

reputation on underpricing of IPOs seems to be weak in our case.

Dummy D4: The dummy D4 representing the new economy companies such as IT and ITeS,

media and entertainment, telecom, biotech, Pharma etc. is found to be positively related with

the short run underpricing with a „t‟ value of 1.40. This indicates that industries with shorter

and less information history will be more under-priced as there is more uncertainty about the

issuing companies. Further, owing to the intangible nature of their assets, these companies are

difficult to value and thus expose investors to greater uncertainty.

Dummy D5: The negative relationship between the dummy D5 (representing private

companies IPOs) and short run underpricing (with „t‟ value of -2.60) indicates that there will be

less underpricing for private companies‟ IPOs vis-à-vis the public sector IPOs as the former are

perceived to be better managed with good growth potential. The majority shareholdings of the

Government in the public sector IPOs gives the impression that there will be more interference

by them in the day to day operation of such companies, and as such, the management will have

less financial and operational autonomy. This may adversely affect operational efficiency and

future growth potential of such public sector companies. The stated policy of the disinvestment

of public sector undertakings gives further impression that Government is not able to meet its


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expenditure out of its own revenue resources and hence resorting to divestment of their share in

these companies to meet the shortfall. All these factors give rise to uncertainty and hence

demand for a higher degree of underpricing by investors in case of public sector enterprises.

Table 6. Empirical Results for Multivariate Regression Model

The Table below shows the result of the multivariate regression analysis with IR as the

dependent variable. Variables Co-efficient (t statistics)

Intercept 1.942443 (4.540695)

CS -0.176552 (-4.788974)

D4 0.079010 (1.396525)

I_Sentiment -0.415502 (-2.632723)

IPE 0.002170 (1.630414)

D5 -0.289732 (-2.603667)

TS 0.010435 (11.68961)

USES 0.236813 (1.806345)

LD 0.008974 (1.737816)

IBRP -0.001041 (-1.182188)

R Squared 0.380261

Adj. R-Squared 0.362993

IR- Initial Return; CS – Proxy for company size defined in terms of log value of proceeds

raised through IPOs, D4 – dummy for companies representing new economy, I_Sentiment –

proxy for investor sentiment expressed in terms of put-call ratio, IPE – industry PE ratio, D5 -

dummy for private companies IPO, TS - time subscribed, Uses - Log (of 1 + no. of uses), LD –

Listing Delay, IBRP – proxy for investment bank reputation in terms of proceeds;

*Variables significant at 20% level and below (One tail test).

Based on the multivariate regression model developed for determining the possible level of

short run underpricing, the average predicted short-run initial returns is 26.11 % which is

higher than average actual short-run underpricing of 24.93%. This shows that the market for

Indian IPOs is overpriced and the difference of (-) 1.18 % is recovered through price correction

over 6 months period when the average return on IPOs becomes (-) 1.21%. It is further

observed that R square and adjusted R square in this model are low at 38.02% and 36.30%

respectively which are in conformity with ex-ante uncertainty hypothesis of underpricing. In

the other words if the R square was high, it would imply that the actual initial return on an

offering is predictable. The theory states that there is a positive relation between ex-ante

uncertainty and expected initial return. The reason for this positive relation is that it is difficult

for investors to predict the actual initial return for an issue coming to the market, giving rise to

the winner‟s curse problem , even though the average initial return in a large sample can be

predicted with reasonable accuracy. Accordingly, R square and Adjusted-R square ratio arrived

at in the final model of this study is consistent with the positive relationship between ex-ante

uncertainty and level of underpricing.

6. Investment Banks’ Reputation and Underpricing of IPOs


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A perusal of past research shows that proxy for an investment bank reputation has been used in

number of studies in various countries as a variable influencing the initial returns, but none of

the studies have attempted to look into the relationship between investment banks reputation

and underpricing of IPOs. However, it was Beatty and Ritter (1985) who attempted to analyse

the relationship between investment bank reputation and underpricing. Beatty and Ritter, inter

alia, have documented that investment banks will not be able to attract investors if there is

insufficient underpricing and not be able to satisfy issuers if the discount offered is too large.

Investment banks who commit new issue pricing errors experience adverse impact on their

businesses.

To test the proposition, Beatty and Ritter have split the sample of common stock issued during

1977-82 in US market into two approximately equal time period for testing the hypothesis. The

first sub-period included the 483 firms that went public between 1977 and the first quarter of

1981. The second sub-period included the 545 firms that went public between second quarter

of 1981 and 1982. They divided the sample into two periods because the proposition predicts

changing market shares, so dividing the samples into sub-period is required to test this

proposition. They have further analysed whether there is a relation between mispricing by an

investment bank and subsequent change in its market share.

To analyse the relation, they defined the “absolute standardized average residual” as a measure

of “mispricing”. For this purpose, they have first computed the predicted initial return based on

the regression coefficient arrived at while testing their first proposition in the same paper, i.e.

higher the ex-ante uncertainty higher the level of expected underpricing. Using the absolute

standardised average residuals as the measure of mispricing, they regressed the percentage

change in the market share of the investment banks in sub-period II as the dependent variable

on absolute standardized average residual for the 49 underwriters (who had 4 or more initial

offerings in the sub-period I) within the OLS framework. As observed by Beatty & Ritter, the

slope co-efficient of -10.83 per cent in their OLS regression implies that as the value of the

explanatory variable changes from 1 Standard Deviation(SD) below the mean to 1 SD above

the mean, the expected market share of investment banks drops by 27.3 per cent. With a„t‟

statistics of 1.94 on the slope co-efficient, the one tailed t value is significant at 3 per cent.

For testing the mispricing hypothesis, the model developed for predicting the possible level of

underpricing in this study is used to calculate the predicted short run initial returns, which are

then subtracted from the actual initial returns to arrive at the residuals that are termed as pricing

errors. Thereafter, based on the study of Beatty and Ritter, absolute standardised average

residual are calculated for each of the 432 IPO issues for taking them as a measure of

mispricing.

To begin with, the data is divided into 7 overlapping sub-periods of 3 years each, generated by

taking 1 year moving average. Standardised pricing error is then individually estimated for all

Investment Banks for each of the sub-periods as under:

• For each underwriter the average of absolute residual is computed after taking into account

the total number of offerings taken public by an underwriter during a given sub-period.


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• The average of absolute residual is further divided by the ratio of standard deviation of the

pricing errors of an underwriter in a given sub-period and the square root of the total number of

offerings taken public by it in the same sub-period so as to arrive at the “standardized pricing

error”.

1

| |n

peipe

pe

Sn n

……………………………………….(1)

Where, and denote standard pricing error and pricing error for each issue for a given merchant

bank observed in the three year sub-period. exhibits standard deviation of pricing errors for

each underwriter in a given sub-period. indicates the number of issues managed/co-managed

by an underwriter in a given sub-period.

As a measure of Investment Bank‟s reputation, the annual market share (defined in terms of

share in the total proceeds raised) for each Investment Bank is then estimated in a particular

year. The change in the market share is then computed by taking the difference of the market

share in the year t+1 and the average market share in 3 previous years (t, t-1, t-2) which were

also used for estimating the pricing error variables. The change in the market share is then

regressed on pricing error using the regression equation as under:

1 0 1 ,t pe t tMS S …………………………… (2)

Where, denotes change in market share in the year t+1. is the standard pricing error at time

period t. and are the co-efficient. I is the stochastic or error.

The relationship between Investment Banks‟ reputation and pricing error shall be evaluated by

examining the sign and magnitude of . Since our data is both cross-sectional (across Investment

Banks) as well as time period (across 7 sub-periods), we employ panel regression methodology

by selecting the appropriate panel data model based on Hausman Specification Test. Table 7

reports the results.

Table 7. Results for panel estimation involving regression between mispricing of IPOs and

Investment Banks‟ reputation*

Correlated Random Effects - Hausman Test

Equation: Untitled

Test cross-section random effects

Test Summary Chi-Sq. Statistic Chi-Sq. d.f. Prob.

Cross-section random 0.408191 1 0.5229

Cross-section random effects test comparisons:


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Variable Fixed Random Var(Diff.) Prob.

MISPRICING -0.112922 -0.089783 0.001312 0.5229

Dependent Variable: IBRP

Method: Panel EGLS (Cross-section random effects)

Sample: 2005 2011

Periods included: 7

Cross-sections included: 7

Total panel (balanced) observations: 49

Swamy and Arora estimator of component variances

White cross-section standard errors & covariance (d.f. corrected)

Variable Coefficient Std. Error t-Statistic Prob.

C -0.259903 0.747867 -0.347525 0.7297

MISPRICING -0.089783 0.027390 -3.277957 0.0020

Effects Specification S.D. Rho

Cross-section random 0.000000 0.0000

Idiosyncratic random 3.856437 1.0000

*The negative relationship still holds when the same methodology is used to study the

relationship between mispricing of IPOs by an investment bank vis-a-vis change in its market

share (proxy for reputation) defined in terms of its share in number of issues.

Although, the methodology followed in this study to calculate mispricing is largely based on

study of Beatty and Ritter (1985), the present study is an improvement over the former because

of the following reasons:

i. Beatty and Ritter have computed the predicted initial return based on the regression

co-efficient arrived at while testing their first proposition in the paper i.e. higher the ex-ante

uncertainty, higher is the level of expected underpricing. They have used only two proxies for

uncertainty, namely, the log value of (1+ number of uses of proceeds listed in in the prospectus)

and the inverse of gross proceeds in the regression analysis for predicting initial returns. An

analysis of the available literature on underpricing of IPOs show that factors influencing

underpricing are much more diverse and relate to company/issue specific parameters, industry

related factors, market related information and macro-economic parameters. Accordingly,

predicted initial return based on only two issue related parameters used in the regression

analysis of Beatty and Ritter makes the factor structure incomplete for underpricing model.

This also raises the possibility of gross underestimation of the initial return along with

overestimation of pricing errors. The model developed in this paper for studying the possible

level of underpricing is based on multivariate linear regression (OLS framework) in which the

initial return (dependent variable) has been regressed vis-à-vis 9 independent variables using


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multivariate regression framework. The use of multi-factor model for underpricing shall

provide better prediction of initial returns and more precise estimates of pricing errors.

ii. To test the proposition, Beatty and Ritter have split the sample of common stock issued

during 1977-82 in US market into two approximately equal length periods for testing the

hypothesis as mentioned above. The two period methods assumes that these variables are

stationary and regression results may, therefore, give static estimates of investment bank

reputation and mispricing. As these parameters are dynamic in concept, the result of the

regression analysis may be biased because the independent variable in the model may have

measurement error problem. To address this issue, the reference period for the present study

has been divided into 7 sub-periods of 3 years each for calculating the mispricing of IPOs by

investment banks on a rolling average basis. Similarly the change in the market share during a

given year has been calculated vis-à-vis the average of 3 consecutive preceding years. This is

based on the presumption that investors, on an average, have a 3 years‟ past memory of average

mispricing of IPOs by investment banks. It is further presumed that investors take into

consideration this period into consideration while deciding to subscribe to a particular issue

managed/ co-managed by investment banks in the subsequent period. As mentioned above, the

change in the market share is then computed by taking the difference of the market share in the

year t+1 and the average market share in 3 previous year (t, t-1, t-2) which were also used for

estimating the pricing error variables.

iii. While Beatty and Ritter estimate the relationship between pricing errors and investment

bank‟s reputation using OLS regression, our estimation procedure involves use of panel

regressions which is more desirable. Panel regressions involve data pooling across

cross-section as well as time-series and hence model coefficients are estimated at a higher

degree of freedom.

As mentioned above, the change in the market share is regressed on pricing error using the

regression equation (2) above. The Correlated Random Effects-Hausman Test conducted to

check the applicability of the fixed or random effect indicates the „p‟ value as 0.5229 (> 0.05).

This shows that the null hypothesis holds in the case and the random effect method is to be

applied for the regression analysis. Accordingly, panel EGLS (Cross Section Random Effects)

method is used to regress change in the market share (proxy for investment bank reputation

IBRP in terms of share in IPO proceeds) on mispricing as the independent variable and a

negative relationship is confirmed with a coefficient and t value of mispricing being -0.089 and

-3.28 (p value of 0.002) respectively. In other words, if an investment bank misprices an issue

by 1 % during a particular period, it will lose its market share by around 9 % in the subsequent

period. The summary of the regression analysis is reported in Table 6 of this study.

7. Summary & Conclusion

In this paper, we covered 432 IPO issues from April, 2001 to December, 2011 for India. Two

propositions were specifically examined:

i. Fundamental determinants of short run initial returns;

ii. Impact of IPOs‟ mispricing on investment banks‟ reputation.

We find that 5 variables i.e. times subscribed (TS), no of uses of IPO proceeds (USES),


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Listing Delay (LD), Industry PE ratio (IPE) and dummy for companies representing new

economies (D4) have a positive relationship with short run initial return, while 4 variables, i.e.

company size (CS), investors‟ sentiment (I_Sentiment), investment bank reputation defined in

terms of share in IPO proceeds (IBRP) and dummy for private companies‟ IPOs (D5) are

negatively related to initial return on IPOs. The results are in conformity with prior literature

on the subject. Our multi-factor model projects an average initial return of 26.11% for the

sample IPOs while the actual average initial return was 24.93%. The Indian IPOs seemed to

be overvalued initially and as more information flows into the system reducing the degree of

uncertainty, the pricing moves back to the equilibrium value resulting in a negative return

between the second trading days to the end of 6th month. Thus the Indian market takes about

6 months to fully incorporate information relating to IPOs. From the policy perspective, with

a view to control excess speculation in the short run, the Government may consider a

lock-in-period of 6 months for IPOs, till the time they are able to achieve their equilibrium

value. In other words, public trading of newly listed IPOs may begin six months from the

listing date. In addition, the capital market regulator may recommend a comprehensive model

as a benchmark for determining the fair pricing of IPOs. It is further observed that IPOs

mispricing significantly impacts Investment Banks‟ reputation and hence pricing of IPOs has

long term implications for policy makers, market intermediaries, as well as investors.

The present study contributes to the capital market literature, especially for emerging

economies.

References

Bajpai, G. N. (2004). A Historical Perspective of the Securities Market Reforms in India. SEBI

Bulletin, 2(4). SEBI.

Bansal, R., & Khanna, A. (2012). Determinants of IPO Underpricing: An Empirical Evidence

from Bombay Stock Exchange after Stock Market Crisis. Retrieved from

http://ssrn.com/abstract=2041158 .

Beatty, R. P., & Ritter, Jay R. (1986). Investment banking, reputation, and the underpricing of

initial public offerings. Journal of Financial Economics,15(1-2), 213-232.

http://dx.doi.org/10.1016/0304-405X(86)90055-3

Vos, E., & Cheung, J. (1992). New Zealand IPOs Underpricing: the Reputation Factor. Small

Enterprise Research, 1(1). 13-22. http://dx.doi.org/10.5172/ser.1.1.13

Faria, E. (2007). Underpring of Brazilian Initial Public Offerings. Master Thesis, Umea School

of Business and Economics.

Ghosh,S.(2002). Underpricing of IPOs: The Indian Experience over the Last Decade.

Retrieved from http://ssrn.com/abstract=336041.

Gunar, N., Onder, Z., & Rhoades, S.D. (1999).Underwriter Reputation and Short Run IPO

Return: A Revaluation Factor for an Emerging Market. Retrieved from

http://ssrn.com/abstract=495742 or http://dx.doi.org/10.2139/ssrn.495742

Karlis, P. (2000). IPO Underpricing. The Park Place Economist, 8. Retrieved from

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http://digitalcommons.iwu.edu/parkplace/vol8/iss1/17.

Kumar, S. S. S. (2007). Short and Long-run Performance of Book built IPOs in India.

International Journal of Management Practices & Contemporary Thoughts, 2(2). 20-29

Kooli, M., & Suret, J. M. (2001). The Aftermarket Performance of Initial Public Offerings in

Canada. Journal of Multinational Financial Management, 14(1), 47-66.

http://dx.doi.org/10.1016/S1042-444X(03)00038-0

Lin, Chien Ting, & Hsu, Shou-Ming. (2008). Determinants of Initial IPO performance:

Evidence from Hong Kong and Taiwan. Applied Financial Economics, 18. 955-963.

http://dx.doi.org/10.1080/09603100701367393

Ljungqvist, A., & B. Espen Eckbo (2006). IPO Underpricing: A Survey. Handbook of

Corporate Finance: Empirical Corporate Finance, A.

Murthy, K. V. B. & Singh, A. K. (2008). IPO Pricing: Informational Inefficiency and

Misallocation in Capital Market. Retrieved from http://ssrn.com/abstract=1303409

Pandey, A., & Vaidyanathan, R. (2008). Determinants of IPO Underpricing in the National

Stock Exchange of India. Retrieved from http://ssrn.com/abstract=1081272

Procianoy, J. L. & Cigerza, G. C. (2007). IPOs in Emerging Market: A Comparison of Brazil,

India and China. Retrieved from http://ssrn.com/abstract=968300.

Ritter, J. R. (1998). Initial Public Offerings. Contemporary Finance Digest, 2(1). 5-30.

Ritter, J. R. (2002). A Review of IPO Activities, Pricing and Allocation. National Bureau of

Economic Research, (NBER) Working Paper Series No. 8805. Retrieved from

http://www.nber.org/papers/w8805.

Reports/Surveys

SEBI Annual Reports

Economic Surveys

Websites

www.sebi.gov.in

www.rbi.org.in

www.mospi.nic.in

www.dipp.nic.in

www.moneycontrol.com

www.chittorgarh.com



http://digitalcommons.iwu.edu/parkplace/vol8/iss1/17



http://www.nber.org/papers/w8805

http://www.sebi.gov.in/

http://www.rbi.org.in/

http://www.mospi.nic.in/

http://www.dipp.nic.in/

http://www.moneycontrol.com/

http://www.chittorgarh.com/


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Determinants of Profitability of Indigenous Chickens in

Swaziland

Bongani J. Siyaya

P.O. Box 4305, Manzini, M200, Swaziland

Micah B. Masuku (Corresponding Author)

Department of Agricultural Economics and Management

P. O. Luyengo, Luyengo. M205. University of Swaziland, Swaziland




Abstract

As a move towards ensuring food security and income generation, the Ministry of Agriculture

advocates for the commercialisation of indigenous chickens. In 2008, the ministry embarked

on a commercialisation training programme. The main purpose of the study was to conduct an

economic analysis of the indigenous chickens’ production in Swaziland, as well as factors

affecting profitability of indigenous chickens’ production. Using a stratified random sampling

technique, the study used primary data from a sample of 147 smallholder poultry farmers who

have been trained by poultry officers on indigenous poultry production in the four regions of

Swaziland. A cost - benefit analysis was used to determine profitability and the Cobb Douglas

production function was used to identify factors affecting profitability of indigenous chickens.

The results revealed an adjusted R2 of 0.85, hence the variables in the model explained 85% of

the variation in profitability. The results further showed that profitability of indigenous

chickens was E0.40 per E1.00 of feed costs. Feed cost, market price, stock size, number of

birds sold and number of birds consumed significantly (p< 0.10) affected profitability.. It is

recommended that farmers organize themselves to take advantage of discounts when

purchasing feed. The Swaziland Government need to construct a hatchery, mini - abattoir and

storage facilities per region to improve the production of indigenous chickens. The hatcheries

can allow farmers to use incubators to improve hatchability. Farmers can also use the abattoirs

to slaughter and dress their chickens and then store them in cold storage for sale. Research on

market size and spread should be undertaken to determine the demand patterns of indigenous


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chickens.

Keywords: Commercialisation, Indigenous chickens, Profitability, Poultry production.

1. Introduction

1.1 Agricultural Production in Swaziland

Agriculture is traditionally the backbone of Swaziland’s economy and a major source of

employment for rural households with over 70% of the population relying on this sector for

their incomes. The diverse agricultural activities that take place in the country include the

production of sugarcane, citrus fruits, and maize, cotton, forestry and livestock. Swaziland’s

agricultural sector is divided into two sub-sectors namely; formal and informal or subsistence.

Subsistence farming is mainly practiced on Swazi Nation Land (SNL), which is about 60

percent of land on Swaziland (MOA, 2012). It is acquired in terms of Swazi law and custom.

While agricultural activities in these areas may be carried out for subsistence purposes, efforts

are made to encourage SNL farmers to practice commercial farming (Thompson, 2012).

According to Thompson (2012) the formal agriculture embraces the large sugarcane and citrus

estates, forestry and other undertakings on individual tenure farms (ITFs), which generate

foreign exchange earnings. It covers about 40 percent of the land in Swaziland.

1.2 Indigenous Poultry Production

The Ministry of Agriculture (MOA) promotes poultry production and emphasises on broiler

production, egg production and the production of indigenous chickens. The MOA (2012)

reported that indigenous poultry production is a fast growing industry in the country. The

indigenous poultry farmers have been encouraged to commercialise in order to improve their

livelihoods in terms of food security, poverty alleviation, income generation and as a drive

towards self-sufficiency in poultry and poultry products. According to Thompson (2012) the

livestock development policy emphasises the commercialisation of cattle, poultry and pigs in

particular, as well as goats in order to create employment and attain food security in the rural

areas.

The most common type of poultry kept in rural households is chicken (Gallus domesticus)

species (Masuku, 2011). Many farmers keep chickens for meat consumption purposes. In the

past chickens were exposed to scavenging systems for feed and had minimal supplementary

feed. There was no provision for housing, thus they were characterized by low input and low

output. Masimula (2004) noted that surveys indicated that 91% of families in rural areas of

Swaziland raise chickens. In Swaziland, indigenous chickens are kept through subsistence

farming practices by almost all the households, with a minimum of at least five birds per family

(Thwala, 2012). Like in other developing countries, Swazi farmers use family labour and

occasionally use commercially available feeds. The chickens are kept under scavenging

production systems with limited application of management interventions to improve

productivity. Thwala (2012) argued that indigenous poultry production is of great importance

to smallholder farmers, but they face the challenge of improving productivity of their flock

which could have financial benefit and promote food security as well as achieve market

potential.


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Currently, consumers opt for organically produced meat from indigenous chickens (Ondwasy

et al., 2006) than meat from broiler chickens. The demand for exotic chickens is declining

worldwide due to a majority of the consumers opting of meat for indigenous chickens.

According to Ondwasy et al. (2006), commercialisation of indigenous poultry production is

therefore timely in terms of meeting the unmet market demand. Commercial indigenous

poultry production is a fast supplementary income-generating enterprise for rural farmers.

Though, there are opportunities for exports of indigenous poultry products, the traditional

poultry marketing channels need to be clearly defined (Thwala, 2012). Indigenous chickens are

ready for marketing at six to eight months and they do not require high financial and technical

inputs. There is no formal or organized market for indigenous chickens and as a result, farmers

of indigenous chickens compete unfairly with broiler chicken farmers, thus forcing indigenous

chicken farmers to lower their prices. However, the demand for indigenous chickens is still

high. Many restaurants and food outlets now serve indigenous chicken meat though, only in

limited amounts (MOA, 2012).

1.3 Profitability of Agricultural Produce

The Agricultural Marketing Resource Centre (AMRC) (2013), on its analysis of agriculture

and rural development defined profit as the excess of income over costs. Profitability was

described as the measure of the returns a business creates after deducting operating costs and

other expenses from income divided by inputs. Though determining profitability may be the

most challenging task, it is also a very rewarding part of a new agricultural enterprise. The use

of the income statement and sensitivity analysis helps to determine profitability of an enterprise.

An income statement measures profitability by recording the costs of production and the value

of production for a set period of time, usually a year (AMRC, 2013).

Chase (2008) noted that producers often try to maximize their income by selling produce

directly to consumers through various marketing outlets where the highest price of the product

can be received. Even though this strategy may allow producers to achieve the highest gross

revenue, it may not yield the highest profit because of the differences in transaction costs.

According to Chase (2008), products are generally priced based on customers demand

competition and costs. Most farmers use the cost based strategy, which is the strategy that

determines profit based on cost. This also requires a budget to be developed for each product

that contributes to the overall profitability of the business. The budget needs to include all costs

of production and transaction costs from the farm or business. Secondly, the profit margin or

percentage should be added to help cover family living and other overhead costs.

1.4 Factors Affecting Profitability of Indigenous Chickens

Natukunda, Kugonza and Kyarisiima (2011) in their study to determine factors affecting

marketing and profitability of indigenous chickens in Uganda used a two stage sampling

involving purposive random sampling technique to select 100 chicken farmer households. In

the study, they found that indigenous chickens were profitable and profit was found to be 5000

Ugandan shillings (UShs) per bird sold. The factors that affected profitability were: total

average costs; distance to the nearest market; access to extension services; education level and

experience of the farmer (Natakunda et al., 2011).


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Hossen (2010) conducted a study on the effect of management interventions on the

productivity and profitability of indigenous chickens in Bangladesh. It was found that

households earn a minimum profit of US$ 47.3 per annum. It was also noted that with the

management interventions such as chick separation and creep feeding of chicks, egg

production was increased and mortality of local chickens was reduced. This resulted in the

increase of the family or household income from US$ 47.3 to US$ 342 per annum. Hossen

(2010) further concluded that weaning of chicks, feed supplementation of broody hens during

incubation and the creep feeding system of management may have formed a basis of the

increasing egg production and survival of the indigenous chickens, which eventually leads to

enhanced productivity and profitability of family poultry in Bangladesh.

Dutta, Islam and Kabir (2013) investigated the production performance of indigenous chickens

in selected areas of Rajshali, in Bangladesh, using a stratified random sampling technique from

six districts. In their study, profitability was calculated using a cost-benefit ratio and it was

estimated at US$ 0.24 and US$ 0.19 per family and per bird respectively (Dutta et al., 2013). It

was concluded that raising indigenous chickens was a feasible and efficient enterprise, which

required better understanding of the socio-economic aspects of the small scale poultry farmers

in urban, semi-urban and rural areas of Bangladesh.

Debbie Cutting, Technoserve Director (Swazi Observer, 31 July 2012) in a study of the key

market dynamics and profit drivers of the indigenous chickens industry in Swaziland, noted

that profitability was affected by four key drivers, namely: vaccination costs, transportation

costs, costs of supplementary feed and the selling price per unit of an indigenous chicken. She

also pointed out that these key drivers vary from one farmer to the other. She emphasised that

overspending on supplementary feed eroded more than 50% of the revenue generated by the

producers and more than 25% of the revenue were spent on transport costs (Swazi Observer, 31

July 2012).

1.5 Statement of the Problem

Sohngwe (2009) reported that farmers who are producing village chickens commercially in

Swaziland were happy with the profit margins they get when selling their chickens. The

demand for organic food and village chickens produced organically was reportedly high. Due

to the limited supply of village chickens in the market, consumers would pay a premium for

them. Whenever available, the catering industry and supermarkets were failing to get suppliers

of village chickens in Swaziland and were unable to satisfy customer demand. Indigenous

chicken production in Swaziland offers prospective and current chicken producers and

entrepreneurs good business opportunities. Indigenous chicken production also offers the

small-scale chicken producers an escape route from the congested and highly competitive

broiler production business in Swaziland. Furthermore, Dlamini (2012), the Minister of

Agriculture, as quoted by the Swazi Observer (June 8, 2012), noted that most small-holder

indigenous poultry farmers were commercialising the industry. He further noted that this was

one endeavor to mitigate food insecurity in the country and to create wealth for the farmers

themselves as indigenous chickens tend to generate more revenue. However, what is still

uncertain is the profitability of indigenous chickens and the factors affecting their profitability.


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1.6 Objectives of the study

The purpose of the study was to assess the economic performance of indigenous chickens

reared by smallholder farmers in Swaziland. The specific objectives of the study were to: (1)

Characterise indigenous poultry farmers; (2) Determine the profitability of indigenous

chickens; and (3) Identify factors affecting profitability of indigenous chickens.


2.1 Research Design

The study involved a descriptive research using quantitative approaches. It sought to determine

the profitability of indigenous chickens and further identify factors affecting their profitability.

2.2 Sampling and Data Collection

The target population for the study was active smallholder farmers of indigenous chickens in

Swaziland that had been trained by poultry officers on the commercialisation programme

between 2009 and 2011. From the population of 729 farmers obtained from a list of farmers

trained on the commercialisation programme in the four regions of Swaziland, 147 farmers

were sampled using stratified random sampling technique. Data were collected using personal

interviews by an aid of structured questionnaire.

2.3 Data Analysis

Data were analysed using STATA version 10 software. The profitability of indigenous chickens

was analysed using descriptive statistics (means, standard deviation, minimum and maximum

values). The Cobb Douglas regression was used to analyse the factors affecting profitability of

indigenous chickens.

2.4 Analytical Framework

Profitability of the indigenous chickens industry was determined as a ratio of profit to total feed

costs. This is because feed costs are major operational costs in the production of poultry,

amounting to about 60%. Thus:

Profitability = Output

Input

Hence:

Profitability of Input X = Profit – Input X

Input X

Therefore:

Profitability of Feed cost = Profit per year - Total feed costs per year

Total feed costs per year


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The empirical analysis of profitability of indigenous chickens was based on the estimation of a

Cobb-Douglas production function in which both the output and inputs were expressed in

logarithmic form. The Cobb-Douglas functional form is widely used to represent the

relationship of an output to inputs (Bravo-Ureta & Pinheiro, 1997). According to Khai and

Yabe (2011) there are many functional forms for estimating the physical relationship between

inputs and output, but the Cobb-Douglas functional form is preferred to other forms, especially

if there are three or more independent variables in the model. The Cobb-Douglas production

function was used to explain the relationship between the dependent variable (profitability of

indigenous chickens) and explanatory variables (factors affecting profitability) and was stated

as follows:

q = f (k, l) = A k α

l β,

Where A, α , β are constants.

The Cobb-Douglas production function for the profitability of indigenous chickens is defined

by the general model, Y, to a given set of resources, X, and other conditional factors are given as

follows:

Y = β0X1β1

X2 β2

X3β3

X4 β4

… X6 β6

µV-U

This function is linearised in order to be able to use the least squares estimations, hence the

following regression specification:

lnYi = α + β1 lnX1 + β2 lnX2 + β3 lnX3 + β4 lnX4 + ……. β6 lnX6 + µ;

Where: Yi = Profitability (profit per feed cost) in Emalangeni;

X1 = Total number of chickens produced per year by the farmer (stock size);

X2 = Total number of chickens sold by the farmer per year;

X3 = Total number of chickens consumed by the household per year;

X4 = Market price per unit of chicken;

X5 = Total vaccination costs per year;

X6 = Total costs of feed per farmer in Emalangeni;

µ = Random error term;

βi = coefficients of the independent variables Xi.

2.5 Explanation of Variables and A Priori Expectations

Profitability (Y): This is the dependent variable and it is measured by profit per feed cost. The

assumption made is that profitability is determined by the variables on the regression model.

Table 1 presents the a priori expectations of the independent variables.

Stock size (X1): Total number of chicken units produced in a year. It is expected to have a

significant and positive effect on profitability because the higher the stock size, the higher the


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probability to sell.

Total number of chickens sold (X2): A positive and significant relationship is expected between

profitability and number of chickens sold.

Total number of chickens consumed (X3): A negative but significant effect is expected between

consumption and profitability.

Market price per bird (X4): This is the average market price of indigenous chicken. Demand for

food commodities is inelastic, so a positive relationship between price and profitability is

expected.

Vaccination costs (X5): These are costs incurred due to diseases or parasites. They increase

total costs and reduce profitability. A negative relationship between vaccination costs and

profitability is expected.

Feed costs (X6)): This refers to total feed costs of producing indigenous chickens and major

costs of production. A significantly negative relationship between feed costs and profitability is

expected.

Table 1. Variables and Expected signs

Variable Expected Sign

Stock size +

Total number of chickens sold +

Total number of chickens consumed -

Market price per bird +

Vaccination costs -

Feed costs -


3.1 Characteristics of Respondents

Table 2 shows the characteristics of respondents according to age, gender, level of formal

education and marital status. Of the 147 respondents that were interviewed, 66% were females

and 34% were males. This is because in most homesteads, males are always at work and not at

home and most of the farming activities are done by women. Therefore, the majority of

indigenous chickens’ farmers were women. Most of the men were those that had retired from

work, thus keeping indigenous chickens in order to earn income. The results in Table 2 also

show that 26% of the respondents were farmers who were above 60 years old. This includes the

group of farmers who were pensioners, and have retired from employment. Twenty one percent

of the respondents were 50 to 59 years old and above, while 27% had a range of 40 to 49 years

old. Twenty four percent of the farmers were aged 30 to 39 years old and only 2% of the

respondents were aged less than 30 years.


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Table 2. Characteristics of Respondents

Variable Frequency Percentages

Gender

Males 97 66

Females 50 34

Age

20 – 29 years 3 2

30 – 39 years 36 24

40 – 49 years 39 27

50 – 59 years 31 21

Above 60 years 38 26

Marital Status

Single 16 11

Married 110 75

Divorced 0 0

Widowed 21 14

Educational Level

Primary 45 31

Secondary 52 35

High School 35 24

Tertiary 5 3

None 10 7

According to the results in Table 2, only 11% of the respondents were single, while 75% were

married and 14% were widows. The results show that only 7% of the respondents did not have

formal education, while 31% of them attended up to primary level of formal education and

35% reached secondary level. Twenty four percent of the respondents completed high school

and 3% had tertiary education. Table 3 further indicates that the average age of the farmers of

indigenous chickens was 49 years. This is because the industry is dominated to a greater extent

by adults who are the home owners and most of them are pensioners or retired. The youngest

farmer was 28 years old and the oldest was 74 years old. The farming experience of the farmers

was 12 years on average, ranging from zero years to 50 years of farming experience.

3.2 Description of the Variables

As shown in Table 3, the average household size was 5 persons with a range of 1 person to 11

persons per household. All farmers of indigenous chickens were found on Swazi Nation Land

(communal land tenure). The average land size allocated per farmer was 3 hectares (ranging

from 0.5 ha to 10 ha). Stock size the previous year (2012) varied from 6 chickens to over 300

chickens with a mean of 71 chickens. The current year stock size showed an overall significant

decline to a mean of 41 chickens per farmer due to prevalent challenges, especially the high

cost of feed. Losses of chickens due to theft stood at about 4 chickens per farmer and chickens

that died due to diseases, predators and weather averaged at 28 chickens per farmer per year.


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Vaccination costs per farmer averaged at E87.16 per year; ranging from zero for subsistence

farmers who used locally available medicines to control diseases, and was E505.00 for more

commercialised farmers. Almost all of the farmers interviewed provided their chickens with

supplementary feed and the average feed cost was at E2459.14 per year. Subsistence farmers

spent at least E200 on feed, while commercialised farmers spent E9000.00 on feed per year.

The cost of breeding stock (hen and cock) costed E66.00 on average, while the most expensive

cock was bought at E200.00. The maximum price for a hen of E120.00 was reported. The

average price of a cock was at E78.00, while the average price of a hen was E54.00. The

average chicken price at the market was E60.00, with a range of E35.00 to E150 maximum per

bird. Flea markets to which farmers sell their chickens were located 22 km away from the

farmers, with a minimum of 1km to 95 km away. Farmers far away from flea markets

complained of high transport costs that reduced their returns as they had to hire cars to the flea

market.

Table 3. Description of the Variables used in the Study

Variable Mean Std. Dev. Min Max

Farmer’s age (years) 49.453 12.394 28 74

Farming experience (years) 12.672 10.835 1 50

Commercial farming exp. (years) 2.9297 2.498 0 21

Household size (persons) 5.472 2.214 1 11

Vaccination costs (E) 87.164 98.345 0 505

Total land size (ha/farmer) 2.949 1.656 .5 10

Land size used by chickens (ha) 2.073 1.129 .4 6

Land tenure (1for SNL; 2 for TDL) 1 0 1 2

Supplementary feed (1= yes; 2 = no) 1.102 .303 1 2

Current stock size (number) 41.898 25.634 10 115

Previous years’ stock size (number) 71.266 53.154 6 316

Previous year feed cost (E) 2459.141 1796.683 200 9000

Off-farm income (1= yes; 2 = no) 1.125 .332 1 2

Breeding stock price (E) 65.992 30.523 0 200

Market price (E) 59.922 19.042 35 150

Extension service (1 = yes; 2 = no) 1.484 .502 1 2

Cooperative membership (1= yes; 2= no) 1.3125 .465 1 2

Production training (1 = yes or 0 = no) 1 .178 0 1

Flea market distance (Km) 22.27344 15.41485 1 95

Stolen chickens (Number) 4.425197 6.533819 0 36

Mortality of chicken (Number) 27.89063 31.87901 0 198

Sales rate (percentage proportion) .3412578 .2704177 0 1


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Even though most farmers were not working, they had off-farm income from children’s support

and husbands support as most farmers were found to be women who had no formal

employment, but housekeepers. All the farmers agreed that they had received training on

indigenous chickens through poultry officers from the regional agricultural offices and from

some parastatal organizations such as SWADE. About 50% of the farmers reported to be

receiving extension service in their areas, while the others claimed they never received

assistance from extension officers. Most of the respondents were either members of

cooperatives or were organised in some way to easily access production training and market

information.

3.4 Profitability of Indigenous Chickens

The profitability of indigenous poultry production was analysed using descriptive statistics

(means, standard deviation, minimum and maximum). These were used to determine viability

of the indigenous chickens as a business. Profitability is described as a ratio of returns or

income to feed costs. Table 4 presents the results of profitability of indigenous chickens.

The mean total returns were estimated at E3539.96 per year and the mean total costs per year

were E2546.31. This shows positive returns from the indigenous chickens industry. The

minimum profit figures were negative because most farmers had no or very low sales per year

(subsistence farmers). The profit figure shows a positive mean of E993.66 and profitability of

E0.40 per bird. This means that for every E1.00 spent on feed which is the primary cost, there is

E0.40 return earned by the farmers, which indicates that indigenous chicken farming is a viable

and profitable enterprise.

Table 4. Profitability of Indigenous Chickens

Variables Mean Std. Dev. Min Max

Total returns (E) 3539.96 4314.45 0 29200

Total costs (E) 2546.31 1848.46 200 9120

Profit (E) 993.66 3867.45 -3976 25022

Profitability (E) 0.40 4.69 -2.05 38.92

US$ 1 = E9.80 (July, 2013)

3.5 Factors Affecting Profitability of Indigenous Chickens

The Cobb-Douglas production function was used to identify the factors that affect profitability

of indigenous poultry production. The results in Table 5 show that the model was able to

explain 85% of the variation in profitability as a result of the independent variables (Adjusted

R- squared = 0.847). This indicates that the model represents a fair goodness of fit between the

profitability of indigenous chickens and the explanatory variables. The tabulated F value is

26.75 at (6, 22) degrees of freedom and the calculated F – value is 26.75 and it also explains a

significant relationship between profitability and the explanatory variables.


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Table 5. Factors Affecting Profitability of Indigenous Chickens.

Variable Coefficient Std. Err. t-value P – Value

Vaccination costs -0.39 0.242 -1.59 0.126

Feed costs -2.18*** 0.205 -10.59 0.000

Stock size 1.64** 0.581 2.82 0.010

Market price 3.37*** 0.485 6.95 0.000

Number of chickens consumed 0.01* 0.003 2.14 0.044

Number of chickens sold 0.50* 0.261 1.91 0.069

Constant -2.80 0.921 -3.04 0.006

F (6, 22) = 26.75; Prob > F = 0.000; R – Squared = 0.880; Adjusted R – squared = 0.846;

*** = significant at 1%; **= significant at 5%; *=significant at 10%.

The costs of feed and market price were found to be significant (p< 0.01) factors of profitability,

whilst costs of vaccination were found to be insignificant. Total feed costs over the year were

significantly (p< 0.01) related to profitability. The results show that when feed costs are

increased by one percent, profitability declines by 2.18%. This result corresponds to the a

priori expectation in relation to feed cost. The results further suggest that there is a significant

(p< 0.01) and positive relationship between profitability and market price of chickens as

expected. This implies that a one percent increase in price of indigenous chickens amounts to

3.37% increase in profitability. Food commodities demand is inelastic, so increase in market

price does not reduce consumption. The higher the number of chickens sold by the farmer, the

greater the returns and the greater the profit earned per farmer given total feed costs. The

previous year stock size was found to have a significant (p< 0.05) relationship with profitability.

An increase in stock size by 1% would increase profitability by 1.64%. The higher the number

of chickens kept, the more chickens available to sell. When the total number of chickens

consumed per year increases by one percent, profitability increases by 0.01%. Though the

results show that there is a significant (p< 0.1) relationship between consumption and

profitability, profitability does not increase when consumption increases. The number of

chickens sold was significantly (p< 0.1) related to profitability. A percentage increase in the

number of chickens sold results to 0.5 percent increases in profitability. The result was not

expected. The possible reason for such a result could be that chicken consumed are regarded as

returns and not as costs.

4. Conclusions and Recommendations

4.1 Conclusions

The study has shown that indigenous chickens are profitable. Therefore, the null hypothesis

that indigenous chickens are not profitable is rejected. The profitability of indigenous chickens

was affected by feed cost, previous year stock size, market prize, the number of chickens

consumed and number of chickens sold.


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4.2 Recommendations

There is a lack of an organized market for indigenous chickens. Further studies should be

conducted to determine the market size and potential for indigenous chickens. Demand and

consumption patterns also need to be verified statistically to improve profitability of

indigenous chickens. In order for farmers to improve profitability, they need to form

associations, produce their own feed or buy feed in bulk so that they benefit from discounts

associated with buying in bulk. Further studies should also be conducted to identify alternative

markets for indigenous chickens.

References

AMRC. (2013). Agriculture and Rural Development Profitability: Will it Make Profit.

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business/finance/profitability, 16/01/13.

Ary, D., Jacobs, L.C., & Razavieh, A. (2002). Introduction to Research in Education. Belmont,

CA: Wadsworth/Thomson Learning.

Bravo-Ureta, B., & Pinheiro, A. E. (1997). Technical, economic, and allocative efficiency in

peasant farming: evidence from the Dominican Republic. The Developing Economies 35,

48-67. http://dx.doi.org/10.1111/j.1746-1049.1997.tb01186.x

Chase, C. (2008). Pricing for Profit. Agricultural Marketing and Resource Centre. USA.

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Dornbusch, R., Fischer, S., & Startz, R. (2008). Macroeconomics. Tenth Edition. McGraw Hill

International Edition.

Fowler, F.J. (2002). Survey Research Methods. Thousand Oaks, CA: Sage Publications.

Khai, H. V., & Yabe, M. (2011). Technical efficiency analysis of rice production in Vietnam.

Journal of ISSAAS , 17(1), 135-146.

Hossen, M. J. (2010). Effect of Management Interventions on the Productivity and Profitability

of Indigenous Chickens Under Rural Conditions in Bangladesh. www.Irrd.org, 18/01/2013.

Dutta, R. K., Islam, M. S., & Kabir M. A. (2013). Production Performance of Indigenous

Chickens (Gallus domesticus L.) in Selected Areas of Rajshali, Bangladesh. American Journal

of Experimental Agriculture 3(2), 308-323.

Magagula, C. (2012). Shaping Swaziland’s Response to Food Insecurity: Indigenous Chickens.

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Martey, E., Ramatu, M., & Kuwornu, J. (2012). Commercialisation of smallholder agriculture

in Ghana: A Tobit regression analysis. African Journal of Agricultural Research.7(14),

2131-2141. http://www.academicjournals.org/AJARDOI:10.5897/AJAR11.1743, 15/10/2012.

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National Agricultural Marketing Board (NAMBOARD). Unpublished Research Project,

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University of Swaziland.

Masuku, M. B. (2011). An Analysis of the Broiler Supply Chain in Swaziland: A Case Study of

the Manzini Region. Asian Journal of Agricultural Sciences, 3(6), 492-499.

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Keeping – The Case of the Swazi Chicken. Mbabane, Swaziland.

Natukunda, K, Kugonza D. R., & Kyarisiima C. C. (2011). Indigenous chickens of the Kamuli

Plains in Uganda: II Factors affecting their marketing and profitability. Livestock Research for

Rural Development. 23, Article #221, http://www.lrrd.org/lrrd23/10/natu23221.htm,

17/10/2013

Ondwasy, H., Wesong, H., & Okitoi, L. (2006). Indigenous Chicken Production Manual.

Technical Note Series Number 18. Kenya Agricultural Research Institute. www.kari.org,

21/09/2012,.

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Ownership Structure and Performance of the

Listed Tunisian Companies

Dr. Habib AFFES

Associate professor at the Faculty of Economics and Management

University of Sfax-Tunisia, Research Unit at Sfax University: LARTIGE


Mrs. Nourchéne Hamza Hakim

Contractual Assistant at the Faculty of Sciences of Sfax

PhD student at the Faculty of Economics and management, Sfax

Research Unit at sfax university: LARTIGE


Received: September 27, 2013 Accepted: November 1, 2013


Abstract

Across this study, we propose to study the role of the ownership structure in the discipline of

executives and test if the managerial shareholdings, the concentration of property and the

property of the institutional investors improve the performance of companies. Based on a

sample of 17 Tunisian firms listed on the TSE between 2001 and 2005, we performed the

variables regressions of ownership structure on the various measures of accounting and stock

market performance.

Our results show that the concentration of ownership acts positively only on the accounting

performance measured by ROE and the ownership of the institutional investors has a positive

and significant effect on the accounting and stock market performance, while the managers

shareholding has a negative and significant effect on the market performance measured by the

Marris ratio.

Keywords: Ownership structure, Ownership of institutional investors, Concentration of

ownership, Managerial shareholding, Performance.


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1. Introduction

The issue of governance has been the subject of a vast literature and continuous to draw the

attention of the general public by economists, jurists but also by sociologists and management

scientists.

The issue of governance appeared with Berle and Means (1932) and the separation of

ownership and decision-making in the major listed companies with widespread shareholding.

This separation causes the deterioration in the companies’ performance. Charreaux (1997)

defines corporate governance as "the set of the organizational mechanisms whose effect is to

determine the powers and influence the management decisions that govern their behavior and

define their discretionary space." Corporate governance is "the set of organizational

mechanisms which define the leaders’ discretionary space" [Charreaux, 1997].

This definition, which focuses on the dominant leadership role, enables to override the analysis

of the relationship between the shareholders and directors and put back corporate governance

in all the relations that a firm has with the shareholders as well as with bankers, employees,

customers or the public authorities. Corporate governance is considered as the set of

mechanisms for controlling the executive and defending the interests of all the stakeholders of

the company. These mechanisms can be either of an external nature, such as the market of

goods and services, the financial market and the leaders’ labor market, or of a domestic nature,

such as the mutual monitoring and the board of directors. The latter is considered as an

important internal control mechanism of the leaders.

The internal mechanisms of corporate governance are defined as the way to control the firm

using its structures and internal processes, for instance, the board of directors, the incentive and

compensation systems, and ownership structure. These mechanisms of internal control, in their

turn, benefited from a direct access to information and have an internal and direct view about

leaders’ behavior, which theoretically helps them monitor the managers better. The external

mechanisms are represented by the market of goods and services, the financial market, the

executives’ labor market, the legal and regulatory environment as well as the lending financial

institutions. The function of these mechanisms is to ensure a disciplinary sanction if there a

non-compliance with the legal and contractual rules as well as with the competition rules.

Several empirical studies attempted to identify the relationship between the control variables,

particularly the variables of corporate governance internal mechanisms that are related to the

ownership structure (majority, institutional, financial shareholders...) and to the features of the

board of directors (composition, size and nature of the directors) and the firm performance.

The results are varied, which implies the absence of optimal characteristics that could increase

the performance of any business. The effectiveness of the internal control mechanisms of the

leaders or their impact on performance depends on the theoretical framework and the context

of the study.


The theory of corporate governance has remarkably developed thanks to the agency theory

which is broadly based on the managerial theory of Berle and Means (1932). The agency


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theory analyzes the consequences of the separation of management and property which creates

conflicts. The agency theory deals with the way to resolve these conflicts by seeking the

optimal type of contract.

This theory first appeared mainly in the work of Alchian and Demsetz (1972), Fama (1980) and

Fama and Jensen (1983). However the article of Jensen and Meckling (1976) is the main

reference on the issue of the agency relationships within the firm. Jensen and Meckling (1976)

define an agency relationship as "a contract by which one or more persons (principal) engages

another person (agent) to execute in his name any task that involves a assigning a power

decision to the agent”. The agency relationship between the shareholders and the managers can

result in conflicts called agency conflicts due to the divergent interests of these people. The

agency theory has analyzed only the relationship between the shareholders and the managers.

This classical analysis is the shareholder-based vision of the corporate governance theory. The

field of corporate governance goes beyond the relationship between the shareholders and the

managers and must be defined much more broadly.

The new vision of corporate governance, more precisely the partnership vision helps overcome

this analysis and put the issue of corporate governance throughout the firm's relations with the

various partners including the banks, the customers, the employees, the government , etc...

Over the past two decades, the poor performance, the scandals and bankruptcies of large

companies have led the media, the investors, the governments, the regulators and the

researchers to select a good governance system to discipline the managers and therefore

improve the companies’ performance (Charreaux, 1998).

Several theoretical studies found a link between ownership structure and performance. First,

many researches tried to highlight the link between the management ownership and the firms’

performance. The obtained results are contradictory. Some found a linear relationship, while

others showed a nonlinear one (Demsetz and Lehn, 1985; Morck et al, 1988. McConnell and

Servaes, 1990, and Hermalin and Weisbach, 1991). Secondly, ownership concentration plays a

crucial role in the discipline of the leaders (Shleifer and Vishny 1986). An examination of its

impact on performance leads to mixed results. Actually, some studies found a positive effect of

the presence of the majority shareholders on performance (Berles and Means (1932), Shleifer

and Vishny (1986)), while other studies concluded that there is no relationship between

ownership concentration and performance (Holderness and Sheehan (1988)).

Investors play an important role in corporate governance. They are great monitoring staff for

the company. Some authors found a positive relationship between the presence of institutional

investors in the capital and the company’s performance (McConnell and Servaes (1990) and

Mohamed Omri). Since the work of Berle and Means (1932) and the identification of the

problems caused by the separation of ownership and decision-making, many studies have

focused on the study of the relationship between ownership structure and business performance.

These studies emphasized that the managers can pursue objectives different from those of the

shareholders, which are therefore contrary to the maximization of the market value of the

shareholders’ wealth. They add that the managers would submit to internal or external

constraints that compel them to manage in accordance with this traditional objective. However,


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Demsetz (1983) argues that ownership / decision separation led to a decline in of the leaders’

debits and there is no reason to think that a firm where its capital is wholly owned by its leader

should be more efficient than a company having a diffuse capital. Currently, there are three

main theories on this subject: "convergence of interests", "neutrality "and" persistence ".

2.1 Thesis of the Alignment of Interests

According to the theory of the alignment of interests initially supported by Berle and Means

and reused by Jensen and Meckling (1976), the more percentage of the capital held by the

managers is significant, the greater the deviation from the objective of the value

maximization is low.

2.2 The Neutrality Thesis

In this thesis, Demsetz (1983) argues that capital ownership structure is an endogenous

response to the process of profit maximization and depends on the firm's operating features and

the pressure exerted by environmental, in other words, all the structures are equivalent.

The neutrality thesis advocated by Demsetz (1983) was taken up by Demsetz and Lehn (1985).

Both authors reject any link between performance and ownership structure by studying the

relationship between the accounting rate of return on equity and the concentration rate of the

capital held by the major shareholders.

This test and this conclusion have been criticized by Morck, Shleifer and Vishny (1988). These

authors identify a nonlinear relationship between the performance measured by Tobin's Q and

the percentage of capital held by the board of directors, the body which is supposed to represent

the capital held by the managers. Depending on the area the capital percentage considered, the

effect of entrenchment or convergence of interests is dominant.

2.3 The entrenchment thesis

The entrenchment thesis set up by Morck, Shleifer and Vishny (1989) states that, contrary to

the theory of the alignment of interests, the managers who have a solid majority of the capital

escape any kind of control and then can manage a way opposite to the value maximization.

Therefore, they will have a lower performance. However, these same authors (1988) using the

Tobin's Q, as a performance indicator, identified a non-linear relationship between

performance and the percentage of capital held by the managers. They concluded that in the

area where the percentage exists, the effect of interest convergence outweighs the effect of

rootedness or vice versa.

2.4 Other Theses

However, there are also nuanced positions. In particular, that of Fama and Jensen (1983)

described as "mitigated neutrality ", based on the argument of natural selection. They

concluded that the organizational forms that survive on time are effective and therefore leave

the possibility of the existence of unsuitable ownership structures in the short term. Their

analysis incorporates the elements of the leaders’ control system. Morck, Shleifer and Vishny

(1988) empirically concluded that the effect of the interest convergence outweighs the effect of


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the rootedness or vice versa depending on the area where the percentage of the capital held by

the Board of Directors exists. To further understand the relationship between ownership

structure and performance, we will be studying the effect of the leaders’ shareholdings on the

performance of the firm.

2.4.1 The Effect of the managers’ Shareholding

The managers can be shareholders in the company. They have a percentage stake in the firm.

The managers’ shareholding is not a very recent phenomenon; it appeared with the agency

theory. This theory assumes that the increase in the share capital held by the managers is a

means of limiting the conflicts of interest between the managers and the shareholders.

An enormous amount of research tried to highlight the link that exists between the managers ’

shareholding and the firms’ performance. The obtained results are contradictory. Some found a

linear relationship, while others showed a nonlinear one. The recent studies that sought the

relationship between the firm’s performance and the capital share held by the leaders came up

with different viewpoints (Demsetz and Lehn, 1985; Morck et all, 1988. McConnell and

Servaes, 1990 and Hermalin and Weisbach, 1991).

Most of the empirical studies dealing with the impact of the managers’ shareholding on

performance are based on five assumptions.

As Milton Friedman (1953) suggests that each event can be associated with an infinite number

of explanations. The first hypothesis considers that the firm’s performance increases with the

managerial participation. The corresponding argument is that of the interest alignment. In other

words, the greater the managers ’ share is, the higher performance is, which means that there is

a good protection of the managers and other owners’ interests (Jensen and Meckling [1976]).

The second states that company’s performance decreases with the capital share held by the

managers and the managers’ entrenchment and the capital cost explain this inverse relationship.

A significant proportion of the capital held by the managers can reduce financial performance

because these managers when having huge shares in the capital of the firm will have so much

power that they will neglect the interests of the other stakeholders. The second argument is that

the capital cost, which is, in fact, the growth of the capital share held by the managers, can

result in the drop of financial performance since it increases the capital cost of the firm due to

the decrease in the market liquidity or to the decline of the diversification opportunities on the

part of the investors (Fama and Jensen [1983 page329]).

The third assumes that the firm’s performance is a non-monotonic function with the

participation of the managers in the capital. The fourth hypothesis suggests that the

managers ’ participation increases with the company’s performance. The last one stipulates that

the managerial participation has no effect on the company’s performance and vice versa

because of the natural selection and the mitigated neutrality.

On the one hand, ownership aligns the executives’ interests with the shareholders’ ones and

increases performance, and on the other hand, it makes the rooting and easier and thus

negatively affects performance which shows the complexity of the role of managers’


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stockholdings.

Several empirical studies contradicted the results concerning the existence of a linear

relationship between the managers ’ shareholding and the firm’s performance and consider the

possible existence of a nonlinear relationship. Non-linearity may be the result of the leaders’

rooting. The study sample of McConnell and Servaes consists of two sub-samples. The first is

composed of 1,173 firms with the analysis relating to the year 1976. The second sample

includes 1,093 firms and refers to the year 1986. Both authors choose the capital share held by

the managers as a proxy for ownership structure and the Tobin's Q as a measure of performance.

They included other variables known as of control such as spending on research and

development, debt, spending on advertising and the asset replacement value. The results of

McConnell and Servaes (1990) confirm the hypothesis that the ownership structure has a

significant impact on the firm’s value. They showed that the value of Tobin's Q increases and

then decreases gradually as the property becomes concentrated in the hands of the managers.

Hermalin and Weisbach (1991) examine the managerial participation effect on Tobin's Q.

Managerial participation is measured by the percentage of the shares held by the new and

former CEOs of the Board of Directors. Using five-year panel data, the authors found a

non-monotonic relationship between managerial participation and performance (positive

between 0 and 1%, decreasing between 1 and 5%, increasing between 5 and 20% and

decreasing beyond 20%). Cho (1998) found the same non-monotonic relationship between

Tobin's Q and management shareholding. However, he believes there are three equations in

which the share capital held by the leaders depends on Q, on investment and on a set of control

variables.

Holderness et al. (1999) reproduce, for the years 1935 and 1995, the central aspects of the study

carried out by Morck et al. and that of Demsetz and Lehn. Morck et al. found a significant

positive relationship between performance and the managerial participation with a level of

managerial ownership between 0 and 5%, by contrast, Morck et al. found no statistically

significant relationship beyond 5%.

Some authors confirm the lack of a relationship between the structure of the managerial

ownership and the firm performance (Demsetz and Lehn, Himmelberg et al (1999), and

Paquerot Alexander (2000)). The study of Demsetz and Lehn focuses on 511 U.S. firms

belonging to different sectors. The analysis is spread over five years from 1976 to 1980. To

assess the impact of the separation between property and decision on performance, the authors

used a regression rate of return on equity measured for accounting purposes (ROA) on a

broadcast indicator of capital. The empirical results showed no relationship between ownership

structure and the rate of return on equity. This result confirms the neutrality thesis supported by

Demsetz (1983). Himmelberg, Hubbard and Palia (1999) reviewed the relationship between

property and performance using panel data of the Compustat large and small companies and

found no relationship between the managers’ shareholding and performance. Himmelberg et al.

(1999) extended the study of Demsetz and Lehn by adding new variables so as to explain the

variation in the ownership structure. Ownership structure is measured by the managers’

shareholding; however, the Tobin's Q is the appropriate measure of performance although the


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authors confirm producing similar results if the ROA is the measure of performance.

Hypothesis 1: The positive relationship between the managers’ shareholding and the

company’s financial performance.

2.4.2 The Impact of Ownership Concentration

Ownership concentration plays an important role in the managers’ discipline (Shleifer and

Vishny 1986). An examination of its impact on performance leads to mixed results. Indeed,

some studies found a positive effect of the presence of the majority shareholders on

performance while in others there is no relationship between ownership concentration and

performance.

Berles and Means (1932) suggest the existence of a positive linear relationship between the

capital concentration and the firm’s value. In the same context, Shleifer and Vishny (1986)

show the positive influence of capital concentration on the performance and therefore the

importance of the role played by large shareholders. Agrawal and Mandelker (1996) suggest

that the existence of large shareholders leads to a better monitoring of management and better

performance especially when ownership is concentrated in the hands of institutional investors.

In Japan, Kaplan and Minton, (1994), Morck, Nakamura and Shivdasani (2000), show that it is

the major shareholders who control the leaders.

The German corporate governance system is also characterized by the presence of large

shareholders. Gorton and Schmid, (2000), show that the value of the German firms improves

when ownership concentration increases. Chen (2001) examines the relationship between

ownership structure and the firm’s value in China. The results show a positive relationship

between a concentrated ownership and the company’s value measured by Tobin's Q.

Holderness and Sheehan (1988) suggest that there is no significant performance difference

between firms with diffused capital and those of which capital is owned by a majority

shareholder.

Similarly, Mulari and Welch, (1989), claim that the performance of closed organizations (with

a small circulation of securities) is not different from that of the open ones (with a high

diffusion of securities). Indeed, the performance of organizations with a high concentration of

capital is similar to that of the organizations with a low concentration of capital. The presence

of majority shareholders in the firms’ capital positively affects their performance. Hence our

hypothesis:

Hypothesis 2: The positive relationship between the percentage of the share capital held by the

majority shareholders and performance.

2.4.3 The Effect of the Institutional Investors’ Ownership:

The emergence of institutional investors, as major holders of financial assets with an increasing

participation in capital markets, is one of the peculiarities of the current financial world, a

feature likely to become more prominent in the coming years. Investors play an important role

in corporate governance. They are great monitors for the company. The presence of

institutional investors alters the relationship between ownership structure and corporate


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performance. The impact of monitoring by institutional investors on corporate performance is

studied by more than one researcher. This impact is ambiguous (Dahia, Lonie and Power, 1998;

Denis, Denis and Sarin, 1997).

McConnell and Servaes (1990) found a positive relationship between institutional investors’

shareholding and the firm’s performance measured by Tobin's Q. This is due to the fact that

institutional investors buy stocks of the companies that have performed well. However, Pound

(1988), Barclay and Holderness (1991); Loderer and Martin (1993) claim that institutional

investors have impact on the firm’s performance only when they are actively involved in

corporate governance. These authors integrate the behavioral dimension of the institutional

investors in the study of the previous relationship.

Among the various institutional investors, the pension funds were carefully considered. British

companies are controlled and managed by pension funds. These are the institutional

shareholders of these companies. Holding a large share of capital is considered as one of the

mechanisms in solving the agency problems that arise when the leaders act against the

shareholders’ interests. Faccio and Lasfer (2000), by comparing the companies in which the

pension funds are shareholders with a group of publicly traded companies in the UK, tested the

hypothesis according to which control increases with ownership concentration and found that

the pension funds reduce the conflicts of interest and improve the business performance. Due to

the size of their shareholding, the UK pension funds are not known by their control and their

voting in the annual general meeting is difficult

Smith (1996) found that the companies controlled by pension funds, such as CalPERS, have a

much higher performance. The observation of the Tunisian economy, even if it is not developed

enough to be compared to the American and French economies, shows that financial

institutions (banks, insurance and investment companies ...) are the institutional investors of

the Tunisian companies. They are involved in the control and management of companies

through their financial contribution. An empirical study conducted by Mohamed Omri (2002)

on this subject shows that the presence of institutional investors has a positive effect on the

performance of the Tunisian firm.

The control functions of the managers may be assigned to specialized agents. In addition to the

main shareholders, banks can be excellent monitors in supervising the managers’ behavior.

Management control by banks is very common in the Japanese companies. Moreover, the

importance of the disciplinary role exerted by banks is considered as one of the determinant

factors of the Japanese firms’ effectiveness.

Financial institutions within the business groups in Japan called keiretsu are both creditors and

shareholders. In other words, the Japanese firms belonging to a keiretsu are controlled by major

banks that are both shareholders and creditors. Firm control through banks is rather a special

form of governance in Japan. In fact, the involvement of the bank in the capital enables it to

control the management of companies.

Contemporary literature was unable to deal with the fact that ownership structure of the

financial institutions could affect their performance. Banks use their position as shareholders to


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increase the profitability of the Japanese company or increase the debt on behalf of these

companies.

In this study, the author used panel data to show that if the bank is at the same time a

shareholder and a creditor, this does not mean profit maximization. Paquerot and Alexander

(2000) studied the effect of ownership structure on the firm’s performance measured by the

Sharpe ratio for the years 1991, 1992 and 1993. On the one hand, they found that the

percentage of the capital held by institutional investors has a negative impact on the firm’s

performance. The institutional shareholders have no power to control the executives, the thing

which confirms the entrenchment thesis.

On the other hand, they concluded that the capital concentration has no impact on the firm’s

performance. Moreover, they found that the percentage of the capital held by the managers has

no effect on the firm’s performance. Finally, we can conclude that the presence of institutional

investors in the companies’ capital significantly influences their performance.

Hence our hypothesis:

Hypothesis 3: There is a positive relationship between the percentage of the capital held by the

institutional investors and performance.

2.4.4 The Effect of Indebtedness:

Economists and management researchers have not always found a consensus on the effect of

indebtedness on the firm’s performance.

The relationship between indebtedness and the firm’s value is studied by more than one

researcher (Modigliani and Miller, 1958, Ross, 1977, Jensen, 1986 and Opler and Titman,

1994).

Modigliani and Miller (1958) showed that indebtedness acts positively on the firm’s value only

in the presence of taxation.

Ross (1977) considers indebtedness as a signal of the firm’s quality and its future profits.

Indeed, indebtedness solves the conflicts that arise from the asymmetric information, hence its

positive role. Under the assumption of free cash flow, Jensen (1986) assumes that indebtedness

is a means of the managers’ discipline which is value-generator and therefore acts positively

on performance.

All these authors discuss the positive role of indebtedness on the firm’s performance. However,

indebtedness can act negatively on performance. Therefore, the relationship between

performance and indebtedness is no longer linear, since it is sometimes positive and sometimes

negative. Opler and Titman (1994) show that excess indebtedness can cause bankruptcy and

direct and indirect costs which lead to the loss of confidence reflected in the loss of customers

even before the period of receivership

For some people, the effect of indebtedness on performance is determined by a number of

factors such as the ownership structure (Charreaux, 1997), the economic environment (Platt

and Platt, 1994) and the field of activity (Titman and Opler, 1994). A study conducted by R J


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Davies et al (2005) on the effect of the indebtedness ratio on performance is built on the work

of Morck et al (1988), McConnell and Servaes (1990), Modigliani and Miller (1963) , Ross

(1977) and Demsetz and Villalonga (2001).

Morck et al (1988) found the result where indebtedness has a negative and insignificant impact

on the firm’s value and hence its performance. This explains that the leaders of highly

leveraged firms hold a large share of the capital. This idea is similar to that of G. Charreaux

(1997). Demsetz and Villalonga, (2001), show that the negative relationship between

indebtedness and performance may be due to inflation.

The indebtedness impact hypothesis

Hypothesis8: indebtedness has a negative impact on performance

2.4.5 The Impact of the Firm’S Size

The firm’s size is an important determinant of companies’ performance.

Management researchers often establish a relationship between firm’s size and its performance.

Actually, this influence is not new. The conducted researches in finance, and more specifically

in corporate governance, consider this variable as a control variable which can be included in

models related to the structure of ownership and the characteristics of the board of directors.

All the researches on the type of this relationship say that the larger the firms get, the higher

their performance is. The researches conducted in financial management show that large size

can cause the emergence of coordination problems of the management teams as well as

conflicts of interest which makes these big companies no longer efficient and then have low

levels of performance.

The results of the researches on the type of performance-size relationship show the

non-linearity of the latter, as it is sometimes positive and sometimes negative. G.Charreaux

distinguishes three types of companies: family-owned, controlled and managerial companies.

There is a performance difference between these three types of companies. According

Charreaux, the firm’s performance does not depend on its size, but rather on the type of the

company. Another study conducted by G.Charreaux on the holdings, the very large companies,

shows that their performance is not different from that of other companies. The hypothesis on

the impact of the firm’s size

Hypothesis 9: The firm’s size is positively associated with performance

Summary of the assumptions

ASSUMPTIONS SIGN PROVIDED

H1: The relationship between the managers’ shareholding and performance is positive +

H2: The relationship between the majority shareholder and performance is positive +

H3: The relationship between the institutional investors’ shareholding and performance is

positive +


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Control variables: H8: The relationship between indebtedness and performance is negative

H9: The relationship between the firm’s size and performance is positive

3. Methodology

3.1 Presentation of the Sample

As far as the characteristics of our sample are concerned, the study focuses on 17 Tunisian

companies listed on the TSE over a five-year period going from 2001 to 2005, which would

mean 85 observations after excluding the banks, the insurance and financial companies and the

property and real estate companies from our sample.

3.2 Model, Variables and Measurements

The aim of our research is to analyze the impact of the variables of ownership structure, namely

the participation of the leaders in the capital, the concentration of ownership, the participation

of the institutional investors in the capital, on the performance of the listed Tunisian

companies.

The Model

PER = c+ α1MAJ+α2MANA+α3INS+α4END+α5TAIL+εt

PERF: is calculated by the accounting measures (ROA, ROE) and the stock market measures

(Tobin's Q and Marris)

MAJ: The percentage of the capital held by the majority shareholders

MANA: The percentage of the capital held by the manager

INS: The percentage of the capital held by the institutional shareholders

END: the company’s indebtedness

TAIL: the firm’s size.

Table 1. Variables and measurements.

Variables of Ownership

Structure

Variables Measures

SP Variables

proppdg % of the capital held by the managers.

propmaj The part of the capital held by the majority shareholders.

propinstit The part of the capital held by the institutional investors.

Variables de performance

ROA Net profit /Total Assets

ROE Net profit/Equity

TOBIN Market value of assets/Asset accounting value

MARRIS Equity market value /Equity accounting value

Variables de contrôle

Lev Indebtedness ratio

LnTA The company’s size measured by Neperian logarithm/total

assets


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Table 2. Descriptive statistics

Variables Minimum Maximum Mean Standard deviation

Propmaj 0,16 0,96 0,5940 0,21079

Proppdg 0,00 0,17 0,0220 0,04703

Propinstit 0,00 0,56 0,1874 0,17131

ROA -18,10 73,78 6,5032 10,02117

ROE -90,10 67,40 11,7066 18,12562

Q TOBIN 0,31 3,99 1,3168 0,65665

Marris 0,57 15,90 3,2174 2,47146

LEV 5,27 98,50 47,2275 18,97193

LNTA 9,58 14,06 11,0304 0,91524

Table 2 shows that the Tunisian companies show: a high concentration of capital, (on average

59.40%), a high debt ratio of about 48%, a poor accounting performance and a better stock

market one.

4. Results and Interpretations

Table 4. Results of the regression variables of ownership structure on the performance

measures

Accounting Measures STOCK MEASURES

ROA ROE TOBIN MARRIS

Constant -3,598 19,287*** 0,154 -1,583

% of capital held by the majority shareholders 20,09**

Managerial ownership -10,223*

% of capital held by the institutional shareholders 15,648** 24,874** 1,125** 4,353**

OverallLiabilities/Total Assets -0,350*** -0,512*** -0,0185*** -0,0749***

LN Total Assets 2,147* 0,165* 0,703**

*** Significant at 1% ; ** Significant at 5% ; * Significant at 10%

4.1. The impact of Equity on Performance

4.1.1 The Participation of the Majority Shareholders

The Tunisian listed companies are characterized by a concentrated ownership structure. Indeed,

the average holding of the majority shareholders is around 60% (see Appendix 1).

The regression result of this variable over the various performance measures shows that the

majority shareholders hae only a positive and significant impact on the return on equity (ROE),

which confirms hypothesis H 2 (see Annex 2).

4.1.2 Managerial Participation

The managers’ ownership of the Tunisian firms is, on average, around 2.2% (see Appendix 1).

This low weak rate below 5% does not mean that the managers’ interests of the listed Tunisian

firms converge towards those of the shareholders.


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This is confirmed by the regression results of this variable on the various measures of the

accounting (ROA, ROE) and the stock market (Tobin's Q, Marris) performance, since the part

of the capital held by the managers has negative and significant effects on all the performance

measures mentioned before. This does not confirm hypothesis H1 (see above).

4.1.3 Participation of the Institutional Shareholders

The institutional shareholders’ participation in the equity of the listed Tunisian firms is, on

average, 18.74% (Appendix 1).

On the basis of the regression variables of ownership structure on the accounting measures and

the stock market performance, we find that institutional investors’ shareholding has a positive

and significant impact on all the performance measures. The effect on the accounting measures

is greater than it is on the stock market ones. This confirms hypothesis H3.

4.2 The impact of the Control Variables on Performance

4.2.1 Indebtedness

The indebtedness rate is measured by the ratio of the total debt to the total assets. The average

indebtedness rate of the listed Tunisian firms is, on average, around 47.22%, but it is highly

dispersed (see Appendix 1). According to the first regression category, we notice that the

leverage has slightly significant negative effects on all the performance measures which

confirms hypothesis H8.

Indebtedness for the Tunisian companies cannot help solve the problems of the

shareholder-managers’ interests after maximizing the firm’s value.

4.2.2 The Company’s Size

The average size of the Tunisian companies measured by the natural logarithm of the total

assets has positive and significant effects on most of the accounting and stock market

performance measures. This confirms hypothesis H9 which states that the larger the firm is, the

better its performance will be. Performance is positively associated with the company’s size.

Table 4. Results of the study and hypotheses checking

Accounting Performance Stock Market Performance

(ROA) (ROE) (Q Tobin) (MARRIS)

Hypotheses on the variables relationship of ownership structure and performance

% Majority + HV

% Managerial - HNV

% Institutional + HV + HV + HV + HV

Hypotheses on the relationships of the control variables and performance

Indebtedness - HV - HV - HV - HV

Size + HV + HV + HV + HV

(+) the relationship is positive and significant.


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(-) the relationship is negative and significant.

HV: Tested hypothesis, HNV: untested hypothesis

5. Conclusion

We tried to distinguish between the variables effects of the internal governance mechanisms,

namely the ownership structure and control variables such as indebtedness and the firm’s size,

on the one hand, the impact on the accounting performance and , on the other hand, on the

market performance.The regression results showed that the hypotheses on the governance

variables are sometimes confirmed and sometimes not in the case of the Tunisian companies in

our sample, but only for some measures.

Indeed, the impact of the ownership structure and indebtedness variables is not the same for all

the performance measures.

The majority shareholding in the listed Tunisian firms has only a positive impact on the

accounting performance measured by the ROE ratio, which confirms our hypothesis.

The managers’ shareholding (managerial ownership) shows a negative and significant effect on

the performance of the market as measured by Marris ratio, which does not validate our

hypothesis.

The participation of the institutional shareholders in the capital of the Tunisian listed

companies gave the expected signs, since the interests of these shareholders have positive

effects on all the performance measures whether accounting or stock. This may reflect the

quality of the institutional shareholders, which are in most cases banks, in controlling and the

pursuing the firm’s objectives.

Concerning the control variables in our model, we realized that: the indebtedness of the

Tunisian listed companies has negative effects on most of the accounting and stock market

performance measures, which does not validate the hypothesis on the disciplinary role of

indebtedness for the managers.

The size of the listed Tunisian firms has positive effects on measures of the accounting and

stock market performance, which confirms the hypothesis and the expected sign.

To better understand the link between the internal control mechanisms and the firm’s

performance, we are interested, in this research, in studying one single system of internal

control namely the ownership structure and its influence on the performance of the firm.

Thus, for ownership structure, we first dealt with the effect of the managers’ ownership on

performance. This served as the basis for several theories the most important of which are the

convergence of interests, rootedness and neutrality. The most common conclusion was that the

first two theories coexist and, depending on the level of the managers’ ownership, either of

them dominates.

Secondly, we discussed the concentration effect and the type of ownership and opted for the

supremacy of the ownership benefits of the majority and institutional shareholders. In fact, the


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effect of this on the firms' performance is generally positive.

We tried to test the hypotheses about the effect of ownership structure on the firm’s

performance. This research used a sample of 17 Tunisian companies listed on the stock

exchange in Tunis between 2001 and 2005. We found that the managers’ ownership has a

negative effect on performance as it is measured by Tobin whereas for the other measures it has

no effect or it is not significant. We also found that the ownership of

the institutional and the majority shareholders has a positive effect.

Our study could have been more extensive if we had had data on the external control

mechanisms which, beside the internal mechanisms, can have a very important role in the

management discipline. These external mechanisms include mainly the legal and regulatory

environment, the market for goods and services, the financial market and the managers’ labor

market.

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CreativeCommons Attribution license (http://creativecommons.org/licenses/by/3.0/).


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Revisiting the Psychometric Properties of Market

Orientation Framework in an Emerging Economy: a

Case-Study of Botswana’S Small Service Firms

Olumide Olasimbo Jaiyeoba,

Department of Marketing, Faculty of Business

University of Botswana

Received: July 18, 2013 Accepted: August 9, 2013


Abstract

While much empirical work has centered on market orientation, an investigation of the

psychometric properties of Market Orientation (MO) scale items as adapted from Kholi and

Jaworski,(1993), in the Botswana context has been under researched. A reliable scale with

demonstrated content and convergent validity is developed in this empirical study and the

impact of market orientation efficiency on economic and noneconomic performance of service

firms is evaluated based on key informant data drawn from sampled service firms in Botswana.

Top management emphasis, centralization, market turbulence, intelligence generation,

dissemination and responsiveness, business performance, customer satisfaction, technological

turbulence, market based reward system, and overall market orientation were found to be

reliable and valid antecedents and consequences of market orientation. The study results using

factor analysis approach, therefore offer one more robustness in the applicability of MO scale

items among Botswana’s small service firms by ensuring that managers use psychometrically

valid scale items to generate, disseminate and respond to information with a view to improving

performance of small service firms.

Keywords: Psychometric Properties of Market orientation, Factor Analysis Approach, Small

Service Firms, Business Performance and Botswana.

1. Introduction

The development of coherent, robust and generalizable theory requires a base of well defined

constructs (Summers, 2001). While much empirical work has centered on market orientation,

an investigation of the psychometric properties of MO scale items as adopted from Kholi and


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Jaworski, (1993), in the Botswana context has been under researched. This study therefore

intends to investigate the reliability and validity of market orientation framework in Botswana.

A reliable scale with demonstrated content and convergent validity is developed and the impact

of market orientation efficiency on economic and noneconomic performance of service firms is

evaluated based on key informant data drawn from sampled service firms in Botswana. Gilliam

and Voss, (2013) postulated that if researchers expend the necessary resources to properly

define constructs during early stages of research projects, this foundation will be strong and

able to support expansive theories. Gilliam and Voss,(2013) concluded that construct

definitions prevent scientific discussion from devolving into babel Thus, the process of

construct definition is a critically important and complex task facing marketing researchers not

only in developed world, but also in the developing economy.

2. Objective of the Study

To investigate the psychometric properties of prominent market orientation factors influencing

the economic and non economic performance of small service firms in Botswana using Factor

analysis Approach.


A scale is said to have content validity, if the scale items form a representative sample of the

theoretical domain of the construct (Churchill, 1979; Bagozzi and Foxall, 1995). Babin and

Svensson, (2012), thus identified the year 1979, as the year of breakthrough from the paradigm

of single item structures and metric measures, as well as the lack of reliability estimates of used

constructs in marketing research to a change towards the use of multi items structures and

metric measures and reliability theory in marketing research of human perception, behaviour or

phenomenon. After this time, the reliability concept became a routine part of the results

sections of marketing research articles. Infact, Churchill,(1979), wrote about an emerging

paradigm for developing measures of marketing constructs, while Peter,(1979),cited in Babin

and Svensson (2012), presented a reliability review of psychometric basics and marketing

practices. Indeed, many otherwise well executed projects fail to have the impact they should

due to poor construct definitions (Churchill,1979).Bearden and Netemeyer, (1999),thus

provided extensive reviews of numerous multi item structures and metric measures in extant

marketing research literature that have considered the estimates of validity and reliability.

Therefore, the goal of measurement development is to produce instruments that carry meaning

and are useful for describing and explaining phenomena. This empirical study thus lend

credence to the need for measurement development. Psychometricians consider three criteria in

their assessment of the quality of measures. The first is the unidimensionality of the scale. This

is concerned with the degree to which the items in the scale load on a single factor Gerbing and

Anderson,(1988). This aspect of a measurement is important because, theory development and

testing requires that a single idea be represented by the measure to allow for subsequent testing

for correlations with other constructs or differences between groups. A second aspect of good

measures is that they are reliable. This characteristic deals with the stability of the measures

over time and the internal consistency of answers on measures containing multiple items, Rust

and Cooil, (1994). This empirical study, thus examine the content validity, dimensionality,


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coefficient alpha, with a focus on the coherence or interrelatedness of the psychometric

properties of small service firms in Botswana. The third indicator of strong measures is validity.

This is concerned with the degree to which the measure in fact represents the construct domain

(Churchill, 1979). Thus, at the heart of repeatability and standardization are the measurement

properties of reliability and validity, which this study intends to explicate.

Mowen & Voss, (2008); Rossiter, (2002), analogously postulated that some authors have

suggested that researcher concentration on operationalisation and statistical analysis have

distracted attention from construct definition. This assertion created the need for this empirical

study among Botswana’s small service firms. Gilliam and Voss, (2010), therefore posited that a

contributing factor is the lack of understanding of an implementable construct definition

process within the extant psychometric literature. Mackenzie, (2003), thus suggested that poor

construct conceptualization and definition plagues many manuscripts submitted for review.

Mackenzie, (2003), noted the impossibility of accurately specifying theoretical relations

between two constructs that lack precise meanings. Summers,(2001),concluded that the

development of coherent ,robust and generalizable theory requires a base of well defined

constructs. Hunt (1991) and Teas and Palan (1997) thus suggested the use of formalized

language in definitions to reduce ambiguity and vagueness in psychometric competence.

Contrastingly, Williamson, (1994), postulated that while the use of formalized language may

facilitate some aspects of the construct definition effort, it introduces a number of problems

that have prevented its widespread adoption. Rejecting this psychometric paradigm, Rossiter,

(2002), suggested that being far more specific in regard to the time and place where the

construct is applicable will aid in construct definition.


The study employed a snowball sample of managers and business owners in the small service

firm domain within Gaborone and its environs. The reason for opting for non-probability rather

than probability sampling was that the sampling frame of the key informants was not available.

In addition, the study was confirmatory in nature in order to improve the understanding of

organizational market orientation behaviour in Botswana context. The final pool of small

service firms to whom questionnaires was sent totaled 400. Eventually, only 249 (constituting

over 60% response rate) usable questionnaires were returned by the respondents. The

questionnaire was pretested prior to collecting data and respondents were asked to identify

items they found unclear, ambiguous or confusing. As a result of the pretest, minor adjustments

were made to the questionnaire. Data was collected between mid July 2012 to Mid October

2012.The service firms sampled included tourism firms (5.6%); transport firms (10.7%);

financial services subsector (9.4%); consulting services (19.2%) and other services subsector

accounting for (55.1%). The majority of the respondent personnel were managers, accounting

for about 50% of the total. This suggests that most respondents were sufficiently experienced to

be able to provide meaningful response to broader policy issues relating to market orientation.

After comparing the responses of the early and late respondents, on a number of characteristics,

no significant difference was found suggesting that the sample is free from response bias. The

sample size and the response rate are consistent with related studies.


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The questionnaire and scale measures (MARKOR Scale) were adapted from Kholi & Jaworski,

(1993) constructs. The items in the questionnaire were measured with the aid of a Five point

Likert type Scale. The internal antecedents were measured by items adapted from Jaworski &

Kholi, (1993). External antecedents were adopted from Jaworski & Kholi, (1993) and Gray et

al,(1998) respectively. Reliability analysis was conducted on all the multi items scales to check

the internal consistency of the scales. This study adopted a cut off of 0.5 for Cronbach’s

Coefficient following Nunally (1978).Using 0.5 as the cut off is not without precedent. It has

been adopted in related studies (Blankson & Stoke, 2002; Blankson & Cheng, 2005).


In order to ascertain whether the measures retained construct validity (i.e. measure what they

are supposed to), an exploratory factor analysis using principal components and varimax

rotation technique was conducted to examine the underlying dimension of MO construct. In

determining the factors, common decision rules employed in empirical research was applied:

minimum Eigen value of 1; KMO measure of sampling adequacy greater than 0.5 and Bartlett’s

test of sphericity are significant, which indicate that the items are appropriate for factor

analysis. This analysis thus test for the distinctiveness of internal and external antecedents,

overall market orientation, as well as economic and non economic performance constructs and

validate the measurement models (See Tables 1-6 below). This empirical study thus exhibit

psychometric equivalence by providing acceptable levels of reliability, variance extracted, and

both discriminant and nomological validity.

All factor loadings included in this study were statistically significant at the 0.01 level and

exceed the arbitrary 0.5 standard. Thus, these measures demonstrate adequate convergent

validity. All of the cross-construct correlations were significantly different from 1.0, which

suggests that discriminant validity was present. In general, these results provide support for

construct validity for the measures included in this study. As displayed in the Tables 1-6 below,

the estimated standard loadings ranged from 0.50- 0.92. These are above the accepted cut-off

value of 0.50 (Teo & King 1996). Finally, all items loaded higher on their respective constructs

than on others, thus providing strong support for discriminant validity. The validity of the scale

therefore explicates the unidimensionality of the components of each scale (Gerbing &

Anderson, 1998) with a principal component factor analysis. These findings thus reduce the

plausibility of threat to validity in this study, by presenting a description of MO construct and

explicative MO model, grounded on the marketing concept.

Table 1. Psychometric properties of market orientation awareness, intelligence generation and

dissemination:

Factor

Loading

Eigen

Value

%

Variance KMO

Bartlett’s

test df

Factor 1: Market orientation awareness α =

0.71, F-test = 51.029 p<0.01 2.174 54.349 70.6 % 198.495 6 p<0.01

We encourage customer comments and

complaints because they help us to do better job 0.760

We have a strong commitment to our customer’s

need 0.809

We are always looking at ways to create 0.787


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customer value in our services

We measures customer’s satisfaction on a regular

basis 0.568

Factor 2: Intelligence generation α = 0.630,

F-test = 141.351 p<0.01 2.948 59.948 66.9 % 469.771 45 p<0.01

In this business, we meet with customers at least

once a year to find out their future needs 0.609

Individuals/Employees from our business

interact directly with customers to learn how to

serve them better

0.468

We often talk with or survey those who can

influence our end users ‘purchases

(e.g.,retailers,distributors)

0.653

In our business unit, information on our

competitors is generated independently by our

business

0.589

We collect industry information by informal

means (e.g., lunch with industry friends, talks

with trade partners).

0.632

In this business, we do a lot of in house market

research 0.594

We survey our end users at least once a year to

assess how they perceive the quality of our

products

0.705

We periodically review the likely effect of

changes in our business environment (e.g.,

regulation) on customer

0.515

Factor 3: Intelligence dissemination α = 0.60,

F-test = 89.409 p<0.01 2.641 44.016 72.4 % 317.927 15 p<0.01

In our business, we have business meetings at

least once a quarter to discuss market trends and

developments

0.703

Marketing personnel in our business spend time

discussing customers future needs with other

employees

0.748

Data on customer satisfaction are disseminated at

all levels in this business on a regular basis 0.783

If anything important happens to a major

customer or market, the whole business knows

about it in a short period

0.716

A lot of informal talk in this business unit

concerns our competitors’ tactics or strategies 0.567

Table 2. Psychometric properties of intelligence responsiveness and top management emphasis

Factor

Loading

Eigen

Value

%

Variance KMO

Bartlett’s

test

df

Factor 4 :Intelligence responsiveness α = 0.55, F-test =

116.689 p<0.01

3.616 55.83 75.00% 688.427 91

p<0.01

We periodically review our product development efforts to

ensure that they are in line with what customers want

0.602

When we find that customers would like us to modify a

product, the business involved make concerted efforts to do

so

0.503

The different activities in this business are well coordinated 0.671


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Principles of market segmentation(market or products we are

dealing with) drive new product development efforts in this

business unit

0.556

When we find that customers are unhappy with the quality of

our service, we take corrective action immediately

0.545

Factor 5 :Top management emphasis α = 0.730, F-test =

22.147 p<0.01

2.238 55.953 69.20% 238.845 6 p<0.01

In this business, manager/owner repeatedly tell employees

that this business survival depends on its adapting to market

trends

0.809

Managers/owners often tell employees to be sensitive to the

activities of our competitors

0.790

Managers keep telling people around here that they must gear

up now to meet customers future needs

0.841

According to managers/owners here, serving customers is the

most important thing our business does

0.501

Table 3. Psychometric properties of risk aversion, centralization, and formalization

Factor

Loading

Eigen

Value

%

Variance KMO

Bartlett’s

test

df

Factor 6 :Risk aversion α = 0.53, F-test = 3.439 p<0.05 1.736 53.403 60.0 % 99.413 6 p<0.01

Managers/owners in this business believe that higher financial

risks are worth taking for higher rewards

0.554

Managers/owners in this business like to take big financial

risks

0.827

Managers here encourage the development of innovating

business strategies, knowing well that some will fail

0.784

Formal business education is the key requirement of the

owner/ manager in our business

0.753

Factor 7: Centralization α = 0. 880, F-test = 12.328 p<0.01 2.947 73.669 78.2 % 602.255 6 p<0.01

There can be little action taken here until a supervisor

approves a decision

0.743

Even small matters have to be referred to someone higher for

a final decision

0.911

I have to ask my boss before I do almost anything 0.922

Any decision I make has to be my boss approval 0.845

Factor 8: Formalization α = 0. 512, F-test = 18.396 p<0.01 1.293 43.106 50.3 % 20.932 3 p<0.01

For most of the things in our business, it is within the authority

of those(owner/manager), who are responsible for them to

decide how they will be done

0.731

The employees in this business are constantly monitored for

rules violation

0.802

Table 4. Psychometric properties of Market based reward system, interpersonal

connectedness ,interpersonal conflict and competition

Factor

Loading

Eigen

Value

%

Variance KMO

Bartlett

‘test

df

Factor 9 : Market based reward system α = 0.782, F-test =

7.135 p<0.01

2.420 60.492 76.8 % 265.436 6 p<0.01

Employees in this business get recognized for being sensitive

to competitive moves

0.740


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Customer satisfaction assessments influence owner/managers

pay in this business

0.847

Formal rewards (e.g., pay rise, promotion) are forthcoming to

anyone who consistently provides good market

intelligence/information

0.789

Salespeople’s performance in this business is measured by the

strength of relationships they build with customers

0.729

Factor 10 : Interpersonal conflict α = 0.62, F-test = 176.980

p<0.01

1.878 37.564 59.0 % 122.742 10 p<0.01

Most employees in this business get along well with each other 0.727

Employees from this business feel that the goals of their

respective business are in harmony with each other

0.669

There is little or no interpersonal conflict in this company 0.515

Factor 11 : Interpersonal connectedness α = 0.81, F-test =

4.373 p<0.01

2.532 63.304 76.0% 316.486 6 p<0.01

In this business, regardless of their rank or position, it is easy

to talk to anyone needed

0.752

There is ample opportunity for informal hall talk among

individuals in this business

0.771

In this business, employees feel comfortable calling each other

when the need arises

0.845

People in this business are quite accessible to one another 0.812

Factor 12 : Competition α = 0.77, F-test = 45.422 p<0.01 3.092 44.171 78.3 % 511.320 21 p<0.01

We regularly monitor our competitors marketing efforts 0.763

We frequently collect marketing data/information on our

competitors to help direct our marketing plans

0.789

Our salespeople are instructed to monitor and report on

competitor activity

0.815

We respond rapidly to competitors actions 0.744

There are many promotion wars in our business. 0.588

Price competition is a hallmark of our business. 0.592

Our competitors are relatively weak 0.584

Table 5. Psychometric properties of market turbulence, general economy, organizational

commitment, esprit de corps and business performance.

Factor

Loading

Eigen

Value

%

Variance KMO

Bartlett’s

test

df

Factor 13 : Market Turbulence α = 0.529, F-test = 9.188

p<0.01

1.894 47.347 67.8 % 110.611 6 p<0.01

In our kind of business, customer’s product preferences

change quite a bit over time

0.717

Our customers tend to look for new product all the time 0.767

We are witnessing demand for our products and services from

customers who never bought them before

0.616


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Sometimes our customers are price sensitive, but on other

occasions, price is relatively unimportant

0.641

Factor 14 : General Economy α = 0.647, F-test = 74.412

p<0.01

1.437 47.895 51.0 % 47.384 3 p<0.01

The customers in our business are likely to be value

conscious

0.820

Our business is more responsive to customer needs in order to

offer good value for money

0.831

Factor 15 : Organizational commitment α = 0.62, F-test =

173.461 p<0.01

2.258 56.442 75.3 % 211.732 6 p<0.01

The bonds between this business and its employees are weak 0.799

Our employees have little or no commitment to this business 0.758

Factor 16 : Esprit de corps α = 0.50, F-test = 14.641 p<0.01 1.715 42.874 63.6 % 83.485 6 p<0.01

People in this business are genuinely concerned about the

needs and problems of each other

0.710

Working for this business is like being a part of a big family 0.749

People in this business feel emotionally attached to each other 0.789

People in this business view themselves as independent

individuals who have to tolerate others around them

0.568

Factor 17 : Business performance α = 0.901, F-test =

14.691 p<0.01

4.888 61.095 89.7 % 1233.140 28 p<0.01

Is it very easy to get your money back in this business 0.583

The profit of our business has increased 0.853

We have remarkable sales growth in our business 0.844

The market share (the market size in relation to that of the

competitors) of this business has gone up

0.733

The sales volume has increased 0.882

The revenues of our business have increased 0.866

The quality of our products/services has improved 0.549

The financial position of our business has improved 0.862

Table 6. Psychometric properties of customer satisfaction

Factor

Loading

Eigen

Value

%

Variance KMO

Bartlett’s

test

d f

Factor 18 : Customer satisfaction α = 0.654, F-test =

19.784 p<0.01

2.341 59.009 71.2 % 217.220 15 p<0.01

We have more loyal customers than competitors 0.666

We often receive complementary phone calls/letters from our

customers

0.722

Our trade partners always praise us about our Product/service

quality

0.664

We hardly receive complaints about our product/service 0.595

We generate new customers in our business on a regular basis 0.663

Customers of this business are happy with our

products/services and prices

0.639

6. Conclusion and Recommendation

This study has examined the psychometric properties and the stability of the factor structure of

MO scale items in Botswana among small service firms. The results demonstrate that MO scale

items in Botswana have sound psychometric properties and a consistent factor structure.


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Although further research is necessary to replicate present findings and provide additional

evidence of the psychometric competence. The Botswana version of MO scale items is thus

posited to be an excellent instrument for the assessment of performance of small service

firms .The instrument therefore exhibits both conceptual and psychometric equivalence by

providing acceptable levels of reliability, variance extracted and both discriminant and

nomological validity. The instrument in this empirical study will thus contribute to theory

development and business performance among small service firms in Botswana. From a

managerial perspective, the MO scale can be used to evaluate small service firms level of MO

efficiency as a baseline measure.

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The Effects of Environmental Munificence and Market

Orientation Dimensions on Performance of Small

Business Firms in Botswana

Olumide Olasimbo Jaiyeoba (Corresponding author)

Department of Marketing, Faculty of Business

University of Botswana, Gaborone

Received: July 13, 2013 Accepted: August 2, 2013

doi:10. 5296/ber.v3i2.4687 URL: http://dx.doi.org/10. 5296/ber.v3i2.4687

Abstract

The significance and importance of the relationship between market orientation and

environmental munificence is clearly embedded in the extant literature. There is however the

acute paucity or conceptual ambiguity of such investigation in developing economies.Thus,this

study aims to investigate the effects of environmental munificence and market orientation

dimensions on performance of small business firms in Botswana. While there is a rich body of

research on market orientation抯 effect on business performance, much little attention has been

given to the combined effects of environmental munificence and market orientation on small

businesses in developing economies. To provide insights into the above inconsistencies, this

study hope to generate empirical results on the combined effects of market orientation and

environmental munificence on small business performance in Botswana

Keywords: Environmental Munificence, Market Orientation, Small Business Firms,

Botswana.

1 Introduction

Botswana has long realized the importance of Small firms in fostering economic growth and in

creating jobs. This led to the introduction, over the last two decades, of targeted financial

support as well as advisory programmes to help Batswana establish their own enterprises.

These programmes, however, were set up more in reaction to specific problems encountered

rather than as the basis of a comprehensive and more focused government policy on Small

businesses. Over the last decade, considerable changes have taken place in the world economic

order, brought about by a number of factors. The most important new factor is the growing

intensity of international competition, spurred by the advent of globalization. The other factor


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that is increasing competitiveness is the rapid introduction of more productive technology and

improved operating procedures in business enterprises throughout the world. The significance

and importance of the relationship between market orientation and environmental munificence

is clearly embedded in the existent literature. There is however the acute paucity or conceptual

ambiguity of such investigation in developing economies.Thus,this study aims to investigate

the effects of environmental munificence and market orientation dimensions on performance

of small business firms in Botswana. The research community largely shares the view that

growing Small firms have a special importance in the economy (Storey,1994). Although there

has been much interest in understanding small firm growth during the last twenty years (Dobbs

and Hamilton,2007;O扲egan et al.,2006;Wiklund,1998;Delmar et al,2003),there is still not

much of a common body or nexus of relationship of well founded knowledge about the causes,

effects or processes of growth (Davidsson and Wiklund,2000).While there is a rich body of

research on market orientation抯 effect on business performance, much little attention has been

given to the combined effects of environmental munificence and market orientation on small

businesses in developing economies. Also a rich body of research in marketing has examined

the relationship between market orientation-firms?focus on the identification and satisfaction

of customer needs and business performance (Ellis 2006;Kirca et al,2005).Still, our

understanding of the relationship between market orientation and environmental munificence,

which is also central for firms?growth and competitive advantage, is much more limited, most

especially in Africa. To provide insights into the above inconsistencies, this study hope to

generate empirical results on the combined effects of market orientation and environmental

munificence on small business performance in Botswana. Environmental munificence is the

scarcity or abundance of critical resources needed by firms operating within an environment

(Randolph& Dess,1984).The resources available within an environment influence the survival

and growth of firms sharing that environment, they also affect the abilities of new firms to enter

this environment (Randolph& Dess,1984).Research has indicated that environmental

munificence is positively associated with the range of strategy and organization options

available to firms, including market orientation dynamics.(Tushman &Anderson,1986).When

resources are abundant, it is relatively easy for firms to survive, and pursue goals other than

survival.However,when resources are scarce, competition intensifies (Dess &

Beard,1984),adversely affecting firm profitability and organizational slack and causing

changes in interorganisational characteristics and tangible and intangible behaviors of

organizational members .Together, these findings suggest that munificence is an important

theoretical dimension.

2 Literature Review

The environment creates opportunities and threats for an organization. It affects organizational

structure, processes, and managerial decision making (Duncan,1972;Keats and Hitt,1988).The

environment creates uncertainty for an organization抯 managers which in turn influences the

information processing needs within the top management team most especially in small

business firms in developing economies. Zahra et al., (1999) thus call for comparative

entrepreneurship studies across multiple countries and cultures, with the underlying premise

that different cultural and economic contexts may lead to differential intensities of


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entrepreneurial orientation and its antecedents and consequences. Managers must cope with

uncertainty by identifying opportunities, recognizing problems or threats, and by implementing

strategic adaptations (Hambrick,1980;Jemison,1984).Therefore, the study of different regions,

cultures, economies and environments becomes a research priority if we want a full

understanding of the nature and the role of entrepreneurship and market orientation.

Environmental munificence refers to environmental capacity which permits organizational

growth and stability. Munificence can also facilitate the generation of slack resources (Cyert

and March, 1963) which the organization can use during periods of scarcity or which can be

used for organizational innovation. Hostile market environments characterized by intense

competition and lack of exploitable opportunities, and dynamic market environments

characterized by rapid technological advancements and rapidly changing consumer

preferences, are considered to have a significant influence on business performance (Covin and

Slevin,1989;Gray et al.,1998;Jaworski and Kholi,1993;Low,2000;Kumar and

Srivastava,2004;Slater and Narver,1994).Clearly, the desire to be competitive in such

environmental conditions may provide the impetus for organizations to implement marketing

audits to ensure the marketing executives to have adequate environmental information for

market conduct, most especially amongst small business firms in developing economies. In the

literature, environment has been defined as a multidimensional concepts (Egeren and onnor,

1998).Following Egeren and onnor (1998) approach, this study will define environment in

terms of marketing manager perceptions of munificence and dynamic attributes.

3 Conceptual Models and Hypotheses Development

Group cohesiveness has been shown to be related to the quantity of interaction (Lott and Lott,

1961) and quality of interaction (Shaw, 1964) between group members, most especially

amongst small business firms. Connectedness between departments facilitates interaction and

the exchange of information (Ruekert & Walker, 1987). Kirca et al.,(2005),analogously

concluded that managers can improve market orientation by emphasizing market-oriented

attitudes, behaviors, and reward systems; tolerating acceptable risk; communicating effectively;

embracing change; and providing opportunities for staff development or advancement while

avoiding formalization, centralization, and interdepartmental conflict. The perception of an

organization as being comprised of different but interdependent departments and functions,

together with the availability of conflict resolution mechanisms, facilitates the open flow of

resources, work and assistance across all organizational departments (Ruekert & Walker

1987).Based on this reasoning, Jaworski and Kholi (1993) postulate that interdepartmental

connectedness fosters an interdependency within the organization and encourages employees

to act in a concerted manner in the processes of knowledge generation and knowledge

utilization. Thus, the following hypothesized relationship could be established:

H1: The higher the level of top management cohesiveness, the higher the Small Business

Firm抯 level of market orientation.

Communication affects strategic decision making by influencing the breadth of the field of

vision during the intelligence generation and dissemination activities of market orientation,

and the processing of information during the intelligence response activities. Kholi and


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Jaworski,(1993),therefore concluded that the role of senior management is critical in shaping

organizational values to promote and reinforce behaviors necessary to serve the current and

future needs of customers, better than their key competitors. Burgess and

Nyajeka,(2007),posited that besides top management reinforcement, their commitment of

continuous communication of specific guidelines to be market-oriented was considered

mandatory to encourage organizational employees, in order to create, disseminate and

effectively respond to market intelligence. Two types of intergroup conflict affect

organizations: relationship conflict and task conflict (Polzer, Milton, & Swann,2002).Burgess

and Nyajeka, (2007), thus postulate that relationship conflict emerges from interpersonal

incompatibility, produces frustration, annoyance and tension; thus reducing information

sharing and causes employees to disengage psychologically and physically from a firm.

Atuahene-Gima & Murray,(2004),concluded that high task conflict adversely affect marketing

strategy development by stifling cross-functional cooperation. The following hypothesized

relationship could be established:

H2: The higher the level of communication exhibited by top management, the higher the

organization level of market orientation.

The literature in business policy and strategic management has long stressed the need to scan

and assess the organization抯 environment and to align environmental characteristics with

organizational capabilities and goals (Miles and Snow,1978). Khandwalla (1976), found that

when managers perceived their environments as being dynamic and uncertain, their strategies

were more likely to be extenstive, more comprehensive and more multifaceted. Environmental

munificence means a great availability of resources in the environment and great opportunity in

access and acquirement of resources needed. This is in line with the position of Covin and

Slevin (1991); and Brown and Kirchhoff,(1997).Environmental munificence, thus refers to

environmental capacity which permits organizational growth and stability. Kholi and Jaworski,

(1990), thus concluded that in those environments high in munificence, an organization may be

able to get away with a minimal amount of market orientation. Dess and Beard, 1984, postulate

that in environments low in munificence, competition increases. In some cases, the intensity of

the relationship between entrepreneurship and market orientation depends on the context in

which firms operate. Covin and Slevin, (1989), posited that the relationship between

entrepreneurship and performance is higher when environmental hostility increases. Dess et al.,

(1997), also argue that entrepreneurial orientation may be especially useful in uncertain or

turbulent environments. Knight (2000), concluded that entrepreneurship may be useful for

small business firms affected by globalization. This reasoning suggests that organizations will

respond to low munificence by using a higher degree of market orientation. The following

hypothesized relationship is posited in this study:

H3: Small Business Firms in environments low in munificence will exhibit a higher degree of

market orientation than Small Business Firms in environments high in munificence.

Market instability or dynamism can come from changes in consumers and in consumers

preferences. In environments marked by stable preferences, there is little need for an

organization to adjust its marketing mix. In contrast, in an environment marked by rapidly


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changing sets of consumers and consumers taste and preferences, there is greater likelihood

that the organization抯 offerings will be mismatched with consumer needs. Technological

turbulence, competitive intensity, and the state of the economy can also bring about

environmental dynamism, which could create diverse opportunities leading to creating value

for consumers, thus making strong market orientation more desirable. Dynamism is the degree

of change or market or market stability.Overall,the reason why market environment

characteristics may influence marketing audits is because marketing audits provide the

marketing management with programmed appraisals and critical evaluations of the

environmental analysis and help ensure the marketing management to identify opportunities

and threats from markets. Dynamic environment is likely to generate opportunities, which the

growth-oriented businesses can take advantage of (Covin & Slevin,1991;Zahra,1993).In their

study of independent Swedish small businesses, Wiklund and Shepherd,(2003), found that

environmental dynamism magnifies the effect the managers rowth aspirations have on the

realization of growth. Based on the discussion earlier, the following exploratory propositions

are presented:

H4: Small Business Firms in environments high in dynamism will exhibit a higher degree of

market orientation than Small Business Firms in environments low in dynamism.

Several empirical studies have found a strong positive relationship between Market orientation

and performance, whether one looks at consumer products, new products, innovation or

services. There is however, a small body of evidence that does not support a strong positive

relationship between MO and business performance. A market orientation provides a unifying

framework and focus for people and departments, thereby creating superior value for

consumers and superior performance for organizations. In a meta-analysis of more than 200

effect sizes, Kirca et al., (2005) find that the effects of market orientation on performance are

strongly positive, although somewhat weaker in emerging markets and service industries. The

meta analysis of Cano et al., (2004) found that the effects of market orientation on performance

are not moderated by national culture, GDP per capita, or human development and are stronger

in service firms than in manufacturing firms. However, only three of the 53 studies they

examined were located in developing economies and they theorized that developing economies

cultural priorities would increase the positive impact of market orientation on performance.

This is consistent with a priori findings of Deshpande and Farley (2004), which states that the

effects of market orientation on performance should be highest in developing economies.

Based on the discussion earlier, the following exploratory propositions are presented:

H5: Small Business Firms with a high degree of market orientation will have higher

performance than Small Business Firms with a low degree of market orientation in Botswana.

Figure 1. Proposed model of Environmental munificence and market orientation dimensions

effect on Small Business Firms In Botswana.


The research design to be adopted in this study is cross-sectional. The target population in this

study would be made up of top management teams of Small business firms in service and


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manufacturing firms as key informants for the firms. The CEOs of 150 small business firms

would be interviewed. Group cohesiveness and communication amongst the small business

firms would be measured by using a series of items to which key informants would respond

using a five point Likert scale. This research intends to use a modification of Slater and Narver

(1992) and Khandwalla (1976) measures to measure munificence, dynamism and

organizational performance. Snowball sampling technique will be utilized due to lack of access

to adequate sampling frame. LISREL (statistical technique of linear structural relations), would

be utilized because it has the potential to address structural relationships among theoretical

(latent) constructs that cannot be directly observed and its ability to incorporate measurement

error in the model. All the scales used would be tested for unidimensionality and reliability in

order to investigate the psychometric competence of scale items.

5. Conclusions

As to environmental ramifications for services marketing management, this study adds support

to the intuitive claims of academicians, that environments high in dynamism and low in

munificence engender higher degrees of market orientation. It could thus be concluded that

those organizations which are in tune with their environments and recognize themselves as

being in high dynamic or low munificence environments will be well advised to invest in

becoming more market oriented.

This study will hopefully contribute to empirical evidence about the relationship among

entrepreneurship, market orientation and performance. Because the adoption of

entrepreneurship and market orientation as part of a firms organizational culture requires

greater effort, it is crucial to understand the relationship of these orientations in terms of their

implementations and implications for performance of small sized firms in Botswana. Therefore,

policies aimed at enhancing entrepreneurial orientation and exploiting its complementarities

with MO constitute an appropriate way to promote economic growth and welfare of small sized

firms in Botswana.

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Investment Strategies of Different Holding Periods:

Evidence from Stock Markets of Hong Kong, Korea,

Shanghai, and Taiwan

Massoud Moslehpour

Dept. of Business Administration, Asia University

500, Lioufeng Rd., Wufeng, Taichung 41354, Taiwan

Tel: +886-423-323-456 (Ext.1962) E-mail: [email protected]

Munkh-Ulzii Batmunkh (Corresponding author)

Dept. of Business Administration, Asia University

500, Lioufeng Rd., Wufeng, Taichung 41354, Taiwan

Tel: +886-423-323-456 E-mail: [email protected]

Received: November 1, 2013 Accepted: November 15, 2013


Abstract

Although there is abundant research focusing on estimating the level of returns on stock market,

there is a lack of studies examining the comparison of stock return movements for short-term

and long-term investment in the Asian stock market. The present study examines return on

investment of different holding periods among selected stock markets in Asia. Based on the

trading performance of key indices and market capitalization value, Korean Stock Exchange

(KRE), Shanghai Stock Exchange (SSE), Hong Kong Stock Exchange (HKSE), and Taiwan

Stock Exchange (TWSE) were selected for this study. In assessing the comparative output of

the case stock markets, this study used ANOVA and post-hoc analysis to process time series

data of daily, monthly, quarterly, semiannually and annually return of investments of indices of

the case stock markets. The results of this study showed that there are significant differences in

return on investment among the case stock markets in the given holding periods. While a

country might have a higher return in short-term investment, it may not necessarily be suitable

for long-term investment as evidenced by their performance from 2001 to 2012.

mailto:[email protected]


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Keywords: Return on Investment, Holding Periods, Short-Term and Long-Term Investment,

HSI, KOSPI, SSECI, TAIEX

1. Introduction

Investment in stock markets has gained unprecedented popularity in financial markets around

the world. Recently the increasing diversity of financial instruments has broadened the

dimension of global investment opportunity to both individual and institutional investors.

Overall competitive pressure has been increased on many stock exchanges due to a range of

significant changes in the industrial environment. The intensive globalization activity brings

stock markets from home-based state to the international arena, where severe competition for

surviving in the financial markets held among investors (Michael, 2009; Sulloway, 2009).

Amid this harsh competition, it is not so easy to make profit from an investment. There are

many economic and social barriers awaiting the investment to be crashed. When

macroeconomic indicators, such as inflation rate and interest rate, move up or down they will

simultaneously trigger uncertainty among the investment decision. Once uncertainty happens,

investors start to sell stocks in order to protect their asset value from devaluation. In the grand

scale, this movement induces volatility into stock markets, which finally cause the value of

shares sink down (Koshnazarov, 2010).

In contrast, during the periods of macroeconomic stability the value of shares keep growing

positively which sends a message to the investors to keep their assets, and even invest more

in buying new shares. Once a positive sign of value of shares appears among investors,

demand for new shares spikes in stock markets, which pulls the price of the shares up. But,

this suitable period of time does not last forever and difficult times for equity values could be

the next movement of the stock market (Araujo, 2009; Chow, Kim, & Sun, 2007).

Therefore, studies in finance overwhelmingly agree that the volatility in stock markets is the

direct reaction to the investment behavior of fund managers. Sometimes financial markets

crash without potential swing in economic fundamentals. Studies conclude that this scenario

appears to be as a common case of investment misbehaving or irrational investment behavior,

which is driven by emotion-greed in the bubbles and fear in the crashes (Climent & Meneu,

2003; Chiang & Zheng, 2010).

Although investment behavior is the key factor in driving stock prices, however, the stock

market performance (measured by market capitalization), trading volume and market return

on investment are also crucial factors for investors. In order to make profit, investors analyze

stock market performance, plan their strategy, and finally put their strategy into action. This

process in whole is called investment behavior (Abdulkadir & Green, 2002; Indrawati, 2002).

Thus, the main purpose of this paper is to compare return on investments among different

stock markets, in Asia in terms of different timing periods.

The capital markets in US and other largest economies might have already been matured.

Therefore, investors now tend to invest into the emerging capital markets of Asia, preferably

South Korea, Taiwan, Hong Kong, and Shanghai, to raise value of their assets. Since 1970s,


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these countries started to exhibit a notable economic growth, and shortly were named as the

tiger economies in the world. The upcoming body of this study focuses more on the stock

markets of mentioned countries, and their performances (Pontines & Siregar, 2009; Singh,

Kumar, & Pandey, 2010).

1.1 Research Problem

The main problem of investors of all times has been the issue of how to do an investment with

low risk and high margin. Even experienced investors do betting blindly as if they were

gambling. According to the previous studies, investment returns may vary in

holding-periods, such as short-term and long-term investment. Thus, studies denote that the

differences in holding periods in investment appear to be as one of the essential factors for

investment strategy (Rigobon, 2003; Zhou, Wu, & Yang, 2011; Singh et al., 2010).

Global equity markets and regional markets are often correlated with one another, especially in

times of economic recession with a prominent contagion and spillover effects. Even in

relatively stable periods, co-moving trending behavior might be presented across equity

markets. Studies on interrelations of equity markets could provide a useful insight for the

international investors who look forward for diversified opportunities. Since co-movements

are common among stock markets, the cross-market gains and losses are prevalent.

Nevertheless, emerging markets with explosive growth rates, such as those in Asia and Pacific

region, have recently attracted market players who seek to diversify their portfolio (Tan,

Chiang, Mason, & Nelling, 2008).

Emerging economies as well as tiger economies are nations with social and economic activity

in the process of rapid growth and industrialization. This process is usually accompanied by an

increase in foreign and domestic investments and life quality. Thus, stock markets of South

Korea, Taiwan, Hong Kong, and Shanghai exhibit characteristics both of emerging and tiger

markets that predominantly attract investors` interest. However, studies state that one of the

key features of emerging markets is that they frequently tend to display upward and downward

movements in stock prices in either of short-term and long term periods. These characteristics

of stock market boost momentum and market swings which in turn add to the market volatility

(Liu, Pan, & Shieh, 1998; Pontines & Siregar, 2009).

Individual investors speculate in short-term and mid-term strategies. However, institutional

investors head for wealth maximization in primary and secondary markets by implementing

long-term investment and other strategies, such as merging and acquisition, as well as IPOs.

Institutional investors rely mostly on long-term value from an investment rather than

speculating in short-term. The key point of long-term investment strategy is not only increasing

the value of capital asset, but also investors can receive income from shares, which is known as

a dividend (In, Kim, & Yoon, 2002; Pontines & Siregar, 2009).

With the foregoing discussion we tried to construct a firm perception of how holding periods

are essential for the decision making pattern of investors, which have recently appeared as one

of the front line issues of latter studies. Do different holding periods impact the investment

returns in emerging stock markets? This is the main question of this study that needs to be

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answered. Thus, present study implements a comparison among investment returns of

emerging stock markets for different holding periods. As for the case stock markets, we select

Shanghai Stock Exchange (hereinafter referred to as SSE), Hong Kong Stock Exchange

(hereinafter referred to as HKSE), Taiwan Stock Exchange (hereinafter referred to as TWSE),

and Korean Stock Exchange (hereinafter referred to as KRE).

2. Related Research and Hypothesis Development

The main purpose of this paper is to give a reasonable answer to the research question: Are

there any significant differences among investment time periods for investment returns in

TWSE, KRE, SSE, and HKSE? If yes, to what extent are these differences exhibited among the

markets? In order to translate the question into theoretical framework we review the following

body of literature.

Recently investors are increasingly seeking for opportunities to minimize the portfolio risk for

an investment return in a given period of time. It is a well established fact that the lower the

correlations among international equity markets the lesser the investment risk. However, the

recent trend of development of emerging stock markets increased the correlation among equity

markets. Therefore, high volatility in returns still exists among developed and emerging equity

markets in terms of holding periods (Dimson, Marsh, & Staunton, 2002; Li, Sarkar, & Wang,

2003; Goetzmann, Li, & Rouwenhorst, 2005).

Numbers of studies reveal differences in returns among the Asian stock markets impacted by

western markets, in both short-term and long-term intervals (Cha & Cheung, 1998; De Roon,

Nijman, & Werker, 2001; Syriopoulos, 2004). However, so far, there is no study to investigate

relationships among the case stock markets of this study.

Mukherjee and Bose (2008) found that recent returns on Indian stock market were severely

influenced by US and other Asian markets including Japan. More importantly, outcomes of

their study suggest that Indian stock market returns impact on the stock returns of major

markets of Asia. Moreover, studies demonstrate that US capital market often exhibit a

significant impact on Asian equity markets in long-term. As well, a notable correlation among

markets of the same region is explained by the degree of restrictions on foreign investment or

certain market characteristics, such as market returns in different holding periods and market

liquidity (Elyasiani, Perera, & Puri, 1998; Lin, 2008).

Hsiao, Hsiao, and Yamashita (2003) found a significant unidirectional causality from the US

market towards stock market returns of Japan and Korea, but not to China and Taiwan. They

also found that the Chinese stock market, based on the data of Shanghai Composite price index,

is not significantly correlated with rest of the Asian markets.

Janakiramanan and Lamba (1998) found that the stock markets of US impact the majority of

Asian markets except for the relatively segmented market of Indonesia. They also revealed that

markets that are located geographically close, such as Australia-New Zealand and

Singapore-Malaysia affect to each other.

Singh, Kumar and Pandey (2010) examine the stock returns volatility spillover effects across


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fifteen stock markets of North America, Europe and Asia. Their research sample for the Asian

stock markets includes China and Indonesia; and the composite stock indices data are used for

both markets. In assessing the investment returns spillover effects, they employed vector

autoregression model, which is used to capture the linear interdependencies among multiple

time series data. Results of their study suggest that information flow within stock markets plays

main role in investment returns. For example, a market that opens earlier generally tends to

have a greater effect on those that open later. Especially, this phenomenon is often displayed

between the equity markets of Japan, Singapore and Hong Kong.

Climent and Meneu (2003) assessed the impacts of the Asian capital market crisis in 1997, on

implication of Southeast Asian markets that include Indonesia, Philippines and Thailand, and

US. Results of their study state that the US equity market affects all the Asian stock markets

except Korea. Moreover, findings of this study also suggest that Asian stock markets with the

close geographical and economical zone demonstrate significant correlations in their

investment returns in short-term and long-term time horizons.

Furthermore, In et al. (2001) examined causality between HKSE, Thailand stock market, and

KRE. They found that Thailand stock market exhibits greater market interdependence, while

HKSE appears as the potential generator of volatility through other Asian stock markets.

Pontines and Siregar (2009) examined correlation of market returns in different holding

periods among eight east Asian stock markets, around the time of the Asian financial recession.

They found significant evidence of increased correlations among market returns on both of

short-term and long-term investment in the post-crisis period, starting especially with declining

in HKSE.

Lee (2009) measured return volatility spillover effects in short-term and long-term investments

among six east Asian stock markets including India. Results found significant spillover effects

among five countries that are geographically close, and as markets as close to each other the

effects were greater. Chuang, Lu, and Tswei (2007) did same study among six Asian stock

markets including Thailand. They found high interdependencies on investment returns in

various time horizons, and the Japanese stock market appears to be a potential volatility

transmitter to other east Asian markets. For the same purpose Singh et al. (2010) used a

GARCH model. They found that the volatility of a particular market return is mostly affected

by one that opens earlier. According to their results the correlation among the Asian markets

was strong.

2.1 Hypothesis Development

Reviewing the theoretical background, we noticed several important aspects for developing

theoretical framework. First, it is obvious that examining correlation of investment returns

within same holding period, or among the same market, as well as the markets that are not

considered to be related to each other, is not good idea. The reason is that correlations between

market returns are more profound among markets that belong to the same geographical and

economical zone. Moreover, returns of equity markets vary according to the holding periods.

Second, previous studies tested the impacts and relationships among stock markets of Asia and

US, but did not target solely on the Asian markets. Therefore, in order to generate rather new

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outcomes, as shown in the Figure 1, we develop the following theoretical framework and

hypothesis.

Figure 1. Research framework

Basing on theoretical foundation, the present study develops the following hypotheses:

H1: There are significant differences among TWSE, HKSE, SSE, and KRE in their daily

investment returns for the period of 2001-2011.

H2: There are significant differences among TWSE, HKSE, SSE, and KRE in their monthly


H3: There are significant differences among TWSE, HKSE, SSE, and KRE in their quarterly


H4: There are significant differences among TWSE, HKSE, SSE, and KRE in their

semiannually investment returns for the period of 2001-2011.

H5: There are significant differences among TWSE, HKSE, SSE, and KRE in their annually



3.1 Data

This study uses time series data of index prices of HSI, KOSPI, SSECI, and TAIEX; covering

periods from January 2001 to April 2012. The time period of chosen data constitutes the

availability and limitation of data source. In order to capture returns in different time horizons

we divided data into time scales of day, month, quarter, semiannual and annual base. The data

for this study was collected from the data source Thomson Reuters Datastream (2013).


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3.2 Methodology

To test the hypotheses of this study we employed analysis of variance (ANOVA). ANOVA is

used to test significance of differences among the means. Furthermore, in order to find the

detailed differences among the subgroups, that could be otherwise undetected; we adopted

post-hoc analysis. Post hoc test is designed for situations in which the researcher has already

obtained a significant omnibus F-test with a factor that consists of three or more means and

additional exploration of the differences among means is needed to provide specific

information on which means are significantly different from each other (Hung, Lu, & Lee,

2010).

Also the descriptive statistics display the characteristics, functions, relationship and patterns of

the research phenomena. It also explains and validates findings. For this study, the p-value is

less than or equal to 5% to indicate statistical significance and to control for type I and type II

error. (Rigobon, 2003).

3.3 Case Stock Markets

3.3.1 Twse

The TWSE is operated by the Taiwan Stock Exchange Corporation (TWSEC), which is a

financial institution that located in Taipei 101, in Taipei, Taiwan. The TWSEC was established

in 1961 and began operating as a stock exchange on 9 February 1962. It is regulated by the

Financial Supervisory Commission of Taiwan. As of 31 December 2010, the TWSE had 758

listed companies with a combined market capitalization of USD821,083 million.

Taiwan Capitalization Weighted Stock Index (TAIEX) is a stock market index for companies

traded on the TWSE. TAIEX covers all of the listed stocks excluding preferred stocks,

full-delivery stocks and newly listed stocks, which are listed for less than one calendar month.

It was first published in 1967 by TWSE with 1966 being the base year with a value of 100

(Taiwan Stock Exchange, 2013).

3.3.2 KRE

KRE is the sole securities exchange operator in South Korea. It is headquartered in Busan, and

has an office for cash markets and market oversight in Seoul. The KRE was created through the

integration of Korea Stock Exchange, Korea Futures Exchange and KOSDAQ Stock Market

under the Korea Stock & Futures Exchange Act. The securities and derivatives markets of

former exchanges are now business divisions of KRE: the Stock Market Division, KOSDAQ

Market Division and Derivatives Market Division. As of October 2012, KE had 1,796 listed

companies with a combined market capitalization of USD1.1 trillion. The Korea Composite

Stock Price Index (KOSPI) is the index of all common stocks traded on the KRE. It's the

representative stock market index of South Korea. KOSPI was introduced in 1983 with the

base value of 100 as of January 4, 1980. It's calculated based on market capitalization (Korean

Stock Exchange, 2013).

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http://en.wikipedia.org/wiki/Taiwan

http://en.wikipedia.org/wiki/Stock_exchange

http://en.wikipedia.org/wiki/Financial_Supervisory_Commission

http://en.wikipedia.org/wiki/Stock_market_index

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3.3.3 SSE

The SSE is a stock exchange that is based in the city of Shanghai, China. It is one of the two

stock exchanges operating independently in the People's Republic of China, the other is the

Shenzhen Stock Exchange. SSE is the one of the six largest stock exchanges in the world by

market capitalization at USD2.3 trillion as of Dec 2011. Unlike the HKSE, the SSE is still not

entirely open to foreign investors due to tight capital account controls exercised by the Chinese

mainland authorities. The current exchange was re-established on November 26, 1990 and was

in operation on December 19 of the same year. It is a non-profit organization directly

administered by the China Securities Regulatory Commission.

The SSE Composite Index (SSECI) is the most commonly used indicator to reflect SSE's

market performance. Constituents for the SSECI are all listed stocks including at the SSE. The

base day for the SSECI is December 19, 1990. The base period is the total market capitalization

of all stocks of that day. The base value is 100. The index was launched on July 15, 1991

(Shanghai Stock Exchange, 2013).

3.3.4 HKSE

The HKSE is a stock exchange located in Hong Kong. It is Asia's second largest stock

exchange in terms of market capitalization behind the Tokyo Stock Exchange, and the fifth

largest in the world. As of 30 November 2011, the HKSE had 1,477 listed companies with a

combined market capitalization of USD2191.6 trillion.

The Hang Seng Index (HSI) is a free float-adjusted market capitalization-weighted stock

market index of HKSE. It is used to record and monitor daily changes of the largest companies

of the HKSE and is the main indicator of the overall market performance in Hong Kong. These

48 constituent companies represent about 60% of capitalization of the HKSE. HSI was started

on November 24, 1969, and is currently compiled and maintained by Hang Seng Indices

Company Limited (Hong Kong Stock Exchange, 2013).

4. Empirical Findings

Under the assumption of five hypotheses in this study, we analyze the time series data of

indices HSI, KOSPI, SSECI, and TAIEX to find out degree of correlation in different holding

periods. The data is divided into five timing scales such as daily, monthly, quarterly,

semiannually, and annually, and analyzed by ANOVA modeling techniques and post-hoc test.

4.1 Descriptive Statistics

Descriptive statistics is the discipline of quantitatively describing the main features of data.

Descriptive statistics are distinguished from inferential statistics, in that it aims to summarize a

data, rather than use the data to learn about the population. This generally means that

descriptive statistics, unlike inferential statistics, is not developed on the basis of probability

theory. Even when a data analysis draws its main conclusions using inferential statistics,

descriptive statistics are generally also presented.


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Table 1. Descriptive statistics of the four case stock markets

Periods

Code

N Mean

Std.

Deviation

Std.

Error

95% Confidence Interval for

Mean

Minimum Maximum Lower Bound Upper Bound

Daily

KRE 2482 .00052 .015984 .000321 -.00011 .00115 -.106 .119

SSE 2482 .00571 .083138 .001669 .00244 .00899 -.250 .350

HKSE 2482 .02073 .121428 .002437 .01595 .02551 -.515 .637

TWSE 2482 .04694 .201066 .004036 .03902 .05485 -.525 .788

Total 9928 .01847 .126116 .001266 .01599 .02095 -.525 .788

Monthly

KRE 2482 .00028 .017037 .000342 -.00039 .00095 -.088 .095

SSE 2482 .00612 .066711 .001339 .00349 .00874 -.410 .322

HKSe 2482 .02081 .134813 .002706 .01550 .02611 -.413 .612

TWSE 2482 .15736 .248274 .004983 .14759 .16713 -.535 .828

Total 9928 .04614 .159098 .001597 .04301 .04927 -.535 .828

Quarterly

KRE 2482 .00052 .015984 .000321 -.00011 .00115 -.106 .119

SSE 2482 .00456 .066194 .001329 .00196 .00717 -.264 .261

HKSE 2482 .07817 .198077 .003976 .07038 .08597 -.488 .909

TWSE 2482 -.33306 .280194 .005624 -.34409 -.32203 -.838 .392

Total 9928 -.06245 .236545 .002374 -.06710 -.05780 -.838 .909

Semi

annually

KRE 2482 .00022 .014446 .000290 -.00035 .00079 -.088 .067

SSE 2482 .03563 .124644 .002502 .03073 .04054 -.401 .493

HKSE 2482 .05435 .298261 .005987 .04261 .06609 -.533 1.125

TWSE 2482 -.85676 .052857 .001061 -.85884 -.85468 -.942 -.664

Total 9928 -.19164 .417995 .004195 -.19986 -.18342 -.942 1.125

Annually

KRE 2482 .01059 .066847 .001342 .00796 .01322 -.375 .240

SSE 2482 .02193 .169393 .003400 .01526 .02860 -.394 .646

HKSE 2482 .04513 .186937 .003752 .03777 .05248 -.580 .803

TWSE 2482 1.67257 .714040 .014332 1.64447 1.70068 .183 4.406

Total 9928 .43755 .808131 .008111 .42166 .45345 -.580 4.406

4.2 ANOVA Analysis

In statistics, ANOVA is a statistical model, in which the observed variance in a particular

variable is partitioned into components attributable to different sources of variation. In its

simplest form, ANOVA provides a statistical test of whether or not the means of several groups

are all equal. For this reason, ANOVA is useful in comparison of more than two means.

According to the results generated from ANOVA analysis shown in the Table 2, all the

proposed hypotheses of this study are supported.

Table 2. ANOVA testing of the four stock markets

Sum of Squares df Mean Square F Sig.

Daily

Between Groups 3.228 3 1.076 69.033 .000

Within Groups 154.664 9924 .016

Total 157.892 9927


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Monthly

Between Groups 41.491 3 13.830 654.269 .000

Within Groups 209.781 9924 .021

Total 251.273 9927

Quarterly

Between Groups 251.824 3 83.941 2.744E3 .000

Within Groups 303.625 9924 .031

Total 555.449 9927

Semi

annually

Between Groups 1467.736 3 489.245 1.820E4 .000

Within Groups 266.704 9924 .027

Total 1734.440 9927

Annually

Between Groups 5049.166 3 1683.055 1.165E4 .000

Within Groups 1433.922 9924 .144

Total 6483.088 9927

4.3 Post-hoc Analysis

In the design and analysis of experiments, post-hoc analysis consists of looking at the data-after

the experiment has concluded-for patterns that were not specified a priori. It is sometimes

called by critics data dredging to evoke the sense that the more one looks the more likely

something will be found. More subtly, each time a pattern in the data is considered, a statistical

test is effectively performed. This greatly inflates the total number of statistical tests and

necessitates the use of multiple testing procedures to compensate.

However, this is difficult to do precisely and in fact most results of post-hoc analyses are

reported as they are with unadjusted p-values. These p-values must be interpreted in light of the

fact that they are a small and selected subset of a potentially large group of p-values. Results of

post-hoc analysis should be explicitly labeled in studies to avoid misleading of audience.

Table 3. Post hoc analysis for daily stock index

Dependent Variable (I) country (J) country

Mean Difference

(I-J) Std. Error Sig.

95% Confidence Interval

Lower Bound Upper Bound

Daily

KRE

SSE -.005196 .003544 .542 -.01510 .00471

HKSE -.020209* .003544 .000 -.03012 -.01030

TWSE -.046418* .003544 .000 -.05633 -.03651

SSE

KRE .005196 .003544 .542 -.00471 .01510

HKSE -.015013* .003544 .000 -.02492 -.00511

TWSE -.041222* .003544 .000 -.05113 -.03131

HKSE

KRE .020209* .003544 .000 .01030 .03012

SSE .015013* .003544 .000 .00511 .02492

TWSE -.026209* .003544 .000 -.03612 -.01630

TWSE KRE .046418* .003544 .000 .03651 .05633

SSE .041222* .003544 .000 .03131 .05113

HKSE .026209* .003544 .000 .01630 .03612

Based on post-hoc daily test results, as shown in the Table 4, the following 6 conclusions can be drawn:

1) there is no significant difference between KRE and SSE (p > .05);


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2) there is significant difference between KRE and HKSE (p < .001);

3) there is significant difference between KRE and TWSE (p < .001);

4) there is significant difference between SSE and HKSE (p < .001),

5) there is significant difference between SSE and TWSE (p < .001);

6) there is significant difference between HKSE and TWSE (p < .001);

Table 4. Post hoc analysis for monthly stock index

Monthly

KRE

SSE -.005839 .004127 .572 -.01738 .00570

HKSE -.020532* .004127 .000 -.03207 -.00899

TWSE -.157083* .004127 .000 -.16862 -.14554

SSE

KRE .005839 .004127 .572 -.00570 .01738

HKSE -.014692* .004127 .005 -.02623 -.00315

TWSE -.151244* .004127 .000 -.16278 -.13970

HKSE

KRE .020532* .004127 .000 .00899 .03207

SSE .014692* .004127 .005 .00315 .02623

TWSE -.136552* .004127 .000 -.14809 -.12501

TWSE

KRE .157083* .004127 .000 .14554 .16862

SSE .151244* .004127 .000 .13970 .16278

HKSE .136552* .004127 .000 .12501 .14809

Based on post-hoc monthly test results, as shown in the Table 5, the following 6 conclusions can be drawn:







Table 5. Post hoc analysis for quarterly stock index

KRE

SSE -.004046 .004965 .882 -.01793 .00984

HKSE -.077657* .004965 .000 -.09154 -.06377

TWSE .333577* .004965 .000 .31969 .34746

SSE

KRE .004046 .004965 .882 -.00984 .01793

HKSE -.073611* .004965 .000 -.08749 -.05973


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Quarterly

TWSE .337623* .004965 .000 .32374 .35151

HKSE

KRE .077657* .004965 .000 .06377 .09154

SSE .073611* .004965 .000 .05973 .08749

TWSE .411234* .004965 .000 .39735 .42512

TWSE

KRE -.333577* .004965 .000 -.34746 -.31969

SSE -.337623* .004965 .000 -.35151 -.32374

HKSE -.411234* .004965 .000 -.42512 -.39735

Based on post-hoc quarterly test results, as shown in the Table 6, the following 6 conclusions can be drawn:

1) there is significant difference between KRE and SSE (p < .001);






Table 6. Post hoc analysis for semiannually stock index

Semi

annually

KRE

SSE -.035418* .004654 .000 -.04843 -.02241

HKSE -.054131* .004654 .000 -.06714 -.04112

TWSE .856973* .004654 .000 .84396 .86998

SSE

KRE .035418* .004654 .000 .02241 .04843

HKSE -.018713* .004654 .001 -.03172 -.00570

TWSE .892391* .004654 .000 .87938 .90540

HKSE KRE .054131* .004654 .000 .04112 .06714

SSE .018713* .004654 .001 .00570 .03172

TWSE .911104* .004654 .000 .89809 .92412

TWSE

KRE -.856973* .004654 .000 -.86998 -.84396

SSE -.892391* .004654 .000 -.90540 -.87938

HKSE -.911104* .004654 .000 -.92412 -.89809

Based on post-hoc semiannually test results, as shown in the Table 7, the following 6 conclusions can be drawn:

1) there is significant difference between KRE and SSE (p < .001);







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Table 7. Post hoc analysis for annually stock index

Annually

KRE

SSE -.011339 .010790 .776 -.04151 .01883

HKSE -.034535 .010790 .017 -.06470 -.00437

TWSE -1.661983* .010790 .000 -1.69215 -1.63181

SSE

KRE .011339 .010790 .776 -.01883 .04151

HKSE -.023196 .010790 .202 -.05336 .00697

TWSE -1.650643* .010790 .000 -1.68081 -1.62047

HKSE

KRE .034535 .010790 .017 .00437 .06470

SSE .023196 .010790 .202 -.00697 .05336

TWSE -1.627448* .010790 .000 -1.65762 -1.59728

TWSE

KRE 1.661983* .010790 .000 1.63181 1.69215

SSE 1.650643* .010790 .000 1.62047 1.68081

HKSE 1.627448* .010790 .000 1.59728 1.65762

Based on post-hoc annually test results, as shown in the Table 8, the following 6 conclusions can be drawn:


2) there is no significant difference between KRE and HKSE (p > .05);


4) there is no significant difference between SSE and HKSE (p > .05),



5. Empirical Contributions

According to the results, it is evident that the market returns are highly diversified among the

case stock markets through the investment time horizon. Thus, in order to make the results

more visible and applicable, we re-categorise each holding periods into three groups. First is

short-term investment period, which includes daily and monthly trading intervals. Second is

mid-term investment period, which includes quarterly and semi-annually trading intervals.

Third is long-term investment period, which includes annually trading interval (Martin, Maria,

Tommy, & Anders, 2012).

5.1 Short-Term Investment Period

According to the results, TWSE appears to be the most profitable market, and the second most

profitable market is HKSE. For SSE, returns are mediocre. Investment returns of SSE are

better than KRE, however are not as high as HKSE and TWSE. Thus, investors are suggested

to be cautious in doing short-term (daily and monthly) investment in KRE.

5.2 Mid-Term Investment Period

The best choice for investment in this period appears to be HKSE and then SSE. The middle

point market here is KRE. The low return investment market for mid-term investing period


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seems to be TWSE. Thus, investors should be careful with mid-term (quarterly and

semi-annually) investment decisions related to TWSE.

5.3 Long-Term Investment Period

Based on the findings of this study, investors can expect better long-term investment return

from TWSE. There are no significant difference between long-term investment returns of the

SSE, HKSE, and KRE. However, fund managers may keep in mind that KRE might be riskier

than the HKSE and SSE because of the lowest investment return for the long-term investment

period.

6. Conclusions and Limitations

6.1 Conclusions

This study investigates the differences for diverse holding periods of investments in the case of

four Asian stock markets. Thus, the primary objective of this research is to demonstrate that

returns of the case stock markets are diversified in different holding periods. To test the

proposed hypotheses this study used ANOVA and time series data, with time interval from

January 01, 2001 to April 26, 2012. The results of ANOVA indicate that all the presumed

hypotheses are supported. Results of post-hoc analysis summarized below.

6.1.1 Daily (short-term) Trading

In daily trading, as shown in the Table 3, returns of HKSE, SSE and TWSE are greater than

returns KRE. In daily trading, the equity market of Taiwan seems to be the most suitable and

the most profitable place than the rest of the markets in this study. Based on the mean values for

daily returns of investment the following ranking from best to worst is exhibited: 1) TWSE, 2)

HKSE, 3) SSE, and 4) KRE. That is, when considering the average return of all stocks in daily

trading the best market seems to be TWSE and the worst market seems to be KRE.

6.1.2 Monthly (short-term) trading

In monthly trading, as shown in the Table 4, returns of HKSE, SSE and TWSE are greater than

returns KRE. Literally, TWSE seem to be the most suitable and the most profitable place again.

Based on the mean values of monthly returns of investment the following ranking from best to

worst is displayed: 1) TWSE, 2) HKSE, 3) SSE, and 4) KRE. Considering the average returns

of all stocks for the monthly holding period, the TWSE obviously appears outperforming the

other three markets while KRE stands at last.

6.1.3 Quarterly (mid-term) Trading

In quarterly trading, as shown in the Table 5, returns of HKSE, SSE and KRE are greater than

returns TWSE. Interesting turn of events when we move from short-term trading to mid-term

trading we can see significant shift in market returns. When it comes to mid-term trading, the

TWSE seems to be the least suitable and least profitable place. In fact TWSE shows a loss of

capital for quarterly holding period. Based on the mean values for quarterly trading the

following rankings from best to worst is presented: 1) HKSE, 2) SSE, 3) KRE, and 4) TWSE.

That is, when considering the average return of all stock in quarterly holding period, HKSE


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significantly surpasses all three other markets, while TWSE significantly does the worst.

6.1.4 Semi-annually (mid-term) Trading

In semi-annual trading, as shown in the Table 6, likewise quarterly, returns of HKSE, SSE and

KRE are greater than returns TWSE. The two mid-term holding periods seem to behave exactly

identical with similar significant differences. Thus, the TWSE Taiwan appears to be the least

suitable and least profitable place again. Based on the mean values for semi-annual trading the

following rankings from best to worst can be assigned: 1) HKSE, 2) SSE, 3) KRE, and 4)

TWSE. Therefore, considering the average return of all stock in quarterly holding period,

HKSE significantly surpasses all three other markets, while TWSE took the last spot.

6.1.5 Annual (long-term) Trading

In annual trading, as shown in the Table 7, returns of HKSE, SSE and TWSE are greater than

returns KRE. When it come yearly returns of investment in stock trading, the TWSE seems to

come back on top once again to be the most suitable and the most profitable place. Based on the

mean values for day trading the following rankings from best to worst can be assigned: 1)

TWSE, 2) HKSE, 3) SSE, and 4) KRE. This finding is very similar to that of the short-term

trading strategy. That is, when considering the average return of all stocks in yearly holding

trading period the best market seems to be the TWSE and the worst market seems to be KRE.

Therefore, we can make a quick and simple conclusion that when it comes to holding stock

periods, considering the four markets chosen for this study, long-term and short-term holding

periods seem to act similarly. The international traders might think of diversification in the four

mentioned markets in order to lower investments risks. Due to the variation of returns between

long-term, mid-term and short-term holding periods, investors should shape the best fit

strategy to meet the goal of low risk and high profit.

6.2 Limitations

This study has several limitations that further studies needed to pay attention. First, due to the

availability of data, the present study employs data that covers time period from 2001 to 2012,

which is not enough to present the whole period of investment returns of the case stock markets.

Although this is the limitation of this study, it should be noted that the economies of the Asian

countries have grown much rapidly during the past decade. Therefore studying of the historic

data before 2001 may not be helpful to the investors to make future predictions.

Second, this study does not consider specific stocks or specific sectors of stock market. Finally,

this study uses ANOVA and post-hoc analysis. Thus, further studies are advised to employ

different approaches and use different sources for data than the present study does, to ensure

and improve the outcomes.

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