Corporate Governance Intelligence: Minority Shareholder’s Aspects (Evidence from Ukraine)

Chinese Business Review

Volume 14, Number 4, April 2015 (Serial Number 142)

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Chinese Business Review

Volume 14, Number 4, April 2015 (Serial Number 142)

Contents

Economics

Currency Systems and Their Role in Entering and Leaving the Economic Crisis 169

Jakub Jedlinský

Socio-Economic Brand “Carpathians” in the Context of Tourism Industry Development in Countries of Central and East Europe 186

Fedir Shandor

Analysis of the Bovespa Futures and Spot Indexes With High Frequency Data 192

Edimilson Costa Lucas, Danilo Braun Santos, Bruno Nunes Medeiro,

Vinicius Augusto Brunassi Silva, Luiz Carlos Monteiro

Management

China’s Development Aid Strategies 201

Wioletta Nowak

Corporate Governance Intelligence: Minority Shareholder’s Aspects (Evidence From Ukraine) 210

Tetiana Momot, Oleksandr Vashchenko, Nina Avanesova, Anna Chudopal

Chinese Business Review, April 2015, Vol. 14, No. 4, 169-185 doi: 10.17265/1537-1506/2015.04.001

Currency Systems and Their Role in Entering and Leaving the

Economic Crisis

Jakub Jedlinský

University of Economics in Prague, Prague, the Czech Republic

The paper focuses on a comparison of two contrasting approaches: having a single universal currency in a given

fiscal area or supporting a concurrent presence of more competing currencies of different types. A systemic analysis

(based on studying both conventional and unorthodox literature) of the modern monetary system points out that the

very type of money that is used suffers internal errors that make a crisis inevitable. The indebtedness is systemic

and unavoidable in a currency that is issued as a liability. Parallel currencies are proposed as a general solution. A

specific solution, including a redefined national currency, is offered too, with an outline of its possible experimental

verification. Such a system could help to prevent the next economic crisis, mitigate it, or at least facilitate its

leaving. The paper also deals with criticism that is held against the idea of concurrent currencies.

Keywords: redefinition of money, Gresham’s law, Tinbergen’s rule, economic crisis

Introduction

The Austrian school of economics sees the economic cycle with its booms and busts (crises) as a monetary

issue caused by fractional reserve banking (Mises, 1998; Soto, 2012). The proposed solution is seen in a return

to full reserve system and gold standard. Minsky’s financial instability hypothesis (1992) describes a similar

problem. The cycle is boosted by the behavior of economic agents. This paper gives credit to these theories but

finds the problem to be deeper, embedded in the very foundations of the currency. The gold standard has its

own issues that will be discussed. It leads to another kind of instability. Any kind of regulation can possibly

mitigate the problems connected to over-indebtedness but cannot prevent the accumulation of debt in the

economy either.

The aim of this paper is to prove that the crisis experienced in 2008 was caused by a wrongly defined

currency. The main hypothesis goes like this: The current monetary system does not perform desired functions

of money satisfactorily. It prevents the economy from reaching its true potential and widens the gaps among

particular economic agents. What is more, it enables the phenomena described by Minsky (1992) and the

Austrians.

The secondary aim of the paper is to support the opinion that a sustainable solution lays in the creation of

such a monetary system that would be flexible. Such flexibility can only be achieved when more concurrent

Acknowledgement: This research was financially supported within a grant (IGA VŠE)—IG210014—Nové směry governance ve světle finanční a dluhové krize.

Jakub Jedlinský, Mgr., Ing., Department of World Economy, University of Economics in Prague, Prague, the Czech Republic. Correspondence concerning this article should be addressed to Jakub Jedlinský, Sokolovská 124, Prague 18600, the Czech

Republic. E-mail: [email protected].

DAVID PUBLISHING

D

ROLE IN ENTERING AND LEAVING THE ECONOMIC CRISIS

170

currencies operate in a market that are designed to specialize for performing certain monetary functions only.

Theorems like Gresham’s law and Tinbergen’s rule will be used in order to prove the hypothesis.

A systemic analysis will be carried out in order to identify the internal errors in the modern currency. A

heterodox approach will be used for the studying of the related literature. A necessity of an emergence of a

crisis will be deducted from these errors. A specific multi-currency monetary setting will be designed that

resonates with the discovered findings and does not suffer the same errors. A possible experimental verification

will be outlined to test the setting.

Literature Review

The neoclassical economics basically operates in terms of real economy and oversees the substantial role

of money as was described by Keen (2011), Hudson, Innes, and Wray (2004), or Borio (Klein, 2012). Some

alternative schools like the Austrian ones or Postkeynesians give regard to credit, though.

According to Minsky (1992), over a protracted period of good times, capitalist economies tend to move

from a financial structure dominated by hedge finance units to a structure in which there is large weight to units

engaged in speculative and Ponzi finance. The instability rises from the emergence of excessive credit that is

taken by market agents in order to speculate or inflate Ponzi bubbles. When a regulator decides to step in and

taper the schemes, Fisher’s debt deflation (1933) may occur, freezing the liquidity in the market, effectively

making any investment impossible.

The Austrian story (Soto, 2012) begins with a central bank setting interest rates below the hypothetical

market price. New money is borrowed into the economy as credit and spent in areas which would normally be

financed less. Bubbles are inflated again, only to burst when people realize that there was not enough

underlying value.

Both theories identify the excessive credit as a cause of the instability, cycle, and crises. Both claim that a

crisis does not have to be triggered by an external shock. The financial instability hypothesis is a model of a

capitalist economy which does not rely upon exogenous shocks to generate business cycles of varying severity

(Minsky, 1992). This paper accepts that the business cycle is not exogenous (as the biblical seven years of

hunger) and studies the question whether it is possible to have a credit based fiat currency and not to inflate the

economy with credit at the same time.

Is it possible to issue new units of money without adding more debt into the economy? The usual way new

money flows into a modern economy was described in a report published by Bank of England (McLeay, 2014).

A commercial bank expands its balance by newly created accounting money on the liabilities side and an asset

against it. The asset is typically a claim against a debtor who has taken credit from the bank, e.g., a mortgage.

But it may also be a bond or even a non-financial asset, anything the bank buys with the money that has not

existed before. As the debtor redeems his/her debt to the bank, the money is being cancelled, too. That is the

way double-entry bookkeeping works. Every unit of money that is collateralized by debt has a termination

moment. Every such unit is only temporary. So is there another way to issue money in the system?

According to Krejčí (1998), cash can be observed as money that is not being terminated, because it has

physical representation that cannot be simply cancelled in an accounting way. Nevertheless, cash is issued by a

central bank to replace electronic (giro) money. When electronic money is replaced by the new cash, it is

terminated but the debt that arose with it is not. The debt thus stays in balances, making cash more of just a

form of credit based money than an independent type that could be seen as non-liability. It is thus impossible


171

for the money issuer (a commercial bank) to redeem such debt with cash, unless the cash is treasured and

frozen. Krejčí (1998) implied that new money can be created, when a central bank performs open market

operations. Such money is collateralized by foreign money, not debt. That is correct when author only

considers a single national economy. From a global perspective, new money entered an economy, while other

currency was withdrawn. Due to the possible change in mutual exchange rate, the total market capitalization of

both currencies can rise but the effect is unsure, especially under the conditions of perfect competition. Mayer

(2014), a proponent of vollgeld/positive money, believed that the only non-liability money is memorial coin.

Also, governments of certain states are allowed to get new cash directly from the central bank and they only

pay the costs of minting and printing. This issue, however, is systemically irrelevant.

The other question is whether it is possible to have growing economy without issuing new money.

According to Fisher’s equation (1933) of exchange, such growth would have to be achieved by either

increasing velocity of money or deflation. Deflation causes perhaps even greater instability to a monetary

economy than inflation does.

This paper sees a solution in a system consisting of multiple parallel currencies, whereby at least some of

them would not be issued against debt. The idea of concurrent currencies was discussed and advocated in

Hayek’s denationalization of money (1976). He said that private currencies issued by commercial banks would

compete with each other. The market would then find the best currency to become dominant in the monetary

area. For Hayek (1976), as a representative of Austrian school of economics, the best currency would be the

one having value which value would increase in time. It would be the best store of value. Inflationary

currencies would not be demanded and used. Frisby (Keiser, 2013a) developed the idea and suggested that

every subject should be allowed to issue a private currency, not only banks. Both promoters of free banking

propose parallel currencies mainly as an instrument to find a single universal currency that would best fit the

needs of a market.

Other economists favor a multi-currency system, because it enables the currencies to specialize for

performing certain functions of money only. An example can be Suntum’s concept (2013) of hard-euro and

soft-euro. This idea is designed to resolve debt issues in the European Union without the need to abandon the

project of a common currency for all the countries. Parallel currencies are discussed and used in praxis in order

to scale the market in certain ways. There are two types of peso in Cuba. There was a parallel currency called

Bony obtainable for foreign currency in socialist Czechoslovakia. It served for buying exclusive luxuries.

Ecuador issues new digital currency as a medium of exchange so that the US dollar1 can be used for redeeming

the sovereign debt (Mathew, 2014). Greece discusses the possibility of issuing parallel currencies for similar

reasons (Bossone & Cattaneo, 2015). Greece’s Minister of Finance Varoufakis (2012) used to be an in-game

economist. In-game virtual economies often use two or more currencies in order to address different issues and

to stabilize the economy. Other important proponents of regional or parallel currencies are Thomas Jefferson,

Bernard Lietaer, or Silvio Gesell (Cohen-Mitchell, 1998).

Some of the monetary functions are contradictory. Examples of theorems that explain trade-offs in using a

single currency are Gresham’s law and Triffin dilemma. The importance of this study lays in the fact that it

follows this perspective but recognizes more monetary functions than the several ones which are commonly

discussed in economics textbooks. It argues that trade-offs in currency settings are more of a general issue.

1 The US dollar has been a national currency in Ecuador since 2000.


172

Other functions of money, including non-economic functions, were explained in the work by Graeber (2011)

and in works of other anthropologists and economists, like Hudson et al. (2004).

Definition of a Currency and Its Functions

In the broadest sense, money is a mathematical expression of value. It is a psychological tool used while

doing economic calculations. Being capable of doing this, money can perform various consequent functions.

Acting as a medium of exchange is referred to as the most basic function; Samuelson (2010) described money

this way in his popular textbook. Money also serves as a store of value and an accounting unit. Beside these,

money also perform at least 15 other functions that are not often mentioned—some of them are economic and

some are social.

Not every currency is used for all the functions. The European (or Western in general) monetary system is,

however, based on the premise that there should be only one type of currency that shall join all of the possible

functions within itself. People usually picture several national currencies when speaking about currencies in

plural. Nevertheless, Euro, US dollar, and Czech crown are principally the same type of currency; the only

difference is the geographical authority that gives patronage. The capability of these currencies to comply with

the desired functions is very similar.

The economic theory often recognizes only the two main functions—medium of exchange and store of

value—plus measure of value (informational function) and sometimes even standard of deferred payments. The

reality is different. Over time, currencies were gaining more and more functions that could be distinguished.

The other functions may be:2

informational—how much costs what; a denominator of value; and what is it profitable to invest in;

allocative—pairing of savings and investments; money flows to hands that can use them in the most

profitable way;

unit of account—the unit you denominate other things in when doing accounting;

clearing unit—unit of account used for offsetting mutual debts;

standard of deferred payment—money that is accepted as an instrument for settling debts;

statutory—virtual penis; declaration of success; score (related to the concept of positional arms race); and

measure of control over the others;

social:3 a manifestation of a social relation between the original and the new owner of the thing (money),

e.g., tribute; members’ allowances: to some extend taxation, a secondary phenomenon confirming the

modification of the social relationship between the original and the new owner of the thing (money), e.g.,

dowry;

wergeld—fine; compensation; and retribution;

power—related to the authority standing behind the currency; increasing the power of the monetary

monopoly;

stabilizing—anchor for other currencies;

world reserve currency—enabling international trade;

investment—using money as an asset; making money out of money; and speculation;

2 It is a non-exhaustive list. 3 According to the anthropologist David Graeber, the original functions of money were not commercial but statutory and social. The very basic quality of money is its power to depersonalize social relations.


173

redistributive—government transfers; taxes; moving wealth from lower levels of the economy to the upper

or vice versa;

stimulant of desirable behavior—ecological permits; generally tokens related to externalities; and food

stamps to some extend;

money laundering—breaking the link between a (criminal) activity and its outcome (profit); connected to

the depersonalization that money does.

The currency that most commonly used is a credit-based fiat currency. Any currency can be defined by its

substance (physical, arbitrary, and electronic protocol), carrier (e.g., a bank note or bullion), monetary unit,

transmission system, institutions, collateral (an asset or commodity the currency is collateralized by), creation

and termination, and monetary authority.

The substance of credit fiat is purely arbitrary (McLeay, 2014). Money is kept on an account of a financial

institution that is entitled to record and claim that someone’s money is in a certain place. Digital money is

nothing more than a record of debt backed by an authority. The substance of credit fiat is double-entry

bookkeeping.

The carrier of credit fiat is sometimes cash, but mostly just the accounting record. Securities may also be

viewed as money. A monetary unit is the basis for calculations. One euro is a similar concept to one kilogram

or one Newton. Usually, it overlaps with the name of the currency (renminbi and yuan being an example of an

exception).

The transmission system is provided by banks, payment systems like Western Union or PayPal, and

basically by accounting. Financial institutions that are empowered to create new money by credit and to keep

the records of money flows are also the most important institutions, second to central banks only. Nowadays,

the capacity of commercial banks to influence the money supply is sometimes considered superior to that of

central banks, according to the theory of endogenous money (Krejčí, 1998). Stock exchanges and legislative

political authorities belong to other important institutions.

Modern fiat money is not collateralized by any physical asset but by the performance of a national

economy. That is an empty political claim with no real content. The only tangible connection to real economy

is the duty to pay taxes in fiat.

Money is created as an accounting record, when someone takes a credit or sells a bond. A corresponding

debt is created, too. It is not possible to create anything against nothing in the double-entry bookkeeping, that is

why there always must be a corresponding debt against new money. The money is also erased, when the credit

is repaid. Equity securities or derivatives can also be considered money. They are created by simple pricing

through accepting their price. Unlike debt securities, they are illiquid and cannot be simply erased in order to

cancel a debt.

The monetary authority is supposedly the state, but it only has a little control over money. The institutions

mentioned above are actually in control. The state creates a legal framework and promotes its currency as a

legal tender. The state guarantees the trust in the currency and in its value. Murphy (2013) said that fiat money

is backed by the fact that you pay taxes in it. Fiat money is backed by men with guns. Bitcoin is not, so why

should it have any value?

Role of Credit Based Fiat Currency in Entering the Crisis

According to Borio (Klein, 2012), Keiser (2013b), Clauss (2009), Keen (2011), Aziz (2013), Dalio (2012),


174

and Cervenka (2012), a credit based fiat currency is experiencing a systemic and global crisis. Ever since the

system was introduced in the 70’s, it has been dominating the world for more than 40 years. That is

significantly longer than the previous Bretton woods system or most systems in centuries before.

In the beginning of the 70’s, the USA represented by President Nixon technically defaulted on their

liabilities and broke away from the gold standard. Many argue today that leaving the gold standard was a

mistake and that such a system could work. The system surely can work, but it is questionable whether it can

work no matter what the circumstances are and no matter what the time is.

There are at least two significant disadvantages related to the gold standard. Firstly, the monetary system

responds poorly to a rapid change in the scarcity of gold. That strongly damaged the Spanish economy when

ships with bullion started to return from Americas. Secondly, the system is not flexible enough. With booming

economy and increase in production, more transactions happen. That—ceteris paribus—leads to an increased

demand (or need) for money. No matter the money is metal coins or paper collateralized by metal, it leads to

reduction of the amount of metal attributable to a unit of money.4 That is dangerous, because the value of the

currency is based on the trust in the value of the collateral. The collateral remains unchanged but must support

more money and logically, the trust in the money decreases. A further negative side effect is that population

tries to keep its savings directly in the underlying asset. That leads to shrinkage of gold reserves,

auto-catalytically, in a spiral. The real value of the currency thus decreases, not only due to nominal inflation,

but also due to thinning of the reserve of collateral.

Bitcoin, for instance, has the same problem. Its amount does not reflect the true needs of an economy in

any way. It does not matter, because it takes over the pricing from dominant currencies in particular states, but

should it once become a dominant currency itself, it would be impractical. Leaving the gold standard was not a

one-time issue forced by unpredictable circumstances. Banknotes became legal tender long time ago. During

the 20th century, the right to exchange banknotes for gold was restricted and left only for states. Later, only

USD was directly pegged to gold, while other currencies did so only through USD. Still, there was a link

between currency and value. The link was getting weaker since 1913, when convertibility of USD to gold fell

from 100% to 40% for the first time. Credit fiat has no link to value any longer. That is why it is a separate type

of money.

This paper assumes that the suitability of the same currency for performing various functions of money

may be different in the beginning of its existence and at its end. This is caused by several factors: the inner

error that is present in every system; awareness about the currency and number of its “users”; and also the

market capitalization of the currency, which is the sum of its units expressed in a relation to another currency.

A system is an organized purposeful structure that consists of interrelated and interdependent elements

(components, entities, factors, members, parts, etc.). These elements continually influence one another (directly

or indirectly) to maintain their activity and the existence of the system, in order to achieve the goal of the

system (WebFinance Inc, 2014). Every system is under the influence of entropy, which leads to a gradual

meltdown. Every system evolves with time, either due to its internal tensions or due to external circumstances it

must react to. There is, however, a tendency to return to a homeostatic balance in every system. In case the

paradigm changes fundamentally—the homeostatic point in this case, a new system can be discussed.

This paper assumes that no system is sustainable in the long run. There has been none to rebut the

4 The other option is deflation.


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assumption. The error seems to be tiny and insignificant considering the benefits of the system. The error grows

in importance with time. One day, there comes a critical moment when the costs of the inner error overgrow the

benefits of the system. Then it is rational to change the paradigm. Fukuyama (1992) wrote the same in “The

End of History and the Last Man”, when commenting on political systems. The value of an idea stands in its

falsifiability. The better a system is, the easier it will be replaced when found wrong. Searching for an ideal

system is like trying to reveal God’s mystery. This paper keeps revealing more and more layers of errors

getting closer to the goal, yet the goal cannot be reached.

It was rational and useful to leave the Bretton woods system that was already failing in the beginning of

the 70’s. Economies needed a currency that would flexibly respond to the market needs. The inner error—debt

integrated into the currencies’ substance—had a negligible importance. It was a favorable trade-off for growth.

From a certain point of view, it was even a protection against overheating of the economy, against inflation,

wasting, etc. But the global systemic debt has been growing fast since then. Today, it paralyzes a notable

portion of Western economies.

The concept of euro was created in the 60’s, which is before abandoning the Bretton woods system and

before the information revolution. It has not evolved by definition since then, it had to adapt to the absence of

gold anchor only. It pulled needed money to the growing economy via credit. The system offered no possibility

to diminish the amount of debt without diminishing the amount of money at the same time.

The “miracles” performed by credit are fundamentally comparable to the “miracles” an association of

counterfeiters could perform for its benefit by lending its forged banknotes in return for interest. In both cases,

the stimulus to the economy would be the same and the only difference is who benefits (Phillips, 1992). Czech

economists discussed the topic from theoretical points of view, including the Austrian perspective:

The view of the creation of credit, its dynamics, and relation to deposits differs between Postkeynesians and Austrians. The Postkeynesians emphasize the relative freedom of commercial banks to provide credit, for a provided credit to a firm of household on the asset side of bank’s balance automatically creates sources on the liabilities side, usually by a current deposit of the client. The Austrian school, on the other hand, binds a healthy credit to a previous acceptance of a term deposit from the client. Austrians also demand 100% reserve requirements in case of a current deposit. It may appear for Postkeynesians that bank deposit policy is senseless; due to the motto “We will create our own sources”. For Austrians, marketing and management on the field of deposits are crucial for a commercial bank. A much faster growth in credit loaning than in GDP will always end up with over-indebtedness of partial subjects, resp. sectors in national economy.5 (Mandel & Tomšík, 2015, p. 1)

Their empirical research (a correlation analysis and Granger causality test) proved that there was no

relationship between the change in terms of deposits and change of credits provided to non-financial businesses

in the Czech Republic in years from 2000 to 2013.

The credit-based fiat currency uncouples investment from savings. That denies the very essence of

capitalism. The error used to be more or less hidden behind the benefits of expanding economy for decades.

5 It is the liberal unautorized translation of “Pohled na vznik úvěru, jeho dynamiku a vztah k depozitům je zcela odlišný u ‘ortodoxních’ postkeynesovců a u představitelů rakouské školy. Postkeynesovci zdůrazňují relativní volnost obchodních bank při poskytování úvěrů, neboť poskytnutí úvěru podniku nebo domácnosti na straně bankovních aktiv z účetního pohledu automaticky vytváří zdroje na straně pasiv zpravidla ve formě běžného depozita klienta. Rakouská škola naopak vznik zdravého úvěru váže na předchozí přijmutí termínovaného depozita od klienta. Zároveň požaduje 100% povinné rezervy bank v případě přijmutí běžného depozita. V případě postkeynesovců se může zdát, že bankovní depozitní politika je zbytečná pod heslem ‘zdroje si vytvoříme sami’. Z pohledu rakouské školy je naopak marketing a management v oblasti depozit pro obchodní banky klíčový. Výrazně rychlejší růst úvěru než HDP nakonec vždy končí předlužením jednotlivých subjektů, resp. sektorů v národním hospodářství”.


176

Before the crisis, the systemic indebtedness had reached a level, when common monetary policies appeared to

be non-functioning. “Monetary policy typically operates by encouraging borrowing, boosting asset prices and

risk-taking. But initial conditions already include too much debt, too-high asset prices (property), and too much

risk-taking” (Klein, 2012, p. 5). In order to keep the circus going and in an attempt to avoid the Japanese

scenario, Western central bankers supported creating bubbles (dot-com bubble, real estate bubbles, and

derivatives bubbles). Stock markets kept skyrocketing and everybody could feel prosperous.

In 2008, it was no longer possible to conceal the systemic fraud. The gigantic financial leverage broke,

Lehman brothers fell, several systemic institutions were nationalized and stock-markets fell. Fisher’s

debt-deflation theory (1933) proved itself true again.

European economies have tried to cure the financial problems by converting over-indebtedness of partial

sectors into states’ balance sheets and then lowering this debt with austerity measures. People learned a lesson

from this attempt. It is impossible to lower the debt-to-gross domestic product (GDP) ratio in a system where

money (and consequently the economy’s outcome) is strongly correlated to debt by using restrictive monetary

policy (Jedlinský, 2014a). It took long years for the leaders to find out that it is equally hopeless as in Argentina

(Eichengreen, 2013). They have changed the strategy recently and tried to mask the indebtedness by cooking

the books.

There are two ways on how to improve the debt-to-GDP ratio, either to report a higher GDP or to report less debt. The GDP may be expanded by including items that traditionally do not enter it. The debt may be hidden in other balance sheets. (Jedlinský, 2014a, p. 7)

In 2014, European countries started counting black market activities in GDP. It makes the ratio lower.

Some economists speculate that Europe will have to default on its debts anyway.

The USA tried a different strategy, when they pushed tremendous amounts of new money into the

economy using quantitative easing. The US economy seems to be in a better shape than the European now

because they did not undergo the counterproductive austerity measures. Still, the idea that the county would

grow out of debt appears to be equally foolish. They have already encountered the liquidity trap. The interest

rates are negative in real terms, even though the data concerning inflation are often being rigged. Newly issued

money does not enter the real economy, because of the risk and something Keiser (2013b) called interest rate

apartheid wall, but only push the bubbles on financial and real estate markets.

The crisis was a clear signal that people should change the currency. The leaders did all they could to save

the currency (and the banks) regardless of the great costs. Many people though started to see the problem in the

currency and financial system used and started to seek for alternatives:

BRICS countries (Brazil, Russia, India, and China) are working on a project of their own reserve currency

and investment bank;

China, Russia, and Japan have been preparing contracts for trade denominated and carried out in their

national currencies;

There have been many protests in the streets. There was more or less a revolution in Iceland;

Anti-systemic political parties and movements are gaining popularity;

Germany has made a lot of effort to get its monetary gold reserves from New York and Paris back to

Frankfurt since 2012. Russia has started issuing bonds collateralized by gold. ISIS plans to issue its own

gold-backed currency;


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Bitcoin and other new cryptocurrencies have become extremely popular, especially after the financial

crisis in Cyprus.

Hayek (1976) suggested abandoning the monetary monopoly in the 70’s already. He would allow

commercial banks to emit private money. In his world, each bank would print its own currency, not a single

common one.

It is, however, clearly not practicable to allow tokens with the same name and readily exchangeable against each other to be issued competitively, since nobody would be in a position to control their quantity and therefore be responsible for their value. (Hayek, 1976, p. 56)

The quote looks a little bit funny and confusing from today’s perspective, because he basically defined the

financial system of credit based fiat currency that people live in and that already existed in the time he wrote

these words (the book was first published in 1976). It is clear from the whole book that Hayek (1976) was not

able to foresee the dimensions that a credit issuance of money by commercial banks would eventually reach. He

treated this money as a small deviation from the norm rather than a systemic matter. In his times, most of the

countries operated on the system of currency board or fixed exchange rate with a fluctuation band.

Role of Credit Based Fiat Currency in Leaving the Crisis

The first issue is a liquidity trap. The interest rates are so low that they cause a liquidity trap. Printing new

money (by Europeanization of debt) does not lead to its allocation in the real economy.

There is, therefore, a longer-term structural problem with monetary policy. As the Bank for International

Settlements noted, Policy does not lean against the booms but eases aggressively and persistently during busts

(Retrieved from http://www.bis.org/publ/arpdf/ar2014e.htm). This induces a downward bias in interest rates

and an upward bias in debt levels, which in turn makes it hard to raise rates without damaging the economy—a

debt trap. Systemic financial crises do not become less frequent or intense, private and public debts continue to

grow, the economy fails to climb onto a stronger sustainable path, and monetary and fiscal policies run out of

ammunition (Retrieved from http://www.bis.org/publ/arpdf/ar2014e.htm). Classical instruments do not perform

their roles. The booming credit boosts the amount of debt but not the GDP, because the velocity of money

continually decreases (Jílek, 2013).

The insufficient purchasing power caused by the fiat currency affected by liquidity trap gave an impulse

for creating many alternative currencies: local currencies, voucher-currencies, virtual currencies, and, last but

not least, cryptocurrencies. The same pattern was applied in the 1930s. Thousands of local currencies appeared

in reaction to the Great Depression (Keiser, 2013c). The study of local currencies in the first half of 20th

century was conducted by Gesell (1916), a proponent of demurrage.

Another issue is over-indebtedness. The economy is too indebted. Such a situation prevents it from

conducting energetic and courageous steps and exposes it to attacks from speculators, hedge funds, etc. The

global complete over-indebtedness seems absurd. It is only possible for two reasons. Firstly, major economic

agents seldom clear their mutual debts. If Germany owes 100 billion to Italy and Italy owes 100 billion to

Germany, the debt is counted as 200 billion, not zero. Secondly, a substantial portion of the debt is not owed to

subjects/creditors but to banks’ balance sheets. It is the debt that, in the double-entry bookkeeping system,

allows banks to create money out of thin air. The final creditor in this system (often referred to as endogenous

money) is virtual. The creditor is an impersonal accounting record—a sheet of paper. There is no one’s claim


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against these initial “debts”. Still people treat the debtors as sinners and inhibit their own economic activity

because of this artificial debt.

As pointed out before, the debt can never be repaid.

To date, the US and the UK have done a good job of managing the trade-off between deleveraging policies and output costs. They did this by avoiding credit crunches while still achieving meaningful debt reductions in their private sectors and their financial systems. This result, however, was achieved at the cost of a substantial re-leveraging of the public sector—including their central banks. As a consequence, deleveraging the central banks will be a primary policy challenge for the foreseeable future. (Buttiglione, Lane, Reichlin, & Reinhart, 2014, p. 1)

Europeans hope to reach the 60% stability and growth pact debt-to-GDP criterion in decades.

The Austrian school is correct in requiring 100% reserves. But such a thing is impossible in a system

where a parasitic (or fiduciary) issuance of money cannot be distinguished from a primary issuance (in fact,

there is nothing like a primary issuance at all. Money created by central banks is also a derivative of debt

securities). Ipso facto, every debt creates new money.

That is why there is a need to separate “hard” money from the credit issuance. It must be a different

instrument. It must be recorded separately, so that the debt gives a correct signal. People are fully dependent on

bookkeeping today. Money is only an accounting record. Cooking the books is the easiest thing ever. People

need to have not-accounting money whose creation and termination would be recorded by accounting, not

performed by it. The Austrian call for 100% reserves seems to be in a contradiction to parallel currencies. A

parallel currency can play a role of a fiduciary instrument to the main currency, thus bypassing the 100%

reserves requirement. This inconsistence is merely apparent, however, each such fiduciary issue would be

clearly distinguishable from the main (hard) currency. Instability in a parallel currency does not have to harm

the stability of the main currency. Nevertheless, the main currency acts as an anchor in the system (just like

gold used to do in the system of free coinage gold standard).

A credit based currency is utterly unusable for repaying the initial debt. It would fully disappear, should it

redeem it. The effort to solve this systematically unsolvable problem leads to constant pushing of banks’

balance sheets and to a threat of their implosion.

Last but not least, there is a productivity trap. Besides these relatively virtual, monetary issues, the

economy experiences a productivity trap. The productivity trap is caused by a rampant growth in work

efficiency achieved thanks to the information revolution and not followed with a similar revolution in finance.

This is a physical problem, directly affecting the real economy. The potential product rises, while purchasing

power does not. Less people are needed for making the same product and there is not a demand for higher

quantity of that product. That is why it is rational to fire some workers. That, however, leads to another

reduction in purchasing power and the economy spirals. It causes nothing less than stagnation, even a decline in

living standards and unemployment, especially among the youth in southern Europe.

Advantages of a Multicurrency System

Does a multicurrency system expect weakening of the state’s monopoly over money? Not necessarily.

Firstly, the monopoly has already been weakened by the emancipation of central banks. Secondly, it is more

and more the commercial banks that control the monetary system, not the central banks. Thirdly, nobody says

that a state cannot run more currencies than one on its own. Online computer games often operate with two or

more in-game currencies and all of those are managed by the developers themselves. The question for a


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multicurrency system is thus not only about the redistribution of power, as Hayek (1976) suggested, but also

just of purely technical nature.

A specified hypothesis of this paper is: It is not desirable to use a single universal currency in a monetary

area. The main reason is that some of the functions of money are contradictory. A maximization of money’s

utility for performing one function directly obstructs the maximization of another function. A typical example

of this inner conflict is described by Gresham’s law and involves the two most basic functions: The more a

currency’s value rises (e.g., because of deflation), the more are its holders motivated to store it and the less are

they motivated to get rid of it, to let the money circulate. The same principle works, vice versa too. If people

are expecting that their money will represent a lower value tomorrow, they are stimulated to spend it today and

provide the economy with liquidity.

They can also see money as a tool designed to satisfy a general interest, to see money as a utility, a

public good, or service. Or, vice versa, they can see it as a tool for satisfying individual interests. The

public interest and the individual interest may be—and often are—partially or completely contradictory, of

course.

Some of the functions help rather an individual (micro); some help rather the society (macro). Any new currency faces a decision what kind of a problem it should be designed to overcome. Either the main task for the currency is to ease the people their economic activities or it is to promise them some profit. (Jedlinský, 2014b, p. 2)

Separating the functions among separate parallel instruments/currencies may lower some needless tension

among economic agents (public sector, households/consumers/citizens or various layers of industry,

businessmen, and companies).

Beside the specific Gresham’s law, there is the general Tinbergen’s rule. It says that an economic policy

can only be successful when the number of independent goals is to be achieved by the equal number of

independent policy tools. You can surely use one currency for achieving multiple policy tools but it will most

likely entail costly trade-offs.

Trying to balance one instrument (money) for achieving multiple tasks always requires trade-offs among

the subsequent policies which prevent optimizing it for achieving either of the tasks or functions. That is

exactly why it is not rational to expect one currency to be universal and optimal at the same time. The more

people adjust it to fulfill function A, the more difficult it is to adjust it to function B.

A farmer needs a car to get him to a town. He also needs a tractor for cultivating his field. He may want to

have a car that can be also used as a tractor, but that would never work, because the size of a tractor and its

accessories prevents it from being fast on roads and operable in streets. A tractor also requires a different

system of gear. The analogy could continue, but the point is that one instrument can appropriately fulfill

multiple functions only in case they do not interfere with each other.

According to Hartmann (Cadwallader, 1984), the more functions good’s attributes perform, the more

valuable or better the good is. That implies that it is not possible to create a currency with an ultimate inner

value, because it is not possible to adjust it in a way that would be optimal for all the desired functions at the

same time.

A medieval Islamic philosopher even said that money must not have any value in itself (it may not be used

for making more money), because that is the only way it can genuinely reflect value of other goods, like a clean,

flat, and smooth mirror (Graeber, 2011).


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It is foolish to want from one instrument to fulfill all the functions that today’s fiat currency performs. An

instrument that shall work as a currency in circulation shall not be a store of value and it definitely shall not be

an investment asset. An instrument that is supposed to be used for redistribution in the form of governmental

transfers shall not be an investment asset. Otherwise, it causes precisely the paradox that wealth moves from

the poor to the rich through the governmental indebtedness. That is not only immoral but also dysfunctional in

the long run. An instrument that is volatile and has no inner value cannot store any value. A unit that is an

expression of debt is not suitable for redeeming the debt. An asset whose value is largely determined by a

notion of rating agencies and speculators is barely an ideal denominator of value.6 Finally, a unit of account

shall be something that is stable and that is not a tool.7

There is no good reason for trying to merge these functions into one instrument. The only reason is the

interest of subjects who possess the monopoly over creation of this instrument. Do states or banks try to

prohibit other currencies to occur? Not really. As was written before, many new currencies appear these days,

not only regional but mainly virtual and crypto. That is a challenge that the EU should stand up to. The

European Central Bank (2012) published a study about virtual currencies in autumn 2012. It more or less said

that virtual currencies (including crypto) are the sign of evolution. They are more of a challenge than a threat to

current financial institutions and banks; there are indeed risks but these risks are rather technical. It is a task for

the authorities to keep an eye on the risks. Virtual currencies allegedly represent no monetary threat for the EU.

A coexistence of multiple parallel currencies in a single monetary area is nothing new. It would be a

mistake to assume that there could only be a currency of one type in a country. There are two types of Cuban

peso. In antiquity, most trade was not carried in metallic money. Every wealthy Roman had fields and

farmhouses. A trade denominated in grain, livestock, or slaves was usual. These are commodities that

automatically grow in the system on a natural basis. Poor urban people were paid in food, lodging, etc. The

tributum pacis that was allegedly paid by St. Wenceslas to Germany was not only carried in talents of silver but

also in oxen. This model had barely changed throughout the Middle Ages, until the Industrial Revolution

started. It was only then when the official currency finally became an instrument of everyday economic

exchange for everybody.

Hayek’s book (1976) Denationalization of Money has already been mentioned in this paper. In the work,

he held the opinion that a currency is the only thing that shall be centrally regulated and offers an antithesis that

it is exactly the currency that must not be regulated. Together with Hayek (1976), the author believes that a

system of parallel currencies without a central authority is capable of providing a better economic outcome to

an economy and also to mitigate the economic cycle—a disease often attributed to capitalism.

The idea of private currencies is definitely not dead or stuck in the 70’s. It is for example, a financial

expert and contributor to Moneyweek magazine, which speaks similarly to Hayek (1976) in his time (Keiser,

2013a). He pointed out the fact that if banks would issue their own private currencies, there would be no need

to save them. Banking would be a business just as any other. Frisby pound makes a step forward from the idea

of money issuing banks. Independent money does not have to be issued by banks but by basically anyone. It is

up to the users which currency they decide to use—be it gold, silver, Bitcoin, Keiser dollar, or Frisby pound.

6 Money can then hardly perform the information function which is one of the principal advantages of capitalism over a centrally planned economy. 7 Because of the quantity, a unit of account must be neutral; it cannot be restricted in quantity.


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Advantages of a Single Universal Currency

There are five basic arguments supporting the idea that a currency should be one and universal:

(1) It is simpler and more understandable;

(2) The inner pressures in a currency send price signals to the economic agents;

(3) The existence of competing currencies would hinder monetary policy of the authority;

(4) A single currency that fits in a monetary area makes the system more stable than a competition of

currencies;

(5) Switching between multiple currencies is connected with conversion costs.

Is it really simpler to understand one extremely complex mechanism or is it simpler to understand several

straightforward mechanisms? Is it easy to understand a control panel of a submarine? Is it difficult to

understand a prepaid credit by your mobile operator, food stamps, score in a video game, or investment gold?8

Almost nobody understands all the coherence and interdependence in the complexity of modern fiat currency. It

is simple only for those who want to stay in ignorance and be manipulated by financial institutions and policy

makers. How many people have already noticed that money is not bound to gold? It has not been for more than

40 years.

Regarding the price of money which provides information whether it pays off to save or to spend, the

ensuing actions of economic agents should bring markets back to the equilibrium. People rarely behave that

(rational) way. They are more likely to behave like a crowd. Crowd behavior is mostly pro-cyclical and not

anti-cyclical. Empirical studies on this subject were awarded with a Nobel Memorial Prize in economics in

2013.

More important is that the existence of multiple currencies does not eliminate this information transmission.

The economic agents still have to cope with a restricted income. The agents still have to decide how they divide

it between savings and spending (even though in different currencies, potentially). The information function is

realized through the mutual exchange rate, similarly to this mechanism in international trade.

The monetary authority does a great job by making the currency back liquid. The note is legal tender for

all debts, public and private. It is against the law to refuse state-owned money. Nobody says that a national

currency must lose this privilege, when the state fosters competing currencies. As was written before, the

European Central Bank as the major European monetary authority is not even hostile towards the existence of

parallel currencies. European Central Banks of some countries do explicitly recognize certain private currencies,

regional currencies, or even Bitcoin.

Money deliberately controlled in supply by an agency whose self-interest forced it to satisfy the wishes of the users might be the best. A money regulated to satisfy the demands of group interests is bound to be the worst possible. (Hayek, 1976, p. 31)

How can people achieve a situation where these institutions must fight for favor of money users, when

they have this favor secured by law or in case they do not have to compete with anyone?

The situation of a universal currency resembles a monoculture, which is a term used in forestry. In the

19th century, Austrian-Hungarian Empire planted monocultures of spruce in Bohemia. The tree grows fast and

its wood can be used for various purposes, from construction through fine furniture to paper. It seemed to be

8 All these instruments may be considered money.


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the one and only ideal timber. The problem is that such a monoculture is vulnerable in the long run. The lack of

biodiversity causes a greater vulnerability against pests and pathogens, the risk of erosion rises, nutrients are

drained out of the soil which harms the water retention capacity—causing floods.9 A Chinese study proves that

biodiversity not only helps to prevent disease but also improves the crop (Zhu, 2000).

There truly are conversion costs. Today, when people do not often have to choose which currency to use,

such costs reach single digit percentage points. It is logical to expect what is in a multi-currency system, the

costs will be pushed down by market forces. These costs can be found to be a price necessary to pay for a

greater stability.

An Outline of a Specific Multi-currency Monetary Setting

This paper considers a situation in which many independent private currencies coexist with a non-credit

national fiat currency. Such a solution was proposed in author’s master thesis (Jedlinský, 2013). Firstly,

imagine a currency issued by a firm. The currency is collateralized by the firm’s production, making the

currency basically a voucher. The firm can issue any amount of the currency it wants and distribute it towards

its employees, trading partners, or whomever it can sell it to. Experiments with such currencies were

successfully conducted after the Great Depression.

Imagine a marketplace that enables exchanging all these private voucher-currencies. Selling the currency

then means exchanging it for another firm’s currency. The idea resembles barter but it avoids all the problems

connected to barter. Thanks to the internet and the technologies developed for cryptocurrencies, such

marketplace thus became reality. It is possible for a customer to pay in a currency he or she prefers, while the

seller receives another currency he or she prefers. The exchange rate is calculated according to supply and

demand. The corresponding money is automatically bought on the marketplace (similar to Forex).

This mechanism already works in cryptos. Many firms already use their own virtual- or

voucher-currencies. They can either develop their own aggregators (again, some firms do it, together) or adopt

the already existing solutions and start their own cryptos. An example of such a marketplace is NXT monetary

system or shape shift. In practice, only several currencies issued by trusted and popular firms would be

probably accepted by the public. Yet, it would stabilize the financial system because money would be pegged

to something specific and tangible. Without the need for systemic debt, the great advantage is that such a

solution would transfer the responsibility for money issuance to the supply side of the market. It means nothing

less than a practical application of Say’s law. The supply would create its own demand. A general glut would

become less probable.

A national currency backed by a state may in fact foster the stability of an economy based on aggregating

private currencies. A national currency is an ideal unit of account of a national economy. It would seem useful,

if a state regulated the duty to declare prices of supplied products in the national currency next to the private one.

It is possible that every seller could declare the exchange rate at will. What would prevent him/her to

declare the prices in the national currency so high they would technically circumvent the law? The law would

state that the issuer of the private currency would have a duty to repay the owner of his/her own currency in the

9 The analogy works well with spruce. Bohemian forests are damaged by the described affects till today but they are keen to return to the natural state when let alone. There are other artificial monocultures which keep the ecosystem for themselves only even though they suffer from the increased vulnerability to diseases and erosion. It is hard to say which example represents fiat currency better.


183

national currency, in case the seller was not able to provide the product the currency stood against, for example,

McDonald’s issues its own currency called cheeze. Cheeze is collateralized by cheeseburgers. One cheeze is a

voucher for a cheeseburger. If a customer owned more cheezes than the restaurant is ready to provide

cheeseburgers, the restaurant would be obliged to repay the customer in the national currency. The more

McDonald’s would overrate its currency compared to the national one, the bigger debt it would create in case it

would not be able to produce a number of cheeseburgers corresponding to the issued cheezes.

The system of private voucher-currencies would thus create a demand for the national currency. The national

currency would stand as an anchor in the system. It would be a common currency instead of a single currency.

The state could also use the currency for functions connected to public interest (investment, social security, etc.).

Both systems would coexist in a symbiosis. They would mutually calm down possible monetary turbulences.

Testing the Setting

Since the findings from this paper do not always correspond to the doctrine of mainstream economics, the

author believes that an experimental testing should be conducted in order to prove them. Experiment with real

people and their money is immoral, thereby a simulation in a virtual economy, yet with real decision-making

people as agents seems to be the right approach.

Two tests have been prepared. The first one is a massive simulation game in which players (firstly

undergraduate students of economics) would play the roles of particular economic agents, including the roles of

government and central bank that are entitled to setup monetary policies. Hundreds of repetitions shall be

executed with different people. Data will be mined from this project and impacts of these policies (including

unorthodox policies) can thus be measured on different subjects. The economy can be designed as a large

economy, a middle one, or as a small opened economy. A fundraising phase of the project is now in progress.

The other test is another simulation with students. Students of several courses at the University of

Economics in Prague will be merged into it. There is already a project in which students create their virtual

e-shops in which virtual goods are being offered for virtual money. The new thing will be using a so-called

group currency instead of the contemporary virtual currency. A group currency is a cryptocurrency concept that

includes the idea of general basic income. The general basic income is the way money is issued and distributed

among the members of a group. The national currency described in the last chapter can be designed in a similar

way. The members will be allowed to vote for the parameters of the issue and distribution. The author of the

group currency concept is collaborating on the project (Retrieved from http://groupcurrency.org/). A

preparation of this project is now in progress and the testing shall begin in February 2016.

Conclusions

Monetary authorities tend to solve the growing problems connected to the currency (especially the

over-indebtedness) by kicking the can down the road. Maintaining a single European currency, only because

the political and economic costs of its collapse may be even bigger, is not the only solution. Europe can keep

using a single currency; it can keep calling it euro. But many issues related to business cycle could be resolved

or mitigated, if the model of credit based fiat currency was abandoned. The EU also needs alternative plans for

the case that the current monetary system collapses independently of its will.

The paper has proved that a monetary system using just one universal currency is unsustainable in the long

run. It is important to pay more attention to the research in the field of parallel currencies. A system using


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multiple parallel currencies will most likely prevail regardless of the opinions of authorities and regardless of

their precedent approval. This argument is supported by the appearance of thousands of regional currencies that

appeared in reaction to the Great Depression or the hundreds of cryptocurrencies that are spontaneously

appearing nowadays.

Gresham’s law explains the need to separate the functions of medium of exchange and store of value

(treasure). Money performs many other functions beside these two basic ones. It is reasonable to expect that

separate currencies will appear also for performing other functions, like:

unit of account;

status symbol;

standard for redeeming debts;

investment asset;

instrument of government redistribution;

stimulator in the field of externalities.

Even if there was a type of money that would be ideal for achieving all the monetary goals, it is a way

more probable that such money would become dominant by proving itself in a competition with other money

projects rather than by simply being defined as a single legal tender by some authority.

The theoretical findings of the paper require to be subjected to a further study and to be tested in practice.

Specific tests designed to prove the findings were outlined in the paper.

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76, p. 164). Samuelson, P. A. (2010). Economics. New York: McGraw-Hill Education. Soto, J. H. (2012). Money, bank credit, and economic cycles. Auburn: The Ludwig von Mises Institute. Suntum, U. V. (2013). A parallel currency proposal for the stronger eurostates (CAWM Discussion Paper No. 64). Varoufakis, Y. (2012). It all began with a strange mail. Retrieved from

http://blogs.valvesoftware.com/economics/it-all-began-with-a-strange-email/ WebFinance Inc. (2014). What is system? Retrieved from http://www.businessdictionary.com/definition/system.html Zhu, Y. (2000). Genetic diversity and disease control in rice. Nature, 406, 718-722.


Socio-Economic Brand “Carpathians” in the Context of Tourism

Industry Development in Countries of Central and East Europe

Fedir Shandor

Uzhhorod National University (UNU), Uzhhorod, Ukraine

Brand in terms of strategy is a way of relationships between the organization and its target groups, aimed at

removing a priori existing conflict. Therefore, formation of a new socio-economic brand “Carpathians”, which joins

a mountain system in the eastern part of Central Europe, Ukraine, Hungary, Poland, Slovakia, Romania, Serbia, and

Austria, will help create a new image of Carpathians and implementation of programs aimed at the increase of

investment activities, building confidence to domestic producers and creating programs to attract tourists to the

most profitable tourist areas, in particular.

Keywords: brands, traditional products, famous brand, successful export

Introduction

Brand is a set of concepts generalizing people’s ideas about certain product, service, company, or person.

It is widely used in marketing and advertising, but nevertheless, it is a financial concern. Brand could have its

own name, symbol, or graphic image, which represents an economic object and is uniquely associated with it in

the minds of consumers. There are several major interpretations of the brand:

in terms of linguists—brand is a way to identify graphically the specific manufacturer’s products;

in terms of advertising—it is a name, term, sign, symbol, or any other characteristic, which clearly

identifies products, service as different from other goods and services;

in terms of strategy—it is a means of relationship between the organization and its target groups, aimed at

removing a priori existing conflict.

Presentation of the main material

Actually, brand is a unique combination of brand values a consumer pays an additional cost for or just

prefers to buy, often causes unique emotions. The difference between a trademark and a brand is: A trademark

may have a high sales turnover and brand has a high income. Brand or trade mark is a commodity that can be

bought and sold. The Business Week magazine together with the Interbrand company regularly evaluates brands.

At the moment, the most expensive brands are Coca-Cola, Microsoft, and IBM.

There are two concepts “brand valuation” and “brand evaluation”, which are translated identically—brand

value, but they have fundamental differences: Brand valuation means “value of brand” and brand evaluation

Fedir Shandor, Ph.D. of philosophy and sociology, head of Tourism Sub-Department, Uzhhorod National University (UNU),

Uzhhorod, Ukraine. Correspondence concerning this article should be addressed to Fedir Shandor, Universytetska Street 14, Uzhhorod, Ukraine.

E-mail: [email protected].

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represents “cost of brand” (Smoliy & Fedorchenko, 2006).

Figure 1. Traditional international symbol of the registered mark for goods and services.

This is a traditional international symbol of the registered mark for goods and services (Figure 1). The

Latin letter R means that the mark has been registered. Labels for goods and services (English trademark) are a

symbol, under which goods and services of one person are different from goods and services of others. These

symbols can be words, numerals, figurative elements, and combinations of colors. In the Civil Code of Ukraine

concerning the mark for goods and services, the term “trademark” is used. The term “trademark” is a direct

borrowing from English. In fact, the terms “mark for goods and services” and “brand” have the same meaning

and can be used as equivalents.

In Ukraine, as in most legislative systems of the former Soviet Union, the rights for the trademark come in

after it has been registered in the appropriate public department. In Ukraine, the State Department of

Intellectual Property (SDIP) has this right. Formally, SDIP is responsible for the entire process of mark

registration. However, in practice, most of the executive functions of SDIP in Ukraine are performed by the

state enterprise “Ukrainian Industrial Property Institute” more known as the Ukrpatent. This institution

examines the applications to register objects of intellectual property. Brand is the subject of intellectual

property, legally protected by the Civil Code and law of Ukraine “about protection of rights for goods and

services marks”, and also on international agreements signed by Ukraine, including the Madrid Agreement

(Retrieved from http://www.legal.com.ua/document/kodeks/000003689-12.html).

Juridical and physical persons of the signatories to the Madrid Agreement or Protocol, may provide in all

other member states of the Madrid system protection of their trademarks through the filing of applications for

these marks at the International Bureau of World Intellectual Property Organization, which carries out such

registration. The international trademark registration has the same effect as its registration statement, submitted

to each of these countries following national procedures. In case there is a need to increase the number of

countries, where the mark protection is provided, the applicant may make a statement on territorial expansion.

Nowadays, Europe promotes the brands like “Alps”, “The Balkans”, and “Pyrenees”.

Therefore, the headway of the trademark “Carpathians” is in the direct economic- and social-political

interest of every Carpathian country. To reach the goal, there should be a tight constant cooperation between

state authorities, science, and business. Scientists have to analyze, propose new ideas, concepts, plans, strategies,

and develop them. Accordingly, state organs should provide with legislative acts, permissions, certification, and

standardization, and business should invest resources to get benefits. Then the evolutionary cycle starts to

operate: Business investing money pays taxes, from which state authorities finance science, which again

produces innovation, and so the movement, improvement goes on (Lukashevytch & Shandor, 2008).


188

Have a look at the geographical location of Carpathians (the Carpathian Mountains) (Figure 2), this

mountain system is situated on the East of Central Europe, on the territory of Ukraine, Hungary, Poland,

Slovakia, Romania, Serbia, and Austria. It is stretched out on 1,500 km, forming a convex arc that closes the

Mid Danube plain. The biggest width is 430 km. Carpathians are one of the main Europe’s watersheds between

the Baltic and the Black Sea. Orographically, the Carpathian chain is divided into West Carpathians, East

Carpathians (a part of which are the so-called Ukrainian Carpathians), the Beskids, Southern Carpathians,

Romanian Western Mountains, and Transylvanian plateau. Prevailing height of the Carpathians is 800-1,200 m,

the highest point is Herlach in Tatras (2,655 m), and in Ukraine it is Hoverla (2,061 m).

Figure 2. The geographical location of Carpathians.

In the next years, the tourist industry in the Carpathian Mountains can expect a considerable stir, because

people’s income decreased, and there will be a need to move from tourism for rich and upper-middle class to

the middle and lower middle class. This class is a new economical base of the new European tourist brand

“Carpathians”: living in rural households, hostels, econom-class motels, which can provide relaxation on the

principle of “decent quality—low prices” (Kvatralnov, 2002). New tourist routes are actively created in

neighboring Carpathian countries with Ukraine. Nowadays, Slovakia, Czech Republic, Poland, Romania,

Serbia, and Hungary are convinced on their own unsuccessful example that they have to care not only of their

own tourist areas (owners of facilities in these areas not only of their objects), but cooperate together on the

united brand—Carpathians (the Carpathian Mountains). Otherwise, this paper will have a replay of

disappointing tourist facts in the Carpathians, when theorists of tourism industry predicted that the Slovakian

Tatras could lose 40% of tourists during the winter season of 2008 to 2009, but the reality has proved a


189

decrease of the tourist flow to about 76%. From 20th of December to 12th of January, every day loss of this

area made about 520 thousand euros. They have been dumped by the other brand “Alps” that has long ago

united countries like France, Switzerland, Italy, Slovenia, and Austria. Today, the seasonal tourist potential of

the brand “Carpathians” in the context of tourism development in Central and Eastern Europe makes about 10

million people (Ananyev, 1966). If the united brand “Carpathians” would not popularize, Carpathian countries

would constantly lose marketing battles with such professionals as Alps, Mediterranean, Pyrenees, and

Scandinavia.

Conclusions

Brand of the region should reflect all elements of uniqueness (Figure 3). The following scheme is provided

as an example.

Figure 3. Brand of the region.

Target groups of branding of the Carpathian territories are:

visitors of the area;

companies and enterprises;

Brands traditional products, known

brand, and successful export

Tourism nature, ecology, events, and attractions

Economy branches, clusters,

education, and natural resources

People traditions,

daily life, education, and

skills

Culture history, traditions,

language, religion, and art


190

residents and employees on the territory;

external markets.

Territorial tourism brand “Carpathians” has to form a clear regional idea: uniting of tourist business

representatives, state authorities, educational institutions, professional associations from eight countries of the

Carpathian region, which set up the following objectives:

differentiate the Carpathian region in the total world tourist flow;

create conditions to improve competitiveness of the Carpathian region on the tourist market;

combine common tourist products and services into one network.

The place of a regional brand in the brand system on example of Transcarpathia/Zakarpattya is depicted in

Figure 4.

Figure 4. The place of a regional brand in the brand system on example of Transcarpathia/Zakarpattya.

General information about forming of a socio-economic tourist brand “Carpathians” in the context of

tourism industry development in Central and Eastern Europe positioned four basic directions of the brand

development in the Carpathian area:

creating an image and implementing programs aimed at increasing of investment activities;

building trust to national producers, comprehensive programs for promotion of national products abroad;

creating an image of an attractive tourist destination and creating programs to attract tourists to the most

profitable tourist areas;

creating a program of an attractive image area.

Traditional produce (local brands)

Produce and services brand

Corporation brand

Castle tourism

(category brand )

Zakarpattya

(brand for regions, towns)

Ukraine (country brand)

Euroasia (continental

brand)


191

References Ananyev, M. (1966). International tourism and its development after World War II. Moscow: Vneshtorhyzdat. Kvatralnov, V. (2002). Biosphere and tourism: The global interaction and ecology, geographic scientific research of territories of

tourist destination, world culture, tourist migration system, pedagogy, sociology and management strategy. Moscow: Nauka. Law of Ukraine. (1993). Article 1 of the Law of Ukraine “on protection of marks for goods and services”. Retrieved from

http://www.legal.com.ua/document/kodeks/000003689-12.html Lukashevytch, M., & Shandor, F. (2008). Sociology of tourism. Uzhhorod: Art Line. Smoliy, V., & Fedorchenko, V. (2006). Encyclopaedic dictionary of tourism. Kyiv: Publishing House.


Analysis of the Bovespa Futures and Spot Indexes With

High Frequency Data

Edimilson Costa Lucas, Danilo Braun Santos, Bruno Nunes Medeiro, Vinicius Augusto Brunassi Silva

EAESP-FGV, Sao Paulo, Brazil

Luiz Carlos Monteiro

Universidad Nacional de Misiones, Misiones, Argentina

Data from the World Federation of Exchanges show that Brazil’s Sao Paulo stock exchange is one of the largest

worldwide in terms of market value. Thus, the objective of this study is to obtain univariate and bivariate

forecasting models based on intraday data from the futures and spot markets of the BOVESPA index. The interest

is to verify if there exist arbitrage opportunities in Brazilian financial market. To this end, three econometric

forecasting models were built: ARFIMA, vector autoregressive (VAR), and vector error correction (VEC).

Furthermore, it presents the results of a Granger causality test for the aforementioned series. This type of study

shows that it is important to identify arbitrage opportunities in financial markets and, in particular, in the

application of these models on data of this nature. In terms of the forecasts made with these models, VEC showed

better results. The causality test shows that futures BOVESPA index Granger causes spot BOVESPA index. This

result may indicate arbitrage opportunities in Brazil.

Keywords: econometric models, arbitration, stock exchange, vector autoregressive (VAR), vector error correction

(VEC), Granger causality

Introduction

According to the World Federation of Exchanges, the Sao Paulo stock exchange (Bovespa) in Brazil is one

of the largest stock exchanges globally in terms of market value. It is well known that the possibility of

forecasting the value of economic assets is very important for investment activities, risk management, and

identification of price lags among financial markets for arbitration purposes. Therefore, understanding the

relationship between spot and futures markets could be crucial for investors to take positions in the market. If it

was possible to identify a precedence of the Bovespa futures index over the Bovespa spot index, the strategies

that make it possible to obtain abnormal returns in these markets could be adopted. Considering the use of high

frequency data, where investors select and maintain portfolios for short periods of time, a successful strategy

could result in the identification of momentary arbitrage opportunities.

Edimilson Costa Lucas, master degree in statistics, EAESP-FGV, Sao Paulo, Brazil. Danilo Braun Santos, master degree in applied mathematics, UNIFESP/EPPEN, EAESP-FGV, Sao Paulo, Brazil. Bruno Nunes Medeiro, master degree in business administration, EAESP-FGV, Sao Paulo, Brazil. Vinicius Augusto Brunassi Silva, master degree in business administration, EAESP-FGV, Sao Paulo, Brazil. Luiz Carlos Monteiro, master degree in economics, UNAM—Universidad Nacional de Misiones, Misiones, Argentina. Correspondence concerning this article should be addressed to Edimilson Costa Lucas, Av. 9 de Julho, 2029, Bela Vista,

01313-902, São Paulo, Brazil. E-mail: [email protected].

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Bachelier (1964) and Cowles (1993) proposed the concept of market efficiency (the market efficiency

hypothesis). A market can be considered efficient, if price changes cannot be predicted, that is, if all the

information available to investors is already incorporated in the price. In such a circumstance, it is impossible

to obtain abnormal returns. Fama (1970) distinguished three forms of market efficiency: weak, semi-strong,

and strong. If the market has a weak form of efficiency, trading tactics based on past prices will not be useful.

If it has a semi-strong form of efficiency, the publicly available information will not help in obtaining gains

above the market. If the valid hypothesis was that of a market with the strong form of efficiency, the use of

securities analysis would be put into question. Oliveira, Nobre, and Zárate (2013) mentioned that asset

prices are unpredictable, because they follow a random walk, and thus, it is not possible to obtain abnormal

returns. Rittler (2012) found that the futures market is the first to incorporate information, which it

subsequently transfers to the spot market. In this paper, it does not intend to identify the market form valid in

Brazil. Rather, it seeks to analyze intraday series and find relationships between the spot market and the futures

markets.

This approach will make it possible to build and analyze forecasting models for the returns series and test

the causality among them. This type of study shows that it is important to identify arbitrage opportunities in

financial markets and, in particular, in the application of these models on data of this nature.

Theoretical Framework

Stoll and Whaley (1990) verified the causal relationship between the returns of the S&P 500 futures and

spot markets. The results indicated that the S&P 500 futures index seemed to anticipate the spot index at an

average time interval of five minutes. Tse (1995) studied the behavior of the Nikkei average index and its

futures contracts. Using an error correction model, the researcher found that changes in futures price lags affect

short-term adjustments of the underlying asset’s future price. Regarding arbitrage, arbitrageurs try to obtain

gains by taking advantage of the difference in prices in one or more markets. Thus, in partially segmented

markets, there would be an opportunity for arbitrage, which would be an error correction mechanism for the

possible variance that the market may show in relation to the intrinsic value of the assets.

According to Lien and Tse (1999), the possibility of arbitrage between the spot price and the future price

is a determinant for the formation of future prices. If the relationship between prices is broken, it will be

possible to earn risk-free gains. If the spot and futures markets are efficient, the price of the futures contracts of

an underlying index in the period t will be a function of the price level of that index in the period t, considering

the net loading cost of the stock index until expiration of the contract and the time to expiration of the futures

contract. Therefore, in line with the efficient market hypothesis, returns in the spot and futures markets should

have a perfect simultaneous correlation and can not be correlated over time.

Brooks, Rew, and Ritson (2001) mentioned that it is possible to observe changes in the stock indexes that

can anticipate changes in future prices, since the index can be considered as a minor set of data affecting the

futures market. Thus, the futures market can anticipate the spot market and market changes will generally affect

both the futures market and the spot market. The researchers studied the UK financial market, looking for

relationships between the FTSE100 index and its index futures using the ARIMA (autoregressive integrated

moving average), vector autoregressive (VAR), and vector error correction (VEC) models. In this paper, the

best forecasting model obtained was the VEC, and the authors inferred that changes in the price lag of futures

could help in anticipating changes in the spot price.


194

Silva (2006) used Johansen’s cointegration and found that the Brazilian futures market anticipates the spot

market. Fonseca, Lamounier, and Bressan (2012) sought to identify lucrative trading strategies based on the

discrepancies between the futures and spot markets for high frequency data. The researchers built the ARIMA,

ARFIMA, VAR, and VEC prevision models and tested the liquid trading strategy and the purchasing and

position maintenance strategy for the August 2006 to October 2009 period. They could identify possibilities for

earning abnormal returns with trading strategies using the VAR model and taking into consideration the

lead-lag effects between the Bovespa spot index and the Bovespa futures index. J. Yang, Z. Yang, and Zhou

(2012) investigated the intraday relationship in the Chinese futures and spot markets, showing a bidirectional

relationship in both markets.

Conrad, Rittler, and Rotfuß (2012) modeled intraday prices in the American market with a GARCH model.

They concluded that the prices of American stocks increased in response to better-than-expected news about

future economic performance.

Finally, Kang, Cheong, and Yoon (2013) studied the futures and spot markets in Korea empirically, using

high frequency data. Their results showed a strong bidirectional causal relationship between the futures and

spot markets, which suggested that the volatility of returns in the spot market could influence the futures market

and vice versa.

Empirical Strategy

The method used in this study focuses on the construction of univariate and bivariate forecasting models

with high frequency data (interval of 15 minutes, due to its liquidity in the Brazilian market). It was chosen to

use the ARFIMA, VAR, and VEC models. The variables used are the closing prices of the Bovespa spot index

and the Bovespa futures index.

The sample used was collected from Bloomberg’s site, taking into consideration intraday data for the

period of 05/02/2014 through 10/19/2014, which corresponds to 119 working days, using a sample with 3,332

observations. Only data generated during the opening times of the stock exchange, between 10 am and 5 pm,

were used. Trading in the “after-market” period was excluded. Some researchers consider these trades to have a

different pattern from the trading during regular opening hours of the stock exchange (Zhang, Russel, & Tsay,

2001). In addition to the models cited above, the causal relationship between the Bovespa futures and spot

indexes was verified through the Granger causality test.

ARFIMA Model

The ARIMA model was proposed by Box and Pierce (1970) and divided into three phases: (a) model

identification/selection; (b) estimation; and (c) verification. In the ARIMA approach (p, d, q), authors

transformed a non-stationary series into a stationary one through d differentiations, considering autoregressive

and moving average components in the series.

It says that the variable xt follows the ARIMA (p, d, q) model, if the variable yt = ∆dxt (xt differentiated d

times) follows an ARMA (p, q) model:

yt = 1yt−1 + ... + pyt−p + σ t + θ1σ t−1 + ... + θqσ t−q

with t NI (0, 1).

The ARFIMA model is used, when the series shows significant autocorrelation for long intervals. That is,

the decay of the autocorrelation function is hyperbolic.


195

If the fractionally differentiated series (1 − L) dxt follows an ARMA (p, q), then xt is called an ARIMA (p,

d, q) process.

VAR and VEC Models

The VAR model is an econometric model used to capture the evolution of the interdependence relations of

multiple temporal series. VAR models generally define restrictions among the equations of the model. A

fundamental question of the VAR model is whether, from the reduced form, it is possible to recover

information in the structural form. Thus, a VAR model can be understood as a generalization of an AR

(autoregressive) univariate model. The process generated by the VAR model is given by:

where yt is a vector N × 1; Φj are matrices N × N with Φ0 = Ie t NIN(0, Ω).

In addition to the VAR models, the VEC model incorporates a long-term relationship into the VAR

relationship, which may improve the estimations.

Results

Economic agents are very interested in forecasting the future value of assets. Researchers and market

participants try to find ways to use the historical prices of assets to obtain information useful for forecasting

their future prices.

Figures 1 and 2 present the logarithm of both series studied. The graphs show that the series are not

stationary and their evolution is apparently very similar, which shows a possible long-term relationship among

them.

Figure 1. Series of the futures Ibovespa logarithm.

1.5

2

2.5

3

3.5

4

1 79 157

235

313

391

469

547

625

703

781

859

937

1015

1093

1171

1249

1327

1405

1483

1561

1639

1717

1795

1873

1951

2029

2107

2185

2263

2341

2419

2497

2575

2653

2731

2809

2887

2965

3043

3121

3199

3277

LFUT


196

Figure 2. Series of the spot Ibovespa logarithm.

Table 1 shows the descriptive statistics of both univariate series. The descriptive statistics show that both

series are negatively a symmetric. The Jarque-Bera test has been used to reject the null hypothesis of normality

for each of them, which was already expected in the financial series. All positioning measurements and

dispersion measurements are very close across both series.

Table 1

Descriptive Statistics

LFUT LSPOT

Mean 10.95790 10.95323

Median 10.96202 10.95495

Maximum 11.06037 11.05586

Minimum 10.86828 10.86558

Std. Dev. 0.047910 0.047264

Skewness -0.020506 -0.004797

Kurtosis 1.896665 1.875511

Jarque-Bera 169.2421 175.5642

Probability 0.000000 0.000000

Observations 3,332 3,332

Stationarity of the Series

The augmented Dickey-Fuller (ADF) test for a unit root was individually performed on each of the series,

and showed that the null hypothesis of a unit root was not rejected for each of the series (p-value = 0.1363

(Ibov Spot); p-value = 0.1361 (Ibov Fut)).

The Kwiatkowski-Phillips-Schmidt-Shin (KPSS) unit root test, whose null hypothesis is that the series are

stationary, was also performed, with the objective to obtain additional confirmation of the results obtained with

1.5

2

2.5

3

3.5

4

1 79 157

235

313

391

469

547

625

703

781

859

937

1015

1093

1171

1249

1327

1405

1483

1561

1639

1717

1795

1873

1951

2029

2107

2185

2263

2341

2419

2497

2575

2653

2731

2809

2887

2965

3043

3121

3199

3277

LSPOT


197

the ADF test. The KPSS tests rejected the null hypothesis that the series are stationary, with 1% significance

(p-value < 0.001). Thus, the results obtained with the ADF test are confirmed by the KPSS test. Therefore, both

series are integrated of order 1.

In order to verify that the series became I(0), ADF unit root tests were performed for the first difference of

both series (p-values < 0.001), indicating that both integrated series are stationary.

Figures 3 and 4 show the graphs of both integrated series, indicating their stationarities.

Figure 3. Graphs of the differentiated series (futures).

Figure 4. Graphs of the differentiated series (spot).

-0.06

-0.04

-0.02

0

0.02

0.04

0.06

0.08

1 71 141

211

281

351

421

491

561

631

701

771

841

911

981

1051

1121

1191

1261

1331

1401

1471

1541

1611

1681

1751

1821

1891

1961

2031

2101

2171

2241

2311

2381

2451

2521

2591

2661

2731

2801

2871

2941

3011

3081

3151

3221

3291

DLFUT

-0.06

-0.04

-0.02

0

0.02

0.04

0.06

0.08

1 81 161

241

321

401

481

561

641

721

801

881

961

1041

1121

1201

1281

1361

1441

1521

1601

1681

1761

1841

1921

2001

2081

2161

2241

2321

2401

2481

2561

2641

2721

2801

2881

2961

3041

3121

3201

3281

DLSPOT


198

VAR

The first model to be estimated will be the VAR, whose objective is to confirm the relationship among the

current values of the Bovespa index, its previous values, and the values of the Bovespa futures index. The first

condition to estimate a VAR model is that the variables in the model as previously shown must be stationary,

the variables d (log) of both series are I(0), and they will be used to estimate the model.

Initially, as per the Akaike information (AIC), the lag order chosen for the VAR model is 4, and without

the constant, with 1% significance. Given that the coefficients for lag 4 were not significant, the VAR model

was estimated again using 3 lags. It improved the model in terms of reducing the AIC.

All the coefficients were shown to be significant (with 10% significance) for the equation relative to

the spot market. Hence, the Bovespa futures index and the Bovespa index lags can forecast the current values of

the Bovespa index, as had already been observed for other financial markets (Stoll & Whaley, 1990). With

regard to the equation of the Bovespa futures index, several coefficients were not significant, with 10%

significance.

Thus, the model found was as follows:

∆X1,t = -0.3244∆X1,t-1 0.2995∆X1,t-2 0.1203∆X1,t-3 + 0.3295∆X2,t-1 + 0.3329∆X2,t-2 + 0.1084∆X2,t-3

∆X2,t = 0.1286∆X1,t-1 0.1191∆X2,t-1

where X1,t = Ibovespa(spot) and X2,t = Ibovespa(future).

After estimating the coefficients, the next stage consists of testing the normality of the residuals and

determining whether they are autocorrelated.

The residuals normality hypothesis is rejected by the Jarque-Bera test (p-value < 0.001). However,

according to Brooks et al. (2001), the violation of this premise does not have any major consequences for large

samples. The residuals did not present significant autocorrelations.

VEC

The Granger causality test verified that DLFUT Granger causes DLSPOT (p-value < 0.001) and

non-Granger DLSPOT causes DLFUT (p-value = 0.1055), as determined by the earlier model.

Using the Johansen cointegration test, along with AIC (AIC = -20.53344*), the null hypothesis of

cointegration of order 1 was not rejected and the chosen model had no constant and no tendency.

After imposing a restriction of the LSPOT coefficient equal to 1 and LFUT equal to -1, this hypothesis

was rejected with 1% significance (p-value < 0.001). Thus, the estimated cointegration coefficients are valid.

The restriction that the cointegration coefficient of LSPOT was equal to 1 and the load coefficient of

DLSPOT was equal to zero was also imposed. This restriction was not rejected with 1% significance (p-value =

0.6441). In the same vein, the restriction that the cointegration coefficient of LSPOT was equal to 1 and the

load coefficient of DLFUT was equal to zero was also imposed. This restriction was rejected with 11%

significance (p-value = 0.1067).

Therefore, the model found was as follows:

∆X1,t = -0.3029∆X1,t-1 0.2517∆X1,t-2 + 0.3098∆X2,t-1 + 0.2864∆X2,t

∆X2,t = 0.0182(X1,t-1 0.9996X2,t-1) + 0.1132∆X1,t-1 0.1045∆X2,t-1

The autocorrelations of the residuals are controlled and the Jarque-Bera normality test was significant

(p-value < 0.001), rejecting the normality of the residuals hypothesis. As has been previously mentioned, the

rejection of this premise does not have a great influence on the results for large samples.


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ARFIMA

Following Fonseca et al. (2012), the ARFIMA model will be used. The last model to be used will be an

ARFIMA model for the univariate series of the Bovespa spot index. This model will be built so as to facilitate

comparison with the forecasts produced using the earlier models.

The correlogram (not shown here) of the spot series shows the presence of long memory in the process,

suggesting the use of fractional difference in the ARIMA model. It can be tested with the R/S test, where the

value of H was significant (p-value < 0.001), indicating that the series presents long memory. The parameter d

was estimated with the Geweke and Porter-Hudak (1983) method. The d value estimated with this method was

0.92.

Thus, the best model found was ARFIMA (1, 0.92, 1) shown in Table 2.

Table 2

ARFIMA Model

Dependent variable: Ibov-spot

Coefficient Standard error z p-value

Phi1 = 0.99711 0.0040897 243.8103 0.00001

Theta1 = 0.189649 0.0524204 36.179 0.00030

Dependent var. average 35.21632 D.P. dependent var. 1,088.413

Innovations average 2.940327 D.P. of innovations 1,005.842

Log-likelihood -27,766.72 AIC 55,539.44

Schwarz criterion 55,557.78 Hannan–Quinn criterion 55,546

Forecast

The VAR, VEC, and ARFIMA models were used to make forecasts for the following 10 working days,

with a total of 280 observations. Using the same criterion as Fonseca et al. (2012) proposed, the mean absolute

percentage error (MAPE) was used to measure the performance of these three forecasting models.

Table 3

MAPE

VAR VEC ARFIMA

MAPE 0.17% 0.15% 0.19%

Table 3 shows that the VEC model presented a lower MAPE, indicating that it is the model whose

forecasts are closer to the observed value, that is, with a lower mean percentage error, in relation to the other

two models used.

Conclusions

The objective of this study was to apply the VAR and VEC multivariate models using high frequency data

from the Ibovespa spot and futures markets. The ARFIMA model was also used to model the univariate series

of the Ivobespa spot market for comparing forecasts.

The Ibovespa future Granger series was found to cause the Ibovespa spot, while the non-Granger Ibovespa

spot causes the Ibovespa future. In terms of the forecasts produced, the VEC model proved to be superior to

others in terms of mean absolute percentage error, showing the lowest mean percentage error of 0.15%.


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Based on the results presented above, the possibility of arbitrage in the market was verified, considering

the spot and futures indexes. Although the models presented are focused on forecasting, such results provide

the basis for the adoption of trading strategies, as proposed by Fonseca et al. (2012).

This study may be extended by increasing the data collection period; despite the successful estimations of

the model, the period analyzed includes only six months of observations, which could introduce a bias in the

results obtained. Furthermore, using other information criteria, like those of Schwarz or Hannan-Quinn, may

lead to substantially different models, which could corroborate or even refine the present findings.

References Bachelier, L. (1964). Theory of speculation. In P. Cootner (Ed), The random character of stock market prices. Cambridge: MIT

Press. Box, G. E. P., & Pierce, D. (1970). Distribuition of residual autocorrelations in autoregressive integrated moving average time

series models. Journal of the American Statistical Association, 65, 1509-1526. Brooks, C., Rew, A. G., & Ritson, S. A. (2001). Trading strategy based on the lead-lag relationship between the spot index and

futures contract for the FTSE 100. International Journal of Forecasting, 17, 31-44. Conrad, C., Rittler, D., & Rotfuß, W. (2012). Modeling and explaining the dynamics of European Union allowance prices at

high-frequency. Energy Economics, 34(1), 316-326. Cowles, A. (1933). Can stock market forecasters forecast? Econometrica, 1, 309-324. Fama, E. F. (1970). Efficient capital markets: A review of theory and empirical work. Journal of Finance, 25, 383-417. Fonseca, N. F., Lamounier, W. M., & Bressan, A. A. (2012). Abnormal returns in the Ibovespa using models for high-frequency

data. Brazilian Review of Finance, 10(2), 243-265. Geweke, J., & Porter-Hudak, S. (1983). The estimation and application of long memory time series models. Journal of Time

Series Analysis, 4, 221-238. Kang, S. H., Cheong, C., & Yoon, S. M. (2013). Intraday volatility spillovers between spot and futures indices: Evidence from the

Korean stock market. Physical A: Statistical Mechanics and Its Applications, 392(8), 1795-1802. Lien, D., & Tse, Y. K. (1999). Forecasting the Nikkei spot index with fractional cointegration. Journal of Forecasting, 18,

259-273. Oliveira, F. A., Nobre, C. N., & Zárate, L. E. (2013). Applying artificial neural networks to prediction of stock price and

improvement of the directional prediction index—Case study of PETR4, Petrobras, Brazil. Expert Systems With Applications, 40(18), 7596-7606.

Rittler, D. (2012). Price discovery and volatility spillovers in the European Union emissions trading scheme: A high-frequency analysis. Journal of Banking and Finance, 36(3), 774-785.

Silva, D. T. (2006). O Conteúdo Informacional Dos Contratos Futuros de IBOVESPA (Doctoraldissertation, Tese (Doutorado em Contabilidade), Departamento de Contabilidade e Atuária, Universidade de Sao Paulo, Sao Paulo).

Stoll, H., & Whaley, R. (1990). Stock market structure and volatility. Review of Financial Studies, 3, 37-71. Tse, Y. K. (1995). Lead-lag relationships between spot index and futures price of the Nikkei stock average. Journal of

Forecasting, 14, 553-563. Yang, J., Yang, Z., & Zhou, Y. (2012). Intraday price discovery and volatility transmission in stock index and stock index futures

markets: Evidence from China. The Journal of Future Markets, 32(2), 99-121. Zhang, M. Y., Russel, J. R., & Tsay, R. S. (2001). A nonlinear autoregressive conditional duration model with applications to

financial transaction data. Journal of Econometrics, 104, 179-207.


China’s Development Aid Strategies

Wioletta Nowak

University of Wroclaw, Wroclaw, Poland

The article studies China’s development assistance policy during the last decades. It shows the evolution of Chinese

approach to providing foreign aid. The analysis is based on White Papers on China’s Foreign Aid from 2011 and

2014, theoretical studies, and reports on China’s foreign aid. From the beginning of the 21st century, China has

become one of the most important emerging donors. Chinese aid is primarily provided to Africa, Latin America,

Asia, and the Pacific. Depending on the region, the assistance is directed to large-scale infrastructure projects,

energy facilities, or natural resource development activities. The aid is combined with investments and trade

arrangements. Generally, China’s aid programme is driven by economic, diplomatic, and strategic objectives. The

rules according to which Chinese assistance is provided to developing countries differ significantly from the rules

established by Development Assistance Committee (DAC) members. Aid-receiving countries do not have to fulfil

strict development assistance regimes and adopt specific economic policies and targets.

Keywords: China, development aid, emerging donor, developing countries, South-South cooperation

Introduction

Since the beginning of the fifties, China has been an aid-receiving country and a donor at the same time.

The total amount of foreign aid to its recipients has been increasing, when it has been receiving less aid and

vice versa. Now, China supports more than 120 developing countries in different regions. It offers development

assistance both to poorer and more developed countries than it is.

China delivers development assistance faster and at lower cost than traditional donors. Besides, it offers

aid without political conditions. China is first of all a partner in development cooperation rather than a donor.

Its involvement in development aid is regarded as a challenge to the existing international system of aid

(Opoku-Mensah, 2009).

China’s aid programme is driven by economic, diplomatic, and strategic objectives. The strategies of

Chinese development assistance policy have been evolving over the years. The level, forms, and priorities of

foreign aid have been adjusted to China’s political and economic conditions.

The aim of the paper is to examine the changes of China’s development assistance objectives and

strategies over the last decades. The analysis of the level of China’s foreign aid to developing countries is

mainly based on White Papers on China’s Foreign Aid from 2011 and 2014. Besides, in the paper, theoretical

studies and reports on China’s foreign aid are analysed.

China’s approach to development aid has been intensively studied in recent years (Bräutigam, 2008; 2011a;

Wioletta Nowak, Ph.D., Faculty of Law, Administration and Economics, University of Wroclaw, Wroclaw, Poland. Correspondence concerning this article should be addressed to Wioletta Nowak, Institute of Economic Sciences, Uniwersytecka

22/26, 50-145 Wroclaw, Poland. E-mail: [email protected].

DAVID PUBLISHING

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CHINA’S DEVELOPMENT AID STRATEGIES

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Lum, Fisher, Gomez-Granger, & Leland, 2009; Gallagher, Irwin, & Koleski, 2012; Wolf, Wang, & Warner,

2013). The main contribution of this paper to the discussion on Chinese aid policy is a comparison of China’s

aid strategies in different periods and regions.

A Brief History of Chinese Foreign Aid

At present, China is one of the most prominent emerging donors. However, it is worth noting that China

has been the recipient country for a few decades. The first important China’s donor was the Soviet Union. It

offered huge aid mainly in the form of equipment, raw materials, and skilled labour force to the People’s

Republic of China after its proclamation in 1949. The implementation of the First Five-Year Plan (1953-1957)

in China would not be possible without the Soviet technical assistance.

It is estimated that over the period 1949-1960, from nine to 15 thousand Soviet engineers, technicians, and

advisers worked in China. Moreover, 156 industrial projects and more than 300 civil and military objects were

built with the Soviet assistance. In the 1950s, Soviet specialists were engaged in almost all China’s branches.

They were mainly active in the first priority industries, such as metallurgy, power production, coal, chemical,

oil, machine-building, and electrical engineering. Besides, they worked in agriculture and forestry, education,

health, financial sphere, and in the planning system. Soviet specialists constructed plants, dams, railroads, and

bridges. Additionally, they trained Chinese personnel. Soviet experts also helped China to organise its modern

health protection system and educational system. Nowadays, the Soviet assistance to China in the fifties is

perceived as the biggest transfer of technology, know-how, construction methods, and experience that has ever

been observed (Verchenko, 2009).

The Soviet Union stopped providing its aid to China at the beginning of the 1960s. After the conflict with

Mao, Khrushchev recalled all Soviet experts from China in the summer of 1960. China again began the

recipient country in the late 1970s. Developed countries and multilateral institutions started to support China

when it launched its strategy of market reforms and “open-door” policy in 1978. China soon became one of the

largest aid-receiving countries in the world. The level of net official development assistance (ODA1) provided

to China over the period 1979-2013 is presented in Figure 1.

Figure 1. Total net ODA disbursements to China in the years 1979-2013 (USD million, current prices). Source: Retrieved from http://stats.oecd.org.

1 ODA is defined as grants or loans to countries and multilateral institutions provided by official agencies. Concessional loans must contain a grant element of at least 25% (using a fixed 10% rate of discount). ODA is provided to promote economic development and welfare in recipient countries (Retrieved from www.oecd.org/dac).

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In the period 1979-1995, donors were gradually increasing their assistance to China. The decline in aid

observed in the years 1990-1991 was the response of donors to the 1989 Tian’anmen Square massacre. From

1996, the level of foreign assistance to China has been decreasing. In the years 2011-2013, total net ODA

disbursements to China were negative. The level of foreign aid that China received was lower than the level of

loans which it repaid.

China has been mainly supported by Japan, Germany, and France. The level of net ODA disbursements to

China from those countries is presented in Figure 2.

Figure 2. Net ODA disbursements to China from its major donors in the years 1979-2013 (USD million, current prices). Source: Retrieved from http://stats.oecd.org.

Since 1979, Japan has been the largest source of development assistance for China. In the years 1982-2006,

Japanese aid far surpassed the aid of other donors. According to Muldavin (2000), Japan has offered aid to

China to maintain national and regional security in the region. Japan’s assistance was an important support for

China during its reform period. The aid was mainly used for infrastructure projects (railway and highway

construction, seaports, airports, energy, oil and coal projects, hydroelectric power plants, industrial plants, and

telecommunication network).

China has an equally long history as the donor country and as recipient one. It celebrated the 60th

anniversary of its foreign aid programme in 2010. Over the decades, China’s foreign aid programme has

changed. One can distinguish three phases in Chinese foreign aid policy. The first phase covers the years

1950-1978, the second covers the period 1979-1994, and the third started in 1995.

China started to provide material assistance to its neighbouring communist countries in 1950. North Korea

and Vietnam were the first beneficiaries of Chinese foreign aid. After the Bandung Conference in 1955, China

increased the number of its recipient countries in Asia and Africa. Cambodia, Nepal, and Egypt were the first

non-communist countries which received Chinese aid in 1956. In the early sixties, China began to support

development projects in Sub-Saharan Africa. In 1960, China assisted Guinea to build match and cigarette plants

and in the years 1961-1962 Chinese agricultural specialists worked in Mali. By 1965, China offered aid to

Central African Republic, Ghana, and Kenya. In the late 1960s, Chinese medical teams were sent to Tanzania,

Somalia, Congo, Mali, and Guinea. China also financed the construction of the Tanzania-Zambia railway in the

years from 1970 to 1975.

Over the period from 1950 to 1978, China provided foreign assistance to achieve political and diplomatic

objectives and to promote communist ideology. Firstly, China used its aid to support independence movements

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specially in African countries. After the Sino-Soviet split, aid became a useful tool in the competition with the

Soviet Union for influence in newly independent countries. China wanted to be considered as a truer ally of

developing countries than the Soviet Union. Thus, Chinese aid was mainly offered as grants or non-interest

loans in contrast to the Soviet loans offered at a rate of 2.5% (Friedman, 2010).

Besides, China used aid to compete with Taiwan for diplomatic recognition. Prior to 1956, no African

country recognised China. At the beginning of the 1960s, it was recognised by 14 African countries (Scalapino,

1964). In the 1970s, the People’s Republic of China was recognised by 22 countries. The establishment of

diplomatic relations with African countries was usually accompanied by the offer of foreign aid (Bräutigam,

2011a).

In 1971, the government of People’s Republic of China was recognised as the legal representative of

China in the United Nations and was given the permanent seat in the UN Security Council. It is worth noting

that one third of supporting votes came from African countries.

In the years from 1979 to 1994, China changed its foreign aid policy. China’s approach to foreign

assistance became more pragmatic than ideological. In the period of economic reforms, foreign aid programmes

were used as tools for supporting Chinese development. China’s decisions of aid allocation were mainly

affected by economic considerations. Unilateral aid was replaced by an economic cooperation which benefits

both China and aid-receiving countries. More precisely, South-South cooperation that respects sovereignty,

does not interfere in recipients’ internal affairs, attaches no political conditions, and asks for no privileges was

promoted (Raposo & Potter, 2010). Besides, China diversified its foreign assistance (aid projects with Chinese

companies, joint ventures, Chinese labour services).

The next turning point in Chinese foreign aid policy was 1994. In that year, the Grand Plan of Trade and

Economic Cooperation was launched by Wu Yi, Minister of Foreign Trade and Economic Cooperation, and the

Export-Import Bank of China (EXIM Bank) was set up. China’s foreign aid was integrated with economic

cooperation tools, including foreign direct investment and labour services. In other words, Chinese foreign

assistance was linked with investment and trade. After the establishment of the EXIM Bank, China began to

provide aid in the form of concessional loans. China’s foreign aid programmes became similar to Japan’s ones.

Before the 1990s, Japan tied foreign aid with foreign trade and investment and provided aid mainly in the form

of loans.

China’s development assistance helps recipient countries to build up their self-development capacity,

respects their choice of political system and development path, and is mutually beneficial (Retrieved from

http://english.gov.cn/archive/white_paper/2014/08/23/content_281474982986592.htm). Unconditional Chinese

foreign aid is very attractive for developing countries, because they do not have to fulfil the strict development

assistance regimes and adopt specific economic policies and targets as in the case of foreign aid provided by

developed countries (Nowak, 2014a).

China is very often criticised for its development aid programmes. The main critiques concern supporting

bad governance, re-indebting poor developing countries, and undermining established consensus on aid

standards.

The Characteristics of Chinese Development Aid

Chinese development aid is very often part of a larger package of investments and trade deals with

aid-receiving countries (Lancaster, 2007). It is difficult to separate it from export credits, investment


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expenditures, or non-concessional state loans. China’s understanding of development assistance differs from

the Development Assistance Committee (DAC) definition of ODA.

Chinese development aid takes a form of complete projects, goods, and materials (mechanical equipment,

transport vehicles, and medicine and medical devices), technical cooperation (mainly in the area of industrial

production and management, agricultural planting and breeding, and medical and health care), human resource

development cooperation, medical teams sent abroad, emergency humanitarian aid, volunteer programmes in

foreign countries, and debt reliefs.

The main financial resources for China’s development aid are grants, interest-free loans, and concessional

loans. Grants are used to finance medium and small projects for social welfare (hospitals, schools, low-cost

houses, and water-supply projects) and to fund human development and technical cooperation in recipient

countries. Interest-free loans are used to finance public facilities in developing countries with relatively good

economic conditions. Large and medium-sized infrastructure projects and manufacturing projects are financed

through concessional loans (Retrieved from http://english.gov.cn/archive/white_paper/2014/08/23/content_

281474982986592.htm).

Grants and interest-free loans are used to promote China’s diplomacy objectives. Chinese state owned

enterprises are involved in such projects. Concessional loans are provided for development, business, and

diplomacy objectives (Bräutigam, 2011b).

In China, there is no one independent agency that manages its development assistance. Instead, different

institutions are involved in providing and controlling aid. The State Council chaired by the Chinese premier has

power to make decisions on foreign assistance but the details are handled by various institutions (Figure 3).

Figure 3. Management of China’s development aid.

China’s bilateral development assistance in the form of grants and zero-interest loans is managed by the

Ministry of Commerce of the People’s Republic of China (MOFCOM). More precisely, the Department of Aid

to Foreign Countries takes charge of it. MOFCOM is responsible for the formulation and implementation of

foreign aid policies and plans. It compiles foreign aid programmes, examines and approves development

assistance projects, and organizes their implementations (Retrieved from http://english.mofcom.gov.

cn/column/history.shtml). The Ministry of Commerce of the People’s Republic of China that regulates and

promotes foreign trade and economic cooperation seems to be very suitable for management of foreign assistance.

Multilateral aid Bilateral aid

The Ministry of Commerce

(Grants, interest-free loans)

The Ministry of Finance

The Export-Import Bank

(Concessional loans)

Management of China’s development aid


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MOFCOM cooperates with the Ministry of Foreign Affairs which oversees aid decisions, whether they are

compatible with overall foreign policy objectives (Bräutigam, 2008). Besides, the Ministry of Commerce

collaborates with the Ministry of Finance that administrates multilateral foreign assistance and the

Export-Import Bank which controls Chinese bilateral foreign aid in the form of concessional loans. The EXIM

Bank is responsible for the evaluation of the concessional loan projects, their allocation, and the recovery of

loans (Retrieved from http://english.gov.cn/official/2011-04/21/content_1849913.htm).

It is worth noting that other China’s ministries also provide development assistance. For instance, foreign

aid comes from the budgets of the Ministry of Agriculture, the Ministry of Transport, the Ministry of Science

and Technology, the Ministry of Health (dissolved in March 2013 became a part of the National Health and

Family Planning Commission), the Ministry of Education, or the Ministry of Culture. Besides, the China

Development Bank provides financing for development and commercial projects in selected countries.

Distribution of Chinese Development Assistance

China’s foreign aid system is not transparent. Moreover, there is no regular, detailed, or timely

information on volume, allocation, and results of development expenditure (Grimm, Rank, McDonald, &

Schickerling, 2011). The volume of Chinese aid seems to be a state secret. Aid figures are a sensitive issue in

China, because it still needs lots of capital for its own development (De Haan, 2011).

In the 1950s, the level of China’s foreign aid was almost constant. A sharp increase in total amount of aid

was observed after the Sino-Soviet split. The level of Chinese aid reached the peak in 1973. At that time, the

total amount of foreign aid covered 2% of GNP. In the years from 1974 to 1980, China drastically limited its

expenditure on foreign aid. From the beginning of the 1990s, the level of Chinese aid has been expanding. In

the years from 2004 to 2009, China’s financial resource for development assistance grew by 29.4% per year.

Officially, by the end of 2009, China had provided a total of 256.29 billion yuan in aid (Retrieved from

http://english.gov.cn/official/2011-04/21/content_1849913.htm). The scale of Chinese development assistance

significantly increased between 2010 and 2012. In the three years, developing countries received 89.34 billion

yuan in aid (Retrieved from http://english.gov.cn/archive/white_paper/2014/08/23/content_281474982986592.

htm). The assistance was provided mainly in the form of concessional loans. The proportion of those loans in

China’s total aid almost doubled from 28.7% in 2009 to 55.7% in the years from 2010 to 2012. Details about

China’s foreign aid are presented in Table 1.

Table 1

China’s Foreign Aid to Developing Countries by the End of 2012 (Billion Yuan)

Form of aid By the end of 2009 2010-2012

Aid volume Percent of total aid Aid volume Percent of total aid

Grants 106.2 41.4% 32.32 36.2%

Interest-free loans 76.54 29.9% 7.26 8.1%

Concessional loans 73.55 28.7% 49.76 55.7%

Source: Retrieved from http://english.gov.cn/official/2011-04/21/content_1849913.htm; http://english.gov.cn/archive/white_paper/2014/08/23/content_281474982986592.htm.

China provides foreign assistance to developing countries in Africa, Asia, Latin America and the

Caribbean, Oceania, and Eastern Europe. The 2014 White Paper reveals that in the years from 2010 to 2012,

121 developing countries (51 in Africa, 30 in Asia, 19 in Latin America and the Caribbean, 12 in Eastern


207

Europe, and nine in Oceania) were regularly receiving Chinese aid. By the end of 2009, China supported 123

developing countries (Retrieved from http://english.gov.cn/official/2011-04/21/content_1849913.htm).

Countries in Africa and Asia received the highest amount of China’s development aid. From 2010 to 2012,

51.7% of Chinese total aid went to Africa and 30.5% to Asian countries.

China has been providing foreign aid to African countries, since the middle of the 1950s. By 1973, it

offered assistance to 30 African countries. From the beginning of the 21st century, the exponential increase in

the total amount of Chinese aid to Africa has been observed.

In the 1970s and 1980s, China provided assistance in the form of infrastructure projects, technical and

public health assistance, public works, and scholarships to study in China (Lum et al., 2009). The Chinese

objectives were first of all political. China wanted to establish diplomatic ties with African nations and to

compete with Taiwan for recognition. At present, China’s aid to Africa is mainly driven by securing access to

oil, natural minerals and raw materials that are essential for its continued development. However, political

interests still play an important role in Chinese foreign aid policy to African nations.

The main political benefits may include: a lack of critics from African countries after the 1989 Tiananmen

Square massacre, supporting China at the UN Commission on human rights in 1997, or switching recognition

from Taiwan to the People’s Republic of China by a few countries (South Africa, Guinea-Bissau and Central

African Republic in 1998, Liberia in 2003, Senegal in 2005, Chad in 2006, and Malawi in 2008).2

China provides aid to African nations in the form of interest-free loans, credit lines, debt cancellation, and

subsidized export credits. In the first decade of the 21st century, China directed its foreign aid mainly to Angola

(infrastructure: railways), Democratic Republic of Congo (infrastructure, mining), Sudan (oil refining, hydro

power, and infrastructure), Gabon (iron ore mining, infrastructure, hydro power, and port facilities), Mozambique

(dam construction, infrastructure, and national stadium), Ethiopia (infrastructure, telecommunications, public

buildings, hydropower, and light industry), and Nigeria (offshore oil development, infrastructure: railways,

medical training) (Lum et al., 2009).

China provides foreign aid to Asia mainly for long-term diplomatic benefits, regional security, strategic

interests (balancing the power among South Asian countries), the improvement in bilateral relationships, and

the access to natural resources, such as ores, copper, rubber, wood, and oil. The main Asian recipients of

Chinese foreign aid are Myanmar, Cambodia, and Laos. China finances infrastructure, hydro power, and

agricultural development projects in these countries. It also provides to them construction materials, equipment,

labour force, and technical expertise.

China also offers assistance to other Asian nations. In Vietnam, China concentrates on a railway

construction, hydro power projects, and ship building facilities. In the Philippines, Chinese aid is directed to

infrastructure, energy, mining, and agriculture. In Pakistan, India, and Sri Lanka, China supports power plant

projects. Kyrgyzstan, Uzbekistan, Kazakhstan, Tajikistan, and Turkmenistan receive aid from China for oil,

natural gas, and mining projects.

The Pacific Island states are supported by China mainly in order to isolate Taiwan which currently

maintains official relations with Kiribati, Marshall Islands, Nauru, Palau, Solomon Islands, and Tuvalu.

China offers foreign aid to Latin America and the Caribbean mainly in order to gain access to natural

resources and agricultural commodities, opening up alternative markets for Chinese goods and investment, and

2 Additionally, Gambia ended diplomatic relations with Taiwan in 2013.


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find supporting for the one-China policy. It is worth noting that 12 countries in the region still recognise

Taiwan. After establishing diplomatic relations with China, countries receive aid (for instance, Dominica in

2005 and Costa Rica in 2007).

During the financial crisis, China supported mainly resource-rich countries in Latin America. From 2005

to 2013, Venezuela received USD 50.6 billion in the form of low-interest loans, Argentina USD 14.1 billion,

Brazil USD 13.4 billion, Ecuador USD 9.9 billion, Mexico USD 2.4 billion, and Peru USD 2.3 billion (Nowak,

2014b).

China supported natural-resource exploration and production in Venezuela, Brazil, Chile, Columbia,

Ecuador, and Argentina. Besides, it financed infrastructure (power plants), transportation, housing, and telecom

projects in the region (Wolf et al., 2013).

China’s foreign aid to developing countries also benefits China itself. From 2000 to 2013, China’s trade

volume with its beneficiaries has increased significantly, for instance, Chinese exports of goods to Angola

increased about 117 times, to Gabon 98 times, and to Mozambique 49 times. In Asia, China increased its

exports of goods to Laos 50 times, Cambodia 21 times, and to Myanmar 15 times. In Latin America, Chinese

merchandise exports to Peru increased 43 times, to Ecuador 40, and to Brazil 29 times (Retrieved from

http://comtrade.un.org/data).

Conclusions

Chinese aid both contributes to economic growth and poverty reduction in recipient countries and benefits

China itself. China offers foreign aid to developing countries to achieve different foreign policy goals. The

objectives and hence strategies of foreign aid have been changing over the years. In the fifties and sixties,

China supported developing countries for political and diplomatic interests, and to spread communist ideology.

It used foreign aid as a tool in the competition with the Soviet Union for supremacy among newly independent

countries and in the competition with Taiwan for recognition.

Nowadays, economic and commercial interests dominate in Chinese foreign aid policy. China provides

assistance for securing access to natural resources and agricultural products, and to increase trade and facilitate

investments. Diplomatic objectives are still important, because Taiwan maintains diplomatic relations with 22

countries. Aid is also used to spread Chinese values.

Over the years, China developed its own model of foreign aid. It combines development assistance with

commercial investments and trade arrangements. Objectives and priorities of China’s assistance depend on the

region.

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Corporate Governance Intelligence: Minority Shareholder’s

Aspects (Evidence From Ukraine)

Tetiana Momot, Oleksandr Vashchenko, Nina Avanesova, Anna Chudopal

O.M. Beketov National University of Urban Economy, Kharkiv, Ukraine

The paper is devoted to the corporate governance intelligence system investigation as the part of the complex

stakeholder-related approach to the corporate strategic intelligence system (CSIS). The special attention is given to

the minority shareholders activism in the system of corporate governance. Some existing methods of abusing

minority shareholders rights, made by joint-stock companies executives, are generalized. The recommendations for

minority shareholder’s rights protection are given. The necessity for the implementation of the

stakeholders-oriented approach for the CSIS creation on the base of companies’ security principles is substantiated.

Keywords: corporate governance intelligence, minority shareholders rights, corporate governance, financial and

economic security system, corporate strategic intelligence

Introduction

The need for corporate governance intelligence arises from the potential conflicts of interests among

stakeholders in the corporate structure. These conflicts of interests (agency problems) arise from two main

sources. Firstly, different stakeholders have different goals and preferences. Secondly, the stakeholders have

imperfect information as to each others’ actions, knowledge, and preferences.

The ownership structure in Ukraine was formed under condition of mass privatization which is caused the

great number of small shareholders’ appearance. At the beginning of 1992, nearly 17 million of

Ukrainians—one third of the country population—own shares of 35 thousand national joint-stock companies.

Minority shareholders did not know their own rights and could not protect their rights in accordance with the

law. Corporate management staff let abuses happen, which are also provoked by shareholders’ legal

irresponsibility and lack of law defense. Moreover, in a highly diffuse ownership structure, there is no incentive

for any owner to monitor corporate management. In condition, when security market did not work and the

market share value was not determined, small shareholders sold their shares namely to corporate management.

Under such conditions, the Ukrainian oligarchic system was developed and during Leonid Kuchma’s second

presidential term took its final form. In 2014, the combined wealth of Ukraine’s 50 richest oligarchs is equal to

85% of Ukraine’s GDP. The total worth of the wealthiest 50 Ukrainians is $112.7 billion, as much as two

annual Ukrainian state budgets. Furthermore, according to Holoyda (2013), 100 individuals represented the

Tetiana Momot, Ph.D. in economics, professor, O.M. Beketov National University of Urban Economy, Kharkiv, Ukraine. Oleksandr Vashchenko, Ph.D., associate professor, O.M. Beketov National University of Urban Economy, Kharkiv, Ukraine. Nina Avanesova, Ph.D., associate professor, O.M. Beketov National University of Urban Economy, Kharkiv, Ukraine. Anna Chudopal, post-graduate student, O.M. Beketov National University of Urban Economy, Kharkiv, Ukraine. Correspondence concerning this article should be addressed to Tetiana Momot, vul. Revolucii, 12, Kharkiv, 61002, Ukraine.

E-mail: [email protected].

DAVID PUBLISHING

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MINORITY SHAREHOLDER’S ASPECTS (EVIDENCE FROM UKRAINE)

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“oligarchs” and “family” or 0.00003% of the total population control 80%-85% of Ukraine’s GDP/wealth. Out

of the 1,645 billionaires followed by Forbes in 2014, nine are from Ukraine (Holoyda, 2013).

Current corporate environment in Ukraine is characterized with the high level of corruption, especially in

light of the deepening socio-political and financial-economic crisis in the country, which poses a serious threat

to the national security of Ukraine. The results of a survey of 84 Ukrainian senior executives and managers

representing 18 industries (Price Waterhouse Coopers, 2011) reveal that economic crime in Ukraine is

characterized as follows:

Thirty-six percent of organizations had experienced economic crime in the past 12 months;

Every third organization does not perform risk assessments;

Assets misappropriation (73%) and bribery and corruption (60%) remain the most common types of

economic crime in Ukraine;

The amount of internal fraud has increased significantly (by 22%) since 2009;

The majority of Ukrainian respondents who suffered economic crime estimated losses up to five million

dollars;

Forty percent of economic crimes are committed by senior management;

One out of five organizations that have suffered from economic crime has not taken any actions against an

internal perpetrator of fraud.

The extent of criminalization and corruption in government has reached a critical point which challenges

the legitimacy of government and threatens it with the collapse of public institutions and the termination

of democratic state development. Fraud is now viewed as an inherent feature of doing business in Ukraine,

which leads companies down a path where the companies themselves provide a rational for potential

fraudsters, and therefore increase the probability of fraud. Economic crimes threaten the basic processes

common to all business—paying and collecting, buying and selling, growing and expending, and sourcing and

supply chain. Thus, one of the key fraud prevention techniques is for businesses to know who with whom is

doing business.

In condition of implementation of the association agreement between Ukraine and the European Union,

the development of the scientific systemic approach to control and prevent economic crime by creating clear

EU standards in the areas of anticorruption and good corporate governance is based on a transparent

intelligence system.

Taking into account all mentioned above, it is vitally important to create a system of corporate governance

intelligence, in order to provide the high level of financial and economic security in the complex corporate

environment.

Recent research has viewed the concept of corporate governance in different ways. Monks and Minow

(1995) presented the corporate governance as the relationship among various participants (chief executive

officer, management, shareholders, and employees) in determining the direction and performance of

corporations. Gillan and Starks (1998) defined corporate governance as the system of laws, rules, and factors

that control operations at the company. A firm’s governance, as they said, comprises the set of structures that

provide boundaries for the firm’s operations. This set of structures includes participants in corporate activities,

such as managers, workers, and suppliers of capital; the returns to those participants; and the constraints under

which they operate. La Porta, Lopez-de-Silanes, Shleifer, and Vishny (1997) and Shleifer and Vishny (1997)


212

defined corporate governance in terms of the economic interests of the participants. In particular, they refer to

corporate governance as dealing “…with the ways in which suppliers of finance to corporations assure

themselves of getting a return on their investment”. The Organization for Economic Co-operation and

Development (2004) defined corporate governance as a set of relationships among a company’s board, its

shareholders, and other stakeholders. It also provides the structure through which the objectives of the company

are set, the means of attaining those objectives, and monitoring performance are determined. Corporate

governance as the system by which companies are directed and managed is presented in Australian Stock

Exchange (ASX) Principles of Good Corporate Governance and Best Practices Recommendations (Retrieved

from http://www.asx.com.au/documents/asx-compliance/principles-and-recommendations-march-2003.pdf). It

influences how the objectives of the company are set and achieved, how risk is monitored and assessed, and

how performance is optimized. Good corporate governance structures encourage companies to create value and

provide accountability and control systems commensurate with the risks involved. Fidrmuc, Goergen, and

Renneboog (2006) determined the corporate governance system as the combination of mechanisms which

ensure that the management (the agent) runs the firm for the benefit of one or several stakeholders (principals).

Such stakeholders may cover shareholders, creditors, suppliers, clients, employees, and other parties with

whom the firm conducts its business. In accordance with Goergen, Brewster, and Wood (2012), corporate

governance deals with the conflicts of interests between the providers of finance and the managers; the

shareholders and the stakeholders; different types of shareholders (mainly the large shareholder and the

minority shareholders); and the prevention or mitigation of these conflicts of interests. Kristie (2013)

emphasized that corporate governance is gathering together a group of smart, accomplished people around a

board table to make good decisions on behalf of the company and its stakeholders.

Generally, corporate governance refers to the host of legal and non-legal principles and practices affecting

control of publicly held business corporations. Most broadly, corporate governance affects not only who

controls publicly traded corporations and for what purpose but also the allocation of risks and returns from the

firm’s activities among the various participants in the firm, including stockholders and managers as well as

creditors, employees, customers, and even communities.

Thus, in highly competitive global markets, a well-run corporate governance intelligence system (CGIS)

can forge information links in the corporate governance system and help to achieve the quality corporate goals

and to support the corporate reputation.

Against this background, this study investigates the impact of shareholders’ activism on the corporate

governance in Ukraine over the period 2000 through 2014.

Objectives and Methodology

Strategic intelligence pertains to the following system of abilities (Thomson Reuters Corporate

Governance Intelligence, 2013):

foresight—the ability to understand trends that present threats or opportunities for corporation;

visioning—the ability to conceptualize an ideal future state based on foresight and create a process to

engage others to implement it;

system thinking—the ability to perceive, synthesize, and integrate elements that function as a whole to

achieve a common purpose;


213

motivating—the ability to motivate different people to work together to implement a vision.

Understanding what motivates people is based upon another ability, personality intelligence;

partnering—the ability to develop strategic alliances with individuals, groups and organizations. This

quality also depends on personality intelligence.

Today’s economic environment demands that enterprises in both the public and private sectors reach beyond traditional boundaries. Citizens, customers, educators, suppliers, investors, and other partners are all demanding better custodianship of their information and more access to strategic resources. As enterprises rise to meet this demand, traditional boundaries are disappearing and the premium on information security is rising. Heightened concerns about critical infrastructure protection and national homeland security are accelerating this trend. (Shillabeer, Buss, & Rousseau, 2011, p. 11)

Thus, the complex stakeholder based approach should be implemented for the corporate intelligent system

development. In accordance with approach suggested by authors, the stakeholder based CGIS is the preferred

system for planning, collecting, processing, analysis, dissemination, and use of intelligence information which

is required for market threats. CGIS includes the following subsystems (in accordance with the groups of key

stockholders) (Corporate Governance Task Force, 2004; Fuld, 2005; Kahaner, 2006):

(1) External intelligence:

public sector: government/policymakers/society (global, national, regional, and local) intelligence;

competitor intelligence;

customer intelligence;

supplier intelligence;

investor intelligence;

business partner intelligence: creditors, project partners;

(2) Internal intelligence:

employee intelligence;

board of directors intelligence and managers intelligence (managing director or chief executive officer

(CEO));

shareholders intelligence.

Corporate governance intelligence is never meant to be a one-shot activity; as the company changes, so

will its intelligence needs. The fundamental mission of CGIS is to provide intelligence to support intelligence

corporate decisions. A well-run intelligence program can forge information links in the corporate governance

system and help to achieve the quality corporate goals (see Table 1).

Corporate governance intelligence is determined as the subsystem of planning, collecting, processing,

analysis, dissemination, and use of corporate governance information which is required for corporate

governance quality evaluation. The emphasis is given to minority shareholders’ problems. It is not taken into

account that developing and improvement of the corporate system have to be provided from the inside (specific

programs for managers) and from the outside—the large number of responsible minority shareholders forming.

It is experienced owner, who is going to stimulate joint stock company (JSC) to protect investors’ rights, to

create stable mechanisms of governing and control and to act openly.

The purpose of this study is to reveal, generalize, and make public some existing methods of abusing,

made by joint-stock companies’ executives, so as to increase the effectiveness of the corporate sector’s activity

in Ukraine and to work out specific recommendations on plain governing of JSC by its owners—shareholders.


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Methodical basis of research are the methods of complex, system, and comparing analysis. The main

object of research is the sample of 20 industrial joint-stock companies in Kharkiv region. The main issue is the

relationships between executives and minority shareholders on their equal rights’ realization. The new approach

is formed by making direct contact with the executives from the name of shareholders.

Table 1

CGIS Subsystems: Stakeholders-Oriented Approach Implementation CGIS subsystems (groups of stakeholders) Objectives Public sector: government/policymakers/society (global, national, regional, and local) intelligence

to monitor government’s policy and its influence on the corporate securitylevel

Competitor intelligence to monitor current and potential competitors; to study brand excellence model with the emphasis on the following focus areas: brand equity,involvement, and price/value

Customer intelligence

to reveal emerging technologies, competitive advantages anddisadvantages, new product ideas; to determine focus group and their exactneeds, to study customer satisfaction and loyalty by measuring the effect ofthe five factors: products, supply, employees, sales, and after-sales service

Suppliers intelligence to reveal suppliers accuracy and quality data, redundancy, ownership, anddiversity certification data; to identify diverse supplier risk for thesupply-chain optimization

Investor intelligence to study the potential investors by using stock signals, index analysis, and market timing indicators

Employees intelligence

to study employee job satisfaction, loyalty, motivation, and well-being atwork by measuring the following seven parameters: image, generalmanagement, line manager, teamwork, daily work, salary and workingconditions, and professional and personal development

Board of directors intelligence managers intelligence(managing director or chief executive officer (CEO))

to estimate the level of board of directors independence from CEO; to studyboard of directors policy of hiring and firing of top corporate management;to study top manager’s needs, skills of management—from hiring, firing,and training employees to negotiating with others, facilitating meetings, andmoving career ahead; the abilities to control the resources and expendituresof the corporation; to gain profit

Shareholders intelligence to study owner’s satisfaction and loyalty by measuring the effect ofdividend policy, the structure, and cost of ownership

Results

The summary of the most spread shareholders legal rights’ and interests’ abuses, while JSC activity looks

like the following:

limited access to the company information for shareholders;

breaking the terms of handing in and making public the information about the general meeting of

shareholders;

inadequate providing of complete and real information about the JSC activity;

unsatisfactory level of participation in making decisions on assets disposal;

unsatisfactory level of participation in controlling of significant amounts contracts;

making difficult for small shareholders to enter supervisory board;

insufficient opportunity for small investors to influence forming of the general meeting agenda;

divided policy issues.

According to the suggested approach, there was a testing of general year’s meeting of shareholder’s

procedures by taking part in the meetings (using warrants from the real shareholders). The results are given in

Figure 1.


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0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Opportunity for shareholders to analyze the year’s financialdocuments before the general meeting

Year’s financial documents distribution during the generalmeeting

Audit Findings’ distribution during the general meeting

Presence of the auditor, who analyzed enterprise’s activity,during the GM

Opportunity for shareholders to ask the auditor questions

Opportunity for the auditor to answer questions

Inspection committee report’s distribution to shareholders

Chief accountant’s presence during the general meeting

Top manager’s report on the year’s activity

Opportunity for shareholders to ask Managers questions onthe activity results

Managers’ answers

Submission by shareholders questions, which are covered bythe general meeting terms of reference

Discussion on the income allocatability (cover of expenses)

Submission of shareholders’ suggestions about the Incomeallocatability (cover of expenses)

Submission of the question about the year’s report ratification

Yes No

Figure 1. Testing results of the general meeting procedure.

In order to study the official documentation of companies, shareholders sent letters of request to the

executives. Testing results show that in 55.5% of situations, shareholders did not get the year’s financial reports

before the general meeting.


216

Sometimes, when shareholders had the chance to get the needed information, they mostly were to make

writing outs from given documents on the last day before the general meeting.

There were only two times, when shareholders were given copies of the documents in time. Even then

their request to learn the contents of the charter and general regulations was declined.

At the best, shareholders could have the old wordings of the charter or just some model forms.

In this context appeal against the executives on different kinds of information, concealing should be

realized in court.

Nevertheless, there are a lot of examples, when the executives ignore minority shareholders’ rights on

getting the whole information about the enterprise.

As a result, minority shareholders have not been able to realize their own rights effectively during the

general meeting, or got the chance to learn the information about the problems, which had to be solved during

the general meeting.

There are also shareholders’ rights abusing in cases of assets operations, such as, transferring, selling at

the lowest cost, and using of credits without purpose.

The important thing is that modern Ukrainian corporate technologies do not insure equal possibilities to

get the information for all shareholders; they are still legally imperfect and not plain enough. These are the

reasons for shareholders to make decisions of destructive character.

Discussion

Unfortunately, many people are simply repulsed from the stock market activities, because financial

documents are not transparent and there are a lot of abuses in the corporate relationships.

In order to estimate the quality of financial reports, specialists of “intensive technologies in

microeconomics foundation” have questioned financial directors and chief accountants. As a result, they

received very uneasy information about unsatisfactory authenticity level of enterprises’ financial reports:

Forty-five percent of financial managers do not think that those reports are reliable. More than 80% of chief

accountants have manipulated the working information in this or that way. Even more, the “receivers” of these

reports have been determined. Financial staff named the following groups of people, to whom they have given

the false information:

in 33% of cases, to creditors (banks, suppliers, etc.);

in 50% of cases, to the government bodies;

in 17% of cases, to the owners.

In conclusion, it has to be mentioned that:

(1) Most of minority shareholders in Ukraine are still titular owners. They are not educated in economical

questions and not protected by the law. Clearly, this situation does not stimulate the development of effective

and transparent corporate governing by shareholders;

(2) Minority shareholders rights and legal interests infringement by the executives are wide spread, while

joint-stock companies work in unqualitative conditions;

(3) Shadow economy has a negative influence on investment development of joint-stock companies.

Income minimizing restricts the dividend’s amount and does not favor the growth of stocks’ price. This fact, in

its turn, does not let people invest their money in shares and does not provide effective stock market

functioning;


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(4) Unsatisfactory level of financial documents authenticity influences badly the investment decision

making not only for shareholders, but also for the future investors;

(5) Low level of the corporate culture does not contribute to the balanced corporate relationships.

Thus, the most topical problems in the corporate governing today in Ukraine to form the corporate ethic

rules in accordance with the European standards (corporate governance guidelines, code of business conduct

and ethics) help to ensure legal regulation and the balance of stakeholder’s interests.

Transparent functioning of the corporate sector will increase its competitiveness and economic

effectiveness. Besides, corporate governing improvement is going to be an important step on the way to

attractive investment conditions creating. It will guarantee the social effect that will make the national economy

more competitive.

Conclusions

CGIS presents a potentially powerful tool for the analysis of the different groups of stakeholders and

permits to create a corporate intelligence network and information economics measurements databases with the

aim to adopt strategic decision making.

The company must select and institutionalize broad corporate security principles to fully protect

stakeholder interests. Enacted principles inform decisions thereby influencing strategies, plans, and policies.

These actions create a culture of security throughout the company. Enterprise security principles are required to

protect stakeholder interests include: accountability, adequacy, awareness, compliance, effectiveness, ethics,

inclusion, individual, equity, information, sharing, measurement, perspective/scope, response, and risk

management.

The implementation of the stakeholders-oriented approach for the CSIS creation on the base of enterprise

security principles will permit:

to evaluate the corporate security on the regular base; to review the evaluation results with stakeholders as

appropriate; and to report on performance to the governing body, including a plan for remedial action to address

any deficiencies;

to identify the most important focus areas the company’s brand and place it in relation to selected

competitors in specific segments;

to identify which initiatives to use to improve or maintain customer satisfaction and strengthen the

development of corporation; to retain current customers and attract new customers;

to optimize corporate supply chain;

to identify management problem and to improve the corporate governance system;

to identify the areas in which corporation can start initiatives to maintain or improve job satisfaction and

strengthen development; to develop employee position descriptions define security roles, responsibilities, skills,

certifications, and agreements to comply with security policy;

to improve the dividend policy and to attract new investors;

to compare the investment in company security protection strategies (principles, policies, procedures,

processes, and controls) with risk. Determination of risk is based on the value, sensitivity, and criticality of the

asset with respect to its vulnerability to loss, damage, disclosure, or denied/interrupted access. Probability,

frequency, and severity of potential vulnerabilities are considered along with a comparison of the cost to

reconstitute the asset versus the cost to protect it;


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to review, assess, and modify corporate security protection strategies in response to the dynamically

changing risk environment in which it operates;

to use the information, systems, and networks across an enterprise and by all stakeholders matches

expectations established by social norms, obligations, being a responsible internet citizen, and enterprise codes

of ethical conduct.

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Corporate Governance Intelligence: Minority Shareholder’s Aspects (Evidence from Ukraine)

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