Dynamic links between financial development and 〖CO〗_2 emissions in Nigeria: evidence from ARDL...

POSTGRADUATE CONFERENCE ON ECONOMICS, PUBLIC ADMINISTRATION AND

BUSINESS (PCEPAB)-5TH SEPTEMBER, 2015

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PROCEEDINGS

Editors:

Assoc. Prof. Dr. VGR Chandran Govindaraju Mohammad Nourani Keshminder Singh Jit Singh Md Aslam Mia Shujaat Mubarik



i

Proceedings of the Postgraduate Conference on Economics, Public

Administration and Business (PCEPAB), 2015

Published by Faculty of Economics and Administration,

University of Malaya

Copyright @ Faculty of Economics and Administration, University of Malaya

All rights reserved.

ISBN 978-967-0380-70-4

Faculty of Economics and Administration


50603 Kuala Lumpur Malaysia

Tel: +603 7967 3749

Fax: +603 7967 3719

Disclaimer

The views and recommendations expressed by the authors are entirely their own and do not

necessarily reflect the views of the editors, the faculty or the university. While every attempt has

been made to ensure consistency of the format and the layout of the proceedings, the editors are

not responsible for the content of the papers appearing in the proceedings.



ii

Table of Contents

Preface ............................................................................................................................................ iv

Conference Themes......................................................................................................................... v

Message from the Dean ................................................................................................................. vi

Message from the Chairman......................................................................................................... vii

Conference Committee ................................................................................................................ viii

Session 1

Determinants of a Multidimensional Poverty Measurement in Malaysia: An Islamic

Perspective ............................................................................................................................. 1

Financing Higher Education through Waqf Institution: An Alternative Approach .................. 11

Theory of Giving from an Islamic Perspective ........................................................................... 21

An analysis of the reasons behind abuse of Murabaha Contracts in disguised Riba in modern

practices ............................................................................................................................... 31

Session 2

Determinants of board size and independence during the Chinese state enterprises reform: A

comparison between controlling shareholder categories .................................................. 44

Knowledge Creation: The Mediator Effect Between Customer Knowledge Exploration and

Firm Knowledge Exploitation in Product-Service Design ............................................... 65

Risk Management Committee’s Characteristics, its Prestige and Efficiency Performance ..... 90

The Performance and Earnings Management of ASEAN Banks in the Liberalization Era ... 117

Session 3

A Review of Information System-based Decision Making on Prosperous Relationship

Marketing ........................................................................................................................... 135

Investors’ vulnerability to anchoring and adjustment, representativeness and availability

heuristics: A comparative analysis of Malaysian and Pakistani Stock Markets ........... 143

Government Expenditure Policy Analysis in Malaysia: A Social Accounting Matrix Approach

............................................................................................................................................ 164

Impact of Information and Communication Technology on Remittance Flow: A Developing

Countries’ Perspective ...................................................................................................... 180

Session 4

Deconstructing the Narratives of Security State and the Role of Power Elite ........................ 196

Market Dynamics and Multiple Borrowing in Microfinance: The Case of Bangladesh ........ 208

The Role of Professionalism, Leadership, and Trust to Promote Organizational Justice ...... 230

The Impact of Human Values and Organizational Citizenship Behaviors on Service Quality

............................................................................................................................................ 271

Session 5

System Dynamics Analysis of the Biodiesel and CPO Productions in Malaysia..................... 272



iii

Dynamic links between financial development and 𝑪𝑶𝟐 emissions in Nigeria: evidence from

ARDL bound test framework ........................................................................................... 282

Bell-Metal Industry of Assam: Some Problems and an Alternative Operating Framework 292

The Mechanics Behind Environmental Strategies in Chemical Manufacturing Firms .......... 308

Exploring Motivational Factors towards Sustainable Consumption: An empirical study in

Malaysia ............................................................................................................................. 309

Session 6

The Economic Impact of Terrorism: A new Model and is Application .................................. 320

Linear and Nonlinear Causal Relationship Between Energy Consumption and Economic

Growth in China: New Evidence Based on Wavelet Analysis ...................................... 321

Steering and Coordinating Society in Urban Governance........................................................ 343

Clustering, Cooperation and Innovation in Developing Countries: Evidence from a Large

Footwear Cluster in Nigeria ............................................................................................. 354

Session 7

Does Terrorism Affect The Economic Performance? The Empirical Analysis Of Islamic

States In Iraq And Syria (ISIS) And Pakistan ................................................................. 370

Aquaculture: A Source of Health and Wealth of Bangladesh .................................................. 371

Women Empowerment through Entrepreneurship: a Case Study of Hulu Terengganu,

Malaysia ............................................................................................................................. 372

Impact of Increasing Marginal Cost on Recreational Visits: Case of Lake View Park in

Pakistan .............................................................................................................................. 402

Session 8

Impacts of Goods and Services Tax on the Income Distribution............................................. 412

The Influence of Host Country National Support on Expatriate Success in Malaysia ........... 426

Does Government Investment Crowd-in Or Crowd-out Private Investment in Malaysia?.... 448

External Debt Financing of Public Capital Formation: Empirical Evidence from Nigeria ... 456



iv

Preface

PCEPAB 2015 is the first conference of its kind that aims to provide a strategic platform for

postgraduate students to enhance their research core competency. Over the past 10 years, the

research field has been on the verge of innovation starting from the emergence of advanced

research methodologies to top-notch publication requirements. This change has posed a

dilemma for many students looking for a way to survive in an excellent intellectual

environment. Therefore, it is essential to develop a strong collaboration and network among

postgraduates. Universities around the globe also recognize that in spite of the superior

experience of academic staff in research activities, postgraduate students as members of the

major research body of any university have very high motivation to create research networks.

With the theme ‘Promoting Growth, Excellence and Sustainability’, PCEPAB 2015 aspires:

1. To provide a research environment for postgraduate students to disseminate their ideas

with others and to create ‘research networks’.

2. To enhance and encourage the ‘research culture’ among the postgraduate students.

3. To provide opportunities for postgraduate students in Malaysia and overseas to

exchange their knowledge in research.

4. To provide a platform for new students to develop research abilities and to carry out

research work more effectively.

5. To increase the confidence level of postgraduate students.

This gathering of research minds is expected to thrust research into a more sophisticated arena

whereby strategic networking will be the key to solve growing research problems.

September 2015



v

Conference Themes

Theme 1: Emerging Trends in Economics

The first theme of the conference encapsulates the emerging trends in economics. These

trends are entrenched from new methodologies to new economic theories and application. The

interesting point of this theme is that it combines both theoretical and applied research on one

platform. Importantly, this theme covers the areas from industrial organization, development

economics, financial economics, and Islamic economics to economic systems with special

attention to the modern trends in research.

Theme 2: Business Management

This theme carries with it research papers from the field of business management. The

conference brings forth researches in contemporary management styles and business

practices. It encapsulates topics ranging from management information system to leadership

styles and their application. In particular, special attention has been given to the research on

the management of small & medium enterprises.

Theme 3: Public Administration

In the theme of public administration, researches proposing new policies for effective

management of government-run institutions are put on top of the list. Special focus has been

given to research related to the role and management of key government institutions. Along

with it, some of the researches have been commended revealing the role of Islamic

institutions in public policy.

In short, the conference combines topics on economics, public administration and business

management to bring forth innovative ideas to cope with challenges in these fields.



vi

Message from the Dean

It gives me immense pleasure and honor to welcome the participants of PCEPAB-2015.

Ladies and Gentlemen,

In this present era of globalization, research has shown pivotal significance. A flood of

inventions and discoveries in every field of life has shown favorable results due to research

and development. Although the pace of inventions, discoveries and technological

advancement in developed nations is spectacular, developing nations are still striving to

imitate these advancements in the right way. Because of its important role, research students

and new researchers need to be provided with a platform to engage together in order to share

and learn emerging trends in research and development. PCEPAB-2015 is an effort anchored

by the Faculty of Economics and Administration, University of Malaya to gather postgraduate

students to share and learn research trends. I believe that this conference will serve this

purpose.

I indeed acknowledged that we owe the success of the conference to many stakeholders. As

such, I sincerely extend my gratitude to the organizing committee for their efforts to design

and organize this conference. I also thank all session chairs for extending their cooperation to

make this conference successful. Also, a warm ‘thank you’ to all the learned scholars for

being with us as discussants. I am sure the way they give their opinions during the PCEPAB-

2015 will be a source of inspiration for scholars, particularly to the postgraduate students who

are new in the field. The success of any event depends on the participants; hence, I convey my

sincere thanks to the participants of this conference who I’m sure will really make it a

memorable knowledge-sharing and learning event.

To all the postgraduate students, I hope that you will spread the light of knowledge to every

corner of the world.

May God bless all of you with health, wealth, name and fame.

Professor Dr. Azina Binti Ismail

Dean



vii

Message from the Chairman

It is a great pleasure to welcome all of you to the first postgraduate conference, PCEPAB

2015, organized solely by the students of the Faculty of Economics and Administration,

University of Malaya. I believe that this will be the right platform for you, as postgraduate

students, to share your research outcomes as well as to have intellectual debates to further

improve your research work.

The theme of the conference emphasizes on issues related to economics, business,

development studies, public administration and management. It provides a great avenue to

share ideas on a wide range of disciplines whereby the opportunity for multidisciplinary

research work in the future will be made possible. An added advantage is that our discussants,

mostly from our own academic staff, will be able to provide the postgraduate students with

constructive comments that will further help improve their work. As a conference chair, I

would also like to thank the organizing committee and the administrative and academic staff

of the Faculty of Economics and Administration for their great help and support.

I hope that you will find the conference enjoyable and valuable. I am sure that you will share

a most pleasant, interesting and fruitful conference.

VGR Chandran

Deputy Dean (Higher Degree)



viii

Conference Committee

Advisor

Professor Dr. Noor Azina Ismail

Dean

Faculty of Economics and Administration, University of Malaya, Malaysia

Chairman

Associate Professor Dr. VGR Chandran Govindaraju

Deputy Dean (higher degree)

Faculty of Economics and Administration, University of Malaya, Malaysia

Organizing Committee

Mohammad Nourani

Department of Economics, Faculty of Economics and Administration

University of Malaya, Malaysia


Keshminder Singh Jit Singh

Department of Economics, Faculty of Economics and Administration



Md Aslam Mia

Department of Development Studies, Faculty of Economics and

Administration



Shujaat Mubarik

Department of Economics, Faculty of Economics and Administration,




PROMOTING GOWTH, EXCELENT AND SUSTAINABILITY - 1

Determinants of a Multidimensional Poverty Measurement in

Malaysia: An Islamic Perspective

Mohamed Saladin Abdul Rasool, Ariffin Md Salleh

Universiti Teknologi MARA (UiTM)

Melaka Branch, Malaysia

Email: [email protected]

Abstract

In practice, most Islamic institutions in Malaysia use the monetary approach in measuring poverty through the

conventional Poverty Line Income (PLI) method. From an Islamic perspective, scholars outline the self-

sufficiency for an individual as the availability of basic food and drinks, shelter and other basic needs as defined

by the society in which he or she belongs to. This broad definition gives room to researchers to examine and

deliberate various components of basic needs of an individual or household to attain certain standard of living.

The objective of the paper is to present a non-monetary poverty measurement, an Islamic Poverty Index (IPI),

calculated using the weighted index method which is expected to exemplify poverty from a multidimensional

perspective. Specifically, the paper would identify factors that determine poverty according to the IPI and also

the PLI method using the regression method. The present study consisted of two stages. Firstly, the expert

review was conducted to formulate the IPI. Secondly, a survey aided by a structured questionnaire developed

using the expert review was carried out on 258 selected head of households in the state of Selangor, the most

populated state in Malaysia. The study revealed that the factors that influenced poverty according to each of

the method were different.

Keywords: Poverty, measurements, multidimensional, monetary indicators

1. Introduction

In practice, government agencies and Islamic institutions in Malaysia use the monetary

approach in measuring poverty through the conventional Poverty Line Income (PLI) method.

From an Islamic perspective, scholars outline the self-sufficiency for an individual as the

availability of basic food and drinks, shelter and other basic needs as defined by the society in

which he or she belongs to. In addition, Al Sabai explains that the minimum living standard is

inclusive of having family, housing and transportation (Monzer Kahf, 1982). Failure to attain

this stipulated needs qualifies individuals to be poor. Poverty is not only complex and multi-

dimensional in nature, it goes beyond the notion of income and encompasses social,

economic and political derivations (Shirazi, 2006).

The objective of the present paper is to present a non-monetary poverty measurement from an

Islamic perspective. The proposed Islamic Poverty Index (IPI) consists of maqasid-al sharia

(objective of the religion) principles namely religion, knowledge, physical-self, offspring and

wealth. The IPI, calculated using the weighted index method is expected to exemplify

poverty from a multidimensional perspective. In addition, determinants of poverty would be

identified. Furthermore, comparison would be made with the existing PLI method. This

paper is organized as follows. The next section outlines the literature review whereas the

mailto:[email protected]




methodology undertaken in this study is deliberated in section 3. Section 4 present the

findings of the study. Finally, the conclusion of the study is highlighted in section 5.

2. Literature Review

Presently, policy makers and Islamic institutions in Malaysia use the monetary method such

as PLI to measure poverty. However, many studies in developed nations have adopted the

non-monetary poverty measurement in recent years.The UNDP developed the Human

Poverty Index (HPI) and Human Development Index (HDI) through the studies by Sen

(1992) and recently introduced the Multidimensional Poverty Index (MPI) developed by

Alkire and Santos (2010). Muslim scholars have used the MPI and HDI to develop human

development and poverty measurement from an Islamic view. Maqasid Shariah

Muldimensional Poverty Index (MSMPI) developed by Kasri (2014) who utilized health,

education, economic, religion and social to represent the five maqasid al-shariah dimensions.

These dimensions were chosen as the author was in the opinion that these are the most

suitable dimension as they are commonly used by economist in the mainstream economy.

However, other scholars such as Seman and Dzolkarnain (2014) used strictly the five

dimensions of the maqasid al-shariah established by Al-Ghazalli and Shatibi. They developed

the Maqasid shariah based Index of Socio-Economic Development using physical-self,

religiosity, knowledge, offspring and wealth. Similarly, Rafi (2014) used the same five

dimensions in developing the Maqasid ash Shariah Index (MSI) with the following

indicators: role of religion. Salat, fasting, pilgrimage and zakat representing religiosity,

average life expectancy, freedom from maltnutrition representing physical-self, survival of

children, safety of person, environmental safety representing offspring, education

representing knowledge and freedom from poverty representing wealth. Rasool and Salleh

(2014) concurs that the five dimensions of maqasid al-shariah as complete and holistic to

exemplify a multidimensional poverty measurement

A key point related to the the the method of poverty measurement is factors that determined

poverty. Literature have highlighted various determinants of poverty. Shireen (1998)

estimated various regression equations, each using poverty incidence as the dependant

variable Her results show that the average number of years of schooling has the strongest

relationship to poverty, suggestingt that an additional year of schooling reduced the incidence

of poverty. Rupasingha and Goetz (2007) studied the social and political forces as

determinants of poverty using spatial analysis. And found out that social capital, ethnic and

income inequality, local political competition, federal grants, foreign-born population, and

spatial effects are found to be important determinants of poverty in US. In a study on the

determinants of poverty in Mexico by Rodriguez (2010), he highlighted that poverty is

related positively to household size, the number of illiterate adults in the household and

location of the household. A study conducted by Awan and Iqbal (2010) using socio-

economics analysis shows that education, family size, nature of occupation and public

amenities play important role in poverty alleviation. Study by Awan et al (2011) revealed

that education is negatively related with the poverty status of individual which implies

education of poor is necessary in breaking the vicious circle of poverty. In general, factors

such as age of the household head, gender of household head, household size, education

level, employment type and amneties are significant variables related to poverty.




3. Methodology

The study utilizes both the monetary and non-monetary poverty measurement as shown by

Figure 1. The monetary poverty measurement adopted in this study is based on the poverty

gap approach using the PLI method with z as poverty gap, z’ as adequacy of income, y as

household income and k as the poverty line income or necessities of the household, explained

by (1). The PLI basically is calculated by comparing the income and the basic needs outlined

by the poverty line. The gap of poverty is denoted by PLI Sufficency.

%100*)/('

%100*)}/(1{

kyz

or

ykz

--------- (1)

The non-monetary method would be represented by IPI. The dimensions in the IPI would be

based on human needs (maqasid al-shariah) principles. The main difference between the

proposed IPI and the MPI developed by Alkire is the weightage in IPI is not equal in

accordance to the maqasid al shariah principles as suggested by Shatibi (Kamali, 2009). This

is because according to Shatibi, human needs are in a hierarchy as follows: religion, physical,

wealth, knowledge and offspring. The overall process of the IPI formulation consist of

deciding the dimensions, weightage of each of the dimensions and finally, IPI computation

and interpretation together with threshold determination. The IPI would be formulated in

accordance to maqasid al-shariah principles, incorporating the methods by Alkire and Santos

(2010). The formula for IPI is as below:

IP1w = ( W1PS + W2WE +W3OS+W4KN + W5RE ) X 100% ------- (2)

where PS- physical self, WE-wealth, OS-offspring, KN-knowledge, RE-religosity and

W1, W2,…W5 - weightage

This quantitative research study employed data derived from a random survey of households

in Selangor, the most populated state in Malaysia. The population in the study were poor and

destitute households. The data comprised on a variety of household well-being issues

gathered through interviews, using structured questionnaire with head of household or other

knowledgeable members. It delves on households’ economic, social and demographic data

using simple random sampling technique. A representative sample was selected using

proportionate stratified random sampling technique with the household heads as the

respondents. 258 respondents were selected from the sampling unit. A close-ended

questionnaire was used as a research instrument to aid five enumerators employed to collect

data from the respondents identified for this study. The data of the study were run through

Statistical Package for Social Science (SPSS).

Multiple linear regression (MLR) analysis was used to determine the contributions of each of

the significant predictors or independent variables towards the variance in the criterion or

dependent variable. This study used stepwise regression method to determine those

independent variables that contributed most significantly to the prediction of the criterion

variable. The independent variables included in the analysis are demographic variables




comprising of household based and the household’s information. They consist of continuos

and categorial type of data. Dummy variables were created for qualitative or categorical

predictors.This section discusses the procedure of regression analysis using enter method

with PLI Sufficiency and IPI as the dependent variable. It has been used to determine the

best predictor in explaining dependent variable. The procedures involved the F-test,

coefficient of determination, analyzing residuals, homoscadicity and multicollinearity.

Equation (3) represent the initial multiple linear regression model with twenty one predictors

for PLI Sufficiency and also IPI.

yi = β0 + β1X1 + β2X2 + β3X3 + β4X4 + β5X5 + β6X6 + β7X7 + β8X8 + β9X9

+ β10X10 + β11X11 + β12X12 + β13X13 + β14X14 + β15X15 + β16X16 + β17X17

+ β18X18 + β19X19 +β20X20 +β21X21 + εi --------------- (3)

where y = PLI Sufficiency and IPI,

X1 = Age, X2 = Gender (1 – Male, 0 – Female), X3 = Marital status (1- Married, 0-

Separated), X4 = Marital status (1- Bachelor, 0- Separated), X5 = Marital status (1-

Widow/widower, 0- Separated), X6 = Marital status (1- Divorced, 0- Separated), X7 = Job

status (1-Self-employed, 0-others), X8 = Job status (1-Permanent job, 0-others), X9 = Job

status (1-Unemployed, 0-others), X10 = Job status (1-Pensioner, 0-others) , X11 = Job status

(1-Part time or contract, 0-others), X12 = Education level (1- UPSR, 0-no formal education),

X13 = Education level, (1- PMR, 0- no formal education), X14 = Education level (1- SPM, 0-

no formal education), X15= Education level (1- STPM, 0- no formal education), X16 =

Education level (1- Cert, 0- no formal education), X17 = Education level (1- Degree and

above, 0- no formal education), X18 =Household size, X19 = Duration of aid, X20 = Number

of children, X21 = Not working adult, and ε is the model error estimated to be normally

distributed with constant variance.

4. Empirical Results

4.1 Dimensions, Indictors and Cutoff of IPI

The non-monetary measurement, IPI is shown by the following equation, with the weightage

of each dimension derived from the rankings determined by expert review:

IPI =(0.252PS + 0.129WE +0.138OS+0.186KN + 0.295RE) X 100%---- (4)

The equation (4) shows that 29.5% of poverty is contributed by spiritual factors, followed by

25.2% physical self, 12.9% wealth, 18.6% knowledge and 13.8% offspring. Thus, the

spiritual dimension is with the highest weightage, about 30%. On the other hand, wealth is

the lowest weightage dimension contributing almost 13% to the incidence of poverty. This

result shows that experts have identified that all the dimensions mentioned by Shatibi as

relevant and significant in the context of the study ranging from 12.9% to 29.5%. The

variables in the study were derived through expert review where thriteen indicators from five

dimensions were identified as shown by Table 1. Firstly, religiosity is considered as an

important dimension of human needs. It is inclusive of religious knowledge, religious

obligation, contribution and mosque activities. Secondly, physical self are physical needs in

daily life such as healthcare and quality of dwelling or living place. Thirdly, knowledge or




mind development is essential in developing the intellectual level and skills of individuals. It

is inclusive of education level and skills. Fourthly, family or offspring are an important

element of human needs. Finally, wealth accumulation such as savings or investments and

ability to generate income or revenue from economic activities complete the formulation of

the IPI.

The next step is to decide the cutoff point or the threshold. From an Islamic point of view, a

individual or household is defined as poor if the household needs acquired is less than the

total need whereas destitute is a situation where the household is unable to sustain even 50%

or half of the needs. From a monetary point of view, this cutoff point is easily identified

based on the poverty line income. However from the non-monetary perspective, it is difficult

to quantify the 50% or 100% level of needs. Alkire (2010) used k=30 in her study with the

assumptions that a deprivation of 30% is sufficient to classify the household as poor.

However, this study chooses k = 40 or the deprivation of at least two dimensions or 6

indicators and for destitute, the value of at least 70 or at least 3 dimensions or 8 indicators.

Since the cutoff or threshold is decided based on K1 (total weightage of indicators) = 40%

where the household must be deprived by at least two dimensions or six indicators to be

categorized as poor. This is explained by Table 2. From the threshold of both the methods

discussed above, the poor group of each measurement could be identified and the number or

rate of poor could be calculated (Table 3). It is obvious that the PLI method showed the

lower number of poor and destitute with 13.2% of respondents as poor (including destitute)

wheras 71.4% according to the IPI method. As the IPI is multidimensional in nature as it

takes into account various dimensions, it is logical that the IPI has a bigger group of

identified poor.

Table 1: Indicators and Weightage

Variables Relative

Weight

(%)

Deprived if …..

Physical Self

Dwelling 12.6 Dwelling is deteriorating

Health & not disabled

Wealth

12.6 Any household member with serious disease

and disabled

Employment type 4.3 Household head without permanent job

House ownership 4.3 Household own house (land)

Savings & investment 4.3 Household head or members without savings

and investment

Offspring

No of children 6.9 Household without children

Attend schooling 6.9 Any children did not attend school




Knowledge

Education level 9.3 Household head did not attend secondary

school

Skills 9.3 Household head without any skills

Religiosity

Religious knowledge 7.4 Household head has basic religious

knowledge

Religious obligations 7.4 Performing of religious obligation

Contribution 7.4 Contribution to close family members

Mosque activities 7.4 Attendance at mosque programmes

Table 2 : Threshold Value

Category PLI Suff.

(Poverty Gap)

IPI

(K)

Poor < 100% 40%

Destitute < 50% 70%

Table 3 : Poverty Rate

Category PLI

Sufficiency IPI(%)

Destitute 0.4 10.5

Poor 12.8 60.9

Non-poor 86.8 28.9

4.2 Determinants of Poverty

Equation (5) and (6) summarizes the relationship between the dependent variables, namely

PLI Sufficiency and IPI and the dependent variables. This is further exemplified by Table 4.

The R - square in equation (6) is higher with a value of 0.29. This explains that the five

significant independent variables are able to explain 29% variation of the IPI. In brief, IPI is

explained by two types of employment indicators, namely Self-employed and Unemployed

and three education attainment indicators, namely PMR, SPM and STPM. All these variables

are negatively correlated to IPI except for Unemployed. Thus, a household with a household

head who is self-employed or who possesses a PMR qualification, a SPM qualification or a

STPM qualification are less deprived in terms of the IPI. Thus, they tend to be not poor as

they able to be independent in fulfilling their daily needs. This could be explained by the fact




that they have the means to fulfill their needs in terms of the five dimensions of maqasid al-

shariah. This result is similar to earlier studies conducted by Shirazi (1994), Amis (1995),

Rodriguez (2010) and Dartanto & Otsubo (2013) that emphasized the role of educational

attainment on poverty. In contrast, households with a household head who is unemployed or

who has low educational attainment tend to be poor as they do not have the means to fulfill

their daily needs.

On the other hand, the R – square value in equation (5) is lower, able to explain 7.5%

variation of PLI Sufficiency with Household Size and No of Working Adult are significant

independent variables. This result supports the findings of various studies such as Shirazi

(1996) and Mohd & Riaz (2012) that revealed that household size or the dependency ratio do

influence poverty. However, the findings of the present study further explain the role of non-

working adults. Both are negatively related to the dependent variable. The coefficient for

household size is -4.948, meaning that a one unit increase in household size is followed by a

decrease of RM4.940 in the PLI Sufficiency. This is because when the household size

increases, the needs of the household also increase. Thus, the PLI Sufficency or the poverty

gap decreases. On the other hand, a decrease in the household size would increase the poverty

gap or PLI Sufficiency as the needs of the household are reduced. Similarly, a one unit

increase in non-working adults is followed by a decrease of the PLI Sufficiency, but the

magnitude is bigger (RM20.014). This proves that the needs of the adults in terms of

monetary value are much higher compared to the average household in the PLI Sufficiency. It

is obvious that the magnitude change in the overall poverty gap or PLI Suffiicency due to the

change in the household size depends on the category of household, especially if it is a non-

working adult one.

PLI Suff.=17.92 – 4.948*household size – 20.014*non-working adults--- (5)

IPI= 0.545 – 0.09*self-employed – 0.139*education level (PMR) – 0.105*education level

(SPM) – 0.133*education level (STPM) + 0.042*unemployed----- (6)

Table 4: Summary of Regression Analysis

Independent

Variables

PLI Sufficiency

IPI

Self-employed -0.090**

Permanent job

Unemployed 0.042*

PMR -0.139**

SPM -0.105**




**p-value<0.01, *p-value<0.05

The regression analysis in the present study shows factors influencing both dependent

variables are different. The IPI is associated with more variables obviously because it is

formulated with five dimensions as compared to the unidimensional PLI Sufficiency Thus,

poverty from these two different method should be addressed differently by the policy

makers and other relevant parties.

5. Conclusion

For Islamic institutions, the need for a holistic poverty measurements are irrefutable. It is

vital for Islamic institutions to device appropriate poverty measurement that are holistic in

nature to identify the targeted poverty group. This is essential to mantain trust between the

society and these institutions as mentioned by Suhaib (2009) who stresses that an ideal

Islamic institutions such as zakat organizations should be able to distribute of zakat funds to

appropriate recipients especially the poverty groups. Shirazi (1996 & 2006) concurs that the

main role of Islamic institutions are to facilitate the Muslims to pay zakat and distribute

efficiently to the appropriate recipient.The present paper proposes a multidimensional

perspective of poverty measurement utilizing index as a tool of measurement. Thus, the

introduction of an Islamic poverty measurement represented by IPI incorporating the various

dimensions as suggested by maqasid al-shariah principles would have an impact on Islamic

institutions as it gives a new perspective of measuring poverty from a micro perspective.

Thus, it is strongly recommended that a comprehensive study to formulate the IPI to be

carried out throughout the zakat organizations in Malaysia and oher Muslim countries. This

would enhance the poverty measurement from an Islamic perspective as it comprises of non-

monetary dimensions that would complement the existing monetary poverty measurements as

explained by Nolan and Whelan (2010, 2012).

References

ALKIRE, S. & SANTOS, E. M. (2010). Acute Multidimensional Poverty: A New Index for

Developing Countries. OPHI Working Paper No. 38. Oxford University Press.

STPM -0.133*

Household size -4.948*

Duration of aid

Children

Not working adult -20.014**

R-square 0.082 0.29

Adj R-square 0.074 0.276

MSE 7134.418 0.019

Multicollinearity No No




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Financing Higher Education through Waqf Institution: An

Alternative Approach

Muhammad Usman

Department of Shari’ah and Economics,


Asmak Ab Rahman

Department of Shari’ah and Economics,


Abstract

The present study critically analyses various alternative options for funding higher education institution and

tries to find out viable option. As a result, it explored waqf a perpetual and sustainable alternative source of

funding. Moreover, the study profiles various fund raising and investment management strategies to produce

perpetual income and use waqf as an instrument in any college and university’s development.

Key words: Funding, Higher Education, Investment, development, Waqf endowment

Introduction

Education is one of the vital elements for the sustainable development of any nation. It is not

only a pivotal element for societal development, but also a key input for economic growth in

the form of human capital. A Number of researchers have considered it as a prerequisite for

economic development. Though education from primary to territory is important for the

development, the role of higher education is more critical (Banya & Elu, 2001, p. 4 &

Oliveria et al., 2009).

Colleges and universities are the main vehicles to impart higher education and cradles for

knowledge acquisition (Jamshidi et al, 2012, p.789). While, the effectiveness of these

institutions heavily depends upon funds they receive, from building labs to award

scholarships. Typically, Government is the main source of this funding for higher education.

However, over the last many decades due to local and global changes, higher education

institutions are facing shortage of funds (Barr, 2004, p. 267). Therefore, literature classifies

factors affecting public funding into two broad categories, i.e. global factors and local factors

Global Factors

Globalization, technological advancement, inflation and global financial crises (2007-08) are

affecting higher education funding (UNESCO, 2012). Likewise, transition towards the

knowledge base economy is also influencing higher education (Jamshidi et al, 2012, p.789).

In addition, every nation knows that higher education is the way to remain in an enviable

place in the world (Lebeau, 2012, p.137).




Local Factors

Political, social, economic and demographic elements are affecting higher education funding.

After the global financial crisis, many countries are facing huge public debt that increases the

fiscal deficit (Michael, 1996). On the other hand, social development and demographic

changes are increasing demand for higher education. Likewise, fiscal constraint, budgeting

formula, including that higher education funding is politically sensitive, are the main factors

affecting public funding for higher educational institutions (Longden, 2001. p.161;

Wangenge, 2008. p. 215; Barr, 2004, p. 267).

Whereas, having lack of accountability and non-responsiveness, higher educational

institutions are heavily being criticised in various countries (Johnstone, 2004, p. 403).The

growing demand of public funding is also an issue for the governments. Whereas, Barr

(1993, p .720) explores higher education is shifting towards market system.

Objectives of the study

The study is using secondary sources to attenuate following objectives.

• To Critically analyse the different sources of financing higher education Institutions

• To explore the most viable and perpetual sources of financing higher education

Institutions

Alternative sources of funding’s for HEIs

As discussed that due to decreasing government funding, colleges and universities are

searching for alternative sources of funds. However, these alternative options have not

emerged as viable options. In proceeding lines, we take an overview of those alternatives and

their limitations.

Raising Fee and Student Loans

One of the immediate steps, which HEI took to bridge the funding requirement, was a

substantial increase in student fee. Kenton et al. (2005, p.114) have illustrated that a decrease

in public funding was always manifested with increase in tuition and other fees. This action

of HEI started affecting quality and promotion of higher education that forced government to

introduce loans as an alternative (Woodhall, 2007, p.6). In response to it several countries

introduced student loans schemes.

In U.K a committee chaired by Lionel Robbins a renowned economist was farmed in 1961.

The committee proposed future recommendations and suggestions on the development of

higher education sector. The main issues highlighted in this committee were growing demand

for higher education and demographic changes. Several economists, submitted their policy

recommendations and proposed student loans as an alternative. Similarly, various developing

countries including Malaysia also introduced student loan scheme (Ramli at el, 2013, p.6) .

Though, it is another issue that what will be the kind and design of these loans? i.e. mortgage-

loans (MLs) or income-contingent loans (ICLs), MLs repayable in fixed instalments over a

fixed period of time. While, ICLs, is repayable with X per cent of individual borrowing as a

proportion of future income (Rasmussen, 2006). The idea of ICLs introduced by famous

American economists Friedman (1955) and Nerlove (1975). Over the period, numerous




researchers, i.e. Barr (1993) & Chapman, (1997) discussed the shape and design of student

loans and relationship with market forces.

However, Goodman and Kaplan (2003) denied this argument and proposed free education

should be provided. Loans depend on the students’ future level of income and ability to

repay. There are few issues with an ICLs i.e. it gives borrower insurance beside future lack of

money (Chapman, 2006). On the other hand, the student has to accept a higher fraction of

risk. Thus, it will deter student, especially those who are financially weak (Bennett, 1992). It

is also an inequitable and inefficient way of financing. Furthermore, MLs also generate issues

on the supply side. It creates imperfection in the capital market that leads to deficiency of

capital (Barr, 1993, p. 721). Similarly, the Robbins Committee report also appeared as

conflicting stance regarding student loans (Robbins, 1963, p.212).

Putting together, increase in tuition fee is not a viable option as it is not only affect the pace

of HEI but it is also a short term solution. Further, owing to various draw backs discussed,

student loan scheme is also not effective in this context ( Ahier , J. 2000). Thus HEI needs to

come up with long term and more sustainable alternative (Collins et al, 1994, p.33; Hyde,

1980; Wattenbarger , 1986).

Privatization of HEI

Due to inadequacy of public sector to finance the HEIs private sector appeared to fill this gap.

In developed nations a significant portion of higher education sector belongs to private sector

(Jamshidi et al, 2012, p.789). Many of the developing nations, due to growing population and

vast expansion in demand of higher education are also looking for transferring partial

ownership of public universities to private sector (Oketch, 2004). Moreover, allowing private

sector to build universities, Pakistan is one of the prominent examples from the developing

countries where, government allowed private sector to establish universities. Presently, a

large proportion of student is studying in these private universities (Halai, 2011).

In past, this process was also appreciated by IMF and World Bank. As part of globalization,

structural adjustment programs (SAPs) introduced by these two global institutions

emphasized to reduce the government roles by privatization of public assets including higher

education (Kwiek, 2014 & Varghese, 2004). Supporting this policy Lee (2008) argued that

governments support for growing private higher education sector is due to find alternatives

for fiscal constraint and growing social demand for higher education. Similarly, issues, i.e.

the impact of technological advancement, increasing demand of research and innovation,

higher education reforms, the massive expansion in demand for higher education systems

played an important role in the development of private higher education institutions

(Geethanjali et al. 2008). In various countries, private higher education institutions have

played a significant role in higher education development. In response to, growing gross

enrolment and institutional budgets, the role of the private sector is considerable (Fahmi,

2007). Furthermore, the following studies are showing same findings, i.e. (Levy, 2011; Pey,

2008; Lane, 2011; Arokiasamy, 2011; Tham,2011& Agarwal, 2007).

However, exploring privatization of higher education Subramanian, (2014, p.16) stated that

private sector treated higher education as “product” and their students are as “customers”

thus, it is a “trading of education”. Moreover, privatization, marketization, and

commercialization are worsening the quality of higher education (Ng, 2012, Kaul ,1993).

Additionally, it is also affecting the promotion of higher education. Privatization of higher

education lowers the chances of education for low income students due to high cost. It may

also create risk of conflicts of interest with organizations and other sponsors. Whereas, with

the market pressure private institutions run programs and disciplines that have a definite

market value equal to their cost. The private institutions reduce the less demanded discipline




in the market. Moreover, it seems like due to privatization higher education institutions

appear more accountable. But to whom? In fact, with privatization universities and colleges

are less accountable to public and elected officials (Lyall, 2006).

In condense form, the privatization of HEIs have also not sustained as a long term alternative

thus requiring to search for some other options.

Cost-sharing

The concept of cost sharing was first introduced by Johnstone, D.B (1986). Studying higher

education mechanism in Europe and U.S.A, he discovered that the demand for higher

education was growing in those countries which had aroused the issue of affordability. To

compete with the issue, he proposed a model for higher education finance by the combination

of four sources of funding. Johnston (p.2) assumed that “cost of higher education in all

countries and in all situations can be viewed as emanating from four principal parties” (1)

the state or taxpayers; (2) Parents; (3) Students; (4) Individuals or Institutional philanthropy.

The similar terms “Cost-sharing” has been appeared before Johnstone’s study such as in

Carnegie Commission report (1973) used “sharing the Cost Burden”, but, after the

Johnston’s study in 1986, the term widely appeared and used in many current studies i.e

World Bank (1986, p.8) used “Cost Recovery”. Moreover, the term has been used in the title

of various present studies, i.e.(Ayalew, 2013; Rasmusen, 2006; Ishengoma, 2004; Owino,

2000; Penrose 1998). In various European countries, the idea of cost-sharing received greater

support than other ideas i.e. cost recovery, user charges and tuition fees.

However, cost sharing mechanism also wants financial assistant for needy students.

Woodhall (2006) stated an adequate financial assistance is essential even in the cost-sharing

to ensure the access of higher education for needy students. In the same way, Ziderman and

Albrecht (1995) explored the various loan schemes have failed due to default rates. Similarly,

administrative cost and interest rate are also creating problems. Therefore, the authors

suggested that for some countries state has to give many as grant or higher education

institutions use alternative source of funding rather than creating burden on the students and

parents.

The advocate this believe higher education should be up to some extent financed by tax

government. Secondly, Parents; may also contribute to the cost of higher education. Thirdly,

students may also share in higher educational costs through their earnings, savings or loans

etc. Finally, the donor and charity institutions those may also contribute in higher education

through gifts, donations or awards to colleges and universities. Numbers of researches have

applauded this concept. For example, Eicher and Thierry (2002, p. 68) claimed that mixed

mode of financing is better than exclusively public funding. Moreover, they proposed public-

private sharing concept with various diversification mechanisms. The authors also claimed

that choice of public-private funding relies on the social and practical constraints of society,

including political process and evaluators and researchers’ rational views etc. (p.75).

Johnstone assumed that cost should be sharing equally in all four participants of the concept.

However, If ignore Johnstone’s assumption and transfer large burden on the philanthropy or

endowment funding. So, it has the more ability to have burden and generate perpetual

funding as alternative sources of funding. It is observed that higher education institution rely

on endowment funds because of other resources diminishing or they may not have ability to

sustain increasing burden. Altbach et al. (1999, p.380) concluded “it is a zero-sum game, in

which a lessening of the burden upon, or revenue from, one party must be compensated either

by a reduction of underlying costs or by a shift of the burden to another party”




Waqf or philanthropy

Higher Educational Institution

Develooment

Waqf institution

Financing Model Investment Model

Equity

Fixed assets

Real estate

Cash

Hedge funds

Private equity

Venture capital

Natural resources

Other

Deposits

Business(s)

etc.

Charity and Aids

Allumi Association

Gifts

special funds

Various Funrasing activities

Government aids

Individual and institutional grants

Soliciting system

Industrialist and Busniss man

philanthropist

etc

Operation expenses

Developmental expenditure

educational programs

Human capital Development

Scholarships

Professesrships

Financial assistant

Accumudation

Etc

Development Model




Discussion

Higher educational waqf institution financing may be challenging, it is depending on the

situation that how the income is coming, how expenses is laid out, who decides financial

decisions and what are the sources of finance. Higher education institutions are soliciting

donations from these major sources, i.e. alumni, non-alumni, individuals, business

corporations, foundations, religious donations. Moreover, there are few others techniques to

rise funds i.e direct mail, legacy creation, specific funds, special activities and others.

Universities may further invest in financial assets, primarily in the equities, including public

equity, private equity, international equity, etc. Whereas, some of them also allocated to real

assets, real estate, alternative security, stocks and bonds, etc. There are various business

investment strategies those may propose additional revenue in Higher education from

different areas, i.e. Incubator program, agriculture sector, equity participation and other

projects etc.

Conclusion The present research discussed that government funding deteriorating due to global and local

perspective and higher educational institutions are looking for alternative funding options. it

critically investigates various alternative options and found mostly these options are not

viable. However, Waqf (Endowment) proved itself as sustainable and perpetual sources of

income. The higher education endowment fund is one of the main alternative sources of

funding in academic activities. Every endowment management has certain unique features.

Some endowment manages small amount of assets and some institution manages large

amount of endowment asset.

The study further claimed that an endowment is major source of institutional discretionary

funds that institution may use it for research and development, risk taking activities and for

future investment. Similarly, waqf institution provides the margin of excellence, the element

of vitality that separate one institution from another one and offer financial and fiscal

autonomy. It may also create diversification in management and investment strategies. Waqf

resources are relatively unrestricted spending forms for the HEIs as compared to public

funding’s. It can be expanded and increased without constraint.

On the other hand, The higher educational institution needs substantial amount on a regular

basis for building computer labs to awarding scholarships, from research & innovation to

online databases system and from expansion of educational programs to operating expenses.

An efficient waqf institution may assist higher educational institution in all these mentioned

extents. However, public funding mostly are prescribed and regulated.

Traditionally, waqf is investing generally in real asset. While, at present higher education

waqf institution should invest in financial assets rather than investing exclusively on real

estate.

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Theory of Giving from an Islamic Perspective

Foyasal Khan

International Islamic University Malaysia,

53100 Gombak, Kuala Lumpur, Malaysia

E-mail: [email protected]

Abstract

For last few decades, a large number of economists and social scientists have been trying to connect non-

economic factors i.e., culture, religion etc. with economics. In every religion, ‘giving’ (in terms of charity in

cash and in kind) has been given utmost importance. Among religions, Islam has focused more extensively on it.

Islam has different categories of ‘giving’. Western literature has also focused on religious giving and religious

attendance. In most cases, they have tried to link these variables with income and observed that among the high

income group, religious giving is preferred over religious attendance (Iannaccone, 1997; Rosborough, 2009 &

2010). Opposite happens among low income group. Of course, there is a relationship between high income and

religious giving, however, variables like religious giving and religious attendance doesn’t totally depend on

income in Islam. Basically, in Islam, both religious giving and religious attendance depends on the level of

Taqwa (Allah fearing). So there is positive relationship between the level of Taqwa and religious giving and

religious attendance. This Islamic proposition has yet shown through model development using microeconomic

framework. In this backdrop, the author aims to come up with a mathematical microeconomic model on ‘Theory

of Giving from an Islamic Perspective’.

Key words: religious giving; religious attendance; Taqwa (Allah fearing); microeconomic

model

1. Introduction

1.1. Background

In the last two centuries, considering non-economic factors in economic discussion was rare

phenomenon. Recently, a large number of economists and social scientists have understood

that limiting discussion on only economic factors is a drawback for which reaching any

meaningful conclusion is almost impossible. Hence, last few decades the economists have

been trying to connect culture, religion etc with economics. In every religion, ‘giving’ (in

terms of charity in cash and in kind) has been given utmost importance. Among religions,

Islam has focused more extensively on it. Islam has different categories of ‘giving’. Some are

obligatory i.e. zakat, ushr and some are recommended i.e. waqf, qard hasan. Western

literature has also focused on religious giving and religious attendance. In most cases, they

have tried to link these variables with income. One of common phenomenon they observed

that among the high income group, religious giving is preferred over religious attendance

(Iannaccone, 1997; Rosborough, 2009 & 2010). Vice versa happens among low income

group. Of course, there is a relationship between high income and religious giving in Islam as

low income group don’t have income above nisab level so they are not commanded to give

zakat, ushr or any other obligatory charity. Having said that variables like religious giving

and religious attendance doesn’t depend on income in Islam. If we ignore the giving in terms

of absolute value and focus on percentage, then we can see that a poor man can also give

more than rich. Even in the early period of Islam, that was actually happening. Some

companions of the prophet (PBUH) donated all of their income and assets for the cause of





Allah while some other companions donated half, one-fourth etc. Basically, in Islam, both

religious giving and religious attendance depends on the level of Taqwa (Allah fearing).

Taqwa has different levels in Islam, for example, the holy Qur’an has used words like

muslimun, mu’minun, muttaqun and muhsinun to differentiate the level of Allah fearing

among Muslims. So there is positive relationship between the level of Taqwa and religious

giving and religious attendance. This Islamic proposition has yet shown through model

development using microeconomic framework. In this backdrop, the author aims to fill up the

gap hoping to throw some thoughts which may be refined and furnished in the light of

comments and observations from the conscious economists.

1.2. Motivation of the study

Recently I have reviewed a working paper entitled “A Theory of Congregational Giving” by

Jonathan Rosborough where a model has been proposed to illuminate long established

empirical facts about religious giving and attendance rates congregationally and the author

predicts that over- representation in religious congregations will be seen by lower income

individuals while higher income members concentrated their focus on giving. When I was

going through his paper I also agree that any attempt to establish the relationship between

Income group and their response to the religious giving and attendance empirically may give

the same prediction in Muslim countries. This is due to the fact that Muslims can be counted

as numbers but number of real Muslims who are practicing ideally the way the last prophet

(PBUH) has taught us to behave and lead our lives are hardy found. In this situation,

empirical findings in Muslim countries may not be meaningful predicting the same result as

Rosborough found. Considering the scenario, I motivate to do modeling the ideal Muslim

giving behaviour.

1.3. Research objectives and contributions

The objectives of this paper are as follows-

a) To review critically the neo-classical model of religious giving

b) To justify the predictions and propositions of the conventional model from Islamic

perspective or through Islamic moral filter

c) To develop an alternative model based on Islamic ideal behaviour

d) To motivate people to behave according to Islamic ideology for the welfare of the

society

1.4. Organization of the study

This paper has three sections. First section provide introduction covering the background and

motivation along with the objectives of the study. Then, the second section is completely

devoted to review on the relevant literature and Third section discusses more details on the

theory of religious giving using Iannaccone (1997) framework of rational choice model and

an Islamic perceive is also provided in relevant places. Finally, last section concludes.




2. A Review of the Relevant Literature

Religious giving as a subject of study has been already caught widely attention in many

academic fields of business and social sciences. Beyond this cross-disciplinary appeal,

scholars all around the world are engaged to discuss the topic globally.

Theories of religious giving are few. (Hoge and Griffin 1992: 4-l in Iannaccone, 1997) state

that most research on giving is “exploratory in nature, not guided by any theoretical models”.

In this backdrop, Iannaccone (1997) shows the advantages of using ‘Rational choice theory’

that seeks to integrate numerous predictions within a single conceptual framework. It is well

suited for modeling the measurable dimensions of religious participation, particularly

contributions. It is easy therefore to sympathize with Hoge’s (1993: 36) claim that the

“rational choice economic model” is a “major theoretical resource” for understanding giving,

one that we would be “unwise” abandon.

Hoge and his associates (1995: 6, 7, 11) admit that “the economic model arouses fervent

opposition on psychological and sociological grounds”. But after weighing each of four

distinct “attacks,” they conclude that “the economic model [is] still the best starting place for

understanding religious giving . . . Religious giving is rational behavior.”

Most formal economic models of religious participation build from Gary Becker’s (1976)

theory of household production. The models of Azzi and Ehrenberg (1975), Sullivan (1985),

Iannaccone (1992), and Montgomery (1995) are all simplified variants of a single, general

model that encompasses church attendance, contributions, religious intermarriage,

denominational mobility, life-cycle patterns, church-sect theory, free-rider problems, the

strength of strict churches, organizational dynamics, and more. Iannaccone (19901 provides a

nontechnical introduction to household production theory and its application to religious

participation.

Lincoln, Morrissey and Mundey (2008) summarize, critique, and assess the existing literature

on religious giving by exploring individual and group level explanations, as well as the socio-

political context in which faith-based generosity occurs. They define ‘religious monetary

giving as financial donations given to religiously affiliated congregations, denominations, and

para-church organizations’ and citing Eckel and Grossman 2004: 272; Queen 1996, the

authors argue that many religions have institutionalized charitable giving, for example the

Christian tithe- that is, giving ten percent of one’s income—and Islam’s zakat, one of the

faith’s five pillars which is an “alms-tax” on roughly 2.5 percent of an individual’s wealth.

In terms of behaviors, beliefs, and demographic considerations, Lincoln, Morrissey and

Mundey (2008) outline the most important instruments that undergird individual religious

giving.

Indicators Variables

Behaviors 1. Attendance:

Relationship between participation and religious giving is positive.

high attendance levels are representative of strong religious commitment,

which typically leads to increased religious giving (Hoge 1995; 1994)




“the relationship between religious giving and involvement in religious

organizations is unambiguously positive.” Chaves and Miller (1999: 171)

“attendance is a very strong predictor of contributions and tends to ‘knock

out’ the other religion variables. Attendance does more than merely take the

place of the observable beliefs and background; it substantially improves over

them because it also captures unobservable components of underlying

religiosity.” Iannaccone (1997: 153)

2. Pledging: planning one’s donations in advance. Pledging and weekly

tithing precipitate greater religious financial generosity.

Beliefs 1. Theological Conservatism: the effect of religious conservatism on

charitable behavior is positive and strong

2. Reciprocity:

Proponents of these religious economies of approach prefer to frame religious

giving as “rational behavior” in which there is a reciprocal relationship

between the donor and the recipient.

In Hoge’s (1995: 56) opinion, “this model remains the most promising

theoretical starting point for understanding religious giving

Demographic

Factors

1. Income:

In aggregate terms, individuals and families with high income generally give

more to religious organizations, and those with low income typically make

smaller donations (Hoge 1994; Chaves and Miller 1999).

aggregate giving to religious organizations is highly skewed (Iannaccone

1997).

2. Age:

Age is being positively related with religious giving.

3. Marriage:

Marriage is found to be positively related with religious giving, especially

when one’s spouse is religious and attends services.

4. Education:

Hoge (1994: 107) concludes that the relationship between education and

giving as a percentage of income is ambiguous.

3. Theory of Giving from Islamic Perspective

In order to develop a theory of giving from Islamic perspective, this paper will follow

‘rational choice model’ developed by Laurence R. Iannaccone’s paper entitled “Skewness

Explained: A Rational Choice Model of Religious Giving” published in 1997. In his paper, he




mentions five assumptions proposed by Hoge (1994: 102-103) as starting points for future

research, the assumptions are:

1. Religious giving is rational behavior and can be modeled using existing sociological

and economic methods

2. People strongly committed to God and God's promises will more money to the church

3. Church members who have more discretionary income will, on average, give more to

the church

4. The distribution of the amount of money given by members of any church is greatly

skewed

5. The amount of money potentially available to churches from members is a variable

sum, not a fixed sum.

Among the assumptions, Iannacone gives special attention on assumption 4 and he mentions

three facts that are suffice to generate skewness in practice: (1) percentage rates of giving

vary greatly from one person to the next; (2) income levels also vary greatly; and (3) income

levels and giving rates are not strongly (and negatively) correlated (Iannaccone, 1997,

pp.142). On the basis of three facts, he develops his simulation on contribution rates,

incomes, and correlations between religiosity and income. The following simulation shows

how the explanation works.

1. Contribution rates: All studies of giving find that the share of income given to

religion varies greatly from one person to the next. Actual shares vary widely, that

they depend on a person’s religiosity, and that the tendency to choose a share (rather

than an absolute dollar amount) is widespread.

2. Incomes: Although actual incomes are both widely dispersed and highly skewed in

every country, his simulation employs a distribution that is nearly symmetric. He

does so to prove that a skewed distribution of contributions will arise even when the

underlying incomes are not skewed.

3. Correlations: Decades of survey research prove that the actual relationship between

religiosity and income is weak. Richer folks may attend church a bit more or pray a

bit less, but on the whole the impact of income is not particularly great.

He states that assumptions (1) through (3) enable the researchers to simulate contributions as

the product of income and share. People take their (randomly distributed) income, multiply

by their (randomly distributed) propensity to give, and arrive at an actual dollar amount:

contribution = share * income (Iannaccone, 1997, pp. 146).

3.1 Assumptions of the general model:

The general model rests on the following two important assumptions:

1. Individuals allocate their time and money resources so as to maximize their utility

from the production of abstract “household commodities.”

2. Religious satisfaction constitutes one such commodity, and for the purpose of formal

analysis all other commodities may be viewed as an aggregate “secular” commodity.




3.2. Details of the model:

To simplify the analysis without altering any key results, assume that each individual

consumes R and S denote the quantities of religious and secular commodities respectively. R

and S are produced with inputs of personal time and purchased goods. 1Hence, R and S are

functions of time and money inputs:

R = R (tR , mR ) (1a)

S = S (tS , mS) (lb)

Where tR and mR denote the amount of time and money devoted to religion, and tS and mS

denote the amount of time and money devoted to all other (secular) activities. The total

amount of available time is of course fixed, since each person has only 24 hours per day.

Hence, letting T denote the total amount of available time and letting H denote hours of work,

each person’s time constraint may be written as:

tR + tS + H T (2)

This simply states that altogether the time devoted to religion plus the time devoted to secular

activities plus the time devoted to work cannot exceed the total time available. In a similar

fashion, the amount of money devoted to religious and secular activities cannot exceed total

income, I.

mR + mS I (3)

Total income equals earnings plus non-earned income. Hence, letting w denote the person’s

wage rate and N his or her non-earned income, we may write total income as

I= wH+ N (4)

Following Becker and others, we can define full income, I*, as the amount of income that

would be generated if the household devoted all its time to market labor.

I*= wT+ N (5)

By definition, a rational consumer seeks to allocate his or her resources so as to maximize the

utility derived from R and S:

U(R, S) (6)

subject to the previously described constraints on time and money income (and subject also to

whatever additional constraints govern the production of household commodities).

Specific Mathematical Form of Functions:

1 “Purchased goods” refers to anything bought with money, including physical items and human services. In the

absence of changing prices, the quantity of such goods can be proxied by the amount of money spent on them.




To proceed, it is must to specify the mathematical form of functions in equations (1) and (6)

because of its relative simplicity and popularity in traditional economic research. This model

will use the Cobb-Douglas form. The Cobb-Douglas specification for equation (6) is:

U (R, S) = RC S1-C (5*)

The Cobb-Douglas specifications for equations (1) are:

R (tR , mR ) = tRa , mR

1-a (1a*)

S (tS , mS) = tSb , mS

1-b (lb*)

These functions are all multiplicative in their inputs (R, S, t, and m) and exponential in their

parameters (a, b, and c). Despite their apparent complexity, the behavioral interpretation of

the equations is straightforward: each one-percent increase in R yields a c-percent increase in

utility, each one-percent increase in tR yields an a-percent increase in religious output, R, and

each one-percent increase in mR yields a (1-a)-percent increase in religious output, R.

The parameter a has an analogous interpretation, but it reflects the relative value of time (as

opposed to money) devoted to religion. Institutional factors such as congregation size (which

affects the incentive to free ride) and denominational norms (concerning giving practices)

certainly influence this parameter - see Hoge and Griffin (1992, chapters 2 and 5) for details.

In terms of the model, denominations whose members average high rates of church

attendance relative to giving (such as Catholics) have a large a-parameter. Denominations

with high rates of giving relative to attendance (such as Mormons and Jews) have a small a-

parameter.

Drawing on standard mathematical results for Cobb-Douglas functions (Varian 1992: 111),

the explicit solution to the preceding utility maximization problem is

tR*= ac(I*/w) (7a)

mR*= (1-a)cI* (7b)

mR*/ tR*= ((1-a)/a)w (7c)

where w and I* denote the individual’s wage rate and full income, respectively.

3.3. Implications of the model from an Islamic perspective:

Let us assume, there are two persons in an Islamic economy and they are different based on

their level of Taqwa. Person A is more Allah-fearing than person B. Their utility functions as

follows:

UA (R, S) = RC S1-C

UB (R, S) = RC S1-C

Where, for person A: Marginal Utility from Religious activities, MUAR > 0; Marginal Utility

from Secular activities MUAS > 0, and for person B: Marginal Utility from Religious

activities, MUBR > 0; Marginal Utility from Secular activities MUBS > 0. Meaning that




engaging in one additional both religious and secular activities give positive utility. But in an

Islamic economy, MUAR > MUBR and MUAS < MUBS. This is happen due to their level of

Taqwa. More Allah conscious people give priority to the religious activities than less Allah

conscious people.

Marginal Utility from Religious activities, MUR 0; Marginal Utility from Secular activities

MUAS > 0. This is a case if a person does not like religious activities, for example skeptics

and atheists. MUR becomes negative when a secular person compels to take part in religious

activities without willingness.

The parameter c captures the relative value that the individual assigns to religious (as

opposed to secular) commodities. We may therefore interpret c as the person’s underlying

religiosity. If c equals zero then the person attaches no value to religion, and larger c’s

correspond to greater levels of religiosity. Empirically, c will depend on the person’s

religious upbringing, personal experiences, beliefs, and numerous unobservable, random

factors. The parameter c thus captures the “religious human capital” effects described in

Iannaccone (1990, 1995: 118-19). In Islam, parameter c does not capture the Islamicity of a

person. Yes, relatively an Islamic man prefers religious activities over secular activities and

for this reason, c is nonzero and c is greater than 1-c but becoming c=1 has no meaning in

Islam if someone is engaged full-time in religious activities (Ibadah) , he will not have any

opportunity of working to earn livelihood. Hence, he has to depend fully on others in order to

live and this is highly discouraged in Islam.2 So, an Islamic man will maintain a balance

between religious and secular activities.3

To understand the behavioral implications of equations (7)) consider their final, rightmost

terms. In the time equations, 7a, this term has the form (1*/w), which equals full income

divided by the wage rate. Since most households derive almost all of their income from

wages, this term is approximately equal to the person’s full allotment of time, T. The model

thus predicts little or no relationship between income and church attendance. The intuition

behind this result is straightforward: each day has 24 hours; so the rich have, on average, no

more time to give to any particular activity (including religion) than do the poor.

But richer people do have more money. The final term in the money equations, 7b is full

income, I*. The model thus predicts that as income grows, dollar contributions will rise

proportionately. In other words, the share of full income given to religion will remain nearly

constant. The share, which equals (1-a)c, will depend on individual religiosity, institutional

attributes, and unobservable random factors. In Islam, rich people will give more money and

they have obligations in this regard. Wealth is a test for the rich, Allah will question them on

the Day of Judgment about the source of their wealth and how they spend it.

We have thus derived the very result that the simulations assumed. Total dollar contributions

arise out of the multiplicative interaction between two factors (full income and underlying

2, "And when the prayer is finished, then you may disperse through the land and seek of the bounty of Allah."

surat Al-Jumu’ah, (verse 10) 3 “When they spend, do so not excessively or sparingly but are ever, between that, justly moderate.” (Qur’an,

25:67)




religiosity) that vary independently of each other. Skewness thus follows as a formal

prediction of a rational choice/household production model of religious participation.

Of course, the model does more than predict skewness. Equations (7) also predict that: church

attendance will be less skewed than giving; church attendance will be virtually unrelated to

earned income; and individual rates of attendance will correlate more strongly with the share

of income contributed than the absolute amount contributed. Finally, the model predicts that,

apart from income, the same set of individual attributes (i.e., the same underlying

determinants of religiosity) will have nearly equal impact upon both contributions and

attendance. Empirically, this means that including attendance in the right hand side of a

contributions regression will tend to wash out the effects of all other individual-level

variables except income. (Alternatively, it means that the ratio of contributions to attendance

should be positively affected by the determinants of full income but relatively unaffected by

the underlying determinants of religiosity. See [7c], and note that the religiosity parameter, c,

has dropped from the equation.)

4. Conclusion

Concept of religiosity as understood by western scholars is different than Islamicity as

understood by Muslims. Hence, using the framework of Iannaccone (1997) cannot express

the ideal mode of Islamic giving behavior. It is, therefore, necessary to work seriously

further to improve the model. Despite the limitations, the model discussed above has also

articulated that religious activities both in terms of attendance and giving depend more on

religiosity (Islamicity) than income and others factors. This model is not empirically tested

yet. This is one of the drawbacks of the paper.

Acknowledgments

This paper was submitted on 31st December, 2013 to Dr. Noorihsan Mohamad for the partial

fulfillment of the requirement in the course ECON 7110: Microeconomic Theory for PhD in

Economics. The author is indebted to Dr. Noorihsan for encouraging me to come up with

mathematical microeconomic model in his course and giving suggestions and comments

during the preparation of this manuscript.

References

DAVIDSON, J. D.; PYLE, R. (1994). “Passing the Plate in Affluent Churches: Why Some

Members Give More than Others." Review of Religious Research, 36 (December,

1994): 181-196.

DONAHUE, M. J. (1994). "Correlates of Religious Giving in Six Protestant Denominations."

Review of Religious Research, 36, no. 2 (December 1994): 149-157.

HOGE, DEAN; YANG, F. (1994), "Determinants of Religious Giving in American

Denominations: Data from Two Nationwide Surveys." Review of Religious Research,

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HOGE, D.; CHARLES, Z.; PATRICK M.; MICHAEL, D. (1996). Money Matters: Personal

Giving in American Churches. Louisville, KY: Westminster John Knox Press

HOGE, DEAN. (1994) "The Problem of Understanding Church Giving." Review of

Religious Research, 36, no. 2 (December 1994): 101-110

IANNACCONE, L. R. (1997). Skewness explained: A rational choice model of religious

giving. Journal for the Scientific Study of Religion, 141-157.

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OLSON, D.; CADDELL, D. (1994). "Generous Congregations, Generous Givers:

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158-167.




An analysis of the reasons behind abuse of Murabaha Contracts

in disguised Riba in modern practices

Imene Tabet

Hamad Bin Khalifa University

Qatar Foundation

Al Luqta St, Ar-Rayyan

Qatar


Abstract

Since the evolution of Islamic Economics and Finance in the 1970’s, Murabaha stood among the most

promising contract in the early stage of the industry and as a debt financing instrument that is suitable for

financing short as well as long run trade. Many scholars strongly supported it, however, it soon developed into

a pool of malpractices and doubtful activities that included disguised elements of the prohibited elements that

are against the basic principles of Islamic Finance. This paper aims at analysing disguised Riba in modern

Murabaha arrangements, as well as the reasons behind this ongoing abuse that is left untreated at many times,

furthermore the impacts of such prolonged activities on the economy. The analysis will be done through

comprehensive assessment of Murabaha applied models such as, Murabaha-Sukuk and Commodity Murabaha

each with respect to the disguised riba element related to it according to the categorization that will be

discussed.

Keywords: Murabaha, Murabaha-Sukuk, Commodity Murabaha, Disguised Riba, Tawarruq, Bay al ‘ina,

1. Introduction The first Islamic Economics and Finance Evolution in 1970’s called out for reformation of

contractual arrangements under the Islamic Financial systems, pioneers and scholars of the

field have succeeded to develop various contracts upon which Islamic Financial Institutions

took their first step into being. The contract that gained significant popularity was the

Murabaha contract which had the biggest share in that advancement. The modified Murabaha

arrangement that scholars established; namely Murabaha by the Order of Purchaser among

others, was developed to enable credit provision in the form of debt financing by banks to its

clients. It is important to note that the contractual structure of most murabaha arrangements

practiced are sharia compliant and are clear from any prohibited elements such as riba and

other haram activities, based upon which the fuqahaa allowed it to be practiced. Nevertheless,

the excessive use of murabaha made it occupy not less than 80% of the Islamic Financial

Institutions’ resources. This popularity did not last long, with the excessive use of it, as well

as the loopholes that continued to prevail as a result of the abuse of practice; Murabaha; in its

current context and practices, soon was deemed to be inconsistent with the Shariah rules and

objectives. This has called scholars to shed some light on the other Islamic Financial Contacts

that have been ignored for a very long time. This study contributes in several ways to the

existing literature. Firstly, the findings carry significance to management and higher

authorities as well as the financial institutions for policy making. The study analyses the





dependence of Islamic Financial Institutions over specific contracts such as Murabaha and to

what level they are depending on it in the light of the ongoing debate of its advantages and

drawbacks,

Secondly, this study conceptualizes the objectives and effects of current implementation of

Islamic Financial Contracts on the financial industry’s development which will further add to

the growing debate of the future capacity and strength of Islamic Finance versus its

conventional counterpart

Thirdly, the highlighted loopholes and recommended solutions may act as a guideline to the

concerned authorities of Islamic financial institutions, specifically those focusing on

providing various Islamic financial products and instruments.

Finally, further policy implications are discussed based on the analysis and discussion.

The organization of this study is as follows. We start the discussion by analysing the recent

literature. This is followed by an analysis of prohibited elements that exist in murabaha

practices in Sect. 3, followed by the reasons behind the untreated deficiencies in Sect. 4, the

economic effects of the untreated loopholes and practices in Sect. 5. And finally, Sect. 6

concludes the discussion by providing some policy recommendation and areas for future

research

2. Literature Review Murabahah is a sale contract in which the seller will informs to the customers all the costs

incurred such as transportation cost and shipping. The value of contract will be added on the

total cost as profit. While, on the other side, and according to Hussin (2010), Murabahah

financing is an asset based financing widely used for house and motor vehicle financing by

Islamic banks.

Numerous researches on Murabaha concept especially after the development of Murabaha by

the Order of the Purchaser and its derivatives have been done by various scholars throughout

the world; one of the most distinguished studies was carries out by shaikh AlQaradawi. He

postulated his theoretical arguments along with various other Fuqahaa’ with respect to

murabaha (Al-Qaradawi, 1995), however, that was when he was a supporter of Murabaha as

it came about, in his paper, he also answers several contemporary fuqahaa critics such as al-

Masi who regarded Murabaha by the Order of Purchaser including elements of gharar and

legal tricks which are prohibited by Islam.

Nevertheless, there are two main scholarly views on Murabaha practices. The first view is

that Murabaha, with all its various applications is vital for Islamic Financial industry’s

growth, either by absolute claim or disapproval of some elements, and the second view is that

Murabaha needs to be eliminated from Islamic Financial practices. First of all, Murabahah is

derived from the word ' ribh ' which means profit. Technically, Murabahah is a price mark-

up that is expressed by seller to buyer for more transparent in the sale and purchase

transaction (Abdul Rahman 2010). Murabahah sales can be made by cash or credit.

According to Institute of Islamic Banking and Insurance (IIBI), (2006), Murabahah is a




contract of sale between the bank and its client for the sale of goods at a price plus an agreed

profit margin for the bank.

A lot of studies exist that support Murabaha. Zaki (2011) wrote a book about the Islamic

finance as an effective took of risk mitigation. He illustrated that Islamic Finance and rules

are used a Risk mitigate and minimize if applied appropriately. Alsayyed,(2010) studied the

uses of Commodity Murabaha, and found that Murabaha is clearly the Islamic treasurer’s

funding product of choice, as it is flexible enough to facilitate many structures for financing,

hedging, and currency exchanging.

On the other hand, many Scholars were of the opposite opinion, Zuhaili (2006) explains that

the Maliki School of Jurisprudence, Umar bin AbdulAziz, Ibn Taymiyyah, Ibn Alqiyym, the

Hanbalis Mohammed bin Allasan Alshaibani and from the Hanafi Schools dislike any

arrangements that include bay al ‘inah And tawarruq for various reasons such as Murabaha

and bai ‘ina practices are a trick and a backdoor to riba, (Al-Zuhaili, 2006). Imam Hanbal

himself disliked those who transact in deferred terms, Zuhaili further explains; practices such

as Murabaha and Tawarruq is actually like the sale of a forced person, this is due to the

nature of the contractual arrangements which could leave the client feeling insolvent,

moreover, this is again the spirit of Islamic Financial Transactions. In fact, most of scholars

nowadays have been more inclined towards this critic side of Murabaha practices due to the

serious loopholes that have been raised

3. Analysis Of Prohibitted Elements That May Exist In Murabaha

Practices Before getting into the analysis of the doubtful practices and the abuse of murabaha contract;

it is vital to go through the development of these practices, in order to be able to trace it to the

beginning. It all started by the first Conference of Islamic Banks in 1979 that was held in

Dubai, where the Murabaha by the Order of Purachasor was suggested and in fact welcomed

by most scholars, clients were selling certain assets to the bank and repurchasing it back on

bases of murabaha for the sake of obtaining liquid cash, this was untill the early 2000’s where

Tawarruq was adobted by several domestic banks soon it became a common practice among

Islamic Banks, with the 15th meeting of Majma Alfiqh Al-Islami which concluded that

tawarruq is permissible, Tawarruq gained popoularity that made its use spread into liquidity

management, especially in the middle east, soon it, soon it was becoming aparent that it was

manipulated and abused, this is when the organized tawarruq came to practice, which made it

clear for some scholars that it was time to speak out againts this act, in the 17 th meeting of

Majma Alfiqh Al-Islamic, Tawarruq was deemed prohibited, yet, its practice remains

ungoing. Furthermore, The most recent development of abusive forms of Murabaha was with

respect to securities, selling stock in favor to one client and selling it back for his own

interest, this is not only bringing unjustifies and secured gain to banks, but it rather is

considered a straight forward riba.

We could see from all these steady flow of that is refelected in the history of Murabaha,

malpractices and are growing to be very serious, moreover, Islamic Banking practitionors

have been more and more daring, this may be due to the lack of serious actions taken against

such practices, or due to the lack of clear cuts in the Sharia Financial Standards and rules




which is opening doees for many exceptions. The rest of the paper will look into these

practices and the reason behind their prelonged and rather untreated existence.

Below is the summary of the main points that would be discussed in this section:

Figure 1. Summary of the main points to be discussed by the Author

Since the 1970’s, Murabaha, as a debt financing instrument, evolved into various contractual

arrangements that are used for different objectives. Its excessive use has often led to doubtfull

practices that seem to make murabaha contract in its sense closer to the interest bearing loans,

which caused some scholars change their initial view about it, and calling for reduction of the

Islamic Banking institutions dependence upon this contract. The discussion below will

analyse several elements that are deemed to be disguised riba practice, the analysis will be

done through assessing several models in the light of the contractual arrangement as well as

their practices.

The main models that will be used in the essessment are, Commodity Murabaha and

Murabaha Sukuk.

3.1 Prohibited Elements That May Exist In Murabaha Practices

1. Sale of debt: One of the main practices that raised doubt about the existence of disguised riba in

Murabaha is the element of sale of debt, for clarity, this will be discussed later in the

light of Murabaha-Sukuk.

Murabaha- Sukuk was adopted to reflect one of the main uses of Murabaha as an

asset-based debt financing instruments, which practitioners claim that it is vital ‘to

accelerate development of Islamic Monetary Market’ and without which Islamic

Banks may suffer from liquidity crunch. (Siddiqui), although Murabaha-sukuk is

somehow limited in its practices, yet it has been increasingly used in the Islamic

Stock market and have amounted to 20% of the sukuk in the Malaysian Islamic Stock

market. Nevertheless, keeping in mind that all scholars held the opinion that

murabaha in any way must not be used as a tool for creating negotiable instruments to

be transacted in the secondary market. In murabaha sukuk, the deferred debt by the

Disguised Riba Practice in Murabaha

Prohibited Elements that may exist in Murabaha practices

Sale of Debt

Tawarruq

Bai Al 'ina

Malpractice of operation elements in Murabaha

Customer acting as Agent to himself

Risk, Finance, or delivery borne by customer




non-debtor is sold for deferred cash (in step number 7, Diagram 1 below), the Islamic

Fiqh Academy counted this as Sale of debt, as Najatulla Siddiqi argued in his paper,

that if we bought and IOU of $90 that is worth $100 after a year; we would be doing

that in order to earn the $10 of interest, thus there is no difference between IOU’s (i.e.

Sukuk) created by murabaha or by lending money. Nevertheless, this view has been

challenged by Chapra and Khan who were of the opinion that, a debt resulting from

murabaha has an element absent from a debt arising from borrowing money; that is,

the mark up on spot price, sale and purchase of murabaha-based Debt would take

place on this extra profit margin. (Khan, 2000)

The key point here is that it has been mentioned explicitly in Islamic Fiqh Academy

(2000, p.234) that there is no difference whether the debt is the result of a loan or

whether it is deferred sale (Academy, 2000), otherwise it would amount to Sale of

Debt, unfortunately, that is what has been practiced as far as Murabaha-sukuk is

concerned.

The problem with this proposition is that what was a profit MARGIN for the seller of

goods and services (on a murabaha basis) may not necessarily remain so when the

same seller ‘sells’ the IOU arising from that transaction. Some of the factors involved

in the determination of the mark up on spot price in murabaha may be different from

those involved in the sale of the resulting IOU at a discount. Furthermore, the extra

profits earned in murabaha sale, over and above those earnable on selling for cash, are

still against sale of goods and services. But the part of it that goes to the buyer of the

murabaha based IOU (according to the above mentioned rationalization) has no goods

and services corresponding to it. It is money for money, with a Contract between

Bank and Customer to decide profit rate on resale and payback period. Customer

purchases shares as bank’s agent, bank pays for the,. Bank sales the shares to the

customer on settlement at profit. Figure 2. describes the basic Murabaha Sukuk

model:

Murabaha has also been applied to generate working capital for business and consumer

credits using Commodity Murabaha as a tool to achieve that. The main difference that needs

to be clarified is that in Murabaha Sukuk, the customer needs a specific commodity for which

the bank provides financing, on the other hand, in Commodity Murabaha, the customer wants

cash. Which brings us to the second and third main elements of disguised riba in Murabaha

Figure 2. Murabaha Sukuk Model, Source: Author’s illustration

1.Sukuk(Trust Certificates) 2.Cash

Sukuk Issuer SPV 3. Spot Payment

4.Spot Delivery 5.Commodity Spot Delivery

6.Deferred Price

7.Return from Deferred Price = x

= x + y

= y




practices namely, tawarruq and bai al ‘ina, which will be assessed in the light of Commodity

Murabaha contractual arrangement.

2. Tawarruq: (Monetization)

In the light of Commodity Murabaha1 (also known as: double murabaha / reversed

murabaha)

Islamic Institutions adobt Tawarruq arrangement to allow for cash financing as a way

to avoid bay al ‘ina, however, tawarruq in itself has been a doubtful elements in

Murabaha arrangements that scholars have deemed to be a disguised riba practice if

not practiced well.

Figure 3. Below is an illustration of how tawarruq is practiced in the context of

Commodity Murabaha in Bank Islam (Malysia).

Figure 3. Contractual Arrangement of Commodity Murabaha as practicedby Bank

Islam Malaysia

Source: www.bankislam.com.my/en/Pages/ShariahConcept.aspx?mlink=PersonalFinancing

1Commodity Murabaha: The bank buys a certain commodity from a broker and sells it to the client, who does not want

to own the commodity, so he sells it to another broker to get cash.

http://www.bankislam.com.my/en/Pages/ShariahConcept.aspx?mlink=PersonalFinancing




The Fiqh Academy of the World League in its seventeenth session held agreed that

organized tawarruq is not allowed. Moreover, as early as 2006, Shaykh Dr. Hussein H

Hassan, a prominent member of many Shariah boards including AAOIFI claimed that

many scholars had reached a consensus that organized tawarruq was indeed haram

(Al-Suwaylim).

The reason of the increasing doubt about the practice of tawarruq in general and in

Murabaha in specific is the fact that the client is not interested in the product per se,

rather the money, and the sale in question is an illusionary sale whereby there is no

actual possission of the item. If we look at Figure 3 above, despite the fact that

arrangements such as making the bank as an agent, and ensuring that the commodity

is not returned to the same party (2 brokers involved), yet the whole issue boils down

to obtaining cash immediately, and paying for it later on with a greater mount, and

this is what majority of fuqaha see as nothing but a disguised riba practice. Islamic

Scholars further dislike such arrangements because they believe that businesses and

consumers should use less contrived methods to obtain financing.

3. Bai Ina(Buy-Sell Back)

Although tawarruq and Bai al ‘ina are both said to be derived from the concept of

Murabaha,. Majority of scholars argue that Bai Ina (Buy-Sell Back) is not but a

replication of the interest-bearing loan in the conventional system. The key difference

between Tawarruq arrangements and Bai al ‘ina is that the latter is done among two

parties, while tawarruq is more than two parties involved. Moreover, in the attempt of

applying Bay al ‘ina in Islamic Financial institutions (i.e. in Malaysia), scholars have

placed certain rules to ensure Shariah complience, such as that there should be no

condition of buy back, and each contract should be done seperately. Nevertheless, if

we look into what has been experienced, everything is done in the same setting.

Figure 3 below clarifies the practice of Bai Ina in the context of Murabaha by

Malaysian Banks.




Figure 4. Bai Al’ina Practice in Murabaha (Malaysia)

Source: http://islamicbankers.me/2012/12/22/the-death-of-bai-inah/ (Islamic Banking: Resource Centre)

All independent Shariah Councils strongly recommended to avoid these instruments

of legal arbitrage in general whether it is in the form of tawarruq or bay al ‘ina. With

the rise of doubts and issues regarding bay al ‘ina, many practitionners believed that

moving from bai al ‘ina to tawarruq in the right thing to do. While both could be

doubtful; it has been increasingly clear that bay al ‘ina is not any different from

interest bearing loans.

These two forms of credit are more clearly parallel to traditional loans and may be

structured to have“rate” resets, rollovers and to accommodate late payment recoveries

which are even more controversial.

3.2 Malpractice Of Operation Elements In Murabaha

The elements that may be considered as disguised riba practices in the context or Murabaha

contractual arrangements go beyond the general elements that are prohibited in themselves

(i.e.sale of debt, tawarruq, and bay al ‘ina). The reformation of murabaha since the 1970’s has

allowed for many loopholes even in term of the abuse in operation elements in itself. We will

now look at the main elements among these arrangements and analyse their reasons in the

light of current practices.

1. Customer’s agency to himself

This concept was introduced after serious mistakes that practitioners committed in the

early stages of Murabaha arrangements developments, when a manager allowed the

client to withdraw the cash needed for purchase from the bank and do all the job by

himself all after which the final price and terms of payment has been concluded. This

is an absolute Riba and not a murabaha sale. Scholars have strictly criticized this

practice till it was brought to an end. A substituting step was introduced, that is,

giving agency to the client, which was believed to be the suitable solution for that

1.Bank sells Asset to

customer at RM30,000 for 60

monthly installment.

(Murabaha sale)

2.Customer Sells Asset to

Bank at RM 20,000 on spot

bases

http://islamicbankers.me/2012/12/22/the-death-of-bai-inah/




problem. Nevertheless, Murabaha has increasingly been criticized for many other

arrangements that seem to be doubtful.

The main argument here is that once the customer becomes an agent for the bank to

take possession of the commodity on behalf the bank and delivering the commodity to

himself, this transfers part of the risk to the customer, especially if the commodity was

bought at the customer’s name from the beginning, this raises the argument that the

profit that the bank gets is guaranteed and without any risks, which is against the

principles of Islamic transactions.

2. Shipping, Risk, or Financing , borne by customer

During the development of murabaha and its application as a financing instrument, it

has come to scholars realization that there are certain key points that must be cleared

and out as a framework in order to ensure the Sharia compliance of murabaha

applications. All fuqahaa’ agreed that in a murabaha contract, all shipping costs, all

risks involved from the moment the contract is initiated till the delivery of commodity

to customer, as well as financing cost must be borne by the Financing Institution (i.e.

Bank). Failing to which the contract may be void and it will be no different from an

interest bearing loan.

These key points were highlighted after several serious malpractices committed

during the early years of murabaha application as what has been aforementioned.

Another issue that scholars raised with respect to shipping and financing in murabaha

arrangement is that in most cases, especially that of import murabaha, Islamic

Financial Institutions do not consider custom duties, Letter of Credit charges, etc. in

their pricing mechanism and the customer must bear all these charges. This is against

the principles of Murabaha where by all costs and related matters needed to deliver

the commodity to the client must be borne by the financier even if it was reflected in

the price. Failing to which will make the Murabaha arrangement interest bearing.

Most of these issues were looked into since the 1983 when the Fiqh Academy

suggested two main points to comply. Firstly, The Bank must own and possess the

commodity BEFORE signing the Murabaha contract with the client. Secondly, the

Bank must bear the risk of damage that could have to the commodity before it reaches

the client along with other risks which give further justification of the profit the bank

gains.

Another case regarding misuse of murabaha that could amount to disguised riba

practices is the issue of physical verification of the commodity, in practice, the

Financial Institution takes only a constructive possession over the commodity, while

the customer actually receives the delivery of the good, there is, however, the risk that

murabaha transaction be executed prior to the procurement of the commodity, which

will render murabaha transaction as being mere financing rather than trading. In other

words, sometimes clients are obliged to fulfil the contract payments before actually

receiving the merchandise, which is completely against the shariah rules. (Ahmad,

2005)

4 Reason Behind Untreated Deficiencies

Now that we have highlighted the main elements leading to disguised Riba in modern

Murabaha practices, it is pertinent to analyze the reasons behind these loopholes being

untreated, and why is Murabaha and its subsequent tools still being practiced despite the

doubts that has been raised and the arguments from many scholars to limit these activities




that seem to be bringing the name of Islamic Financial instruments to suspicion. These

reasons will be highlighted in the light of their nature, some of which are problems in the

theoretical approach of developing Islamic Financial instruments, meanwhile other reasons

are due to deficiency in application.

4.1 Theoretical Reasons Behind Untreated Deficiencies:

1- One of the main problems faces in the development of Islamic Financial

instruments and working towards improving it generally is the lack of

cooperation between finance experts and Sharia scholars and Sharia board

members. The Shariah members at many times know what opinion is

demanded and expected from them before they truly analyze the cases from a

proper Sharia perspective. At time Shariah members are bias towards what is

wanted from them rather than what they believe Shariah accepts. Many

scholars have recommended to establish an independent body of Sharia

members that are responsible for solving all doubts and disputes, having an

independent body, preferably under the central bank, will result in an

unbiasedness among Sharia members when calling out for their opinions.

2- Lack of vision of contracts, this is indeed on of the main shortcomings of

Islamic Financial institutions, we are often carried away by various things

from trying to compete with our conventional counterparts or strive to

maximize the Islamic Financial institutions share in the market, this major

shortcoming of the mission of Islamic Banking and Finance in general and the

lack of vision towards the actual responsibility of development that must be

the ultimate idea behind Islamic Banking and Finance industry. The aim for

economic development of our Muslim countries especially must be put into

effect, and that should be the path upon which Islamic Financial Instruments

must be developed.

3- As far as Islamic Financial Instruments are concerned, there is a huge lack of

understanding and differentiating between the Constants and Variables of each

contract, knowing which parts of the contract are constants that must exist in

order for the product to be Shariah compliant, and the other elements that

could be altered and developed in order to invent efficient tools for Islamic

Financial sector. Moreover, this cannot be efficiently implemented without a

proper application of fiqh rules with the consideration of maqasid of shariah as

a comprehensive methodology of developing Islamic Financial Instruments

with considering micro as well as macro approach, lack of which has

contributed immensely to the abuse and misuse of Murabaha, among many

others, Islamic Financial Instruments. In other words, in a certain model, each

individual contract may seem perfectly Shariah compliant, however, once it is

practiced with the rest of the model on a macro level; it raises serious doubt

about it Sharia compliance. This is one of main reasons why many scholars,

including Shaikh AlQaradawi, who was a proponent for Murabaha by Order of

Purchaser when it first evolved in 1970’s, however, after all the doubts that

has been raised about its application he attacked it and strongly held the

opinion of limiting its application as much as possible.

4- One of the most obvious reasons behind the continuous use of Murabaha

based Instruments is the fact that it is deemed to be one of the least risky

financial instruments banks may use in financing various activities, with the

numerous uses of it from liquidity absorption, debt financing, and international




trade financing, Islamic Financial Institutions prefer Murabaha over other

instruments that has been called for to replace it.

4.2 Practical Reasons Behind Untreated Deficiencies:

1- Lack of proper and sufficient Islamic Banking staffing; there is a huge problem in the

distribution of human capital in Islamic Financial Institutions, those who have best

knowledge and experience in banking have weak Shariah knowledge and have the

dominating decision making positions. This eventually caused those with Shariah

knowledge to be there just for consultation, often deemed to have unsuitable opinions

due to lack of economic and practical knowledge.

2- Competition with conventional counterparts, as far as Islamic Financial Institutions

are concerned, we are overwhelmed by competing with our conventional counterparts,

this have caused the Islamic Banking sector to stick to certain activities for the sake of

competition while overlooking the Shariah aspect that could have been forgone for the

sake of competition or even could have rather brought a bigger gain to the Islamic

Financial Industry.

3- Lack of alternative focuses; as many scholars and Islamic Economists have been

suggesting, we must avoid those doubtful practices, it is time to look into developing

other Islamic Financial instruments that has not been focused on, including

Musharaka, Mudaraba, Salam, and many other contracts that are believed to have

huge capacities and a promising future. There is yet room for further development of

Murabaha application that various scholars have suggested. This could include

establishing independent Financial Institution specializing in Murabaha financing or

debt financing in general, whereby they have complete possession of commodities

and trading facilities that enables them to purchase the subject matters. This new

mechanism will enable the separation of trading and financing activities which is the

key solution for the current malpractices. (Ahmad, 2005).

5. Economic Effect Of Untreated Practices

It is pertinent to look into the effect of these untreated practices and issues raising from

abuse of Murabaha products. This will enable us to have a clear idea of the economic as

well as financial dimention of the current situations. Summarized below are the main

negative effects economists believe that is being caused as a result of abuse of Murabaha.

Effect on Economy:

1- Promoting Consumerism: amounting to more than 80% of Islamic Banks resources,

and being an instrument for debt financing, this huge fraction reflects how much

people are seeking debts for financing for things regardless the level of their need and

affordability. Just like in the conventional system, opening the door and giving easy

access for debt financing proved to promote consumerism among the society.

2- The excessive use of murabaha, just like the interest-bearing loans- has pushed

people to be indebted which may eventually lead to higher levels of bankruptcy and

insolvency. Despite the fact that there are credit assessments that are undertaken, this

is one of the main reasons why scholars such as imam hanbal have criticized those

who depends on defer payment sales.

3- The spread of Murabaha as a way of financing debt have significantly caused the lack

of Benevolent loans, this is because to the rather higher profitability of murabaha.

This is bad because the original concept of debt financing in true Islamic practices is

through benevolent loans.




4- The strong reliance on Murabaha as a financial instrument has significantly reduced

the amount of Investments that are undertaken through Sharika, which is, despite the

fact that is productive rather than consumptive, bears greater risk, which has caused

investors to stick to murabaha since it is deemed to be more secured and a safer

contractual arrangement.

5- Murabaha, in its contemporary practices is most likely to widen the income gap,

leading the rich people to become richer and poor people will be poorer, this is mainly

due to the nature of facilitating credit by banks, who are more likely to accept

financing people who the bank feels safe about their ability of paying back.

Ironically, the aforementioned reasons are among the main causes that have lead to the

financial crisis in 2008, which Islamic Finance claim to be immune to. This indeed puts

further emphasis on the need to shedding light upon new financial products and new

mechanism to be adopted by Islamic Financial Institutions to fulfil greater economic

development and interests.

6. Conclusion:

Despite the fact that Murabaha through all the ways that is has been practiced have

contributed prominently to the growth of Islamic Finance throughout the past years, it

was built to be a powerful tool that had so many uses ranging from Securitization

(Tawarruq), Liquidity absorption by Central Banks, risk mitigation tools for financial

institutions, debt financing for business, car and house financing for individuals..etc,

however, the current contractual arrangements involving murabaha in practice has

developed many loopholes that very little effort have been done to treat, this have caused

many problems and doubts, furthermore it have developed the practices that is said to be

what have caused the financial crisis of 2008. This have caused prominent scholars to call

for a switch in the products currently used in the industry, or at least treating the existing

doubtful practices through introducing new mechanisms. Nevertheless, it is hoped that

economist will start considering indulging more productive contractual arrangement in

financing activities by means of equity financing.

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Academy 1985-2000. Jeddah: Islamic Research and Training Institute, Islamic Development

Bank.

Ahmad, P. D. (2005). Islamic Banking Modes of Finance: proposals for further Evolution.

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Al-Qaradawi, Y. (1995). Murabaha Sale bu the Order of Purchaser and its Application in

Islamic Banks in The Light of Tests and Legal Maxims.

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muenchen.de/id/eprint/20262

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Khan, M. C. (2000). Regulation and Supervision of Islamic Banks. Jeddah: Islamic Research

and Training Institute, Islamic Development Bank.

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publication Sdn Bhd.

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Publishing Limited.




Determinants of board size and independence during the Chinese

state enterprises reform: A comparison between controlling

shareholder categories

Zhang Cheng

(Corresponding author)

Institute of Graduate Studies,

University of Malaya, 50603 Kuala Lumpur, Malaysia


Phone: 006+0108924719

Cheong Kee Cheok

Department of Economics, Faculty of Economics and Administration,



Abstract:

The role a corporate board played in corporate governance is a controversial topic. China’s case is made more

complex by the fact it is undergoing economic transition during the past 3 decades, which created additionally a

situation of tension between government control and private sector preeminence. This study focuses on the

determinants of board size and board independence for firms with different categories of controlling shareholders

and in different stages of state enterprises reform. The study selected 439 firms that are listed in Chinese domestic

stock markets during the periods between 2000 and 2012. The fixed effects regression was applied in this study to

test the relationships between Chinese specific corporate governance mechanisms and corporate board size and

independence. The results show that the determinants of Chinese board size and independence vary across different

controlling shareholder categories. These corporate governance mechanisms can take the place of the corporate

board. Specifically, a supervisory board can substitute board independence in central government controlled firms,

while CEO duality, ownership concentration and state ownership can be substitutes for board size and

independence in local government and state enterprise entity controlled firms. Tradable shares lead to a larger and

independent board in all firms except for central government controlled firms. Taken together, this study does not

support the widespread belief that state ownership or control is detrimental to firm performance. Rather the state

can help in mornitoring managerial behavior and improve corporate governance practice.

Key words: Board composition, Corporate governance, Split share structure reform, Controlling

shareholders

JEL codes: G380, G340






1. Introduction

Corporate boards are at the center of corporate governance, with board size and composition

figure prominently in governance reform. Yet little conclusive evidence exists as to what

determines board size and independence, and their impact on corporate governance. On the

determinants of board composition, some scholars hold the view that board size and board

independence are primarily determined by the CEO’s bargaining power with the rest of the

directors (Iwasaki, 2008, Arthur, 2001, Hermalin and Weisbach, 1998, Combs et al., 2007).

Others argue that board size and board independence are endogenously determined by firm

specific characteristics and the tradeoff between the cost and benefit of the board’s monitoring

(Boone et al., 2007, Linck et al., 2008, Lehn et al., 2009).

If there is no agreement even in situations in which the private economy is dominant, arriving at

any definitive conclusion is even more difficult in China, where economic transition has created

a situation somewhere between government control and private sector preeminence. This

situation is the product of the state enterprises reform (Chen et al., 2006). Arguably the most

important of these reforms is the so-called “split-share reform” of 2005. This reform was aimed

at revitalizing the depressed Chinese financial market caused by the split-share structure, before

the reform, less than one third of the total number of shares were tradable with the rest non-

tradable. The reform converts non-tradable shares to tradable ones.

Understanding corporate board governance before and after this reform is important in its own

right but also because it speaks to the efficiency of these reforms. Beyond these specific issues,

the importance of China’s enterprise sector derives from its rapidly growing size, exemplified by

it counting some of the largest companies in the world (i.e. China Sinopec, State Grid

Corporation of China etc.).

Within the above framework, the specific objectives of this study are to: (1) examine and

compare the determinants of board size and board independence before and after the reform, and

(2) compare how these determinants vary across different categories of controlling shareholders.

This comparison has hitherto not been made; Chen and Al-Najjar (2012)’s work was based on

1999 to 2003 data, i.e. before the reform took place. This study contributes to existing literature

by analyzing the influence of Chinese specific corporate governance mechanisms on Chinese

board structure in different controlling shareholder categories and in different stages of state

enterprises reform.

The structure of this paper is as follows. Section 2 is a brief literature review. Section 3 is the

review of China’s enterprise system and split-share structure reform. Section 4 is the explanation

about methodology and data. Section 5 is about empirical analysis. Section 6 is the conclusion

part of this study. Section 7 lists the references of this study.




2. Brief Review of Related Literature

Literature regarding agency theory, resource dependent theory and power circulation theory

constitute the theoretical basis for the determinants of board composition. The agency theory

proposed that the main function of the corporate board is to monitor managers on behalf of

shareholders, so that corporate board size and board independence is determined by the tradeoffs

between the cost and benefit of board monitoring. The cost of monitoring refers to information

transferring and processing cost that directors spend to transfer their expertise to the firm as well

as the direct cost such as director’s compensation. The benefit of monitoring refers to the

manager’s potential private benefit that may be extracted from the firm. The resource dependent

theory argued that the main function of corporate board is to provide resources and advices

needed for the firm’s daily operations. Therefore, board composition is determined by the

resources and advice needed for a firm’s daily operations. Larger firms with wider scope of

operations tend to have more independent directors, since larger firms face more serious agency

problems and needs more information than smaller firms. The power circulation theory

emphasized that CEOs may face power contests with rival executives and outside directors.

Thus, board composition is driven by CEO’s bargaining power with the rest of directors in the

board (Boone et al., 2007, Combs et al., 2007). Arthur (2001) opines that board composition is

actually a bargain between the CEO and the rest directors on the board. Combs et al. (2007)

argue that shareholders are concerned about board composition when the CEO is powerful

because the CEO might use that power to pursue his own interests at the expense of

shareholders’ interests. Finkelstein and D'Aveni (1994) propose that CEO duality promotes CEO

expropriation activities by reducing the effectiveness of board monitoring.

As for empirical studies across different regions, the UK’s board composition is found to be less

determined by the monitoring related factors (Guest, 2008). Russia’s board composition is high

related to the bargaining variables (Iwasaki, 2008). Malaysia’s board composition is driven by

the scope of operations and monitoring factors (Germain et al., 2014). Board composition in

Taiwan is highly influenced by CEO characteristics and government regulations (Chen, 2014).

3. China’s enterprise system and split share structure reform

China’s enterprise system is different from that in other countries in that it started from a

situation in which all enterprises were state-owned. A series of enterprise reforms then relaxed

state ownership while retaining a degree of control. Under the strategy of “retaining the large and

releasing the small”, the Chinese government identified about 100 strategic enterprises for full

government ownership but allowed varying degrees of privatization for other state enterprises

not so classified (Jefferson and Su, 2006). These reforms have produced enterprises with links to

the state that defy easy identification (Liao et al., 2014). Nevertheless, according to the China

Securities Regulatory Commission (CSRC), the ultimate controlling shareholders are the

investors who, i) hold directly or indirectly 50% of the total outstanding shares, ii) control




directly or indirectly 30% of total voting rights, iii) can use the voting rights to select more than

50% of board directors, iv) have significant influence over the decision making in shareholder’s

meeting, v) other situations recognized by CSRC.

3.1 Ultimate controlling shareholders in China

Based on the above definition, four types of enterprises can be distinguished: i) Marketized state-

owned enterprises (SOEs) owned by SOE entities (SOCF), Such as China National Petroleum

Corporation, China Power Investment Corporation and Sinosteel Corporation. ii) SOEs affiliated

to the central government agencies (CGCF), central state assets management bureaus and state

council, such as China Great Wall Computer Shenzhen Company Limited, China Merchants

Property Development Company Limited. iii) SOEs affiliated to local government agencies

(LGCF), local state assets management bureaus and local government, such as Guangzhou

Automobile Group Company Limited, Shanghai Pharmaceuticals Holding Company Limited. iv)

Firms controlled by individuals (PCF), such as Suning Commerce Group Company Limited,

Zhejiang Busen Garments Company Limited.

CGCFs are the focus of Chinese economic reform and are strictly monitored by central

government (Xu et al., 2006). Their CEOs and chairmen are usually carefully selected by the

central government and must have the motivation to perform well since most of them are in line

to be promoted to the rank of Minister (Chen et al., 2009). LGCFs are less monitored by central

government, since the further away the region is from the Chinese Communist Party’s power

center (Beijing), the harder it is for the central government to enforce its regulations (Chen et al.,

2009). Local governments do have the right to set their own regulations in order to manage local

state assets (Lipinga et al., 2006).

Both CGCFs and LGCFs are less likely to be totally profit oriented, since the officials of Chinese

government agencies are public servants, their promotion depends on how well they implement

government instructions and receive fixed salaries. Even though they have the right to select

managers, directors and approve the investment plans proposed by the management, as

government officials, they are prohibited from involving in firm management directly. They also

have no residual cash flow rights, with all the dividend revenues submitted to the Minister of

Finance. Therefore, the main agency problems of government controlled firms are between

controlling shareholders and minority shareholders (Berkman et al., 2012).

In contrast, SOCFs are more likely to pursue profitability and enjoy a degree of autonomy. They

can retain their after-tax profits. Managers typically receive explicit monetary rewards based on

firm performance, hence the incentive compensation mitigated the agency problems between

controlling shareholders and minority shareholders (Berkman et al., 2012).

PCFs are firms controlled directly by individuals and only existed after the “opening-up”

launched in1978. They resemble their counterparts in developed countries in many ways and are

more likely to be market oriented and commercially motivated (Wei et al., 2014). The




government has limited supervisory power over PCFs. PCFs are more likely to maximize

shareholder wealth since they would select a management team mainly based on its ability to

maximize shareholder’s wealth (Berkman et al., 2012).

3.2 Split share structure reform

The split-share structure reform in 2005 is an important milestone of Chinese state enterprise

reform since it converted non-tradable shares, which accounted for more than two thirds of the

total shares, into tradable shares that permitted more private ownership of Chinese state

enterprises. Before the reform, the main agency problem was between the controlling (state)

shareholders and minority (non-state) shareholders, who had limited power to influence the

management of firms (Yeh et al., 2009). Managers had little incentive to work hard because the

government paid their fixed salaries. Further, the state had motives like political stability,

regional and macroeconomic advancement rather than to protect the interests of tradable

shareholders whose only objective was wealth creation (Hou and Lee, 2012, Jiang et al., 2008).

Third, Chinese laws and regulations protecting the interests of shareholders were only upgraded

gradually. For example, The Guidelines for Introducing Independent Directors to the Board of

Directors of Listed Companies (The guidelines for independent directors) was issued by CSRC

in August 2001 and stipulated that listed firms must have at least one third of board members

who are independent directors by the end of June 2003 (Shan and Round, 2012). The Code of

Corporate Governance for Listed Companies in China was established in January 2002 with the

aim to protect the interests of minority shareholders. The result has been considerable

unhappiness among private investors in listed firms. However, on 29 April 2005, CSRC made

the decision to convert non-tradable shares into tradable shares. As a result, the conflicting

interests between tradable shareholders and non-tradable shareholders were minimized (Guo and

Keown, 2009). Chinese listed firms face more monitoring from outside tradable shareholders

than before.

4. Methodology and Data

4.1 Variables and models

The determinants of board size and board independence investigated in this study are important

corporate governance variables and firm specific character variables that are frequently

examined in the determinants of board composition studies conducted both in other countries and

in China (Boone et al., 2007, Chen and Al-Najjar, 2012). While different from studies in other

countries, this study tested some corporate governance variables that are specific to China,

namely high state ownership, high ownership concentration, use of a two-tier board structure, the

existence of a split-share structure including both tradable shares and non-tradable shares, as well

as having CEOs with dual positions in the firm (Oliver et al., 2014).




In this study, Board size refers to the total number of directors nominated to the corporate board

including both executive directors and non-executive directors. Board independence is the

percentage of independent directors on the corporate board. While, according to the Guidelines

for establishing independent directors of listed companies, independent directors are those who

hold no other positions in the company and have no relationships with its major shareholders that

may affect its independent judgment. Independent director is an important monitoring

mechanism to guard against a manager’s self-serving behaviors.

Supervisory board size (Supervisory Size) refers to the number of directors in the supervisory

board. China adopted a two-tier board structure that includes a main board of directors and a

supervisory board. The main function of the supervisory board is to monitor the main board and

give advice on the board’s operations (Xiao et al., 2004). The supervisory board has the right to

propose the dismissal of board directors and top managers, as well as to curb directors’ and top

managers’ compensation (Ding et al., 2007). The supervisory board should consist of at least

three persons including representatives of employees and shareholders, but managers, directors

and financial controllers are not qualified (Oliver et al., 2014). Besides, supervisory board was

set up to make up for the deficiencies of board of directors due to its lack of independence since

the CEO may be the chairman of the board as well. As a result, this study predicts that a large

board size will need a large supervisory board size to monitor it. Given that the monitoring role

played by the supervisory board is similar to the monitoring role played by independent

directors, firms with a larger supervisory board do not need to rely on independent directors.

CEO duality (Duality) represents a CEO’s bargaining power over board composition. It is

measured by a dummy variable equal to 1 if CEO and chairman of the board are assumed by the

same person (Finkelstein and D'Aveni, 1994). Eventhough CEO duality may lead to a strong

leadership and fast decision making, there is a trend in which the positions of CEO and board

chairman are being seperated gradually in China, since it can provide for more effective

monitoring and constrains on CEO’s self-serving behaviors (Yang et al., 2011). According to the

power circulation theory, top management keeps shifting the coalition and power struggle, CEO

tends to use his power to form a dominant board composition with loyal inside directors rather

than outside independent directors to avoid power contest with their rivals (Combs et al., 2007).

This study predicts that when the CEO is also the chairman of the board, he or she has more

bargaining power over board composition in the firm to safeguard his own interests (Iwasaki,

2008). As a result, board size tends to be smaller and the number of independent directors tends

to be less.

Percentage of tradable shares (Tradable) is an indicator of the degree of a firm’s privatization

measured by percentage of total shares that allowed to be traded freely. Tradable shares represent

the interests of Chinese domestic investors. In contrast, non-tradable shares represent the

interests of government. Yeh et al. (2009) opined that the split share structure reform in 2005 had

alleviated the horizontal agency problem between non-tradable shareholders and tradable

shareholders because tradable shareholders were given the opportunity to have a voice in

corporate decision-making. Due to the alleviation of the agency problems with the increase in

tradable shares, this study predicts that an increase in tradable shares may lead to a decrease in




board size and board independence, because board monitoring is less important when there is no

serious agency problem.

Ownership concentration (Concentration) is an important Chinese corporate governance

mechanism measured by the sum of the percentage of shares owned by top 10 largest

shareholders. When ownership is highly concentrated in the hands of a few large shareholders,

minority shareholders find it costly to monitor the behavior of management. As a result, large

shareholders who have more interests in the corporation, will assume more responsibilities in

monitoring its management (Shleifer and Vishny, 1997). In addition, ownership concentration

would put constraints on CEO’s self-serving behaviors. In China, large shareholders have always

involved themselves in major corporate decision-making and managerial processes (Gul et al.,

2010). Thus, the main agency problem under concentrated ownership structure is between large

shareholders and minority shareholders (Yang et al., 2011). Hence, this study predicts that

ownership concentration is a substitute monitoring mechanism for board of directors, thus, board

size and board independence would be reduced with an increase in the degree of ownership

concentration.

State Ownership (State Ownership) is another Chinese corporate governance characteristic.

Since China followed the path of partial privatization, state ownership was retained in the firms

to allow the government to intervene when there is a need to do so. State ownership represents

the overall property of Chinese citizens; therefore, the purpose of state ownership is not solely

related to profit maximization as pursued by other shareholders. The dominance of state

ownership may lead to the divergence of capital resources for non-profit uses, causing insider

control problems since it lacks effective external monitoring over management. While the

controlling power would ultimate fall into the hands of directors and managers who bear minimal

risk of their decisions and free from market disciplines (Oliver et al., 2014, Tian and Estrin,

2008). Due to the inefficiency of state ownership, CEOs in firms with high state ownership are

easy to add inside directors and keep the board smaller and less independence to facilitate them

in their pursuit of self-interests.

A number of other variables help explain board size and independence. Thus

ROA and Tobin Q (Tobinq) are measures of a firm’s accounting and market performance

representing the resources and advice needed from corporate board, since better firm

performance tends to have a larger and more independent board (Jackling and Johl, 2009). Firm

size (Logassets) and firm age (firmage) are firm characteristic variables measured by natural

logarithm of total assets and number of years since the firm was established.




The equation can be elaborated below:

(1)

it 1 it 2 it 3 it 4 it 5

6 it 7 it 8 it 9 it i it

Board Size = + upervisory Size + + + 10 + State Ownership

+ + + +

itS Duality Tradable Concen

FirmSize FirmAge ROA Tobinq

(2)

it 1 it 2 it 3 it 4 it 5

6 it 7 it 8 it 9 it i it

Board Independence = + upervisory Size + + + 10 + State Ownership

+ + + +

itS Duality Tradable Concen

FirmSize FirmAge ROA Tobinq

4.2 Data and Model Robustness

Data pertinent to this study were collected from a sample of firms listed on the Shanghai and

Shenzhen Stock Exchanges. There were 439 non-financial firms selected during the period

between 2000 and 2012. Firms not continuously listed during this period were excluded from the

sample. Based on the ultimate controlling shareholder, the sample was also divided into several

subsamples made up of firms controlled by SOE entities (SOCF), by private investors (PCF), by

local government (LGCF) and by central government (CGCF). In addition, since the split share

structure reform took place in 2005, the subsamples used in this study were further divided into a

‘before reform’ subsample (from year 2000 to 2004) and a ‘after reform’ subsample (from year

2005 to 2012). All of the financial data and corporate governance data used in this study are

available in the companies’ annual reports collected by the China Stock Market and Accounting

Research Database and CCER database developed by GTA Information Technology Company

Limited and SinoFin Financial Information Company Limited. The descriptive statistics for the

data during these periods are shown in Table 2 in the appendix.

The models above can be estimated by both fixed effects and random effects. Fixed effects

assumed that each firm’s individual effects are correlated with the independent variables, while,

random effects assumes that the individual effects are not correlated with the independent

variables. According to the Hausman test, the difference of the regression coefficients between

fixed effects and random effects is systematic, suggesting that fixed effects is more useful than

random effects (Baltagi et al., 2003) Thus, the models are estimated by fixed effects in this study

and shown in Table (1a) and Table (1b).

To check the robustness of the models, this study conducted a bivariate correlation analysis and

found that the variables in the model are independent of each other, the highest correlation being

0.549 between state ownership and tradable shares, suggesting that there are no strong

relationships among independent variables in the model. This study also checked the variance

inflation factor (VIF) to make sure that there was no multicolinearity problem. Besides, the

Chow test for structure break suggested that there is a structure break between each subsample.




Table (1a) Determinants of Board Size

SOCF PCF LGCF CGCF Full Before After

Supervisory

Size 0.373*** 0.604*** 0.444*** 0.901*** 0.469*** 0.551*** 0.394***

(5.33) (10.56) (9.71) (10.48) (15.53) (14.86) (7.75)

Duality -0.235 -0.532*** -0.408** -0.0439 -0.292*** -0.202* -0.375**

(-1.29) (-4.76) (-2.76) (-0.17) (-3.70) (-2.37) (-2.70)

Tradable 0.463 0.668*** 0.901*** 0.427 0.566*** -0.0819 0.530*

(1.95) (3.51) (3.61) (0.72) (5.01) (-0.50) (2.32)

Concentration -1.929** -0.683 0.861* 0.0810 -0.165 0.182 -2.168*

(-2.74) (-1.90) (2.27) (0.12) (-0.69) (0.78) (-2.40)

State

Ownership -0.433 1.441*** -0.810** -0.359 -0.208 -0.105 -0.360

(-1.52) (4.00) (-2.94) (-0.73) (-1.60) (-0.64) (-1.18)

Firm_age -0.0392* -0.0167 0.00456 -0.0286 -0.0264*** -0.0431** -0.0183

(-2.39) (-1.16) (0.31) (-0.90) (-3.58) (-2.98) (-0.79)

Firm_size 0.0820 0.652*** 0.324** -0.735*** 0.226*** 0.134 0.137

(0.74) (6.10) (3.05) (-4.67) (3.91) (1.22) (1.59)

ROA -0.108 -0.0680 0.0398 0.757* -0.0295 0.0544 0.000423

(-1.07) (-0.60) (0.29) (2.15) (-0.45) (0.54) (0.01)

Tobinq -0.129* 0.0166 -0.0606 0.0830 0.000185 0.00225 -0.107*

(-2.30) (0.79) (-1.71) (1.25) (0.01) (0.16) (-2.03)

_cons 9.123*** 0.756 4.046*** 13.12*** 5.607*** 6.339*** 8.152***

(7.96) (0.82) (4.03) (8.61) (10.42) (6.85) (7.78)

N 1720 1444 1993 500 5657 3054 2603

R2 within 0.0292 0.1729 0.085 0.3114 0.0766 0.0962 0.0355

R2 between 0.059 0.1401 0.1791 0.0075 0.1897 0.1952 0.1192

R2 overall 0.0635 0.1456 0.1726 0.0325 0.1435 0.1774 0.0887

t statistics in parentheses

* p < 0.05, ** p < 0.01, *** p < 0.001

Table (1b) Determinants of Board Independence


Supervisory

Size

0.00325 -0.00180 -0.00352 -0.0120*** -0.000945 -0.00594*** -0.00167




(0.72) (-0.52) (-1.31) (-3.69) (-0.54) (-4.08) (-0.60)

Duality 0.00342 -0.00607 -0.0220* 0.0201* -0.00447 0.00655 0.000454

(0.29) (-0.89) (-2.53) (2.05) (-0.98) (1.96) (0.06)

Tradable 0.286*** 0.142*** 0.213*** -0.0334 0.233*** -0.00771 0.0417***

(18.62) (12.29) (14.52) (-1.49) (35.68) (-1.20) (3.32)

Concentration -0.0651 -0.0917*** -0.104*** -0.00618 -0.0978*** -0.00175 -0.192***

(-1.43) (-4.19) (-4.64) (-0.25) (-7.10) (-0.19) (-3.89)

State

Ownership

-0.00522 0.0384 -0.0436** 0.0449* -0.0280*** 0.00988 -0.00884

(-0.28) (1.75) (-2.69) (2.41) (-3.72) (1.53) (-0.53)

Firm_age 0.0337*** 0.0223*** 0.0257*** 0.00293* 0.0300*** 0.00180** 0.0670***

(31.79) (25.49) (30.09) (2.43) (70.37) (3.17) (52.87)

Firm_size -0.00760 -0.00145 -0.0260*** 0.00620 -0.0143*** 0.0146*** -0.0000985

(-1.07) (-0.22) (-4.16) (1.04) (-4.27) (3.37) (-0.02)

ROA -0.0223*** 0.00433 -0.0230** -0.0104 -0.00896* 0.00134 -0.0103*

(-3.41) (0.63) (-2.88) (-0.78) (-2.38) (0.34) (-2.23)

Tobinq -0.0301*** -0.00200 -0.0107*** -0.00309 -0.00727*** 0.000642 -0.0161***

(-8.26) (-1.56) (-5.14) (-1.23) (-7.31) (1.15) (-5.56)

_cons -0.0735 0.0417 0.259*** 0.311*** 0.0531 0.216*** -0.234***

(-0.99) (0.74) (4.39) (5.41) (1.71) (5.94) (-4.08)

N 1720 1444 1993 500 5657 3054 2603

R2 within 0.546 0.3623 0.3422 0.1262 0.526 0.0468 0.6742

R2 between 0.1396 0.0274 0.1135 0.0008 0.0025 0.0084 0.0011

R2 overall 0.2964 0.1191 0.1211 0.0217 0.2213 0.019 0.1307

t statistics in parentheses

* p < 0.05, ** p < 0.01, *** p < 0.001

5. Empirical findings

Summary of Empirical Findings of Table (1a) and Table (1b)


BS BI BS BI BS BI BS BI BS BI BS BI BS BI

Supervisory

Size P P P P N P P N P

CEO duality N N N

Tradable P P P P P P P P




Concentration N N N N

State Ownership P N N

P represents positive relationship.

N represents negative relationship.

BS represents board size.

BI represents board independence.

5.1 Supervisory board

The results suggest that a larger board size needs a lager supervisory board to monitor its

behaviors. It can be a substitute for the monitoring role played by independent directors only

when the government supervision is strong or when the importance of independent directors has

not been emphasized by CSRC. This study found that supervisory board size is a positive

determinant of board size in all firms since the main function of supervisory board is to monitor

the main board and the management (Oliver et al., 2014). As for its relationships with board

independence, even though the functions of supervisory board and independent directors are

similar, the supervisory board cannot be a substitute for the function played by independent

directors completely with respect to different controlling shareholders. A supervisory board can

be a substitute for independent directors in CGCFs, where government supervision is strong. In

addition, it can also be a substitute for independent directors before the split-share structure

reform when CSRC regulations towards hiring independent directors have not been strengthened.

5.2 CEO duality

A CEO who is also the chairman of the board finds it easier to reduce the number of rivals

among inside directors who can challenge his power and question his interests. He can hardly

reduce the number of independent directors since their percentage on the board is a requirement

decided by CSRC. This study found that CEO duality could influence board size significantly

rather than board independence. Besides, CEO’s bargaining power over smaller board size is

only significant in LGCFs and PCFs where government supervision is weak. This is because

local government is geographically far from the Chinese central government power center

(Beijing) (Cheng et al., 2009). CEOs find it easier to bargain for a smaller board size to seek

their own benefit. Besides, CEOs in PCFs usually have close relationships with large

shareholders, or even appoint themselves the chairman of the board, thus giving themselves more

bargaining power over a firm’s corporate board composition.

5.3 Tradable shares

The influence of tradable shares over board size and board independence tends to be positive in

all firms except for CGCFs, where government supervision is strong. This suggest that a larger




and more independent board is needed to represent and protect tradable shareholder’s interests,

since a larger and more independent board can provide more resources and advice needed for a

firm’s daily operations and can monitoring the management behaviors well (Boone et al., 2007).

However, CGCFs are less likely to be totally market oriented and the agency problems between

the controlling shareholders and minority shareholders are serious (Berkman et al., 2012),

therefore, tradable shareholders have limited influence over corporate board composition. In

addition, tradable shareholders’ influence over board independence is more pronounced after the

split-share structure reform, since they have been given an opportunity to have a voice for their

own benefit (Yeh et al., 2009).

5.4 Ownership Concentration

Ownership concentration is another important corporate governance mechanism that tends to

serve as a substitute for the monitoring role played by independent directors. The reason is that

when ownership is highly concentrated in the hands of a few large shareholders, minority

shareholders would find it costly to monitor managerial behavior and large shareholders

undertake most of the monitoring activities. However, the independent director’s monitoring role

can only be a substitute for ownership concentration in PCFs and LGCFs, where government

supervision is weak. Since under concentrated ownership structure, large shareholders usually

involve themselves in corporate decision-making and managerial process, and minority

shareholder’s interests could be expropriated easily without government supervision (Gul et al.,

2010).

5.5 State Ownership

The influence of retained state ownership on board composition largely depends on whether the

influence of ownership rights can be subsumed under control rights. State ownership has more

influence over PCFs and LGCFs where government’s supervision is weak. It is less influential

over CGCFs and SOCFs since state interests can be protected through the controlling rights and

not just through the ownership rights. Specifically, it leads to a larger board size in PCFs but a

smaller board size in LGCFs. This is because a smaller and less independent board is easier for

the state to extract benefits from LGCFs. When it comes to the PCFs, state ownership tends to

lead to a larger board size, because PCFs are less concerned about the state interests compared

with LGCFs, and therefore a larger board is easier for state to protect their benefits.

6. Conclusion

Chinese corporate governance has its own characteristics that differ from other contries. The

variables tested in this study represent these specific characteristics, they are state ownership,

ownership concentration, a two-tier board structure, a split-share structure and CEO with dual




positions. These characteristics are found to be significant determinants of Chinese board size

and independence. At the same time, China was undergoing economic transition, with reforms

leading to the establishment of listed firms being contolled by different shareholder categories.

This study finds that the influence of these specific corproate governance mechanisms on

corporate board composition varies accross different controlling shareholders. Supervisory board

plays a monitoring role as substitutes for independent directors (Chen and Al-Najjar, 2012), only

when government’s supervision power is strong. As for Ownership Concentration, CEO duality

and state ownership, which represents the interests of large shareholders, CEO’s bargianing

power and the state tend to substitute the governance role played by corporate board only when

government supervison power is weak. In contrast, tradable shares that represent the interests of

Chinese domestic investors can only extert their influence on corporate board composition when

government supervision is weak.

What do the above results reveal about China’s corporate governance, more specifically the role

of state played in corporate governance? First, in the absence of a full market economy,

alternative corporate governance mechanisms for monitoring a firm’s management and

performance has a place and can take the place of corporate board. Second, the closer the

government supervises, the less likely these alternative mechanisms substitute corporate board.

Third, these results obtained based on data colledted from publicly listed firms, suggesting that

the government strategy of listing is an effective means to achieve solid corporate governance.

Finally, the split share structure reform has a positive impact on corporate governance and

represents an important step in China’s reform of its corporate sector.

Taken together, these findings do not support the widespread belief that state ownership or

control is necessarily detrimental to firm performance (Tian and Estrin, 2008, Yang et al., 2011).

However, it is accepted that the retained state ownership send a signal to the public that the state

will not expropriate shareholder’s wealth, it plays an active role in supervising management

behaviors and improving corporate governance (Sun and Tong, 2003). In addition, future studies

can explore in detail other controlling shareholders, such as foreign and institutional

shareholders. Since with the continuing reformation of Chinese state enterprises, diversified

ownership structure will be introduced to financially support firm’s development.

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Appendix:

Table2: Descriptive Analysis

Full (Year 2000 to 2012 )

Variable Obs Mean Std. Dev. Min Max

Board Size 5685 9.327 2.185 3.000 19.000

Board Independence 5685 0.294 0.130 0.000 0.730

Supervisory Size 5685 4.070 1.303 0.000 11.000

Duality 5687 0.113 0.317 0.000 1.000

Concentration 5701 0.568 0.146 0.103 1.000

Tradable 5707 0.372 0.233 0.000 1.000

State ownership 5707 0.264 0.257 0.000 0.886

Firm_age 5707 12.217 4.961 1.044 28.608

Firm_size 5707 9.344 0.518 7.562 11.702

ROA 5706 0.018 0.296 -16.112 8.183

Tobinq 5707 1.636 1.342 0.000 44.530

SOCF

Board Size 1731 9.73 2.34 4.00 19.00



Duality 1736 0.101 0.302 0.000 1.000

Concentration 1741 0.422 0.187 0.000 0.886

Tradable 1735 0.614 0.131 0.208 1.000

State ownership 1741 0.394 0.250 0.000 0.886

Firm_age 1741 9.335 4.568 1.044 26.145

Firm_size 1741 9.281 0.475 7.640 11.702

ROA 1741 0.014 0.400 -16.112 0.634

Tobinq 1741 1.510 0.767 0.000 9.361

PCF




Board Size 1446 8.57 1.99 3.00 17.00



Duality 1449 0.154 0.361 0.000 1.000

Concentration 1450 0.350 0.242 0.000 1.000

Tradable 1450 0.521 0.148 0.103 1.000

State ownership 1450 0.048 0.116 0.000 0.740

Firm_age 1450 14.027 4.845 1.214 28.416

Firm_size 1450 9.176 0.489 7.578 11.558

ROA 1449 0.026 0.295 -6.069 8.183

Tobinq 1450 1.970 2.150 0.000 44.530

LGCF

Board Size 2006 9.44 2.08 5.00 18.00



Duality 2002 0.109 0.312 0.000 1.000

Concentration 2014 0.353 0.247 0.000 0.886

Tradable 2014 0.561 0.141 0.135 1.000

State ownership 2014 0.301 0.242 0.000 0.850

Firm_age 2014 12.942 4.447 1.510 26.030

Firm_size 2014 9.441 0.488 7.562 11.649

ROA 2014 0.015 0.210 -6.338 0.514

Tobinq 2014 1.502 0.946 0.000 15.656

CGCF

Board Size 502 9.66 2.05 5.00 15.00



Duality 500 0.054 0.226 0.000 1.000

Concentration 502 0.336 0.262 0.000 0.850

Tradable 502 0.578 0.158 0.219 1.000

State ownership 502 0.291 0.250 0.000 0.850

Firm_age 502 14.074 4.076 4.589 28.608

Firm_size 502 9.664 0.623 7.599 11.659




ROA 502 0.020 0.121 -2.380 0.208

Tobinq 502 1.642 1.025 0.585 9.371

After

(Year 2005 to 2012)

Board Size 3061 9.168 1.980 4.000 18.000



Duality 3067 0.112 0.315 0.000 1.000

Concentration 3073 0.533 0.149 0.120 1.000

Tradable 3073 0.272 0.241 0.000 0.903

State_hold 3073 0.168 0.218 0.000 0.812

Firm_age 3073 15.219 3.821 7.047 28.608

Firm_size 3073 9.471 0.540 7.578 11.514

ROA 3073 0.031 0.170 -2.746 8.183

Tobinq 3073 1.811 1.692 0.477 44.530

Before

(Year 2000 to 2004)

Board Size 2624 9.512 2.390 3.000 19.000



Duality 2620 0.115 0.319 0.000 1.000

Concentration 2628 0.610 0.131 0.103 0.950

Tradable 2634 0.488 0.156 0.000 1.000

State ownership 2634 0.377 0.254 0.000 0.886

Firm_age 2634 8.715 3.676 1.044 21.603

Firm_size 2634 9.197 0.449 7.562 11.702

ROA 2633 0.002 0.394 -16.112 0.514

Tobinq 2634 1.431 0.698 0.000 10.172

Table 3: Correlation Metrix

Board Size

Board

Independence

Supervisory

Size Duality Concentration Tradable

State

Ownership Firm_age Firm_size ROA

Board Size 1




Board

Independence -0.132 1

Supervisory

Size 0.336 -0.099 1

Duality -0.077 -0.005 -0.063 1

Concentration 0.103 -0.163 0.094 -0.104 1

Tradable 0.095 -0.112 0.054 -0.030 0.376 1

State

Ownership 0.138 -0.244 0.178 -0.072 0.406 0.549 1

Firm_age -0.102 0.457 -0.060 0.055 -0.412 -0.459 -0.497 1

Firm_size 0.220 0.186 0.129 -0.075 0.094 -0.147 -0.007 0.167 1

ROA 0.002 0.010 0.003 0.001 0.012 -0.022 -0.024 0.023 0.082 1

Tobinq -0.105 0.003 -0.076 0.065 -0.122 -0.192 -0.164 0.125 -0.262 -0.034

Table (4a). Chow Test for structure break of board size in different subsamples

Coef. Coef. Coef. Coef. Coef.

Supervisory

Size 0.50318***

Supervisory

Size 0.51465***

Supervisory

Size 0.55603***

Supervisory

Size 0.49955***

Supervisory

Size 0.5241***

Duality -0.2598*** Duality -0.201*** Duality -0.4198*** Duality -0.1645 Duality 0.01602

Concentration 0.1971 Concentration 0.31374 Concentration 0.12641 Concentration 0.81931*** Concentration 0.19882

Tradable 0.65162*** Tradable 0.52166*** Tradable 0.13747 Tradable 1.20959*** Tradable 1.01779***

State_hold 0.64178*** State_hold 0.22968*** State_hold 0.54703*** State_hold -0.9452*** State_hold 0.05809

LGCF*

Supervisory

Size 0.04905

CGCF*

Supervisory

Size 0.03264***

SOCF *

Supervisory

Size -0.0977***

PCF *

Supervisory

Size 0.01826

dumASP*

Supervisory

Size 0.00699

LGCF*

duality 0.02617

CGCF*

duality -0.9847***

SOCF*

duality 0.52949***

PCF*

duality -0.2287

dumASP*

duality -0.4907***

LGCF*

tradable 0.59111***

CGCF*

tradable 1.60063***

SOCF*

tradable 1.24805***

PCF*

tradable -0.6818***

dumASP*

tradable -1.3074***

LGCF*

Concentration 0.44575

CGCF*

Concentration 0.58515***

SOCF*

Concentration 0.95942***

PCF*

Concentration -1.4281***

dumASP*

Concentration 0.50568

LGCF*

state_hold -1.963***

CGCF*


SOCF*


PCF*

state_hold 2.15096***

dumASP*

state_hold 0.96765***

_cons 6.76162*** _cons 6.75107*** _cons 6.77457*** _cons 6.86722*** _cons 6.66257***

F(5,5647) =

F(5,5647) =

F(5,5647) =

F(5,5647)=124

F(5,5647)=




121.54 126.43 125.02 .71 114.69

Prob>F=

0.0000

Prob>F=

0.0000

Prob>F=

0.0000

Prob>F=

0.0000

Prob>F=

0.0000

dumASP is the dummy variable equal to1 if the firm year is between 2005 and 2012.

Table (4b). Chow Test for structure break of board independence in different subsamples

Coef. Coef. Coef. Coef. Coef.

Supervisory

Size

-0.0053***

Supervisory

Size

-0.0113***

Supervisory Size

-0.0018 Supervisory

Size

-0.004***

Supervisory

Size

-0.0154***

Duality -0.0143*** Duality -0.0199*** Duality -0.0154*** Duality -0.0367*** Duality -0.0406***

Concentration -0.105*** Concentration -0.0896*** Concentration 0.0103 Concentration -0.0935*** Concentration -0.2281***

Tradable 0.06232*** Tradable 0.05944*** Tradable -0.0361*** Tradable 0.07145*** Tradable 0.35488***

State_hold -0.1548*** State_hold -0.1573*** State_hold -0.0422*** State_hold -0.14*** State_hold -0.0114

LGCF*

Supervisory

Size

0.00089

CGCF*

Supervisory

Size

0.01303***

SOCF *

Supervisory

Size

-0.0059***

PCF *

Supervisory

Size

-0.0003

dumASP*

Supervisory

Size

0.0248***

LGCF*

duality

-0.0216***

CGCF*

duality

0.01703

SOCF*

duality

-0.0211***

PCF*

duality

0.0383***

dumASP*

duality

0.05854***

LGCF*

tradable

-0.0741***

CGCF*

tradable

-0.1153***

SOCF*

tradable

0.19661***

PCF*

tradable

-0.1147***

dumASP*

tradable

-0.3664***

LGCF*

Concentration

0.07962***

CGCF*

Concentration

0.13333***

SOCF*

Concentration

-0.2041***

PCF*

Concentration

0.07276***

dumASP*

Concentration

0.33935***

LGCF*

state_hold

0.08***

CGCF*

state_hold

0.19893***

SOCF*

state_hold

-0.0637***

PCF*

state_hold

0.07412***

dumASP*

state_hold

-0.0137

_cons 0.37924*** _cons 0.38494*** _cons 0.35105*** _cons 0.37668*** _cons 0.26316***

F(5,5647)=

117.90

F(5,5647)=

156.08

F(5,5647)

= 17.65

F(5,5647)=

79.76

F(5,5647)=

254.11

Prob>F=

0.000

Prob>F=

0.000

Prob>F=

0.000

Prob>F=

0.0000

Prob>F=

0.0000




dumASP is the dummy variable equal to1 if the firm year is between 2005 and 2012




Knowledge Creation: The Mediator Effect Between Customer

Knowledge Exploration and Firm Knowledge Exploitation in

Product-Service Design

Anisa Mohd Yusoff

Faculty of Industrial Management

Noor Azlinna Azizan (Phd)

Director of Entrepreneurship Centre/ Professor of Finance and Entrepreneurship

University Malaysia Pahang

Abstract

The paper is about the investigation of how customer knowledge captured during use-phase and retirement stage

in the product development cycle. Customer knowledge is integrated with firm-owned knowledge and converted

into new ideas or solutions through knowledge conversion process. As such, enhance the customer value

proposition in terms of product and service function. In addition to that, the research also examined the role of

knowledge creation process during PSS design as a mediator between the knowledge exploration-exploitation

and customer value proposition. Although, literatures related to these three elements (customer knowledge,

knowledge creation and product design) are discussed quite often. However, little discussion found in the context

of integrated product-service and none integrate the three elements in a single research. Our intended

contributions in this article are twofold. First, to empirically examine the effect of customer knowledge captured

from other product life cycle and firm-owned knowledge towards new knowledge creation in Product-Service

System design. Second, to empirically prove knowledge creation in PSS design is crucial to enhancing customer value proposition in terms of product and service function.

The research focused on the organization as the unit of analysis. The Multimedia Super Corridor (MSC) of IT

and Multimedia cluster was chosen as the study group. One thousand questionnaires were sent out, and there

were 156 responses collected. The distribution of respondents is summarized according to MSC cluster, size, and

year of operation. The research utilized four main constructs, (a) knowledge exploration (capturing knowledge

from customers during use phase and retirement stage), (b) knowledge exploitation (deployment of firm existing

knowledge stored in knowledge-based, manuals and documentation and expert knowledge), (c) KCP in PSS

design (the SECI mode) and (d) customer value proposition (product and service function). The relationships

among those constructs were structured in four main hypotheses. Partial least squares structural equation

modeling was employed to assess the model.

Keywords: Knowledge, knowledge creation, Product-Service System, value proposition,

SECI

I. Introduction

In functional economy, functional sales is addressed rather than the physical product (Park,

Geum, & Lee, 2012), which getting much attention, particularly in developed countries

(Akasaka, Nemoto, Kimita, & Shimomura, 2012). The terms such as Product-Service System

(PSS), product-related services or full-services are interchangeably used to designate the

integrated of product-service offerings (Velamuri, Neyer, & Möslein, 2011) for selling

functions. Functionality describes the ability of integrated product-services (Durugbo &




Riedel, 2013) to provide the function, usability, or purpose of it, rather than the physical

artifact.

PSS firms move from traditional selling artifact manufactured to combination of services and

products to enhance customer loyalty by having long-term business relationship with

customers (Alonso-Rasgado, Thompson, & Elfström, 2004) and offer sustainable solutions

(Nguyen, Schnürmacher, & Stark, 2014). Subsequently, PSS enhance existing customer

value (Kang & Snell, 2007), generate more profit (Husted & Allen, 2009; Dingzu Zhang &

Wang, 2010) and reduce environmental effect (Goedkoop et al., 1999; Shimomura, Nemoto,

& Kimita, 2014).

In earlier product oriented, firm technical product knowledge is required, however, designing

and developing a PSS is not an easy task due its systemic characteristics, actors involved and

its related components (Kimita, Shimomura, & Arai, 2009; Pezzotta, Cavalieri, & Gaiardelli,

2012). Therefore, systematic planning is required to improve continually and enhance

customer demand. Innovation in PSS can be done in two ways, include employee ideas or

customer feedbacks (Schenkl, Schmidt, Schockenhoff, & Maurer, 2014) from the use-phase

(Beuren, Gomes Ferreira, & Cauchick Miguel, 2013). Offering PSS requires firm (product

designer) and customer interaction and produce in depth and wider scope of knowledge

(Schenkl et al., 2014) could enhance the quality of its design solutions (Akasaka et al., 2012).

Flexibility becomes crucial issue as any specific product can be combined with services to

meet customer requirement through distinct operational processes (Reim, Parida, & Örtqvist,

2014; Ueda, Takenaka, Váncza, & Monostori, 2009). Customer's experience are explored to

improve existing firm core product concept and manufacturing capabilities (Goedkoop,

Halen, Riele, & Rommens, 1999), reduce the needs for service throughout the product usage

phase. Hence, PSS focus on lengthening the durability of a product-service which in turn

reduce material/resource usage but at the same time retain the quality (Mont, 2002).

Exploring customer’s experience and exploiting firm internal knowledge gathered from each

phase of new PSS development are crucial to integrate product functionality and its related

services into one solution. The firm that continues searches (CKE) for new knowledge from

customers' experiences and use internal knowledge (FIKE) for upgrading an existing system

may have opportunities to succeed (Prahalad & Ramaswamy, 2004). A firm may choose to

maintain internal knowledge if the firm is very competitive and at strong position in the

industry which that knowledge is sufficient (Denford, 2013). Explorative and exploitative

learning are a complementary concept for optimizing resources and makes the essential

processes efficient and effective (Guidice, Heames, & Wang, 2009). Both approaches offer

renewed in knowledge, but both differ in cost, learning ability and duration (Denford, 2013;

Kang & Snell, 2007).

Designing PSS requires multiple discipline perspective (Morelli, 2003) such as different

background that contribute to new insights and innovative ideas gained from experiential

learning (Nonaka & von Krogh, 2009) to reduce service requirements during use-phase

(Dongmin Zhang, Hu, Xu, & Zhang, 2012). Earlier finding have shown the importance of

customer integration in the concept and design process of new product development (W.

Song, Ming, & Xu, 2013; Dongmin Zhang et al., 2012), innovation (Schaarschmidt & Kilian,

2014; C. W. Y. Wong, Wong, & Boon-itt, 2013) (J. Wu, Guo, and Shi, 2013), product quality

(Su, Chen, & Sha, 2006; Weng & Huang, 2010), service quality (Tseng, 2012) and

operational performance (He, Keung Lai, Sun, & Chen, 2014; Menguc, Auh, & Uslu, 2013;

Yeung, Lo, Yeung, & Cheng, 2008; Ying & Wu, 2012). On the other hand, previous research

on exploitation of firm internal knowledge (see e.g. Ahmed-Kristensen & Vianello, (2014);

Baxter, Roy, Doultsinou, Gao, & Kalta, (2009); Leary (2001); Roy et al. (2014); Dongmin




Zhang et al. (2012)). Issues from a different stage of product development are crucial input

for PSS design, as customers or the designers’ past experiences can be transferred to facilitate

future product improvements (Ahmed-Kristensen & Vianello, 2014). This study highlights

two issues regarding customer knowledge and firm internal knowledge. First, although

customer knowledge from use-phase and retirement stage are relevant for design phase,

product designer seldom acquires adequate knowledge from service engineer, which result to

inadequate of knowledge transfer between the two teams (Ahmed-Kristensen & Vianello,

2014).

Second, although crucial ideas from the customer are captured, and firm skills and

experiences are enormous, that knowledge has less impact if they cannot be converted,

integrated, applied and shared. New knowledge captured with highly tacit knowledge will

lead to knowledge conversion process. Since new knowledge is the source of innovation, it is

crucial to interpreting knowledge obtained and integrate with firm’s owned knowledge to

improve current product design and its capabilities. The previous research has proven

knowledge creation process affect new product development (Jing & Yang, 2010; Richtnér &

Åhlström, 2010; Wan Zaaimuddin, Goh, & Eze, 2009; Winegard, 2010) product success

(Schulze & Hoegl, 2005), service quality (Tseng, 2012) and co-creation for new product

development (Kohlbacher, 2008). However, those study related knowledge creation and

product development focus on the development of traditional product or service instead of the

integration of both into one final solution.

In summary, this article investigates how customer knowledge exploration (CKE) and firm

internal knowledge exploitation (FIKE) from the entire product development cycle, facilitate

knowledge creation process (KCP) during PSS design. In addition, the study discusses how

the KCP in the product design enhance product-service performance (PSP). The paper has

two contributions: first it offers novel views of how CKE and FIKE enhance new knowledge

creation for product design and PSP. Second, it also demonstrates the three factors CKE,

FIKE and KCP are equally important and well predict the performance of integrated product-

service performance offer to the customer.

II. Theoretical Development and Hypothesess

A. Knowledge

Nonaka and Takeuchi (1995) define knowledge as "beliefs and commitment, action and

meaning". Whereas, Davenport and Probst (2000) have stated knowledge is always bound

within persons not organization, which reflect as the whole body of cognition's and skills

individual use to resolve problems. It is commonly agreed that knowledge is an organized

mixture of thoughts, set of laws, actions, and information (Bhatt, 2000). Nonaka and

Takeuchi (1995) categorized knowledge into tacit and explicit knowledge. They define tacit

knowledge as instance belief, point of view, technical skill and know-how which is created by

individuals through direct experience handling a situation or use of technology. External

knowledge (tacit) from customers, suppliers, partners, and industries who poses know-what

are demanded by customers and what are the requirement that fulfill the needs and know-why

the reasons customer demand. An internalized (tacit) knowledge that has the know what,

why and how characteristic which resides in an individual or employee. In contrast, explicit

knowledge is codified knowledge, stored, articulated and communicated which can be

transmitted in a formal language, for instance databases, handbooks, maps, manual, text,

formulas, guideline, procedures, reports and could be documented and distributed to others.

Explicit knowledge embedded in trademarks, inventions, patents, knowledge recipes, etc. and

a portion of the core know-how of a design.




B. PSS development phase

With adequate resources and supported, PSS will be success, if the product critical success

factor such as distinctive paybacks to customers, high quality, innovative design, and

reasonable price are well planned, designed and implemented (Brown & Eisenhardt, 1995). In

new product development, the product is created based on market needs that determine the

firm success and competitiveness. Furthermore, the information can be collected by

understanding the market needs through having communication with them. PSS development

integrate alignment of existing design and its realization processes of both product and

services (Aurich, Wolf, Siener, & Schweitzer, 2009) which apparently becomes a challenge to

manufacturing firm, when the firm processes and approaches have to match with the new

system (Marques, Cunha, Valente, & Leitão, 2013). In addition, the provider core

capabilities in manufacturing physical products and its corporate culture may lead to

anticipated solutions related to the product but in restrict manner (Aurich et al., 2009). The

product development process must ensure the functionality and services are offered to

customers, as such integrated product-service development integrate tangible product and

intangible service to provide solution to customers (Exner, Lindow, Buchholz, & Stark, 2014)

instead of pure product ownership (Baines et al., 2007).

Previous research on new product development can be found in prior studies (e.g. Durugbo &

Riedel (2013); Y.-J. Chen, Chen, & Wu (2009); Isaksson et al., (2009); Ismail & Monsef

(2012); Dongmin Zhang et al.(2012); Pezzotta et al. (2012); Aurich, Fuchs, & Wagenknecht

(2006); Schaarschmidt & Kilian (2014); (Hadaya & Marchildon, 2012)). For instance Hadaya

& Marchildon, (2012) state several phases in product development include (a) Beginning of

life (BOL) which refer to the starting point new product concept is developed, clearly

defined, manufactured and delivered to customers; (b) Middle of life (MOL) is the utilization

of product, services delivered and maintenance for the product; (c) End of life (EOL) product

refers to the stage that product is recycled, remanufactured, reused or disposed. Durugbo &

Riedel (2013) suggested four product development stages for integrated product and service:

design, development, delivery, and disposal. Having the similar layout of product

development, Zhang et al., (2012), the modified version using new knowledge exploration

and existing exploitation is shown in Figure 1.




Figure 1: PSS product life cycle for knowledge exploration and exploitation (Modified

version from Zhang et al., (2012) )

The life cycle includes exploration of the market and customer need by identifying the

requirement of new product and the potential of the provider own capabilities through their

existing knowledge. The product life cycle is divided into three main cycles, beginning of life

cycle (BOL) which includes planning product concept, and design the concept. The BOL

cycle is followed by the Production activities where the detailed design for manufacturing and

production takes place. The Middle of Life cycle (MOL) focuses on utilization of product,

services and maintenance. Whereas end-of life cycle (EOL) includes reuse, remanufacturing,

recycle and disposal or take-back policy.

C. How CKE and internal knowledge exploitation is transferred from one process to

another and create new knowledge during PSS design

There are many models related to managing knowledge, among them are von Krogh and

Roos, Nonaka/Takeuchi, Choo, Wiig, Boisot and Bennet (Cristea & Ă, 2009). These models

help firms to appreciate what they have gone through and forecast what will happen in the

future. However, in this research, only Nonaka and Takeuchi model is discussed in detailed,

as it is seen relevant in the context of the KCP.. Nonaka & Takeuchi’s knowledge creation

model is a dynamic model by assuming human knowledge interplay between tacit knowledge

and explicit knowledge through human interaction between persons (i.e., dialogue) known as

SECI (Socialization, Externalization, Combination and Externalization) (Nonaka & Konno,

1998). During the development of integrated product and service, several types of knowledge

are required, they are explicit knowledge (strategies and rationale for products and processes),

and tacit knowledge (awareness or insight about processes) (Schenkl, Schmidt, Schockenhoff,

& Maurer, 2014).

Another element of knowledge filtration is added to Nonaka’s model to purify the quality of

knowledge captured and prior knowledge owned by employees. Those organizations who fail




to leverage firm knowledge effectively will suffer various information related anxiety and

face challenge of keeping up with organizing information overload which refers to the high

volume of information that poorly organized and difficult to access and summarize

(MacDonald et al., 2011). It also affects stress on individuals in terms of mental overload

(Strother & Ulij, 2012), productivity and financial losses (Cloete & Snyman, 2003) to

organizations. Several criteria used to filter the knowledge captured: safety, newness, and

relevance. The first criteria is to filter for safety, which ensure information gathered is not

harmful to the firm, thus by filtering process will reduce the consequences. Second, filter for

the relevance of the knowledge captured. As Hanka & Fuka (2005) claim "just-in-time"

knowledge inventories concept access relevant knowledge at the right time when and place

where it is needed becomes crucial. Also highlighted by (Bray & Prietula, 2007), important

knowledge today may not be important for future changes in surrounding, thus filtering

process may avoid overloaded irrelevance knowledge. Third, filter for newness of

knowledge. Knowledge captured must be new to the firm which may provide potential

innovation either incremental or radical (Garcia & Calantone, 2002).

This study research model comprises of four main constructs, customer knowledge

exploration, firm internal knowledge exploitation, knowledge creation in PSS design and

product-service performance. The research model of the study is as shown in Figure 2.

Figure 2

Research model

Socialization. In order to make the socialization process works, employees must show some

sort of they have expertise about the product knowledge. Employees gather knowledge by

learning from past experience, developing and extending the firm internal knowledge

(Alonso-Rasgado et al., 2004; Atuahene-Gima, 2005) such as expert knowledge, diagnosis

skills, facilities and professional equipment, experience, objectivity and integrity, ethical

codes; and relational capital (Aarikka-Stenroos & Jaakkola, 2012). This knowledge can be

gathered from different employees at different stages of PSS development phase: product

design, manufacturing, use-phase and retirement phase. In addition, new knowledge can be

obtained from external sources through socializing with customers (Andreeva & Kianto,

2011). During idea generation, provider starts identifying customer demands through

customer suggestion and complaint (Homburg & Kuehnl, 2014) based on product-service

operation, direct experience, outcome and value received (Johnston & Clark, 2001). In order

to solve the current problem, it requires defining problems appropriately, which lead to

specifying the requirement that meets product-services characteristics. This can be done by

focusing on lead users of a product or processes (Hippel, 1986). The lead user’s knowledge

can be captured in various ways, either virtual channel or face to face. Different providers

may have different approaches how the new knowledge is acquired, such as customer visits

(Schaarschmidt & Kilian, 2014), brainstorming with customer (Alam, 2013), dialogues

(Pezzotta et al., 2012), in-depth interviews (Baxter et al., 2009; Kindström & Kowalkowski,




2009), observations of social networking sites, blog, online communities, and forum. This

process is called “experiential sharing” or defined as social interactions between two entities

such as the exchange of the specialized skills of firm internal knowledge with customer

experience (Argote & Ingram, 2000) Other approaches for socialization is face-to-face

discussion, knowledge repository / firm databases, customer management systems, and

decision support tools (Chong, Chong, & Gan, 2011). In short the more customer knowledge

is explored, and internal firm knowledge is exploited the more new knowledge will be

created. Thus we hypothesized:

Filtration. Filtration is a process where knowledge gathered or created is filtered to ensure

knowledge obtained conform to the firm predefined goals and objectives (Jamal El-Den,

2006) and potential harmful knowledge will be eliminated from the database (Markovitch &

Paul, 1993). This step requires careful discussion among team members to decide which

knowledge will stay or face out. Unnecessary, spillover or redundant knowledge are discarded

to improve the quality of knowledge asset using the filtering system (Yingnan, Yuduo, &

Xiongfei, 2012). Only unique, relevant, and potential knowledge will be selected for creation

of new knowledge. The more customer knowledge captured, the more filtration process has

to take place, to purify new knowledge obtained. As for FIK, the filtration process is as

equally required for CKE. The reason is knowledge can decline in value based on several

factors, such as time, environment, different sectors / target customers, and technology

changes. Thus, filtration process applies to newly captured knowledge or prior knowledge

owned by employees. Thus the following hypotheses are formulated:

Externalization. In the externalization stage, customer knowledge is articulated in common

terms and explicit concepts such as metaphors, analogies, hypotheses and models (Nonaka

and Takeuchi, 1995), images, symbols, and language including design and product concepts

(Schulte, 2008). Nonaka & Takeuchi also refer this activity as “creating new concept’. For

example in PSS modelling, both product and service are equally important, thus the designing

of both aspects must take place concurrently at the beginning of the new PSS development

(Geng et al., 2011). Customer support during after-sales service is crucial for customer

satisfaction, organization competitiveness, increase product success (Goffin & New, 2001).

As such the authors suggest, the concept of service should be designed in the product for cost

efficiency and effectiveness. Furthermore, the decision making during designing new product

concept will affect product reliability, maintenance and repair (Goffin & New, 2001).

Because of that, customers’ feedback from the use-phase and retirement stage must be

analyzed carefully and need to be translated into understandable meaning. Therefore, a new

concept of the new solution can be determined. At this stage, not only CKE is important, but

FIKE such as experiences gathered through all stages in PSS development. This knowledge

can be captured by utilizing IT application system (Varra et al., 2012). The interaction of

both knowledge, lead to simplification of knowledge conversion from tacit to explicit

knowledge.

Combination. Firm internal knowledge such as experience, mental models, and thoughts and

the new explicit knowledge articulated by individual employees are combined with other

employees (collectively) knowledge and later processed into more complex and systematic,

explicit knowledge (Nonaka & Toyama, 2003; Song, 2008). For example in PSS design,

once, new unique ideas either related to product or its services functions are collected,

customers’ need can be developed by combining with FIKE (Marques et al.,2013) such as




skills, strategy, and previous experiences gathered during PSS developments. The

combination process involves reconfigure current explicit knowledge through sorting, adding,

reorganizing, and combining processes which yield to new explicit knowledge (encoded

knowledge) (Chatti, 2012) using IT system such as electronic communication, formal

documents, database, and shared management (Hosseini, 2011). With the advance of IT,

creative use of computerized communication networks and large repositories can assist this

knowledge conversion (Nonaka & Toyama, 2003).The providers and customers interaction

co-create insight, skills and relationship through a combination of the customer’s and firm

internal unique knowledge, hence new product and service concept are developed. The

service concept is a solution to a customer problem through activities and interaction.

However, unique value and experienced are created based on the knowledge and skills apply

during consumption, subject to user requirements (Edvardsson, Kristensson, Magnusson, &

Sundström, 2012) Seven examples of service elements suggested by Goffin & New (2001):

installation, user training, documentation, maintenance and repair, on-line support, warranty,

and upgrades. The product concept in PSS present the similarity with the service design

concept, which again include customers’ requirements (Kimita & Shimomura, 2014) such as

functionality, cost, durability, and environmental safety (Schulze & Hoegl, 2005). Another

product concept that need to be incorporated during product design is sustainability issue, in

terms of reduce waste, reduce the usage of material, recyclable and re-use material and easy to

disassemble for disposal (Khor & Udin, 2013). Later, new concept must be analyzed in

terms of its feasibility such as technical availability, adaptability, viability, and cost-benefit

before it is executed.. Once the detail design is defined, a model or a prototype is built to

validate and verify the product design appear as what it is planned. In this case, the prototype

built is tested and must satisfy both product and service elements (Exner et al., 2014). In

summary, during the combination of KCP both CKE and FIKE are crucial sources. Thus we

hypothesize:

Internalization. During internalization process, embedded knowledge such as shared norm

and firm routines are formed once explicit encoded knowledge is transformed into new tacit

knowledge by embodying explicit knowledge through learning by doing, training,

documentation or simulations (Nonaka, Toyama, & Konno, 2000). During training, new

product and service concept are applied so they become individual’s knowledge (Nonaka &

Toyama, 2003). Later, this trigger a new cycle of knowledge creation when team members

socialize and share the new ideas (Nonaka et al., 2000). Knowledge sharing, transfer existing

knowledge from one individual to another, regardless among colleagues within the

department or across departments (Andreeva & Kianto, 2011). This phase is crucial

(Oyefolahan & Dominic, 2011) as it affects knowledge creation and respond to changes,

innovate and achieve organizational competitive advantage. It also contributes to the

development of competency among employees and innovative capability of the organization.

It can be implemented with the support of IT resources such as email, intranet /extranet,

portal, video conferencing, teleconferencing and forums such as communities of practice and

training (Sandhawalia & Dalcher, 2011). In order to allow knowledge can be reused for

future use, knowledge should be recycled and upgraded whenever necessary. Knowledge

storage support organization memory and individuals to access and FIKE and provide coding

and indexing of knowledge for future retrieval. Finally this collective new concept and design

knowledge is transformed into new tacit when it is embodied in shared norm and firm

routines through learning by doing, training and simulation (Nonaka et al., 2000). At this

phase, new knowledge created is applied in real business. At this stage, an increase in




capturing customer knowledge will increase the ability of employees to embodying explicit

knowledge, similarly firm past experiences are crucial input for new knowledge creation.

Thus, the following are hypothesized:

Hypothesis 1a/b/c/d/e: Customer knowledge exploration (CKE) is positively related to

knowledge creation process (KCP) during new PSS design.

Hypothesis 2a/b/c/d/e: Firm internal knowledge exploitation (FIKE) is positively related to

knowledge creation process (KCP) during new PSS design.

D. Customer knowledge exploration (CKE), firm internal knowledge exploitation

(FIKE) and customer value proposition in terms of product-service performance

(PSP)

A customer value proposition is the basis understanding how the products or services are

experienced by the target user and gain the benefits of consuming the products. It is the core

element of business model and the first step in developing a business model that describes the

logic connection of products and services offer to the customer (Petrovic & Kittl, 2003) and

solve customers’ needs or their problems (OECD, 2012). The value proposition of a product,

adds value in total that can be quantified and measured. The higher value proposition can be

defined the more chance of the product will be accepted by customers (Ott, 2000). Boons and

Leudeke-Freund (2013) state that the relationship between organizations and their customers

is clearly defined by value proposition, which develop not because of specific products or

services but relatively by the value exchange between provider and intended users whom the

products are designed for. Without customer value proposition, it is similar to business

without the target in the marketplace (Morris et al., 2005). Hence, new product development

is considered success when it can contribute to earning revenue and meeting firm objectives

by fulfilling customer needs and satisfaction. Product and service performance is measured

based on product functionality and service quality. Product functionality is defined as the

incorporation of service offers into the traditional product offer, together with extending

product lifecycle (Lindström, Dagman, & Karlberg, 2014). Obviously, there are other

strategies to achieve product success, but one example is product quality such as product

functionality, durability, compatibility, its design (Schulze & Hoegl, 2005) and price

(Morschett, 2006). Also, the characteristic such as the level of product quality, performance,

mechanical and technical features and reliability (Antioco, Moenaert, Feinberg, & Wetzels,

2008) are examples of product functionalities. The service quality measures the effective and

efficient transformation of resources in the form of services that satisfy customer’s need

(Yoon, Kim, & Rhee, 2012).

One approach to offer value to customers is through capturing service feedbacks from

customers. The feedbacks can be crucial sources to enhance PSP. Besides the ability of the

firm to provide solutions to the current problem, it also can deliver supplementary services to

customers (Morschett, 2006). Customer knowledge in terms of sustainability, is another

potential criteria that may affect product-service performance in order to reduce the usage or

replacement of material that can contribute to environmental safety. As a result, less number

of production, cause a reduction in waste generated; increase in dematerialization product in

proper such as re-use, recycling and take back (Maxwell & van der Vorst, 2003). Similarly

production can be reduced through services delivery such as user training, maintenance,

repairs and warranty services, which enhance the efficiency of the product being sold

(Morschett, 2006) thus reduce number of production.




CKE. The objectives of CKE are to enhance customer satisfaction through value proposed to

them besides gaining other benefits such as innovativeness (Yli-Renko, Autio, & Sapienza,

2001) flexibility, timely response to customer demands, long term relationship and increase in

revenue (Claycomb, Dröge, & Germain, 2005). In this research, the product-service

performance is the final research output. It is chosen due to the value proposed to customers,

in line with the sources of input discussed earlier, for example customer knowledge and firm

internal knowledge. Furthermore, the process of knowledge creation discussed earlier is in

the product-design context. Thus, product-service performance as an output of product design

seems fit. Furthermore, previous study already proved customer knowledge provides some

sort of benefits such as product-service offering (Abebe & Angriawan, 2014), service quality

(Tseng, 2012), and firm’s sustainable innovation (Ayuso, Rodríguez, García-Castro, & Ariño,

2011). Since both CKE and FIKE activities are implemented in this study, the result may

involve with incremental and radical innovation in product, or process (Abebe & Angriawan,

2014).

FIKE. Similarly, deploying firm internal knowledge is also an important enabler for PSS

design, quality, and its development speed (Dongmin Zhang et al., 2012). The provider may

customize product offering by utilizing its resources to identify specific patterns and rules

regarding domain-specific knowledge about customer needs through relationship invested for

their knowledge exchange Sun (2007). The capabilities of the provider to create new and

utilize previous knowledge is depending on how the provider interprets and integrate them

(Hadaya & Marchildon, 2012; Isaksson et al., 2009). Previous research has clearly stated that

exploitation and exploration activities have a different effect on firm performance (Bocanet &

Ponsiglione, 2012). It seems that exploitation of existing knowledge improves current

performance in the existing environment in terms of its efficiency and effectiveness of the

existing system. On the other hand, knowledge exploration provides long-term benefit

(Bocanet & Ponsiglione, 2012). This can be done when employees’ abilities, experience,

training and skills are enhanced internally from time to time perform the assigned task

(Bocanet & Ponsiglione, 2012). This may affect the efficiency and effectiveness of product

offering while at the same time innovate the approach used to deliver customer service. Hence

the following hypotheses are formulated:

H3a/3b: Customer knowledge exploration and firm internal knowledge exploitation are

positively related to product-service performance.

E. Knowledge creation process (KCP) and Product-service performance(PSP)

Many firms have implemented management initiatives after realized that knowledge resources

such as CKE and FIKE are the basic capabilities for value proposition and source of

competitive advantage (Schiuma, Carlucci, & Lerro, 2012). Through management initiatives,

knowledge resources are linked to organizational capabilities, processes and performance

(Schiuma et al., 2012). In addition, by managing knowledge, firms can enhance business

processes and maximize opportunities. Hence, PSS depends on how well the knowledge

management initiatives are implemented. In order to extract knowledge from its external

sources, it requires organizational capabilities to integrate them in the organization,

knowledge processes, and managerial activities such as teamwork, community of practice,

adoption and the use of advanced ICT (Chung & Chen, 2012). However, the knowledge

acquired from external sources alone could not provide impact on organizational

performance, except if the knowledge is integrated with internal firm resources (Chung &

Chen, 2012). Tseng (2012) has proved KCP (knowledge chain) is one of the primary

activities that could affect the service quality.




Socialization: The socialization between customers and employees during the planning phase

create opportunity to capture customer embodied knowledge such as customer ideas,

suggestions or complaint (Aarikka-Stenroos & Jaakkola, 2012) from any phase of PSS

development and that knowledge are shared through face-to-face or virtual meeting (Varra et

al., 2012). However, knowledge captured from service delivery during use-phase and

retirement stage is crucial for product design phase to enhance existing and future product

design. The customer may share their personalized experience (Hosseini, 2011) with the

team members for example personal expertise, value that they search (Paswan, D’Souza, &

Rajamma, 2014), feeling, emotion, experience and mental model (Hosseini, 2011) through

creative dialogue (Song, 2008). This knowledge provides idea generation to solve the current

problem by focusing on lead users as they represent strong influences of a future product or

process (Schulze & Hoegl, 2005). Socialization during concept development with customers

enable customer experiential learning using product offering in terms of product quality

standards, design of products, production plans, and costs are shared (Claycomb, Dröge, &

Germain, 2005); allow PSS provider to be in a better position to integrate their knowledge for

innovative product concept (Schulze & Hoegl, 2005); and ensure the concept for the new

functionality meets its requirements (Kimita & Shimomura, 2014).

Filtration. Through socialization process, however, ideas or suggestions captured can be

enormous that lead to knowledge spillover. In addition, the high volume of knowledge may

not guarantee they meet the pre-specified quality and conform to the firm predefined goals

and objectives (Jamal El-Den, 2006). Harmful knowledge should be discarded from the firm

database (Markovitch & Paul, 1993) as they cause firm to have difficulties in searching,

handling, evaluating knowledge, and making right decision, besides facing disappointment

and personal stress (MacDonald et al., 2011). Only, unique, relevant, and potential knowledge

will be considered for the creation of new knowledge. The more customer knowledge

captured, the more prior knowledge of FIKE, hence the more filtration process has to take

place to purify new or existing knowledge according to specified targets in designing new

integrated product-service. Quality knowledge will enhance the output, such as product

functions, services or maintenance. With that, the following is hypothesized:

Externalization: During the planning stage the focus is on generating new knowledge, new

solution for both types of product-service developments by identifying customer suggestions

and complaints (Homburg & Kuehnl, 2014). The key ideas are to define problems

appropriately which lead to specifying the requirement that meet product-services

performance. One way is to focusing on lead users of a product or processes as they represent

strong influence of a future product or process (Von Hippel, 1986). After distinguished ideas

captured from customers, employee generates understanding of what is going to be developed

by externalizing the understanding into metaphors or concept creation. By identifying the

customers’ need, customer satisfaction is enhanced through new PSS requirement developed

based on external and internal resources. During this phase, the team able to use this metaphor

to think about how to replicate the motion in future product that enabled them to produce the

desired effects and new concepts are formed (Gourlay & Hill, 2003). In addition, this phase is

crucial during product design for both product and service modeling. Besides that, PSS

design focus on the durability of a product by reducing resources usage without jeopadising

the quality (Mont, 2002), enhance existing customers’ value (Kang & Snell, 2007) generate

more profit (Husted & Allen, 2009; Dingzu Zhang & Wang, 2010) and reduce environmental




effect (Goedkoop et al., 1999; Shimomura, Nemoto, & Kimita, 2014). Thus externalization

meets the requirement for product design. Thus, we hypothesize:

Combination: During combination in PSS design, managers are engaged in planning

strategies and operational organizing internal and external firm knowledge using advance IS

(Nonaka, Byosiere, Borucki, & Konno, 1994) such as Computer Aided Design and Product

Data Management (Dongmin Zhang et al., 2012). Internal and external knowledge design are

combined, expecially knowledge from service designers or customers feedbacks on service,

maintenance and product retirement. These feedbacks are required to create new complicated

and systematic concepts: diagrams, flowcharts, graphs, and models, which will enhance

previous design in terms of product functions or service quality. Hence, we proposed:

Internalization: In planning for concept design, PSS focus to generate as many ideas that

might be feasible for developing PSS. Internalization of explicit knowledge to tacit

knowledge (embodying explicit knowledge into tacit knowledge) stimulates the realization of

new product innovation in the organization (Li, Huang, & Tsai, 2009). New knowledge in

terms of technical know-how or mental model (Chatti, 2012) improve service processes and

performances and may distinguish from competitor’s product (Hara, Shimada, & Arai, 2013)

are internalized via application or participation (Kenney & Gudergan, 2006), simulation or

experiment (Nonaka and Toyama, 2003). Virtual world of knowledge acquisition through

application in engaging prototyping, testing and benchmarking is disseminated to other

functional units (Nonaka et al., 1994). Furthermore, many studies have proven

internalization lead to greater flexibility in distributing information (Kenney & Gudergan,

2006) that leads to better idea generation in planning and designing PSS, reduce response

time and obtaining better adaptation of environmental change. Finally, the newly created

concept is disseminated to other unit during planning and implementation of product design.

Combination assists the new product based on the firm’s existing capabilities, technically and

economically thus project team has a better understanding of the new product concept created

objectives and requirement (Schulze, 2005). Hence, it is argued that combination mode in

knowledge creation positively affect PSP. Thus, we contend that internalization during the

design phase is positively related to product and service performance.

H4a/b/c/d/e: Knowledge creation process (KCP) during PSS design is positively related to

product-service performance(PSP).

F. The mediating effect of knowledge creation process (KCP) in PSS design on

knowledge exploration-exploitation and product-service performance(PSP)

The PSS performance is closely related to the activities in the KCP. PSS delivery, offer

several benefits to the provider: such as reduced costs, extended product life and use,

efficient use of resources, reduced life-cycle environmental impact (Durugbo et al., 2010). At

the same time, customer gain benefits in terms of accessibility, evolvability, interoperability,

maintainability, modularity, portability and scalability (Durugbo et al., 2010). In other words,

customers may enjoy new functionalities and value delivered to them through service

enhancement (Barquet et al, 2013) In product development, customer knowledge and firm

experience provide valuable knowledge to design new product concept. New knowledge

created through KCP: sharing, filtering, creating concepts, justifying new concept, and

application of new concepts. Without KCP, the interaction between new knowledge captured




from external sources and previously acquired knowledge may have little impact on new

knowledge creation thus performance of an integrated product-service becomes stagnant.

Previous finding by Tseng (2012) shows knowledge chain play full mediated role between

external knowledge and service quality. The mediator, at this point provides a process

where internal and external knowledge can be interpreted, upgraded, applied and shared in

the new project development. Thus, the following hypotheses are formulated:

H5a/b/c/d/e: Knowledge creation process (socialization / filtration/ externalization/

combination/ internalization) mediates the relationship between customer knowledge

explration (CKE) and product-service performance(PSP)

H6a/b/c/d/e: Knowledge creation process (socialization / filtration/ externalization/

combination/ internalization) mediates the relationship between firm internal knowledge

exploitation and product-service performance(PSP)

III. RESEARCH METHODOLOGY

A. Sample and data collection Unit of analysis in this research was an organization rather than personal or employee

performance. The Multimedia Super Corridor (MSC) of IT and Multimedia cluster was

chosen as the study group. There were 1871 organizations of IT cluster and 331 firms of

Multimedia cluster (www.msc.com). For pilot testing, 300 questionnaires were sent out to the

same group. The respondents were identified based on certain criteria which who hold a

position as a manager in IT/ Production/ Service/ Quality/ Marketing/ Customer Department.

The managers were also required to have at least one year experience. Their responses were

based on voluntary, they may answers question namelessly. All items were measured using

6-point Likert scale ranging from “strongly disagree” to “strongly agree”. The instrument

was pilot tested with 50 managers from the same group. Certain questions were removed and

upgraded based on suggestions from respondents. In the actual survey, one thousand

questionnaires were sent out and156 (15.6%) were collected but three responses were

discarded due to missing data. The distribution of respondents is according to MSC cluster,

size, and year of operation. There were 41 (26%) respondents from Creative Multimedia

cluster and IT related firms 115(74%). With regards to firm size, the majority of respondents

worked in small firms with less than 35 employees (55%), and only 12% of the respondents

were from large size firms with more than 200 employees. Most firms involved in the

research have been operating for more than five years (41%), followed by three to four years

of operation (23%), one to two years of operation (13%), two to three years of operation

(12%) and less than a year of operation (11%).

B. Construct and their questions

There were eight constructs and thirty-eight items. Exploration and exploitation were

independent constructs.. Knowledge creation processes had five sub-constructs: social, filter,

external, combine and internal. Product-service performance (PSP) was a dependent

construct. All eight constructs had reflective measures. Table 1 shows the detail of construct

instruments.




Table 1 Detail constructs Code Construct Item Author

CKE Knowledge Exploration 4 Prieto et al., (2009)

FIKE Knowledge Exploitation 4 Prieto et al., (2009)

SOCIAL Socialization 4 J. H. Song et al. (2011)

FILTER Filtration 4 Author

EXTERNAL Externalization 4 J. H. Song et al. (2011)

COMBINE Combination 4 J. H. Song et al. (2011)

INTERNAL Internalization 4 J. H. Song et al. (2011)

PSP Product –service

performance

10 He et al., (2014); Swink, Narasimhan, & Wang (2007)

C. Data analysis

Two statistical tools were used to analyze the data SPSS (ver 22.0) and SmartPLS (3.0).

Structural equation modeling (SEM) using SmartPLS was adopted to examine the causal

relationships between the dependent and independent variables in the actual survey. It was

chosen due to several reasons: consistency, flexibility and robustness (Chin & Newsted,

1999). Other reasons for using PLS is due to little theory available, the need of predictive

accuracy, and uncertain model specification (K. K. Wong, 2013). In addition SmartPLS is

used because of the ability to interpret the interaction between latent variables besides the

direct effect (Henseler & Chin, 2010).

a) Validity and Reliability analysis

For common method bias (CMB), the SPSS was used to examine factor analysis. The

analysis extracted ten components for all items which accounted for70% cumulative loadings,

while the first factor loaded to 19% of the total variance which is less than 50%. Thus, it is

concluded there is no significant method bias in the examined data. The analysis by Kaiser-

Meyer-Olkin (KMO) measure sampling adequacy was 0.761, which was larger than 0.5 as

recommended by Kaiser (1974). The Bartlett Test of Sphericity lead to significance level

0.00 (p < 0.01) indicating the investigation of the population correlation was not on identity

matrix. Using an extraction method of Principal Component Analysis, for item reduction, the

factor was extracted to fix number of factors (8 factors) as mentioned in the literature. It was

followed by the rotation method of Promax with Kaiser, the factor loadings. All items were

accounted for 70% cumulative loadings and one item was removed due to higher cross

loadings. The scale reliabilities using Cronbach's alpha for all items were above 0.7 (Hair,

2010). Thus it was concluded that the measurement had an acceptable level of reliability.

b) Measurement model The measurement model was determined by investigating the relationship between the

constructs and their indicators as shown in Table 2. The internal consistency reliability,

convergent validity, and discriminant validity were examined for the reflective constructs.

Internal consistency reliability was evaluated through an examination of composite reliability.

For each of eight reflective constructs (CKE, FIKE, Social, Filter, External, Combine,

Internal, PSP), the composite reliability exceeded the minimum requirement of 0.80. All

constructs had less than 0.95 for composite reliability, which may lead to the measurements

used were semantically non-redundant items (Hair et al., 2014). Convergent validity was

initially examined through indicator reliability. The standardized indicator outer loadings

must be 0.6 or higher (Hair et al., 2014). Thus, another seven indicators were removed. The




average variance extracted (AVE) is also a measure of convergent validity. The analysis of

AVEs exceeded the cutoff point 0.50 for all the reflective constructs in the model (Hair et al.,

2014). To end, the (Fornell & Larcker., 1981) criterion for assessing discriminant validity was

applied. As shown in Table 3, the square root of inter construct correlations were below the

construct AVEs, thus demonstrating discriminant validity. Finally, all indicator loadings were

higher than their cross loadings, providing further evidence that all the criteria for

discriminant validity were met.

Table 2

Factor loadings, composite reliability, and average variance extracted

Construct Indicators

. . Item

Loadin

g

IR CR AVE

Customer

knowledge

exploration

During product development, to what extent does your firm

explore. . .

Explore problem areas with regards to product and service delivery

with which customer is dissatisfied during customer use-phase. 0.669 0.448 0.809 0.588

Explore problem areas during maintenance which customer is

dissatisfied. 0.778 0.605

Explore numerous novel and useful ideas with regards to product

recycle, reuse or disposal?. 0.844 0.712

Firm

internal

knowledge

exploitation

During product development, to what extent does your firm exploit . . .

Existing knowledge elements are identified, connected and

combined 0.668 0.446

Existing competencies related to products/services design that are

currently being offered? 0.85 0.723 0.848 0.653

Lessons learned in other areas of the organization in operation?

(E.g. manufacturing, marketing, service department) 0.889 0.790

Socializatio

n

Share experiences between employees and customers. 0.725 0.526

Collect work-related information and ideas from employees and

customers 0.826 0.682 0.864 0.614

Capture customer feeling or emotions 0.734 0.539

Fitration Capture customer or employee ideas, suggestions which are new to

the firm 0.843 0.711

Capture customer or employee ideas, suggestions which are

relevant to the firm. 0.842 0.709

Discard ideas or suggestions that may harm organization 0.648 0.420 0.867 0.623

Notify all employees with regard to obsolete or failure in a

previous procedure, methods or techniques. 0.798 0.637

Externa-

lization

Develop new ideas through constructive dialogue by using figures

and diagram 0.852 0.726 Develop general rules and concepts based on several possible

examples 0.672 0.452

Facilitate creative and constructive conversation among the

members 0.846 0.716 0.839 0.638

Combi-

nation

Engage in continued dialogue through reflection among the

members 0.863 0.745

Evaluate the newly developed concepts by a reasonable evaluation

system and organizational vision / mission 0.817 0.667

Conduct experiments and share knowledge with the entire

organization to evaluate the value of the concepts 0.84 0.706 0.895 0.682

Test theoretical knowledge about customer needs 0.765 0.585

Interna-

lization

Combine existing and new concepts in meaningful ways 0.877 0.769

Collaborate with various departments 0.876 0.767




Use newly learned knowledge as the sources for the future

applications 0.795 0.632 0.870 0.690

Product-

Service perfor-

mance

Product reliability 0.82 0.672

Product functionality 0.761 0.579

Product durability 0.64 0.410 0.921 0.596

Product maintenance 0.899 0.808

Product upgrades 0.837 0.701

Product trainings 0.687 0.472

Product spare part 0.803 0.645

Table 3

Construct correlations, mean and standard deviation

Construct 1 2 3 4 5 6 7 8

1. COMBINE 0.826

2. FIKE 0.18 0.808

3. CKE 0.177 0.092 0.767

4.

EXTERNAL

0.247 0.201 0.326 0.798

5. FILTER 0.209 0.152 0.203 0.335 0.789

6.

INTERNAL

0.153 0.322 0.118 0.354 0.068 0.831

7. PSP 0.368 0.361 0.433 0.46 0.349 0.346 0.772

8. SOCIAL 0.209 0.411 0.176 0.252 0.341 0.194 0.362 0.784

Note: The square root of AVE is shown on the diagonal of the construct correlations and

inter-construct correlations are shown off the diagonal.

c) Structural model

The structural model was assessed to examine the relationship between constructs and the

model’s predictive capabilities (Hair et al., 2014). First, a model that was free from any

collinearity issues was established by performing VIF analysis using linear regression in

SPSS for each independent variable. All VIFs were above 1.00 and well below 4.0, which

indicates that the model was not having collinearity problems (Hair et al., 2014). Second, the

basic theory of the model was tested using SmartPLS and the path analysis results are shown

in Table 4. The structural model was resampling for 1000 times to achieve consistent

magnitude and significance. As indicated in Table 5, using PLS, Beta coefficients, t-statistics,

lower and an upper limit of confidence intervals are presented. Another approach used was

Ordinary Least Squares (OLS) regression. By averaging the items within each construct, the t-

statistic and Beta coefficient were calculated. However, the results of OLS were not

consistent with the PLS. The result of PLS will be used for further analysis and discussion.

Fourteen hypotheses were accepted, and three were rejected. Hypotheses 1 a/b/c/d/e/f were

predicted a positive relationship between CKE and KCP (Social, Filter, External, Combine,

Internal). Four modes of KCP were positively affected by CKE: Social (p < 0.05), Filter (p <

0.01), External (p< 0.01) and Combine (p < 0.05) except Internal. Hypotheses 2 a/b/c/d/e

predicted a positive relationship between FIKE and KCP, and all were supported except

Filter: Social (p<0.01), External (p<0.05), Combine (p < 0.05) and Internal (p<0.01).

Hypotheses 3 predicted both CKE and FIKE had a positive relationship with PSP, both were




supported ( p < 0 .01 and p < 0.1). Hypotheses 4 expected that all knowledge creation

process had a positive effect on PSP. However only three hypotheses were accepted: Filter

(at p < 0.05), External (at p < 0 .01) and Combine (at p < 0.01). Both Social and Internal

had a positive relationship with PSP but not significant.

Table 4

Path coefficients and results of hypotheses tests

Path PLS result OLS result

Co-

efficient

T- Stat. Confidence

interval

Co-

efficient

T-Stat.

H1a: CKE -> SOCIAL 0.139 2.042** (0.008, 0.275) 0.169 2.127

H2a: FIKE -> SOCIAL 0.398 5.983*** (0.271, 0.53) 0.385 5.171

H1b: CKE -> FILTER 0.191 3.021*** (0.072, 0.308) 0.175 2.203

H2b: FIKE -> FILTER 0.135 1.941 (-0.012, 0.277) 0.094 1.166

H1c: CKE -> EXTERNAL 0.31 4.583*** (0.178, 0.449) 0.319 4.180

H2c: FIKE -> EXTERNAL 0.172 2.249** (0.028, 0.33) 0.181 2.278

H1d: CKE -> COMBINE 0.162 2.046** (0.008, 0.326) 0.179 2.258

H2d: FIKE -> COMBINE 0.165 2.054** (0.008, 0.327) 0.155 1.953

H1e: CKE -> INTERNAL 0.089 1.096 (-0.061, 0.263) 0.134 1.683

H2e: FIKE -> INTERNAL 0.313 4.098*** (0.156, 0.45) 0.334 4.403

H3a: CKE -> PSP 0.268 4.323*** (0.147, 0.382) 0.421 5.768

H3b: FIKE -> PSP 0.164 2.322** (0.035, 0.29) 0.342 4.523

H4a: SOCIAL -> PSP 0.093 1.267 (-0.063, 0.237) 0.361 4.799

H4b: FILTER -> PSP 0.131 2.13** (0.013, 0.256) 0.283 3.659

H4c: EXTERNAL -> PSP 0.177 2.67*** (0.042, 0.311) 0.443 6.135

H4d: COMBINE -> PSP 0.178 2.724*** (0.002, 0.274) 0.369 4.931

H4e: INTERNAL -> PSP 0.145 1.9 (0.048, 0.31) 0.334 4.396

Note: ** p < 0.05, ***p < 0.01

In Table 5, shows R2, communality and redundancy. The prediction value of R2 was tested

according to three categories: weak (0.25), moderate (0.50) or substantial (0.75) (Hair et al.,

2011, 2014). The prediction of PSP was slightly below moderate (R2=0.451), prediction for

KCP of the five modes were below weak standard: Social (R2=0.188), Filter (R2=0.059),

External (R2=0.135), Combine (R2=0.058) and Internal (R2=0.111). Although PSP had below

moderate relationship value (R2=0.451), considering KCP, CKE and FIKE were about

knowledge in different context as the only antecedent for the PSP, 45.1 percent of the

variance explained seem to be adequate and meaningful. In order to evaluate the predictive

relevance of the endogenous latent variables such as Social, Filter, External, Combine,

Internal, and PSP, a blindfolding omission at distance of D = 7 was used. The Q2 for Combine

(0.079), External (0.121) Internal (0.009), Social (0.137) and PSP (0.29) were above 0.15,

which indicated medium predictive relevance. Based on the effect size of (f2) measures the

influence of a specific predictor on an endogenous variable by calculating the change in the

R2 if the predictor is excluded from the model (Cohen, 1988). The change in the R2 indicates

the substantive effect on the R2 values of the endogenous variable. The standard measures to

assess f2 value of endogenous variables are small (0.02), medium (0.15) and large (0.35)

effect size. The results show the effect size f2 values of endogenous variables (PSP) ranged

from small effect size to slightly below medium effect size (0.115) indicating acceptable




predictive relevance. The overall quality of the research model was computed using the

Goodness of Fit (GoF) formula: GoF= √ Average R2 x Average Communality = 0.3270

(Tenenhaus et al., 2005)

Table 5

R2, communality and redundancy

Construct R2 Communality Redundancy Q2 PSP

CKE - 0.588 0.182 0.115

FIKE - 0.653 0.323 0.037

SOCIAL 0.188 0.614 0.345 0.101 0.011

FILTER 0.059 0.623 0.375 0.027 0.025

EXTERNAL 0.135 0.638 0.286 0.070 0.041

COMBINE 0.058 0.682 0.454 0.037 0.051

INTERNAL 0.111 0.690 0.366 0.066 0.031

PSP 0.451 0.596 0.475 0.260 -

Average 0.167 0.641 0.351 0.116

d) Mediation effect

Later, the mediation effect of KCP between CKE / FIKE and PSP were tested. Table 6

represent the matrix correlation between the three constructs were tested individually.

According to (Baron & Kenny, 1986), to test mediation there are three important steps need

to follow: Firstly, the independent variable (CKE and FIKE) must affect the mediator (KCP);

secondly, the independent variable must significantly affect the dependent variable; and

thirdly, the mediator must significantly affect the dependent variable. If these conditions are

met, the effect of the dependent variable will reduce when the mediator variable is included in

the model.

Thus, the first step was to test the mediation effect of two independent variables: CKE and

FIKE on each process of knowledge creation during product design. Separate coefficients for

each step were tested. As revealed in Table 6, the first column highlight the correlation matrix

between CKE and KCP, which were significant at all knowledge creation mode (except in the

Internal mode). On the other hand correlation matrix between FIKE and KCP show all

matrix correlations of knowledge creation mode were significant except in the Filter mode.

Hence, CKE for Internal mode and FIKE for filter mode are not qualified for further

mediation effect. Second, the examination continued with testing the effect of the

independent variable (CKE and FIKE) and dependent variable of PSP without the effect of

KCP. In the second column of Table 6, shows the effect of CKE and PSP; and FIKE and

PSP, which both were significant at p< 0.01. Because the second step met the requirements,

the following step was implemented.

The third step was to regress the dependent variable of PSP on both independent variable

(CKE and FIKE) and on the mediator KCP (except in the Internal mode for CKE and the

filter mode for FIKE). In the second column of Table 6, shows the intervening variable of

KCP affects the dependent variable in regressing both the independent variable (CKE and

FIKE) and the mediator (KCP) on the dependent variable (PSP). In the third column of Beta

difference, the effect of CKE and FIKE on PSP were higher when excluded the intervening

KCP variables. This condition met the third rule of examining mediation effect as highlighted

by Baron & Kenny (1986).

The fourth step, was to examine whether some form of mediation exist by checking the

significant effect of intervening variable to dependent variable after the independent variable

were controlled. Table 6 shows the effect of KCP to PSP are remained significant after CKE

and FIKE were controlled. Thus, the finding supports of KCP has a partial mediating effect,




meaning that the three constructs CKE/FIKE, and KCP are significant predictors of PSP. The

finding demonstrates the relationship between CKE/FIKE and PSP, mediated by KCP.

However, Internal mode of knowledge creation processes does not mediate the effect between

CKE and PSP. Similarly, Filter of the KCP is not a mediator between FIKE and PSP.

Table 6

Evaluation of the mediating effects of KCP between CKE and PSP

Model 1

KCP (KCP)

Model 2

PSP without KCP

S F E C 1 PSP

CKE 0.212*** 0.208*** 0.323*** 0.182** 0.148 0.439***

FIKE 0.421*** 0.174 0.216** 0.187* 0.324*** 0.371***

Model 3

PSP with KCP

Beta difference (Model 2 and Model 3)

S F E C I S F E C I

CKE 0.383*** 0.384**

*

0.319*** 0.383*** Nil

-0.056 -0.055 -0.12 -0.056

Nil

S/F/E/C/I 0.298*** 0.282**

*

0.357*** 0.312***

FIKE 0.265*** Nil 0.286*** 0.311** 0.281*** -0.107 Nil -0.084 -0.063 -0.064

S/F/E/C/I 0.260*** Nil 0.402*** 0.324*** 0.278***

Note: S: Social, F: Filter, E:External. C:Combine, I:Internal

V. DISCUSSIONS AND SUMMARY

The test results show that CKE is positively and significantly related with KCP during PSS

design except with Internalization modes. Although the relationship between the two

constructs is positive, the relationship is not significant. Whereas FIKE is positively and

significantly related with KCP during PSS design. Both CKE and FIKE are positively and

significantly related to PSP. This means CKE and FIKE are contributors for product and

service performance.

Finally, PSP is influenced by how well new knowledge is created using SfECI modes during

PSS design. Only three modes of KCP (Filtration, Externalization and Combination) proved

to be predictors of PSP. Socialization and Internalization modes show a positive relationship

towards KCP but not significant. It is because, the two important modes of KCP are

Externalization and Combination, which are both contributing factors to new knowledge

creation, whereas Socialization is treated as capturing input process thus it has less impact

towards PSP. Similarly, Internalization involves with internalizing and distributing output of

KCP and becomes an input for future use. However, it seems that Filtration process is equally

important as externalization and combination modes that have significant positive

relationships towards PSP. The filtration process could enhance the quality of knowledge

created and improve the product functionality and service quality.

The mediating effect demonstrates the relationship between CKE, FIKE, and PSP is

mediated by KCP. KCP has a partial mediating effect, meaning that the three constructs

CKE, FIKE, and KCP are significantly predicting PSP. However, an Internalization of

knowledge creation mode does not mediate the effect between CKE and PSP. Similarly,

Filtration mode of the KCP failed to mediate the relationship between FIKE and PSP.

The study has implication on theoretical and practical. First, in terms of theoretical the paper

offers novel views of how the KCP using SfECI approach during an integrated product-

service design to mediate the effect between the PSS performance and CKE and FIKE.

Second, additional process during knowledge creation, Filtration is added to the original SECI




process to ensure the information gathered during socialization is filtered according to the

firm's objective and requirement. Third, the research also demonstrates the importance of

new search especially customer knowledge from the user-pays and retirement stage during the

PSS product design, while at the same time maintain the exploitation of existing capabilities

to enhance new concept creation that has the ability to embed the service and end-of-life

options in the product design.

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Risk Management Committee’s Characteristics, its Prestige and

Efficiency Performance

Qian Long Kweh

Universiti Tenaga Nasional

Sultan Haji Ahmad Shah Campus, 26700 Muadzam Shah, Pahang

Malaysia

[email protected]

Wen-Min Lu

National Defense University

No. 70, Sec. 2, Zhongyang North Rd., Beitou, Taipei 112

Taiwan

[email protected]

Noor Azlinna Azizan

Universiti Malaysia Pahang

Lebuhraya Tun Razak, 26600 Gambang Kuantan, Pahang

Malaysia

[email protected]

Abstract

We examine the effects of risk management committee’s characteristics and prestige on efficiency performance,

and the moderating effect of risk management committee’s prestige on the association between risk management

committee’s characteristics and the efficiency performance of Malaysian insurance companies across 2008-

2013. We apply the dynamic network slacks-based measure (DNSBM) model to estimate efficiency performance

and the truncated regression with a bootstrapping procedure shows that risk management committee’s

characteristics and prestige have significantly positive impacts on efficiency performance. However, risk

management committee’s prestige could minify the positive effect of risk management committee’s

characteristics on efficiency performance.

Key words: risk management committee; director’s prestige; efficiency; dynamic network data envelopment

analysis; truncated regression




1. Introduction

In Asia, it has been argued that Malaysian financial system was not affected by the global

financial crisis in the late 2000s. However, Malaysia indeed felt the spill-over effect as

evidenced by the large drop in exports alongside domestic demand (Asian Development

Bank, 2009). The relatively small effect of the global financial crisis could be because most

Asian countries including Malaysia have introduced much better financial regulatory regimes

since the Asian financial crisis of the late 1990s. That is, financial institutions in the Asian

countries have improved their corporate governance (CG) and internal risk management.

Learning from the lesson, the bad impacts of the financial crises on corporate performance

would be less eminent if risk management was properly regulated. In other words, there is a

serious lack of risk management in financial institutions.

It is surprising to see the relatively few research conducted on corporate risk management in

Malaysia as compared to other emerging economies seeing the growing importance of risk

management around the world. Since risk management has cost control implications, an

analysis of the impact of risk management on corporate performance is necessary to

substantiate findings of previous studies, which generally argues that the implementation of

risk management will improve corporate performance. That is, prior studies suggest that risk

management has a positive relationship with corporate performance. For example, Aebi,

Sabato, and Schmid (2012) find that the presence of a chief risk officer (CRO) in a bank’s

executive board and the situation in which the CRO reports directly to the board of directors

are positively related to corporate performance. Furthermore, risk management not only

contribute to corporate performance, but also positively affect the performance of new

product development as documented by Mu, Peng, and MacLachlan (2009).

Data envelopment analysis (DEA), a non-parametric method that utilizes mathematical

programming to handle multiple variables and relationships simultaneously (Cooper, Seiford,

& Tone, 2006), provides us with an opportunity to view corporate performance from resource

dependence view. In the DEA literature, a growing body of studies also documents the

impact of risk management on efficiency. Using traditional DEA, Kao, Lin, Hsu, and Chen

(2011) prove that risk factors contribute to the performance of financial holding companies

(FHCs), especially in managing credit risk after the 2008 financial crisis. Hadad, Hall,

Kenjegalieva, Santoso, and Simper (2011) indicate that enhancing internal risk management

could improve the productivity of the Indonesian banks, which is measured through the

Malmquist productivity indices of DEA. In a more related study, Cummins, Dionne, Gagné,

and Nouira (2009) show that risk management significantly increases the efficiency of

companies in the U.S. property-liability insurance industry.

Taken together, anecdotal evidence suggests that risk management increases corporate

performance, whereby if a financial institution has a well-established risk management

system, it would have lower costs and ultimately higher efficiency performance. In this

regards, risk management committee plays an important role in ensuring the risk management

system in a financial institution. Therefore, we expect that if a financial institution has an

efficient risk management committee, it would have lower costs and ultimately higher

efficiency performance. To comprehensively measure efficiency performance, we apply a

dynamic network DEA model that takes intermediate measures or linking activities into

consideration over long-term periods (Kaoru Tone & Tsutsui, 2014).




While the resource-dependence perspective (Pfeffer & Salancik, 1978) is able to describe the

benefits of having an efficient risk management committee and efficiency performance

measurement, several studies (Certo, 2003; Kirchmaier & Kollo, 2006) have revealed that

board prestige has effects on corporate performance based on sociological research on

prestige (for example, MacKinnon & Langford, 1994; Wegener, 1992). Note that prestige is a

commonly-used notion in social network theory and yet it is a construct difficult to define

precisely. The empirical research to date provides mixed evidence in regards of the impacts

of board prestige on corporate performance. The precise cause was open to debate.

Furthermore, a prestigious board structure does not necessarily implicate a prestigious risk

management committee. Consequently, it is an empirical question whether risk management

committee’s prestige has any impacts on corporate performance and what its moderating

effect on the association between risk management committee’s characteristics and corporate

performance would be.

This study is significant in that risk management ought to be integrated into the business, as a

matter of highest priority, before another economic catastrophe happens. Moreover, this study

provides a good explanation as to why risk management committee’s prestige is a key issue

in risk management committee structure and why having prestigious risk management

committee has many benefits to corporate performance.

The continuing divisions of this study proceed as follows. Section 2 develops the main

hypotheses. Section 3 discusses research design. While Section 4 presents the findings,

Section 5 concludes this study.

2. Hypotheses Development Concerned with reducing the cost or the cost of risk, risk management, which is generally

understood to mean methods used to reduce risk and control loss, comes into place. The

leading study, Froot, Scharfstein, and Stein (1993), has provided theoretical insights on

corporate risk management policies, which have then served as guidance for much of the

extant empirical studies relating to risk management. Stulz (1996) presents a theory of

corporate risk management and argues that the main goal of risk management is to shield a

company from the possibility of costly situations, whereby such situations would ultimately

cause financial distress. In other words, risk management is designed to reduce the expected

costs of facing financial problem while ensuring exploitation of comparative advantage.

With respect to the relationship between risk management and corporate performance, Mu et

al. (2009) find that risk management not only contributes to corporate performance, it could

also positively affect the performance of new product development. In a recent study,

Matthews (2013) argues that Chinese banks have in recent years developed modern risk

management methods. Using a network DEA framework, the author finds that there is no

significant direct relationship between the two self-constructed risk metrics and objective

measure of performance such as return on assets. Over the 18-month period from July 2007

to December 2008, Aebi et al. (2012) find that the presence of a chief risk officer (CRO) in a

bank’s executive board and the situation in which the CRO reports directly to the board of

directors are related to a better stock returns and return on equity. Using 14 Taiwanese FHCs

for the period 2001-2009, Kao et al. (2011) prove that risk management contributes to the

operating efficiency of FHCs, especially in managing credit risk after the 2008 financial




crisis. Using Indonesian banks over the period Q1 2003 to Q2 2007, Hadad et al. (2011)

indicate that enhancing internal risk management could improve the productivity of the

Indonesian banks. In a more related study, Cummins et al. (2009) show that risk management

significantly increases the efficiency of the U.S. property-liability insurance industry for the

period 1995 through 2003. Overall, these results suggest that risk management contributes to

firm performance.

In light of the empirical evidence described in the preceding paragraph, which mostly show

that risk management is positively associated with corporate performance, we predict that

risk management increases efficiency performance. Therefore, we present a directional

hypothesis in alternate form for the three attributes of risk management, in line with Ng,

Chong, and Ismail (2013):

Hypothesis 1: Other things being equal, the number of directors on the risk management

committee including executive and non-executive directors, the number of risk management

committee meetings, and the proportion of independent directors in the risk management

committee are significantly and positively associated with efficiency performance.

A typical characteristic of an individual is prestige, which is defined by D'Aveni (1990) as

“the property of having status”. The term prestige embodies a multitude of concepts like

esteemed educational qualification, prior experience serving military, government, or

business, and social connections (see also D'Aveni & Kesner, 1993; Daily & Johnson, 1997).

In the context of risk management committee (or board of directors at a wider perspective),

the term can be generally understood to mean the committee members’ credibility,

trustworthiness, and competency. As D'Aveni (1990) point out, however, prestige might

reflect an illusion of competence on the individual level. Specifically, prior studies

predominantly rely on objective indicators to proxy for prestige, which renders possibility

that the social network theory is associated with good name alone rather than hard attributes

like elite educational affiliations (Kirchmaier & Kollo, 2006).

In a seminal contribution to the importance of directors’ prestige, May (1939) contend that

prestigious directors on British boards are expert in nothing but someone with high-status

name on the prospectus. The existence of prestigious directors in a company might therefore

cause agency problems whereby the shareholders’ goal is not fulfilled, and affect corporate

performance in the long run. Therefore, linking social networks to prestige would be able to

highlight the feature of high-status name, isolating it from ability. To measure prestige,

Kirchmaier and Kollo (2006) have applied titles carried by directors in their name such as

‘Lord’ and ‘Sir’ and yet found that prestige in terms of title does not significantly affect firm

value.

The Malaysian also use many honorifics, whereby heredity royal titles are reserved for royal

families of Malaysia while titles of honour, both federal and state, are regularly granted to

both men and women who have made significant contributions to the society with respect to




fields such as politics and business. Since the past few decades, the title glut1 in Malaysia has

created a phenomenon of relationship-based connection, which is particularly prevalent in the

relationship between politics and business. Such connection is linked with social networks

(synonymous with “political connections”)2, a unique scenario in the Malaysian corporate

world. To be specific, titles granted to individual in recognition of his or her various services

to the government may act as public signal of the individual’s prestige. In the literature,

scholars have also documented the prevailing phenomenon of social networks or political

connections in Malaysia, implying the existence of relationship-based capitalism (for

example, Bliss & Gul, 2012a, 2012b; Bliss, Gul, & Majid, 2011; Gomez & Jomo, 1997;

Johnson & Mitton, 2003).

In other words, as prestige is in itself a highly-regarded status, risk management committee

directors of a company who carry titles in their name may have more advantages in managing

risks as compared to those who do not have any social connections. From the resource-based

perspective, prestigious directors should be able to draw more resources and benefits from

their social connections. Before employing these theories – the resource-based view theory

and the social networks theory – to examine risk management committee’s prestige, it is

necessary to discuss some relevant studies. So far this chapter has focused on directors’

prestige or social connections through titles of honour. To the best of our knowledge, using

titles and honorifics granted by government to measure prestige provides us a distinctive

opportunity to examine the relationship-based scenario in Malaysia, which is principally

unobservable in the insurance industry.

Serious discussions on this topic document that social networks at the firm level as a whole

allow companies to benefit from various aspects: capital controls (Johnson & Mitton, 2003;

Mitchell & Joseph, 2010), financial bailout (Faccio, Masulis, & McConnell, 2006), retarding

financial development (Rajan & Zingales, 2003), tax benefits (Adhikari, Derashid, & Zhang,

2006; Wu, Wu, Zhou, & Wu, 2012), and preferential access to debt financing (Chan, Dang, &

Yan, 2012; Claessens, Feijen, & Laeven, 2008; Khwaja & Mian, 2005; Yeh, Shu, & Chiu,

2013). However, all the previously mentioned studies do not take into consideration social

connections on account of title’s prestige. Moreover, it is important to bear in mind the

possible bias in the classification of politically connected companies, which is achieved by

referring to the list of companies identified by prior studies for the out-of-date sample period.

In addition, while social networks may provide companies with various benefits, empirical

evidence on Malaysian sample to date strongly suggests that connected companies are more

risky than non-connected companies based on the perspective of performance. Using 424

Malaysian firms, Johnson and Mitton (2003) show that connected companies were hit harder

during the 1997 Asian financial crisis. Their regression analysis shows that connections result

in a greater stock price decline, which is an average of 7.5 percentage points during the crisis

period. Connected firms experienced drops in share prices to a greater extent than non-

connected firms because it is accepted that the social network ability to provide privileges

was reduced by the crisis. Consistent with the market perception, they prove empirically that

the imposition of capital controls in September 1998 affects positively the performance of

connected firms.

1 In Malaysia, the ratio of titled individuals to the country’s population is higher than that of the United

Kingdom and both systems are vastly different. 2 Malay cultural expert Eddin Khoo claimed that titles are widely abused for their advantages and connections.




The preceding studies imply that many parties consider connected firms as risky, especially

during financial crisis. Specifically, while companies with prestigious directors on board have

some benefits, they do not seem to benefit fully from resources provided by the social

network such as the lower effective tax rate and preferential access to financing. However,

Poon, Yap, and Lee (2013) find that potential agency problems could be minimized through

socially-connected board members. This notion is consistent with the argument by Johnson

and Mitton (2003) and Gul (2006), which states that controlling function of the ruling

political party helps politically connected companies recovered faster after the financial

crisis.

To elaborate on the main idea, political theorists like North (1990) and Olson (1993) explain

why social connections with political parties come into existence. The reason politicians or

government people get connected with companies is to control the companies. By controlling

the companies, those with political power would be able to create personal wealth in private

institutions. Apart from personal wealth, they also pursue goals that are beneficial to the

government’s agenda, in which Chang and Wong (2004) describe it as to pursue the

communal interests and social objectives. Both of the politicians’ acts are to reward their

supporters for their political votes. In return, the socially-connected individuals receive

benefits from various governmental interventions such as profitable contracts for their

attached companies.

While abovementioned theoretical and empirical studies refer to organizational connections

in which political parties or government transfer resources to connected firms, it is reasonable

to apply the same reasoning to explain social networks in terms of prestigious directors on

boards, particularly risk management committee. In particular, we integrate the social-

network notion of prestige through titled directors by Kirchmaier and Kollo (2006) and the

theories of North (1990) and Olson (1993) and contend that titles of honour carried by

directors bring about benefits to companies. In other words, social networks might improve

corporate performance if directors on risk management committee carry titles in their name

or commonly known as socially connected.

In view of the different expectations regarding the effect of social connections on corporate

performance, it is also an empirical issue whether social networks moderate the monitoring

effectiveness of risk management committee in managing corporate risks. Based on the

resource-dependence perspective (Pfeffer & Salancik, 1978) and the social network theory,

we develop the following hypothesis to test the main effect of prestige on corporate

performance.

Hypothesis 2: Other things being equal, the number of titles of honour carried by directors on

risk management committee is significantly and positively associated with efficiency

performance.

However, other things being equal and echoing the theories of North (1990), Olson (1993),

and Chang and Wong (2004), we predict that the positive effect of risk management on

efficiency performance might be moderated by prestige. This competing argument leads to

the following hypothesis, in alternate form:




Hypothesis 3: Other things being equal, the number of titles of honour carried by directors on

risk management committee significantly and negatively moderates the relationship between

risk management and efficiency performance.

3. Research Design

3.1 Dynamic network operating process for insurance companies

In this study, we employ a dynamic DEA model with network structure (Kaoru Tone &

Tsutsui, 2014) to assess the corporate performance of insurance companies in Malaysia from

an operational view over long-term periods. It is worth noting that insurance companies

should efficiently manage their resources to be profitable and ultimately sustainable,

especially in the aftermath of the global financial crises that affected the worldwide financial

markets. Since insurance companies might have difficulty in controlling carry-overs in an

instant manner due to the highly volatile market, they should thus assess and improve their

corporate performance on a long-term basis, considering intermediate measures at the same

time, all of which would enable them to assess their dynamic performance at a clearer

picture.

Figure 1: The Dynamic Network Operating Processes for Insurance Companies

To further illustrate the discussion, we present a diagram on the dynamic network operating

processes for insurance companies. As shown schematically in Figure 1, the two-stage DEA

analysis is divided into two main components, namely the resource-management efficiency

and the profitability efficiency. The resource-management efficiency is proposed to assess

how efficient an insurance company manage their inputted resources in relation to other

insurers, while the profitability efficiency is designed to evaluate how efficient an insurance

company generate profits relative to other insurers in the dynamic and challenging market.

Table 1 Definitions of the Input, Carry-over, Intermediate, and Output Variables

Variable Definition

Stage 2

Profitability

Efficiency t

Stage 1

Resource-

Management

Efficiency t

Carry-over

Property, plant,

and Equipment t-1

Intermediate

Incurred claims plus

additions to reserves t

Investment assets t

Period t Period t+1

Input

Labor and business

service expenses t

Output

Operating income t

Operating cash flow t

Stage 2

Profitability

Efficiency t+1

Stage 1

Resource-

Management

Efficiency t+1

Input

Labor and business

service expenses t+1

Output

Operating income t+1

Operating cash flow t+1

Carry-over

Property, plant,

and Equipment t

Carry-over

Property, plant,

and Equipment t+1

Intermediate

Incurred claims plus

additions to reserves t+1

Investment assets t+1

Carry-over

Debt capital t-1

Equity capital t-1

Carry-over

Debt capital t

Equity capital t

Carry-over

Debt capital t+1

Equity capital t+1




Input

Labor and business

service expenses (x1)

The total amount of operating expenses including staff expenses for the year, which is available in the income

statement (Chen, Liu, & Kweh, 2014; Eling & Luhnen, 2010a; Lu, Wang, & Kweh, 2014).

Carry-over

Debt capital (c1) The total amount of liabilities at the beginning of the year, which is available in the balance sheet (Chen et al.,

2014; Cummins, Weiss, Xie, & Zi, 2010; Lu et al., 2014).

Equity capital (c2) The total amount of shareholders’ equities at the beginning of the year, which is available in the balance sheet

(Eling & Luhnen, 2010a; Greene & Segal, 2004; Kaoru Tone & Sahoo, 2005).

Property, plant, and

equipment (c3)

The total amount of property, plant, and equipment at the beginning of the year, which is available in the

balance sheet.

Intermediate

Incurred benefits plus

additions to reserves

(z1)

While incurred benefits are claims paid for the year, additions to reserves are the funds received by insurers

not needed for benefit payments and expenses that are added to policy reserves at the end of the year (Chen et

al., 2014; Eling & Luhnen, 2010a; Lu et al., 2014).

Investment assets (z2) The total amount of investment assets at the end of the year, which is available in the balance sheet (Chen et

al., 2014; Eling & Luhnen, 2010a)

Output

Operating income (y1) The total amount of operating income for the year, which is available in the income statement.

Operating cash flow

(y2)

The total amount of cash flow generated from operations for the year, which is available in the statement of

cash flow.

Note:

1. All variables are denoted in RM million.

2. The value-added approach or called the production approach is used in this study.

In the selection of inputs, intermediates, carry-overs, and outputs, two factors need to be

considered (Bowlin, 1995). The first consideration is the production function nature of the

DEA model used, in which this study applies the dynamic DEA with network structure

through a slacks-based measure (SBM) approach (Kaoru Tone & Tsutsui, 2014). The second

thought should be related to the financial analysis nature of the research, where by this study

focuses on the insurance industry. Therefore, as can be seen in Figure 1 above, insurers

consume labor and business service expenses along with debt capital and equity capital as

inputted carry-overs to produce incurred claims plus additions to reserve and investment

assets.3 These two intermediates, together with property, plant, and equipment as inputted

carry-overs, are next utilized to generate operating income and operating cash flow. In Table

1, we summarize the variables used by citing relevant studies. Table 2 provides the summary

statistics of the inputs, intermediates, and outputs of our sample over the sample period 2008-

2013. Consistent with prior studies (Chen et al., 2014; Lu et al., 2014), we deflate the

variables to 2007 by dividing them by the 2007 Malaysia's Consumer Price Index (CPI) at

105.7.

Table 2 Summary Statistics of the Input, Carry-over, Intermediate, and Output Variables

Mean Std. Dev. Minimum Maximum

3 Eling and Luhnen (2010b) point out that labor, business services and materials, and capital are the three main

resources used by insurance companies.




Panel A: Year 2008

Operating expenses (x1) 76.76 64.65 8.53 292.05

Total liabilitiest-1 (c1) 2,277.23 7,167.53 126.59 39,757.26

Total shareholders’ equitiest-1 (c2) 351.69 357.01 99.59 1,668.22

Property, plant and equipmentt-1 (c3) 75.22 134.19 1.72 591.38

Incurred benefits plus additions to reserves (z1) 8,602.06 1,144.49 8,012.00 13,481.27

Investment assets (z2) 2,857.63 6,328.23 90.47 33,811.04

Operating income (y1) 858.59 1,170.97 54.45 6,135.83

Operating cash flow (y2) 2,020.03 109.18 1,792.97 2,489.48

Panel B: Year 2009





Incurred benefits plus additions to reserves (z1) 8,934.22 3,130.89 983.36 22,278.22


Operating income (y1) 988.54 1,295.74 117.82 6,229.05


Panel C: Year 2010







Operating income (y1) 1,176.02 1,480.65 131.39 7,217.12


Panel D: Year 2011












Panel E: Year 2012








Operating cash flow (y2) 2,034.27 278.90 949.64 2,805.66

Panel E: Year 2013









3.2 The dynamic slack-based measure model with network structure

As for the DEA formulation, consider the dynamic network operating processes in Figure 1

that deals with n insurers (j = 1,…,n), k stages ( 1,..., )k K over T periods ( 1, ,t T ). At

each period, insurers utilize common k

tm inputs (i = 1,b…, k

tm ) consisting of k stages to

produce k

tr outputs (i = 1,…, k

tr ) consisting of k stages. Let k

iotx(i = 1,…,

k

tm) and

k

roty(i =

1,…, k

tr ) represent the observed input and output values of insurer j consisting of k stages at

period t, respectively,

( , )k h

jtz denote carry-overs values between periods t and t+1. In this

study, the category link is symbolized as badC

. To identify them by period (t), insurer (j),

stages ( k ), and item (i), this study utilizes a notion

,k bad

potC

,( 1, , ; 1, , ; 1,..., )k bad

tp m t T k K for representing bad link values where nbad refers to




the number of bad links. These are all observed values up to the period T. Let ,k bad

tm denote

the observed inputted carry-over values of insurer j consisting of k stages at period t. Using

these expressions for the operating production processes, this study expresses the target

oinsurer (o = 1,…,n). This study thus defines the non-oriented efficiency by solving the

following programs:

,,

1 , ,1 1 1

*

1 1 1

1 11

1 11

k k badtt

kt

k badkK m m ptT k it

t t k k bad k k badk i pt t iot pot

ok

K rT k rtt t k kk r

t rot

ssw

T m m x CMin

sw

T r y

(1)

1

1

1

( , ) ( , )

1 1

. .

( 1,..., ; 1, , ; 1,..., )

( 1,..., ; 1, , ; 1,..., )

1( 1, , )

, ( , )( 1, , )

nk k k k k

iot ijt jt it tj

nk k k k k

rot rjt jt rt tj

n k

jtj

n nk h h k h k

jt jt jt jtj j

k

pot

s t

x x s i m t T k K

y y s r r t T k K

t T

z z k h t T

C

, , , ,

1

, , ,

11 1

,

( 1, , ; 1, , ; 1,..., )

( 1, , ; 1, , 1; 1,..., )

0, 0, 0, 0

nbad k bad k k bad k bad

pjt jt pt tj

n nk bad k bad k bad

ijt jt ijt jt tj j

k k k k bad

jt it rt pt

C s p m t T k K

C C p m t T k K

s s s

(2)

where o denotes the overall efficiency during the period T, while

k

its

, k

rts

and ,k bad

pts

are

slack variables denoting, input excess, outputs shortfall, link excess, and link deviation,

respectively. The above-stated objective function, an extension of the non-oriented SBM

model (K. Tone, 2001), deals with excesses in both inputs and undesirable (bad) links. The

numerator is the average input efficiency and the denominator is the inverse of the average

output efficiency. The objective function value is also units-invariant. Note that the non-

oriented overall efficiency is a ratio that ranges between zero and unity; when all slacks are

nil, a DMU will be given an efficiency score of 1.4 Put differently, oinsurer is called non-

oriented overall efficient or briefly overall efficient if the optimal solution for Equation (1)

satisfies 1o .

,,

, ,1 1 1

1 1

11

11

k k badtt

kt

k badkK m m ptk it

t k k bad k k badk i pt t iot pot

tk

K rk rtt k kk r

t rot

ssw

m m x C

sw

r y

(3)

4 The DEA score measuring relative efficiency ranges from 0 to 1, in which an insurer with the score of one is

relatively efficient, while one with a score of less than 1 is relatively inefficient.




where 1

1 T

o t tT

in Equation (3). If all optimal solutions satisfy 1t , oinsurer is

called non-oriented period efficient or briefly period efficient for period T. Again, this is true

under the condition that the optimal slacks for period t in Equation (3) are all zero.

,,

, ,1 1

1

11

11

k k badtt

kt

k badkm m ptit

k k bad k k badi pt t iot pot

k

tk

r rt

k krt rot

ss

m m x C

s

r y

(4)

In Equation (4), 1

kK k

t k t tw . If all optimal solutions satisfy 1k

t , oinsurer is called

non-oriented period efficient or briefly period efficient with the stage k at the period T,

provided that the optimal slacks with the stages k at period t in Equation (4) are all zero.

3.3 Empirical Models

Truncated regression is an appropriate method in the regression analysis involving efficiency

scores as the dependent variable (Simar & Wilson, 2007). Simar and Wilson (2007)

document that OLS or Tobit regression is a relatively inefficient tool for this kind of study.

Simar and Wilson (2011) argue that truncated regression with bootstrapping approach could

best overcome the unknown serial correlation complicating the two-phase analysis.

Therefore, we apply the truncated regression model recommended by Simar and Wilson

(2011) to evaluate the relationship between exogenous factors and the efficiency performance

of insurance companies in Malaysia. Specifically, this study tests the following specification:

, 1,...,j j jX j n (5)

where α is the intercept and εj is the error term. Xj represents a 1 d vector of observation-

specific variables for insurer j, which is expected to be associated with the insurer’s

efficiency score, viz. j . That is, the scalar and the vector in Equation (5) are unknown

parameters to be estimated.

Instead of using Tobit estimation, Simar and Wilson propose an approach based on a

truncated regression with a bootstrapping procedure for estimating Equation (5). The

performance of their Monte Carlo experiments is satisfactory. To obtain an assumption that

the distribution of j , which is restricted by the condition 1j jZ , before truncation

is truncated with zero mean, unknown variance and a truncation point that are determined by

different conditions, Equation (5) is modified and we thus estimate the following equation:

2

ˆ , 1,...,

: (0, ) , 1 , 1,..., .

j j j

j j j

Z j n

where

N such that Z j n

(6)

Note that the true but unobserved efficiency j is replaced by its estimate, viz. ˆj . We use

the parametric bootstrapping technique for regression process to derive more accurate




bootstrap confidence intervals for the estimates of parameters 2, , and to estimate

Equation (6) by maximizing the corresponding likelihood function, and give heed to the

2, .

In this study, we construct the two main truncated regression models, Equations 7 and 8, to

test our hypotheses. To confirm the fitness of the models, we conduct a simulation test with a

total of 3,000 experimental observations.

0 1 2 3

4

it it it it

it it

PERF RMGT PRES CG control variables

Other control variables

(7)

0 1 2 3

4 5

*

it it it it

it it it

PERF RMGT PRES RMGT PRES

CG control variables Other control variables

(8)

where:

PERFit = Insurer i’s efficiency scores in terms of non-oriented overall efficiency in

year t.

RMGTit

= Insurer i’s risk management as proxied by RMSIZE, RMMEET, and RMIND

in year t. Specifically, (a) RMSIZEit refers to the natural logarithm of the

number of directors on the risk management committee including executive

and non-executive directors, while (b) RMINDit means the proportion of

independent directors in the risk management committee. (c) RMMEETit is

the natural logarithm of the number of risk management committee meeting,

following Ng et al. (2013).

PRESit

= The natural logarithm of insurer i’s number of directors carrying titles of

honour in their name in year t.

CG control variablesit

BSIZEit = The natural logarithm of insurer i’s number of directors on the board in year

t.

BINDit = Insurer i’s proportion of independent directors to total directors in year t.

BMEETit = The natural logarithm of insurer i’s number board meeting in year t.

Other control variablesit

FSIZEit = The natural logarithm of insurer i’s total assets in year t.

LEVit = Insurer i’s ratio of total liabilities to total assets in year t.

LIQit = Insurer i’s ratio of insurance receivable to insurance payable in year t.

PGit = Insurer i’s growth in total premiums received in year t.

TYPEit = A categorical variable, in which insurer i is assigned a value of one, two, or

three if insurer i is a general insurer, life and general insurer, or life insurer in

year t, respectively.

LOCALit = A dummy variable that takes a value of one if insurer i is a locally-bred

company, and zero otherwise.

We expect to have significantly positive coefficients on 1 and 2 , and significantly

negative coefficient on 3 for Equations (7) and (8), respectively.

3.4 Data Collection




In this study, we first identify all licensed insurance companies in Malaysia that are available

on the website of Central Bank of Malaysia

(http://www.bnm.gov.my/index.php?ch=13&cat=insurance). Subject to the availability of

annual reports, we are able to have an initial dataset for the period from 2007 to 2013. In

other words, restricting our data to the stated sample period maximizes our sample size. To

ensure that we have a balanced panel dataset for analysis, we exclude insurance companies

for which we could not obtain complete required information. With that, our final sample

dataset consists of 30 insurance companies in Malaysia. These insurers’ total assets account

for approximately 98.5 per cent of the total assets of all insurers in Malaysia. That is, our

sample of insurance companies is representative of the insurance industry in Malaysia.

Overall we have 30 insurance companies in Malaysia for the DEA analysis and 180 firm-year

observations for the regression analysis.

As far as the sample size is concerned, we find that the sample size of this study is not

a problem for at least two reasons. First, the sample size meets the requirement of the DEA

approach, which requires that the number of decision-making units (DMUs)5 should be at

least twice the sum of the variables used for the DEA analysis (Golany & Roll, 1989). In this

study, the 30 insurance companies are 3.75 times more than the total number of variables

(1+2+2+1+2). Second, in the regression analysis, we apply truncated regression with a

bootstrapping approach (Simar & Wilson, 2011; Simar & Wilson, 2007), which is able to

mitigate the susceptibility of small sample size. As discussed earlier, the sample insurers are

approximately 98.5 per cent of the insurance industry in Malaysia, indicating that the final

sample used in this study is adequate.

In addition, the final sample dataset fulfils the assumption of ‘isotonicity’, which is another

requirement of a DEA-application study. The term ‘isotonicity’ can be described as the

existence of correlations that are positive among variables used in the DEA analysis, meaning

a proportional increase in an input variable would result in a proportional increase in an

output variable. The untabulated Pearson and Spearman correlation coefficients between

inputs and intermediates (the first-stage output), and between intermediates and outputs

reveal significantly positive correlations between inputs and outputs in the two stages of the

DEA analysis, respectively; thereby satisfying the condition. Particularly, the estimated DEA

efficiency results are meaningful when the DMUs are assumed to be “similar” and

“calculable” units. Taken together, the two-stage DEA model of this study is deemed valid,

and therefore the efficiency performance estimates are meaningful.

4. Results and Analysis

4.1 Efficiency Performance Analysis

On the question of overall efficiency, the general insurers achieve an average score of 0.718

over the sample period 2008-2013. The results indicate that the companies still have some

rooms to improve their overall performance in this dynamic business world. In regards of

period efficiency, it is somewhat surprising that the period efficiency estimates are found to

increase in 2009. This finding confirms an earlier statement that “it has been argued that

Malaysian financial system was not affected by the global financial crisis in the late 2000s.”

However, the performance fluctuated thereafter in the following years. Among the 30

insurers, The Pacific Insurance Berhad, Prudential Assurance Malaysia Berhad, and Manulife

Insurance Berhad appear to set the benchmark of efficiency for their peers as evident by the

5 In this study, the DMUs refer to the sample insurance companies in Malaysia.




ranking information. That is, the inefficient insurers could take the aforementioned

companies as role models in improving their performance.

Table 3 Overall and Period Efficiency Analysis (EFF1)

Mean efficiency score

Rank

Insurer 2008 2009 2010 2011 2012 2013 Overall

AmG Insurance Berhad 0.484 0.372 0.638 0.840 0.376 0.342 0.494 23

Berjaya Sompo Insurance Berhad 0.385 0.360 0.449 0.448 0.321 0.313 0.378 26

Kurnia Insurans (Malaysia) Berhad 0.416 0.528 0.560 0.463 0.347 0.319 0.435 25

Lonpac Insurance Berhad 0.732 0.454 0.668 0.747 0.735 0.734 0.659 17

Multi-Purpose Insurans Berhad 0.914 1.000 0.639 0.699 0.663 0.638 0.759 14

Pacific & Orient Insurance Co. Berhad 0.494 0.539 0.534 0.623 0.593 0.501 0.547 22

RHB Insurance Berhad 0.855 0.865 0.868 0.897 0.871 0.781 0.856 12

Tune Insurance Malaysia Berhad 0.991 0.997 0.963 1.000 1.000 1.000 0.992 7

Uni.Asia General Insurance Berhad 0.307 0.309 0.323 0.342 0.317 0.323 0.320 30

Etiqa Insurance Berhad 1.000 1.000 1.000 1.000 1.000 0.999 1.000 5

MCIS Zurich Insurance Berhad 0.422 0.399 0.383 0.375 0.246 0.247 0.344 28

AXA Affin Life Insurance Berhad 0.412 0.735 0.653 0.565 0.718 0.664 0.600 19

AmLife Insurance Berhad 0.624 0.998 0.998 1.000 0.465 0.485 0.712 16

Hong Leong Assurance Berhad 0.309 0.676 0.495 0.546 0.492 0.418 0.489 24

CIMB Aviva Assurance Berhad 0.419 0.354 0.306 0.359 0.289 0.326 0.338 29

Uni.Asia Life Assurance Berhad 0.666 0.605 0.625 0.787 1.000 0.707 0.723 15

Average for local insurers 0.589 0.637 0.631 0.668 0.590 0.550 0.603

AIG Malaysia Insurance Berhad 0.465 0.470 0.679 0.777 0.631 0.739 0.624 18

Allianz General Insurance Company (M) Berhad 0.655 0.604 0.529 0.601 0.516 0.468 0.562 21

MSIG Insurance (M) Berhad 0.921 0.995 0.998 0.999 0.999 0.999 0.985 9

Overseas Assurance Corporation (M) Berhad 0.902 0.986 1.000 1.000 0.434 0.381 0.779 13

The Pacific Insurance Berhad 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1

QBE Insurance (M) Berhad 1.000 0.991 1.000 0.872 1.000 1.000 0.975 10

Tokio Marine Insurans (M) Berhad 0.735 0.684 0.454 0.583 0.531 0.492 0.578 20

AIA Berhad 0.666 0.856 0.923 1.000 1.000 1.000 0.899 11

Prudential Assurance Malaysia Berhad 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1

Zurich Insurance Malaysia Berhad 0.981 0.998 0.997 0.997 0.992 0.995 0.994 6

Allianz Life Insurance Malaysia Berhad 0.916 1.000 1.000 1.000 1.000 0.998 0.986 8

Great Eastern Life Assurance (M) Berhad 1.000 1.000 1.000 1.000 1.000 1.000 1.000 4

Manulife Insurance Berhad 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1

Tokio Marine Life Insurance Malaysia Berhad 0.464 0.416 0.417 0.401 0.226 0.225 0.356 27

Average for foreign insurers 0.836 0.857 0.857 0.874 0.809 0.807 0.838




Total average efficiency score 0.705 0.740 0.737 0.764 0.692 0.670 0.718

Standard deviation 0.253 0.263 0.251 0.241 0.292 0.292 0.248

Minimum efficiency score 0.307 0.309 0.306 0.342 0.226 0.225 0.320

Maximum efficiency score 1.000 1.000 1.000 1.000 1.000 1.000 1.000

In addition, the results in Table 3 also show that foreign insurers are more efficient than local

insurers across the sample period 2008-2013. On the whole, foreign insurers are on average

23.5 per cent more efficient than local insurers. The trend of performance for local insurers

mirrors that of the overall efficiency, fluctuating over the years. As for foreign insurers, their

efficiency scores increase almost monotically from 2008 to 2011 before running into a sharp

decrease in 2012. Turning now to the driver of the overall efficiency, we would compare the

results of resource-management efficiency and profitability efficiency that are reported in

Tables 4 and 5, respectively. It is interesting to note that the average efficiency scores of

resource-management efficiency in all years are higher than those of profitability efficiency.

The findings on the total average show that insurers obtain an average resource-management

efficiency score of 0.774 but only 0.675 in terms of profitability efficiency.

Table 4 Average and Period Efficiency Analysis for Stage 1 – Resource-Management Efficiency (EFF2)


Rank

Insurer 2008 2009 2010 2011 2012 2013 Average




























AIA Berhad 0.705 0.837 0.946 1.000 1.000 1.000 0.915 12












The observation that resource-management efficiency is the main driver that contributes to

overall efficiency, however, is only found in local insurers. Interestingly, the efficiency

scores of profitability efficiency (periodic average = 0.522) for local insurers are obviously

much lower than those of their resource-management efficiency (periodic average = 0.722),

both across 2008-2013 and on the average basis. In contrast to local insurers, foreign insurers

appear to achieve better profitability efficiency (periodic average = 0.849) instead of

resource-management efficiency (periodic average = 0.832). These differences could be

explained in part by the fact that local and foreign insurers possess different strengths. It is

intuitive that local insurers rely more on resource-management efficiency in driving their

overall performance due to locality. However, another question arises on whether differences

truly exist between them, who probably have their exclusive characteristics.

Table 5 Average and Period Efficiency Analysis for Stage 2 – Profitability Efficiency (EFF3)


Rank Insurer 2008 2009 2010 2011 2012 2013 Average




























AIA Berhad 0.639 0.875 0.902 1.000 1.000 1.000 0.903 13












To address the question raised earlier, we present Table 6, documenting test of difference on

the efficiency scores across 2008-2013. Both non-parametric Mann-Whitney U test and

parametric t-test reveal that the significant differences exist between local insurers and

foreign insurers on the three categories of efficiencies. Specifically, foreign insurers are

statistically shown to have significantly higher overall efficiency, resource-management

efficiency, and profitability efficiency as compared to local insurers. As an additional

analysis, we also compare among the type of services provided by the insurers. The

insignificant results obtained in Table 6 suggest that they could be homogenous in providing

insurance services. In summary, we find that foreign insurers are the constant good

performers in relation to local insurers and the main driver of their respectable overall




performance is their capability in transforming intermediates like investment assets into

operating cash flow.

Table 6 Test of Difference on the Efficiency Scores over the Sample Period 2008-2013

Features Classification

Overall

period

efficiency

Resource-

management

efficiency

Profitability efficiency

Mean Median Mean Median Mean Median

By capital

source

Local insurers (N = 96) 0.611 0.579 0.722 0.689 0.536 0.482

Foreign insurers (N = 84) 0.840 0.998 0.832 0.998 0.851 0.999

Test of difference (p-value) 0.000 0.000 0.001 0.005 0.000 0.000

By type of

services

General (N = 96) 0.711 0.681 0.744 0.716 0.689 0.927

Life & General (N = 30) 0.691 0.739 0.795 0.838 0.614 0.796

Life (N = 54) 0.744 0.855 0.814 0.855 0.711 0.849

Test of difference (p-value) 0.635 0.594 0.159 0.480 0.475 0.7047

4.2 Descriptive Statistics

Table 7 compares the descriptive statistics between local insurers and foreign insurers on

independent variables included in the empirical model. It is apparent that local insurers have

more directors serving as risk management committees (RMSIZE) and they hold more

meetings annually (RMMEET) (mean = 5 times) as compared to foreign insurers. While local

insurers hire about 4 persons on average as risk management committee, foreign insurers

generally have less than their counterparts. Risk management committee members of foreign

insurance companies meet for approximately 4 times on average yearly. However, the

number of independent directors in the risk management committee (RMIND) of foreign

insurance companies is larger than that of local insurers. In regards of another main variable,

viz. PRES, we find that local insurers have more directors on risk management committee

who carry titles in their name relative to foreign insurers. Overall, the difference-in-means

results indicate that statistically significant differences exist between local insurers and

foreign insurers with respect to risk management committee’s characteristics, board of

directors’ characteristics with the exception of board independence, and firm size.

Table 7 Test of Difference on the Independent Variables between Local and Foreign Insurers

Variable

Local insurer (N = 96) Foreign insurer (N = 84) Test of difference

(p-value) Mean Std. Dev. Mean Std. Dev.

RMSIZE 1.383 0.315 1.309 0.251 0.043

RMIND 0.612 0.274 0.726 0.176 0.002

RMMEET 1.601 0.513 1.447 0.229 0.006

PRES 1.103 0.391 0.593 0.441 0.001




BSIZE 1.942 0.216 1.801 0.194 0.001

BIND 0.543 0.149 0.550 0.156 0.386

BMEET 2.060 0.319 1.884 0.191 0.001

FSIZE 21.222 0.967 21.883 1.446 0.001

LEV 0.704 0.192 0.742 0.216 0.102

LIQ 2.061 0.898 0.797 0.715 0.218

PG 0.227 0.599 0.172 0.374 0.232

4.3 Regression Analysis

In this study, small sample size could have dishonoured the assumption that error terms are

independent of exogenous variables in a regression analysis. However, it is worth noting that

the truncated regression with bootstrapping approach used in this study could overcome the

small-sample problem. Besides, one researcher would expect strong correlations between the

efficiency scores and exogenous variables. Therefore, we test for the possibility of

multicollinearity. The untabulated correlation coefficients are generally lower than 0.6. Apart

from the correlation analysis, we also conduct the diagnostics of variance inflation factors

(VIF) whose values are all less than 2.2. These surfaced outcomes provide supports that there

is no potential multicollinearity problem in our regression analysis.

Before proceeding to discuss the regression results, it will be necessary to justify the use of

ordinary least square (OLS) in this study alongside the truncated regression technique. In a

DEA-application study that involves regression analysis in the second phase, Banker and

Natarajan (2008) have demonstrated that OLS regression analysis yields consistent estimators

of the regression coefficients. Therefore, in line with prior studies (for example, Chen et al.,

2014; Hsiao, Chang, Cianci, & Huang, 2010; Kweh, Lu, & Wang, 2014) and for sensitivity

analysis, we also present OLS results in Table 8.

Table 8 Regression Results – Overall Efficiency

Variable

Truncated regression

Ordinary least square

Coefficient p-value Coefficient p-value Coefficient p-value Coefficient p-value

Constant 1.437 0.047 0.492 0.166 0.665 0.090 1.346 0.016

RMSIZE 0.456 0.007 0.291 0.098 -0.008 0.924 -0.376 0.035

RMIND 0.234 0.077 0.736 0.041 0.004 0.961 -0.421 0.124

RMMEET 0.100 0.110 0.177 0.135

0.130 0.006 0.223 0.034

PRES 0.193 0.035 1.013 0.040 0.096 0.042 -0.640 0.051

RMSIZE* PRES -0.188 0.148 0.438 0.011

RMIND* PRES -0.417 0.087 0.347 0.127

RMMEET* PRES -0.262 0.074 -0.072 0.405

BSIZE –0.726 0.004 -0.274 0.073 -0.201 0.066 -0.198 0.087

BIND –0.692 0.018 -0.424 0.049 -0.100 0.467 0.000 0.998

BMEET –0.040 0.212 -0.205 0.064 -0.033 0.706 -0.108 0.232

FSIZE 0.042 0.098 0.053 0.046 0.021 0.251 0.023 0.238




LEV 0.308 0.059 -0.036 0.217 -0.138 0.116 -0.076 0.403

LIQ 0.003 0.168 0.010 0.011 0.006 0.000 0.006 0.000

PG 0.095 0.079 0.143 0.017 0.109 0.002 0.114 0.001

TYPE –0.012 0.215 0.030 0.145 0.021 0.400 0.015 0.525

LOCAL –0.138 0.066 -0.110 0.068 -0.268 0.000 -0.268 0.000

YEAR Dummies Yes Yes

YES YES

N 180 180

Log likelihood 18.799 23.419

Adj. R2

0.258 0.283

F-value 5.788*** 5.406***

On the one hand, as shown in Table 8, risk management committee’s characteristics are

found to have significantly positive impact on the overall efficiency of insurance companies

in Malaysia, with the exception of RMMEET. The coefficients on RMSIZE and RMIND are

0.456 and 0.234 with p-values of 0.007 and 0.077, respectively. However, these two variables

do not reach the conventional significance level under OLS. On the other hand, both

truncated regression and OLS results show that PRES is significantly and positively related to

overall efficiency. These findings, particularly those of truncated regression, support

hypothesis 1 and hypothesis 2 of this study.

If we now turn to the columns comprising interaction terms, it can be observed that the

results of truncated regression again corroborate our hypothesis. The interaction terms on

RMSIZE* PRES, RMIND* PRES and RMMEET* PRES are all negative, suggesting that the

number of titles of honour carried by directors on risk management committee (PRES)

significantly and negatively moderate the relationship between risk management and

efficiency performance, after controlling for board characteristics and firm’s characteristics.

In summary, it is therefore likely that direct regression analysis is invalid for the second-

phase regression estimation involving DEA scores as the dependent variable.

4.4 Discussion – Decision-making Matrix

In Malaysia, the insurance industry has potential market growth and its attractiveness has

drawn in foreign insurance companies to the country. Another interesting feature is the strong

financial system of Malaysia. In spite of the disastrous global financial crisis in the late

2000s, financial institutions like insurance companies in Malaysia felt only a relatively small

spill-over effect. A possible explanation for this might be that insurers in Malaysia have been

managing well their efficiency performance, which implies that performance evaluation is a

key tool for their sustainability. There are, however, other explanations. First, financial

institutions in Malaysia have strengthened their corporate governance and risk management

system since the 1997 Asian financial crisis. Second, insurance companies in Malaysia have

been mandated to have separate risk management committee at board level since 2003. It can




therefore be assumed that performance evaluation and risk management are particularly

important concerns for companies in the Malaysian insurance industry.

In addition to the univariate and multivariate analyses, utilizing the Stage-1 and Stage-2

efficiency scores, this study constructs a decision-making matrix for managers in insurance

companies. Note that in the Pearson correlation coefficients of variables used in regression

analysis, the correlation between EFF2 and EFF3 is 0.567, which is significant at the 1 per

cent level. The decision-making matrix is shown in Figure 2, whereby the X-axis represents

the resource-management efficiency and the Y-axis represents the profitability efficiency. By

setting reference lines at the median values of the respective sets of efficiency scores, this

study is able to assign each insurer a zone in the decision-making matrix. Through

discussions for each of the zone, this thesis provides some strategic measures for managers in

insurance companies for improving their overall efficiency performance. This study names

each zone based on the business strategy of Boston Consulting Group (BCG) matrix, in

which the upper-right quadrant (Zone A) – the “stars”, the upper-left quadrant (Zone B) – the

“question marks”, the lower-right quadrant (Zone C) – the “cash cows”, and the lower-left

quadrant (Zone D) – the “problem child” are considered.

Figure 2: Stage 1/Stage 2 Efficiency Matrix

The “stars” (Zone A): Insurance companies included in this zone are found to have higher

resource-management efficiency and profitability efficiency. 11 “stars” are identified: AIA

Berhad (C1), Allianz Life Insurance Malaysia Berhad (C4), MSIG Insurance (M) Berhad

(C6), Prudential Assurance Malaysia Berhad (C9), QBE Insurance (M) Berhad (C10), The

Pacific Insurance Berhad (C12), Tune Insurance Malaysia Berhad (C15), Zurich Insurance

Malaysia Berhad (C16), Etiqa Insurance Berhad (C24), Great Eastern Life Assurance (M)

Berhad (C25), and Manulife Insurance Berhad (C27). During the period 2008-2013, these




insurers are considered to have relatively better operating condition. These exemplary

insurers should maintain their competitive advantages and capabilities in transforming inputs

into value-added outputs. Particularly, they should continue keeping and improving their

well-established risk management system as that would result in lower costs and ultimately

higher efficiency performance.

This study could conclude that Prudential Assurance Malaysia Berhad and The Pacific

Insurance Berhad outshine the other insurers. It is interesting to note that these two insurers

are foreign insurance companies incorporated in Malaysia, consistent with the tests of

differences. Taken together, other insurers could deem these two flagships as the role model

in improving their efficiency performance from the risk management perspective.

The “question marks” (Zone B): Four insurers are included in this zone, namely AIG

Malaysia Insurance Berhad (C2), Multi-Purpose Insurans Berhad (C7), RHB Insurance

Berhad (C11), and Lonpac Insurance Berhad (C26). Although these insurers have relatively

better profitability efficiency, their resource-management efficiency is considered as below

par. To sustain their profitability efficiency, this thesis suggests that these four insurers

should focus on improving their capabilities in transforming inputs into value-added outputs.

If this situation persists in a longer term, this thesis would expect that profitability

efficiencies of these insurers suffer. More explicitly, only by managing well their resources,

they would be able to continue generating high profitability efficiency. Therefore, it is

suggested that managers of these insurers should reduce a great waste of resources. To

achieve this aim, they are advised to hire more directors, preferably sufficiently independent

professionals on risk management committee to first improve their resource-management

efficiency. Moreover, they should have an appropriate number of prestigious directors who

can bring about resources. Overall, these “question marks” may learn from the benchmarks in

Zone A, from which they could learn new breakthrough in managing efficiently resources.

The “cash cows” (Zone C): This zone comprises insurers that have relatively higher

resource-management efficiency but lower profitability efficiency as compared to their

counterparts. The list of insurers includes Overseas Assurance Corporation (M) Berhad (C8),

AmLife Insurance Berhad (C18), Kurnia Insurans (Malaysia) Berhad (C19), and Uni.Asia

Life Assurance Berhad (C30). It is expected that these insurers are gradually gaining

competitive advantages. That is, their efficiency in allocating resources is an accomplishment

that is hard to be imitated, and which should turn out to be a fast growth in their profitability

efficiency. Therefore, this thesis recommends these insurers to recruit more qualified and

independent professionals for reviewing the adequacy of resources for not only the

performance of risk management system, but also investment management activities. In any

case, these insurers should continue learning from the benchmarks in Zone A such as more

investment should be put in marketing activities to increase the amount of premiums earned.

The “problem child” (Zone D): Insurance companies that fall in Zone D are characterized

by lower Stage-1 and Stage-2 efficiency performance. These insurers, with low

competitiveness in both resource allocation and profitability, are Allianz General Insurance

Company (M) Berhad (C3), Hong Leong Assurance Berhad (C5), Tokio Marine Insurans (M)

Berhad (C13), Tokio Marine Life Insurance Malaysia Berhad (C14), AmG Insurance Berhad

(C17), Kurnia Insurans (Malaysia) Berhad (C19), Pacific & Orient Insurance Co. Berhad

(C20), AXA Affin Life Insurance Berhad (C21), Berjaya Sompo Insurance Berhad (C22),




CIMB Aviva Assurance Berhad (C23), MCIS Zurich Insurance Berhad (C28), and Uni.Asia

General Insurance Berhad (C29). To improve their efficiency performance, this thesis

suggests that they should strictly follow the reference sets in the other zones. For example,

they might consider having industry cooperation to strengthen their competitiveness.

Insurers of particularly concerns, which also appear in the Group C for poor insurers earlier,

are AXA Affin Life Insurance Berhad, Berjaya Sompo Insurance Berhad, CIMB Aviva

Assurance Berhad, MCIS Zurich Insurance Berhad, and Uni.Asia General Insurance Berhad,

three of which are locally-bred insurance companies. They should learn from the benchmarks

in Zone A, wherein the first step is to improve their internal resource allocation, and then is to

study market demands before mapping out guidelines on operating processes for their future.

5. Conclusion

This study has found that risk management committee’s characteristics including the number

of directors on risk management committee, the proportion of independent directors on risk

management committee, and the number of meetings held annually by risk management

committee are significantly and positively related to the efficiency performance of Malaysian

insurers over the sample period 2008-2013. As predicted, risk management committee’s

prestige has a significantly positive effect on efficiency performance. However, this variable

significantly and negatively moderates the relationship between risk management

committee’s characteristics and efficiency performance. These findings support not only

resource-dependence theory and social network theory, but also the political theory.

Furthermore, the effort undertaken here has extended our knowledge in a DEA-application

study that involves a second-phase regression analysis, in which truncated regression is found

to have provided more consistent results as compared to OLS.

Taken together, this study has successfully demonstrated the application of the dynamic DEA

with a network structure and truncated regression in examining the effect of exogenous

factors on efficiency scores. It would be interesting to expand this study to a wider coverage

of insurance companies. For example, further research might explore the performance of

insurance companies in Asian countries using a metafrontier dynamic DEA with a network

structure to cater the different frontier technology of each country.

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The Performance and Earnings Management of ASEAN Banks in

the Liberalization Era

Mohammad Nourani



Jalan Universiti, 50603 Kuala Lumpur, Malaysia


Qian Long Kweh

Department of Accounting

College of Business Management and Accounting

Universiti Tenaga Nasional

Sultan Haji Ahmad Shah Campus, 26700 Muadzam Shah, Pahang, Malaysia


Wen-Min Lu

Department of Financial Management

National Defense University

No. 70, Sec. 2, Zhongyang North Rd., Beitou, Taipei 112, Taiwan


Abstract

After the 1997 Asian financial crisis, Southeast Asian nations have implemented financial liberalization policies

with the purpose of boosting their economies. This scenario has enthused both performance evaluation (a pro)

and earnings management (a con). In this study, we first build on a dynamic network DEA (DN-DEA) approach,

called dynamic network slacks-based measure (DNSBM), to estimate the managerial and profitability

efficiencies of ASEAN commercial banks for the period from 2007 to 2013. On the overall basis, Singaporean banks appear to be the most efficient among all with an average score of 0.622 over the sample period.

Interestingly, the sample banks are found to have about 62.8 per cent of room for improvement. Second, through

panel data model and truncated regression, we find that the negative impacts of earnings management practices

on efficiency are found in loan loss provisions. Overall, it is advisable that policy makers with oversight function

should promote performance evaluation from a multidimensional perspective and keep an eye on earnings

management practices in terms of loan loss provisions.

Keywords: performance evaluation; dynamic network DEA; earnings management;

liberalization; ASEAN

Introduction

According to a report by ADB (2011), Asian emerging economies hold approximately half of

the world’s total exchange reserves and the whole region is also the major exporter and

importer of capitals. This phenomenon attests the underdeveloped intra-regional financial

system to efficiently channel surplus funds. Consequently, effective regional coalition and

Corresponding author





cooperation is needful in dealing with this immaturity. Among all, the Association of

Southeast Asian Nations (ASEAN)1 has succeeded to create a strong integration among its

members of Southeast Asian nations. Followed by the Asian financial crisis that erupted in

mid-1997, many emerging countries in Asia have experienced substantial rectifications in

their financial liberalization policies with the purpose of boosting their economies.

Specifically, developing countries in South East Asia have experienced various forms of

financial liberalizations in promoting efficient allocation of resources to achieve greater

economic growth during the last few decades. As a result of financial liberalization policies,

the international capital mobility has increased between partner countries through different

international agreements such as ASEAN (Lim, 2005). However, it might be a blessing in

disguise or a curse.

On the one hand, there exists substantial capital inflows into the host countries (Chan and

Karim, 2011). In addition, the increased competition as the consequence of liberalization

policies stimulates firms to put more cautions on their activities such cost management, risk

monitoring, and resource allocation (Gardener et al., 2011). That is, opening up the economy

to international investors leads to higher efficiency of firms by means of intensifying the

competition within a domestic market. According to the seminal works of McKinnon (1973)

and Shaw (1973), financial liberalization yields higher economic growth through increasing

interest rate level which enhances the competition among the market players, while the

allocation of resources are well realized. Therefore, financial liberalization is likely to

increase higher savings which eventually nurtures economic growth by ameliorating the

investment quantity and quality, i.e. efficient allocation of resources (Reinhart and Tokatlidis,

2003). This is the reason why evaluating the efficiency becomes very important in the recent

years where many of the emerging countries have undergone full liberalization policies or

under the process of being liberalized, i.e. partial liberalization.

On the other hand, liberalization enhances competition, which dampens firms’ profitability.

Therefore, underperforming firms will be expelled from the marketplace because lower

profitability increases the risk of bankruptcy (Baik et al., 2011, Becchetti and Sierra, 2003,

Bolt et al., 2012). Put differently, this will create an incentive for managers to sham their

corporate performance in order to attract investors. In fact, past studies prove that pressurized

firms with high chance of bankruptcy are more inclined towards engaging “earnings

management2 (EM)” practices (García Lara et al., 2009, Beneish et al., 2012). Therefore, the

dramatic shift in liberalization policies in emerging countries has predisposed market players

to manipulate the information about financial reporting. It has been repeatedly reported that

the intensified competition as the results of liberalization and government deregulation brings

new opportunities for economic prosperity.

However, the flip side of the coin tells different story. Internal managers are more prone

towards hyperbolizing the firm’s performance to market participants within a competitive

environment (Tinaikar and Xue, 2009). Therefore, firms may report higher earnings compared

1 ASEAN was established on August 1967 by the signing agreement of five countries namely, Indonesia,

Malaysia, Philippines, Singapore and Thailand. Since then, membership has expanded to include Brunei,

Cambodia, Laos, Myanmar, and Vietnam, constituting the ten Member States of ASEAN. 2 Earnings management is defined as the use of managerial judgment to manipulate the financial reporting with

the purpose of either influencing contractual outcomes which depend on the financial reports or misleading the

stakeholders (and investors) about the company’s performance HEALY, P. M. & WAHLEN, J. M. (1999). A

Review of the Earnings Management Literature and Its Implications for Standard Setting. Accounting Horizons,

13, 365-383..




to other rivals to attract investors. In a comprehensive review of the EM literature, Healy and

Wahlen (1999) conclude that “ the evidence is consistent with firms managing earnings to

window-dress financial statements prior to public securities’ offerings, to increase corporate

managers’ compensation and job security, to avoid violating lending contracts, or to reduce

regulatory costs or to increase regulatory benefits” (p.368). In his review, Healy and Wahlen

(1999) emphasizes that the past studies have focused on whether EM exists and why, yet the

empirical issue on the effect of any earnings management practices on efficiency?” (Healy

and Wahlen, 1999, p.380) has not been well explored.

As banking sector has been the centerpiece in the eyes of policy makers due to its invaluable

importance to the economic development, the sound and well-functioning banking sector is a

potent engine of economic growth. In this vein, banking institutions are not exempted from

this upshot, rather they are also more susceptible to EM practices compared to non-financial

organizations (Grougiou et al., 2014) due to their wide-ranging financial products and

complicated operation which lead to information opacity (Levine, 2004) and asymmetry

(Mülbert, 2009). Moreover, as highlighted by Greenawalt and Sinkey Jr (1988), the higher

chance of earnings manipulation in banking institutions might be attributed to the subjective

judgment that managers has to make in regards to expected reserves for losses. Specifically,

during the period of high profit, banks’ managers incline to smooth the earnings by recording

more loan losses and vice versa (Cornett et al., 2009). While the theoretical and empirical

literature support the amplification in both firm efficiency and EM practices followed by

liberalization, the question remains that how EM could be observed from testing its relation to

efficiency of banks.

To measure banking performance, we adopt dynamic network DEA (DN-DEA) to deal with

inefficiencies of interacting divisions that are embedded inside the banks’ production process.

Frontier efficiency analysis, which has received a considerable attention by researchers, is

more appropriate than a single-dimensional ratio analysis. Data envelopment analysis (DEA),

introduced by the influential work of Charnes et al. (1978), has been coined as the most

frequent frontier efficiency approach used by researchers, particularly among banking studies

(Liu et al., 2013). The value of DEA lies in its ability to transform various performance

aspects into a single efficiency score (Yeh, 1996) through evaluating the relative performance

of a decision-making unit (DMU) compared to its peers or competitors operating within a

same group (Liu et al., 2013). However, the traditional DEA models are not sufficient to

measure the banks’ complex production process because these models assume the system as a

single black box that converts inputs to outputs (Wang et al., 2014). Accordingly, the detailed

sources of inefficiency could not be identified when applying the traditional DEA models.

Given the above discussion, this study aims to estimate the dynamic network efficiency and

address the relationship between EM practices and efficiency of ASEAN banking institutions.

Therefore, the purpose of this study is two-fold. First, we apply the newly developed DN-

DEA model called dynamic network slacks-based measure (DNSBM), formulated by Tone

and Tsutsui (2014), which deals with multiple divisions connected by links of network

structure within each period vertically and also combines the network structure by means of

carry-over activities between two succeeding periods horizontally. The second important

objective of the study is to investigate the influence of controversial EM practices on the

divisional efficiency scores of ASEAN banking institutions. To measure EM practices, we

follow Adams et al. (2009) to use the ratio of loan loss provisions to loans. As a robustness

check, we also include the ratio of loan loss reserves to loans as another measure of EM




practices. To the best of authors’ knowledge, this study is the first of its kind to examine the

effect of EM on the efficiency of ASEAN banking institutions.

The remainder of this paper unfolds as follows: Section 2 reviews the extant literature on

banking efficiency studies. Section 3 describes the data collection and the methodology used.

Section 4 presents the empirical findings and the discussion, and section 5 concludes the

paper.

Efficiency Studies in ASEAN Banking Sector

In this section, we try to map out the studies addressing the efficiency analysis of banking

institutions in ASEAN alliance. We note that the application of efficiency evaluation in

ASEAN economies is very scant at the moment. Hence, we also focus our attention to East

Asian studies of banking efficiency, where necessary, in order to provide a befitting

background of the subject matter.

Laeven (1999) estimates the technical efficiency of East Asian banks during 1992 to

1996. The input variables include interest expense, labor expense, other operating expense

and the output variables include loans and securities. The efficiency results were surprising

since the scores were increasing or constant during the pre-crisis period in which one might

expect a declining efficiency trend. The author, therefore, tries to shed some lights on the risk -

taking behavior of commercial banks. The findings assert that the banks with low efficiency

scores have endured the crisis due to taking fewer loans and thus less risk.

The first ASEAN banking efficiency paper appearing in the literature, authored by Karim

(2001), is the analysis of scale and cost efficiencies using the stochastic cost frontier

approach. The author uses the banking data of four countries during 1989 to 1996, including

Indonesia, Malaysia, the Philippines, and Thailand, out of ten members due to data

unavailability for the remaining countries. Using the intermediation approach, three inputs

(wages and salaries, land, buildings, and equipment and interest on deposits) and five outputs

(commercial and industrial loans, other loans, time deposits, demand deposits, and securities

and investments) are selected for the efficiency analysis. His findings on profit and cost

efficiency suggest that Thai banks are the least inefficient followed by Indonesian and

Pilipino banks while Malaysian banks perform the best. The author binds the inefficiency of

Indonesian and Pilipino banks to their restrictive regulatory systems. His results also support

the consolidation policy where the larger banks incline towards higher cost efficiency.

Williams and Nguyen (2005) examine the profit efficiency using stochastic frontier approach

for the South East Asian commercial banks in the period of 1990 to 2003. The authors utilize

the unbalanced dataset of 231 commercial banks from five countries (Indonesia, Korea,

Malaysia, the Philippines, and Thailand) to create a common frontier. This is disputatious,

however, the efficiency results can be controlled for significant cross-country differences

(Berger et al., 2000). Williams and Nguyen apply different country economic indicators to

control for cross-border differences. Their key findings support the policy of bank

privatization which leads to higher profit efficiency.

Gardener et al. (2011) provide an empirical efficiency analysis of selected five

ASEAN banking institutions, including Indonesia, Malaysia, the Philippines, Thailand, and

Vietnam for the period of 1998 to 2004. The authors estimate the technical and cost

efficiencies using DEA with two outputs (net loans and other earning assets) and three inputs




(fixed assets, deposits and personnel costs). Their key findings show that the efficiency of

banks over the sample period has reduced interpreting the weak restructuring of post-1997

crisis. Malaysian and Vietnamese banks perform better in terms of technical and cost

efficiency while Indonesia and Thailand possess the least technical and cost efficient banks in

the post crisis era. Furthermore, countries with higher economic growth rates tend to be more

efficient.

In summary, the above literature of efficiency studies in East Asian banking sector put

forward the importance of cross-country comparison in which the efficiency scores differ

between countries and also before and after the crisis event. The restructuring of financial

institutions takes some time to be effectively implemented and an immediate analysis might

not be appropriate to judge the true influence of restructuring policies. In addition, due to

limitation in data, the above studies fail to consider more countries into analysis in order to

provide a more inclusive picture of ASEAN alliance. Therefore, our study aims to fill the gap

by addressing a more recent period in efficiency analysis as well as a broader group of

ASEAN commercial banks.

Data Envelopment Analysis in Banking Sector

The literature on frontier efficiency methodology, in particular DEA3, is fruitful with

numerous research works focusing on methodological development, application-centered and

both theory and application studies (see Cook and Seiford (2009) and Emrouznejad et al.

(2008) for methodological and theoretical developments and see Liu et al. (2013) for a survey

of application-embedded studies). Liu et al. (2013), who review high-ranked DEA papers

published during 1978 through 2010, indicate that application-embedded papers account for

nearly two-thirds of all published papers and banking studies cover 10.3% of this category

(most popular field). Since the invention of novel DEA by Charnes et al. (1978), the

groundbreaking work of Sherman and Gold (1985), where the authors examine the operating

efficiency of bank branches, paves the way for the application of DEA in banking sector.

Sherman and Gold’s argument about the uniqueness of DEA technique embraced by a number

of banking researchers (Parkan, 1987, Rangan et al., 1988, Elyasiani and Mehdian, 1990,

Berg et al., 1993). Berger and Humphrey (1997), a survey-based study, and Thanassoulis

(1999), an informative study, motivate the researchers by providing the potential areas that

need to be addressed in the domain of banking efficiency and the scope for enhancing the role

of DEA in banking, respectively.

However, as mentioned before, the banks’ complex production process requires more

sophisticated techniques to account for internal structures within the black box. Fortunately,

Following the pioneer work of Färe and Grosskopf (1996), who were the initiators to

investigate the “black box”, many researchers developed new methodologies to overcome the

shortcomings (see Halkos et al. (2014) for a survey of two-stage DEA models). While a rising

number of studies pointing to the meaningfulness of decomposing the banks’ performance

into sub-divisions (Seiford and Zhu, 1999, Luo, 2003, Lo and Lu, 2006, Avkiran, 2009, Lin

and Chiu, 2013), the application of DN-DEA in banking is still in its embryonic stage

(Avkiran, 2014a, Fukuyama and Weber, 2013, Kao and Liu, 2014, Wanke et al., 2014). For

example, Avkiran (2014a) assesses the dynamic efficiency of Chinese commercial banks

3 According to a comprehensive survery of frontier efficiency analysis in financial institutions, mostly banking,

by BERGER, A. N. & HUMPHREY, D. B. (1997). Efficiency of financial institutions: International survey and

directions for future research. European Journal of Operational Research, 98, 175-212., DEA is the most

frequently used approach for efficiency evaluation.




combined with network structure; Wanke et al. (2014) measure the efficiency of Brazilian

banks using dynamic SBM; Kao and Liu (2014) propose a relational network model applied

to a set of Taiwanese commercial banks; and Fukuyama and Weber (2013) provide an

example of dynamic network DEA using a large sample of Japanese banks. Hence, our study

contributes to the scarce literature of DN-DEA in banking and it is the first study to apply this

technique in a cross-country sample.

Research Design

Data Collection

The efforts to test the hypothesis of this study focus on nine emerging economies: Brunei

Darussalam, Cambodia, Indonesia, Lao People’s Democratic Republic, Malaysia, Philippines,

Singapore, Thailand, and Vietnam. These countries share a main trait, in which they are

members of the ASEAN. Therefore, we argue that the sample banks in this study are by no

means more influential in countries with larger bank populations. Note also that our data

screening process leaves us with no banks from Myanmar, which is also one of the ASEAN

members. This is not surprising because information is sometimes lacking in emerging

economies.

All data are extracted from the Bankscope database for the period from 2007 to 2013. We

collect financial data for as many commercial banks as possible for each country and screen

the initial dataset in the following ways. Firstly, we focus only on commercial banks which

have similar products and services, whereby each of the banks are treated as a DMU for the

DEA analysis. Secondly, we eliminate banks with no complete financial data for the DEA

analysis over the sample period. Finally, we remove banks with missing data for measuring

the testing variable, viz. earnings management. As such, we have a balanced panel dataset that

is made up of 138 commercial banks in each year, in particular: Brunei Darussalam 1,

Cambodia 9, Indonesia 55, Lao People’s Democratic Republic 4, Malaysia 1, Philippines 20,

Singapore 8, Thailand 20, and Vietnam 20. It should be noted that we examine the operating

processes of banks using intermediation approach in line with prior studies4 (Avkiran, 2014a,

Miller and Noulas, 1996, Bhattacharyya et al., 1997, Sturm and Williams, 2004, Avkiran and

Thoraneenitiyan, 2010).

Table 1 Summary statistics of inputs, intermediates, and outputs

Mean Standard Deviation 1st Quartile 3rd Quartile

Input

Personnel expenses (X2) 75.865 140.196 7.000 66.750

Other operating expenses

(X3)

90.096 159.157 8.000 82.750

Input (carry-over)

Fixed assets (X1) 89.986 189.728 6.000 67.750

Liquid assets (X4) 7,422.737 18,799.629 398.000 5,060.750

Intermediate

Loans (Z1) 5,516.260 14,150.085 296.550 3,591.500

Other earning assets (Z2) 5,347.262 9,516.799 2,556.250 4,101.750

4 In an investigation of major DEA applications in banking literature in top journals across 2004 – 2009,

AVKIRAN, N. K. (2011). Association of DEA super-efficiency estimates with financial ratios: Investigating the

case for Chinese banks. Omega, 39, 323-334. reaches the conclusion that “there is no clear agreement amongst

the selection of inputs and outputs beyond the general observance of the intermediation approach to bank

behavior” (Avkiran, 2011, p.326).




Deposits (Z3) 7,424.737 18,799.629 400.000 5,062.750

Output

Net interest income (Y1) 277.247 535.101 31.700 227.000

Note:

1. All variables are denoted in USD million.

2. Definitions of the variables are as follows. Personnel expenses are total staff costs in year t. Other operating

expenses are total operating costs other than staff costs in year t. Fixed assets are total tangible property, plant,

and equipment in year t-1. Liquid assets are resources that could be converted into cash quickly in year t-1.

Loans are temporary funds provided to customers at interest in year t. Other earning assets include financial

investments in stocks and bonds in year t. Deposits are monies kept by customers at banks in year t. Net interest

income refers to the excess income generated from loans and other earnings assets over expenses associated with

interests on deposits in year t.

In regards of the DEA analysis, we present Table 1 to summarize the descriptive statistics of

variables used. Furthermore, we also perform correlation analysis for the variables. Table 2

shows that all correlation coefficients are significantly positive, indicating that the inputs,

carry-overs, intermediates, and outputs are isotonically related. In other words, the selected

variables are appropriate for further analysis using the stipulated dynamic network DEA

model. Finally, as the number of banks meets the requirement that the number of DMUs

should be larger than double or triple the number of variables used for the DEA analysis, we

conclude that the developed DEA model has high construct validity.

Table 2 Spearman correlation coefficients

X2 X3 X1 X4 Z1 Z2 Z3 Y1

Personnel expenses (X2)

1.000

Other operating

expenses (X3)

0.959 1.000

Fixed assets (X1) 0.875 0.881 1.000

Liquid assets (X4) 0.944 0.946 0.859 1.000

Loans (Z1) 0.938 0.926 0.845 0.975 1.000

Other earning assets

(Z2)

0.692 0.738 0.628 0.767 0.707 1.000

Deposits (Z3) 0.944 0.946 0.859 1.000 0.975 0.767 1.000

Net interest income

(Y1)

0.951 0.937 0.877 0.941 0.949 0.691 0.941 1.000

Note:

1. All of the coefficients are significant at the 1% significance level.

2. See Table 1 for the definitions of the variables.

The traditional DEA models assume a production process as a single ‘black box’ that

transform inputs to outputs. Therefore, every activity has to be categorized as ‘input’ or

‘output’. This would create a problem when there is a complex production process that

requires multiple inputs and outputs. Accordingly, the network DEA models overcome the

abovementioned shortcoming by considering multiple divisions of production within the

black box while evaluating the overall efficiency as well. The network structure allows the

evaluation of the connectivity between inner linking activities (Kao, 2009, Tone and Tsutsui,

2009), hence, it will enable us to build processes of banks’ inner business activities.

This study also considers the linking activities between two succeeding periods which allows

us to take the effect of time on performance measure into account. More specifically, we

incorporate the time effect by means of carry-over activities between the subsequent periods.




As such, the idea of dynamic DEA (Tone and Tsutsui, 2010) observe the long term fluctuated

trends of banks through the years.

In addition to the above, in traditional DEA models, the relative efficiency for each DMU is

measured under the assumption of the proportional changes of input and output variables,

meaning the models are radial. In fact, radial models may lack objectivity in terms of

reflecting the real input/output conditions for each organization. Furthermore, these models

assume that inputs and outputs can be adjusted according to their ratios, which cannot be

adopted under certain circumstances. As a solution, DNSBM, a proposed model by Tone and

Tsutsui (2014), is a non-radial model which takes the possibility of non-proportional changes

of inputs and outputs into account. This model deals with slacks when estimating the

divisional and overall efficiencies. Considering differences of input and output slacks

concurrently, this study uses non-oriented efficiency to estimate banks’ performance. The

dynamic network processes is shown in Figure 1.

Figure 1 The conceptual framework of the dynamic network production processes for

banks

Modelling the Dynamic Network SBM

Consider the dynamic network processes presented in Figure 1 that deals with n banks (j =

1,…,n) consisting of k divisions ( 1,..., )k K over T terms ( 1, ,t T ). At each term, banks

have common k

tm inputs (i = 1,b…, k

tm ) consisting of k divisions and k

tr outputs (i = 1,…, k

tr ) consisting of k divisions. Let k

iotx (i = 1,…,k

tm ) and k

roty (i = 1,…, k

tr ) denote the

observed input and output values of bank j consisting of k divisions at term t, respectively. ( , )k h

jtz denote the continuity of link flows (carry-overs) between terms t and t+1. This study

symbolizes the category link as badC . In order to identify them by term (t), bank (j) , divisions

( k ) and item (i), this study employs the notion ,k bad

potC ,( 1, , ; 1, , ; 1,..., )k bad

tp m t T k K

for denoting bad link values where nbad is the number of bad links. These are all observed




values up to the term T. Let ,k bad

tm denote the observed carry-over input values of DMU j

consisting of k divisions at term t. Using these expressions for production, this study

expresses the target obank (o = 1,…,n). Therefore, this study defines the non-oriented

efficiency by solving program as follows:

Let o denote the overall efficiency during the term T. Where

k

its

, k

rts

and ,k bad

pts

are slack

variables denoting, respectively, input excess, outputs shortfall, link excess, and link

deviation.

This objective function is an extension of the non-oriented SBM model (Tone, 2001) and

deals with excesses in both input resources and undesirable (bad) links. The numerator is the

average input efficiency and the denominator is the inverse of the average output efficiency.

This study defines the non-oriented overall efficiency as a ratio that ranges between 0 and 1,

and attains 1 when all slacks are zero. This objective function value is also units-invariant.

,,

1 , ,1 1 1

*

1 1 1

1 11

1 11

k k badtt

kt

k badkK m m ptT k it

t t k k bad k k badk i pt t iot pot

ok

K rT k rtt t k kk r

t rot

ssw

T m m x CMin

sw

T r y

（1）

1

1

1

( , ) ( , )

1 1

. .

( 1,..., ; 1, , ; 1,..., )

( 1,..., ; 1, , ; 1,..., )

1( 1, , )

, ( , )( 1, , )

nk k k k k

iot ijt jt it tj

nk k k k k

rot rjt jt rt tj

n k

jtj

n nk h h k h k

jt jt jt jtj j

k

pot

s t

x x s i m t T k K

y y s r r t T k K

t T

z z k h t T

C

, , , ,

1

, , ,

11 1

,

( 1, , ; 1, , ; 1,..., )

( 1, , ; 1, , 1; 1,..., )

0, 0, 0, 0

nbad k bad k k bad k bad

pjt jt pt tj

n nk bad k bad k bad

ijt jt ijt jt tj j

k k k k bad

jt it rt pt

C s p m t T k K

C C p m t T k K

s s s

（2）

If the optimal solution for (1) satisfies 1o , obank is called non-oriented overall efficient or

briefly overall efficient.




,,

, ,1 1 1

1 1

11

11

k k badtt

kt

k badkK m m ptk it

t k k bad k k badk i pt t iot pot

tk

K rk rtt k kk r

t rot

ssw

m m x C

sw

r y

（3）

In (3), 1

1 T

o t tT

.If all optimal solutions of satisfy 1t , obank is called non-oriented

term efficient or briefly term efficient for term T. This implies that the optimal slacks for term

t in (3) are all zero.

,,

, ,1 1

1

11

11

k k badtt

kt

k badkm m ptit

k k bad k k badi pt t iot pot

k

tk

r rt

k krt rot

ss

m m x C

s

r y

（4）

In (4), 1

kK k

t k t tw .If all optimal solutions of satisfy 1k

t , obank is called non-oriented

term efficient or briefly term efficient with the divisions k at the term T. This implies that the

optimal slacks with the divisions k at term t in (4) are all zero.

Empirical Findings and Discussion

Dynamic Network Performance Analysis

Table 3 shows the results of the dynamic network DEA model for banking institutions in

ASEAN region. Specifically, the table presents both yearly and average of overall, managerial

and profitability efficiency scores. While the overall efficiency of ASEAN member countries

seems to drop during 2008 to 2012 and then increases in 2013, Singapore banking sector

tends to swim against the tide. Also, Singaporean banks appear to be more efficient in terms

of overall efficiency followed by Cambodia and Malaysia with average scores of 0.622, 0.511

and 0.421 respectively. The overall efficiency of total sample shows a monotonic decrease

over the period with 62.8 per cent room for improvement on average.

In addition, Table 3 also provides the breakdown of overall efficiency into managerial and

profitability efficiencies. In the first division, i.e. managerial efficiency, we can see

fluctuating trends in countries’ banking performance; however, the total sample average is

again at declining trend. Although the managerial efficiency of ASEAN banking institutions

suggests the poor performance of banking sectors in the region, it happens to be more

efficient when compared to profitability efficiency. The results indicate the slightly better

performance of managerial division, in particular in the last three years, pointing that most

countries have enhanced their capabilities to manage the human resources but have failed to

create salient profit-making capacities using their managerial abilities. Nonetheless, there

exists large room for improvement in both managerial and profitability efficiencies. For

instance, bank institutions in ASEAN region can improve their managerial and profitability

efficiencies by 59.7 per cent and 62.8 per cent respectively in order to be fully efficient.




Table 3 Overall, managerial and profitability efficiencies of banks in ASEAN countries

for the period of 2008-13

Country 2008 2009 2010 2011 2012 2013 Average

Overall efficiency

Brunei 0.295 0.210 0.215 0.201 0.132 0.160 0.202

Cambodia 0.693 0.559 0.553 0.511 0.353 0.398 0.511

Indonesia 0.484 0.466 0.451 0.409 0.324 0.311 0.408

Laos 0.587 0.407 0.465 0.342 0.227 0.282 0.385

Malaysia 0.620 0.519 0.375 0.337 0.259 0.417 0.421

Philippines 0.319 0.289 0.284 0.249 0.217 0.240 0.266

Singapore 0.585 0.630 0.609 0.603 0.690 0.614 0.622

Thailand 0.357 0.311 0.322 0.318 0.296 0.288 0.315

Vietnam 0.387 0.372 0.369 0.312 0.242 0.245 0.321

Total sample 0.450 0.417 0.410 0.373 0.311 0.310 0.378

Managerial efficiency

Brunei 0.239 0.234 0.239 0.267 0.273 0.254 0.251

Cambodia 0.751 0.638 0.639 0.696 0.726 0.639 0.681

Indonesia 0.425 0.448 0.426 0.429 0.398 0.328 0.409

Laos 0.654 0.561 0.473 0.509 0.527 0.502 0.538

Malaysia 0.881 0.833 0.648 0.602 0.765 0.772 0.750

Philippines 0.229 0.246 0.236 0.233 0.212 0.191 0.225

Singapore 0.694 0.724 0.742 0.756 0.739 0.694 0.725

Thailand 0.287 0.296 0.306 0.305 0.266 0.263 0.287

Vietnam 0.482 0.452 0.416 0.359 0.315 0.318 0.390

Total sample 0.430 0.430 0.414 0.411 0.387 0.346 0.403

Profitability efficiency

Brunei 0.350 0.186 0.190 0.141 0.030 0.067 0.161

Cambodia 0.642 0.479 0.473 0.330 0.161 0.202 0.381

Indonesia 0.549 0.486 0.476 0.392 0.312 0.314 0.421

Laos 0.524 0.293 0.459 0.189 0.087 0.134 0.281

Malaysia 0.390 0.308 0.190 0.133 0.120 0.087 0.205

Philippines 0.408 0.331 0.331 0.263 0.232 0.288 0.309

Singapore 0.529 0.580 0.572 0.572 0.680 0.596 0.588

Thailand 0.426 0.326 0.341 0.334 0.327 0.316 0.345

Vietnam 0.310 0.312 0.331 0.268 0.211 0.187 0.270

Total sample 0.478 0.411 0.415 0.344 0.289 0.293 0.372

This study applies Kruskal–Wallis test, a non-parametric statistical analysis, to examine

whether differences exist among efficiency performance of countries in the region (Brockett

& Golany, 1996). As the significance level of 1%, as shown in Table 4, we prove that there is

a significant difference among ASEAN countries in terms of efficiency scores. The statistical

findings indicate the superiority of Singaporean banks in overall efficiency and profitability

efficiency while Malaysia outperforms in managerial efficiency division. It should be noted

that Bruneian banking sector is ranked as the least efficient member of ASEAN coalition in

both overall and divisional efficiencies.

Table 4 Non-parametric statistical test of difference

Country No. of

banks

Overall

efficiency

average

Kruskal–

wallis test

(p-Value)

Managerial

efficiency

average

Kruskal–

wallis test

(p-Value)

Profitability

efficiency

average

Kruskal–

wallis test

(p-Value)




Brunei 1 0.202 0.000*** 0.251 0.000*** 0.161 0.000***

Cambodia 9 0.511 0.681 0.381

Indonesia 55 0.408 0.409 0.421

Laos 4 0.385 0.538 0.281

Malaysia 1 0.421 0.750 0.205

Philippines 20 0.266 0.225 0.309

Singapore 8 0.622 0.725 0.588

Thailand 20 0.315 0.287 0.345

Vietnam 20 0.321 0.390 0.270

Total Sample 138 0.378 0.403 0.372

Note:

*, **, and *** denote the statistical significance at the 10%, 5%, and 1% level, respectively.

The untabulated results show that only one bank is found to be non-oriented efficient. This

high level of inefficiency encourages us to report the frontier projections. These potential

improvements for inefficient DMUs are determined based on those on the efficient frontier,

i.e. benchmark units (Avkiran, 2014b). Table 5 provides the average excess and shortage of

each variable for all member countries. A positive percentage implies the shortage of

resources (inputs) and a negative percentage implies the excess of resources (outputs).

The findings in Table 5 suggest that the ASEAN members on average have to cut their

personnel expenses and other operating expenses by 59.4 per cent and 59 per cent

respectively. The carry-overs are approximately same as the primary inputs for banks in

which these two input quantities have to be reduced by 60.7 per cent (fixed assets) and 59.9

per cent (liquid assets). The three intermediates act as dual-role variables in production

process meaning that they are outputs for the first division and inputs for the second division.

Consequently, the suggestions on potential improvements are mixed for these variables. For

instance, other earning assets have to be increased for Brunei, Cambodia, Indonesia, Laos and

Malaysia while it has to be decreased for Philippines, Singapore, Thailand and Vietnam. In

summary, ASEAN banks could be efficient if they can increase their net interest income on

average, as the only output, by 21.1 per cent while performing the required changes in inputs,

carry-overs and intermediate variables.

Table 5 Frontier projections for banks in ASEAN countries (%)

Input Carry-over Intermediate Output

Country X2 X3 X1 X4 Z1 Z2 Z3 Y1

Brunei -75.2 -73.7 -75.8 -83.4 -60.9 11.2 -72.0 8.8

Cambodia -25.5 -29.8 -40.3 -56.8 -27.7 6.6 -23.2 21.3

Indonesia -60.5 -56.6 -60.2 -55.6 -37.1 10.3 -37.3 19.3




Laos -39.9 -44.1 -54.8 -65.7 -26.6 7.2 -25.5 32.0

Malaysia -39.6 -12.4 -22.9 -68.5 -30.7 5.1 -41.0 69.1

Philippines -75.0 -79.8 -77.8 -68.1 -49.4 -25.7 -61.0 7.1

Singapore -31.6 -32.7 -18.2 -30.5 -9.6 -15.5 -30.4 101.3

Thailand -69.8 -71.8 -72.2 -63.9 -59.2 -29.3 -54.7 6.9

Vietnam -60.9 -60.3 -61.6 -69.5 -48.2 -11.1 -54.5 18.5

Total sample -59.4 -59.0 -60.7 -59.9 -41.3 -5.6 -44.4 21.1

Note:

Personnel expenses (X2); Other operating expenses (X3); Fixed assets (X1); Liquid assets (X4); Loans (Z1);

Other earning assets (Z2); Deposits (Z3); Net interest income (Y1).

Negative: Excess of resources.

Positive: Shortage of resources.

The Relationship between Earnings Management and Efficiency

In a DEA-application involving multivariate analysis, a researcher may employ ordinary least

squares (OLS) for the regression analysis. Through OLS, Banker and Natarajan (2008) show

that consistent estimators of the regression coefficients could be obtained despite the fact that

efficiency scores range between zero and one. In this study, the regression results are adjusted

for year-specific and country-specific effects. Specifically, we employ panel data estimation

procedures, which adjust for the time-series and cross-sectional effects. Note that the

Breusch-Godfrey Serial Correlation Lagrange Multiplier (LM) test suggests that panel data

regression is a better estimation technique as compared to pooled regression in this study,

while the Hausman test indicates that fixed-effects model (FEM), instead of random-effects

model (REM), should be applied.

Therefore, we employ the fixed-effects panel data regression model to examine the

relationship between earnings management and overall efficiency. In this study, the following

regression models are run to test the hypotheses:

0 1 2 3 4 5

it it it it it it i

i it

OE LLPL LLRL LNASSETS GROW LIAB Yr

Country

(1)

where:

itOE = The non-oriented DNSBM overall efficiency score based on variable

returns to scale in year t.

itLLPL = Loan loss provisions scaled by loans in year t.

itLLRP

= Loan loss reserves scaled by loans in year t.

itLNASSETS

= The natural logarithm of total assets in year t.

itGROW

= The growth rate of net income in year t.

itLIAB

= Total liabilities scaled by total assets in year t.




iYr = Year-specific effect dummy variables.

iCountry = Country-specific effect dummy variables.

Based on Adams et al. (2009), we argue that earnings management in banks commonly

happens through loan loss provisions and loan loss reserves due to the nature of their

discretionary choices. If bank managers engage in earning management, we would expect to

have significantly negative coefficients on 1 and 2 because the good-looking earnings

today have to be paid off in the future, in which case it would be shown up in this study

through the dynamic performance measure that is measured over a long-term period.

In addition, we also test the potential problem caused by multicollinearity. The diagnostic test

of variance inflation factors (VIF), which is untabulated, suggest multicolliearity problem

does not exist in this study, whereby the centered VIF values are all less than 1.5 (Kennedy,

1998). We also perform diagnostic test of potential heteroskedasticity for the regression

residuals and we find evidence of heteroskedasticity. Therefore, p-values in Table 6 are

corrected using White cross-section standard errors. The F-statistics indicates that Equation

(1) is statistically significant.

Table 6 Regression results

FEM Truncated Regression

Variable Coefficient Standard

Error

P-value Coefficient Standard

Error

P-value

Intercept 1.402*** 0.131 0.000 0.804*** 0.063 0.000

LLPL -0.200*** 0.031 0.000 -0.682* 0.378 0.071

LLRP 0.243 0.152 0.110 0.493*** 0.100 0.000

LNASSETS -0.144*** 0.014 0.000 -0.028*** 0.006 0.000

GROW 0.011*** 0.002 0.000 0.011*** 0.003 0.000

LIAB 0.058 0.056 0.308 -0.284*** 0.057 0.000

Year dummies Yes Yes

Country

dummies

Yes Yes

Adjusted R-

squared

0.838

F-statistic 31.229***

Log-likelihood 193.026

Note:

*, **, and *** denote the statistical significance at the 10%, 5%, and 1% level, respectively.

The results in Table 6 indicate that loan loss provisions (LLPL) are significantly and

negatively related to the dynamic overall efficiency of banks in the ASEAN countries,

suggesting that earnings management today will be paid off in dynamic performance in the

long term, consistent with our prediction. However, the positive coefficient on loan loss

reserves (LLRP) does not reach the conventional significance level. For another sensitivity

analysis, we estimate Equations (1) using truncated regression, following Lu et al. (2014).

The truncated regression results remain almost qualitatively the same as those of the FEM. In

summary, we find that earnings management engaged by bank managers could be observed

from loan loss provisions rather than loan loss reserves from the perspective of dynamic

performance.




Conclusions

This study aims to address two key questions in the literature of bank efficiency. Firstly, we

provide a unique example of the application of DN-DEA model in banking that is still in its

embryonic stage. More specifically, we decompose the efficiency of ASEAN banking

institutions into managerial efficiency and profitability efficiency using the newly developed

DN-DEA model, viz. DNSBM. Secondly, we provide an empirical answer to the important

question that what the effect of any EM practices is on the efficiency of firms.

For the first objective, the findings reveal that there exists large room for improvement in

efficiency domain of ASEAN banks. This will accentuate the need for a better policy

formulation in the region to boost the banking sectors upwards. Indeed, the role of ASEAN

alliance could be very influential to achieve this goal. Likewise, the monotonic decrease in the

overall and divisional efficiencies of the total sample is alarming. Among all, the overall

performance of Singaporean banking sector outstrips that of any other banking sectors in

ASEAN region. In detail, Singapore is ranked first in profitability division and second in

managerial division. Meanwhile, the poor performance of Malaysian banking sector on

profitability efficiency drags down its overall efficiency despite its spectacular managerial

efficiency scores. In order to determine the reasons behind the inefficiencies of ASEAN

banks, we investigate the potential areas of improvement relevant to input and output

variables. The results suggest the equal attention should be given to carry-overs as well as

inputs where the ASEAN banks have to reduce the input and carry-over variables by

approximately 60 per cent.

For the second objective, we find a significant negative relationship between loan loss

provisions and dynamic performance of ASEAN banks. However, the loan loss reserves could

not satisfy our proposed hypothesis in determining the EM practices of banking institutions.

Therefore, we argue that loan loss provisions is an appropriate proxy for banks’ EM practices

which significantly dampen the dynamic efficiency of ASEAN banks.

All in all, more researches need to be done to confirm the generalizability of our results.

Indeed, the new approach developed in this study on the relationship between EM practices

and performance demands global appeal. It can be applied to those banking sectors where the

sources of inefficiencies are unknown. Another important area for future research would be to

compare various methodologies developed in the domain of DN-DEA among banking

institutions.

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A Review of Information System-based Decision Making on

Prosperous Relationship Marketing

Morteza Jamalzadeh

Faculty of Business and Accountancy, University of Malaya

50603 Kuala Lumpur, Malaysia

[email protected]

Nasrin Azar



[email protected]

Quah Chee Heong



[email protected]

Abstract

Information Systems (IS) is widely addressed amongst marketing literature in recent years. However, a working

definition and implementation of Information Systems is hard to come by among marketers and managers. This

study aim to review the role of Information System in decision making process and understand the extent to

which relationship marketing can be successful in firms. The study further extends knowledge on the conceptual

frameworks of decision making and effect of information system throughout the processes.

Keywords: Decision Making; Information Systems; Relationship Marketing; Success.

1 Introduction Old-fashioned marketing concentrated on trade of low-value products to high numbers of

consumers (Hau & Ngo, 2012). The idea of marketing grew out of economics with an early

bias toward distribution activities and efficiency of marketing channels. There are limited

practical outlines for a mutual relationship with customers have been proposed (Nijssen &

Frambach, 2001). However, a customer-based principle began to take shape as relationship

marketing thinking emerged. It is observed that firm-to-firm relationships were not the

traditional marketer-marketing relationship, but a cooperative existence between firms,

known as symbiotic relationships.

It is noted that the tendency of firms to improve longer interactions with main clients and key

suppliers, outweighing the focus on isolated contacts and providing impetus to relationship

marketing thinking. In this marketing model customer based approach and relationship

importance was replaced with traditional market-based or product-based models (Sarshar, et

al., 2010). Relationship marketing and information systems has been adopted enthusiastically






in many businesses since it was proven to provide a competitive advantage in the business

and decision making process.

Many association in major industries implemented such system with the same objective in

mind, to increase their revenue stream and to provide better customer service. The promise of

relationship marketing and information systems in businesses proved so alluring that many

adopted such marketing programs has little or no consideration of the feasibility of the

relationship marketing and information systems with the nature of their businesses (Sarshar,

et al., 2010). In this sense, companies might find the marketing information systems useful to

provide affiliate programs that adopted and the contents are viable and do interest of

consumers and effect positively on their decisions towards the products and services.

Therefore, information systems in decision making process become very important and firms

cannot neglect the issue if proper consideration on the feasibility and practicality of the

knowledge and information system was not taken into consideration.

2 Literature review 2.1 Information System in Firms

Formerly, large businesses were successful to resolve the issues of computer systems, which

have been adapted in their organizations. Typically, the problems occur in collecting, saving

and spreading the available data or the scattered data in their organizations. Besides, the

management has practiced hand-off attitude on this matter. Therefore, all the staff was

responsible in data processing, to prepare the information that they need in any particular of

time.

There are changes in computer architecture system and computerization approach parallel to

the technology improvement. Thus, the management starts aware on the important of

information system in their organizations. Therefore, these companies and firms try to apply

information system in their organizations (Yeh, et al., 2012). At the beginning, most of them

have facing computer literacy problem. This problem especially affected on those managers

in the operation and middle level. It is because most of them had never been exposed to the

computer usage and the role of information.

On the contrary, they have been exposed on the management theories as the problems-solving

tools. As the result, they cannot identify the importance of information system. At that time,

most of the data processing staffs were so disappointed with this scenario. This is because

most of them were poor in management theories. Therefore, they have creating and

developing information system, where they think it is the most suitable and accurate system

for these managers usage (Sääksjärvi & Talvinen, 1993). However, there is lots of situation

where the system was ignored, as it is not reach these managers’ requirement.

Nevertheless, later, the managers in operation and middle level have prepared themselves in

computer knowledge and information system. Then, they are starting to understand the

problem solving and decision making process logic, thus they can identify the information

that they need. In the meantime, the data processing staffs also preparing themselves in

management theories, thus they can co-operate with these managers in creating information

system. As the result, information system was created and developed in favorable to the

managers. Finally, it is necessary to develop information system for all companies and firms

throughout the world (Yeh, et al., 2012; Oakford & Williams, 2011).




Information Systems has meant deploying new technology solutions, such as content or

document management systems, data warehousing or portal applications. Overall, it would

not be easy to have an effective information management. There are many organizations

having issues in the integration of an information management environment. The reasons are

because of too many systems for integration, unlimited requests and demands from end users,

and complexity in organization management and the nature of business (Yeh, et al., 2012).

Marketing information system is not confined to just technology but is also involved in the

business process where it underpins the creation and use of information.

2.2 Concept of Relationship Marketing

There is a constant paradigm shift in marketing in the past few decades (Hau & Ngo, 2012).

The relationship marketing is a relatively new area that gained popularity in most industries

and field research. Many scholars have indicated that merely depending on marketing mix

variables will not be sufficient to attract or to retain customers in the industries. Commercial

companies lack differentiation in their product and services.

Competitive pricing and attractive promotions by the firms have tremendously increased the

customer loyalty. Thus, the traditional approach of marketing mix variables is not adequate to

serve the current market needs (Hau & Ngo, 2012). Many scholars have agreed that

relationship marketing strategies is an important tool for many companies to improve

customer retention and profitability. The study further elaborates that relationship marketing

is aimed at delivering long-term value and satisfaction to customers (Hau & Ngo, 2012).

Relationship marketing requires all the departments in a company to work together as a team

to serve the customers and subsequently to retain them with the organization. The study view

relationship marketing as maintaining continuous relationship and creating potential

customers. According to one study, relationship marketing is also known as real customer

understanding which is about how companies retain existing customers and establish long -

term relationship (Kaur, et al., 2012).

Therefore, relationship marketing can be summarized as establishing and developing strong

and lasting relationship with customers (Cravens, 1998). Having defined on interpretation of

relationship marketing, the next obvious question is why an organization needs relationship

when it can market its products on its own. While an organization might have a huge

infrastructure or has a really successful product, it definitely cannot bank on its own strength

by its own.

Hence, relationship marketing would come into the picture. The needs for relationship plays

an essential part as the affiliate web site does not only customize the look and feel of the web

site to cater with the taste of the various local markets but it also helps to solve the

complexity in terms of technical and marketing demands. Further to this, each website does

enjoy a certain niche market (Kaur, et al., 2012). Hence, by engaging in an affiliate, it helps

to facilitate direct communication between the sellers and the niche market of the site.

These helps to boost profit and enhance online brand awareness. Relationship marketing is an

essential part of marketing in any e-commerce website and in fact most non e-commerce sites

could utilize this technology to implement performance marketing campaigns. Furthermore,

when the researcher compared relationship marketing to a brick and mortar business,

relationship marketing has a prior advantage as there is no heavy investment cost incurred




and it is negligible with most programs being free to join (Hau & Ngo, 2012). In addition,

there is no need to maintain an inventory since the hassle of purchasing, stocking of items

and storing of finished items and dispatching the items are handled by the merchant.

Necessity for customer service does not arise if using a relationship marketing methodology

(e.g. Information Systems) for online business. This is due to that customer services that

plays a major role in the success or failure of a business does not pose any threat as there is

no direct dealing with the customers. The affiliate’s site will automatically direct the traffic,

or rather the customers to the merchant. Though it is not every marketers who earns a big

income, the fact remains that the attractive feature of relationship marketing is that there is no

restriction of the market. This improves the market data collection for future use using

knowledge management system and effect the decision making process in the organization.

2.3 IS-based Decision Making

Organizations should manage marketing information in an organized form to ensure better

decision making process. It can be possible through managing their information system

within the firm. The researchers have clearly identified two types of decision making:

programmed and unprogrammed. The programmed type which is leading to a long term

objectives and it has been followed with well planning and strategic analysis.

On the other hand, the unprogrammed type consists of those decisions accrue in the

operational environment without any planning. The decision making processes has been

divided to two basic types: Classic and Administrative (George & Jones, 2005). The classic is

being practiced everyday through our routine; starting by using alternative solutions then

select the best solution. But by looking at the other side which is the administrative view,

managers will look at the previous experiences to take an advantage in processing the

decision.

The most important stage in decision making process is a decision itself; usually the leader or

the manager has the authority to making the decision. But before making the decision, the

manger will have to test this decision, which means the manager will make sure that decision

is following the correct structure. The manager should also determine any common decisions

to avoid any past mistakes and weaknesses. A manager will be making the decision surely

within the discussion, but obviously he/she will have his/her own decision.

Here it shows us how the manager will deal with the decision. Because actually no manager

makes a decision individually, it involves the team as well but it depends how the manager is

interacting with their ideas and suggestions. The team members should be involving in the

discussion, but unfortunately not all the members are participating which makes the decision

harder for the manager. And sometimes the leader himself/herself is not interacting with the

members, because the manager will be satisfied with his/her own decision.

Yet communication is always taking a place while making a decision even though is

dependent issue (Mind.Tools.Community, 2010). In addition, in situation where it needs a

quick decision, marketing information system can help to decide fast and accurate at the same

time. This is all done by implementing knowledge environment so employees will be

expected such a similar decision to be made immediately.

Decision support system (DSS) is also an option in this issue since it is a computer-based

decision. Organizations can practice their employees with this type of decision by learning




lessons from the previous experiences or similar situations by using information systems

(Bakhrankova, 2010). The organization can also train their employees into scenario training

so they will be qualified to deal with emergency cases. Group meetings will be a good idea to

evaluate the results behind that decision, so the employees can have it as references for

further or similar situations.

2.4 Decision Making Constituents

A study has managed to do some connectivity between explicit knowledge in information

system and decision making process (Nicolas, 2004). He has categorized decision making

into 3 phases Intelligence, conception and selection processes. “The intelligence phase

represents the phase of problem definition. Individuals involved in the decision making

process have to find reflective elements and to manage ignorance”.

It is basically the process of intelligence of having an ability to define the problem into

explicit knowledge. Managers will have a good idea about the problem, but they will need to

demonstrate their knowledge about the problem to the members in order to serve each

element of the problem.

At this phase, knowledge will be transferring from individual to other till all the members get

a very deep idea about the problem overview.

After determining the problem, the process will reach to have a decision making action.

Managers will offer their solutions, and there will practice knowledge sharing, ideas

analyzing, discussions and brainstorming processes. Every individual will have his own

concept towards the problem, and the tacit knowledge will be demonstrated here since each

individual is willing to share his/her solution.

This phase (conception) will have a creativity element of establishing solutions, all the

members will be involving in the brainstorming process in order to have a very complex

collection of solution, and that’s what the mangers want (Nicolas, 2004). After reaching to

the confliction point, which is the complexity of solutions; then they will need to move to the

selection phase. The selection phase will include all the possible solutions, the members will

need to analyze all the alternatives and then generate the decision by choosing the best

solution.

Tacit knowledge from information system is very important here, because in order to support

the suggested solution; members will need to demonstrate their tacit knowledge into explicit

view to explain the reasons and analysis. Most of the employees will have great suggestions,

but they will face the problem of ingoing transferring the tacit knowledge (Nicolas, 2004).

That’s why it’d advisable to have a variety of communication and presentation skills in order

to demonstrate the views, ideas and suggestion in very profession method.

This research focused on decision making process into the knowledge environment, which

means it relies on the managerial decision making. Ahmed (2008) has defined the identified

the decision making as follow “the process of selecting from several choices, products or

ideas, and taking action”. This definition is considered as the globalization concept of

decision making process, and under any situation. The definition cover the overall steps to

make a decision from defining objectives, generating ideas then making a decision.




Ahmed (2008) has redefined the steps into his research about managerial decision making.

The steps as follows: Identify the problem; Generate alternative solutions; choose the best

alternative and lastly implement and monitor the chosen solution. After that Ahmed (2008)

has mapped the four steps to the four functions of management Planning, Organizing,

Leading and Controlling. It might look simple to have the four functions implemented, but

apparently the four functions need a lot of effort and hard work. The planning phase is

determined and done by the top and middle managers since it requires determining the

strategic goals behind the problem.

Organizing is the first important function into decision making process. The managers or

leaders will have to ensure the sharing knowledge activity between employees and in the

organization as a whole. If the organization follows the thinking environment tools and

features; they will successfully implement the organizing function. Organizations are advised

to implement information and knowledge environment to encourage all the employees work

together, support them to share the valuable knowledge (Ahmed, 2008). The leading function

is done after the decision has made, managers have to coordinate all the activities regarding

that decision to have an overall idea about it.

Managers will have to spend more effort to coordinate the action in a way to prove the

decision was made is working properly. The controlling function is the second important

function, managers will need to monitor and evaluate the results of that decision. As

mentioned before, organization will have a great repository of all the decisions and its results.

The evaluation reports will bring a lot of benefits to the organization since it will make the

database full of decision making experiences (Ahmed, 2008).

Overall, the abovementioned steps need delicate information system facilitating decision

making process. With higher level of experience, the companies and firms are getting more

interested in implementation of IS in their organization. In the meantime, the operation and

middle level managers are adjusting with the existing system. All operation and middle level

managers can accept the IS concept, where they can combine the data and the software that

fulfil their need and requirements for decision making (Wright & Ashill, 1998).

Further, the objectives of information systems in today world of businesses can be different

based on the nature of the business. The purpose of information system is to minimize the

management needs in understanding the computer techniques and help them with better and

faster decisions. Therefore, improving its capacity and capability in order to adapt it with the

management-working environment has restructured the marketing information system and

decision making process in general.

Information system did contribute to the problem solving and decision making where it

prepares the organization wide information resources. Therefore, the top management should

give their official commitment on its operation and try to provide the computer tools to the

operation and middle level managers. The existence of marketing information system gives

benefits to these managers, as the essential information is supplied to them unceasingly.

3 Conclusion This endeavor shed light on the key role of information systems in decision making process

for successful relationship marketing in firms. The paper has reviewed several methods and

constructs related to decision making processes and explained the role of information system




on these processes. It also enhanced the idea about how knowledge within information

system can improve the process of decision making. This paper also presented the importance

of relationship marketing context and decision making components. According to the

reviews, using information system to learn basic knowledge on the problems, managers in

organization can make fast and agile decisions that would not be possible without. Further

investigation is suggested to clear out the role of information systems in decision making

process and the link to successful relationship marketing.

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Investors’ vulnerability to anchoring and adjustment,

representativeness and availability heuristics: A comparative

analysis of Malaysian and Pakistani Stock Markets

Habib Hussain Khan

Department of Finance and Banking, University of Malaya

Iram Naz

Muhammad Ali Jinnah University, Islamabad, Pakistan

Fiza Qureshi

University of Sindh, Jamshoro, Pakistan

Abdul Ghafoor

Department of Finance and Banking, University of Malaya

Abstract

Applying both quantitative and qualitative approaches, we study (i) the influence of heuristics (anchoring and

adjustment, representativeness and availability) on investors’ stock buying behavior, (ii) influence of

demographic factors (age, gender, education, experience and income) on level of heuristics, (iii) comparison

between Malaysian and Pakistani investors in their susceptibility to these biases, and (iv) whether heuristics

influence the investors differently when they make buy decisions for themselves and/or for clients. Self-

constructed questionnaires were administered to investors in stock exchanges in Pakistan and Malaysia to

secure data using convenient sampling. Data has been analyzed through items’ description, ANOVA, t-test, correlation and quantile regression. Results from descriptive analysis indicate presence of all three heuristics

among investor in course of their stock buying decision. These findings are also supported by results from

regression and correlation analyses. Demographic factors have significant correlation with level of heuristics

indicating that investors in high age, education and experience groups have lower level of heuristics. Level of

heuristics is significantly different for both countries with Malaysia having slightly lower averages however

impact of heuristics is not different across Malaysia and Pakistan. Across types of investors, the impact of

heuristics is higher when purchase decisions are made on behalf of their clients.

Key Words: Heuristics, Anchoring and adjustment, Availability, Representativeness, Stock

Buying Behavior

1. Introduction

Mental shortcuts (as opposed to thorough information gathering and analysis) in decision

making process are referred to as “heuristics”. Although heuristics can be helpful in many

situations; they often lead to biased decisions (Tversky & Kahneman, 1974). Use of

heuristics in financial decision making is well-established phenomenon in behavioral

economics/finance literature [see for example (De Bondt & Thaler, 1985; Bernard & Thomas,

1989; De Bondt & Thaler, 1990)]. Literature provides many examples of poor decision

making such as selling winners too early and holding losers too long, and excessive trading

(Odean, 1998), under-diversification (Goetzmann & Kumar, 2008). Such behaviors

(anomalies) are observed in stock markets as against the assumptions of traditional finance




theory but no satisfactory explanation of such behaviors exists in traditional finance theory.

However, behavioral finance tries to understand the underlying motivations behind such

irregular patterns (Subrahmanyam, 2008).

Some of the studies which have been carried out in context of stock market and behavioral

biases show that investors are greatly influenced by their behavioral characteristics. For

example Ariely, Loewenstein, and Prelec (2006) argue that judging the fundamental value of

the assets is a tough task so investors are likely to value their assets in relative terms, mostly

they become anchored to previous buy prices. Similarly, Barber, Odean, and Zhu (2009) find

that investors are likely to buy “attention grabbing” or “in news” stocks because these are

easy to recall. Moreover, investors tend to buy previously owned stocks because they can

easily recall them and also have some information about them.

Although literature recognizes the role of heuristics and biases in investors’ decisions to buy

or sell the stock, focus has mostly been on developed markets. A direct linkage between

heuristics and stock buying decision has not been established so distinctively in developing

countries. Economies in developing countries differ from those in developed countries in

term of political stability, law and order situations, technological development, use of

information technology, financial structure, income level and education etc. Similarly stock

markets and investors across developing and developed countries may also differ. Investors’

attitudes and behaviors are shaped by environmental factors and it is likely that such

behaviors are reflected in their decision making for example Pompian (2006) considers

education is an important tool to overcome heuristics and biases. Therefore behavioral biases

may work differently due to differences in education levels between developed and

developing countries. Moreover, early research in behavioral finance has mostly focused a

single heuristic and considered it to be operating independently. Nevertheless, the

developments in behavioral decision theory specify that different heuristics often operate

collectively and influence the decisions and predictions (Ganzach & Krantz, 1990, 1991;

Czaczkes & Ganzach, 1996). In this study we consider three heuristics namely anchoring and

adjustment, representativeness and availability in context of Malaysian and Pakistani stock

markets.

The methodology applied in behavioral studies differs in that they use qualitative approaches

to examine whether or not behavioral biases influence particular decisions however such

findings have not been tested using statistical methods. We use both qualitative and

quantitative approaches to study (i) the influence of heuristics (anchoring and adjustment,

representativeness and availability) on investors’ stock buying behavior, (ii) influence of

demographic factors (age, gender, education, experience and income level) on heuristics, (iii)

comparison between Malaysian and Pakistani investors in their susceptibility to these biases,

and (iv) whether heuristics influence the investors differently when they make buy decisions

for themselves and/or for clients.

Based on mixed approach (qualitative and quantitative), this study contributes towards

literature on behavioral finance in terms of its context (developing countries) and

methodological approach. The study has implications for financial decision makers in

Malaysia and Pakistan (such as private investors, financial brokers, fund managers, and

financial consultants) because the knowledge of relevant biases can prevent decision makers

from falling prey to these biases and hence irrational decisions. Self-constructed




questionnaire is administered to investors in stock exchanges in Pakistan and Malaysia to

secure data using convenient sampling. Results from descriptive analysis show that all three

heuristics (Anchoring and Adjustment, Representativeness, and Availability) are likely to

influence investors’ stock buying. These findings are also supported by regression and

correlation analyses. Demographic factors have significant correlation with level of

heuristics. Level of heuristics is significantly different for both countries with Malaysia

having slightly lower averages however impact of heuristics is not different across Malaysia

and Pakistan. Across types of investors, the impact of heuristics is higher when purchase

decisions are made on behalf of their clients.

The study is organized as follows. Chapter 2 discusses the previous literature on our intended

variables. Chapter 3 represents the discussion on methodology and construction of

instrument. In Chapter 4, we report the results and discussion. Chapter 5 contains conclusion,

limitations and future direction of research.


The concept of heuristics was first introduced by Tversky and Kahneman (1974) who suggest

that under the situations of uncertainty, individuals use mental shortcuts or rule of thumb

strategies in decision making called “heuristics”. These heuristics turn complex situations

into simple cognitive operations. In many cases such “mental short-cuts” may prove to be

helpful in dealing with complex and uncertain situations; however there are greater chances

that they lead to biased decisions. In the following section we consider literature on three

heuristics; anchoring and adjustment, representativeness and availability one by one.

Although literature on anchoring and adjustment in context of capital market is not matured,

there are certain areas where anchoring is found to have significant role on financial

decisions. For example Degeorge, Patel, and Zeckhauser (1999) find that executives aim to

exceed salient EPS thresholds thus a specific level of ESP serves as anchor for executives

which influences their decision. Similarly investors are not ready to bid the stock prices high

enough when stocks are at or near their peak historical prices because they are anchored to

historical highest (George & Hwang, 2004).

Cen, Hilary, Wei, and Zhang (2010) and Cen, Hilary, and Wei (2013) observe that while

estimating the future success of firm, investors are anchored to historical averages. They also

find that for the firms with high industry median-adjusted forecasted earnings per share, stock

returns happen to be higher than for firms with low industry median-adjusted forecasted

earnings per share. They term this phenomenon as the cross-sectional anchoring of forecasted

earnings per share effect. Johnson, Schnytzer, and Liu (2009) find anchoring and adjustment

in financial market; in comparison to the horserace. They explain that the advantage given by

horse barrier position serves as anchor for horse betters’ probability judgment. Kaustia,

Alho, and Puttonen (2008) find significant anchoring effects in long-term future stock return

estimates in Scandinavian stock market. Williams (2010) finds that stock prices depend on

four things one being anchoring level. Campbell and Sharpe (2009) identify anchoring effect

of historical values in predictions of macroeconomic data such as the consumer price index or

non-farm payroll employment by professionals, resulting in significant forecast errors.

Corporate acquisitions are also found to be affected by anchoring bias (Baker, Pan, &

Wurgler, 2009). Anchoring and adjustment affects the extremity of earning forecasts (Amir &

Ganzach, 1998).




Anchoring has also been reported to influence various types of decisions in many different

contexts. These include judicial sentencing decisions (Englich, Mussweiler, & Strack, 2006),

personal injury verdicts (Chapman & Bornstein, 1996), estimation of the likelihood of

diseases (Brewer, Chapman, Schwartz, & Bergus, 2007), job performance evaluation

(Latham, Budworth, Yanar, & Whyte, 2008), judges’ rankings in competitions (Ginsburgh &

Van Ours, 2003), and real estate acquisitions (Northcraft & Neale, 1987). In addition,

anchoring has been shown to influence intuitive numerical estimations (Wilson, Houston,

Etling, & Brekke, 1996), probability estimates (Plous, 1989), estimations of sample means

and standard deviations (Lovie, 1985) and estimates of confidence intervals (Block & Harper,

1991), sales predictions (Hogarth, 1981), Bayesian updating tasks (Lopes, 1991), utility

assessments (Schkade & Johnson, 1989), risk assessments (Lichtenstein, Slovic, Fischhoff,

Layman, & Combs, 1978), preferences of gambles (Lichtenstein & Slovic, 1971), perception

of deception and information leakage (Zuckerman, Koestner, Colella, & Alton, 1984),

negotiation outcomes (Ritov, 1996), and choices between product categories (Davis, Hoch, &

Ragsdale, 1986). Although we did not find a study that directly linked anchoring bias to

investors’ decision to invest in stocks but studies on anchoring and stock market do suggest

that it can influence such decision.

Literature on representativeness bias is however very limited as compared to anchoring and

adjustment bias. Yet there are studies which clearly indicate the role of representativeness in

financial decisions. For example Johnson (1983) studies the use of representativeness

heuristic in judgmental predictions of corporate bankruptcy and found that bankruptcy

probability judgments are governed by the assessed similarity of the corporate financial data.

Further forms of representativeness like base rate neglect and sample size neglect are tested

by Jacobs and Potenza (1991). They find that the judgment heuristic biases displayed by

adults are specific to the social domain and that they develop over time. However, greater use

of base rates develops at the same time in the object domain. Cox and Mouw (1992) find that

representativeness leads to misunderstanding of statistical concepts even when participants

can witness their unreasonable approach towards situation. Even after changing answers to

incorporate appropriate information related to situation, the post-test responses revealed the

presence of representativeness. Pham (1998) discovers that “how do I feel about it heuristics”

to be present in decision making. This heuristic arises when a representative of the target

exists in mind and it generates feelings.

Kahneman, Slovic, and Tversky (1982) apply representativeness bias to the world of sports

and find its role in different forms, such concepts can also be translated to financial decision

making (Pompian, 2006). For instance the concept of permitting the game “to go longer” in

order to increase the probability that the stronger player wins can also apply to investing,

where it is called time diversification, which refers to the idea that investors should spread

their assets across ventures operating according to a variety of market cycles, giving their

allocations plenty of time to work properly. Time diversification helps reduce the risk that an

investor will be caught entering or abandoning a particular investment or category at a

disadvantageous point in the economic cycle. It is particularly relevant with regard to highly

volatile investments, such as stocks and long-term bonds, whose prices can fluctuate in the

short term. Holding onto these assets for longer periods of time can soften the effects of such

fluctuations.




The availability heuristic (a common cognitive strategy in human decision making) provides

an example of how the process of making a judgment influences the evaluation of relevant

events. People's judgments of probability and frequency of events are based on the ease with

which examples of those events come to mind (Tversky & Kahneman, 1973). Availability is

reported to affect decision making in different spheres of lives for example Folkes (1988)

finds that availability influences the judgments about product performance. Similarly Barber

and Odean (2002) discover that investors tend to invest in attention grabbing stocks because

choosing a suitable stock or group of stocks need considerable effort and time because there

are thousands of stocks available in the market. Investors however tend to limit their search to

only attention grabbing stocks. They also found that during high trading days the purchase of

stocks was nearly twice as compared to normal trading days also they tend to buy more

stocks of companies that are in the news. Investors behave like this because they tend to buy

more on high attention days. Their most relevant finding was that, attention grabbing stock

which investors buy due to the availability bias did not beat the market and they never earn

abnormal profits. Barber and Odean (2002) illustrate a direct practical application of

availability bias in individual finance: investors tend to deviate from rationality because they

lack time, resources and skills to process huge volume of data that ought to contextualize a

truly “rational” stock purchase. Information that is literally available to investors simply isn’t

always cognitively available. When pertinent information isn’t available in this latter,

practical sense, decisions are ultimately flawed.

3. Methodology

3.1 Population, Sample, Analysis Technique

Active investors and brokers in Pakistani and Malaysian stock markets constitute population

of this study. Considering the typical nature of population, convenient sampling has been

used and a total of 1000 questionnaires are served to investors at Pakistani and Malaysian1

Stock Exchanges for data collection. We received approximately 300 responses (160 from

Pakistan and 140 from Malaysia), however; we dropped some questionnaires for

incompleteness. A total of 240 usable questionnaires were used in data analysis (144 from

Pakistan and 96 from Malaysia). Following conventions in behavioral studies, items

descriptive analysis has been used as main approach to analyze data whereas t-test, ANOVA,

correlation and quintile regression analyses have been used as supplementary approach for

robustness check.

3.2 Instrument for Data Collection

To capture the presence/absence of heuristics under study, we develop a questionnaire with

the help of and inspiration from Pompian (2006). In addition to three heuristics (anchoring

and adjustment, representativeness, and availability) we also construct a variable for stock

buying behavior which measures investors’ inclination to invest in stocks as compared to

other investment opportunities i. e. bonds etc. The questionnaire was pilot tested in two

stages and checked for validity and reliability so that it can be used for statistical analysis

1In case of Malaysia, some questions were slightly changed to incorporate local currency in numerical examples




such as regression and correlation2. Generalizability of this questionnaire may however be

limited because of specific characteristics of population.3 The questionnaire consists of 28

questions (excluding demographic factors such age, gender, education, experience and

income), each item captures the response on 5 point likert scale (from strongly disagree to

strongly agree). (Questionnaire can be obtained from author if required)

4. Results and Discussion

Items descriptive analysis is conducted as primary analysis technique to explain most

frequent response of investors to different aspects of heuristics under study. As additional

techniques, data has been analyzed through t-test, ANOVA correlation, and quintile

regression. Descriptive analysis of items shows the frequency of investors’ responses to a

particular question, which can be interpreted in term of presence or absence of particular bias.

For example if more frequent responses on a five point likert scale (from strongly disagree to

strongly agree) are 4 or 5, this would mean an “agree” for 4 and “Strongly agree” for 5,

responses to the question. This can be interpreted as the presence of a particular aspect of

bias. Following section presents the descriptive analysis of each item in questionnaire aimed

at capturing the particular aspect of intended bias.

4.1 Items’ Descriptive Analysis

Table 1 presents the percentage responses to each question for anchoring and adjustment

from both Malaysia and Pakistan. A particular heuristic is said to be “present among

investors” if sum of responses for both strongly agree and agree dominates sum of responses

for strongly disagree and disagree.

Question 1 is posed to check the tendency of the investors to make general market forecasts

that are too close to current levels. Agree versus disagree numbers (%) are 56.2 and 6.2

respectively for Malaysia whereas for Pakistan they are 52.8 and 9 respectively. Second

question measures the investors’ tendency to anchor their forecasts on historical minimum or

maximum prices. Responses for this question are 96.9% (agree) versus 3.1% (disagree) for

Malaysia and 91% and 9% for Pakistan. Third question gauges the tendency of investors to

make a forecast of the percentage that a particular asset class might rise or fall based on the

current level of returns, and to capture the investors’ tendency to anchor their forecasts for

prices on most recent historical percentage increase or decrease. For Malaysia, the responses

are 76.1 (agree) versus 14.5 (disagree), while for Pakistan these are 80.5 versus 13.4.

Investors are likely to anchor on the current economic conditions of a particular country; to

measure this tendency question 4 is asked. Responses for Malaysia are 51 versus 9.3 and 49.3

versus 9.8 for Pakistan. Investors, who are biased with anchoring and adjustment, tend to

anchor on historical maximum or minimum stock prices; question five measures this

phenomenon. Responses to this question are 13.5 versus 46.8 for Malaysia and 47.3 versus

13.2 for Pakistan. In question six, five point measurement scale includes two options (4 and

5) very close to the given value of 900,000 representing high level of anchoring, while other

options were fairly away from this value with option 1 exactly 10% less of this value. In case

of Malaysia the responses for option “4” and “5” are 73.9 versus 21.9 for option 1 and 2; for

2 Factor analysis is used to for validity, whereas Cronbach's alpha for reliability. Cronbach's alpha in case of

each group of questions is more than 0.6. 3 For example it may only be used to analyze the buying behavior of investors in stock market.




Pakistan, these responses are 75.7 versus 20.2 respectively. Question seven measures the

phenomena that investors, who are exposed to anchoring and adjustment, tend to anchor to

current economic conditions of a particular company.




Table 1: Percentage Responses to questions on Anchoring and Adjustment

Questions for Anchoring and Adjustment Responses in %

Malaysia Pakistan

1 Suppose that KSE-100 Index is currently at 13500, in your opinion, KSE-100 index at

the end of year 2012 would be somewhat closer to the current level.

SDA DA N A SA

1.0 5.2 37.5 47.9 8.3

SDA DA N A SA

1.4 7.6 38.2 49.3 3.5

2 Suppose you own a stock that is now at 52 weeks highest price level, you are likely to

sell the security at this price level because in your opinion, it has achieved the maximum

price level.

SDA DA N A SA

0.0 3.1 0.0 55.2 41.7

SDA DA N A SA

1.4 4.9 2.8 52.1 38.9

3 Suppose price of a stock increased by 17% during the last year. Then the expected

increase in this stock till the end of current year would be somewhat closer to 17%.

SDA DA N A SA

1.0 13.5 9.4 41.7 34.4

SDA DA N A SA

3.5 9.7 6.3 45.8 34.7

4 Overall economic growth of Pakistan has been declining for the past many years. You

foresee a similar trend of growth in coming years.

SDA DA N A SA

1.0 8.3 39.6 45.8 5.2

SDA DA N A SA

3.5 6.3 41.0 44.4 4.9

5 Suppose you bought the stock of ABC Corporation at RS 12. Couple of months ago, the

stock reached at RS 20. You thought to sell it then but somehow you could not.

Unfortunately the stock dropped to RS 15 and currently trading at 15. Now to sell this

stock, you are likely to wait until it returns to RS 20.

SDA DA N A SA

3.1 43.8 39.6 12.5 1.0

SDA DA N A SA

0.7 46.5 39.6 8.3 4.9

6 Suppose you want to sell your house. Your real estate agent prices your home at

900,000. You did not receive any bids for some days. One day your agent tells you that

local real estate prices are down by 10% on average and that you must also revise your

ask price. Your new price is most likely to be closer to:

SDA DA N A SA

16.7 5.2 4.2 65.6 8.3

SDA DA N A SA

16.0 4.2 4.2 69.4 6.3

7 Suppose that stock of ABC Corporation has outperformed the market for past several

years, considering its past, this stock is expected to show similar performance in future.

SDA DA N A SA

0.0 7.3 4.2 83.3 5.2

SDA DA N A SA

1.4 5.6 3.5 84.0 5.6

***SDA=Strongly Disagree, DA= Disagree, N=Neutral, A=Agree, SA=Strongly Agree



151

Responses for this question are 88.5 versus 7.3 in case of Malaysia and 89.6 versus 7 in case of

Pakistan.

Collectively sum of “agree” and “strongly agree” responses dominates the sum of “disagree” and

“strongly disagree “options in nearly all of the questions except for question 5 where opposite is

true. Respondents’ agreement in general to all questions (except one) supports the presence of

anchoring and adjustment. The questions are posed to gauge whether or not the investors behave

in predicted ways under anchoring and adjustment. Their agreement to such actions confirms that

they are likely to make decisions which are under the influence of anchoring and adjustment.

Moreover, the responses from investors in Malaysia and Pakistan are on average similar

therefore we conclude that vulnerability of investors to anchoring and adjustment is same across

these two countries.

Table 2 shows investors’ responses to each question for representativeness from Malaysia and

Pakistan. Interpretation of responses is same as in case of anchoring and adjustment. Question 8

measures the phenomena that while judging the likelihood of a particular investment outcome,

investors often fail to accurately consider the sample size of the data on which they base their

judgments. The responses are 84.4 versus 9.4 and 84 versus 8.3 for Malaysia and Pakistan

respectively. Similarly the investors, who are biased with representativeness, tend to neglect the

sample size while analyzing the performance of stocks, questions 9 measures this phenomenon.

Responses are 83.4 versus 5.2 and 87.5 versus 6.9 for Malaysia and Pakistan respectively.

Question 10 measures the fact that representativeness heuristic can lead investors to ignore the

base reality and consider a given characteristic as representativeness of whole the scenario.

Responses to this question are 87.5 versus 7.3 for Malaysia and 84 versus 6.3 for Pakistan.

Question 11 gauges the investors’ tendency to determine the potential success of an investment

in a company by contextualizing the venture in a familiar, easy-to-understand classification

scheme is known as base rate neglect. For Malaysia, the responses are 57.2 versus 6.3 whereas

for Pakistan these are 61.9 versus 3.5. Question 12 measures the investors’ tendency to ignore

the base reality. Responses for Malaysia are 86.5 versus 7.3 while for Pakistan, responses are

86.1 and 9.6. Investors’ tendency to show base rate neglect was further confirmed by asking the

question 13. Responses are 81.3 versus 13.5 and 80.6 versus 14.6 for Malaysia and Pakistan

respectively.



152

Table 2: Percentage Responses to questions on Representativeness

Questions for Representativeness Responses in %

Malaysia Pakistan

8 Suppose you are not satisfied with your analyst’s tips about stock purchase. Your friend

tells you about his own analyst that he gave him three great stock picks over the past

month. You are likely to consider your friend’s analyst as “successful” and decide to

switch to this analyst.

SDA DA N A SA

4.2 5.2 6.3 17.7 66.7

SDA DA N A SA

1.4 6.9 7.6 13.2 70.8

9 Suppose you analyzed the performance of a stock for last 10 quarters. You found that its

performance during the initial 4 or 5 quarters has been poor but for last four quarters it

has been excellent so you expect the same excellent performance from the stock in

future.

SDA DA N A SA

2.1 3.1 11.5 81.3 2.1

SDA DA N A SA

0.0 6.9 5.6 85.4 2.1

10 Troubled steel companies can either be (A) The companies that will go out of business;

or (B) The companies that are likely to recover. In your opinion, a 75 year old steel

manufacturing company, which is currently facing some business difficulties, belongs to

category (A) because recently there have been many bankruptcies in steel industry.

SDA DA N A SA

2.1 5.2 5.2 53.1 34.4

SDA DA N A SA

0.0 6.3 9.7 46.5 37.5

11 Suppose you are looking for a long term investment stock. You are told by your friend

about a new IPO Company ABC and that most firms have placed a buy rating on this

stock. You are likely to buy this stock.

SDA DA N A SA

0.0 6.3 37.5 51.0 5.2

SDA DA N A SA

1.4 2.1 34.7 55.6 6.3

12 New IPOs can either be (A) the stocks constituting successful long term investment or

(B) the stocks that will fail as long term investment. In your opinion, ABC Company (the

new IPO) belongs to category (A) because IPOs are good long term investments.

SDA DA N A SA

0.0 7.3 6.3 49.0 37.5

SDA DA N A SA

2.1 7.6 4.2 46.5 39.6

13 AAA rated municipal bonds can either be (A) safe municipal bonds or (B) risky

municipal bonds. In your opinion, AAA rated bond issued by inner city of a racially

divided country belongs to (B) because of potential riskiness of the country (racial

disputes).

SDA DA N A SA

1.0 12.5 5.2 79.2 2.1

SDA DA N A SA

4.9 9.7 4.9 76.4 4.2

14 Analysis of track record of a money manager for past six months suggests that on

average money manager has performed better. Thus you are likely to conclude that his

performance is result of skilled allocation and security selection.

SDA DA N A SA

1.0 6.3 69.8 14.6 8.3

SDA DA N A SA

0.7 5.6 67.4 22.9 3.5




153

Sample size neglect can lead the investors to wrong conclusion about the performance of

analysts or money managers by taking too narrow sample period of their performance record;

question 14 verifies this aspect. For Malaysia and Pakistan 22.9 versus 7.3 and 26.4 versus 6.3

responses are received respectively.

Results are similar to that of anchoring and adjustment. Again on average, the sum of “agree”

and “strongly agree” responses dominates the sum of “disagree” and “strongly disagree” options

in all cases. Respondents’ agreement in general to all questions not only supports the presence of

representativeness bias but also confirms that it can lead them to sample size neglect and base

rate neglect. Moreover, the responses from investors in Malaysia and Pakistan are on average

similar therefore like anchoring and adjustment, we conclude that vulnerability of investors to

representativeness is same across these two countries.

Investors’ responses to each question for availability from Malaysia and Pakistan are shown in

table 3. Investors’ tendency to rely on readily available knowledge rather than examine other

alternatives or procedures is known as availability bias. Four types of availability biases apply

most to investors: retrievability, narrow range of experience, categorization and resonance.

Retrievability refers to the ease with which the information can be recalled; question 15

measures retrievability. Responses are 91.7 versus 4.1 and 90.3 versus 6.3 for Malaysia and

Pakistan respectively. Investors’ tendency to categorize or call for information that matches a

certain reference is known as categorization and this is measured through question 16. Responses

for this question are 89.6 versus 9.3 for Malaysia and 82.4 versus 4 for Pakistan. Question 17

measures the extent to which certain, given situations matches with individuals’ own, personal

situations can also influence judgment and this is known as resonance. For Malaysia, the

responses are 84.4 versus 6.2 while for Pakistan these are 81.3 versus 12.5. When a person

possesses a too restrictive frame of reference from which to formulate an objective estimate, then

narrow range of experience bias often results; question 18 gauges the narrow range of

experience. 81.3 versus 11.5 are the responses for Malaysia and 84.1 versus 7.6 are ones for

Pakistan. Presence of narrow range of experience among investors is further confirmed by asking

question 19. Responses from Malaysia and Pakistan are 11.4 versus 19.8 and 17.4 versus 13.2

respectively. Finally, question 20 confirms the presence of narrow range of experience among

investors for which responses are 89.7 versus 8.3 and 86.8 versus 6.9 for Malaysia and Pakistan.



154

Table 3: Percentage Responses to questions on Availability

Questions for Availability Responses in %

Malaysia Pakistan

15 Suppose you hear about a great stock tip from your friend who has a good stock market

sense, he recommends you to purchase the stock of ABC Company. You are likely to

buy some shares because your friend is usually right about these things.

SDA DA N A SA

1.0 3.1 4.2 54.2 37.5

SDA DA N A SA

2.1 4.2 3.5 49.3 41.0

16 Suppose you recently studied a success report about a generic drug maker company and

you plan to purchase 100 shares of it. Right before you do, you hear on popular financial

news that another drug maker company just reported great earnings and its stock is up by

10%. You are likely to take this information as confirmation that generics are a good

area for investment and proceed with the purchase.

SDA DA N A SA

1.0 8.3 1.0 47.9 41.7

SDA DA N A SA

1.4 3.5 2.8 54.9 37.5

17 What type of music do you like? In your opinion, the percentage of people who have

similar taste in music as yours is more than the percentage of people who like the other

types.

SDA DA N A SA

3.1 3.1 9.4 79.2 5.2

SDA DA N A SA

4.9 7.6 5.6 77.8 3.5

18 In your opinion, USA provides the best investment opportunities.

SDA DA N A SA

4.2 7.3 7.3 75.0 6.3

SDA DA N A SA

2.1 5.6 8.3 78.5 5.6

19 Suppose during a visit to a Hi Tech Company, you meet many of your college fellows

who studied mathematics at college and were very good at it. You can conclude from

this experience that good mathematics students tend to join the Hi Tech companies.

SDA DA N A SA

2.1 17.7 68.8 8.3 3.1

SDA DA N A SA

4.2 9.0 69.4 15.3 2.1

20 Suppose you are working in a fast growing Hi Tech company and you are asked which

industry generates most successful investments? You are likely to refer to Hi Tech

industry because you have witnessed this industry generating very good investments in

the past.

SDA DA N A SA

0.0 8.3 2.1 87.5 2.1

SDA DA N A SA

0.0 6.9 6.3 84.7 2.1




PROMOTING GROWTH, EXCELENCE AND SUSTAINABILITY- 155

Similar to anchoring and adjustment and representativeness responses favoring the presence

of availability of dominate in almost all cases. Their consent to the questions supports the

presence of availability because questions are designed such that they show the behaviors of

investors who are likely to fall prey to availability bias. Moreover, the responses from

investors in Malaysia and Pakistan are on average similar therefore like anchoring and

adjustment, we conclude that vulnerability of investors to representativeness is same across

these two countries.

4.2 Correlation and Regression Analysis

In order to support our results from descriptive analysis, we also perform correlation and

regression analyses which are not the conventional approaches in behavioral finance

however; we do so as robustness check. It is interesting to note that results of descriptive

analysis are supported by both correlation and regression analyses. Table 5 displays the

results or correlation analysis. Investors’ buying behavior (last column and last row) is

significantly related to all three biases.41 All three heuristics are significantly related to stock

buying decision. Three demographic factors (age, education and experience) are significant

with negative signs. This finding reveals that level of heuristics is lower for investors in

higher age groups, with more experience and more education. Income level is however

positively related to level of heuristics indicating that investors in lower income groups are

more careful in their analysis and have lower level of biases as compared to their counterparts

in high income groups.

Table 4: Correlation Analysis

ANCH REP AVA DEC AGE GENDER EDUCATION EXPERIENCE

REP .734** 1

AVA .666** .638** 1

DEC .316** .471** .516** 1

AGE -.877** -.865** -.843** -.498** 1

GENDER -.031 -.009 .049 .040 .024 1

EDUCATION -.862** -.852** -.767** -.422** .941** .029 1

EXPERIENCE

-.887** -.851** -.804** -.368** .947** .026 .973** 1

INCOM .880** .867** .807** .478** -.969** -.003 -.958** -.940**

Very important statistics when we apply regression analysis is “F” value which shows the

goodness of fit for the model. F value for our model is 38.63252 which is significant at

p<0.05. Therefore our model is good fit for these variables. Table 5 shows the coefficients

and significance levels for dependent variables (heuristics). Last column reveals that all of the

independent variables (heuristics) are significant predictors of dependent variable (stock

buying behavior). However, significant intercept shows that there are other important

predictors of buying behavior which have not been considered in this model. Although it is

41 ** show the significance level for correlation at 0.01 52 From model summary table in appendix A




difficult to interpret the magnitude and direction of coefficients for heuristics, the

significance of these coefficients can be interpreted in term of likelihood of investors to be

influenced by heuristics under study while making stock buy decision.

Table 5: Regression Analysis

Variables Coefficients Std. Error t Sig.

1 (Constant) 1.454 .261 5.561 .000

Anchoring -.274 .088 -3.096 .002

Representativeness .405 .096 4.219 .000

Availability .548 .088 6.232 .000

Two more regressions are run in order to test that a) heuristics impact investors’ stock buying

decision differently in sample countries and b) the impact of heuristics is different for

investors when they make purchase decisions for themselves and/or for their clients. In order

to test cross country difference, we use a dummy variable which equals 1 if the respondent is

from Pakistan and 0 otherwise. Then we multiply this variable with each heuristic, making an

interactive term for each heuristic. These interaction terms are then used as independent

variables along with heuristics in a regression equation with stock buying decision as

dependent variable. Table 7 in appendix “A” shows the results of regression with interactive

dummy for country. However, coefficients on all interactive terms are non-significant

therefore we conclude that impact of heuristics on investors’ buying behavior is similar

across both countries.

To check for differences in impact of heuristics across investors’ type (brokers and individual

investors) we construct a dummy variable which equals 1 if respondent is an individual

investor (uses his own money) and 0 otherwise. We then multiply this dummy variable with

all three heuristics to get interaction terms. Stock buying behavior is then regress on

heuristics along with interaction terms of investors’ type dummy. Results of this analysis are

given in table 8 in appendix “A”. Coefficients on all interactive terms are significant

therefore we interpret that the impact of heuristics different for investors when they make

purchase decisions for themselves and/or for their clients. A negative coefficient on

interaction term shows that of impact of heuristics is higher for investors who make stock

buying decision on behalf of others.

4.3 ANOVA and T-test

In order to test whether level of heuristics differs across two countries we compare three

heuristics using t-test. Results reveal that averages across all three heuristics differ

significantly with lower averages for Malaysia across Pakistan. Results of t-test are not

reported for sake of brevity. Although correlation among demographic variable (Age, gender,

education, experience and income) and heuristics indicates significant relationship, we use

ANOVA to test whether level of heuristics significantly differ based on demographic factors.

Results reveal that level of heuristics differs significantly for all demographic groups except

gender. Results for ANOVA are reported in Appendix A: table 9 through table 12.




5. Conclusion

Although literature recognizes the role of heuristics and biases in investors’ decisions to buy

or sell the stock, focus has mostly been on developed markets. A direct linkage between

heuristics and stock buying decision has not been established so distinctively in developing

countries. Economies in developing countries differ from those in developed countries in

term of political stability, law and order situations, technological development, use of

information technology, financial structure, income level and education etc. Similarly stock

markets and investors across developing and developed countries may also differ. Investors’

attitudes and behaviors are shaped by environmental factors and it is likely that such

behaviors are reflected in their decision making for example Pompian (2006) considers

education is an important tool to overcome heuristics and biases. Therefore behavioral biases

may work differently due to differences in education levels between developed and

developing countries. Moreover, early research in behavioral finance has mostly focused a

single heuristic and considered it to be operating independently. Nevertheless, the

developments in behavioral decision theory specify that different heuristics often operate

collectively and influence the decisions and predictions (Ganzach & Krantz, 1990, 1991;

Czaczkes & Ganzach, 1996). In this study we consider three heuristics namely anchoring and

adjustment, representativeness and availability in context of Malaysian and Pakistani stock

markets.

The methodology applied in behavioral studies differs in that they use qualitative approaches

to examine whether or not behavioral biases influence particular decisions however such

findings have not been tested using statistical methods. We use both qualitative and

quantitative approaches to study (i) the influence of heuristics (anchoring and adjustment,

representativeness and availability) on investors’ stock buying behavior, (ii) influence of

demographic factors (age, gender, education, experience and income level) on heuristics, (iii)

comparison between Malaysian and Pakistani investors in their susceptibility to these biases,

and (iv) whether heuristics influence the investors differently when they make buy decisions

for themselves and/or for clients.

In order to collect data on heuristics, a questionnaire is developed with the help of and

inspiration from Pompian (2006). In addition to three heuristics, we also construct a variable

for stock buying behavior which measures investors’ inclination to invest in stocks as

compared to other investment opportunities i. e. bonds etc. Considering the typical nature of

population, convenient sampling has been used and a total of 1000 questionnaires are served

to investors at stock exchanges in Malaysia and Pakistan. A total of 240 usable questionnaires

were used in data analysis (144 from Pakistan and 96 from Malaysia). Items descriptive

analysis has been used as main approach to analyze data whereas ANOVA, t-test, correlation

and Regression analyses have been used as supplementary approach to support findings from

descriptive analysis.

Results from descriptive analysis show that all three heuristics (Anchoring and Adjustment,

Representativeness, and Availability) are likely to influence investors’ stock buying decision.

These findings are also supported by results from regression and correlation analyses.

Demographic factors have significant correlation with level of heuristics; the level of

heuristics is lower for investors in higher age groups, with more experience and more




education. Income level is however positively related to level of heuristics indicating that

investors in lower income groups are more careful in their analysis and have lower level of

biases as compared to their counterparts in high income groups. Level of heuristics is

significantly different for both countries with Malaysia having slightly lower averages

however impact of heuristics is not different across Malaysia and Pakistan. Across types of

investors, the impact of heuristics is higher when purchase decisions are made on behalf of

their clients.

Implications of heuristics can be far reaching for investors. First, the investors who are biased

with anchoring and adjustment are more likely purchase a stock that may behave against their

expectations. For example if investors are anchored to historical high stock prices and expect

the stock to recover, they may keep on holding their losing stocks for too long (Odean, 1998).

Similarly they may get anchored to historical percentage increase in prices and expect the

similar trend in future; this leads them to buying the overvalued stock. Investors can also

become anchored to historical performance of companies which may actually deviate from

their trends of past performance because of certain uncontrollable economic factors. Second,

the investors who are exposed to representativeness bias are more likely to buy a wrong stock

for their portfolio. For example they may base their buying decision on insufficient past data,

this may lead them to buy a stock that may not have the potential meet their expectation in

future (sample size neglect). Investor may also fall prey to another type of representativeness

bias (base rate neglect) for example looking for a long-term investment stock they may end

up with stock that is not in fact a long-term investment (i.e. New IPO companies). Third

most investors, if asked to identify the “best” mutual fund company, are likely to select a firm

that engages in heavy advertising. In addition to maintaining a high public relations profile,

these firms also “cherry pick” the funds with the best results in their fund lineups, which

makes this belief more “available” to be recalled. In reality, the companies that manage some

of today’s highest-performing mutual funds undertake little to no advertising. Consumers

who overlook these funds in favor of more widely publicized alternatives may exemplify

retrievability/availability bias. Investors will choose investments based on information that is

available to them (advertising, suggestions from advisors, friends, etc.) and will not engage in

disciplined research or due diligence to verify that the investment selected is a good one.

Our study is limited to only three heuristics (Anchoring and Adjustment, Representativeness,

and Availability) whereas behavioral finance literature has identified more than 50 biases that

can influence the investors’ stock purchase decision. Moreover, we explore the influence of

heuristics only on investors’ stock purchase decision, other financial decisions such as stock

sell decision from investors’ perspective, investing, financing, asset management, dividend

policy and mergers and acquisition decisions from corporate perspective are also exposed to

influence of heuristics. This study can be enhanced to these areas as well. We do not address

the details of what sort of problems these heuristics can create for investors. Further research

on consequences of different biases can be a good contribution to the literature. Moreover,

given that there are just enough observations to analyze the impact, it could also be rewarding

to examine an alternative measure (Investors’ trading data, if available) for capturing the

heuristics.




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Appendix A

Table 6: Model Summary

Model Sum of

Squares

df Mean

Square

F Sig.

1 Regression 19.432 3 6.477 38.632 .000b

Residual 39.402 235 .168

Total 58.834 238

Table 7: Regression with Country Dummy

Variables Coefficients Std. Error t

1 (Constant) 1.443 .270 5.343

Anchoring -.268 .125 -

2.134

Representativeness .359 .149 2.406

Availability .588 .159 3.700

Anch X Pak -.017 .185 -.091

Rep X Pak .071 .193 .366

Ava X Pak -.050 .184 -.271

Table 8: Regression with type of investor's Dummy

Variables Coefficients Std. Error t

1 (Constant) 1.442 .267 5.396

Anchoring -.131 .157 -.834

Representativeness .349 .147 2.365

Availability .459 .140 3.280




Anch X Inv -.197 .084 -2.321

Rep X Inv -.090 .027 -3.272

Ava X Inv -.112 .042 -2.626

Table 9: ANOVA based on AGE

Sum of Squares df Mean Square F Sig.

Anchoring Between Groups 43.968 3 14.656 331.774 .000

Within Groups 10.425 236 .044

Total 54.394 239

Representativeness Between Groups 33.292 3 11.097 239.643 .000


Total 44.220 239

Availability Between Groups 32.890 3 10.963 225.381 .000


Total 44.370 239

Table 10: ANOVA based on Education




Total 54.394 239



Total 44.220 239



Total 44.370 239

Table 11: ANOVA based on Experience




Total 54.394 239



Total 44.220 239



Total 44.370 239




Government Expenditure Policy Analysis in Malaysia: A Social

Accounting Matrix Approach

Mohammad Mahdi Kiaeeha

National University of Malaysia (UKM)

43600 Bangi, Selangor Darul Ehsan, Malaysia


Abstract

In developing countries, government spending has a critical function to play in alleviating aggregate

demand (AD). Also, in macroeconomics, rising government expenditure could have multiplier effects in the final

stage of national income equilibrium. This research compares “Demand-Side” and “Supply-Side” analysis in

the framework of the Malaysia Social Accounting Matrix (SAM) 2005 to assess the economic effects of

government expenditure and evaluate its economic effect. The comparative analysis of these multipliers by using

the Malaysian data is presented. The result demonstrates that the Supply-Side multipliers would be a preferable

tool in allocating government expenditure. It concludes that providing infrastructure in “Service” sector should

be prioritized rather than all other choices, when the economic growth is the most urgent goal of the

government. Hence, the result could be generalized to other developing countries, such as the ASEAN countries.

Key words: Social Accounting Matrix (SAM), Supply-side Multipliers, Demand-side

Multipliers, Government expenditure.

1. Introduction

Currently, Malaysia confronts challenges in moving towards becoming a high-income

economy. The Malaysian government is deeply aware of the challenges and has set itself a

forceful goal of becoming a high-income economy by 2020, which will need a doubling of

private investment as a share of GDP between 2010 and 2020. Initiatives have been

proliferated to reach these objectives, most remarkably the New Economic Model (NEM),

which was developed by the National Economic Advisory Council (NEAC) and inaugurated

by the prime minister in 2009. Additionally, Strategic initiatives involve the Economic

Transformation Program to motivate private investment and the Government Transformation

Program to make a leaner and more consultative government, with measurable goals in the

form of Strategic Reform Initiatives and National Key Result Areas. There are well over 100

different recommendations summarized in the NEM, with a new Delivery Unit and

Performance Management created to guarantee that reforms are fulfilled (OECD, 2013).

Practically, in most of the economic areas, the government has undertaken policy reforms and

shaped or revamped institutions to ensure that the reforms bring results. A Special Task Force

to Facilitate Business (PEMUDAH) was formed in 2007, comprising of corporate leaders and





public officials to simplify business operations and thus successfully ameliorate Malaysia’s

ranking in the World Bank’s Doing Business report. The Malaysia Productivity Corporation

is spearheading a wide-ranging review of business regulations to ameliorate processes and

procedures. The investment promotion agency renamed the Malaysian Investment

(previously Industrial) Development Authority (MIDA) to mirror its broader remit in order to

promote services as well as manufacturing. Furthermore, the Putrajaya Committee on GLCs

(Government-Linked Companies) High Performance was formed to lead the GLC

Transformation Program. A new Malaysian Code of Corporate Governance and a

Competition Act were promulgated in 2012 and 2010, respectively. In the financial segment,

the government has a Capital Market Master Plan 2 and a Financial Sector Blueprint for

2011-20, following the earlier Capital Market Master Plan and Financial Sector (OECD,

2013).

It is obvious that the Malaysian government is currently looking for ways to stimulate

investing or provide better infrastructure for investing. The Input-Output economic approach

provides suitable tools for this purpose.

In the Input-output approach, the identification of the foremost sectors is considered to be

helpful for economic planning, especially in developing countries since it aims to generate

above average rises in economic activity and therefore, stimulate whole economic growth.

Based on this view, the government expenditure policy concentrates on special key sectors to

motivate overall economic output and growth (Lenzen, 2013). Hence, this research plans to

assess the efficiency of government intervention in the Malaysian economy by expending in

specific sectors and improving its infrastructure.

The rest of this research is organized as follows: Section 2 provides the background for

government expenditure in the Malaysian economy; Section 3 includes the review of

literature in this field; Section 4 explains the economic construction procedures in forming

the SAM and the method used in this paper; the data, findings and discussions are provided in

Section 5; Section 6 presents the conclusion and policy recommendations. The study also

contains a brief technical appendix in which the detailed tables are organized.

2. Analyzing Government policy in Malaysia

From the economic perspective, when we have a positive shock in government expenditure

for one economic sector, the macro-effects on other product accounts, production factor

accounts and institutional income distributions are generally positive. These comments must

not however take away the attention from the ultimate results of the analyses. While the

enlargement of the macro-effects may be altered by a clearer analysis, the path of the effects

is unlikely to be different.

It is believed that development policies should emphasis on production sectors that have the

largest combined backward and forward linkages (Hirschman, 1985). However, subsequent

studies have found out that the concentration on production linkages in an input-output model

may provide misleading policy prescriptions (Vogel, 1994). Hence, it would be much better

to observe the policy effects in more detailed models such as the Social Accounting Matrix




(SAM). However, prior to that, it is important to get a more detailed literature review of the

Malaysian economy in this field.

The Department of Statistics (DOS) of Malaysia has shown that Malaysia’s Government

Spending was boosted from 59,635 Million Malaysian Ringgit (MYR) in 2004 to 64,516

Million MYR in 2005. In fact, from 1975 until 2005, Government Spending in Malaysia

averaged 22,498 Million MYR, with an all-time high of 64,516 Million MYR in 2005 and a

record low of 3,924 Million MYR in 1975 (Trading Economics, 2012) (Department of

Statistics Malaysia, 2012).

0.000

0.020

0.040

0.060

0.080

0.100

0.120

0.140

0.160

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Malaysia General Government Expenditure

to GDP

Figure 1. Malaysia General Government Expenditure to GDP




Furthermore, the government of Malaysia has recently initiated the Government

Transformation Plan (GTP) in its bid to escalate the public service delivery efficiency, which

is intended to cut public deficit through minimizing wastage and rationalizing subsidies.

In the case of Malaysia, numerous studies have been carried out on the relationship between

the Malaysian government expenditure and revenue. Nonetheless, most of these studies were

performed at the Malaysian federal level. For instance, the analysis tax spend hypothesis for

Malaysia was proven by Ram (1988). Parallel outcomes were gained by Mithani and Khoon

(1999). Another report by A. Aziz et al (2000) uncovered that there would be a bi-directional

causality on tax revenue and government spending nexus inferring a Malaysian fiscal

synchronization. Conversely, Narayan (2005) achieved co-integration and causality between

government revenue and government expenditure in Malaysia. In addition, fiscal relationship

at the state level has been examined by Zulkefly (2003).


The theoretical relationship of economic growth and government expenditure is well

documented in the literature. There are two main divergent economic theories concerning the

relationship between economic growth and government expenditure. Keynesian macro-

economic theory has commonly presumed that boosted government expenditure leads to high

summative demand and speedy economic growth, while the Wagnerian theory tends to

provide the opposite interpretation. The latter argues that a rise in national income creates

more government expenditure (Dandan, M. M. 2011).

A number of researchers had focused on the relationship between economic output (and also

economic growth) and government expenditure. In a specific way, we only concentrate on the

literature that investigates this relationship by IO and SAM methods. However, the outcomes

varied from one paper to another.

Specifically, in terms of government spending, Keuning and Thorbecke (1989) analyzed the

effect of Indonesia’s public expenditure on its income distribution for the World Bank. They

found out that a decline of government expenditure affect sectorial output and income

growth; and moreover the average income of each household group varies based on the

government budget options. Dorosh and Sahn (1997) investigated a fall in government

spending in the SAM models for four African countries, namely Cameroon, Gambia,

Madagascar and Nigeria in order to investigate the impact of policy reforms on real incomes

of various household groups. They successfully evidenced the relevance of the SAM model

for emphasizing and focusing issues related to government expenditure, income distribution

and poverty.

The SAM method has a relatively short history in Malaysia. Among the pioneers of SAM in

Malaysia, are Ahluwia and Lysy (1979), (Pyatt and Round, 1979), Ramesh et al. (1980), and

Pyatt et al., (1984). Subsequently, Harun et al. (2012) developed the Malaysian SAM

thoroughly by the incorporation of the disaggregating private capital investments and public




sector capital investments according to different production segments. It was obvious that

there were only a few studies regarding the above-mentioned items in Malaysia. Hence, the

present study intends to fill this gap.

4. Methods

4.1 SAM and the Malaysian Economy

Different types of analytical tools can be adopted to evaluate the impact of government

spending on economic variables (such as output). However, in this case, government

expenditure is a component of the national accounts, and hence there is a need to briefly

clarify this method.

The Social Accounting Matrix (SAM) performs as an accounting platform that offers such an

approach (Jorge Alarcón et al, 2011). The SAM, as the literature shows, can be used for the

investigation of public infrastructure investments, public spending in general, and

furthermore on other sectorial policies and trade policies. This matrix allows the analysis of

the effectiveness of past economic programs and the simulation and comparison of possible

consequences of future policies or mixed policy, and also permits the evaluation of external

shocks (Jorge Alarcón et al, 2011).

As expected, SAM fortunately brings together the contemporaneous and unified information

in an extensive economy-wide manner: (i) National income and production accounts; (ii)

Detailed I/O information and section accounts; (iii) Employment of production factors and

earnings data; (iv) Multi lateral partner-trade data; and (v) Nationally sampled and directly

representative household survey data (Tarp, 2003). In this way, the data sources in Malaysia

reveal their strong reliability.

Before pursuing into detailed SAM accounts, we depict a table, which demonstrates how

macro-data could be systematized in a SAM format (Table 1). Table 1 is necessarily a double

entry representation of the dominant macro-economic accounting identities. This table

describes an open-economy Macro-SAM with the consideration of the government sector in

terms of the macro-accounting identities. It must be pointed out that in this case, intermediate

goods are netted out.

Table 12. An Open-economy Macro-SAM with a government sector

Receipts Expenditures Total

1 2 3 4 5

1. Suppliers - C G I E Demand

2. Households Y - - - - Income

3. Government - T - - - Receipts

4. Capital Account - Sh Sg - St Savings

5. Rest of World M - - - - Imports




Total Supply Expenditure Expenditure Investment ROW

Additional variables: t42=Sh=private saving, t32=T=tax payments, t43=Sg=government saving,

t15=E=export, t45=St=foreign savings, t51=M=import, t13=G=government spending.

Accounting identities: 1. Y+M=C+G+I+E (GNP), 2. C+T+Sh=Y (Income), 3. G+Sg=T (Government

budget), 4. I=Sh+Sg+St (Saving-Investment), 5. E+St=M (Trade balance).

(Tarp, 2003)

Factors of production of this economy are generally of two types: labor and capital.

Moreover, the labor is disaggregated into three dimensions: rural citizens, urban citizens, and

non-citizens. This macro-table is elaborated in accordance with international input-output

standards and it reveals the most exhaustive and meticulous picture of the I/O production

structure of the Malaysian economy in the current situation.

As a general idea, economic sections targeted for expansion, whether to serve domestic or

external markets, may have totally different effects on domestic sectors, production factor

usage and relative incomes, and these impressions will fundamentally have political as well

as economic outcomes (Tarp, 2003). Accordingly, the Malaysian SAM normally exhibits

precise information on its macroeconomic functions and effects, which should surely

facilitate its role in macroeconomic analysis and policy-making formulation.

4.2 Structures and Schematic of the Malaysian SAM for the Year 2005

Generally, in a SAM we have different types of accounts and sub-accounts. The degree of

disaggregation and classification of SAM could vary from one SAM to another because they

are designed based on the interests of the economy and data existence. However, most of the

time, countries compile SAM by highlighting income distribution as compared to the other

aims. The Malaysian economy has carried out a similar practice where SAM for years 1970,

1978, 2000 and 2005 were totally compiled for the purpose of distribution of income, while

the SAM for 1983 was made for the purpose of flow of funds. The flow theme of funds was

chosen in order to develop deeper into the transactors of income and expenses. As the

problem of income inequality is still vital in Malaysia, the selected theme for SAM 2005 was

distribution of income, where it gives the framework of income distribution in a socio-

economic model. Besides, this theme supports the third thrust of the Ninth Malaysia Plan to

address continuing socio-economic inequalities fundamentally and productively (Jamal and

Raham, 2009).

A simple structure of Malaysia SAM 2005 is presented in Table 2. It describes the

interdependencies between sectors in the economy within a single-accounting framework for

the year 2005. The SAM is indicated by a square matrix in which each transaction or account

has got its own row and column. The incomings are represented as incomes for the row (i)

and outgoings are represented as expenditures for the column (j). The corresponding row and

column totals of the matrix must be equal, consistent with the major fundamental law of

economics, which for every income there is a corresponding outlay or expenditure

(Thorbecke, 2001).




Table 13. Schematic of Social Accounting Matrix for Malaysia, 2005

Receipts Activities Commodities Factors Households Government Saving/

investment

Rest of

World

(ROW)

Total

Activities Gross output Gross

output

Commodities Intermediate

inputs

Household

consumption

Government

consumption Investment Export Demands

Factors Capital and

labor

Factor

income

from ROW

Factor

income

Households

Household

income from

factor

ownership

Government

transfer to

households

Household

transfer to

ROW

Household

income

Government

Output

taxes, factor

taxes

Sales taxes,

export taxes

Government

income from

factor

ownership/taxes

Household

transfer to

government

(direct)

ROW

transfers to

government

Government

income

Saving/

Investment

Household

savings

Government

savings

Foreign

savings savings

Rest of

World

(ROW)

Imports

ROW income

from factor

ownership

Government

transfer to

ROW

Capital

outflows to

ROW

Total Activities Supply

expenditures

Factor

expenditures

Household

expenditures

Government

expenditures Investment

Capital

inflows

from ROW

(Jamal and Raham, 2009)

The selected theme and the degree of disaggregation of the individual accounts depend

fundamentally on the questions to be answered using SAM.

4.3 SAM Technical Structure

The following flowchart illustrates the main interrelationship among SAM accounts.




Figure 2. Simplified interrelationship among principal SAM accounts (production activities,

factors and institutions) (Thorbecke and Hong-Sang, 1996)

From the methodological point of view, we have supply-based and demand-based methods

for analyzing SAM. The demand base itself has four approaches: 1. Accounting multiplier, 2.

Fixed-price multiplier, 3. SPA (Structural Path Analysis), and 4. Mixed approach or Supply

limited approach. Furthermore, as an economic tool, the effects of three kinds of economic

policies would be analyzed by means of SAM on the endogenous accounts (Kiaeeha, 2010).

The present study will analyze and compare the “Demand-Side” and “Supply-Side”

multipliers of “Social Accounting Matrix” for Malaysia.

In this method, the SAM structure presents flows and relationships between output, demands

and income of factors of production, and also the decomposition of these interactions into

separate effects. Going from SAM to a model structure requires the designation of each

account as endogenous or exogenous. This can be viewed schematically from the table

below:

Table 3. Simplified schematic social accounting matrix

Expenditures

Endogenous accounts Exogenous. Totals

Factors Institutions

(Households and

companies)

Production

activities

Sums of other

accounts

Receipts 1 2 3 4 5

Endogenous accounts

Factors 1 0 0 T13 x1 y1

Productions activities

Factors Factorial Income

distributions

Institutions Including

Household Income

Distribution




Institutions, i.e. households and

companies 2 T21 T22 0 x2 y2

production activities 3 0 T32 T33 x3 y3

Exogenous accounts

Sum of other accounts 4 l'1 l'2 l'3 t yx

Totals 5 y'1 y'2 y'3 y'x

(Thorbecke and Hong-Sang, 1996)

For analytical purposes, the endogenous section of the transaction matrix would be converted

into the corresponding matrix of average expenditure propensities. Hence, the demand- and

supply- side models are written in matrix notation as follows:

Xd = AXd + Y

And

Xs = V + XsB

Where

Xd is the column vector of sectoral outputs, xi; Xs is the row vector of sectoral inputs, xj; A is

a matrix of direct-input technical coefficients, aij; B is a matrix of direct-output allocation

coefficients, bij; Y is a column vector of sectoral final demands, yi; and V is a row vector of

sectoral value added, vj.

The respective solutions of the two models are written as follows:

Xd = LY

And

Xs = VG

Where L = (I − A)−1 and G = (I − B)−1 exist and are non-negative, and where Y and V are

known (exogenously determined). The basic assumption of the demand-side (supply-side)

model is that demand (supply) patterns are stable over time. The matrix A (B) can be used for

forecasting of vector Xd (Xs) with exogenously given vector Y (V) for a future year. Note that

Xd and Xs for a future year will not be equal, as the two models are independent (Bon and

Yashoro, 1996).

Now the “Demand-Side” and “Supply-Side” multipliers can be calculated and their results

will be compared in the case of increasing “government expenditure” policy. The results of

employing these methods are explained in the next segment.




5. Results and Discussion

5.1 Data and aggregation

In this study, in order to investigate the effect of government expenditure on the Malaysian

Economy, 120 production accounts were aggregated into 9 sectors: 1. Primary Agriculture, 2.

Vegetable oil products, 3. Animal products, 4. Forest and fisheries product, 5. Natural

resources, extractive and related industries, 6. Processed food, 7. Textile and wearing apparel,

8. Manufacturing products, 9. Services.

5.2 Scenario and estimated results

The Malaysian SAM was used to investigate the effect of 1,000 RM rise in government

expenditure (for each economic sector) on the overall economy and also on each sector

separately. Subsequently, the results of this policy were compared for the two models.

The analysis begins with the Demand-Side output Multiplier. Technically, this Multiplier

illustrates the total amount of output induced by the requirement from all economic sectors to

produce output for satisfying the demand of the specific sector for an extra Ringgit Malaysia

(RM) (Currency) of output. In this study, for simulating the Multiplier, it was assumed that

the government tends to spend 1,000 RM (Based on the unit base of the Malaysia SAM 2005)

on the economic sector that has the highest effect in the whole economy.

Hence, for instance, in order to satisfy the demand for an extra Ringgit of “Vegetable oil

products” output, the production induces output of all industries in the economy to a total of

2,835 RM output ultimately. Finally, when comparing all of these output Multipliers of

different industries in Malaysia, it was observed that the “Vegetable oil products” had the

highest effect in this multiplier.

In terms of the Supply-Side output Multiplier model, the process of affecting sectors was

similar to the Demand-Side output Multiplier, but the difference was in the beginning point

of the shock, which starts from the supply side of the economy. Here, the results showed that

the highest effect belongs to the “Service sector” with a total effect of 5.388 RM on the

economy.

Previous studies by Bon and Bing (1993), and Bon and Yashoro (1996) illustrated that the

demand-side model performs somewhat better in terms of total output forecasts, while the

supply-side model performs somewhat better for a larger number of sectors.

Furthermore, Bong and Bing (1993) suggested that further research should concentrate on

combining the two models for direct measurement of the relative importance of demand and

supply forces. However, Mizrahi (1989) showed that these two models can be understood as

special cases of a generalized input-output and SAM model that combines the above two

principles.

All in all, when employing these multipliers to analyze the effect of Government Expenditure

policy (1st type of economic policy), based on the Demand-Side multiplier the most effective




sector in improving the production of the Malaysian economy is “Vegetable oil products”,

but on the contrary, for the Supply-Side multiplier the most considerable sector is “Service”.

In general, the Supply-Side multiplier of sectors is higher than their peers’ sectors on the

Demand-Side multiplier.

6. Conclusion and Policy Recommendations

Accordingly, this paper attempts to assess the effect of Malaysian government spending on

the economy. As indicated earlier, the SAM framework provides detailed and valuable

information on the economic and social structures of a country. Its main advantage in

incorporating the economic production and social structures into a single-unit framework

makes it a great tool for improving the socio-macroeconomic database of a nation. Thus, as

the Malaysian economy develops to become more complex, the required statistics and

information required for tracking the distribution of income have to be enhanced so that it is

in line with the aspirations of central planners in addressing current and future scenarios. The

Malaysia SAM serves as one of the tools in assisting a better-formulated policy and well-

designed planning.

Generally, most policymakers view public expenditures as a fiscal tool to affect

macroeconomic variables such as output and employment. In this regard, as we have a few

economic sectors in the aggregated SAM, it seems that it is better to consider the Supply-Side

Model Multiplier as a preferable tool, and hence “Government expenditures” particularly in

the “Service” sector should be prioritized compared to all other choices of spending, when

economic growth is the most urgent goal of the government. These results may be

generalized and applied to other developing countries that have the similar economic

structures as Malaysia.

Appendix

Table 4. Aggregating Sectors

1 RAWAG Primary agriculture

2 VEGOIL Vegetable oil products

3 ANIMAL Animal Product

4 F&FISH Forest and fisheries product

5 MINERAL

Natural resources, extractive and related

industries

6 FOOD Processed food

7 TEXT Textile and wearing apparel

8 MANU Manufacturing products




9 SVCS Services

Table 5. Demand-Side Output Multiplier (Calculated in this article)

Demand-Side

Output

Multiplier

RAWAG VEGOIL ANIMAL F&FISH MINERAL FOOD TEXT MANU SVCS

1 2 3 4 5 6 7 8 9

RAWAG 1 1.233 0.060 0.404 0.013 0.011 0.117 0.019 0.009 0.019

VEGOIL 2 0.113 2.013 0.055 0.027 0.022 0.058 0.037 0.033 0.040

ANIMAL 3 0.027 0.010 1.159 0.007 0.006 0.023 0.022 0.004 0.009

F&FISH 4 0.013 0.016 0.015 1.039 0.009 0.048 0.016 0.023 0.019

MINERAL 5 0.019 0.018 0.020 0.021 1.038 0.015 0.029 0.083 0.027

FOOD 6 0.062 0.034 0.050 0.034 0.022 1.180 0.028 0.017 0.037

TEXT 7 0.010 0.015 0.010 0.031 0.010 0.010 1.440 0.010 0.017

MANU 8 0.246 0.252 0.277 0.259 0.111 0.207 0.408 1.276 0.294

SVCS 9 0.295 0.418 0.334 0.328 0.266 0.325 0.521 0.258 1.692

Total 2.018 2.835 2.323 1.758 1.495 1.984 2.520 1.712 2.154

Table 6. Supply-Side Output Multiplier (Calculated in this article)

Supply-Side

Output

Multiplier

RAWAG VEGOIL ANIMAL F&FISH MINERAL FOOD TEXT MANU SVCS

1 2 3 4 5 6 7 8 9

RAWAG 1 1.233 0.278 0.278 0.016 0.061 0.212 0.017 0.348 0.653

VEGOIL 2 0.024 2.013 0.008 0.007 0.026 0.022 0.007 0.274 0.296

ANIMAL 3 0.040 0.064 1.159 0.012 0.046 0.060 0.029 0.250 0.444

F&FISH 4 0.011 0.059 0.008 1.039 0.043 0.071 0.012 0.726 0.525

MINERAL 5 0.003 0.015 0.002 0.005 1.038 0.005 0.005 0.582 0.167

FOOD 6 0.034 0.087 0.019 0.023 0.068 1.180 0.014 0.364 0.699

TEXT 7 0.010 0.075 0.008 0.041 0.061 0.021 1.440 0.421 0.651

MANU 8 0.006 0.030 0.005 0.008 0.016 0.010 0.010 1.276 0.260

SVCS 9 0.009 0.057 0.007 0.012 0.043 0.017 0.014 0.293 1.692

Total 1.371 2.678 1.494 1.163 1.402 1.597 1.548 4.533 5.388

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Impact of Information and Communication Technology on

Remittance Flow: A Developing Countries’ Perspective

Md Aslam Mia

Faculty of Economics and Administration, University of Malaya

50603 Kuala-Lumpur, Malaysia

Phone: +60133417794

[email protected]

Shamima Nasrin



Phone: +60133417794

[email protected]

Mohammad Nourani



Phone: +60173251926

[email protected]

Navaz Naghavi



Phone: +60178700942

[email protected]

Angathevar Baskaran



Phone: +60172414050

[email protected]

Abstract This study investigated the impact of information and communication technology (ICT), as well as macroeconomic

factors on remittance inflow and outflow, with particular focus on developing countries in Asia, Africa and Latin

America. It employed longitudinal datasets for the period 2005 to 2012, and generalized method of moments

(GMM) technique. The findings reveal that most of the ICT and macroeconomic factors have a positive impact on

remittance inflow and outflow. The mobile and internet (fixed broadband internet) subscribers; online banking and

automated teller machine (ATM), exchange rates, inflation, gross domestic product (GDP) and availability of

deposit accounts were found to have significant positive effects on remittance flow. The results suggest that not

only is ICT necessary for a healthy flow of remittance but also economic factors and good governance play an

important role. Drawing from the results, some policy implications are discussed.

Keywords: mobile, internet, ATM, remittance, developing country







1. Introduction

The importance of remittance in development has been highly acknowledged by researchers in

recent years (Córdova and Olmedo 2006; Guha 2013; Beine et al. 2012). A number of empirical

studies showed that remittances have a positive impact on poverty alleviation, inequality,

growth, education and household’s welfare (Cooray 2012; Nyamongo et al. 2012; Gupta et al.

2007; Anzoategui et al. 2014; Adams Jr and Page 2005). In contrast, some researchers have also

found mixed impact of remittance on growth, financial development and poverty nexus (Bettin

and Zazzaro 2012; Rapoport and Docquier 2006; Chami et al. 2006). The importance of

remittance is highly significant to the low income families and livelihood sustainability.

Theoretically, that is the central reason that family members move abroad.

The estimated remittance flow to developing countries has been increasing steadily despite the

global recession and large deportation of migrants from some host countries. It soared to

US$404 billion in 2013 and is expected to reach US$436 and US$516 in 2014 and 2016

respectively (World Bank 2014). Apart from official remittance flow, large number of

remittance are transferred by informal channels such as money laundering, hundi, carried cash

and many more that are unreported in the official account of a country. For example, during

1981 to 2000, it was reported that there was a huge flow of remittance through unofficial

channels which amounted to more than 54% of total remittance flow (Ratha 2006)1. There are

several factors behind this huge flow of remittance through unofficial channels including high

service charge, exchange rate volatility, poor banking sector, transaction period, and privacy of

senders (Watterson 2013; Freund and Spatafora 2008; Ratha 2006). However, transaction costs

have slowly reduced since the early 1990’s because of high competition in the remittance

market (Orozco and Center 2004).

Nowadays, the medium of remittance flow adds a different dimension to various commercial

services offered by formal and semi-formal banking institutions. New types of services

emerged, mainly driven by information and communication technology (ICT), which are

largely accepted as easy, reliable and fast in satisfying the demands of clients. Huge expansion

of internet2, mobile subscriptions, and substantial use of ICT in commercial banks, remittance

industry and exchange houses have led to faster processing of remittance flow that is several

times higher compared to the conventional method3. Watterson (2013) emphasized the

significant role of technology-based service such as usage of internet and mobile phone for

remittance transaction in order to compete with the informal channel. Similarly, Amy (2010)

documented that use of Information Technology has restructured the banking sector

significantly. Hence, ICT is playing a vital role to ease all kinds of transaction process.

Although there are many research studies examining the importance of remittance in economic

development, there are not many studies that focus on the impact of information and

communication technology (such as mobile phones, internet and automated teller machine),

combined with macroeconomic factors (exchange rate, inflation, bank branch, deposit accounts,

1 According to Bahar et al. (2006), the amount of unofficial remittance flow accounted for more than 59% during that period

which has been cited from an IMF report. 2 From here onwards, internet means fixed broadband internet subscribers. 3 Conventional approach refers to manual process of sending remittance by bank draft or telegraphic transfer process which

usually requires longer transaction period




world governance indicators, GDP and so on), on remittance flow. This study aims to fill this

gap in the literature by contributing in two ways. First, it examines the flow of remittance, both

inflow and outflow, in relation to ICT and macroeconomic factors. Secondly, it employs latest

dataset (2005-2012) with the specific focus on developing countries from Asia, Africa and

Latin America. Drawing from the empirical results, the study presents some major policy

implications that will aid policy formulation and decision making for healthy flow of

remittance.

The paper is organized as follows. Section 2 presents the review of literature in this area.

Section 3 discusses the research design. The empirical findings are presented and discussed in

section 4. Lastly, section 5 concludes the study and proposes some policy suggestions.


As a result of globalization, the boundaries, customs, conversations and dealers have been

greatly reduced which has increased the speed and cost efficiency in different arenas (Bonyani

and Zarei 2013). In this context, remittance flow is one of the results of globalization.

Information and communication technology has substantially reduced the transaction cost for

both the remitters and intermediaries (up to 30% to 40% in some cases) (Litan and Rivlin

2001). Expatriates opt to use informal channels for transactions as a result of cumbersome

formal channels and relative ease of informal channels.

Inflow of remittance to the developing countries is drawing considerable attention from the

researchers because of its impact on the domestic economy. Remittance constitutes a large

source of foreign income for many developing countries compared to other financial flows and

in some cases exceeds export revenue, foreign direct investment and aid (Bettin and Zazzaro

2012; Ruiz-Arranz and Giuliano 2005).

One of the important factors influencing remittance is the transaction cost. The highest

(US$21.51) and lowest (US$1.35) average costs are recorded for sending US$200 in South

Africa and Asia respectively (World Bank 2014). Ratha (2005) noted that transaction costs of

remittance could be reduced further by promoting mobile banking technology as a reliable

financial service of commercial banks. Angelakopoulos and Mihiotis (2011) stated that internet

technologies have a great influence on the banking sector and inclusion of Automated Teller

Machines, mobile banking, use of internet and land lines for transaction constitutes the

technological framework of e-banking. David et al. (2013) found that the mobile banking

system has positively influenced migrants’ remittance flow due to its simplicity, reliability and

affordability. Similarly, Siegel and Fransen (2013) documented that mobile banking could be a

revolutionary tool to pushdown remittance transaction cost in Africa. However, the financial

infrastructure has to be elevated substantially in order to realize the economic values of this new

technology. Emergence of information and communication technology, including mobile and

internet banking in developing countries, have become an ideal choice for financial transactions

in recent years.

Demirgüç-Kunt et al. (2011) empirically found that remittances are significantly associated

with number of bank branches, accounts per capita, and ratio of deposits to GDP while

examining the importance of macroeconomic factors in remittance flow. Another study focused

on migrants’ choice of remittance channel and it revealed that financial education of the




immigrants, cost reduction and financial inclusion appear to be important determinants behind

use of formal channels of remittance flow (Kosse and Vermeulen 2014). They also showed that

availability of automated teller machine (ATM) terminals, level of GDP in the home country

and people’s preference to use internet banking, play pivotal roles in remittance flow. Ratha

(2006) has emphasized improving access to banking services to facilitate the remittance inflow

to the recipient countries. Studies also focused on the relationship between financial openness,

financial development and remittance inflow. Mookerjee and Roberts (2011) showed that

greater financial sector development contributes to a greater remittance inflow in a country.

They used the number of bank branches per 1000 km2 as the proxy for financial development.

However, the review of literature reveals that little attempt has been made to investigate the role

of information and communication technology (ICT) on remittance flow (inflow and outflow).

Therefore, this study aims to focus on this aspect and address this gap in the existing literature.

Furthermore, most of the previous studies focused on specific factors separately, whereas this

study combines both information technology and macroeconomic factors to assess the

remittance flow in developing countries.

3. Research Design

3.1 Variables Selection

In this study, remittance inflow and outflow are dependent variables. Exchange rate (Exrate) is

one of the important factors in international transactions, thus for remittance flows as well.

Faini (1994) argued that real exchange rate depreciation could possibly have a negative impact

on remittance value. Furthermore, policy makers prefer to use fixed exchange rate regime to

maintain the flow of remittance (Singer 2010). On the other hand, large flows of remittance

substantially appreciates the real exchange rate in Latin American and Caribbean countries

(Ratha and Mohapatra 2007).

Most of the previous studies have investigated the impact of remittance on a recipient country’s

inflation rather than focusing on how inflation affects remittance inflow (Ball et al. 2013; Khan

and Islam 2013). Theoretically, if inflation increases domestically, the cost of living also rises

proportionately. This could be a driving force for immigrants to send more money to maintain

their households’ expenditure in the home country. Thus, we would expect that inflation has a

positive effect on remittance flow.

Banks represent the availability of banking services that disburse the remittance through their

branches and commercial wings. Although the formal banking sector in most developing

countries is not well established, it has outperformed in recent years in terms of providing

services and outreaching to the community. For instance, ATM is one of the latest innovations

for banking services with widespread use in developing countries. The ATM system has

benefited both parties, remitters and beneficiaries, in that the former is allowed to do the

transaction easily while the latter could withdraw the money worldwide (Kosse and Vermeulen

2014).

In the era of globalization ICT has shaped international transactions in different ways.

Electronic-commerce is one of the finest products of ICT that helps to expand commercial

activities as well as non-profit businesses or services through the platform of computer network




(Liu 2013). Internet and mobile phones brought about a ‘leapfrogging’ over traditional methods

and massive improvement to remittance flow. Therefore significant improvements have taken

place to increase the remittance flow.

Mobile banking allows a customer to do online transactions from anywhere around the world.

David et al. (2013) found that mobile technology has significantly enhanced remittance flow.

Data on the number of mobile banking users is not available in developing countries, thus this

study uses mobile and fixed broadband internet subscribers as a proxy. It uses fixed broadband

internet subscription rather than normal internet subscription because it is reliable. Although

there are other electronic payment systems such as Paypal, Ikobo, Zoom, Dwolla,

TransferWise, Moneygrams, and Western Union, lack of available data and a lack of aggregate

database did not allow us to include them in this study.

World governance indicator (WGI) of a country comprises six different categories including,

voice and accountability, political stability and absence of violence/terrorism, government

effectiveness, regulatory quality, rule of law, and control of corruption. This study took the

average of all six indicators to estimate aggregate governance indicators for each year (Govt.

Ind.). The lower score of WGI shows the weak government structure while higher average

score means the strong governance framework. The WGI ultimately reflects immigrants trust

and reliability about the ruling government in the home country. Furthermore, a good

government structure, represented by positive WGI values, could be a positive indicator for

remitters to send money home and invest it domestically rather than keeping it or investing

abroad. From a remittance outflow perspective, if the home country WGI is lower, expatriates,

as well as nationals of the country, will have a lack of trust on the home country. They may be

motivated to transfer money abroad rather than injecting into the local economy due to fear of

losing their investment. Weak governance structure of the residing country also influences them

to avoid unexpected risks and uncertain return. Thus, we can hypothesize a direct relationship

of WGI with remittance inflow and inverse relationship with outflow. Figure 1 illustrates the

theoretical framework which incorporates the variables used in this study. Moreover, the

descriptions of variables are provided in Table 1.




Figure 2: Theoretical framework

Table 14: Measurements of Variables

Variable Description

Remittance Inflow (RemIn) Measured in millions of US$ per year.

Remittance Outflow

(RemOut)

Measured in Millions of US$ per year.

Exchange Rate (Exrate) Local currency unit against US$, period average per year.

Inflation (Inf) Consumer prices measured in % per annum.

Bank Branch (Banbr) Commercial bank branches per 100,000 adults per year.

Automated Teller Machine

(ATM)

Automated Teller Machines per 100,000 adults per year.

Mobile (Mob) Mobile subscribers per 100 people per year.

Fixed Broadband Internet

(Int)

Internet Subscribers per 100 people per year with a digital

subscriber line, cable modem or other high speed technology.

Deposit Accounts (DepAcc) Depositors with commercial banks per 100,000 per year

Worldwide Governance

Indicator (WGI)

Aggregate average of 6 variables. The values ranging from -2.5

to 2.5.

Gross Domestic Product

(GDP)

GDP per capita based on purchasing power parity (PPP)

measured in current international $

3.2 Model Specification

The study applied dynamic generalized method of moments (GMM), which has not been

previously used by other authors in this context. In this model specification, economic variables




are treated as endogenous. The reason is that these variables do not display significant times

series variations, implying that lagged values are very similar to current values (see Baltagi et

al. (2009) and Honig (2008) who discuss about the exogenous and endogenous variables).

However, due to rapid technological change over the last decade, ICT indicators reveal

significant variation annually. These are considered as exogenous variables in the models. It is

worth emphasizing that the moment condition utilizes lag-dependent variable. The dynamic

GMM estimator proposed by Arellano and Bond (1991) eliminates any endogeneity that may be

due to the correlation of country specific, time-invariant factors and the right hand side

repressors. Lagged levels of the dependent variable, predetermined variables and endogenous

variables are used to form GMM-type instruments. First differences of the strictly exogenous

variables are used as standard instruments (Roodman 2006).

As for the diagnostics tests, Sargen’s test of over-identification examines the appropriateness of

the instruments used, while Arellano-Bond AR (2) tests the existence of the second-order serial

correlation in the first-differenced residuals. The model specification is as the following:

Log Rem𝑗𝑖𝑡 = 𝛽0 + 𝛽1𝐿𝑜𝑔 𝑅𝑒𝑚𝑖𝑡−1 + 𝛽2𝐸𝑥𝑟𝑎𝑡𝑒𝑖𝑡 + 𝛽3𝐼𝑛𝑓𝑖𝑡 + 𝛽4𝐿𝑜𝑔𝐺𝐷𝑃𝑖𝑡 + 𝛽5𝑊𝐺𝐼𝑖𝑡 +

𝛽6𝐵𝑎𝑛𝑏𝑟𝑖𝑡 + 𝛽7𝐴𝑇𝑀𝑖𝑡 + 𝛽8𝑀𝑜𝑏𝑖𝑡 + 𝛽9𝐼𝑛𝑡 𝐵𝑟.𝑖𝑡+ 𝛽10𝐷𝑒𝑝𝐴𝑐𝑐𝑖𝑡 + 𝜇𝑖 +휀𝑖𝑡

Rem𝑗𝑖𝑡 , where j=1, 2 means remittance inflow and outflow respectively with a time period of t

from 2005 to 2012. Additionally, i represent country ranging values from 1 to 41 while 𝛽1 to

𝛽10 are the coefficients of respective variables. Likewise, 𝜇𝑖 and 휀𝑖𝑡 represents the country fixed

effect used to control for time-invariant country-specific factors and error term in the model.

3.3 Data

The study collected data from the World Bank database for 41 developing countries from Asia,

Africa and North America4. The longitudinal data ranges from 2005 to 2012 with total

observation of 3266. Among all variables inflation, and world governance indicators have

negative values. Negative inflation means the prices of goods and services have decreased

which led to deflation in the economy. Positive WGI means the governance in the country is

well functioning while negative value shows the weak governance structure of the country.

Since the mean WGI is negative, we can simply say that the governance of the developing

countries chosen in the sample are not well performed. However, the highest WGI score

4 The sample includes the following countries: Afghanistan, Bangladesh, China, India, Indonesia, Iran, Iraq,

Kazakhstan, Kenya, Jordan, Latvia, Lebanon, Lesotho, Maldives, Malaysia, Sri Lanka, Tajikistan, Tanzania,

Thailand, Timor-Leste, Togo, Uganda, Nepal, Namibia, Myanmar, Pakistan, Papua New Guinea, Philippines,

Turkey, Azerbaijan, Benin, Bhutan, Ukraine, Ghana, Guyana, Guinea, Haiti, Trinidad and Tobago, Samoa, St.

Lucia and St. Kitts and Nevis.




recorded at 1.06 also shows that countries with good governance are also present within the

sample size. In terms of GDP, the sample also includes the least developed country

(US$920.66) and a relatively well developing country (US$29689.56) with a mean average

GDP of US$7641.31. Although none of the variables was observed to have the full panel data

(328 total observations), highest number of observation (326) was recorded for internet

followed by mobile (322), exchange rate (320), and GDP (320). The lowest number of

observations accounted for deposit accounts (196). Tables 2 illustrates the descriptive statistics

of variables.

Table 15: Descriptive statistics of variables (N= 41)

Variables Mean SD Min Max Obs.

RemIna 3686.93 8961.25 2.24 68820.52 314

RemOut 569.82 1246.45 0.52 6785.53 268

Exrate 783.41 2195.95 0.48 12175.54 320

Inf 8.05 6.75 -10.07 53.23 312

Banbr 10.52 11.69 0.62 66.91 308

ATM 17.25 21.45 0.06 92.39 260

Mob 59.83 40.47 0.26 185.82 322

Int Br 16.08 18.27 0.07 79.35 326

DepAcc 338.59 571.37 6.52 3368.39 196

WGI -0.46 0.63 -1.79 1.06 320

GDP 7641.31 6683.65 920.66 29689.56 320

a. Please refer to Table 1 for variable description.

4. Discussion on Empirical Findings

Multicollinearity is one of the severe problems in multiple regression analysis that produces

unexpected results in estimation process. Thus, pairwise correlation among the main

information and communication technology variables are estimated (see Table 3). The findings

reveal that there is relatively strong correlation among some of the telecommunication

indicators which might increase the potential problem of multicollinearity. The correlation

coefficient ranges from 0.28 to 0.77. The lowest correlation is recorded between Dep.Acc and

Banbr, which makes sense to keep them in a same regression. The highest multicollinearity was

recorded between mobile and internet subscribers. This is due to the fact that, in the era of

telecommunication and smart technology revolution, people also use high speed internet (e.g.

3G, 4G and etc.) in their mobile (smart phone). Therefore, to reduce the probability of

multicollinearity, the rest of the technological variables are introduced separately in the base

regression models similar to Naghavi and Lau (2014).

Table 16: Pairwise correlation between variables (2005-2012)

Dep.Acc Mob Int Br Banbr ATM

DepAcca 1

Mob 0.62 1

Int.Br 0.39 0.77 1




Banbr 0.28 0.49 0.67 1

ATM 0.72 0.73 0.73 0.53 1

a. Please refer to Table 1 for variable description.

Since the study used GMM method to estimate the parameters of β1 to β9, the coefficients are

easily interpretable (see Table 4 and 5). The base models include most of the macroeconomic

variables such as exchange rate, inflation, WGI and GDP in both remittance inflow (model 1 to

4 in Table 4) and outflow (model 5 to 8 in Table 5). All the macroeconomic variables remained

significant in both the remittance inflow and outflow models (1-8), although the significance

level has changed despite introducing the technological variables separately. This outcome

shows the significance of the models and robustness of the results. However, when broadband

internet subscription was introduced in model 2 and 6, WGI was not significant even at a 10%

significance level.

Table 17: Factors affecting remittance inflow in Developing countries

Variable Expected Model Model Model Model

Sign 1 2 3 4

Lag Remittance Inflow 0.003***a 0.398*** 0.576*** 0.003***

(0.0001)b (0.05) (0.02) (0.0001)

Exrate + 0.0001 0.0009* 0.001** 0.0008***

(0.0004) (0.0005) (0.0003) (0.0002)

Inf + 0.036** 0.027*** 0.009*** 0.054***

(0.008) (0.004) (0.001) (0.016)

LogGDP + 0.36*** 0.828*** 0.507** 0.37***

(0.012) (0.015) (0.018) (0.012)

Govt.Ind + 1.174*** 0.0082 0.678*** 1.063***

(0.006) (0.001) (0.001) (0.006)

Banbr + 0.063***

(0.0007)

DepAcc + 0.0007*

(0.0003)

Int Br + 0.027***

(0.004)

Mob + 0.007***

(0.001)

ATM + 0.019*** 0.019***

(0.003) (0.003)

Number of Instruments 44 32 29 44

Sargan test c 0.12 0.215 0.102 0.381

Arellano-Bond test d 0.33 0.385 0.586 0.385

a. *, **, *** indicates statistical significance at 10%, 5% and 1% respectively.

b. Values in parenthesis show the standard error.

c. The Sargan test is a test of over identifying restrictions. The null hypothesis is that the

instruments are valid instruments.




d. Null hypothesis of Arellano-Bond test for AR (2) is for no autocorrelation in the second

order of residuals.

As macroeconomic factors play an important role, this study also found analogous effects of

these factors on remittance flow, which is in line with other studies. The coefficients of

exchange rate varied from 0.01% to 0.1% (from model 1 to model 4) in remittances inflow with

one additional unit increase in exchange rate against US$. On the other hand, the remittance

outflow coefficients value ranges from 0.01% to 0.2% with additional unit increase in exchange

rate. Slightly higher coefficient of remittance outflow against exchange rate increase revealed

that, due to the price increase, goods and commodities become expensive and can motivate

immigrants to send more remittances for adjusting the net effects in the domestic country. On

the other hand, significant flow of remittance towards a country can appreciate real exchange

rate which might have a negative impact such as Dutch-Disease-like phenomenon (Castañeda

and Catalán 2007; Ratha and Mohapatra 2007). Inflation has a similar effect on remittance

inflow and outflow. As inflation increases the prices of goods and commodities domestically,

more remittance is needed to maintain the same level of households’ expenditures. As such,

remittance flow proportionately changes in relation with the inflation rate. However, the

magnitude of remittance flow changes were large (coefficients varies from 0.9% to 5.4%) for

inflation than exchange rate for additional unit increase in inflation and exchange rate

respectively. Inflation increase is directly related to price increase while exchange rate change

is indirectly related towards the prices of the goods and commodities. So the impact was higher

for inflation changes while both these variables met the expected sign.

GDP is one of the primary and most widely-used indicators to gauge the health of a country’s

economy. This study found that GDP has a positive significant impact on remittance flow (both

inflow and outflow). The empirical findings suggest that the impact of GDP in remittance flow

is robust and remained significant in all the models except when mobile subscriptions is added

in outflow (model 7). Obviously, increasing GDP is a good thing, which indicates the prosperity

of a country, however higher GDP also promotes remittance outflow. When per capita GDP is

high for a country, it shows the development of the country and attracts more immigrants which

substantially increased the remittance outflow. Furthermore, the remittance inflow coefficients

are higher compared to outflow and the estimated net remittance flow is positive based on

estimated model.

The study used world governance indicator (WGI) as a proxy to gauge the overall situation of a

country, particularly governance structure, to see the impact in remittance flow. It found a

significant and dualistic results which have very important implications for policy makers. In

the context of remittance inflow, WGI is positively associated with remittance and observed the

highest coefficients (1.174 in model 1) among all other variables included in the model. On the

other hand, remittance outflow is adversely related with WGI. This suggests that good

governance of a country (considering all those six factors) attracts remittances because

immigrants feel safe and secure to invest domestically rather than holding cash or investing

abroad. However, additional unit increase in WGI will lead to a significant amount of

remittance outflow from the country. This finding is quite exceptional from the existing

literature. Two conclusions can be drawn from this finding. Firstly, improvement in WGI might

be good for the country in general, but greater financial openness allows easy remittance




outflow, when there is no outflow restriction. Secondly, in micro level, we can assume that

regardless of the governance structure of a country (whether it is good or bad), immigrants are

honor-bound to send their hard-core earnings to their beloved family due to the maternal

relationship. However, the estimated net effect of WGI (if we take remittance inflow and

outflow together with WGI) is still associated positively with remittance.

In terms of impact of ICT on remittance flow, the three main components, namely broadband

internet, mobile and ATM, showed significantly positive as hypothesized. The coefficients are

higher for broadband internet compared to mobile subscribers. As broadband internet is

required for international transactions, particularly for internet banking (for online transactions),

the impact is somewhat larger than mobile subscriptions. In aggregate, broadband internet can

be used not only in fixed line broadband but also in several high speed digital devices (e.g.

smart phone). Thus, it is estimated to have a better significant impact of per unit increase in

broadband internet subscriptions. Kosse and Vermeulen (2014) have found that those who are

familiar with internet banking are likely to use banking service for channelling the remittance.

Furthermore, researchers also found that the number of internet users has substantially

increased in the last few years and this technology allows clients to do online transactions from

any part of the world and that has significantly affected the remittance flow (David et al. 2013).

Mihalciuc et al. (2008) argued that extensive use of mobile phones increased the interaction

between financial institutions and customers. That is, easy access of information increased the

efficiency of both parties. For example, electronic payment is becoming increasingly popular in

the Middle East countries which enables remitters to use e-banking (O'Flynn 2009).

Table 18: Factors affecting remittance outflow in developing countries.

Variable Expected Model Model Model Model

Sign 5 6 7 8

Lag Remittance

Outflow

0.088*a 0.534*** 0.963*** 0.375***

(0.083)b (0.0007) (0.000) (0.07)

Exrate + 0.0001 0.001 0.0001*** 0.002**

(0.536) (0.07) (0.000) (0.0008)

Inf + 0.011*** 0.045*** 0.022*** 0.019**

(0.004) (0.012) (0.000) (0.008)

LogGDP + 1.07** 1.055* 0.053 0.608***

(0.026) (0.053) (0.345) (0.05)

Govt.Ind - -1.02** -0.652 -0.403*** -0.908***

(0.048) (0.401) (0.001) (0.08)

Banbr + 0.050**

(0.0003)

DepAcc + 0.0003**

(0.02)

Int br + 0.026**

(0.01)

Mob + 0.001**

(0.01)




ATM + 0.019*** 0.012**

(0.003) (0.01)

Number of Instruments 44 26 29 25

Sargan test c 0.12 0.486 0.8 0.45

Arellano-Bond test d 0.33 0.69 0.312 0.766

a. *, **, *** indicates statistical significance at 10%, 5% and 1% respectively.

b. Values in parenthesis show the standard error.

c. The Sargan test is a test of over identifying restrictions. The null hypothesis is that the

instruments are valid instruments.

d. Null hypothesis of Arellano-Bond test for AR (2) is for no autocorrelation in the second

order of residuals.

Automated Teller Machine (ATM), which is one of the extended financial services by formal

banking institutions, promotes remittance flow. Our findings suggest that for each additional

unit increase in ATM it will increase both the remittance inflow and outflow. This finding is

similar to the results of Kosse and Vermeulen (2014) that ATM makes a positive impact on

remittance flow. Online transaction becomes easier through ATM and immigrants can transfer

money to third party within seconds. This kind of transfer requires less transaction cost and

thereby motivates immigrants to use such services. Freund and Spatafora (2008) found that

transaction cost was adversely related with remittance flow. Furthermore, Orozco and Center

(2004) found that 1% of total remittance flow from US to Latin America and the Caribbean was

done through ATM and credit or smart card.

Overall, the usage of ICT in remittance flow has had substantial negative impacts on informal

channelling of remittance, as argued by Watterson (2013). Thus, it is helping not only to

increase the official remittance flow, but also helps to reduce the illegal informal channelling of

remittance.

Importance of financial developments largely contributed to remittance flow. The study

examined the availability of commercial banks branches and the number of deposit accounts

holders as a measure of financial depth and openness. Bank branches, which are used to

withdraw remittance that has been sent by expatriates abroad, made a significant positive

impact in remittance flow. This finding is similar to Mookerjee and Roberts (2011) that greater

financial development or greater bank branch showed significant remittance inflow. Demirgüç-

Kunt et al. (2011) also found that remittance flow are strongly related with bank branch as well

as accounts per capita. Remittance outflow is also positively associated with larger bank

branches. However, remittance outflow could be restricted due to several reasons including the

protection of the domestic country’s interest. Some countries might have imposed limitation on

outward remittance flow in fear of financial downturn or immersive impact in the local

currency and domestic economy (Mohapatra and Ratha 2010).

Lastly, similar effects have been observed for the number of deposit accounts on remittance

inflow and outflow. The underlying reason behind these positive relations postulate that, in case

of remittance inflow, deposit accounts are used for keeping the remittance in the bank account

and withdrawals are based on the beneficiary’s preference. On the other hand, formal banking

institutions also require (most often) bank account in their respective banks for channelling

remittance outflow. As such, an account holder can easily transfer the expected amount of




remittance to their destination. Online transaction becomes easier and more convenient when an

immigrant has a deposit account and uses the same account number for online transactions such

as transferring remittance. Demirgüç-Kunt et al. (2011) also showed a positive relationship

between bank account and remittance. Furthermore, some commercial banks have offered

attractive remittance deposit account for the healthy flow of the remittance worldwide.

To sum up, the results showed that ICT and macroeconomic factors played an important role in

remittance flow. Particularly, mobile subscriptions, internet users, ATM, exchange rate,

inflation, bank branch, GDP, WGI and deposit accounts have had a significant impact on

remittance flow.

5. Conclusion and Policy Recommendation

Remittance is an external source of financing for most developing countries and contributes

positively to their economic development path. This study examined the impact of ICT and

macroeconomic factors on remittance flow using a dataset of 41 developing countries covering

the period from 2005 to 2012. The results showed that substantial usage of ICT (ATM, mobile

and internet subscriptions) and banking services by financial institutions play a pivotal role in

remittance inflow and outflow. On the other hand, macroeconomic factors such as exchange

rate, inflation, bank branch, deposits account, GDP and WGI also contribute significantly to

remittance flow. The findings of this study have important implications for policy makers trying

to stimulate the remittance flow.

We should note that further innovative ICT initiatives have to be taken in the financial domain

by government or private industries or by both to retain and increase the flow of remittance that

significantly contributes to the national economies, particularly in developing countries.

Furthermore, exchange rate and inflation factors need to be more carefully looked into by

monetary authorities and perhaps there is a need for cost-benefit analysis for choosing a suitable

policy formulation. Government, the key player, should promote expansion of banking sectors

and make sure the financial inclusion of all sections of the society through different ICT

innovations and incentives. Governance structures should be promoted for a healthy remittance

flow by taking consideration of several dimensions. For example, in terms of banking industry,

they should provide hassle-free, secured and reliable banking service to the migrants by

providing a range of financial products and services. Simple but secured online banking

systems (user-friendly) should be developed to help less educated immigrants and promote

remittance flow through official channels and to help reduce illegal money transfers. Finally,

ICT sector actors should provide cost efficient access to everyone which will, in turn, motivate

people to use legal means of remittance flow and shy away from illegal money transfer

network.

Acknowledgement

Authors would like to thanks Howard (Rick) Steel for his English editing support.




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Deconstructing the Narratives of Security State and the Role of

Power Elite

Ayesha Shoukat



[email protected]

Abstract

This paper attempts to clarify the roles of the power elite in the profound political transformation of Pakistan from

an ideological to a security state. The exercise and maintenance of power is framed by a theoretical

interdisciplinary framework that encompasses political as well as socio-economic dimensions. This framework is

set against the interplay of ethnic and geographic factionalism, with the exercise of military power explained by

extant theories. Understanding the complex concept of power requires deconstructing key elements of the past to

understand the ways power is enacted, expressed, described, concealed, or legitimized. This is accomplished by

reference to documents and interviews that speak to the social and historical context.

Keywords: Ideological state, security state, power elites, collusions and contestations, two

nation theory, military elite, separation of West Pakistan.

Introduction:

The notion of Pakistan as an “Ideological State1” was based on the two nation doctrine in which

populace heterogeneity should be followed by political and geographical autonomy. Although

Pakistan self-determination was based on ideological grounds, it turned out to be a “Garrison

State2” (Lasswell, 1941) or “Security state3” (LaPorte, 1969). Pakistan retained many of the

external forms of democracy, while the effective power was gradually concentrated in the

military elite in the name of security and sovereignty. The given socioeconomic, historical and

cultural conditions favored certain groups, classes and other social formations to support power

shift for their own vested interests. The role of power elites have been extensively discussed in

sociology and political science. The role of the different interest groups in the process of the

1 ideological state apparatus A term developed by the Marxist theorist, Louis Althusser to denote institutions such

as education, the churches, family, media, trade unions, and law, which were formally outside state control but

which served to transmit the values of the state, to interpellate those individuals affected by them, and to maintain

order in a society, above all to reproduce capitalist relations of production.(The Dictionary of Sociology, 1998) 2 The dominant group is constituted by the specialists on violence, since force is the distinctive skill of soldiers and

police. The specialist on violence rises in power as other skill groups subside, such as the specialists on civil

administration, party and pressure-group administration, and specialists on propaganda or persuasion. (Harold D.

Lasswell, 1948)

3 A post- World War II state in which nearly all aspects of political, economic, intellectual, and social life are

dominated by considerations of national defense and the drive to maintain a defense establishment capable of

protecting the state against all comers. (US Military Dictionary)





government is a well discussed topic in literature. The early 1900 scholars like David Truman4

and Earl latham5 have wrote about government process as a result of interaction of these interest

groups (elites)(Maniruzzaman, 1966).

In the story of creation of security state, the question of defining a narrative of events

inevitably lead back to the central question about the role of narrative in history more generally.

Even postmodernism, which is supposed to playfully deconstruct or reassemble the elements of

the past, has frequently been reduced to a method. As Hayden whites has suggested, the

construction of historical narratives almost inevitably implies the “emplotment” of events to

convey moral meaning(White, 2009). When we study the history of Pakistan with power elite

philosophy then one came to realize that the fundamental ground theories on which all political

and social building of country’s existence is standing can be divided in three junctures. The

objective of this article is to deconstruct, to uncover the hidden, multi-faceted meanings and

thereby to reveal the codes of power in the narrative of Pakistan’s ideology and existence.

First is Two Nation Theory, the one on basis of which country was separated from united India.

It is considered to be the reason and base of demanding a separate home land for the Muslims

of United India who from centuries were living together(Cohen, 2002).

Second is the East Pakistan separation tragedy, it is also been acclaimed that at the time of

partition it was a deliberate act by the British and Hindus to create such a boundary line which

makes a very narrow link between two Muslim majority areas of united India and later they

keep conspiring the locals of east Pakistan against West Pakistan and created a rift between

them which ultimately ended up by civil disobedience and separation of East Pakistan after a

war with India. Though there were internal problems of East Pakistan with Military but India

jumped in and ended up in having a war which results to Pakistan in shape of losing its East

wing.

Third is the belief that Military is the last savior for the country in all political and economic

crises. And whenever a country reaches to any political or economic brink, it’s always is

Military which comes as a savior and takes country out of such chaos and disaster(Cohen,

2002).

The article is presented in six parts, first the introduction in which I gave a brief explanation of

the purpose of writing this paper along with the three fundamental theories which will be

discussed in different perspective ahead. In second part, the methodology is explained and after

that part 3 to 5 are presenting the debate on the three narratives of the theories discussed above.

Lastly I have concluded the discussion with the concept of role of power elites and their own

vested interest behind all those events and incidences.

4 D. B. Truman, The Governmental Process. New York: Alfred A. Knopf, i95i; E. Latham, "The Group Basis of

Politics, Notes for a Theory," American Political Science Review, Vol. 46, I952, pp. 376-397; G. A. Almond,

Rapporteur, "Research Note, A Comparative Study of Interest Groups and the Political Process," American

Political Science Review, Vol. 52, 1958, pp. 270-282. 5 Latham, op. cit., p. 390.




Methodology:

This article is polemic in nature in which Meta –Analysis6 technique is used to deconstruct the

events which leads to certain drawing of history. For it, the procedure followed is to analyze the

results of the researches and studies of other scholars who narrated those incidences in their

own specific explanation and later question them with a new perspective which is based on the

data and other studies results.

The research question answered in this study is that how a state which is considered to be an

ideological state turn out to be a security state in a time due to multiple incidences and events.

And what role power elites played in this transformation.

First Narrative:

Few events have been more imperative to the history of contemporary South Asia than the

partition of the subcontinent into India and Pakistan in 1947. The coming of partition has troupe

a powerful shadow on historical reconstructions of the decades before 1947, while the

complications of partition have persistent to leave their mark on sub continental politics even

till date. Yet, neither scholars of British India nor scholars of Pakistan and Indian nationalism

tried to find a persuasive place for partition within their larger historical narratives (Pandey

1994, 204-5). For British Empire historian, Partition is the result of the failure of the British rule

of transition from colonial to post-colonial rule. For Indian it is “the unfortunate outcome of

sectarian and separatist politics," and "a tragic accompaniment to the exhilaration and promise

of a freedom fought for with courage and velour" (Menon and Bhasin 1998, 3). And for

Pakistani Nationalist it is a triumph of success of having a homeland based on a Muslim

ideology. But the issue which comes here in Pakistan’s history narration is that the partition is

not of a subcontinent, but of the Indian Muslim community itself, and it had made the fitting of

the creation of Pakistan into any simple narrative of Muslim community extremely problematic

(Hardy 1972). Later the emergence of Bangladesh in 1971 made this all the more grim.

Every child in Pakistan is brought up being taught three fundamental theories7. Due to it, there

visions are planned as per so and inborn fear and aggression towards India starts building up

from day one which ask for the need of Military to protect them from their giant enemy which

not only suppress them before the independence but afterwards also, Military’s continuous

conspiracies take away from them, the left wing though initially Bengali’s don’t want to be

separated by us.

The search for a narrative structure to contain the history of partition must begin with the search

for a narrative of the high politics of Pakistan's creation that at least delivers room for an

understanding of the issues that everyday lives influenced the decisions made in Delhi and

6 A meta-analysis refers to methods that focus on contrasting and combining results from different studies, in the

hope of identifying patterns among study results, sources of disagreement among those results, or other interesting

relationships that may come to light in the context of multiple studies 7 The task of rewriting history books started in earnest in 1981, when General Zia ul Haq declared compulsory the

teaching of Pakistan studies to all degree students, including those at engineering and medical colleges. The

University Grants Commission issued a directive to prospective textbook authors specifying that the objective of

the new course is to 'induce pride for the nation’s past, enthusiasm for the present, and unshakeable faith in the

stability and longevity of Pakistan. (University Grants Commission directive, quoted in Azhar Hamid, et al.

Mutalliyah-i-Pakistan (Islamabad: Allama Iqbal Open University, 1983), p. xi.)




London. But when we see the historical epochal events in more detail and unbiasedly, we see

that the reality is something else. There is an ample amount of literature which argued that the

concept of two nation theory was very new for the Muslims of India as it was introduced in

early 1900. When British internally have decided to roll back to their country and leave this

colony due to multiple factors of facing continuous aggression by Indian for their independence

started from the independence war of India in 1857 and the pressure they have after First World

War. But they don’t want to leave India being strong enough to be a future political and

economic opponent. United India was the biggest colony of British Empire which after

independence can become there biggest rival economically and politically. So it was well

planned to divide them before handing them back there independence(Ganguly, 2013). Having

said that, no doubt the rifts and the issues among Muslims and Hindus of that area were there

and naturally since the problem was there so it was escalated and magnified but point to ponder

is that was the area given to Pakistan geographically was this much developed to inhibit as a

separate independent state? Were the problems really this much serious that after the major

player “British” who created all these disparities, the two other victims, “Muslims and Hindus”

could not find a way to manage their grievances together? Was the Division done solely on the

demand of Muslims of having separate homeland or was the seed implanted by the British

intentionally to divide the state before leaving? Were they really in such a soft heart towards the

Muslims of United India that they don’t want them to be suppressed by Hindus after they leave?

And if so then why they kept suppressing them by joining hands with Hindus at the time of

British rule though before their invasion, India was governed by Muslim Mughal Empire and

such Muslim Hindu issues were never recorded in history(Ganguly, 2013; Hasan, 1997). There

are writers like (Hardy, 1972) who mentioned that the Partition of Pakistan was not only

partition of Muslims from Hindus but is been observed as a Partition of Indian Muslim

Community itself. But at the same times there is an ample amount of literature supporting Two

Nation theory also like (Sayeed, 1998) “Pakistan: The Formative Phase 1857-1948” deals with

the differences in the political attitudes of the Hindu and Muslim communities in British India

from the war of independence in 1857 until the independence of India and Pakistan in 1947.

The author highlights the anti-western as well as pro-monarchial tendencies of the Muslims of

India. Ayesha Jalal and Sujata Bose’s Modern South Asia: History, Culture, Political Economy

paints a similar picture when the authors emphasize the divergent political attitudes of the two

communities (Hindus and Muslims) inhabiting United India.(Bose & Jalal, 1998)

This gives any rational person a thought to think that who then internally be beneficiary of this

division actually. Who among the Muslims played the role of creating this sense among

Muslims of United India? If they were the real representative of the suppressed class then it

makes a strong lucidity that yes the problem was there and the solution was a separate home

land. But we see that the leaders of Muslim league who actually introduced Pakistan

Movements were the rich Muslim landlords, Modern educated secular urbanities and the

commercial minorities of Western India (W. Wilcox, 1968). Who truly have never been the

victim of the suppression and disparity of Hindus or British? Then what could be there purpose

to fight for separate homeland and independence? One good faith thought could be the pain

they feel for their fellow Muslims and the other more convincing thought could be there

personal benefit out of this separation. Primarily, Muslim league never demanded a separate

homeland, it wanted a loose federation with maximum powers to Muslim majority units but

when congress did not agree, the demand become of a separate state, which was surprisingly




backed by British. (Gilmartin, 1998) in his work attempted to do the narration of partition of

Pakistan in context of its impact on South Asia history and concluded it as a result of an events

which relate ‘High Politics’ with the everyday life in India. He said that Pakistan which was

demanded as a symbol of moral order, surpassing the divisions among Muslims was dominated

by elites who came quickly to mistrust the particularism of Pakistani society as a threat to

state’s own moral sovereignty.

Prof. Khalid Bin Sayeed in late 1990’s asked a question that “Pakistan, with all its weaknesses,

has a state, but does it have a nation?’. The two Nation theory is based on the philosophy that

Muslims around the world are one nation and hence cannot live under one state with Hindus of

United India but we see that in Pakistan there is a number of ethnic factionalism which had

developed right from the beginning till today and doesn’t allow a country to emerge up as a

nation. Ayesha Jalal said that Jinnah was the “sole-nationalist” in quest on its Nation(Jalal,

1985) but at the same time in her work she was questioning this also that weather Jinnah ever

really wanted the creation of separate homeland for Muslims of United India or weather the

actual partition was forced by the leaders of Congress who found it more convenient to give

Jinnah a "truncated, moth-eaten" Pakistan rather than to give him the political position he

wanted in a united India. But it is also reality that when in 1937 Jinnah’s Muslim league could

only win 55 vote he coined the formula of “Two Nation Theory”.

“Islam and Hindus mare not religions in the strict sense of the word, but are, in fact different

and distinct social order (…). The Hindus and the Muslims belong to two different religious

philosophies, social customs, and literatures (…). To yoke together such nations under a single

State, one as a numerical minority and the other as a majority, must lead to growing discontent

and the final destruction of any fabric that may be so built up for the government of such a

state”8.

Initially the Muslim separatism developed primarily among the British provinces where

Muslims were in minority, Muslim majority provinces accepted Pakistan movement in 19409.

“The intellect of these regions evolved a nationalist ideology that was over-determined by its

socio-economic and political interest… From Syed Ahmad Khan to Jinnah, this elite shaped an

ethnic variety of nationalism based on Islam”(Jaffrelot, 2002).

(Shaikh, 1989) In her work links this movement with the result of the attempts of literate elites

of Muslim community. Which she called as Ashraf ‘elites’. When we see Pakistan after the

independence, we see the three major elite groups controlling the state and major decisions of

the country. Who saved there entity and their existence. Those were the big landlords of

western India who after the creation of Pakistan saved their land by any further division or any

kind of reforms. Other were the Modern educated urbanities who took charge of all state

departments as Bureaucrats and the last were those commercial minorities who were working as

a traders in the western India and were having little profit, but after independence when Hindu

entrepreneur migrated from western India, they got an opportunity to avail those units in

cheaper prices and allotments and develop themselves as a Business men. (Gustav F Papanek,

1962) has done a detailed survey on the nature of the entrepreneurs in Pakistan in early decade

and was of the view that most of them were the traders who migrated from western India but in

8 Speech of Jinnah in Lahore session of Muslim League in 1940. 9 C. jaffrelot. (2002 ), Pakistan: Nationalism without A Nation




his work he mentioned about the growing disparities among East Pakistan due to this west

Pakistan oriented entrepreneurial development. Pakistan’s industrial sector started expanding

due to two major reasons, one the endless support by government and the other was the

international changing scene after world war 11 which brings lot of export options to Pakistan’s

investors10. Which later was expanded under first military regime, (1958 -1968) in shape of

giving maximum import licenses11 to newly developed corporate elite of specifically west

Pakistan and subsidizing private industrial sector(LaPorte, 1969; Naqvi, 1964; Gustav Fritz

Papanek, 1967; Gustav F Papanek, Lewis, & Soligo, 1965; Richard, 1965). So it becomes quite

evident when we join the bits and pieces of all this history the creation of the major elite players

in Pakistan. Landlord elite, bureaucratic elite and corporate elite.

Second Narrative:

Coming to the other irrefutable episode of Pakistan after creation. The separation of east wing

of Pakistan. The average Pakistani thinks that the reason of losing this east wing is actually

conspiracy of India. Which started from the time of independence in 1947. But not much is

known about it that when Military had started having problems in East Pakistan, most of the

Bengali’s did migrated to India from their borders attached with it and India was not ready to

accept them for a long time, for this reason later India jumped in the war against Pakistan and

helped in availing separate homeland for Bengalis so it can revert back the migrants who

entered in its borders. Though the India’s Military were entering East Pakistan from those

borders continuously to fight with Pakistan’s military(Marwah, 1979).

Our focus is to raise the issues which created problems between military and Bengalis. Events

show that how the East Pakistan’s rights at economic and political grounds were sabotaged by

the bureaucrats and corporate elite of West Pakistan. “Wealth appeared to be increasingly

concentrated within a business oligarchy, the so-called twenty-two families belonging to West

Pakistan, while real wages of workers stagnated. East Pakistan, later independent Bangladesh,

became increasingly resentful over political under-representation and resource transfers from

its agricultural exports for industrial investment in West Pakistan”(Ali, 2004) . It is in record

that in the meeting of the chamber of commerce of Pakistan the representative of east Pakistan

wing quoted themselves as been felt as a became a colony of “Brown Englishmen” now after

separation.

(Sisson & Rose, 1991) in his Book, “War and Secession: Pakistan, India, and the Creation of

Bangladesh’ discussed in detail the political and economic reasons of the war of 1971, the

distrust of Bengali’s towards West Pakistan (particularly Punjabi elites) and the resultant

creation of Bangladesh. Though it is recorded that the Bengali’s issues of national identity

along with West Pakistan have started from the day one in shape of language riots12 which keep

excelling in shape of demands like not appropriate representation in national assembly as per

10 Industry contribution expanded from 1% of 1947 to 6 % by 1959. Industrial assets increased ninefold and private

muslims owned firms control two third of these new assets who were not in the scene before 1947. (Gustav F

Papanek, 1962)

11 See (Naqvi, 1964) 12 When Jinnah in his Dhaka declaration in 1948, announced “Urdu” as a national language was not accepted by

East Bengal with full heart. And later when in 1952 the second Prime Minister Khawaja Nizam ud Din, Himself a

Bengali, reaffirm Urdu as national language resulted in language riots.




population and not given proper share in government expenditure as compare to West

Pakistan(Oldenburg, 1985).

The number of Bengalis on top bureaucratic positions were far less than West Pakistan13.

Certainly as west Pakistan’s urbanities strive at that time for separate homeland for their own

interest so does the urbanities of east Pakistan but when they don’t find them given there due

share so the confrontation occurred among the elites. On the other hand, the economic boost

Pakistan enjoyed in 1960’s was not seen again by corporate elite of East Pakistan been

transferred them on fair grounds. What corporate elite of West Pakistan did was to win most of

the export contracts on the basis of their personal contacts with the bureaucrats at top policy

making posts belonging to West Pakistan.

Table 1: Capital formation in East and West Pakistan from 1960-70

This table shows clearly the capital formation at private and public level in East and West

Pakistan throughout 1960’s. Same as the Government consumption on expenditure in both

wings which is almost double in West Pakistan as compare to East Pakistan, though

demographically East Pakistan was bigger than West Pakistan. With the emergence of

Bangladesh, Pakistan was the first nation to have suffered division in the post-world war period

(Jahan 1972; Choudhury 1974).

This shows the contestations among the elites who at time of independence joined together for

their vested interest but how later they further get divided to save their own benefits. And how

internal rifts and elite wars created this event of separation of East Wing of Pakistan. (Sayeed,

1972) strong words explains clearly the role and influence of power elites in this separation. He

said “I would support the view that this dissension arose largely because the power elites of

West Pakistan formulated certain policies which provoked so much opposition and Bitterness

from the East that the system was brought to the verge of collapse. It might have been saved in

March 1971, but the power elites were not prepared to let the system be transformed into one

more acceptable to the East”.

13 By Mid 1950’s, 0f 741 top civil servants, only 51 were Bengali, none of whom have a rank of secretary. Of 41

Joint secretaries, only 3 were bengali’s, of 133 deputy secretaries 10 were Bengalis. (Sisson & Rose, 1991)




We have discussed the vested interests of power elites of Pakistan in creating a rift between

India and Pakistan at such gigantic level that it turns country towards a security state. But what

could be the reason of India to give a country which is five times smaller than it in size and

population that much importance? Why there defense, foreign and strategic policies revolve

around Pakistan? India has always been concerned about its autonomous status in South Asia

and always is in aspiration to shape the regional security environment (Dash, 1996; Rais, 1991).

(Mohan, 2006) explained in detail the role of India in balancing the power in this South Asia

region. There are factors like Kashmir issue, resource share14 and support to international allies

to enter in this area which always makes both the country very sensitive towards each other’s

policies and actions(Mukherjee, 1983). There are studies like (Verma, 2008) which argues that

stable Pakistan is certainly not in the interest of India. China has also been the vital factor of

discourse among the two countries since the equivalent size neighbor ad competitor in next

world giant for India is always been China. And Pakistan always had a strong alliance with

it(W. A. Wilcox, 1964). As the power elites of Pakistan are using the name of security threat

from India and same as it is India’s interest too to sustain this rift between two countries(Jalal,

1987).

Third Narrative:

Finally, the third core theory of Military as a last savior and true and loyal institution of a

country. This certainly has a role with the second theory also. (Schanberg, 1971) in his article

emphasized on the role of military in the separation of Pakistan. He blamed the military troops

of West Pakistan (majorly Punjab) to brutally demonstrate the military regime's irrational

determination of holding on to East Pakistan at whatever cost and by whatever tactics

necessary15.

After Independence, the only institute which was developed and trained with Pakistan was of

military, rest all were in their primitive stages of development. When after the creation, the

resources and decisive positions were divided among the bureaucrats and the landlords who

played active role in political arenas also, Military found themselves been dictated by the

primitive less developed elite groups which was not acceptable by them. The only way to make

them realize was by showing them that the Military is well developed institute of all arena from

security to political handlings. This can be done by first catering the need of providing the

security to the people which is the fundamental need of a Human. For it they have to be

psychologically been dictated the fear of any Giant who can sabotage all their resources and

future plans. Since other elite groups have win this land to save their own resources but what if

it can again been sabotaged.

So the political, bureaucratic elites have looked towards Military as a savior for their own

vested interest.in return of it Military gets what it wants , which was the never ending relaying

and power of influencing all political and economic decisions of a country. (Mani, 2007) had

considered Pakistan as a weak state and a professional military domain. She in her work argued

that Pakistan’s state institutes had failed to work effectively from the first decade due to

inherent weakness and “Pakistani elites fiercely competed for control of the state”. She gave

14 (Pandian, 2005) 15 It was recorded by foreign diplomat’s estimates that the army has killed at least 200,000 Bengalis.(Schanberg,

1971)




credit to the British trained Military of Pakistan of that time to always take charge of political

problems and amongst it been able to establish their own entrepreneurship. Which primarily

had started as a charitable foundation but with time expands and today despite evidence that

military-owned enterprises frequently function through privileges (subsidies, preferred

government contracts),mainstream analysts of Pakistan’s economy judge that these corporations

play an important national development role16. The other contribution first military coup did is

the creation of the industrial elite who grow at the cost of majority of people(Rashid, 1978)

which sustain till date. Pakistan is considered as ‘over developed’ state with under developed

polity by scholars like (Alavi, 1972) and the reason has been given by him and scholars like

(Jalal, 1995) as the consequence of the persisting disjunction between “(the processes of) state

construction and political processes”. Which could be the result of skewed relationship between

a relatively stable state apparatus, which Pakistan inherited from its colonial past, and an

unstable political system. The power elite presiding over the operation of the state machinery

has sought to perpetuate the in egalitarian class structures in the society and played upon the

intra-societal divides, to retain its hold over power(Behuria, 2009).

In 1950’s it was recorded that the country which was in early development stages and need to

spend on great percentage their budget on education, health and infrastructure development,

spends 70% of GDP on defense expenditure. But this cannot be prevailed by one time

investment, it is an institute which can restrain its power by building this savior image all the

time17. Which perhaps gives a reason of having four wars with India in 67 years and having

four Military Coups of 31 years. This gives us the fourth Power Elite of Pakistan, i-e Military

Elite and perhaps the strongest one. it is evident during all coup’s that the military ruler divided

his political opponents and keep them eternally divided in the interest of survival of his regime

and it allows us to apply Samuel P. Huntington’s famous metaphorical assertion, Pakistan is yet

to evolve a “liberal, antimilitaristic consensus” to brush military aside “into a discredited cranny

of history”(Behuria, 2009).

Conclusion:

16 “Fauji Group Targets Companies for Sale,” Daily Times (Pakistan), August 10, 2004 17 The defense expenditure of Pakistan:




So if I conclude my discussion, it seems that the transformation of a country to security state is

actually the result of the vested interest of the power elites of that area. Who at times keep

colluding with each other to avail a collective benefits and same as on other times come under

contestation to save their own benefits when see other power elite becoming more stronger.

This also show the creation of many other elites as a result of the bigger plans of the existing

elites. Like the creation of Military elite by the Political, Bureaucrat and landlord elites of early

days. And later the creation of Religious elite by Military in 1980’s and after 9/11 to extend

their coup years and control on country. Undoubtedly, we cannot underestimate the role of

international society in all this power game and their influence on the economic policy of a

country(Fatima, 1997) . Though, military regimes are always been considered as partner of

choice by many states as it helps them achieve there international objectives but is always been

observed that each military regime ended creating more disaster for a country as it is not

representing the democratic voice of a country (Behuria, 2009; Chengappa, 1999; Gregory &

Revill, 2008; Nelson, 2009; Rizvi, 2000).

So if we conclude that the Governance in Pakistan is an elusive harmonizing act between the

military elite and the elected civilian government. It is a right time to understand the delicacy of

this power-sharing arrangement between military who have a vital influence over foreign,

security and key domestic issues, and have an ability to mediate confrontations among feuding

political leaders, parties or state institutions whenever such confrontation deemed threatening to

political stability. On the other hand, civilian government enjoys substantial autonomy for

political and economic management and exercise of state authority, it is expected always to

consider the military’s sensibilities. The military has repeatedly demonstrated that it can and

will influence the nature and direction of political change without necessarily assuming power

(Rizvi, 1998).

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Market Dynamics and Multiple Borrowing in Microfinance: The

Case of Bangladesh

Md Aslam Mia

Department of Development Studies




Abstract

There are several factors that have derided the fame of microfinance from ‘hero to zero’ within a very short period

of time and multiple borrowing is one of them. Looking into the market dynamics, particularly the supply and

demand, this study outlines important factors that results multiple borrowing paradox. A multitude of microfinance

operations, aggressive expansion, high penetration rate and institutional leakages are main supply side factors

while consumption demand of hardcore poor, new or expanding micro-enterprise, and household characteristics

are the demand side factors. Impact of multiple borrowing further discussed from the view of borrower, supplier

and academic community.

Keywords: microfinance institutions, multiple borrowing, demand, supply, Bangladesh

JEL: D11, D21, G23, H31

1. Introduction

Microfinance has been severely affected by multiple borrowing and other associated problems

(Dichter et al., 2007, Faruqee and Khalily, 2011, Mpogole et al., 2012). This is further

compounded by exogenous and endogenous shocks in the sector worldwide (Lutzenkirchen and

Weistroffer, 2012). However, the positive impacts of microfinance especially in poverty

reduction has been well documented (Mazumder and Lu, 2015, Imai and Azam, 2012, Swain

and Floro, 2012, Khandker, 2005, Imai et al., 2012). Nevertheless, the problem of multiple

borrowing with its attendant consequence of ‘microfinance-bubble’ has continued to bedevil the

concept. Hence, granting access to finance has turned to be a torn in the flesh of both private

and institutional lenders.

Multiple borrowing is synonymous with over-indebtedness when monthly loan repayment

exceeds 50 per cent of the income (Maurer and Pytkowska, 2010). Over-indebtedness has been

defined as a situation whereby a borrower fails to keep to the repayment schedule which in the

long run increases borrowers’ financial vulnerabilities (Schicks, 2014). Over-indebtedness has

negative impact on the livelihood and wellbeing of borrowers in the society which is in sharp

contrast to the promise of microfinance. As a result of over-indebtedness some borrowers

engage in multiple borrowing which creates more problems such as hunger in families

(Chaudhury and Matin, 2002). As a result, instead of borrowers gaining financial freedom they





forced into ‘debt trap’ or ‘debt peonage’ (Faruqee and Khalily, 2011, Fafchamps and Gubert,

2007).

Furthermore, the news that has sparked the global interest concerns the suicide epidemic and

microfinance in India. A number of Indian farmers, particularly from Andhra Pradesh (one of

the mostly microfinance penetrated area) committed suicide because they were unable to repay

their loans (Levin, 2012). The multiple borrowing issues is believed to be the reason behind

such chaos in the sector as researchers pointed out the causality between multiple borrowing

and suicide epidemic (Biswas, 2010, Levin, 2012, Ashta et al., 2011). However, comprehensive

discussions on both demand and supply side factors and the impact of multiple borrowing have

not been fully explored. Hence, this study attempts to examine the market dynamism behind

multiple borrowing and their impact on suppliers, borrowers and the academic community. This

study also highlights that taking necessary steps in microfinance operation is vital before the

impact of multiple borrowing become outrageous. Furthermore, this study underscores some

policy guidelines that are significant to the management of the microfinance institutions (MFIs)

in Bangladesh, and can be extended to the countries facing similar problems.

This study contributes to the existing literature in several ways. Firstly, factors of multiple

borrowing are discussed in the context of Bangladesh microfinance sector, which is one of the

largest (in terms of number of clients) sector in the world (Micro-Credit Regulatory Authority,

2015). Secondly, the impact of multiple borrowing is examined based on existing literature and

the discussion further extended in the perspectives of borrowers, suppliers and the academic

community. The study highlights policy measures that could be used to mitigate the problems

of multiple borrowing. Lastly, this study do not oppose the view of micro financing rather it

raises concern among the respective authorities to reassess their expectation and re-think

ongoing policies.

The rest of the paper is organized as follows. Section 2 discusses multiple borrowing and

market dynamics. The supply side and demand side factors in relation to multiple borrowing are

discussed separately in sections 3 and 4 respectively. Section 5 discusses the impact of multiple

borrowing. Lastly, this study concludes with some policy implications, limitations of the study

and suggestions for possible future studies.

2. Multiple Borrowing and Market Dynamics

Multiple borrowing simply refers to the multiple microfinance membership for an individual or

household (Faruqee and Khalily, 2011, Lutzenkirchen and Weistroffer, 2012, Lahkar and

Pingali, 2014). When an individual borrows from more than one MFIs, it is called ‘individual

multiple borrowing’, while if more than one person from the same household (normal

household unit) borrow from same or different MFIs it is known as ‘households multiple

borrowing’(Faruqee and Khalily, 2011). Generally, borrowing from different MFIs and

investing them together in a productive business enhances the social wellbeing of borrowers.

However, it may have disastrous effect if borrowers keep accumulating debt with little ability

for repayment.




Market dynamics plays very significant role in multiple borrowing. Generally, if someone

needs urgent cash, for consumption purposes, to repay preceding loans, expanding their

business, or some other obligations, such individual might borrow from different microfinance

institutions or other alternative sources. Literally, the necessity compels the borrowers to take

loans from other MFIs operating in nearby areas. MFIs are largely considered as loan sources

given their friendly loan procurement with little or no punishment for defaults in repayment.

This however, encourages multiple borrowing.

Guha and Chowdhury (2013) argue that the structure of the sector encourages multiple

borrowing. For example, competition in micro-credit markets complements consumer’s

sovereignty, allowing them to get services from different institutions simultaneously (Casini,

2010, Guha and Chowdhury, 2013, Faruqee and Khalily, 2011). Furthermore, lack of

comprehensive financial facilities also motivate borrowers to enjoy the services of other MFIs,

when the current MFIs fail to provide such services (Krishnaswamy, 2007). Figure 1 below

describes relationship between multiple borrowing and market dynamics.

Figure 1 multiple borrowing and market dynamics

Source: Authors proposed framework.

2. Supply Side Factors

‘Supply creates its own demand’ is the classical doctrine of economics, known as ‘Say’s Law’

and it gives insight to market dynamics, regardless of its poor acceptance among Keynesian

economists (Kates, 2005). Microfinance operations are most likely related to supply-led

initiatives that deliberately provide financial services to their clients including credit, savings,

micro-insurance, international money transfer (remittance) etc.

According to Shaffer (1998), if there are more banks for a given pool of fixed borrowers, it is

highly unlikely to assume that there will be no bad loans given, although the borrowers might




be rejected from some other banks or financial institutions. When a borrower is rejected by one

financial institution, the other institutions might not get the exact information due to the

information asymmetry as to investigate reasons for earlier rejections. Furthermore, banks and

other financial institutions compete to provide first credit to the borrowers, although it might

result to loaning in a bad project (Northcott, 2004). Shaffer (1998) termed it as ‘winner’s curse’

that exists when a borrower can reapply to other institutions after being rejected by formal or

informal financial institutions. Due to the informality of the microfinance sector and lack of

comprehensive technology and capital equipment, identifying bad or risky borrowers is costly.

Recent phenomena of commercialization of this industry triggered by high competition and

movement of formal lending institutions to offer credit to the borrowers, aggravate the situation

(Krishnaswamy, 2007).

2.1 More MFIs in operation

Although the first microfinance institution in Bangladesh ‘Grameen Bank’ was created by

Professor Muhammad Yunus in 1976, hundreds of registered and non-registered MFIs are

currently operating in the sector (table 1). The rapid growth of microfinance in the last decade is

believed to be one of the most prominent reasons behind multiple borrowing or overlapping

(McIntosh et al., 2005, Roberts, 2013). The sector has grown intensely in the last decade and

commercialization in their operation has also increased (Kates, 2005, Charitonenko et al., 2004,

Christen and Drake, 2002). It has been observed that incumbent MFIs were more aggressive in

expanding their business for capturing the niche market and increase their market share (Micro-

Credit Regulatory Authority, 2015). The branch expansion has experienced average 15 per cent

growth while the growth rate was 9 per cent for new MFIs creation during 2005 to 2012.

However, the actual number of total clients has not grown at the same rate with branch

expansion or new MFIs creation. Clients grew by only 6 per cent per annum although the

average loan outstanding and average savings have increased by 21 per cent respectively. This

comparatively wide gap between loan outstanding and clients’ growth basically shows an

indication of multiple borrowing. Assuming that average loan size remains relatively stable,

only multiple borrowing can push up the average loan to grow by 21 per cent per annum in this

context. Thus, more MFIs, and their aggressive expansion is most likely to result in multiple

borrowing.

Table 1: Basic Statistics of registered Microfinance Institutions in Bangladesh (in Taka), 2005-

20121.

Indicator 2005 2006 2007 2008 2009 2010 2011 2012* Average

Growth**

MFI 469 641 344 453 420 517 580 643 9per cent

Branches 7,733 12,156 11,112 13,636 16,851 17,252 18,066 17,977 15per cent

Number of clients

(million) 18.82 22.89 20.83 25.13 24.77 25.28 26.08 24.64 5per cent

Loan Outstanding

(Billion)a

56.06

(0.72)

75.2

(0.96)

85.87

(1.10)

85.87

(1.10)

143.13

(1.84)

145.02

(1.86)

173

(2.22)

211.2

(2.70) 21per cent

Savings

(Billion)a

21.01

(0.27)

27.64

(0.35)

37.76

(0.48)

47.39

(0.61)

50.61

(0.65)

51.36

(0.66)

63.27

(0.81)

75.21

(0.96) 21per cent

1 The table values are excluding Grameen Bank.




Source: Author’s own compilation from various MRA annual reports.

Note: * as of 30th June 2012 **Average arithmetic growth a Values in the parenthesis are in

US$ at an average rate of US$ 1=Taka 78.10 in 2013 as per World Bank (2015).

2.2 High competition and expansion in the sector

Expanding credit services through expansion of branches to capture the niche market is quite a

common practice among the institutions particularly for the big MFIs due to their high growth

strategy. The competition in Bangladesh is most likely to be ‘localized competition’ among

MFIs. We have observed that, many firms are competing in some areas (like Dhaka, Chittagong

and Rangpur districts of Bangladesh), while there are several places only few MFIs are

established (Figure 3). Hence, it is most likely that the high market penetration rate in those

districts very much coincides with geographical concentration (Figure 3 and Figure 4).

Additionally, only few MFIs (example Top 10 or Top 20) operate across the country where

most of them are localized or regionally oriented. This has an impact on pricing of the MFIs

products: only nearby firms are affected because of localize competition. It is most likely that

the benefit of true competition (particularly in price) is not realized as it should be under the

definition of competitive market when the market structure is evenly distributed across the

country.

Guha and Chowdhury (2013) attempt to establish the relationship between competition and

multiple borrowing. They found that competition between socially motivated MFIs may

enhance multiple borrowing, which also increases the risk of loan default. This has been

corroborated by others (e.g. Krishnaswamy (2007). Figure 2 below shows the time series

relationship between microfinance institutions branch expansion in relation to individual and

households multiple borrowing. Faruqee and Khalily (2011) empirically showed that average

individual and household overlapping or multiple borrowing growth rate were on average,

15.35 per cent and 13.81 per cent per annum respectively between the periods of 2002 to 2009.

The trend of individual and household overlapping rates have gradually increased over the

period. Household multiple borrowing was slightly higher since the beginning of the study

period 2002 and a wider gap was observed between household and individual multiple

borrowing rate in the later period of the study. This phenomenon depict borrowers are rational

and to avoid unnecessary problems, they also motivate their family members to obtain loan

from different MFIs apart from self-borrowing. This is comparatively easy from the borrowing

side and MFIs are less likely to deny the loans as they will consider it as a fresh loan despite the

borrowers coming from same households.




Figure-2: Multiple membership and MFI’s branch expansion

Source: The first part of the graph is adapted from Faruqee and Khalily (2011) and the second

graph is estimated by Author with the data collected from various annual reports of the Micro-

Credit Regulatory Authority

2.4. Operational leakages

Operational leakages of microfinance may have contributed to the multiple borrowing

phenomenon. Lack of intra-record systems and labor-intensive operations deteriorate the

performance of microfinance institutions. Furthermore, MFI’s are considered as small and non-

specialized human resource pool where the staff do not possess sufficient operational and

computer skills, lack of training opportunities etc. (Kulik and Molinari, 2004). Thus, the loan

screening process is not up to the standard as practiced in the formal financial sector before the

loan disbursement (Lutzenkirchen and Weistroffer, 2012). According to Frankiewicz (2004),

almost 46 per cent of the MFI’s worldwide have very low usage of technology in providing

financial services to poor communities. Additionally, rarely MFIs have centralized borrowers

profile within their institutions and they do not have intra record system among their

counterparts. Hence, it is difficult to figure out ‘fresh’ and ‘multiple borrowers’ from the pool

of borrowers. All these factors collectively accelerate multiple borrowing.

To mitigate the issue, Figure 3 proposes a comprehensive operational outline that may set up

with the help of information and communication technology. The dash rectangle is the proposed

idea which is currently missing from the microfinance operation. Based on the proposed

framework, once the loan application is delivered to the branch or regional office, profiles of

the borrowers are forwarded to the regional hub database and onto the Micro-credit Regulatory

Authority for their record. The accessibility to the regional database system will provide

adequate information to the branch office whether to disburse the loan or not by looking into

the key information of the applicants once they receive loan request from borrowers. By doing

so, MFIs can trace the borrowers status and share the relevant information among them.

Lutzenkirchen and Weistroffer (2012) also proposed to have credit bureau or regional databases

to mitigate the lending hazards and over borrowing issues.

0

10

20

30

40

50

2002

2003

2004

2005

2006

2007

2008

2009

Per

cen

tag

e

Individual and Households

Overlapping Rate(2002-2009)

Individual

overlapping

Households

overlapping0

5000

10000

15000

20000

Number of MFI's Branches

(2002-2009)

Branch




Figure 1: Operational framework of microfinance institutions (MFIs).

Source: Authors’ proposed framework.

2.5. High penetration rate

Market penetration rate in the microfinance context may refer to the ratio of actual number of

borrowers over the total number of targeted borrowers. In the case of Bangladesh microfinance,

this penetration rate is quite similar to the percentage of borrowers to poor people estimated by

the Micro-credit Regulatory Authority. Based on the empirical figure, it could be said that the

sector is experiencing medium growth (above 20%) but with higher penetration rate (between

25% to 30%) in the sector (Gonzalez and Javoy, 2011). Lutzenkirchen and Weistroffer (2012)

showed that, the Bangladesh microfinance sector observed a higher market penetration rate

among all other countries that use microfinance as poverty alleviation tool, where low

penetration was more worrisome for countries like Peru (only 5 %) (Pearlman, 2012).

Figure 3 shows the percentage of borrowers to poor people in the 64 districts of Bangladesh.

There are some districts that recorded well above of 100 per cent market penetration rate. These




include, Sylhet, Feni, Meherpur, Dhaka, Narayanganj, Narsingdi and Chittagong. The highest

penetration rate was recorded above 150 per cent in Feni and Meherpur districts that generally

indicates austere multiple borrowing. The total number of actual borrowers outnumbers poor

people in the districts that coincided with multiple borrowers. The strategic locations of these

areas are also significant due to the importance of their economic activities that may have an

impact on multiple borrowing.

Dhaka is the capital city and accommodates the largest number of MFIs while Chittagong and

Sylhet are the divisional capital of the South-East and North-East regions of Bangladesh.

Additionally, Narayanganj and Narsingdi districts are in close proximity to the capital city of

Dhaka. Meherpur is the smallest district in Bangladesh and Feni district is predominantly

agricultural that favorably recounts high market penetration rate (Bangladesh Bureau of

Statistics, 2013). For the agricultural business (those who grow agricultural products) there is a

lag period of investment and return. For example, in the case of rice production, it takes almost

4 to 5 months to harvest the final products and usually twice in a year. Thus, a farmer (who is

also a borrower) needs cash on hand to meet the consumption expenditures during this interval

period. To support the microenterprise and satisfy their consumption demand, entrepreneurs

tend to borrow from multiple microfinance institutions. Hence, it is quite reasonable to believe

that, in a saturated market of microfinance, high market penetration rates and socio-economic

diversifications re-enforced and exacerbated multiple borrowing (Lutzenkirchen and

Weistroffer, 2012).




Figure 3: Market penetration of MFIs in Bangladesh (2010)

Source: Adapted from MRA (2010)

2.6. Uneven distribution

The location of MFIs across the country is not evenly distributed. Figure 4 below shows that

most of the MFIs are highly concentrated in the capital of regional division such as, Chittagong

(the birth place of microfinance), Rajshahi and Rangpur. Economically these areas are better

than other divisional districts due to their diverse economic activities and being the main city of

the respective divisions (Bangladesh Bureau of Statistics, 2011). Although the southern part of

Bangladesh is mostly vulnerable to natural disasters and severely poor, the concentration of

MFIs are very less in comparison to other parts of the country. This is very similar with the

findings of Sharma and Zeller (1999) that most of the MFIs or their branches are located in

well-established developed areas compared to very remote and poor region. However, the

institutions may also find it easy for setting their businesses in those areas for greater

connectivity, easy accessibility to the resources and other economic synergies.




Figure 4: Geographical Concentration of NGO-MFIs in Bangladesh (2010)

Source: Adapted from MRA (2010)

The policy of setting more MFIs into these specific areas exposed the tendency of targeting

good pockets by MFIs than providing financial services to the hardcore poor. However, the

concept of ‘Location Economics’ is very significant in this context and the sector most likely to

follow the macro models of land use patterns. In general, production activity in space is mostly

correlated with the concentration of population and there is positive feedback between

consumers location and firms (Kilkenny and Thisse, 1999). Yet, MFIs should locate themselves

in close proximity to the poorest of the poor and provide financial services to them as it is the

original aim of such informal banking creation. Hence, reallocation of MFIs from mostly




concentrated areas to less concentrated areas will ensure better financial services to the poor

community.

3. Demand Side Factors

‘Necessity knows no laws’ is most relevant concerning the poor community. Although the

creation of microfinance institutions were basically aimed to provide credit for establishing

micro enterprise, borrowers are sometimes forced to borrow from multiple sources due to an

urgent necessity to gratify their demand. Behavioral economics has significant impact in the

decision making of an individual in this regard (Kahneman and Tversky, 1979). Although

classical economics assume that, humans are rational in all the decision making, however, the

concept of ‘Homo-Economics’ is not always true (Rosenberg, 2009). In the case of ‘over-

confidentiality bias’ and ‘hyperbolic discounting’ a borrower may overestimate the present

necessity and make decision that may mislead them (Kahneman and Tversky, 1979).

Similarly, the literature discusses that borrowers prefer to borrow from different MFIs for

smoothening their consumption, timing repayment and maintain their cash flows (Srinivasan

and Kamath, 2009). Furthermore, there are no sanctions by existing MFIs against such actions

(Coleman, 1999, Fernando, 1997) given their incapability to trace out who borrowed from

which institutions and through falsification of the borrowers identity (Krishnaswamy, 2007). In

the competitive market, easy screening process and the relaxation of MFIs loan standards

directly motivate the borrowers to have loans from various MFIs. However, if the loan amounts

are not used for the actual purpose and not invested into the productive assets ventures,

microfinance program may fail to bring expected outcomes and could create disastrous effect to

the borrowers. Several factors that may promote multiple borrowing from demand cum

borrower’s side have been identified.

3.1. To meet the consumption demand

The target group of MFI’s are poor people and in Bangladesh more than 76 per cent of the

people live below US$2 per day (Management Association, 2013) and these group of people are

believed to be the major clients of MFI’s. Reasonably, these high percentages of people do not

have sufficient income for their daily consumption needs. Although MFI’s loans are initially for

forming new or expanding old micro-enterprises, not all loans are injected into micro-

enterprise. Part of the loan, most likely a major portion of it, will be spent for consumption and

only a small percentage will be invested in micro-enterprise (if there is any remaining

afterwards).

The lion-share of loans from MFI’s are being spent on consumption (Mallick, 2012, Sinha and

Matin, 1998, Rahman, 1999). Similarly, Pearlman (2012) pointed out that in some cases,

entrepreneurs use credit as the consumption purpose and left insufficient working capital for

running their micro-enterprise operation. The propensity to consume is high and the maximum

utility is attained through current consumption rather than in future through investment,

particularly for the very hardcore poor. Reciprocally, the marginal propensity to saving is




expected to be low and this result in a poor investment record. Additionally, since consumption

is autonomous expenditure, people are more prone to borrow from any available sources to

fulfill their consumption demand.

We consider the nature of consumption of hardcore group of poor borrowers with the Zakat

receiver2. Following Yusoff (2010), the consumption function of poor people is estimated as

follows:

𝐶𝑝 = 𝐶𝑎 + 𝐶𝑏(𝑌) + 𝐶𝑐( 𝐿) 0 Cb 1 0 Cc 1

𝐶𝑝 = 𝐶𝑎 + 𝐶𝑑(𝐿 + 𝑌)…………. (1)

Overall MFI’s borrower’s consumption is assumed to be Cp, while Ca is the autonomous

consumption, even though income is zero. Cb and Cc is marginal propensity to consume (MPC)

in relation with income (Y) and loan amount borrowed (L) respectively. Both of the MPC’s are

positive and less than one which implies that, something will be remaining for savings cum

investment. But, most likely, Cb and Cc are very close to 1 for the low income groups.

Furthermore, we expect Cb and Cc is almost similar, thus it leads to a new MPC of Cd (in

equation 1). As the extreme hardcore poor people have insufficient earnings, they even borrow

money from individuals as well as money lenders to satisfy their consumptions and repay back

when they received loan. Therefore, it assumed that, consumption expenses will not be financed

from loan borrowing, if the income is sufficient. Theoretically, consumption expenditure is not

expected to increase after a certain level of income, and surplus of more than the break-even

level is invested into productive resources. Khan (2005) found that, in rural Bangladesh,

demand for cereal consumption reduces as income increases gradually. So it is most likely to

expect that a portion of the loan amount will be spent for consumption, particularly for the very

poor community after satisfying their consumption demand. Yunus (2006) also mentioned why

the formal lending institutions are reluctant to provide financial services to the poor by saying:

‘Poor people are not credit worthy […] they will not be able to pay back […] no matter

how much money you give, they will eat and the money will be over, they can’t pay you

back’.

However, to have better impact of micro-enterprise loans, a complementary consumption credit

may be designed for the hardcore poor that can satisfy their consumption demand. Furthermore,

since most of the loan repayments are on weekly basis, MFIs may categorically restructure their

loan repayment schedule. For agricultural business, since there is a lag period of initial

investment and return, loan repayment should be quarterly or semiannually that will not put

extra pressure to the borrowers. They can simply get the cash by selling their agricultural

products and settle the loan installment. Hence, borrower will not be motivated to over-borrow

from other MFIs to repay their existing loans (Fischer and Ghatak, 2010).

2 Zakat is one of the five pillars of Islam, and according to Shariah law, every year the eligible people need to make a payment of certain amount of their wealth, typically 2.5 percent, as a charitable and religious purpose. The

receivers of this Zakat must be a poor person who has insufficient income to sustain his or her livelihood.




3.2. Necessity for business creation or expansion and insufficient loans

Setting up a new, or expansion of existing, micro-enterprise require significant amount of

financing, and micro-finance institutions loans are small in size that motivate borrowers to take

multiple loans (Srinivasan and Kamath, 2009). A recent investigation on multiple borrowing by

Mpogole et al. (2012) in Iringa, Tanzania found that prevalence of multiple borrowing is very

severe . They argue that the amounts of loan disbursed by MFIs were insufficient and clients

were allegedly borrowing from other MFIs and money lenders to meet the family and business

obligations. The above finding is consistent with the study by Krishnaswamy (2007) in Indian

microfinance sector. He argued that large investment in micro-enterprise motivate the

borrowers to borrow from various MFIs and stretch them together. He termed this as

‘opportunity borrower’ because of the nature of the borrowing. Furthermore, he also classified

‘distress-borrowing’ as those who borrow to meet the lumpy expenditure, consumption or repay

previous loans (for example, borrowing from MFIs to repay money lenders or other MFIs). The

author states that lack of product diversification of the institutions are among factors

contributing to multiple borrowing because some MFIs only provide credit while clients may

need extended financial services such as saving, micro-insurance and etc.

3.3. Households characteristics

In the context of saturated microfinance sector in Bangladesh, Chaudhury and Matin (2002)

have looked into the dimensions and dynamics of multiple borrowing by Bangladesh Rural

Advancement Committee (BRAC) borrowers with a sample size of 240 respondents. Although

they have not clearly examined the main factors involved, their findings led to a fruitful

conclusion. They have claimed that female-owned and resourceful households tend to borrow

from multiple sources because females are the main targets of NGO-MFIs. Furthermore, they

classified all the borrowers into three main categories, namely surplus, occasionally deficit and

chronically deficit households, as a proxy measure of poverty groups and found no statistically

significant relationship in multiple borrowing. They observed that chronically deficit

households borrowed on average from two MFIs, which is similar to other groups but the

average loan taken within last three years varied according to the different poverty group.

Mpogole et al. (2012) discovered that, education level and number of dependents of the

respondent played an important role in multiple borrowing. Highly educated clients borrowed

from more than one MFIs and more dependents in the family substantially increase the loan

contracts. It is most likely that, highly educated respondents are optimistic in their business and

most favorable in creating loan portfolios comprising different MFIs to capture various benefits

provided by them (for example training, technical and nontechnical assistances in their

business etc.). Krishnaswamy (2007) further argued that the importance of collective behaviors

placed an important role in multiple borrowing particularly for group or partnership loan

contract. It may be helpful to have workshop, seminars and training with borrowers to enhance

their financial literacy. Once they know the pros and cons of multiple borrowing, their decision

in taking multiple loans may be revisited.




4. Impact of Multiple Borrowing

4.1. The borrower’s perspective

There are two general thoughts that have been incited by the researchers. Firstly, the protagonist

argues that when people borrow from different sources, particularly from various MFIs, they

have the ability to repay the loan and the least chance to fall in the debt trap, assuming

entrepreneurs are rational (Armendáriz and Morduch, 2010, Burki and Shah, 2007, Lahkar and

Pingali, 2014). While the antagonists argue that borrowing from multiple sources results in the

cycle of debt and delinquency, as well as overall negative impacts on poverty alleviation and

employment generation (Faruqee and Khalily, 2011, Chaudhury and Matin, 2002, Mpogole et

al., 2012).

Impact of multiple borrowing could be very severe for poorest community of the society while

some borrowers could properly manage the funds and prosper in their business and enhance

their socio-economic livelihood. Investigating the impact of multiple borrowing has multi-

dimensional aspects and the results vary based on the methods/estimation chosen. Schicks and

Rosenberg (2011) argue that multiple borrowing, or cross borrowing, is one of the

measurements of over-indebtedness and could be used as a proxy of early warnings. They stated

that, multiple borrowing represents a person’s cycle of debt and largely attributed to higher risk

of default. The problem happens in the absence of credit bureau when borrowers do not know

how much they are capable to repay and they keep accumulating more debt. Secondly, the

scenario becomes worse when borrowers take a fresh loan to repay existing debt and it creates

uncertainty about when they will be retiring from all debt services. However, further empirical

study by Schicks (2013) in the context of Ghanaian microfinance also revealed that, multiple

borrowing or cross-borrowing, is not significant in over indebtedness, and statistically failed to

prove delinquency too (Schicks, 2014). The result may vary for extreme levels of multiple

borrowing, given the context of borrower’s socio-economic condition (Maurer and Pytkowska,

2010).

Boiwa and Bwisa (2014) investigated the impact of multiple borrowing on the living standard

of borrowers with a sample size of 47 including 8 groups in Kenya. Their studies differ from

other multiple borrowing investigations in that they have extended the inquiry into investment,

health and safety of the clients. They conclude that multiple borrowing increases the income

and savings of the households when they manage the funds appropriately and establish

economic empowerment since income, savings and employment opportunities are interrelated.

Furthermore, they found that, engaging with different MFIs enhance the nutrition, living

condition and preventive healthcare because some MFIs also provide those services apart from

their original product of loan. However, this study has inadequate analysis for robustness of

their results.

Krishnaswamy (2007) concluded that multiple borrowers are purely business-oriented and

manage their loan portfolio by investing into productive assets that generated enough revenue to

cover the repayments in the context of Indian microfinance sector. Borrowing from various

MFIs, stretching them together and putting it into the micro-enterprise business may give them

the synergies of large capital investment despite the high risk. However, Zeballos et al. (2014)




argued that, those who take such risks in investment are less likely be defaulted than those who

take less risks among the microfinance borrowers.

Researcher also found the convincing relationship between multiple borrowing and suicide

incidents. This put the policy makers and practitioner under heavier pressure to rethink the

success of microfinance. These suicide cases are the result of multiple borrowing, over-

indebtedness, and coercive recovery practice of the sector (Biswas, 2010). Ashta et al. (2011)

found that high growth and high market penetration rate in the sector is quite likely related to

male suicide. When a person is severely indebted and unable to service his or her debt, it

enhances his fragility and limits his self-confidence, increasing the probability of suicide. There

is a causal relationship between bankruptcy and suicide (Watanabe et al., 2006). Borrowers

think the ultimate way of coping with over indebtedness and multiple borrowing is to commit

suicide which opposes the original promise of microfinance. Nonetheless, borrowers also incur

high transaction costs when they loan from different MFIs (than a single loan) (Srinivasan and

Kamath, 2009).

4.2 The supplier’s perspective

4.2.1. Declining in repayment performance

In the case of multiple borrowing, it is most unlikely that multiple borrowers will be able to

repay back all the loan installments for borrowed amounts due to the constraints on income.

Hence, it effect loan repayment performance of the borrowers that directly deteriorate the

financial performance of MFIs (Northcott, 2004, Srinivasan and Kamath, 2009). Chaudhury

and Matin (2002) empirically related multiple borrowing in loan performance of households

and have drawn a distinctive conclusion that on average when households borrow from more

than one NGO-MFIs, their repayment performance declines. They have argued that, poorer

households face more irregularity and observed an upward trend in loan repayment as move up

the poverty self-assessment status from chronically deficit to surplus unit of households.

Additionally, in terms of land ownership status, it is observed that households with 50 to 99

decimal of land recorded the highest loan repayment over 95 per cent while the rate was below

70 per cent for the landless category. In general, when money is fungible and a borrower

obtains loans from two different MFIs or more, it is very unlikely that they will be able to repay

the loan installments from same business project and exceeding their loan repayment capacity.

However, the generated income will be shared for both loans assuming multiple loans were

invested into only one project.

Mpogole et al. (2012) found that, in Tanzania, about 70 per cent of the respondent said that they

have faced problem in repayment due to multiple borrowing and multiple loans pending. This

corroborates an earlier study which conclude that multiple borrowing has a negative impact on

loan repayment Chaudhury and Matin (2002). Borrowing from different MFIs increases their

liability and threatens to be loan defaulted (Mpogole et al., 2012). To incorporate the other

households attributes in loan repayment performance, Brehanu and Fufa (2008) pointed out the

importance of types of loan, land and livestock holding, experience in doing business,

additional income apart from the original business to be significantly important.




In examining the impact of multiple borrowing in Indian microfinance, Krishnaswamy (2007),

estimated that multiple borrowers and single borrowers have the same level of repayment rate

which is similar with other studies (Schicks, 2014, Schicks, 2013, Schicks and Rosenberg,

2011). However, these results are in contrast with the findings of Chaudhury and Matin (2002),

Mpogole et al. (2012). Nevertheless, it does not guarantee the improvement in loan repayment,

since there might be some other factors involved. Krishnaswamy (2007) also estimated a

‘magic’ amount of repayment threshold that if a borrower loans up to Rs. 25000, or up to 30 per

cent of their annual income, the repayment is supposed to be stable. However, beyond this rule

of thumb threshold, repayment irregularities may occur in general. Giving multiple loans to the

same person and experiencing irregularities in loans installments, over indebtedness and

possibly suicide does not move hand in hand with the objectives of microfinance. Hence, it

could be argued that the amount of loan disbursed to multiple borrowers can be channeled into

new borrowers that will enhance the depth of outreach of MFIs (Bos and Millone, 2015).

4.2.2. Quality of the loan portfolio

In a saturated market, expanding credit to the pool of borrowers also deteriorates the portfolio

quality, hence more exposure to risky loans by MFIs (Lutzenkirchen and Weistroffer, 2012,

Gonzalez, 2010). Using empirical evidence, Gonzalez (2010) demonstrate that, when market

penetration rates exceed 8 percent in relation to total population, portfolio quality is adversely

affected. In the case of Bangladesh microfinance, on average the market penetration rate is

above 25 per cent, three times higher than the threshold estimated by Gonzalez (2010).

Lutzenkirchen and Weistroffer (2012) explained this outcome by integrating both clients and

internal human resource management. Firstly, in a fast growing market, finding the low risk

borrowers from a pool of poor borrowers are costly and difficult. Thus, loans are disbursed to

high risk borrowers, focusing more on wealthy and urban entrepreneurs deliberately. Secondly,

to cope with such growth of the institutions, management are reluctant to hire new staff, hence

it increases the workload of existing employees and substantially diminishes the quality of

monitoring of the clients. Thus, not only that the untrained and inexperienced staffs are less

efficient in monitoring the loans, but also they find it difficult to select low risk borrowers in a

highly penetrated market.

4.3. The academic perspective

Majority of the performance evaluation of microfinance institutions studies used secondary

data, self-reported by the MFIs into a database such as Mixmarket and widely used in the recent

literature (Hermes et al., 2011, Ben Soltane, 2014, Roberts, 2013, Ahlin et al., 2011, Cull and

Morduch, 2007). Although the large set of data are available, researchers mostly used several

indicators such as, average loan size, number of borrowers, number of savers, number of

women, active clients, gross loan portfolio, etc. that basically capture their intended research

objective(s) (Twaha and Rashid, 2012, Hisako, 2009, Quayes, 2012, Bos and Millone, 2015,

Serrano-Cinca and Gutiérrez-Nieto, 2014, Mia, 2014).

Previous studies used certain indicators which were either under or over-estimated due to the

multiple borrowing issues. For example, average loan size (sometimes defined as average loan

size/GNI per capita) which is basically the ratio of total loan outstanding divided by the total

number of borrowers as a proxy measure to capture the outreach (providing financial services to




the poorest of the poor) of MFIs (Quayes, 2012, Hisako, 2009, Bos and Millone, 2015, Hermes

et al., 2011, Conning, 1999, Servin et al., 2012). It is largely accepted that, smaller average loan

size associated with higher outreach (Louis et al., 2013). This implies that, although MFIs are

making small loans, they are catering to large number of borrowers and deepening their social

objectives with given level of resources. However, in the presence of multiple borrowing, the

numbers of total borrowers are actually overestimated. Particularly, the multiple borrowers are

over counted by respective MFIs, hence, the average loan size is underestimated. Thus, it raises

the question of reliability and robustness of using such variables in the estimation considering

the percentage of multiple borrowing is quite large (in Bangladesh, it was over 30% in 2009).

Thus, we argue that when there is a possibility that the indicator can be affected by the multiple

counting in MFIs, multiple borrowing issues should be analyzed considering appropriate

measurements.

Therefore, in this study, we propose to adjust the actual figure by discounting the rate of

multiple borrowers. The estimation process can be similar like the way real Gross Domestic

Product (GDP) is estimated from the nominal GDP with consideration of inflation. In this case,

rate of multiple borrowing, more concisely individual multiple borrowing should be treated as a

deflator. However, the actual individual multiple borrowing rate should be reliable and

concrete, otherwise it will result in under or overestimate of the adjustment again.

5. Conclusion

After examining the market dynamics, it is mostly likely that more MFIs in operation,

aggressive business expansion, high penetration rates and uneven distribution of MFIs across

the country are the main supply side factors behind multiple borrowing. Furthermore, borrowers

use multiple loans for consumption purpose (Krishnaswamy, 2007), large investment

(Krishnaswamy, 2007, Mpogole et al., 2012, Boiwa and Bwisa, 2014, Fernando, 1997) and

repayment of previous loans (Duvendack and Palmer-Jones, 2012, Venkata and Yamini, 2010,

Boiwa and Bwisa, 2014, Coleman, 1999) and these are the main demand side factors. Also,

households and individual characteristics are relevant in multiple borrowing (Mpogole et al.,

2012, Chaudhury and Matin, 2002, Krishnaswamy, 2007).

Examining the impact of multiple borrowing, this study would like to acknowledge that,

multiple borrowing has resulted in irregularities of repayment/over indebtedness (Boiwa and

Bwisa, 2014, Venkata and Yamini, 2010, Mpogole et al., 2012) while researchers also found no

or less impact (Schicks, 2013, Schicks and Rosenberg, 2011, Krishnaswamy, 2007). The severe

case of multiple borrowing and over indebtedness in India resulted in several suicide cases that

created chaos in the industry. However, the dispute raises concern about the effectiveness of

microfinance not only among the practitioners, but also among policy makers as a way of

alleviating poverty. However, it is most likely that the negative impact of multiple borrowing

outpaced the benefits; hence policy intervention is necessary to correct such inherent market

failures. To deal with this, necessary steps should be taken for a healthy credit flow in the

sector. Below are some policy guidelines that can cure or perhaps mitigate the multiple

borrowing phenomenon in a greater extent,




a) Creation of credit bureau or regional hub databases and sharing the basic information

about borrowers before loan disbursement among MFIs. Information and

communication technology can play a significant role in this context.

b) The aggressive expansion of MFIs branch and creation of new MFIs in the saturated

market should be limited and reallocation of branches to the less penetrated area will

ensure the financial services to the poor community in a greater extent.

c) Incumbent MFIs should develop borrower’s oriented products, such as consumer credit

and other necessary financial services (example, insurance, savings, money transfer and

etc.) that can gratify the demand of their clients in a greater extent.

d) The loan size should not be ‘same for all’ rather than it should vary based on the nature

of enterprise and demand from the borrowers.

e) The loan repayment schedule should be restructured based on types of business rather

than general weekly installment.

f) Workshop, seminar and training program should be arranged to enhance the financial

literacy of the borrowers.

g) Academic community should take necessary adjustments while taking some indicators

that may be under or over-estimated due to the influence of the multiple borrowing.

h) Lastly, monitoring and supervising the microfinance activities urged the authorities to

take necessary steps before this crisis become widespread.

The original aim of this study is not to stop the microfinance program rather raising concern

among the respective authorities about the challenges that the sector is experiencing. We

discussed the causes behind multiple borrowing and their impact based on general figures and

facts. However, rigorous empirical estimation is required to understand the dynamics of

multiple borrowing in a greater extent. Proper investigation of cross country context should be

carried out to see the impact of multiple borrowing. Though, empirical analysis may not truly

reflect the factors of multiple borrowing and their impact, in depth case studies will enhance the

understanding of such phenomenon to a greater magnitude.

Acknowledgement

I would like to thank Dr. VGR Chandran and Mr. Vita for their constructive comments and

suggestions.

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The Role of Professionalism, Leadership, and Trust to Promote

Organizational Justice

Imran Shafique



Abstract

The aim of this study is to empirically investigate the relationship among professionalism, leadership, and trust in

organizational justice. Pakistan is selected as a case study. Data was collected by random sampling technique by

using survey questionnaire. The sample size is composed of twenty public sector universities of Pakistan. The

instrument’s reliability is assessed by Cronbach’s alpha. Furthermore, to analyze the hypotheses correlation and

regression techniques are used respectively. The results state that professionalism, leadership, and trust plays

vital role to promote organizational justice.

Keywords: professionalism, leadership, trust, organizational justice

Introduction

In today’s competitive business environment, organizational justice is the essence of keeping

employees effective, loyal, and committed to organization as well as to their colleagues. Justice

in an organization is vital because of its impact on the performance of the organization in terms

of work effectiveness, trustworthiness of the employees and nurturing mutual respect among

employees (Sheppard, et al., 1992). Organizational justice, in its most general sense, is the way

individuals perceive justice regarding practices in their organizations (Bies and Moag, 1986;

Greenberg, 1990).

The study of organizational justice has received great consideration from the researchers and

scholars and it has become frequently researched topics in the field of industrial-organizational

psychology, human resource management and organization behavior (Cropanzano &

Greenberg, 1997). Perceptions of organizational justice establish an important heuristic in

organizational decision-making, as research relates it to job satisfaction, leadership,

organizational citizenship, organizational commitment, trust in colleagues and supervisors,

turnover, mutual respect among colleagues, job performance, customer satisfaction and leader-

member exchange.

1.2 Trust and Organizational Justice

People evaluate the treatment they receive in organizations of which they are employees with

the treatments that other employees in the same organization or employees of the other

organizations receive, and make evaluations about the level of justice in the organization

according to their own perceptions. It is believed that these evaluations play a key role in the

way members perform their organizational duties and responsibilities. Therefore, the concept of

organizational justice is frequently included in studies concerning organizations and




management (Cohen-Charash and Spector, 2001; Konovsky, 2000). Greenberg (1990) stated

that organizational justice refers to people's perceptions of the fairness of treatment received

from organizations and it is a basic requirement for the effective functioning of organizations.

Trust and organizational justice are inseparable, if employee perceives fair and just treatment

from the organization as well as from colleagues; she/he feels organization as well as

colleagues trustworthy. Trust has been defined as “an individual’s or group’s willingness to be

vulnerable to another party based on the confidence that the latter party is benevolent, reliable,

competent, honest, and open” (Hoy & Tschannen-Moran, 1999:189).

In the educational setting two different referents of trust are considered; teacher trust in

colleagues and teacher trust in the principal. Hoy and Kupersmith (1985) developed scales to

measure faculty trust in colleagues and in principals which was further improved by Hoy and

Tschannen-Moran (1999), they developed the Omnibus T-Scale, which determined particularly

the willingness to risk vulnerability and reflected five facets of trust that is; benevolence,

reliability, competency, honesty, and openness.

There are two primary emphases in this study. The first emphasis is the relationship of

Teachers’ professionalism and faculty trust in colleagues with organizational justice. Teachers’

professionalism is a constituent of healthy climates and is linked to trust in colleagues (Hoy, et

al., 2002). When teachers trust each other, they are more likely to communicate and impart

ideas about refining curriculum and teaching methodology. The second emphasis of this study

is the relationship of collegial principal leadership and teacher trust in the principal with

organizational justice. Collegial leadership is where principals are helpful and supportive to

teachers and treat them as people and colleagues, however set high standards for them to

follow. Similarly, Corwin and Borman (1988) affirmed that through administrative support and

collegial leadership, principals can influence teaching positively but through administrative

control they can influence negatively. Furthermore, teachers are more likely to experiment and

take risks to improve the quality of instructions when they are supported by their superiors

(Hoffman, et al., 1994).

Collegial leadership is principal behavior that is concerned with meeting both the social needs

of the faculty and achieving the goals of the school. The principal treats teachers as colleagues,

is open, egalitarian, and friendly, but at the same time sets clear expectations and standards of

performance (Hoy, et al., 2002). Teachers’ professionalism is described as teacher’s

commitment to students and engagement in the teaching task, while respecting the professional

expertise of colleagues. Professional interactions among teachers are open and cooperative.

Teachers are supportive of one another and help each another. Teachers display warmth and

kindliness. Teachers’ professionalism is a respect for colleagues’ competence, commitment to

students, autonomous judgment, mutual cooperation, and support for colleagues (Hoy, et al.,

2002).

The collegial leadership of the principal is critical in nurturing a trusting relationship with the

faculty, and such trust is pivotal in developing a sense of organizational justice. Professional

teacher relationships are significant in facilitating trust among teachers, which in turn enhances

a sense of fairness in the school.




The topic of organizational justice and trust is not new in administrative literature but it’s a

negligent issue in education sector (Hoy & Tarter, 2004). In the context of Pakistan, few studies

have been carried out on organizational justice. Salfi (2011) revealed that the heads of

successful schools develop a common and shared school vision to promote a culture of

collaboration, support and trust. They empower others to lead and distribute leadership

responsibilities throughout the school. If a school wants to improve and be successful, trust

plays a significant role (Hoy & Tarter, 2004). So trust must be always nurtured and preserved in

an organization to ensure its existence. Murtaza, et al. (2011) conducted a study in public sector

of Pakistan and revealed that organizational justice is positively related with job satisfaction.

Hoy and Tater (2004) identified a new construct including collegial leadership and Teachers’

professionalism; that has potential impacts on organizational justice. This research on collegial

principal leadership, Teachers’ professionalism, trust in principal and colleagues and

organizational justice has been done specifically in an elementary schools settings hence results

of this study may fill gaps in the research in these settings and further confirm the new concept

of organizational justice in schools.

1.3 Statement of the Problem

Organizational justice is essential for maintaining employee loyalty, commitment, job

satisfaction and effectiveness. In the context of schools, organizational justice is – what is just

and fair treatment for faculty. There are two major participants of organizational justice in the

context of schools, i.e. faculty and principal. There is a need to look at these participants’

behavior (Teachers’ professionalism and collegial principal leadership) to foster faculty trust in

colleagues and principal, which is pivotal to promote organizational justice. Furthermore,

studies are being carried out on organizational justice in schools; in different environments and

cultures all over the world. In Pakistan, researchers are concerned about studying organizational

justice in the context of organizational management, but it’s a neglected concern in the

educational administration and management

1.4 Objectives

To assess the relationship between Teachers’ professionalism and faculty trust in

colleagues.

To assess the relationship between collegial principal leadership and faculty trust in

principal.

To assess the relationship between faculty trust in colleagues and principal, and

organizational justice.

To assess the mediating behavior of trust in principal and trust in colleagues.

To assess the relationship and extent with which Teachers’ professionalism, collegial

principal leadership and faculty trust in colleagues and principal are related to





2.1 Literature Review

2.2 Organizational Justice

Justice in organizations is not a new concept in literature but it has been a negligent issue in the

field of education (Hoy & Tarter, 2004). It has been argued that organizational justice plays an

important role in the development of teachers’ attitudes towards the school which is highly

associated with their job satisfaction (Colquitt et al., 2001). Moreover, the health of an

individual is greatly affected by organizational justice (Kivimaki, et al., 2003). Thus, justice is

not only important for an organization but also important for the well-being of the workers in an

organization because justice has a vital role on enhancing individuals’ satisfaction (Poole,

2008).

According to Poulus (2004), justice should be made as a main agenda in schools because

teachers want justice in work place. Annamalai (2010) also found that in school setup,

organizational justice has important influence towards satisfaction in performance appraisal at

individual (teacher) level and also trust at organizational level. It is also believed that taking

measures that will increase teachers’ organizational commitment, especially reinforcing

organizational justice in schools, will be useful.

According to Singer (1993), justice should be given priority in all organization affairs;

otherwise there will be some negative impact on the organization performance. Justice in the

workplace has a significant relationship with employee’s satisfaction (Poulus, 2004) and the

effectiveness of an organization (Colquitt, et al., 2001). An organizational justice perception

plays an important role in the development of organizational commitment and job satisfaction.

Perceived organizational justice significantly correlates with both job satisfaction and

organization commitment. Those who perceive justice in their organization are more likely to

feel satisfied with their job and feel less likely to leave and feel more committed to their job

(Bakhshi, et al., 2009).

Organizational justice in literature is divided into four dimensions: distributive justice,

procedural justice, interpersonal justice and informational justice (Colquitt et al., 2001).

Distributive justice refers to the employees’ perception towards fairness of the outcomes

received as a result of an allocation decision while procedural justice refers to the employees’

perception towards fairness of the procedures used to make allocation decisions (Cropanzano &

Greenberg, 1997). Other researchers explains that distributive justice refers to employees

perception towards the rewards that he /she receives includes promotion and incentives

whereas, procedural justice refers to the perceptions of the employees’ regarding the procedures

and process of acquiring rewards (Thibaut & Walker, 1975). Interpersonal justice refers to

employees’ perceptions towards the interpersonal treatment that he/she gets during the process

of garnering incentives (Bies & Moag, 1986). Finally, informational justice refers to the

perceptions of employees’ about getting clear information regarding decisions made by the

organization (Bies, Shapiro, & Cummings, 1988). These complete four dimensions are the

processes that are involved in rewarding employees.

Hoy and Tarter’s (2004) study of organizational justice and trust is also important in the context

of this study. Their model predicted that Teachers’ professionalism is directly related to faculty

trust in colleagues, which in turn promotes organizational justice in the workplace and




reinforces trust. Similarly, the collegial principal leadership generates faculty trust in the

principal, which independently enhances organizational justice in the school and reinforces

trust. They suggest ten principles of justice for schools setting, which describe the crux of

literature on organizational justice in schools.

i) Equity principle states that outputs acquired by the individuals from the organization

should be proportionate to their inputs. The compensations that teachers receive for

their contributions to the school should reflect balance; teachers should not take an

impression that their contributions are underrated or unrewarded.

ii) Perception principle states that justice is all about an individual’s perception about

fairness. Teachers must perceive that their principal is “following the rules” fairly, for

this principal let them know by word and deed that fair and just procedures will be

followed. Kumar, et al. (2009) revealed in their study that the perception of

organizational justice enhances the positive commitment that employees feel towards

the organization. Perception of organizational justice seems to be one of the most

important reasons for creating a sense in employee that he is a part of the organization.

According to Folger and Konovsky (1989), individuals with a high-level of perceived

organizational justice also express a high level of commitment to the organization.

iii) Voice principal states that principals should involve teachers in decision making when

they have a personal stake in the outcome and when they have the expertise to

contribute to the decisions (Hoy and Tarter, 2003). Principals need to promote both

informal and formal procedures to provoke teacher voice. A cup of coffee with teachers

in the staff room or “walking around” gives opportunities for informal voice. Formal

voice can be raised at faculty meetings, department meetings, in written

communication, and in a reliable “open door” policy.

iv) Interpersonal justice principle states treating employees with sensitivity, dignity and

respect promotes the feeling of fairness. If a bad news is given with respect and with

adequate information, it builds a feel of fair treatment. Sometimes principals have to

communicate adverse information to teachers about their performance or any other

assignment, at that time if they take into account timing, background, and delivery of

such information it will be more likely to create a sense of trust in the principal by

teachers which in turn promote a sense of organizational justice.

v) Consistency principle suggests the fair, evident and consistent application of rules,

regulations, and policies which at the same time gives flexibility to consider individual

needs and unusual circumstances. Consistent behavior is not essentially identical

behavior in all situations, but somewhat it is action that consistently suits the situation.

Therefore, in one situation the behavior may call for direct action whereas another

situation may require a soft touch or a more democratic approach. Effective leadership

is synchronizing appropriate leader behavior with the aspects of the situation (Yukl,

1998).

vi) Egalitarian principle describes that decision making should be free of self-centeredness

and self-interest and formed by the shared mission of the organization. The mission and

aim of the organization must take priority over individual benefits; no one’s interests

take preference over the needs of the collective. Like, assigning new faculty members

to the senior classes appears to violate the egalitarian principle. Such practices are not

in the interest of the school or teachers. The steering mission of public schools should

provide a comprehensive, efficient and effective education to all students, which also

comprises quality of instructions. Self-interest and in-house politics are components

that can erode egalitarianism.




vii) Correction principle explains that faulty or inadequate decisions should be corrected,

which depends on feedback, response and willingness to back a bad decision. Usually

supervisors and managers suppose that to admit a mistake is to someway weaken or

challenge their authority. But on the contrary, readiness to appraise a poor decision and

correcting it in all prospects builds in teachers a feeling of trust regarding fairness and

impartiality of the principal. The correction principle emphasizes the necessity for

feedback and precise information. For instance, if teachers conflict with an evaluation,

they must be given provisions for challenge. New indication may guide the principal’s

reappraisal in a just and balanced way. Correction principle suggests that two-way

communication is vital in appraising and reversing the poor decisions. Flexibility in the

organization of the school should openly promote feedback and reviewing of critical

decisions.

viii) Accuracy principle says that decisions must be established on accurate information.

Correction is indivisibly tangled with accuracy. The accuracy principle endorses a sense

of justice by exhibiting that decisions are supported by sound indications and

evidences. Principals who center their judgments on logical evidence rather than

narratives or rumors are expected to underline the confidence that the principal is

probing for the truth and is candidly welcomes new information. Accuracy stimulates

fairness similar to that correction assures; that the organization will treat employees

justly keeping in view the new information.

ix) Representative principle states interests representing the issues of concerned parties

should be taken into account while making decisions. Organizational decisions affect

many of its stakeholders. Decision making that provokes the views and sentiments of

those affected constituencies, justifies the representative principle. For instance, if

school is going to change its curriculum it will effect what teachers teach. In this

scenario, teachers should be represented in the decision-making process because they

not only have a personal concern in the decision outcome but they have also the

expertise, knowledge and wisdom to contribute to a good decision. Representation

principle is addressed, when teachers trust and consider their ideas and opinions are

being represented and have impact on results.

x) Ethical justice principle suggests following established moral and ethical standards.

Justice is primarily an ethical standard. “Honesty, integrity, authenticity, sincerity,

equality, impartiality, trustworthiness, and honor are contemporary ethical and moral

standards that should guide behavior in decision making in school organizations” (Hoy

and Tarter 2004:252). Researchers have been debating on what ethical standards should

be included or excluded, but if school administrators have the courage to obey to only

above mentioned ethical standards they will not have to go far in the subject to create a

fair and just school environment.

2.3 Trust

“Trust is one party’s willingness to be vulnerable to another party based on the confidence that

the latter party is benevolent, reliable, competent, honest, and open” (Hoy and Tschannen-

Moran, 1999:189). Trust is confidence that trusted party is bothered with safeguarding the well-

being of the trusting party while being reliable and competent in fulfilling one’s expectations

(Mishra, 1996).

Golumbiewski and McConkie, (1975:2) defined trust as; “A generalized expectancy held by the

work group that the word, promise, and written or oral statement of another individual, group,

or organization can be relied upon”. Hoy and his colleagues from Ohio State University have




been studying trust in school environment from a perspective made up of specific aspects that

can be measured empirically for more than two decades. In 1985 Hoy and Kupersmith

developed an instrument called the Trust Scales (T-Scales) on theoretical footings of Rotter

(1967). The instrument was developed to measure two aspects: faculty trust in the principal and

faculty trust in colleagues. Their initial research also involved linking trust with principal

authenticity. Authenticity describes behaviors through which the principal shows willingness to

admit mistakes, avoid manipulating others, and behaving like real people instead of a

bureaucrat. Their conclusions were that all three dimensions of trust were related to each other

and authentic behavior leads to teacher trust in the principal. Principal authenticity was also

related to teacher trust in the organization. There was only a slight correlation between principal

authentic behaviors and teacher trust in colleagues.

Hoy and Tschannen-Moran (1999) further used the bases of Hoy and Kupersmith’s (1985) T-

Scale and developed Omnibus T-Scale. The Omnibus T-Scale was first tested in elementary

schools and then retested at the high school level. The final version was comprised of 26 items

that detailed into three referents of trust: faculty trust in the principal, faculty trust in colleagues,

and faculty trust in clients. As anticipated, faculty trust in each of these three groups was fairly

related to each other, which inferred that faculty trust in schools is prevalent. When teachers

trust their principal, they tend more to trust each other and their clients.

Faculty trust is a shared property to the extent with which the faculty as a community is eager to

risk vulnerability (Hoy & Tschannen-Moran, 1998; Tschannen-Moran & Hoy, 2001). From the

literature review, we get to know that faculty trust is an accumulation of the following five

facets: benevolence, reliability, competence, honesty, and openness.

Benevolence is confidence that one’s safety or something one concern about will be

safeguarded and not be exploited by the trusted party (Cummings and Bromily, 1996; Hosmer,

1995. Benevolence is made upon expectations. Parents expect teachers to act in the best

interests of their child while treating them with fairness and compassion. Similarly, teachers

trust their students and parents believe that neither will challenge their teaching. Benevolence is

the “accepted vulnerability to another’s possible but not expected ill will” (Baier, 1986:236).

Benevolence is the foremost element of trust relationships as it is based on mutual

understandings of each other’s well-being.

Reliability is the predictability; that is, consistency of behavior and knowing what to expect

from others (Hosmer, 1995). Predictability alone does not build trust because people can do

predictable behaviors which might be against the well-being of others, like being dishonest or

self-centered. Reliability contains a sense of confidence that one’s need may be met in positive

ways and the trusted person will come through or find alternatives to get the best possible

solution in the collective interest of all parties. “Reliability is the confidence that others will

consistently act in ways that are beneficial to the trustee” (Hoy and Tarter, 2004:254).

Competence is the ability to accomplish a task up to the expected standards (Mishra, 1996). In

organizations, most of the tasks are interdependent, teachers must have confidence that

deadlines will be met, tasks will be completed efficiently and the quality of the results will be

adequate. Reliability and benevolence are not enough to build trust if there is lack of

competence to accomplish the task. Once someone disappoints to do a job appropriately or




demonstrates a lack of expertise, knowledge and skill, it is hard for others to trust him despite

his good intentions.

Honesty refers to a person’s truthfulness, integrity, and authenticity. Rotter (1967) defined trust

as being able to rely on the word, promise, verbal or written statement of another individual or

group. Honesty is developed on the consistency between truthful statements and actions.

Honesty denotes integrity or a connection between words and deeds. Being responsible for your

actions and not falsifying the truth in order to shift blame is the core of honesty (Tschannen-

Moran and Hoy, 1998).

Openness is a willingness to share relevant information that makes one vulnerable to others.

Openness indicates reciprocity of trust, which explains that having a confidence that all parties

involved will not exploit or harm the other parties. People who hide information aggravate

distrust and end up being isolated (Kramer, Brewer, & Hanna, 1996). Trust begets trust whereas

distrust begets distrust.

2.4 Trust in Principal

From most of the studies on trust in principal it is deduced that trust arises from principal’s

behavior that is caring, collegial, supportive, egalitarian and protective (Tarter & Hoy, 1988;

Tarter, et al., 1989). Faculty trust in principal is defined in literature as: “The faculty has

confidence that the principal will keep his or her word and act in the best interest of the

teachers” (Tschannen-Moran and Hoy, 1998: 342)

Hoffman et al. (1994) found that faculty trust in the principal is highly related to the openness

of the principal, but trust in the principal is only weakly related to openness in teacher behavior.

Trust in principal is mainly a consequence of supportive and collegial principal behavior. “The

successful principal is one who integrates a press for the task and a consideration for teacher

colleagues, who influences superiors without selling-out the teachers, and who protects teachers

from unwarranted outside interference. Effective principals are not only intellectual leaders in

their schools, but are also colleagues who serve and support and also build confidence” (Tarter

& Hoy, 1988:23).

Blumberg, et al., (1978) carried out a study to refine the meaning of the word “trust” and to

define more precisely what teachers need when they think about trusting principals. They were

among the first researchers of trust in schools. In their exploratory research, they found that

teachers’ trust in the principal was more associated to their relationships with the principal as

compared to the organizational responsibilities of the principal. That is, it seemed more

important to teachers how the principal consider them professionally than how the principal ran

the school.

In the study, 85 teachers registered in a graduate program were asked to answer to the

statement, “I trust my principal.” As a result, 179 statements developed, from which the

researchers made 10 categories and developed a questionnaire to rank them. From this study,

five expectations from principal, believed by teachers are raised, which are credibility, support,

fairness, professional openness, and participative decision-making.

(Hoy, et al., 1992; Tarter, et al., 1989; Tarter, et al., 1995) demonstrated that different behaviors

of principal and colleagues made different impact on faculty trust in colleagues and principal.




Supportive leadership of the principal propagate the degree of trust teachers felt for the

principal but did not produced trust among the faculty for each other. At the same time, both

collegial and promised behavior of teachers aided create trust in colleagues, but did not make a

significant contribution to trust in the principal. The authenticity of the principal’s behavior is

positively correlated with both aspects of faculty trust (Hoy and Kupersmith, 1986).

The relationship of employees' trust in organizations and its members with the organizations,

leaders plays an important role in the generation of organizational justice. Trust can be studied

on the basis of Blau’s (1964) Social Exchange Theory. This theory explains how individuals

feel about a relationship and the expected results of that relationship (Blau, 1964). If a person

trusts another person he/she will expect some benefits from the relationship. Frazier (2010)

found differential effects of procedural, interpersonal and informational justice on perceived

trustworthiness. He also says that consistent with multifoci organizational justice and social

exchange theory, the effects are dependent on the authority figure being referenced and the

nature of the exchange relationship between authority and subordinate.

Faculty trust in the principal appears crucial to the development of a sense of justice in the

school. As teachers trusting each another is vital in creating fairness in the workplace, so is the

faculty trust in principal and both predicts a close connection between faculty trust and

organizational justice (Hoy and Tarter, 2004). When teachers trust the principal as reliable,

authentic and egalitarian, it encourages open interactions between teachers and principal

(Hoffman, et al., 1994) and implies that principal is competent, and concerned about teachers

(Geist and Hoy, 2003). When principals earn the trust of the faculty, they strengthen a sense of

esteem and respect at the workplace (Hodson, 2001).

2.5 Trust in Colleagues

Faculty trust in colleagues is an important issue in the development and progress of effective

schools. Uline, et al., (1998) argued that effective schools consider both instrumental and

expressive components. Instrumental components of a school refer to students’ achievement

while expressive components of a school include trust in the principal, trust in colleagues, and

school health. They deduced that faculty trust in the principal, teacher trust in colleagues,

organizational health, and student achievement all have significant relationships with teachers’

perception of school effectiveness. Though, teachers’ trust in colleagues is more significantly

linked with perceptions of effectiveness than teachers’ trust in principal.

Tarter, et al., (1989) researched the impact of school climate on faculty trust and found several

significant relationships. They studied 72 secondary schools in New Jersey using trust scales

designed by Hoy and Kupersmith (1985) to measure the faculty trust in the principal and faculty

trust in colleagues. According to the expectations, open school climates were positively

correlated with teachers’ trust in the principal and colleagues. Positive relationships were

obtained between teachers’ trust in principal and principal supportive behavior as well as it was

found that engaged teacher behavior is positively related to teachers’ trust in colleagues.

Negative relationships were discovered between teachers’ trust in principal and directive

principal behavior and at the same time, negative relationships appeared between teachers’ trust

in colleagues and teacher frustration from interference from supervisors and colleagues. Their

research further highlighted the importance of leadership in establishing and maintaining

climates that are empowering because engaged and frustrated teacher behaviors were both

http://gom.sagepub.com/search?author1=M.+Lance+Frazier&sortspec=date&submit=Submit




related to their trust in the principal. Noticeably, faculty trust in the principal had no effect on

faculty trust in colleagues, and vice versa. The final conclusion was “the principal remains the

single most important individual in the development of organizational climate, but not the

development of trust in colleagues” (Hoy & Kupersmith, 1985:306).

Higher levels of teachers’ professionalism are linked with a faculty that trusts in colleagues

(Hoy, Hannum & Tschannen-Moran 1998; Smith, Hoy & Sweetland, 2001; Sweetland & Hoy,

2000). Open and collegial interactions between teachers convince teachers to trust each other

(Hoffman, Sabo, & Hoy, 1994). “It is an atmosphere of openness and professionalism that leads

to a trust and cooperation among colleagues and the principal, which ultimately promotes

effective schools. Supportive leaders and colleagues build self-confidence in individual teachers

to take risks and try new approaches” (Tarter, Sabo, & Hoy, 1995:84).

Faculty trust in colleagues is crucial and essential condition for organizational justice. Trust is

an important constituent of interpersonal relationships; in fact, the right endurance of a social

group may depend on its members’ willingness to exercise trust with each other (Rotter, 1967).

When colleagues trust one another, it promotes the openness and authenticity of interpersonal

relations (Hoffman et al., 1994), and establishes a climate where members will likely to treat

one another with esteem, honesty, and altruism – all features of a just, fair and caring

workplace. Trust in colleagues develops the ability to establish a sense of self-esteem and

dignity, to enjoy healthy social relations (Hodson, 2001). Therefore, it can be expected that

faculty trust in colleagues enhances a fair and just workplace which in turn reinforces a feeling

of trust among teachers.

2.6 Collegial Principal Leadership

Collegial leadership is described by supportive and egalitarian behavior. A principal can lead

his team in a way that directly effects faculty trust in the principal and indirectly promotes a

sense of organizational justice. Through concepts of collegial leadership, we can say that

collegial principal leadership seizes three important concerns of leadership which are: concern

for people, concern for the task, and concern for change. The principal whose behavior is

expressive, instrumental, and change-oriented, that is, who leads with friendly, supportive

behavior, sets clear expectations and standards of performance, and is open to change, is likely

to be successful (Yukl, 1998). Moreover, such collegial principal behavior fosters a culture of

trust and justice. . Collegial principals build faculty trust in the principal and inspire Teachers’

professionalisms that lead to trust in colleagues (Dean, 2011).

The principal is not only dedicated to task achievement, but is sympathetic, helpful, and

honestly concerned about the well-being of teachers. The principal also lets faculty know what

is expected of them while upholding certain standards of performance (Tschannen-Moran,

1997). Characteristics of collegial leadership of the principal measured on the Organizational

Climate Index comprise the following: “The principal treats all faculty members as his or her

equal. The principal maintains definite standards of performance. The principal is friendly and

approachable. The principal explores all sides of topics and admits that other opinions exist”

(Hoy, et al., 2002:42).

Titrek and Osman (2009) carried out a study to determine the levels of organizational justice in

Turkish schools, according to managers' and employees' perceptions. There were 104 school

managers, 834 teachers and 78 other employees (1,016) took part in the study, which were




selected from 7 cities’ schools. Results of the study expressed that most deficiencies in

organizational justice behaviors in Turkish schools are due to managers' behavior towards

employees. This revealed that dishonest, unauthentic, non-collegial behavior of the principal

may lead to a feeling of unjust and unfair organization among teachers.

Collegial leadership affords more decision-making opportunities to teachers. Sweetland and

Hoy (2000) concluded that the one of the strongest climate predictors of teacher empowerment

were collegial leadership. They stated, “Schools in which the principal’s leadership is collegial,

teachers demonstrate a high degree of professionalism.” (Sweetland & Hoy, 2000:720).

Teachers are not impressed by principals who share decision-making only because it is

instructed by superiors (Malen & Ogawa, 1988; Malen et al., 1990). Teachers must feel like

they are trusted by their administrators as professionals who are capable of making choices to

help the organization. Collegial leadership is the key component that allows principals to

release power to teachers whom they trust.

Finally, other researchers conclude that transformational, collegial, and supportive leadership

styles intertwine with trust to help produce the most effective work environments (Hoy &

Miskel, 2005; Hoy, Sabo, & Barnes, 1996). Supportive or collegial leadership is essential

because teachers who feel supported by their administrators are more likely to experiment or

take risks to improve institution (Hoffman et al., 1994).

2.7 Teachers’ Professionalism

Teachers’ professionalism describes teacher behavior characterized by commitment to students

and engagement in the teaching task while admiring the professional expertise of colleagues.

Professional interactions among teachers should be open, cooperative and supportive of one

another and also exhibit warmth and friendliness.

Teachers’ professionalism is another aspect that comes from the development of the

Organizational Climate Index (OCI) developed by Hoy, et al., (2002). “Collegial leadership

refers to the openness of teacher and principal relations, whereas openness of teacher

interactions is encapsulated in teachers’ professionalism” (Sweetland & Hoy, 2000:709).

Teachers’ professionalism is “marked by respect for colleague competence, commitment to

students, autonomous judgment, and mutual cooperation and support of colleagues” (Hoy, et

al., 2002:42).

While developing Organizational Climate Index (OCI), Hoy and Sabo (1998) used teachers’

professionalism to mention four distinct features: teacher commitment, teacher collegiality,

teacher affiliation, and teacher disengagement. Teacher commitment indicates teachers’

dedication to students and their learning. Teacher collegiality is the kindness, sincerity and

friendliness that exist among colleagues. Teacher affiliation refers to their strong association to

the school, colleagues, and students. Teacher disengagement means deficiency of time spent in

the teaching task. Hoy and Sabo (1998) discovered that teacher commitment, teacher

collegiality, and teacher affiliation subject in a positive direction, while teacher disengagement

subjects negatively.

Hoy, et al., (2002) discovered that teachers’ professionalism was the strongest predictor of

faculty trust in colleagues and that it was the only climate variable that has an independent

relationship with trust in colleagues. When teachers see their colleagues working hard and




handling situations professionally, they develop trust and respect for the capability and

competence of those colleagues.

Geist and Hoy (2004) also found teachers’ professionalism to be the strongest interpreter of

teacher trust in colleagues. Geist and Hoy (2004) also exposed a positive relationship between

teachers’ professionalism and empowering school structure. When principals design rules and

regulations that help teachers rather than hinder, then a culture of trust develops causing

teachers to become more professional in their relationships with superiors and colleagues. Other

climate studies also suggest that higher the levels of teacher professional behavior, greater

would be the faculty trust in colleagues (Hoy, et al., 1998; Smith, et al., 2001; Sweetland &

Hoy, 2000).

2.8 Collegial Principal Leadership, Teachers’ Professionalism and Trust

An assessment of climate studies is important when debating collegial leadership. A cautious

view of school climate discusses in this debate; both metaphors of health and openness. Hoy

and Sabo (1998) seen collegial leadership as the openness of teacher-principal relations while

teachers’ professionalism as the openness of teacher interactions which develop healthy

organization. Hoy, et al., (2002) further explored this parsimonious view of climate creating a

new instrument called the Organizational Climate Index (OCI). The OCI had strong validity

and demonstrated that collegial principal leadership is crucial in developing faculty trust in

principals. Leaders who were open with teachers, treating them as colleagues while setting

reasonable standards were not only respected by teachers but were rewarded with their trust.

Faculty trust was also a prominent component of healthy and open school climates. The most

important outcome of these studies was that different dimensions of school climate are

responsible for different trust relationships.

Another study linking collegial leadership, teachers’ professionalism, and trust was conducted

by Goddard, et al. in 2004. They examined the dimensions of trust, climate, and principal and

teacher authenticity, they discovered that authentic behaviors lead to trust in both teachers and

principals. Teacher trust in colleagues was explained by the four climate measures, but only

teachers’ professionalism caused a significant independent contribution. Similarly, faculty trust

in the principal was defined by the four climate measures with collegial leadership cause a

strong and significant contribution. Teachers’ professionalism also caused a small but

significant contribution to faculty trust in the principal. Concluding their study, Goddard et al.,

(2004) observed that trust in the principal is defined by the principal’s behavior, and trust in

colleagues in defined by interactions with colleagues. Teachers’ professionalism combined with

collegial leadership engenders a strong trust in the leader.

In a study of 75 middle schools, Hoy and Tarter (2004) measured collegial leadership, teachers’

professionalism, trust and organizational justice. Teacher trust in the principal and teacher trust

in colleagues were measured using Omnibus T-Scale. Collegial leadership and teachers’

professionalism were measured using Organizational Climate index, and organizational justice

was measured using the Organizational Justice Index. It was found that collegial leadership of

the principal is critical in nurturing a trusting relationship with the faculty and such trust is a

key to organizational justice. Professional teacher relationships are significant in accelerating

trust among teachers, which in turn promotes a feel of fairness in the school. Another finding of




the study was the strong trust justice relationship for faculty trust in colleagues, but faculty trust

in principal didn’t make significant contribution in the explanation of organizational justice.

2.9 Conclusion

A review of the literature indicates relationships between collegial leadership and teacher trust

in the principal and a link between teachers’ professionalism and teacher trust in colleagues.

Earlier researches suggest that a sense of justice in the school workplace is dependent on leader

behavior that is equitable, considerate, respectful, consistent, free of self-interest, honest, and

ethical. Such kind of principal leadership behavior is more likely to create a perception of fair,

equal, balanced and just treatment among teachers. Furthermore teachers want to participate in

decisions that affect them, but they must be willing to put the interests of the school ahead of

their own and have the feeling that their views are being truly represented in the process of

deciding, it promotes a sense of fairness among teachers. Moreover, leaders must have the

sense, wisdom and confidence to converse and rectify poor decisions as they get feedback and

more precise information. Teacher’s trust towards colleagues and principal is very significant

because when teachers’ trust their colleagues and principal, they will show commitment in their

work and a sense of organizational justice will be developed. Open and healthy climates also

have been linked to organizational justice. Because collegial leadership and teachers’

professionalism are components of open and healthy climates, then there are implications of

links between these factors and organizational justice. Trust is the variable along the pathway to

organizational justice and is developed through the relationships that collegial principals and

professional teachers have with each other.

Research Design

3.1 Introduction

This chapter outlines the research methodology including the research sample, data collection

procedures, conceptual framework, hypotheses and data analysis procedures.

3.2 Data Sample

The study is based on primary data. The universe for this research is 94 Fauji Foundation Model

Schools from all over Pakistan. A sample of 16 schools among these 94 Fauji Foundation

Model Schools with an average of 16 teachers each was selected. Sample contained schools

from Punjab and Khyber Pakhtun Khuwah provinces as majority of the schools are situated in

these two provinces. Balochistan province has only two campuses of Fauji Foundation Model

School, while Sindh has only six campuses of this school. The sample included rural, urban,

and suburban areas of diverse socioeconomic compositions.

3.3 Respondents

Data was collected from permanent class teachers or faculty members who make decisions

about curriculum and develop lesson plans. A total of 256 questionnaires were distributed,

while 176 returned, but 157 were considered. No principals, teacher assistants, substitute

teachers, or administration staff was surveyed. The participants were of diverse academic




qualification, experience and age. Mostly participants were female, because study was

conducted in the elementary setting.

3.4 Data Collection Procedures

After acquiring permission from the principals on telephone; questionnaires were sent to the

schools via post. The questionnaire was containing a brief explanation about the purpose of the

study, instructions to fill the questionnaire and assurance to the faculty that all responses would

be treated confidentially. Teachers were also informed that they may refuse to respond to any

items that made them feel uncomfortable and they could choose not to participate or to cease

their participation at any time.

To collect the data for this study; items from three instruments were combined to develop a

questionnaire using seven point likert scale. The instruments from which items were collected

included the following: (a) the Organizational Climate Index (Hoy, et al., 2002), (b) the

Organizational Justice Index (Hoy & Tarter, 2004) and (c) the Omnibus Trust Scale (Hoy &

Tschannen-Moran, 1999). The instruments are listed in the first column of Table 3.1. The

second column lists the Variables used in the study.

Table 3.1: Variables of the study with their instruments

Instrument Variables used in the study

Organizational Climate Index

Collegial Leadership.

Teachers’ professionalism.

Omnibus Trust Scale

Faculty Trust in the Principal.

Faculty Trust in Colleagues.

Organizational Justice index

Organizational justice.

The independent variables were collegial leadership, teacher professional behavior, faculty trust

in principal, faculty trust in colleagues, while there was only one dependent variable that is





3.5 Conceptual Framework

Fig 3.1: Based on Hoy and Tarter, (2004)

3.6 Hypotheses

Based on the literature and above conceptual model, following hypotheses are formulated for

empirical testing:

H1: Collegial principal leadership has a positive relationship with faculty trust in principal.

H2: Teachers’ professionalism has a positive relationship with faculty trust in colleagues.

H3: Faculty trust in colleagues contributes in the explanation of relationship between

teachers’ professionalism and organizational justice.

H4: Faculty trust in principal contributes in the explanation of the relationship between

collegial principal leadership and organizational justice.

H5a: Collegial principal leadership has a positive relationship with organizational justice.

H5b: Teachers’ professionalism has a positive relationship with organizational justice.

H5c: Trust in principal has a positive relationship with organizational justice.

H5d: Trust in colleagues has a positive relationship with organizational justice.

3.7 Data Analysis Techniques

The following data analysis techniques have been used in this research to meet the objectives of

the study and to test the hypotheses.

Frequency tables have been used to express the demographics (gender, age, experience and

academic qualification) of the respondents. Descriptive statistics of variables study the

descriptive of responses of the respondents and the measures of dispersion in their responses.

The statistic table indicates minimum and maximum values, mean and standard deviation of the

data. Mean scores show that where the average response of the respondents for organizational

Teachers’

professionalism

Collegial Principal

Leadership

Faculty Trust in

Principal

Faculty Trust in

Colleagues

Organizational

Justice




justice, collegial principal leadership, Teachers’ professionalism, trust in principal and trust in

colleagues lie.

Reliability of the instrument used was measured through Cronbach’s alpha. Consistency of a

measure is called its reliability. A measure is said to have a high reliability if it produces

consistent results under consistent conditions. The value of the cronbach’s alpha ranges from 0

to 1, if value is closer to one instrument will be more reliable.

The correlation analysis has been used in the study to know the strength and direction of the

relationship among all the variables.

The regression analysis is a statistical tool that is used for investigating the relationships

between variables. It is usually used to study the causal effect of one variable on other. In this

study, the effect of independent variables (trust in principal, trust in colleagues, collegial

principal leadership and Teachers’ professionalism) is examined on dependent variable

(organizational justice). Regression analysis also shows that how much of the variations in the

model are caused by independent variable.

3.8 Conclusion

The purpose of this study was to determine the effects of collegial leadership, teachers’

professionalism and teacher trust in the principal and colleagues on organizational justice. The

target population of the study was teachers and faculty members who are directly involve in

making curriculum decisions and developing lesson plans at Fauji Foundation Model Schools

throughout Pakistan. Primary data was gathered through questionnaire. The techniques used in

this study to analyse the data are descriptive statistics, correlation analysis, cronbach’s alpha

and regression analysis.

Results and Discussions

4.1 Introduction

This chapter provides the analysis of data collected using research design and methodology

already explained in preceding chapter and then interpretation of results describing the

acceptance or rejection of hypotheses. At the beginning of the chapter descriptive analysis of all

variables used in the study is discussed. To check the reliability of the questionnaire Cronbach’s

alpha is used. To study the relation between independent, dependent and mediating variables

the correlation analysis is used and at the end to check the impact of independent variables

(Teachers’ professionalism and collegial principal leadership) and mediating variables (trust in

colleagues and trust in principal) on dependent variable (organizational justice) multiple

regression is used.

4.2 Demographic information of the Respondents

Table 4.1 shows the age of the respondents. The frequency distribution of the age shows that

the highest percentage i-e 51.0 percent lies in the age group between 21 to 30 years, while the

second large age group is between 31 to 40 years with a percentage of 33.8 percent. 11.5

percent respondents lie in the age group between 41 to 50 years, and only 3.8 percent of the

respondents are of 50 years or plus.




Table 4.1: Age of the Respondents

Frequency Percent Valid Percent Cumulative

Percent

Valid

21-30 80 51.0 51.0 51.0

31-40 53 33.8 33.8 84.7

41-50 18 11.5 11.5 96.2

50 plus 6 3.8 3.8 100.0

Total 157 100.0 100.0

Table 4.2 shows the gender of the respondents. The frequency distribution of the gender shows

that there are more female teachers with a percentage of 95.5 percent, while percentage for male

teachers is 4.5 percent. Sample is having more female respondents as study has been conducted

in an elementary schools setting.

Table 4.2: Gender of the Respondents


Percent

Valid

Male 7 4.5 4.5 4.5

Female 150 95.5 95.5 100.0

Total 157 100.0 100.0

Table 4.3 shows the academic qualification of the respondents. The frequency distribution

shows that the majority of the teachers are having Masters degree with a percentage of 79

percent, then there are 16 percent of the respondents with Bachlors degree and only 4.5 percent

respondents have M. phil. degree.

Table 4.3: Academic Qualification of the Respondents


Percent

Valid

Bachelors 26 16.6 16.6 16.6

Masters 124 79.0 79.0 95.5

M.Phil. 7 4.5 4.5 100.0

Total 157 100.0 100.0

Table 4.4 shows the experience of the respondents. The frequency table shows that 50.3

percent of the respondents have 1 – 5 years of teaching experience. 29.3 percent of the

respondents lie in the group having 6 – 10 years of experience. 14 percent of the respondents




have 11 – 15 years’ experience, while 4.5 percent are with 16 – 20 years’ experience. And only

1.9 percent of the respondents are having 20 or plus years’ teaching experience.

Table 4.4: Experience of the Respondents


Percent

Valid

1-5 79 50.3 50.3 50.3

6-10 46 29.3 29.3 79.6

11-15 22 14.0 14.0 93.6

16-20 7 4.5 4.5 98.1

20 plus 3 1.9 1.9 100.0

Total 157 100.0 100.0

4.3 Descriptive Statistics

The data was collected through questionnaires based on a seven point likert scale ranging from

1 (Strongly disagree) to 7 (Strongly agree). The data was collected from the teachers of Fauji

Foundation model Schools. Descriptive statistics gives an idea about the inclination of the

responses against each variable.

Table 4.5: Descriptive Statistics - Trust in Principal

Sr. No. Statement Mean Std. Deviation

1 Teachers in this school trust the principal. 6.2994 .81229

2 The teachers in this school are suspicious of most

of the principal’s actions. 6.4968 .82138

3 The teachers in this school have faith in the

integrity of the principal. 6.4140 .84766

4 The principal in this school typically acts in the

best interests of teachers. 6.1911 1.09856

5 The principal of this school doesn’t show concern

for the teachers. 6.1975 1.35609




6 Teachers in this school can rely on the principal. 6.0255 1.21396

7 The principal in this school is competent in doing

his/her job. 6.4713 .62594

8 The principal doesn’t tell teachers what is really

going on. 5.2930 1.90230

Trust in principal 6.1736 .65208

4.3.1 Trust in Principal

The analysis of the variable “trust in principal” depicts the statistics that responses against all

items for this variable are inclined towards “agree” option. Overall mean value for trust in

principal is 6.1, which explains that respondents are more inclined towards the option “agree”.

The standard deviation for trust in principal shows that 0.65 deviations from the mean exist

among responses of the respondents.

Table 4.6: Descriptive Statistics - Trust in Colleagues


1 Teachers in this school trust each other. 5.7070 1.61428

2 Teachers in this school typically look out for each

other. 3.6688 2.12551

3 Teachers in this school are suspicious of each

other. 5.6306 1.62625

4 Even in difficult situations, teachers in this school

can depend on each other. 5.8344 1.21342

5 Teachers in this school do their jobs well. 6.5987 .57579

6 Teachers in this school have faith in the integrity of

their colleagues. 6.2866 .93405




7 Teachers in this school are open with each other. 5.3057 1.84552

8 When other teachers in this school tell you

something, you can believe it. 5.3248 1.57796

Trust in Colleagues 5.5446 .84720

4.3.2 Trust in Colleagues

The results of the descriptive analysis for the variable “trust in colleagues” depicts that majority

respondents have selected the option “agree. Overall mean value for trust in colleagues is 5.5,

which explains that respondents are more leaning towards the option “agree”. Standard

deviation for trust in colleagues is 0.84, which describes that there are somewhat more

variations among respondents’ responses, may be due to different perceptions of respondents

regarding colleagues behavior.

Table 4.7: Descriptive Statistics - Collegial Principal Leadership


1 The principal explores all sides of topics and admits

that the other opinions exist. 6.4395 .87220

2 The principal treats all faculty members as his/her

equal. 6.5541 .63443

3 The principal is friendly and approachable. 6.2739 1.08375

4 The principal lets faculty know what is expected of

them. 6.1783 1.18486

5 The principal maintains definite standards of

performance. 6.1401 .82787

6 The principal puts suggestions made by the faculty

into operations. 6.3567 .86241

7 The principal is willing to make changes. 6.3567 .63055

Collegial Principal Leadership 6.4040 .51053




4.3.3 Collegial Principal Leadership

The descriptive statistics of the factors of the variable “collegial principal leadership” shows

more tendencies towards the option “agree”. Overall mean value for collegial principal

leadership is 6.4, which describes that respondents are more inclined towards the option

“agree”. Standard deviation for collegial principal leadership is 0.51, which explains that there

are somewhat more variations among responses of the respondents.

Table 4.8: Descriptive Statistics - Teacher’ Professionalism


1 Teachers help and support each other. 6.4395 .87220

2 Teachers accomplish their jobs with enthusiasm. 6.5541 .63443

3 Teachers respect the professional competence of

their colleagues. 6.2739 1.08375

4 The interactions between faculty members are

cooperative. 6.1783 1.18486

5 Teachers in this school exercise professional

judgment. 6.1401 .82787

6 Teachers “go the extra mile” with their students. 6.3567 .86241

7 Teachers provide strong social support for

colleagues. 6.3567 .63055

Teachers’ Professionalism 6.3285 .56947

4.3.4 Teachers’ professionalism

The descriptive statistics for the factors of the variable “Teachers’ professionalism” shows that

maximum responses are inclined towards “agree” option. Overall mean value for Teachers’

professionalism is 6.3, which explains that respondents have more tendency towards the option

“agree”. Overall standard deviation for Teachers’ professionalism is 0.56, which illustrates that

there are somewhat more variations among responses of the respondents from the mean value.




Table 4.9: Descriptive Statistics – Organizational Justice


1 The principal behavior is consistent. 6.0064 1.25829

2 The principal doesn’t play favorites. 5.8408 1.65448

3 The principal treats everyone with respect and

dignity. 6.8471 .36101

4 There is no preferential treatment in this school. 5.0955 2.22683

5 The principal in this school is fair to everyone. 6.4713 .97770

6 The principal adheres to high ethical standards. 6.7707 .42173

7 Teachers are involved in decisions that affect them. 5.3822 1.93991

8 Teachers are treated fairly in this school. 6.0701 1.27659

Organizational Justice 6.0605 .70093

4.3.5 Organizational Justice

The descriptive analysis of the factors for the dependent variable “organizational justice” shows

that most of the responses are inclined towards “agree” option. Overall mean value for

organizational justice is 6.0 approximately, which defines that respondents are more inclined

towards the option “agree”. Overall standard deviation for organizational justice is 0.70, which

describes that there are somewhat high variations among responses of the respondents.

4.4 Reliability Analysis

To verify the reliability of the variables as well as of the questionnaire as a whole, Cronbach’s

Alpha has been used, which shows to what extent items of the instruments are internally

consistent or reliable for getting a true response from a respondent.

Overall reliability of the measurement scale shows cronbach’s alpha coefficient value equals to

0.868 which describes that the scale is reliable, while the total number of items is 38. This value

of cronbach’s alpha surpasses the recommended value of 0.7 (Nunnally, 1978; Kline, 1999),

illustrating sufficient internal consistency in the measurement scale used in the study.




Table 4.10: Reliability Statistics

Cronbach's Alpha N of items

Trust in principal .716 08

Trust in Colleagues .764 08

Collegial Principal Leadership .729 07

Teachers’ Professionalism .758 07

Organizational Justice .643 08

Overall Reliability of the Scale .868 38

Table 4.7 shows the reliability statistics of the variables, which describes that scale is

sufficiently reliable. Trust in colleagues and Teachers’ professionalism, have greater reliability

whereas trust in principal and organizational justice have lesser reliability.

To test the hypotheses derived for the study in preceding chapters, correlation and regression

analysis have been used. First correlation among the variables including demographic has been

discussed to know the direction and strength of the relation among those variables. Further

significance of the relationships is also taken into account.

4.5 Correlation Analysis

Table 4.11: Correlations

TP TC CPL TPro OJ Quali Exp

Trust in

Principal

1

Trust in

Colleagues

.510** 1

Collegial

Principal

.654** .395** 1




Leadership

Teachers’

Professionalism

.373** .758** .373** 1

Organizational

Justice

.601** .413** .500** .185* 1

Qualification

.112 .100 -.074 .093 -.144 1

Experience

.228** .401** .141 .144 .285** -.042 1

**. Correlation is significant at the 0.01 level (2-tailed).

*. Correlation is significant at the 0.05 level (2-tailed).

Table 4.11 shows the correlation among the variables of the study, while correlation with

demographics is also given in the table.

Trust in principal has a significant relationship with all the four other variables of the study.

Trust in principal has a positive and strongest correlation (i.e. 0.654) with collegial principal

leadership, and it is significant at 99% level. This shows that if collegial principal leadership

exists, there would be trust in principal. With organization justice and trust in colleagues; it has

positive as well as high correlation (i.e. 0.601 and 0.510 respectively), furthermore both are

significant at 99% level. Teachers’ professionalism has a medium but positive correlation with

trust in principal (i.e. 0.373), which is significant at 99% level.

Trust in colleagues has a significant relationship with all other four variables under study. With

Teachers’ professionalism, trust in colleagues has the positive and highest correlation (i.e.

0.758) among all variables, and it is significant at 99% level. This explains that trust in

colleagues and teachers’ professionalism compliments each other. Trust in principal and trust in

colleagues has a positive, strong and significant at 99% level correlation (i.e. 0.510). With

collegial principal leadership and organizational justice it has medium yet positive correlation

(i.e. 0.413 and 0.395 respectively), and both are significant at 99% level.

There exists a significant correlation among collegial principal leadership and remaining four

variables. Collegial principal leadership has a positive and highest correlation (i.e.0.654) with

trust in principal, among all variables, and it is also significant at 99% level. There exists a

strong and positive correlation (i.e. 0.500) between collegial principal leadership and

organizational justice, which is also significant at 99% level, whereas with teachers’

professionalism and trust in colleagues, collegial principal leadership has medium but positive

and significant at 99% level relationship (i.e. 0.373 and 0.395 respectively).




Teachers’ professionalism has a significant correlation with all other variables of the study. It

has positive and highest correlation (i.e. 0.758) among all variables with trust in colleagues,

which is also significant at 99% level. Trust in principal and collegial principal leadership has a

positive and medium correlation with teachers’ professionalism with 99% level of significance.

But between organizational justice and teachers’ professionalism, there exists a weak yet

positive correlation (i.e. 0.185), which is significant at 95% level.

Organizational justice is significantly correlated with all other variables of the study. It has

positive and highest correlation (i.e. 0.601) with trust in principal, which is also significant at

99% level. With collegial principal leadership it has positive and high correlation (0.500), with

99% level of significance. Trust in colleagues and organizational justice have positive and

medium correlation (i.e. 0.413), but significant at 99% level. Between teachers’ professionalism

and organizational justice, there exists a positive and weak correlation (0.185), which is

significant at 95% level.

Two of the controlled variables; qualification of the teachers and their experience are also

considered in correlation analysis. Table shows that qualification has a positive but weak

correlation with trust in principal, trust in colleagues and Teachers’ professionalism, but these

correlations are insignificant. With collegial principal leadership and organizational justice,

qualification has a negative as well as weak correlation, but insignificant.

Experience of the teachers has significant at 99% level correlation with trust in colleagues, trust

in principal and organizational justice. Trust in principal has positive and weak correlation with

experience while trust in colleagues has a positive and medium correlation with experience.

This depicts that experience matters in building trust. With organizational justice, it has positive

and weak but 99% significant correlation. Qualification and experience of the teachers have

insignificant, weak and negative correlation between them.

4.6 Regression Analysis

In order to know the relationship between independent and dependent variables of the study,

multiple linear regression analysis has been used. Stepwise method is used where intentions

were to study the effect of mediators between independent and dependent variables.

4.6.1 Collegial Principal Leadership and Trust in principal

Table 4.12: Model Summaryb

Model R R

Square

Adjusted R

Square

Std. Error of the

Estimate

Change Statistics

F

Change

Sig. F

Change

1 .654a .427 .424 .49499 115.732 .000

a. Predictors: (Constant), CPL

b. Dependent Variable: TP




Table 4.13: Coefficientsa

Model Unstandardized Coefficients Standardized Coefficients T Sig.

B Std. Error Beta

(Constant) .826 .499 1.656 .100

CPL .835 .078 .654 10.758 .000

a. Dependent Variable: TP

Table 4.12 shows the model summary. The value of R square is 0.427, which shows that 42.7%

variations of the model are explained due to independent variable. Table 4.13 describes the beta

coefficients of independent variable, which depicts that there will be 83.5% increase in trust in

principal due to unit increase in collegial principal leadership; furthermore values are


Table 4.14: Model Summary

Model R R

Square

Adjusted R

Square

Std. Error of the

Estimate

Change Statistics

R Square

Change

F

Change

Sig. F

Change

1 .500a .250 .245 .60885 - 51.754 .000

2 .618b .381 .373 .55490 .131 32.608 .000

a. Predictors: (Constant), CPL

b. Predictors: (Constant), CPL, TP



B Std. Error Beta

1 (Constant) 1.662 .613 2.709 .008

CPL .687 .095 .500 7.194 .000

2

(Constant) 1.237 .564 2.193 .030

CPL .258 .115 .188 2.239 .027

TP .514 .090 .478 5.710 .000

a. Dependent Variable: OJ

Table 4.14 illustrates the change in R square of the model when mediating variable is added to

the model. When trust is added to the model its fitness has increased yet significant. Table 4.15

shows that collegial principal leadership (independent variable) has a positive relationship with

organizational justice (dependent variable), which is significant at 99% level. But when trust in

principal (mediating variable) is added, it has become significant at 95% level yet positively

related.

4.6.2 Teachers’ professionalism and Trust in Colleagues


Model R R Square Adjusted R Square Std. Error of the Estimate




1 .758a .574 .571 .55473

a. Predictors: (Constant), PTB

b. Dependent Variable: TC



B Std. Error Beta

(Constant) -1.588 .496 -3.205 .002

PTB 1.127 .078 .758 14.452 .000

a. Dependent Variable: TC

Table 4.16 shows the model summary, where value of R square is 0.574, which shows that

57.4% variations in the model are explained due to independent variable. Table 4.17 describes

the beta coefficients of independent variable, which depicts that there will be 112% increase in

trust in colleagues due to unit increase in Teachers’ professionalism; furthermore values are


Table 4.18: Model Summary

Model R R

Square

Adjusted R

Square

Std. Error of the

Estimate

Change Statistics

R Square

Change

F

Change

Sig. F

Change

1 .185a .034 .028 .69101 - 5.513 .020

2 .457b .209 .199 .62750 .174 33.965 .000

a. Predictors: (Constant), PTB

b. Predictors: (Constant), PTB, TC



B Std. Error Beta

1 (Constant) 4.617 .617 7.479 .000

PTB .228 .097 .185 2.348 .020

2

(Constant) 5.458 .579 9.429 .000

PTB -.369 .135 -.300 -2.728 .007

TC .530 .091 .640 5.828 .000


Table 4.18 illustrates the change in R square of the model when mediating variable is added to

the model. When trust is added to the model fitness has increased and became more significant.

Table 4.19 shows that Teachers’ professionalism (independent variable) has a positive

relationship with organizational justice (dependent variable), which is 95% significant. But

when trust in colleagues (mediating variable) is added, it has become 99% significant but

negatively related.




4.7 Incremental Regression

The incremental regression is performed to check the significance of each variable in model and

to assess the extent of their significance in the model. It is performed by removing individual

independent variables from the model to check the change in the significance of model due to

removal of any variable, and by checking the effect on the value of R-square.

Table 4.20: Incremental Regression

Variables OLS1 OLS2 OLS3 OLS4 OLS5

Trust in Principal .416*** - .533*** .562*** .453***

Trust in Colleagues .311*** .435*** - .299*** .107*

Collegial Principal

Leadership

.302*** .593*** .281** - .238**

Teachers’

professionalism

-.401*** -.461 -.094 -.349*** -

R square .438 .364 .386 .411 .394

R square change - .074 .051 .027 .044

F change 29.56*** 29.18*** 32.07*** 35.56*** 33.10***

Significance level: p < 0.01 (***), 0.05 (**), 0.1 (*)

Column 2 of Table 4.20 illustrates that R square of the model including all independent

variables is 0.438, which shows 44% variations of the total variations are explained due to

independent variables.

Furthermore it shows that all independent variables are significant at 99% level. Trust in

principal, trust in colleagues and collegial principal leadership is positively related with

organizational justice while teachers’ professionalism is negatively related with organizational

justice.




Column 3 of the table above shows that when trust in principal is removed from the model, it

has altered the value of R-square to a highest degree (0.074 decreases) as the value for the R-

square changes from 0.438 to 0.364, as shown in the table below. This decrease in the value of

the R-square shows that trust in principal is the most significant variable in the model. Next

significant variable among all variables is trust in colleagues, then comes teachers’

professionalism and collegial principal leadership is the least significant variable in the model.

Table 4.21: Results of incremental regression after removing individual independent

variable

R square (original) 0.438

R square after removing trust in principal 0.364

R square after removing trust in colleagues 0.386

R square after removing teachers’ professionalism 0.394

R square after removing collegial leadership 0.411

4.8 Regression Analysis including Demographics


Model R R Square Adjusted R Square Std. Error of the

Estimate

Change Statistics

F

Change

Sig. F Change

1 .688a .474 .453 .51844 22.525 .000

a. Predictors: (Constant), Exp, Qualif, CPL, PTB, TP, TC

b. Dependent Variable: OJ

Table 4.22 shows the model summary which tells that 47.4% of the total variations are

explained due to independent variables, which is also significant at 99% level.


Model Unstandardized

Coefficients

Standardized

Coefficients

t Sig. Collinearity

Statistics

B Std. Error Beta Tolerance VIF

(Constant) 2.674 .640 4.177 .000

TP .464 .092 .431 5.012 .000 .474 2.111

TC .336 .085 .406 3.925 .000 .329 3.044

CPL .234 .112 .170 2.087 .039 .527 1.898

PTB -.395 .115 -.321 -3.431 .001 .402 2.488

Qualification -.302 .097 -.191 -3.126 .002 .940 1.064




Experience -.040 .046 -.056 -.878 .381 .873 1.146


Table 4.23 depicts that adding demographics makes; trust in principal, trust in colleagues,

teachers’ professionalism and qualification significant at 99% level, while collegial principal

leadership 95% significant. Experience of the teachers is insignificant. Trust in principal, trust

in colleagues and collegial principal leadership is positively related with organizational justice,

while teachers’ professionalism, qualification and experience of the teachers are negatively

related with organizational justice.

4.9 Hypotheses Testing

H1. Collegial principal leadership has a positive relationship with faculty trust in

principal.

From correlation analysis we get to know that collegial principal leadership has a positive and

highest correlation (i.e.0.654) with trust in principal, among all variables, and it is also

significant at 99% level. From regression run between collegial principal leadership and trust in

principal we get to know that these are positively related and there will be 83.5% increase in

trust in principal due to unit increase in collegial principal leadership; furthermore values are

significant at 99% level. These findings are also supported by the findings of Titrek and Osman

(2009), Hoy and Tarter (2004) and Godderd et al. (1998).

H2: Teachers’ professionalism has a positive relationship with faculty trust in colleagues.

Correlation analysis tells us that teachers’ professionalism has positive and highest correlation

(i.e. 0.758) among all variables with trust in colleagues, which is also significant at 99% level.

In regression analysis (table 4.14) it is shown that teachers’ professionalism is positively related

with trust in colleagues and there will be 112% increase in trust in colleagues due to unit

increase in teachers’ professionalism, furthermore values are significant at 99% level. These

results are also backed with the conclusions given by Hoy and Tarter (2004), Hoy, et al. (2002),

Smith et al. (2001), and Geist & Hoy (2004) in their studies.

H3: Faculty trust in colleagues contributes in the explanation of relationship between

Teachers’ professionalism and organizational justice.

Table 4.15 illustrates that when trust in colleagues was added to the model its fitness increased

from 0.034 to 0.209 and became more significant. Table 4.16 shows that teachers’

professionalism (independent variable) has a positive relationship with organizational justice

(dependent variable), which is significant at 95% level. But when trust in colleagues (mediating

variable) is added, it has become significant at 99% level and relation between teachers’

professionalism and organizational justice became negative.

H4: Faculty trust in principal contributes in the explanation of relationship between

collegial principal leadership and organizational justice.

From table 4.11 illustrates that when trust in principal was added to the model its fitness

increased from 0.250 to 0.381, which is significant at 99% level. Table 4.12 shows that

collegial principal leadership (independent variable) has a positive relationship with




organizational justice (dependent variable), which is significant at 99% level. But when trust in

principal (mediating variable) is added, it has become significant at 95% level yet positively

related.

H5a: Collegial principal leadership has a positive relationship with organizational justice.

There exists a strong and positive correlation (i.e. 0.500) between collegial principal leadership

and organizational justice, which is also significant at 99% level. As well as from incremental

regression, we come to know that there exist a positive and significant relationship between

collegial principal leadership and organizational justice. And removal of collegial principal

leadership from the model results in a decrease in R square.

H5b: Teachers’ professionalism has a positive relationship with organizational justice.

Between teachers’ professionalism and organizational justice, there exists a positive but weak

correlation (0.185), which is significant at 95% level. Regression analysis tells us that there

exists a negative and significant relationship between these two variables, which rejects the

hypotheses. Incremental regression shows that removal of teachers’ professionalism from the

model results in a decrease in R square.

H5c: Trust in principal has a positive relationship with organizational justice.

Correlation analysis shows a positive and highest correlation (i.e. 0.601) between trust in

principal organizational justice among all variables, which is also significant at 99% level.

Regression analysis shows that trust in principal is positively and significantly related with

organizational justice. Incremental regression shows the highest decrease in the value of the R-

square with the removal of trust in principal from the model which depicts that trust in principal

is the most significant variable in the model.

H5d: Trust in colleagues has a positive relationship with organizational justice.

Correlation analysis illustrates that trust in colleagues and organizational justice has positive

and medium correlation (i.e. 0.413), but significant at 99% level. Regression analysis describes

that trust in colleagues is positively and significantly related with organizational justice, but

incremental regression depicts that its removal from the model decreases the value of R square,

and also makes teachers’ professionalism insignificant.

4.10 Findings about Demographic Variables

Two of the controlled variables; qualification of the teachers and their experience are also

considered in correlation analysis. Correlation table shows that qualification has a positive but

weak correlation with trust in principal, trust in colleagues and teachers’ professionalism, but

these correlations are insignificant. With collegial principal leadership and organizational

justice, qualification has a negative as well as weak correlation, which is also insignificant.

Experience of the teachers has significant at 99% level correlation with trust in colleagues, trust

in principal and organizational justice. Trust in principal has positive and weak correlation with

experience while trust in colleagues has a positive and medium correlation with experience.

This depicts that experience matters in building trust. With organizational justice, it has positive

and weak but significant at 99% level correlation.




Regression analysis depicts that adding demographics makes; trust in principal, trust in

colleagues, Teachers’ professionalism and qualification significant at 99%, while collegial

principal leadership 95% significant. Experience of the teachers is insignificant. Trust in

principal, trust in colleagues and collegial principal leadership is positively related with

organizational justice, while Teachers’ professionalism, qualification and experience of the

teachers are negatively related with organizational justice.

4.11 Conclusion

In this chapter, results of the study have been presented along with their interpretations. First of

all descriptive statistics of all the variables is discussed. Descriptive analysis of demographics

shows that there are more female teachers than male in the sample. Majority of the sample lies

between age group 21 – 40 years. Majority of the teachers have Masters degree and lies in the

experience group 1 – 10 years. Correlation shows that all variables are positively and

significantly related with each other, while regression shows that all independent variables are

significant at 99% level. Trust in principal, trust in colleagues and collegial principal leadership

is positively related with organizational justice while Teachers’ professionalism is negatively

related with organizational justice. Reliability of all the variables has been checked using

Cronbach’s Alpha coefficient and found reliable.

Conclusions and Recommendations

5.1 Introduction

This chapter provides an overview of the findings and conclusions of the results,

recommendations suggested on the basis of the findings, future research directions and

limitations of the study.

5.2 Findings and Conclusion of the study

Collegial principal leadership and trust in principal jointly as well as individually

contribute to explain organizational justice.

Teachers’ professionalism and trust in colleagues jointly as well as individually

contribute to explain organizational justice, but Teachers’ professionalism has a

negative relationship with organizational justice.

Collegial leadership, trust in principal, Teachers’ professionalism, and trust in

colleagues jointly contribute to predict organizational justice.

Experience of the teachers correlates positively as well as significantly with


Qualification of the teachers correlates negatively with organizational justice.

Collegial principal leadership also contributes to explain trust in principal.

Teachers’ professionalism also contributes to explain trust in colleagues.

The results show that there exists a strong relationship between trust in principal and

organizational justice. The strong impact of principal trust on organizational justice is obvious

as the principal is the single and the most dominant person in emerging a sense of

organizational justice in school. The principal of the school is far more significant than the

faculty in generating a just and fair school environment at least with respect to his professional

interactions.




Trust of teachers in their colleagues is not a negligible factor. Faculty trust in colleagues makes

an extensive independent impact on the school’s justice system. Nevertheless, it is within the

principal’s power to build a climate of justice by exhibiting in word and deed a commitment to

the justice. The leader leads by example, and there may be no further important character than

fair and just interactions with subordinates, to be an ethical leader.

Results of the study also advocate that the principal can lead in a manner that directly stimulates

faculty trust in the principal and indirectly generate a sense of organizational justice through

such trust. Collegial principal leadership seizes three significant concerns of leadership; concern

for people, concern for the job, and concern for change. If principal’s behavior is expressive,

helpful, and change-oriented and has friendly and supportive behavior, sets clear expectations

and standards of performance for teachers and is open to change, he will likely to be successful

(Yukl, 1998). Moreover, such collegial principal behavior cultivates a culture of trust and

justice.

Teachers’ professionalism also has an independent role in creating a culture of trust and justice

in school. The principal acquires the starring role, but the faculty secures a sound supporting

role. If teachers treat one another as competent professionals, make autonomous judgments,

show a commitment to students, and engage in cooperation and support, they will learn to rely

and trust one another, which also indirectly stimulate a feel of organizational justice in the

school.

As Teachers’ professionalism involves autonomous judgments, cooperation, support and

commitment to all stakeholders of the schools including students, parents, principal and

undoubtedly colleagues, so sometimes teacher consideration for other stakeholders give a

negative feel to trust in colleagues, which eventually has a negative impact on his sense about

organizational justice. Moreover, sometimes unfair rewarding of professional behavior also

leads to a negative feel about organizational justice.

Summing up we can say that, the collegial leadership of the principal is critical in promoting a

trusting relationship with the faculty and such trust is pivotal in nurturing a sense of

organizational justice. Professional teacher relationships are noteworthy in facilitating trust

among teachers, which in turn strengthens a sense of fairness in the school. However, the trust-

justice relationship for faculty is not as strong as for the principal; faculty trust in colleagues

does make a substantial independent contribution in the explanation of organizational justice.

Furthermore, findings of the study revealed the strength of the trust-justice relationship; both

aspects of trust are the most significant variables of the model and show the variations in model

higher than two other independent variables in organizational justice. Faculty trust in principal

and colleagues are; while acting as mediators better explaining the organizational justice than

the two other variables; collegial principal leadership and Teachers’ professionalism.

5.3 Recommendations

A few recommendations based on this analysis of organizational justice, trust, teachers’

professionalism and leader behavior, are:

As trust in principal is strongly related with collegial principal behavior, principal is

required to be equitable, sympathetic, respectful, unbiased, honest, and ethical in his

relationships with teachers.




Being a leader, principal can be open with teachers, treat them as colleagues while

setting reasonable standards for performance and clear performance expectations.

Teachers can be involved in decisions that affect them as they do not have only a

personal concern in the decision outcome but they have also the expertise, knowledge

and wisdom to contribute to a good decision.

In order to develop a sense of just and fair organization, teachers’ professionalism can

be rewarded and admired by the principal as well as the colleagues.

Teachers are required to respect other teachers’ competence and their professional

expertise, and promote mutual cooperation; this professional behavior will build trust

among them.

Professional interactions among teachers can be open, cooperative and supportive of one

another and also exhibit warmth and friendliness.

Principal can help teachers cultivate a sense of trust among them by trusting them to

make autonomous decisions in the best interests of all the stakeholders of the school.

Principal can remember that justice and trust are inseparable; one cannot have one

without the other.

5.4 Limitations and Future Research Directions

This study did not deal with the generation of faculty trust in parents and students

because attention was on fair and just relations between the principal and teachers and

among teachers themselves. The concept of organizational justice should be expanded to

relationships between teachers and students.

This study only involved elementary schools or schools that were similar to the

elementary setting. The sample consisted primarily of female teachers. More research

needs to be conducted to see if the results would be the same in the secondary setting as

well as in high schools settings.

In this study, only Fauji Foundation Model Schools have been considered, the research

can be expanded to government as well as private schools.

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Questionnaire

Name (optional): _______________________________ Gender: _______________

Age (In years): _____________ Academic Qualification: _______________________

Experience (In years): ___________________

Directions: Following are the statements about your school. Kindly indicate your level of

agreement with the statement from strongly disagree to strongly agree. Your answers will be

kept confidential.

Str

on

gly

Dis

ag

ree

Dis

ag

ree

So

mew

ha

t D

isa

gree

Neu

tra

l

So

mew

ha

t A

gree

Ag

ree

Str

on

gly

Ag

ree

1 Teachers in this school trust the principal. 1 2 3 4 5 6 7

2 The teachers in this school are suspicious of most of the

principal’s actions.

1 2 3 4 5 6 7

3 The teachers in this school have faith in the integrity of the

principal.

1 2 3 4 5 6 7

4 The principal in this school typically acts in the best interests 1 2 3 4 5 6 7




of teachers.

5 The principal of this school doesn’t show concern for the

teachers.

1 2 3 4 5 6 7

6 Teachers in this school can rely on the principal. 1 2 3 4 5 6 7

7 The principal in this school is competent in doing his/her job. 1 2 3 4 5 6 7

8 The principal doesn’t tell teachers what is really going on. 1 2 3 4 5 6 7

9 Teachers in this school trust each other. 1 2 3 4 5 6 7

10 Teachers in this school typically look out for each other. 1 2 3 4 5 6 7

11 Teachers in this school are suspicious of each other. 1 2 3 4 5 6 7

12 Even in difficult situations, teachers in this school can depend

on each other.

1 2 3 4 5 6 7

13 Teachers in this school do their jobs well. 1 2 3 4 5 6 7

14 Teachers in this school have faith in the integrity of their

colleagues.

1 2 3 4 5 6 7

15 Teachers in this school are open with each other. 1 2 3 4 5 6 7

16 When other teachers in this school tell you something, you can

believe it.

1 2 3 4 5 6 7

17 The principal explores all sides of topics and admits that the

other opinions exist.

1 2 3 4 5 6 7

18 The principal treats all faculty members as his/her equal. 1 2 3 4 5 6 7

19 The principal is friendly and approachable. 1 2 3 4 5 6 7

20 The principal lets faculty know what is expected of them. 1 2 3 4 5 6 7

21 The principal maintains definite standards of performance. 1 2 3 4 5 6 7

22 The principal puts suggestions made by the faculty into

operations.

1 2 3 4 5 6 7

23 The principal is willing to make changes. 1 2 3 4 5 6 7

24 Teachers help and support each other. 1 2 3 4 5 6 7

25 Teachers accomplish their jobs with enthusiasm. 1 2 3 4 5 6 7

26 Teachers respect the professional competence of their

colleagues.

1 2 3 4 5 6 7

27 The interactions between faculty members are cooperative. 1 2 3 4 5 6 7

28 Teachers in this school exercise professional judgment. 1 2 3 4 5 6 7




29 Teachers “go the extra mile” with their students. 1 2 3 4 5 6 7

30 Teachers provide strong social support for colleagues. 1 2 3 4 5 6 7

31 The principal behavior is consistent. 1 2 3 4 5 6 7

32 The principal doesn’t play favorites. 1 2 3 4 5 6 7

33 The principal treats everyone with respect and dignity. 1 2 3 4 5 6 7

34 There is no preferential treatment in this school. 1 2 3 4 5 6 7

35 The principal in this school is fair to everyone. 1 2 3 4 5 6 7

36 The principal adheres to high ethical standards. 1 2 3 4 5 6 7

37 Teachers are involved in decisions that affect them. 1 2 3 4 5 6 7

38 Teachers are treated fairly in this school. 1 2 3 4 5 6 7




The Impact of Human Values and Organizational Citizenship

Behaviors on Service Quality

Zahra Kamiab Ph.D Student Faculty of Economic and Public Administration


[email protected]

Abstract The examination of organizational citizenship behaviors as the mediating variable through which human values

affect service quality is still scarce. Approach: This study examined the mediation effects of organizational

citizenship behaviors on the relationships between human values and service quality. The human values studied

were the existence of a structure with ten motivational types of value by Schwartz (1992, 2005) and service quality

was studied in terms of five dimensions from Parasuraman (1988) instrument. Data were collected from a sample

of 117 branches of two governmental commercial banks in Kuala Lumpur, Malaysia. The participants in this study

included 351 employees and 585 customers. To achieve these objectives a mediation model was tested using

structural equation modeling procedure to examine if the hypothesized model fit the data. Results: The results

showed that organizational citizenship behaviors fully mediated the relationships between human values and bank

service quality. Conclusion/Recommendations: The findings of this study suggest that human values play a critical

role in enhancing employee’s organizational citizenship behaviors and service quality. Organizational citizenship

behaviors mediate the effects of human values on service quality. To improve service quality, employers should

improve values and managers try to know employee’s values since these practices have an impact on employee’s

organizational citizenship behaviors which in turn would affect service quality.

Key words: Human values, organizational citizenship behaviors, service quality





System Dynamics Analysis of the Biodiesel and CPO Productions

in Malaysia

Sahra Mohammadi, Fatimah Mohamed Arshad, Abdulla Ibragimov

Universiti Putra Malaysia 43400 Serdang Selangor Malaysia


Email:[email protected]

Email:[email protected]

Abstract

This paper examines the biodiesel and crude palm oil productions in Malaysia using a system dynamics

approach. There is an increasing demand for biodiesel in the world. The Biofuels Directive has set targets

rising biodiesel production from 2% in 2005 to 20% by 2020 with Malaysia and Indonesia having the

potential to capture 20% share of the biofuels market in Europe. The Malaysian government also expects that

the blend 10 program of biodiesel will significantly increase demand for the feedstock including crude palm

oil. This paper utilizes system dynamics approach as it enables one to capture the feedback

relationships, nonlinearity, and delay exist in commodity markets including palm oil. The model is simulated

for 44 years starting from 1982 to 2025. The simulation results indicate that the CPO demand for biodiesel will

increase in double which requires better concerns in production and stock of palm oil.

Key words: crude palm oil; biodiesel; system

dynamics

1 Introduction

Energy consumption in Malaysia has been growing at a fast rate. Oil, which is mainly utilized

in the transportation and industrial sectors, accounts for a big portion of total energy

consumption in Malaysia. Since the supply of fossil fuel is depleting rapidly, renewable

energy resources have been emerging to fulfill the world demand. Malaysia recognizes the

renewable energy resources as the fifth fuel after oil, coal, natural gas and hydro. It

emphasizes on reliability and cost-effectiveness of energy supply and sustainability (Basiron,

2008).

The demand for biodiesel was triggered by the increase in crude oil price between 2004 and

2005. As shown in Figure 1, in 2005, the crude oil price dramatically increased by about 30%

from USD 37.8/barrel in 2004 to USD 53.4/barrel in 2005 and continued to increases in the

following years. Meanwhile, the price of crude pam oil (CPO) decreased by 15.5% from RM

1,610/mt to RM 1,349/mt during the same period. The sharp decrease in crude oil price

triggered the production of biodiesel. However, the advent of this new product coupled with

other traditional economic factors pushed the price of CPO up again by 40%, increasing

sharply from RM 1,511/mt in 2006 to RM 2,531/mt in 2007.







Figure 1. Biodiesel Production (Metric Ton), CPO and Crude Oil Prices (RM per

Metric Ton), 2006-2014

Source: MPOB, 2015; Malaysia Biofuels Annual, 2013

The palm oil industry has significant economic advantages and it requires a careful

understanding of the behavior of key variables in the market. This paper investigates the

possible future behaviors of biodiesel and CPO productions in Malaysia for the next ten years

using a system dynamics approach. More specifically, this paper simulates the future

behavior of CPO demand for biodiesel productions with regards to changes in CPO and crude

oil prices. It also examines the impact of higher efficiency in fresh fruit bunch (FFB)

harvesting mechanism in the volume of CPO production (Figure 2-3).

Figure 2. Scenarios of Possible future behaviors

of CPO and Crude Oil prices

Figure 3. Scenarios of Possible Future Behavior

of CPO and Biodiesel Productions

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

-

500

1,000

1,500

2,000

2,500

3,000

3,500

2006 2007 2008 2009 2010 2011 2012 2013 2014

MT

RM

/MT

BD Production Crude Oil Price CPO Price




1.1 CPO Production

Table 1 shows the oil palm planted area and production of CPO in Sabah, Sarawak, and Peninsular

Malaysia. As shown, planted area and CPO production in Sabah has increased by 93.4% and 97%

from 93,967 ha and 156,471 mt in 1980 to 1.4 mn ha and 5.5 mn mt in 2012, respectively.

Similarly, plantation and production in Sarawak show significant increase of 97% and 99% during

the same period, respectively. In Peninsular Malaysia, planted area and CPO production has

increased from 906,590 ha and 2.4 mn mt in 1980 to 2.5 mn ha and 10.3 mn mt in 2012,

suggesting an increase of 64% and 76% respectively. The total production of CPO in Malaysia has

increased by 86% from 2.5 mn mt in 1980 to about 18.8 mn mt in 2012. The annual growth of

CPO production has changed over the last three decades indicating an average growth of 7.7% in

1980s, 5.2% in 1990s, and 4.2% in 2000s.

Table 1. The Palm Planted Area (‘000 ha) and Production of CPO (‘000 mt) in Sabah,

Sarawak, and Peninsular Malaysia, 1980-2012

Year

Sabah Sarawak Peninsular Malaysia

Plante

d Area

CPO

Production

Planted

Area

CPO

Production

Plante

d

Area

CPO

Production

1980 94 156 23 22 907 2,394

1985 162 285 29 49 1,292 3,801

1990 276 679 55 108 1,698 5,308

1995 518 1,494 119 222 1,903 6,095

2000 1,001 3,110 330 520 2,046 7,212

2005 1,209 5,334 543 1,337 2,299 8,291

2010 1,410 5,316 919 2,180 2,525 9,498

2011 1,432 5,843 1,022 2,696 2,547 10,373

2012 1,443 5,543 1,076 2,923 2,558 10,320

Source: MPIC, 1990 & 2005; MPOB, 2012

1.2 CPO and Crude Oil prices

The price of crude palm oil has appeared with significant fluctuations during the last decades. The

CPO price has increased from RM 701/mt in 1990 to RM 2,384/mt in 2014, suggesting an increase

of 70% (MPOB 2015). The price increase attributes to changes in the world palm oil and soybean

oil prices as well as an increase in the demand for palm oil products. The price of crude oil has also

raised sharply from USD 23/barrel in 1990 to USD 90.9/barrel in 2014, indicating an increase of

74%. As forecasted by the World Bank (2015), the price of crude oil is expected to decrease by

about 28% from USD 90.9/barrel in 2014 to 64.6/barrel in 2020 following by an increase of 22%

and reaching USD 82.9/barrel in 2025.

1.3 Biodiesel Production

The rapid increase in crude oil price above the price levels of vegetable oils, beginning in 2004,

provided the impetus for turning vegetable oils into biodiesel for transportation fuel. Accordingly,




palm oil feed stocks are considered as an alternative source of energy to eliminate the use of fossil

fuel, with Malaysia and Indonesia having the potential to capture the biggest market shares. As

stated by Fatimah Mohamed Arshad (2008), Malaysia and Indonesia have the potential to capture

20% share of the world’s biofuel product, if the price of CPO remains attractive compared to that

of crude oil.

Biodiesel in Malaysia was commercially introduced by the end of 2005 when the price of CPO

decreased by 15.5% compared to its previous year. Malaysia’s National Biofuel Policy introduced

on August 2005 aims to position Malaysia as a global biodiesel producer. The primary goals of the

policy are to expand and diversify the market for crude palm oil, to increase the export of biodiesel

and biofuel feed stocks, to help alleviate rural poverty, and help addressing long-term domestic

energy needs (Amna and Fatimah, 2010). The mandatory biodiesel blending was launched on June

2011 which requires diesel to contain 5 percent of biodiesel. It is expected that the share of

biodiesel will increases from 5% to 10% in the future (Applanaidu, 2013).

However, the biodiesel production in Malaysia is significantly under its potential level. The

attempts of Malaysian government to increase its use of biofuels and to expand the market both

domestically and internationally have not been successful due to the unfavorable market conditions

including high crude palm oil prices and the delay in implementing biodiesel blend from 2008 to

June 2011. As presented in Table 2, there are 29 biorefineries in Malaysia with an estimated

capacity to produce 2.74 mn liters of biodiesel. However, the quantity of biodiesel produced is less

than 25% of the maximum capacity. The CPO quantity used in biodiesel production is estimated

591,000 mt in 2014 which is about 2% of total CPO production in Malaysia.

Table 2. Biodiesel Production Capacity and CPO Used Year No. of Bio-

refineries

Nameplate

Capacity

(‘000 Liters)

Capacity

Use (%)

BD

Production

('000 Liters)

CPO Use

in BD

('000 MT)

CPO

Price

(RM/MT)

Crude oil

Price

(RM/Barrel)

2006 8 530 66.60% 353,275 325 1,511 1,760

2007 15 1,121 38.80% 434,800 400 2,531 1,824

2008 23 2,019 25.80% 521,760 480 2,778 2,416

2009 27 2,610 9.20% 241,314 222 2,245 1,622

2010 28 2,746 3.20% 86,960 80 2,705 1,898

2011 28 2,746 2.00% 55,437 51 3,219 2,373

2012 29 2,746 5.50% 152,180 140 2,764 2,447

2013 29 2,746 13.80% 379,363 349 2,371 2,268

2014 29 2,746 23.40% 642,417 591 2,384 2,101

Source: Malaysia Biofuels Annual, 2013

2 Methodology

This paper utilizes system dynamics approach to study the possible future behaviors of CPO and

biodiesel productions in Malaysia. System dynamics is a method to describe, model, simulate and

analyze dynamically complex systems in terms of the processes, information, organizational

boundaries and strategies (Pruyt, 2013). It is used to examine the feedback relationship between

variables, non-linearity, and delay that exist in systems (Richardson and Pugh, 1985). As stated by

Sterman (2000), system dynamics helps to learn about dynamic complexity, understand the sources

of policy resistance and design more effective policies.




Casual loop diagrams (CLD) and stock and flow (S&F) diagrams are two commonly used

diagrams in system dynamics modeling. Basically, CLD is the qualitative presentation of a system

behavior. It portraits the feedback structure of a system and shows the relationship between

selected variables. As the modelling process progresses, the CLD model is converted into a

physical structure known as stock and flow diagram. S&F diagram is the quantitative presentation

of the system behavior defined by equations, parameters, and initial conditions.

Figure 3 presents the CLD for oil palm plantation sector and biodiesel production sector in

Malaysia. It consist of three balancing (negative) feedback loops and one reinforcing (positive)

feedback loop which are illustrated as follows.

Figure 3. CLD for Oil Palm Plantation and Biodiesel Sectors

CPO Production Loop (B1): as CPO price increases, the expected CPO price and profitability

increase which lead to an increase in new planting. As new planting increases, planting rate, total

crop and total mature crop increase which lead to higher gain in total FFB harvested and CPO

production. Increase in CPO production cause CPO inventory to go up which leads to lower CPO

prices.

Land Availability Loop (B2): increases in new planting and plantation rate cause total planted area

to increase which leads to a decline in available area. As available area declines, there will be less

area available for new planting. It is estimated that Malaysia has a maximum land capacity of 5.6

Total MatureCrop

Total PlantedArea

CPO TotalDemand

Max LandCapacity

Available Area

ExpectedProduction Cost

ExpectedProfitability

New Planting

FFB per CropArea

Total FFB

Total Crop

Planting Rate

Decay Rate

CPOProduction

CPOImport

CPO Inventory

CPOExport

BiodieselProduction

PPODemand

CPO InventoryCoverage

CPO Price

Expected CPOPrice

R1

Replanting

B1

B2

B3

Biodiesel Price

BiodieselCost

Crude OilPrice

+

+

+

+-

++

+

+

+

+

+

+

-

+

+

+

+

+

-

+

- +

-

+ +

-

+

+

+




mn hectares. To date, the oil palm plantation has grown to 5 mn hectares indicating that only 600

thousand hectares are left for oil palm future plantation (Henriksson, 2012).

Palm Age Profile Loop (R1): as new planting, planting rate and total mature crop increase, decay

rate goes up which leads to an increase in replanting activities and new planting.

Biodiesel Production Loop (B3): if the CPO price goes up, the biodiesel price increases which

reduces the biodiesel production and total demand for CPO. As demand for CPO declines, CPO

inventory goes up which leads to lower CPO prices.

Figure 4 presents the S&F diagram associated with CPO and biodiesel productions, using Vensim

modeling software. There are four stocks (levels) constituting the palm oil plantation sector

including immature crops, young crops, mature crops and old crops. The lifespan of oil palm is

between 24-32 years. The peak yield of FFB of oil palm is during mature age and it gradually

declines thereafter. To formulate the CPO production, FFB/ha/year is multiplied by the oil

extraction rate (OER).

The biodiesel production is determined by the margin between CPO and crude oil prices. That is,

as the price ratio increases, production of biodiesel become more attractive. The current mandatary

share of biodiesel is 5% which refers to a blend of 5% palm methyl ester and 95% petroleum based

diesel. The conversion rate of CPO to biodiesel is estimated 0.88 (dimensionless) with a blending

cost of about RM80 per ton or 0.80 cents per liter (Malaysia Biofuels Annual, 2013).

Figure 4. S&F diagram for CPO and Biodiesel Production Sectors




3 Model Validation

Model validation is important in detecting the flaws in the system structure. For start, it is always

helpful to compare simulation results with observed historical behaviors. A sound model should

replicate the plausible behaviors to the observed patterns. As shown in figure 4 and 5, simulation

results of CPO and biodiesel productions produce similar behaviors to the historical data.

Moreover, statistical tests including RMSPE and inequality statistics were used to build confidence

in the model. The test’s results show that there is no systematic error in the model and the model

captures right behaviors. It is necessary to note that the model is not developed for point-by-point

prediction, rather the aim is to study the system behaviors and to obtain some understanding about

the market structure.

Figure 4. Simulation of CPO Used in Biodiesel Production, 1982-2014

Figure 5. Simulation of CPO Production, 1982-2014

4 Scenario Analysis

The purpose of the model is to examine the possible future behavior of CPO production and CPO

demand for biodiesel production in Malaysia. In first scenario, we introduce blends 10 and 15 of

biodiesel into the system. In second scenario, we increase FFB yield which can be obtain by

improving harvesting mechanism.

CPO Used in BD

600,000

450,000

300,000

150,000

0

1982 1986 1990 1994 1998 2002 2006 2010 2014

Time (Year)

ton

/Yea

r

CPO Used in BD : Actual

CPO Used in BD : Simulation

CPO Production

20 M

15 M

10 M

5 M

0

1982 1986 1990 1994 1998 2002 2006 2010 2014

Time (Year)

ton

/Yea

r

CPO Production : Actual

CPO Production : Simulation




4.1 Scenario I

Simulation results show that the CPO price is expected to increase from RM 2,384/mt in 2014 to

RM 3,671/mt in 2025, suggesting an increase of 35%. Using this result and the forecasted crude oil

prices by the World Bank, we examine the likely behavior of CPO demand in biodiesel production.

The simulation results show that, under the business as usual scenario, CPO demand for biodiesel

production exhibits decline from 591,000 mt in 2014 to 494,618 mt in 2025 due to increases in

CPO prices relative to that of crude oil. Under scenario I, we introduce blend 10 and 15 of

biodiesel into the model, which refers to a blend of 10% and 15% of palm methyl ester and 90%

and 85% petroleum based diesel, respectively. The simulation results show that CPO demand for

biodiesel production increases to about 1.0 and 1.45 mn mt in 2015, suggesting 49% and 66%

increases in CPO demand for biodiesel production, respectively (Figure 6).

4.2 Scenario II

As the demand for palm oil is raising, an increase in productivity gain can help improving the

stability of CPO price. There is a potential increase in the FFB yield. Currently, there is a

significant yield variation between plantations, smallholders as well as mills in Malaysia. Over the

last decades, the average FFB yield is estimated between 19 and 21 mt/ha/year. Lack of exposure

to best practices and the insufficient economies of scale are the main factors resulting in inefficient

crop yield across the nation (ETP, 2014). The simulation results show that, under the business as

usual, the CPO production is expected to increase from 19.56 mn mt in 2014 to 25.33 mn mt in

2025. Under scenario II, we assume an increase in FFB yield by an average of 22 and 23

mt/ha/year. The simulation results show that the CPO production raises to 26.68 and 27.8 mn mt,

suggesting 4% and 8% productivity increases, respectively (Figure 7).

Figure 6. Simulation result for Scenario I (‘000 MT), 1982-2025

Figure 7. Simulation result for Scenario II (‘000 MT), 1982-2025

2

50% 75% 95% 100%

CPO Used in BD

2 M

1.5 M

1 M

500,000

01982 1993 2004 2014 2025

Time (Year)3

50% 75% 95% 100%

CPO Production

40 M

30 M

20 M

10 M

01982 1993 2004 2014 2025

Time (Year)




5 Discussion

Palm oil is a major source of sustainable and renewable raw material for the biofuel industry in the

world, with Malaysia and Indonesia having the potential to capture the biggest market shares.

However, the biodiesel production in Malaysia is significantly under its potential level. For

biodiesel production to remain viable, CPO price must decline further. The competitiveness of

palm oil implies that it will remain as an important source of renewable raw material for biofuel

industries in the future. Moreover, productivity gains in the palm oil industry have a significant

impact on economic growth. Hence, it is important to enhance higher efficiency in CPO

production. The FFB yield can be improved through initiatives that increase productivity of labors

in plantations. For instance, the harvesting process should rely more on motorized equipment

rather than labors who are currently the main source in harvesting. The government should enforce

policies to monitor the FFB acceptance process by mills to make sure that only good quality crops

are processed. Technological advances will help to raise yields and maximizing oil production.

6 Conclusion

This study investigates in likely behavior of CPO production as well as CPO demand for biodiesel

production in Malaysia by developing a simulation model. The model is simulated for 44 years

starting from 1982 to 2025. The simulation outputs indicate that the advent of B10 and B15 of

biodiesel production will increase the CPO demand for biodiesel by 49% and 66%, respectively.

The results also indicate that there is a potential increase in the FFB yield and CPO production in

Malaysia. One possible solution to improve the harvesting performance would be to utilize

motorized equipment and technological advances.

Reference

AMNA AWAD ABDEL HAMEED, & FATIMAH MOHAMED ARSHAD. (2010). Inroads of

Palm Oil into the Middle East and North Africa Region. Selongor Malaysia: University Putra

Malaysia Press.

APPLANAIDU, S. D., FATIMAH MOHAMED ARSHAD, MAD NASIR SHAMSUDIN, &

YUSOP Z. (2010). The Impact of Biodiesel Demand on the Malaysian Palm Oil Market: A

Combination of Econometric and System Dynamics Approach. Paper presented at the

International Conference on Business and Economic Research (ICBER), Sarawak. March

2010.

BASIRON, Y. (2008). Palm Oil Production through Sustainable Plantations. European Journal of

Lipid Science and Technology. 109: 289-295.

FATIMAH MOHAMED ARSHAD. (2008). Palm Oil Based Diesel: An Inconvenient Opportune?

IMPAK, Issue 4, 2008.

MALAYSIA BIOFUELS ANNUAL. (2013). The Malaysian Palm Oil Sector- Overview.

Retrieved from

MPIC (Ministry of Plantation Industries and Commodities). (1990). Statistics on Commodities

1990, 2nd Edition.

MPIC (Ministry of Plantation Industries and Commodities). (2005). Statistics on Commodities

2005, 19th edition.

MPOB (Malaysian Palm Oil Board). (2012). Malaysian Palm Oil Statistics. 32th edition.




MPOB (Malaysian Palm Oil Board). (2015). Statistics. Retrieved from

PRUYT, E. (2013). Small System Dynamics Models for Big Issues. TU Delft Library, Delft, The

Netherlands.

RICHARDSON, G. P. PUGH, A. L. (1985). Introduction to System Dynamics Modeling with

Dynamo. The MIT Press, England.

STERMAN, J. D. (2000). Business dynamics: Systems Thinking and Modeling for a Complex

World. New York: McGraw-Hill.




Dynamic links between financial development and 𝑪𝑶𝟐

emissions in Nigeria: evidence from ARDL bound test

framework

Hamisu Sadi Ali, Law Siong Hook, Zulkornain Bin Yusop & Lee Chin

Department of Economics, Faculty of Economics and Management Universiti Putra

Malaysia, 43400 Serdang, Selangor-Malaysia

Abstract

Using ARDL bound test approach for the period of 1971-2010 the present article examined the links

between financial development, energy consumption, trade openness, economic growth and 𝐶𝑂2

emissions in Nigeria. The result reveals that variables were cointegrated as null hypothesis was rejected

at 5% level of significance. Furthermore based on short run dynamics, financial development, economic

growth and energy consumption have positive significant impact on 𝐶𝑂2 emissions, while trade openness

have negative insignificant impact on 𝐶𝑂2 emissions. In the long-run however, the finding proved that

financial development, economic growth and energy consumption have positive and significant influence

on 𝐶𝑂2 emissions, while trade openness has negative significant impact on 𝐶𝑂2 emissions in Nigeria. The

policy implication is that Nigerian public authority should focus more on initiating environmentally

friendly policies that can reduce carbon emissions and explore other alternative sources of energy

considering its movement with the financial sector performance. Proper trade liberalization policies

should be put in place considering its roles in reducing carbon emission that will improve environmental

quality in the country.

Keywords: 𝐶𝑂2 emissions; Energy consumption; Financial development; Economic

growth; Trade openness; Nigeria.

Introduction

Environmental quality and sustainability is one of the aims that each country is trying to

preserve considering its importance to the inhabitants and their socio-economic dealings

which if not properly checked could even affect their health conditions. The issue of

global warming is one of the serious problems that is facing both industrialized,

emerging and developing countries in the world because of its negative effect of

degrading environmental quality that have serious negative consequences, for example

depletion of the ozone layer that is highly related to 𝐶𝑂2 emissions which is the main

cause of global warming (Alam, et al. 2012). One of the key areas the recent G7 summit

focus is de-carbonation of the globe that is to reduce the level of carbon emissions so as

to safeguard the environment from degradation. The performance of financial sector

could be attributed to other key economic sectors, for example industrial sector that uses

substantial amount of energy which affect the environmental quality despite the growth

of the financial sector as well as overall economic performance. High energy

consumptions could lead to higher 𝐶𝑂2 emissions in Nigeria because fossil fuel

consumption contributed to about 75% of energy consumption in Nigeria (Yusuf, 2014).




Literature on financial development and other environmental variables is still meagre

because the area is not largely explored. Therefore the nexus between financial

development and 𝐶𝑂2 emissions is interesting considering the relevance of financial

sector in determining the performances of other economic sectors, for example industrial

sector. The connection is that firms requires finances in order to initiate businesses or

expand their operations, and by doing that the level of 𝐶𝑂2 emissions is increasing daily

which have negative repercussions on the environmental quality. Despite numerous

empirical studies that discussed about the nexus of financial development and other

environmental variables, still no single study that explore the relationship between

financial development and key environmental variables of 𝐶𝑂2 emissions and energy

consumption in Nigeria.

Review of related literature

Various empirical studies examines the links between the variable of interest as well as

other control variables in different countries, but based on our search no single study

that investigated this nexus in Nigeria despite its major roles in both productions and

consumptions of high volume of energy in Africa, as well as it also contribute on

increasing 𝐶𝑂2 emissions in the world. The relationship between energy consumption

and economic growth is investigated by Oh and Lee (2005) using VECM approach for

the period of 1981Q1-2000Q4. The outcome reveals that in the short-run no causal

nexus exist, in the long-run however there is unidirectional causality running from

economic performance to the consumption of energy. The relationship between energy

use and economic growth is examined by Hye and Riaz (2008) in Pakistan for the time

period of 1971-2007 based on ARDL form of Granger-causality. In the short-run the

result of the causality indicated bi-directional causality among the variables, whereas

unidirectional causality exists from economic growth to energy use in the long-run. the

consumption of energy do not affect growth in the long-run because as energy prices

increases it will influence other prices to rises and this leads to the increase in the cost of

doing business hence adversely affected the economy. Tamazian, et al. (2009) in their

panel study on the nexus between economic and financial market development on

environmental degradation for the period of 1992-2004 using standard reduced form

modelling technique across BRIC countries. The result indicated that financial and

economic developments determine the quality of environment in the study sample

countries. The result also shows that higher level of economic and financial advances

reduces the deprivation of the environment. It also highlight based on the finding that

financial liberalization and openness contributes massively to the reduction of 𝐶𝑂2

emissions. Applying ARDL bound testing approach in Tanzania for the period of 1971-

2006 Odhiambo (2009) investigated the relationship between energy consumption and

economic performance and concluded that there is unidirectional causality running from

overall energy uses to economic growth.

The impact of C𝑂2 emissions on economic growth and financial development for the

period of 1980-2008 is examined by Al-mulali and Sab (2012a) for thirty Sub-Saharan

African countries. The result shows that despite high rate of environment pollution




energy uses has essential impact on financial development and economic growth in the

countries investigated. The relationship between energy consumption and economic

growth financial market development is also examined by Al-mulali and Sab (2012b)

across 19 countries for the period of 1980-2008 and the results claimed that energy

consumption affect financial development and economic growth significantly. Though,

the development is attached with adverse effect considering its influence on increasing

the rate of C𝑂2 emissions in the countries under investigation. Chaudhry, et al. (2012)

investigated the nexus between energy uses and economic performance for the period of

1972-2012 in Pakistan using ARDL framework. The result shows that when oil is used a

proxy for energy consumption the effect is negative to economic growth. Applied

VECM technique in Tunisia for the period of 1980-2007 Abid and Sebri (2012) study

the links between energy consumption and economic growth. The result shows that in

general economic perspective energy uses enhance economic growth, whereas if sectoral

level is considered energy consumption affected economic growth negatively. Islam, et

al. (2013) investigated the impact of financial market performance, economic growth

and population growth on energy uses in Malaysia. The outcome suggests that energy

uses influence financial development and economic growth in short-run and long-run.

However, energy consumption nexus with population growth is only sustainable in the

short-run.

Shahbaz, et al. (2013a) applied ARDL bound testing approach to study the connection

between energy uses and economic growth by including the financial development and

trade variables in China for the period of 1971-2011. The empirical result reveals that

energy uses, financial development and trade have positive significant impact on

economic growth. Shahbaz et al., (2013b) used ARDL approach and investigated the

links between economic growth, energy consumption, financial development, trade

openness and 𝐶𝑂2 emissions in Indonesia for the time frame of 1975Q1-2011Q2. The

finding shows that when economy grows and energy consumption increases 𝐶𝑂2

emissions also increases, while financial development and financial trade liberalization

reduces it. Conversely, the causality VECM analysis reveals feedback hypothesis

between consumption of energy and 𝐶𝑂2 emissions, two ways causality among

economic growth and C𝑂2 emissions and one way causality running from financial

development to C𝑂2 emissions. The impact financial development on energy uses is

investigated using system-GMM method across EU member countries for the period of

1990-2011 by Mert Topcu (2013). The result reveals that financial development has

important impact on energy uses in old EU member countries despite the indicator of

financial development used. On the new member countries however, it depends on the

type of financial development indicator used. When bank indicator is use the effect

shows an inverted U-shaped while it indicated no substantial connection exist when

stock market indicator is use. The relationship between energy consumption, economic

growth and financial development is investigated in India for the period of 1971-2009

using ARDL framework by Mahalik and Mallick (2014). The result indicated that

energy consumption affected ratio of urban population positively, while its effect on

economic growth and financial development is negative. The finding also reveals that




urban population growth adversely influence economic growth, whereas energy

consumption positively affected it.

Uçan, et al. (2014) investigated the impact of renewable and non-renewable energy on

economic growth for 15 EU member countries for the period of 1990-2011 using panel

cointegration analysis. The result established long-run relationship between the

variables. The Granger-causality test result shows unidirectional causal relationship

running from non-renewable energy consumption to economic growth. The causal nexus

among consumption of energy, oil price and economic performance is studied by

Osigwe and Aramowo (2015) in Nigeria based on Granger-causality test analysis. The

outcome shows that the causality between energy uses and economic growth is two

ways. When electricity is used as a measure of energy consumption however,

bidirectional causality exists among energy consumption and economic growth and

price of electricity and its uses as well. While no causal relationship that exists between

kerosene consumption, kerosene prices and economic performance in Nigeria. Ali, et al.

(2015) applied autoregressive distributed lag framework and examine the impact of

financial development on energy consumption in Nigeria using a quarterly data of

1972Q1-2011Q4. The result suggests that variables were cointegrated as null hypothesis

is rejected at 1% significance level. Based on the short-run dynamics financial

development significantly affects consumption of energy and economic growth

adversely, while energy prices positively affect energy consumption significantly. In the

long-run however, the impact of financial development on energy consumption is

negative and insignificant, while the impact on economic growth is negative but

significant and that of energy prices still maintain its positive and significant impact on

energy consumption. Applying Sadorsky (2010) to investigate the marginal impact of

financial development on the energy uses and income across 53 economies for the

period of 1999-2008, Chang (2015) applied different indicators of financial development

and found that energy consumption increase when income rises in both developing and

emerging market countries, while in developed nations it increase with income

transitory up to certain level of income. In low income economies however,

consumption of energy increase with level of financial development when the proxy is

private and domestic credits. However, when stock market indicators are used to

measures financial development, energy consumption marginally reduces with the

financial market development in developed countries while it rises with in higher

income countries of emerging and developing economies.

Data, source and measurements

This study derived its data from world development indicators (WDI CD ROM, 2015)

via World Bank data base for the period of 1971-2010. Financial development is

measured by the domestic credit to private sector as a ratio of GDP, we used 𝐶𝑂2

emissions in kilo terms to represent 𝐶𝑂2 emissions, energy consumption is proxied by

fossil fuel consumption which comprised of coal, oil, petroleum, and natural gas

products, economic growth is measured by real GDP per-capita and trade openness is

measured by sum of export and import as a ratio of GDP.




Econometric model specification

In order to specify the ARDL form of vector error correction model we followed Khan

et al., (2005), Fosu and Magnus (2006) and specify our model our model as follows;

∆ln𝐶𝑂2𝑡 = 𝛽0 + 𝛽1ln𝐶𝑂2𝑡−1 + 𝛽2𝐹𝐷𝑡−1 + 𝛽3ln𝐸𝐶𝑡−1 + 𝛽4𝑙𝑛𝐸𝐺𝑡−1 + 𝛽5ln𝑇𝑂𝑡−1 +

∑ 𝛾𝑖𝑝𝑖 ∆ln𝐶𝑂2𝑡−1 + ∑ 𝛿𝑗

𝑞𝑗 ∆ln𝐹𝐷𝑡−𝑗 + ∑ 𝜑𝑙

𝑝𝑙 ∆ln𝐸𝐶𝑡−𝑙 + ∑ 𝜔𝑘

𝑝𝑙 ∆ln𝐸𝐺𝑡−𝑚 +

∑ 𝜂𝑚𝛥𝑞𝑚 𝑙𝑛𝑇𝑂𝑡−𝑛 + 휀𝑡

(1)

Where; 𝑙𝑛𝐶𝑂2 is the log of 𝐶𝑂2 emissions, 𝑙𝑛𝐹𝐷 is the log of financial development,

𝑙𝑛𝐸𝐶 is the log of energy consumption, 𝑙𝑛𝐸𝐺 is the log of economic growth, 𝑙𝑛𝑇𝑂 is the

log of trade openness and subscript t denote time period. The first stage is to estimate

equation (1) using OLS and then move on to test Wald test of F-test with the intention of

testing joint significance of the coefficients of lagged variables in order to observe if

there is long-run relationship among the variables.

The next step is to test the null hypothesis 𝐻0 = 𝛽1 = 𝛽2 = 𝛽3 = 𝛽4 = 𝛽5 = 0 which stated

that there is no cointegration against alternate 𝐻𝑎 ≠ 𝛽1 ≠ 𝛽2 ≠ 𝛽3 ≠ 𝛽4 ≠ 𝛽5 ≠ 0

which stated there is cointegration among the variables. As suggested by Pesaran, et al.

(2001) if the value of the calculated F-test is greater than the upper bound critical value

we reject the null hypothesis of no cointegration which implies the existence of long-run

relationship. However, if the value of estimated F-test is less than lower critical value

null hypothesis cannot be rejected which implies there is no long-run relationship,

whereas if the value of the estimated F-test lies within lower and upper critical value the

result remains indecisive (Pesaran & Pesaran, 1997). We move on to test the long-run

coefficients of ARDL based on the equation (2) below;

ln𝐶𝑂2𝑡 = 𝛽0 + ∑ 𝛾𝑖𝑝𝑖=1 ln𝐶𝑂2𝑡−1 +

∑ 𝛿𝑗𝑞1𝑗=0 lnFD𝑡−𝑗+ ∑ 𝜑𝑙

𝑞2𝑖=0 ln𝐸𝐶𝑡−𝑙+ ∑ 𝜂𝑚

𝑞3𝑚=1 𝑙𝑛𝐸𝐺𝑡−𝑚+ ∑ ∪𝑛

𝑞4𝑚=0 𝑙𝑛𝑇𝑂𝑡−𝑚 + 휀𝑡 (2)

We choose SBC to select lag length of the model and applied error correction model

with a view to determine short-run dynamics of the variables;

∆ln𝐶𝑂2𝑡= 𝛽0 + ∑ 𝛾𝑖𝑝𝑖 ∆ln𝐶𝑂2𝑡−1 +

∑ 𝛿𝑗∆𝑞𝑗 ln𝐹𝐷𝑡−𝑗+ ∑ 𝜑𝑙

𝑞𝑖 ∆ln𝐸𝐶𝑡−𝑙 + ∑ 𝜂𝑚∆

𝑞𝑚 𝑙𝑛𝐸𝐺𝑡−𝑚+ ∑ ∪𝑛 ∆

𝑞𝑚 𝑙𝑛𝑇𝑂𝑡−𝑚 + 𝜗𝑒𝑐𝑚𝑡−1 +

휀𝑡 (3)




We Followed Pesaran (1997) in order to test the stability of the long-run coefficient as

well as the short-run dynamics by applying cumulative sum of recursive residuals

(CUSUM) and the cumulative sum of squares of recursive residuals (CUSUMSQ).

Results and discussions

Table 1: Results of the ADF and PP unit root tests from 1971-2010

ADF PP

Level

Variables Constant Without

Trend

Constant With

Trend

Constant Without

Trend

Constant With

Trend

𝐥𝐧𝐅𝐃𝒕 -2.423 -2.616 -2.192 -2.418

𝐥𝐧𝑪𝑶𝟐𝒕 -2.512 -2.552 -2.512 -2.552

𝐥𝐧𝐄𝐂𝒕 -4.918* -3.299*** -4.878* -3.495***

𝐥𝐧𝐄𝐆𝒕 1.649 0.025 1.265 0.006

𝐥𝐧𝐓𝐎𝒕 -2.565 -2.641 -2.565 -2.641

First Difference

𝐥𝐧𝑭𝑫𝒕 -4.930* -4.815* -4.320* -4.238*

𝐥𝐧𝑪𝑶𝟐𝒕 -6.786* -6.691* -6.896* -6.743*

𝐥𝐧𝐄𝐂𝒕

-4.509* -5.258* -4.467* 5.241*

𝐥𝐧𝐄𝐆𝒕 -5.139* -5.673* -5.204* -5.659*

𝐥𝐧𝐓𝐎𝒕 -7.490* -7.616* -7.457* -7.573*

NB: The ADF and PP test equations include both constant and trend terms. The Schwarz information

criterion (SIC) is used to select the optimal lag order in the ADF test equation. The values in brackets are

corresponding p-values *denote significance level at 1%, **5%, and ***10% respectively

The stationarity of the variables is very essential in any time series analysis, the result of

ADF and PP test in table 1 above shows that only energy consumption is integrated at

level means is I(0) variable, while both financial development, 𝐶𝑂2 emissions,

economic growth and trade openness are non-stationary at level but are stationary at first

difference which means the four (4) variables are I(1). Considering the combination of

I(0) and I(1) variable, ARDL is appropriate method to apply (Pesaran, et al. 2001) so as

to test and see whether variables have long-run relationship or not.




Cointegration test

Table 2: ARDL bound test estimation result

Model for estimation Lag length

F-statistics

Significance level

Critical bound ______________________

F-statistics

__________________

I(0) I(1)

𝑭𝑪𝒐𝟐(𝑭𝑫|EG|EC|TO) 4 5.92 1% 4.42 6.25

5% 3.20 4.54

10% 2.66 3.83

N.B: *, ** and *** denote significant at 1%, 5% and 10% levels, respectively. Critical values are obtained

from Narayan (2005) (Table Case III: Unrestricted intercept and no trend; pg. 1988)

The ARDL cointegration test reported shows that the calculated F-statistics (5.92) is

greater than upper bound critical values as shown in the Narayan table. The

interpretation remains variables were cointegrated as we reject null hypothesis at 5%

level of significance. Since the long-run relationship is confirmed we then move to

estimate our equation (2) in order to obtain long-run coefficients, the outcome is shown

in table 3 below;

Table 3: Estimated long-run coefficients based on SBC Dependent variable (∆𝑙𝑛𝐶𝑂2𝑡)

Regressors Coefficients T-ratio (p-values)

Constant -11.075 -5.106 (0.000)*

𝐥𝐧𝑭𝑫𝒕 0.133 1.826 (0.082)***

𝐥𝐧𝑬𝑮𝒕 0.687 8.784 (0.000)*

𝐥𝐧𝑬𝑪𝒕 0.915 8.214 (0.000)**

𝐥𝐧𝑻𝑶𝒕 -0.530 -8.452 (0.030)**

NB: *denote significance level at 1%, **5%, and ***10% respectively

The result shows that financial development has positive significant impact on 𝐶𝑂2

emissions, impliedly it means that when financial development increases by 1% in

Nigeria, it stimulates 𝐶𝑂2 emissions to increases by 0.1%, which means financial

development is attached with negative environmental consequences as it creates more

carbon emissions. This finding substantiated the outcome of Al-mulali and Sab (2012b)

for a sample of 19 countries. Economic growth has positive and significant impact on

𝐶𝑂2 emissions as 1% increase in economic performance leads to 0.6% increase in 𝐶𝑂2

emissions, Energy consumption is also positive and significant on 𝐶𝑂2 emissions as 1%

increase in energy consumption could leads to 0.9% increase in 𝐶𝑂2 emissions. The

finding reconfirmed the outcome of a study by Al-mulali and Sab (2012a) across 30

African countries, while trade openness has negative but significant impact on 𝐶𝑂2




emissions, this reveals that when trade openness increases by 1% in Nigeria, it leads to

0.5% decline of 𝐶𝑂2 emissions, thus trade openness does not increase 𝐶𝑂2 emissions but

rather reduces it in case of Nigeria.

Conclusion and policy recommendations

We applied ARDL bound test approach and analysed annual data for the period of 1971-

2010 in order to ascertain the dynamic links between 𝐶𝑂2 emissions, energy

consumption, trade openness, economic growth and financial development in Nigeria .

Based on F-test the variables were cointegrated and null hypothesis was rejected at 5%

significance level. The short-run dynamics reveals that 𝐶𝑂2 emissions positively affect

financial development significantly, while economic growth, energy consumptions and

trade openness significantly affect financial development albeit negatively. The long-run

result however reveals that 𝐶𝑂2 emissions, economic growth and energy consumption

have significant positive impact on financial development, whereas trade openness

maintains its negative impact on financial development as in the short-run. The policy

implication suggested based on the research outcome is that policy makers in this

country are faced with two challenges of balancing between achieving high level of

financial development and improve environmental quality simultaneously without which

financial sector development could lead to massive environmental degradation

considering its influence on triggering 𝐶𝑂2 emissions as well as higher consumptions of

energy. The alternative mode of energy consumptions (e.g. green energy) is among the

prerequisite conditions that the authority needs to explore in order to reduce continuous

environmental degradation in the country that is caused by excessive fossil fuel

consumptions which leads to higher 𝐶𝑂2 emissions and caused depletion of the ozone

layer, and hence increase global warming. The next policy alternative is to adopt

suitable trade openness policies that will help in reducing the level of carbon emission

and hence improve environmental quality.

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Bell-Metal Industry of Assam: Some Problems and an Alternative

Operating Framework

Chayasmita Deka,

Department of Economics, Christ University

Hosur Road, Bangalore- 560029,

India


Abstract

The bell-metal industry of Sarthebari in Assam is one of the oldest industrial clusters of India. Bell-metal craft is the

identity of the village. It was a legacy and it still is today. However this industry is currently facing a lot of problems.

Though the profitability of the industry is increasing, but this is not reflected in the lives of the artisans who are the

main bearers of skill. The industry is operating in a faulty operating framework wherein some traders are externally

controlling the industry by obliging the artisans to sell back most part of their finished products to them. The artisans

are just paid the making charge with no extra profits or benefits. A declining productivity of artisans, increasing

indebtness, disorientation among local educated youths to join in the trade is slowly pushing the craft to a gloomy path

of extinction. Through a rigorous field survey and statistical analysis the research identifies some demand and supply

side determinants which can be strategically used to enhance the profitability of the industry. This research also

designs an alternative operating framework which takes into account all the problems inherent in the industry and

suggests a highly promising future by enhancing the socio-economic value of the industry.

Keywords: Bell-metal, supply volume, demand frequency, RCFS operating framework, socio-

economic value

Introduction

Even in the era of MNCs and FDIs, the potential of small and medium scale enterprises (SME) in

boosting the economy of local residents of a region and consequently of the state can-not be

undermined. SMEs can make every village self-sufficient without having to migrate to the urban

areas for a livelihood as those are the regions where employment is mostly generated. The SMEs

bear a cultural identity of the villages as the skills of the trade are passed down from one

generation to the next. The bell-metal industry is one of the oldest SME in India which emerged

mainly due to the skills of the artisans. It was a legacy and even today it is; with the entire

manufacturing process being hand-made without even the use of electricity. Unfortunately, the

industry today is facing various socio economic problems. The educated youths of the village are

dis incentivised to join in the trade due to lack of socio economic security and other health

concerns. In such a gloomy backdrop, the future of the industry is at stake.

There has not been much literature specific to this bell-metal industry of Assam. Quite a few

researchers have worked in this area. Much of their study was based on the brass metal industry of

Hajo, another region in the proximity of Sarthebari. Related studies have focussed on finding out

the production process of the industry. The performance of the industry and its socio-economic

impact in the lives of the people were mainly researched upon. Studies have analysed the past and

present status of brass-metal industry. Problems pertaining to the brass metal industry have also

been identified. However identification of a problem is not an end in itself. Suitable solutions have





to be devised which can address all the problems. Also no work has been done to identify

strategies to enhance the profitability of the industry.

This research shall explore the bell-metal industry of Assam from a social and marketing

perspective to identify the demand and supply side problems inherent in the industry and to devise

strategies/framework (which shall take account of all currently identified problems) to increase the

profitability of the industry and especially of the artisans who are the main bearers of the skill.

Sarthebari Bell-metal Cluster

Sarthebari is a quaint sleepy town in Barpeta district of western Assam. With The rhythmic clutters

of the metals, the beat of the heavy hammers are the first sounds one can hear even before the sun

rises. Bell-metal is not just a trade of the town; it has been its identity since ages, a skilled passion

being passed on from generations back without fail. There are different views regarding the origin

of the bell-metal industry in Sarthebari. Even today bell-metal continues to be the major source of

livelihood.

The bell-metal production units are operational in different districts of Assam. During the time of

Ahom and Koch kings, bell metal production centres existed at Dhekiajuli, Raha and Titabar in

Central and Eastern Assam respectively. However production today is confined mainly in

Sarthebari after the disintegration of the other centres. The bell-metal production units of

Sarthebari are clustered in the Sarthebari Revenue Circle within the Barpeta district of Assam. The

production units within the cluster are scattered in Sarthebari, Palla, Gomura, Namsala, Karakuchi,

Bamunpara, Botia, Kalatoli, Lochima, Amrikhowa, Singra and Kamarpara villages. There are a

total of 284 bell-metal production units currently in operation employing about 1260 artisans. The

number of employees per unit on an average is thus about 4-5 workers. There are about 4385

households in the 12 villages of the cluster with a population of 28,038 persons according to the

2001 Census of India.

The Core Production Process

An alloy of copper and tin mixed in ratio 78:22 makes bell-metal. . However the production of

bell-metals using the virgin metals is not feasible both in terms of cost and time consumed. The

alternative is the use of old, decrepit bell (bhanga kanh) which is widely pursued by the artisans to

produce new metal. The production of bell-metal in the manufacturing units still follows the

traditional mode of production. It’s a use and reuse method which is popularly being followed. The

main disadvantage here is that some amount of metal gets lost every time in the production

process. Coke and charcoal are the fuels used in the bell-metal industry. The old, decrepit pieces of

bell-metal are further grinded to tinier pieces, which are then melted by putting them in an earthen

pot called ‘mohi’. Then using charcoal, fire is lighted in the aafar (the furnace where the crucibles

can be placed), where the mohi is placed in order to melt the scrap metal. After the scrap metal

turns to liquid, it is poured in the aakar (a circular shaped dice made of clay and used to pour out

the melted bell-metal for cooling to take a solid form). The molten metal cools down there and

takes the shape of a solid form, locally popular as aautakanha. The bell-metal lump is heated in

aafar. After it is heated, the red lump is put out of the aafar. Then by holding the hot bell-metal

piece in a niyeri (an anvil made of iron and circular in shape), the Ojha-kanhar (head artisan) holds

the cake with a sarah (tongs made of iron) so as to rotate the lump in the required direction and the

bhaigas (assistant artisans) sit around the niyeri. Then in order to expand the lump, it is hammered




in a rhythmic manner till it gets a desired shape and size. Currently however some of the

production units have started using flat sheet produced by rolling the metal lump in a rolling

machine. This reduces the physical labour of the kanhars (artisans) greatly. The cost of making

such flat sheets from the lump is Rs.8 per kilogram metal. Once the product attains shape, it is

again placed in the aafar to make it hot and red. Then it is immersed in water of PaniDhol (a water

container made of wood and used to submerge the products for cooling) so that it becomes hard

and cold. Whatever defects remain in the shape of the product, it is hammered with small hammers

to bring it to a proper shape. During this process, certain cracks may develop in the outer edge of

the product. An artisan specialised to deal with such refinement called kaitnar cuts the cracked

edge with the help of a kati (a pair of scissors used to cut the thin sheets of bell-metal to give

proper shape after hammering). He also cleans product’s black layer with a khanta (an iron

instrument used for polishing bell-metal products). Product is then heated again in fire, after which

it is polished in a wooden unit called kund by two artisans. Lac is required to fix the product during

polishing. Then the product goes through the last stage, which is polishing, designing and

finishing. Following this method of production different kinds of products are being used again

with diverse range of sizes, shape and design.

Types of Bell-Metal Product

The products are classified into four different classes based on its quality. They are: bazaruwa (low

quality products), aachli (good quality products), charach (better quality products) and aachli

charach (best quality products). The bazaruwa and aachli range of products are in general available

in market and are sold at lower prices. The charach and aachli charach range of products fetch very

good prices but these are beyond the reach of the average buyers. Again there are a diverse range

of products mainly utensils that are being produced with a variety of sizes among each type. Apart

from utensils, a limited number of articles which are a symbol of Assam’s culture like a ‘Sarai’ and

‘Bata’ are produced. One form of Assamese musical instrument called ‘Taal’ which is used in the

religious and cultural performances is also made out of bell-metal. Some of the products currently

produced and the various sizes in which they are produced are listed below:

PRODUCT NAME SIZES

Jail Baati 100-1300

Charach Jail Baati 200-900

Bahir Kanor Baati 200-900

Charach Bahir Kanor Baati 200-900

Aachli Bahir Kanor Baati 200-1300

Jul Khonda Soriya 1100-3000

Bhor Taal 200-5000

Saadha Jail Kahi 200-3000

Charach Jail Kahi 900-2500

Aachli Charach Jail Kahi 500-2500

Jail Ban Kahi 700-2500

Charach Jail Ban Kahi 700-2500

Aachli Charach Jail Ban Kahi 900-3000

Sanda Pehi Lota 500-700

Plate Bata 200-600

Pasang Taal 1000-3250

Table:1 Present product variants and their size ranges

Source: Records of Assam Bell-metal Cooperative Society Limited




Size-Charge Relation

The interesting fact to be noticed in these size variations is the variations in making charge of the

products that goes in a slightly upper parabolic fashion with the increase in sizes. This holds true in

various extents in most of the range of products. The variation in making charge contributes to the

variations in retail price of a particular product among different size ranges.

According to the current pricing strategy,

Maximum Retail Price (MRP) = Making charge (𝑃𝑀𝐶 ) + Price of raw material/kg (𝑃𝑅𝑀 ) +

Price of lost metal/kg (𝑃𝐿𝑀) + Commission (𝑃𝐶 )

This pricing strategy is being followed by all the firms (the production units) for all the products of

different size range. Thus these firms act as price takers. In the MRP equation shown above, (

𝑃𝑅𝑀), (𝑃𝐿𝑀), (𝑃𝐶 ) is same for all the products and sizes. Thus a difference in making charge brings

about a difference in MRP of products.

Fig 1: Slight concave charge curve generated by the size-charge relationship in the making of ‘Jail-

Bati’.




Fig 2: Size-charge relationship in making of ‘Bhor Taal’.

From the analysis of size-charge relationships, two significant trends have been noticed. In

products like ‘Jail Bati’, ‘Bhor-Taal’, and ‘Aachli-Bata’ the charge curve takes a slightly concave

shape in its middle size range portions. This indicates that the making charge of smaller sized

products are high and as the size range increases the making charge decreases for a while and after

a point, the making charge further increases. In the shaping of the middle size ranged products the

processes can be carried out in bulk. Hence the making charge is less. But the large sized products

cannot be shaped in bulk and has to be processed one at a time. Thus more human effort goes into

the making of large sized products and so their making charge is also high. As for the small sized

products, a lot of time and effort goes in the intricate designing process.

Fig 3: Size-Charge relationship in making of ‘Jail Ban Kahi’




Fig 4: Size-Charge relationship in making of ‘Charach Jail Kahi’

The second trend has been noticed in the making of ‘Jail Ban Kahi’ and ‘Aachli Charach Jail

Kahi’. The former is a specially designed dish with three stands. The latter is a supreme quality

dish. Both of these are big sized products with even size variations ranging from 700-3000 for the

former and 500-2500 for the latter. Thus these can also not be prepared in bulk. Manufacturing

such items consumes a lot of time and effort. Hence from the flat shaped charge curve it can be

seen that irrespective of the size of the product, the making charge is same for all the products.

Field Survey and Data Collection

In order to have a deeper insight into the demand for these products and their supply status two

detailed survey was conducted. The first survey was the supply side survey and the second was the

demand side survey. The intention was to search for solutions to enhance the profitability of the

industry. So efforts were made to find out whether there are some demand and supply side factors

which are accountable for the invisible profits. Data collection was both primary and secondary.

For the primary data collection, structured interviews with the respondents were carried out.

Respondents were selected through a purposive sampling method (for the demand side survey) and

proportional sampling method (for supply side survey). In the supply side survey, addresses of the

factory units were collected from the Assam Bell-metal Cooperative Society Limited Head office,

Sarthebari. The factory units were separately listed based on the commodity produced. The sample

factory units were randomly picked from the list of units manufacturing various commodities in a

proportional manner. Secondary data was collected for the records of the Assam Bell-metal

Cooperative Society Limited. Reports of net profits, no. of operating units, amount of raw

materials used, the value addition in each stage of production, cost of raw materials, commission to

be paid, etc. were collected. The above details were collected for the last ten years. The primary

data was collected from 112 respondents; 40 for the demand side survey (in Sarthebari, Guwahati,

Tezpur and Dibrugarh towns of Assam) and 72 for the supply side survey (from Sarthebari town).




Analysis of the Data

The survey conducted for demand side analysis and supply side analysis was mostly a market

survey with nominal inputs. Both the dependent and independent variables were nominal in nature

with more than two categories. So for the analysis, the data was grouped by categorising

respondents into some characteristic nominal categories. The cross sectional, qualitative data was

then tabulated and entered in IBM SPSS Statistics 21. In the demand side analysis, the dependent

variable is product demand frequency, which had three categories namely high demand, occasional

demand and rare demand. The response variables in the demand side are purchase purpose, price

response, product preference, quality awareness and willingness, diversification response, purchase

source and sales strategy. In the supply side, the dependent variable is supply volume and the

response variables are producer’s problems, threat due to machine made products, source of raw

materials, sites of distribution of finished products, supply of fuel, employment duration, seasonal

unemployment, desire to join other means of livelihood, education level and land ownership. The

dependent variable supply volume has three categories namely high supply, occasional supply and

rare supply. Cross tabulation analysis was carried out to analyse the data.

Supply side Analysis

Table 2: Cross Tabulation analysis between producers’ problem and supply volume

The supply analysis reveals that out of 72 respondents questioned, 50% are high suppliers, 30.6%

are occasional suppliers and 19.4% are negligible suppliers. For 54.2% respondents, lack of raw

materials is one of the main problems of the industry, 25% says lack of working capital is one of

the main issues while the remaining 20.8% pointed the lack of financial assistance as the pressing

problem faced by the industry. Lack of working capital is the main cause behind the negligible

supply as reported by 57.1% of the negligible suppliers. Any situation which can eliminate this

worry of the problem of working capital among the artisans can help in boosting the supply

volume by this group of negligible suppliers. With a significance value of 0.021 which is less than

0.05 (from Pearson chi-square test), there appears to be a significant association between the

problems associated with the industry and the supply volume of bell-metal products.

Though the volume of bell-metal products supplied by the local suppliers of the industry is quite

sufficient, yet the market is flooded with cheap machine made products from Moradabad, Uttar

Pradesh. These products are machine made at lower cost and hence their MRP is also low. They




are lighter and more lustrous than the traditionally produced articles as they are polished using

sophisticated machineries. However the durability of this machine- made products is low when

compared to the traditionally made bell-metal products. The traditionally made products fetch

good value even when they are broken as the decrepit broken pieces of bell metal serve as a

valuable raw material for further manufacturing of new products. The machine made products

loses their value once they are broken. Most of the consumers do not know how to differentiate

between these two differently made products and the machine made products being cheap sale

more.

Table 3: Cross Tabulation analysis between supply volume and threat due to intrusion of machine

made product

As shown by the table above, 76.4% of the artisans feel a threat due to the flooding of the market

by the machine-made product and 23.6% still believe that the machine-made products cannot

outsmart the original traditional manufactured products. All the negligible suppliers reported a

feeling of threat from the machine made products. The feeling of threat from the flooding of the

market by the machine made products also seems to be associated with the volume of bell-metal

supply. Thus new provisions are required which would ensure the trademarking of the traditional

products. This would bring a brand value and hence would serve as a shield against the threats

from machine made products.

For the provision of raw materials, about 62.5% of suppliers are still heavily dependent on the

traders, 22.2% depend on the Assam Bell-metal Cooperative Limited while a small fraction 15.3%

purchase raw materials themselves against loans. While 78.6% of the negligible suppliers purchase

raw materials annually against loans from private money lenders at high rate of interest, the rest of

the high and occasional suppliers are heavily dependent on the traders for their supply of raw

materials. Though there are banking services in rural areas of Sarthebari and adjoining areas,

however the artisans find taking loans from the private village money lenders an easier option. If

however they are not able to repay their loan amounts in time, they cannot purchase any raw

material for the next year. As a result, such production units are forced to remain closed till they

are able to repay all the multiplying loan amounts. Closure of the units again leads to seasonal

unemployment. The statistics are displayed in the cross tab below.




Table 4: Cross tabulation analysis between supply volume and source of procuring raw inputs

The analysis of the sources of supply of finished products reveals that 55.6% of suppliers supply

their finished products to the traders while 31.9% supply it to the Assam Bell-metal Cooperative

and the remaining 12.5% of the artisans sell their finished products themselves. According to

previous study conducted on the bell-metal industry, most of the artisans who procure their raw

materials from the traders are obliged to sell back the finished products to the traders. In the

process, the artisans just receive the making charge while the major share of profit is reaped by the

traders. This obligation leaves the artisans with no incentives to produce more and improve the

existing products in terms of design and diversity. Also 77.8% respondents reported irregular and

insufficient supply of fuels which also results in seasonal closure of the production units.

While 66.7% are employed throughout the year, the remaining 33.3% are not employed

throughout. These seasonal unemployment again arises not due to a lack of demand for labour, but

because the firms are not able to continue production. The survey conducted reveals that 73.6%

were not able to continue production due to shortage of raw materials, 23.6% were in debt and had

to shut down the production units and a negligible fraction (only 2%) had some demand issues.

Thus there is a need for some association or some common centres that takes care of the supply of

raw materials and fuel. Any effort in this direction shall help artisans to deviate their effort and

concentration in the upgradation of production techniques, diversifying the range of products and

evolution of new designs within each product.

Education level doesn’t directly impact the supply volume; but results from the cross tab reveals

that a majority of the artisans (40.3%) are 10th pass while 36.1% have an education qualification of

senior secondary education or above (12th) and only 23.6% of the artisans are school dropouts. On

the land ownership front, 38.9% has some other forms of property ownership; the remaining 61.1%

has no other property ownership.




Demand side Analysis

Table 5: Cross Tabulation between demand frequency and purchase purpose

Table 6: Cross Tabulation between demand frequency and price response

The demand side analysis reveals that 45% customers purchase bell-metal products for daily use,

40% for cultural use and 15% for aesthetic purpose. The rare demanders demand mainly for

cultural purpose (85.7%), followed by aesthetic purpose (14.3%) and none for daily purpose.

Among the occasional demanders, 53.3% purchase for cultural purpose, 26.7% for daily purpose

and 20% for aesthetic purpose. Among the high demanders, 77.8% purchase for daily purpose.

With a Pearson Chi square value of 0.002, there is a significant association between the purchase

purpose and product demand. One main point that can be taken to the advantage of the bell -metal

industry is that since 55% customers purchase bell-metal products for purposes other than daily

use, therefore its demand is mainly price inelastic. Thus a price increase to some extent will not

significantly reduce demand. This is supported by the analysis of price response with product

demand. 55% respondents reported that they would be unaffected by a price change and 12.5%




said their purchase would increase with an increase in price of the products. Although 32.5% said

that their purchase of the product would decrease with an increase in price, but 85.7% of such

respondents are rare demanders. So a price increase of product would not reduce their demand for

the same.

Similarly, cross tabulation of customer preferences with product demand reveals that 82.5%

customers prefer quality products, 10% prefer good looking products while 7.5% considers price

of the products as their preferences. 42.9% of those whose preference lies on the price of products

are again rare demanders. There is a significant influence of customer preferences with product

demand. 87.5% of the customers also indicated a willingness to learn how to identify between

traditionally made durable products and machine made non-durable products. While 72.5%

supported product diversification, 27.5% said they were satisfied with the currently available range

of products. However, diversification response of customers simply reflected their opinion and

eagerness to purchase different product variants. It in no way directly affects their product demand.

Among 40 customers who were interviewed, 60% advocates popularisation as the strategy that

should be used to increase sales of bell-metal products, 22.5% suggests using price strategy to

increase sales and 17.5% suggest that diversification of bell-metal products should be used as a

strategy to increase sales. Among the respondents who support price strategy, 57.1% are rare

demanders, 20% are occasional demanders and 11.1% are high demanders. However, customers’

view on strategies to increase sales of bell-metal products is also not directly associated with their

demands for the bell-metal products.

A faulty operating system & Design of an alternative

Based on the findings of the cross tabulation analysis, the loopholes of the bell-metal industrial

framework have been identified. The core problem found to be interrelated in the demand and

supply situations of the entire industry lies in the framework in which the bell-metal industry is

currently functioning. There are three formal parties: the traders, the artisans and the Assam Bell -

metal Cooperative Society Limited. While the former two act as dominant players the last is only

an authority for the sake of name as it functions very passively. The traders’ sources the raw

materials (broken metals) and the artisans purchase raw materials from these traders under the

obligation to sell back most of the finished products back to them. In the current framework, there

appears to be an absence of a regulatory body or an association which could look into matters

pertaining to finances and working capital; procuring raw materials and selling of finished

products, etc. which is under the present system a responsibility of the production units

themselves. Overburdening artisans with irrelevant duties lowers their productivity. Secondly, the

bell-metal industry does not have any proper records of their expenses incurred. As stated by the

President of Assam Bell-metal Cooperative Society Limited, they do not receive any invoice of all

the major financial dealings carried out with the Marwari traders of Guwahati as the bell-metal

industry is exempted from the tax system. Thus the industry does not have details of how a sum of

Rs 2 crores granted by the Government of India has been utilised. There is another sum of Rs 3

crores allocated in the name of Assam Bell-metal Cooperative Society Limited granted during the

same time. But the Society is not able to withdraw the same amount due to their inability to

produce the invoices of the past expenses incurred. The third and the most important problem lies

with the overdependence of the manufacturing units with the traders who as a consequence has




started controlling the profits of the industry, leaving very little incentives with the artisans

themselves.

Currently, the bell-metal industry is almost a perfectly competitive market, where there are many

production units, each functioning like an independent firm. Each of these firms produces exactly

the similar products and takes the price determined by the market. There is a very low entry barrier

in the present industrial framework. New firms can start with an investment as less as Rs.30, 000-

40,000. The demands for the products are more or less the same irrespective of the prices.

Fig 5: The present operating framework of the Bell-metal Industry

An Alternative Operating Framework

The perfectly competitive industry can be converted into a monopoly industry under the name of

bell-metal industrial village. The RCFS (Reorganised Common Facilities Services Unit) will serve

as the head centre, controlling all the core functions of the reorganised cluster. The other

production units will be brought under one common umbrella of the production wing of the RCFS.

There would be 8 different sub units: the grinding unit, the melting furnace, the moulding unit, the

rolling unit, the shaping unit, the annealing and fixing unit, the designing unit and the polishing

unit. These sub divisions are based completely on the specialised divisions of manufacturing

process. All the artisans formerly associated with the task of grinding in the family product ion

units would be pooled together in the grinding unit. The same would hold for all the other units.

The raw materials would be procured by the RCFS ant the artisans would no longer need to worry

about the issues related to procuring raw materials like taking loans, shutting down units if unable

to repay the loans, laying off of artisans in order to downsize the production units due to lack of

fund, etc. The artisans in the grinding unit would work together for grinding the broken decrepit




metal. Then those would be sent to the melting unit where melting can be done faster and easily in

large melting furnace. The molten metal would then be sent to the moulding unit where the hot

molten metal would be placed in different sized aafars to take the desired shape and size. After

they are cooled into lumps, these would be sent to the rolling unit where all the lumps can be rolled

into sheets using the rolling machine which is currently done either by hand or are taken to some

far village for rolling, a very time consuming affair. The rolled sheets would then be sent to the

shaping unit where they would be given the desired shape and form. The next unit in the octane is

the annealing and fixing unit. This is required for some products like the ‘ban bati’, ‘bata’, ‘jail ban

kahi’ etc. which are made in two separate parts and are subsequently joined together. The next unit

of the octane is the designing unit, where the intricate designs would be engraved on the products.

These would then finally be sent to the polishing unit, where the product will take the final shape.

The finished goods would be sent back to the production unit which will subsequently be

transferred to the marketing unit through the RCFS. The marketing unit would take the

responsibility of selling the products, popularising the products through advertising, expansion of

the market, etc. The marketing unit would also be responsible to collect the broken metal from the

customers and other sources. The income earned by selling the finished products would be spent

again for the further function of the units. The marketing units would also take responsibility of

appointing specialised designers in order to brainstorm into possible ways of product

diversification. Training facilities would be organised by the RCFS in which artisans from one unit

would be sent to the subsequent units for training and skill enhancement.

The artisans would receive a fixed salary for their service which would be taxable minimally. But

for every additional piece of product produced they would be paid additional payment as bonus.

The bonus would not be taxed and this would be an incentive for the artisans to produce more. All

the collected taxes would be collected in one common fund in the name of RCFS. Presently, there

are no provisions of artisan pensions after they leave the units due to their inability to work during

old age. Also many artisans suffer from numerous health problems like asthma, other breathing

difficulties due to constant exposure to fire and smoke; eye disorder, muscle pain and join pain,

etc. The collected tax would provide pension schemes to artisans who would work for a minimum

of 15 years. The main wealth of the industry is the skills of the artisans. So the wealth of the

industry would be insured by giving health cover to all the artisans working in any of the units.

Also other youth from the village currently involved in agriculture, and other small jobs can work

in this unit as part time depending on the availability of slots. They would be paid based on per

unit of article produced. This system would wipe out the problem of seasonal unemployment

among youths when their crop fails due to irregular monsoon or when their business shuts down.




Fig 6: The proposed RCFS centered Bell-metal industrial Octane

The profits generated by selling bell-metal products, the tax collected and other grants received

would be the fund of the RCFS and its wings. This framework under which the industry would be

transformed into a monopoly industry framework, all benefits of a monopoly industry can be taken

to raise the profits margin. The demand for bell metal products being price inelastic, the prices can

be increased for all the products without losing demand for it. Again prices can be increased

specifically on the smaller and the larger sized products as described by the charge curve through

the size-charge relationship. This new framework would increase the productivity of the artisans be

shifting their focus only into the making of bell-metal products. By increasing the size of the

industry, it can also reach internal economies of scale and benefit henceforth. The RCFS is thus a

win-win situation for all.

Conclusion

This paper explores the bell-metal industry of Assam in an indepth manner. All aspects of the

industry and also the artisans and their socio-economic lives were explored. The artisans were

found to be unconditionally passionate about their work in the industry. Their passion towards the

craft even supersedes their expectations of profit from the trade. Most of the factory units seemed

to care less about the payments that accrued to them. They seemed to fail to realize the value of

their skills. When interviewed about their efforts to move towards the machine based production

process, a reluctant effort was found to prevail among the artisans. Apart from the lack of working

capital to move towards such process, doubts about the durability of machine made bell metal




products is the rationale behind their reluctance. The machine made products would bring more

profits to the artisans, but they prefer losing increments in profit to maintaining the quality and

originality of products. This is something to be appreciated of course, but what is wrong about this

attitude is that the increasing threat from similar looking machine made products from some other

states of India might wipe out the very roots of the bell-metal industry; the bell-metal industry of

Sarthebari in Assam. The alternative operating framework controlled through RCFS with a

somewhat monopoly structure can bring solutions to this problem apart from solving other socio-

economic concerns of the lives of the artisans. However reorganising such a scattered industry into

a systematic monopoly industry will need some time and government initiative. This framework

cannot be put into operation without State’s initiative, which is its limitation. This paper answers

the question as to how the bell-metal industry of Sarthebari can be retained; use of diversity in

product variants to suit the tastes of existing customers and at the same time how negligible

demanders can be brought into the category of occasional or high demanders. It looks into how the

business operations be flourished in the state. It has not explored on possibilities and means to

expand the bell-metal industry in a national level and among neighbouring nations. This was a

limitation of the present paper which subsequent researches in this area can explore. Nevertheless,

this research suggests a highly promising operating framework based on consumer preferences and

keeping in view producers’ problems, which has the potential to bring back the ‘invisible profits’

back to the artisans. All that is required is- ‘reorganisation, commitment and diversification’.

Success and prosperity of the SME will automatically follow.

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The Mechanics Behind Environmental Strategies in Chemical

Manufacturing Firms

Keshminder Singh1, 2

1Centre for Economics and Finance Studies (CfEFS), Faculty of Business and Management

University Teknologi MARA

40450, Selangor, Malaysia


VGR Chandran

Department of Development Studies, Faculty of Economics and Administration


50603, Kuala Lumpur, Malaysia


Santha Chenayah@Ramu 2Department of Economics, Faculty of Economics and Administration




Abstract

The evaluation of an effective environmental strategy goes beyond understanding its antecedence and benefits. In

this aspect, identifying and understanding the multiple mechanics behind the formulation, design and

implementation of environmental strategies serve as an important avenue and so far, there is no clear evidence

in past studies indicating these mechanics. We, in this paper, explored the environmental management strands of

literatures regarding corporate environmentalism to expand and identify the internal mechanics behind the

environmental strategies in large Malaysian chemical manufacturing firms. Given the exploratory nature of the

study, a case study method using a semi-structured interview is used to ascertain these mechanics. Interestingly,

the results revealed seven important mechanics of the environmental strategies in large chemical firms. Among

them include a central system, internal system, quantifiable measurement, specific environmental management

unit, strategy alignment, collaboration and collective involvement. These mechanics are later clustered into two

categories, system and commitment, with regard to the role that they play in the environmental strategy of firms.

Additionally, powerful and influential top management commitments were found to contribute towards the

initiation of these mechanics. The findings also validate the past evidences in the context of a developing country, specifically for the chemical industry.

Keywords: mechanics of environmental strategy, chemical industry, environmental

orientation.







Exploring Motivational Factors towards Sustainable

Consumption: An empirical study in Malaysia

Leila Baktash

Department of Applied Statistics, Faculty of Economic & Administration,




Muzalwana Abdul Talib

Department of Applied Statistics, Faculty of Economic & Administration,




Abstract

Changing consumption and production pattern owing to rapid urbanization, economic and social dynamics,

have become great challenges to movements towards sustainable development in many developed and

developing nations. Unsustainable consumption gives rise to huge negative externalities of greenhouse gas

emission which lead to environmental degradation. Transformation in consumption pattern requires substantial

reorganization of the society and changes in lifestyles to encourage the preservation of natural environmental

endowment. Part of consumption transformation is by promoting ‘green’ household consumption specifically the

green products. In the case of Malaysia, speedy urbanization, consumption and lifestyles step up the resource-

waste problems. The major aim of this study is to determine the influent factors of Malaysian customers green

perception on loyalty towards green purchase. The factors include several marketing mix elements, namely,

price, promotion and place; and two intrinsic motivational factors: trust and quality. The key findings indicate

three factors: trust, quality and place have significant impact on customer loyalty towards green products. The

result can shed light on the development of new strategies in promoting green products and technological

advancement in green product innovation. Green product enhancement would further accelerate customer

loyalty and, in consequence, transforming consumers to embark on sustainable consumption.

Keywords: Customer loyalty, Green product, Promotion, Quality, Trust, Price, Place,

Malaysia

1.0 Introduction

Within the last decades, the consumption and production pattern have severely impacted the

environmental sustainability. Speedy economic growth and increasing population number

over the years would largely contribute to unsustainable consumption if the public are not

well-informed on which ones are the best-performing products and how to make the most

efficient use of the products. Malaysia, for example, is a country with impressive

developmental progress for years, however, there are clear evidences of negative externalities

on the environment. For example, most of the clean rivers are polluted because of unsuitable

emissions by sewage treatment plants, factories, farm animal, land destruction by cutting trees

and domestic solid waste disposal (Adham et al, 2013).






There are numerous environmental issues need to be properly addressed. Although Malaysia

was ranked as a 25th in terms of Environmental Performance Index (EPI) in 2011 in the

world, there is still a need to speed up the rate of the environment upkeep so as to reduce

environmental degradation. With the escalating needs for socio-economic advancement, due

to increase in people’s living standard and quality of life, it is necessary to ensure that

Malaysia’s economic growth is, at least, at par with the efforts which foster environmental

sustainability. Different policies need to be mainstreamed to promote sustainable consumption

and production practices for a balanced country’s future development. In the case of Malaysia,

the government SCP-related instruments include regulatory, economic and education, to name

a few (Adham et al., 2013). From the business perspective, the role can be made realized

through current business process such as innovation, marketing and communications and by

working in partnership with consumers (WBCSD, 2008).

The dawn of green concepts has carved the footprints towards environmental protection,

sustainable life style and sustainable development. The green culture need to be instilled and

the customers’ current habitual consumption behavior that are unsustainable need to be

changed (WBCSD, 2008). Nevertheless, consumer willingness to act on environmental

concerns would not be translated into sustainable behavior without factors like availability,

convenience, performance or any related information on the green products. Green marketing

is one of the strategic marketing plan aims to reduce the effects on the environment by design,

produce packaging, labeling and consumption (Delafrooz et al. 2013) It focuses on the ideal

marketing mix to achieve maximum profit potential while adhering to sustainability

principles. (Gittell et al, 2015). One of the effective green marketing strategies is understand

the market and the underlying values and beliefs of the consumers and develop a marketing

plan that aligns well with the values, beliefs, desires for qualities and affordability. Generally,

marketers would develop their strategies around these areas in marketing to enhance branding,

sales and profitability, hence creating a sustainable marketing strategy (Gittell et al, 2015)

Through green marketing, organizations use their environmental consciousness as a marketing

tool which act as a competitive advantage (Kontic & Biljeskovic, 2010). With the need to go

‘green’, it is now a high time for business organizations to opt for green marketing globally

(Bhalerao, 2014). Studies have shown that green marketing activities based on the marketing

mix elements, have had an important influence on increasing consumer knowledge and thus,

shifting consumers into purchasing green products (Delafrooz et al., 2013; Juwaher et al.,

2012; Cohen, 1973). Essentially, the intrinsic influent factors to purchase intention, and

insofar as customer`s loyalty to repurchase the green products are concerned, quality and trust

need to be taken into account. As also been discussed, green marketing strategies could be

fostered to earn consumer trust (Ottman & Mallen, 2014) and in another media form, it was

reported that trust, is actually the key to sustainable consumption (Upchurch, 2013).

The primary objective of this study is to identify the relationship between green perceived of

three marketing mix variables and two intrinsic factors on customer’s loyalty towards green

purchase. This study should shed a light on the business marketing strategy development so as

to increase customer perceived quality and trust and further promote customer`s green




purchase loyalty. The next section of this study focuses on review of previous studies,

followed by the conceptual framework. The section on Methodology explains the

Confirmatory factor analysis (CFA) and Structural Equation Model (SEM) to test the

reliability of the determinants and hypotheses of the study and data collection method. In

addition five related hypotheses on the key expected relationships were explained. In the

section ‘Results and discussion’ the finding of the CFA and SEM analysis were presented.

The last section includes the concluding part on the analysis for researchers in making new

strategies and policies.

2.0 Literature review and conceptual framework

Numerous research studies have indicated that today’s consumers are more concerned and

conscious about the environmental impact due to their daily consumption. For instance, the

study by Dagnoli(1990,1991) and Klein (1990) showed that 60 to 90 percent of consumers

would relate their purchasing habit to its environmental impact. There are several factors

which have shown significant effect on green purchase intention based on previous research

work. Some of these factors are similar in a number of studies, like consumer confidence and

satisfaction derived from the products. Based a study by Lassoued (2015) on food products,

consumers put more confidence on the credence attributes of the products i.e. brand quality

and safety, which are basically, intrinsic nature of the product. Likewise, trust is the other

intrinsic factor contributing consumer confidence, which is the key driver to brand loyalty and

hence purchase intention. A study by Aktepe and Toklu (2014) has shown the impact of

customer satisfaction on product loyalty. Their study was on loyalty towards organic products

in Indonesia by utilizing classification algorithms and Structural Equation Modeling. In

another study, positive effect of customer satisfaction and green purchase intention also has

been revealed (Morel, 2012). This study also explored the effect of four traditional marketing-

mix elements (price, promotion, products and place), as well as word of mouth (WOM) on

consumer`s attitude towards purchasing eco-friendly products specifically fasting moving

consumer goods or non-durable ones. The study concludes the important factors affecting

customer`s intention towards purchasing eco-friendly products are word of mouth and

advertising on green product itself. Word of mouth is a form of communication that is

happening between individuals and the people they trust: friends, family other users and

consumer organizations. To a certain extent, this word of mouth form pillars of trust which

could influence on the purchase intention of green products (Upchurch, 2013). Of the same,

overall positive correlation between effective green marketing strategies and customers’

purchase pattern for green products has been proved in a study on the impact of green

marketing on customers’ perception on environmental concerns and green products in

Mauritius (Juwaheer et al., 2010). Based on a study by Qinqin Liang (2014) on green

electronic products in China, all factors under study; attitude toward green purchase, green

perceived value, subjective norm and green trust show significant positive effect on purchase

intention. The study on green purchase has been extended to exploring leveraging factors for

sustained green consumption behavior based on consumption value perceptions. Two factors




found to be the most effective are customer`s price and knowledge perception that the

outcome of sustained green consumption is to pay the green price premium (Biswas et al,

2015).

One of the studies conducted in Malaysia by Wong et al (2012) on factors affecting youth

attitude in purchasing green products conducted in Malaysia and Singapore, four significant

factors which are perceived consumer effectiveness, health consciousness, attitudes toward

the environment, and social influence. Another study by Rizwan, et al (2013) explore the

influence of three intrinsic factors, namely, green perceived value, green perceived risk, and

trust on purchase intention based green marketing. The results show perceived value and risk

significantly related to trust and in consequence, towards purchase intention. The study,

however, does not discover any correlational relationship between value and risk. Jen Mei et

al (2012) reported findings from their study on antecedents of green purchase intention among

Malaysian consumers to determine the factors influence the green purchase intention. Some of

factors identified to have substantial influence on green purchase intention are environmental

knowledge; environmental attitude, governmental initiative and peer pressure.

Lee (2008) stated there is vast research work on green marketing in the Western countries

while this is not the case for the countries in Asia as such more of similar studies should be

done in the countries in these regions. Although many scholars in Malaysia agree on the

tremendous growth of green consciousness among the Malaysian consumers, the aspects of

purchase behavior are largely unobserved (Goh & Nabsiah, 2015; Kong et al. 2014). For this

study, a theoretical framework is adopted to explore the effect of green perception towards

green loyalty for several marketing mix elements, namely, price, place and promotion; and

two intrinsic motivational factors that are quality and trust. On realizing the strategic

importance of marketing mix and intrinsic factors on enhancing green product loyalty, the

conceptual model is proposed as shown in Figure 1. The conceptual framework for this study

exemplifies a number of relationships between green perceived marketing mix; promotion,

price, place;, and intrinsic factors i.e. quality and trust onto customer`s loyalty towards green

purchase. Figure 1 illustrates the hypothesized factors and outcomes of consumer loyalty

towards green purchase.

Figure 3: Proposed Research Model




The proposed conceptual framework considers three marketing mix elements; price,

promotion and place as the green marketing factors influencing the purchase intention, that

has attracted a large body of research. The framework also incorporates the imperative

intrinsic factors such as trust and quality which proven to have profound impact on green

purchase decision. It is important to highlight that the dependent construct of the model is

green product loyalty, a construct which is under-researched within the context of Malaysian

consumers.

3.0 Methodology

3.1 Hypotheses

The primary objective of identifying the association between green perceptions on several

marketing mix variables: price, place, promotion; and intrinsic factors of quality and trust

towards customer’s loyalty on green purchase, the following five research hypotheses were

tested:

H1: Green perceived promotion positively affect customer`s loyalty towards green purchase.

H2: Green perceived price positively affect customer`s loyalty towards green purchase.

H3: Green perceived quality positively affect customer`s loyalty towards green purchase.

H4: Green perceived trust positively affect customer`s loyalty towards green purchase.

H5: Green perceived place positively affect customer`s loyalty towards green purchase.

3.2 Research design

This study utilized an online survey to collect data from Malaysian residents’ perception on

purchasing green products in Malaysia. The data was collected within two-month period i.e.

during February and March 2015, 244 of the returned questionnaires are usable. The survey

was designed to elicit items for the six constructs in the conceptual model; three constructs for

perception on green marketing mix elements and two constructs of intrinsic factors and a

construct for loyalty towards green purchase intentions. A structured online questionnaire was

developed for this study. The questionnaire includes firstly, a section on respondents’

background such as gender, age, place of residence, monthly income. The second section

included the items or statements measuring on customer`s green perceptions on loyalty

towards green purchase. The perception measured statements represent one endogenous

construct: Loyalty and five exogenous constructs: Promotion, Quality, Trust, Place and Price.

Table 1 lists down the measured statements for each constructs. The perceptions were

assessed through a series of statements and rate on a 5 point Likert-type scale from “strongly

agree” (5) to strongly disagree (1). Data from respondents were tested for reliability, internal

consistency of measures using Cronbach’s alpha (Churchill, 1979).The data obtained from

respondents were cleaned and prepared for analysis stage. To identify the factors influencing

customer`s loyalty towards green purchase among Malaysian customers, this study utilizes the

confirmatory factor analysis (CFA) on structure equation modeling (SEM). Confirmatory

factor analysis (CFA) is used to evaluate the reliability or accuracy of the measurement

procedure. It also enable us to examine the research hypotheses if there are associations




between observed indicators (e.g., measured items of factors) and latent factors i.e. influence

on purchase intention on green products . Structure equation modeling (SEM) is a best way to

explore multiple relationships between factors and to estimate measurement properties and

theoretical relationships of the research framework (Hair, 2010) on factors influencing on

customer`s loyalty towards green purchase in Malaysia. To assess the validity of model the

other fit indices are also observed from the estimation of model fit. Chi-square, Goodness-of-

fit index (GFI), Adjusted goodness-of-fit index (AGFI), Comparative fit index (CFI), Normed

fit index (NFI) and root mean square error of approximation (RMSEA).

Table 2: Statements of measured items for each construct

Constructs Code Measured items/ Statements Loyalty Loy1 Over the past year, my loyalty to green product has grown stronger

Loy2 I have been a consumer of green products for sometimes

Loy3 I recommend Green products to my friends

Loy4 I pay attention to Green advertising

Loy5 The green products represent with high quality that I would like to repurchase green

products.

Loy6 I pay attention to my friends/family opinion concerning Green product

Loy7 I understand the information on Green packaging

Loy8 I am willing to pay a premium price for a Green product

Loy9 I would like to repurchase green products.

Loy10 Green product environmental functions provide very good value

Promotion Pro1 It is essential to promote green living in Malaysia

Pro2 The price of green products is lower than the average market price for similar

products

Pro3 I buy green products because they are cheaper options.

Pro4 I think the price of green products is reasonable

Pro5 Green products are well promoted

Pro6 Green products are reasonably priced

Quality Qua1 I think quality is an important criterion when I buy products

Qua2 It is important for me to buy high-quality products

Qua3 I think green products supposed to be good in quality

Qua4 I think green products are fresher than other products

Trust Tr1 Green product’s environmental reputation is reliable.

Tr2 Green product’s environmental performance is dependable.

Tr3 Green product’s environmental claims is trustworthy.

Tr4 Green product’s environmental concern meets my expectations.

Tr5 Green products protect the environment.

Tr6 Green product’s environmental reputation is reliable.

Place Pla1 I easily find Green products in a supermarket

Pla2 I know where the Green displays are located in my supermarket

Price Pr1 I compare prices of the other products with green product

Pr2 I always check prices at the supermarket among brands to ensure I acquire the best

value for money product




Pr3 I think price is important when I buy products

Pr4 When I buy the green products, I would ensure that I am getting its value for money

4.0 Results and Discussion

4.1 Characteristics of respondents

The sample observations totaled to 244 respondents who lives in different parts of Malaysia.

Of the total sample, 63.5% (155/244) were female and 36.5% (89/244) were male. Most of

respondents were Malay (46.7%, 114/244), Chinese (20%, 49/244), Indian (12%, 29/244) and

(21.3%, 52/244) international. Largely, the respondents’ age are in the range of 26-35 years

old (48.8%, 119/244) and 36.5%, 89/244 is in the 18-25 years category. (41%, 100/244) of

respondents have bachelor degree and 43%, 105/244 are either master or PhD holder. From

the employment status, 24.6%, 60/244: students, 21.7%, 53/244: not employed, 20.5%,

50/244: in the government sector and 25.8%, 63/244 in private sector. Majority of respondents

32%, 78/244 earn RM 2001 to RM4000 of monthly income. The largest percentage of

respondent live in Kuala Lumpur (40%, 97/244) and the second largest is in Petaling Jaya

(32%, 77/244). More than 40%, 104/244 of the respondents purchase green products at least

once a month and 29%, 71/244 purchase once a week.

4.2 Descriptive and Confirmatory factor analysis (CFA)

Table 2 depicts the several statistical results: descriptive statistics, CFA item loadings,

Cronbach’s Alpha coefficients for each measured items. The application of CFA during the

early stage of analysis is a way to estimate the significant constraints in the research model

and identify the number of factors on observed variables with specific values. CFA is an

example of the structural equation model (SEM), which known as the linear structural

relationship model (Jöreskog & Sörbom, 2004). The results presented in Table 2 show strong

factor loadings i.e., ≥ 0.4 (Cua et al., 2001) in all factors, except one measured item under

promotion, with significant p-values <0.001. Thus, all the items for each factor should be

included in the model but not promotion measured item number 6 with factor loading =0.076

< 0.4 and p-value= 0.273 > 0.001. The Cronbach’s alpha coefficients for all factors range

from 0.582 to 0.858, indicating the constructs are reliable measures.




Table 2: Summary results of measured items for each construct

CONSTRUCTS CODE/

ITEMS

MEAN SD ITEMS

LOADING

CRONBACH’S

ALPHA

ITEMS

ERROR

RESULT

LOYALTY Loy1 3.97 .678 .578 0.842

Loy2 3.42 .937 .555 0.847 .187 Supported

Loy3 3.66 .818 .527 0.843 .161 Supported

Loy4 3.59 .962 .564 0.856 .193 Supported

Loy5 3.64 .930 .698 0.846 .199 Supported

Loy6 3.93 .814 .696 0.855 .181 Supported

Loy7 3.77 .860 .667 0.852 .162 Supported

Loy8 3.79 .755 .712 0.857 .187 Supported

Loy9 3.72 .864 .724 0.845 .146 Supported

Loy10 3.99 .740 .535 0.858 .174 Supported

PROMOTION Pro1 3.16 1.009 .888 0.788

Pro2 2.57 1.006 .546 0.623 .075 Supported

Pro3 2.37 1.067 .422 0.658 .081 Supported

Pro4 2.99 1.144 .734 0.594 .086 Supported

Pro5 2.95 1.059 .496 0.678 .079 Supported

Pro6 4.16 .881

.076 0.619 .068 Not

Supported

QUALITY Qua1 4.30 .728 .635 0.701

Qua2 4.05 .892 .770 0.68 .189 Supported

Qua3 4.16 .808 .761 0.699 .171 Supported

Qua4 3.97 .824 .601 0.672 .132 Supported

Tr1 3.81 .726 .598 0.829

Tr2 3.76 .750 .723 0.788 .144 Supported

Tr3 3.65 .724 .686 0.811 .137 Supported

Tr4 3.66 .751 .798 0.804 .150 Supported

Tr5 3.69 .754 .674 0.823 .142 Supported

Tr6 4.10 .730 .608 0.799 .134 Supported

PLACE Pla1 3.51 .941 .822 0.799

Pla2 3.41 1.056 .815 0.582 .105 Supported

PRICE Pr1 4.07 .872 .678 0.582

Pr2 3.90 .906 .691 0.59 .158 Supported

Pr3 3.95 .795 .405 0.583 .111 Supported

Pr4 4.05 .823 .578 0.684 .125 Supported

*** Significant at < 0.001

4.2 Structural Equation Modeling (SEM)

To determine the factors influencing customer`s loyalty on green purchase, this study

employed structural equation modeling (SEM) by using Amos 20. SEM is among the best

methods to explore multiple relationships and measurement properties (Hair,2010). While

Table 3 depicts the hypothesis test results of each influent factor with the path coefficients,

Figure 2 illustrates the resulting structured model with the estimation of factors. Findings of

this study indicate that both green perceived intrinsic factors show positive associations to

customer`s loyalty towards green purchase (quality with β=0.232 and p-value<0.001, trust




with β=0.401 and p-value<0.001) Only one green perceived marketing mix element that have

positive effect on customer`s loyalty towards green purchase is place with β=0.232 and p-

value<0.001 However green perceived promotion (β=0.074; p-value>0.001) and green

perceived price (β= - 0.014;p-value>0.001) do not have significant effect on customer`s

loyalty towards green purchase. The squared multiple correlations result showed that 47% of

variation in the customer`s loyalty were explained by quality, trust and place which it is

exceed from 40%. Measure of model fit using five indices all indicate that the model is fit.

(Goodness-of-fit index (GFI =1 > 0.8, Adjusted goodness-of-fit index (AGFI) =0.994>0.8,

Comparative fit index (CFI) =1 > 0.9, Normed fit index (NFI) =0.999>0.9 and root mean

square error of approximation (RMSEA) =0.000 < 0.10, and the chi-square value estimated as

0.199 with p-value=0.656 > 0.05.

Table 3: Path Coefficient

Hypothesis Estimate S.E. C.R. P Results

H1 Loyalty <--- Promotion .074 .037 1.447 .148 Not Supported

H2 Loyalty <--- Price -.014 .044 -.303 .762 Not Supported

H3 Loyalty <--- Quality .232 .047 4.534 *** Supported

H4 Loyalty <--- Trust .401 .057 7.223 *** Supported

H5 Loyalty <--- Place .232 .032 4.456 *** Supported

*** Significant at p <0.001

Figure 4: Research structural model

5.0 Conclusion

This study identified the relationship between green perceived of three marketing mix

elements: place, price and promotion; and two intrinsic factors: quality and trust on

customer’s loyalty towards green purchase. The findings indicate that green trust is the most




important criteria in influencing customer`s loyalty towards green purchase, followed by

perceived quality and place. However, the association between promotion and price to

customer`s loyalty towards green purchase is not supported. Trust and quality are similarly the

influent factors affecting green purchase as revealed by the findings of previous studies by

Lassoued (2015) and Rizwan, et al (2013). This finding implies the customers concern about

environmental, social and economic issues are apparent and that they are increasingly willing

to act on those concerns. For business organizations, green trust among their customers and

potential customers can be fostered by contributing more efforts towards environmental

related activities. This can establish an environmentally friendly image to the public that they

are truly committed to the environmental issues. Increased green product positive public

image that further lead trust to purchase intention and thus, add growth to loyalty. From the

marketing mix perspectives, only place was found to have significant positive influence on

loyalty. Price and promotion do not support customers’ loyalty towards loyalty. It could

possibly be that the current practices of green marketing activities are not effective in

attracting the customers. Through strategic and innovative marketing mix elements, business

organizations could actually influence their customers’ choice and use of products that foster

sustainable consumption.

Findings of this study would provide several managerial implications for green marketing

strategy in different industry. First and foremost, it would help to better understand the factors

influencing consumers’ loyalty toward green product through improving the standard of green

product and indirectly improve the green product in the local market. Business organizations

should increase the customer`s loyalty by improving the quality of their products. The

importance of product`s quality is ability to create positive experiences to the consumers,

which has a critical role in developing customer`s loyalty. Through green marketing, customer

awareness, knowledge and understanding on the green products would be increased and more

importantly, it would help to change the way they consume and how to live more sustainable

lifestyles. Business organizations also can start becoming customer mentors on environmental

issues which help to build trust and loyalty on green products, and in turn, fostering

sustainable consumption.

This study was conducted based on a sample of respondents who lives in different part of

Malaysia with different cultural background, lifestyles and socio-economics with experiences

of purchasing green products. Therefore, there is a possibility of a cultural bias playing a role

in the outcome of the study. The results of this study are only supported by the sample of this

study. To further validate of the research model, the next step is to fit the model to different

target sample. Further study could be conducted to a different segment of consumers to a

larger sampling size or different geographical area. In this case the result may be reflective of

the actual purchase behavior of consumers in Malaysia. Continuous investigations using other

measures of the constructs may be necessary in order to increase the awareness of the green

products. Finally this study only focused on general multiple product categories, such as

organic food, cleaning products and therefore there is no sufficient evidence to support the




effect of price and promotion, however with focusing on specific products may produce

different findings.

6.0 References

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Planning Unit, Prime Minister’s Department With Financial Support From The European Union’s Programme.

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Towards Hotels And Restaurants In West Sumatra, Indonesia. Procedia Environmental Sciences, 20, 261 – 270.

Sachin Kumar Manglaa, P. K., Mukesh Kumar Baruaba. (2015). Risk Analysis In Green Supply Chain Using

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Intention Towards Private Label Food Products In Malaysia. Asian Journal Of Business And Management

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http://www.theguardian.com/sustainable-business/trust-marketing-mainstream-sustainable-consumption

http://www.wbcsd.org/




The Economic Impact of Terrorism: A new Model and is

Application

Alam Khan

Faculty of Economic and Public Administration


Abstract

This paper introduces a new economic model the terrorist attack vulnerability evaluation model (TAVE-Model)

to analyze the effects of a possible terrorist attack and its application to Pakistan economy. The TAVE-Model

relies on indicators such as economic desgrowth (-δ), intensity of terrorist attack (αi), terrorist attack losses (-π),

economic wear (Π) due to an attack, level of terrorist attack tension (ζ), level of negotiation (η) and total

economic leaking (Ωt) due to an attack. The underlying intuition is that the economic impact of a terrorist attack

depends on a country’s vulnerability to attacks from domestic and international terrorist groups, which jointly

determines the leakage from economic growth (-δ) and hence the impact on growth. The TAVE-Model shows that

if the real GDP growth rate (∆Оr) is small, then the total economic leaking (Ωt) due to an attack will always

affect economic performance. At the same time, this economy will experience permanent economic desgrowth (-

δ). On the other hand, if the real GDP growth rate (∆Оr) is high, then total economic leaking (Ωt) due to a

terrorist attack will have a more limited impact in the beginning stage. Total economic leaking (Ω t) will cause

economic desgrowth (-δ) only at a later stage. The quantitative estimates of the economic cost of terrorism

generated by TAVE- model should give policymakers at least some rough clues about what is at stake economically in the event of a terrorist attack.

Key Words: Desgrowth; Terrorism; GDP; TAVEmodel




Linear and Nonlinear Causal Relationship Between Energy

Consumption and Economic Growth in China: New Evidence Based

on Wavelet Analysis

Ha Junsheng, Tan Pei Pei, Goh Kim Leng

Faculty of Economics & Administration

University Of Malaya


Email Address: [email protected]

Abstract

This paper attempts to re-assess the nexus between energy consumption and economic growth in China with linear

and nonlinear tests based on wavelet multiscale analysis. Autoregressive distributed lag (ARDL) model is adopted to

test the long run relationship on the original annual data from 1953 to 2011. The results supports neutrality

hypothesis. In addition, the new nonlinear causality test proposed by Nishiyama et al (2011) also failed to detect

energy-growth nexus in any direction. Thus the data are then decomposed by Maximal Overlap Discrete Wavelet

Transform into time series at different time scales that correspond to short, medium and long term time horizons.

The standard linear causality test identifies feedback relationship between economic growth and energy

consumption at all the time scale (short, medium and long run). Moreover, the nonlinear causality test reveals

evidence of nonlinear causality relationship only in the long run, which further supports the feedback hypothesis on

energy-growth nexus. The estimated results imply that Chinese economic development is strongly energy dependent.

Therefore, delicately designed energy policy aiming at sustaining economic growth and tackling environmental

issues simultaneously should be implemented in China.

Key words: Wavelet transforms, Granger causality, ARDL, Energy consumption, Economic

growth.

1 Background and motivation of study

Over the past few decades, the relationship between energy consumption and economic growth

still appear controversial despite the numerous studies that have been conducted. Yet, more

attention has been drawn to this field due to its importance in providing policy implications. If

unidirectional causality relationship is found from economic growth to energy consumption as

found by Kraft and Kraft (1978) and Abosedra and Baghestani (1991), i.e. the conservation

hypothesis, then energy conservation policy can be implemented since it will have little or no

negative impact on the economic growth; if the causality relationship is found to run in the





opposite direction as found by Stern (1993) and Zarnikau (1996), i.e. the growth hypothesis, then

energy conservation policy is expected to hamper the economic growth. Hence alternative energy

policy needs to be designed. These policy insights are especially needed in countries that aim at

sustaining fast economic growth.

China is one of the countries with impressive economic growth performance. In the past decades,

its growth rates has maintained at highest rates ever. In order to sustain its fast economic

development, the government has been spending great amount of capital, especially in energy-

intensive sectors. As a result, energy consumption has kept increasing. China has already

surpassed U.S. to become the largest energy consumer in the world as reported by the U.S.

Energy Information Administration (2013); while at the same time, China is also the world’s

second largest economy(World bank 2013), of which 2012 GDP reached US. $ 8.358

trillion(World bank 2013). However, from 1953 to 1980, the real GDP per capita (GPC) of China

has grown at a rather slow rate; only since the late 1980s, the GPC has been growing sharply as

indicated in Figure 1. This trend can be addressed to the implementation of the economic reform,

more specifically the so-called “Open Door policy”, which was initiated in around 1980. Before

the economic reform, due to problems relating to its closed economic system and poor

infrastructures, the economy was rather stagnant. After the reform, the economic policies were

aiming mainly at stimulating economic growth therefore the GDP per capita started to grow

faster than ever. Yet, due to its large population, in 2012, the GPC of China is reported to rank

77th in the world as compared to that of USA rank 11th (Schwab 2013). As the GPC of China is

still low while the population is still large and increasing, China government will certainly have

to take a much longer time than others to meet its economic target, which gives it little room to

slow down the economic development. On the other hand, although Energy consumption per

capita of China has been increasing at a very slow rate throughout the past decades as indicated

by the flat line in Figure 1, due to the tremendous amount of total energy consumption and its fast

growing rate, China is the world’s biggest emitter of greenhouse gases (GHGs)1, which has put it

under international pressure to be more responsible towards the environment, i.e. to reduce GHGs

emission. The direct solution seems to be reduction in energy consumption. This puts China into

dilemma: if the energy consumption has positive influence on economic growth (growth

hypothesis) then adopting energy conservation policies will definitely hamper the sustainable

growth, although it may cause reduction in GHGs emission. If this were true, then the

Government would have to make alternative policies, for example, focusing more on the clean

energy development. Therefore, there is dire need to identify the accurate interactive nexus

1 The international organizations have reported this fact since the year 2007(The New York Times. (2007). "China

overtakes U.S. in greenhouse gas emissions." Retrieved 07/12/2013, from

http://www.nytimes.com/2007/06/20/business/worldbusiness/20iht-emit.1.6227564.html?_r=0.); however, Chinese

government did not acknowledge it until recent years ( Buckley, C. (2010). "China says it is world's top greenhouse

gas emitter." Retrieved 7/12/2013, from http://www.reuters.com/article/2010/11/23/us-climate-cancun-china-

idUSTRE6AM1NG20101123.)




between economicgrowth and energy consumption in order to help Chinese Government design

proper and prudent energy policies that can help the country meet its own expected targets while

solving problems such as environmental issues.

Fig.1. Energy consumption per capita and real GDP per capita (1953-2011),

SCE indicates standard coal equivalent

Source: Calculations based on the data of the National Bureau of Statistics of China

However, the existing energy economy literature has produced rather contradicting results on

energy-growth nexus in China. By conducting a thorough literature review on the studies of

Chinese energy economy, Ma, Oxley et al. (2010) conclude that the possible reasons of the mixed

findings include the differences in the methods used, study periods, data sources and coverage of

independent variables. Table 1 summarizes the existing literatures and their findings in China.

Table 1 Selected literatures and their findings on energy-growth nexus in China

Authors Period Methodology Causality relationship

Shiu and Lam (2004) 1971-2000 Bivariate model (ECM) Energy(electricity)→GDP in

both short and long run

Soytas and Sari (2006) 1971-2002 Multivariate model (T-Y) Energy---GDP (no cointegration) Zou and Chau (2006) 1953-2002 Bivariate model (ECM) Energy (oil)→GDP in short run

Energy (oil) ↔GDP in long run

Chen, Kuo et al. (2007) 1971-2001 Bivariate model (ECM) GDP---Energy (electricity)

Yuan, Zhao et al. (2007) 1978-2004 Bivariate model (ECM) Energy (electricity) →GDP in

both Short and long run

Zhang and Cheng (2009) 1960-2007 Multivariate Model (T-Y) GDP→Energy in the long run

Wang, Wang et al. (2011) 1972-2006 Multivariate (ARDL) Energy→GDP in both long and

short run




Talha Yalta and Cakar (2012) 1971-2007 meboot with bootstrap Engery---GDP

Zhang and Yang (2013) 1978-2009 Multivariate (T-Y) Energy↔GDP in the long run

Note: “→” stands for “unidirectional Granger cause” , “---“ stands for “does not Granger cause” and “↔” stands for “bidirectional Granger cause”.

Shiu and Lam (2004) found unidirectional causality from electricity consumption to GDP during

1971 to 2000 in both short and long run using error correction model (ECM). Then Soytas and

Sari (2006) applied Toda-Yamamoto (T-Y) test (1995) and found no causality relationship

between energy consumption and GDP from 1971 to 2002. Zou and Chau (2006) again adopted

the ECM model and reported unidirectional causality from oil consumption to GDP in the short

run and bidirectional causality between oil consumption and GDP in the long run during 1953 to

2002. However, applying same method, Chen, Kuo et al. (2007) fail to capture any causality

between GDP and electricity consumption from 1971 to 2001. One the other hand, Yuan, Zhao et

al. (2007) reported unidirectional causality from electricity consumption to GDP in both long and

short run during 1978 to 2004 using Bivariate ECM. Zhang and Cheng (2009) adopted

Multivariate model using T-Y test procedure and found unidirectional causality from GDP to

Energy in the long run on the period of 1960 to 2007. Wang, Wang et al. (2011) also adopted

Multivariate model but using Autoregressive Distributed Lag (ARDL) test approach and reported

unidirectional causality from energy consumption to GDP in both short and long run. Talha Yalta

and Cakar (2012) applied meboot technique with bootstrapping and reported findings that

supports neutrality hypothesis in China. Zhang and Yang (2013) adopted Multivariate model with

T-Y test procedure and found bidirectional causality between energy consumption and GDP.

From these studies above, we can see that analysis based on different methods and data sample or

even same methods do not provide consistent findings on energy-growth nexus.

In order to have more reliable and conclusive findings, Karanfil (2009) advises to look for new

research direction, new perspective and adopt new techniques. He suggests that applying the

same traditional techniques on different data sets or time periods will only add more confusing

results to the literature. This was supported by Payne (2010) and Ozturk (2010), who have

conducted comprehensive literature reviews on the empirical studies conducted in the past three

decades. They have come to the similar conclusion that we should adopt new approach and

methods. In addition, Talha Yalta and Cakar (2012) suggest that the future studies should adopt

the “state of art econometric methods” and be “more focused and detailed” in identifying reliable

information on the energy-growth nexus with robust test results.

In line with these suggestions, this study differs from the existing literature in at least two ways.

First, this study adopts wavelet analysis to examine the potential multi-scale causality

relationship between energy consumption and economic growth in China, which is neglected in

the literature. Granger (1969, 1980) suggested that rather than testing the causality over a single

period a more meaningful causality test should be conducted across different periods using a

spectral-density approach. In line of this, as a preliminary effort to capture the relationship




between the cyclical components of electricity consumption and economic growth, Yuan, Zhao et

al. (2007) used Hodrick-Prescott approach to decompose the series. They found that

conintegration relationship exist between both the trend components and the cyclical

components. However, the HP filtering method has been criticized by Harvey and Jaeger (1993),

Cogley and Nason (1995), Baxter and King (1999) and McCallum (2000) among others. The

main drawback is that if the original series is stationary at difference, the HP filtering causes

distortion to its dynamics by inducing spurious information in the cyclical components. In

contrary, wavelet decomposition is considered to be the method that formalizes the concept of

decomposition (Ramsey 1999) and it is proved to preserve the information before and after the

filtering. Ozun and Cifter (2007) conducted the first study to examine energy-growth nexus using

wavelet multi-scale analysis in Turkey. With the same data of Soytas and Sari (2007), they

managed to identify the causality relationships at different time scales which were not revealed

by the former study. Likewise, Aslan, Apergis et al. (2013) applied the wavelet decomposition

method to the US energy market and they found that at the high frequency (short term), energy

consumption is influenced by GDP, which is consistent with the results of the causality

relationship of the original time series. Furthermore, at the lower frequency (medium and long

term), the bidirectional relationship is found. Therefore, it concludes that the short term dynamic

dominates the longer term relationship. Inspired by these studies, we decompose the data series

of energy consumption and economic growth to study the causality relationship on a scale by

scale basis in China. Second, this study aims to capture the information on the nonlinear causality

relationship. Payne (2010) suggests that the information captured by linear causality test may not

be adequate to reveal the energy-growth nexus therefore research adopting nonlinear causality is

worthwhile. Few studies have been done in order to detect the nonlinear causality in the

international market, e.g. Lee and Chang (2007), Chiou-Wei, Chen et al. (2008) and Dergiades,

Martinopoulos et al. (2013). However, the techniques adopted in these studies seem not be able to

draw reliable conclusions. For example, Chiou-Wei, Chen et al. (2008) admit the drawback of the

technique used that may have caused over-rejection problem despite the promising results found

in their study. In our study we adopt the newly proposed consistent technique by Nishiyama,

Hitomi et al. (2011) that will help provide accurate information to the policy makers. Overall, the

novelty of combining the wavelet analysis with both linear and nonlinear causality test helps

reveal the hidden information on the energy-growth nexus in China.

The rest of this article is organized as follows. Empirical methods, data source will be explained

in section 2; Section 3 reports and analyzes the results and section 4 offers concluding remarks.




2 Methodology and Data

2.1 Time-frequency Wavelet Decomposition

In order to overcome the limitations of the traditional Fourier transform, which assumes the time

series to be stationary2, or in another sense with constant frequencies over time, wavelet

transform was introduced so that time-varying characteristics of the time series could be studied.

This improvement is possible due to the deliberately chosen or designed wavelets. A wavelet is a

mathematical function, 𝑥(𝑡) , that fulfills the following two conditions(Gençay, Selçuk et al.

2001):

∫ 𝒙(𝑡)𝑑𝑡 = 0∞

−∞ (1), ∫ |𝒙(𝑡)|2 𝑑𝑡 = 1

∞

−∞ (2)

These conditions ensure that the wavelet function must go up and down in waveform along the x-

axis and the energy of the wavelet is unity. There are different types of wavelets available that

suits the needs of studying variety of time series. In this study, we choose the Daubechies Least

Asymmetric wavelet with length of 8(LA8) since it “is orthogonal, near symmetric and have a

compact support and good smoothness properties”(Benhmad 2011).

Having selected the wavelet filter, we need to choose the suitable type of wavelet

transform. There are two types of wavelet transforms. One is Continuous wavelet transform

(CWT), which is to project the original time series onto the wavelets,ψ𝑢,𝑠(𝑡), in order to obtain

the wavelet coefficients. ψ𝑢,𝑠(𝑡) are generated by scaling (s) and translation (u) of a basis or

mother wavelet, ψ(t) (Aguiar-Conraria, Azevedo et al. 2008):

ψ𝑢,𝑠(𝑡) =1

√|𝑠| ψ(

𝑡−𝑢

𝑠), s, u ∈ 𝑅, 𝑆 ≠ 0 (3)

Where “s” and “u” are the scaling and translation parameter; “s” determines the wavelet length

while “u” indicates the wavelet location and 1

√|𝑠| is used to ensure the norm of the daughter

wavelets to be unity.

CWT is presented as (Benhmad 2012):

W(u, s) = ∫ 𝑓(𝑡)∞

−∞ψ𝑢,𝑠(𝑡)𝑑𝑡 (4)

2 Therefore it has minimum applicability in economic time series study as it has been found that most of

macroeconomic time series are nonstationary at level, Nelson, C. R. and C. R. Plosser (1982). "Trends and random

walks in macroeconmic time series: some evidence and implications." Journal of monetary economics 10(2): 139-

162..




However, CWT has its draw back as it utilizes all possible integers for “s” and “u” in equation 3

and 4. Therefore, it has the problem of generating redundant amount of information from the

original time series (Gençay, Selçuk et al. 2001). Discrete wavelet transform (DWT) is developed

to overcome this drawback by keeping the minimum but sufficient number of coefficients that are

able to preserve the complete information from the original time series by removing some

unnecessary coefficients in CWT. The DWT is conducted by a critical sampling of the CWT

coefficients by setting conditions for the parameter “s” and “u” in equation 1 as follows(Gençay,

Selçuk et al. 2001):

𝑠 = 2−𝑗 and 𝑢 = 𝑘2−𝑗, 𝑗, 𝑘 ∈ 𝑍 (5)

It is clear from equation 5 that this sampling is dyadic. With these conditions, minimum basis

functions for DWT is produced via(Gençay, Selçuk et al. 2001):

ψ𝑗,𝑘(𝑡) = 2𝑗

2ψ(2𝑗𝑡 − 𝑘) 𝑗, 𝑘 ∈ 𝑍 (6)

Equation 6 creates an orthogonal basis for DWT based on which, a time series with length N can

be analyzed by DWT at dyadic scales and the largest number of scales or decomposition level,

“j”, in equation 5 and 6 is given by the formula (Gençay, Selçuk et al. 2001):

𝑗 = log2(𝑁) (7) Where N is the sample size.

To implement DWT, two filters are needed. A wavelet filter ψ𝑙 = (ψ1 … + ψ𝐿−1) and a scaling

filter φ𝑙 = (φ1 … + φ𝐿−1). The wavelet filter is obtained by equation 6 and has the following

properties:

∑ ψ𝑙 = 0𝐿−1𝑙=0 (8), ∑ ψ𝑙

2 = 1𝐿−1𝑙=0 (9), and ∑ ψ𝑙

𝑙−1𝑙=0 ψ𝑙+2𝑛 = 0 (10)

Where L stands for the even integer width of the filters.

These properties ensure that: (1) the wavelet filter must integrate to zero; (2) it must have unit

energy; (3) it is orthogonal to its even shifts. The scaling filter is related to wavelet filter by a

quadrature mirror filter relationship: φ𝑙 = (−1)𝑙+1ψ𝐿−1−𝑙 for 𝑙 = 0, … , 𝐿 − 1.

By using these filters, the original time series,𝑥(𝑡), is decomposed into subseries that contain

different information at different time scales. Practically, the DWT is implemented by using a

pyramid algorithm introduced by Mallat (1989). At the first decomposition level, 𝑥(𝑡) is filtered

by wavelet filter ψ1,𝑙(high-pass) and scaling filter φ1,𝑙 (low-pass) to obtain the wavelet and

scaling coefficients 𝑑1,𝑡(high frequency) and 𝑠1,𝑡(low frequency). These coefficients are

downsampled to be at half length of 𝑥(𝑡) by removing every 2𝑗 coefficients. 𝑑1,𝑡provide the

details information or the short-term components that indicate the fluctuations or noise of the




original series while 𝑠1,𝑡 contain the approximation information or the long-term component that

represents the trend of the original series. In the next level, the scaling coefficients 𝑠1,𝑡 is further

filtered or decomposed into high and low frequency components 𝑑2,𝑡 and 𝑠2,𝑡. This process is

then repeated until the highest decomposition level j, which is determined by equation 7. A DWT

with j decomposition level decompose the original time series into high frequency wavelet

coefficients, 𝑑1,𝑡 , 𝑑2,𝑡 , … 𝑑𝑗,𝑡 and low frequency scaling coefficients 𝑠𝑗,𝑡.

The DWT representation of the original time series is presented below(Tiwari, Dar et al. 2013):

𝑥(𝑡) = ∑ 𝑠𝑗,𝑘φ𝑗,𝑘(𝑡)𝑘 + ∑ 𝑑𝑗,𝑘𝑘 ψ𝑗,𝑘(𝑡) + ∑ 𝑑𝑗−1,𝑘𝑘 ψ𝑗−1,𝑘(𝑡) + ⋯ + ∑ 𝑑1,𝑘𝑘 ψ1,𝑘(𝑡) (11)

Where 𝑠𝑗,𝑘 is the smooth/approximation coefficients that capture the trend of the original time

series 𝑥(𝑡) while 𝑑𝑗,𝑘 to 𝑑1,𝑘 represent the detail coefficients that contain the information on the

short-term deviation from the trend.

Equation 11 also shows that the original time series can be reconstructed by adding up the short-

term and trend components. This reconstruction process is regarded as the multiresolution

analysis (MRA) (Mallat 1989).

In practice, Maximal Overlap DWT(MODWT), an alternative version of DWT, is usually

preferred for the following reasons: 1) MODWT is able to handle data with any sample size,i.e.

not only power of 2, 2) the transform is invariant to shift, i.e. a shift in the time series will not

cause alterations in the transform coefficients(Tiwari, Dar et al. 2013). Moreover, it is not very

crucial in choosing specific wavelet filter when MODWT is implemented(Percival and Walden

2000). As compared to DWT, there is no downsampling of coefficients in MODWT. The

MODWT Scaling coefficients 𝑣𝑗,𝑡 and wavelet coefficients 𝑤𝑗,𝑡 are obtained as:

𝑤𝑗,𝑡 = ∑ 𝜔𝑗,𝑙𝑋𝑡−𝑙 𝑚𝑜𝑑 𝑁𝐿−1𝑙=0 (12) and 𝑣𝑗,𝑡 = ∑ δ𝑗,𝑙𝑋𝑡−𝑙 𝑚𝑜𝑑 𝑁

𝐿−1𝑙=0 (13)

Where the wavelet filters 𝜔𝑙 and scaling filters δ𝑙 for MODWT are obtained by rescaling their

counterparts of DWT as:

𝜔𝑗,𝑙 =ψ𝑗,𝑙

2𝑗

2⁄ (14) and δ𝑗,𝑙 =

φ𝑗,𝑙

2𝑗

2⁄ (15)

Equation 14 and 15 indicate that, in contrary to DWT filters, the filters of MODWT have half

energy.

When applying MODWT, a practical issue facing the researcher is called boundary condition.

Nason (2008) explains the problem in details that when calculating the wavelet coefficients,

especially using long filters such as Daubechies’, some sample values at the length boundary will

be missing due to the calculation method. Gençay, Selçuk et al. (2001) state the similar cause that




when one end of the data series is encountered during filtering, an established method is needed

to calculate the remaining coefficients. In this study we use a common method, which is to

assume that the original time series x(t) is with symmetric end reflection, i.e. x(-t)=x(t) and

x(1+t)=x(1-t), e.g. x(-1)=x(1).

2.2 Bounds Testing Procedure for Cointegration

This study adopted the ARDL bounds testing procedure, which was initially proposed by Pesaran

and Shin (1998) and then extended by Pesaran, Shin et al. (2001), to examine the long-run

cointegration relationship between energy consumption and economic growth. The cointegration

test is conducted to avoid spurious regression problem using the data series with long-run

equilibrium relationship. The ARDL approach is selected based on its advantages over other

methods. First, the series under study need not to be integrated of the same order. They can be a

mixture of I(0) and I(1). Second, it can be applied on the data with small sample size. Third, it

provides relatively reliable results even if some of series is endogenous (Harris and Sollis 2003)

and it does not have the problem of pushing the short-term dynamic into the residuals since it is

not residual-based test (Banerjee, Dolado et al. 1993, Banerjee, Dolado et al. 1998, Pattichis

1999). The ARDL model is presented below:

∆𝑙𝑛𝑒𝑐𝑡 = 𝑎0 + ∑ 𝑎1𝑖∆𝑙𝑛𝑒𝑐𝑡−𝑖 + ∑ 𝑎2𝑖∆𝑙𝑛𝑔𝑝𝑐𝑡−𝑖 + 𝑎3𝑙𝑛𝑒𝑐𝑡−1 + 𝑎4𝑙𝑛𝑔𝑝𝑐𝑡−1 + 𝜇𝑡𝑛𝑖=0

𝑛𝑖=1 (16)

∆𝑙𝑛𝑔𝑝𝑐𝑡 = 𝑏0 + ∑ 𝑏1𝑖∆𝑙𝑛𝑔𝑝𝑐𝑡−𝑖 + ∑ 𝑏2𝑖∆𝑙𝑛𝑒𝑐𝑡−𝑖 + 𝑏3𝑙𝑛𝑔𝑝𝑐𝑡−1 + 𝑏4𝑙𝑛𝑒𝑐𝑡−1 + 𝜇𝑡𝑛𝑖=0

𝑛𝑖=1 (17)

Where ln denotes the natural log, ec is energy consumption per capita, and gpc is real GDP per

capita. ∆ is the first difference operator and 𝜇𝑡 is the white noise error term. n is the maximum

lag length.

The bounds testing procedure examines the long-run relationship by restricting the lagged level

variables 𝑙𝑛𝑒𝑐𝑡−1 𝑎𝑛𝑑 𝑙𝑛𝑔𝑝𝑐𝑡−1. A joint significance F-statistic is used to test the null hypothesis

of no cointegration as H0:a3=a4=0 and H0:b3=b4=0 against the alternative hypothesis of

cointegration as Ha:a3≠a4≠0 and Ha:b3≠b4≠0 in equation 11 and 12 respectively. Two sets of

critical values for the large sample size (500 to 1000 observations) are reported by Pesaran, Shin

et al. (2001). Narayan (2005) calculated critical values for sample size (30 to 80 observations),

which is more suitable and therefore used in this study. The set of upper bound assumes that all

the variables are I(1) while the set of lower bound assumes them to be I(1). If the F-statistic is

greater than the upper bound critical value, the null hypothesis of no cointegration is rejected. If it

is smaller than the lower bound critical value, the null hypothesis cannot be rejected. But if it

falls in between the two bounds, the cointegration test becomes inconclusive.




2.3 Nonlinear Causality Method

In order to capture the nonlinear causality relationship between energy consumption and

economic growth in China, we adopt a recently proposed powerful test by Nishiyama, Hitomi et

al. (2011). Using Monte Carlo simulation, the test is proved to have nontrivial power against √𝑇

local alternatives, where T is the sample size. The simulation also shows that the test has good

size and power properties. We briefly describe the test in this section following Nishiyama,

Hitomi et al. (2011).

The standard Granger causality is defined based on the concept of optimum linear predictor.

Hence the causality from economic growth (Y) to energy consumption(C) is defined when the

linear prediction of energy consumption can be improved by the current and the past information

of economic growth as shown in equation 18.

E[Ct−P(Ct|Ct-1,…,C1)]2˃ E[Ct−P(Ct|Ct-1,…,C1, Yt-1,…,Y1)]2 (18)

Where P is the optimum linear predictor.

Nishiyama et al(2011) try to not only capture the linear but also nonlinear dependency between

the two time series by replacing the linear predictor by conditional expectation. They define

possible nonlinear causality as:

E[Ct−E(Ct|Ct-1,…,C1)]2˃ E[Ct−E(Ct|Ct-1,…,C1, Yt-1,…,Y1)]2 (19)

Where E is the conditional expectation.

By rearrangement, the null hypothesis is:

E(Ct|Ct-1,…,C1, Yt-1,…,Y1)− E(Ct|Ct-1,…,C1)=0 with probability one (20)

While the alternative hypothesis is:

E[E(Ct|Ct-1,…,C1, Yt-1,…,Y1)]− E(Ct|Ct-1,…,C1)2>0 (21)

The authors managed to construct the test statistic S based on moment conditions. Therefore, the

test is considered as one of the tests for omitted variables, which has been discussed extensively

in the literature by Bierens(1982, 1984), Robinson (1989), Bierens and Ploberger (1997), Chen

and Fan (1999) among others. Interested readers are referred to Nishiyama, Hitomi et al.

(2011)for detailed construction of the test statistics. In addition, the critical value is calculated

using simulation. As Gonzalo and Taamouti (2011) pointed out, this test has the advantage with

simple simulation process and in the sense that its critical values are independent from the data.




The test statistics and the critical values are calculated by using the Gauss code developed by

Nishiyama, Hitomi et al. (2011)3.

2.4 Data Description

The sample data used in this study are annual time series for China during the period of

1953 to 2011. The data of real GDP per capita (gpc) is obtained by adjusting the nominal GDP

per capita with the GDP deflator (GDP index) (base 1952=100). The data of energy consumption

per capita (ec) is obtained by dividing total energy consumption by the average total population.

All these data are collected from the National Bureau of statistics of China. The variables are

transformed into natural logarithm (lnec and lngpc respectively) therefore their first differences

represent their growth rates.

3 Empirical Evidence

3.1 Wavelet Decomposition

We first We carried out wavelet decomposition on the real GDP per capita (lngpc) and energy

consumption per capita (lnec) time series into 6 decomposed time series d1, d2, d3, d4, d5 at

different time scales corresponding to different frequency components of the original series and a

smoothed series of s5 which respresents the long run trend of the original series. The original

series is then represented in the time-frequency domain. The d1 represents the lowest time scale

(highest frequency) that occurs at a time horizon of 2 to 4 years while d5 represents the highest

time scale (lowest frequency) of 32 to 64 years. S5 represents the trend of the original series that

occur at a time horizon longer than 64 years. The decomposed d1 to d5 and the s5 of lnec and

lngpc are shown in Figure 2 and Figure 3 respectively.

3 We thank Prof. Nishiyama for sharing the code.




Figure. 2. The decomposed time series of energy consumption per capita (lnec), 1953-2011




Figure. 3. The decomposed time series of real GDP per capita (lngpc), 1953-2011

3.2 Unit Root Results

Both linear and nonlinear causality tests require the knowledge order of integration about the

time series under study. Hence, we carried out the standard unit root tests: Augmented Dickey-

Fuller (ADF), Phillips-Perron (PP) and Kwiatkowski-Phillips-Schmidt-Shin (KPSS) tests. The

Results of these unit root tests are presented in Table 2. For the original time series lnec and

lngpc, although KPSS test show some conflicting results, ADF and PP tests strongly indicate the




series to be I (1). For the decomposed time series d1 to d5 of lnec and lngpc, although there are

some conflicting results, overall these series are confirmed to be I (0).

Table 2 Unit root test

ADF PP KPSS

Level lnec -2.93 -3.27 0.07

Lngpc -1.35 -0.91 0.24***

ec_d1 -8.19*** -57.26** 0.11

ec_d2 -2.97** -4.16*** 0.19

ec_d3 -4.99*** -3.56*** 0.03

ec_d4 -3.03** -2.86* 0.06

ec_d5 -4.82*** -1.67 0.14

gpc_d1 -8.05*** --44.46*** 0.16

gpc_d2 -2.52 -3.93*** 0.20

gpc_d3 -3.49** -3.70*** 0.03

gpc_d4 -2.98** -1.11 0.07

gpc_d5 -7.06*** -0.05 0.24

First differences Lnec -4.33*** -4.47*** 0.10

Lngpc -5.43*** -4.80*** 0.57**

Notes: The optimal numbers of lags for ADF tests were selected based on SIC; the bandwidth for KPSS and

PP tests were chosen based on Newey-West selection procedure using Bartlett kernel. *, ** denote significance

at 5% and 1% respectively. The model of trend with intercept is chosen for the two original series while the

model with intercept only is chosen for all the wavelet reconstructed series.

3.3 ARDL Test Results

Although ARDL test does not require the information on the exact order of integration for the

data series, none of the series should be integrated of the order greater than 1. According to the

unit root test in the previous section, it is confirmed that both of the original series are I (1).

Therefore, we may safely proceed to test the long run relationship between energy consumption

and economic growth using ARDL test.

The initial step in applying ARDL test is to determine the optimal lag order for each variable in

the testing equation. We choose the maximum lag order as 3 years for our annual data as

suggested by Enders (2004) to be relatively long in order to capture the dynamic relationship

between the series. Based on Akaike’s Information Criterion (AIC), the optimal combination lag

order is selected as ARDL (3, 1), when lnec is the dependent variable and ARDL (2, 3) when

lngpc is the dependent variable. A general-to-specific approach with consideration of removing

serial correlation is adopted to find the parsimonious equation for the two models. Finally, the

final equations are selected as:




∆𝑙𝑛𝑒𝑐𝑡 = 𝑎0 + 𝑎1 ∆𝑙𝑛𝑒𝑐𝑡−1 + 𝑎2∆𝑙𝑛𝑒𝑐𝑡−3 + 𝑎3𝑙𝑛𝑔𝑝𝑐𝑡−1 + 𝑎4𝑙𝑛𝑒𝑐𝑡−1 + 𝜇𝑡 (19)

∆𝑙𝑛𝑔𝑝𝑐𝑡 = 𝑏0 + 𝑏1∆𝑙𝑛𝑔𝑝𝑐𝑡−1 + 𝑏2∆𝑙𝑛𝑔𝑝𝑐𝑡−2 + 𝑏3∆𝑙𝑛𝑒𝑐𝑡−1 + 𝑏4𝑙𝑛𝑔𝑝𝑐𝑡−1

+𝑏5𝑙𝑛𝑒𝑐𝑡−1 + 𝜇𝑡 (20)

We conducted diagnostic tests on the residuals (not reported here, available upon request). Both

models pass serial correlation test, ARCH test. However, both of the models have the problem of

non-normal errors. Yet, this will not affect the coefficient estimates as the non-normality problem

is mainly caused by excess kurtosis according to Paruolo (1997) as cited by MacDonald and

Ricci (2004), Hanif, Alavi et al. (2011) and Nordin, Nordin et al. (2014). Functional form test

shows that Equation 2 has some problem of misspecification but equation 1 is free from such

problem. This kind of problem is quite common. In fact Pesaran, Shin et al. (2001) also identified

some functional form problem and they addressed the cause to “some non-linear effects or

asymmetries in the adjustment”. Overall, these two equations should provide a sound basis for

cointegration test. The calculated F-statistics for cointegration and the results of the diagnostic

tests on the ARDL model are reported in Table 3. In both models, the Null of no cointegration

relationship between energy consumption and economic growth cannot be rejected at 5% level,

which supports the neutrality hypothesis.

Table 3 The results of ARDL test

Dependent variable Calculated F-statistic

Lnec 4.587

Lngpc 2.746

Critical value (F-test)

Significance level lower bounds I(0) Upper bounds I(1)

1% 7.400 8.510

5% 5.125 6.000

Note: the critical values for lower and upper bounds are obtained from Case III as in Narayan (2005):

Unrestricted intercept and no trend (k=1)

These findings are consistent with the studies of Soytas and Sari (2006), Chen, Kuo et al.

(2007) and Talha Yalta and Cakar (2012) but contradictory with other studies. The usual practice

when the method fails to capture long run relationship among nonstationary data is to difference

them and apply standard Granger causality test on the first differences. However, in this study,

we will try to explore the Granger causality relationship between economic growth and energy

consumption in China by using wavelet-multiscale analysis. The details are presented in the next

section.




3.4 Linear and Nonlinear Granger Causality Test on the Decomposed Time Series

Since using ARDL technique failed to capture any cointegration relationship between energy

consumption and economic growth, we conduct both linear and nonlinear(Nishiyama, Hitomi et

al. 2011) causality tests using the first difference of the original time series(lnec and lngpc). As

shown in Table 4, a unidirectional linear causal relationship running from energy consumption to

economic growth is found while no nonlinear causal relationship is captured between the two

variables. This result is partially consistent with Shiu and Lam (2004), Zou and Chau (2006),

Yuan, Zhao et al. (2007) and Wang, Wang et al. (2011) in the sense that growth hypothesis is

supported in the short run.

However, in order to draw more reliable policy implications, we combine linear and nonlinear

causality tests with wavelet multiscale analysis, as an alternative way to cointegration test and

error correction model, to reassess the causal relationship between energy consumption and

economic growth at different time scale, i.e. short, medium and long run. To be more specific, we

apply both linear and nonlinear causality test on the decomposed time series of d1 to d5, which

are all stationary at level based on unit root test results. The results are presented in Table 4. For

the linear causality tests, it is found that there is bidirectional causal relationship at each time

scale between economic growth and energy consumption, which supports feedback hypothesis.

Therefore, with the help of wavelet analysis, it is found that not only energy consumption

contributes economic growth but economic growth also causes energy consumption. On the other

hand, for the nonlinear causality tests, although no causal relationship was found between energy

consumption and economic growth at d1, d2 and d3 which correspond short and medium runs,

bidirectional causal relationship was found between the two variables at d4 and d5, which

corresponds the long run. The nonlinear causality relationship found in the long run should not be

surprising as we found that the misspecification in the ARDL model in the previous section

already exhibit some nonlinearity between economic growth and energy consumption. Such

nonlinear causal relationship reveals the fact that in the past half century over, energy

consumption and economic growth in China have been affected by structural changes that are

usually caused by economic events or changes in energy policy.

On the whole, based on the empirical results provided by the linear and nonlinear causality tests

with wavelet multiscale analysis, it can be more safely argued that in the case of China, feedback

hypothesis is supported with reasonable statistical evidences. Therefore, policies aiming at saving

energy alone will definitely hamper the economic growth. In order to sustain economic growth

while solving the environmental issues, green technology such as clean energy must be

developed. Realizing this, Chinese Government has set the target in the 12 th five-year plan to

make major investments in the two areas: clean energy and clean energy cars besides energy

conservation(KPMG China 2011). However, the government must bear in mind about two

important points. Firstly, clean energy is a must not an alternative. This means that the

government must ensure that the target that it sets for the coming years to be achieved or the




economic growth will hardly be sustained. Some studies have been done to evaluate the policy

impact of China’s renewable energy plan. Some achievements have been made(Hong, Zhou et al.

2013, Zhang, Andrews-Speed et al. 2013) while problems and challenges still exist. Zhang,

Andrews-Speed et al. (2013) found that China’s renewable energy plan has put the development

of renewable energy manufacturing industry as the priority over the generation of the renewable

energy. Such approach has caused overcapacity of renewable energy industry and may

compromise the effectiveness and contributions of renewable for the economy. In addition, Hong,

Zhou et al. (2013) analyzed the possible outcome of the impact of energy policy of the

government in the 12th five year plan under different scenarios by simulations. Challenges and

constraints were identified that may reduce the renewable energy contribution in the coming

years include: grid bottleneck, weak technical performance and low energy efficiency of the

related technologies. Therefore, the government should ensure that the energy policy targets on

renewable energy can be met by identifying and tackling such kind of problems and challenges.

A more comprehensive plan on the renewable energy production and technology should be

designed. Secondly, as our results suggest that there exists bidirectional nonlinear causal

relationship between energy consumption and economic growth in China. So it is advised that the

government must consider the impact of structural changes, such as policy changes, on the causal

relationship between energy consumption and economic growth. The ambitious plan of

developing renewable energy is relatively new in China and should be considered a drastically

structural change. The process of increasing the share of renewable energy, which is expected to

replace some traditional energy, will not be easy and smooth. However, in order to sustain its

economic growth with no abrupt shock, the government must take such nonlinear causal

relationship into consideration and design and implement appropriate energy policy with extra

caution.

Table 4 Linear and Nonlinear causality test

Test Test statistics Test Test statistics

Linear Nonlinear linear Nonlinear

lnec → lngpc lngpc → lnec

Original 8.14** 7.01 Original 1.39 8.63

d1 5.91** 7.06 d1 3.13* 7.62

d2 5.56** 6.99 d2 3.38* 7.43

d3 10.06** 11.05 d3 9.90** 8.94

d4 11.87** 18.38* d4 75.62** 15.67*

d5 143.68** 25.13* d5 57.2** 23.86*

Note: *, **denote significance level at 5% and 1% respectively. “ln” stands for natural logarithm, “ec” stands for

energy consumption and “gpc” stands for GDP per capita. “→” stands for Granger cause.




4 Conclusions

This paper applied the wavelet multi-scale analysis with linear and nonlinear causality tests to

investigate the causal relationship between energy consumption and economic growth in China in

the period of 1953 to 2011.

For the original time series, the ARDL model fails to detect any long run relationship between

economic growth and energy consumption. However, with the wavelet multi-scale analysis,

bidirectional linear causality relationship is found at all the time scale. On the other hand, the

nonlinear causality test also fails to detect any causality relationship between economic growth

and energy consumption. Again, with the wavelet multi-scale analysis, bidirectional nonlinear

causality relationship is found in the long run. Overall, the energy-growth nexus is found to be

very complex in China. The results imply that the feedback hypothesis is supported with

reasonable statistical evidence of both linear and nonlinear causality tests.

With respect to policy implications, the result of linear bidirectional causality relationship

between economic growth and energy consumption suggest that the government of China should

consider the impact of energy conservation policy on its economic development. In addition, the

result of nonlinear bidirectional causality relationship in the long run imply that the energy

consumption and economic growth are inextricably connected to each other, which urge the

Chinese government to be more cautious in reducing energy consumption in order to solve the

environmental problems. The dependence of economic growth on energy consumption imply that

any energy shocks such as the ones resulted from energy conservation policies with poor

structure and inappropriate approach may hamper the economic growth, especially in the long

run.

Therefore, in order to sustain the economic growth, policies that aim at reducing energy

consumption should be reevaluated. The fact is that on one hand the demand of energy

consumption keeps increasing and the country’s economy is energy-dependent in China as shown

in this and previous studies; on the other hand, the issue of energy security and environmental

concerns bring overwhelming pressure both domestically and internationally that urge the

Chinese government to delicately design effective policies. Nevertheless, it is possible to achieve

the targets of economic growth and environment protection simultaneously to tackle all these

issues. Policies should aim more on the development of energy efficiency technologies and the

green technology such as wind and solar energy, rather than reducing the total energy

consumption directly. Given that the main source of energy is still coal, oil and gas, direct

energy conservation policy alone will not reasonably be able to benefit the country in the long

run.




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Steering and Coordinating Society in Urban Governance

Nurussaadah Mokhtar

Department of Urban and Regional Planning

Faculty of Built Environment, University of Malaya, Kuala Lumpur

Malaysia


Abstract

This paper describes the roles of government in steering and coordinating society in the view of modern

governance where participation of non-governmental actors is active. In this perspective, government interacts

with its environment- where society provides inputs to the government that will be converted into policies. In

this interaction, conflicts will occur as a result of diversity in participation in public policy making. Through

examples of urban governance processes carried out by governments at different places around the world, the

complex relationships that strike the balance between state-centric and society-centric is explored. Based on

significant challenges faced in the complexity of steering and coordinating society to achieve sustainable

development policies, this paper, consequently, holds firmly to the principle that government remains a

dominant role in modern governance due to its supremacy as a leader of the state.

Keywords: steering and coordinating, governance, sustainable development policies,

government, urban governance

1 Background of the term ‘governance’

It is a real challenge to write on ‘governance’, particularly in the realms of public

administration theory. This challenge is due to a couple of reasons. When the New Public

Management (NPM) was introduced, that new idea was responding to the ‘old public

administration’ that was generally viewed as in bad shape-governments that were always

associated with inefficiency and ineffectiveness. The aims and goals of the NPM movement

are noble, in theory. However, once implemented over a period of time, several flaws began

to show-disregarding society as citizens and failure of many privatization policies. People

began considering that the NPM is not all good. As that happen, a new idea emerged.

‘Governance’, although not a new term, is a new idea in public administration that is

commonly seen to offer what both ‘old public administration’ and NPM generally failed to

implement in reality. At this moment of time, it is a challenge to write on ‘governance’ since

it is a new concept in comparison to the previous two concepts where actual implementation

on ground is still under experimentation. Most governments in the world, particularly the less

developed countries are in the stage of moving towards ‘governance’ and therefore most

literature is still at theoretical stage. Not many references can be found on the performance of

‘governance’ implementation as compared to those under NPM and the ‘old public

administration’.

Another challenge is due to the fact that the most prominent authors of this subject admit that

the notion ‘governance’ can lead to confusion if not examined correctly. As Pierre (2000)

puts forward, “The governance literature is slightly confusing in its conceptualization of

governance”. In addition, Kooiman (2003) argues that the scholars in the discourse of





governance are still at the stage of ‘creative disorder’ due to a great scope of governance

paradigm. The term ‘governance’ can be universal in many different contexts. However, the

focus of this paper is merely at ‘political governance’. Even so, ‘governance’ being an old

term, then reinforced in new setting in different period of time to tackle different set of

societal complexities could still lead to confusion if the root of the term is not explained.

To avoid such confusion and to stay focused, this paper begins by defining the different

concepts of ‘steering’ and ‘coordinating’ in governance process from different perspectives.

Definitions by scholars such as Jon Pierre, Jan Kooiman, B.Guy Peters and Gerry Stoker are

compared against the definition by the authors of the best-seller Reinventing Government and

the widely read book The New Public Service: Serving, not Steering. This analysis of

definitions is provided in the second section: Understanding the Two Governing Approaches:

‘Steering’ and ‘Coordinating.’ The third section: Steering and Coordinating the Society

continues with the process of governance. It discusses the role of steering and coordinating

by the government in governing the society towards sustainable development. With the aid of

David Easton’s systems theory, the process where government interacts with its environment

to get inputs is illustrated. In the fourth section: Urban Governance: Challenges in Steering

and Coordinating Society, the complexity in the processes of governance is elaborated

through discussions of examples of challenges experienced around the world.

2 The Two Governing Approaches: ‘Steering’ and ‘Coordinating’

By looking from comparative politics perspective where governance can be studied from two

different approaches, which are ‘old governance’ and ‘new governance’, the concepts of

‘steering’ and ‘coordinating’ are clearly defined. The ‘old governance’ perspective, that is

perceived as state-centric highlights a theoretical view on governance in the role of

government as to steer the society and the economy (Peters, 2003). According to Kooiman

(2003), “steering is a powerful metaphor for governing in the traditional sense”. The latter

perspective focuses on coordination and self-governance within different types of networks

and public-private interactions, and therefore labeled as society-centric.

In the literature of ‘modern governance’ or ‘new governance’, Pierre (2000), a well-known

scholar in the discourse of political governance, defines governance as “sustaining

coordination and coherence among a wide variety of actors with different purposes and

objectives such as political actors and institutions, corporate interests, civil society and

transnational organizations”. He extended “governance is about how to maintain the

‘steering’ role of political institutions despite the internal and external challenges to the state”.

There are however a variety of perceptions and understandings on the concept of ‘steering’.

The famous Osbourne and Gaebler’s Reinventing Government advises government to steer

instead of rowing. They wrote, “Those who steer the boat have far more power over its

destination than those who row it”. In advocating entrepreneurial spirit in government tasks

as a response to the common view that the government in that period of time was merely a

large, inappropriate bureaucracy, Osbourne and Gaebler suggested ‘privatization’ as a




solution. They defined ‘steering’ as government’s responsibility to set up policies and leave

the implementation process to other actors, which is done through privatization process.

The Denhardts’ well-read book, The New Public Service: Serving, not Steering provides a

different view on ‘steering’, responding to the loosely defined ‘steering’ by the authors of

Reinventing Government. According to the Denhardts, ‘steering’ role of government is not

only appropriate but also impossible. They argue so as they view ‘steering’ as ‘controlling’

where government is the only player in policy-making and no negotiation or collaboration

exists with the society. Instead of ‘steering’ they urge government to serve, and in their point

of view, ‘serving’ is defined similarly to the way several scholars define ‘steering’. Their

proposed ‘serving’ role includes the tasks of mediation, reconciliation and adjudication. All

these require among others, the skills of conflict resolution and negotiation as interaction with

various parties take place.

Apart from Pierre’s, this article also adopts the definition of ‘steering’ as a process whereby

governments conduct negotiation of policies and implementation with different actors of

different objectives and purposes (Stoker, 2003). As Stoker (2003) elaborates, “Steering

involves government learning a different ‘operating code’ which rests less on its authority to

make decisions and instead builds on its capacity to create the conditions for positive-sum

partnerships and setting or changing the rules of the game to encourage what are perceived as

beneficial outcomes”. This ‘down to earth’ inclination is in line with the idea of governance

as involving interactions between the government, market and society where collective action

is needed to ensure effectiveness of policy-making process. This definition of ‘steering’

seems to strike the balance between the state-centric and the society-centric approaches in the

discourse of political governance.

Although there are many versions of the concept of ‘steering’, there is a common key element

of it, which is ‘direction’ (Kooiman, 2003). Kooiman elaborates that by steering, a

government, as a governor, will lead its people in a direction which will take them to their

goal. Steering, in spite of being uni-directional and top-down in its character, is yet an

interactive relationship since some form of ‘collaboration’ does exist in the process of

governance.

3 Steering and Coordinating Society

To understand the process of governance, one needs to study the political system as explained

by David Easton through his ‘systems theory’. Easton argues that political sphere interacts

with its environment (refer to Figure 1). This environment comprises of different actors that

provide inputs to the government. In what Easton calls the ‘Black Box’, the political and

bureaucratic institutions will convert these inputs into outputs, in form of policies. These

outputs will be tested in implementation where the new policies interact with the environment

to produce ‘outcomes’ and through what he calls the ‘feedback loop’, those ‘outcomes’ will

generate new inputs to the government. Naturally, it is a cyclical process, thus a never-ending

story.




Figure 1: David Easton’s systems theory in studying interaction between government and its environment.

Source: Easton, D., (1979). A Systems Analysis of Political Life, Chicago and London: The University of Chicago Press.

According to Pierre and Peters (2000), “Society performs complementary and occasionally

competitive functions in the process of governance.” It simply means that the society plays

role in presenting their ‘wants’ and ‘demands’ to the government. Although the society’s

‘wants’ and ‘demands’ are not the sole inputs, they shape much of the inputs in addition to

those aspired by the politicians. In the context of political governance, the interactions of

government with the societies, in theory, takes place in different forms. In more traditional

models, the cooperation between state and society takes place in namely ‘pluralist’,

‘corporatist’ and ‘corporatist-pluralist’ models (Pierre and Peters, 2000). While both

‘pluralist’ and ‘corporatist’ models are seen compatible with the ‘old governance’,

‘corporatist-pluralist’ model on the other hand carries very much the idea of ‘modern’ or ‘new

governance’’ as the system recognized the legitimate role of society in participating in policy

making. In this model, in giving inputs to the government, negotiation and coordination will

take place to deal with conflicting wants and demands among the society that comprise of

different actors.

In a more modified form of ‘corporatist-pluralist’ model takes place in the direct partnership

and cooperation between public authorities and private corporate actors in policy

development (Mayntz, 2003). In ‘new governance’, the recognition of the importance of

collaboration between the state and society in policy making has lead to the emergence of the

idea and practice of ‘policy networks’. In several countries with strong civil society,

collaboration occurs between the state and representatives of major stakeholders within a

society, such as business and labour. Although the government of Singapore is known to be

highly authoritarian, it practices this collaboration process in order to achieve successful

policy making and implementation.

In this stage, one will notice several challenges that require attention. In interaction with

citizens, a government deals with diversity and thus complexity. Another challenge is the

issue of governability. In order to achieve good governance, and since society plays partial

responsibility in the process of governance, one might ask if a particular society is ready to

play that role. If society is equipped, another question that arises is whether the government

is fully capable to conduct good governance. As Mayntz (2003) stresses, “Modern




governance can only emerge in societies that meet certain institutional and structural

preconditions, both on the side of the political regime and on the side of civil society.

Political authorities must be in a general way acceptable as guardians of public welfare. The

second essential precondition is the existence of a strong, functionally differentiated, and

well-organized civil society”.

In the following stage where government takes action is mainly dealing with policies

implementation process. This is where the roles of steering and coordinating are clearly

demonstrated. In the implementation of Local Agenda 21 for example, the leader of a local

neighborhood who has a general idea of what is needed by his people participates in the

implementation of the policies. What he demands will usually be in conflict with what other

stakeholders push for. Whatever sorts of conflicts have to be negotiated and certain priorities

will have to be compromised, and none of these can come about without the leadership of the

government through its steering and coordinating roles.

4 Urban Governance: Challenges in steering and coordinating society

‘Governance’ takes a partnership approach that maintains the leadership roles of the

government and acknowledges the rights of the people and the resources by other

stakeholders in decision making processes. This is particularly relevant in the context of

urban governance where partnerships between different stakeholders are considered as

fundamental in the legitimacy of policies and decisions made under urban governance

processes. UN-HABITAT (2005) defines urban governance as the sum of the many ways

individuals and institutions, public and private, plan and manage the common affairs of the

city. It is a continuing process through which conflicting or diverse interests may be

accommodated and cooperative action can be taken. It includes formal institutions as well as

informal arrangements and the social capital of citizens. The idea of urban governance has

been promoted widely but not without critics. The practices of urban governance have

recorded several obstacles and challenges. Several challenges that require more

comprehension and analysis are highlighted and discussed below:

a. Eligibility of participants among citizens

Fung (2007) is among several scholars that questions the eligibility of participants among

citizens in the process of urban decision making. In the name of democracy where citizens’

voices must be heard, would quality of the decisions made be affected if one considers that

there exist citizens who do not possess the knowledge, competence and such skills to

command compliance and cooperation in the urban partnerships? It should be considered that

they might not have the information and knowledge to make good judgments and decisions as

public administrators have been trained to do. The revitalization project of Pólwiejska Street

in Poznań, Poland demonstrates an example of uneven partnership as local community actors

were too weak to become equal partners with the city government. They were too weak to

exercise a significant and positive impact on project implementation (Swianiewicz et al.,

2006). In fact, many public policies and decisions are determined not through deliberation

but rather through the technical expertise of officials whose training and professional




specialization suits them to solving particular problems and this mode usually does not

involve citizens (Fung, 2007).

b. Less relevant representation among stakeholders

In our eagerness for greater public representation, we must not forget that citizen participants

comprise tiny portion of the population, and unless they are known to represent a

constituency, there are no guarantees that each citizen participant is influential in his or her

community (Irvin and Stansbury, 2004). The relevance of representation among stakeholders

in an urban decision making process is among others, due to the fact that the decisions will

affect numerous aspects of their lives. However, there exist problems of less relevant

representation by group of communities that will be affected the most as compared to other

groups of stakeholders. Therefore, the decisions made with inputs from the less affected

communities and stakeholders may not be the best decisions that will minimize negative

impacts of policies or decisions made.

An example to illustrate this problem is the case of aboriginal communities on Cape York

peninsular in north Queensland. The major development projects carried out in that area were

unusually severe and in some cases were completely destructive of indigenous society and

culture (O’Faircheallaigh, 2002). However, they have been excluded from the public

appraisal process particularly the statutory social impact assessment (SIA) carried out as part

of the governance process. O’Faircheallaigh (2002) added that their exclusion is not new as it

had been so for about 200 years, not unintentionally, but deliberately and systematically.

Other than the case of minority as explained above, less relevant representation among

citizens may as well be in regards to their socio-economic and educational background.

Individuals who are wealthier and better educated tend to participate more than those who

lack these advantages, as do those who have special interests or stronger views (Fiorina, 1999

in Fung, 2006). The factors of age and gender play roles too. Midden’s research in Europe

identified more men participate as opposed to women and the very young and the very old

among the communities recorded less involvement as compared to other range of ages (Baker

et al. 2005). These findings suggest inappropriate representation of the relevant population of

the public.

c. Facilitation of discussions and activities

Partnership meetings of multi-stakeholders often lead to ‘talkfest’ where dialogues are

emphasized rather than concrete action or policy action (Potts et al., 2007). As a result,

objectives of the meetings cannot be achieved. This explains the importance of meeting

facilitation. In fact, facilitation is the most frequently mentioned factor contributing to the

success or failure of public hearings (Baker et al., 2005).

Facilitation of multi-stakeholder meetings is undoubtedly the responsibility of the local

government. To build partnership, local government must adopt the roles of facilitator and

enabler (Phang, 2000). It is highly crucial that local governments invest on training their

officers that will be responsible to carry out meetings that deal with various stakeholders.

Baker et al. (2005) have specified that a facilitator requires a highly polished human and

communication skills. The facilitator’s scope of duty does not centre on technicalities of the




meetings merely but it is extended to sensitively managing the audience or the participants

emotion. Moreover, in the context of urban governance where meetings do not only involve

the citizens representatives but also other stakeholders of diverse interest, the leadership in

running the meetings, to listen to all voices and to ensure participants remain calm and

objective throughout the processes is indeed a highly difficult task.

d. Continuous and sustained commitment by stakeholders

In assessing the on-going ecologically sustainable urban development project in an industrial

estate called Lawson, an area in Greater Blue Mountains, New South Wales, Potts et al.

(2007) concluded that such collaborative project is evolving in nature. It is a partnership

between the Blue Mountain City Council, the New South Wales Department of Environment

and Conservation, Sydney Catchment Authority, Australian Museum and Botanical Garden

Trust, three universities (Sydney, New South Wales and West Sydney), the community and

the business companies. Their challenge is huge: deciding on sustainable approaches to land

zoning that ensures harmony between business and industrial activities surrounding the

catchment and ‘lungs’ of the basin of Sydney that is listed as a World Heritage Area. Such

ambitious development is indeed a long term process that demand a continuous and sustained

commitment by all the stakeholders mentioned. Despite experiencing short-term failures and

personality conflicts within and between partners, their high degree of enthusiasm to

transform Lawson into a model of sustainable urban development is more important and in

fact, a factor that will contribute to positive outcomes in the long run.

Figure 2: The general process of urban governance is long and demands a continuous and sustained commitment by

various stakeholders.

Source: UG Toolkit Series, UN-HABITAT, 2003.

e. Distrust and pessimism

It is said that the nature of bureaucracy appreciates not the value of trust. Like other secular

worldviews developed by the westerners that acknowledge nothing but materialism, this

Weberian system of government disregard the worth and the power of trust particularly in the

relationship between the government or the public administrators and the citizens. An

important but unattended consideration in citizen participation efforts is whether public

officials trust citizens… (Yang, 2005). This phenomenon of distrust is possibly due to the

public administrators’ view that the citizens are incapable of participating in decision making

process. In fact, they believe that their participation may prolong or worse, complicate the

process altogether. Many administrators are ambivalent or feel problematic about public

involvement. Some even hold resentment toward citizens (Yang, 2005). Likewise, citizens

have had the same attitude towards public administrators. Praises and positive feedbacks do




not usually make headlines but even minor cases of public administrators’ inefficiency would

tarnish their reputation to a severe extent. As a consequence, there exist tensions when both

parties have to cooperate in activities such as urban governance processes.

A similar dimension of distrust can be exemplified by the case of West Bengal government in

India where NGOs attempts to raise political consciousness and organize low income

communities around local issues have been prohibited (Vendana, 1999). This is a paradox to

urban governance principles that acknowledge the roles of different stakeholders including

that of NGOs or other civic institutions in the process of urban governance. This occurrence

of distrust may have lead to the attitude of pessimism towards the significance of urban

governance. Vendana (1999) also finds that very few NGOs take up high conflictive projects

or programmes that deal with issues of access to land, security of tenure, low-income housing

etc. Although their roles can significantly affect the urban decision making process and

therefore benefit the citizens, they would not be without the recognition and support of the

local government as a leader in the process of urban governance.

f. Funding issues

In studying the relationship between the government and urban NGOs in Bombay, Vendana

(1999) finds that most of the large NGOs or internationally reputed NGOs get called for

government funding while the small and medium size NGOs get excluded. Instead of

practicing the known good values of an NGO, their modus operandi in dealing with

government is by using personal contacts and influence, favoritism and nepotism (Vendana,

1999). Hamish (1999), in his research on NGOs and community-based organizations (CBOs)

working on environmental improvement in Calcutta discovers that CBOs often operate within

networks of political patronage where some receive small, regular funding from political

parties. Such phenomenon is a challenge in urban governance as it contradicts the principles

of urban governance especially the principle of transparency.

The other aspect of funding problem is regarding the financial resource bases of local

authorities which are limited. Few are able to generate enough resources for meeting their

expenditure (Phang, 2000). In the sphere of urban governance where local governments work

horizontally with other higher levels of government as equal partners, they still have to

depend on the funding or subsidies allocated by them. Usually the fund may not be

transferred promptly and consequently may halt or delay the processes in urban governance.

g. Costly participatory urban decision making

Partnership between multi stakeholders is indeed a powerful tool in the process of urban

governance. Even so, however powerful it is, it possesses a large barrier, which is the cost-

both money and time. Irvin and Stansbury (2004) point out that the cost of a decision made

by citizen participation groups is arguably more expensive than that of a single agency

administrator, even if the citizen participants' time costs are ignored. They suggest that it is

impractical to spend so much on citizen participation if the decision made collaboratively is

the same with decision made by a trained or experienced public administrator, due to the fact




that the decision may only cost the public administrator’s one day as compared to months or

years that may be required by the groups of citizens. Observations made at community

governance workshops as part of the South African West Coast development planning process

recorded that participants indicated that the process was time consuming and questioned its

cost effectiveness and its potential to deliver (Groenewald and Smith, 2002). Clearly the

feasibility of an urban governance process need to be aligned with the budget allocated for

such process, and this is without a doubt a very difficult task to be delivered by the local

government as a facilitator of the process.

h. Problem of quality data and information

The quality of decision making depends heavily upon the quality of information. Problems

with information (outdated, incomplete, unreliable, scattered amongst different stakeholders,

not helpfully focused) are the most commonly cited constraint in urban development decision

making (UN-HABITAT, 2004). The availability of relevant and reliable data and information

remain obstacles in achieving partnerships objectives. The Lawson project facilitated by the

Blue Mountain City Council, New South Wales demonstrated that micro-scale data about

business waste and resource use is often absent (Potts et al., 2007). Potts et al. added that

their partnership also lack integrated regional data and publicly available indicators on

sustainability and innovation.

i. Challenges in negotiation

Complexity in agreeing on strategies and translating them into implementable actions is a

common issue in urban governance partnership. This complexity, which is due to difficulty in

achieving shared view among stakeholders may be argued as the most critical challenge in

urban governance. Action planning process, viewed as the most important tool in the process

requires detailed and continuous negotiation among stakeholders. The case of collaborative

public open space design in self-help housing in Minas-Polvorilla, Mexico City is an example

of this challenge. However, how much complex it was, due to sustained commitment by the

stakeholders involved, despite various problems of reaching agreement between the different

groups, the workshops proceeded (Juarez-Galeana, 2006).

5 Conclusions Although the academic discourse in governance is very vast, this paper has attempted to focus

on the political governance along the line of modern governance. The theme of modern

governance centres on the transformation of the dynamic roles of government as well as

active and legitimate participation of non-governmental actors in policy development and

implementation. These two major qualities of modern governance have been described in this

paper through the roles of government in steering and coordinating the society.

In the process of governing society where government interacts with multiple level of

community, dual responsibilities by each party take place. In taking part by providing inputs

to the government, the society carries a responsibility. On the other end, the government’s




responsibility is to coordinate the different inputs by different actors through reconciliation

and negotiation. Both responsibilities are carried on to the stage of policies implementation

where it is lead and monitored by the government. This balance relationship position the state

in the centre of a continuum of state-centric and society-centric.

It is also important to acknowledge the complexity of the process of governance as well as the

diversity of the stakeholders involved, and the paper has embarked on highlighting the

challenges faced through experiences of different stakeholders in selected examples of urban

governance processes. Although urban governance offers sustainable partnerships tools that

can implement sustainable development objectives, is not an easy task as it is a dynamic

process. It involves different groups of people with different interests and it is characterized

by conflicts and long negotiations. Consequently, as opposed to perceptions that

governments’ roles should be minimized in governance process, the paper contends that the

leadership roles of government in governance are very crucial. In the government’s role in

steering and coordinating, its character as a leader and facilitator is clearly manifested.

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Clustering, Cooperation and Innovation in Developing Countries:

Evidence from a Large Footwear Cluster in Nigeria

Isola Oluseyi

Department of Development Studies

Faculty of Economics and Administration,University of Malaya

50603 Kuala Lumpur, Malaysia.

E-mail: [email protected]; [email protected]

Tel: +6014650053

Abstract

Despite the important role of innovation in a market-driven economy, little evidence exist on innovation activities of

SMEs located within industrial clusters in many developing countries. This paper describes the nature and

characteristics of innovation and cooperative activities among informal manufacturers in developing country

contexts. The evidence is based on a very large cluster of footwear manufacturing firms in Nigeria. The evidence

shows that innovation is prevalent among the firms but these are mostly incremental. This indicates that capabilities

for radical innovation, which is necessary for catching-up, is lacking among the firms. But in the face of adequate

resources and policy support, the firms could potentially accumulate such capabilities because most of them already

develop their existing innovations on their own. Interaction within the domestic innovation system is prevalent but

mostly market-based. Hence, innovation policies should seek to foster firms’ interactions beyond simple buy-sell

relationships with such sources.

Keywords: Clustering, footwear, innovation, cooperation, Nigeria

1. Introduction

Economic growth and development are intricately linked with innovative activities and at the

same time, the ability of firms to create knowledge and innovate is crucial for increased

productivity and global competitiveness. By extension, the knowledge, skills, experience,

relationships and motivation necessary for technical change in clusters are very important to the

competitiveness and growth of firms in the clusters. In other words, firms that operate within the

clusters usually experience more growth and are more likely to introduce more innovations than

isolated firms (Beaudry and Breschi, 2000). This is connected with the fact that innovation is a

dynamic process of creating new goods and services as well as all other aspects related with it.

However, despite the important role of innovation in a market-driven economy, little evidence

exist on innovation activities of SMEs located within industrial clusters in many developing

countries such as Nigeria (Bala-Subrahmanya, 2005).






This paper responds to this gap in the literature. The paper analyses and discusses the innovation

and cooperation activities of the footwear firms in the Aba cluster. Innovation is broadly defined

to include the application of knowledge in production in a sense that is primarily new to the firm

but not necessarily to the industry, the market or the world. With reference to cooperation,

attention is paid to firms’ interactions with economic actors within the domestic innovation

system.

There are several reasons why a focus on clusters is useful. Geographic and sectoral clustering of

enterprises, most especially in developing countries, has been recognised as a veritable approach

to overcoming constraints to economic growth and development (McCormick, 1999). Lundvall

(1988) earlier opined that geographic agglomeration promotes innovative activities. This opinion

is based on the notion that firms do not innovate nor grow in isolation (Pyke, 1992:1; Edquist,

1997:1). Geographic proximity of firms is particularly important in developing countries, like

Nigeria, where poor infrastructure, weak information systems, and culture that place high value

on oral tradition and face-to-face communication are the norms (McCormick, 1999). Clusters

appear to be a useful instrument for addressing some of the industrial challenges of the

economically marginalised in developing countries (Albu, 1997). Consequently, firms in dense

geographic proximity tend to benefit from the agglomeration relative to isolated enterprises

(Oyelaran-Oyeyinka, 2005). Clustering at its most basic level encourages information sharing

and opportunities for learning new techniques and designs. Moreover, clustering appears to have

the ability to make African countries overcome some of the challenges to industrialisation. This

could be accomplished inter alia through increasing market access, fostering communication and

information sharing, facilitating technological upgrading, increasing efficiency, and contributing

to the development of supportive institutions (McCormick, 1999).

2. Study context, data and method

2.1 The empirical context

The footwear industry in Nigeria comprises a few formal firms and a large number of artisanal

entrepreneurs. They are concentrated in several industrial clusters, most notably in Onitsha and

Aba, respectively in Anambra and Abia states in South-Eastern Nigeria. These clusters in Nigeria

are dominated by entrepreneurs of Igbo origin from the Southeastern part of the country. The

Igbo people are presumably highly entrepreneurial (Brautigam, 1997). In terms of number of

firms and geographical space, the Aba cluster is the largest in the country, and presumably in

West Africa outside the organized formal sector. It is widely acknowledged as the footwear

capital of West Africa; consequently, it commands a significant market share. Wholesalers from

across the sub-continent are among the major distributors of the products from the cluster. From

a statistical perspective, data, trends, patterns and lessons from this cluster could well represent

all the footwear clusters in Nigeria. Given these characteristics, this study focuses on the Aba

cluster. Among the locals, and for trading purposes, the Aba cluster is located in a space known

as the Ariara market. This was the location where the data for this study was collected.




2.2 Sampling and data collection

Data collection spanned the period August 5th – 31st, 2013. Primary data was collected from a

random sample of 400 informal enterprises. Ten field assistants, all university graduates, were

employed and trained to join the researcher for the purpose of data collection. Using a structured

questionnaire, the field assistants held oral interviews with the respondents while they worked.

This was necessary not only as a way to control the integrity of information collected but also

because the shoemakers were mostly too busy or poorly educated to self-administer the survey.

The questionnaire elicited information on the characteristics of the firms, knowledge acquisition

methodology of firms, inter- and intra-firm collaborations, funding and innovations activities. In

all, 370 respondents, that is, 92.5% of the sample, completed the questionnaire. Of these, only

291 (72.8% of the sample) were usable in the analyses after removing outliers and missing

responses in all the relevant variables. The response rate compares with previous studies in the

same context (Siyanbola et al. 2011; 2012).

2.3 Data analysis

Missing values in the data were taken into account by using available case analysis (Osborne,

2013: p. 118). In other words, only those cases with complete data on the relevant variables were

analysed (Pallant, 2007: p.57). This approach is suitable because the number of cases with

missing values is a small proportion of the overall sample and the values are demonstrably

missing at random (MAR). Extreme outliers were removed from the data file to avoid bias.

3. Results

3.1 Sample characteristics

Most of the firms in the Aba cluster are micro enterprises according to the definition of the

Nigeria Vision 2020 Program (2009).1 About 97% of them employed ten or fewer employees.

Average age of firms in the sample is 14 years and only about 13% had been in existence for up

to 25 years. Formal capital is negligible, hinting at a huge gap for public policy in relation to the

provision of funding to stimulate the establishment and growth of enterprises. About 50% of the

firms sourced their initial capital from friends and family while about 47% obtained their start-up

capital from personal savings. Consistent with Forrest’s (1994) observation, it is clear that the

cluster is predominantly artisanal. Most of the entrepreneurs had only secondary school education

and acquired their skill by apprenticeship. Documentation hardly occurs but learning by doing

and observation as well as oral instruction is predominant.

3.2 Innovation in the Aba footwear cluster

For the purpose of this study, innovative firms are those that have mastered and implemented the

design and production of goods and services that are new to them, irrespective of whether they

1 The Vision 2020 Program was the flagship of the Obasanjo administration. The main aim of the program, following

a Glodman Sachs report, was to set Nigeria up to be one of the largest economies in the world by the year 2020.




are new to their competitors, their countries or the world. Information on innovative firms that

have introduced some sort of innovations between 2011 and 2013 is shown in Table 1. The table

reveals that a total of 90.1% of the firms engaged in innovation activities, while 9.9% of them

reported no innovation activities. In other words, majority of the firms have designed and

produced footwear that are either new to them, their competitors or to the world.

Table 1: Innovative firms

Firm’s Response (n=273) Percentage

Yes 90.1

No 9.9

Total 100

While some innovations are associated with R&D outputs, much of the innovation by SMEs in

the developing countries such as Nigeria are gotten from non-R&D activities. Some of these non-

R&D activities include the acquisition of external knowledge or new equipment and machinery,

new market activities and design. As such many of the innovations reported in the developing

countries are new design, and improvement in quality of products, installation of new equipment,

changed sales and marketing methods and improved new products/services (Gebreeyesus and

Mohnen, 2012). Analysis of the survey of the firms shows that over 50% of the footwear SMEs

frequently change the design of their products while very few (2.1%) reported no changes to

products (Table 2).

Table 2: Rate of change of product designs

Rate of change (n= 288) Percentage

Very frequently 39.9

Frequently 26.7

Occasionally 31.3

Not at all 2.1

Total 100.0

Many scholars have asserted that clustering increases the level of information sharing and

opportunities for learning new techniques and designs (McCormick, 1999). Analysis of the mode

of development of new products by the innovating firms is shown in Table 3. Information in the

table showed that almost all the firms surveyed (97.4%) produced their own designs by

themselves. Very few firms used the support of foreign technical actors (1.3%) while a negligible

number of enterprises used a licensed product (0.4%).




Table 3: Mode of development of new products

Mode (n = 234) Percentage

Licensing 0.4

Own development 97.9

Foreign Technical support 1.3

Others (Please specify) 0.4

Total 100.0

According to the mainstream literature on innovation, four categories of novelty of innovations

can be recognised in relation to the firm and the market. Based on level of increasing novelty,

these categories include, (1) innovations that are new only to the firm, (2) innovations that are

new to the market of the firm (and its competitors), (3) innovations that are new to the country

and (4) innovations that are a world first (Sithole et al., 2012). Close to half of the firms in the

footwear sector developed product innovation that are new to the market while a little over one

third developed products that are solely new to the their businesses. A little over 20.0% of the

enterprise had innovations that are new to the world (Table 4). This suggests that most product

innovations undertaken by the firms are incremental. In other words, firms mostly modify

existing products rather than develop completely new ones.

Table 4 Novelty of the products

In discussions on innovation, patents and intellectual property are an important topic. The

protection of intellectual property is thought to be beneficial to innovation. However, its

relevance especially in the informal sector and in developing countries is arguable. In general,

innovation in the informal sector and in latecomer countries’ contexts does not fulfil the novelty

requirements for patenting. As the results in Table 4 suggest, innovation in the study context is

mostly incremental and are not ideal for formal intellectual property protection. Yet, the

knowledge embodied within each new product requires some form of protection otherwise the

Newness (n=242) Percentage

Your business 31.0

Local market 45.9

Global market 23.1

Total 100.0




pace of innovation may decline. How then do firms in the Aba footwear cluster surmount this

challenge?

To start with, the survey evidence suggests that almost none of the firms have a formal

intellectual property right (Table 5). The arrangement in the cluster, as discovered during the

course of this study, is nonetheless striking. It bears some semblance with the formal patent

assessment procedure but also has unique informal elements. The local industry association

functions as the institutional authority that offers and enforces intellectual property protection in

the cluster. By definition, every firm in the cluster belongs to the association. Whenever any firm

claims to have come up with a new design, it submits a sample of the relevant footwear to the

association that then verifies the veracity of the claim by checking with its members. If genuine,

the association makes an open announcement of the design throughout the market and bars any

member except the original designer from reproducing the design for a period of 3 -6 months on

average. This mechanism has limitations as it is highly sensitive to personal whims and caprices,

yet it has proven quite effective by being less expensive and more rapid than formal procedures.

Table 5: Formal intellectual property rights

Firm’s Response (n=216) Percentage

Yes 6.9

No 93.1

Total 100.0

3.3 Assessment of the domestic environment for innovation

Conducive policy and regulatory environment are prerequisites for carrying out successful

innovations. There are several ways by which businesses can be motivated to introduce

innovative products to the market. Some of these include: establishment of national funding

agencies, tax incentives for R&D and innovations, direct funding of R&D and innovation through

grants and subsidies. Supportive measures such as these provide enabling domestic environment

for innovation. It could also lead to the development of a strong collaboration among the key

elements of national innovation system. While assessing the local environment for the

introduction of innovative footwear products, the result of the analysis suggests that the domestic

environment for innovation in the footwear sector is poor. For instance, virtually all the firms

surveyed reported that there are very few government incentives for innovation. Majority of the

enterprises also stated that motivations for innovation such as technical support from local

universities and research institutes, efficient standard organisations, quality infrastructure,

venture capital, appropriate modern equipment, skilled manpower are either non-existent or

grossly inadequate (see Table 6).




Table 6 Assessment of the domestic environment for innovation

Assessment Indicators (n=268) Very

poor

Poor Fair Good Excellent

Government incentives for

innovation

99.6 0.4

Scientific/skilled manpower (n=267)

96.3 3.0 0.7

Local universities and research institutes for technical support

97.0 1.1 1.9

Standards organisation for

regulatory work

96.2 2.3 1.5

Acquisition of modern equipment 88.3 7.2 4.2 0.4

Quality of ICT services (e.g. internet)

90.5 3.4 2.7 2.7 0.8

Good Infrastructure 94.8 4.2 0.5 0.5

Availability of venture capital 83.7 8.2 4.3 3.8

3.4 Firms’ cooperation activities

Innovation process involves a diverse of cooperative activities in the conceptualisation and

development of new products and processes. As a dynamic process, it also involves a multitude

of diversified group of actors associated by linkages with varied degrees of intensity (Fløysand

and Jakobsen, 2010). These multifaceted and multi-stakeholder process are evolving and

represented in different types of relationships at various levels (Nelson and Winter, 1982).

Cooperative alliances such as these are needed for firms to survive and thrive in a highly

competitive environment. Some of the partners involved in such collaborations range from

universities (George et al, 2002; Wu, 2011), suppliers (Nieto & Santamaría, 2007), customers

(e.g., Belderbos et al, 2004), service intermediaries (Pangarkar & Wu, 2012) and government

officials (Wu & Chen, 2012) to competitors (Luoet al, 2007).

One of the most crucial elements of the concept of innovation is that the product, processes,

organizational structure or marketing strategies implemented by the firm must be new. More

importantly, the implemented idea should add value to all the stakeholders involved. Enterprises

approach innovation from different perspectives. Some firms use a centralist method while some

others adopt the broad approach to innovation (Danish Confederation of Trade Unions, 2007).

The assumption of the centralist method is that only the key members of staff are involved in the

innovation process and as such the development and implementation of innovation activities are




carried out in collaboration with the top management. Meanwhile, in the case of the broad

approach, employees in general make significant contribution to innovation process. The

assumption is that employees at the bottom of the ladder are closer to the consumers than the top

management staff and as such they are usually aware of the customer needs. This has been

defined as bottom-up employee-driven innovation. In other words, this idea is entrenched in the

fact that conceiving ideas, implementing ideas and value creation are not only the concern of the

few employees such as engineers and other highly educated people, but are based on systematic

cooperation of all employee groups (Danish Confederation of Trade Unions, 2007).

The result of the analysis in Table 7 listed various ways by which workers such as apprentice and

employees could collaborate on innovation process. With regards to the exchange of information

and experience, over 50% of the respondents are of the opinion that there has been increasing

cooperation among the apprentices and employees in innovation process. However, 55.1% of the

enterprises reported that cooperation on innovation has either been decreasing or remained the

same with regard to labour training. On product development, close to half of the surveyed

enterprises stated that cooperation on innovation process on new product development has either

been decreasing or remained the same. Meanwhile, quite a number of them (51.1%) attested to

the fact that there is a strong cooperation with apprentice and employees on new product

development.

Table 7: Cooperation among workers (apprentice & employees)

Strongly decreased

Decreased Unchanged Increased Strongly increased

Exchange of

information &

experiences

11.90 7.14 27.38 16.67 36.90

Labour Training

27.5

9.6

18.0

14.4

30.5

New product

development

19.6

8.2

21.1

11.9

39.2

Literature on cooperation with competitors reflects both positive and negative impacts on firm’s

strategic behaviour and performance. For instance, many scholars are of the opinion that

cooperation with competitors reduces the inefficiencies of competition, increases information

flow, improves economies of scale, decreases risks and increases the rate of development of new

product and processes (Gnyawali & Park, 2011; Ritala & Hurmelinna‐Laukkanen, 2012).

Meanwhile, other contrasting literature assert that cooperation with competitors could bring about

knowledge leakage, management inefficiencies, unethical business practices and unhealthy




competition (Luo et al., 2007; Nieto & Santamaría, 2007). This study examines the existence of

innovation activities and processes that an enterprise in the shoe manufacturing sector might have

with its competitors. Such activities include exchange of information and experience, quality

improvement, labour training, marketing of products, sourcing of raw materials and sharing of

equipment. According to the result of the analysis, many of the enterprises (51.4%) reported that

they collaborated with other shoe manufacturers in the area of exchange of information and

experience. With regard to quality improvement, less than half of the enterprise surveyed has

cooperated with their competitors. There seems to be less cooperation on labour training among

the shoe manufacturers as many of them reported that cooperation has either been decreasing

(49.1%) or remained the same (24.0%) in recent years. Many of the firms also reported that there

is little collaboration on marketing of products among the shoe manufacturers as over half of the

enterprise do not cooperate on marketing. Same trend could also be noticed on sourcing of raw

materials where 70.7% of the firms said that they do not engage with other competitors in

sourcing of raw materials. The case is however different on the issue of sharing of equipment

among the shoe manufacturers. Close to 70% of the shoe manufacturing firms said that they

usually share equipment with other shoe manufacturing firms.

Table 8: Cooperation with competitors

Strongly

decreased

Decreased Unchanged Increased Strongly

increased

Exchange of

information & experiences

13.8 8.3 26.6 28.3 23.1

Quality improvement

19.0 8.7 24.9 28.0 19.4

Labour Training 35.0 14.1 24.0 17.0 9.9

Marketing of

products

49.0 5.5 22.4 9.7 13.4

Sourcing of raw materials

68.3 12.4 11.0 5.5 2.8

Sharing of equipment

14.2 3.1 13.1 32.5 37.0

In recent times, it has become increasingly important for firm to seek for external sources of

knowledge in order to be able to innovate sustainably. This line of thought argues that the ability

of an enterprise to source, utilise and manage external knowledge is a key component in firm’s

competitive advantage most especially the role of the suppliers (Schiele, 2006). Alliances with

suppliers are of different types. For instance, it could be in form of partnership where suppliers




are involved in the development of new products (Cantista and Tylecote, 2008; Valle and

Vazquez-Bustelo, 2009). Strategic alliance with the suppliers are usually associated with

activities such as relating with customers with regard to their preferences or reducing product

lifestyles (Fossas-Olalla et al., 2010). This section deals with the role of the raw materials

suppliers as sources of knowledge for innovation in the shoe manufacturing sector. Some of the

issues examined include exchange of information and experience, quality improvement, speeding

up delivery, joint labour training and joint marketing. Results of the analysis show that about one

third of the enterprises (34.5%) reported that they collaborated with their raw material suppliers

in the area of exchange of information and experience. With regard to quality improvement,

36.8% of the firms reported that they cooperate with the raw suppliers on quality improvements.

In the same light, about 40% of the shoe makers reported that they often discuss with the raw

materials suppliers on issues related with delivery of the primary raw materials for the shoe

making. On joint labour training and marketing, the shoe makers seem to have weak

collaborations. For instance, 3.3% and 4.8% of the enterprises in the clusters cooperated with

their raw materials suppliers in the area of joint labour and marketing respectively.

Table 9: Cooperation with raw material suppliers

Strongly

decreased


increased

Exchange of

information &

experiences

37.6 11.5 16.4 22.0 12.5

Quality improvement

37.2 9.7 16.3 22.6 14.2

Speeding up delivery

34.5 10.5 15.3 21.3 18.5

Joint labour

training

79.3 11.1 6.3 2.6 0.7

Joint marketing 82.3 8.5 4.4 3.7 1.1

As mentioned earlier, the kind of association developed with suppliers is one of the key factors in

firm’s innovation process. This association often produces linkage between purchasing of goods

and innovation as a result of networks of firms (Hakkanson and Eriksson, 1993). Suppliers

become useful when an enterprise is in need of a particular knowledge beyond its competence

and as such looks out for external sources of information from partners such as the suppliers of

machinery. Based on this fact, some authors have attributed the benefits of collaboration between

a firm and suppliers to improvement in operation and innovation performance (Liu et al., 2000).

This study also examined the influence of the suppliers of machinery on the innovation process




of the shoe manufacturers in the clusters. Some of the issues considered along this line include

exchange of information and experience, quality improvement, speeding up delivery, joint labour

training and joint marketing. In comparison to the results of the analysis of the relationship of the

shoe makers with their raw material suppliers, the enterprises has weaker relationship with the

machinery suppliers. For instance, about 14% of the enterprises reported that they collaborated

with their machinery suppliers in the area of exchange of information and experience. With

regard to quality improvement, 13% of the firms reported that they did cooperate with the

suppliers of machinery. Similarly, 13% of the enterprises collaborated with the suppliers of

machinery on how to speed up the delivery of products. In the same light, virtually all the shoe

makers reported that they do not discuss with the suppliers of the machinery on issues related

joint labour training and marketing.

Table 10: Cooperation with machinery suppliers

Strongly

decreased


increased

Exchange of

information & experiences

64.2 14.8 8.6 6.8 5.6

Quality

improvement

64.4 11.9 10.6 7.5 5.6

Speeding up delivery

64.6 6.8 15.5 8.7 4.3

Joint labour training

82.8 12.1 1.0 3.0 1.0

Joint

marketing

90.9 5.1 3.0 1.0

The strand of cooperative literature that are grounded in network and game theories have asserted

that cooperation often with specific stakeholders or partners add value to customers (Ingram &

Roberts, 2000). Form of innovation cooperation with the customer is usually recognised within

the context of the introduction of new products. This is coming with the fact that the customer’s

experience in the use of products is valuable in improving existing designs (Tether, 2002; Shaw,

1994) as well as the development of new ones. Scholars have also found out that development of

an innovative products with customers could help to increase market share and support the

integrity of a firm’s products (Tether, 2002). In the same vein, cooperation between firms and

customers has also been found out to reduce risks related to introduction of new products to the

markets (von Hippel, 1976; Ragatz et al., 1997; Tether, 2002). While trying to study the influence

of customers on innovation process in the shoe manufacturing cluster, the study considered issues




such as exchange of information and experience, quality improvement, setting up of production

specification and organisation of production. Analysis of results showed that most of the shoe

manufacturers have strong collaboration with the customers on these issues. For instance, 58.5%

of the enterprise surveyed reported that they cooperate with the customers on the issue of

exchange of information and experience. At the same time, over 66.3% of the shoe makers

collaborate with the customers on issue of quality improvement. Same could also be said about

the setting up of production specification where over half of the firms collaborate with the

customers. However, the case is a little bit different with regard to organisation of production.

For instance, 43.7% of the enterprises worked with the customers in the organisation of

production.

Table 11: Cooperation with customers

Strongly

decreased


increased

Exchange of

information

& experiences

9.8 4.4 27.3 22.4 36.1

Quality

improvement

8.3 2.4 22.9 30.7 35.6

Setting of

production specification

10.8 12.3 20.6 11.8 44.6

Organisation

of production

43.2 7.4 5.8 6.3 37.4

The innovation literature has established that innovation is highly related to the ability of firm to

absorb and utilise external knowledge. Based on this fact, it has become important for firms to

cooperate with knowledge institutions such as the universities and research institutes for

competitive advantage (Wu, 2011; Tether, 2002). Such formal cooperation include R&D

conglomerates, joint research ventures or information exchange agreements. Three categories of

such R&D cooperation can be recognised. There is the transaction cost approach which involves

sharing of the R&D projects costs, risks and the protection of the dissemination of the outcome of

the research activities (Williamson, 1985). The strategic management method looks at the

cooperation in order to access additional resources for competitive advantages (Teece, 1986).

There is also the industrial organisation method that is based on knowledge spillovers among

major stakeholders. (Petit and Tolwinski, 1999). This section examined the role of the knowledge

institutions such as the universities and the research institutes in the innovation process of the




shoe makers in the clusters. The study looked at issues such as exchange of information and

experience, quality improvement, setting up of production specification and organisation of

production. According to the result of the analysis, majority of the firms do not have

collaborations with the knowledge institutions. For instance, virtually all (97.3%) the enterprise

surveyed reported that they do not cooperate with either the universities or research institutes

during the innovation process most especially with regard to the issue of exchange of information

and experience. Similarly, over 99.2% of the shoe makers do not collaborate with the knowledge

institutions on issue of labour training. Same could also be said about the new product

development where 98.5% of the firms do not collaborate with the knowledge institutions. On the

issue of quality improvement, 98.1% of the shoe makers do not collaborate with the universities

and research institutes around the clusters. With regard to organisation of production, 98.9% of

the enterprises do not work with the knowledge institutions.

Table 12: Cooperation with universities and research institutes

Strongly

decreased


increased

Exchange of

information &

experiences

96.2 1.1 1.6 1.1

Labour Training

98.4 0.8 0.4 0.4

New product development

96.2 2.3 1.1 0.4

Quality

improvement

95.5 2.6 1.1 0.4 0.4

Organisation of production

97.7 1.2 1.2

4. Conclusions and Implications for Policy

This paper has focused on how firms in a developing country cluster innovate and interact with

economic actors within the domestic innovation system. The evidence presented herein suggests

that innovation is prevalent among the SMEs in the footwear industry in Nigeria but these are

mostly incremental. For policy, the indication is that capabilities for radical innovations which

are necessary for catching-up is lacking among the firms. Notwithstanding, in the face of

adequate resources and policy support, the firms could potentially accumulate such capabilities.

This is because most of them already develop their existing innovations on their own. Interaction

within the domestic innovation system is prevalent as well but not uniform across different types




of economic actors. Importantly, universities and other knowledge sources became less relevant

in the firms’ portfolio of cooperation partners while customers became more important. This

suggests two things for policy. First, university-industry interactions need to be strengthened at

least in the sector studied here. Second, market-based sources such as customers are an important

source of innovation-related knowledge. As a result, innovation policies should seek to foster

firms’ interactions beyond simply buy-sell relationships with such sources.

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PROMOTING GROWTH, EXCELENCE AND SUSTAINABILITY - 370

Does Terrorism Affect The Economic Performance? The

Empirical Analysis Of Islamic States In Iraq And Syria (ISIS)

And Pakistan

Alam Khan

Faculty of Economic and Public Administration


Abstract

This study evaluates the impact of terrorism on economic performance of the three most affect economies of

world due to terrorism. This study concentrates on the economies of Iraq, Syria and Pakistan. This research

Study has applied the economics of Crime Monitoring Model (ECM) of Ruiz Estrada and Ndoma (2014) for

analysis. The results of study explain that terrorism has badly affected the economic performance of the

economies of Iraq, Syria and Pakistan. Instead of direct fighting against the terrorist group in the said

economies, the developed world especially the Europe and United States of America may review the terrorism

policy about these economies and may eradicates the terrorism by reducing poverty, religious discrimination

and inequality to increase the opportunity cost of terrorism.




Aquaculture: A Source of Health and Wealth of Bangladesh

Md. Sohel Rana

Department of Economics



Abstract:

The population of the earth is increasing rapidly and creating concerns of many things. One of the concerns of

the increasing number of people is the food. According to FAO, It is predicted that the global population will

increase by another 2 billion and reached to a mark of 9.6 billion by 2050, Simultaneously at the present point of

time, the world contains more than 800 million of the total population who have been continuously suffering

from chronic malnourishment, therefore the food security and health of the population are at big concerns.

Besides fish consumptions has increased from 18.4 kg in 2009 to 19.2 Kg in 2012 (FAO, 2014). Which may put

pressure on fisheries industry immensely.

Aquaculture of fisheries plays a significant role in eliminating hunger, promoting health and reducing poverty.

This particular sector employs huge number of people and supports millions of people in Bangladesh. In context

of Bangladesh aquaculture can be a key sector since fish food is the most traded food all over the world. Since FAO is promoting Blue Growth utilizing socio-economic management of aquatic resources therefore people of

the world must take initiatives to ensure the health of the world, health of themselves and future food security to

ensure Blue World. The aim of the paper is to estimate contribution of Aquaculture in promoting fisheries

production and export growth, meeting domestic fish food supply and employing poor people. This paper will

also point out the safety issues that the small and medium aquaculture producers encounter.

Keywords: Aquaculture, Food Security, Blue World, Aquaculture Production and Export,

Food Safety Issues, Bangladesh




Women Empowerment through Entrepreneurship: a Case Study

of Hulu Terengganu, Malaysia

Anjali Dewi Krishnan

Binary University

No.20 Jalan Hormat 25/49, Taman Sri Muda, 40400, Malaysia

Abstract:

This paper attempts to explore the perceived entrepreneurial characteristics of women entrepreneurs in Hulu

Terengganu besides identifying the influences of perceived entrepreneurial characteristics on the business

performance. It starts by reviewing the basic of entrepreneurship and women’s participation in entrepreneurial

venture besides exploring the entrepreneurial traits of women entrepreneurs at Hulu Terengganu. The results

gathered from the research used to investigate the relationship between women entrepreneurs’ characteristics

and business performance. Self-efficacy, entrepreneurial alertness, tolerance of ambiguity, attitude towards

entrepreneurship and some other cognitive style that portraying entrepreneurial characteristics were discovered

through this research. This research finishes by presenting that entrepreneurial characteristics of women

entrepreneurs do carry an impact on business performance.

Keywords: Entrepreneur, Entrepreneurial characeristics, Business Performance

1.0 Introduction

Women are recognized as successful entrepreneurs globally (Heilbrunn 2004). This is also

evident in Malaysia; statistics show that Malaysian entrepreneur’s population grew from 1.2

million in 1982 to 2.2 in 2008 with a significant proportion of women (Department of

Statistic, 2009). The government has given emphasis, supported and initiated various

activities to increase the number of women participants (Ming-Yen & Siong-Choy, 2008)

across broad spectrum of business activities (Abdul Razak Omar, 1998).

It is also said that women are more active in entrepreneurship compared to male counterparts

(Deakins & Freel, 2003). This is very true of the womenfolk of Ulu Trengganu, they are

ubiquitous in all activities of business. This difference as compared to other regions in the

country gives reason to study women entrepreneurship in Ulu Trengganu; especially into their

characteristics which makes them different.

1.1 Statement of the problem

Entrepreneurship contributes significantly to a healthy economy (Kjeldsen & Nielsen, 2006)

and is a push factor for economic and social development throughout the world (Audretsch,

2003). Minniti (2009) study proves that there is a positive correlation between economic

growth and female entrepreneurship. In Malaysia, entrepreneurs through SMEs, with




significant government support, account for 97.3% of the total businesses and contributed

32.5% to the GDP of the country in 2011 (Department of Statistics Malaysia, 2012) with a

sizable role played by women (Ahmad, 2009). The Malaysian Business Commission (2010)

shows that food and beverage were among the top business venture in Malaysia and 49,554

business units of it are owned by women in the 2010 and increased to 54,626 units in the year

2011.

However, with least support from outside including government, womenfolk in Ulu

Trengganu, are empowering through entrepreneurship as ducks to water. There are many

studies that principally focus on problems, hindrance and government support (Center for

Women’s Business Research: Key Facts 2006), but not on identification of traits that

successful entrepreneurs’ posses in a community know for such activities since decades.

Hence, a research problem emerges from the lack of understanding of such successful women

entrepreneurs and entrepreneurial characteristics possessed by them. This research aims to

explore these traits to fill the gap in the current literature, through a case study of a successful

community in Hulu Terengganu that can be a role model across the nation.

1.2 Significance of the problem

Entrepreneurship contributes significantly to a healthy economy (Kjeldsen & Nielsen, 2006)

and is a push factor for economic and social development throughout the world (Audretsch,

2003). Minniti (2009) study proves that there is a positive correlation between economic

growth and female entrepreneurship. In Malaysia, entrepreneurs through SMEs, with

significant government support, account for 97.3% of the total businesses and contributed

32.5% to the GDP of the country in 2011 (Department of Statistics Malaysia, 2012) with a

sizable role played by women (Ahmad, 2009). The Malaysian Business Commission (2010)

shows that food and beverage were among the top business venture in Malaysia and 49,554

business units of it are owned by women in the 2010 and increased to 54,626 units in the year

2011.

However, with least support from outside including government, womenfolk in Ulu

Terengganu, are empowering through entrepreneurship as ducks to water. There are many

studies that principally focus on problems, hindrance and government support (Center for

Women’s Business Research: Key Facts 2006), but not on identification of traits that

successful entrepreneurs’ posses in a community know for such activities since decades.

Hence, a research problem emerges from the lack of understanding of such successful women

entrepreneurs and entrepreneurial characteristics possessed by them. This research aims to

explore these traits to fill the gap in the current literature, through a case study of a successful

community in Hulu Terengganu that can be a role model across the nation.

1.3 Purpose of the Research

This study may provide an opportunity to find out the characteristics associated with

entrepreneurship and exploring the relationship it carries on business performance.




1.4 Hypothesis/ Research question

Specific objectives

To answer the main objectives, a couple of specific independent objectives are formulated to

understand the issue better. The followings are the specific objectives formulated:

(1) To explore the entrepreneurial characteristics of women entrepreneur at Hulu Terengganu

(2) To examine the relationship between entrepreneurial characteristics of women

entrepreneur at Hulu Terengganu and their business performance

Research Questions

1) What are the perceived entrepreneurial characteristics of women entrepreneurs in Hulu

Terengganu, Malaysia?

2) What are the influences of perceived entrepreneurial characteristics on the business

performance of women entrepreneurs in Hulu Terengganu, Malaysia

Hypotheses

Hypothesis 1

H0: There is no any significant relationship between personality traits and business

performance

H1: There is a significant relationship between personality traits and business performance

Hypothesis 2

H0: There is no any significant relationship between need for achievement and business

performance

H1: There is a significant relationship between need for achievement and business

performance

Hypothesis 3

H0: There is no any significant relationship between risk taking propensity and business

performance

H1: There is a significant relationship between risk taking propensity and business

performance

Hypothesis 4




H0: There is no any significant relationship between tolerance for an ambiguity and business

performance

H1: There is a significant relationship between tolerance for an ambiguity and business

performance

Hypothesis 5

H0: There is no any significant relationship between self-efficacy and business performance

H1: There is a significant relationship between self-efficacy and business performance

Hypothesis 6

H0: There is no any significant relationship between cognitive characteristic and business

performance

H1: There is a significant relationship between cognitive characteristic and business

performance

Hypothesis 7

H0: There is no any significant relationship between entrepreneurial alertness and business

performance

H1: There is a significant relationship between entrepreneurial alertness and business

performance

Hypothesis 8

H0: There is no any significant relationship between entrepreneurial attitude and business

performance

H1: There is a significant relationship between entrepreneurial attitude and business

performance

Hypothesis 9

H0: There is no any significant relationship between cognitive style and business performance

H1: There is a significant relationship between cognitive style and business performance

1.5 Assumption

There are some facts that should be stated.




(1) The women entrepreneurs from Hulu Terengganu selected as the sampling unit assuming

that there are the group of women entrepreneurs who are making significant contribution to

the growth of nation to an extent.

(2) It is also assumed that all the respondents are homogenous.

(3) Also assumed that all the respondents are willing to make repayment.

1.6 Limitations

There are few limitations has been addressed by the researches. The first and foremost is the

researcher could not happen to conduct a nationwide survey in obtaining the expected data.

Thus, it is quite difficult in making a significant conclusion that can be generalized to the

entire women entrepreneurs. The respondents who were from Hulu Terengganu have been

chosen for this study. This sampling frame had limited the generalizability of the findings.

Consequently, the results of this study cannot represent the entire women entrepreneurs’

community but only a segment of the women entrepreneurs. The respondents of this study

were limited to only women entrepreneurs in the rural community. Therefore, the

entrepreneurial characteristics and business performance of the suburban and urban women

entrepreneurs is not covered in this research. There is no denying that the findings may

change if a larger sample covering both urban and rural areas were used. Also, this study is

subject to time and cost constraints. With a longer time period and availability of bigger fund

will give a better chance to cover more area to give better wider findings. Notwithstanding the

shortcomings, findings of this study have provided insights into women entrepreneurs,

entrepreneurial characteristics and business performance.

1.7 Definition

Definition Concepts

Entrepreneurship Entrepreneurship is seen as making new combinations which include the

introduction of new goods, new methods of production, opening of new markets,

new sources of supply and new organisations (Schumpeter, 1934)

Entrepreneurial

characteristics

Refer to the desired traits, which enable an entrepreneur to do what is expected of

him/her and succeed in business. It is the combination of these characteristics that is

required to enable any one to perform effectively as an entrepreneur. It is possible

for people to develop these characteristics and succeed in their careers as

entrepreneurs. Successful entrepreneurs have common characteristics.

Business

Performance

The accomplishment of a given task measured against preset known standards of

accuracy, completeness, cost, and speed in an organization.





An overview of previous researches related to the research topic is discussed here followed by

a framework to show the relationships between the variables.

2.2 Entrepreneurship

Entrepreneurship definition is dynamic and has evolved over time, Richard Cantillon (1775)

first defined entrepreneurs as individual who are expert in taking risk which translate

entrepreneurship as an art of risk taking, with the most recent by Hitt et al. (2011) which

argues that, entrepreneurship is a process where an individual engages in discovery,

evaluation and exploitation of opportunities. Others (Schumpeter (1934), Drucker, (1985),

Gartner (1988)) have also defined entrepreneurship, with all having a common theme,

business for the first time and its successful management.

2.3 Women Entrepreneurship

There is a significant increase in the numbers of women entrepreneurs throughout the world

(Heilbrunn, 2004). This phenomenon is backed up by behaviour of individual, social and

economic factors (Kavitha, Anantharaman & Sharmila, 2008). The evident social factor

which includes early life experience, stage of career, personal background, family background

and growth environment ( Gibb, 1993) and social pressures (Hebert et al, 1997) strongly

motivate women to become entrepreneurs. In essence, women become entrepreneurs in order

to balance work and family (Kirk & Belovics, 2006).

Among other motivating factors, social networks are also a major factor that motivates

women entrepreneurs (Gadar & Yunus, 2009). Besides these factors, self confidence of

having adequate skills and knowledge together with the knowledge of existing opportunities

gives women a positive attitude to venture in to business (Langowitz & Minniti, 2007).

Although there is many factors motivate women entrepreneurs, money was never a part of it

and it is a result of career dissatisfaction (Cromie, 1987). Not only giving greater flexibility

and coming out of traditional office bureaucracy, but being an entrepreneur means satisfying

their needs and also of their family and children (Lee & Rogoff, 1997).

Malaysia’s development is strongly supported by the women participation in economic

activity which is becoming a growing importance to the country (Ahmad, 2009). Their huge

success in contributing to the nation’s success is backed up by their courage and high level of

commitment in business (Mansor, Suzanna & Siti, 2008). Women entrepreneurs are becoming

more evidently important to the staggering rate in growth of the SMEs and their indirect

contribution to the Malaysian economy. The number of women in Malaysian SMEs in the

year 2003 was 1,122,000 or 36.8 percent of the total employment in SMEs and the number is

going up each year (Ming-Yen & Siong-Choy, 2008) and across diverse business activities.

This advancement is supported by the establishment of Federation Council’s organizations

Women’s Entrepreneurship and also by other women entrepreneurs association such as

Peniagawati, Usahanita, Wawasanita and Sarawak Usahanita and has helped women

entrepreneurs achieve global position (Abdul Razak Omar, 1998).




According to the Malaysian Business Commission 2010 food and beverage were among the

top business venture in Malaysia. There are 49,554 business units which are owned by women

in the 2010 and 54,626 units in the year 2011. This increasing figure clearly shows that

Malaysian women are strongly committed to perform in commercial and economic activities.

Norman and McDonald (2004) study found a sizable women entrepreneurs involved in the

home stay business which has a positive effect of the country’s economy, environment and

social aspects (Intan Osman et. al, 2008).

This clearly shows that many women are involved and show keen interest in self-employment

(O’Brien, 1983) besides maintaining a balance between their personal life and career

(Md.zabid & Fariza, 1992).

2.4 Role of Entrepreneurial Development

Entrepreneurs play a major role in contributing and developing the economy of a country.

Many economist and politicians believe that entrepreneurs are the notable contributors of

economic growth and job creation and this is why many countries promote entrepreneurial

activity (Audretsch & Thurik, 2001; Holcombe, 1998; Reynolds et al., 2000, 2001, 2002;

Wennekers, Thurik & Buis, 1997).

Entrepreneurs are not only linked with economic growth through the new firm creation which

creates new economic opportunities (Wennekers, Thurik & Buis, 1997) but also linked to

wealth distribution (Saemundsson & Kirchhoff, 2002; Schumpeter, 1993; Schumpeter, 1996)

and in reducing poverty (Bridges.org, 2002; Christy & Dassie, 2000; Saini, 2001; UNDP,

2001). On top of all this, entrepreneurs create social wealth out of total economic value

created. This happens where markets are not being able to cater specific social needs, where

the government agencies fail to provide services such as welfare and basic education in many

poor countries (Venkataraman, 1997).

In recognizing the role of entrepreneurship, in the year 1993, the General Assembly of the

United Nations Organisation approved a resolution recognizing entrepreneurship as economic

and social force that increases the living standards throughout the world. It also urged their

member countries to build and implement policies to encourage entrepreneurship in the

society (Slaughter, 1996).

2.5 Entrepreneurial Traits

2.5.1 Need for Achievement and Enterprise Performance

In 1965, McClelland studied the relationship among characteristics of entrepreneurs, strategy

and growth of SMEs. The findings revealed that higher achievers spend time thinking on how

to do things better, tend to take immediate responsibility for tasks, display initiatives and

always want feedback on their level of performance (McClelland 1965; McClelland 1987),

which is supported by similar findings by Rotter in 1966. On top of that, Johnson (1990)

revealed a positive relationship between need for achievement and entrepreneurial

performance. This is further supported by a meta-analysis conducted by Collins, Hanges and

Locke (2004) who found that both measures of need for achievement are valid. A more recent




study in 2007 found need for achievement is significantly correlated with both the choice of

an entrepreneurial career and with entrepreneurial performance (Rauch & Frese, 2007b).

2.5.2 Risk Taking Propensity and Enterprise Performance

In entrepreneurship studies, the idea regarding risks and uncertainty emerged in the 18th

century through economic theory developed by Cantillon in 1931 (Kirby 2003). The results

are mixed, some have positive relationship, but others are negative. Meta-analysis

investigating this relationship found positive correlation between these two elements (Rauch

et. al., 2007b, Davidsson, 2007). Similarly study investigating this dimension, found that risk-

taking and organizational performance produced a curvilinear relationship. The clarification

for this phenomenon is found in another study in Australia which found that risk-taking which

involved taking calculated risk had positive impact on firm performance, but taking risk

which were considered as daring actions were considered as detrimental for firm performance

(Coulthard, 2007). However, a meta-analysis confirms the positive effect of risk-taking on

entrepreneurship and business success (Rauch and Frese 2007b). The overall relationship

between risk-taking, entrepreneurship, and business success was minimal, indicating the

presence of moderators. This leads to the conclusion that the effect of risk-taking on

entrepreneurship and business success is positive and significant, but weak (Isaga, 2007).

2.5.3 Tolerance for Ambiguity and Enterprise Performance

An entrepreneur with a high tolerance level for ambiguity is one who finds an unclear

situation challenging and struggles to overcome such situations in order to perform better

(Teoh & Foo 1997). With regard to this phenomenon, several researchers have concluded that

entrepreneurs have a significantly higher capacity to tolerate ambiguity than is the case with

managers (Koh 1996; Teoh & Foo 1997). This is because the challenges and potential

associated with business growth are, by their very nature, unpredictable (Schere 1982). As a

result of this, entrepreneurs are required to have considerable tolerance and view uncertainty

as an exciting stimulus rather than a severe threat (Gasse 1982). In fact, if ambiguity tolerance

serves as an exciting stimulus it may foster entrepreneurial success (Begley & Boyd 1987b).

This concept falls in line with the previous notion that entrepreneurs with a higher tolerance

for ambiguity are those who obtain superior results if their mission is in line with company

growth (Gupta & Govindarajan, 1984). Further evidence for the validity of this notion comes

from a recent study carried out by Walley (2007). The author found that successful

entrepreneurs have a greater tolerance for ambiguity than failed entrepreneurs.

2.5.4 Self-Efficacy and Enterprise Performance

Much work has been focused on this theme since it is believed that people who have higher

self-efficacy are most probably to start a venture and lead their venture to growth than people

who have lower self-efficacy (Judge and Bono 2001; Kirby 2003 and Rauch and Frese

2007b). Furthermore, it is argued that people with a high level of self-efficacy tend to set

higher goals, persist even in the face of failure, and sees difficult tasks as challenges to be

conquered rather than issues to be avoided (Kuratko & Hodgetts, 2001). Due to the important

role of self-efficacy, many research works has been done to investigate the effect of self-




efficacy on business performance (Baum and Locke 2004). For instance, a meta-analysis

carried out by Judge and Bono (2001) showed a robust, positive link between self-efficacy

and work related performance, proving that self-efficacy is an entrepreneurial feature that

might determine performance. In his studies, Forbes (2005b) measured the link between self-

efficacy and enterprise performance and his findings confirm that self-efficacy and enterprise

performance are positively linked. Likewise, Anna et al. (2000), Baum, Locke and Smith

(2001), Baum and Locke (2004) identified a positive relationship between the self-efficacy of

entrepreneurs and the growth of ventures.

2.6 Cognitive

2.6.1 Entrepreneurial Alertness and Enterprise Performance

Researchers have attempted to understand the role of alertness in venture activities. For

example, Tang (2008) studies the effects of alertness on entrepreneurs' commitment to their

new ventures. The researcher found that highly alert entrepreneurs showed greater

commitment to their firm than less alert entrepreneurs. Following this, Hsieh, Kelley and Liu

(2009) examined the role of alertness in the opportunity recognition process. Their study

confirms a positive relationship between opportunity recognition and alertness, indicating that

entrepreneurial alertness may provide valuable conceptual tools for understanding the process

of opportunity identification and venture performance. Given the importance of alertness in

opportunity identification, linking alertness to firm growth seems highly valuable. This

argument also applies to Ardichvili, Cardozo and Ray (2003) who asserted that successful

entrepreneurs are more likely to have an approach that assists them in recognising

opportunities, which will lead to profits in the future. Thus, it seems clear that entrepreneurial

alertness poses a useful dimension for understanding various aspects of entrepreneurship.

However, a limited number of empirical studies exist in this area (Tang 2008).

2.6.1 Attitude toward Entrepreneurship and Enterprise Performance

A number of studies have tried to understand individual’s attitudes towards entrepreneurship

(Wiklund and Shepherd 2003a; Torimiro and Onco-Adetayo 2005; Kolvereid & Isaksen

2006; Caliendo, Fossen & Kritikos 2009). Studies indicate that attitude is an important

determinant of an individual’s success in entrepreneurship, because a favourable attitude

towards entrepreneurship increases entrepreneurial activity and aspiration, which in turn

positively affect the performance of the enterprise (Kirby 2003). For example, Turan and Kara

(2007) revealed that Turkish entrepreneurs exhibit positive attitudes and a steady

determination with regard to entrepreneurial activities. In line with these findings, a study by

Nybakk and Hansen (2008) revealed that entrepreneurs who exhibit a stronger entrepreneurial

attitude appear to be more likely to change the way they organise their enterprise and tend to

have higher income growth. Subsequently, studies of growth have also found that positive

attitude toward entrepreneurship having a positive effect on the growth of SMEs (Miner et al.

1994; Kolvereid & Bullvag 1996; Wiklund & Shepherd 2003).

2.6.2 Cognitive Style Indicators and Enterprise Performance




Allinson, Chell, and Hayes (2000) and Kickul and Krueger (2004) differentiated between

entrepreneurs and non-entrepreneurs using cognitive style as the distinguishing factor. In

support of the argument, both studies found that entrepreneurs were more intuitive than the

general population of managers. Given the promise of the cognitive approach as a field of

study, linking cognitive styles to firm growth seems highly valuable. For example, Allinson,

Chell and Hayes (2000) and Hough and Ogilvie (2005) suggest that different cognitive styles

among individuals can explain variations in information-processing, decision-making and

outcomes (e.g., business outcomes). Empirically, studies are available regarding the

relationship between cognitive styles and enterprise growth. Among the studies which link

cognitive styles and performance, the one by Allinson, Chell and Hayes (2000) reveals that

entrepreneurs of successful firms are more intuitive in their cognitive styles than the general

population. Similarly, Sadler-Smith (2004) found a positive relationship between intuitive

decision style and subsequent financial performance. In addition, Armstrong and Hird (2009)

investigated whether or not cognitive style is an important factor in identifying individuals

with the potential to become successful entrepreneurs. Their findings indicate that successful

entrepreneurs exhibited higher levels of creating style than non-successful entrepreneurs.

Conceptual Framework

Employee Motivation

Business Performance

Entrepreneurial Characteristics

Personality traits

Need for achievement

Risk taking propensity

Tolerance for an ambiguity

Self-efficacy

Cognitive Characteristics

Entrepreneurial alertness

Entrepreneurial attitude

Cognitive style

Dependent Variables




3.0 Introduction

This chapter will describe the tools, techniques and data analysis methods developed for the

use in the subsequent chapter. Thus, this chapter illustrates the collaborating establishments,

procedures and methods used to conduct this research to investigate entrepreneurial

characteristics of women entrepreneurs and the relationship it carries towards business

performance. The objectives are repeated here to reiterate how the objectives match the data

collection.

3.1 Justification

This study is quantitative in nature. Quantitative data usually employed to determine

relationships between the variables. This research is based on exploratory research design.

According to Babbie, an exploratory research is essential whenever a researcher is breaking

new ground, and these studies almost always yield new insight into the topic. As there are

little or no studies that have explored the women entrepreneurs’ entrepreneurial characteristics

in Malaysia’s context, thus, this research will give insight to the women entrepreneurs’

entrepreneurial characteristics and the relationship it carries towards business performance.

This fact makes this study exploratory in nature.

3.2 Research Design

For this study we have identified the quantitative methodology to describe and measure the

data. This method is ideal in understanding the specific objectives of this study and helps the

researcher to make specific prediction and gives ideas for future studies. A questionnaire

design was used in this research to gather data from the women entrepreneurs from Hulu

Terengganu. This approach was chosen because easy to assess the entrepreneurial

characteristics of women entrepreneurs. Based on the research objectives statement where a

couple of hypotheses will be tested, we have identified the independent and dependent

variables as follows; the independent variables are entrepreneurial and cognitive

characteristics of women entrepreneurs (personality traits, need for achievement, risk taking

propensity, tolerance for an ambiguity, self-efficacy, entrepreneurial alertness, entrepreneurial

attitude and cognitive style). The dependent variable is business performance.

3.3Sampling Technique

Convenience sampling method was employed in this study. Generally, the questionnaires

were distributed among women entrepreneurs in Hulu Terengganu. The specific area of focus

for this research is the town of Kuala Berang. The samples from this particular town is

deemed as representative of the whole district of Hulu Terengganu as Kuala Berang is the

administrative capital of the district and most of the businesses operate here.

3.3 Research Instrument

The research instrument was a self-administered questionnaire. This questionnaire was

developed through adaptation from various researchers. The personality traits section

examines the women entrepreneurs' psychological profile and includes indicators such as; the




need for achievement, locus of control, innovativeness, risk-taking propensity, self-efficacy

and tolerance for ambiguity. Several items were developed for each individual variable and

women entrepreneurs were required to indicate their level of agreement with these items by

using a 5 point Likert scale. Accordingly, need for achievement was measured by the scale

adapted from Steers and Braunstein (1976), which was also used in other research

(Hansemark 1998; Entrialgo, Vazquez and Fernandez 2000; Stewart et al. 2003). The

entrepreneur’s locus of control was measured by three different dimensions, namely: internal

attributing, chance attributing and powerful others (Levenson 1981). These were also

observed in other works (e.g., Koh 1996; Hansemark 1998; Littunen and Virtanen 2006).

Items taken from the Jackson Personality Inventory (Jackson 1984), which was used in other

works (Cromie 2000; Nchimbi 2002; Gurol and Atsan 2006), were used to measure an

entrepreneur’s innovativeness and risk-taking propensity. The scale developed by Sherer et al.

(1982) was used to measure the entrepreneur’s self-efficacy. This scale was chosen because it

is frequently reported to have high reliability (Chen, Gully, and Eden 2001). Lastly, the items

used to measure tolerance of ambiguity were taken from MacDonald (1970). This scale

consists of 20 items and was reported to have high reliability and validity (Gurol and Atsan

2006).

The items used to measure cognitive characteristics are based on a 5-point Likert scale

ranging from 1 (strongly disagree) to 5 (strongly agree). Attitude towards entrepreneurship

was measured using a scale adopted from Turan and Kara (2007). This scale measures the

extent to which the entrepreneur has a positive attitude towards entrepreneurship. We assess

cognitive style with the 18-item Cognitive Style Indicator (CoSI) developed by Cools and

Van Den Broeck (2007). This scale distinguishes a knowing style, a planning style and a

creating style. This scale has been used often as it has shown itself to be reliable and valid

across different countries (Cools and van den Broeck 2007; Marcati, Guido and Peluso 2008).

Eight items adapted from Tang, Tang and Lohrke (2008) were used to measure entrepreneur’s

alertness. These items were developed on the basis of the Kirzner (1979) definition. This scale

has been found to have strong reliability and validity (Tang 2008). The scale incorporates

eight items, four of which represent low alertness while the other four represent high

alertness. The items adapted from Davidson (1989) which were also used by Kolvereid

(1992), Olomi (2001) and Nchimbi (2002) were used to gather information about the

motivation of individuals for starting their businesses. The items comprise both pull factors

and push factors. The respondents were first required to rate the extent to which different

factors were important to them when they started their businesses on a 5-point Likert scale.

Furthermore, the respondents were also required to indicate a degree to which reasons for

starting their businesses are still important to them. The scale ranged from 1 (not important at

all) to 5 (very important).

3.5 Statistical Treatment

The data that were gathered from the questionnaires were coded, edited and then entered into

personal computer using SPSS version 20 for window 2010. Further editing and clearing were

done prior to the analysis.




4.0 Finding and Analysis

This chapter reports the findings and results of the analysis derived from the survey data. It

begins with a descriptive analysis on the respondents’ demographic data and their firm’s

performance. It is followed by reliability analysis, description of their entrepreneurial

characteristics, correlation analysis, multiple regression analysis and hypothesis testing

4.1 Summary Result

4.1.1 Demographics Characteristics of Respondents

A total of 313 survey questionnaire were distributed and collected from women entrepreneurs

from Hulu Terengganu. The response rate is 100%.

Table 4.1 presents the summary of the demographic details.

Demographic

Factors % N

Age Group

20-30 30.0 94

31-40 30.7 96

41-50 39.3 123

Total 100.0 313

Marriage Status

Married 59.7 187

Single 30.0 94

Widowed 10.2 32

Total 100.0 313

Highest Education Level % N

Never Attended School 10.2 32

Primary School 30.0 94

STPM / Diploma 40.3 126

Degree 10.2 32

Others 9.3 23

Total 100.0 313

Table 4.1 Respondent Demographic

In this survey, most of the respondents are in the age group of 41-50 and amounted to 39.3 %

of the total number of respondents. It is followed by the age group of 31-40 and 20-30, at 30.7

% and 30.0 % respectively. 187 or 59.7 % of the respondents are married and 30 % remain

single while 10.2 % are widowed. Looking in the highest level of education of the

respondents, STPM / Diploma holders top the table with 126 (40.3%), followed by Primary

School leavers at 30.0% of the total respondent.




4.2 Firm Performance

Total number of workers

Frequency Percent Valid Percent Cumulative Percent

Valid No changes 96 30.7 30.7 30.7

Increase 155 49.5 49.5 80.2

Decrease 30 9.6 9.6 89.8

No workers 32 10.2 10.2 100.0

Total 313 100.0 100.0

Table 4.2 Number of Workers

Table 4.2 explains the total number of workers a firm has. It tends to explain the pattern in the

terms of increase and decrease of workers for the last three years. From the table, it is

reasonable to say that 49.5% of the total firms experienced increase in the total number of

workers while 9.6% experienced decrease, 30.7% had no changes in number of workers and

10.2 % firms did not employ any workers.

Total number of relatives working for the firm


Valid Increase 96 30.7 30.7 30.7

No

relatives 217 69.3 69.3 100.0

Total 313 100.0 100.0

Table 4.3 Number of Relatives Working at Firm

Table 4.3 explains the number of relatives working for a firm in the last three years. It tends to

look at the increase and decrease of number of relatives working in a firm. Based on the table,

it is safe to say that 30.7 % of the total number of firms had experienced increase in number

of relatives working for them. The remaining 69.3% of the firms have no relatives attached

with them.

Firm Sales


Valid Increase 219 70.0 70.0 70.0

Decrease 32 10.2 10.2 80.2

No changes 62 19.8 19.8 100.0

Total 313 100.0 100.0

Table 4.4 Firm’s Sales




Table 4.4 explains the firms’ sales in the last three years. A total of 70.0% firms experienced

increase in their sales compared to 10.2% of decrease in total sales. A total of 62 firms or 19.8

firms reported that their sales remained unchanged.

Firm profit


Valid Increase 219 70.0 70.0 70.0

Decrease 32 10.2 10.2 80.2

No changes 62 19.8 19.8 100.0

Total 313 100.0 100.0

Table 4.5 Firm’s Profit

Table 4.5 explains the level of profit a firm experienced in the last three years. It is evident

that 219 respondent covering 70.0 of the total respondent had increased profit in their

business. 10.2% seems to have a reduced profit level in the last there years and 19.8% had

their profit unchanged.

Asset development for the last 3 years


Valid Increase 187 59.7 59.7 59.7

Decrease 96 30.7 30.7 90.4

No changes 30 9.6 9.6 100.0

Total 313 100.0 100.0

Table 4.6 Firms Asset

In the table 4.6 is the response to the question of assets accumulation in the last three years.

59.7% of the total respondent agreed that their assets are increased while 30.7% reported

decrease in the assets. A total 9.6% of respondent had no changes in their assets.

4.3 Reliability Analysis

Cronbach’s alpha is computed for internal validity and is discussed below.

Reliability Statistics

Variables Cronbach’s Alpha N of items Interpretation

Self-efficacy 0.706 14 Good

Tolerance for

Ambiguity

0.761 12 Good

Risk Taking

Propensity

0.236 3 Poor

Need for

Achievement

0.498 5 Poor

Entrepreneurial 0.651 7 Moderate




Alertness

Attitude towards

Entrepreneurship

0.720 16 Good

Cognitive Style

Indicators

0.832 18 Very Good

Table 4.7 Reliability Analysis Summary

The results indicate that the Cronbach’s Alpha for 14 items in Self-efficacy is 0.706. The

result shows that this independent variable is ranged as good. The questions about Self-

efficacy have good reliability. The reliability result of Tolerance for Ambiguity measures at

0.761 for 12 items. The result shows that this independent variable is ranged as good. The

questions about Tolerance for Ambiguity have good reliability. The reliability result of Risk

Taking Propensity measures at 0.236 for 3 items. The results shows that this independent

variable is ranged as poor. The questions about Risk Taking Propensity are not reliable for

this research and will not be used for further analysis. The reliability result of Need for

Achievement measures at 0.498 for 5 items. The results shows that this independent variable

is ranged as poor. The questions about Need for Achievement are not reliable for this research

and will not be used for further analysis. The reliability result of Entrepreneurial Alertness

measures at 0.651 for 7 items. The result shows that this independent variable is ranged as

moderate. The questions about Entrepreneurial Alertness have moderate reliability. The

results indicate that the Cronbach’s Alpha for 16 items in Attitude towards Entrepreneurship

is 0.720. The result shows that this independent variable is ranged as good. The questions

about Attitude towards Entrepreneurship have good reliability. The reliability result of

Cognitive Style Indicators measures at 0.832 for 18 items. The result shows that this

independent variable is ranged as very good. The questions about Cognitive Style Indicators

have a very good reliability.

4.4 Entrepreneurial Characteristics

IVs N Mean

Self-efficacy 313 2.94

Tolerance for Ambiguity 313 3.66

Entrepreneurial Alertness 313 3.53

Attitude towards Entrepreneurship 313 3.57

Cognitive Style indicator 313 3.91

Table 4.8 Entrepreneurial Characteristics

Table 4.8 explains the level of each variable that makes up entrepreneurial characteristics

among the respondent. The table shows the mean value for each variable. The figures range

from 1 to 5, where 1 being lowest and 5 being the highest. The higher the mean value gets,

higher the level of association of an individual with the said variable. Based on that,




Cognitive Style Indicator is the highest entrepreneurial character among the women

entrepreneurs in Hulu Terengganu. Self-efficacy scored the lowest at 2.94.

4.6 Correlations Analysis

In this section, Pearson Correlation Coefficient test results are displayed and will form the

basis to analyse the hypothesis.

Business Performance

Self-efficacy Pearson Correlation .179

Sig. (2-tailed) .001

N 313

Tolerance for Ambiguity Pearson Correlation .085


N 313

Entrepreneurial Alertness Pearson Correlation -.285


N 313

Attitude towards

Entrepreneurship

Pearson Correlation -.369


N 313

Cognitive Style Indicators Pearson Correlation .043


N 313

Table 4.9 Summary of Correlation Analysis

4.7 Multiple Regression Analysis

Model Summary

Model R R Square

Adjusted R

Square Std. Error of the Estimate

1 .657a .432 .419 .44753

Table 4.7.1 Model Summary




ANOVAb

Model

Sum of

Squares df Mean Square F Sig.

1 Regression 46.424 7 6.632 33.113 .000a

Residual 61.086 305 .200

Total 107.511 312

Table 4.7.2 Anova Table

Model Unstandardized Coefficients Standardized

Coefficients

T Sig.

B Std. Error Beta

1 (Constant)

Tolerance for

Ambiguity

Self-efficacy

Entrepreneurial

Alertness

Attitude

Towards

Entrepreneurship

Cognitive Style

Indicator

3.227

.573

-.619

-.208

-.789

.570

.628

.086

.117

.071

.100

.101

.411

-.431

-.196

-.499

.344

5.141

6.661

-5.310

-2.948

-7.883

5.651

.000

.000

.000

.003

.000

.000

Table 4.7.3 Coefficients Table

It is noted from Table 4.7.1 as shown above, that the correlation coefficient (R) is 0.657

which indicates a positive linear relationship between ‘Business Performance’, the dependent

variable and the five independent variables. Thus, the results indicate that ‘Business

Performance’ is significantly affected by all the five types of independent variables, discussed

in this study.

Table 4.7.2 also shows that the multiple coefficient of determination (R²) is 0.432,

indicating that about 43.2% of the variation in ‘Business Performance’ could be jointly

explained by the given five independent variables which are Tolerance for Ambiguity, Self-

efficacy, Entrepreneurial Alertness, Attitude towards Entrepreneurship and Cognitive Style

Indicator




As per the ANOVA table above, the F-value of the model used for this research is 33.113

(Sig. = 0.000), indicating significance of model at 0.05, the chosen level of significance.

Thus, confirming the fitness of the model which indicates that there is statistically significant

relationship between ‘Business Performance’ and each of the independent variables.

From the Coefficients table 4.7.3, it shows that all the variables have a significant effect on

the ‘Business Performance’, the dependent variable. The P-value for all the independent

variable are less than 5% (0.05), which is the chosen level of significance, indicating that all

five independent variables had significant relationship with ‘Business Performance’.

4.8 Hypothesis Testing based on Correlations Analysis

IVs r value Relationship Hypothesis

Self-efficacy .179 Low relationship H1 Accepted

Entrepreneurial Alertness -.285 Low relationship H1 Accepted

Tolerance for Ambiguity .085 Very low relationship H1 Accepted

Attitude Towards Entrepreneurship -.369 Moderate relationship H1 Accepted

Cognitive Style Indicator .043 Very low relationship H1 Accepted

From the results of the correlation analysis, it shows that the hypothesis (H1) is accepted for

all the independent variable tested. This is because each of the independent variables has

some values no matter positive or negative. For Entrepreneurial Alertness and Attitude

towards Entrepreneurship, there is a negative correlation or negative relationship with the

dependent variable. As in this research we are trying to test whether each independent

variable has relationship with the independent variable or not, that being the case, all the

alternative hypothesis (H1) in this research are accepted.

5.0 Conclusion

This section primarily focused on discussing the finding and recommendations of this

research. The first section will begin with discussion of the research question based on the

finding on section 4. This will be followed by recommendation for further research in this

area, limitations of this research and conclusion.

5.2 Findings Related to Research Question 1:

What are the perceived entrepreneurial characteristics of women entrepreneurs in Hulu

Terengganu, Malaysia?

IVs N Mean

Self-efficacy 313 2.94

Tolerance for Ambiguity 313 3.66

Entrepreneurial Alertness 313 3.53

Attitude towards Entrepreneurship 313 3.57

Cognitive Style indicator 313 3.91




Based on the results of the research, women entrepreneurs of Hulu Terengganu seems to have

all the entrepreneurial characteristics tested in this research which are; self-efficacy, tolerance

for ambiguity, entrepreneurial alertness, attitude towards entrepreneurship and cognitive style

indicators. All this variables have a mean value between 2.94 and 3.91 out of a perfect 5.

Cognitive Style Indicator is the highest entrepreneurial character among the women

entrepreneurs in Hulu Terengganu at 3.91 and self-efficacy scored the lowest at 2.94.

5.3 Findings related to Research Question 2:

What are the influences of perceived entrepreneurial characteristics on the business

performance of women entrepreneurs in Hulu Terengganu, Malaysia?

IVs r value Influence on Business Performance

Self-efficacy .179 Low positive

Entrepreneurial Alertness -.285 Low negative

Tolerance for Ambiguity .085 Very low positive

Attitude Towards Entrepreneurship -.369 Moderate negative

Cognitive Style Indicator .043 Very low positive

From the results of the analysis, different entrepreneurial characteristics have different

influences on the business performance of women entrepreneurs in Hulu Terengganu,

Malaysia. Tolerance for Ambiguity and Cognitive style indicator tend to have a very low

positive relationship with business performance. Self-efficacy have a low positive influence

on business performance while Entrepreneurial Alertness and Attitude towards

Entrepreneurship have low negative influence and moderate negative influence on business

performance respectively.

5.4 Recommendations for the Future Research

This study is basically exploratory and cross-sectional in nature and is by no means an

exhaustive study on the students’ market. Additionally the results only reflect on the response

from limited women entrepreneurs in the rural, such as the women entrepreneurs in Hulu

Terengganu. Further measures for this study to be conducted on national basis would be

beneficial, research to include rural areas and smaller towns and with bigger sample size to

reflect the demographic composition of Malaysia.

Apart from entrepreneurial characteristics, there are other factors such as motivational factors,

start-up factors and supportive environmental factors to be considered in determining what

affect business performance.

Conclusion of the Research

This research has been conducted to identify the entrepreneurial characteristics of women

entrepreneurs and the relationship it carries towards business performance. At the end, this

research has met its objectives and successfully answered the research’s questions. Moreover,

this research will provide some ground work or became a benchmark for upcoming researches

on entrepreneurial characteristics. The findings have successfully able to provide certain




significant methods regarding the relationship exists between entrepreneurial characteristics

of women entrepreneurs and business performance. Thus, this research can be a guideline for

other researchers who intended to research in the same field to a certain extend.

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Impact of Increasing Marginal Cost on Recreational Visits: Case

of Lake View Park in Pakistan

Wajiha Haq


Jalan Universiti, Kuala Lumpur

Malaysia

AND

National University of Science and Technology

H-12, Islamabad

Pakistan

Abstract

Parks and picnic resorts have played an important role in creating amenity value and positive externality.

Pakistan is very rich country in terms of natural landscapes and picnic points. Lake View Park is situated in

Islamabad which is capital city of Pakistan. The immediate community being benefited by this park is of twin

cities which are Rawalpindi and Islamabad. People from far places also come to visit this park. This park is situated near Rawal Lake and provides recreational area along with scenic beauty of wildlife. This research

paper focuses on finding the benefits of parks and to see whether it was beneficial to invest in improving quality

of such public place for which imposition of entry fees was required. In December 2010, there was public

resistance about imposing entry ticket (fees) in Lake View Park which was charged to collect Rs. 30 million to be

invested on park. Questionnaire based primary data has been collected. Results showed that the investment of

Rs. 30 million in Lake View Park financed through Rs. 10 entry ticket was beneficial and didn’t reduced the

demand of visitors for visit by increasing price. Other factors also showed that marginal benefit was greater

than the increase in marginal cost.

Key words: Marginal cost, Lake View Park, marginal benefit, travel cost

Introduction

Parks and picnic resorts have played an important role in creating amenity value. Their role

has remained very important in creating positive externality. Pakistan is very rich country in

terms of natural landscapes and picnic points. It faces four seasons and provides a chance to

enjoy the beauty of four seasons. Pakistan’s tourism industry has remained under developed.

Pakistan has a lot of security concerns and people face a lot emotionally disturbing factors

like terrorist attacks etc. In such situation, an excursion place has a lot of value as people can

relax in peaceful place and beautiful environment. Literature has also provided evidence that

improving quality of environment imposes positive impact on public health. Improving water

and air quality exerts significant positive impact on people that they also value.

Lake View Park is situated in Islamabad, capital of Pakistan. The immediate community

being benefited by this park is of twin cities which are Rawalpindi and Islamabad. People

from far places also come to visit this park. This park is situated near Rawal Lake and




provides recreational area along with scenic beauty of wildlife. This research paper focuses on

finding the benefits of parks and to see whether it is beneficial to invest in improving quality

of such public places. In this study, Lake View Park has been taken to analyze the costs and

benefits. In December 2010, there was public resistance about imposing entry ticket in Lake

View Park which was charged in compensation for Rs. 30 million to be invested on park. This

paper analyses whether the benefits of investment were more than its cost or not. We have

used travel cost method to do cost benefit analysis of investment in Lake View for which

people showed resistance.

Literature on finding positive impacts of externality is very few. People find it very difficult

to measure costs and benefits and usually the administration do not bother to find costs and

benefits of any investment in a park as they find it cumbersome. This research paper will not

only add to literature by providing evidences but will also provide new insight about how

people in Pakistan value such amenities. This research will also open discussion on whether

imposing entry fees on parks is beneficial or not.

Literature Review

Recreational sites have significantly positive impact that people value. Instead of just

focusing on how frequently people visit a site as an indicator of their value to such places,

non-market goods indicators have also been taken. Non-monetary benefits of recreational

sites have also been taken but their estimate is difficult. Contingent value just provides

preferences which does not provide accurate estimate of costs and benefits. (Adamowicz

et.al., 1997). It was found that the attitudes of people is towards frequently visiting parks.

Such sites in focus have significant impact on development and improvement of relaxed

environments. (Manfredo, Yuan & Mcquire, 1992). Many studies have found that those who

are environmentally conscious value the environment more. For them the marginal benefit for

environmental quality improvement will be high. This was indicated by Granzen and Olsen in

1991 and Hines, Hungerford and Tomera in 1987. The importance of environmental quality

and its value has been indicated by demand curve which shows the marginal willingness and

benefits that people derive from such resorts. Loomis and Walsh in 1997 estimated demand

curve for recreational sites. Mihalic in 2000 found that people’s decisions to visit any resort is

affected by the value they perceive thus the scenic beauty plays an important role in rendering

the decisions of tourists whether to visit the site or not. It was further found that the value

people attach to recreational sites also help them to choose between where to visit and where

to not. This mechanism works like market demand of products and their choice mechanism

between different products. (Jurowski et. al., 1995). Hightower, Brady and Baker in 2002

inferred in their research that consumers act upon their perceptions and make future decisions

but these perceptions are formed by physical environment. Thus people value the importance

of their environmental surroundings as a valuable environment allows them to make quality

decisions. Clark and Kahn in 1989 found that there are objective measures present in

measuring environmental quality like we see that air quality is measured by the percentage of

oxygen, nitrogen and carbon dioxide. Such a research on measuring on environmental quality

through these objective measures was also conducted by Smith and Desvouges in 1985.

Whitehead, Haab and Huang in 2000 found that objective measures play an important role in




finding the value of natural amenities and public parks but non-monetary factors also are very

important in affecting the people’s decision to visit some place or not. This objective method

is difficult to use for a particular site. Eom and Larson used travel cost method to measure the

environmental quality benefits. It is by far most popular method for non-market way of

valuation of environmental amenities. It is better than contingent method. Freeman in 1993

derived a demand curve and calculated consumer benefits. He also derived explicit value of

price of recreational site. In 1989, Bocksteal and McConnell explained that the revealed

preference method has problems of subjectivity by incorporating individual preferences if we

are also incorporating in travel cost method other factors focusing on revealed preferences.

Different factors affect the value of environment perceived by individuals. Pollution of

different kinds affects the environment as well as people’s demand for such places. Water

quality has been largely affected by crops production through use of pesticides, insecticides

and other chemicals. Such chemicals not only affect the chemistry of soil but also affect under

soil water. The water reservoirs under water are also affected and hence affect drinking water

and water used for other work. Many policies have been made seeing cost and benefit of

improving water quality of surface water and underground water. However the benefits of

improving water quality or the direct effect of controlling pollution of water through soil

cannot be directly observed so technique of valuation based on price cannot be used.

Fertilizers used for improving crop production also become a source of surface water

pollution. They get dissolved in water and eventually make drinking water injurious to health.

(Crutchfield, Hansen, and Ribaudo, 1993). Improved environmental quality benefits are

defined as increase in utility due to improvement in quality and given by difference of utility

before and after environmental quality improvement. In case of water quality improvement,

demand and cost curves cannot be directly observed so estimate of marginal benefit due to

improved quality of environment can easily be observed. Different approaches are used to

quantify the change in quality. There are two approaches. Direct approach involves

individual’s choices which they actually among sources of water. Indirect approach involves

asking individuals about their preferences about the choices of water source. (Smith, 1993).

There are benefits of improved water quality to nation in a way that in increase fisheries

industries and tourist industry by providing good places for those who are interested in

fisheries sports. Russell and Vaughan in 1982 used travel cost model to estimate the benefits

of improved water quality. Travel cost method focuses on calculation of time and cost

incurred in visiting the site. On different travel cost people’s willingness to visit the site is

checked. Improved water quality will not only improve fisheries but will also attract new

participants. Existing fisherman will increase their catch by increasing number of days of

catching. Travel cost model actually measured per fisherman benefits through improved water

quality. The estimated benefits were between $300-966 depending on pollution eradication.

Data Description

Survey method has been used to analyze the relationship. 100 respondents filled the

questionnaire and out of which 95 were selected. 5 questionnaire responses were discarded as

they contained a lot of missing values. Questionnaire has been attached in the appendix. Same




questionnaire was used by Chin Huang, Huang and Lee in 2011. First seven questions were

used as measurement of “environmental service quality” variable. Questions from 8-11 were

used as measuring instrument for “congestion” variable. Questions from 12-15 were used as

of measure “facility/transportation” variable. Random sampling technique was used. 60 were

female respondents whereas 35 were female respondents. Table 1 shows descriptive statistics.

It shows that the average numbers of trips that people make to Lake View Park in a year are

approximately 2 with standard deviation of around 1. Average travel is approximately 3 (data

was in log form) which means Rs. 932.180 is the average travel cost with small standard

deviation. Average statistics of other variables are also given in table 1 which is computed

from the responses of questions asked in questionnaire for respective variables. Average age

is 22 and average gender is female.

Methodology

In this research paper, travel cost method has been used for the valuation of Lake View Park

and to see per person costs and benefits. How should the travel cost be estimated has been

cited by different authors. Some say that actual method of travel cost estimation for zonal

areas is to calculate number of trips to that particular area from different zones. Average

travel cost per mile is calculated and average travel cost per time is represented by a proxy of

per hour wage. Then distance and time to destination is asked by questionnaire which gives

estimate of total travel cost per mile and time. Freeman in 1993 in his research paper used

substitute price as an estimate of travel cost. If average travel cost is not estimated correctly

then it can lead to underestimation of demand. Also if again the substitute price is not a good

estimate of travel cost then it can lead to underestimation of demand for public resort (whose

costs and benefits are being calculated). We have also asked people about their travel cost for

round trip to Lake View Park as estimation of average cost/ mile estimate was difficult.

Random selection was used for sampling. Ordinary least square method has been used to

analyze the data and infer the results. The econometric model tested through ordinary least

square is as follows:

Y = α + β logX1 + θ X2 + γ X3 + δ X4 + ψ X5 + λ X6

Results

Data was collected from questionnaire method. The reliability of questions to measure the

required variables was checked. Cumulative Chronbach alpha for questions addressing the

variable of environmental quality was 0.72. Cumulative Chronbach alpha for questions

addressing the questions of congestion was 0.71 and 0.69 for facility transportation. 0.7 and

above level of Chronbach alpha is considered satisfactory for considering questions reliable

for the estimation of particular variable.

The model described above was estimated where we were going to see the travel cost effects

on number of trips taken to Lake View Park. Other factors were also considered to affect the

number of trips including environmental quality, congestion, transport quality, gender and

age. Table 2 shows correlation matrix. Correlations between the variables were first

considered before regressing the variables on number of trips. Numbers of trips are found to




be negatively correlated with cost i-e as the travel cost increases, number of trips decreases.

Correlation between two variables is significant. Environmental quality is considered

positively and significantly correlated with number of trips. Environmental quality includes

cleanliness of streets and roads, low levels of noise pollution, good vendors, clean and good

communication and transportation system. Trips to Lake View Park will increase with

increase in environmental quality. Congestion is negatively related with number of trips but

the relationship is not significant. Congestion is operationally defined as the how much

parking areas are crowded by people and how much other areas are crowded by tourists.

Transport facility and other facility are positively and significantly correlated with number of

trips. These facilities include clean public toilets, better parking areas and transportation

system allowing people to go easily to Lake View Park. Better transport/facility will increase

number of visits to Lake View Park. Gender and age have insignificant correlation with

number of trips.

Table 3 shows regression analysis. Number of trips to Lake View Park is significantly

affected by the number of travel cost. One percent increase in travel cost decreases number of

trips by 0.0012 percent whereas average number of trips in a year is 4. Thus magnitude of

effect of travel cost on number of trips is very small. One unit increase in environmental

quality significantly increases the number of trips by 0.068. Gender, age and congestion do

not significantly affect the number of trips. Facility/transportation significantly and positively

affects the number of trips. One unit increase in facility/transportation increases number of

trips by 0.148. These results show that number of trips is significantly affected by travel cost

but the magnitude of effect is smaller whereas other factors significantly affecting number of

trips to Lake View Park are environmental quality and facility/transportation. Model is

significant as evident by F-statistics shown in table 5 and the variables explain 42% variation

in number of trips shown in table 4. Durbin Watson is around 2 showing no autocorrelation as

well as VIF (vector inflation factor) is low showing that data also do not suffer from the

problem of multicollinearity.

Conclusion

This research was supposed to address the issue that whether putting Rs. 10 as entry ticket to

Lake View Park against which people resisted is beneficial or not in order to cover

development expenditures of Rs. 30 million. Lake View Park has a lot of existence. Lake

View Park is Wildlife Park with exciting games and scenic beauty of lake situated in capital

of Pakistan. People averagely visit the park twice a year. It is important to see that how

demand for the visits of park are affected by price. In this research paper it was found that the

travel cost affects number of visits but the magnitude is very small. Average travel cost is

around Rs. 900 and one percent (Rs. 9) travel cost decreases trip by 0.0012% which means

that the number of trip s taken per year by visitors will remain same even with the implication

of entry fees Rs. 10. Through this estimation, we see that there is less cost than benefits hence

measures have to be taken to improve Lake View Park. Investment of Rs. 30 million will not

affect the demand curve of visitors and will not curtail the existent customer base whereas

improving the quality will attract more visitors as environmental quality also positively

affects the number of visitors. Better air, clean roads, neat streets and lower level of noise




pollution contribute to betterment of environmental quality. We can also see that investment

undertaken after the decision of 2010; visitors to Lake View Parks have been increased. Thus

we can say that by using travel cost method. We have estimated that the travel cost and

approximated that benefits of investment will exceed the cost. Although the estimate is not as

accurate as when travel cost is calculated by using average travel cost per mile/time or

substitutes price. Even in their case the wrong estimate of average travel cost may lead

underestimation or overestimation of costs and benefits.

Thus the investment of Rs. 30 million in Lake View Park financed through Rs. 10 entry ticket

was beneficial and didn’t reduced the demand of visitors for visit by increasing price. Other

factors also showed that marginal benefit were greater.

References

Freeman, A. M. (2003). The measurement of environmental and resource values: theory and

methods. RFF press

Adamowicz, V., Swait, J., Boxall, P., Louviere, J., & Williams, M. (1997). Perceptions versus

objective measures of environmental quality in combined revealed and stated

preference models of environmental valuation, Journal of Environmental Economics

and Management, 32, 65-84.

Bockstael, M., McConnell, K., & I. E.(1989). Strand, Measuring the Benefits of

Improvements in Water Quality: the Chesapeake Bay. Marine Resource Economics, 6,

1-18.

Clark, D. E., & Kahn. J. R. (1989). The two-stage hedonic wage approach: a methodology for

the evaluation of environmental amenities, Journal of Environmental Economics and

Management, 16, pp. 106-120.

Crutchfield, S., Hansen, L., & Ribaudo, M. (1993). Agricultural and water-quality conflicts.

Economic dimensions of the problem. Agriculture information bulletin (No. PB-94-

103348/XAB; USDA/AIB--676). Economic Research Service, Washington, DC

(United States). Resources and Technology Div..

Eom, Y. S., & Larson, D. M. (2006). Improving environmental valuation estimates through

consistent use of revealed and stated preference information. Journal of

Environmental Economics and Management, 52(1), 501-516.

Granzin, K. L., & Olsen, J. E. (1991). Characterizing participants in activities protecting the

environment: A focus on donating, recycling, and conservation behaviors. Journal of

Public Policy & Marketing, 1-27.

Hightower Jr, R., Brady, M. K., & Baker, T. L. (2002). Investigating the role of the physical

environment in hedonic service consumption: an exploratory study of sporting events.

Journal of Business Research, 55(9), 697-707.

Hines, J. M., Hungerford, H. R., & Tomera, A. N. (1987). Analysis and synthesis of research

on responsible environmental behavior: A meta-analysis. The Journal of

environmental education, 18(2), 1-8.

Huang, C. H., & Lee, C. H. (2011). Evaluating recreational benefits of environmental quality

improvement. In International conference on humanities, geography and economics

(ICHGE’2011), Pattaya, December (pp. 308-312).




Jurowski, C., Uysal, M., Williams, D. R., & Nog, F. P. (1995). An examination of preferences

and evaluations of visitors based on environmental attitudes: Biscayne Bay National

Park. Journal of Sustainable Tourism, 3(2), 73-86.

Loomis, J. B., & Walsh, R. G. (1997). Recreation economic decisions; comparing benefits

and costs (No. Ed. 2). Venture Publishing Inc..

Manfredo. M., Yuan, S., & McGuire, F.(1992). The influence of attitude accessibility on

attitude-behavior relationships: implications for recreation research. Journal of

Leisure Research, 24, 157-170.

Mihalic, T. (2000). Environmental management of a tourist destination: A factor of tourism

competitiveness. Tourism Management, 21(1), 65-78.

Smith, V. K. (1993). Nonmarket valuation of environmental resources: an interpretive

appraisal. Land Economics, 1-26.

Smith, V. K., & Desvousges. W.H. (1985). The generalized travel cost model and quality

benefits: A consideration. Southern Economic Journal, 52, 371-381.

Vaughan, W. J., & Russell, C. S. (1982). Freshwater recreational fishing: The national

benefits of water pollution control. Washington, DC: Resources for the Future.

Whitehead, J. C., Haab, T. C., & Huang, J. C. (2000). Measuring recreation benefits of quality

improvements with revealed and stated behavior data. Resource and energy

economics, 22(4), 339-354.

Appendix

Figure 1: Genderwise frequency distribution

Male=1

Female=0

Table 1: Descriptive statistics

Mean

Std.

Deviation N

No of trips 2.2660 1.23720 94




Travel cost 2.9695 .20052 94

Env quality 17.2234 3.21674 94

Congestion 10.2021 2.89449 94

Transport

facility 12.5638 2.76910 94

Gender .3723 .48602 94

Age 22.0319 1.45508 94

Table 2: Correaltions

No of trips

Travelc

ost

Env

quality

Congestio

n

Transport

facility Gender Age

Pearson

Correlation

No. of trips 1.000 -.103* .072* -.027* .135* .112* .037

LCOST -.103* 1.000 .092 .287 .103 -.022 -.224

Env quality .072* .092 1.000 .350* .267 -.088 -.013

Congestion -.027 .287 .350 1.000 .322* -.062 .090

Transport

facility .122* -.088 -.062 -.086 1.000 -.086 -.095

Gender .012 -.022 -.088 -.062 -.086 1.000 .196

Age .037 -.224 -.013 .090 -.095 .196 1.000

Table 3: Regression analysis

Model

Unstandardized

Coefficients

Standardized

Coefficients

t Sig.

Collinearity Statistics

B Std. Error Beta Tolerance VIF

1 No. of trips 5.158 2.026 2.546 .013

Travel cost -.738 -.041 -.120 2.861 .023 .917 1.090

Env quality .026 .029 .068 2.342 .008 .851 1.175

Congestion .057 .051 .133 1.116 .267 .765 1.308

Transport

facility .066 .0386 .148 3.627 .059 .869 1.151

Gender .008 .274 .003 .027 .978 .948 1.055

Age -.016 .096 -.019 -.168 .867 .870 1.149

Dependent Variable: No of trips

Table 4: Model summary

Model R R Square

Adjusted R

Square

Std. Error of

the Estimate

Durbin-

Watson




1 .648a .42 .38 1.23868 1.888

a. Predictors: (Constant), Transport facility, Travel cost, Env quality,

Congestion, Gender, Age

b. Dependent Variable: No of trips

Table 5: Anova

Model

Sum of

Squares df Mean Square F Sig.

1 Regression 5.795 4 1.449 2.944 .032

Residual 136.556 89 1.534

Total 142.351 93

a. Predictors: (Constant), Transport facility, Travel cost, Environmental quality,

Congestion, Gender, Age

b. Dependent Variable: No of trips

Questionnaire

GENDER____________________AGE________________

This questionnaire is about your satisfaction level achieved by going to Lake View Park. Give

the rank according to your satisfaction levels highly satisfactory (1), satisfactory (2), neutral

(3), not satisfactory (4) and very bad (5).

1. I think the transport system is conveniently well.

2. I think the streets are clean.

3. I think the roads connecting from various areas to destination are well.

4. I think there is no noise pollution.

5. I think venders have neat.

6. I think the traveler service center can provide complete travel information.

7. I think the air quality is good.

8. I think there are too many vehicles.

9. I think the parking lot is too crowded.

10. I think the biking path is too crowded.




11. I think the number of tourists is huge.

12. I think public toilets are sufficient.

13. I think public toilets are clean.

14. I think the parking places are adequate.

15. I consider the transportation system, including taxi and other public transport, as

convenient.

How many times you visited Lake View Park last year?

___________________________________________________________________________

___

What was the cost of your round trip to Lake View Park?

___________________________________________________________________________

___

Source: Huang & Lee (2011)




Impacts of Goods and Services Tax on the Income Distribution

Juliana Abdul Kadir

Zarinah Yusof

Mohamed Aslam Gulam Hassan

Faculty of Econmics and Administration, University of Malaya

Abstract

This study evaluates the impact of Malaysia’s Goods and Services Tax (GST) on income distribution. The

computable general equilibrium model is applied to simulate the different rates of GST on different income groups.

Results indicate that the most influential income group from GST implementation is low-income. This income group get affected more due to their high sensitivity towards consumption patterns particularly on basic goods. It reveals

that the low-income group is burdened with more tax than middle and higher income groups. The Malaysian

government needs to revise the items under zero rated and exempt supplies for certain necessities goods.

Keywords: Goods and services tax, Income distribution, Malaysia, Computable General

Equilibrium

JEL Classifications: H2, E6.

1.0 Introduction

Malaysia is among the most growing countries of the Asian region with characterized as a fast

development for the last three decades. The GDP grew at an average of 6.7% from 1971 to 1990

(Fanara, 2005) and the rate is around 5.7% between 2010 and 2013 (World Bank, 2013).

Malaysia is similar with other developing nations which dependent on indirect taxes (76.7%)

during the initial phases of development in 1960 (Kasipillai, 2006). After 1981, direct taxes took

over with given higher contribution to the country than indirect taxes.

During the last few years, the Malaysian government has been planning the introduction of goods

and services tax (GST) in the country. The advantages for considering the GST are to overcome

the inherent weaknesses in the sales tax system and to broaden the revenue base (ETP Annual

Report, 2012; Lau, 2013; Saira, 2010; Singh, 2014; Tan, 2012). However, it is generally

perceived that the introduction of the GST at 6 per cent would result in price increases for certain

products and decreases in other cases (Ismail, 2014; Whatt, 2013). The price impact from the

introduction of the GST is a major concern, particularly for consumers from the lower income

bracket since they will be worse affected than the other income groups. The lower income group

is more sensitive to price shocks in the market since they spend most of their income on

consumption and have very little savings.

In 2012, more than 50% of the labor force in Malaysia earn a monthly income below RM3,000

(Department of Statistics, 2012a). This income is considered to be in the lower income bracket




for households in Malaysia. Middle income starts from RM3000 up to RM70001. The average

monthly income for a household in Malaysia increased by 24.22% from RM4,025 (2009) to

RM5,000 (2012), as reported in the 2012 household income survey (Department of Statistics,

2012b).

The Malaysian Gini coefficient in 2012 was 0.431, which is still high compared to other ASEAN

countries, such as Thailand (0.4) and Indonesia (0.37); and India (0.33) in the Asian region

(Mohamad Hanadzlah, 2013). The Gini Index is a measurement of income distribution, as the

value becomes closer to 1, it possesses an inequality level. The Malaysian Index remained

constant at 0.4 since the late 1980s, but showed an improvement in 2004 (0.462), and 2009

(0.441) to 2012 (0.431) (Economic Planning Unit, 2013).

In addition, only 1.7 and 1.8 million people could afford to pay income tax in 2012 and 2013

respectively, as compared to the 11.4 million of total labor force in Malaysia (Lee, 2012). From

this number, only 15.8% qualified as taxpayers. This shows that people do not earn enough to

qualify as a taxpayer (Mun, 2013). On the one hand, Malaysia is heavily reliant on direct taxes

since 1981, of which a large portion is contributed by corporate and petroleum revenue – in 2013,

corporate tax was 48%, and petroleum tax was 25% - while income tax was only 19% out of the

total direct taxes (Bank Negara Malaysia, 2014). This shows that most of the individuals are not

able to pay income tax in Malaysia since the proportion of taxpayers was only 19% in 2012-2013.

In addition, based on the study by the Royal Malaysian Customs Department, people who earn an

income of less than RM3000 do not qualify to pay income tax. However, these individuals do not

realize that they have been contributing to the revenue from the sales and services taxes estimated

at RM71 per month (Faizulnudin, 2012; Tholasy, 2012). However, after the government

establishes and implements the GST at 6%, it is possible that those people who earn less than

RM3000 will be able to pay this tax.

For 2013, sales and services taxes contributed 28% and 17% to the total indirect taxes,

respectively, which was led by excise duties at 34% (Bank Negara Malaysia, 2014). When both

sales and services taxes were combined, it showed that consumption taxes contributed around

45% to the total indirect taxes. The important thing to mention here is that this tax is not paid by

the consumer directly to the government but that the taxes are included in the prices of the goods

and services. The case is similar is goods and services tax is implemented, no one is excluded

from payment. The concern here is that, the implementation of the GST will have an impact on

the macroeconomic level and income distribution because these two factors describe the overall

economic situation. Income distribution in Malaysia would be less equal as GST will be

implemented (Palil & Ibrahim, 2011).

The most of the income distribution studies in Malaysia concentrated on aspects pertaining to

poverty (Anand, 1977), income distribution in the rural sector (Shand, 1987), economic growth

and income inequality (Shari, 2000), and income distribution across ethnic groups (Saari,

Dietzenbacher, & Los, 2010). These studies mostly evaluate the welfare of people and determine

the Gini coefficient in Malaysia based on the findings.

1 Author justification based on households per capita income in Malaysia (Department of Statistics, 2012b).




Accordingly, this study tries to fill the gap in the research on GST in Malaysia to identify the

possible impacts on the income distribution among people reflected by GST implementation. It is

felt that there is a high requirement to fill the gap created in the literature. Therefore, this study is

important to determine and to analyze the impact of the GST as a new tax reform on the

distributional income in Malaysia.

2.0 Tax Reformation in Malaysia

Malaysia has practiced many tax system adjustments since more than last 50 years. Tax reform

called incremental approach2 has taken several slight steps of tax modifications by affecting a

single tax. The public sector in Malaysia is huge since 1970s before privatization policy

implemented in 1983 under tax reform strategy. This policy has downsized tax revenue due to

certain factors: (1) government has given tax incentives for investment, reinvestment, export,

research and development, labor utilization, manpower training and others purposes to make

corporate investment attractive; (2) export duties and customs duties to GDP have dropped 3%

and 1% respectively between 1978-1988; (3) sales tax has improved from 5% to 10% in 1983; (4)

development taxes on professional, business and rental income have levied at 5% and additional

5% has been imposed on profit tax; and numerous individual income surtaxes has been applied

(Jomo, 2000; Wan Abdullah, 2010; Wee, 2006).

Malaysia also same with other countries affected from financial crisis in 1997 and experienced

with tax reformation. Reduction in the number of excise duties in 1982 compliment with an

application of specific rather than ad valorem levies has led to yields deteriorating during the

period of inflation coupled with minimal revenue buoyancy of excise taxes. Therefore, another

smaller tax sources and petroleum revenues have risen to compensate with the diminishing in tax

revenue sources. Daim Zainuddin, the former minister of finance, started in 1984, recommended

for cutting down both individual income tax rates for all kinds of taxpayers and taxable income

brackets from 12 to 9 in 1985 (Narayanan, 1996). The new marginal tax rates have been dropped

into the new range of 5%-40% substituted the standard array of 6%-55%. In addition, in the 1991

budget, the range of marginal tax rates was reduced into 4%-35% and corporate tax rate from

40%-35%, effective from the 1989 review year.

In 1986, new corporate tax has been released for new investors and existing businesses which

consistently meet the current needs to encourage investment as well as to promote economic

growth. This incentive was under the Promotion of Investment Act (1986) which provided a

number of schemes for tax relief including exemption from taxes on imported raw materials and

machinery and tax breaks for bigger companies that purchase inputs from small firms

(Narayanan, 1996). Those adjustments have been affected direct tax revenue and government

revenues as well. In particular, government revenue expanded at 7.07% annually between 1984

and 1991 which largely contributed by petroleum sector. In 1990, development tax on companies

was abolished beginning with a one percent reduction (Narayanan, 1996). Economic condition in

1987-1990 indicated that there was a growth in GDP, recovered to 5.2% in 1987 and climbed to

2 mostly focused on predetermined target




9.7% in 1990 after grew from 1985 which worth negative amount. In 1990, there were two

deficits, budget deficit and current account deficit, rose at 5% and 4.1% respectively (Narayanan,

1996).

In fact, the revenue declined for the first time in 30 years in 1986-19873, arising from a

tremendously reduce in petroleum prices. This encourages raises in budget deficit which had been

reduced in 1984-1985 (Narayanan, 1996). The over-reliance on petroleum led taxes is applied in

a narrow base (Narayanan, 1996) and based on the increasing in tax exemption and tax incentives

to the private sector and industry (Singh, 2002). Particularly, these are generally as an

encouragement for the company to increase their investment amount since uncertainty in

petroleum price (Singh, 2002). Therefore, afford to reduce the dependency on direct taxes and

non-oil commodity taxes have been taken. In addition, by 1987, Malaysia has been successfully

reformed its fiscal policies consequent to the mention issues and the global recession.

Other action was concentrated on consumption taxes in the early of 1988, when Daim highlighted

value added tax (VAT) to be further considered (Narayanan, 1996). The recommendation of a

broad-based VAT was designed, however was put on hold, probably until the Treasury obtained

the expertise to observe it throughout. The VAT, with a well-publicized reputation for

regressively, was not for a beginner finance minister with an eye for the highest office. Instead,

the proposal to implement the sales tax and services tax into a single broad-based tax on

consumption was also declared in the 1993 budget speech, but yet stayed conspicuously

soundless on the issue.

On the other hand, the 1993 budget lowered the top rates for both types of taxes from 35% to

34% (1994) and 30% (1995) to maintain income and corporate taxes competitive between

Malaysia's ASEAN neighbors. The same budget also absolutely abolished or lowered import

duties for more than 600 products, which particularly consumption goods, and for additional

2,600 products in the 1995 budget (Narayanan, 1996). However, no major tax effort has been

implemented apart from improved import and excise duties on tobacco and alcoholic products

and the widening of the service tax base in the 1992 and 1993 budgets (Narayanan, 1996).

Direct tax collection has been dropped might because of waived from tax imposing (1999) and

restructured in the tax system (2000). Tax reform in 1999 made government less dependence on

indirect tax. Furthermore, in assessment year 2000, the collection of tax has been reducing

influenced by the restructuring of the tax system and waive in income tax in 1999. But federal

government tax revenue in 2001-20054 was registered a faster growth with the major contribution

is from direct tax. In this plan, direct tax became a big contributor since there was increased in a

number of taxpayer’s in line with the introduction of Self-Assessment System (SAS)5 and the

higher oil price (ADB, 2006; Loganathan & Taha, 2007). Whilst there was a bit decrease in

export duties revenue preceding a minimal decline in exports make growth of indirect tax was

slowed.

3 5th Malaysian Plan 4 8th Malaysian Plan 5 Is introduced to upgrade the tax administration and to enhance voluntary compliance.




In 2002, the government has designed and implemented several policies and strategies through

the Pre-emptive Stimulus Package6 to minimize the negative impact of the external recession. The

policies include alteration of corporate tax with (1) 70% exemption for pioneer status; (2)

exemption increased from 10% to 20% for promoting export locally-product (Bernardi, Fraschini,

& Shome, 2007). As compared to 2002, direct tax collection dropped by 3.39% (2003) for all

types of direct taxes except for petroleum revenue. Among the factors which influenced to this

trend was the reduction of the corporate tax rate from 28% (1999)7 to 20% (2002). Indeed this

reduction also influenced by the effect of the war in Iraq and Severe Acute Respiratory Syndrome

(SARS) in 2003 towards the country economy (Bernardi et al., 2007; Taha & Loganathan, 2008).

In 2004, Self-Assessment System has been implemented towards personal tax payer where this

reformation has raised individual income tax and increase collection of direct tax revenue

(Choong & Edward, 2011; Loganathan & Taha, 2007). In 2005, with higher revenue from

petroleum taxes and dividend payments from the state-run oil company, it was helped

government to increase development spending and reduce taxes imposed. It can be proved that

when Malaysian government also relies heavily on revenue from oil and gas industries where the

amount of collection reached RM14, 566 million (Bloomberg News, 2006). Besides that, several

tax modifications have been done towards: (1) individual income tax in 2004; (2) import and

excise duties in 2000; (3) sales tax in 2002; and again (4) import duties in 2012.

In 2010, under the New Economic Model under 6th Prime Minister recommends some reforms to

enhance revenue for Malaysia. The key component of the reforms is to wider tax base; therefore

GST was introduced as a new tax system for Malaysia8. The twofold reasons for a more

diversified tax base were to reduce reliance (1) on income tax (2012:56.4%, 2013:58%), and (2)

petroleum revenue (2012:32.6%, 2013:30.6%) in order to encourage and stimulate individuals’

income and firms’ profit by lowering both rates (Ismail, 2014; Tan, 2012; Whatt, 2013).

Therefore, the plan was announced to make the GST implementation become reality which will

be completely implemented on 1 April 2015 (GST Malaysia, 2014; The Malaysian Insider, 2013;

The Star, 2013).

3.0 Specification of the Model

The CGE model of this study is to estimate the changes in the direction of the effect of the GST

on income distribution in Malaysia. The model has been applied after made some modifications

from Robinson model to capture the institutional arrangements in the Malaysian economy. To

meet the research objective, model is aggregated into 15 sectors: agriculture and mining (2

sectors), industrial and manufacturing (7 sectors) and services (6 sectors). Table 1 represent the

sectors classification used.

Table 1: Aggregated sectors in the model

6 Contain some relevant fiscal measures to improve investment as well 7 It should be noted that the government has kept the corporate tax rate unchanged since 1998 as 28%. In the Budget 2007, it has

reduced from 28% to 26% and 2009 was 25% up till now.

8 Before is referred as Value Added Tax (VAT)




No

Aggregated Sectors

Sectors in

2005 Input-Output

1 Agricultural, Forestry and Logging 1-12

2 Crude Oil, Natural Gas and Mining 13-16

3 Food Processing 17-29

4 Textiles and Leather Industries 30-35

5 Petroleum Refinery 44

6 Chemicals and Rubber Processing 45-55

7 Cement, Lime and Plaster, Clay and Ceramic 56-59

8 Iron and Steel Products 60-64

9 Manufacturing 36-43 & 65-85

10 Electricity and Gas 86

11 Wholesale and Retail Trade 87-94

12 Land, Water, Air and Other Transport Services 95-100

13 Communication 101-101

14 Financial Institution and Insurance 102-105

15 Other Services 106-120

The model used 2 factors input; labor and capital which is mobile across sectors, and four agents

in the economy; households, firms, governments and the rest of the world. The model is dynamic,

applied to a small open economy following theoretical structure of Robinson, Kilkenny &

Hanson (1990) model. We begin with reviewing the basic characteristics of AGE model,

explaining household comprehensively, discussing data, calibration process and algebraic model

summary.

Economic agents. Our model includes four types of economic agents; households, firms,

government and rest of the world. We simulates the consumers and producers optimization

behavior, as well as the government and captures all transactions in the circular flow of income.

Private households. The model includes 3 types of household, classified according to their

income level, higher income, middle income and lower income groups. Each household has a

choice for different consumption goods. The characteristics and disaggregation of them are

provided in the ‘data’ section.




Production. The production activities in the various sub-sectors chosen are important in this

model to examine the objective of this study. A composite goods are produced in each sectors can

be transform into exported goods or commodity sold in a domestic market. Each production

activities is assumed to combine primary inputs; labor and capital, in a constant return to scale

using the Cobb-Douglas production function to produce final product. Total production of

domestic output, Xi, is given as follows:

𝑋𝑖 = 𝐴𝐾𝑖𝛽

𝐿𝑖1−𝛽

The nested structure of the production in the CGE model is presented in Figure 1. The industries

in the model using domestic and foreign commodities and factor inputs.

Figure 1: Nested Production Structure in the economy

Prices. As a price taker, small country as Malaysia has no power to effect the world import price,

therefore import price is an exogenously taken in the model. The domestic prices of imports

(𝑃𝑀𝑖 ) and exports (𝑃𝑋𝑖) are determined by world prices (pwm and pwe, respectively), exchange

rate (EXR) and import tariff (tm) or export subsidy (te).

𝑃𝑀𝑖 = 𝑝𝑤𝑚𝑖 (1 + 𝑡𝑖𝑚)𝐸𝑋𝑅

𝑃𝑋𝑖 = 𝑝𝑤𝑒𝑖 (1 − 𝑡𝑖𝑒)𝐸𝑋𝑅

International trade. The model is designed to capture the imperfect substitution using Armington

assumption. The domestic and exported goods are combine into composite goods according to

constant elasticity of substitution (CET) function while the combination between domestic and

imported goods is using constant elasticity of transformation (CES) function. The producer price

of the composite goods can be derived as below.

Final Product

Value added Intermediate

Labor Capital Composite

Commodities

Domesti

c

Importe

d

Leontief

Cobb- Douglas

CES




𝑃𝑄𝑖 =𝑃𝐷𝑖 . 𝐷𝑖 + 𝑃𝑀𝑖 . 𝑀𝑖

𝑄𝑖

where, 𝑃𝑄𝑖, 𝑃𝐷𝑖 , 𝑃𝑀𝑖 denotes price of composite commodities, price of domestic output and price

of imported product for sector i, while 𝑄𝑖, 𝐷𝑖, 𝑀𝑖 , are the quantity produced by them.

Domestic demand. Total domestic demand consists of four components; household expenditure,

investment demand, government spending and intermediate demand. All the components yield a

fixed nominal expenditure shares. For instance, household spends for paying income tax, and

saves a fixed shares of disposable income. Household expenditure functions are derived from a

Cobb-Douglas utility function. They try to maximize the utility through consumption

expenditure.

Private consumption is a household demands determined using fixed expenditure shares.

𝑄𝐻𝑐ℎ = 𝛽𝑐ℎ ∙ (1 − 𝑚𝑝𝑠ℎ ) ∙ (1 − 𝑡𝑦ℎ) ∙ 𝑌𝐻ℎ

𝑃𝑄𝑐

where 𝑄𝐻𝑐ℎ is a private consumption, 𝑃𝑄𝑐 is a price of composite goods, 𝑚𝑝𝑠ℎ , 𝑌𝐻ℎ , 𝑡𝑦ℎ , 𝛽𝑐ℎ are

household savings rate, income, income tax rate and expenditure shares.

The investment demands are derived from capital composition matrix with fixed proportion of

domestic output. Fixed investment demand (𝐹𝐼𝑁𝑉) is quantity of fixed investment demand

(𝑓𝑖𝑛𝑣̅̅ ̅̅ ̅̅ ) for commodity in the base-year measurement, multiplied by an investment adjustment

factor (𝐼𝐴𝐷𝐽), that considered as exogenous variable.

𝐹𝐼𝑁𝑉𝑐 = 𝑓𝑖𝑛𝑣̅̅ ̅̅ ̅̅ 𝑐 ∙ 𝐼𝐴𝐷𝐽

For the government, total spending on goods and services is exogenously fixed because

government decides how much to purchase the commodities in particular. Government

expenditure (EG) consists of expenditure on goods and services (𝑃𝑐𝑄𝑐) and transfer payments

(𝑡𝑟).

𝐸𝐺 = ∑ 𝑡𝑟 + ∑ 𝑃𝑐 𝑄𝑐

Intermediate demand is calculated from sectoral output subject to fixed input-output coefficients.

Total composite demand broadly grouped into total domestic demand and total import demand.

Figure 2 shows the nested structure of demand in the economy.




Figure 2: Nested Demand Structure in the economy

Income. Total government revenue (𝐺𝑅) consists of direct taxes and indirect taxes. Direct taxes

consists of three types of taxes collected by the government which are household income

tax (ℎℎ𝑡𝑎𝑥), corporate tax (𝑐𝑜𝑟𝑡𝑎𝑥), petroleum tax (𝑝𝑒𝑡𝑡𝑎𝑥) while indirect taxes includes tariff

(𝑡𝑎𝑟𝑖𝑓𝑓) and goods and services taxes (𝑔𝑠𝑡).

𝐺𝑅 = ℎℎ𝑡𝑎𝑥 + 𝑐𝑜𝑟𝑡𝑎𝑥 + 𝑝𝑒𝑡𝑡𝑎𝑥 + 𝑡𝑎𝑟𝑖𝑓𝑓 + 𝑔𝑠𝑡

We assume export and excise duties are not significantly contribute to the government revenue.

For income distribution (𝑌𝑑𝑖𝑠𝑡), function is depends on household consumption (ℎℎ𝑐𝑙𝑒𝑠),

marginal propensity to consume (1 − 𝑚𝑝𝑠), tax rate (1 − 𝑡ℎ) and household income (𝑌ℎ). 𝑥 is

referred to high, middle and low income groups.

𝑌𝑑𝑖𝑠𝑡(𝑥) = ∑ ∑ ℎℎ𝑐𝑙𝑒𝑠𝑖 (𝑥)(1 − 𝑚𝑝𝑠(𝑥))(1 − 𝑡ℎ(𝑥))𝑌ℎ𝑡(𝑥)

𝑖𝑡

The group would affected more is depend on high sensitivity they are towards this function.

Welfare measurement. For measuring the people welfare, we use equivalent variation. The

change in the total household consumption equates to a welfare change as measured by the

Hicksian equivalent variation. The function is related to utility level of household (𝑈) before and

after shock and income level of household (𝐼).

Household

Expenditure

Government

Spending Investment

Demand

Intermediate

Demand

Total Composite Demand

Domestic Demand Imported Demand




𝐸𝑉ℎ = ( 𝑈ℎ

1 − 𝑈ℎ0)

𝑈ℎ0 𝐼ℎ − ℎℎ𝑠𝑎𝑣

Macro closure. The general price index is fixed exogenously in the model and all prices are fixed

at unity. The supplies of labor and capital are fixed. In the short run, only labor is sectorally

mobile but capital is fixed, but in long run, both the labor and the capital are mobile.

Foreign closure of the model is warranted through the balance-of-payment (BOP) constraint. The

total value of exports equals the total value of imports accounting for an initial BOP deficit or

surplus given by the base year statistics. The BOP constraint thereby determines the real

exchange rate which indicates the (endogenous) value of the domestic currency vis-a` vis the

foreign currency (the latter being exogenous in a small-open-economy setting).

4.0 Data

Data is obtained from various sources, primary data is applied from Malaysian Input-Output

Table for 2005, the Malaysian Household Income Survey for 2012 and Household Expenditure

Survey for 2009. The data has been combined to form a consistent benchmark dataset.

For the empirical parameterization of the model and to provide estimation of the distributional

impacts towards households income, households are disaggregated into 3 categorizes and are

classified according to their income level; higher income, middle income and lower income

groups. Based on HIES, we applied data on household, but not considered data on individual

income and expenditure. The variable location is consider the same, no difference between rural

and urban areas. We also used one indicator to cross-check this dataset, which is through

educational level. The income is measured based on gross monthly income including allowance.

We follow the definition of household income groups of top 20%, middle 40% and bottom 40%

of total households in Malaysia in 2012. Based on this proportion, we decided the range of

incomes among them. The details of the three income groups are explained in Table 2.

Table 2: The Range of the Three Income Groups

Income Group Range of Income

(RM)

Income Share Consumption Share

Higher Above 7000 65% 48%

Middle 3000 - 7000 25% 36%

Lower Below 3000 10% 16%

Lower income group is composed of people who has a secondary education or less, holding of at

least certificate or diploma and has an undergraduate university degree certificate with no

working experiences. They are consider as a lower skill labor. Their monthly income is below

RM3000. We determine this range of income as referred to the one-off fund given by a




government to some of the Malaysian resident. The selected people has qualified to receive this

payment as subject to the certain monthly income level. Bantuan Rakyat 1 Malaysia (BRIM)

scheme has been introduced in year 2012 to help Malaysian people which income is less than

RM3000. By 2014, government has considered to widen the coverage up to the people whose

income is less than RM4000.

Middle income group is composed of people who holding a certificate or diploma and has an

undergraduate university degree certificate with less working years experiences. Their monthly

income is between RM3000-RM7000. Higher income group is consider people holding

undergraduate university degree with more working experiences as well as has a postgraduate

university degree certificate such as PhD level. Their monthly income is RM7000 and above.

5.0 Policy Simulation Experiments

The model is a dynamic. This study examine the GST impacts towards income distribution in

Malaysia over a period of 55 years. We divided these years into 12 different periods, each having

5 years and each duration are independent of each other. This gap is chosen based on the 5 years

Malaysian Plan. The benchmark year is 2005 with considering 6% GST rate. For every 5 years,

the rate will be increased for 1 to 2 per cent. All the simulations will be started from 2015 and end

on 2070 and the maximum GST rate is 25% that is in 2070 as shown in Table 3.

Table 3: Years and rates of GST for Policy Experiment

Year Rate Year Rate Year Rate

2015 6% 2035 10% 2055 18%

2020 7% 2040 11% 2060 20%

2025 8% 2045 13% 2065 23%

2030 9% 2050 15% 2070 25%

6.0 Results

This section presents the results from the policy simulation experiments describe above, focusing

in the dynamic effect of GST on income distribution. The experiments perform a simple

comparative dynamic model.

In this experiment, the model is used to determine the effects of the GST implementation. This

policy set up a beginning GST rate as 6 per cent. GST would affected either lower, middle or

higher income earners. The analysis is based on equivalent variation.

Table 4: GST Impact on Each Income Group from 2015-2070

2005 2015 2020 2025 2030 2035

Higher 0.021 0.021 0.023 0.023 0.024 0.024




Middle 0.308 0.319 0.335 0.344 0.353 0.361

Lower 4.988 5.181 5.439 5.593 5.741 5.883

2040 2045 2050 2055 2060 2065 2070

Higher 0.025 0.025 0.026 0.026 0.026 0.026 0.026

Middle 0.360 0.376 0.383 0.387 0.391 0.395 0.396

Lower 6.017 6.140 6.251 6.331 6.410 6.484 6.522

Table 4 presents the GST impact on income distribution. The table shows the levels of these

indicators in years 2015 to 2070. Increases in GST rate leads to increase the impact on income

distribution for the stipulated periods. It can be noted that the magnitudes of the impact of GST

rate changes are increased gradually for these three income groups. GST give more influenced on

lower income compared to middle and higher income. The changes is about 30% in the lower

income group when GST rate increased from 6% in 2005 to 25% in 2070.

7.0 Conclusion

Low-income group would affected more due to high sensitivity they have towards consumption

patterns. Study conducted by HIES found that, in 2012 lower-income group spent 38.8 per cent

on food and 27.5 per cent on utilities of their monthly income. This indicated that this group

expenses more on basic goods compared to the middle and high incomes. In fact, regarding Lau

et al. (2013), they averaged that 30 per cent of income was spent on food for those earning less

than RM1, 000 compared to 5 per cent for people with an income above RM10, 000. In this case,

this study try to examine which group would be affected more from GST implementation.

In general, consumption tax are naturally regressive, which implies that the poor are burdened

with more tax than the rich (Lim, 2014; Rasiah, 2014; Tholasy, 2014). Hence, this will worsen

the income distribution. Nevertheless, this concern, might be addressed if the revenue of indirect

taxes is redistributed in terms of free education or free health care for the lower income group.

Furthermore, the government should consider waiving indirect taxes on necessity goods and basic

items (Bond & Hughes, 2013). The Malaysian government should consider setting up items under

zero rated and exempt supplies for certain necessities to minimize the tax burden on the poor and

to ensure that income is equally distributed (GST Malaysia, 2014, Whatt, 2013).

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The Influence of Host Country National Support on Expatriate

Success in Malaysia

Hak Liong Chan

Putra Business School, Universiti Putra Malaysia

43400, Serdang, Selangor Darul Ehsan, Malaysia


Dahlia Zawawi ,ͣ Siew Imm Ngᵇ

Faculty of Economics and Management, Universiti Putra Malaysia

43400, Serdang, Selangor Darul Ehsan, Malaysia

E-mail: [email protected] ͣ, [email protected]ᵇ

Abstract

This study examines the effects of host country national (HCN) support on expatriate adjustment and withdrawal

intentions, and in turn expatriate performance. This study aims to improve the problems of cross-cultural

adjustment concerning general living, work and interaction faced by expatriates in shared services and outsourcing

(SSO) industry in Malaysia.

In order to provide a broader view of expatriate success, it is critical to study cross-cultural adjustment, job

performance and withdrawal intentions concurrently in this research. Stakeholders are groups of entities or

individuals that are important to expatriates where HCNs are parts of them. Therefore, this study intends to explore

the support HCNs in influencing expatriate success, particularly withdrawal intentions as the ultimate success

criterion. In addition, this research is corroborated by job demands and resources (JD-R) model.

Key words: support, host country nationals, expatriate success, Malaysia

1.0 Introduction

Globalisation has become a universal phenomenon that allows multinationals companies

(MNCs) to show their interest in the growth of international job mobility and relocations in order

to meet global workforce needs (Mercer, 2013). Many MNCs are highly reliant on expatriates to







manage their business operations abroad (Selmer, 2001; Huff, Song and B.Gresh, 2014).

Generally, expatriates are employees who work abroad within a specified time frame (Woods,

2003; Mayerhofer, Hartmann, Michelitsch-Riedl and Kollinger, 2004). Expatriates require

international assignment as an effective tool to help them develop their cross-national and cross-

cultural competencies (Yao, 2013) in terms of their ability to adapt, to understand different

cultures and to develop a global mindset (Lee and Kartika, 2014). It has been suggested that

including the three components which are cross-cultural adjustment, job performance and

withdrawal intentions will draw a more sophisticated and wider view of expatriate success

(Bhaskar-Shrinivas, Harrison, Shaffer and Luk, 2005; Shaffer, Ferzandi, Harrison, Gregersen and

Black; Benson and Pattie, 2009). Expatriate success is strongly connected to their ability to

adjust to different conditions of work and non-work domains in the host country (Farh, Bartol,

Shapiro and Shin, 2010). Expatriates show greater intentions to remain until the end of the

assignment when they are able to overcome adjustment difficulties (Pinto, Cabral-Cardoso and

Werther, 2012b).

This study will be conducted in Malaysia and focus on shared services and outsourcing (SSO)

industry. MNCs start to set up their shared services centres and increase the need for information

technology (IT), operations and accounting experts to fill in the positions in Malaysia (The Star

Online, 2013b). Thus, skilled expatriates are required to support and enhance the SSO business

operations in Malaysia. Malaysia is being recognised by MNCs worldwide as one of the best

places to run SSO businesses (Tey, 2014). SSO is a combination of services that is made up with

the best competitive strategy that uses information and communication technology, finance and

accounting, human resources, and engineering design and services (Multimedia Development

Corporation, 2015). Malaysia is the world’s leader in SSO industry particularly in IT, which is

expected to increase its investment from US$800 million in 2010 to over US$2 billion in 2015

(PricewaterhouseCoopers, 2012). Around 300 foreign and multinational companies established

their regional and global SSO centres in Malaysia, contributing billion of investments and

thousands of career opportunities (The Star Online, 2013a).

Many studies (Kraimer, Wayne and Jaworski, 2001; Lee and Vorst, 2010; Mahajan and De Silva,

2012) have been done to examine the role of support on expatriate adjustment and job

performance. Social support is a major contributor to poor cross-cultural adjustment to improve

job performance and early return of expatriates (Beehr and Glazer, 2001; Glazer, 2006).

Takeuchi (2010) emphasises that primary stakeholders are those who can influence expatriates or

are influenced by them including host country nationals (HCNs). Expatriate experience is

embedded in an expatriate’s day-to-day navigation with his or her stakeholders (Miao, Adler and

Xu, 2011). It can be understood through the observation of dynamics between expatriates and

their stakeholders. Again, researchers highlight that expatriates desire support from different

stakeholders especially at the beginning of the relocations (Kraimer and Wayne, 2004; Toh and

Denisi, 2007). Stakeholders can help expatriates achieve their main objectives by providing

whatever they need to succeed in international assignment. This research aims to find out




whether HCN support has a considerable implication on expatriate success, is still an under-

researched area in Malaysia.

1.1 Problem Statement

Research on international assignment emphasises on the importance of cross-cultural adjustment

to expatriate experience. However, with every 5 to 12 assignment given to the expatriates, one of

them will fail (Marston, 2011). This is because companies mistakenly assume that expatriates

who have successfully completed an assignment in one country will be able to do the same

elsewhere. It was proven that 52% of the expatriates consider the inability to adapt to host

culture is the greatest difficulty for them (Tower Watson, 2012). According to Brookfield Global

Relocation Services (2014), 15% of the expatriates indicate that cultural adjustment is one of the

main reasons of assignment failure. These issues show that cultural challenges can make

expatriates feel uncomfortable that prevent them from performing better and completing

assignment.

Besides poor cross-cultural adjustment, expatriates’ family-related problems have become a

leading reason for assignment failure (Ernst and Young, 2013). A survey conducted by Cartus

(2014), a global relocation company, reported that 76% of the expatriates agree that the family or

personal situations are the top reason why expatriates withdrew from their assignments. In

addition, 61% of them rated the inability of the family to adjust to the host location as a second

reason of failure. In particular, spouse dissatisfaction is the most influential factor of expatriate

failure (Mohn, 2011). It is identified by 13% of the expatriates who find that dissatisfied spouse

is a cause for them to fail the assignments (Brookfield Global Relocation Services, 2014). An

overseas assignment is not cheap. It basically costs between two to four times of the expatriate’s

base salary, depending on its locations (Alsop, 2014). When an expatriate fails an assignment, it

can cost an organisation approximately $1million for each failure whereby this figure is

multiplied with the increase of group moves (Mohn, 2011). With all these reasons identified,

these evidence prove that expatriate personal and family issues have become the main hurdles for

successful overseas assignments that bring financial loss to the company.

Based on the problems highlighted above, this study attempts to identify the effect of HCN

support on expatriate adjustment and withdrawal intentions, and in turn expatriate performance

which are considered the main criteria of expatraite success (Caligiuri, Joshi and Lazarova; 1999;

Shaffer, et al, 2006). Researchers have suggested that HCNs (e.g, Lee and Vorst, 2010; Mahajan

and De Silva, 2012) are sources of interaction that can provide psychological resources that give

recognition and to facilitate expatriate adjustment. It is confirmed that social support can help

eliminate the risk of assignment failure (Stroppa and Spieß, 2011). Hence, this study will focus

on HCN support that is expected to minimise the aforementioned problems encountered by

expatriates in Malaysia.




Previous studies discuss specifically about the willingness of HCNs to provide support and the

interaction with HCNs on expatriate adjustment and performance (e.g., Varma, et al., 2011;

Bakel, et al., 2011; Varma, et al., 2012). HCNs are believed to provide the best source of support

and role information for expatriates to deal with the uncertainty and anxiety. It has been

advocated that HCN support can help expatriates complete their assignments successfully (e.g.,

Toh and Denisi, 2005; Toh and Denisi, 2007). Mahajan and De Silva (2012) suggest that there

will a possible effect of HCNs on expatriates’ withdrawal cognitions. In fact, whether HCN

support can influence withdrawal intentions has yet to be validated. This study would like to

make a contribution to investigate the possible relationship between HCN support and

withdrawal intentions.

2.0 Jobs Demands and Resources Model

The JD-R model assumes that every occupation bears its own risk factors in terms of job stress

or burnout (Demerouti, Bakker, Nachreiner and Schaufeli, 2001). The model can be classified

into two categories, chiefly job demands and job resources which are applicable to various

occupational contexts, regardless of the demands and resources (Demerouti, Bakker, Nachreiner

and Schaufeli, 2001). Job demands refer to those physical, social or organisational aspects of the

job that need an employee’s continuous physical or mental effort that cost physiologically and

psychologically (Bakker, Demerouti and Euwema, 2005). For example, work pressure,

demanding interaction effort and uncomfortable physical environment. Job resources, on the

other hand, refer to those physical, social or organisational aspects of the job that help an

employee achieve work goals, reduce physiological and psychological job demands or improve

personal growth and development (Bakker, Demerouti and Euwema, 2005; Demerouti and

Bakker, 2011). For example, social support, autonomy and career opportunities.

In international environment, MNCs have started paying closer attention to expatriates’ work-

related outcomes such as job engagement and burnout to ensure successful business operation

abroad (Rattrie and Kittler, 2014). JD-R model can act as an invaluable tool for explaining

burnout and engagement across national contexts (Rattrie and Kittler, 2014). A number of

expatriate-related studies have applied JD-R model as the main theory to identify key

contributions (e.g., Lazarova, Westman and Shaffer, 2010; Mahajan and De Silva, 2012; Cole

and Nesbeth, 2014; Ren, Shaffer, Harrison, Fu and Fodchuk, 2014). At first, Lazarova, Westman

and Shaffer (2010) note that expatriate and spouse adjustment can be predicted by both demands

and resources. From a JD-R point of view, resources can directly and indirectly buffer the

negative effects of demands from expatriate adjustment. The model also implies that engagement

can be linked to demands through adjustment where expatriates can easily become engaged in

their roles that contribute to effective job performance. Besides, Mahajan and De Silva (2012)

postulate that JD-R model is a useful theory to investigate the relationship between HCN support

and expatriate adjustment. They highlight that HCN support is a job resource that can reduce




expatriate maladjustment resulting from the influence of unmet role expectations. Cole and

Nesbeth (2014) also posits that the model can better the understanding about expatriate

performance within the work-family interface to ensure that the demands exposed and the

resources available to expatriates are balanced. To provide new insights, Ren, et al. (2014)

integrate both reactive factors (cultural novelty, cultural values distance and host country

language deficiency) and proactive factors (information seeking, relationship building and

positive framing) in this area of study, the JD-R model contends that these factors contribute to

both adjustment and embeddedness of expatriates, which are expected to influence the

subsequent outcomes in terms of retention cognitions, and in turn actual turnover.

Social support is a prominent situational variable to buffer against job strain at workplace

(Kaplan, Cassel and Gore, 1977; Sarason, Levine, Basham and Sarason, 1983; Gottlieb and

Bergen, 2010). According to Bakker and Demerouti (2007), social support plays a moderating

role in different work situations when (1) the beginning of a stressor is predictable to certain

extent (e.g., role clarity, performance feedback) (2) the reasons are understandable why a stressor

exists to certain extent (e.g., role information by colleagues or supervisors) (3) the aspects of the

stressor are controlled by the person who experiences it to certain extent (e.g., job decision-

making. Social support is a straightforward job resource to mitigate the negative effects of job

demands (e.g., heavy workload, emotional and physical demands) and protect employees from

significant stressful experience at workplace.

Primarily based on the notion of JD-R model in this present study, job demands are those job

aspects that require employees to devote mental and physical efforts to overcome (Bakker,

Demerouti and Euwema, 2005), the expatriate success criteria can be considered as job demands

as how they are defined and characterised in the literature. Cross-cultural adjustment is the

process of adaptation to living and working in a host country (Black, 1988; Black and Gregersen,

1991). The adjustment process takes people behavioural, cognitive and emotional efforts in order

to become more adjusted to the novel environment (Haslberger, 2008). Harrison and Shaffer

(2005) define expatriate performance as the form of effort, including time and energy, an

expatriate makes for the purpose of the assignment. Employing the JD-R model, Rattrie and

Kittler (2014) stress that adjustment is one of the critical factors in determining successful

international working context. The authors also claim that the model is promosing in managing

well-being and performance related outcomes of expatriates. Withdrawal intentions, on the other

hand, are defined as the degree to which expatriates plan to return to their home early even

before they have not finished their assignments (Bhaskar-Shrinivas, et al, 2005). As the matter of

fact, Swider and Zimmerman (2014) argue that employees who intend to withdraw spend more

time, energy and effort looking for job alternatives that can negatively influence their job

performance at the current job. All in all, the inception of the JD-R model in international setting

has demonstrated its application where the increase of job resources may reflect the reduction of

job demands among expatriates in return. However, there is a substantial gap impeding a




comprehensive understanding of the JD-R model about the management of burnout and

engagement in different contexts in particular (Rattrie and Kittler, 2014).

To contribute to the JD-R model, HCN support is expected to minimise the aforementioned job

demands of expatriates. It has been corroborated by Montgomery, Peeters, Schaufeli and Ouden

(2003) that the resources in terms of support can be classified into work and family domain to

predict organisational outcomes. Ren et al. (2014) assert that expatriates who possess more

resources may feel more energetic and motivated to continue staying on their assignment.

Concurrently, the model is also applicable in supporting the interrelationship between the three

criteria of expatriate success simultaneously. As expatriate adjustment is part of the job demand

(Rattrie and Kittler, 2014), there is a strong connection with expatriates’ withdrawal intentions

and job performance (Ren, et al., 2014). When expatriates’ adjustment is poor, their withdrawal

intentions are higher and job performance to be lower. It is followed by the diminished level of

emotional resources can reduce employee’s efforts to complete the tasks that result declining job

performance (Swider and Zimmerman, 2014). This describes the situation where expatriates with

withdrawal intentions may not be able to perform well. Given that POS, HCN support and

spousal support are classified as resources in the JD-R model, they are able to explain the

interaction with expatriate adjustment and its consequential outcomes related to withdrawal

intentions and job performance.


3.1 Adjustment and Cross-Cultural Adjustment

Adjustment is defined as the degree of psychology comfort an individual feels in a new situation

(Black, 1988). Adjustment and adaptation are used interchangeably in cultural context to explain

acceptance, satisfaction, skills, behaviour and interaction within local community (Shi and

Franklin, 2013). From expatriate perspective, adjustment means the degree of comfort without

the presence of stress, which is strongly related to cross-cultural environment (Black, 1988;

Selmer and Fenner, 2009). Adjustment engages the learning of new culture which consists of

three components: behaviours, cognitions and emotions so that they can be more effective and

content in new environment (Haslberger, 2008). Expatriate can imitate and/or learn suitable

behaviours that are well accepted by the host culture to reduce anxiety and uncertainty.

Therefore, those culturally adjusted expatriates are able to absorb new behaviours, norms and

rules that become the foundation of the host cultures (Church, 1982).

In cross-cultural context, there is a difference between psychological adjustment and socio-

cultural adjustment (Ward and Kennedy, 1993). Psychological adjustment focuses on

individual’s well being and level of satisfaction whereas socio-cultural adjustment focuses on

individual’s social skills, especially the expatriates’ ability to communicate with host nationals.

Expatriates may face numerous challenges during the process of cultural adjustment because




culture shock, uncertainty and differences can exist at the same time in a different setting (Wang

and Nayir, 2006). Consequently, expatriates who fail to overcome cultural uncertainties are

likely to suffer from stress that leads to maladjustment. Those with poor experience in the host

culture may perceive that their own culture is inferior (Church, 1982).

Cross-cultural adjustment, on the other hand, is the process of adaptation to living and working

in a culturally different environment (Black, 1988; Black and Gregersen, 1991). The concept of

cross-cultural adjustment is built due to the earlier research on culture shock (Oberg, 1960).

Culture shock is a phenomenon where a foreigner is anxious, confused and apathetic until a new

set of behavioural assumption is developed to facilitate his or her understanding of the social

behaviour of local natives (Wang and Nayir, 2006). Cross-cultural adjustment consists of three

facets of cross-cultural adjustment to assess expatriate ability to adjust in a foreign culture

(Black, Mendenhall and Oddou, 1991). General adjustment refers to life condition in host

country such as housing, shopping, food, weather, entertainmet, transportation and health care

facilities. Interaction adjustment mainly deals with interaction between expatriates and host

nationals. Work adjustment includes responsibilities, supervisions and performance during the

assignment. This model has been very successful in supporting theoretical framework of

numerous expatriate studies (Haslberger, 2008).

3.2 Host Country National Support and Expatriate Adjustment

Host country nationals (HCNs) are individuals or local employees working within the host unit

(Toh and Denisi, 2007). A growing amount of studies emphasise on the factors influencing

HCNs’ perspective and the effects of their attitudes towards expatriates. Research suggests that

attention should be paid to this group of important ‘stakeholder’ in expatriate management

(Takeuchi, 2010). This is because HCNs provide expatriates with the best sources of information

on local culture and customs, role information and social support (Johnson, Kristof-Brown,

Vianen, Pater and Klein, 2003; Varma, Toh and Budhwar, 2006; Toh and Denisi, 2007). Prior

studies have highlighted that HCN support can facilitate expatriate success in particular (e.g.,

Caligiuri and Lazarona, 2002; Toh and Denisi, 2005; Toh and Denisi, 2007; Mahajan and De

Silva, 2012). Although HCNs are important to expatriates, there is no claim that HCNs are

always motivated to give them support. HCNs’ helping behaviours are a matter of personal

option and are not compulsory in job description (Wang and Fang, 2014). These behaviours

come from personal initiative and motivation in nature.

Several researches highlight that HCN support is important to expatriate adjustment (Black,

1990; Lee and Vorst, 2010; Mahajan and De Silva, 2012; Abdul Malek, Budhwar and Reiche,

2014). At first Black (1990) draws a sample of 220 American expatriates working in Japan,

Korea, Taiwan and Hong Kong. Zero-order correlation analysis shows that expatriates who

receive more HCN emotional support have greater general and interaction adjustment but not




work adjustment. It is found that HCN support can facilitate expatriates to learn the propoer

ways of interacting with HCNs. The finding is backed by eleven interviews with expatriate

respondents, who comment those HCNs are helpful in facilitating their cross-cultural adjustment

in the host countries. Furthermore, Lee and Vorst (2010) use 74 English teacher expatriates in

Taiwan as a sample to examine the influence of Taiwanese co-worker support on expatriate

adjustment. Regression indicates that Taiwanese co-worker support has a positive impact on

expatriates’ work and interaction adjustment but not on general adjustment. In fact, the main

point is the relationship between Taiwanese HCNs and interaction adjustment is much stronger.

The overall result can be explained by 51% of the expatriates have stayed in Taiwan for more

than 3 years, while 58% of expatriates are not beginners of Chinese language learners.

According to Mahajan and De Silva (2012), JD-R theory is applied to explain HCN support is

crucial to reduce the adverse effect of expatriate maladjustment, the researchers contend that

informational and social support from HCNs are useful for facilitating expatriate adjustment.

Unquestionably, getting support from HCNs can help expatriates to better understand the host

culture in order to get rid of those uncertainties in the host country. A similar study by Abdul

Malek et al. (2014) in Malaysia, investigating two forms of HCN support concerning emotional

and informational support as highlighted earlier by Mahajan and De Silva (2012). Surprisingly,

adopting path analysis, the findings are inconsistent with several past studies (e.g., Black, 1990;

Lee and Vorst, 2010) as HCN support is not significantly related to expatriate adjustment. One of

the main reasons is possibly due to the high power distance culture in Malaysia which creates a

glass ceiling between HCNs and expatriates, who are always perceived to hold higher positions

in a company. Another reason is Malaysians are collectivist, who are cautious about ‘outsiders’,

so this group of people is normally accepted by invitation or permission only.

Based on the literature discussed above, it gives an indication of HCN support is absolutely

imperative to assist expatriates in overcoming cultural adjustment difficulties, but a few do not

substantiate this fact due to certain host cultural factors are difficult for expatriates to deal with

them effectively. For sure, HCNs might not have the ability and resource to provide those kinds

of necessary support that help ease expatriate adjustment related to both work and nonwork

domains. In the nutshell, whether HCN support can be an important factor of expatriate success,

exclusively for the three criteria has not been lacking empirically.

3.3 Expatriate Adjustment and Withdrawal Intentions

Organisational withdrawal is defined as a set of underlying behaviours and intentions that

contribute to the outcomes of negative job attitudes and other factors (Hanisch and Hulin, 1991).

Withdrawal intentions are not actual turnover, instead withdrawal intentions are better predictors

of actual turnover (Cohen and Freund, 2005). This actual turnover can be determined by an

individual’s self-expressed actions or intentions.Withdrawal intentions comprise three different




forms: (1) plans to search for another job (2) general thoughts of quitting the currrent job and (3)

intentions to quit the current job (Jaros, Jermier, Koehler and Sincich, 1993). On top of this, Blau

(2000) and Carmeli (2005) argue that withdrawal intentions are a multidimensiocal concept

because the employees can withdraw themselves either from their job, organisation or

occupation. Intentions to withdraw from the job are defined employees leave their current job,

but they might retain in the same organisation. Employees who intend to withdraw from the

organisation are likely to leave their companies in the future. However, employees who plan to

withdraw from their occupation may encounter decision-making dilemma, since the new

occupation would be totally different than the former ones (Blau, 2000; Carmeli, 2005).

The basic theoretical argument suggests that adjustment is a multifaceted approach to predict a

positive relationship with intent to stay in a new environment. Black and colleagues (Black and

Stephens, 1989; Gregersen and Black, 1990) are the first researchers to investigate how job and

nonjob adjustment influence intent to stay of expatriates. Regression finds out that general and

interaction adjustment are positively correlated with intent to stay, but not work adjustment. This

is because most well-adjusted expatriates can focus on the similiarities of their job despite the

cultural differences at the workplace. The scholars also highlight that general environment and

interaction with HCNs make adjustment more crucial to affect expatriates’ withdrawal

intentions. Contrary to these findings, Gabel, Dolan and Cerdin (2005) ascertain that expatriates

who are unadjusted to work show greater interest in leaving their assignment. Caligiuri (1997)

explains that both variables are related to each other and causal at one time, whereby this

argument supports a negative linear relationship between expatriate adjustment and desire to

terminate in her study.

Intent to return early of expatrates is a central consequence for MCNs due to its theoretical and

practical contributions for international assignments. Takeuchi, Yun and Tesluk (2002) base on a

sample of 243 Japanese expatriates in the United States working for various industries, the three

facets of adjustment are rated by three sources (spouse, superiors and expatriates) as predictors

of intent to return early in order to reduce the common method variance. Structural equation

modelling (SEM) analysis indicates that both general and work adjustment are negatively related

to intent to return early, but not interaction adjustment. The results of this study are consistent

with previous findings that support a negative relationship between general and work adjustment,

and expatriates’ withdrawal cognitions (Harrison and Shaffer, 2005; Wu and Ang, 2011).

However, interaction adjustment does not work in their cases. In particular, supporting practises

from organisation can encourage expatriates’ interactions with HCNs at work which motivate

them to succeed in their assignments (Wu and Ang, 2011). Based on the multidimensional

concept of withdrawal intentions by Blau (2000) and Carmeli (2005), only work adjustment is

influential on assignment withdrawal intentions but there are no correlations found between

general and interaction adjustment, and withdrawal intentions in expatriate context (Pinto,

Cabral-Cardosoa and Werther, 2012a).




Apart from that, several studies prove that the three facets of adjustment have negative effects on

assignment withdrawal cogitions (Kraimer and Wayne, 2004; Bhaskar-Shrinivas, et al., 2005;

Ren, et al, 2014). Expatriates who receive adjustment support from the company are likely to

complete their assignment, but it does not represent higher level of performance (Kraimer and

Wayne, 2004). Bhaskar-Shrinivas et al. (2005) highlight the fact that many obstacles of

assignment withdrawal take place such as loss of face, negative career implications and uncertain

employment in home country that might reduce different forms of assignment inputs. Although

findings demonstrate that the three facets of adjustment have a negative relationship with

withdrawal cognitions, general or environmental adjustment is the strongest determinant of

withdrawal decisions (Bhaskar-Shrinivas, et al., 2005; Harrison and Shaffer, 2005). This issue is

reiterated by Ren et al. (2014), agree that environment mainly impinges upon expatriates who

experience poor adaptation that leads to assignment withdrawal. Drawing upon JD-R model,

assignment demands require extra effort or resource depletion of expatriates to alleviate

maladjustment. Two different studies are carried out separately by the authors: The first study

consists of 181 expatriate teachers from 30 different countries while the second study consists of

2,207 expatriates from English-speaking countries in Hong Kong. As a result, the findings of

these two studies confirm a positive relationship between expatriate adjustment and retention

cognitions, it indicates that expatriates who are embedded in the host subsidiaries and

community are more likely to retain in their assignments.

The literature has discussed the relationship between expatriate adjustment and withdrawal

intentions in various research settings that provide a broader view of expatriate withdrawal.

Although most studies have agreed that poorer expatriate adjustment causes higher level of

withdrawal intentions in general, it is uncertain to know exactly which dimension of adjustment

has played a leading role in affecting expatriate withdrawal. As noted by Pinto et al. (2012a), the

concept of expatriate withdrawal intentions can be multidimensional as those unadjusted

expatriates may not think to leave their current assignment, occupation or organisation, which

has received less attention since its development in 2012. This is due to the fact that other

possible factors associated with host environment during the expatriation can influence

expatriate withdrawal.

3.4 Expatriate Adjustment and Expatriate Performance

Drawing upon the model of Motowidlo and colleagues., four dimensions of expatriate job

performance are proposed by Caligiuri (1997), mainly technical performance,

contextual/managerial performance, contextual/prosocial performance, and expatriate-specific

performance. Technical performance refers to the expatriate’s ability to apply technical

knowledge and skills in their job. Contextual/managerial performance refers to the expatriate’s

ability to maintain good relationships with coworkers, and provide subordinates training and

development. Contextual/prosocial performance includes organisational commitment,

motivation, effort, team-building, and personal discipline. Finally, expatriate-specific




performance includes replacement training, transferring information, cultural adaptation,

language proficiency and developing good relationships with HCNs (Caligiuri, 1997). To

simplify, contextual/managerial performance and expatriate-specific performance are combined

and conceptualised as expatriate contextual performance. Expatriate task performance is the

combination of technical performance and contextual/prosocial performance (Kraimer et al.,

2001).

Parker and McEvoy (1993) are the pioneers who empirically examine the relationship between

expatriate adjustment and expatriate performance of 169 expatriates from 12 countries. The

researchers find that work adjustment has positive effects on self-rated job performance. Job

performance increases when expatriates make better work adjustment rather than general and

interaction adjustment. Shay and Baack (2006) examine the relationship between work

adjustment and self-rated task performance, and HCN subordinate-rated contextual performance

among 153 expatriates from nine international hotels. Findings indicate that work adjustment is

positively related to both task and contextual performance which are rated by the two sources,

respectively. Furthermore, Kawai and Strange (2014) depend upon self-rated job performance

and find out that those 118 Japanese expatriates in Germany have higher levels of task and

contextual performance when their work adjustment increases. It can be argued that

organisation’s dedication to expatriate well-being in terms of career development has contributed

to improved expatriate performance.

It is important to understand that the degree of expatriate performance is established depending

upon how well the expatriates are able to adjust to their work life (work adjustment) and non-

work life (general and interaction adjustment) in the host country. Caligiuri (1997) suggests a

positive linear relationship between adjustment, and self-, peer- and leader-rated performance of

115 expatriates based in an American-based MNC. Results show that expatriate adjustment is

significantly correlated with self-rated performance, but not with both peer and leader ratings

where halo error may be a primary reason to make these relationships non significant. Kraimer

and her colleagues (Kraimer, et al., 2001; Kraimer and Wayne, 2004) rely on supervisor-rated

performance as consequence of adjustment. They apply stress management theory to predict

well-adjusted expatriates will be able to perform well in a different work and general

environment. Therefore, the results show that work adjustment is positively related to task

performance while interaction adjustment is positively related to contextual performance which

provide support for Caligiuri’s (1997) taxanomy of expatriate success. Similarly, Lee et al.

(2013) focus on work and interaction adjustment guided by social exchange theory, there is a

positive relationship found between the two dimensions of adjustment and expatriate

performance. Despite general adjustment, it has been argued that work and interaction

adjustment are the most important determinants in expatriate adjustment and expatriate success,

respectively (Lee and Sukoco, 2010).




Based on the three meta-analyses by Hechanova, Beehr, and Christiansen (2003), Bhaskar-

Shrinivas et al. (2005) and Mol, Willemsen and Molen (2005), their findings for the positive

relationships between the three facets of adjustment and expatriate performance are not

supported positively. However, Mol et al. (2005) argue that the findings of Hechanova et al.

(2003) are weaker due to the the correlation does not support the definition of adjustment related

to performance cited in Black (1988). Bhaskar-Shrinivas et al. (2005) assert that adjustment has

substantial impacts on psychological strains and expatriate performance. According to Lee and

Sukoco (2010), a sample of 218 expatriates from Taiwanese MNC firms is validated. Although a

positive and significant relationship between adjustment and performance is confirmed, the

authors argue that expatriate adjustment does not directly influence job performance, so it does

not support the notion of Black (1988), proposing the adjustment level can determine the

performance level. Instead, the psychological comfort is critical to expatriates to develop a set of

operational capabilities for their performance (Lee and Sukoco, 2010). Wu and Ang (2011) stress

that expatriates’ ability to adjust determine the chances of succeeding in an international

assignment. With 169 expatriates working for MNCs in Singapore, the findings demonstrate that

interaction adjustment facilitates expatriates’ relationship building with HCNs that contributes to

their contextual performance. Expatriates with minor difficulties at work are more likely to

perform their duties well that lead to better task performance. Nevertheless, general adjustment

does not influence neither task nor contextual performance.

Expatriates with higher adjustment are more likely to form a kind of psychological comfort

which helps them to stabilise their moods and perform well. With 114 expatriate respondents

from 653 MNCs in Vietnam, Wang and Tran (2012) postulate that only work and interaction

adjustment are positively related to supervisor-rated job performance. General adjustment does

not have any effects on job performance, the authors argue that general living should be referred

to overall adapatation and it is not directly related to operational capabilities at workplace. In

Malaysian context, researchers (Abdul Malek and Budhwar, 2013; Abdul Malek, et al., 2014)

indicate that work adjustment is positively related to task and contextual performance while

interaction adjustment is positively related to contextual performance. General adjustment is not

significantly related to expatriate performance. However, self-rated performance increases the

possibility of common method variance that cannot be completely excluded in their study. In

addition, Lee and Kartika (2014) apply work adjustment theory to explain successful work

adjustment is determined by the individuals and environments, and hence the finding reveals that

expatriate adjustment has positive effects on task, contextual and overall performance. The

theory supports those well-adjusted expatriates will devote more personal resources (e.g., time,

effort, emotion quality) on improving job performance.

A large amount of studies are carried out on expatriate adjustment and expatriate performance

throughout the years, surprisingly, the results of these studies are inconclusive. Some researchers

agree on higher cross-cultural adjustment does not neccessarily determine higher job

performance in international assignment. In fact, the concept and measurement of expatriate




performance used in these studies are different from one to another despite the emphasis on task

and contextual performance. Better concept and measures must be developed to accommodate

the essence of cross-cultural adjustment.

3.5 Withdrawal Intentions and Expatriate Performance

It is a severe phenomenon when expatriates who underperform, but they still continue staying in

the assignment. Thomas and Lazarova (2006) stress that intent to remain is inadequate to

determine how successful an expatriate is in regards of his or her job performance during

overseas assignment. Only one study is done so far to investigate the relationship between

withdrawal cognitions and expatriate performance where the sample is selected from 193

expatriates and 108 expatriate-spouse dyad in Hong Kong (Harrison and Shaffer, 2005).

Adopting spouse-reported withdrawal cognitions and self-reported performance of expatriates,

withdrawal cognitions is not significantly related to any components of job performance: task

completion, relationship building and overall performance, and it supports previous argument

(Thomas and Lazarova, 2006). This sole empirical finding, however, is not concrete enough to

produce a strong theory and generalise to other settings as majority of the expatriates of this

study is from Western countries. Another point is different sources of performance rating should

also be applied to predict the true performance of the expatriates, such as supervisory-rating or

peer-rating rather than self-rating which is likely to cause bias result.

Figure 1: Proposed Research Framework

Notes:

indicates the replications

indicates the contributions

4.0 Conclusion

Expatriate

Adjustment

Expatriate

Performance

Host Country

National Support

Withdrawal

Intentions




As international assignments become increasingly important to both individuals’ and

organisations’ development, the literature has paid attention to the three overarching criteria for

expatriate success, namely expatriate adjustment, job performance and withdrawal/retention

decisions (Caligiuri, 1997; Kraimer and Wayne, 2004; Shaffer, et al., 2006). It has been

suggested that including the three components will draw a more sophisticated and wider view of

expatriate success (Bhaskar-Shrinivas, et al., 2005; Shaffer, et al., 2006; Benson and Pattie,

2009). Expatriates who are successful in bridging the relation gaps with host community are

likely to be benefitted from receiving role information and social support from HCNs

(e.g.,Varma, Pichler, Budhwar and Biswas, 2009; Varma, Budhwar and Pichler, 2011; Varma,

Pichler, Budhwar and Kupferer, 2012). Therefore, HCN support is incorporated in this study

because it has been suggested an important factor to facilitate successful overseas assignment.

This study is expected to contribute both theoretically and practically. The findings of this study

would like to help expatriates in SSO companies in Malaysia to acquire insights about the

positivity of HCN support on expatriate success. These SSO companies can adopt the proposed

research framework to improve expatriates’ view of relocation.

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Does Government Investment Crowd-in or Crowd-out Private

Investment in Malaysia?

Hoda Hajian Universiti Putra Malaysia Serdang, Selangor, 43400.

[email protected]

Azali Mohamed Universiti Putra Malaysia Serdang, Selangor, 43400.

[email protected]

Abstract

Motivated by the concern of Malaysia’s government to increase private capital formation rate while the country has

witnessed relatively low rate of private capital formation in the post-financial crisis area, this study aims to evaluate

the long run relationship between private investment and government investment that is almost debt financed. Using

a trivariate vector error correction model and time-series data covering last 44 years (from 1970 to 2013) this paper

finds evidence of long-run complementary effect of government investment on private investment in Malaysia.

Key words: Government investment, private investment, crowding-in/out, VECM

Introduction

This study aims to investigate the relationship between private domestic investment and

government (almost debt-financed) investment; motivated by the government concern to revive

private capital formation in Malaysia in order to achieve developed country status by 2020, in one

hand and the increasing level of Malaysia government debt in the other hand -having its potential

side effects. The Tenth Malaysia Plan (TMP) requires a large increase in the private investment

rate growth more than 12% annually over the next 5 years, a significant increase from the 2%

annual growth achieved in the Ninth Malaysia Plan. The debt is used to finance government

investments and development expenditures. However, some economic theory and empirical

evidence refer to negative effects of such government expenditure. In some conditions

government debt-funded investments result in adverse effect in real economy, here specifically

domestic private investment.

Private domestic investment in Malaysia has shifted to a lower rate after the financial crisis and

has never reached back to the prior levels. At the same time, government budget balance has been

facing persistence deficit balances in the aftermath of the AFC. As the figure 1 shows

government investment during 1970s and 1980s is countercyclical. However, in all the years after

the AFC except 2012 and 2013 government policy changes to increase public investment to a

level above the private domestic sector’s. One reason for this is to encourage private domestic

and foreign investment. This implicitly means that Malaysia government believes in the positive






effect of increase in government investment or the crowding-in effect. This study reexamines this

assumption to provide further evidence on the issue at hand or put it differently for the crowding-

out vs. crowding in hypothesis.

Crowding out theory is more relevant to the economic condition of advanced economies whereas

in case of emerging and developing countries crowding-in effect is justifiable. The former theory,

argues that debt financed government investment reduces the loanable funds available for private

investment, thus imposing increasing pressure on interest rate and reduce the level of private

investment. The later can be realized through improving the investment environment and

provision of infrastructural support (Greene and Villanueva, 1991).

Empirical evidence is far from conclusive. In one hand, there are several empirical evidence that

support the complementary effect of government investment to private investment including

Aschauer (1989) and Erenburg (1993) for U.S., Greene & Villanueva (1991) for 23 developing

countries, Odedokun (1997) for 48 developing countries, Narayan (2004) for Fiji, Ang (2009) for

Malaysia, Hatano (2010) for Japan. In the other hand negative or replacement effect was found by

Monadjemi (1993), Ghura & Goodwin (2000) for Asia and Latin America, Ramey (2008), De

Castro & Hernandez De Cos (2008), Jorn et al., (2006), Engen & Hubbard (2005), Ardagna, et

al., (2007), Afonso & Sousa (2012), Voss, (2002), Mitra (2006) for India, among others. Against

this backdrop, this article reexamines the effect of government investment on domestic private

sector with the scope of Malaysia over the period of 44 years from1970 to 2013.

This study differs with previous literature in a number of aspects. First, its focus is on the private

domestic capital formation rather than the total private capital formation that has been studied in

most of the previous literature. This is due to avoid aggregation bias in a large foreign direct

investment (FDI) recipient country like Malaysia (Ang, 2009). Second, present study employs

extended and revised time-series data of Malaysia annual capital formation compared to the

similar study by Ang (2009). Third, it extends the model by adding one control variable and

enhances the empirical methodology by checking for the endogenous break point in the co-

integrating relation. Finally, it contributes to the rather scares private investment in Malaysia. We

hope that the result of this study contribute to better understanding of the issue, help policy

makers and inspire further research.

Economic background

This section reviews investment behavior in Malaysia through the period 1970 to 2013. Malaysia

started 1960 with the level of total investment being 10.1% of GDP much lower than average of

lower and middle income countries which was 21.3% at the time. By mid-1960s it increased

rapidly about 17%, before the decay in late 1960s due to the higher economic uncertainty

triggered by the racial riots of 1969. After conducting improvements in the investment incentives

Act of 1968. The 1970s witnessed considerable increase in capital formation, reaching a record

high level in the early 1980s. As the global economic recession hits the country in 1985 total

investment as well as domestic and foreign investment diminished, confronted with large

government deficit and current account deficits following the recession.

Figure 1 depicts the trend of the private domestic, public and total investment rates as percent to

GDP. As it shows the rapid increase in private domestic investment started from 1987 at 12.05%




of GDP rate. Total investment was primarily funded by domestic saving, supplemented by

foreign saving. Meanwhile Malaysia financial system contributed to the increasing rate of total

investment over the years to reach a peak of 27% of GDP in 1997. By Asian financial crisis hit

the economy the trend witnessed a sharp fall to the low level of 5.51% in 1999. This notable

reduction resulted in a decline in total investment since then.

Figure 1. Trend of total, private domestic and public investment rate (as percent to GDP)

for 1970 to 2013 in Malaysia.

Notes: `"Private domestic investment is gross private fixed capital formation minus FDI as percent of GDP; Government investment is gross

public fixed capital formation as percent of GDP and total investment refers to sum of private and government investments (as percent of GDP).

Source: Made by author using World Bank Data.

It worth mentioning that total investment is composed of private investment and government

investment, and the private investment itself is comprised of domestic and foreign private

investment with the later known as foreign direct investment (FDI). Inflows of FDI builds an

important part of total private investment given that Malaysia is among the most successful

developing countries in attracting large amount of FDI.

Model and Data

As mentioned before in developing countries complementary effect of government investment to

private investment is widely accepted. Public investment may facilitate and stimulate private

investment through the provision of infrastructural support (Greene and Villanueva, 1991). This

can raise the productivity of capital, and expand the overall resource availability by increasing

output. On the other hand, it is possible that public investment crowd-out private investment in

different ways. In Mundel-Fleming theory under floating exchange rate regime, increase in

government deficit leads to higher interest rate therefore less investment from private sector.

010

2030

40

Per

cent

of G

DP

1970 1980 1990 2000 2010year

Total investment Private Domestic Investment (PDI)

Government Investment (GI)




Another crowding-out mechanism is explained by the demand for loanable funds. What happens

is that when the economy is at full capacity the increase in budget deficit –to finance additional

government investment spending- leads to increase in demand for loanable funds. This shifts the

loanable funds demand curve rightwards and upwards, increasing the real interest rate. A higher

real interest rate increases the opportunity cost of borrowing, thus decreases the interest-sensitive

expenditure such as investment. It occurs when increased government borrowing to finance

public investment, a kind of expansionary fiscal policy, reduces private sector investment

spending. To put it differently, crowding out refers to government spending using up financial

and other resources that would otherwise be used by private enterprise. Another interpretation of

this term by some economists is government providing a service or goods that would otherwise

be a business opportunity for private industry (Blejer and Khan, 1984; Aschauer, 1989. Thus

from theoretical view it appears that no prior judgment can be made about the effect of

government investment on private investment.

As the above discussion reveals the effect of government investment on PDI is an empirical

question. Therefore, following model specification is suggested:

𝑃𝐷𝐼𝑡 = 𝑓(𝐺𝐼𝑡 , 𝑦𝑡)

Where 𝑃𝐷𝐼𝑡 is the steady state private domestic investment, 𝐺𝐼𝑡 is public investment and 𝑦𝑡 refers

to economic growth rate that captures the general economic condition and is a control variable

used in related literature.

Two dummy variables would be incorporated into the above specification alternatively. One is to

account for the Asian financial crisis 1997-1998 outlier data. Second is to tack account of any

regime shift after the AFC. The dummy variables are defined as:

𝐷97−98 = {1 𝑖𝑓𝑡 = 1997 − 98

0 𝑜𝑡ℎ𝑒𝑟𝑤𝑖𝑠𝑒 }

𝐷𝑅 = {1 𝑖𝑓𝑡 ≥ 1997

0 𝑜𝑡ℎ𝑒𝑟𝑤𝑖𝑠𝑒 }

Private domestic investment (PDI) is measured by gross fixed private capital formation minus

foreign direct investment (FDI), public investment (PUB) is measured by gross fixed public

capital formation, y is measured by GDP growth rate. Annual data covering the period 1970 to

2013 are employed. The data are obtained from World Bank economic indicator database except

data on private fixed capital formation from 1970 to 1990 that was obtained from Monthly

Statistical Bulletin of Bank Negara Malaysia, Monetary and Banking in Malaysia, (BNM, 1994).

Methodology

A VAR based model is used in order to examine how the variables are related in the long-run.

The use of VAR model as a multiequation model is justifiable due to possible endogeneity and

feedback effect of the model variables. This modeling procedure includes three steps. First step is

checking the level of integration of all the variables including in the model using augmented




Dickey-Fuller (ADF) test. In case, the variables are all in the same level of integration so called

I(1), second step would be to check for the existence of cointegration relation using Johansen

cointegration test which allows this test among multivariable group. Finding of any cointegration

relation leads toward third step which is modeling the long run relation using a vector error

correction framework.

The VAR model is in following form:

𝑥𝑡 = 𝜇 + ∑ 𝜑𝑗

𝑝

𝑗=1

𝑥𝑡−𝑗 + 휀𝑡

Where 𝑥𝑡 = [𝑃𝐷𝐼𝑡 , 𝐺𝐼𝑡, 𝑦𝑡]′, 𝜇 is a vector of constant terms where 𝜇 = [𝜇𝑃𝐷𝐼, 𝜇𝐺𝐼, 𝜇𝑦 ]′and 𝜑𝑗 is a

matrix of VAR parameters for lag j. the vector of error terms 휀𝑡 = [ 휀𝑃𝐷𝐼, 휀𝐺𝐼 , 휀𝑦]′~ 𝐼𝑁(0, 𝛺),

where 𝛺 is the variance-covariance matrix of the residuals.

The VAR model in equation 2 can be transformed into a vector error correction model (VECM)

as equation 3 below:

∆𝑥𝑡 = 𝜇 + 𝑥𝑡−1 + 𝜆 ∑ 𝛾𝑗 ∆𝑥𝑡−𝑗

𝑝−1

𝑗=1

+ 휀𝑡

Where ∆= 1 − 𝐿, 𝜆 is the long run multiplier matrix. The important assumption in this

specification is that 휀𝑡 is serially uncorrelated. This highlights the importance of optimal lag

selection in a VAR model. In that lag order should be high enough to prevent residual correlation

in one hand and low enough not to cause overestimation.

Result and discussion

Table 1 reports the result of ADF unit root test which shows all the variables are non-stationary at

level and integrated of level one.

Table 1. Augmented Dickey-Fuller Test.

Level First- difference

PDIt -2.7421 -5.1276***

GIt -2.3692 -5.8889***

yt -0.9212 -10.1372*** Notes: estimating the unit root equations for all the variables separately revealed 1 lag and 0 difference lag, plus intercept and t rend are the

appropriate model specifications, except for growth variable that no intercept and trend is needed.

*** Indicates 1% level of significance.




Given that all variables are I(1), cointegration test should be performed. Before cointegration test,

the optimal lag should be chosen. In order to do that VAR level with different lags (p, maximum

4 due to sample size) were estimated. Based on Schwarz criterion 1lag was chosen as the optimal

lag length. Next, from the estimated VAR at level with 1 lags Johansen Cointegration test was

performed to test if there is long-run relation among the variables. The result revealed the

existence of one cointegrating relation among the variables. Table 2 shows the unanimous result

given by Trace statistics as well as Maximum Eigenvalue statistics. It worth mentioning that by

adding more lags (𝜌 ≥ 3) to the VAR system no cointegration relation can be obtained. Thus, in

what follows VECM modeling is proceed up to 2 lags.

Table.2. Johansen cointegration test

Notes: ** indicates significance at 5% level.

Consequently, modeling process can be followed using VECM framework. The results of

cointegrating equations obtained from VECM estimated models are summarized in Table 3

presenting cointegrating vectors and speed of adjustment and diagnostic check statistics for each

model. The first model (Model A) is the VECM with just one lag as suggested by Schwarz

criterion before. The coefficient on ECTt-1 or the speed of adjustment is significant at 1% level

and has the correct sign. That means the existence of long run relationship among the variables.

However, in short run (one year) there is no causality from government investment to private

investment since the relevant short run coefficient is not significant. To improve the model from

the influence of outlier data or regime changes from Asian financial crisis the dummies

introduced earlier are incorporated in the base model and estimated individually. The result of

model B that is the basic VECM with 1 lag plus the dummy variable of D97-98 also shows

significant and negative speed of adjustment which is favorable. Another favorable result is the

coefficient of government investment in short run becomes significant in 5% level. The speed of

adjustment for model A and B are 14% and 16% respectively that means 7 year and 61/4 year take

for the private investment to return to the equilibrium level after a shock to government

investment.

The post-estimation diagnostic checks reveal the existence of some problem in each model A and

B. The residual of the cointegrating equation of Model A is not normally distributed. This

problem is rectified by adding dummy variable in Model B, but then taking account of the outlier

has induced residuals to be serially correlated up to 7 lags. Therefore to rectify the serial

Trace statistics Maximum eigenvalue

Lag 𝑟 = 0 𝑟 ≤ 1 r≤ 2 𝑟 = 0 𝑟 = 1 𝑟 = 2

p=1 40.2140** 11.7630 2.1108 28.4510** 9.6522 2.1108




correlation problem in the residuals Model C with 2 lags was estimated. Model D adds D97-98

variable to Model C.

Table 3. Cointegrated Equations

Notes:*** Indicates significance at 1% level.

χ2 Normal, indicates Jarque-Bera normality test of the residuals obtained from the VECM model. F

Serial1and F Serial2 are the Breusch-Godfrey LM test statistics for one and two lag respectively.

Increasing the number of lags of VECM model to two lags did not solve the residual serial

correlation problem. The pattern of residual problems in model C and D is similar to A and B.

That is including dummy variable normalize but serially correlates the residuals at the same time.

Adding more lag increased the relatively low R square and adjusted R square of the model.

However, no short run coefficient becomes significant in model C and D.

In sum, the above analysis showed existence of long run complementary relationship between

government investment and private investment. In other words, although no short run effect could

be detected by this study the positive effect of government investment increase seems to be

persistent for several years on private investment. Ang (2009) found similar complementary

effect but his result were stronger than what was found by present paper. The speed of adjustment

is his models are two times faster than what was obtained here. Moreover, he found significant

short run effect for public investment which this study was not able to discover. However,

Guimaraes & Unteroberdoerster (2006) found no significant effect for government spending to

influence private investment in Malaysia. Against such contradictory findings, the need for

further study remains necessary.

Conclusion

This study reexamined crowd-out vs. crowd-in concept in the long run in the context of a newly

industrialized country of Malaysia for the last 44 years (1970-2013). It contributed to the rather

limited literature on the relationship between government and private investment. The result

supported the complementary or crowd-in effect of government investment on private

investment. However, regarding the contradictory evidence obtained from different researches

Model A

𝜌 = 1

Model B

𝜌 = 1

Model C

𝜌 = 2

Model D

𝜌 = 2

Intercept 6.075 4.246 6.303 5.035

GI 1.171*** 1.108*** 1.162*** 1.120***

y 0.331*** 0.273*** 0.393*** 0.350***

ECTt-1 -0.143*** -0.160*** -0.145*** 0.190***

χ2 Normal 29.286*** 0.738 51.028*** 0.602

F Serial1 0.786 6.939*** 0.619 10.659***

F Serial2 2.441 6.029*** 0.357 5.240***




and also the shortcomings of the model in present paper, it is necessary to revisit the issue using a

more consistent model.

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http://dx.doi.org/10.1016/j.jpolmod.2004.06.002

http://dx.doi.org/10.1016/S0264-9993(00)00074-2




External Debt Financing of Public Capital Formation: Empirical

Evidence from Nigeria

Ibrahim Mohammed Adamu

Rajah Rasiah

Faculty of Economics and Administration, University of Malaya, Kuala lumpur, Malaysia

[email protected]; [email protected]

Abstract This paper examines empirically the effect of external debt financing of public capital formation in Nigeria, spanning

between 1970 through 2014. The empirical results are based on autoregressive distributed lag (ARDL) bound testing

to cointegration approach. Following the confirmation of orders of integration and a unique cointegration relation

among the variables, our findings revealed that external debt and foreign direct investment are negatively correlated

with the public capital foration, but openness is positive in both long run and short run. Therefore, the study suggests

that investment in an infrastructure oriented project with a higher rate of return would free Nation from future

indebtednesss. Furthermore, good structural reform such as public-private partnership will enhance foreign direct

investment, and promote public infrastructure efficiency.

Key words: External debt; FDI; Public investment.

1. Introduction

Inadequate public capital investment1 especially in infrastructure development has been a

common problem in Nigeria, despite her position as the largest oil producer and exporter in

Africa and sixth position among the top oil exporters in the World. Added to that, in the last

fourty years the country had borrowed over $35billion as at 2004 (Debt Management Office,

2004), through which to finance her budget deficit and investment in basic infrastructure services.

Unfortunately, numerous infrastructure gaps continue to hamper development in economic and

social sectors. In a nutshell, the priority infrastructure services such as electricity,

telecommunication, water supply, and transport services to mention but a few remained

absolutely inadequate and the existing ones are of poor quality by any standard (USAID, 2007).

Due to increasing external debt stock, Nigeria entered negotiation for debt relief with Paris club

creditors2 in 2003. In 2006, Nigeria benefit from a debt relief amounting to $18billion following

the implementation of the Heavily Indebted Poor Countries (HIPCs) initiative and the

Multilateral Debt Relief Initiative (MDRI) jointly with the Paris club of creditor’s debt relief

intervention (Johansson, 2010). This had drastically reduced the total external debt stock to

$3.5billion as at 2006 (DMO, 2006), this development would provide resources available for

investment in the critical priority sectors of the economy, such as road networks, power, water

and other infrastructure to stimulate productive sectors in the economy. Though, it has been

observed that in the eight year period (i.e. after the debt relief in 2006) additional external debt

1 From now, public capital, public capital formation or investment will be used interchangeably. 2 An informal group of official money lenders established in 1956, maily to coordinate and overcome problems of payment difficulties

encountered by countries that owed its member nations. The member nations include UK, France, Germany, Japan, Italy, Netherlands, USA,

Belgium, Denmark, Austris, Spain, Switzerland, Russia and Finland.






has continued to grow amounting to $9.7 billion as at 2014 (Debt Management Office, 2014)

respectively.

Table 1, provides a summary trends of external debt indicators and public investment over the

years. It can be seen clearly that in the 1970s and early 1980s, the debt indicators were very low

and the growth of capital infrastructure was impressive. Though, this could be financed through

revenue from the oil exports. The subsequent collapse in the oil price in 1978 and the sudden

international debt crisis of 1982 reversed the trend where growth in public investment begins to

decline substantially. Indeed, Nigeria’s inability in meeting the debt service requirements had

worsen the debt stock. Despite the increased external borrowing over the period, especially in the

mid-1980s and early 2000, Nigeria’s public investment (measured as a share of GDP) did not

yield any satisfactory improvement to the nation’s infrastructure development objectives because

the external debt had increased without accompanying increase in public investment. Until quite

after the debt relief in 2006, the trends begin to improve (see table 1).

Table 1 External debt and Public investment, 1970-2014 ________________________________________________________________________________________________________

Year 1970 1975 1980 1985 1990 1995 2000 2004 2006 2010 2014

________________________________________________________________________________________________________

External debt ($b) 0.5 1.1 4.3 18.9 33.1 32.6 28.2 35.9 3.5 4.6 9.7

Debt to GDP ratio 3.1 1.6 3.8 23.9 105.2 76.6 62.3 65.1 48.2 6.5 2.4

Debt service ratio 2.3 0.6 1.2 0.7 25.3 15.6 8.7 8.6 8.9 0.3 0.4 Pub. Inv. to GDP 13.1 18.5 35.2 12.0 14.1 7.1 7.0 7.4 8.3 15.0 15.7

________________________________________________________________________________________________________

Source: Debt Management Office, Nigeria (2014) and Central Bank of Nigeria (2014).

However, a number of theories have explored the importance as well as adverse effect of external

borrowing. Kopits and Symansky (1998); Emmerson, Frayne and Love (2003) and Kellerman

(2007) have reported that the “golden rule” of public sector borrowing provides a special

consideration to investment in capital expenditure. Based on the fiscal rule, public deficit is not

harm as long as the government deficit is complemented by an increase in physical assets, and the

expenditures must be covered by revenue while for investment expenditure recourse to debt is

allowed. On the other hand, Krugman (1988) and Sachs (1989) established a case regarding the

adverse effects of high debt using debt overhang hypothesis. They fundamentally argue that

country’s accumulated debt acts as a tax on future output, thus discouraging savings and

investment potentials. They suggested that debt reduction or forgiveness is the best alternative to

enhance investment and growth in developing countries.

Empirically, literature on the external debt financing of public investment has not attracted much

empirical interest and the existing ones have produced inconclusive results. Clements,

Bhattacharya and Nguyen (2003) investigate the determinants of public investment in low income

countries. They found an insignificant effect of external debt as opposed to debt service which

depresses public investment. Lora and Olivera (2007) found higher debt ratios caused a decline in

social expenditure in a study of fifty developing countries. Fosu (2010) and Quattiri and Fosu

(2012) in their studies of Sub-Saharan African countries concluded that the relationship between

external debt and investment in social sector remain negative. Hence, a similar result was found

by Deshpande, (1997) in a study of thirteen severely indebted poor countries. A recent study of

Babu, Gisore and Lawrence (2014) also confirmed that high public debt reduces public capital

investment in the East African Community (EAC). Contrarily, Lora (2007) estimated a model of




public investment in Latin America. Findings reveal that increasing debt stock is associated with

improvement in public infrastructure investment. On the other hand, Ndikumana and Verick

(2008) found foreign direct investment crowd in domestic investment in Sub-Saharan African

countries. Unlike Agosin and Machado (2005) for the case of Africa, Asia and Latin America,

Eregha (2012) for ECOWAS countries confirmed a negative effect of FDI on domestic

investment. Equally, with regard to Nigeria, there has not been much effort to examine the impact

of external debt financing on public investment. Though, there are few studies that investigate the

effect of external debt, but focused on either aggregate investment or growth. Edo (2002)

examines the effect of external debt on African countries with emphasis on Nigeria and Morocco.

He found a negative effect of external debt on investment. Adegbite, Ayadi and Ayadi (2008)

found the same results to that of Edo (2002), in which external debt affects investment and

growth negatively. From the empirical literature, the majority of the studies report a negative

correlation apart from Lora (2007).

Nevertheless, the following gaps have been identified. First, some studies ignored the issue of

unit root and cointegration test (e.g. Adegbite, Ayadi and Ayadi, 2008). According to Granger

and Newbold (1974) estimation of nonstationary time series data may render the results

“spurious”. Second, previous studies have either focused on the external debt and private capital

investment, or aggregate investment or growth, but failed to consider the contribution of external

debt on public capital formation, which remain the prime mover of economic activities of any

nation. This is a very serious gap which needs to be addressed. Added to that, a considerable

number of studies are cross country case, which could not address country specific problems with

regard to the external debt finanacing of public capital formation. Thirdly, to the best of our

knowledge no empirical study has attracted interest to address this issue in Nigeria.

Hence, the objective of this paper is to examine empirically the external debt financing of public

capital investment in Nigeria. Specifically, the choice of Nigeria was motivated by the long years

of debt overhang, and suddenly the nation benefited from a debt relief. Thus, a sensitive factor

like debt relief may certainly reduce the level of debt stock (Lora and Olivera, 2007), and would

provide available resources for investment, particularly in infrastructure development to stimulate

private sector participation, and accelerate growth.

This paper contributes to the existing literature in two novel ways: First, we employ a recent

autoregressive distributed lag (ARDL) bound testing to cointegration approach developed by

Pesaran, Shin and Smith (2001), which is more reliable in small samples than Johansen and

Juselius (1990) and Engle and Granger (1974) cointegration test (Pesaran, Shin and Smith, 2001).

Second, we incorporate foreign direct investment into the investment equation since foreign

direct investment can support technology transfer and managerial know how, which in turn

enhances public capital investment. Though, Rasiah, Gammeltoft and Jiang (2010) have

maintained that foreign direct investment may encounter high political risk and macroeconomic

instability if motivated by a particular interest, especially in an oil and gas economies such as

Nigeria, Iran and Venezuela among others. Indeed, to the best of our knowledge, no empirical

research that has explored this important issue of external debt financing and public capital

investment interaction using this approach. Therefore, the combination of these aforementioned

novel thoughts provides the basis for our study and distinguishes our work from others.




Following the introductory part, the rest of the paper is structured as follows: Section 2 specifies

the investment model and data sources. Section 3 presents the methodology of the study and

empirical analysis while Section 4 concludes and offers some policy implications.

2. Model specification and Data

This study adopts a modified version of Fosu (2010) and Quattri and Fosu (2012), and specifies a

single country public investment equation as shown below:

),,()()/()(

tttt OPNFDIEDfIG

(1)

Where IG is the public capital investment as a proxy of gross fixed capital formation, ED is the

external debt, FDI is the foreign direct investment inflow, and OPN is the trade openness (The

ratio of trade to GDP). However, we adjust the series closer to stationarity by transforming Eq.(1)

into a log linear form (Lutkepohl, 2004).

t3t2t10 lnlnFDI lnED ln tt OPNIG (2)

All variables are defined earlier. However, subscript t is time span covering annual data between

1970 and 2014 and the symbol µ is the usual stochastic error term which assumed to be normally

distributed. The corresponding coefficients for the parameters (α0–α3) are the unknown

coefficients to be estimated.

Our data consist of 45 annual observations from 1970 to 2014. The public investment is collected

from Central Bank of Nigeria, and the external debt data were taken from the Debt Management

Office, Nigeria. The foreign direct investment inflow and trade openness are available in World

Development Indicators CD-ROM, World Bank. All data are expressed in real terms.

3. Methodology and Empirical analysis

Our empirical analysis begins with the descriptive statistics and correlation matrix of the

candidate variables, but due to economy of space we reserve the result upon request. Prior to

adoption of an econometric methodology, the properties of the data series have to examine to

ascertain their order of integration. Thus, we employ Augmented Dickey Fuller (1981) and

Phillips and Perron (1988) tests. Table 2 presents the results of the unit root test where lnIG, lnED

and lnFDI are intergrated of order one, i.e., I(1) or stationary at first difference whereas lnOPN is

found intergrated of order zero, i.e. I(0). The combination of these orders of integration justifies

the adoption of ARDL bound testing to cointegration approach by Pesaran (Pesaran, Shin and

Smith, 2001).

Table 2 Unit root test

Variable

ADF test

PP test

I(d)

Level

First difference

Level

First difference

lnIG

-0.844(2)

[0.952]

-3.484(3)**

[0.055]

-2.057(1)

[0.553]

-6.252(5)***

[0.000]

I(1)




lnED -1.605(1)

[0.773]

-5.060(0)***

[0.005]

-1.074(3)

[0.921]

-4.689(7)***

[0.002]

I(1)

lnFDI

-2.244(0)

[0.453]

-4.429(9)***

[0.006]

-2.241(4)

[0.455]

-9.901(3)***

[0.000]

I(1)

lnOPN

-3.446(2)**

[0.059]

-3.650(6)**

[0.039]

-3.297(0)*

[0.080]

-8.144(2)***

[0.000]

I(0)/I(1)

Note: ***, ** and * denotes 1%, 5% and 10% significance level. Constant and time trend is included in the test. An automatic maximum lag is

used by the Akaike Information Criterion for ADF tests, and Newey-West bandwidth using Bartlett kernel for PP tests respectively. Numbers in

square brackets are the p-values.

Upon the confirmation of the orders of integration, the next is to apply the ARDL bound testing

to cointegration approach for the long run relationship among the variables and the estimation of

short run using unrestricted error correction model corresponding to equation (2) which

interchangeably gives equation (3) to (6) below:

t

p

i

tt

p

i

p

i

p

i

tttttt

ttttt

DOPNFDIEDIG

OPNFDIEDIGIG

,1

1

1,4

1 1 1

1,31,21,1

141312110

2006lnlnlnln

lnlnlnlnln

(3)

t

p

i

tt

p

i

p

i

p

i

tttttt

ttttt

OPNFDIEDIG

OPNFDIEDIGIG

,2

1

1,4

1 1 1

1,31,21,1

141312110

lnlnlnln

lnlnlnlnln

(4)

t

p

i

tt

p

i

p

i

p

i

tttttt

ttttt

OPNEDIGFDI

OPNEDIGFDIFDI

3

1

1,4

1 1 1

1,31,21,1

141312110

lnlnlnln

lnlnlnlnln

(5)

t

p

i

tt

p

i

p

i

p

i

tttttt

ttttt

FDIEDIGOPN

FDIEDIGOPNOPN

,4

1

1,4

1 1 1

1,31,21,1

141312110

lnlnlnln

lnlnlnlnln

(6)

where ∆ is the first difference operator, p is the lag length, and μit are stochastic error terms.

Hence, bearing the structural break in mind following the drastic reduction in the external debt

stock, we incorporated into Eq.(3) a zero-one dummy variable to account for the effects of debt

relief in 2006. It takes the value of 1 from 1970 to 2006 and 0 afterward.

However, Wald test (F-test) is used to examine the long run relationship. The F-statistics also for

the joint hypothesis. The null hypothesis is that the coefficients of the lagged variables are equal

to zero, which entails the absence of long run relationship among the variables, whereas the

alternative hypothesis denotes at least one of these coefficients is not equal to zero. To conduct

the ARDL test, the first step is to estimate Eq.(3) - (6) using ordinary least square method and

apply the F- test for joint significance. Representatively, the null hypothesis for Eq.(3) - (6) is H0:

φ1=φ2=φ3=φ4=0 (No long run relationship) and against the alternative hypotheses H1: φ1 ≠ φ2 ≠

φ3 ≠ φ4 ≠ 0 (existence of Long run relationship). Accordingly, F-test has non-standard distribution

which depends on whether the variables included in the ARDL model are I(0) or I(1), rather the

critical values are provided by Pesaran, Shin and Smith (2001) and Narayan (2005). The




calculated F- value of the ARDL models are compared with critical values. If the calculated F-

statistics is greater than the upper bound value, then we concluded that no long run relationship is

rejected against the alternative hypothesis that long run relationship exists. Conversely, if the

calculated F-statistics is less than the lower bound critical values, the null hypothesis is accepted

suggesting that the long run relationship does not exist. Table 3 presents the results of the ARDL

cointegrating tests for the four models. The calculated F-statistics (4.918) of the investment

model is greater than the upper bound critical values provided by Narayan (2005) and Pesaran et

al., (2001) at the 5% level of significance. This validates the rejection of the null hypothesis

against the alternative hypothesis that there exists a long-run cointegrating relationship among the

variables. Thus, the F- statistics of the rest of the models are less than the lower bound critical

values, therefore, we accept the null hypothesis that there is no long run relationship. To provide

further support for the long run relationship, we employ Johansen and Juselius (1990)

multivariate cointegration test. The results are shown in Table 4 supporting the hypothesis of one

cointegrating vector.

Table 3 ARDL cointegration results

Estimated models Optimum Lag Length F-statistics, (k=3); T=45 Structural break Decision

FIG (IG/ED, FDI, OPN) 1, 1, 1, 1 4.918** 1985 Cointegration

FED (ED/IG, FDI, OPN) 1, 1, 0, 0 2.595 2006 No cointegration

FFDI (FDI/IG, FDI, OPN) 1, 0, 0, 0 2.195 1984 No cointegration

FOPN (OPN/IG, ED, FDI) 1, 1, 0, 1 2.769 1983 No cointegration

Significance level

Asymptotic critical values: LBV, I(0); UBV, I(1)

Narayan (2005) Pesaran et al., (2001)

1% 4.983 6.423 4.29 5.61

5% 3.535 4.733 3.23 4.35

10% 2.893 3.983 2.72 3.77

Note: ** indicate 5% level of significance. LBV and UBV denote Lower Bound Value and Upper Bound Value respectively. Critical values are

taken from Narayan (2005), case III, unrestricted intercept and no trend, Pp 1988 and Pesaran et al., (2001) case III, unrestricted intercept and no

trend Pp 300.

Table 4. Johansen and Juselius (1990) Multivariate cointegration test results

Hypothesis Trace statistics At 5% critical value Maximum-eigen statistics At 5% critical value

R = 0 61.259** 47.21 45.419 ** 27.07

R ≤ 1 15.839 29.68 11.071 20.97

R ≤ 2 4.768 15.41 4.606 14.07

R ≤ 3 0.162 3.76 0.162 3.76

Notes: *** and ** indicates 1% and 5% significance level.

Table 5 and 6 presents the long run and short run elasticities. The result provides support for our

a priori expectation. The coefficient of external debt has the correct sign, negative and

statistically significant at the 5% level in the long run, but appear insignificant in the short run.

On average, for every 1% increase in external debt, public investment falls by 29%. Our result is

similar to that of Edo (2002); Fosu (2010); Quattiri and Fosu (2012); Deshpande, (1997); Babu,

Gisore and Lawrence (2014), and disproves the study of Lora (2007). This implies that the

reduction in external debt stock through the debt relief initiative under the Highly Indebted Poor

Countries (HIPC) does not enhance public capital formation.

The coefficient of foreign direct investment is indeterminate, but appear negative and statistically

significant in both long run and short run at the 1% and 10% level. This implies that a 1%

decrease in FDI decreases public investment by 17% in the long and 12% in the short run,

respectively. Our finding is not consistent with Ndikumana and Verick (2008), but proved the




results of Agosin and Machado (2005) and Eregha (2012). This may be attributed to poor

macroeconomic policies and fear of political instability that has been a threat to viable business

environment by MNC’s as viewed by Rasiah (Rasiah, Gammeltoft and Jiang (2010). Equally, the

coefficient of trade openness is positive and statistically significant in both long run and short run

at the 10% and 5% level. This implies that a 1% increase in trade openness increases public

investment by 15% in the long run and 39% in the short run. This suggests that the country’s

ability to interact and compete globally has driven public investment.

The coefficient of the shift dummy variable (D2006) capturing the effects of debt relief is positive

and statistically significant. This indicates that the debt relief, which granted to Nigeria has

produced a drastic fall of external debt stock, and freed about 13% of the resources which are

expanded on debt repayment in the past. The one lagged error correction term is negative and

statistically significant as expected, though, is relatively small in magnitude, this reaffirmed the

existence of the long run cointegration relationship among the variables. The results also imply

that the deviation from the long run equilibrium in the previous period is corrected by 13% in the

next period. Furthermore, the short run model passes through appropriate diagnostic tests such as

serial correlation test, Jaque-Bera test for normality of the residuals, ARCH test for

heteroskedasticity, and Ramsey RESET for functional form and confirmed the model was free

from misspecification (see table 7). Similarly, CUSUM and CUSUM SQUARE for stability test

(Brown, Durbin and Evans, 1975), indicates that the test statistics are within the 5% confidence

interval, therefore, the model is stable and reliable over the sample period (see figure 1).

Table 5. Long run elasticities, Dependent variable = lnIG

Variable Coefficient Std. Error t-Statistics P-value

Constant -31.282*** 3.590 -8.712 0.000

lnED -0.293** 0.138 -2.123 0.041

lnFDI -1.657*** 0.228 -7.263 0.000

lnOPN 1.519* 0.810 1.876 0.068

Note: Note: ***, ** and * denotes 1%, 5% and 10% significance level respectively.

Table 6. Short run elasticities, Dependent variable = lnIG

Variable Coefficient Std. Error t-Statistics P-value

Constant 0.180*** 0.046 3.843 0.000

∆lnIG (-1) 0.019 0.143 0.137 0.891

∆lnED -0.058 0.080 -1.722 0.475

∆lnED (-1) -0.083 0.079 -1.050 0.301

∆lnFDI -0.118* 0.063 -1.873 0.070

∆lnFDI (-1) -0.120* 0.069 -1.733 0.093

∆lnOPN 0.386** 0.124 3.093 0.004

∆lnOPN (-1) 0.072 0.134 0.534 0.596

D2006 0.130** 0.062 -2.094 0.044

ECM (-1) -0.133** -0.054 -2.463 0.019

Note: ***, ** and * denotes 1%, 5% and 10% significance level respectively. R-squared [0.617]; Adjusted R-squared [0.506]; F-statistics [5.563

(0.000)]; DW statistics [1.908].

Table 7. Short run Diagnostic test

Test

Null hypothesis

Test statistics

Decision

χ2 serial correlation [2] H0: No autocorrelation 0.6908 [0.5092] Do not reject H0

χ2 Jaque-bera H0: Normality of stochastic term 1.9515 [0.3769] Do not reject H0

χ2ARCH [1] H0: Homoskedasticity 0.7652 [0.3872] Do not reject H0

χ2`Ramsey RESET [1] H0: No mis-specification 0.8742 [0.2778] Do not reject H0




Figure 1 Residuals plots for CUSUM and CUSUMSQ

-16

-12

-8

-4

0

4

8

12

16

88 90 92 94 96 98 00 02 04 06 08 10 12

CUSUM 5% Significance

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

88 90 92 94 96 98 00 02 04 06 08 10 12

CUSUM of Squares 5% Significance

5. Conclusion

In this paper, we examine empirically the external debt financing of public capital investment

in Nigeria from 1970 to 2014 using ARDL bound testing to cointegrating approach. Following

the findings, there are two essential features observed from this paper: (i) it is clearly shown that

external debt affects public capital investment negatively. This implies that the reduction in the

debt stock following the debt relief granted to Nigeria in 2006 under Highly Indebted Poor

Countries initiative (HIPC) did not yield any impressive contribution to public capital formation.

Our findings disregard the Krugman (1988) and Sachs (1989) debt overhang hypothesis that debt

forgiveness or reduction could enhance investment and stimulate growth. (ii) the negative effect

of foreign direct investment also is consistent with view of Rasia, Gammeltoft and Jiang (2010)

that poor macroeconomic instability and political risk, particularly in an oil rich nations like

Nigeria. Conversely, we consider these results as tentative and further empirical investigation has

to be conducted. Finally, the major policy implication of this finding is that loans should be

adequately extended to investment in infrastructure development rather than in consumption

expenditure. This is by investing in development oriented projects with a higher rate of return that

would repay back the loans. In addition, there is the need for attracting foreign direct investment

through structural reforms, such as public-private partnership will encourage foreign investors,

and promote public infrastructure efficiency.

Acknowledgement

My appreciation goes to Dr. T. C. Tang, whose valuable comments and suggestions was my

strength to prepare the manuscript.

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