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THE BUCHAREST<br />
ACADEMY OF ECONOMIC<br />
STUDIES<br />
<strong>Proceedings</strong><br />
of the International Conference<br />
ACCOUNTING AND MANAGEMENT<br />
INFORMATION SYSTEMS<br />
AMIS 2011<br />
The sixth edition<br />
June 8-9, 2011<br />
The Bucharest Academy of Economic Studies<br />
Piaţa Romană No. 6, Sector 1<br />
Bucharest, Romania<br />
ISSN 2247 − 6245<br />
ISSN-L 2247 − 6245<br />
FACULTY OF ACCOUNTING<br />
AND MANAGEMENT INFORMATION<br />
SYSTEMS
President<br />
Pavel NASTASE<br />
Members<br />
Organizing Committee<br />
Pavel NASTASE ASE Bucharest<br />
Vasile RAILEANU ASE Bucharest<br />
Catalin ALBU ASE Bucharest<br />
Nadia ALBU ASE Bucharest<br />
Dana BOLDEANU ASE Bucharest<br />
Daniela CALU ASE Bucharest<br />
Costin CIORA ASE Bucharest<br />
Iulia JIANU ASE Bucharest<br />
Florin MIHAI ASE Bucharest<br />
Iuliana SANDU ASE Bucharest<br />
Andrei STANCIU ASE Bucharest<br />
Scientific Committee<br />
ASE Bucharest<br />
Romania<br />
David ALEXANDER<br />
University of Birmingham<br />
United Kingdom<br />
Alain BURLAUD INTEC Paris France<br />
Raluca DIMITRIU ASE Bucharest Romania<br />
Robert FAFF University of Queensland Australia<br />
Nicoleta FARCANE University of the West of Timisoara Romania<br />
Liliana FELEAGA ASE Bucharest Romania<br />
Niculae FELEAGA ASE Bucharest Romania<br />
Andrei FILIP ESSEC Paris France<br />
Philippe GERMAK INTEC Paris France<br />
Oktay GÜVEMLI Marmara University Turkey<br />
Allan HODGSON University of Amsterdam The Netherlands<br />
Bogdan IONESCU ASE Bucharest Romania<br />
Dorin LIXANDROIU Transilvania University, Brasov Romania<br />
Alan LORD Bowling Green University United States of America<br />
Dumitru MATIS University “Babes-Bolyai”, Cluj Romania<br />
Ana MORARIU ASE Bucharest Romania<br />
Mihaela MUNTEAN University of the West of Timisoara Romania<br />
Marc NIKITIN University of Orléans France<br />
Recep PEKDEMIR Istanbul University Turkey<br />
Bernard RAFFOURNIER HEC Geneva Switzerland<br />
Vasile RAILEANU ASE Bucharest Romania<br />
Mihai RISTEA ASE Bucharest Romania<br />
Vasile ROBU ASE Bucharest Romania<br />
Camelia STOICA ASE Bucharest Romania<br />
Donna STREET Dayton University United States of America<br />
Claudia Elena SERBAN ASE Bucharest Romania<br />
Brândusa STEFANESCU ASE Bucharest Romania<br />
Petru STEFEA University of the West of Timisoara Romania<br />
Ilie TAMAS ASE Bucharest Romania<br />
Adriana TIRON TUDOR University “Babes-Bolyai”, Cluj Romania<br />
Alexandru TUGUI University “A.I. Cuza”, Iasi Romania<br />
Eugeniu TURLEA ASE Bucharest Romania<br />
Eddy VAASSEN University of Amsterdam The Netherlands<br />
Lee YAO Loyola University United States of America
CONTENTS<br />
Preface<br />
PS1 Auditing<br />
Chairperson: David PROCHAZKA, University of Economics, Prague, Czech Republic<br />
AUDIT COMMITTEES AS INCREASING VECTORS OF FINANCIAL<br />
INFORMATION QUALITY<br />
Neluta MITEA<br />
THE FINANCIAL AUDITOR’S RISK BEHAVIOUR – THE INFLUENCE<br />
OF AGE ON RISK BEHAVIOUR IN A FINANCIAL AUDIT CONTEXT<br />
Iancu Octavian IONESCU<br />
Eugeniu TURLEA<br />
THE INVESTIGATION OF ROMANIAN AUDITORS' PERCEPTIONS<br />
OVER THE INTERNAL AUDIT PRACTICES -<br />
AN ATTEMPT TO IDENTIFY THE BEST PRACTICES<br />
IN THE CONTEXT OF CORPORATE GOVERNANCE<br />
Cristina BOTA-AVRAM<br />
PS2 Public accounting<br />
Chairperson: Răzvan MUSTAŢĂ, Babes-Bolyai University, Romania<br />
PUBLIC SECTOR PERFORMANCE FROM THE PERSPECTIVE<br />
OF CORPORATE SOCIAL RESPONSIBILITY – A EUROPEAN<br />
AND NATIONAL APPROACH<br />
Eugeniu TURLEA<br />
Aurelia STEFANESCU<br />
Monica DUDIAN<br />
Mihaela MOCANU<br />
Adriana CALU<br />
IMPROVEMENT IN ACCOUNTING SYSTEM AND PERFORMANCE<br />
MANAGEMENT OF IRAN’S UNIVERSITIES IN THELIGHT OF<br />
CONTINGENCY THEORY<br />
Martin BROAD<br />
Abbas ALIMORADI<br />
THE ERA OF INTERNAL AUDIT IN THE PUBLIC FINANCE SECTOR<br />
IN POLAND<br />
Agnieszka SKOCZYLAS<br />
Wojciech NOWAK<br />
BOUNDRIES REGARDING THE IMPLEMENTATION<br />
OF THE NATIONAL STRATEGY FOR THE FINANCIAL REPORTING<br />
OF THE PRIVATE SECTOR ENTITIES<br />
Ramona LAPTES<br />
Adriana Florina POPA<br />
~ 3 ~<br />
3<br />
12<br />
14<br />
15<br />
32<br />
45<br />
68<br />
69<br />
91<br />
114<br />
133
PS3 Financial analysis I<br />
Chairperson: Petru OPRIS, West University of Timişoara, Romania<br />
FINANCIAL RATIOS AND MARKET VALUATION<br />
ON EMERGENT MARKETS: THE ROMANIAN CASE<br />
Bogdan DIMA<br />
Petru OPRIS<br />
A HYBRID DEVICE OF SELF ORGANIZING MAPS (SOM)<br />
AND MULTIVARIATE ADAPTIVE REGRESSION SPLINES (MARS)<br />
FOR THE FORECASTING OF FIRMS’ BANKRUPTCY<br />
Javier de ANDRES<br />
Fernando SΑNCHEZ-LASHERAS<br />
Pedro LORCA<br />
Francisco Javier DE COS-JUEZ<br />
THE RELEVANCE OF COMPANY EVALUATION METHODS<br />
IN CONDITIONS OF ECONOMIC INSTABILITY. EMPIRICAL STUDY<br />
ON THE COMPANIES QUOTED IN THE BUCHAREST STOCK<br />
EXCHANGE<br />
Marilena MIRONIUC<br />
Mihai CARP<br />
Ioan-Bogdan ROBU<br />
FINANCIAL RISK ANALYSIS AT THE STOCK EXCHANGE LISTED<br />
COMPANIES IN THE PASSENGER ROAD TRANSPORTATION<br />
INDUSTRY<br />
Vlad IORDACHE<br />
Vasile ROBU<br />
Costin CIORA<br />
PS4 IFRS I<br />
Chairperson: David ALEXANDER, University of Birmingham, UK<br />
BENEFITS AND COSTS OF PREPARING IFRS STATEMENTS<br />
BY NON-LISTED COMPANIES: EVIDENCE FROM THE CZECH<br />
REPUBLIC<br />
David PROCHΑZKA<br />
PS5 Fair value<br />
Chairperson: Mihaela DUMITRANA, Academy of Economic Studies, Bucharest,<br />
Romania<br />
THE IMPACT OF THE ED/2009/5 FAIR VALUE MEASUREMENT<br />
ON THE PROFESSIONALS<br />
Mirela PAUNESCU<br />
Mirela NICHITA<br />
PS6 Management information systems I<br />
Chairperson: Pavel NASTASE, Bucharest Academy of Economic Studies, Romania<br />
AN ENTERPRISE ONTOLOGICAL APPROACH FOR SEMANTIC WEB<br />
Adrian COZGAREA<br />
Gabriel COZGAREA<br />
Delia BABEANU<br />
~ 4 ~<br />
149<br />
150<br />
162<br />
183<br />
201<br />
210<br />
211<br />
229<br />
230<br />
248<br />
249
ENTERPRISE 2.0 – IS THE MARKET READY?<br />
Dragos Marian MANGIUC<br />
NON-TECHNICAL CHALLENGES IN ADOPTING ENTERPRISE 2.0<br />
Dragos Marian MANGIUC<br />
CRITICAL SUCCESS FACTORS FOR THE ORACLE DATABASE<br />
AUDIT<br />
Simona Felicia UNCHIASU<br />
Pavel NASTASE<br />
PS7 Financial instruments<br />
Chairperson: Florin VASVARI, London Business School, UK<br />
USE OF FINANCIAL SECURITIES IN THE CZECH REPUBLIC: SOME<br />
EVIDENCE FROM SMES<br />
Jiřν STROUHAL<br />
Marie PASEKOVÁ<br />
Eva HRUBOŠOVΑ<br />
Carmen Giorgiana BONACI<br />
THE FINANCIAL INNOVATION AND THE DYNAMIC CAPITAL<br />
MARKET<br />
Flavia Mirela BARNA<br />
Miruna Lucia NACHESCU<br />
A SELECTION FUZZY MODEL INVOLVING ASSETS AND PROJECTS<br />
Adrian Victor BĂDESCU<br />
Radu Nicolae CRISTEA<br />
Dana-Maria BOLDEANU<br />
THE ROLE OF FINANCIAL DESCRIPTORS IN THE OPTIMAL<br />
PORTFOLIO SELECTION<br />
Bogdan DIMA<br />
Flavia BARNA<br />
Horatiu REGEP<br />
PS8 Intellectual Capital<br />
Chairperson: Niculae FELEAGA, Bucharest Academy of Economic Studies, Romania<br />
INTELLECTUAL CAPITAL DISCLOSURE: EUROPEAN EVIDENCE<br />
Liliana FELEAGA<br />
Niculae FELEAGA<br />
Voicu Dan DRAGOMIR<br />
Luciana Maria RABU<br />
INTELLECTUAL CAPITAL: THE ANNUAL REPORTING PRACTICES<br />
Nicoleta Maria IENCIU<br />
Dumitru MATIŞ<br />
DETERMINANTS OF INTELLECTUAL CAPITAL DISCLOSURE IN<br />
THE CASE OF ROMANIAN COMPANIES<br />
Maria Cristina MORARIU<br />
~ 5 ~<br />
258<br />
275<br />
287<br />
302<br />
303<br />
317<br />
334<br />
347<br />
368<br />
369<br />
380<br />
395
PS9 IFRS II<br />
Chairperson: Dumitru MATIS, Babes-Bolyai University, Romania<br />
IMPACTS AND CHANGES IN THE ACCOUNTING POLICIES AFTER<br />
THE IAS ADOPTION: A COMPARISON BETWEEN THE<br />
MANUFACTURING AND THE COMMERCIAL SECTOR IN GREECE<br />
Sotirios KARATZIMAS<br />
Stella ZOUNTA<br />
Vagia KYRIAKIDOU<br />
PS10 Performance management<br />
Chairperson: Petru STEFEA, West University of Timisoara, Romania<br />
VALUE AND PERFORMANCE IN A REGULATED ENVIRONMENT:<br />
THE CASE OF TELECOMMUNICATIONS IN ROMANIA<br />
Alina Carmen ALMASAN<br />
Corina GROSU<br />
QUO VADIS IN MEASURING BUSINESS PERFORMANCE? A<br />
PRACTICAL SOLUTION FOR THE IT SECTOR<br />
Claudia Elena SERBAN<br />
Oana-Adelina FLORICIOIU<br />
Radu-Daniel LOGHIN<br />
EFFECTIVE AND EFFICIENT TOOLS IN HUMAN RESSOURCES<br />
MANAGEMENT CONTROL<br />
Mihaela Adriana DUMITRANA<br />
Gabriel RADU<br />
Mariana Elena GLAVAN<br />
Gabriel JINGA<br />
FLEXIBILIZING THE TERMINATION OF THE EMPLOYMENT<br />
CONTRACT: PROS AND CONS<br />
Raluca DIMITRIU<br />
PS11 Management information systems II<br />
Chairperson: Iuliana IONESCU, Bucharest Academy of Economic Studies, Romania<br />
A CASE STUDY FOR START-UP COMPANIES IMPLEMENTING E-<br />
BUSINESS TECHNOLOGIES<br />
Carmen TIMOFTE<br />
ANALYZING E-COMMERCE PROTOCOLS<br />
Carmen TIMOFTE<br />
MODELING ON A SEMANTIC-BASED REPRESENTATION OF<br />
PEDAGOGICAL OBJECTS E-LEARNING-TYPE IN<br />
ORGANIZATIONAL MEMORY: CONNECTING ONTOLOGY WITH<br />
LOM META-DATA<br />
Iuliana IONESCU<br />
Vasile FLORESCU<br />
Bogdan IONESCU<br />
Ofelia Ema ALECA<br />
~ 6 ~<br />
416<br />
417<br />
431<br />
432<br />
444<br />
458<br />
466<br />
481<br />
482<br />
488<br />
496
SEMANTIC ANNOTATION AND ASSOCIATION OF WEB<br />
DOCUMENTS: A PROPOSAL FOR SEMANTIC MODELING IN THE<br />
CONTEXT OF E-RECRUITMENT IN THE IT FIELD<br />
Bogdan IONESCU<br />
Iuliana IONESCU<br />
Vasile FLORESCU<br />
Andrei TINCA<br />
DECISIONS DRIVE SUCCESS<br />
Dragos STOICA<br />
Pavel NASTASE<br />
PS12 Corporate governance and ethics<br />
Chairperson: Nicoleta FARCANE, West University of Timisoara, Romania<br />
CORPORATE VALUES, THE COMPANIES’ FRAMEWORK<br />
OF ETHICAL BEHAVIOUR<br />
Elena Roxana ANGHEL-ILCU<br />
HOW CAN CORPORATE GOVERNANCE MITIGATE FRAUD?<br />
Victoria STANCIU<br />
Ali EDEN<br />
Veronica IVANCENCO<br />
ETHICS AND RESPONSIBILITY IN IT<br />
Valerica MARES<br />
Marius Daniel MARES<br />
CORPORATE GOVERNANCE PRINCIPLES: AN EVOLUTIONARY<br />
APPROACH IN TERMS OF DIRECTORS-MANAGERS RELATIONSHIP,<br />
IN THE DEVELOPING ECONOMIC CONTEXT OF 21ST CENTURY<br />
Maria GROSU<br />
Roxana-Manuela DICU<br />
Daniela MARDIROS<br />
PS13 Issues in financial accounting<br />
Chairperson: Tudor GRECU, KPMG Romania<br />
IMPACT OF FUNDED STATUS OF PENSIONS ON BORROWING<br />
COSTS OF STATES<br />
Maria-Iuliana SANDU<br />
THE IMPACT OF UNREALISED FOREIGN EXCHANGE<br />
DIFFERENCES<br />
Georgiana TOADER<br />
Mihaela Adriana DUMITRANA<br />
VALUE RELEVANCE OF CONSOLIDATED VERSUS PARENT<br />
COMPANY FINANCIAL STATEMENTS<br />
Victor-Octavian MULLER<br />
THE ADVANTAGES VS. THE DISADVANTAGES OF OUTSOURCING<br />
THE ACCOUNTING AND FINANCIAL SERVICE<br />
Vasile-Daniel PAVALOAIA<br />
Ioan ANDONE<br />
~ 7 ~<br />
514<br />
532<br />
544<br />
545<br />
565<br />
580<br />
593<br />
612<br />
613<br />
619<br />
629<br />
650
PS14 Management information systems III<br />
Chairperson: Javier DE ANDRES, University of Oviedo, Spain<br />
AUDITING NEW INFORMATION TECHNOLOGY SOLUTIONS FOR<br />
ECONOMIC GROWTH<br />
Delia BABEANU<br />
Gabriel COZGAREA<br />
Adrian COZGAREA<br />
Ilie TAMAS<br />
Nicolae DAVIDESCU<br />
A TEST OF DIFFERENT MODELS FOR THE ESTIMATION OF THE<br />
LABOR COSTS OF SOFTWARE PROJECTS<br />
Javier de ANDRES<br />
Pedro LORCA<br />
IT COMPLEXITY AND COSTS<br />
Marius Daniel MARES<br />
Valerica MARES<br />
PS15 XBRL<br />
Chairperson: Sorin BRICIU, 1 Decembrie 1918 University, Alba Iulia, Romania<br />
THE EFFICIENCY OF SMALL AND MEDIUM ENTERPRISES BY<br />
THE IMPLEMENTATION OF WEB-BASED ACCOUNTING<br />
Sorin BRICIU<br />
Florin MIHAI<br />
Constantin GROZA<br />
13 YEARS AFTER: AN XBRL LITERATURE REVIEW AND<br />
OVERVIEW<br />
Claudia URDARI<br />
Adriana TIRON TUDOR<br />
THE INFLUENCE OF FIRM-SPECIFIC CHARACTERISTICS ON THE<br />
EXTENT OF VOLUNTARY DISCLOSURE IN XBRL: AN EMPIRICAL<br />
ANALYSIS OF SEC FILINGS<br />
Devrimi KAYA<br />
PS16 SMEs<br />
Chairperson: Jiri STROUHAL, University of Economics Prague, Czech Republic<br />
OBLIGATION OR OPPORTUNITY FOR DRAWING THE CASH-FLOW<br />
STATEMENT. THE CASE OF ROMANIAN SMALL AND MEDIUM<br />
ENTERPRISES<br />
Adina POPA<br />
Rodica BLIDISEL<br />
Nicoleta FARCANE<br />
Dan STIRBU<br />
ROMANIAN PROFESSIONAL ACCOUNTANTS’ PERCEPTION<br />
ON THE DIFFERENTIAL FINANCIAL REPORTING FOR SMALL<br />
AND MEDIUM-SIZED ENTERPRISES<br />
Stefan BUNEA<br />
Marian SACARIN<br />
Mihaela MINU<br />
~ 8 ~<br />
659<br />
660<br />
679<br />
694<br />
702<br />
703<br />
720<br />
732<br />
758<br />
759<br />
770
ACCOUNTING PRINCIPLES AND BOOK-TAX (DIS)CONNECTION<br />
IN ROMANIA<br />
Costel ISTRATE<br />
PS17 Financial analysis II<br />
Chairperson: Sotirios KARATZIMAS, University of Aegean, Greece<br />
FUNDAMENTAL DETERMINANTS OF CAPITAL STRUCTURE<br />
CHOICE: A SURVEY OF ROMANIAN COMPANIES<br />
Marilen PIRTEA<br />
Cristina NICOLESCU<br />
Claudiu BOTOC<br />
IMPACT OF LONG-TERM INVESTMENT DECISIONS ON<br />
PROFITABILITY AND COMPETITIVE ADVANTAGE IN BUSINESS.<br />
CASE STUDY IN THE MINING INDUSTRY IN ROMANIA<br />
Claudia Elena SERBAN<br />
Oana-Adelina FLORICIOIU<br />
Radu-Daniel LOGHIN<br />
INCLUDING BEHAVIOURAL ELEMENTS IN ASSET ALLOCATION<br />
PROCESS<br />
Aurora MURGEA<br />
PS18 Education<br />
Chairperson: Alain BURLAUD, INTEC Paris, France<br />
ACCOUNTING STUDENTS’ ACADEMIC PERFORMANCE: A BATTLE<br />
BETWEEN PERCEPTIONS? A ROMANIAN RESEARCH NOTE<br />
Carmen Giorgiana BONACI<br />
Razvan V. MUSTATA<br />
Alexandra MUTIU<br />
Dumitru MATIS<br />
PERCEPTION OF THE ROMANIAN ACCOUNTANTS REGARDING<br />
THE FINANCIAL ACCOUNTING EDUCATION<br />
Paul DIACONU<br />
Vasile GORGAN<br />
Catalina GORGAN<br />
Nicoleta COMAN<br />
Codrina SANDRU<br />
MANAGEMENT VIEW RELATED TO HIGHER EDUCATION –<br />
AN ANALYSIS OF THE ROMANIAN BUSINESS PERCEPTIONS<br />
Mihaela STET<br />
Alexandra ROSU<br />
SOCIAL NETWORKING IMPACT ON EDUCATIONAL PROCESSES<br />
IN ROMANIA<br />
Florin MIHAI<br />
Andrei STANCIU<br />
Ofelia Ema ALECA<br />
~ 9 ~<br />
787<br />
804<br />
805<br />
821<br />
833<br />
860<br />
861<br />
880<br />
892<br />
900
THE BEGINNINGS OF TRANSYLVANIAN CLUJ ACCOUNTING<br />
SCHOOL<br />
Teodora Viorica FARCAS<br />
Adriana TIRON TUDOR<br />
PS19 Financial markets<br />
Chairperson: Andrei FILIP, ESSEC Paris, France<br />
FINANCIAL MARKET EFFICIENCY AND PERSPECTIVES<br />
ON IFRS ADOPTION. CASE STUDY FOR THE UNITED KINGDOM,<br />
THE UNITED STATES OF AMERICA AND JAPAN<br />
Stefana DIMA (CRISTEA)<br />
Bogdan DIMA<br />
Otilia ŞĂRĂMĂT<br />
PROPERTIES OF ANALYSTS’ FORECASTS FOR ROMANIAN LISTED<br />
COMPANIES: HOW MUCH DO FIRM-SPECIFIC FACTORS MATTER?<br />
Mihaela IONASCU<br />
NET INCOME VERSUS COMPREHENSIVE INCOME FOR<br />
PROFESSIONAL INVESTORS<br />
Iulia JIANU<br />
Ionel JIANU<br />
Ionela GUSATU<br />
PS20 Environmental accounting<br />
Chairperson: Massimo POLLIFRONI, University of Turin, Italy<br />
EXPLORATORY STUDY ON SOCIAL AND ENVIRONMENTAL<br />
REPORTING OF EUROPEAN COMPANIES IN CRISES PERIOD<br />
Camelia Iuliana LUNGU<br />
Chirata CARAIANI<br />
Cornelia DASCALU<br />
Raluca Gina GUŞE<br />
A COMPLEX APPROACH TO CLIMATE CHANGE EXTERNALITIES<br />
Florian COLCEAG<br />
Cornelia DASCALU<br />
Chirata CARAIANI<br />
Camelia Iuliana LUNGU<br />
Raluca Gina GUŞE<br />
DIFFERENCES REGARDING ENVIRONMENTAL REPORTING:<br />
THE CASE OF ROMANIAN ORGANIZATIONS<br />
Ionel-Alin IENCIU<br />
ENVIRONMENTAL SUSTAINABILITY AND SOCIAL<br />
RESPONSIBILITY: A THEORETICAL PROPOSAL<br />
FOR AN ACCOUNTING EVALUATION<br />
Massimo POLLIFRONI<br />
THE IMPACT OF THE SUSTAINABLE DEVELOPMENT<br />
ON THE FINANCIAL STATE OF THE COMPANY – SECTOR STUDY<br />
Petru STEFEA<br />
Cristina CIRCA<br />
~ 10 ~<br />
916<br />
939<br />
940<br />
959<br />
966<br />
988<br />
989<br />
1006<br />
1024<br />
1042<br />
1061
EMPIRICAL STUDY REGARDING KEY INDICATORS<br />
CORRELATIONS FOR SUSTAINABLE PERFORMANCE BUDGETING<br />
Violeta CIMPOERU<br />
Maria RADU<br />
Valentin CIMPOERU<br />
PS21 Management information systems IV<br />
Chairperson: Felicia ALBESCU, Bucharest Academy of Economic Studies, Romania<br />
MANAGEMENT INFORMATION SYSTEMS –<br />
AN APPROACH INSIDE AND OUTSIDE THE ORGANIZATIONAL<br />
Georgiana Andreea CIOANĂ<br />
Ilinca HOTARAN<br />
BEYOND REPORTING IN BUSINESS INTELLIGENCE:<br />
INTELLIGENCE THROUGH ANALYTICS<br />
Irina Bogdana PUGNA<br />
Felicia ALBESCU<br />
Robert SOVA<br />
PS22 Management accounting<br />
Chairperson: Mathew TSAMENYI, University of Birmingham, UK<br />
SURVEY OF THE PRODUCT COSTING METHODS USED<br />
IN CZECH REPUBLIC<br />
Boris POPESKO<br />
Petr NOVAK<br />
THE ROLE OF COSTS AND CONTROL IN ENSURING A<br />
SUCCESSFUL MANAGEMENT IN THE DECISIONAL PROCESS<br />
Stefania-Eliza BANA (PANCIU)<br />
Florinel Marian SGARDEA<br />
THE CHANGE IN MANAGEMENT ACCOUNTING IN ROMANIA<br />
Madalina DUMITRU<br />
Daniela CALU<br />
Gorgan CATALINA<br />
Adriana CALU<br />
Georgiana TOADER<br />
~ 11 ~<br />
1075<br />
1089<br />
1090<br />
1110<br />
1125<br />
1126<br />
1135<br />
1149
Accounting and Management Information Systems (AMIS)<br />
International Conference<br />
The AMIS International Conference organized by the Faculty of Accounting and<br />
Management Information Systems of the Bucharest Academy of Economic Studies,<br />
Romania, has already become an established milestone within the Romanian<br />
accounting research environment. As such, it has already reached its 6 th edition since<br />
its inception in 2006. All submissions/reviewing processes are handled on-line, with a<br />
high-quality double-blind review process ensured by esteemed national and<br />
international reviewers. For this year’s edition, we have attracted 155 participants<br />
from various parts of the world (including Europe, USA, Asia and Australia), thus<br />
ensuring good geographical coverage. Only full papers in English are to be submitted<br />
for the conference, in various domains such as: financial reporting, managerial<br />
accounting, auditing, financial analysis, management information systems, and<br />
business law. The criteria considered in the review process are: the technical<br />
correctness, the novelty and originality, the importance to the field, the organization<br />
and the clarity of the paper, the relevance of references, and the quality of results. For<br />
each criterion a mark is awarded, and a weighted average is then produced<br />
electronically. Comments from the reviewers are also mandatory and are available in<br />
the on-line system to authors, who can then incorporate them in the revisions of their<br />
work. All editions have websites that can be accessed via www.amis.ase.ro/.<br />
We have continued to obtain for this year’s edition of the conference the participation<br />
of many international scholars. These are:<br />
� Professor Mary BARTH, Stanford University, United States of America, the<br />
conference keynote speaker;<br />
� Professor David ALEXANDER of the University of Birmingham, United<br />
Kingdom;<br />
� Professor Alain BURLAUD, Director of INTEC/CNAM of Paris, France;<br />
� Professor David CAIRNS – London School of Economics, the United Kingdom;<br />
� Assistant Professor Andrei FILIP – ESSEC (Ecole Superieure des Sciences<br />
Economiques et Commerciales) Business School, Paris;<br />
� Professor Donna STREET, University of Dayton, United States of America;<br />
� Professor Mathew TSAMENYI – University of Birmingham, United Kingdom;<br />
� Assistant Professor Florin VASVARI – London Business School, United Kingdom.<br />
Their participation is extremely encouraging and beneficial to our delegates. They<br />
have offered extensive feedback and have ensured a good conference experience to<br />
conference participants.<br />
This year’s keynote speaker is Dr. Mary Barth, the Joan E. Horngren Professor of<br />
Accounting at the Stanford University, Graduate School of Business (GSB). Prof.<br />
Barth was a member of the International Accounting Standards Board (IASB) from its<br />
inception in 2001. Currently, she serves as the Academic Advisor to the IASB.<br />
Professor Barth’s research is published in a variety of journals and has won several<br />
awards, including the American Accounting Association’s (AAA) Competitive<br />
Manuscript Award and, on two occasions each, the AAA Wildman Medal Award and<br />
the Best Paper Award of the Financial Accounting and Reporting Section of the AAA.
She is the Accounting Department Editor of Management Science, has been an<br />
Associate Editor of The Accounting Review, and is on the Editorial Boards of several<br />
other academic journals. Professor Barth is a recipient of the GSB’s MBA<br />
Distinguished Teaching Award and PhD Faculty Distinguished Service Award, and<br />
served as a Senior Associate Dean for Academic Affairs at the GSB from 2002 until<br />
2009. Professor Barth is a Vice President of the International Association for<br />
Accounting Education and Research and is active in the AAA, having served as Vice<br />
President and as Chair of several committees. Professor Barth’s research focuses on<br />
financial accounting and reporting issues, particularly topics of interest to accounting<br />
standard setters. Such topics include using fair values in financial reporting, stockbased<br />
compensation, recognition versus disclosure, asset securitizations, asset<br />
revaluations, the information roles of accruals and cash flows, the relation between<br />
financial statement quality and cost of capital, and issues related to global financial<br />
reporting and convergence.<br />
All the other international guests have extensive experience and have published in top<br />
journals in a variety of fields related to accounting. Prof. Donna Street, Prof.<br />
David Alexander and Assist. Prof. Andrei Filip published their work in the field of<br />
financial reporting with a focus on International Financial Reporting Standards, Prof.<br />
Alain Burlaud and Prof. Mathew Tsamenyi are especially focused on managerial<br />
accounting, while Prof. David Cairns is additionally interested in the field of auditing.<br />
It already became customary for our conference to introduce new events every<br />
edition. In this respect, we are proud to host in conjunction with this year’s edition:<br />
� a Joint IAAER - IFRS Foundation IFRS Framework-Based Teaching Workshop,<br />
in which three teams of authors guided the audience through the designing of<br />
Framework-based IFRS teaching cases;<br />
� an ACCA IAAER Seed Grant Program for Early Career Researchers<br />
Deliverable, that continues and extends on the last year’s IAAER-ACCA-KPMG<br />
Early career researcher consortium. Five teams of authors who received funding<br />
from the ACCA and mentorship from internationally recognized mentors<br />
reported now on the development of their research;<br />
� an Academic Performance and Evaluation Panel, during which panelists<br />
discussed various aspects related to evaluation the work of academics, in an<br />
internationalized and competitive context.<br />
The next year’s edition is scheduled to take place on June 13-14 2012. We are<br />
committed to continue to play an increased role in advancing accounting research in<br />
Central and Eastern Europe, and we will continue to collaborate in this respect with<br />
the International Association for Accounting Education and Research (IAAER),<br />
whose Director of Research and Educational Activities, Dr. Donna Street, is a<br />
constant presence at and support to our events. Our collaboration has continued on the<br />
same fruitful grounds with the Association of Chartered Certified Accountants<br />
(ACCA) and KPMG Romania. All these organizations are dedicated to the<br />
development of accounting research and practice worldwide, and are committed to<br />
strengthen the collaboration with our institution for the years to come. I am convinced<br />
that our partnership will be one of many satisfactions.<br />
~ 13 ~<br />
Prof. univ. dr. Pavel NASTASE<br />
Conference Chair
PS1 Auditing<br />
Chairperson:<br />
David PROCHAZKA, University of Economics, Prague, Czech<br />
Republic<br />
AUDIT COMMITTEES AS INCREASING VECTORS OF<br />
FINANCIAL INFORMATION QUALITY<br />
Neluta MITEA<br />
THE FINANCIAL AUDITOR’S RISK BEHAVIOUR –<br />
THE INFLUENCE OF AGE ON RISK BEHAVIOUR IN A<br />
FINANCIAL AUDIT CONTEXT<br />
Iancu Octavian IONESCU<br />
Eugeniu TURLEA<br />
THE INVESTIGATION OF ROMANIAN AUDITORS'<br />
PERCEPTIONS OVER THE INTERNAL AUDIT<br />
PRACTICES - AN ATTEMPT TO IDENTIFY THE BEST<br />
PRACTICES IN THE CONTEXT OF CORPORATE<br />
GOVERNANCE<br />
Cristina BOTA-AVRAM
AUDIT COMMITTEES AS INCREASING VECTORS<br />
OF FINANCIAL INFORMATION QUALITY<br />
Neluta MITEA 1<br />
Andrei Şaguna University in Constanţa, Romania<br />
ABSTRACT<br />
Capital markets feel a current need to dispose of high quality information. As a response to<br />
this need, this paper proposes the intervention of audit committees whose main objective<br />
consists in monitoring the financial activity. The present study offers interesting insights by<br />
examining the relevant ideas developed previously in the literature with the scope of<br />
understanding, reinterpreting and rediscovering from interesting points of view the audit<br />
committee’s major role in increasing the quality of financial information. Audit committee<br />
represents one of the mechanisms controlling managers’ opportunistic behavior, under the<br />
circumstances of agency theory and information asymmetry. By conducting this study I<br />
wanted to reinforce the role of specialized literature and of empirical researches in<br />
determining new solutions and hypothesis regarding audit committee effectiveness.<br />
KEYWORDS: audit committee, audit committee effectiveness, agency theory, information<br />
asymmetry, financial information<br />
INTRODUCTION<br />
In the last years we have been witnessing a significant increase of general interest in<br />
corporate governance. The reason for this interest lies on the economic environment’s<br />
concern regarding the multitude and the deep consequences of the financial scandals<br />
that started, in general, from the accounting and financial frauds. Notable<br />
bankruptcies are also a consequence of the lack of integrity characterizing the<br />
accounting professionals and companies’ management. It is well known that, under<br />
managers or shareholders’ pressures, they used to practice a creative accounting and<br />
also fraudulent financial reporting. Their purpose was to manipulate stock prices for<br />
listed companies. Therefore, at present, we could all notice a strong concern in the<br />
economic environment for the way by witch managers are controlled and supervised<br />
in their actions and decisions taken. In this respect, the audit committees’ role<br />
becomes essential for the right functioning of financial reporting process. Although<br />
the responsibility for annual financial statements comes to the management of the<br />
organization, a major role in securing the financial information users of statements’<br />
reality comes to auditors.<br />
Financial scandals generated a number of deep debates at national and international<br />
levels, on themes like: the importance of corporate governance, the structure of<br />
supervising committees, the relations between audit committees and the participants<br />
to financial reporting process. However, the financial information crisis tends to<br />
1<br />
Correspondence address: Neluţa MITEA, “Andrei Şaguna” University in Constanţa, Romania; email:<br />
nelutamitea@yahoo.com<br />
~ 15 ~
discredit the audit function whose role consists in monitoring the quality of published<br />
financial statements. In this context characterized by the loss of financial information<br />
credibility, we are witnessing a significant effort aiming to redefine the internal<br />
governance bodies, by introducing audit committees in the bosom of companies’<br />
boards. The genesis of audit committees suggests that their inclusion in the structure<br />
of corporate governance should be understood as part of the reaction to corporate<br />
abuses occurring over the last three decades. The audit committee was an attempt to<br />
specifically designate responsibility for accounting-related matters, to provide a<br />
reporting structure for insiders that would circumvent managerial retribution and to<br />
supervise relations with the external auditors. Comprehensive regulatory changes<br />
brought on by recent corporate governance reforms have broadly redefined and reemphasized<br />
the roles and responsibilities of all participants to the financial reporting<br />
process. Therefore, the international academic environment is nowadays preoccupied<br />
by the concept of audit committee, because it is used to affirm that the quality of<br />
financial reporting depends on the characteristics of audit committees. This committee<br />
has as objectives, the increase of financial statements’ credibility, and the assistance<br />
of enterprises’ boards in the exercise of their actions and diligences, but also the<br />
protection of internal and external auditors’ independence from managers’ pressures.<br />
The present paper proposes an analysis framework concerning audit committee’s<br />
contributions, in terms of audit quality and financial information quality too. On the<br />
other hand, this study intends to inform the accounting professionals about the present<br />
existent perception concerning the role of audit missions. I also studied the audit<br />
committee’s tasks and its imperative characteristics (independence, expertise and<br />
competence, financial experience, involvement degree). All these factors do influence<br />
the reduction of failures in audit work. The different criteria enounced form altogether<br />
the measures for audit committee effectiveness. By having appeal to the empirical<br />
research studies, I arrived to assess the main action levers of audit committee. An<br />
independent audit committee offers the premise to get reliable accounting information<br />
and also relevant and pertinent financial statements. The originality of this paper<br />
consists in evaluating the circumstances under which the audit committee might<br />
improve the quality of financial information. The orientation of this approach<br />
supposes a confrontation of economic theories, namely the agency theory and the<br />
information asymmetry. In the conditions of agency relations, the audit committee is<br />
supposed to act effectively.<br />
In theory, this study continues the research directions of authors like Knapp (1991),<br />
Pigé (2003), Chemangui (2004), Manita (2008) and also those of Turley and Zaman<br />
(2007) and others. However, the originality of this paper consists in studying the audit<br />
committee by conducting the research demarche towards the audit process analyzes.<br />
Turley and Zaman (2007) addressed audit committees especially by the perspective of<br />
agency relations. The purpose of Turley and Zaman’s researches focused on the<br />
identification of conditions and processes affecting the audit committees’ potential<br />
effectiveness. The results of the researches highlight the importance of informal<br />
processes around the audit committees and also the impact of this committee on<br />
corporate governance. The informal connections between the members of audit<br />
committees and management, could serve at the maximization of audit committee<br />
effectiveness. These qualitative researches do not foresee a generalization of the<br />
results, but they support us to perceive exactly the factors influencing the<br />
effectiveness or the lack of effectiveness concerning audit committees. For this goal, I<br />
~ 16 ~
took into account the essential role of audit committee manifested by the virtue of its<br />
privileged access to the accounting and financial information and of its central place<br />
in the companies’ control and supervising process.<br />
RESEARCH METHODOLOGY<br />
From an operational viewpoint, I was interested in choosing an adequate research<br />
method which could have helped me in tracing potential solutions aiming to improve<br />
financial information credibility, by the means of audit committees. Because of the<br />
fact that this paper does not represent an empirical study, but a fundamental research<br />
item, I proceeded to a history of literature addressing the subject of audit committees<br />
and of financial information quality in order to draw conclusions highlighting the<br />
research results. Especially the results of this study could participate at the<br />
identification of future research perspectives. First of all, I identified the theme chosen<br />
in the specialized literature. As a consequence, I used as research methodology, the<br />
inductive research which supports the main idea concerning the generalization of<br />
conclusions as a result of the literature analysis. The summary of scientific documents<br />
was realized by having consulted specialized magazines, other sources of<br />
documentation and also an important number of items and research studies. On the<br />
basis of this synthesis, I proved the capacity of the audit committee to increase the<br />
integrity of internal and external audit functions and, in the same time, I analyzed the<br />
relations between the audit committee and its attributes concerning the quality of<br />
financial information. At the end of this study, I proceeded to draw some conclusions<br />
in order to highlight the contribution of the present paper to a better understanding of<br />
the audit committee’s role according to its own limits.<br />
1. AUDIT COMMITTEE – AN INCREASING VECTOR OF FINANCIAL<br />
INFORMATION QUALITY<br />
Recent financial scandals have disrupted both the concept and techniques for<br />
measuring the audit quality. These scandals have led international professionals and<br />
also the academic environment to redefine regulations and assessing mechanisms<br />
concerning audit quality. Therefore, in the middle of professionals’ preoccupations,<br />
there is audit committee, because it is considered that its characteristics do influence<br />
the quality of financial statements. The scandals dating from the early 2000s sowed<br />
doubts connected to the effectiveness of those committees. Famous cases with strong<br />
impact on the credibility of financial information transmitted to investors, in addition<br />
to Enron case, are also those of dot-com series and Credit Lyonnais (2001), Toshihide<br />
Iguchi and Daiwa Bank (1995), Hollinger International Inc. (2004), Flaming Ferraris<br />
(1999), Parmalat (2003), World Com (2001). Among the main causes of financial<br />
scandals there are the information asymmetry and the opportunistic behavior of the<br />
agents. Studying the causes and effects of these failures in question, specialists arrived<br />
to propose possible solutions to agency problems, including audit monitoring and<br />
performances measurement. As regards monitoring activity, the problems which are<br />
held to be taken into account, concern internal and external bodies involved and their<br />
independence (especially for financial audit). For the measurement of performances,<br />
the latter depends on information entered and on instruments used.<br />
As a result of financial scandals, the Sarbanes-Oxley Act arises in the U.S.A (2002,<br />
SOX). Its purpose consists in establishing improved standards for all American public<br />
~ 17 ~
companies (including non-American companies that are listed on U.S. stock market),<br />
for their management and for public accounting firms. The law covers such issues as<br />
auditor independence, corporate governance, internal control and the improved<br />
disclosure of financial statements. There are similar regulations in other countries<br />
such as: the so-called J-SOX in Japan, CLERP9 in Australia, LSF (La Loi de Sécurité<br />
Financière) in France, Bill 198 in Canada. This concept occurs more often in Romania<br />
too, because of the multinationals. With the Sarbanes-Oxley Act, audit committee<br />
became the legal body responsible for monitoring and control (Prat dit Hauret &<br />
Komarev, 2005). The audit committee’s responsibilities consist in supervising<br />
financial reporting issued by the entities, monitoring the relations with internal and<br />
external auditors, supervising policies and practices of detecting and preventing<br />
financial errors and frauds, respecting business ethics. In Europe, by the means of the<br />
8 th Directive revised by the European Parliament, listed companies are required to<br />
establish audit committees starting from July 2008. Romania feels also the necessity<br />
to strengthen the role of audit committee in supervising risks management and in<br />
improving the communication with entities’ management. Nowadays Romania is in<br />
line with international practices in risk management and corporate governance by the<br />
means of an entire series of legislative acts. Thus, according to Ordinance no 90/2008,<br />
entities of public interest are required to monitor the effectiveness of the internal<br />
control system; this monitoring activity will be included in the audit committee’s<br />
tasks.<br />
According to the International Standard on Auditing no 260 (ISA 260),<br />
“Communication of audit matters to those charged with governance”, the auditor<br />
should communicate audit issues of governance interest, issues arising from the audit<br />
of financial statements. In the respect of this ISA, the term of governance will be used<br />
for describing the role of persons in charge with supervising, control and management<br />
of an organization. Those charged with governance should be sure that the entity is<br />
able to achieve its objectives regarding the reliability of financial reporting, the<br />
effectiveness and the efficiency of operations, the compliance with the applicable law.<br />
The auditor must prove professional reasoning in order to communicate audit matters<br />
of governance interest, considering the structure of every entity, the circumstances of<br />
audit engagement and any relevant legal issue. Audit committee’s members are<br />
supposed to know the best practices for this vital function of the organizations.<br />
The objective of this paper is not only to achieve a synthesis of international empirical<br />
researches studies that approached the subject of audit committees. The present study<br />
intends to fix the conditions under which audit committee could improve the quality<br />
of the financial information. In this regard, I considered as dominant current, positive<br />
inspiring and interpreting works. Positive studies are based, in general, on the<br />
qualitative analysis of information about the subject matter, information from archives<br />
and databases. The goal of the positive studies consists in identifying statistical<br />
regularities between the audit committee’s characteristics, on the one hand, and the<br />
quality of audit process and of financial information, on the other hand. There are<br />
authors who dedicated their studies to the functioning of audit committees. Therefore,<br />
we could appreciate that audit committee’s activity should be regarded in function of<br />
its effectiveness and performance and, that is why, an important role in such a context,<br />
comes to the questioning process adopted by the audit practitioners (Spira, 2003).<br />
Other authors have tried to identify the factors influencing the “potential”<br />
effectiveness of audit committees. The members of audit committee must demonstrate<br />
~ 18 ~
independence, competence, professional and moral tenure. In spite of some<br />
shortcomings, the informal links between audit committee’s members and<br />
management could serve to the effectiveness maximization. Therefore, audit<br />
committee might be seen as a valuable tool interfering in governance (Magrane &<br />
Malthus, 2010). There are certain complementarities between the independence and<br />
the competence of audit committee’s members: independence is viewed according to<br />
audit committee’s involvement in taking decisions, while competence is foreseen in<br />
the committee’s obligation to review tasks and activities connected to internal audit<br />
(Goodwin, 2003). Following the systemic vision of the authors discussed above, we<br />
could notice that the role of audit committees consists in coordinating the obligations<br />
of internal and external auditors in order not to affect the integrity of audit process,<br />
but to increase its usefulness. The introduction of the Sarbanes-Oxley Act was an<br />
occasion to oblige responsible bodies to announce the internal control errors and<br />
weaknesses. Therefore, entities that have published the cases connected to the<br />
weaknesses of the internal control have formed the basis for numerous research<br />
studies. Starting from them, we could conclude that there is a possible link between<br />
the internal control weaknesses and the audit committee effectiveness. Studies that<br />
followed the introduction of SOX consider the audit committee as a preventive factor<br />
for internal control weaknesses. There are some studies confirming those results<br />
(Zhang et al., 2007). Audit committee’s size and its competences are the factors<br />
influencing the rapid and effective correction of internal control weaknesses (Goh,<br />
2009). In the meantime, auditors’ professional reasoning is proportional to their<br />
expertise (DeZoort, 1998). This author assumes that the members of audit committees<br />
proving experience in auditing and internal control, are able to make judgments closer<br />
to those coming from the external auditors, the latter being considered the truest<br />
specialists in the field. Moreover, less experienced individuals, might make difficult a<br />
rigorous control. In a more recent study, the researchers highlight that audit<br />
committees’ members are mainly based on intuition in the process concerning the<br />
establishment of professional reasoning and that the key element of committee’s<br />
effectiveness consists in members’ ability to put challenging questions (Gendron et<br />
al., 2004). The research models I’ve studied prove that financial and extra-financial<br />
expertise of audit committees’ members does represent the key factor of this body<br />
effectiveness, the internal control quality depending on this factor. In this respect, the<br />
members of audit committees are required to orient internal audit efforts towards the<br />
detection of financial errors and weaknesses.<br />
There are research studies indicating the positive effects of the Sarbanes-Oxley Act on<br />
the financial reporting process, on capital cost and on company’s value (Bedard,<br />
2006; Ashbough-Skaife et al. 2007; Cohen et al. 2008). The authors examine the SOX<br />
impact by having appeal to a comparison between external auditors’ current<br />
experiences and their interactions with the various mechanisms of corporate<br />
governance (board, audit committee etc.). As well as the auditors’ experience, that of<br />
management reveals the fact that the compliance to legislative acts has a positive<br />
impact on the relation between audit committee and external auditors and also<br />
between audit committee and company’s board. Cohen et al. (2008) notice that, in<br />
general, audit committee does not participate directly to the resolution of conflicts<br />
between auditors and management, preferring to be just informed about the eventual<br />
misunderstandings that could appear. In case of a conflict, audit committee becomes a<br />
true relay of spontaneous information for internal audit responsible (Turley & Zaman,<br />
2007). The improvement of internal costs effectiveness resulting from SOX adoption,<br />
~ 19 ~
contributes to the decrease of information risk as well as to that of capital (Ashbaugh-<br />
Skaife et al, 2007). Concerning the relation between audit committee and external<br />
auditors, research studies show us that this relation is more formalized. This aspect<br />
starts from the premise that external auditor represents the main actor of certification<br />
process. Therefore, the quality of the audit mission depends on the external auditor’s<br />
independence. The Sarbanes-Oxley Act limits a parallel consultancy activity<br />
conducted by external auditors within the same organization. Audit committee will<br />
intervene in the conflict arising between external auditor and management, protecting<br />
auditor’s independence. When audit committee’s members prove serious auditing<br />
knowledge and a strong economic formation, they tend to sustain external auditors<br />
(DeZoort, 1998). On the other hand, when the audit committees’ members were<br />
managers of companies in the past, is much easier for them to fraternize with the<br />
audited entity’s management (DeZoort, 1998). Globally, studies point out that audit<br />
committee’s members are increasingly tempted to defend external auditors’ opinion<br />
when we observe an increase of their competences in auditing but also a manifestation<br />
of their independence. Therefore, this paper highlights the idea that audit committee<br />
must have a financial expert as member who possesses either professional<br />
qualification or experience in preparing, auditing, analyzing or evaluating financial<br />
statements but also it should have an understanding of audit committee functions.<br />
Audit committee’s members should make every effort to promote the audit quality, by<br />
imposing specific conditions to external auditors aiming to cover risk areas. In the<br />
meantime, audit committee should optimize external control program. According to<br />
SOX, audit committee is responsible for external auditor remuneration. Therefore, the<br />
committee is held to prove its effectiveness, by establishing an agreed price justifying<br />
the work and also the results. From research studies, we could notice that in the<br />
U.S.A. there are accentuate complementarities between audit committee’s<br />
independence and external audit expenditures. The presence of an audit committee<br />
increases fees corresponding to the global audit effort and reduces the fee to be paid<br />
for the complexity of the mission (Collier & Gregory, 1996).<br />
As a conclusion for this first part of the paper, I sustain that audit process is a complex<br />
one and that audit committee has a vital role for determining the quality of audit<br />
mission and of financial information. An audit committee could be defined as subcommittee<br />
in the governing body that will make arrangement for internal audit and<br />
facilitate the completion of external audit. Audit committees try to enhance the ability<br />
of the board to fulfill its legal responsibilities and ensure the credibility and<br />
objectivity of the financial reporting. The quality of audit process depends largely on<br />
auditor’s quality (independence, competence, expertise and ethics), but also on the<br />
organization of this process. Audit committee’s members seem to break down audit<br />
process considering established procedures and proposed accounting adjustments.<br />
However, a particular attention should be paid to the relationship between audit<br />
committee and external and internal auditors. Audit committee’s expertise in auditing<br />
and economics could influence the quality of audit mission and also the quality of<br />
financial information.<br />
2. AUDIT COMMITTEE FACE TO FRAUDULENT FINANCIAL<br />
STATEMENTS<br />
The emergence of a financial accounting is historically connected to the development<br />
of corporations inducing the need to communicate financial information towards<br />
~ 20 ~
shareholders as companies’ owners and also towards other interested parties. In<br />
literature there are a number of studies that place financial information in its real<br />
context, marked by constraints and imperfections. Seen as a typical information<br />
system, accounting differs from other information systems on three levels: “by the<br />
specificity of the principles supporting the profession; by the specificity of processed<br />
data and by the specificity of processing methods” (Grenier, 2000: 1122). Therefore,<br />
Grenier and Bonnebouche are the promoters of a scheme including accounting<br />
principles in the representation process. “These principles interpose between the<br />
reality to be represented and the observer (at the level of observation principles –<br />
prudence, quantification), between the reality and the information’s user (at the level<br />
of principles concerning representation’s construction), or between the user and the<br />
observer (at the level of deontological principles – sincerity, regularity)” (Grenier,<br />
2000: 1123). Listed companies from modern economy surpass the legal reporting<br />
duties and develop a true “financial communication strategy” (Guimard, 1997: 342).<br />
Fraudulent financial statements represent a threat for users’ trust. Those statements<br />
have captured the attention of business community, accounting professionals,<br />
academic environment and also of regulators. At present, we could notice the<br />
necessity to prevent financial frauds and to detect those strategies able to keep away<br />
this type of incidents. Fraud risk could be reduced by combining detection and<br />
prevention measures. Michael R. Young (2003) who has spent almost twenty years<br />
defending accounting firms accused of fraud recognizes that the introduction of the<br />
Sarbanes-Oxley Act could be useful. Experience proves us that violation of laws and<br />
regulations is, in general, the result of deficiencies within corporate governance and<br />
internal control. Independence and financial sophistication of members are regarded<br />
as challenges for audit committees. Therefore, in order to get a future success, audit<br />
committees should ensure that the organization has determined initially a viable audit<br />
function.<br />
However, audit committees’ presence in the bosom of companies aims to prevent the<br />
production and transmission of fraudulent financial statements. Audit committee is<br />
held to make sure that financial statements are not the result of accounting errors or<br />
frauds. Some authors have studied the usefulness of an audit committee in preventing<br />
frauds. Audit committee could play a significant role in preventing, detecting and<br />
investigating frauds. As long as we are talking about prevention, the main aspect for<br />
audit committees in preventing frauds consists in observing management and external<br />
auditors’ expectations. In addition, it is necessary for an audit committee to manifest<br />
zero tolerance when it detects errors; audit committee should take seriously into<br />
account any attempt to defraud, to investigate it subsequently and to act accordingly<br />
to the importance of the event.<br />
Two empirical studies validate the audit committee usefulness (McMullen, 1996;<br />
Uzun et al., 2004) and other two deny this usefulness (Beasley, 1996; Carcello &<br />
Nagy, 2004). McMullen (1996) detects a significant negative relation between the<br />
presence of an audit committee and fraud. The lack of reliability regarding financial<br />
information has less severe consequences. However, not the same thing occurs when<br />
correcting accounting results. Firms with audit committees are associated with fewer<br />
shareholder lawsuits alleging fraud, fewer quarterly earnings restatements, fewer SEC<br />
(Security Exchange Commission) enforcement actions, fewer illegal acts and fewer<br />
instances of auditor turnover when there is an auditor-client accounting disagreement<br />
(McMullen, 1996). Research studies follow various types of measures when they<br />
~ 21 ~
address audit committee independence. Uzun et al. (2004) discuss about frauds, while<br />
other authors are preoccupied with the measure of correcting the results (Agrawal &<br />
Chadha, 2005). However, no less important are the contributions of entirely<br />
independent audit committees regarded as a factor of fraud prevention (Abbott et al.,<br />
2000). They show that companies getting audit committees composed of independent<br />
directors are less sanctioned for fraudulent reporting. Audit committee’s<br />
independence affects both companies’ management earnings and investors’<br />
perceptions. A good audit committee would affect shareholders’ perception<br />
concerning auditors, especially in those circumstances in which shareholders might<br />
experience a greater threat to auditors’ independence (Raghunandan & Rama, 2003).<br />
Audit committees are held to select auditors. If the reputation of audit committee’s<br />
members depended on the quality of audit mission results, surely audit committees<br />
would be interested in selecting the best auditors. An auditor could be appreciated<br />
according to his capacity to detect and to report errors and omissions in financial<br />
statements (Chersan, 2009). There are other research studies demonstrating that audit<br />
committee’s discipline is strongly linked to the organization of internal governance.<br />
An entirely independent audit committee will allow the prevention of accounting<br />
irregularities, unless the CEO is not involved in selecting board members (Carcello &<br />
Nagy, 2004). Further studies present less extreme consequences. The presence of a<br />
financial expert in audit committee might reduce the likelihood of correcting the<br />
accounting results (Abbott et al., 2004; Agrawal & Chadha, 2005). Herdman (2002),<br />
chief accountant of SEC (Securities and Exchange Commission) highlighted the<br />
importance of audit committees in post-SOX era sustaining that the role of audit<br />
committee is one essential for enduring the integrity of published financial statements<br />
on which investors are based. At a different level, Sheela Thiruvadi (2008) examined<br />
the impact of gender differences on audit committee’s characteristics. The authors<br />
have shown that those committees managed by women, act differently from<br />
committees managed by men. The composition of audit committees evolves according<br />
to company’s nature (size, growth etc) and to the environment in which it operates<br />
(Deli & Gillan, 2000). The likelihood that there is an entirely independent audit<br />
committee is associated in a negative way to company’s growth opportunities and in a<br />
positive way to company’s size (Deli & Gillan, 2000). Some researches results might<br />
help the policy-makers, the investors and companies’ management to focus on audit<br />
committee’s characteristics which could be crucial for the ethical behavior of the<br />
entire body (Persons, 2009).<br />
Without going too far with frauds cases or that regarding the violation of accounting<br />
principles, some authors have studied only the practices of the opportunistic<br />
management. If an audit committee was equipped with a rigorous capacity to follow<br />
the accounting policies, it should provide constraints on opportunistic and<br />
discretionary behavior. From the analysis I conducted, I arrived to conclude that<br />
accounting practices are less discretionary when the audit committee’s level of<br />
financial experience is higher (Bedard et al., 2004). An accounting manipulation with<br />
an opportunistic purpose could represent, in extremis, a case of financial fraud.<br />
Examples on this subject are the situations in which the management of the results<br />
permits to companies’ managers to increase financial information relevance by<br />
highlighting false future returns. In order to reduce risks, audit committee’s members<br />
are supposed to communicate in time to managers, to internal and external auditors<br />
the accounting problems and shortcomings. However, other studies go further, taking<br />
into account different competence forms of audit committee, such as governance<br />
~ 22 ~
expertise which could control the management of the accounting result (Bedard et al.,<br />
2004; Yang & Krishnan, 2005). As a consequence, the level of expertise, and<br />
especially the accounting expertise of audit committee’s members, does represent an<br />
important element in preventing the results manipulation which will influence the<br />
quality of the financial information. The reliability of financial information is thus<br />
considered a fundamental attribute depending on a series of factors. The mere<br />
presence of the audit committee is able to improve both the financial information<br />
reliability (fewer accounting irregularities and cases of results manipulations) and its<br />
relevance.<br />
As a conclusion of this second part of the paper, I appreciate that audit committee’s<br />
role is not one neutral to the quality of audit process and of financial information. So,<br />
audit committee could play a very important role for mitigating agency problem. It<br />
could also replace many deficiencies of a particular company which are the causes of<br />
agency problem. Deficiency may be lack of independence of external auditor or lack<br />
of efficiency in the internal control systems. Although audit committees could not<br />
have prevented the financial scandals, the empirical research studies confer to those<br />
committees a certain effectiveness and usefulness for company’s governance systems.<br />
The members of audit committees should cultivate closes relations with the CEO and<br />
the CFO, with internal and external auditors in order to solve the difficulties and<br />
shortcomings. Therefore, it is imperative for audit committees’ members to be<br />
informed of all significant matters relating to financial reporting. The prevention of<br />
accounting errors and frauds depends on audit committee’s characteristics. However,<br />
a fully independent audit committee does not succeed in entirely eliminating<br />
fraudulent financial reporting.<br />
3. THE QUALITY OF AUDIT COMMITY IN CONDITIONS OF AGENCY<br />
THEORY AND INFORMATION ASYMMETRY<br />
The researches on audit committee’s role and on financial information quality get new<br />
meanings for positive theories. On this line, this paper retains the agency theory and<br />
the information asymmetry. Financial information’s characteristics are strongly<br />
linked, in this case, to interest conflicts arising between actors involved in the<br />
economic process. Auditing is a solution to information asymmetry problems which<br />
occur between managers and shareholders or between managers and the others.<br />
Jensen and Meckling (1976) start their research from the hypothesis that auditing<br />
represents a monitoring activity contributing to the increase of company’s value. On<br />
the basis of its role as corporate governance’s mechanism, auditing is focused on the<br />
reduction of agency costs (Jensen & Meckling, 1976; Fama & Jensen, 1983) and on<br />
guarantying information’s reliability and relevance to the information’s users. This<br />
information is supposed to correspond to the true and fair view. Research demarches<br />
started, usually, from the premise that economic actors do not have a free access to<br />
financial information. The consequences of this observation highlight the idea that<br />
information itself has a cost. Information available on market is partial and<br />
asymmetric. The theory of information asymmetry is based on Akerlof’s study (1970)<br />
which “analyses buyers and sellers’ behavior by abandoning the hypothesis of perfect<br />
information in order to suppose consumer’s uncertainty regarding the quality of<br />
purchased goods” (Raimbourg, 1997: 190). The hypothesis of information asymmetry<br />
is strongly linked to the agency theory and to the existence of agency relations. The<br />
agency theory was established by Jensen and Meckling in 1976. The authors offered a<br />
~ 23 ~
new vision on organizations, with significant consequences at the analyzed level of<br />
financial communication. The agency theory is concerned with “a contractual<br />
relationship between two or more persons under which, one or more persons, called<br />
the agent(s), is (are) supposed to perform some services on behalf of the principal”.<br />
Both the agent and the principal are assumed to be rational economic persons<br />
motivated by self-interests (Jensen & Meckling, 1976). And agency theory suggests<br />
that, owing to the separation of corporate management and ownership, shareholders<br />
require protection because managers may have agendas different from their owners,<br />
and thus they might not always act in the owners’ best interests (Fama & Jensen,<br />
1983; Jensen & Meckling, 1976). These authors define the agency relation as “a<br />
contractual relation whereby one or more persons named principal employ/s another<br />
person named the agent in order to exercise in his/their name a certain task implying<br />
the delegation of decision-making power to the agent” (Jensen and Meckling, 1976).<br />
According to this theory, it is supposed that agents act on behalf of the shareholders,<br />
respecting the interests of the latter. However, management could prove an<br />
opportunistic behavior, putting the spotlight on their interests, looking for getting<br />
personal advantages, such as remuneration, financial benefits and professional<br />
prestige. Those advantages seem unprofitable for the entity because of the fact that<br />
they increase company’s costs. In order to minimize the risks, the principal will put in<br />
application a number of measures intended to determine the agent to reveal all the<br />
information. There are some empirical studies confirming the fact that, in general,<br />
shareholders are interested in maintaining entities’ control by reducing the<br />
information’s transparency (Haniffa & Cooke, 2002; Makhija & Patton, 2004).<br />
By analyzing the agency problem, this paper aims to show that Jensen’s agency<br />
theory has evolved continuously, arriving to present itself as an organizational theory<br />
including two different research currents: a purely economic theory centered on<br />
market’s functioning and a research theory associated to psychology, sociology,<br />
anthropology and biology. The research theory highlights human behavior both on<br />
individual level and on the social one. The studies in the field show that managers<br />
arrive to build a set of opportunities, at the expense of the principal (the shareholders).<br />
This paper considers that the principal is disadvantaged because of information<br />
asymmetry. The sources of the conflicts arisen between the principal and the agent are<br />
externalities coming from asymmetries of information, differences in attitudes<br />
towards risk, differences in decision-making rights. This paper proposes a solution in<br />
order to solve the organizational shortcoming, by finding cheaper ways such as the<br />
effective and useful audit committees. The latter is held to provide accurate, complete<br />
and fair information to the shareholders concerning enterprise’s situation, starting<br />
from the moral obligation of audit committee’s members to manifest independence<br />
(Domnişoru & Vânătoru, 2008). However, there are other authors who expressed their<br />
skepticism about auditors’ independence within audit process, because of company’s<br />
superior position (Nichols & Price, 1976). The conflict arising between managers and<br />
auditors has been associated by researchers to the imbalance characterizing the<br />
rapport of forces between them (Nichols & Price, 1976). We could notice that, behind<br />
the closed doors of listed companies, there is the true and fair view or the so-called<br />
faithful image “guarded” by managers as a result of audit committee’s intervention.<br />
The correspondence between the true and fair view and the economic reality depends<br />
on audit committee. At this point, it is the turn for morality, competence (Gendron et<br />
al., 2004) and for audit committee’s independence to enter the game of the<br />
~ 24 ~
information asymmetry. According to those characteristics enounced above, the<br />
companies’ destiny will be decided soon.<br />
There are also authors considering that the agency relation appears when “an<br />
individual (or an enterprise) entrusts to another part the management of its own<br />
interests” (Raimbourg, 1997: 188). Agency theory becomes crucial when we add the<br />
context of information asymmetry. As shown in some research studies (Marois &<br />
Bompoint, 2004), agency theory has sense only under the circumstances of an<br />
imperfect and asymmetric information between the parties involved (the agent has a<br />
superior knowledge of the task to be fulfilled than the principal). In such a framework,<br />
the authors address a particular importance to agency costs (including expenditures’<br />
supervision by the principal, expenditures incurred by the staff in order to keep in<br />
touch with the principal; eventual losses). The agency costs in any enterprise will<br />
depend on the lack of information about the agent’s activities, on the costs of<br />
monitoring and analyzing the management’s performance, on the costs of devising a<br />
bonus scheme which rewards the agent maximizing the principal’s welfare and on the<br />
costs for determining and enforcing policy rules. An audit committee is a solution to<br />
reduce the problem of incentives (Fama & Jensen, 1983). The greater is the proportion<br />
of outside dispersed shareholders, the more likely it is, that the company will form an<br />
audit committee in order to reduce agency costs. However, there are a number of<br />
uncertainties linked to agent’s behavior (risk and moral hazard) (Raimbourg, 1997:<br />
189). Moral hazard with hidden actions occurs when the agent can determine to a<br />
degree the outcome of his or her action, and the principal can not directly observe the<br />
agent’s effort, or perfectly infer it from the company’s information system. Even<br />
Romanian literature acknowledges the existence of agency relationships between<br />
financial information’s users. Decoupling control of property led to the increase of<br />
agency problems. The relationships between managers and shareholders, as well as<br />
the levers the latter has to control managers’ activity (by the means of audit), have<br />
been frequently discussed by the researchers.<br />
In theory, this paper can afford to go beyond the indirect approaches concerning the<br />
assessment of audit quality and to propose, following the examples of authors like<br />
Knapp (1991), Carcello et al. (1992), Pigé (2003), Chemangui (2004), Manita (2008),<br />
a direct analyze of audit process. The present study aims to emphasize the audit<br />
quality indicators and also the way by which they could be influenced. For such a<br />
research demarche I took into account the privileged role of the audit committee’s<br />
members. However, when information transmitted to audit committee does not prove<br />
useful, the committee’s role becomes a ceremonial one (Gendron et al, 2004). The<br />
fact that the members of audit committee occupy the central place in the control<br />
process helped me to better understand the indicators measuring audit quality. Despite<br />
all these, audit quality is not uniform at all and, therefore, it has represented the<br />
research theme for a lot of authors. When the researchers reveal bankruptcies<br />
situations, a great attention would be paid to audit quality (Wooten, 2003). However,<br />
it is very difficult for us to know the real number of audits proving a poor quality<br />
because of the fact that not all of them have been published. To observe audit process<br />
requires a sustainable effort; consequently, researchers studied audit quality by the<br />
means of auditor’s quality (DeAngelo, 1981; Nichols & Smith, 1983; Kaplan, 1995;<br />
Lennox, 1999). De Angelo (1981: 183) defined the audit quality as “market’s<br />
assessment on the adjacent likelihood that an auditor would discover simultaneously a<br />
significant anomaly or irregularity in the enterprise’s accounting system and that he<br />
~ 25 ~
would make public this anomaly”. In this regard, some authors conclude that an audit<br />
report would be qualitative only if it is the result of a competent audit process and of<br />
an independent one, technically speaking (Citron & Taffler, 1992). Research studies<br />
of Nichols and Smith (1983), Knapp (1991), Kaplan (1995), Lennox (1999) retained<br />
this demarche defining audit quality according to technique competence (the quality<br />
to detect frauds and errors) and to auditor’s independence (the quality to reveal errors,<br />
to make them known). The Big 8 CPA firms supply a higher level of audit quality<br />
than do smaller CPA firms because the Big 8 possess technological advantages that<br />
lead to the detection of more material errors in client financial statements (DeAngelo,<br />
1981). Furthermore, Big 8 auditors are viewed as being more independent as they<br />
have greater reputation at stake. Committee’s members could understand the<br />
difference between the oversight function of the committee and the decision-making<br />
function of management and must be willing to challenge management when<br />
necessary (Blue Ribbon Commission Report, 1999). In other words, DeAngelo (1981)<br />
argues that larger audit firms have a greater investment in the reputation capital. In<br />
order to protect their investment, audit firms are likely to provide higher quality<br />
audits. There is a lower incidence of litigation against Big Eight auditors than against<br />
non-Big Eight ones (Palmrose, 1988) and also a positive relation between board size<br />
and financial fraud (Beasley, 1996). A smaller board is more effective at fulfilling a<br />
controlling function whereas larger boards are easier for the CEO to control. The<br />
characteristics of audit committees influence negatively the significance when board’s<br />
characteristics are included (Carcello & Nagy, 2004). The reports of the<br />
ineffectiveness in audit quality evaluation have driven both the professional and<br />
academic world to rethink the current rules and mechanisms for audit quality<br />
assessment and to debate this subject and its measurability.<br />
From another perspective, Chemangui (2004) arrives to assess audit quality according<br />
to auditor’s quality, the auditor being viewed as an individual or as a group of<br />
individuals. By extending the approach area, other researchers have studied the<br />
indicators of audit quality according to auditor’s fees (Malone & Roberts, 1996;<br />
David et al., 2006) or to his reputation (McNair, 1991; Palmrose, 1988; Moizer,<br />
1997). At the same time, audit quality could depend on organizational characteristics<br />
of audit committee. The members of audit committee could have different motivations<br />
for improving the quality of audit process (Power, 1995). The authors cite a number<br />
of quality indicators such as: human resource (Wooten, 2003), quality control (Prat dit<br />
Hauret, 2000; Malone & Roberts, 1996), expertise (Wooten, 2003), professional<br />
negligence affecting audit quality (Malone & Roberts, 1996; McNair, 1991). Even<br />
audit committee’s size has a significant impact on financial reporting (Felo et al.,<br />
2003). Their results highlight the idea that there is a positive relation between the<br />
audit committee’s size and the quality of financial reporting, although studies realized<br />
by Abbott et al. (2004) as well as those of Bedard et al. (2004) infirmed the<br />
affirmation above. On the other hand, a company could have problems connected to<br />
its financial statements when there is not a frequency in meetings of audit committee’s<br />
members (McMullen, 1996). Therefore, this paper sustains that the frequency of this<br />
meetings could improve and intensify the control of financial reporting process.<br />
The assessment of audit quality imposes some conceptual and empirical limits<br />
influencing financial information credibility. Some limits are linked to the risk of<br />
compliance with management (Fama & Jensen, 1983a; Craswell, 1988); others are<br />
reported to the characteristics of identified indicators (very simplistic indicators or<br />
~ 26 ~
indicators reducing audit quality), and also to their incapacity to determine the<br />
solution for audit quality improvement (Sutton, 1993). In this sense, the last quoted<br />
author tried to validate a number of key factors on which audit quality depends. He<br />
identified 19 factors. Further, Manita (2008) developed a tool for assessing audit<br />
quality which is composed of 49 quality indicators assigned to different stages of<br />
auditing. The author shows clearly that audit process is a complex one which needs to<br />
be understood and observed on several dimensions. Manita’s study (2008) proves the<br />
fact that the quality of audit process is not tributary only to technical aspects<br />
characterizing auditors, but also to their quality characteristics (independence,<br />
competence, expertise, ethics) as well as to organizational characteristics of audit<br />
firms (audit team, organization of audit mission etc.). However, it is necessary to<br />
specify the fact that the quoted study refers to a period prior to SOX introduction; this<br />
event forced listed companies to establish audit committees. Manita has realized a<br />
quantitative research using a sample of auditors which could not have had the same<br />
education and perception on audit quality, as future audit committees’ members.<br />
Cohen et al. (2002) interviewed 36 auditors in connection with corporate governance<br />
influence on audit process, including the role of audit committees. After the<br />
interviews, he concluded that auditors perceive management as the main header of<br />
corporate governance. An important number of auditors interviewed considered audit<br />
committees weak and ineffective. However, financial scandals and particularly the<br />
failure of Arthur Andersen auditing firm, confirmed the insufficiency of this indirect<br />
approach of audit assessment. Therefore, subsequent authors have addressed this<br />
research question from a different perspective in order to make clear the way by<br />
which this control system could be effective. They also intended to clarify audit<br />
committee’s relevance for contributing to the reduction of audit failures. In this<br />
respect, the paper draws attention to the need for studying an important aspect which<br />
could influence the quality of financial information: that of communication and<br />
collaboration between auditors and audit committees (Spira, 2003; Turley & Zaman,<br />
2007). It seems that companies’ owners are very sensitive about the way in which<br />
auditors communicate with audit committee’s members, about the identified risks and<br />
the released results. On the other hand, this paper highlights the idea that audit<br />
committees’ members prove respect to those auditors that take into account the risks<br />
in question and the sensitive areas noticed during the audit process. This fact denotes,<br />
in the eyes of audit committees’ members, the effectiveness and competence of<br />
auditors.<br />
This part of the present study concludes that company’s integrity depends, to some<br />
extent, on the independence and competence of audit committees’ members.<br />
However, independence and competence are not the only criteria to be taken into<br />
account in measuring the quality of audit process.<br />
DISCUSSION AND CONCLUSIONS<br />
By making a review of literature addressing audit committee’s theme, I arrived to<br />
better understand the audit committee’s role but also to propose some solutions for<br />
improving financial information quality. This paper also takes into account the<br />
problem of increasing the accuracy, integrity and conformity of financial statements<br />
transmitted to the users from all levels. Audit committee has preoccupied researchers<br />
for a long time. However, by studying a large part of the published works on this<br />
subject, I noticed almost the absence of clear solutions concerning the effective<br />
~ 27 ~
intervention of audit committees in the increasing of financial information quality. For<br />
this paper, I started from the unanimous need of capital markets to dispose of high<br />
quality information. As a response to this need, regulators introduced the obligation<br />
for listed companies to dispose of audit committees. The main role of these audit<br />
committees consists in monitoring financial situations. Therefore, audit committees<br />
should supervise the quality of the applied accounting principles and also the way by<br />
which these principles affect financial situations. By the contribution of this paper, we<br />
could appreciate that audit committee represents one of mechanisms controlling the<br />
opportunistic behavior of managers, under the circumstances of the agency theory and<br />
information asymmetry. From the empirical research studies, I found that the major<br />
function of audit committees consists in reducing financial reporting risks.<br />
The results of this fundamental research highlight some possible solutions by which<br />
we could increase audit committee effectiveness in corporate governance and in<br />
financial reporting. Audit committee effectiveness depends on the financial and extrafinancial<br />
expertise of the members. At the same time, the members of audit<br />
committees should be “champions” in ethics and they must prove independence,<br />
competence, morality and professional reasoning. Audit committee’s characteristics<br />
are crucial for preventing frauds and accounting errors. However, the results of this<br />
research paper indicate the fact that a fully independent audit committee is not able to<br />
eliminate the entire fraudulent financial reporting. Generalizing, we could consider<br />
that the intention of the Sarbanes-Oxley Act or of a Blue Ribbon Committee Report<br />
seems insufficient for preventing fraudulent behavior manifested by companies’<br />
management. As a consequence, all the persons involved in corporate governance<br />
should be more vigilant to the importance of financial information’s quality. Unlike<br />
the employee fraud, management fraud is more difficult to be detected because of<br />
managers’ manipulation attempts and because of their opportunistic behavior. The<br />
internal control systems can not be made entirely responsible for managerial frauds.<br />
Therefore, we could appreciate that we need independent audit committees<br />
monitoring the integrity of financial reporting and ceasing managers’ manipulations.<br />
In order to achieve this goal, the present paper proposes to the audit committees’<br />
members to protect external auditors from the pressures exercised by managers. Audit<br />
committees should possess real and sufficient information and should assume their<br />
responsibility to fraud detection and prevention. However, this paper contains some<br />
doubts linked to the ability of audit committees’ members to prevent all potential<br />
frauds. This study sustains that the members of audit committees should cultivate<br />
close relationships with the CEO and the CFO, with internal and external auditors in<br />
order to solve the difficulties. In is imperative for the members to be informed of all<br />
significant matters concerning financial reporting. Also, the frequency of audit<br />
committee’s meetings could improve and intensify the control of financial reporting<br />
process. Even the informal relations between the members of audit committees and<br />
management could serve to maximize audit committee effectiveness. Agency problem<br />
is and will be there as long as there are organizations based on corporate type. During<br />
this study I observed that not only agency problem but also the failure of different<br />
corporate governance instruments creates difficulties. An independent audit<br />
committee is one of the most important mechanisms for minimizing these types of<br />
problems. The establishment of an audit committee has a lot of value to different<br />
types of users which could ensure the credibility of the financial information.<br />
~ 28 ~
This study reflects my own opinion about the importance of audit committees. I<br />
consider that a clarification of independence definition, could subsequently lead to a<br />
manifestation of a truly audit committee independence. This positive consequence<br />
will enhance its effectiveness and will improve the quality of financial information.<br />
This paper gives me the possibility to affirm that it is necessary to find as soon as<br />
possible real solutions concerning agency and corporate governance issues marking<br />
the financial communication. The study provides the premises for identifying future<br />
research perspectives extremely generous. In this sense, I propose to explore several<br />
directions such as: the empirical studies on the information asymmetry phenomenon<br />
or agency relations manifested on Romanian market at different levels; intercultural<br />
studies concerning governance shortcomings within companies; empirical research<br />
studies based on the corporate governance impact on audit process within Romanian<br />
enterprises. Future studies could investigate the circumstances under which, by<br />
changing audit committee’s characteristics, by increasing the meetings number of<br />
audit committee’s members, by increasing also the number of financial experts within<br />
audit committees or even that of women as members in those committees, we could<br />
affect audit value and quality, including the quality of financial information<br />
transmitted on the market.<br />
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THE FINANCIAL AUDITOR’S RISK BEHAVIOUR –<br />
THE INFLUENCE OF AGE ON RISK BEHAVIOUR<br />
IN A FINANCIAL AUDIT CONTEXT<br />
Iancu Octavian IONESCU 1 & Eugeniu TURLEA<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
A main issue in the audit process is the risk faced by the decision makers in every aspect of an<br />
audit process decision. The decision makers’ risk behaviour and their attitude towards risk is<br />
considered to be central to the way business risk, in general, and audit risk, in particular, is<br />
managed but no conclusive theory as to what influences the decision makers’ risk behaviour<br />
is commonly accepted. Although previous studies have brought arguments in favour of<br />
different factors considered to have an influence on the decision makers’ risk behaviour, what<br />
is not known is whether age has an influence on risk behaviour. This article advances the<br />
hypothesis that the auditor’s attitude towards risk is influenced by the auditor’s age, in a<br />
financial audit context. The methodological approach used was the survey of a representative<br />
sample using a carefully designed questionnaire and the use of statistical software to<br />
investigate the responses. The analysis of data collected revealed that there is a strong<br />
correlation between the financial auditor’s risk behaviour and the financial auditor’s age,<br />
confirming the research hypothesis as well as setting a starting point for future research.<br />
KEYWORDS: risk, age, financial audit, risk behaviour, correlation<br />
INTRODUCTION<br />
Throughout his work the financial auditor uses an element that is central to all audit<br />
activities: risk assessment. The activity of risk assessment is closely linked to the<br />
auditor’s risk behaviour and risk attitude, as well as professional judgement. The<br />
validity and quality of the financial auditor’s professional judgement as well as his<br />
risk behaviour are critically important elements which work together to strengthen the<br />
reputation of the auditing profession. Generally, the academic literature related to<br />
professional judgement, risk and decision making in audit showed that professional<br />
judgement and decision making are inherent to any audit stage, that the risk<br />
preferences and risk behaviour varies widely between auditors and that a wide<br />
spectrum of factors influence professional judgement and risk behaviour. The<br />
relationship between professional judgement and risk is a direct and constant one<br />
because professional judgement in audit is exercised in a risk context. In exercising<br />
professional judgement, the auditor makes initial risk assessments which are<br />
consequently modified in the light of the new audit evidence gathered throughout the<br />
audit process. Any risk assessment in audit implies professional judgement to some<br />
extent. However, despite the fact that there are a significant number of empirical<br />
studies on risk behaviour and decision making, these studies did not produce uniform<br />
1<br />
Correspondence address: Iancu Octavian IONESCU, Bucharest Academy of Economic Studies,<br />
Romania; email: octavian.i.ionescu@gmail.com
findings. As the audit process is at the heart of the business world and while the audit<br />
firm itself is a business, general characteristics of risk can be extrapolated to embrace<br />
a more general business risk view. There are solid grounds to argue that the financial<br />
auditor is a business decision maker. Moreover, while the audit process is basically a<br />
team work led by the audit firms’ managers and partners, risk theory that applies to<br />
business managers will certainly apply to the audit field as well. Risk is a concept<br />
whose definition has not generated a consensus in the academic or business circles but<br />
is generally accepted that it relates to issues of unpredictability, decision making and<br />
potential loss. Risk is intrinsically linked with decision-making and every decision<br />
made in business implies a certain degree of risk. According to March and Shapira<br />
(1987), the importance of risk to decision making is attested by its position in decision<br />
theory and by the high level of interest in risk assessment in audit. Kendrick (2004)<br />
underlines the importance of understanding the personal attitudes to risk and considers<br />
the attitude and behaviour dimension one of the key dimensions to understanding risk.<br />
The rationale of the importance of understanding the decision makers’ risk behaviour<br />
as underlined by Kendrick (2004), is that, to a certain extent, the strategies of an<br />
organisation reflect the dispositions of their managers in terms of their background,<br />
beliefs, attitudes and problem-solving styles. This behavioural aspect of risk taking in<br />
decision making introduces the fundamental question about the determinants of risk<br />
behaviour. What exactly determines or influences a decision maker’s risk behaviour<br />
when making a decision? There are currently several views accepted. The most<br />
popular are those articulated by Kogan and Wallach (1967): the dispositional view,<br />
which considers the personal characteristics of a decision maker such as natural<br />
predisposition towards taking or avoiding risk to be determinant of the type of<br />
decision taken and the situational view, which considers the context in which the<br />
decision is taken to be determinant of the decision maker’s risk behaviour,<br />
irrespective of dispositional preferences. There are also integrative views accepted<br />
which suggest that the dispositional risk propensity interacts with situational factors in<br />
determining risk taking behaviour (Baird and Thomas, 1985; Sitkin and Pablo, 1992;<br />
Das and Teng, 2001; Kendrick, 2004). This study follows the integrative lines and<br />
proposes that age is a transcending factor which influences the decision makers’ risk<br />
behaviour irrespective of dispositional or contextual factors. The purpose of this<br />
article is to establish the relationship between the auditor’s age and the auditor’s risk<br />
behaviour in a financial audit context, contributing to the understanding of risk<br />
behaviour and adding to the literature on the relationship between age and risk. The<br />
research question is whether the auditor’s age can influence his/her risk behaviour.<br />
The research method is the hypothesis testing using questionnaires on a sample of<br />
practising financial auditors, active members of The Romanian Chamber of Financial<br />
Auditors (CAFR). The data will be analysed using the SPSS statistical software. The<br />
main contribution of this work will be to complement the academic research on risk<br />
and help to better understand the financial auditor’s risk behaviour in a financial audit<br />
context.<br />
1. LITERATURE REVIEW<br />
In this chapter, theories and previous research in the field of risk behaviour is<br />
explored. All the relevant theories and literature regarding risk and its relationship<br />
with age will be discussed. The chapter begins with a discussion of the theories<br />
regarding risk behaviour, followed by a discussion of the academic literature on the<br />
~ 33 ~
elationship between age and risk. This approach will analyse the theories of risk from<br />
different angles and will enable a multidimensional view on previous literature.<br />
1.1. Theories on the determinants of risk behaviour<br />
Academic theories which attempted to explain the risk behaviour of decision makers<br />
date back as far as 1738 (Bernoulli, 1738) and there are a significant number of<br />
empirical studies in the area of risk taking behaviour. However, these studies have not<br />
produced uniform findings. The theories of risk taking behaviour are split into two<br />
major competing paradigms: one which emphasizes the importance of individual<br />
dispositional differences, which is called the dispositional view, and one which<br />
emphasizes the importance of situational factors, called the situational view. The<br />
dispositional view focuses on the individual differences in risk taking behaviour. For<br />
this school of thought, the general traits and general dispositional tendencies of the<br />
decision makers are believed to dictate their risk taking attitude. It argues that some<br />
people have a natural predisposition to be more risk-seeking or more risk-averse than<br />
others, irrespective of the situation or the context of the problem. In support of this<br />
theory, a significant number of empirical studies have reported on individual<br />
differences in risk taking behaviour. Alderfer and Bierman (Alderfer and Bierman,<br />
1970) use two questions from Kogan and Wallach’s (Kogan and Wallach, 1964)<br />
Choice Dilemma Questionnaire relating to financial investment, alongside other types<br />
of questions, to substantiate considerations regarding individual differences in<br />
attitudes towards risk choice in financial investment. However, Alderfer and Bierman<br />
(Alderfer and Bierman, 1970), among many other scholars (Bromiley and Curley,<br />
1992; Weber, Blais and Betz, 2002), raise doubts as to the appropriateness of using<br />
Kogan and Wallach’s (Kogan and Wallach, 1964) Choice Dilemma Questionnaire to<br />
extract generalities about any attitude behaviour relationship. It is interesting to<br />
observe that by using the Kogan and Wallach’s (1964) Choice Dilemma<br />
Questionnaire and by being critical of it at the same time, Alderfer and Bierman<br />
(Alderfer and Bierman, 1970) are actually raising doubts about the validity of their<br />
own findings. In a study that directly examined the consistency of dispositional risk<br />
taking behaviour in two groups, one risk-seeking and one risk-averse, Schneider and<br />
Lopes (Schneider and Lopes, 1986) found that the risk-seeking group tended to prefer<br />
riskier choice on a consistent base when compared with the risk-averse group.<br />
Bromiley and Curley (Bromiley and Curley, 1992) observed that some people were<br />
more tolerant towards risk than others and found that individuals tend to be consistent<br />
in their attitudes towards risk. In an experiment in which the roles of risk attitude and<br />
tolerance for ambiguity in predicting choice were jointly assessed, Ghosh and Ray<br />
(Ghosh and Ray, 1997) found that both risk attitude and ambiguity intolerance<br />
determined choice behaviour. Based on individual differences in risk taking as an<br />
individual attribute, scholars have introduced the concept of risk propensity, defined<br />
by Sitkin and Weingart (Sitkin and Weingart, 1995) as “an individual’s current<br />
tendency to take or avoid risks” (Sitkin and Weingart 1995, p.1575). Rowe (Rowe,<br />
1977) and Fischhoff et al. (Fischhoff et al., 1981) have used the term risk propensity<br />
with reference to a consistent individual trait towards taking or avoiding risks. Das<br />
and Teng (Das and Teng, 2001) observe that Sitkin and Weingart (Sitkin and<br />
Weingart, 1995) believe that even the critics of the dispositional approach to risk<br />
“have employed the traditional conception of risk propensity as a stable individual<br />
attribute” (Sitkin and Weingart 1995, p.1575). However, this view is questioned by<br />
Weber, Blais and Betz (Weber et al., 2002). In their study, Weber, Blais and Betz<br />
~ 34 ~
(Weber et al., 2002) present a psychometric scale that assesses risk taking in five<br />
content domains – financial decisions (separately for investing versus gambling),<br />
health/safety, recreational, ethical and social decisions – and find that the degree of<br />
risk taking was highly domain specific, not consistently risk-averse or consistently<br />
risk-seeking. The findings of Weber, Blais and Betz (Weber et al., 2002) are contrary<br />
to those of Rowe (Rowe, 1977), Fischhoff et al. (Fischhoff et al., 1981), Schneider<br />
and Lopes (Schneider and Lopes, 1986), Bromiley and Curley (Bromiley and Curley,<br />
1992) and Sitkin and Weingart (Sitkin and Weingart, 1995), making it one of the<br />
findings supporting the situational view. Many empirical studies suggest that<br />
situational factors such as the framing of the problem and the context in which the<br />
decision on risk is taken have a greater influence on risk taking behaviour. Slovic<br />
(Slovic, 1972) argues that high correlations between risk-taking measures in<br />
structurally different settings are highly unlikely, suggesting that different settings in<br />
which decision on risk is made will have different decisional outcomes. March and<br />
Shapira (March and Shapira, 1987) find that managers, as decision makers, make a<br />
sharp distinction between taking risk and gambling, which implies that the context or<br />
situation of the decision plays a major role in risk taking behaviour. In line with these<br />
findings, a very strong argument in favour of the situational view of risk taking<br />
behaviour comes from a seminal study conducted by Kahneman and Tversky<br />
(Kahneman and Tversky, 1979) in which the authors advance an alternative theory of<br />
choice under risk – the prospect theory. Essentially, the prospect theory suggests that<br />
individuals tend to interpret the outcomes of a risky decision according to a reference<br />
point – such as the status quo - which changes depending on whether the outcome is<br />
framed as a gain or as a loss. In line with this view, March (March, 1988) introduces<br />
the term adaptive aspirations as a complement to Kahneman and Tversky’s<br />
(Kahneman and Tversky, 1979) reference point. In the prospect theory, Kahneman<br />
and Tversky (Kahneman and Tversky, 1979) and later Tversky and Kahnemann<br />
(Tversky and Kahnemann, 1991) contradict the expected utility model (Bernoulli,<br />
1738; von Neumann and Morgestern, 1947) and argue that, in evaluating risk, value is<br />
assigned to gains and losses rather than to final assets, and probabilities are replaced<br />
by decision weights. Kahneman and Tversky (Kahneman and Tversky, 1979) argue<br />
that the carriers of value or utility are the actual changes of wealth rather than the final<br />
asset positions that include current wealth. In particular, Kahneman and Tversky<br />
(Kahneman and Tversky, 1979) observe that people under weigh outcomes that are<br />
only probable in comparison with outcomes that are obtained with certainty and call<br />
this the certainty effect. Consequently, Kahneman and Tversky (Kahneman and<br />
Tversky, 1979) argue that the certainty effect contributes to decision makers being<br />
risk averse in choices involving sure gains and risk seeking in choices involving sure<br />
losses. There is evidence to support this view in a study by Highhouse and Yüce<br />
(Highhouse and Yüce, 1996) who investigated the attempt to empirically separate<br />
threat and opportunity perceptions from loss and gain perspectives. Highhouse and<br />
Yüce (Highhouse and Yüce, 1996) found that when in the loss domain, most decision<br />
makers perceived the risk alternative as an opportunity and when in the gain domain,<br />
most decision makers perceived the risk alternative as a threat. However, it is<br />
interesting to observe that Kahneman and Tversky’s (Kahneman and Tversky, 1979)<br />
prospect theory, although demonstrates several phenomena which violate the<br />
principles of expected utility theory, it is based on responses of students and faculty to<br />
hypothetical choice problems of the type that resembles a gambling situation and<br />
therefore their arguments may be questionable in the light of the findings by Schubert<br />
et al. (Schubert et al., 1999) which suggests that abstract gambling experiments might<br />
~ 35 ~
not be adequate for the analysis of risk attitudes. The main conclusion of the risk<br />
literature review is that since Kogan and Wallace (Kogan and Wallace, 1967) first<br />
articulated the fundamental question about the determinants of risk behaviour in terms<br />
of whether they are dispositional or situational, the issue remains unresolved.<br />
1.2. Relationship between age and risk behaviour<br />
While conventional wisdom suggests that individuals take fewer risks as they age, the<br />
evidence from empirical studies yields contradictory results. In an early study on the<br />
relationship between age and risk behaviour, Wallach and Kogan (1961) compared<br />
risk-taking behaviour of college age and elderly men and women, and found that the<br />
older subjects, both males and females, were significantly more conservative than the<br />
college students. Recognizing the shortfalls of examining two extreme age groups,<br />
Kogan and Wallach (1967) comment in a later review article on the need for further<br />
exploration of age – risk–taking relationship using less extreme age groups. In an<br />
attempt to satisfy this need, Vroom and Pahl (1971) investigate the age-risk behaviour<br />
relationship on a sample of almost 1,500 managers with age ranging from 22 to 60<br />
years. After plotting the data obtained using the Kogan and Wallach (1964) choice<br />
dilemma questionnaire as a measure of risk propensity, Vroom and Pahl (1971) found<br />
that the slope of the relationship between mean riskiness and age is greatest in the age<br />
range 22 to 32 years, flattens out in the age range 33 to 48 years and increases again in<br />
the age range 48 to 58 years. This means that for the managers used in Vroom and<br />
Pahl’s (1971) study, the age group 22 to 32 years and 48 to 58 years appears to be<br />
more risk seeking whereas the age group 33 to 48 appears to be more risk averse.<br />
Vroom and Pahl (1971) also find evidence that the value people place on risk<br />
decreases with age in a linear relationship. The results from Vroom and Pahl (1971)<br />
study offer evidence that there is a significant relationship between age and measures<br />
of both risk taking and of the value placed on risk. However, caution must be<br />
exercised in interpreting the findings of Vroom and Pahl (1971) as the instrument<br />
used to measure risk propensity – Kogan and Wallach’s (1964) choice dilemma<br />
questionnaire – has been subject to a number of criticisms (Cartwright, 1971;<br />
MacCrimmon and Wehrung, 1984; Shaver and Scott, 1991; Kamalanabhan, Sunder<br />
and Vasanthi, 2000). There is also the possibility that the sample used may have had<br />
unique properties which might render the results artifactual. Despite these limitations,<br />
the findings of Wallach and Kogan (1961) and Vroom and Pahl (1971) are supported<br />
by those of Morin and Suarez (1983) who conclude that, on average, risk aversion<br />
increases with age. However, these findings do not seem to hold unconditionally -<br />
while on average and for those individuals with low levels of net worth risk aversion<br />
increases with age, for those individuals with high levels of net worth risk aversion<br />
decreases with age (Morin and Suarez, 1983). This is in line with Kahneman and<br />
Tversky’s (1979) prospect theory - in which age may be a factor that alters the<br />
“objective” assessment of risk – and which could represent an alternative theoretical<br />
explanation for how age may affect financial decision making. The views presented<br />
by Wallach and Kogan (1961), Vroom and Pahl (1971) and Morin and Suarez (1985)<br />
that risk taking decreases with age, are challenged by the findings of Bellante and<br />
Saba (1986), Wang and Hanna (1997) and Bellante and Green (2004) who argue that,<br />
on the contrary, risk tolerance increases with age. It appears that, similarly to the risk<br />
behaviour theory, the relationship between age and risk behaviour is not conclusive<br />
and that additional variable factors must be taken into account.<br />
~ 36 ~
2. RESEARCH METHODOLOGY<br />
The research philosophy of this study is based on the positivist deductive approach<br />
embracing a critical realism epistemology. In the deductive approach of this study<br />
there are several stages of the research: hypotheses are presented following the review<br />
of the literature, the hypotheses are expressed in operational terms which propose a<br />
relationship between two specific variables and, finally, testing the hypothesis and<br />
examining the outcome of the test. If necessary, the theory is modified in the light of<br />
the findings. The research in this explanatory study will be cross-sectional and the<br />
quantitative mono method using questionnaires, together with analysis of quantitative<br />
data, will be used to establish causal relationships between the variables contained in<br />
the hypotheses.<br />
2.1. Research hypothesis<br />
Based on the literature review on age and risk behaviour while pursuing the research<br />
objective, the following main hypothesis together with two deriving secondary<br />
hypotheses is advanced:<br />
Hypothesis 1. The financial auditor’s age influences his risk behaviour in a financial<br />
audit context.<br />
Hypothesis 1a. There is a significant correlation between the financial auditor’s age<br />
and his risk behaviour, in a financial audit context.<br />
Hypothesis 1b. The financial auditor’s risk tolerance is negatively correlated with his<br />
age, in a financial audit context.<br />
2.2. Research strategy<br />
The objective of the present research is to answer the research question and identify<br />
whether the auditor’s risk behaviour is influenced by his age. Due to time and<br />
economic constraints, in answering the research question, the survey method is<br />
selected for the purpose of this study in order to collect a sufficient amount of primary<br />
data. The use of questionnaires is the most widely used data collection technique in a<br />
survey and, in this study, a questionnaire containing 4 questions will be distributed to<br />
a representative sample of 650 practising financial auditors, active members of The<br />
Romanian Chamber of Financial Auditors (CAFR), for primary data collection. The<br />
data collected will then be analysed using graphic representations and SPSS statistical<br />
software and the results will be used to validate or invalidate the hypotheses. The<br />
findings will be discussed and conclusions will be drawn. The design of the<br />
questionnaire is essential for the reliability and validity of the data, hence great care<br />
has been given to the framing and wording of questions. In this study, the<br />
questionnaire which will be administered to the chosen sample will consist of 4<br />
questions (see Appendix 1). Question 1 is a quantity type question to determine the<br />
age of the respondent. Questions 2, 3 and 4 are rating type questions using a four<br />
point Likert scale in which the respondent is asked how strongly he or she agrees or<br />
disagrees with a statement. Four points were used for the Likert scale (strongly agree,<br />
tend to agree, tend to disagree and strongly disagree) to eliminate the possibility that<br />
the respondent will ‘sit on the fence’ by ticking the middle ‘not sure’ category which<br />
will render the response ambiguous. We choose the four point Likert scale because we<br />
wanted the respondent to express a clear opinion on the statements, which enabled us<br />
~ 37 ~
to clearly determine whether the respondent is more or less risk seeker or more or less<br />
risk averse in certain situations.<br />
3. FINDINGS AND DISCUSSION<br />
In August 2011 the questionnaires were distributed to 650 practising financial<br />
auditors, active members of The Romanian Chamber of Financial Auditors (CAFR).<br />
There were a total of 368 responses received which means a 56.6% actual response<br />
rate. This actual response rate is above the expected 50% response rate for which we<br />
have hoped at the design stage of the study. Out of a total of 368 actual responses, 16<br />
responses had to be left aside because in these three cases the questionnaire has not<br />
been filled in properly and responses to some of the questions were either missing or<br />
incomplete. However, 352 responses were valid which means a total effective<br />
response rate of 54.1%.<br />
3.1. Data coding<br />
The responses to the Questions 2, 3 and 4, which are rating type questions using a<br />
four point Likert scale, were coded by assigning to each response option representing<br />
a point on the Likert scale a number value from 1 to 4, with 1 representing the highest<br />
preference towards risk and 4 representing the least preference towards risk. Risk will<br />
be represented by the Total Risk Score variable arrived at by adding the<br />
corresponding values for each respondent’s answer to questions 2, 3 and 4. Therefore,<br />
the more preference for risk a person would show in his/her risk attitude or behaviour,<br />
the lower the Total Risk Score would be. For a clearer picture of the coding<br />
procedure, see Table 1 below.<br />
Table 1. Illustration of the coding of responses for the questions using the four point<br />
Likert scale<br />
For Questions 2, 3 and 4:<br />
Tend to Tend to Strongly<br />
Strongly Agree Agree Disagree Disagree<br />
1 2 3 4<br />
__________________________________________________________________<br />
3.2. Hypotheses testing<br />
Testing Hypothesis 1a. There is a significant correlation between the financial<br />
auditor’s age and his risk behaviour, in a financial audit context.<br />
In order to test Hypothesis 1a the respondents’ answers to Question 1, 2, 3 and 4,<br />
which tests the risk propensities of the respondents in a specific financial audit<br />
context, are investigated. Running a correlation test for the two variables of age and<br />
~ 38 ~
isk behaviour using the SPSS statistical software will show the following results (see<br />
Table 2).<br />
Table 2. The sample correlation test for the two variables of age and risk behaviour<br />
Age<br />
Total Risk Score<br />
~ 39 ~<br />
Age Total Risk Score<br />
Pearson Correlation 1 .680 **<br />
Sig. (2-tailed) .000<br />
N 352 352<br />
Pearson Correlation .680 ** 1<br />
Sig. (2-tailed) .000<br />
N 352 352<br />
For the selected sample, the correlation coefficient between age and risk behaviour is<br />
0,680 which indicates that the correlation is significant. The value of the correlation<br />
coefficient (0,680) is not close to zero, so there is evidence of a linear relationship<br />
between the two variables. It is positive, so the slope of the straight line resulting from<br />
the linear relationship is also positive. That is, as total risk score increases, indicating<br />
a more risk adverse person, age also increases. Finally, the value of the correlation<br />
coefficient is close to 1 or -1 indicating that the relationship is a strong one. As a<br />
consequence of the result of the test, there is evidence to retain Hypothesis 1a and<br />
conclude that there is a significant correlation between the financial auditor’s age and<br />
his risk behaviour, in a financial audit context.<br />
Testing Hypothesis 1b. The financial auditor’s risk tolerance is negatively correlated<br />
with his age, in a financial audit context.<br />
In order to test Hypothesis 1b the respondents’ answers to Question 1, 2, 3 and 4,<br />
which tests the risk propensities of the respondents in a specific financial audit<br />
context, are investigated. This time, though, the data will be presented in a scatter<br />
plot, with Total Risk Score plotted against age (see Figure 1).<br />
From the scatter plot it appears that when age is high, total risk score is also high<br />
which suggests that as age increases, total risk score may also increase. It is therefore<br />
a positive correlation between Total Risk Score and age, a fact which is confirmed by<br />
the positive value of the correlation coefficient (0,680) obtained in the statistic test<br />
performed when testing Hypothesis 1a. However, bearing in mind that a high value of<br />
Total Risk Score means a decreased risk tolerance, the higher the age, the more<br />
decreased risk tolerance appears to be. In other words, risk tolerance tends to be<br />
associated with lower age of the respondents and as age increases, risk tolerance<br />
decreases. This is equivalent with the conclusion that there is a negative correlation<br />
between risk tolerance and age. As a consequence of the result of the test, there is<br />
evidence to retain Hypothesis 1b and conclude that the financial auditor’s risk<br />
tolerance is negatively correlated with his age, in a financial audit context.
As both Hypothesis 1a and Hypothesis 1b are retained, there is evidence to support<br />
the main Hypothesis 1, which is retained, and conclude that the financial auditor’s age<br />
influences his risk behaviour in a financial audit context.<br />
CONCLUSION<br />
Figure 1. Scatter plot with Total Risk Score plotted against Age<br />
This study investigated the relationship between financial auditor’s age and his risk<br />
behaviour in a financial audit context. The study concentrated on the analysis of risk<br />
behaviour and on the identification of a relationship between risk behaviour and the<br />
age of the financial auditor. The responses of 352 practising financial auditors, active<br />
members of The Romanian Chamber of Financial Auditors (CAFR), to the 4<br />
questions contained in the questionnaires were analysed using a series of statistical<br />
tests. The design of the questionnaire centred on carefully wording the questions<br />
together with the data coding method represent the pivotal point of the study. The<br />
responses’ analysis and findings provide significant evidence in favour of the main<br />
research hypothesis. Consequently, the results of this study demonstrate that the<br />
auditors’ risk behaviour is influenced by his/her age. However, one limitation of this<br />
study is the relatively small sample size. Although statistically a sample number of<br />
352 respondents is considered to be enough to draw conclusions about the population,<br />
a larger number of participants would not only improve the validity and reliability of<br />
the findings, but it might also indicate slightly different results, especially in the<br />
borderline results. A second limitation refers to the way risk propensity was measured<br />
by using a four point Likert scale. The four point Likert scale was chosen because it<br />
translates the risk propensity showed by a respondent into different measurable and<br />
analysable grades. The use of a Likert scale with more points would have resulted in a<br />
more finely graded scale of measurement of risk propensity. Finally, the main<br />
~ 40 ~
conclusion of this study, that age is a personal factor that influences the auditor’s risk<br />
behaviour, could be used as a starting point for future research on the auditor’s<br />
judgement and decision making process.<br />
ACKNOWLEDGEMENTS<br />
This article is a result of the project „Doctoral Program and PhD Students in the<br />
education research and innovation triangle”. This project is co funded by European<br />
Social Fund through The Sectorial Operational Programme for Human Resources<br />
Development 2007-2013, coordinated by The Bucharest Academy of Economic<br />
Studies.<br />
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APPENDIX 1<br />
The research questionnaire<br />
You are asked a series of questions, some requiring you to make a decision in<br />
hypothetical situations, others requiring you to express your view.<br />
All the information you provide will be used for research purposes only and will be<br />
treated in the strictest confidence. You will not be identified from the information you<br />
provide.<br />
I hope you find completing the questionnaire enjoyable and thank you for taking the<br />
time to answer it. A summary of the findings will be emailed to you.<br />
Question 1.<br />
What is your age?<br />
Question 2.<br />
You are the recently appointed the auditor of ABC Ltd., about which you know that it<br />
is a medium size developer with one shareholder that also represents the company’s<br />
management. You know that the company has invested a substantial sum of its<br />
financial reserves in the development of a residential area which is now finalised. You<br />
know that if the company manages to sell all the houses in the residential area in the<br />
current financial year, there will be substantial success, not only financially but also in<br />
market share. But if the company will not manage to sell all of its houses from its<br />
residential area, it will be faced with serious liquidity and reputational problems. You<br />
also know that there are 60% chances that the company will manage to sell all the<br />
houses and 40% chances to be unable to sell all the houses.<br />
Assuming that these are the only information available, please express your opinion<br />
on the following statement:<br />
The inherent risk at the ABC srl level is small.<br />
Answer:<br />
(please tick only one box)<br />
Tend to Tend to<br />
Strongly agree Agree Disagree Strongly disagree<br />
Question 3.<br />
A recent approach in financial audit is the one based on business risk. The business<br />
risk audit approach is based on a company’s objectives: a certain level of profitability,<br />
obtaining a certain market share, maintaining a certain level of liquidity, brand
improvement etc. In essence, audit business risk approach is about the cost that a<br />
company could incur if it doesn’t meet its strategic objectives.<br />
Considering the case of company ABC srl, presented in the previous question<br />
(Question 2), please express your opinion on the following statement:<br />
The business risk in the case of ABC srl (the risk that it will not meet its objectives) is<br />
small.<br />
Answer:<br />
(please tick only one box)<br />
Tend to Tend to<br />
Strongly agree Agree Disagree Strongly disagree<br />
Question 4.<br />
Assuming you are solvent and living in a comfortable lifestyle, in addition to<br />
whatever you own you have been given 1,000 on condition that you choose one<br />
option from the following two:<br />
� You may gamble the 1,000 - with a 50% chance of winning, in which case<br />
you keep the whole 1,000, and a 50% chance of losing, in which case you lose<br />
all the money<br />
Or<br />
� You may keep 500 of the 1,000 without gambling<br />
Please express your opinion on the following statement:<br />
Gambling the 1,000 is a better choice.<br />
Answer:<br />
(please tick only one box)<br />
Tend to Tend to<br />
Strongly agree Agree Disagree Strongly disagree<br />
~ 44 ~
THE INVESTIGATION OF ROMANIAN AUDITORS'<br />
PERCEPTIONS OVER THE INTERNAL AUDIT<br />
PRACTICES - AN ATTEMPT TO IDENTIFY THE BEST<br />
PRACTICES IN THE CONTEXT OF CORPORATE<br />
GOVERNANCE<br />
Cristina BOTA-AVRAM 1<br />
Babes-Bolyai University, Romania<br />
ABSTRACT<br />
The main purpose of this study is to explore based on an empirical study, the Romanian<br />
auditors’ perceptions over the internal audit practices that should be included into an<br />
integrated framework of good audit practices in the context of corporate governance. It is<br />
also aims to investigate the actual applicability of the proposed internal audit practices. The<br />
research tool used was represented by the e-mail questionnaire, addressed to a sample of<br />
members of Chambers of Financial Auditors of Romania. Even if the response rate was not<br />
quite significant, the value of the paper is argued by the fact that these first results, combined<br />
with other research tools (probably more effective) that could be used in the next research<br />
activities, could represent a significant starting point in developing an integrated framework<br />
of good internal audit practices in the context of corporate governance.<br />
KEYWORDS: internal auditing, Romanian auditors, corporate governance, good practices,<br />
auditors’ perception<br />
INTRODUCTION<br />
The events that characterise the end of 20 th century and the beginning of 21 st century<br />
had been generated big pressures over the internal audit’s role and developments in<br />
the context of latest developments of corporate governance concept. In the last years,<br />
there are more and more specialists that all are agreed about the significance of<br />
internal audit position in the context of corporate governance (Leung, 2003; Whitley;<br />
Paape, 2007; Allen, 2008). Internal audit’s position is even more important as it is<br />
strategically located at the meeting point of the interests of management, board of<br />
directors and other stakeholders (Allen, 2008). Also, there are big pressures over the<br />
chief internal auditor who should be in full knowledge of all the key elements of<br />
corporate governance framework in order to be able to identify those areas where<br />
internal audit could provide a real added value by enhancing the effectiveness of<br />
corporate governance process (Leung, 2003).<br />
In the context of latest developments of corporate governance process, it is more and<br />
more highlighted the idea of internal’s audit approach as an integral part of the<br />
1<br />
Correspondence address: Cristina BOTA-AVRAM, Babeş-Bolyai University, Romania; email:<br />
botaavram@gmail.com<br />
~ 45 ~
corporate governance framework, so internal audit should become more active,<br />
playing a significant role as one of the key role players in the effectiveness of<br />
managing businesses (Paape, 2003; Allen 2008). The expectations of management<br />
and board of directors and not only from the chief internal auditor and his department<br />
are strongly increasing. It’s become absolutely necessary for the internal auditors to<br />
develop a global vision over the key elements of corporate governance, looking for<br />
solutions that could ensure the enhancing of their activities and their skills and<br />
abilities for the assessment and monitoring of those key elements, in order to ensure<br />
the effectiveness of corporate governance mechanisms.<br />
Also, the global economic crisis that strongly affected the world economy starting<br />
with 2008 was another reason that put the light over the real added value provided by<br />
internal audit, especially in the context of corporate governance and risk management.<br />
From the beginning of global economic crisis, there were many organisms and<br />
organisations that tried to identify the major factors as being determinant in issuing<br />
this economic crisis. A report realized by a group of seven supervisory agencies like<br />
the French Banking Commission, the German Federal Financial Supervisory<br />
Authority, the Swiss Federal Banking Commission, the U.K. Financial Services<br />
Authority, and, in the United States, the Office of the Comptroller of the Currency,<br />
the Securities and Exchange Commission, and the Federal Reserve Bank of New York<br />
(Senior Supervisors Group, 2008) emphasized the weakness and shortcomings of risk<br />
management and its failure in the in the process of identifying and effective<br />
management of various groups of risks, due to an increasing complexity of services<br />
offered and because of risky nature of business conducted as a relevant negative factor<br />
that was determinant in issuing the present economic crisis.<br />
The impact of such factors like weak management and inefficient corporate<br />
governance was also underlined at the European Conference on Corporate<br />
Governance (8th European Corporate Governance Conference), held in Stockholm in<br />
December 2009, where it had been given important critics to the audit function about<br />
its weakness and ineffectiveness in fighting against to a poor corporate governance<br />
and against to a weak risk management process. In this context, the role of internal<br />
audit should be to provide a reasonable assurance over the effectiveness of risk<br />
management. But it is not internal audit’s responsibility to take some actions response<br />
in order to face the negative risks identified. So, internal audit is not responsible to<br />
implement the action response to prevent the identified risks, but its main<br />
responsibility is to provide to management relevant reports over the assessment of key<br />
risks and the effectiveness of all these categories of risks (Leech, 2008).<br />
The above were presented only few factors that increased the pressures over internal<br />
audit function to look for developing of a set of good audit practices, especially in the<br />
context of corporate governance, so internal audit to be able to prove its quality of real<br />
added value provider. The investigation over the auditor’s perception over the good<br />
audit practices could provide a significant starting point in developing such a<br />
framework that could integrate relevant internal audit practices, especially in the<br />
context of the necessity to improve those audit practices within an emergent economy<br />
like the Romanian one.<br />
~ 46 ~
1. ROLE AND PRACTICES OF INTERNAL AUDIT IN CORPORATE<br />
GOVERNANCE – BACKGROUND LITERATURE<br />
The International Standards for the Professional Practice of Internal Auditing<br />
(Standards) issued by The Internal Auditing Standards Board of The Institute of<br />
Internal Auditors (IIA) – last version issued in October 2008 and revised in October<br />
2010 states in the Glossary part that the value added provided by internal audit<br />
activity is proved “when it provides objective and relevant assurance, and contributes<br />
to the effectiveness and efficiency of governance, risk management and control<br />
processes” (IIA, 2011). In fact, Standard 2110 - Governance emphasized more<br />
exactly which must be the role of internal audit in the process of corporate<br />
governance.<br />
Figure 1. Role of internal audit in governance – vision of IIA standards<br />
(Source: adaptation after Standard 2110 – Governance)<br />
Also, the previous versions of IIA internal auditing standards were emphasizing the<br />
role and contribution of internal audit in the context of ensuring good corporate<br />
governance. Under these circumstances, in the international speciality literature there<br />
could be identified a lot of relevant papers and articles with relevant findings in the<br />
highlighting of internal audit’s contribution and good practices in the corporate<br />
governance (Baker and Owsen, 2002; Vinten, 2002; Melville, 2003; Paape et al.,<br />
2003; KPMG, 2003; Gramling et al., 2004; Yakhou and Dorweiller, 2005; Whitley,<br />
2005; Sarrens and De Beelde, 2006; Gramling and Hermanson, 2006; Zain and<br />
Subramaniam, 2007; Allen, 2008; Archambeault et al., 2008; Ray, 2009; Sarrens,<br />
2009; Arena and Azzone, 2009; Sarrens et al., 2009; Sarrens and Abdolmohammadi,<br />
2011). Next, our intention is to summarize the most significant internal audit practices<br />
identified in the context of corporate governance from author’s point of view, without<br />
claiming that it’s a global and exhaustive synthesis.<br />
Whitley (2005) highlights through his study the main steps that internal audit should<br />
fulfil in order to provide its contribution to the corporate governance system, of which<br />
the most important are:<br />
• Internal audit must assist the board in the self assessment of its governance;<br />
~ 47 ~
• Internal audit has to promote to the audit committee best ideas on good<br />
practices for internal controls and risks management processes;<br />
• Internal audit has to include in its audit plan some major objectives like<br />
information and transparency in the annual audit plan.<br />
• Internal audit should be preoccupied to review the ethical code and ethical<br />
politics of the company in order to ensure there are correctly and delivered<br />
timely to the employees of the company.<br />
• Internal audit should look for the solutions to enhance the effectiveness of<br />
assurance activities focused on compliance, aiming to reduce the long terms<br />
costs.<br />
A valuable synthesis of the main good practices through internal audit could deliver<br />
more added-value to the corporate governance it is also realised by Allen (2008). In<br />
his vision, internal audit should be approached as “a stronger player in the<br />
governance team, and smart boards could obtain a highly valuable source of<br />
expertise by assuring this position to the internal audit function” (Allen, 2008). In the<br />
context of new challenges that internal audit have to face it in the light of recently<br />
economic turbulences, Allen (2008) highlights the main good internal audit practices<br />
through the effectiveness of corporate governance could be really enhanced:<br />
• Internal auditors should occupy a strategic position where the interests of<br />
management, boards and stakeholders intersect. In this way, internal auditors<br />
could identify what could be done for companies to become more risk<br />
intelligent.<br />
• Internal auditors could contribute to better governance by highlighting<br />
significant connections between various parts of the organization and different<br />
kinds of risks.<br />
• Internal auditors could serve as advocates for using non-financial metrics to<br />
help manage risk and to help discover new value and develop competitive<br />
advantage. In this direction, Allen (2008) points out the vital role that internal<br />
audit could play by consulting with management on which nonfinancial<br />
metrics may be more useful.<br />
• Also, internal audit could have a strong contribution for the enhancing of<br />
entity’s ethical conscience.<br />
Analysing the internal audit’s role in modern corporate governance, KPMG developed<br />
a relevant report through there are proposed some significant guidelines in the<br />
developing of internal audit good practices in the context of modern corporate<br />
governance. Most relevant internal audit good practices promoted by KPMG’s report<br />
(KPMG, 2003) are including:<br />
• The necessity to assure the independence guidelines for internal audit which<br />
are referring at least at:<br />
� Internal audit function must be independent of the audited activities and<br />
also must be independent from every day internal processes.<br />
� Internal audit must be able to exercise its mission on its own initiative in all<br />
departments, establishments and functions of the entity.<br />
� Internal audit must be free to report and to disclose all its findings.<br />
� The head of internal audit department should have the authority to<br />
communicate directly and on his initiative to the board, to the chairman of<br />
the board and to the audit committee and its chairman.<br />
~ 48 ~
• Internal audit assist the board in fulfilling its corporate governance<br />
responsibilities. In this direction, KPMG’s report emphasizes the key roles of<br />
internal audit in assisting the board and its audit committee in accomplishing<br />
its governance responsibilities, these key roles assuming at least a deliverance<br />
of next issues like:<br />
� An objective evaluation of the existing risk and internal control framework.<br />
� Systematic analysis of business processes and associated controls.<br />
� Reviews of the existence and value of assets.<br />
� A source of information on major frauds and irregularities.<br />
� Ad hoc reviews of other areas of concern, including unacceptable levels of<br />
risk.<br />
� Reviews of the compliance framework and specific compliance issues.<br />
� Reviews of operational and financial performance.<br />
� Recommendations for more effective and efficient use of resources.<br />
� Assessments of the accomplishment of corporate goals and objectives.<br />
� Feedback on adherence to the organisation’s values and code of<br />
conduct/code of ethics (KPMG, 2003).<br />
• Also, KPMG’s report states that internal audit should have the ability to<br />
transcend all departments without fear of limitation of scope.<br />
• The board/audit committee should have the ability to directly and critically<br />
analyse and evaluate the internal audit function about its contribution to the<br />
fulfilment of the board’s responsibility for internal controls.<br />
One of the most significant organizations at European level from internal audit’s point<br />
of view – European Confederation of Institutes of Internal Auditing (ECIIA)<br />
developed a survey at European level over the role of internal audit in corporate<br />
governance in Europe aiming to identify its current status, the necessary<br />
improvements and future tasks that should be accomplished. Based on a survey<br />
realised between all national institutes of internal auditing in Europe, ECIIA (2007)<br />
report realised to develop a widespread picture of corporate governance activities and<br />
internal audit developments in European context, in the same time looking for the<br />
answers at some questions over the current involvement of internal audit in corporate<br />
governance process, and finally to develop a set of proposals for good practices in<br />
order to improve the role of internal audit in European corporate governance.<br />
It’s obviously the amplitude and the increasing number of researches dedicated to<br />
the investigation of the role of internal audit in corporate governance at international<br />
level. A strong preoccupation could be also identified at national level, even if it is<br />
not as well debated as at international level. Through their papers, Romanian<br />
researchers (Dobroteanu and Dobroteanu, 2006; Manolescu and Roman, 2007;<br />
Stanciu and Eden, 2007; Weaver, 2008; Morariu et al., 2008; Zapodeanu et al.,<br />
2009; Morariu et al., 2009; Sgardea et al., 2009; Manolescu et al., 2010; Dobroteanu<br />
et al., 2011) aim to identify essential aspects of corporate governance according to<br />
its latest evolutions at international level.<br />
~ 49 ~
Figure 2. Proposals for enhancing the role and practices of internal audit in European<br />
corporate governance<br />
(Source: an adaption after ECIIA, 2007)<br />
~ 50 ~
But there are only few papers that follow to identify the good internal audit practices<br />
in the context of corporate governance. In this direction, a relevant contribution is<br />
given by Stanciu and Eden (2007), which discussed in their paper the increasing role<br />
of internal audit in corporate governance, but also the management expectations<br />
related to the internal audit’s added value at corporate governance. Based on their<br />
practical experience on internal audit activity and a strong background literature,<br />
Stanciu and Eden (2007) deliver a lot of relevant suggestions for enhancing internal<br />
audit activity, especially in national context, in order to ensure internal audit is<br />
providing real added-value to risk management and corporate governance processes.<br />
In the same direction, Morariu et al (2009) emphasizes the necessity of building a<br />
strong partnership between internal auditor and management, as a premise for the<br />
increasing real added-value delivered by internal audit, in the context of developing<br />
the competencies supported by the implementing of a rational internal control<br />
system.<br />
From author’s knowledge till that moment there aren’t developed papers over the<br />
investigation of auditors’ perception regarding the good internal audit practices that<br />
should be taken in consideration especially in Romanian context. From this point of<br />
view, the author’s opinion is that a research dedicated to the identifying of good<br />
internal audit practices from corporate governance’s point of view deserves to pay a<br />
lot of attention in research efforts, even if a research like the one developed within<br />
this paper could be considered only a starting point due to the difficulty and<br />
complexity of discussed subject.<br />
2. RESEARCH METHODOLOGY DEVELOPMENT<br />
2.1. Scientific approach<br />
The present study is based on fundamental type of scientific research, under the<br />
auspices of mainstream research, in the construction of research methodology being<br />
included both quantitative and qualitative elements. Based on the relevant literature<br />
that was reviewed with a focus on mainly research developments with significant<br />
theoretical and practical implications for the internal audit’s role and practices in the<br />
field of corporate governance it was develop a summary of main internal audit<br />
practices that should be taken in consideration into an integrated framework of good<br />
audit practices in the corporate governance’s area.<br />
These internal audit practices were, then, tested based on empirical study developed in<br />
order to highlight the Romanian auditors’ perception over the internal audit practices<br />
in corporate governance area. For the internal audit practices tested through this<br />
survey, there were tested two main criteria like:<br />
• Proposals for good practices - The agreement or disagreement of inclusion of<br />
identified internal audit practices into a set of good practices from<br />
respondents’ point of view<br />
• Applicability - The actual applicability of the proposed internal audit<br />
practices.<br />
~ 51 ~
2.2. The purpose and objectives of the empirical study<br />
The purpose of this study was to develop a starting point in the process of identifying<br />
the good internal audit practices in the context of corporate governance, without<br />
claiming that there were identified the most relevant internal audit practices. More<br />
specifically, the main objectives of the present study were:<br />
• To obtain a synthetic view from the Romanian auditors’ point of view regarding<br />
the good internal audit practices that should be taken in consideration.<br />
• To test the real applicability of the proposed internal audit practices from the<br />
respondents’ point of view<br />
• To try to obtain other proposals of good practices from respondents, that should<br />
also be taken in consideration.<br />
Based on literature review develop until this moment, it was made a selection of the<br />
most significant and relevant audit practices, all these being included in questionnaire<br />
used to develop this present study. In Table no.1 are summarised all these internal<br />
audit practices over it was tested the auditors’ perception from their proposal but also<br />
from their applicability point of view.<br />
Table 1. The synthesis of internal audit practices proposed and tested<br />
within this present study<br />
No. The internal audit practices proposed within this study<br />
1. Internal audit should be placed in the hierarchical structure of the entity in order to ensure the greatest<br />
independence as possible.<br />
2. Internal audit should develop a strong partnership with external audit, based on mutual trust.<br />
3. Chief of internal audit department should have regular meetings with the chairman of the audit committee,<br />
so that between them being developed a relationship based on mutual trust.<br />
4. Internal audit carries out its activities taking in consideration the strategic and operational risks identified at<br />
the level of each major function within the entity.<br />
5. Internal audit communicate to the external auditor the risk categories identified at the level of financialaccounting<br />
function, the deficiencies discovered and also the recommendations issued.<br />
6. Internal audit should provide the support in the reviewing of ethical code and politics for ensuring there are<br />
correctly and timely communicated to the employees.<br />
7. Internal audit should realise an analysis and systematically assessment of the main functions within the<br />
entity, but also to the internal control procedures related to them.<br />
8. Internal audit should be a relevant source of information on major fraud and irregularities.<br />
9. The recommendations issued by internal audit should be focused firstly for more effective and efficient use<br />
of resources.<br />
10. Internal audit should made an assessment of the accomplished of corporate goals and objectives.<br />
11. Internal audit assists board/audit committee in self-assessment of its corporate governance effectiveness.<br />
12. Internal audit should develop an internal audit charter complementary with the one of the audit committee.<br />
13. Internal audit should promote to the audit committee the best practices over the internal controls procedures<br />
and risk management.<br />
~ 52 ~
14. Internal audit should discussed with the audit committee the internal audit plan, major findings that have<br />
resulted from internal audit work activities, but also major information about the monitoring of follow-up of<br />
audit findings.<br />
15. Internal audit should include in the internal audit plan, the objectives that are referring at the providing of<br />
accurate and transparent information.<br />
16. Internal audit is preoccupied by the identification of relevant opportunities for the ensuring of assurance<br />
activities from compliance’s point of view, aiming to reduce long term costs.<br />
17. Chief of internal audit department should communicate to the audit committee the illegal acts or<br />
irregularities perpetuated or tolerated by management.<br />
18. Internal audit should develop a balanced partnership with management, based on mutual trust.<br />
19. Internal audit should have regular meetings with management in order to inform over the entity’ strategies,<br />
the changes in risks profiles, but also over the major changes in entity’ policies and procedures.<br />
20. Internal audit is not responsible for implementing a good corporate governance, risk management or internal<br />
control system, but it should provide a strong support for the increasing of their effectiveness.<br />
21. Internal audit is consulted about the choice/changing of external audit firm that would realise the external<br />
audit.<br />
22. Internal audit should monitor the follow-up of internal audit, but also external audit recommendations,<br />
communicating the results to the audit committee.<br />
23. Internal audit, with the audit committee’s approval might propose the internal audit report’s publication for<br />
the ensuring a greater transparency required by a good corporate governance.<br />
(Source: a projection made by author based on relevant literature review)<br />
2.3. The tools and sample used<br />
This empirical study was based on a emailed questionnaire sent to members of<br />
Chambers of Financial Auditors of Romania (CAFR) working in various positions:<br />
external auditor or internal auditor. The questionnaire as research technique was used<br />
in conjunction with the sample as a tool research. The sample used in this research<br />
was determined starting from the members of professional body which coordinates the<br />
audit activity (internal and external) at national level. Thus, our statistical population<br />
included the active members of CAFR, whose email and contact details were<br />
available on the CAFR’s website. The period for developing this research was<br />
February – March 2011. In spite of its disadvantages, the option for using the e-mail<br />
questionnaire was argued by the necessity of including in the sample a large number<br />
of respondents, while an alternative direct approach would be quite difficult.<br />
The questionnaire used was developed on next sections:<br />
1. Part I – General Information<br />
2. Part II – Perceptions over internal audit’s role and practices in corporate<br />
governance<br />
3. Part IV - Perceptions over external audit’s role and practices in corporate<br />
governance<br />
4. Part V - Perceptions over audit committee’s role and practices in corporate<br />
governance<br />
The specific objective of this paper is to analyse the results of Part I and Part II, more<br />
exactly, the respondent’ perceptions over the internal audit’s contribution and good<br />
practices in the context of corporate governance. It is necessary to mention that for<br />
~ 53 ~
each section, the respondent had the possibility to propose another good audit<br />
practices, beside the ones mentioned within the questionnaire, because as it was<br />
mentioned before, this study claims to be only a starting point in the identifying the<br />
best audit practices in the field of corporate governance. The sample used in this<br />
survey is presented in Table no.2.<br />
Table 2. Sample used and response rate obtain in the present study<br />
Sample of members CAFR selected 1 924<br />
Invalid email contacts 2 386<br />
Valid contacts 3=1-2 538<br />
Respondents with no audit experience 4 67<br />
Final sample 5=3-4 471<br />
Questionnaires received 6 44<br />
First response rate 7= 6/5*100 9,34%<br />
Invalid questionnaires 8 20<br />
Final number of valid questionnaires 9=6-8 24<br />
Final response rate 10= 9/5*100 5,10%<br />
(Source: projection made by the author)<br />
Unfortunately, from the first sample, a quite big numbers of selected contacts proved<br />
to be invalid due to the failures messages received at the mail delivery. After the<br />
questionnaire was sent there were some respondents that honestly admitted they have<br />
the quality of member CAFR, but they don’t have enough or not all audit experience<br />
(67 respondents). From the total of 44 received questionnaires, a significant number<br />
of 20 questionnaires were considered invalid due to some errors in proper fulfilling of<br />
questionnaires. The first part was included general information about the respondents,<br />
especially about their professional experience. In the final lot of valid questionnaires<br />
there were not included the questionnaires completed by the respondents with no audit<br />
experience, starting from their statement about their professional experience.<br />
3. DISCUSSION OF RESULTS<br />
3.1. The analysis of results<br />
Even if the statistic literature admits as being reasonable a rate of response of at least<br />
5 % (Rotariu and Ilut, 2006), our common sense can’t afford us to accept the obtained<br />
response rate (only 5,10%) as being a quite relevant one. But in spite of this great<br />
disadvantage, that we have to admit we were aware from the very beginning when we<br />
decided to use such a research tool, we still believe that the relevancy of our findings<br />
are consistent in the manner they will be considered as a starting point in developing<br />
more complexes researches by using also in conjunction with other research tools.<br />
Shih and Fan (2009) develop an interesting meta-analysis of comparing response rates<br />
in email and paper surveys. Their meta-analysis showed that e-mail survey mode<br />
generally has considerably lower response rate than traditional mail survey mode<br />
regardless of other survey characteristics (e.g. target population, use of reminders for<br />
non-respondents, use of incentives). Also, another supposition of Shih and Fan (2009)<br />
is that lower response rate in e-mail survey might partially be the result of prevalent<br />
junk/spam e-mails nowadays, which may have caused many potential respondents to<br />
ignore legitimate e-mail surveys. But in spite of these disadvantages, Shih and Fan<br />
(2009) are agreed that this does not necessarily mean that e-mail survey should not<br />
~ 54 ~
have its place in the repertoire of survey researchers. There shouldn’t be ignored the<br />
advantages of e-mail survey like:<br />
� a shorter response time,<br />
� considerably lower survey cost,<br />
� capability of reaching a large sample of respondents,<br />
� knowledge about whether an e-mail survey has been delivered to the correct email<br />
address, etc.<br />
Shih and Fan (2009) sustain that these unique characteristics of e-mail survey make it<br />
a significant tool for survey researchers in some research situations, in spite of its<br />
inferiority in terms of survey response rate currently shown in the recent literature.<br />
As could be noticed from Table no.3, from the total of our final sample of<br />
respondents, 70,8% were represented by members of Chambers of Financial Auditors<br />
of Romania (CAFR) working on internal auditor position, while 29,2% state they are<br />
working as external auditor. From the final sample, there had been removed the<br />
questionnaires completed by respondents working on other positions like manager,<br />
due to the main objectives of this study – the investigation of auditors’ perception<br />
over the internal audit’s role and good practices.<br />
Analysing their professional experience, as it is presented in Table no.3, over 70% of<br />
our respondents state they have a professional experience on the audit activity over 5<br />
years. We assume that this significant proportion of the respondents with relevant<br />
professional experience could be considered as an important argument in considering<br />
the findings of this survey as a good starting point in developing an integrated<br />
framework of good practices in the context of corporate governance.<br />
The respondents’ position<br />
Table 3. The professional experience of respondents<br />
under 2 years<br />
Professional experience<br />
~ 55 ~<br />
between 2 and 5<br />
years over 5 years Total<br />
Internal auditor 8,3% 12,5% 50,0% 70,8%<br />
External auditor<br />
8,3%<br />
0.0%<br />
20,8% 29,2%<br />
Total 16,7% 12,5% 70,8% 100,0%<br />
(Source: a projection made by the author by using SPSS 16)<br />
For all internal audit practices mentioned above in Table no.1, the purpose of this<br />
study was to investigate the auditors’ perception from the point of view of:<br />
� Their proposal for inclusion into a set of good practices for internal audit<br />
activity. Thus the respondents had the possibility to express their agreement or<br />
disagreement about the proposals of internal audit practices by using Likert<br />
Scale where:<br />
(1) – Strongly disagree;<br />
(2) – Disagree;<br />
(3) – Not sure;<br />
(4) – Agree;<br />
(5) – Strongly agree.
� Their actual applicability was tested by using also Likert scale, where:<br />
(1) – Unknown;<br />
(2) – Known, but never applied;<br />
(3) – Known, but rarely applied;<br />
(4) – Known and often applied;<br />
(5) – Known and always applied.<br />
Next, in Table no.4 and Table no.5 there are presented the frequencies obtained for<br />
the tested internal audit practices from both point of view: their proposal and their<br />
applicability.<br />
No. Proposals for internal audit practices<br />
1 Internal audit should be placed in the<br />
hierarchical structure of the entity in<br />
order to ensure the greatest<br />
2<br />
independence as possible.<br />
Internal audit should develop a strong<br />
partnership with external audit, based<br />
on mutual trust.<br />
3 Chief of internal audit department<br />
should have regular meetings with the<br />
chairman of the audit committee, so that<br />
between them being developed a<br />
relationship based on mutual trust.<br />
4 Internal audit carries out its activities<br />
taking in consideration the strategic and<br />
operational risks identified at the level<br />
Table 4 Proposals for internal audit practices<br />
of each major function within the entity.<br />
5 Internal audit communicate to the<br />
external auditor the risk categories<br />
identified at the level of financialaccounting<br />
function, the deficiencies<br />
discovered and also the<br />
recommendations issued.<br />
6 Internal audit should provide the<br />
support in the reviewing of ethical code<br />
and politics for ensuring there are<br />
correctly and timely communicated to<br />
the employees.<br />
7 Internal audit should realise an analysis<br />
and systematically assessment of the<br />
main functions within the entity, but<br />
also to the internal control procedures<br />
related to them.<br />
8 Internal audit should be a source of<br />
information on major fraud and<br />
irregularities.<br />
9 The recommendations issued by<br />
internal audit should be focused firstly<br />
for more effective and efficient use of<br />
resources.<br />
10 Internal audit should made an<br />
assessment of the accomplished of<br />
corporate goals and objectives.<br />
~ 56 ~<br />
Response options<br />
(1) (2) (3) (4) (5)<br />
Total<br />
0% 0% 17% 13% 71% 100%<br />
0% 0% 17% 17% 67% 100%<br />
0% 8% 21% 13% 58% 100%<br />
0% 0% 13% 17% 71% 100%<br />
0% 0% 29% 17% 54% 100%<br />
0% 4% 17% 29% 50% 100%<br />
0% 0% 13% 17% 71% 100%<br />
0% 0% 21% 13% 67% 100%<br />
0% 0% 21% 25% 54% 100%<br />
0% 8% 17% 25% 50% 100%
11 Internal audit assists board/audit<br />
committee in self-assessment of its<br />
corporate governance effectiveness.<br />
12 Internal audit should develop an<br />
internal audit charter complementary<br />
with the one of the audit committee.<br />
13 Internal audit should promote to the<br />
audit committee the best practices over<br />
the internal controls procedures and risk<br />
management.<br />
14 Internal audit should discussed with the<br />
audit committee the internal audit plan,<br />
major findings that have resulted from<br />
internal audit work activities, but also<br />
major information about the monitoring<br />
of follow-up of audit findings.<br />
15 Internal audit should include in the<br />
internal audit plan, the objectives that<br />
are referring at the providing of<br />
accurate and transparent information.<br />
16 Internal audit is preoccupied by the<br />
identification of relevant opportunities<br />
for the ensuring of assurance activities<br />
from compliance’s point of view,<br />
aiming to reduce long term costs.<br />
17 Chief of internal audit department<br />
should communicate to the audit<br />
committee the illegal acts or<br />
irregularities perpetuated or tolerated by<br />
management.<br />
18 Internal audit should develop a<br />
balanced partnership with management,<br />
based on mutual trust.<br />
19 Internal audit should have regular<br />
meetings with management in order to<br />
inform over the entity’ strategies, the<br />
changes in risks profiles, but also over<br />
the major changes in entity’ policies<br />
and procedures.<br />
20 Internal audit is not responsible for<br />
implementing a good corporate<br />
governance, risk management or<br />
internal control system, but it should<br />
provide a strong support for the<br />
increasing of their effectiveness.<br />
21 Internal audit is consulted about the<br />
choice/changing of external audit firm<br />
that would realise the external audit.<br />
22 Internal audit should monitor the<br />
follow-up of internal audit, but also<br />
external audit recommendations,<br />
communicating the results to the audit<br />
committee.<br />
4% 13% 33% 13% 38% 100%<br />
8% 13% 21% 25% 33% 100%<br />
0% 8% 29% 8% 54% 100%<br />
0% 4% 13% 13% 71% 100%<br />
0% 8% 13% 33% 46% 100%<br />
0% 4% 17% 33% 46% 100%<br />
0% 0% 17% 8% 75% 100%<br />
0% 4% 12% 29% 54% 100%<br />
0% 4% 17% 29% 50% 100%<br />
0% 0% 29% 17% 54% 100%<br />
8% 13% 29% 25% 25% 100%<br />
0% 0% 17% 25% 58% 100%<br />
23 Internal audit, with the audit<br />
committee’s approval might propose<br />
the internal audit report’s publication<br />
for the ensuring a greater transparency<br />
4% 8% 38% 17% 33% 100%<br />
required by a good corporate<br />
governance.<br />
(Source: a projection made by the author by using SPSS 16)<br />
~ 57 ~
Table 5 Application of the proposed internal audit practices<br />
No. Actual application of internal audit practices<br />
1<br />
Internal audit should be placed in the<br />
hierarchical structure of the entity in order to<br />
ensure the greatest independence as possible.<br />
2 Internal audit should develop a strong<br />
partnership with external audit, based on<br />
mutual trust.<br />
3 Chief of internal audit department should have<br />
regular meetings with the chairman of the audit<br />
committee, so that between them being<br />
developed a relationship based on mutual trust.<br />
4 Internal audit carries out its activities taking in<br />
consideration the strategic and operational risks<br />
identified at the level of each major function<br />
within the entity.<br />
5 Internal audit communicate to the external<br />
auditor the risk categories identified at the level<br />
of financial-accounting function, the<br />
deficiencies discovered and also the<br />
recommendations issued.<br />
6 Internal audit should provide the support in the<br />
reviewing of ethical code and politics for<br />
ensuring there are correctly and timely<br />
communicated to the employees.<br />
7 Internal audit should realise an analysis and<br />
systematically assessment of the main<br />
functions within the entity, but also to the<br />
internal control procedures related to them.<br />
8<br />
Internal audit should be a source of information<br />
on major fraud and irregularities.<br />
9 The recommendations issued by internal audit<br />
should be focused firstly for more effective and<br />
efficient use of resources.<br />
10 Internal audit should made an assessment of the<br />
accomplished of corporate goals and<br />
objectives.<br />
11 Internal audit assists board/audit committee in<br />
self-assessment of its corporate governance<br />
effectiveness.<br />
12 Internal audit should develop an internal audit<br />
charter complementary with the one of the<br />
audit committee.<br />
13 Internal audit should promote to the audit<br />
committee the best practices over the internal<br />
controls procedures and risk management.<br />
14 Internal audit should discussed with the audit<br />
committee the internal audit plan, major<br />
findings that have resulted from internal audit<br />
work activities, but also major information<br />
about the monitoring of follow-up of audit<br />
findings.<br />
15 Internal audit should include in the internal<br />
audit plan, the objectives that are referring at<br />
the providing of accurate and transparent<br />
information.<br />
~ 58 ~<br />
Response options<br />
(1) (2) (3) (4) (5)<br />
Total<br />
0% 4% 37% 42% 17% 100%<br />
0% 4% 50% 29% 17% 100%<br />
8% 17% 38% 29% 8% 100%<br />
0% 4% 38% 33% 25% 100%<br />
0% 8% 42% 38% 13% 100%<br />
13% 17% 33% 29% 8% 100%<br />
4% 8% 33% 46% 8% 100%<br />
4% 4% 42% 29% 21% 100%<br />
0% 4% 42% 25% 29% 100%<br />
8% 8% 54% 21% 8% 100%<br />
17% 17% 42% 21% 4% 100%<br />
21% 8% 46% 25% 0% 100%<br />
8% 13% 38% 42% 0% 100%<br />
8% 4% 17% 42% 29% 100%<br />
13% 4% 38% 33% 13% 100%
16 Internal audit is preoccupied by the<br />
identification of relevant opportunities for the<br />
ensuring of assurance activities from<br />
compliance’s point of view, aiming to reduce<br />
long term costs.<br />
17 Chief of internal audit department should<br />
communicate to the audit committee the illegal<br />
acts or irregularities perpetuated or tolerated by<br />
management.<br />
18 Internal audit should develop a balanced<br />
partnership with management, based on mutual<br />
trust.<br />
19 Internal audit should have regular meetings<br />
with management in order to inform over the<br />
entity’ strategies, the changes in risks profiles,<br />
but also over the major changes in entity’<br />
policies and procedures.<br />
20 Internal audit is not responsible for<br />
implementing a good corporate governance,<br />
risk management or internal control system, but<br />
it should provide a strong support for the<br />
increasing of their effectiveness.<br />
21 Internal audit is consulted about the<br />
choice/changing of external audit firm that<br />
would realise the external audit.<br />
22 Internal audit should monitor the follow-up of<br />
internal audit, but also external audit<br />
recommendations, communicating the results<br />
to the audit committee.<br />
~ 59 ~<br />
8% 8% 50% 25% 8% 100%<br />
8% 4% 21% 42% 25% 100%<br />
0% 8% 42% 42% 8% 100%<br />
0% 17% 46% 29% 8% 100%<br />
0% 8% 46% 33% 13% 100%<br />
8% 8% 50% 25% 8% 100%<br />
4% 13% 25% 38% 21% 100%<br />
23 Internal audit, with the audit committee’s<br />
approval might propose the internal audit<br />
report’s publication for the ensuring a greater<br />
transparency required by a good corporate<br />
governance.<br />
21% 33% 38% 8% 0% 100%<br />
(Source: a projection made by the author by using SPSS 16)<br />
Analysing the above tables, it could be noticed there are some internal audit practices<br />
like the internal audit practice no.1 (“Internal audit should be placed in the<br />
hierarchical structure of the entity in order to ensure the greatest independence as<br />
possible”) for which 71% of respondent are strongly agree, but only 17% state they<br />
are known and always applied, and 42% say that they are known and often applied.<br />
The same situation is also available for other practices like practice no.2 (“Internal<br />
audit should develop a strong partnership with external audit, based on mutual<br />
trust.”) or practice no.17 (“Chief of internal audit department should communicate to<br />
the audit committee the illegal acts or irregularities perpetuated or tolerated by<br />
management.”). For many of those practices there seems to be significant differences<br />
between the respondent’s perception over their proposals and their current<br />
applicability at this moment. We consider it as a sign that it’s time to review our<br />
current internal audit practices currently applied and see what changes are really<br />
necessary, especially in this difficult and volatile economic context. Next, in table<br />
no.6 and table no.7 for each internal audit practices it was calculated the basis<br />
statistical parameters, for both table the display order being descending means.
Table.6 Statistical parameters for proposals of internal audit practices<br />
Proposals of internal audit practices N Minimum Maximum Mean<br />
Internal audit carries out its activities taking in<br />
consideration the strategic and operational<br />
risks identified at the level of each major<br />
function within the entity.<br />
Chief of internal audit department should<br />
communicate to the audit committee the<br />
illegal acts or irregularities perpetuated or<br />
tolerated by management.<br />
Internal audit should realise an analysis and<br />
systematically assessment of the main<br />
functions within the entity, but also to the<br />
internal control procedures related to them.<br />
Internal audit should be placed in the<br />
hierarchical structure of the entity in order to<br />
ensure the greatest independence as possible<br />
Internal audit should discussed with the audit<br />
committee the internal audit plan, major<br />
findings that have resulted from internal audit<br />
work activities, but also major information<br />
about the monitoring of follow-up of audit<br />
findings.<br />
Internal audit should develop a strong<br />
partnership with external audit, based on<br />
mutual trust.<br />
Internal audit should be a relevant source of<br />
information on major fraud and irregularities.<br />
Internal audit should monitor the follow-up of<br />
internal audit, but also external audit<br />
recommendations, communicating the results<br />
to the audit committee.<br />
The recommendations issued by internal audit<br />
should be focused firstly for more effective<br />
and efficient use of resources.<br />
Internal audit should develop a balanced<br />
partnership with management, based on<br />
mutual trust.<br />
Internal audit should provide the support in<br />
the reviewing of ethical code and politics for<br />
ensuring there are correctly and timely<br />
communicated to the employees.<br />
Internal audit communicate to the external<br />
auditor the risk categories identified at the<br />
level of financial-accounting function, the<br />
deficiencies discovered and also the<br />
recommendations issued.<br />
Internal audit is not responsible for<br />
implementing a good corporate governance,<br />
risk management or internal control system,<br />
but it should provide a strong support for the<br />
increasing of their effectiveness.<br />
Internal audit should have regular meetings<br />
with management in order to inform over the<br />
entity’ strategies, the changes in risks profiles,<br />
but also over the major changes in entity’<br />
policies and procedures.<br />
~ 60 ~<br />
Std.<br />
Deviation<br />
24 3,00 5,00 4,5833 ,71728<br />
24 3,00 5,00 4,5833 ,77553<br />
24 3,00 5,00 4,5833 ,71728<br />
24 3,00 5,00 4,5417 ,77903<br />
24 2,00 5,00 4,5000 ,88465<br />
24 3,00 5,00 4,5000 ,78019<br />
24 3,00 5,00 4,4583 ,83297<br />
24 3,00 5,00 4,4167 ,77553<br />
24 3,00 5,00 4,3333 ,81650<br />
24 2,00 5,00 4,3333 ,86811<br />
24 2,00 5,00 4,2500 ,89685<br />
24 3,00 5,00 4,2500 ,89685<br />
24 3,00 5,00 4,2500 ,89685<br />
24 2,00 5,00 4,2500 ,89685
Chief of internal audit department should have<br />
regular meetings with the chairman of the<br />
audit committee, so that between them being<br />
developed a relationship based on mutual<br />
trust.<br />
Internal audit is preoccupied by the<br />
identification of relevant opportunities for the<br />
ensuring of assurance activities from<br />
compliance’s point of view, aiming to reduce<br />
long term costs.<br />
Internal audit should made an assessment of<br />
the accomplished of corporate goals and<br />
objectives.<br />
Internal audit should include in the internal<br />
audit plan, the objectives that are referring at<br />
the providing of accurate and transparent<br />
information.<br />
Internal audit should promote to the audit<br />
committee the best practices over the internal<br />
controls procedures and risk management.<br />
Internal audit, with the audit committee’s<br />
approval might propose the internal audit<br />
report’s publication for the ensuring a greater<br />
transparency required by a good corporate<br />
governance.<br />
Internal audit assists board/audit committee in<br />
self-assessment of its corporate governance<br />
effectiveness<br />
Internal audit should develop an internal audit<br />
charter complementary with the audit<br />
committee’s charter.<br />
Internal audit is consulted about the<br />
choice/changing of external audit firm that<br />
would realise the external audit.<br />
24 2,00 5,00 4,2083 1,06237<br />
24 2,00 5,00 4,2083 ,88363<br />
24 2,00 5,00 4,1667 1,00722<br />
24 2,00 5,00 4,1667 ,96309<br />
24 2,00 5,00 4,0833 1,10007<br />
24 1,00 5,00 3,6667 1,16718<br />
24 1,00 5,00 3,6667 1,23945<br />
24 1,00 5,00 3,6250 1,31256<br />
24 1,00 5,00 3,4583 1,25036<br />
Valid N (listwise) 24<br />
(Source: a projection made by the author by using SPSS 16)<br />
Table 7 Statistical parameters for application of internal audit practices<br />
Application of internal audit practices N Minimum Maximum Mean<br />
Internal audit should discussed with the audit<br />
committee the internal audit plan, major findings that<br />
have resulted from internal audit work activities, but<br />
also major information about the monitoring of<br />
follow-up of audit findings.<br />
The recommendations issued by internal audit should<br />
be focused firstly for more effective and efficient use<br />
of resources.<br />
Internal audit carries out its activities taking in<br />
consideration the strategic and operational risks<br />
identified at the level of each major function within<br />
the entity.<br />
Internal audit should be placed in the hierarchical<br />
structure of the entity in order to ensure the greatest<br />
independence as possible<br />
Chief of internal audit department should<br />
communicate to the audit committee the illegal acts or<br />
irregularities perpetuated or tolerated by management.<br />
~ 61 ~<br />
Std.<br />
Deviation<br />
24 1,00 5,00 3,7917 1,17877<br />
24 2,00 5,00 3,7917 ,93153<br />
24 2,00 5,00 3,7917 ,88363<br />
24 2,0 5,0 3,708 ,8065<br />
24 1,00 5,00 3,7083 1,16018
Internal audit should develop a strong partnership<br />
with external audit, based on mutual trust.<br />
Internal audit should monitor the follow-up of internal<br />
audit, but also external audit recommendations,<br />
communicating the results to the audit committee.<br />
Internal audit should be a relevant source of<br />
information on major fraud and irregularities.<br />
Internal audit communicate to the external auditor the<br />
risk categories identified at the level of financialaccounting<br />
function, the deficiencies discovered and<br />
also the recommendations issued.<br />
Internal audit should develop a balanced partnership<br />
with management, based on mutual trust.<br />
Internal audit is not responsible for implementing a<br />
good corporate governance, risk management or<br />
internal control system, but it should provide a strong<br />
support for the increasing of their effectiveness.<br />
Internal audit should realise an analysis and<br />
systematically assessment of the main functions<br />
within the entity, but also to the internal control<br />
procedures related to them.<br />
Internal audit should include in the internal audit plan,<br />
the objectives that are referring at the providing of<br />
accurate and transparent information.<br />
Internal audit should have regular meetings with<br />
management in order to inform over the entity’<br />
strategies, the changes in risks profiles, but also over<br />
the major changes in entity’ policies and procedures.<br />
Internal audit is preoccupied by the identification of<br />
relevant opportunities for the ensuring of assurance<br />
activities from compliance’s point of view, aiming to<br />
reduce long term costs.<br />
Internal audit should made an assessment of the<br />
accomplished of corporate goals and objectives.<br />
Chief of internal audit department should have regular<br />
meetings with the chairman of the audit committee, so<br />
that between them being developed a relationship<br />
based on mutual trust.<br />
Internal audit should promote to the audit committee<br />
the best practices over the internal controls<br />
procedures and risk management.<br />
Internal audit should provide the support in the<br />
reviewing of ethical code and politics for ensuring<br />
there are correctly and timely communicated to the<br />
employees.<br />
Internal audit assists board/audit committee in selfassessment<br />
of its corporate governance effectiveness<br />
Internal audit should develop an internal audit charter<br />
complementary with the audit committee’s charter.<br />
Internal audit is consulted about the choice/changing<br />
of external audit firm that would realise the external<br />
audit.<br />
Internal audit, with the audit committee’s approval<br />
might propose the internal audit report’s publication<br />
for the ensuring a greater transparency required by a<br />
good corporate governance.<br />
24 2,00 5,00 3,5833 ,82970<br />
24 1,00 5,00 3,5833 1,10007<br />
24 1,00 5,00 3,5833 1,01795<br />
24 2,00 5,00 3,5417 ,83297<br />
24 2,00 5,00 3,5000 ,78019<br />
24 2,00 5,00 3,5000 ,83406<br />
24 1,00 5,00 3,4583 ,93153<br />
24 1,00 5,00 3,2917 1,16018<br />
24 2,00 5,00 3,2917 ,85867<br />
24 1,00 5,00 3,1667 1,00722<br />
24 1,00 5,00 3,1250 ,99181<br />
24 1,00 5,00 3,1250 1,07592<br />
24 1,00 4,00 3,1250 ,94696<br />
24 1,00 5,00 3,0417 1,16018<br />
24 1,00 5,00 2,7917 1,10253<br />
24 1,00 4,00 2,7500 1,07339<br />
24 1,00 5,00 2,4167 1,05981<br />
24 1,00 4,00 2,3333 ,91683<br />
Valid N (listwise) 24<br />
(Source: a projection made by the author by using SPSS 16)<br />
~ 62 ~
Based on the above tables, we propose to develop a ranking for the good practices<br />
and uncertain practices, from both their proposal and their application, starting from<br />
the display order by descending means (first 5 means and last 5 means).<br />
From the point of view of their proposals, the good practices from the respondents’<br />
point of view are:<br />
� Internal audit carries out its activities taking in consideration the strategic and<br />
operational risks identified at the level of each major function within the entity.<br />
� Chief of internal audit department should communicate to the audit committee<br />
the illegal acts or irregularities perpetuated or tolerated by management.<br />
� Internal audit should realise an analysis and systematically assessment of the<br />
main functions within the entity, but also to the internal control procedures<br />
related to them.<br />
� Internal audit should be placed in the hierarchical structure of the entity in<br />
order to ensure the greatest independence as possible.<br />
� Internal audit should discussed with the audit committee the internal audit plan,<br />
major findings that have resulted from internal audit work activities, but also<br />
major information about the monitoring of follow-up of audit findings.<br />
� Internal audit should develop a strong partnership with external audit, based<br />
on mutual trust.<br />
� Internal audit should be a relevant source of information on major fraud and<br />
irregularities.<br />
� Internal audit should monitor the follow-up of internal audit, but also external<br />
audit recommendations, communicating the results to the audit committee.<br />
From the point of view of their proposals, the uncertain practices from the<br />
respondents’ point of view are (their mean is around 3,4-3,6 ):<br />
� Internal audit should include in the internal audit plan, the objectives that are<br />
referring at the providing of accurate and transparent information.<br />
� Internal audit should promote to the audit committee the best practices over the<br />
internal controls procedures and risk management.<br />
� Internal audit, with the audit committee’s approval might propose the internal<br />
audit report’s publication for the ensuring a greater transparency required by a<br />
good corporate governance.<br />
� Internal audit assists board/audit committee in self-assessment of its corporate<br />
governance effectiveness.<br />
� Internal audit should develop an internal audit charter complementary with the<br />
audit committee’s charter.<br />
� Internal audit is consulted about the choice/changing of external audit firm that<br />
would realise the external audit.<br />
From the point of view of their application, the good internal audit practices which<br />
are more applied, taking in consideration their mean (around 3,5-3,7, which means<br />
these practices are between rarely and often applied):<br />
� Internal audit should discussed with the audit committee the internal audit plan,<br />
major findings that have resulted from internal audit work activities, but also<br />
major information about the monitoring of follow-up of audit findings<br />
� The recommendations issued by internal audit should be focused firstly for<br />
more effective and efficient use of resources.<br />
~ 63 ~
� Internal audit carries out its activities taking in consideration the strategic and<br />
operational risks identified at the level of each major function within the entity..<br />
� Internal audit should be placed in the hierarchical structure of the entity in<br />
order to ensure the greatest independence as possible<br />
� Chief of internal audit department should communicate to the audit committee<br />
the illegal acts or irregularities perpetuated or tolerated by management.<br />
� Internal audit should develop a strong partnership with external audit, based<br />
on mutual trust.<br />
� Internal audit should monitor the follow-up of internal audit, but also external<br />
audit recommendations, communicating the results to the audit committee<br />
� Internal audit should be a relevant source of information on major fraud and<br />
irregularities.<br />
From the point of view of their application, the mostly unapplied internal audit<br />
practices taking in consideration their mean (between 2,3-3 which means these<br />
practices are never or quite rarely applied):<br />
� Internal audit should provide the support in the reviewing of ethical code and<br />
politics for ensuring there are correctly and timely communicated to the<br />
employees.<br />
� Internal audit assists board/audit committee in self-assessment of its corporate<br />
governance effectiveness.<br />
� Internal audit should develop an internal audit charter complementary with the<br />
audit committee’s charter.<br />
� Internal audit is consulted about the choice/changing of external audit firm that<br />
would realise the external audit.<br />
� Internal audit, with the audit committee’s approval might propose the internal<br />
audit report’s publication for the ensuring a greater transparency required by a<br />
good corporate governance.<br />
Analysing the good means from both their proposal and their application, it could be<br />
observe that, generally speaking, the mean obtain when speaking about their<br />
application is lower than the mean when speaking about their proposal, which could<br />
be understand as an agreement of the respondents for inclusion of those practices into<br />
an integrated framework of good internal audit practices in corporate governance, in<br />
spite of the fact that now there are only rarely or sometimes applied. The same<br />
situation seems to be available for the practices that from their proposal’s point of<br />
view are not so well agreed by the respondents, but in the same time they are never or<br />
quite rarely applied, even if these are known for the respondents.<br />
3.2. Limits of the developed study and suggestions for further research<br />
A major disadvantage of this study is represented by the response rate, which even is<br />
over 5% (as recommended in statistical literature), still our common sense couldn’t<br />
afford us to consider this response rate as being sufficient relevant. But, in spite of this<br />
great disadvantage, we still believe the value of this paper is proved by creating the<br />
necessary premises to develop a good starting point in the construction of an<br />
integrated framework of good audit practices in corporate governance.<br />
Also, another limit of our study is the short period for developing such a study,<br />
because we are perfectly aware that through the extension of the period for obtaining<br />
~ 64 ~
the answers and resending some follow-up mails to the respondents that didn’t answer<br />
at this questionnaire, it would be possible to obtain a greater response rate.<br />
Because of the small number of respondents, it wasn’t possible to develop a separate<br />
analysis over two distinct subsamples: internal auditors and external auditors, all<br />
having the quality of member of CAFR. But we are strongly convinced that such a<br />
separate analysis but of course in case of greater number of respondents could provide<br />
interesting results over the internal auditor but also external auditors’ perception over<br />
good audit practices in the corporate governance’s area.<br />
CONCLUSIONS<br />
From the results obtained it can be noticed that Romanian auditors are not quite open<br />
for the practices that could determine perhaps too much transparency necessary for a<br />
good corporate governance. Quite clear examples in that direction is given by the<br />
small mean obtain for the practice: “Internal audit, with the audit committee’s<br />
approval might propose the internal audit report’s publication for the ensuring a<br />
greater transparency required by good corporate governance” that mostly of the<br />
respondents were not sure about the utility of such a internal audit practice. If this<br />
result would be correlated with the current applicability of this practice, the<br />
conclusion would be the same, this practice obtaining the small mean from its<br />
application’s point of view.<br />
Also, there are other practices of internal audit that were not very well received by the<br />
respondents, neither from their proposal, nor from their application like the ones that<br />
are referring at the specific role of internal audit in corporate governance (for example<br />
“Internal audit assists board/audit committee in self-assessment of its corporate<br />
governance effectiveness”). The big question is: Romanian auditors aren’t perfectly<br />
aware about their contribution to the corporate governance system or they don’t want<br />
to assume it? We hope that future researches dedicated to such a subject will provide<br />
more clearly the perspectives that Romanian internal audit should follow for<br />
developing the audit practices in the right direction identified also at international<br />
level.<br />
ACKNOWLEDGEMENTS<br />
This paper was supported from the European Social Fund through Sectorial<br />
Operational Programme Human Resources Development 2007-2013, research project<br />
POSDRU/89/1.5/S/59184 “Performance and excellence in postdoctoral research<br />
within the field of economic sciences in Romania”, Babeş-Bolyai University, Cluj-<br />
Napoca being a partner within the project.<br />
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~ 67 ~
PS2 Audit Public accounting<br />
Chairperson<br />
Răzvan MUSTAŢĂ, Babes-Bolyai University, Romania<br />
PUBLIC SECTOR PERFORMANCE<br />
FROM THE PERSPECTIVE OF CORPORATE SOCIAL<br />
RESPONSIBILITY – A EUROPEAN AND NATIONAL<br />
APPROACH<br />
Eugeniu TURLEA, Aurelia STEFANESCU, Monica DUDIAN<br />
Mihaela MOCANU, Adriana CALU<br />
MANAGEMENT OF IRAN’S UNIVERSITIES IN<br />
THELIGHT OF CONTINGENCY THEORY<br />
Martin BROAD, Abbas ALIMORADI<br />
THE ERA OF INTERNAL AUDIT IN THE PUBLIC<br />
FINANCE SECTOR IN POLAND<br />
Agnieszka SKOCZYLAS, Wojciech NOWAK<br />
BOUNDRIES REGARDING THE IMPLEMENTATION<br />
OF THE NATIONAL STRATEGY FOR THE FINANCIAL<br />
REPORTING OF THE PRIVATE SECTOR ENTITIES<br />
Ramona LAPTES, Adriana Florina POPA
PUBLIC SECTOR PERFORMANCE FROM THE<br />
PERSPECTIVE OF CORPORATE SOCIAL<br />
RESPONSIBILITY – A EUROPEAN AND NATIONAL<br />
APPROACH<br />
Eugeniu ŢURLEA 1 , Aurelia ŞTEFĂNESCU, Mihaela MOCANU,<br />
Monica DUDIAN & Adriana CALU<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
The analysis of the current state of the public sector reveals the dependence on political<br />
changes, the interaction of a great number of actors, the gap between offer and demand, a<br />
chronic deficit of financial resources and failure in the efforts to achieve performance. By<br />
means of fundamental research, corporate social responsibility (CSR) is integrated into the<br />
equation of performance of public sector entities. The research endeavour consists of a<br />
synthesis of the literature in the field, as well as of the relevant regulations. The present paper<br />
defines the CSR concept, identifies the characteristic features of the public sector as argument<br />
for implementing CSR in this sector and proposes a CSR framework for the Romanian public<br />
sector. Moreover, we point out how CSR issues are disclosed and perceived in the public<br />
sector of the European Union countries, with reference to the particular case of the<br />
healthcare system.<br />
KEYWORDS: corporate social responsibility, public sector, performance, Romania,<br />
European Union, public healthcare system<br />
INTRODUCTION<br />
The current environment dominated by repeated changes of governmental policies,<br />
significant decrease of public resources, impairment of the public service quality, and<br />
reduced capacity of the public sector to respond to the expectations of the community<br />
require that the performance of public sector entities is approached from the<br />
perspective of corporate social responsibility. Starting from the variety of<br />
connotations of the corporate social responsibility present in the relevant literature,<br />
from the characteristic features of the public sector of European Union countries, as<br />
well as from the way corporate social responsibility is perceived in the public sector<br />
of the Member States, we propose a general corporate social framework for the public<br />
sector of Romania. We consider that such an approach strengthens the commitment of<br />
public sector entities to the benefit of society, environment, and economic welfare and<br />
contributes to improving public sector performance.<br />
The research is interpretative in nature and consists of three dimensions: conceptual<br />
clarifications of corporate social responsibility (CSR), characteristics of the public<br />
1<br />
Correspondence address: Eugeniu TURLEA, Bucharest Academy of Economic Studies, Romania;<br />
email: eturlea@yahoo.com<br />
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sector and arguments for implementing corporate social responsibility, namely the<br />
proposal of a CSR framework in Romania’s public sector. Additional to approaching<br />
CSR in the public sector, authors performed a qualitative analysis consisting in the<br />
investigation of the websites of different relevant institutions from countries in the<br />
European Union. The purpose of this analysis was to find to what extent these<br />
organisms publish information on the social responsibility of the health system in that<br />
country and the way they perceive social responsibility. The research endeavour<br />
consists in a synthesis of the ideas published in the literature on this topic, as well as<br />
of the regulations developed by the organisms in the field.<br />
1. APPROACHES OF THE CONCEPT OF CORPORATE SOCIAL<br />
RESPONSIBILITY. LITERATURE REVIEW<br />
In the literature, the understanding of the concept of „corporate social responsibility”<br />
is wide and translates into different labels. Since this concept is barely approached<br />
from the perspective of the public sector, we will relate to the perspective of the<br />
private sector. Gjølberg (2009), Walker & Parent (2010) and Vasilescu et al. (2010)<br />
suggest related concepts such as “corporate social responsiveness”, “sustainable<br />
development”, “corporate sustainable development”, “corporate citizenship”,<br />
“corporate philanthropy” and “corporate social rectitude”, which hinder consensus on<br />
the definition of CSR. Contrary to this statement, Siltaoja (2009) considers that<br />
corporate social responsibility covers these and other related terms, thus serving as an<br />
umbrella term.<br />
Merali (2006) defines the concept of corporate social responsibility from a complex<br />
perspective and considers that it “includes a commitment to altruistic values for the<br />
benefit of society in general”. A different approach is that of Albareda et al. (2008),<br />
who analyze corporate social responsibility in relationship to the role of government<br />
in promoting this type of mentality. Starting from the assumption that businesses<br />
operate beyond national boundaries and that their impact on society needs to be taken<br />
more into account, authors claim that corporate social responsibility is “a useful<br />
framework, within which new ways of collaborating between corporations,<br />
governments and civil society can be found, creating innovative mechanisms for<br />
governance”. A similar vision is supported by Sahlin-Andersson (2006), who<br />
considers CSR a global trend that incorporates business corporations, states,<br />
international organizations and civil society organizations. The author conveys the<br />
following meanings to social responsibility:<br />
� A regulatory framework that places new demands on corporations, whereby<br />
self-regulations as well as globally applicable standards represent a significant<br />
proportion of this framework;<br />
� A mobilization of corporate actors to assist states and international<br />
organizations, on the background that corporations become increasingly<br />
important in the world and thus are co-opted by states in their efforts to build<br />
global welfare.<br />
� A management trend that conveys to organisations an image of legitimacy,<br />
modernity and attractiveness in the opinion of potential employees,<br />
collaborators, customers and other factors.<br />
Štreimikienė & Pušinaitė (2009) approach social responsibility from the perspective<br />
of management, considering it a management strategy option. Authors think that by<br />
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integrating social responsibility in strategic planning, companies maintain or improve<br />
their financial performance. An opposed opinion is that of Kakabadse & Rozuel<br />
(2006), who claim that corporations perceive differently corporate social<br />
responsibility, and when two corporations claim they are socially responsible, their<br />
commitment is not comparable. Proponent of the existence of differences in the<br />
perceptions of corporate social responsibility depending on the geographical area is<br />
also the International Institute for Sustainable Development (2004).<br />
The analysis of perceptions on corporate social responsibility in the Anglo-American<br />
and in the European environment emphasizes the existence of differences. In favour<br />
of the characteristic features of the Anglo-American area plead Carroll (1991) &<br />
Gjølberg (2009). Carroll (1991) defines social responsibility with reference to the<br />
economic, legal, ethical and philanthropic responsibilities of companies, while<br />
Gjølberg (2009) considers that the US tradition of corporate philanthropy has<br />
influenced the CSR discourse and practices. In the European area, as opposed to the<br />
Anglo-American environment, corporations understand CSR as responsibility in all<br />
their activities, as Porter (2003) states. By means of a bidimensional analysis,<br />
Gjølberg (2009) considers that the European approach is focused on integrating CSR<br />
into the management of core business operations. In this context, Juholin (2004)<br />
brings the argument that Europe adopted the triple bottom line approach of Elkington<br />
(1997), who distinguishes between people (social), the planet (environment) and<br />
profit (economics).<br />
Formulating a definition for the concept of corporate social responsibility proves to be<br />
a difficult endeavour, even from an official perspective. By reference to the ideas<br />
published by the entities involved in this direction, we present an official approach of<br />
the concept of corporate social responsibility. For the European Commission, CSR is<br />
“a concept whereby companies integrate social and environmental concerns in their<br />
business operations and in their interaction with their stakeholders on a voluntary<br />
basis.” In the view of the World Business Council for Sustainable Development,<br />
corporate social responsibility is “the continuing commitment by business to behave<br />
ethically and contribute to economic development while improving the quality of life<br />
of the workforce and their families as well as of the local community and society at<br />
large.” The International Institute for Sustainable Development represented by the<br />
ISO Strategic Advisory Group (SAG) on Social Responsibility argues the difficulty of<br />
defining “social responsibility”, considered “a balanced approach for organizations to<br />
address economic, social and environmental issues in a way that aims to benefit<br />
people, communities and society.” In particular, according to ISO 26000 (2010),<br />
social responsibility is the responsibility of an organization regarding the impact of its<br />
decisions and activities on the society and the environment, translated into an ethical<br />
and transparent behaviour which contributes to sustainable development, to the health<br />
and welfare of society, takes into account the expectations of stakeholders, follows the<br />
laws in force and agrees to the international behaviour norms, is integrated within the<br />
organization and implemented in its relationships.<br />
In our opinion, the complexity of the CSR concept is also due to the principles of<br />
accountability, transparency, ethical behaviour, following the interests of all<br />
stakeholders, and obeying the laws, the international behavioural norms and the<br />
human rights. The analysis of these principles emphasizes that CSR comprises not<br />
only economic and legal aspects, but also ethical aspects. The economic aspect of<br />
social responsibility refers to achieving a correct output regarding the quality-price<br />
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atio, while the legal aspect refers to following formal norms, both domestic and<br />
international. The ethical component goes beyond the legal framework and consists in<br />
respecting al socially recognized behavioural norms. In the view of Lantos (2001), the<br />
ethical aspect means the organization makes what is „right, just and fair”. In order to<br />
eliminate confusions between ethical and altruistic, Lantos (2001) excludes the<br />
synonymy ethical-altruistic, because when an organization follows the social<br />
responsibility principles, this leads to an increase in the social welfare, without the<br />
welfare of the organization’s owners being diminished.<br />
The research of the connotations of the corporate social responsibility concept points<br />
out its complexity and diversity. The absence of a consensus on the understanding of<br />
this concept does not reveal the low interest of researchers, but the major concern to<br />
identify new perspectives, in accordance with the development of society as a whole.<br />
2. CHARACTERISTICS OF THE PUBLIC SECTOR VERSUS THE PRIVATE<br />
SECTOR REGARDING SOCIAL RESPONSIBILITY<br />
Identifying the boundaries between the public sector and the private sector proves to<br />
be a difficult process, due to numerous overlaps, but at the same time a process which<br />
is extensively dealt with in the relevant academic literature. Fryer et al. (2007)<br />
explains the interest shown in this subject through the existence of blurred boundaries<br />
between the public sector and the private sector, which in some areas overlap.<br />
However, we consider that the features of the public sector can be derived based on a<br />
comparative approach, namely by comparison with the private sector.<br />
From the perspective of economic theory (Angelescu et al, 2001), the public sector is<br />
the totality of public companies and public administrations. A similar endeavour in<br />
defining the public sector – based on the structure of the organizations – is also<br />
supported by Fryer et al. (2007). Accordingly, public organizations are organizations<br />
that deliver governmental goods and services at local or national level. The traditional<br />
assumption underlying the understanding of public organizations is that they deliver<br />
services to the public and are publicly funded, owned and operated.<br />
From another perspective, Broadbent & Guthrie (2008) argue that this assumption is<br />
nowadays debatable, due to the phenomena of privatization and corporatization which<br />
spread more and more in the public sectors worldwide. On one hand, privatization can<br />
be defined as the process of selling state-owned assets, whereas management control<br />
passes to private shareholders. On the other hand, corporatization consists in the<br />
efforts to make public organizations function similar to how private firms function<br />
when facing a competitive market or efficient regulation – if they were monopolies.<br />
In an approach that considers the type of decisions made, Dascălu et al. (1996) defines<br />
the public sector as an entity consisting of institutions where collective or political<br />
decisions are made (whereas these institutions are the central and local public<br />
administrations with their subordinated public entities) or institutions which<br />
accomplish objectives and tasks of public interest.<br />
National regulations (Public Finance Law no. 500/2002) do not define in a<br />
comprehensive manner the public sector. It is defined indirectly by referring to the<br />
generic term of public institutions, which comprise the Parliament, the Presidential<br />
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Administration, the Ministries, other bodies of public administrations, other public<br />
authorities, autonomous public institutions, irrespective of their financing sources.<br />
At international level, the International Public Sector Accounting Standards (IPSAS)<br />
use the term of Government Business Enterprise. According to IPSAS 1 Presentation<br />
of Financial Statements, Government Business Enterprise means an entity that has all<br />
the following characteristics:<br />
� Is an entity with the power to contract in its own name;<br />
� Has been assigned the financial and operational authority to carry on a business;<br />
� Sells goods and services, in the normal course of its business, to other entities at<br />
a profit or full cost recovery;<br />
� Is not reliant on continuing government funding to be a going concern (other<br />
than purchases of outputs at arm’s length); and<br />
� Is controlled by a public sector entity.<br />
With reference to the characteristics of the public sector, Fryer et al. (2007) considers<br />
that their main feature is the absence of the goal of profit maximization, unlike private<br />
organizations. In our view, this characteristic does not offer simplicity to the sector,<br />
but complexity, taking into account that the public perceives the performance of the<br />
public sector by reference to the quality of service. Based on the dual comparative<br />
approach (public sector – private sector), but in an exhaustive manner, Sundin &<br />
Tillmar (2008) identify the following characteristics of the public sector entities:<br />
� Are guided by political and social objectives;<br />
� Their main source of funding is the taxes collected, which they allocate based<br />
on equity principles;<br />
� The services delivered by them have a direct impact on the public, but also an<br />
indirect impact on the community;<br />
� Are subject to public scrutiny, their decision making process must be as<br />
transparent as possible and the consensus among interest groups must be<br />
ensured.<br />
In our opinion, involving the public in the control of public sector entities and<br />
ensuring the transparency of the decisional process are characteristics in favour of the<br />
need to ensure a general social responsibility framework in this sector.<br />
From another perspective, Heracleous & Johnston (2009) define public organizations<br />
through the association of two main dysfunctions: bureaucracy and inertia. Authors<br />
consider that this prejudgment is so deeply rooted into the minds of the public<br />
opinion, that businesses which develop bureaucracy and inertia are frequently<br />
classified as businesses with an “almost public sector mentality”. Although the<br />
balance between the invested value for each resource unit from the private sector, on<br />
one hand, and from the public sector, on the other hand, inclines towards the private<br />
sector, the public sector should go beyond this limit by assimilating the experience of<br />
the private sector. Heracleous & Johnston (2009) highlight that the public sector is<br />
constantly encouraged to adopt models and practices which proved successful in the<br />
private sector, so that its performance can be improved. Strategic management<br />
models, change management processes, quality management, performance<br />
measurement are only some examples of such private sector practices.<br />
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Fryer et al. (2007) completes the picture of the public sector characteristics with their<br />
regional and temporal fluctuations, which they support through arguments. The<br />
authors think that temporal fluctuations are due to the fact that public sector is subject<br />
to “the whims and fancies of government”. Regional fluctuations is generated by<br />
changes in administration, which lead to changes in the organization of at least one<br />
area of the public sector, since each administration has its own approach, ideas,<br />
interests and visions. The overly dependence on administration change results in<br />
uncertainty, requires time for the acceptance and assimilation of the new visions and<br />
reduces the quality of services, by increased time of response to public inquiries and<br />
by the reduction of service offer. Although due to its nature, the private sector does<br />
not face such challenges, this characteristic is important for it, too, since it is<br />
indirectly impacted by the decisions of the administration.<br />
An interesting approach of the public sector belongs to Talbot (2003). He postulated<br />
that public services are three-dimensional: there is the policy, the managerial and the<br />
professional domain. According to this approach, the employees of the public sector<br />
are challenged to frequently switch between these often conflicting domains. For<br />
instance, in a single day, it may happen that the manager of a public organization must<br />
switch from the role as manager to the role of professional or policy-maker. Each of<br />
these three domains differs through its own patterns and values, which are almost<br />
always contradictory with each other. Thus, by comparison with the private sector,<br />
where managers are almost exclusively dedicated to the managerial field, in the public<br />
sector, employees in governing positions are challenged to accept the inherent<br />
contradictions between these three domains, to get over the resulting conflicts and<br />
uncertainties and to find a satisfactory balance.<br />
A fundamental characteristic of public service is identified by Marobela (2008). In his<br />
opinion, the boundary between the public sector and the private sector is drawn not<br />
only by the objectives pursued but also by the manner in which the service is<br />
delivered. Moreover, Parasuraman et al. (1985) quoted by Fryer et al. (2007)<br />
approaches the characteristics of the public sector from the perspective of the quality<br />
of the services in the public sector, namely intangibility, heterogeneity, and<br />
inseparability, which he defines as following: intangibility means that no precise<br />
definition and measurement of the services is possible; heterogeneity means that<br />
services suffer from lack of consistency, since they depend on the interaction between<br />
the individual service provider and the customer; inseparability refers to the<br />
simultaneous occurrence of the delivery and the “consumption” of the service and the<br />
potential influence of the customer on the outcome of the service provided<br />
Fryer et al. (2007) identify the features of the public sector from the perspective of the<br />
demand, by comparison with the private sector. Through the bidimensional analysis<br />
(public sector – private sector) of the number of customers, authors conclude that<br />
unlike the public sector where in the absence of the profitability objective the increase<br />
of the customers’ number means an increase of the efforts, in the private sector the<br />
increased demand leads to profit maximization and therefore it is a major objective.<br />
We think that in present times, characterized by the limitation of public resources and<br />
the increase of the demand for services, this feature means that the public sector<br />
should identify and adopt alternative measures in order to fulfil public expectations.<br />
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The research points out that there are several approaches in the relevant literature with<br />
regard to the characteristics of the public sector. By referring to the public sector in<br />
Romania, we add to the above characteristics its complexity, which is generated by<br />
the nature of the provided services and by the following actors which interact within<br />
the system: entities with competences in the regulation, coordination, strategy and<br />
oversight of public policies; financing entities; buyers; public service suppliers;<br />
consumers (taxpayers, public). Moreover, we consider that a thorough analysis of the<br />
characteristics of the public sector reflects the causes of the difficulties this sector<br />
faces, by comparison with the private sector.<br />
3. ARGUMENTS IN FAVOUR OF CORPORATE SOCIAL RESPONSIBILITY<br />
IN THE PUBLIC SECTOR<br />
CSR being approached only limitedly in the public sector, as well as the absence of<br />
the goal of profit maximization are counterarguments for developing CSR in this<br />
sector. But, if we consider that the goal of profit maximization, although belonging to<br />
the private sector, is circumscribed to the performance goal (convergent with the<br />
public sector), as well as that the objective of public sector entities is to fulfil the<br />
expectations of the public (the citizens), we can state that social responsibility is<br />
implicitly present in the public sector. Kakabadse & Rozuel (2006) feel that<br />
approaching ethical, social and environmental issues is more appropriate in the public<br />
sector than in any other sector, since by their very nature, public organizations are<br />
expected to contribute to the citizens’ welfare and solve social problems.<br />
For Siltaoja (2009), legitimacy and reputation represent pertinent arguments in favour<br />
of corporate social responsibility in the public sector. The author considers that an<br />
entity of the public sector becomes legitimate when it promotes corporate social<br />
responsibility at the level of the entire entity. Walker& Parent (2010) give to CSR the<br />
role to protect reputation, because it mitigates the attempts to discredit the public<br />
organization.<br />
Kakabadse and Rozuel (2006) argue the need for social responsibility in the public<br />
sector from the perspective of the globalization of economies. Authors think that the<br />
globalization of the activities of the entities from the private sector leads to the<br />
prevalence of the economic over social interests. Consequently, limiting this impact is<br />
a responsibility for both the private and the public sector, because governance should<br />
get involved twofold: to develop a proper environment that enables private<br />
organizations to act with social responsibility, namely to ensure that public service<br />
entities are responsive to the needs of the community, show concern for the<br />
environment and efficiently and effectively support economic growth.<br />
Norway and Denmark are persuasive examples for the dual involvement of their<br />
governments in the field of corporate social responsibility. Starting with 2008,<br />
Norway has the first independent policy in the area of CSR, common for both the<br />
entities of the private sector and the entities of the public sector, public funds (pension<br />
fund) and public acquisitions. The main objectives of this policy are: clearly defining<br />
the state’s expectations from the private sector and establishing the role of the<br />
authorities and private entities, increasing the motivation and the ability of companies<br />
for CSR, and the Norwegian state taking an international role in promoting and<br />
implementing CSR. If we refer strictly to the corporate social responsibility of the<br />
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state, the main aspects taken into consideration by the policy are: long-term<br />
sustainable management of the resources of public entities, responsibility in managing<br />
the pension fund, applying CSR principles in public acquisition, environmental<br />
protection and ensuring that human rights are respected. For elaborating and adopting<br />
the CSR model, the Norwegian government relates to the international norms and<br />
experience, complemented by public consultations with social partners. In its action<br />
plan for implementing CSR, Denmark defines similar goals as Norway and is based<br />
on public consultations and international experience. The areas targeted for applying<br />
CSR principles are as follows: public acquisitions, companies in which the state is<br />
major shareholder (they must report on CSR compliance), public investments, public<br />
funds, environment and climate changes.<br />
In relationship to the characteristic features of the public sector, we consider that<br />
another argument in favour of CSR is the intercorelation between the social<br />
responsibility and the performance of public sector entities. In our opinion, CSR is a<br />
driver for the financial and non-financial performance of the entities of the public<br />
sector. For supporting this statement, we present the following aspects:<br />
� Social responsibility implies the voluntary agreement of the entity to be<br />
assessed, to answer for its actions and to implement corrective measures for<br />
eliminating the found deficiencies;<br />
� Transparency acts as an incentive mechanism against the potentially<br />
opportunistic behaviour of management, promotes monitoring and eliminates<br />
informational asymmetry between the public sector and the constituencies (the<br />
public) with regard to the use of resources.<br />
� Ethical behaviour eliminates the conflicts of interests from the entity, which<br />
could generate lack of trust regarding the manner in which public resources<br />
are built and used;<br />
� Following the interests of all stakeholders implies the used of economic<br />
resources as efficiently as possible, on the general background of sustainable<br />
development;<br />
� The ethical, legal and environmental issues, as well as the issues regarding the<br />
social context accompany all steps of the process of design and delivery of<br />
public services/ products.<br />
4. RESEARCH ON THE DISCLOSURE WITH RESPECT<br />
TO CORPORATE SOCIAL RESPONSIBILITY<br />
IN THE PUBLIC SECTOR OF THE EUROPEAN UNION COUNTRIES.<br />
THE CASE OF THE HEALTH SYSTEM<br />
The research endeavour takes into account the result of the empirical study<br />
performed by Ştefănescu et al (2010) on identifying the extent to which the concept<br />
of performance is used and quantified in the entities of the public healthcare system<br />
of the European Union member states. Based on the research performed by<br />
investigating the websites of the relevant institutions from the EU member states,<br />
authors concluded that there are concerns on defining performance in the public<br />
healthcare system, but the disclosures on performance, due to the fact that there are<br />
no explicit and exhaustive requirements.<br />
Starting from the assumption of the intercorrelation corporate social responsibility –<br />
performance, we continued the research in order to identify to what extent these<br />
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odies disclose information on the social responsibility within the health system of<br />
that country and the way they perceive social responsibility. Moreover, the research<br />
had in view to identify the information disclosed in the three areas of social<br />
responsibility, namely society, environment and economy. For this purpose, we took<br />
into consideration only the information disclosed in English. The extent to which<br />
those countries offer such disclosure was diverse, an overall view of that situation<br />
being presented in Appendix 1.<br />
The performed research emphasizes that the relevant national bodies of the Member<br />
States show concern for corporate social responsibility issues, but the disclosure of<br />
such information is limited. We consider that an argument for this state of facts is<br />
that this concept is relatively recent and, at international level, the public sector has<br />
not shown great interest for disclosing information on social responsibility issues.<br />
None of the investigated countries uses this phrase in the exact above-mentioned<br />
form. The only country that uses a similar term is Ireland, designating it „corporate<br />
accountability”. Moreover, some countries (Austria, Germany, Great Britain,<br />
Denmark, Ireland, Lithuania, and Malta) use related terms: „responsibility”,<br />
„accountability”, and „sustainability”.<br />
Related to the social dimension of the corporate social responsibility concept, the<br />
research points out that the entities involved in the public healthcare system are aware<br />
of their responsibility towards the public and the time horizon over which they assume<br />
this responsibility. Thus, Austria and the Nordic countries (especially Sweden) are<br />
those most concerned for the short- and long-term responsibility towards the public.<br />
As a sign of short-term responsibility towards the population we considered the<br />
disclosure of information on the patient rights, on the importance given to their<br />
individual needs and to the possibilities given to them to express their dissatisfaction<br />
with the system. European countries that show such an orientation towards the<br />
patients are: Austria, Belgium, Cyprus, Denmark, France, Ireland, Italy, Sweden and<br />
the Czech Republic. As a sign of long-term responsibility towards the public in social<br />
matters we took into consideration the measures taken for promoting a healthy<br />
lifestyle and for preventing health problems. Numerous European countries have<br />
stated their concern for health promotion and prevention: Austria, Belgium, Estonia,<br />
Finland, Hungary, Malta, The Netherlands, Slovenia, Sweden and Romania. Germany<br />
is the country that surprises by the fact it does not disclose information in English on<br />
social responsibility. However, there are countries that demonstrate a wider vision on<br />
the responsibility towards the public: Italy and Latvia. They both go beyond the<br />
general discourse on the responsibility of public institutions and take into<br />
consideration the responsibility of the employees in the system, whose part is critical<br />
and complements the responsibility of policy-makers. By the use of the concept<br />
„Clinical Governance”, Italy gives prominence to the role and the responsibility of the<br />
employees of the healthcare system. Latvia guides the employees of the State Agency<br />
of Medicines by publishing a Code of Ethics.<br />
A particular case is the responsibility of the entities towards the environment.<br />
Denmark is the only country in which the responsible bodies from the healthcare<br />
system take responsibility towards the environment by reducing their energy<br />
consumption and CO2 emission. The concern for the environment of other countries<br />
(Spain, Estonia, Finland, and Hungary) is limited to the impact of the environment on<br />
public health.<br />
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The research of the economic dimension of social responsibility shows that Denmark,<br />
Germany and Great Britain are the only countries with explicit concerns in this area.<br />
Denmark has in view the affordability of the treatments, while Great Britain declares<br />
that the provided services should be available to all, no matter the ability to pay of the<br />
beneficiaries. In Germany, the importance of medicinal products and medical devices<br />
as economic goods is also recognized, although the protection of public health is in<br />
the foreground. An interesting initiative is that of Great Britain, which launched in<br />
March 2011 “The Public Health Responsibility Deal”, with the purpose to involve the<br />
business environment in achieving public health goals.<br />
5. PROPOSAL OF A GENERAL CSR FRAMEWORK FOR THE ROMANIAN<br />
PUBLIC SECTOR<br />
The assumption underlying the proposal of a general CSR framework is based on its<br />
limitation in the Romanian public sector, with impact on the performance of the<br />
entities within this sector. From a structural point of view, the general framework<br />
includes the following components: defining the CSR concept; internal and external<br />
pressures on the public sector; external and internal stakeholder; responsibility areas;<br />
the process of CSR implementation in the public sector and communication on CSR<br />
matters.<br />
The definition of corporate social responsibility in the public sector<br />
Since public sector organizations differ from their private sector counterparts, it is<br />
necessary to formulate a definition of corporate social responsibility that is welladapted<br />
to this kind of entities. For the purposes of this paper, the following definition<br />
of CSR is considered to be most appropriate: „CSR of public sector organizations is<br />
their commitment to altruistic values for the benefit of people, environment and<br />
economic welfare”.<br />
The external environment of the public sector<br />
In the view of Nutt (2005), political considerations are an important part of the<br />
external environment of the public sector. Changes in policy and the imposition of<br />
short time-horizons on public managers are permanent challenges for public entities.<br />
Short-time objectives are the consequence of political changes that constrains<br />
politicians to achieve quick results in order to ensure success in the next round of<br />
elections. From a political perspective, political issues become more important than<br />
economic issues, and entities must adapt to the political environmental factors. Thus,<br />
we feel that political pressures make the development of CSR in the public sector<br />
necessary.<br />
In addition to political pressures, the external environment of the public sector is<br />
characterized by complexity, dynamism, munificence. Dynamism is generated by<br />
knowledge development, technological innovations, as well as by the constant<br />
changes of regulations within the public sector. The munificence is understood by<br />
Kearney et al. (2009) as a multidimensional concept that includes dynamism, industry<br />
growth, technological opportunities, and the demand for new products or services. We<br />
consider that a munificent environment influences the public sector entities twofold.<br />
~ 78 ~
On one hand, it helps them to build slack resources and to access external resources in<br />
difficult times, and on the other hand, it stimulates them to choose CSR practices,<br />
because social, human and ecological issues are more pregnant than in stagnant<br />
environments.<br />
The internal environment of the public sector<br />
Whereas the external environment influences the public sector organization and<br />
implicitly its attitude towards CSR, the internal environment actively participates and<br />
completes the integration of CSR within this sector. For Kearney et al. (2009),<br />
internal environment consists of the following components: structure/formalization,<br />
decision making process, control, and rewards/motivations. By referring to the<br />
characteristic features of the Romanian public sector, we develop the components of<br />
the internal environment, as follows:<br />
� Formalization refers to the existence of explicitly formulated and written<br />
procedures that guides the activity of the entity, as well as the existence of<br />
specific organization charts, job descriptions, strategic and operational plans.<br />
Although a high degree of formalization has the disadvantage of a low<br />
flexibility in the decision-making process, we consider that it favours the<br />
implementation of corporate social responsibility due to the already existing<br />
customized patterns.<br />
� The decision-making process is characterized by rigidity, because the<br />
resources are mainly public, have the tendency to diminish and are limited<br />
with regard to their allocation for investments that would significantly<br />
contribute to enhancing the ability to respond to economic, social,<br />
humanitarian and ecologic issues of the community. We consider that the<br />
inflexibility of the decision-making process is the main impediment in<br />
implementing CSR within the Romanian public sector;<br />
� The existence of adequate control systems facilitates the implementation of<br />
CSR, because they can tightly monitor behaviour and resource utilization and<br />
support a responsible attitude within the public sector entities;<br />
� Rewards are an obstacle for CSR success in the public sector. We support this<br />
statement by the fact that the current ways of rewarding human capital within<br />
the public sector are limited both financially and motivationally. Therefore,<br />
the human resource does not have the motivation to get involved into CSR-<br />
related activities. In our opinion, rewarding human capital should be<br />
rethought, so that it takes into consideration the objectives, their level of<br />
achievement and their usefulness.<br />
Stakeholders<br />
Due to its nature, in the public sector interact numerous actors who a stake in its<br />
activity, namely: entities with responsibilities in the regulation, coordination, strategy<br />
and oversight of public policy; financing entities; buyers; suppliers of public services;<br />
consumers (taxpayers, public). The identification of stakeholders in establishing a<br />
CSR framework in the public sector is necessary, although even in case of the<br />
“stakeholder” concept, there is no consensus on its definition. Regarding the<br />
classification of the stakeholders, Kakabadse & Rozuel (2006) suggest the<br />
classification provided by Fottler et al. (1989), who identify three broad categories of<br />
stakeholders: internal stakeholders, interface stakeholders, and external stakeholders.<br />
~ 79 ~
Internal stakeholders are those who belong to the entity and typically include<br />
management, professional, and non-professional staff. Interface stakeholders are those<br />
with double membership, they function both internally and externally to the<br />
organization and include the taxpayers. External stakeholders can be divided into<br />
three subgroups, as follows: those who provide inputs into the organization (e.g.<br />
suppliers, service beneficiaries and funds providers), those who compete with the<br />
public entity (e.g. other institutions or related organizations operating in the same<br />
field as the public sector entity), and those who have a special interest in how the<br />
organization functions (e.g. professional associations, government regulatory<br />
agencies, labour unions, the media or the local community).<br />
Responsibility areas<br />
In a traditional sense, “responsibility” reflects the state or fact of being accountable or<br />
to blame for something (http://www.dexonline.news20.ro). Thus, it is necessary to<br />
identify the responsibility areas, so that appropriate processes and controls can be<br />
implemented in each of them. Responsibility areas of the public sector entities differ<br />
depending on the activity type, but also present overlapping areas that refer to:<br />
environmental issues (mitigation of environmental damage; eliminating waste and<br />
emissions; maximization of the efficiency and productivity of resources etc.), social<br />
issues (contribution to arts, education and cultural matters, involvement in the<br />
community, ensuring appropriate labour practices, respecting human rights etc. and<br />
economic issues (maintaining economic efficiency; monitoring the impact on the<br />
economic well-being of the stakeholders etc.).<br />
Implementation process<br />
Additional to the external and internal factors that affect the attitude of the public<br />
sector organizations towards corporate social responsibility and the overlapping<br />
responsibility areas of the entity (ecological, social and economic), this component of<br />
the proposed CSR framework is the process of implementation itself. We think that<br />
successfully implementing CSR requires a systematic approach that is in accordance<br />
with the public organization’s activity, culture, environment, risk profile and<br />
operating conditions. The endeavour of designing a model for CSR implementation in<br />
the public sector is based on the CSR implementation framework elaborated by<br />
Hohnen (2007) for businesses, synthesized in Table. 1.<br />
Table 1. Model for CSR implementation in the public sector<br />
Steps Description<br />
� Plan<br />
Assess CSR Define CSR<br />
Identify external and internal influences<br />
Identify stakeholders<br />
Develop a CSR strategy<br />
� Do Develop CSR commitments<br />
Establish persons involved in strategy development<br />
Research on existent CSR practices at other organizations<br />
Prepare a list of CSR actions<br />
Develop and support ideas for proceeding<br />
Decide on direction, approach, boundaries and focus areas<br />
Identify main potential CSR commitments<br />
Discuss with major stakeholders<br />
Prepare a draft of CSR commitments<br />
Consult on the draft with the relevant stakeholders<br />
~ 80 ~
Steps Description<br />
Implement CSR<br />
commitments<br />
Develop a CSR decision-making structure<br />
Set performance targets<br />
Engage persons to whom CSR commitments apply<br />
Design and conduct CSR training<br />
Communicate CSR commitments externally and internally<br />
� Check Measure performance<br />
Report on performance<br />
� Improve Identify opportunities for improvement<br />
Improve<br />
� Cross-check Return to plan and start the next cycle<br />
(Source: own design after Hohnen, 2007)<br />
Communication on CSR matters<br />
Due to the role of corporate social responsibility practices in matters of legitimacy and<br />
reputation of public sector organizations, the communication of how the entity<br />
implements CSR is almost as important as the implemented practices themselves.<br />
Therefore, the choice of the channels and forms of communication that are most<br />
adequate to the specificity of a certain public sector entity is a critical part of the<br />
proposed CSR framework. In reality, the interest of public managers is not to act<br />
responsibly, by taking into consideration social, environmental and economic issues,<br />
but to be perceived as acting in accordance with CSR practices. A similar idea is<br />
supported by Owen (2008), who states that managers are more concerned over issues<br />
related to image rather than true commitment to transparency and accountability. The<br />
choice for a certain communication channel (booklets, trainings, electronic<br />
communication, internal publications, staff meetings, verbal communication, policy<br />
manual etc.) depends on the addressees of the CSR practices and the exact nature of<br />
the public sector entity that decides to implement CSR practices.<br />
CONCLUSIONS<br />
The present research points out that defining the concept of corporate social<br />
responsibility is difficult in the literature, due to its multiple facets. However, the<br />
economic, environmental and social aspects are elements that overlap in most of the<br />
meanings conveyed to the concept of corporate social responsibility. The limited<br />
approach of this concept in the national and international public sector was the<br />
starting point for identifying the characteristics of the public sector in order to argue<br />
the opportunity of implementing CSR in this sector.<br />
The complexity of the public healthcare system and the difficulties it faces were the<br />
arguments that guided our research on the CSR disclosure and perception in the EU<br />
states. Following the research carried out we found there are concerns for the social,<br />
environmental and economic dimension of social responsibility. Denmark is the only<br />
country that has a full vision on corporate social responsibility and discloses complete<br />
information on its three dimensions. Austria and Germany show concern for the social<br />
and economic side of CSR. Sweden, Belgium, Cyprus, France, Ireland, Italy and the<br />
Czech Republic disclose information that shows only responsibility to the public and<br />
the time-horizon for which they take responsibility, while Italy and Latvia also focus<br />
on the responsibility of the employees of the public healthcare system. In Belgium,<br />
Estonia, Finland, Hungary, Malta, Netherlands, Slovenia, Sweden and Romania,<br />
concerns for corporate social responsibility are limited to health promotion and<br />
~ 81 ~
protection. At the opposite side, Germany and Great Britain disclose information on<br />
the economic dimension of CSR (Great Britain supports the accessibility and<br />
availability of healthcare services, irrespective of the ability to pay of the<br />
beneficiaries, initiated a programme in order to involve the business environment in<br />
fulfilling public health goals, while Germany recognizes the importance of medical<br />
products and devices as economic goods).<br />
In Romania, corporate social governance is not a major objective of the persons in<br />
charge in the public sector. On this background, we consider that adopting a general<br />
corporate social responsibility framework will respond socially, environmentally and<br />
economically to the real needs of the community, will improve the performance of<br />
public sector entities and will consolidate their orientation towards the public.<br />
ACKNOWLEDGEMENTS<br />
This work was supported by CNCSIS–UEFISCDI, project no.955/19.01.2009 PNII –<br />
IDEI, code ID_1827/2008, Panopticon on the performance connotations in the public<br />
sector entities in Romania – creation versus dissemination.<br />
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~ 84 ~
ANNEX 1<br />
Disclosures on social responsibility in the public healthcare system of the<br />
European Union countries<br />
Country Name of<br />
Institution<br />
Site Disclosure<br />
language<br />
Information on social responsibility in the<br />
healthcare system<br />
Germany The Federal http://www.bmg.bund.de - German There is no information in English on social<br />
Ministry<br />
Health<br />
of<br />
- English responsibility issues.<br />
Federal http://www.bfarm.de/cln - German Its mission statement shows a degree of concern<br />
Institute for _103/EN/Home/home_no - English for social and economic issues: Their<br />
Drugs and de.html<br />
(partially) responsibility is to protect human health, but they<br />
Medical<br />
also recognize the importance of medicinal<br />
Devices<br />
products and medical devices as economic goods.<br />
However, there is no other information in English<br />
on social responsibility issues.<br />
Paul-Ehrlich- http://www.pei.de/EN/ho - German There is no explicit information in English on<br />
Institut me/nodeen.html?__nnn=t - English<br />
rue<br />
social responsibility issues.<br />
Austria Federal http://www.bmg.gv.at/cm - German There is information about the Austrian Health<br />
Ministry of s/site/thema.html?channe - English Care System. The Austrian state is aware of its<br />
Health l=CH0993<br />
(partially) responsibility to provide the best possible health<br />
care services to all citizens.<br />
Orientation towards the patient: Quality,<br />
Belgium Federal Public http://www.health.belgiu - Dutch<br />
transparency and orientation towards patients play<br />
an important role. The opinions of the patient<br />
advocacy groups matter in decision making. The<br />
rights of the patients are legally defined and can<br />
also be enforced by law.<br />
Efficient use of resources: They recognize the<br />
importance of efficiently using the available<br />
resources in providing health care of high quality.<br />
However, no explicit concern for the environment<br />
is stated.<br />
Health promotion and prevention are also<br />
important issues. There are several free of charge<br />
preventive services, such as the mother-child-pass<br />
examination programme, which exists since 1974.<br />
In October 2010, the report “Assessing Socio-<br />
Economic Impacts of GMOs. Issues to Consider<br />
for Policy Development” was issued by the<br />
Ministry. Additionally, annual reports on the Drug<br />
Situation in Austria were issued.<br />
Information on various environmental issues.<br />
Service (FPS) m.be/eportal<br />
- French Useful information on health issues for the<br />
Health, Food<br />
- German population: risks and diseases, care, patient rights<br />
Chain Safety<br />
- English and intercultural mediation, healthy life, end of<br />
and<br />
Environment<br />
life, social issues etc.<br />
Bulgaria Bulgarian http://www.bda.bg/index. - Bulgarian There is no information in English on social<br />
Drug Agency php?lang=en<br />
- English responsibility issues.<br />
– Ministry of<br />
Health<br />
(partially)<br />
Cyprus Ministry of http://www.moh.gov.cy/ - Greek The Mission of the Ministry is to continuously<br />
Health moh/moh.nsf/index_en/in - Turkish improve the health of the population through the<br />
of the dex_en<br />
- English prevention of disease and the provision of high<br />
Republic of<br />
level health care.<br />
Cyprus<br />
Booklet on Patient’s Rights and Citizen’s Charter<br />
not available in English.<br />
There is no other information in English on social<br />
responsibility issues.<br />
Great Department of http://www.dh.gov.uk/en/ - English The concern for accountability issues towards<br />
Britain Health index.htm<br />
public health is evident.<br />
The Department of Health published in July 2010
Country Name of<br />
Institution<br />
Denmark<br />
Ministry of<br />
the Interior<br />
and Health<br />
Site Disclosure<br />
language<br />
http://www.sundhedsmin<br />
isteriet.dk/English.aspx<br />
- Danish<br />
- English<br />
~ 86 ~<br />
Information on social responsibility in the<br />
healthcare system<br />
a White Paper called “Equity and Excellence:<br />
Liberating the NHS”. The core values are to<br />
provide “a comprehensive service, available to all,<br />
free at the point of use, based on need, not ability<br />
to pay”. Regular reports of the Department of<br />
Health on the progress in following the Structural<br />
Reform Plan are published monthly. They promote<br />
transparency and accountability across<br />
Government and allow people to check that the<br />
department is meeting its commitment.<br />
Moreover, in March 2011, the Department of<br />
Health launched “The Public Health<br />
Responsibility Deal”. The main idea behind it is<br />
that businesses can contribute to public health<br />
goals. Businesses are invited to sign up the pledges<br />
in the Responsibility Deal and to fulfil the<br />
monitoring and evaluation requirements for each<br />
pledge.<br />
Brief information on patients’ rights in a<br />
publication regarding healthcare in Denmark,<br />
(partially) issued in 2008.<br />
Information on the reform programme “Welfare<br />
and Choice”, launched in May 2002 by the Danish<br />
Government. The programme aims at enhancing<br />
the competition and quality of public-sector<br />
services through choice. A great emphasis is<br />
placed on the freedom of choice citizens have.<br />
Danish http://www.dkma.dk/1024-<br />
Danish The mission of the Danish Medicines Agency is to<br />
Medicines visUKLSForside.asp?artik-<br />
English ensure the availability of effective and safe<br />
Agency elID=728<br />
(partially) healthcare products – medicinal products, medical<br />
devices and new therapies and to promote the<br />
proper use of such products.<br />
Clear concern for social responsibility issues,<br />
revealed in the publication “Perspectives and<br />
challenges 2011-2016”. They focus on the health<br />
and welfare of people and animals, but also take<br />
into consideration economic issues, such as<br />
affordability of the treatments. They also recognize<br />
their responsibility as public institution towards the<br />
environment. For instance, they take measures for<br />
reducing their energy consumption and CO2 emission.<br />
Spain The Ministry http://www.msps.es/en/h - Spanish There is no information in English on social<br />
of Health and ome.htm<br />
- Catalan responsibility issues.<br />
Consumer<br />
- Basque However, there is information in Spanish on issues<br />
Affairs Spain<br />
- Galician such as patient safety and environmental and<br />
Estonia State Agency http://www.sam.ee/<br />
- Valencia occupational health.<br />
- French<br />
- English<br />
(partially)<br />
- Estonian The main responsibility of the Agency is the<br />
of Medicines<br />
- English protection and promotion of public and animal<br />
The Ministry http://www.sm.ee/eng.ht<br />
(partially) health, through the supervision of medicines for<br />
human and veterinary use.<br />
However, there is no information in English on<br />
social responsibility issues.<br />
- Estonian Information on the Esthonian National Health Plan<br />
of Social ml<br />
- Russian 2009-2020. Clear orientation towards social<br />
Affairs<br />
- English responsibility issues:<br />
(partially) - the plan is meant to ensure that the people of<br />
Estonia live longer, happier, healthier lives;<br />
- overall objective: long life and quality of life;<br />
- plans activities in five different fields: social
Country Name of<br />
Institution<br />
Finland The Ministry<br />
of Social<br />
Affairs and<br />
Health<br />
Site Disclosure<br />
language<br />
http://www.stm.fi/en/fron - Finnish<br />
tpage<br />
- English<br />
~ 87 ~<br />
Information on social responsibility in the<br />
healthcare system<br />
cohesion; children’s and young people’s health;<br />
the environment; healthy lifestyles; and health<br />
care.<br />
Clear orientation towards social responsibility<br />
issues. Information in English on the client and<br />
France The Ministry<br />
(partially) patient rights (including legislation on the topic).<br />
Information in English on the promotion of<br />
welfare. The Ministry supports the welfare of<br />
people: by social and health services; by ensuring<br />
income security; by increasing and maintaining<br />
their social welfare, security and participation in<br />
society, and by reducing poverty and social<br />
exclusion; by using health promotion; by using<br />
prevention work; by safeguarding a healthy living<br />
environment and safe work environment.<br />
http://www.santesports.g - French There is no information in English on social<br />
of Health and ouv.fr/<br />
responsibility issues.<br />
Sport<br />
However, there is information on the rights of the<br />
patients, as well as a list of answers to frequently<br />
asked questions.<br />
Greece The National http://www.eof.gr/web/g - Greek No explicit information in English on social<br />
Organization uest<br />
- English responsibility issues.<br />
for Medicines<br />
(partially) EOF is a public entity of the Ministry of Health.<br />
(EOF)<br />
EOF mission is to ensure public health and safety<br />
with regard to several products, marketed in<br />
Greece: medicinal products for human and<br />
veterinary use; medicated animal foods and food<br />
additives; foodstuffs intended for particular<br />
Hungary The Ministry<br />
nutritional uses and food supplements; biocides;<br />
medical devices and cosmetics.<br />
http://www.eum.hu/engli - HungarianThe<br />
summary of the national public health<br />
of Health of sh<br />
- English programme from 2006 shows concern for the<br />
the Republic<br />
(partially) lifestyle of the population (whereas nutrition,<br />
of Hungary<br />
smoking, HIV/AIDS, alcohol and drug prevention<br />
are important issues), for health education and for<br />
the environment. In 2004, Hungary was the host<br />
country of the Fourth European Ministerial<br />
Conference on Environment and Health.<br />
Information on the international relations with<br />
OECD, WHO and the Council of Europe.<br />
Ireland The http://www.dohc.ie/ - Irish The mission of the department is to improve the<br />
Department<br />
- English health and well-being of people in a manner that<br />
of Health and<br />
promotes better health for everyone, fair access,<br />
Children<br />
responsive and appropriate care delivery, and high<br />
performance.<br />
Customer-orientation: Principles of Quality<br />
Customer Service, issued in July 2000 and given<br />
effect by the Department’s Quality Customer<br />
Action Plan.<br />
Concern for sustainability: The Minister<br />
established the Expert Group on Resource<br />
Allocation and Financing in the Health Sector in<br />
April 2009. In July 2010, the group issued a report<br />
on resource allocation, financing and<br />
sustainability in health care.<br />
A variety of other information: fact sheets,<br />
publications, statistics, legislation, press releases<br />
etc.<br />
No explicit information in English on social<br />
responsibility issues. However, the Statement of<br />
Strategy 2008-2010 discusses the need for<br />
commitment to people-centred services, and the<br />
need to develop a modern, effective and transparent
Country Name of<br />
Institution<br />
The Irish<br />
Medicines<br />
Board (IMB)<br />
Site Disclosure<br />
language<br />
http://www.imb.ie/ - Irish<br />
- English<br />
Italy The Ministry http://www.salute.gov.it/ - Italian<br />
of Health<br />
- English<br />
~ 88 ~<br />
Information on social responsibility in the<br />
healthcare system<br />
framework of legislation, regulation and<br />
accountability.<br />
In 2007 the Commission on Patient Safety and<br />
Quality Assurance was established. Its mission was<br />
to develop proposals for a health service wide<br />
(encompassing both the public and the private<br />
sectors) system of governance based on corporate<br />
accountability for the quality and safety of health<br />
services.<br />
The Framework for Public & Service User<br />
Involvement in Health and Social Care Regulation<br />
in Ireland, issued in December 2009, emphasizes<br />
the importance of involving service users and<br />
members of the public in health and social care<br />
services. This follows the recommendation of<br />
OECD that the Irish Public Service place greater<br />
focus on citizens and their expectations, and on<br />
targeting delivery of services from their<br />
perspective to achieve broader societal goals.<br />
No information in English on explicit social<br />
responsibility issues. However, information in<br />
(partially) English on clinical governance, quality and safety<br />
in health care.<br />
Clinical Governance is an integrated approach to<br />
modernize the health system, placing at the centre<br />
of programming and health management the<br />
citizen’s needs. It also places importance on the<br />
role and responsibility of healthcare workers thus<br />
promoting healthcare quality.<br />
Information on patient safety and risk<br />
management, including information on stakeholder<br />
involvement in safety promotion and<br />
Latvia The State http://www.vza.gov.lv/ - Latvian<br />
recommendations for healthcare workers.<br />
Information on the objective of the Agency: to<br />
Agency of<br />
- English ensure availability of efficient, safe and qualitative<br />
Medicines<br />
(partially) medicines to the Latvian population.<br />
Code of Ethics for the purpose of guiding the<br />
Agency employees.<br />
Quarterly informative bulletin 2003-2010 in<br />
Latvian.<br />
Annual Report in English with no explicit<br />
information on social responsibility issues.<br />
Lithuania The State http://www.vvkt.lt/ - LithuanianDeclared<br />
main responsibility is the protection of<br />
Medicines<br />
- English public health. Information on the policy of quality,<br />
Control<br />
(partially) on its vision, mission and principles.<br />
Agency<br />
The motto is: “To consumer only high quality, safe<br />
(SMCA)<br />
and effective medicines”.<br />
Annual reports partly drafted in English for the<br />
period 2003-2007 with no explicit reference to<br />
social responsibility issues.<br />
LuxembouThe<br />
Ministry http://www.ms.public.lu/ - French No information in English on social responsibility<br />
g of Health fr/index.html<br />
issues.<br />
Information in French on the Governmental Health<br />
Programme 2009.<br />
Information, including regulatory initiatives, on<br />
topics such as school medicine, promoting health<br />
and preventing diseases, health when travelling and<br />
immigrating, public health protection.<br />
Malta The Ministry https://ehealth.gov.mt/He - English General information: The stated mission is to<br />
of Health, althPortal/default.aspx<br />
protect and promote the health of the people of the<br />
Elderly and<br />
Islands of Malta. The Health Division is committed<br />
Community<br />
to assuring the accessibility, quality and<br />
Care<br />
sustainability of the public health services and
Country Name of<br />
Institution<br />
The The Ministry<br />
Netherlandof<br />
Health,<br />
s Welfare and<br />
Sport<br />
Poland The Ministry<br />
of Health<br />
Portugal The Ministry<br />
of Health<br />
Slovakia The Ministry<br />
of Health of<br />
the Slovak<br />
Republic<br />
Slovenia The Ministry<br />
of Health<br />
Site Disclosure<br />
language<br />
http://english.minvws.nl/<br />
en/<br />
http://www.mz.gov.pl/w<br />
wwmzold/index?mr=m0<br />
&ms=&ml=en&mi=535<br />
&mx=6&ma=239<br />
http://www.minsaude.pt/portal<br />
http://www.health.gov.sk<br />
/<br />
- Dutch<br />
- English<br />
- Polish<br />
- English<br />
(partially)<br />
~ 89 ~<br />
Information on social responsibility in the<br />
healthcare system<br />
resources.<br />
Information on the structure and responsibilities of<br />
the Strategy and Sustainability Division,<br />
established in 2006.<br />
Information on the mission statement, objectives<br />
and services of the Elderly Care Department.<br />
Information on the Health Promotion Unit, which,<br />
among others, offers counselling and organizes<br />
mass media campaigns on health issues. It<br />
additionally organizes aerobic sessions, weight<br />
management clinics and smoking cessation clinics.<br />
Information on different themes and if the case,<br />
information on the Ministry’s policy and measures<br />
regarding those themes: abortion, alcohol, blood,<br />
disabled people, drugs, EU-Health Portal,<br />
euthanasia, Exceptional Medical Expenses Act,<br />
food and food safety, health insurance system, ICT<br />
in healthcare, infectious diseases, long-term care,<br />
medicines, mental health care, patient safety,<br />
prevention, professionals in health care, senior<br />
citizens, sexually transmitted infections, smoking,<br />
social support, sports and youth.<br />
Different documents, publicly available in English,<br />
such as:<br />
- the lecture “In pursuit of sustainability”, held in<br />
2005 by a representative of the Ministry.<br />
- the paper “Health Care in an Ageing Society, a<br />
Challenge for all European Countries”, 2004<br />
- parliamentary document on measures to be taken<br />
to guarantee the sustainability of long-term care,<br />
2008<br />
No information in English on social responsibility<br />
issues.<br />
- PortugueseNo information in English on social responsibility<br />
issues.<br />
Information in Portuguese on the national health<br />
policy.<br />
- Slovak No information in English on social responsibility<br />
issues.<br />
http://www.mz.gov.si/en/ - Slovene Information on its activities, namely health<br />
- English improvement and preventive activities. The basis<br />
(partially) for these activities is the understanding of health as<br />
something of value both to individuals and to<br />
society as a whole, and as a precondition for the<br />
successful economic and social development of the<br />
country.<br />
The national programme of food and nutrition<br />
policy 2005-2010, describing the three pillars of<br />
nutrition policy (food safety, healthy nutrition,<br />
local sustainable supply), as well as the evaluation<br />
of programmes and health indicators.<br />
The plan for upgrading the health care system by<br />
2020 (issued February 2011).<br />
Sweden The Ministry http://www.sweden.gov.s - Swedish The Swedish Social Policy Model emphasizes the<br />
of Health and e/sb/d/2061<br />
- English role of the public sector in contributing to people's<br />
Social Affairs<br />
welfare, such as health and medical care. The<br />
governmental support by means of social<br />
insurance is provided in different phases of life.<br />
Moreover, the support and service of the public
Country Name of<br />
Institution<br />
Site Disclosure<br />
language<br />
The Swedish http://www.fhi.se/en/ - Swedish<br />
National<br />
- English<br />
Institute of<br />
Public Health<br />
National http://www.socialstyrelse - Swedish<br />
Board of n.se/english/aboutus - English<br />
Health<br />
Welfare<br />
and<br />
Czech The Ministry http://www.mzcr.cz/En<br />
of Health of<br />
the Czech<br />
Republic<br />
Romania<br />
The Ministry<br />
of Health<br />
National<br />
Medicines<br />
Agency<br />
- Czech<br />
- English<br />
~ 90 ~<br />
Information on social responsibility in the<br />
healthcare system<br />
sector are based on individual needs.<br />
Information on the results of an analysis<br />
performed by the Ministry regarding possible<br />
developments of the elderly population's needs for<br />
health care and elderly care over the next forty<br />
years.<br />
Other policy areas that demonstrate social<br />
responsibility: children rights, dental treatment,<br />
disabilities, elderly care, sickness insurance and<br />
public health.<br />
Regarding public health, there are numerous<br />
measures taken by the Government in order to<br />
promote citizens’ ability to make healthy choices,<br />
such as:<br />
- a forum for dialogue on ways in which society<br />
can contribute to healthy eating-habits and<br />
physical activities;<br />
- an advisory board to give advice on alcohol,<br />
drugs, doping and tobacco policy, and a secretariat<br />
to coordinate its work;<br />
Domains of public health objectives: participation;<br />
economic and social prerequisites; conditions<br />
during childhood and adolescence; health in<br />
working life; environments and products; healthpromoting<br />
health services;<br />
Protection against communicable diseases;<br />
sexuality and reproductive health; physical<br />
activity; eating habits and food; tobacco, alcohol,<br />
illicit drugs, doping and gambling<br />
Information on the role to co-ordinate, develop and<br />
follow up the communicable disease prevention<br />
and control in Sweden.<br />
Information on how to report malpractice or<br />
dissatisfaction in Health Care or Social Services.<br />
Main principles of the health service in the Czech<br />
Republic: solidarity, high degree of selfadministration,<br />
multisource financing with major<br />
share of public health insurance, equal availability<br />
of health care for all insured persons and<br />
obligatory vaccination against infectious diseases.<br />
Information on the procedure for filing a<br />
complaint and the authorities to which one can<br />
complain.<br />
Ethical code of patient rights including eleven<br />
main points. A list of ten rights of children patients<br />
as well as of foreigners as parents<br />
http://www.ms.ro/ - RomanianGuide for Healthy Eating, 2006<br />
No clear concern of the Ministry Strategic Plan<br />
2008-2010 for social responsibility<br />
http://www.anm.ro/en/ho<br />
me.html<br />
No information on social responsibility issues<br />
- RomanianQuarterly<br />
informative bulletins in Romanian from<br />
- English within the period 1999-2010<br />
The informative bulletin 2/2010 states the strategic<br />
objectives of the National Medicines Agency,<br />
among which the protection of public health.
IMPROVEMENT IN ACCOUNTING SYSTEM<br />
AND PERFORMANCE MANAGEMENT<br />
OF IRAN’S UNIVERSITIES IN THE LIGHT<br />
OF CONTINGENCY THEORY<br />
Martin BROAD 1 & Abbas ALIMORADI<br />
University of Southampton, United Kingdom<br />
ABSTRACT<br />
Many external factors have affected Governmental Universities of Iran in the past six years.<br />
Decentralization in terms of delegation of authority, financial pressure, and competitive<br />
position for better quality and higher performance in teaching and research are the main<br />
factors. This study investigates the effects of the aforementioned variables on the accounting<br />
systems of Iran’s higher education institutions. According to Contingency Theory in<br />
accounting, there is no identical management accounting system or control system to fulfil the<br />
needs of all organizations in every situation (Chenhall, 2003, Otley, 1980). Based on the<br />
Contingency Theory literature a theoretical model has been developed and empirically tested.<br />
Data were collected from the Governmental Universities in Iran during the latter part of 2009<br />
through a postal questionnaire. All 126 Governmental Universities in Iran were sent the<br />
questionnaire and responses were obtained from Financial, Education, and Research<br />
Departments in each university. Fully completed and usable questionnaires were collected<br />
from 246 Departments (65.1 percent response rate) and Structural Equation Modelling<br />
(SEM) was used to test the model. The preliminary results and analyses support the existing<br />
literature in the most parts. Present study contributes in methodology and theory areas by<br />
several points as well as proposing some suggestions for policy makers of Iran’s Higher<br />
Education and Universities’ Management.<br />
KEYWORDS: Accounting System, Performance Management, Contingency Theory,<br />
Higher Education, Structural Equation Modelling, Developing Countries, Iran<br />
INTRODUCTION<br />
Iran has two big categories of universities namely Governmental and Nongovernmental<br />
Universities. Still the main load of higher education is on the<br />
Governmental Universities which are funded by the Government for the majority of<br />
their activities. Four basic reasons encouraged the researcher to undertake this study.<br />
First, Iran’s Parliament passed the Forth Five-year Development Plan Act in 2004,<br />
thereby proposed a reform for the universities and delegated them authority for<br />
decision-making more than before. Second reason is the low performance of higher<br />
education institutions in Iran in term of international ranking, as the best universities<br />
in Iran are not ranked within the first 500 universities. Third, financial pressure and<br />
competitive positions as other factors have been imposing on the universities during<br />
1 Correspondence address: Martin BROAD, Director MSc Accounting and Finance, University of<br />
Southampton, UK; email: aas1e08@soton.ac.uk<br />
~ 91 ~
ecent years. Finally, the researcher’s involvement as a lecturer and deputy-chancellor<br />
of administrative and finance in a popular university was a key motivation for<br />
undertaking this study. Many external factors have affected Iran’s universities in the<br />
past six years. Decentralization in terms of delegation of authority, financial pressure<br />
or budget constraint and competitive position for better quality and higher<br />
performance in teaching and research are the main factors.<br />
This study investigates the effects of aforementioned variables on the accounting<br />
system and performance management of Iran’s higher education institutions by the aid<br />
of Contingency Theory. The remainder of this paper consist of five sections. The next<br />
section is about literature review and hypothesis development followed by the section<br />
of variable measurement, and then the methodology section. The fourth section<br />
presents the results of SEM analyses and hypotheses tests. In final section the<br />
implications of the results are discussed and some conclusion and contribution is<br />
explored.<br />
1. RELATED LITERATURE AND HYPOTHESES DEVELOPMENT<br />
According to Contingency Theory in accounting, there is no an identical management<br />
accounting system or control system to accomplish the requirements of all<br />
organizations in all situations (Otley, 1980). There are many studies having looked at<br />
the effect of different external and contextual variables on design or change in<br />
management accounting system or (in a wider area) management control system.<br />
Most of these studies are in private sector organizations context. Chapman (1997),<br />
Chenhall (2003), and Langfield-Smith (1997) have reviewed the contingency based<br />
studies in accounting almost comprehensively. Looking at those reviews reveals that<br />
there are many inconsistent findings and equivocal postulates concerning the effect of<br />
contextual and environmental variables on design and use of management control<br />
systems as well as organizational performance (Chenhall, 2003). In addition, in spite<br />
of loads of contingency-based researches regarding the private companies’ context,<br />
the field of public organization has not attracted sufficient attention in this matter<br />
(Chapman, 1997). On the other hand, there are many differences between public and<br />
private organizations so usefulness of contingency propositions which have been<br />
confirmed in the context of private companies, needs further investigations and<br />
evidence for public sector (Miah and Mia, 1996).<br />
Based on the Contingency Theory and Performance Management literature, three<br />
external variables namely “competitive position”, “financial pressure” and<br />
“decentralization” and three aspects of accounting system including “improvement”,<br />
“budgetary participation”, and “emphasis on budget controls” were chosen in order to<br />
their effects on universities’ departmental performance be tested. In Performance<br />
Management part, using some parts of the framework proposed by Otley (1999), the<br />
interaction amongst those external variables, accounting system and two dimensions<br />
of performance management, namely performance measures and reward system, are<br />
investigated. Ten hypotheses are developed to assess the interactions between abovementioned<br />
variables and to support these hypotheses, some instances of evidence in<br />
the literature are stated as below.<br />
~ 92 ~
1.2. Improved accounting system (H1)<br />
Decentralization has been considered as on of the prevalent causes for development in<br />
management accounting systems. It is believed that broad scope and comprehensive<br />
information with predictive characteristic could better serve organizations with<br />
decentralized structures (Gordon and Narayanan, 1984). Level of sophistication in<br />
management accounting system and decentralization are positively associated in UK<br />
firms (Abdel-Kader and Luther, 2008). Budding (2008) conducting a research in<br />
Dutch municipalities, found that decentralization is related to design and use of more<br />
sophisticated management accounting system.<br />
Competition is known as another motive for improvement in accounting systems.<br />
Organizations which feel more intense competition would try to change their<br />
management control system and adopt some new techniques to help them surviving<br />
under competition pressure (Cooper, 1995). Khandwalla (1972) found that in the<br />
circumstance of competition demand for control in organization would increase and<br />
organizations are likely to spend more money on their control systems. He also<br />
discovered that grater competition leads the companies to change their accounting<br />
systems to more sophisticated ones and much more use of accounting information.<br />
Cavalluzzo et al.’s findings (1998) highlighted the importance of external competition<br />
and its effect on governmental efficiency and accounting system design and use.<br />
Financial pressure has also been considered as one of the causes of cost accounting<br />
system development in hospitals (Orloff et al., 1992). Reid and Smith (2000) found<br />
that most of the companies in their research sample had started to develop their<br />
management accounting systems during the period of cashflow crisis, deficit of<br />
finance, or innovation. The association between financial pressures and evolution in<br />
one section of UK universities’ accounting systems – former Polytechnic sector – was<br />
confirmed (Broad, 2001). Based on aforementioned studies and situation of Iranian<br />
universities the hypothesis below is proposed:<br />
H1. Universities which are (a) more “decentralized” and (b) facing more intense<br />
“competition” and (c) higher “financial pressure” have more “improved accounting<br />
system”.<br />
1.3. Budget control and participative budgeting (H2 and H3)<br />
Impact of decentralization on budgetary behaviour including participative budgeting<br />
and more emphasis on budget control has been assessed in contingency-oriented<br />
researches. It was confirmed that decentralized companies mostly are interested in<br />
emphasis on formal management control systems (Burns and Waterhouse, 1975).<br />
Miah and Mia’s (1996) collected data from governmental organizations in New<br />
Zealand showed that in the case of delegating more responsibility and authority from<br />
top managers to the lower managers, more control and financial activities evaluation<br />
is needed. Kempkes and Pohl (2008) argue that universities’ autonomy not only is<br />
related to the better research performance, but also it is associated with increase in the<br />
efficiency of budget consumption in those institutions. On the other hand,<br />
decentralization, in term of autonomy in decision-making, is considered as one of the<br />
antecedents of participative budgeting (Modell et al., 2000). Several studies have been<br />
looked at the relationship between these two variables. For example Merchant (1981)<br />
~ 93 ~
found that for large, divers, and decentralized organizations stress on sophisticated<br />
and participative budgets is of high importance. Gul et al. (1995) found some<br />
confirming evidence regarding the association between decentralization and<br />
participative budgeting in Hong Kong companies. The results of another study<br />
confirmed also the facilitative role of decentralization to boost budgeting practices<br />
such as participative budgeting in the public sector of a developing country (Awio and<br />
Northcott, 2001).<br />
Also environmental hostility has a significant relationship with putting more stress on<br />
performing in the boundaries of budgets (Otley, 1978). Financial pressure might be<br />
alleged as an external restriction and hostility from the Government on Iranian<br />
universities. In more hostile environment resulted from resource limitations and<br />
intense competitions, there will be much more reliance on formal control (Imoisili,<br />
1989). No direct evidence could be found to confirm the negative association between<br />
financial pressure and participative budgeting, however several papers have looked at<br />
the effects of participative budgeting and budgetary slack (Young, 1985, Awasthi,<br />
1988, Dunk, 1993a, Van der Stede, 2000, Davila and Wouters, 2005, Kren and Maiga,<br />
2007). On the other side, it has been confirmed that rigid budget control could<br />
negatively affect the slack in budgets (Merchant, 1985a, Dunk, 1993a). If<br />
aforementioned relationships are true, it is expected that budget constraints would<br />
hamper the participative budgeting practices. So it seems reasonable to propose<br />
hypotheses 2 and 3 as below.<br />
H2. Universities which are (a) more “decentralized” and (b) facing “higher financial<br />
pressure” put more “emphasis on budget control”.<br />
H3. “Participative budgeting” in Iran’s universities are (a) positively associated with<br />
“decentralization”, but (b) negatively with “financial pressure”.<br />
1.4. Effect of accounting and budgetary system on performance (H4 to H6)<br />
It seems evident as well as has been claimed by many researchers that accessing to<br />
more information would assist managers to make decision much more effectively (for<br />
example see: Chenhall, 2003, Baines and Langfield-Smith, 2003). Cadez and<br />
Guilding (2008) found that there is a positive association among the degree of usage<br />
of strategic management accounting techniques and performance. Several researchers<br />
have proposed that in an uncertain environment, the information provided by<br />
management accounting system is much more useful (for example see: Gordon and<br />
Narayanan, 1984). Competition has been identified as an index of uncertain<br />
environment (Mia and Clarke, 1999). Simons (1990) doing a two year field study in<br />
two competing companies, tried to investigate the extent and process of formal<br />
management control system effects on strategy formulation to be assured that<br />
competitive advantages would be saved. It is almost an accepted expectation of<br />
accounting systems as a part of management control system to help organizations in<br />
gaining competitive advantages (Bromwich, 1990). Then following hypothesis is<br />
suggested:<br />
H4. “Universities’ departmental performance” is (a) positively related to “improved<br />
accounting system” (b) mediating by “competitive advantage”.<br />
~ 94 ~
Shields and Shields (1998) have reviewed 47 published papers which had<br />
investigated the effects of participative budgeting on several dependent variables.<br />
Performance with 31 frequencies is the most frequent dependent variable in those<br />
researches. Although organisational scholars such as Argyris (1952) and Becker and<br />
Green (1962) have proposed positive relationship between participative budgeting<br />
and performance (Kren, 1992), results of the studies in management accounting in this<br />
regard are somehow equivocal (Chenhall, 1986). Therefore, many of the studies in<br />
this field have looked at a mediating variable which may affect the relationship<br />
between participation and performance. While the definition of budgets proposed by<br />
King et al. (2010) can also be employed for public organizations, participative<br />
budgeting in a public organization is not quite similar to a private organization, so it is<br />
expected that its mediating variable may also vary. In public sector organizations, at<br />
least in context of Iranian universities budgeting system is mainly about distribution<br />
of funds between different departments and activities. Thus, it seems that if<br />
participative budgeting could improve the Departments’ satisfaction with budgets it<br />
might improve their performance, otherwise it may do not have any positive<br />
consequence on performance or even negative, as it might create extra duty for each<br />
department and employee. A significant association has been confirmed between<br />
participative budgeting and both of job satisfaction and satisfaction with budgets<br />
(Chenhall, 1986). So it can be expected to:<br />
H5. “Universities’ departmental performance” is (a) positively related to<br />
“participative budgeting”, (b) mediating by “satisfaction with budgets”.<br />
Hopwood (1972) proposed three different styles of performance evaluation so called<br />
Profit Conscious and Budget Constrained as well as Non- accounting Measures. He<br />
concluded that use of Profit Conscious style is more related to the improved<br />
organizational performance and less job-related tension amongst employees and their<br />
supervisors, however Otley (1978) could not confirm this results in another company<br />
and tried to justify the contradictory results by proposing the difference between main<br />
activity centres in those companies. Many other studies in Finance Theory framework<br />
found that budget control which is resulted from financial pressure in state-owned<br />
enterprise which are production firms could have negative effects on employment,<br />
pay rise, and sustainability in market, but a positive effect on productivity (Bertero<br />
and Rondi, 2000, Nickell and Nicolitsas, 1999, Musso and Schiavo, 2008).<br />
Nonetheless, it should be borne in mind that budget control in Iranian universities<br />
mainly is about cash and fund, so it is somehow different with budget control in<br />
private organizations. Shen (2003) found that budget constraint in US hospitals is<br />
adversely related to the quality of their performance. In higher education field also<br />
many studies have discussed consequences of budget constraint on their performance.<br />
Reform in universities’ funding resulted in more budget control in Ghana’s<br />
universities could reduce their efficiency and create many problems for them (Brock,<br />
1996), this is also the case for the universities in Sri Lanka (Chandrasiri, 2003).<br />
Greenaway and Haynes (2003) argue that budget constraint in UK universities<br />
resulted in poorer performance in at least four aspects of activities namely class size,<br />
recruitment and remuneration, research, and social exclusion, although universities<br />
have endeavoured to compensate this problem by increasing their productivity. So the<br />
sixth hypothesis is proposed as below:<br />
~ 95 ~
H6. “Universities’ departmental performance” is negatively associated with “more<br />
budget control”.<br />
Figure 1, concisely, illustrates hypothesis 1 to 6 in a schematic expression.<br />
Figure 1 Effects of external variables on Iranian universities’ accounting system<br />
and performance (proposal)<br />
Competitive<br />
position<br />
H1b H1c<br />
Improved<br />
accounting system<br />
Competitive<br />
advantage<br />
H4b<br />
H1a<br />
1.5. Comprehensive performance measures (H7)<br />
Financial pressure Decentralization<br />
H2a H2b<br />
More emphasis on<br />
budget control<br />
H6<br />
University’s departmental<br />
performance<br />
According to the balanced scorecard notion (Kaplan and Norton, 1993) it seems<br />
evident that in a new situation such as competitive position organizations are more<br />
likely to employ new and comprehensive measures to evaluate their performances.<br />
Use of qualitative measures besides quantitative measures in the competitive positions<br />
appears to be prevalent to lead organizations in a better point compared to their rivals<br />
(Amir and Lev, 1996). As a result of another empirical study, it is claimed that there is<br />
a positive and significant association among the magnitude of market competition and<br />
use of multiple performance measures in manufacturing organizations (Hoque et al.,<br />
2001). Recently this idea was confirmed in Taiwanese high-tech manufacturing firms<br />
as well (Schulz et al., 2010). Although Kaplan (2001) giving several evidence, claims<br />
that use of non-financial performance measures alongside with the traditional<br />
measures is also useful in non-for-profit organizations, little empirical investigation<br />
has been conducted in the context of public organizations. Thus, it seems interesting<br />
to below hypothesis be tested in some public organizations:<br />
H7. Use of “comprehensive performance measures” is more important for the<br />
universities which are facing more intense “competition”.<br />
~ 96 ~<br />
H5b<br />
Participative<br />
budgeting system<br />
H4b H5a<br />
H5b<br />
H4a<br />
H3b<br />
H3a<br />
Satisfaction with<br />
budgets
Flamholtz (1983) argues that accounting and budgeting system could not be seen as a<br />
complete control system and they should be linked with other parts of holistic<br />
management control system, including an appropriate reward system, to be able to<br />
meet their ultimate objectives. It was confirmed, empirically, that localization in<br />
designing reward system could better benefit organizations (Thompson and Richter,<br />
1998). Shelley (1999) argues that there is high level of autonomy for each university<br />
in the UK to specify its own appraisal system, whereas it has not been the case for<br />
Iran’s universities for many years. As it was mentioned earlier, following the new<br />
legal reform it was supposed to universities be delegated more authority and<br />
autonomy to change, legislate and administrate most of regulations that they think<br />
should be corrected or there is ambiguity on them. So it may be claimed that:<br />
H8. “Improvement in the universities’ reward system” is associated with their level<br />
of “decentralization”.<br />
1.6. Use of accounting in performance management (H9)<br />
It is still hard to deny the importance and usefulness of accounting information to help<br />
the management in performing their main tasks especially in decision-making and<br />
control (Zimmerman, 1995).There are some evidence in the literature that support the<br />
direct association among decentralization and usage extent of accounting information<br />
(for example see: Miah and Mia, 1996, Budding, 2008) and indirect relationship<br />
between competitive position and usage degree of accounting systems after changing<br />
it to a more efficient system (for example see: Khandwalla, 1972, Simons, 1990).<br />
Although Gordon and Narayanan (1984) could not find a significant association<br />
among structure and usefulness of accounting information system, findings by<br />
Chenhall and Morris (1986) confirmed the existence of such a relationship. Based on<br />
this inconsistent results Miah and Mia (1996) endeavoured to test some propositions<br />
in this regard at governmental organizations in New Zealand and found positive<br />
association among them. Abernethy and Vagnoni (2004) performing an exploratory<br />
study in two Italian teaching hospitals, found that decentralization in sense of<br />
authority delegation directly affects the extent of usage of accounting systems in<br />
decision-making and control aspects. On the other side, findings by Mia and Clarke<br />
(1999) confirmed the association between intensified competition and increased use<br />
of management accounting information. Therefore, proposition below is stated:<br />
H9. The extent of “use of accounting information in performance management” by<br />
the universities is related to (a) their level of “decentralization” and (b) intense of<br />
“competition”.<br />
1.7. Performance management and performance (H10)<br />
In relation with the influence of two chosen aspect of performance management as<br />
well as usage of accounting information in PM, on organizational performance several<br />
confirming evidence could be found in the literature. Regarding the effect of<br />
improved reward system, Ittner and Larcker (1995) tried to assess the association<br />
amongst TQM practices, reward system, and level of performance. They found<br />
supporting evidence for positive relationship between emphasis on non-traditional<br />
information and reward system with performance just for the companies using TQM<br />
practices less broadly. Gomez Mejia (1992) found positive association between<br />
reward system, diversification, and performance. Bonner and Sprinkle (2002)<br />
reviewed and proposed the relationship of monetary incentives, effort (direction,<br />
~ 97 ~
duration, intensity, and strategy development) , and task performance. In a recent<br />
study, it was also confirmed that performance-based payment would affect<br />
employees’ effort which consequently improve organizational performance (Schulz et<br />
al., 2010). However, no study could be found investigating the direct association<br />
between improvement in reward system and organizational performance. In addition,<br />
there are many empirical studies confirming positive relationship between<br />
“comprehensive performance measures” and “organizational performance” (Kaplan<br />
and Norton, 1993, Chenhall, 1997, Lee and Yang, 2010). Widener (2006) also found<br />
some evidence supporting the positive association between importance of<br />
performance measures and firms’ performance. Schulz et al. (2010) also found that<br />
employing comprehensive performance measures would increase organizational<br />
performance. Comprehensive performance measures is also crucial for governmental<br />
organizations as it has been proved that behavioural aspects of performance<br />
management practices are not less important than their financial aspects in public<br />
organizations (Verbeeten, 2008).<br />
Finally, it has been claimed by many researchers that accessing to more information<br />
would assist managers to make decision much more effectively (for example: Miah<br />
and Mia, 1996, Baines and Langfield-Smith, 2003, Chenhall and Langfield Smith,<br />
2003). Mia and Clarke’s (1999) findings showed that the improvement in<br />
performance of business units is related to the extent of usage of information provided<br />
by management accounting system in the competitive situations. Miah and Mia<br />
(1996) also found positive relationship between grater usage of accounting<br />
information and performance. So the final hypothesis is as below:<br />
H10. Universities’ departmental performance is positively related to (a)<br />
“improvement in reward system”, (b) importance of “comprehensive performance<br />
measures” and (c) “use of accounting information in performance management”.<br />
The schematic diagram below, Figure 2, summarizes the hypotheses 7 to 10 of this<br />
research.<br />
Figure 2 Interaction between external factors, accounting system and performance<br />
management at Iran’s universities (proposal)<br />
Competitive<br />
positions<br />
H7<br />
Comprehensive<br />
performance<br />
measures<br />
H9b H9a<br />
H10b<br />
Usage of accounting<br />
information in PM<br />
H10c<br />
University’s departmental<br />
performance<br />
~ 98 ~<br />
H10a<br />
Decentralization<br />
H8<br />
Improvement in<br />
reward system
2. VARIABLE MEASUREMENT<br />
For variable measurement, it has been attempted to use and modify extant instruments<br />
as far as possible. To measure the 12 main variables of this study, 66 indicators<br />
(questions) were employed by use of a six-point Likert type scale questionnaire. To<br />
measure “Competitive Position” the instrument of Khandwalla (1972) has been<br />
adapted , so the extent of competition tension in education, research, and overall<br />
issues has been asked. For measuring “Financial Pressure” 4 questions designed by<br />
the researcher as no existing questionnaire could be found in this regard. The extent of<br />
financial pressure, how often they need to postpone or ignore some expenditure due to<br />
budget constraint, trend of budget growth, and their overall opinion regarding the<br />
existence of financial pressure are the content of those 4 questions. There are several<br />
kind of instrument for “Decentralization” measurement, however the instrument of<br />
Inkson et al. (1970) has been modified in this study. The degree of authority for two<br />
aspects of activities namely decision making and legislation in five areas of research,<br />
education, financial, administrative, and recruitment have shaped the 6 questions<br />
concerning the decentralization. Another question tried to gauge the effect of new<br />
reform on delegating more authority to the universities.<br />
To quantify “Improvement in Accounting Systems” a question with 11 section was<br />
designed using the instruments of Khandwalla (1972), Chenhall and Morris (1986) ,<br />
and Martí and Vía (2007). The content of this question is about the changes in<br />
accounting systems in some attributes of the system such as frequency, accuracy, and<br />
qualification of accounting reports, speed of preparing accounting reports, demand for<br />
different accounting reports, use of internal and independent auditing, use of nonfinancial<br />
information in accounting reports, use of new techniques of management<br />
accounting, and computerising accounting practices, as well as automatic reporting.<br />
“Participative Budgeting” was measured by 6 questions adapted from Milani (1975).<br />
Involvement in finalizing their budgets, their influence on finalizing budgets, the<br />
importance of participative budgeting for them to have reasonable budgets, the<br />
frequency of their contacts with and from budgeting department, and the<br />
convincement of reasoning by Budget Department after changing some parts of their<br />
budgets are the content of those questions. As “Budget Emphasis” in public<br />
organizations is somewhat different with private companies, no instrument could be<br />
found for this variable as well. Therefore 3 questions were employed for this purpose<br />
including the extent of budget emphasis, authority to transfer budget funds between<br />
headings, and importance of compliance between actual performance and budget<br />
figures.<br />
To gauge “Satisfaction with Budgets” the respondents were asked to express their<br />
satisfaction with completeness, fairness, and flexibility of budgets. In another question<br />
their opinion about other staff’s satisfaction with budgets were questioned.<br />
“Competitive Advantage” was measured by employing Guilding (1999) instrument<br />
and requesting the recipients about the extent of their use of accounting information in<br />
competitors’ cost assessment and position monitoring, strategic costing, and offering<br />
competitive price in proposals. To evaluate “Use of Comprehensive Performance<br />
Measures” the instruments of Hopwood (1972) and Otley (1978) have been modified<br />
and a combination of quantitative and qualitative common measures were asked. The<br />
extent of effort put into their jobs, their concern with quality, the extent of students’<br />
satisfaction with them, their attitudes to their tasks and university, the punctuality and<br />
~ 99 ~
length of their presence at their workplace, their task accomplishment on time, and<br />
their concern with costs and budgets have been the indicators for this variable.<br />
As reward system of faculty members and other staff are slightly different in Iran’s<br />
universities, it has been endeavoured to measure “Improvement in Reward System”<br />
separately in two questions. Proper relationship between amounts of salary, other<br />
earning, and annual promotion with job performance were common in two questions.<br />
The question regarding other staff has a fourth section to obtain their opinion about<br />
proper link between staff’s overtime payment and their job performance. Using the<br />
formats and anchors employed by Cravens and Guilding (2001), Guilding (2002), and<br />
Cadez and Guilding (2008) a four-section question was asked from all managers to<br />
assess the extent of their “Usage of Accounting Information for Performance<br />
Management”. The aspects of performance management were adapted to the Iran’s<br />
circumstances based on the framework proposed by Otley (1999) including goal<br />
definition and standard setting, performance measurement and comparing to the<br />
targets, expenditure controlling and decision-making, and rewarding and<br />
compensation.<br />
For measuring “Universities’ Departmental Performance” the instrument of Merchant<br />
(1981) which has been used by other researchers such as Brownell and Merchant<br />
(1990) and Dunk (1995) was employed. To avoid from massive subjectivity bias, five<br />
key performance indicators which are normally used by different departments in<br />
Iranian universities were placed in the questionnaires. For Education Departments the<br />
indicators are the rate of graduation during the planned period, quality of instructors<br />
which can be measured based on combination of faculty members (more lecturers=1,<br />
more full professor=6), graduates’ success in passing entrance exams to study in<br />
upper levels, graduates success in finding jobs compared to other universities, and<br />
quality of programmes and courses. Employed key performance indicators for<br />
Research Departments include “number of national publications”, “number of<br />
international publications”, “number of applied research projects and contracts”,<br />
“number of registered patents and inventions”, and “amount of research income”. Key<br />
performance indicators for Financial Departments are ability to pay for expenses and<br />
liabilities on time, new investment in constructing or purchasing new buildings, new<br />
investment in teaching, research, and experimental assets and facilities, growth in<br />
other revenues other than governmental budgets, and percentage of saved budgets at<br />
the end of each year. All of them were requested to rate their overall performance<br />
compared to their counterparts in other universities as the sixth questions.<br />
3. METHODOLOGY<br />
The suitable philosophy and paradigm for this study seemed to be positivism and<br />
functionalist and, as it was mentioned earlier, Contingency Theory was adopted as the<br />
underlying theory for it. Choosing cross sectional survey as research strategy, data<br />
were collected from the Governmental Universities in Iran during the latter part of<br />
2009 through a postal questionnaire. Three main divisions of activity namely<br />
Research Department, Education Department, and Financial Department of all 126<br />
Governmental Universities in Iran were sent the questionnaire. Therefore, the<br />
population of this study was 378 departments of Iranian State Universities.<br />
~ 100 ~
To analyse the data, Structural Equation Modelling (SEM) technique has been<br />
employed as the main tool, and it has been run by a computer programme called<br />
Amos, version 17. SEM is a systematic approach that employed for test of models fit<br />
by doing factor analysis and linear regression at the same time (Williams et al., 2009).<br />
This technique could take the measures directly from questionnaire as indicators or<br />
observed variables to estimate the relevant concepts or latent variables (Hoyle, 1995).<br />
By using this technique combination of moderating and intervening models can also<br />
be tested and some changes in initial model would be possible.<br />
4. PRELIMINARY RESULTS<br />
275 completed questionnaires were collected from the universities (72.8 percent<br />
response rate), but only 262 of them were fully completed without any missing data,<br />
as it is necessary for SEM, then the real response rate is 69.3 percent. Finally by<br />
screening the data and in order to gain an acceptable level of normality of distribution<br />
16 questionnaires were set aside as outliers, so final response rate is 65.1 percent. The<br />
brief results of descriptive analysis have been shown in the table 1 as below.<br />
Table 1 Descriptive statistic results of the data, using SPSS 17.<br />
Variables Min* Max* Mean Std.<br />
Dev.<br />
Skew. Kurt.<br />
No. of<br />
Items<br />
Cronbach’s<br />
Alpha<br />
Competitive position 2 6 4.21 0.74 -.200 -.415 3 .74<br />
Financial pressure 2 6 4.58 0.64 -.302 -.464 4 .77<br />
Decentralization 1 6 3.19 0.84 .094 -.852 7 .91<br />
Improved<br />
accounting system<br />
2 6 4.26 0.75 .170 -.757 11 .87<br />
Participative budgeting 1 6 3.01 0.94 .100 .291 6 .88<br />
More emphasis on budget<br />
control<br />
2 6 4.45 0.83 -.508 .141 3 .85<br />
Competitive advantage 1 5 2.25 0.96 .455 -.645 4 .95<br />
Satisfaction with budgets 1 6 2.95 0.88 .146 -.093 4 .87<br />
Comprehensive<br />
performance measures<br />
1 6 4.38 0.87 -.445 .208 7 .91<br />
Appropriate<br />
reward system<br />
1 6 3.21 0.96 .477 .575 7 .88<br />
Usage of accounting<br />
information in PM<br />
1 6 3.16 1.03 .264 -.336 4 .91<br />
Departmental performance 1 6 3.45 0.72 .133 -.046 6 .76<br />
* Theoretical Min and Max are 1 and 6 respectively.<br />
To analyse the data by SEM, two phases should be performed , namely measurement<br />
model and structural model (Williams et al., 2009). By running the first phase which<br />
is actually a kind of confirmatory factor analysis the reliability of indicators has been<br />
tested and confirmed, of course to gain a better model some of the indicators have<br />
been dropped out of the model by the indication of the initial results (Shook et al.,<br />
2004). After running the two proposed models by SEM, based on the outcomes of the<br />
first phase, the indices of “Model Fit” showed that the collected data are fit to the<br />
models.<br />
~ 101 ~
4.1. Accounting System Model<br />
According to the first model’s results (Figure 3) most of the indices of fit are good, for<br />
instance CMIN/DF is 1.224, CFI equals .975, NFI is .881, and RMSEM is .030, so all<br />
indices other than NFI which is slightly less than acceptable amount of .9, are at a<br />
good status (higher than acceptable). Table 2 concisely illustrates the indices of fit for<br />
the first model run by SEM.<br />
Figure 3. Effects of external variables on Iranian universities’ accounting system and<br />
performance (outcome)<br />
e12<br />
e11<br />
e10<br />
e9<br />
e8<br />
e7<br />
e6<br />
e5<br />
e4<br />
e3<br />
e2<br />
e1<br />
DECENT1<br />
DECENT2<br />
DECENT3<br />
DECENT4<br />
PARBUD1<br />
PARBUD3<br />
PARBUD5<br />
PARBUD6<br />
.84<br />
.66<br />
.82<br />
.90<br />
.77<br />
.59<br />
.68<br />
.70 .83<br />
.84<br />
.80 .63<br />
.79<br />
.62<br />
e19<br />
FINPRE1<br />
DECENT<br />
PARBUD<br />
BUDEMP1<br />
e13 e14 e15<br />
.18<br />
e30<br />
SATBUD1<br />
.56 .75<br />
.17<br />
SATBUD2<br />
.67 .82<br />
.72<br />
SATBUD3<br />
.52<br />
.75<br />
SATBUD<br />
SATBUD4<br />
.56<br />
.92<br />
.81<br />
DEPPER1<br />
e36<br />
.61<br />
.41<br />
Accounting System Model<br />
.37<br />
e33<br />
.78<br />
DEPPER2<br />
e37<br />
.83<br />
.12<br />
-.22<br />
FINPRE2<br />
FINPRE<br />
e20<br />
BUDEMP<br />
.56<br />
.91 .75 .85<br />
.05<br />
.08<br />
.21<br />
.82 .81 .70<br />
.68<br />
.65<br />
.33<br />
.31<br />
.15<br />
.04<br />
.44<br />
BUDEMP2<br />
-.06<br />
e31<br />
DEPPER<br />
.32<br />
.70 .81 .64<br />
.50<br />
.66<br />
DEPPER3<br />
e38<br />
.13<br />
~ 102 ~<br />
FINPRE4<br />
.08<br />
.07<br />
.72<br />
COMPOS<br />
IMPACC<br />
BUDEMP3<br />
e34<br />
.40<br />
e32<br />
COMADV<br />
e35<br />
.81<br />
DEPPER4<br />
e39<br />
.41<br />
e21<br />
.18.80<br />
.49<br />
.04<br />
COMPOS3<br />
.46<br />
.68 COMPOS1<br />
.64<br />
.80<br />
.71COMPOS2<br />
.50<br />
.64<br />
IMPACC8<br />
.77<br />
.88<br />
IMPACC9<br />
.85<br />
.72<br />
.88<br />
IMPACC10<br />
IMPACC11<br />
COMADV3<br />
.78<br />
.73<br />
.00<br />
.85<br />
COMADV1<br />
.82<br />
.91 COMADV2<br />
.79<br />
.63<br />
.86<br />
DEPPER6<br />
e40<br />
.66<br />
.74<br />
e16<br />
e17<br />
e18<br />
e22<br />
e23<br />
e24<br />
e25<br />
e26<br />
e27<br />
e28<br />
COMADV4 e29<br />
By comparing the real values with acceptable figures of indices proposed in the<br />
literature (Byrne, 2001) it can be concluded that the structural model is sufficiently
eliable. Of all indices in Table 2 just NFI is slightly less than acceptable range and it<br />
is due to the complexity of the model (Kline, 2005), however for assessing the fitness<br />
of a model reliance on the combination of indices (not just one index) has been<br />
recommended (Byrne, 2001, Shook et al., 2004). Figure 3 indicates the graphic results<br />
of the run of this model. In that Figure, rectangles represent observed variables and<br />
ellipses show the latent variables. Factor loadings (between observed and latent<br />
variables), common variances (as indicators of strength of relationship), and<br />
regression coefficients (between latent variables or factors) can be found on figure<br />
below in standardized form.<br />
Table 2. Indices of fit for the Accounting System Model<br />
The abbreviations that have been used in Figures 3 (previous page) and 4 and Tables 3<br />
Index<br />
Model<br />
and 5 mean as below:<br />
CMIN DF CMIN/DF CFI NFI RMSEA<br />
Real values 624 510 1.224 .975 .881 .030<br />
Acceptable<br />
values<br />
N/A N/A Less than 3 More than .9 More than .9 Less than .05<br />
DECENT = Decentralization<br />
COMPOS = Competitive Position<br />
FINPRE = Financial Pressure<br />
IMPACC = Improved Accounting System<br />
BUDEMP = More Budget Control<br />
PARBUD = Participative Budgeting<br />
SATBUD = Satisfaction with Budgets<br />
REWSYS = Appropriateness of Reward System<br />
USACPM = Use of Accounting in Performance Management<br />
COMPME = Comprehensive Performance Measures<br />
Based on the estimations resulted from SEM analysis (presented in Table 3) which are<br />
mostly consistent with the literature, it can be claimed that “improvement of<br />
accounting system” is related to “competitive position” (+.40); however this<br />
relationship could not be confirmed with “decentralization” (+.04) and “financial<br />
pressure” (+.08). On the other hand the association of “participative budgeting” with<br />
“decentralization” (+.37) and “financial pressure” (-.22) was supported. Moreover, it<br />
was confirmed that the universities with higher “financial pressure” and more<br />
“decentralization” (more delegated authority) put more “emphasis on budget<br />
controls”, though the association with “financial pressure” (+.44) was found stronger<br />
than “decentralization” (+.12). In addition, the positive effect of “improved<br />
accounting system” (+.13) and “participative budgeting” (+.31) on “universities’<br />
performance” was confirmed, nevertheless the negative effect of “budget control” was<br />
not found so significant (-.06). Furthermore, “competitive advantage” does not seem<br />
to mediate the relationship between “improved accounting system” and “universities’<br />
performance” (+.003), but partial mediation of “satisfaction with budgets” on<br />
association between “participative budgeting” and “performance” was found<br />
significant (+.14).<br />
~ 103 ~
Table 3. Regression coefficients based on Maximum Likelihood (ML) for Accounting<br />
System Model<br />
Variables Estimate S.E. C.R. P<br />
DECENT ->IMPACC<br />
COMPOS->IMPACC<br />
FINPRE ->IMPACC<br />
DECENT->PARBUD<br />
FINPRE ->PARBUD<br />
FINPRE ->BUDEMP<br />
DECENT->BUDEMP<br />
PARBUD->SATBUD<br />
IMPACC->COMADV<br />
SATBUD->DEPPER<br />
PARBUD->DEPPER<br />
BUDEMP->DEPPER<br />
COMADV->DEPPER<br />
IMPACC->DEPPER<br />
.055<br />
.723<br />
.116<br />
.323<br />
-.219<br />
.489<br />
.114<br />
.412<br />
.033<br />
.270<br />
.259<br />
-.047<br />
.049<br />
.078<br />
4.2. Performance Management Model<br />
~ 104 ~<br />
.082<br />
.143<br />
.092<br />
.059<br />
.066<br />
.080<br />
.066<br />
.073<br />
.057<br />
.064<br />
.062<br />
.048<br />
.045<br />
.037<br />
.673<br />
5.053<br />
1.259<br />
5.464<br />
-3.313<br />
6.094<br />
1.721<br />
5.638<br />
.578<br />
4.240<br />
4.175<br />
-.984<br />
1.100<br />
2.132<br />
In relation to the outcomes of second model (Figure 4) the indices are approximately<br />
the same as the previous model. CMIN/DF is 1.285, CFI is .974, NFI is .894, and<br />
RMSEM equals .034, so for this model also all indices except NFI are higher than<br />
acceptable level. As it can be discovered from the comparison between NFI indices of<br />
these two models, NFI for this model (.894) is slightly better than NFI for the<br />
previous model (.881). This point supports this idea that NFI is quite sensitive to the<br />
complexity of the model (Kline, 2005), as the later model is slightly simpler than the<br />
previous one. Indices of fit for this model can be seen in Table 4.<br />
Index<br />
Model<br />
Table 4. Indices of fit for the Performance Management Model<br />
.501<br />
.000<br />
.208<br />
.000<br />
.000<br />
.000<br />
.085<br />
.000<br />
.563<br />
.000<br />
.000<br />
.325<br />
.271<br />
.033<br />
CMIN DF CMIN/DF CFI NFI RMSEA<br />
Real values 367 287 1.285 .974 .894 .034<br />
Acceptable<br />
values<br />
N/A N/A Less than 3 More than .9 More than .9 Less than .05<br />
Having had a fit model; it might be reasonable to trust on the results of the structural<br />
relationships between latent variables. Regression coefficients resulted from SEM<br />
analysis regarding the Performance Management Model (Table 5) show the<br />
association between proposed latent variables.
e10<br />
e9<br />
e8<br />
e7<br />
e6<br />
e5<br />
e4<br />
e3<br />
e2<br />
e1<br />
Figure 4. Effects of external variables on Iranian universities’ Performance<br />
Management and Performance (outcome)<br />
.84<br />
DECENT1<br />
.66 .91<br />
DECENT2 .81<br />
.91 .82<br />
DECENT3.77<br />
.59<br />
DECENT4<br />
DECENT<br />
.47<br />
.30<br />
REWSYS2 .69<br />
.74.86<br />
FREWSYS<br />
.29<br />
REWSYS3<br />
.74<br />
USACPM1<br />
.65<br />
.86<br />
USACPM2 .81<br />
.66 .81<br />
USACPM3.79<br />
.62<br />
USACPM4<br />
.60<br />
DEPPER1<br />
e26<br />
Performance Management Model<br />
.12<br />
.32<br />
e14 e15<br />
USACPM<br />
e23<br />
DEPPER<br />
.20<br />
~ 105 ~<br />
COMPOS<br />
.10<br />
SREWSYS<br />
.78 .70 .82 .65 .81<br />
.48<br />
.67<br />
.42<br />
DEPPER2 DEPPER3 DEPPER4<br />
e27<br />
.12<br />
.27<br />
.16<br />
.49<br />
.14<br />
.04<br />
e28<br />
.04<br />
.32<br />
e25<br />
e29<br />
.14<br />
COMPME<br />
e24<br />
.67<br />
.45<br />
COMPOS1 e11<br />
.66<br />
.81<br />
COMPOS2 e12<br />
.70<br />
.49<br />
COMPOS3 e13<br />
.65<br />
.80 REWSYS5 e16<br />
.82<br />
.91<br />
.37 .63<br />
REWSYS6 e17<br />
.40<br />
REWSYS7 e18<br />
.87<br />
.75<br />
COMPME1<br />
.88<br />
e19<br />
.94 COMPME2<br />
.60<br />
.36<br />
e20<br />
.55COMPME3<br />
.31 e21<br />
COMPME4 e22<br />
.66<br />
DEPPER6<br />
Table 5. Regression coefficients based on Maximum Likelihood (ML) for<br />
Performance Management Model<br />
Variables Estimate S.E. C.R. P<br />
DECENT ->FREWSYS<br />
DECENT ->SREWSYS<br />
DECENT->USACPM<br />
COMPOS ->COMPME<br />
COMPOS->USACPM<br />
FREWSYS -> DEPPER<br />
SREWSYS -> DEPPER<br />
COMPME->DEPPER<br />
USACPM->DEPPER<br />
.145<br />
.330<br />
.278<br />
.621<br />
.201<br />
.033<br />
.023<br />
.202<br />
.199<br />
.085<br />
.073<br />
.067<br />
.130<br />
.105<br />
.052<br />
.059<br />
.045<br />
.053<br />
e30<br />
1.700<br />
4.490<br />
4.145<br />
4.781<br />
1.909<br />
.635<br />
.391<br />
4.538<br />
3.782<br />
Therefore, it can be asserted that based on this model which is fit with the collected<br />
data there is a significant association between “competitive position” and employing a<br />
“comprehensive set of performance measures” (+.81), but not so strong association<br />
with the “usage of accounting information for performance management” (+.14). On<br />
the other side, although the effect of “decentralization” on more “usage of accounting<br />
information in performance management” was explored significant, its effect on better<br />
“reward system” appears to be different for faculty members (+.12) and other staff<br />
(+32). It seems vital to be mentioned here that based on the exploratory and<br />
.089<br />
.000<br />
.000<br />
.000<br />
.056<br />
.526<br />
.696<br />
.000<br />
.000
confirmatory factor analysis, it seemed inevitable to distinct between “reward system”<br />
for faculty members and other staff and treat them as two separate variables in the<br />
model. Finally, consistent with main stream of Balanced Scorecard researches,<br />
association between use of “comprehensive performance measures” and<br />
“performance” was supported (+.32), nevertheless the relationship among “better<br />
reward system” and higher “performance” neither for faculty members (+.06) nor for<br />
other staff (+.03) could be proved. Nevertheless, the association among “usage of<br />
accounting information in performance management” and “performance” appears to<br />
be significant (+.27). Figure 4 shows the results of this model in more details<br />
schematically.<br />
Table 6 and 7 below, summarise the results of test of proposed hypotheses including a<br />
brief description of hypotheses contents, confirmation or rejection, and the level of<br />
significance for supported hypotheses.<br />
Table 6. Results of hypotheses testing, Accounting System Model<br />
H no. Content of hypothesis Result of test<br />
H1 Association between “improved accounting system” and:<br />
a. “decentralization”<br />
Rejected<br />
b. “competitive position”<br />
Confirmed***<br />
c. “financial pressure”<br />
Rejected<br />
H2 Association between “emphasis on budget control” and:<br />
a. “decentralization”<br />
Confirmed***<br />
b. “financial pressure”<br />
Confirmed***<br />
H3 Association between “participative budgeting” and:<br />
a. “decentralization” (positively)<br />
Confirmed*<br />
b. “financial pressure” (negatively)<br />
Confirmed***<br />
H4 Association between “departmental performance” and:<br />
a. “participative budgeting”, directly<br />
Confirmed***<br />
b. “participative budgeting” via “satisfaction with budgets”<br />
Confirmed***<br />
H5 Association between “departmental performance” and:<br />
a. “improved accounting system”, directly<br />
Confirmed**<br />
b. “improved accounting system” via “competitive advantage”<br />
Rejected<br />
H6 Association between “departmental performance” and “emphasis on budget controls” Rejected<br />
*** = .01, ** = .05, and * = .10 level of significance<br />
Table 7. Results of hypotheses testing, Performance Managements Model<br />
H no. Content of hypothesis Result of test<br />
H7 Association between importance of “comprehensive performance measures” and “<br />
competitive position”<br />
Confirmed***<br />
H8 Association between “decentralization” and “improvement in reward system” of:<br />
a. faculty members<br />
b. other staff<br />
H9 Association between “usage of accounting reports in PM” and:<br />
a. “decentralization”<br />
H10<br />
b. “competitive position”<br />
Association between “departmental performance” and:<br />
a. “improved reward system”<br />
b. “comprehensive performance measures”<br />
c. “usage of accounting reports in PM”<br />
*** = .01, ** = .05, and * = .10 level of significance<br />
~ 106 ~<br />
Confirmed*<br />
Confirmed***<br />
Confirmed***<br />
Confirmed*<br />
Rejected<br />
Confirmed***<br />
Confirmed***
DISCUSSION AND CONCLUSION<br />
By looking at the new situations such as delegation of authority from the Government<br />
to the Universities in Iran, competitive positions and financial limitations which the<br />
universities in Iran are facing with, it seemed that Contingency Theory can explain<br />
and predict some changes in their accounting system and performance management.<br />
Although the vast majority of the contingency-based studies have been done in private<br />
sector, the results of this study showed that most of the contingency postulates are<br />
somehow true in public organizations such as the state universities even in a<br />
developing country like Iran.<br />
As the results of hypotheses testing indicate (Tables 6 and 7) just one hypothesis out<br />
of ten was fully rejected and three more were partly refused. It means that the findings<br />
of this research mostly confirm the existing literature; however in some parts they are<br />
not consistent with the expectations stem from the literature. Firstly, according to this<br />
results, of three proposed factors which could cause improvement in accounting<br />
systems of Iran’ universities only competitive positions found to be influential, but not<br />
decentralization and financial pressure. So in relation to “decentralization”, the result<br />
supports Baines and Langfield-Smith (2003), but contradicts some others (Miah and<br />
Mia, 1996, Budding, 2008). It might be due to the deletion of some of the observed<br />
variables underlying “improved accounting system” by the SEM. This removal left<br />
just those variables that emphasis on the technical aspects of improvement in<br />
accounting systems. Contradiction with the literature regarding the effect of “financial<br />
pressure” is more justifiable because those evidence are mostly about cashflow crises<br />
as proxy of financial pressure (Reid and Smith, 2000) or improvement just in costing<br />
system (Orloff et al., 1992) whereas the case in Iran’ universities is about “budget<br />
constraint” and its effect on improvement of overall accounting system not just<br />
costing system.<br />
Secondly, not only no indirect association could be found between “improved<br />
accounting system” and “universities’ performance” via creating “competitive<br />
advantage” for them (in contrary with the findings of Bromwich, 1990, Simons, 1990,<br />
Hoque et al., 2001), but also the direct effect is not as strong as the effect of<br />
“participative budgeting” on “universities performance”. This might imply two points<br />
at least. First, the nature and objectives of use of accounting system in public<br />
organizations is different with private companies (Miah and Mia, 1996, Jackson and<br />
Lapsley, 2003) as they may use that information mainly for control purposes<br />
(Abernethy and Vagnoni, 2004). In addition, it supports this notion that in public<br />
organization still budgeting aspects of accounting system is more important than<br />
other aspects such as technical improvements in those systems (Goddard, 2005,<br />
Ramadhan, 2009).<br />
Thirdly, test of the sixth hypothesis showed that there is, unexpectedly, no significant<br />
negative relationship between “more budget emphasis” and “universities’<br />
performance”. Although it was against the proposed hypothesis, however there are<br />
many contradictory findings in the literature around this matter (Hopwood, 1972,<br />
Otley, 1978, Hirst, 1981, Lau and Tan, 1998). Studies in the area of Finance Theory<br />
suggest that more budget control could increase the productivity of organizations,<br />
although it may negatively affect their employment, pay rise, and sustainability in<br />
market (Bertero and Rondi, 2000, Nickell and Nicolitsas, 1999, Musso and Schiavo,<br />
~ 107 ~
2008). On the other hand, it is argued that in organizations with domination of<br />
professionals (Abernethy and Stoelwinder, 1995, Broadbent, 2007), sever stress on<br />
budget controls could be considered as an obstacle of performance improvement<br />
while another study showed that more budget control in US hospitals is adversely<br />
related to the quality of their performance (Shen, 2003). So it seems that several<br />
variables are acting in the area of that relationship that they may counteract and offset<br />
the effect of one another.<br />
Finally, as expected and consistent with previous studies, the positive association are<br />
confirmed amongst two proposed contingent variables (decentralization and<br />
competitive position) with two aspects of performance management (improvement in<br />
reward system and use of comprehensive performance measures), respectively<br />
(Kaplan and Norton, 1996a, Chenhall, 1997, Perera et al., 1997, Schulz et al., 2010,<br />
Shelley, 1999). Also relationship between aforementioned external variables and<br />
extent of “usage of accounting information in performance management” is supported<br />
as so did implicitly other researches (Simons, 1990, Miah and Mia, 1996, Ballantine<br />
et al., 1998, Budding, 2008). On the other hand the effect of those changes in<br />
performance management practices, except for “improved reward system”, on<br />
universities’ performance proved to be remarkable based on this study and supports<br />
the literature (Kaplan, 2001, Karathanos and Karathanos, 2005, Widener, 2006, Cadez<br />
and Guilding, 2008, Schulz et al., 2010).<br />
However, some explanations could be provided for not finding significant positive<br />
association between “improved reward system” and “universities’ performance”.<br />
First, most of the studies which found positive association between reward system and<br />
performance, have been conducted in private organizations where there are more<br />
objective criteria of performance to be linked with employees’ rewards (Modell et al.,<br />
2000). Second, it is argued that there is no perfect linkage between individuals’<br />
performance evaluation and organizational performance evaluation, so improving<br />
reward system by better linking with individuals’ performance does not necessarily<br />
mean it would improve organizational performance (Metawie and Gilman, 2005). In<br />
addition, some studies suggest that connecting performance measures to the reward<br />
system could create some side effects such as gaming, task negligence, tunnel vision,<br />
and short-termism (Ittner et al., 1997, Goddard et al., 2000, Ittner et al., 2003) which<br />
they may hamper the organizational performance. Moreover, it has been claimed that<br />
incentive-based reward system could boost quantitative performance, but not<br />
qualitative performance (Verbeeten, 2008), whereas in public organizations especially<br />
in universities quality of performance seems to be more important. Finally, many of<br />
studies which found positive association among reward system and performance have<br />
inserted some kind of intervening variables such as efforts (Bonner and Sprinkle,<br />
2002), and strategy diversification (Gomez Mejia, 1992), therefore devising a<br />
mediating variable such as motivation or job satisfaction might have better been<br />
explained the association between reward system and universities performance.<br />
This study contributes to the literature in several ways including methodological,<br />
theoretical, and practical contributions. Design, adapt, and test of an instrument with<br />
high degree of reliability and validity regarding the accounting system and<br />
performance management of universities, conducting a nation-wide and large scale<br />
survey in the area of performance management of public organizations whiles prior<br />
studies in this regard are mostly qualitative and case-based (Verbeeten, 2008), and use<br />
~ 108 ~
of SEM as the main data analysing procedure to overcome some previous statistical<br />
problems in this kind of researches as well as opening a new avenue for Iranian<br />
researchers (as this technique is not well-known in Iran) are the main methodological<br />
contributions of this study. In term of theoretical, this research contributes by several<br />
points such as investigating about dissemination of knowledge concerning<br />
management accounting and performance management in developing countries<br />
(Hopper et al., 2008), extending and testing the contingency postulates in public<br />
sector organizations particularly in Higher Education of a developing country<br />
(Chenhall, 2003), acting as one of the rare studies that broadened contingency notions<br />
from the accounting area to the performance management realm (Cuganesan and<br />
Donovan, 2011), and explicitly proposing and testing “financial pressure” in term of<br />
budget constraint as a new contingent variable (Chenhall, 2003, Abdel-Kader and<br />
Luther, 2008) as well as proposing it as a hindering antecedents for participative<br />
budgeting (Shields and Shields, 1998).<br />
Finally, policymakers in Iran’s Higher Education can use the outcome of this research<br />
to understand the extent of success in implementation of new reform in Iran Higher<br />
Education and justify the priority of decentralization to the centralized decisionmaking<br />
concerning the universities’ activities as well as the consequences of<br />
participative budgeting on the performance of universities. In addition, universities’<br />
management also may learn some lessons from this study such as implementing<br />
participative budgeting at least at internal level, doing more amendments in their<br />
reward system, and design and use of broader range of performance measures for<br />
evaluating the performance of their employees rather than relying just on traditional<br />
measures such as punctuality or length of presence at the workplace.<br />
Care should be taken for use of the results of this study due to some limitations such<br />
as the problems related to questionnaire-based studies, relatively small sample size (as<br />
SEM needs larger sample size), not including all variables affecting universities’<br />
performance such as strategy and political environment, and ignorance of students’<br />
perspective. In the future, many replications could be undertaken in this matter in Iran<br />
or other developing country’s context. Moreover undertaking a qualitative research<br />
methodology could increase the understandings around the result of this study and<br />
may add to the robustness of these findings. In this research just three department of<br />
the universities, namely Education, Research, and Financial Divisions were<br />
investigated, future studies could take into the account the Students Affair Division<br />
and look at the students’ perspective too.<br />
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~ 113 ~
THE ERA OF INTERNAL AUDIT IN THE PUBLIC<br />
FINANCE SECTOR IN POLAND<br />
Agnieszka SKOCZYLAS 1 & Wojciech A. NOWAK<br />
University of Lodz, Poland<br />
ABSTRACT<br />
The modern internal audit was introduced to the Polish Public Finance Sector in 2002. From<br />
this moment the evolution of internal auditing in Poland is progressing from the<br />
implementation of strict financial functions through the assessment of compliance of public<br />
sector entities, until the assessment of the effectiveness and efficiency of the institution. The<br />
aim of this paper is to present the development of internal audit in the Polish Sector of Public<br />
Finance. In this study the following are presented: Polish legislation in the internal audit, the<br />
scope of its operation in the public finance sector, as well as the direction of its changes.<br />
KEYWORDS: internal audit, countries in transition, public finance sector, management<br />
control, internal audit development and evolution, internal audit regulation, EU accession<br />
INTRODUCTION<br />
Statehood in Poland has a thousand-year old tradition, after all, intermittent periods of<br />
its absence. Modern, independent Polish state was reborn in 1918, as a result of<br />
processes of surmounting the First World War. It covered the lands, which for over<br />
120 years were under the rule of Russia, Prussia and Austro-Hungarian Empire. Its<br />
first task was to merge into one state organism the systems of government and local<br />
government which derived from nineteenth-century tradition, respectively: Russian,<br />
Prussian and Austro-Hungarian. This tumultuous process took more than 20 years,<br />
until the outbreak of World War II in September 1939. The already mentioned process<br />
comprised adoption of the Polish Constitution (in 1921) as well as its extensive<br />
change (in 1935), and building (in 1933) the legal foundations of a uniform system of<br />
local government functioning under the supervision of state authorities.<br />
Within the central as well as local government of the reborn state certain control and<br />
inspection functions in the financial and economic affairs were to be fulfilled. On the<br />
national level, their implementation was assigned to the heads of state offices and the<br />
Supreme Chamber of Control while on the level of local government the role was<br />
performed by the management of local government units, revision committees of<br />
representative councils, the inspection union of local government and national<br />
supervisory authorities. Control and inspection functions fulfilled by the heads of state<br />
and local government boards were focused on issues relevant to contemporary internal<br />
audit in financial and operational affairs (aspects). This situation was maintained –<br />
except for the period of World War II - without substantial changes to the early 2000s,<br />
until the beginning of preparations for accession to the European Union, except that in<br />
1 Correspondence address: Agnieszka SKOCZYLAS, Accounting Department, University of Lodz,<br />
Matejki 22/26, 91-360 Lodz, Poland, email: agnieszka.skoczylas@uni.lodz.pl, wanowak@uni.lodz.pl<br />
~ 114 ~
a centrally planned economy era and at the beginning of the period of the last political<br />
transition (to 1992) revision of local government associations did not work and their<br />
functions were performed by the local government units.<br />
Pattern of existence and mechanism of control and inspection functions in the<br />
government sector were governed by the law in the rank of Acts and Directives, while<br />
approaches and procedures of control and inspection functions were not standardized.<br />
Internal audit activity was not so much advanced as in other highly developed<br />
countries. Therefore, one of the first tasks to be undertaken in preparation for Polish<br />
entry to the European Union was the introduction of modern internal audit in the<br />
public finance sector. The most significance in this process was given to ensuring<br />
consistency in polish system of control and inspection with the internal audit system<br />
in the European Union. The article is presents an analysis of its development since its<br />
introduction in 2002 to the present day.<br />
1. ADJUSTMENT OF THE INTERNAL AUDIT IN THE POLISH PUBLIC<br />
FINANCE SECTOR<br />
As a result of integration with the European Union and to ensure the proper<br />
functioning of the public finance sector, Poland was obliged to build a system that<br />
would guarantee the accuracy and efficiency of the collection and disbursement of<br />
public funds and management of the property, known as the public internal financial<br />
control (PIFC) (Robert de Koning, 2007) In accordance with European guidelines<br />
(Agenda 2000, 1997), one of the major components of the system of public internal<br />
financial control is "an independent internal audit functioning in all required by law<br />
public institutions responsible for the creation of audit on the basis of international<br />
standards for internal audit, as well as the central body responsible for harmonizing<br />
and coordinating system auditorium in the country" (Chojna-Duch E., 2002, p. 59).<br />
Adaptation to EU requirements made it necessary to regulate the issue of internal<br />
financial control and internal audit in order to improve efficiency, transparency and<br />
openness of public administration and better use of public funds (Chojna-Duch E.,<br />
2002, pp. 58-59).<br />
The internal audit was introduced to the Polish law in 2002. The universally binding<br />
legal instrument in this respect was, and still is, the Public Finance Act (Law Gazette<br />
No. 155, item. 1014). It regulates not only the definition and rationale of the internal<br />
audit, but also introduces the principles of organization and coordination of internal<br />
audit, as well as eligibility requirements which must be met by internal auditors. The<br />
Public Finance Act is accompanied by other acts which complement the provisions of<br />
the Act, so-called executory provisions. These include:<br />
� directives concerning the detailed method and procedures for conducting<br />
internal audit,<br />
� announcements of the Internal Audit Standards, the Code of Ethics and<br />
Internal Audit Charter in the public finance sector.<br />
The Directives apply to the conduct of internal audit, depending on the nature of the<br />
services provided, and also indicates the most important documents that should be<br />
created as a consequence of audit. Announcements, in turn, provide a set of<br />
constructions and guidelines relating to the functioning of the audit and the activities<br />
of internal auditors.<br />
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Each of the existing documents is subject to continuous evolution. List of legislation<br />
on internal audit activity in the public finance sector since its inception to the present<br />
time is presented in Table 1.<br />
Table 1. List of legislative acts in force in the Polish sector of public finances<br />
in the years 2002-2009<br />
Year Acts Directives Announcements<br />
2002 Act of 26 November 1998 on Directive of the Minister of<br />
2003<br />
2004<br />
public finance (Law Gazette<br />
No. 155, item. 1014).<br />
Finance of 5 July 2002 on the<br />
detailed method and procedures<br />
for internal audit (Law Gazette<br />
No. 111, item. 973).<br />
Announcement No. 2 Minister of<br />
Finance dated 30 January 2003<br />
concerning the announcement of<br />
"Standards for Internal Audit in the<br />
2005 Act of 30 June 2005 on public<br />
finance ( Law Gazette<br />
No. 249, item. 2104)<br />
public finance sector" ( Official<br />
Journal MF No. 3, item. 14)<br />
2006<br />
2007<br />
2008<br />
2009 Act of 27 August 2009 on<br />
public finance ( Law Gazette<br />
No. 157, item. 1240)<br />
Directives of the Minister of<br />
Finance dated 24 June 2006 on<br />
the detailed method and<br />
procedures for internal audit<br />
(Law Gazette No. 112, item.<br />
765).<br />
Directive of the Minister of<br />
Finance dated 10 April 2008 on<br />
the detailed method and<br />
procedures for internal audit (<br />
Law Gazette No. 66, item. 406).<br />
2010 Directive of the Minister of<br />
Finance on 1 February 2010 on<br />
the conduct and documentation<br />
of internal audit (Law Gazette<br />
No. 21, item. 108).<br />
(Source: Authors' research)<br />
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Announcement No. 6 of the<br />
Minister of Finance dated 28 April<br />
2004 on the announcement of "Code<br />
of Ethics of the internal auditor in<br />
the public finance sector, " and the<br />
"Charter of internal audit units of<br />
public finance" ( Official Journal<br />
MF No 6, item. 28)<br />
Announcement No. 11 of the<br />
Minister of Finance dated 26 June<br />
2006 on internal audit standards in<br />
the public finance sector ( Official<br />
Journal MF No. 7, item. 56)<br />
Announcement No. 8 Ministry of<br />
Finance dated 20 April 2010 on the<br />
standards of internal audit in the<br />
public finance sector. (Official<br />
Journal MF No. 5, item. 24)<br />
The most important changes in individual acts in force in respect of internal audit<br />
were related to the modification of the perception of its role in the organization and<br />
the nature of the services provided by it. The breakthrough came at the time of<br />
introduction in the Polish public finance sector the International Standards for the<br />
Professional Practice of Internal Auditing developed by the Institute of Internal<br />
Auditors in the United States (The Institute of Internal Auditors). These standards are<br />
considered the most important guidelines for the functioning of the internal audit and
are used and respected by the majority of public and private institutions in the world.<br />
In Poland, from 26 June 2006, the standards were introduced as mandatory for use by<br />
public sector institutions. This resulted in a change in existing law. The key change<br />
was introduced, however, in 2009. It was associated with a significant extension of<br />
services provided by the internal auditors, as well as a new perspective on the role and<br />
place of audit in public sector organizations.<br />
2. RIGHT INTERNAL AUDIT APPROACH - DEFINITION AND SCOPE<br />
OF SERVICES PROVIDED BY IT<br />
The internal audit was introduced to the public finance sector units for the first time in<br />
the amended Public Finance Act of 26 November 1998. Given the need to fulfil the<br />
provisions in providing pre-public system of internal financial control, basic<br />
definitions, principles, and also organization and coordination of internal audit have<br />
been included alongside those relating to the functioning of financial control in<br />
Chapter 5 of the Public Finance Act of 1998, "Control of financial and internal audit<br />
in the public finance sector". This Act defined the internal audit as "all activities<br />
through which a manager of a unit receives an objective and independent assessment<br />
of functioning in the field of finance in terms of legality, economic prudence,<br />
efficacy, reliability, and transparency and openness".<br />
The statutory duties of the main tasks of the internal auditor were:<br />
• examination of accounting documents and records in the accounts,<br />
• evaluation system for the collection of public funds and their availability as<br />
well as management of the property,<br />
• assessment of efficiency and economy of financial management.<br />
The internal audit activity in its initial phase of development was equated with<br />
financial control. The audit was at that time seen as a mechanism for checking the<br />
functioning of transactions and financial procedures. It included the verification of the<br />
accounting operations and aimed at reviewing and highlighting errors, as well as<br />
evaluation of internal regulations in this regard. This resulted in an audit that was seen<br />
as a kind of financial control, which resulted from the tasks assigned to it.<br />
In 2005, the Public Finance Act was changed, which resulted in the change of the<br />
definition of internal audit. During this period the internal audit was a collective term<br />
comprising "all activities, such as:<br />
• an independent assessment of the management and control systems within a<br />
unit including the financial control procedures, which aim at providing the<br />
manager with an objective and unbiased evaluation of the adequacy, efficiency<br />
and effectiveness of these systems,<br />
• consulting services, including the submission of proposals aimed at improving<br />
the functioning of the organization".<br />
The principle activity of the audit remained within the financial area. However, the<br />
auditor was entitled to perform certain additional services related to the provision of<br />
consulting activities, as well as proposals for improving the functioning of the<br />
organization. Thus, the catalogue of the activities within which the auditor could<br />
perform their duties was extended. Its tasks were to assess:<br />
• business compliance with the law and the applicable procedures in the unit,<br />
~ 117 ~
• efficiency and economy of activities undertaken in the field of management<br />
and control systems,<br />
• reliability of financial statements and reports on budget implementation.<br />
The last, very significant substitution in the functioning of the internal audit took<br />
place in 2009. Not only did the Public Finance Act published in 2009 introduce a new<br />
concept of internal audit, much closer to the international auditing standards, but it<br />
also replaced the concept of financial control and management control. According to<br />
the above mentioned Act "Internal auditing is an independent and objective activity<br />
designed to add value and improve organizations. Internal audit assists the unit in<br />
carrying out its activity through a systematic assessment of the management control<br />
and operations consultancy" (Act of 27 August 2009).<br />
Based on the above definition, the role of modern internal audit in the Polish public<br />
finance sector is the management control assessment, which according to the current<br />
law on public finance means the whole of the action taken to ensure that the<br />
objectives and tasks are consistent with the law, efficient, cost-effective and timely<br />
(Act of 27 August 2009, art. 68.). The most important aspects, according to the Polish<br />
legislature, which should be included in management control, are (Act of 27 August<br />
2009, art. 68.):<br />
• business compliance with laws and internal procedures,<br />
• effectiveness and efficiency of operations,<br />
• the reliability of financial statements,<br />
• protection of resources,<br />
• upholding and promoting the principles of ethical conduct,<br />
• effectiveness and efficiency of information flow,<br />
• risk management.<br />
The concept of management control is associated with the implementation of relevant<br />
activities by the managing of the institution through which the organization achieves<br />
its goals. These activities should proceed in a timely manner, in accordance with the<br />
law and procedures, and thus contribute to obtaining the greatest possible advantage,<br />
while making the most economical use of outlay. The legislature, therefore, did not<br />
resign from the current tasks assigned to internal audit, namely financial control,<br />
which is much narrower than the term management control, and it is a part of it. In the<br />
current Public Finance Act financial control was left at the discretion of heads of<br />
units, by keeping the record of director's responsibilities for financial management of<br />
the institutions. This does not mean, however, that managers were exempt from the<br />
implementation of the remaining tasks of the exercise of financial control. On the<br />
contrary, the scope of the management of public organization has a significant<br />
extension, through the introduction of management control, which covers all types of<br />
activities and all areas and processes operating in the unit, including financial one as<br />
well. We can say that the management control absorbed the financial control<br />
and proper financial control became one of the elements of management control<br />
(Figure 1).<br />
~ 118 ~
Financial<br />
control<br />
Figure 1. Management control and financial control<br />
Management<br />
control<br />
concerns the processes of collecting and distributing<br />
public funds and management of property.<br />
means all actions taken to ensure that the objectives<br />
and tasks are accomplished in a manner consistent<br />
with the law, efficient, cost-effective and timely.<br />
(Source: Authors' research)<br />
Management control in relation to the functioning of Polish public sector, refers to the<br />
concept of internal control, which was defined by international organizations such as<br />
COSO (The Committee of Sponsoring Organizations Treadway Commission) or<br />
INTOSAI (International Organization of Supreme Audit Institutions by The<br />
International Standards of Supreme Audit Institutions - ISSAI). According to them,<br />
internal control is a tool or a management process used to obtain reasonable assurance<br />
that management objectives have been achieved. It is performed by a board of<br />
institutions, management and other employees of the organization (Risk Management<br />
- Integrated Framework, COSO, 2004). Internal control, from the standpoint of<br />
international organizations is perceived in a much broader way than internal control,<br />
which was formed in the culture of the Polish public organizations. So far, the internal<br />
control functioning in polish units meant comparing the actual state with the required<br />
one and was performed by a specially established organizational units (so-called<br />
institutional control).<br />
A guideline to implementation and evaluation of management control in the public<br />
finance sector are the management control standards established by the Minister of<br />
Finance (Journal of Law MF No. 15, item. 84). It is "an ordered set of guidelines that<br />
those responsible for the operation of management control should use to create,<br />
evaluate and improve management control system" (Journal of Law MF No. 15, item.<br />
84). Their purpose is to promote the implementation of a coherent and uniform model<br />
of management control in public finance sector, in accordance with international<br />
standards, taking into account the specific tasks of the implementing institution.<br />
The standards include five elements that correspond to each management control<br />
tasks, which is presented in Figure 2.<br />
~ 119 ~
Figure 2. Elements of management control according to the Standards<br />
of management control in the Polish Public Finance Sector<br />
Compliance Operations<br />
Financial Strategic<br />
MONITORING AND EVALUATION<br />
INFORMATION AND COMMUNICATION<br />
CONTROL MECHANISMS<br />
OBJECTIVES AND RISK MANAGEMENT<br />
INTERNAL CONTROL<br />
(Source: Authors' research)<br />
Taking into consideration the international guidelines on internal control, as well as<br />
American literature in this field, one should emphasise that the definition of<br />
management control which is presented in the Polish Public Finance Act is not<br />
significantly different from the recognition of internal control by international<br />
organizations. Its role and scope of activities are important elements in terms of public<br />
sector institutions. The exercising of management control in terms proposed by the<br />
legislator can contribute not only to improvement of the quality of the management of<br />
these bodies, but also to the entire system of public finance.<br />
The correctness of functioning of the management control system in the public<br />
finance sector, in accordance with the current law, should be supervised by the<br />
internal audit. It is its duty to assess the adequacy, efficiency and effectiveness of its<br />
functioning. From the standpoint of the Polish law there are new tasks for internal<br />
auditors. Analysing this issue with reference to international guidelines, it should be<br />
said that the internal audit functioning in the Polish sector of public finances has<br />
finally come closer to a global perspective on the role of internal audit in the<br />
management of the organization. The evolution of internal audit is shown in Table 2.<br />
Apart from the range of the internal audit services in public sector entities, which<br />
were required by the legislature, auditors are required to apply some general<br />
principles in their operations. They are carrying out their tasks on the basis of an<br />
annual audit plan, which has to be prepared by the auditor by the end of the calendar<br />
year. The auditor is also required to prepare a report presenting the realisation of<br />
audit activities. For 8 years of audit activity, the model of audit plan and audit report<br />
were prepared by the Minister of Finance. In 2010, the idea of common model was<br />
abandoned and a list of positions required in both the plan and the report was<br />
published. Planning of the internal audit is based on documented risk analysis. In<br />
determining the scope of areas to be surveyed in a given year the internal auditor is<br />
obliged to take into account the results of risk analysis, managers attentions, the<br />
priorities of the audit committee, the number and qualifications of auditors working in<br />
auditing, as well as the time needed for implementation of planned activities.<br />
~ 120 ~<br />
PUBLIC SECTOR ENTITY
Table 2. The evolution of the definition and scope of internal audit units of the Polish<br />
public finance sector<br />
Years<br />
Definition of Internal Audit Scope of services<br />
2002-2005 Internal audit is all activities through which The statutory duty of the main tasks of the<br />
manager of a unit receives an objective and internal auditor was:<br />
independent assessment of functioning in the � examination of accounting documents and<br />
field of finance in terms of legality, economic records in the accounts,<br />
prudence, efficacy, reliability, and transparency � evaluation system for the collection of public<br />
and openness.<br />
funds and their availability as well as<br />
management of the property,<br />
� assessment of efficiency and economy of<br />
financial management.<br />
2006-2009 Internal audit is all activities, such as:<br />
� an independent assessment of the<br />
management and control systems within a<br />
unit including the financial control<br />
procedures, which aims at providing the<br />
manager with an objective and unbiased<br />
evaluation of the adequacy, efficiency and<br />
effectiveness of these systems,<br />
� consulting services, including the<br />
submission of proposals aimed at improving<br />
the functioning of the organization.<br />
From 2010 Internal auditing is an independent and objective<br />
activity designed to add value and improve<br />
organizations. Internal audit assists the unit in<br />
carrying out its activity through a systematic<br />
assessment of the management control and<br />
operations consultancy.<br />
~ 121 ~<br />
Internal audit task was to assess:<br />
� business compliance with the law and the<br />
applicable procedures in the unit,<br />
� efficiency and economy of activities<br />
undertaken in the field of management and<br />
control systems,<br />
� reliability of financial statements and reports<br />
on budget implementation.<br />
The correctness of functioning of the<br />
management control system in the public units,<br />
in accordance with the current law, should be<br />
supervised by the internal audit. It is its duty to<br />
assess the adequacy, efficiency and effectiveness<br />
of its functioning.<br />
(Source: Authors' calculations based on the Public Finance Act in Poland between the years<br />
2002-2009)<br />
The internal audit units of the Polish sector of public finance provide various services.<br />
Until 2005 in the first phase of its development the auditors were able to accomplish<br />
the tasks included in the annual audit plan and audit commission (assigned task). The<br />
people to delegate tasks were the head of the unit in which auditor was employed and<br />
the responsible minister. Since 2005, the internal auditor can also carry out<br />
consultancy services. To achieve this aim auditors, while are preparing the annual<br />
plan, have to assign sufficient amount of time to complete it.<br />
In 2009, according to International Standards of IIA, a provision that the internal<br />
auditor performs assurance and consulting services was introduced. Assurance<br />
services are meant by a group of activities undertaken to provide an independent and<br />
objective assessment of the functioning of management control. Consulting services<br />
comprise all activities aiming at improving the institution's activities. Despite the<br />
adoption of International Standards and their nomenclature, interpretation of Polish<br />
legislature is not entirely consistent with them.<br />
Internal auditors can perform their tasks providing they receive a personal<br />
authorization issued by the head of the public organization. Assurance services<br />
provided by the auditor should be based on risk analysis and an audit programme. The<br />
audit programme must include a subjective and objective study, which define who and<br />
what will be subject to assessment. Completion of the activities finishes with<br />
preparation of the audit report, which is subject to appeal. As far as consulting<br />
services are concerned auditors have the right to prepare different audit documents,
depending on type and nature of services provided. It should be emphasize that the<br />
methodology of implementation of audit assignments adopted in Poland in accordance<br />
with the national legislation does not differ significantly from the techniques<br />
presented in the International Internal Audit Standards.<br />
3. THE ORGANIZATION OF INTERNAL AUDIT SECTION IN PUBLIC<br />
FINANCE SECTOR UNITS<br />
Organization of Internal Audit in the Polish public finance sector is diverse<br />
(Kaczurak-Kozak, M., 2006, p. 97). It can be perceived in two ways:<br />
� depending on the environment in which the institution employing an internal<br />
auditor is functioning,<br />
� the place of the internal audit unit within the organizational structure.<br />
In the first point internal auditing in public finance sector operates on three levels:<br />
central, local government and public unit, which is presented in Figure 3.<br />
Figure 3. Organization of Internal Audit in the Polish public finance sector<br />
Central level<br />
(government administration)<br />
Public finance sector<br />
Level of public finance units<br />
(Source: Authors' research)<br />
Since the beginning of internal audit in the public finance sector, the coordinating<br />
body on the level of government (central) is the Minister of Finance. Initially,<br />
between 2002-2005, the Ministry of Finance performed his/ her tasks with the<br />
assistance of Chief Internal Auditor, working in the Ministry of Finance and his/her<br />
subordinate organizational unit. The Minister's tasks included the setting of standards<br />
of audit and financial control, cooperation with foreign institutions, collecting<br />
information on the performance of audit and financial controls as well as improving<br />
the functioning of these areas. At the end of 2006 the position of Chief Internal<br />
Auditor was defuncted, and by mid-2009, the Minister of Finance performed the tasks<br />
associated with coordinating the audit, only with the assistance of an organizational<br />
unit in the form of the Audit Department of the Public Sector. Since September 2009,<br />
individual ministers have been obliged to appoint an audit committee in all the<br />
ministries supervised by them. The Committees' responsibility is to advise the<br />
Minister in the area of internal audit and management control in public bodies<br />
subordinate to him/her. The committee must consist of at least three members,<br />
including a person appointed by the responsible minister, having the rank of secretary<br />
or undersecretary, who will perform the function of a chairman and at least two<br />
independent members who are not employees of the ministry, or its subordinate units.<br />
In accordance with International Standards for the Professional Practice of Internal<br />
Auditing IIA committees should operate in each unit having an internal audit. In<br />
~ 122 ~<br />
Level of local government
Poland, a different solution has been introduced, which means the committees operate<br />
on the level of ministries, not the local units.<br />
On the level of local government the internal audit organization and coordination is<br />
the responsibility of the borough leader, mayor, or the city president. It should be<br />
noted that as far as these institutions are concerned, a certain degree of freedom was<br />
given by the Minister of Finance, which results in a variety of internal auditor<br />
activities in the whole public finance sector. This is due to decentralization, and<br />
consequently the ability of the management to take decision on certain issues in a<br />
manner independent of the government.<br />
The third level of internal audit organization in the public sector consist of, listed in<br />
the Act, public sector entities and local government units which accumulate<br />
substantial public funding or carry out significant public expenditure. Conducting<br />
internal audit in those institutions is a requirement imposed by the legislature. The<br />
coordinating body of their activities are individual ministers and appointed by them<br />
audit committees.<br />
Another important issue in the functioning of internal auditing in public finance sector<br />
is the position of internal auditor and internal audit unit within the organizational<br />
structure (Winiarska K., 2006, p. 261). According to the Public Finance Act,<br />
institutions of this sector were obliged to ensure that the internal audit unit has<br />
organizational autonomy through direct subordination to the head of the organization<br />
in which this unit operates. Internal audit activities, in accordance with the Public<br />
Finance Act, are coordinated by an internal auditor employed by the head of the<br />
institution (Art. 277, 280). Subordination of business in this area is shown in Figure 4.<br />
Figure 4. Organizational subordination of internal audit in public sector<br />
organizations<br />
Internal Audit<br />
Unit<br />
Internal auditors<br />
Head of organization<br />
The chief audit executive<br />
Tasks of the Audit Coordinator<br />
(Source: Authors' research)<br />
The organizational structure presented in the figure should operate in any public<br />
sector institution. In fact, the organization and place of internal audit and the internal<br />
auditor in the organizational structure of units is varied. This mainly concerns the<br />
subordination of the internal audit unit and the subordination of the internal auditor.<br />
An analysis of data collected in Poland by the Audit Department of Public Finance<br />
Sector, Ministry of Finance shows that (Kubik A., 2005, No. 1, p. 35):<br />
� single positions of internal auditor is mostly created,<br />
~ 123 ~<br />
other people called<br />
Assistants Internal Audit
� there are cases of mergers of units or positions of the internal audit with<br />
internal control unit or another (the overwhelming trend in this area is in units<br />
of local government).<br />
IIA Standards raise questions related to the organization of internal audit, as well as<br />
the tasks performed by internal auditors. According to them, the internal audit unit,<br />
precisely the chief audit executive should be on the level of the organization which<br />
will give him/her the organizational and functional independence in performing their<br />
audit activity (Kubik A., 2005, p. 6). According to the Institute of IIA the chief audit<br />
executive should report directly to a functional internal audit committee or its board.<br />
For administrative purposes, however, the chief audit executive should report directly<br />
to the President or the Director of the organization (Gleim I.N., 2004, p. 38). IIA<br />
Institute in its Standards emphasizes a need to establish the committee and council<br />
audit which they believe should be composed of people independent of the<br />
management unit and whose responsibility is to assist internal auditors in carrying out<br />
their duties independently and objectively. Standards indicate the position of the chief<br />
audit executive in the organizational structure but do not designate the place for other<br />
internal auditors. As a result of above mentioned managers are given the freedom to<br />
shape the function of the audit. One should be remember though that each institution<br />
is different, has its own regulations and organizational structure. The Standards are<br />
meant to provide guidance and assistance in the era of internal audit organization but<br />
do not impose a ready and unambiguous solution.<br />
Another important issue is the number of internal auditors working in institutions of<br />
the public finance sector. Some organizations employ from 1 to 5 or even 20 auditors<br />
and other auditors work half or quarter-time. There are no guidelines to regulate this<br />
issue. On the other hand, if such guidelines were to occur, it is worth considering their<br />
content. According to E.J. Saunders, there are no established standards for the<br />
construction, organization of internal audit and the number of people that should be<br />
employed in it. This decision may be taken based on the assessment of the<br />
organization, its structure and specificity of function. Number of employed internal<br />
auditors should reflect the needs and development of an institution. The above cited<br />
author recommends that their number in the unit should account for 2% of the<br />
employees in the organization (Saunders E.J., 2003, p. 47). However, the quality of<br />
the human factor should be considered there because, as K. Czerwinski points out,<br />
employing even a large number of internal auditors in the organization will not<br />
compensate for the lack of experienced people in the field of internal auditing, which<br />
may lead to limiting the scope of audit work (Czerwinski K., 2004, p. 32). It should be<br />
also noted that each institution operates in a changing environment and, therefore, an<br />
internal audit of the unit must keep pace with these changes, and even overtake them<br />
(See E.J. Saunders, p. 47).<br />
Without questioning any of the listed solutions for the internal audit organization it<br />
should be emphasized that while creating the internal audit unit one should take into<br />
account the needs resulting from the necessity to ensure the supervision and control<br />
over the functioning of the institution. This unit should be adjusted to the size,<br />
structure and needs of individuals and consist of highly qualified people to ensure a<br />
variety of performed tasks (Czerwinski K., 2004, p. 24). The main objective<br />
underlying the introduction of internal audit in any institution should be to strive for<br />
high quality of its operations by streamlining management processes, to stimulate<br />
~ 124 ~
continuous quality improvement by supporting the activities of the management,<br />
including increased efficiency of the internal control system, reducing operating costs<br />
and the elimination of waste of financial resources (Chojna-Duch E., p. 61).<br />
4. AUDIT – STILL INTERNAL OR ALREADY EXTERNAL –<br />
ORGANIZATIONS OF PUBLIC FINANCE SECTOR OBLIGED<br />
AND EMPOWERED TO CONDUCT INTERNAL AUDIT<br />
The obligation to conduct an internal audit from the moment of its existence in the<br />
Polish sector of public finances concerned most of the institutions belonging to this<br />
sector. These included in particular: the ministries, central offices, regional offices,<br />
customs offices, tax offices, earmarked funds, health insurance. Other organization<br />
obliged to conduct internal audit were public sector organizations that gather<br />
substantial public money or make a considerable expense. On this basis, the Minister<br />
of Finance defined the amounts of revenue and expenditure which, if exceeded during<br />
the year, shall be subject to internal audit (This amount was 40 000 000). In 2005,<br />
when the Public Finance Act was amended, the list of public organizations obliged to<br />
conduct an internal audit was extended and included: Treasury of the Chamber,<br />
Chamber of Customs, prosecution, or regional audit chambers. The number of entities<br />
obliged to conduct audit increased from year to year, as shown in Table 3.<br />
Table 3. The number of public sector entities obligated to conduct internal audit<br />
and internal auditor jobs<br />
Number of public sector<br />
entities, including:<br />
- number of units of a<br />
central government<br />
Year The obligation to conduct<br />
internal auditor<br />
~ 125 ~<br />
Obligation to employ<br />
an internal auditor<br />
2002 1600 No information<br />
2003 1600 No information<br />
2004 2200 No information<br />
2005 2200 No information<br />
2006 2400 No information<br />
2007 2557 1269<br />
2008 2643 1358<br />
2009 2751 1455<br />
2006 1300 577<br />
2007 1936 648<br />
2008 1959 674<br />
2009 1975 690<br />
- number of units of local 2006 1100 No information<br />
government<br />
2007 621 621<br />
2008 684 684<br />
2009 776 776<br />
(Source: Authors' research based on reports of the Ministry of Finance, Internal Audit in the<br />
public sector in 2006-2009)<br />
In 2009 the legislature modified the list of public sector entities obliged to conduct<br />
internal audit and their number decreased. Currently, they are such units as: the Prime<br />
Minister's Office, ministries, provincial offices, chambers of Customs and Revenue,<br />
Department of Social Insurance, the Agricultural Social Insurance and National<br />
Health Fund. Individuals (art. 272, Act of 27 August 2009), such as: state budgetary<br />
units, public universities, independent public health care, executive agencies, state-
appropriated funds and local government units are required to conduct an internal<br />
audit when a certain amount of income or expenditure is exceeded. In the remaining<br />
institutions internal audit can be conducted if the head of this organization has the<br />
will, or when it is imposed by the responsible minister.<br />
According to the European guidelines (Agenda 2000), mentioned at the beginning of<br />
the article, the concept of public internal financial control is associated with the<br />
provision of "an independent internal audit, acting in all the public institutions by<br />
law". It should therefore be considered whether the legislative requirement should<br />
differentiate internal audit units in the Polish public sector due to the amount of<br />
revenues or expenditures made. So should the financial aspect be the factor<br />
determining the proper and effective functioning of public institutions? On the one<br />
hand, internal auditing in Poland is developing through the implementation of<br />
international standards and change of policies, on the other hand it always remains in<br />
the area of financial control, by limiting the directory of units required to conduct the<br />
audit using a single criterion - the amount of revenue or expenditure.<br />
Another key issue in the field of auditing in public finance sector organizations is the<br />
obligation to employ an internal auditor. Until 2009, each public sector entity obliged<br />
to conduct an internal audit was required to hire an internal auditor. According to<br />
current legislation some institutions are given the choice between the internal audit<br />
being conducted by an employed internal auditor or by an auditor working for several<br />
organization. This alternative results in public organizations using external audit.<br />
External service provider may be either a natural or legal person who must meet<br />
certain requirements imposed by law on public finance. These include in particular:<br />
• the need to meet eligibility requirements governing the profession of internal<br />
auditor in the public finance sector,<br />
• the obligation to conduct an audit under the provisions of the Public Finance<br />
Act and its implementing legislation.<br />
When an organization decides to use the services of an external audit it is required to<br />
sign a contract for at least a year. The possibility of using external service is accepted<br />
by the responsible minister. The local government organizations can use external<br />
audit services only if the amount of income and the amount of revenues and expenses<br />
and expenditures is less than 100 000 000.<br />
From an organizational point of view of internal audit, one should also mention the<br />
protection of people employed as auditors in the public finance sector. In 2002-2005,<br />
the body authorised to terminate the contract with an internal auditor or to change<br />
conditions of contract was the Chief Inspector of Internal Audit. After the liquidation<br />
of the position of Chief Internal Auditor the responsibilities were taken over by<br />
Minister of Finance. In 2009, the amended Finance Act retained the entry defining<br />
employment and change of working conditions of the internal auditor, but limited the<br />
circle of auditors, only to chiefs audit executives.<br />
5. LICENCE TO PRACTICE AS AN INTERNAL AUDITOR<br />
Since 2002, namely the emergence of internal audit in the Polish law, the internal<br />
auditor could be anyone who (Art. 35k, Act of 26 November 1998 ) :<br />
• has the Polish citizenship (January 2006),<br />
~ 126 ~
• has full legal capacity and makes full use of public rights,<br />
• has not been penalized,<br />
• has a higher education,<br />
• passed the test organized by the Examination Commission.<br />
These conditions gave, on the one hand, the possibility of applying for internal<br />
auditing to a large numbers of Polish citizens, on the other hand imposed an<br />
obligation to pass a state exam. The legislature, taking into account the impossibility<br />
of finding suitably qualified auditors, in the first phase of the internal audit activity in<br />
Poland, introduced a so-called transitional period. The period meant that anyone who<br />
wanted could be employed in the internal audit but the guarantee of employment was<br />
obtain only after passing the state exam by the end of 2004 year.<br />
The examination was held by a specially appointed Examination Committee, which<br />
began functioning to 2003 and finished its activity in 2006. It consisted of two parts,<br />
written and spoken and its requirements were clearly defined by law. As a result of it<br />
the right to work in internal audit in the public finance sector was gained by 2,181<br />
people. It is noted that the period between 2003-2006 was the moment when<br />
significant financial resources, including the EU, were involved, internal Audit in the<br />
Polish public sector developed and qualification of auditor were substantially<br />
improved.<br />
In 2006 numerous changes in access to the profession of public sector auditor were<br />
introduced. The idea of state exam was abandoned but people who previously passed<br />
the state exam preserved their rights. Promotion, however, was given to people who<br />
(art. 58 Act of 30 June 2005):<br />
• completed controller application and passed an exam conducted by the<br />
Examining Board appointed by the President of the Supreme Chamber of<br />
Control,<br />
• passed an exam qualifying for the post of inspector of fiscal control,<br />
• were certified accounting auditors.<br />
These alterations resulted in changing number of auditors employed in the public<br />
finance sector, which is presented in Table 4.<br />
Table 4. Number of auditors working in the public finance sector required<br />
to maintain an internal audit<br />
Year Audited units (approximately) Number of people employed in Internal Auditing<br />
Total Internal auditors Auxiliary<br />
2004 2200 663 415 118<br />
2005 2200 709 537 137<br />
2006 2400 1054 859 107<br />
2007 2550 980 742 67<br />
2008 2640 972 821 123<br />
2009 2751 918 800 118<br />
(Source: Authors' research based on reports of the Ministry of Finance, Internal Audit in the<br />
public sector in 2006-2009)<br />
The results presented in the table show a significant increase in the number of internal<br />
auditors by the end of 2006, an average of more than 200 people a year. Since 2007<br />
the decreasing trend can be observed, while the number of staff employed in the<br />
~ 127 ~
sections of the internal audit units of public sector finance increased at fairly rapid<br />
pace.<br />
Finally, in 2009, another modification in acquiring audit rights was introduced. As a<br />
result, the Supreme Chamber of Control controllers and fiscal control inspectors were<br />
deprived of the right to work as internal auditors and the right to work in this<br />
profession was given to whose who have obtained a post-graduate diploma in internal<br />
auditing and have a two-year practice. The legislator defined the practice in internal<br />
audit as: conducting audit, performing control activity in the area of UE funds by tax<br />
inspectors and supervising and performing inspection activities by the auditors of the<br />
Supreme Chamber of Control. The legislator did not, however, define the scope of<br />
law which should be included in the programme of postgraduate studies in this area,<br />
but pointed out that units entitled to issue diplomas were the ones with the right to<br />
award the degree Ph.D. in economics or law.<br />
It is difficult to assess the impact of these changes on the profession of internal<br />
auditor, and the functioning of public sector entities. There is currently no available<br />
data on the number of auditors employed in these institutions, or providing services to<br />
them in 2010. However, taking into account the provisions and requirements of laws,<br />
and thus the possibility of resigning from audit given to selected units, one can expect<br />
a further decline in these numbers. However, taking into consideration changes in the<br />
qualifications for the job of internal auditor - post-graduate studies in the field of<br />
internal auditing, you can count on a significant increase in the number of people<br />
interested in gaining permission to perform the profession. But will the public sector<br />
respond to this interest with proper supply, will there be the managers of public<br />
entities who will want to hire an auditor, or use such services.<br />
6. EVALUATION AS A DETERMINANT OF THE DIRECTION<br />
OF INTERNAL AUDIT DEVELOPMENT IN POLISH PUBLIC FINANCE<br />
SECTOR<br />
Changes in the economy necessitate the continued improvement of public<br />
organizations and more efficient management of public funds. Depending on the<br />
modification of rules for the functioning of public sector entities and the activities of<br />
these organizations the nature and extent of services provided by auditors is also<br />
subject to transformation. In order to assess the activities undertaken by public<br />
organizations, thereby improving their performance evaluation process is used. It<br />
involves a systematic examination of the value or characteristics of a particular<br />
program, project, activity, subject to the usual criteria, the purpose of its improvement<br />
and development (A. Haber, M. Szalaj, 2009).<br />
The amended Public Finance Act of 2009 contains a number of conditions designed to<br />
be introduce to the Polish public sector evaluation (A. Haber, M. Szalaj, 2009). One<br />
of them is to modify the tasks assigned to internal audit. As mentioned earlier, the role<br />
of internal audit since 2009, has been to assess the adequacy, efficiency and<br />
effectiveness of management control in the public finance sector. These tasks are<br />
associated with the implementation of a series of steps intended to measure the effects<br />
of these institutions. They are defined in the literature as efficiency audit (called also<br />
value for money audit). Its primary purpose is to focus on efficiency, effectiveness<br />
and economy of operation of Polish public organizations. It uses a series of indicators<br />
~ 128 ~
and metrics to measure efficiency. From the perspective of the scope of internal audit<br />
work in Poland it is certainly a significant progress. Internal audit, since its<br />
introduction in the public finance sector, focused primarily on assessing the<br />
compatibility of the organization with the applicable rules, guidelines, particularly<br />
with regard to the financial area. Now its task is to verify the effectiveness and<br />
efficiency of all processes in the organization. Taking into account the development<br />
trends of internal audit in Poland, we can define its various forms, which have<br />
appeared in Poland since its introduction to public finance sector. They are presented<br />
in Table 5.<br />
Table 5. Formation of various types of audits in the Polish public finances<br />
Year Type of audit Description<br />
2002 Financial audit Internal audit checks the functioning of transactions and financial<br />
procedures. It included the verification of the accounting operations and<br />
aimed at reviewing and highlighting errors, as well as evaluation of internal<br />
regulations in this regard.<br />
2005 Compliance audit Internal audit assess that the organization activity is adhering to law,<br />
regulations and control standards and other guidelines<br />
2006 Operational audit This type of audit falls within the category of services to facilitate the<br />
management unit by evaluating four management functions: planning,<br />
organizing, controlling and monitoring. The purpose of its conduct is to<br />
answer the question why the problem exists and what is its cause.<br />
2009 Efficiency audit<br />
Value for money audit<br />
Internal audit assess the adequacy, efficiency and effectiveness of<br />
functioning of the public organizations.<br />
(Source: Authors' research)<br />
Using various types of audits by the internal auditors of the Polish sector of public<br />
finances was dictated by the changes which occurred in the organization of this sector.<br />
The public sector since the 80's of the last century has undergone a metamorphosis,<br />
from the bureaucratic form defined by Weber in the direction of effective, efficient<br />
and pro-quality systems. Following these changes, transformations are also subject to<br />
internal audit role. The emergence of performance-audit related to the implementation<br />
of performance budgeting in the public finance sector, whose idea is to improve<br />
expenditure management in the public sector (More, Lubińska T., 2007, pp. 32-45 ) . In<br />
the implementation of performance budgeting, it is necessary to appoint suitably<br />
defined and hierarchical objectives for the collection and disbursement of public funds<br />
and the identification of specific outcomes and indicators for their verification.<br />
Budgeting allows you to determine which tasks are most important for achieving the<br />
specific targets and using indicators shows the extent to which they were completed<br />
(Bombik P.K., 2006, No. 437, p. 476). Similar basis governs the methodology used in<br />
the implementation of the efficiency audit. Due to the constant changes taking place in<br />
public finance sector, you can expect that the tasks and role of internal audit will be<br />
subject to further change, so as to provide reasonable assurance on the functioning of<br />
the institutions of this sector.<br />
CONCLUSION<br />
Internal Audit in the Polish sector of public finances appeared in the twenty-first<br />
century, in the world it has a centuries-old tradition (Peemöller V.H., Kunowski S.,<br />
1997, nr 27, Fach 28, s. 1264). It has gone a long way in shaping its position on the<br />
international area. The evolution of internal audit in Poland and the world is presented<br />
in Table 6.<br />
~ 129 ~
Table 6. Development of Internal Audit in the Polish sector of public finances<br />
and the world<br />
The development of internal audit in the world Development of Internal Audit in the Polish public<br />
finances<br />
1950<br />
Control of the accounting records<br />
1960 Control of the accounting records and<br />
compliance with the basic operation<br />
procedures<br />
1970<br />
Analysis of existing procedures<br />
1980 Evaluation of existing procedures<br />
concerning introduction of additional<br />
control<br />
2000<br />
2001<br />
2002<br />
Evaluation of internal control and<br />
reporting on its state managers.<br />
Evaluation of risk management<br />
Reducing risks and improving risk<br />
management system<br />
2002<br />
~ 130 ~<br />
Examination of accounting documents and<br />
records in their accounts.<br />
Evaluation system for the collection of<br />
public funds and their availability and<br />
management of the property.<br />
2003<br />
Assessment of compliance with applicable<br />
procedures.<br />
Evaluation of the effectiveness and<br />
Add value 2005<br />
economy of activities undertaken in the<br />
field of management and control systems<br />
and the reliability of financial statements.<br />
Improving<br />
organization.<br />
the functioning of the<br />
2006/2007 ??? 2009/2010 Add value.<br />
Evaluation of the adequacy, efficiency and<br />
effectiveness of management control<br />
system.<br />
(Source: Authors' research based on the K.H. Spencer Pickett, The Internal Auditor at Work:<br />
A Practical Guide to Everyday Challenges, John Wiley & Sons, Inc.., Hoboken, New Jersey,<br />
2004, p. 11, Winiarska K., 2008, p. 7).<br />
Based on the information provided, we can conclude that the evolution of internal<br />
auditing in Poland is progressing from the implementation of strict financial<br />
functions, to evaluation of operations of the institutions, which assist managers in<br />
managing the unit. This progress is reflected in the public sector very clearly, where<br />
the definition of internal audit and the scope of services provided by it has changed<br />
over 8 years in a significant way, starting from the evaluation of financial operations<br />
through the assessment of compliance of public sector entities, until the assessment of<br />
the effectiveness and efficiency of the institution. The evolution of internal auditing in<br />
Poland took place in a similar way as in the world, however, started much later and<br />
proceeded faster. The experience which the Polish sector of public finances has drawn<br />
from the development trend of the audit in the world had significant impact.
Currently, internal audit is becoming an increasingly useful tool for the Polish sector<br />
of the public finances units, it is not only used to gather information, but it evolves<br />
towards the provision of ready-made applications and management arrangements,<br />
which may result in increased efficiency of the organization. Given this rapid process<br />
of change which is subjected to public entities in Poland, as well as having a<br />
progressive pace of change in the world it is difficult to indicate what will be the next<br />
stage of development of internal audit, both in Poland and abroad.<br />
REFERENCES<br />
Act of 26 November 1998 on Public Finance (Law Gazette No. 155, item. 1014)<br />
Act of 30 June 2005 on Public Finance ( Law Gazette No. 249, item. 2104)<br />
Act of 27 August 2009 on Public Finance (Law Gazette No. 157, item. 1240)<br />
Act of 1933 a partial change of the system of local government (Law Gazette No. 35 item.<br />
294)<br />
Act of 1944 the organization and operation of councils ( Law Gazette No. 5 item. 22)<br />
Act of 1990 Local Government ( Law Gazette No. 16 item. 95)<br />
Act of 1992 on Regional Accounting Offices ( Law Gazette No. 85 item. 428)<br />
Agenda 2000 - an action plan, adopted by the European Commission on July 15, 1997., in the<br />
final form approved by the European Council in Berlin in March 1999. This plan has set<br />
the reform in the EU and established accession strategy<br />
Announcement No. 2 Minister of Finance dated 30 January 2003 concerning the<br />
announcement of "Standards for Internal Audit in the public finance sector" (Official<br />
Journal MF No. 3, item. 14)<br />
Announcement No. 23 of the Minister of Finance dated 16 December 2009 on the Standards<br />
for the management control of public finances, (Official Journal MF No. 15, item. 84)<br />
Announcement No. 6 of the Minister of Finance dated 28 April 2004 on the announcement of<br />
"Code of Ethics of the internal auditor in the public finance sector," and the "Charter of<br />
internal audit units of public finance" (Official Journal MF No 6, pos. 28)<br />
Announcement No. 11 of the Minister of Finance dated 26 June 2006 on internal audit<br />
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BOUNDRIES REGARDING THE IMPLEMENTATION<br />
OF THE NATIONAL STRATEGY FOR THE FINANCIAL<br />
REPORTING OF THE PRIVATE SECTOR ENTITIES<br />
Ramona LAPTES 1<br />
Transylvania University of Brasov, Romania<br />
Adriana Florina POPA<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
In the early 2000, the Romanian accounting entered in a new stage of reform, built in<br />
connection to the international realities. In 2004, in Romania, the authorities have initiated a<br />
national strategy to improve the financial reporting, considered to be a true catalyst for<br />
developing a sustainable economy. The present demonstrates that the national strategy for<br />
improving the financial reporting of the private economic entities, mostly based on the<br />
elaboration of the individual annual financial statements of the public entities according to<br />
the IFRS referential, has encountered some difficulties in the complex process of<br />
implementation. The identification and the analysis of the difficulties, but also the highlight of<br />
the progress of implementing the national strategy for improving the financial reporting of<br />
the private sector entities, are the main objectives of this study.<br />
KEYWORDS: accounting, financial reporting, Romania, national strategy, IFRS,<br />
conformity<br />
INTRODUCTION<br />
It is a currently known fact that the world economy is shifting from a model built on<br />
interdependent national economies to a model represented by a network of<br />
multinational companies that operate globally. This economic climate imposed<br />
reconsiderations and reorientations in the accounting area. In the late '90s, the general<br />
trend in the accounting field was to reach the goal of standardization and<br />
harmonization of the national accounting systems. The harmonization process didn’t<br />
have the expected outcome and, in the recent years, internationally, there is a retreat<br />
towards the national convergence (Lapteş, 2007).<br />
The accounting evolved nowadays to another level of knowledge, a process caused by<br />
the profound changes that took place in the economic field, under the inertia of the<br />
globalization and the internationalization of the economies. The accounting experts<br />
called the recent dynamic of the accounting as accounting postmodernism.<br />
In Romania, the accounting postmodernism was described by professor Ionaşcu and<br />
several meanings are reserved to it (Ionaşcu, 2003):<br />
1 Correspondence address: Ramona LAPTEŞ, Transylvania University of Brasov,<br />
Faculty of Economic Sciences and Business Administration, Romania; email address:<br />
ramonalaptes@hotmail.com<br />
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� The accounting theoreticians attempt to find answers to the current phenomena<br />
(the globalization of the economies, the continuous deregulations of the markets,<br />
the steady development of the consumer society and of the information society),<br />
which raises issues in the business administration;<br />
� The postmodernist society is seen in a continuous transformation that requires a<br />
multidisciplinary approach to the economic management of the entity, a mix of<br />
economics, sociology, philosophy and law;<br />
� The accounting postmodernist researches, started in UK after 1980, and taken<br />
over by the French specialists, are, in the vision of professor Ionascu, those<br />
considered to be post –constructivist, the interpretative ones and the critical<br />
radical current.<br />
The accounting research oriented towards postmodernism show interest primarily in<br />
the accounting language and the accounting information meaning, as a way of social<br />
communication.<br />
In this context, in 2002, IASB and FASB signed a memorandum and agreed to<br />
complete a project named „The International Short Term Convergence”, with the<br />
main goal of eliminating a series of differences between the IAS and the US GAAP<br />
referentials, until the end of 2005. After that date, a second step was set, reflected in a<br />
common project called „Draft of Common Checking of the International<br />
Convergence” (Ristea et al., 2006).<br />
Contrary to the normalization efforts of the two bodies, the convergence of the US<br />
GAAP / IAS is not a simple process, primarily due to the disagreement regarding the<br />
sphere of the influence between the two accounting referentials. If the US GAAP are<br />
required to the companies seeking for funding from the U.S. capital markets, the IFRS<br />
accounting referential is recommended to the companies seeking to be listed on the<br />
international capital markets. Therefore, the IAS/IFRS referential is intended to cover<br />
a larger area and it refers to companies with different structures (Lapteş, 2007).<br />
Fully aware of this advantage of the IFRS referential, on 17 th of November 2007, the<br />
SEC publicly announced that it recognizes, starting from the financial year 2007, the<br />
financial statements of the foreign entities in accordance with the IFRS without prior<br />
reconciliation to the U.S. GAAP. In this regard, Sarah Johnson made the following<br />
affirmation in 2008: “Goodbye GAAP - It's time to start preparing for the arrival of<br />
the international accounting standards” (Dumitrana et al., 2010).<br />
At the European Union level, the process of the IAS/IFRS referential implementation<br />
started on the 1st of January 2004, when two periods were identified (Ristea et al.,<br />
2006):<br />
� the interval between the 1st of January 2004 and the 31st of December 2004<br />
represented the transition period, the period of the restatement of the financial<br />
statements or the comparative period;<br />
� the interval between the 1st of January 2005and the 31st of December 2005<br />
represented the period of actual appliance or the period of the elaboration of the<br />
first financial statements according to the IFRS referential.<br />
Basically, at the European level, according to the Regulation 1606/2002 on the<br />
application of the international accounting standards, known as “the IAS Regulation”,<br />
starting the 1st of January 2005, all the companies listed on EU capital markets,<br />
~ 134 ~
including the credit institutions and the insurance companies, were required to publish<br />
the consolidated financial statements under the IFRS. This approach led to the<br />
development of two accounting systems in the European Union countries,<br />
simultaneously applicable: an accounting system based on the IFRS and another one<br />
based on the national GAAP. The member states chose the conformity with the IFRS,<br />
both for the individual financial statements of the listed companies and for the<br />
consolidated and individual financial statements of the unlisted companies. Therefore,<br />
starting on the 1st of January 2005, 7000 listed European groups gave up the national<br />
accounting regulations in favor of the appliance of the international financial reporting<br />
standards (Ristea et al., 2010).<br />
FEE (Federation of European Accountants) believes that countries and markets are<br />
best served by high quality financial information and that this is best delivered by a<br />
single independent global standard setter for accounting and corporate reporting. In<br />
April 2009, the G20 (the Group of Twenty) called on the world’s accounting standard<br />
setters to continue to work towards a single set of high-quality global financial<br />
reporting standards. FFE believes that the G20 should urge the IASB to use all<br />
existing high quality accounting standard setting expertise from around the world,<br />
including those within FASB and EFRAG (the European Financial Reporting<br />
Advisory Group), to work together on new global solutions in those areas that really<br />
matter to investors (FEE, 2009).<br />
Inside the European Union, the discrepancies signaled between the accounting<br />
directives and the IFRS referential led to the necessity to adopt the Modernization<br />
Directive 51/2003. This directive offered to the companies that organize their<br />
accounting according to the European directives the possibility of appealing to the<br />
IAS/IFRS accounting options. The directive amended the European directives<br />
regarding the content of the annual statements, the balance sheet and the income<br />
statement disclosure, the valuation rules, the issue of the provisions, the structure of<br />
the audit report, the content of the annual report and others (Ristea et al., 2006).<br />
Which is, though, the situation of the implementation of the IFRS referential in<br />
Romania?<br />
In Romania, the state authorities believe that the improvement of the financial<br />
reporting in our country in the next period should have its pillars on the extension of<br />
the IFRS referential. Therefore, in 2004, by the adoption of the Government Decision<br />
no. 2170/2004, the Romanian Government approved the National Strategy Action<br />
Plan in order to improve the financial reporting in Romania. This country action plan<br />
includes the objectives regarding the development of the business environment,<br />
arising from the program of measures agreed by the Romanian Government and the<br />
International Bank for Reconstruction and Development, underlying the Loan<br />
Agreement for programmatic adjustment (PAL), signed at Bucharest on 27 th of<br />
September 2004.<br />
The monitoring of the implementation of the Country Action Plan in order to improve<br />
the Romanian financial reporting was initially the attribution of the Accounting<br />
Advisory Board, which was organized and operated under the Government Decision<br />
no. 1449/2002.<br />
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The Accounting Advisory Board, by the Ministry of Finance, informed the Romanian<br />
Government on a quarterly basis about the progress made in achieving the objectives<br />
of the Country Action Plan. In 2005, by Government Decision no 401/2005, the<br />
Accounting Advisory Board was reorganized into the Accounting and Financial<br />
Reporting Council (CCRF), an independent supervisory body, with attributions in the<br />
insurance of the convergence of the national regulations and practices in the financial<br />
accounting and auditing with the European Union regulations.<br />
The Romanian Accounting Group (GRC), consisting of experts on accounting issues,<br />
was set up inside the CCRF, in order to provide support, consulting, training and<br />
informing services, in order to ensure the implementation of effective and efficient<br />
processes used in the translation of the IFRS and the related materials, and to provide<br />
a source for the development and the timely implementation of the IFRS in Romania.<br />
The increase in the quality of the financial reports is considered a key component of<br />
the sustainable economic development in Romania. This requirement has become, in<br />
the last decades, the main priority for many countries and it presently represents the<br />
subject of significant reforms in the field.<br />
The quality of the financial reports, directly involving the accounting and auditing<br />
standards, as a legal and institutional framework for implementing them, is an end in<br />
itself. The ultimate goal is to bring added value to the financial reporting system in<br />
order to support the stability of the financial system and the economic growth in the<br />
private sector.<br />
As part of the reform, from the end of 2002 until February 2003, the World Bank<br />
experts conducted an assessment of the existing standards and practices related to the<br />
accounting and the financial audit of the financial statements, in order to identify the<br />
necessary reforms for improving the financial reporting by the private sector. The<br />
recommendations from this evaluation were included in the Report on the Observance<br />
of Standards and Codes (ROSC) adopted on the 9 th of May 2003.<br />
The present shows that the initiative of bringing the national accounting regulations as<br />
close as possible to the international financial reporting standards had no success. The<br />
Order no. 907/2003 (amended by the Order no. 2001/2006) on the application of the<br />
International Financial Reporting Standards require that the economic entities, listed<br />
on a regulated market, which elaborate consolidated financial statements, have to<br />
apply the international financial reporting standards starting 2007. The other<br />
economic entities, considered of public interest, can apply the international financial<br />
reporting standards in the elaboration of the individual or the consolidated financial<br />
statements for their own information needs. However, in the relation with the state, all<br />
the entities, including those applying the international financial reporting standards,<br />
have to prepare the annual financial statements in accordance with the European<br />
directives (Jianu et al., 2009).<br />
1. RESEARCH METHODOLOGY<br />
In the recent years, in Romania, the accounting of the economic entities has been<br />
frequently reconsidered and submitted to a comprehensive reform process, initiated in<br />
the early 2000. In 2004, the Romanian Government approved the National Strategy<br />
for the Action Plan implementation, in order to improve the financial reporting.<br />
~ 136 ~
What are the coordinates of this national strategy? What is present stage of the<br />
National Strategy for improving the financial reporting in Romania? What are the<br />
limits of applying the international financial reporting standards by the Romanian<br />
economic entities? These are several questions that we intend to answer to in this<br />
paper. In order to achieve this goal, we conducted a normative type of research, which<br />
allowed us to identify and analyze the key issues of the National Strategy for<br />
improving the financial reporting of the economic entities operating in the private<br />
sector.<br />
2. BOUNDARIES OF THE NATIONAL STRATEGY FOR IMPROVING<br />
THE FINANCIAL REPORTING<br />
The accession process to the European Union provided to the Romanian Government<br />
a conceptual framework for the reform of the accounting, the financial auditing and<br />
the financial reporting, represented by the community acquis. The acquis includes:<br />
primary legislation (treaties), secondary legislation (directives, regulations, decisions,<br />
recommendations, etc) and case studies.<br />
The Accounting Advisory Board (CCC), which operated under the Ministry of<br />
Finance and brought together representatives of the government, the regulatory<br />
authorities, the accounting and auditing professions, the business environment and the<br />
academics who showed interest in the financial reporting issues, was appointed to<br />
develop a country action plan in order to improve the financial reporting in Romania.<br />
The Council's activity aimed to increase the confidence of the users of accounting<br />
information in the financial reporting and the corporate governance.<br />
According to the GD no. 2170/2004, the country action plan to improve the financial<br />
reporting in Romania is a detailed document which sets out the specific actions to be<br />
completed in order to achieve the reform objectives.<br />
This plan is a dynamic document, because it is based on the community acquis, which<br />
is constantly evolving, and because Romania will change its ability to adopt and carry<br />
out the reform as the objectives will be achieved.<br />
In April 2004, the Accounting Advisory Board, with the World Bank’s assistance,<br />
started to develop the Country Action Plan with the strategic goal “The fulfillment of<br />
the major accounting and auditing obligations, arising from the community acquis<br />
prior to 2007 - the accession date”.<br />
Several alternative policies were identified in the Country Action Plan, including:<br />
• establishing a program to introduce the International Financial Reporting<br />
Standards (IFRS), according to the implementation capacity;<br />
• a detailed definition of the public interest of the entities;<br />
• selecting the most appropriate model for setting up an independent oversight<br />
body of the audit and the accounting field, as a whole;<br />
• the development of the professional training and the higher economic<br />
education integration in the training programs reform.<br />
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After the first stage of implementing the Country Action Plan, which ended in<br />
September 2005, the Financial Reporting Council has concluded that the areas of<br />
interest are:<br />
• the insurance of the accounting and auditing Romanian legislation compliance<br />
with the community acquis;<br />
• the implementation of the IFRS and the International Standards of Audit (ISA)<br />
at the public interest entities, for the financial year ended at 31 st of December<br />
2006;<br />
• the improvement of the operational capacity of regulatory bodies;<br />
• the improvement of the oversight of the accounting and auditing professions,<br />
the corporate governance and the public transparency, as outlined in the<br />
community acquis, both at legislative level, as well as at the best practices in<br />
the European Union level.<br />
The implementation of the Country Action Plan implies a mix of short and medium<br />
term projects.<br />
According to the GD no. 2170/2004, the short-term objectives are:<br />
• setting up the Steering Committee for the implementation of the Country<br />
Action Plan;<br />
• the amendment of the primary and secondary legislation;<br />
• improving the organization of the Accounting Advisory Board and the<br />
operational capacity of regulatory institutions: MFP (Ministry of Finances),<br />
BNR (National Romanian Bank), CNVM (Romanian National Securities<br />
Commission) and CSA (Insurance Supervisory Commission);<br />
• the continuous improvement of the professional training;<br />
• the assessment of the ways to enhance the quality and the credibility of the<br />
financial audit.<br />
The long-term objectives are:<br />
• the compliance of the Romanian legislation with the accounting law based on<br />
the IFRS and the European directives;<br />
• the completion of the secondary legislation for the capital market;<br />
• launching the implementation process to ensure an improved public<br />
transparency of the financial statements of the listed companies and other<br />
public interest entities;<br />
• improving the organization and the development of the best practices for the<br />
professional bodies in the accounting and financial audit field.<br />
The IFRS adoption determines a major change in the accounting language for the<br />
public interest entities, as well as for the accounting consultants, the auditors and the<br />
analysts in the financial accounting field. Moreover, this approach, which is a major<br />
national one, will determine additional responsibilities for all the regulatory bodies.<br />
The transition to the IFRS is not exclusively regarding the accounting field, but it has<br />
much wider implications - from the basic activity planning to the strategic<br />
management of the business entities. The adoption of IFRS requires the following<br />
(CSA, 2006):<br />
• a new performance appraisal system;<br />
~ 138 ~
• improving the quality of information for management in order to adopt the<br />
most appropriate decision;<br />
• increasing the competitiveness;<br />
• changing the whole basis of reporting.<br />
For the investors, the implementation of the IFRS referential will lead to the increase<br />
of the credibility of the information submitted by the companies, a better<br />
understanding of the risks and benefits and to the comparability of the results<br />
achieved by the companies activating in the same domain.<br />
In the transition to the IFRS, Romania joined the pilot group of countries that carry<br />
out the ROSC program for accounting and auditing. The ROSC program and its<br />
component for accounting and audit are a part of the initiative to strengthen the<br />
international financial architecture. The current international economic context, under<br />
the sign of the global economic crisis, demonstrates the understatement of the<br />
importance of the pillar represented by the accounting and auditing standards.<br />
For Romania, the World Bank experts have made an initial assessment of the existing<br />
regulations and practices in the accounting and financial audit, in 2003, and the<br />
findings were presented in the ROSC report on accounting and auditing, published in<br />
May 2003. At that time, Romania's progress in accounting in the recent years was<br />
highlighted and a number of basic policy recommendations were formulated,<br />
including: the harmonization of the laws and standards; the financial reporting of the<br />
credit institutions, the insurance companies and the pension funds; the consolidated<br />
financial statements disclosure; the accounting and auditing surveillance; the Chamber<br />
of Financial Auditors of Romania (CAFR) independence; a twinning agreement for<br />
CAFR to help the transfer of knowledge, education and professional training (World<br />
Bank, 2003).<br />
In 2003, the strategic objective of the Country Action Plan for improving the financial<br />
reporting in Romania was the "Fulfillment of the major accounting and auditing<br />
obligations, arising from the community acquis before 2007 - the accession date". In<br />
order to achieve this goal, five basic objectives were formulated in the action plan, as<br />
follows:<br />
• the compliance of the Romanian legislation in the field of accounting and<br />
auditing with the community acquis;<br />
• the implementation of the IFRS and ISA for the public interest entities (PIE)<br />
from the 1st of January 2006;<br />
• the improvement of the operational capacity of the insurance regulatory body<br />
(CSA);<br />
• improving the operational capacity of the regulatory body of the capital market<br />
(CNVM);<br />
• the improvement of the surveillance, the corporate governance and the public<br />
transparency.<br />
Although, in the recent years, Romania has made significant progresses in increasing<br />
the quality of the financial reporting by implementing the National strategy for<br />
improving the financial reporting of the private economic entities, in the ROSC report<br />
on accounting and auditing, published by the World Bank experts in December 2008,<br />
some issues to be corrected in the future were identified.<br />
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3. CURRENT PROBLEMS OF THE NATIONAL STRATEGY<br />
FOR IMPROVING THE FINANCIAL REPORTING OF THE PRIVATE<br />
SECTOR ENTITIES<br />
As noted, one of the goals of the National Strategy for improving the financial<br />
reporting refers to the compliance of the Romanian accounting with the applicable<br />
European Union regulations.<br />
At the EU level, by the Regulation no. 1606/2002 (the so-called IFRS Regulation), the<br />
mandatory IFRS application for the elaboration of the consolidated financial<br />
statements by the listed companies was agreed only for those IFRS approved at the<br />
Community level, by the European Commission's regulations, starting the 1 st of<br />
January 2005. The Member States had the option of extending the scope of<br />
application of the IFRS for other categories of companies, and for the individual<br />
financial statements.<br />
In what follows, we intend to present the sticking points, actual and potential, of the<br />
National Strategy for improving the financial reporting of the private economic<br />
entities, as identified by the representatives of the World Bank and the International<br />
Monetary Fund in the ROSC report on accounting and auditing, published in<br />
December 2008 (World Bank, 2008):<br />
� the process of setting the accounting regulations in Romania is supervised by the<br />
Ministry of Finances, which issues the accounting regulations for the Romanian<br />
trade sector. The main accounting rules are discussed in the Accounting and<br />
Financial Reporting Council (CCRF), which brings together the key monitoring<br />
bodies and the stakeholders interested in the Romanian financial and regulating<br />
system. CCRF is chaired by the Ministry of Finances and includes<br />
representatives from: BNR, CNVM, CSA, CSSPP (Private Pension System<br />
Supervisory Commission), the Ministry of Justice, CAFR, CECCAR (The Body<br />
of Expert and Licensed Accountants of Romania), academics and professional<br />
associations for the commercial sector. However, CCRF doesn’t bring together<br />
representatives of the banking and insurance sector, any of those who elaborate<br />
or use the financial statements or the technical staff of the member firms of the<br />
international audit networks;<br />
� compared to the Ministry Order no. 94/2001, Accounting regulations<br />
harmonized with the European directives and the International Accounting<br />
Standards, the explicit reference to the IFRS referential was removed from the<br />
Ministry Order no. 3055/2009, Accounting regulations in accordance with the<br />
EU directives. The absence of an explicit reference to the IFRS, when the<br />
Romanian Accounting Regulations don’t provide detailed guidance, is seen by<br />
the accounting and auditing professions and by those who prepare the financial<br />
statements as a problem. According to the Ministry Order no. 94/2001, the<br />
IAS/IFRS referential was applied when no other specific treatment was<br />
indicated. In the content of the Ministry Order no 3055/2009, there is no explicit<br />
reference to the IFRS.<br />
� if the banks and the listed companies prepare consolidated financial statements<br />
according the IFRS approved by the European Commission, the banks and the<br />
listed companies without subsidiaries are not required to prepare financial<br />
statements in accordance with the approved IFRS. This reality leads to a<br />
potential lack of comparability between the listed entities and the banks: while<br />
~ 140 ~
the parent companies prepare the consolidated financial statements according to<br />
the IFRS, other banks and listed companies without subsidiaries prepare the<br />
financial statements according to the Romanian accounting regulations;<br />
� according to the Accounting law no 82/1991, the insurance companies prepare<br />
the consolidated financial statements using either the approved IFRS or the<br />
Romanian accounting regulations in the insurance sector, which is a<br />
transposition of the Insurance Accounts Directive. For 2006, the Romanian<br />
insurance companies didn’t prepare the consolidated financial statements in<br />
accordance with the IFRS. The CSA should require all the insurance companies<br />
to publish their financial statements prepared in accordance with the approved<br />
IFRS, because they are public interest entities. Moreover, the CSA should allow<br />
the insurance companies to supplement the provisions of the IFRS 4 Insurance<br />
Contracts with other accounting standards. Currently, the IFRS 4 Insurance<br />
Contracts is incomplete and some insurance companies include provisions of<br />
U.S. GAAP in their accounting policies, to the extent they are consistent with<br />
the IFRS 4;<br />
� the Emergency Ordinance no. 90/2008 on the statutory audit introduced a<br />
system of public oversight by the establishment of the Public Oversight Board<br />
of the Statutory Audit Activity (CSPAAS), which will have to undertake<br />
external quality assurance for the statutory auditors and the audit firms that audit<br />
public interest entities;<br />
� although the CECCAR and CAFR professional bodies have changed in the<br />
recent years the governing principles, the agreements and the governance<br />
practices, they are not fully understood or known. Therefore, an independent<br />
person should conduct a review of the governance arrangements of both<br />
professional bodies;<br />
� particular attention should be paid to the program of quality assurance and<br />
review, initiated by CAFR in 2003: the department of monitoring and<br />
professional competence activates with 7 hired persons (5 inspectors and 2<br />
assistant inspectors) under the responsibility of an authorized inspector. The<br />
inspectors were intensively trained on the IFRS and ISA issues by experts from<br />
the Institute of Chartered Accountants of Scotland (ICAS). However, the work<br />
quality reviews take, on average, only one or two days and are conducted by<br />
inspectors who don’t have significant experience in auditing. Two of the<br />
inspectors are students of ACCA (Association of Chartered Certified<br />
Accountants) and the other five are qualified financial auditors. Although the<br />
inspectors from the CAFR monitoring department have received adequate<br />
training, their minimal professional experience as auditors, is a shortcoming that<br />
can’t be neglected. The lack of practical experience in auditing could affect their<br />
ability to review the audit working papers, especially when reviewing the audit<br />
working papers for banks or insurance companies. One solution would be to<br />
include auditors with experience in these areas in the monitoring teams, on an ad<br />
hoc basis. Furthermore, the average time allocated to the review and quality<br />
assurance activities in the field of the financial audit varies from one to two<br />
days. The period of time for the individual controls must be extended<br />
significantly for a better quality review of the audit work performed by the<br />
auditors. In the coming years, CAFR could consider limiting the frequency of<br />
checking the work of auditors who are not involved in the public interest<br />
entities, to only once every six years, in favor of improving the quality of<br />
reviewing the work of the auditors inside the public interest entities. According<br />
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to the 8th Directive, as amended, the auditors of public interest entities should<br />
be checked at least once at every three years;<br />
� the small number of specialists in accounting and financial audit, as required by<br />
IFRS, is doubled by a lack of skilled graduates in accounting. Traditionally, the<br />
audit firms staff rotation is very high and it often happens that a graduate, who<br />
has only two years of experience within a member firm from an international<br />
network of audit firms, to be offered a manager position in the financial or<br />
accounting department. Therefore, there is a clear need for the Romanian<br />
universities to demonstrate their ability to produce graduates able to meet new<br />
market requirements;<br />
� the consultation process for issuing the accounting and auditing regulations<br />
could be improved. In Romania, there is a lack in terms of implementing an<br />
effective process of consultation with those who prepare the financial<br />
statements, the auditors and the users of financial statements. It is possible that<br />
the consultation process is not efficient as long as the entities feel that their<br />
opinion does not influence the body that regulates and supervises their activity;<br />
� in Romania, both the CAFR and CECCAR independently translated all the ISA<br />
and the IFAC Code of Ethics in the relative context of their own activities. A<br />
single quality translation of the ISA and the IFAC Code of Ethics for Romania<br />
would reduce the confusion about the source and availability of the applicable<br />
standards and would eliminate the differences of terminology that may exist in<br />
the multiple translations. The multiple translations are a waste of resources and<br />
are a good example for the lack of cooperation between the two professional<br />
bodies. In the following period, a real cooperation between CAFR and<br />
CECCAR is needed in order to avoid the multiple translations and to agree on<br />
the terminology used;<br />
� although the auditors are the subject to some civil, disciplinary, administrative<br />
and criminal sanctions, in Romania legal actions against auditors were not<br />
initiated;<br />
� in general, the surveillance bodies focus more on monitoring the prudential<br />
criteria than on the financial reporting, as follows:<br />
• the focus of the monitoring department of the CSA appears to be more on<br />
the prudential requirements than on the financial reporting. No case of<br />
infringement of the financial reporting requirements was communicated or<br />
published;<br />
• the monitoring unit of the CNVM, which reviews the financial statements of<br />
listed companies, include six people who were prepared, particularly on<br />
IFRS, under a project funded by the European Union, in particular IFRS<br />
(Phare 2005 "The strengthening of the institutional capacity of CNVM”).<br />
The monitoring unit began its activity in May 2008 and, among other duties,<br />
it reviews the consolidated financial statements of the listed companies<br />
prepared according to the approved IFRS. The quick implementation of the<br />
knowledge acquired in the EU project, to ensure an effective review of the<br />
financial statements in accordance with the IFRS, challenged to the newly<br />
established unit. Although the penalties stipulated by the securities law<br />
include the civil liability of those who prepare the financial statements, the<br />
directors and the auditors, no action has been reported in court till now. The<br />
Bucharest Stock Exchange reviews the financial statements of the listed<br />
companies to see if they have the complete documentation, but in the<br />
absence of an overall review of the annual reporting, including the financial<br />
~ 142 ~
statements and the audit report, it doesn’t assess the quality of the<br />
information provided by them. Furthermore, the CNVM is required to<br />
monitor and implement the financial reporting of the listed companies. The<br />
CNVM has never asked about the restatement of the financial statements and<br />
has limited only to setting fines for their late filing;<br />
� the Romanian Accounting Regulations provides little or no information about<br />
the matters covered by the following IFRS: IFRS 2, Share-based payment;<br />
IFRS 6, Exploration for and evaluation of mineral resources; IFRS 8, Operating<br />
Segments; IAS 40, Investment Property and IAS 41, Agriculture.<br />
Although Romania has implemented the relevant accounting directives, the absence of<br />
many necessary elements for supporting the infrastructure, combined with the<br />
Romanian tradition of the rules-based accounting, is challenging in terms of ensuring<br />
that the principles set out in EU legislation are applied in a such a manner that the<br />
quality the financial reporting is ensured.<br />
The International Financial Reporting Standards are based on concepts and not on<br />
rules, calling for the professional reasoning of the accountants and the auditors. At the<br />
same time, in obtaining financial information, the emphasis is placed on the<br />
evaluation before the accounting recognition of a transaction, but also on the principle<br />
of materiality and on the cost-benefit ratio. All these requirements were new<br />
approaches to the Romanian accounting since the passage to the international<br />
financial reporting standards, even if a partial one, involved not merely a change in<br />
the accounting rules but a whole process of change at the company’s level (Jianu et<br />
al., 2009).<br />
Studies that have been conducted in Romania in the recent years on the opening of the<br />
economic entities to the accounting based on IFRS show the reluctance of the<br />
majority towards the reform of the financial reporting system in this direction, the<br />
main justification being related to charging the companies with additional costs (costs<br />
of audit, staff training costs, software costs etc).<br />
A study conducted in 2009, shows the reluctance of most professional accountants<br />
involved in the research to the reform of the financial reporting, based on the<br />
philosophy of IFRS: 84.8% of the respondents considered that the harmonization of<br />
the Romanian accounting regulations the IFRS for the large firms during 2000-2005,<br />
was purely dictated by political decision. Only 12.1% of the respondents saw in the<br />
process of harmonization of the Romanian accounting regulations with the IFRS<br />
referential a necessity imposed by the development and the globalization of the capital<br />
markets (Lapteş and Popa, 2009). Regarding the delimitation of an area of application<br />
of the IFRS referential in the Romanian accounting, we find, from the same study, the<br />
following (Lapteş and Popa, 2009):<br />
� 45,4% of the respondents considered that the IFRS referential should be adopted<br />
by all the economic entities;<br />
� 15,1% of the respondents considered that the IFRS referential should be adopted<br />
only by the listed companies, both for the consolidated and the individual<br />
financial statements;<br />
� 15,1% of the respondents considered that the IFRS referential should be adopted<br />
only by the big companies by the public interest entities;<br />
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� 12,1% of the respondents considered that the IFRS referential should be adopted<br />
only by the entities that want choose so;<br />
� The other respondents consider IFRS referential is useful for the economic<br />
entities that are interested in financing their activity from the international<br />
market.<br />
Another study, done in 2009, in the companies providing accounting and audit<br />
services, referring to the opportunity of the IFRS referential implementation in<br />
relation to the professional accountants level of training in this area, demonstrates that<br />
at the implementation date most of the Romanian accounting professionals didn’t<br />
know this referential, the awareness degree being an alarming one, less than 20%.<br />
Nowadays, 75% of the respondents who were the object of the research consider that<br />
the accounting professionals master the IFRS referential, but the other respondents,<br />
25%, believe that the Romanian accounting professionals are not ready to apply the<br />
IFRS referential (Jianu et al., 2009).<br />
The training of the staff involved in the IFRS application is a long-term goal. The<br />
public interest entities must train their own experts, because, presently, there aren’t<br />
enough experts on the IFRS application. On the other hand, the IFRS are in a<br />
continuous development process which involves a continuous training of the<br />
professional accountants.<br />
In Romania, although there were some progresses compared to 2003, the quality<br />
assurance system and the enforcement mechanisms for the general purpose financial<br />
statements and the audit requirements are still insufficient. For example, the system<br />
adopted by the CAFR in order to ensure the quality is operational, but the monitoring<br />
team, which includes five professional auditors, lacks the experience and the<br />
professional skills in auditing, especially in the financial sector. The Chamber of<br />
Financial Auditors Romania needs to significantly improve the monitoring team and<br />
the quality assurance system in order to achieve the objectives set by the 8th Directive<br />
(World Bank, 2008).<br />
In this respect, in Romania, a Strategy for the public oversight of statutory audit work<br />
was developed in 2010, being initiated by the Public Oversight Board of the Statutory<br />
Audit Activity (CSPAAS), an organization founded in 2008 by the transposition of<br />
the Directive 2006/43 / EC. The key strategic objective of the CSPAAS is to promote<br />
and to follow the increase in the public confidence in the statutory auditing of the<br />
annual financial statements and the consolidated financial statements (CSPAAS,<br />
2010).<br />
If the Romanian National Bank monitors and adopts the financial reporting<br />
requirements applicable to the banks and the non-banking financial institutions, the<br />
insurance supervisory bodies haven’t published any example of application of the<br />
financial reporting requirements. In this context, the effectiveness of the Insurance<br />
Supervisory Commission (CSA) in monitoring the quality of the general purpose<br />
financial statements issued by the insurance companies becomes questionable.<br />
~ 144 ~
The Insurance Supervisory Commission (CSA) welcomed the following approach to<br />
the national strategy for the transition to the IFRS implementation by the insurance<br />
companies (CSA, 2006):<br />
� starting from the financial year 2007, the insurance companies listed on a<br />
regulated market or being prepared for listing at the balance sheet date, and<br />
which elaborate consolidated financial statements, had to elaborate such<br />
financial statements according to the IFRS;<br />
� for the financial years of 2008 and 2009, the insurance companies had to prepare<br />
annual and consolidated financial statements according to the IFRS, as the<br />
second set of financial statements for the information needs of the CSA, the<br />
market and other categories of users;<br />
� based on the assessments made referring to the IFRS application in the<br />
individual financial statements, a decision was going to be adopted regarding the<br />
possibility of elaborating the financial statements of insurance companies<br />
according to the IFRS, as a single set, since 2010.<br />
For the economic entities in the insurance sector, the IASB decided to implement a<br />
specific standard for this activity, which will be gradually applied over two-stages. In<br />
the first stage, this specific standard was not used, the applicable principles being<br />
those provided by: IAS 32, Financial Instruments: Disclosure and Presentation, IAS<br />
39, Financial Instruments: Recognition and Measurement and the IFRS 4, Insurance<br />
Contracts. The second phase ended in the late 2010 with the adoption of the specific<br />
standard to the insurance domain (CSA, 2006).<br />
On the other hand, the unit responsible for monitoring the listed companies, set up<br />
inside CNVM, began its activities in May 2008 and is challenged to review the<br />
consolidated financial statements prepared in accordance with the International<br />
Financial Reporting Standards.<br />
Moreover, the Romanian National Bank, by the BNR Order no. 9/2010 on the<br />
application of the International Financial Reporting Standards by the credit<br />
institutions, as a basis of accounting, decided the elaboration of the annual individual<br />
financial statements in accordance with the IFRS starting from the fiscal year 2012.<br />
In conclusion, in Romania, the national strategy for improving the financial reporting<br />
of the private economic entities is mostly based on the elaboration of the individual<br />
annual financial statements of the public entities under the IFRS referential, but the<br />
experience of the recent years demonstrates unequivocally that in our country, there<br />
are some difficulties in implementing the IFRS, as follows (Toma, 2010):<br />
� the misinterpretation of the IFRS or the terminology problems, sometimes<br />
generated by the translation errors or the multiple translations;<br />
� the confusion that occurs between the standards and the regulations; wrongly,<br />
we come to equate the two concepts, even if they are different issues: the<br />
standards have a recommendation character, they aren’t mandatory and are<br />
issued by non governmental bodies, while the regulations are mandatory and are<br />
issued by government institutions;<br />
� the IFRS nature is another issue for the Romanian accounting professionals:<br />
when reading an International Financial Reporting Standard, the Romanian<br />
accounting specialists are particularly concerned about the accounting<br />
~ 145 ~
investigation, rather than the elements regarding the accounting information<br />
disclosure in the financial statements;<br />
� the financial reporting refers to the general financial statements, the same way<br />
the IFRS treat this subject, while the accounting regulations in Romania<br />
laconically question the general financial reporting;<br />
� the confusion connected to the applicability of the IFRS: the international<br />
financial reporting standards are issued in order to be applied by the economic<br />
entities and can’t be brought to a governmental level in order to consolidate a<br />
nationally centralized accounting;<br />
� the relationship between taxation and accounting, which is not settled at the<br />
European level, because two issues can be identified in this area: first, issues of<br />
cost, generated by drawing two sets of financial statements, second, drawbacks<br />
related to the reliability (when information from balance sheets prepared<br />
according to different accounting referentials are read, it's hard to believe that no<br />
question was raised: what are the actual results?);<br />
� internationally and nationally no clear import pattern of the IFRS emerged:<br />
taking over the IFRS, adopting some national standards of financial reporting or<br />
setting up of national standards based on the IFRS principles?;<br />
� difficulties in applying the IFRS for the small and medium enterprises,<br />
considering that in the Romanian law these entities are not clearly defined small<br />
and medium enterprises;<br />
� issues related to IFRS implementation costs, while the Romanian state is facing<br />
difficulties in applying the international financial reporting standards in the<br />
public sector system;<br />
� in the context of implementing the IFRS, the human factor, that is the<br />
accounting professional, should not be neglected, considering that at his level,<br />
possible training, ethical and professional reasoning issues can be identified, due<br />
to his universally recognized subordination to the taxation.<br />
DISCUSSION AND CONCLUSIONS<br />
The accounting professionals have repeated on various occasions that, nowadays, the<br />
accounting community is driven by the strong desire of standardization and<br />
harmonization of the international accounting practices and, more recently, of<br />
convergence in the accounting field, in order to increase the comparability and the<br />
credibility of the information disclosed in the financial statements.<br />
In order to achieve these aims, the national standard setters must give their input into<br />
draft IFRS pronouncements in order to ensure that IFRS meet the needs of the<br />
stakeholders in their countries and to contribute to the thought process as to how to<br />
develop the best accounting and financial reporting solutions (FEE, 2009).<br />
Since 1990, the Romanian accounting theory and practice is in a constant search for<br />
an identity. Since then we have witnessed the "import" of accounting solutions that<br />
have been transformed into genuine referentials that helped us to react in every<br />
moment of change.<br />
Year 2000 was for the Romanian accounting the beginning of a large process of<br />
reconstruction, especially in the conceptual field. Furthermore, as the accounting<br />
~ 146 ~
eform went ahead the economy reform, the supply of accounting information did not<br />
follow, but anticipated the demand.<br />
Since 2001, with the adoption of the Ministry Order no. 94/2001, Romania<br />
experiences the implementation of the IFRS referential and, presently, a national<br />
Strategy of improving the financial reporting of the economic entities is now outlined.<br />
It remains to be seen whether, contrary to all the difficulties, the path that we intend to<br />
follow, will lead to the increase of the quality and the reliability of the financial<br />
reporting of the economic entities. Certainly, an important role in achieving this goal<br />
belongs to the accounting professional, whose difficult mission is to keep up with the<br />
frequent reconsiderations of the accounting rules, largely decided at the international<br />
level.<br />
This is another step taken in achieving a final goal of developing a functional model<br />
for optimizing the national strategy regarding the financial reporting of the Romanian<br />
private entities.<br />
ACKNOWLEDGEMENTS<br />
This research was financed through the research contract in partnership CNMP 92-<br />
085/2008, Development of a functional model for optimizing the national strategy<br />
regarding the financial reporting of the Romanian private entities.<br />
REFERENCES<br />
Dumitrana, M., Jianu, I. and Lapteş, R. (2010) „Panoptical on the financial statements – from<br />
international to national”, Accounting and Management Information Systems, vol. 9,<br />
no. 1: 72-91<br />
Ionaşcu, I. (2003) The dynamic of the contemporary accounting doctrines, Bucharest:<br />
Economic Printing House<br />
Jianu, I., Lapteş, R. and Radu, G. (2009) „The financial-accounting audit, facilitator and<br />
integrator of the harmonization process of the financial reporting with the European<br />
directives and the IFRS”, Financial Audit, vol. 7, no. 10: 11-22<br />
Lapteş, R. (2007) History, present and perspective regarding the company’s financial<br />
statements in Romania, Bucharest: The Academy of Economic Studies<br />
Lapteş, R. and Popa A.F. (2009) „The IFRS Standard for Small and Medium-Sized Entities –<br />
Another Challenge for the Romanian Accounting?”, The Scientific Annals of the<br />
Alexandru Ioan Cuza University of Iasi, Economic Sciences Section, LVI tome: 27-34<br />
Ristea, M., Olimid, L., Calu, D. (2006) Compared Accounting Systems, Bucharest: CECCAR<br />
Printing House<br />
Ristea, M., Jianu, I. and Jianu, I. (2010) „The Romanian Experience in the Implementation of<br />
the International Financial Reporting Standards and of the International Accounting<br />
Standards for the Public Sector”, The Transylvanian Review of Administrative<br />
Sciences, vol. 25, no. 1: 169-192<br />
Toma, M. (2010) „Difficulties of the International Standards Implementation in Romania”,<br />
Curierul Național, anul 15, no. 5634<br />
World Bank (2003) „Report on the Observance of Standards and Codes (ROSC) –<br />
Accounting and Audit, Romania, 2003”, available on-line at<br />
www.siteresources.worldbank.org/.../Resources/Romania_ROSC_Rom.pdf, accessed<br />
on January 05, 2011<br />
~ 147 ~
World Bank (2008) „Report on the Observance of Standards and Codes (ROSC) –<br />
Accounting and Audit, Romania, 2008”, available on-line at<br />
www.siteresources.worldbank.org/.../Resources/Romania_ROSC_Rom.pdf, accessed<br />
on January 06, 2011<br />
FEE (2009) “Future approach to Setting Global Financial Reporting Standards”, available online<br />
at http://www.ceccar.ro/_b/en/fee.pdf, accessed on March 31, 2011<br />
C.S.A. (2006) „The Strategy for the Implementation of International Financial Reporting<br />
Standards (IFRS) at the Insurance Entities”, available on-line at www.csaisc.ro/index.php?option=com_content,<br />
accessed on January 07, 2011<br />
CSPAAS (2010) „The Strategy on the Public Surveillance of the Statutory Audit Activity”,<br />
available on-line at www.discutii.mfinante.ro/static/10/Mfp/cspaas/Strategie_CSPAAS<br />
.pdf, accessed on January 07, 2011<br />
GD 2170/2004 for approving the National Strategy for implementing the Country Action Plan<br />
in order to improve the financial reporting in Romania and some measures for the<br />
organization of the Accounting Advisory Board<br />
GD 401/2005 for setting up the Accounting and Financial Reporting Council by the<br />
reorganization of the Accounting Advisory Board<br />
Regulation no. 1606/2002 of the European Parliament and the Council on the 19 th of July<br />
2002 regarding the application of the international accounting standards<br />
Directives, Regulations and other official acts available on-line at http://ec.europa.eu/<br />
internal_market/accounting/officialdocs_en.htm, accessed on March 28, 2011<br />
~ 148 ~
PS3 Financial analysis I<br />
Chairperson<br />
Petru OPRIS, West University of Timişoara, Romania<br />
FINANCIAL RATIOS AND MARKET VALUATION ON<br />
EMERGENT MARKETS: THE ROMANIAN CASE<br />
Bogdan DIMA, Petru OPRIS<br />
A HYBRID DEVICE OF SELF ORGANIZING MAPS<br />
(SOM) AND MULTIVARIATE ADAPTIVE REGRESSION<br />
SPLINES (MARS) FOR THE FORECASTING OF FIRMS’<br />
BANKRUPTCY<br />
Javier de ANDRES, Fernando SΑNCHEZ-LASHERAS,<br />
Pedro LORCA, Francisco Javier DE COS-JUEZ<br />
THE RELEVANCE OF COMPANY EVALUATION<br />
METHODS IN CONDITIONS OF ECONOMIC<br />
INSTABILITY. EMPIRICAL STUDY<br />
ON THE COMPANIES QUOTED IN THE BUCHAREST<br />
STOCK EXCHANGE<br />
Marilena MIRONIUC, Mihai CARP, Ioan-Bogdan ROBU<br />
FINANCIAL RISK ANALYSIS AT THE STOCK<br />
EXCHANGE LISTED COMPANIES IN THE<br />
PASSENGER ROAD TRANSPORTATION INDUSTRY<br />
Vlad IORDACHE, Vasile ROBU, Costin CIORA<br />
~ 149 ~
FINANCIAL RATIOS AND MARKET VALUATION ON<br />
EMERGENT MARKETS: THE ROMANIAN CASE<br />
Bogdan DIMA 1 & Petru OPRIS<br />
West University of Timişoara, Romania<br />
ABSTRACT<br />
We are investigating the predictive relevance of the issuers’ financial ratios for the financial<br />
instruments’ market prices. Using a sample of Romanian companies listed at Bucharest Stock<br />
Exchange we are finding in a GMM- System framework that even in short run (5 years) there<br />
is some room for considering such relevance. This result suggests that the standard finding in<br />
literature according to which financial ratios usually displays weak predictive power in short<br />
horizons and some predictive power in long horizons should be more clearly analyzed in the<br />
context of the recent economic and financial instability..<br />
KEYWORDS: Financial ratios; Returns predictability; Fundamentals; Market value;<br />
GMM-System estimators<br />
INTRODUCTION<br />
We are testing the relevance of the financial ratios for the formation of stocks’ prices<br />
on an emergent capital market such the Romanian one. Are these prices connected<br />
with the fundamental variables linked to the issuer’s financial situation? Is there a<br />
transmission process between the changes in this situation and prices adjustments? Is<br />
this relevant for the valuation literature?<br />
The key point is that both accounting data and share prices have as purpose to reflect<br />
value (capital) and change in value (profit). Thus, one important issue arises when<br />
questioning about the existence of relationship between these two and timing (lags<br />
due to need for finishing reporting period).<br />
The current stage of the research in this field is resumed by Cochrane (2001:388) as:<br />
“Returns are predictable. In particular, (a) Variables including the dividend/price ratio<br />
and term premium can in fact predict substantial amounts of stock return variation.<br />
This phenomenon occurs over business cycle and longer horizons. Daily, weekly, and<br />
monthly stock returns are still close to unpredictable …”.<br />
However, this conclusion is criticized from several directions. For instance, it was<br />
observed that in testing the connections between the descriptors of the issuers’<br />
financial architecture and the evolutions of prices the statistical inference is<br />
problematic since the highly persistent set of financial ratios displays frequently near-<br />
1<br />
Correspondence address: Bogdan DIMA, West University of Timişoara, Romania;<br />
email: bogdan.dima@feaa.uvt.ro, http://www.feaa.uvt.ro<br />
~ 150 ~
to-unit root properties. Thus, there can appear uninformative inferences on predictive<br />
relations (Valkanov, 2003; Lewellen, 2004).<br />
Another observation underlines the fact that the process by which the<br />
contemporaneous stock price reflects value relevant information (both accounting and<br />
non-accounting) remains unchanged over time. In our opinion, this is a critical<br />
hypothesis, since it is equivalent with the absence of any learning process in the<br />
investors’ decisions, process that would be able to guide the adjustments in the<br />
construction and management of financial assets’ portfolios. If this is presumed, then<br />
it is possible to take into account more sophisticated inter-linkages between the<br />
evolution of stocks and the financial performance of their issuers. A direct testable<br />
consequence for such inter-linkages could be the manifestation of non-linear<br />
connections between prices’ dynamics and the content of the financial statements. In<br />
this sense, there are recent empirical evidence showing convexity in the relationship<br />
between prices and accounting information. Empirical tests, although exploratory,<br />
provide further evidence of a nonlinear relation between stock price and accounting<br />
measures of earnings and book value (see, for instance, Riffe and Thompson, 1998).<br />
In the mean time, it is not completely clear how much predictive power can be<br />
attributed to financial ratios.<br />
Summers (1986), Fama and French (1988), and Campbell and Shiller (1989, 2005)<br />
suggest a simple theory of slow mean reversion to explain the predictive power. That<br />
is, stock prices cannot drift too far from their fundamentals (e.g., dividend, earnings,<br />
and book value) in the long run. The theory of slow mean reversion requires financial<br />
ratios to be stationary.<br />
As Chang et al. (2008) notes “The phenomenon of the mean-reversion discussed from<br />
the literature explore whether the stock price followed random walk. If the stock<br />
prices violate the trend of random walk, one possibility is the stock prices followed<br />
mean-reversion process. If the stock prices followed mean reversion in the long-run,<br />
the price movements should be predictable from the movements in firm fundamental<br />
values. In this sense, determining whether stock prices are mean-reversion is a very<br />
important issue for investors. Consequently, to analysis equity fundamentals, what is<br />
important is to verify whether the stock price moves with its firm’s fundamental”.<br />
Lamont (1998) argues that fundamentals predict returns in the short run, while prices<br />
predict returns in the long run. Supplementary, the prediction relation between returns<br />
and financial ratios appears to suffer from structural instability over time. Especially,<br />
in the late 1990s, the prediction relation seems not robust (see, Goyal and Welch,<br />
2003; Paye and Timmermann, 2006; Lettau and Van Nieuwerburgh, 2008).<br />
Also, it should be considered the argument advanced by Lettau and Van<br />
Nieuwerburgh (2008) who are suggesting that the puzzling empirical patterns in<br />
return prediction are caused by the changes in the steady-state mean of financial ratios<br />
and are estimating regime-switching models for the steady-state mean of financial<br />
ratios.<br />
Guan (2010) noticed that firm financial ratios can help identify stocks that outperform<br />
other stocks during recessions, even after controlling for firm characteristics such as<br />
~ 151 ~
size, book-to-market ratio and past returns. Using a parsimonious composite score<br />
based on the unadjusted and industry-adjusted financial ratios, firms with high scores<br />
earn 1.29% per month more than firms with low scores during recessions. The return<br />
differences are smaller but significantly negative during expansions. The strong<br />
predicting power of financial ratios is not due to its ability to predict the beta (since<br />
the high score firms and low score firms have similar betas). The findings suggest that<br />
financial ratios provide valuable incremental information about stock systematic risk<br />
at the business cycle frequency besides the size, book-to-market, momentum<br />
characteristics and betas.<br />
However, the emergent capital markets are characterized by lower levels of financial<br />
instruments liquidity, imperfect transaction mechanisms, frequent situations of<br />
information asymmetry and fragile institutional framework.<br />
In this context, the objective of this study is to seek for some empirical evidences if or<br />
if not there is an even limited predictive capacity of the issuers’ financial status<br />
descriptors on emerging markets by examining a set of data for some companies<br />
which are quoted on Bucharest Stock Exchange in order to identify if the financial<br />
ratios are significant and positively correlated with the evolution of market values.<br />
The paper is organized as follows: Section 2 describes the methodology. Section 3<br />
reports on the data used for the empirical tests and on the results of these tests. Some<br />
conclusions are formulated and some future research analytical directions are<br />
indicated in Section 4.<br />
1. METHODOLOGICAL FRAMEWORK<br />
An initial step of our methodological approach consists in testing the relevance of the<br />
financial ratios for the market values of the companies. If these ratios appears to be<br />
connected to the dynamic of market values, then it can be argued that there<br />
information content is relevant for the decisions of investors to incorporate the<br />
financial instrument issued by the considered companies in their portfolio. In such<br />
case, the market value is performance-driven and reflects some relevant fundamental<br />
determinants of issuers’ financial situations.<br />
Thus, we run preliminary regressions as:<br />
Closeit , =β 0 +β iXit , +δ t+η i+ε it ,<br />
Here, the dependent variation of market daily close prices (CLOSE) is linked to<br />
individual X financial ratios. ηi is the unobserved time-invariant specific effects; δt<br />
captures a common deterministic trend; εit is a random disturbance assumed to be<br />
normal, and identical distributed (IID) with E (εit)=0; Var (εit) =σ 2 >0 .<br />
In order to estimate the involved parameters, we apply the so-called GMM-System<br />
estimation. The GMM-System methodology – as proposed by Arellano and Bover<br />
(1995), Blundell and Bond (1998, 2000) and Windmeijer (2005) - is involved because<br />
estimators like fixed and random effects, IV or standard GMM may yield to biased<br />
results. Also, since a small panel sample may produce “downward bias of the<br />
estimated asymptotic standard errors” in the two-step procedure (Baltagi, 2008: 154),<br />
~ 152 ~<br />
( 1)
we use the “Windmeijer correction” for the estimated standard errors. More exactly,<br />
Windmeijer (2000, 2005) observes that part of downward bias which can appear for<br />
the standard errors in small samples is due to extra variation caused by the initial<br />
weight matrix estimation being itself based on consistent estimates of the equation<br />
parameters. In order to correct this bias, it is possible to calculate bias-corrected<br />
standard error estimates which take into account the variation of the initial parameter<br />
estimates. We employ a version of this correction applicable for GMM models<br />
estimated using an iterate-to-convergence procedure.<br />
There are several advantages of the GMM-SYS over other static or dynamic panel<br />
estimation methods. Among these: static panel estimates, as the OLS models, are<br />
subjected to the problem of dynamic panel bias (Bond, 2002); in our database, we<br />
have 12 companies (N) analyzed over a short time span of 5 years (T) and the<br />
literature includes several arguments for dynamic panel model being specially<br />
designed for a situation where “T” is smaller than “N” in order to control for dynamic<br />
panel bias (Bond 2002; Baltagi 2008); the problem of the potential endogeneity can be<br />
easier addressed in dynamic panel models than in static and OLS models, since all<br />
variables from the regression which are not correlated with the error term (including<br />
lagged and differenced variables) can be potentially used as valid instrumental<br />
variables; the dynamic panel model is able to identify short and long-run involved<br />
effects (Baltagi 2008). Also, the GMM-System exploits the stationarity restrictions,<br />
while the first-differenced GMM estimator can behave poorly when the time series<br />
are persistent.<br />
The GMM-System tries to simultaneous estimate the Equation 1 together with a respecification<br />
designed to eliminate the company-specific effects by using first<br />
differences of the involved variables as:<br />
Δ Closeit , =βiΔ Xit , +δ t+η i+ΘΔ Zit<br />
, +ε it ,<br />
Z is a set of instruments for the dependent and explanatory variables. The system-<br />
GMM approach estimates equations (1) and (2) simultaneously, by using lagged<br />
levels and lagged differences as instruments. The presence of both lagged levels and<br />
differences is justified by Arellano and Bover (1995) and Blundell and Bond (1998)<br />
which showed that lagged levels can be poor instruments for first-differenced<br />
variables, particularly if the variables are “persistent”. For comparison purposes, we<br />
are reporting the results of a dynamic GMM (Arellano and Bond, 1991).<br />
Further, the financial ratios that individually appear to be relevant for the formation of<br />
market prices can be aggregated in a single indicator of issuers’ financial conditions<br />
for instance by using the Principal Components Analysis applied on these ratios.<br />
This procedure models the variance structure of a set of observed variables using<br />
linear combinations of the variables. These linear combinations (components) may be<br />
used in subsequent analysis, and the combination coefficients (loadings) can be used<br />
for a subsequent interpretation of the components. The global indicator is constructed<br />
by weighting the individual disclosure dummies with these loadings. Details on the<br />
procedure are provided in Appendix. We are involving such approach since: (a) this is<br />
a procedure of reducing the number of observed variables to a smaller number of<br />
principal components which account for most of the variance of the observed<br />
~ 153 ~<br />
( 2 )
variables; (b) we are expecting the financial ratios to be highly correlated; (c)<br />
component scores are a linear combination of the observed variables weighted by<br />
eigenvectors and thus allows for considering the relative importance of individual<br />
variables. Such global indicator is designed to be use for an overall assessment of the<br />
impact exercised by the financial ratios on market values.<br />
2. DATA AND EMPIRICAL RESULTS<br />
2.1. Romanian capital market data<br />
Our dataset consists in 12 companies from the first tier of the Bucharest Stock<br />
Exchange over a time span between 2005 and 2009. These stocks have a maximal<br />
degree of liquidity and are forming a significant fraction of the market. The variables<br />
reflect the annual close prices, the business turnover, two liquidity ratios, the net<br />
treasury ratio and the dividends per share. In our opinion, such financial ratios are<br />
susceptible to capture in a synthetic manner the financial situations of the issuers as<br />
well as the returns obtained by the investors. Consequently, these ratios are<br />
presumably relevant for investment decisions even on an imperfect market such as the<br />
Romanian one with slow prices adjustment mechanisms and their effects on longer<br />
market cycles.<br />
The data are provided by Bucharest Stock Exchange and represents the (log) last close<br />
of the year indexes as dependent variable and a set of financial ratios computed based<br />
on the financial statements of the issuers as explicative variables.<br />
Table 1 reports on the main statistic characteristics of the data. The data displays nonnormal<br />
distributions with significant fat-tails effects. The values of the dispersion as<br />
well as the parameters of the distribution suggest the possibility of some significant<br />
outliers in for the observation period.<br />
Table 1. Main statistic characteristics of data (yearly values; variation, %)<br />
Close prices Current liquidity ratioQuick ratioNet treasury ratio Dividends per share<br />
Mean 62.65 96.37 119.06 24.44 -1.37<br />
Median 30.00 -2.60 2.46 -0.23 0.00<br />
Maximum 2145.22 2843.53 2430.21 1673.31 270.59<br />
Minimum -94.05 -99.00 -99.07 -627.93 -100.00<br />
Std. Dev. 287.44 421.74 468.11 275.25 63.07<br />
Skewness 6.59 5.49 4.16 3.49 1.77<br />
Kurtosis 48.35 33.97 19.23 23.63 9.00<br />
Jarque-Bera 5482.73 2653.52 818.20 1165.79 119.37<br />
Number of observations 60 60 60 60 60<br />
Such potential heterogeneity requires an adequate methodology for dealing with the<br />
induced bias in data and can be viewed as a supplementary argument for the involving<br />
of the GMM-System approach.<br />
~ 154 ~
2.2. Results<br />
Our preliminary evaluation reported in Table 2 indicates that all the considered<br />
financial ratios are significant and positively correlated with the evolution of market<br />
values.<br />
Table 2. Market value of shares and financial ratios of issuers<br />
Explanatory<br />
Current liquidity ratio = 1.03*** (0.28)<br />
Total current assets /<br />
Total current liabilities<br />
Quick ratio =<br />
(Cash and short term investments+<br />
Total receivable, net) /<br />
Total current liabilities<br />
Net treasury ratio =<br />
Treasury, net / Total Assets<br />
Dividends per share<br />
~ 155 ~<br />
0.99***(0.27)<br />
0.25* (0.14)<br />
0.98***(0.33)<br />
M1 -2.42[0.02] -1.90[0.06] -2.14[0.03] -1.65[0.10]<br />
M2 1.49[0.14] 1.23[0.22] 0.42[0.68] -0.52[0.68]<br />
Sargan [0.74]<br />
[0.77]<br />
[0.64]<br />
[0.61]<br />
(Df=14) (Df=14) (Df=14) (Df=14)<br />
Observations (balanced) 48 48 48 48<br />
Standard errors (heteroskedasticity corrected) are in round brackets. The null that each<br />
coefficient is equal to zero is tested using the second-step robust standard<br />
errors.***/**/*- statistically significant, respectively at the 1%, 5%, and 10% level.<br />
M1 and M2 are tests for first-order and second-order serial correlation in the firstdifferenced<br />
residuals, asymptotically distributed as N(0,1) under the null hypothesis<br />
of no serial correlation (based on robust two-steps GMM estimators). Sargan is a test<br />
of the over-identifying restrictions, asymptotically distributed as χ2, under the null of<br />
instruments’ validity (two-steps estimators).<br />
Thus, the considered financial ratios can be viewed as providing for the investors a<br />
synthetic description of the issuers’ performances and financial health as well as the<br />
dividend policies. Based on their informational content, the investors can evaluate the<br />
financial risks associated with holding and trading the stocks and, in caeteris paribus<br />
conditions, the associated returns.<br />
Consequently, Table 3 displays the results of a Principal Components Analysis on the<br />
individual ratios in order to provide such a synthetic descriptor of the issuers’<br />
financial status.<br />
The first section of Table 3 summarizes the eigenvalues, showing the values, the<br />
forward difference in the eigenvalues and the proportion of total variance explained.<br />
Since we are performing principal components on a correlation matrix, the sum of the<br />
scaled variances for the four ratios is equal to 4. The first principal component<br />
accounts for 55% of the total variance while the second accounts for 28% of the total.<br />
The first two components account for over 83% of the variation.
The second section describes the linear combination coefficients. One can notice that<br />
the first principal component (labeled “PC1”) is a linear combination of all four ratios.<br />
Thus, it might reasonably be interpreted as a global financial situation indicator. The<br />
second principal component (labeled “PC2”) has negative loadings for the dividends<br />
per share and it appears to represent an indicator of financial architecture’ descriptors<br />
(without the investors remuneration component).<br />
Table 3. Principal Components Analysis for financial ratios<br />
Number Value Difference Proportion<br />
~ 156 ~<br />
Cumulative<br />
value<br />
Cumulative<br />
proportion<br />
1.00 2.20 1.08 0.55 2.20 0.55<br />
2.00 1.12 0.52 0.28 3.31 0.83<br />
3.00 0.60 0.51 0.15 3.91 0.98<br />
4.00 0.09 --- 0.02 4.00 1.00<br />
Eigenvectors (loadings):<br />
Variable PC 1 PC 2 PC 3 PC 4<br />
Current liquidity ratio =<br />
Total current assets /<br />
Total current liabilities<br />
0.64 0.00 -0.27 -0.72<br />
Quick ratio =<br />
(Cash and short term<br />
investments+ Total receivable, net) /<br />
Total current liabilities 0.64 0.00 -0.33 0.70<br />
Net treasury ratio =<br />
Treasury, net / Total Assets 0.29 0.71 0.63 0.03<br />
Dividends per share 0.30 -0.70 0.65 0.03<br />
Included observations: 59; balanced sample (listwise missing value deletion);<br />
computed using: Spearman rank-order correlations; extracting 4 of 4 possible<br />
components<br />
For an evaluation of the first principal component in its hypostasis of overall indicator<br />
of issuers’ financial situations and dividends policies, we run separate testing<br />
regressions with the indicator against close prices as well as against business<br />
turnovers (Table 4 and 5).<br />
Table 4. Market value of shares and financial situation indicator<br />
Explanatory GMM-DIF GMM-SYS<br />
Close prices(t-1) -0.12*** (0.04) -0.20** (0.09)<br />
Financial situation of issuers 39.40*** (4.07) 42.71*** (11.75)<br />
M1 -1.87 [0.06]<br />
M2 1.23[0.22]<br />
Sargan [0.30]<br />
[0.82]<br />
(Df=12)<br />
(Df=14)<br />
Observations (balanced) 35 48<br />
Standard errors (heteroskedasticity corrected) are in round brackets. The null that each<br />
coefficient is equal to zero is tested using the second-step robust standard<br />
errors.***/**/*- statistically significant, respectively at the 1%, 5%, and 10% level.
M1 and M2 are tests for first-order and second-order serial correlation in the firstdifferenced<br />
residuals, asymptotically distributed as N(0,1) under the null hypothesis<br />
of no serial correlation (based on robust two-steps GMM estimators). Sargan is a test<br />
of the over-identifying restrictions, asymptotically distributed as χ2, under the null of<br />
instruments’ validity (two-steps estimators). White period instrument weighting<br />
matrix and White period standard errors & covariance (no degree of freedom<br />
correction) are used for dynamic GMM. Transformation of the data in GMM-System:<br />
Orthogonal deviations method.<br />
Table 5. Business turnover and financial situation indicator<br />
Explanatory GMM-DIF GMM-SYS<br />
Business turnover(t-1) -0.28*** (0.06) 0.13(0.66)<br />
Financial situation of issuers 9.50*** (1.47) 14.16*** (3.88)<br />
M1 -2.16 [0.03]<br />
M2 -0.48[0.63]<br />
Sargan [0.33]<br />
[0.49]<br />
(Df=12)<br />
(Df=10)<br />
Observations (balanced) 35 48<br />
Standard errors (heteroskedasticity corrected) are in round brackets. The null that each<br />
coefficient is equal to zero is tested using the second-step robust standard<br />
errors.***/**/*- statistically significant, respectively at the 1%, 5%, and 10% level.<br />
M1 and M2 are tests for first-order and second-order serial correlation in the firstdifferenced<br />
residuals, asymptotically distributed as N(0,1) under the null hypothesis<br />
of no serial correlation (based on robust two-steps GMM estimators). Sargan is a test<br />
of the over-identifying restrictions, asymptotically distributed as χ2, under the null of<br />
instruments’ validity (two-steps estimators). White period instrument weighting<br />
matrix and White period standard errors & covariance (no degree of freedom<br />
correction) are used for dynamic GMM. Transformation of the data in GMM-System:<br />
Orthogonal deviations method.<br />
The results of such regressions suggest that the financial status of the issuers matters<br />
both for the formation of stocks’ prices as well as for the business dynamic of the<br />
issuers. This outcome remains robust to the change in estimation methodology as well<br />
as to the inclusion as control variables of the lagged values of dependent ones.<br />
However, our empirical model does not incorporate a formal description of the<br />
implied transmission channels and does not examine the possible implications for a<br />
more accurate description of such channels of the dual impact on financial ratios on<br />
prices and turnovers. Thus, a broader analysis should consider these issues and should<br />
extend the set of explanatory variables.<br />
DISCUSSION AND CONCLUSIONS<br />
The objective of the study is to seek for some empirical evidences if or if not there is<br />
an even limited predictive capacity of the issuers’ financial status descriptors on<br />
emerging markets by examining a set of data for some companies which are quoted<br />
on Bucharest Stock Exchange in order to identify if the financial ratios are significant<br />
and positively correlated with the evolution of market values.<br />
~ 157 ~
Of course, there are some clear limits of the proposed analysis. Among them:<br />
• The limited number of issuers / financial ratios considered;<br />
• The heterogeneous structure of the data sample;<br />
• The short data span;<br />
• The possible disturbances induced by the nonlinear interactions among the<br />
explanatory variables etc.<br />
Further research directions should minimally: 1) considering an underlying<br />
mechanism for the potential impact in the changes in financial status and policies<br />
dividends at issuers level for both the market values and business turnovers; 2)<br />
integrating a larger set of explanatory variables especially from the descriptors of<br />
financial equilibrium and performances; 3) providing more conceptual explanations<br />
for the signaling effects of the financial ratios and for their impact on investors’<br />
decisions.<br />
Despite such caveats, it can be argued that even such a limited study can highlight the<br />
existence of some signaling mechanisms through which the informational variables<br />
describing the issuers’ financial status can affect the prices even in a case of an<br />
emergent market with significant informational imperfections such as the Romanian<br />
one.<br />
REFERENCES<br />
Arrelano M., and Bover O., (1995) „Another look at the instrumental variables estimation of<br />
error components models”, Journal of Econometrics, , pp. 68, 29-51.<br />
Baltagi B.H., (2008) „Econometric Analysis of Panel Data”, Chichester:John Wiley & Sons<br />
Ltd, 4th edition,.<br />
Blundell R., Bond S., (2000) „GMM Estimation with persistent panel data: an application to<br />
production functions”, Econometric Reviews, Taylor and Francis Journals, 19(3),<br />
pp. 321-340.<br />
Blundell R., Bond S., (1998) „Initial conditions and moment restrictions in dynamic panel<br />
data models”, Journal of Econometrics, Elsevier, 87(1), pp.115-143.<br />
Blundell R., Bond S., Windmeijer F., (2000) „Estimation in dynamic panel data models:<br />
improving on the performance of the standard GMM estimato”, IFS Working Papers<br />
W00/12, Institute for Fiscal Studies,.<br />
Bond S., (2002) „Dynamic Panel Models: A Guide to Micro Data Methods and Practice”,<br />
Institute for Fiscal Studies, Department of Economics, UCL, CEMMAP (Centre for<br />
Microdata Methods and practice) Working Paper CWPO9/02,. Available online:<br />
http://cemmap.ifs.org.uk/wps/cwp0209.pdf.<br />
Bucharest Stock Exchange (2011) available at: www.bvb.ro „Indices and indicators”,<br />
„Trading and statistics” accesed on 12.03.2011<br />
Campbell J.Y., and R. J. Shiller, (1989) „The Dividend-Price Ratio and Expectations of<br />
Future Dividends and Discount Factors”, Review of Financial Studie, No 1,<br />
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Campbell, J.Y., Shiller R.J., Stock price, (1988) „Earnings and Expected Dividends”, Journal<br />
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Chang Hsu-Ling, Yahn-Shir Chen, Chi-Wei Su, Chang Ya-Wen, (2008) „The Relationship<br />
between Stock Price and EPS: Evidence Based on Taiwan Panel Data”, Economics<br />
Bulletin, 30 (3): 1-12.<br />
Cochrane J.H., (2001) „Asset Pricing”, Princeton University Press,.<br />
Fama E.F., French K.R., (1988) „Dividend Yields and Expected Stock Returns”, Journal of<br />
Financial Economics No. 22, pp. 3–27.<br />
~ 158 ~
Goyal A., Welch I., (2003) „Predicting the Equity Premium with Dividend Ratios”,<br />
Management Science No. 49(5), pp. 639–654.<br />
Guan J., (2010) Measure of Stock Systematic Risk at the Business Cycle Frequency Using<br />
Financial Statement Information, Working Paper.<br />
Lamont O., (1998). „Earnings and Expected Returns”, Journal of Finance 53, 1563–87.<br />
Lettau M., Van Nieuwerburgh S., (2008) „Reconciling the Return Predictability Evidence”,<br />
Review of Financial Studies, No. 21, pp. 1607-1652.<br />
Lewellen J.W., (2004) „Predicting Returns with Financial Ratios”, Journal of Financial<br />
Economics No. 74(2), pp. 209–235.<br />
Paye B.S., Timmermann A., (2006) „Instability of Return Prediction Models”, Forthcoming<br />
Journal of Empirical Finance, No. 13, pp. 274-315.<br />
Riffe S., Thompson R., (1998) „The Relation between Stock Prices and Accounting<br />
Information”, Review of Accounting Studies, No. 4(2), pp. 325-351(27).<br />
Valkanov R., „Long-Horizon Regressions: Theoretical Results and Applications”, Journal of<br />
Financial Economics<br />
Windmeijer, F. (2000). “Moment conditions for fixed effects count data models with<br />
endogenous regressors”. Economics Letters, Elsevier, 68(1): 21-24.<br />
Windmeijer, F. (2005). “A finite sample correction for the variance of linear efficient twostep<br />
GMM estimators”. Journal of Econometrics, Elsevier, 126(1): 25-51.<br />
~ 159 ~
APPENDIX<br />
Principal Component Analysis<br />
Principal components analysis is a variable reduction procedure. Thus it is similar in<br />
many respects to exploratory factor analysis but there are significant conceptual<br />
differences between the two procedures. Perhaps the most important of these<br />
differences deals with the assumption of an underlying causal structure: factor<br />
analysis assumes that the co-variation in the observed variables is due to the presence<br />
of one or more latent variables (factors) that exert causal influence on these observed<br />
variables. In contrast, principal component analysis makes no such special<br />
assumptions about an underlying causal model and allows for analysis of more<br />
various empirical situations. Its central idea is to reduce the dimensionality of a set of<br />
interrelated variables, while retaining as much as possible from the variation which is<br />
present in dataset. The procedure is currently widely applied from climatology to<br />
economics, genetics, psychology or quality control (see for details Jolliffe 2002).<br />
This type of analysis models the variance structure of a set of observed variables by<br />
using linear combinations of the variables. These linear combinations, or components,<br />
may be used in subsequent analysis, and the combination coefficients, or loadings,<br />
may be used in interpreting the components.<br />
The principal components of a set of variables are obtained by computing the<br />
eigenvalue decomposition of the observed variance matrix. The first principal<br />
component is the unit-length linear combination of the original variables with<br />
maximum variance. Subsequent principal components maximize variance among<br />
unit-length linear combinations that are orthogonal to the previous components.<br />
From the singular value decomposition, a ( nxp ) data matrix Y of rank r could be<br />
represented as:<br />
'<br />
Y = UDV ( a.1.<br />
)<br />
U and V are orthonormal matrices of the left and right singular vectors, and D is a<br />
diagonal matrix containing the singular values.<br />
More generally, one could write:<br />
'<br />
Y = AB ( a.2.<br />
)<br />
A is an (nxr), and B is a (pxr) matrix, both of rank r, and<br />
β<br />
2 1−α<br />
A= n UD<br />
−β<br />
B n 2 α<br />
= VD a.3.<br />
( )<br />
Thus 0 ≤ α ≤ 1 is a factor which adjusts the relative weighting of the left<br />
(observations) and right (variables) singular vectors, and the terms involving β are<br />
scaling factors where β ∈ { 0,<br />
α}<br />
.<br />
The basic options in computing the scores A and the corresponding loadings B involve<br />
the choice of (loading) weight parameter α and (observation) scaling parameter β.<br />
In the principal components context, let ∑ be the cross-product moment (dispersion)<br />
matrix of Y, and let perform the eigenvalue decomposition:
'<br />
∑ = LΛL ( a.4.<br />
)<br />
Here L is the pxp matrix of eigenvectors and Λ is the diagonal matrix with<br />
eigenvalues on the diagonal. The eigenvectors, which are given by the columns of L,<br />
are identified up to the choice of sign. It could be observed the facts that since the<br />
' '<br />
eigenvectors are by construction orthogonal, L L = LL = I m .<br />
1<br />
−1<br />
There could be done some settings as U = YLD , V = L,<br />
D = ( nΛ<br />
)2,<br />
so that:<br />
β<br />
2 −α<br />
A= n YLD<br />
β<br />
−<br />
B n 2 α<br />
= LD a.5.<br />
~ 161 ~<br />
( )<br />
A can be interpreted as the weighted principal components scores, and B as the<br />
weighted principal components loadings.<br />
Others detail of this procedure concerns an appropriate choice of the weight parameter<br />
α and the scaling parameter β through which different scores and loadings with<br />
various properties could be constructed.
A HYBRID DEVICE OF SELF ORGANIZING MAPS<br />
(SOM) AND MULTIVARIATE ADAPTIVE REGRESSION<br />
SPLINES (MARS) FOR THE FORECASTING OF FIRMS’<br />
BANKRUPTCY<br />
Javier de ANDRÉS 1 , Fernando SÁNCHEZ-LASHERAS,<br />
Pedro LORCA & Francisco Javier de COS JUEZ<br />
University of Oviedo, Spain<br />
ABSTRACT<br />
This paper proposes a new approach to the forecasting of firms’ bankruptcy. Our proposal is<br />
a hybrid method in which sound companies are divided in clusters according to their<br />
financial similarities and then each cluster is replaced by a director vector which summarizes<br />
all of them. In order to do this, we use Self Organizing Maps (SOM). Once the companies in<br />
clusters have been replaced by director vectors, we estimate a classification model through<br />
Multivariate Adaptive Regression Splines (MARS). For the test of the model we considered a<br />
real setting of Spanish enterprises from the construction sector because of the importance of<br />
this branch of activity in the Spanish economy. It is also remarkable that in our dataset the<br />
proportion of distressed firms is very close to that which is derived from Economic statistics.<br />
With this procedure we intend to overcome the sampling-bias problems that matched-pairs<br />
models often suffer.<br />
KEYWORDS: Bankruptcy, Self Organized Maps (SOM), Multivariate Adaptive Regression<br />
Splines (MARS), Construction firms<br />
INTRODUCTION<br />
During the last years the importance of bankruptcy forecasting models is very high<br />
due to the current financial crisis, which demands an even more careful management<br />
of financial resources. Furthermore, under Basel II Accord recommendations (Bank<br />
for International Settlements, 2006), banks which choose to develop their own<br />
empirical model to quantify required capital for credit risk (Internal Rating-Based<br />
Approach) are required to maintain less capital than those using the Standardized<br />
Approach.<br />
According to Sueyoshi and Goto (2009a), research on bankruptcy-based performance<br />
assessment can be classified into three broad categories. First, those studies centered<br />
on a particular model, which test how such model performs in comparison with<br />
others. Second, research focused on the selection of an appropriate set of variables to<br />
implement a particular model. The third category comprises papers which investigate<br />
the bankruptcy process.<br />
1 Correspondence address: Javier de ANDRÉS, University of Oviedo, Faculty of Economy<br />
and Business, Department of Accounting, Avda.del Cristo s/n, Oviedo 33006, Spain;<br />
email: jdandres@uniovi.es<br />
~ 162 ~
Among these categories, the first is the one which has received most attention by<br />
researchers. The tested models are mainly statistical methodologies (for a review of<br />
the most outstanding studies see Keasey and Watson, 1991; Balcaen and Ooghe,<br />
2006, among others) and Artificial Intelligence techniques (for a review see, e.g., Aziz<br />
and Dar, 2006; Ravi Kumar and Ravi, 2007).<br />
Ravi Kumar and Ravi (2007) discuss the models which have been most frequently<br />
used in studies focused in insolvency prediction via intelligent systems. These models<br />
are Fuzzy Logic (FL), Neural Networks (NN), Genetic Algorithms (GA), Case-Based<br />
Reasoning Systems (CBR), Rough Sets (RS), Support Vector Machines (SVM),<br />
Decision trees (DT), Data Envelopment Analysis (DEA) and Hybrid Systems (HS).<br />
Among these, HS are the most promising. These combine two or more intelligent<br />
techniques in several forms to derive the advantages of all of them. HS have received<br />
considerable attention from researchers as they amplify the advantages of the<br />
intelligent techniques while simultaneously nullifying their disadvantages. Most HS<br />
require a considerable amount of data to reach to accurate estimations. This is not a<br />
problem nowadays, as there exist publicly available databases containing financial<br />
information of listed and unlisted firms.<br />
However, studies using HS for bankruptcy prediction suffer from a drawback which is<br />
that the majority of them estimate the model upon the basis of a sample in which nonfailed<br />
companies are underrepresented. In most cases a matched-pairs design is used.<br />
The selection of non-failed firms is arbitrary, which makes the model to achieve a<br />
high in-sample percentage of correct classifications but it is likely to be inaccurate for<br />
failure prediction in new cases drawn from a real population.<br />
Another strategy is to consider a “real” population as the sample. That is, to consider<br />
all the companies for which we have financial information available. However, as<br />
only a very small percentage of firms enter into financial distress in a normal<br />
economic situation, such samples are very unbalanced. This causes coefficient<br />
instability and leads to poor performance ability of the models.<br />
As an alternative to both strategies we propose a HS model where, upon the basis of a<br />
real population of firms, data are preprocessed to summarize the information of<br />
healthy firms. So, the initial unbalanced sample is transformed into a balanced one<br />
which retains the main features of the healthy firms. Self Organized Maps (SOM) is<br />
used in this stage. Then a classification device is developed upon the transformed<br />
sample, for which we use the Multivariate Adaptive Regression Splines (MARS)<br />
approach. The results are compared with benchmarks which are popular in bankruptcy<br />
prediction literature. As an important application of the combined approach, this paper<br />
applies it to the solvency assessment of Spanish construction firms.<br />
The remainder of the paper is structured as follows. Section 1 revises prior studies on<br />
bankruptcy prediction using HS. Section 2 is devoted to build the database. Section 3<br />
describes the algorithm and the analytical procedures we used. Section 4 comments on<br />
the main results, including the benchmark techniques applied. Finally, section 5 is<br />
devoted to the summary and main conclusions, including also some further research<br />
avenues.<br />
~ 163 ~
1. PRIOR BANKRUPTCY RESEARCH USING HYBRID SYSTEMS<br />
Basically, there are four types of HS which have been applied to financial distress<br />
prediction:<br />
• Hybrid Algorithms (HA), where two or more intelligent algorithms are tightly<br />
integrated to form a new classification device (i.e., GA-trained NN, neurofuzzy<br />
systems).<br />
• Ensemble Classifiers (EC), which consist of multiple single classifiers whose<br />
decision is combined to form that of the combined system, usually by applying<br />
a voting scheme.<br />
• Feature Selectors (FS). In these systems, an algorithm is used for the selection<br />
of the predictors of failure among a list of feasible variables and another model<br />
is used to predict the bankruptcy status using the selected indicators.<br />
• Clustering and Classificatory devices (CC). These HSs preprocess the financial<br />
information on the failed and non-failed firms and identify groups based on<br />
similarities. The grouping information is used in the subsequent estimation of a<br />
classification model.<br />
Tables 1, 2, 3 and 4 contain a summary of a selection of the most outstanding studies<br />
on financial failure prediction using each type of HSs.<br />
Table 1. Studies on bankruptcy prediction using the HA approach<br />
Authors Main tested method Sample composition Main results<br />
Tseng and Lin<br />
(2005)<br />
Wang et al.<br />
(2005)<br />
Ahn and Kim<br />
(2009)<br />
Chuang and Lin<br />
(2009)<br />
Li and Sun<br />
(2009)<br />
Fuzzy sets integrated into a<br />
logit model.<br />
Hybrid algorithm of fuzzy<br />
sets and SVM.<br />
Instance selection for CBR<br />
using GA.<br />
Hybrid model of MARS, NN<br />
and CBR.<br />
Hybrid model of CBR and<br />
ELECTRE outranking<br />
method.<br />
Yeh et al. (2010) Hybrid model of DEA, RS<br />
and SVM.<br />
904 companies, 353 of<br />
them either failed or<br />
acquired.<br />
Dataset 1: 30 failed and 30<br />
nonfailed firms.<br />
Dataset 2: 653 data, with<br />
357 cases granted and 296<br />
cases refused.<br />
Dataset 3: 1225 credit<br />
applicants, of which 323<br />
are observed bad creditors.<br />
1335 solvent companies<br />
and 1335 failed.<br />
1000 credit applications,<br />
300 of them bad.<br />
81 healthy companies and<br />
81 companies in distress.<br />
76 healthy firms and 38<br />
distressed.<br />
~ 164 ~<br />
The proposed model provides<br />
more information than<br />
conventional models.<br />
The results are not conclusive<br />
as they depend on the<br />
characteristics of the datasets.<br />
the prediction accuracy of the<br />
proposed model is higher than<br />
the best performance of<br />
different NNs.<br />
The hybrid model outperforms<br />
single models and a hybrid<br />
model of MARS and NN.<br />
The hybrid model outperforms<br />
other comparative CBR<br />
models.<br />
The proposed model performs<br />
better than NNs.<br />
Table 2. Studies on bankruptcy prediction using the FS approach<br />
Authors Main tested method Sample composition Main results<br />
Huang et al.<br />
(2007)<br />
Hybridization of F-score,<br />
genetic algorithms (feature<br />
selection) and SVM.<br />
Dataset 1: 307<br />
creditworthy applicants<br />
and 383 not creditworthy.<br />
Dataset 2: 700<br />
creditworthy and 300 notcreditworthy.<br />
With a small feature subset, a<br />
hybrid SVM-GA system<br />
obtains a good classification<br />
performance.
Authors Main tested method Sample composition Main results<br />
Chen et al.<br />
(2009)<br />
MARS for feature selection<br />
and SVM for classification.<br />
Tsai (2009) t-statistic analysis for feature<br />
selection and NNs for<br />
classification.<br />
Chaudhuri and<br />
De (2010)<br />
Fuzzy clustering for feature<br />
selection and SVM for<br />
classification.<br />
Cho et al. (2010) DTs for feature selection and<br />
CBR for classification.<br />
Li et al. (2010) GA and statistical methods<br />
for feature selection, CBR<br />
for classification.<br />
Ravisankar and<br />
Ravi (2010)<br />
t-statistic analysis and Group<br />
Method of Data Handling<br />
(GMDH) (A SOM model)<br />
for feature selection. GMDH<br />
for classification.<br />
1130 good and 870 bad<br />
credit applications.<br />
Five datasets: 3 approx.<br />
balanced, 1 with a 2/1 ratio<br />
of good to bad cases and 1<br />
resembles a real<br />
population.<br />
50 bankrupt firms matched<br />
with 50 non-bankrupt.<br />
500 healthy and 500<br />
bankrupt firms.<br />
135 healthy companies and<br />
135 distressed ones.<br />
Dataset 1: 29 healthy banks<br />
and 37 bankrupt.<br />
Dataset 2: 22 healthy banks<br />
and 18 bankrupt.<br />
Dataset 3: 64 healthy banks<br />
and 65 bankrupt.<br />
Dataset 4: 30 healthy banks<br />
and 30 bankrupt.<br />
~ 165 ~<br />
The hybrid system<br />
outperforms both several<br />
individual approaches (CART,<br />
SVM and MARS) and a<br />
hybrid system which combines<br />
SVM and CART.<br />
The proposed model<br />
outperforms benchmarking<br />
systems.<br />
The rating estimation done by<br />
the model does not depend on<br />
heuristics.<br />
The proposed models<br />
outperform Logit and NNs.<br />
If a true optimal feature subset<br />
is not used CBR could<br />
possibly produce lower<br />
performance.<br />
The proposed models<br />
outperform other neural<br />
architectures.<br />
Table 3. Studies on bankruptcy prediction using the EC approach<br />
Authors Main tested method Sample composition Main results<br />
Alfaro et al. Adaptive boosting (adaboost) 590 failed and 590 non- Adaboost outperforms NN.<br />
(2008)<br />
of CT.<br />
failed firms.<br />
Kim and Cho Ensemble of NN using 307 instances of<br />
The model outperforms non-<br />
(2008)<br />
evolutionary computation creditworthy applications evolutionary ensembles of<br />
techniques.<br />
and 383 where it is not. NN.<br />
Tsai and Wu Ensemble of several NN. Dataset 1:307 creditworthy Multiple NN classifiers do not<br />
(2008)<br />
applications and 383 not outperform a single best<br />
creditworthy.<br />
neural network classifier in<br />
Dataset 2: 700 good and<br />
300 bad credits.<br />
Dataset 3: 307 good and<br />
383 bad credits.<br />
many cases.<br />
Yu et al. (2008) Bootstrap aggregating Dataset 1: 357 good credit The proposed model<br />
(bagging) of NN.<br />
cases and 296 refused. consistently outperforms<br />
Dataset 2: 30 failed and 30<br />
non-failed firms.<br />
single models and other EC.<br />
Hung and Chen Stacking of algorithms based 56 bankrupt companies and The ensemble performs better<br />
(2009)<br />
on bankruptcy probabilities. 64 non-bankrupt<br />
than other ensembles which<br />
companies.<br />
use the weighting or voting<br />
strategy.<br />
Karthik Chandra Boosting of multi layer 120 failed and 120 healthy Boosting yields results<br />
et al. (2009). perceptron NN, CART, companies.<br />
superior to those reported in<br />
RandomForests, SVM and<br />
previous studies on the same<br />
logistic regression.<br />
data set<br />
Nanni and Random subspaces, class Same as in Tsai and Wu Random subspaces perform<br />
Lumnini (2009) switching and rotation<br />
forests.<br />
(2008).<br />
better than the other EC.<br />
Yu et al. (2010) Ensemble of SVM devices. 902 good loans and 323 The proposed ensemble<br />
bad cases.<br />
consistently outperforms other<br />
ensemble models and five<br />
single systems.
Table 4. Studies on bankruptcy prediction using the CC approach<br />
Authors Main tested method Sample composition Main results<br />
Alam et al.<br />
(2000)<br />
Foglia et al.<br />
(2001)<br />
Fuzzy clustering and SOM. 8 failed banks and 248<br />
non-failed-banks.<br />
Logit model for the<br />
estimation of bank borrowers<br />
default probabilities and<br />
cluster analysis to assign<br />
borrowers to credit scoring<br />
grades.<br />
Hsieh (2005) Clustering algorithms for<br />
identifying unrepresentative<br />
subsamples and NN using the<br />
remainder of their samples.<br />
Defu et al. (2008) Same as Hsieh (2005) but<br />
using also classification<br />
trees.<br />
Hu and Wang<br />
(2008)<br />
Identification of clusters<br />
prior to the training of a NN.<br />
Abdou (2009) Genetic programming and<br />
SOM.<br />
Boyacioglu et al.<br />
(2009)<br />
De Andrés et al.<br />
(2011)<br />
k-means clustering and<br />
SOM.<br />
Fuzzy clustering and then a<br />
MARS model is estimated on<br />
the clusterized data.<br />
3343 firms divided in<br />
several credit scoring<br />
grades.<br />
Dataset 1: 700<br />
creditworthy applications<br />
and 300 not-creditworthy.<br />
Dataset 2: 368 accepted<br />
credits and 222 that were<br />
denied.<br />
Dataset 1: 307 good and<br />
383 bad credits.<br />
Dataset 2: 700 good and<br />
300 bad credits.<br />
300 piece of data divided<br />
into 3 credit conditions.<br />
851 good loans and 411<br />
bad loans.<br />
21 failed banks and 46<br />
non-failed banks.<br />
59336 healthy and 138<br />
failed firms.<br />
~ 166 ~<br />
The estimated model provides<br />
an ordinal rating of the data set<br />
in terms of failing likelihood<br />
possibility.<br />
The ultimate choice in<br />
defining a bank's internal<br />
grading system relies on<br />
empirical ground.<br />
The model is efficient in<br />
comparison with benchmark<br />
methods.<br />
GA and K-means algorithm<br />
can effectively improve the<br />
classification accuracy of a<br />
credit scoring model.<br />
The model offers a good rate<br />
of correct classifications<br />
although it lacks some<br />
generalization power.<br />
The best model depends on the<br />
choice of misclassification<br />
costs.<br />
Neither methods can<br />
outperform multilayer<br />
perceptron NN.<br />
The proposed model<br />
outperform single<br />
classification devices (NN,<br />
LDA, MARS).<br />
It must be pointed out that if the bankruptcy prediction models are eventually to be<br />
used in a predictive context, the estimation samples of failing and non-failing firms<br />
should be representative of the whole population of firms (Ooghe and Joos, 1990).<br />
Nevertheless, in the great majority of the hybrid prediction models revised in tables 1<br />
to 4, the samples are not representative of the whole population. Most studies<br />
oversample failing companies because of the low frequency rate of failing firms in the<br />
economy. A common strategy is the use of matched pairs samples (on the basis of<br />
size, sector, and/or age). This can lead to biased parameter estimates especially if the<br />
sample is made up of failed firms and very sound companies. In that case the model<br />
will achieve a high percentage of correct classifications but it is likely to be inaccurate<br />
for failure prediction in new cases drawn from a real population.<br />
An alternate sampling strategy is to consider a real population. As Foglia et al. (2001)<br />
point out, this procedure increases the variance of the estimates of coefficients due to<br />
the data imbalance between sound and unsound firms. An additional drawback is that,<br />
having into account that in a normal economy most companies are non-bankrupt, to<br />
classify all the firms as “not-bankrupt” would let the model reach a high percentage of<br />
correct classifications. To avoid this, the algorithm can be designed to consider the<br />
different misclassification costs (the costs of classifying as insolvent a company<br />
which is solvent are much lower than those of the opposite error). Such a model will
pay more attention to accurately classifying the failing companies at the expense of<br />
more misclassifications of non-failing firms.<br />
However, the estimation of the different misclassification costs is not straightforward<br />
as it depends on the financial decision to be taken. Furthermore, such estimation is a<br />
subjective task as it also depends on the risk profile of the agent who makes the<br />
decision.<br />
As an alternative to both approaches, we propose a method which enables the<br />
formation of a sample which is representative of the main features of the population<br />
but retains the balanced design and the stability of the coefficients.<br />
Our proposal is a hybrid method in which sound companies are divided in clusters<br />
according to their financial similarities and then each cluster is replaced by a director<br />
vector which summarizes all of them. The clustering process is made by means of a<br />
SOM procedure. The most relevant reasons for choosing SOM among the different<br />
methods for clustering are the following two: first, this technique was specifically<br />
designed for multidimensional datasets, and is able to take advantage of their<br />
complexity and second, unlike other methods for data-reduction and clustering, this<br />
family of algorithms is characterized by a learning process that is constantly updated<br />
as it takes more information from the input data, improving the output dynamically<br />
over the training stage and therefore producing more reliable results.<br />
Prior to the calculation of clusters, sound companies are divided into two groups:<br />
1. Companies which are actually sound but whose financial features have a certain<br />
degree of similarity with those of failed ones. These are called “borderline”<br />
companies.<br />
2. Companies which are sound and whose financial features are clearly different<br />
from those of bankrupt companies.<br />
The clustering process is carried out separately for each group of firms. Although the<br />
idea of considering a “grey zone” or group of doubtful firms has been previously<br />
introduced by other researchers (see, i.e., Ooghe et al., 1992; Alam, et al., 2000;<br />
Tseng and Lin, 2005), we made the discrimination between sound and doubtful firms<br />
on a multivariate basis by using a non-euclidean distance measure (the Mahalanobis<br />
distance).<br />
Once the companies in clusters have been replaced by director vectors, we estimate a<br />
classification model through MARS. The reason for choosing MARS as the second<br />
part of the hybrid system lies in the fact that this technique is a flexible procedure,<br />
which models relationships that are nearly additive or involve interactions with fewer<br />
variables (Hastie and Tibshirani, 1990). MARS builds flexible models by fitting<br />
piecewise linear regressions; that is, the nonlinearity of a model is approximated<br />
through the use of separate regression slopes in a limited number of intervals of the<br />
variable space. This is made by using a procedure which is inspired by the recursive<br />
partitioning technique governing Classification And Regression Trees (CART)<br />
algorithm (Breiman et al., 1984). Such features make it especially suitable for the<br />
bankruptcy prediction problem, as the variety of indicators that can be computed upon<br />
the financial statements of a firm can be considered as manifestations of a small<br />
number of financial features (i.e. profitability, solvency, etc.). So, a small number of<br />
~ 167 ~
indicators can represent most of the information contained in the annual accounts<br />
(Yli-Olli and Virtanen, 1989). Consequently, some studies (see, i.e., Lee et al., 2006;<br />
Chen et al., 2006) found evidence that MARS performs better than other approaches<br />
when applied to financial classification purposes. As benchmarks for our hybrid<br />
system we estimated a simple MARS model (whithout the SOM-preprocessing stage)<br />
and a multilayer BP-trained NN.<br />
2. THE DATABASE<br />
In the present research we consider failing and nonfailing firms from the construction<br />
sector in Spain. The recent credit crisis and economic downturn have had some<br />
serious implications for the Spanish construction sector. As the economic situation<br />
changed, along with the increase in unemployment and the rise of the interest rates,<br />
the expectations of house prices' evolution that sustained demand and encouraged new<br />
developments disappeared. Consequently, firms in the real estate and construction<br />
sectors are facing difficulties and challenges which affect their future viability.<br />
2.1. Enterprises in the sample<br />
In Spain, bankruptcy is regulated by the Bankruptcy Act 22/2003, of 9 th July. This Act<br />
contemplates a unique proceeding, which is called “bankruptcy” (concurso de<br />
acreedores). This procedure can conclude either with the approval of the settlement of<br />
creditors or with the liquidation of the company. Filing for bankruptcy does not<br />
necessarily means that the firm is insolvent. However, the recovery rate (understood<br />
as cents on the euro recouped by creditors through the regulated procedures) in Spain<br />
is lower than in many developed countries, i.e. Belgium, Denmark, Finland, Iceland,<br />
Ireland, Norway, Netherlands, Sweden, United Kingdom, Canada, United States,<br />
Hong Kong, Japan, Korea, Singapore, Taiwan, New Zealand, or Australia (IFC,<br />
2010). So, in practice bankruptcy procedure can be understood as insolvency.<br />
Many papers on bankruptcy prediction have focused on the manufacturing sector (i.e.<br />
Altman, 1968; Begley et al., 1996; Zhang, Hu, Patuwo, and Indro, 1999; Becchetti<br />
and Sierra, 2003). Nevertheless, there are several papers examining the bankruptcy in<br />
sectors other than manufacturing. For example, telecommunications industry<br />
(Foreman, 2003); restaurant industry (Gu, 2002; Kim and Gu, 2006; Young and Gu,<br />
2010); air carriers (Davalos et al., 1999); nursing facility industry (Knox et al., 2009);<br />
oil companies (Sena and Williams, 1998); retail sector (Bhargava et al., 1998);<br />
construction industry (Sueyoshi and Goto, 2009b).<br />
Therefore, a database with Spanish construction firms was drawn up. As bankrupt<br />
companies we considered those whose judicial declaration took place in 2008. In<br />
accordance with Spanish legislation, limited liability companies are required to<br />
deposit their annual accounts in the Registro Mercantil. This information is gathered<br />
and provided by Bureau van Dijk and Informa for Spanish firms in the SABI<br />
database, one of Europe´s leading publishers of electronic business information.<br />
Bureau Van Dijk is also the provider of the Wharton Research Data Service. We<br />
deleted from the sample companies that did not provide full information about all the<br />
variables from the year prior to bankruptcy. To avoid the distortions caused by defects<br />
in the preparation of financial information of small enterprises, whose annual<br />
accounts are generally unaudited, we also deleted from the database those firms<br />
~ 168 ~
whose total assets were below 100K €. Once these filters were applied, we obtained a<br />
final data set that was made up of 63.107 firms. Of these, a total of 256 companies<br />
went bankrupt in 2008.<br />
Although there has been a significant reduction in the number of construction firms,<br />
only a limited number of Spanish construction companies fell into insolvency during<br />
2008 (0.40%).<br />
2.2. The financial ratios for predicting bankruptcy<br />
In this paper we used the five variables proposed by E.I. Altman in his seminal paper<br />
on the usefulness of linear discriminant analysis (Altman, 1968). The reasons for this<br />
choice were the following: i) they are variables that are readily available for any<br />
company. It must be borne in mind that increasing the number of variables has the<br />
undesirable effect of reducing the number of companies in the dataset, since not all<br />
companies provide equal levels of information; ii) several papers used this same set of<br />
variables to test the effectiveness of statistical techniques and/or other models for<br />
bankruptcy prediction (i.e., Odom and Sharda, 1993, for neural networks or Lizarraga<br />
Dallo, 1998 for the logit model); iii) it should be noted that some authors (i.e., Begley<br />
et al., 1996; Lizárraga Dallo, 1997, and Grice and Ingram, 2001) have studied the<br />
validity of the Altman function when applied in other geographical settings and time<br />
spans. They concluded that with a proper reassessment of the coefficients, the model<br />
proposed by Altman in 1968 remains as a valid approximation for the issue of<br />
predicting insolvency.<br />
Therefore, the five variables used in this paper are the following:<br />
X1 = working capital/total assets<br />
X2 = retained earnings/total assets<br />
X3 = earnings before interest and taxes (EBIT)/total assets<br />
X4 = market value of equity/book value of total debt<br />
X5 = sales/total assets<br />
Regarding the fourth of the variables, it should be noted that its calculation is difficult<br />
in environments where only a small percentage of companies are quoted. Therefore,<br />
in subsequent sectoral applications of this model to predict insolvency, the author<br />
replaced, in the numerator of this variable, the market value of equity by the book<br />
value of equity (Altman, 1993). In this research we considered such a definition.<br />
Tables 5 and 6 show some descriptive statistics for the variables.<br />
Table 5. Descriptive statistics (bankruptcy companies).<br />
Variable Q1 Median Q3 Mean StdDev Asymmet. Kurtosis<br />
X 1 -0.138 0.006 0.157 -0.024 0.450 -1.692 7.848<br />
X 2 -0.123 0.015 0.069 -0.122 0.412 -2.838 10.725<br />
X 3 -0.170 0.013 0.052 -0.109 0.310 -2.277 5.742<br />
X 4 -0.092 0.031 0.103 0.008 0.304 4.028 41.531<br />
X 5 0.786 1.407 2.229 1.602 1.101 0.905 0.682<br />
~ 169 ~
Table 6. Descriptive statistics (healthy companies)<br />
Variable Q1 Median Q3 Mean StdDev Asymmet. Kurtosis<br />
X 1 -0.016 0.136 0.367 0.160 0.352 -2.560 69.241<br />
X 2 0.025 0.126 0.310 0.163 0.321 -8.391 456.771<br />
X 3 0.019 0.051 0.104 0.060 0.173 -5.728 234.588<br />
X 4 0.062 0.217 0.607 1.237 51.701 239.962 59307.861<br />
X 5 0.802 1.400 2.130 1.596 1.212 3.077 48.180<br />
From a first examination of the information contained in Tables 5 and 6 it is clear that<br />
the statistical distribution of the considered variables is asymmetric and extremely<br />
leptokurtic. This corroborates previous results on the statistical distribution of the<br />
financial indicators (Lau et al., 1995; Martikainen et al., 1995, among others) and<br />
advises against the use of parametrical models.<br />
3. ALGORITHM AND ANALYTICAL PROCEDURE<br />
3.1. The proposed hybrid model<br />
The model proposed in the present research combines the use of MARS models with a<br />
clustering technique which is SOM mapping in order to obtain a MARS model which<br />
uses as training information only those companies considered as representative of<br />
each cluster. A more detailed explanation of the steps of the algorithm is presented<br />
below.<br />
Step 1: Study of the similarities of the bankrupt companies by means of Mahalanobis’<br />
distances. The Mahalanobis distance of all the bankrupt companies was calculated.<br />
Step 2:Those bankrupted companies that were more dissimilar to the rest of the<br />
sample were signalled as outliers and removed from the data set to be employed for<br />
step 3 although they were taken into account for the training and validation of the<br />
model. The determination of the bankrupted companies considered as outliers was<br />
done by means of the robust estimation of the parameters in the Mahalanobis distance<br />
(Rousseeuw and Van Zomeren, 1990) and the comparison with a critical value of the<br />
Chi-square distribution (in our case the 95% quantile).<br />
Step 3: The Mahalanobis distance of each one of the non-bankrupt companies versus<br />
the set of all the bankrupted companies not considered as outliers was calculated.<br />
Step 4: A new category of companies was created, which was called “borderline”.<br />
The companies that were not considered as outliers when compared with the sample<br />
of bankrupt companies are supposed to be more likely to go bankrupt than the rest of<br />
non-bankrupted companies. Therefore they were included in this new category.<br />
Step 5: Companies belonging to non-bankrupted and borderline populations were<br />
classified in clusters using the self-organizing maps algorithm (Kohonen, 1995).<br />
Several clusters of different dimensions were defined and trained with the nonbankrupted<br />
and borderline sets. This step is performed in order to obtain a more<br />
balanced set of data for the training of the models in the next steps.<br />
~ 170 ~
Step 6: An algorithm based on multivariate adaptive regression splines (MARS)<br />
(Friedman, 1991) was then used to implement a different model for each set of<br />
clusters. These models are estimated in order to determine the number of clusters that<br />
best represents the initial set of data. Every MARS model was then applied to the<br />
initial set of bankrupt and non-bankrupt companies and the performance of each one<br />
was evaluated by means of their specificity and sensibility (more details on this point<br />
are provided below).<br />
Step 7: The last step of the algorithm consisted in the training and validation of a<br />
MARS model using the number of clusters with the best performance in step 6.<br />
3.2. The Mahalanobis distance<br />
The Mahalanobis distance is a non-euclidean distance measure (Mahalanobis, 1936)<br />
based on correlations between variables by means of which different patterns can be<br />
identified and analyzed. It is a useful way of determining the similarity of an unknown<br />
sample set to a known one. It differs from Euclidean distance in that it takes into<br />
account the correlations in the data set and is scale-invariant, i.e. not dependent on the<br />
scale of measurements.<br />
Given the vectors that represents the set of variables of two companies<br />
x ∈ℜ<br />
n<br />
x2 ∈ℜ<br />
, their Mahalanobis distance can be calculated as follows:<br />
T<br />
d ( x1,<br />
x2)<br />
= ( x1<br />
− x2)<br />
⋅ A ⋅ ( x1<br />
− x2)<br />
A<br />
~ 171 ~<br />
n<br />
1 and<br />
nxn<br />
Where A∈ ℜ is positively semi-definite and represents the inverse of the<br />
covariance matrix of class<br />
{I}<br />
. The Mahalanobis distance is therefore a weighted<br />
Euclidean distance where the weighting is determined by the range of variability of<br />
the sample point; expressed by the covariance matrix (Avishekand Maiti, 2010).<br />
T<br />
Using the eigenvalue decomposition, A can be decomposed into A = W ⋅W<br />
. Thus, it<br />
is also feasible to learn the matrix W . Then, we have<br />
d<br />
A<br />
T<br />
T<br />
( x1,<br />
x2)<br />
= ( x1<br />
− x2)<br />
⋅ ( W ⋅W<br />
) ⋅ ( x1<br />
− x2)<br />
3.3. Self-organized Maps neural networks<br />
The name Self-Organizing Map (SOM) represents a class of neural-network<br />
algorithms in the unsupervised-learning category. The SOM is an algorithm used to<br />
visualize and interpret large high-dimensional data sets.<br />
The SOM map (Jeong et al., 2010) consists of a regular grid of processing units,<br />
"neurons". A model of some multidimensional observation, eventually a vector<br />
consisting of features, is associated with each unit. The map attempts to represent all<br />
the available observations with optimal accuracy using a restricted set of models. At<br />
the same time the models become ordered on the grid so that similar models are close<br />
to each other and dissimilar models far from each other.<br />
Let N n<br />
be the dimension of the n sample vectors<br />
X ( t)<br />
∈ℜ<br />
,<br />
t = 1,<br />
2,..<br />
n<br />
, where each<br />
sample vector is identified by a label. The two-dimensional output layer contains a<br />
(1)<br />
(2)
k = 1,..., x<br />
rectangular mesh of<br />
dim × ydim<br />
nodes, each serving as codebook vector k W of<br />
dimension N . The training of the weight (codebook) vectors of the map’s nodes is<br />
realized by the following algorithm (Kohonen, 1995):<br />
For a given number of iterations do:<br />
1. Pick up randomly one sample vector X (t)<br />
2. Find the nearest weight vector c W : X −Wc = min j X −W<br />
j<br />
3. Update the weights Wi according to the rule:<br />
[ X ( t)<br />
−W<br />
( ) ]<br />
Wi i ci<br />
i<br />
( t + 1)<br />
= W ( t)<br />
+ h ( t)<br />
t<br />
(3)<br />
h (t)<br />
Where ci is the neighbour function that is usually of the gaussian type:<br />
2<br />
hci( t)<br />
= α( t)<br />
exp( − Wc<br />
−Wi<br />
/ 2σ<br />
( t))<br />
or of a local “bubble” type (Kohonen, 1995).<br />
h (t)<br />
Weights of neurons laying in the neighbourhood ci of the winning neuron are<br />
moved closer to<br />
X (t)<br />
. The learning rate α ( t)<br />
∈[<br />
0,<br />
1]<br />
decreases monotonically with<br />
time, σ (t)<br />
determining that the radius of the neighbourhood also decreases<br />
monotonically. After many iterations and a slow reduction of α (t)<br />
and σ (t)<br />
, the<br />
neighbourhood covers only a single node and the map is formed: neurons with<br />
weights that are close in the parameter space W are also close on the mesh and can be<br />
labelled with names (classes) of input clusters. A graphical interpretation of the<br />
Mahalanobis distance can be found in the research of Maesschalck et al. (2000).<br />
3.4. Multivariate adaptive regression splines (MARS) model<br />
As stated earlier, MARS is a multivariate nonparametric regression technique<br />
developed by Friedman (1991). Its main purpose is to predict the values of a<br />
continuous dependent variable,<br />
y ( n × 1)<br />
r<br />
, from a set of independent explanatory<br />
v<br />
variables,<br />
X ( n×<br />
p)<br />
. The MARS model can be represented as:<br />
r<br />
y =<br />
f<br />
r<br />
r ( X ) + e<br />
where er is an error vector of dimension<br />
( ) 1 × n<br />
MARS can be considered as a generalisation of classification and regression trees<br />
(CART) (Hastie et al., 2003), and is able to overcome some of its limitations. MARS<br />
does not require any a priori assumptions about the underlying functional relationship<br />
between dependent and independent variables. Instead, this relation is covered from a<br />
set of coefficients and piecewise polynomials of degree q (basis functions) that are<br />
entirely driven from the regression data ( ) y<br />
r r<br />
X ,<br />
. The MARS regression model is<br />
constructed by fitting basis functions to distinct intervals of the independent variables.<br />
Generally, piecewise polynomials, also called splines, have pieces smoothly<br />
connected together. In MARS terminology, the joining points of the polynomials are<br />
.<br />
~ 172 ~<br />
(4)
called knots, nodes or breakdown points. These will be denoted by the small letter t.<br />
For a spline of degree q each segment is a polynomial function. MARS uses two-sided<br />
truncated power functions as spline basis functions. These are described by the<br />
following equations (Sekulic and Kowalski, 1992):<br />
[ ( x − t)<br />
]<br />
q<br />
− +<br />
[ ( x − t)<br />
]<br />
q<br />
+ +<br />
( ) 0 ≥<br />
( t − x)<br />
q ⎧ if x < t<br />
= ⎨<br />
⎩ 0 otherwise<br />
( t − x)<br />
q ⎧ if x ≥ t<br />
= ⎨<br />
⎩ 0 otherwise<br />
where q<br />
is the power to which the splines are raised and which determines the<br />
degree of smoothness of the resultant function estimate.<br />
The MARS model of a dependent variable yr<br />
with M basis functions (terms) can be<br />
written as follows (Friedman and Roosen, 1995):<br />
r<br />
yˆ<br />
= fˆ<br />
M<br />
r<br />
M<br />
∑<br />
m=<br />
1<br />
( x)<br />
= c + c B ( x)<br />
0<br />
m<br />
m<br />
r<br />
is the dependent variable predicted by the MARS model, 0 c is a constant,<br />
where yˆr<br />
r<br />
Bm ( x)<br />
is the m-th basis function, which may be a single spline basis function,<br />
and m c is the coefficient of the m-th basis function.<br />
Both the variables to be introduced into the model and the knot positions for each<br />
individual variable have to be optimized. For a data set X r<br />
containing nobjects and<br />
p<br />
explanatory variables, there are<br />
N = n × p<br />
pairs of spline basis functions, given by<br />
equations (5) and (6), with knot locations ij x (<br />
i = 1 , 2,...,<br />
n;<br />
j = 1,<br />
2,...,<br />
p<br />
).<br />
A two-step procedure is followed to construct the final model. First, in order to select<br />
the consecutive pairs of basis functions of the model, a two-at-a-time forward<br />
stepwise procedure is implemented (Friedman and Roosen, 1995). This forward<br />
stepwise selection process leads to a very complex and overfitted model. Such a<br />
model, although adequately fitting the estimation data, has poor predictive abilities for<br />
new objects. To improve the prediction, the redundant basis functions are removed<br />
one at a time using a backward stepwise procedure. To determine which basis<br />
functions should be included in the model, MARS utilizes the generalized crossvalidation<br />
(GVC) criterion (Sekulic and Kowalski, 1992). GVC is the mean squared<br />
residual error divided by a penalty which is dependent on model complexity. Then,<br />
GVC is defined in the following way:<br />
GVC<br />
( M )<br />
1<br />
n<br />
=<br />
n<br />
∑<br />
i=<br />
1<br />
( ˆ r<br />
y − f ( x ) )<br />
i<br />
M<br />
( ( ) ) 2<br />
1−<br />
C M / n<br />
i<br />
2<br />
~ 173 ~<br />
(5)<br />
(6)<br />
(7)<br />
(8)
( ) M<br />
where C<br />
is a complexity penalty that increases with the number of basis functions<br />
in the model and which is defined as:<br />
( M ) = ( M + 1)<br />
d M<br />
C +<br />
where M is the number of basis functions in equation 7, and the parameter d is a<br />
penalty for each basis function included into the model. d can be also regarded as a<br />
smoothing parameter. In the present research, d equals 2. This value can be chosen by<br />
model user but it must be remarked that a smaller d generates a larger model with<br />
more basis functions; a larger d creates a smaller model with less basis functions<br />
(Kriner, 2007). Further details about the selection of the d parameter can be seen in<br />
Friedman (1991).<br />
The maximum interaction level of the spline basis functions is restricted to 10 as the<br />
application of the MARS model to the studied data set confirmed that the maximum<br />
*<br />
interaction level (optimal model size M ) was 2.<br />
The main steps of the MARS algorithm as applied in this research can be summarized<br />
as follows (Sekulic and Kowalski, 1992):<br />
1. Select the maximum allowed complexity for the model and define the d<br />
parameter.<br />
2. Forward stepwise selection:<br />
3. Start with the simplest model, i.e. with the constant coefficient only.<br />
4. Explore the space of the basis functions for each explanatory variable.<br />
5. Determine the number of basis functions ( M ) that minimizes the prediction<br />
error and include them into the model.<br />
6. Go to step 2 until a model with a predetermined complexity is derived.<br />
7. Backward stepwise selection:<br />
8. Search the entire set of basis functions (excluding the constant) and delete<br />
from the model the one that contributes least to the overall goodness of fit<br />
using the GCV criterion.<br />
9. Repeat 5 until GCV reaches its maximum.<br />
The predetermined complexity of MARS model in step 3 should be considerably<br />
∗<br />
∗<br />
larger than the optimal (minimal GCV) model size M , so choosing 2 M as the<br />
minimum predetermined complexity for the model is enough in general (Friedman<br />
and Roosen, 1995).<br />
The predictive ability of the MARS model can be evaluated in terms of the root mean<br />
squared error of cross-validation (RMSECV) and the squared leave-one-out<br />
2<br />
correlation coefficient (<br />
q<br />
). To compute RMSECV, one object is left out from the<br />
data set and the model is constructed for the remaining n −1<br />
objects. Then the model<br />
is used to predict the value for the object which is left out. When all objects have been<br />
left out once, RMSECV is given by the following expression (Friedman and Roosen,<br />
1995):<br />
~ 174 ~<br />
(9)
RMSECV =<br />
n<br />
∑<br />
i=<br />
1<br />
( y − yˆ<br />
)<br />
i<br />
n<br />
2<br />
−i<br />
where i y is the value of the dependent variable of the i-th object and<br />
~ 175 ~<br />
(10)<br />
yˆ −i<br />
is the<br />
predicted value of the dependent variable of the i-th object with the model built<br />
without the i-th object.<br />
The value of<br />
q<br />
1<br />
n<br />
∑<br />
2 i=<br />
1 = − n<br />
∑<br />
i=<br />
1<br />
2<br />
q<br />
is given as:<br />
( y − yˆ<br />
)<br />
i<br />
( y − y)<br />
i<br />
2<br />
−i<br />
2<br />
where y is the mean value of the dependent variable for all n objects.<br />
Finally, we must comment on the procedure used to assess the performance of the<br />
model. The first measure is accuracy, which is the global percentage of correct<br />
classifications. We also computed the sensitivity, which is the percentage of bankrupt<br />
companies which were correctly classified. The last measure is specificity, which is<br />
the proportion of healthy companies correctly identified.<br />
4. RESULTS<br />
In this section we detail the results of the algorithm, as well as those of the benchmark<br />
techniques.<br />
4.1. The algorithm<br />
First, table 7 details the number of clusters for each model. All companies belonging<br />
to non-bankrupt and borderline populations were classified in clusters using SOM.<br />
The clusters were obtained as the output of step 5 of the algorithm. As can be<br />
observed, the minimum number of clusters used for the models is 144. This means<br />
that the original SOM was of ( 12 × 12)<br />
neurons. Please note that each cluster is<br />
represented by a director vector. A director vector (Perner, 2008) can be described as<br />
the expected value for each one of the independent variables for all the companies that<br />
belong to a certain cluster. Models with less neurons were tested but not included in<br />
the present research due to their lower performance. As it was already mentioned<br />
before, this step was performed in order to obtain a more balanced set of data for the<br />
training of the models in the following steps in which each cluster was represented by<br />
a director vector that aims to summarize the information of all the individuals<br />
contained in each subset. Table 7 shows the number of clusters that were used and in<br />
which model they were employed. Please note that all the models were trained using<br />
the 204 bankrupted companies.<br />
(11)
Model name<br />
Table 7. Number of clusters used for each model<br />
Number of director vectors (clusters)<br />
Non-bankrupt companies Borderline companies<br />
M1 144 144<br />
M2 169 169<br />
M3 196 196<br />
M4 225 225<br />
M5 256 256<br />
M6 289 289<br />
M7 324 324<br />
M8 361 361<br />
M9 400 400<br />
An algorithm based on MARS models (step 6) was afterwards used in order to<br />
implement a different model for each set of clusters. The intention of these models is<br />
to determine the number of clusters that best represents the initial set of data. In order<br />
to reach this aim, all the models were trained using a set which comprises (a) all the<br />
bankrupted companies, (b) the director vectors corresponding to non-bankrupt nonborderline<br />
companies and (c) the director vectors corresponding to borderline<br />
companies. The validation was made by calculating the confusion matrix using the<br />
information of the original database. Table 8 shows the average percentage of<br />
correctly classified companies in the five runs of each model. The last column of the<br />
mentioned table represents the total percentage of companies of the database that were<br />
correctly classified by the model. This is the most important parameter as it gives us<br />
an outlook of the global performance of the model. It is noticeable that although no<br />
maximum degree value was imposed to the MARS models all the models from M1 to<br />
M9 were of degree 3.<br />
Table 8. Average percentage of companies that are correctly classified in their<br />
corresponding category<br />
Model name<br />
Bankrupt<br />
% of companies correctly classified<br />
Non-bankrupt Borderline Non-bankrupt + Borderline Total<br />
M1 88.10 57.50 89.70 82.51 79.16<br />
M2 88.30 58.30 90.70 83.46 79.94<br />
M3 88.90 59.80 91.20 84.19 81.18<br />
M4 88.90 60.30 91.30 84.38 81.96<br />
M5 88.70 60.40 91.60 84.63 84.29<br />
M6 88.50 60.60 92.30 85.22 85.22<br />
M7 87.90 62.80 91.50 85.09 85.09<br />
M8 87.30 61.30 87.20 81.42 81.43<br />
M9 85.40 58.80 83.20 77.75 77.78<br />
According to the results of Table 8, the model with the highest performance was M6<br />
although their results were very close to M7 and that was the reason why in the last<br />
step of the algorithm two MARS models were validated and trained using as input<br />
information the numbers of clusters defined by both M6 and M7. Finally, step 7<br />
consisted in the training and validation of M6 and M7. We used as input information<br />
~ 176 ~
the whole database and performed five runs in which 80% of the information was<br />
used for training and the other 20% for validation.<br />
Table 9 contains a confusion matrix in which the mean values obtained in the<br />
validation of the results of the five different M6 MARS models are shown. Please<br />
note that the results of model M7 are not presented as they were slightly worst than<br />
those obtained for M6.<br />
Table 9. Confusion matrix: average values of the validation results of 5 different M6<br />
MARS models trained<br />
Predicted<br />
category<br />
Real category<br />
Non-bankrupt Bankrupt<br />
Non-bankrupt 11,513 6<br />
Bankrupt 1,339 46<br />
In addition, according to the information contained in Table 8 it must be remarked<br />
that the specificity of the model is 89.58%, that is, it is able to detect 89.58% of the<br />
companies that did not go bankrupt. It also detects 88.46% of all those companies that<br />
went bankrupt (sensitivity). Finally, we must also underline that the global accuracy<br />
of the model is 89.58%.<br />
4.2. Benchmark techniques<br />
As indicated above, the benchmark techniques used to compare with the results<br />
obtained by the algorithm proposed in the present paper were two: back propagation<br />
NN and MARS. The model has 5 neurons in the input layer and 7 in the intermediate.<br />
The MARS model obtained was of degree 2 although no maximum degree condition<br />
was imposed.<br />
For the estimation of the accuracy of NN and MARS, we followed a procedure similar<br />
to that proposed to test the accuracy of the proposed algorithm. NN and the MARS<br />
model were applied to five random selected training data bases (80% of the data<br />
chosen at random) and tested over their corresponding validation subsets (the<br />
remaining 20% of the database).<br />
For the case of the NN model, the results obtained in the five runs yielded an average<br />
specificity of 99.95 %, an average sensitivity of 21.00 % and an average global<br />
accuracy of 99.01%. Although the specificity the NN-based device is higher than that<br />
of our proposal, it is inefficient for the detection of bankrupt companies, due to its low<br />
sensitivity. This makes this model useless for decision-aid purposes because the costs<br />
of the error consisting in considering a bankrupt company as non-bankrupt are very<br />
much higher than that of the opposite error.<br />
The results obtained for the MARS model were as follows: average specificity of<br />
99.79 %, average sensitivity of 3.85 % and average global accuracy of 99.78%. These<br />
results are even worse than those of NN, so it can be concluded that the MARS model<br />
is also useless for practical purposes.<br />
~ 177 ~
5. SUMMARY, CONCLUDING REMARKS AND FURTHER RESEARCH<br />
This paper proposes a new approach to the forecasting of firms’ bankruptcy. Our<br />
proposal is a hybrid method in which sound companies are divided in clusters<br />
according to their financial similarities and then each cluster is replaced by a director<br />
vector which summarizes all of them. In order to do this, we use SOM mapping. Once<br />
the companies in clusters have been replaced by director vectors, we estimate a<br />
classification model through MARS.<br />
For the test of the model we considered a real setting of Spanish enterprises from the<br />
construction sector because of the importance of this branch of activity in the Spanish<br />
economy. It is also remarkable that in our dataset the proportion of distressed firms is<br />
very close to that which is derived from Economic statistics. With this procedure we<br />
intend to overcome the sampling-bias problems that matched-pairs models often<br />
suffer.<br />
We also used two benchmark techniques to compare with the results obtained by the<br />
algorithm proposed in the present paper: a back propagation neural network and a<br />
MARS model.<br />
Our results show that the proposed hybrid approach is much more accurate than the<br />
benchmark techniques for the identification of the companies that go bankrupt. As<br />
future research efforts we can mention the application of the procedure proposed in<br />
the present research to other related tasks in the field of financial statements analysis<br />
(i.e. prediction of takeovers, analysis of bond ratings etc.).<br />
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THE RELEVANCE OF COMPANY EVALUATION<br />
METHODS IN CONDITIONS OF ECONOMIC<br />
INSTABILITY. EMPIRICAL STUDY<br />
ON THE COMPANIES QUOTED IN THE BUCHAREST<br />
STOCK EXCHANGE<br />
Marilena MIRONIUC 1 , Mihai CARP & Bogdan ROBU-IOAN<br />
“Alexandru Ioan Cuza” University of Iasi, Romania<br />
ABSTRACT<br />
In the context of the economic-financial instability that characterizes the current business<br />
environment, knowing the value dimension of companies is an essential requirement for a<br />
correct support of strategic decisions. The objectivity of the value obtained depends on the<br />
relevance of the evaluation methods, determined by the ability to failthfully notice the<br />
influence of all the factors that characterize the economic environment. This study aims at<br />
establishing a hierarchy of the three major evaluation approaches (patrimonial, comparative,<br />
and based on the present value of the flows), according the mentioned criterium. Starting<br />
from a sample of 40 companies quoted in the Bucharest Stock Exchange, we have determined<br />
the ability of each method to provide a faithful and credible value, through the indication of<br />
potential risks. This study has allowed the identification of the profile of the insolvency risk<br />
according to the three suggested evaluation methods, obtaining the classification functions of<br />
the companies into risk groups, as well as the probabilities to determine insolvency. The<br />
results were obtained using the factorial analysis of multiple correspondencies, the<br />
discriminant analysis, and the logistic regression analysis, and the data were processed using<br />
the SPSS 19.0 statistic software.<br />
KEYWORDS: evaluation methods, relevance, insolvency risk, factorial analysis,<br />
discriminant analysis, logistic regression analysis<br />
INTRODUCTION<br />
The evolution of the world’s economy, marked by the globalization of the economic<br />
phenomenon, both at a geographical level and in what concerns the free circulation of<br />
capital, has imposed the need to quantify businesses according to their value, as a<br />
significant benchmark that supports the investment decision of the owners of available<br />
financial resources.<br />
The evolution of the company aims to provide a value dimension of the entity rather<br />
than setting a price at which they can sell. If price is an objective measure, resulted<br />
from the confrontation of the demand with the offer, value is identified as a subjective<br />
notion depending on the influence of a large number of factors that mark the destiny<br />
of a company.<br />
1<br />
Correspondence address: Marilena MIRONIUC, “Alexandru Ioan Cuza” University of Iaşi,<br />
Romania; email: marilena@uaic.ro<br />
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The value of an economic entity may differ from its price in response to the pressure<br />
applied by: the objectives followed in the transaction (continuity of activity,<br />
dissolution, strategy modifications), the existence of a company brand, the raise of the<br />
market quota, the consolidation of the business with new activity segments, the value<br />
of the human capital, social or emotional reasons, etc. All these factors reflect a<br />
shadow of relativity upon the notion of value, which they eventually reduce to an<br />
estimation unconditionally subject to change. The volatitity of the concept can be<br />
related both to the time perspective, as the value amount established is practicalyy<br />
valid only at the moment of the evaluation, and to the spatial, geographical, political<br />
instability, social, or natural factors perspective, the last one having a significant<br />
weight in the quantification process.<br />
This gives birth to a series of questions that have not yet found an answer: Is the value<br />
of the company composed of the value of its net assets (the sum of the composing<br />
parts), or is it determind by the company’s ability to generate future benefits for the<br />
interest owners? What is the value of a company that, although it has a balanced<br />
asset structure and has generated substantial benefits for the shareholders in the past,<br />
activates on a collapsed market? Does it really have no monetary equivalent? Here<br />
we refer to the famous “one-dollar takeovers”. If the answers to these questions are<br />
searched for in a period of economic-financial crisis, the difficulty of finding them<br />
raises with the multiplication of the factors that exert pressures on the economic<br />
entities (lack of outlets, lack of financial resources, social pressures, legal<br />
inconsistencies, etc.).<br />
The need to establish the value of companies reveals its importance in various<br />
moments of their development, marking thus their destinies. The provision of a value<br />
level is required in cases of property transfers to other shareholders, since it is known<br />
that the interests of the parties involved in the trasaction are divergent. The quotation<br />
of the companies on the capital market is another moment that requires a value<br />
support of the company’s dimension, since the investors are interested in a correctly<br />
estimated share price, which would give them the possibility to obtain future earnings.<br />
Within restructuring operations, establishing the company’s value is the basic element<br />
that conditions the success of the performed action, a process aimed to capitalize on<br />
the competitive advantages that can be offered by a different form of organization. As<br />
Thauvron (2007) notices, evaluation is a company management instrument that<br />
managers use to guide the operations performed in order to meet the fundamental<br />
objective of maximizing the entity’s value. Under these circumstances, the doctrine of<br />
the economic-financial analysis is called upon to offer solutions for supporting the<br />
investment process to the purpose of performing it in an objective manner, providing<br />
useful benchmarks for the health of the economic environment in general.<br />
The diversity of the solutions used to establish the value of the companies is included<br />
into major approaches based on: the present value of the cash flows, the evaluation of<br />
the equity, or comparisons between market values. Each of these approaches is<br />
supported by significant data generated by the presence of the company in the<br />
economic environment and attempts to provide pertinent value solutions.<br />
These evaluation methods are mainly supported by the influence of quantitative<br />
factors. Only the extent to which these determiners also include the effects of<br />
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qualitative data, present in the competition area, provides a faithful image of the value<br />
of the companies. The usefullnss of these estimations lies therefore in their ability to<br />
provide a value determined by the influence of most factors that affect the economic<br />
environment.<br />
In periods marked by economic instability, the pecuniary measurement approach of<br />
the company becomes a difficult process, receiving special importance. In this sense,<br />
in the present study, we aim at identifying, through a mainly quantitative analysis, the<br />
extent to which evaluation methods provide appropriate information on the value of<br />
the companies, stressing, for the companies quoted in the Bucharest Stock Exchange,<br />
the relevance of each approach in supporting financial decisions.<br />
1. APPROACHES AND VIEWPOINTS ON THE EVALUATION METHODS<br />
OF THE COMPANY<br />
The evaluation of economic entities is a complex activity that requires the use of<br />
inter-disciplinary information benchmarks such as accounting, finance, management,<br />
law, or taxation, as well as an important connection with the practice, thus coagulating<br />
the three major approaches of the field.<br />
1.1. The method of the discounted cash flow<br />
Based, according to financial theory, on the ability of the entity to generate future<br />
cash flows, this method is considered to have higher information valences than the<br />
other approaches.<br />
The value of the company is equal to the sum of the future cash flows it will generate,<br />
made present at a rate that reflects the cost of the resources employed to achieve them<br />
(Thauvron, 2007). The definitions of the used flows are extremely varied. Usually, the<br />
free cash-flows after tax, the net benefit, the current result, or the gross operational<br />
excess are retained (de La Bruslerie, 2006). Used with precedence, free cash flows are<br />
generated by the operating activity, without quantifying the effect of debts, which are<br />
computed after tax (Fernandez, 2010).<br />
The method of discounted cash flows, also known as DCF, is at the center of the<br />
concerns of estimating the value of the company from the investors’ perspective, from<br />
that of the company’s capital owners (the shareholders), and of bonds owners (Berk,<br />
et al., 2008).<br />
Ceddaha (2010) notices the use of the weighted average cost of capital – WACC to<br />
the purpose of discounting the mentioned flows, a measure that must encompass the<br />
payment requirements of capital providers. It is necessary to make a distinction<br />
between the cost of borrowed resources and the cost of the own capital. Sander et al.<br />
(2007), Ingram et al. (2010) and Fama et al. (2004) stated that, in the case of listed<br />
companies, the cost of equity is calculated, especially, through the CAPM model<br />
(Capital Assets Pricing Model) and other models based on the market equilibrium are<br />
used alternative. Shareholders always wish to be paid a higher quantum than the debt<br />
cost because the creditors are not affected in the same manner by the risk of<br />
bankruptcy of the company. For this reason, WACC is computed as a weighted<br />
average of the risks taken by the two categories of financial resource providers.<br />
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Taken from the analyses performed by Keynes, according to which “the value of a<br />
company corresponds to the present dimension of future income flows generated by<br />
its capital possessions” (Walter, et al., 2008), this method resorts to uncertain inputs<br />
forecast on different time horizons, thus attracting a subjective dimension. The<br />
subjectivity of this method comes from the difficulty of making relevant forecasts,<br />
since the general economic environment is characterized by intense and frequent<br />
modifications. The limits of the method have been extensively studied, trying to<br />
provide solutions for their removal. Thus, Baroni et al. (2006), Atherton et al. (2008)<br />
and Young (2007) note in their work, the difficulty of obtaining reliable sizes on the<br />
discount rate, on the future revenues and expenses, and the size of the final value, as<br />
variables that determine the relevance of the evaluation method. Mallinson et al.<br />
(2000) and French (2006) state that the subjectivity of the method is due to the<br />
influence of the factors such as: the lack of comparable information regarding the<br />
sales and the assets value, the significant dynamics of the market that determines large<br />
variations of the transfer pricing (very difficult to forecast), the dependence method of<br />
comparable size and the number of transactions existing in the market.<br />
1.2. The patrimony evaluation method<br />
This approach can be characterized, according to Walter and Brian (2008), through<br />
the statement that “the company is worth what it owns”. This approach consists in<br />
establishing the value of the company based on the information provided by the<br />
financial statements published by the entity. More specifically, this means the<br />
estimation of the dimension of the assets that remain at the shareholder’s disposal<br />
after its reduction by the total debts of the company.<br />
If the evaluation process is applied on companies whose activity predictably continues<br />
incessantly, as well as a time benchmark, as the financial statements achievement date<br />
approaches, the value of the company is given by the volume of the equity value<br />
(EV). The pertinence of this evaluation is supported by the application of accounting<br />
laws that impose an annual correction of the balance structures with the differences<br />
generated by the economic reality, to the purpose of reflecting a faithful image of the<br />
financial position and performances of the entity. When the activity of quantifying the<br />
company’s value does not coincide with the moment when the annual statements are<br />
drawn, it is necessary to correct the EV by the extent of the influences generated by<br />
the value deviations identified after the re-evaluation and alteration of each balance<br />
post.<br />
De La Bruslerie (2006) notices the difference that should be preserved in connection<br />
with the financial dimension of the evaluated assets, as an operational value estimated<br />
from the perspective of the continuity of the activity antagonistic with the liquidity<br />
value of each separate patrimony element.<br />
Thauvron (2007) considers that value, supported by this method, reflects a static<br />
vision on reality, which does not take into account the future profitability of the<br />
company. Moreover, this method does not include the influence of other factors that<br />
affect value, such as: the current state of the activity field in which the company<br />
operates, human resources, contracts, etc., elements that are not reflected in the<br />
accounting statements (Fernandez, 2010).<br />
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Although financial theory criticizes the patrimonial approaches used in company<br />
evaluations, characterizing them as limiting, they are a practical solution, often used,<br />
and has a low degree of uncertainty.<br />
1.3. The comparative method<br />
According to this approach, value is computed through the relation with the<br />
dimension of certain indicators provided by the companies in the same activity field<br />
as the subject company. This is a simple, practical, fast, and objective method because<br />
it avoids using discount rates whose estimation is always delicate (Thauvron, 2007).<br />
However, for the efficient application of this method, the pertinence of the sample of<br />
comparable economic agents is particularly important.<br />
Also called the multiples method, it is based on computing ratios (multiples) at the<br />
level of the selected companies. This calculus uses measures such as the own capital,<br />
the sales figure, the net result, the free cash flows, the current result, etc. The model<br />
uses the average of the multiplication at the sample level in order to correct the<br />
measure identified for establishing the value of the economic entity.<br />
The development of the evaluation process can be synthesized in the following stages:<br />
defining the sample, selecting and calculating the multiples, and applying the ratios on<br />
the selected indicator.<br />
The diversity of the methods, as well as their various degrees of relevance in<br />
establishing appropriate values for the economic entities, have generatd intense<br />
debates reflected in numerous studies.<br />
As a result, Gollier and Weitzman (2010) wonder over what period financial<br />
predictions can be made, when the discount rate used is a subjective measure. They<br />
answer by stating that “we have to admit the non-existence of a well-supported<br />
principle that allows us to extrapolate a ratio in the past on the future benefits, over a<br />
long period of time”. It is also possible to discuss the extent to which the discount rate<br />
objectively reflects the cost of the invested capitals according to the computing<br />
method. One of the most important equations in monetary theory and practice is that<br />
of the weighted average cost of capital (WACC), from which results the cash flows<br />
discount rate. Miller (2006) notices the relativity of the computing method of the<br />
mentioned rate, presenting an improved version, which, in the author’s opinion,<br />
generates significantly higher results. The funding of investment projects determines,<br />
according to accounting norms, a capitalization of the interests. This process does not<br />
generate, at the same moment, a decrease of the taxes, which affects the relevance of<br />
the result provided by the calculus of the weighted average cost of capital after tax<br />
(Pierru and Babusiaux, 2010).<br />
In the same tendecy to explain and increase the reliability of the field, Booth (2007)<br />
suggests a method for computing the discount rate specific to each evaluation method.<br />
Richardson and Tinaikar (2004) notice the tight connection between accounting and<br />
the company evaluation models, stressing the interrelations between them, both at a<br />
procedural level and at that of the basic objective of providing users with reliable<br />
information. We can say that the evaluation methods are models for the accounting of<br />
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the future and that the efficiency of these techniques derives from the way that<br />
accounting principles are implemented (Penman, 2010).<br />
Beiner et al. (2006) and Klein (2002) state that between the value of the company and<br />
the quality of corporate governance there is a direct and positive connection. They<br />
support their opinion with a study performed on quoted Swiss companies, reflecting at<br />
the end the correlations established between the two phenomena. In the same<br />
direction, we can notice that the connection between the value of the company and the<br />
compensations obtained by managers has a significant impact on their decisions to get<br />
involved in the governance of the entity. Shareholders prefer the manager’s<br />
compensation to be tightly connected with the value of the company, because this<br />
connection provides management with the motivation to create wealth for the owners<br />
(Lee and Chen, 2011).<br />
2. RESEARCH METHODOLOGY<br />
The purpose of this study is to stress the informational usefulness of evaluation<br />
methods, their ability to objectively reflect, in conditions of economic insability, the<br />
value tendencies of the company. Used by managers in the control process through<br />
the value of the economic entities, the techniques for establishing the monetary<br />
equivalent of the business must provide an appropriate financial dimension, able to<br />
support the strategic decisions that have to be taken. In this sense, the dynamic<br />
analysis of these values can provide clues on the potential risks, especially on the<br />
insolvency risk, the relevance of the method having in this case a major importance.<br />
Knowing that the results obtained from the usage of evaluation methods are directly<br />
related and tightly connected to the financial state and performance of the company,<br />
based on a deductive-inductive approach, we aim to create a hierarchy of these<br />
methods (patrimonial – equity value, based on the net present cash flows, based on<br />
market comparisons), starting from the analysis of a sample of companies quoted in<br />
the Bucharest Stock Exchange (BSE). The comparability criterion used to classify<br />
evaluation methods will be the number of cases correctly included into one of the two<br />
categories (solvent and insolvent companies).<br />
This approach, based on a positivist process, implies validating the formulated work<br />
hypotheses, through empiric results obtained after the analysis of the data collected<br />
from the studied sample (Smith, 2003).<br />
2.1. Formulating the work hypotheses<br />
Considering the computing method of the value of a company based on the three<br />
evaluation methods previously mentioned, we aim to test the following formulated<br />
work hypotheses:<br />
Hypothesis 1: It is identified a profile of the insolvency risk based on the association<br />
of the increase/decrease indexes of the values estimated following the application of<br />
the three evaluation methods, in the analyzed sample.<br />
Hypothesis 2: There is a score function obtained on the basis of the increase/decrease<br />
indexes of the value of the studied entities, which classify them into two groups of<br />
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isk (one characterized by the insolvency risk and the other with no insolvency risk) in<br />
order to identify the degree of objectivity of the evaluation methods regarding the<br />
exposal of the entities to the insolvency risk.<br />
Hypothesis 3: There is a model for determining the degree of relevance of evaluation<br />
methods, based on estimating the probability of insolvency risk, which uses the values<br />
of the related increase/decrease indexes.<br />
2.2. Analyzed variables<br />
In order to meet the objectives of the research, in the present study we have<br />
considered the variables synthesized in the following table.<br />
Table 1. Analyzed variables<br />
Symbol Meaning Index computing method<br />
IEV EVvariation index (EVi-EVi-1)/EV1 IMC MC variation index (MCi-MCi-1)/MCi IVFCF VFCF variation index (VFCFi-VFCFi-1)/VFCFi The value of the company obtained using each evaluation method has taken into<br />
consideration the following initial determinations:<br />
EV = At – Dt, where:<br />
- EV = the company’s own capital – equity value (net accounting asset);<br />
- At - total company assets at the end of the fiscal year;<br />
- Dt - total company debts at the end of the fiscal year.<br />
MC = NrIS * VS = NrIS * EPS * PERmedium = Rnet * PERmediu where:<br />
- MC – corrected stock exchange capitalization;<br />
- VS – share value;<br />
- EPS - earnings per share;<br />
- PERmedium – the average price earnings ratio per activity branch;<br />
- NrIS - number of issued shares;<br />
- Rnet – net result of the fiscal year.<br />
VFCF = [FCFi+1/ (1+WACC) 1 ] + [FCFi+2/ (1+WACC) 2 ] +[FCFi+3/ (1+WACC) 3 ]<br />
+[FCFi+4/ (1+WACC) 4 ] + [FCFi+5/ (1+WACC) 5 ], where:<br />
- VFCF – net present value of the free cash flows;<br />
- FCFi – the free cahs flows at the reference moment i;<br />
- WACC – the weighted average cost of capital at the reference moment i,<br />
discount rate.<br />
The current value is obtained by discounting the future annual cash flows or by<br />
multiplying them by a discount factor (Mironiuc, 2009). In order to forecast future<br />
cash flows (i+1,…, i+5), we have applied the CFPV evaluation method, as follows:<br />
1. An average raise index of the turnover (TO) has been computed as the general<br />
average between the raise indexes for each fiscal year, from 2005 until 2009;<br />
2. Based on this raise index, the TO values corresponding to the fiscal years:<br />
2010, …, 2014 have been forecast;<br />
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3. FCF was computed for each fiscal year as the difference between the net cash<br />
(NC) at the end and at the beginning of the analyzed period.<br />
4. NC is expressed as the computed difference between the cash assets and the<br />
cash liabilities.<br />
5. The average weight of the FCF value in the total SF has been established,<br />
computed for the weights specific to each fiscal year, from 2005 until 2009;<br />
6. Based on the average weight of the FCF value in the total TO, FCF was<br />
predicted for the fiscal years 2010,..., 2014, as the product between the TO<br />
predicted for these years (2010,…, 2014) and the average weight obtained;<br />
7. WACC was computed for the fiscal years 2008 and 2009 based on the<br />
relation: WACC = [EV/ (EV+Dt] * ROCE + [Dt/ (EV+Dt] * Rd, and ROCE =<br />
Rnet/EV, Rd = RNOA + (RNOA – ROCE) * EV/Dt, RNOA = Rop/At, where<br />
(Mironiuc, 2006) :<br />
- ROCE - return on common shareholders’ equity;<br />
- Rnet - net result;<br />
- Rop - operational result;<br />
- RNOA - return on net operating assets;<br />
- Rd – interest rate corresponding to the debts.<br />
The category variables used to identify the profile of the insolvency risk were<br />
obtained by discretizing the three indexes (IEV, IMC, IVFCF), using the SPSS 19.0<br />
statistic software (Jaba, 2004). In order to determine the intervals corresponding to the<br />
discretized variables categories, we have taken into account the average (m) and the<br />
square deviation (σ) for each of the three indexes. Therefore, the selected intervals<br />
include index values as follows: (-∞; m-σ/2) for a low index, [m-σ/2; m+σ/2) for a<br />
medium index, and [m-σ/2; +∞) for a high index. The newly resulted variables are<br />
synthesized in Table 2.<br />
Ctg_I EV<br />
Ctg_I MC<br />
Ctg_I FCF<br />
Table 2. Analyzed category variables<br />
Symbol Meaning Interval relation<br />
The category variable corresponding<br />
to the index of the EV value increase<br />
(-∞;-0.665) – low IEV; [-0.665; -0.035) - medium<br />
IEV; [-0.035; +∞) - high IEV The category variable corresponding<br />
to the index of the MC value increase<br />
(-∞; -0.315) – low IMC; [-0.315;1.195) - medium<br />
IMC; [1.195;+∞) - high IMC The category variable corresponding (-∞;-1.3) – low IVFCF; [-1.3;0.94) - medium IVFCF; to the index of the VFCF value [0.94;+∞) - high IVFCF increase<br />
The analyzed category variables will be used to identify the profile of the insolvency<br />
risk, by pointing out the associations between these variables and the state of the<br />
analyzed company (be it insolvent or not).<br />
2.3. Data and sample<br />
The target population studied is composed of the companies quoted in the Bucharest<br />
Stock Exchange (BSE). From this population, we have randomly extracted a sample<br />
of 40 quoted companies (BSE), as follows: 20 insolvent companies whose bankruptcy<br />
procedure started in 2010 and 20 companies whose shares can still be sold and that<br />
have a profitable economic-financial activity. Their list is provided in Table 3.<br />
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Table 3. List of the companies in the extracted sample<br />
BSE Symbols<br />
Insolvency risk No insolvency risk<br />
ADCA COGL IASO PRON ADMET BBGA BRNA CAOR<br />
AVIM CRMC ICER ROMJ ARCO BEZA BUCV CERB<br />
CEBI EEOB INLA SEPE ARCV BIBU BUTU CFED<br />
CEIB GETR MUIL TCCP ARMT BEUC CABZ CFOR<br />
COAR HIRY PANX VILC BAZV BRCR CACU CLEL<br />
(The symbols have been taken from www.bvb.ro)<br />
From the studied sample, of the total insolvent companies, 75% operate in the<br />
industrial field, 5% in commerce, and 20% in services, and in the case of companies<br />
with no insolvency risk, 60% of them operate in industry, 15% in commerce, and 25%<br />
in services. The structure of the sample according to the activity field of the quoted<br />
companies is given in Figure 1.<br />
Figure 1. Structure of the extracted sample according to the activity field<br />
of the companies<br />
The data was collected from the financial statements of the companies quoted in BSE,<br />
for the fiscal years 2004-2009, presented on the Web sites: http://bvb.ro,<br />
http://www.doingbusiness.ro and http://recom.onrc.ro.<br />
2.4. Data analysis methods<br />
In order to meet the objectives of the research and to validate the work hypotheses, a<br />
series of data analysis methods are necessary. The methods used in the study are the<br />
factorial analysis of multiple correspondencies, the discriminant analysis, and the<br />
logistic regression analysis.<br />
The factorial analysis of multiple correspondencies (FAMC) is a multi-varied<br />
analysis method, developed for the first time by Benzécri in 1969, for the study of the<br />
associations between three or more nominal (category) variables, and is a generalized<br />
version of the factorial analysis of correspondencies (Lebart at al., 2006). Therefore,<br />
for a sample of n individuals, we have values recorded for a series of m associated<br />
variables, based on which we can obtain the profile of an individual in a certain group,<br />
after studying the associations between the analyzed variables. This method<br />
synthesizes the initial information by studying the associations between the variables<br />
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stressed through a dispersion diagram built on a system of factorial axes organized<br />
downwards, according to their importance in explaining the total variance of the<br />
cloud.<br />
The discriminant analysis (DA) is a multi-varied classification method, initially<br />
suggested by Fisher in 1936, in order to differentate between individuals belonging to<br />
the same species, according to a series of specific characteristics. The method aims to<br />
classify a population into predefined groups, based on certain score functions (Z),<br />
which express the relations between the independent variables, Xi, and the categories<br />
of classification variables. The relation between the category dependent variable<br />
(dichotomous or multi-chotomous) and the linear combinations of several metric<br />
independent variables is of the form: Z = α0 + α1X1 + α 2X2 + ... + α nXn. In this<br />
relation, Z is the computed score; Xi with (i=1,...,n) are the independent variables; αi<br />
are the coefficients of the model (unkown). Each company can be associated to a<br />
score computed based on the individual values of the Xi variables. According to the<br />
value of the obtained score, a company can be included in one class or another of the<br />
category variable. In DA, the methodological approach implies: obtaining the<br />
discriminant functions (as a linear combination of Xi), identifying the independent<br />
variables that contribute the most to explaining the differences between the groups,<br />
classifying the individuals for predictive purposes by allocating them to a specific<br />
group according to the score obtained, starting from the specified values of the Xi<br />
variables and evaluating the accuracy of the classification (Lebart at al., 2006).<br />
The logistic regression analysis (LRA) is applied in order to determine the probability<br />
of occurrence of the insolvency risk and uses the regression models with dependent<br />
alternative variables, of the form: Y = β0 + βiXi + ε, where Y = 0 in case there is no<br />
insolvency risk and Y = 1 in case the insolvency risk exists, and Xi represents the<br />
independent variables (factors), βi the coefficients of the logistic regression model,<br />
and ε is the error component. Moreover, since Y is a Bernoulli variable (Gujarati,<br />
2004), it associates to the values one and zero the following probabilities of<br />
occurrence: p for Y = 1 and q for Y = 0. LRA starts from the idea that the conditioned<br />
average, M(Yi/Xi) = pi, is based on a logistic distribution: M(Yi/Xi) = pi = 1/[1+e^-<br />
(β0+βiXi)] = 1/(1+e^-zi). After applying the reverse function, there will result that zi =<br />
ln[pi/(1-pi)], and the logistic model will be defined by the relation Li = ln[pi/(1-pi)] =<br />
β0+βiXi+εi (Gujarati, 2004).<br />
The identification of the profile of the insolvency risk (based on the three evaluation<br />
methods), obtaining the coefficients of the disciminant function, as well as those of<br />
the logistic regression model, have been achieved using the SPSS 19.0 statistic<br />
software.<br />
3. RESEARCH RESULTS AND DISCUSSIONS<br />
After applying the FAMC method on the data in the studied sample, we have obtained<br />
the diagram in Figure 2. This diagram presents the associations between The state of<br />
the company and The index classes corresponding to the three evaluation methods:<br />
based on the EV (own capital), on the MC, and on the VFCF. This method was<br />
applied only after the discretization of the expression variables of the company’s<br />
value (corresponding to the three methods), and for three classes have been built for<br />
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each of the three variables: 1 – low index (-∞; m-σ/2); 2- medium index [m-σ/2;<br />
m+σ/2) and 3- high index [m-σ/2; +∞).<br />
Figure 2. The profile of the risk of insolvency according to the three evaluation<br />
methods<br />
According to the diagram in Figure 2, we can see that for the period 2008-2009, the<br />
association between the characteristic indexes of the three evaluation methods<br />
significantly differs in what concerns the state of the company, by representing the<br />
variables categories in the system of two factorial axes, characterized by the<br />
dimensions: Dimension 1 and Dimension 2. The two dimensions are obtained based<br />
on a linear combination of the analyzed variables (frequency of occurrence will be<br />
considered in each variable category). Cumulative, dimensions explain at least 50% of<br />
the degree of association between the analyzed variables. Therefore, for the analyzed<br />
sample, we can notice that bankrupt companies have a low variation index of the EV<br />
and MC value, but record a high variation index of VFCF. Unlike them, solvable<br />
companies have a medium and respectively high index indice of the EV value and a<br />
medium variation index for the values computed using the MC and VFCF methods.<br />
We can see thus that in the case of insolvent companies there is a reverse correlation<br />
between their values obtained based on free cash flows and patrimony and<br />
comparative methods (corrected stock exchange capital). From an optimistic<br />
perspective, the value of the company, obtained by discounting the future cash flows,<br />
is not supported by the current economic reality, but the value of the entity can be<br />
correctly evaluated through patrimony methods and by the correct stock echange<br />
capitalization.<br />
We can conclude that in crisis conditions the EV as well as the MC faithfully indicate<br />
the state of a company at a certain moment, in comparison with the VFCF-based<br />
evaluation, which provides a distorted (overestimated) image of the position and<br />
financial performance of the company. Insolvent companies will attempt to improve<br />
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the image provided by the decreasing values recorded by EV and MC, by stressing<br />
oversized future cash flows, not correlated with the financial realities (the company’s<br />
position and performance). Moreover, after data analysis in SPSS, for the analyzed<br />
sample, 40.2% of the variation corresponding to the state of the company (its being<br />
insolvent or not) is determined by IEV, a rather high value compared to the 23.7%<br />
determined by IMC and the 29.3% determined by IVFCF, which explains the importance<br />
of using the net accounting asset in presenting the faithful image of the company. As<br />
a result, the patrimony method can be considered the main method that can serve to<br />
present the real state of a company and implicitly to indicate the insolvency risk, in an<br />
unstable economic environment.<br />
Applying DA on the data in the analyzed sample, respectively the analysis of the<br />
indexes punctually recorded for each individual company, based on the three<br />
suggested evaluation methods, we have obtained in SPSS a series of descriptive<br />
statistics synthesized in Table 4. Based on them, the intervals corresponding to each<br />
category variable in Table 2 have also been determined.<br />
Table 4. Descriptive statistics at the sample level<br />
State of the<br />
Company<br />
Insolvent<br />
companies<br />
Solvent<br />
companies<br />
Total<br />
Variable Mean<br />
Standard<br />
deviation<br />
IEV -2.73 9.56<br />
IMC 0.29 1.50<br />
IVFCF 1.68 6.55<br />
IEV -0.14 0.27<br />
IMC 0.60 1.50<br />
IVFCF -0.60 2.30<br />
IEV -1.43 6.80<br />
IMC 0.45 1.49<br />
IVFCF 0.54 4.98<br />
The descriptive statistics presented in Table 4 point out a series of differences at the<br />
sample level, in what concerns the state of the company (solvent or insolvent),<br />
according to the values of the indexes of the three evaluation methods. We can see<br />
that a bankrupt company records a very small average value of IEV and a high average<br />
value of IVFCF, a situation opposed to the state recorded for solvent companies, the<br />
difference between the values of the indexes corresponding to the used methods being<br />
rather low. We can draw the conclusion that obtaining a value in an optimistic<br />
manner, through the method based on the present cash flows, can be realistically<br />
evaluated using the patrimony method, which seems much more prudent and which<br />
takes into account the economic realities, the position and financial performance of<br />
the company. At the IMC level, the difference between the average values of the<br />
indexes for solvent and insolvent companies is insignificant (0.31), compared to the<br />
differences resulted after applying the other methods (2.59 for EV and 1.08 for<br />
VFCF). This indicates that the method based on the corrected stock exchange capital<br />
(corrected market capitalization) market cannot signal any significant difference<br />
between the value of a solvent company and that of an insolvent company, as its<br />
usage does not allow the identification of the insolvency risk.<br />
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Table 4. Coefficients of the classification functions and the structure matrix<br />
Variables<br />
Standardized<br />
function<br />
Structure matrix<br />
State of the company<br />
Insolvent Solvent<br />
IEV 0.695 0.566 -0.075 -0.005<br />
IMC 0.190 0.308 0.180 0.266<br />
IVFCF -0.797 -0.687 0.093 -0.017<br />
Constant - - -0.899 -0.779<br />
In what concerns the impact of each method, we will take into consideration the<br />
values of the specific indexes of the three evaluation techniques, the results being<br />
synthesized in Table 4, in the Structure matrix column. The coefficients<br />
corresponding to each index indicate the degree of correlation between the index and<br />
the standardized classification function, obtained by aggregating the products between<br />
the coefficients and the associated indexes. High values (over 0.5) of the coefficients<br />
in the Structure matrix signal a strong correlation between the associated index and<br />
the classification function, as well as in what concerns influence. We can notice that<br />
in the case of IMC the value of the correlation coefficient is insignificant (0.308),<br />
which demonstrates that the MC method does not significantly contribute to stressing<br />
the differences between the two states of the companies (insolvent/ solvent).<br />
In the case of VFCF, high values of IVFCF indicate the presence of insolvency risk<br />
because of the strong negative correlation (-0.687) between the index and the<br />
Standardized function. The score of the Standardized function, obtained for an<br />
analyzed company, will be significantly diminshed by high values of IVFCF and will<br />
lead to classifying the company in the insolvent group. In contrast with IVFCF, IEV is<br />
strongly and positively correlated (0.566) with the Standardized function, and high<br />
values of this index will determine a high classification score and implicitly including<br />
the analyzed company in the solvent group. The standardized function is the<br />
mathematical model that leads to classifying an analyzed company into the two<br />
categories (solvent/insolvent), based on the belonging of the value of the obtained<br />
score to the classification intervals. This has the form: Score = 0,695IEV + 0,190IMC -<br />
0,797IVFCF, and low values of the scores are associated with insolvent companies,<br />
while high values of the scores are associated with solvent companies. A score close<br />
to -0.337 indicates the presence of the insolvency risk, and a score close to the<br />
average value 0.337 indicates the absence of this risk (these values represent the<br />
averages of the scores corresponding to the two classification groups). Moreover, the<br />
values of the coefficients associated to the indexes of the standardized function also<br />
indicate the importance of the method in obtaining the classification score and<br />
implicitly indicating the state of the company.<br />
Based on these results, we can conclude that the cash flow discount method allows<br />
obtaining distorted results concerning the value of the companies. Insolvent<br />
companies will attempt to hide their unfavorable financial state (their position and<br />
performance) expressed through low values of EV. Solvent companies have a high IEV,<br />
recording low values of IVFCF, thus revealing the usefulness of applying the prudence<br />
principle with the purpose of obtaining a faithful image. In this case we can also state<br />
that the evaluation method based on EV best indicates the position and financial<br />
performance of a company at a given moment, unlike the other two methods.<br />
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The main advantage of DA is obtaining classification functions, which will allow the<br />
subsequent inclusion of the companies that are not part of the analyzed sample, in<br />
predictive purposes. The coefficients associated with the indexes of the evaluation<br />
methods are presented in Table 4, and the classification functions obtained have the<br />
form: ScoreInsolvent = -0.899 -0.075IEV + 0.180IMC +0.093IVFCF and ScoreSolvent = -<br />
0.005IEV + 0.266IMC -0.017IVFCF. By replacing the two variable functions with the<br />
data presented by a company that will have to be classified into one of the two<br />
categories, two score values will be obtained (a value for ScoreInsolvent and a value for<br />
ScoreSolvent). These values will be compared, and the highest value will also determine<br />
the company’s belonging to one of the two categories.<br />
In what concerns the LRA method, the main results obtained in SPSS concern the<br />
functions for determining the probability of occurrence of the insolvency risk for a<br />
comoany, after the application of each evaluation method. For an analyzed company,<br />
the three probabilities of occurrence of the insolvency risk will be compared,<br />
according to the used method, with the purpose of their classification. Moreover,<br />
based on the probability computing functions, LRA allows a series of comparisons in<br />
what concerns the correct classification of the analyzed companies into the insolvent/<br />
solvent groups. This way, the method used to obtain a classification function that has<br />
the fewest wrongly classified cases will be the method that best indicates the absence<br />
of the insolvency risk and implicitly a faithful image. The obtained results are<br />
synthesized in Table 5, and for the interpretation of the function coefficients, their<br />
exponential value (exp) will be used.<br />
Variables<br />
Table 5. Results obtained through LRA<br />
Exponential coefficients of the<br />
probability<br />
EV MC VFCF<br />
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Correctly forecast cases<br />
Solvent Insolvent<br />
IEV 0.183 - - 75% 55%<br />
I MC - 0.862 - 40% 80%<br />
I VFCF - - 1.243 60% 50%<br />
Constant 0.557 1.067 0.975 - -<br />
(*Sig < 0.5)<br />
Starting from the results obtained in SPSS, based on the coefficients associated to the<br />
variation indexes of the evaluation methods, it is possible to obtain the functions for<br />
determining the probabilities of occurrence of the insolvency risk. Therefore, for each<br />
method, a probabilistic model of the insolvency risk will be obtained, having the<br />
form:<br />
EV: [pinsolvent/(1-pinsolvent)] = 0.557·(0.183)^IEV;<br />
MC: [pinsolvent/(1-pinsolvent)] = 1.067·(0.862)^IMC;<br />
VFCF: [pinsolvent/(1-pinsolvent)] = 0.975·(1.243)^IVFCF;<br />
Therefore, for IEV = 0 (the company has not recorded any modifications of EV), the<br />
probability for a company to be bankrupt and not solvent is 0.557 (the ratio between<br />
the probabilities for the two states), and an increase of the index by one unit (IEV = 1,<br />
double EV) will amplify this risk by 0.183, eventually generating an insolvency risk<br />
of 0.102 (0.557·0.183). The EV method successfully indicates 75% of the solvent<br />
companies (error 25%) and 55% of the insolvent companies (error 45%), resulting in
a total error for the case when this method does not indicate correctly the solvent and<br />
insolvent companies of 11.25% (25%·45%). We can conclude that the prioritary usage<br />
of this method will indicate companies with no insolvency risk.<br />
For IMC = 0 (the company has not recorded any modifications of MC), the probability<br />
for a company to be bankrupt and not solvent is 1.067 (the ratio between the<br />
probabilities for the two states), and an increase of the index by one unit (IMC = 1,<br />
double MC from one period to another) will amplify this risk by 0.862, eventually<br />
generating an insolvency risk of 0.920 = 1.067·0.862 (the ratio between the<br />
probabilities for the two states). The MC method successfully indicates 40% of the<br />
solvent companies (error 60%) and 80% of the insolvent companies (error 20%),<br />
resulting in a total error for the case when this method does not indicate correctly the<br />
solvent and insolvent companies of 12% (60%·20%). We mention that this method<br />
can be considered ideal for recognizing companies with an insolvency risk, in the<br />
conditions in which the capital market is sensitive enough to any element that may<br />
indicate the presence of this risk.<br />
For IVFCF = 0 (the company has not recorded any modifications of VFCF), the<br />
probability for a company to be bankrupt and not solvent is 0.975 (the ratio between<br />
the probabilities for the two states), and an increase of the index by one unit (IVFCF =<br />
1, double VFCF from one period to another) will amplify this risk by 1.243,<br />
eventually generating an insolvency risk of 1.212 = 0.975·1.243 (the ratio between the<br />
probabilities for the two states). The VFCF method successfully indicates 60% of the<br />
solvent companies (error 40%) and 50% of the insolvent companies (error 50%),<br />
resulting in a total error for the case when this method does not indicate correctly the<br />
solvent and insolvent companies of 20% (40%·50%). Since there is the risk not to<br />
provide the best clues on the presence of the insolvency risk (error risk = 20%), we<br />
consider that the VFCF-based method is not appropriate for signaling the insolvency<br />
risk.<br />
Following the analysis of the LRA evaluation method, we consider it appropriate to<br />
use the EV method, which can successfully indicate the presence of the insolvency<br />
risk in the company, having the lowest error risk (11.25%).<br />
CONCLUSIONS<br />
This study brings a series of contributions concerning the relevance of the evaluation<br />
methods in presenting the actual state of the companies and their real value, in<br />
conditions of economic instability.<br />
An essential point in this study is the identification of the usefulness and of the degree<br />
of objectivity of each evaluation method, as well as of the opportunities to signal<br />
insolvency risks, extremely useful in the managers’ approaches to govern companies<br />
by reporting the decisions to the value of the business; here we refer to the concept of<br />
“governance through value”. The patrimony methods, although currently challenged<br />
for their inability to encapsulate in the value of the company anything but what is<br />
recorded in the accounting statements, provide a prudent value image, appropriate in<br />
conditions of economic instability, favoring the long-term preservation of the business<br />
stability. The methods based on the discounted cash flows, although highly valued,<br />
provide, in our opinion, a distorted image on reality because of their relativity and<br />
~ 197 ~
uncertainty triggered by the forecast process, implied by their application. As an<br />
essential element for supporting these statements, a question mark is raised<br />
concerning the usage of measures related to the past in order to quantify what can<br />
happen in the future.<br />
In what concerns the MC-based method, we can state that the volatility of the stock<br />
flow, influenced by the tilte demand and offer on the capital market, as well as by<br />
other factors concerning the degree of market development, the investors’ trust, the<br />
applicable legislation, as well as by many other external factors, cannot faithfully<br />
indicate the value of the company at a certain moment. This method can be combined<br />
with the others in order to accentuate the trust in a potential value obtained based on a<br />
certain method.<br />
In what concerns the data analysis methods, the application of FAMC has the<br />
importance of identifying a profile of the insolvency risk, based on value variation<br />
indexes (starting from obtaining the value of the company according to the three<br />
methods considered). DA supports obtaining company classification functions<br />
according to the insolvency risk (usefulness of the method), and through the values of<br />
the coefficients associated to the indexes in the classification functions, it allows<br />
evaluating the degree to which a method significantly contributes to identifying the<br />
considered risk. This is how a first hierarchy of the methods is achieved, using the<br />
explicitation criterion of the variance of the passage from one state to another<br />
(solvency-insolvency) based on the variation indexes of the value computed according<br />
to the analyzed methods. A higher weight of the variation of the state (the insolvency<br />
risk) attributed to an index corresponding to a method, will indicate a higher<br />
importance of this method. From the performed analysis, we could see that both the<br />
value computed using EV and that using VFCF significantly contribute to the<br />
classification of the companies into solvent and insolvent.<br />
Another significant element of this study is the identification of the probabilities of<br />
occurrence/identification of the insolvency risk based on the evaluation methods.<br />
Moreover, their hierarchy has been achieved according to the number of correctly<br />
classified cases, in this case EV clearly detaching itself from the other evaluation<br />
methods.<br />
By validating the three work hypotheses suggested in the study, after meeting the<br />
objectives of the research, we can state that in conditions of economic instability<br />
(financial crises), the value of the company estimated using EV can be considered<br />
relevant in presenting a faithful image of the company. Simple and easy to apply, this<br />
method does not expose the shareholders to the potential risks of the capital market, to<br />
the problems and limitations of the forecasts, nor to the subjectivity and relativity of<br />
the other evaluation methods.<br />
The limitations of this study are generated by its exclusive focus on BSE and by the<br />
size of the sample, being mainly caused by the limited access to the causality and<br />
specialized information necessary to develop our research. Future research directions<br />
will aim at surpassing these limitations by suggesting extended and in-depth studies<br />
on other capital markets, by including other methods, as well as by a better<br />
identification of the factors that condition obtaining objective and appropriate<br />
company values, as an essential support for investment and management decisions.<br />
~ 198 ~
ACKNOWLEDGEMENTS<br />
This work was supported by the the European Social Fund in Romania, under the<br />
responsibility of the Managing Authority for the Sectoral Operational Programme for<br />
Human Resources Development 2007-2013 [grant POSDRU/CPP 107/DMI<br />
1.5/S/78342]<br />
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~ 200 ~
FINANCIAL RISK ANALYSIS AT THE STOCK<br />
EXCHANGE LISTED COMPANIES IN THE<br />
PASSENGER ROAD TRANSPORTATION INDUSTRY<br />
Vlad IORDACHE 1 , Vasile ROBU& Costin CIORA<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
We are tempted to say that business activity is usually influenced by the emergence of<br />
operational risk, but we should not overlook the impact that the structure of funding sources<br />
can have on the outcome of the enterprise. Financial risk appears when funding from<br />
borrowed sources involving charges for payment of debts (interest) which affect the<br />
profitability of the enterprise. The purpose of this paper is to show the level of financial risk<br />
present at a number of five listed companies in the passenger road transportation industry.<br />
The analysis was based on interpretation of risk level using the results obtained by<br />
calculating the coefficient of financial leverage for a period of five years; the purpose was to<br />
demonstrate that using this tool managers can make decisions in a short time so that decision<br />
making process will not be long standing.<br />
KEYWORDS: financial leverage, financial risk, methods, profitability, risk<br />
INTRODUCTION<br />
The beginning of our era has been characterized both by risk and uncertainty, and this<br />
prompted us to turn our attention towards measuring the degree of risk present in our<br />
activity, why? Because the rules of the game had to be changed during it, because the<br />
need to adapt to new economic conditions have requested it.<br />
Risk and uncertainty have been and still are problems that have concerned both<br />
scholars and practitioners since ancient times.<br />
We are tempted to say that a business activity is usually influenced by the emergence<br />
of operational risk, but we should not overlook the impact that the structure of funding<br />
sources may have on the outcome of the enterprise.<br />
Future business decisions or actions are often influenced by financial risk, so that<br />
financial risk analysis is an important information both by value and correlation with<br />
the findings of operational risk analysis, for a globally risk assessment.<br />
The capital of a company consists of two components: equity and borrowed capital.<br />
The two components raise different costs of capital. Thus the cost of borrowed capital<br />
1<br />
Correspondence address: Vlad IORDACHE, Bucharest Academy of Economic Studies, Romania;<br />
email: vlad.jordache@yahoo.com<br />
~ 201 ~
includes the value related to financial expenses with the interest that the company<br />
must constantly bear from the moment it used the credit lines.<br />
So, borrowing involves a change in the results, thus leading to changes in financial<br />
risk. Financial risk arises from the presence of financial expenditure that remunerates<br />
borrowed capital (interest on loans).<br />
Financial risk or capital risk looks over financial structure and depends on the<br />
financing of the activity: if it is financed solely by equity, financial risk is not present.<br />
Financial risk appears when funding from borrowed sources involving charges for<br />
payment of debts (interest) which affect the profitability of the enterprise.<br />
The crisis has manifested itself in full effect in 2008-2009 affecting capital market<br />
development both nationally and internationally. This led to declines in most listed<br />
companies’ stock quotes. For investors it is important to pursue all necessary<br />
information concerning the development or liquidation of their portfolio, market<br />
development being a crucial factor. Investors have watched the evolution of capital<br />
market crisis even before the event took place, observing also the evolution of the<br />
financial risk of companies on which they had assets, correlated with the development<br />
of stock market indicators.<br />
1. LITERATURE REVIEW<br />
The issue of financial leverage is represented initially in the theories presented by<br />
Modigliani and Miller. They tried to identify an optimal value of financial leverage to<br />
enable an increase in company value, concluding ultimately that the two independent<br />
variables have no relationship.<br />
In 1958 Modigliani and Mill have theorized that firm value is independent of capital<br />
structure. Later, Myers and Majluf (1984), Fama and French (2002) showed the<br />
impact of taxation on capital structure and the value of the company, promoting the<br />
idea of asymmetric information and agent costs. (Triandafil, C, 2007)<br />
The financial leverage impact on investors` perception on a specific company caused<br />
contradictions between theories issued by various theorists. Thus it was found out that<br />
leverage is a positive sign for investors, especially in light of the fact that only one<br />
company with good financial results will be able to attract external financial<br />
resources. (Ross, S, 1977)<br />
Other theorists have noted that the lever can have a negative impact on potential<br />
investors because by indebtement the company tends to become riskier. Another point<br />
of view was that when the firm used external financing resources, operational cash<br />
flow was not sufficient to cover financial obligations. (Miller, M. and Rock, K., 1985)<br />
2. THE IMPORTANCE OF DETERMINING THE LEVEL OF FINANCIAL<br />
RISK IN PASSENGER ROAD TRANSPORTATION<br />
Financial risk analysis in the area of passenger transport is and will remain of great<br />
importance, because there will always be the need of individuals to move in the<br />
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society we live in. Additionally, risk is a part of all existing activities in the context of<br />
today’s economy, even more when the need for funding is increasing.<br />
Transportation is an important sector of the economy both in terms of its direct<br />
contribution to the GDP and of its role in the movement of goods and persons<br />
involved in the creation of gross value added of other industries. It is still an evolving<br />
industry that promises positive developments<br />
Passenger transportation is following an ascending trend, and this is mainly due to the<br />
increased contribution of intercity and international road transport. Transport holds a<br />
share of about 7% of gross domestic product, representing the second category of<br />
services, after trade, as importance in the tertiary sector; at the same time it is an<br />
activity with a contribution equivalent to growth of agriculture. In contrast, shipments<br />
are constantly changing, with high annual growth rates. Passenger road transportation<br />
covers 70% of travel need.<br />
In conclusion, having this current economic climate we felt that the study on the<br />
development of the level of financial risk is interesting for any investor who wants to<br />
develop a portfolio and wants an easy tool that shows him the financial risk level of<br />
the company he is wishing to invest into.<br />
3. FINANCIAL RISK ASSESSMENT THROUGH THE ANALYSIS<br />
OF FINANCIAL LEVERAGE RATIO EVOLUTION<br />
Financial risk assessment can be made using position indicator to overall break even<br />
point. In addition, for assessing is also used the sensitivity analysis of return on equity<br />
that falls under the funding policy. It can be said that the sensitivity analysis is a risk<br />
measurement method in direct correlation with the performance of a system.<br />
Sensitivity analysis can be regarded as a risk quantification tool for influencing<br />
economic activities and management, as financial analysis and diagnosis method used<br />
in the study of financial equilibrium and, therefore, as a basis for technical and<br />
financial evaluation of the decision. In terms of the financial balance diagnosis,<br />
sensitivity analysis shows the exact action of the two axes that give the sense of<br />
equilibrium concept, namely: profitability and risk. The model used to study the<br />
sensitivity is financial leverage effect.<br />
In terms of the financial risk, this is the additional risk of the activity, a risk over the<br />
economic risk, given that the company is self-financing the activity whilst is also<br />
borrowing money.<br />
The financial risk depends on the following factors:<br />
� The financing way, reflected by capital structure<br />
� Cost of equity and borrowed capitals<br />
The existence of an accurate assessment of financial risk level is of interest for both<br />
creditors and shareholders. The basis of a decision regarding the financing activity is<br />
supported if the proposed solution offers low risk and if the expected benefits justify<br />
the committed effort.<br />
The creditor or the shareholder will study in this regard, particularly the status of<br />
liquidity, beeing less interested in working capital analysis. The decision making<br />
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concerning investment, composition of circulating asset and short-term commitments<br />
have a greater importance than the information about the values of assets and longterm<br />
commitments. A potential investor interest is particularly directed to the<br />
company's ability to generate profit.<br />
The analysis and assessment of financial risk can be based on financial leverage ratio<br />
(CLF). This ratio expresses the sensitivity of the exercise net result to the changes in<br />
operating result:<br />
ΔRnet<br />
/ Rnet<br />
CLF = (1)<br />
Δ Re xer / Re xer<br />
where: Rnet – net result<br />
Rexer – operating result<br />
Financial leverage ratio expresses the percentage change in response to changes in net<br />
operating result by a percentage of operating result and its size is directly proportional<br />
to the degree of financial risk.<br />
For a factorial point of view the financial leverage ratio used to assess financial risk is<br />
determined based on the profit and loss account, in which net result is obtained after<br />
deducting income tax from the gross result:<br />
Rnet = Rbrut × (1 −i)<br />
Rnet = [ Re xer − Chfin + ( Vfin + Re xtr) ] × (1 − i)<br />
(2)<br />
where: Rbrut - the gross result<br />
Chfin - financial charges<br />
Vfin - financial income<br />
Rextr – extraordinary result<br />
i - tax rate<br />
But the financial income and the extraordinary result are not related to the activity that<br />
the enterprise currently has in progress, so the calculation relationship of financial<br />
leverage ratio becomes:<br />
Re xer<br />
CLF =<br />
(3)<br />
Re xer − Chfin<br />
To prevent financial risk firms should calculate and ensure a break even point, set up<br />
as a confidence interval and not as a predetermined reference value. The limits of this<br />
range are determined by the level of uncertainty the company is evolving in. When it<br />
tends to zero, we will certainly be talking about a punctual profitability and not about<br />
an interval in which profitability is attained with a satisfactory profitability. And,<br />
when uncertainty is high, the confidence interval has such high level that it becomes<br />
unusable in decision making.<br />
4. THE EVOLUTION OF THE FINANCIAL LEVERAGE RATIO<br />
To analyze the financial risk we performed a comparative study of the evolution of<br />
the financial leverage ratio value over a period of five years in a number of five<br />
companies, all listed on the Bucharest Stock Exchange. This should be noted because<br />
of the fact that when traded companies needing funding and not wanting to use the<br />
~ 204 ~
loans of the banking system, they may decide to resort to financing instruments from<br />
the capital market.<br />
The determination of the financial leverage ratio lies in the need for investors to<br />
assess financial risk in making investment decision.<br />
To start the analysis we considered necessary to review the progress of the BET index<br />
in the five years under study to observe the evolution of the annual value of<br />
transactions volume on the capital market.<br />
Graph 1. BET evolution during 2005-2009<br />
(Source: Information taken from www.bvb.ro)<br />
As it can be seen from the chart concerning the BET index evolution calculated on the<br />
basis of traded volume during 2005 - 2009 we find that the level of 51% of BET index<br />
in 2005 recorded a downward trend for the period 2006-2007, culminating in a<br />
negative level of about - 70% in 2008. This can be justified by the concerns that were<br />
on the market in 2008, considering that this was a maximum period of the crisis we<br />
are still going through.<br />
The negative trend from 2008 was stopped and in 2009 we can find that the anti-crisis<br />
effects at economic level began to make their presence felt, so it led to a positive<br />
evolution of the BET index, a sign that the stock market evolutions have registered a<br />
recovery.<br />
Next, we proceed to the analysis of results evolution achieved by the financial<br />
leverage ratio. We conducted a comparative analysis of this indicator on a period of<br />
five years for a total of five companies that are listed on the stock market. This study<br />
was conducted to determine the level of financial risk, using a method easy to use for<br />
its quantification.<br />
~ 205 ~
Table 1. Financial leverage ratio calculation<br />
Year Company<br />
2005<br />
2006<br />
2007<br />
2008<br />
2009<br />
Operating<br />
Results<br />
~ 206 ~<br />
Financial<br />
expenses<br />
Financial leverage<br />
ratio<br />
A 135,954 106,098 4.55<br />
B 340,480 12,965 1.04<br />
C 42,462 0 1.00<br />
D 259,340 92,433 1.55<br />
E 152,315 2,256 1.02<br />
A 148,039 90,419 2.57<br />
B -217,481 20,220 0.91<br />
C 100,234 44,344 1.79<br />
D 191,170 57,360 1.43<br />
E -224,138 0 1.00<br />
A 122,680 134,543 -10.34<br />
B -1,074,561 33,900 0.97<br />
C 87,778 54,681 2.65<br />
D 157,521 71,935 1.84<br />
E 104,597 155,946 -2.04<br />
A 203,248 232,993 -6.83<br />
B -4,173,555 994,840 0.81<br />
C 52,278 43,783 6.15<br />
D 379,252 163,053 1.75<br />
E 104,597 155,946 -2.04<br />
A 474,635 439,066 13.34<br />
B -2,912,626 1,485,391 0.66<br />
C -214,284 19,722 0.92<br />
D 513,750 253,856 1.98<br />
E 324,285 118,090 1.57<br />
(Source: Personal calculations based on data taken from the annual financial statements of<br />
companies listed on BSE)<br />
Company A – S.C. EXPRESS TRANSPORT S.A., Târgu Jiu<br />
Company B – S.C. MONDOTRANS S.A., Târgoviște<br />
Company C – S.C. TRANSALBA S.A., Alba Iulia<br />
Company D – S.C. TRANSBUZ S.A., Slatina<br />
Company E – S.C. VALEA PRAHOVEI S.A., Câmpina<br />
The calculations made on the basis of such information is summarized in the chart<br />
below where we realized an annual comparison of the evolution of financial leverage<br />
ratio to highlight the evolution of the financial risk of each company within the five<br />
years of analysis.
Graph 1. CLF evolutions during 2005-2009<br />
(Source: Personal calculations based on data taken from annual financial statements of<br />
companies listed on BSE)<br />
The results for 2005 by calculating the financial leverage ratio for the five companies<br />
allow us to affirm the following:<br />
� For the company A there is a very high level of financial risk greater than the<br />
average of the other companies, which can translate into a level of financial<br />
expenditure greater than the income level of the year, following the possible<br />
situation that the company resorted to using sources of loan whose<br />
reimbursement is accompanied by a high level of risk<br />
� The results for the other companies are within 1 to 1.5, which means that the<br />
financial risk recorded by the four companies can be classified as minor.<br />
� We can say that financial risk value obtained based on the leverage ratio in<br />
2005 is correlated with the BET index, which registered a growth of trading<br />
and hence a higher volume, so the capital flows were directed towards<br />
investment in the purchase of new portfolios.<br />
In terms of the leverage ratio level evolution for 2006 is registered an overall negative<br />
trend, because the values recorded by this indicator show a very high level of financial<br />
risk.<br />
The companies B and E have registered values that can make us conclude that the<br />
their financial risk is a minor, CLF values being very close to the value 1, a situation<br />
possible because the share of financial expenditures was very low in the year 2006.<br />
For 2007, the CLF values recorded for the five companies have reflected evolutions<br />
different than the previous year. So if the previous year was reflected a bad general<br />
situation featuring a maximum financial risk for most analyzed companies, the<br />
situation in 2007 is balanced with a low risk degree.<br />
The negative situation that has emerged from the analysis of the company E financial<br />
burden is the result of much higher financial expenditure than the income of the year.<br />
~ 207 ~
The high value of financial expenditure levels may be the result of very high interest<br />
costs. It must therefore be followed the evolution of the risk in the future, to see if the<br />
degree of indebtment continues to be very high.<br />
The year 2008 brings significant changes in the level of the financial risk for the five<br />
companies analyzed. These relatively favorable evolutions of the previous years for<br />
the companies have developed negatively this year, aspect that must be correlated<br />
with the evolution of the banking institutions. It is known that 2008 was a year<br />
marked by adverse evolutions of the credit institutions level because they wanted to<br />
minimize such risks and thus the financing instruments became more expensive.<br />
Therefore, the negative values recorded by the companies A and B were determined<br />
by high levels of financial expenditure, which can be the result of the credit cost rise<br />
by increasing interests that at the company level had the effect of increasing the share<br />
of interest expenditures in total financial expenses and thus caused a negative<br />
financial leverage ratio.<br />
The companies B and D present a tolerable level of financial risk, a minor risk,<br />
succeeding in managing costs to maintain the same levels of the previous years and so<br />
for them the crisis was not that strong.<br />
The C Company recorded a very high financial risk, which results in a high level of<br />
uncertainty with respect to the consequences of the financial situation of the company<br />
and so the financial situation will be followed for a longer period also by using<br />
analytical methods that include more precise and accurate assessment tools.<br />
CLF levels recorded in 2008 were normal for this period of uncertainty in which the<br />
rumors characterized mainly the capital market evolutions.<br />
The year 2009 is characterized by some stability, because the leverage ratio levels for<br />
the five companies have been in amounts similar to the previous year. The situation<br />
has stabilized, a high level of financial risk registering only at company A, where it<br />
was recorded a very high level of financial risk.<br />
The other companies have stabilized their situation and demonstrated lower levels of<br />
values of financial risk with financial leverage ratio in the range of 0.7 to 1.5. The<br />
situation in 2009 is the result of relative reduction in the amount of financial expenses<br />
as a result of enterprise management guidance to reduce the share of interest expense<br />
on one hand and a return to their funding sources, on the other hand.<br />
CONCLUSIONS<br />
In conclusion, the importance of financial leverage ratio of current financial<br />
management and forecasting comes from the fact that the net result is sensitive to<br />
indebtedness and it conditions the size of benefit and dividend per share, of great<br />
interest to shareholders and self-financing business, which enhances equity.<br />
A more precise estimation of the level of financial leverage ratio comes to meet both<br />
businesses and potential investors’ demands as an easy way to assess the degree of<br />
companies risk exposure.<br />
~ 208 ~
The times we are living require the existence of early and effective means for<br />
estimating the likely benefits and losses so that decisions are taken in a short time and<br />
at a level of risk as low as possible. The results should be correlated with the<br />
evolution for the year 2010 when the economic crisis effects have diminished and<br />
creditors tried to relax the credit market.<br />
To prevent the financial risk firms should calculate and ensure a break even point, set<br />
up as a confidence interval and not as a predetermined baseline value. The range is<br />
determined at this time by the level of uncertainty the enterprise is deploying its<br />
activity in. When it tends to zero, it will certainly be a punctual return and not an<br />
interval in which profitability is achieved with satisfactory probability. And, when<br />
uncertainty is high, the confidence interval has a size so large that it becomes<br />
unusable in decision making. (Prunea 2003)<br />
AKNOWLEDGEMENT<br />
This article is a result of the project „Doctoral Program and PhD Students in the<br />
education research and innovation triangle”. This project is co funded by European<br />
Social Fund through The Sectorial Operational Programme for Human Resources<br />
Development 2007-2013, coordinated by The Bucharest Academy of Economic<br />
Studies.<br />
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Petrescu, S. (2005), Performanţă şi risc în analiza financiară, Analele ştinţifice ale<br />
Universităţii ”Alexandru Ioan Cuza” din Iaşi<br />
Prunea, P., (2003), Riscul în activitatea economică. Ipostaze. Factori. Modalităţi de reducere,<br />
Editura Economică, Bucureşti<br />
Ross, S. (1977) The determination of financial structure: the incentive-signalling approach<br />
Stancu, D., Stancu, Ion., (2006), Asimetria informaţională, creşterea sustenabilă, riscurile de<br />
exploatare şi de îndatorare, a IV-a ediţie a Risk Management Forum 2006,<br />
IBR Bucureşti, accesat la http://store.ectap.ro/articole/163.pdf, la data de 20.03.2010<br />
Şerban, C., (2003), Teză de Doctorat: Strategii de prevenire a riscurilor din activitatea<br />
economico-financiara a intreprinderilor<br />
Triandafil, C. M., Brezeanu, P., Huidumac, C., (2007), Levierul financiar la interferenţa<br />
dintre clasic şi modern: studiu de caz asupra întreprinderilor cota te la BVB, sectiunea<br />
echipamente<br />
~ 209 ~
PS4 IFRS I<br />
Chairperson<br />
David ALEXANDER, University of Birmingham, UK<br />
BENEFITS AND COSTS OF PREPARING IFRS<br />
STATEMENTS BY NON-LISTED COMPANIES:<br />
EVIDENCE FROM THE CZECH REPUBLIC<br />
David PROCHΑZKA<br />
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BENEFITS AND COSTS OF PREPARING IFRS<br />
STATEMENTS BY NON-LISTED COMPANIES:<br />
EVIDENCE FROM THE CZECH REPUBLIC<br />
David PROCHÁZKA 1<br />
University of Economics, Prague, Czech Republic<br />
ABSTRACT<br />
EU Regulation No. 1606/2002 obliges companies listed on the EU stock exchanges to prepare<br />
consolidated financial statements in compliance with IFRS. Many Czech companies are under<br />
control of foreign companies (listed on EU capital markets). As the voluntary application of<br />
IFRS was not allowed until 2010, Czech companies prepared financial statements according<br />
to Czech legislative for statutory purposes. However, for consolidation purposes, they had to<br />
provide parent companies with financial statements prepared in compliance with IFRS.<br />
The paper deals with three basic approaches to the conversion of financial statements. The<br />
first method uses conversion on the financial statements level. The second method applies the<br />
conversion on the trial balance level. Finally, some companies prefer to implement<br />
specialised accounting software, which enables to record all accounting transactions<br />
parallelly under CAS and IFRS. Each method is shortly described and its main cost-benefits<br />
are analysed. Theoretical conclusions are shortly evidenced by empirical data on example of<br />
the Czech non-listed companies.<br />
KEYWORDS: Conversion of Financial Statements; IFRS; Czech Accounting Standards;<br />
Dual (Financial) Accounting System.<br />
INTRODUCTION<br />
The adoption of the International Financial Reporting Standards has caused a radical<br />
change in financial reporting, esp. in countries with the code-law tradition of<br />
accounting regulation. The research evidences an increased usefulness of financial<br />
statements prepared in accordance with the IFRS worldwide. The benefits of<br />
accounting harmonisation are well known. However, the implementation of the IFRS<br />
into national legislation elicits costs for many subjects involved in the process. E.g.<br />
many national legislations decree entities to prepare the IFRS statements for European<br />
stock exchanges and simultaneously to prepare the financial statements based on<br />
national accounting standards for statutory and/or tax purposes. As a consequence,<br />
entities have to maintain two different sets of accounting data. The conversion of<br />
financial statements from one set to another is a complex and costly process. The<br />
paper’s main aim is to analyse advantages and disadvantages of various methods used<br />
for the conversion of financial statements and to evaluate current practice in the Czech<br />
Republic as far as non-listed companies concern.<br />
1<br />
Correspondence address: David Procházka, University of Economics, Prague;<br />
email: prochazd@vse.cz<br />
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1. BACKGROUND<br />
1.1. Literature overview<br />
The International Accounting Standard Committee was set up in 1973 as the reaction<br />
of accounting profession to a steady shift from the stewardship function of financial<br />
accounting (oriented mainly on the past course) to the forward-looking orientation and<br />
the need of reliable and comparable information useful in decision-making regarding<br />
the allocation of scarce resources not only on a national level, but also in the<br />
worldwide context. After some 30 years, the IFRS are leading principles (at least for<br />
listed companies) in many countries.<br />
Recent researches have demonstrated the usefulness of accounting information<br />
contained in financial statements prepared according to the IFRS. The IFRS adoption<br />
has increased the quality of disclosed information comparing to national GAAP<br />
(Barth et al., 2008, p. 496). Moreover, the IFRS adoption in Europe has not only<br />
contributed to the enhancement of financial reporting, but has also assisted in<br />
improving the comparability between countries Macías (2008, p. 8.). This<br />
improvement in quality is significant across Europe as shown by Aubert and<br />
Grudnitski (2009) and esp. in countries with code law (Morais and Curto, 2007a),<br />
where accounting was and still is more closely linked to taxation systems. The same<br />
authors (Morais and Curto, 2007b) proved that this tendency is accompanied with less<br />
smooth earnings since financial reporting in accordance with the IFRS is not closely<br />
related to the taxation as local accounting standards are. Inwinkl and Aussenegg<br />
(2009) support this view and add that lower level of earnings management under the<br />
IFRS is more substantial factor in the Central and Eastern European countries as the<br />
IFRS allow less discretion than national tax-oriented accounting standards.<br />
The IFRS have had a material impact on firms’ financial information in some<br />
countries. The increase in value relevance is demonstrated esp. in countries with<br />
significant level of discretion in financial reporting, such as Italy (Paglietti and<br />
Conversano, 2007; Cordazzo, 2008) or Spain (Pardo et al. 2009; Ferrer et al., 2009).<br />
The positive influence of the IFRS adoption is also evidenced in transitional countries,<br />
e.g. in Romania (Mustata et al., 2009) Poland (Jaruga et al., 2007) or Russia<br />
(Bagaeva, 2009). The evidence confirming the value relevance of the IFRS is also<br />
available for countries, which traditionally focus on supplying the high quality<br />
information for external users, such as United Kingdom (Christensen et al., 2009;<br />
Ferrer et al., 2009).<br />
To conclude a short literature overview on usefulness of the IFRS, it may be stressed<br />
that the adoption process helps in solving problems both on microeconomic and<br />
macroeconomic level. Firstly, IFRS statements reduce informational asymmetry<br />
between providers and recipients of capital (Dumontier and Maghraoui, 2007); thus<br />
lowering the costs of monitoring management behaviour. As a consequence, the costs<br />
of capital are predominantly cut down (Lee et al. 2008). Transparency and<br />
interconnectivity of capital markets together with the intensification of foreign direct<br />
investments flows (Marquez-Ramos, 2009) are typical examples of positive<br />
macroeconomic side-effects of the IFRS worldwide application.<br />
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1.2. Paper’s aim and contribution<br />
As the previous summary of literature shows, the benefits of IFRS adoption are<br />
significant and can be traced in many areas of economy. On the other hand, not<br />
negligible costs are induced by the harmonisation process. Entities are obliged to<br />
prepare financial statements, which may be more complex than under local GAAP;<br />
investors have to recustomise models computing intrinsic values of corporate<br />
securities, creditors need to adjust their risk assessment models, state authorities solve<br />
the problem how to ensure control of tax duty fulfilment under new accounting<br />
regime, etc. Not all costs of the IFRS implementation are borne by those who take<br />
advantage of more useful and comparable financial statements. A comprehensive<br />
cost-benefit analysis of the IFRS implementation is difficult because it is unfeasible to<br />
compare benefits of one group involved with costs of another group.<br />
The paper focuses on firms preparing financial statements in compliance with the<br />
IFRS. More specifically, advantages, disadvantages and costs of various methods used<br />
for the preparing of IFRS financial statements will be scrutinised. The problem seems<br />
to be very trivial at the first sight. The method used and cost incurred should be very<br />
similar as under any else reporting system. However, we should have on mind that<br />
financial reporting is a subject of state regulation in many countries. Besides IFRS<br />
statements for stock exchanges, entities may also be bound to prepare financial<br />
statements according to national accounting standards for statutory and/or tax<br />
purposes. As a consequence, entities face a problem how to ensure the preparation of<br />
two sets of financial statements, usually substantially different, in order to meet all<br />
legal requirements under restriction of minimal costs. This issue will be referred as<br />
conversion of financial statements further in the text.<br />
Advantages and disadvantages of various approaches to the conversion of financial<br />
statements will be evaluated (Chapter 2). Further, a short description of regulatory<br />
framework for financial reporting within the European Union together with the<br />
analysis of accounting regulation in the Czech Republic will be performed (Chapter<br />
3.1). Finally, empirical evidence will be presented to support the theoretical findings<br />
on conversion of financial statements process and its specifics in the Czech Republic<br />
(Chapter 3.2-3.3).<br />
General findings of the paper on possible methods of financial statements conversion<br />
may be utilised by all entities around the world that are in charge of preparing two<br />
sets of financial statements. The benefit-cost analysis of those methods are valid<br />
regardless whether two or more set of statements are prepared by listed or non-listed<br />
companies, obligatory or voluntarily. Moreover, national regulators of accounting<br />
may be influenced by the analysis to undertake certain steps reducing the cost burden<br />
for companies and/or enhancing benefits from the IFRS adoption for national<br />
economy as a whole.<br />
The paper also contains a short analysis on an example of non-listed companies<br />
domiciled in the Czech Republic. The Czech Republic as a case country has been<br />
chosen for two reasons. The conversion of financial statements is an accounting issue<br />
of great importance because about 40% of Czech companies prepare two sets of<br />
financial statements. Secondly, accounting profession has been striving to persuade<br />
the regulator of accounting in the Czech Republic (i.e. the Ministry of Finance) to<br />
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undertaken certain measures and thus to improve rather unsatisfactory situation. After<br />
many years, the Ministry of Finance reflected the effort of accounting profession and<br />
amended the Act on accounting by enabling selected entities to apply the IFRS on a<br />
voluntary basis. The historical development in the Czech Republic can serve as an<br />
inspiration for the regulators of financial reporting in other countries, both in positive<br />
and negative sense. It can be assumed that countries, whose accounting regulation is<br />
based on the code law approach and whose accounting is tightly subordinated to tax<br />
system requirements, may face a similar problem.<br />
2. CONVERSION OF FINANCIAL STATEMENTS<br />
The conversion of financial statements can be defined as a process when an entity<br />
prepares two or more sets of financial statements, each in compliance with distinct<br />
financial reporting standards. Financial statements different from statutory accounts<br />
for bank credit purposes; financial statements based on national legislation for tax<br />
purposes by listed companies; financial statements according to foreign GAAP for the<br />
purpose of consolidation by parent company domiciled abroad or financial statements<br />
in accordance with generally accepted principles instead of local GAAP for stock<br />
exchanges are most common examples of financial statements conversion.<br />
There are three dimension of financial statements conversion:<br />
• preparation of the first individual financial statements (opening balance sheet<br />
respectively) prepared in compliance with an alternative set of financial<br />
reporting standards;<br />
• reporting of individual financial statements and other figures needed for<br />
consolidation or other purposes in regular intervals;<br />
• consolidation of individual financial statements.<br />
The number of particular steps in each mentioned phase may differ depending on the<br />
purpose of conversion. Whether a company makes conversion on its own or whether<br />
it uses a template (e.g. prepared by parent company) is another factor influencing the<br />
process of conversion.<br />
Further in the paper, the case of national financial statements conversion into IFRS<br />
financial statements for the purpose of consolidation by foreign parent company will<br />
be assumed. E.g. a company based in the Czech Republic, and reporting under Czech<br />
Accounting Standards for statutory purposes, is owned e.g. by a German parent<br />
company listed on a Frankfurt Stock Exchange. For the consolidation purposes, the<br />
Czech company has to prepare additional set of financial statements in compliance<br />
with the IFRS. Despite this narrow specification, general applicability of the paper’s<br />
conclusions should not be impaired.<br />
2.1. Phase 1: Preparation of the first financial statements according to the IFRS<br />
There are several steps, which shall be undertaken in this phase:<br />
• The preparation for the first time adoption of IFRS:<br />
� establishing of general “road map” for the conversion (expected costs,<br />
deadlines, responsible persons, methods, controls);<br />
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� introduction of basic principles on which IFRS are based to all people in<br />
charge with the adoption (not only company’s accountants and<br />
management, but also IT specialists, tax specialists, etc.);<br />
� overview of current accounting software and other information systems.<br />
• The analysis of local GAAP:<br />
� identification of general differences between national GAAP and the IFRS;<br />
� identification of differences between entity’s accounting politics under<br />
national GAAP and the IFRS;<br />
� list of all differences, which will be subject of conversion, structured in<br />
following groups: applied under both systems, but applying different<br />
accounting methods; applied only in local GAAP, but not under IFRS;<br />
applied only in the IFRS, but not under local GAAP.<br />
• The accounting choices:<br />
� measurement bases used in IFRS statements;<br />
� accounting politics, incl. useful lives for non-current assets, level of<br />
significance, etc.;<br />
� usually defined by the parent company in order to hold uniform<br />
consolidation politics.<br />
• The formulation of data needed for the conversion:<br />
� design of a “conversion bridge”, which will be used for the conversion<br />
(usually usage of spreadsheets);<br />
� definition of outputs from current accounting SW needed for the conversion<br />
(e.g. accounts receivable datasets with amounts and due dates);<br />
� definition of external inputs (e.g. interest rates for discounting of long-term<br />
receivables and payables, etc.).<br />
• The creation of a “conversion bridge”:<br />
� reclassification of items (usually between non-current and current);<br />
� remeasurement of accounting elements, when different measurement bases<br />
are applied under local GAAP and the IFRS;<br />
� elimination of items recognised only under local GAAP (e.g. certain kinds<br />
of provisions, capitalised establishment costs, etc.);<br />
� recognition of items required by the IFRS and not applied under local<br />
GAAP (e.g. finance leases assets and liabilities);<br />
� recognition of items required by IFRS 3 if a subsidiary was acquired within<br />
business combination;<br />
� calculation of all amounts relating to the conversion incl. deferred tax.<br />
• The preparation of financial statements and other information:<br />
� usually according to the template designed by a parent company.<br />
• The implementation of opening balance into accounting SW or other IS:<br />
� relevant only if dual accounting system will be used for keeping accounts<br />
(more details in next subchapter).<br />
The implementation of outputs and figures calculated within the conversion of<br />
financial statements is a process, which requires a lot of time. If an entity does not<br />
possess accounting software enabling parallel (dual) keeping of accounts under<br />
different set of accounting standards, implementation of a new information system or<br />
reengineering of the current software is needed. This is a timely and costly issue.<br />
Therefore many entities select other technical solutions, which will be used for the<br />
conversion of financial statements in subsequent periods.<br />
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2.2. Phase 2: Periodic financial statements conversion – technical solutions<br />
The advantages and disadvantages of various methods of financial statements<br />
conversion are relevant especially in case of regular (e.g. monthly) reporting. No<br />
general advice, which solution to adopt, exists. Each entity should have take into<br />
account its specific conditions and chose an approach mixing benefits and cost in the<br />
most favourable manner.<br />
There are three basic approaches how to transform financial statements from one set<br />
of accounting standards to another set of financial statements (Mejzlík, 2006):<br />
• conversion on financial statements level;<br />
• conversion on trial balance level;<br />
• dual accounting system (separate module for each set).<br />
The choice of conversion method appropriate for an entity depends on many factors,<br />
at least labour and ICT costs, number and nature of differences, frequency of and<br />
deadlines for reporting should be taken into consideration.<br />
Conversion on financial statements level<br />
This method uses only the reclassification of items presented in statutory financial<br />
statements. The main advantages of the method are:<br />
• easy and quick to implement;<br />
• no specialised ICT is needed;<br />
• low cost and labour burden;<br />
• easy to check the correctness of adjustments.<br />
The disadvantages are:<br />
• applicable only if the number of differences is very low (no measurement,<br />
recognition, accounting policies issues);<br />
• workable only for those cases when classification is the only one difference.<br />
Conversion on trial balance level<br />
In this case, the list of accounts (trial balance) based on local GAAP is exported from<br />
an accounting software and then adjustments are made in spreadsheets (like Excel).<br />
The following pros can be identified:<br />
• no specialised ICT is needed (data spreadsheets are sufficient),<br />
• applicable even if the number of differences is higher.<br />
The cons of this method are:<br />
• applicable only for differences in recognition of items (provisions, IFRS 3<br />
recognised assets); however not operational for different measurement issues<br />
(work-in progress) and dissimilar accounting policies (depreciation);<br />
• additional accounting expert for the IFRS should be employed => higher<br />
salary expenses;<br />
• conversion system is designed by the expert => his/her substitution in case of<br />
illness or termination of the job is questionable and sometimes even excluded<br />
without additional significant costs;<br />
• testing of the correctness and conclusiveness of the „conversion bridge“ is<br />
complicated and causes additional problems esp. for auditors;<br />
~ 216 ~
• the consistency of adjustments within periods and data relationships (e.g.<br />
retained earnings) are hard to hold;<br />
• the way of archiving of underlying documents relating to the conversion,<br />
which is made outside the accounting system, is an open issue.<br />
Moreover, this method is indecisive as far as meeting reporting deadlines concerns.<br />
After all transactions according to local GAAP are recorded, no additional<br />
transactions need to be recorded into the accounting system. However, afterwards the<br />
whole conversion process has to be carried out.<br />
Timely and error-free data recording is a limiting factor of this method. Most delays<br />
are caused because deadlines for recording of transactions are not held, e.g. missing<br />
transactions are accounted for additionally due to delay of underlying documentation<br />
and the whole conversion must be run once again. Predefined tables, macros and other<br />
automatic calculations may mitigate the negative consequences of those delays,<br />
although not in all cases.<br />
Dual accounting system<br />
The accounting system is set up so as it enables entities to record all transactions<br />
twice regarding on the different requirements of the both financial reporting<br />
standards. There are following plusses of this method:<br />
• all types of differences could be included;<br />
• conclusiveness and objectivity is secured as all „adjustments“ are incurred<br />
directly in SW modules;<br />
• customisation of accounting SW is possible and more outputs for management<br />
are available;<br />
• the only viable solution if number of difference is very high;<br />
• possible integration of accounting software with consolidation reporting<br />
systems and other ICT systems.<br />
This method has following minuses:<br />
• implementation of a new or an upgrade of current SW is needed => additional<br />
costs and changes in processes;<br />
• more transactions are recorded (more workload => additional employees =><br />
higher labour costs);<br />
• question is how to record the transactions (all transaction to record twice in<br />
each module or to make special module for different transactions only);<br />
• way of archiving of the documents is not clear-cut (shall be documents<br />
numbered, ordered and stored according to local GAAP or IFRS or in a<br />
combined manner?).<br />
This method of conversion of financial statements brings uncertain results regarding<br />
the reporting deadlines. More transactions need to be recorded into accounting<br />
software. However, if all is recorded, additional adjustments are not needed, as both<br />
sets of financial statements can be exported directly from accounting software.<br />
Moreover, recording of additional transactions do not cause any serious delays,<br />
because updated IFRS statements can be retrieved from accounting software<br />
immediately.<br />
~ 217 ~
2.3. Phase 3: Consolidation of individual financial statements – technical<br />
solutions<br />
After individual statements are converted for consolidation purposes, the<br />
consolidation can be processed. The way of submission of individual statements to<br />
parent company is a general problem of consolidation independent on the conversion<br />
of financial statements process. The phenomenon exists even if all consolidated<br />
entities use the same financial reporting standards in their statutory accounts.<br />
However, the technical solution of this issue is often interconnected with a method<br />
used for the conversion. Particular design of consolidation or reporting system<br />
depends on:<br />
• the size of consolidation group;<br />
• the informational needs for managing the concern;<br />
• costs of each solution.<br />
There are several possible ways how group entities can submit their financial<br />
statements to parent companies.<br />
• Separate spreadsheet tables without any links:<br />
� consolidation is made „by hand“ or data are entered into a relatively simple<br />
system;<br />
� can be applied only if the structure of a consolidation group is relatively<br />
simple (two or three companies, low number of intragroup transactions,<br />
etc.);<br />
� a method requiring low costs.<br />
• Integrated spreadsheet file with links:<br />
� consolidation is made by the merging predefined spreadsheets files filled-in<br />
by all companies;<br />
� applicable if consolidation group is not to big (several companies – usually<br />
not more than eight);<br />
� if there are a lot of links among files and many intragroup transactions to be<br />
eliminated, Random Access Memory may not be able to process the<br />
calculations and computer systems may fall down;<br />
� a low cost method; hard to hold consistency between periods; problematic<br />
for auditors to check interconnections between individual and consolidated<br />
statements.<br />
• Special consolidation software:<br />
� developed directly by a parent company or purchased solution customised<br />
according to requirements of a consolidating company;<br />
� some types of consolidation software is based on spreadsheets (usually<br />
break-down systems – from the top to the bottom) – software typically<br />
developed internally by consolidation group, e.g. by programming new<br />
functions in spreadsheet software and then integrated with data warehouse;<br />
� other types of software work with databases (usually sum-up systems –<br />
from the bottom to the top) – typically stand-alone software purchased from<br />
external IT company;<br />
� relatively expensive; conclusive; easy to check by auditors.<br />
• Integrated accounting/consolidation SW:<br />
� the highest level of integration of accounting and consolidation software;<br />
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� all-in-one solution, when entities keep their accounts in accounting<br />
software and parent company retrieve data directly from accounting module<br />
into consolidation module;<br />
� relatively expensive solution; all advantages of keeping accounts within<br />
one integrated system.<br />
3. EVALUATION OF THE FINANCIAL REPORTING DEVELOPMENT<br />
IN THE CZECH REPUBLIC<br />
3.1 Regulation of financial reporting in the Czech Republic<br />
As a member state of the EU, regulation of accounting in the Czech Republic shall<br />
conform to the EU legislation. The chief source of the EU guidance comes from the<br />
following documents.<br />
• Fourth Council Directive 78/660/EEC of 25 July 1978 based on Article 54 (3)<br />
(g) of the Treaty on annual accounts of certain types of companies (incl.<br />
subsequent amendments);<br />
• Seventh Council Directive 83/349/EEC of 13 June 1983 based on the Article<br />
54 (3) (g) of the Treaty on consolidated accounts;<br />
• Regulation (EC) 1606/2002 of the European Parliament and of the Council of<br />
19 July 2002 on the application of international accounting standards.<br />
Regulation on International Accounting Standards ordains a duty to prepare<br />
consolidated financial statements by publicly traded companies. Member states may<br />
broaden the scope of entities, which are obliged/allowed to apply the IFRS (e.g. in<br />
individual financial statements of listed companies or in individual/consolidated<br />
financial statements of non-listed companies).<br />
The main means of Czech national accounting regulation is the code law. The Czech<br />
accounting and financial reporting is regulated by:<br />
• Act No. 513/1991 Coll., Commercial code;<br />
• Act No. 563/1991 Coll., on accounting;<br />
• Decree of Ministry of Finance No. 500/2002 Coll., amending some enactments<br />
of Act No. 563/1991 Coll., on accounting, in the financial statements of<br />
business enterprises;<br />
• Czech Accounting Standards (further “CAS”) for business enterprises subject<br />
to Decree of Ministry of Finance No. 500/2002 Coll.<br />
Act on accounting until 2010<br />
Despite the fact that EU regulations are generally binding in their entirety and are<br />
directly applicable in all member states of the EU without any further implementation<br />
in national legislations, the provisions of Regulation (EC) 1606/2002 were<br />
incorporated directly in the Act No. 563/1991 Coll., on accounting. The obligation to<br />
prepare consolidated financial statements accoutring to the International Accounting<br />
Standards as adopted by the EU by companies listed on the EU capital markets is<br />
included in §23a, article 1. However, the Czech regulator of accounting went one step<br />
further and set up a duty for listed companies to prepare also their individual financial<br />
statements according to the IFRS. Pursuant to § 19, article 9 “entities, which are<br />
business companies and which are the issuers of securities publicly traded on a<br />
regulated market in the member states of the European Union, shall apply the<br />
~ 219 ~
International Accounting Standards as adopted by the EU for keeping their accounts<br />
and for preparation of financial statements”.<br />
In addition, the IFRS can be applied in consolidated financial statements of non-listed<br />
companies voluntarily (§23a, article 2).<br />
No other entities were allowed to choose the IFRS on voluntary basis.<br />
Act on accounting from 2011<br />
After several years of effort by academics and practitioners, the Ministry of Finance<br />
proposed an amendment of Act on accounting, which was approved by the Parliament<br />
in 2010. Starting from 2011, companies specified by the Act are allowed to select the<br />
IFRS as the basis for preparation of individual financial statements, which are<br />
accepted for statutory purposes. Pursuant to the new §19a, articles 7 and 8, following<br />
three groups of entities may opt to use the IFRS in their individual financial<br />
statements:<br />
• parent companies preparing consolidated financial statements in compliance<br />
with the IFRS voluntarily pursuant to §23a, article 2;<br />
• subsidiaries belonging to a consolidation group for which the consolidating<br />
company prepares IFRS consolidated statements;<br />
• joint ventures belonging to a consolidation group for which the consolidating<br />
company prepares IFRS consolidated statements.<br />
The amendment of the Act has changed the features of companies covered by<br />
Category II (see their description further in the text). From 2011, the Category II<br />
entities can opt whether to prepare two sets of financial statements (both CAS and<br />
IFRS) or whether to prepare only one set of financial statements (just IFRS).<br />
3.2 Issues regarding the implementation of Regulation (EC) 1606/2002<br />
The adoption of IFRS in the EU has elicited new practical problems for companies<br />
affected. Member states of the EU follow different paths when implementing<br />
Regulation 1606/2002. Some countries have enacted only minimal requirements set<br />
up by the Regulation, i.e. only the obligation to prepare consolidated financial<br />
statements in compliance with the IFRS by listed companies; other countries have<br />
broadened the scope to their individual statements. Compulsory or voluntary<br />
application of the IFRS by non-listed companies is also possible in some countries.<br />
Following approaches are preferred in selected countries:<br />
• Compulsory IFRS application in consolidated statements of listed companies<br />
(pursuant to EU Regulation) and simultaneously<br />
� compulsory IFRS application in individual statements (e.g. Italy, Iceland,<br />
Cyprus, Malta, Greece, Slovakia, the Czech Republic);<br />
� compulsory application of local GAAP in individual statements (e.g.<br />
Austria, Belgium);<br />
� right of choice between local GAAP and IFRS in individual statements (e.g.<br />
the Netherlands, Denmark, Ireland, Hungary).<br />
• Compulsory IFRS application in consolidated statements of non-listed<br />
companies and simultaneously<br />
� compulsory IFRS application in individual statements (e.g. Cyprus, Malta).<br />
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• Voluntary application of the IFRS in consolidated statements of non-listed<br />
companies and simultaneously<br />
� compulsory application of local GAAP in individual statements (e.g. the<br />
Czech Republic before 2010);<br />
� right of choice between local GAAP and IFRS in individual statements (e.g.<br />
the Netherlands, the Czech Republic after 2011).<br />
• Compulsory/voluntary application of the IFRS in individual statements of nonlisted<br />
companies (e.g. Denmark, Estonia, Finland, Ireland, the Netherlands,<br />
Poland, etc.).<br />
As far as financial reporting concerns, three groups of Czech companies can be<br />
recognised. To summarise, provisions of the Czech Act on Accounting distinguished<br />
following groups of companies until 2010:<br />
• Category I (very heterogeneous bulk of Czech companies that are publicly<br />
traded on stock exchanges in the EU markets – IFRS reporting only):<br />
These entities have both to account for their transactions and to prepare their financial<br />
statements (both individual and consolidated) using the IFRS. These companies are<br />
not required to prepare their financial statements according to the Czech Accounting<br />
Standards (further “CAS”) as financial statements prepared in accordance with the<br />
IFRS are also accepted for the statutory purposes.<br />
• Category II (majority of big companies, small and medium-sized enterprises –<br />
both CAS and IFRS reporting):<br />
This category covers a diverse group of companies, for which the common feature is<br />
that companies in question are not a direct issuer of publicly traded securities.<br />
Nevertheless, their owners are such issuers. Therefore, the companies belonging to<br />
this category shall prepare their individual financial statements in accordance with the<br />
CAS for statutory purposes. In addition, they are supposed to provide their parent<br />
companies with financial statements and other information needed for consolidation<br />
in compliance with the IFRS. Act on accounting until 2010 did not permit any<br />
voluntary application of the IFRS instead of the CAS by this kind of entities.<br />
Companies preparing consolidated financial statements voluntarily pursuant to §23a,<br />
article 2 may be also subsided in this group.<br />
• Category III (Small and medium-sized enterprises – only CAS reporting):<br />
Category III covers family owned companies and other companies that are neither<br />
direct, nor indirect issuer of publicly traded securities. They shall account for and<br />
report in accordance with the CAS (again without possibility to apply the IFRS<br />
voluntary).<br />
Provisions of Act on accounting required mandatory application of the IFRS not only<br />
in consolidated financial statements of listed companies (pursuant to Regulation<br />
1606/2002), but also mandatory application of the IFRS in their individual statements.<br />
Individual financial statements are accepted for statutory purposes levied by the<br />
Commercial Code and are submitted to Business Register. That means that listed<br />
companies (Category I companies) are not engaged in the process of financial<br />
statements conversion, as both individual and consolidated financial statements are<br />
prepared according to the IFRS and no additional set of financial statements prepared<br />
in accordance with the Czech Accounting Standards (CAS) is necessary.<br />
~ 221 ~
The conversion of financial statements was an important issue for companies covered<br />
by Category II. The majority of Czech companies are not directly listed on stock<br />
exchanges (there are only 60 issuers listed on Prague Stock Exchange). According to<br />
Act on accounting, all non-listed companies had to keep their accounts and prepare<br />
their individual financial statements in accordance with the Czech accounting<br />
legislation. However, about 40% of Czech companies are under control of foreign<br />
owners. A lot of them are domiciled in Germany, Netherlands, Austria and other EU<br />
member states and they are often listed on stock exchanges. For the consolidation<br />
purposes, Czech companies must provide their parent companies with IFRS financial<br />
statements.<br />
As a voluntary application of the IFRS in individual financial statements had not been<br />
allowed till the end of 2010, affected companies faced a problem of financial<br />
statements conversion. Statutory accounts were held in compliance with the CAS; and<br />
consequently statutory statements had to be converted into IFRS statements.<br />
The conversion is not a trivial issue as a huge number of differences between CAS<br />
and IFRS exist. The crucial conceptual weak points of financial reporting under the<br />
CAS are:<br />
• no identification of users of financial statements and of their needs (it is not<br />
explicitly expressed, but state and its authorities are considered to be the<br />
primal user of financial statements);<br />
• absent specification of objectives of financial reporting;<br />
• vague requirements on qualitative characteristics that determine critically<br />
usefulness of information in financial statements;<br />
• absent definitions of fundamental accounting elements;<br />
• misinterpreted notion of true and fair view;<br />
• unsound and/or missing accounting principles for many accounting spheres.<br />
The situation becomes worse, when we deal with accounting treatment of certain<br />
items. PricewaterhouseCooper (2009) published a comprehensive analysis, which<br />
comprises differences between IFRS and CAS on 80 pages. Therefore, the decision,<br />
which method of conversion to use, needs a deeper analysis by an entity’s<br />
management. All relevant advantages, disadvantages, possible benefits and cost<br />
restrains should be taken into account.<br />
With reference to a general analysis carried out earlier, the first method of conversion<br />
(on financial statements level) is not appropriate for the vast of Czech companies, as<br />
differences between CAS and IFRS are not insignificant. Remaining two approaches<br />
are therefore favoured by Czech companies. The second method of financial<br />
statements conversions (on trial balance level with usage of spreadsheet applications<br />
like Excel, OpenOffice, etc.) represents “golden middle way”, as benefits and costs<br />
are balanced for the majority of Czech companies reporting both under CAS and<br />
IFRS. Low level of conclusiveness and dependence on the only one accounting expert<br />
responsible for the conversion is offset by significant ICT cost savings, because no<br />
specialised software is used under this approach. The last method (dual accounting<br />
system) is applied by those Czech companies belonging to consolidation groups<br />
which use the same accounting and reporting system for all group companies.<br />
Sometimes hardware and software is placed in another location (e.g. at a group<br />
central) and companies keep their accounts via remote access. Higher ICT (ERP or<br />
~ 222 ~
other sophisticated systems are used) and labour (more bookkeepers are needed for<br />
recording each transaction virtually twice) costs are counterbalanced by two dataset of<br />
information. Moreover, the conclusiveness and consistency of accounting records is a<br />
valuable asset of this method.<br />
3.3. Readiness of Czech non-listed companies for the switch to IFRS<br />
It is obvious that impossibility to apply the IFRS voluntary produces high social costs<br />
regardless, which method of conversion is chosen by entities. Scarce economic<br />
resources have to be employed in non-productive use. Academics and accounting<br />
profession tried therefore persistently to persuade the Ministry of Finance to amend<br />
the Act on accounting by enabling voluntary application of the IFRS in individual<br />
financial statements by Category II companies. The Ministry of Finance finally<br />
recognised this proposal to be justified. Starting from 2011, Czech companies, which<br />
are consolidated companies in the context of Regulation 1606/2002, can chose to<br />
prepare their individual financial statement in accordance with the IFRS. In case of<br />
optional application of the IFRS, financial statements conversion is not an issue<br />
anymore. However, companies may decide to maintain current status quo and to<br />
prepare their individual statements further under CAS principles.<br />
New provisions of the Act were enacted in December 2010. How many entities will<br />
utilise amendments of the Act is still uncertain. As the implementation of new<br />
accounting software is a quite complicated project, it is highly improbable that any<br />
companies have switched to the IFRS already from January 2011. First empirical<br />
evidence will not be available sooner than next year. Author of the paper carried out a<br />
quick empirical pre-research to evaluate the readiness of companies, external<br />
accounting firms, auditors and accounting software developing firms for the IFRS<br />
transition. A questionnaire containing two sets of questions was answered by ten<br />
accounting or auditing firms. The first group of questions relates to the possible extent<br />
of differences between the IFRS and CAS among various types of companies,<br />
namely:<br />
• How significant are differences between the IFRS and CAS among<br />
manufacturing companies?<br />
• How significant are differences between the IFRS and CAS among merchants?<br />
• How significant are differences between the IFRS and CAS among companies<br />
providing services (without financial sector)?<br />
Table 1. Differences between IFRS and CAS financial statements<br />
Insignificant<br />
Rather<br />
insignificant<br />
Rather significant Significant<br />
Manufacturers 0% 0% 60% 40%<br />
Merchants 80% 20% 0% 0%<br />
Services 0% 50% 40% 10%<br />
The second group of questions focuses on evaluation of readiness for the IFRS<br />
adoption by various subjects, namely:<br />
• How do you evaluate readiness of companies for voluntary application of the<br />
IFRS?<br />
• How do you evaluate readiness of external accounting firms for voluntary<br />
application of the IFRS?<br />
~ 223 ~
• How do you evaluate readiness of auditors for voluntary application of the IFRS?<br />
• How do you evaluate readiness of accounting software developing firms for<br />
voluntary application of the IFRS?<br />
Table 2. Readiness for voluntary application of IFRS by non-listed companies<br />
Certainly not Rather not Rather yes Certainly yes<br />
Entities 0% 10% 40% 50%<br />
Accounting firms 10% 30% 50% 10%<br />
Auditors 0% 50% 50% 0%<br />
Software firms 10% 80% 10% 0%<br />
Despite the fact, that the research is not fully representational because of restricted<br />
size of the sample, certain tendencies can be derived from the respondents’ answers.<br />
The reactions to the first set of questions affirm a general conclusion about high<br />
number of differences between the IFRS and CAS. According to professional<br />
accountants and auditors, this issue is relevant esp. for manufacturing companies<br />
(which create a significant part of Czech gross domestic product). In addition, entities<br />
providing services usually struggle with revenue recognition as there is no guidance<br />
on this issue (neither general, nor for the construction contracts) in CAS and revenue<br />
recognition is mainly influenced by legal and tax matters.<br />
As far as readiness for voluntary application of the IFRS concerns, companies are on<br />
the top of the list. Companies, currently preparing both sets of financial statements,<br />
should have relatively smaller difficulties when shifting from CAS statutory accounts<br />
to the IFRS. On the other side, it is believed that Czech software firms are not ready<br />
for the transition, which could bring problems for companies considering voluntary<br />
IFRS adoption. ICT solutions for keeping accounts according to the IFRS are offered<br />
by foreign software developers (such SAP, etc.). However, costs of this solution can<br />
be prohibitive for affected companies, esp. for medium sized enterprises.<br />
The possible advantages from a voluntary shift to IFRS in statutory accounting may<br />
be evaluated with reference to experience of Czech listed companies, which have to<br />
apply IFRS obligatory both in consolidated and individual financial statements. There<br />
are about 60 issuers on Prague Stock Exchange, from which were excluded some<br />
issuers such as public sector institutions (Ministry of Finance, City of Prague, City of<br />
Liberec), financial institutions and issuers with domicile located abroad.<br />
Representatives of 23 companies remaining in the sample were asked for filling-up a<br />
questionnaire scrutinizing benefits and costs from the IFRS implementation in their<br />
companies. The benefits mentioned by already-adopters may serve as a useful source<br />
of reference for those companies, who are contemplating about utilising of a new<br />
provision of Act on accounting allowing voluntary IFRS adoption in individual<br />
financial statements by designated entities. The answers of eleven respondents on<br />
benefits are summarized in Table 3.<br />
Table 3. Benefits from IFRS implementation on companies’ level<br />
Certainly Rather yes Rather not Certainly<br />
yes<br />
not<br />
Easier access to financing by share capital 73% 27% 0% 0%<br />
Easier access to financing by bonds 9% 55% 27% 9%<br />
Easier access to financing by bank credits 0% 45% 36% 18%<br />
~ 224 ~
Certainly Rather yes Rather not Certainly<br />
yes<br />
not<br />
Easier reporting within consolidation group 64% 36% 0% 0%<br />
Increased relevance of data for management 0% 27% 55% 18%<br />
Increased credibility for our trade partners 0% 64% 27% 9%<br />
Increased reputation for general public 0% 45% 55% 0%<br />
Once again, presented table cannot be supposed to represent generally valid<br />
inferences due to a restricted sample. However, it can be said that results are not<br />
surprising for the most of answers and they correspond to expectations. As IFRS are<br />
compulsory for listed companies, the connection between IFRS implementation and<br />
the possibility to raise share capital financing is very close. A successful issuance of<br />
bonds is also supported by the IFRS adoption, as capital markets are the only source<br />
of available debt funds even in such an undeveloped capital market like in the Czech<br />
Republic. Banks possess more tools for evaluating financial health of applicants for<br />
bank credits, therefore IFRS adopters do not perceive the shift to IFRS to be really<br />
relevant for this purposes. Based on personal talks with some representatives, IFRS<br />
statements play no role in banks’ assessment whether to grant a company with<br />
requested credit or not. Nevertheless, IFRS statements are said to reduce costs of<br />
preparing applications forms and other documentation required by bank significantly.<br />
The IFRS implementation is not supposed to enhance data relevance for management<br />
purposes. It is a quite interesting outcome, when taking into account relatively low<br />
relevance and usefulness of accounting principles set up by Czech national accounting<br />
legislation. There are at least two possible explanations to this phenomenon. Firstly,<br />
managers are accustomed to former Czech accounting standards, which they used for<br />
years, and their do not understand and/or do not believe in data based on the IFRS.<br />
Secondly, due to weakness of the CAS companies were forced to developed highquality<br />
management accounting systems removing those weak points and supplying<br />
relevant data for decision-making. Therefore, a shift to IFRS has not produced any<br />
significant increase in data relevance from managers’ point of view. This finding<br />
needs further attention and scrutiny.<br />
Representatives are indecisive regarding the influence of IFRS statements and annual<br />
reports on company reputation in the eyes of general public. On the other side, IFRS<br />
statements are supposed to be welcomed by trade partners. They are usually applied<br />
for credit scoring of customers and other risk management procedures. Finally, the<br />
IFRS implementation brought substantial advantages in the process of preparing<br />
consolidated financial statements. Representatives of all listed companies assert that<br />
the IFRS adoption has eased reporting within consolidation group. This may be the<br />
crucial supporting element for those Czech non-listed companies when evaluating<br />
whether to adopt IFRS voluntarily in individual financial statements as it is allowed<br />
by Act on accounting starting from 2011.<br />
CONCLUSIONS<br />
The IFRS implementation into the Czech legislation has brought new quality to<br />
financial reporting due to their usefulness in comparison with the CAS. On the other<br />
side, if the IFRS are not allowed to be applied voluntarily in individual financial<br />
statements of listed companies or in individual statements of non-listed companies<br />
belonging to a group consolidated in compliance with the IFRS, the necessity of<br />
~ 225 ~
financial statements conversion occurs. The second case is a common practice in the<br />
Czech Republic because Act on accounting did not enable non-listed entities to use<br />
the IFRS on a optional basis until 2010. The financial statements conversion is<br />
therefore an issue for almost 40% of Czech companies. To keep accounts according to<br />
two sets of relatively difference accounting standards in single accounting software is<br />
very costly matter. Therefore, most entities have chosen to make the conversion<br />
through Excel and similar data spreadsheets on trial balance level.<br />
Such an approach reduces costs significantly; however accuracy and transparency of<br />
the conversion process heavily rest on the abilities of a single expert who are in<br />
charge of the conversion. The conclusiveness of such conversions is not high in<br />
general. The author of paper has experience from a significant number of companies,<br />
of which financial statements converted from CAS to IFRS using trial balance method<br />
of conversion are not in compliance with all provisions of IFRS. Spreadsheets are not<br />
constructed to cope with all nuances of double-entry accounting. With rising number<br />
of differences between CAS and IFRS, omissions and computing mistakes are<br />
common feature of this method of financial statement conversion. Mistakes and<br />
omissions remain even after being checked by auditors. As a consequence, the quality<br />
of consolidated financial statements presented by parent companies may be severely<br />
impaired, because a lot of Czech companies create a significant part of consolidated<br />
figures. In my opinion, this is an issue of a fundamental importance not only for the<br />
Czech Republic, but worldwide. Nevertheless, this issue are not really addressed by<br />
either current practice or research.<br />
In the context of previous doubts, the amendment of Act on accounting by the end of<br />
2010, which enables selected companies to apply the IFRS voluntarily, shall be<br />
welcomed. By allowing companies to apply the IFRS in their individual statements,<br />
the Czech Republic follows pattern of financial reporting used e.g. in the Netherlands,<br />
Denmark, Ireland, etc. The amendment should lead to presenting accounting<br />
information, which is more useful for public. The second favourable effect would be<br />
the reducing cost connected with recording transactions and preparing financial<br />
statements under two different set of accounting standards. Finally, the risk of errors<br />
contained in consolidated financial statements would substantially decrease, because<br />
voluntary IFRS adoption in individual financial statement means that all records are<br />
kept within accounting software and not outside in spreadsheets.<br />
Claims to prepare individual statements compulsory according to national accounting<br />
legislation (e.g. for tax purposes) levy high costs on companies and have other<br />
negative economic consequences. National regulator of accounting should enable<br />
affected companies to prepare their individual statements on alternative basis, mostly<br />
in compliance with the IFRS. The development in the Czech Republic can serve as a<br />
source of inspiration for all those countries solving the relationship of financial<br />
reporting standards applied for consolidated and individual financial statements.<br />
However, more robust empirical evidence will be available earliest in 2013, as first<br />
companies will probably switch to the IFRS from year 2012.<br />
There are some restrictions impairing inferences of this study. Firstly, not all<br />
companies are allowed to apply the IFRS voluntarily. Only entities, which are subject<br />
of a full consolidation under IFRS principles, are allowed to take advantage of the<br />
option offered by the amendment of Act on accounting. As a consequence, companies<br />
~ 226 ~
classified as investments in associate and consolidated by equity method are excluded<br />
from this option.<br />
The crucial problem is, although, that Czech accounting is closely linked with the<br />
taxation system. For the computation of current income tax, only net income<br />
according to the CAS is relevant. Therefore, all companies regardless whether they<br />
prepare individual financial statements according to the IFRS compulsory or<br />
voluntarily have to keep evidence of taxable income based on the CAS. Without<br />
releasing financial accounting from the income tax law, the conversion of financial<br />
statements will remain a common practice for Czech companies. Author of the paper<br />
is a member of a researcher team that is currently working on a study evaluating<br />
various approaches how tax system can be separated from the financial reporting. The<br />
future conclusions of this study can be valid for all countries, in which state regulator<br />
carries out the regulation of financial reporting mainly for the tax purposes.<br />
ACKNOWLEDGEMENT<br />
The paper is processed as an output of a research project “Auxiliary Computer<br />
Applications – Support for the IFRS Implementation in Business Practice” supported<br />
by the Internal Science Foundation of the University of Economics, Prague<br />
(registration number F1/3/2010).<br />
REFERENCES<br />
Aubert, F., Grudnitski, G. (2009) “The Importance and Impact of Mandatory Adoption of<br />
International Financial Reporting Standards in Europe”, Tampere, 32nd Annual<br />
Congress of the European Accounting Association, 12. 5. 2009 – 15. 5. 2009.<br />
Bagaeva, A. (2009) “The IFRS and Accounting Quality in the Transitional Economy: A Case<br />
of Russia”, Tampere, 32nd Annual Congress of the European Accounting Association,<br />
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Barth, M. E., Landsman, W. R., Lang, M. H. (2008) “International Accounting Standards<br />
and Accounting Quality”, Journal of Accounting Research, 2008, vol. 46, is. 3, pp.<br />
467–498.<br />
Christensen, H. B., Lee, E., Walker, M. (2009) “Do IFRS Reconciliations Convey<br />
Information? The Effect of Debt Contracting”, Journal of Accounting Research,<br />
vol. 47, is. 5, p. 1167–1199.<br />
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forward, Brussels, CEC, 13.06.2000.<br />
Cordazzo, M. (2008) “The Impact of IAS/IFRS on Accounting Practices: Evidences From<br />
Italian Listed Companies”, Rotterdam, 31st Annual Congress of the European<br />
Accounting Association, 22. 4. 2009 – 25. 4. 2009.<br />
Dumontier, P., Maghraoui, R. (2007) “Does the Adoption of IAS-IFRS Reduce Information<br />
Asymmetry Systematically?”, Lisbon, 30th Annual Congress of the European<br />
Accounting Association, 24. 4. 2009 – 27. 4. 2009.<br />
Ferrer, C., Callao, S., Jarne, J. I., Lainez, J. A. (2009) “IFRS Adoption in Spain and the<br />
United Kingdom: Effects on Accounting Numbers and Relevance”, Tampere, 32nd<br />
Annual Congress of the European Accounting Association, 12. 5. 2009 – 15. 5. 2009.<br />
International Accounting Standards Board 2009 International Financial Reporting Standards<br />
2009 bound volume. London: IASB, 2009. ISBN 978-1-905590-90-2.<br />
Inwinkl, P., Aussenegg, W (2009) “Earnings Management and Local vs. International<br />
Accounting Standards of European Public Firms”, Tampere, 32nd Annual Congress of<br />
the European Accounting Association, 12. 5. 2009 – 15. 5. 2009.<br />
~ 227 ~
Jaruga, A., Fijalkowska, J., Frendzel, M., Jaruga-Baranowska, M. (2007) “The Impact of<br />
IAS/IFRS on the Accounting Regulations and Practical Implementation in Poland”,<br />
Lisbon, 30th Annual Congress of the European Accounting Association, 24. 4.<br />
2009 – 27. 4. 2009.<br />
Lee, E., Walker, M., Christensen, H. B. (2008) Mandating IFRS: its Impact on the Cost of<br />
Equity Capital in Europe, London: The Association of Chartered Certified<br />
Accountants, 2008.<br />
Marquez-Ramos, L. (2009) “The Effect of IFRS Adoption on Trade and Foreign Direct<br />
Investments”, Tampere, 32nd Annual Congress of the European Accounting<br />
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systémy], Prague: Oeconomica Publishing house, 2006.<br />
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Influence of Country-Specific Factors”, Lisbon, 30th Annual Congress of the European<br />
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the European Accounting Association, 12. 5. 2009 – 15. 5. 2009.<br />
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PS5 Fair value<br />
Chairperson<br />
Mihaela DUMITRANA, Bucharest Academy of Economic<br />
Studies, Romania<br />
THE IMPACT OF THE ED/2009/5 FAIR VALUE<br />
MEASUREMENT ON THE PROFESSIONALS<br />
Mirela PAUNESCU, Mirela NICHITA<br />
~ 229 ~
THE IMPACT OF THE ED/2009/5 FAIR VALUE<br />
MEASUREMENT ON THE PROFESSIONALS<br />
Mirela PĂUNESCU 1 & Mirela NICHITA<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
The main objective of this research is to find out the reaction that the Exposure Draft issued<br />
by IASB on Fair value measurement had on different types of respondents. The main data<br />
comes from the IASB’ web site and consists in the comment letters the responded submitted<br />
on IASB’s request. As we will see, the vast majority of the respondents were in favour of the<br />
project, even if they (almost) all had something to comment on specific issues. The main<br />
objections of the respondents and their main suggestion were revealed as a result of this piece<br />
of research. Our study contributes to the accounting literature by examining the users’<br />
opinions on the Exposure Draft issued by IASB in the first stage. When new standard will be<br />
published, we intend to trace the modification and deviation from the ED in the new standard<br />
based on the users’ comments.<br />
KEYWORDS: Fair value measurement, exposure draft, comment letters, SFAS 157<br />
INTRODUCTION<br />
The fair value measurement model over the past years is a requirement or an<br />
alternative offered to entities among several IFRSs. In some case, the use of fair value<br />
is mandatory (such as for financial instruments, for investment property and so on), in<br />
other it is the company’s option (such as for measuring fixed assets). But the<br />
definition of fair value and the requirements related to disclosure is to be found in<br />
several IFRSs. Until nowadays, many IFRSs provide disparate, inconsistent and<br />
sometimes limited, guidance on how to measure or to disclose information about the<br />
fair value. This is why in September 2005 the Board added to its agenda a project to<br />
clarify the meaning of fair value and to provide guidance for its application in IFRSs.<br />
As a result, in November 2006 IASB published a discussion paper on Fair Value<br />
Measurements. In line with the past and as a reflection of the need for increased<br />
convergence with US generally accepted accounting principles (US GAAP), the<br />
paper’s starting point was the Statement of Financial Accounting Standards No. 157<br />
Fair Value Measurements (SFAS 157). The paper issued by IASB and SFAS 157 are<br />
almost identical in all respects. As the Americans moved faster, IASB took advantage<br />
of the fact that their standard was already published and applicable. But the draft<br />
discussion is only the starting point as IASB published 13 questions for which it<br />
requested responses. The number of received comment letters exceeds 150.<br />
1<br />
Correspondence address: Mirela PĂUNESCU, Bucharest Academy of Economic Studies, Romania;<br />
email: mirela.paunescu@gmail.com<br />
~ 230 ~
1. BACKGROUND<br />
The main objective of our research is to find out the reaction the Exposure Draft<br />
issued by IASB on Fair value measurement had on different types of respondents<br />
(more precisely on big accounting companies, professional bodies, banks and banks’<br />
regulators, universities, and so on). The main data comes from the IASB’ web site and<br />
consists in the comment letters the responded submitted on IASB’s request.<br />
As we will see, the vast majority of the respondents were in favour of the project,<br />
even if they (almost) all had something to comment on specific issues. The main<br />
objections of the respondents and their main suggestion were revealed as a result of<br />
this piece of research.<br />
We will not approach in this piece of research the subject of the validity of the fair<br />
value model, its pros and cons, nor even the reaction of professional toward the fair<br />
value model as a result of the financial crisis.<br />
Our study contributes to the accounting literature by examining the users’ opinions on<br />
the Exposure Draft issued by IASB in the first stage.<br />
1.1. A short history of the ED on Fair Value Measurement<br />
IASB’s intention is to provide a framework for measuring fair value and disclosure<br />
about fair value. This ED does not introduce new fair value measurements, nor is<br />
intended to change the rule neither of measuring the fair value nor for choosing a<br />
model based on the fair value. IASB planed only to specify how entities should<br />
measure fair value and disclose fair value information and not when entities should<br />
measure assets and liabilities at fair value. The new coming Standard will only apply<br />
when other IFRSs require or permit fair value measurements or disclosures and not to<br />
measurements that are only similar to fair value in some respects.<br />
Following the above mentioned discussion draft paper, in March 2008 the Board<br />
published a discussion paper named Reducing Complexity in Reporting Financial<br />
Instruments aiming to consider how to simplify the reporting of financial instruments,<br />
including when fair value is an appropriate measurement basis for financial<br />
instruments.<br />
In March 2009 the Board issued Improving Disclosures about Financial Instruments.<br />
That document aims to enhance disclosures about fair value measurements of<br />
financial instruments.<br />
1.2. Literature review<br />
From our knowledge, there is no similar study conducted on this issue. On the other<br />
hand, IASB by itself published a short letter with its own interpretation on the<br />
respondents’ views and answer on the questionnaire. In order to be as objective as<br />
possible, we did not read this material before conducting our study. We have<br />
researched by our own the answers, and in the end we have made a comparison with<br />
the findings of IASB. Our findings may be a little different from IASB’s and the<br />
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difference is normal and justified by the subjective factor coming from interpretation<br />
of descriptive answers.<br />
1.3. The main requirements of the exposure draft<br />
As we have mentioned before, IASB’s intention is to provide a framework for<br />
measuring fair value and disclosure about fair value. Probably the most important<br />
aspect of the ED is the definition of the fair value (par. 1 ED):<br />
“The amount for which an asset could be exchanged, a liability settled, or an equity<br />
instrument granted could be exchanged, between knowledgeable, willing parties in an<br />
arm’s length transaction”.<br />
In order to appraise the fair value, the entity must identify the reference market and<br />
the market participants. The market to be used is the most advantageous market to<br />
which the entity has access. The most advantageous market is the market that<br />
maximizes the amount that would be received to sell the asset after considering<br />
transaction costs and transport costs, and it is in most of the cases the principal market<br />
of the entity, meaning the market with the greatest volume and level of activity for the<br />
asset.<br />
As for the market participants, even if the entity should not identify them specifically,<br />
it should consider their characteristics and the fact that they must be independent of<br />
each other; knowledgeable, able and willing to enter into a transaction for the asset.<br />
Also very interesting is the assumption on which the pricing of the fair value is based,<br />
namely the highest and the best use. More precisely, when there is no actual<br />
transaction in order to freely observe the price, in order to asses the price that market<br />
participants would use for the asset the entity must assume that the market participant<br />
will use the asset in its highest and best use (HBU) that is physically possible, legally<br />
permissible and financially feasible at the measurement date, and, accordingly will<br />
maximise the value of the asset or the group of assets.<br />
The highest and best use of the asset may be “in use” or “in exchange”. HBU is ‘in<br />
use’ if the asset would provide maximum value to market participants mainly through<br />
its use, on a stand alone base or in combination with other assets. If the highest and<br />
best use of the asset is in use, the fair value of the asset shall be measured using an inuse<br />
valuation premise. HBU is “in exchange” if the asset would provide maximum<br />
value to market participants principally on a stand-alone basis. If the highest and best<br />
use of the asset is in exchange, the fair value of the asset shall be measured using an<br />
in-exchange valuation premise.<br />
A change from the previous rules is set by the ED’s requirement regarding the<br />
treatment of the fair value at initial recognition of the item. According to par. 34 ”if an<br />
IFRS requires or permits an entity to measure an asset or liability initially at fair value<br />
and the transaction price differs from fair value, the entity recognizes the resulting<br />
gain or loss in profit or loss unless the IFRS requires otherwise”.<br />
In order to estimate the price at which an orderly transaction would take place<br />
between market participants, the entity must use valuation techniques. Those<br />
techniques may relate the market approach, income approach or cost approach. The<br />
market approach uses prices and other relevant information generated by market<br />
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transactions involving identical or comparable assets or liabilities (including a<br />
business). The income approach uses valuation techniques to convert future amounts,<br />
such as cash flows or income to a single present (discounted) amount. The cost<br />
approach reflects the amount that would currently be required to replace the service<br />
capacity of an asset and it is often referred to as current replacement cost.<br />
The assumptions that market participants would use when pricing the asset or liability,<br />
are named by the ED “inputs” to the valuation technique. Such inputs may be:<br />
(a) Observable inputs – that are developed on the basis of available market data and<br />
reflect the assumptions that market participants would use when pricing the item.<br />
(b) Unobservable inputs – inputs for which market data are not available and that are<br />
developed on the basis of the best information available about the assumptions that<br />
market participants would use when pricing the item.<br />
Perhaps one of the most important step forward made by IASB was the attempt to<br />
standardized the computation of fair value by prioritizing the inputs in 3 levels (part<br />
of the fair value hierarchy). Actually, the entity must used first all the level 1 inputs<br />
available ( they are given the highest priority), than level 2 and if there is no other<br />
choice available, level 3 inputs may be used ( they are given the lowest priority).<br />
According to IASB’s view, level 1, inputs are unadjusted quoted prices in active<br />
markets for identical assets or liabilities that the entity can access at the measurement<br />
date.<br />
Level 2 inputs are inputs (other than quoted prices included within Level 1) that are<br />
observable for the asset or liability, either directly (for example prices) or indirectly<br />
(i.e. derived from prices) for substantially the full term of the asset or liability.<br />
Included in Level 2 inputs are the following:<br />
(a) Quoted prices for similar assets or liabilities in active markets;<br />
(b) Quoted prices for identical or similar assets or liabilities in markets that are<br />
not active (paragraph B5 provides examples of factors that may indicate that a market<br />
is not active)<br />
(c) Inputs other than quoted prices that are observable for the asset or liability<br />
(e.g. interest rates and yield curves observable at commonly quoted intervals,<br />
volatilities, prepayment speeds, loss severities, credit risks and default rates)<br />
(d) Inputs that are derived principally from or corroborated by observable<br />
market data by correlation or other means (market-corroborated inputs).<br />
As we can see the inputs in the second level require adjustments in order to be used.<br />
Level 3 inputs, according to par 53, “are inputs for the asset or liability that are not<br />
based on observable market data (unobservable inputs)”. Unobservable inputs shall be<br />
used to measure fair value only when relevant observable inputs are not available,<br />
meaning when there is little or no market activity for the asset or liability at the<br />
measurement date. But, as the fair value measurement objective remains the same<br />
(which is an exit price from the perspective of a market participant that holds the asset<br />
or owes the liability), unobservable inputs still shall reflect the assumptions that<br />
market participants would use when pricing the asset or liability, including<br />
assumptions about risk.<br />
As for disclosure requirements, the entity shall disclose information that enables users<br />
of its financial statements to assess the methods and inputs used to develop those<br />
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measurements and, for fair value measurements using significant unobservable inputs<br />
(Level 3), the effect of the measurements on profit or loss or other comprehensive<br />
income for the period.<br />
2. HYPOTHESIS DEVELOPMENT<br />
2.1. Research Design<br />
The main objective of the research is the analysis of the extent to which new adopted<br />
accounting values, and especially the fair value, answer to the need of informational<br />
for users that do not only want to know what were the results for the previous<br />
financial period, but they’d like to be able to anticipate future trends based on<br />
information released by the financial statements. Alternatively, we analyzed and tried<br />
to group and summarize the main criticisms or proposals developed by the IASB<br />
improvements project and we tried to determine whether the responses analyzed in<br />
homogeneous classes of respondents are consistent. Our assumptions were that<br />
respondents (by category) will identify the same problems and propose the same<br />
changes, but these assumptions have been contradicted in some respects by the<br />
research conducted. We have also tried to draw a conclusion with regards of how fair<br />
value will be accepted after IFRS publishes a standard for measuring it, and to<br />
consider "maturity" as its concept.<br />
2.2. Sample selection<br />
In order to infer the results found after analyzing letters of comments received by<br />
IASB, we used typical methods of descriptive statistics. The population was made up<br />
of letters of comments received by IASB as a result of the questions published by<br />
IASB on its own site (www.ifrs.org or www.iasb.org). Comments came from a<br />
questionnaire containing 13 questions and any interested person could have expressed<br />
their views. Number of individuals in the population (in our case the number of letters<br />
published) was 160. The research was conducted on a sample basis, the number of<br />
individuals in the sample was 100 (i.e. 62.5% of total population) and by that we<br />
made sure that we have selected a sufficient number of responses from all categories<br />
we have previously identified. Thanks to the high population we believe that the<br />
sample is representative for the population and so we can draw conclusions relevant to<br />
this level.<br />
We usually avoided the letters from individuals, noting from past experience that they<br />
do not have full capacity to respond to all issues in the questionnaire (which in<br />
principle we wanted) or they generally tend to agree or disagree with the IASB project<br />
without, however, bringing qualitative arguments for their opinion. In contrast, with<br />
exceptions, are entities famous or at least well known in their category (such as<br />
regulatory bodies, banks and universities) that have been able to justify their<br />
arguments for a response, pro or contrary to the belief of IASB.<br />
Sampling was done by using a stratification method. The population was then divided<br />
into layers and from those layers either all individuals were chosen or we have applied<br />
a controlled selection for that layer. The reasons for choosing this method were as<br />
follows: the investigator knew the population (the letters were numbered and<br />
respondents were identified by name and / or institution, the country they came from<br />
~ 234 ~
and the representative body which they have represented), those who responded to<br />
questions were not uniform (different backgrounds, with different interests), we aimed<br />
to capture the views of each significant category identified, in some layers / categories<br />
there was a significant number of individuals while in others (significant categories<br />
for the research) there was a very small number (for example in „Other groups” or<br />
„Regulatory institutions / bodies” individuals were numerous, while in „Large<br />
accounting companies” or „Universities” the number of individuals who answered the<br />
questions was small) and the last reason is that that some groups have had the<br />
resources of all kinds so they have answered to all ( or almost ) all of the to questions,<br />
while others had not and such they either did not give a relevant response or did not<br />
answered for more than one or two questions (e.g. letters of response from the large<br />
accounting firms have a high qualitative value, the respondents argued their views,<br />
even contrary to those of the IASB, with well-grounded arguments, while individuals<br />
who responded personally were either simply approving or not, but they did not<br />
presented any arguments to contradict or to agree with the 13 questions in the<br />
questionnaire).<br />
Out of the 13 questions we have chosen 8 questions for which we have processed the<br />
answers. Selection criteria was based on the question’s relevance for the research<br />
questions, the type of response that the question demanded and the importance we<br />
granted to the question with reference to our research.<br />
The number of those who answered a straight „yes” or „no” for the questions was<br />
very low. In fact, from all the responses received, we had to decide whether the<br />
answer is rather “agree” or “disagree” with what the ED requested. We have found a<br />
significant number of responses: "Yes we agree but we think that ..."and the<br />
disagreements or the proposed improvements to be more significant than the issues<br />
agreed upon. Responses like "partially agree” were treated, depending on the<br />
question, as YES or NO answers, meaning that if the number of proposed<br />
observations (and not disagreements) was insignificant and the question did not<br />
require consent without any reservation, we consider the answer to be “ YES I agree”.<br />
If the person answering rather disapproved or wished-for a change or an alteration in a<br />
number of issues, we have treated the answer as NO.<br />
After classification of responses in four categories (Yes, No, Partial Agreement and<br />
N / A - no response) we have considered the responses of "Mostly agree" as<br />
disapproval, and we have calculated the main statistical indicators based on responses<br />
reinterpreted and reclassified into three categories (answer YES, NO and N / A - not<br />
answered). The categories identified by us are listed below:<br />
Table 1. Category of respondents<br />
Nr. Abbreviation Category<br />
1 A Others<br />
2 B Banks<br />
3 C Professional bodies (accounting and auditing)<br />
4 E Evaluation Regulatory bodies<br />
5 F Larger accounting companies (Big 4 and others)<br />
6 I Assurance companies and actuaries<br />
7 S Stock exchange markets and similar entities<br />
8 U Universities<br />
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We have added together Assurance companies and actuaries because there were too<br />
few letters to make two classes separate. Also, in “Professional bodies (accounting<br />
and auditing) we have included accounting professions”.<br />
2.3. Questions selected<br />
Definition of fair value and related guidance<br />
Question 1<br />
The exposure draft proposes defining fair value as ‘the price that would be received to<br />
sell an asset or paid to transfer a liability in an orderly transaction between market<br />
participants at the measurement date’ (an exit price) (see paragraph 1 of the draft<br />
IFRS and paragraphs BC15–BC18 of the Basis for Conclusions). This definition is<br />
relevant only when fair value is used in IFRSs. Is this definition appropriate? Why or<br />
why not? If not, what would be a better definition and why?<br />
The transaction<br />
Question 3<br />
The exposure draft proposes that a fair value measurement assumes that the<br />
transaction to sell the asset or transfer the liability takes place in the most<br />
advantageous market to which the entity has access (see paragraphs 8–12 of the draft<br />
IFRS and paragraphs BC37–BC41 of the Basis for Conclusions). Is this approach<br />
appropriate? Why or why not?<br />
Question 4<br />
The exposure draft proposes that an entity should determine fair value using the<br />
assumptions that market participants would use in pricing the asset or liability (see<br />
paragraphs 13 and 14 of the draft IFRS and paragraphs BC42–BC45 of the Basis for<br />
Conclusions). Is the description of market participants adequately described in the<br />
context of the definition? Why or why not?<br />
Application to assets: highest and best use and valuation premise<br />
Question 6<br />
When an entity uses an asset together with other assets in a way that differs from the<br />
highest and best use of the asset, the exposure draft proposes that the entity should<br />
separate the fair value of the asset group into two components: (a) the value of the<br />
assets assuming their current use and (b) the amount by which that value differs from<br />
the fair value of the assets (ie their incremental value). The entity should recognise the<br />
incremental value together with the asset to which it relates (see paragraphs 20 and 21<br />
of the draft IFRS and paragraphs BC54 and BC55 of the Basis for Conclusions). Is the<br />
proposed guidance sufficient and appropriate? If not, why?<br />
Fair value at initial recognition<br />
Question 9<br />
The exposure draft lists four cases in which the fair value of an asset or liability at<br />
initial recognition might differ from the transaction price. An entity would recognise<br />
any resulting gain or loss unless the relevant IFRS for the asset or liability requires<br />
otherwise. For example, as already required by IAS 39, on initial recognition of a<br />
financial instrument, an entity would recognize the difference between the transaction<br />
price and the fair value as a gain or loss only if that fair value is evidenced by<br />
observable market prices or, when using a valuation technique, solely by observable<br />
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market data (see paragraphs 36 and 37 of the draft IFRS, paragraphs D27 and D32 of<br />
Appendix D and paragraphs BC76–BC79 of the Basis for Conclusions). Is this<br />
proposal appropriate? In which situation(s) would it not be appropriate and why?<br />
Valuation techniques<br />
Question 10<br />
The exposure draft proposes guidance on valuation techniques, including specific<br />
guidance on markets that are no longer active (see paragraphs 38–55 of the draft<br />
IFRS, paragraphs B5–B18 of Appendix B, paragraphs BC80–BC97 of the Basis for<br />
Conclusions and paragraphs IE10–IE21 and IE28–IE38 of the draft illustrative<br />
examples). Is this proposed guidance appropriate and sufficient? Why or why not?<br />
Disclosures<br />
Question 11<br />
The exposure draft proposes disclosure requirements to enable users of financial<br />
statements to assess the methods and inputs used to develop fair value measurements<br />
and, for fair value measurements using significant unobservable inputs (Level 3), the<br />
effect of the measurements on profit or loss or other comprehensive income for the<br />
period (see paragraphs 56–61 of the draft IFRS and paragraphs BC98–BC106 of the<br />
Basis for Conclusions). Are these proposals appropriate? Why or why not?<br />
Convergence with US GAAP<br />
Question 12<br />
The exposure draft differs from Statement of Financial Accounting Standards No. 157<br />
Fair Value Measurements (SFAS 157) in some respects (see paragraph BC110 of the<br />
Basis for Conclusions). The Board believes that these differences result in<br />
improvements over SFAS 157. Do you agree that the approach that the exposure draft<br />
proposes for those issues is more appropriate than the approach in SFAS 157? Why or<br />
why not? Are there other differences that have not been identified and could result in<br />
significant differences in practice?<br />
3. ANSWERS FOR THE SELECTED QUESTIONS<br />
As a general remark, the overwhelming majority responded favourably to the IASB’s<br />
project, whether they agreed with the IASB’s view or not on particular aspects.<br />
We also noticed that the large majority of respondents disagree with the exposure<br />
draft in at least one or two aspects, the number of unfavourable responses being more<br />
numerous than the positive ones.<br />
Question 1<br />
The exposure draft proposes defining fair value as ‘the price that would be received to<br />
sell an asset or paid to transfer a liability in an orderly transaction between market<br />
participants at the measurement date’ (an exit price) (see paragraph 1 of the draft<br />
IFRS and paragraphs BC15–BC18 of the Basis for Conclusions). This definition is<br />
relevant only when fair value is used in IFRSs.<br />
In the IASB’s view (paragraph 1 of the draft IFRS) “fair value is the price that would<br />
be received to sell an asset or paid to transfer a liability in an orderly transaction<br />
between market participants at the measurement date.<br />
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As we have noticed, the fair value is mainly based on an exit value (price received to<br />
sell an asset). From the illustrative examples and the guidance given by ED it results<br />
that even when the company does not intend to sell the asset or an active market is not<br />
available, the estimated price is still to be used.<br />
The first question relates to the definition of fair value and related guidance and is<br />
about how do respondents consider that definition, appropriate or not? Arguments<br />
were requested regardless of the answer. Also, in case the respondent disagreed, a<br />
better definition in his view was requested together with the reason in its favour.<br />
For the first question, approximately 66% from the respondents answered that they do<br />
not agree with the definition proposed by IFRS for the fair value, and they have<br />
considered that the value defined by the ED is not feasible for every reporting entities,<br />
nor that it may cover all the questions and particular situation that may appear in the<br />
real life. The main objection for the fair value’s definition is that it should not be<br />
based on an exit price (or an exit value), regardless of the situation in which it might<br />
appear, but also on an entry price or on another value, depending on the particular<br />
situation. The vast majority of those that disagreed underline the fact that especially<br />
for liabilities a notion such as “settlement” is not appropriate, but it rather should be<br />
considered in exchange a “transfer: of the liability and more than that, as an active<br />
market for liabilities is, if not impossible, than it is very hard to find, an exit value is<br />
not at all appropriate for them.<br />
An other significant part of respondents emphasized that the definition given by ED to<br />
the fair value is not consistent with the examples also presented by IFRS in a separate<br />
document and they made reference to more than one example that relied on the “in<br />
use value” although the fair value is to be based on the exit price.<br />
On the other hand an insignificant number of letters strongly recommended IASB to<br />
give up the definition based on (restricted on) the exit price and to allow entities to<br />
determine the fair value based on the intention the company has with regard to that<br />
asset (to sell or to use the asset) or based on the “business model” of the company<br />
(meaning that if the company doesn’t have any intention to sell the asset but it rather<br />
intends to use it, the fair value should be computed completely based on the in use<br />
value, and not on an selling price, as long as this price it is not relevant for the entity<br />
with regard to that specific asset).<br />
Interesting and to be expected was the reaction of evaluators and actuaries: they have<br />
criticized that there are to many definitions for the fair value, basically the same (at<br />
least supposed to lead to the same result), but which may lead to misunderstandings.<br />
They recommended IASB to use the same definition given in their own standards.<br />
The transaction<br />
Question 3<br />
The exposure draft proposes that a fair value measurement assumes that the asset or<br />
liability is exchanged in an orderly transaction between market participants to sell the<br />
asset or transfer the liability at the measurement date (paragraphs 8–12 of the draft<br />
IFRS). An orderly transaction implies exposure to the market for a period before the<br />
measurement date, it is not a forced transaction and takes place in the most<br />
advantageous market to which the entity has access.<br />
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The most advantageous market is the market that maximizes the amount that would be<br />
received to sell the asset or minimizes the amount that would be paid to transfer the<br />
liability, after considering transaction costs and transport costs.<br />
IASB intends to find out with the third question if the approach for the most<br />
advantageous market is appropriate or not, and the respondents were also asked to<br />
present arguments supporting their answer.<br />
As for the second question regarding the definition of the market in order to determine<br />
the fair value (definition which includes the term “most advantageous market”) a little<br />
bit more than 50% from the comment letters (to be more accurate : 58% from the data<br />
we have searched) have disagreed with IASB’s approach. However we may assume<br />
that the answers were evenly divided between those agreeing and those disagreeing<br />
with the IASB’s vision about the “perfect market”.<br />
Those who disagreed with the definition proposed by the ED suggested that it is better<br />
to use the main market on which the entity usually sales (very probably the market on<br />
which the company record the highest level of sales).<br />
Some letters disapproved strongly the choice of the most advantageous market,<br />
recommending, in the name of prudence and with consideration with what happed as<br />
a result of the financial crisis, the use of the smallest price available on the markets<br />
(especially for banks which evaluate their financial assets using the fair value model).<br />
Question 4<br />
In order to estimate the fair value, according to the exposure draft (see paragraphs 13<br />
and 14 of the draft IFRS) entities should determine fair value using the assumptions<br />
that market participants would use in pricing the asset or liability. Market participants<br />
should be independent of each other, knowledgeable, able to enter into a transaction<br />
and willing to enter into a transaction. More guidance is given by IASB in the Basis of<br />
Conclusion and Illustrative examples. For example, the entity should not specifically<br />
identify market participants, but should reasonably use the most probable assumptions<br />
of market participants, taking into consideration the asset or liability, the most<br />
advantageous market and characteristics that distinguish market participants.<br />
The fourth question from the questionnaire and third in our research was about the<br />
respondents view about the description given by IASB for market participants. On this<br />
question most letters were favourable projects are recognized definition of exposure<br />
(56.41%) but those who are approved almost equal to the number disapproved. Those<br />
who responded negatively tied the rule of how to define fair value (Q1 as the answer<br />
was negative and therefore felt unable to agree with Q3). Those disagreeing with the<br />
definition of market participants underlined the difficulties probable to be encountered<br />
by the entities in assuming the other party’s information. More than that, some<br />
information are not available to persons from outside the entity. Many of the letters<br />
also stress the subjectivity of such an assumption.<br />
Question 6<br />
The next question focuses on what do respondents believe about using the highest and<br />
best use assumption when measuring the fair value. The exposure draft assumes that<br />
market participants are able to generate economic benefit by using the asset in its<br />
~ 239 ~
highest and best use. Highest and best use refers to the use of an asset by market<br />
participants that would maximise the value of the asset or the group of assets and<br />
liabilities considering uses of the asset that are physically possible, legally permissible<br />
and financially feasible at the measurement date. A physically possible premise takes<br />
into account the physical characteristics of the asset to be considered when pricing the<br />
asset, such as the location or size of a property. A legally permissible hypothesis takes<br />
into account any legal restrictions on the use of the asset such as the zoning<br />
regulations applicable to a property. A financially feasible premise takes into account<br />
whether a use of the asset that is physically possible and legally permissible generates<br />
adequate income or cash flows to produce an investment return normally required<br />
from an investment in that asset put to that use.<br />
The fourth question (Q 6) was designed in order to see the respondent’s views on the<br />
requirement for the entity to split the fair value of group assets into two components:<br />
(a) the value of the assets and assuming its current use (b) the amount by which this<br />
value varies fair value of assets (i.e. incremental value).<br />
This question have arisen live disputes, and the vast majority of respondents saw the<br />
provision as being irrelevant and as having a lot of disadvantages among which we<br />
quote: irrelevant, leading to confusion, unnecessarily increases the complexity of<br />
evaluation and reporting, and so on. Most of the respondents suggested that this<br />
recognition of the value of the asset value must be made incremental (global) and not<br />
separately.<br />
Question 5<br />
Fair value at initial recognition<br />
When an asset is acquired in an exchange transaction for that asset or liability, the<br />
transaction price is the entry price, meaning the price paid to acquire the asset. Even if<br />
conceptually entry prices and exit prices are different, in many cases they will be<br />
equal. In such cases, the fair value of an asset or liability at initial recognition equals<br />
the entry (transaction) price. There are many factors enumerated by IFRS to be taken<br />
into consideration in order to determine if the entry price is the same as the exit price.<br />
However, when an entity uses an asset together with other assets in a way that differs<br />
from the highest and best use of the asset the exposure draft proposes that the entity<br />
should separate the fair value of the asset group into two components: (a) the value of<br />
the assets assuming their current use and (b) the amount by which that value differs<br />
from the fair value of the assets (ie their incremental value). The entity should<br />
recognise the incremental value together with the asset to which it relates (see<br />
paragraphs 20 and 21 of the draft IFRS). Moreover, if an IFRS requires or permits an<br />
entity to measure an asset or liability initially at fair value and the transaction price<br />
differs from fair value, the entity recognizes the resulting gain or loss in profit or loss<br />
unless the IFRS requires otherwise.<br />
The fifth question (Q 9) was aiming to find the opinion on how to initially recognize<br />
the value of a possible difference between the fair value and the value of entry (entry<br />
price). The majority of respondents have not agreed to such recognition of difference<br />
in the income statement claiming that lead to its volatility and found that such a<br />
provision allows manipulation of financial statements (59%). However the exposure<br />
draft provides that such recognition is possible only when relevant IFRSs require or<br />
permit the use of those elements of fair value for initial recognition.<br />
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Question 10<br />
With the sixth question in our research (Q 10), IASB wanted to know if the way the<br />
assessment techniques are described in the absence of active markets and illustrative<br />
examples included in the annex to the project are sufficient and relevant. The majority<br />
of respondents (57%) disapproved, accusing them mainly because there is not enough<br />
information, and making reference to the Guidelines already published by the IASB in<br />
October 2008: “Measurement and disclosure of financial instruments that no longer<br />
exists an active market”.<br />
Question 11<br />
For the seventh question (Q 11), which was meant to cover additional disclosure, the<br />
majority of respondents agreed with the requirements to increase transparency of<br />
financial statements that are derived from the presentation of information about how<br />
to determine the fair value hierarchy and the assumptions used, only that, on the other<br />
hand, the IASB approach was found inappropriate (70.13% - among the highest rates<br />
of disapproval). Most often raised issue was the very high cost required to submit<br />
information requested by the exposure draft. On the other hand, the request for<br />
additional information deriving from the ED did not seem as feasible as would have<br />
been the specific demands from each reporting standard (basically, in their opinion,<br />
the requirement for specific disclosure should come from the standards addressing<br />
those elements, for example, intangible assets, tangible or so). A significant number<br />
of questionnaire’s participants expressed the view that further submissions costs will<br />
be far exceed the benefits generated by these presentations.<br />
Also a significant number of letters disapproved with the IASB’s view with regards of<br />
certain information that should have been present according to the ED. Those<br />
information seemed to the above mentioned to be too numerous and tricky (such as<br />
those in the interim report under IAS 34).<br />
Question 12<br />
For the last question (Q 12) on the differences between the American standard on fair<br />
value and the Exposure Draft, the majority of respondents (more than 50%) believed<br />
that the difference in requirements between exposure draft and SFAS 157 is actually<br />
an improvement proposed by the ED over the SFAS, and therefore agreed to the<br />
difference. Yet, the overwhelming majority of those who understand and were willing<br />
to accept the difference between the American and the International standard (in draft)<br />
have recommended the IASB and FASB to meet and agree upon uniform<br />
requirements.<br />
There were a significant number of participants who said that although the difference<br />
is relatively identifiable and measurable, they do not agree with the difference<br />
between the two rules and that it would be more beneficial a consistent view or a<br />
common development based on a dedicated standard value fair.<br />
Only an insignificant number (disagreeing with the differences) have said that they<br />
would recommend the American Standard in the name of convergence. However,<br />
most of the letters were from professional bodies or entities that came from countries<br />
"friendly" with the U.S., countries which have a reporting system based on US GAAP<br />
rather than on IFRS (e.g. Canada). The only argument those entities used (although<br />
most of them did not present any arguments) was that US FAS is older and has<br />
already been published by the FASB.<br />
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4. THE IASB’S COMMENTS ON THE SURVEY<br />
According to the IASB’s opinion, nearly all respondents were in favour of the ED.<br />
Overall, the following themes deriving from the comment letters were identified by<br />
IASB among others:<br />
1. Having a single source of guidance will reduce complexity and improve<br />
consistency in application of fair value measurements;<br />
2. The IASB and FASB should work together to develop fully-converged<br />
guidance for fair value measurements in IFRSs and US GAAP;<br />
3. An exit price notion is not relevant for assets when an entity does not intend<br />
to sell the asset (i.e. when it is being used in the operations of the business or<br />
it is a financial asset not held for trading);<br />
4. Some of the guidance for measuring fair value in inactive markets in the<br />
Expert Advisory Panel’s report should be added to the final IFRS on fair<br />
value measurement guidance.<br />
As for specific issues, relating to the definition of the fair value, IASB found that there<br />
were some respondents that thought the proposal to define fair value as an exit price is<br />
appropriate because it retains the exchange notion in the current definition, provides a<br />
clear measurement objective, also removes the complexity caused by the diverse<br />
guidance in IFRSs, and it increases convergence with US GAAP.<br />
On the other hand, some respondents were reported to be on the opinion that it is<br />
inappropriate to define fair value exclusively as an exit price, but it rather should<br />
reflects an entry price in some circumstances (e.g. business combinations) and an exit<br />
price in others (e.g. financial instruments), in order to provide useful information and<br />
to be more relevant.<br />
Other respondents were reported to think that fair value should not be market-based,<br />
but should instead reflect the value to the business taking into account an entity’s<br />
ability to generate future cash flows by using the asset or liability within the business.<br />
IASB recognizes that many respondents believed that the exit price notion is not<br />
appropriate for liabilities because, in most cases, an entity cannot transfer its liabilities<br />
and therefore there is no ‘exit price’ but rather a settlement of a liability.<br />
As for the transaction, according to IASB comments, some of the respondents agreed<br />
with the proposal to base a fair value measurement on the price in the most<br />
advantageous market for the asset or liability and thought that there is no significant<br />
difference in fair values whether they are measured using the most advantageous<br />
market or the principal market. Other was reported to be confused about the two<br />
notions.<br />
IASB also reported that some respondents were concerned that using the most<br />
advantageous market introduces an upward bias into the measurement while the<br />
thought that the exposure draft does not provide sufficient guidance on what to do<br />
where there is no observable.<br />
With regards of the market participants, IASB informed that generally, respondents<br />
agreed with the market participant notion even than some commented that the<br />
~ 242 ~
proposed guidance does not sufficiently address how to apply the market participant<br />
notion when there is no observable market.<br />
IASB also notified that a part of the respondents considered that fair value should<br />
instead be measured from the entity’s perspective, especially when Level 3 inputs are<br />
involved.<br />
As for the highest and best use and valuation premise, many respondents were<br />
reported to agree with the proposal that fair value reflects the highest and best use of<br />
an asset while other thought inappropriate for a fair value measurement to consider<br />
the highest and best use of an asset. They believe that fair value should better reflect<br />
an entity’s current use of the asset in order not to over-inflate the value and to avoid<br />
inconsistencies between the cash flows generated from using the asset (in the<br />
statement of financial performance) and the value of the asset (in the statement of<br />
financial position).<br />
Even if that subject was one of the most disagreed upon, in our opinion, IASB noticed<br />
in its comments on incremental value, when highest and best use differs from current<br />
use, that several respondents had concerns about the proposal to require an entity to<br />
separate the fair value of an asset group when one or more of the assets is used in a<br />
way that differs from its highest and best use as this is inconsistent with the valuation<br />
premise, which states that all assets within a group must be measured on the same<br />
basis (i.e. either in use or in exchange). Moreover, the opinion was that it will be<br />
costly to measure the value of an asset or an asset group on two different bases (one<br />
being the current use and the other being the highest and best use), particularly since<br />
they think it is costly enough to analyse whether an asset’s current use is its highest<br />
and best use to comply with the proposed requirements.<br />
As for the valuation premise, IASB also did not express in figure the percentage of<br />
those disagreeing, but presented the main concerns as being the lack of relevance of<br />
the highest and best use concept and also confusion by the ‘clarification’ in the<br />
exposure draft that the in-use valuation premise assumes that the asset is sold<br />
individually, not as part of the sale of an asset group.<br />
With respect to fair value at initial recognition in IASB’s view respondents generally<br />
agreed that the four situations listed in the ED might lead to a difference between<br />
entry and exit prices at initial recognition but disagreed with keeping the prohibition<br />
in IAS 39 to defer day 1 gains and losses if the fair value is not based solely on<br />
observable inputs while other thought there should be a clear principle and the type of<br />
asset or liability should not influence the recognition of gains or losses.<br />
IASB considers many respondents agreed with the descriptions of valuation<br />
techniques in the exposure draft and find them helpful, while other respondents,<br />
mainly in the valuation community, believed that an IFRS on fair value measurement<br />
should not contain information about valuation techniques, but valuation standards<br />
and practice guidance should (and already do) address this. The opinion that the<br />
replacement cost approach as a valuation technique is inconsistent with the exit price<br />
notion was also mentioned.<br />
With respect to disclosures requirements, both our findings and IASB’s comments are<br />
in line with each other. Both the agreement with the proposed disclosures in order to<br />
~ 243 ~
provide meaningful information to users about the relative subjectivity about fair<br />
value measurements and the concern that it will be too onerous and probable for the<br />
benefit to outweigh the cost, especially for the Level 3 disclosures were reported. Also<br />
the volume of disclosures and the risk of overwhelming users with information were<br />
brought up by IASB.<br />
ASB also mentions some respondents thought that disclosures should be addressed in<br />
each standard and that they might be different depending on the asset or liability being<br />
measured.<br />
CONCLUSION<br />
The responses in their rough form, unclassified on the type of respondents and<br />
depending on the answer, and are presented in the following table:<br />
Table 2. Unclassified answers<br />
Q1 Q3 Q4 Q6 Q9 Q10 Q11 Q12<br />
Yes 30 33 44 15 30 33 23 31<br />
No 55 43 32 52 41 42 52 27<br />
N/A 12 21 22 33 27 23 23 38<br />
Partially agree 3 3 2 0 2 2 2 4<br />
Answers 100 100 100 100 100 100 100 100<br />
The next step was to classify the answer on the respondent’s type and to give up the<br />
last category (“Partially agree”) and to combine it with the Yes or No category,<br />
accordingly.<br />
Table 3. Yes – NO classification answers<br />
% Q1 Q3 Q4 Q6 Q9 Q10 Q11 Q12<br />
Yes 34,09 41,77 56,41 22,39 41,10 42,86 29,87 50,00<br />
No 65,91 58,23 43,59 77,61 58,90 57,14 70,13 50,00<br />
Total % 100 100 100 100 100 100 100 100<br />
As we may see, the most disapproved with questions were Q 6 and Q 11. Question 6<br />
refers to the recognition of the increment value up to the fair value for the group to<br />
which the asset belongs, where the use of the asset intended by the entity is different<br />
than its higher and best use. Question 11 addresses the requirement of supplementary<br />
information about how the fair value was measured, and it was expected to be a<br />
challenging question, with regards of high costs required and the cost – benefit<br />
relationship.<br />
~ 244 ~
%<br />
100,00<br />
80,00<br />
60,00<br />
40,00<br />
20,00<br />
0,00<br />
Figure 1. Yes – NO classification answers<br />
Answers<br />
Q1 Q3 Q4 Q6 Q9 Q10 Q11 Q12<br />
Questions<br />
More than that, responses were heterogeneous among classes of respondents which<br />
shows that the problems related to the fair value model still remains open, unresolved.<br />
We anticipated at least for certain questions to receive homogeneous (uniform)<br />
answers among classes; this assumption, however, was proved wrong by the<br />
responses.<br />
Some results, however, could have been anticipated and are confirmed by values<br />
obtained, such as:<br />
1. Banks and insurers (we have analyzed 20 letters coming from such<br />
respondents) were especially against further disclosure as required by IASB.<br />
The number of letters disagreeing ( 13 out of 16 responses for that question)<br />
was twice higher than the average;<br />
2. Insurance companies have largely frowned upon the definition of fair value (<br />
even more than banks had), coming probably as a result of the fact that they<br />
are more affected in terms of provisions and reserves to be measured than<br />
banks are ( 9 answers against the definition from 11 as compared to 12<br />
answers against from 18 valid answers coming from banks);<br />
3. Accounting firms have also largely disapproved the supplementary<br />
information required to be presented. They were in majority against the IASB<br />
proposal with regards to Q 9, Q 10 and Q 11;<br />
4. Both stock exchange markets and universities have welcomed and approved<br />
the requirements for submission of additional information (with very high<br />
values as compared with the average);<br />
5. Evaluators have unanimously condemned the new definition of fair value and<br />
illustrative examples of computing present value techniques, which is only<br />
logic as they have their own rules for determining the market value and<br />
methods used to compute present value of assets (such as methods based on<br />
the income or cash flow);<br />
6. Both large accounting firms and universities have strongly resisted to the<br />
proposal for recognition of gains from the first day, gains resulting from the<br />
difference between original cost and fair value of the transaction.<br />
We have also tried to see if there is any correlation between the answers and found<br />
out that even if they are correlated, the coefficients of correlation are very small<br />
~ 245 ~<br />
Yes<br />
No
(below 0.4) with the exception of Q 3 – Q 4 for which we have computed a 0.5634<br />
value (the highest correlation value).<br />
If we codify the negative answers with -1 and positives ones with 1, than we obtain<br />
the following values:<br />
Table 4. Average on classes of respondents and questions<br />
Question A B C E F I S U<br />
Q1 0,00 -0,33 -0,45 -1,00 0,50 -0,64 0,50 -0,60<br />
Q3 -0,60 -0,11 -0,13 0,00 0,14 -0,43 0,00 -0,50<br />
Q4 0,00 0,11 0,10 0,00 0,25 -0,43 1,00 0,50<br />
Q6 -0,33 -0,54 -0,80 -1,010 -0,14 -0,67 1,00 -0,33<br />
Q9 0,00 -0,11 -0,03 0,00 -0,71 -0,20 -0,50 -1,00<br />
Q10 0,50 -0,29 0,16 -1,00 -0,50 -0,43 0,00 -1,00<br />
Q11 -0,60 -0,53 -0,38 -1,00 -0,71 -0,43 0,50 1,00<br />
Q12 0,50 -0,63 0,38 0,00 0,00 -0,50 0,33 -1,00<br />
Legend<br />
Abbreviation Category<br />
A Others<br />
B Banks<br />
C Professional bodies ( accounting and auditing)<br />
E Evaluation Regulatory bodies<br />
F Larger accounting companies ( Big 4 and others)<br />
I Assurance companies and actuaries<br />
S Stock exchange markets and similar entities<br />
U Universities<br />
If we look in Table 4 we note that the average for the question is mostly negative<br />
(indicating that the respondents gave a negative answer to the question) except for<br />
questions 4 and 12, for which most respondents (but not an overwhelmingly<br />
percentage) agreed. Question 4 concerns the definition of market participants, and<br />
question 12 concerns the convergence with U.S. standards of reporting.<br />
The same table shows that most disapproved questions were Q 6 and Q 11. Question 6<br />
refers to the recognition of fair value increment for the group to which the asset<br />
belongs, where he makes use of the asset is different than HBU entity (use of<br />
optimal). Question 11 addresses the disclosure of information about how to measure<br />
fair value, and it was expected to be challenged, most respondents referring to the<br />
high costs required by supplementary information and the cost - benefit.<br />
As a general remark, the majority of respondents agreed with the idea of the exposure<br />
draft but disagreed with the exposure draft on most of the features, the number of<br />
unfavourable responses being more numerous than the positive ones. Thus, we note<br />
that the average for the question is mostly negative (indicating that the respondents<br />
gave a negative answer to the question) except for questions 4 and 12, for which most<br />
(but not an overwhelming majority) agreed. Question 4 is concerned with the<br />
definition of market participants, and question 12 with the convergence with U.S.<br />
standards.<br />
As a final conclusion we may draw from the piece of research conducted, is the<br />
observation that the dispute is far from coming to its end. If IASB takes into account<br />
~ 246 ~
the criticisms and suggestions, then it would issue a totally different standard of<br />
current exposure draft, or it would allow multiple methods of presentation and<br />
techniques for calculating fair value.<br />
Also as a general remark, the majority of respondents agreed with the idea of the<br />
exposure draft but disagreed with the exposure draft on most of the features, the<br />
number of unfavourable responses being more numerous than the positive ones. Thus,<br />
we note that the average for the question is mostly negative (indicating that the<br />
respondents gave a negative answer to the question) except for questions 4 and 12, for<br />
which most (but not an overwhelming majority) agreed. Question 4 is concerned with<br />
the definition of market participants, and question 12 with the convergence with U.S.<br />
standards.<br />
The most disapproved with questions were Q 6 and Q 11. Question 6 refers to the<br />
recognition of the increment value up to the fair value for the group to which the asset<br />
belongs, where the use of the asset intended by the entity is different than its higher<br />
and best use. Question 11 addresses the requirement of supplementary information<br />
about how the fair value was measured, and it was expected to be a challenging<br />
question, with regards of high costs required and the cost – benefit relationship.<br />
REFERENCES<br />
IASB meeting, Comment letter summary, Agenda reference 2 A, October 2009,<br />
www.iasb.org , accessed April 2011<br />
Exposure Draft ED/2009/5, Fair Value Measurement, http://www.ifrs.org/Current+Projects/<br />
IASB+Projects/Fair+Value+Measurement/ED/ED.htm , accessed April 2011<br />
Basis for Conclusions Exposure Draft Fair Value Measurement, http://www.ifrs.org/<br />
Current+Projects/IASB+Projects/Fair+Value+Measurement/ED/ED.htm, accessed April<br />
2011<br />
Comment letters for ED 5, http://www.ifrs.org/Current+Projects/IASB+Projects/Fair+Value<br />
+Measurement/ED/ED.htm , accessed April 2011<br />
Tufcea (Păunescu) Mirela (2010), Evoluţie şi dezvoltare privind evaluarea în contabilitate,<br />
Teză de doctorat<br />
Ronnen, J., (2008), „To Fair Value or Not to Fair Value: A Broader Perspective”, Abacus, vol. 44,<br />
no. 2, 2008, http://pages.stern.nyu.edu/~jronen/articles/Fair_Values.pdf<br />
*** Ernst & Young (2005), „How fair is fair value?”, London,<br />
http://www.anc.gouv.fr/sections/la_recherche_a_l_anc/1ers_etats_generaux/a_wilson_h<br />
ow_fair_is/downloadFile/file/A_WILSON_How_Fair_is_Fair_Value.pdf?nocache=129<br />
2609799.42, accessed April 2011<br />
~ 247 ~
PS6 Management information systems I<br />
Chairperson<br />
Pavel NASTASE, Bucharest Academy of Economic Studies,<br />
Romania<br />
AN ENTERPRISE ONTOLOGICAL APPROACH<br />
FOR SEMANTIC WEB<br />
Adrian COZGAREA, Gabriel COZGAREA, Delia BABEANU<br />
ENTERPRISE 2.0 – IS THE MARKET READY?<br />
Dragos Marian MANGIUC<br />
NON-TECHNICAL CHALLENGES IN ADOPTING<br />
ENTERPRISE 2.0<br />
Dragos Marian MANGIUC<br />
CRITICAL SUCCESS FACTORS FOR THE ORACLE<br />
DATABASE AUDIT<br />
Simona Felicia UNCHIASU, Pavel NASTASE<br />
~ 248 ~
AN ENTERPRISE ONTOLOGICAL APPROACH<br />
FOR SEMANTIC WEB<br />
Adrian COZGAREA 1 , Gabriel COZGAREA & Delia BABEANU<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
Considered part of artificial intelligence, ontologies became a technique over and over used<br />
in the analysis of informational systems from different domains. Because it enables<br />
description of structural characteristics and semantic in simple relative terms, and in WEB<br />
semantic conditions, facilitates the knowledge sharing between the different users. Ontologies<br />
bring a plus of knowledge in relation with "traditional" formalisms (Entity-Relationship<br />
model, Object-Oriented model, etc.). This article presents the formals specific to ontologies<br />
and proposes a relative ontology of the enterprise through the light of users' information on<br />
WEB.<br />
KEYWORDS: Informational systems, knowledge designing and management, ontologies,<br />
semantic WEB<br />
INTRODUCTION<br />
In the present conditions, when the informational organizations area is subjected to<br />
outstanding dynamics, analysis and modeling of informational systems invoke the<br />
existence of advanced techniques and methodologies, to allow as much of related<br />
activities are carried out automatically by means of appropriate software tools. To<br />
achieve such an aim the applications software or computers in general, to become able<br />
to "understand" all of the data or information exchanged, so that the analyst to be<br />
discharged from routine activities or irrelevant.<br />
The adoption of Internet specific technologies by most organizations has led to the<br />
increasing interdependence of their reason for modeling and designing information<br />
systems, a conceptual framework of the current ad (possibly standardized) common,<br />
reusable and sufficiently flexible. Such an objective can be achieved only through<br />
abstract universal formalisms, and completely independent of implementation<br />
techniques.<br />
The two objectives mentioned above, have become the artificial intelligence object<br />
study, more precisely of the knowledge representation systems, which offers a<br />
technique focused on the ontology term, a concept taken from the philosophy by<br />
which it is assigned to the branch of philosophy what is studying the traits of<br />
existence (Romanian Academy, Institute of Linguistics "Iorgu Iordan", 1998). In<br />
1 Correspondence address: Adrian COZGAREA, Academy of Economic Studies, Bucharest;<br />
email: acozgarea@gmail.com<br />
~ 249 ~
computer science, the term was introduced by Thomas R. Gruber, in 1993, to appoint<br />
"an explicit specification of a conceptualization (Gruber, T., 1993: 199).<br />
Meant any ontology consist in disseminating them, so that the knowledge described to<br />
be shared between many researchers have more scope to be analyzed. For this reason,<br />
the real power of ontologies is offer by the semantic WEB, an extension of the current<br />
WEB in which the organization and access to public data are secured according to<br />
their semantics. The term "semantic WEB" was introduced by Tim Berners-Lee<br />
(inventor of the World Wide Web) with the following meaning: "a web of data that<br />
can be processed directly and indirectly by machines" (Berners-Lee, T. et al., 2001).<br />
In this article, there are presented the main concepts, techniques and methodologies to<br />
specific ontologies and semantic WEB, and then to be described a proposed ontology<br />
for enterprises that want to benefit from the advantages offered by the two<br />
technologies.<br />
1. ONTOLOGIES AND SEMANTIC WEB IN LITERATURE REVIEW<br />
1.1.Ontologies<br />
The reference in the field of ontologies represents "A translation approach to portable<br />
ontologies" (Gruber, T., 1993: 199), which describes the formal framework for the<br />
design and use of ontologies in order of representation of knowledge. Thus, ontology<br />
(in computer sense) represents, in fact, a conceptual model of knowledge related to a<br />
particular domain, as described by a set of terms: classes restrained with essential<br />
properties, relationships, objects, and the restrictions applied to them. Classes describe<br />
the essential concepts of interest domain, and relationships most often mentioned are<br />
those of type "is-a", for taxonomies description. Once conceived, ontology can be<br />
populated with specific data: each class will correspond to a collection of objects<br />
(individuals) who have specific values for attributes.<br />
Similarities ontologies with conceptual schema of relational databases, or even with<br />
the oriented-object model is evident, only as an ontology aims not only to the data and<br />
relationships between them, but also the knowledge obtained on the basis of the rules<br />
of inference. In addition, it must not be forgotten the reason of any ontology -the<br />
availability to all researchers interested in - that is not valid in the case of classical<br />
models reminded before.<br />
Depending on the scope, ontologies may be designed for a general domain (such as<br />
space, time, etc.), for a specific domain (medical, economic, technical, etc.) or for a<br />
certain application (sales management of a firm, employees records of a company,<br />
etc.). Because these latter are not available or public, they are actually pseudoontologies<br />
(Fensel, D. et al., 2008).<br />
The purpose of the description of ontologies has been proposed in several languages:<br />
Resource Description Framework (RDF), Knowledge Interchange Format (KIF), Web<br />
Ontology Language (OWL), etc. A detailed presentation on this topic is made in<br />
(Fensel D. et al., 2008). There are attempts (some very successful) representation of<br />
the ontologies in UML or even in the Entity-Relationship formalism. The best known<br />
~ 250 ~
example, in this sense, constitutes REA ontology (Resources-Events-Agents) proposed<br />
by McCarthy in 1982 for the accounting field and described by an E-R diagram.<br />
In our study, we have focused on particular OWL language created for the ontologies<br />
development for the WEB. Available in version 2 (2009), the OWL represents a<br />
declarative expression of the ontologies.<br />
1.2. Web Ontology Language (OWL)<br />
Web Ontology Language is developed by W3C (World Wide Web Consortium), an<br />
international community. Specific OWL is the consideration of open worlds, i.e.<br />
description of knowledge is not limited to a file or to a specific context. For example,<br />
a class defined in ontology can be refined or extended in other ontologies. OWL<br />
offers more syntax that can be used in various purposes: Functional-Style syntax,<br />
RDF/XML syntax, RDF Turtle Syntax etc. Of these, in practice, the most used syntax<br />
is RDF/XML which is based on the expressions defined in RDF (rdf:), RDFS (RDF<br />
Schema - rdfs:) and XML Schema (xsd:).<br />
The different concepts used OWL formalism in three categories: entities, expressions,<br />
and axioms. Entities that constitute the foundation of structural ontologies are<br />
represented by individuals, classes and properties. The elementary axioms are<br />
statements relative to entities, and the expressions are built on the basis of complex<br />
phrases entities. Individuals are concrete objects (instances), classes of domain<br />
studied represent collections of individuals, and the attributes signify properties<br />
(characteristics) of objects.<br />
In OWL, a class can be defined in several ways: by specifying explicit its contents as<br />
a subclass of existing classes (subClassOf), by applying logical operators<br />
(intersectionOf, unionOf, complementOf, oneOf, etc.) on existing or undertake classes<br />
by defining certain restrictions on properties of another class. Also, OWL offers two<br />
predefined classes, Thing(T) and Nothing(⊥); the first stand at the basis of any<br />
hierarchy, and the second can be designated as a subclass without instances for any<br />
class in the hierarchy. The applied classes describe the axioms actually links between<br />
these and may concern: a relationship of sub classing (subClassOf), a relationship in<br />
which two classes have the same individuals (equivalentClass) or a relationship<br />
through which individuals of a different classes are another class of individuals<br />
(disjointWith).<br />
Individuals are clearly defining the target dealing with classes that they belong to.<br />
Axioms applied to individuals are sameIndividualAs (two individuals covered by the<br />
same concept) and differentFrom (previous deny).<br />
Properties in OWL can be of type object (ObjectProperty), stating that correlate<br />
individuals of two classes or type of date (DataTypeProperty), involving elementary<br />
values (integer, string, etc). Regardless of their type, the properties may be<br />
characterized by a set of axioms: subPropertyOf (property is a specialization of<br />
another), InverseOf (the two properties are additional/opposite), functionalProperty<br />
(describes a property mono-value), and transitiveProperty (if property P has connects<br />
the object A to B and B to C, then P tie on A and C) etc.<br />
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1.3. Using ontologies<br />
As we've seen, any ontology is designed for the purpose of representation and<br />
network shares knowledge in a format accessible to both human, and especially<br />
software. As the basis of the Semantic WEB, ontologies are used for the purpose of<br />
the description of the WEB documents semantics in a language based on logic (e.g.<br />
OWL) that can be understood by WEB applications or intelligent agencies. By using<br />
the ontologies "... tomorrow's applications can be «intelligent», in the sense that they<br />
can more accurately work at the human conceptual level" (W3C, 2004).<br />
By processing the automatic ontologies (through an inference engine called reasoner)<br />
can provide knowledge and services for the applications in the field of artificial<br />
intelligence: semantics search engines, software agents, intelligent databases,<br />
knowledge management applications or for assisting decisions etc.<br />
In order to design and use of ontologies were developed several software tools that<br />
provide both their editing and processing of knowledge described. For our study, we<br />
used Protégé open-source application, developed on a Java platform by the Stanford<br />
Center for Biomedical Informatics Research. By inference modules (reasoners)<br />
incorporated (e.g. FaCT ++, Pellet etc.), Protégé can automatically generate a<br />
hierarchy of classes (infer hierarchy) on the basis of specifications to ensure logical<br />
consistence verification for ontology.<br />
2. DESIGN METHODOLOGIES FOR ONTOLOGIES<br />
The review literature offers a wide enough range of methodologies for ontologies<br />
design, some of them dedicated to even the economic or business domain. In the<br />
paperwork (Paredes-Moreno A. et al., 2010), is described a methodology for<br />
development of the business ontologies in 6 stages:<br />
• Requirements analysis;<br />
• The collection of metadata (schemas, restrictions, management rules etc.);<br />
• Construction: presume description of the hierarchy of classes and ontology<br />
populating with queries of classes (class queries);<br />
• Ontology refine;<br />
• Test by comparing the ontology with the other relevant ontologies;<br />
• Feedback: collection of learning and the selection of the best practices of<br />
integration.<br />
An example of a general methodology is the one proposed in respect of (Noy N.F. &<br />
McGuinness D. L., 2001), that the necessary development stages of ontologies are:<br />
• Determining the scope and purpose of the ontology, during which must answer<br />
some basic questions: what is the area covered by the ontology?, in what<br />
purpose will be used ontology? Who will use and will maintain ontology? etc.<br />
• Possibility to reuse existing ontologies. In this stage recommend consulting the<br />
libraries of ontologies published on the WEB, and in case that is an ontology<br />
of the image area is intended to be created, then it will be necessary to import<br />
them;<br />
• Identification and enumeration of main terms in the ontology;<br />
• the definition of classes and class hierarchy;<br />
~ 252 ~
• Setting properties for each class;<br />
• Define the characteristics associated with the properties (type, scope and co<br />
domain, the axioms, if any, etc.);<br />
• The creation of instance, which supposedly define individuals for classes, as<br />
well as updating the property with the appropriate values.<br />
A general methodology, in 6 steps, it is proposed in (Peffers K. et al., 2007):<br />
• Identification of the problem and motivation (solution justification);<br />
• Definition of the objectives of a solutions derived from the definition of the<br />
problem;<br />
• Ontology design and development;<br />
• Demonstration of utility items obtained previously in solving of one or more<br />
instances of the problem;<br />
• Evaluation of solution in relation to the problem;<br />
• The communication.<br />
Of these methodologies, we choose on the proposed (Noy N.F. & McGuinness D. L.,<br />
2001), because is much closed to information systems modeling and design<br />
methodologies and, additionally, is a methodology that is mapped very well on<br />
Protégé logic tool used in our research.<br />
3. THE PROPOSED ONTOLOGY FOR ENTERPRISES REPRESENTING<br />
ON THE WEB<br />
The steps followed for development of the enterprise's own ontologies are, according<br />
to the general guide for the ontologies preparation (Noy N.F. & McGuinness D. L.,<br />
2001), the following:<br />
3.1. Domain and scope determination for the ontology<br />
Proposed ontology aims description of an enterprise in the light of information and<br />
knowledge traced by potential users-beneficiaries: products and services supplied,<br />
jobs offer, as well as indicators that can provide a picture of the economic-financial<br />
condition of the enterprise. As potential users, we have in mind traders interested in<br />
finding a vendor for a particular product or service, investors on financial market and<br />
the people who watch finding a job.<br />
3.2. The re-use of the existing ontologies in the field<br />
The best known ontologies for enterprise are published only in the stage of conceptual<br />
models, they are not implemented and in a language (such as OWL) to allow their<br />
import by anonymous users. We have in mind here: TOronto Virtual Enterprise<br />
(TOVE), ontology developed by a group of researchers at the Toronto University,<br />
Resources-Events-Agents (REA) proposed by McCarthy, Business Model Ontology<br />
(BMO) developed by Osterwalder and Pigneur (Osterwalder A. & Pigneur Y., 2002)<br />
etc. By shared ontologies, most are either too complex or contain irrelevant our<br />
objective elements (are focusing only on certain activities – sales, supply chain<br />
management, etc. or approaches the enterprise only in terms of organizational). In<br />
conclusion, the proposed new ontology does not contain any item imported from<br />
another formal existence on the WEB.<br />
~ 253 ~
3.3. Used terms in ontology<br />
In our vision, any enterprise (producing goods and/or services) can be described by<br />
the following concepts:<br />
• Enterprise such as (name, location, etc.);<br />
• The offer of goods and services provided by enterprise;<br />
• Jobs offer;<br />
• Economic indicators for production activity (turnover, production obtained);<br />
• Indicators of return (profit, return rate);<br />
• Indicators of liquidity (current ration, quick ratio);<br />
• Economic and financial indicators of profitability (profit margin, return on assets,<br />
return on equity);<br />
• Economic-financial indicators for risk evaluation (debt coverage ratio, debt to<br />
equity).<br />
3.4. The hierarchy of classes<br />
From the terms presented in the previous step, we believe that our ontology may be<br />
based on the following classes as are represented by the Protégé in the Figure 1. After<br />
defining the classes we have resorted to define axioms attaching thereto. For example,<br />
individuals may not belong to the class Enterprise classes State or Offer, the converse<br />
is obviously valid. For example, the class declaration Enterprise in OWL (after the<br />
syntax of RDF/XML) is the following:<br />
<br />
Enterprise<br />
<br />
<br />
<br />
<br />
Figure 1. The ontology proposed to be developed for an enterprise<br />
~ 254 ~
3.5. Defining properties for classes (including its characteristics)<br />
Since a subclass inherits all super class properties, we insisted on defining properties<br />
at the level of base classes. In a first phase, we defined the properties of the object<br />
type, i.e. those serving in the correlation of individuals come through different classes.<br />
So, for example, Enterprise class is correlated of Offer and States classes through the<br />
properties hasOffer and hasState. To allow inference and in the opposite direction, we<br />
proceeded to define inverse properties (inverseOf) those declared previously, i.e.<br />
offerOf and stateOf. Graphically, links are represented by Protégé as in the Figure 2.<br />
In OWL, disclaimers second inverse properties (for example, hasOffer and offerOf)<br />
are presented below:<br />
<br />
hasOffer<br />
<br />
<br />
<br />
<br />
offerOf<br />
<br />
<br />
<br />
<br />
Figure 2. Links between classes<br />
Of course, for each class we defined and the main properties of date type: eName,<br />
eAddress (with sub property uri), eCity, eCountry for Enterprise, oName and ōdate<br />
for Offer. And, limit to only one example, we provide the code for the property OWL<br />
eAddress (destined for address postal record) and eUri (WEB address) of the<br />
Enterprise class:<br />
~ 255 ~
<br />
eAddress<br />
<br />
<br />
<br />
<br />
eUri<br />
<br />
<br />
<br />
<br />
3.6. Ontology populate with individuals<br />
To verify the proposed ontologies, we defined two enterprises: Alpha (Bucharest,<br />
Romania), Beta (London, England), the first with an offer to the format of a product<br />
(AlphaProd) and a service (AlphaServ), and the second with an offer-product<br />
(BetaProd).<br />
With the scope of verifying the ontology, we performed the following tests using<br />
Protégé:<br />
• Verifying logical consistence (with Pelllet and FaCT++) – both reasoners<br />
have validated the ontology<br />
• Applying logical queries, in order to knowledge verification:<br />
o Which are enterprises that provide services (Enterprise and hasOffer some<br />
Service)?<br />
o Which are enterprises in London that provide products (Enterprise and<br />
eCity value "London" and hasOffer some Product)?<br />
CONCLUSIONS<br />
Nevertheless, public ontologies may lead getting the new information and to enriching<br />
existing knowledge bases. Analysis of an enterprise by proposed ontology provides<br />
general information about its activity and to what it can offer the partners: goods,<br />
services, etc. For this reason, we consider that the development of ontology should<br />
target primarily her usefulness both for ordinary users, and domain for the researchers<br />
involved. And if the structure of ontology can be read and processed by the existing<br />
software tools, it may be regarded as it has achieved the goal: to share knowledge of<br />
all those interested.<br />
REFERENCES<br />
Academia Română, Institutul de Lingvistică „Iorgu Iordan” (1998), Dicţionarul explicativ al<br />
limbii române, ediţia a II-a, Editura Univers Enciclopedic<br />
Berners-Lee T., Hendler J., Lassila O. (2001), “The Semantic Web”, Scientific American,<br />
no. 5<br />
Fensel D., Kerrigan M., Zaremba M. (2008), Implementing Semantic Web Services, Springer<br />
Gruber, T. (1993), “A translation approach to portable ontologies”, Knowledge Acquisition<br />
vol. 5, no.2:199-220<br />
~ 256 ~
McCarthy W.E. (1982), “The REA accounting model: A generalized framework for<br />
accounting systems in a shared data environment”, The Accounting Review, vol. 57,<br />
no. 3:554-578<br />
Noy N.F., McGuinness D.L. (2001), Ontology Development 101: A Guide to Creating Your<br />
First Ontology', Stanford Knowledge Systems Laboratory Technical Report KSL-01-<br />
05, available on-line at, http://protege.stanford.edu/publications/ontology_development/<br />
ontology101.pdf<br />
Osterwalder A., Pigneur Y. (2002), An e-Business Model Ontology for Modeling e-Business,<br />
15th Bled Electronic Commerce Conference, Bled, Slovenia, June 17 - 19, 2002,<br />
available on-line at, http://129.3.20.41/eps/io/papers/0202/0202004.pdf<br />
Paredes-Moreno A., Martinez-Lopez F.J., Schwartz D.G. (2010), “A methodology for the<br />
semi-automatic creation of data-driven detailed business ontologies”, Information<br />
Systems, vol. 35:758-773<br />
Peffers K.,Tuunanen T., Rothenberger M.A.,Chatterjee S. (2007), “A design science research<br />
methodology for information systems research”, Journal of Management Information<br />
Systems vol. 24, no.3:45–77.<br />
Stanford University School of Medicine (2010), Protégé, available on-line at,<br />
http://protege.stanford.edu<br />
University of Toronto, TOVE Ontology Project (1992), available on-line at,<br />
http://www.eil.utoronto.ca/enterprise-modelling/tove/<br />
W3C, OWL (Web Ontology Language) (2009), available on-line at,<br />
http://www.w3.org/TR/2009/REC-owl2-overview-20091027/<br />
W3C, OWL Web Ontology Language - Use Cases and Requirements (2004), available on-line<br />
at, http://www.w3.org/TR/webont-req/<br />
~ 257 ~
ENTERPRISE 2.0 – IS THE MARKET READY?<br />
Dragoş Marian MANGIUC 1<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
Enterprise 2.0 family technologies have growing popularity, the cloud computing market is<br />
growing rapidly and, as a consequence, companies of all sizes start to evaluate the potential<br />
fit. The use of “Software as a Service”, “Platform as a Service” and “Infrastructure as a<br />
Service” has been evolving during the past years and has become increasingly popular. As its<br />
computing viability and benefits are legitimized, the adoption rate is rapidly increasing. The<br />
most popular business model in the abovementioned family is by far “Software as a Service”<br />
(also called SaaS), which is a software distribution model assuming the software applications<br />
are hosted and maintained by the vendor or the distributor, and user access is granted<br />
exclusively by means of the Internet. Based on both literature review and action research, the<br />
paper at hand is a synthesis for the results of an empirical study performed during the last<br />
two years among Romanian and foreign companies, in order to outline and provide an<br />
objective and unbiased answer to the question: “Is the market ready for these technologies or<br />
did they come too soon?”. The paper is a part of a larger research performed by the author in<br />
the field of Enterprise 2.0 technologies.<br />
KEYWORDS: Enterprise 2.0, Software as a Service, Platform as a Service, Infrastructure<br />
as a Service, Empirical study<br />
INTRODUCTION<br />
As the Enterprise 2.0 family of technologies is evolving and facing ever-growing<br />
adoption, we can also observe the development of some next-generation business<br />
models for the purchase and use of business software applications, business platform<br />
and business infrastructure components. The “flagship” of these new models is, by<br />
far, “Software as a Service”, usually abbreviated SaaS, which has evolved to be a<br />
quite common practice for Enterprise 2.0 – specific software distribution (Menken,<br />
2008). As semantic technologies penetrate and consolidate the modern organizations<br />
business processes, the traditional “sales” of business IT architectural layers<br />
(software, platform, infrastructure) give up in front of the new business models, as the<br />
consumers become aware of the simplicity and the efficiency of this new practice<br />
(Fan et. al., 2009). Based on a recent empirical study performed by the author, the<br />
paper at hand is an attempt to figure out whether this “movement” towards cloud<br />
computing is the advent of a new era in business IT, or just a fragile “wave” of<br />
interest for a novelty.<br />
1<br />
Correspondence address: Dragoş Marian MANGIUC, Bucharest Academy of Economic Studies,<br />
Romania; email: mangiuc@gmail.com<br />
~ 258 ~
1. RESEARCH METHODOLOGY<br />
This attempt is part of a larger research performed by the author in the field of<br />
organizational memory and Enterprise 2.0 technologies, and also continues a previous<br />
doctoral research in the field of computer-assisted financial audit tools and<br />
techniques, whose final results were publicly defended in order to be validated by<br />
both the scientific and academic community. The main goal of the aforementioned<br />
research was the identification of some new areas of applicability for the modern<br />
knowledge-based information technologies in the field of financial audit.<br />
When possible, a direct identification of the practitioners’ expectations was attempted<br />
by means of direct interviews and also by means of the empirical study questionnaire.<br />
The questions for the empirical study were carefully designed so as to get unbiased,<br />
objective answers. The members of the target group were encouraged to add their own<br />
observations regarding the questionnaire. Validation of the research conclusions was<br />
performed by means of an informal discussion with some “real life practitioners”,<br />
members of some companies which performed or are in the process of performing the<br />
shift to Enterprise 2.0. In case some other author’s opinion was enclosed in the paper,<br />
whether in exact quotation or synthetic form, a complete mention of the source<br />
identification information was made. Some of the data in the paper is based on the<br />
results of some previous market research studies that were credited accordingly.<br />
The author has over seven years of previous experience in the research area, and also<br />
a series of previous research results (published articles, conference attendances and<br />
doctoral research). By defending the research results at the proceedings of such a<br />
prominent scientific conference, attended by both scholars and practitioners bearing<br />
some interest in the research area, the author attempts to get further validation of his<br />
opinions, both confirmation and rejection of the aforementioned opinions’ scientific<br />
and practical importance being welcome.<br />
2. OLD vs. NEW IN GETTING BUSINESS SOFTWARE<br />
Traditionally, software applications are regarded as products, or as assets, both for the<br />
producer and the consumer. They are usually bought by the consumer, which may be<br />
considered the owner of a copy of the program (Cusumano, 2004). The customer pays<br />
a license fee which renders him the right to install and use the software application in<br />
a certain hardware configuration and for a certain number of users. In most of the<br />
cases, the software may be used for an unlimited time period, but on a single machine.<br />
The consumer might also pay a periodic fee, usually 5 to 25% of the initial price for<br />
update, maintenance and technical support services. From the accounting point of<br />
view, software applications are “capitalized”, which means they are to be presented as<br />
an asset in the buyer’s financial statements (Iod, 2002), and suffer depreciation based<br />
on their acquisition value and presumed lifespan.<br />
The “standard” model of software as a product has been adopted mainly due to the<br />
tremendous success of some software producing companies like Microsoft, Oracle or<br />
SAP, which were proud to report the huge profits obtained. But aside from the<br />
“success stories”, the situation is very similar to the music industry, being almost<br />
exclusively based on “hits” or “breakthroughs”, which are extremely advertised<br />
software applications being of great interest for the large public (Haines, 2008).<br />
~ 259 ~
However, the software products which are not regarded as “hits” by the market and<br />
the general public usually get much smaller profits, and their producers are almost<br />
always on a narrow line between profit and loss. Moreover, the top software<br />
producers almost never adopt the open standards which allow for free data transfer<br />
among applications. “Sealing” the applications, limiting the user’s choice to a few<br />
proprietary formats and avoiding any possibility of converting documents to the<br />
formats of the direct competitors were always “features” of the top software<br />
producers, despite the major drawback they represent for the consumers and the final<br />
users. Once a company has become a customer, its possibilities to migrate to a<br />
cheaper or better product were drastically reduced (Gannod et. al., 2005).<br />
Even if the aforementioned analysis reveals a series of important benefits, using<br />
software as a product is also marked by a set of major issues. In most cases, the<br />
software application is downloaded from the vendor’s website, and installation and<br />
setup are the exclusive task of the customer. As a consequence, the software<br />
application has to be prepared to run in heterogeneous, unstable or unforeseen<br />
environments (Pohl et. al., 2005). The software application is usually installed across<br />
the customer’s network, on hardware configurations and operating systems installed<br />
and configured by the customer. At least in theory, the software application has to be<br />
able to face any challenge in terms of configuration and operate in any environment,<br />
with any set of parameters. According to the author’s, reaching this goal is extremely<br />
expensive for the application’s developer.<br />
The second major drawback software developers have to face is the “cross-platform”<br />
support for their software, or the support for multiple operating systems. When a<br />
software developer intends to get a significant market share for its product, it has to<br />
develop a few separate versions of the software, one for each major operating system<br />
(Windows, Linux, MacOs, Unix). The more than significant differences among the<br />
aforementioned operating systems render just a small part of the application source<br />
code usable in all the versions, the development of four or five almost different<br />
applications (one for each operating system) being required in most of the cases. The<br />
negative impact on the software developer is obvious in this situation. A large<br />
quantity of time and human resources, which otherwise might be used for adding new<br />
features to the application, is used instead to test the software on different operating<br />
systems, on different operating systems’ versions, or on different hardware<br />
configurations (Haines, 2008).<br />
The drawbacks often affect the consumer, too. In most cases the cost of installation,<br />
setup and configuration for the purchased software applications are significantly<br />
larger than the purchase cost per se. Each organization has its own network, having<br />
many features and idiosyncrasies and, by consequence, aspects as the network<br />
topology or hardware incompatibilities have to be foreseen, taken into account and<br />
dealt with. Even for the most popular applications, which usually are thoroughly<br />
tested and adequately documented, the system or the network administrators take<br />
major risks for each setup and update of the software.<br />
As a result of the aforementioned drawbacks, both software application developers<br />
and their customers are eager to adopt a new model for the development and the<br />
distribution of such applications, usually known as “Software as a Service” and<br />
abbreviated SaaS. Even if the model is around for a few years, being far from a total<br />
~ 260 ~
novelty, the difference resides in its recent success registered as a consequence of the<br />
high compatibility with the Enterprise 2.0 family of technologies (Blokdijk, 2008).<br />
The SaaS success during last few years is tightly interconnected with the advent and<br />
the rise of the Web 2.0 technologies. As network connection and Internet access are<br />
ubiquitous, the business model behind the new approach may be accessible for the<br />
vast majority of software consumers. Web applications have reached a maturity level<br />
allowing on-line users to get the same experience and facilities as from traditional,<br />
off-line applications (Heydarnoori et. al., 2006). In the author’s opinion, a comparison<br />
of the Web-based e-mail management suites (like Gmail) with traditional e-mail client<br />
applications as Microsoft Outlook, or a comparison of the traditional Microsoft Office<br />
suite with the Google Docs on-line suite may be enlightening.<br />
Cloud computing applications are faster, simpler and cheaper to use, as there is no<br />
involvement of capital requirement for servers or storage and operational expenses for<br />
running a large data center (Buyya et. al., 2011). Cloud industry is growing quickly<br />
and vendors are investing significant amounts of money to develop solutions-as-aservice,<br />
suggesting they believe in the success of this technology as an alternative to<br />
traditional IT solutions. A very large scale study, performed by Gartner Inc.<br />
(Krautheim, 2009), the world’s leading information technology research and advisory<br />
company, revealed that for the 2008-2013 time interval, an impressive growth of the<br />
Enterprise 2.0 and cloud computing market is predicted, from 9.1 to 26.6 billion $. In<br />
order to get a better view of the facts, the Compound Annual Growth Rate (or CAGR)<br />
was chosen to be computed. The compound annual growth rate is calculated by taking<br />
the n th root of the total percentage growth rate, where n is the number of years in the<br />
period being considered. Taking into account that the estimated growth is not<br />
considered to be linear (or constant), the CAGR allows for results comparison, both<br />
intra-industry and cross-industry. The following formula was applied (Formula 1):<br />
Formula 1. The Compound Annual Growth Rate<br />
⎛ Ending Value ⎞<br />
CAGR = ⎜<br />
Begining Value ⎟<br />
⎝<br />
⎠<br />
~ 261 ~<br />
⎛ 1 ⎞<br />
⎜<br />
Nr.<br />
of years ⎟<br />
⎝<br />
⎠<br />
(Source: Grundfest, 1990:350)<br />
A value of 24% is computed for the CAGR, based on the aforementioned formula. In<br />
the author’s opinion, the growth rate has a definitely large value, which renders the<br />
Enterprise 2.0 as a mature, settled set of technologies. A ten billion dollar market,<br />
having almost 25% growth per year does not appear based on an experiment or a<br />
single “pioneer” company. A company moving from SaaP to SaaS becomes more and<br />
more a trend follower than a trend setter.<br />
According to the author, the general support or interest for SaaS, which is clearly<br />
observed for the majority of the corporate software consumers resides in the rapid<br />
adoption of the SaaS business model by the small companies in the fields or industries<br />
requiring many complex (and often overwhelmingly complex) software applications.<br />
Using software as a service was mostly attractive because it allowed to small<br />
companies having a minimal IT department (or having no IT department at all) to use<br />
software application otherwise out of reach due to installation, configuration and<br />
maintenance issues not manageable in the absence of a well-staffed IT department.<br />
−1
A large multinational company almost always affords to assemble a team of<br />
professionals in order to properly install, configure and manage networks or largescale<br />
software applications, but a small company almost never can afford such costs.<br />
In our opinion, the second major benefit of software as a service is that the customer<br />
is allowed to pay only for what he really needs. The vast majority of corporate<br />
business software applications come with a fixed minimal cost of the hardware,<br />
installation and configuration efforts involved, usually computed for a large-scale<br />
department. Even if the department dimensions are significantly smaller, the cost is<br />
much less elastic and does not fall back accordingly. As a result, small companies are<br />
often forced to support cost levels similar to the ones of the large companies. Using<br />
SaaS allows the customers to significantly reduce the aforementioned costs, as they<br />
usually are charged based on the amount of time, storage space or application<br />
resources used. Even if the advantages are obvious, it is not to expect that all<br />
companies will unconditionally (or blindly) move to the new technology, without a<br />
shadow of a doubt. Thus, one question of main importance, included in the aforesaid<br />
empirical study, requested the members of the target group to state their key buying<br />
(or not buying) criteria. Four main criteria were provided (cost, scalability, expertise<br />
and operational stability), and the respondents were encouraged to provide their own<br />
criteria, if not in the list. The weight of each main criterion in the answers received is<br />
stated in Table 1:<br />
Table 1. The weight of each main criterion<br />
CRITERION WEIGHT<br />
Cost 80.2%<br />
Operational stability 74.6%<br />
Scalability 32.9%<br />
Expertise 25.8%<br />
In the author’s opinion, the results may be explained as follows:<br />
• Cost – the size of the expense implied by moving to Enterprise 2.0 is still the<br />
most important of the criteria. As the switch to SaaS is mainly taken into<br />
account by small or medium sized organizations, unable to afford large IT<br />
departments, this kind of companies was the main target of the questionnaire.<br />
Even if moving from SaaP to SaaS is attractive due to the small IT costs on<br />
the long term, the immediate costs of the process are still an important concern<br />
for the potential customers. In a previous paper (Mangiuc, 2010), the author<br />
provided a model and a set of results in the field of computing ROI (Return on<br />
Investment) for an Enterprise 2.0 implementation.<br />
• Operational stability – most of the managers are concerned about the impact<br />
of the “movement” on the organization’s current activity. Small companies<br />
usually fight a lot for their market share and, due to the fierce competition; a<br />
temporary shutdown of their services is usually out of question. In this case, it<br />
is the duty of the “cloud mover”, or the service provider to develop and<br />
present a strategy allowing the customer’s transition to Enterprise 2.0 without<br />
compromising its operational stability. And with a 74.6% rate of concern,<br />
building such strategy will be no easy task.<br />
• Scalability – most of the respondents do not regard scalability as an important<br />
concern, and this is mainly due to the aggressive advertising campaign of the<br />
“cloud movers”, which claim that adopting software as a service usually<br />
~ 262 ~
comes with unlimited scalability at almost no cost. Even if this is mostly true,<br />
the collateral scalability costs have to be taken into account. For example, if a<br />
new branch office of the company is opened, the cost of the extra software<br />
access required by the software provider is usually small, but the costs of the<br />
underlying hardware and network communications infrastructure may not be<br />
as small as the amount paid to access the software applications from within the<br />
new location.<br />
• Expertise – the lack of expertise in migrating to the cloud seems not to be an<br />
important concern for the customers, as they regard this kind of expertise<br />
mostly as an additional service provided by the migration assistant or by the<br />
Enterprise 2.0 services provider. In most customers’ opinion, the migration<br />
expertise is to be bought from the provider, not gathered by the customer itself<br />
(Buyya and Bubendorfer, 2009).<br />
In addition to the four aforesaid criteria, the respondents also provided the following<br />
additional buying criteria (presented in the reverse order, by number of occurrences):<br />
• Security-related services (81%) – according to the survey results, security<br />
seems to be a top priority for the potential customers, and usually, the first<br />
questions asked by a company before moving to cloud are all about security<br />
issues. Even if customers who admit that their own information systems have<br />
serious security issues are quite hard to convince about the secured<br />
environment of the cloud-based services. In the author’s opinion, this behavior<br />
is mainly due to the fear of the unknown, and if improperly handled, it may<br />
become a real deal breaker, even more important than cost. The provider of the<br />
Enterprise 2.0 services usually has to explain in great detail the security<br />
measures related to the following procedures:<br />
� Protection of data during transit and in storage (obfuscation, cloud-specific<br />
storage etc.);<br />
� Encryption and decryption algorithms (strength, implementation);<br />
� Disaster recovery policies (backup systems, disaster recovery plans etc.);<br />
� Restricted access, intrusion protection and firewall services;<br />
� Security documentation and certifications;<br />
� Data security procedures related to the termination of service.<br />
Tightly related to the security issues are the legal issues of the cloud-based<br />
business model. Most of the potential customers are very interested in the legal<br />
jurisdiction and framework applicable for each potential contract they will<br />
agree on, as well as the legal authority that is able to decide in case of<br />
litigation.<br />
• Service and support (73%) – most customers look at moving to cloud and<br />
using Enterprise 2.0 as a milestone of their business activity and are very<br />
concerned about the support they will get to successfully accomplish the<br />
process. As most providers claim 24/7 availability for their services, most<br />
customers also expect 24/7 technical support, at least in the first stages of the<br />
transition. Most of the respondents required full time support for their<br />
employees, as the final users of the service, not particularly for the IT<br />
department and staff. In the author’s opinion, most of the potential customers<br />
feel like their business processes will be somehow “outsourced”, or look at<br />
moving to cloud computing as a “leap of faith” (Walsh, 2009), so as full time<br />
service and support are fundamental prerequisites for the success of the<br />
migration.<br />
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• Flexibility (73%) – a large part of the respondents were concerned about the<br />
ability of the provider to integrate and manage hybrid environments, which<br />
will allow the customer company to leverage their cloud services while also<br />
augmenting their internal IT capabilities. Large heterogeneous environments<br />
are frequently due to a large number of legacy systems, to previous evolution<br />
attempts, or to previous failed or successful cost-cutting attempts. However,<br />
Enterprise 2.0 services providers always advertise the “universality” of the<br />
cloud computing, as well as the “full availability” of the provided applications<br />
and services, for computers which have “only a Web browser installed”. As a<br />
result, most customers expect almost unlimited flexibility, and also assume<br />
their entire IT infrastructure will be fully functional in the cloud.<br />
• Performance (72%) – since the advent of Web applications and Internet-based<br />
computing, some voices complained about the “performance gap” between<br />
desktop applications and their on-line counterparts (Youseff et. al., 2008). For<br />
almost a decade, Web applications were regarded as a palliative, incomplete<br />
way of replacing traditional desktop applications. Even if broadband Internet<br />
and the huge technological advances made the border between desktop and<br />
Web more and more hollow, some traditionalist customers still fear about a<br />
performance decrease when moving from traditional to cloud-specific<br />
computing techniques. When analyzing the current offer of cloud computing<br />
solutions, we may discover that the fear is not completely ill-founded. Most<br />
potential customers should assess the cloud provider’s capabilities at the subsegment<br />
level (i.e. CRM, SCM, and ERP) due to large differences in the subsegments<br />
maturity and performance.<br />
• Availability (72%) – most cloud services providers show off a lot about the<br />
24/7 availability of their services and, consequently, even a minor stop of the<br />
service (a few minutes) is regarded as a small disaster. For example, if Google<br />
document management or e-mail services become unavailable, even for a few<br />
seconds, the media makes a lot of hype on the subject. If this happens for a<br />
provider whose services are mostly free of charge, it is obvious that<br />
unavailability of a paid service will be very harshly sanctioned by the<br />
customers. Some of the respondents even asked about the existence of<br />
contractual clauses and compensations for the service unavailability periods.<br />
• Issue resolution (68%) – some of the potential customers feel that the general<br />
phone-based or Internet-based support is not enough for such an important<br />
choice like migration to the cloud and, consequently, ask for direct assistance<br />
in issue resolution. On the other hand, most of the Enterprise 2.0 services<br />
providers are quite reluctant to provide direct support, especially when it<br />
implies sending own employees to the customer’s location. Moreover, the<br />
location of the provider may be in a different country, or even on a different<br />
continent than the location of the customer. In order to fill this gap, a new kind<br />
of business raised during the last years, offering “cloud moving services”.<br />
Having a strong contractual basis with both the service provider and the<br />
customer, the cloud mover company offers to assist the customer as an<br />
external consultant, compensating for the provider’s lack of ability to provide<br />
direct support.<br />
• The billing model (67%) – migrating to cloud-based services implies, for most<br />
companies, a re-design of their perspective of IT costs. Switching from local<br />
to cloud usually leads to important savings on server hardware, software<br />
licensing, infrastructure maintenance and administration labor costs. Even if<br />
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the main reason to embrace Enterprise 2.0 is a significant decrease of the ITrelated<br />
costs, some customers may be suspicious at first when facing the<br />
cloud-specific billing models. One main advantage of the cloud is the ability<br />
of the customer to pay only for usage. This model applies for all the layers of<br />
Enterprise 2.0 (SaaS, IaaS, PaaS). Even if the information that customers<br />
“will only pay for what they use” is ubiquitous, there is no uniform unit yet.<br />
The service provider may charge based on the Internet bandwidth used, the<br />
storage space employed, or the instance-hour for each provided service (the<br />
service provided for one hour to one computer of the customer).<br />
• Years of experience and customer portfolio (66%) – even if the cloud is still<br />
very “young” among the IT-specific approaches, some of the main players on<br />
the market (like Google, Oracle or Microsoft) may already claim to have<br />
significant experience with moving customers from local to cloud-based<br />
services. A large number of respondents admitted that in case of an eventual<br />
migration, they would more likely choose a “big” name in the field (like the<br />
three abovementioned companies), than a newcomer, even if the latter has a<br />
much better offer in terms of costs and support policy. Some of the<br />
respondents even admitted that having the leaders of their industry or branch<br />
in his customer portfolio may be the best reference an Enterprise 2.0 services<br />
provider can get.<br />
• Quality of the applications hosted in the cloud (42%) – the cloud computing is<br />
new, but still old enough to be prone to competition. As presented in figure 1,<br />
there are multiple offerings for each family and sub-segment of the cloudbased<br />
set of services.<br />
KEY ACTORS<br />
Picture 1. Cloud computing families and sub-segments<br />
Software-as-a Service (SaaS) Platform-as-a Service (PaaS) Infrastructure-as-a Service (IaaS)<br />
Salesforce<br />
Google Apps<br />
Oracle<br />
Facebook<br />
Netsuite<br />
Force<br />
Caspio<br />
Google App Engine<br />
Microsoft Azure<br />
CRM CCC DCC ERP SCM<br />
Integration as a Service<br />
CLOUD<br />
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Integration<br />
as a Service<br />
Rightscale<br />
Amazon Web Services<br />
Eucalyptus<br />
GoGrid<br />
Compute<br />
Services<br />
Private<br />
Cloud<br />
When analyzing the potential cloud computing solutions, companies should assess<br />
each cloud provider’s capabilities at the sub-segment level (i.e. CRM, SCM, ERP),<br />
due to large differences in the sub-segments maturity. For each sub-segment, a set of
epresentative players have to be selected based on their offer, individual maturity,<br />
and the role they play within their sub-segment. The current landscape of the cloud<br />
services offer is a mix of new and recent niche players competing with more<br />
established software and hardware vendors. The providers have to be compared based<br />
on the following criteria (at least):<br />
� Domain of activity;<br />
� Date of first cloud release;<br />
� Year-on-year growth (for example, 2009 to 2010);<br />
� Key differentiators;<br />
� A sample of key clients;<br />
� A sample of key partnerships;<br />
• Business process services (23%) – in some cases, migration to cloud<br />
computing may have a greater effect than usual on the structure and dynamic<br />
of a company business processes. Consequently, the potential customer may<br />
consider that the re-engineering of the affected business processes is a part of<br />
the Enterprise 2.0 implementation process, leaving this task for the cloud<br />
service provider. The provider, on the other hand, has seldom enough<br />
knowledge of the customer’s position and business model details to provide<br />
valid advice in re-modeling the business process. In the author’s opinion, this<br />
is another situation where the expertise of a cloud mover or a consultant<br />
company would make a significant difference.<br />
• The exit plan (11%) – due to business consciousness (or just distrust), a small<br />
group of respondents considered that a valid exit plan should be part of the<br />
deal. Most of the expressed concerns were about data security after the cloudbased<br />
service use is discontinued, and also about a proper service cancelation<br />
procedure in case of a switch to a new provider, which should be able to<br />
access and copy business data from the old one. The question also applies for<br />
the situation of a return to the software and business model that the customer<br />
had before moving to the cloud. Another issue brought into discussion was the<br />
provider’s treatment of sensible business data in the case of a late or overdue<br />
payment for the service.<br />
The analysis of the aforementioned criteria reveals that even if most of the potential<br />
customers are rather interested in a migration to the cloud, they would agree to take<br />
this step only after getting reasonable assurance about the safety and the sustainability<br />
of the approach. As a result, the author considers that the main players on the<br />
Enterprise 2.0 market need a “change of tone” in their advertising campaigns, with<br />
less emphasis on marketing promises and more answers to the key “fears” of the<br />
potential customer.<br />
Despite all the aforesaid advantages, we consider the SaaS model not to be a universal<br />
solution for all the corporate business software issues. According to some of the<br />
quoted authors (Heydarnoori et. al., 2006; Blokdijk, 2008), the new model will never<br />
replace the traditional model entirely, but will provide an increasingly better<br />
alternative to the software as a product. We also consider there are a set of major<br />
issues and a set of business areas where SaaS has less of a chance to succeed.<br />
According to the author, most of the issues originate from the fact that the customer is<br />
required to have extremely strong confidence in the software service provider. In<br />
some situations, granting such confidence to an outsider may be considered as a proof<br />
of irresponsibility and may even compromise business continuity. For example:<br />
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• A large multinational company producing candy and chocolate products<br />
should never let a software provider store and manage the secret<br />
manufacturing recipes for the products.<br />
• A government agency processing secret or confidential information should<br />
never let an external service supplier manage its data sets.<br />
• A healthcare institution taking the confidentiality of their patients’ medical<br />
history very seriously, should not hand the management of the medical history<br />
data to an outside service provider.<br />
• A bank should never let a service provider manage all the customers’ financial<br />
information and even perform transactions on behalf of the customers.<br />
Some other aspects here are open for interpretation. For example, the issue of the<br />
legal framework applicable in such contexts: to what extent has a Romanian company<br />
using applications hosted on Cayman Islands servers to comply with the local and the<br />
remote legal framework (Hall and Frey, 2007).<br />
All the aforesaid issues diminish as the distributors of such applications provide<br />
solutions for the privacy, security and trust-related problems. Even though, the list of<br />
questionable practices remains open. For example, the SaaS model does not provide<br />
the means for the service consumer to locally store his own data. The customer’s data<br />
are stored in the application provider’s data center, placing the Internet between the<br />
customer and the provider. Consequently, any malfunction of the application<br />
provider’s system or the customer’s Internet Service Provider (ISP) renders the<br />
application unusable for the customer. Moreover, a malfunction of the application<br />
provider’s system renders the application unusable for all its customers, which may be<br />
hundreds, thousands or millions of people or companies. The advantage of a<br />
centralized application management is the significant cost decrease, but the “dark<br />
side” of the matter is that any malfunction affects everybody. In the author’s opinion,<br />
a SaaS offer can easily become the victim of its own success if inadequately managed.<br />
A rapid increase in the number of customers not followed by the necessary increases<br />
in bandwidth, security systems, backup systems and staff may throw into chaos an<br />
otherwise successful project. Obviously, the “software as a product” model is also<br />
prone to disasters, but the malfunction only affects a customer or a small group of<br />
customers, not everybody in the same time. Even if the customer’s IT team is able to<br />
get involved swiftly in case of a malfunction, its expertise level in debugging the<br />
application is significantly lower than the application developer’s.<br />
As a SaaS application provider, the merely existence of the company and business<br />
process depends on the provided application’s availability. The large providers of<br />
SaaS (like Google) are always bragging about the “24/7” availability of their<br />
applications and, by consequence, any malfunction, even a partial or limited one, is<br />
severely penalized by the media and also by the customers. The above is true even for<br />
the free applications, but in the case of commercial ones, a serious malfunction may<br />
irreversibly damage the image of the provider. On the other hand, investing in security<br />
and backup may be somehow appealing for a SaaS provider, as the benefits of the<br />
investment are simultaneously “delivered” to all its customers.<br />
The landscape of the Software-as-a-Service market is divided today into a few main<br />
sub-segments:<br />
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• Customer Relationship Management (CRM) – The “on demand” CRM market<br />
is one of the most mature sub-segments in the SaaS market. The first players<br />
arrived on the market in early 2000 and, since then, the market has grown<br />
towards maturity. According to analysts (Walters and Newton, 2010), the<br />
CRM “on demand” market will generate more than 2 billion USD in 2011 and<br />
will represent more than 20% of the entire CRM market.<br />
• Enterprise Resource Planning (ERP) – ERP defines a broad area of subcategories,<br />
from human resources to financial management. Today, most of<br />
the SaaS ERP customers are midsized companies. Large corporations are still<br />
confronted with limitations due to the complexity of their needs preventing<br />
them from entirely embracing cloud ERP solutions.<br />
• Supply Chain Management (SCM) – Supply chain management applications<br />
are those that allow companies to improve externally oriented processes, to<br />
manage selected portions of their supply chains, and to control their supplier<br />
base.<br />
• Content, Communication and Collaboration (CCC) – The content,<br />
communication and collaboration market varies in the maturity of its subsegments.<br />
Adoption rates range from a high use of SaaS (where 60% of all elearning<br />
solutions are SaaS-based) to medium (10% of e-mail) and low<br />
adoption (only 2% of enterprise content management systems run on SaaS).<br />
• Digital Content Creation (DCC) – SaaS currently represents a small part of<br />
the digital content creation market. This market relies, more than others, on<br />
customer decisions; consequently, as the consumer’s appetite for digital video<br />
(Youtube, MySpace...) shows tremendous growth and online image editing<br />
software versions (e.g. Adobe Photoshop Online, Picasa, etc.) are appearing,<br />
many evolution directions are ahead for digital imaging and video.<br />
3. FURTHER DEVELOPMENT OF THE SAAS MODEL –<br />
INFRASTRUCTURE AND PLATFORM AS A SERVICE<br />
The interest for cloud computing in the infrastructure market has grown substantially<br />
during the last five years, and so have the investments (Ashta and Patel, 2010).<br />
Several infrastructure services have been re-labeled and this causes confusion<br />
between the various offerings. From outsourcing, the market has already moved to<br />
infrastructure utility and, as cloud computing grows, infrastructure utility is becoming<br />
Infrastructure-as-a-Service (IaaS). Today, public cloud infrastructure is not yet able<br />
to provide a complete offering to companies and therefore the market is growing<br />
slowly, being still based on the early hybrid cloud models. The main areas of interest<br />
for this market are considered to be:<br />
• Backup & storage services – In the online backup and storage services market,<br />
price competition is high, forcing providers to keep costs low to maintain<br />
profitability. Consequently, the providers are looking to gain their benefits<br />
from economies of scale.<br />
• Compute services – The key added value offered by compute providers is<br />
elastic computing power, which can transparently cater to the organization’s<br />
fluctuating needs. Currently, on demand compute services is at an early stage.<br />
• Private cloud computing – A private cloud environment is a solution that<br />
enables companies to centralize their IT resources instead of working with<br />
separate environments. The advantages for companies include the ability to<br />
access a pool of resources that offers the flexibility and scalability to handle<br />
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fluctuating demands, and cost savings through “on demand” provisioning of<br />
virtualized resources.<br />
As a result, the idea of providing technology “by request” is no longer limited to<br />
software applications, but is also extending to some other areas, as the infrastructure<br />
or the hardware system. The term “Infrastructure as a Service” (or IaaS) is used far<br />
less than SaaS, but is becoming a more and more important component of the<br />
Enterprise 2.0 family of technologies. For example, the Amazon company, worldwide<br />
renowned for its virtual store and generally considered the largest book seller in the<br />
world, started to provide IaaS services, the most successful one being S3 (short for<br />
Simple Storage Service). The service allows companies to rent data storage capacity,<br />
paying only for the occupied space. Even if the service, in its essence, is a very simple<br />
one, it allowed for the development of a whole suite of third-party applications aimed<br />
at access and data management, the very low prices asked forcing to a general<br />
decrease in the price of the Internet-based data storage services (AWS, 2009). The S3<br />
service may be used as a back-end for any software application (traditional or Webbased),<br />
its major strong points being scalability and extreme flexibility. A consumer<br />
of the S3 service in need of a significant and immediate increase of the S3 storage<br />
space does not have to do anything to get it, but use as many data storage space is<br />
needed, a subsequent payment being performed, depending on the subscription terms.<br />
There is no need a to add and configure new drives or storage units, and there is no<br />
need to contact Amazon in order to ask for a supplement, the whole process being<br />
implicit, when the new files of the customer are saved on the provider’s storage<br />
servers. So, the customer gets instantaneous and smooth scalability for the<br />
infrastructure provided as a service.<br />
A second member of the same family of services, is EC2 (short for Elastic Computing<br />
Cloud), consisting in a set of virtual machines which may be rented by the customers.<br />
The virtual machines are usually based on open-source software (Linux, Apache,<br />
MySQL, PHP) and are able to instantaneously scale up or down, depending on the<br />
customer’s needs for the server. This service also had a price so low, that a general<br />
decrease in the price of the hosting services occurred. As the customers only pay for<br />
what they use, there is no minimum price (AWS, 2009).<br />
Although having generated considerable interest, Platform as a Service is still an<br />
early-stage market. The software development platform providers have broadened<br />
their scope to enable multi-tenant development and by leveraging their presence in the<br />
SaaS market, are bringing these platforms to the market as PaaS solutions.<br />
Another technology having a solid contribution for the success of the SaaS model is<br />
virtualization, which is the abstraction and the re-partitioning of the existing hardware<br />
resources (Battle & Benson, 2008). The procedure provides an increased application<br />
independence of the hardware configuration, allowing processes or operating systems<br />
to execute in total isolation. A virtual machine is a “guest” operating system which<br />
executes over a “host” operating system, and the technique releases the guest<br />
operating system from dealing directly with the hardware components. According to<br />
the author, the main advantages of virtualization are:<br />
• Server consolidation – more physical servers are “concentrated” in a much<br />
more powerful virtual server, with a significant decrease in the cost of the<br />
processing unit.<br />
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• Server partitioning with resource limitation – allows for a physical server to<br />
be “broken” in a set of virtual servers, and also for a very detailed limitation of<br />
the resources each virtual server (or partition) is allowed to use.<br />
• Application sandboxing – provides a security and isolation mechanism for an<br />
application or operating system, allowing it to execute completely separate<br />
from the other applications and operating systems sharing the same physical<br />
resources.<br />
• Management of the development and testing platforms – allows for the easy<br />
simulation of the different execution environments, a useful tool for software<br />
applications development and testing.<br />
• Rollout, rollback and patching – allows simplifying the application update<br />
process, by means of the update rollout and updating rollback, both at the<br />
application and the operating system level.<br />
The use of the virtual machines significantly increased the efficiency of server<br />
resources management, allowing for a significant decrease in the total amount of<br />
hardware that needs to be deployed, installed, configured and maintained. Some<br />
Internet Service Providers (ISP’s) employed virtualization in order to simultaneously<br />
execute different operating system instances on the same physical machine. The<br />
instances are then offered to the customers as Virtual Private Servers (or VPS). Five<br />
years ago, the ISP had to buy, install and configure a physical server for each<br />
customer in need of a server hosting, rendering the server hosting process very<br />
expensive, even prohibitive for the small companies which did not need the whole<br />
power of a physical server.<br />
Platform-as-a-Service (or PaaS) is a set of web-based services that provide all the<br />
facilities required to support the complete life cycle of building and delivering web<br />
applications and services, where the user is typically within the software developing<br />
organization. Most PaaS systems are hosted, Web-based application-development<br />
platforms, providing end-to-end or, in some cases, partial environments for<br />
developing full applicative programs online. They handle tasks from editing code to<br />
debugging, deployment, runtime, and management. In PaaS, the system's provider<br />
makes most of the choices that determine how the application infrastructure operates,<br />
such as the type of operating system used, the APIs, the programming language, and<br />
the management capabilities. Users build their applications with the provider's ondemand<br />
tools and collaborative development environment. Despite its high<br />
technological interest, PaaS adoption is slow to take off because the PaaS solutions<br />
are relatively new and still lack standards.<br />
PaaS remains an early-stage market with revenue of around 50 million USD, which<br />
represents approximately 1.5% of the total application development market. Despite<br />
the massive investments vendors such as Microsoft, Google and Salesforce performed<br />
in PaaS technologies, the PaaS market remains immature and most vendors still have<br />
proprietary and differing programming standards. As a result of its high technological<br />
interest, and also because SaaS is growing sharply, the PaaS market will experience a<br />
high growth in the coming five years (estimated to be around 50% of the present<br />
value) and reach 400 million USD in 2013 (10% of the total application development<br />
market) (Lawton, 2008). In the next years the confidence in the PaaS model is<br />
expected to grow, so more organizations will build their applications in PaaS<br />
environments. Organizations will be encouraged to experiment the PaaS<br />
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development, taking advantage of the familiarity and previous experience they have<br />
with their SaaS solutions.<br />
4. MAIN RISKS IN ADOPTING ENTERPRISE 2.0<br />
Another key set of questions included in the aforesaid empirical study tried to identify<br />
the main risks that members of the target group consider to assume in the eventuality<br />
of an Enterprise 2.0 implementation. As the question was open-ended, a lot of<br />
different answers were received, so the author re-arranged the answers by grouping<br />
them into fewer categories (based on similarity or resemblance). In the descending<br />
order of occurrence, the main risks in adopting cloud-related technologies were stated<br />
as follows:<br />
• The loss of governance – moving to the cloud forces the customer to accept<br />
the control of the service provider on a quite large number of important issues<br />
and areas of the own business process. This loss of control is widely perceived<br />
as a very large potential security breach and it may be the main reason<br />
customers tend to choose service providers having a frontrunner position on<br />
the market, or, at least, a very good and well established reputation.<br />
• The lock-in – most potential customers feel there is currently little on offer in<br />
the way of tools, procedures or standard data formats or services interfaces<br />
that could guarantee data, application and service portability. This can make it<br />
difficult for the customer to migrate from one provider to another or to migrate<br />
data and services back to an in-house IT environment.<br />
• Compliance risks – some of the respondents stated that part of their investment<br />
in achieving certification (e.g. to an industry standard or to a set of regulatory<br />
requirements) may be put at risk by migration to the cloud. In most cases, the<br />
compliance test process will require the cloud-based services providers to<br />
produce evidence of their own compliance with the relevant requirements,<br />
and, in some cases, even to permit audit by the cloud customer. In a few<br />
situations, even the use of a public cloud-based infrastructure implies that<br />
certain kinds of compliance cannot be achieved.<br />
• Data protection – as previously stated, cloud computing poses several data<br />
protection risks for both cloud customers and providers. In some cases, it may<br />
be difficult for the cloud customer to effectively check the data handling<br />
practices of the cloud services provider. On the other hand, some cloud<br />
providers do offer exhaustive information on their data handling practices.<br />
Some also offer certification summaries on their data processing and data<br />
security activities, and fully describe the data controls they have in place.<br />
• Management interface compromise – the customer-usable management<br />
interfaces of a public cloud services provider are accessible through the<br />
Internet and, consequently, mediate access to larger sets of resources (than<br />
traditional hosting providers), posing an increased risk, especially when<br />
combined with remote access and Web browser vulnerabilities.<br />
• Insecure or incomplete data deletion – when a request to delete a cloud<br />
resource is made, as with most operating systems, this may not result in true<br />
wiping of the data. Associated with the use of multiple tenancies, and the reuse<br />
of hardware resources, this may represent a higher risk to the customer than<br />
using dedicated hardware.<br />
• Malicious insider – while usually less likely, the damage which may be caused<br />
by malicious insiders is often far greater. Cloud architectures necessitate<br />
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certain roles which are extremely high-risk. Examples include the cloud<br />
services provider’s system administrators and managed security service<br />
providers.<br />
• Isolation failure – multi-tenancy and shared resources are defining<br />
characteristics of cloud computing. This risk category covers the failure of<br />
mechanisms separating storage, memory, routing, and even reputation between<br />
different tenants.<br />
In the author’s opinion, most of the aforementioned risks are basically security<br />
concerns due to the migration from one business model to another. Most of the risks<br />
also have counterparts in the traditional, software-as-a-product model and are far from<br />
being cloud-specific. It is obvious that potential customers need in-detail knowledge<br />
of the security system that the cloud-services provider offers, but they also need to reassess<br />
the own security systems, in order to perform a fair comparison.<br />
DISCUSSION AND CONCLUSIONS<br />
The Enterprise 2.0 technologies have led to the advent and development of new<br />
business models for the IT-specific needs of an organization. Software-as-a-Service<br />
(SaaS), Infrastructure-as-a-Service (IaaS) and Platform-as-a-Service (PaaS) are just<br />
the first “wave” of such models facilitating the access of small and medium<br />
organizations to advanced IT-management tools traditionally reserved for the very<br />
large companies. Based on the results of an empirical study, the paper is an attempt to<br />
identify the general attitude of the potential customers towards moving to cloud<br />
computing, and also, the key orientation criteria for the aforementioned group. As<br />
revealed by the results of the survey, most of the potential customers are generally<br />
eager to implement cloud-based technologies in their organizations, but only as a<br />
result of a well-thought and detailed migration strategy. The initial key buying criteria<br />
provided in the survey were completed with a few more by the respondents,<br />
demonstrating a precautious and mature attitude towards going through a process<br />
which small companies usually cannot afford to fail. Employing SaaS implies a series<br />
of major changes in the way software applications are licensed and used. Many<br />
challenges arise, both for the software services providers and for the software<br />
consumers, but SaaS is able to provide both sides the benefits of a new and efficient<br />
software distribution model. The main benefits for the consumers usually reside in the<br />
decrease of the infrastructure expenses and immediate access to the latest version of<br />
the software applications they use. As for the software developers, they are able to get<br />
improved feed-back from the users of their applications, leading to a general decrease<br />
in the development costs and, as a result, an increase in the profit margin of their<br />
product. Moreover, the SaaS model is not the only successful initiative of this kind.<br />
Due to the almost unlimited possibilities offered by the virtualization process,<br />
infrastructure also becomes a service, significantly decreasing installation and<br />
maintenance costs for the hardware systems and the network (infrastructure<br />
management costs). The SaaS market is the most successful segment of the Enterprise<br />
2.0 family, and its success leverages the growth of the IaaS and PaaS markets, which<br />
are still in early stages, but with tremendous potential for the next five years. The<br />
respondents identified a set of major risks in adopting cloud-based technologies, and<br />
the identified risks may be regarded as key improvement areas for the cloud-based<br />
services providers.<br />
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The adoption of the new software distribution model will not happen overnight, but<br />
will become a gradual process, having a variable growth rate, but, according to the<br />
author, the first companies to discover the benefits of the new model, and the<br />
companies willing to adapt in order to get the benefits, will gather significant<br />
competitive advantages from the adoption of the model.<br />
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NON-TECHNICAL CHALLENGES<br />
IN ADOPTING ENTERPRISE 2.0<br />
Dragoş Marian MANGIUC 1<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
As the family of Enterprise 2.0 technologies is developing and gaining market share, and<br />
migration to cloud-based computing becomes more of a natural choice for many small or<br />
medium-sized organizations, a growing number of companies start to look interested in the<br />
new wave of technologies. Even if the adoption rate of cloud-based services is rapidly<br />
increasing, the migration process is far from being smooth, or even standardized. Thus, the<br />
potential beneficiary of an Enterprise 2.0 implementation faces a wide range of challenges on<br />
many levels: operational, software, platform, infrastructure, security etc. Based on both<br />
literature review and action research, the paper at hand is a synthesis for the results of an<br />
empirical study (a survey) performed during the last two years among Romanian and foreign<br />
small and medium-sized companies, in order to pinpoint the most important non-technical<br />
challenges that an executive has to face when looking at a migration to the cloud. The paper<br />
is a part of a larger research performed by the author in the field of Enterprise 2.0<br />
technologies.<br />
KEYWORDS: Enterprise 2.0, Cloud computing, Migration, Challenges, Empirical study<br />
INTRODUCTION<br />
The “traditional” setup of IT management for an organization implies that the<br />
aforesaid organization has total control and ubiquitous visibility over the owned<br />
infrastructure and the employed services. All the components are fully accessible and,<br />
also, precisely measurable by means of an organization-level defined set of metrics<br />
and indicators. No matter how complex it is, each component of the IT infrastructure<br />
is taken into account for the computation of a performance indicator and, as a result, it<br />
may be “tuned” so as to reach its optimal performance level. Adopting Enterprise 2.0<br />
technologies and migrating to cloud services may significantly diminish the visibility<br />
and control levels that the organization has over the employed components and<br />
services. The immediate effect of this fact is the lack of some important guarantees<br />
regarding the quality and the good operation of services. Moreover, the adoption of<br />
Software as a Service (SaaS) brings further limitations of the beneficiary’s visibility<br />
over the cloud infrastructure and its operation parameters (Walters, 2009). Such<br />
parameters may enclose vital information (transaction ID, instance ID, application<br />
type, security level, location, DNS information etc.). However, as long as this kind of<br />
information is not standardized, the comprehension of its contents, meaning and use<br />
may be a challenging process for the organization benefiting from the service. As the<br />
1 Correspondence address: Dragoş Marian MANGIUC, Bucharest Academy of Economic Studies,<br />
Romania; email: mangiuc@gmail.com<br />
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ange of cloud-based services is expanding, the beneficiary may face the need to<br />
monitor hundreds of instances and thousands of indicators. As a result, the author<br />
thinks that a conceptual framework for the management of cloud-based business<br />
processes becomes more and more of a necessity.<br />
During the last years, a lot of IT companies migrated from the centralized model of<br />
running applications on prohibitively priced mainframes to the distributed model,<br />
Internet-oriented and having a service-based architecture. It is usually considered that<br />
applications and IT resources designed by the guidelines of the Service Oriented<br />
Architecture (SOA) provide a solid foundation for the adoption and integration of the<br />
cloud domain conceptual frameworks (Shan, 2010). Building their IT development on<br />
such conceptual framework, enterprises are able to re-scale swiftly in order to satisfy<br />
the needs of their customers. There is also the advantage of splitting the applications<br />
themselves from the physical resources they require, as well as the possibility to<br />
instantly gather additional resources of software, platform and infrastructure in order<br />
to successfully face some activity “peaks”. However, as the performed survey reveals,<br />
not all enterprises are prepared or eager to take this chance in order to fundamentally<br />
change the way they benefit from IT. The reasons for this behavior seem to be very<br />
different from one company to another. In many cases, the drawbacks are due to<br />
business constraints, for example, when the business processes and the underlying<br />
data set are extremely tightly coupled, with a set of very weakly defined integration<br />
points. In some other cases, the migration is not possible due to a very strong<br />
dependence on the existing and legacy information systems which are bound by<br />
proprietary, legally protected data formats or whose further development is no more<br />
feasible because of efficiency reasons. In such cases, the adoption of Enterprise 2.0<br />
technologies is excessively costly to remain an attractive choice.<br />
In the author’s opinion, the cloud-based technologies may become an important part<br />
of a modern approach, able to design and create a dynamic, flexible and adaptable<br />
organization, as the applications and services they support are no longer dependent on<br />
a single, fixed infrastructure. As virtualization and the SOA approach infiltrate the<br />
enterprise, a set of weakly coupled services, executing on an agile and scalable<br />
architecture, may transform any organization into a node of the cloud. By gaining<br />
these new abilities, organizations may be able to rapidly adapt to change. As any of<br />
the previous IT “revolutions”, the cloud-based approach is both the result of a<br />
technological evolution and the result of a business processes re-engineering<br />
demarche.<br />
The author performed an analysis of the main factors governing the evolution of<br />
Enterprise 2.0 technologies, and concluded that the many different factors may be<br />
synthesized in a number of seven main elements leading to an increase in value from<br />
three main perspectives: economic, architectural and strategic (Figure 1). The gain of<br />
economic value is mainly due to the “pay-as-you-go” or “pay-as-you-grow” models<br />
which allow the extension of the IT architecture without requiring the “traditional”<br />
capital expenses. The gain of architectural value is due to the existence of a unique<br />
and abstract environment for IT development. The gain of strategic value is due to the<br />
fact that the enterprise is able to focus on its business core, leaving the IT<br />
management tasks to external actors. A literature review in the field (Kittlaus and<br />
Clough, 2009) leads to the conclusion that the factors influencing the success of an<br />
organization’s adaptation to Enterprise 2.0 may be synthesized as follows:<br />
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• The virtualization techniques and the extremely rapid development of the<br />
market.<br />
• The rapid development of the hardware components (mostly processors and<br />
network equipment).<br />
• The quick development of broadband networks.<br />
• The accelerated increase of the IT infrastructure requests for an organization.<br />
• The fast evolution and the significant decrease of the time-to-market indicator<br />
for Internet-based applications.<br />
• The waves of economic crisis which impose continuous cost cuts for the<br />
enterprises.<br />
Figure 1. The Seven Elements of Cloud Service Value<br />
The adoption of Enterprise 2.0 requests the organizations to appeal to a set of<br />
technologies which are still during the development phase, along with a significant reengineering<br />
of the business models (Ristola, 2010). The author’s survey revealed that<br />
a large number of organizations and IT departments try to keep risk at an manageable<br />
level by identifying the gaps in technology or process and trying to provide acceptable<br />
solutions for the identified issues. The main issues faced when implementing<br />
Enterprise 2.0, as revealed by the survey, are presented in Figure 2. The author’s<br />
survey may be compared with a similar research performed during the same period by<br />
CIO Research (Golden, 2009) amongst the cloud services providers. The results of<br />
this study are synthesized in Table 1. The comparative analysis of the two studies<br />
reveals as obvious that security, performance and integration are the main concerns<br />
for both the Enterprise 2.0 services providers and their actual and potential customers.<br />
Even if the perspectives of providers and customers do not match 100%, in the<br />
author’s opinion this is mainly due to the different evaluation techniques employed by<br />
each group. While the service providers use the Quality of Service (QoS) indicator, or<br />
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the way it was defined by the contractual agreements (Service Level Agreements –<br />
SLA) as a fundamental landmark, the customers mostly value the service experience<br />
itself. The following table (Table 2) presents the opinions of cloud services providers’<br />
and customers’, side by side.<br />
Figure 2. The main concerns of the Enterprise 2.0 services beneficiaries<br />
Table 1. The main concerns of the Enterprise 2.0 services providers<br />
CONCERN RESPONDENTS<br />
Security 45%<br />
Integration with existing systems 26%<br />
Loss of control over data 26%<br />
Availability concerns 25%<br />
Performance issues 24%<br />
IT Governance issues 19%<br />
Regulatory/compliance concerns 19%<br />
Dissatisfaction with vendor pricing/offer 12%<br />
Ability to bring systems back in-house 11%<br />
Lack of customization opportunities 11%<br />
Measuring ROI 11%<br />
Not sure 7%<br />
Other 6%<br />
In many cases, the IT departments over focus on the infrastructure level<br />
functionalities, losing sight of the operational and managerial perspective. The IT staff<br />
ignorance in the field of business practices or in the field of organizational financial<br />
policy may render more damage to the organization than the technical solution is able<br />
to fix. Consequently, it is mandatory to also analyze the non-technical factors of<br />
influence for the success or the failure of a cloud migration process. Without claiming<br />
to have built an exhaustive model, the author reasons that organizations should always<br />
go through the following five steps before taking the final decision about choosing an<br />
Enterprise 2.0 solution:<br />
1. The mandatory identification of the real reasons for the adoption of the cloud<br />
model, from the business, the value and the cultural perspectives. The process<br />
implies to identify the data, process and service elements which are fully<br />
compatible with the new paradigm. The risk level assessment and the<br />
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identification of compliance requests are also recommended in order to<br />
understand how the organization internal systems will be affected.<br />
2. The development of a risk assessment and management system associated to<br />
the various risk levels. The mechanism should be integrated in the future<br />
information and IT systems lifecycle. The assessment has to include all the<br />
datasets, services and business processes pending for migration in the cloud.<br />
3. The development of a governance strategy and a security strategy. The<br />
candidate services have to be connected with the associated data and business<br />
processes. After that, the service, data and processes have to be relocated<br />
together, so as to comply with the organizational business strategy and<br />
business objectives.<br />
4. The implementation of security and governance measures, as well as the<br />
system and operational requests.<br />
5. An assessment of the risk management practices for the main potential cloud<br />
services providers. Based on their own requests, the managers of the migration<br />
process may assess the risk of each potential offer, deciding whether it is good<br />
or bad for the organization.<br />
Table 2. Providers vs. customers’ perspective<br />
CUSTOMERS PROVIDERS<br />
Data security<br />
Do not trust the cloud. What if something goes wrong?<br />
Regulatory reasons exist for data to be locally retained What is the true cost of providing Service<br />
Level Agreements (SLAs) as described by<br />
the contract?<br />
Service latency<br />
The cloud can be many milliseconds away. SaaS/PaaS models are challenging.<br />
The cloud is not suitable for real-time applications. Much lower upfront revenue.<br />
Application availability<br />
Cannot switch from existing legacy applications. Customers want open standards/APIs.<br />
Equivalent cloud applications do not exist. Need to continuously add value.<br />
The understanding of the Enterprise 2.0 implementation processes and technologies in<br />
their most intimate details, along with a reasonable internal maturity level of the<br />
organization, will definitely help management to determine the time and the manner<br />
cloud based services may be employed in order to support the own business processes<br />
(both the core and the auxiliary level). While most of the technical issues prove to be<br />
highly quantifiable (at least on a superficial level), it is compulsory that non-technical<br />
issues are identified and dealt with. The most significant non-technical issues that a<br />
cloud migration may impose for a large-scale organization may be considered as<br />
belonging to three main groups: financial, operational and organizational.<br />
5. RESEARCH METHODOLOGY<br />
This attempt is part of a larger research performed by the author in the field of<br />
organizational memory and Enterprise 2.0 technologies, and also continues a previous<br />
doctoral research in the field of computer-assisted financial audit tools and<br />
techniques, the final results of which were publicly defended in order to be validated<br />
by both the scientific and academic community. The main goal of the aforementioned<br />
research was the identification of some new areas of applicability for the modern<br />
knowledge-based information technologies in the field of financial audit.<br />
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When possible, a direct identification of the practitioners’ expectations was attempted<br />
by means of direct interviews and also by means of the empirical study questionnaire<br />
(a survey). The questions for the empirical study were carefully designed so as to get<br />
unbiased, objective answers. The members of the target group were encouraged to add<br />
their own observations regarding the questionnaire. Validation of the research<br />
conclusions was performed by means of an informal discussion with some “real life<br />
practitioners”, members of some companies which performed or are in the process of<br />
performing the shift to Enterprise 2.0. In case some other author’s opinion was<br />
enclosed in the paper, whether in exact quotation or synthetic form, a complete<br />
mention of the source identification information was made. Some of the data in the<br />
paper is based on the results of some previous market research studies that were<br />
credited accordingly.<br />
The author has over seven years of previous experience in the research area, and also<br />
a series of previous research results (published articles, conference attendances and<br />
doctoral research). By defending the research results at the proceedings of such a<br />
prominent scientific conference, attended by both scholars and practitioners bearing<br />
some interest in the research area, the author attempts to get further validation of his<br />
opinions, both confirmation and rejection of the aforementioned opinions’ scientific<br />
and practical importance being welcome.<br />
6. FINANCIAL CHALLENGES<br />
The “traditional” business processes for the IT-centered companies usually require<br />
constant relationships with both customers and service providers on multiple levels:<br />
data, control and management. The first efforts for a migration to the cloud may seem<br />
twice as costly as developing an in-house solution, as the IT department will have to<br />
manage both the legacy and the newly arisen relationships. Even a quick analysis,<br />
(that the survey proved to be true) leads to the conclusion that the migration process is<br />
way more appealing for the small and medium size companies, than for the large-size<br />
multinational companies. In the author’s opinion, the whole range of the Enterprise<br />
2.0 services looks more attractive for small-sized companies, which are more sensitive<br />
to the flexibility and cost savings of such a solution. The performed survey proved<br />
that most of the cloud-based services beneficiaries are small-sized companies.<br />
7. ENTERPRISE SCALABILITY CHALLENGES<br />
Taking into account that using cloud-based services is not always less expensive than<br />
the traditional version, enterprises should estimate the benefits of the investment<br />
during its whole lifespan, not only on the immediate level. The return on investment<br />
(ROI), for which a cloud investment-specific evaluation model was previously built<br />
and presented (Mangiuc, 2010), is extremely useful, but still unable to provide a<br />
complete view by itself. For a better insight, it is advisable to also look for and<br />
account the “hidden” costs of storage systems, employee training, network equipment<br />
etc., as each one has its own financial implications. All these aspects have to be taken<br />
into account before deciding for or against the migration to the cloud.<br />
Cost variability is an important aspect of cloud-based technologies implementation. If<br />
cost variability, transparence and scalability are taken into account, the migration to<br />
the cloud may be regarded as an opportunity and also as a challenge. In the life of any<br />
IT-oriented organization there are times when the IT infrastructure becomes<br />
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overloaded. In such situations, instead of a long and painful cloud migration process,<br />
it is possible to see the cloud as an extension of the internal datacenter. In some other<br />
cases a cloud-based alternative may be regarded as a very efficient back-up solution,<br />
supporting real-time update and immediate activation if the internal infrastructure<br />
collapses. Even though, it may happen that the fees paid to a cloud service provider<br />
for a few tears do not look so small when compared against the immediate costs of an<br />
internal infrastructure (hardware acquisitions, deployment, configuration etc.). As a<br />
consequence, the organization management has to look at the financial figures from<br />
multiple perspectives in order to state whether an Enterprise 2.0 implementation<br />
stands. In the author’s opinion, answers should be provided to a few important<br />
questions:<br />
• Which are the tradeoffs of each option?<br />
• Which kind of benefits is more important for the organization?<br />
• Will the organization take real advantage from the fact that the IT department<br />
will only focus on cloud-level applications instead of the traditional processes?<br />
• Which are the real business and financial implications of letting go all the<br />
specialists who are currently designing, deploying and maintaining servers?<br />
• As most of the business processes will move on-line, has the organization<br />
enough know-how to choose wisely?<br />
• The new business opportunities will take advantage of the cloud-based<br />
services, or will the potential customers become scared or confused?<br />
Moreover, some important voices claim the cloud platform to be a reliable and<br />
inexpensive environment to test the new ideas and enterprise applications (Gonçalves,<br />
2009). The new enterprise applications may be rapidly scaled to the dimension of the<br />
markets they are aimed at, even as prototypes. However, the benefits are significantly<br />
higher in the case of a large number of small-sized applications than for a single largesized<br />
application. This observation raises a legitimate question: how could one define<br />
the optimal size of a cloud-based application, so as the efficiency for the enterprise to<br />
reach its maximum value? The implementation of an Enterprise 2.0 application is still<br />
too complex to answer this question in exact terms.<br />
On the other hand, from the cloud-based services provider point of view, even if<br />
international bodies open standards which allow and encourage interoperability<br />
between cloud implementations, the “personalization” of some functionality will<br />
always be required in order to address specific customer requests. And, of course, the<br />
huge amounts of money that cloud providers invest in their own data centers<br />
(including the employment of highly qualified personnel) will not lead to any profit if<br />
the customers cancel their subscriptions prematurely. As a consequence, it is very<br />
likely that a large part of the provider’s investment to be quite aggressively transferred<br />
to the migration costs of its first customers.<br />
To sum up, it is possible to state that the cloud-based services migration process and,<br />
even more, a possible in-house return process imply a too high level of costs to be<br />
decided without an extremely thorough and coherent financial analysis.<br />
8. SOFTWARE LICENSING<br />
License management and virtualization are important issues for the large-sized<br />
organizations. The management of package-based software applications is not as easy<br />
as for a personal computer, mostly when the many computers and sub-networks of the<br />
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organization use different software packages. The integration of the packages and the<br />
evaluation of the total licensing cost are one of the major challenges of a large scale<br />
organization financial management.<br />
Contemporary IT departments have network administrators which have to ensure the<br />
compliance with the contractual agreements of the different types of acquired<br />
software licenses, and to monitor the use of the acquired tools and services in order to<br />
maintain optimum efficiency. It is not uncommon to find that most members of an<br />
organization constantly use application that the IT department had no knowledge of,<br />
or that some licenses are constantly paid for, without being used once. A migration to<br />
the cloud should automatically eliminate all the aforementioned issues, as the use of<br />
the service is controlled and measured by the provider. Even though, the future<br />
savings may be difficult to foresee, mostly when the service providers employ<br />
licensing models that are too “traditional”, or somehow incompatible with the cloud<br />
paradigm. In the author’s opinion, among the few licensing models employed<br />
nowadays, the least adequate are:<br />
• The model based on the number of processors – in most cases, the hardware<br />
resources needed to execute a cloud-based application fluctuate massively.<br />
Due to the nature of Enterprise 2.0 services, neither the IT department, nor the<br />
final users are able to know exactly how many processing units are employed<br />
at a certain time. Moreover, if the running application needs some extra<br />
computing power, the cloud service, by its nature, will perform an automatic<br />
acquisition of the needed resources, without asking the final user’s permission.<br />
Such flexibility may lead to a significant fluctuation of the service fees,<br />
frustrating or confusing the final users.<br />
• The model based on the number of instances – using virtualization as a<br />
horizontal scalability assurance solution may become awkward when some of<br />
the acquired virtual instances need to expand over more physical units in order<br />
to successfully handle all the processing requests. From a theoretical point of<br />
view, each organization should acquire more licenses than it currently needs,<br />
with the sole purpose of covering the eventual increases from the future.<br />
Recent surveys (Shalom, 2008) disclose that the licensing costs volume has an<br />
about 20% increase when the migration to a virtualized architecture is<br />
performed.<br />
• The model based on the number of users – in some cases, licensing fees are<br />
computed based on the number of users accessing the application<br />
simultaneously. A large number of cloud-based applications employ this<br />
model, allowing the provider a strict control of usage based on the number of<br />
licensed users. However, an essential advantage of an elastic environment, like<br />
the cloud, has to be the immediate possibility of scaling the application, based<br />
to the business needs of a certain moment. In the absence of this capability, the<br />
customer will probably have to buy more licenses than the organization<br />
actually needs, licenses dedicated to some potential users that the customer<br />
might as well never have.<br />
In the author’s opinion, such obsolete models based on the number of processors, the<br />
number of instances or the number of users, are not able to perform in a satisfactory<br />
manner any more, when applied to an extremely “elastic” environment as the<br />
Enterprise 2.0. Using “provisions” is not a viable solution, but a very costly<br />
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alternative, able to significantly reduce or even cancel the benefits of decreasing<br />
capital and operation expenses in the cloud.<br />
9. BUSINESS OPERATIONS CHALLENGES<br />
Business operations cover aspects related to consumption and the non-technical<br />
management of the IT services. These include, but are not limited to, the way<br />
organizations deal with security measures and procedures, transaction processing etc.<br />
Using Enterprise 2.0 services, an organization may deploy an Internet-based business<br />
process inside its own information system, may add virtual resources when necessary,<br />
and then may drop the resources when no longer needed. This kind of elasticity allows<br />
for the adoption of some new business models, including the “pay-as-you-go” system,<br />
employed for the use of infrastructure and IT management resources, with the obvious<br />
result of immediate upsize or downsize scalability, as requested by the current<br />
operational needs. Even if benefits are obvious, organizations should evaluate their<br />
cloud-based services provider the same way they evaluate their own IT resources<br />
(datacenter, infrastructure, bandwidth etc.). This way the organization will be able to<br />
properly decide about a possible migration to the cloud, in order to avoid the collapse<br />
of the own business processes. In the author’s opinion, the evaluation of the options<br />
and the adoption of the final decision have to take into account the following<br />
elements:<br />
• The migration to the cloud has to provide strategic value, not just cost<br />
decreases – The initial success of the cloud-based offers was due almost<br />
exclusively to the extremely low prices (as compared to the traditional<br />
solutions). Even so, to face the competition, the cloud-based services providers<br />
have to offer more than low prices. This will allow organizations to position<br />
their IT strategy from the wider perspective of the own business processes.<br />
• Migration of the core business processes to the cloud – even if a large number<br />
of companies claimed the migration of their own business processes to the<br />
cloud, the actual way to get competitive advantages in the process is quite<br />
vague. It is still open for debate whether cloud-based services are able to<br />
provide reliable support for critical processes, on the same level with the<br />
traditional approach (Gu and Cheung, 2009). Moreover, when the company’s<br />
main competitors use the same services provider, the competitive advantages<br />
become vaguer and harder to describe or measure.<br />
• The complex issues of business integration have to be solved – The complexity<br />
of an application execution framework increases when the employed<br />
technologies evolve for a significant period. The direct consequence is that the<br />
migration to the cloud will be significantly more difficult when the<br />
organization has complex and tightly integrated applications, or previously<br />
developed in-house applications, enclosing specific functionalities, security or<br />
performance elements. As the cloud-based range of solutions is extending, the<br />
demand for integration tools and services will substantially increase.<br />
• A very good match of the employee skills has to be performed – an important<br />
dimension of the enterprise migration plan has to be the acquirement of the<br />
necessary competences to manage the new cloud-based technologies, along<br />
with the continuation of the existing business processes. Developing the<br />
competences of all the involved employees to a level where they are able to<br />
manage advanced cloud computing elements, especially the implementation,<br />
deployment and documentation of the internal business processes raises a set<br />
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of additional constraints over the existing organizational cloud migration plan.<br />
It may prove to be extremely difficult to update all the involved personnel due<br />
to the complex nature of architectural, implementation and operational aspects.<br />
On the other hand, it may be quite difficult to recruit third-party experts able to<br />
assist or drive the organization through the migration process. This is mainly<br />
because the eventual external experts have to become very familiar with the<br />
existent business models and processes. Both alternatives involve taking major<br />
risks, being highly dependent on the employees openness to the new<br />
organization model, as well as their ability to see and document the<br />
operational details which control the migration process.<br />
10. ORGANIZATIONAL CHALLENGES<br />
Each enterprise dealing with the idea of a migration to the cloud needs a full and deep<br />
understanding of the organizational implications of the two main alternatives: the<br />
management of an own IT investment or the acquisition of IT as a service from<br />
external providers. The IT managers and all the stakeholders of the business process<br />
have to analyze the short-term costs and the long-term benefits of the migration<br />
process. The level of service that each potential provider is able to offer is a critical<br />
piece of information, and also the foundation to analyze the quality of services (QoS)<br />
based on the service uptime, service response and service performance, which have to<br />
be compared against the current or the reference values. In the author’s opinion, even<br />
if it represents a costly process, it is advisable that the enterprise implements a pilot<br />
business process based on the new technologies, regarded as a prototype. Such<br />
process will allow the organization accommodation to the new approach and its key<br />
specific elements. This “exercise” should take into account some extremely important<br />
elements, like:<br />
• Solving conflicts regarding the services distribution channels – an evergrowing<br />
number of Enterprise 2.0 services providers aggressively enlarged the<br />
range of provided services, in order to get as much market share as possible.<br />
Consequently, the conflicts between the provider’s technical staff and the<br />
technical staff of its business partners are more and more recurrent<br />
(Rochwerger et al., 2009). Such conflicts may “explode” anytime, affecting<br />
not only the cloud services provider, but also its customers. Such aspects are<br />
extremely harmful for the customers’ perception and trust, inducing the idea<br />
that the services supply chain is not too well defined.<br />
• Distribution of service on multiple levels – organizations that have already<br />
invested in own storage and security systems no longer have a solid appetite<br />
for a migration to the cloud environment. Moreover, trans-organizational<br />
software applications may prove difficult to switch to Enterprise 2.0, if their<br />
development process was not based on a set of open and convertible standards.<br />
As a result, many of the potential customers may become interested only in a<br />
partial adoption of the cloud model, or in a hybrid adoption formula (like<br />
private cloud).<br />
• Solving the security and reliability issues of the business processes – the<br />
enterprises’ care for their own data is already common knowledge. Most of the<br />
enterprises take ample measures so as their data does not get lost or stolen.<br />
Also, most enterprises consider the cloud environment as a serious security<br />
threat, and, as a result, the surveys reveal security concerns as the most<br />
important concerns for a potential cloud customer, surpassing the performance<br />
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or reliability issues. As the cloud-based services gain popularity and wide<br />
public acceptance, they will become a more important target for hackers.<br />
Consequently, the essential challenge for a cloud services provider will be to<br />
protect organizational data both from external attacks (from outside the<br />
firewall) and from internal attacks (from applications which execute in<br />
different virtual machines, but on the same physical machine). Some of the<br />
aforementioned issues are not limited to the IT solution and cannot be<br />
addressed only on a technical level. This is why cloud services providers have<br />
to cooperate with their customers so as the implemented security practices get<br />
official certification from industry-specific independent bodies.<br />
DISCUSSION AND CONCLUSIONS<br />
Even if the Enterprise 2.0 set of technologies and the migration to the cloud offer<br />
significant values and opportunities for the IT-based organizations, the traditional<br />
concerns in the field of security, integration, service availability are still applicable.<br />
However, many issues arise due to the specific nature of these services which imply<br />
that information belonging to multiple organizations is stored and processed on the<br />
same hardware platform (multi-tenancy). Moreover, there are further suspicions raised<br />
by the fact that not only the corporate data, but a large part of the corporate business<br />
processes takes place outside the corporate datacenter. Based on a previous survey,<br />
the paper at hand is an attempt to identify and debate the main non-technical issues an<br />
organization may face when designing or executing a migration from the traditional<br />
IT model to the cloud-based IT model. The research led to the idea that the<br />
assessment and evaluation of the cloud-based systems risks has to become a<br />
continuous process, not only a step in the migration plan. This is mainly due to the<br />
rapid development of the domain, which may render today’s assertion obsolete in a<br />
few months or a year. Consequently, the author tried to find the generally applicable<br />
facts and solutions, without detailing the case of a certain cloud-based services<br />
provider on the market today.<br />
Most of the observed issues and drawbacks were discussed by their operational and<br />
managerial implications. One of the key issues at a managerial level proves to be the<br />
lack of standards applicable for the cloud-based companies adopting Enterprise 2.0.<br />
The existing standards only assure the cloud services interoperability, so as the tools,<br />
applications, virtual images and other informational assets of an organization may be<br />
shared in different cloud environments. The portability standards, able to allow the<br />
transfer of a company’s applications and business processes from a service provider to<br />
another are still to be expected. The paper also supports the idea that both the external<br />
services providers and the organizations developing in-house solutions have to<br />
implement operational interfaces for their services, able to allow user account<br />
management, user rights management, service execution modifications, data back-up,<br />
resources management and secure application partitioning. Moreover, a coherent and<br />
robust security policies system has to be implemented, in order to separate the final<br />
user’s perspective from the underlying infrastructure and execution platform, and to<br />
respect the multi-tier architecture definition and IT governance principles. Nowadays,<br />
a lot of normative bodies and organizations try to collect the best practices in the field<br />
and elaborate standards and conceptual frameworks (like the TM Forum, ITIL, and<br />
Microsoft Operations Framework).<br />
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The decision to migrate to cloud-based services has a tremendous impact over both<br />
technical and non-technical aspects of an organization. The business owners have to<br />
be convinced that the return on investment (ROI) may be achieved at the predicted<br />
level. The technical staff (enterprise architects, developers, operational and IT<br />
management teams) must have a complete and proper understanding of the risks<br />
attached to placing the enterprise business processes in the cloud. When the<br />
organization is missing the proper human capital, or the migration design and<br />
execution teams are not motivated enough, the final results may be far from the<br />
predicted ones, and frustration may take the place of the competitive advantage.<br />
REFERENCES<br />
Golden, B. (2009) “The case against Cloud Computing, Part: II.”, CIO White Papers,<br />
available on-line at http://www.cio.com/article/478419/<br />
Gonçalves, Vânia (2009) “Adding Value to the Network: Exploring the Software as a Service<br />
and Platform as a Service Models for Mobile Operators”, Mobile Wireless Middleware,<br />
Operating Systems, and Applications – Workshops, Lecture Notes of the Institute for<br />
Computer Sciences, Social Informatics and Telecommunications Engineering, vol. 12:<br />
13-22<br />
Gu, Lin, Cheung, Shing-Chi (2009) “Constructing and testing privacy-aware services in a<br />
cloud computing environment: challenges and opportunities”, Proceeding Internetware<br />
'09, <strong>Proceedings</strong> of the First Asia-Pacific Symposium on Internetware, ISBN: 978-1-<br />
60558-872-8<br />
Kittlaus, Hans-Bernd, Clough, Peter N. (2009) Software Product Management and Pricing:<br />
Key Success Factors for Software Organizations, Springer Publishing, ISBN: 978-3-<br />
540-76986-6<br />
Mangiuc Dragoș (2010) “Enterprise 2.0 Implementation Success Evaluation Model”, AMIS<br />
2010 - <strong>Proceedings</strong> of the 5th International Conference, Accounting and Management<br />
Information Systems, vol.1: 1023-1039<br />
Ristola, Jaakko (2010) “Information Technology Service Management for Cloud<br />
Computing”, Ph.D. thesis, Aalto University School of Science and Technology,<br />
available on-line at http://lib.tkk.fi/Dipl/2010/urn100243.pdf<br />
Rochwerger, B., Breitgand, D., Levy, E., Galis, A., Nagin, K., Llorente, I. M., Montero, R.,<br />
Wolfsthal, Y., Elmroth, E., Caceres, J., Ben-Yehuda, M., Emmerich, W., Galan, F.<br />
(2009) “The Reservoir Model and Architecture for Open Federated Cloud Computing”,<br />
IBM Journal of Research and Development, vol.53, no.4:1-11<br />
Shalom, Nati (2008) “Space-Based Architecture and The End of Tier-based Computing”,<br />
GigaSpace Technologies Whitepapers, available on-line at http://www.gigaspaces.com<br />
/files/main/Presentations/ByCustomers/white_papers/The_End_of_Tier.pdf<br />
Shan, Tony (2010) “SOA and Cloud Computing: Synergy, Interlock and Transition”,<br />
proceedings of the IEEE 3rd International Conference on Cloud Computing (CLOUD<br />
2010), available on-line at http://www.thecloudcomputing.org/2010/<br />
Walters, Tim (2009) “SaaS - The Benefits and Challenges of Implementing an Enterprise<br />
Scale SAS Warehouse and Business Intelligence Shared Service”, SAS Global Forum<br />
2009, available on-line at http://support.sas.com/resources/papers/proceedings09/261-<br />
2009.pdf<br />
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CRITICAL SUCCESS FACTORS FOR THE ORACLE<br />
DATABASE AUDIT<br />
Simona Felicia UNCHIASU 1 & Pavel NASTASE<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
The increased use of Internet, portable devices, mobile and wireless technologies has<br />
enhanced and eased the access to information and expanded the risk of unauthorized<br />
disclosure of confidential personal, customers and business related information. All the<br />
aforementioned factors have facilitated the corporate espionage, privacy breach, data<br />
leakage and terrorism, therefore the information security topic was brought in the forefront of<br />
information technology concerns for many organizations. Expectations in terms of<br />
confidentiality, integrity and availability of the information are high, since shareholders,<br />
employees, customers and business partners demand a real-time access and accurate data.<br />
Risks associated with such information systems need to be addressed. An effective approach<br />
must consider the risks introduced by all components of an information system, like<br />
application, operating system, network and telecommunication, databases, interfaces with<br />
other legacy systems and by the physical environment. In the past, many IT audits were<br />
performed just at the application or at the network level and quite frequently the database<br />
was overlooked, even though it is the repository for critical data and therefore a key<br />
component of any information system. Loosing data confidentiality, integrity and availability<br />
can cost a company not only in terms of sales but in reputation and litigation costs also.<br />
Currently, the interest in auditing databases has increased due to the growing legal and<br />
regulatory frameworks as well. Having this in our mind, we tried to propose in this article an<br />
audit plan that best covers the ORACLE databases vulnerabilities and hardening issues. The<br />
audit plan is based on literature review, COBIT framework and our own practical<br />
experiences with databases. We analyzed the COBIT framework and we selected the<br />
processes and the relevant control objectives that are critical for the database control and we<br />
translated them into audit steps.<br />
KEYWORDS: IT Governance, COBIT, Data breach, Database vulnerabilities, Database<br />
audit program<br />
INTRODUCTION<br />
The increased use of Internet, portable computer devices, mobile and wireless<br />
technologies has enhanced and eased the access to information and expanded the risk<br />
of unauthorized disclosure of confidential personal, customers and business related<br />
information. All the aforementioned factors have facilitated the corporate espionage,<br />
privacy breach and terrorism, therefore the information security topic was brought in<br />
the forefront of information technology concerns for many organizations. The new<br />
technological developments have provided new opportunities for the occurrence of<br />
information systems related problems such as data leakage, identity theft, malicious<br />
1 Correspondence address: Simona Felicia UNCHIASU, CISA, CRISC, Ph.D. student, Bucharest<br />
Academy of Economic Studies, Romania; email: simonaunchiasu@yahoo.com<br />
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attacks using viruses, denial of service attacks, systems unavailability, and the list<br />
could go on.<br />
Nowadays, companies face the challenge of protecting the sensitive data stored in<br />
their information systems. Data protection, also known as information security, means<br />
to prevent the outside and inside attempts to access data, to monitor and review the<br />
users’ activities, so as to detect and prevent unauthorized system access, use,<br />
disclosure, disruption and possibly fraudulent activities.<br />
A large number of financial, ERPs (Enterprise Resource Planning) and CRMs<br />
(Customer Relationship Management) information systems reside on Oracle<br />
databases; therefore the IT and financial auditors together with security officers<br />
should be aware of the auditing techniques and of the audit related capabilities that<br />
database offers. Organizations that do not make efforts on protecting their information<br />
assets are exposed to significant operational, including fraud, reputational and<br />
compliance risks, without to mention the threats faced in accomplishing their goals<br />
and objectives. Expectations in terms of confidentiality, integrity and availability of<br />
the information are high, since shareholders, employees, customers and business<br />
partners demand a real-time access and accurate data.<br />
Risks associated with such information systems need to be addressed. An effective<br />
approach must consider the risks introduced by all components of an information<br />
system, like application, operating system, network and telecommunication,<br />
databases, interfaces with other legacy systems and by the physical environment. In<br />
the past, many IT audits were performed just at the application or at the network level<br />
and quite frequently the database was overlooked, even though it is the repository for<br />
critical data and therefore a key component of any information system. Loosing data<br />
confidentiality, integrity and availability can cost a company not only in terms of sales<br />
but in reputation and litigation costs also. Currently, the interest in auditing databases<br />
has increased due to the growing legal and regulatory frameworks as well.<br />
Having this in our mind, we tried to propose in this article an audit plan that best<br />
covers the ORACLE databases vulnerabilities and hardening issues. The audit plan is<br />
based on literature review, COBIT framework and our own practical experiences with<br />
databases. We analyzed the COBIT framework and we selected the processes and the<br />
relevant control objectives that are critical for the database control and we translated<br />
them into audit steps.<br />
1. TODAY’S THREAT LANDSCAPE<br />
Today’s threat landscape has shifted from widespread and unfocussed Internet worms<br />
to targeted attacks aimed at specific companies. Over the years, two fundamental<br />
issues have been constant. Firstly, the threat landscape continues to evolve and gain in<br />
complexity. Secondly, attackers will always be a step ahead of the defenders in<br />
exploiting vulnerabilities across people, process and technologies. What has changed<br />
today is the motivation, the methods and tools employed by these attacks: nowadays<br />
we are no longer fighting an individual hacker, but a highly organized, well-funded<br />
crime syndicate.<br />
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Data breaches is in the forefront of the threat landscape and usually, it occurs in all<br />
types of organizations but today, the targeting of financial services is quite shocking.<br />
Stealing digital money and, perhaps more important, large volumes of sensitive<br />
customer data became a priority for the cyber criminals. According to the study “2010<br />
Data Breach Investigations Report” conducted by Verizon Risk Team in cooperation<br />
with the United States Secret Service, a growing percentage of cases and an<br />
astounding 94% of all compromised records in 2009 were in financial services<br />
industry. Moreover, it was estimated that more than 900 million records were<br />
compromised over the last five years, with a peak in 2008. Payment card data,<br />
personal information and bank accounts data were the most compromised data types.<br />
It is very difficult to point out the geographic origin of these attach especially when it<br />
relies mainly on source IP addresses. Figure 1 shows the regional origin of the<br />
external attacks, having on the top the breaches originated from East European<br />
countries.<br />
Europe - East (incl. Russia)<br />
America - North<br />
Asia - East<br />
Europe - West<br />
Middle East<br />
Africa<br />
Asia - South/Southeast<br />
Oceania<br />
Unknown<br />
Figure 1. Origin of external attacks<br />
2%<br />
2%<br />
2%<br />
5%<br />
(Source: 2010 Data Breach Investigation report, Verizon, 2010: 16)<br />
An astonishing 94% of the records were stolen using hacking techniques. The top<br />
three types of hacking are formed by the use of stolen login credentials, exploitation<br />
of backdoor or command/control channel and SQL injection. It is worth mentioning<br />
that in the data breach scenarios, SQL injection has three main uses, like:<br />
� query data from the database;<br />
� modify data within the database;<br />
� distribute malware to the systems.<br />
The aforementioned study brings into discussion the assets from which data were<br />
stolen, and as expected, servers and applications are on the top. Figure 2 shows a<br />
statistic of the types of compromised assets.<br />
10%<br />
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19%<br />
18%<br />
21%<br />
31%
Figure 2. Types of compromised assets<br />
Type Category % of Breaches % of Records<br />
Database server Servers & Applications 25% 92%<br />
Desktop computer End-User Devices 21% 1%<br />
Web app/server Servers & Applications 19% 13%<br />
Payment card Offline Data 18%
Enterprise Governance is a relatively new term that refers to the way an organization<br />
is managed. “Enterprise Governance constitutes the entire accountability framework<br />
of the organizations. There are two dimensions of enterprise governance –<br />
conformance and performance that need to be in balance.” This statement captures the<br />
essence of enterprise governance as described by the International Federation of<br />
Accountants (IFAC) in the report “Enterprise Governance – Getting the Balance<br />
Right”.<br />
IT governance is an integral part of enterprise governance, a combined business and<br />
IT issue which requires a business driven approach. According to ISACA, IT<br />
governance has been defined as “the responsibility of the board of directors and<br />
executive management, and consists of the leadership and organizational structures<br />
and processes that ensure that the organization’s IT sustains and extends the<br />
organizations strategies and objectives.” (ISACA, Board Briefing on IT Governance,<br />
2 nd Edition, USA 2003) Furthermore, the implementation of IT governance ensures<br />
that the IT function adds value to the company while balancing risks versus return.<br />
IT governance is a comprehensive term that encompasses IT processes, IT resources,<br />
information, business and legal issues, and all concerns stakeholders, senior<br />
management, process owners, users, auditors and suppliers. A critical path to the<br />
success of IT governance is an effective communication among all parties involved,<br />
based on a common language, constructive relationship and commitment in<br />
addressing the issues. Basically, the IT governance is made of two issues: IT delivers<br />
value to the business and IT risks are mitigated to an acceptable level, which means<br />
the strategic alignment of IT with the business and the establishment of accountability<br />
within the enterprise.<br />
IT governance integrates and institutionalizes best practices and is an enabler for the<br />
company in taking full advantage of its information, thus maximizing benefits,<br />
gaining competitive advantage and exploiting successfully the opportunities.<br />
Business must deal with risks. Risk is an inherent part of business, brought to our<br />
attention as a result of major events occurred over the past years: fraud incidents,<br />
major credit failure, information technology exploits and information flows. In order<br />
to put risk in the proper business context, the Committee of Sponsoring Organization<br />
of the Tradeway Commission (COSO) issued in 2004 the Enterprise Risk<br />
Management Integrated Framework, known as COSO ERM Framework, which<br />
defines risk as follows: “Risk is the possibility that an event will occur and adversely<br />
affect the achievement of an objective”.<br />
According to COSO ERM Framework, the above mentioned process is defined as<br />
follows: “enterprise risk management is a process, effected by an entity’s board of<br />
directors, management, and other personnel, applied in strategy setting and across the<br />
enterprise, designed to identify potential events that may affect the entity and manage<br />
risk to be within its risk appetite, to provide reasonable assurance regarding the<br />
achievement of entity objectives”.<br />
Risk management is not something new to the business world. Several industries,<br />
among them being the financial services, insurance services and the energy<br />
~ 291 ~
companies, have developed and tested risk management techniques in order to<br />
mitigate the key risks associated to those industries.<br />
Companies have traditionally focused on the financial risks, but recently, increased<br />
attention was paid to the operational risk and systemic risk mainly due to the<br />
regulators’ concerns. The technology and information security risks are a significant<br />
part of the aforementioned risks. Today economy brings a new spectrum of IT related<br />
risks, such as disclosure of confidential data, non-availability of services negotiated<br />
due to systems downtime, or missed business opportunities caused by a rigid IT<br />
infrastructure. Basically, risk management addresses the IT risks, defined as “the<br />
business risk associated with the use, ownership, operation, involvement, influence<br />
and adoption of IT within an enterprise. IT risks consist of IT related events that could<br />
potentially impact the business.” (ISACA, Implementing and Continually Improving<br />
IT Governance, 2009)<br />
Risk management is a continuous process with two components, identification and<br />
control. It begins with a clear understanding of the company’s appetite for risk, which<br />
drives all the risk mitigation efforts and influences future investments in technology.<br />
Afterwards, it continues with the identification of risks and their impact on assets.<br />
Once identified, risks must be controlled and mitigated by countermeasures to an<br />
acceptable level. Consideration should be given to the residual risk, as well. The<br />
performance of risk mitigation process should be measured and monitored on a<br />
continuous basis.<br />
Control Objectives for Information and related Technology – COBIT is an IT<br />
governance framework which provides a structure for developing control objectives.<br />
The framework is strongly focused on controls and less on execution and support. It<br />
allows managers to overpass the gap between control requirements, technical issues<br />
and business risks, by providing clear policies and good practices for IT controls from<br />
a business perspective. COBIT provides a framework to ensure that IT is aligned with<br />
the business, acts as an enabler for business and its usage maximizes benefits, IT<br />
resources are used responsibly and IT risks are managed appropriately. Furthermore,<br />
it covers security topic in addition to other risks that can occur while using<br />
information systems.<br />
COBIT has been aligned and harmonized with other IT standards and best practices<br />
like COSO ERM Framework, ITIL, ISO/IEC 17799 and SEI Capability Maturity<br />
Model. COBIT is positioned at a high level and acts as an integrator of the different<br />
guidance materials. The framework is focused on what is required to achieve,<br />
meaning adequate management and control of IT, while the more detailed IT<br />
standards and best practices are at a lower level of detail describing how to manage<br />
and control specific IT topics.<br />
COBIT framework map IT activities in a generic process model divided in four<br />
domains which are:<br />
• Plan and Organise<br />
• Acquire and Implement<br />
• Deliver and Support<br />
• Monitor and Evaluate<br />
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These four domains are interrelated; while “Plan and Organise” provides direction to<br />
solution delivery and service delivery, “Acquire and Implement” provides the<br />
solutions and passes them to be transformed into services, “Deliver and support”<br />
receives the solutions and makes them usable for the end users and “Monitor and<br />
Evaluate” monitors all processes to ensure that the direction provided is followed.<br />
Across the four domains, 34 processes are identified, each one having a number of<br />
control objectives.<br />
The principle that COBIT framework relies on, depicted in Figure 3, is that IT<br />
resources are managed by IT processes in order to achieve IT goals that respond to the<br />
business requirements.<br />
Figure 3: The COBIT Cube<br />
(Source: COBIT 4.1 Excerpt, IT Governance Institute, 2007: 25)<br />
It is worth mentioning that the level of security and controls implemented for the<br />
information systems should be correlated with the risk the respective system poses to<br />
the overall organization, therefore controls may vary depending on the level of risk<br />
identified for that particular system.<br />
3. RESEARCH APPROACH AND METHODOLOGY FOR THE ORACLE<br />
DATABASE AUDIT<br />
In the following pages we tried to propose an audit plan that best covers the databases<br />
vulnerabilities and hardening issues. The audit plan is based on literature review,<br />
COBIT framework and on our own practical experiences with databases. We analyzed<br />
the COBIT framework and we selected the processes and the relevant control<br />
objectives that are critical for the database control and we translated them into audit<br />
steps.<br />
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3.1 Planning and scoping of the audit<br />
The key starting point in performing the database audit is to understand the business<br />
risk that lies in the system of which the respective database is a component. It is<br />
important for the auditors to understand how the system is used, what is the criticality<br />
of the transactions processed by the system and the confidentiality and availability<br />
requirements for the data stored in its database.<br />
The second step is to obtain an understanding of the IT environment and to see how<br />
the database fits into the overall system architecture. A clear picture of the IT<br />
architecture will help the auditor to identify and assess the risks created by each<br />
component of the information system, e.g. application, interfaces, network topology,<br />
operating system that may potentially influence the database security. In this respect,<br />
the auditor should:<br />
� interview the application / system administrator;<br />
� interview the business owners of the systems;<br />
� review an inventory of IT infrastructure (servers, databases, applications, etc);<br />
� review network topology;<br />
� perform a general review of the IT policies and procedures in place to observe<br />
how the internal control system is.<br />
Based on the review, the risk category is identified for each component of the<br />
information system.<br />
A lack of a clear understanding of the business risks and of the IT environment may<br />
result in an audit report that is not capturing the risks that the information system<br />
really poses to the organization and the findings and recommendation could be<br />
unrealistic and could not mitigate the existing risks.<br />
Following the thorough understanding of the risks involved and the IT environment,<br />
the subsequent steps are performed:<br />
• Define the audit scope and objectives. These should be aligned with the Annual<br />
Audit Plan and Audit Charter and should consider the budget and time<br />
limitations.<br />
• Define the audit limitations and constraints, if any.<br />
• Review the previous database audit reports. Reports issued by both internal and<br />
external auditors and the regulatory bodies should be considered. Determine<br />
whether the issues previously identified have been corrected, taking into<br />
account the following:<br />
� the efficiency and the response time of the corrective measures;<br />
� addressing of the root cause problem (if possible) and not only of the<br />
consequences.<br />
The auditor should assess the overall risk level employed by the remaining<br />
findings and recommendations, left unsolved.<br />
• Based on the assessment of the previous audit reports, changes in the scope and<br />
objectives of the audit should be performed, if it is the case.<br />
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3.2 Oracle database audit steps<br />
Three phases were identified when performing the audit fieldwork: data gathering, the<br />
actual hands-on activities for testing the security and the database internal controls<br />
and the report writing.<br />
Data gathering<br />
During data gathering stage, the auditor must gain a through understanding of the<br />
Oracle database environment. In this respect the following information should be<br />
obtained and assessed:<br />
• Organizational chart and job descriptions of the staff involved in database<br />
related activities;<br />
• Policies and procedures governing the day-to-day database activities;<br />
• List of outsourcers and contractors;<br />
• IT Risk assessment document;<br />
• The internal and external Service Level Agreements - SLAs;<br />
• A list with the projects related to databases planed for current year and the<br />
projects performed during the last year;<br />
• High - level system architecture;<br />
• Database servers architecture;<br />
• Network diagram;<br />
• List with Oracle database servers, their locations and the applications they<br />
support with the corresponding licenses;<br />
• Version and release of the Oracle database and related tools implemented, like<br />
Oracle Enterprise Manager, Oracle Advanced Security Option;<br />
• The operating system on which the database resides;<br />
• Number of the database instances;<br />
• Utility software used to log on and manage the database, like TOAD;<br />
• Relevant information security requirements related to the databases;<br />
• Incident management procedure and a list with the incidents reported at the<br />
database level for a period covering the last year;<br />
• Business Continuity Plans – BCP and Disaster Recovery Plans – DRP related<br />
to databases;<br />
• Record retention policy.<br />
The auditor will conduct interviews with the DBAs administrators and security<br />
administrator to determine their awareness level related to their daily tasks, corporate<br />
policies and procedures employed, their professional skills and the current processes<br />
and tools used to administer and maintain security of the database.<br />
Operating system audit tests<br />
During the second phase of the fieldwork, the auditor will test the internal controls<br />
and the security of the database. The operating system security, hereinafter called OS,<br />
is the foundation for securing Oracle databases. Insecurely configured operating<br />
systems are the primary target of both internal and external attackers. If an attacker<br />
gains access to an operating system account like the Oracle account, he/she can<br />
potentially do the following:<br />
• compromise the database by accessing all the data;<br />
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• delete and modify all files, including database files and binaries;<br />
• modify start-up parameters;<br />
• shut down the system.<br />
The operating system on which the database resides must be adequately protected;<br />
therefore the critical controls and audit test to be performed at the OS level are<br />
described below:<br />
• Oracle permissions<br />
Inadequate files and directory permissions increase the database risk level. The<br />
file permissions should be checked in $ORACLE_HOME/bin and<br />
$ORACLE_HOME and should all be owned by Oracle accounts and by root<br />
administrator.<br />
• Secure or remove default accounts<br />
During database creation, Oracle creates several default database users and<br />
schemas. The default accounts name and their default passwords should be<br />
changed. For example, the default DBSNMP account is used by Oracle Intelligent<br />
Agent to login to each Oracle System ID that it manages.<br />
• Membership of OSOPER and OSDBA roles<br />
The OSOPER and OSDBA roles are created at the operating system level when<br />
Oracle is installed. They cannot be granted. Membership of OSOPER and<br />
OSDBA roles should be checked.<br />
• Permissions of the data files (.dbf)<br />
The data files need to be adequately protected, therefore permission to the .dbf<br />
files need to be checked.<br />
• Raw device permissions<br />
Oracle raw devices should have minimum permissions, thus only Oracle can use<br />
them.<br />
• Secure network communications<br />
The TNS is Oracle’s networking architecture. TNS sends a lot of information in<br />
clear such as the version number of the database. An advanced attacker can sniff<br />
traffic and gain valuable information; therefore the auditor should assess the<br />
security controls implemented.<br />
• Scripts that contains usernames and passwords in clear text<br />
The auditor should look for scripts containing usernames and passwords stored in<br />
clear text. It may be the case that an automated script with a password inside is<br />
required; consequently encryption techniques for the password should be used.<br />
• ALTER privileges.<br />
The auditor should ensure that no user has ALTER SESSION and ALTER<br />
SYSTEM privileges.<br />
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• Export files<br />
The auditor should check for the existence of the export file. Attackers might<br />
either export the database’s data including users’ passwords or be able to read a<br />
legitimate export which could facilitate the database attack.<br />
• Archive log files<br />
The data usually archived in the log files are precious and should be protected.<br />
The auditor should locate the archive log files and check that no user except the<br />
legitimate ones can read them.<br />
• Access to native PL/SQL compiler in production environment<br />
The access to native PL/SQL compilation in production should be removed. The<br />
access to this functionality would allow the execution of other binary files and to<br />
wrap existing packages with the attackers’ own code.<br />
• Vulnerability scan<br />
The auditor should review the OS vulnerabilities scan report.<br />
Oracle database audit tests<br />
During the fieldwork, the auditor will test the database implemented controls. Listed<br />
below are the critical audit tests that should be performed:<br />
• Oracle database support<br />
The auditor should check if the database version running on the servers is<br />
currently supported by the vendor and if not, to look for additional agreements<br />
between organization and vendor.<br />
• Patch management process<br />
The auditor should assess the process for reviewing and applying databases and<br />
operating system patches. The entire patch management process and the respective<br />
procedures should be checked. Evidence must be provided related to a sample of<br />
patches chosen by the auditor.<br />
• Promotion to production process<br />
All promotions to production (patches, updates, new functionalities, bug fixes)<br />
should be thoroughly tested before bringing them into production environment. A<br />
severe control process must be in place for promotion to production activities.<br />
• Database change control process<br />
The auditor should review the change control process to ensure that all database<br />
changes are performed in a controlled manner. Evidence for a sample of recent<br />
database changes should be obtained and analysed.<br />
• Incident management process<br />
The auditor should review the incident management process. All incidents must be<br />
recorded in a history log and reports on the respective incidents must exist. In a<br />
later stage of the organization’s maturity level, all the solutions used for solving<br />
incidents could be gathered to organize a knowledge database. A sample of<br />
database incidents should be reviewed.<br />
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• Database monitoring process<br />
A regular process for monitoring key-database functions and security related<br />
events should be implemented. The auditor should obtain any reports or queries<br />
that are used for monitoring the system.<br />
Procedures for monitoring sensitive accounts and privileges, system level<br />
privileges and database objects are recommended to be in place. The output of the<br />
following queries should be reviewed to determine whether:<br />
� the updates made by the database administrator accounts are monitored:<br />
SELECT *FROM<br />
DBA_STMT_AUDIT_OPTS;<br />
� auditing is in place for all system level privileges:<br />
SELECT *FROM<br />
DBA_PRIV_AUDIT_OPTS;<br />
� auditing is in place for database objects:<br />
SELECT *FROM<br />
DBA_OBJ_AUDIT_OPTS;<br />
Furthermore, the auditor should review the process for monitoring:<br />
� errors in the alert log and the creation of trace files;<br />
� unexpected database start-ups and shut-downs.<br />
• Audit trail mechanisms<br />
The auditor should assess the adequacy of the level of auditing set for the users’<br />
actions. The setting for the AUDIT_TRAIL parameter in the init.ora file<br />
should be check to determine if auditing is enabled.<br />
• Retention policy<br />
The auditor should review the data retention policy and assess if the location<br />
where are stored is secured from tampering. Attention should be paid to audit<br />
trails and logs retention procedures.<br />
• Scrambled data on the test databases<br />
Significant efforts are done and a lot of money is spent to preserve data<br />
confidentiality, but sometimes all the efforts are compromised by minor details.<br />
Test environment must be fed with data, and it is commonly used to take the test<br />
data from the production environment. Usually, test environments are less<br />
protected then the production one, therefore before promoting the data into test<br />
environment, these should be scrambled. The auditor should look for the<br />
scrambling mechanisms.<br />
• User management process<br />
The auditor should review the user management procedures. In addition to the<br />
usual process of creation and deletion of users, special attention should be paid to<br />
the procedures used for reviewing inactive profiles, users that never logged on and<br />
accounts inactive for more than 30 days or the maximum required by the<br />
organization security policy.<br />
The auditor should obtain from the Human Resources Department a list of<br />
terminated employees and compare it with the list of the users, to ensure that<br />
accounts were revoked in a timely manner.<br />
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• Access and authorization<br />
All users and their activities in the system should be uniquely identifiable. In this<br />
respect, the following aspects must be reviewed:<br />
� procedures used to log on to the system. Each database administrator should<br />
use a unique account to log on and to administer the database. The user<br />
sharing practice, if exists, should be immediately discontinued.<br />
� obtain a list of users to ensure that default accounts and generic accounts, like<br />
test or guest, are not used;<br />
� the users’ profiles should be linked with job description and respect the<br />
segregation principles;<br />
� the process for granting and revoking temporary accounts, like vendor and<br />
consultants account;<br />
� users should not have access to the DBA_SOURCE view. The query to be run<br />
is:<br />
SELECT * FROM DBA_TAB_PRIVS<br />
WHERE TABLE_NAME=’ALL_SOURCE’;<br />
� roles and user accounts that have INSERT, UPDATE or DELETE privileges;<br />
� roles created with the WITH ADMIN OPTIONS;<br />
� privileges assigned with GRANT option;<br />
� privileges assigned to PUBLIC account;<br />
� SYS or SYSTEM should own all objects in the SYSTEM table;<br />
� security over access to the Data Dictionary;<br />
Procedures should be in place for obtaining emergency access to the database. The<br />
emergency access should be revoked after the business issue is solved. Procedure<br />
should exist for remote connection to the database. The auditor should assess the<br />
adequacy of the aforementioned processes based on a sample review.<br />
• Password features<br />
The auditor should review the following:<br />
� the process for establishing the initial password;<br />
� generic password and passwords that can be easily guessed should not be<br />
used;<br />
� password attributes like: change password at first log on, frequency of change,<br />
password length, use of special characters, password history log, etc.<br />
� password attributes should be aligned with the organization security policy.<br />
• Encryption<br />
Encryption mechanisms should be used to protect confidential information where<br />
appropriate.<br />
• Trusted relationship<br />
Trusted relationship should be restricted and protected.<br />
• Disaster recovery and back-up arrangements<br />
A disaster recovery strategy and back-up procedures should exist and should be<br />
tested on a regular basis.<br />
The auditor should review the following:<br />
� the strategy for back-up and recovery of the database;<br />
� the process for securing and storing tape backups;<br />
� how the damaged and obsolete equipments are disposed;<br />
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� business continuity plan;<br />
� testing plans and results of the last disaster recovery test.<br />
• Physical security<br />
Physical access to database systems should be restricted to authorised personnel<br />
only. The auditor should visit the data centre to ensure that database systems are<br />
stored in secured environments, like equipments are connected to an alternative<br />
power source, there are smoke detectors, fire extinguishers, there are no pipes<br />
crossing the data room, etc and that password-protected screen savers are in place.<br />
Once all of the aforementioned audit steps will be covered, the results will be captured<br />
in the audit report.<br />
CONCLUSIONS<br />
Today’s threat landscape has evolved toward targeted attacks aimed at specific<br />
companies, specially the financial services ones. Stealing digital money, payment card<br />
information, personal data and customers databases became the top priority for<br />
attackers. And all these data are stored in the databases.<br />
Oracle is used worldwide to house business database applications. If not well<br />
protected, the databases become a very attractive target for the attackers. Oracle has<br />
enhanced the security features of the database but if not properly configured, is almost<br />
useless. Hardening measures that are at no cost and easy to implement should be<br />
known by all database administrators and IT auditors. It was proven that 64% of the<br />
breaches could be easily prevented by the implementation of simple and cheap<br />
controls. Clearly there is a strong need for improving and enforcing the accountability<br />
management. The simple goal is to ensure that users do not have more privileges than<br />
they need and all access is monitored. The practices of using generic accounts and<br />
username sharing should be discontinued. Even if everybody agrees that it shouldn’t<br />
be there, there are still active default accounts or default passwords.<br />
The audit of the databases has become a critical challenge for organizations. Any<br />
deficiency in the database security can nullify all the controls that have been<br />
implemented at the application level. Moreover, the regulatory environment has<br />
increased over the last years, international and national regulations have evolved in<br />
detailed frameworks covering the internal control system and special data aspects, like<br />
preserving confidentiality, integrity and availability. All these regulatory constraints<br />
have been translated into the activation of audit trails mechanisms within the<br />
information systems and into the growth of the storage capacity, all this having a<br />
serious impact on the performance of the information systems. Nowadays, the IT<br />
management faces a new challenge that is to find the right balance between the risk<br />
level introduced by the information systems and the mitigating controls with a direct<br />
impact on the systems’ performance.<br />
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REFERENCES<br />
Al Marcella (2006) IT Audit Practices, ISACA Training Week - Budapest, Training support<br />
materials<br />
Bill Bruck (2003) Taming the Information Tsunami – 2 nd edition, Microsoft Press<br />
Charles Le Grand and Dan Sarel (2008) “Database Security, Compliance and Audit”,<br />
Information Systems Control Journal, vol. 5: 27-31<br />
Christopher Reed (2010) “Achieving Data Warehouse Nirvana – The Critical Role of<br />
Information Control”, Information Systems Control Journal, vol. 4: 31-34<br />
Information Systems Audit and Control Association (2006) CISA Review Manual, USA,<br />
IT Governance Institute (2007) COBIT 4.1, USA<br />
Information Systems Audit and Control Associations (2009) Security, Audit and Control<br />
Features Oracle Database 3 rd Edition, USA,<br />
Jeffrey T. Hare (2008) “Monitoring Privileged Application Users in Oracle Applications<br />
Environment”, Information Systems Control Journal, vol. 6: 46-50<br />
John H. White (2006) “Important, But Often Dismissed: Internal Control in a Microsoft<br />
Access Database”, Information Systems Control Journal, vol. 6: 30-34<br />
Mike Pinch (2009) “Database Activity Monitoring: An Emerging Technology for Audit and<br />
Compliance”, Information Systems Control Journal, vol. 1: 44-47<br />
Mukul Pareek (2006) “Living with Risk”, Information Systems Control Journal, vol. 6: 35-38<br />
Nancy Bagranoff, Mark Simkin, Carolyn Norman (2008) Core Concepts of Accounting<br />
Information Systems, John Wiley & Sons, INC, USA<br />
Nastase Pavel, Lunceanu - Unchiasu Simona Felicia (2010) “IT Governance Maturity level<br />
for the Romanian companies”, 11 th World Congress of Accounting Educators and<br />
Researchers – Conference volume, Singapore<br />
Nastase Pavel and etc. (2007) Auditul si Controlul Sistemelor Informationale, Editura<br />
Economica<br />
Paul J. Sobel (2007) Auditor’s Risk Management Guide: Integrating Auditing and ERM, CCH<br />
Learning Center, USA<br />
Ponemon Institute (2010) 2009 US Cost of a Data Breach Study, available on-line at<br />
www.encryptionreports.com<br />
Robert Dollinger, Luciana Andron (2005) Baze de date si gestiunea tranzactiilor”, Editura<br />
Albastra<br />
S. Anantha Sayana (2003) “Auditing OS and Database Controls”, Information Systems<br />
Control Journal, Vol. 3, available on-line at www.isaca.org<br />
Steve Rimell (2007) Advanced IT Audit School, IT Audit School training material, Athens<br />
Verizon Risk Team (2010) 2010 Data Breach Investigation Report, available on-line at<br />
www.verizonbusiness.com<br />
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PS7 Financial instruments<br />
Chairperson<br />
Florin VASVARI, London Business School, UK<br />
USE OF FINANCIAL SECURITIES IN THE CZECH<br />
REPUBLIC: SOME EVIDENCE FROM SMES<br />
Jiřν STROUHAL, Marie PASEKOVÁ,<br />
Eva HRUBOŠOVΑ, Carmen Giorgiana BONACI<br />
THE FINANCIAL INNOVATION<br />
AND THE DYNAMIC CAPITAL MARKET<br />
Flavia Mirela BARNA, Miruna Lucia NACHESCU<br />
A SELECTION FUZZY MODEL INVOLVING ASSETS<br />
AND PROJECTS<br />
Adrian Victor BĂDESCU, Radu Nicolae CRISTEA,<br />
Dana-Maria BOLDEANU<br />
THE ROLE OF FINANCIAL DESCRIPTORS<br />
IN THE OPTIMAL PORTFOLIO SELECTION<br />
Bogdan DIMA, Flavia BARNA, Horatiu REGEP<br />
~ 302 ~
USE OF FINANCIAL SECURITIES IN THE CZECH<br />
REPUBLIC: SOME EVIDENCE FROM SMES<br />
Jiřν STROUHAL 1 & Marie PASEKOVÁ<br />
University of Economics Prague, Czech Republic<br />
Eva HRUBOŠOVΑ<br />
Tomas Bata University in Zlin, Czech Republic<br />
Carmen Giorgiana BONACI<br />
Babes-Bolyai University, Romania<br />
ABSTRACT<br />
The international accounting harmonization process and recent developments in international<br />
financial reporting standards determined a shift in accounting paradigms from historical cost<br />
accounting towards fair value accounting. Our paper analyzes how this shift impacted upon<br />
Czech accounting by particularly focusing on reporting for securities. Extending the objective<br />
of our paper, we assess the current status in terms of securities being used by small and<br />
medium-sized entities and entities’ ability to measure these financial instruments. The<br />
developed analysis relies on information being collected through the use of a questionnaire<br />
based survey. Finally we conclude through a comparative approach of Czech accounting<br />
regulations and International Financial Reporting Standards in the area of financial<br />
instruments.<br />
KEYWORDS: financial securities, financial reporting, measurement, SMEs, financial<br />
derivatives, Czech Republic.<br />
INTRODUCTION<br />
Searching for the solutions of measurement issues represents one of the key problems<br />
analyzed within current research. There may be seen a conflict between the<br />
requirements for relevance and timeliness of measurement on one side and the<br />
reliability and conclusive evidence on the other side. However, it shall be stated that<br />
the important problem of measurement issues is the possibility of subjective<br />
manipulation with values, which is possible when using certain measurement bases.<br />
Actual economic environment strongly affects the requirements for measurement<br />
requested from users.<br />
When considering an economic boom there can be seen higher optimism of investors<br />
which leads towards requirement of measurement of all accounting items at fair<br />
values, which mainly represent current market prices of assets. Using this concept<br />
means the turn from the prudence principle and conservative historical costs concept<br />
in financial accounting. Moreover fair value concept in financial accounting leads to<br />
higher tendency of revaluation assets or liabilities affecting profit or loss of the<br />
company.<br />
1<br />
Correspondence address: Jiřν STROUHAL, University of Economics Prague, Czech Republic;<br />
email: jiri.strouhal@vse.cv<br />
~ 303 ~
Meanwhile, upon economic recession users revaluate their views on accounting<br />
methods, especially the measurement bases. Economic recession evokes the<br />
renaissance of conservative approaches in measurement, especially the applicability<br />
of prudence principle. Confidence in financial market upon recession is thrilled; there<br />
can be seen strong price swings. Swings in market prices of financial instruments or<br />
breakdown of real estate market may also evoke valid doubts whether the fair value<br />
concept (and market price is the most reliable evidence) is really the most objective<br />
and most reliable approach suitable for wide spectrum of users of accounting<br />
information.<br />
We think that the tendency of fair value measurement results from the investors’<br />
pressure: the main objective for investors was capital spillover and maximization of<br />
short-term profit. It is impossible to ignore the fact that all these requirements were<br />
strongly connected with economic boom conditions. A rather too “optimistic”<br />
approach applied upon economic boom is based on fair value approach. The high<br />
value of assets which is given by active market or it is based on the estimates in case<br />
that active market does not exist, leads towards rising equity as well as balance sheet<br />
sum and in case of revaluation through profit or loss also towards fictive profits which<br />
can be distributed to owners. It shall be also stated that the estimates of fair values<br />
used to have low level of reliability because of subjective estimates of valuator or<br />
based on mathematical models which are connected with restrictive assumptions.<br />
On the other hand the approach based on accounting conservatism and prudence<br />
principle in recession periods may (jointly with inflation) lead towards erosion of<br />
company’s substance and deepen and prolong the recession. Our paper focuses on<br />
measurement issues in the particular field of financial securities. Another particularity<br />
of the study relies on presenting small and medium-sized entities’ (SMEs)<br />
perspective. Problems arising while reporting for financial securities are being<br />
discussed. Since some of Czech entities report under Czech accounting regulations<br />
while others under IFRSs, it is interesting to observe the impact of this mixed<br />
accounting regulation environment upon accounting practices. A questionnaire based<br />
survey was conducted in order to capture the current state of facts in reporting for<br />
financial securities at national level.<br />
The remainder of our paper is structured as follows: section 2 develops a literature<br />
review analysis on financial reporting and the use of derivatives in emerging<br />
economies; sections 3 discusses securities’ measurement and the corresponding<br />
valuation process; section 4 develops the analysis of information obtained through the<br />
questionnaire based survey and interprets the obtained results from our sample of<br />
Czech SMEs; and section 5 concludes upon the developed research with reference to<br />
IFRSs and Czech accounting regulations in the filed of financial instruments.<br />
1. LITERATURE REVIEW<br />
Before the IFRS standards were adopted in the EU, it was stock exchanges in<br />
particular which required that listed entities submit financial statements in compliance<br />
with the IFRS or US GAAP. Previous researches dealing with the degree of disclosure<br />
(Cooke, 1992; Meek et al., 1995), or the probability of using multinational standards<br />
(El-Gazzar et al., 1999; Murphy, 1999; Leuz, 2003) indicate a positive correlation<br />
~ 304 ~
etween the listing of accounting units on foreign markets and the degree of<br />
disclosure and use of multinational standards as the basis for financial reporting.<br />
In 2002, the European Union Commission adopted Regulation 1606/2002 which<br />
established an obligation for companies being listed on European stock exchanges to<br />
prepare their consolidated financial statements under IFRS, no later than 2005.<br />
Whittington (2005) emphasizes the fact that previous to this decision, each EU<br />
country required a different national reporting approach for listed companies. Among<br />
the benefits of having a single set of financial reporting standards applied by<br />
companies we must mention: easier access to foreign capital markets, increased<br />
confidence of foreign companies in domestic capital markets, worldwide<br />
comparability of accounting information, increased transparency, increased clarity<br />
through the "common accounting language", simplifying the regulation process of<br />
capital markets and lower susceptibility of accounting standards by political pressures.<br />
Of course that all these benefits are first derived at a theoretical level and have also<br />
already been tested within research accounting literature with what we might call<br />
mixed results. The application of international financial reporting standards within<br />
emerging economies has also raised the interest of accounting research. Concerns<br />
being raised mainly relate to the lack of qualified accountants and auditors and to the<br />
low markets’ efficiency (Eccher and Healy, 2000; Sucher and Alexander, 2002). It is<br />
these circumstances that also led to some of the Czech companies to apply IFRSs,<br />
while others still applying national accounting regulations, therefore creating an<br />
interesting setting to be analyzed.<br />
One of the problems being raised by companies in terms of risk management is<br />
related to hedge activities actually being hindered through the requirements of hedge<br />
accounting, which are mostly found to be far from the economic truth. Therefore it<br />
becomes difficult for entities engaging in hedging activities to qualify for hedge<br />
accounting even though as Trombley (2003) underlines entities want to apply hedge<br />
accounting.<br />
Numerous studies in our professional practice have dealt with the bond between the<br />
economic and the accounting concept of hedging. Melumad et al. (1999), for instance,<br />
indicates that the application of hedge accounting in compliance with the US standard<br />
SFAS 133 leads to deviations from optimum hedging in the economic sense.<br />
However, Barnes (2001) draws attention to the fact that these deviations from<br />
economic hedging are the very consequence of the set hedge accounting model,<br />
pointing out that hedge accounting may motivate poorly performing companies to<br />
speculate and influence their economic results on a short-term basis.<br />
Several studies have dealt with the information and control effects of hedge<br />
accounting (e.g. Jorgensen, 1997; Hughes et al., 2002). The most interesting finding<br />
lies in the fact that the voluntary application of hedge accounting leads to a deviation<br />
from the optimum hedging strategy (as opposed to the exclusive application of<br />
economic hedging without the application of the principles of hedge accounting).<br />
Beyond hedging activities, our analysis extends to the use of derivatives. A series of<br />
other studies in accounting research literature analyze derivatives trading and<br />
derivatives markets role within emerging economies. The development of capital<br />
markets has the ability to enhance economic development through its influence on<br />
efficiency, solvability and competition within the financial sector, by mobilizing<br />
~ 305 ~
financial savings, efficiency of investments allocation, entities’ solvability,<br />
decentralization of property and distribution of wealth, as well as by new and<br />
developing entities’ access to share based financing (Stoica et al., 2006, p. 30).<br />
Capital represents a different type of commodity, but one that is essential for<br />
emerging countries’ economic development, capital accumulation, be it by internal<br />
development, direct foreign investments and/or help being received from outside,<br />
being necessary in order to bring economic ratios to the level that is required through<br />
development plans. In order to reach these objectives a series of institutional settings<br />
must be considered so that they also enhance capital accumulation. By this we refer to<br />
commercial and savings banks, investment banks and other financial institutions,<br />
insurance companies, pension funds and not least the securities’ market (Enthoven,<br />
1973, p. 196). The development of the capital market within developed economies<br />
still represents a crucial element when it comes to stimulating capital formation<br />
(Riahi-Belkaoui, 2002, p. 26), having the ability to generate a part of the capital that is<br />
necessary for local or foreign entities and end encouraging investments.<br />
Furthermore, trade literature documents those markets for derivatives’ trading play an<br />
important role when it comes to the development of a country’s financial structure by<br />
creating some connections between cash markets, hedgers and speculators. The<br />
increase in the use of derivatives offers alternatives for risk management and<br />
facilitates cash flows towards emerging economies, while also creating the context to<br />
enhance systematic risk and negative effects during financial crisis periods (Lien and<br />
Zhang, 2008). We therefore consider it important to acknowledge the fact that<br />
derivatives can play both positive and negative roles. A series of studies (such as<br />
Kregel, 1998, Dodd, 2000, IMF, 2002) demonstrate the importance of derivatives<br />
when it comes to hedging and risk management, but also the related possibility to<br />
increase risk within financial systems by generating an unforeseeable dynamic in<br />
crisis development, while also offering channels for crisis propagation.<br />
Derivatives dissociate risks being associated with classic trading instruments beyond<br />
countries’ boundaries, regardless if it is market risk, credit risk, liquidity risk, interest<br />
rate risk or currency risk. More precisely, derivatives should transfer these risks from<br />
investors who do not want them towards those with a better capacity to manage them<br />
(Lien and Zhang, 2008, p. 40). Therefore, handling investments at international level<br />
becomes more attractive by generating opportunities to develop cash flows as well as<br />
to diversify investment portfolio. Still, we consider that risk enhancement, using<br />
derivatives with the purpose of avoiding prudential regulations and manipulating<br />
capital adequacy requirements should not only be looked at as simple side effects. We<br />
can even asses that inadequate use of derivatives creates the fundament that might<br />
lead to financial crisis unleashing. This is due to the fact that derivatives accelerate<br />
cash outflows during crises and therefore increase cash flows volatility at international<br />
level, further amplifying the crisis by making its evolution unforeseeable.<br />
The generally accepted main function of derivatives market is that of facilitating risk<br />
transfer between economic agents (Lien and Zhang, 2008, p. 48), the diverse shapes<br />
being taken by derivative financial instruments offering packages with certain<br />
payment patterns, redistributing and reallocating the risk associated with future cash<br />
flows between market participants. By contracting a certain position on the futures<br />
market that is actually opposed to the one on the spot market, compensating losses<br />
~ 306 ~
within the latter becomes possible based on the gains within the first. The<br />
standardized, organized and centralized nature of futures markets makes it possible<br />
for risks to be carried by other parties, such as speculators, who naturally benefit from<br />
a premium that matches the undertaken risk.<br />
A study being developed by the International Monetary Fund in 2002 (IFM, 2002)<br />
was offering examples of derivatives use with the purpose of redistributing risk and<br />
facilitating cash flows from outside the countries towards emerging economies.<br />
Among these examples we must mention currency derivatives being used in order to<br />
hedge for unexpected changes of the exchange rate and the impact that might have<br />
upon investments, and interest rate swaps that allow corporation and banks to exploit<br />
the comparative advantage of borrowing at a fixed rate versus a variable one within<br />
different markets.<br />
Another aspect which we consider relevant is the fact that trading futures and options<br />
involves lowers costs when compared with trading within the spot market (Lien and<br />
Zhang, 2008, p. 52). When trading derivatives an increase of informational flows<br />
within the market is also expected, therefore generating the potential for the<br />
development of a price forecast function within derivatives market. We must also not<br />
forget that futures prices contain information regarding the anticipated demand which<br />
could be used within the decision making process. A detailed analysis on the price<br />
forecast function in derivatives markets id developed by Mayhew (2000).<br />
Futures markets are considered to have a role in stabilizing prices based on the<br />
following reasoning: by offering protection against losses related to price risk, future<br />
markets encourage goods storing, this representing a mechanism being used in order<br />
to stabilize prices within the spot market. It is therefore assumed that futures markets<br />
have the ability to reduce volatility within spot markets. On the other hand, Mayhew<br />
(2000) documents that if the market is not perfect from the competitiveness point of<br />
view introducing futures contracts might determine many of the producers to<br />
manipulate prices within the spot market through the production process and the<br />
storing decisions, therefore actually increasing volatility within the spot market.<br />
Despite the increase in derivatives use within emerging economies, their trading level<br />
can not be compared with trading in more mature markets. The study being developed<br />
by the International Monetary Fund (2002) shows that among the most common<br />
problems that determine decreases of derivatives trading volumes within emergent<br />
economies we find the week and inadequate infrastructure of the legal system and of<br />
the markets, restrictions regarding derivatives use as well as the assembly of markets<br />
that are relatively little developed within the considered economies. The effects of<br />
derivatives markets, both the positive and negative ones, depend on the fiscal and<br />
financial fundament of emerging economies within which they are being developed<br />
(Lien and Zhang, 2008, p. 56). In other words, as Khor (2001) documented, when<br />
analyzing derivatives trading we must not only focus on derivatives use per se, but we<br />
should also consider the weaknesses at the root of national financial systems, as well<br />
as some shortcomings in microeconomic policies. Morales (2001) analyzes the<br />
benefits and risks of central banks using currency and interest rate derivatives outside<br />
the country when considering both calm periods and turbulent times. The obtained<br />
results document that the effect derivatives trading can have on an emerging<br />
economy’s capacity to handle risk and to attract intermediate capital actually depends<br />
on the internal financial system’s capacity to adapt to changes taking place in<br />
~ 307 ~
financial risk, including links with liquidity and changes taking place in market<br />
conditions.<br />
When discussing the role of derivatives trading within emergent economies we must<br />
also consider the place where trading can take place, namely within organized<br />
exchanges or within Over the Counter (OTC) markets. This is due to the fact that the<br />
structure of the trading environment has been documented to represent a significant<br />
factor in the development of derivatives market (Lien and Zhang, 2008, p. 60).<br />
Merton and Bodie (1995) correlated at a conceptual level the functions of the financial<br />
system and organizational structures within which these functions are fulfilled,<br />
assessing that financial intermediaries differ from one country to another and that the<br />
structure of the financial system changes in time. Therefore if the basic functions of<br />
derivatives markets stay the same within all markets they could be facilitated through<br />
the different institutional structures which are required to be tailored after the above<br />
mentioned functions.<br />
Considering all these aspects, we may say that issuing the right prudential regulations<br />
within emergent economies represents a real challenge for the authorized regulatory<br />
bodies. Lien and Zhang (2008) document that these regulations should create<br />
incentives for market participants to use derivatives in an adequate manner and to<br />
facilitate the development of cash flows without increasing capital risk levels. In this<br />
regard a series of aspects should be considered such as updating accounting<br />
regulations, developing clear foresights for risk management and related to financial<br />
institutions’ capital, and more transparent reporting regarding the transactions taking<br />
place within derivatives markets (Dodd, 2000).<br />
Another study being developed by the International Monetary Fund in 2003 (quoted<br />
by Lien and Zhang, 2008) documents that regulatory bodies must find a the middle<br />
way between allowing for more efficient risk management and the risk of increased<br />
exposure to potential vulnerabilities in the market’s development process. It is<br />
therefore expected for financial institutions to prove high quality risk management<br />
abilities and continuous updating of regulatory bodies’ capacity to measure risk.<br />
2. FINANCIAL SECURITIES’ MEASUREMENT<br />
We will further synthesize some main aspects related to financial securities’<br />
measurement practices before proceeding with analyzing the responses being received<br />
from the analyzed entities in relation to these practices. Selected portfolios of shares<br />
shall be revaluated at fair value. Fair value can be determined as a market price of<br />
shares or could be based on valuation models. Especially at less transparent markets<br />
shall be used these models. As common methods shall be stated:<br />
• net asset value model,<br />
• Price/Earnings ratio model,<br />
• dividend discount model.<br />
The net asset value model is based on book values, and the fair value is determined<br />
from the net asset value of the issuer. As a major limitation of this model shall be<br />
considered the absolute inconsistency of measurement bases where is applied both<br />
cost model as well as fair value approach. From the mathematical point of view it is<br />
the ratio of equity to number of issued shares.<br />
~ 308 ~
Price/Earnings ratio model is a very popular method how to determine the fair value<br />
of shares. It is a product of earnings per share ratio and price/earnings ratio.<br />
According to IFRSs it is required to present EPS ratio within the statement of<br />
comprehensive income. However there shall be stated following limitation of this<br />
model: (i) in certain markets it is not easy to find out P/E ratio value, and (ii) this<br />
model is not applicable in case that the valuated company reaches loss.<br />
Finally we have to mention Gordon’s dividend discount model. In this case the fair<br />
value is calculated as a ratio between the estimated amount of dividends to required<br />
rate of return less growth rate of dividends. As a major disadvantage of this model<br />
shall be stated the fact it cannot be applicable for those share issuers reaching loss and<br />
those who do not pay dividends.<br />
The main objective of this research was to determine, whether SMEs use financial<br />
instruments, whether the entities are able to calculate their fair value, and finally<br />
whether companies use hedging instruments as a tools of risk management. A<br />
questionnaire based survey was conducted in order to obtain the necessary<br />
information. The questionnaires were distributed in printed and electronic form.<br />
3. DEVELOPING THE ANALYSIS AND INTERPRETING RESULTS<br />
Our analysis is based on responses being obtained from a total of 111 companies with<br />
annual turnover exceeding CZK 5 billion. Respondents were asked to characterize<br />
their business based on the main area of their activity. They could select one or more<br />
of the following categories: production, trade, services, finance and insurance. None<br />
of the respondents belonged to the insurance sector. The structure of our sample in<br />
accordance to the area of activity respondents declared to belong to is presented in<br />
Figure 1. We must mention the fact that some of the companies reported more than<br />
one branch of activity.<br />
Figure 1. Sample’s structure based on companies’ area of activity<br />
50%<br />
45%<br />
40%<br />
35%<br />
30%<br />
25%<br />
20%<br />
15%<br />
10%<br />
5%<br />
0%<br />
45,9%<br />
20,7%<br />
~ 309 ~<br />
33,3%<br />
2,7%<br />
Production (51) Trade (23) Services (37) Finance (3)<br />
(Source: author’s projection)
The overview of investments being made in securities by the companies in our sample<br />
is presented in Figure 2. The obtained results show that the analyzed companies<br />
mainly invest in shares, bills of exchange and checks. Investments in stock warrants,<br />
interim certificates, warrants, inward bills, dock warrants and agriculture warrants<br />
proved to be less common within our sample.<br />
Figure 2. The relative number of references to the types of securities in which<br />
companies invest<br />
40%<br />
30%<br />
20%<br />
10%<br />
0%<br />
Share<br />
Stock warrant<br />
Interim certificate<br />
Participation …<br />
Bond<br />
Bill of exchange<br />
Check<br />
Warrant<br />
~ 310 ~<br />
Inward bill<br />
Dock warrant<br />
(Source: author’s projection)<br />
Agriculture warrant<br />
All<br />
Fina…<br />
Trade<br />
The structure of the securities being used by Czech entities corresponds with the<br />
economic developments within each considered period. During the crisis, there was a<br />
strong distrust in the financial system all over the world. This impacted upon<br />
investments in the stock market. During the past two years shares lost 10% of their<br />
value and have been trading far below their intrinsic value. Bonds were considered to<br />
contribute in making investment less attractive to investors. This can be explained by<br />
having state and municipal bonds presenting a relatively low yield which is closely<br />
linked to low interest rates in the Czech Republic and abroad, and also by not<br />
recording high nominal values for these types of securities. The results being obtained<br />
through the questionnaire also reflect SMEs not being able to invest in bonds in six<br />
digit numbers. A paradoxical phenomenon is revealed through the fact that riskier<br />
types of bonds, such as bonds being issued by corporations, were found do be more<br />
attractive. This indicates the fact that investors tend to rather trust corporations than<br />
the state. As a consequence, in 2010 huge investor interest was documented in bonds<br />
issued by Microsoft, while US government bonds were not found to be so attractive.
Bills of exchange and checks represent traditional securities being used by entities to<br />
pay their debts and liabilities. Due to the fact that Czech national regulations have<br />
been covering these types of securities for more than sixty years now, entities can rely<br />
on clear rules and good law enforcement. This also explains why they represent the<br />
most commonly used securities in Czech Republic.<br />
Figure 3 offers an overview on our sample entities’ investments in derivative<br />
contracts. Foreign currency derivatives are most commonly used, in the shape of<br />
currency forwards, currency swaps, currency options and currency futures, which<br />
together constitute 37.8% of references.<br />
Other types of derivatives are referred to only in 12.6% of the references. Analyzed<br />
businesses but do not actually use commodity derivatives. Another interesting fact<br />
being observed is that most of the references to the use of derivatives come from the<br />
manufacturing companies.<br />
Figure 3. The relative number of references to the types of derivatives being used by<br />
sample companies<br />
20%<br />
18%<br />
16%<br />
14%<br />
12%<br />
10%<br />
8%<br />
6%<br />
4%<br />
2%<br />
0%<br />
FX forward<br />
FRA<br />
Equity forward<br />
Commodity forward<br />
FX futures<br />
Interest rate futures<br />
Equity futures<br />
Commodity futures<br />
FX swap<br />
Interest rate swap<br />
Cross-currency swap<br />
Equity swap<br />
Commodity swap<br />
FX option<br />
Interest rate option<br />
Equity option<br />
Commodity option<br />
(Source: author’s projection)<br />
~ 311 ~<br />
All<br />
Services<br />
Derivatives represent a highly debated topic nowadays. When trying to explain the<br />
interest for derivatives we find several reasons. Among them there is also derivatives<br />
contribution in the context of the 2007 financial crisis. It was this point in time that<br />
once again attracted the use of the term toxic assets as equivalent for derivative<br />
financial instruments. SMEs are expected to use derivatives for risk management<br />
purposes rather than for speculation. As it was also shown in Figure 3, most of the<br />
entities have to deal with currency risk or/and interest rate risk.
Once again we documented the reputation of some contracts, such as forwards and<br />
swaps, which have proven themselves to investors by some years now. Both bankers<br />
and entrepreneurs themselves already have experience with such contracts in the<br />
Czech financial market. The characteristics making these contracts attractive are their<br />
particular clarity and low complexity of the contract. The following chart 1 and chart<br />
2 document that it represents a well grounded judgment to hedge for exchange rate<br />
risk or interest rate risk. The trend in developments of CZK against the EUR, USD<br />
and GBP, as well as developments in interest rates over the last decade make a good<br />
point in showing why it is so important to develop hedge activities.<br />
Chart 1. Currency rate developments - CZK / EUR, USD and GBP<br />
for the 1999-2010 periods<br />
(Source: www.cnb.cz, authors’ processing)<br />
Chart 2. PRIBOR 3M and 3M EURIBOR for the 1999-2010 periods<br />
(Source: www.cnb.cz; www.euribor-rates.eu, authors’ processing)<br />
~ 312 ~
Pirchegger (2006) is concerned with the fact that accounting units tend to note<br />
primarily the high level of disclosure obligations in relation to hedge accounting and<br />
the costs related thereto. On the other hand, the primary goal of the standard-issuing<br />
authority is the incontestable effort to provide investors with highly relevant<br />
information. The fact that the information on hedge accounting should form an<br />
indivisible part of the financial statements is motivated by the effort to assure<br />
investors that the criteria applicable to the field of hedge accounting were applied<br />
correctly rather than by the fact that the information on hedge accounting causes<br />
considerable additional costs to accounting units. The following figure provides<br />
evidence on the use of hedge activities by tested companies.<br />
All<br />
Production<br />
Trade<br />
Services<br />
Finance<br />
not applied<br />
fair value hedge<br />
cash flow hedge<br />
hedge of net foreign operation<br />
All<br />
~ 313 ~<br />
Finance<br />
90%<br />
80%<br />
70%<br />
60%<br />
50%<br />
40%<br />
30%<br />
20%<br />
10%<br />
0%<br />
The obtained results document that the analyzed entities remain conservative with<br />
regard to hedge activities which appear as new or little known in the Czech Republic.<br />
The reason behind these results might be due to these types of contracts being<br />
considered as risky. Furthermore when considering the Czech analyzed entities’<br />
portfolios we mainly find shares and debt securities, bills of exchange and checks.<br />
Meanwhile derivatives were mainly used within the manufacturing industry with<br />
entities preferring the standard form of currency forwards, currency swaps, currency<br />
options and currency futures.<br />
FINAL DISCUSSION AND CONCLUSIONS<br />
The most significant differences when comparing IFRSs with Czech accounting<br />
regulations are related to the relatively low requirements on disclosure. Guidance<br />
being offered in the area of reporting for financial instruments under IFRSs is mainly<br />
considered to be solution focused. This is done by associated with the real issues, or<br />
more precisely through the current market value of these instruments. This is due to<br />
standard setters’ endeavor to provide investors with the latest available information<br />
when preparing financial statements. This information is wanted to include all recent
developments in the assets’ prices as reflected within the market. Though the<br />
assumption is certainly noble, the cornerstone of its applicability relies on the<br />
existence of a highly functional and transparent market. And unfortunately, for the<br />
time being, it seems like the Czech market is not. Fair value measurement is one of<br />
the measurement bases being accepted in the Czech Republic, but it is usually<br />
determined based on valuation models, rather than by using the market price.<br />
When comparing the measurement bases comprised within the IFRSs and Czech<br />
regulations, we must also underline the fact that under Czech law it is impossible to<br />
measure long-term assets and liabilities at present-value (amortized cost extension),<br />
the same as current assets and liabilities and those with a maturity of one year in the<br />
Czech environment. Therefore, entities follow the applicable regulations requiring the<br />
assessment and presentation of their nominal values. Absolute ignorance of the time<br />
value of money can and do significantly influence (in full compliance with statutory<br />
requirements) financial statements and probably provide investors with information<br />
that drives bad investment decisions.<br />
The financial reporting of non-listed companies in the field of financial instruments is<br />
to a certain extent affected by requirements compliant with the IFRS. In the field of<br />
equity securities, there are identical requirements for the initial recognition;<br />
nevertheless, the subsequent revaluations are carried out in a different manner,<br />
depending on the comparability of the assignment of the individual tools to the<br />
respective portfolios. The adoption of portfolios applicable in international standards<br />
(HFT, AFS) and the subsequent application of identical requirements to them would<br />
be beneficial in the field of investments in equity securities in the Czech Republic.<br />
In the field of bonds reporting, the level of compatibility between the IFRS<br />
requirements and Czech regulations is not significant due to the different approach to<br />
discount/premium amortization. That is why the introduction of the HTM portfolio<br />
would be beneficial in the Czech Republic on condition that the tax consequences are<br />
resolved at the same time, i.e. that the premium amortization is fully allowable for tax<br />
purposes from the viewpoint of the investor purchasing a bond.<br />
Derivative contracts are recorded in the accounting system in compliance with the<br />
IFRS requirements. In this respect, a relatively significant problem lies in the fact that<br />
companies negotiating derivative contracts lack the appropriate information and<br />
knowledge, as well as in the fact that the amount of disclosed information on such<br />
contracts is insufficient. Hedge accounting has become more popular in the Czech<br />
Republic lately. Primarily, such efforts are motivated by tax aspects, with the Income<br />
Tax Act establishing that the costs of derivatives negotiated for the purpose of<br />
hedging are fully allowable for tax purposes. Long debates in this field were evoked<br />
by the fact that it was unclear whether the provision of the law concerned meant the<br />
economic or the accounting concept of hedging. Thanks to that provision in particular,<br />
companies introduced the application of the concept of hedge accounting. The future<br />
of hedge accounting in the Czech Republic is connected to a great extent with the<br />
possibility of a wide application of the fair-value option.<br />
~ 314 ~
ACKNOWLEDGEMENTS<br />
This paper is one of the research outputs of the projects P403/11/0002 and<br />
GA402/09/0225 registered in the Czech Science Foundation (GACR) and project<br />
number POSDRU/89/1.5/S/59184 ‘Performance and excellence in postdoctoral<br />
research within the field of economic sciences in Romania’, Babeş-Bolyai University,<br />
Cluj-Napoca being a partner within the project.<br />
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*** www.cnb.cz (Czech National Bank website)<br />
*** www.euribor-rates.eu (EURIBOR rates online)<br />
~ 316 ~
THE FINANCIAL INNOVATION<br />
AND THE DYNAMIC CAPITAL MARKET<br />
Flavia Mirela BARNA & Miruna Lucia NACHESCU 1<br />
West University of Timisoara, Romania<br />
ABSTRACT<br />
The financial innovation is not a new process. All instruments, techniques, services and<br />
capital markets that exist now have been financial innovations at the moment when they came<br />
into being. The amplitude of innovation and structural development was without precedent:<br />
new financial instruments appeared, new negotiation markets came into being and new<br />
regulations were issued, the rapid succession finding the necessary support in the „bigbang”;<br />
we’ve passed from regulated activity in the financial field to the deregulated activity<br />
and then to the re-regulated activity while auto-regulations were always present.<br />
The financial globalization generated the changing of the contemporary financial<br />
environment, represented by the increased interdependence of the national financial spaces,<br />
remarkable mobility of capital flows, concentration of financial activities in favorable areas<br />
and the creation of important international financial centers, expansion of the financial<br />
operations volume as well as the creation of new financial instruments. In the context of the<br />
financial globalization, the speed of innovating in the financial field was highly increased.<br />
KEYWORDS: financial innovation, risk, ETFs, financial derivatives<br />
INTRODUCTION<br />
The objective of this paper is presenting the financial innovation, both from the<br />
theoretical and applied point of view. During the last decades, we have been witnesses<br />
of the never before seen development of new financial instruments that justify the<br />
description of the world economy, used by James Tobin “the paper economy”.<br />
The amplitude of the innovation process and of the structural changes of the<br />
developed financial markets is bigger than ever: new structures, new negotiation<br />
markets, new techniques and financial instruments, new rules and regulations.<br />
According to Jack Marshall, „The financial engineering is not an instrument; it is a<br />
profession that uses instruments”. The derivative financial instruments came into<br />
being from speculative reasons and from the normal desire of protection against the<br />
commercial and financial risks. The increased volume of the international market and<br />
of the derivative instruments lead to a continuous diversification of the instruments<br />
and support assets.<br />
1 Correspondence address: Miruna Lucia, Nachescu, West University of Timisoara,<br />
Faculty of Economics and Business Administration; email: mnachescu@oxygencomputers.ro<br />
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1. THE COMPLEX PROCESS OF FINANCIAL INOVATION<br />
“Innovate” is defined in Webster’s Collegiate Dictionary as “to introduce as or as if<br />
new,” with the root of the word deriving from the Latin word “novus” or new.<br />
Economists use the word “innovation” in an expansive fashion to describe shocks to<br />
the economy (e.g., “monetary policy innovations”) as well as the responses to these<br />
shocks (e.g., Euro deposits).<br />
The “innovations” are sometimes divided into product or process innovation, with<br />
product innovations exemplified by new derivative contracts, new corporate securities<br />
or new forms of pooled investment products, and process improvements typified by<br />
new means of distributing securities, processing transactions, or pricing transactions.<br />
Financial innovation, process innovation as well as product innovation (representing<br />
the diversification and modernization of the financial products already existing on the<br />
capital markets) is vectors of the financial liberalization. The expected results of the<br />
financial innovation usually regard the economic growth. Their efficiency can be<br />
estimated in direct causal relation, by measuring the changes of those growth ratios.<br />
Financial innovation is in fact a way of diversifying the investment possibilities for<br />
the financial resources existing in the real economic world. In this context, financial<br />
globalization can be regarded as a filter placed either before the results (when we have<br />
an amplifying effect) or after them, making the efficiency judgments regarding the<br />
financial innovation used very difficult (dilution effect).<br />
The innovations in the financial field do not imply obligatory new products or<br />
services, being also associated to the changes that are done to the existing products<br />
and services, in order to make them more suitable to the demands of a continuously<br />
changes of the market. As a consequence, the financial innovation is a continuous<br />
process, the financial institutions being both interested and stimulated to improve their<br />
products and services in order to fulfill the client’s needs and increase their profits.<br />
Merton (1992) invented the concept of „spiral financial innovation” to describe how<br />
such new financial products satisfy the demand existing on a certain market,<br />
generating new financial products and new markets where these financial products are<br />
being sold and bought. The new financial instruments allow the new investors to<br />
diversify their portfolios and to control the risk through an advanced management that<br />
implies the use of derivatives financial instruments. Another innovation refers to the<br />
coming into being of structured finance (complex financial instruments) that has<br />
stimulated the growth of the capital markets. The new financial instruments allow the<br />
investors to diversify the risk associated to investments. A significant innovation was<br />
the transformation of illiquid actives, especially mortgage and consumption credits,<br />
into liquid exchange securities that are being exchanged on the capital markets.<br />
One sub-branch of the literature on financial innovation has created lists or<br />
taxonomies of innovations. For example, Finnerty (1988, 1992, 2001) has created a<br />
list of over 60 securities innovations, organized by broad type of instrument (debt,<br />
preferred stock, convertible securities, and common equities) and by the function<br />
served (reallocating risk, increasing liquidity, reducing agency costs, reducing<br />
transactions costs, reducing taxes or circumventing regulatory constraints.)<br />
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The financial engineering represents the process of creating financial innovative<br />
instruments with the purpose of solving certain financial problems. A new financial<br />
instrument is truly innovative only if it helps the capital markets to function more<br />
efficient, making them “less incomplete”. [***, Security Innovation in Corporate<br />
Bond Markets, f.a:1].<br />
The financial engineering came as a necessity, in the context of profound<br />
transformation of the financial markets in the 60s [Eales, B., 2000: 1], determined by<br />
the giving up of the fixed exchange rates, political instability, inflation, price<br />
instability on the financial markets. The increasing incertitude made most of the<br />
participants on the financial markets to look for protection through new financial<br />
products. The concept of financial engineering started to be used after the model<br />
Black-Scholes of evaluating the options price came into being, at the beginning of the<br />
70s. The financial innovation can be seen mainly in the field of interests (especially<br />
on short terms), in the currencies field and that of shares and bonds: from the classic<br />
derivatives (options, futures), to the exotic options, futures rate agreements (FRA),<br />
interest swaps, to the hybrid or synthetic products, but also in the case of the<br />
„securization process” that fits the same category, as well as the investment funds in<br />
monetary actives.<br />
In the process of financial innovation, the institutional investors have a very important<br />
role: they are the promoters of new financial products, that they need in order to<br />
protect themselves against certain risks or to obtain the wanted results and they are the<br />
first users of these new products. The brokerage on a large scale of holding financial<br />
assets is welcomed now, when the sophistication of the financial products is bigger<br />
each day, when information is so important, when looking after a certain portfolio<br />
implies more and more time and energy and when the management of risks by using<br />
modern methods implies advanced knowledge or the use of professionals.<br />
2. THE CHALANGE OF THE FINANCIAL INOVATION<br />
Being conscious of the dangers of globalization and those generated by the increased<br />
usage of financial innovation, the national supervision authorities for the financial<br />
markets, have included in their major concerns the updating of their national<br />
regulations in the field but also the increasing of the international cooperation (at least<br />
in the regulatory field).<br />
By settlement (regulation) we mean the supervision and control exercised by the<br />
government over the activities of private companies, having as objectives the<br />
efficiency, correctitude and safety [Bannock, G.; Manser, W., 1990: 172]. Starting<br />
from the observation that excessive settlement can act as an obstacle at entry on the<br />
capital market and therefore reduces concurrence, the trend of de-regulation appeared,<br />
more visible in the case of stock exchanges.<br />
The process of deregulation means the elimination of controls imposed by the<br />
government on the market operations (in general), taking into account that some of<br />
them are not good for the economy [Bannock, G.; Manser, W., 1990:112]. The main<br />
purpose of the deregulation of the capital market was to stimulate the concurrence in<br />
the field and between intermediaries, in favor of the investors. Deregulation has been<br />
a visible trend for some years now (since the 80s) in the economic and financial<br />
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policy of developed countries. It was determined by the internationalization of<br />
markets generated an increased competition in the financial system and a bigger<br />
fluidity on the capital markets.<br />
Augusto de la Tore and Sergio L. Schmukler (2007: 120) have established a relation<br />
between the stock market internationalization and the stock market liberalization.<br />
They have shown that before the moment of stock market liberalization, the average<br />
market capitalization of international firms/GDP was of 1.8%, after this moment, the<br />
average increased to 7.7%.<br />
The concept of de-regulation does not imply giving up rules and regulations (at least<br />
not in totality). The capital markets stay regulated, being organized markets. A clear,<br />
precise, complete and stable set of laws is a necessary premise to ensure the future<br />
development of the capital markets. De-regulation has stimulated the financial<br />
innovation, but sometimes, excessive rules were the starting point for creating new<br />
financial products; in some cases, the „battle” between the financial intermediaries and<br />
the regulating authorities of the financial markets lead to a process of re-regulating.<br />
Important technological progress assisted the financial innovations in the process of<br />
developing the capital markets. The development of the communication system<br />
increased and made the speed of transmission of the financial information in the world<br />
much higher. The lack of information was reduced and the geographical distances<br />
became less significant for the investors. The technological innovation also influenced<br />
the transaction methods, the online brokerage services, the real time payment systems<br />
and many other systems and services.<br />
All these innovations lead to the reduction of the transaction costs and to the<br />
improved liquidity of the capital markets.<br />
Augusto de la Tore and Sergio L. Schmukler (2007: 121) have also analyzed the<br />
relation between stock market internationalization and reforms and have shown that<br />
the market capitalization of international firms/GDP has increased after the<br />
introduction of the electronic trading platform from an average of only 3.1% to an<br />
average of 14.4%.<br />
3. THE IMPACT OF FINANCIAL INOVATION ON THE DYNAMICS<br />
OF MARKETS<br />
The financial innovation made it possible for the investors to manage better their<br />
portfolios in a very volatile environment. On the other hand, beside the obvious<br />
advantages, the new financial products, the new financial markets brought with them<br />
new risks for the investors and new challenges for the regulating and supervising<br />
authorities.<br />
At this moment, we consider that the main characteristic of the new financial<br />
instruments is given by the fact that they allow the separation of characteristics and<br />
risks and their combination in very new and diverse ways. This gives the investors<br />
and the ones demanding loans the possibility to keep the wanted characteristics and to<br />
give rid of the ones they do not want. Therefore it is possible to have a much<br />
diversified lot of instruments that include all possible combinations of the<br />
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characteristics: form (capital market versus banks), due time (short term versus long<br />
term), interest rate (fixed versus floating), liquidity (there is or isn’t a secondary<br />
market for that particular element).<br />
In this context, we can distinguish between what would be called innovation of<br />
instruments and ex post innovation. In the first case, a new instrument is created with<br />
a certain set of characteristics, while in the second case, the same effect can be<br />
obtained through a technique that allows the characteristics of a certain active or<br />
passive element to be changed after the event took place, not by exchanging the<br />
instrument’s characteristics but by a sort of exchange of obligations. A simple<br />
example is a swap operation where two parties exchange obligations of paying the<br />
interests that were set at fixed or floating interest rates. In fact, this kind of operations<br />
allows different users to use their comparative advantages on different markets and to<br />
sell them to others.<br />
3.1. The case of ETFs<br />
Due to the financial innovation, the last few decades were characterized by an<br />
increased number of financial instruments used on the capital market, the ETFs being<br />
regarded as a revolutionary instrument that has an unexpected impact on the global<br />
investment environment. The unprecedented dynamics of the international capital<br />
markets lead to the increased competition between the financial instruments, adapted<br />
to the different risk, investment or speculative management needs, the ETS gaining a<br />
more and more important place in the preferred investment alternatives both of<br />
institutional investors as well as individual investors.<br />
Considered as the result of serendipity (Gary L.Gastineau, 2010: p.1), ETFs are a<br />
special category of investment fund, structured in a similar way as the traditional<br />
funds but listed and sold/bought on the market as usual shares. Richard Ferri defines<br />
them as: “baskets of titles” bought and sold as individual shares through a brokerage<br />
company on a certain exchange market (Richard Ferri, 2009: p. xvii). The hybrid form<br />
of mutual funds, the ETFs, invest in a certain shares or bonds portfolio that imitate the<br />
structure of an index or reference point, with the purpose of reproducing the<br />
performance of that index or reference point.<br />
The ETFs offer great flexibility and are well adapted to answer to the investors needs.<br />
They have lots of applications in the chosen investment strategy. They can be used<br />
with very good results in different models of assets allocation (Strategic Asset<br />
Allocation, Tactical Asset Allocation, Dynamic Asset Allocation, Integrated Asset<br />
Allocation, Constant-Weighting Asset Allocation, Insured Asset Allocation), in<br />
sophisticated hedging strategies and cash-flow management strategies, being the<br />
optimum solution for more fluid investments in times of portfolio transition<br />
(transition management).<br />
Between the frequently associated to ETF strategies we have those of the type coresatellite.<br />
The ETFs can be used as the core of the portfolio, following the best<br />
diversification possible on different classes of assets and an expected profitability<br />
close to the average market one. In the same time, concentrated investments can be<br />
done, in a certain sector or country, creating a satellite independent portfolio, that<br />
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involves smaller capital allocations than in the case of a core portfolio that has a<br />
higher risk but also a superior profitability than the market’s profitability.<br />
The correlation between the profitability and risk of financial instruments, the<br />
estimation of future trends, the costs and benefits associated to the holding of certain<br />
assets but also the distinctive characteristics of each particular instrument are the<br />
object of interest of all entities on the capital market.<br />
A comparative analyze of the ETFs and main derivatives instruments that are the main<br />
competitors (Futures on index, swaps on index and options on index) becomes<br />
pertinent. The main differences between these regard explicit costs (commissions and<br />
other taxes), implicit costs (harder to measure – impact of the market, opportunity<br />
costs, expected tracking error), liquidity, operational complexity (documenting,<br />
supervision etc), the risk of counterparty but also the regulated constraints (limitation<br />
of the exposure on certain assets). Also, in choosing the optimum instrument, we have<br />
to take into account the transaction period, the strategy applied by the portfolio<br />
manager as well as the conditions imposed by the client.<br />
Even if they are competitors, the financial innovation phenomenon allowed the<br />
diversification of financial products and gave birth to some very attractive and<br />
complex combinations like the ETFs on futures or the futures on ETFs, having as a<br />
result the harmonization of the used instruments’ characteristics.<br />
Another rival product is the swap on index that, as the ETFs, is attractive for the<br />
portfolio managers and the institutional investors as it offers the possibility of<br />
diversifying the portfolios. The swap on indexes is a contractual financial agreement<br />
that generates a transaction between two parts, where at least one of them is willing to<br />
pay the other a rate of profitability based on stock exchange indexes, at a future<br />
moment, until the end of the contract. The other part is going to make payments based<br />
on a fix or variable interest applied on the same percentage of the capital value that is<br />
at the basis of the swap. Similar to the ETFs and futures contracts, swaps are used in<br />
strategies of asset allocation, their number increasing significantly between 2006-<br />
2008, from 475 billion $ to 1,475 trillions $ in 2008, before Lehman Brothers went<br />
bankrupt. Unlike the ETFs, swaps (agreements between the parts implicated in the<br />
transaction to exchange between themselves the financial advantages they have on<br />
different markets) are not negotiated on a regulated stock exchange market, being<br />
transactions between dealers. Beside the absence of a secondary market, another<br />
disadvantage is the lack of a centralized discounting system, the obligation of a<br />
thorough documentation and of an administrative support and implicates the<br />
possibility of counterparty risk as there is no warranty that the parts are going to fulfill<br />
their obligations.<br />
Another instrument that offers exposure either on the entire market or on specific<br />
segments through a single transaction is the option contract on indexes. This is a<br />
standardized engagement that ensures the right of the buyer, but not the obligation, to<br />
buy or sell a specified quantity of a support asset, at an established price, in exchange<br />
of the payment of a bonus paid to the seller of the option through a compensation<br />
house.<br />
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Compared with the ETFs, the options on indexes have the advantage of investing in<br />
the first place a small capital, limited to the bonus paid and also having an ex-ante<br />
determined risk. The buyer cannot lose more than the price of the option or of the<br />
bonus paid if the stock exchange index is not evolving accordingly to the expectation.<br />
It has to be mentioned that the options on the indexes S&P 500 are among the most<br />
popular ones, along with those on Dow Jones Industrial Average Index Options or<br />
Nasdaq 100 Index Options.<br />
The apparition of ETFs made it possible for combined products as the options on<br />
ETFs to come into being. The differences between the options on indexes and those<br />
on ETFs are numerous. The most important is that while the options on ETFs are<br />
finalized with the delivery of ETF units, the options on indexes are liquidated through<br />
compensation, namely through the payment in cash of the differences between the<br />
price of the contract and the price of the support asset at due time. Also, by being of<br />
America style, the options on ETFs can be exercised at any given moment before due<br />
time, while the options on indexes (European style) can be exercised only at due time.<br />
One of the reasons of an accelerated growth of the ETFs in respect to other<br />
instruments refers to the fact that while the futures, swaps or options contracts are<br />
classified as derivatives, the ETFs are instruments that are more secure (fully funded).<br />
In a period where the cautions attitude of investors and the increased wish for<br />
protection against risk dominate the market, the ETFs have gained an important place<br />
especially among the middle size and conservative investors. Still, in the case of ETFs<br />
the costs are known ex-ante while in the case of futures the spreads are not known<br />
until the moment when they occur. The simplicity of ETFs transactions is not<br />
comparable to the management of the margin or the documentation of the swap,<br />
making the investors accept a higher cost for the ETFs.<br />
Even if they are preferred many times over other investment alternatives, as in the<br />
case of any other financial instrument, the investors in ETFs must take into account<br />
also the potential risks. Beside the market risk, the counterparty risk and the liquidity<br />
risk that we can find also in the case of other investment funds, the ETFs present a<br />
specific risk as there are cases when their performance doesn’t follow the<br />
performance of the index. In this case, the difference between the performance of the<br />
ETF and that of the index it follows is named tracking error.<br />
According to a study performed by Morgan Stanley, the tracking-error associated to<br />
the ETFs registered an important increase in 2009, factors as the market’s volatility,<br />
diversification demands, the optimization strategies and the capital fluctuations in the<br />
companies with reduced capitalization contributed at the ETFs failure to reach the<br />
performance of the benchmark. If in 2008 the tracking error associated to the ETFs<br />
listed on the American markets was of only 0.52%, in 2009 it reached 1.25%. For<br />
example, iShares MSCI Emerging Markets Index obtained in 2009 a profitability of<br />
71.8% while the reference index registered 6.7% more, namely 78.5%. We must<br />
accept that some funds of the American market, such as style ETFs, have registered<br />
surprisingly performances, while the sector ones, on merchandise and with fixed<br />
income are left behind in respect to the benchmark.<br />
Even if holding ETFs is not risk free, the institutional investors, especially the<br />
European ones where the retail sector is still developing, use these products more and<br />
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more often as they can be a real solution for investments in the times of crises and<br />
incertitude that we are going through. Despite the international investing environment<br />
characterized by risk and incertitude, when investors become more and more selective<br />
and pay more attention to their investment alternatives, to choosing those classes of<br />
assets and investment strategies that could protect them, the use of ETFs became more<br />
popular and the volume of transactions with ETFs increased. Even more, while the net<br />
sales of the mutual funds have decreased as a result of the financial crises, the sales of<br />
the ETFs have grown. So, we can consider that the financial crisis was more of an<br />
opportunity than a threat for the ETFs ecosystem.<br />
A closer look at the statistic data regarding the ETFs market comes to the support of<br />
what we’ve said earlier. So, in 2008, the administrated assets of the ETFs listed in<br />
Europe grown with up to 11% while in USA they decreased with 14.39%. Inevitable,<br />
the question why this difference between the two markets? Beside the fact that USA<br />
was the scene of the first signs of the crises, we can notice the volatility of the market<br />
shown in the fluctuations of the market indexes, the S&P 500 registering for example<br />
daily fluctuations of over 5%, 18 times in 2008 (this only happened 17 times in the<br />
last 53 years). The decrease of assets held by the American ETFs becomes<br />
explainable, while in the case of the European markets, where the instability was felt<br />
only later through the contagion effect, they continued to grow.<br />
Another reason is that in USA, the ETFs are mostly used by the individual investors<br />
that in the context of a turbulent market have preferred to use bank deposits end to<br />
avoid the exposure associated to ETFs. In Europe on the other hand, the ETFs market<br />
is usually used by institutional investors that have withdrawn the investments in<br />
certificates, swap contracts and other structured products and have directed these<br />
resources towards ETFs, considering they were safer.<br />
Even if the administrated assets of the European ETFs have increased, they represent<br />
less than a third of the total administrated assets of the American market that classifies<br />
at the first according to this criteria, with over 800 billion $. The USA market can be<br />
characterized by a much higher homogeneity and liquidity than the European one<br />
where we are faced with a certain degree of fragmenting even if we have a joint<br />
regulatory frame (UCITS IV); also, in the USA, hedging funds are the main category<br />
of ETFs’ users while in Europe users only recently started to use this kind of products,<br />
being normally more interested in derivatives products of the over-the-counter market.<br />
The biggest transaction volumes on the European market are those on the stock<br />
exchanged of Germany and UK, but we have to say that many of the ETFs<br />
transactions are done on the OTC market.<br />
Back on the global level, the assets administrated by the ETFs have seen a fall of<br />
10.74% in 2008, followed by a spectacular growth in 2009, from 711.1 billion of $ in<br />
2008 to 1,036 billion $ in 2009 and to 1,239 billion $ in October 2010 (graph 1).<br />
As to the numeric evolution of ETFs, the increasing trend was kept during the crises,<br />
both in Europe and USA, as the graph below shows. We can notice that in 2008, the<br />
number of funds existing on the market grew with 36.09% in respect to 2007, in<br />
October 2010 the number of these being of 2409, with over 200% more than in 2007.<br />
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Graph 1. The evolution of ETFs at global level in respect to the administrated assets<br />
(Source: processed after Blackrock, Oct. 2010)<br />
Looking back, it is interesting to mention that the annual compound ratio of growth of<br />
the number of ETFs from the moment when they were introduced in 1993 and until<br />
the end of 2007 was of 53% in comparison with the annual compound ratio of growth<br />
of the number of mutual fund that reached only 4%.<br />
Numar de ETF-uri<br />
2600<br />
2400<br />
2200<br />
2000<br />
1800<br />
1600<br />
1400<br />
1200<br />
1000<br />
800<br />
600<br />
400<br />
200<br />
0<br />
1400<br />
1300<br />
1200<br />
1100<br />
1000<br />
900<br />
800<br />
700<br />
600<br />
500<br />
400<br />
300<br />
200<br />
100<br />
0<br />
Active administrate (mld.$)<br />
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010<br />
Active adm. (mld.$) 0,8 1,1 2,3 5,3 8,2 17,6 39,6 74,3 104,8 141,6 212 309,8 412,1 565,6 796,7 711,1 1.036 1.239<br />
Graph 2. The numeric evolution of ETFs at global level<br />
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010<br />
Numar 3 3 4 21 21 31 33 92 202 280 282 336 461 714 1.1721.595 1.9452.409<br />
(Source: processed after BlackRock, Oct. 2010)<br />
If we refer to the dynamics of the ETFs’ market on regions, we can reflect the<br />
situation at the end of October 2010 in the table below. We can observe that Europe is<br />
again ahead of USA, with a growth rate of the European ETFs bigger than that<br />
registered in America. The constant growth of the European ETFs can be due to a<br />
complex of factors that influence the decision of fund managers regarding the<br />
localization of ETFs: the existence of specialized personnel in the field, the favorable<br />
fiscal rules, the regulations and formalities regarding the new products. For example,<br />
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as a consequence of the favorable fiscal regime, Ireland became an important player<br />
on the European market, with a share market of over 28% of the European ETFs.<br />
Also, we notice the numerical increase of ETFs in Asia-Pacific, where, even if the<br />
ETFs industry is of only 188 such funds, the growth potential is extremely high,<br />
almost one third of the Asian financial institutions using already ETFs in their<br />
investment strategies. The statistic data reveals the fact that at the end of November<br />
2010, the top of Asian ETFs (except Japan) in respect to the administrated assets is<br />
dominated by iShares FTSE A50 China Index ETF, Tracker Fund of Hong Kong and<br />
Hang Seng Index ETF, all of them being listed on the stock exchange of Hong Kong.<br />
Graph 3. The numeric evolution of ETFs in the last year, on regions<br />
Nr ETF-uri<br />
1200<br />
1000<br />
800<br />
600<br />
400<br />
200<br />
0<br />
2009 2010 Crestere<br />
SUA 772 887 14,90%<br />
Europa 832 1048 26%<br />
Asia-Pacific 128 188 46,90%<br />
(Source: processed after BlackRock, Oct. 2010)<br />
The next graph reflects in a concise manner the analyzed market shares. In the „rest of<br />
the world” category we have included Latin America with only 26 ETFs, Africa and<br />
Middle East with 29 such funds.<br />
Graph 4. The market share in respect to the number of ETFs<br />
7,80%<br />
11,88%<br />
43,50%<br />
36,82%<br />
(Source: processing after BlackRock, Oct. 2010)<br />
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SUA<br />
Europa<br />
Asia-Pacific<br />
Restul lumii<br />
If we were to make a comparison in respect to the volume of net capitals invested in<br />
the ETF, according to the statistic data for the first 10 months of 2010, the level for<br />
USA was of 85.9 billions $, more than the double of investments in Europe. To what<br />
concerns the net capital invested in Asian ETFs (except Japan) this was of 9.5 billion<br />
$. In Japan, the investments in ETFs, registered for the same analysis horizon, were of
5.5 billion $, the most important fund regarded from the administrated assets respect<br />
being TOPIX ETF issued by Nomura Asset Management – the main supplier of ETFs<br />
on the Japanese market with a market share of 53.7 % at the end of November.<br />
Graph 5. Net capital invested in ETFs during the first 10 months of 2010<br />
(Source: processed after BlackRock, Nov.2010)<br />
Continuing with the analyze of the ETFs market, we are going to present the most<br />
used ETFs in the world, the first positions being held by ETF SPDR Trust Series 1<br />
(symbol SPY), ETF Russell 1000 Index (symbol IWD) and ETF PowerShares QQQ<br />
Trust Index (symbol QQQQ), as statistic data from the end of October 2010 showed.<br />
Table 1. Most sold/bought ETFs at global level<br />
ETF<br />
~ 327 ~<br />
Average daily<br />
transactional<br />
volume (billions $)<br />
SPDR S&P 500 20.513,7 78.243,9<br />
iShares Russell 2000 Index Fund 3.726,1 13.185,5<br />
PowerShares QQQ Trust 3.287,9 22.249,5<br />
iShares MSCI Emg.Mkts.Ind. Fund 2.084,1 44.906,1<br />
iShares MSCI Brazil Index Fund 1.193,3 10.512,5<br />
iShares MSCI EAFE Index Fund 1.005,4 35.123,5<br />
Financial Select Sector SPDR Fund 969,8 5.255,8<br />
ProShares UltraShort S&P 500 891,0 3.433,4<br />
iShares Barclays 20+ Yr. T Bond Fund 858,4 2.987,9<br />
Energy Select Sector SPDR Fund 759,0 6.583,3<br />
(Source: processing after BlackRock, Oct. 2010)<br />
Administrated<br />
actives<br />
(billions $)<br />
The SPDR Trust Series 1 ETF (symbol SPY) follows the performance of the S&P 500<br />
index that include American companies with high stock exchange capitalization, such<br />
as Exxon, Procter &Gamble, Microsoft, JP Morgan etc. On the second place we can<br />
find Russell 1000 Index ETF (symbol IWD) based on the Russell 3000 index that<br />
measures the performance of the top 3000 companies of USA from the stock<br />
exchange capitalization point of view. The index is updated annually in respect to the<br />
free-float and the companies must fulfill certain criteria in order to be kept or to be<br />
included in the index. Among these companies we can find Procter &Gamble, JP<br />
Morgan, Johnson &Johnson etc. Then, we have PowerShares QQQ Trust Index ETF<br />
(symbol QQQQ) that regards the Nasdaq 100 index with the biggest and most present
on the market 100 non-financial companies listed on Nasdaq Stock Market. This<br />
offers the possibility of long term investments in companies of the technology<br />
industry such as Apple, Microsoft, Google, Cisco, Oracle etc.<br />
The presented aspects allow us to say that the ETFs represent one of the most<br />
important financial innovations of the last decades, given their spreading and the<br />
investors’ interest in selecting the ETFs as priority investment alternative. The simple<br />
way of diversifying the portfolio and of dividing risks as well as the harmonizing the<br />
aspects regarding profitability and risk are added to the main reason for which<br />
investors prefer ETFs, namely that they combine the advantages of a mutual fund with<br />
those of a share.<br />
3.2. The case of the financial derivatives<br />
Derivatives in general, came into being as a reaction to the existing risk, but their use<br />
can be risky in some cases. They represent one of the most invocated examples of<br />
what financial innovation means, as an answer to the market needs.<br />
Through the protection they offer against risks, the types of derivative products are<br />
very diversified. The financial risks regard mainly the risk of exchange rate and that<br />
of the interest rate, have made the object of interest starting from the 70s (passing<br />
from the fixed rate to the floating system) and mainly after the 80s (inflation, dollar’s<br />
instability, high increase of the interest rate), and also the risk of the exchange<br />
security variation (named the market risk or risk of financial assets quotation).<br />
The global derivatives market is a main pillar of the international financial system and<br />
economy. As an indispensable tool for risk management and investment purposes,<br />
derivatives are used by more than 94 percent of the world’s largest companies. They<br />
contribute to improving operational, information, price, valuation and allocation<br />
efficiency, thus substantially increasing the efficiency of financial and commodity<br />
markets. Derivatives help lower the cost of capital and enable firms to effectively<br />
invest and channel their resources. These factors are an important driver of economic<br />
growth.14) Europe – as the most important region in the global derivatives market –<br />
stands to benefit immensely from the positive impact of derivatives.<br />
The derivatives market can be dividend in two parts: Exchange –Traded Derivatives<br />
(ETD) and OTC Derivatives (OTCD), interdependent components of a single global<br />
risk transfer mechanism. The increased risk associated with the OTCD market along<br />
with the growth in the last one (see the graph) represents one of the crises<br />
determinants. Additional details are essential to understanding ETD and OTCD: (i)<br />
Notional – or face – value of the underlying transactions only tell part of the story and<br />
imply excessive levels of leverage and risk in OTCD markets. (ii) OTCDs and ETDs<br />
are a subset of a broader mechanism to transfer risk among a diverse spectrum of<br />
participants and for a wide array of needs. (iii) By other measures – such as notional<br />
turnover – the ETD market is occasionally the larger sibling of the two.<br />
~ 328 ~
Figure 1. Mainstream View of Global Financial Markets<br />
(Source: Rowady, P., 2010)<br />
On the OTC market, as we have already shown, more and more complex derivatives<br />
are used. In the next example we try to show the classification of such complex<br />
derivatives at the end of the first semester of 2010.<br />
Figure 2. The most usual derivatives products of the global OTC market<br />
(Source: Triennial and semiannual surveys, Positions in global over the counter (OTC)<br />
derivatives markets at end-June 2010, 2010:8)<br />
In contrast to the decline in notional amounts outstanding of OTC contracts, gross<br />
market values for existing OTC contracts rose by 15% to 25 trillion $ at end-June on<br />
the back of sharp asset price movements. Gross credit exposures, after netting<br />
~ 329 ~
agreements, which had dropped slightly in the half-year up to end - 2009 (–6%)<br />
increased by 2% to 3.6 trillion $. Overall, nominal growth in amounts outstanding was<br />
subdued or negative in all risk categories, with a 7% drop in credit derivatives leading<br />
in percentage terms.<br />
We can easily notice that the most used instruments on this market are the derivatives<br />
on interest rates. The second place is held by the Credit Default Swaps, these being<br />
the most used category of derivatives on the OTC market and not only. In our opinion,<br />
the degree of information and education regarding the derivatives financial<br />
instruments used influences the degree of exposure to the associated risks.<br />
Figure 3. The structure of derivatives products on the global OTC market<br />
(Source: Triennial and semiannual surveys, Positions in global over the counter (OTC)<br />
derivatives markets at end-June 2010, 2010:9)<br />
Notional amounts outstanding of OTC interest rate derivatives remained stable at 452<br />
trillion $ in the first half of 2010, after increasing by 3% in the previous six months.<br />
Positions between reporting dealer fell by 5%, while business with non-financial<br />
customers grew by 6%, mainly in short maturities. Market values were buoyant, rising<br />
by 25% in aggregate in the half-year up to June 2010, with the value of contracts on<br />
US dollar interest rates increasing by 42%.<br />
Notional amounts outstanding of credit default swaps declined for the fifth<br />
consecutive period, largely due to terminations of existing contracts. The structure of<br />
the market continued to change. Positions in the generally more liquid multi-name<br />
contracts increased by 10%, while those in single-name contracts continued to<br />
decline, with a decrease of 16%. Gross market values for single-name contracts<br />
dropped by 20%, while those for multi-name contracts increased by 21%.<br />
In our opinion, the credit default swap contracts’ market, estimated at 55 trillions $,<br />
but unregulated and lacking transparence, could generate the next crises of the<br />
financial system. While the fear of a new crises on the credit default swap contracts<br />
market is accentuated in the financial system, the apparently imminent intervention of<br />
the authorities (in order to regulate these contracts and make them more transparent)<br />
~ 330 ~
seams to intensify the pessimism of the markets, as the immediate effects of certain<br />
measures cannot be predicted.<br />
As they are contracts and not titles or insurance policies, the credit default swap<br />
contracts can be closed very quickly, a simple phone call or message being enough.<br />
This is one of the reasons that make them so interesting. The majority of technical<br />
aspects were standardized by the International Association for Derivatives and Swap<br />
Contracts.<br />
In addition, as long as there is a seller ready to answer to the wishes of a creditor (to<br />
transfer risks), a credit default swap can cover almost any transaction. So, after almost<br />
a decade of exponential growth, the market of credit default swaps is close to the first<br />
major decline, due also to the contemporary financial crises, liquid assets being scarce<br />
on the capital market.<br />
In particular, special purpose vehicles (SPVs) and hedge funds are singled out for the<br />
first time. In the past, this breakdown had been used only by a subset of reporters in<br />
the past, so that data for these sub-categories in June 2010 are not directly comparable<br />
with those of previous periods. In the current period, CDS contracts with hedge funds<br />
and SPVs account for about 5% and 4% respectively of total notional amounts<br />
outstanding with other financial institutions.<br />
In this context, a product created as a hedging instrument became a possibility for the<br />
investors that want to bet on almost any transaction on the credit market. The hedging<br />
funds have invaded the credit market, in search of rapid profits.<br />
The financial crisis has brought to light several deficiencies in the derivatives market<br />
– specifically in those segments lacking standardization and centralized clearing.<br />
Consequently, the once strong market growth coupled with blind spots in regulation<br />
and supervision have given way to a substantial build-up of systemic risk, in the OTC<br />
segment.<br />
Deficiencies of the market include:<br />
� Excessive build-up of bilateral exposures and insufficient collateralization,<br />
resulting in a dramatic increase in counterparty risks;<br />
� Insufficient risk valuation and risk management capabilities;<br />
� Interconnectedness and complexity;<br />
� Lack of transparency in selected areas of the market, hindering market<br />
participants and supervisors from recognizing existing risks;<br />
� Operational inefficiencies and limited legal certainty.<br />
A substantial share of derivatives trading activity is concentrated in the hands of a few<br />
international banks (so-called broker-dealers). Accordingly, their exposures from<br />
derivatives are high. For example, the four largest US derivatives players hold<br />
derivatives positions resulting in credit exposures of more than €900 billion, an<br />
amount more than twice their equity capital.<br />
As revealed by the current crisis, OTC derivatives markets have yet another<br />
fundamental weakness: they lack sufficient capabilities for comprehensive risk<br />
assessment and management. For complex derivatives, the problem is twofold. First,<br />
~ 331 ~
many market participants lack the ability to adequately price and value derivatives<br />
and, in some cases, independent valuations by a third party are not available to<br />
support them. Second, after having exposed themselves to risks, many do not have<br />
sufficient capabilities to monitor and mitigate these risks effectively.<br />
DISCUSSION AND CONCLUSIONS<br />
During the last decades we have experienced the rapid development and<br />
sophistication of the financial systems leading to diversified and complex financial<br />
activities and instruments. In this process, the evolution of the financial sector plays a<br />
more and more important role in the appearance and amplification of the<br />
macroeconomic fluctuations. The negative effects of this financial instability<br />
underline the necessity of adopting measurements in the prudential regulation field, in<br />
accounting, in risk measurement, in monetary policy etc, for fortifying the financial<br />
system and ensuring the macroeconomic stability.<br />
The amplitude of the derivatives markets and of certain new financial instruments is<br />
due to the volatility of the global financial environment but also, they are a factor of<br />
instability due to the advantage they offer to the speculators.<br />
The aspects presented in the present paper allow us to say that the financial innovation<br />
contributed and still contributes to the increasing financial integration, the new<br />
products being created in such a way as not to depend on borders or geographic zones.<br />
Still, these financial innovations can become a brake for the deregulation process, as<br />
the emergence of new micro and macroeconomic risks makes it important to establish<br />
new prudential regulations.<br />
REFERENCES<br />
Abner, D.J (2010) The ETF Handbook: How to Value and Trade Exchange-Traded Funds,<br />
New Jersey: John Wiley & Sons Inc., Hoboken<br />
Baluch, A. & Ariff, M. (2007) "Derivative markets and economic growth: Is there a<br />
relationship?" Globalisation and Development Centre, available online at<br />
http://works.bepress.com/mohamed_ariff/5.<br />
Bannock, G. & Manser, W. (1990) The Penguin International Dictionary of Finance,<br />
London: Penguin Books<br />
Ceresoli, M. & Guillaud, M.(1992) Titrisation. Gestion financière de la banque, Paris: ESKA<br />
De la Tore, A. & Schmukler S. (2007) Emerging Capital Markets and Globalization, The<br />
International Bank for Reconstruction and Development / The World Bank,<br />
Washington, DC<br />
Eales, B.(2000) Financial engineering, Macmillan Press, Houndmills<br />
Ferri, R.A (2009) The ETF Book: All You Need to Know About Exchange-Traded Funds, New<br />
Jersey: John Wiley & Sons Inc., Hoboken<br />
Finnerty, J. D. (1992) “An overview of corporate securities innovation”, Journal of Applied<br />
Corporate Finance 4(4):23-39.<br />
Finnerty, J.D. (1988) “Financial engineering in corporate finance: An overview”, Financial<br />
Management, 17:14-33.<br />
Finnerty, J.D. (2001) Debt Management, Cambridge, MA: Harvard Business School Press<br />
Gastineau, G. L (2010) The Exchange-Traded Funds Manual, New Jersey: John Wiley &<br />
Sons Inc., Hoboken<br />
Hull, J (2007) Fundamentals of futures and option markets, 6th edition, New Jersey: Prentice<br />
Hall<br />
~ 332 ~
Marshall, J. & Bansal, V. (2004) Financial Engineering: A Complete Guide to Financial<br />
Innovation, New York: New York Institute of Finance<br />
Merton, R.C. (1992) “Financial innovation and economic performance”, Journal of Applied<br />
Corporate Finance 4<br />
Roe, M. (forthcoming 2011) "The Derivatives Players' Payment Priorities as Financial Crisis<br />
Accelerator," Stanford Law Review, available online on SRRN:<br />
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1567075<br />
Rowady, P. (2010) The global risk Transfer Market, TABB Group Study<br />
***BlackRock, ETF Global Handbook Q3 2010, www.blackrockinternational.com<br />
***, Security Innovation in Corporate Bond Markets, University of Toronto<br />
*** The Global Derivatives Market. An Introduction” (2008)<br />
*** Triennial Central Bank Survey – BIS (2010) – “Foreign Exchange and derivatives<br />
market activity in 2010”<br />
~ 333 ~
A SELECTION FUZZY MODEL INVOLVING ASSETS<br />
AND PROJECTS<br />
Adrian Victor BĂDESCU 1 ,<br />
Radu Nicolae CRISTEA & Dana-Maria BOLDEANU<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
The last decade has brought on an increase and dynamic diversification of the investments,<br />
most of them focused on traditional securities, with an alert orientation towards alternative<br />
means of investment, like private shares, private debt and real estate investments. By<br />
diversifying various types of assets, the overall risk of the portfolio can be reduced, while the<br />
medium and long term potential benefits may increase. If we consider the transaction costs as<br />
being proportional, we shall use the expected net return and standard deviation as objective<br />
functions. We propose a bi-objective programming model for solving the mixed assets<br />
portfolio selection problem within developed research, by resorting to a series of remarkable<br />
results of the fuzzy theory.<br />
KEYWORDS: Fuzzy model, securities portfolio, expected net return, investment decision<br />
INTRODUCTION<br />
The fuzzy approaches are used frequently for describing and treating uncertain and<br />
imprecise elements from a decision problem. Similarly, fuzzy theory facilitates the<br />
uncertainty analysis of systems in which it is caused by elements of unclear origin,<br />
rather than its random nature, and may be applied in order to mathematically quantify<br />
imprecise observation values, linguistically data or verbal decisions. The group<br />
membership function, a central model of any fuzzy model, is thought as being the<br />
strongest landmark of fuzzy set theory (Munda et al., 1992). In practical applications<br />
concerning set theory, the construction of membership functions is usually<br />
accomplished thru iterations (McNeil and Freiberger, 1994), (Bardossy and<br />
Duckstein, 1995), (Klir and Yuan, 1996).<br />
Together with fuzzy theory and probability analysis, the existing approach methods<br />
for uncertainty and imprecision also include another version, based on using interval<br />
mathematics. In many cases, using intervals for expressing the variation of certain<br />
coefficients may serve the purpose of research to a greater extent. (Alefeld and Mayer,<br />
1996)<br />
It has been frequently suggested that the origin of modern mathematical models in<br />
finances resides in Louis Bachelier’s dissertation over speculation theory. However<br />
true that may be, there is no doubt that Markowitz’s research regarding portfolio<br />
1 Correspondence address: Adrian Victor BĂDESCU, Bucharest Academy of Economic Studies,<br />
Romania; email: badescuadi@gmail.com<br />
~ 334 ~
selection had the strongest impact over modern financial mathematics. Hence,<br />
Markowitz’s theory over portfolio management analyses individual agents of the<br />
financial markets. This theory combines concepts of probability theory and<br />
optimizations in order to model the agents’ behaviour during various times of<br />
evolution in economy. The theory assumes that agents are searching for a balance<br />
between maximizing income and minimizing investment risks. Income is calculated<br />
with medium efficiency, and the risk is a variance of the assets that form the portfolio.<br />
Such mathematical representations of income and risk have allowed the<br />
implementation of optimization techniques in studies concerning portfolio<br />
management. The two objectives of the investors – maximizing profits and<br />
minimizing risks – are oriented so that they maximize the income’s expected value<br />
and minimize the variance of the portfolio’s value. The solution will hence be a<br />
function of the risk level to the resulted income. Although recent models present new<br />
and varied perspectives of the mathematical definitions of risk and economic agents’<br />
income (investors, in this case), the relationship between income and risk has always<br />
been one of the problems that the financial theories have tried to resolve.<br />
Although the fact that the analysis of the problems described by the portfolio<br />
selection, related to the model efficiency mean-variance can be resolved in a<br />
polynomial time interval, historically speaking, many efforts have been made in order<br />
to reduce the effective computation time. Sharpe’s model (1963) represents one of the<br />
main successes in this field. The model reduces the estimation of the number of the<br />
variance-covariance coefficients to a much smaller total value. Considering the<br />
hypothesis according to which investors’ decisions are influenced only by the income<br />
risk (which is smaller than the income mean), the Mean-Semivariance (M-S) method<br />
was suggested, in order to develop the model known today as Markowitz-Mao-<br />
Swalm. In this case, the definition of semivariance is the expected value of the square<br />
of the deviation from the mean or, more generally speaking, the value selected as<br />
critical by the decision taker.<br />
In order to solve the problem of large-size portfolio optimization models, Konno and<br />
Yamazaki (Konno and Yamazaki, 1991) have analysed the efficiency mean-absolute<br />
deviation – type approach for investment risk measurement. Using the data supplied<br />
by the Tokyo stock market, Konno and Yamazaki have compared the performance<br />
resulted from the efficiency mean-variance model, with respect to the efficiency<br />
mean-absolute deviation model, and discovered that the efficiency levels of the two<br />
were extremely close. Feinstein and Thapa (Feinstein and Thapa, 1993) have<br />
rephrased the above-mentioned model, equivalent to the one developed by Konno<br />
(Konno et al., 1993) and that simultaneously halves the restrictions on the number of<br />
non-zero assets of the optimal portfolio. Also, while Konno demonstrated that the<br />
efficiency mean-absolute deviation does not need a covariance matrix, Simaan<br />
(Simaan, 1997) discovers that this should lead to a much higher estimated risk and<br />
exceed the benefits.<br />
1. THE BI-OBJECTIVE MODEL FOR MIXED ASSETS PORTFOLIO<br />
SELECTION<br />
In order to illustrate our method, we assume that an investor assigns his wealth in<br />
projects and traditional assets. Therefore, regarding the mixed assets portfolio<br />
selection, the available assets for investments are divided in two types. The first class<br />
~ 335 ~
of assets resides in traditional titles. The second resides in projects. The main<br />
difference between the two types of investments is that decisional variables for<br />
projects are binary, while the ones for securities are continuous. There is an available<br />
budget for each project, and the budgets can be quantified by investors or experts. We<br />
assume that the total cost of a project is the same as the budget needed to start the<br />
project. Also, the project investments cannot be reallocated in any moment of time,<br />
unlike title investments.<br />
We consider the structure of securities from the mixed assets as having n risky titles<br />
S i , i = 1,<br />
2 ,..., n , that offer random earning rates, as well as m projects, Pj , j = 1,<br />
2,...,<br />
m . We<br />
assume that the investor starts with a portfolio that includes only securities titles, and<br />
then decides to rebuild the new mixed securities portfolio, including titles and<br />
projects.<br />
To formalize the problem we introduce the following notations:<br />
~<br />
r i : random variable, which represents rate of return on securities without transactional<br />
costs S i , i = 1,<br />
2 ,..., n , ;<br />
r : expected net return for securities without transactional costs S i , i = 1,<br />
2,...,<br />
n,<br />
;<br />
i<br />
~<br />
j<br />
R : random variable representing random net earnings of a project j 1,<br />
2,...,<br />
m<br />
R : project expected net return after cost deduction , j = 1,<br />
2,...,<br />
m ;<br />
j<br />
M: total value of securities owned by an investor;<br />
X : total value of investment on risky securities S i , i = 1,<br />
2,...,<br />
n,<br />
i<br />
i<br />
x : rate of total investment in risky assets S i , i = 1,<br />
2,...,<br />
n,<br />
0<br />
i<br />
~ 336 ~<br />
P j<br />
P j<br />
, = ;<br />
X : total value of risky securities investment from the existing portfolio , i 1,<br />
2,...,<br />
n,<br />
0<br />
i<br />
S i = ;<br />
S i , i = 1,<br />
2,...,<br />
n ;<br />
x : rate of total value of risky securities investment in existing portfolio ,<br />
k : rate of transactional costs for risky securities , i 1,<br />
2,...,<br />
n,<br />
i<br />
j<br />
S i = and non risky asset n+<br />
1<br />
z : binary variable which indicates if the project is a selected asset or not , j = 1,<br />
2,...,<br />
m<br />
z ⎧1,<br />
if Pj project is selected for investments<br />
j = ⎨<br />
⎩0,<br />
if not<br />
⎛ ~ ~ ~ ~ ~ ~ ⎞<br />
We assume that the vector of random variables ⎜ r 1,<br />
r 2 ,..., r n,<br />
R1<br />
, R 2 ,..., R m ⎟ is distributed<br />
⎝<br />
⎠<br />
on a given space { ( r1t ,..., rnt<br />
, R1t<br />
,..., R mt ) , t = 1,<br />
2,...,<br />
T } with known probabilities:<br />
⎧⎛<br />
~ ~ ~ ~ ~ ~ ⎞<br />
⎫<br />
pt = Pr ⎨⎜<br />
r1<br />
, r 2 ,..., r n,<br />
R1<br />
, R 2 ,..., R m ⎟ = ( r1t<br />
,..., rnt<br />
, R1t<br />
,..., Rmt<br />
) ⎬,<br />
t = 1,<br />
2,...,<br />
T<br />
⎩⎝<br />
⎠<br />
⎭<br />
Then, expected net return i<br />
is given by the relation: ri<br />
= ∑<br />
=<br />
return j<br />
r of risky securities<br />
T<br />
, i 1,<br />
2,...,<br />
n,<br />
ptrit<br />
, i = 1,<br />
2,...,<br />
n,<br />
where it<br />
t 1<br />
T<br />
R of Pj , j = 1,<br />
2,...,<br />
m project, is given by: R j = ∑ pt<br />
R jt , j = 1,<br />
2,....,<br />
m , where jt<br />
t=<br />
1<br />
be generated through predicted data.<br />
P j<br />
S ;<br />
S i = without transactional costs<br />
r can be predicted. Expected net<br />
R can<br />
Having a securities mixed portfolio ( x 1 , x2<br />
,..., xn<br />
, z1,<br />
z 2 ,..., z m ) , the expected return of the<br />
portfolio without transactional costs can be expressed by:
n+<br />
1<br />
m<br />
∑ri X i + ∑R j z j = ∑∑ pt<br />
rit<br />
X i + ∑∑<br />
i=<br />
1 j=<br />
1<br />
where = Mx , i = 1,<br />
2,...,<br />
n + 1<br />
X i<br />
n+<br />
1 T<br />
i şi r , t = 1,<br />
2,...,<br />
T .<br />
rn + 1 , t = n + 1<br />
i=<br />
1 t=<br />
1 j=<br />
1 t=<br />
1<br />
~ 337 ~<br />
m<br />
T<br />
p R<br />
We are using a „V” form function for expressing transactional costs. The transactional<br />
costs of securities S i , i = 1,<br />
2,...,<br />
n,<br />
n + 1 will be given the relation: 0 .<br />
t<br />
jt<br />
z<br />
j<br />
C i ( X i ) = k i X i − X i<br />
Consequently, total transaction costs of mixed securities portfolio are expressed as<br />
such:<br />
n+<br />
1<br />
∑Ci( X i ) = ∑<br />
i=<br />
1<br />
n+<br />
1<br />
i=<br />
1<br />
k<br />
i<br />
X<br />
i<br />
− X<br />
Considering x = ( x x + ) , z = ( z ,..., z ) and X ( X X )<br />
1 ,..., n 1<br />
1 m<br />
= 1 ,..., , then the net expected return<br />
n + 1<br />
of the mixed securities portfolio after the payment of transactional costs is given by<br />
the relation:<br />
f<br />
=<br />
( X , z)<br />
n+<br />
1 T<br />
=<br />
n+<br />
1<br />
∑riXi+ ∑Rjzj−∑ i=<br />
1 j=<br />
1<br />
∑∑ pt<br />
rit<br />
X i + ∑∑ pt<br />
R jt z j −∑<br />
i=<br />
1 t=<br />
1 j=<br />
1 t=<br />
1<br />
m<br />
m<br />
T<br />
n+<br />
1<br />
i=<br />
1<br />
0<br />
i<br />
C ( X ) =<br />
0 0 0<br />
If we consider the following notations x 1 ,..., xn<br />
, x1<br />
,..., xn<br />
, xn<br />
+ 1 for<br />
0 0 0<br />
X 1 ,..., X n , X n+<br />
1,<br />
X 1 ,..., X n , X n+<br />
1 , then the net expected return of the mixed securities<br />
portfolio after the payment of transactional costs is given by:<br />
f<br />
n+<br />
1 T<br />
i<br />
n+<br />
1<br />
i=<br />
1<br />
( x,<br />
z)<br />
= ∑∑ pt<br />
rit<br />
xi<br />
M + ∑∑ pt<br />
R jt z j − ∑<br />
i=<br />
1 t=<br />
1 j=<br />
1 t=<br />
1<br />
m<br />
T<br />
k<br />
i<br />
i<br />
X<br />
n+<br />
1<br />
i=<br />
1<br />
i<br />
− X<br />
i<br />
0<br />
i<br />
k M x − x<br />
Maximizing the expected net return f ( x , z ) of the mixed securities portfolio with<br />
respect to the payment of transactional costs can be considered a prime objective of<br />
the selection problem of this portfolio.<br />
In selecting the traditional titles portfolio, Markowitz used variance to measure the<br />
portfolio risk, the first risk quantity measure. Since then, different risk assessment<br />
methods have been suggested within specialized literature concerning financial<br />
portfolio selection [3]. These methods include semivariance, absolute deviation, semiabsolute<br />
deviation and so on. Considering that the semi-absolute deviation is more<br />
appropriate for portfolio risk measurement, we shall use the semi-absolute deviation<br />
function in the mixed title portfolio selection model.<br />
The semi-absolute deviation of a mixed title portfolio return of states t = 1,<br />
2,...,<br />
T can<br />
be represented by:<br />
W<br />
t<br />
n<br />
∑<br />
( X ,<br />
z)<br />
= p ( r − r )<br />
i=<br />
1<br />
i<br />
ti<br />
i<br />
2<br />
X<br />
i<br />
+<br />
z<br />
j<br />
m<br />
∑ ( Rtj<br />
− R j )<br />
j=<br />
1<br />
M<br />
2<br />
p<br />
i<br />
i<br />
0<br />
i
In this approach, we can use the function ( x z )<br />
~ 338 ~<br />
w , to measure the portfolio risk.<br />
Minimizing the mixed title portfolio risk can be considered as the second objective of<br />
the selection problem for the mixed title portfolio.<br />
When it comes to the mixed securities portfolio (which includes titles and projects), a<br />
number of restrictions must be taken into consideration.<br />
We introduce the following notations:<br />
B : the project’s capital budget , j = 1,<br />
2,...,<br />
m , for instance, the cost paid by the investor<br />
j<br />
P j<br />
once the project is chosen and started;<br />
B : the maximum invested sum assigned to the project components out of the mixed<br />
securities portfolio;<br />
Y : total investment value for the j<br />
j P project for instance Yj = Bj<br />
z j,<br />
j = 1,<br />
2,...,<br />
m<br />
S: the investment’s maximum value for components of the titles which form the<br />
mixed securities portfolio.<br />
With the following restrictions:<br />
• Budgetary restriction of the project component:<br />
m<br />
m<br />
∑Yj= ∑<br />
j=<br />
1 j=<br />
1<br />
B<br />
j<br />
z<br />
j<br />
≤ B<br />
• Budgetary restriction of the title component:<br />
∑ + n 1<br />
i=<br />
1<br />
x M ≤ S<br />
• Budgetary restriction of the capital:<br />
m<br />
n+<br />
1<br />
• Non-zero restriction:<br />
∑Yj+ ∑ xi<br />
M = ∑Bjzj+ ∑<br />
j=<br />
1 i=<br />
1<br />
j=<br />
1<br />
x i<br />
i<br />
m<br />
n+<br />
1<br />
i=<br />
1<br />
≥ 0 , i = 1,<br />
2,...,<br />
n + 1<br />
x M ≤ M<br />
By implementing these restrictions, the bi-objective problem (BOP) of the mixed<br />
securities portfolio selection can be expressed as:<br />
Figure 1. Expression of the bi-objective problem (BOP) for mixed securities portfolio<br />
max<br />
min w ( x,<br />
z ) =<br />
j = 1<br />
n + 1<br />
i = 1<br />
j = 1<br />
x<br />
z<br />
m<br />
∑<br />
∑<br />
m<br />
B<br />
x M ≤ S<br />
0,<br />
z<br />
i =<br />
≤ B<br />
n + 1<br />
i = 1<br />
1,<br />
2,...,<br />
n + 1<br />
i = 1<br />
∑ B j z j + ∑ x i M ≤ M<br />
i<br />
j<br />
≥<br />
=<br />
n + 1<br />
{ 0,<br />
1}<br />
, j = 1,<br />
2,...,<br />
m.<br />
t it i<br />
i = 1 t =<br />
1<br />
j = 1 t = 1<br />
p<br />
( r − r )<br />
2<br />
X<br />
z<br />
i<br />
∑ ( R tj − R j )<br />
j = 1<br />
M<br />
n + 1<br />
f ( x,<br />
z ) = ∑∑prxM+ ∑∑ p t R jt z j − ∑ k<br />
i<br />
j<br />
j<br />
n<br />
∑<br />
T<br />
i<br />
ti<br />
i<br />
i<br />
m<br />
+<br />
T<br />
j<br />
m<br />
i = 1<br />
2<br />
i<br />
M<br />
p<br />
i<br />
x<br />
i<br />
− x<br />
0<br />
i
2. FUZZY MIXED SECURITIES PORTFOLIO SELECTION MODEL<br />
We are going to describe the management method for the decision taker’s<br />
expectations, by highlighting the interpretation of his rational behaviours (Albrecht,<br />
2003; Bădescu et al, 2005). Thus, because investments are generally influenced by<br />
changes in social and economical factors, an approach towards optimization is not<br />
always the best solution. In many cases, a “satisfactory” approach from the investor’s<br />
perspective is preferred, rather than an approach towards optimization. An investor<br />
always has different levels of aspiration for the anticipated profit and risk. In the real<br />
world of financial management, the experts’ knowledge and expertise are very<br />
important with taking decisions.<br />
Relying on the experts’ knowledge, an investor can decide his level of aspiration for<br />
the portfolio’s anticipated profit and risk. Watada (2001) proposed a logistic function,<br />
a sigmoid membership function, for expressing the levels of aspiration of an<br />
individual, concerning the anticipated profit and risk. The sigmoid membership<br />
function is<br />
1<br />
f ( x)<br />
=<br />
1 + exp( −αx)<br />
.<br />
We consider that it is more appropriate to use the logistic function in order to reveal a<br />
vague/fuzzy level of the objective which an investor can consider (Bellman et al.,<br />
1970; Konno et al., 1993). According to the maximization principle and using the<br />
variance to measure the portfolio risk, Watada (2001) proposed a fuzzy portfolio<br />
selection model which extends Markowitz’s Mean-variance model for the fuzzy case.<br />
Regarding the suggested portfolio rebalancing model, the two objectives are taken<br />
into consideration (profit and risk), as well as the limitations of the portfolio’s<br />
liquidity. Since the anticipated profile, risk and liquidity are vague and uncertain, we<br />
use the sigmoid membership function introduced by Watada (2001) to express the<br />
aspiration level of the anticipated profile, risk and portfolio liquidity. Using the risk<br />
function of the semi-absolute deviation to measure the portfolio risk, we suggest a<br />
rebalancing model for the fuzzy portfolio, which is based on the Bellman-Zadeh<br />
maximization principle (Bellman et al., 1970).<br />
The membership functions for the objective for anticipated profile, risk and liquidities<br />
are given as follows:<br />
a) The membership function for the objective „the portfolio’s anticipated profit”:<br />
1<br />
μ r ( x)<br />
=<br />
1 + exp( −α<br />
( E ( r(<br />
x))<br />
− r<br />
where r is the inflexion point where the membership function takes the value 0.5 and<br />
M<br />
α can be given by the investor, according to its own degrees of satisfaction for the<br />
r<br />
anticipated profile. r M<br />
~ 339 ~<br />
r<br />
represents the central aspiration level for the anticipated profile<br />
returned by the portfolio. Figure 2 shows the membership function for the established<br />
profit objective.<br />
M<br />
))
Figure 2. The membership function for the established portfolio’s anticipated profit<br />
b) The membership function of the objective „the portfolio’s risk”:<br />
1<br />
μ w ( x)<br />
=<br />
1 + exp( α ( w(<br />
x)<br />
− w ))<br />
where w is the inflexion point where the membership function takes the value 0.5<br />
M<br />
and α can be given by the investor, according to its own degrees of satisfaction for<br />
r<br />
the anticipated profile. r represents the central aspiration level for the anticipated<br />
M<br />
profile returned by the portfolio. Figure 3 shows the membership function for the<br />
established risk objective.<br />
Figure 3. The membership function for the established risk portfolio<br />
c) The membership function of the objective „the portfolio’s liquidities”:<br />
1<br />
μ ˆ ( x)<br />
= l<br />
1+<br />
exp( −α<br />
( ( ˆ<br />
l E l ( x))<br />
− lM<br />
))<br />
where l is the inflexion point where the membership function takes the value 0.5 and<br />
M<br />
α can be given by the investor, according to its own degrees of satisfaction for the<br />
r<br />
anticipated profile. r represents the central aspiration level for the anticipated profile<br />
M<br />
returned by the portfolio. Figure 4 shows the membership function for the established<br />
liquidity objective.<br />
w<br />
~ 340 ~<br />
M
Figure 4. The membership function for the established liquidity objective<br />
Observation 1: α f and w<br />
respectively,<br />
μ w ( x,<br />
z)<br />
α determine the shape of the functions family ( x,<br />
z)<br />
,where α > 0 and > 0<br />
α f and α , the lower the vague dimension.<br />
w<br />
f<br />
w<br />
~ 341 ~<br />
μ and,<br />
α . The greater the value of the parameters<br />
According to the priciple of Bellman and Zadeh (Bellman et al., 1970), we can define<br />
the following expression:<br />
λ = min { μ f ( x, z ), μ w ( x,<br />
z ) } .<br />
The fuzzy mixed securities portfolio selection problem can be defined as:<br />
and all (PBO) restrictions.<br />
1<br />
1−<br />
λ<br />
1<br />
max λ<br />
μ<br />
μ<br />
f<br />
w<br />
( x,<br />
z)<br />
≥ λ<br />
( x,<br />
z)<br />
≥ λ<br />
Consideringη<br />
= log , then λ = .<br />
1 + exp(<br />
−η<br />
)<br />
The logistic function is monotonic and increasing, so maximizing λleads to<br />
maximizingη . So, this problem can be transformed into an equivalent one, as follows:<br />
maxη<br />
α ( f ( x,<br />
z)<br />
− f<br />
α<br />
f<br />
w<br />
M<br />
) −η<br />
≥ 0<br />
( w(<br />
x,<br />
z)<br />
−ω<br />
) + η ≤ 0<br />
Figure 5. Expression of the linear programming problem (PPL)<br />
and all (PBO) restrictions, where α f and α are the parameters that can be given by the<br />
w<br />
investor, based on his level of satisfaction regarding the expected return and risk.<br />
Note that (PPL) is a classical linear programming problem, and can be solved using<br />
one of the linear programming algorithms, for instance the simplex method.<br />
M<br />
f
Also, the family of S-shaped nonlinear functions of the two factors can modify its<br />
shape with respect to the parametersα f and α . By selecting the values of these<br />
w<br />
parameters, the aspiration levels of the two factors can be precisely described. On the<br />
other hand, different parameter values can reflect different levels of aspiration of the<br />
investors. As follows, it is convenient for them to elaborate investment strategies by<br />
using the suggested model for the mixed assets portfolio selection.<br />
2. INVESTMENT DECISION ON A ASSETS PORTFOLIO BASED<br />
ON A FUZZY ALTERNATIVE<br />
In order to illustrate this section’s suggested approach, let’s consider the case of an<br />
investor who analyses the possibility of reconstructing a portfolio made out of shares<br />
from four assets Microsoft, Google, Apple, Yahoo:<br />
Table 1. Initial Portfolio assets<br />
MICROSOFT GOOGLE APPLE YAHOO<br />
20% 40% 30% 10%<br />
The reconstruction process requires the decision taker to consider introducing<br />
securities in his shares package.<br />
The utilized data have been observed during October 2009 – September 2010 and<br />
registered with weekly frequency. The data was extracted using Google Finance and<br />
processed thru a set of procedures which imply: determining the rates of return,<br />
eliminating the aberrant values within risk formation, regrouping the data in four<br />
week modules (which describe a period) and estimating the accomplishment<br />
probability of the respective rates of return.<br />
We assume that the total worth of the actives M owned by the investor is of 350.000$.<br />
Until now, the investor had bought only risk-free assets (bonds) but, because they<br />
have a smaller return than risk assets, the investor wants to increase the value of the<br />
portfolio’s dividends. So, in order to reach its objective, the investor reallocates the<br />
available funds between the four risk assets and two projects.<br />
The rates of return for the four risky assets and their accomplishment probabilities are<br />
given in the following table:<br />
Table 2. Rates of return and probabilities for the risky assets<br />
PROBABILITY MICROSOFT<br />
(M)<br />
GOOGLE<br />
(G)<br />
APPLE<br />
(A)<br />
YAHOO<br />
(Y)<br />
0.36 0.000305779 0.0296 0.08938 0.005416<br />
0.28 0.026493352 0.00285 0.02558 0.03937<br />
0.22 0.008808809 0.002234 0.01394 0.03433<br />
0.14 0.069485842 0.03369 0.031953 0.04019<br />
We assume that the maximum value of the investment S assigned to the actions is of<br />
260.000$, and the maximum value B assigned to immovable projects is of 90.000$.<br />
~ 342 ~
We already have the values of f M and w to 0.04 and, respectively, 0.375. The<br />
M<br />
possible values for the two projects are listed in the next table by their budgets:<br />
Table 3. Budgets and probabilities for 2 projects<br />
PROBABILITY P 1 P 2<br />
0.36 50000$ 30000$<br />
0.28 45000$ 35000$<br />
0.22 25000$ 32000$<br />
0.14 5000$ 12000$<br />
For the data in the above tables, we have calculated the risk matrix (as standard<br />
deviation):<br />
Table 4. Risk matrix for assets and projects<br />
MICROSOFT GOOGLE APPLE YAHOO P1 P2<br />
0.008875 0.013423 0.037774 0.010102 7920 408<br />
0.022008 0.002317 0.027516 0.032607 4339.032 3005.573<br />
0.00295 0.002343 0.01893 0.026541 5534.691 1257.031<br />
0.031648 0.015311 0.002069 0.023363 11898.47 6480.551<br />
Also, using Excel 2010 processor, we have estimated the rates of return on the assets,<br />
and obtained the following values:<br />
Table 5. Rates of return on assets and projects<br />
MICROSOFT GOOGLE APPLE YAHOO P1 P2<br />
0.015098 0.007229 0.026423 0.022253 0.105143 0.083771<br />
Because the projects are expressed in absolute values and not return rates, the values<br />
needed to be normalized by dividing thru M.<br />
Using data resulted before we have determined satisfactory investments strategies<br />
solving the optimisation problem, which has the following format:<br />
max η<br />
j=<br />
1<br />
t it i<br />
i=<br />
1 t=<br />
1<br />
j=<br />
1 t=<br />
1<br />
B<br />
i=<br />
1<br />
z<br />
p<br />
≤ B;<br />
( r − r )<br />
n+<br />
1<br />
i=<br />
1<br />
2<br />
X<br />
z<br />
x M ≤ S;<br />
∑ ( Rtj<br />
− R j )<br />
j=<br />
1<br />
j=<br />
1<br />
M<br />
{ 0,<br />
1}<br />
, j = 1,<br />
2,...,<br />
m.<br />
n+<br />
1<br />
0<br />
α f ( ∑∑prxM+ ∑∑ pt<br />
R jt z j −∑kiMxi−xi−f<br />
⎛<br />
⎜<br />
⎜<br />
α<br />
⎜<br />
w ⎜<br />
⎜<br />
⎜<br />
⎝<br />
m<br />
∑<br />
i<br />
n+<br />
1 T<br />
j<br />
n<br />
∑<br />
j<br />
x ≥ 0,<br />
i = 1,<br />
2,...,<br />
n;<br />
z =<br />
i<br />
ti<br />
i<br />
∑<br />
j<br />
i<br />
m<br />
i<br />
+<br />
T<br />
j<br />
m<br />
m<br />
i=<br />
1<br />
~ 343 ~<br />
2<br />
n+<br />
1<br />
∑Bjzj+ ∑xiM≤M<br />
i=<br />
1<br />
p<br />
i<br />
− ω<br />
M<br />
M<br />
⎞<br />
⎟<br />
⎟<br />
⎟<br />
⎟<br />
+ η ≤ 0<br />
⎟<br />
⎟<br />
⎠<br />
) −η<br />
≥ 0
We used a fuzzy alternative both to avoid solving a bi-objective model and mostly to<br />
highlight the decision taker’s expected satisfaction. In other words, because a<br />
nonlinear membership function may change its shape according to the parameter<br />
values, the function could better reflect the investor’s logic and expectations from this<br />
portfolio.<br />
Figure 6. Nonlinear membership function of the portfolio<br />
Table 6. Rate of return and involved risk on the selected portfolio<br />
Η ΑF ΑW<br />
PORTFOLIO RATE<br />
OF RETURN<br />
INVOLVED<br />
RISK<br />
30 600 800 0.09 0.00000002<br />
37 500 1000 0.115 0.00000001<br />
52.5 400 1200 0.215 0.000000014<br />
We consider that the first alternative is preferred by the investor, because it generates<br />
the highest degree of satisfaction after mathematically illustrating its logic regarding<br />
the investment decision. So, in order to find the portfolio structure in this case, we<br />
elaborate the following function with the aid of Wolfram Mathematica software:<br />
Figure 7. Mathematical expression of the portfolio structure<br />
We obtain the following optimal portfolio structure for maximizing the decision<br />
taker’s satisfaction:<br />
Table 7. Optimal portfolio structure<br />
MICROSOFT<br />
(M)<br />
GOOGLE<br />
(G)<br />
APPLE<br />
(A)<br />
YAHOO<br />
(Y)<br />
P1 P2<br />
7% 34% 37% 22% Yes No<br />
~ 344 ~
CONCLUSIONS<br />
We can conclude by showing that, in today’s extremely dynamic and unpredictable<br />
business environment, the decision takers invest in various categories of assets in<br />
order to maintain a competitive advantage. Certain securities and projects may be<br />
integrated a mixed assets portfolio. Thus, the mixed assets portfolio amplifies the<br />
investors’ opportunities. Regarding the expected efficiency and risk, the two objective<br />
functions have been implemented as a bi-objective programming model than can<br />
reflect the investor’s hopes and expectation once the mixed assets portfolio has been<br />
determined, by means of a selection problem with transactional costs.<br />
Moreover, the investors’ vaguely expressed expectations regarding the efficiency and<br />
risk levels are considered to be fuzzy numbers in order to be formally illustrated in a<br />
way that allows them to determine the optimal portfolio structure, by means of<br />
specialized algorithms. The experimental results show that the suggested model can<br />
successfully generate a portfolio strategy, depending on the degree of satisfaction<br />
expected by the investor.<br />
ACKNOWLEDGEMENT<br />
This work was supported by CNCSIS –UEFISCSU, project number PNII – IDEI<br />
_1805/2008.<br />
REFERENCES<br />
Albrecht, Peter (2003) „Risk Measures”, University of Mannheim, Institute for Insurance<br />
Science, available on-line at http://www.gravitascapital.com/Research/Risk/<br />
Risk%20Based%20Capital%20Allocation.pdf<br />
Bădescu, A. V., Dobre, I., Sacal, B. (2005) Metode cantitative de fundamentare a deciziilor în<br />
condiţii de risc şi incertitudine, Editura Atlas Press, Bucureşti<br />
Bardossy, A. and Duckstein, L. (1995) Fuzzy rule-based modeling with applications to<br />
Geophysical, Biological and. Engineering Systems, 1 st Edn, CRC Press, Boca Raton<br />
Klir G.J., Ute, St. C., Yuan, B. (1995) Fuzzy Sets and Fuzzy Logic: Theory and Application,<br />
Prentice-Hall, New Jersey<br />
McNeill. D. and Freiberger, P. (1994) Fuzzy logic, New York, Simon & Schuster, Inc.<br />
Alefeld, G. and Mayer, G. (1996) “Interval Analysis: theory and applications”, Journal of<br />
Applied Mathematics, vol. 121, p421-464.<br />
Bellman, R.E. and Zadeh, L.A. (1970) „Decision making in a fuzzy environment”,<br />
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Feinstein, C.D. and Thapa, M.N. (1993) “Notes: A Reformulation of a Mean-Absolute<br />
Deviation Portfolio Optimization Model”, Management Science, Vol.39, No.12:1552-<br />
1553<br />
Konno, H., Pliska, S. R. and Suzuki, K. (1993) „Optimal portfolios with asymptotic criteria”,<br />
Annals of Operations Research, Vol. 45:187–204<br />
Konno, K. and Yamazaki, H. (1991) „Mean absolute deviation portfolio optimization model<br />
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Munda, G., Nijkamp, P., Rietveld, P. (1992) “Fuzzy multigroup conflict resolution for<br />
environmental management”, Serie Research Memoranda, vol. 67<br />
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mean absolute deviation model”, Management Science, Vol. 43: 1437–1446<br />
Smithson, M.J.; Verkuilen, J. (2006), „Fuzzy Set Theory: Applications in the Social<br />
Sciences”, Sage Publications, vol. 147<br />
~ 345 ~
Tanaka, H. and Guo, P. (1999) „Portfolio selection based on upper and lower exponential<br />
possibility distributions”, European Journal of Operational Research, Vol. 114:<br />
115–126<br />
Watada, J. (2001) „Fuzzy portfolio model for decision making in investment”, In Y. Yoshida<br />
editor, Dynamical Aspects in Fuzzy Decision Making, Physica-Verlag, Heidelberg,<br />
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Zhou, X. Y. and Li, D. (2000) „Continuous-time mean-variance portfolio selection: a<br />
stochastic LQ framework”, Applied Mathematics and Optimization, Vol. 42:19–33<br />
~ 346 ~
THE ROLE OF FINANCIAL DESCRIPTORS<br />
IN THE OPTIMAL PORTFOLIO SELECTION<br />
Bogdan DIMA 1 , Flavia BARNA & Horatiu REGEP<br />
West University of Timisoara, Romania<br />
ABSTRACT<br />
The central point of this paper is the selection of an optimal portfolio of financial instruments<br />
based on financial descriptors. In the first phase has been proposed and tested a statistical<br />
model aimed at the connections between the financial statements descriptors of issuers and<br />
the market values return of stocks issued by them. Thus, we identified those descriptors which<br />
in the period under review (2006-2009), had a direct impact on the dynamics of stock prices<br />
traded on the capital market in Europe. In the second stage it was used a selection model of a<br />
set of optimal portfolios based on those financial descriptors considered relevant. The main<br />
results support the idea that we can have a set of optimal portfolios that generate returns<br />
expected by investors by using exclusively financial descriptors.<br />
KEYWORDS: financial descriptors, optimal portfolio, selection criteria, market values<br />
return.<br />
INTRODUCTION<br />
The complexity of the investment process derives from the size and market liquidity,<br />
investor attitudes towards risk, the complexity of endogenous and exogenous factors<br />
analyzed by each investor at the moment of the elaboration of the strategy of portfolio<br />
selection.<br />
The identification of the opportunities to invest, the choice of an economic sector, the<br />
evaluation of the financial descriptors of issuers and their role in the random evolution<br />
of the financial instruments are aspects that need to be considered by any investor.<br />
One of the most difficult aspects of investing in the stock market is selecting the best<br />
performing stocks. The success of quantitative strategies stock selection is well<br />
documented in developed markets.<br />
For example, whereas Claessens, Dasgupta and Glen (1998) find the premium for<br />
large companies and growth stocks, Fama and French (1998), Patel (1998) and<br />
Rouwenhorst (1999) report a premium for value stocks and small companies.<br />
Claessens et al. (1998) also document the premium for beta and turnover.<br />
This article has as main objective the analysis of the connections between the<br />
descriptors of the financial statements of issuers and the market values return of<br />
stocks issued by them. In this context, we propose to identify the financial indicators<br />
1 Correspondence address: Bogdan DIMA, The Faculty of Economics and Business Administration,<br />
West University of Timisoara, Romania; email: bogdan.dima@feaa.uvt.ro<br />
~ 347 ~
which in a reference time span between 2006 and 2009 had a direct impact on the<br />
dynamics of stock prices traded on the capital market in Europe as well as to use such<br />
base for the selection of an optimal set of portfolios.<br />
1. MODEL USED TO IDENTIFY AND ANALYZE THE CONNECTIONS<br />
BETWEEN FINANCIAL DESCRIPTORS – RETURN OF FINANCIAL<br />
INSTRUMENTS IN ORDER TO SELECT AN OPTIMAL PORTFOLIO<br />
A first step in initiating an analytical approach aiming at the impact of financial<br />
descriptors on the market values return of financial instruments traded on developed<br />
European capital markets is to identify a formal model that highlights these<br />
interconnections:<br />
returnit = ρxit + γt + ηi + εit (1)<br />
x – vector of explanatory variables (financial descriptors)<br />
ρ – independent variable coefficient<br />
Closeit<br />
returnt = ln( ) * 100 (2)<br />
Close<br />
ηi – overlooked effects<br />
γt – common deterministic trend<br />
εit – random disturbance assumed to be normally and identically distributed<br />
where E(εit) = 0; Var (εit) = σ 2 > 0 (3)<br />
In our opinion, from the manifold financial descriptors, we performed a selection of<br />
nine indicators that characterize liquidity, leverage, effectiveness and profitability of<br />
an issuer:<br />
it−1<br />
� Current liquidity (LC) – reflect the possibility of current patrimony elements<br />
to be converted into liquidities within a short period of time in order to pay off<br />
current debt. If the total amount of current liabilities is higher than the total<br />
value of current assets then this indicator is sub-unit and this could indicate<br />
that the short-term financing was used to purchase "long-term assets which is<br />
normally considered dangerous, although there are sectors where a sub-unit<br />
value is considered acceptable:<br />
Ac – current assets<br />
Dts – current short-term debt<br />
Ac<br />
LC = * 100 (4)<br />
Dts<br />
� Quick liquidity (LR) - reflects the possibility of current assets that are<br />
materialized in outstanding debts and treasury to cover current liabilities; we<br />
subtract the stocks because these have the lowest characteristic of liquidity of<br />
current assets:<br />
Ac − S<br />
LR = * 100 (5)<br />
Dts<br />
S – stocks<br />
~ 348 ~
� Leverage (GI) - reflect the total liabilities to total assets and follows the<br />
company's ability to cover with the available resources all uses and how<br />
resources are distributed for use:<br />
DT – total liabilities<br />
AT – total assets<br />
DT<br />
GÎ = * 100 (6)<br />
AT<br />
� Earnings per share (EPS) - reflects the profit for each owned share and is<br />
calculated as the ratio between net profit and the weighted average of number<br />
of common shares outstanding during that year. The dynamics of this indicator<br />
presents to the investors a picture of the performance of the issuer:<br />
Πnet<br />
EPS = * 100 (7)<br />
WNacţ<br />
Пnet – net profit<br />
WNacţ – balanced average of number of common shares outstanding during that year<br />
� Diluted earnings per share (diluted EPS) - to determine this rate, the<br />
corresponding net profits to common shareholders and the balanced average of<br />
shares are adjusted with the influences of all dilutive potential common shares.<br />
Dilutive potential common shares are considered to be converted into common<br />
shares at the beginning of the period or at the issue date of the potential<br />
common shares.<br />
� Dividend rate (DR) - reflects the profits which returns to shareholders for each<br />
share owned, and is calculated as the ratio of dividends paid to shareholders<br />
and the balanced average of number of common shares during that year. The<br />
dynamics of this rate shows the issuing company's management vision on the<br />
dynamics of stock prices:<br />
RD =<br />
D – dividends paid to shareholders<br />
D<br />
* 100<br />
WNacţ<br />
� Return on assets (ROA) - one of the leading indicators of profitability of a<br />
company from the point of view of profits made, which measures the<br />
efficiency of asset utilization in order to obtain profit:<br />
~ 349 ~<br />
(8)<br />
Πnet<br />
ROA = * 100 (9)<br />
AT<br />
� Return on equity (ROE) - can be considered the most important indicator that<br />
measures the performance of companies, because this actually shows the<br />
contribution of the shareholders to finance the company:<br />
Cpr – equity<br />
ROE =<br />
Πnet<br />
* 100<br />
Cpr<br />
(10)
� Financial leverage (FL) - indicates that the issuer finances his activity through<br />
loans. Thus, we can have volatility in the revenue due to the rise of interest<br />
expenses:<br />
DT<br />
LF = * 100 (11)<br />
Cpr<br />
In the second step we select a set of investment portfolios that meet the investment<br />
requirements starting from the identification and financial analysis of those financial<br />
descriptors that have a correlation with the dynamics of the market price of stocks of<br />
the issuing companies.<br />
The proposed model assumes that any investor will try to invest his capital in optimal<br />
conditions in terms of financial statements of the issuing companies taken under<br />
consideration. In this context, we will follow the next steps:<br />
� Selection of potential financial assets that the investor takes into account in<br />
structuring its portfolio;<br />
� Estimating the connections between the financial statements descriptor of<br />
issuers and the dynamics of historical prices;<br />
� An estimation based on the results obtained in the previous step of a possible<br />
evolution of the return market values for a forecasting perspective according to<br />
the period in which a portfolio will be constituted. In our case, we took into<br />
account the results from the period 2006-2008 and we determined an estimation<br />
of a possible return that an investor can expect for 2009. The estimation for<br />
2009 follows the identification of possible positive and negative returns on<br />
which investors can decide on the type of transaction (long or short) Thus, in<br />
case of returns higher than zero investors will trade long, and in case of a return<br />
lower than zero then the investor will trade short;<br />
� The selection of a method of allocating the available financial resources among<br />
the various classes and individual assets taken into consideration. The chosen<br />
method for the selection of the set of portfolios will be the inversely<br />
proportional allocation with the historical volatility of returns. In this regard, the<br />
premise is that all investors have a medium / high risk aversion and therefore<br />
they pursue the setting up of "defensive" portfolios with a structure that will be<br />
preserved for longer temporary perspectives of holding financial assets:<br />
Wi<br />
=<br />
~ 350 ~<br />
1<br />
σ<br />
2<br />
i<br />
n 1<br />
∑ 2<br />
i= 1 σ i<br />
(12)<br />
Wi – percentage of a financial asset in an investment portfolio<br />
σi 2 – historical volatility of returns of financial asset<br />
� Portfolio establishment and management and the evaluation of ex-post returns<br />
and their subsequent risk. Evaluation will be done using the Sharpe and Sortino<br />
ratio.<br />
Sharpe Ratio (ShR) - It is useful in comparing two portfolios or stocks in terms of<br />
risk-adjusted return. The higher the Sharpe Ratio, the more sufficient are returns for
each unit of risk. It is calculated by first subtracting the estimate return from the return<br />
of the portfolio, then dividing by the standard deviation of the portfolio.<br />
_<br />
R – portfolio return<br />
ER – estimated return for a period of time<br />
σP – portfolio standard deviation<br />
_<br />
R−<br />
ER<br />
ShR = (13)<br />
σ<br />
Sortino Ratio (SR) - is similar to the Sharpe ratio, except it uses downside deviation<br />
for the denominator instead of standard deviation, the use of which doesn't<br />
discriminate between up and down volatility.<br />
R − ER<br />
SR = (14)<br />
σ d<br />
R – return over a period of time<br />
σ2 – downside risk – standard deviation of negative returns<br />
2. THE IMPLEMENTATION OF MODELS AND THE INTERPRETATION<br />
OF RESULTS<br />
The models will be tested empirically on a set of 137 companies listed on European<br />
capital markets. The issuing companies that were selected for fundamental analysis are<br />
included in the structure of some important indexes from the European capital market:<br />
CAC40 (France), Ibex 35 (Spain), S & P MIB (Italy), DAX (Germany), FTSE 100<br />
(UK) BUX (Hungary), PX (Czech Republic) and WIG 20 (Poland).<br />
The perspective of analysis considered for analyzing financial descriptors is<br />
2006-2008, and for the year 2009 we accomplished a forecast of possible returns that<br />
an issuer can record based on the results obtained from the analysis of the financial<br />
rates.<br />
For an easier implementation of the model, the selected issuing companies were<br />
grouped according to sectors in which they operate (see Annex 1-5):<br />
� basic materials sector - 18 companies;<br />
� industrial sector - 24 companies;<br />
� technology, telecommunications and media sector - 19 companies;<br />
� energy sector - 29 companies;<br />
� consumer and health sector - 47 companies.<br />
The used methodology implies recourse to a "Panel Generalized Method of<br />
Movements."<br />
There are several advantages of the GMM-SYS over other static or dynamic panel<br />
estimation methods. Among these: static panel estimates, as the OLS models, are<br />
subjected to the problem of dynamic panel bias (Bond, 2002); in our database, we<br />
have 127 companies (N) analyzed over a short time span of 3 years (T) and the<br />
literature includes several arguments for dynamic panel model being specially<br />
designed for a situation where “T” is smaller than “N” in order to control for dynamic<br />
panel bias (Bond 2002; Baltagi 2008); the problem of the potential endogeneity can be<br />
easier addressed in dynamic panel models than in static and OLS models, since all<br />
P<br />
~ 351 ~
variables from the regression which are not correlated with the error term (including<br />
lagged and differenced variables) can be potentially used as valid instrumental<br />
variables; the dynamic panel model is able to identify short and long-run involved<br />
effects (Baltagi 2008). Also, the GMM-System exploits the stationarity restrictions,<br />
while the first-differenced GMM estimator can behave poorly when the time series<br />
are persistent.<br />
The obtained empirical results are presented in the following table:<br />
Table 1 Statistic model results<br />
Dependent Variable: Market returns<br />
Method: Panel Generalized Method of Moments<br />
Transformation: First Differences<br />
White period instrument weighting matrix<br />
White period standard errors & covariance (d.f. corrected)<br />
Instrument specification: Lagged values of returns (from 1 to 3), EPS and ROA (from 1<br />
To 2)<br />
Constant added to instrument list<br />
A) Basic materials (18 companies)<br />
Variable Coefficient Std. Error t-Statistic Prob.<br />
Returns(-1) -1.243457 0.092652 -13.42078 0.0000<br />
EPS(-1) 0.091567 0.022418 4.084497 0.0011<br />
ROA(-1) -18.69844 2.601485 -7.187601 0.0000<br />
ROE(-1) 8.809040 2.473420 3.561482 0.0031<br />
B) Industrial (24 companies)<br />
Variable Coefficient Std. Error t-Statistic Prob.<br />
Returns(-1) -0.963363 0.083750 -11.50283 0.0000<br />
Diluted EPS(-1) -17.34071 10.35401 -1.674782 0.1095<br />
Effective interest rate(-1) -26.85258 7.338023 -3.659376 0.0016<br />
C) Technology, telecommunications, media (19 companies)<br />
Variable Coefficient Std. Error t-Statistic Prob.<br />
Returns(-1) -1.037504 0.139906 -7.415721 0.0000<br />
EPS(-1) 1.349303 0.201852 6.684601 0.0000<br />
D) Energy (29 companies)<br />
Variable Coefficient Std. Error t-Statistic Prob.<br />
Returns(-1) -1.001197 0.085291 -11.73854 0.0000<br />
EPS(-1) -1.940791 0.557147 -3.483446 0.0017<br />
E) Consumer, health (47 companies)<br />
Variable Coefficient Std. Error t-Statistic Prob.<br />
Returns(-1) 0.887278 0.897732 0.988355 0.3286<br />
Current liquidity(-1) 7.336577 1.439564 5.096389 0.0000<br />
Quick ratio(-1) -15.90176 3.375288 -4.711231 0.0000<br />
EPS(-1) 0.506861 0.090912 5.575270 0.0000<br />
(Source: Developed by the author based on data’s supplied by Teletrader Software AG)<br />
~ 352 ~
Analyzing these results shows that for the basic materials sector:<br />
� The variable with maximum potential explanatory is ROA followed by EPS and<br />
ROE. The profitableness estimator calculated by reference to the total on net<br />
assets appears to be negatively correlated with the dynamic of the stocks return.<br />
A possible explanation for this result is that the invested resources return is<br />
estimated before the allocation of the net results of the issuer. Consequently, it<br />
reflects the efficiency of the resource, but does not indicate the way the results<br />
achieved due to the global activity of the company are used. In the same time<br />
the sectors and / or issuers which register a growing rhythm higher than the<br />
market average associate higher levels of ownership and trading risk. These<br />
risks are offset by the existence of a higher level of results that can be<br />
distributed to potential investors so that the risk premium required by them and<br />
incorporated into the prices decreases once with the increase of ROA providing<br />
one of the channels through which the positive dynamics of this rate attenuates<br />
price volatility;<br />
� In the same time, an increase of the return obtained by investors quantified by<br />
ROE determines an increase of the relative preference for holding their shares<br />
with a higher level of that rate. Consequently, the growth of ROE determine the<br />
increases of demand translated in conditions of higher elasticity of price in their<br />
dynamics;<br />
� Similar effects are exercised by the increase of EPS, variable which is<br />
consistent and systematic associated with the dynamics of prices for all<br />
considered sectors.<br />
In the industrial sector case the results presented in table 1 indicate the followings:<br />
� The variable with maximum potential explanatory is the effective interest rate<br />
followed by diluted EPS. The dynamics of effective interest rates is negatively<br />
correlated with the dynamics of stocks return. The dynamics of this rate can<br />
generate a volatility of revenues as a result of increasing the weight of borrowed<br />
capital in total debts. In the same time, in the industrial sector are accepted<br />
higher levels of borrowed capital necessary to conduct and / or develop the<br />
issuing company's business;<br />
� The dynamics of the diluted EPS indicator is similar to the EPS indicator<br />
dynamics, thus systematically associated to price dynamics of the sector.<br />
The only variable which has a maximum explanatory potential in the technology,<br />
telecommunication and media and energy sector is EPS.<br />
In the last sector case - consumer, health - according to the obtained results the<br />
following can be mentioned:<br />
� The variable with maximum potential explanatory is EPS followed by current<br />
and quick liquidity. EPS dynamics is a direct factor of influence of the<br />
dynamics of stock prices of issuers because it expresses the share of profit for<br />
each share owned;<br />
� Similar effects are exercised also by the dynamics of liquidity rates which<br />
shows the capacity of an issuing company to cover their current liabilities with<br />
current assets.<br />
Based on the results obtained from the analysis of the financial statements descriptors<br />
using statistical model there were identified the interconnections between these<br />
~ 353 ~
descriptors and the stock market value return. So, in the following table it is presented<br />
the importance of financial indicators in relation to the dynamics of the price on the<br />
stock market.<br />
Table 2. The importance of financial descriptors in relation to the dynamics<br />
of stock market price<br />
Sector LC LR GÎ EPS<br />
EPS<br />
diluted<br />
RD ROA ROE LF<br />
Basic Materials Ins Ins Ins S Ins Ins S S Ins<br />
Industrial Ins Ins Ins Ins S Ins Ins Ins S<br />
Technology,<br />
Telecommunication,<br />
Media<br />
Ins Ins Ins S Ins Ins Ins Ins Ins<br />
Energy Ins Ins Ins S Ins Ins Ins Ins Ins<br />
Consumer, Health S S Ins S Ins Ins Ins Ins Ins<br />
(Source: Developed by the author based on the results generated by the statistical model)<br />
Legend:<br />
Ins = insignificant<br />
S = significant<br />
Starting from these premises, it was implemented a selection model of an optimal<br />
portfolio for each analyzed sector. We also determined the potential returns in the year<br />
2009 which varies depending on the portfolio type; long or short (see Figure 1.).<br />
Figure 1. Potential returns of investment portfolios in the year 2009<br />
50.00%<br />
40.00%<br />
30.00%<br />
20.00%<br />
10.00%<br />
0.00%<br />
-10.00%<br />
-20.00%<br />
Returns obtained by the investment portfolios<br />
Basic<br />
Materials<br />
Industrial<br />
Teh, Tec,<br />
Media<br />
Long Portfolio 49.20% 34.05% 4.37% 3.25% 24.25%<br />
Short Portfolio -4.52% -5.45% 11.74% -9.95% -17.14%<br />
Sectors<br />
Long Portfolio Short Portfolio<br />
~ 354 ~<br />
Energy<br />
Consumer,<br />
Health<br />
(Source: Developed by the author based on the selection model of an optimal portfolio based<br />
on financial descriptors)<br />
From the analysis of the optimal portfolios on sectors it can be observed that all the<br />
long portfolios are recording positive returns, the highest returns being within the<br />
basic materials sector (49.2%) and in the industrial sector (34, 05%).
In the short portfolios case only the technology, telecommunications and media sector<br />
register positive returns of only 11.73%.<br />
The returns of the selected portfolios are directly influenced by the allocation of<br />
stocks in the portfolio and the number of issuers taken into account. So, for the basic<br />
material sector were taken into account 18 issuers, 24 in the industrial sectors, 19 in<br />
the technology, telecommunications, media sector, 29 and in the energy sector and 47<br />
in the consumer and health sector.<br />
In the long portfolio structure were taken into account only those companies for which<br />
the estimates of the potential returns, based on the financial descriptors for the period<br />
2006-2008, were positive. In the situation when the estimated returns are negative,<br />
those companies have entered the short portfolio composition. (See Annexes 6-15).<br />
An important issue for an investor is also the ex-post evaluation of the returns and<br />
their subsequent risks for the set of the optimal portfolios. A comparative analysis of<br />
the Sharpe and Sortino ratios highlights the fact that for all sectors the Sharpe ratio is<br />
lower than the Sortino ratio.<br />
Table 3. Portfolios types and performances<br />
Sector Portfolio Type Return 2009 Sharpe Sortino No. Instruments<br />
Basic Materials<br />
long<br />
short<br />
49.20%<br />
-4.52%<br />
-0.645<br />
0.1518<br />
0.3792<br />
2.5638<br />
16<br />
2<br />
Consumer, Health<br />
long<br />
short<br />
24.25%<br />
-17.14%<br />
0.4007<br />
-0.148<br />
0.5311<br />
1.6868<br />
18<br />
29<br />
Energy<br />
long<br />
short<br />
3.25%<br />
-9.95%<br />
-0.4998<br />
-0.7758<br />
-0.2704<br />
-0.2969<br />
23<br />
6<br />
Industrial<br />
long<br />
short<br />
34.05%<br />
-5.45%<br />
-0.603<br />
-1.6289<br />
0.6424<br />
1.9725<br />
2<br />
22<br />
Tec, Tel, Media<br />
long 4.37% -0.3442 0.4591 3<br />
short -11.74% -0.9381 0.7431 16<br />
(Source: Developed by author)<br />
Using the Sharpe ratios to compare and select among investment alternatives can be<br />
difficult because the measure of risk, portfolio standard deviation, penalizes portfolios<br />
for positive upside returns as much as the undesirable downside returns.<br />
CONCLUSIONS<br />
The selection of an optimal portfolio must have an investment strategy based on<br />
investment objective, risk aversion of the investor, the type and characteristics of<br />
investment instruments.<br />
The diversity of the investment objectives, the behavioral changes of an investor, and<br />
the enrichment of the overall investments spectrum for the holders of capital led to the<br />
development of techniques and selection models and portfolio investments<br />
management models.<br />
~ 355 ~
Following the presented results it can be mentioned that we can create a set of optimal<br />
equities portfolios in order to generate returns above the returns obtained by the<br />
instruments that are considered risk-free only by using financial descriptors. Because<br />
in the structure of portfolios are included only stocks traded in developed capital<br />
markets, it can be said in the first instance that the developed portfolios are destined to<br />
investors with a low aversion to risk.<br />
However, by applying the selection criteria based on financial descriptors we<br />
followed the development of some "defensive" portfolios whose structure to be<br />
preserved for longer time horizons for holding financial assets. Thus, by applying this<br />
method it can be said that these portfolios can also be selected by investors with an<br />
average risk aversions.<br />
REFERENCES<br />
Baltagi B.H., (2008) Econometric Analysis of Panel Data, Chichester: John Wiley & Sons<br />
Ltd, 4th edition.<br />
Blackburn, K., Hung, V., T., Y. (1998), – “A Theory of Growth, Financial Development, and<br />
Trade” Economica Vol. 65, No. 257.<br />
Bond S., Dynamic Panel Models: A Guide to Micro Data Methods and Practice, Institute for<br />
Fiscal Studies, Department of Economics, UCL, CEMMAP (Centre for Microdata<br />
Methods and practice) Working Paper CWPO9/02, 2002. Available online:<br />
http://cemmap.ifs.org.uk/wps/cwp0209.pdf.<br />
Claessens, S., Dasgupta, S. and Glen J. (1998), “The cross section of stock returns: Evidence<br />
from emerging markets”, Emerging Markets Quarterly 2, 4–13<br />
Fama, E., French, K. (1996), “Multifactor explanations of asset pricing anomalies”, Journal<br />
of Finance 51, 55–84<br />
Fama, E, French, K. (1998), “Value versus growth: the international evidence”, Journal of<br />
Finance 53<br />
Greenwood, J., Jovanovic, B., (1990) “Financial Development, Growth, and the Distribution<br />
of Income”, Journal of Political Economy, Vol. 98, Nr. 1<br />
Reilly, B, (2000) Investment Analysis and Portfolio Management, Harcourt College<br />
Publishres<br />
Patel, S., (1998), “Cross-sectional variation in emerging markets equity returns, January<br />
1988-March 1997”, Emerging Markets Quarterly 2, 57–70<br />
Rouwenhorst, G., (1998), “International momentum strategies,” Journal of Finance 53,<br />
267–284<br />
Rouwenhorst, G., (1999), “Local return factors and turnover in emerging stock markets”,<br />
Journal of Finance 54, 1439–1464<br />
Sharpe, W.,(1963) „A simplifield model of portfolio analysis”, Management Science, Vol 9,<br />
Nr. 1<br />
Sharpe, W.,(1964) „Capital Assets Prices – A theory of market equilibrium under conditions<br />
of risk”, Journal of Finance, Vol. 19, Nr. 3<br />
Sharpe,W., (1970) Portfolio theory and capital markets, Mc Graw-Hill Book, 1970;<br />
~ 356 ~
APPENDIX 1<br />
Issuing companies from the consumer and health sector<br />
No. Issuing Symbol Issuing Name Country in which is traded<br />
1 AsB Associated British Food Plc<br />
2 Bai British Airways Plc<br />
3 BAT British American Tobacco Plc<br />
4 Car Carnival Corporation & Plc<br />
5 Com Compass Group Plc<br />
6 Dia Diageo Plc<br />
7 ITG Imperial Tobacco Group Plc<br />
8 Ico InterContinental<br />
9 Kin Kingfisher Plc<br />
10<br />
11<br />
MaS<br />
Mor<br />
Marks & Spencer Group Plc<br />
Morrison Supermarkets Plc<br />
Great Britanie<br />
12 Nex Next Plc<br />
13 SAB SABMiller Plc<br />
14 Jsa J Sainsbury Plc<br />
15 Unl Unilever Plc<br />
16 Whi Whitbread Plc<br />
17<br />
Wol Wolseley Plc<br />
18<br />
Ast Astra Zeneca Plc<br />
19<br />
Gla GlaxoSmithKline Plc<br />
20<br />
SmN Smith & Nephew Plc<br />
21 Aco Accor<br />
22 Crr Carrefour SA<br />
23 Dan Danone<br />
24 Lor L'Oreal SA<br />
25 LVM LVMH<br />
26<br />
27<br />
Mic<br />
PeR<br />
Michelin<br />
Pernod-Ricard<br />
France<br />
28 Peu Peugeot<br />
29 PiP Pinault Printemps Redoute SA<br />
30<br />
Ren Renault<br />
31<br />
Ess Essilor International<br />
32<br />
San Sanofi-Aventis<br />
33 Adi Adidas AG<br />
34 Dai Daimler AG<br />
35 Dpo Deutsche Post AG<br />
36<br />
37<br />
Hen<br />
Luf<br />
Henkel KGaA<br />
Lufthansa AG<br />
Germany<br />
38<br />
Met Metro AG<br />
39<br />
FrM Fresenius Medical Care AG<br />
40<br />
Mer Merck KGaA<br />
41 Aug Autogrill SpA<br />
42 Bul Bulgari SpA<br />
43 Geo Geox Spa<br />
Italy<br />
44 Lot Lottomatica SpA<br />
45 Lux Luxottica Group SpA<br />
46<br />
47<br />
EgP<br />
GeR<br />
Egis Pharmaceuticals Ltd<br />
Gedeon Richter Plc.<br />
Hungary<br />
(Source: Developed by the author based on data’s supplied by Teletrader Software AG)
APPENDIX 2<br />
Issuing companies from the basic material sector<br />
No. Issuing Symbol Issuing Name Country in which is traded<br />
1 Ang Anglo American Plc<br />
2 Ant Antofagasta Plc<br />
3 BHP BHP Billiton Plc<br />
4 Bun Bunzl Plc<br />
5 JoM Johnson Matthey Plc<br />
6 Kaz Kazakhmys Plc<br />
7 Lon Lonmin Plc<br />
8 Rti Rio Tinto Plc<br />
9 Vre Vedanta Resources Plcs<br />
10 Xst Xstrata Plc<br />
11 Air Air Liquide SA<br />
12 Arc Arcelor Mittal SA<br />
13 BAS BASF SE<br />
14 Bay Bayer AG<br />
15 Lin Linde AG<br />
Great Britanie<br />
France<br />
Germany<br />
16 Ace Acerinox SA Spain<br />
17 TVK TVK Nyrt. Hungary<br />
18 KGH KGHM Polska Miedz SA Poland<br />
(Source: Developed by the author based on data’s supplied by Teletrader Software AG)
APPENDIX 3<br />
Issuing companies from the energy sector<br />
No. Issuing Symbol Issuing Name Country in which is traded<br />
1 BGG BG Group<br />
2 BPl BP Plc<br />
3 Cen Centrica Plc<br />
4 InP International Power Plc<br />
5 Nat National Grid Plc<br />
6 Rod Royal Dutch Shell Plc<br />
7 ScS Scottish & Southern Energy<br />
8 Sev Sever Trent Plc<br />
9 UUG United Utilities Group<br />
10 Ele Electricite de France<br />
11 GDF GDF Suez<br />
12 Sce Schneider Electric<br />
13 Teh Technip<br />
14 Tot Total<br />
15 Veo Veolia Environnement<br />
16 EON EON AG<br />
17 RWE RWE AG<br />
18 Ene Enel Spa<br />
19 Eni Eni SpA<br />
20 Sam Saipem SpA<br />
21 SnR Snam Rete Gas SpA<br />
22 Ten Tenaris SA<br />
23 Ter Terna SpA<br />
24 Ena Enagas SA<br />
25 Ibe Iberdrola SA<br />
26 Red Red Electrica Corporacion SA<br />
27 Rep Repsol YPF SA<br />
Great Britanie<br />
France<br />
Germany<br />
Italy<br />
Spain<br />
28 CEZ CEZ a.s. Czech Republic<br />
29 PGo<br />
Polskie Gornictwo Naftowe I<br />
Gazownictwo SA<br />
Poland<br />
(Source: Developed by the author based on data’s supplied by Teletrader Software AG)
APPENDIX 4<br />
Issuing companies from the industrial sector<br />
No. Issuing Symbol Issuing Name Country in which is traded<br />
1 Aam Amec Plc<br />
2 BAE BAE Systems Plc<br />
3 Cap Capita Group Plc<br />
4 Cob Cobham Plc<br />
5 GfS G4S Plc<br />
6 Rex Rexam Plc<br />
7 Smi Smiths Group Plc<br />
8 Als Alstrom RGPT<br />
9 Bou Bouygues<br />
10 Eur European Aeronautic<br />
11 Laf Lafarge<br />
12 Sai Saint Gobain SA<br />
13 Val Vallourec<br />
14 Atl Atlantia SpA<br />
15 Buz Buzzi Unicem SpA<br />
16 Fin Finmeccanica SpA<br />
17 Ita Italcementi SpA<br />
18 Pir Pirelli & C SpA<br />
19 Abn Abertis Infraestructuras SA<br />
20 Acc Acciona SA<br />
21 AdC<br />
Actividades de Construccion y<br />
Servicios SA<br />
22 FCC<br />
Fomento de Construcciones y<br />
Contratas SA<br />
23 Sac Sacyr Vallehermoso SA<br />
Great Britanie<br />
France<br />
24 Pol Polimex Mostostal SA<br />
(Source: Developed by the author based on data’s supplied by Teletrader Software AG)
APPENDIX 5<br />
Issuing companies from the technology, telecommunication and media sector<br />
No. Issuing Symbol Issuing Name Country in which is traded<br />
1 Pea Pearson Plc<br />
2 ReE Reed Elsevier Plc<br />
3 Sag Sage Group Plc<br />
4 BTG BT Group Plc<br />
5 Vod Vodafone Group Plc<br />
6 Alc Alcatel - Lucent<br />
7 CaG Cap Gemini<br />
8 Lag Lagardere<br />
9 Viv Vivendi<br />
10 STM STMicroelectronics<br />
11 FTe France Telecom<br />
Great Britanie<br />
France<br />
12 Med Mediaset SpA Italy<br />
13 SAP SAP AG<br />
14 Sie Siemens AG<br />
15 DTe Deutsche Telekom AG<br />
Germany<br />
16 Mte Magyar Telekom Plc. Hungary<br />
17 AsP Asseco Poland SA<br />
18 TVN TVN<br />
Poland<br />
19 TeP Telekomunikacja Polska SA<br />
(Source: Developed by the author based on data’s supplied by Teletrader Software AG)
Issuers<br />
Reverse of the historical<br />
volatility<br />
APPENDIX 6<br />
Long Portfolio – Basic Materials<br />
Long Portfolio – Basic Materials<br />
Percentage in<br />
portfolio<br />
Return 2009 Sharpe Sortino<br />
ANG 0.022185148 6.29% 3.53% -0.5107 0.6867<br />
ANT 0.0231364 6.56% 5.55% -0.1887 2.1034<br />
BHP 0.029353603 8.32% 3.60% -0.7597 -0.2039<br />
BUN 0.06543166 18.54% 2.50% -0.8002 -0.0482<br />
JOM 0.024097184 6.83% 2.29% -0.6970 0.0782<br />
KAZ 0.010039867 2.84% 4.98% -0.2262 1.5248<br />
RTI 0.010292587 2.92% 2.40% -0.6643 0.1426<br />
VRE 0.011601309 3.29% 4.77% -0.2974 1.2052<br />
XST 0.00978431 2.77% 1.55% -0.3701 0.5649<br />
AIR 0.035380491 10.02% 2.39% -0.4005 0.6994<br />
ARC 0.012170432 3.45% 2.20% -0.5752 0.3197<br />
BAS 0.012613244 3.57% 1.61% -0.8454 -0.2851<br />
BAY 0.023833625 6.75% 2.01% -1.2470 -0.7276<br />
LIN 0.035860521 10.16% 3.46% -0.3887 0.8148<br />
TVK 0.013800255 3.91% 1.35% -1.8041 -1.0818<br />
KGH 0.013351281 3.78% 5.02% -0.2951 1.4172<br />
Portfolio total results 49.20% -0.6450 0.3792<br />
(Source: Developed by the author based on data’s supplied by Teletrader Software AG)<br />
Issuers<br />
Reverse of the historical<br />
volatility<br />
APPENDIX 7<br />
Short Portfolio – Basic Materials<br />
Short Portfolio – Basic Materials<br />
Percentage in<br />
portfolio<br />
Return 2009 Sharpe Sortino<br />
LON 0.016005694 5.85% -4.48% -0.1103 1.4202<br />
ACE 0.257460102 94.15% -0.04% 0.1680 2.6349<br />
Portfolio total results -4.52% 0.1518 2.5638<br />
(Source: Developed by the author based on data’s supplied by Teletrader Software AG)<br />
Issuers<br />
Reverse of the historical<br />
volatility<br />
APPENDIX 8<br />
Long Portfolio – Industrial<br />
Long Portfolio – Industrial<br />
Percentage in<br />
portfolio<br />
Return 2009 Sharpe Sortino<br />
PIR 0.019066141 46.28% 21.81% -0.3093 0.9483<br />
SAC 0.022134656 53.72% 12.24% -0.8560 0.3790<br />
Portfolio total results 34.05% -0.6030 0.6424<br />
(Source: Developed by the author based on data’s supplied by Teletrader Software AG)
Issuers<br />
Reverse of the historical<br />
volatility<br />
APPENDIX 9<br />
Short Portfolio – Industrial<br />
Short Portfolio – Industrial<br />
Percentage in<br />
portfolio<br />
Return 2009 Sharpe Sortino<br />
AAM 0.016401409 0.92% -0.44% 0.4170 1.9396<br />
BAE 0.045896192 2.58% 0.12% -0.2434 -0.2772<br />
CAP 0.238192812 13.39% -0.23% 1.5493<br />
COB 0.215857306 12.13% -2.45% 0.9961 25.6738<br />
GFS 0.045349148 2.55% -0.61% 0.5493 2.9011<br />
REX 0.386229871 21.71% 4.10% -8.5042 -8.1120<br />
SMI 0.127765798 7.18% -0.98% 0.2329 2.4259<br />
ALS 0.021769595 1.22% -0.19% 0.2197 0.9757<br />
BOU 0.025188283 1.42% -0.27% 0.0711 1.0378<br />
EUR 0.04793502 2.69% -0.43% -0.5139 0.8213<br />
LAF 0.017322387 0.97% -0.28% -0.0329 0.9870<br />
SAI 0.030057442 1.69% -0.21% -0.2276 0.7103<br />
VAL 0.03063795 1.72% -0.78% 0.6771 2.5315<br />
ATL 0.023656664 1.33% -0.44% -0.0358 1.1800<br />
BUZ 0.056713145 3.19% 0.10% -0.8674 0.0760<br />
FIN 0.025986729 1.46% -0.03% -0.4805 0.1693<br />
ITA 0.190676246 10.72% -0.68% -1.0642 0.3729<br />
ABN 0.037139801 2.09% -0.46% -0.2671 0.9622<br />
ACC 0.015147998 0.85% -0.02% 0.3524 0.8646<br />
ADC 0.117841337 6.62% -0.42% 0.5630 1.9142<br />
FCC 0.052200676 2.93% -0.68% -0.5527 0.9953<br />
POL 0.010841156 0.61% -0.16% -0.9332 0.2320<br />
Portfolio total results -5.45% -1.6289 1.9725<br />
(Source: Developed by the author based on data’s supplied by Teletrader Software AG)
Issuers<br />
APPENDIX 10<br />
Long Portfolio – Technology, Telecommunication, Media<br />
Long Portfolio – Technology, Telecommunication, Media<br />
Reverse of the historical<br />
volatility<br />
Percentage in<br />
portfolio<br />
Return 2009 Sharpe Sortino<br />
ALC 0.051982532 40.87% 2.12% -0.7364 0.9034<br />
VOD 0.034247661 26.93% 0.92% 0.0206 0.2328<br />
REE 0.040955308 32.20% 1.32% -0.1514 0.0844<br />
Portfolio total results 4.37% -0.3442 0.4591<br />
(Source: Developed by the author based on data’s supplied by Teletrader Software AG)<br />
Issuers<br />
APPENDIX 11<br />
Short Portfolio – Technology, Telecommunication, Media<br />
Short Portfolio – Technology, Telecommunication, Media<br />
Reverse of the historical<br />
volatility<br />
Percentage in<br />
portfolio<br />
Return 2009 Sharpe Sortino<br />
SAG 0.144674503 10.96% -2.82% -0.2905 2.0891<br />
CAG 0.057731314 4.37% -0.66% -0.5298 0.7998<br />
STM 0.056135725 4.25% -1.25% -0.6233 1.0065<br />
SAP 0.092180188 6.98% -1.87% -0.2570 1.9074<br />
SIE 0.018239249 1.38% -0.27% -0.0992 0.5921<br />
ASP 0.018812126 1.42% -0.40% -0.7449 0.4595<br />
BTG 0.033245451 2.52% 0.00% -0.8644 -0.0038<br />
FTE 0.053872152 4.08% 0.55% -0.3715 -1.5403<br />
DTE 0.048042671 3.64% 0.16% -0.5656 -0.2934<br />
MTE 0.056392702 4.27% -1.32% -0.1533 1.7651<br />
TEP 0.276635976 20.95% 3.99% -3.3167 -4.3541<br />
PEA 0.24939242 18.89% -6.22% 0.2399 6.0395<br />
LAG 0.050400443 3.82% 0.08% -1.0828 -0.0720<br />
VIV 0.055944963 4.24% 0.47% -0.7945 -0.8909<br />
MED 0.076738867 5.81% -2.02% -0.4055 1.6147<br />
TVN 0.032094408 2.43% -0.15% -0.5988 0.2078<br />
Portfolio total results -11.74% -0.9381 0.7431<br />
(Source: Developed by the author based on data’s supplied by Teletrader Software AG)
Issuers<br />
Reverse of the historical<br />
volatility<br />
APPENDIX 12<br />
Long Portfolio – Energy<br />
Long Portfolio – Energy<br />
Percentage in<br />
portfolio<br />
Return 2009 Sharpe Sortino<br />
BGG 0.028977064 2.44% 0.39% 0.0544 0.1592<br />
BPL 0.084494223 7.12% 0.94% -0.0181 1.5035<br />
CEN 0.064298989 5.42% 0.30% -0.5196 0.3585<br />
INP 0.024766436 2.09% 0.53% -0.2968 0.6791<br />
NAT 0.062127045 5.23% -0.04% -0.4448 -0.4228<br />
ROD 0.057752406 4.87% 0.24% -0.2315 0.1202<br />
SCS 0.057186825 4.82% -0.23% -0.7489 -0.4609<br />
SEV 0.07158607 6.03% -0.59% -0.9685 -1.0838<br />
ELE 0.018795954 1.58% 0.00% -0.4586 -0.3317<br />
GDF 0.076343655 6.43% -0.99% -0.6179 -2.8227<br />
SCE 0.030487483 2.57% 1.11% -0.0504 1.6029<br />
TOT 0.047834164 4.03% 0.59% -0.3014 0.7947<br />
VEO 0.018159955 1.53% 0.06% -0.6428 0.0408<br />
EON 0.022675592 1.91% 0.05% -0.4437 -0.3141<br />
RWE 0.036385786 3.07% 0.20% -0.4045 0.1806<br />
ENE 0.031336693 2.64% -0.25% -0.8351 -0.4057<br />
SAM 0.017183152 1.45% 1.01% -0.0396 1.5498<br />
SNR 0.194584446 16.39% -2.30% -1.1743 -2.4805<br />
TER 0.088590574 7.46% 1.83% 0.1961 3.0341<br />
ENA 0.05308896 4.47% -0.04% -0.5037 -0.3673<br />
IBE 0.028908774 2.44% 0.05% -0.4743 -0.2045<br />
RED 0.042636587 3.59% 0.27% -0.0975 -0.0242<br />
PGO 0.02871033 2.42% 0.12% -0.2968 -0.2839<br />
Portfolio total results 3.25% -0.4998 -0.2704<br />
(Source: Developed by the author based on data’s supplied by Teletrader Software AG)<br />
Issuers<br />
Reverse of the historical<br />
volatility<br />
APPENDIX 13<br />
Short Portfolio – Energy<br />
Short Portfolio – Energy<br />
Percentage in<br />
portfolio<br />
Return 2009 Sharpe Sortino<br />
UUG 0.12768126 41.37% 9.69% -1.5899 -2.5465<br />
TEH 0.020772981 6.73% -5.50% -0.0176 1.9044<br />
ENI 0.050903745 16.49% -1.20% -0.5192 0.4389<br />
TEN 0.037933675 12.29% -8.84% -0.0196 2.5236<br />
REP 0.049131346 15.92% -3.43% -0.3040 1.1412<br />
CEZ 0.022196159 7.19% -0.67% 0.2715 0.8921<br />
Portfolio total results -9.95% -0.7758 -0.2969<br />
(Source: Developed by the author based on data’s supplied by Teletrader Software AG)
Issuers<br />
Reverse of the historical<br />
volatility<br />
APPENDIX 14<br />
Long Portfolio – Consumer and Health<br />
Long Portfolio – Consumer and Health<br />
Percentage in<br />
portfolio<br />
Return 2009 Sharpe Sortino<br />
BAT 0.04923405 4.45% 0.50% -0.0296 -0.0743<br />
COM 0.424818819 38.36% 9.89% 1.5250<br />
ITG 0.029323261 2.65% 0.15% -0.5072 -0.3945<br />
MOR 0.053458756 4.83% -0.05% -0.2925 -1.3345<br />
SAB 0.052164709 4.71% 2.12% 0.4155 4.4693<br />
JSA 0.06213955 5.61% -0.09% -0.5199 -0.1406<br />
UNL 0.043470034 3.92% 0.92% 0.1967 1.9200<br />
CRR 0.024714297 2.23% 0.44% -0.3468 0.5346<br />
DAN 0.047687406 4.31% -0.04% -1.2497 -0.7596<br />
LOR 0.028242658 2.55% 0.57% 0.0088 1.0237<br />
PEU 0.013482852 1.22% 0.81% -1.1551 -0.1214<br />
ADI 0.029582532 2.67% 0.88% -0.1433 1.1744<br />
DAI 0.015824574 1.43% 0.47% -0.3648 0.4486<br />
HEN 0.035402205 3.20% 1.53% -0.1021 1.7094<br />
MET 0.022949306 2.07% 0.83% -0.1731 1.0906<br />
SMN 0.054918656 4.96% 1.87% -0.3960 1.3506<br />
ESS 0.060231098 5.44% 1.19% -0.0943 1.5414<br />
GER 0.059948977 5.41% 2.23% -0.6908 1.1382<br />
Portfolio total results 24.25% 0.4007 0.5311<br />
(Source: Developed by the author based on data’s supplied by Teletrader Software AG)
Issuers<br />
Reverse of the historical<br />
volatility<br />
APPENDIX 15<br />
Short Portfolio – Consumer and Health<br />
Short Portfolio – Consumer and Health<br />
Percentage in<br />
portfolio<br />
Return 2009 Sharpe Sortino<br />
ASB 0.067878453 1.81% -0.21% 0.2781 1.6364<br />
BAI 1.65379711 44.10% -1.73% -0.3703 1.1198<br />
CAR 0.08628845 2.30% -0.80% 0.1049 2.7965<br />
DIA 0.104599189 2.79% -0.34% 0.5418 2.7262<br />
ICO 0.20627226 5.50% -2.55% 0.1863 3.3631<br />
KIN 0.047856299 1.28% -0.67% 0.7964 3.7658<br />
MAS 0.028116616 0.75% -0.47% -0.0344 1.9630<br />
NEX 0.0657654 1.75% -1.15% 0.2173 4.0763<br />
WHI 0.082041483 2.19% -0.94% 0.0634 2.9462<br />
WOL 0.132581657 3.54% -4.16% 0.4147 5.3919<br />
ACO 0.053647824 1.43% -0.12% -0.2343 0.8441<br />
LVM 0.034355041 0.92% -0.45% 0.1120 2.1253<br />
MIC 0.02449765 0.65% -0.23% -0.0960 1.1839<br />
PER 0.041080512 1.10% -0.13% -0.1264 0.8294<br />
PIP 0.024090464 0.64% -0.38% -0.0809 1.5868<br />
REN 0.011639419 0.31% -0.21% -0.2972 0.8763<br />
DPO 0.028210338 0.75% -0.09% -0.3306 0.5660<br />
LUF 0.056710993 1.51% -0.07% -0.3812 0.7549<br />
AUG 0.033813984 0.90% -0.44% -0.0906 1.8048<br />
BUL 0.030128833 0.80% -0.22% -0.2144 1.0467<br />
GEO 0.01555927 0.41% -0.04% -0.4831 0.1890<br />
LOT 0.151319161 4.04% 0.92% -1.8141 -1.1365<br />
LUX 0.044147036 1.18% -0.41% 0.2477 2.1071<br />
AST 0.040191611 1.07% -0.04% 1.1744 2.2830<br />
GLA 0.371314234 9.90% -0.27% -0.1769 1.1701<br />
SAN 0.089951668 2.40% -0.46% 0.6762 2.7014<br />
FRM 0.109384875 2.92% -0.30% 1.0265 3.6298<br />
MER 0.046398123 1.24% -0.01% 0.3080 0.8698<br />
EGP 0.06827401 1.82% -1.15% -0.1901 2.4934<br />
Portfolio total results -17.14% -0.1480 1.6868<br />
(Source: Developed by the author based on data’s supplied by Teletrader Software AG)
PS8 Intellectual Capital<br />
Chairperson<br />
Niculae FELEAGA, Bucharest Academy of Economic Studies,<br />
Romania<br />
INTELLECTUAL CAPITAL DISCLOSURE:<br />
EUROPEAN EVIDENCE<br />
Liliana FELEAGA, Niculae FELEAGA,<br />
Voicu Dan DRAGOMIR, Luciana Maria RABU<br />
INTELLECTUAL CAPITAL:<br />
THE ANNUAL REPORTING PRACTICES<br />
Nicoleta Maria IENCIU, Dumitru MATIŞ<br />
DETERMINANTS OF INTELLECTUAL CAPITAL<br />
DISCLOSURE IN THE CASE OF ROMANIAN<br />
COMPANIES<br />
Maria Cristina MORARIU<br />
~ 368 ~
INTELLECTUAL CAPITAL DISCLOSURE:<br />
EUROPEAN EVIDENCE<br />
Liliana FELEAGA 1 , Niculae FELEAGA,<br />
Voicu Dan DRAGOMIR & Luciana Maria RABU<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
The aim of this research is to examine the degree to which different categories of intellectual<br />
capital are disclosed in the annual reports of a sample of large European companies. The<br />
sample comprises 18 companies included in the STOXX® Europe TMI Software & Computer<br />
Services Index, from 6 countries. Keeping with the previous literature, the present study has<br />
analyzed the disclosed items of intellectual capital outside the financial reports of these<br />
entities; this methodological choice assumes that disclosure outside the requirements of<br />
accounting standards shows the true commitment of managers in the creation and<br />
development of intellectual capital. For the content analysis of intellectual capital disclosures<br />
we have used relevant methodologies from the prior literature. The elements disclosed in<br />
narrative form were coded as binary variables on an index scale, and several frequencies and<br />
charts are included in the discussion section.<br />
KEYWORDS: Intellectual capital, software companies, European firms, research methods<br />
for intellectual capital assessment<br />
INTRODUCTION<br />
The expansion of information technologies and cost-effective communication services<br />
has profoundly transformed industrial activities. Productive systems have gone<br />
through massive mutations, which are relying on the emergence of a new economic<br />
logic. Dematerialized production, the exponential growth of information services and<br />
the integration of data flows into readily accessible databases have led to the<br />
configuration of a post-industrial economy, whose qualitative attributes of flexibility<br />
and reactivity are an essential part of this highly adaptive system. In other words,<br />
tangible investments are progressively giving place to intangible elements, such as<br />
knowledge management systems. Global markets do no longer exclusively deal with<br />
goods and services; knowledge has also become a highly valued commodity, which is<br />
transferred by itself or in association with traditional material goods. Therefore,<br />
companies and nations seek to gain a competitive advantage on any global market, by<br />
supplying increasing amounts of knowledge or “intellectual capital”, which<br />
incorporate impressive material, monetary and human resources. Quite many studies<br />
point to the fact that between 75% and 90% of international market capitalization is<br />
attributable to intangible assets (Hand & Lev, 2005; Baklouti et al., 2007; Zyla, 2010).<br />
In other words, intellectual capital has become the major component of growth and<br />
success for companies of any size. The advent of these changes has provided strong<br />
1 Correspondence address: Liliana FELEAGĂ, The Bucharest Academy of Economic Studies, Piata<br />
Romana nr. 6, sector 1, Bucuresti, cod 010374, e-mail: liliana_malciu @yahoo.com<br />
~ 369 ~
incentives for managers to include intellectual capital disclosures into the annual<br />
reports, in order to acknowledge and demonstrate the effectiveness of intangibles<br />
management (Brennan & Connell, 2000). This type of information is required by<br />
investors with the clear aim to narrow the information gap (Wong & Gardner, 2005).<br />
Consequently, the management, measurement, and disclosure of intellectual capital<br />
have gained relevance as a major research topic (Petty and Guthrie, 1999).<br />
The present paper investigates the reporting practices of companies included in the<br />
STOXX Europe TMI Software & Computer Services index. We believe it to be the<br />
first study in this field targeting the intellectual capital disclosures of firms in the IT<br />
sector, therefore significantly contributing to the intellectual capital disclosure<br />
literature. The results are useful for all those interested in the extent of voluntary<br />
disclosures of intellectual capital, while professional bodies and regulators may also<br />
benefit from the application of relevant methodologies in the creation of guidelines<br />
and accounting policies for those components of intellectual capital which are not yet<br />
formally recognized as assets in the corporate financial statements.<br />
The present study is also testing and thoroughly discussing the methodology of<br />
Guthrie et al. (1999), whose intellectual capital framework involves 24 variables<br />
across three intellectual capital categories. This contribution to the literature is timely<br />
and relevant, since we propose that the aforementioned methodology should be<br />
incorporated into the mainstream corporate disclosure framework, by shaping it to<br />
meet the needs of all stakeholders.<br />
The remainder of the paper is structured as follows. First, several definitions of<br />
intellectual capital and some of its components are provided. In the following, the<br />
paper describes the research method and presents the results. In the final section, the<br />
conclusions are accompanied by a description of tentative avenues of research.<br />
1. THE DEFINITION OF INTELLECTUAL CAPITAL<br />
The global expansion of intangible investments is a major incentive for academic<br />
research. Thinkers from a multitude of fields have attempted to discover the criteria<br />
for the recognition and measurement of this type of corporate investments, which are<br />
by no means similar to acquiring property, plant and equipment. However, the main<br />
obstacle is establishing the perimeter of analysis, since there is no universally<br />
acceptable definition of “intangible investment”. The heterogeneity and the vastness<br />
of the conceptual implications arise also from the usual confusion between such terms<br />
as “intangible”, “dematerialized” or “intellectual” (Feleagă et al., 2010). Moreover,<br />
the term “investment” itself is subject to controversy. For these reasons, we prefer to<br />
use the notion of “intellectual capital”.<br />
The concept of “intellectual capital” has been introduced in the context of academic<br />
research conducted at the beginning of the 1990s on North American and<br />
Scandinavian companies (Dow Chemical, Canadian Imperial Bank of Commerce, and<br />
Skandia, respectively). The results of these investigations are to be found in two<br />
fundamental contributions of Edvinsson & Malone (1997) and Stewart (1997). Thus,<br />
the former consider intellectual capital to be equivalent to having corporate control<br />
over knowledge, management techniques, market relationships and professional skills,<br />
the synergy of which would offer a competitive advantage to the respective firm.<br />
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Similarly, Stewart (1997) considers intellectual capital to consist of “intellectual<br />
material – knowledge, information, intellectual property, experience – that can be put<br />
to use to create wealth”.<br />
Generally, the literature has identified three sub-phenomena that constitute the<br />
concept of intellectual capital: human capital, structural (internal) capital, and<br />
customer (external) capital.<br />
Human capital is the set of collective knowledge, creativity, management skills and<br />
entrepreneurship abilities observable at the employees of an entity. These resources<br />
can be grouped in three categories (Edvinsson & Malone, 1997): competencies<br />
(talents, experience, capacities), attitudes (motivation, managerial abilities), and<br />
intellectual agility (the capacity to innovate and to establish new patterns of<br />
knowledge). The authors insist on the fact that, as employees leave the company, their<br />
human capital may no longer be available to the entity. Thus, human capital is much<br />
more volatile than structural capital, but crucial to the development and survival of<br />
any organization. Entities should not refrain from investing in human capital simply<br />
because of its high degree of volatility.<br />
Other researchers have analyzed human capital from a different perspective,<br />
describing the enterprise as a dynamic mixture of specific organizational capacities,<br />
not as an inventory of resources with a potential for interaction (Bounfour, 2000). In<br />
this vision, human capital could be reduced to the ensemble of implicit knowledge<br />
and routines stored in the brains of the employees. This knowledge can be broken<br />
down into: information, quality of working teams, collective capacities, organizational<br />
competences and culture. Human capital is an essential component of any entity, since<br />
organizations can exist only when they benefit from the presence of humans and their<br />
creativity (Bounfour, 2000).<br />
According to Stewart, human capital develops when an enterprise is intensively using<br />
the knowledge of its employees, or when a large number of individuals acquire useful<br />
knowledge for their work within the enterprise. In other words, in order to develop<br />
their competitive edge, companies are forced to accumulate, preserve and use their<br />
human capital in the most efficient way possible. Human capital also comes as<br />
a “surprise gift” to the company: the employer knows its worth (the opportunity cost<br />
of education) and its returns (higher earnings for the firm), but no one knows the<br />
actual content of this capital. That is, the manager does not know for sure which of the<br />
abilities developed through education are useful for the economic activity (Hartog,<br />
1999).<br />
Structural (internal) capital is the “protective environment” for human capital,<br />
allowing the employment of the latter for value creating purposes (Stewart, 1997).<br />
Between these two forms of capital there is a fundamental difference (UNI P&MS,<br />
2000): “Structural capital can be owned by the organization whereas human capital is<br />
volatile. People can walk away, they might fall ill or die, or they might be enticed<br />
away by a competitor. They cannot be owned.” Structural capital relates to a firm’s<br />
databases, procedures, systems, distribution networks and anything that has higher<br />
value to the company than material value (cost).<br />
~ 371 ~
Customer (external) capital relates to the knowledge that is embedded in the<br />
relationships external to the firm (Bontis, 1998). This consists of marketing channels,<br />
relationships with customers and suppliers, brand names and reputation. Some of<br />
these can be considered to be proprietary, but only in a temporal sense and, even then,<br />
not with any degree of confidence. For instance, a company has some influence over<br />
the value of its customer relationships; however, reputation and relationships can<br />
change over time and a company cannot control the behavior of customers or<br />
suppliers if they are not compliant (Guthrie & Petty, 2000).<br />
The three components of intellectual capital should not be seen in isolation. They are<br />
complementary and in permanent interaction between each other and with other<br />
external factors (Edvinsson and Malone, 1997).<br />
2. METHODOLOGICAL ASPECTS: SAMPLE SELECTION AND RESULTS<br />
The purpose of our research is to examine the extent to which different categories of<br />
intellectual capital are disclosed in the annual reports of large European companies.<br />
The preliminary sample includes 21 companies listed in the STOXX® Europe TMI<br />
Software & Computer Services index. In accordance with the Classification<br />
Benchmark (ICB) provided by Stoxx ltd., the Software & Computer Services Sector<br />
contains: (i) companies that provide consulting services to other businesses relating to<br />
information technology, (ii) companies providing Internet-related services, such as<br />
Internet access providers and search engines and providers of Web site design, Web<br />
hosting, domain-name registration and e-mail services; and (iii) publishers and<br />
distributors of computer software for home or corporate use. One company was<br />
eliminated because it did not include any information related to intellectual capital in<br />
its annual reports, and another two because they did not have their reports available on<br />
the website until 30 September 2010. The final sample was comprised of 18<br />
companies from 6 countries, and is presented in Table 1.<br />
The majority of research contributions in the field of intellectual capital reporting<br />
have focused on the content analysis of annual reports (Subbarao & Zeghal, 1997;<br />
Guthrie & Petty, 2000; Brennan, 2001; Olsson, 2001; Williams, 2001, Wong and<br />
Gardner, 2005; Morariu, 2010). Annual reports are a highly useful source of data,<br />
because managers of companies commonly signal what is important through the<br />
reporting mechanism (Guthrie & Petty, 2000; Goh & Lim, 2004). They are also a<br />
good proxy for measuring the comparative position and trends of intellectual capital<br />
between firms, industries and countries (Abeysekera & Guthrie, 2005).<br />
Table 1. Sample companies<br />
COMPANIES COUNTRY COMPANIES COUNTRY<br />
Atos Origin FR Kudelski CH<br />
Autonomy Corporation GB Logica GB<br />
Aveva Group GB Micro Focus International GB<br />
Cap Gemini FR Misys GB<br />
Dassault Systems FR Sage Group GB<br />
Dimension Data GB SAP DE<br />
Fidessa Group GB Temenos Group CH<br />
Indra Sistemas ES Tieto FI<br />
Invensys GB United Internet DE<br />
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In a manner similar to prior research, the collection procedure in our study has<br />
ignored the elements which are already included as part of the financial statements.<br />
Since all the companies in our sample are in compliance with the International<br />
Financial Reporting Standards (IFRS), the mandatory disclosures on the face of the<br />
financial statements and in the notes to the accounts are not indicative of the<br />
managers’ propensity to disclose intellectual capital elements in the “Management<br />
discussion” section of the annual report (Guthrie & Petty, 2000; Brennan, 2001; Ax &<br />
Marton, 2008).<br />
For the content analysis for annual reports, the methodology developed by Guthrie et<br />
al. (1999) was considered relevant, since it proposes a framework which classifies<br />
intellectual capital into three components: internal capital, external capital and<br />
employee competence. The components of each dimension are listed in Table 2.<br />
Table 2. Intellectual capital elements used in the coding instrument<br />
INTERNAL CAPITAL<br />
(ORGANIZATION CAPITAL)<br />
EXTERNAL CAPITAL<br />
(CUSTOMER/RELATIONAL<br />
CAPITAL)<br />
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EMPLOYEE COMPETENCE<br />
(HUMAN CAPITAL)<br />
Patents Brands Know-how<br />
Copyrights Customers Education<br />
Trademarks Customer loyalty Vocational qualification<br />
Management philosophy Company names Work-related knowledge<br />
Corporate culture Distribution channels Work-related competencies<br />
Management processes Business collaborations Entrepreneurial spirit<br />
Information systems Licensing agreements<br />
Networking systems Favorable contracts<br />
Financial relations Franchising agreements<br />
The prior research (Guthrie et al., 1999) has employed a coding scale to measure the<br />
quantity of disclosure concerning the component elements of intellectual capital. This<br />
four-point scale is presented as follows:<br />
� 0 – the element is not present in the annual report;<br />
� 1 – the element can be found in a narrative;<br />
� 2 – the element takes a numerical form (counts, frequencies, trends);<br />
� 3 – the element is presented in monetary terms.<br />
However, the preliminary results of a pilot test and the consultation of related<br />
literature have shown that the components of intellectual capital are mainly presented<br />
in narrative form (Guthrie et al., 1999; Goh & Lim, 2004; Bukh et. al, 2005, Ax &<br />
Marton 2008). This implies that companies are more interested in simply pointing out<br />
where the added value lies rather than assigning currency value to it (Petty & Guthrie,<br />
2000; Wong & Gardner, 2005). For this reason, our investigation does not consider<br />
the four-point scale as relevant, and uses instead a binary coding system (present/not<br />
present).<br />
We collected the cross-sectional raw data from the annual reports of the selected<br />
companies, for one fiscal year. Depending on the accounting period of each company,<br />
year-end dates varied between the 31st December 2009 and the 30th September 2010.<br />
The first stage of the content analysis procedure was performed by a junior researcher,<br />
who extracted data related to intellectual capital from the annual reports onto a coding
sheet with several variables. Another researcher independently confirmed the coding<br />
for each element and filled in a spreadsheet on the basis of the information reported<br />
on the coding sheets. This gives a high degree of confidence in the overall result.<br />
Table 3 shows the frequencies found in the content analysis of the annual reports of<br />
the 18 listed companies in the sample. The results are presented in nominal terms and<br />
also proportional terms with regards to our particular sample size. In parallel, the<br />
results reported by Guthrie et al. (1999) are shown for comparative purposes.<br />
Table 3. The frequencies of disclosures concerning intellectual capital elements, side<br />
by side with the results of Guthrie et al. (1999)<br />
COMPANY<br />
CURRENT STUDY GUTHRIE ET AL.<br />
(1999)<br />
Sample: 18 100% Sample: 20 100%<br />
Internal Capital (organization capital)<br />
Patents 8 44% 3 15%<br />
Copyrights 5 28% 1 5%<br />
Trademarks 6 33% 2 10%<br />
Management philosophy 14 78% 12 60%<br />
Corporate culture 8 44% 6 30%<br />
Management processes 14 78% 15 75%<br />
Information systems 13 72% 10 50%<br />
Networking systems 9 50% 3 15%<br />
Financial relations<br />
External Capital (customer/relational capital)<br />
8 44% 1 5%<br />
Brands 6 33% 9 45%<br />
Customers 18 100% 16 80%<br />
Customer loyalty 12 77% 7 35%<br />
Company names 3 17% 5 20%<br />
Distribution channels 4 22% 10 50%<br />
Business collaborations 15 83% 13 65%<br />
Licensing agreements 6 33% 8 40%<br />
Favorable contracts 5 28% 1 5%<br />
Franchising agreements<br />
Employee competence (Human Capital)<br />
0 0% 1 5%<br />
Know-how 6 33% 6 30%<br />
Education 6 33% 6 30%<br />
Vocational qualification 3 17% 1 5%<br />
Work-related knowledge 14 78% 12 60%<br />
Work-related competencies 15 83% 9 45%<br />
Entrepreneurial spirit 4 22% 19 95%<br />
Frequencies found compare poorly with those of Guthrie et al. (1999). This result was<br />
to be expected, given that the current sample is significantly different from that<br />
employed by the latter researchers. The firms included in the STOXX® Europe TMI<br />
Software & Computer Services index are significantly larger than those listed on the<br />
Australian Stock Exchange, as indicated by Guthrie et al. (1999). Larger firms are<br />
more likely to disclose more information (Guthrie and Mathews, 1985) and to possess<br />
more intellectual capital because they are more visible and have more resources at<br />
their disposal to sponsor new initiatives (Abeysekera & Guthrie, 2005). Secondly, the<br />
sample of Guthrie et al. included companies from six industries, whereas the present<br />
study is focused on only one intangibles-oriented industry. The companies belonging<br />
to the Software & Computer Services Sector are more likely to design, develop, sell<br />
or exploit resources of an intellectual nature, thus being able to disclose more<br />
~ 374 ~
information related to their intangible capital (Wong & Gardner, 2005). Thirdly, the<br />
timing of this research can also be a cause of the differences between the presented<br />
results. Our study has been conducted more than a decade after that of Guthrie et al.<br />
(2009). The passage of time is expected to have lead to a refinement of the<br />
companies’ policies regarding the disclosure of intellectual capital.<br />
When assessing the Intellectual Capital disclosures under the three components of IC:<br />
internal capital, external capital and human capital (Figure 1), Internal Capital has the<br />
largest reporting rate of 42% of the IC attributes disclosed (85 elements out of 202).<br />
Items of External Capital are the second most reported elements, in the proportion of<br />
34% (69 elements out of 202), while Employee Competence class comprise the most<br />
neglected elements, with 24% of the total disclosures (48 items out of 202).<br />
As shown in Table 3, only one of the 24 elements of IC scored 100% disclosure rate<br />
across sample companies: information related to customers was disclosed by all 18<br />
companies. At the opposite pole, no information on franchising agreements is<br />
disclosed whatsoever.<br />
The internal capital is the structural capital that is contained inside the firm, and<br />
includes intellectual property (patent, copyright, and trademarks) and intangible<br />
infrastructure assets (management philosophy, corporate culture, management<br />
processes, information systems, networking systems and financial relations). The<br />
company that showed the highest number of internal IC attributes was SAP, which<br />
disclosed quantitative and qualitative information on all nine components of internal<br />
capital. The next ranked company displaying high internal IC attributes was Atos<br />
Origin, which presented information on all aspects of internal capital except<br />
copyrights. The company that showed the lowest number of internal IC attributes was<br />
Temenos Groups, which included data only about information systems.<br />
Figure 1. Intellectual Capital Disclosures with a breakdown on the three main classes<br />
Regarding Internal Capital, the disclosures related to management philosophy and<br />
management processes are the most common, each with 14 elements out of 85.<br />
Considering the total sample of 18 companies, the proportion of companies which<br />
disclosed such information is of 77%. Disclosures regarding corporate information<br />
systems are the second most common, with 13 items out of 85, being relevant for 72%<br />
of the sample companies. Out of the 9 attributes of the internal capital, the ones with<br />
~ 375 ~
the lowest disclosure frequency were: copyrights (disclosed by five companies) and<br />
trademarks (disclosed by six companies). These results are consistent to those<br />
reported by Bozzolan et al (2003) who found large amounts of disclosure in<br />
management processes and information technology, while intellectual property was<br />
the most rarely disclosed. For the current study, the other internal IC attributes<br />
proportions are shown in the figure below (Figure 2).<br />
Figure 2. Internal IC disclosures, with a breakdown on the nine components<br />
The external perspective of IC is relevant for the relationships and sources of value<br />
from outside the firm. Guthrie & Petty (2000) explained the large proportion of<br />
external capital disclosures through the increased emphasis in recent years on<br />
rationalizing distribution channels, reconfiguring a firm’s value chain and reassessing<br />
customer value. In the present study, none of the companies exhibited full disclosure<br />
on the nine components of external capital. The companies that showed the highest<br />
number of external IC attributes (5 out of 9) were: Cap Gemini, Indra Sistemas,<br />
Logica, SAP and Temenos Group. On the other side, the poorest disclosures are to be<br />
found at Tieto and United Internet, which provided information on only two relevant<br />
components of external capital.<br />
Figure 3. External IC disclosures, with a breakdown on the nine components<br />
~ 376 ~
As shown in Figure 3, within external capital reporting, the two most popular<br />
elements were related to customers (100% disclosure rate) and business collaborations<br />
(with data to be found in 15 out of 18 reports). The emergence of customer disclosure<br />
is not surprising as the emphasis on customers within the management accounting<br />
literature is very relevant for companies irrespective of industry (Foster, Gupta, and<br />
Sjoblom, 1996), while the high rate of disclosure relative to collaborations with other<br />
businesses can be explained by the international exposure of companies from our<br />
sample.<br />
The final aspect under consideration is the human perspective, which takes into<br />
account the contributions of the employees and includes areas such as training,<br />
education and entrepreneurial spirit. The company that demonstrated the highest<br />
human intellectual capital disclosure was SAP, which presented qualitative and<br />
quantitative information on all six components of human capital. In contrast to SAP,<br />
three other companies reported on only one component of human capital: Aveva<br />
Group (on work-related competencies), Kudelski (on know-how) and United Internet<br />
(on education).<br />
The most popular type of human IC disclosure is about work-related competencies<br />
(present in 15 annual reports). Work-related knowledge is the second most popular<br />
choice in the human capital disclosures, while vocational qualification was an item<br />
that received very little attention (6.25%). These results are comparable to those<br />
reported by Bozzolan et al (2003) and by Wong & Gardner (2005). Overall, the<br />
disclosure proportions for the current study are shown in the Figure 4, which also<br />
includes the other types of disclosures that were displayed by companies.<br />
Figure 4. Employee competence (Human Capital) disclosures, with a breakdown on<br />
the six components<br />
CONCLUSIONS<br />
Thomas Stewart (1991) formulated the following hypothesis: “Intellectual capital is<br />
becoming corporate America’s most valuable asset and can be its sharpest competitive<br />
weapon. The challenge is to find what you have, and use it”. However, a major<br />
obstacle in achieving competitiveness is tracing the epistemological perimeter of the<br />
~ 377 ~
concept of intellectual capital. To illustrate this difficulty, in the first section of the<br />
present article, a literature review was constructed around the proposed definitions for<br />
the concept of intellectual capital, along with a description of its components. The<br />
strategic importance of organizational knowledge is a strong incentive for researchers<br />
to propose definitions, perspectives and methods for the recognition and valuation of<br />
intellectual capital.<br />
In the second section, the present study was set out to apply content analysis<br />
rigorously and to examine the nature and extent of intellectual capital disclosure for<br />
the companies included in the STOXX® Europe TMI Software & Computer Services<br />
index. The results indicate that the reports issued by these companies emphasized the<br />
importance of intellectual capital and covered a wide range of intellectual capital<br />
items. In a similar note with other related studies, empirical evidence shows that,<br />
although firms talk of human capital as the most important asset, in practice the most<br />
reported category is internal capital with 42% (which was divided into intellectual<br />
property 9.4% and infrastructure assets 32.6%), followed by external capital with 34%<br />
and employee competence with 24%.<br />
Secondly, evidence shows that very limited disclosure was made on patent, copyright,<br />
trademark, company names, distribution channels, brands, franchising agreement,<br />
know-how, entrepreneurial spirit and vocational qualification. This implies that<br />
standard-setters are welcomed to develop an accounting framework that would allow<br />
the recognition and measurement of such IC elements for which there are no<br />
applicable accounting standards.<br />
There is much scope for further research in this area. More data on companies in the<br />
Software & Computer Services sector could be gathered in a longitudinal design,<br />
which would provide more insight and would provide empirical evidence not only in<br />
the extent of disclosure, but also on the time variations in IC reporting. Moreover, the<br />
sample could be extended to include companies from other sectors, which would<br />
serve to estimate a statistical model with a sector control variable. Finally, a more<br />
developed research design could explore the complex motivations behind the<br />
disclosure of IC, at a managerial level and from a market perspective.<br />
ACKNOWLEDGEMENTS<br />
This work was supported by CNCSIS –UEFISCSU, project number PNII – IDEI code<br />
1859/2008, contract no. 837/2009.<br />
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INTELLECTUAL CAPITAL:<br />
THE ANNUAL REPORTING PRACTICES<br />
Nicoleta Maria IENCIU 1 & Dumitru MATIŞ<br />
Babes-Bolyai University, Romania<br />
ABSTRACT<br />
The objective of this study is to examine voluntary intellectual capital disclosure provided by<br />
listed Romanian entities in annual reports from the year 2009. In order to achieve such<br />
objective we have undergone an applicative, quantitative research, using as method of<br />
research the content analysis of the annual statements from Romanian entities listed at the<br />
Bucharest Stock Exchange on information supplied on intellectual capital.<br />
KEYWORDS: Intellectual Capital, Annual Reports, Romanian Listed Entities, Voluntary<br />
disclosure<br />
INTRODUCTION<br />
Researchers of economics have lately manifested a great interest in studying and<br />
informing potential investors regarding the true "fortune" of entities, because they<br />
believe that people are ignored to a large extent, the resignation of a key employee is<br />
not registered in the financial documents, hence the statement that individuals have an<br />
important power within a company, due to their knowledge.<br />
The switch to an economy based on knowledge had a major impact on the accounting<br />
profession. Information is power and accountants had access to data understood by<br />
very few or which were not within reach for just anyone. The technological<br />
developments made information available at a large scale, and the routine activities,<br />
such as processing and analysis, are now left to be taken care of by the IT team. As far<br />
as accounting competences are concerned, a recent publication from FMAC (The<br />
Financial Management and Accounting Committee within the International<br />
Accounting Federation) states that: “Local knowledge and technical competency will<br />
become insufficient; instead, emphasis will be placed on contributions which bring<br />
value in the accounting”. In order to obtain an input in value, the accounting<br />
profession will have to combine knowledge with understanding the “traditional”<br />
financial information with more „sophisticated” interpretation techniques. This means<br />
developing an accountant vigilance, which includes creating relations with other<br />
departments and appreciating how their role contributes to the company's strategic<br />
direction. Accountants must consider themselves not as „crushing numbers”, but also<br />
as „strategic advisers” that can help entities to understand and evaluate their financial<br />
and competitive position. The need to cross to a new level, to a rebirth of accounting<br />
emerged from this, considering all non-tangible elements, even intellectual capital.<br />
Nevertheless, many researchers hesitate in defining intellectual capital, but feel that<br />
1 Correspondence address: Nicoleta Maria IENCIU, Babeş-Bolyai University, Faculty of Economics<br />
and Business Administration,Cluj-Napoca, Romania; email: nicoleta.ienciu@econ.ubbcluj.ro<br />
~ 380 ~
this capital, which contains non-financial and related information, is the basic value<br />
for a company (Amir & Lev, 1996; Edvinsson & Malone, 1997; Stewart, 1997;<br />
Bontis, 1999, 2001, Ittner, 2008). They claim that intellectual capital supports entities<br />
in creating value and offers competitive advantages. Therefore, intellectual capital can<br />
be considered as one of the most valuable „assets” and the most competitive “weapon” in<br />
business.<br />
Consequently, the fundamental objective of this paper is to create an accurate image<br />
of what intellectual capital represents from the angle of accounting researches. In<br />
order to achieve this objective, we perform a content analysis of the annual reports<br />
from entities listed on the Romanian capital market.<br />
1. PRIOR RESEARCH AND BACKGROUND<br />
The annual reports prepared and published by the entities listed on the capital market<br />
have been used to investigate the practice of reporting information on intellectual<br />
capital (Brennan, 2001; Guthrie et al., 1999, 2006) and the content analysis of the<br />
annual statements having been used by various researchers, because it represents a<br />
good instrument for a comparative assessment of positions and trends used in<br />
preparing the statements.<br />
Australian researchers have been amongst the first to adopt the content analysis as a<br />
means to examine the practices used by entities to manage and prepare the statements<br />
on intellectual capital. Guthrie and Petty (2000), by referring to the Australian annual<br />
reporting practices, focus on intellectual capital utilized by the largest 19 entities, on<br />
market capitalization. They use the method of content analysis and a modified version<br />
of Sveiby’s model in order to classify information on intellectual capital. The three<br />
dimensions of the intellectual capital conceptual framework (internal capital, external<br />
capital and human capital) together with the related subcategories (nine for the internal<br />
capital framework, nine for the external capital and six for the human capital) are encoded<br />
with the value 0 when the variable is not included in the annual statement, 1 if the value is<br />
presented in a discursive fashion, 2 when the information is approached from a<br />
quantitative point of view and 3 when the information is assessed monetarily. The results<br />
from Australian researches are far from being systematic, despite the attention and<br />
significance granted to intellectual capital. Australian entities do not have an agreed<br />
framework for preparing reports concerning the intellectual capital, moreover, it appears<br />
the „notion of assessing and reporting intellectual capital is enclosed into a rhetorical<br />
framework lacking in content” (Guthrie & Petty, 2000, p. 246). This is also supported by<br />
the statement according to which „almost every aspect related to intellectual capital has<br />
been presented in a discursive fashion and not under monetary terms” (Guthrie & Petty,<br />
2000, p. 247).<br />
Brennan (2001) conducted a similar study with relation to Irish entities, analyzing<br />
annual statements from 21 entities listed on the stocks market. The author used an<br />
identical scheme as Guthrie & Petty (2000) in order to encode data in the content<br />
analysis of annual reports and has identified similar results to the Australian study.<br />
Results obtained indicated that the Irish context was similar to the Australian one<br />
because there is no reporting frame for intellectual capital; hence the entities assess<br />
their intellectual capital by using the qualitative method and less the quantitative one.<br />
Just as Guthrie & Petty (2000) have noticed, these results emphasize the difficulties<br />
~ 381 ~
encountered by entities in the administrative process for assessment and reporting of<br />
intellectual capital.<br />
A study conducted by Olsson (2001) examined the annual statements of the 18 most<br />
important entities listed at the Swedish Stock Exchange, selected based on their<br />
turnover, drafting a list of five elements in order to evaluate the level of human capital<br />
reporting. The study pointed out that neither company granted more than 7% space,<br />
as part of their annual statements, for presenting information on human resources, as<br />
the information found in the statements had both quantitative and qualitative<br />
deficiencies.<br />
In their study on Malaysian entities, by using the questionnaire on intellectual capital<br />
Bontis (2000) have found evidence linking corporate performance to the relevance<br />
granted to human, structural and relational capital. A similar study has also been<br />
conducted in Ireland (O’Reagan et al. 2001), coming to the result that intellectual<br />
capital becomes a key element for the value of entities and national economic<br />
performance. Even more so, it has been indicated that the usefulness of annual<br />
statements is more and more challenged as they do not include intellectual capital<br />
elements.<br />
Therefore, based on the ideas presented above, we have conducted a study of our own,<br />
using the content analysis method with regards to the annual reports of entities listed on<br />
the Romanian capital market, intending to analyze the relevance of the ideas that have<br />
been studied until now by transferring them into the chosen sample of entities.<br />
2. RESEARCH METHODOLOGY<br />
The present paper contains a study performed on 68 entities listed on the Bucharest<br />
Stock Exchange (BSE), Main Market (starting on December 31st, 2009). The<br />
participant entities are from high technology industries such as: manufacturing,<br />
mining and quarrying, constructions, financial services, transport, wholesale and retail<br />
trade, tourism (see Appendix 1). In the study we took into account all the entities listed<br />
on the BSE Market. Thus, from a total of 100 entities, we analyzed 68 entities (considered<br />
the most traded), 6 of them being suspended and 26 non-listed. The sample was chosen<br />
based on the fact that listed entities are obligated to publish their annual statements,<br />
open to the public and, at the same time, deemed to be renowned entities heavily<br />
impacting on the economy of a country. The entities included in the study is<br />
represented by entities listed at the). The sources used for extracting information on<br />
intellectual capital were the annual statements for the fiscal year 2009, because we consider<br />
them the most important sources of information made available by the entities to the<br />
external users and in particular to the shareholders.<br />
We have made a content analysis, included in the study, for the annual statements of entities<br />
listed on the Bucharest Stock Exchanges, wherein we have monitored the three dimensions<br />
of the intellectual capital conceptual framework (internal capital, external capital and human<br />
capital) together with the related subcategories (for the purpose of classifying information,<br />
we have used a modified version of Sveiby’s model) which we have grouped as follows:<br />
two subcategories for the framework of internal capital (the intellectual property – patents,<br />
copyrights, registered trademark; the infrastructure assets – corporate culture, management<br />
of processes, IT system, networks systems, research projects, financial relations), five for<br />
~ 382 ~
external capital (the customers – company’s customers, the loyalty of customers, customer<br />
relations, customer involvement, attracting new customers; the reputation / image of the<br />
company; the supply and distribution channels – relations with suppliers and competitors;<br />
the cooperation – in business, research, concluded contracts; concluded agreements –<br />
franchises, licenses) and four for the human capital (education; employees; work-related<br />
knowledge and work-related competencies).<br />
3. THE ANALYSIS OF OBTAINED RESULTS<br />
Starting from the classification of the intellectual capital elements by means of a<br />
modified version of the Sveiby’s model (Bozzolan et al., 2003), we have performed a<br />
content analysis of the annual statements of the entities listed on the Bucharest Stock<br />
Exchange (Table 1) during which we have monitored the three dimensions of the<br />
intellectual capital conceptual framework (internal, external and human capital) together<br />
with the related subcategories we have grouped according to Table 2.<br />
Table 1. The scoring system of information regarding intellectual capital within<br />
Romanian listed entities in 2009<br />
(panel A)<br />
Structural/ Internal<br />
Capital<br />
Intellectual property<br />
(patents, copyrights,<br />
registered trademark)<br />
Infrastructure assets<br />
(corporate culture,<br />
management of<br />
processes, IT system,<br />
networks systems,<br />
research projects,<br />
financial relations)<br />
Relational/ External<br />
Capital<br />
Customers<br />
(company’s customers,<br />
the loyalty of<br />
customers, customer<br />
relations, customer<br />
involvement, attracting<br />
new customers)<br />
The image of the<br />
company<br />
Supply and distribution<br />
channels (relations with<br />
suppliers and<br />
competitors)<br />
Aerostar<br />
Alro<br />
Altur<br />
Alumil Rom Industry<br />
Amonil<br />
Antibiotice<br />
Armatura<br />
~ 383 ~<br />
Azomures<br />
Banca Comerciala<br />
Carpatica<br />
Banca Transilvania<br />
Bermas<br />
Biofarm<br />
Boromir Prod<br />
Banca Romana de<br />
Dezvoltare<br />
0,3 0,3 0,3 0,3 0,3 0,5 0,5 0,3 0,3 0,3 0 0,3 0,3 0,3 1<br />
0 0 0 0 0 0,5 0,5 0 0 0 0 0 0 0 1<br />
0,5 0,5 0,5 0,5 0,5 0,5 0,5 0,5 0,5 0,5 0 0,5 0,5 0,5 0,5<br />
0,4 0,5 0,2 0,7 0,4 0,5 0,4 0,6 0,5 0,3 0,4 0,5 0 0 0,6<br />
0,5 1 0,5 1 0 0,5 0,5 0,5 0,5 1 1 1 0 0 1<br />
0 0 0 0 0 0,5 0,5 0,5 0,5 0 0 0 0 0 0,5<br />
0,5 1 0,5 0,5 1 0,5 0,5 0,5 0,5 0,5 0,5 1 0 0 0,5<br />
CNTEE Electrica
Cooperation<br />
(in business, research,<br />
concluded contracts)<br />
Concluded agreements<br />
(franchises, licenses)<br />
Aerostar<br />
Alro<br />
Altur<br />
Alumil Rom Industry<br />
Amonil<br />
Antibiotice<br />
Armatura<br />
~ 384 ~<br />
Azomures<br />
Banca Comerciala<br />
Carpatica<br />
Banca Transilvania<br />
Bermas<br />
Biofarm<br />
Boromir Prod<br />
Banca Romana de<br />
Dezvoltare<br />
0,5 0,5 0 1 0,5 0,5 0,5 0,5 1 0 0,5 0,5 0 0 0,5<br />
0,5 0 0 1 0,5 0,5 0 1 0 0 0 0 0 0 0,5<br />
Human Capital 0,5 0,6 0,5 0,3 0,1 0,3 0,6 0,3 0,1 0,1 0,1 0,5 0 0,6 0,3<br />
Education 0 0,5 0 0 0 0,5 0,5 0 0 0 0 0 0 0 0<br />
Employees 0,5 1 1 1 0,5 0,5 1 1 0,5 1 1 1 0 1 0,5<br />
Work-related<br />
knowledge<br />
Work-related<br />
competencies<br />
1 0,5 1 0 0 0 0 0 0 0 0 0 0 1 0<br />
0,5 0,5 0 0 0 0 1 0 0 0 0 1 0 0,5 0,5<br />
Table 1. The scoring system of information regarding intellectual capital within<br />
Romanian listed entities in 2009<br />
(panel B)<br />
Structural/ Internal<br />
Capital<br />
Intellectual property<br />
(patents, copyrights,<br />
registered<br />
trademark)<br />
Infrastructure assets<br />
(corporate culture,<br />
management of<br />
processes, IT<br />
system, networks<br />
systems, research<br />
projects, financial<br />
relations)<br />
Relational/ External<br />
Capital<br />
Customers<br />
(company’s<br />
customers, the<br />
loyalty of<br />
customers, customer<br />
relations, customer<br />
involvement,<br />
attracting new<br />
customers)<br />
Carbochim<br />
Casa de Bucovina<br />
Cemacon<br />
Comcm<br />
Comelf<br />
Compa<br />
Compania<br />
Energopetrol<br />
Condmag<br />
Contor Grup<br />
Dafora<br />
Electroaparataj<br />
Electroputere<br />
Farmaceutica<br />
Remedia<br />
Grupul Industrial<br />
Electrocontact<br />
Impact Developer<br />
Constructor<br />
0,3 0,3 0,3 0,3 0,3 0,5 0,3 0,3 0,3 0 0,3 0,3 0,5 0,3 0,3<br />
0 0 0 0 0 0 0 0 0 0 0 0 0,5 0 0<br />
0,5 0,5 0,5 0,5 0,5 1 0,5 0,5 0,5 0 0,5 0,5 0,5 0,5 0,5<br />
0,1 0,3 0,3 0,4 0,3 0,3 0,4 0,4 0,3 0,5 0,4 0,3 0,6 0,2 0<br />
0,5 0,5 0,5 1 0,5 0,5 1 1 0,5 1 1 0,5 1 0,5 0<br />
CNTEE Electrica
The image of the<br />
company<br />
Supply and<br />
distribution channels<br />
(relations with<br />
suppliers and<br />
competitors)<br />
Cooperation<br />
(in business,<br />
research, concluded<br />
contracts)<br />
Concluded<br />
agreements<br />
(franchises, licenses)<br />
Carbochim<br />
Casa de Bucovina<br />
Cemacon<br />
Comcm<br />
Comelf<br />
Compa<br />
Compania<br />
Energopetrol<br />
~ 385 ~<br />
Condmag<br />
Contor Grup<br />
Dafora<br />
Electroaparataj<br />
Electroputere<br />
Farmaceutica<br />
Remedia<br />
Grupul Industrial<br />
Electrocontact<br />
Impact Developer<br />
Constructor<br />
0 0 0 0 0 0 0 0 0 0,5 0 0 0 0 0<br />
0 0,5 0,5 1 0,5 0,5 1 0,5 0,5 0,5 1 0,5 1 0,5 0<br />
0 0,5 0,5 0 0,5 0,5 0 0,5 0,5 0,5 0 0,5 0 0 0<br />
0 0 0 0 0 0 0 0 0 0 0 1 0 0<br />
Human Capital 0,3 0,6 0 0,5 0,3 0,4 0 0,4 0,6 0,4 0,5 0,3 0 0,5 0,6<br />
Education 0 0,5 0 0,5 0 0 0 0 0,5 0 0 0 0 0 0,5<br />
Employees 1 1 0 0,5 0,5 0,5 0 0,5 1 1 1 0,5 0 1 1<br />
Work-related<br />
knowledge<br />
0 0,5 0 0,5 0 1 0 0,5 0,5 0 0,5 0 0 0 0,5<br />
Work-related<br />
competencies<br />
0 0,5 0 0,5 0,5 0 0 0,5 0,5 0,5 0,5 0,5 0 1 0,5<br />
Table 1. The scoring system of information regarding intellectual capital within<br />
Romanian listed entities in 2009<br />
(panel C)<br />
Structural/ Internal<br />
Capital<br />
Intellectual<br />
property<br />
(patents,<br />
copyrights,<br />
registered<br />
trademark)<br />
Infrastructure assets<br />
(corporate culture,<br />
management of<br />
processes, IT<br />
system, networks<br />
systems, research<br />
projects, financial<br />
relations)<br />
Relational/<br />
External Capital<br />
Mecanica Ceahlau<br />
Mechel Targoviste<br />
Mefin<br />
Mj Maillis Romania<br />
Oil Terminal<br />
Oltchim<br />
OMV Petrom<br />
Petrolexportimport<br />
Prodplast<br />
Romcarbon<br />
Rompetrol Rafinare<br />
Rompetrol Well<br />
Services<br />
SNTGN Transgaz<br />
SSIF Broker<br />
Santierul Naval<br />
Orsova<br />
0,5 0,3 0 0,3 0 1 1 0 0,5 0,5 0,5 0,5 0,5 0,3 0,3<br />
0,5 0 0 0 0 1 1 0 0,5 0,5 0,5 0,5 0,5 0 0<br />
0,5 0,5 0 0,5 0 1 0,5 0 0,5 0,5 0,5 0,5 0,5 0,5 0,5<br />
0,6 0,4 0,6 0,4 0,5 0,6 0,8 0,4 0,6 0,6 0,7 0,7 0,7 0,3 0,3
Customers<br />
(company’s<br />
customers, the<br />
loyalty of<br />
customers,<br />
customer relations,<br />
customer<br />
involvement,<br />
attracting new<br />
customers)<br />
The image of the<br />
company<br />
Supply and<br />
distribution<br />
channels (relations<br />
with suppliers and<br />
competitors)<br />
Cooperation<br />
(in business,<br />
research, concluded<br />
contracts)<br />
Concluded<br />
agreements<br />
(franchises,<br />
licenses)<br />
Mecanica Ceahlau<br />
Mechel Targoviste<br />
Mefin<br />
Mj Maillis Romania<br />
Oil Terminal<br />
Oltchim<br />
OMV Petrom<br />
~ 386 ~<br />
Petrolexportimport<br />
Prodplast<br />
Romcarbon<br />
Rompetrol Rafinare<br />
Rompetrol Well<br />
Services<br />
SNTGN Transgaz<br />
SSIF Broker<br />
Santierul Naval<br />
Orsova<br />
1 1 0,5 0,5 1 1 1 1 1 1 1 1 1 0,5 0,5<br />
0,5 0 0,5 0,5 0 0 0,5 0 0,5 0,5 0,5 0,5 0,5 0 0<br />
1 0,5 0,5 0,5 1 1 1 1 1 1 1 1 1 0,5 0,5<br />
0,5 0,5 1 0,5 0,5 0,5 0,5 0 0,5 0,5 0,5 0,5 0,5 0,5 0,5<br />
0 0 0,5 0 0 0,5 1 0 0 0 0,5 0,5 0,5 0 0<br />
Human Capital 0,5 0,5 0,5 0,4 0,4 0,1 0,5 0,3 0,4 0,4 0,6 0,6 0,6 0,1 0,3<br />
Education 0 0 0,5 0,5 0 0 0,5 0 0,5 0 0,5 0,5 0,5 0 0<br />
Employees 0,5 1 0,5 0,5 1 0,5 0,5 1 1 1 1 1 1 0,5 1<br />
Work-related<br />
knowledge<br />
Work-related<br />
competencies<br />
0,5 0,5 0,5 0 0 0 0,5 0 0,5 0,5 0,5 0,5 0,5 0 0<br />
1 0,5 0,5 0,5 0,5 0 0,5 0 0,5 0 0,5 0,5 0,5 0 0<br />
Table 1. The scoring system of information regarding intellectual capital within<br />
Romanian listed entities in 2009<br />
(panel D)<br />
Structural/ Internal<br />
Capital<br />
Intellectual property<br />
(patents, copyrights,<br />
registered<br />
trademark)<br />
Transilvania Constructii<br />
SIF Banat Crisana<br />
SIF Moldova<br />
SIF Muntenia<br />
SIF Oltenia<br />
SIF Transilvania<br />
Sinteza<br />
Siretul Pascani<br />
SOCEP<br />
TMK Artrom<br />
Teraplast<br />
Titan<br />
Turbomecanica<br />
Turism Felix<br />
Turism Hoteluri Marea<br />
Neagra<br />
0,3 1 0,3 0,3 0,3 0,3 0,5 0,3 0 0,3 0,3 0,5 0 0,8 0,3<br />
0 1 0 0 0 0 0 0 0 0 0 0,5 0 1 0
Infrastructure assets<br />
(corporate culture,<br />
management of<br />
processes, IT<br />
system, networks<br />
systems, research<br />
projects, financial<br />
relations)<br />
Relational/ External<br />
Capital<br />
Customers<br />
(company’s<br />
customers, the<br />
loyalty of customers,<br />
customer relations,<br />
customer<br />
involvement,<br />
attracting new<br />
customers)<br />
The image of the<br />
company<br />
Supply and<br />
distribution channels<br />
(relations with<br />
suppliers and<br />
competitors)<br />
Cooperation<br />
(in business,<br />
research, concluded<br />
contracts)<br />
Concluded<br />
agreements<br />
(franchises, licenses)<br />
Transilvania Constructii<br />
SIF Banat Crisana<br />
SIF Moldova<br />
SIF Muntenia<br />
SIF Oltenia<br />
SIF Transilvania<br />
Sinteza<br />
~ 387 ~<br />
Siretul Pascani<br />
SOCEP<br />
TMK Artrom<br />
Teraplast<br />
Titan<br />
Turbomecanica<br />
Turism Felix<br />
Turism Hoteluri Marea<br />
Neagra<br />
0,5 1 0,5 0,5 0,5 0,5 1 0,5 0 0,5 0,5 0,5 0 0,5 0,5<br />
0,5 0,8 0,5 0 0,1 0 0,1 0,4 0,4 0,5 0,7 0,5 0,4 0,5 0,3<br />
0,5 1 1 0 0 0 0 0,5 1 1 1 1 0,5 1 0,5<br />
0 0,5 0 0 0 0 0 0,5 0 0 0,5 0 0 0 0<br />
1 1 1 0 0 0 0,5 0,5 1 1 1 1 0,5 1 0,5<br />
0,5 1 0,5 0 0,5 0 0 0,5 0 0,5 0,5 0,5 1 0 0<br />
0,5 0,5 0 0 0 0 0 0 0 0 0,5 0 0 0,5 0,5<br />
Human Capital 0,1 0,1 0,6 0,3 0,4 0,5 0,4 0,6 0,3 0,1 0,6 0,3 0,5 0,3 0,3<br />
Education 0 0 0,5 0 0,5 0,5 0 0,5 0 0 0,5 0,5 0 0 0<br />
Employees 0,5 0,5 1 1 1 0,5 1 1 1 0,5 1 0,5 1 1 1<br />
Work-related<br />
knowledge<br />
Work-related<br />
competencies<br />
0 0 0,5 0 0 0,5 0,5 0,5 0 0 0,5 0 0,5 0 0<br />
0 0 0,5 0 0 0,5 0 0,5 0 0 0,5 0 0,5 0 0
Table 1. The scoring system of information regarding intellectual capital within<br />
Romanian listed entities in 2009<br />
(panel E)<br />
UAMT<br />
UCM Resita<br />
UZTEL<br />
Structural/ Internal Capital 0,3 0 0,8 0,3 0,8 0,3 0,3 0 0,2<br />
Intellectual property<br />
(patents, copyrights, registered<br />
trademark)<br />
Infrastructure assets<br />
(corporate culture, management<br />
of processes, IT system,<br />
networks systems, research<br />
projects, financial relations)<br />
~ 388 ~<br />
Vae Apcarom<br />
Ves<br />
0 0 1 0 1 0 0 0 0,1<br />
0,5 0 0,5 0,5 0,5 0,5 0,5 0 0,3<br />
Relational/ External Capital 0,5 0,7 0,6 0,4 0,4 0,3 0,4 0,2 0,4<br />
Customers<br />
(company’s customers, the<br />
loyalty of customers, customer<br />
relations, customer involvement,<br />
attracting new customers)<br />
1 1 1 0,5 0,5 0,5 0,5 0 0,8<br />
The image of the company 0 0,5 0,5 0,5 0 0,5 0,5 0 0<br />
Supply and distribution<br />
channels (relations with<br />
suppliers and competitors)<br />
1 1 0,5 0,5 0,5 0,5 0,5 1 0,8<br />
Cooperation<br />
(in business, research,<br />
concluded contracts)<br />
0,5 0,5 0,5 0,5 0 0 0,5 0 0,2<br />
Concluded agreements<br />
(franchises, licenses)<br />
0 0,5 0,5 0 1 0 0 0 0,1<br />
Human Capital 0,5 0,4 0,5 0,5 0,4 0,4 0,1 0 0,3<br />
Education 0,5 0 0,5 0,5 0 0 0 0 0<br />
Employees 0,5 1 0,5 0,5 0,5 0,5 0,5 0 0,9<br />
Work-related knowledge 0,5 0 0,5 0,5 0,5 0,5 0 0 0,1<br />
Work-related competencies 0,5 0,5 0,5 0,5 0,5 0,5 0 0 0,1<br />
0 = the entities do not provide any information; 0.5 – the entities provide qualitative information; 1 – the entities provide<br />
quantitative information<br />
(Source: accomplished by authors)<br />
These variables have been encoded with the score (value) 0 when the variable is not<br />
included in the annual statement, 0,5 when the information is approached from a<br />
qualitative point of view, 1 when the information is approached quantitatively. In the end,<br />
we have calculated an average of scores and we have obtained a final scoring granted to<br />
entities for information supplied in the annual statements on intellectual capital according<br />
to Table 1.<br />
Vrancart<br />
Zentiva<br />
Zimtub<br />
TOTAL
Table 2. The analyzed elements of intellectual capital<br />
1. Internal capital 2. External capital 3. Human capital<br />
Intellectual property Customers Education<br />
1.1. Patents 2.1. Customers Employees<br />
1.2. Copyrights 2.2. Customer loyalty Work-related knowledge<br />
1.3. Trade-marks 2.3. Business collaboration Work-related competence<br />
Infrastructure assets 2.4. Customer involvement<br />
1.4. Corporate culture 2.5. Attracting new customers<br />
1.5. Management processes Entity reputation<br />
1.6. Information systems Supply and distribution channels<br />
1.7. Networking systems 2.6. Relationships with suppliers<br />
1.8. Research projects 2.7. Relationships with competitors<br />
1.9. Financial Contacts Collaborations<br />
2.8. Business collaboration<br />
2.9. Research collaborations<br />
2.10. Contracts<br />
Agreements<br />
2.11. Franchising agreements<br />
2.12. Licensing agreements<br />
(Source: adapted from Bozzolan et al., 2003)<br />
We can notice the low interest manifested by Romanian entities in reporting<br />
intellectual capital. Scorings obtained by the reports on elements within internal,<br />
external and human capital have been 0,21; 0,38, and 0,27, relatively small scorings,<br />
which signifies that most entities report insignificant information with regards to<br />
intellectual capital, information which are mostly qualitative, non-financial and nonmonetary,<br />
related to the components elements of intellectual capital. The scorings<br />
presented above were calculated using the following formulas:<br />
ScoringIC<br />
ScoringEC<br />
ScoringHC<br />
=<br />
=<br />
=<br />
⎛<br />
m<br />
n<br />
j<br />
∑<br />
i<br />
∑<br />
1<br />
⎜<br />
⎜ = 1<br />
⎜<br />
= 1<br />
⎜<br />
⎝<br />
⎛<br />
~ 389 ~<br />
n<br />
m<br />
n<br />
j<br />
∑<br />
i<br />
∑<br />
2<br />
⎜<br />
⎜ = 1<br />
⎜<br />
= 1<br />
⎜<br />
⎝<br />
⎛<br />
m<br />
n<br />
j<br />
∑<br />
i<br />
∑<br />
3<br />
⎜<br />
⎜ = 1<br />
⎜<br />
= 1<br />
⎜<br />
⎝<br />
ICDj<br />
m 1<br />
m 2<br />
n<br />
n<br />
ECDj<br />
HCDj<br />
m 3<br />
⎞<br />
⎟<br />
⎟<br />
⎟<br />
⎟<br />
⎠<br />
⎞<br />
⎟<br />
⎟<br />
⎟<br />
⎟<br />
⎠<br />
⎞<br />
⎟<br />
⎟<br />
⎟<br />
⎟<br />
⎠<br />
(1)<br />
(2)<br />
(3)
Where:<br />
ICDj/ECDj/HCDj = Internal Capital/External Capital/Human Capital dimensions<br />
(components considered for our research)<br />
m1 = Internal Capital dimension (2 analyzed components)<br />
m2 = External Capital dimension (5 analyzed components)<br />
m3 = Human Capital dimension (4 analyzed components)<br />
n = the analyzed population (68 analyzed entities)<br />
The scores obtained, using the prior formulas and according with Table 1 are<br />
presented in Table 3.<br />
Table 3. The obtained scores regarding the intellectual capital reporting<br />
Intellectual capital components Scoring<br />
Internal capital 0,21<br />
External capital 0,38<br />
Human capital 0,27<br />
(Source: accomplished by authors)<br />
We can observe from the scores obtained and presented above that the information<br />
regarding internal capital, external capital and human capital provided by the Romanian<br />
listed entities are qualitative information.<br />
Hence the question we have asked: Is there a lack of interest for intellectual capital’s<br />
components within Romanian listed entities, or more likely a lack for a reporting and<br />
evaluation framework for the intellectual capital which makes this information be<br />
considered irrelevant for the company? At the same time, the small percentage<br />
represented by reporting information on intellectual capital can be also explained by<br />
the fact that although management would like to provide more relevant and useful<br />
information to the public, they cannot act in such a way, because the danger of<br />
competitors’ „espionage” persists. As underlined by Williams (2001) as well, „such<br />
reporting can catch attention from undesired parts as well”. Therefore, although there<br />
are sufficient arguments to convince management that reporting information on<br />
intellectual capital is a necessity, they would not act because such reporting could<br />
affect the company in a negative way, in particular for the case where the intellectual<br />
capital groundwork is a poor one. On the other hand, the annual statement can<br />
indicate that one priority for the company consists in investing financial resources in<br />
the internal „production” or the purchase of new assets. Or, to the contrary, a report<br />
from a company disposing of little intellectual capital might have a negative impact<br />
on the company’s reputation on the stock market, because this way it can be<br />
considered unsuccessful.<br />
If we were to perform an analysis of information reported for the three groups of<br />
components related to intellectual capital, we should mention that:<br />
• according to expectations, aspects reported with regards to the internal structure<br />
were part of the field of research projects. Information related to intellectual<br />
property have not been reported, except on rare occasions, as they are irrelevant;<br />
• information regarding the external structure referred to four elements in<br />
particular: customers, company’s reputation, distribution chains, cooperation<br />
and licenses;<br />
~ 390 ~
• as for the human capital, four of the Romanian participating entities offered no<br />
information whatsoever for this topic. The most frequently reported element<br />
and the closest to human resource was the one regarding the number of<br />
employees, while the rest of annual reports were divided between the<br />
knowledge of human capital, competences thereof and the employees training.<br />
CONCLUSIONS<br />
In this paper we aimed to achieve the proposed objective, to present an accurate image<br />
of what intellectual capital represents for Romanian listed entities. In order to achieve<br />
the purpose of our study, we have made a content analysis, of annual reports of<br />
entities listed on the Bucharest Stock Exchanges, wherein we have monitored the<br />
three dimensions of the intellectual capital conceptual framework (internal capital,<br />
external capital and human capital) together with the related subcategories, using a<br />
modified version of Sveiby’s model.<br />
As a result of the study, we draw the conclusion that the treatment for intellectual<br />
capital framework in Romania is in an initial stage. Most Romanian entities handle<br />
this matter with indifference, reporting only certain information in connection to this<br />
subject, yet without creating an individual framework of reporting.<br />
Results obtained indicated that the national context is similar to the international<br />
context because there is no reporting framework for intellectual capital. Romanian<br />
listed entities do not have an agreed framework for preparing reports concerning the<br />
intellectual capital; most information related to intellectual capital has been presented in a<br />
discursive mode and not under monetary terms.<br />
During future research, we will consider the analysis of annual reports for a longer<br />
period of time, with a larger sample of listed entities on the national capital market or<br />
international capital market. For the time being, the limitation of the study is given by<br />
the relatively small population of entities participating to the analysis. Also, during<br />
future research we will have in view more elements of intellectual capital for the<br />
purpose of increasing the relevance of study.<br />
ACKNOWLEDGEMENTS<br />
This work was supported by CNMP, project number 92-085/2008. The project is entitled<br />
“Developing a functional model for optimizing the national strategy regarding financial<br />
reporting within Romanian private sector entities”.<br />
REFERENCES<br />
Amir, E. & Lev, B. (1996) “Value-relevance of non-financial information: the wireless<br />
communications industry”, Journal of Accounting and Economics, August-December: 3-30<br />
Bozzolan, S., Favotto, F. & Ricceri, F. (2003) “Italian annual intellectual capital disclosure: an<br />
empirical analysis”, Journal of Intellectual Capital, vol. 4, no. 4: 543-558<br />
Bontis, N. (2001) "Assessing knowledge assets: A review of the models used to measure intellectual<br />
capital", International Journal of Management Reviews, vol. 3, no.1: 41-60<br />
~ 391 ~
Bontis, N. (1999) "Managing organizational knowledge by diagnosing intellectual capital: Framing<br />
and advancing the state of the field", International Journal of Technology Management,<br />
vol. 18, no.5-8: 433-62<br />
Edvinsson, L. & Malone, M.S. (1997) Intellectual Capital: Realizing Your Company’s True Value<br />
by Finding Its Hidden Brainpower, HarperCollins, New York, NY<br />
Guthrie, J. & Petty, R. (2000) “Intellectual capital: Australian annual reporting practices”, Journal of<br />
Intellectual Capital, vol. 1, no. 3: 241-51<br />
Ittner C. (2008) „Does measuring intangibles for management purposes improve performance? A<br />
review of the evidence”, Accounting and Business Research, vol. 38, no. 3: 261-272<br />
Brennan, N. (2001) “Reporting Intellectual Capital in Annual Reports: Evidence from Ireland”,<br />
Accounting, Auditing & Accountability Journal, vol. 14, no. 4: 423-436<br />
Olsson, B. (2001) “Annual reporting practices: information about human resources in corporate<br />
annual reports in major Swedish companies”, Journal of Human Resource Costing &<br />
Accounting, vol. 6, no. 1: 39-52<br />
Bontis, N. (2000) “Assessing knowledge assets: a review of the models used to measure intellectual<br />
capital”, working paper, McMaster University, Hamilton<br />
O’Reagan, P., O’Donnell, D., Kennedy, T., Bontis, N. & Cleary, P. (2001) “Perceptions of<br />
Intellectual Capital: Irish Evidence”, paper submitted to: Birgitta Olsson, Editor, Journal of<br />
Human Resource Costing & Accounting, Personnel Economics Institute, School of Business,<br />
Stockholm University, S-106 91 Stockholm, Sweden<br />
Guthrie, J., Petty, R. & Ricceri, F. (2006) “The voluntary reporting of intellectual capital: comparing<br />
evidence from Hong Kong and Australia”, Journal of Intellectual Capital, vol. 7, no. 2: 254-71<br />
Guthrie, J., Petty, R., Ferrier, F. & Wells, R. (1999) "There is no accounting for intellectual capital in<br />
Australia: review of annual reporting practices and the internal measurement of intangibles<br />
within Australian organizations", International Symposium - Measuring and reporting<br />
intellectual capital: experience, issues and prospects, June: 9-10<br />
~ 392 ~
APPENDIX 1<br />
The analyzed entities<br />
Entities Field of activity<br />
1 Aerostar Manufacturing<br />
2 Alro Manufacturing<br />
3 Altur Manufacturing<br />
4 Alumil Rom Industry Wholesale and retail trade<br />
5 Amonil Manufacturing<br />
6 Antibiotice Manufacturing<br />
7 Armătura Manufacturing<br />
8 Azomureş Manufacturing<br />
9 Banca Comercială Carpatica Financial services<br />
10 Banca Transilvania Financial services<br />
11 Bermas Manufacturing<br />
12 Biofarm Manufacturing<br />
13 Boromir Prod Wholesale and retail trade<br />
14 BRD Financial services<br />
15 C.N.T.E.E Transelectrica Manufacturing<br />
16 Carbochim Manufacturing<br />
17 Casa de Bucovina Tourism<br />
18 Cemacon Manufacturing<br />
19 Comcm Manufacturing<br />
20 Comelf Manufacturing<br />
21 Compa Manufacturing<br />
22 Compania Energopetrol Constructions<br />
23 Condmag Manufacturing<br />
24 Contor Grup Constructions<br />
25 Dafora Mining and quarrying<br />
26 Electroaparataj Mining and quarrying<br />
27 Electroputere Manufacturing<br />
28 Farmaceutica Remedia Wholesale and retail trade<br />
29 Grupul Industrial Electrocontact Manufacturing<br />
30 Impact Developer & Contractor Constructions<br />
31 Mecanica Ceahlău Manufacturing<br />
32 Mechel Târgovişte Manufacturing<br />
33 Mefin Manufacturing<br />
34 MJ Mailis România Manufacturing<br />
35 Oil Terminal Transport<br />
36 Oltchim Manufacturing<br />
37 OMV Petrom Manufacturing<br />
38 Petrolexportimport Wholesale and retail trade<br />
39 Prodplast Mining and quarrying<br />
40 Romcarbon Manufacturing<br />
41 Rompetrol Rafinare Manufacturing<br />
42 Rompetrol Well Services Mining and quarrying<br />
43 S.N.T.G.N. Transgaz Transport<br />
44 S.S.I.F. Broker Financial services<br />
45 Şantierul Naval Orşova Manufacturing<br />
46 SIF Banat Crişana Financial services<br />
47 SIF Moldova Financial services
Entities Field of activity<br />
48 SIF Muntenia Financial services<br />
49 SIF Transilvania Financial services<br />
50 SIF Oltenia Financial services<br />
51 Transilvania Constructii Financial services<br />
52 Sinteza Manufacturing<br />
53 Siretul Paşcani Manufacturing<br />
54 Socep Transport<br />
55 T.M.K. Artrom Manufacturing<br />
56 Teraplast Manufacturing<br />
57 Titan Manufacturing<br />
58 Turbomecanica Manufacturing<br />
59 Turism Felix Tourism<br />
60 Turism, hoteluri, restaurante Marea Neagră<br />
Tourism<br />
61 UAMT Manufacturing<br />
62 UCM Reşiţa Manufacturing<br />
63 Uztel Manufacturing<br />
64 Vae Apcarom Manufacturing<br />
65 Ves Constructions<br />
66 Vrancart Manufacturing<br />
67 Zentiva Manufacturing<br />
68 Zimtub Manufacturing<br />
(Source: accomplished by authors)<br />
~ 394 ~
DETERMINANTS OF INTELLECTUAL CAPITAL<br />
DISCLOSURE IN THE CASE OF ROMANIAN<br />
COMPANIES<br />
Maria Cristina MORARIU 1<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
After reviewing the literature in area of intellectual capital disclosure (ICD) and<br />
determinants of ICD we acknowledged the need for conducting similar studies in the case of<br />
Romanian companies listed on the Bucharest Stock Exchange (BSE). Consequently, we carry<br />
out a content analysis of the annual reports of Romanian companies having as a primary<br />
objective the assessment of the extent to which they disclose information in respect of the<br />
intellectual capital (IC). Furthermore, using descriptive statistics, T test, Pearson correlation<br />
and multiple regression analysis we are testing if determinants like company size and industry<br />
type have influenced the disclosure of IC. Achieving this, we believe that our study contributes<br />
to the ICD literature, represents a basis for comparison with the results of other studies from<br />
other developing countries; it challenges researchers to extend the area of analysis by<br />
considering the relation between ICD and other possible determinants.<br />
KEYWORDS: intellectual capital, disclosure, determinants, intangible assets, reporting,<br />
Romania<br />
INTRODUCTION<br />
In time, economists such as Walras and Fisher considered human beings, or their<br />
acquired abilities and skills (English Classical School) as a component of capital<br />
(Kiker, 1966; Kendrick, 1961). Their reasons for inclusion were: (1) the cost of<br />
rearing and educating human beings is a real cost; (2) the product of their labour adds<br />
to the national wealth; (3) an expenditure on a human being that increases this product<br />
will, ceteris paribus, increases national wealth (Kiker, 1966: 485). In our days,<br />
perspective has changed in the way that researchers and practitioners concentrate their<br />
attention on the abilities and skills embedded in the human beings. By doing so, in<br />
time a new concept has been born, developed and continues to challenge practitioners<br />
and researchers: intellectual capital (IC).<br />
The concept of IC was advanced by Adam Mueller, Friedrich List (Kendrick, 1961:<br />
105) and referred to technical knowledge, know-how, forms of organization and<br />
tangible capital goods. It is the result of investment in the discovery and the spread of<br />
productive knowledge. In 1997, Stewart defines it as “packaged useful knowledge”<br />
that includes the organization’s processes, technologies, patents, employees’ skills<br />
1 Correspondencce address: Cristina Maria MORARIU, The Academy of Economic Studies,<br />
Bucharest, Department of International Accounting and Financial Reporting;<br />
email: cristina.m.morariu@gmail.com<br />
~ 395 ~
and information about customers, suppliers and stakeholders (Luthy, 1998: 4). In<br />
1996, Brooking defines IC as combined intangible assets that enable the company to<br />
function and comprises market assets, intellectual property assets, human – centred<br />
assets, infrastructure assets (Luthy, 1998: 4). In Edvinsson and Malone’s view, IC is<br />
formed of human capital and structural capital (customer, organizational, innovation<br />
and process capital) and considers it as debt issue (Lonnqvist, 2002). OECD defines<br />
IC as human capital and structural capital, where the former refers to software,<br />
distribution and supply chain, and the latter refers to employee’s resources, customers<br />
and suppliers (Lonnqvist, 2002). Lonnqvist (2002: 14) by considering it as a synonym<br />
of intangible assets defines IC as immaterial sources of value related to employees’<br />
capabilities, organization’s resources and the way of operating them and the<br />
relationship with its stakeholders. Some authors (Roslender and Fincham, 2001: 387)<br />
are saying that IC is the “new” goodwill, something that the business builds up over<br />
time, and which provides the major foundation for its continued competitive<br />
advantage. According to other studies, (Stanciu, 2008, Morariu, 2010) IC is an<br />
underlying characteristic of the employees, from which future benefits are expected to<br />
flow to the company and that encompasses the followings: skills, capabilities,<br />
experience, knowledge and last but not least morality. Ricceri (Striukova et al., 2008)<br />
launches the idea according to which IC encompasses both resources that exist at a<br />
particular point in time (a stock of IC) and the fluid way these resources are used and<br />
interact with other resources to achieve the organisation’s goal. In 1997 Sveiby<br />
(Guthrie and Petty 2000: 242) developed a framework for understanding IC that<br />
classifies intangibles into three parts: internal structure (consisting of items such as<br />
patents, concepts, models research and development, computer and administrative<br />
systems, organizational culture and spirit), external structure (relationships with<br />
customers, suppliers, brand names, trademarks, reputation) and employee competence<br />
(education, skills, training, values, experience). The difficulty of defining IC and the<br />
multiple understandings assigned to this concept made that reporting of IC to be a<br />
challenging task for both the reporters and for the users of information. Numerous<br />
studies investigated the quantity an the quality of information that companies provide<br />
in respect of IC (Guthrie and Petty, 2000; Brennan, 2001; Bontis, 2003; Goh and Lim,<br />
2004; Abdolmohammadi, 2005; Wong and Gardner, 2005; Bozzolan et al., 2006;<br />
Vergauwen et al., 2007; Ax and Marton, 2008; Bruggen, 2009; Yau et al., 2009;<br />
White et al., 2010; Oliveira et al., 2010; Yi and Davey, 2010; Ousama and Fatima,<br />
2010; Branco et al., 2011; Singh and Kansal, 2011) and several studies were carried<br />
out to provide evidence regarding the factors that my have contributed to the<br />
disclosure of IC (Bruggen, 2009; Orens et al., 2009; Yau et al., 2009; Rimmel<br />
et al., 2010; Sharabati et al., 2010; Oliveira et al., 2010; Huang et al., 2010; Branco<br />
et al. 2011).<br />
The number of the above studies carried out in different countries and even different<br />
continents corroborated with the lack of literature in the case of Romanian companies,<br />
challenged us to the present paper. Hence, we carry out a study that has two major<br />
objectives: to analyse the quantity and the quality of IC items made in the annual<br />
reports of the sample companies; and to focus on the analysis of the determinants of<br />
ICD for the same sample companies. Twenty one annual reports as at 31 December<br />
2009 of Romanian companies listed on the Bucharest Stock Exchange were collected,<br />
and represented the sample companies. IC framework used in this study is a<br />
combination of that used by Guthrie and Petty (2000) and the framework resulted<br />
~ 396 ~
from the work performed by a panel of researchers from the World Congress on<br />
Intellectual Capital (WCIC). The resulted framework is composed of 33 IC items.<br />
Regarding the methodology, in order to achieve our first objective, we conducted a<br />
content analysis considering both the number and the location of the 33 IC items<br />
classified under three captions: internal (structural capital), external capital and human<br />
capital. For the second objective, an IC disclosure index (ICD_Index) was constructed<br />
for each company which had a common base containing the 33 IC items. Results<br />
obtained for ICD_Index are used when testing (through descriptive statistics, T test,<br />
Pearson correlation and multiple regression analysis) whether certain factors such<br />
company size and industry type influence ICD.<br />
Being a pioneering study, our paper contributes to the ICD literature by providing<br />
empirical evidence of the status of IC reporting and of determinants of ICD in a<br />
developing country context. In addition, the results obtained represent a basis for<br />
comparison with those obtained by other studies carried out in other developing<br />
countries; can be used in Meta analysis and challenges researchers to extend the area<br />
of analysis by considering the relation between ICD and other possible determinants.<br />
To address our objectives, the paper is structured as follows: the next section briefly<br />
explores the relevant research studies carried out in the area of ICD and the<br />
determinants of ICD using the results therein as arguments for our hypothesis<br />
development. The following section then explains the research methodologies used to<br />
conduct the empirical analysis. Independently, another section presents and examines<br />
the results of the research. The final section provides a summary of the paper<br />
including conclusions and also discussing the key limitations of the study and future<br />
research implications of its findings.<br />
1. LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT<br />
The central research questions that are addressed by this paper can be presented as<br />
follows: “What is the nature and extent of ICDs made by public Romanian<br />
companies?” and “What are the key drivers of voluntary disclosure?”<br />
There are several studies investigating the quantity and the quality of information that<br />
companies provide in respect of IC and several studies carried out aiming to provide<br />
evidence regarding the factors that may have contributed to the disclosure of IC. Few<br />
examples of such studies are summarised below in chronological order. Guthrie and<br />
Petty (2000) analysed the ICD practices in the case of 19 Australian companies and<br />
found that internal capital and human capital are quite evenly matched (30%) while<br />
external capital is the most disclosed with 40%. Brennan (2001) examines to what<br />
extent Irish listed companies report IC information within their annual reports. As a<br />
result of conducting content analysis on 10,000 Canadian companies, with the<br />
objective to identify instances in which ICDs took place, Bontis (2003) found that<br />
only 68 companies out of 10,000 even used the IC terms in their annual report.<br />
Findings from Malaysia (Goh and Lim 2004) reveal the fact that companies in<br />
Malaysia follow the trend of other countries to include IC information in their annual<br />
reports in the way that external capital had been mostly disclosed (41%).<br />
Abdolmohammadi (2005) investigates the nature and extent of ICD within the annual<br />
reports of US companies. Findings from this study reveal that IC categories “Brand”<br />
~ 397 ~
(external capital), “Competence” (human capital), “Partnership” (external capital) and<br />
“Intellectual Property” (internal) were IC attributes with the highest frequency of<br />
disclosure. Having the same objective, Wong and Gardner (2005) analyzed the annual<br />
reports of 60 companies from New Zeeland and acknowledged that external capital is<br />
the most IC category disclosed with 48%. Bozzolan et al. (2006) compared ICD<br />
practices of 30 Italian firms and 30 UK firms and concluded that sample companies<br />
from both countries voluntarily disclose a substantial amount of information about<br />
their IC. With regard to the relative importance of the three categories of ICD, the<br />
focus on external structure ranks highest (52.38% for Italian firms and 60.22% for UK<br />
firms). Analysing 60 firms from Sweden, Denmark and UK, Vergauwen et al. (2007)<br />
found that relational capital has the highest amount of disclosure (46%). Disclosures<br />
of IC were analysed by Ax and Marton (2008) in order to study the association<br />
between human capital disclosure and human capital management practices and<br />
carried out a content analysis on 27 Swedish companies. Bruggen et al. (2009)<br />
analyzed 125 listed Australian companies and found that structural capital is the most<br />
frequently disclosed category (97.5%). Yau et al. (2009) examines the extent and<br />
nature of voluntary intellectual capital (IC) disclosure by 60 public companies in<br />
Malaysia and how the disclosure may be explained by the economics or other<br />
rationale of corporate disclosure. Feleaga et al. (2010) analysis the annual report of 18<br />
companies from 6 European countries and concluded that internal capital with 42% is<br />
the most disclosed IC category, followed by external capital with 34% and employee<br />
competence with 24%.<br />
Even if most of the studies are carried out in the area of ICD, there are several ones<br />
considering the factors that may determine companies to disclose IC. According to the<br />
previous literature, the following factors have been tested so to confirm whether they<br />
influence ICD: company size, industry type, information asymmetry, leverage,<br />
ownership, company’s age, profitability, nationality, auditor type, listing status,<br />
foreign activity. The empirical evidence has sometimes shown a clear positive<br />
relationship (size; capital intensity; foreign listing; internationality; ownership<br />
structure) and sometimes a mixed relationship (leverage, audit firm size, profitability)<br />
with levels of ICD.<br />
When trying to determine the extent of intellectual capital disclosure practices in the<br />
case of a sample of 30 Swedish listed companies, Beaulieu et al. (2002) considered<br />
the effect of three variables: size, profitability, and industry classification. The<br />
empirical results indicate that only size is significantly associated with the disclosure<br />
of intellectual capital items.<br />
To provide some empirical insights to the factors that might explain the type and<br />
amount of information disclosed about intangibles, Bozzolan et al. (2003) tested the<br />
influence of size and industry on the extent and the content of ICDs. They found that<br />
size and industry seemed to explain differences in IC reporting behaviour among<br />
Italian companies. Extending the research in the field of ICD by considering a<br />
comparison between Italian and UK firms, Bozzolan et al. (2006) considers more<br />
variables that could possibly influence the level of IC disclosure that are to be: size,<br />
industry type, leverage, ownership, profitability, and nationality. The results of the<br />
study reveal a modest support for industry type influencing ICD and that firm size<br />
influences ICD. Against expectations, the study finds no support for nationality<br />
variable on ICD.<br />
~ 398 ~
Garcia-Meca et al. (2005) used univariate analysis and found a positive relation<br />
between a proactive intangibles disclosure strategy (in presentations to sell-side<br />
analysts) and size, international listing, market-to-book ratio and type of meeting.<br />
They also used multivariate analysis and found that while leverage, profitability,<br />
industry and an investor relations department have no influence on the extent of<br />
disclosure of intangibles, a partial variation was explained by firm size and type of<br />
meeting.<br />
In their paper, Oliveira et al. (2006) study the disclosure practices in the case of 56<br />
Portuguese companies and identify size, industry type, ownership structure, audit type<br />
and listing rules as key variables of interest. Leverage, profitability and foreign<br />
activity don’t seem to influence ICD. In line with their results are those obtained by<br />
Branco et al. (2011) that find size and industry to be explanatory variables for the<br />
extent of ICD in the case of Portuguese companies after investigating ICD both in<br />
annual reports and on the internet.<br />
Boesso and Kumar (2007) examine what factors in addition to the needs of financial<br />
markets drive the voluntary disclosure practices of companies in Italy and United<br />
States. Results show that in addition to investors’ information needs, factors such as<br />
company emphasis on stakeholder management, relevance of intangible asset, and<br />
market complexity affect both the volume and the quality of voluntary disclosures.<br />
White et al. (2007) are using an ICD index score of voluntary disclosures to test<br />
statistically the relationship between voluntary disclosures and traditional agency<br />
theory variables in the case of 96 biotechnological Australian listed companies. The<br />
key drivers of voluntary ICDs were the level of board independence, firm age, level of<br />
leverage and firm size. By extending the research, White et al. (2010) compare the<br />
nature and extent of voluntary ICDs in the case of 156 UK and Australian<br />
biotechnology companies. Considering the same continent, Bruggen et al. (2009) are<br />
examining the determinants of the decision to disclose IC in annual reports in the case<br />
of 125 Australian listed companies. The paper finds that industry type and firm size<br />
play a key role as a determinant for the disclosure of intellectual property in annual<br />
reports and no relationship between the level of information asymmetry and ICD.<br />
Orens et al. (2009) are conducting a content-analysis of corporate web sites from four<br />
continental European countries (Belgium, France, Germany and The Netherlands) on<br />
the presence of IC information. The data show that IC disclosure is positively<br />
associated with firm size, lower information asymmetry, and leverage.<br />
As opposite to the results obtained before, in other countries, are the results obtained<br />
by Rimmel et al. (2009). The authors applied a disclosure index regarding IC included<br />
in the IPO prospectuses of Japanese companies to test whether industry type,<br />
ownership structure prior to the IPO, company age and company size influenced<br />
disclosure. The results show that the first three factors (industry, ownership and size)<br />
are not significant when it comes to explaining voluntary disclosure of information.<br />
Nevertheless, company age, did, however, have a significant influence on the extent<br />
of disclosure for Japanese companies. Similar results are obtained by Huang et al.<br />
(2010) but in the case of availability of internal IC information in the case of<br />
Malaysian companies. With the aim to explore several contingency variables<br />
(environmental uncertainty, business strategy, and technological advancement, market<br />
~ 399 ~
to book ratio, size, profitability and industry type) in the context of management<br />
accounting and the availability of internal IC information, the authors developed a<br />
questionnaire that was posted to managers of Malaysian companies. It is found that<br />
industry and size are not significantly related to the availability of internal IC<br />
information in Malaysian companies.<br />
Table 1 below presents a summary of the features of the studies concerned with the<br />
determinants of ICD.<br />
Table 1. Feature of studies analysing the determinants of ICD<br />
Authors Year Country Size<br />
Industry<br />
type<br />
Info<br />
Auditor Listing Foreign<br />
Asymmetr Leverage Ownership Age Profitability Nationality type Status Activity<br />
~ 400 ~<br />
Business Business Techn<br />
Complexit Strategy Adv<br />
P. R. Beaulieu et al. 2002 Sweden yes no n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a<br />
S. Bozzolan et al. 2003 Italy yes yes n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a<br />
Garcıa-Meca et al. 2005 Spain yes no n/a no n/a n/a no n/a n/a yes n/a n/a n/a n/a<br />
S. Bozzolan et al. 2006 Italy and UK yes yes n/a no no n/a no no n/a n/a n/a n/a n/a n/a<br />
L. Oliveira et al. 2006 Portugal yes yes n/a no yes n/a no n/a yes yes no n/a n/a n/a<br />
G. Boesso and K.<br />
Kumar<br />
2007<br />
Italy and United<br />
States<br />
yes yes n/a n/a n/a n/a n/a n/a n/a n/a n/a yes n/a n/a<br />
G. White et al. 2007 Australia yes n/a n/a yes yes n/a no n/a n/a n/a n/a n/a n/a n/a<br />
A. Brüggen et al. 2009 Australia yes yes no n/a n/a n/a n/a no n/a n/a n/a n/a n/a n/a<br />
R. Orens et al. 2009<br />
Belgium,<br />
France,<br />
Germany and<br />
The Netherlands<br />
yes n/a yes yes n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a<br />
G. Rimmel et al. 2009 Japan no no n/a n/a yes yes n/a n/a n/a n/a n/a n/a n/a n/a<br />
G. White et al. 2010 Australia & UK yes n/a n/a no n/a n/a n/a yes n/a n/a n/a n/a n/a n/a<br />
C. C. Huang et al. 2010 Malaysia no no n/a n/a n/a n/a no n/a n/a no n/a n/a yes yes<br />
M. C. Branco et al. 2011 Portugal yes yes n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a<br />
Total studies where the<br />
variable was tested<br />
13 10 2 6 4 1 5 3 2 3 1 1 1 1<br />
Total studies where the<br />
variable influences ICD<br />
11 6 1 2 3 1 0 1 2 2 0 1 1 1<br />
% Studies where variable was<br />
tested/Total Studies<br />
% Studies where variable<br />
100% 77% 15% 46% 31% 8% 38% 23% 15% 23% 8% 8% 8% 8%<br />
influences/Total Studies<br />
variable was tested<br />
85% 60% 50% 33% 75% 100% 0% 33% 100% 67% 0% 100% 100% 100%<br />
Legend:<br />
yes means that the variable was tested and that it influences ICD;<br />
no means that the variable was tested but that it does not influences ICD;<br />
n/a means that the variable was not tested<br />
According to the mixed results obtained by previous studies we can observe that the<br />
determinants of ICD are not clearly shown, yet. In addition, Romanian companies<br />
were not the subject of a similar study at all. Like studies made by Beaulieu et al.<br />
(2002), Bozzolan et al. (2003; 2006), Garcıa-Meca et al. (2005), Oliveira et al. (2006),<br />
Boesso and Kumar (2007), Bruggen et al. (2009), Orens et al. (2009), Branco et al.<br />
(2011) we propose that company size is an important factor for IC disclosure in the<br />
case of Romanian companies as larger companies can afford the cost to provide this<br />
voluntary information. In addition, size is the most commonly used independent<br />
variable as all 13 studies reviewed (see Table 1) considered it in their analysis and<br />
85% of the studies showed that there is a positive correlation between the size of the<br />
company and the level of ICD. All these arguments lead to our first null hypothesis:<br />
H1: There is no relation between company size and IC disclosure<br />
Prior research has also noted that voluntary disclosures are influenced by industry<br />
membership. It has been found that voluntary disclosures are more frequent and
comprehensive in some industries, such as, utility, and financial services, than others,<br />
such as, publishing. Literature provides complementary interpretation keys for<br />
explaining the industry effect on corporate disclosure: this is because proprietary costs<br />
vary across industries (Meek et al, 1995); firms are pressed to disclose industryrelated<br />
information in their annual reports (Cooke, 1992) by external investors who<br />
need information on a company’s relative position in an industry in order to assess<br />
company value (Dye, 1985); disclosure within an industry may also be shaped by the<br />
behaviour of a dominant company (Cooke, 1992); the international exposure of a<br />
particular industry might affect the extent of disclosure (Raffournier, 1995);<br />
intellectual capital is in some industries more important than in others and therefore<br />
value-relevant for investors. The results obtained with respect to the variable industry<br />
type are mixed, in the way that the studies reviewed which considered that industry<br />
type is a determinant for ICD (Bozzolan et al., 2003, Bozzolan et al., 2006, Oliveira et<br />
al., 2006, Boesso and Kumar, 2007, Bruggen et al., 2009, Branco et al., 2011) were<br />
almost balanced by the number of studies that concluded industry type does not have<br />
influence on ICD (Beaulieu et al., 2002, Garcıa-Meca et al., 2005, Rimmel et al.,<br />
2009, Huang et al., 2010). This, corroborated with the fact that 77% of the studies<br />
tested this correlation, brought us to the following null hypothesis:<br />
H2: There is no relation between type of industry (traditional versus knowledge<br />
intensive) in which the company is operating and IC disclosure<br />
Last but not least, we test whether there is any combination between company size<br />
and industry type that may have influenced the level of ICD and formulate the<br />
following hypothesis:<br />
H3: There is no relation between the combination of company size and industry<br />
type and IC disclosure<br />
2. RESEARCH METHODOLOGY<br />
This section contains a description of (1) the sample and data selection; (2) the<br />
content analysis used to assess the quantity and the quality of ICD; (3) the<br />
methodology used to test if company size and industry type are determinants of the<br />
level of ICD.<br />
2.1. Data Selection<br />
There is evidence from prior studies that ICDs tend to be predominantly discursive in<br />
nature (Ax and Marton, 2008, Guthrie and Petty, 2000; Goh and Lim, 2004, Bukh et.<br />
al 2005). According to the results obtained by Petty et al. (2008), 68% of their<br />
respondents used the annual report to learn more about a company and as an aid to<br />
decision-making. This is consistent with the literature that positions the annual report<br />
as a key accountability document to stakeholders (Lang and Lundholm, 1993).<br />
According to Garcia-Mecca (2005) analysts and investors, draw on annual report<br />
information in their work and this is not only related to financial information, but also<br />
to non financial and narrative reporting. Additionally, much of the literature suggests<br />
annual reports as basis for gathering data. In order to provide comparison with these<br />
studies and future ones, this paper uses annual reports only. Information that is<br />
disclosed by other means, such as on websites is not included. In addition, this study<br />
~ 401 ~
analyses the quality of disclosures by examining the reporting theme, the form of<br />
disclosure (quantified or not) and location of disclosure (Guthrie et al., 2004).<br />
2.2. Sample<br />
Our sample consists of Romanian firms that are listed on BSE, where a total of 98<br />
companies are classified in four exchange segments: tier I (22), tier II (48), tier IIII<br />
(1), unlisted (27). For the purposes of our study, we consider the analysis of the<br />
annual reports in the case of companies traded within tier I. As the objective of our<br />
study is to analyse to what extend Romanian companies disclose IC information, we<br />
have eliminated foreign companies even if traded on BSE. Our final sample consists<br />
of 21 companies. The reason for including the tier I companies was that they are more<br />
likely to disclose more information and are generally more transparent. We believe<br />
that this sample allows general conclusions on publicly listed Romanian companies.<br />
For constructing a comparable framework with other studies, we have used for the<br />
classification of the Romanian sample companies into sectors of activity and<br />
industries, the classifications and the definitions provided by the Global Industry<br />
Classification Standard (GICS) at June 30, 2010. Accordingly, the sectors and<br />
industries that the sample companies belong to are: Materials sector (Metals &<br />
Mining, Chemical industry) with 3 observations, HealthCare sector (Pharmaceuticals)<br />
with 2 observations, Financial sector (Commercial Banks, Real Estate Management &<br />
Development, Capital Markets) with 10 observations, Utilities sector (Electric<br />
Utilities, Gas Utilities) with 2 observations, Industrials sector (Marine, Aerospace &<br />
Defence) with 2 observations, Energy sector (Oil, Gas & Consumable Fuels) with 2<br />
observations. Companies’ classification into sectors and industries has been revised<br />
independently by a second researcher. Furthermore, for the purposes of testing our<br />
hypothesis, the industries are classified into traditional industries (food, automobiles,<br />
chemicals, construction, electronics, manufacturing, oil, utilities, textile/clothing, and<br />
tourism/leisure) and knowledge intensive business services (KIBS) (internet<br />
application provision, biotechnology, entertainment, IT distribution, high tech<br />
manufacturing, media, retail, software, systems integration, telecommunications, and<br />
web services. Accordingly from this perspective we shall have nine observations<br />
under traditional industry category and 12 observations under knowledge intensive<br />
industry. The Table 3 at the end of this section provides us with a picture of the<br />
companies classified under both criteria: GICS versus KIBS classification criteria.<br />
2.3 Methodology used to assess the quantity and the quality of ICD<br />
As many previous studies carried out in this field (Petty et al., 2008; Bruggen et al.,<br />
2009; Goh and Lim, 2004; Boesso and Kumar, 2007; Striukova et al., 2008) we<br />
conduct a content analysis to scrutinize the IC reporting practices of the sample<br />
companies. As a technique, it involves codifying information into pre-defined<br />
categories in order to derive patterns in the presentation and reporting of information<br />
(Guthrie and Petty, 2000: 245). For a content analysis to be effective there needs to be<br />
clearly defined decision rules and a clear understanding of the coding framework<br />
(Wong and Gardner, 2005). In this research, phrases are viewed to be the most<br />
reliable and complete unit of analysis, as individual words have little meaning without<br />
context. Choosing phrases also eliminates one’s concern that content analysis<br />
overemphasises quantity over quality through simple word counting. To ensure<br />
~ 402 ~
eliable data, a rigorous and transparent coding procedure was undertaken by two<br />
different coders. Each coder was given clear and transparent coding procedures to be<br />
followed, respectively: only code for voluntary disclosure, code for meaning rather<br />
than exact words as concepts are broad, code only for positive and negative meanings.<br />
Discrepancies were analysed for size and for resolution.<br />
The content analysis involved coding the information in accordance with a selected<br />
framework of IC indicators. The IC framework was derived from the one used by<br />
Guthrie and Petty (2000). For the purpose of our study, we modified this IC<br />
framework to achieve a better comparison with other studies. As such, we kept the<br />
headings and the items used by Guthrie and Petty, but we have added extra items<br />
identified in the framework resulted from the work performed by a panel of<br />
researchers from the World Congress on Intellectual Capital (WCIC) (Bontis 2003).<br />
Professional judgment was used to eliminate redundancies between these two<br />
frameworks. The resulting IC items are presented in Table 2.<br />
Table 2. Categories of IC used for this study<br />
Internal (Structural) Capital External (customer/relational) capital Emplyoee competence (human capital)<br />
Intellectual Property Brand Know how (Employee know-how)<br />
Patents Customers (Customer knowledge) Education (Employee Knowledge)<br />
Copyrights Customer loyalty (Customer capital) Skills - vocational qualification (Employee Skills)<br />
Trademarks Company names (Company Reputation) Work-related knowledge (Expertise)<br />
Infrastructure asset Distribution channels Work-related competencies (Productivity)<br />
Management philosophy Business collaboration Entrepreneurial spirit<br />
Corporate Culture (Organisational Culture) Licensing agreeements Human Capital<br />
Management processes (Management<br />
Quality)<br />
Favourable contracts Human Assets<br />
Information Systems Franshising agreements<br />
Networking systems (Expert Networks) Relational Capital<br />
Financial Relations<br />
Corporate University/Corporate learning<br />
Cultural diversity<br />
Structural Capital<br />
Supplier Knowledge<br />
The brackets present the terminology used by the researchers from the WCIC<br />
corresponding to the one used by Guthrie and Petty (2000). Items that didn’t overlap<br />
were added to those already existing obtaining in this way a total of 33 IC items<br />
(14 for internal capital, 11 for external capital and 8 for human capital). This<br />
extension allowed us to measure both the level of disclosing IC components and to<br />
ascertain whether companies disclose the word itself, the latter finding being a proof<br />
of the importance that companies give to IC. The method used was for one researcher<br />
to read the annual reports and record information related to each attribute (location,<br />
quantity and nature of the information) on a coding sheet. A second coder<br />
independently confirmed the score of each company. This gives a high degree of<br />
confidence in the overall result. Our content analysis focuses on voluntary<br />
information (that is it is not required by an accounting standard or corporation law).<br />
This is consistent with other ICDs studies (Guthrie and Petty, 2000; Brennan, 2001;<br />
Ax and Marton, 2008).The results represent a matrix of information identifying the<br />
incidence of IC reporting across 33 IC attributes, which was used to facilitate an<br />
overall assessment of the extent to which IC is reported by Romanian listed<br />
companies. Considering the limited length of annual report as cost and design reasons<br />
limit the number of pages, volume or disclosure of a particular item signals how<br />
important it is considered to be (Striukova et al., 2008). Although content analysis is a<br />
~ 403 ~
source of rich data, it is labour intensive and time consuming methodology (Boesso<br />
and Kumar, 2007; Striukova et al. 2008). As such, it is fairly common to find a<br />
relatively small sample size in studies using this methodology<br />
2.4 Methodology used for the analysis of the determinants of ICD<br />
In order to analyse the determinants of ICD, we constructed an IC disclosure index<br />
(ICD_Index) for each company which had a common base containing the 33 IC items.<br />
In constructing the disclosure index, dichotomous scoring for each of the 33 IC items<br />
was used (disclosure =1, non-disclosure =0). Hence, the maximum possible score<br />
attainable by a company was 33 with a minimum theoretical score of 0. Furthermore,<br />
ICD_Index is used to test (through descriptive statistics, T test, Pearson correlation and<br />
multiple regression analysis) whether certain factors such company size and industry<br />
type influence ICD.<br />
2.4.1 Measure of ICD_Index (dependent variables)<br />
Based on the total of the 33 IC items, we are constructing a weighted disclosure index<br />
calculated in accordance with the following formula:<br />
n<br />
∑<br />
i=<br />
1<br />
ICD_Index = ( di / M ) x100<br />
percent<br />
Where ICD_Index is the disclosure index dependent variable, di expresses item i<br />
when the item’s value is 1 with disclosure and 0 when there was no disclosure, and M<br />
is 33 (the total number of items being measured).<br />
2.4. 2 Measure of company size and industry type (independent variables)<br />
This section describes how the independent variables are measured.<br />
Size: Researchers have commonly used different measures such as sales, revenue,<br />
asset, and number of employees, as proxies for company size. Alternative proxies of<br />
firm size include total assets (Oliveira et al., 2006; Bruggen et al., 2009); turnover<br />
(Bozzolan et al., 2003; Bozzolan et al., 2006; Oliveira et al., 2006); market<br />
capitalization (Garcıa-Meca et al., 2005; Oliveira et al., 2006; White et al., 2007;<br />
White et al., 2010); and number of employees (Oliveira et al., 2006; Boesso and<br />
Kumar, 2007; Huang et al., 2010). While market capitalization is a market-related<br />
characteristic, the other three proxies are structure-related characteristics. For our<br />
study we shall use as a proxy the company turnover (sales) for the year ending 31<br />
December 2009 as we consider turnover to give us the market share no matter what<br />
market one may refer to. Total assets are not that relevant unless comparison is made<br />
within the same industry; the number of employees is less relevant as there industry<br />
types that can be more labour intensive than other. For the purposes of our study, size<br />
is measured as the natural logarithm of the firm’s sales taken from annual reports as of<br />
31 December 2009.<br />
Industry type: To capture the influence of industry on the voluntary disclosure of<br />
intangibles information, we use a dichotomous variable (applying 1 for firms<br />
belonging to high intangibles intensive industries; and 0 otherwise). Similar to other<br />
studies in this area, we separate between traditional industries such as food,<br />
automobiles, chemicals, construction, electronics, manufacturing, oil, utilities,<br />
~ 404 ~
textile/clothing, and tourism/leisure, and non-traditional Knowledge intensive<br />
industries such as internet application provision, biotechnology, entertainment, IT<br />
distribution, high tech manufacturing, media, retail, software, systems integration,<br />
telecommunications, and web services. In general, intangible assets are assumed to<br />
play a more important role in non traditional industries whereas traditional industries<br />
depend more on tangible assets. It is expected that industries with high levels of<br />
intangibles will voluntarily provide more information about intangibles, consistent<br />
with prior studies. Table 3 below is presenting the companies analysed classified<br />
according to traditional versus knowledge intensive criteria.<br />
KIBS<br />
Criteria<br />
GICS<br />
Criteria<br />
Table 3. Companies classified under the KIBS and GICS criteria<br />
Traditional Industry Knowledge Intensive Knowledge Intensive Traditional Industry Traditional Industry Traditional Industry<br />
Materials sector<br />
(Metals & Mining,<br />
Chemical industry)<br />
HealthCare sector<br />
(Pharmaceuticals)<br />
Financial sector<br />
(Commercial Banks, Real<br />
Estate Management &<br />
Development, Capital<br />
Markets)<br />
~ 405 ~<br />
Utilities sector<br />
(Electric Utilities, Gas<br />
Utilities)<br />
Industrials sector<br />
(Marine, Aerospace &<br />
Defence)<br />
Energy sector (Oil,<br />
Gas & Consumable<br />
Fuels)<br />
No of<br />
companies<br />
3 2 10 2 2 2<br />
Company<br />
name<br />
ALRO S.A. ANTIBIOTICE S.A.<br />
BANCA COMERCIALA<br />
CARPATICA S.A.<br />
C.N.T.E.E.<br />
SOCEP S.A.<br />
TRANSELECTRICA<br />
S.N.T.G.N.<br />
OIL TERMINAL<br />
S.A.<br />
AZOMURES S.A. BIOFARM S.A. BANCA TRANSILVANIA TRANSGAZ S.A.<br />
BRD - GROUPE SOCIETE<br />
TURBOMECANICA OMV PETROM<br />
OLTCHIM S.A. RM.<br />
GENERALE<br />
IMPACT DEVELOPER &<br />
CONTRACTOR S.A.<br />
S.S.I.F. BROKER S.A.<br />
SIF BANAT CRISANA<br />
SIF MOLDOVA S.A.<br />
SIF MUNTENIA S.A.<br />
SIF OLTENIA S.A.<br />
SIF TRANSILVANIA S.A.<br />
3. RESULTS AND ANALYSIS<br />
3.1 Results and analysis regarding the quantity and quality of ICD<br />
We first analyze the content of the annual reports. The results are shown in Table 4, at<br />
the end of this section, where the number of hits is summarized in accordance with the<br />
classification categories. We identified a total of 222 hits related to IC attributes.<br />
Internal (structural) capital is the most frequently disclosed category representing<br />
47.30% of IC attributes disclosed (105 hits out of 222), followed by the disclosures of<br />
the external (relational) capital with 27.48% (61 hits out of 222) and employee<br />
competence (human capital) with 25.22% (56 hits out of 222). When it comes to the<br />
nature of the information disclosed, a significant percentage of the information<br />
reported is qualitative 76% (169 hits out of 222) leaving the rest of 24% (53 hits out<br />
of 222) for quantitative IC attributes disclosure. Companies that disclosed most<br />
attributes in quantitative form are Transilvania Bank (for 6 attributes), Biofarm<br />
(for 5 attributes) and OMV Petrom (for 5 attributes). Each of these companies belong<br />
to different industries (Commercial Banks, Pharmaceuticals and Oil, Gas &<br />
Consumable Fuels), industry specific not being explanation for this. Results obtained<br />
confirm that Romanian listed companies are in line with other countries companies’<br />
disclosures trend in the way that ICDs are most of qualitative nature.
Furthermore, none of the 33 attributes scored 100% disclosure across sample<br />
companies. It means that no attribute was disclosed by all 21 companies. Out of the<br />
33 IC related terms considered for this study, only 22 terms appear in the annual<br />
reports of Romanian listed companies. The maximum number of attributes disclosed<br />
per company is 15 (is the case of Impact Developer and Contractor and OMV<br />
Petrom), followed by a number of 13 attributes disclosed in the case of Alro and 12 in<br />
the case of Antibiotice. Of those 22 terms, “Management philosophy” is disclosed<br />
most frequently with 46 hits in the annual reports of 18 Romanian companies.<br />
Considering the total sample of 21 companies, the number of companies disclosing<br />
“Management philosophy” implies IC consciousness (86% of the sample companies).<br />
However, these companies did not give a value to this attribute. “Work-related<br />
knowledge” (Employee Expertise, Expert Teams) is the second most frequently<br />
reported term with 23 hits in the annual reports of 15 companies. In this case<br />
12 companies (80% from the total of 15 companies) assigned a quantitative value to<br />
this attribute with 15 hits out of 23 being quantitative not qualitative. In addition,<br />
work-related knowledge attribute is the attribute with the highest number of<br />
quantitative information assigned (15 hits out of a total of a 53 quantitative<br />
information hits). Still, in-depth analysis shows that about 65% of the hits for this<br />
attribute are quantitatively disclosed (15 hits out of the 23 hits) which does not make<br />
the “Work-related knowledge” attribute the leading item, but the “Education” one.<br />
This latter attribute, “Education” is the third most frequently disclosed term in annual<br />
reports with 18 hits in the annual reports of 11 companies. Out of these 11 companies,<br />
8 companies (73%) assigned a quantitative value to this attribute with 12 hits out of<br />
18 hits (67%) being quantitative not qualitative. Out of the 33 attributes, the ones with<br />
the lowest disclosure frequency were: “Networking systems (Expert Networks)” with<br />
1 hit disclosed by one company (Transilvania Bank), “Favorable contracts” with 2 hits<br />
both disclosed by one company (Impact Developer and Contractor) and<br />
“Entrepreneurial spirit” (Employee Value, Human Value) with 1 hit disclosed by one<br />
company (Alro).<br />
In terms of disclosure location, IC information is reported in diverse sections of the<br />
annual reports. Notably, this information is extensively mentioned in the director’s<br />
report and operations and activities’ description sections. This demonstrates<br />
companies’ concern for reporting IC. The variation in ICDs may be explained by<br />
differences in information production costs. An alternative explanation may be that<br />
firms focus their ICD on those IC elements that are most relevant for the company’s<br />
value creation process (Vergauwen et al., 2007: 1164). Below are examples quoted<br />
from annual reports.<br />
Internal (Structural) Capital<br />
Eighteen companies disclosed on the significance of management philosophy, while<br />
nine companies (43% out of full sample of 21 companies) disclosed on the importance<br />
of “Corporate University/Corporate learning”. The importance of “Corporate Culture”<br />
is also clearly shown as it is disclosed by 33% of the companies.<br />
Corporate University/Corporate learning attribute is reported by Transilvania Bank as:<br />
“Training on products and services comprises a large range of sessions provided to<br />
our staff to become thoroughly accustomed with the best possible practices to ensure<br />
customer satisfaction”. Annual Report, Human Resources section.<br />
~ 406 ~
External (customer/relational) capital<br />
Different attributes of external (customer/relational) capital category are disclosed by<br />
ten companies. Accordingly, “Distribution channels” is the most reported attribute as<br />
it is disclosed by ten companies (48% out of full sample of 21 companies), followed<br />
by “Business Collaboration” (43% of full sample companies) attribute reported by<br />
nine companies and by “Brand” (38% of 21 companies) attribute disclosed in the<br />
annual reports of eight companies.<br />
“Business Collaboration” is reported by Azomures as:<br />
“The distribution of the production on the internal market is realized 94% though a<br />
well established network of partners”. It explains how the collaboration with<br />
distributors allows the company to distribute virtually all of its production. Annual<br />
Report, section 1.1.2. Markets<br />
Employee competence (human capital)<br />
A maximum of 15 companies disclosed information on the significance of “Workrelated<br />
knowledge” (that is 71% of 21 companies), while 11 companies (52% out of<br />
full sample of 21 companies) disclosed on the importance of “Education”. The<br />
importance of “Skills” is also clearly shown by its disclosure in the annual report of<br />
6 companies (29% of the sample companies).<br />
“Work-related knowledge” as reported by Transgaz SA:<br />
“in 2009 (…) 1602 employees have been professionally qualified for jobs like<br />
electrician, welder (…)”.Annual Report, page 20.<br />
Company name<br />
Alro<br />
Antibiotice<br />
Banca Carpatica<br />
Table 4. Results of the content analysis<br />
Banca<br />
Transilvania<br />
Biofarm<br />
Azomures<br />
BRD Groupe<br />
Societe G enerale<br />
CNTEE Trans<br />
electrica<br />
Im pact D eveloper<br />
and Contractor<br />
O il T erm in al<br />
Oltchim Valcea<br />
OMV Petrom<br />
SNTGN Transgaz<br />
~ 407 ~<br />
S.S.I.F. Broker<br />
SIF Banat<br />
Crisana<br />
SIF M oldova<br />
SIF M untenia<br />
SIF Oltenia<br />
SIF Transilvania<br />
Socep<br />
Turbo M ecanica<br />
T otal hits<br />
%<br />
Q u alitative<br />
Q uantitative<br />
Internal (Structural) Capital 15 9 3 15 3 3 4 4 16 3 2 15 2 2 2 4 1 1 0 0 1 105 47% 97 8 92% 8%<br />
Intellectual Property 1 2 1 1 7 1 13 6% 12 1 92% 8%<br />
Patents 1 1 1 3 1% 3 0 100% 0%<br />
Copyrights 0 0% 0 0 n/a n/a<br />
Trademarks 2 3 2 7 3% 5 2 71% 29%<br />
Infrastructure asset 0 0% 0 0 n/a n/a<br />
Management philosophy 7 2 2 5 2 2 1 7 2 2 5 1 2 1 2 1 1 1 46 21% 46 0 100% 0%<br />
Corporate Culture 5 1 1 1 1 1 3 13 6% 13 0 100% 0%<br />
Management processes 1 2 3 1% 3 0 100% 0%<br />
Information Systems x 1 1 1 3 1% 3 0 100% 0%<br />
Networking systems 1 1 0% 0 1 0% 100%<br />
Financial Relations 0 0% 0 0 n/a n/a<br />
Corporate University/Corporate learning 1 2 3 1 1 1 5 1 1 16 7% 12 4 75% 25%<br />
Cultural diversity 0 0% 0 0 n/a n/a<br />
Structural Capital 0 0% 0 0 n/a n/a<br />
External (customer/relational) capital 4 9 0 2 2 3 3 0 11 2 8 6 3 0 0 1 0 0 1 0 1 56 25% 46 10 82% 18%<br />
Brand 3 1 1 1 3 1 1 1 12 5% 6 6 50% 50%<br />
Customers (Customer knowledge) 0 0% 0 0 n/a n/a<br />
Customer loyalty (Customer capital) 3 3 1% 3 0 100% 0%<br />
Company names (Company Reputation) 1 1 1 3 1% 3 0 100% 0%<br />
Distribution channels 2 2 1 1 2 1 1 2 1 1 14 6% 11 3 79% 21%<br />
Business collaboration 1 1 1 1 1 1 1 1 1 9 4% 8 1 89% 11%<br />
Licensing agreeements 2 2 1 1 5 1 1 13 6% 13 0 100% 0%<br />
Favourable contracts 2 2 1% 2 0 100% 0%<br />
Franshising agreements 0 0% 0 0 n/a n/a<br />
Relational Capital 0 0% 0 0 n/a n/a<br />
Supplier Knowledge 0 0% 0 0 n/a n/a<br />
Emplyoee competence (human capital) 8 1 0 2 1 1 2 0 12 2 1 13 2 2 2 5 1 2 2 1 1 61 27% 26 35 43% 57%<br />
Know how (Employee know-how) 1 1 3 5 2% 2 3 40% 60%<br />
Education (Employee Knowledge) 1 1 3 1 4 1 1 1 2 1 2 18 8% 6 12 33% 67%<br />
Skills - vocational qualification (Skills) 1 1 1 2 2 1 8 4% 6 2 75% 25%<br />
Work-related knowledge (Expertise) 3 1 1 4 1 1 2 1 1 1 3 1 1 1 1 23 10% 8 15 35% 65%<br />
Work-related competencies (Productivity) 1 2 3 6 3% 3 3 50% 50%<br />
Entrepreneurial spirit 1 1 0% 1 0 100% 0%<br />
Human Capital 0 0% 0 0 n/a n/a<br />
Human Assets 0 0% 0 0 n/a n/a<br />
Total hits 27 19 3 19 6 7 9 4 39 7 11 34 7 4 4 10 2 3 3 1 3 222 100% 169 53 76% 24%<br />
No of atributes hit, of which 13 12 2 10 5 6 6 3 15 6 6 15 7 3 4 6 2 3 2 1 3 130<br />
Internal (Structural) Capital 5 6 2 6 2 2 3 3 4 2 1 5 2 1 2 3 1 1 0 0 1 52<br />
External (customer/relational) capital 2 5 0 2 2 3 2 0 6 2 4 5 3 0 0 1 0 0 1 0 1 39<br />
Emplyoee competence (human capital) 6 1 0 2 1 1 1 0 5 2 1 5 2 2 2 2 1 2 1 1 1 39<br />
Q u alitative %<br />
Q u antitative %
3.2 Analysis of the results in the case of the ICD determinants<br />
The data collected for this study was analysed through the use of T test, Pearson<br />
correlation and multiple regression analysis using SPSS Version 13 software.<br />
In order to have a first impression of the data introduced and to check for errors or<br />
problems we have computed for the basic descriptive statistics; mean minimum and<br />
maximum values for the entire variable in the case of each company. The Table 5<br />
below presets our first descriptive statistics.<br />
Table 5. Descriptive statistics<br />
N Minimum Maximum Mean<br />
Internal_Structural_Capital 0<br />
Intellectual_Property 21 0 1 0.29<br />
Patents 21 0 1 0.14<br />
Copyrights 21 0 0 0<br />
Trademarks 21 0 1 0.14<br />
Infrastructure_asset 21 0 0 0<br />
Management_philosophy 21 0 1 0.86<br />
Corporate_Culture_Organisational_Culture 21 0 1 0.33<br />
Management_processes_Management_Quality 21 0 1 0.1<br />
Information_Systems_Knowledge_Sharing_Knowledge_M<br />
anagement Or 21 0 1 0.14<br />
Networking_systems_Expert_Networks 21 0 1 0.05<br />
Financial_Relations 21 0 0 0<br />
Corporate_UniversityCorporate_learning 21 0 1 0.43<br />
Cultural_diversity 21 0 0 0<br />
Structural_Capital 21 0 0 0<br />
External_customerrelational_capital 21 0 0 0<br />
Brand 21 0 1 0.38<br />
Customers_Customer_knowledge 21 0 0 0<br />
Customer_loyalty_Customer_capital 21 0 1 0.05<br />
Company_names_Company_Reputation 21 0 1 0.14<br />
Distribution_channels 21 0 1 0.48<br />
Business_collaboration 21 0 1 0.43<br />
Licensing_agreeements 21 0 1 0.33<br />
Favourable_contracts 21 0 1 0.05<br />
Franshising_agreements 21 0 0 0<br />
Relational_Capital 21 0 0 0<br />
Supplier_Knowledge 21 0 0 0<br />
Emplyoee_competence_human_capital 21 0 0 0<br />
Know_how_Employee_knowhow 21 0 1 0.14<br />
Education_Employee_Knowledge 21 0 1 0.52<br />
Skills__vocational_qualification_Employee_Skills 21 0 1 0.29<br />
Workrelated_knowledge_Employee_Expertise_Expert_Te<br />
ams 21 0 1 0.71<br />
Workrelated_competencies_Employee_Productivity 21 0 1 0.14<br />
Entrepreneurial_spirit_Employee_Value_Human_Value<br />
21 0 1 0.05<br />
Human_Capital 21 0 0 0<br />
Human_Assets 21 0 0 0<br />
Industry_type 21 0 1 0.52<br />
Frequency_IC_Item 21 1 15 6.1905<br />
ICD_Index 21 0.03 0.45 0.1876<br />
Company_size 21 15 23.53 19.6929<br />
Valid N (listwise) 0<br />
~ 408 ~
This output shows for each of the 40 variables, the number (N) of companies with no<br />
missing data on that variable. The Valid N (listwise) is the number (21) which has no<br />
missing data on any variable. The Table 5 also shows the minimum and the maximum<br />
score that any company had on that variable. These value are normal considering the<br />
dichotomous variable that can take a minimum of “0” value and a maximum of “1” as<br />
applicable. It can be observed that for several variables, the maximum value is also<br />
“0” which means that they were not disclosed by any of the company analysed<br />
(Copyrights, Infrastructure_asset, Financial_Relations, Cultural_diversity,<br />
Structural_Capital, External_customer_relational_capital, Customers_Customer_<br />
knowledge, Franshising_agreements, Relational_Capital, Supplier_Knowledge,<br />
Emplyoee_competence, Human_Capital, Human_Asset). In addition, the Table 5<br />
provides the mean for each variable. It can be noted that: 86% of the companies<br />
disclosed information about Management_philosophy; 71% of the companies<br />
disclosed information about Employee_Expertise follwed by Education_Employee<br />
disclosed in the case of 52% of the sample companies. Considering the sample<br />
companies, we can also conclude that 52% of the companies belong to knowledge<br />
intensive industry.<br />
Further on we considered the frequency of scale variable to test whether ICD_Index<br />
and Company_size are normally distributed. In this respected we have used the<br />
histogram for ICD_Index and Company_size. These are presented below.<br />
Frequency<br />
Graph 1. ICD_Index distribution Graph 2. Company_size distribution<br />
7<br />
6<br />
5<br />
4<br />
3<br />
2<br />
1<br />
0<br />
0.00<br />
0.10<br />
0.20<br />
0.30<br />
ICD_Index<br />
0.40<br />
0.50<br />
Mean =<br />
0.1876<br />
Std. Dev. =<br />
0.13161...<br />
Frequency<br />
5<br />
4<br />
3<br />
2<br />
1<br />
0<br />
14.00<br />
~ 409 ~<br />
16.00<br />
18.00<br />
20.00<br />
Company_size<br />
22.00<br />
24.00<br />
Mean =<br />
19.6929<br />
Std. Dev. =<br />
2.0397<br />
N = 21<br />
Considering the graphs obtained, we can conclude that Company_size is<br />
approximately normally distributed (there is a small number of scores for low values<br />
and a relative small numbers of scores for high values; that most scores are for the<br />
middle values). In the case of ICD_Index, we can notice that the bars form a pattern<br />
quite different from the normal curve line (there is a small number of scores for low<br />
values but a relatively low number of scores for high values; the most scores are not<br />
for the middle values) so it may be debatable whether it is normally distributed.<br />
Because of this debate, we computed in the case of both variables the mean, median,<br />
mode and skewness (see Table 6 below). They will help us to determine the central<br />
tendency of the variables.
Table 6. Descriptive statistics for ICD_Index and Company_size<br />
ICD_Index Company_size<br />
N<br />
Valid 21 21<br />
Missing 0 0<br />
Mean<br />
0.1876 19.6929<br />
Median<br />
0.1818 19.2080<br />
Mode<br />
0.18 15.00<br />
Std. Deviation<br />
0.13161 2.03970<br />
Skewness<br />
0.966 0.004<br />
Std. Error of Skewness<br />
0.501 0.501<br />
Range<br />
0.42 8.53<br />
Minimum<br />
0.03 15.00<br />
Maximum<br />
0.45 23.53<br />
a. Multiple modes exist. The smallest value is shown<br />
As it can be observed the mean and the median in the case of both variable are very<br />
similar which support that ICD_Index and Company size are approximately normally<br />
distributed. In addition, the statistic skewness is < 1 (0.966 and 0.004) in both cases<br />
which also support that the variables are normally distributed. It is true that in the case<br />
of ICD_Index the value is very close to 1, but as long as it is lower then 1, then we<br />
can consider as being approximately normally distributed.<br />
Before running any inferential statistics, first we examined the relationship between<br />
the variables to determine how to conduct the hypothesis testing analysis.<br />
3.2.1 Testing hypothesis H1<br />
H1: There is no relation between company size and IC disclosure<br />
Within H1 hypothesis, the independent variable is nominal and the dependent variable<br />
is an approximately normally distributed scale variable. Accordingly, H1 hypothesis<br />
is a basic two variable difference hypothesis and for testing it we chose the T test. The<br />
results of the T test are presented in the Table 7 below (since the independent samples<br />
T test procedure compares the two group means, it is useful to know what the mean<br />
values are so, we present their values in the Table 8). The test compares the means for<br />
two groups of cases. We can observe that the significance value for Levene test is<br />
high (0.147 that is greater than .05) and because of this we shall consider the results<br />
that assume equal variances for both groups. Regarding the significance value for the<br />
T test, we can observe it is also high (0.195 respective 0.207) and corroborated with<br />
the fact that the confidence interval for the mean difference contains zero then we can<br />
not conclude that there is a significant difference between the two group means. In<br />
conclusion the results obtained don’t reject the null hypothesis H1 and thus for<br />
Romanian companies industry type does not seam to influence IC disclosure.<br />
Table 7. Results of T test: Group statistics<br />
Std. Std. Error<br />
Industry_type N Mean Deviation Mean<br />
ICD_Index<br />
traditional 10 0.2273 0.15402 0.04871<br />
knowledge_intensive 11 0.1515 0.10141 0.03058<br />
~ 410 ~
ICD_Index<br />
Equal<br />
variances<br />
assumed<br />
Equal<br />
variances not<br />
assumed<br />
Table 8. Results of T test: Independent samples test<br />
Levene's Test for<br />
Equality of Variances<br />
3.2.2. Testing hypothesis H2<br />
F Sig. t df<br />
~ 411 ~<br />
Sig. (2tailed)<br />
t-test for Equality of Means<br />
Mean<br />
Difference<br />
Std. Error<br />
Difference<br />
95% Confidence<br />
Interval of the<br />
Difference<br />
Lower Upper<br />
2.288 0.147 1.344 19 0.195 0.07576 0.05638 -0.04224 0.19376<br />
1.317 15.347 0.207 0.07576 0.05751 -0.04658 0.19809<br />
H2: There is no relation between industry type and IC disclosure<br />
In the case of H2 hypothesis both independent and dependent variables are scale so it<br />
is a basic two variable associational hypothesis. Accordingly to test the hypothesis we<br />
chose Pearson correlation.<br />
For Pearson correlation we first must check whether the two variables have a linear<br />
relationship. For this we are going to generate a scatterplot. We considered both a<br />
curve and a linear line.<br />
ICD_Index<br />
0.50<br />
0.40<br />
0.30<br />
0.20<br />
0.10<br />
0.00<br />
Graph 3. Correlation between ICD_Index and Company_size<br />
14.00<br />
16.00<br />
18.00<br />
20.00<br />
Company_size<br />
R Sq Quadratic =0.152<br />
R Sq Linear = 0.139<br />
From the graph above we can observe that there is a positive correlation between the<br />
variables, but that the correlation is relatively week (r squared is only 0.139 or 0. 152).<br />
In addition, it seams that the linear line fits the point better than the curve so we can<br />
consider that the variables have a linear relationship and we can continue out testing<br />
with Pearson correlation. The Table 9 below presents the results obtained for Pearson<br />
correlation (r). The Table 9 shows that the two variable are not significantly correlated<br />
r (21) = 0.373, p > 0.05. Because the p value of 0.096 > 0.05 it means that r in not<br />
statistically significant and thus it suggests that hypothesis H2 is not being rejected<br />
and thus we can state that company size does not influence the IC disclosure.<br />
22.00<br />
24.00
ICD_Index<br />
Company_size<br />
a. Listwise N=21<br />
3.2.3 Testing hypothesis H3<br />
Table 9. Pearson correlation results<br />
ICD_Index Company_size<br />
Pearson Correlation 1 0.373<br />
Sig. (2-tailed) 0.096<br />
Pearson Correlation 0.373 1<br />
Sig. (2-tailed) 0.096<br />
H3: There is no relation between the combination of company size and industry<br />
type and IC disclosure<br />
In the case of hypothesis H3 we have one normally distributed scale dependent<br />
variable (ICD_Index) and two independent variables from which one is nominal<br />
(Industry_type) and the other is scale (Company_size). Accordingly we are using<br />
multiple regression analysis to test the hypothesis H3. The results of multiple<br />
regression analysis are presented in Table 10, Table 11, and Table 12 below.<br />
Table 10. Multiple regression results: Model summary<br />
Model R R Square Adjusted R Square Std. Error of the Estimate<br />
1 0.445 0.198 0.109 0.12424<br />
a. Predictors: (Constant), Industry_type, Company_size<br />
Table 11. Multiple regression results: ANOVA<br />
Model Sum of Squares df Mean Square F Sig.<br />
1<br />
Regression 0.069 2 0.034 2.220 0.137<br />
Residual 0.278 18 0.015<br />
Total 0.346 20<br />
a. Predictors: (Constant), Industry_type, Company_size<br />
b. Dependent Variable: ICD_Index<br />
Table 12. Multiple regression results: Coefficients<br />
Unstandardized Coefficients Standardized Coefficients<br />
Model<br />
B Std. Error Beta<br />
t Sig.<br />
1<br />
(Constant) -0.208 0.278 -0.746 0.465<br />
Company_size 0.022 0.014 0.337 1.579 0.132<br />
Industry_type<br />
a. Dependent Variable: ICD_Index<br />
-0.063 0.055 -0.245 -1.146 0.267<br />
Simultaneous multiple regression was conducted to investigate the best predictors of<br />
ICD_Index. When the combination of variables to predict IC disclosure included<br />
company size and industry type F (2, 18) = 2.220, p = 0.137 > 0.05. The adjusted R<br />
squared is 0.109 which means that 11% of the variance in ICD_Index was explained<br />
by the model. According to the results obtained it means that we can not reject<br />
~ 412 ~
hypothesis H3 and thus we can state that there is no relation between any combination<br />
of company size and industry type and IC disclosure.<br />
DISCUSSION AND CONCLUSIONS<br />
Our research paper had two major objectives: to analyse the quantity and the quality<br />
of IC items made in the annual reports by Romanian listed companies; and to analyse<br />
whether company size and industry type are determinants of ICD for the same sample<br />
companies. 21 annual reports as at 31 December 2009 of Romanian companies listed<br />
on the BSE were collected, and represented the sample companies. IC framework<br />
used in this study was a combination of that used by Guthrie and Petty (2000) and the<br />
framework resulted from the work performed by a panel of researchers from the<br />
WCIC. The resulted framework was composed of 33 IC items. In order to achieve our<br />
first objective, we conducted a content analysis considering both the number and the<br />
location of the 33 IC items classified under three captions: internal (structural capital),<br />
external capital and human capital. The results show that internal capital is the most<br />
frequently disclosed category representing 47.3%, followed by the disclosures of the<br />
external capital with 27.5% and employee competence with 25.2%. Furthermore, our<br />
results support the findings according to which companies disclose IC more<br />
qualitatively than quantitatively. For the second objective, an IC disclosure index<br />
(ICD_Index) was constructed for each company which had a common base containing<br />
the 33 IC items. In constructing the disclosure index, dichotomous scoring for each of<br />
the 33 IC items was used (disclosure =1, non-disclosure =0). The study tested if<br />
(1) company size is a determinant of ICD (H1 hypothesis) using Pearson correlation<br />
analysis; (2) industry type is a determinant of ICD (H2 hypothesis) using T test<br />
analysis; and last but not least (3) if there is any combination between company size<br />
and industry type that can determine the level of ICD (H3 hypothesis) using multiple<br />
regression analysis. According to the results obtained we concluded that in the case of<br />
Romanian listed companies there is no association between the level of ICD and<br />
company size (p=0.195 respective p= 0.207), industry type (r (21) = 0.373, p > 0.05)<br />
and no combination between company size and industry type (F (2, 18) = 2.220,<br />
p = 0.137 > 0.05). Our paper contributes to the ICD literature by providing empirical<br />
evidence of the status of IC reporting and of determinants of ICD in a developing<br />
country context. In addition, the results obtained represent a basis for comparison with<br />
those obtained by other studies carried out in other developing countries. As any<br />
research paper, our study is subject to a number of limitations. One limitation refers to<br />
the content analysis. Analysing the annual reports based on the specified list of IC<br />
related terms may not provide the whole picture or ICDs practices. Next, while we<br />
believe that our sample is representative for Romanian listed companies, a larger<br />
sample could help to further improve the extrapolation of this study. This study is<br />
based on the annual reports for 2009 only; a longitudinal study could provide more<br />
insights and could include not only levels of ICDs but also an analysis of changes in<br />
ICDs. Some research on disclosure practice uses the survey method for collecting<br />
data. Future research could consider interviewing managers about their disclosure<br />
rationale. In addition, this study challenges researchers to extend the area of analysis<br />
by considering the relation between ICD and other possible determinants.<br />
~ 413 ~
ACKNOWLEDGEMENTS<br />
This work was supported by CNCSIS –UEFISCSU, project number PNII – IDEI code<br />
1859/2008, contract no. 837/2009.<br />
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Accounting”, Accounting, Auditing & Accountability Journal, vol. 14, no. 4,<br />
pp. 383-398<br />
Sharabati, A. A. et al. (2010) “Intellectual Capital and Business Performance in the<br />
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~ 415 ~
PS9 IFRS II<br />
Chairperson<br />
Dumitru MATIS, Babes-Bolyai University, Romania<br />
IMPACTS AND CHANGES IN THE ACCOUNTING<br />
POLICIES AFTER THE IAS ADOPTION:<br />
A COMPARISON BETWEEN THE MANUFACTURING<br />
AND THE COMMERCIAL SECTOR IN GREECE<br />
Sotirios KARATZIMAS, Stella ZOUNTA, Vagia KYRIAKIDOU
IMPACTS AND CHANGES IN THE ACCOUNTING<br />
POLICIES AFTER THE IAS ADOPTION:<br />
A COMPARISON BETWEEN THE MANUFACTURING<br />
AND THE COMMERCIAL SECTOR IN GREECE<br />
Sotirios KARATZIMAS 1 & Stella ZOUNTA<br />
University of Aegean, Greece<br />
Vagia KYRIAKIDOU<br />
National and Kapodistrian University of Athens, Greece<br />
ABSTRACT<br />
The present study examines the changes that occurred in the accounting policies of the Greek<br />
companies, after the adoption of IAS. More precisely, a comparison analysis between the<br />
manufacturing and the commercial sector is conducted. In order to achieve that, we analyze<br />
the impact of the IAS transition in the net income of the Greek listed manufacturing and<br />
commercial companies by applying a new index on the field, we identify the most important<br />
changes in accounting policies and we proceed by comparing the differences and similarities<br />
between the two sectors. Results suggest that the application of the “fair value” is the<br />
accounting policy that affected most significantly both sectors, while the similarities between<br />
the two sectors seem to excel their differences.<br />
KEYWORDS: Accounting policies, IAS, manufacturing sector, commercial sector, Greece<br />
INTRODUCTION<br />
From the 1st of January 2005 all listed companies in the European Union (EU) have<br />
to prepare their financial statements according to the International Accounting<br />
Standards (IAS) promoted by the International Accounting Standards Board (IASB).<br />
The introduction of new international standards brought great changes in the way that<br />
companies prepared their financial statements, especially in countries were the<br />
domestic accounting standards were stakeholder oriented, (e.g. Greece, Germany,<br />
France) since IAS are heavily influenced by the shareholder oriented Anglo-Saxon<br />
accounting model.<br />
The Greek accounting system is typically characterized as stakeholder-oriented and<br />
tax-driven (Ballas, 1994; Spathis et al., 2003) and differs substantially from IAS,<br />
which are shareholder oriented and independent of tax reporting considerations. The<br />
different roles of the accounting systems have several important implications for<br />
accounting standards. The Greek Generally Accepted Accounting Principles (GAAP)<br />
generally encourage a ‘prudent’ approach to asset valuation and liability recognition<br />
to facilitate contract with stakeholders, thus allowing managers great flexibility in<br />
valuing assets at the lowest amount possible to minimize tax liability, while IAS<br />
1 Correspondence address: Sotirios KARATZIMAS, University of Aegean, Dept. of Business<br />
Administration, Chios, Greece; email: skaratzimas@aegean.gr<br />
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promote a ‘true and fair’ presentation of balance sheets to facilitate decision-making<br />
for investors, limiting such flexibility (Spathis and Georgakopoulou, 2007).<br />
In general, the new accounting standards appear significant differences from the<br />
Greek GAAP and brought forth new basis in the preparation of financial statement<br />
reporting and the analysis of financial information. The new standards have<br />
significant deviations from the Greek legislation, while their application demanded<br />
various changes in the internal environment of Greek companies, since a great number<br />
of accounting policies that were used, had to be rejected and replaced by new.<br />
Moreover, according to Rahman et al. (2002) studies that deal with accounting<br />
policies in single country contexts indicate that the choice of accounting methods and<br />
policies is also affected by the firm characteristics, which means that the changes in<br />
the internal environment of the Greek companies could vary depending on the specific<br />
sector characteristics of each company. In other words, the new accounting policies<br />
that affected most significantly the manufacturing sector might differ from those that<br />
mostly affected the commercial sector.<br />
The purpose of the present study is to draw the picture of the changes in accounting<br />
policies that occurred in the Greek manufacturing and commercial sectors, and to<br />
compare the implications in the two sectors. In order to achieve that we analyze the<br />
impact of the IAS transition in the net income of all the manufacturing and<br />
commercial companies listed in the Athens Stock Exchange (ASE), we identify the<br />
most important changes in accounting policies and we proceed by comparing the<br />
differences and similarities between the two sectors. We quantify the impact by<br />
presenting a new index on the field, and we investigate which IAS caused the most<br />
significant changes in each of the two sectors, from the establishment of new<br />
accounting policies.<br />
The differences in the income statements between the two different accounting<br />
standards are presented in the 2005 reconciliation statement, which also provides the<br />
reasoning behind these changes in the form of adjustments. We proceeded by<br />
analyzing the reconciliation statements, we examined the adjustments that took place<br />
in every company of the two sectors and finally found the impact of the IAS transition<br />
as it appears through the changes of accounting policies.<br />
The remainder of the paper is organized as follows: In the next section the relevant<br />
literature is reviewed. In the third section the survey’s methodology is analyzed and in<br />
the fourth the results are presented. Finally, in the fifth section we conclude by<br />
discussing the outcomes of the survey.<br />
1. PRIOR RESEARCH<br />
The adoption of the IAS from the EU is considered to be one of the greatest changes<br />
in the history of financial reporting, making IAS the most widely accepted financial<br />
reporting model (Hung and Subramanyam, 2007). However, there is still an urgent<br />
need for managers and investors to understand the implications of the transition. This<br />
is especially true in European countries with stakeholder oriented accounting systems<br />
such as Greece, Germany, France, Spain and Italy, since IAS is an accounting model<br />
heavily influenced by the share-holder oriented Anglo-Saxon model. Consequently,<br />
~ 418 ~
the IAS adoption caused fundamental changes in the basis of financial reporting of<br />
many European countries.<br />
Several studies have been conducted in order to compare IAS to national accounting<br />
standards and to identify the impacts of the transition in European countries. For<br />
example, studies that focus on the transition and implementation of IAS in the EU and<br />
their impact on firms include those conducted by Jermakowicz (2004) in Belgium,<br />
Street and Larson (2004), Shipper (2005) and Whittington (2005) within EU member<br />
states, Sucher and Jindrichovska (2004) in the Czech Republic, Vellam (2004) in<br />
Poland, Weissenberger et al. (2004), Haller and Eierle (2004) and Hung and<br />
Subramanyam (2007) in Germany, while other studies investigate the financial<br />
reporting and the quality of information under IAS (Glaum and Street, 2003; Tarca,<br />
2004; Cuijpers and Buijink, 2005; Barth et al., 2005; Van Tendeloo and Vanstraelen,<br />
2005, etc.).<br />
Most of the studies investigating the impacts of the IAS transition, confirmed the<br />
problems of implementing IAS (Jermakowicz, 2004; Sucher and Jindrichovska, 2004;<br />
Hung and Subramanyam, 2007), while others analyzed the differences between<br />
domestic financial reporting and the IASB conceptual framework (Vellam, 2004).<br />
These studies concluded that the major differences between domestic and<br />
international accounting standards are related to the linkage between financial<br />
reporting and tax accounting. Greece has also been the setting for studying (e.g.<br />
Bellas et al., 2007; Georgakopoulou et al., 2009; Apostolou et al., 2006, etc.), mostly<br />
due to the country’s stakeholder orientation and the existence of several creative<br />
accounting practices prior to IAS (Tsalavoutas and Evans, 2010; Baralexis, 2004).<br />
The most common method to examine the transition from an accounting model to<br />
another is by analyzing the reconciliation statements provided by the adopting<br />
companies. Surveys that analyze the reconciliation statements include those of<br />
Weetman and Gray (1990, 1991), Cooke (1993) and Hellman (1993) who examined<br />
the differences between US GAAP and IAS as presented through the 20-F<br />
reconciliation statements by applying Gray’s (1980) ‘conservatism index’. Adams et<br />
al. (1993) extended the use of this index and of partial indices and were the first to<br />
employ the index in comparing Finnish GAAP to IAS. By 1998, Weetman et al.<br />
renamed the Gray (1980) index as ‘comparability index’, in order to highlight the use<br />
of the index as a means of comparability.<br />
The recent transition of European companies to IAS in 2005 and its impacts are<br />
widely examined through the analysis of the 2004 financial statements which were<br />
initially prepared on the basis of national GAAP and later restated under IAS, as<br />
comparatives for the 2005 financial statements. Such recent studies, include the study<br />
conducted by Bertoni and De Rosa (2006) who applied the ‘comparability index’ to<br />
net income, equity and partial adjustments on the 2004 financial statements of<br />
companies listed in the Italian stock exchange and concluded that Italian GAAP are<br />
more conservative than IAS, while Lopes and Viana (2006) applied the<br />
‘comparability index’ in companies listed in the Portuguese stock exchange and found<br />
that IAS had led to less conservative reported profits. Furthermore, by applying this<br />
index to compare IAS and Greek GAAP Tsalavoutas and Evans (2010) found that<br />
IAS have a significant impact on the financial position of Greek listed companies as<br />
well as on gearing and liquidity ratios while Cordazzo (2008) provided empirical<br />
~ 419 ~
evidence of the nature and the size of the differences between Italian GAAP and IAS<br />
by proposing a new measure of accounting comparability, the ‘proportionality index’.<br />
The present study is an attempt to identify which of the new accounting policies that<br />
were applied following the IAS adoption caused the most significant changes in the<br />
Greek manufacturing and commercial companies. Furthermore it is a first comparison<br />
of the transition’s implications between the two sectors. According to Watts and<br />
Zimmermann (1990) there is ample evidence that companies with different<br />
characteristics such as industry membership adopt different accounting practices,<br />
subsequently, it is expected that different accounting policies had different level of<br />
impact in the under-examination sectors. As Jaafar and McLeay (2007) note, the<br />
conventional research focuses on variations in the accounting policies adopted by<br />
firms between countries, presupposing that accounting methods and policies<br />
systematically reflect rules and regulations of the country where the firms operate.<br />
However, diversity of accounting policies results from the “real” differences in the<br />
operating circumstances each sector faces (Jaafar and McLeay, 2007), while<br />
furthermore, Aisbitt (2001) points out that, sector characteristics play a significant<br />
role in accounting policy choice.<br />
2. RESEARCH DATA AND METHODOLOGY<br />
2.1 Scope of the study<br />
The scope of the present study is to examine the impacts and changes that were<br />
caused by the IAS adoption, in the accounting policies used in the Greek companies.<br />
More precisely, we conduct a comparison analysis between the manufacturing and the<br />
commercial sector. We attempt to draw the picture of the changes that occurred in the<br />
accounting policies of the Greek listed manufacturing and commercial companies.<br />
In order to achieve that, we analyze the reconciliation statements of the net income as<br />
they are presented in the annual reports of the companies in the transition year 2005.<br />
We analyze the adjustments on net income since they provide a great amount of<br />
information concerning changes in accounting methods and policies as for example<br />
those used for inventory valuation, assets valuation, impairment and depreciation,<br />
determination of provisions, etc.<br />
At first, we conduct a frequency analysis of the adjustments caused by each IAS<br />
application in the sample, in order to gain a general view of the transition effects and<br />
to identify the new accounting policies that affected the majority of the Greek<br />
companies. Then, by applying the proposed index in the data, we quantify the total<br />
impact of each IAS on net income and we find those accounting policies the<br />
application of which affected most significantly each sector’s net income in total.<br />
2.2 Data collection<br />
The sample under investigation includes all the manufacturing and commercial<br />
companies listed on the Athens Stock Exchange, which have completed the transition<br />
of consolidated financial accounts to IAS. According to IFRS 1 ‘…company’s first<br />
IFRS financial statements should include a reconciliation of shareholders’ equity and<br />
net income…’. In order to have a more thorough view of the changes in accounting<br />
~ 420 ~
policies, we examined the net income reconciliation statements. It turned out though,<br />
that from the 87 manufacturing companies listed in the ASE, only 59 provided<br />
adequate net income reconciliation statements, while from the 82 listed commercial<br />
companies, only 54. It should be mentioned here that from the 59 manufactures, 3<br />
belong to the ‘Gas and Oil’ sub-sector, 13 to the ‘Basic Resources’ sub-sector, 20 to<br />
the ‘Construction and Material’ sub-sector, 2 to the ‘Chemicals’ sub-sector and 21 to<br />
the ‘Industrial Goods and Services’ sub-sector. While from the 54 commercial<br />
companies, 8 belong to the ‘Retail’ sub-sector, 26 to the ‘Personal and Household<br />
Goods’ and 19 to the ‘Food and Beverage’ sub-sector.<br />
2.3 Descriptive evidence<br />
At first we gathered the net income reconciliation forms of the 59 manufactures and<br />
the 54 commercial companies, and proceeded by analyzing the frequency of the<br />
adjustments on the companies’ net income that were caused due to the IAS transition.<br />
The net income reconciliation statements provide the following data (Appendix):<br />
• the net income based on the Greek GAAP,<br />
• the adjustments that were caused due to the application of IAS in the company<br />
and finally<br />
• the net income based on the International Accounting Standards.<br />
Table 1 shows the frequency of the adjustments to the net income caused by each<br />
IAS, in order for the sample companies to convert to IAS.<br />
Table 1. Frequency of all individual adjustments caused by IAS adoption<br />
Adjustments by: No of companies affected:<br />
IAS Title Manufacturing sector Commercial sector<br />
IAS 2 Inventories 10 10<br />
IAS 11 Construction contracts 13 1<br />
IAS 12 Deferred taxes<br />
Property, plant and equipment<br />
46 48<br />
IAS 16<br />
IAS 17 Leases 25 23<br />
IAS 18 Revenue recognition 6 10<br />
IAS 19 Employee benefits 50 47<br />
IAS 20 Government grants<br />
Changes in foreign exchange rates<br />
22 22<br />
IAS 21<br />
26<br />
23<br />
IAS 23 Borrowing cost<br />
Consolidated financial statements<br />
2 -<br />
IAS 27<br />
IAS 28 Investments in associates 13 14<br />
IAS 31 Joint ventures 5 2<br />
IAS 36 Impairment of assets<br />
Provisions, contingent liabilities and<br />
9 7<br />
IAS 37<br />
assets<br />
IAS 38 Intangible assets 52 52<br />
IAS 39 Financial instruments 22 31<br />
IAS 40 Property investments 3 -<br />
IAS 41 Biological assets - 6<br />
IFRS 3<br />
Total No<br />
Business Combinations 10 3<br />
of companies:<br />
59<br />
54<br />
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57<br />
14<br />
44<br />
50<br />
9<br />
35
First evidence deriving from the examination of the net income reconciliation<br />
statements of the manufacturing companies, show that the most frequent adjustments<br />
were caused by the application of the following IAS:<br />
• IAS 16 - caused adjustments in 57 companies,<br />
• IAS 38 - affected 52 companies,<br />
• IAS 19 - affected 50 companies,<br />
• IAS 12 - affected 46 companies, and<br />
• IAS 37 - caused adjustments to 44 companies.<br />
On the other hand, concerning the commercial sector, the most frequent adjustments<br />
were caused by the application of the IAS as follows:<br />
• IAS 38, which affected 52 companies<br />
• IAS 16 - 50 companies<br />
• IAS 12 - affected 48 companies<br />
• IAS 19 - caused adjustments to 47 companies, and<br />
• IAS 37 - affected 35 companies<br />
From the above first evidence it turns out that IAS 12, 16, 19, 37 and 38 affected the<br />
majority of the sample companies both in the manufacturing and the commercial<br />
sector. By examining the adjustments on the reconciliation statements it turns out that<br />
the most important changes that occurred in the accounting policies from the<br />
application of the above-mentioned IAS in both sectors, are the following:<br />
Concerning IAS 16 the most important changes on accounting policies were:<br />
• The valuation of tangibles on fair value<br />
• The change in the depreciation rates of tangible assets<br />
Regarding IAS 38 the most frequent adjustments in accounting policies were:<br />
• The differentiation of the depreciation rate for intangibles<br />
• The non-recognition of start-up costs as intangible assets<br />
The most frequent adjustments deriving from the application of IAS 19 were:<br />
• The recognition of compensations due to retirement, and<br />
• The recognition of benefits to the personnel<br />
Concerning IAS 12, the most frequent adjustments deriving from its application were:<br />
• The recognition of deferred taxes<br />
• The recognition of the income taxes of the period as expenses<br />
And finally, the most frequent adjustments deriving from the application of IAS 37<br />
turned out to be:<br />
• The general adjustments of the account ‘provisions’, and more specific<br />
• The provisions for ‘bad debtors’ and for ‘impairment of assets’.<br />
First evidence shows that the introduction of fair value for the valuation of tangible<br />
and intangible assets (IAS 16 and 38), in contrast to the Greek historical cost<br />
valuation, and the subsequent change in the depreciation amounts which are<br />
calculated based on the useful life of the asset, are the new accounting policies that<br />
affected the majority of the Greek manufacturing and commercial companies.<br />
Moreover, the non-recognition of the start-up costs (IAS 38), in contrast to their<br />
capitalization according to the Greek GAAP is another important change of policy,<br />
while IAS 19 introduced compensations and employee benefits that were not<br />
calculated according to the Greek GAAP. Another important change in accounting<br />
~ 422 ~
policy was established by the recognition of deferred taxes (IAS 12), which is<br />
different from the treatment based on the Greek GAAP, according to which the<br />
concept of deferred taxes does not exist and there is no distinction between current<br />
and deferred tax. Additionally, IAS 12 defines the expense of the income tax when<br />
incurred, in contrast to the Greek non-recognition of taxes as an expense of the period.<br />
Finally, the explicit distinction of provisions from contingent liabilities introduced by<br />
IAS 37 is a different policy compared to the requirement of the Greek GAAP to<br />
companies to recognize liabilities for any risk which can be defined.<br />
After identifying the aforementioned evidence and in order to run into more valid<br />
conclusions we quantified the impact from the IAS adoption and thus found which<br />
IAS affected most significantly the net income of the two sectors, and consequently<br />
the changes in accounting policies that affected most significantly the sectors’<br />
income.<br />
2.4 Methodology<br />
The indices that are used in the accounting literature to measure the impact of the IAS<br />
adoption on a company can be also applied to quantify the impacts on the entire sector<br />
the company belongs to. There is though a very important omission: they don’t take<br />
under much consideration the fact that particular IAS may affect only specific<br />
companies and, thus, are difficult to be measured on a total basis in order for them to<br />
be compared with other IAS that affected other companies so as to find the most<br />
important IAS that affected the entire sector. In several cases, the application of a<br />
particular IAS might affect only few companies but to a great extent. Moreover, the<br />
adoption of IAS could have a different impact on the financial results of companies<br />
belonging to different sectors, thus a subsequent comparison of the IAS implication<br />
between the two sectors is conducted.<br />
The proposed index can be used to analyze the impact of the transition, by taking as a<br />
parameter of significance the extent to which each IAS affected the companies under<br />
examination in each sector. The analysis is applied on the data extracted from the<br />
annual reports of the Greek listed companies, examining the impact of IAS in a group<br />
of 59 manufacturing and 54 commercial companies. The IAS that we examined were<br />
those that turned out to appear more frequently in the adjustments that took place in<br />
the income statement of the sample companies (Table 1). Specifically, regarding the<br />
manufacturing sector, IAS 21 “Changes in foreign exchange rates”, IAS 18 “Revenue<br />
recognition” and IAS 40 “Property investments”, which were found to have a very<br />
small numeric impact on the net income, were excluded from the analysis. However,<br />
the limited impact they have on net income is captured by the error term included in<br />
the proposed index. While concerning the commercial sector, IAS 23 “Borrowing<br />
cost”, IAS 28 “Investments in associates”, IAS 31 “Joint ventures”, IAS 40 “Property<br />
investments” and IFRS 3 “Business combinations” were excluded due to the<br />
very small numeric impact. The IAS that were eventually examined are presented in<br />
Table 2.<br />
The first step of the analysis aims to identify whether the companies of the sector<br />
were affected at any degree by the application of the IAS under examination. For this<br />
reason, a dummy variable was created for each IASi and we placed the data as<br />
follows:<br />
~ 423 ~
• 0 in cases were the impact of the IAS application in a company’s net income<br />
was zero, i.e. IASi caused no change on net income<br />
• 1 in cases were the impact of the IAS application in a company’s net income<br />
was either positive or negative<br />
Then we proceeded by conducting frequency analysis and particularly central<br />
tendency analysis in order to find the tendency of the impacts caused in net income by<br />
the application of IASi (di). This analysis provides useful information concerning the<br />
effect of IAS application on income. The results are presented in Table 2 and refer to<br />
each specific sector. It is obvious that there is a noticeable differentiation concerning<br />
the impact of each IAS to the income of the under-examination companies.<br />
The second step of the analysis concerns the estimation of the coefficients of each<br />
IAS. Thus a Regression analysis was conducted based on Ordinary Least Squares<br />
(OLS) by using the following equation:<br />
Where,<br />
• Yj is the difference between income calculated based on Greek GAAP and<br />
income calculated based on IAS for each company belonging to the under<br />
examination sector<br />
• the vector bi shows the estimated coefficient of each IAS under examination,<br />
• Xi,j is the observed difference of IASi over companyj, and<br />
• an error is added to the model in order to describe changes in income (before<br />
and after IAS) depending on other parameters (other IAS).<br />
From this equation the coefficient of each IAS under examination (bi) is calculated.<br />
These coefficients comprise the sign of the change on income by the implementation<br />
of the IAS. Finally, the following index is proposed resulting from the combination of<br />
the above calculations:<br />
( IF )<br />
Im pact Factori<br />
i = Eq. 2<br />
ci<br />
Where ci equals:<br />
n<br />
j = ∑ bi<br />
X i,<br />
j<br />
i,<br />
j<br />
Y + ε<br />
c<br />
1<br />
i<br />
1<br />
Eq. 1<br />
i = bi<br />
Eq. 3<br />
di<br />
And di is the score resulting from the central tendency of IASi.<br />
The impact of each IAS on the income of the under-examination companies is<br />
estimated by applying the index to the collected data (Table 2, “Impact Factor”). The<br />
positive or negative figure of the Impact Factor shows the total positive or negative<br />
impact that the application of the particular IAS had on the income of the<br />
manufacturing or the commercial sector.<br />
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Table 2. IAS under examination, tendency analysis and impact factor<br />
Sectors: Manufacturing Commercial<br />
Tendency score<br />
Tendency<br />
Parameters<br />
(di)<br />
Impact factor score (di) Impact factor<br />
IAS 2 0,1525 0,183 0,1887 -0,327<br />
IAS 11 0,2203 0,308 0,0189 0,001<br />
IAS 12 0,7627 1,375 0,9057 -1,155<br />
IAS 16 0,9661 2,660 0,9245 -1,693<br />
IAS 17 0,4068 2,998 0,6434 2,934<br />
IAS 18 - - 0,3774 -0,427<br />
IAS 19 0,8475 0,304 0,8868 -0,680<br />
IAS 20 0,3729 -0,123 0,4151 0,989<br />
IAS 21 - - 0,434 -0,327<br />
IAS 23 0,0339 -0,002 - -<br />
IAS 27 0,2373 0,157 0,1698 -0,145<br />
IAS 28 0,2203 -0,125 - -<br />
IAS 31 0,0847 -0,102 - -<br />
IAS 36 0,2004 0,205 0,1321 0,427<br />
IAS 37 0,7288 1,151 0,6604 -0,862<br />
IAS 38 0,8814 1,998 0,9057 -0,780<br />
IAS 39 0,3559 0,290 0,5849 -0,537<br />
IAS 41 - - 0,1132 -0,170<br />
IFRS 3 0,1695 0,748 - -<br />
Finally, the absolute values of the impact factors provide the importance rate. That is<br />
the significance of each IAS impact on the sector’s net income. Thus as Eq.4 shows,<br />
the Importance Rate of the IASi (IRi) is equal to the absolute value of the Impact<br />
Factor of the specific IASi (IFi):<br />
IR =<br />
i<br />
IF<br />
i<br />
Eq. 4<br />
Eventually the outcomes of the index we applied rated as most significant impacts on<br />
the manufacturing sector, those caused by the application of IAS 17 (2,998), IAS 16<br />
(2,660), IAS 38 (1,998), IAS 12 (1,375) and IAS 37 (1,151). Moreover, it turned out<br />
that IAS 20, 23, 28 and 31 had in total a negative impact on the net income of the<br />
manufacturing sector.<br />
Concerning the commercial sector, it turned out that the most significant<br />
impact on the entire sector’s net income was caused by the application of IAS 17<br />
(2,934), IAS 16 (1,693), IAS 12 (1,155), IAS 20 (0,989) and IAS 37 (0,862), while,<br />
the vast majority of the IAS (IAS 2, 12, 16, 17, 18, 19, 21, 27, 37, 38 and 39) had a<br />
negative impact in total on the sector’s income. In the following table (Table 3), the<br />
ranking of the IR of each applied IAS is presented together with the estimated weight<br />
based on the proposed index.<br />
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CONCLUSION<br />
Table 3. Importance rate<br />
Manufacturing sector Commercial sector<br />
1 IAS 17 2,998 IAS 17 2,934<br />
2 IAS 16 2,660 IAS 16 1,693<br />
3 IAS 38 1,998 IAS 12 1,155<br />
4 IAS 12 1,375 IAS 20 0,989<br />
5 IAS 37 1,151 IAS 37 0,862<br />
6 IFRS 3 0,748 IAS 38 0,780<br />
7 IAS 11 0,308 IAS 19 0,680<br />
8 IAS 19 0,304 IAS 36 0,620<br />
9 IAS 39 0,290 IAS 39 0,537<br />
10 IAS 36 0,205 IAS 18 0,427<br />
11 IAS 2 0,183 IAS 21 0,327<br />
12 IAS 27 0,157 IAS 41 0,170<br />
13 IAS 28 0,125 IAS 27 0,145<br />
14 IAS 20 0,123 IAS 2 0,144<br />
15 IAS 31 0,102 IAS 11 0,001<br />
16 IAS 23 0,002 - -<br />
According to Jaafar and McLeay (2007) the sector of operations determines the<br />
financial reporting practices adopted by a firm. Consequently, we expected that the<br />
IAS transition had different impact in the manufacturing and the commercial sector.<br />
However, in this first attempt to compare the Greek manufacturing and commercial<br />
sectors in terms of changes in accounting policies following the IAS adoption, the<br />
similarities between the two sectors seem to excel their differences.<br />
In the frequency analysis of the adjustments caused by the IAS transition, it turns out<br />
that the majority of the companies belonging to either sector were affected by the<br />
same IAS. Specifically, IAS 16 “PPE”, IAS 38 “Intangible assets”, IAS 12 “Deferred<br />
taxes”, IAS 19 “Employee benefits” and IAS 37 “Provisions, contingent liabilities and<br />
assets”. Consequently, as it turns out form the adjustments’ examination, the new<br />
policies that were applied and affected the majority of the companies in both sectors<br />
were the assets’ revaluation on fair value, the depreciation rates based on the useful<br />
life of the asset, the non-recognition of start-up costs as intangibles, the recognition of<br />
employee benefits, the recognition of deferred taxes and the expense of the income<br />
taxes of the period, as well as the distinction of provisions from contingent liabilities.<br />
A few differences turned out though, when we examined the accounting policies the<br />
application of which had the most significant impact on the net income of the entire<br />
manufacturing and commercial sectors. By applying the proposed index to the data<br />
from the manufacturing sector, we found that the most significant impact on the entire<br />
sector’s income was caused from the application of IAS 17, IAS 16, IAS 38, IAS 12<br />
and IAS 37. Regarding the commercial sector the respective IAS with the most<br />
significant impact were IAS 17, IAS 16, IAS 12, IAS 20 and IAS 37.<br />
It is very important to note that IAS 17 had the most significant impact on the entire<br />
net income of both sectors, although it affected only 25 of the 59 manufactures and<br />
23 of the 54 commercial companies. In particular, the new policies that were<br />
established from the application of IAS 17, were the recognition of financial leasing<br />
~ 426 ~
as tangible assets and their subsequent treatment concerning revaluation and<br />
depreciation and the recognition of the profit gained from Sales and Leaseback<br />
directly in income through transitional liabilities accounts, instead of initially<br />
presenting this profit as non-operating profit and then through a tax regulation<br />
transferring it to the tax-free reserves. This great impact shows that these new policies<br />
affected the companies that operate with the use of leases to a great extent.<br />
The most noticeable differences that turned out derive from the application of IAS 20,<br />
IFRS 3, IAS 11 and IAS 41. IAS 20, “Government grants”, had a very significant<br />
impact on the net income of the commercial sector while it didn’t significantly affect<br />
the manufacturing sector. In the meantime, this particular IAS affected the same<br />
number (22) of companies in both sectors, which shows that it affected the<br />
commercial companies to a greater extent and thus we could conclude that the<br />
amounts of government grants are higher in the commercial sector. To be more<br />
specific, the new accounting policy established by IAS 20 defines that government<br />
grants shall be recognized as income over the periods necessary to match them with<br />
the related costs, which are indented to compensate on a systematic basis, instead of<br />
being credited directly to shareholders’ interests according to the Greek GAAP.<br />
Contrarily, IFRS 3 “Business combinations” had a strong impact in the net income of<br />
the manufacturing sector, while it had a minor impact on the commercial companies<br />
and IAS 11 “Construction contracts” had an impact only on manufactures. More<br />
specific, IFRS 3 defines that all business combinations within its scope, would apply<br />
the purchase method and therefore will valuate and depreciate goodwill and recognize<br />
negative goodwill directly on the income statement, in contrast to the Greek Law<br />
which also permits the pooling of interests method. The fact that IFRS 3 affected only<br />
10 of the 59 manufacturing companies, shows that it had a very strong impact to<br />
companies that applied the pooling of interests method and were obliged to adopt the<br />
purchase method. Regarding IAS 11, it is expected that its application would affect<br />
only manufacturing companies which mainly deal with constructions, due to its<br />
nature. Likewise, IAS 41 “Biological assets” is expected to affect only the<br />
commercial sector.<br />
Concluding, in general the two sectors appear to have more similarities than<br />
differences regarding the impact and the changes in accounting policies that followed<br />
the IAS transition. The most significant impact was caused from the new accounting<br />
policies concerning the revaluation of assets on fair value and the new depreciation<br />
rates which are linked to IAS 16, 38 and 17.<br />
It should be mentioned here, that due to the insufficient or completely absent data<br />
concerning the reconciliation statements of 28 companies belonging to the<br />
manufacturing sector and 28 belonging to the commercial sector, we don’t provide<br />
evidence that picture the total view of the two sectors. However, the sample of the<br />
study comprises from the 68% of the listed manufacturing companies and the 66% of<br />
the commercial companies and thus is considered to be representative. As for further<br />
research, it would be very interesting to compare the outcomes of the proposed<br />
methodology with the outcomes of the classical approach by applying Gray’s<br />
comparability and partial adjustment indices to the collected data.<br />
~ 427 ~
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APPENDIX<br />
Example of net income reconciliation statement<br />
Net Income - 31 December 2004 - (Euro in thousands)<br />
Balance as per Greek Consolidated Financial Statements 91.283<br />
1 Difference between the provision for staff leaving indemnity (per Greek legislation) and<br />
defined benefit plan with the provision as calculated by the actuarial valuation - IAS 19<br />
1.262<br />
2 Provision for deferred tax - IAS 12 (9.346)<br />
3 Reversal of the revaluation of fixed assets and the effect of depreciation taken - IAS 16 186<br />
4 Write off of capitalized costs with no future benefit - IAS 38 5.036<br />
5 Write off of capitalized research and development costs and reversal of related depreciation<br />
- IAS 38<br />
(1.082)<br />
6 Adjustment of tangible assets depreciation to conform with the group policy - IAS 16 23.009<br />
7 Equity accounting (Differences from conversion to IAS of associates’ accounts) – IAS 28 (8.643)<br />
8 Other provisions / adjustments - IAS 37 (14.013)<br />
9 Reclassification of grant from equity to deferred income or liabilities - IAS 20 1.285<br />
10 Income tax for the period - IAS 12 (3.244)<br />
11 Goodwill and depreciation of goodwill - IFRS 3 4.602<br />
12 Exchange gains (timing differences) - IAS 21 9.808<br />
13 Different method of stock valuation - IAS 2 31.446<br />
14 Effect of IAS 39 – IAS 39 (106)<br />
15 Other (616)<br />
Balance as per IFRS Consolidated Financial Statements 130.867<br />
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PS10 Performance management<br />
Chairperson<br />
Petru STEFEA, West University of Timisoara, Romania<br />
VALUE AND PERFORMANCE IN A REGULATED<br />
ENVIRONMENT: THE CASE<br />
OF TELECOMMUNICATIONS IN ROMANIA<br />
Alina Carmen ALMASAN, Corina GROSU<br />
QUO VADIS IN MEASURING BUSINESS<br />
PERFORMANCE? A PRACTICAL SOLUTION<br />
FOR THE IT SECTOR<br />
Claudia Elena SERBAN, Oana-Adelina FLORICIOIU,<br />
Radu-Daniel LOGHIN<br />
EFFECTIVE AND EFFICIENT TOOLS IN HUMAN<br />
RESSOURCES MANAGEMENT CONTROL<br />
Mihaela Adriana DUMITRANA, Gabriel RADU,<br />
Mariana Elena GLAVAN, Gabriel JINGA<br />
FLEXIBILIZING THE TERMINATION OF THE<br />
EMPLOYMENT CONTRACT: PROS AND CONS<br />
Raluca DIMITRIU<br />
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VALUE AND PERFORMANCE IN A REGULATED<br />
ENVIRONMENT: THE CASE<br />
OF TELECOMMUNICATIONS IN ROMANIA<br />
Alina Carmen ALMASAN 1 & Corina GROSU<br />
West University of Timisoara, Romania<br />
ABSTRACT<br />
The purpose of this paper is to present a case study concerning the effects of regulation on the<br />
performance management system. We often wondered how a company can manage its<br />
performance operating in a highly regulated field. We chose to study Romanian traditional<br />
telecommunications operator Romtelecom, because as dominant operator on the relevant<br />
markets, it is subject to strict regulations and controls from the regulatory authority<br />
(ANCOM). In this paper we have made a careful review of regulations that have a direct<br />
impact on management control system and performance measurement, in order to identify<br />
those elements which “escape” from regulation and that the company could capitalize to<br />
create value and improve the performance. Multiple sources of data collection allowed us to<br />
provide a more comprehensive picture of the phenomenon, so we can draw some conclusions<br />
relevant to the studied issues.<br />
KEYWORDS: performance, regulation, management control, telecommunication<br />
INTRODUCTION<br />
The telecommunications industry has undergone enormous changes over the past 20<br />
years in entire Europe. Technological developments and the privatization of major<br />
telecommunications operators have significantly changed the conditions under which<br />
the former monopoly operators were accustomed to operate. Given the strategic<br />
importance and size of such operators it is obvious that privatization has also<br />
generated a considerable financial impact.<br />
Romanian experience in telecommunications is not different from that of other states.<br />
In addition, legislation in this area is strongly felt, significantly influencing the<br />
performance of operators. In fact, this aspect of the impact that regulation has on the<br />
performance of national telecommunications operators was less treated in the<br />
literature. Palcic and Reeves (2010) have summarized the issues on which empirical<br />
studies in the literature were focused:<br />
• the impact of privatization on the performance of British Telecom, as the first<br />
major privatization in this area (Florio, 2001; Dnes, 1995; Megginson, 1998);<br />
• cross-country comparisons regarding the impact of privatization on<br />
performance and cross-country studies of productivity and performance in<br />
general (Bortolotti et al.; 2002; Daβler et al., 2002);<br />
1<br />
Correspondence address: Alina Carmen ALMASAN, West University of Timisoara, Romania;<br />
email: alina.almasan@feaa.uvt.ro<br />
~ 432 ~
• comparative analysis between countries on the impact of competition and<br />
regulation on telecommunications operators (Boyland and Nicoletti, 2000).<br />
Romanian literature in this area is still poor, the few published works mainly targeting<br />
the use of management accounting and management control tools at main operators<br />
on the Romanian market (Unchiasu, 2008, Almasan and Grosu, 2010).<br />
This paper addresses two main questions: (a) to which extent telecoms regulations<br />
affect the management control practices and thus performance measurement system?<br />
and (b) which management control tools “escape” from regulation and can be<br />
exploited in order to create value and improve company performance?<br />
Further, the paper is structured as follows: the first section concerns the delimitation<br />
of a theoretical framework on the issue of performance and regulation; the second<br />
section contains a brief description of the organizational context of studied company -<br />
the Romanian traditional telecommunications operator Romtelecom; third section<br />
describes the research method and presents some research findings. The paper then<br />
finishes with a discussion and conclusions section.<br />
1. THEORETICAL FRAMEWORK<br />
1.1. Value and performance: imperatives in current context<br />
Any organization, through its actions, aims at becoming the best, the most powerful<br />
company operating in the same area. In other words, companies constantly seek to<br />
achieve performance. Johnson (1992) said that the only way a company can survive in<br />
the current context is searching competitive excellence. Achieving superior<br />
performance requires a rethink of all processes involved in the value creation<br />
mechanism.<br />
For many entities, creating value represents a strategic challenge, which requires<br />
successful exploitation of all opportunities, in order to generate long term benefits.<br />
Generally, organizations are oriented towards short-term objectives, directing their<br />
attention to the company's current situation and taking fewer actions that will generate<br />
long term future benefits.<br />
For the customer, value has a relative character, on the one hand it depends on<br />
consumer characteristics and the situation in which he founds himself, and on the<br />
other hand depends on whether consumers will appreciate the value of an offer<br />
compared to competitors’ offers.<br />
Teller (1999) believes that the economic value offered to the consumer is "the relative<br />
value that a product offers to the consumer in a special way. It is the maximum<br />
amount that he will be willing to pay, assuming that it is perfectly informed about the<br />
product, but also to competitive offerings."<br />
For customers, price is a sacrifice that they make for the acquisition of several<br />
functionalities. Given the functionalities provided to him by the good, the client will<br />
decide if the price of that commodity is acceptable. Thus, the value is an opportunity<br />
judgment on the relationship between functionality and price.<br />
~ 433 ~
The resources of an enterprise are a real potential of functionality. Transforming them<br />
into functionalities not always coincide with processes strictly carried out within the<br />
entity. Many times, some activities are carried out by appealing to other organizations<br />
(suppliers, distributors, etc.), getting out of the perimeter of an enterprise. Resource<br />
transformation into functionalities (which corresponds to value creation system) must<br />
be examined on the entire value chain, each entity being a "link" in this chain.<br />
So, value is the result of a set of intended features. The fact is that it is determined<br />
either by the market or by a customer's preferences, but in both cases it is found, not<br />
built by the company. It is an information to be sought outside, not calculated inside<br />
the company, through costs.<br />
The issues mentioned above aimed at the customer value, but also must be discussed<br />
the creation of shareholders value. Knight (1998) believes that a higher profitability<br />
does not guarantee value creation for company shareholders, because value creation<br />
requires three rules, namely:<br />
• level of profitability has nothing to do with value creating – profit amount<br />
does not represent a company's advantage over another;<br />
• all companies start from the same level in value creation;<br />
• each entity has to face different challenges.<br />
Like Knight, many authors believe that profit is not the best indicator to assess the<br />
value, in this regard considering the cash flow released by the activities to be the<br />
relevant measure. Dalborg (1999) identified four fundamental elements in creating<br />
shareholder value: operational excellence, achieving a proper financial structure,<br />
focusing on all aspects and reliable earnings growth. The author believes that success<br />
in creating shareholder value is a very good positioning in all four issues mentioned<br />
above.<br />
Performance measurement is not sufficient unless it is considered together with the<br />
resources, activities and objectives. Furthermore, performance needs to be managed.<br />
1.2. Regulation: a complex and difficult issue<br />
With the elimination of monopoly on the telecommunications market, the industry is<br />
proving to be extremely dynamic and unpredictable at the same time.<br />
Telecommunications companies operate in a highly competitive environment, and<br />
their efforts regarding the adoption of appropriate strategies are important. In such a<br />
context, firms must be able to anticipate, develop and rapidly respond to<br />
developments in the sector, in order to survive and gain an advantage over<br />
competitors.<br />
The environment is one of the factors that influence the strategy and performance of<br />
an organization. Current environment, characterized by make competitive advantages<br />
to be rapidly created and eroded.<br />
The main forces to be considered when developing the strategy of a telecom operator<br />
are (Terplan and Morreale, 2000): technology, regulation, customers and competition.<br />
The major issue raised by the public services is that they require considerable<br />
~ 434 ~
investment in infrastructure, once invested the amount can not be recovered by<br />
assigning new destinations assets.<br />
A widely discussed topic in the telecommunications literature is representing by the<br />
role of regulation in industry development (Beardsley and Farrell, 2005; Michalis,<br />
2001). Arguments have been both in favor of an active role played by the authorities<br />
in protecting consumers' interests (Beardsley and Farrell, 2005; Haring and Rohlfs,<br />
1997) and against excessive regulation (Haring and Rohlfs, 1997). This makes it<br />
extremely difficult for any regulator to find a balance between various interests, often<br />
conflicting, of those involved.<br />
Beardsley and Farrell (2005) described the role of regulation as follows: "The purpose<br />
of economic regulation should be the same in all sectors: to facilitate fair competition,<br />
or, where there is a natural monopoly, to ensure proper pricing and a high level of<br />
services quality. A real competition is a strong growth of the sector, which in turn will<br />
generate a faster economic growth and benefits for all." Certainly, this goal is so<br />
noble, but the practice has shown that authorities from everywhere are trying hard to<br />
get a set of rules, neutral and convenient for all.<br />
Although the regulation is not a recent issue, it raises a particular interest during the<br />
last few years. An explanation of this fact could be that the need for regulation is<br />
correlated with industry maturity (Vesa et al., 2005), in all respects.<br />
In our opinion, a fully liberalized telecommunications market, without any<br />
intervention by regulatory authorities, it is hard to imagine, if not impossible. As long<br />
as these services are publicly available, user interests must be protected. Of course,<br />
any excessive regulation is not desirable; it can restrict operators’ rights and limit the<br />
competition.<br />
The problem of regulation does not finish with the liberalization and privatization, of<br />
at least two reasons (Hills, 1986):<br />
• where monopolies have operated for a long time, the market share of main<br />
operator is dominant, even if the competition has been opened;<br />
• even after liberalization, if the market entry is easy, major operators require a<br />
certain protection to allow them to recover the costs invested in infrastructure.<br />
The regulation was designed to create benefits for consumers, so they can benefit<br />
from telecom services at lower prices than those charged by a firm in monopoly. The<br />
problem is that among the consumers could not be identified a common interest<br />
(Hills, 1986), because service users are of different categories and their interests<br />
differ. On long run, their common interest is to reduce expenses regarding network<br />
access, but on short term no category of users is willing to bear additional costs in<br />
order to benefit from universal service.<br />
We believe that regulation of a complex and dynamic field, such telecommunications,<br />
is an extremely delicate matter, for several reasons:<br />
• First, it must be impartial, even if governments still have a higher or lower part<br />
of incumbent operators shares, former monopolists;<br />
~ 435 ~
• Secondly, it must cover all key issues for an effective development of<br />
activities and must contain some aspects to ensure regulatory authority control<br />
over compliance with obligations imposed on operators;<br />
• And thirdly, caution must be exercised not to create imbalances in the market.<br />
Regulation is not a recent process, but concerns regarding this issue have been<br />
intensified lately, with the technological and information revolution. Regulatory<br />
authorities have been created in almost all countries; rules have been harmonized in<br />
different countries within regional organizations and, later, at international level.<br />
2. BACKGROUD TO THE CASE COMPANY<br />
The company chosen for our study is the main Romanian telecommunications<br />
operator - Romtelecom. The company had been founded in 1930, after the Second<br />
World War was nationalized, and in 1990 Rom-Post-Telecom was created, stateowned<br />
company in telecommunications, post and broadcasting areas. Subsequently, in<br />
1991, by separation of telecommunications services from the post services, the<br />
company becomes Romtelecom - the state operator in telecoms, with monopoly on the<br />
basic services. In 1997, Romtelecom has been transformed into joint stock company<br />
for privatization. That same year two mobile operators were launched, which created<br />
a highly competitive environment; the results were remarkable, the rate of increase in<br />
the number of mobile users being among the highest in Europe at that time.<br />
Romanian telecommunications have developed more slowly, primarily because of the<br />
monopoly which operated for a long time, and state control, which was not able to<br />
manage and fund a sector with a high growth rate. It could be observed that, where<br />
competition was allowed, the results were significant.<br />
A series of regulations were adopted during this period, primarily aimed at<br />
transposing EU legislation. As a result, on February 1998 Romania's<br />
telecommunications market was liberalized, except for fixed telephony and leased<br />
lines, markets that were to be opened from January 2003.<br />
Privatization has involved several steps. The first of these, in 1998, the Greek operator<br />
OTE acquired 35% of Romtelecom shares, taking also the management of the<br />
company, while Romanian government held the majority. Under the privatization<br />
agreement, the government was required to keep the monopoly in fixed telephony<br />
until the end of 2002. The second phase, aimed at taking over the majority by the<br />
Greek company, the remaining shares being held by the Ministry of Communications<br />
and Information Society, representing the state, its share being 45.99% currently.<br />
After privatization and liberalization, the company was forced to act in order to adapt<br />
itself to new business conditions. Romtelecom describes its mission as "ever-growing<br />
delivering promptly ever-growing reliable telecommunication and entertainment<br />
services" (Romtelecom's website, 2011). The company's vision can be summarized as<br />
follows: "Romtelecom is the service company setting the standards within Romania,<br />
by exceeding the expectations of customers, employees and shareholders in the<br />
provision of high quality communication, entertainment and IT solutions<br />
(Romtelecom's website, 2011).<br />
~ 436 ~
Romtelecom has undergone a major transformation over recent years, successfully<br />
managing to respond to the challenge of becoming more efficient and developing a<br />
portfolio of alternative services, in addition to traditional fixed telephony offer. The<br />
company currently offers to its customers a wide variety of services: voice, data and<br />
broadband Internet services, combined packages that include IT equipment and<br />
complex solutions for IT & C.<br />
3. RESEARCH RESULTS<br />
3.1. Research method<br />
This paper is part of a broader study conducted during 2005-2010. The study uses<br />
multiple sources to collect evidence, namely: regulatory package for<br />
telecommunications, publicly available information, including Romtelecom’s annual<br />
reports and regulatory authority reports on company studied, as well as methodologies<br />
developed by the company for computing the costs of regulated services. The access<br />
to these data was relatively easy, being public information. We had the opportunity to<br />
compare the sources, which allows us to provide a more comprehensive and<br />
conclusive picture of the phenomenon.<br />
The regulatory package has been provided by the regulator and it allowed us to cover<br />
all aspects regarding the legislation that studied company must deal with.<br />
Romtelecom’s annual reports allowed us to understand the history of the organization,<br />
the change it went through and how the regulation has had an impact on its results.<br />
Regulatory authority reports on Romtelecom helped us to confirm or invalidate<br />
certain conclusions drawn from analysis of data collected from company reports.<br />
In the last part of the analysis we have tried to overlap the information obtained over<br />
the theoretical framework, so we can respond to the questions raised in this paper.<br />
3.2. Case findings<br />
This section of the paper contains a brief description of the organization in order to<br />
understand the entity's management control system, followed by a summary of the<br />
effects generated by the regulations on management control system and performance<br />
measurement.<br />
With the full liberalization of the telecommunications sector, Romtelecom has been<br />
forced to cope with the rigors of competition, which is why both the strategy and<br />
structure had to be adapted to the new conditions.<br />
As a former monopoly operator, with a vertical structure, Romtelecom experience<br />
problems with the rigidity of its structure, overloaded in relation to the tasks required<br />
and difficult to model, in a dynamic environment such as telecommunications. Taking<br />
into account the three main forces acting in the telecommunications sector and,<br />
implicitly, on analyzed entity - customers, competition, changes – it has been<br />
observed the need to "reinvent" the business. In 2007, Romtelecom has launched a<br />
comprehensive process of business reengineering in order to improve internal<br />
processes. In essence, this redesign is to create two business units and a support unit.<br />
The two business units are: wholesale, covering infrastructure management and<br />
~ 437 ~
elationships with other operators, respectively, retail, whose objective is social<br />
marketing and customer relationship management. Support unit provides support<br />
services for both business units.<br />
It can be noticed that, in fact, strategic business units were created, namely, division<br />
of the company with their own mission and objectives, designed to maximize profit<br />
and provide "relevant" services. Certainly, these units are small enough to be flexible<br />
and, at the same time, large enough to control several factors that can affect long term<br />
performance.<br />
Romtelecom, like other traditional telecommunications operators, had to adapt to the<br />
highly competitive market conditions. To ensure greater business flexibility and<br />
reduce time to market for new services, in 2007 Romtelecom has refocused its<br />
business strategy and launched the "Customer 1 st " project, which aimed to bring<br />
additional benefits to customers, either at the same or at a lower price.<br />
The company aims to focus on new services whose markets are not subject to the<br />
regulations, unlike the classical voice market, which is strongly regulated. In the latter<br />
case, Romtelecom does not have the desired freedom; instead broadband Internet<br />
services and digital television allow the company to display their creativity.<br />
Regulation covers a set of rules on the quality of services provided to the public, but<br />
also on cost accounting system, in order to set the prices based on costs. Romtelecom<br />
was designated as having significant power on the relevant retail markets. This<br />
position entails a number of additional rules the operator must comply with. From this<br />
perspective, the entity subjected to our analysis has to face some pressure from the<br />
regulatory authority and at the same time, from shareholders which pursue the<br />
achievement of performance objectives, while creating value.<br />
The interventions of regulatory authority are strongly felt in several areas: (a)<br />
managerial accounting system; (b) divisional performance measurement system and<br />
(c) pricing services.<br />
(a) managerial accounting system<br />
The ANCOM Decision no. 1380 / 2003 requires Romtelecom to elaborate a<br />
"methodology for separate accounting implementation", which aims to prepare a set<br />
of separate financial statements (for each business unit), using some information<br />
provided by the managerial accounting system.<br />
In addition, operators with significant market power are required to develop a topdown<br />
model for computing the long-run incremental costs (LRIC) for activities<br />
related to interconnection and access to an operator network or to its associated<br />
infrastructure, in order use these costs for setting cost-oriented prices. ANCOM<br />
approved a regulation regarding the implementation of this model for Romtelecom<br />
(Decision no. 1381 / 2003), as well as for the two mobile operators with significant<br />
market power. LRIC practice is recognized as the best practice in the field, being used<br />
by most European Union member states.<br />
~ 438 ~
LRIC models provide cost orientation of prices and, at the same time, a basis for<br />
making investment decisions. ANCOM sets the prices after a reconciliation process of<br />
bottom-up model developed by the regulatory authority with top-down model<br />
implemented by the operator. To benefit from both models, practice uses a "hybrid"<br />
model that involves reconciliation between bottom-up LRIC model and top-down<br />
model.<br />
(b) divisional performance measurement system<br />
Even if internal transactions do not affect the overall performance of the organization,<br />
performance assessment of each business unit should be discussed. The internal<br />
transfers between business units are directed particularly from transport and access<br />
network units to the "retail" division. The problem of determining the value of these<br />
services is extremely important, in terms of assessing the performance of each<br />
business unit.<br />
The value of internal transfers it is settled differently, depending on business unit<br />
located as provider (Decision no. 1380 / 2003). For transport network, the transfer<br />
price is set on effective full cost basis, while for access network it is used the market<br />
price determined on the basis of actual cost.<br />
These transfer prices affect the profit of each division, so that performance<br />
measurement of each division is distorted. In addition, financial measures used for<br />
performance measurement are influenced by an indicator required by the regulatory<br />
authority - the weighted average cost of capital.<br />
In Romtelecom’s case, the weighted average cost of capital used to prepare the<br />
financial statements of each business units, for reporting to the regulatory authority, as<br />
well as for computing the costs of regulated services, is communicated by ANCOM<br />
after reconciliation between it and Romtelecom during the consultation procedure to<br />
develop hybrid model of LRIC. The resulting rate is 15.24% and it has been used<br />
throughout the period 2004-2009.<br />
The calculation of an indicator such as economic value added (EVA) will require<br />
additional recalculation using a real weighted average cost of capital. Moreover, the<br />
operating result after tax for each business unit is also affected by internal transfers.<br />
(c) pricing services<br />
Pricing services offered by operators that have a significant position on relevant<br />
markets is a delicate issue. Sure, the regulator has imposed prices based on cost, in<br />
order to promote competition in telecommunications markets. The price of<br />
telecommunications services is considered as a variable that corresponds to the ratio<br />
between what the customer is willing to pay and the utility he receives in relation to<br />
that service (Kollmann, 2000).<br />
Pricing is only a part of a much broader problem regarding the determination of what<br />
services will be maintained and those which will be dropped, the capacity to be<br />
installed and how available capacity will be allocated (Balakrishnan and<br />
Sivaramakrishnan, 2002). Also, problem of pricing services becomes a highly<br />
~ 439 ~
complex given that information regarding market and demand are plentiful (Banker et<br />
al., 2002). But in this entire "landscape" appears the national regulatory authority,<br />
which complicates much more the situation.<br />
For Romtelecom, the operator designated as having significant power on relevant<br />
retail markets, the regulatory authority established by Decision no. 1949 / 2007<br />
control formula for price rising. Maximum average annual increase of prices is<br />
determined by the consumer price index communicated by the National Institute of<br />
Statistics.<br />
In addition, any price change, introduction of new packages of services or discounts<br />
should be communicated to the ANCOM. Authority has the right to verify if, through<br />
its prices, Romtelecom fails obligation not to practice dumping prices, which aim at<br />
limiting the entry or restricing competition.<br />
Price checking by ANCOM is made based on information supplied by the operator in<br />
its separate financial statements. Moreover, Romtelecom has the obligation to<br />
transmit, at authority request, information on monthly traffic registered for different<br />
categories of subscribers, identified by combinations or packages of services and<br />
available options in the operator offer. If violations of obligations imposed are found<br />
after this control, ANCOM can impose an appropriate change of prices or withdraw<br />
the service packages.<br />
The considerations explained above are only part of regulations imposed on the<br />
company studied. We limited our description just to those that have a direct impact on<br />
management accounting system and performance measurement system. Under these<br />
circumstances, we ask ourselves: how company's performance can be managed in<br />
these conditions? In the next section we will discuss the information collected and<br />
draw some conclusions from the conducted study.<br />
DISCUSSION AND CONSLUSIONS<br />
Opening competition was a turning point in terms of how Romtelecom understood the<br />
articulation of its actions by reference to the competitive environment in which<br />
operated, an environment that no longer resembles to the one in which activated for a<br />
long time. These changes have required the entity greater flexibility in its actions in<br />
order to meet the needs of users of its traditional services (fixed telephony). In the<br />
following, we are answering to the two questions addressed at the beginning of this<br />
paper.<br />
(a) to which extent telecoms regulations affect the management control practices<br />
and thus performance measurement system?<br />
Management control system of Romtelecom is strongly influenced by these<br />
regulations, the freedom company has to choose and implement performance<br />
management tools is strongly limited.<br />
Performance measurement has suffered, especially when we talk about divisional<br />
performance. Most regulations are affecting revenues, as well as costs of each<br />
division and thus their profits. Because financial indicators that are based on profit,<br />
~ 440 ~
are primarily used for performance measurement is understandable that the<br />
interventions of the regulatory authority distort the management accounting system<br />
and performance measurement process.<br />
Given that the regulatory authority exercises strict control over prices on the<br />
telecommunications market, we believe that managing the costs is an imperative; in<br />
this respect Japanese approach of target costing may be useful, supported by an<br />
efficient activity-based management.<br />
However, regulation should not be viewed as a negative aspect. It can also provide<br />
benefits that can be capitalized. For example, for pricing the interconnection services,<br />
LRIC costing model uses data from separate financial statements and relies on<br />
information regarding operators’ recent performance, thereby enabling the elimination<br />
of costs related to structural and operational inefficiencies, and estimating long-term<br />
evolution of these costs.<br />
(b) which management control tools “escape” from regulation and can be<br />
exploited in order to create value and improve company performance?<br />
Addressing the concept of performance, Alazard and Separi (2003) stated that<br />
"performance requires a holistic view of interdependencies between internal and<br />
external, quantitative and qualitative, techniques and human, physical and financial<br />
management parameters." Trying to measure the value created by the organization<br />
solely on the basis of purely financial indicators can lead to a manipulation of<br />
numbers. These negative effects can be counteracted by supplementing the analysis of<br />
financial indicators with non-financial elements. Service quality is one of these<br />
elements, aiming at appropriate quality management.<br />
Quality is increasingly recognized as a key competitive advantage and it is more and<br />
more placed by enterprises in their global strategic choices. In order to improve<br />
quality, the company must invest in prevention, with beneficial effects in saving other<br />
cost categories. Quality in telecommunications can be appreciated by the customer<br />
through the following features: fastness of service installation, promptitude in<br />
replying to failures requests, signal quality, the time required for purchasing new<br />
services, customer information, payment method, changing contractual terms, price,<br />
service customization, compatibility with other services.<br />
A common view in literature is that a satisfied customer is the best indicator of the<br />
quality of any business. While much of the literature suggests that total quality<br />
management facilitate customer satisfaction, Sharma et al. (2010) believe that this is<br />
not necessarily true in the case of privatized monopolies. However, a solution could<br />
be the implementation of a set of concepts and management tools aimed at involving<br />
all staff in order to achieve continuous performance improvement (Hoque, 2003).<br />
But organizational change often encounters resistance from actors who refuse to adapt<br />
to these change. For example, sudden changes of regulations, of technologies or<br />
customer requirements may cause institutional contradictions / inconsistencies<br />
(Sharma et al., 2010). Such a situation was encountered in Romtelecom, when the<br />
reengineering process started, in conjunction with the redesign of organization<br />
structure and activity-based management implementation.<br />
~ 441 ~
This phenomenon is not unique, such problems being faced by other European<br />
incumbent operators. Trying to implement activity-based costing system in the<br />
Portuguese telecommunications incumbent operator found resistance from production<br />
employees and managers (Major and Hopper, 2005).<br />
We believe that paying an increased attention to encourage a behavior that contribute<br />
to developing an organizational culture that promotes cooperation and a processoriented<br />
management, instead of perpetuating routine from public sector, can be an<br />
action directed toward improving organizational performance.<br />
Our analysis is limited to one case study. Therefore may not be applicable to other<br />
Romanian telecommunications companies. Our intention has not been to develop a<br />
comprehensive theoretical framework, but to explain and understand the effects of<br />
regulation on management control system and identify practices that can be used in<br />
order to achieve superior performance. Thus, the work may offer a different<br />
perspective to companies that fail to find solutions to improve performance in a highly<br />
regulated environment.<br />
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79-97<br />
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~ 443 ~
QUO VADIS IN MEASURING BUSINESS<br />
PERFORMANCE? A PRACTICAL SOLUTION<br />
FOR THE IT SECTOR<br />
Claudia Elena SERBAN 1 ,<br />
Oana-Adelina FLORICIOIU & Radu-Daniel LOGHIN<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
This paper aims to provide, in light of the growing importance of performance management<br />
in all socio-human activities, a strategic planning and management system for the IT sector.<br />
Using a strategic planning and management control system in an efficient way helps to<br />
generate value and raise the living standards in a community. These form the premises for<br />
sustainable growth, an ideal which should concern every active or inactive member of a<br />
society. The contents of the paper are the result of applied positive research, as it tries to<br />
shape an existing strategic planning and management system regarding the necessities of<br />
information technology for the betterment of the economy.<br />
KEYWORDS: performance, performance management, management control system,<br />
performance monitoring, balanced scorecard<br />
INTRODUCTION<br />
The term performance originates in Latin, and its current meaning has been retained<br />
in English as the ability of socio-human activity to reach its purpose, vision, and its<br />
innate objectives. Attempting to define this notion from an economic point of view, a<br />
notion which, as Jianu I. stated, is so „sweet” in meaning but so “bitter” in<br />
complexity, we can distinguish three major directions pertaining to the success margin<br />
in achieving strategic objectives as well as goals relevant for socio-human activities,<br />
the ability of a socio-human activity to bring value to all related parties, as well as the<br />
ability of socio-human activity to achieve a high level of effectiveness and efficiency.<br />
According to the first direction, socio-human activity is performant when it achieves<br />
its intended strategic perspectives. In desiring to follow the strategic perspectives,<br />
enterprises or socio-human-activities develop monitoring systems, which are used to<br />
trace out the appropriate course of action. Monitoring involves using goals as well as<br />
some sophisticated valuation systems. In this context, enterprises, identical size, area<br />
of interest and even socio-political-geographical factors are easily distinguishable<br />
according to the vision set out by the human equity relevant to the economic sector.<br />
Jianu I., in her work titled Evaluarea, prezentarea şi analiza performanţei<br />
întreprinderii,” captures this aspect with the following paragraph: “What is an<br />
achievement in a given statement, set by certain goals and objectives may not be so<br />
1<br />
Correspondence address: Claudia Elena SERBAN, Bucharest Academy of Economic Studies;<br />
email: claudiaserbanos@yahoo.com<br />
~ 444 ~
considered under a different statement, set by other objectives. Performance can be<br />
considered only by achieving preset goals and objectives.”<br />
According to the second view, “performance in enterprises (socio-human activities) is<br />
anything that enhances the value-cost set and not just something that reduces costs or<br />
increases value”, as Jianu I. wrote in the same paper, mentioned previously. Added<br />
value must be analysed through the perspective of all parties involved in the entity’s<br />
activity – stock-holders, employees, customers, and not the least through the lens of<br />
the social-political and natural enviroment in which the said activity occurs.<br />
The last vision can be found in Niculescu M.’s volume Diagnostic global strategic:<br />
“an enterprise is theoretically performant if it is at the same time both productive and<br />
effective.” Our opinion is that the meaning of performance cannot be reduced to the<br />
meaning of these terms. Productivity expresses only a state of fact that characterises<br />
the productive activity of an enterprise. The fact that an enterprise is productive does<br />
not mean it is necessarily performant.<br />
“Every organization, regardless of type, needs a clear and cohesive performance<br />
measurement framework that is understood by all levels of the organization and that<br />
supports objectives and the collection of results”, mentions Procurement Executives<br />
Associations in “Guide to a Balanced Scorecard Performance Management<br />
Methodology.” According to this guide, performance measurement is the process used<br />
in determining the companies’ progress and meeting the goals, in matters of efficiency<br />
(resource consumption), product quality and results.“Performance management”<br />
means using performance measures to change processes, activities, and organizational<br />
culture and to allow the establishment of policies and objectives as well as their<br />
implementation. “Performance measurement precedes and includes performance<br />
measurement,” wrote C. Albu and N. Albu in Soluţii practice de eficientizare a<br />
activităţilor de creştere a performanţei organizaţionale.<br />
Performance has to be tracked, measured and managed around the clock. We can state<br />
that an organization’s performance depends on its environment, strategy and mission<br />
as well as its responses in matters of flexibility and adaptability. “Measurements are<br />
key. If you cannot measure it, you cannot control it. If you cannot control it, you<br />
cannot manage it. If you cannot manage it, you cannot improve it and achieve<br />
performance,” state P. Kueng P. and A.J.W Krahn in “Building a process.<br />
Performance Measurement Systems: some early experiences.”<br />
As C. Albu and N. Albu mention in the article above, “the way we perceive<br />
performance is a representation of the business’s activities, it is a communication<br />
means by establishing a common terminology, it helps us comprehend the<br />
phenomenon, it has limits (like any other construct) and that is why the modeling<br />
(construction, integration and model valuation) is more important than the model<br />
itself. As they write, “the control and measurement of the performance must be<br />
coherent with the mission, the strategy, governance and organization’s objectives, and<br />
more they have to ensure their presence and compliance in the organization’s current<br />
actions.”<br />
The enterprise, as a complex and adaptive system, with a certain finality and being<br />
permeable to influences from the exterior, can be considered a set of subsystems.<br />
~ 445 ~
Through the lens of the management, the enterprise is composed of the leadership<br />
subsystem, the subordinated subsystem (operational) and the information subsystem<br />
that links the first two. As C. Caraiani and M. Dumitrana wrote in Contabilitate de<br />
Gestiune şi Control de Gestiune, “solving problems, identifying the connections<br />
between the subsystems, revealing the appropriate information which allow the<br />
operating and leadership subsystems to achieve the established goals can be favoured<br />
by using performance monitoring and reporting statements.” These monitoring<br />
statements are the dashboard (DB), balanced scorecard (BSC), performance prism<br />
(PP), and skandia navigator (SN).<br />
Grafton, J. Lillis, AM and Widener, SK presented in the publication „The role of<br />
performance measurement and evaluation in building organizational capabilities and<br />
performance”, a study on the impact of using monitoring tools relevant to strategic<br />
performance of the future direction of the organization. The study concludes that<br />
management should use a wide range of financial and non-financial indicators in the<br />
monitoring of strategic performance in order to achieve an increase in the value of the<br />
organization, namely the sustainability of the business. Narrowing the area of<br />
monitoring instruments, the authors state, has led to an incomplete feedback, therefore<br />
to decisions affecting the profitability and sustainability.<br />
A good performance measurement system is a way to see if the chosen strategy was<br />
adequate, if it focuses the employee’s attention on what matters most for success,<br />
represents a communication medium for all the company and is very well defined.<br />
This means using quality data, establishing targets, around the clock monitoring to<br />
ensure the targets are met, and initiatives to eliminate negative deviance from the said<br />
targets. We will try to clarify this aspect in the following section. As the approach<br />
varies from sector to sector, we have chosen to restrict the focus to the IT sector. The<br />
contents of the paper are the result of scientific observation, in which the following<br />
concepts are described: performance, performance management, management control<br />
system, performance monitoring.<br />
1. BALANCED SCORECARD (BSC) – STRATEGIC PLANNING<br />
AND MANAGEMENT SYSTEM<br />
Balanced Scorcard was first proposed as a strategic planning and management system<br />
for enterprises’ activities in 1992, by Robert Kaplan and David Norton, with a<br />
backdrop of insufficiencies regarding American companies’ reporting practices.<br />
Recent studies on the relationship between organisation size, product cycles, market<br />
share and Balanced Scorecard usage show that there is a strong bond between the<br />
organisation’s size and BSC usage, as Hoque and James wrote in the article “Linking<br />
balanced scorecard measures to size and market factors: Impact on Organizational<br />
Performance” The BSC has also been incorporated into management accounting<br />
curricula, and has become a standard service offered within many management consulting<br />
firms.<br />
The main reason that large corporations are implementing BSC as a strategic planning<br />
and management system is the fast access it offers to solutions to problems such as:<br />
• Constraints at the data level, which mostly appear in great companies, as a<br />
consequence of decentralization and activity structuring.<br />
~ 446 ~
• The need to simulate efficient transmission, which becomes more obvious<br />
inside corporations.<br />
• Comprehensive information and measurement problems that appear in large<br />
corporations (Kaplan & Atkinson, 1998, cited in Hoque & James, 2000).<br />
• Setting techniques to help evaluate performance levels (Hoque & James, 2000)<br />
• Managing a parameter creates inefficiencies in other unmonitored areas, in<br />
addition to conflicts and gaming at an organizational level (Anthony &<br />
Govindarajan 1998, Malina & Selto 2001, Smith 2002).<br />
BSC is centered around 4 axes as follows:<br />
Financial perspective (what are the stockholders’ expectations?)<br />
Through the financial perspective, we measure the way in which financial<br />
performance is viewed, meaning the number of debtors, cashflows and return on<br />
investment. An enterprises’ financial perspective is vital for achieving success, but<br />
financial data have two major drawbacks. First, they are historical data, and the<br />
enterprises’ market value can greatly surpass the grand total of all net assets. The<br />
difference between these two values is called intangible assets, as J. Tobin wrote in<br />
“A general equilibrium approach to monetary theory.” These are not considered in<br />
standard financial statements. Classic measures used to draw this perspective are:<br />
profit, EBIT, EBITDA, EBT, increase in revenue, revenue obtained through new<br />
products, gross profit in percentages, reduction of costs in key areas, economic value<br />
added, return on equity.<br />
Customer Perspective (what are the customers’ expectations?)<br />
From the customers’ perspective we measure the direct impact taht the enterprise has<br />
over its customers, meaning the necessary time needed to process a phone order, the<br />
results of customer surveys, number of complaints received or the enterprises’<br />
standing among customers. Classical measures include: market share, level of<br />
customer satisfaction, neccesary time to comply with a customers’ request, number of<br />
customer complaints, and time spent with the customers.<br />
Internal process perspective (to satisfy customers and stockholders, what key<br />
processes must be controlled?).<br />
This perspective measures the way in which performance is added in key processes;<br />
for instance, in time spent surveying, the number of units that require reproduction, or<br />
production costs. Classic measures include:<br />
Innovation: production capacity, number of new products or services, time necessary<br />
to develop new products, number of new production licenses<br />
Operational process: productivity, number of flaws, the time necessary to deliver a<br />
product to a customer, the percentage of deliveries in real time, the time necessary to<br />
synchronise production with orders, time required for deployment and tunning, real<br />
production time<br />
Post-delivery services: time required to replace and repair malfunctioning products,<br />
time required to train customers in using the product.<br />
~ 447 ~
Learning and growth perspective (to reach the objectives, what is the required<br />
growth?)<br />
This perspective is oriented towards the enterprise’s growth curve, for instance, the<br />
number of employee suggestions or the required time to train employees.<br />
In the balanced scorecard, we find many financial measures, but there are also<br />
measures pertaining to customers, quality, internal efficiency, and its ability to grow<br />
and improve and grow over time. The balanced scorecard is designed to comply with<br />
an enterprise’s key manager requirements (strategic business unit); as it provides<br />
specific measures for the enterprise’s four perspectives, it can be considered to be a<br />
privileged global strategic planning and performance management system. Through<br />
its information content, this performance control system is action-oriented and<br />
prediction-oriented, as the result of a data selection process, so the information<br />
provided to the management are not too comprehensive.<br />
Classic measures: employee degrees and qualification, figures which show employee<br />
satisfaction, employee productivity, the timeliness of information systems, the number<br />
of control procedures proposed, the percentage of employee suggestions which were<br />
implemented.<br />
Among the pluses this system offers are: providing the company’s leadership with a<br />
clear view of the business, aligning the key performance initiatives with strategies, at<br />
all levels; transmission and comprehension of the objectives and strategies, and<br />
partners’ expectations.<br />
Among the minuses of this system are as follows: the start point for modeling is<br />
strategy, not the partner’s expectations; the number of the partners is limited to four<br />
(neglecting the enviroment, suppliers, competitors; and including employees to<br />
internal growth); it does not specify a link with the means to stimulate the employees.<br />
In each perspective, a company must define the following:<br />
• Strategic objectives – what is the strategy for that perspective;<br />
• Performance Measures – how will progress be measured in that business;<br />
• Targets - the target for each measure;<br />
• Strategic Initiatives - what must be done to achieve the targets.<br />
2. WHY SHOULD THERE BE A BALANCED SCORECARD<br />
FOR THE IT SECTOR?<br />
We focused on the Balanced Scorecard in order to provide an in-depth understanding<br />
of the process in which the ideas found in management accounting entered the world<br />
of specific organization practices and technologies.<br />
Increasing public interest in the consequences of economic processes on the<br />
environment or corporate social problems generated by these processes, are putting<br />
pressure on companies’ management and require a certain type of transparent<br />
reporting, which should respond to the satisfaction of all stakeholders, conclude Li, N.<br />
and Toppinem, A. in the study presented in the paper „Corporate responsibility and<br />
sustainable competitive advantage in forest-based indusy: Complementary or conflict<br />
goals?”<br />
~ 448 ~
We considered this as well, by using the balanced scorecard as a pilot instrument, an<br />
array of economic and financial indicators (short-term monitoring instruments) -<br />
goals, to identify failures in time, but at the same time to serve as a transparent<br />
reporting to all stakeholders.<br />
BSC was drawn into a series of influential articles and business bestsellers (especially<br />
Kaplan & Norton, 1992, 1996), which now form the basis of a major consulting<br />
industry and a set of organization practices. Society was fascinated by the concept of a<br />
strategic planning and performance measurement system, which is now translated into<br />
a multitude of specific practices, compiled today in a Balanced Scorecard.<br />
We chose the IT sector because the challenges are greater when it comes to<br />
performance management, which make it difficult to conclude if the existing<br />
performance serves the strategic objectives. At least in principle, the IT organisations<br />
measure, monitor and act according to the information they collect by applying a<br />
variety of systems and performance management techniques. However, these tend to<br />
measure technical performace. Information pertaining to non-technical performance is<br />
rarely considered, especially data that allows managers to establish whether projects<br />
unfold as planned. There are clues regarding potential performance problems, such as<br />
projects that require the management’s intervention or initiatives that have already<br />
been taken to ensure that problems are solved.<br />
3. THE PRACTICAL SOLUTION<br />
The idea of forging a balanced scorecard to measure IT efficiency is not a new one, as<br />
it has been implemented succesfully by numerous IT corporations. The key to<br />
successfully executing this idea is the ability to clearly view the connection between<br />
IT objectives and goals (as seen by a Chief Information Officer (CIO)) and broad<br />
business goals and objectives (as seen by a Chief Executive Officer (CEO)). This<br />
connection is not invariably obvious. A process for managing performance to reveal<br />
both technical and volatile measures must be painstakingly built. This means<br />
collecting data relevant to performance regarding critical performance measures,<br />
analysing information to define „the objective,” establishing targets relevant for each<br />
measure, frequent monitoring to determine potential driftage, discussing issues with<br />
higher tier management and implementing adequate reforms. This process, however,<br />
cannot work properly without appropriate performance measures (technical and nontechnical)<br />
which will help identify key areas, which require improvement.<br />
Among some of many obstacles facing management, teams are the following:<br />
• dwindling product cycles<br />
• recruiting, rewarding and maintaining talents<br />
• operating and transmiting critical development decisions<br />
• following the demand and supplying the right products<br />
• the emergence of new technologies which invalidate existing products<br />
• unforseen vulnerabilities related to the enterprises’ systems<br />
• undetected threats with dire consequences over the business<br />
To meet the demands of the sector, we can design a strategic planning and<br />
performance management system in the form of a hybrid balanced scorecard, to<br />
incorporate both aspects relating to IT strategic management as well as business<br />
management.<br />
~ 449 ~
Of special interest are the various threats and vulnerabilities in information<br />
technology, as these present a unique aspect of the sector, while the rest are applicable<br />
to other domains as well.<br />
Table 1. Key aspects and focus which define IT management and monitoring<br />
proposals<br />
Aspect Focus<br />
Security<br />
Management<br />
(enterprise-wide)<br />
Critical Business<br />
Applications<br />
Computer<br />
Installations<br />
Security management<br />
at enterpise level.<br />
A business<br />
application that is<br />
critical to the success<br />
of the enterprise<br />
A computer<br />
installation that<br />
supports one or more<br />
business applications<br />
Networks A network that<br />
supports one or more<br />
business applications<br />
Issues<br />
Probed<br />
The commitment provided by<br />
top management to promoting<br />
good information security<br />
practices across the enterprise,<br />
along with the allocation of<br />
appropriate resources. The<br />
aspect in question deals with<br />
vulnerabilites caused by<br />
inadequate security policies<br />
adopted by security<br />
management, as well as their<br />
ability to expose and encounter<br />
threats.<br />
The security requirements of<br />
the application and the<br />
arrangements made for<br />
identifying risks and keeping<br />
them within acceptable levels.<br />
Typical vulnerabilities for this<br />
level include holes left by<br />
programmers in the source<br />
code of the applications in<br />
question and bugs, and threats<br />
come from inconsistencies<br />
between data collection and the<br />
application, as well as<br />
unauthorised copying of the<br />
source code by competitors and<br />
illegal users.<br />
How requirements for<br />
computer services are<br />
identified, and how the<br />
computers are set up and run in<br />
order to meet those<br />
requirements. Typical<br />
vulnerabilities for computer<br />
services include storage<br />
devices and hardware<br />
frameworks that can be stolen<br />
or damaged.<br />
How requirements for network<br />
services are identified; and how<br />
the networks are set up and run<br />
~ 450 ~<br />
How they affect the perspectives<br />
set in BSC<br />
User perspective: through the<br />
enterprise’s policy towards user<br />
requests relevant to its systems<br />
Internal process: perspective<br />
through the effectiveness of its<br />
quality control policies and its<br />
quality manual developed with the<br />
help of the internal audit.<br />
Financial perspective: through<br />
costs linked with a decision made<br />
to mentain a decent level of<br />
security for the enterprise’s<br />
systems.<br />
Learning and innovation: through<br />
policies which encourage the<br />
development of a securityconscious<br />
culture, regarding data<br />
handling that promotes individual<br />
actions<br />
User perspective: through<br />
applications which are able to<br />
identify and block requests from<br />
unauthorised users<br />
Internal process perspective:<br />
through procedures and functions<br />
which allow the rapid compiling of<br />
update packages<br />
Financial perspective: through<br />
financial-accounting applications<br />
that don’t distort user inputs<br />
Learning and innovation: through<br />
interactive simulation technologies<br />
as well as evolving programming<br />
enviroments.<br />
User perspective: through<br />
satisfaction pertaining to the<br />
technology used by the enterprise<br />
Internal process perspective:<br />
through the wear and depreciation<br />
of the computer installations and<br />
their compatability with various<br />
equipments<br />
Financial perspective: through their<br />
amortisation rate during operations<br />
Learning and innovation: through<br />
technologies’ adaptive potential.<br />
User perspective: by the<br />
connection speed recorded while<br />
servicing their needs.
Aspect Focus<br />
Systems<br />
Development<br />
A systems<br />
development unit or<br />
department, or a<br />
particular systems<br />
development project.<br />
Issues<br />
Probed<br />
in order to meet those<br />
requirements. Threats from the<br />
network are represented by<br />
virus attacks and phishing<br />
attempts, and vulnerabilities<br />
pertain to the ill-managed acces<br />
authorisations in the<br />
enterprises’ own network and<br />
inadequate encryptions for<br />
inbound and outbound<br />
transmissions.<br />
How business requirements<br />
(including information security<br />
requirements) are identified;<br />
and how systems are designed<br />
and built to meet those<br />
requirements. Vulnerabilities<br />
can be caused by inadequate<br />
testing in the development<br />
stage of the systems and<br />
products and threats can arise<br />
from fatal errors neglected in<br />
the development phase.<br />
~ 451 ~<br />
How they affect the perspectives<br />
set in BSC<br />
Internal process perspective:<br />
through the efficiency of<br />
transmissions between terminals in<br />
the programming dept.<br />
Financial perspective: through the<br />
costs required to build and mentain<br />
the network<br />
Learning and innovation: through<br />
the WAN acces to international<br />
scientific databases<br />
User perspective: through concern<br />
shown towards their needs before<br />
setting changes<br />
Internal process perspective:<br />
through internal procedures used to<br />
identify and encounter possible<br />
threats.<br />
Financial perspective: through the<br />
value added to the market value of<br />
the enterprise by the implemented<br />
system<br />
Learning and innovation: through<br />
the percentage of innovation in the<br />
actual development<br />
*As Cisco Systems shows, the rising prices of IT sector stocks are volatile and depends on competitors’<br />
decisions as well as the brokers’ negotiation skills (R.D. Loghin, „Implicaţiile contabile ale achiziţiilor<br />
de fotbalişti de către cluburile de fotbal,” 2010).<br />
The ever-present shadow of vulnerabilities and threats to the system, as well as<br />
classical problems, can prevent meeting organisational objectives, a fact that can be<br />
checked through a set of measures meant to support active performance monitoring<br />
efforts, and revealed through statistical, operational and accounting evidence.<br />
Measuring performance and risk converge at a common ground, through different<br />
trajectories: measuring performance becomes more risk-oriented through a set of<br />
performance measures that can detect signals of weakness from the enviroment in a<br />
timely fashion; risk measurement becomes more performance-oriented as it connects<br />
potential threats and opportunities to the enterprises’ strategic objectives.<br />
There are different studies in which, besides the classical performance oriented BSC,<br />
there are references to approaches regarding enterprise-wide risk management.<br />
(Mamoru, 2004; Nagumo, 2004; Beasley et. al. 2006; Woods, 2007). The set of<br />
measures, in order for a more efficient layout, are structured into four perspectives,<br />
and those are: user perspective, financial perspective, internal process perspective and<br />
a learning and innovation perspective.<br />
3.1. User perspective<br />
We chose to replace the customer perspective with the user perspective, as the<br />
recipients of information technology aren’t restricted to customers. Users is a term to<br />
include all those who use information systems developed and mantained by the<br />
enterprise. They have the ability to interact with the supplier and notify it about the<br />
degree of those interactions. The GUI interface is intuitive, but for many users there<br />
needs to be a support system capable of receiving calls and complaints. The enterprise
should respond to every request in an effective and efficient manner, an aspect that<br />
can be measured by the number of the call center’s telephone sessions. The<br />
satisfaction of users does not only include the positive aspects, but also the negative<br />
ones, such as complaints regarding the quality of operator-customer relations. Also in<br />
focus is the time it takes to fulfill a request, expressed in hours, which should be<br />
diminished as far as possible while maintaining the necessary quality.<br />
A novel approach to user management is the inclusion of social aid and sponsorships<br />
in the overall promotion strategy, as a viable alternative to advertising expenses.<br />
The objectives of this perspectives are: customer satisfaction (monitoring measures<br />
proposed: the total number of complaints, the total number of solved complaints, the<br />
number of received calls, the number of first call resolutions); protection against<br />
digital piracy (monitoring measures proposed: cost of digital piracy/Revenue*1000,<br />
cost of digital piracy/total Revenue); positive image (monitoring measures proposed:<br />
total protocol and sponsorship expenses to 1000 monetary units in revenue).<br />
Table 2. User perspective design<br />
Measure Metrics and<br />
positive trend<br />
Data source Benchmark<br />
Total number of complaints Number, decreasing mails, phone calls,<br />
surveys<br />
none<br />
Total number of solved<br />
complaints<br />
Number, increasing surveys, session records none<br />
Number of received calls Number, decreasing Phone bills none<br />
Number of first call resolutions Number, increasing Phone bills, surveys none<br />
Cost of digital<br />
Currency, decreasing Police reports, income Sector reports<br />
piracy/Revenue*1000<br />
statement<br />
Cost of digital piracy/Total Currency, decreasing Police reports, income Sector reports<br />
Revenue<br />
statement<br />
Total protocol and<br />
Currency, no fluctuation Income statement Published financial<br />
sponsorship expenses to 1000<br />
monetary units in revenue<br />
reports<br />
3.2. Internal process perspective<br />
To survive the passing of time, an IT enterprise must be in touch with the latest<br />
developments, and this implies a constant renewal of user licenses. The information<br />
technology market constantly bears witness to new technologies, which open new<br />
venues for business while closing old and ineffective ones. Also, as Table 1 shows, in<br />
information technology it is imperative to develop a quality handbook as well as to<br />
measure all clues regarding the risks posed by threats and vulnerabilities for solid<br />
operational, financial and investment activities.<br />
The objectives of this perspectives are: ensuring system quality (proposed monitoring<br />
measures: average period required to produce an update, no. of implemented security<br />
procedures per employee, threats/update, the average time it takes to cover a<br />
vulnerability, the average network downtime, average worktime of the equipment<br />
divided by total work schedule, no. of required interventions to bring a system<br />
online); adapting to new technologies (monitoring measures proposed: license<br />
renewal rate, the frequency of installing new operating systems, variation of novel<br />
equipment acquisitions as percentage of total balance sheet growth).<br />
~ 452 ~
Tabel 3. Internal process design<br />
Measure<br />
Metrics and positive<br />
trend<br />
Data source Benchmark<br />
Average period required to<br />
produce an update<br />
Hours, decreasing Development logs None<br />
No. of implemented security Number, increasing Statements of None<br />
procedures/employee<br />
compliance<br />
Threats/Update Number, increasing Source code Rival systems<br />
The average time it takes to Hours, decreasing<br />
cover a vulnerability<br />
Development logs Market-wide surveys<br />
Average network downtime Percentage, decreasing Maintenance logs None<br />
Average worktime of the Percentage, decreasing Maintenance logs, None<br />
equipment divided by total work<br />
schedule<br />
schedules<br />
No. of required interventions to<br />
bring a system online<br />
Number, decreasing Maintenance logs None<br />
License renewal rate Percentage, increasing Invoices, inventory<br />
lists<br />
Financial statements<br />
The frequency of installing new<br />
operating systems<br />
Percentage,increasing Maintenance logs Financial statements<br />
Variation of novel equipment Percentage, increasing Balance sheet, Financial statements<br />
acquisitions as percentage of<br />
total balance sheet growth<br />
inventory list<br />
3.3. Learning and innovation perspective<br />
An IT enterpises’ ability to improve its services and products is highly dependent on<br />
the R&D expenses it plans to risk to develop a new product or service. The success<br />
rate of such efforts can be measured by reporting R&D expenses to those which were<br />
convertible into assets, as well as through counting independent, unfinanced<br />
initiatives. One learning process that is vital for this field is attending industry-focused<br />
and sponsored conferences and events. The objectives of this perspectives are:<br />
attending relevant IT-focused events and conferences (monitoring measures proposed:<br />
conference buget fluctuations as part of the overall buget fluctuation, the margin of<br />
fulfillment for the revenue expected from attendance, number of attendees/overall<br />
possible events); bringing new products and services (proposed monitoring measures:<br />
unconvertible R&D expenses/capitalised R&D expenses, the number of new<br />
programming languages learned by the employees).<br />
Tabel 4. Learning and innovation perspective design<br />
Measure Metrics and positive trend Data source Benchmark<br />
Conference buget<br />
fluctuations as part of the<br />
overall buget fluctuation<br />
Currency, increasing Annual budget None<br />
Margin of fulfillment for the percentage, increasing Financial predictions, None<br />
revenue expected from<br />
attendance<br />
income statement<br />
Number of attendees/Overall Percentage, increasing Event brochures, calls for Call for papers,<br />
possible events<br />
papers, attendance logs paper lists<br />
Unconvertible R&D<br />
Percentage, decreasing Balance sheet, income None<br />
expenses/Capitalised R&D<br />
expenses<br />
statement<br />
Number of new programming Number, increasing Academic Degrees, None<br />
languages learned by the<br />
employees<br />
Queries<br />
~ 453 ~
3.4. The financial perspective<br />
The IT sector is witnessing a period of unprecedented growth, and those responsible<br />
for financial management of the entities are forced to reflect that growth into the value<br />
they add to their stockholders. The stockholders look towards their stocks from the<br />
lens of the value those stocks add to their personal fortune, from the time the titles are<br />
purchased. This growth includes, on one side, dividends paid during all financial<br />
periods and on the other, the growth of stock prices. These two elements combined<br />
compose the shareholders’ earnings in the set of measures relating to the financial<br />
perspective. The enterprise must afford selectivity, in case of a liquidity deficit. The<br />
risk of information systems also plays a significat role in measuring the attractivity of<br />
the company to its investors. A single model, measurable, can help decision-making,<br />
regarding what and when to invest in, and more important, what it should not invest<br />
in, in order to ensure what programs can provide the highest return in revenue.<br />
The objectives of this perspectives are: increasing stockholder earnings (Monitoring<br />
measures proposed: the growth of own stocks relative to that of the sector, business<br />
market value, equity loss or win from reevaluation, loss of equity, economic value<br />
added, turnover from dealing with own stocks); increasing dividends (monitoring<br />
measures proposed: the increase of the dividend distribution rate, net dividend to 1000<br />
monetary units in revenue); the increase of financial leverage (monitoring measures<br />
proposed: financial leverage); reducing audit risks (monitoring measures proposed:<br />
the proportion of information systems audit risks as part of the overall inherent and<br />
control risks, the risk of one’s own stocks relative to the market).<br />
Tabel 5. Financial perspective design<br />
Measure Metrics and positive trend Data source Benchmark<br />
The growth of own<br />
stocks relative to that of<br />
the sector<br />
Percentage, increasing Stock market<br />
transaction data<br />
This set of measures can be used not only to help the three parties involved to follow<br />
the guidelines, but also a a benchmark for determining management bonuses:<br />
Bonus actual = Bonus precedent x(1-x) (Formula nr.1)<br />
Where x is the deviation from targets in percentages. This variable is determined, as<br />
the next formula shows, by comparing the targets for the selected measures relevant to<br />
~ 454 ~<br />
Stock market<br />
transaction data<br />
Business market value currency, increasing Valuation reports Financial news<br />
Equity loss or win from currency, increasing Balance sheet, equity Equity statement<br />
reevaluation<br />
statement<br />
Loss of equity currency, decreasing Balance sheet, income<br />
statement<br />
Financial news<br />
Increase of the dividend<br />
distribution rate<br />
percentage, increasing Financial statements Financial news<br />
Net dividend to 1000<br />
monetary units in revenue<br />
Currency, stable or increasing Financial statements Financial news<br />
Self financing capacity Currency, increasing Income statement Financial<br />
statements<br />
The proportion of<br />
information systems audit<br />
risks as part of the overall<br />
inherent and control risks<br />
Percentage, decreasing Audit report None<br />
The risk of own stocks Percentage, decreasing Stock market reports Stock market<br />
relative to the market<br />
reports
the manager with the actual figures. This applies only to the measures where a<br />
deviation is negative or undesirable by the owners, weighted according to their wish.<br />
Finally, the bonus the manager recieves for his or her performance is determined<br />
through comparison with the present bonus.<br />
1<br />
∑ ⎜<br />
⎛<br />
⎟<br />
⎞<br />
n x − x ÷ xp<br />
× gi<br />
=<br />
⎝ n p<br />
x<br />
⎠<br />
1<br />
∑i<br />
gi<br />
~ 455 ~<br />
(Formula nr. 2)<br />
Balsam, S., Fernando, GD, and Tripathy, A. published in February 2011, in „The<br />
impact of firm strategy on performance measures used in execution compensation”, a<br />
study on the correlation between business strategy, performance measurement<br />
indicators and compensation management. In most cases, according to the study,<br />
management is rewarded based on sales, resulting in its concern for achieving<br />
competitive advantages in the market by reducing the selling price or increase of<br />
physical supply of products, business decisions that often affect the stability. Strategic<br />
performance monitoring focused mainly on elements that are related to the level of<br />
executive remuneration is made at the expense of accounting tools that would allow<br />
identification of failure, which is built in an aggressive start of event risk.<br />
CONCLUSIONS AND FURTHER RESEARCH<br />
“Ignoranti, quem portum petat, nullus suus ventus est”( the wind is never favorable to<br />
those who don't know where they are going), said Lucius Seneca. Any business pilot<br />
needs a direction and a solid navigating system to give him much-needed guidance for<br />
meeting targets. Through a balanced scorecard, with its four perspectives, we get a<br />
“business compass,” which can be mounted on any entity. Adapting the system for the<br />
needs of the IT sector presents a challenge, in both promoting change for the recipients,<br />
as well as integrating its many features with the sectors’ requirements. Threats and<br />
vulnerabilities that threaten the business present a focused point for the IT sector, so any<br />
initiative that plans to develop a BSC must consider them before implementing it. The<br />
measures found inside the perspectives must not be taken individually under analysis, as<br />
they form a network of more or less interconnected aspects, and one success may mean<br />
another failure. There may be hostility towards the system from the management, as a<br />
“compass” can take away freedom or evaluate their deviations in a credible way, with<br />
implications stretching to their pockets. That is why the life expectancy of the system<br />
depends foremost on the persuasiveness of its promoters.<br />
In this paper, we evaluated the opportunity and structure of a strategic planning and<br />
management system, and laid the foundation for such a system based on empirical<br />
experience and professional reasoning. The targets and initiatives in the balanced<br />
scorecard were of no interest for the paper, as no IT company was willing to test the<br />
system. The critics of the model, who consider that BSC fails to consider all relevant<br />
parties, address the first obvious limitation. Moreover, recent trends may someday<br />
remove the identified threats and vulnerabilities alltogether, making the current<br />
system obsolete. The lack of direct feedback from spokespersons representing the<br />
sector is also a factor that somewhat diminishes its overall utility and desirability.<br />
We hope that the current results will encourage further studies and stimulate the<br />
management consulting industry to develop or refine its models for the IT sector, in
order to develop portable, intuitive and compressed BSC systems or systems similar<br />
to BSC. We also plan to further our efforts to help IT companies apply the said BSC<br />
and monitor their evolution. The result of the monitoring may be presented in a future<br />
conference.<br />
REFERENCES<br />
Albu, C., Albu, N. (2005) Soluţii practice de eficientizare a activităţilor de creştere a<br />
performanţei organizaţionale, Ed. CECCAR, Bucureşti<br />
Anthony R.N., Govindarajan V. (1998) Management Control Systems, Irwin-McGrawHill,<br />
New York, NY,<br />
Balsam, S., Fernando, GD, Tripathy, A. (2011) „The impact of firm strategy on performance<br />
measures used in execution compensation”, Journal of Business Research, vol. 64,<br />
no. 2: 187-193<br />
Beasley, M., Chen, A., Nunez, K., and Wright, L. (2006) “Working Hand in Hand: Balanced<br />
Scorecard and Enterprise Risk Management”, Strategic Finance, March,<br />
Caraiani C., Dumitrana M. (2005) Contabilitate de Gestiune şi Control de Gestiune, Editura<br />
InfoMega, Bucureşti,<br />
Grafton, J. Lillis, AM, Widener, SK (2010) „The role of performance measurement and<br />
evaluation in building organizational capabilities and performance”, Accounting<br />
Organizations and Society, vol. 35, no. 7: 689-706<br />
Hoque, Z., James, W. (2000) “Linking balanced scorecard measures to size and market<br />
factors: Impact on Organizational Performance”, Journal of Management Accounting<br />
Research, Vol. 12<br />
Ionascu I. , Stere M., Andrei T. (2006) Control de gestiune, Editura Economica, Bucuresti<br />
Jianu, I (2007) Evaluarea, prezentarea şi analiza performanţei întreprinderii, Ed. CECCAR,<br />
Bucureşti<br />
Kueng, P. Krahn, A.J.W. (1999) “Building a process. Performance Measurement Systems:<br />
some early experiences“, Journal of Scientific& Industrial Research<br />
Li, N., Toppinem, A. (2011) „Corporate responsibility and sustainable competitive advantage<br />
in forest-based industry: Complementary or conflict goals? ”, Forest Policy and<br />
Economics, vol. 13, no. 2 (SI): 113-123<br />
Loghin,R.D. (2010) Implicaţiile contabile ale achiziţiilor de fotbalişti de către cluburile de<br />
fotbal,<br />
Malina M.A., Selto F.H. (2001) “Communicating and Controlling Strategy: An Empirical<br />
Study of the Effectiveness of the Balanced Scorecard”, Journal of Management<br />
Accounting Research, Vol. 13<br />
Mamoru, U. (2004) “Risk Management and Risk Business Enterprise Risk Management using<br />
Balanced Scorecard”, Management Systems, Vol.14 No.2<br />
Naguno, T. (2004) “Aligning Enterprise Risk Management with strategy through the BSC: the<br />
bank of Tokyo-Mitsubishi approach”, Harvard Business Publishing<br />
Niculescu, M (2003) Diagnostic global strategic, Ed. Economica, Bucureşti<br />
Lorino, P, (1995) Comptes et recits de la performance, Ed. D’Organisation, Paris<br />
Procurement Executives Associations, “Guide to a Balanced Scorecard Performance<br />
Management Methodology“<br />
Smith M.J. (2002) “Gaming Non Financial Performance Measures”, Journal of Management<br />
Accounting Research, Vol. 14.<br />
Tobin J., (1969) “A general equilibrium approach to monetary theory”, Journal of Money<br />
Credit and Banking – cited in Phd. Thesis - Gavrila A. “Integrarea sistemelor<br />
informatice de gestiune pe internet”<br />
Woods, M., (2007) “Linking risk management to strategic controls: a case study of Tesco<br />
plc”,International Journal of Risk Assessment and Management, Vol. 7 No. 8<br />
*** http://www.smartofficenews.com.au/Business/Technology/W2M2N6L8<br />
***http://www.informationweek.com/blog/main/archives/2005/11/outsourcing_it.html<br />
~ 456 ~
***http://www.isaca.org – IASCA site<br />
***http://www.netmba.com/accounting/mgmt/balanced-scorecard/ - NetMba site<br />
***http://www.balancedscorecard.org/BSCResources/PerformanceMeasurement/tabid/59/Def<br />
ault.aspx – the Balanced Scorecard Institute site<br />
~ 457 ~
EFFECTIVE AND EFFICIENT TOOLS IN HUMAN<br />
RESSOURCES MANAGEMENT CONTROL<br />
Mihaela Adriana DUMITRANA 1 , Gabriel RADU,<br />
Mariana Elena GLAVAN & Gabriel JINGA<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
The main objective of our study is to select the most important quantitative techniques that<br />
may be applied as tools in human resources management control, in order to facilitate the<br />
prediction of human resource indicators that may be presented under an appropriate form,<br />
clear and user friendly and then used by managers in their decision making process. For this<br />
reason we have analysed the regression analysis and the learning curves, tools that are<br />
considered appropriate in human resources management control. The cases that presented in<br />
our research form part of our cooperation projects with different companies, projects aiming<br />
to improve and sustain an efficient human resources management control.<br />
KEYWORDS: human resources, regression analysis, learning curves, balanced scorecard<br />
for human resources<br />
INTRODUCTION<br />
A company uses a lot of resources such as: financial, natural or human resources<br />
(HR). The most important of all, for a company, is still the human resource and this is<br />
because without it, it would be impossible to accomplish the mission or to attain a<br />
specific vision within a company.<br />
The capital theory (Becker and Schultz, 1964) considers the employees as assets that<br />
may be valued based on their competences. Human resources are the most important<br />
capital of a company – the vital contact with customers – the key for success (Tom<br />
Farmer, 2010).<br />
Waterman recognized that the organization – people, culture, capacity – represents an<br />
important source of competitive advantages. People are the strategy (Waterman, 1994,<br />
p. 21-22). The increase in financial performances of a company is due to a good<br />
implementation of a human resources strategy, a Knowledge Management.<br />
The importance attributed to human resources is revealed by the seven principles of<br />
total quality management. The sixth principle of the TQM sais that: people are the<br />
organization’s primary resource and these resources execute the organization’s<br />
processes. Machines are tools and contribute to the productivity of people. However,<br />
they have no meaning without people to figure out how to use them in concert with<br />
one another to create the company’s outputs.<br />
1 Correspondence address: Mihaela Adriana DUMITRAANA, Bucharest Academy of Economic<br />
Studies, Romania; email: mihaelaadumitrana@yahoo.com<br />
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The concept of sustainable development (SD) and the concept of corporate social<br />
responsibility (CSR) have a major influence over the way that HR is managed. For<br />
example, in the case of SD, considering the priority of values, the natural resources<br />
comes first, followed by humanity saving. On the contrary, CSR concept considers<br />
that the management priority must be given to HR, followed by to the life standards.<br />
HR is associated with values such as: ethics, engagement for a long period of time,<br />
interrelationship between internal and external actors, objectives etc. Consequently,<br />
the balanced scorecard proposed in our research is based on these concepts and the<br />
indicators are linked to priorities.<br />
1. QUANTITATIVE TECHNIQUES IN HUMAN RESOURCES FORECASTING<br />
1.1 Regression analysis<br />
In order to prepare a balanced scorecard for the presentation of certain indicators<br />
needed by the management is necessary to compare forecasts against real amounts. To<br />
emphasize better the objective of our research we shall calculate the predetermined<br />
and real indicators for the human resource. We consider the application of the<br />
regression analysis as for being a worthy solution in forecasting, because we want to<br />
prove the interrelationship between two variables selected for human resources, e.g.<br />
total cost and training expenses. Based on these two variables we want to calculate the<br />
influence of training expenses on the total cost for a certain level of training expenses.<br />
This will be a first effect, because another will influence the quantity and the quality<br />
of goods or services produced by company. Regression analysis is a forecasting<br />
method based on historical data meant to find the best fit between two variables – one<br />
dependent on the other, and use the straight line to predict future values. The equation<br />
of a straight line is:<br />
where:<br />
y = ax+b<br />
a is the gradient or slope<br />
b is the intercept with the y axis<br />
n is the sample size.<br />
On the horizontal axis we have the independent variable – training expenses, and the<br />
dependent variable, y, is located on the vertical axis – total cost.<br />
The formulas applied to calculate a and b, are the following:<br />
a = (n∑xy- ∑x∑ y)/(n∑x 2 -(∑x) 2 )<br />
b =∑y/n-a∑x/n<br />
Supposing we have, the following data, for a small company, for a period of six<br />
months:<br />
Month Training expenses (mu) Total cost (mu)<br />
April 2,000 34,000<br />
May 4,000 33,000<br />
June 5,000 33,000<br />
July 3,000 31,000<br />
August 1,000 30,000<br />
September 2,000 30,000<br />
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we want to compute the total cost, if training expenses will be mu 6,000.<br />
To forecast costs, when training expenses are known, we must calculate the following<br />
elements:<br />
Month X Y XY X 2 Y 2<br />
April 2 34 68 4 4,624<br />
May 4 33 132 16 17,424<br />
June 5 33 165 25 27,225<br />
July 3 31 93 9 8,649<br />
August 1 30 30 1 900<br />
September 2 30 60 4 3,600<br />
Total 17 191 548 59 62,422<br />
a = (6*548-17*191)/(6*59-17 2 ) = 0.63<br />
b = 191/6-0.63*17/6 = 33.58<br />
When training expenditure is zero, costs will be mu 33,585, and for every mu 1 spent<br />
on training, costs will increase by mu 0.63. If training expenses will be mu 6,000, the<br />
total cost will be:<br />
Y = ax + b = 0.63*6 + 33,585 = 33,589<br />
For forecasting costs for any level of training expenses, the equation of straight line<br />
shall be used. Also for all costs related to human resources, regression analysis may<br />
be used as a relevant tool.<br />
If we want to show the strength of the linear relationship between the two variables,<br />
we can achieve this by calculating the correlation coefficient (r):<br />
r = (n∑xy-∑x∑y)/√(n∑x 2 -(∑x) 2 ((n∑y 2 -(∑y) 2 )<br />
The correlation coefficient may have values within the interval [-1; +1]. The<br />
interpretation of this instrument may be as follows:<br />
• r is close to +1: there is a strong positive correlation between the two variables;<br />
• r is close to -1: there is a strong negative correlation between the two variables;<br />
• r is close to 0: there is a weak relationship between the two variables.<br />
For our example r will be:<br />
r = (6*548-17*191)/(6*59-17 2 )(6*62,442-191 2 ) = 0.0087<br />
r is close to 0 meaning that between training expenses and total cost is a weak<br />
relationship, due to the small amount of training expenses in total cost. For small<br />
companies, the budget meant for personnel training is not as important as for big<br />
companies, where the relationship between variables is strong positive.<br />
2.2. Learning curves<br />
Estimates are forecasts of our expectations based on past conditions and on all<br />
changes predicted for the future. A relevant example may be the learning curves as an<br />
application of non-linear equations.<br />
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Managers need to know all about the time needed to produce a number of units of<br />
output, especially for new products that the company intends to launch on the market.<br />
In this case experiences show that learning is more rapid in the first periods, and after<br />
that, the learning rate decreases gradually until the realization of a certain number of<br />
products or jobs, when time becomes a constant (the Bell curve).<br />
Why is it important to calculate the learning curves effect? The answer is a simple<br />
one, because there is always a link between the number of hours needed to produce an<br />
expected number of products or to realize a number of specific jobs and the number of<br />
human resources employed for this reason. The number of persons that is asked for all<br />
tasks must be remunerated and their salaries and wages influence the costs per unit of<br />
output, the total cost and the efficiency. If the learning curves effect is calculated, it is<br />
possible to determine how productivity increases and consequently how to decrease<br />
the cost per unit.<br />
In conclusion the effect of learning curves is declining in average time and in average<br />
cost per unit.<br />
Wrights Law states the following: as cumulative output doubles, the cumulative<br />
average time per unit falls to a fixed percentage (the learning rate) of the previous<br />
average time (Lucey, 2001, p. 167).<br />
When the curve becomes horizontal, the learning effect is lost and production time per<br />
unit becomes a constant.<br />
The effect of learning curves can be calculated using two methods:<br />
1. cumulative average time method;<br />
2. marginal method.<br />
Both methods use the same general formula, although they have different manners of<br />
defining the elements.<br />
The learning curve is a non-linear function and the formula used is:<br />
Y = ax b<br />
Where:<br />
a – time taken to produce the first unit or batch<br />
b – learning coefficient<br />
x – cumulative output expressed in units or in batches.<br />
The definition of Y is different from one method to the other. For example, for a<br />
cumulative average time method, Y is cumulative average time per object, for x<br />
objects, while for a marginal method, Y is the marginal time for object x.<br />
a) Cumulative average time method<br />
It involves the preparation of a table where the average time is reduced by the learning<br />
rate each time that the output doubles.<br />
~ 461 ~
Researchers have demonstrated that the trend is to decrease the time it takes to<br />
produce an object at a constant rate equal to the rate at which the output increases. For<br />
example, a 90% learning curve shows that, as cumulative total output doubles, the<br />
cumulative average time to produce one object decreases to 10%.<br />
The example that will be presented is based on the data provided by a small<br />
manufacturing company that intends to launch a new product. They asked us to<br />
calculate the total time needed for the production of sixteen batches, when the<br />
learning curve was anticipated at 90%.<br />
The data we used in order to make the calculation is the following:<br />
Cumulative number of batches Cumulative average time per<br />
batch (hours)<br />
Cumulative total hours<br />
(1) (2) (3) = (1)*(2)<br />
1 200 200<br />
2 180 (200*90%) 360<br />
4 162 (180*90%) 648<br />
8 145.5 (162*90%) 1,166.4<br />
16 131.22 (145.5*90%) 2,099.52<br />
The last figure of this table 131.22 and is not the time needed to produce the sixteenth<br />
batch. If we want to calculate this time, two steps must be performed:<br />
Step 1 Calculate the average time for the fifteenth batch and cumulative average time<br />
to produce 15 batches;<br />
Step2 Calculate the time for sixteenth batch as a difference between cumulative total<br />
hours for 16 batches and cumulative average time to produce 15 batches.<br />
Step 1 General relation: Y = ax b<br />
b = log (1-proportionaldecrease)/log2 = log(1-0.1)/log2 = log0.9/log2 = -0.1520<br />
a = 200; x = 15<br />
y = 200*15 -0.152 = 132.5 hours – average time for batch no. 15<br />
Cumulative average time to produce fifteen batches = 132.5*15 = 1,987.5 hours<br />
Step 2 Time for the sixteenth batch = 2,099.52 – 1,987.5 = 112.02 hours<br />
b) Marginal method<br />
The basic assumption in a marginal method is: the time needed to produce a marginal<br />
unit of a batch will be reduced with a given fixed percentage when the cumulative<br />
output doubles.<br />
Using the same example, the illustration of a marginal learning curve, for a 90% rate,<br />
will be:<br />
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Table 3<br />
Cumulative number of batches Cumulative average time per<br />
marginal batch (hours)<br />
Cumulative total hours<br />
(1) (2) (3)=(1)*(2)<br />
1 200 200<br />
2 180 360<br />
4 162 ?<br />
8 145.5 ?<br />
16 131.22 ?<br />
In this table, figures are the same as in Table 2, but the significance is different. So<br />
that, the numbers of column 2 (200, 180, 162, 145.8, 131.22) represent the number of<br />
hours used to produce batches number 1, 2, 3, 4,….,16, and not the average hours to<br />
produce the first batch, the second, the third,…, because we do not have the marginal<br />
time needed to produce batches number 3, 5, 6, 7, 9,…,15. To calculate these values<br />
the formula is: Y=ax b , where Y is the time to produce the marginal batch (unit), and is<br />
used to calculate the time to produce the sixteenth batch. The steps are the following:<br />
a) To calculate the time for batch nr. 16<br />
Y = 200*16 -0.152 = 131.22 hours<br />
b) To compute the cumulative time for cumulative number of batches (16).<br />
It is impossible to calculate directly this time. In order to find out this value we will<br />
calculate for each batch from 1 to 16, and the sum of those durations will be the<br />
answer of our question.<br />
Time to produce batch no 3 = 200*3 -0.152 = 169.2 hours<br />
Time to produce batch no 5 = 200*5 -0.152 = 156.6 hours<br />
Time to produce batch no 6 = 200*6 -0.152 = 152.32 hours<br />
Time to produce batch no 7 = 200*7 -0.152 = 148.7 hours<br />
Time to produce batch no 9 = 200*9 -0,152 = 143.2 hours<br />
Time to produce batch no 10 = 200*10 -0.152 = 140.94 hours<br />
Time to produce batch no 11 = 200*11 -0.152 = 138.9 hours<br />
Time to produce batch no 12 = 200*12 -0.152 = 137.08 hours<br />
Time to produce batch no 13 = 200*13 -0.152 = 135.43 hours<br />
Time to produce batch no 14 = 200*14 -0.152 = 133.9 hours<br />
Time to produce batch no 15 = 200*15 -0.152 = 132.5 hours<br />
Total time calculation = 200 + 180 + 169.2 + 162 + 156.6 + 152.32 + 148.7 + 145.8 +<br />
143.2 + 140.94 + 138.9 + 137.08 + 135.43 + 133.9 + 132.5 + 131.22 = 2,407.79 hours<br />
After a comparison between the two methods, few conclusions have aroused:<br />
� The general formula was the same, but the results were different because Y was<br />
interpreted in different manners.<br />
� Total time for sixteen batches was by method 1: 2,099 hours and by method 2:<br />
2,407.79 hours. A difference of 308.79 was calculated, due to the reduction of<br />
production time for each unit of output, in the marginal method.<br />
� Learning curves are not equivalent for two different methods.<br />
~ 463 ~
� Because results are so different it is important to select carefully what method<br />
to apply. In our opinion, the first method is appropriate because it is simple and<br />
the cost-benefit relation will be a favourable one.<br />
� The number of predetermined hours once calculated, will be the starting point<br />
for determining the number of employees needed to achieve the target output as<br />
well as salaries and wages, as an important part of the total cost.<br />
3. BALANCED SCORECARD FOR HUMAN RESOURCES<br />
A balanced scorecard (BSC) is a performance measurement and reporting system that<br />
strikes a balance between financial and nonfinancial measures, links performance to<br />
rewards, and gives explicit recognition to the diversity of organizational goals<br />
(Horngren et al., 2008).<br />
BSC is an important tool for managers because they may understand the effect of their<br />
actions on the nonfinancial and financial indicators, allowing them to analyse how the<br />
company attained its goals, for a certain period, as part of a long term strategy.<br />
Generally, a BSC is prepared for the company as a whole, but we propose a BSC only<br />
for the human resources, because we consider this resource as for being vulnerable<br />
and it must be treated accordingly.<br />
A BSC for human resources (HRBSC) may include indicators grouped in four axes:<br />
� Economic axis<br />
� Life quality axis<br />
� Ethical axis<br />
� Societal and environmental axis<br />
and may be presented as follows:<br />
Economic<br />
Total employees<br />
Shares allocated to employees (% in total equity)<br />
Revenue per employee<br />
Average cost per employee<br />
Cost of HR function per employee<br />
% of cost reduction due to learning curves<br />
Productivity (sales revenue/direct labour hours)<br />
% of training cost in total cost or in sales<br />
% reduction in process cycle time<br />
Ethic<br />
Average salary/sector salary<br />
Women salaries<br />
Men salaries<br />
Number of handicap employees<br />
Average salary per handicap person<br />
Women managers<br />
% of internal rules respected<br />
Table 4<br />
~ 464 ~<br />
Life quality<br />
Working conditions<br />
Working hours<br />
Working accidents (%)<br />
Illness time<br />
Part time employees<br />
Access to services (transport, kindergarten)<br />
Employees implication in management<br />
Qualification and autonomy<br />
Training days per employee<br />
Leadership competence<br />
Negotiation capacity<br />
Societal and environmental<br />
Number of employees implicated in external actions<br />
HR policy in respect with the environment<br />
Number of employees participating to humanitarian<br />
actions<br />
Tutorial hours for young employees<br />
This HRBSC contains indicators for: human effectiveness; employment;<br />
competences; motivation; that in our opinion, are enough to analyse the contribution<br />
of HR to the global performance.
From another point of view, indicators may be used to manage a corporate social<br />
responsibility, because they may measure human resource performance, based on four<br />
axes, both internal and external, so that all kind of analysis are possible.<br />
Indicators presented in HRBSC must be calculated as predetermined figures versus<br />
real figure, facilitating the calculation of variances, the identification of causes leading<br />
to differences and, respectively, the decision making process on how to eliminate the<br />
causes that influence performance.<br />
CONCLUSIONS<br />
i. HR strategy is influenced by SD and CSR.<br />
ii. HR strategy is contributing to the increase of global performance of a company.<br />
iii. The concept of HR is linked to human capital.<br />
iv. To forecast HR indicators quantitative techniques are the best solution.<br />
v. All kind of costs related to HR may be treated as independent variables in<br />
relation with a dependent variable.<br />
vi. We have calculated only the effect of training expenses, in order to prove that a<br />
strong relationship exists, if the amount is a relevant one.<br />
vii. To calculate the effect of the learning curves is something important from two<br />
points of view: first of all because productivity increases, and secondly because<br />
the cost per unit of object decreases. These are important when the number of<br />
employees and total salary costs are calculated.<br />
viii. HRBSC proposed by this research is different from the classical content of a<br />
BSC, where the four axes are: financial, process, customers and competence.<br />
ACKNOWLEDGEMENTS<br />
This work was supported by CNCSIS – UEFISCSU, project number PNII – IDEI<br />
1858/2008 „MANAGEMENT CONTROL IN THE SUSTAINABLE<br />
DEVELOPMENT OF THE HUMAN RESSOURCES”.<br />
REFERENCES<br />
Berland N., De Ronge Y., (2010) Controle de gestion: perspectives strategiques et<br />
manageriales, Ed. Pearson,<br />
Caraiani C., Dumitrana M., (coordonatori), (2010) Control de gestiune, Ed. Universirară<br />
Horngren, Sundem, (2008), Management accounting, Pearson International Edition, Stratton,<br />
Schatzberg, Burgstahler<br />
Pfeffer J., (2010), Resursele umane în ecuaţia profitului, Ed. All<br />
Stephany D., (2003), Developpement durable et performance de l’entreprise, Ed.Liaisons<br />
Waterman R.H., (1994), What America Does Right, W.W. Norton<br />
~ 465 ~
FLEXIBILIZING THE TERMINATION OF THE<br />
EMPLOYMENT CONTRACT: PROS AND CONS<br />
Raluca DIMITRIU 1<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
The changes in the Romanian Labour Code appear to be a way of implementing the concept<br />
of flexicurity in our system of law. And among all institutions changed by the new law,<br />
probably the one related to termination of employment has the most dramatic effect within<br />
labour relations and the very application of the principle of workers’ protection. The<br />
Government’s goal was to offer the possibility for the employers to dismiss and employ<br />
personnel more easily, allowing him/her to select best employees at a time of economic crisis.<br />
However, as a result of an analysis of how the flexicurity principles were applied in other<br />
states (especially in case of the new member states) one may be very much afraid that<br />
flexicurity cannot be obtained by just un-protect the employees and simplify the dismissal<br />
procedure. This is why the changes in the Labour Code, particularly with the intention to<br />
render more flexible the labour market and the contractual arrangements were received by<br />
trade unions, and by the entire society with deep concerns and skepticism. From the<br />
perspective of trade unions, if the implementation of the flexicurity concept seems to be<br />
successful in some of the European states, since it guarantees a certain level of protection, in<br />
Romania such a process would be disadvantageous for employees in terms of the special job<br />
stability they enjoyed. The paper aims to put into light the advantages and disadvantages of<br />
the very recent changes in the Labour Code, and to configure a possible perspective in this<br />
regard.<br />
KEYWORDS: Labour law, employment contract, dismissal, flexicurity<br />
INTRODUCTION<br />
Although the tendency is to be gradually diminished, the role of the state within the<br />
perimeter of the Romanian labour law is still significant. This is manifested, on one<br />
hand, through its specialized bodies especially Labour Inspection, for controlling the<br />
manners of application of the legal provisions. Moreover, for a long time, the state has<br />
intervened by subsidizing certain inefficient industries, in order to avoid the massive<br />
reduction of the work places; for the moment, it has renounced to such a policy.<br />
On the other hand, the state’s intervention in labour relations is manifested through<br />
the detailed regulation of the work relations, which are left to the collective<br />
negotiation to a lesser extent than in other law systems. And this is why one of the<br />
main issues of the current controversy regarding the modification of the Labour Code<br />
was related to the way in which an employment contract should end. The Labour<br />
1 Correspondence address: Raluca DIMITRIU, Labour Law Department,<br />
Faculty of Accounting and Management Information Systems, Academy of Economic Studies, 6,<br />
Romana Square; email: raluca_dimitriu@yahoo.com, Raluca.Dimitriu@cig.ase.ro<br />
~ 466 ~
Code has been modified through Law no. 40/2011, published in the Official Monitor<br />
of Romania no. 225 from 31 March 2011.<br />
How far should the legislator intervene in order to leave the employer’s decision free,<br />
but still to protect the employee against potential abuses? This is obviously a question<br />
each of the social partners should answer in his own way: the trade unions by<br />
revealing the importance of labour protection and the fact the very reason of existing<br />
labour law is to take care of employees, and the employers’ organisations by insisting<br />
that the employer actually created the working places, so he should normally be<br />
allowed to decide what to do with them and with the employment contracts.<br />
The point here is that a law, even a perfect one, can never protect against its own<br />
breaching. In other words, the problem that many employers behave abusively and<br />
disrespect the law cannot be solved by changing the law itself. It is the tools of<br />
applying the legal regulations which have to become stronger, i.e. Labour Inspection.<br />
In order to fully understand the meaning of changing the Labour Code in respect with<br />
the termination of labour contracts, as well as its responses within Romanian society,<br />
one should first have a look at the evolution of Romanian law in this regards.<br />
The previous Labour Code of 1972 was adopted at the time of a regime in which,<br />
within the labour legal relations, the employer was practically always a state<br />
enterprise. Protecting the employee in relation to the employer meant, in fact,<br />
protecting the individual from the state. This is one of the reasons the jurists were<br />
unanimous in restrictively configuring the regime of dismissal.<br />
On the other hand, the communist labour legislation did not even allow the individual<br />
to freely move from one state enterprise to another. Though formally stipulated by<br />
law, resignation was rare, being considered rather reprehensible and leading to the<br />
loss of certain rights, as a consequence of ‘discontinuing the length of service’.<br />
Unemployment was out of the question and each person had a certain guaranteed job.<br />
The graduates of higher education were obliged to receive employment in the<br />
enterprises assigned to them, most often far away from home.<br />
As compared to the full guarantee of the working place that the communist laws<br />
ensured, the Labour Code of 2003 could not bring about a complete flexibilisation,<br />
since the workers kept expecting or demanding the same level of stability. On the<br />
contrary, under the pressure of trade unions, but also of the general public opinion,<br />
whose expectations continued to stay high, the present Code maintained a whole<br />
series of restrictions concerning dismissals, as well as the complete and express<br />
regulation of the reasons for which an employee could be dismissed.<br />
However, after eight years in force, the Labour Code has been changed, aiming at rebalancing<br />
the powers of the parties over the issue of the termination of the<br />
employment. These changes may lead to a new content of the concept of job security,<br />
and also to a new approach of the idea of career.<br />
~ 467 ~
1. TERMINATION BY LAW<br />
The employment contract is concluded intuitu personae, which makes its effects cease<br />
automatically when the employee dies. Indeed, a contract is said to be intuitu<br />
personae when it is entered into in the consideration of the person of the cocontracting<br />
party, i.e. where such consideration is essential for the contract. The very<br />
substance of the employment contract depends on the workers’ personal qualities; if<br />
he dies, the contract is automatically terminated. The same regulation may be found in<br />
case of disappearance of the natural person; the law stipulates the procedure of legally<br />
declaring death.<br />
The employment contract also terminates de jure in case the employee is declared<br />
legally incompetent. Indeed, according to art. 13, para. 4 of the Labour Code, ‘it is<br />
forbidden to employ persons that have been declared legally incompetent’. Normally,<br />
if the legal declaration of incompetence occurs during the fulfilment of the contract, it<br />
will automatically trigger the termination of the contract, as the labour contract<br />
presupposes the employee’s full discernment.<br />
However, the symmetrical hypothesis, namely the death of the employer - natural<br />
person, respectively the dissolution of the employer - legal person, did not represent a<br />
case of the de jure termination of the employment contract. In such a case, the<br />
employees had to be dismissed, for reasons independent of them.<br />
This was the result of a change in the Labour Code, made in 2006, with the purpose to<br />
allow these employees whose enterprises have been dissolved to benefit from the<br />
protection measures related to collective dismissal, while other requirements are<br />
complied with as well.<br />
Such a strange asymmetry led to many difficulties in practice. The employment<br />
contracts could not be legally terminated in case the employer disappeared; the firm<br />
has been dissolved or even the employer - natural person died. Many authors<br />
repeatedly suggested that this cases should be included among the ones in which a<br />
contract is automatically terminated (Ticlea, 2009: 516)<br />
This is why the new law attained to include among the reasons for termination by law<br />
not only the case where the employee disappears or dies, but also the case where the<br />
same happens with the employer – natural person, or if the employer – legal person<br />
dissolves.<br />
An unsolved problem remains thou. The dissolution procedure takes time, and<br />
meanwhile, some of the employees are still needed, in order perform the liquidation<br />
stage, making the payments to the creditors and organising the process of winding up.<br />
However, the employment contracts are terminated, with no exceptions, so the<br />
employer should re-hire some of the employee in order to run the process of<br />
liquidation. Those new contracts would be concluded for a fix term contract, but this<br />
case is not provided under art. 81 of the Labour Code, among the cases where a fixedterm<br />
contract can be concluded.<br />
~ 468 ~
Another reason for termination of an employment contract under the law is the case of<br />
retirement of the employee. The new law solved a major problem resulted from the<br />
modification of the Labour Code through Law no. 49/2010.<br />
Until 2010, the contract was considered as ended on the date when the decision for<br />
age limit retirement, anticipatory retirement or invalidity retirement has been<br />
communicated by the Pension Authority. If the employee did not request retirement,<br />
although he fulfilled the standard requirements for age limit and pension<br />
contributions, the employer could dismiss him, according to art. 61, letter e) of the<br />
Labour Code.<br />
The Law 49/2010 changed this rule, provided that the moment when the employment<br />
contract was considered as ended is not the one when the Pension Authority<br />
communicated the decision, but the very moment when the employee fulfilled the<br />
standard age requirements and the level of pension contributions. The only problem<br />
here was that the new law completely forgot about the case of invalidity retirement.<br />
Invalidity retirement occurs when the total or at least half of the working abilities are<br />
lost due to labour accidents, occupational diseases, TB, common diseases or accidents<br />
that are not related to work. According to the requirements of the working place and<br />
the level of the reduced working ability, invalidity is:<br />
• first degree, characterised by the total loss of the working abilities, the selfservice,<br />
self-control or spatial orientation abilities, the invalid needing care or<br />
permanent supervision by another person;<br />
• second degree, characterised by the total loss of the working abilities, the<br />
invalid having still the capacity of self-service, self-control and spatial<br />
orientation, without needing help from another person;<br />
• third degree, characterised by the loss of at least half of the working abilities,<br />
the invalid being unable to perform any professional activity.<br />
Of three degrees of invalidity, the first two lead to incompatibility between the status<br />
of a pensioner and that of an employee. Only in case of the third degree invalidity<br />
pensioner is allowed to cumulate his pension with the salary, continuing his activity<br />
either in the same working place, or in another.<br />
However, no mention regarding the moment of ending the employment contract of<br />
persons who are retired for invalidity was left in the Labour Code during 2010, and<br />
this situation created many problems. In practice, employees preferred to resign, in<br />
order not to lose the right to the invalidity pension.<br />
The recent modification of the Labour Code by Law no. 40/2011 refers both to the<br />
age retirement and to the invalid retirement, redressing the provision on termination<br />
by law. According to the Labour Code, the employment also ends de jure when the<br />
demand of reinstatement in the position hold by a person unlawfully or groundlessly<br />
dismissed has been admitted, from the date of the final reinstatement judgment.<br />
This is the situation of an employee illegally dismissed, who brought an action in<br />
court not only for cancelling the dismissal, but also for reinstatement in the previous<br />
position. If on that particular position another worker was in the mean time hired, his<br />
employment will be automatically terminated. This text practically represents an<br />
~ 469 ~
application of the nullity theory. Indeed, the nullity of the decision to dismiss the first<br />
employee represents the cause of termination the employment contract of the second<br />
one.<br />
However, for a long period of time doctrine and practice faced a very specific<br />
difficulty here: how will be ended the employment of an employee who did not<br />
request reinstatement in court? It may be the case of an employee who found an<br />
alternative job, so he/she wouldn’t have to comeback into the same position. But<br />
Labour Code contained no solution on how the original employment should end. It<br />
wouldn’t be a dismissal, since the dismissal decision has been annulled by the court,<br />
nor it would be a resignation, since the employee didn’t formally resigned, and it<br />
wouldn’t be a termination by mutual consent (even thou both parties did want to end<br />
the contract) since the parties were in fact in a dispute.<br />
The modification of the Labour code includes this case among the cases of<br />
termination under the law, which is one of de lege ferenda proposals made by most of<br />
the authors lately.<br />
Indeed, according to art. 78 para. 3 recently introduced in the Labour Code, in case<br />
the employee does not appeal in court for re-instatement in the job he had prior to the<br />
dismissal, his/her employment will end under the law from the moment when the<br />
court decision is final. This will mean that, even thou the dismissal has been cancelled<br />
in court, the contract would be still considered as ended, but on another ground,<br />
namely the ground of law itself.<br />
Another new regulation is provided by the law changing the Labour Cod in respect<br />
with the withdrawal of official recognition and legal authorisations.<br />
In certain cases, the employment contract can only be fulfilled by persons who<br />
received official recognition, authorisation or attestation for carrying out the<br />
respective activity. For instance, Law no. 333/2003 on guarding objectives, goods,<br />
values and on the person’s protection, stipulates that: ‘Employment of the personnel<br />
with guarding duties or as bodyguards is made on the basis of the attestation issued by<br />
the police, of the certificate attesting the graduation of the professional training<br />
course, of the certificate of criminal record and, according to case, of the police gun<br />
permit’.<br />
Similarly, according to Law no. 126/1995 on the regime of explosives, the conclusion<br />
of the labour contracts for employees working as artificers depends on their<br />
professional authorisation issued by the administrative bodies.<br />
Withdrawal of authorisation, permit or attestation will automatically lead to<br />
termination of the employment contract.<br />
The new regulation here includes the case in which the authorisations have not been<br />
withdrawn, but they expired. Until this new change of the Labour Code there have<br />
been no solutions for this case, so one couldn’t say how such a contract would end. As<br />
a result of changing the Labour Code, the employment will be considered as<br />
terminated by law from the moment when the period for which the official recognition<br />
~ 470 ~
and legal authorisations expired. However, the employee still has 6 months in which<br />
he may renew the authorisations requested to do the profession.<br />
In case the authorisations or official recognitions have not been withdrawn, but<br />
suspended, a new case of suspension of the employment occurs - recently regulated<br />
by the new changes in the Labour Code. Indeed, according to art. 52 para. 1 f), the<br />
contract is suspended by law during the suspension, by the competent authorities, of<br />
the authorisation, permit or attestation requested for exercising of the profession. The<br />
employee has no right to salary during this suspension, but he will remain bound by<br />
the rest of contractual rights and obligations, e.g. by the fidelity obligation.<br />
The administrative decision to withdraw or to suspend an authorisation may be<br />
contested in court, according to Law no. 554/2004, on administrative disputes. In case<br />
the court considers that withdraw or suspension was not decided according to the law,<br />
we consider that the employee will have the right to re-instatement, with the payment<br />
of the due salary owed for the period he was deprived of this right. However, not the<br />
employer will pay but the authority whose decision has been successfully contested.<br />
A change which led to many controversies was the one regarding the relation between<br />
termination of employment and suspension of the employment. In fact, we consider<br />
this has not been a real change, because the jurisprudential solution was the same even<br />
before this new law. According to art. 49 para.5 and 6, each time when during the<br />
time of suspension of the employment a reason for termination by law occurs, the<br />
cause of termination will prevail. In case of suspension of the labour contract, all<br />
terms related to conclusion, modification or termination of the employment contract<br />
will be correspondently suspended, except those related to the termination of the<br />
employment by law.<br />
This is just an explanation of how the relation between termination and suspension<br />
works; it is not really a new rule. For instance, even before this changed, if at the<br />
moment when a fixed-term contract expired, the employee was in medical leave, the<br />
employment still ended. The employee had the right to proper indemnity for<br />
incapacity to work, but the employment ended inexorable.<br />
However, trade unions argue that because of this new article, the employee is less<br />
protected than he/she was before.<br />
2. DISMISSAL<br />
2.1. Protection of the Employee<br />
The ‘separation’ between labour law and civil law was based on the legislator’s often<br />
vigorous intervention in regulating relations between the parties. Their legal equality<br />
ceases with the conclusion of the labour contract. From then onwards, one of the<br />
parties is subordinate to the other and even enters a relation of dependence towards<br />
the other. Though still considered as belonging to private law, labour law has many<br />
imperative provisions, norms of public order meant to re-balance the relation between<br />
the two parties.<br />
~ 471 ~
In Romanian legislation, art. 6 of the L.C. stipulates the principle of employees’<br />
protection in the context of the provision regarding the prohibition of any<br />
discrimination in exercising rights granted by law. The text must be understood in<br />
relation to the provisions of art. 41, paragraph 2 of the Romanian Constitution,<br />
according to which ‘employees have the right to social protection measures. These<br />
refer to the employees’ safety and health, women’s and youth working conditions, the<br />
setting up of minimum national gross wages, weekly rest, paid leave, the carrying out<br />
of the activity in special conditions, professional formation, as well as other specific<br />
situations, established by law’.<br />
As a result, the protection of employees is one of the main principles of labour law.<br />
When it comes to the regulation of dismissal, such protection is even stronger, being<br />
ensured, among others, by the following:<br />
• The employer shall make use of all possible reasonable means to avoid<br />
dismissal;<br />
• Strict procedures shall be enforced so that non-compliance with these<br />
procedures shall incur annulment of the dismissal;<br />
• The dismissal decision shall be issued in a written form;<br />
• The elements of the dismissal decision shall be imposed under the law.<br />
Absence of any of these elements shall entail annulment of the dismissal;<br />
• Dismissal shall be forbidden for any other reasons except for the 5 reasons<br />
accepted expressly by the law;<br />
• Dismissal of certain categories of employees who are during special periods,<br />
shall be forbidden;<br />
• The dismissed employee shall have the right to go to court; the burden of<br />
proof shall lie with the employer;<br />
• The employer shall have the obligation to submit the evidence from the very<br />
first day of the trial;<br />
• The employee shall have the right to obtain reintegration and damages in<br />
court, if the dismissal has been annulled.<br />
Moreover, under the Labour Code, employees shall not be dismissed while they are in<br />
one of the following cases:<br />
• during the time of temporary incapacity of work, ascertained by medical<br />
certificate;<br />
• during quarantine leave;<br />
• during the period of pregnancy, as long as the employer is informed about this<br />
fact, prior to issuing the decision of dismissal;<br />
• during maternity leave;<br />
• during childrearing and care giving leave until the child reaches the age of two<br />
or, in the case of a disabled child, until he becomes three;<br />
• during the care giving leave for a sick child up to the age of seven or, in the<br />
case of a disabled child, until he reaches the age of 18;<br />
• while holding an eligible position in a trade union, except for the situation<br />
when dismissal is ordered due for disciplinary reasons;<br />
• while on holiday;<br />
• during the maternal risk leave, as well as during the leave granted to those<br />
employees who have recently given birth or who are breastfeeding. The<br />
~ 472 ~
interdiction of dismissal can be extended only once, for up to six months, from<br />
the date the employee has returned to work within the enterprise.<br />
The collective labour contracts can include other periods of time when dismissal may<br />
be forbidden. For instance, some of them stipulate dismissal of women who returned<br />
from the child-rearing leave during the first 6 months from the date they returned of<br />
work, for reasons of lack of professional standards.<br />
The collective labour contracts also stipulate compensation pays owed to the<br />
employees dismissed for reasons that are not related to them.<br />
Besides these protective rules, the recent change of labour legislation aims to allow<br />
the employer to freely organise the working force and to dismiss employees more<br />
easily than before.<br />
As a result, the interdictions to dismiss are subject to change. They will be not<br />
applicable in case of dissolution of the company, a case not taken into account by the<br />
legislation prior this change. Of, course, in fact, the interdictions couldn’t be applied<br />
in such case, continuing the employment being practically impossible, but until now<br />
there has been no regulation in this respect.<br />
More importantly, the interdictions to dismiss in case of trade unions’ leaders and<br />
employees’ representatives are tremendously diminished. Until now, they couldn’t be<br />
dismissed for the entire period of the mandate, and for another 2 years afterwards. The<br />
dismissal was allowed not even for incompetence. The union leader’s protection was<br />
considered in itself an element of union freedom (Dimitriu, 2007: 18).<br />
Indeed, if the union leader is not adequately protected from pressure exerted by the<br />
employer or a third party, the union organisation or union freedom of its members can<br />
be endangered. This explained the meaning of many decisions taken by the Romanian<br />
Constitutional Court, regarding the legal differentiation between union leaders and<br />
other employees. The question was: is it normal that the law creates a special legal<br />
system for a certain category of employees whilst excluding others? The prohibition<br />
against dismissing union leaders was considered by the Constitutional Court not to<br />
constitute a privilege, but a measure of protection ensuring equal treatment of the<br />
trade union on the one hand, and the trading company on the other, as parties to the<br />
collective labour contract. The employee representatives elected to the leading trade<br />
union bodies are in different situation than other categories of employees.<br />
Consequently, they cannot be treated in the same way.<br />
However, according to the recent change of the Labour Code, the trade union’s<br />
leaders and the employees’ representatives can be dismissed immediately after the end<br />
of their mandate, and for any kind of reasons, including incompetence. It is no<br />
surprise that trade unions were deeply unsatisfied with this new regulation, in our<br />
opinion this being one of the major concerns of the trade unions, a ground for a<br />
negative reaction to the enforcing of the new law.<br />
~ 473 ~
2.2. Dismissal for lack of professional standards<br />
Another element of the new legislation is related to the dismissal for incompetence.<br />
According to art. 61, letter d) of the L.C., the employer can order the dismissal of an<br />
employee in case he is professionally unfit for the job position he holds. Among the<br />
grounds for dismissal provided by art. 61 of the L.C., dismissal for professional<br />
inadequacy represents the ground closest to common law.<br />
Indeed, the circumstance that the employee ‘is not professionally fit for the job<br />
position he holds’ represents nothing else than the failure to fulfil the contractual<br />
duties by one of the parties, a typical case for termination for breach of the contract in<br />
the common law. Practically, professional inadequacy represents (or should represent)<br />
the most frequently invoked ground for dismissal: the employer is not content about<br />
his employee’s work.<br />
The grounds wherefore a person might be considered professionally unfit have been<br />
most often divided into objective circumstances (related to the non-fulfilment of the<br />
requirements for studies or training), and subjective (related to the employee’s skills<br />
or abilities).<br />
According to art. 63 para. 2 – new inserted into the law - dismissing an employee on<br />
that ground can be decided only after a prerequisite evaluation of the employee,<br />
according to a procedure established by the collective agreement or by internal<br />
regulations.<br />
The employee has to be informed about the criteria for this evaluation for the very<br />
moment he is hired. This is an application, into Romanian labour law, of a general<br />
principle regarding the workers’ right to information and consultation. There is now a<br />
broad legislation of the European Community on employees’ information and<br />
consultation in both individual and collective relations. The EC Law prescribes that<br />
specific information and consultation takes place in cases of mass dismissal or the<br />
transfer of an undertaking. And the Directive on the European Works Council<br />
provides for a duty of information also in general questions, but it only applies to<br />
large undertakings that are involved in cross-border activities. Moreover, in many<br />
Member States the statutes nowadays establish that the employer has to<br />
give information to the employees in questions of general importance (Rebhahn,<br />
2004: 123).<br />
Also before this recent change of Labour Code the employer had the right to examine<br />
the competence of the employee, according to some criteria established either by the<br />
employer himself, or by a contract concluded with the trade union. This right of the<br />
employer is today expressly provided, so it wouldn’t be possible anymore for a trade<br />
union to request or expect to be consulted in this regard.<br />
We have to point out here that this is – again – not a completely new solution.<br />
However, the recent change in Labour Code does bring a new approach in this regard.<br />
In order to understand the new element, we should first look over the way the<br />
dismissal for incompetence was regulated in the recent past in our Labour Code.<br />
~ 474 ~
Though dismissal due to professional inadequacy should represent the ‘specific<br />
ground’ for dismissal, in relation with which all the other grounds for dismissal would<br />
rather seemed as exceptions, the legal procedure for dismissal due to professional<br />
inadequacy was so cumbersome and difficult to comply with, that in reality the<br />
employers avoided to order dismissal on this ground, trying to terminate the labour<br />
relations by invoking other grounds.<br />
Indeed, according to Art. 63, paragraph 2 of the Labour Code, the employee’s<br />
dismissal due to professional inadequacy could be ordered only after the employee’s<br />
preliminary evaluation, in accordance with the evaluation procedure established by<br />
the applicable collective labour contract, concluded at national level, branch of<br />
activity or group of enterprises, as well as by the internal regulations.<br />
Yet, the Collective contract concluded at the national level for 2007 - 2010 had not<br />
provided an evaluation procedure, but one of preliminary investigation, similar to the<br />
compulsory investigation in the case of disciplinary dismissal. As such, before the<br />
recent modifications of Labour Code, dismissal due to professional inadequacy was<br />
conditioned by carrying out both procedures, regular evaluation, as well as<br />
preliminary investigation. Even if a procedure of the employees’ regular evaluation<br />
could be inserted in the collective labour contracts concluded at branch or company<br />
level, preliminary investigation still remained compulsory for everybody, because it<br />
was provided in the Collective labour contract concluded at the national level. Thus,<br />
an employee couldn’t be automatically dismissed for professional inadequacy, only on<br />
the basis of the poor results of the evaluation.<br />
Investigation prior to dismissal for professional inadequacy was carried out according<br />
to the procedure provided by Art. 77 of the Collective labour contract concluded at the<br />
national level. According to it, the investigation of the employee for professional<br />
inadequacy was made by a commission appointed by the employer. The commission<br />
summoned the employee and conveyed to him in writing the following, at least 15<br />
days in advance: the date (exact time and place when the commission meets) and the<br />
manner in which the investigation will be carried out.<br />
This entire procedure is no longer in force. Currently in Romania there is no<br />
Collective contract concluded at the national level, because the one concluded for<br />
2007 – 2010 expired, and a new contract, thou negotiated between social partners at<br />
the national level, never entered into force because it wasn’t registered at the Ministry<br />
of Labour.<br />
As a result, today the law is directly applicable in the labour relations. And in the law<br />
there is no preliminary procedure provided in order to dismiss an employee for<br />
incompetence. The only condition is that such an evaluation should be provided, and<br />
the Labour Code, recently modified, enlarged the possibility of the employer to apply<br />
his own criteria in evaluating the employee.<br />
In fact, the change intervened in the Labour Code is more important than it appeared<br />
at the first view, because it has to be connected with the lack of a Collective contract<br />
concluded at the national level. Therefore, today, in case of dismissal for lack of<br />
professional standards, the employer shall do a prior assessment of the employees,<br />
under criteria that should be known by the employees from the date when they are<br />
hired. The assessment can be done also to select employees that are to be dismissed<br />
for economic reasons.<br />
~ 475 ~
2.3. Dismissal for economic reasons<br />
The Labour Code, modified by Law no. 40/2011, stipulates some gradual measures<br />
that the employer can take in case of economic difficulties, prior to dismissal. He shall<br />
therefore do the following:<br />
• Reduce the working days. According to the changes in the Labour Code<br />
introduced in March 2011, in case of temporary reduction of the activity, for<br />
economic reasons that exceed 30 days, the employer can reduce the working<br />
days to 4 days per week and can reduce the salary correspondingly, until the<br />
situation is remedied;<br />
• Suspend the labour contracts of the employees, and pay them 75% of their<br />
salaries;<br />
• As a last resort / ultima ratio, lay them off.<br />
The employer shall give the employee the chance to be transferred to another job<br />
corresponding to the employee’s training and skills, and if the employer has no such<br />
vacancies, the employer shall inform the local Employment Agency about the<br />
employee laid off, so that the agency could identify an available job, dismissal cannot<br />
be annulled for the reason that the employer has not ensured re-training (professional<br />
reconversion) of the employee.<br />
The employer shall offer the employee a job corresponding to his current<br />
competences, not to his potential competences.<br />
The rule of proportionality shall not apply, and the court shall assess the legality of<br />
the dismissal exclusively against the way in which the employer has fulfilled his prior<br />
obligations stipulated either by the law or in the collective labour contract.<br />
In the case of collective dismissal, according to the new regulation, the employer will<br />
be allowed to give priority to performance criteria (not to social criteria, as it currently<br />
happens). Today, prior to any social criterion of establishing the order of priority in<br />
cases of collective dismissals, the employer is free to evaluate the employees’<br />
performances. The criteria related to the professional performances of the employees<br />
will prevail upon the social criteria.<br />
With respect to selection or ranking criteria, international labour standards guidance is<br />
provided by Article 23 of the Termination of Employment Recommendation (No.<br />
166) which stipulates that the selection by the employer of workers whose<br />
employment is to be terminated for reasons of an economic, technological, structural<br />
or similar nature should be made according to criteria, established wherever possible<br />
in advance, which give due weight both to the interests of the undertaking,<br />
establishment or service and to the interests of the workers. In comparative practice,<br />
the criteria most often applied relate to occupational skills, length of service, family<br />
circumstances, with preference sometimes being given to a particular criterion such as<br />
the protection of a vulnerable category of workers or the difficulty of finding<br />
alternative employment. The determination of the selection and/or ranking criteria<br />
should be guided by the specificities of each national labour market, including the<br />
existence of active labour market policies and institutions to support redundant<br />
workers. It is, however, of particular importance to ensure that, as a result of the<br />
preference given to some criteria, certain protected workers, such as workers’<br />
representatives, are not dismissed in an arbitrary manner on the pretext of a collective<br />
termination of employment (International Labour Organisation, 2011).<br />
~ 476 ~
The rules regarding the collective dismissal are no longer applicable to public<br />
employees (workers employed by public administrative bodies). Until now, the<br />
Romanian legislation has not excluded them from the rules of collective dismissal,<br />
even though the Directive 98/59/EC was not applicable to these employees.<br />
Until now, if the employer re-launched the activities whose interruption have led to<br />
massive dismissals before the 9 month-term ended, the employees who have been<br />
dismissed had the right to be re-employed in the same job positions they previously<br />
held, without any examination, job competition or probation time. According to Law<br />
no. 40/2011, this term has been reduced to just 45 days. After this short period the<br />
employer will be allowed to re-establish the jobs, employing other persons that the<br />
ones dismissed. Not surprisingly, the trade unions declared their dissatisfaction<br />
regarding this change in the law.<br />
2.4. The notice<br />
According to the Labour Code, the employees dismissed for non-imputable reasons<br />
shall be given a prior notice. The term stipulated in the notice does not depend on the<br />
years worked by the employee in the company or any other criteria. Under the law,<br />
the term stipulated in the notice shall be at least 15 working days. The collective<br />
labour contracts include derogations that are advantageous to the employees by<br />
stipulating longer terms. The employees on probation period shall not be given prior<br />
notices.<br />
The term of notice is suspended if the employment contract is also suspended.<br />
Moreover, the collective labour contracts provide that during the term of the notice<br />
the employees are allowed to shorten their working time by 4 hours, as compared to<br />
the working schedule of the enterprise, in order to look for another working place,<br />
without their wages and other rights being restricted because of that.<br />
During the term of the notice, the employee has all the rights and obligations resulting<br />
from the employment contract: he still has the duty to carry out work, to refrain from<br />
any act of disloyal competition, as well as from any act of indiscipline. If he does not<br />
comply with all these duties, he will be dismissed on disciplinary grounds, without<br />
being necessary to wait for the end of the notice term.<br />
The Law no. 40/2011 prolonged the notice period; it is now 20 days. This is because<br />
the prior version of Labour Code provided 15 working days as a notice term<br />
mandatory in case of dismissal, but the collective contract concluded at the national<br />
level for 2007-2010 provided 20 days. At present, since the previous contract<br />
concluded at the national level expired, and no other contract has been registered with<br />
the Ministry of Labour, the legal provision would be directly applicable. The change<br />
in the Labour Code could also mean that the legislator assures that even in the case no<br />
other collective contract at the national level will ever enter into force, the minimum<br />
period of notice will still be 20 days.<br />
~ 477 ~
3. RESIGNATION<br />
According to art. 79 para. 2 of Labour Code, as it was recently modified, the employer is<br />
obliged to register the employee’s resignation, otherwise the latter being allowed to prove<br />
the resignation by any means. The new element here is that the employer will be<br />
sanctioned, if he fails to register the resignation, with a fine from 1,500 to 3,000 lei.<br />
This change was made as a result of many cases when the tendency of the employers<br />
not to register employees’ resignation can be noticed, since no fine has been provided<br />
for this behaviour (Stefanescu, 2010: 464)<br />
When it comes to resignation, the major issue here is the way in which notice in case<br />
of resignation is regulated. It is prolonged to 20 working days in case of executive<br />
functions and 45 working days in case of managerial positions.<br />
Labour Code priory provided only 15 calendar days for executive positions and 30<br />
days for managerial positions. Therefore, the length of the notice has been changed.<br />
But the real problem here is that the law provides a minimum period of notice. The<br />
parties may convene through the individual or collective contract a longer period of<br />
notice, which cannot be shorter than the legal one. This rule is not only<br />
disadvantageous for the employee, but also it breaches the major principle according<br />
to which the parties may only convene in the advantage of the employees. It is the<br />
only provision in the entire Labour Code in which the parties are obliged to convene<br />
in pejus, so the employees may only have a worst situation that the one provided in<br />
law. From a juridical point of view, such a provision is completely wrong, especially<br />
in respect with the general rules of labour law.<br />
CONCLUSIONS<br />
The European Union is trying to find its own way in the attempt to increase<br />
competitiveness while maintaining, at the same time, a high level of social protection<br />
within the Social European Model. On the theoretical level, in the new member states,<br />
one of the effects of joining the European Union is the reception of the concept of<br />
flexicurity and the debate surrounding this issue.<br />
One of the starting points of the debate is that the idea that “one size fits all” may still<br />
be a dangerous approach – when it comes to the concept of flexicurity. On the<br />
contrary, the experience of the new member states may lead to new nuances when<br />
debating the flexicurity concept.<br />
Furthermore, the existing research on flexicurity shows that neither flexibility nor<br />
security is an unambiguous concept.<br />
If flexibility is seen as the opposite of rigidity, then without any doubt its occurrence<br />
in an economy on the move appears as desirable. Flexibility is considered to be an<br />
inherent feature of labour demand and supply. Both being driven by individual<br />
interest, they tend to become flexible in order to meet each other as none of them can<br />
survive independently (Ghinararu, 2010: 77).<br />
~ 478 ~
If, on the contrary, the flexibility of labour relations implies deregulation and the<br />
removal of restrictions on contractual freedom, then it may create even more<br />
problems, rather than solve them. As already said before, ‘between the strong and the<br />
weak, between the rich and the poor, it is freedom that oppresses and the law that sets<br />
free.’ These are, in fact, the circumstances wherein the labour law has emerged and<br />
defined itself as a protective law.<br />
If security is not concerned with the certainty of a working place, but with the security<br />
of a career or, to put it more generally, with the socio-economic security, focusing on<br />
protecting the more vulnerable groups, then it may ensure the necessary balance<br />
between insiders and ousiders.<br />
But if it only aims at maintaining the existing job security, without the appropriate<br />
absorption of the outsiders on the labour market (an idea that sometimes creeps in the<br />
very discourse of trade unions, as the main representatives of the existing employees),<br />
imbalances on the labor market may grow deeper, instead of becoming less visible.<br />
The simultaneous protection of insiders and outsiders implies their uniform treatment,<br />
not as two distinct categories of persons, but as one single class of persons able to<br />
work, whether they are carrying out an employment contract or not, at that precise<br />
moment. Theoretically, the excessive protection of the employment contracts leads to<br />
lack of protection granted to the outsiders, who find themselves facing an<br />
insurmountable wall when it comes to getting access to a job. Moreover, the<br />
employer’s competitiveness suffers from this situation, as long as he is not in the<br />
position to permanently select the most suitable workers in a continuously changing<br />
economy.<br />
„Getting more people into good jobs” is an objective, while flexicurity is (or may be)<br />
one method. The extent to which the application of the method leads to reaching this<br />
aim is still an open question. Flexicurity itself demands to be flexibly adapted – from<br />
case to case, from one state to another.<br />
Some authors consider flexicurity a political strategy rather than a scientific concept.<br />
The policy of flexicurity is, in most cases, qualified as a „win – win” type of policy,<br />
considered to be a somehow hypocritical qualification by certain market analysts in<br />
the new member states, because beyond theory, it seems that in practice workers are<br />
losing rather than gaining something out of it.<br />
From the perspective of trade unions, if the implementation of the flexicurity concept<br />
seems to be successful in some of the European states, since it guarantees a certain<br />
level of protection, in Romania such a process would be disadvantageous for<br />
employees in terms of the special job stability they enjoyed, in the context of the<br />
Labour Code. The changes in the Labour Code, particularly with the intention to<br />
render more flexible the labour market and the contractual arrangements were<br />
received by trade unions, and by the entire society with deep concerns and scepticism.<br />
A segmentation of labour market is a common European trend. Many authors<br />
suggested not to enhance but rather to circumvent the protective legislation on<br />
individual dismissals that exists in all European countries by resorting to atypical<br />
contracts that fall outside the sphere of protection (Veneziani, 2009: 127). In the same<br />
view, the Romanian law – maker may focus not as much on protection of the workers<br />
~ 479 ~
in case of dismissal than on extension of some of the rules of protection for the case of<br />
the persons who don’t formally work on a ground of an employment contract.<br />
In fact, when approaching the question of flexicurity, perhaps the starting point should<br />
not be the legislation itself, as the practice of applying it. Besides, the new member<br />
states have several particularities in implementing the concept of flexicurity, among<br />
which we can identify at least 4: psychological particularities, coming from the shock<br />
of adapting to a new system for the workers trained during communism, particularities<br />
derived from the competitive disadvantages of economies in the new member states,<br />
particularities concerning the type of social dialogue practiced and those concerning<br />
the labour force itself, in the context in which the phenomenon of workers’ migration<br />
reaches unusual dimensions.<br />
In this context, the changes in the Romanian Labour Code appear to be a way of<br />
implementing the concept of flexicurity in our system of law. And among all<br />
institutions changed by the new law, probably the one related to termination of<br />
employment has the most dramatic effect within labour relations and the very<br />
application of the principle of workers’ protection. The Government’s goal was to<br />
offer the possibility for the employers to dismiss and employ personnel more easily,<br />
allowing him/her to select best employees at a time of economic crisis. However, as a<br />
result of an analysis of how the flexicurity principles were applied in other states<br />
(especially in case of the new member states) one may be very much afraid that<br />
flexicurity cannot be obtained by just un-protect the employees and simplify the<br />
dismissal procedure.<br />
Consequently, will the Government’s goal be attained? Or perhaps the scepticism of<br />
the Romanian society in respect with the new labour legislation is justified? Only time<br />
will answer this question, for sure.<br />
ACKNOWLEDGEMENTS<br />
This work was supported by CNCSIS-UEFISCU, project number PN II 1772/2008.<br />
REFERENCES<br />
Dimitriu, R., (2007), Romanian Industrial Relations Law, Antwerp, Ed. Intersentia<br />
International Labour Organisation, (2011), Memorandum of Technical Comments on the Draft<br />
Labour Code and the Draft Law on Social Dialogue of Romania, http://www.araco.org<br />
Ghinararu, C., (2010), Flexicurity and social dialogue in Romania – perspectives on the<br />
implementation of flexicurity principles in Romanian undertakings, European Institute<br />
of Romania<br />
Rebhahn, R., (2004) “Collective Labour Law in Europe in a Comparative Perspective”, The<br />
International Journal of Comparative Labour Law and Industrial Relations (II),<br />
Vol. 20/1: 107-132.<br />
Stefanescu, I.T., (2010), Theoretical and Practice Treatise of Labour Law, Bucharest, Ed.<br />
Univers Juridic<br />
Ticlea, Al., (2009), Labour Law Treatise, Bucharest, Ed. Univers Juridic<br />
Veneziani, B, (2009), The transformation of Labour Law in Europe, edited by Hepple, B,<br />
Veneziani B., Oxford and Portland, Hart Publishing<br />
~ 480 ~
PS11 Management information systems II<br />
Chairperson<br />
Iuliana IONESCU, Bucharest Academy of Economic Studies,<br />
Romania<br />
A CASE STUDY FOR START-UP COMPANIES<br />
IMPLEMENTING E-BUSINESS TECHNOLOGIES<br />
Carmen TIMOFTE<br />
ANALYZING E-COMMERCE PROTOCOLS<br />
Carmen TIMOFTE<br />
MODELING ON A SEMANTIC-BASED<br />
REPRESENTATION OF PEDAGOGICAL OBJECTS E-<br />
LEARNING-TYPE IN ORGANIZATIONAL MEMORY:<br />
CONNECTING ONTOLOGY WITH LOM META-DATA<br />
Iuliana IONESCU, Vasile FLORESCU,<br />
Bogdan IONESCU, Ofelia Ema ALECA<br />
SEMANTIC ANNOTATION AND ASSOCIATION OF<br />
WEB DOCUMENTS: A PROPOSAL FOR SEMANTIC<br />
MODELING IN THE CONTEXT OF E-RECRUITMENT<br />
IN THE IT FIELD<br />
Bogdan IONESCU, Iuliana IONESCU,<br />
Vasile FLORESCU, Andrei TINCA<br />
DECISIONS DRIVE SUCCESS<br />
Dragos STOICA, Pavel NASTASE<br />
~ 481 ~
A CASE STUDY FOR START-UP COMPANIES<br />
IMPLEMENTING E-BUSINESS TECHNOLOGIES<br />
Carmen TIMOFTE 1<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
The World Wide Web has dramatically changed the way corporations conduct business. This<br />
paradigm shift has made it paramount that company managers fully understand and<br />
appreciate the important advantages of E-Business technologies. Which e-business<br />
technology to chose, if you will have the opportunity? This is why I tried to present an<br />
overview of these technologies and the you will learn how and when you can chose one of<br />
theme, implemented in open software, personal software or platform of e-business.<br />
KEYWORDS: e-business, e-commerce, protocol, technology, SEO.<br />
INTRODUCTION<br />
E-Business is now a very familiar term with most businesses and people. This has<br />
now taken such a wide coverage and reach that it is no longer an alternate means of<br />
business transactions, but an integral part of any kind of business. The term e-business<br />
(e-biz) now encompasses almost every opportunity, either commercial or interaction,<br />
and provides a wide range of choices of technologies and means to offer them.<br />
Internet and web technologies are driving fundamental changes in the way that<br />
businesses interact. We need to implement to the rapidly changing technologies and<br />
approaches to implementation underpinning these changes. I want to develop an<br />
instrument to enable you to interpret, select and utilize a shifting set of protocols and<br />
standards from the emerging technologies, based on close examination of a small set<br />
of core standards and knowledge gained from studying prevailing protocols and<br />
development technologies.<br />
1. OVERVIEW<br />
The direction toward Web services will particularly help “Net Generation”<br />
companies—companies that are born on the Web—to become successful by allowing<br />
their services to be easily discovered worldwide and easily integrated with other<br />
services ranging in scale from other Net Generation services to enterprise-scale<br />
services.<br />
In a few short years, e-business has gone from a simple concept to an undeniable<br />
reality, and for good reason. It works for everyone: consumers, businesses, and<br />
1 Correspondence address: Carmen TIMOFTE, Economic Informatics Department, Academy of<br />
Economic Studies, Bucharest, Romania; email: carmen@ase.ro<br />
~ 482 ~
governments. The primary values of e-business, such as cost savings, revenue growth,<br />
and customer satisfaction, are proving to be only the tip of the iceberg. Having<br />
realized the benefit of Web-enabling individual business processes, many companies<br />
now seek further return on investment (ROI) by integrating new and existing ebusiness<br />
applications and technologies. The key to their success is to find a way to<br />
give customers what they want without the expense of traditional business operations.<br />
E-business is the system re-engineering of business processes to take advantage of the<br />
efficiency afforded by information technology and electronic communications. It<br />
may consist of something as simple as establishing a retail website, or might involve a<br />
complete overhaul of the way a big company handles orders internally.<br />
The common factor is communication.<br />
Most business processes are based on moving data from one point to another. It is<br />
only during manufacturing or after a deal has been consummated that physical goods<br />
must be moved. As a result, most improvements in business result from advances in<br />
information technology, a field that is changing so rapidly it is difficult even for<br />
professionals to keep up with it.<br />
It is always a question how to select in a fast-moving technological subject. The<br />
philosophy is that professionals must learn not technology alone, but how to keep up<br />
with technology.<br />
Sometimes, it’s not important to have the newest technology in your company, but<br />
you need to use the most appropriate one for your e-business, based on factors like:<br />
� permitting an easy and rapid way for updating the system,<br />
� making periodically/permanent changes – this is the way to keep you site<br />
“alive”; a lot of studies demonstrate that a static site had a short life duration,<br />
comparing with the “dynamic” sites; the life of site = the live of e-business;<br />
dynamic site= site with a lot of daily changes;<br />
� have qualified persons for supporting all the changes in systems, platforms,<br />
technologies.<br />
2. TECHNOLOGIES USED IN E-BUSINESS<br />
E-business technologies can be split into 2 categories: packaged solutions and web<br />
development, both of them implemented by big software companies, as well like open<br />
software foundation.<br />
� Packaged Solutions - there are a lot of packaged solutions which enable e-<br />
Business operations starting from larger enterprise packages for Customer<br />
Relationship Management (CRM), Supply Chain Management (SCM) or<br />
Enterprise Resources Planning (ERP) to smaller and leaner packages for<br />
limited set of functions such as Email Applications, Peer-to-Peer computer<br />
networking software, etc. These packaged solutions are also customizable to a<br />
certain extent to suit the individual e-Business providing organization.<br />
� E-Business web development - on the other hand, most of the e-Business<br />
enablement is carried out by customized web applications built to address<br />
specific needs of the e-Business products or services.<br />
~ 483 ~
Typically, following are some of the common technology aspects that need to be<br />
considered while deciding and during development of e-Business website or web<br />
applications.<br />
� Architecture of an e-Commerce system: function and implementation of major<br />
system components (web servers, browsers, proxies, caches, databases);<br />
critical system properties (scalability, reliability, security, safety);<br />
� Developing e-Commerce systems: development team, development process;<br />
� Web data formats: XML, HTML, XHTML, WML, RSS and ways of<br />
transforming and displaying them;<br />
� Data modeling and storage: relational database management systems<br />
(RDBMS); SQL; data warehousing;<br />
� Web Services: introduction to the concept of web services and serviceoriented<br />
architectures (SOA), OSOA (Open SOA); XML and SOAP; web<br />
services description and discovery (WSDL, UDDI);<br />
� Development tools and technologies: The Open-Source software stack<br />
(Apache, Tomcat, Axis); Microsoft .NET, Java, Java 2 Platform, Enterprise<br />
Edition (J2EE), Common Object Request Broker Architecture (CORBA),<br />
Transactions;<br />
� Advanced topics: Security and privacy, search engine technology.<br />
Many of these technology choices continue to evolve and expand as the open<br />
standards specification evolves to include a broader view of the enterprise<br />
architecture. E-Business models go forward through use of Open Source, Web 2.0 and<br />
m-Commerce. Currently many Open Sources solutions are available on the market,<br />
which provide the e-Business providers options to customize these systems to<br />
whatever extent they want.<br />
Various business models such as SaaS (Software as a Service) are gaining popularity<br />
due to the flexibility offered with maximum customization, less cost and minimal<br />
system ownership. Furthermore, e-Business transactions are no longer limited to<br />
computers, but can also be transacted through mobile devices such as mobiles, PDAs,<br />
i-Phones and so on.<br />
Considering the leaps taken by technology and infrastructure, there are no limits to<br />
what form and shape would e-Business take in the years to come.<br />
3. CASE STUDY<br />
After 10 years of studies and working with e-commerce systems, I have identified<br />
several issues that have to be addressed in order to choose the right technology and<br />
system for your business.<br />
This is why I chose to conduct a case study to identify what people would choose<br />
when they need to develop an e-commerce system.<br />
There are 2 types of companies:<br />
� the start-up – when they want to start from the beginning an e-commerce<br />
business;<br />
~ 484 ~
� with legacy applications- who need the package solution, like Customer<br />
Relationship Management (CRM), Supply Chain Management (SCM) or<br />
Enterprise Resources Planning (ERP).<br />
I chose the start-up companies, with different type of company size:<br />
� small company – with 2-10 employees, 1-20 products;<br />
� medium company – with max 50 employees, 20-40 products;<br />
� large company – with hundred employess and products; this type of companies<br />
exist in traditional business, but want to start online business from scratch (like<br />
start-up, but with o lot of employees, traditional product etc.)<br />
There are a few ways to develop e-commerce systems:<br />
� (1) starting from zero, writing code for a specific application;<br />
o using Java, .Net, php with mysql etc.<br />
o need a hosting site, database, web server etc.<br />
o problems with: testing the application, extended for a larger application;<br />
� (2) using freeware template from Internet,<br />
o with application customization, including writing code; using Java, .Net,<br />
php with mysql;<br />
o need a hosting site, database, web server etc.<br />
o short time of implementation, possible problems with understanding the<br />
application code;<br />
� (3) downloading software programs for creating e-commerce application;<br />
o free – for test available 2-4 weeks;<br />
o commercial software;<br />
o can be installed them on your system;<br />
o you need hosting server, databases, web servers etc.<br />
� (4) using an existing platform for develop e-commerce application; all<br />
components remote;<br />
o free: for testing and starting with minimum of cost; easy to implement; not<br />
too many options customizable; hosting, SEO optimizations including,<br />
easy to test, payment and security integrated;<br />
o not free: paying by month, by traffic or percentage of sales; hosting, SEO<br />
optimizations including; easy to test, payment and security integrated with<br />
the platform.<br />
� (5) buying an e-commerce platform; all components remote;<br />
o object oriented;<br />
o o lot of personalized choice;<br />
o expensive (prices from 5.000-80.000$, and more);<br />
o tested be a team;<br />
o recommended for large company, with hundred of products;<br />
o or for company who want to offer hosting and e-commerce platform<br />
o SEO, payment, security, protocols (SET) included;<br />
This study is about the start-up companies, with different type of budget.<br />
An e-commerce/e-business platform can use 1/many e-business technology and<br />
permit to host hundred/thousand e-commerce site, like an umbrela (all use the same<br />
technology, payment system, e-commerce protocols, included SEO optimisation,<br />
trafic analysis, report by hour/dday/week/month/product/sales/ users etc.).<br />
~ 485 ~
The case study was made on a sample of 115 young persons who wanted:<br />
� to launch small personal electronic business;<br />
� or group (2-5 people)- for starting e-business;<br />
� to propose launching a new business direction (electronic) in the companies<br />
they worked for.<br />
The next table presents the most important result of the case study:<br />
Type of<br />
e-commerce<br />
system<br />
Caracteristics<br />
(1) –<br />
programming all<br />
the code<br />
Non e-commerce platforms e-commerce platforms<br />
(2)- using<br />
freeware<br />
templates<br />
~ 486 ~<br />
(3)- software<br />
existing<br />
(4)- using a<br />
platform<br />
Type of company Small Small Small/ Small/Medium/ Large<br />
medium Large<br />
Difficulty of<br />
implementation<br />
5 4 3 2 3<br />
Duration of<br />
implementation<br />
5 3 3 3 2<br />
Modularity 2 3 2 0- for free/3 5<br />
Personalization 5 3 2 2- for free/3 5<br />
Cost of software 0 0 3 0- for free /3 5<br />
Cost of<br />
implementation<br />
2 2 3 0 0<br />
Efficiency 3 2 3 3- for free /4 5<br />
Code reuse 0 5 3 5 5<br />
Application testing 5 4 2 3 2<br />
Number of persons<br />
required<br />
2-5 1-2 3-8 1-3 2-3<br />
Percentage of<br />
people questioned<br />
19 10 22 41 8<br />
(Personal research)<br />
(5)- buying a<br />
platform<br />
The number represent a scale value from 0=minim/easy/cheap, to<br />
5= maxim/difficult/expensive.<br />
The study highlights the fact that you can create e-commerce/e-business sites with<br />
minimum effort and maximum efficiency using stable platform, with secure and<br />
proven technology.<br />
If you want a lot of personalizations, you have time, a small budget, you can chose to<br />
write direct the code aplications. If you are a large company, with experience in<br />
traditional business and you want to start a new section on-line, you can choose to buy<br />
a stable e-business system, modular, with a lot of personalization, expensive, but<br />
secure and robust.<br />
CONCLUSION<br />
E-business is booming as organizations strive to gain efficiencies through improved<br />
workflows, resource management, just-in-time provisioning and business<br />
relationships. This paper explores the driving forces behind such developments,<br />
introducing fundamental technologies and protocols (on previous articles) upon which<br />
new systems and services can be built - including Service Oriented Architectures, web<br />
services, XML and associated security standards. Case studies illustrate the business
strategies behind the deployment of e-business technologies. All of them will explore<br />
professional and ethical issues surrounding web technology developments, use<br />
software tools to create schemes and web service models, deploy collaborating<br />
applications, and consolidate your learning in a final project, a viable e–business<br />
application.<br />
REFERENCES<br />
Xu, J., Quaddus, M. (2009) Foundation of E-Business and E-Business Technologies,<br />
www.techrepublic.com/whitepapers/overview-part-i-foundation-of-e-business-and-ebusiness-technologies/1908243/;<br />
Timofte, C. (2007) E-business Technologies- revistaie.ase.ro/content/44/14-timofte.pdf;<br />
Timofte, C. (2007) E-business Technologies - Proceeding of International Conference on<br />
Informatics in Economy<br />
Timofte, C. (2009) Trends in E-commerce Protocols - Carmen Timofte, Proceeding of<br />
International Conference on Informatics in Economy;<br />
(2010) – How to Create a Successful E-Business -www.ehow.com/ how_5952307_createsuccessful-e_business.html;<br />
(2011) – TechWeb White Paper Library White Papers, Webcasts, Case Studies and Research<br />
Papers - whitepaper.techweb.com/ cmptechweb/ e-business technologies.htm;<br />
(2009) – e-Business, ebusiness provider, eBusiness technology provider, eBusiness<br />
technologies_files, www.alletec.com/knowledge_ebusiness.htm/;<br />
(2004) – e-business Technology, Solution, and Design Overview_files -<br />
www.redbooks.ibm.com/Redbooks.nsf/IBM Redbooks Student Edition IBM;<br />
(2007) – Cover Pages SGML and XML News 2007 Q1.htm -xml.coverpages.org;<br />
(2007) – Cover Pages Open SOA Collaboration Vendors Advance SCA and SDO Specs for<br />
Standardization.htm - xml.coverpages.org, , march;<br />
(2008) – LLC – improving your business processes through the Internet.htm -<br />
www.ebiztechonline.com/eBusiness Technology;<br />
(2010) – E-Business Scenario and Technological Implementation- www.altiusdirectory.com/<br />
Computers/e-business-scenario.html;<br />
(2010) – The Advantages of E-Business Technologies -www.ehow.com/list_5991399_<br />
advantages-e_business-technologies.html;<br />
(2007) – www.osoa.org.<br />
~ 487 ~
ANALYZING E-COMMERCE PROTOCOLS<br />
Carmen TIMOFTE 1<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
Many researchers have looked at the problem of verifying e-commerce protocols, but much<br />
work remains to be done. On the final, I present the trends for the utilization of formal<br />
methods for the verification of modern complicated protocols and protocol suites for the real<br />
commercial world.<br />
KEYWORDS: E-commerce, protocols, SET, AADS, 3D Secure, SSL.<br />
INTRODUCTION<br />
Electronic commerce requires protocols of great complexity. To make a purchase over<br />
the Internet, the customer typically submits his credit card number to the merchant,<br />
protected by a protocol such as SSL. However, many potential customers are uneasy<br />
about revealing their credit card number over the Internet. The SET protocol has been<br />
proposed by a consortium of credit card and software companies.<br />
SET aims to protect sensitive card-holder information, to ensure payment integrity<br />
and to authenticate merchants and card-holders.<br />
The paper provides a review of the existing e-commerce protocols, making an<br />
analysis of their most important characteristics. The purpose is to determine the trends<br />
and to present a formal method for verification of these protocols.<br />
1. OVERVIEW OF EXISTING PROTOCOLS<br />
All existing protocols (A & M, 2007) use cryptographic functions like: message<br />
digest (integrity), secret key encryption (privacy), public key, encryption (privacy and<br />
authentication), digital envelopes (integrity and privacy), digital signatures<br />
(authentication), digital certificates (authentication).<br />
E-commerce protocols that were developed and some of them, used, more often or<br />
less often, are:<br />
• SET (Secure Electronic Transaction)- in 1996 it was developed by Visa şi<br />
Mastercard, with the assistence of IBM, Microsoft, Netscape, GTE, SAIC,<br />
Terisa and Verisign;<br />
1<br />
Correspondence address: Carmen TIMOFTE, Economic Informatics Department, Academy of<br />
Economic Studies; email: carmen@ase.ro<br />
~ 488 ~
• iKP (Internet Keyed Payments Protocol) – it was developed by IBM, the<br />
Research Center T.J.Watson in collaboration with Zurich Research<br />
Laboratory; is a protocol based on public key to making payments on the<br />
Internet, involving at least three parties.<br />
• Secure Courier – it was proposed by Netscape, to create a secure electronic<br />
commerce on the Internet. It wants to be a protocol for the next level of SSL.<br />
• OPT (Open Trading Protocol)- it was created in 1997 by the consortium of<br />
28 companies (IBM, Oracle, Sun Microsystems, Netscape, Nokia, HP, AT &<br />
T, Fujitsu, etc..) to create a trade on network completely unprotected;<br />
• SNPP (Simple Network Payment Protocol)- it was proposed by M.I.T.,<br />
Laboratory of Computer Science, in 1992;<br />
• IBS (Internet Billing Protocol)- it was developed by Carnegie Mellon<br />
University in 1994; is inserted into SET; first variant of this protocol is based<br />
on Kerberos, using a private key and batch invoices to ensure services both<br />
traders and buyers.<br />
• JEPI (Joint Electronic Payment Initiative) – it was developed by W3C and<br />
CommerceNet<br />
• EMV – it was developed by EuroPay and use the chips technology on credit /<br />
debit cards;<br />
• E-Check (Electronic Checkbook)- working on a SmartCard of FSTC –USA<br />
(Financial Services and Technology Consortium);<br />
• SEPP (Secure Electronic Payment Protocol) – accepted by MasterCard, IBM<br />
and Netscape;<br />
• STT (Secure Transaction Technology) – developed by Visa and Microsoft;<br />
• TLS (Transport Layer Security) – it’s a secure protocol for simple task, who’s<br />
coding information on credit cards, sent to the Web and ensure that<br />
transactions are not intercepted by a third party. It is developed by IETF<br />
(Internet Engineering Task Force) and is similar to SSL (Secure Socket Layer<br />
of Netscape). It is an open protocol, high level, which allows the addition of<br />
new technologies for authentication and encoding / decoding;<br />
• P3P (Platform for Privacy Preferences) – developed by W3C and provide a<br />
platform for online transaction, allowing different preferences, the cultural<br />
norms and environments to various legislative;<br />
• OPS (Open Profile Standard) – it’s a complement of P3P and provides a<br />
secure storage of user profile information. Ensure the protection of individual<br />
data and the exchange of data on-line and may establish specific consumer<br />
marketing environment.<br />
2. THE MOST IMPORTANT E-COMMERCE PROTOCOLS<br />
The e-commerce community can choose from a wide range of protocols when<br />
designing new applications, but SET distinguishes as the most popular. Companies<br />
such as Hitachi, IBM and VeriSign are currently testing SET-based products (for<br />
example, Microsoft Wallet). Some security experts feel that, for various reasons, SET<br />
will never gain widespread acceptance. Whether it does or not, we can be certain that<br />
new e-commerce protocols will be developed. Unlike SSL, they will not require the<br />
customer to trust the merchant. These new protocols will probably share much of<br />
SET's architecture.<br />
~ 489 ~
SSL (Secure Socket Layer)<br />
SSL protects the communication between a client and a server and provides<br />
authentication to both parties. SSL (TLS) resides below application protocols and<br />
above transport protocols. Most common use of SSL is to secure web protocol HTTP,<br />
TCP/IP and others Internet applications, like e-commerce.<br />
Most Internet merchants use the SSL protocol to prevent eaves droppers from learning<br />
customers’ account details, adopting the classical idea that bad persons are always<br />
outsiders. This arrangement has two major limitations:<br />
• customers must trust merchants to keep these details secure, and merchants<br />
may be dishonest or, more often, incompetent.<br />
• merchants must trust customers, who do not sign anything, and have little<br />
protection from stolen cards or from customers who repudiate their<br />
purchases.<br />
Visa and MasterCard designed the SET protocol to solve these problems by keeping<br />
sensitive information confidential and by authenticating Cardholders and Merchants.<br />
The SET Protocol<br />
The overall architecture of SET is based on a rooted hierarchy of Certification<br />
Authorities (CAs), whose task is to provide customers with digital certificates for<br />
signature and encryption. Customers must generate and safeguard their private keys<br />
(R, 2000).<br />
A normal run of the SET protocol consists of five phases. The first two phases —<br />
Card-holder Registration and Merchant Registration — are used by the protocol<br />
participants to register their keys and to get the appropriate certificates. The remaining<br />
three phases — Purchase Request, Payment Authorization and Payment Capture —<br />
constitute the electronic transaction itself. To accomplish these tasks SET uses<br />
numerous combinations of hashing, public key and symmetric key cryptography<br />
based on the PKCS#7 standards from RSA Laboratories.<br />
Problems with SET<br />
• significant changes in the existing payment infrastructure<br />
• changes in the business model<br />
• it is slow: banks need 750 transactions per second, and SET offers 1<br />
transaction per second<br />
• the sheer size of the documentation which takes over 1000 pages.<br />
• more substantial obstacle is the protocol’s complexity. Academic protocols<br />
are typically short, straight-line programs; they seldom go beyond two levels<br />
of encryption and generate few secrets.<br />
SET has many features that make its verification hard (P, 2002):<br />
• Multiple nested encryptions and duplicate message fields require<br />
abbreviations.<br />
• Ubiquitous generation of random numbers and keys cause a state-space<br />
explosion in model checking.<br />
~ 490 ~
• Many alternative protocol paths make it hard to single out the few key roles<br />
used either by manual analysis or by model-checkers to restrict the search<br />
space.<br />
SET was based on X.509 certificates with several extensions and was intended to<br />
become the de facto standard of payment method on the Internet. Despite heavy<br />
publicity, it failed to win market share (B & S, 2009). Reasons for this include:<br />
network effect - need to install client software (an e-wallet); cost and complexity for<br />
merchants to offer support and comparatively low cost and simplicity of the existing<br />
SSL based alternative; client-side certificate distribution logistics. SET needs to be<br />
revived by introducing an emerging, alternative technology: AADS - Account<br />
Authority Digital Signatures.<br />
AADS (Account Authority Digital Signature)<br />
The most important objective of AADS is to incorporate strong authentication into<br />
existing business infrastructures, with public key digital signature. Neither a PIN nor a<br />
password is required to be transmitted to the receiver for validating the identity of the<br />
sender (W & W, 2004).<br />
An AADS transaction eliminates the need to append a certificate to a digitally signed<br />
transaction. The transaction/document with appended digital signature is all that is<br />
necessary for an AADS transaction (with no appended certificate). At the receiving<br />
party, the appended digital signature is authenticated by retrieving the public key from<br />
the associated account record (not from an appended certificate).<br />
There have been some early electronic commerce pilots that have relied on certificatebased<br />
bindings which minimize the software changes to existing business<br />
implementations. Benefits from small pilots would typically be less than expense of<br />
modifying existing business process implementations (especially if it hasn't yet been<br />
determined exactly what the changes should be long term).<br />
3D Secure<br />
The basic concept of the protocol is to tie the financial authorization process with an<br />
online authentication. This authentication is based on a three domain model (that is<br />
the 3-D in the name). The three domains are: Acquirer Domain (the merchant and the<br />
bank to which money is being paid), the Issuer Domain (the bank which issued the<br />
card being used) and finally the Interoperability Domain (the infrastructure provided<br />
by the credit card scheme to support the 3-D Secure protocol).<br />
The protocol uses XML messages sent over SSL connections with client<br />
authentication (this ensures the authenticity of peers, the server and the client, using<br />
digital certificates).<br />
3. THE IDEAL E-COMMERCE PROTOCOLS<br />
Researchers have identified a number of desirable characteristics that must be<br />
satisfied by e-commerce protocols (B&P, 2002):<br />
• should ensure fair exchange,<br />
~ 491 ~
• should not require manual dispute resolution in case of unfair behavior by<br />
one party,<br />
• each party should be assured that the item he is about to receive is indeed the<br />
correct one,<br />
• should not require the active involvement of an online trusted third party,<br />
• should ensure anonymity for the customer and optionally for the merchant.<br />
Fair exchange: Ideally fair exchange requires that either both the parties involved in<br />
the transaction receive each other’s items or none do. However, researchers have<br />
often used the term in a weaker sense: the protocol gathers enough evidence during<br />
execution so that, in case one party behaves unfairly and obtains the other’s item. If a<br />
dispute occurs, a judge looks at the evidence and delivers his judgment. The dispute<br />
resolution is performed after the protocol execution, that is, after the customer has<br />
obtained his product or the merchant his money. However, such “after-the-fact”<br />
protection may be inadequate in an e-commerce environment where the customer and<br />
the merchant may be unreachable after the transaction (R & R, 2001).<br />
Avoiding manual dispute resolution: The need for manual dispute resolution, when<br />
one party behaves unfairly, does not arise if protocols provide true fair exchange –<br />
under all circumstances either both the parties receive each other’s items or none do.<br />
Protocols providing true fair exchange typically use an online trusted third party. The<br />
third party receives the information from each party involved in the e-commerce<br />
transaction and then forwards it to the other party. As a result if any party misbehaves<br />
or prematurely quits, no harm is caused to the other party.<br />
Ensuring correct item will be received: Before exchanging the items, each party must<br />
have the confidence that the item he is about to receive from the other party will<br />
indeed be the correct one. The use of an online trusted third party helps to meet this<br />
requirement as well. Although using a trusted third party helps meet some<br />
requirements, the third party is a source of bottleneck for these protocols. Not only is<br />
the performance of the third party an issue, but also its vulnerability to denial of<br />
service attacks.<br />
Reducing involvement of the third party: Several protocols have been proposed that<br />
do not use the third party unless a problem, such as, a party misbehaving or<br />
prematurely aborting, occurs. Such protocols are termed optimistic. Most of these<br />
protocols do not ensure true fair exchange.<br />
No existing e-commerce protocol that we know of satisfies all of these requirements<br />
simultaneously. There are a lot of things to develop in the e-commerce protocols. This<br />
is why the research community works with de software companies to obtain the ideal<br />
protocol, accepted by all.<br />
4. PROTOCOL’S VERIFICATION<br />
In the analysis of conventional communication protocols (G & L, 2001), three kinds<br />
of techniques have been applied to this problem:<br />
• Inference-construction methods are utilizing modal logics similar to those<br />
that have been developed for the analysis of the evolution of knowledge and<br />
belief in distributed systems. These methods are widely used and a number of<br />
~ 492 ~
specific problems are associated with them, related to: the analysis of zero<br />
knowledge protocols, the detection of parallel session multi-role flaws, the<br />
transformation of messages and prepositions to idealized messages, the fact<br />
that there is no complete semantics for the logic, and the modeling of<br />
freshness.<br />
• Attack-construction methods construct probable attack sets based on the<br />
algebraic properties of the protocol's algorithms. These methods are targeted<br />
towards ensuring authentication, correctness, or security properties; they are<br />
not dependent on the correctness of a proposed logic. Their main<br />
disadvantage lies in the big number of possible events that must be examined<br />
and the exponential searches. They can be divided into three sub-categories<br />
based on their theoretical foundation: �methods based on general purpose<br />
validation languages, �algebraic simplification theoretic model methods and<br />
�special purpose expert system, scenario based methods.<br />
• proof-construction methods a recent approach, which has the potential of<br />
being as thorough as attack construction in finding possible attacks, while<br />
avoiding exponential searches by replacing them with theorems about these<br />
searches. It is complementary to inference-construction methods, since they<br />
are also based on the problem formalization through hypotheses and<br />
authentication properties, but rely on problem-specific properties and a<br />
specification at a finer level of precision.<br />
The robustness principles are therefore helpful, in that adherence to them contribute to<br />
the simplicity of protocols and avoid a considerable number of published confusions<br />
and mistakes: be very clear about the security goals and assumptions; be clear about<br />
the purpose of encryption (secrecy, authenticity, etc.); do not assume that its use is<br />
synonymous with security, be careful that your protocol does not make some<br />
unexamined assumption about the properties of the underlying cryptographic<br />
algorithm; be sure to distinguish different protocol runs from each other; do not<br />
assume that a message you receive has only a particular form, even if you can check<br />
this; sign before encrypting; the identity should be mentioned explicitly in the<br />
message.<br />
5. TRENDS<br />
Several researchers believe that in the near future, more effort will be spent on<br />
designing secure protocols and less on formal verifications (K & a, 2005). As<br />
expected, this trend has received criticism similar in nature to that expressed towards<br />
the use of formal methods in program design and implementation.<br />
Other researchers argues that design specifications do not guarantee that protocols<br />
will meet security goals that were not foreseen by the design approach, that the<br />
protocols designed are sometimes impractical, and that — due to the imprecision of<br />
design principles — flawed protocols may in any case be designed.<br />
A protocol analysis toolkit-based can be described as follows:<br />
• initially, use an inference-construction method, like BAN, to determine what<br />
the role of each message of a protocol should be and to ensure freshness<br />
properties;<br />
~ 493 ~
• then, use an attack construction method, like NRL Protocol Analyzer, for<br />
finding simple attacks quickly;<br />
• and finally, utilize a proof-construction method to investigate deeper<br />
properties with a modest amount of effort.<br />
Furthermore, some areas where current research is conducted have emerged.<br />
Another interesting research direction is the investigation of the potential integration<br />
of methods (like the NRL Protocol Analyzer) and the Interrogator model within the<br />
methodology of fail stop protocols in the cases of protocols that do not satisfy the failstop<br />
requirements. To ease and extend the use of these it would be useful to achieve<br />
automatic translation of a higher-level protocol specification language, using<br />
exhaustive finite-state analysis and formal logic methods.<br />
The research community is also working towards developing tools that take easy-towrite<br />
specifications of protocols and the expected properties and quickly perform<br />
formal analyses checking for failures of these protocols to achieve their desired<br />
properties.<br />
An interesting research trend lies in the fact that many current activities use formal<br />
methods for analyzing and verifying modern protocols and protocol suites to be used<br />
in the commercial world. These suites consist from a set of single protocols which<br />
interact with each other causing, previously unknown, potential vulnerability.<br />
CONCLUSION<br />
The research community, working towards developing more effective techniques to<br />
design protocols that are guaranteed to be reliable and correct in the first place, has<br />
implemented the synthesis approach. Most of the recent research in this area is<br />
focused on the application of the notion of channels in order to effectively implement<br />
the layered approach.<br />
Researchers have identified a number of desirable properties of e-commerce<br />
protocols: should ensure fair exchange, should not require manual dispute resolution<br />
in case of unfair behavior by one party, each party should have the assurance that the<br />
item he is about to receive is the correct one, should not require the active<br />
involvement of a trusted third party.<br />
These properties must be introduced in the next generation of e-commerce’s protocols<br />
for having secure e-commerce world.<br />
REFERENCES<br />
Anderson, R.& More, T., (2007) „Information security economics – and beyond”, Advances<br />
in Cryptology – Crypto, LNCS 4622, available on-line at www.cl.cam.ac.uk/<br />
~rja14/Papers/econ_crypto.pdf, (date of consultation: may, 10, 2011);<br />
Bella, G. & Paulson, L. C., (2002) “The Verification of an Industrial Payment Protocol”,<br />
<strong>Proceedings</strong> of the 9th ACM Conference on Computer and Communications Security,<br />
available on-line at www.dmi.unict.it/~giamp/Seminars/SETCCS02.pdf, (date of<br />
consultation: may, 10, 2011);<br />
~ 494 ~
Boping, Z. & Shiyu, S., (2009), ”An Improved SET Protocol”, <strong>Proceedings</strong> of the 2009<br />
International Symposium on Information Processing (ISIP’09), Huangshan, P. R.<br />
China, August 21-23, pp. 267-272, available on-line at www.academypublisher.com/<br />
proc/isip09/papers/isip09p267.pdf, (date of consultation: may, 10, 2011);<br />
Gürgens, S. & Lopez, J., (2001) “Suitability of a classical analysis method for e-commerce<br />
protocols”, Information Security, 4th International Conference, ISC 2001, volume<br />
2200 of lncs, www.informatik.uni-trier.de/~ley/db/conf/isw/isc2001.html;<br />
Katsaros, P., Odontidis, V., Gousidou-koutita, M., (2005) “Colored Petri Net based model<br />
checking and failure analysis for E-commerce protocols”, Dept. of Computer Science,<br />
University of Aarhus, pp. 267-283;<br />
Paulson, L. C., (2002) „Verifying the SET Protocol: Overview”, International Conference on<br />
Formal Aspects of Security (FASec), LNCS, available on-line at<br />
http://www.cl.cam.ac.uk./~lcp/papers/Auth/SET-overview-2002.pdf<br />
(date of consultation: april, 10, 2011);<br />
Ramakrishnan, G., (2000) „Secure Electronic Transaction (SET) Protocol”, available on-line<br />
at www.isaca.org/Journal/Past-Issues/2000/Volume-6/Pages/Secure-Electronic-<br />
Transaction-SET -Protocol.aspx (date of consultation: april, 10, 2011);<br />
Ray, I. & Ray, I., (2001) ”An Anonymous Fair Exchange E-commerce Protocol”,<br />
<strong>Proceedings</strong> of the International Workshop on Internet Computing and Ecommerce,<br />
pp. 172-179;<br />
Wheeler, A. M. & Wheeler, L. H., (2004) „Account Authority Digital Signature (AADS)<br />
System”, available on-line at www.wikipatents.com/US-Patent-6820202/accountauthority-digital-signature-aads-system<br />
(date of consultation: may, 10, 2011);<br />
~ 495 ~
MODELING ON A SEMANTIC-BASED<br />
REPRESENTATION OF PEDAGOGICAL OBJECTS E-<br />
LEARNING-TYPE IN ORGANIZATIONAL MEMORY:<br />
CONNECTING ONTOLOGY WITH LOM META-DATA<br />
Iuliana IONESCU 1 , Vasile FLORESCU,<br />
Bogdan IONESCU & Ofelia Ema ALECA<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
The emergence of Internet technologies, especially of Web technologies has really opened the<br />
perspective of online use for pedagogical content, also-called pedagogical objects (OP),<br />
based on the structure of learning scenarios (Learning Design). The semantic-based<br />
representation of pedagogical objects by associating an ontology with LOM meta-data makes<br />
the objects more accessible, reusable and customizable in the context of training activities.<br />
The present paper is structured in two main sections: the first section represents a review of<br />
the reference literature concerning the modeling on a semantic-based representation of elearning<br />
training in organizational memory. The second section contains several instances of<br />
the models presented in the first section and the operational models for the teaching unit<br />
"economic and financial analysis of organization’s business".<br />
KEYWORDS: Organizational Memory of e-learning, Learning objects, Standards of elearning,<br />
Meta-data, Ontology, Indexing<br />
INTRODUCTION<br />
The emergence of Internet technologies, especially of Web technologies has really<br />
opened the perspective of e-learning training, available to those interested in<br />
pedagogical content accessed by users on the Web (Bourda, 2002, Abel et al., 2003)<br />
and used online on the structure of pedagogical scenarios (Hernandez et al., 2008;<br />
Florescu & Aleca, 2009). However, the use of pedagogical resources of e-learning,<br />
stored in organizational memory, could cause problems of access, management, reuse,<br />
and finally integration on a technical and pedagogical level.<br />
In removing these inconveniences the representation and indexing of these<br />
pedagogical objects is of importance (Benayache, 2005; Hernandez et al., 2008). In<br />
fact, a non-indexed pedagogical resource is unavailable, and therefore cannot be used.<br />
According to Abel et al. (2003), the applied organizational memory e-learning also<br />
contains other elements than pedagogical objects, related to the pedagogical training:<br />
the elements concerning the actors involved in training process (specificity, actor’s<br />
1 Correspondence address: Iuliana IONESCU Academy of Economic Studies, Management<br />
Information Systems department, Bucharest, Romana str., No. 5, Sector 1;<br />
email: ionescu.iuliana@gmail.com,<br />
~ 496 ~
ehavior - meaning how to act over the time, profiles, etc.) and the administrative<br />
management of the educational process, as well (registration, marks, and so on).<br />
1. RESEARCH METHODOLOGY<br />
In the present paper, our approach is a research-development type: the literature<br />
review, where we approached the major aspects regarding the pedagogical objects of<br />
e-learning training in organizational memory, followed by the development of a<br />
methodology for defining an ontology which, starting from a reference nucleus<br />
(corpus) describes an educational area circumscribed to the “financial and economic<br />
analysis”. To achieve our research work we passed through two important steps,<br />
which are:<br />
� The literature review which approaches the modeling issue on a semanticbased<br />
representation of e-learning pedagogical objects in organizational<br />
memory;<br />
� Instantiation of the models on a semantic-based representation of pedagogical<br />
objects on “economic and financial analysis of business organizations” area,<br />
provided by the academic curriculum of the e-learning training in economics.<br />
At the same time, our research work makes a conceptual clarification regarding the<br />
semantic-based representation of pedagogical objects and also referring to the<br />
perspective of computer-assisted conversion from an UML conceptual model to an<br />
ontology in OWL language (Web Ontology Language) or RDFS (Resource<br />
Description Framework Schema).<br />
2. LITERATURE REVIEW<br />
2.1. Organizational memory of e-learning training<br />
According to Abel et al. (2003), an educational process is always organized based on<br />
the main actors (tutor and student, secretary, manager, technician), the knowledge of<br />
the actors (which interfere with the educational environment), the skills of the<br />
educational process involved, and the different types of information (definitions,<br />
exercises, solutions, case studies, etc.) prepared under different forms (reports, books,<br />
website, and so on) and stored on various media (paper, video, etc.). This way, one<br />
could say that an e-learning educational process can be assimilated to an<br />
organizational entity.<br />
The organization’s resources are managed by an organizational memory training<br />
(MOF). As a matter of fact, MOF capitalizes on the following: the Learning Object<br />
(LO), also-called pedagogical objects (OP) related by the content of the field training,<br />
the relationships between them, and also the information about the actors (their<br />
specificity, their activity over the time, and the kind), the information regarding the<br />
administrative management of training process (registration, student marks, and<br />
so on).<br />
Choosing the formalism for representing and accessing the OP in MOF is a very<br />
significant, but also a difficult problem concerning the semantic-based representation<br />
of pedagogical objects. It is important that the models of representation of OP<br />
articulate the LOM meta-data (Learning Object Metadata) with the application<br />
~ 497 ~
ontology, with the purpose of ensuring the semantic-based access on e-learning<br />
training programs. The MOF’s pedagogical resources are provided for all e-learning<br />
trainers by the local warehouse, also-called Learning Object Repositories (LORs). In<br />
essence, an e-learning system which has the MOF support should allow the trainers to<br />
formulate several informational requests in order to find out the particular OP.<br />
2.2. Pegagogical objects<br />
For e-learning training programs, a so-called Learning Object Repository (LOR) is<br />
set up, where all pedagogical objects are stored and indexed (OP). Our scientific paper<br />
is mainly focused on the representation of pedagogical objects related to the content<br />
of the training field, which is often identified with the pedagogical resources of the<br />
training process. The working group IEEE-LTSC (Learning Technology Standards<br />
Committee) defines the OP as “any numerical or non-numerical entity which can be<br />
used, reused or referenced during the computer-support learning activity”.<br />
To clear away any possible confusion, Strijker (2004) removes the non-numerical<br />
data, like books and libraries, from the conceptual definition. Wisconsin University<br />
(Wisc-Online, 2007) defines the pedagogical objects as “small autonomous learning<br />
units in line; they are small enough to be well-integrated into an educational activity, a<br />
lesson, a module or a course”. According to Hernadez et al. (2008), an OP represents<br />
“a semantic unit of learning resource”. In its assessment evaluation methodologies of<br />
distance learning educational standards, the Romanian Agency for Quality Assurance<br />
in Higher Education (ARACIS) defines the learning unit as “the structural element of<br />
the course, which is unitary from thematic standpoint, integrates a set of specific skills<br />
and, finally, is completed by an evaluation. This is equivalent to one or more chapters<br />
of a semester course”.<br />
Pernin (2003) classifies the pedagogical objects into three fundamental categories,<br />
which are:<br />
� pedagogical units, which allow the structuring of the training and its<br />
organization in space and time;<br />
� pedagogical activities, which define the certain modalities of acquisition,<br />
validation and communication of one or more knowledge (the IMS-LD standard<br />
was specifically developed to define learning scenarios);<br />
� pedagogical, physical and numerical resources required by the carrying out of<br />
the activities.<br />
Our research work is aimed at the pedagogical objects representing learning units,<br />
also-called learning objects.<br />
An OP is often segmented into a finer granulation to allocate the production activity<br />
between different actors (Charlet et al., 2008). A granule represents a pedagogical<br />
object meaning the smallest possible learning pedagogical unit of a pedagogical<br />
pathway. According to IEEE-LTSC (2002) an OP can develop from the smallest<br />
possible learning pedagogical unit to a complete course. Depending on the granularity<br />
level, an OP can be classified in two categories: an elemental OP (text, image, video<br />
and animation) and a composite OP. Each pedagogical object (OP) can be composed<br />
of one or more Web pages, each of these representing different parts of the reference<br />
corpus.<br />
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Structuring the educational content of any domain consists in breaking up the<br />
knowledge in basic units of fine granularity, allowing for indexing, filtering and<br />
reusing operations. A pedagogical unit (educational discipline) can be organized into<br />
a structure which includes: curricula, pedagogical unit, courses, lessons, exercises and<br />
elements of self-valuation. To represent the educational resources of a pedagogical<br />
unit, the framework model is defined using an UML diagram (Figure 1). Within the<br />
curriculum, the courses are planned; these contain the lessons, which are made up of<br />
pedagogical objects, and the connections are actually represented - within the<br />
framework model - by the aggregation of relationships between the appropriate<br />
classes (pedagogical unit, curricula, lesson and pedagogical object).<br />
Figure 1. Objectual structure of a pedagogical unit for e-learning training<br />
Within the framework module we specify the particularities of the pedagogical object<br />
including: the type (course, module, assisted-activity and so on), the name, and its<br />
format. As we have already seen, the pedagogical objects are divided in two<br />
categories (elemental OP and composite OP) depending on their complexity and<br />
usage. This classification is represented by the aggregation of relationships between<br />
the classes - composite pedagogical object, elemental pedagogical object and the<br />
class - pedagogical object. In turn, the composite pedagogical objects consist of one<br />
or more pedagogical objects (elementals or composites), which is represented in the<br />
model by associating the classes “composite pedagogical object” and “pedagogical<br />
object”.<br />
The pedagogical objects composing a lesson can refer to: the content of the lesson, the<br />
bibliographical sources, and the set of exercises and tests. The diversity of<br />
achievement and presentation of the lessons and pedagogical objects presumes a<br />
variety of resources (multimedia resources such pictures etc.). Once created, a<br />
pedagogical object must be:<br />
� reusable in different educational contexts;<br />
� independent by the distribution support and training platform;<br />
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� indexed – described so that they can be easily accessed.<br />
All the pedagogical objects for a specific training field constitute the so-called<br />
pedagogical file.<br />
2.3. Meta-data and description standards of pedagogical objects<br />
2.3.1. Meta-data for description of pedagogical objects<br />
The meta-data represent, in fact, the structured data which describe other data, in the<br />
present case, data about pedagogical objects. They are represented by a set of<br />
pedagogical object descriptors which are structured by using a meta-data schema.<br />
These descriptors are used with the purpose of indexing the pedagogical objects, the<br />
only way to easily locate them in the OP database. According to Iles et al. (2008) the<br />
objectives of the meta-data are:<br />
� Description of the pedagogical objects, with varying level of detail;<br />
� Improving the search capability into OP databases or warehouses;<br />
� Facile and quick evaluation of OP content adequacy;<br />
� Improving the management of access rights;<br />
� Organizing of pedagogical object warehouses;<br />
� Certifying the intellectual authority of the content (author, created date,<br />
responsible authority, upgrade date, and the kind).<br />
2.3.2. LOM and SCORM standards<br />
A standardized OP description is essential in ensuring the reuse and access to OPs.<br />
The reference literature (Hernandez et al., 2008, Florescu & Aleca, 2009) refers to the<br />
complementarity of LOM (Learning Object Metadata) and SCORM (Sharable<br />
Content Object Reference Model) standards (see Figure 2):<br />
Figure 2. SCORM and LOM descriptions<br />
(Source: According to Hernandez et al., 2008)<br />
A pedagogical object represents a LOM object and consists of SCORM elements, and<br />
can contain more pedagogical objects. According to the LOM standard, the<br />
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pedagogical object is annotated using different elements or meta-data such as its<br />
associated access rights, technical requirements and features, educational<br />
particularities, etc.<br />
The LOM standard (2002) specifies the syntax and semantics of the pedagogical<br />
meta-data and also defines the necessary attributes for an appropriate and complete<br />
description of pedagogical objects, by regrouping these objects in nine categories<br />
(generalities, life cycle, meta-meta-data, technical information, pedagogical<br />
information, rights, relationships, comments and classification). The purpose of LOM<br />
is to allow retrieval of OPs, prepare them, and introduce certain pedagogical<br />
dimensions in their description. It should be noted that many research papers propose<br />
the substitution of one or more LOM elements by concepts which belong to<br />
ontologies, in order to solve some problems of semantic ambiguity. Implementing the<br />
LOM standard can be done using XML or RDF (Ouafia et al., 2009).<br />
The SCORM standard (2004) guides the creation of structured pedagogical resources<br />
and also treats the following elements (Pernin, 2004):<br />
• Packing – allows the transfer of the pedagogical objects content, focusing on<br />
their structure. A package represents an archived file that contains educational<br />
resources, such as HTML, JPG, Word files, attended by an XML file<br />
containing multiple sections, including the section reserved for meta-data<br />
(where the package is described), the resources section (which consists of a<br />
list of resources along with the connections to the (URL), and an organization<br />
section (which contains the structure of resources).<br />
• Meta-data – allows the structuring of information which describes the nature<br />
and the objectives of the content.<br />
• Communication – manages the access to the pedagogical objects within the<br />
learning network.<br />
• Sequence and browsing – establish the access mode in terms of the activities<br />
tree.<br />
The aggregation of content is structured on three levels:<br />
� Basic digital resources represent the basis of pedagogical objects and can be<br />
found in the form of simple elements, such as HTML files;<br />
� Shared objects are composed of multiple basic objects, in accordance with the<br />
SCROM protocol. They represent the lowest level of granularity that the<br />
pedagogical objects can have in an e-learning platform;<br />
� Aggregation of the content consists in a number of educational resources,<br />
structured as modules and lessons.<br />
A pedagogical object can combine more elementary components: DOC, JPG, PDF<br />
files, or other pedagogical objects. The LOM meta-data and the SCORM structure<br />
allow, on one hand, the description and the indexing the pedagogical objects using the<br />
LOM meta-data and, on the other hand, structuring of the pedagogical objects in<br />
conformity with the SCORM standard.<br />
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3. ONTOLOGIES<br />
3.1. Briefly about ontology<br />
For many years, the ontology science has been used in Knowledge Engineering (IC)<br />
and Artificial Intelligence (IA) in order to structure the concepts of the specific field<br />
of study. The ontology allows the definition of overall concepts shared within a field<br />
of study, in a formal, explicit, referential and consensual manner (Gruber 1993; Studer<br />
1998). This presents the organization of the concepts and relationships. The<br />
ontology’s core contains four (Stumme & Maedache, 2001):<br />
where:<br />
O:=(C,≤C, R, ≤R)<br />
C represents the set of concepts,<br />
≤C represents the partial order on C,<br />
R represents the set of relationships defined on CxC, and<br />
≤R represents a partial order on R.<br />
Once defined, an ontology must be clear, coherent, intelligible and easy to use and<br />
expand (in fact, easy to update when an evolution occurs).<br />
3.2. Ontology for e-learning<br />
E-learning training technology is based on the following elements: the actors<br />
(students, tutors, designers, administrators); learning fields; educational resources<br />
used for learning (courses, cases of study, complementary documents). The basic<br />
elements are modulated as sub-technologies of the global training ontology.<br />
Nowadays, many researches are based on ontologies for indexing and accessing of<br />
pedagogical objects in support systems for e-learning training (Abel et al., 2003;<br />
Lenne et al., 2005; Knight, 2005). Semantic representation of pedagogical objects is<br />
based on two important concepts: field ontology and training ontology, respectively.<br />
Elements of the field ontology<br />
The field ontology describes the specific concepts of a certain application field, such<br />
as, Data Analysis, Financial Management, Databases, and so on. This is an explicit<br />
and formal specification of a shared conceptualization, proper to a particular<br />
application field (Borst, 1997; Charlet et al., 2008). In addition, it presents the<br />
advantage of allowing a normalization of the concepts, which provides a better<br />
representation of knowledge. The concepts represent the objects, precepts and ideas of<br />
the field and the relationships represent the connections between these concepts.<br />
Actually, the structure of the field ontology defines the relationships established<br />
between the concepts.<br />
The reference literature on the field ontology conveys the following terms: concept,<br />
relationship and axiom. Within an ontology, a concept is uniquely identified and its<br />
various meanings are represented by labels. Semantic relationships represent a type of<br />
interaction between the concepts of the application field. The concept’s links can be<br />
taxonomic (relation of specificity/generality) or non-taxonomic (also-called<br />
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associative). This aspect is represented on the conceptual schema of ontology through<br />
an association of a reflexive class. The axioms are always true expressions. Including<br />
axioms into an ontology can have more objectives, such as: defining the sense of the<br />
components, setting out the restrictions on the attributes values, determining the<br />
arguments of a relationship, verifying the validity of specified or inferred information<br />
(Hernandez et al., 2008).<br />
The field ontology allows the representation of the pedagogical objects in relation to<br />
the percepts (concepts) approached by the field (Hernandez et al., 2008). This is<br />
significant for semantic-based granulation of the application’s field knowledge.<br />
According to Hernadez (2005), we must distinguish between the field’s knowledge<br />
which describe factual situations, and ontology which define a number of constraints<br />
on the structure and content of the field’s knowledge. The field ontology can be<br />
plotted using an UML model and especially the class diagrams, mainly because they<br />
allow the modeling of the concepts (entities) of the field. In Figure 3 we present the<br />
generic framework for representing a field ontology using the UML formalism.<br />
Figure 3. Extract from the field ontology of the discipline “Relational Database”<br />
The option for UML is primarily motivated by the fact that it is well-known, and<br />
secondly, this mode of representation is recommended by the opportunities offered on<br />
the line of creating an ontology, starting from the class diagrams orientated on a<br />
precise field (Faucher et al., 2010), corroborated with mail use proposed by Mefteh et<br />
al. (2009) and presented in Table 1. In Figure 4 we present the relation between the<br />
UML model, the annotated UML model, the RDFS ontology and the pivot UML<br />
model.<br />
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Figure 4. Transforming process: UML model. Ontology in RDFS<br />
(Source: According to Faucher et al., 2008))<br />
Tabel 1<br />
UML RDF(S),OWL<br />
Class owl :Class<br />
Generalization rdfs :subclassOf<br />
Association owl :ObjectProperty<br />
Attributes owl :DatatypeProperty<br />
InstanceOf rdf :type<br />
Multiplicity owl :minCardinality, owl :maxCardinality<br />
By annotations, all the interesting elements of the model are selected. The annotation<br />
mechanism uses the intrinsic possibilities of UML extension, such as: profiles,<br />
stereotypes, and labeled values. Then, the annotations are exploited while the<br />
ontology is built up, in order to guide the process of model transformation. The<br />
annotated UML model represents an extension of the UML model, which is orientated<br />
on a precise activity field. The pivot model, actually an UML model of ontology,<br />
contains the information required for building up the ontology, in accordance with the<br />
UML meta-model. The second change is based on the connections between the UML<br />
elements and an ontology structure, like RDFS or OWL.<br />
Elements of training ontology<br />
The training ontology describes the specific concepts of the training process, such as:<br />
type of actors involved in the training process, type of pedagogical activities, type of<br />
documents etc. According to Benayache (2005), the training field performs with<br />
specific training concepts:<br />
• Actors of the training process (teacher, student, secretary, administrator,<br />
technician etc.);<br />
• Documents (reading notes, slides, books, Web pages, Web sites and so on);<br />
• Educational resources (digital resources, teaching aids etc.).<br />
All these concepts and relationships constitute the training ontology. The standard<br />
structure of the training ontology, according to Abel et al. (2004), is presented in<br />
Figure 5.<br />
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Integration of ontologies<br />
Figure 5. The structure of training ontology<br />
(Source: According to Abel et al., 2004))<br />
The two types of ontology (field and training) are not independent. The description of<br />
field ontology (knowledgeBeanObject) requires some additional references to the<br />
appropriate concepts of training ontology (trainingOntologyObject). For example, if<br />
we need to specify that a document contains knowledge related to concept Indicators<br />
of financial analysis, we only need to link the concept Document (belonging to the<br />
training ontology) with the concept Indicators of financial analysis, belonging to the<br />
field ontology for Economic and Financial Analysis module. The pedagogical<br />
relationships like “prerequisite” or “uses” that occur between concepts of the field<br />
ontology are defined in the training ontology. Figure 6 presents the general framework<br />
of integration between the two ontologies for a training-type e-learning process, with<br />
application in the financial and accounting field - adapting the general model of Abel<br />
(2004).<br />
At the basis of the two integrated ontologies we find the E MemFC concept which<br />
contains:<br />
• all the concepts of the field ontology designated by the Application Concept<br />
class;<br />
• all the concepts of the training ontology designated by the Field Concept<br />
class;<br />
• the KnowledgeBean class which contains all the concepts that belong to a<br />
field ontology; besides, these concepts must be studied in the training<br />
program by all the “trained” students;<br />
• TrainingProperty represents the class of relationships occurring between<br />
concepts.<br />
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Figure 6. General framework of ontology integration for e-learning in financial<br />
and accounting field<br />
The two classes, inherited from the concept E_MemFC, are sub-classes of the<br />
E_MemFC class. The relationships between the concepts can be created anytime in<br />
each of the two ontologies.<br />
3.3. Associating the ontology of field with LOM meta-data<br />
To address the problems related to the lack of semantics in terms of representing and<br />
accessing the pedagogical objects (OP), one can associate the ontologies to certain<br />
elements of LOM (Phaedra & Permanand, 2006, Ouafia et al., 2009). There are two<br />
ways to achieve this association:<br />
• Substituting of one or more LOM elements by concepts found in ontologies;<br />
• Building up a field ontology based on the description schema of LOM.<br />
In fact, the second solution resolves much better the problem concerning the inclusion<br />
of semantics in the OP representation, referring rather to “Who contains?” instead of<br />
“What contains?”.<br />
3.4. Languages for defining of ontologies<br />
A language for defining ontologies must provide the epistemological fundamentals<br />
necessary to describe the ontology’s concepts (classes), their properties and<br />
relationships (attributes and roles), and the constraints on these properties. Currently,<br />
there are various languages for defining and manipulating ontologies. Many of them<br />
are semantic web-orientated: XML to manage the markers used for structuring<br />
documents, RDF (Resource Description Framework) to manage the meta-data of<br />
XML documents, DAML+OIL to represent the meta-data and ontologies, OWL<br />
(Ontology Web Language – standard of World Wide Web Consortium) to formalize<br />
the ontologies.<br />
Among all, the most representative language is OWL, which is a revised version of<br />
the DAML+OIL language. OWL represents a dialect of XML (eXtensible Markup<br />
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Language) and an extension of RDF and RDFS (RDF Schema), as well. In Table 2 we<br />
present an adaptation to Chrisment et al. (2006) for encoding the conceptual schema<br />
elements of a Web ontology using the OWL language.<br />
Table 2<br />
Conceptual schema elements Representing in OWL<br />
Class
“Economic and Financial Analysis”, “Accounting” and “Management and<br />
Information Systems”. For the “Economic and Financial Analysis” module, one can<br />
define more courses, structured in pedagogical entities or learning entities. In the<br />
Figure 7 we have presented the component of the course “Analysis of output<br />
activities”, and also the content of two learning entities within it.<br />
Figure 7. General framework of ontologies integration for e-learning in Financial<br />
and Accounting field<br />
4.2. Instantiation of the “Oriented on activity specialization” model using UML<br />
for the ontology that defines the “Economic and Financial Analysis”<br />
in a formative context<br />
The instantiation of the representation model corresponding to the ontology of<br />
“Economic and Financial Analysis”, firstly involved building the domain’s ontology,<br />
by defining the concepts and the relations between the concepts. It is well-known that<br />
the process of building up and improving an ontology is quite difficult. Besides,<br />
building up an operational ontology occurs in three main steps:<br />
• Conceptualization, consisting in identifying the knowledge within a<br />
representative area of the field, regrouping in semantic classes and structuring<br />
them in networks;<br />
• Defining the ontologies, implying the formalization of the conceptual model<br />
attained in the previous step;<br />
• Operationalization, presuming the transcription of the ontology in a formal<br />
and operational language of knowledge representation.<br />
In the present paper we already completed the first two steps. The conceptualization<br />
step was performed based on the reference corpus for the Economic and Financial<br />
Analysis field (guidebooks, books, articles, Web pages and so on). In fact, to<br />
complete the conceptualization step it was absolutely necessary to rely on a thesaurus<br />
created by experts in the field. Regarding the second step, the research team has<br />
proceeded to transcribe the ontology in the UML language.<br />
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Reviewing some relevant papers (Isfanescu & Robu. 2002, Valceanu and Robu, 2005<br />
and Dinu, 2001) we built a knowledge base which allowed us to set up the “postulant”<br />
terms for the ontology, the concepts and the ontology’s terms, respectively. The field<br />
of “Economic and Financial Analysis” is based on set of methods, techniques and<br />
tools for information processing with the purpose of diagnosing the status of an<br />
economic entity (Dinu, 2001). The diagnosis can be an internal one, required by the<br />
decision support systems or, on the contrary, performed for the benefit of an external<br />
entity, such as some clients, auditors, or financial institutions.<br />
The financial indicators system represents the main working tool in economical and<br />
financial analysis. These indicators can be either simple or aggregated, based on other<br />
indicators. The diagnosis is accomplished based on the significance level of the simple<br />
indicators which explains a particular event. The methods and techniques frequently<br />
used in the analysis process rely on a set of indices and rates.<br />
The structuring of the concepts and of the relationships is based on the semantic<br />
connections between the terms. It is represented in an ontology by the relationships<br />
between classes - relationships of association, aggregation or inheritance (see Figure 8).<br />
Figure 8. Meta-model of the ontology in the Economic and Financial Analysis field<br />
Source: According to Florescu & Aleca, 2009 and Reynaud & Tort, 2000<br />
The ontology of the field can be structured into several levels of detail. In the<br />
proposed instantiation, the research team has proceeded to detailing the “indicators”<br />
nodes (see Figure 9) and “methods and techniques” (see Figure 10).<br />
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Figure 9. Ontology for detailing the “indicators” node<br />
(Source: According to Dinu, 2001)<br />
In the process of detailing the node “methods and techniques” we have to identify,<br />
within the methods and techniques, the following: devising and comparing the results,<br />
benchmarking, grouping, modeling, defining charts, evaluation scores, the ABC<br />
method and the scores method.<br />
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Figure 10. Ontology for detailing the “methods and techniques” node<br />
Scoring method<br />
Indices<br />
Averages<br />
Relative sizes of the structure<br />
Rate of return<br />
CONCLUSIONS<br />
Rate of financial balance<br />
Chain substitution method<br />
Methods and Techniques<br />
Rates<br />
Rate on debt management<br />
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ABC method<br />
Comparison<br />
Modeling<br />
Division<br />
Evaluation grid<br />
Rate of liquidity and solvency<br />
Benchmarking<br />
Rate management<br />
In the context of extending the use of e-learning, the pedagogical object representation<br />
must ensure the reuse and interoperability, taking into account the specific standards<br />
of the field (LOM and SCORM). In the present paper we brought a number of<br />
clarifications on the conceptual level, and we also described the semantic-based<br />
representation models of pedagogical objects for e-learning training, and we<br />
instantiated the models in the scenario of the pedagogical entity belonging to<br />
“Economical and financial analysis of organizational activity”. In the future, our<br />
research work will focus on defining a methodological framework in order to create<br />
the ontology of the field, further developing the thesaurus of the field and the content<br />
of the pedagogical objects.<br />
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e-learning, UMR CNRS 6599 Heuristique et Diagnostic des Systèmes Complexes<br />
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Enschede, Centre for Telematica and Information Technology<br />
Bourda, Y. (2002) “Des objets pédagogiques aux dossiers pédagogiques (via l’indexation)”,<br />
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CEMAFORAD 04<br />
Isfanescu, A., Robu, V. (2002) Analiza economico-financiara, Editura ASE, Bucuresti<br />
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learning content, Journal of Interactive Media in Education, No. 07, available on-line<br />
at http://jime.open.ac.uk/article/2005-7/274<br />
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apprentissage”, EIAH 2005, 105-116, available on-line at http://hal.archivesouvertes.fr/docs/00/03/18/40/PDF/8.pdf<br />
Mefteh, W., Bouju A., Malki, J. (2009) “Cadre applicatif pour la construction d’ontologie<br />
basee sur un modele conceptuel UML 2 et la reutilisation des ontologies”, Programme<br />
de l’Atelier construction d’ontologies GBPOnto, available on-line at wwwlimbio.smbh.univ-paris13.fr/GBPOnto.2009/web3-meftehetall.pdf<br />
Ouafia, G., Abel M.H., Moulin, C (2009) “LOMonto : Une ontologie pour l’indexation<br />
d’objets pedagogiques”, Programme de l’Atelier construction d’ontologies GBPOnto,<br />
available on-line at www-limbio.smbh.univ-paris13.fr/GBPOnto.2009/web4ouafiaetall.pdf<br />
Pernin, J.P. (2003) “Objets pédagogiques : unités d’apprentissage, activités ou ressources ? ”,<br />
Revue Sciences et Techniques Educatives, Hors série 2003 " Ressources numériques,<br />
XML et éducation": 179-210<br />
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Pernin, J.P. (2004) LOM, SCORM et IMS-Learning Design : ressources, activités et<br />
scénarios, ERTé e-Praxis, Lyon, Laboratoire CLIPS-IMAG, Grenoble<br />
Phaedra, M., Permanand, M. (2006) “Incorporating multiple ontologies into the ieee learning<br />
object metadata standard”, CSWWS: 143–154.<br />
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Recommendation, Mars.<br />
Reynaud, Ch., F. Tort (2000) “Diriger la réutilisation de composants à l’aide d’ontologies”,<br />
Ingénierie de connaissances, available on-line at ftp://ftp.inria.fr/INRIA/Projects/<br />
gemo/gemo/GemoReport-340.pdf<br />
SCORM (2004) Le modèle SCORM, available on-line at http://www.adlnet.org<br />
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dissertation, Faculty of Behavioural Sciences, University of Twente, Enschede,<br />
Netherlands<br />
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Methods”, Data and Knowledge Engineering, Vol. 25, No. 1-2: 161-197<br />
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IJCAI, SeattleUSA, Morgan Kaufmann : 225-234<br />
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SEMANTIC ANNOTATION AND ASSOCIATION<br />
OF WEB DOCUMENTS: A PROPOSAL FOR SEMANTIC<br />
MODELING IN THE CONTEXT OF E-RECRUITMENT<br />
IN THE IT FIELD<br />
Bogdan IONESCU 1 , Iuliana IONESCU,<br />
Vasile FLORESCU & Andrei TINCA<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
The emergence of the Internet has widely opened opportunities for web applications based on<br />
the modeling of textual knowledge from electronic documents, with the aim of identifying the<br />
useful parts. This is also the case of e-recruitment applications, which aim at the optimizing<br />
and automating the processes by semantic association between CVs an job offers. Our paper<br />
considers the problem of semantic-based annotation of semi-structured documents, and<br />
proposes a semantic model for e-recruitment in the IT domain.<br />
KEYWORDS: e-recruitment, ontology, semantic annotation, information system, similarity<br />
measure<br />
INTRODUCTION<br />
The Internet has become essential, and the web is currently the dominant paradigm for<br />
the optimization of the recruitment processes. Most of the job seekers post CVs on<br />
web servers, and employers post job offers. The employment market is gradually<br />
moving onto the web using semi-structured documents (Rafter and Smyth, 2000:1;<br />
Bizer et al., 2005:1; Kessler et al., 2009:2; Kessler, 2010:16; Popescu and Popescu,<br />
2010:1), which translates into massive databases containing CVs and job offers,<br />
which are difficult to process in the absence of adequate techniques. This is the reason<br />
why research is done in the area of optimizing recruitment processes using Internet<br />
technologies, by adding semantics to standardized documents containing information<br />
regarding CVs and job offers (Figure 1).<br />
The semi-structured documents are semantically annotated (based on their content)<br />
and they are related to a field ontology. In the particular case of recruitment, the field<br />
ontology is inspired from the most significant parts from CVs and job offers<br />
(Yahiaoui et al., 2006). „Intelligent” programs can compare document instances using<br />
the common reference (ontology) and also detect ontological similarities between<br />
multiple instances.<br />
Despite significant progress in the area of semantic annotation of semi-structured<br />
documents, the process of creating the annotations and particularly the matching of<br />
1<br />
Correspondence address: Bogdan IONESCU, ASE Bucharest, Piata Romana nr.6, Sector 1<br />
Bucharest; email: ionescub@gmail.com<br />
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these documents are still difficult and resource-intensive. An essential factor to the<br />
recruitment process is the creation of a controlled vocabulary for the field, and the<br />
construction, maintenance and update of the ontology (concepts, properties and<br />
relations). These two elements guide the process of data extraction from semistructured<br />
documents and thus ease the process of their semantic annotation (as<br />
compared to annotations generated in the absence of an ontology).<br />
Figure 1. Generic framework for the recruitment process<br />
Our paper considers the problem of semantic-based annotation of semi-structured<br />
documents, and proposes a semantic model for e-recruitment in the IT domain.<br />
The paper is structured as follows: Section 2 presents the research methodology.<br />
Section 3 presents the literature review in the area of semantic annotation of semistructured<br />
documents related to the recruitment process (CVs and job offers) and their<br />
pairing using an ontology. Section 4 proposes a global framework for modeling the<br />
ontology of e-recruitment in the IT field. We conclude with the last section, where we<br />
consider the implementation of the proposed models by developing an e-recruitment<br />
platform.<br />
1. RESEARCH METHODOLOGY<br />
In our research, we have taken an action-based, constructivist approach: the literature<br />
review (where the fundamentals of semantic-based modeling for e-recruitment<br />
documents) is followed by the proposal of a controlled vocabulary and an ontology<br />
for the semantic annotation of recruitment documents in the IT field.<br />
The semantic-based approach to the optimization of data-flows within the human<br />
resources (HR) domain, in connection with the profiles of the job offers, is followed<br />
by our conceptual clarifications regarding the process of annotation and pairing of<br />
semi-structured documents. The results of our research recommend a new approach to<br />
human resources management, and offer support for developing an e-recruitment<br />
platform, founded on the utilization of the field ontology in the processes of<br />
annotation and semantic pairing of semi-structured documents.<br />
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2. LITERATURE REVIEW<br />
2.1. E-recruitment and the job market<br />
The recruitment process is based on the sum of the actions required to find candidates<br />
matching the job offers. E-recruitment involves the use of IT and communications<br />
technologies, and particularly the web (Bizer et al., 2005:2, Trichet and Radevski,<br />
2006:1; Yahiaoui et al., 2006:2). However, e-recruitment does not yet have a strictlydefined<br />
sense and understanding (Fondeur, 2006:2; Mellet, 2006:3). As a „cousin” of<br />
e-business, it refers to the instruments used to facilitate and eventually automate the<br />
web-based recruitment process. According to Kessler et al, (2008:1), there was a<br />
quick transition from pure intermediary, informative processes to externalizing the<br />
recruitment towards entities specialized in e-recruitment. The success enjoyed by erecruitment<br />
has led to the creation of many job portals, also called job boards<br />
(Yahiaoui et al., 2006:2; Kessler et al, 2009:3; Popescu and Popescu, 2010:2). This<br />
has created awareness and risen the interest in the modeling and semantic search of<br />
semi-structured web documents.<br />
The formal modeling of a document’s contents in terms of obtained (as is the case<br />
with CVs) and required (job offers) with the help of an ontology, between profiles for<br />
applicants and work requirements, opens the possibility to automate the processes of<br />
comparing, matching and associating these documents on a semantic basis, yielding a<br />
matching coefficient (Trichet and Radevski, 2006:2; Kessler et al, 2008:3; Kessler et<br />
al., 2009:3; Thiam, 2010:5).<br />
2.2. The Annotation and Association of Web documents, based on content<br />
2.2.1. General Framework<br />
The semantic annotation of web documents (Fig. 2) is essential for their storage, as<br />
well as the search and retrieval of the documents relevant to a particular need<br />
(Hernadez and Aussenac-Gilles, 2004:3; Abrouk, 2006:5, Thiam, 2010:5).<br />
By semantic annotation, we attach a „note” to semi-structured documents; in other<br />
words, meta-data which describes the contents both in a formally and explicitly. This<br />
note can be stored inside the document or in another document related to the content<br />
through an URI (Uniform Resource Identifier), being available to users or agent<br />
programs with the purpose of finding documents relevant for a certain requirement<br />
(Abrouk, 2006:7). The construction of the note is based on a thesaurus, or a field<br />
ontology (Guissé et al., 2009:4), both founded on a controlled vocabulary. A variety<br />
of programs which annotate semantically are already available (Aussenac-Gilles et<br />
al., 2008:3; Thiam, 2010:6). Mathet and Widlöcher (2009:2-3) introduce generic<br />
annotation instruments such as „Glozz”, a platform which processes linguistic objects<br />
(especially discursive).<br />
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Figure 2. Framework for semantic annotation and pairing<br />
A controlled vocabulary is defined as a collection of terms, defined by experts in a<br />
field (Hernandez:4, 2005). The term is a word (e.g., State budget), or a group of words<br />
(e.g., Public debt). The meaning of the words is not necessarily defined, and there is<br />
no logical connection between the terms. There are two broad categories of terms:<br />
• Descriptors, which explicitly represent a concept contained in a reference text;<br />
• Non-descriptors (synonyms), always linked to a descriptor<br />
The controlled vocabulary can be used to label content. A catalogue is a typical<br />
example of a controlled vocabulary. A thesaurus is a hierarchical dictionary of<br />
normalized terms, also called descriptors. A descriptor shows the context for term<br />
usage, and has a unique, non-ambiguous sense (multiple senses and synonyms are<br />
eliminated).<br />
• A lexicon contains descriptors (representing a concept of the field) and nondescriptors<br />
(linked to a descriptor, generally synonyms);<br />
• A collection of definitions, also known as notes;<br />
• A classifying structure (also known as a direct semantic medium), expressed<br />
as a structure of relations between a lexicon’s terms.<br />
In Figure 3 we present the classifying structure for Human Resources management,<br />
according to the on-line thesaurus MOTBIS (2011). For the description of the<br />
semantic medium we use several types of descriptors: generic (GD), specific (SD) ,<br />
equivalent (ED), and associative (AD).<br />
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Figure 3. Extract from Company Management Thesaurus<br />
ED<br />
Personnel management<br />
Competency management<br />
GD<br />
Organisation<br />
Management<br />
Hman<br />
Resources<br />
Management<br />
SD<br />
Carrer management<br />
Personnel recruitment<br />
Benefit system<br />
(Adapted from MOTBIS, 2010:on-line rendering)<br />
A field ontology corresponds to a generic, conceptual description of the entities<br />
belonging to a field, and is required for building applications based on knowledge. An<br />
ontology is composed of classes and entities. The classes are composed of entities<br />
which are similar. A machine-understandable class id equivalent to the “term”<br />
concept, as understood by a human. Thus, a field ontology consists of concepts<br />
specific to a particular domain. The field ontology is superior to a thesaurus from a<br />
conceptual and semantic point of view, but some of the hierarchies stem from the<br />
thesaurus. In practice, an ontology is a graph structure, where the nodes represent the<br />
concepts, and the links represent the relations (or roles) between concepts. The<br />
generic framework for semantic annotation is presented in Figure 4.<br />
A field ontology can be encoded using OWL (Web Ontology Language), which is<br />
based on XML. Several editing programs are available (TERMINAE, Differential<br />
Outology Editor, Ontology Editor, Protege2000, Ontolingua, etc.).<br />
The semantic structures (meta-data) obtained through this guided extraction (using a<br />
thesaurus or ontolgy) are associated to semi-structured documents (Desmontils and<br />
Jacquin, 2002:3). The documents are retrieved according to the link between the<br />
semantic structure and the source document.<br />
The semantic indexing of semi-structured documents is based on the meta-data<br />
extracted from the sources. The indexing facilitates semantic queries issued for a<br />
specific order. According to Guissé et al. (2009:2) the indexing is used to describe the<br />
sum of the semantic annotation, seen as a space between texts and a semantic<br />
structure. The authors differentiate three sub-structures for an index, which describe:<br />
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TA<br />
Work law<br />
Jobs<br />
Proffesion: administration<br />
and management
Figure 4. Semantic annotation using an ontology<br />
(Adapted from: Yahiaoui and Boufaida, 2006:8)<br />
• Which text fragments are documentary units (du), which can be used to<br />
establish an indexing link;<br />
• Which semantic units (su) can be associated to documentary units, and which<br />
relations these units have (a thesaurus or an ontology)<br />
• The association of documentary units to the semantic units(dui, sui), in other<br />
words, an indexing link.<br />
Generally, an indexing link can be represented as (li; dui; sui), where li is the list of<br />
properties linking dui to sui. The structure of the index is in accordance with the<br />
structure of the ontology for the field where the documents belong. The semantic<br />
indexing of semi-structured web documents can be realized:<br />
• Automatically, by determining in an automated way the most important terms<br />
of the document, for further analysis. This is how search engines process Web<br />
pages, by “crawling” the web and associating an index to pages;<br />
• Semi-automatically, using specific techniques for knowledge engineering and<br />
automated treatment of language documents (Desmontils and Jacquin,<br />
2002:2), having a human who aides and guides the process.<br />
The similarity between the concepts of an ontology, calculated from the taxonomical<br />
link « is-a », can form the basis of XML document indexing (Zargayouna and Salotti,<br />
2004:5).<br />
The semantic querying of databases containing semi-structured XML documents is<br />
based on using the ontologies and identifying the similarities (Bizer et al., 2005:7;<br />
Boucetta et al., 2005:4) in: ontologies, queries and semi-structured XML documents,<br />
and in semi-structured XML documents.<br />
2.2.2. Semantic annotation of CVs and Job Offers<br />
The first step in the annotation process is the creation of a HR ontology. Currently, the<br />
most widely used standard for publishing job offers and applications is HR-XML,<br />
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which is developed and maintained by the HR Consortium (which is an independent<br />
association dedicated to improving the automation of human-resources related dataexchanges<br />
through the use of XML.) Because the hiring process is not longer<br />
restricted to a national level, the process of semantic indexing must rely on the<br />
occupational classifications specific to a certain language/geographical zone. In the<br />
US, according to the Standard Occupational Classification, the workers are classified<br />
into 840 occupations (23 major groups and 97 minor groups). In the Euro area, given<br />
the differences in languages and education systems, there are ongoing efforts to level<br />
the playing field. The process is set up so that each country must have its input into<br />
the European Qualifications Framework. This framework will provide a common<br />
reference used to asses knowledge, skills and competences.<br />
According to Bizer et al. (2005:9), the HR ontology is split into several subontologies,<br />
as follows:<br />
Figure 5. Sub-ontologies within the HR Ontology<br />
(Source: Bizer et al., 2005:9)<br />
Each sub-ontology must be modeled taking into account the particularities of the<br />
national standards, and we must mention that the development of such standards<br />
requires considerable effort and expert skills. Also, the ontologies must be<br />
permanently updated, which is a difficult process when multiple national actors are<br />
involved, such as in the EU.<br />
2.2.3. Semantic Matching between CVs and Job Offers<br />
Semantic matching is the process in which the metadata extracted from a CV is<br />
compared to the metadata of a job offer, using a controlled vocabulary associated to<br />
the domain. The result of the matching process must be a Matching Index (MI).<br />
The MI indicates the quality of the match, by comparing several concept hierarchies<br />
(such as qualifications and competencies) expressed as a tree structure (Bizer et al.,<br />
2005:10).<br />
Besides the basic requirements, there are several criteria which should be satisfied by<br />
the matching process:<br />
• It must account for employer preferences regarding the weighting of<br />
competencies expressed in the job offer;<br />
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• It should verify the credentials presented in a CV, based on evidence such a<br />
electronically signed documents. The quality of the credentials should<br />
influence the weighting.<br />
CV<br />
Job<br />
Offer<br />
Figure 6. The process of annotation and matching<br />
HR Ontology<br />
Semantic Annotation<br />
CV Metadata<br />
Semantic Annotation JO Metadata<br />
HR Ontology<br />
The following example relies on ideas from Bizer et. al., (2005:11), and Boucetta et.<br />
al. (2005:9). To measure the similarity between two concepts we must calculate the<br />
distance (d) between the concepts, as represented by their position in the hierarchy.<br />
For concepts c1 and c2, their similarity is expressed as simc(c1, c2)=1-dc(c1, c2).<br />
However, the distance between concepts situated higher in the hierarchy (for example,<br />
medicine and IT) is greater than the distance between concepts lower in the hierarchy<br />
(databases and programming). To account for this, a milestone is attributed to each<br />
level, as follows:<br />
k is a factor larger than 1 which indicates the rate at which the value decreases<br />
throughout the hierarchy, and l(n) is the „depth” of the node in the hierarchy, as<br />
illustrated in Figure 7.<br />
In our example, we have set k = 2, and for the root, we consider l(n) =0. We note that<br />
the path between any two concepts on the graph passes through a common parent, and<br />
so, the distance between concepts will be measured by their milestones and the<br />
milestone of their closest parent:<br />
where ccp is the closest common parent of c1 and c2. This model supports the<br />
assumption that the distance between close „brothers” (like „C++” and „Java”) is<br />
smaller than the distance between „cousins” (such as „Invoicing” and „Oracle<br />
Databases”).<br />
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CV-JO<br />
Matching<br />
Matching<br />
Index
1/2<br />
1/4<br />
1/8<br />
1/16<br />
Figure 7. Ontology component with associated milestone values<br />
Treasury<br />
(Adapted from Bizer et. al., 2005:11)<br />
To illustrate, we wish to calculate the distance between the concepts of „MySQL” and<br />
„C++”. The closest common parent is „IT”, and thus the calculation is:<br />
dc(MySQL, C++) = dc(MySQL, IT) + dc(C++, IT)<br />
= (1/4-1/16) + (1/4-1/16) = 0,25<br />
Thus, the similarity between the two concepts is:<br />
simc(MySQL, C++) = 1 – 0,25 = 0,75<br />
The distance between two remote concepts would be:<br />
dc(Invoicing, OracleDatabase) = (1/2-1/16) + (1/2-1/16) = 0,875<br />
and their similarity:<br />
Finance<br />
simc(Invoicing, OracleDatabase) = 1-0,875 = 0,125<br />
Bizer et. (2005:11) al propose a scheme for integrating competence levels (cl)<br />
required by a job offer using the following formula:<br />
Where 0
Each skill from the job offer ( ) is compared with each skill in the cv ( ), taking<br />
in account both concept and required competence similarity. The best match is<br />
multiplied by the weight factor; the sum represents the final matching index.<br />
2.2.4. Support system for semantic annotation and matching of CVs<br />
and job offers<br />
In the current context of an increasingly virtual job market, a multitude of instruments<br />
support systems based on ontologies are developed, with the aim of enhancing the<br />
data-flows. In Figure 8 we present the general architecture of a an annotation and<br />
matching (pairing) system for e-recruitment, relying on the human resources ontology<br />
(HR_Ontology).<br />
Figure 8. The architecture of an e-recruitment system<br />
(Source: adaptation from Yahiaoui et al., 2 006:3 and Boucetta et al., 2008:3)<br />
The actors of such a system (job seekers, employers, recruiters) are assisted in erecruitment<br />
processes for the following types of activities:<br />
• Semi-structured documents are uploaded on the web (CVs, job offers) in a<br />
XML data repository<br />
• The documents undergo the process of semantic annotation using the HR<br />
ontology, the result of this process is meta-data which are stored together with<br />
the documents<br />
• A user launches a query to determine the matches found on the server, the<br />
query is formalized and forwarded to the association component, which relies<br />
on meta-data and on the ontology, using an inference engine. The result<br />
expresses the association (match) index, and the elements specific to the<br />
document (URI, matching index according to: personal qualifications,<br />
requirements, competencies). The result is presented as a “quadrulpe”,<br />
assisting the user in making a decision.<br />
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The human resource ontology is constructed for the semantic annotation of CVs and<br />
job offers. Its concepts and relations between concepts are inspired from the common<br />
parts of the most significant sections of CVs and job offers (personal qualifications,<br />
requirements, diplomas, personal experience and competency).<br />
3. PROPOSAL FOR AN E-RECRUITMENT ONTOLOGY,<br />
WITH AN EXAMPLE OF AN ONTOLOGY IN THE DATABASE AREA<br />
3.1. Modeling the common reference for e-recruitment in the IT area<br />
The IT field is of special interest to large corporations, from a human resource point<br />
of view. The optimization of the e-recruitment processes involves, firstly, a common<br />
reference (ontology) able to link the employer requirements and job seekers’ offers,<br />
namely, what the job seekers obtained by studies and professional experience. In our<br />
research we opted for three types of ontologies on which the recruitment process<br />
should be based (Figure 9):<br />
• Job seekers – based data extracted from CVs<br />
• Employers – based on requirements related to the job offers<br />
• The national accreditation of qualifications and occupational standards – based<br />
on a national occupational classification.<br />
Figure 9. Generic framework for the definition of IT ontologies<br />
The competencies represent the shared part for the three types of ontologies, and at<br />
the same time the fundamental component for the development of a support system in<br />
the e-recruitment processes.<br />
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3.2. IT competency ontologies within job offers<br />
For the IT field, regarding the job seekers, we define a generic ontology named<br />
Competencies. Within this competency, we find the IT Competency sub-ontology,<br />
present in the majority of the CVs and job requirements issued by employers. This<br />
sub-ontology is composed from knowledge and technical skills found in the IT field,<br />
and implemented in the corporate IT systems.<br />
According to the specific requirements found in job offers, some IT Competency subontologies<br />
can be considered as complementary to main (specific) ontologies, related<br />
to well-defined activity areas (accounting, analysis, marketing etc), in connection to<br />
the specificity of the job offers. However, for the IT field, the sub-ontologies<br />
stemming from “IT Competencies” can be considered of special importance.<br />
For the field of IT, three sub-ontologies are of interest, and each of them can be<br />
further organized into sub-ontologies:<br />
• Theory and Technical Foundations -- these define IT specific competencies,<br />
both from a theoretical and practical point of view. Some examples are:<br />
technical and functional architecture of IT systems, the design and<br />
development of IT systems, database management, IT governance, data and<br />
application security, communication, networking etc.<br />
• Organizational competencies – these define the elements of organizational<br />
culture, adjacent to the IT field; these are required for the implementation,<br />
integration and maintenance of IT systems in the corporate environment. Some<br />
of these competencies gaining traction in the IT field are: audit knowledge,<br />
accounting, activity budgeting, human resource and occupational standards<br />
management, quality management, legal knowledge, etc.<br />
• Techincal skills – referring to one’s capacity to use technologies and products,<br />
and behavioral skills, referring to action and anticipation, pedagogy, problemsolving,<br />
professional efficiency (adaptability, integrity, pragmatism, rigor),<br />
management skills (leadership, management, organization), and relational<br />
(good listener, communication), etc.<br />
3.3. Ontologies based on employer requirements within job offers<br />
The employers specify, for job openings in the IT area, requirements focused mainly<br />
on competencies, in correlation with national and European occupational standards. In<br />
the IT domain, the job offers fall within the following sections:<br />
• IT systems management<br />
• IT project management<br />
• The design, development, implementation and maintenance of an IT system;<br />
• The study, design, implementation, integration and operation of IT<br />
infrastructure<br />
• Technical support offered to users<br />
• Control, audit, and IT security<br />
• Operational management—for IT employers (budget, decision)<br />
Each sub-ontology can be developed on other sub-ontologies (or subjects), which, at<br />
this level, are essentially job offers (which must be issued in accordance with the<br />
national occupational standard). In turn, these offers are associated to sub-ontologies<br />
described in the competency sections relating to applicants’ CVs.<br />
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For example, for the sub-ontology “The design, development, implementation and<br />
maintenance of an IT system”, which actually represents the lifecycle of software<br />
products, we can define the next positions:<br />
• Specialist for currently-implemented IT systems;<br />
• IT systems designer;<br />
• IT systems tester;<br />
• Application integrator;<br />
• Product customization<br />
3.4. Ontologies based on occupational standards<br />
The ontologies based on occupational standards are issued by national entities which<br />
define and implement occupational standards. Periodically, these entities publish a<br />
classification which contains professional competencies required by employers to<br />
recruit qualified work force.<br />
This classification is the result of the experience of human resources directors from<br />
the IT field, and aims to be a formal instrument for a common description of<br />
employment requirements in professions related to organizations within the field of<br />
informational systems. Essentially, this occupational standard classification offers a<br />
clear image of the evolution of corporate IT systems. The formalization of the<br />
professions and occupational standards related to corporate IT systems is a procedure<br />
which is frequently updated due to the constantly changing nature of the IT field,<br />
which brings along structural modifications in the requirements for IT jobs.<br />
The common reference for occupational standards in the IT recruitment field has<br />
undergone several mutations recently, due to the orientation towards “IT<br />
competencies”, complementary to occupational standards based on jobs. This new<br />
orientation brings the possibility if an international reference for IT competencies (e-<br />
Competence Framework) which, is implemented in Europe by CNN/ISSS (European<br />
Committee for Standardisation / Information Society Standardisation System).<br />
The structuring of competencies and occupational standards in the IT field is, in<br />
essence, a technical view of an information system. The occupational standards<br />
specific to IT will undergo structural changes, moving away from an emphasis on<br />
technical aspects related to the IT jobs, towards a global view, in which corporate IT<br />
systems are directly linked to the business and its strategy, and that IT systems are not<br />
only technical, but their role is strongly connected with enterprise functions.<br />
In Romania, eighteen occupational standards are defined in the field of IT and<br />
telecoms (CNFPA, 2010):<br />
1. Application administrator<br />
2. Computer and network operator<br />
3. Data input technician<br />
4. Text and image manipulation technician<br />
5. Operator in the field of computer-assisted design<br />
6. Specialist in the field of computer-assisted design<br />
7. Graphic designer (DTP designer);<br />
8. Web designer (high-school level studies);<br />
9. Systems software engineer<br />
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10. Computer network administrator<br />
11. Information systems programmer<br />
12. Auxiliary programmer<br />
13. Information system consultant<br />
14. IT department directors<br />
15. Analyst<br />
16. Information systems architect<br />
17. Database administrator<br />
18. Specialist in IT security and processes<br />
These occupational standards, which in light of the semantic web are actually<br />
ontologies, are not currently associated to domains specific to IT.<br />
3.5. Formalizing an unitary ontology for e-recruitment in the IT field<br />
For the design of an e-recruitment portal, all the components based on<br />
competencies—offered by the job seekers and required by employers, and included in<br />
the Romanian occupational standards, must be included in an ontology—even if the<br />
components are not hierarchical. Thus, in the current paper, we propose to develop the<br />
sub-ontology related to IT scientific/technical competencies.<br />
This IT scientific/technical competencies ontology can be hierarchically organized in<br />
more sub-ontologies which actually define information technologies, useful both for<br />
research and in the corporate environment. In building such a hierarchy we must<br />
cover all IT domains according to the related disciplines, from an applied science<br />
point of view. The correctness of such an undertaking depends on the association<br />
between the know-how of the informational field and the ontologies found in CVs and<br />
required by employers in the recruitment process.<br />
We briefly introduce some semantic aggregations related to the IT field:<br />
� E-learning;<br />
� Intelligent systems;<br />
� Databases;<br />
� Management information systems;<br />
� IT&C;<br />
� Web Based Communities;<br />
� Interfaces and Human Computer Interaction;<br />
� Data Mining;<br />
� Networks; e-technologies;<br />
� Computer Graphics;<br />
� Collaborative Technologies;<br />
� Informatics, etc.<br />
Each sub-ontology can be placed in a hierarchy according to the “Theory<br />
Foundations” and “Technical aspects” criteria. We present some examples of sub-subonotologies,<br />
according to the aforementioned criteria, for the field Informatics:<br />
1) Theory Foundations: algorithms; architectures; Artificial intelligence;<br />
Compilers; Complex Systems; Data modeling; Expert Systems; Interfaces;<br />
Numerical computation; Object Orientation; Ontologies; Programming<br />
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Languages; Programming Techniques; Scientific Computing; Service Oriented<br />
Architecture (SOA)<br />
2) Technical aspects: Adaptive Systems; Computer Aided Design; Computing<br />
Practices; Database Management; Embedded Systems; Interoperability;<br />
Networking; Simulation; Software Development; Software Engineering;<br />
System Integration; UML.<br />
The sub-ontologies are quantified by attributed which are finally used to form scores,<br />
by successive aggregations. These are generally attributed by the employer, according<br />
to the importance defined by the requirements if the job offer. At an atomic level, the<br />
ontologies contain themes, or subjects. This themes describe the last level of subontology<br />
in the hierarchy.<br />
3.6 Sub-ontologies applied to the database field<br />
For the IT field we propose a number of significant semantic aggregations of a subontology<br />
which describes the necessary competencies for a recruitment candidate,<br />
required by the employer for a job in the field of databases (Figure 10). According to<br />
this target, the database sub-ontology was divided in more sub-ontologies, according<br />
to “Theory Foundations” and “Technical aspects”. Thus, two new sub-ontologies<br />
emerged, namely: “Data Modeling”, quantified with a score of 30%, and “Database<br />
Management”, quantified with 45%.<br />
Figure 10. Ontology for the database field<br />
While the majority of the sub-ontologies belong almost exclusively to the Database<br />
sub-ontology, more precisely, to “Theory Foundations” and “Technical aspects”,<br />
some of them belong to the fundamental domain of database utilization (“XML and<br />
databases” and “Designing a Business Intelligence Solutions”).<br />
In parallel with the definition of sub-ontologies directly referring to fundamental and<br />
technical aspects related to databases, according to employer requirements, more<br />
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items were required, such as ”Working with operating systems”, “Programming<br />
concepts”, “Understanding of server management”. These sub-ontologies belong to<br />
other ontologies, related to distinct areas within the IT field, such as: operating<br />
systems architecture, programming languages and physical server architecture.<br />
We present an example of ontologies for the database domain (100%):<br />
• Working with operating systems (5%)<br />
• Programming concepts (10%)<br />
• Understanding of server management concepts such as roles and tracing (10%)<br />
• XML and databases (5%)<br />
• Describing XML functionality<br />
• Shredding XML data<br />
• Working with XML data types<br />
• Applying data integrity to XML data<br />
• Describing best practices for working with XML data<br />
• DATA Modeling (30%)<br />
� Core relational database concepts (10%)<br />
� Designing databases at both the conceptual and logical levels (10%)<br />
� Data Integrity Using Constraints (5%)<br />
• Describing data integrity<br />
• Enforcing domain integrity<br />
• Enforcing entity integrity<br />
• Enforcing referential integrity<br />
• DATABASE MANAGEMENT (45%)<br />
� Implementing DataBases (15%)<br />
• Work with the data types<br />
• Design and implement tables and views<br />
• Manage the concept of an index.<br />
• Design and implement stored procedures.<br />
• Managing and Monitoring Transactions<br />
• Implement table types, table valued parameters.<br />
• Describe transactions.<br />
� Querying Relational Data (15%)<br />
• Retrieve data.<br />
• Explain and perform single table queries.<br />
• Perform joins between tables.<br />
• Summarize data and aggregate functions.<br />
• Modify data.<br />
• Write a sub-query.<br />
• Use Stored Procedures.<br />
� Database administration (10%)<br />
• Administer server and surface security, access, and network configuration;<br />
Import, export, transform, and replicate data<br />
• Manipulate schemas, tables, indexes, and views<br />
• Automate maintenance and implement policy-based management<br />
• Monitor server activity and tune performance<br />
• Manage log shipping and database mirroring<br />
• Perform backups and recovery.<br />
� Designing a Business Intelligence Solutions (5%)<br />
• Design a Business Intelligence (BI) architecture in client-server databases.<br />
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• Design a strategy for implementing the extract, transform, load (ETL).<br />
• Design a strategy for managing packages.<br />
• Design an online analytical processing (OLAP) solution architecture.<br />
• Design queries for an OLAP solution.<br />
• Design and develop a Reporting solution architecture.<br />
• Design data mining solutions.<br />
CONCLUSIONS<br />
The topic of semi-structured web document annotation, with the aim of finding and<br />
associating the relevant documents, is of interest to academia, but also to the job<br />
market. Our paper starts with a literature review, then focuses on the semantic<br />
modeling of e-recruitment documents, then proposes an ontology for the database<br />
field, and concludes with further research topics. The proposed ontology is inspired<br />
from the common parts, which we considered significant, of CVs and job offers in the<br />
field of databases.<br />
The papers also brings clarifications regarding the essential concepts for the semantic<br />
modeling of e-recruitment systems: field ontology, semantic annotation, semantic<br />
indexing, and semantic association of documents. For the continuity of the research,<br />
the authors envision three objectives. The first objective is to design an e-recruitment<br />
system, integrating the proposed models. The second objective is the development of<br />
a support system for semantic annotation of semi-structured documents related to erecruitment<br />
processes. The third objective is to add new functionality to e-recruitment<br />
systems, increasing the relevance of meta-data extracted from the CVs and job offers,<br />
by offering advice to job seekers based on their profiles, and helping employers<br />
formulate better job offers.<br />
REFERENCES<br />
Abrouk., L. (2006) “Annotation de documents par le contexte de citation bas´ee sur une<br />
ontologie”, Thesis, Universite Montpelier II, available on-line at http://tel.archivesouvertes.fr/docs/00/14/25/68/PDF/these.pdf<br />
Aussenac-Gilles N., Despres S. and Szulman S. (2008) “The terminae method and platform<br />
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Gap between Text and Knowledge: Selected Contributions to Ontology learning from<br />
Text, IOS Press<br />
Bizer, C., Heese, R., Mochol, M., Oldakowski, R., Tolksdorf, R., and Eckstein, R. (2005)<br />
“The Impact of Semantic Web Technologies on Job Recruitment Processes”,<br />
WIRTSCHAFTSINFORMATIK, Part 15, 1367-1381<br />
Boucetta, Z., Boufaida, Z., Yahiaoui, L. (2008) “Appariement sémantique des documents à<br />
base d'ontologie pour le E-recrutement”, available on-line at<br />
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4967.pdf&usg=AFQjCNEAYLZs5G9lcV_sFckLxS5ZcH5P9Q<br />
Desmontils, E., Jacquin, C., Morin, E. (2002) “Indexation sémantique de documents sur le<br />
Web: application aux ressources humaines“, available on-line at<br />
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Fondeur, Y. (2006) “Internet, recrutement et recherche d’emploi : une introduction“, Revue<br />
de l’IRES - numéro spécial : Internet, recrutement et recherche d’emploi, 3(52), 3–10.<br />
Guissé, A., Lévy, F., Nazarenko, A., Szulman, S., “Annotation sémantique pour l’indexation<br />
de règles métiers“, TIA 2009, available on-line att http://www.irit.fr/<br />
TIA09/thekey/articles/guisse-levy-nazarenko-szulman.pdf<br />
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Hernandez, N. (2005), “Ontologies de domaine pour la modélisation du contexte en recherche<br />
d’inoformation“, Doctoral Thesis, Université de Toulouse<br />
Hernandez, N., Aussenac-Giles, N. (2004.) “OntoExplo : Ontologies pour l’aide à une activité<br />
de veille ou d’exploration d’un domaine“, Actes de la VIème Journées de l'innovation,<br />
Kessler R., Bechet N., Roche M., El-Beze M. and TORRES-MORENO J. M. (2008)<br />
“Automatic profiling system for ranking candidates answers in human resources“,<br />
OTM ’08 in Monterrey, Mexico, p. 625–634.<br />
Kessler, R. (2010) “Traitement automatique d’informations appliqué aux ressources<br />
humaines“, Thesis , Academie D’Aix Marseilles<br />
Kessler, R., Béchet, N., Torres-Moreno, J.M., Roche, M., El-Bèze M. (2009) “Profilage de<br />
candidatures assisté par Relevance Feedback“, TALN 2009, Senlis, 24–26 juin 2009,<br />
available on-line at http://academic.research.microsoft.com/Publication/11024713/<br />
profilage-de-candidatures-assist%C3%A9-par-relevance-feedback<br />
Mathet, Y, and A. Widlöcher (2009), “La plate-forme d'annotation Glozz: environnement<br />
d’annotation et d’exploration de corpus”, Actes de TALN 2009, Senlis, France<br />
Mellet, K. (2006) “Sésame, ouvre-toi! Analyse des données d’usage d’un moteur de recherche<br />
d’annonces d’offres d’emploi: www.keljob.com“, Revue de l’IRES- numéro spécial:<br />
Internet, recrutement et recherche d’emploi 3(52), 71–100<br />
MOTBIS (2011), available on-line at: http://www.motbis.cndp.fr/index.php/indexergeneralites/24-regles-dindexation.html<br />
Popescu, M., and Popescu, E., (2010) “A Human Resource Ontology for Recruitment”,<br />
Faculty of economic sciences, available on-line at http://www.fse.tibiscus.ro/<br />
anale/Lucrari2010/155.%20Craioveanu%20Georgiana.pdf<br />
Rafter, R., Smyth, B. (2000) “Passive Profiling from Server Logs in an Online Recruitment<br />
Environment”, <strong>Proceedings</strong> of the IJCAI Workshop on Intelligent Techniques for Web<br />
Personalisation 2001, available on-line at http://maya.cs.depaul.edu/~mobasher/<br />
itwp01/papers/rafter.pdf<br />
Thiam, M. (2010) “Annotation Semantique de Documents Semi-structures pour la Recherche<br />
d’Information“, These en co-tutelle, available on-line at http://tel.archivesouvertes.fr/docs/00/54/29/32/PDF/These_MT8dec2010.pdf<br />
Trichet F., Radevski V. (2006) “Competency-based Systems dedicated to e-Recruitment“,<br />
<strong>Proceedings</strong> of the 4th International Conference on Computer Science and Information<br />
Technology., pp 185-197, Volume3, ISBN: 9957-8592-0-X, Amman (CSIT'2006)<br />
Yahiaoui, L., Boufaïda, Z., Prié, Y. (2006) “Automatisation du e-recrutement dans le cadre du<br />
web sémantique“, Proceeding of the 17th Journées Francophones d’Ingénierie des<br />
Connaissances (IC 2006), 28-30 June 2006, France<br />
Yahiaoui, L., Boufaïda, Z., (2006) “Annotation semantique de documents – Application au erecrutement“,<br />
available on-line at http://bu.umc.edu.dz/theses/informatique/YAH4491.pdf<br />
Zargayouna, H., and Salotti, S. (2004) “Mesure de similarité dans une ontologie pour<br />
l'indexation sémantique de documents XML”, available on-line at http://hal.archivesouvertes.fr/docs/00/38/05/73/PDF/IC2004_Zargayouna.pdf<br />
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DECISIONS DRIVE SUCCESS<br />
Dragos STOICA 1 & Pavel NASTASE<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
Organizations are forced to be overly dependent on past experience due to the lack of usable<br />
information, or the inability to quickly and effectively analyse unstructured data. Significant<br />
amounts of data are ignored, mismanaged or underutilized - one in three business leaders<br />
report making critical decisions with incomplete or untrustworthy information (Merv Adrian,<br />
2010). This is no longer acceptable. With the growing velocity, volume and variety of complex<br />
data, organizations will have to rethink and reshape the way they work. The data has to be<br />
changed into information that yields fast and conclude answers, thus allowing the decision<br />
factors to make choices that lead to the improving of the performance inside the company.<br />
Due to a lack of timely and accurate information, project and process management within the<br />
software and systems development and delivery lifecycle often rely more on guesswork than<br />
good insights. At the same time, marketplace and budgetary pressures force teams to<br />
continually make faster progress with fewer resources. To optimize business results and<br />
competitiveness, organizations need to give decision makers and teams the ability to make<br />
informed decisions based on real-time information. This paper explores how an inability to<br />
quickly access and analyze data within the development lifecycle limits the effectiveness of<br />
project teams and explains how organizations can create transparency across the processes<br />
that support effective software delivery. Also the paper shows the benefits of capturing the<br />
right data and delivering it to the right people at the right time. Business Analytics with<br />
Business Intelligence are the key factors which contributes to making successful business<br />
decisions and supporting.<br />
KEYWORDS: Decision making, Business Analytics, Business Intelligence,<br />
DECISION MAKING - INTRODUCTION<br />
Organizations operating in today’s global economy are faced with unprecedented<br />
competitive and regulatory pressures and a heightened level of uncertainty. Driven by<br />
geopolitical trends and financial scandals, national and international regulatory<br />
agencies have performed rules with far-reaching impact on the daily operations of<br />
organizations in all industries. By most accounts, the uncertainty is more profound<br />
than in the past decades, and is likely elevated by the amount of data and information<br />
available to decision makers nowadays. Hence, there is a trend towards continuously<br />
shrinking decision cycles where improved, faster, more accurate, insightful and<br />
flexible decision making commands a premium and serves as basis for competitive<br />
advantage. However, significant shortcomings persist in the ability of organizations to<br />
address the decision-making needs of its employees.<br />
1 Correspondence address: Dragoş STOICA, IBM Romania, Ph. D Student at Bucharest Academy of<br />
Economic Studies, Romania; email: dragoshstoica@yahoo.com<br />
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The current limitations in the quality of decision making and information delivery<br />
range from an inability of organizations to capture the right data and deliver it to the<br />
right people at the right time, to poor data quality, system complexity and the<br />
disconnect of business analytics from operational systems. Those shortcomings are<br />
due to the lack of appropriate investment in business analytics solutions and the<br />
differences between the information delivery and decision support functionality of<br />
most of those solutions.<br />
Organizations need to know what is happening now, what is likely to happen next and<br />
what actions should be taken to get the optimal results. The lack of control over<br />
information is likely felt by users and decision makers in their daily jobs. Managers<br />
may lack confidence in their information, may frequently use the wrong information<br />
and may even miss information they should be using. The differences between timely,<br />
accurate information and the people who need it can broadly affect the quality of<br />
decisions and business outcomes.<br />
Most organizations claim that their data is an asset; many have built data warehouses<br />
to collect and store data. However, in some cases, the more suitable metaphor should<br />
be data landfills. Many organizations have become efficient at capturing data, but<br />
much less capable of organizing, analysing, extracting and delivering it from those<br />
data stores to enhance the overall decision-making quality. If data is indeed an asset,<br />
market research suggests that a large amount of it remains inactive and is not<br />
leveraged to its full potential (IBM White Paper, 2009).<br />
Creating intelligence by collecting real insight from this data is what continues to<br />
elude organizations. Despite years of discussions about scorecards and metrics,<br />
experience and perception are often the guide lines for making important, even critical<br />
decisions, although current research reveals a clear link between business<br />
performance and the use of business analytics (Gros Mary E., Goul Michael &<br />
Demirkan Haluk, 2011). Hence, the question is what exactly is business analytics and<br />
how can it help an organization to improve its business process.<br />
Business analytics is, simply, the application of analytical techniques to resolve<br />
business issues. It provides organizations with a framework for decision making,<br />
helping organizations solve complex business problems, improve performance, drive<br />
sustainable growth through innovation, anticipate and plan for change while managing<br />
and balancing risks (Trkman Peter, McCormack Kevin, Valadares de Oliveira Marcos<br />
Paulo & Bronzo Ladeira Marcelo, 2010).<br />
1. DECISION-CENTRIC BUSINESS INTELLIGENCE<br />
Effective decision making requires a business analytics framework that incorporates<br />
the people, processes, technology and the culture of an organization. This common<br />
framework provides flexibility across the entire range of analytical decision-making<br />
types from highly managed operational analytics to discovery-based analytics such as<br />
credit fraud scenarios or setting dynamic credit limits.<br />
Assigning meaning to data, deriving knowledge from data, building the appropriate<br />
models from and about the data, and deriving optimal management decision support<br />
are the key activities to support organizations in business processes from all fields of<br />
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the process chain, technical design, control, production, quality control, logistics, and<br />
strategic management. This set of key activities is summarized under the term<br />
business intelligence.<br />
The purpose of Business Intelligence is to take a company’s historical and operational<br />
data, process it with analytics software and present the data in an easy-to-read and<br />
familiar format to enterprise users.<br />
In today’s highly competitive and challenging environment, companies need to<br />
continually assess and redirect their actions in order to stay on top of the markets they<br />
choose to serve. In order to make the needed changes, many companies are asking<br />
questions such as:<br />
• Which of our customers are most profitable to do business with?<br />
• Which products and services can be cross-sold most effectively?<br />
• Which sales channels are most effective for which products?<br />
• How can we boost marketing campaign results?<br />
• How can we improve customer loyalty?<br />
• What is the real cost of retaining a satisfied customer?<br />
• How can we improve the overall quality of our customers’ experience with us?<br />
Business Intelligence systems can help provide the answers to these types of<br />
questions. The general concept of business intelligence approach is outlined in Figure<br />
1. The methodology focuses completely on the business relevant aspects, i.e. on the<br />
business input and the business output. Business input means that the problem is<br />
analysed and solved, together with the corresponding data, while business output is<br />
the problem knowledge or problem solution generated by the approach, which can be<br />
turned into business operations to improve desired aspects of the business. The critical<br />
tasks on the approach from problem and data to an optimal business solution are the<br />
data mining/data analysis and optimization tasks.<br />
Figure 1. Business Intelligence<br />
(Source: Back Thomas (2002), Adaptive business intelligence based on evolution strategies:<br />
some application examples of self-adaptive software, Information Sciences 148 113–121)<br />
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The assurance of Business Intelligence is in specific and timely knowledge about<br />
customers, products and markets. This knowledge can help boost profits, reduce costs<br />
and support better, more effective management. Based on comprehensive, detailed<br />
and relevant information, this knowledge is fundamental to achieving and sustaining a<br />
competitive advantage. However, organizations implementing a Business Intelligence<br />
solution may face several challenges:<br />
• Integrating complex data from heterogeneous hardware platforms and<br />
software environments;<br />
• Managing distributed systems that have no single point of control and timesensitive<br />
operations;<br />
• Improving data access while reducing expenses;<br />
• Performing frequent updates across already overtaxed networks with rapidly<br />
increasing traffic;<br />
• Backing up, recovering and archiving data within diminishing availability<br />
windows;<br />
• Incorporating efficiencies of new technologies without requiring massive<br />
downtime, costs or retraining;<br />
• Providing scalable servers to run multi-terabyte applications;<br />
• Providing storage that protects data and is scalable, open and manageable.<br />
Business Intelligence requires information on demand achieved by combining<br />
multidimensional data analysis and data mining with advanced statistical and<br />
analytical functions in a real-time, integrated environment. Data collection methods,<br />
multimedia files and rapid-access tools that grow and adjust as needed create this<br />
dynamic system. Constant vigilance, including tuning and monitoring of these<br />
systems, helps maintain a sharp focus for overall enterprise effectiveness.<br />
The essential criteria for building a Business Intelligence system include:<br />
• What critical information enables an enterprise to deliver competitive value;<br />
• Who needs access to information and in what form;<br />
• What criteria and processes will be used to manage and protect information<br />
access;<br />
• Can the organization financially afford to implement these processes;<br />
• Can the organization build and manage the skills and systems needed to<br />
collect, validate and synthesize the data.<br />
Furthermore, to be able to understand the complexity of the business intelligence<br />
system I will present four tiers which will be applied on a case study. These<br />
considerations aim to help provide a preliminary framework for implementing a<br />
Business Intelligence system. The stages are used to help define the scope of Business<br />
Intelligence infrastructure required by an organization.<br />
1.2 Tier I: Identifying mission-critical information and enterprise success<br />
factors<br />
The main question is what data is vital to the health of the enterprise and is strategic<br />
and tactical to its business. Operational indicators could include data such as load<br />
factors for transportation companies, aging backlog at a manufacturing plant, welldrilling<br />
count for oil exploration companies and on-shelf inventory for retailers. These<br />
operational details can affect strategic shifts such as realignment of profit goals;<br />
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investment in skills or technology; consideration of mergers, acquisitions or<br />
partnerships; repositioning of the company; or targeting a key segment. Such<br />
enterprise success factors constitute critical information.<br />
Business Intelligence provides access to information required to keep the enterprise<br />
vibrant and competitive. A clear understanding of strategic and tactical information is<br />
the cornerstone of a Business Intelligence system. Anything less may not trigger alerts<br />
when potentially fatal trouble-spots occur. A thorough analysis and validation process<br />
can help determine the information requirements for the overall design of a Business<br />
Intelligence system.<br />
Moreover, for a better understanding of the first stage an example is needed. We will<br />
take the case of a company that sells IT equipment and has communication<br />
deficiencies between departments. If there is a lack of information between the<br />
financial department and sales department this can result in delays in payments (both<br />
accounts receivable and accounts payable), thus outstanding invoices, overcharging,<br />
penalties, and unsatisfied customers that will drive to poor market share. However,<br />
every business aims to improve its overall performance and increase profits. Success<br />
factors derive from efficient workflow and transparent information within the<br />
company that will lead to faster process execution, satisfied and loyal customers, and<br />
increasing profit.<br />
Figure 1. Typical Process Problems without Business Intelligence<br />
1.3 Tier II: Determining who needs access in the system, the essential criteria<br />
and processes<br />
The goals of a Business Intelligence system are to help maintain a competitive edge,<br />
allowing to respond in a timely manner to competitive opportunities or threats.<br />
Business Intelligence system should help monitor the vital statistics of the enterprise<br />
in a real-time environment and to mobilize team response as appropriate. Determining<br />
who needs access, what criteria will govern that access and what processes will be<br />
used to manage access will influence networking, processing and analysis costs.<br />
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In the case study mentioned at tier one it is essential to determine who needs access<br />
and to what information. If we refer to a company that sells IT equipment, the<br />
information transparency between the sales and finance departments is essential. For<br />
example when selling a laptop the invoice is done by a sales representative and should<br />
be available in real time on the system for the finance department. Also the sales<br />
department should be able to see the stock on the system and request additional items<br />
if necessary. On the other hand, the finance department must inform the sales<br />
representative if there are any issues with the customers in terms of payments,<br />
supplementary costs or VAT/ import regulation changes. The system consolidates all<br />
the information inserted by the sales representatives at the end of the week in order to<br />
create a report for the finance department. The layer sits between people and systems,<br />
and manages the process across those participants, thus prioritizes the work, but also<br />
gives visibility and control.<br />
1.4 Tier III: Calculating the costs<br />
Figure 2. Layer for Control and Visibility<br />
Several factors affect the cost of implementing a Business Intelligence system, such as<br />
the amount of information gathered and analysed and the frequency needed to refresh<br />
the information. In addition, analysis can become expensive, and the time spent<br />
modelling can be length. Cost decisions will influence the system design - for<br />
example the choice of servers, storage and software.<br />
After determining the options and the cost of installing or updating an enterprise<br />
Business Intelligence system, it is needed to decide what kind of system to build. Can<br />
the current system deliver sufficient results by upgrading some of the components?<br />
Will partial upgrades be feasible in the future? Is the best in the industry components<br />
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desired? What is the cost of installing new systems versus performing upgrades of the<br />
current system? Does the return on investment (ROI) incorporate post-installation or<br />
post-migration maintenance and upgrade costs?<br />
In the case of the company stated above, implementing the system involves high costs<br />
at start-up, but it pays off rapidly due to less employees, the reduce maintenance costs,<br />
no additional expenses, prompt reply to customers and better services provided. All<br />
of these are key factors that drive a success business.<br />
1.5 Tier IV: Building the necessary system which comprises the essential skills<br />
Tier one, two, and three formed the basis of the Business Intelligence system. Along<br />
with tier four the system is complete, but due to fast evolution of technology and high<br />
competition the system will be improved on periodical bases. The system is starting<br />
from a human interface, input data, and based on defined business rules is facilitates<br />
the workflow and provides a well-organized, competent, resourceful and professional<br />
business data management.<br />
A system which comprises these essential skills is not sufficient as the management<br />
team need metrics and analytics that drive decision optimization in order to have a<br />
better view and understanding of the business. Looking at tier 2, the case study shows<br />
that the system runs a sales report at the end of each week and it can also run other<br />
reports at different time period as it was designed according to every company’s<br />
needs. For example the sale department manager needs to extract information<br />
regarding the number of contracts sighed by a seller into a certain period of time, to<br />
evaluate the performance of that seller or to see whether these customers have<br />
complied with the contract terms, the manager runs the Business Intelligence System<br />
which generates a complete report. This system is set-up according to any business/<br />
department requirements and can be changed/ modified as needed, anytime after it<br />
was created by the user.<br />
Figure 3. The essential system capabilities<br />
2. ANALYTICS DRIVE DECISION OPTIMIZATION<br />
Improve decision-making, productivity and efficiency through an environment where<br />
relevant, actionable, accurate and timely information is provided to monitor and<br />
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improve performance. The ability to optimize performance within a company<br />
typically depends on a decision-makers' ability to measure and understand business<br />
analytics, then act upon the information at the right time. Using data to derive insight<br />
requires more than operational reporting and financial roll-ups. Data should be<br />
transformed into insight and rapidly delivered at the point of need, on demand in the<br />
right time, in formats that your enterprise can use to act in ways that are beneficial to<br />
the business and optimize performance.<br />
Business analytics enable the fundamental shift to a different way of making<br />
intelligent decisions: evidence-based. This demands real data, derived from every<br />
possible source, governed and secured, with assured quality and known provenance,<br />
with a clear organization consensus about its meaning. The information agenda helps<br />
to ensure this is in place. It allows repeating that data is what matters the most,<br />
therefore nothing happens without it.<br />
The information platform is the informational core system, designed to gather data<br />
wherever it is needed and filter it through the organization’s strategy-driven<br />
evaluative processes to ensure the facts needed are always available. In reality it is<br />
more than that, the platform provides the processing power to serve up real-time<br />
streaming data, combine it with historical data as needed, and analyse it in everchanging,<br />
increasingly sophisticated ways. There was a time when reporting was the<br />
state of the art – just being able to deliver an organised presentation of what happened<br />
in the business yesterday, last month, or last quarter was a great leap forward. Some<br />
organizations still focus on this simple delivery of history in new visualizations with<br />
portal technology and mobile devices as if these were sufficient, but it is not.<br />
In the latter years of the 20 th century, there was a great focus on “what-if”, simple<br />
scenario building that substituted possible values in standard models of how the<br />
business works. It was coupled with improvements in online analytical processing,<br />
ways to “drill down” into pre-designed summary reports to see what drove the results.<br />
These two steps forward allowed more sophisticated business intelligence, but they<br />
fell far short of statistical techniques long in use for rich modelling of outcomes.<br />
Comparing “what is” or “what was” to what “should have been” depends on a rich<br />
understanding of statistical techniques, a normative model of how the business ought<br />
to be.<br />
Nowadays, business analytics offers benefits to these older approaches could only<br />
grope towards. They can function as the “brain” of the nervous system that the<br />
information platform provides, moving from data gathering and interpretation to<br />
model building, real-time comparison of current reality to forecasted and hoped-for<br />
outcomes. Most important, they also serve as the basis for action: sometimes<br />
automated, sometimes requiring human intervention, but always goal-directed, aimed<br />
at improving results and moving the business forward.<br />
The skills needed to realize this vision are not widespread; most organizations have<br />
local resources of business “power users” who know both the business and some of<br />
the requisite technology, but few have a real centre of excellence for advance analytic<br />
techniques. Those that do, often isolate those scientists by design or by accident, from<br />
the everyday practical realities of the business.<br />
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Putting these pieces together is more than defining a strategy, implementing a<br />
technology roadmap, and a solution installation. It is a journey that involves maturity<br />
assessment, skills acquisition, cultural change, and a clear vision. To achieve these<br />
goals, organizations need help with planning, prioritizing, and executing on their<br />
chosen projects together with a framework that leverages those efforts and makes<br />
them part of a broader initiative to sustain transformation as a continuous process.<br />
Building predictive models is an iterative process in which a model is created from an<br />
initial hypothesis and then refined until it produces a valuable business outcome or<br />
discarded in favour of another model with more potential. Developing and then using<br />
predictive models involves the following tasks:<br />
• Scope and define the predictive analytics project. What business processes will<br />
be analysed as part of the initiative, and what are the desired business<br />
outcomes?<br />
• Explore and profile organization data. Because predictive analytics is a dataintensive<br />
application, considerable effort is required to determine the data that<br />
is needed for the project, where it is stored and whether it is readily accessible,<br />
and its current state.<br />
• Gather, cleanse and integrate the data. Once the necessary data is located and<br />
evaluated, work often needs to be done to turn it into a clean, consistent and<br />
comprehensive set of information that is ready to be analysed. That process<br />
may be minimized if an enterprise data warehouse is leveraged as the primary<br />
data source. But external and unstructured data is often used to augment<br />
warehoused information, which can add to the data integration and cleansing<br />
work.<br />
• Build the predictive models. The model builders over here, testing models and<br />
their underlying hypotheses through steps such as including and ruling out<br />
different variables and factors, back-testing the models against historical data,<br />
and determining the potential business value of the analytical results produced<br />
by the models.<br />
• Incorporate analytics into business processes. Business analytics tools and<br />
models are of no business value unless they are incorporated into business<br />
processes so that they can be used to help manage (and hopefully grow)<br />
business operations.<br />
• Monitor the models and measure their business results. Predictive models need<br />
to adapt to changing business conditions and data. The results produced need<br />
to be tracked to illustrate which models are providing the most value to the<br />
organization.<br />
• Manage the models. Reduce the models with little business value, improve the<br />
ones that may not yet be delivering on their expected outcome but still have<br />
potential, and adjust the ones that are producing valuable results to further<br />
improve them.<br />
The system proposed designed as a library that supports all types of users in all three<br />
environments: Design, Execution, and Optimization with all tools around a single<br />
shared model. All the users share access to the same process model. This eliminates<br />
not just the need for separate tools for business people and departments, but also the<br />
major transformation and “round tripping” problems that exist.<br />
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One key benefit to our system is that it is much easier for business people to<br />
collaborate between departments because everyone is sharing the same common<br />
process models. The shared model also makes it possible for business people to do a<br />
lot more of the process design work themselves, which gives them more control and<br />
allows them to make business process changes more rapidly. A third major benefit is<br />
that the shared model enables massive reuse. Everything is in the same library which<br />
makes it easy to share components across projects. Finally, the shared model<br />
integrates process performance data with the process design data. This allows to<br />
automatically provide powerful graphic interfaces for business users enabling them to<br />
understand and manage work.<br />
Figure 4. Shared Model Architecture<br />
The proposed system capability offers a full range of reporting, analysis and<br />
dash-boarding to enable managers to quickly gain new insights and take actions to<br />
drive better business outcomes. The system drives improved business outcomes with:<br />
• A single consistent view of the business;<br />
• A full range of decision making capabilities;<br />
• Easily accessible information wherever and whenever needed;<br />
• Deeply optimized solutions for unparalleled performance;<br />
• Rapid time to value and return on investment (ROI), including the flexibility<br />
to grow with the business.<br />
The key change that an analytic culture brings about is that decisions are made where<br />
and when they are needed most by the people who are close to the issues and have the<br />
most at stake. For example, ideas about a customer retention and customer loyalty,<br />
“total view of best customers” ultimately mean more in the hands of a banker advising<br />
its clients than they do to an information architect, because the banker can create<br />
value with them. Delivering it depends on the right data, a capable platform, and a<br />
rich set of analytics in the hands of people who can use them. The result is<br />
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information that makes a difference and it can have transformational implications for<br />
a business. Organizations that build the systems to power that transformation will<br />
drive past those that do not at an accelerating rate as the use of advanced, predictive<br />
analytics changes the way business is done.<br />
DISCUSSION AND CONCLUSIONS<br />
By envisioning and acting on new ways to use information, organizations are<br />
transforming themselves into smarter, intelligent enterprises. New information<br />
strategies are making it possible to create new revenue opportunities, reduce costs and<br />
differentiate from the competitors. The goal is not just to manage information<br />
intelligently but to operate differently and more effectively by using real-time analysis<br />
of massive amounts of information to optimize critical business activities.<br />
In the current economic conditions the need for transformation becomes more urgent.<br />
Even with the flood of data in the organization, one in three business leaders are<br />
frequently making major decisions with incomplete or distrusted information.<br />
Business is all about taking risks assuming that the odds are in the organization’s<br />
favour. Business success depends on organizations being able to forecast scenarios<br />
accurately to make business plans and deploy resources so that they are able to seize<br />
opportunities, neutralize threats and mitigate risks. Clearly, predictive analytics can<br />
play a key role in day-to-day business operations. It can help organizations focus on<br />
strategy and continually make plans based on actual performance and expected<br />
scenarios.<br />
Business analytics is a natural evolution path for Business Intelligence. It is something<br />
that many users desire, but have often needed to obtain separate from their current<br />
Business Intelligence tools. Business analytics can play a fundamental role in<br />
day-to-day business operations. If they are available to workers, business analytics<br />
modelling tools can help business people continually make their plans based on “what<br />
if” analyses and forecasts that leverage both deep historical data and fresh streams of<br />
current event data.<br />
The most important assurance of business analytics is that it will become pervasive,<br />
guiding all decisions, transactions and applications. For the technology to achieve that<br />
challenge, organizations must move toward a comprehensive advanced analytics<br />
strategy that integrates data mining, content analytics and in-database analytics.<br />
REFERENCES<br />
Adkins Tony (2006), Case studies in performance management: a guide from the experts,<br />
John Wiley,<br />
Back Thomas (2002), “Adaptive business intelligence based on evolution strategies: some<br />
application examples of self-adaptive software”, Information Sciences, vol. 148,<br />
no. 4: 113 - 121<br />
Beyer Hans-Georg (2001), The Theory of Evolution Strategies, Series on Natural<br />
Computation, Springer, Berlin<br />
Gros Mary E., Goul, Michael, Demirkan, Haluk (2011), “Promoting Effective Decision<br />
Making Using Analytics in a Virtual Technology Lab”, Decision Sciences Journal of<br />
Innovative Education, vol. 9, no. 1: 119 - 127<br />
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Grossmann Wilfried (2010), “A Conceptual Approach for Data Integration in Business<br />
Analytics”, International Journal of Software and Informatics, vol 4, no 1: 53 - 67<br />
IBM White Paper (2009), From reporting to performance management – A roadmap, IBM<br />
Canada<br />
Merv Adrian (2010), “Information and Analytics: Enabling Business Optimization”, IT<br />
Market Strategy, available on-line at http://mervadrian.files.wordpress.com/2010/07/<br />
ibm-ilt-initiative-v6-11.pdf<br />
Năstase Pavel, Stoica Dragos (2010), “A new business dimension - business analytics”,<br />
Journal of Accounting and Management Information Systems, vol 4: 603 - 618<br />
Năstase Pavel, Stoica Dragos (2010), “From information management to knowledge<br />
management for midsize companies”, Accounting and Management Information<br />
Systems, AMIS 2010<br />
Năstase Pavel, Mihai Florin, Stanciu Andrei, Stoica Dragos (2009), “From Document<br />
Management to Knowledge Management”, International Conference “Challenges of<br />
contemporary knowledge-based economy (ICMEA), - third edition -,<br />
Trkman Peter, McCormack Kevin, Valadares de Oliveira Marcos Paulo, Bronzo Ladeira<br />
Marcelo (2010), “The impact of business analytics on supply chain performance”,<br />
Decision Support Systems, vol. 49, no. 3: 318 – 327<br />
Vrugt Jasper A., Robinson Bruce A. (2007), “Improved evolutionary optimization from<br />
genetically adaptive multimethod search”, <strong>Proceedings</strong> of the National Academy of<br />
Sciences of the United States of America, Vol. 104, No. 3: 708-711<br />
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PS12 Corporate governance and ethics<br />
Chairperson<br />
Nicoleta FARCANE, West University of Timisoara, Romania<br />
CORPORATE VALUES, THE COMPANIES’<br />
FRAMEWORK OF ETHICAL BEHAVIOUR<br />
Elena Roxana ANGHEL-ILCU<br />
HOW CAN CORPORATE GOVERNANCE<br />
MITIGATE FRAUD?<br />
Victoria STANCIU, Ali EDEN, Veronica IVANCENCO<br />
ETHICS AND RESPONSIBILITY IN IT<br />
Valerica MARES, Marius Daniel MARES<br />
CORPORATE GOVERNANCE PRINCIPLES:<br />
AN EVOLUTIONARY APPROACH IN TERMS<br />
OF DIRECTORS-MANAGERS RELATIONSHIP,<br />
IN THE DEVELOPING ECONOMIC CONTEXT<br />
OF 21ST CENTURY<br />
Maria GROSU, Roxana-Manuela DICU, Daniela MARDIROS<br />
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CORPORATE VALUES, THE COMPANIES’<br />
FRAMEWORK OF ETHICAL BEHAVIOUR<br />
Elena Roxana ANGHEL-ILCU 1<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
This paper aims to find the corporate values that guide companies’ operations in everyday<br />
activities and then to establish a general value system of the companies which we consider to<br />
be a moral framework of ethical conduct. Our research is conducted in the European context;<br />
we considered a sample that consists of British and French companies. There are few studies<br />
related in the existing literature, and the opportunity of this research is justified through the<br />
necessity of establishing the boundaries of corporate activity and decision-making under the<br />
imperative of profit grows. The originality of this paper is the statistical apparatus that is<br />
used in the aggregation of initial data. We consider that the company’s steps in the<br />
identification of the inner corporate values after a selection process, is similar with a voting<br />
system, more specific, a preferential voting system which permits to a company to give its<br />
‘vote of confidence’ to a specific value and the ‘vote of no confidence’ to another different<br />
value. A preferential voting system allows a hierarchical systematization between more<br />
competing options and, thus, in our opinion, is more suitable for our goal rather than a<br />
simple frequency determination. Our results present the corporate value system that is<br />
applicable at the time present in a European context. We also confronted this value system<br />
which is practiced in the British and French companies with a theoretical one formulated by<br />
scholars. This has revealed that the existing corporate value system can be easily challenged<br />
because of the lack of consistency and the significant number of weakness discovered.<br />
KEYWORDS: Corporate Values, Corporate Value System, Preferential Voting System,<br />
European Companies, Comparative Studies<br />
INTRODUCTION<br />
Knowing “what values we stand for” and “what values customers over time have<br />
come to appreciate us for” is vital for the companies’ success. The values rooted in<br />
the organisation need to resonate with the values perceived and appreciated by the<br />
customers over time, and vice versa (Urde, 2009).<br />
Bearing these thoughts in mind, our aim is to find the corporate values that guide<br />
companies’ operations in everyday activities and then to establish a general value<br />
system of the companies which we consider to be a moral framework of ethical<br />
conduct. Our research is conducted in the European context; we considered a sample<br />
that consists of British and French companies, a representative exhibit of two opposite<br />
and paradigmatic accounting traditions: the Anglo-Saxon accounting system and the<br />
Continental accounting system. There are few studies related in the existing literature,<br />
1<br />
Correspondence address: Elena Roxana ANGHEL-ILCU, Academy of Economic Studies, Bucharest,<br />
Romania; email: ilcu_roxana@yahoo.com<br />
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and the opportunity of this research is justified through the necessity of establishing<br />
the boundaries of corporate activity and decision-making under the imperative of<br />
profit grows. The originality of this paper is the statistical apparatus that is used in the<br />
aggregation of initial data. We consider that the company’s steps in the identification<br />
of the inner corporate values after a selection process is similar with a voting system,<br />
more specific, a preferential voting system which permits to the company to give its<br />
‘vote of confidence’ to a specific value and the ‘vote of no confidence’ to another<br />
different value. A preferential voting system allows a hierarchical systematization<br />
between more competing options and, thus, in our opinion, is more suitable for our<br />
goal rather than a simple frequency determination. Our results present the corporate<br />
value system that is applicable at the time present in a European context. We also<br />
confronted this value system which is practiced in the British and French companies<br />
with a theoretical one formulated by scholars. This has revealed that the existing<br />
corporate value system can be easily challenged because of the lack of consistency<br />
and the significant number of weakness discovered.<br />
This paper is organized in two main sections: the first section includes the literature<br />
review with discussion on four ‘hot’ topics: corporate trust, corporate identity, codes<br />
of ethics and corporate values. The second section is dedicated to the statistical<br />
apparatus that is used to establish the general value system of the companies in the<br />
European context.<br />
1. IS ‘CREDIBILITY’ A SYNONYM FOR TODAY’S CORPORATE<br />
ACTIVITIES?<br />
1.1. Trust, a Milestone for Today’s Companies<br />
According to Garcia-Marza (2005), trust is one of the company’s most important<br />
intangibles. Trust is paramount for product acceptance, a good working atmosphere<br />
and smooth relationships. It enables cooperation, promotes network relationships,<br />
facilitates effective responses to crises, reduces harmful conflict, decreases transaction<br />
costs and facilitates the effective functioning of groups (Sundaramurthy, 2008).<br />
Although trust is recognized as a decisive factor for the company in relation with<br />
every stakeholder, little effort is being made to manage it. According to Garcia-Marza<br />
(2005), business ethics aims to provide advice and indications on how to approach<br />
this situation.<br />
Ethical behaviour is a precondition for an enterprise to obtain the status of a credible<br />
and trustworthy partner, which, in the long-run, ensures the company’s success.<br />
Enterprises should not only be concerned about making a profit, but also be engaged<br />
in actions that appear to further some social good, beyond the interests of the firm and<br />
what is required by law (Lindgreen, Swaen and Johnston, 2008). A company’s moral<br />
responsibility is defined according to the possible agreement among the interests of all<br />
enterprise stakeholders. Interests common to all stakeholders exist; to be satisfied,<br />
stakeholders demand a specific orientation in management decisions and actions. The<br />
company needs credibility or society’s consent to be able to act and achieve its<br />
objectives (Garcia-Marza, 2005).<br />
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1.2. The Lack of Trust or the Crisis of Credibility<br />
An enterprise’s ethical behaviour demands a conscious and positive attitude from the<br />
enterprise’s key stakeholders towards the enterprise’s core values, culture and climate<br />
in a way that stimulates the desired achievement of business ethics (Lindgreen, Swaen<br />
and Johnston, 2008). This is a real challenge for companies to achieve. According to<br />
market and social trend analyst Daniel Yankelovich, the public’s widespread cynicism<br />
toward businesses today is a real crisis of confidence that companies must face. The<br />
recent global financial crisis is, in fact, a major crisis of trust. The current wave of<br />
disapproval began in 2001 with the bursting of the dot-com bubble, the ensuing bear<br />
market, and the financial scandals involving Enron, WorldCom, Tyco, and others<br />
(Van Lee, Fabish and McGaw, 2005). Business people may attribute recent corporate<br />
scandals to “a few bad apples,” but the public needs more than that to be convinced. A<br />
2002 Gallup Poll found that almost 80 percent of the public believes corruption is<br />
endemic in the corporate world and that executive greed and immorality are the top<br />
causes of current economic woes (Rosell and Yankelovich, 2003).<br />
The first crisis of confidence was the Great Depression of the 1930s which continued<br />
until World War II. Although scholars have not agreed on the exact causes and their<br />
relative importance, it is considered that some of the events that generated the Great<br />
Depression were the massive banks failures, the stock market crash, actions taken by<br />
the US Federal Reserve that contracted the money supply, as well as the Britain’s<br />
decision to return to the Gold standard (Bernanke, 1995). These were marked by a<br />
weakening of confidence in the free-market economy and public disillusionment in<br />
big business, respectively.<br />
Rosell and Yankelovich (2003) suggest that the current crisis of confidence is<br />
different because senior executives, not just corporations, are viewed as being directly<br />
responsible for the scandals. Their over-the-top compensation, excessive management<br />
perks, and perceived willingness to trade jobs, environmental standards, and labour<br />
rights for profits squeezed out of globalization have fanned mistrust in the individuals<br />
who run companies and, secondarily, in the companies themselves. The impact so far<br />
has generated new norms and provisions such as the Combined Code (UK Corporate<br />
Governance Code), that sets out the requirements of disclosure for the public listed<br />
companies on delicate issues such as director remuneration, accountability and audit,<br />
appointment of the directors, relationships with shareholders etc. (FRC, 2010).<br />
Companies are required to break out of narrow frameworks that reinforce mistrust and<br />
create blind spots. Companies should learn to understand the viewpoints of others<br />
who see the world differently and use that understanding to inform actions and<br />
develop ‘trust equity’ (Rosell and Yankelovich, 2003). Change at this deeper level can<br />
open up new possibilities both for addressing the current wave of mistrust and for<br />
creating competitive advantage.<br />
In regaining trust, we consider that companies should think and act a strategy of real<br />
value creation for all the stakeholders, in a transparent and credible manner, starting<br />
with defining a corporate identity that should always be aligned with an ethical<br />
conduct.<br />
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2. ORGANIZATIONAL IDENTITY AND CORPORATE IDENTITY<br />
Identity construction in social practices has constituted one of the main foci of<br />
research in sociolinguistics over the last twenty years (De Fina, 2007). Within identity<br />
theory, social constructionism is perhaps the most general perspective. It views<br />
identity as a process, not as a given or a product, always embedded in social practices<br />
and thus takes an anti-essentialist view of the self. The approach is a dynamic one,<br />
allowing for constant flux and interplay between different aspects of an individual’s<br />
diverse social and personal identities in response to contextual influences (Holmes,<br />
2006).<br />
Hatch and Schultz (1997) distinguish between organizational identity and corporate<br />
identity. The discussion of identity within the organizational literature has developed<br />
around the concept of organizational identity, while the marketing literature focuses<br />
on corporate identity.<br />
Organizational identity refers to members’ perceptions, feelings and thoughts about<br />
their organization. Scholars and academics share a common orientation towards<br />
organizational identity as a dynamic, processual phenomenon (Oliver, Statler and<br />
Roos, 2010).<br />
Bhatia and Lung (2006: p.266) define corporate identity as “…a multidimensional<br />
and dynamic construct that is realized in and through the discursive practices of<br />
members of business and disciplinary cultures”. Corporate identity is conceptualized<br />
as a function of leadership and it is formulated by top management. There are cases,<br />
like the one described by Gérard Mestrallet, the Chairman and CEO of GDF Suez<br />
(France), where the corporate identity of an entity is the result of a bottom-up,<br />
grassroots movement in which all employees participate. However, this is the<br />
exception rather than the rule. The corporate identity lays the ground rules of the<br />
ideology and performance of the corporation, and it is usually put together by top<br />
management. The construction of corporate identity is constrained by the goals of the<br />
corporate world and its ideology and is moulded on the basis of the differences<br />
between specific communities. Identity is co-constructed in relation to a specific<br />
audience (Garcés-Conejos Blitvich, 2010).<br />
We consider that the identity assessment is crucial in formulating an eligible discourse<br />
that represents the vision of the company. Most of the cases, the companies set out<br />
this discourse in a formal manner as a set of principles, objectives, policies which are<br />
aggregated in one document, or a set of interrelated documents that comprise the<br />
company’s code of ethics or conduct.<br />
3. CORPORATE CODES OF ETHICS AND CODES OF CONDUCT<br />
Langlois and Schlegelmilch (1990) defined a code of ethics as a corporate statement<br />
that registers corporate principles, ethics, rules of conduct, codes of practice, or<br />
company philosophy concerning responsibility to stakeholders, the environment, or<br />
any other aspects of society external to the company.<br />
Corporate codes of ethics contain valuable information about corporate commitments<br />
regarding desired behaviour of management and employees. Such commitments have<br />
~ 548 ~
an impact on the individual behaviour of members as well as on the organization as a<br />
whole in order to propagate its moral norms and values. Corporate codes of ethics are<br />
the normative claimed and desired practices that an organization develops with<br />
respect to moral behaviour. Codes articulate norms for the regulation of the actions<br />
and moral responsibilities of management and employees toward its stakeholders.<br />
Codes of ethics express the corporate mission and the normative responsibilities to<br />
which the organization aspires (Donker, Poff and Zahir, 2008). Kaptein (2004) states<br />
that a code of ethics clarifies the objectives the company pursues, the norms and<br />
values it upholds and what it can be held accountable for. A code of ethics contains<br />
the company’s responsibilities, principles, values and/ or norms. A code of ethics thus<br />
demonstrates a company’s awareness of ethical issues and indicates how it will deal<br />
with such topics. An important but underemphasized function of codes involves the<br />
fact that, by making a firm’s values explicit, an effective code equips members of an<br />
organization with ethical justifications that can be used in resolving individual and<br />
organizational dilemmas (Donker, Poff and Zahir, 2008).<br />
Caracsco and Singh (2003) examined the content of the codes of conduct of the<br />
world’s 50 largest transnational non-financial firms (ranked by foreign assets) in<br />
2000. They analyzed three main areas:<br />
(a) behaviour and actions covered by the code,<br />
(b) enforcement procedures and,<br />
(c) penalties for noncompliance.<br />
Also, the firms were concerned about conduct that promoted positive values and<br />
relationships (e.g., relations with customers/ suppliers, employees, and the<br />
environment) and conduct that was negative either in a legal or ethical sense (e.g.,<br />
conflict of interest and insider trading) but it should be noted that concerns relating to<br />
the latter were more emphasized in the codes the authors examined.<br />
Kaptein and Wempe (2002) suggest that corporate codes can be instruments for<br />
achieving cohesion in daily operations. A code of ethics that articulates corporate<br />
values and norms offers employees guidance and support in order to fulfil corporate<br />
goals. Corporate reputation regarding ethical behaviour of management and<br />
employees can have an important impact on economic corporate performance.<br />
Organizations choose to assess their way of making business either in a code of ethics,<br />
a code of conduct, or sometimes, the both of them. The differences between the two<br />
have been clearly established by Painter-Morland (2008): “A code of ethics is<br />
normally slightly longer, but still aspirational rather than directive in tone. Codes of<br />
conduct, however, are directive in form and intent. Their purpose is to provide<br />
employees with behavioural guidelines”.<br />
There are no generally accepted standards with respect to the names that are used to<br />
refer to various kinds of codes. There are many examples of shorter documents that<br />
are nevertheless referred to as “codes of conduct”, and brief value statements that are<br />
called “codes of ethics”. Sometimes companies have a brief values statement that is<br />
fleshed out in more detail in a code of ethics and that is supported by a number of<br />
more specific codes of conduct. In many cases, these codes are supported by a whole<br />
hierarchy of policy documents and organizational procedures. This array of<br />
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documents has long been regarded as one of the most important elements of a<br />
successful ethics management program.<br />
4. CORPORATE VALUES, A FRAMEWORK OF MORAL BEHAVIOUR<br />
4.1. What Are the Corporate Values?<br />
First, the field of corporate values research is particularly relevant in today’s difficult<br />
economic conditions because the positive attitude of an enterprise towards the core<br />
values with ethical content and ethical climate will have an important impact on the<br />
solving recent financial crisis as well as future economic and social development<br />
(Duh, Belak and Milfelner, 2010).<br />
Corporate values can be defined as operating philosophies or principles that guide an<br />
organization’s internal conduct, as well as its relationship with the external world<br />
(Garcés-Conejos Blitvich, 2010). Van Lee, Fabish and McGaw (2005) also define<br />
values as “a corporation’s institutional standards of behaviour”. A similar approach to<br />
the concept of value appears in Fritzsche’s (1995) article, in which he defines values<br />
as the explicit or implicit conception of what is desirable that has an influence on<br />
behaviour, based on appropriate behaviour standards. According to several authors<br />
(Garcia-Marza, 2005), the ethical behaviour of an enterprise is not possible without<br />
ethical core values.<br />
The ethical behaviour of enterprises is possible only when the key stakeholders (the<br />
shareholders and the top management) of an enterprise have a positive attitude<br />
towards the ethical core values. If so, they will impact the emergence of such<br />
enterprise culture and climate that will support and enable the ethical behaviour.<br />
Therefore, the enterprise’s ethical behaviour demands a conscious and positive<br />
attitude towards the enterprise’s core values, culture and climate in a way<br />
that stimulates the desired achievement of business ethics (Duh, Belak and<br />
Milfelner, 2010) and which is essential for the enterprise’s long-term success<br />
(Garcia-Marza, 2005).<br />
4.2. Purpose and Role<br />
Corporate values determine the organisation’s behaviour (Schwartz, 2001). Craig and<br />
Douglas (2006) suggest values could be examined at different levels: the level of the<br />
individual; and the level of the society, where specific groups, organisations and<br />
people interact.<br />
The corporate values are about what the company stands for and how its employees<br />
conduct themselves. Corporate values frame a role for the corporation that gives it a<br />
purpose beyond profit (Cha and Edmondson, 2006). Most importantly, the corporate<br />
values’ primary target public is the company’s employees, who are expected to derive<br />
a sense of collective identity from the values stated, and to infuse those values into<br />
their professional practices (Garcés-Conejos Blitvich, 2010), in other words, a<br />
“…sense of purpose and identity in a world that is in flux” (Lagace, 2006). Therefore,<br />
the primary purpose of the corporate values is socialization and enculturation of the<br />
company’s employees.<br />
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By making their corporate values public, companies want to present a positive image<br />
of the corporation, one that is in accordance with current standards of ethics. Although<br />
there is no certainty as to whether its corporate values will be read and by whom, by<br />
making them public, a company’s corporate values can be compared with those of<br />
other companies and make them more attractive for investors or future employees.<br />
Thus, corporate values external, secondary purpose is promotional, i.e., to promote<br />
and market the company as well as to recruit potential talent (Garcés-Conejos<br />
Blitvich, 2010) and also, to promote a positive image of the company and generate<br />
confidence amongst its stakeholders.<br />
4.3. The Need of Corporate Values<br />
According to Paine (2003), the corporate values developed as a response to the need<br />
for corporations to be measured in terms of both financial and ethical standards.<br />
Ethical standards are determined by the context in which a corporation is operating,<br />
and are therefore in constant flux. Companies should also try to set a higher ethical<br />
standard and contribute to broader societal goals. In other words, companies should<br />
achieve profitability in ways that help build a better society.<br />
Although the long-term changes are still underway, it seems that companies whose<br />
primary value is profit no longer achieve superior market performance (Collins and<br />
Porras, 1994). Hultman (2005: p.41) indicates that although some managers may find<br />
organizations being both “humanist” and “practical” counterintuitive “…research<br />
clearly indicates that this is not only possible but also necessary”.<br />
An example of the reorientation of companies as a response of changes occurring in<br />
the elderly culture could be the ‘green’, environmentally-friendly approach to<br />
business observed in many corporate values statements of companies, which reflects<br />
the current, more environmentally-conscious mentality of the culture as a whole<br />
(Garcés-Conejos Blitvich, 2010).<br />
The need of corporate values is also set on a monetary basis reflected in the<br />
company’s financial performance. But most companies are not measuring their Return<br />
on Value indicator (ROV). In a business environment increasingly dominated by<br />
attention to different definable returns on specific investments, most senior executives<br />
are surprisingly lax in attempting to quantify the ROV (Van Lee, Fabish and McGaw<br />
2005), even when different studies already show statistically significant evidence that<br />
corporate values positively correlate with companies performance (Donker, Poff and<br />
Zahir, 2008). In a similar manner, a 1992 study by Digital Equipment Corp. found<br />
that managers in Great Britain share the familiar concern about aligning actual<br />
business practices with espoused beliefs, thus managing the gap between rhetoric and<br />
reality. Of the 429 British managers surveyed, 80 percent said their organizations<br />
have written values statements, 89 percent agreed that values provide organizational<br />
stability in a chaotic world, and 82 percent asserted that values contribute to the<br />
bottom line (Filipczak, 1993).<br />
Generally, companies follow the same “values cycle”: They articulate a set of<br />
corporate values and attempt to embed them in management practices, which they<br />
hope will reinforce behaviours that benefit the company and communities inside and<br />
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outside the firm, and which in turn strengthen the institution’s values (Van Lee,<br />
Fabish and McGaw, 2005).<br />
4.4. Personal Values and Corporate Values<br />
A value system is a set of consistent ethic values and measures used for the purpose of<br />
ethical and/or ideological integrity. A value system can be understood when<br />
considering one person as an individual – and we refer, then, to a personal value<br />
system – or, if we take into account a group of persons organized as a distinctive<br />
entity, we refer, then, to a corporate value system.<br />
According to Mujtaba and Sims (2006), individuals have their own set of values that<br />
guide their personal and professional decisions. People create these values, in part,<br />
during the socialization process, which is an important component of the informal and<br />
formal measures of business ethics implementation that key stakeholders must<br />
consider for their enterprises to be successful. The value system of the individual is<br />
the group of personal values, arranged hierarchically on the basis of the relative<br />
importance that each individual assigns them (Fritzsche, 1995). In a similar manner,<br />
we consider that it is also a system that is both self-imposed and followed by its own<br />
author, in a voluntary manner to create the premises for conduct and decision-making<br />
in day-by-day activities. This system acts as a mental barrier between what is<br />
considered to be ‘good’ and what is considered to be ‘wrong’ in the self-conduit to set<br />
a state of personal interior comfort for one’s actions. It is worth to notice that the<br />
concept of ‘good’ and ‘bad’ is a very relative one; it depends on personal feelings,<br />
culture, education, being also a product of social interact, geographical location,<br />
religion, tradition, philosophy and so on, thus the value system may differ<br />
significantly from one person to another at a first glance; and secondly, the personal<br />
value system may differ significantly from a corporate value system.<br />
An individual who possess a personal value system that is employed, has to confront<br />
his/her value system with the corporate value system of the employer and this<br />
situation could lead to some unpredictable personal conflicts of interests. These<br />
conflicts can be managed in a two-folded manner: (a) the person adheres to the<br />
corporate value system, and (b) the person influences the corporate value system.<br />
(a) The person adheres to the corporate value system<br />
The adherence to the corporate value system can lead to two possibilities: (1) in<br />
the confrontation of the two value systems, the personal value system remains<br />
unchanged, and (2) the individual changes his/her personal value system.<br />
The first situation – where the person maintains unchanged the personal value<br />
system in the confrontation with the corporate value system – leads to some<br />
major interior conflicts of interest. The person must act against his/her credo in<br />
order to complete every-day tasks assigned by the manager. This is from far, the<br />
most undesirable situation because it can lead to some catastrophic effects on<br />
the health and safety of one individual.<br />
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The second situation appears when the personal value system is changed by the<br />
corporate value system. It is interesting to notice, however, that the change may<br />
happen with or without the person’s awareness.<br />
In a similar manner, Cambra-Fierro, Polo-Redondo and Wilson (2008) consider<br />
that the influence of corporate values on individuals’ values system is not<br />
immediate and that employees may need time to be persuaded that certain<br />
values are correct.<br />
The same authors make an interesting connection between the company size and<br />
the influence of the corporate values on the personal values. They suggest that it<br />
is very possible that in smaller companies, or in family business, the<br />
relationships between shareholders, managers and workers are much more<br />
personal and closer. So the chance that there is an identification of the<br />
individual’s values with the company’s increases, while in larger companies<br />
where the distance between management and workers is larger and the<br />
relationships are more anonymous and impersonal, this may be more difficult to<br />
achieve.<br />
We find this idea to be relative true in its theoretical approach, but, in our<br />
opinion, this may not be true at all when we look for it in the day-by-day<br />
companies’ existence. The authors suggest that the employees hired in larger<br />
organizations are less likely to be influenced by the corporate values because the<br />
relationships between managers and staff are more ‘anonymous and<br />
impersonal’. We consider that the attributes of the professional relationships are<br />
not a decisive factor in establishing whether personal value system of one<br />
employee is affected by the corporate value system. We suggest that one<br />
decisive factor that generates such an influence is the number of the working<br />
hours. A survey conducted by the European Management Association (EMA) in<br />
2006 among middle, senior managers and directors from all sectors of activities,<br />
including public, private and voluntary in five European countries (Germany,<br />
Lithuania, Malta, Spain and the UK) shows an average working day that range<br />
between 12 hours allocated for working time solely plus the time allocated for<br />
travelling to and from work in Germany and 10 hours for the same purposes in<br />
Lithuania.<br />
Considering that the time allocated to work solely plus the time allocated for<br />
travelling to and from work exceeds by far all other activities during an average<br />
day (in descending order: rest time including sleep, 8 hours on average; time<br />
with family 3 hours on average; sports/leisure time 1 hour average), it is almost<br />
impossible not to be influenced by the working environment and by the<br />
corporate values. Also, in a similar manner, the results of the EMA (2006)<br />
survey states that in all countries, the majority of respondents do feel that their<br />
personal behaviour is affected by the culture and philosophy of the company/<br />
organisation within which they work. Malta was the country which had the most<br />
respondents indicating that their personal behaviour was totally affected by the<br />
culture and philosophy of the company/ organisation within which they work<br />
(17.5 per cent of respondents hit response 1 = totally agree). Overall, the impact<br />
of culture and philosophy of the company/ organisation appears to be strongest<br />
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in Germany where over 89 per cent of responses were between 1 and 3 where 1<br />
= totally agree and 5 = not at all agreement.<br />
Cambra-Fierro, Polo-Redondo and Wilson (2008) also consider that the extent<br />
of corporate values influence on personal value system go beyond the mere<br />
working environment, but having an impact on employees’ global values system<br />
outside of the work environment. In particular, this is evident in the buying<br />
behaviour practices in relation to supplier loyalty and environmental concern.<br />
We find this statement to be poorly argued because it analyse only two<br />
corporate values, i.e. buying behaviour practices in relation to supplier loyalty<br />
and environmental concern. The analysis takes into account too few values for<br />
drawing such a conclusion on employees’ conduct outside the work<br />
environment. Also, the two values contain from the beginning an intrinsic<br />
essence of ‘desirable behaviour’ in the community, regardless the fact they were<br />
stated by the company. Who does not want to be perceived as an<br />
environmentalist?<br />
(b) The person influences the corporate value system<br />
In day-by-day activities, at the confrontation of the personal value system with<br />
the corporate value system, the former can bear a decisive weight in making<br />
decisions. It has been suggested that a lot of managers act in their own interest,<br />
by so-called ‘psychological selfishness’ that is to say, that they are trying to<br />
align their company’s behaviour towards a value system similar to their own.<br />
This will enable them to feel good as they will not have to face a contradiction<br />
between their personal values and their work behaviour (Hemingway and<br />
Maclagan, 2004).<br />
The fact that the personal and corporate values do not always match can relate<br />
to the level of power an individual has in the workplace. As those with power<br />
may be able to bring the organisation’s behaviour nearer to their own individual<br />
value system and those with less power have to put up with the imposed values<br />
(Vitell and Ramos-Hidalgo, 2006). In addition other authors (Hemingway and<br />
MacIagan, 2004) have established that a society’s group of values and its<br />
culture also affect an organisation’s corporate values which clearly suggest that<br />
there is interaction between individual values, social values and corporate<br />
values.<br />
5. SAMPLE SELECTION AND METHODOLOGICAL ASPECTS<br />
The empirical contribution of this paper to the existing literature aims to offer a<br />
representative image of the values system of the European companies, determined in<br />
accordance to a specific methodology which consists of a hierarchical aggregation of<br />
every individual corporate value found mostly in the corporate codes of ethics or<br />
conduct published on the companies’ website. Thus, our research question is: “What<br />
is the corporate ethical framework that guides the European companies in day-by-day<br />
activities?”<br />
In order to achieve this, we need to select a sample of companies that is representative<br />
for Europe, thus we took into account two selection criteria: the activity sector and the<br />
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geographical area. Regarding the first selection criteria, the activity sector, we used<br />
the instrument offered by Euroland.com to select the major company for every listed<br />
activity sector, ranked by market capitalization indicator at 31 st December 2008. Thus,<br />
our final sample consists of the major 21 European companies corresponding to 21<br />
activity sectors: Aerospace & defence, Mining & metals, Entertainment & leisure,<br />
Diversified services, Health & pharmaceuticals, Banks, Oil & gas, Retail, Consumer<br />
products – food, beverages, Telecom, Chemicals, Transportation, Insurance, Utilities,<br />
Consumer products – non-food, Autos & transport equipment, Manufacturing, IT<br />
Information technology, Real estate, Construction & materials and Media (Euroland’s<br />
denominations). Regarding the second selection criteria, geographical area, our<br />
sample reflects the two European countries that are well-known in the existing<br />
literature for their opposite paradigmatic accounting tradition: the United Kingdom<br />
and France. Thus, we have a balanced sample of 10 British companies and 11 France<br />
companies. A detailed image of the final sample is found in Table 1.<br />
Table 1. Final sample companies, grouped by country and activity sector<br />
No. Share Country Activity sector<br />
1. BAE Systems (LSE) London Aerospace & defense<br />
2. BHP Billiton (LSE) London Mining & metals<br />
3. Compass Group (LSE) London Entertainment & leisure<br />
4. Experian (LSE) London Diversified services<br />
5. GlaxoSmithKline (LSE) London Health & pharmaceuticals<br />
6. HSBC Holdings (LSE) London Banks<br />
7. Royal Dutch Shell (LSE) London Oil & gas<br />
8. Tesco (LSE) London Retail<br />
9. Unilever (LSE) London Consumer products – food, beverages<br />
10. Vodafone Grp (LSE) London Telecom<br />
11. Air Liquide (PAR) Paris Chemicals<br />
12. APRR (PAR) Paris Transportation<br />
13. Axa (PAR) Paris Insurance<br />
14. GDF SUEZ (PAR) Paris Utilities<br />
15. L'Oreal (PAR) Paris Consumer products – non-food<br />
16. Renault (PAR) Paris Autos & transport equipment<br />
17. Schneider Electric (PAR) Paris Manufacturing<br />
18. STMicroelectronics (PAR) Paris IT, Information technology<br />
19. Unibail-Rodamco (PAR) Paris Real estate<br />
20. Vinci (PAR) Paris Construction & materials<br />
21. Vivendi (PAR) Paris Media<br />
In our target sample, the values statement was presented in the code of ethics or<br />
conduct for 71.43 percent of the total companies. The rest of the 28.57 percent of the<br />
companies presented their corporate values statements in their corporate annual<br />
reports (APPR: 2008 Annual Report, pp.32 and Schneider Electric : 2008 annual<br />
report, pp.13), in a specific brochure (AXA: Axa’s Commitements, pp.5) and directly<br />
on a webpage of the website (Experian, HSBC Holdings and Vivendi). According to a<br />
related survey conducted by the American Management Association (AMA), on its<br />
council and executive members in April and May 2002, to establish how the corporate<br />
values are communicated to the employees, 86 percent of the total 175 executives<br />
who responded said their companies specifically write or state their values, including<br />
them in employee handbooks (71 percent), in company brochures (67 percent), on<br />
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their Web sites (50 percent) or on wall posters (41 percent) (Anon, 2002b). Our<br />
results on the corporate values communication differ significantly from the AMA’s<br />
results, but these differences are expectable considering the fact that we have no<br />
comparability between the two target samples and the data collection methods.<br />
The content analysis that was carried out to find the corporate values of the<br />
companies, allowed us to extract some preliminary conclusions regarding the<br />
quantitative formulation of the corporate values statement of the companies. The<br />
number of corporate values presented by one company range between one value to a<br />
maximum of seven values, most of the companies being situated at the middle of the<br />
corporate values distribution. A detailed image of this statistic is presented in Table 2.<br />
Also, the total number of corporate values that were presented by all the companies in<br />
the target sample is 42. Thus, our distribution of corporate values contains 42 items,<br />
and every company present up to a maximum of 7 items in their corporate values<br />
statement.<br />
Table 2. The number of values presented by one company<br />
Corporate Values Interval Absolute Frequencies Relative Frequencies<br />
1 – 2 Corporate Values 6 Companies .28<br />
3 – 5 Corporate Values 10 Companies .48<br />
6 – 7 Corporate Values 5 Companies .24<br />
A statistical methodology to aggregate and arrange the corporate values was needed in<br />
our quest to find the value system of the target sample companies. We consulted the<br />
existing studies in the literature to find what methodologies were also used for<br />
obtaining some related results. The studies identified in the existing literature, AMA<br />
(2002), Filipczak (1993) and Van Lee, Fabish and McGaw (2005) use the same<br />
statistical apparatus: the authors use a statistical survey as method for collecting<br />
quantitative information on corporate values, this survey is then sent to a large<br />
numbers of executives, managers or directors of different companies and different<br />
activity sectors and the rate of responses is no more than 9-10 percent. Then, the<br />
authors simply aggregate the responses and choose the corporate value with the<br />
highest frequency regardless others important factors such are value rankings and<br />
hierarchy. Some further limitations of this statistical apparatus regard the fact that it<br />
does not collect written and, therefore, unchangeable data from a corporate value<br />
official statement, it collects what the respondents know to be the corporate values,<br />
enhancing thus the degree of human mistake. Also, because of the survey method, it is<br />
possible to send the same survey to more than one manager in the same company,<br />
therefore, the values of one company being considered at the moment of statistical<br />
aggregation more than just once in the detriment of the values of other companies,<br />
resulting in a biased result.<br />
We propose a methodology for establishing the value system of companies that<br />
overcomes all these limitations, as discussed as follow:<br />
(a) Regarding the data collection, we replaced the statistical survey with the content<br />
analysis of official corporate documents that contain the corporate value<br />
statement, thus removing the human mistake and the biased results. Our sample<br />
is representative for every activity sector; we have chosen the major company in<br />
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sector ranked by market capitalization at 31 st December 2008. These<br />
improvements, however bear an inner limitation regarding the relative small<br />
size of our target sample;<br />
(b) A more complex approach for the results aggregation was needed to establish<br />
the value system of the sample companies, because the presentation of the<br />
corporate values met some specific characteristic that should be considered:<br />
i. The corporate values are presented in a hierarchical manner. The first<br />
corporate value presented is the most important for the respective company;<br />
ii. No company chooses the same value more than once. This means that every<br />
value have a specific weight and importance in the corporate value statement;<br />
iii. Every corporate value is chosen by at least one company. This creates the<br />
premises of a wide variety of corporate values – a total of 42 items in our<br />
corporate values distribution. This characteristic is important because it<br />
considers the willing of one company to choose or not to choose a specific<br />
value;<br />
iv. The number of corporate values presented differs from company to company.<br />
As discussed earlier, the companies in our sample presented up to 7 different<br />
corporate values in their corporate values statement.<br />
Since all these characteristic are met in the process of the corporate values<br />
assessment, we consider that the methodology that applies at their aggregation is the<br />
preferential voting system which can be defined as an electoral system in which voters<br />
rank parties or candidates on the ballot paper in order of their choice (Reynolds,<br />
Reilly and Ellis, 2008). The companies choose a specific value from the entire range<br />
of existing values based on inner considerations, it is a preferred corporate value and<br />
they give it a ‘vote of confidence’ detrimental to another value which is not preferred<br />
thus receiving a ‘vote of no confidence’. The system enables voters (the companies)<br />
to express their preferences between candidates (the corporate values) rather than<br />
simply their first choice. For this reason, it is often known as ‘preferential voting’<br />
(Reynolds, Reilly and Ellis, 2008).<br />
The Alternative Vote, the Borda Count, the Single Transferable Vote and the<br />
Supplementary Vote are all examples of preferential voting systems. Considering the<br />
four characteristics of the corporate values mentioned above, we consider that the<br />
preferential voting system that applies for our goal is the Borda Count.<br />
The Borda Count is a candidate-centred preferential system used in either single- or<br />
multi-member districts in which voters use numbers to mark their preferences on the<br />
ballot paper and each preference marked is then assigned a value using equal steps.<br />
For example, in a ten-candidate field a first preference is worth one, a second<br />
preference is worth 0.9 and so on, with a tenth preference worth 0.1. Because it<br />
sometimes elects broadly acceptable candidates, rather than those preferred by the<br />
majority, the Borda Count is often described as a consensus-based electoral system,<br />
rather than a majority one (Reynolds, Reilly and Ellis, 2008).<br />
The process of data collection met all the conditions and criteria discussed above, as it<br />
follows: on the basis of content analysis, we ranked the corporate values with 1 for the<br />
first company choice, 2 for the second choice and so on, till the last choice, which was<br />
ranked with 7. On our way of consulting more corporate values statements of different<br />
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companies, we continued to add new corporate values until we reached the 42 nd<br />
corporate value.<br />
After accomplishing this step, our primary data consists of the final list of 42<br />
corporate values and their different ‘votes of confidence’ which were ranked from 1 =<br />
most preferred corporate value to 7 = less preferred corporate value. We also<br />
identified the ‘vote of no confidence’ which was ranked with 8 = the corporate value<br />
is not preferred.<br />
The number of points given to each corporate value for each ranking is determined by<br />
n which is the maximum number of the proposed corporate values of one company<br />
considering also the ‘vote of no confidence’. Thus, the most preferred corporate value<br />
(ranked 1) receives the maximum of 8 points ( n ); the second preferred corporate<br />
value (ranked 2) receives 7 pointes ( n −1),<br />
and so on, until the less preferred<br />
company value (ranked 7) receives 2 points ( n − 6 ). The ‘vote of no confidence’<br />
receives the minimum of 1 point ( n − 7 ).<br />
When all the votes have been counted, and the points added up, the corporate value<br />
with the highest number of points win. Thus, in the descending order of number of<br />
points received, we establish the value system of our target sample companies.<br />
6. RESULTS AND DISCUSSION<br />
6.1. The European perspective<br />
The final count of points revealed the value system of the European companies. The<br />
final ranking consists of 17 positions, some of the corporate values obtaining the same<br />
number of points, thus sharing the same position.<br />
It is also interesting to notice the maximum and the minimum number of points that a<br />
corporate value may obtain in the final count. If all the sample companies would have<br />
ranked the same corporate value with the ‘vote of confidence’ as their first preference,<br />
then the value would achieve a number of 168 points. Also, on the opposite side, the<br />
minimum number of points would be achieved if all the sample companies would give<br />
the ‘vote of no confidence’ to a specific corporate value. In this theoretical<br />
assumption, the total number of points would be 21. But this theoretical assumption<br />
infringes the third characteristic of the corporate values that states that ‘Every<br />
corporate value is chosen by at least one company’. Thus, is necessarily that at least<br />
one company to give the immediate number of points above the minimum to the<br />
respective value. Considering this, the minimum number of points that a corporate<br />
value may achieve is 22 and shows that the respective value is less preferred.<br />
The top three values of the European companies are: ‘Integrity’ with a score of 78<br />
points, ‘Respect’ with a score of 58 points and ‘Honesty’ with 48 points. The<br />
corporate values with the lowest number of points, with an equal scoring of 23 points,<br />
are ‘Tenacity’ and ‘Work Smart, Play Hard’. A detailed image of the corporate value<br />
system of the European companies is found in Table 3. An interesting corporate value<br />
that appears in our ranking is ‘High Performance’. Although it does not score a high<br />
position, it is still a presence in the ranking, and our concern is that the financial high<br />
profits are not compatible with a value system, which is more a framework of ethical<br />
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ehaviour. Only few managers will admit that profitability is not just an unfortunate<br />
requirement but a cherished value (Filipczak, 1993).<br />
Table 3. The value system of the European companies<br />
Value Points Top Value Points Top Value Points Top<br />
Integrity 78 1 Beauty 28 12 High Performance 26 14<br />
Respect 58 2 Confidence 28 12 Straightforward 26 14<br />
Honesty 48 3 Drive 28 12 Dependable 26 14<br />
Openness 43 4 Curiosity 28 12 Pragmatism 26 14<br />
Professional 42 5 Consumer focused 28 12 Value Creation 26 14<br />
Transparency 36 6 Commitment 27 13 Cohesion 25 15<br />
Trust 35 7 Fairness 27 13 Example 25 15<br />
Responsibility 35 7 Patient focused 27 13 Courage to Lead Change 25 15<br />
Safety 34 8 Connected 27 13 Win-Win Relationships 25 15<br />
Ethical 34 8 Innovation 27 13 Creativity 25 15<br />
Passionate 32 9 Cultural Diversity 27 13 Lucidity 24 16<br />
Team Spirit 30 10 Rigor 27 13 Humility 24 16<br />
Effectiveness 29 11 Daring 26 14 Tenacity 23 17<br />
Accountability 28 12 Excellence 26 14 Work Smart, Play Hard 23 17<br />
Based on data collection extracted from official corporate documents, our results<br />
reflect the existing corporate value system which is in use at the moment present. But<br />
the corporate value system is also a theoretical challenge for different authors. As<br />
such, Garcia-Marza, (2005) proposes that fundamental corporate values representing<br />
the corporate constitutional framework that would establish the basic rules of the<br />
relations between the company and various groups are: integrity, credibility, fairness,<br />
dialogue, transparency, dignity, legality, civic commitment, environment and<br />
responsibility. Eliminating any of these values means that a dialogue will no longer<br />
represent a process of reaching agreement, but will instead become a mere strategy or<br />
compromise, whereby the final outcome is decided by the more powerful side.<br />
On confrontation between the two value systems of corporation, we find some<br />
similarities among major discrepancies. We need to identify the correspondence<br />
between the corporate values in both value systems. This assignment can be achieved<br />
if we have a correct definition of the analysed terms. According to Garcia-Marza,<br />
(2005):<br />
1) Integrity: Coherence between what is said and what is done;<br />
2) Credibility: Trust in the expectations placed in the company;<br />
3) Fairness: Equal distribution of burdens and benefits;<br />
4) Dialogue: Possibility for participation and consensus mechanisms among the<br />
various groups involved and/or affected;<br />
5) Transparency: Truthfulness, intelligibility and accessibility in internal and<br />
external communication structures;<br />
6) Dignity: Respect for and encouragement of human rights and of the values<br />
involved in reciprocal recognition between individuals;<br />
7) Legality: Compliance with laws and legal provisions;<br />
8) Civic commitment: Contribution to local and regional development, coresponsibility<br />
for social order;<br />
~ 559 ~
9) Environment: Position on the maintenance and improvement of the<br />
environment;<br />
10) Responsibility: Capacity for anticipation of and response to social expectations<br />
and demands.<br />
The existing corporate value system is similar with the theoretical corporate value<br />
system regarding 4 corporate values, meaning: Integrity (78 points), Fairness<br />
(27 points), Transparency (36 points), and Responsibility (35 points). Other<br />
similarities can be assigned based on the definitions above, meaning: the theoretical<br />
corporate value Credibility can be assigned to existing corporate value Trust<br />
(35 points) and the theoretical corporate value Dialogue can be assigned to existing<br />
corporate value Openness (43 points). Considering the rest of the discrepancies, we<br />
find that the corporate value statement, i.e. the corporate value system of the existing<br />
companies, is not coherent, and lacks of important pillars, which were not taken in<br />
considerations, thus we have unasserted areas on important aspects like: Dignity,<br />
Legality, Civic commitment and Environment.<br />
6.2. The British and French Perspective<br />
Having a balanced sample between the British and the French companies<br />
(10 companies from UK and 11 companies in France), we can establish what is the<br />
British corporate value system, and also, what is the French corporate value system. A<br />
detailed image of these value systems can be found in Table 4 and Table 5.<br />
Table 4. The value system of the British companies<br />
Value Points Top Value Points Top Value Points Top<br />
Integrity 43 1 High Performance 15 9 Cohesion 10 13<br />
Respect 42 2 Dependable 15 9 Effective 10 13<br />
Honesty 37 3 Passionate 14 10 Example 10 13<br />
Openness 26 4 Win-Win Relationships 14 10 Lucidity 10 13<br />
Safety 23 5 Courage to Lead Change 13 11 Tenacity 10 13<br />
Ethical 21 6 Work Smart, Play Hard 12 12 Innovation 10 13<br />
Trust 17 7 Beauty 10 13 Pragmatism 10 13<br />
Responsibility 17 7 Confidence 10 13 Team Spirit 10 13<br />
Accountability 17 7 Drive 10 13 Consumer focused 10 13<br />
Professional 17 7 Commitment 10 13 Cultural Diversity 10 13<br />
Curiosity 17 7 Fairness 10 13 Value Creation 10 13<br />
Patient focused 16 8 Daring 10 13 Creativity 10 13<br />
Connected 16 8 Excellence 10 13 Rigor 10 13<br />
Transparency 15 9 Straightforward 10 13 Humility 10 13<br />
The top three British corporate values are identical with the general ranking. We<br />
obtained ‘Integrity’ (43 points), ‘Respect’ (42 points) and ‘Honesty’ (37 points).<br />
Thus, we can state that the European corporate value system has a British influence.<br />
In France, the ranking is quite different. Although the top corporate value remains<br />
‘Integrity’ (35 points), the next places are held by ‘Professional’ (25 points) and<br />
‘Transparency’ (21 points).<br />
~ 560 ~
Table 5. The value system of the French companies<br />
Value Points Top Value Points Top Value Points Top<br />
Integrity 35 1 Fairness 17 7 Humility 14 10<br />
Professional 25 2 Innovation 17 7 Ethical 13 11<br />
Transparency 21 3 Cultural Diversity 17 7 Tenacity 13 11<br />
Team Spirit 20 4 Rigor 17 7 Courage to Lead Change 12 12<br />
Effective 19 5 Respect 16 8 Honesty 11 13<br />
Trust 18 6 Daring 16 8 Safety 11 13<br />
Responsibility 18 6 Excellence 16 8 Accountability 11 13<br />
Beauty 18 6 Straightforward 16 8 Patient focused 11 13<br />
Confidence 18 6 Pragmatism 16 8 High Performance 11 13<br />
Drive 18 6 Value Creation 16 8 Win-Win Relationships 11 13<br />
Passionate 18 6 Cohesion 15 9 Connected 11 13<br />
Consumer<br />
focused<br />
18 6 Example 15 9 Dependable 11 13<br />
Openness 17 7 Creativity 15 9 Curiosity 11 13<br />
Commitment 17 7 Lucidity 14 10 Work Smart, Play Hard 11 13<br />
It is also interesting to notice that the British and French companies have a different<br />
view in assessing their corporate values. This conclusion is easily drawn when we<br />
analyse the number of specific, traditionalistic British corporate values and the<br />
number of specific, traditionalistic French corporate values. In the total of<br />
42 corporate values, a number of 10 corporate values were chosen by British<br />
companies only and a number of 22 corporate values were chosen by French<br />
companies only.<br />
These values are those who received the least number of points in every country value<br />
system: the British corporate value system contains 22 corporate values which scored<br />
10 points, i.e. 10 ‘votes of no confidence’ from the 10 th British companies (one ‘vote<br />
of no confidence’ score 1 point according to Borda Count algorithm) and the French<br />
corporate value system contains 10 values which scored 11 points, i.e. 11 ‘votes of no<br />
confidence’ from the 11 th French companies. This state that the French companies<br />
have a significant higher propensity to a larger horizon and a whole spectrum of<br />
different corporate values that can be elected than a British company. These results<br />
are in concordance with some well-known inherited and specific country traditions,<br />
i.e. the strictness and rigour of British people, and the specific French laissez-faire.<br />
Regarding the manner of presentation of values, we found that the corporate values of<br />
many companies’ starts by including their vision and then proceeds to list each<br />
significant value, which is followed either by a series of bullet points describing the<br />
ways in which the value is instantiated or by a brief narrative that carries out the same<br />
function. However, this layout is not the only type of realization of the genre to be<br />
found. In the corpus, for example, Royall Dutch Shell uses a diagram to present its<br />
vision and values. GlaxoSmithKline uses bullet points to list their values, but these are<br />
followed by very long narratives. Most statements contain an abstract noun to refer to<br />
the specific value, and the narrative or bullet points that follow it make the<br />
abstractness of the value concrete by detailing specific ways in which the value is<br />
enacted. Also, these findings are in concordance with the results found by Garcés-<br />
Conejos Blitvich (2010).<br />
~ 561 ~
CONCLUSIONS<br />
This paper studied the corporate value system in a European context, and specifically,<br />
a value system that can be found in British and French companies. Also, the statistical<br />
apparatus is primer in the existing literature; we considered the methodology of a<br />
preferential voting system in selecting the preferred corporate values. Our results<br />
show that the top three corporate values are Integrity, Respect and Honesty, values<br />
found also in the British corporate value system. A slighter difference is found in the<br />
French corporate value system; here the top three values are: Integrity, Professional<br />
and Transparency. We confronted the existing corporate value system with a<br />
theoretical value system formulated by scholars and this lead us to the conclusion that<br />
the existing corporate value system lacks in consistency, therefore is a challengeable<br />
system with visible weaknesses.<br />
We consider that the companies should adopt a more responsible conduit in the<br />
relationships with different groups of stakeholders. A company has the main purpose<br />
to use the existing resources to obtain profit, but it should never forget that the<br />
resources are all limited, and when we state resources, we refer not only to the most<br />
visible, like raw materials and plant, property and equipment, but an entire spectrum<br />
ranging from the human life, to biosphere, the atmosphere, in different words, the<br />
entire ecosphere.<br />
The companies should revise their corporate value system, in a manner to achieve<br />
consistency and credibility, thus to regain the communities’ confidence and thus, to<br />
overcome the existing crisis of credibility. After all, a corporate value system is a<br />
moral framework of ethical behaviour, and the abatement from this framework should<br />
not be compromised in the continuing battle between ethics and financial<br />
performance.<br />
The limitations of our study is inherent because this subject matter is constantly in<br />
flux, implying that such studies can be no more than a snapshot at a certain point in<br />
time. Such studies have a very short Product Life Cycle (PLC) (Ulhoi, 1993). As<br />
stated before, other important limitation is the relative small size of the target sample.<br />
This being the case, we consider that this study can be further developed by<br />
considering a larger target sample companies from a wider geographical area.<br />
ACKNOWLEDGEMENTS<br />
This article is a result of the project „Doctoral Program and PhD Students in the<br />
education research and innovation triangle”. This project is co funded by European<br />
Social Fund through The Sectorial Operational Programme for Human Resources<br />
Development 2007-2013, coordinated by The Bucharest Academy of Economic<br />
Studies.<br />
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HOW CAN CORPORATE GOVERNANCE MITIGATE<br />
FRAUD?<br />
Victoria STANCIU 1 , Ali EDEN & Veronica IVANCENCO<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
Fraud is a risk that should not be ignored. Studies on accounting field have showed the<br />
seriousness of fraud problem and the nature of fraud. Researches within this area have<br />
emphasized the fraud models and suggested how to prevent, detect and investigate frauds.<br />
Strong corporate governance and a solid corporate culture are important pillars for fraud<br />
prevention. Important professional communities and professional bodies have analyzed the<br />
causes of the actual crisis, and all the surveys emphasized weaknesses in corporate<br />
governance and risk management. That is why important improvements are expected in<br />
corporate governance field. In crisis time, there is also a potential higher risk of fraudulent<br />
financial reporting. Whether is using a simple or sophisticate scheme fraud might affect<br />
people, processes and companies’ or individuals reputation.<br />
The objective of this paper is to examine the fraud phenomenon and fraud vectors aiming at<br />
identifying appropriate prevention actions. The authors focus on the link between strong<br />
corporate governance, a solid internal audit function and the role of external auditors in the<br />
fight against fraud.<br />
KEYWORDS: fraud, fraudulent financial statement, internal audit, corporate governance<br />
INTRODUCTION<br />
The accounting and audit professional literature have analyzed in detail the well<br />
known cases such as Enron, WoldCom, Xerox in US and the European fraudulent<br />
reporting cases as for example Vivendi, Parmalat. The researches in accounting and<br />
forensic accounting have emphasized the nature of frauds and the causes that have<br />
facilitated them. The final objective of all those studies was to reveal the professional<br />
framework for fraud prevention, detection and investigation.<br />
Important results in the fraud research were publishes by Donald Cressey in the mid-<br />
20th century. Cressey is the author of the “classic theory” of fraud that identifies the<br />
well known “fraud triangle”. The fraud triangle seeks to explain the necessary frame<br />
for fraud to occur: opportunity, pressure/incentive and rationalization. In Cressey’s<br />
opinion, if any one of the three elements is missing, fraud may not occur. In order for<br />
fraud to occur, there has to be an ability to commit fraud. Incentive has also been<br />
called “pressure” and can be materialized in various forms but any of these determine<br />
the perpetrator to seek gains via financial fraud. If we analyze the three elements<br />
defining the fraud triangle one characteristic can be emphasize: opportunity and<br />
1<br />
Correspondence address: Victoria Stanciu, Academy of Economic Studies, Bucharest Romania;<br />
email: stanciuvictoria58@hotmail.com<br />
~ 565 ~
incentive only exist or they don’t or, in other words, exists or they potential exists. In<br />
opposite, rationalization depends on the individual and the circumstances he is facing.<br />
In difficult periods, as the one we are passing through, the fraud risk is increasing.<br />
There is also a higher potential risk for registering fraudulent financial statements.<br />
The Association of Certified Fraud Examiners' (ACFE) 2010 Report on the Nation<br />
estimates the cost of fraud to be 5% of businesses annual revenues. Globally, this<br />
translates to approximately $2.9 trillion of economic losses due to fraud (ACFE,<br />
2010). Since 1950s professionals and academicians have offered important insights<br />
that have gone beyond the fraud triangle. Their research had as objective to define<br />
effective ways to prevent, detect, investigate, and remediate fraud. Even so, it appears<br />
that fraud in all its various forms remains a problem that is increasing in frequency<br />
and severity. KPMG’s Fraud Survey 2003 showed a flag alert emphasizing an<br />
increase in overall fraud levels since its 1998 survey and noted that fraudulent<br />
financial reporting had more than doubled from 1998 (KPMG, 2003). The most recent<br />
surveys confirm the ascendant trend of fraud, in all its forms. Everybody is aware that<br />
it is impossible to detect and/or prevent all the frauds but is essential to design and<br />
implement an effective fraud risk management process.<br />
The present paper aim at emphasizing the characteristics of fraud and to present the<br />
authors’ research results regarding means of improvement of fraud risk management<br />
process. In this respect the authors opt for an empiric study. The research imposed a<br />
large documentation in the professional specialized literature, focusing on surveys and<br />
studies on fraud topic issued by international professional bodies and international<br />
organizations. The conclusions retain from the accounting and fraud forensic<br />
literature, the opinion of recognized specialists in the field and the authors’ personal<br />
practical experience have been valuated in the deductive and inductive<br />
methodological process in order to identify the aspects that can be considered flag<br />
alerts for possible fraudulent financial reporting and means for fraud prevention in its<br />
various forms.<br />
1. FRAUD PREMISE<br />
To understand why people commit fraud, the authors’ research started from the<br />
Cassey’s theory, the “fraud triangle” analysing the three elements determining fraud:<br />
Opportunity is the ability to commit fraud and has its roots in the perpetrator believe<br />
that its actions will remain undetected. As a remark, opportunities do not have to be<br />
real; they only must be perceived as real by the perpetrator. The perpetrator’s believe<br />
that he can run its actions without being detected is based on identified weaknesses in<br />
the internal control, internal audit inclusively (were this function is implemented),<br />
poor management oversight, inadequate external oversight and monitoring (run by<br />
external auditors, supervision entities, governmental units), the company’s failure to<br />
establish adequate procedures to detect fraudulent activity, lack of prosecution of<br />
perpetrators, weak ethical culture (as for example poor “tone at the top”), limits in the<br />
implementation of segregation of duties’ principle, the existence of a financial and/or<br />
emotional motivation. Cases as Enron emphasized as an opportunity the<br />
environmental complexity and related parties. The Enron structure was very complex<br />
as a result of merges and usage of special entities (related parties) created in order to<br />
hide losses and fraud and maintain the image of a profitable and successful company.<br />
~ 566 ~
Studies on frauds have emphasized that opportunity is created also through the use of<br />
position and authority of the individuals. A top position in the company confers power<br />
and the possibility to attract co-perpetrators by inducing fear of punishment or<br />
promising rewards.<br />
All the surveys and studies have emphasized that opportunity is the element over<br />
which business owners have the most control. Limiting opportunities for fraud is one,<br />
and very important, way a company can reduce fraud. This is an important conclusion<br />
the authors’ retain in their effort to identify means for mitigate fraud.<br />
The pressure is a very strong factor and has financial and non-financial nature. It is<br />
important to underline that pressure takes different forms: high financial needs, need<br />
to report better results comparing with the real financial status of the company,<br />
frustrations related to the work environment, professional aspiration and the desire to<br />
reach it sooner, relationship needs, the competitive professional environment and<br />
sometimes just the person’s will to prove he/she can defeat the system, the increase of<br />
bonuses (the remuneration system) and the list can continue. Professionals in fraud<br />
forensic concluded that pressure is generally nonobservable. This conclusion is very<br />
important for external auditors work: they have limited interaction with the<br />
company’s employees, potential perpetrators inclusvelly, and they can’t evaluate<br />
current behavior of individuals and its change. As a result, people changing behaviour<br />
is identifiable by their coleagues and direct managers. Internal audit has also an<br />
important role being more close to the activities and people involved in those<br />
activities.<br />
In crisis years, the potential of fraudulent financial reporting is higher as a result of<br />
pressure registered by the executive management to fulfill the business objectives, so<br />
that their own financial position or even professional status in the company not to be<br />
affected. In such context, the adoption of a more “aggressive accounting” can create<br />
the perception of solid financial statements. This pressure is higher in the case of the<br />
companies rated on the market.<br />
In crisis years, the management is focused more on business objectives and costs’<br />
decreasing. As a result, it is the risk of diminishing the attention related to risk<br />
management field. The possible consequences are the postponing or even omission of<br />
updating the risk management process according with the existing conditions.<br />
Rationalization is considered by many specialists to be a crucial component in most<br />
frauds. For those who are generally dishonest, it is probably easier to rationalize theirs<br />
fraud actions. But what it happens with those with higher moral standards? In many<br />
cases, persons that had proved in time ethical and professional integrity are the<br />
initiators of frauds or fraudulent financial reporting. How can be explained this new<br />
situation? Cressey indicated that a morally acceptable rationalization is necessary<br />
before the crime takes place and this is the result of the fact that the perpetrator does<br />
not view himself as a criminal. This statement is confirmed by the 2007 Oversight<br />
System Report on Corporate Fraud indicating that 40% of the respondents have<br />
declared “they do not consider their actions fraudulent” (Oversight Systems, 2007).<br />
The fraudster fills like justifying his misdeeds to himself before he commits them so<br />
that he perceives his illegal behavior is as acceptable. The justification can take<br />
different forms:<br />
~ 567 ~
� his/her action is, in fact, benefic for the company,<br />
� there is no other option for the moment and this situation will be changed soon,<br />
� it is just a solution for the moment,<br />
� she/he will payback the money, the fraud being considered a “loan”.<br />
By rationalization the fraudster is preserving his self-image as an upright and<br />
trustworthy person.<br />
All the above mentioned justifications are linked to the pressure registered and the<br />
perceived opportunity retain by the perpetrator. Like pressure, rationalization is not a<br />
readily observable characteristic, and for the auditor (internal or external) it’s not<br />
possible to identify it.<br />
As a recognize of the its importance, “fraud triangle” theory has became an integral<br />
part of Statement on Auditing Standards No. 99 issued by American Institute of<br />
Certified Public Accountants (AICPA). SAS 99 became effective for audits of<br />
financial statements for periods beginning on or after December 15, 2002.<br />
Concluding, the “fraud triangle” can explain the fraudulent financial action itself but it<br />
can’t explain how are attracted other persons in this action being known that such<br />
action involves in many cases top management, head of accounting, individuals with<br />
internal control attributions and simple accountants. The professionals in fraud<br />
detection have recognized the importance of Cressey’s theory, but they emphasized<br />
that the triangle alone is an inadequate tool for deterring, preventing, and detecting<br />
fraud. This is the result of the two of the characteristics - pressure and rationalization -<br />
that cannot be observed. As a response to this fact, the researche effort continued<br />
aming to develop fraud models able to provide an alternative view of the fraud act.<br />
Some of those models were considered to be more appropriate tools in deterrence,<br />
prevention, and detection.<br />
2. FROM “FRAUD TRIANGLE” TO THE “FRAUD DIAMOND”<br />
The “fraud diamond” concept was issued in 2004 by David T. Wolfe and Dana R.<br />
Hermanson. They added at the already known three components of “fraud triangle”<br />
the fourth: the individual’s capability. In financial statement frauds, involving large<br />
amounts, the solid accounting knowledge and specific abilities are essential. Wolfe<br />
and Hermanson have selected four observable characteristics that can be identified in<br />
case of frauds involving large amounts (Wolfe, 2004):<br />
• “Authoritative position or function within the organization;<br />
• Capacity to understand and exploit accounting systems and internal control<br />
weaknesses, possibly leveraging responsibility and abusing authority to<br />
complete and conceal the fraud;<br />
• Confidence (ego) that she will not be detected, or, if caught, that she will talk<br />
herself out of trouble;<br />
• Capability to deal with the stress created within an otherwise good person<br />
when she commits bad acts”.<br />
The fraud diamond highlights the fact that the capabilities to commit fraud are<br />
explicitly and separately considered in the assessment of fraud risk. As a result, the<br />
fraud diamond moves beyond viewing fraud opportunity largely in terms of<br />
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environmental or situational factors. The capabilities are generated by the person’s<br />
position or function within the organization that may offer the ability to create or<br />
exploit an opportunity for fraud not available to others. If we consider one important<br />
conclusion retained by the Fraudulent Financial Reporting: 1987–1997, An Analysis<br />
of U.S. Public Companies (Beasley et al., 1999) namely that corporate CEOs were<br />
implicated in over 70% of public-company accounting frauds (indicating that many<br />
organizations do not implement sufficient checks and balances to mitigate the CEO’s<br />
capabilities to influence and perpetuate fraud) the above statement is valid. The<br />
fraudster understands and exploits internal control weaknesses and uses his position to<br />
the greatest advantage. This fact is confirmed by the Association of Certified Fraud<br />
Examiners 2010 survey conclusions: 51% of the perpetrators of occupational fraud<br />
had at least a bachelor’s degree, 49% of the fraudsters were over 40 years, 46% of the<br />
frauds the Association recently studied were committed by managers or executives<br />
(ACFE, 2010).<br />
The fraudster has a strong ego and great confidence that he will not be detected, and<br />
he believes that he could easily talk himself out of trouble if caught. It is important to<br />
emphasize that a person with a very persuasive personality may be able to convince<br />
others to go along with a fraud. This explains what Cressey’s model couldn’t.<br />
In the article “The Human Face of Fraud” Allan Roddy notes that the perpetrator<br />
“makes unusual and significant demands of those who work for him or her, cultivates<br />
fear rather than respect … and consequently avoids being subject to the same rules<br />
and procedures as others.” Many financial reporting frauds are committed by<br />
subordinates reacting to an edict from above to “make your numbers at all costs, or<br />
else” (Allan, 2003).<br />
The research in fraud field reveals a fraud model named MICE. MICE is the acronym<br />
from money, ideology, coercion, and ego (entitlement). Jason Thomas defined the<br />
model taking into consideration that in financial reporting fraud the motivating<br />
elements are monetary incentives, bonuses, or stock options. In this respect, top<br />
executives feel the presure to provide solid financial results, based on above<br />
mentioned elements, being to the delimitated nonshareable individual pressure<br />
described by Cressey. The present paper authors appreciate that MICE model<br />
responds to the well known cases of Enron, WorldCom, Adelphia, Phar-Mor. In all<br />
these cases, the perpetrators appeared to be motivated by money, ego, and entitlement.<br />
The MICE model includes also the ideology aiming at explaining frauds like tax<br />
evasion and terrorist financing.<br />
3. PERPETRATORS’ PROFILE<br />
The authors’ documentation on fraus and forensic accounting literature reveals the<br />
existance of a two defined types of perpetrators: the “predator” and the “accidental<br />
fraudster”.<br />
In their work, Forensic Accounting and Fraud Examination, Kranacher, Riley, and<br />
Wells characterize "accidental fraudster” by the following characteristics: first-time<br />
offender; middle-aged; well-educated; trusted employee; in a position of<br />
responsibility; and considered a good citizen through service works at the office, in<br />
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the community, or at a charitable organization (Dorminey, 2010). This profile is<br />
recognise in Cressey’s “fraud triangle”.<br />
In opposition with the accidental fraudster, the specialits have defined a new profile<br />
specific for the predator, represented by an individus or an organization (Dorminey,<br />
2010):<br />
• “Predators seek out organizations where they can start to scheme almost<br />
immediately upon being hired.<br />
• At some point, many accidental fraudsters, if not caught beforehand, will move<br />
from the behavior characteristic of an accidental fraudster to that of a<br />
predator.<br />
• Financial statement fraud perpetrators often appear to start as accidental<br />
fraudsters, or even just as earnings managers, and sooner or later become<br />
predators”.<br />
The antifraud professionals concluded that the perpetrators are better organized, have<br />
better concealment schemes, and are better prepared to deal with auditors and other<br />
oversight mechanisms or entities. As a result, the recommended tools for exposing<br />
them are professional skepticism, brainstorming and critical thinking. In essence, all<br />
these tools, are recommended by the international audit standards as for example<br />
ISA 240.<br />
The losses caused by individual fraudster can be substantial, but, in case of collusion,<br />
losses increase dramatically. Cressey analysed the individual and accidental<br />
fraudulent. The big and complex fraud cases, registered in the last years, impose a<br />
new approach in fraud detection: predators and fraud under conditions of collusion.<br />
The fraudster can be considered to have a strong personality, a good self control and<br />
deals also very well with stress: the fraudster lies convincingly and possesses the skill<br />
to keep track of the lies, so that the overall story is credible. In this respect, for<br />
internal and external auditors it is more difficult to detect fraud cases being known the<br />
fact that fraudsters also alter or hide or alter documents.<br />
4. WHAT ARE THE STATISTICS SAY?<br />
In May 2010, COSO published its survey on US public corporations’ fraudulent<br />
financial statements (COSO, 2010). The survey covers an extended period, 1998-<br />
2007, few years being subsequent to the issuance of the Sarbanes-Oxley Act. This fact<br />
is not altering the survey’s conclusions; separate analysis on the period after SOX<br />
implementation didn’t reveal significant changes in the conclusions.<br />
The survey emphasize that 26% of the companies registering fraudulent financial<br />
reporting have changed the auditors in the period between the last correct financial<br />
statement and the first fraudulent one; 60% of the them have changed the auditor in<br />
the period when they registered the fraud and the rest of 40% have changed the<br />
auditors in the previous fiscal period they registered frauds. This can be explained by<br />
the fact that the new auditor needs time to understand the specificity of the company’s<br />
activity and its internal control system. This is more time consuming in case of big<br />
and complex companies, having particular activities. This is the reason why, an<br />
important attention is needed by the financial auditor in the client acceptance phase<br />
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and later in the documentation phase. For the auditor is crucial to analyze and<br />
understand the internal control system of the auditee. In this respect, it is necessary to<br />
be fulfilled all the ISA 315’s requirements.<br />
Another important conclusion of the survey is that the majority of the frauds were<br />
registered in more that 1 year, the average period being 24 months.<br />
Starting from the responsibilities of the board and audit committee members, the<br />
survey analyzed some board governance characteristics aiming at finding correlation<br />
between these characteristics and fraud actions. In this respect, the survey has<br />
analyzed characteristics like:<br />
� composition of boards<br />
� audit committee’s composition and number of meetings. It is important to<br />
emphasize that 95% of the companies registering fraudulent financial reporting<br />
had the audit committee composed by three members, many of them<br />
(comparing with the companies having correct financial reporting) having<br />
knowledge and experience in accounting and finance.<br />
The survey showed that 11% of the board members had knowledge in accounting and<br />
finance, having a higher weight comparing with non fraudulent companies. The<br />
fraudulent companies scheduled more board meetings. This fact can be explained by<br />
the possible existing financial pressure at the top.<br />
The survey didn’t revealed significant differences in the composition of boards<br />
between the fraudulent companies and the non-fraudulent ones. As a result, we can<br />
conclude that more important are:<br />
� the governance process itself,<br />
� the quality of the documents and analysis at this level,<br />
� communication between the executive managers and the external auditors,<br />
audit committee and executive managers and audit committee and external<br />
auditors.<br />
� focusing the board meetings debates just on financial figures without assessing<br />
the financial reporting process can be the cause of cases of fraudulent financial<br />
reporting.<br />
In this respect, we appreciate that for the auditors will be useful to check to what<br />
extent were analyzed by the audit committee and the supervision committee the fraud<br />
detection and prevention process and the overall internal control system. Studies in<br />
the filed have emphasized that companies had implemented whistleblower<br />
applications, permitting to report - under anonymity – frauds and unethical behavior,<br />
had diminished by 50% of fraud cases.<br />
The same survey retained that there were no differences between fraud and no-fraud<br />
firms in the number of directors who left the board during the first fraud year. In the<br />
same time, a large majority of both fraud and no-fraud firms had compensation<br />
committees and were registered relatively few differences in their characteristics.<br />
The COSO study emphasize that fraudulent financial reporting was registered in all<br />
industries and in companies with different size. Even new companies were identified<br />
as fraudulent. It is proved that big companies have registered less fraud or fraudulent<br />
~ 571 ~
eporting cases, but the implied amounts were significant more important. The<br />
explanation for the frauds in small firms stays in the fact that they are more exposed<br />
to fraud because of lack of controls or the inadequate internal control system.<br />
The fraud remains undetected in many cases. The same survey showed that big<br />
six/four audit companies audited 79% of the fraudulent companies. For the<br />
223 fraudulent companies in the survey sample, 43% obtained unqualified auditor<br />
opinion, 56% obtained unqualified auditor opinion along with explanatory language.<br />
Just one firm registered qualified auditor opinion. This conclusion emphasize the fact,<br />
underlined by IASs, that detecting fraud imply different tests and procedures that<br />
those imposed by financial audit reviews. We all must be aware of the fact that will be<br />
never possible to prevent and detect all frauds. It must be taken into consideration the<br />
significant number of accounting records determining sampling and substantive tests.<br />
The samplings, even performed on most accurate techniques together with the<br />
substantive tests aim at identify routine errors determined by inadequate or missing<br />
controls and unintentional errors in accounting system. In case of frauds, we are<br />
dealing with intentionally actions, run based on predefined schemas aiming to hide the<br />
action. The red flags can appear in relation with a limited number of transactions that<br />
can or can not be selected in the audit sample.<br />
Studies on fraud problem have emphasized that the fraud was detected as a result of:<br />
information provided by the employees, clients, providers, anonym sources or<br />
accidentally. A recent document issued by ACFE (Association of Certified Fraud<br />
Examiners) notes that ”The inherently clandestine nature of fraud means that many<br />
cases will never be revealed, and, of those that are, the full amount of losses might not<br />
be uncovered, quantified or reported” (ACFE, 2010). The ACFE study retains that<br />
individuals having high position in the organization, and implicitly having experience<br />
and high education level, register the highest rate of fraud. As a result, the study<br />
brings up the problem of trust given to the employees. Individuals who work for an<br />
organization a longer period of time engender more trust from their co-workers. They<br />
may also acquire higher level of authority; they succeed to consolidate professional<br />
relation inside and outside the company and get better understanding of procedures<br />
and means to evade internal controls. Their skills, abilities, authority and position will<br />
permit to conceive sophisticated fraud schema. As a result the losses increase. For<br />
higher position in the organization operate less standard controls and the individuals<br />
on these position based on their expertise and knowledge have the ability to avoid the<br />
existing controls. As we already stated in a previous chapter, they have the power to<br />
attract other individuals in the fraud actions.<br />
5. HOW WE CAN MITIGATE THE FRAUD?<br />
Based on the analysis on fraud cases the auditing profession has adopted more<br />
rigorous auditing standards and procedures underling the importance of professional<br />
skepticism, promoting discussions in the audit team regarding moments or activities<br />
that can provide opportunities for fraud, adequate test considering fraud when<br />
conducting a financial statement audit etc. Regulators have issued more severe rules<br />
and legislation. Complex teams build from fraud forensic specialists and software<br />
developers have develop dedicated software aiming at adding continuous monitoring<br />
features to back-office systems. But the continuous increasing trend of frauds imposes<br />
more efforts to mitigate the fraud problem.<br />
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Knowing the factors that contribute to the fraud it is more easily to find ways to<br />
mitigate the phenomenon. In this respect, the most important factors that contribute to<br />
fraud success can be considered the followings:<br />
1. Inadequate leadership at the top;<br />
2. Poor internal controls, including inadequate monitor or individuals’ work<br />
review;<br />
3. Management override of internal controls;<br />
4. Autocratic senior management;<br />
5. Aggressive accounting policies;<br />
6. Collusion between employees;<br />
7. Collusion between employees and third parties;<br />
8. Management less focus on ethical values and culture;<br />
9. Insufficient external and internal oversight.<br />
It can be mentioned that, in cases of collusion, internal controls centered on<br />
segregation of duties are generally ineffective in preventing fraud and other financial<br />
crimes. Many companies have recognize that the frauds could be prevented by<br />
implementing effective controls. In this respect organizations are implementing<br />
tighter controls and broader oversight. The management is more aware that fraud<br />
prevention and detection processes must be design, implemented and periodically<br />
tested and improved. Their measures must focus on controls that diminish the<br />
opportunity to commit fraud. Management can’t operate on the employees’ need and<br />
rationalization but can limit the fraud opportunity. In this respect, organizations must<br />
design and implement processes, procedures and controls that effectively detect<br />
fraudulent activity if it occurs. An important role plays the organization culture and<br />
ethic. The employees must be aware of the fact that the fraud phenomenon must be<br />
revealed and that they are the first to report the events even if it is a suspicion of<br />
fraud. The employees can be the first to identifying changes in the behavior and life<br />
standard of theirs co-workers that can be important flag alerts of possible unethical<br />
actions.<br />
Distinct red flags can be established for employees and management. Some red flags<br />
that may indicate the fraud risk in case of the employees can be considered the<br />
followings:<br />
� uncomfortable being reviewed their work or uncomfortable to share<br />
responsibilities with another colleague;<br />
� strong desire for personal gain or higher gains;<br />
� showing a “beat the system attitude”;<br />
� frustrations;<br />
� live beyond their means, changes in individuals‘ lifestyle and behavior;<br />
� significant personal debt and credit problems;<br />
� too close relationship with customers or vendors;<br />
� refusal to take vacation or sick leave;<br />
� high employee turnover, especially in those areas which are more vulnerable to<br />
fraud;<br />
� lack of segregation of duties in the vulnerable area.<br />
For the management part, red flags can be considered (DiNapoli):<br />
� refuse to provide information to auditors;<br />
� engaging in frequent disputes with auditors;<br />
� making pressure on the auditors (see Enron case for example);<br />
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� management decisions are dominated by an individual or small group;<br />
� weak internal control environment;<br />
� inexperienced accounting personnel;<br />
� decentralization without adequate monitoring;<br />
� changes in external auditors;<br />
� company assets sold under market value;<br />
� high employee turnover rate;<br />
� unexpected overdrafts or declines in cash balances;<br />
� financial transaction that doesn’t make sense;<br />
� service contracts result in no product;<br />
� photocopied or missing documents, delays in offering information and<br />
documents.<br />
Studies on fraud cases consistently shows that red flags were present, but were either<br />
not recognized or were recognized and no response answer was performed. We<br />
believe that in the fraud detection process, it is important to recognize the difference<br />
between error and fraud and remember that responsibility for follow-up investigation<br />
of a red flag should be assign to the most experienced, skilled and responsible person.<br />
The success of the fraud management process implemented in the company stays in<br />
the role of the employees’ communication. A milestone, from the company’s<br />
perspective is the ethical work environment based on a code of ethic (or code of<br />
business conduct). Continuous communication and training are critical to enforce a<br />
solid ethical culture and building a positive work environment and encouraging selfreporting<br />
of unethical actions and/or compliance violations. In order to mitigate the<br />
fraud, the organization must understand the unique nature of its workforce and the<br />
vectors that motivate this workforce.<br />
The AICPA guide, "Management Override of Internal Controls: The Achilles' Heel of<br />
Fraud Prevention - The Audit Committee and Oversight of Financial Reporting,"<br />
identifies six key actions that the audit committee should consider in performing these<br />
duties:<br />
• “Maintaining skepticism,<br />
• Strengthening committee understanding of the business,<br />
• Brainstorming to identify fraud risks,<br />
• Using the code of conduct to assess the financial reporting culture,<br />
• Ensuring the entity cultivates a vigorous whistleblower program, and<br />
• Developing a broad information and feedback network”.<br />
In the article, "Preventing and Detecting Collusive Management Fraud" (The CPA<br />
Journal, October 2008), Stephen E. Silver, Arron Scott Fleming, and Richard A.<br />
Riley, Jr., suggest that, beyond the review of management's fraud risk assessment, an<br />
audit committee should consider the following questions:<br />
• “Do the internal auditors and the audit committee have the knowledge,<br />
education, and awareness of the various fraudulent management override and<br />
collusive schemes that may be perpetrated by management?<br />
• Has the audit committee reviewed a comprehensive fraud risk assessment,<br />
including how collusive fraud and management override schemes are<br />
mitigated and detected?<br />
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• Have audit committee members participated in continuing education<br />
programs that can prepare them for appraising management's fraud risk<br />
assessment?<br />
• Did the audit committee assist in the collusive and management override fraud<br />
risk assessment process, or did it rely solely on the internal or external audit<br />
group?<br />
• Does the audit committee have direct oversight of the internal audit or do the<br />
internal auditors report to management?”<br />
The present paper authors appreciate that the above questions are essential in<br />
understanding the skills, knowledge and implication of internal auditors and audit<br />
committee members on fraud topic. The audit committee’s members should focus on<br />
the personality traits and skills of top executives and others responsible for high-risk<br />
areas when assessing fraud risk or seeking to prevent or detect fraud. Routine<br />
background checks on new employees can identify past criminal convictions<br />
(Wolf, 2004).<br />
In the authors’ opinion, mitigating fraud risk implies a joint effort of board, executive<br />
management, audit committee, ethic committee, remuneration committee and units<br />
ensuring compliance, internal audit and risk management functions. External auditors<br />
must take part to this effort too.<br />
The main actors remain the board members and the audit committee members. The<br />
“tone” is provided by the board that has to fully adhere and respect its responsibilities<br />
related to the overall risk management, fraud risk being imbedded in the overall risk<br />
management process. The “tone at the top” means a clear signal insight and outsight<br />
of the company that fraud risk tolerance is zero. The board oversight will focus on the<br />
compliance with regulations regarding fraud and the effectiveness of the fraud<br />
prevention, detection, investigation and remediation. Good corporate governance<br />
determines strong ethical principles an organizational culture promoting those ethic<br />
principles and values. The “art” and knowledge of the top management is to come<br />
down these principles from the written code in the day-to-day activities and make all<br />
the employees adhere to them. The board has to oversee the antifraud process<br />
implemented by the executive management and assess its effectiveness. If the<br />
executives are let to operate without ensuring the proper feedback, the board is in the<br />
impossibility to cover its responsibilities in an appropriate manner.<br />
Non executive members of the board are also members in the audit committee and<br />
they must become the catalysts in the overseen process. They are an important vector<br />
implementing the board requirements in the audit (internal and external), compliance<br />
and risk area work and ensuring the feedback from the audit committee to the board<br />
regarding the conclusions of the financial reporting, internal control and monitor<br />
processes’ effectiveness and compliance. The authors believe that the role of audit<br />
committee increases as a result of the new requirements in the risk management and<br />
compliance area. From the fraud management perspective the audit committee must<br />
ensure a proactive approach in fraud risk process.<br />
In order to mitigate fraud the implemented process must be tailored on the company’s<br />
characteristics. In this respect, for the fraud mitigation program success, it is<br />
compulsory to be identified the critical areas that can be subject of fraud actions and<br />
~ 575 ~
the potential schemas that can be used. A periodical internal control system<br />
assessment will emphasize the week controls or the ones that can be avoided by<br />
different executive and managerial positions. All these information, put together will<br />
emphasize the real fraud exposure and the prevention techniques needed.<br />
As the authors emphasized in a previous chapter, that it is impossible to prevent all<br />
risks and the companies must be aware that frauds can remain undetected or their real<br />
extent is not possible to be always establish. In this respect it is realistic to determine<br />
an acceptable fraud loss (exposure). All the control systems will be then calibrated to<br />
maintain fraud risk exposure under this accepted level. The fraud detection controls<br />
will be added to the prevention ones.<br />
The audit committee is asked to oversee the audit activities. In this respect the<br />
committee’s members are asked to understand how internal audit is strategically<br />
address fraud and how internal audit work is run for fraud detection. The same<br />
approach is to be considered in relation with the external auditors. The<br />
communication with external auditors must be characterized by transparence and<br />
openness from both parts. The audit committee must allocate time for assessing the<br />
executive management actions and monitor on fraud area and analyze litigations,<br />
fraud tips and fraud events. Being a communication bridge between board, on one<br />
hand, and, on the other hand, internal and external auditors, executive managers and<br />
supervision entities, the audit committee dispose of all the information related to the<br />
risk exposure and control and can provide its assessment and conclusions to the board<br />
so that the most adequate risk-related decision to be taken.<br />
The audit committee in its continuous monitor over the internal audit function must<br />
ensure audit improvement. Risk oriented approach in internal audit work is essential.<br />
Internal audit is asked to adjust its work to the identified risks and adapt its procedures<br />
and techniques to fraud detection. More than ever, today is necessary to put in<br />
practice continuous audit approach. The software tolls can ensure the extension of the<br />
transaction analysis so that sampling concept to achieve another perception. Another<br />
important role of internal audit is to ensure its support in the company’s ethical<br />
culture. Internal audit is not just a control entity it has also the role to make everybody<br />
aware of risk and ethical values. In the authors’ opinion, for the effectiveness of the<br />
control activities in general and internal audit in particular, is not enough to identify<br />
unconformities and determine their impact, maybe is more important to make aware<br />
the one that has generated the unconformity about the risk the company is exposed as<br />
a result of its action.<br />
6. FRAUD EDUCATION AND TRAINING<br />
The growing rate of fraud and the low rate of success of fraud identification raise a lot<br />
of questions related to the adequacy of the regulatory framework, the quality of the<br />
internal and external auditors’ work and management quality. The importance of the<br />
phenomenon by extent, implications and impact, social inclusively, determined<br />
substantial concern for professional bodies (accountants, internal auditors, financial<br />
auditors and fraud examiners), regulatory bodies and governments. Their response<br />
was reflected in:<br />
� IASs review;<br />
~ 576 ~
� strengthen regulations as for example Sarbanes-Oxley Act with its implications<br />
for both auditors and companies, The Combined Code on Corporate<br />
Governance and many others;<br />
� practical guides issued by professional bodies in many cases based on a joint<br />
effort as for example Managing the business Risk of Fraud issued by IIA,<br />
AICPA and ACFE.<br />
Another important issue is related to the education area. Can we talk about<br />
insufficient ethic training during university studies? Are the graduates prepared to<br />
deal with the real ethical dilemmas or accounting and fraud forensic? Are their<br />
accounting and auditing knowledge strong enough to ensure a solid base for their<br />
professional activity and further developments? Is there a gap between the theoretic<br />
and practical training of the graduates? How the university’s curriculum can be<br />
improved?<br />
The authors’ opinion is that improvements are necessary in both theoretical and<br />
practical training. Important changes can be considered in the curriculum also<br />
ensuring more space for fraud and ethical courses.<br />
Another question waiting for an answer is: How is most appropriate to teach ethics, as<br />
a stand alone topic or imbedded in accounting and/or audit topics? The authors<br />
appreciate that any of the approaches can be followed but a theoretical presentation is<br />
not going to provide the expected result. Study cases, debates, investigation<br />
techniques will increase not just the students’ interest for the topic but will succeed to<br />
offer a solid professional knowledge base for future developments.<br />
DISCUSSION AND CONCLUSIONS<br />
The fraud problem, in all its forms – corruption, asset misappropriation, fraudulent<br />
statements, registers a continuous upward trend. It is a problem affecting public<br />
organizations and private companies as well in all the countries, and all the<br />
industries/sectors. All the surveys issued on this topic emphasize this phenomenon<br />
and its increasing financial impact over the economies. The governments and<br />
regulatory bodies issued regulations aiming to strengthen the control over the fraud<br />
risk and limit its likelihood and impact. The fist documents issues in the field are from<br />
the 1990s: U.S. Sentencing Guidelines (1991), COSO (1992), Financial Services<br />
Action Plan (1999), U.S. Department of Justice Enforcement Guidance (Holder<br />
Memo) 1999. In 2000s, the regulatory bodies increased the requirements issuing new<br />
important regulations as for example: Sarbanes-Oxley Act of 2002, The Combined<br />
Code on Corporate Governance 2003, European Council on Economic Fraud 2003,<br />
Revised Combined Code with Turnbull, Smith, and Higgs Guidance 2005/2006. The<br />
response to the fraud problem stands not just in the regulatory environment and the<br />
supervision bodies’ monitor, but also in the companies’ improved governance.<br />
Companies must understand that if they are not proactively managing risk fraud the<br />
consequences could be very severe. In some industries as for example the financial<br />
and insurance, a major fraud could put out the business over night or can damage so<br />
deep the companies’ reputation that the business recovery could be extremely costly<br />
and uncertain.<br />
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As the surveys showed, solid governance ensures a diminished incidence of fraud.<br />
The key of the problem stands in the organizations’ board and supervisory bodies’<br />
vision and decision. The solution stays in the implementation of a tailored fraud<br />
prevention, detection and monitor process. The process effectiveness must be monitor<br />
and the executive management must perform periodical assessments in order to ensure<br />
the needed improvements. There is no common and predefined solution for the fraud<br />
risk management. Being part of the overall risk management process, it has to be<br />
tailored to the company’s size, profile and characteristics.<br />
The ethical aspects and the organization’ culture are extremely important for the fraud<br />
prevention and detection process. The code of ethic existence, its full understanding<br />
by the employees - meaning implications of fraud and unethical actions, way of<br />
conduct and reaction in specific circumstances, are compulsory. The periodic<br />
trainings on this topic must reveal that the code of ethic is not just a written document<br />
but an attitude and way of conduct in day-to-day activities. Here the top management<br />
implication is critical, at this level is provided the so called “ton on the top” which is<br />
very important for the employees’ acceptance and alignment to its requirements.<br />
The companies must be more are more aware that good governance, strong fraud<br />
prevention processes help increase investors, regulators and the general public the<br />
confidence in the integrity of company’s financial reports and this could help to attract<br />
and retain capital.<br />
There are no surveys on fraud topic published for Romania. The authors believe that<br />
there is an imperative need for transparence in this problem. The fraud exists whether<br />
or not it is detected or recognized and in order to limit this phenomenon we must know<br />
its specific characteristics. These characteristics are generated by the regulatory<br />
framework (taxation one being extremely important), the quality of the supervision<br />
bodies’ monitor, the quality of the organizations’ governance, the people level of<br />
education, ethic and training and many other factors. Romanian public surveys on<br />
occupational fraud will reveal all these aspects and, what is more important, the ways<br />
frauds are committed so that the most adequate solution to be found. As long as we<br />
are not going to understand were we are and how this fraud problem is affecting<br />
Romanian companies the results in the fraud prevention and detection will remain<br />
modest and ineffective. These surveys on Romanian organizations will make more<br />
aware the managers on the importance to implement an effective fraud prevention and<br />
detection process.<br />
The efforts and resources implied by these surveys are important, but the benefits are<br />
huge. A joint effort of the professionals and academic bodies having the support of the<br />
regulatory and even governmental bodies will ensure the project success.<br />
The universities curriculum must extent the space allocated to ethics, fraud and audit<br />
forensic. Practical training based on strong theoretical knowledge will ensure the<br />
graduate success in their professional life.<br />
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REFERENCES<br />
AICPA (2005) Management Override of Internal Controls: The Achilles' Heel of Fraud<br />
Prevention - The Audit Committee and Oversight of Financial Reporting, available online<br />
at http://www.businesswire.com/portal/binary/com.epicentric.contentmanagement.<br />
servlet.ContentDeliveryServlet/services/ir_and_pr/ir_resource_center/editorials/2005/AIC<br />
PA.pdf, 20 th Match 2011.<br />
Allan, R (2003) “The Human Face of Fraud”, CA Magazine, May 2003, available on-line at<br />
http://www.camagazine.com/archives/print-edition/2003/may/regulars/camagazine23440.<br />
aspx, 2 nd of March 2011.<br />
Association of Certified Fraud Examiners (ACFE, 2002) Report to on Occupational Fraud<br />
and Abuse. 2002, available on-line at www.som.yale.edu/faculty/Sunder/FinancialFraud/<br />
2002%20Report%20on%20Fraud.pdf, 10 th January 2011.<br />
Association of Certified Fraud Examiners (ACFE, 2010) Report to the nations on<br />
occupational fraud and abuse. 2010 Global Fraud Study, available on-line at<br />
www.acfe.com/rttn/rttn-2010.pdf, 10 th January 2011.<br />
Carcelo J., Nagy A. Auditor Industry Specialization and Fraudulent Financial Reporting,<br />
available on-line at http://aaahq.org/audit/midyear/03midyear/papers/Specialist.pdf, 10 th<br />
March 2011.<br />
Cohen J. Krishnamoorthy G, Wright A. “The Corporate Governance Mosaic And Financial<br />
Reporting Quality”. Journal of Accounting Literature, 2004, pp. 87-152, available on-line<br />
at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1086743, 5 th of March 2011.<br />
COSO (2010) Fraudulent financial reporting 1998-2007. An analysis of U.S. public<br />
Corporations, available on-line at www.coso.org/documents, 25 th January 2010.<br />
DiNapoli T. Red Flags for Fraud. State of New York Office of the State Comptroller,<br />
available on-line at http://www.osc.state.ny.us/localgov/pubs/red_flags_fraud.pdf, 10 th<br />
March 2011.<br />
Dorminey, D and al. (2010) Beyond the Fraud Triangle, CPA Jurnal, July 2010, available at<br />
http://findarticles.com/p/articles/mi_qa5346/is_201007/ai_n54718070/, 15 th March 2011.<br />
Gursen H. F. Fraud profile-Fraudsters’ Work and Result, available on-line at<br />
www.cimejes.com, 5 th March 2011.<br />
IFAC Manual de Standarde Internaţionale de Audit şi Control de Calitate. Audit financiar<br />
2009. Ed. Irecson.<br />
IIA, AICPA, ACFE (2008)Managing the Business Risk of Fraud: A practical Guide.<br />
Executive Summary, available on-line at http://www.aicpa.org/InterestAreas/<br />
ForensicAndValuation/Resources/PractAidsGuidance/DownloadableDocuments/managin<br />
g_business_risk_fraud_excerpt.pdf, 25 th March 2011.<br />
KPMG KPMG Forensic -Fraud Survey 2003, available on-line at<br />
http://www.amr.kpmg.com/aci/docs/surveys/Fraud%20Survey_040855_R5.pdf, 20 th<br />
December 2010.<br />
Laflèche D, Elzinga D, Seeto R. Trust and occupational fraud. How to trust is just as<br />
important as whom to trust. A Grant Thornton white paper. 2001, available on-line at<br />
http://www.grantthornton.ca/resources/insights/white_papers/Trust_and_occupational_fra<br />
ud_2010_electronic.pdf, 5 th March 2011.<br />
Oversight Systems The 2007 Oversight System Report on Corporate Fraud, available on-line<br />
at http://www.ethicsworld.org/ethicsandemployees/PDF%20links/Oversight_2007_<br />
Fraud_Survey.pdf, 3 rd March 2011.<br />
Silver S, Fleming A.S, and. Riley, R. Jr. (2008) Preventing and Detecting Collusive<br />
Management Fraud. The CPA Journal, October 2008, available on-line at<br />
http://findarticles.com/p/articles/mi_qa5346/is_200810/ai_n30993408/, 1 st of March<br />
2011.<br />
Wolfe, D and Hermanson, D The Fraud Diamond: Considering the Four Elements of<br />
Fraud, available on-line at http://www.nysscpa.org/cpajournal/2004/1204/essentials/<br />
p38.htm, 10 th March 2011.<br />
~ 579 ~
ETHICS AND RESPONSIBILITY IN IT<br />
Valerica MARES 1<br />
Bucharest Academy of Economic Studies, Romania<br />
Marius Daniel MARES<br />
Spiru Haret University, Romania<br />
ABSTRACT<br />
In this article the authors aim to create a presentation of the triangle morals-ethicsresponsibility<br />
with an accent on the current globalized society. Business ethics has to<br />
disseminate in all the corners of a company, and first of all it has to be understood.<br />
Understanding the moral criteria of behaviour in business is important because the new<br />
Organizational structures create new complications, related to information flow and<br />
information administration inside various workgroups and in the entire organization, for<br />
which there are no traditional precedents.<br />
KEYWORDS: business ethics, informatics criminality corporatist social responsibility,<br />
ethical investments, green energies<br />
INTRODUCTION<br />
Eudaimonia means happiness, and the first to talk on this theme was the philosopher<br />
Aristotel in Nichomahic Ethics where he talks about virtue that is needed by people to<br />
lead the best possible life. The main idea of Aristotel is that there are different<br />
opinions about what is best for people and these differences have to be resolved. The<br />
question is: What is good? Aristotel doesn’t look for a list of things that’d be easy to<br />
make, Aristotel looks for the highest of the goods and considers that this, no matter<br />
what it’d be, has three characteristics: it is desirable in itself, it is not desirable for<br />
another thing, and all the other things are desirable for it. Nobody lives for a certain<br />
goal except the one of goodness. And all the subordinated aims, as health and wealth<br />
are wished for the reason that they promote good and because they are good in<br />
themselves.<br />
The term ethics has at least three different meanings. First of all ethics refers to the so<br />
called manners, customs and traditions specific to different cultures. Business ethics<br />
implies introducing in daily decisions and in management strategies more norms than<br />
the law requires. P. V. Lewis defines business ethics as „that set of principles or<br />
arguments that should govern the business behaviour, individually or collectively”. A<br />
company that is socially responsible, that is it takes into account not only the interests<br />
of the shareholders but also the interests of all the groups affected by its activity, so<br />
business ethics is a cost and implies delegating resources from the trajectory imposed<br />
by a strict computation of economic efficiency. The problems and the opportunities<br />
1 Correspondence address: Valerica MAREŞ, Bucharest Academy of Economic Studies,<br />
Faculty of Accounting and Management Information Systems; email: maresvalerica@yahoo.com<br />
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created by the new technology, by the globalization process, by the privatization of<br />
the media raises new ethic and spiritual challenges for those who work in social<br />
communications. These challenges can be effectively met by those who accept the<br />
fact that, in order to serve a human being, building a community based on solidarity,<br />
justice and love, and presenting the truth about the human life are and will remain<br />
aspects central to ethics.<br />
The increase in the importance given to business ethics can be explained through the<br />
changes suffered by the strategies and the structures of the corporations. Recent<br />
currents in the managerial theory and practice, as total quality management, as well as<br />
restructuring and redimensioning processes for top companies left to abandoning<br />
many traditional practices for managing economic processes. Intricate and rigid<br />
managerial hierarchies have been considerably flattened. As a consequence, the<br />
authority and the decisional responsibility have been dispersed more and more inside<br />
the company: important decisions are taken at lower hierarchical levels and by more<br />
employees. That’s why it is required that each employee, not just the management,<br />
should understand as well as possible the complexity of the problems and how they<br />
should be reflected in the practical behaviour of the company in the economic<br />
environment.<br />
Business ethics costs: money, human resources and time, expertise, opportunities, as<br />
investments or development. Moreover, business ethics and its most visible form, the<br />
social involvement of the companies, are options that are not required by low. In the<br />
classical form of the corporatist philanthropy, in the regulated form of donation and<br />
sponsorship or in the modern form of corporatist social responsibility integrated in the<br />
management strategy, the social involvement of the companies has been perceived for<br />
a long time as a less and less necessary cost, a luxury of large corporations.<br />
On the one side, involvement in the community is the appanage of the strong ones, a<br />
distinct sign of economic power. Thus, it has taken the image of the generosity of<br />
prosperous companies. Corporations, as well as organizations that have the social and<br />
economic power, have to assume not only the role of economic agents, but also the<br />
role of caretakers of the public interest, acting to assist the communities in who’s<br />
neighbourhood they operate. As wealthy members of the society, the large companies<br />
felt they were obliged to help the poorest social groups.<br />
On the other side, when it comes to companies that imply some risk, as the tobacco,<br />
food, pharmaceutical companies, the ones that extract and process oil, community<br />
involvement took the socially convenient form of risk management strategies, being<br />
considered an efficient means to prevent and resolve the cries created by pollution,<br />
deleterious products, by the improper working conditions. Until recently, business<br />
ethics and social responsibility programs have been considered the jewellery of the<br />
crown of large corporations.<br />
Business ethics consider businesses from a larger perspective that is all the members<br />
of the society have different material needs that they have to satisfy in the economic<br />
system, through production activities, services, distribution, repairs etc. Businesses<br />
are not the only possible way to satisfy these material needs. They appeared, during<br />
the rise of the capitalism, as the most efficient solution to sustain a rapid and constant<br />
economic growth (although not lacking in crises and difficult periods), an increase in<br />
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the economic efficiency, of quality and the variety of products and services, a relative<br />
or absolute decrease of prices etc. It is essential that the society doesn’t exist for the<br />
business people to profit from it, but on the contrary, it exists to support social needs.<br />
1. SOCIAL RESPONSIBILITY AND THE NEW DIMENSIONS<br />
OF GLOBALIZATION<br />
The social responsibility of an entity means what the society expects from an<br />
organization from an economic, legal, ethic and philanthropic point of view at a<br />
certain moment.<br />
Figure 1. Level of ethic<br />
Social responsibility is a concept regarding the contribution that companies have to<br />
have at the development of the modern society, and it is also called corporate<br />
citizenship, corporate philanthropy, corporate societal marketing, community affairs,<br />
and community development.<br />
International states and institutions realized that the assimilation of the principles of<br />
social responsibility by the companies serves the objectives of durable development<br />
and led to the appearance of international standards for defining what means„desirable<br />
corporatist behaviour”. United Nations, European Union and the Organization of<br />
Economic Cooperation and Development are the most important institutions that<br />
committed themselves in creating a framework for defining social responsibility and<br />
for establishing indicators through which they can be evaluated in a transparent way.<br />
This framework has been accompanied by recommendations and principles to guide<br />
the states and the local authorities in formulating public policies that could promote<br />
and ensure transparency and support social responsibility initiatives.<br />
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Figure 2. Connection between companies and communities<br />
In order to prove that it is socially responsible, a company has to understand which is<br />
the social responsibility principles promoted at an international level and to<br />
periodically report in order to integrate these principles in its activities.<br />
Without being perceived as a sign of economic power, social responsibility takes now<br />
a form of corporatist civics – a way of keeping the business relationships stable and<br />
profitable for all the parts involved, a non-aggressive way, a least detrimental<br />
functioning way next to a community, a friendly way to communicate with the<br />
society. In this form, social responsibility is nothing less than a modern, open and<br />
flexible way of management. The practices and programs of social responsibility thus<br />
become accessible and more and more interesting for small enterprises in their<br />
business environment.<br />
Social responsibility is often seen wrongly as the exclusive responsibility of the brand<br />
manager, rather than a common responsibility of all the top managers in a company.<br />
This happens because, indeed, many companies started doing social responsibility<br />
after being surprised by the answer of the public to some of the aspects of their<br />
activities that they didn’t see as part of their business responsibilities. For example<br />
NIKE had to stand a mass boycott after the media denounced the abusive work<br />
practices of some of their suppliers in Indonesia.<br />
In the business practices from small enterprises, the differentiation between<br />
management and shareholders is vague and employees have multiple roles and the<br />
main activities aim at solving the daily problems, which is done mainly through<br />
informal relationships and communication. Also the interpersonal relationships play a<br />
very important role. Moreover, when it comes to small enterprises, one can talk of an<br />
increase degree of interdependence in the relations with the communities. Often, the<br />
companies get involved in the life of the community through charitable actions. It<br />
should not be forgotten that the small enterprises are vulnerable on the market; they<br />
are subject to pressures done by the large companies for which they are suppliers of<br />
products and services. The standards and the models of social responsibility are<br />
promoted as a solution to the more and more difficult problems that the small<br />
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enterprises have to confront on the European market. The uncertainty generated by the<br />
pressures of the large companies, the unstable position on the former traditional<br />
markets force the small enterprises to create strong partnerships, personal<br />
relationships that can offer trust. It will be noticed a tendency of the small enterprises<br />
to compensate the instability on the market with an increase of stability of the<br />
interhuman relationships, with the employees, the business partners and the clients.<br />
The social involvement of the small enterprises leads to an increase of the reputation<br />
in the community, to improving the personal image of the owner and of the<br />
administrator, and to increasing the trust in the enterprise, to increasing the loyalty<br />
towards the company. All these guarantee the stability of the relationships with the<br />
business partners, with the employees and the community.<br />
There are also other factors that discourage the practices of social responsibility in<br />
small companies: lack of managerial culture of the owners and administrators, an<br />
aggressive attitude towars the market and competition of the small company<br />
managers, the paternalist and authoritarian management style, conservatism, the<br />
refuse of innovation in business practices.<br />
In order to support companies the General Secretariat of the UN has created a<br />
program Global Compact which is a partnership between United Nations and<br />
companies for attaining a durable development at global level. Global Compact is a<br />
network that comprises agencies of the United Nations, companies, union<br />
organizations, business organizations, academic organizations, civil society<br />
organizations, governmental/administrative institutions and is oriented towards social<br />
responsibility on the basis of 10 universal principles, divided in domains of interest<br />
and on dimensions: internal and external.<br />
2. THE ETHIC INVESTMENTS IN IT<br />
As soon as the interest of the public towards corporate responsibility increases, there<br />
appears and grows considerably a new category of shareholders, who are interested<br />
not only in the profitability of their investment, but also in the moral correctness and<br />
the social responsibility of the companies in which they have shares. Unlike militant<br />
shareholders, the adepts of ethical investments don’t use directly their investments for<br />
forcing companies to listen to their opinions and take them into consideration. They<br />
look for those investments which are in the same time profitable and compatible with<br />
certain ethical standards. In Cowton’s definition, ethical investments are those that<br />
„use ethical, social and ecological criteria for selecting and administrating investment<br />
portfolios when it comes to shares of certain companies”.<br />
The criteria for evaluation and selection of the companies can be negative or positive.<br />
Those removed from the list of ethical companies are often the companies that<br />
produce or trade alcohol, tobacco, military equipment and any products that are<br />
detrimental to the environment or whose production is pollutant and consumes<br />
nonregenerable resources. Companies that support oppressive political regimes<br />
exploit cheap work labour from poor countries and employ minors; and finally the<br />
companies that violate the rights of animals, that endanger biodiversity and those that<br />
promote genetic engineering etc.<br />
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The companies that meet the positive criteria are those that are involved in conserving<br />
and protecting the environment, in improving public transportation and living<br />
conditions, repairing and conserving buildings and architectural monuments, those<br />
that promote „green” energies and those that ensure the equality of chances when<br />
promoting employees, work safety conditions etc.<br />
Besides the normative ethic motivation, the ethic investments can be desirable also<br />
from a strictly economic point of view. The risks of having the public boycott some<br />
products that are not accepted or the risk of ecologic disasters can influence the<br />
dynamics of shares and the ethic companies are less exposed to such risks.<br />
On the other side, the success on the market of ethic products can make the<br />
investments they finance very attractive. The majority of ethic investment funds make<br />
the selection of companies in whose shares are interested starting from the data<br />
offered by the market. The profitable companies are then selected from ethic<br />
onorability criteria, resulting a classification that is periodically re-evaluated and<br />
made public. In practice the selection of the criteria and of the companies that meet<br />
them is not at all easy. For example, many corporations from the electronic industry<br />
produce household and medical equipment as well as military equipment. In the same<br />
time, the investment in bank shares is not safe enough, because banks can finance<br />
companies that don’t meet the criteria of ethic investors.<br />
In Romania, far from being an ethic undertaking, social responsibility is a possibility<br />
of the companies to move the attention of population to legal obligations they should<br />
meet in welfare actions. For example a company that is a big polluter advertises for its<br />
action of planting trees that it does with volunteers, calling these actions „corporatist<br />
social responsibility” and ethic investment.<br />
The ethic investment movement spread considerably, with effects that are not<br />
negligible. By aiming at investments towards corporations that meet certain moral<br />
standards, investors don’t exert an influence just on the policies of a certain company,<br />
but also stimulates the other corporations to reconsider their ethic behaviour in order<br />
to avoid a possible and predictible decrease of their attractiveness on the capital<br />
markets in a short tem perspective.<br />
3. THE ETHICS OF THE IT WORKFORCE<br />
The sensitive personnel problems confronting the multinational IT corporations are<br />
the following:<br />
1) The payment of the employees, who work for multinational companies in<br />
countries with a development level sensibly lower than in their home countries. It is<br />
imputed to foreign investors that they exploit the labour from underdeveloped<br />
countries, paying a couple of times less expensive the same labour done by employees<br />
in their home countries with similar qualifications. On the other side the former are<br />
disadvantaged by the fact that, by moving the investment and the production units to<br />
the third world, there will be an increase in unemployment in the developed countries.<br />
Transnational corporations are fiercely criticized for adopting selfish policies, in the<br />
pursuit of maximizing profit, and they break that hypothetic social contract with<br />
different categories of shareholders, causing prejudices to employees from their home<br />
countries – who lose their work and who’s union pressure decreases in intensity when<br />
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the owner can menace with relocation of investments in other countries – and to<br />
employees from the third world – who are exposed to an equivalent work load to<br />
those in developed countries but are paid worse. The counter arguments are numerous<br />
and powerful. First of all the alternative for the employs in the underdeveloped<br />
countries is to have a low pay (compared to the employees from the developed world)<br />
or to not be paid at all, as long as the main point of interest for the foreign investors is<br />
the low cost of the work force. It can be stated, many times rightly, that the salaries<br />
offered by multinational corporations are sensibly higher than the average from the<br />
poor countries in which these companies operate.<br />
Besides the work environment offered by these multinationals is more correct, more<br />
civilized and some principles when recruiting ad promoting labour are being<br />
implanted in the countries from the Third World, thus creating more evolved models<br />
for the leadership for treating the workforce.<br />
On the other side, well paid employees from advanced countries are invited to accept<br />
the lows of the market and of competition. Maintaining high salaries is not an absolute<br />
privilege, not correlated with efficiency, productivity and efficiency. It is said that is<br />
the work places would be maintained at any cost, as well as the very high level of the<br />
salaries, the competition would take advantage and would invade the poor countries,<br />
where it would create products and services with a similar quality, but much cheaper,<br />
which would allow them to reconquer the market, ruining in the end the competitors<br />
that don’t adapt. The end would be tragic: bankruptcy, that is unemployment, reduced<br />
budgetary funds for social assistance, fewer internal resources for investments (newly<br />
created work places) etc In a word, after a short while a „social” policy of<br />
multinational corporations would have extremely bad consequences for everybody.<br />
2) The management of branches from other countries of multinational<br />
corporations raises a lot of ethic problems. Many companies prefer to offer low credit<br />
to local managers, and implant managers from their home countries to the<br />
management of local branches. These managers sometimes don’t know well enough<br />
the traditions of the local problems and are not flexible enough towards the wishes<br />
and the difficulties of the partners and the employees from the countries where they<br />
are implanted. This is the main reason why, in these last years, multinational<br />
corporations adopted a policy of managerial adaption, and promoted more and more<br />
actively local leaders, trained professionally in the west, where they can learn the<br />
methods and techniques of modern management.<br />
3) Women discrimination is a delicate problem; the investor companies are not<br />
necessarily culpable of it, because it is not its managers are those who impose it, but<br />
the local traditions and religious beliefs. Multinational corporations are criticized by<br />
the public opinion from the origin countries that they are not more determined in<br />
having an active policy, even aggressive, for eliminating women discrimination from<br />
the Third World, where it represents a hard to combat practice. Other, more<br />
reasonable critics, refer to the fact that, in some countries where religion doesn’t<br />
prevent women from playing a role in economic life, the sexual discrimination takes<br />
other forms, as employing mainly women because their salaries are lower than those<br />
demanded by men.<br />
4) Employing minors is, obviously, the most often incriminated aspect and<br />
obviously the most criticable, in terms of personnel problems of the multinational<br />
corporations. Thus it is deemed that without the material support of the children<br />
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employed, their families would lack subsistence means, and those kids would have to<br />
choose between dying of hunger and begging, stealing and roving. It is certain that<br />
education, health and psychosomatic development of the children that work while still<br />
young, are affected, and their future is sombre. By removing an appreciable number<br />
of children from the educational circuit, the qualification of labour from the poor<br />
countries stagnates at a very low level, with long term consequences in the<br />
development and modernization of these countries. Thus the evil is done at individual<br />
as well as at social level.<br />
5)The measures taken to protect the employees constitute a problem for<br />
international companies in terms of their public image in the origin countries and less<br />
in the weakly developed countries in which they operate., although it is the employees<br />
in poor countries that suffer. In the third world the labour legislation is weakly<br />
developed or practically inexistent, thus the standards for protecting the personnel at<br />
the work place are very low compared to the developed countries. That’s why<br />
multinational corporations take much fewer measures for protecting the labour in the<br />
branches from the third world as they do, forced by the legislation and by the public<br />
opinion. In their origin countries, as a consequence there are many accidents, with<br />
victims and grave mutilations of the employees at the work place. It is imperatively<br />
required that the multinational companies should be more exigent in terms of work<br />
safety. They don’t reject the idea and take some measures, but not much, invoking<br />
profitability and competitively. If they spent as much as necessary for the safety of the<br />
employees, the costs would increase significantly and if some competitive companies<br />
don’t’ take these measures, they risk to be pushed out of the market, which should<br />
bring back again the old dramatic dilemma of the workers from the poor countries:<br />
risks and low salaries, versus no salaries. All that can be achieved through good<br />
intentions is a compromise of the two requirements – the economic and the moral<br />
ones.<br />
When we want to talk about these we have to have an emphasis on people more than<br />
on simple technological actions in themselves. The teologic perspective on hackers is<br />
that they’re nothing else than the effect of sin that once entered in the world affects all<br />
its domains. No punishment will succeed in removing these deeds, because the real<br />
change of man should not start from the exterior towards the interior, but from interior<br />
towards exterior. The majority of those who are caught and jailed will not learn<br />
anything from this experience, but this doesn’t mean they don’t deserve to be<br />
punished for what they did, but they have to realize they need a change from interior<br />
towards exterior. When their heart will be good, when their thoughts will be pure,<br />
when their conscience will not condemn them anymore because their deeds are good,<br />
then they will be truly changed. But it is not enough to condemn just the sin, thus<br />
becoming irresponsible for our deeds. The sin has entered the world through the first<br />
people but this doesn’t mean we’re not able to be the masters of the sin. We have to<br />
respect ourselves and for the ones around us, because once we have this respect we<br />
will not allow ourselves to enter the private domains of those around us without<br />
asking for permission.<br />
4. SECURITY OF INFORMATION SYSTEMS AND E-CRIMINALITY<br />
The impressive development of technology led to an increase in profits, on the one<br />
side, and to an increase in dangers and fearfulness on the other side. As the electronic<br />
media become more accessible to the general public, the informatics criminality is<br />
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developed and diversified, becoming more than traditional fraud or falsification. On<br />
Internet, information became the cheapest weapon in the world, but the problem of its<br />
security gives headaches to the world’s powers, as on Internet every computer is like a<br />
leaf of a tree and the network components are like branches. It is enough to cut a<br />
branch and its result is equivalent to cutting the leaf.<br />
The sophisticated world of the informatics systems is extremely alluring being a<br />
digital world where are possible electronic businesses, efficient documentation over<br />
Internet, distance learning, instantaneous communications, but apart from that the<br />
information technology is not lacking in risks – one of the most important being the<br />
criminality.<br />
The notion of informatics criminality is now more than the traditional definition<br />
referring to criminality against informatics systems, and also includes most crimes<br />
that can be done over the Internet using information systems.<br />
Informatics criminality has a very high price in economic terms as well as from a<br />
human security perspective. Before the age of developing informational technologies,<br />
the main concern in regard to informatics data was keeping their confidentiality,<br />
something that could not be achieved by simply protecting them physically (for<br />
example, by locking them with a key in the rooms were information was being<br />
stored).<br />
Nowadays, along with the confidentiality there are the important aspects of security of<br />
the IT that have become a complex and concerning problem for all organization types,<br />
being in the same time a legal requirement. In order to ensure the security of the IT<br />
and of the personal data, the authorities and public institutions with competences in<br />
the field, the service providers, nongovernmental organizations and other<br />
representatives of the civil society have common activities and programs in order to<br />
prevent e-criminality.<br />
Criminals can launch massive attacks with informatics viruses against<br />
telecommunication networks for defence, electric power, gas and water or against the<br />
systems for traffic control for aeronautic, naval and terrestrial industries, against<br />
informatics systems of banks, stock exchanges, insurance societies, that can disturb<br />
the activities in these fields.<br />
The security requests of the informatics systems are based on a number of operational<br />
and integration, legal, social, moral and human aspects with other informatics<br />
systems. Informatics criminality can have severe consequences that can extend to<br />
heavy financial and reputation losses that also come together with the security events,<br />
and in these conditions the security management of the informatics systems becomes<br />
extremely important.<br />
In respect to criminality in the field of data networks, especially Internet, one can<br />
distinguish the infractionality that aims at paralyzing the entire system or a part of it<br />
or a structure that works with it, through virus programs or attack of the type Denial<br />
of Service (DoS).<br />
The age in which hackers wanted to prove their programming abilities has passed.<br />
Meanwhile they discovered opportunities to make profit over Internet, as through<br />
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Phishing. There are numerous traps through which criminals can get rich in the virtual<br />
space, as by cloning the sites of banks, when the client receives an e-mail in which it<br />
is required to enter on the site of the so called bank, the account data, the username,<br />
the password and the secret access codes, and all the thief have to do is to empty the<br />
account. According to the estimates of the Organization for Security and Cooperation<br />
in Europe (OSCE), the informatics criminality produces an annual loss of 100 billion<br />
dollars. The German association of the commercial society claims that in Germany, in<br />
2007, the total value of the damage amounted to 13 billion euro. Other studies say that<br />
e-criminality has become even more profitable than drug traffic. The international<br />
authorities for legal pursuits have identified three regions in the world from which<br />
come the majority of the trap e-mails: Russia, China in Brazil, areas in which the<br />
illegal businesses flourish. The interest of the hackers is mainly focused on the<br />
passwords of top-managers, in order to obtain extremely valuable information.<br />
In the current crisis conditions it is to be noted that e-criminality is done more<br />
frequently through:<br />
� a larger number of viruses, worms and Trojans that attack computer networks;<br />
� sending by email of false deduction coupons in the name of well known<br />
companies;<br />
� an intensification of attacks caused by spyware, scanning ports, informatics<br />
sabotages, pornography, computer thrift (desktop and mobile), abuses of<br />
employees;<br />
� an increased incidence of attacks from within organizations;<br />
� attacks executed from outside that are aimed at countries like: USA, China,<br />
Russia, Nigeria, South Korea, Germany and India.<br />
More and more attacks are done through zombie computers grouped in networks<br />
called boot net through which criminals’ pirate computers, without the knowledge of<br />
the owners of the computers and use them for sending spam or for destroying other<br />
computers. Programs can be distributed in different ways, one of them being as<br />
attachment to e-mail or downloads from certain sites. Few technologies can provide<br />
protection against all these phenomena that continue to increase (e.g. in December<br />
2007 approximately 65% of all e-mails were spam) and a solution is being searched<br />
which would solve the current challenges. The concept of Unified Threat<br />
Management (UTM) offers a global approach to the problem of the security of IT, by<br />
protecting the clients against attacks of versions types as:<br />
� scanning IP Reputation;<br />
� anti-spam based on patterns of messages;<br />
� white lists and blacklists;<br />
� antivirus based on signatures of families of viruses;<br />
� protection against “zero-hour outbreaks”;<br />
� intrusions prevention systems at the e-mail level.<br />
The informatics criminality does not comprise only spam and viruses; it can also<br />
strike other aspects of the economic and social life. There have been cases when the<br />
adepts of different terrorist organizations, on certain occasions, as the success of some<br />
of their actions, build site of sympathy for such groups, presenting details for<br />
preparing them and congratulating the courage and the mastership of terrorists as if it<br />
was a game. Other sites provide updated information for creating bombs or<br />
instructions for manipulating explosive substances.<br />
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Another category of terrorist activities over Internet is the dissemination of messages<br />
of hate and incitation to violence through the Web pages and unfortunately things<br />
don’t stop at such activities, which in most cases are a precursor of real terrorist<br />
actions and can get to incitation to attack and finally to organize grave criminal acts.<br />
Criminal organizations have converted with an amazing speed to the most<br />
sophisticated technologies and they use encrypted software for communicating over<br />
Internet with a high degree of security. Network is a formidable means also for<br />
organized bands that deal with drugs and arms traffic, as well as medicines, with<br />
washing black money etc. because these bands understood that Internet is an ideal<br />
communication means, cheap, fast and pretty secure when using encryption software.<br />
In many countries of the world, displaying and distributing obscene materials in<br />
public is against the law. There is no doubt that Internet, through its open nature, has<br />
become such a place. Thus, performing such activities through a mega - network, is<br />
most of the times prone to breaking the law. Nevertheless locations that contain<br />
materials for adults are very numerous and the growing number of these sites and the<br />
negative impact of disseminating obscene materials, of popularizing child<br />
pornography on Internet have led to an increasing concern of the public opinion<br />
regarding the multiplication of such an activity over the network. The fact that deviant<br />
behaviour has moved their place of action does not change their criminal nature.<br />
Apart from the older forms of e-criminality related to Internet, there are also some<br />
new ones like: “offers for adoption” that cover selling of children or organs for<br />
transplant.<br />
Despite the sustained efforts of a company to protect its clients, a growing number of<br />
users of the Internet have lost their faith in the efficiency of the security methods and<br />
that’s why a new culture of security is required in the contemporary society.<br />
Pirating computer software represents another form of criminality related to Internet.<br />
It is achieved by downloading programs spread over the Internet, on a computer,<br />
when this operation is not authorized by the titular of the author rights.<br />
The European Union and the Council of Europe have projects on cooperation against<br />
cybercrime in Eastern Europe. Public and private sector organisations and initiatives<br />
engaged in this field, such as the European Union, OECD, Interpol, ICMEC, ECPAT,<br />
eNACSO, La Strada and Microsoft promoted good practices and contributed to the<br />
discussion on strategies and policies to promote a safer Internet for children.<br />
5. ETHIC CONTROVERSIES OVER ENVIRONMENT PROTECTION<br />
This is the battlefield of the most disputes concerning global warming and<br />
multinational corporations are the first to be incriminated, because environment<br />
destruction, which often claims life’s, produce grave, often irreversible effects not<br />
only in the countries where they take place, but they also affect the global climate, the<br />
quality of water and air on a global scale. The causes of ecologic destructions are the<br />
same as in the case of insufficient employee protection at the work place: the<br />
legislation is very permissive, the local population has a low degree of technological<br />
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competence and doesn’t understand the dangers to which it is exposed, the high costs<br />
of non-polluting technologies etc.<br />
In fact, the case that brought a focus on international business ethics was the disaster<br />
from Bhopal, in India, but the earthquake and the tsunami from Japan, from March<br />
2011 and the explosions at the nuclear power plant from Fukushima is enhancing this<br />
discussion. Faced to these phenomena, the reaction and the pressure of the<br />
international public opinion have been strong enough to force transnational<br />
corporations to accept that they have an obligation to take radical measures for<br />
ecologic protection in the countries where the local legislation doesn’t impose very<br />
high standards, by covering the higher costs that are required by non-polluting<br />
technologies as well as by advertising and training the personnel and the population.<br />
Faced with this set of problems, the competitors (their vast majority) have silently<br />
agreed to be more responsible towards the ecologic dangers, because the public<br />
opinion from their origin countries have an extremely hostile attitude towards the<br />
companies with a dubious reputation in terms of environment protection policy.<br />
Due to the variety of cultural values and moral principles around the planet and<br />
because the accommodative policies had inacceptable effects, there appeared more<br />
and more strongly the idea of elaborating international ethic codes, with the explicit<br />
agreement of government or non-government associations, in which the main role<br />
goes to the large transnational corporations.<br />
The International Institute for Business Ethics proposes the following three basic<br />
principles for companies:<br />
• INTEGRATION: Business ethics has to be implemented in all the aspects of<br />
the organizational culture and it has to be reflected in managerial systems.<br />
Companies have to start by integrating the ethics in fixing the objectives and<br />
the practices for recruiting, employing and promoting the personnel.<br />
• IMPLEMENTATION: The ethic behaviour is not just an idea; it is also an<br />
effort for implementing a plan for changing the attitude in different activity<br />
branches of a corporation. Examples: changing the reward and stimulation<br />
systems, promoting better practices for protecting the environment, consulting<br />
experts whenever it is required.<br />
• INTERNATIONALIZATION: The ever more extended opening towards a<br />
global market is necessary for any successful business in the 21st century. It<br />
can be achieved through international partnerships, commercial blocks and by<br />
implementing GATT agreements or other similar agreements. The clarification<br />
of a company’s definition of the moral integrity, so that it can transcend<br />
national borders, is necessary for any corporation that operates on the global<br />
market, and has as result an action plan and an ethic code without a specific<br />
cultural colour, which doesn’t require essential changes when applied in a<br />
global context.<br />
CONCLUSIONS<br />
1. The last decade saw an explosion of ethic behaviour codes of multinational<br />
corporations in international business. The majority of these codes are created<br />
according to the principles established by OECD (Organization of Economic<br />
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Cooperation and Development) and ICGN (International Corporate Governance<br />
Network). Unfortunately, many of these behaviour codes state vague truisms, and top<br />
managers and analysts recognize that there is a lot to be done in implementing the<br />
principles declared in these codes in the daily activity of companies that operate on a<br />
global level.<br />
2. Informatics criminality is a phenomenon which implied ethics and it affects<br />
the international image of a country in a negatively way.<br />
3. Many problems are still waiting for a solution that is strongly proofed<br />
theoretically and verified in practice. It is important that the most pressing problems<br />
have already been formulated and accepted by the community of transnational<br />
corporations, which is a lot. Once started, the process of evolution of ethics in<br />
international business will continue for sure, in an accelerated rhythm, hopefully with<br />
positive results, for more and larger categories of interactive groups in the global<br />
economy.<br />
REFERENCES<br />
Cowton, Ch., Crisp, R., (1998) Business Ethics. Perspectives on the Practice of Theory,<br />
Oxford University Press<br />
Crane, A., Matten, D. (2004) Business Ethics. A European Perspective, Oxford University<br />
Press<br />
Lewis, P. V. (1995). “Defining ‘Business Ethics’: Like Nailing Jello to the Wall” Journal of<br />
Business Ethics 14 / 1985, p. 839-853<br />
Petre Rău (2010) “Infracţionalitatea pe calculator“ http://www.rap.freehosting.net/Infract<br />
Stella Petecel (1998) Aristotel Etica nicomahică, Bucureşti, Editura Ştiinţifică şi<br />
Enciclopedică<br />
Tudor Amza, Cosmin Amza (2003) Criminalitate informatică, Ed. Lumina Lex, Bucharest<br />
http://www.coe.int/cybercrime<br />
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CORPORATE GOVERNANCE PRINCIPLES:<br />
AN EVOLUTIONARY APPROACH IN TERMS<br />
OF DIRECTORS-MANAGERS RELATIONSHIP,<br />
IN THE DEVELOPING ECONOMIC CONTEXT<br />
OF 21ST CENTURY<br />
Maria GROSU 1 , Roxana-Manuela DICU & Daniela MARDIROS<br />
"Alexandru Ioan Cuza" University of Iasi, Romania<br />
ABSTRACT<br />
Corporate governance is intended to guide companies in adopting best practices and<br />
appropriate behaviour both in management and in relations with the stakeholders. This paper<br />
aims to examine corporate governance principles through three different approaches. First<br />
one refers to the temporal evolution of the principles starting with their appearance in 1992<br />
until present days, presenting the countries and the bodies which had the highest influence in<br />
this evolution (Great Britain, France, United States of America, and Organization for<br />
Economic Co-operation and Development). This part contains a special reference to the<br />
application of corporate governance principles in Romania. A second approach takes into<br />
consideration the degree of development of world’s economies and their attitude on<br />
willingness to adopt and develop corporate governance principles. The third perspective<br />
analyzes the principles, considered significant in our opinion, with their presentation both<br />
from a general point of view and in the particular case of Romania: the fair treatment of<br />
shareholders and of the stakeholders vs. the well-known conflict between them, the role and<br />
the responsibility of the Board of Directors, and the transparency and the dissemination of<br />
information. In this context, an analysis of the Romanian business environment emphasises<br />
the lack of authority of the Board of Directors’ members, a requirement to independence, and<br />
to transparency. Based on the evolution of corporate governance principles and on the<br />
current state of Romania’s codes, the results of the research are to be a base for<br />
reconsidering the principles of corporate governance in Romania and worldwide.<br />
KEYWORDS: corporate governance, managers, Board of Directors, corporate<br />
governance codes, responsibility<br />
INTRODUCTION<br />
The globalization of businesses, the development of new information technologies<br />
and communications have created an environment which allowed the development of<br />
the world’s economies. Managers and directors had to adapt and to cope with<br />
situation of unknown complexity and with difficulties created by a world in constant<br />
motion. This development required a new perspective from the companies and a new<br />
approach of their management, in terms of ethics, responsibility and practice, all<br />
known as corporate governance. In addition, valuing human capital, the importance of<br />
1<br />
Correspondence address: Maria GROSU, “Alexandru Ioan Cuza” University of Iasi, Romania;<br />
email: maria_lia24@yahoo.com<br />
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skills and expertise of employees, their institutionalized knowledge, has positive<br />
valences, in the context of the 21 st century.<br />
Corporate governance (CG) is a system through which a company is managed and<br />
controlled, according to best practices in a specific field. At the enterprise level,<br />
corporate governance investigates the distribution of power and responsibilities<br />
between the organization of shareholders, directors and managers. Currently the<br />
definition of the concept has expanded and it is used to describe the act of governing,<br />
the way to administer, manage the states, world bodies and businesses. As a system, it<br />
has rules, principles and guiding lines, all these being presented in an evolutionary<br />
context.<br />
1. THE EVOLUTION OF CORPORATE GOVERNANCE PRINCIPLES<br />
AT EUROPEAN LEVEL<br />
In Europe, the first corporate governance code was the Cadbury Code (issued in<br />
1992), which formed the basis for the Corporate Governance Code of the London<br />
Stock Exchange and held three basic principles of corporate governance (Cadbury,<br />
1992): transparency, integrity and responsibility. The Code took the name from Sir<br />
Adrian Cadbury, who was the Chairman of the Board of Directors for Cadbury<br />
Company for 14 years.<br />
If transparency, demonstrated through publication and dissemination of information,<br />
promotes a determined Board of Directors (BD) and allows stakeholders access to<br />
information about the company, the principle of integrity requires the company to<br />
behave honestly in all undertaken activities. An appropriate conduct and disclosure of<br />
information required by all those interested, especially by the shareholders, should<br />
lead, according to the Code, to the principle of accountability. Responsibility as a<br />
principle of corporate governance is the effective duty of the BD and is manifested by<br />
the provision of information that meets the quality requirements in order to be<br />
relevant to decision making.<br />
Later, as a result of financial scandals that have destabilized the operation of the<br />
British system, the importance of corporate governance was reconsidered, quality of<br />
implementation of recommendations contained in the Cadbury Code being discussed<br />
in a series of progress reports issued in the coming years. Thus, in 1995, the<br />
Greenbury Report was prepared, which highlighted the problems of managers’<br />
remuneration and the reality of wage amounts released. In 1998, the Hampel Report<br />
appeared which, on the one hand, synthesized the application of recommendations<br />
from Cadbury Code for the last five years, and, on the other side hand, made a series<br />
of new proposals. After wards, the Hampel Report was followed by the Higgs Report,<br />
which gave special attention to independent non-executive directors (audit<br />
committee), monitoring how to respect the interests of shareholders.<br />
Summarizing, the recommendations contained in the Cadbury Code have considered<br />
the following aspects:<br />
• Division of responsibilities at the top level of the company to be clearly<br />
formulated and accepted by all;<br />
• The Board of Directors must be constituted of both executives and nonexecutive<br />
directors to represent the independent interests of shareholders;<br />
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• Executive directors should be appointed by the shareholders for a term of<br />
three years, as a rule, and must be subject to annual review process;<br />
• Non-executive directors should work in the independent committees (audit)<br />
and are mandated to represent shareholders' interest in fields covering results,<br />
strategy, quality management etc.<br />
• Auditor independence is essential; therefore, the Audit Committee has the<br />
task of selecting auditors so that their mission is one of quality.<br />
Even if the failure of these recommendations has not been sanctioned by law,<br />
however, the compliance of listed companies has resulted in their self-discipline.<br />
Starting from the Cadbury Code and given the reports for monitoring the progress of<br />
implementation of the recommendations, in 2000 the Combined Code of corporate<br />
governance is completed. It was perceived as a code of best practices and became an<br />
imperative requirement for listed companies at the London Stock Exchange. The<br />
Combined Code contains two parts: one part for the principles of good governance<br />
and a second part, covering the code of best practices. Both parts consist of two<br />
identical sections: Section I - Companies (A. Executive, B. Remuneration of<br />
management, C. Relationship with shareholders, D. Accounting and auditing) and<br />
Section II - Institutional Investors. The principles of good governance, set out in the<br />
first part of the Combined Code, were six and were referring to:<br />
• Every company has to be effectively managed by a Board of Directors;<br />
• Between the Presidency and the Executive Director must be a clear division<br />
of responsibilities;<br />
• The Board of Directors’ activity should be based on stability and<br />
independence;<br />
• Managers' remuneration should be linked to their achieved performance;<br />
• The Board of Directors should establish formal and transparent procedures of<br />
internal control and maintain appropriate relationships with company<br />
auditors;<br />
• In the relationship with shareholders, companies must be prepared to engage<br />
dialogue with institutional investors, but also with private ones.<br />
In addition, to implement these principles in the companies, the Code makes a number<br />
of recommendations with preventive role that refer to both sections mentioned above.<br />
Even if this code is voluntary, institutional investors require companies to either<br />
comply or explain reasons for not apply the principles and recommendations.<br />
In response to the British initiative in relation to corporate governance standards, the<br />
French doctrine envisaged both the regulatory process and the preparation of reports,<br />
the same way as the British doctrine. Regarding the legislation, in 1996, considered to<br />
be a starting year, a law was issued, that offered two models which could guide<br />
companies in their corporate governance systems. Compared to the Cadbury Code,<br />
which allows the coexistence in the BD of both executive and non-executive directors,<br />
the French notion considered a radical solution (Richard and Miellet, 2002), the<br />
application of the dualist model of governance, through a clear separation of the<br />
Executive from the Board of Directors / Supervisory Board. Another French model is<br />
the monist model, that is closer to Anglo-Saxon concept, meaning that both<br />
executives and non-executive directors met in a single (but collegial) Board.<br />
However, the monist model has been criticized because allowed increasing the power<br />
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of the President-Chief Executive Officer, directors not being able to take action than<br />
in a collegial manner. So, on the one hand, the belief was that managers had an overall<br />
responsibility, but, on the other hand, their power could only disapprove without<br />
acting in the direction of the President's conduct.<br />
In these circumstances it was considered necessary to issue rules that would enhance<br />
the power of the directors, developing a series of reports prepared by experts and<br />
monitored by the French parliament. It is about Viénot I Report, issued in 1995,<br />
Marini Report, issued in 1996, Viénot II Report, issued in 1999 (Richard and Miellet,<br />
2002), which offered several recommendations, not necessarily implemented, the<br />
reason being the rejection of the idea of change. However, since 1999, listed French<br />
companies have agreed to report on corporate governance, while respecting the<br />
principle of transparency (the publication of salaries of managers) and they have<br />
showed that they had recourse to the appointment of independent directors. An issue<br />
that has raised much discussion was the fact that the French doctrine sustained the<br />
social interest of the company over the interest of shareholders, and, because of that<br />
situation, many abuses were committed in the name of “social goodness”, in violation<br />
of law or by finding “legal openings” (Onofrei, 2009).<br />
These drawbacks were alleviated by changes in French corporate governance law,<br />
namely:<br />
• the Law adopted on May 15, 2001 introduced the obligation to publish salaries<br />
of managers by all companies (listed and unlisted); this specification is<br />
required to ensure a balance between the power of decision-making bodies, to<br />
avoid membership in several Boards of Directors, to observe the minority<br />
shareholders’ rights and to ensure the transparency of information;<br />
• Financial Security Law of 2003 provided the compliance of good practices by<br />
both companies and financial markets to ensure investor’s confidence; thus,<br />
due to financial scandals in the U.S. (see Enron, Worldcom), it was denied, by<br />
that law, the initiation of takeover bids without shareholder approval.<br />
Regarding the imposed rules, studies have shown that approximately 54% of listed<br />
French companies have complied with the corporate governance reports. In this sense,<br />
the dual governance structure was most common (either by separating the positions of<br />
President and the Chief Executive Officer, either by separating the Directorate and the<br />
Supervisory Board), to comply with a legal obligation to publish the remuneration of<br />
managers. It appeared more frequently the presence of independent directors, and<br />
companies have responded positively to Government's initiative to ensure<br />
transparency through the dissemination and publication of information, knowing that,<br />
this way, stakeholders shared information about the company.<br />
In the EEC, public information about the “Corporate Governance in Europe” appeared<br />
in June 1995. Changes and improvements to the Codes of CG occur during this<br />
period, so in March 2010, the Code “ecoDa Corporate Governance Principles and<br />
Guidance for Unlisted Companies in Europe” was adopted. It was issued by The<br />
European Confederation of Directors’ Associations (ecoDa). This Corporate<br />
Governance Code includes a set of 14 principles that focus specifically on the<br />
protection of minority shareholders in the face of possible abuses by controlling<br />
shareholders.<br />
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The corporate governance system in Europe is considered an insider system (Clark,<br />
2007), characterized by the presence of active shareholders within the corporation and<br />
it is in direct business relationship with the entity. Therefore, concentrated ownership<br />
is associated with the control, the mission of management seeks the interest of<br />
stakeholders groups, to increase added value for them. In addition, business strategy<br />
proclaims active long term involvement of the stakeholders.<br />
Important to note is that, by Directive 2006/46/EC, the Commission adopted an<br />
Action Plan announcing measures to modernize Companies law and to enhance<br />
corporate governance in the Community. Short-term priorities of Community action<br />
in this area have involved, inter alia, the following: confirmation of the collective<br />
responsibility of directors and improving information on corporate governance<br />
practices applied in companies. According to the plan of action, members of the<br />
administrative, management and supervision bodies of a company must act according<br />
to the powers which have been conferred by law. Also, companies whose securities<br />
are admitted to trading on a regulated market and which have their registered office in<br />
the Community are required to submit an annual statement on the CG when the<br />
company applies the corporate governance provisions other than those set by national<br />
laws, whether these provisions are set directly into a corporate governance code of the<br />
company or any corporate governance code which the company may decide to apply.<br />
For the adopted system of corporate governance to contribute to improving the<br />
company's potential for creating value, it is not sufficient only the concern for legal<br />
and financial dimension of corporate governance (separation between property<br />
function and directorate function), but it is also important the managerial dimension,<br />
which makes the creation of value an effect of applying a set of skills in a context<br />
based on discipline and accountability.<br />
2. THE AMERICAN DOCTRINE – A DIFFERENT APPROACH<br />
OF CORPORATE GOVERNANCE<br />
North American doctrine, in relation to corporate governance, comes in conflict, in<br />
some points, with the rules of European law (in particular, French law), namely:<br />
• In the U.S., the audit committee appoints the independent external auditor,<br />
while in France, General Meeting of Shareholders is one that takes the<br />
decision as a response to the Board of Directors proposal;<br />
• U.S. law strengthens the protection of employees who provide “important”<br />
information to leadership;<br />
• Directors who amend the annual financial statements may be required, under<br />
U.S. law, to repay bonuses and other remuneration received, while French<br />
law prohibits such practices;<br />
• Under U.S. law, auditors must provide information and documents on the<br />
company's activity to Securities Exchange Commission and other inspection<br />
authorities; the French law considers it a breach of confidentiality.<br />
For a better understanding of this specification, we must mention the fact that in US,<br />
the first “Official situation of corporate governance” was issued in September 1997,<br />
and the first set of “Corporate governance principles” was framed in 1999.<br />
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If we consider the evolution of corporate governance principles in the U.S., we can<br />
report that, in terms of managers’ remuneration increase (especially in the form of<br />
stock-options), in the 90s there was a relaxation of the ethical principles of<br />
management, and corporate social responsibility was put in a shadow by personal<br />
interest. The serious bankruptcies in the 2000s destroyed investor’s confidence and<br />
thus the principles of corporate governance were re-imposed, especially in terms of<br />
improved quality and transparency of financial reporting.<br />
Therefore, the scandals in 2000 formed the basis of reflection for improving corporate<br />
governance legislation in the U.S., but not only. In this regard, in July 2002, Sarbanes-<br />
Oxley Federal Act was issued, known as “The accounting reform of public companies<br />
and investor’s protection law”, applicable to all companies operating in the U.S.,<br />
whether indigenous or not (there were about 1,300 foreign companies operating in the<br />
U.S.). Among the important provisions of this law, we can enumerate: the president<br />
must certify under oath the company's financial statements; managers are not allowed<br />
to credit the managed company; in the event of subsequent changes to previously<br />
announced results, the managers’ participation to the profit will be readjusted; audit<br />
committee must be composed entirely of independent directors; the protection of<br />
employees' rights and their contributions to pension funds; on suspicion of fraud,<br />
Securities Exchange Commission will be able to dismiss managers without agreement<br />
with the General Meeting of Shareholders.<br />
We have noted that, under the provisions of this law, the intention was to restore<br />
investors’ confidence in American capital markets by increasing the stringency of<br />
corporate governance rules. To supplement the provisions of Sarbanes-Oxley, Richard<br />
Breeden (Chairman of the Securities Exchange Commission and the administrator<br />
appointed by the U.S. bankruptcy judge for overseeing WorldCom's bankruptcy)<br />
published in 2003 a report that makes 78 recommendations on corporate governance,<br />
including: a prohibition of overlapping of the function of President of the Board of<br />
Directors with General Manager; better remuneration of directors, with the obligation<br />
to invest 25% of net income on the stock market, buying shares in the administered<br />
company; a prohibition for administrators to be members of the Board of Directors in<br />
more than two companies; a convergence of interests of shareholders with those of<br />
managers, etc.<br />
Although the U.S. attitude towards corporate governance system was appreciated,<br />
however, the financial crisis in 2007 could not have been prevented. In particular, this<br />
was due to the acute lack of liquidity, the chain of bankruptcies, which had<br />
repercussion on investors in the sense that their confidence in capital markets was<br />
destroyed.<br />
3. THE INTERNATIONAL POINT OF VIEW ON CORPORATE<br />
GOVERNANCE PRINCIPLES<br />
Internationally, the OECD (33 members) is the organization which, in May 1999,<br />
adopted five principles of corporate governance that have emerged as the global<br />
benchmark (WB and IMF are guided by these principles in preparing their reports)<br />
and have inspired the development of corporate governance codes not only for the<br />
Member States (from 2010 are OECD members three more countries: Chile, Israel<br />
and Slovenia), but also for other countries. The corporate governance principles were<br />
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set out by the OECD in a general manner, each Member State being able to apply<br />
them according to specific national circumstances.<br />
To analyze the evolution of principles issued by the OECD, in the table below we<br />
present the codes adopted since 1999, the last update being in September 2005,<br />
according to European Corporate Governance Institute (see table 1). It is noted in the<br />
presented situation that the five principles of corporate governance, adopted in 1999,<br />
were completed both with three principles (or rules), and a general framework, issued<br />
within five years of the first initiative in this direction. Of course, in addition, some<br />
nuances have taken place in expressing, some of them quite significant. In this sense,<br />
if in 1999, the term “corporate governance rules” was used, the version of the 2004<br />
Code used the phrase “corporate governance regime”. In addition, very importantly, a<br />
new formulation is introduced, “must” instead of “should”, therefore the corporate<br />
governance principles are becoming imperative, these no longer being seen as<br />
recommendations. Consequently, improved versions of the Codes issued by the<br />
OECD increase the value of corporate governance principles and contribute to<br />
international financial stability.<br />
Table 1. The evolution of corporate governance principles according to OECD<br />
Corporate governance code<br />
Principles and regulations May<br />
1999<br />
Jan<br />
2004<br />
Apr<br />
2004<br />
Dec<br />
2004<br />
Sept 2005<br />
1. The shareholders’ rights and their key<br />
positions<br />
* * * * *<br />
2. Fair treatment of shareholders * * * * *<br />
3. The role of stakeholders in the corporate<br />
governance<br />
* * * * *<br />
4. Transparency and dissemination of<br />
information<br />
* * * * *<br />
5. The responsibility of the Board of Directors * * * * *<br />
6. Ensuring an effective legal framework for<br />
the companies in the Member States<br />
* *<br />
7. The state in the position of shareholder * *<br />
8. Fair treatment of all stakeholders * *<br />
General framework for corporate<br />
governance<br />
* * * *<br />
Given the different goals of the reform of the corporate governance on the American<br />
continent, the question of convergence of these systems was asked, especially for the<br />
reason that the business environment has features in common, without excluding<br />
management errors, accounting manipulation, bankruptcy, loss of value of assets,<br />
massive layoffs of employees, etc. In this respect, OECD has developed a guide for<br />
the convergence of corporate governance codes, which contains a minimal set of six<br />
rules applicable to listed companies, namely:<br />
• applying the principle of comply or explain;<br />
• defining the audit functions and establishing limits of action for auditors;<br />
• improving transparency;<br />
• defining conflicts of interest and their control;<br />
• improving and simplifying voting procedures and increasing the role of<br />
General Meeting of Shareholders;<br />
• increasing the role of independent directors (non-executive directors) in the<br />
company.<br />
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The implementation of these rules has been monitored by the OECD in 30 countries,<br />
and results showed that 11 states have made changes in corporate law with an impact<br />
on five or four of the six rules listed (Switzerland, Italy, Belgium, USA, Germany,<br />
Greece, Czech Republic, Poland, South Korea and Japan), eight states have not taken<br />
any change in this regard (Finland, Australia, Hungary, Denmark, Slovakia, Norway,<br />
Luxemburg and Iceland), while other states have made changes in Corporations law<br />
which affected less than four rules.<br />
4. CORPORATE GOVERNANCE PRINCIPLES IN ROMANIA<br />
In Romania, the need to implement the rules of corporate governance was determined<br />
by the privatization process which required companies to improve management<br />
practices, on the one hand, and by to transfer the control and surveillance from<br />
political organizations to specialized Board of Directors, on the other. By the issuance<br />
of the first law of privatization (in 1991), the State Council was replaced by General<br />
Meeting of Shareholders and the Board of Directors was established. The<br />
implementation of corporate governance rules was a way to harmonize internal<br />
business environment with a functioning market economy requirements.<br />
The first corporate governance code in Romania was issued in June 2000 by “The<br />
International Center for Entrepreneurial Studies” and targeted public companies listed<br />
on Bucharest Stock Exchange. The code rules have not been so well received by the<br />
market, the last one focusing especially on the ground that protects minority<br />
shareholders.<br />
Subsequently, in 2008, the Code of Corporate Governance of BSE was issued,<br />
including a number of 19 principles. Of 19 principles, 14 principles aimed, directly,<br />
the Board of Directors, its powers and functions, with emphasis on the independence<br />
of non-executive directors. This situation is surely due to the recommendations of The<br />
World Bank for our country as a result of a study undertaken for the period 2001-2006<br />
in 17 countries in transition (McGee, 2008). The study focused on changes in<br />
corporate governance practices, being analyzed the way companies comply with its<br />
principles. The results of the analysis revealed that Romania was ranked five, along<br />
with Bulgaria and Slovakia in terms of compliance of corporate governance<br />
principles. In these circumstances, the recommendations of World Bank were<br />
following two directions:<br />
• The need to increase the role of the Board of Directors and the need for<br />
creating specialized committees to advise the board;<br />
• At the General Meetings of Shareholders in the listed companies, external<br />
auditors should take part in order to provide explanations for how the<br />
shareholders had honored their obligations under the contracts.<br />
• According to authors’ study on the public information on “Corporate<br />
Governance”, presented by 65 listed companies on Bucharest Stock<br />
Exchange (1 st and 2 nd category) on their websites, few conclusions can be<br />
drawn:<br />
• Only three of the analyzed companies (5%) are managed under a dualist<br />
system (Carpatica SA, OMV Petrom SA, Prodplast SA);<br />
• Eight companies (12%) have adopted their own Corporate Governance codes<br />
(Alro SA, Antibiotice SA, Azomureş SA, Transelectrica SA, Ropharma SA,<br />
Transgaz SA, Altur SA and Carpatica SA);<br />
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• 32% of the companies (21 out of 65) have no mentioning about corporate<br />
governance system or rules on their websites or in their reports;<br />
• A weakness for 35% of the listed companies on BSE (23 out of 65) is the fact<br />
that they are managed under a monist system (which reunites in a single<br />
Board both executive and non-executive directors), without the position of<br />
President to be separated from that of CEO.<br />
The percentage of the companies that don’t publish any information about corporate<br />
governance (32%) poses a question mark on the assurance of transparency, one of the<br />
base principles of corporate governance, according to Cadbury Code.<br />
In conclusion, the same as political power, economic power must be limited by<br />
separating the executive directors (managers) of non-executive directors, and by<br />
dispersing ownership. Any shareholder has the tendency to abuse his power of<br />
control, and lack of separation of the two categories of directors will lead undoubtedly<br />
to a concern for personal interest, let alone the interests of the company.<br />
5. A DIFFERENT VIEW ON CORPORATE GOVERNANCE PRINCIPLES.<br />
DO THE RAPID ECONOMIC GROWTH<br />
AND THE INDUSTRIALIZATION PROCESS MATTER?<br />
Another way of approach the corporate governance principles is through the personal<br />
involvement of states, the concerns for improving these principles. This may be<br />
reflected by the number of codes issued, but also by their topicality. According to a<br />
date analysis of the world’s codes on corporate governance, the Great Britain has<br />
issued the most codes (31), the last one being issued on 2010, so it has further<br />
concerns on this line. The most recent code was issued by Egypt (February 13, 2011).<br />
Components of the world’s economy, emerging economies are characterized by the<br />
fact that they belong to nations whose social and business activity is in a rapid process<br />
of growth and industrialization. One argument for this assertion is the fact that 28<br />
emerging market economies were recorded in 2006 according to classifications, and<br />
their number reached to be over 40 in 2010. Considered to be in the process of<br />
transition between developing economies status and status of developed economies<br />
and wanting to accede as soon as possible to the latter status, emerging economies<br />
have openly adopted codes of corporate governance, in order to facilitate the conquest<br />
of new market segments (transparency - the dissemination and disclosure, honest<br />
behavior - valence which shows integrity and accountability in all undertaken<br />
activities -translated in providing information that is relevant for decision making).<br />
However, these codes are the way through they guide their behavior, designed to<br />
serve non-traditionalist customer, open for new products and services, for innovation<br />
and investment in technology. The situation of emerging economies that have adopted<br />
codes of corporate governance is presented in Table no. 2.<br />
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Table 2. World’s emerging economies that have adopted CG codes<br />
Period Emerging economies and corporate governance codes<br />
1994 South Africa has adopted the first code of CG<br />
1998 India has adopted the first code of CG<br />
Thailand has adopted the first code of CG<br />
1999 Mexico has adopted the first code of CG<br />
Korea has adopted the first code of CG<br />
India has adopted the second code of CG<br />
Thailand has adopted the second code of CG<br />
2000 Indonesia has adopted the first code of CG<br />
Malaysia has adopted the first code of CG<br />
Romania has adopted the first code of CG<br />
India has adopted the third code of CG<br />
2001 Brasilia has adopted the first code of CG<br />
China has adopted the first code of CG<br />
Czech Republic has adopted the first code of CG<br />
Peru has adopted the first code of CG<br />
Singapore has adopted the first code of CG<br />
Indonesia has adopted the second code of CG<br />
2002 Pakistan has adopted the second and the last code of CG<br />
Hungary has adopted the first code of CG<br />
Russia has adopted the code of CG<br />
Slovakia has adopted the first code of CG<br />
Taiwan has adopted the first and the last code of CG<br />
South Africa has adopted the second code of CG<br />
Thailand has adopted the third code of CG<br />
Brasilia has adopted the second code of CG<br />
Peru has adopted the second and the last code of CG<br />
2003 Lithuania has adopted the first and the last code of CG<br />
Nigeria has adopted the first code of CG<br />
Turkey has adopted the first code of CG<br />
Korea has adopted the second and the last code of CG<br />
2004 Argentina has adopted the first and the last code of CG<br />
Bangladesh has adopted the first and the last code of CG<br />
Brasilia has adopted the third code of CG<br />
China has adopted the second and the last code of CG<br />
Czech Republic has adopted the second code of CG<br />
Singapore has adopted the second code of CG<br />
2005 Latvia has adopted the first code of CG<br />
Singapore has adopted the second and the last code of CG<br />
Turkey has adopted the second and the last code of CG<br />
2006 Egypt has adopted the first code of CG<br />
Egypt has adopted the second code of CG<br />
Estonia has adopted the first and the last code of CG<br />
Saudi Arabia has adopted the first and the last code of CG<br />
Sri Lanka has adopted the first code of CG<br />
Thailand has adopted the fourth and the last code of CG<br />
2007 Bulgaria has adopted the first and the last code of CG<br />
Columbia has adopted the first code of CG<br />
United Arab Emirates has adopted the first and the last code of CG<br />
Indonesia has adopted the third and the last code of CG<br />
Malaysia has adopted the second and the last code of CG<br />
Hungary has adopted the second code of CG<br />
Nigeria has adopted the second code of CG<br />
~ 602 ~
Period Emerging economies and corporate governance codes<br />
2008 Morocco has adopted the first and the last code of CG<br />
Slovakia has adopted the second and the last code of CG<br />
Hungary has adopted the third and the last code of CG<br />
Nigeria has adopted the third and the last code of CG<br />
Sri Lanka has adopted the second and the last code of CG<br />
2009 South Africa has adopted the third code of CG<br />
India has adopted the fourth and the last code of CG<br />
Romania has adopted the second code of CG<br />
Brasilia has adopted the fourth and the last code of CG<br />
Columbia has adopted the second and the last code of CG<br />
2010 Bahrain has adopted the first and the last code of CG<br />
South Africa has adopted the fourth and the last code of CG<br />
Mexico has adopted the second and the last code of CG<br />
Latvia has adopted the second and the last code of CG<br />
2011 Egypt has adopted the third and the last code of CG<br />
According to our study, the situation of the countries with developed economies is<br />
different. Their status impose a continuous preoccupation for corporate governance<br />
because, unofficial, they give the international tone in terms of applying the principles<br />
and code of corporate governance, in being responsible and in updating the codes and<br />
rules of corporate governance. We consider relevant a commentary on the situation of<br />
issuance of corporate governance codes in 2010.<br />
As we can notice, Great Britain remains the most prolific in issuing corporate<br />
governance codes, with five updates. United States and Germany are next countries<br />
whose preoccupation in terms of corporate governance is obvious, considering the<br />
number of codes already issued until 2010 (13).<br />
Table 3. Developed economies that have adopted corporate governance codes<br />
in 2010<br />
Period Developed economies and corporate governance codes<br />
2010 Australia has adopted the 10 th and the last code of CG<br />
Norway has adopted the 6 th and the last code of CG<br />
Germania has adopted the 14 th and the last code of CG<br />
France has adopted the 9 th and the last code of CG<br />
Great Britain has adopted the 27 th , 28 th , 29 th , 30 th , 31 st and the last code of CG<br />
USA has adopted the 14 th and the last code of CG<br />
Greece has adopted the 3 rd and the last code of CG<br />
Ireland has adopted the 3 rd , the 4 th and the last code of CG<br />
Portugal has adopted the 8 th and the last code of CG<br />
Denmark has adopted the 8 th and the last code of CG<br />
Sweden has adopted the 7 th and the last code of CG<br />
Next to emerging economies and developed economies, frontier economies, as a<br />
subset of emerging economies, do not had preoccupations for corporate governance<br />
codes, because their activity is not yet focused on principles of high conduit and<br />
behavior. Although, there are some tendencies towards a code of corporate<br />
governance, as follows:<br />
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Table 4. The codes of corporate governance in world’s frontier economies<br />
Period Frontier economies and corporate governance codes<br />
2001 Malta has adopted the first code of CG<br />
2002 Cyprus has adopted the first code of CG<br />
Kenya has adopted the first and the second (last) code of CG<br />
2003 Cyprus has adopted the second code of CG<br />
Ukraine has adopted the first and the last code of CG<br />
2004 Slovenia has adopted the first code of CG<br />
2005 Malta has adopted the second and the third (last) code of CG<br />
Slovenia has adopted the second code of CG<br />
2006 Cyprus has adopted the third and the last code of CG<br />
2007 Slovenia has adopted the third code of CG<br />
2008 Serbia has adopted the first and the last code of CG<br />
Tunisia has adopted the first and the last code of CG<br />
2009 Croatia has adopted the first and the last code of CG<br />
Slovenia has adopted the fourth and the last code of CG<br />
2010 -<br />
As we can notice, the codes were issued in the first decade of the 21 st century, and<br />
Slovenia was the most prolific in developing and improving a national corporate<br />
governance code (four codes), being followed by Cyprus with three codes and Malta<br />
with also three codes.<br />
6. THE FAIR TREATMENT PRINCIPLE. THE DIRECTORS’<br />
PERSPECTIVE ON THE SHAREHOLDER-STAKEHOLDER DISPUTE<br />
Another approach on the principles of corporate governance is through the principles<br />
which were given more importance over time. In our opinion, one is the fair treatment<br />
principle, whether it is about stakeholders or shareholders.<br />
Directors and manager need to be aware of the interests of stakeholders in corporate<br />
governance; however their responsibility towards them is valued and questioned.<br />
According to OECD, which presented a condensed list of stakeholders in corporate<br />
governance, they include the follows (Frémond, 2000):<br />
• Employees: There is widespread agreement that they are a prime stakeholder.<br />
Their internal position, their direct role in business development and<br />
productivity, the dependence of a company on their knowledge, abilities, and<br />
expertise are the main arguments in this direction;<br />
• Shareholders: Some would say that shareholders are the first stakeholder,<br />
hence the controversy over the main concerns of directors, presented in this<br />
paper;<br />
• Management: Controversial, but some believe that managers are<br />
stakeholders, because they help maintaining and developing company’s<br />
capital, establish strategies, based on known data;<br />
• Creditors: Creditors’ rights are often protected under contract and backed by<br />
collateral so they are seldom treated as “owners” as the shareholders are;<br />
• Trade unions: Some argue that this group is redundant with the employee<br />
group;<br />
~ 604 ~
• Customers: Most stakeholder models include customers;<br />
• Suppliers: Often considered a stakeholder;<br />
• The local community: Broader definitions of stakeholders widen the concept<br />
to include responsibilities to local communities and, more generally, civil<br />
society;<br />
• Future generations: Sustainable development is at the center of the<br />
stakeholder debate and this suggests a responsibility to future generations -<br />
those who will one day be reliant upon the physical environment - as a<br />
stakeholder group.<br />
So, stakeholders are any entity (person, group or possibly non-human entity) that can<br />
affect or can be affected by the actions or policies of an organization. It is a bidirectional<br />
relationship. Each stakeholder group has different expectations about what<br />
it wants and different claims upon the organization.<br />
A problem is the attitude of directors towards taking strategic decisions involving<br />
shareholder-stakeholder conflicts (Adams et al., 2010). There is considerable dispute<br />
about whose interests should be taken into account. The shareholder model states that<br />
the purpose of the corporation is to promote shareholder value, but the stakeholder<br />
model states that the purpose of the corporation is to serve a wider range of interests.<br />
The legitimacy of each stakeholder will depend on ethical and political perspective on<br />
whether certain groups should be considered as stakeholders.<br />
Enhancing shareholder value is a desirable strategy, but international accounting<br />
regulations are referring to all the stakeholders, as users of financial information. Of<br />
course, the investor is considered to be the main stakeholder, hence the orientation<br />
towards him. Stakeholders are equally principled, yet views shareholders as one<br />
among several stakeholders whose interests deserve consideration. The<br />
preoccupations either for stakeholders or for shareholders are polar strategies, but<br />
most decision makers, however, will follow their principles to find a middle ground in<br />
light of the context.<br />
In this context, we may consider that the board members will endorse corporate<br />
actions that benefit shareholders the more they hold values that are compatible with<br />
the economic interests of equity investors, but board members who represent a<br />
particular non-shareholder constituency (employee representatives) exhibit a<br />
stakeholders stance in general because their role calls on them to balance the interests<br />
of several constituencies.<br />
Whether corporate governance should be monist or dualist can be a theme in debates<br />
over stakeholder/shareholder approach of the Board of Directors. So, are the Directors<br />
custodians of shareholders’ money and thus are accountable only for shareholders or<br />
are they leaders of an enterprise which has responsibilities for all the stakeholders?<br />
So, the problem is if the directors are acting in respect of maximizing the<br />
shareholders’ profits or they are pursuing less profitable, but more responsible actions<br />
which concern the interest of employees, the environment and the society as a whole<br />
(Lee, 2006).<br />
The principle “The role of stakeholders in the corporate governance” suffered some<br />
tinting over time, in the sense that it insists on “equal treatment of all stakeholders”<br />
~ 605 ~
(see Principle no. 8 of the table 1). Among them, an important category represents<br />
employees, as prime stakeholders and indispensable component of the company’s<br />
information system, without which no entity could function. In the current economic<br />
context, we must make a special mention about Peter Drucker’s demarcation between<br />
manual workers (who work with their hands and produce goods and services) and socalled<br />
“knowledge workers” (who work primarily with the mind, not with hands, and<br />
produces ideas, information, knowledge), analyzed in his book “The Effective<br />
Executive” (1966), becomes increasingly important. Both part of the intellectual<br />
capital’s component known as human capital (the abilities, skills, expertise of the<br />
employees), the “knowledge” distinction make the transition from traditional<br />
approach of capital to the new modern one.<br />
Thus, we consider the company's employees as its greatest asset and indeed the prime<br />
stakeholder (along with material and financial resources), because they are the only<br />
subjects in the triad of factors of production: labor-capital-nature, the other two<br />
factors are only objects that can be handled according to subjects’ knowledge, skills<br />
and abilities. Under these conditions, fair treatment of employees is absolutely<br />
necessary and imperative, even if we bear in mind that, in some cases, as both<br />
stakeholders and shareholders in their company, employees are exposed to greater<br />
risks than other shareholders who have diversified portfolios.<br />
7. THE DIRECTORS AND THEIR STATUS IN THE COMPANY.<br />
CONCERNS FOR A QUALITY MANAGEMENT<br />
In line with quality of human capital and the principle of “Transparency and<br />
dissemination of information”, an important category of information that corporate<br />
governance requires aims remuneration policy of both managers/officers (presented<br />
below) and non-executive directors, their selection procedure, competences and<br />
previous experience. Strategic and effective oversight of a company are functions that<br />
are incumbent upon the Board of Directors, responsible for ensuring quality<br />
management by recruiting key managers, determining their remuneration and by<br />
developing and implementing measures to punish or replace them, according to the<br />
provisions of management contracts.<br />
Corporate governance reforms following the corporate scandals of the turn of the<br />
century focused heavily on increasing the representation of outside directors,<br />
managers and officers. In addition, listing standards were changed to require boards to<br />
have a majority of outside directors, as mentioned before in this paper. Many<br />
countries have introduced requirements on the percentage of outside directors on<br />
boards as well as on the fraction of outside directors on the nominating committee,<br />
compensation committee, and audit committee (Fahlenbrach et.al, 2010).<br />
This context requires a few special mentions about Romania. First, all corporate<br />
governance codes, including Romania’s, distinguish between executive and nonexecutive<br />
directors. Thus, Romania has aligned itself with global trends in listing<br />
standards. So, non-executive directors are those who are not related to executive<br />
management and have the majority in the Board of Directors (at. 138^1 of the<br />
Companies Law). Art. 140^2 of the Companies Law includes clear references to the<br />
members of the remuneration, nomination and audit committees. At least one member<br />
of each committee must be independent non-executive director. The Audit Committee<br />
~ 606 ~
and The Remuneration Committee consist only of non-executive directors. At least<br />
one Audit Committee member must have experience in application of accounting<br />
principles or audit.<br />
As for independence, art. 138^2 from the Companies Law stipulates that one or more<br />
members of the Board of Directors to be independent, only if specifically mentioned<br />
in Company’s status. In appointing an independent director, the General Meeting of<br />
Shareholders considers the following criteria:<br />
a) he is not a director of a company or of companies controlled by it and not<br />
have accomplished such a position in the last five years;<br />
b) he has not been an employee of a company or a company controlled by it or<br />
to have had such a close relationship over the past five years;<br />
c) he did not receive or have received from the company or a company<br />
controlled by it an additional remuneration or other benefits, other than those<br />
corresponding to its quality of non-executive director;<br />
d) he is not significant shareholder of the Company (owns less than 10% of the<br />
stock);<br />
e) he does not have or have had in the past year business relationship with a<br />
company or a company controlled by it, either personally or as a partner,<br />
shareholder, director, officer or employee of a company that has a<br />
relationship with the entity, if, by their substantial nature, they are likely to<br />
affect their objectivity;<br />
f) he is not or have been within the last three years financial auditor or person<br />
associated with the current auditor of a company or a company controlled by<br />
it;<br />
g) he is a director in another company where a director of the company is a nonexecutive<br />
director;<br />
h) he hasn’t been non-executive director of the company more than three seats;<br />
i) have no family relationship with a person in one of the situations mentioned<br />
in points a) and d).<br />
Contrary to the trends worldwide, however, the Companies Law provides that the<br />
management company may be delegated to one or more managers, one of which is the<br />
general manager (Chief Executive Officer - CEO), and these executives may be<br />
among the BD members, executive directors, given that the corporate governance<br />
codes require a separation of executive from the directorate.<br />
Another issue that arises is that of internal and external directors. Related to abovementioned<br />
independence, a director can be chosen from outside the entity. Wellmeaning,<br />
this way cannot always be beneficial if a company takes into consideration<br />
the costs and benefits of outside directors into account. Inside and outside directors<br />
face different trade-offs when deciding whether to stay on the board or resign. An<br />
inside director who resigns from the board most likely also has to resign from his job.<br />
Consequently, an inside director who has doubts about the firm’s future or knows that<br />
the firm will reveal bad news may find that her best course of action is to stay on the<br />
board and work to improve the firm’s performance. Outside directors are particularly<br />
valuable in situations where the firm’s performance is troubled since at such times<br />
their independence enables them to assess objectively the performance of executives<br />
and make changes if they are appropriate.<br />
~ 607 ~
So, in contrast, an outside director in the same situation who does not resign faces the<br />
risk of experiencing a loss of reputation as an outside director when the bad news<br />
breaks. Such a loss of reputation may make it harder for the director to obtain other<br />
board seats and perhaps even to keep the seats he already has. Furthermore, the<br />
director would likely face an increase in his workload as the firm undergoes change<br />
and restructuring. We believe that all these references to the directors may be<br />
submitted under the auspices of the principle of responsibility of the Board of<br />
Directors.<br />
8. THE MANAGEMENT FROM THE PERSPECTIVE OF CORPORATE<br />
GOVERNANCE PRINCIPLES: BETWEEN COMPETENCE, ABILITIES,<br />
REPUTATION AND RESPONSIBILITY<br />
A clear delineation of requirements for managerial positions in an enterprise, of the<br />
skills required for them is specific to the dualist system of corporate governance. If<br />
managers are elected by the Board of Directors from outside the enterprise, then most<br />
likely they are chosen on the basis of competence and skills, as evidenced by learning<br />
and experience. In the monist system, the choice for Chief Executive Officer can be<br />
considered subjective. In Romania, the practiced system is no clearly defined, given<br />
that art. 143, par. (3), says that the president of Board of Directors can be Chief<br />
Executive Officer, offering this way the possibility for en enterprise to choose it.<br />
We believe that the most appropriate would be for managers to be fully delimited<br />
from the Board of Directors, so there could be a proper coordination at the enterprise<br />
level. To support this statement, we must specify that the Companies Law the<br />
organization of the dualist system in Romania, as Supervisory Board and the<br />
Directorate, which are two separate entities, with separate responsibilities.<br />
Related to Romania, corporate governance principles issued by Bucharest Stock<br />
Exchange, do not have a separate chapter focusing on the responsibilities of<br />
management for achieving a high level of corporate governance, it is evident that<br />
management has an essential role to play if a company is to meet the governance<br />
standards of the revised principles. The principles underline the fact that high ethical<br />
standards, are in the long term interest of the company: they are essential if the<br />
company is to be regarded as being credible and trustworthy. Many companies have<br />
found it useful to develop company codes of conduct, often based on professional<br />
standards and, sometimes, broader codes of behavior. There is a mention though to<br />
the confidentiality of documents and information received, kept and signed during the<br />
mandate period.<br />
In terms of reputation, the problem is the conflict of interest which can arise in<br />
managers’ case, regardless their level. They have the obligation to tell the truth, but<br />
simultaneously have incentives, so they are motivated to send biased information to<br />
the users. In the context of financial reporting, managers are relevant information<br />
providers, who jointly produce financial reports with the auditors. Incentives for<br />
biased reporting may arise for managers when bonuses are linked to performance<br />
(Koch and Schmidt, 2010).<br />
~ 608 ~
CONCLUSIONS<br />
Starting from transparency, integrity and responsibility, the principles of corporate<br />
governance have followed a continuous development, but their main focus was<br />
always on the separation of functions between directors and managers, on applying a<br />
fair treatment for stakeholders and shareholders and on establishing a clear role for<br />
both the Board of Directors and the managers.<br />
Regarding the Board of Directors, in the first place, an overlapping of functions was<br />
allowed in the case of president of the Board of Directors and Chief Executive<br />
Officer. Later, after the financial scandals in the 2000s, a prohibition was issued in<br />
this sense. This was completed with a supplementary specification, regarding the fact<br />
that a director cannot be member in more than two boards. In respect of shareholders,<br />
USA supports the increase of power for the majority shareholders. Comparing to that,<br />
in Europe, the role of the Board of Directors is less significant, the main focus being<br />
on the better protection of the minority shareholders, against possible abuses of<br />
majority shareholders.<br />
Because of all these differences, OECD, from its position of international body, has<br />
developed a guide for the convergence of corporate governance codes, which contains<br />
a minimal set of six rules applicable to listed companies, namely: applying the<br />
principle of comply or explain; defining the audit functions and establishing limits of<br />
action for auditors; improving transparency; defining conflicts of interest and their<br />
control; improving and simplifying voting procedures and increasing the role of<br />
General Meeting of Shareholders; increasing the role of independent directors (nonexecutive<br />
directors) in the company.<br />
Romania does not choose yet its path. According to Companies law, Romanian<br />
companies must specify in the Company’s status the applied system. If the monist<br />
system is chosen, the managers can be elected from the executive directors, the Board<br />
of Directors being formed by both executive and non-executive directors. For the<br />
latter ones, there are clear specifications related to their participation in non-executive<br />
committees (audit, remuneration or nominating). This is the most frequent situation,<br />
but the modifications of the Companies law have included, in the past few years, the<br />
international alternative of complete separation between the directors and the<br />
managers. For these changes, the leadership of a company takes different names: the<br />
Board of Directors becomes Supervisory Board and the executive management<br />
becomes the Directorate. The flexibility of the managing/supervising structures is a<br />
way through which the companies can adapt to the competitive environment, but also<br />
adjust the power between shareholders, directors and managers.<br />
In our opinion, as a conclusion, the structure and the functioning of the Board of<br />
Directors/Supervisory Board provides from inside the company, seen as a whole,<br />
information about its value and ethics. Although this role of the Board of Directors is<br />
undeniable, in present days, the media attention is oriented on the Chief Executive<br />
Officer of a company. We consider that the Board of Directors needs to regain and to<br />
bring in front its “hidden” authority.<br />
The practice demonstrated that the simple opposition of the shareholders is neither<br />
efficient nor sufficient to influence the managing style of the officers and their<br />
~ 609 ~
decisions which often can be considered as subjective. As a solution, it is<br />
recommended that the most of the Board of Directors’ members to be independent,<br />
and from outside the company, as much as possible.<br />
As a response to all these aspects, in the last years, it is aimed the transition from<br />
Agency Theory to Stewardship Theory, with direct impact on managers’ behavior and<br />
on their relationship with the shareholders, in the decision making process. If the<br />
Agency Theory has economic roots, the Stewardship Theory has psychological and<br />
sociological origins. Applying the Stewardship Theory in Romania means in fact to<br />
choose the dualist system and a new, approach on the management of a company,<br />
through the separation between the supervising structures and managing ones. This<br />
way, the managers will be elected based on their competences, abilities and<br />
knowledge, and the Supervisory Board will justify its mediating role in a company.<br />
ACKNOWLEDGEMENTS<br />
This work received financial support through the project “Post-Doctoral Studies in<br />
Economics: continuous training program of elite researchers”, contract<br />
no. POSDRU/89/1.5/S/61755, financed by the European Social Fund in Romania, by<br />
the Sectoral Operational Programme for Human Resources Development 2007-2013.<br />
REFERENCES<br />
Adams, R., Licht, A. and Sagiv, L. (2010), “Shareholders and Stakeholders: How Do<br />
Directors Decide”, Finance Working Paper No. 276/ March 2010, European Corporate<br />
Governance Institute, available on-line at http://papers.ssrn.com/sol3/<br />
papers.cfm?abstract_id=1549482, date of the consultation February 20, 2011<br />
Bucharest Stock Exchange (2009), “Corporate Governance Code”, last revised on January<br />
22 nd , available on-line at http://www.ecgi.org/codes/code.php?code_id=252, date of the<br />
consultation March 15, 2011<br />
Cadbury, A. (1992), Report of the Committee on the Financial Aspects of Coroprate<br />
Governance, Burges Sciences Press, London, 1992, p. 16.<br />
Clark, T. (2007), International Corporate Governance. A Comparative Approach, Routledge<br />
Taylor & Francis Group, London<br />
Fahlenbrach R., Low A., Stultz R., “The Dark Side of the Outside Directors: Do they quit<br />
when they are most needed”, Finance Working Paper No. 281/ March 2010, European<br />
Corporate Governance Institute, available on-line at http://papers.ssrn.com/<br />
sol3/papers.cfm?abstract_id=1585192, date of the consultation February 20, 2011<br />
Frémond, O. (2000), “The role of Stakeholders”, available on-line at<br />
http://www.oecd.org/dataoecd/5/41/1930657.pdf , date of the consultation March 15,<br />
2011.<br />
Koch, C. and Schmidt, C. (2010), “Disclosing conflicts of interest – Do experience and<br />
reputation matter?”, Accounting Organizations and Society No.35: 95-107<br />
Lee, I. (2006), “Corporate Law and the Role of the Corporations in the Society: Monism,<br />
pluralism, markets and politics”, The Canadian Bar Review, No.1, vol. 85, July,<br />
available on-line at http://www.law.utoronto.ca/documents/lee/CorporateLaw_<br />
CanBarRev.pdf , date of the consultation March 10, 2011.<br />
McGee, R. (2008), Corporate Governance in Transition Economies, Springer Science, New<br />
York<br />
Neagu, O. (2007), “The Human Capital in the 21 st Century Organization”, Studia<br />
Universitatis Vasile Goldiş Arad – Economic Sciences, Issue no. 1-2: 162-171<br />
Onofrei, M. (2009), Guvernanţa financiară corporativă, Wolters Kluwer, Bucureşti<br />
~ 610 ~
Richard, B. and Miellet, D. (2002), La dynamique du gouvernement d’entreprise, Edition<br />
d’Organisation, Paris<br />
The European Conferedation of Directors’ Associations (ecoDa) (2010), “ecoDa Corporate<br />
Governance Guidance and Principles for Unlisted Companies in Europe”, available online<br />
at http://www.ecgi.org/codes/code.php?code_id=291, date of the consultation<br />
April 2, 2011<br />
***, 2006/46/CE Directive of European Parliament and Council from the 14 of June 2006<br />
amending Council Directives 78/660/EEC on the annual accounts of certain types of<br />
companies, 83/349/EEC on consolidated accounts, 86/635/EEC on the annual accounts<br />
and consolidated accounts of banks and other financial institutions and 91/674/EEC on<br />
the annual accounts and consolidated accounts of insurance undertakings, available online<br />
at http://eur-lex.europa.eu/LexUriServ/site/en/oj/2006/l_224/l_22420060816<br />
en00010007.pdf, date of the consultation March 29, 2011<br />
***, Companies Law no. 31/1990, modified and actualized in 2010, available on-line at<br />
http://rubinian.com/lsc_00.php<br />
~ 611 ~
PS13 Issues in financial accounting<br />
Chairperson<br />
Tudor GRECU, KPMG Romania<br />
IMPACT OF FUNDED STATUS OF PENSIONS ON<br />
BORROWING COSTS OF STATES<br />
Maria-Iuliana SANDU<br />
THE IMPACT OF UNREALISED FOREIGN<br />
EXCHANGE DIFFERENCES<br />
Georgiana TOADER, Mihaela Adriana DUMITRANA<br />
VALUE RELEVANCE OF CONSOLIDATED VERSUS<br />
PARENT COMPANY FINANCIAL STATEMENTS<br />
Victor-Octavian MULLER<br />
THE ADVANTAGES VS. THE DISADVANTAGES<br />
OF OUTSOURCING THE ACCOUNTING<br />
AND FINANCIAL SERVICE<br />
Vasile-Daniel PAVALOAIA, Ioan ANDONE<br />
~ 612 ~
IMPACT OF FUNDED STATUS OF PENSIONS<br />
ON BORROWING COSTS OF STATES<br />
Maria-Iuliana SANDU 1<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
The paper offers a general view of the pension performance measures as they are understood<br />
by current research. Each measure detailed in the study follows the intuition that<br />
performance can be measured only by comparison to a fixed item, being it asset benchmarks,<br />
minimum revenue or minimum operating costs. The paper follows a structure that highlights<br />
the main performance measures developed until present moment. The results of the paper<br />
bring upfront the difficulties that the Romanian pension market has to overcome in order to<br />
ensure valid information about the retirement income. In order to asses the state of the art in<br />
the field I conducted a literature survey.<br />
KEYWORDS: pension, performance,, portfolio, rate of return<br />
INTRODUCTION<br />
Financial collapse met demographic crisis and resulted in a testing time for pension<br />
systems all over the world. The need for an efficient measure of pension performance<br />
is more stringent as the system has to insure against indigence in old age. As many<br />
pension systems are asset backed, the retirement amount depends on the uncertainties<br />
of investment markets. The study follows the recent studies regarding pension<br />
performance and intends to give an overall image of the subject with commentaries on<br />
the Romanian case.<br />
1. OPTIMAL LONG-TERM BENCHMARKS<br />
As employee’s savings for pensions go into the capital market, the immediate trend in<br />
performance measurement for pension plans was to use the same methods used in the<br />
case of mutual funds. Antolin [2010] identifies this as a problem of performance<br />
valuation, as different investment horizons should determine different performance<br />
measures. Short-term returns overlook factors that affect pension performance (i.e.<br />
administrative and investment management costs, behavior of participants, retirement<br />
age, benefits from other social insurance programs, patterns of lifetime earnings).<br />
Under the short-returns performance criterion and minimum return guarantee, fund<br />
managers can seek short-term performance instead of a long-term one, although longterm<br />
performance is the objective of a pension system. Antolin [2010] considers<br />
optimal long-term benchmarks as the best option for pension performance evaluation.<br />
1 Correspondence address: Maria Iuliana SANDU P.hD. Candidate, Bucharest Academy of Economic<br />
Studies Romana Square, no. 6, Sector 1, Bucharest, Romania; email: iuliana.sandu@cig.ase.ro<br />
~ 613 ~
Some policy makers believe that the optimal asset allocation is set by competition on<br />
the pension market. The assumption in these cases is that the participant does not<br />
suffer from financial illiteracy and that the data available on the market is complete.<br />
Castaneda [2010] addresses the belief that competition can lead to optimal asset<br />
allocation by analyzing the performance of pension fund managers that are subject to<br />
restriction as minimum return guarantee. The results show that managers can<br />
underperform.<br />
Campbell and Viceira [2002] introduce strategic asset allocation – a portfolio choice<br />
for long-term investors and address in this way the difference between mutual fund<br />
investors and pension fund investors.<br />
În Romania defined contribution type funds (DC) have monopoly. According to<br />
Viceira [2007] there are two major sub-types of DC that provide rebalancing between<br />
asset classes: (i)lifestyle plans that automatically rebalance their holdings toward a<br />
target asset mix that remains constant over time and (ii) life-cycle funds where the<br />
target mix varies across time, becoming more conservative over time.<br />
In analyzing the life-cycle funds, Viceira [2010] makes the distinction between<br />
financial wealth and human wealth. He argues that for a typical working investor,<br />
human wealth represents the largest part of the wealth at a young age whereas the<br />
financial health is predominant as the worker ages. This separation between financial<br />
wealth and human wealth create a pattern of investments that dictates the asset<br />
allocation. Thus, when human capital is not correlated with systematic risk (measured<br />
by the correlation of labor income and stock returns) the investor allocates most<br />
financial wealth to stock whereas if human capital risk (i.e. shocks to labor income) is<br />
correlated with stocks, then the investor invests mostly in bonds. There seem to be a<br />
lower degree of correlation between systematic risk and human capital at an earlier<br />
age in the worker’s life.<br />
The most common plan in developing economies where the regulatory constrains are<br />
rigid is the life-cycle fund with a heavy asset allocation towards fixed income assets.<br />
Viceira [2009] offers two reasons for the heavy allocation of developing countries in<br />
domestic government bonds and cash instruments. The first one is the local belief that<br />
fixed-revenue investments minimize short-run return volatility and therefore are<br />
considered the less risky investment choice. The second reason relates to fiscal deficit<br />
financing considerations and the fact that governments try to use the pension<br />
contributions to finance their fiscal deficits. Unfortunately, the modern theory of longterm<br />
asset allocation suggests that holding large amounts of government bonds is not<br />
in line with the retiree objective even if it might be a safe investment option.<br />
2. REPLACEMENT RATE<br />
Another problem in extrapolating the performance measures of mutual funds to<br />
pension funds is the myopia regarding human capital risk. The traditional measures of<br />
performance do not capture the specific human capital risk: volatility in labor<br />
earnings, uncertainty in hours of work, length of work life and length of life after<br />
retirement. Mitchell [2010] addresses the performance as a replacement rate,<br />
identifying a rate between benefits paid by a pension system (or projected to be paid)<br />
and a minimum criterion (i.e. country’s income-based poverty line, the minimum<br />
~ 614 ~
wage level, national average earning measure). Other references to replacement rates<br />
describe it as the amount of income a retiree receives as pension to an active worker<br />
income level OECD [2009].<br />
Nevertheless, there are critics made to the replacement rate measure that refer to the<br />
core of the rate: consumption measure. Many replacement rates fail to express the<br />
consumption level appropriate for a retiree. Developing a replacement rate involves<br />
other several difficulties such as: indicator used as numerator , numerator indicator in<br />
net or gross form, inflation perturbance, life span after retirement, household<br />
composition alteration, retirees’ expense or medical costs.<br />
3. NET VALUE ADDED<br />
As the purpose of a pension fund is to maximize, subject to liability-related and<br />
operational risk constrains, the long term net return of the pension fund,<br />
Ambachtsheer [1996] introduces to the literature of pension performance the notion of<br />
net value added (NVA). In this approach, the value creation of pension funds, and<br />
thus performance, has two sources: (i) strategic asset allocation that generates returns<br />
above the minimum return required and (ii) active asset management. The model<br />
emphasizes on the importance of operational costs in the overall performance of a<br />
pension fund. According to Viceira [2010] a plan that charges an operating fee of 1<br />
percent of assets and has an expected return gross of costs of 7 percent will cost plan<br />
participants 39 percent of their assets over an investment horizon of 35 years.<br />
The results offered by the NVA measures were biased by the size of the pension fund<br />
(total fund pension assets) as increased size determines increased economy of scale<br />
and by the passive management of the investments.<br />
The need to measure performance of pension funds was tackled by researchers like<br />
Keith Ambachtsheer and John McLaughlin when they decided to initiate CEM<br />
Benchmarking Inc., a global benchmarking company based in Toronto. CEM stands<br />
for Cost Effectiveness Measurement data base and includes various statistics from<br />
pension funds including rate of returns and operating fees. The organization has over<br />
700 pension funds as clients that receive performance guidance for their activity. The<br />
outputs of CEM follow the same methodology: obtaining standardized information<br />
from the fund and compare the results with those of the peers.<br />
4. CROSS-COUNTRY PENSION PERFORMANCE COMPARISON<br />
Antolin [2008] summarizes a study undertook by the Organization for Economic<br />
Co-Operation and Development (OECD) and the World Bank that was intended to<br />
compare investment performance of privately managed pension funds across several<br />
OECD, Latin American and Central and Eastern European (CEE) countries.<br />
The methods used to assess pension performance across countries include standard<br />
risk-adjusted measures (e.g. Sharpe ratios) and artificially constructed benchmarks<br />
portfolios using Markowitz portfolio optimization approach with historical data.<br />
Sharpe ratios measure the excess return on a risk unit and it is frequently used to<br />
determine the most favorable investment strategy. Accordingly, in an investment<br />
strategy the investor should choose the portfolio that returns the highest Sharpe Ratio.<br />
~ 615 ~
Cross-country performance comparative analysis has several faults that must be<br />
highlighted:<br />
� asset allocation between equity and bonds show a wide variation among<br />
different countries;<br />
� different levels of liquidity on capital markets make way for different asset<br />
valuation methods;<br />
� different calculation methods for rate-of-returns (reported returns gross of<br />
management fees or net of management fees);<br />
� Sharpe ratio can be used under the assumption that a riskless rate exist or if<br />
proxies for it are used instead;<br />
� regulatory environment;<br />
� idiosyncratic characteristics of each country pension system.<br />
The conclusion of Antolin’s study [2008] is that Sharpe ratios and Markowitz meanvariance<br />
approach with historical data can be used to compare the pension plan<br />
performance to artificially constructed benchmarks. However, in countries were<br />
private plans have recently been implemented the historical data on which the study<br />
might be based is scarce. Antolin [2008] suggests that progress should be done in data<br />
collection as to enhance the development of international standards for the reporting<br />
of pension fund performance that could support more in depth performance<br />
evaluation.<br />
5. RESULTS<br />
At the present moment Romania uses short-term returns to measure performance for<br />
pension funds (24 months periods). As mentioned by Antolin [2010], the high rates of<br />
return exhibited by pension funds in developing countries might be related to high<br />
interest rates in the economy or a country-specific risk premium arising from lack of<br />
development of domestic capital market, making short-term returns not viable as a<br />
pension performance measure.<br />
Another major issue in the Romanian case is that there is no investment option that<br />
can be regarded as a risk-free asset for long-term investors. Treasury bills might be<br />
risk-free from a short-term point of view but on the long run they fail to provide<br />
protection against reinvestment risk. Government bonds provide protection against<br />
reinvestment risk (long-term bonds protect investors from reinvestment risk because<br />
falls in interest rates are compensated with capital gains in the value of the bond) but<br />
cannot manage the inflation risk. Viceira [2010] considers that true riskless assets for<br />
developing countries are long-term inflation-indexed bonds but Walker [2010]<br />
recommends the short-term bonds as an alternative for protection against unexpected<br />
changes in inflation rates.<br />
Private pension participants in Romania suffer from the capital market infancy.<br />
Defined contribution plans imply that participants choose where to invest their<br />
contributions, which exposes them to capital market risk arising from directly holding<br />
the asset.<br />
The strict regulation of the Romanian pension market can affect the overall<br />
performance of a pension fund. Imposing the limits of asset allocation and relying<br />
heavily on local investment assets induce myopia towards currency hedging. Holding<br />
~ 616 ~
foreign currency in reserve currencies as the euro or commodity-based currencies as<br />
the Australian dollar might reduce the portfolio volatility when there is no domestic<br />
asset that is riskless in real terms Viceira [2010].<br />
Table 1. Private pension’s issues in the Romanian case<br />
• Low density of contributions (in this case the individuals have low accumulated assets and face low<br />
retirement income)<br />
• Minimum return guarantee issues (determine underperformance of pension fund managers and can<br />
focus managers on short run performance rather than the necessary long run performance)<br />
• Restrictions on maximum equity exposure (involve poor diversification of portfolios, thus<br />
underperformance of pension fund)<br />
• No studies regarding the optimal level of equity exposure (default option for investment triggers<br />
passive management)<br />
• Absence of real risk-free assets<br />
• Capital market infancy (generating unjustified rates of return because of the country specific risk<br />
premium)<br />
• Private pension infancy (triggers high operating costs)<br />
• Lack of currency hedging (trigger suboptimal performance)<br />
(Source: Author)<br />
CONCLUSION<br />
Romania faces the pension transformation from pay-as-you-go redistributiv system to<br />
a multi-pillar approach. The distribution of wealth at retirement is of interest to<br />
sponsors, members and policy makers as the failure of assuring a competitive income<br />
in retirement translates into social crisis Although measurement solution for pension<br />
performance do not seem as a necessity in the accumulation period that the present<br />
Romanian pension market is experiencing, the moment when the future retirement<br />
incomes must be paid has to be carefully planed in advance. The information provided<br />
from different pension environments is of utmost importance but strategies have to be<br />
tailored for the unique case of Romania<br />
This literature review shows how pension performance is tackled in various countries<br />
from mutual fund specific performance measures to measures adapted for the pension<br />
objective. This study intends to be a starting point for the search of performant<br />
pension measures adapted for the Romanian pension system that can provide future<br />
retirees with competitive income levels.<br />
AKNOWLEDGEMENTS<br />
This work was supported by DoEsEc project - “Doctoral Studies in Economy at<br />
European Knowledge Standards “, co-funded by European Social Fund through the<br />
Sectorial Operational Programme for Human Resources Development 2007 – 2013,<br />
and coordinated by The Bucharest Academy of Economic Studies.<br />
REFERENCES<br />
Ambachtsheer, Keith; Capelle, R., and Scheibelhut, T. 1998, “Improving Pension Fund<br />
Performance”, Financial Analysts Journal<br />
Antolin, P., and Tapia, W. 2010, “Investment Performance of Privately Managed Pension<br />
Funds: Overview of the Available Data”, Evaluating the Financial Performance of<br />
Pension Funds – Directions in Development, the World Bank<br />
~ 617 ~
Bagliano, F., Fugazza, C., Nicodano, G. 2010, “Pension Funds, Life-Cycle Asset Allocation,<br />
and Performance Evaluation”, Evaluating the Financial Performance of Pension Funds<br />
– Directions in Development, the World Bank<br />
Castaneda, P., Rudolph, H. 2010, “Portfolio Choice, Minimum Return Guarantees, and<br />
Competition in Defined Contribution Pension Systems”, Evaluating the Financial<br />
Performance of Pension Funds – Directions in Development, the World Bank<br />
Grinblatt, M., Titman, S.1993. “Performance Measurement without Benchmarks: An<br />
Examination of Mutual Fund Returns”, Journal of Business, vol. 66, no.1<br />
Heinz P. R., Hinz R., Antolin P., and Yermo J. 2010, “Evaluating the Financial Performance<br />
of Pension Funds”, Evaluating the Financial Performance of Pension Funds –<br />
Directions in Development. The World Bank Bank<br />
Mitchell, O., Turner, J. 2010, “Labor Market Uncertainty and Pension System Performance”,<br />
Evaluating the Financial Performance of Pension Funds – Directions in Development.<br />
The World Bank<br />
Viceira, L. 2010, “Application of Advances in Financial Theory and Evidence to Pension<br />
Fund Design in Developing Economies”, Evaluating the Financial Performance of<br />
Pension Funds – Directions in Development<br />
Walker, E., Iglesias, A. 2010, “Financial Performance of Pension Funds: An Exploratory<br />
Study”, Evaluating the Financial Performance of Pension Funds – Directions in<br />
Development. The World Bank<br />
http://www.reuters.com/<br />
~ 618 ~
THE IMPACT OF UNREALISED FOREIGN EXCHANGE<br />
DIFFERENCES<br />
Georgiana TOADER 1 & Mihaela Adriana DUMITRANA<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
The present study is intended to be an analyze of the main Romanian legal provision in what<br />
concerns the impact of foreign exchange differences and potential consequences at the level<br />
of financial statements for companies. In Romanian legislation, the issue of the foreign<br />
exchange differences is treated at a general level: these are recognized as a Profit and Loss<br />
item and as a consequence, they are included in the taxable base when booked in the<br />
accounting. Our legislation does not provide for specific treatments depending on the<br />
“realization moment” of these differences or depending on the conditions for recognizing a<br />
gain / loss from foreign exchange differences. For the unrealized exchange differences arising<br />
from the application of accounting rules on monthly assessment of foreign currency monetary<br />
items, there isn’t a specific event or transaction to determine income or expenditure. This<br />
monthly review depending on the National Bank of Romania foreign exchange rate valid on<br />
the last day of the month aims to bring closer to reality the financial position of an entity.<br />
The exchange rate is a monetary policy item set by the central bank and may be influenced by<br />
various factors such as: monetary policy of the BNR; inflation target objectives and rate of<br />
exchange stabilization or reduction efforts, as is the case of BNR in the last years to fulfil EU<br />
criteria for adoption of the EURO; periodical influences of speculative capitals on the<br />
exchange rate level; economic status and especially exports and imports. However, a<br />
taxpayer should not be charged unless there is evidence of the "economic enrichment"<br />
thereof. However, this enrichment, seen as a rising economic value of the company, depends<br />
on the perspective from which is seen: the owner of the company or the tax authorities. The<br />
exchange differences impact also the value of the owners’ equity for which a minimum level is<br />
requested under the commercial company law. In case of negative values, this triggers<br />
various risks at the level of the continuity principle or even endangers the existence of the<br />
company.<br />
KEYWORDS: foreign exchange differences, profit allocation, accrual principle, economic<br />
enrichment, realised income/profit;<br />
INTRODUCTION<br />
The ongoing study on the impact of differences must be based on accounting<br />
principles underlying their recognition in accounting. This is the main factor<br />
determining other tax related effects, profit allocation and consequences on the<br />
financial statements. The basis for elaborating this study consist of an range of<br />
practical observations undertaken in connection with the consequence of law<br />
provisions (accounting, taxation, legal) related to the unrealised foreign exchange<br />
differences, on the allocation manner resulting from their inclusion in the taxable<br />
1<br />
Correspondence address: Georgiana Gabriela TOADER, Bucharest Academy of Economic Studies;<br />
email: geogiana.toader@vtm.ro<br />
~ 619 ~
ase, as well as on the potential bias over the fair image of the financial statement for<br />
a company.<br />
According to Order 3055/2009, in Romania is applicable the accrual principle which<br />
includes recognition of the effects of transactions and other events as they happen and<br />
not as cash or its equivalent is received or paid. Due to the accrual basis and the duty<br />
to monthly assess claims and liabilities in foreign currency, these rules lead to<br />
monthly recognition in the profit and loss account of the foreign exchange differences.<br />
Their recognition from an accounting perspective represents the motivation for their<br />
inclusion in the taxable basis, as specified in the Tax Code.<br />
Among the international studies on the complex consequences of the exchange<br />
differences, both fiscal and accounting, the most recent is the General Report prepared<br />
by International Fiscal Association in 2009, based on observations received from 37<br />
countries, of which are: Australia, Austria, Brazil, Canada, Denmark, Germany,<br />
Japan, the Netherlands. Based on the comments submitted by each of the 37 countries<br />
the IFA issued a report that captures a wide range of implications of transactions<br />
generating foreign exchange difference, in the form of observations:<br />
� Most countries have not developed an adequate tax system that takes into<br />
account the impact of exchange differences on income measurement. While<br />
some concepts are addressed in national law, such as the nature of exchange<br />
differences, timing of recognition or source, however it is shown that there is<br />
insufficient knowledge about the process of identifying differences, especially<br />
with regard to the possibility of distorting income measurement.<br />
� There is no common treatment with regard to considering the gains or losses<br />
from exchange differences as an ordinary element, recognized in the profit or<br />
loss account or a an element of capital (in the proper conditions) based on<br />
connection or lack of connection with another transaction. As it results from<br />
the observations received from the countries included in the study, in the<br />
majority of the cases the exchange rate differences are recognized in the profit<br />
or loss account.<br />
� There are different approaches when recognizing the effects of exchange<br />
differences. Although it is difficult to establish universal conclusions, the main<br />
trend however can be identified as the need to find a state of "economic<br />
enrichment" which can be qualified as income. A taxpayer should not be<br />
charged unless there is evidence of the "economic enrichment" thereof.<br />
However, this enrichment, seen as a rising economic value of the company,<br />
depends on the perspective from which is seen: the owner of the company or<br />
the tax authorities.<br />
� In certain countries, the tax rules allow the use of currencies other than the<br />
national currency for tax calculation. This is a recent approach found in some<br />
countries to allow accurate measurement of economic income, especially for<br />
multinational companies (Canada, USA, Italy, Australia, Netherlands and<br />
UK). The principle of this approach requires that in cases where the "natural<br />
currency" used to conduct business is other than that of the company's country<br />
of residence, allows calculation of net taxable income in the natural currency<br />
of the business, following that for effective reporting, it will be eventually<br />
converted back into the currency of that country. In this way it avoids any<br />
distortions related to the measurement of taxable income that could be caused<br />
~ 620 ~
y the foreign exchange differences and which would not in fact create real<br />
economic value for the company.<br />
� Not enough attention was paid to the development of separate paragraphs in<br />
the double taxation conventions to address this aspect, which may affect the<br />
level of taxable income. The reason for which this approach has not been<br />
possible is the difficulty of determining the location of the exchange<br />
differences (in which of the two countries in the convention) and especially<br />
the precise identification of what represents income. Inevitably, with respect to<br />
this issue, questions arise about in which currency should be kept track of<br />
income and the way in which countries will establish tax rules to determine<br />
and control how these are calculated.<br />
The Chairman of IFA congress held in Vancouver in 2009, Mr. Gregory May (USA)<br />
has emphasized that any international transaction assumes the existence of foreign<br />
exchange differences and therefore of complicated and intricate tax complications.<br />
Transactions undertaken by a company that involves at least two currencies raise, in<br />
general few very important aspects:<br />
• Timing and measurement;<br />
• Source;<br />
• Characterization of the gain or loss (ordinary income, as an auxiliary result<br />
from economic transactions or financial income as main result from financial<br />
transactions).<br />
This is a well discussed issue but the idea of bringing it back in the current discussion<br />
is necessary due to the implications on the level of taxation, especially in obtaining<br />
financing in this difficult time for companies that have resisted so far without debt<br />
(especially in the last three years since the crisis started), but especially those who<br />
could not avoid calling on loans. It is known that the tax laws and accounting of a<br />
country are a deciding factor for investors who want to place their capital in a given<br />
region.<br />
Currently, according to Romanian legislation, the unrealized differences affect the<br />
profit loss account (PLA) and implicitly the default rate of taxation. Exchange<br />
differences are recognized in the accounts as income, respectively as expenses in the<br />
period to which they belong, thereby determining the outcome of accounting and<br />
taxation. Depending on the company's degree of debt and the source of the funds<br />
obtained from foreign sources, exchange loss is deductible or not. If it is nondeductible<br />
this year, such a loss is carried forward to subsequent years until its full<br />
recovery. In case which the foreign exchange difference is a gain it represents a<br />
taxable item that will increase the income tax owed by the entity.<br />
Recognizing the exchange differences via PLA, affecting the result, through the<br />
financial statements, has an impact on owners’ equity, which can increase, in case of<br />
gains, or decrease, in case of losses. Primarily, this material wants to follow at least<br />
three aspects related to the influence of unrealized foreign exchange differences on<br />
the finances of a company which funds its activities through long-term lending in<br />
foreign currency, obtained either from the banks or from associates:<br />
• Recognition means in accounting;<br />
• Influence on the taxation level and the possible „snowball” effect;<br />
• Effect on the level of owners ‘equity.<br />
~ 621 ~
1. RECOGNITION MEANS IN ACCOUNTING<br />
Order 3055/2009 on accounting regulations in accordance with the Fourth Directive<br />
of the European Economic Community and the Seventh Directive of the European<br />
Economic Community specify the criteria for recognition in the revenue and<br />
expenditure accounts.<br />
„ a) revenue represents recorded increases in economic benefits during the<br />
accounting period, in the form of inputs, or increases in assets or reductions in<br />
debt, which are reflected in increases of equity other than those resulting from<br />
shareholders contributions;<br />
b) expenditures represent reductions of recorded economic benefits during the<br />
accounting period, in the form of outputs, or decreases in assets or increases in<br />
debt, which are reflected in decreases of equity other than those resulting from<br />
shareholder distribution.<br />
Based on these definitions it is noted that there are no recognition differences between<br />
revenue/expenditure elements realized or not, because there is no definition of the<br />
term “realized” from this point of view. The only definition for the term “realized<br />
revenue” is met in case of re-evaluated assets for which the re-evaluation surplus is<br />
recognized as realized revenue through transactions related to the respective assets.<br />
„(3) The re-evaluation surplus included in the re-evaluation reserve is<br />
capitalized through the direct transfer to the reserves (account 1065 “Reserves<br />
representing income from re-evaluation reserves”), when this surplus<br />
represents a realized income.<br />
For the current regulations, the income is considered realized at removal<br />
from records of the assets for which the re-evaluation reserve is made.<br />
However, part of the income can be realized as the asset is used by the entity. In<br />
this case, the transferred reserve value is the difference between depreciation<br />
value based on revalued book value and the depreciation based on original cost<br />
of asset. „<br />
Although the definition of the income or expense items does not meet any evidence<br />
showing what means "realized" yet, it can be shown that their production is based on<br />
an activity or a transaction, for which exchange differences registration is not<br />
applicable, because they occur as a consequence of a basic transaction (a loan) and the<br />
monthly assessment of accounting rules, and not as an independent transaction.<br />
For the unrealized exchange differences arising from the application of accounting<br />
rules on monthly assessment of foreign currency monetary items, there isn’t a specific<br />
event or transaction record to determine income or expenditure. This monthly review<br />
depending on the National Bank of Romania foreign exchange rate valid on the last<br />
day of the month aims to bring closer to reality the financial position of an entity.<br />
From the perspective of equity and fair image of earnings at the end of the month, the<br />
recognition elements of foreign exchange is a tool to update, depending on the<br />
exchange rate, the value of the entity at that time. But the question arises whether this<br />
monthly amount update actually produces an increase in economic value (in case of<br />
profit from exchange rate differences) or a reduction in economic value (in case of<br />
loss) that can be recognized as a taxable item?<br />
~ 622 ~
However, the entity has not conducted any activity in this respect, meaning that it<br />
cannot determine or controls the obtainment of gains or losses from exchange<br />
differences. The exchange rate is a monetary policy item set by the central bank and<br />
may be influenced by various factors such as:<br />
• Monetary policy of the BNR;<br />
• Inflation target objectives and rate of exchange stabilization or reduction<br />
efforts, as is the case of BNR in the last years to fulfil EU criteria for adoption<br />
of the EURO;<br />
• Periodical influences of speculative capitals on the exchange rate level;<br />
• Economic status and especially exports and imports.<br />
Assume the following example: A company has at the end of the year a debt of<br />
1,000,000 EURO - Loan from an associate. The official exchange rate RON/EUR for<br />
31.12.2010 was 4.2848, so the loan will have an equivalent value of 4,284,800 RON.<br />
On 02/28/2011, the exchange rate is 4.2139 RON / EUR. The loan will be presented<br />
in the accounts amounting to 4,213,900 RON with an unrealized gain from the foreign<br />
exchange amounting to 74.500 RON for which a tax is due (assuming that amount<br />
only) of 11.920 RON.<br />
In the example above we can see that the company has not undertaken any activities<br />
to this end to get that "revenue" of 74.500 RON, however it owes taxes for that<br />
amount. If we assume that the company is in the development period, immediately<br />
after its incorporation, and the only way to receive funding is loans from associates<br />
(financial institutions rarely support early development projects or start-ups). Suppose<br />
that the funds necessary to pay taxes are only calculated on the basis of a new<br />
currency loan, which in turn will generate an increased rate differences impact on the<br />
financial statements.<br />
Suppose the example situation as valid at the year’s end, i.e., following the<br />
revaluation of the loan, at the end of the year there is a profit of 74.500 RON<br />
(ignoring the effect of other transactions). After recording the income tax expense -<br />
11,920 RON - a net profit of 62.850 RON is obtained. Relating to this result some<br />
questions arise:<br />
• Is this result distributable as dividends to the associates?<br />
• Is this profit an indicator of the company’s “performance”, based on which it<br />
can obtain credits from a financial institution?<br />
• How will the company’s feasibility rates be calculated, taking into<br />
consideration the “realized” profit?<br />
• Which would be the result if these transactions were entered in the business<br />
currency - EUR?<br />
Related with the "distribution" of the profit or not, in the Order 3055/2009 (or<br />
Accounting Law 82/1991) there are no provisions that prohibit or specify what<br />
conditions must be fulfilled for the results to be distributed as dividends. For example,<br />
in case of the revaluation reserve it is directly specified under what conditions<br />
distribution can be made and what are the consequences of breaching these<br />
provisions:<br />
~ 623 ~
„Art. 124 - (1) In case the reassessment of tangible assets is to be performed,<br />
the difference between the value resulting from revaluation and the value at<br />
historical cost must be presented in the revaluation reserve as a distinct subelement<br />
in "Capital and reserves” (account 105 "Revaluation reserves").<br />
Treatment of the revaluation reserve for tax purposes must be presented in the<br />
notes.<br />
(8) No part of the revaluation reserve may be distributed directly or indirectly,<br />
unless the revalued asset was exploited, in which case the revaluation surplus is<br />
actually realized revenue.”<br />
And for this specific case, there is the definition for "actual gain realized": it involves<br />
the removal from evidence (by sale, disposal or other similar transaction) of the asset<br />
that generated it. So, unlike the case of exchange differences where that are<br />
immediately recognised in the PLA and taxed as such, in case of assets revaluation,<br />
the same accounting treatment no longer applies and, as a consequence, neither does<br />
the fiscal one. There is a reference in the Companies Law, Article 67 relating to the<br />
distributable profit, but it refers to the way of determining what actually represents a<br />
matter of accounting principles and rules.<br />
„Art. 67. - (1) Profit part which is paid to each associate constitutes a dividend.<br />
(2) Dividends are distributed to shareholders in proportion to their<br />
participation to the share capital, unless the articles of association stipulates<br />
otherwise. They are paid within the period set by the general meeting of<br />
shareholders or, where appropriate, established by special laws, but not later<br />
than six months from the date of approval of annual accounts for the year<br />
ended. Otherwise, the company will pay damages for the period of delay at the<br />
statutory rate if the articles of association or the decision of general meeting of<br />
shareholders approved the accounts for the financial year did not establish a<br />
higher interest rate.<br />
Par. (2) was modified by pt. 36. of Law no. 441/2006 beginning with<br />
01.12.2006.<br />
(3) Dividends can only be distributed from lawfully determined profits.<br />
(4) Dividends paid contrary to the provisions of par. (2) and (3) are returned,<br />
if the company proves that the associates knew of the irregularities of their<br />
distribution or, under the current circumstances, should have known.<br />
(5) The right to receive the dividends, paid against the provisions of par. (2)<br />
and (3), is prescribed in 3 years from their distribution„.<br />
„Art. 272 1 . - The founder, manager, director or legal representative of the<br />
company shall be punished with imprisonment from 2 to 8 years, in case of:<br />
1. spreading false news or using other fraudulent means which employ the<br />
effect of raising or lowering the value of shares or company bonds or other<br />
securities owned by company for the purpose of obtaining for himself or others,<br />
a benefit at the damage of society;<br />
2. receives or pays dividends, in any form, for fictitious or non-distributable<br />
profits, or otherwise lacking the financial situation resulting from this.„<br />
~ 624 ~
What means "fictitious or non-distributable profits”? Is the situation presented in our<br />
example in this category? Regarding the other two questions, the answers are obvious:<br />
• No financial institution will take into account the profits made from exchange<br />
rate differences as a "realized" profit or achievable in the future;<br />
• The rates of return that would take into account such a profit will also express<br />
vague clues on the financial status of the company for unsuspecting users.<br />
The principle of prudence stated in Order 3055/2009 clearly refers to the recognition<br />
of profit at the balance sheet:<br />
„41 – The prudence principle. When drawing-up the yearly financial statements,<br />
the evaluation must be made cautiously and, especially:<br />
a) in the profit and loss account can be included only the balance date<br />
profit;„<br />
However there are some elements which could complete the given statement:<br />
• The “realized profit” definition and the recognition criteria;<br />
• The fact that not only at the end of the year, but after every transaction just the<br />
“realized profit” must be recognized;<br />
With regard to the last question (Which is the result if these transactions were<br />
highlighted in the business operation currency – EURO?) we can take the example<br />
amounts and perform the calculation just in EURO, to determine the taxable basis.<br />
Data from the above example are: Debt - 1,000,000 EUR - Loan from associate.<br />
Official exchange rate RON/EUR for 31.12.2010 was 4.2848,<br />
Since the exchange rate has no influence on the euro value, which remained<br />
unchanged, the result will be zero because there are no differences. Suppose that the<br />
company prepares external reports, to the parent company, in EUR and that the result<br />
achieved at the end of the year is only the exchange differences in the amount of<br />
74,500 RON, net profit after tax. Under the rules of conversion, the elements of the<br />
PLA will be converted into the reporting currency at the average EUR exchange rate<br />
(assuming that it is 4.2 RON/EUR). In this case, the Romanian company would report<br />
to the parent company a profit of 17,738 EUR. We can assume that the parent<br />
company wants exclusive distribution of this result and that the dividends tax will be<br />
paid for, according to Double Tax Conventions.<br />
The conclusions drawn from the cases described above merely highlight, to a lesser<br />
extent, the effects of the exchange differences resulting from recognition in the PLA<br />
and their inclusion in the taxable basis:<br />
• Recognition of a gain/loss from unrealized exchange rate differences affect<br />
(distort?) the result obtained;<br />
• Generate income tax (or tax cuts for the deductible loss);<br />
• Can generate dividend through the distribution of the result that incorporate<br />
elements of exchange rate differences;<br />
• Distorts the reporting prepared in the currency for conducting business if the<br />
reporting is based on amounts in lei, based on the rate of closure (for the<br />
review) respectively the average rate (for the PLA).<br />
~ 625 ~
• If the records should be kept exclusively in EUR, it has been observed that there<br />
is an unrealized exchange rate difference and thus there would be no impact on<br />
the distributable fees or profit;<br />
• For cancelling or balancing these effects, the taxpayers can take measures to<br />
counteract, through initiating financial transactions such as currency hedging<br />
transactions or by directing the economic activities dependent of the existence<br />
of a strong currency in the country. This will affect the taxpayers' behaviour and<br />
even more the accuracy of the criteria used for measuring economic income.<br />
2. INFLUENCE OF THE TAXATION LEVEL AND THE POSSIBLE<br />
“SNOWBALL” EFFECT<br />
Immediate recognition through PLA of exchange differences generates effects over<br />
the tax level, and thus on the final price established by the companies for services<br />
rendered or goods sold in order to recover their costs. In the example above we have<br />
presented the case where the funds to pay the necessary tax are calculated on the basis<br />
of a new loan in foreign currency.<br />
Suppose that the company borrows an amount of EUR 100,000 necessary to pay the<br />
income tax at the end of the first quarter, the exchange rate being 4.2 RON / EUR.<br />
Income from exchange rate differences will be worth 1.1 million * (4.2139 - 4.2000)<br />
= 15.290 RON and corresponding tax amount will be 2.446 RON. It is noted that the<br />
taxation of such income from exchange rate differences will create a "snowball" type<br />
self-generating situation. This situation will be reflected in prices that will increase<br />
systematically. There is the possibility that such costs can be capitalized in the amount<br />
of investment for a long term project.<br />
Notice of 22/12/2003 on measures concerning the organization and conduct of<br />
management accounting permit differences of the associated borrowing in value of<br />
assets or long-term services:<br />
„Other expenses that may be included in certain specific circumstances the cost<br />
of goods, works, services:<br />
- Borrowing costs may be included in cost of goods, works and services, etc.<br />
only insofar as they are directly attributable to the acquisition, construction or<br />
production of qualifying asset production, in accordance with applicable<br />
accounting regulations.<br />
Borrowing costs include interest and other expenses incurred by a legal<br />
entity in connection with loan funds.<br />
A qualifying asset is a manufacturing asset that necessarily takes a<br />
substantial period of time to get ready for its intended use or sale;<br />
- General administrative expenses may be included in cost of goods since they<br />
represent costs incurred to bring the goods to the final form and place and<br />
justify their taking into account under specific conditions of operation. „<br />
As such, the unrealized exchange differences, to not immediately affect the PLA, will<br />
be included in the cost of the respective asset and will be part of the depreciation or<br />
costs for operation or sale. So the value of the assets will be influenced by the<br />
unrealized rate of exchange differences requiring a periodical market value testing so<br />
that a non-sustainable value is not reflected in accounting. Presently, due to the<br />
~ 626 ~
difficult economic situation at general level, the need to call on credits is more<br />
stringent and this is overlaid over the suspicion of the banks to grant credits which<br />
creates extremely high eligibility criteria which block access to financing. In this case<br />
a company has few solutions to support itself financially:<br />
• Maximum usage of the supplier’s credit;<br />
• Careful following of receivable;<br />
• Cost and unsustainable contract restructuring.<br />
Because of this, it might be recommended from an accounting point of view, but also<br />
fiscally, a relaxation of rules for the exchange differences:<br />
• Either by increasing the degree of debt which allows deductibility of exchange<br />
differences loss;<br />
• Or by separating the accounting aspect from the fiscal one, meaning<br />
recognition of the exchange differences in the PLA at evaluation, but taxing<br />
them at realization.<br />
3. EFFECT ON THE LEVEL OF OWNERS EQUITY<br />
One of the effects of exchange differences registration consists in the reduction of<br />
owners’ equity below the minimum level specified by the commercial company law<br />
or even taking negative values, posing the issue if the continuity principle is still<br />
applicable or even endangering the existence of the company.<br />
„Art. 153 24 . - (1) If the board of administration, respectively directors, find that,<br />
following certain losses, set by the lawfully approved yearly financial<br />
statements, the net worth of the company, determined as a difference between<br />
the total assets and the total debts, reduced to less than half the underwritten<br />
share capital, it will immediately convoke the extraordinary general meeting to<br />
decide if the company must be dissolved<br />
(2) Through the articles of association is can be established that the<br />
extraordinary general meeting can be convoked even for a less significant<br />
reduction of the net worth than the one specified in par. (1), establishing this<br />
minimum level of the net works via reporting to the underwritten share capital.<br />
………………………………..<br />
(5) In the case of non-convoking the extraordinary general meeting as per<br />
par. (1) or if the meeting could not validly deliberate on the second<br />
convocation, any interested party can approach the court to ask the dissolution<br />
of the company. The dissolution can be requested in the case the company’s<br />
obligation acc. to par.(4) is not respected. In either case, the court may give the<br />
company a period, not exceeding six months, to rectify the situation. The<br />
Company shall be dissolved if the net worth cannot be reconstructed up to a<br />
value at least half the share capital until the court decision, regarding<br />
dissolution, becomes irrevocable.. "<br />
Another aspect is related to the degree of debt provided by the Tax Code for<br />
deductibility of interest and exchange differences: the loss from exchange differences<br />
reduces the result and thus the equity result.<br />
~ 627 ~
CONCLUSIONS<br />
As could be determined from the above, the impact of exchange differences on both<br />
accounting and taxation level is extremely important for an item that cannot be<br />
controlled by the firm. Normally, the activity of a company and its level of taxation<br />
should be influenced only by transactions which it can determine or it can control in<br />
order to obtain profit. Also, information users should have access to clear information<br />
on the impact of exchange differences in business activity. Due to the impact of<br />
exchange differences, financial systems have developed in some countries in order to<br />
prevent or protect against currency risk, which currently in Romania are not available<br />
or not applicable. Therefore, a reconsideration of how to recognize the accounting<br />
definition of profit/ gain realized, as is already the case for revaluation of tangible<br />
assets, but especially when it is taxed such exchange differences could be very useful<br />
in the present economic situation.<br />
REFERENCES<br />
Ana Stoian (2003) Accounting and tax administration, Ed. ASE, Bucharest;<br />
Gabriel Radu (2005) Accounting and Taxation: from theory to practice, Ed. Ex Ponto,<br />
Bucharest;<br />
George Vintilă (2005) Financial management of company, Ed. Didactic and Pedagogical,<br />
Bucharest;<br />
Ion Stancu (1994), Financial management of traders, Ed.Economic, Bucharest;<br />
Review The Economic Amphiteatre, 2011, published by ASE;<br />
Review The Journal of Accounting and Management Information System, 2009 – 2011,<br />
published by the Accounting and Management Information System Faculty;<br />
Accounting Law no. 82/1991;<br />
Companies Law no 31/1990;<br />
„ General Report of IFA” Vancouver Congres 2009;<br />
International Reporting Standards, Ed. CECCAR, Bucureşti, 2009;<br />
Order no 3055/2009 on accounting regulations in accordance with the Fourth Directive of the<br />
European Economic Community and the Seventh Directive of the European Economic<br />
Community;<br />
Tax Code;<br />
Nick Pantaleo (Canada) and J. Scott Wilkie (Canada), 2009, “General Report“ available<br />
online at http://www.ifa.nl/members_only/congress_documents/pages/default.aspx<br />
IFA Cahiers 2009, Volume 94B, “Foreign exchange issues in international taxation”,<br />
available online at http://online2.ibfd.org/kbase/<br />
~ 628 ~
VALUE RELEVANCE OF CONSOLIDATED VERSUS<br />
PARENT COMPANY FINANCIAL STATEMENTS<br />
Victor-Octavian MULLER 1<br />
Babeş-Bolyai University, Romania<br />
ABSTRACT<br />
Within the European Union, parent companies have to prepare and publish both consolidated<br />
and individual financial statements. The objective of financial statements with general<br />
purpose is to give information regarding the financial position, performance and changes in<br />
financial position of the reporting entity, information that is useful to investors and other<br />
users in making economic decisions. In order to be useful, financial information needs to be<br />
relevant to the decision-making process of users in general, and investors in particular.<br />
Therefore, the following question arises naturally – which of the two sets best serves the<br />
information needs of investors (and other categories of users), respectively which of the two<br />
sets is more relevant for investors? In our scientific endeavor we set to carry out an empirical<br />
association study on the problem of market value relevance of consolidated financial<br />
statements and of individual financial statements of the parent company, searching for an<br />
answer to the above question. In this sense, we analyze the (absolute and relative) market<br />
value relevance of consolidated accounting information of listed companies between 2003-<br />
2008 on the largest stock markets in Europe (London, Paris, and Frankfurt). Through this<br />
empirical study we intend to contribute to the relatively limited literature on this topic with a<br />
comparative time analysis of the absolute and incremental relevance of financial information<br />
supplied by the two categories of financial statements (group and individual).<br />
KEYWORDS: Consolidated Financial Statements, Parent Company Financial Statements,<br />
Market Value Relevance<br />
INTRODUCTION<br />
The objective of financial statements (with general purpose) is to give information<br />
regarding the financial position, performance and changes in financial position of the<br />
reporting entity, that is useful to a wide range of users in making economic decisions.<br />
According to the conceptual framework of IASB (par. 10), considering that investors<br />
are suppliers of risk-bearing capital, issuing financial statements that satisfy their<br />
information needs allows satisfying the information needs of other categories of users<br />
of financial statements, as well. This conception of IASB (as well as of FASB) is<br />
maintained in the exposure draft for phase A regarding the improvement of the<br />
Conceptual framework, where the two boards consider that the needs of the other<br />
members of the primary user group will be in general and essentially the same with<br />
the needs of ordinary shareholders (IASB, 2008a: BC 1.20).<br />
Furthermore, in order to be useful, financial information needs to be relevant to the<br />
decision-making process of users in general, and investors in particular, meaning that<br />
1 Correspondence address: Victor-Octavian MÜLLER, Babeş-Bolyai University, Cluj-Napoca,<br />
Romania; email: victor.muller@econ.ubbcluj.ro<br />
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it must have the capacity to influence their economic decisions. Relevance represents,<br />
in fact, one of the main characteristics of financial information quality (Francis et al.,<br />
2004). It is well known that relevance is now considered (see the stipulations of IASB<br />
Conceptual Framework) one of the qualitative characteristics of financial information<br />
together with reliability, understandability and comparability. Moreover, in the<br />
exposure draft regarding the improvement of the Conceptual framework, IASB and<br />
FASB named relevance and faithful representation as the two fundamental qualitative<br />
characteristics of financial information (IASB, 2008a: QC2). According to the two<br />
boards, relevance is linked to connecting economic phenomena to the decisions of<br />
capital suppliers and of other users of financial information (IASB, 2008a: QC12).<br />
Therefore, in order to make assessments on the quality of information of financial<br />
statements, it is absolutely necessary to quantify this relevance (capacity to influence)<br />
of financial information.<br />
A fertile environment to perform such a measurement is the capital market, where<br />
investors’ decisions (as users of financial information) are reflected directly in the<br />
share price of the reporting entity. In this context, market value relevance is measured<br />
by the ability of financial information to capture or summarize information that<br />
influences share prices (Francis & Schipper, 1999). According to the same authors<br />
market value relevance means the existence of a statistical correlation/association<br />
between financial information and prices or returns, and also the fact that this<br />
information explains market prices to an extensive measure, starting from the<br />
presumption of the efficient market in which prices reflect the available information<br />
(Francis & Schipper, 1999: 326). This approach presumes that the function of<br />
financial information is to reflect economic income represented by stock return and<br />
economic value, respectively, represented by market prices (Hellström, 2006: 326).<br />
Financial information is supplied mainly through financial statements of entities<br />
(listed on the capital market). In the majority of cases (at least on the large European<br />
stock markets) listed companies own one or more subsidiaries, and therefore are<br />
obligated (through national accounting legislation as well as stock exchange<br />
regulations) to prepare consolidated financial statements for the group they own. At<br />
the same time, as legal persons, companies are legally obligated to present individual<br />
financial statements. Consequently, parent companies are obligated to a dual reporting<br />
materialized in two sets of financial statements – one at individual level, the other at<br />
group level. Therefore, the following question arises naturally – which of the two sets<br />
best serves the information needs of investors (and other categories of users),<br />
respectively which of the two sets is more relevant to substantiating decisions. Of<br />
course, the possibility of both sets at the same time best serving the information needs<br />
is not ruled out.<br />
Considering all these aspects, in our scientific endeavor we set to carry out an<br />
empirical association study on the problem of market value relevance of consolidated<br />
financial statements and of individual financial statements of the parent company,<br />
searching for an answer to the above question. Market value relevance can be<br />
evaluated through event studies in which the market reaction to financial information<br />
announcements is analyzed, or through association studies used to measure the<br />
explicit connection between indicators of company market value (e.g. stock price)<br />
and financial information. This second perspective of evaluation is applied in most<br />
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market value relevance studies (Hellström, 2006: 328) and has also been approached<br />
in our research.<br />
In this sense, we pursued an analysis of (absolute and relative) market value relevance<br />
of consolidated and parent company accounting information of listed entities between<br />
2003-2008 on the largest stock markets in Europe (London, Paris, and Frankfurt). We<br />
chose a time frame of several years in order to be able to follow the evolution in time<br />
of the relevance (absolute and relative) of consolidated financial statements. It must<br />
be mentioned, however, that strictly from the point of view of the calendar year<br />
relevance is measured for the period 2004-2009, because statistical associations are<br />
based on stock prices from April the following year.<br />
The reminder of the paper is organized as follows. The next section (first numbered<br />
section) relates our study to previous technical and academic literature. Section 2<br />
explains the research methodology (including sample selection and data sources as<br />
well as the development of hypotheses and empirical models). Section 3 reports the<br />
descriptive statistics while in section 4 we expose the empirical results obtained. The<br />
final section provides a discussion of results and conclusions.<br />
1. LITERATURE REVIEW<br />
The importance and currentness of this problem results, to a great extent, from the<br />
recent concerns of IASB and FASB, published in the Discussion paper entitled<br />
„Preliminary views on an improved conceptual framework for financial reporting –<br />
The Reporting Entity” (IASB, 2008b), in which the problem of dual reporting and the<br />
utility of the two categories of financial statements is under discussion, presenting<br />
different points of view from the accounting world (for and against dual reporting).<br />
This discussion paper was published by IASB in May 2008 and is part of Phase D of<br />
the project (unreeled jointly with FASB) of improving the current Conceptual<br />
Framework. The preliminary view of the two bodies is that a parent company should<br />
always present consolidated financial statements. However, at the same time, the<br />
boards consider that through the conceptual framework presenting individual financial<br />
statements by the parent company should not be prevented as long as these are<br />
included in the same report as the consolidated financial statements (IASB, 2008c:<br />
137-140).<br />
Concerning the empirical research that has tackled this matter, there are only a few<br />
studies which could be identified in the international literature. In general, they bring<br />
evidence in favor of the superior relevance of consolidated financial statements (ex.<br />
Harris et al., 1994, Niskanen et al., 1998, Abad et al., 2000) respectively evidence<br />
regarding a lack of relevance increment of individual financial statements of the<br />
parent company (Niskanen et al., 1998, Goncharov et al., 2009).<br />
In their study, Harris et al. (1994) compare the value relevance of accounting<br />
measures for U.S. and German firms matched on industry and firm size. One of their<br />
conclusions based on their empirical findings states that the explanatory power of<br />
accounting data is increasing in the level of consolidation and that unconsolidated<br />
data perform poorly relative to the consolidated data. Niskanen et. al (1998) examine<br />
the information content of consolidated versus parent-only earnings, using accounting<br />
and market data from Finnish firms. Their results show that consolidated earnings are<br />
a significant incremental explanatory variable for stock returns, while parent-only<br />
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earnings are not, thus indicating that consolidation improves the information content<br />
of earnings, and that the requirement to disclose parent-only earnings should be based<br />
on arguments other than their value-relevance to shareholders.<br />
Abad et al. (2000) investigate the value relevance of consolidated versus parent<br />
company accounting information on a sample of Spanish firms listed on the Madrid<br />
Stock Exchange. The authors use the Edwards-Bell-Ohlson valuation framework to<br />
generate the results. The empirical findings show that, from this valuation perspective,<br />
consolidated information dominated parent company (non-consolidated) information.<br />
Finally, Goncharov et. al. (2009) examine the possibly different economic functions<br />
of company (single) and group (consolidated) accounts using a large number of<br />
accounting and market-based metrics from a sample of German companies. Their<br />
analysis indicates higher value relevance, predictive ability, and timeliness of group<br />
accounts as compared to company accounts. Furthermore, they could not identify an<br />
incremental usefulness of single accounts.<br />
Also regarding the value relevance of consolidated information are empirical<br />
studies which investigate the value relevance of consolidated financial<br />
statements in the context of the IFRS transition. A series of empirical studies<br />
have proven the rise of market value relevance following IFRS adoption (Bartov<br />
et al., 2005; Jermakowicz et al., 2007, Barth et al., 2007; Lin and Paananen,<br />
2007). However, there are also studies showing that IFRS has not lead to a rise in<br />
the market value relevance of consolidated financial statements (Callao et al.,<br />
2007; Hung and Subramanyam, 2007; Gjerde et al., 2008; Paananen, 2008).<br />
According to a recent study (Armstrong et al., 2010), the mandatory application<br />
of IFRS when presenting consolidated financial statements starting with 2005<br />
determines an improvement of the quality of accounting information as seen by<br />
the investors.<br />
2. RESEARCH METHODOLOGY<br />
2.1. Sample selection and data sources<br />
In this empirical research we followed the analysis of market value relevance of<br />
consolidated accounting information on companies on the large European stock<br />
markets in 2003-2008. The European stock market (monitored by Federation of<br />
European Securities Exchanges – FESE) comprises capital markets from EU countries<br />
as well as Iceland, Norway and Switzerland. The large European capital markets<br />
(which exceed the threshold of 5% of the total European capital market) include,<br />
according to table 2: BME Spanish Exchanges, Borsa Italiana, Deutsche Börse,<br />
London Stock Exchange, NASDAQ OMX Nordic, NYSE EURONEXT and SIX<br />
Swiss Exchange. The criteria chosen to estimate the size of a stock market (and<br />
implicitly of selecting it) is market capitalization and the volume of share trading<br />
(within and outside of the electronic system) for each year of the analyzed period. In<br />
order to form a representative sample of the large European stock markets we decided<br />
to include in our sample the top European stock markets that together exceed 50% of<br />
the total size of the largest European stock markets and respectively 50% of the total<br />
size of the European capital market for each of the six years. Of course, we dare think<br />
that such a sample can be considered representative at the level of the European<br />
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capital market as a whole, since the large European markets – for which the sample is<br />
representative – represent over 90% of the total European capital market.<br />
So, as seen in table 3, the largest stock markets are Deutsche Börse, London Stock<br />
Exchange and NYSE Euronext, which together exceed the conditions aforementioned<br />
in each year of study. On average, for the analyzed period, the three stock exchanges<br />
represent 67,5% of the transaction volume, respectively 60,3% of the market<br />
capitalization of the European capital market. In fact, these are the only stock markets<br />
that individually exceed 10% of the total market capitalization, respectively of the<br />
total volume of share trading on European stock markets for the six years of the<br />
analyzed period, which constitutes an additional argument for considering the sample<br />
as representative for large European stock markets.<br />
From the four stock exchanges that make up NYSE Euronext we chose Paris Stock<br />
Exchange (the largest of the four, accounting for 70% of the companies included in<br />
the EURONEXT100 index) and for the German stock market we chose, of course,<br />
Frankfurt Stock Exchange (again the largest of the seven component stock<br />
exchanges). To continue, the main criteria for selection that we established for each<br />
stock exchange is the belonging to the main index which includes the first 100 of the<br />
largest and most traded companies on that particular stock exchange. So, for the<br />
London stock exchange we chose FTSE 100, for the Parisian stock exchange<br />
EURONEXT 100, and for the Frankfurt stock exchange HDAX 110. The HDAX 110<br />
index represents the extended version of DAX 30 and includes companies from the<br />
DAX, MDAX and TecDAX. We chose this index since it is the closest as structure<br />
and number of included companies to FTSE 100 and EURONEXT 100.<br />
We excluded financial and insurance companies from the sample because their<br />
structure and accounting practices differ significantly from those of non-financial<br />
companies (Hellström, 2006: 335). As well, to eliminate composition differences of<br />
the sample from one year to the other (which would affect comparability of results in<br />
time), we excluded companies that have not been listed on the stock exchanges for the<br />
whole analyzed period. At the same time, to increase the homogeneity of the sample<br />
and to use the same time span (31.03 – 30.04) to determine average share price,<br />
companies who close financial years (for financial statement purposes) at a date<br />
different from 31.12 were excluded. Therefore, after going through these steps, the<br />
final sample is made up of 98 companies, respectively 588 firm-year observations as<br />
can be seen in table 1. The sample constitutes, therefore, a two-dimensional balanced<br />
panel data noted Xit, which is practically a data set containing observations on the<br />
individual characteristics (e.g. equity, income) of the same (i = 1,..., 98) for a number<br />
of year (t = 1,..., 6).<br />
Based on this complete sample, throughout the paper we constructed different subsamples<br />
for each year, stock exchange or other sub-samples which have been<br />
described in the study at the moment when they were used. It must be mentioned that<br />
we did not study comparatively the market value relevance of consolidated (and<br />
individual) financial statements for the three stock markets. Creating sub-samples is<br />
only meant to get confirmation (to strengthen) of the empirical results obtained from<br />
the complete sample.<br />
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Table 1. Final sample composition<br />
Frankfurt Stock Exchange London Stock Exchange Paris Stock Exchange<br />
1 BASF 1 AMEC 1 Accor<br />
2 Bayer 2 Anglo American 2 Air Liquide<br />
3 BB Biotech 3 Antofagasta 3 Bouygues<br />
4 Beiersdorf 4 Astrazeneca 4 Cap Gemini<br />
5 BMW 5 Autonomy 5 Carrefour<br />
6 Celesio 6 Bae Systems 6 Christian Dior<br />
7 Continental 7 Balfour Beatty 7 Ciments Francais<br />
8 Daimler 8 BG Group 8 Danone<br />
9 Deutsche Börse 9 BP 9 EADS<br />
10 Deutsche Lufthansa 10 British American Tobacco 10 Eramet<br />
11 Deutsche Telekom 11 Cairn Energy 11 Essilor International<br />
12 Eon 12 Capita Group 12 Iliad<br />
13 Elring Klinger 13 Centrica 13 Imerys<br />
14 Fuchs Petrolub 14 Cobham 14 Klepierre<br />
15 Gildemeister 15 Foreign&Col Investment 15 L'oreal<br />
16 Heidelbergcement 16 Glaxosmithkline 16 Lagardere<br />
17 Henkel 17 Hammerson 17 Michelin<br />
18 Hochtief 18 Intertek Group 18 Peugeot<br />
19 Hugo Boss 19 International Power 19 PPR<br />
20 Krones 20 Liberty International 20 Publicis Groupe<br />
21 Leoni 21 Pearson 21 Renault<br />
22 Metro 22 Randgold Resources 22 Saint Gobain<br />
23 MLP 23 Reed Elsevier 23 Sanofi-Aventis<br />
24 Morphosys 24 Rexam 24 Schneider Electric<br />
25 Nordex 25 Rio Tinto 25 Technip<br />
26 Pfeiffer Vacuum Techno 26 Rolls-Royce Group 26 TF1<br />
27 Pfleiderer 27 Segro 27 Total<br />
28 Rheinmetall 28 Serco Group 28 Vallourec<br />
29 Rhön-Klinikum 29 Smith & Nephew 29 Veolia Environ<br />
30 RWE 30 Tullow Oil 30 Vinci (Ex.Sge)<br />
31 Salzgitter 31 Unilever 31 Vivendi<br />
32 SAP 32 Xstrata<br />
33 United Internet<br />
34 Volkswagen<br />
35 Vossloh<br />
Total companies included in the final sample: 98<br />
Total number of observations (company-year) included in the final sample: 588 (98 companies x 6 years)<br />
Consolidated and individual financial information (group equity, parent company<br />
equity, group earnings, parent company earnings, number of shares) was collected<br />
manually from the annual reports for the 588 year-observations of the complete<br />
sample, after being previously downloaded from the official web-sites of the<br />
respective companies. For many German companies using parent company annual<br />
reports was necessary because annual group reports did not include parent company<br />
financial statements, but only consolidated financial statements.<br />
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Share prices for the sampled observations were also collected manually from the<br />
finance.yahoo.com database. This database can be accessed without charge and is<br />
recommended by Andrei & Bourbonnais (2008: 30). For the development of the<br />
study, we computed average closing share prices for 31.03 – 30.04 of each year,<br />
making sure that companies have already published the annual reports for the<br />
preceding year. We consider that using average closing prices for a certain period of<br />
time (as opposed to using the closing price of a certain day – for example 31.03) has<br />
the advantage of neutralizing possible daily fluctuations of the prices, caused by<br />
factors that are not linked to the financial information published in the annual reports.<br />
A very important aspect for every empirical study based on testing linear regressions<br />
is the problem of identifying and eliminating outliers (Martin & Roberts, 2006: 703).<br />
In this respect, we established two filters: the first filter (applied by Hellström, 2006)<br />
eliminated observations that, in the first stage, exceed five standard deviations from<br />
the average value of equity (consolidated and individual, respectively)/share price and<br />
net income (consolidated and individual, respectively)/share price and then (after<br />
eliminating these ones) the ones that exceed three standard deviations from the<br />
average. The second filter (applied by Collins et al. 1997, Gu, 2007) eliminates<br />
outliers for which residuals have absolute values exceeding 4 standard deviations<br />
from zero for consolidated financial statements regressions, respectively for parent<br />
company individual financial statements. This methodology was applied for the<br />
complete sample (n=588), as well as for each sub-sample used throughout the study.<br />
The final dimension of each sample is indicated in the first column of each table,<br />
which represents the empirical results for the various regression models employed.<br />
2.2. Hypotheses development<br />
For the purpose of this study, we formulated the following four hypotheses related to<br />
the „confrontation” on the relevance of consolidated financial statements and parent<br />
company individual financial statements.<br />
Hypothesis 1: Information supplied by consolidated financial statements are more<br />
value relevant than information supplied by individual financial statements of the<br />
parent company. This hypothesis represents the starting point and basis for<br />
elaborating and testing the next hypotheses. Naturally, for its development we took<br />
into consideration empirical results of previous research, which support the thesis of<br />
consolidated financial statement superiority (Harris et al., 1994, Niskanen et al., 1998,<br />
Abad et al., 2000, Goncharov et al., 2009). As mentioned before throughout this<br />
scientific endeavor, the capacity of individual financial statements of the parent<br />
company to reflect its real economic power is reduced. The information supplied by<br />
these statements often appear insufficient, especially for those users of accounting<br />
information whose fulfillment of individual goals depends on the activity of more or<br />
all of the companies within the group (Theisen, 2000: 494). Therefore, consolidated<br />
financial statements, which reflect the economic power of the whole business<br />
combination (presenting information on all the resources and activities within the<br />
scope of the reporting entity), should supply more relevant information to the stock<br />
market investors.<br />
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Table 2. Evolution of trade volume and market capitalization for the European stock<br />
markets in 2004-2009 (percentages)<br />
(Source: Federation of European Securities Exchanges www.fese.be and author’s<br />
calculations)<br />
Table 3. Evolution of trade volumes and market capitalization for the main European<br />
stock markets in 2004-2009 (millions Euro)<br />
(Source: Federation of European Securities Exchanges (www.fese.be) and author’s<br />
calculations)<br />
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Hypothesis 2: The value relevance of information supplied by consolidated financial<br />
statements has been increasing (in the analyzed period of time). At the basis of the<br />
development of this hypothesis lies, on one hand, the results of previous studies<br />
(Collins et al. 1997, Gjerde et al, 2007), which show that the relevance of financial<br />
statements has increased over time. On the other hand, we also start from the<br />
presumption that the qualitative level of the regulations for presenting consolidated<br />
financial statements has increased over time, especially considering the adoption of<br />
IFRS in 2005 and their constant improvement in time as a result of IASB concern<br />
(together with FASB) to elaborate global standards of high quality.<br />
Hypothesis 3: The value relevance surplus supplied by consolidated financial<br />
statements as opposed to individual financial statements of the parent company has an<br />
increasing trend (in the analyzed period of time). This hypothesis represents, to a<br />
certain extent, a blending of the first two aforementioned hypotheses. For its<br />
development, we also took into consideration the fact that the European and national<br />
accounting regulations on presenting parent company financial statements generally<br />
evolve at a slower pace (compared to international standards), and have not been<br />
substantially modified in the analyzed period of time.<br />
Hypothesis 4: Information supplied together by consolidated financial statements and<br />
parent company statements are more value relevant as opposite to information<br />
supplied only by consolidated financial statements. While consolidated financial<br />
statements are meant to offer a true and fair view on the financial position and<br />
performance of the economic entity (the group), individual financial statements have<br />
not only the role to inform on the financial position and performance of the legal<br />
entity (the parent company), but also represent to starting point in determining taxes<br />
and computing distributable income (Goncharov et al., 2009: 335). Therefore, it is<br />
plausible for information supplied by parent company financial statements to bring a<br />
surplus of relevance (market value relevance), beyond consolidated information,<br />
which leads to the fact that a dual reporting is superior (from the point of view of<br />
relevance) to consolidated reporting.<br />
2.3 Development of empirical models and description of the variables involved<br />
In order to empirically test the research hypotheses on the market value relevance of<br />
information supplied by consolidated and parent company financial statements, we<br />
developed a series of econometric valuation models which measure the degree of<br />
association between share price and accounting information supplied by financial<br />
statements (equity and net income). The starting point in developing these models was<br />
the following linear regression (whose parameters are to be estimated using ordinary<br />
least square OLS):<br />
Initial model: Pit = α0 + α1 * Cpit + α2 * Rezit + εit (1)<br />
Where<br />
Pit = share price of company i in year t<br />
Cpit = equity/share of company i in year t<br />
Rezit = net income/share of company i in year t<br />
εit = residual value (error term) for company i in year t<br />
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This regression model in which the dependent variable is the share price level (price<br />
level regression), has the advantage that it is affected in a small amount by an<br />
eventual inefficiency of the market, since price level regressions reflect information<br />
accumulated since the establishment of the companies (concentrated for example in<br />
net assets) (Aboody et al., 2002: 978). At the same time, another advantage of this<br />
model is that it can be decomposed, so that the two explanatory variables (equity and<br />
net income) are broken down to their components. The basis for this is the Ohlson<br />
(1995) valuation model, which expresses share price as a function of current<br />
accounting value of equity plus discounted value of future (abnormal) results. The<br />
model was initially proposed by Preinreich in 1938, later used by Edwards and Bell<br />
(1961), Edey (1962) and Peasnell (1982), but it was restored and popularised in<br />
accounting literature through papers written by Ohlson and respectively Feltham and<br />
Ohlson in 1995 (see Abad et al., 2000: 165).<br />
To compare relevance in absolute values of information supplied by consolidated<br />
financial statements, respectively by parent company financial statements, the<br />
following empirical models were elaborated:<br />
Model 1: Pit = α0 + α1 * pBVit + α2 * pEit + εit (2)<br />
Model 2: Pit = α0 + α1 * cBVit + α2 * cEit + εit (3)<br />
Where<br />
pBVit = book value of parent company equity/share of company i in year t<br />
pEit = parent company net income/share of company i in year t<br />
cBVit = book value of group equity/share of company i in year t<br />
cEit = group earnings/share of company i in year t<br />
In order to make inferences regarding incremental utility of information supplied by<br />
consolidated financial statements (considering that both sets of financial statements<br />
are published by the sampled companies) we developed a model to include both<br />
categories of information:<br />
Model 3: Pit = α0+ α1 * pBVit+ α2 * ∆cBV it+ α3 * pEit+ α4 * ∆cE it + εit (4)<br />
Where<br />
∆cBVit = difference between group equity and parent company equity/share of<br />
company i in year t<br />
∆cEit = difference between group earnings and parent company<br />
earnings/share of company i in year t<br />
These three empirical models will be used to test the first three hypotheses. Therefore,<br />
in order to confirm hypothesis 1 regarding consolidated information relevance<br />
superiority, explanation power of model 2 quantified by adjusted R2 must be greater<br />
than the explanation power of model 1. Since R 2 coefficient of determination<br />
increases with the introduction of new exogenous variables (and thus not being<br />
adequate to make comparisons between models with a different number of<br />
explanatory variables), we use coefficient of determination corrected with the number<br />
of degrees of freedom (or adjusted R 2 ).<br />
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In order to test if an eventual relevance difference (that is relevance increment ∆ Adj.<br />
R2) is statistically significant, we use models 1 and 3, checking the level of R2 change<br />
of model 1, after introducing supplementary variables from model 3 (corresponding to<br />
consolidated information). As well, to confirm/refute hypothesis 3, we verify if the<br />
difference between explanatory power of model 3 and explanatory power of model 1<br />
follow an increasing trend in the analyzed period of time. About hypothesis 2, we will<br />
of course follow the evolution in time of explanatory power of model 2.<br />
A fourth empirical model was developed to verify hypothesis 4, regarding the market<br />
value relevance superiority of information supplied (together) by consolidated and<br />
parent company financial statements as opposed to consolidated information. This is<br />
based on model 2 (based on consolidated information) and also includes information<br />
supplied by parent company financial statements:<br />
Model 4: Pit = α0+ α1 * cBVit +α2 * ∆pBV it +α3 * cEit +α4 * ∆pE it + εit (5)<br />
Where<br />
∆pBVit = difference between parent company equity and group equity/share of<br />
company i in year t<br />
∆pEit = difference between parent company earnings and group<br />
earnings/share of company i in year t<br />
To confirm hypothesis 4, the explanatory power of model 4 must be superior to the<br />
explanatory power of model 2, and the change in explanatory power, as a result of<br />
introducing the two variables which represent information regarding the parent<br />
company, must be statistically significant.<br />
3. DESCRIPTIVE STATISTICS<br />
From the descriptive statistics analysis presented in table 4 (absolute values) and table<br />
6 (values per share) there are more relevant conclusions that can be extracted<br />
regarding the variables considered in this study. To begin with, an increasing trend of<br />
the average share price and total market capitalization can be noticed (for the<br />
companies of the sample) until 2006, followed by a slight decrease in 2007 and a<br />
more steep one in 2008, due to the economic-financial global crisis, of course. A<br />
similar evolution can be noticed for consolidated equity, consolidated income and<br />
parent company income (expressed in values per share). However, a clear trend<br />
cannot be identified for parent company equity. Worthwhile to remark is the increase<br />
(up until the beginning of the crisis) in the difference between group equity and parent<br />
company equity, respectively between group earnings and parent company earnings,<br />
indicating an increase in time of the contribution of subsidiaries to consolidated<br />
equity, respectively to consolidated earnings.<br />
If we concentrate the analysis on the three stock exchanges (that form the sample),<br />
what stands out is the fact that the average of all variables is very low compared for<br />
the companies listed at the London Stock Exchange compared to those listed on<br />
Frankfurt or Paris Stock Exchange, which is due especially to the high average<br />
number if shares issued by English companies (1.814 million shares/company)<br />
compared to German companies (341 million shares/company) and French<br />
(332 million shares/company). This state of facts is based on the long tradition in<br />
financing of the big companies on the Great Britain stock market (country with an<br />
~ 639 ~
Anglo-Saxon economy). By analyzing absolute values results that companies listed on<br />
Paris Stock Exchange (and included in the sample) have, on average, the highest<br />
market capitalization and the highest consolidated equity. The market capitalization<br />
average values for the three sub-samples are situated in the same size range (tenths of<br />
billion Euros) deviating from the average of the complete sample (13,9 billion Euro)<br />
with 14% at the most, indicating a relatively homogenous complete sample (from the<br />
point of view of company size).<br />
Table 4. Statistical synthesis of variables (absolute average values in mil. Euro)<br />
Period/Sample Variables<br />
No. Shares<br />
Average<br />
price<br />
Average<br />
Mk. cap. cBV cE pBV pE<br />
2003-2008 (n=588) 819.2 36.0 13886.0 7620.8 1231.7 6034.0 865.0<br />
2003 (n=98) 799.1 25.3 10505.2 6156.2 668.5 5339.6 652.9<br />
2004 (n=98) 803.6 27.5 11677.4 6721.2 964.1 5561.8 600.4<br />
2005 (n=98) 781.7 40.4 14746.4 7731.5 1425.9 5985.4 874.2<br />
2006 (n=98) 824.8 48.9 17643.8 8328.3 1600.2 6173.9 904.7<br />
2007 (n=98) 827.9 46.7 16831.9 8590.4 1594.9 6698.8 1374.6<br />
2008 (n=98) 878.1 26.8 11911.4 8197.5 1136.8 6444.3 783.0<br />
Frankfurt St. Ex.<br />
(n=35) 341.1 41.5 11596.9 7396.5 869.4 4740.4 617.2<br />
London St. Ex. (n=32) 1814.2 9.3 14950.4 6464.5 1554.1 5277.7 1202.0<br />
Paris St. Ex. (n=31) 331.9 57.3 15371.8 9067.8 1308.0 8275.1 796.8<br />
Regarding the existent associations between the variables employed in the<br />
econometric models (see Pearson correlation matrix in table 5), it can be seen that<br />
there are strong significant correlations between the dependent variable (share price)<br />
and the explanatory variables ( equity, respectively earnings per share, at consolidated<br />
and individual level), which signals the relevance of these accounting values to<br />
explain the market value of companies. Correlations between share price and<br />
consolidated accounting values are higher, suggesting the possibility (or even the<br />
probability) of superiority (from the market value relevance point of view) of<br />
consolidated financial statements as opposed to parent company financial statements.<br />
Of course, this supposition is to be confirmed or refuted by statistical inferences<br />
(econometric models).<br />
It must be mentioned, as well, the existence of significant correlations between some<br />
explanatory variables used in the same econometric models. We are referring<br />
especially to group equity and group earnings (per share). These correlations, which<br />
indicate the existence of multicollinearity between variables are, however, common to<br />
such studies, since they are present in numerous empirical research (see Naceur &<br />
Goaied, 2004; Aboody et al., 2002; Hevas et al., 2000; Abad et al., 2000; Rees, 1997;<br />
Collins et al., 1997).<br />
~ 640 ~
Table 5. Correlation matrix of variables<br />
Pearson Correlation<br />
Price cBV cE pBV pE ∆cBV ∆cE<br />
Price 1.000<br />
cBV 0.776 1.000<br />
cE 0.781 0.788 1.000<br />
pBV 0.679 0.784 0.598 1.000<br />
pE 0.620 0.407 0.404 0.510 1.000<br />
∆cBV 0.552 0.729 0.601 0.146 0.099 1.000<br />
∆cE 0.534 0.481 0.709 0.251 -0.329 0.489 1.000<br />
*All correlations are significant at 0,01.<br />
To examine if multicollinearity generates instability of empirical results, we<br />
computed, for each coefficient of the explanatory variables from the econometric<br />
models, the variance inflation factor (VIF), which quantifies to what extent the<br />
variance for a coefficient is increased due to collinearity (Andrei & Bourbonnais,<br />
2008: 274). When variables are not correlated, the variance inflation factor is 1. VIF<br />
values of more than 5 (see Jermakowicz et al., 2007) or even 10 (see Kutner et al.,<br />
2004) are regarded in the specialty literature as indication of (serious) autocorrelation<br />
problems between independent variables.<br />
Table 6. Descriptive statistics for variables (expressed in values per share)<br />
Period/Sample<br />
Variables (per share)<br />
Price cBV pBV ∆cBV cE pE ∆cE<br />
2003-2008 Average 35.971 19.848 13.978 5.833 3.039 1.770 1.201<br />
n= 548 Median 27.775 13.560 10.780 1.490 1.985 1.065 0.560<br />
Std. deviation 39.356 21.656 13.872 13.363 3.714 2.133 2.937<br />
2003 Average 25.312 17.305 13.450 3.656 1.964 1.395 0.433<br />
n= 88 Median 20.930 11.920 10.010 1.105 1.210 0.710 0.175<br />
Std. deviation 25.528 18.009 13.092 11.183 2.177 1.899 1.857<br />
2004 Average 27.543 18.987 14.160 4.828 2.622 1.412 1.161<br />
n= 86 Median 24.240 14.100 11.230 1.835 1.435 0.940 0.520<br />
Std. deviation 21.315 19.074 12.960 11.189 3.110 1.447 2.406<br />
2005 Average 40.372 19.477 13.567 5.910 3.137 1.685 1.531<br />
n= 88 Median 35.315 12.640 10.650 1.600 2.020 1.110 0.620<br />
Std. deviation 33.977 20.823 13.065 11.713 3.613 1.773 2.620<br />
2006 Average 48.908 20.784 14.813 5.970 3.247 1.723 1.608<br />
n= 83 Median 46.410 14.940 11.510 1.190 2.420 1.170 0.820<br />
Std. deviation 41.670 22.312 14.736 13.050 3.408 1.844 2.225<br />
2007 Average 46.694 20.326 13.513 6.812 3.672 2.174 1.509<br />
n= 87 Median 34.535 14.640 10.220 1.500 2.780 1.120 0.580<br />
Std. deviation 61.331 22.894 13.573 14.913 3.893 2.329 2.873<br />
2008 Average 26.771 19.766 13.206 6.560 3.168 1.750 1.433<br />
n= 89 Median 20.605 13.350 9.230 1.640 1.875 1.225 0.560<br />
Std. deviation 32.389 24.231 13.029 16.773 4.605 2.083 3.565<br />
Frankfurt Stock Average 41.481 23.021 14.597 8.424 3.458 2.136 1.287<br />
Exchange Median 34.070 17.925 12.465 4.220 2.870 1.545 0.725<br />
n= 192 Std. deviation 32.489 17.834 9.213 13.410 3.232 2.212 3.123<br />
London Stock Average 9.291 3.112 2.427 0.666 0.683 0.431 0.228<br />
Exchange Median 6.220 1.640 1.610 0.075 0.370 0.205 0.120<br />
n= 174 Std. deviation 8.551 3.285 2.411 2.220 0.894 0.634 0.695<br />
Paris Stock Average 57.290 34.610 26.199 8.411 5.337 2.749 2.596<br />
Exchange Median 48.000 25.550 21.850 3.610 3.370 2.060 1.310<br />
n= 171 Std. deviation 49.157 26.072 15.897 19.113 6.422 2.408 5.879<br />
~ 641 ~
4. EMPIRICAL RESULTS<br />
As we mentioned when we described the empirical models developed, in order to test<br />
the hypothesis regarding the superior value relevance of consolidated financial<br />
statements (as opposed to parent company financial statements), in the first stage we<br />
compared the absolute value relevance of information supplied by the two types of<br />
financial statements, based on two regression models. The empirical results regarding<br />
the two models are presented in table 7 and illustrated graphically in figure 1. By<br />
comparing the explanatory power (Adj. R2) of the two models for the whole analyzed<br />
period (2004-2008) as well as for each year and each stock exchange included in the<br />
sample, the superiority of the value relevance of information provided by consolidated<br />
financial statements clearly stands out. Concerning the coefficients of the two<br />
regressions, they are significant (and positive) for each sub-sample and for the<br />
complete sample, usually at 0,001 level (at least at 0,05 level for model 2 related to<br />
consolidated reporting, respectively at 0,1 for model 2 related to individual reporting).<br />
At the same time, the estimated coefficients have values of variance inflation factor<br />
(VIF) under 5, indicating the fact that there are no worrying aspect regarding the<br />
effects of multicollinearity between explanatory variables of the model. In the second<br />
stage we considered testing the relevance difference between group statements and<br />
parent company financial statements (that is incremental ∆ Adj. R2) to see if it is<br />
statistically significant. Therefore, based on models 1 and 3 (see table 8 respectively<br />
figure 2) we checked the level of statistical significance of changing the explanatory<br />
power of model 1 after introducing supplementary variables corresponding to<br />
consolidated information from model 3, and concluded that the relevance surplus is<br />
statistically significant at 0,001 level. Consequently, the first hypothesis regarding the<br />
superiority in terms of relevance of consolidated financial statements (as opposed to<br />
information provided by parent company statements) is statistically confirmed.<br />
At the same time, from the analysis of the empirical results obtained (see table 7 and<br />
figure 1) we clearly observe the increasing trend of relevance (market value<br />
relevance) of consolidated financial statements, starting with a value (of the<br />
explanatory power of model 2 Adj. R2) of 64,7% in 2003 and reaching 77,9% in<br />
2008. The slight decrease of the power of explanation from 2007 against 2006 is<br />
singular, and can be credited, of course, to the financial-economic crisis and does not<br />
affect, in our opinion, the increasing trend of the analyzed period. Therefore, this<br />
statistical evidence permits to confirm the second hypothesis regarding the increase in<br />
time of the relevance of consolidated financial statements.<br />
~ 642 ~
Table 7. Empirical results for regression models 1 and 2<br />
**** significant at 0.001; *** significant at 0.01; ** significant at 0.05; * significant at 0.1<br />
Figure 1. Evolution of value relevance (in absolute terms) of consolidated financial<br />
statements (CFS) and parent company financial statements (PFS)<br />
2003 2004 2005 2006 2007 2008 2003-08<br />
Adj.<br />
2<br />
R<br />
Model 1 PFS 56.3% 57.3% 65.4% 64.4% 49.4% 53.0% 53.2%<br />
Adj.<br />
2<br />
R<br />
Model 2 CFS 64.7% 65.9% 69.0% 79.4% 74.2% 77.9% 66.3%<br />
∆Adj. R2 8.4% 8.6% 3.6% 15.0% 24.8 24.9% 13.1%<br />
In order to test hypothesis 3 regarding the increase in time of the relevance variance<br />
between the two categories of financial statements, we verified if there is a trend over<br />
the analyzed period for the difference measure between the coefficient of<br />
~ 643 ~
determination of model 3 (corresponding to consolidated financial statements) and the<br />
coefficient of determination of model 1 (corresponding to individual financial<br />
statements). In this respect, to better delineate the trend, we split the analyzed period<br />
(2003-2008) in three sub-periods of two years, computing for each sub-period the<br />
average explanatory power for the corresponding years (see figure 2). From the<br />
conducted analysis results an increase in time of the difference between the two<br />
coefficients of determination, from 8,8% (for 2003-2004) to 25,8% (for 2007-2008).<br />
Considering the statistical significance of the respective difference certified by<br />
statistic tests applied to verify hypothesis 1 (at 0,001 level), we can conclude that the<br />
third hypothesis, as well, regarding the increasing trend of the relevance surplus<br />
provided by consolidated information is statistically confirmed.<br />
Table 8. Empirical results for regression model 3<br />
Period/<br />
Characteristics MODEL 3<br />
Sample α0 pBV ∆cBV pE ∆cE F Adj R 2<br />
2003-2008<br />
n= 548<br />
2003<br />
n= 88<br />
2004<br />
n= 86<br />
2005<br />
n= 88<br />
2006<br />
n= 84<br />
Alfa 10.343 0.725 0.386 5.167 3.139<br />
t 8.885**** 9.493**** 4.885**** 10.051**** 8.682****<br />
VIF - 1.83 1.865 1.905 1.881<br />
Alfa 9.072 0.629 0.374 3.714 2.197<br />
t 4.663**** 3.761**** 2.599*** 2.996*** 2.306**<br />
VIF - 2.545 1.452 3.177 1.994<br />
Alfa 9.34 0.572 0.449 5.433 1.336<br />
t 4.173**** 3.166*** 2.957*** 3.624**** 1.731*<br />
VIF - 2.562 1.338 2.156 1.656<br />
Alfa 12.484 1.095 0.615 4.344 1.415<br />
t 4.354**** 5.151**** 2.802*** 2.681*** 1.475*<br />
VIF - 2.165 1.959 2.28 1.816<br />
Alfa 15.198 0.882 0.612 5.634 4.506<br />
t 5.542**** 3.589**** 2.683*** 2.817*** 3.335****<br />
VIF - 2.295 2.198 2.343 2.209<br />
2007<br />
n= 87<br />
Alfa<br />
t<br />
VIF<br />
12.184<br />
3.926****<br />
-<br />
0.383<br />
1.943**<br />
1.777<br />
0.433<br />
1.743*<br />
3.451<br />
7.369<br />
6.241****<br />
1.833<br />
4.82<br />
3.651****<br />
3.62<br />
2008<br />
n= 89<br />
Alfa<br />
t<br />
VIF<br />
8.54<br />
4.245****<br />
-<br />
0.371<br />
2.881***<br />
1.643<br />
0.041<br />
3.17***<br />
2.988<br />
4.052<br />
5.572****<br />
1.345<br />
4.078<br />
6.303****<br />
3.404<br />
Frankfurt<br />
n= 192<br />
Alfa<br />
t<br />
VIF<br />
17.465<br />
6.418****<br />
-<br />
0.355<br />
2.137**<br />
1.22<br />
0.408<br />
3.335****<br />
1.496<br />
5.012<br />
6.485****<br />
1.543<br />
3.523<br />
6.491****<br />
1.581<br />
London<br />
n= 174<br />
Alfa<br />
t<br />
VIF<br />
4.376<br />
6.894****<br />
-<br />
0.634<br />
3.008***<br />
1.449<br />
0.423<br />
1.875*<br />
1.33<br />
5.029<br />
6.100****<br />
1.446<br />
2.964<br />
4.172****<br />
1.341<br />
Paris<br />
n= 171<br />
Alfa<br />
t<br />
VIF<br />
24.288<br />
6.963****<br />
-<br />
0.395<br />
2.934***<br />
1.505<br />
0.282<br />
2.133**<br />
2.018<br />
5.216<br />
5.779****<br />
1.516<br />
2.507<br />
5.876****<br />
2.109<br />
**** significant at 0.001; *** sig. at 0.01; ** sig. at 0.05; * sig. at 0.1<br />
~ 644 ~<br />
272.155 68.40%<br />
37.159 65.60%<br />
38.119 65.60%<br />
51.127 71.50%<br />
79.46 80.10%<br />
60.571 74.40%<br />
78.3 79.60%<br />
46.899 50.90%<br />
35.461 47.10%<br />
59.001 58.90%
Figure 2. Evolution of value relevance increment of CFS relative to PFS<br />
2003-2004 2005-2006 2007-2008 2003-2008<br />
Adj. R 2 Model 1 PFS 56.8% 64.9% 51.2% 53.2%<br />
Adj. R 2 Model 3 CFS* 65.6% 75.8% 77.0% 68.4%<br />
∆ Adj. R2 (M3-M1) 8.8% 10.9% 25.8% 15.2%<br />
Sig. 0.000 0.000 0.000 0.000<br />
To continue, we tested regression model 4, developed to verify the hypothesis<br />
regarding the superiority for the capital market of information provided (together) by<br />
consolidated financial statements and parent company statements as opposed to<br />
consolidated information. The empirical results are synthesized in table 9.<br />
Table 9. Empirical results for regression model 4<br />
Period /<br />
Sample<br />
2003-08<br />
n= 548<br />
Alfa<br />
t<br />
VIF<br />
α0<br />
10.279<br />
9.093****<br />
-<br />
cBV<br />
0.692<br />
9.220****<br />
4.525<br />
Characteristics MODEL 4<br />
∆pBV cE ∆pE<br />
0.381 5.384 1.845<br />
4.049**** 10.640**** 3.862****<br />
2.75 5.916 3.247<br />
F Adj. R2<br />
282.185 68.60%<br />
2003<br />
n= 88<br />
Alfa<br />
t<br />
VIF<br />
9.266<br />
4.739****<br />
-<br />
0.58<br />
3.211****<br />
6.361<br />
0.211<br />
1.08<br />
2.628<br />
3.954<br />
3.023***<br />
4.631<br />
1.341<br />
1.455<br />
1.588<br />
36.676 65.50%<br />
2004<br />
n= 86<br />
Alfa<br />
t<br />
VIF<br />
10.02<br />
4.932****<br />
-<br />
0.57<br />
3.536***<br />
5.223<br />
0.284<br />
1.447<br />
2.715<br />
4.565<br />
3.533****<br />
8.844<br />
2.123<br />
1.526<br />
5.786<br />
43.689 67.80%<br />
2005<br />
n= 88<br />
Alfa<br />
t<br />
VIF<br />
12.334<br />
4.585****<br />
-<br />
1.042<br />
5.064****<br />
2.165<br />
0.444<br />
1.646*<br />
1.959<br />
4.946<br />
3.248***<br />
2.28<br />
3.688<br />
2.382**<br />
1.816<br />
54.156 71.40%<br />
2006<br />
n= 84<br />
Alfa<br />
t<br />
VIF<br />
14.847<br />
5.456****<br />
-<br />
1.039<br />
4.698****<br />
7.03<br />
0.422<br />
1.737*<br />
2.93<br />
4.298<br />
2.523**<br />
9.714<br />
-0.36<br />
-0.204<br />
4.457<br />
80.453 79.70%<br />
2007<br />
n= 87<br />
Alfa<br />
t<br />
VIF<br />
11.779<br />
3.948****<br />
-<br />
0.4<br />
2.042**<br />
5.211<br />
-0.51<br />
-0.196<br />
3.864<br />
7.403<br />
6.349****<br />
5.228<br />
2.702<br />
2.124**<br />
3.386<br />
64.171 75.10%<br />
2008<br />
n= 89<br />
Alfa<br />
t<br />
VIF<br />
8.933<br />
4.597****<br />
-<br />
0.346<br />
2.770***<br />
5.82<br />
0.289<br />
1.962*<br />
3.959<br />
4.036<br />
5.670****<br />
6.621<br />
-0.004<br />
-0.005<br />
5.279<br />
76.529 78.40%<br />
Frankfurt<br />
n= 192<br />
Alfa<br />
t<br />
VIF<br />
17.099<br />
6.411****<br />
-<br />
0.356<br />
2.207**<br />
4.504<br />
0.76<br />
0.382<br />
3.97<br />
5.347<br />
6.844****<br />
3.508<br />
1.287<br />
1.931*<br />
2.342<br />
48.063 50.80%<br />
London<br />
n= 174<br />
Alfa<br />
t<br />
VIF<br />
4.384<br />
7.464****<br />
-<br />
0.47<br />
2.175**<br />
3.145<br />
0.16<br />
0.667<br />
1.875<br />
5.275<br />
6.964****<br />
2.881<br />
0.992<br />
1.091<br />
2.099<br />
44.292 52.30%<br />
Paris<br />
n= 171<br />
Alfa<br />
t<br />
VIF<br />
23.66<br />
6.972****<br />
-<br />
0.385<br />
2.917***<br />
4.099<br />
0.117<br />
0.755<br />
2.983<br />
5.385<br />
6.165****<br />
10.7<br />
2.803<br />
3.481**<br />
7.699<br />
63.212 60.00%<br />
**** significant at 0.001; *** sig. at 0.01; ** sig. at 0.05; * sig. at 0.1<br />
~ 645 ~
As mentioned before, this has the starting point in model 2 (based on consolidated<br />
information) and also includes information offered by parent company financial<br />
statements. The comparison between the explanatory power of the two models (see<br />
table 10) reveals a superiority (statistically significant) of model 4 (based on dual<br />
information) of 2,3% for the whole sample.<br />
Table 10. Empirical results regarding the difference of value relevance between<br />
models 2 and 4<br />
2003 2004 2005 2006 2007 2008 2003-08<br />
Adj. R2 Model 2 SFC 64.70% 65.90% 69.00% 79.40% 74.20% 77.90% 66.30%<br />
Adj. R2 Model 4 Dual 65.50% 67.80% 71.40% 79.70% 75.10% 78.40% 68.60%<br />
∆ Adj. R2 (M4-M2) 0.80% 1.90% 2.40% 0.30% 0.90% 0.50% 2.30%<br />
Sig. 0.164 0.038 0.014 0.202 0.091 0.151 0.000<br />
Frankfurt Londra Paris<br />
Adj. R2 Model 2 SFC 50.30% 52.20% 57.10%<br />
Adj. R2 Model 4 Dual 50.80% 52.30% 60.00%<br />
∆ Adj. R2 (M4-M2) 0.50% 0.10% 2.90%<br />
Sig. 0.133 0.409 0.001<br />
However, bringing the analysis at the level of each year, respectively of each stock<br />
exchange (from the sample), there is a fluctuation of the difference (between the<br />
explanatory power of the two models) in the interval 0,3% - 2,4%, respectively<br />
0,1% - 2,9%. From the six years, only for 2004 (1,9%) and 2005 (2,4%) the difference<br />
is significant (at 0,05 level). As well, only for the French stock exchange (2,9%) there<br />
is a statistically significant value (at 0,001 level). These „mixed” results allow, in our<br />
opinion, only a partial confirmation of the fourth hypothesis regarding the superior<br />
relevance of dual reporting as opposed to consolidated financial reporting.<br />
DISCUSSIONS AND CONCLUSIONS<br />
In this study we investigated using econometric regression models the absolute and<br />
relative market value relevance of consolidated financial statements for companies<br />
listed during 2003-2008 on the largest stock markets in Europe (London, Paris, and<br />
Frankfurt stock exchanges). For this purpose we focused on the „confrontation”<br />
regarding the value relevance between consolidated financial statements and parent<br />
company financial statements. As expected (and in accord with previous empirical<br />
studies, for example Harris et al., 1994, Niskanen et al., 1998, Abad et al., 2000,<br />
Goncharov et al., 2009), the results have shown an increase in superiority (statistically<br />
significant) of the relevance of consolidated statements (in detriment of individual<br />
ones). While in the analyzed period, consolidated financial statements have seen a<br />
positive trend of relevance, individual statements have had an oscillating relevance<br />
(inside some limits).<br />
These results prove, of course, the importance (usefulness) of consolidated financial<br />
statements especially for investors on the capital market. Therewith, they question the<br />
necessity of publishing parent company financial statements (according to national<br />
regulations) as long as they present consolidated financial statements. As a matter of<br />
fact, in the USA the obligation to publish parent company financial statements was<br />
eliminated since 1982, following the issuing of Accounting Series Release no. 302.<br />
~ 646 ~
(Francis, 1986: 394). We consider that these conclusions are valid not only for large<br />
European capital markets, but also for emerging capital markets (such as the one in<br />
Hungary, Poland, Romania, Bulgaria).<br />
In the end, some aspects regarding the limitations of this study should be mentioned,<br />
as well as the perspectives of future empirical research. First, it is possible to raise the<br />
problem of sample representativeness (and implicitly of the results obtained) for the<br />
large European capital markets and respectively for the whole European capital<br />
market. In this respect, future research could extend the analysis (and the sample) to<br />
other capital markets in Europe, as well as to companies that are not included in the<br />
main index of the stock market they are listed on. Second, the obtained results are<br />
based only on testing linear price level regression models. Future research could<br />
employ nonlinear models, for example logarithmic models (see Hellström, 2006)<br />
respectively return regression models (see Bartov et al., 2005). And third, the present<br />
study investigates relevance and therefore usefulness for decision making of<br />
consolidated financial statements only from the point of view of the investors on<br />
capital market. So, a future research theme less approached until now (see Goncharov<br />
et al., 2009) would be to investigate the relevance of financial statements from the<br />
perspective of other categories of users (for example financial institutions in their role<br />
as creditors).<br />
ACKNOWLEDGEMENTS<br />
This paper is part of the research project POSDRU/89/1.5/S/59184 ‘Performance and<br />
excellence in postdoctoral research within the field of economic sciences in<br />
Romania’, Babeş-Bolyai University, Cluj-Napoca being a partner within the project.<br />
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THE ADVANTAGES VS. THE DISADVANTAGES<br />
OF OUTSOURCING THE ACCOUNTING<br />
AND FINANCIAL SERVICE<br />
Vasile-Daniel PAVALOAIA 1 & Ioan ANDONE<br />
"Alexandru Ioan Cuza" University of Iasi, Romania<br />
ABSTRACT<br />
In January 2010, Forbes magazine published an article by an attractive title: Romania –<br />
became an accounting outsourcing destination. The article states that our country has fully<br />
entered the market of accounting service outsourcing. Also, the results of a study ordered by<br />
PricewaterhouseCoopers in 2010 confirm that outsourcing has encountered a revival in the<br />
last six months and the trend is ascending. The director of PricewaterhouseCoopers says that<br />
companies still resort to service outsourcing primarily to reduce costs but at the same level,<br />
customers began to also appreciate other aspects such as high efficiency, high quality<br />
services and, of course, access to high-level talent and expertise. In the above mentioned<br />
context, in author’s opinion, the theme of the current research seems appropriate as it<br />
proposes and emphasize of the fundamental aspects of outsourcing in general and specific<br />
issues related to outsourcing the services of accounting and financial analysis. This study<br />
illustrates novel aspects related to the requirements for outsourcing accounting services in<br />
our country and captures the authors' opinion on the possibilities of outsourcing the financial<br />
and economic analysis services, since these belong to a quite sensitive category. If this<br />
information comes across foreign hands, the financial and accounting information can be<br />
used for destructive purposes.<br />
KEYWORDS: outsourcing, outsourcing accounting service, outsourcing financial analysis<br />
service<br />
1. MEASURING THE BENEFITS OF OUTSOURCING FINANCIAL<br />
SERVICES<br />
Although outsourcing is a common practice in the business environment, a survey<br />
[Stancu, 2008] conducted by KPMG International reveals that 42% of outsourcing<br />
contracts are not based on a formal framework meant to assess the strategic benefits<br />
obtained by the enterprise. The study identifies a number of other issues, caused by<br />
the outsourcing agreements that the businesses face. Among those issues are<br />
identified the following: uncertainty regarding the costs involved in the process of<br />
selecting a provider for the outsourced services, long time required for completion the<br />
tendering phase (KMPG recommended that this phase should not exceed 6 months),<br />
the human factor (60%) and not technology (12%) is the main problem encountered in<br />
the development of the outsourcing process. Even though companies covered by the<br />
survey consider outsourcing as a process with real benefits to their business, they<br />
1 Correspondence address: Vasile-Daniel W. PĂVĂLOAIA Ph.D. Lecturer, ”Alexandru Ioan Cuza”<br />
University of Iasi, Faculty of Economics and Business Administration, 22, CAROL I Boulevard,<br />
EACSI Dept.; email: danpav@uaic.ro<br />
~ 650 ~
must be able to accurately demonstrate the measure of the obtained profits as<br />
decisions based on intuition or some unsubstantiated allegations, are not the<br />
appropriate means of action.<br />
A study of the level of outsourcing services from our country, the analysis of<br />
Romania's balance of payments from the 2005, reveals the following information:<br />
Informatics services recorded a deficit of 14 million euros, which represents an<br />
outsourcing amounting to 149 million euro and an internalisation of 163 million<br />
euros. By analyzing the evolution of legal services, financial & accounting and<br />
management consulting can be concluded that the internalization is higher than the<br />
outsourcing, since they have achieved revenues of 117 million euros worth in the<br />
terms of making payments of 222 million euros. From this brief analysis conducted in<br />
late 2005 we notice that, even since then, Romania can be considered an attractive<br />
country for outsourcing, both in services and industrial sectors [CNP, p.5].<br />
Concerning the international services outsourcing, during the year of 2005, they<br />
accounted for only 0.1% of GDP in Romania. The analysis took into the account the<br />
IT services area, while legal services, financial, accounting and management<br />
consultancy recorded and internalisation amounted to 101 million euros,<br />
approximately 0.2% of GDP.<br />
Business<br />
process<br />
outsourced<br />
Finance and<br />
accounting<br />
Table 1. Classification of business process outsourcing<br />
Types of services associated<br />
to outsourced process<br />
Internal Audit<br />
Management of expenses<br />
Receivables and payables analysis<br />
Billing<br />
Financial Reporting<br />
Management services taxes<br />
Tax Reporting<br />
Budgeting<br />
General Accounting<br />
Treasury<br />
~ 651 ~<br />
Service suppliers<br />
Finance Accounting<br />
Accenture<br />
Capgemini<br />
CGI<br />
CSC<br />
EDS<br />
HCL Tech<br />
iGate<br />
Patni<br />
Satyam<br />
Wipro<br />
(Source: [Brown-Wilson Group, 2007]; [Mattoo, 2004, p.4])<br />
BDO Seidman<br />
BKD<br />
CBIZ<br />
Convergys<br />
CroweChizek<br />
Delloite & Touche<br />
Ernst & Young<br />
Intelenet Global<br />
IQ Backoffice<br />
KPMG<br />
Mellon Financial<br />
Outsource Partners International<br />
PriceWaterhouseCoopers<br />
Grant Thornton<br />
RSM McGladrey<br />
Thus, in order to improve the activity of outsourcing the financial services, both<br />
companies (beneficiaries) and suppliers (outsourcing service providers) should apply<br />
the following rules [Păvăloaia, 2008]:<br />
� to define the indicators necessary to assess the contribution of outsourcing to<br />
achieve economic goals;<br />
� not ignore the human factor issues;<br />
� to have a common vision (customer-supplier) into the the definition of<br />
success;<br />
� the selection processes used should be flexible;<br />
� there should be a strong and transparent business relationship between supplier<br />
and recipient;
� to use auditing standards;<br />
� outsourcing should be based on best international practices.<br />
The literature contains numerous references to the classification of business process<br />
outsourcing. They are based on the type of economic process for outsourcing. In<br />
Table 1 are presented only specific types of services related to finance and accounting<br />
processes as well as firms that are located into the top providers of such services.<br />
In Romania, too during the recent years it has been established a number of firms,<br />
especially small, aiming to provide services in financial accounting. They activates<br />
alongside with world renowned companies which have entered the market from the<br />
our country one by one. The firms are Deloitte & Touche, KPMG, Ernst & Young and<br />
PriceWaterhouseCoopers, also known as the group of four, title granted after<br />
ArthurAndersen firm collapse. Thus, strictly linked to the economic environment, in<br />
Table 2 are presented as an example the supply of outsourcing services firm Deloitte<br />
Romania and structure.<br />
Type of outsourced<br />
service<br />
Types<br />
of activities<br />
Table 2 .The offer and structure of the outsourcing services<br />
from Deloitte Romania firm<br />
Accounting and financial<br />
services<br />
Complete records, including<br />
reports and financial<br />
statements for management<br />
use.<br />
~ 652 ~<br />
Payroll and secretarial<br />
services<br />
Preparation of annual<br />
statements for income<br />
taxes withheld from<br />
wages.<br />
Tax Administration<br />
Record of the Financial<br />
Administration for<br />
income tax, VAT and<br />
other taxes.<br />
Review of accounting records Payroll Preparation Preparation of tax<br />
returns<br />
The program of staff<br />
agreements<br />
Payroll -<br />
Other services: electronic<br />
banking, etc.<br />
- -<br />
(Source: Adaptation after [Delloite, 2008])<br />
For the year of 2009, the Black Book of Outsourcing study [Brown-Wilson, 2008, p.<br />
15] predicts that a number of functional areas such as finance, accounting and IT<br />
infrastructure, will continue their upward trend in increasing the share of types of the<br />
outsourced services. Thus, financial accounting services will increase by 75.2%<br />
compared to 2008, being located on the 2nd place (due to their rate of growth) after<br />
acquiring services, brokerage, sales management and payments whose growth is<br />
estimated at 83.4%. The knowledge society has triggered activity centered on<br />
knowledge process outsourcing, called KPO - Knowledge Process Outsourcing. As a<br />
direct result, interpretations, diagnostic, market research, data analysis etc. are the<br />
work of specialists whose advance preparation is very laborious. As part of KPO, the<br />
level of qualification of human resources used and the degree of involvement of the<br />
beneficiary of these services will be much higher, since between the two partners<br />
must exist a close communication, and the customer will be responsible for validating<br />
or providing guidance to customer into its activity.
Market surveys show that the main processes or activities subject to outsourcing are:<br />
manufacturing (53%), logistics (51%), HR (35%), sales and marketing (33%),<br />
research and development (32%) and finance and accounting (24%).<br />
Although outsourcing finance and accounting service are located on the last places we<br />
ilustrate that a strong tendency to increase their share into the outsourced services is<br />
expected. On the other hand,the reason for not widely outsourcing the accounting<br />
functions in Romania, can be explained by the fact that the information in this area are<br />
considered crucial because the company supports the foundation of strategic decisions<br />
and, as a result, managers are reluctant to outsourcing.<br />
2. SERVICES OUTSOURCING OF ACCOUNTING AND ECONOMIC<br />
AND FINANCIAL ANALYSIS<br />
In order to establish the financial and accounting activities that are suitable for<br />
outsourcing is necessary to make a careful analysis that takes into account an<br />
important criteria regarding the importance of the data and processed information.<br />
Thus, we can distinguish a number of situations that correspond to the following three<br />
classifications: (1) financial and accounting activities that are most often outsourced<br />
(known into literature [Sako, 2006, p. 507] as special transactional processes), (2)<br />
financial and accounting activities that are good candidates for outsourcing<br />
(outsourcing is suitable but there are some concerns about the loss of the internal<br />
competences due to outsourcing) and (3) the strategic financial and accounting<br />
activities, that normally are not outsourced.<br />
While specific financial accounting transactional processes are easily outsourced as<br />
the applicable solutions are standardized, the activities involving a high level of<br />
expertise, as internal audit, budgeting, taxes, economic and financial analysis, are<br />
more difficult to outsource. They involve a high degree of knowledge of enterprise<br />
and internal and /or external factors that may affect the decisions and objectives<br />
fullfillement. If the latter activities will be outsourced,the processes will be called<br />
transformational processes because, in order to conduct them, the provider must<br />
perform a variety of customizations. Thus, in Figure 1 are graphically presented, the<br />
financial and accounting activities according to their degree of outsourcing.<br />
The taxonomy of the outsourced activities greatly influences the management manner<br />
of company providing accounting services. Thus, the main activity can be structured<br />
in accounting, auditing and other services, such as valuation services, research,<br />
restructuring, financial analysis etc. Latest services refer to more complex activities<br />
that requires high-level skills.<br />
At the start of start outsourcing services towards a customer, it can be carried out<br />
routine accounting activities such as information processing accounts and primary<br />
records, and later may move forward to providing of value added services such as<br />
diagnosis and economic and financial analysis that helps the accounting officer officer<br />
or chief financial officer into the specific decision-making processes<br />
[www.outsourcing-journal.com].<br />
~ 653 ~
Figure 1. Classification of the financial and accounting activities according<br />
to the degree of outsourcing<br />
(Source: Adaptation after: [Rehmann Goup, 2007]; [Morgan Chamber, 2007])<br />
2.1 Accounting service outsourcing<br />
Accounting firms in Romania are organized in double circuits, namely financial<br />
accounting (also known as general accounting) and management accounting (also<br />
called management accounting or analytical) which is not normalized, being applied<br />
according to the needs and particularities of the business.<br />
In Romania, the Accounting Act had established by Article 10 that "the responsibility<br />
for organization and management accounting is the administrator, officer or other<br />
person who is liable for the management of that unit". Specific accounting tasks can<br />
be carried out into two variants [Horomnea, 2007]: throughout their functional<br />
departments or through agreements regarding the supply of accounting services. In the<br />
first case, firms held a finance and accounting department under the leadership of<br />
chief financial officer, chief accounting officer or another person empowered to<br />
perform these functions. In the second case, the accounting can be performed on a<br />
contractual basis for the provision of services of accounting, done with individuals<br />
(accountant, chartered accountant) or legal persons authorized members of the Body<br />
of Expert and Licensed Accountants from the Romania (CECCAR) . In this situation,<br />
changes to accounting by the enactment of Law no. 259/2007 refers to the art. 10<br />
paragraph 4 of that responsibility lies with the organization and management<br />
accounting service provider, according to the contractual provisions and applicable<br />
laws.<br />
The information presented above helps us detach from the Romania Accounting Act<br />
that the law allows any enterprise, that belongs to either public or private sectors, to<br />
outsource the entire accounting functions or only certain accounting work to a third<br />
~ 654 ~
party, with only one condition: that the supplier of these services is an authorized<br />
member CECCAR.<br />
Standardization of financial accounting’s work led to the outsourcing with greater<br />
ease of this branch of accounting. The flexibility of the organization as well as the<br />
specific features that characterize the information in the course of managerial<br />
accounting industry, makes managerial accounting more difficult to be outsourced.<br />
We believe that outsourcing accounting services leads to an increased fairness and<br />
legality of business transactions reflected within the documents from both the<br />
beneficiary and the customer.<br />
By outsourcing its accounting services, the company, through its employees, will fully<br />
concentrate its resources and creative force for the purposes of carrying out those<br />
activities in which the firm excels, while ensuring the overall management and<br />
flexibility of conditions that no longer feel the risks associated with outsourcing<br />
activities, as they are transferred (through the conditions from the the agreement) to<br />
the supplier [Păvăloaia, 2009].<br />
There should not be overlooked the access to industry best practices and latest and<br />
more advanced technologies. Unlike enterprises, outsourcing providers have every<br />
incentive to keep up with the latest innovations in order to ensure their market<br />
competitiveness. Thus, if accounting is a back-office function for a firm, for the<br />
outsourced company is the main objective of activity and is, therefore, treated<br />
accordingly.<br />
2.2 Outsourcing the economic and financial analysis service<br />
In general, studies reveals that it is not possible for small and medium enterprises to<br />
hold employees which can develop industry-specific situations and analysis specific<br />
to the economic and financial analysis. Preparation of its specific synthetic<br />
documents, involves along with a time consuming activity , a rather important and a<br />
high level of expertise that should be paid accordingly. Furthermore, analysts must<br />
constantly participate to specialized training in order to be informed about the best<br />
and current practices in the field. Neither the specific legislation should not be<br />
neglected. Rather, it should always be considered and therefore, employees must<br />
constantly update their knowledge on legislation. The experience gained by them is<br />
the expertise they own in this field and it is composed from the specific cases and<br />
general knowledge facts about the economic and financial area. Therefore, the above<br />
issues constitute some sources that could stand as the basis for calculating the<br />
personnel costs involved in the activities of economic and financial analysis.<br />
In the light of the above information, outsourcing of financial services must take into<br />
account several criteria, among which in our opinion, the most important would be the<br />
size of the enterprise. Thus, SMEs must be treated differently than large companies.<br />
While the first category of companies is not motivated in holding their own<br />
employees for those somehow seasonal but highly complex activities, the last<br />
category must have at least one department or even a team of economic and financial<br />
analysis [Păvăloaia 2010].<br />
~ 655 ~
An outsourcing model is shown in Figure 2. It is obtained by combining the two<br />
models developed by the author Zhu [Zhu, etc., 2001, p.39, 373-378] and Lever<br />
[Lever, 1997, p.20, 37-48].<br />
Planning*<br />
Discovery**<br />
Figura 2. An outsourcing process model<br />
Development*<br />
Negociation**<br />
~ 656 ~<br />
Implementing*<br />
Transition**<br />
(Source: Adaptation after [Marshall, ş.a., 2005, p. 348])<br />
Surviving*<br />
Evaluation**<br />
At the strategic level, the issues and circumstances that must be considered in the case<br />
of outsourcing the economic and financial analysis are [Păvăloaia 2008]:<br />
� establishing the competence over the firm that takes over the activities (degree<br />
of competence and expertise of employees), hence the quality of prepared<br />
statements;<br />
� establishing confidence, loyalty of the external partner, the degree of trust<br />
toward the partner, that will ensure confidentiality on company accounts;<br />
� the size of the company that takes over the activities, the ratio of customers<br />
and employees; could the partner complete the tasks in due time ?;<br />
� the costs involved in outsourcing, it would be desirable to establish a fixed<br />
amount paid monthly or annually for the possibility of a proper budget<br />
allocations.<br />
One way of resolving or, more secure, to mitigate the effects of the above problems<br />
would be to specify all the details in the contract that covers outsourcing services<br />
contract between the beneficiary and provider.<br />
For many businesses, regardless of size, outsourcing could be an essential element in<br />
achieving its objectives, including those that relate to business profitability. Therefore,<br />
we mention some of the reasons why a company is forced to turn to the outsourcing of<br />
financial and economic analysis:<br />
� diminish and control costs;<br />
� restoring the company's vision and focus on its core competencies;<br />
� using a high-level expertise and know-how;<br />
� release the internal resources and focus on other aspects;<br />
� a high-performance services contribute to the added value of the enterprise;<br />
� outsourced business resources are not available within the enterprise.<br />
The effects of outsourcing specific economic and financial analysis can be identified<br />
through the annual accounts, as they present the following aspects: an increase in<br />
working capital, because the entity no longer purchase computer equipment for<br />
specific records; a reduction in borrowing cycle operation, whereas the external<br />
benefits are paid at intervals greater than the wage debts; a reduction of value added,<br />
because the fees will take the place of wages and social expenditures.<br />
Also, by working with an external provider, the company is exempt from<br />
responsibility for drawing up the synthesis documents specific to accounting and<br />
reporting, which is taken over by the provider under the law governing financial and
accounting activity. Also, professional risk insurance (which every accounting firm is<br />
required to hold) guarantees compensation in case of errors.<br />
Closely related to the outsourcing company's financial and economic analysis, in<br />
Table 3, is illustrated the projections presented by Black Book of Outsourcing<br />
[Brown-Wilson Group, 2008] on trends for 2009 budgets for outsourcing.<br />
Table 3. Outsourced areas and the trend of budgetary allocation in 2009<br />
The field intended for outsourcing The trend of budget allocation<br />
IT Infrastructure 63,4 %<br />
Computerised applications 55,1 %<br />
Accounting and financial processes 21,8 %<br />
Knowledge processes 11,7 %<br />
Mediation processes 11,3 %<br />
Transactions and business processes 6,9 %<br />
Call centers 0,7 %<br />
Human resources -2,4 %<br />
DISCUSSION AND CONCLUSIONS<br />
In conclusion, we point out that in Romania, the firms that provide financial and<br />
accounting services, consulting and/or audit, are members of professional<br />
organizations such as CECCA.R. and/or C.A.F.R. These bodies that gouverns the<br />
accounting profession and the manner of keeping the accounts in our country. Under<br />
these circumstances, the firms are sheltered under the umbrella of those bodies that<br />
ensure quality financial and accounting services to members through regular audits.<br />
The main advantage that outsourcing brings to a company is cost diminishing. Thus,<br />
variable expenses consumed by financial-accounting turns into fixed costs, and this<br />
action allows avoiding the costs of seasonal activities, characterized by over-activity<br />
(overtime payment) and/or sub-activity periods (assumption downtime). Outsourcing<br />
leads to costs reduce and eliminates the costs of employee access to legal expertise<br />
and fiscal accounts in Romania. Thus, employees must participate in training courses<br />
on a regular basis. Such trainings can be quite expensive, and through outsourcing,<br />
their cost is passed on to the service provider. Due to outsourcing, the company no<br />
longer needs to keep up with technology and computer software, which brings a new<br />
set of economies, worthy of consideration.<br />
In addition to these advantages, we point out that outsourcing the accounting function<br />
entails some risk. Firstly, the company could lose control of the essential functions<br />
that includes information regarding other core business functions, such as commercial<br />
office, production, personnel. Secondly, confidentiality and integrity of financial<br />
accounting information is a strategic goal, which must thoroughly observed. Thirdly,<br />
a number of mandatory accounting justifing statements, can not be accessed quickly,<br />
as long as they are in the posession of the service provider. This deficiency could be<br />
removed by e-accounting, which would allow 24/7 access to company accounting and<br />
financial information. Finally, credibility, expertise and reputation of the service<br />
supplier must be thoroughly tested and checked before signing the agreement with the<br />
provider. This way can be prevented a number of drawbacks such as fraud, missing<br />
the deadline dates for the financial statements, over-invoicing, lack of<br />
professionalism, etc.<br />
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ACKNOWLEDGEMENT<br />
This current research is conducted under the auspices of the Postdoctoral<br />
Program”Studii Post-Doctorale în Economie: program de formare continuă a<br />
cercetătorilor de elită – SPODE” developed by the Romanian Academy (POSDRU<br />
Grant POSDRU/89/1.5/S/61755) and financed by Fondul Social European prin<br />
Programul Operaţional Sectorial Dezvoltarea Resurselor Umane 2007-2013.<br />
REFERENCES<br />
AberdeenGroup, (2007)The Aberdeen Report: The state of the Market 2007, A Harte-Hanks<br />
Company, USA 2007.<br />
Stancu, M., (2008) Companiile nu cunosc valoarea propriilor contracte de externalizare,<br />
KPMG News 28 Februarie 2008, Bucure ti, www.kpmg.ro .<br />
Wilson, S., Brown, D., (2007) The Black Book of Outsourcing 2007, accesat la data de 8<br />
septembrie 2008<br />
Brown-Wilson Group, (2008) The State of Outsourcing Industry Report, Brown-Wilson<br />
Group, 2008 http://www.theblackbookofoutsourcing.com/docs/<br />
2008StateofOutsourcingIndustryReport.pdf<br />
Mattoo, A., Wunsch, S., (2004) Pre-empting Protectionism in Services: The GATS and<br />
Outsourcing, World Bank Policy Research Working Paper 2004,<br />
http://www.theblackbookofoutsourcing.com/top10enterprisefinancial accounting.html<br />
Păvăloaia, V.-D., (2008) Integrarea tehnologiilor informaţionale în analiza financiară,<br />
Editura Universităţii „Alexandru Ioan Cuza”, Iaşi 2008.<br />
Delloite, (2008) Externalizarea serviciilor financiare. Soluţii pentru afacerea dumneavoastră,<br />
Bucure ti 2008, www.kpmg.ro.<br />
Păvăloaia, V.-D., (2009) “Chapter 29 – A computerized solutions for the financial diagnose of<br />
the SMEs”, in <strong>Proceedings</strong> of the European Computing Conference Vol.2, Springer<br />
Science NY 2009.<br />
Sako, M., (2006) “Outsourcing and Offshoring: Implications for Productivity of Business<br />
Services”. Oxford Review of Economic Policy, Vol. 22, Issue 4, 2006.<br />
Fotache, D., Hurbean, L., Dospinescu, O., Păvăloaia, V.-D., (2010) Procese organizationale<br />
si integrare informational. Enterprise Resource Planning, Editura Universităţii<br />
„Alexandru Ioan Cuza”, Iaşi 2010.<br />
The Rehmann Goup (2007), Finance & Accounting Outsourcing,<br />
http://www.rehmann.com/pdfs/SellSheets/fa_outsourcing.pdf.<br />
Morgan Chamber, (2007) Finance and Accounting Outsourcing. A Morgan Chamber<br />
Factsheet, Morgan Chamber 2007, http://www.morganchambers.com/downloads/<br />
Finance_and_Accounting_Fact_Sheet_Mar07.pdf<br />
Horomnea, E., Tabără, N., Budugan, D., Georgescu, I., Be ianu, L., (2007) Bazele<br />
contabilităţii, Edi ia a IIa, Ed. Sedcom Libris, Ia i 2007.<br />
Zhu, Z., Hsu, K. and Lillie, J., (2001) Outsourcing – a strategic move: the process and the<br />
ingredients for success. Mgmnt Decision, 2001.<br />
Lever, S., (1997) An analysis of managerial motivations behind outsourcing practices in<br />
human resources. Hum. Resource Planning, 1997.<br />
Marshall, D., Lamming, R., Fynes, B., (2005) “The development of an outsourcing process<br />
model”, International Journal of Logistics: Research and Applications,<br />
Taylor&Francis, Vol. 8, No. 4, December 2005.<br />
Business Process Outsourcing: The Finance and Accounting Process, Outsourcing Journal,<br />
septembrie 1999, www.outsourcing-journal.com.<br />
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PS14 Management information systems III<br />
Chairperson<br />
Javier de ANDRES, University of Oviedo, Spain<br />
AUDITING NEW INFORMATION TECHNOLOGY<br />
SOLUTIONS FOR ECONOMIC GROWTH<br />
Delia BABEANU, Gabriel COZGAREA, Adrian COZGAREA,<br />
Ilie TAMAS, Nicolae DAVIDESCU<br />
A TEST OF DIFFERENT MODELS<br />
FOR THE ESTIMATION OF THE LABOR COSTS<br />
OF SOFTWARE PROJECTS<br />
Javier DE ANDRES, Pedro LORCA<br />
IT COMPLEXITY AND COSTS<br />
Marius Daniel MARES, Valerica MARES<br />
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AUDITING NEW INFORMATION TECHNOLOGY<br />
SOLUTIONS FOR ECONOMIC GROWTH<br />
Delia BABEANU 1 , Gabriel COZGARE, Adrian COZGAREA,<br />
Ilie TAMAS & Nicolae DAVIDESCU<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
Auditing solutions for economic growth is tied in large part by factors that have major impact<br />
on the development of a company. Among the most important factors it is included the<br />
permanent identification of new threats and vulnerabilities and the manner in which<br />
companies adopt the best solutions for treatment. It also requires the development of a<br />
customize information strategy related the growth and modernize of a company, as well as an<br />
efficient business plan involves the objective analysis of how the society, from its founding<br />
until now, the performance achieved and identified critical processes.<br />
A security solution adopted in IT&C to cover economic growth and global competition is to<br />
outsource the tasks that are not part of the main object of activity of the company by external<br />
entities to reduce costs and to preserve and concentrate its efforts towards achieving the main<br />
activity through more efficient use of human resource, capital and technology. But this is not<br />
enough, because to ensure flexibility and to reduce costs it is necessary to use and improve<br />
work with modular and integrated services on a platform level, like cloud computing.<br />
KEYWORDS: threats and vulnerabilities, information strategy, outsourcing, cloud<br />
computing<br />
INTRODUCTION<br />
In the digital era, in a continuous update of the way in which economic growth leaves<br />
its traces in our lives, information systems, just like any other science, knows the<br />
major developments. These developments are related to the needs of users of any<br />
type, whether end-users or companies who develop new technologies of software<br />
applications or hardware.<br />
The speed of their implementation in relation to the needs of an entity, but also users,<br />
lead to the emergence of risks to the activities of the business. Thus, the creation of<br />
methods, procedures, security policies to ensure the proper functioning of computer<br />
and information system, is a continuous process, but useful, which requires time and<br />
experience in the field.<br />
The period of accelerated transition to the model of the economy and society,<br />
characterized by laborious and profound transformations in all areas of activity, with<br />
particular economic implications, has a magnitude and rapidity unknown since now.<br />
1<br />
Correspondence address: Delia BĂBEANU, Bucharest Academy of Economic Studies, Romania;<br />
email: delia.del@gmail.com<br />
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Due to these changes in the economy, demand and supply at the global level have an<br />
important role, involving increasingly internet technology.<br />
The process of modernization and development of a company, in terms of commercial<br />
activities, is a permanent concern for both the primary managers of companies, as<br />
well as for its employees, through a process of restructuring and adapting to new<br />
requirements imposed after our country join to the European Union.<br />
Development of a customize information strategy related the development and<br />
modernize of a company, as well as an efficient business plan involves the objective<br />
analysis of how the society, from its founding until now, the performance achieved<br />
and identified critical points. The use of information technologies and<br />
communications stimulate global competition, economic growth and overall control<br />
accelerates the economic-financial monetary transactions.<br />
Radical changes occurring in a company, and the whole economy based on<br />
information technologies induce the "new economy", which is based on knowledge.<br />
Therefore, the problems are of convergences and divergences nature between "new<br />
economy" and "traditional" economy, but also by the difference in economic<br />
behavior: the new face of the existing (cries, 2011).<br />
The new economy is linked, in the current language, of internet-based economy and is<br />
sometimes called the "digital economy", "network economy" or "e-economy". But, it<br />
does not refer only to the internet economy companies. This is a complex merge<br />
between the digital economy (internet, digital goods and services, new business<br />
models, new ways of work), globalization, innovation, sustainable development.<br />
Innovation and competition constitute the engine of development, and rapid and<br />
profound structural changes at the macro and micro economic level imposed by the<br />
global character of technological change and economic activities involve balancing<br />
the activities between the internal and external levels, local and global. Basic concepts<br />
of the new economy are the emergence of future activities carried out from<br />
development/remote, of information technologies and communications. Existing<br />
activities are carried out faster, more productive, and at a lower cost, and the<br />
emergence of new economic sectors with an impressive growth is due to intangible<br />
activities and processes of learning and knowledge.<br />
The main processes occurring in the new economy are provided by the accelerated<br />
development of advanced communications, with the predominantly to network<br />
internet. Development of electronic commerce, the emergence of new models of<br />
business restructuring/re-engineering companies, promote new rules and forms of<br />
organization, based on predictive society, on innovation and the expansion of forms of<br />
activity and working remotely. These processes have three defining characteristics,<br />
namely: access and instant response, personalized service, as well as the simultaneous<br />
presence in several places (ubiquity).<br />
1. RESEARCH METHODOLOGY<br />
The modality for research data collection consists in studying the sources and nature<br />
of solutions adopted in information technology, explanations and interpretations, all<br />
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of the techniques, methods and procedures adopted in terminology work to carry out<br />
terminology research.<br />
We propose to start with literature review in identifying new IT threats and<br />
vulnerabilities continue with a case study regarding information strategy for online<br />
business and proposal to eliminate threats and vulnerabilities by using outsourcing<br />
and cloud computing.<br />
As we know, information strategy must be aligning to IT novelty, so the future studies<br />
will be according to new technologies for online business to improve the economic<br />
performance.<br />
The next steps present the flow of the research:<br />
� Defining the research and development of its approach<br />
The first step in the research was the definition of the problem to study. To define<br />
correct strategies, it was considered important the existing relevant information, and<br />
establishes the necessary information for making decision. The definition of the<br />
problem involved discussions with decision makers of companies, interviews with<br />
experts in the field, secondary data analysis and qualitative research sometimes, such<br />
as "focus group".<br />
This technique was used to see how viable is a new software product or a new service<br />
as proposed for implementation. We set up a group of 8-9 managers, from a company<br />
to discuss some of the issues on which we have proposed. The group was led by us<br />
together with an IT specialist – manager moderator at company which conducted the<br />
interview. He started the discussion at a very general level, and then, gradually, was<br />
focused on the subject in question, in the form of information security along the flow<br />
of information; the participants were not told before that is the subject of the question,<br />
but only the area of interest.<br />
Focus group website has proven to be useful for understanding the perceptions and<br />
behavior of the users' computer system; generating new ideas for software or<br />
hardware products located at maturity; getting impressions, information related to the<br />
launch of new software products; the development of concepts, new ideas in regards<br />
to advertising for products developed in society; reactions to the change in the price of<br />
services, obtaining preliminary reactions to specific marketing programs.<br />
� The research plan<br />
Research plan represented a guide for conducting research. Established procedures for<br />
obtaining the required data and its purpose was to present a study, which give answers<br />
on how to identify security risks, security breaches and provide information related to<br />
their appearance for the preparation of a detailed final conclusions with<br />
recommendations.<br />
Research plan involved taking the following steps: analysis of secondary data,<br />
qualitative research, quantitative methods of data collection, the definition of the<br />
necessary information, documentation, sample proposal and setting the size of the<br />
sample, the data analysis plan (security policy, organization, management of<br />
information security, human resources security, physical security and the<br />
environment, communication and management of logical operations, control of access<br />
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to the computer system, the acquisition, development and maintenance of information<br />
systems, management of information security incidents, business continuity<br />
management, compliance with legal requirements).<br />
� Collecting data<br />
The process of data collection included personal interview. Careful selection of the<br />
data, training where necessary interdisciplinary approach, the control and evaluation<br />
of information received were essential to minimize errors which could arise in the<br />
process of collecting data.<br />
� Processing and analyzing information<br />
The processing of the information included grouping, editing, coding, transfer and<br />
verification of the replies given by the interviewee. Each data was inspected carefully<br />
and where necessary, corrected. The data was transcribed into a database and verified<br />
the accuracy. The last step is to analyze data.<br />
� Presenting research conclusions<br />
The conclusions of the entire project analysis contain research problem and<br />
objectives, the plan of research, the collecting data, the procedures adopted for the<br />
analysis and the results obtained. The results are set out explicitly in order to be easily<br />
implemented and follow in a future research.<br />
2. LITERATURE REVIEW IN IDENTIFYING NEW IT THREATS<br />
AND VULNERABILITIES<br />
Vulnerabilities and threats are the risks of computer networks of a company. These<br />
vulnerabilities result from removing the damage through network attacks. A<br />
vulnerability of a computer system is a weakness in an application or operating<br />
system, application code or configuration that makes it possible to exploit a threat in<br />
the system (or the underlying network) by creating a negative impact or damage.<br />
Threats are units that take action on the vulnerabilities by trying to exploit. A threat<br />
may be an unauthorized user, such as a hacker or even a system administrator by<br />
trying to gain access to a system beyond the level authorized in advance. It rarely<br />
happens that the application or system processes can act as threats.<br />
The discovery of these vulnerabilities requires prioritizing their mitigation and<br />
determination of the impact on infrastructure. Priority will not be accorded the<br />
vulnerabilities that are accessible to those who have not been exploited nor have an<br />
immediate impact on the infrastructure. In setting priorities on cutting vulnerabilities<br />
will keep into account the sensitivity of the data on computer systems that are<br />
affected. Must know at first what data in the network are very sensitive. For this it is<br />
necessary to a classification of such data by labeling them as: highly sensitive,<br />
moderate, minimal, non-sensitive.<br />
Any date that puts business continuity in the game should be classified as extremely<br />
sensitive date. The data that can be easily recreated and are read-only public are<br />
susceptible. Some organizations make the mistake of fixing vulnerabilities to be<br />
exploited, than to watch what impact have these in the processing of classified data.<br />
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IT infrastructure is based on tools for automated vulnerability assessment to find<br />
vulnerabilities in their systems and networks. Vulnerability assessment tools, also<br />
known as scanning tools can be run without an IP address, a range of IP addresses,<br />
host websites, firewalls, routers and other critical infrastructure in order to discover<br />
the vulnerabilities associated with these systems and networks.<br />
Companies Security Policy typically define the following activities as unacceptable:<br />
outside reconnaissance probing, penetration - inside reconnaissance, escalate privilege<br />
- gain foothold and pillage, expand influence - exploit and cleanup to cover tracks,<br />
profit. For these problems we have the following situations:<br />
• Network Reconnaissance of the footprint of the target system is trace route to<br />
present potential access paths and vulnerable entry points through the target<br />
network. NMAP(Network Mapper) open source utility developed reports the<br />
operating systems of OSs and firewalls;<br />
• eTrust from Computer Associates can capture the packets of all protocols on a<br />
network and save (non SSL) pages viewed on desktops, use techniques which<br />
do not harm target machines, identify which machine names are alive with a<br />
ping sweep, identify which services are available on each machine using a<br />
UDP/TCP port scan/strobe;<br />
• Take advantage of vulnerabilities to break into target systems: crack logon<br />
passwords using dictionary or brute-force attempts using, modifying cookies<br />
to access other accounts, sending shell commands in input fields, initiate<br />
emails infected with worms and Trojan horse viruses;<br />
• Once elevated privilege is obtained: hide evidence of intrusion, reduce<br />
detection during future incursions, Provide services to other hackers, such as<br />
storing files on the compromised machine for others to obtain files, Use<br />
infected system to launch Distributed Denial of Service attacks on another<br />
target;<br />
• Profit from attack like: steal information, run up charges, on client browsers,<br />
point the default website to a malicious site, and deface web pages served on<br />
web servers (such as IIS).<br />
In other words, the definition of the risk is:<br />
Risk = Threat x Vulnerability<br />
Where: risk is being exposed to threats, risks are the potential to incur consequences<br />
of harm or loss of target assets, a risk factor is the likelihood of resources being<br />
attacked, threats are dangerous actions that can cause harm. The degree of threat<br />
depends on the attacker's skills, knowledge, resources, authority and motives.<br />
How we may build a risk is shown in the table below.<br />
Table 1. Samples of risk appearances<br />
No. Threat Vulnerability Risk<br />
1. Hacker Improper use of technology Hacking<br />
2. Insiders Inability to control technology Social engineering<br />
3. Industrial espionage Inability to react quickly enough System intrusion, break-ins<br />
4. Cracker Concentration of data Unauthorized system access<br />
5. Terrorist Incorrect Data entry System penetration<br />
(Source: Information security threats and vulnerability, 2011<br />
http://www.wilsonmar.com/1secvul.htm)<br />
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The importance of IT Risk and Compliance management has grown dramatically as<br />
business operations are increasingly dependent on information systems technology. IT<br />
related failures can have a serious impact on business performance and thus managing<br />
IT risks is a necessary component to ensuring overall corporate health.<br />
3. PROPOSALS FOR REMOVING THREATS AND VULNERABILITIES<br />
One of the best modality to reduce risk is use outsourcing services which means the<br />
transfer of the management and/or day-to-day execution of a process of deal<br />
processed by external service provider. Another term is usually used to refer to<br />
outsourcing and Business Process Outsourcing – business process Outsourcing or<br />
BPO. In any outsourcing arrangement, there are at least two parties involved. The first<br />
is the company client, acting to achieve one or more processes to deal with a foreign<br />
party, and the second is vendor (provider) company that runs the business processes in<br />
the interests of the client.<br />
The decision to outsource the tasks that are not part of the main object of activity of<br />
the company by the external entity is usually taken in order to reduce costs and to<br />
preserve and concentrate its efforts towards achieving the main activity, through more<br />
efficient use of manpower resources, capital and technology.<br />
The organizational structure of a company benefiting from these services change<br />
through acceptance of the completion of these activities, foreign contract. To call<br />
upon the services of other companies as part of its business, it takes as between the<br />
company and the service provider to have a consolidated partnership of trust and<br />
responsibility assumed. On the basis of this partnership, the supplier is in charge of<br />
purchasing all the means necessary to achieve the secondary activities of the firm,<br />
including manpower, material resources and the necessary technology.<br />
The organizational structure of a company benefiting from these services change<br />
through acceptance of the completion of these activities, foreign contract. To call<br />
upon the services of other companies as part of its business, it takes as between the<br />
company and the service provider to have a consolidated partnership of trust and<br />
responsibility assumed. On the basis of this partnership, the supplier is in charge of<br />
purchasing all the means necessary to achieve the secondary activities of the firm,<br />
including manpower, material resources and the necessary technology.<br />
In large building outsourcing is more complex. An example is agent (broker), which is<br />
a service that finds the intercooler in the interest of the customer, the suppliers by<br />
connecting some of the external management and operations responsibilities<br />
(Bragg, 2006).<br />
Classification of outsourced business processes can be achieved through three main<br />
categories of outsourced business processes:<br />
• Information Technology-Information Technology Outsourcing outsourced (IT<br />
Outsourcing) Outsourcing the design, development, implementation and<br />
management of IT products and processes provided by a third party;<br />
• Outsourcing business processes that are not listed in the previous categories.<br />
Example: accounting, marketing, sales, administrative development.<br />
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Securing services outsourcing<br />
It was observed an exponential growth in the number of companies which have<br />
concluded that the lack of control of activity was and is the main reason for not<br />
wanting outsourcing services. Overriding question to that effect would be if<br />
outsourcing is safe or not. Recommendations for determining safe levels of exposure<br />
we can pose when outsourcing a service (in the present case, a cogent example is<br />
outsourcing IT) require: data classification, the classification of organizations,<br />
choosing a service provider and expanding the low-risk activities (Allen G, 2003).<br />
The choice activity suitable for outsourcing will be watching: penetration testing<br />
security consultants and Auditors, in case of disaster planning and business<br />
continuity; analysis and processes restructure, system performance/load testing,<br />
support for hardware and software, as well as the development and integration<br />
activities, Automation scenarios, detect intrusions.<br />
Safety strategy of outsourcing for services technology contains four stages (micro<br />
sourcing 2008):<br />
• identification of problems and current commercial potential, including: secure<br />
the data, improving operational efficiency, enhancing the speed of<br />
responsiveness to customer requirements, reduce operational costs;<br />
• the adaptation of new technology-based solution to the problem of the most<br />
important of the society;<br />
• establish evolutionary phase in which the company;<br />
• ensuring that the immediate option of technology will help the future<br />
development of society.<br />
In conclusion, the risk factors of security at the outsourcing of activities will be, in the<br />
vast majority of cases, those who will provide the benefits of outsourcing. If a<br />
business depends on the actual costs, then you must take into account the services<br />
provided by the remote provider (offshore vendor).<br />
Table 2. A few common objectives and parallel between outsourcing and customers<br />
Factor – objective The Customer (Internal) Outsourcer (Extern)<br />
Cost per unit of<br />
service – the<br />
opposite goal<br />
Quality of servicethe<br />
opposite<br />
objective in a way<br />
Operations-objective<br />
opposite in some<br />
way<br />
Customers want to obtain the least<br />
expensive services:<br />
-Definition of the precautionary and<br />
control services and associated costs;<br />
-Proposals for application from suppliers<br />
in the sphere of big business;<br />
-Good price Negotiation (not the smallest,<br />
an acceptable price/quality ratio).<br />
Customers want the important guarantees<br />
at the level of services, joined the metric,<br />
with the major objective of predefined<br />
(unfavorable payments) if the provider of<br />
outsourced services do not meet the quality<br />
of services. Customers want compensation<br />
for loss in business.<br />
Services and systems provided by the<br />
outsourcer must be integrated well and<br />
easily with other operations of our clients.<br />
This assumes the application in some<br />
cases, a considerable customization and<br />
system services.<br />
~ 666 ~<br />
The objective of this vendor is to maximize<br />
long-term profitability through:<br />
-High-cost rate;<br />
-The proposal price flexibility in rules to<br />
allow an additional income;<br />
-Large volume of standard services;<br />
-Large customers retention;<br />
-The economy of the ranges of products.<br />
Vendors prefer loss or lack of minimum<br />
level of services with the requirements in the<br />
quality specification of unsatisfied events of<br />
the level of service.<br />
The vendors wish to be responsible only for<br />
a fee subscription type.<br />
Services and systems provided by outsource<br />
must be integrated well and easily with other<br />
operations of our clients. This assumes the<br />
application in some cases, considerable<br />
customization and system services.
Factor – objective The Customer (Internal) Outsourcer (Extern)<br />
Complexity – a<br />
similar Objective<br />
Easy to use – a<br />
similar Objective<br />
Systems and services can be complex<br />
undercover, but can be simple to use.<br />
Systems and services must be simple and<br />
intuitive, requiring minimal training and<br />
helpdesk by phone.<br />
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Systems and operations must be easy to<br />
handle in order to maintain and change, but<br />
with a high cost of entry customers trying to<br />
be competitive on the market through them.<br />
Systems and services must be intuitive and<br />
simple, require a minimum technical support<br />
customers.<br />
In the recommendation of the general risks of outsourcing's namely: loss control<br />
service; the viability of the service provider; the quality of services; issues of trust in<br />
partner; the performance of applications and services; lack of experience in the field;<br />
hidden costs and unreliable; customizations and enhancements limited; transfer of<br />
knowledge; shared environments; elements of legacy.<br />
When all the risks of outsourcing are taken into consideration, there is at least one to<br />
which you take the decision to use a third party. Anyway, there are a number of<br />
proofs for these categories of risks occur often and are satisfactory to the purchaser<br />
and seller prospects.<br />
Outsourcing was a tool with the help of which multinational companies tried to reduce<br />
overhead costs. However, even for the multinationals there were some problems<br />
managing offshore projects. Remoteness, lack of openness and transparency in<br />
relations between a customer and service provider, cultural barriers could bring to<br />
nothing all potential savings and benefits.<br />
Another proposal to remove threats and vulnerabilities is cloud computing. The<br />
comparison between the outsourcing and cloud computing is presented in the<br />
following figure, where the arrows show the information flow.<br />
Figure 1. Comparison between outsourcing and cloud computing<br />
Cloud computing can be defined as a new style of computing in which dynamically<br />
scalable and often virtualized resources are provided as a services over the Internet.<br />
Cloud computing has become a significant technology trend, and many experts expect
that cloud computing will reshape information technology (IT) processes and the IT<br />
marketplace. Advantages of the cloud computing technology include cost savings,<br />
high availability, and easy scalability.<br />
These are presented by detail in the figure below.<br />
Figure 2. Advantages and disadvantages in cloud computing<br />
• reduce capital costs<br />
• reduce IT human resources costs<br />
• business scalability grow<br />
• high availability, flexibility<br />
• increase storage, more mobility<br />
• highly automated<br />
Cloud<br />
Computing<br />
In traditional data centers, the common approaches to security include perimeter<br />
firewall, demilitarized zones, network segmentation, intrusion detection and<br />
prevention systems, and network monitoring tools.<br />
Figure 3. Followed processes in IT management assessment through Cloud<br />
Computing<br />
(Adapted after: Iron Mountain, 2011)<br />
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• Dependent on the Internet/Intranet<br />
• Legal aspects relating to the<br />
ownership of data<br />
• Inefficient use of computer<br />
peripherals<br />
ADVANTAGES DESADVANTAGES
The security requirements for cloud computing providers begins with the same<br />
techniques and tools as for traditional data centers, which includes the application of a<br />
strong network security perimeter. However, physical segmentation and hardware<br />
based security cannot protect against attacks between virtual machines on the same<br />
server. Cloud computing servers use the same operating systems, enterprise and Web<br />
applications as localized virtual machines and physical servers. Therefore, an attacker<br />
can remotely exploit vulnerabilities in these systems and applications.<br />
Virtualization increase the number of machines to manage, service provision becomes<br />
crucial since it directly affects service management and maintenance and operation<br />
efficiency. Automation, the next core technology, can make resources available for<br />
users through self-service without getting the service providers involved. A stable and<br />
powerful automation management program can reduce the marginal cost to zero,<br />
which in turn can promote the scale effect of cloud computing. (B Furht, A Escalante,<br />
2010)<br />
Cloud computing is a solution in today's principles competitive world when business<br />
strategies should be made quickly. Comparing with conventional IT outsourcing, an<br />
approach of cloud computing allows customers:<br />
• to reduce expense for building infrastructure, security in information<br />
strategy and business responsiveness with faster time to market coverage;<br />
• to acquire online business strategies, using online process and reducing<br />
capital investments;<br />
• staying flexible to the market by growing business efficiency without<br />
losing business control (more efficiency for business). (D Kharchenko,<br />
2010)<br />
4. GENERAL FRAMEWORK FOR INFORMATION STRATEGIES<br />
Improving productivity performance is essential to companies and not only if they are<br />
competitive at the global level and have a strong economic growth. Adoption in the<br />
business of all new technologies will lead to ensure the realization of the proposed<br />
performance and getting revenue for development.<br />
4.1. Building a complex strategy<br />
According to the terms of the business, but also financial, IT & C advanced<br />
technologies combined with innovation in the business will lead to economic<br />
transformation and the new media business in the coming years. Factors acting on<br />
entities in relation to ICT are: business environment, culture, business structure,<br />
standard procedures, business processes, policies and security management, decision<br />
management, etc.<br />
In this way, an information strategy at the entity level to obtain business directs<br />
performance. The model of information society strategies is shown in Figure 4. Based<br />
on the system of Knowledge, Understanding and Exploiting the Information<br />
Resources (KUEIR) we build information society strategies.<br />
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Figure 4. System of knowledge, understanding and exploiting<br />
the information resources<br />
Context<br />
PAST FUTURE<br />
(Adapted after: Roceanu, Buga, 2003)<br />
We start from the fact that the triangular strategy components are known, which is<br />
based the construction, namely:<br />
• A triangular strategy 1 (ST1) represents the organizational or management<br />
strategy;<br />
• A triangular strategy 2 (ST2) entered in this Assembly through informational<br />
strategy, based on the IT strategy;<br />
• A triangular strategy 3 (ST3) considered to be the marketing strategy.<br />
A triangular strategy is a simple framework for understanding the impact on business<br />
information systems, which link the information systems strategy and organizational<br />
strategy and describes the balance to be maintained in the planning of the business.<br />
The triangular strategy requires security for all of the elements. Risks which are<br />
subject to the strategy are always identified and assessed, leading to difficulties in the<br />
current functioning of the company in terms of the use of new technologies. For this<br />
we propose a security strategy of the alignment to the triangular strategy to ensure<br />
proper development from the company's creation until maturity of business activities.<br />
We also need to take into account updating the activity objects of the company, as<br />
well as the suspension or permanent dissolve of activity and the destruction of data<br />
and information which are no longer used.<br />
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Figure 5. General framework for information strategies<br />
(Source: PhD Thesis” Information strategies for merchandise societies using internet<br />
technologies”, 2008)<br />
The security strategy is reported still in the phase of preparation and planning to<br />
KUEIR and building step by step along with other strategies, assessing the impact that<br />
it has at any stage of development of company. Implementation of the security<br />
strategy ensures the continuous provision of information and related services.<br />
The security model of the strategy shall be implemented on any type of company, not<br />
only for online business. A better correlation of all the components between the<br />
strategies leads to development activities in conditions of maximum safety in the<br />
design phase of a task.<br />
The information strategy at company level, as shown in Figure 6 presented by using<br />
BPMN (Business Process Model and Notation), is needed because all information<br />
components are defined in the empirical phase of the company development.<br />
Implementing ISMS (Information Security Management System) according to ISO<br />
27001 requires that the system which must certified to be already designed and<br />
implemented. In the strategy case, the system is in the design phase, it still does not<br />
exist physically or logically, and at this stage we can implement security controls and<br />
procedures to ensure the proper development of future activities.<br />
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Figure 6. General framework for information strategies<br />
KUEIR<br />
Management<br />
IT Strategy<br />
Marketing<br />
IT Security<br />
KUEIR<br />
Process<br />
Management Processes<br />
IT Strategy Process<br />
Marketing Processes<br />
Security Processes<br />
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ISMS
ISMS Process<br />
(Source: Applying ISO 27000 in business strategies)<br />
4.2. Managing the implementation of ISMS according to ISO 27001<br />
An ISMS (Information Security Management System) is a management system based<br />
on a systemic approach to the risks to which the company is exposed to and aims to<br />
establish, implement, operate, monitor, review, maintain and improve information<br />
security policies, information systems and personnel.<br />
Entities which considered that the information in the framework of the activities and<br />
not only, must be protected, should have a management system to control the risks<br />
arising from all levels of access. According to the ISO 27001 (ISACA, 2008), keeping<br />
information by implementing a management system and certification of information<br />
security, it will represent the business card of the organization for customers and<br />
business partners.<br />
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We mention the advantages to deploying such a system:<br />
• increase credibility in front of customers and partners;<br />
• elimination of risks due to leakage of information;<br />
• sensitivity of users information system with regard to the security of<br />
information at national level and the link with the external environment;<br />
• the existence of a proper environment to the elimination of problems related to<br />
information security;<br />
• implement and development of best practices-level entity, ensuring business<br />
continuity.<br />
Figure 7. Security scenario in business environment<br />
(Source: Adapted after: ISO 27000 series)<br />
Implementing an Information Security Management System (ISMS), according to the<br />
standard, presumes the following stages: determination of purpose; analysis of<br />
documentations; analysis of the processes of the entity; inventory of information<br />
assets of the entity; risk identification; risk management; setting goals and means to<br />
mitigate those risks; defining information security policy; development and<br />
implementation of procedures; training of personnel; monitoring compliance with the<br />
requirements of ISMS information system of business; evaluation of the effectiveness<br />
of the measures taken to minimize the risks; certification of ISMS's implemented.<br />
Benefits of certification include: offering by managers a better control over<br />
information flows from the certified entity; identification and monitoring of risks<br />
which affect the activity of the organization, the impact of events on the proper<br />
functioning of the Organization (example: an employee leaving, spying, intentional<br />
destruction of property of the entity, etc.); offering to customers and business partners<br />
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greater confidence in the organization certified; indication of the performance by the<br />
organization of the conditions of the standard ISO 27001 (this standard contains<br />
among other things, the best recommendations made by the experts in security);<br />
reducing the need for a possible system security assessment on the part of customers<br />
or business partners; the opportunity to meet all the conditions of eligibility to tender,<br />
where certification of ISMS is a criteria; better image and position in the market, in<br />
the face of competition (ISO27001, 2008).<br />
Quantification of costs is one of the core issues in the information strategy. Thus, in<br />
the phase of setting up the company, the risk is due to the latest generation<br />
technologies used and untested enough, leading to high costs.<br />
In the maturity stage of the business, the costs are due to outdated technologies which<br />
must be replaced by those of the last generation. The acquisition of advanced<br />
technologies will lead to the elimination of a part of risks, if they are chosen<br />
according to the requirements of business and are implemented at normal parameters.<br />
Advantages of the implementation of information strategies are due to the large extent<br />
exact which planned parallel development stages are: marketing, management, IT,<br />
security. Also, the implementation there of in the framework of a business entity level<br />
leads to clarity of the requirements of the business of supply, ensuring the quality and<br />
efficiency of an activity at low cost.<br />
Synthetic, in relation with the business requirements, we consider the original input<br />
data, as in company, the information system. As data output, we ask for information<br />
system performing, secure, based on innovation and competition.<br />
At the level of internal processing company, we have: models of strategy, models of<br />
security (security policy), the re-technology model of a task, the methodology for the<br />
audit of security, the methodology for the audit of information systems management,<br />
model of outsourcing services, model predictive society architecture informational<br />
strategy analysis of society based on the experience of other undertakings resulting<br />
from the development of a set of questionnaires.<br />
CONCLUSIONS<br />
The proposals for detailed building information develop strategies based on the<br />
following requirements: online Business and marketing website; the establishment of<br />
a security policy of the level of the entity that contains both information system and<br />
computer system; management, planning and organization of the information system;<br />
the latest generation of advanced technologies and their appropriate use in business<br />
activities; predictive aligned with the Business Entity online; informational flow<br />
within the framework of the strategies and risk assessment; outsourcing services and<br />
risk assessment of internal and external company; model of re-technology if renewing<br />
a technology aged and not only; the development and consolidation of information<br />
strategies; methodology of information systems audit and security management.<br />
IT infrastructure of an organization is adopted to meet the requirements of current<br />
capabilities to improve trade and network expansion requirements to partners and<br />
service providers. Trends such as virtualization and wireless are related to<br />
infrastructure concerning the optimization and flexibility. Also, rising security threats<br />
~ 675 ~
with increased capabilities, are exploring new ways to find vulnerabilities in the<br />
infrastructure of your organization and reduce the maximum damage in the<br />
exploitation. For many of the threats that are identified, an organization must take<br />
immediate measures to mitigate them.<br />
However, threats evolve and add a different set of challenges, which require<br />
continuous monitoring of new threat scenarios that run as a result of the discovery of<br />
new vulnerability.<br />
A security solution must find in all parts of the business: management strategy,<br />
marketing strategy, IT strategy and security strategy and to ensure that the resources<br />
of the organization are protected against threats present or evolving.<br />
Due to restrained budget allocated for IT security, in companies we meet often a<br />
precarious or even at all security. However, there are situations in which this service<br />
is outsourcing or uses virtual rent resources.<br />
To ensure a good developments and economic growth in large part depend on IT<br />
security strategy implemented and tested constantly, updated whenever necessary.<br />
A detailed analysis, based on results from interviews with managers on a sample of<br />
companies, but also the manner in which is used security strategy is required in the<br />
future.<br />
Update continuously information strategy is a necessity for the maintenance and<br />
development of a business plan in an enterprise, as well as the development of new<br />
objects of activity. This is done usually by testing an older information strategy,<br />
analysis and implementation of new elements, and finally to retest. Informational<br />
strategy analysis is carried out on the basis of questionnaires, which must define each<br />
activity. The questionnaires drawn up aimed at laws, standards, guidelines and<br />
procedures governing practice in successful information system, own experience in<br />
the field of computer systems, in order to implement new structures in the security<br />
policy. Preparation of the questionnaire would based in particular on the identification<br />
of risks at the level of information strategies of companies, and their analysis is a plan<br />
for improving information security in the implementation of new internet<br />
technologies.<br />
ACKNOWLEDGEMENT<br />
The strategies describe in this paperwork are presented detailed in PhD thesis of the<br />
first author and related paper works in references.<br />
REFERENCES<br />
Allen, J., et al., (January 2003), „Outsourcing Managed Security Services”, Carnegie Mellon<br />
University, Pittsburgh, PA: Software Engineering Institute, , http://www.fedcirc.com<br />
Băbeanu D, Tamaş I, Cozgarea G, (2009), Information strategy perspective for business<br />
continuity assurance, AMIS 2009 International Conference, Bucharest, Published in<br />
Journal of Accounting and Management Information Systems, Vol. 8, Nr. 4, 2009<br />
Băbeanu D, Tamaş I, Cozgarea G, Davidescu N, (2009), It audit trends in information<br />
security framework, AMIS 2009 International Conference, Bucharest<br />
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Băbeanu D, (2008), Information strategies for merchandise societies using internet<br />
technologies, PhD thesis, Bucharest<br />
Băbeanu D, Cozgarea G, Pugna I, Gavrilă A, (2009), “Information flow assured by IT&C<br />
continuity planning”, Internationl Conference – “Integrarea Europeană- noi provocări<br />
pentru economia României”, Published in “Analele Universităţii din Oradea”<br />
Borko Furht, Armando Escalante, (2010), Handbook of Cloud Computing, Publishing house<br />
Springer, USA<br />
Centrul de Resurse pentru Iniţiative Etice şi Solidare (CRIES), (2011), „Noua economie”<br />
available on-line at http://www.cries.ro<br />
Cloud Staffing and IT Outsourcing Evolution, (2010), available on-line at<br />
http://itonews.eu/en/news/global-news/cloud-staffing/index.html<br />
Data security council of India, (2011) „Threats and vulnerability management” available online<br />
at http://www.dsci.in/taxonomypage/88<br />
Domeniul IT, neafectat de criza economica, (2008), available on-line at<br />
http://www.ziarulfaclia.ro/Domeniul-IT-neafectat-de-criza-economica+19939<br />
Dr. M.S.Aswal, Paramjeet Rawat, Tarun Kumar (2009) „Threats and Vulnerabilities in<br />
Wireless Mesh Networks”, International Journal of Recent Trends in Engineering,<br />
Vol 2, No. 4<br />
Free software guru Richard Stallman on government IT and why he hates the cloud, (2011),<br />
available on-line at http://www.computerweekly.com/Articles/2011/03/08/245758/<br />
Exclusive-Free-software-guru-Richard-Stallman-on-government-IT-and-why-he-hatesthe.htm<br />
Hamzescu I. R., Fratostiteanu C., Marinescu L (2002) Noua economie (New Economy) şi<br />
societatea informaţională, capitolul Noua economie (E-Economie) - Un nou mod de<br />
organizare a afacerilor, Bucureşti, Publishing house Universitaria<br />
Identify new threats and vulnerabilities, (2011), available on-line at<br />
http://www.ciradar.com/Demos/Marketing/Identify-New-Competitive-Threats.aspx<br />
Information security, (2009), Cyber Threats and Vulnerabilities Place Federal Systems at<br />
Risk, United States Government Accountability Office<br />
Information security threats and vulnerability, (2011), available on-line at,<br />
http://www.wilsonmar.com/1secvul.htm<br />
IT Audit and Assurance Guidelines, (2010), available on-line at http://www.isaca.org<br />
IT security, Threats, Vulnerability and countermeasures, (2010), available on-line at<br />
http://www.ifap.ed.gov/presentations/attachments/30ITSecurityThreatsVulnerabilitiesa<br />
ndCountermeasuresV1.pdf<br />
Iron Mountain (2011), “Information Management and the Cloud”, available on-line at<br />
http://whitepapers.zdnet.com<br />
ISO 27001, 2011, available on-line at http://www.27001-online.com/secpols.htm<br />
MacLean Don, Ben Akoh, Bjornar Egede-Nissen, (2010), ICTs, sustainability and the green<br />
economy available on-line at http://www.giswatch.org/the-reports<br />
Methodological Recommendations for Information Systems Audit Report, (2008), INTOSAI<br />
Lima Declaration of Guidelines on Auditing Precepts<br />
National information assurance training and education center, (2011) „Threats and<br />
vulnerability” available on-line at http://niatec.info/ViewPage.aspx?id=0<br />
Neal Hindocha, Eric Chien, (2003), Malicious threats and vulnerabilities in instant<br />
messaging, Symantec Security Response<br />
New survey reveals top fraud threats and vulnerabilities, (2011), available on-line at<br />
http://bankinganalyticsblog.fico.com/2011/01/new-survey-reveals-top-fraud-threatsand-vulnerabilities-.html<br />
Offshore IT Outsourcing Services, (2011), “Technology”, available on-line at<br />
http://www.icreon.net/technology.shtml<br />
Piaţa IT din Romania va creşte în 2011-2012 în medie cu 7%, (2011), available on-line at,<br />
http://www.bloombiz.ro/it-c/piata-it-din-romania-va-creste-in-2011-2012-in-medie-cu-<br />
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Rangu Călin, (2009),”Modele de outsourcing IT: Multi-sourcing”, available on-line at,<br />
http://www.marketwatch.ro/1002/Managerial_Tools/Outsourcing/<br />
Roceanu I, Buga I – “Informaţia – repere conceptuale şi coordonate de securitate”, Editura<br />
Universităţii Naţionale de Apărare, Bucureşti 2003, ISBN 973-663-005-6<br />
Steven M. Bragg, (2006), „Outsourcing, a guide to… selecting the correct business<br />
unit….negotiating the contract…maintaining control of the process”, ISBN<br />
0471781495, 9780471781493<br />
Taylor L., (2004), “Vulnerabilities an threats” available on-line at<br />
http://www.intranetjournal.com/articles/200404/ij_04_21_04a.html<br />
Technical support outsourcing, 2011, available on-line at, http://www.microsourcing.com<br />
Teodorescu Alexandra, (2011), “Criza economica, oportunitatea de care au nevoie<br />
companiile din IT”, available on-line at http://www.wall-street.ro/articol/IT-C-<br />
Tehnologie/74648/Deloitte-Criza-economica-oportunitatea-de-care-au-nevoiecompaniile-<br />
din-IT.html<br />
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A TEST OF DIFFERENT MODELS<br />
FOR THE ESTIMATION OF THE LABOR COSTS<br />
OF SOFTWARE PROJECTS<br />
Javier de ANDRES 1 & Pedro LORCA<br />
University of Oviedo, Spain<br />
ABSTRACT<br />
The development of methods for the estimation of the labor costs (effort costs) in the<br />
development of software projects is of key importance for the management of this kind of<br />
projects. In the present research we test the accuracy of two models derived from the Cobb-<br />
Douglas production function against a linear model. The Cobb-Douglas function allows<br />
variable returns to scale, while the linear model implies hypothesizes constant returns to<br />
scale and a certain level of fixed costs. Our main results indicate that a linear model with<br />
constant returns to scale provides more accurate estimations than the Cobb-Douglas-derived<br />
cost functions. We found that Cobb-Douglas models are not stable in the presence of outliers.<br />
Finally our results suggest a limited influence of software development capital on effort<br />
(labor) costs.<br />
KEYWORDS: labor costs, Cobb-Douglas, software effort, scale returns, fixed costs<br />
INTRODUCTION<br />
Nowadays, software development activities are important for many organizations, and<br />
primarily for software companies. More than $300 billon are spent each year on<br />
approximately 250,000 projects, which equates to an average budget of $1,2 million.<br />
The financial implications of this are substantial (Boetticher, 2003). So, there is a<br />
growing interest in the management techniques for software projects.<br />
When managing software projects one of the most important tasks is the estimation of<br />
the costs. An estimate of the costs is desired even during the earlier stages of the<br />
development (Xu and Khoshgoftaar, 2004). Hu et al. (1998) indicate that a 200 to 300<br />
percent cost overrun and a 100 percent schedule slippage would not be unusual in<br />
large software systems development projects. Millions of dollars have been wasted in<br />
projects that are abandoned because of severe cost overruns and schedule slippages<br />
(Keil et al., 1995; Rothfeder, 1988). The main components of software project costs<br />
are hardware costs, training and travel costs and effort costs, which are the costs for<br />
paying software engineers. While the former are easy to estimate, effort costs are<br />
harder to assess in the earlier stages of a project (Heinrich, 1997).<br />
Some models have been proposed to estimate such costs. Most of the models rely on<br />
the use of heuristic procedures based on statistical/machine learning models. Some<br />
1 Correspondence address: Javier de ANDRÉS, University of Oviedo, Faculty of Economy and<br />
Business, Department of Accounting, Avda.del Cristo s/n, Oviedo 33006, Spain; E-mail:<br />
jdandres@uniovi.es<br />
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others imply theoretical assumptions and can be used to complement the former.<br />
Among these, those who use econometric theory have been paid certain attention.<br />
These models consider software development as an economic process where a series<br />
of inputs (labor, capital) are transformed into an output which is the software product.<br />
Some of the models postulate for the software production process a Cobb-Douglas<br />
function with variable returns to scale and a multiplicative relationship among<br />
production factors.<br />
However, despite decades of research in this domain, software estimation is still<br />
considered a challenge for most researchers and practitioners, and no research<br />
approach has currently been recognized as having produced estimation models that<br />
are considered to perform well enough to meet market needs and expectations (De<br />
Barcelos et al., 2007). The reason maybe that most of the prior research that found<br />
variable returns to scale was developed using heterogeneous datasets, which may<br />
originate a better fitting of nonlinear functions. In the present research we test two<br />
bivariate cost functions derived from the Cobb-Douglas model against a linear<br />
function which assumes that costs follow an additive pattern with constant returns to<br />
scale. We use a homogeneous case base of real data which comprises projects<br />
developed by only one software company.<br />
The remainder of this paper is structured as follows. Section 1 reviews related<br />
research on the estimation of software effort costs. Section 2 details the models that<br />
we test as well as the procedures used to assess their goodness of fit. Section 3<br />
explains the main features of the analyzed sample and defines the variables used in<br />
the study. Section 4 outlines the main results. Finally, section 5 contains the main<br />
conclusions and directions for future research.<br />
1. PRIOR RESEARCH ON THE ESTIMATION OF SOFTWARE EFFORT<br />
COSTS<br />
Research on the estimation of software effort costs has a long history. According to<br />
Pendharkar (2010), researchers have followed two approaches: statistical and machine<br />
learning techniques and theory-based techniques.<br />
The former are heuristic methods that examine relationships between a series of cost<br />
drivers and software effort, which acts as the dependent variable of the model. These<br />
models do not involve a-priori considerations on the functional form of the<br />
relationship among variables. Among the applied techniques we can highlight back<br />
propagation-trained multilayer neural networks (Wittig and Finnie, 1994), case-based<br />
reasoning (Shepperd and Schofield, 1997; Kadoka et al., 2000), genetically-trained<br />
neural networks (Shukla, 2000), rule induction systems (Mair et al., 2000), genetic<br />
programming (Burgess and Lefley, 2001), radial basis function neural networks (Shin<br />
and Goel, 2000; Abbas, 2002), analogy and regression towards the mean (Jørgensen et<br />
al., 2003), fuzzy logic (Xu et al., 2004), ordinal regression (Sentas et al., 2005),<br />
support vector machines (Oliveira, 2006), Bayesian statistics (van Koten and Gray,<br />
2006), wavelet neural networks (Vinay Kumar et al., 2008), fuzzy clustering (Aroba<br />
et al., 2008), regression trees (Elish, 2009), genetic algorithms (Oliveira et al., 2010),<br />
fuzzy logic (Muzaffar and Ahmed, 2010 Azzeh et al., 2011), probabilistic neural<br />
networks (Pendharkar, 2010), and functional networks (El-Sebakhy, 2011). Some<br />
authors even suggest that software effort estimation could be improved by using<br />
hybrid regression approaches (Mukhopadhyay et al., 1992; McDonell and Shepperd,<br />
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2003; Braga et al., 2007). For a review of different models see Burgess and Lefley<br />
(2001) and Jørgensen (2004).<br />
However, it must be pointed out that most techniques require large training sets to<br />
achieve good predictions. This means a limitation, as most of the available databases<br />
for research are of small size. A way to obtain large databases is to include projects<br />
from different software houses, but this poses additional limitations which will be<br />
explained later. Furthermore, these models yield complex regression surfaces. Then<br />
there is a substantial risk of overfitting, that is, the accuracy of the model can<br />
dramatically fall when applied to data not included in the estimation set. In fact, many<br />
authors withdraw only a few cases for validation, and remove outliers from the<br />
sample in order to achieve better results.<br />
Nevertheless, these limitations do not imply that machine learning/statistical<br />
approaches must be rejected. As Shepperd and Schofield (1997) indicate, additional<br />
and complementary methods of software project effort prediction should be applied.<br />
In this regard, the second type of models, that is, those who incorporate some<br />
theoretical assumptions in the estimation process, are of special interest. A<br />
theoretically sound model could yield some insights into the fundamental behavior of<br />
software development processes that were not apparent form empirical models (Hu et<br />
al, 1998).<br />
In this regard, a fruitful approach is to consider software development as an economic<br />
production process where inputs are converted into outputs. Then, software cost<br />
estimation problem becomes the problem of understanding the relationships between<br />
input and output variables (Pendharkar et al., 2008). If we follow this approach, two<br />
key issues are to determine if the relation among independent variables is additive or<br />
multiplicative, and whether economies/diseconomies of scale do exist. A production<br />
process exhibits local increasing returns to scale if, at a fixed volume, the marginal<br />
returns of additional input exceed the average returns. Among the reasons for<br />
economies of scale in the software development process are labor specialization<br />
(learning curves), and the use of CASE tools (Banker and Kemerer, 1989). Among the<br />
reasons for diseconomies of scale are higher team size leading to increased<br />
communication requirements and increased conflicts, project complexity and<br />
increased project overhead activities, such as planning and documentation (Banker<br />
and Kemerer, 1989; Conte et al., 1986; Jones, 1986). In presence of economies of<br />
scale the returns of the process increase marginally as the volume of the production<br />
increases, that is, the marginal cost of producing an additional unit decreases as more<br />
units are produced. The opposite happens if there are diseconomies of scale, where the<br />
marginal cost of producing an additional unit of output increases.<br />
The first relevant theoretical model is the constructive cost model (COCOMO),<br />
developed by Boehm (1981). COCOMO estimates effort using the following<br />
exponential function:<br />
Y =a(KLOC) q (1)<br />
Where Y is the effort in person-months, KLOC is software size measured in terms of<br />
thousands of lines of code, and a and q are constants determined by the environment<br />
and the complexity of the application to be developed. COCOMO has three levels<br />
(basic, intermediate and advanced), with increasing refinement in the estimation of<br />
~ 681 ~
a and q. The exponential approach has later been used in other models such as<br />
COCOMO II (Boehm et al., 1995) and Constructive Systems Engineering Cost Model<br />
(COSYSMO) (Valerdi, 2008), among others.<br />
In the exponential models the parameter q is of special importance as it determines the<br />
existence of economies/diseconomies of scale. These models generally assume q>1<br />
which means that diseconomies of scale are present no matter the software size we<br />
consider. Another two drawbacks of COCOMO and related models are a) the<br />
subjectivity of the cost drivers used to determine a and q (Fenton and Pfleeger, 1997)<br />
and b) the high correlations among such cost drivers (Chulani et al., 1999).<br />
Other popular models which assume multiplicative relationships among variables are<br />
the software lifecycle analysis (SLIM) (Putnam, 1982), and the SELECT cost<br />
estimator (Boehm et al., 2000).<br />
An alternative to the multiplicative models is the assumption that the relationship<br />
among variables can be described using a linear function. An example of this is the<br />
following:<br />
Y = a + b (size) (2)<br />
Where a and b are constant parameters. This approach means constant returns to scale<br />
and the existence of a certain amount of fixed costs. It has been successfully used in<br />
the Esprit Mermaid project (see Kok et al. (1990) for further details). Furthermore,<br />
Mair et al. (2000), McDonell and Shepperd (2003) and Cuadrado-Gallego et al.<br />
(2007) used linear regression-based approaches.<br />
Data envelopment analysis (DEA) has also been applied to investigate the existence<br />
of economies/diseconomies of scale in the software development process. The works<br />
of Banker and Kemerer (1989), Banker et al. (1994), and Pendharkar (2006) are<br />
outstanding examples. However, the results of some of the studies are inconclusive,<br />
and Kitchenham (2002) indicates that the assumptions of DEA are unsuitable for<br />
estimation of production function form of software engineering variables.<br />
More recently, the Cobb-Douglas production function has been applied to software<br />
effort estimation (Hu, 1997; Pickard et al., 1999; Pendharkar et al., 2008, among<br />
others). It takes the following general form:<br />
Output = C0 (Input 1) C 1 (Input 2) C 2 (3)<br />
Where Input 1 and Input 2 are usually labor and capital, respectively, and Ci are fixed<br />
parameters. Note that the values of C1 and C2 determine the existence of<br />
increasing/decreasing/constant returns to scale.<br />
For the specific case of software development the output is usually considered as an<br />
independent variable rather than the dependent variable of the model, as the size of<br />
the software product to be delivered depends on requirements assessment and client<br />
needs. Then, the production function is transformed into a cost function, as follows:<br />
Y = A(x) b (z) c (4)<br />
~ 682 ~
Where Y is the software effort, x is the software development capital and z is the<br />
output (a measure of the size of the software product). The parameters to be estimated<br />
are A=C0 C1 , b=C2×C1 and c=-C1.<br />
Software engineering researchers have shown a lot of interest in the value of variables<br />
b and c of the software development effort function. If b and c are less than one then<br />
software effort function shows increasing returns to scale. When b and c equal one<br />
then the software effort function shows constant returns to scale. If b and c are greater<br />
than one then returns to scale are decreasing.<br />
The cost model derived from the Cobb-Douglas production function can be<br />
understood as an extension of exponential models. However, some studies which used<br />
the Cobb-Douglas function (e.g., Pendharkar et al., 2008) as well as some others<br />
which used DEA (i.e., Banker and Kemerer, 1989) found evidence of significant<br />
economies of scale. This is not in accordance with COCOMO and related models,<br />
which assume decreasing returns to scale.<br />
As Kitchenham (2002) indicates, the results of research efforts on software cost<br />
estimation are heavily dependent on the used dataset. For example, Pendharkar et al.<br />
(2008) used the International Software Benchmarking Standards Group (ISBSG)<br />
database, which merges data from many organizations, and this may lead to the fitting of<br />
a nonlinear model even when the true relationship is linear. Figure 1 exemplifies this.<br />
Figure 1. Individual size-effort graphs<br />
~ 683 ~
Figure 2. Aggregated size-effort graph<br />
It can be seen that a linear model such as that of equation (2) fits better the data for<br />
individual organizations (figure 1 graphs), with projects which are more homogeneous<br />
in terms of productivity and fixed costs. However, when we merge data from different<br />
companies (figure 2 graph), with projects of different size, and different productivity<br />
and fixed costs a nonlinear function, such as that derived from the Cobb-Douglas<br />
function, provides better fitting. This may lead to the biased conclusion that<br />
economies/diseconomies of scales do exist.<br />
In the present research we try to determine the most adequate model when considering<br />
a homogeneous set of projects from only one organization. The specific tested<br />
models, and the description of the dataset used are discussed in the following two<br />
sections.<br />
2. THE TESTED MODELS AND THE ACCURACY MEASURES<br />
In this paper we have taken several alternative cost functions. According to Dolado<br />
(2001) there are two basic criteria, apart from those of statistical validity, which make<br />
a cost function valid and comparable to other functions. The first, consists in that the<br />
function defined must have “economic plausibility”, which means that the relation<br />
identified should show a reasonable behavior, and should make economic sense. The<br />
second criterion consists in that the cost functions are only valid within the range of<br />
the data used to derive the equation. If cost functions are to be compared, they should<br />
be derived under the same assumptions.<br />
The first model is the cost function that derives from the Cobb-Douglas production<br />
function (equation (4)). There are several properties of the Cobb–Douglas function<br />
that make it of interest for the estimation of software projects costs (Pendharkar et al.,<br />
2008). First, the Cobb–Douglas function is a strictly convex function which means<br />
that the minimum for a Cobb–Douglas function is a unique absolute minimum<br />
(Chiang and Wainwright, 2005). Second, if the software effort function takes the<br />
Cobb–Douglas form then this means that there exists a unique software size and team<br />
size combination that will theoretically provide the lowest software development<br />
effort. Third, the Cobb–Douglas function is homogeneous of degree (b + c). This<br />
~ 684 ~
means that multiplying inputs x and y by an amount k will alter the effort y by the<br />
proportion (k) b+c . Fourth, some prior researchers (i.e. Pickard et al., 1999) found that<br />
this model is very stable in software engineering data sets with regard to outliers.<br />
In this model parameters A, b and c were estimated by using a nonlinear least-squares<br />
procedure. This is what we call a non-linear Cobb-Douglas model (NL-CD).<br />
The second model represents also a Cobb-Douglas based cost function and is obtained<br />
by taking logarithms on both sides of (4) and solving the resulting equation using least<br />
squares linear regression:<br />
Ln(Y)=Ln(A) + bLn(x) + cLn(z) (5)<br />
This model is denoted as Log Linear Cobb-Douglas (LL-CD).<br />
The last model we tested is a least squares linear regression estimated using the<br />
original variables:<br />
Y = A + bx + cz (6)<br />
As settled above, this model assumes fixed costs and constant returns to scale. With<br />
regard to the measurement of the goodness of fit of the three models, we computed<br />
four global accuracy measures. First, for each of the cases in the sample we calculated<br />
the magnitude of relative error (MRE), as follows:<br />
i Yi Yi<br />
ˆ Y −<br />
MRE=<br />
(7)<br />
Where, Yi denotes the actual effort of ith project, and denotes the estimated effort of<br />
ith project.<br />
The first two global measures are the mean and the median of MRE (denoted MMRE<br />
and MdMRE, respectively):<br />
1 n<br />
MMRE = × ∑ MRE<br />
(8)<br />
n 1=<br />
i<br />
MdMRE = median (MRE) (9)<br />
These indicators, especially MMRE, are commonly used in studies on software effort<br />
costs (see, Shepperd and Schofield, 1997; Cuadrado-Gallego et al., 2007; Vinay<br />
Kumar et al., 2008, and Mittas et al., 2010, for a few examples). Small MMRE and<br />
MdMRE values indicate the low level of estimation error. However, MMRE is<br />
unbalanced and penalizes overestimation more than underestimation (Lie et al., 2009).<br />
MdMRE is an aggregate measure which is less sensitive to extreme values (Foss et<br />
al., 2003). It exhibits a similar pattern to MMRE but it is more likely to select the true<br />
model especially in the underestimation cases.<br />
~ 685 ~
Another indicator which is often calculated is Pred(25), which is the percentage of<br />
projects for which MRE is less than 25% (see, e.g., Shepperd and Schofield, 1997,<br />
and Vinay Kumar et al., 2008):<br />
1 n<br />
Pr ed(<br />
25)<br />
= × ∑ ( MRE ≤ 0,<br />
25)<br />
(10)<br />
n 1=<br />
i<br />
The last measure is the average square root error index (ASREI):<br />
N<br />
[ ( ) ] Yˆ<br />
= ∑ i − i Y<br />
1<br />
ASREI (10)<br />
N<br />
i=<br />
1<br />
Where N is the number of projects in the sample. ASREI is a robust indicator which is<br />
commonly used to evaluate goodness of fit on data (see, e.g., Hale et al., 2000; Smith<br />
et al., 2001; Pendharkar et al., 2008).<br />
Since LL-CD model predicts log effort, for the calculation of the accuracy measures<br />
corresponding to this model we take the anti-log values to compute the value of<br />
model-predicted effort. This procedure is commonly used in studies that consider loglinear<br />
models (see, e.g., Pendharkar, 2008).<br />
The four measures are calculated both using the original sample and a jackknife<br />
procedure. Jackknife is a validation technique consisting in removing each case and<br />
then using the rest of the cases to predict the removed one. This method has been used<br />
by some of the prior researchers (e.g., Shepperd and Schofield, 1997). The reason is to<br />
detect the overfitting problems that nonlinear/nonparametrical models often suffer.<br />
3. SAMPLE AND VARIABLES<br />
In this research we used the Desharnais dataset, which comprises 81 commercial<br />
projects developed by a Canadian software house in the late 80s. This dataset was<br />
initially compiled by Desharnais (1989) and is currently available at Sayyad Shirabad<br />
and Menzies (2005). It has been extensively used by researchers on software effort<br />
costs (Shepperd and Schofield, 1997; Burgess and Lefley, 2001; Oliveira et al., 2010;<br />
Azzeh et al., 2011, among many others).<br />
Despite the projects in the Desharnais database are more than 20 years old it is<br />
noticeable that it is still used in scientific research. One of its advantages is that all the<br />
projects were developed by the same software firm and the time span is relatively<br />
short. This leads to a better assessment of the models, as it guarantees the ceteris<br />
paribus requirement which must be fulfilled in the estimation of econometric models.<br />
That is, the variability of the sample with regard to organizational and technological<br />
factors which are not explicitly represented by variables in the dataset is lesser than in<br />
other datasets which comprise projects from several houses / several decades.<br />
Projects n. 38, 44, 66 and 75 of the Desharnais dataset have missing data. As well as<br />
many of the previous researchers that used this dataset, we discarded these projects.<br />
So, our final sample comprises the 77 cases with complete information.<br />
~ 686 ~
The Desharnais dataset contains eleven attributes. Three of these variables are suitable<br />
to the estimation of our models. First, as a measure of the software output we<br />
considered the adjusted functional points. The function-point method was proposed by<br />
Albrecht (1979) and is based on the functionality of the software rather than on its<br />
size in terms of lines of code. Most of the prior research efforts use functional points<br />
as the proxy for size. More recently, extensions of this methodology have been<br />
developed, as for example the object-point method (Sneed, 1996).<br />
Second, as proxy for the software development capital we chose the developers team<br />
experience, measured in years. As for some of the cases the value of this variable was<br />
equal to zero, we added 0.1 to all the observations in order to allow the log<br />
transformation. In our view, this attribute is a better proxy of the software<br />
development capital than others which are often used such as team size (see, e.g.,<br />
Pendharkar et al., 2008). It is not clear that a bigger team size leads to higher<br />
productivity because bigger teams may involve increased communication<br />
requirements, increased conflicts and increased project overhead activities (Banker<br />
and Kemerer, 1989).<br />
Finally, with regard to the the project effort, its measurement can be considered a<br />
challenging endeavor. The Project Management Institute (2008) defines the project<br />
effort metric as “the number of labor units required to complete an activity or other<br />
project element. This is usually expressed as staff hours, staff days, or staff weeks and<br />
should not be confused with duration”. So we measured project effort using the<br />
amount of person-hours needed to the completion of the project, as Desharnais dataset<br />
does not include the total cost in monetary units. A limitation of this, which is shared<br />
with the majority of the prior research efforts, is that our models do not take into<br />
account that the experience of the developers has an effect on the costs of the project.<br />
Wages of developers with more experience are generally higher.<br />
Table 1 contains some descriptive information on the studied variables.<br />
Table 1. Descriptive information<br />
Statistics Y (Software effort) x (team experience in z (adjusted functional<br />
years)<br />
points)<br />
Mean 4833.909 2.298 298.013<br />
Standard Deviation 4188.185 1.328 182.263<br />
Minimum 546 0 73<br />
Maximum 23940 4 1127<br />
Percentile 10 1093.4 1 116.8<br />
Percentile 25 2306.5 1 171<br />
Percentile 50 3542 2 258<br />
Percentile 75 5848.5 4 379.5<br />
Percentile 90 10733.8 4 523<br />
4. RESULTS<br />
Table 2 shows the estimation results. We provide parameter estimates and the<br />
accuracy measures explained above. It is noticeable that LL-CD and linear models<br />
show significant levels of heteroskedasticity, so robust standard errors are provided.<br />
~ 687 ~
Parameter estimates<br />
A coefficient<br />
(standard error)<br />
t-statistic<br />
A coefficient<br />
(standard error)<br />
t-statistic<br />
A coefficient<br />
(standard error)<br />
t-statistic<br />
Table 2. Estimation results<br />
NL-CD LL-CD Linear<br />
19.146<br />
(13.460)<br />
1.42<br />
0.116<br />
(0.101)<br />
1.16<br />
0.955<br />
(0.118)<br />
8.07<br />
~ 688 ~<br />
2.906<br />
(0.705)<br />
4.12<br />
0.238<br />
(0.155)<br />
1.54<br />
0.902<br />
(0.130)<br />
6.92<br />
-313.316<br />
(921.541)<br />
-0.34<br />
186.046<br />
(261.509)<br />
0.71<br />
15.774<br />
(3.978)<br />
3.96<br />
R 2 0.790 0.441 0.498<br />
Accuracy measures (in-sample)<br />
MMRE 0.679 0.602 0.713<br />
MdMRE 0.307 0.364 0.315<br />
Pred(25) 41.558% 36.363% 42.857%<br />
ASREI 0.589 3.110 0.001<br />
Accuracy measures (jackknife)<br />
MMRE 4.872×10 45 2.249 1.917<br />
MdMRE 0.998 0.485 0.501<br />
Pred(25) 25.974% 28.571% 37.662%<br />
ASREI 1.230×10 24 16.280 3.031<br />
It is noticeable that with regard to the estimation sample and the most usual accuracy<br />
measure (MMRE) the Cobb-Douglas models outperform the linear approach.<br />
However, on a global basis, an especially when we consider the most robust measures<br />
(ASREI and jackknifed indicators), the linear model is superior. In this regard, in NL-<br />
CD c is very close to 1, and the 95% confidence interval for this parameter contains<br />
this value.<br />
So, our data suggest that software effort follows an additive rather than a<br />
multiplicative/exponential pattern, with constant returns to scale. This is not in<br />
accordance with prior researchers (Hu, 1997; Pickard et al., 1999; Pendharkar, 2006;<br />
Pendharkar et al., 2008) which suggested the existence of economies of scale in<br />
software development. As noted above, the reason may lay in the fact that some of the<br />
prior researchers merged data from a variety of software houses, while our dataset<br />
contains projects from a single organization.<br />
Our analysis also reveals that NL-CD performance falls dramatically when jackknifed<br />
measures are considered. This is an evidence of overfitting, which reduces the utility<br />
of the model. LL-CD and linear models seem to be more robust.<br />
Another interesting finding is that in the three models the 95% confidence interval for<br />
b contains the value zero. This implies that either software development capital is not<br />
a relevant cost driver or the proxy for its measurement which is available in the<br />
Desharnais dataset (the team experience) is not an accurate one. In this regard, we<br />
must remark that Pendharkar et al. (2008) found that software development capital is<br />
a relevant factor, but they used as proxy the size of the team of developers. This<br />
question is a matter for future research efforts.<br />
Furthermore, it is remarkable that MMREs are always higher than MdMREs. So, the<br />
distribution of MRE is asymmetrical. In addition, an examination of the residuals<br />
leads to the conclusion that the estimation errors are caused by a few cases which are
very far away from the predicted value. In this regard, a large amount of error in the<br />
NL-CD model is caused by a single case (n. 81). Size and effort for this case are 1127<br />
and 23940, respectively. These values are approximately 3×Percentile 75 and<br />
4×Percentile 75, respectively, so on a univariate basis we can consider case n. 81 as<br />
an outlier with regard to both variables. Then, we removed this observation from the<br />
sample and proceeded to the reestimation of the models. The results are detailed in<br />
table 3.<br />
Parameter estimates<br />
A coefficient<br />
(standard error)<br />
t-statistic<br />
A coefficient<br />
(standard error)<br />
t-statistic<br />
A coefficient<br />
(standard error)<br />
t-statistic<br />
Table 3. Estimation results after the deletion of case n. 81.<br />
NL-CD LL-CD Linear<br />
59.183<br />
(48.720)<br />
1.21<br />
0.104<br />
(0.094)<br />
1.11<br />
0.761<br />
(0.141)<br />
5.40<br />
~ 689 ~<br />
3.073<br />
(0.739)<br />
4.15<br />
0.231<br />
(0.155)<br />
1.49<br />
0.872<br />
(0.136)<br />
6.39<br />
357.891<br />
(752.083)<br />
0.48<br />
190.053<br />
(245.508)<br />
0.77<br />
13.141<br />
(3.457)<br />
3.80<br />
R 2 0.763 0.402 0.353<br />
Accuracy measures (in-sample)<br />
MMRE 0.676 0.600 0.710<br />
MdMRE 0.314 0.341 0.318<br />
Pred(25) 40.789% 38.157% 42.105%<br />
ASREI 0.751 3.112 0.994<br />
Accuracy measures (jackknife)<br />
MMRE 6.159×10 10 1.799 2.139<br />
MdMRE 0.980 0.527 0.322<br />
Pred(25) 26.315% 30.263% 44.736%<br />
ASREI 3532516.8 11.135 4.321<br />
It is noticeable that the deletion of the outlier is more beneficial for the Cobb-Douglas<br />
models than for the linear approach. This is especially true for the NL-CD model.<br />
This result is not in accordance with findings of prior researchers, which suggest that<br />
the Cobb-Douglas model is very stable with regard to outliers (see, e.g., Pickard et al.,<br />
1999). However, even after dropping observation n. 81 the linear model still<br />
outperforms the other two in terms of the most robust accuracy indicators. So, we can<br />
conclude that the additive model with constant returns is superior.<br />
5. SUMMARY, CONCLUSIONS AND DIRECTIONS FOR FUTURE<br />
RESEARCH<br />
The estimation of software development costs is an important task in the management<br />
of software projects. In most cases the major cost factor is labor. For this reason<br />
estimating development effort is central to the management and control of a software<br />
project. However, these costs are not easy to anticipate. So, a series of models have<br />
been proposed. Some of them are heuristic methods that solely rely on the use of<br />
statistical / machine learning techniques.<br />
However, these models can be complemented with others that incorporate theoretical<br />
assumptions. Some of these systems are based on exponential functions which assume<br />
the existence of decreasing returns to scale while others state that significant scale<br />
economies do exist. Other models are linear systems which postulate that returns to
scale are constant. Nevertheless, most of the research that found variable returns to<br />
scale was developed using heterogeneous datasets, which may originate a better<br />
fitting of nonlinear functions. So, in the present research we tested the accuracy of<br />
two models derived from the Cobb-Douglas production function against a linear<br />
model. We use data from a single organization, which guarantees a better fulfillment<br />
of the ceteris paribus assumption that should be present in the estimation of<br />
econometric models.<br />
Our main results indicate that a linear model with constant returns to scale provides<br />
more accurate estimations than the Cobb-Douglas-derived cost functions. In addition,<br />
we found that Cobb-Douglas models are not stable in the presence of outliers. This<br />
result has practical implications. The most important is that we should be cautious<br />
when using models derived from a dataset containing projects from organizations<br />
which are very different. Software production process heavily depends on immaterial<br />
assets such as engineers abilities and the efficiency of the organizational structure.<br />
These factors are mainly firm-specific.<br />
Another result of our research is that the influence of software development capital on<br />
software costs is very little in our models. This means that either software<br />
development capital is not a relevant cost driver or the proxy for its measurement is<br />
not an accurate one. This is an interesting avenue for future research.<br />
Finally, we must also mention others directions for future research. First, additional<br />
datasets can be obtained and analyzed in order to gain further evidence of the results<br />
of the present paper. Second, and due to the existence of outliers, robust regression<br />
procedures could improve estimation results. In this regard, and having into account<br />
the presence of heteroskedaticity, a quantile regression approach could yield a better<br />
understanding of the behavior of software effort costs.<br />
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IT COMPLEXITY AND COSTS<br />
Marius Daniel MARES 1<br />
Spiru Haret University, Romania<br />
Valerica MARES<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
The direct development of information systems is proved to be a risky en audit report<br />
enterprise if it’s not forgone by activities meant to require a team, and unified technology of<br />
analysis, design, development, implementation, operation and maintenance, aspects that have<br />
to be taken into account when making an information system’s audit. The audit is requested<br />
by the developer or by the beneficiary in order to get that information that give trust in<br />
application, the certitude that the expected results are correct, complete, in the requested<br />
structure and they are obtained in real time.<br />
KEYWORDS: operation and maintenance strategy, emerging organizations, utility and<br />
usability, audit report<br />
INTRODUCTION<br />
The information system is meant to cover all the problems of the economic agent, to<br />
create interactions between components, so that in the information plan a structure is<br />
overlapped on the physical structure of the system attached to the economic agent.<br />
The production flows have correspondents in information flows. Transmitters and<br />
receivers of different levels of processing information are associated to the actors<br />
involved in the processes. The information systems are complex work, completed<br />
during several years, and they need;<br />
• Large funds, very large in some cases;<br />
• Complex and stable teams of analysts, designers, programmers and staff dealing<br />
with testing, implementation and maintenance;<br />
• The setting of objectives;<br />
• The definition of a development, operation and maintenance strategy;<br />
• The acquisition of equipments and tools necessary to make processing,<br />
connections and development of the external flows.<br />
• The competence of the staff in order to correctly and efficiently use the system;<br />
1. IT A CHALLENGE FOR MANAGERS<br />
The complexity of the information systems and their quite long making timescale are<br />
causing a series of problems which have to be taken into account and solved so that,<br />
the expected results are finally got.<br />
1 Correspondence address: Marius Daniel MAREŞ, Spiru Haret University, Faculty of Management,<br />
Finance and Accounting, Bucharest; email: maresdaniel@yahoo.com<br />
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First, during the development cycle of the information system changes occur within<br />
the managerial team of the beneficiary. In case a new managerial team has another<br />
vision upon the agreed indicators on which its decisions are based, changes in<br />
specifications occur, involving modifications of the information system’s structure.<br />
Secondly, the latest information technologies that appear require the ongoing<br />
adaptation of the information systems development team. Changes occur in the<br />
approach of the assistance tools and in the use of the options. Using the latest<br />
resources, a series of components are finally designed. The information system<br />
becomes inhomogeneous in terms of technologies of development.<br />
Thirdly, the development of the company by purchasing new equipments, the<br />
reorganization of the production flow, the transition to the making of new products,<br />
the introduction of the elements of total quality management come to influence the<br />
structure and functions of the information system in terms of quality and amount. The<br />
problem of data acquisition acquires a new dimension when it comes of tools with<br />
programmed command or in case of robotic production lines.<br />
Fourthly, during several years, the team of programmers, web designers, testers and<br />
implementers undergoes itself modifications. Different specialists reunify the team.<br />
All these fluctuations are reflected in the working system, in the quality of<br />
components or stages of the information systems.<br />
Fifthly, the economic environment, the legislation and the dynamics of the processes<br />
of the information society leads to evolutions that have to be reflected in the<br />
information systems. The modifications of some calculation algorithms, the need to<br />
use new coefficients, the appearance of some information exchange between the<br />
company and the public institutions of state also have to be reflected in the<br />
information systems being designed.<br />
All these processes are simultaneously deploying producing combined effects while<br />
the objective initially set the one of making an information system for company’s<br />
management remains unchanged. There are situations in which even the target date<br />
remains unchanged. In case the new requirements lead to a significant increase of the<br />
final product’s complexity – the information management system – to supplement the<br />
resources needed to develop a higher workload the increase of the amount of<br />
investment is required. The increase of workload simultaneously deployed requires<br />
new approaches at the level of conception of the information system.<br />
The goal of a maintenance manager is to employ a management system that optimizes<br />
the use of scarce resources (manpower, equipment, material, and funds) to maintain<br />
the facilities and equipment that are the responsibility of the maintenance<br />
organization. The system should provide for integrated processes giving the manager<br />
control over the maintenance of all facilities and maintainable equipment from<br />
acquisition to disposal. The following lists what the system should do:<br />
• Address all resources involved,<br />
• Maintain maintenance inventory,<br />
• Record and maintain work history,<br />
• Include work tasks and frequencies,<br />
• Accommodate all methods of work accomplishment,<br />
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• Effectively interface and communicate with related and supporting systems<br />
ranging from work generation through work performance and evaluation,<br />
• Support each customer's mission,<br />
• Ensure communication with each customer,<br />
• Provide feedback information for analysis, and<br />
• Reduce costs through effective maintenance planning.<br />
A modern Computerized Maintenance Management Systems (CMMS) meets these<br />
requirements and assists the facilities maintenance manager with work reception,<br />
planning, control, performance, evaluation, and reporting. Such a system will also<br />
maintain historical information for management use. The manager should evaluate<br />
management data requirements and establish electronic data needs prior to acquiring a<br />
system or additions to, or replacement of, an existing system.<br />
2. THE IT DEPENDENCES<br />
An information system has in its structure processing modules such as MO1, MO2,<br />
Mon and data structures as Str1, Str2, and Strm. Their physical configuration is very<br />
varied depending of the used development technique.<br />
The Ann correspondence matrix for modules is constructed.<br />
The element aij = 1 if only the MOi module is called by the MOj module, otherwise<br />
aij=0.<br />
The Bmn matrix is constructed in order to establish the relationship module-data.<br />
The element bij=1 if the Moj module uses the Stri data structure, otherwise bij=0.<br />
The Ann matrix highlights the references between the modules.<br />
The Bmn matrix highlights the references provided by the modules.<br />
The Nrm indicator – the total number of modules references, is marked by the<br />
operation:<br />
n n<br />
Nrm = ∑ ∑<br />
i=<br />
1 j=<br />
1<br />
The Nrd indicator– the total number of data references - is calculated by modules<br />
using the operation:<br />
m n<br />
Nrd = ∑∑<br />
i=<br />
1 j=<br />
1<br />
The complexity of the information system CSI, in Halstead acceptance, is given by the<br />
relation:<br />
CSI = Nrm log2 Nrm + Nrd log2 Nrd<br />
In case that are taken into account the modification that appear during the<br />
development cycle, the process of system execution gets a convergent iterative nature.<br />
Ak iteration includes all the processes that are created between two modifications. As<br />
the process of the information system’s making gets to an end, the convergent nature<br />
targets to fulfil the basic objective, in the same time with the reduction of the effort of<br />
inclusion modifications. For each k iteration k are defined<br />
rm N, k<br />
rd N , respectively CSIk.<br />
b<br />
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a<br />
ij<br />
ij
If it’s calculated:<br />
Δk = CSIk – CSIk-1,<br />
The convergent iterative nature targets that:<br />
� the string Δ1, Δ2 , ... ΔL is a string with finite number of terms<br />
� Δ1 > Δ2> … >ΔL = 0.<br />
A relation between the CO cost of the information system and its complexity is<br />
established as follows;<br />
CO=α βCSI +γCO e ,<br />
where α, β and γ are the estimated coefficients of the model<br />
Between the W productivity of those who elaborate an information system and its<br />
complexity there is a relation as follows:<br />
W= f(CSI)<br />
The relation between complexity and productivity is given by:<br />
W = α e−βCSI +γ<br />
where α, β and γ are estimated coefficients.<br />
Depending on the complexity and the ns number of employees the D making<br />
timescale of an information system is given by;<br />
D = h(CSI, ns)<br />
In function of the system’s complexity and its timescale of making the ns number of<br />
employees is given by the relation:<br />
ns = g(CSI1, D)<br />
In order to keep the same turnkey deadline, if are taken into account the l and L<br />
iterations of the information system’s making process the following levels are<br />
estimated:<br />
and the subtraction:<br />
1<br />
1<br />
ns = g(<br />
CSI , D)<br />
L<br />
n =g(CSD s<br />
1, D)<br />
Δ L1=<br />
L<br />
ns -<br />
Means the increase of the number of employees necessary to set the making of the<br />
information system within the agreed deadline, even though there are everyway<br />
modifications regarding the information system.<br />
1<br />
n s<br />
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3. IT PART OF THE MANAGERIAL STRATEGY<br />
The making of an information system is meant to support the decisional deed at all<br />
levels. The increase of information, its quality, and its getting promptness are strong<br />
arguments to determine a quality leap undertaken by the knowledge-based society.<br />
Based on these reasons, the implementation of an information system must generate<br />
positive effects both for its users and especially for its direct beneficiaries of the<br />
processed information.<br />
In order to obtain this desideratum, within the making process, is needed the<br />
application of all the requirements regarding the management of quality of the<br />
information system. It is also necessary to make the audit of the information system in<br />
order to obtain the guarantee that this one is correctly and completely making the<br />
processing for which it’s been designed, and any data combination, other than the<br />
correct and complete one, is reported and it’s not generating side effects in medium<br />
and long term.<br />
Within the making of audit processes regarding the information systems’<br />
development, it’s necessary to take into account the features of the organization for<br />
which the system is designed and first, the stability of the organization. The<br />
development of the information systems is made in the context of the evolution of<br />
socio-economic environment. No matter their dimension, the dynamics of the changes<br />
within the organization requires the adaptation of development methods of the<br />
information systems to the latest requirements or the appearance of some new<br />
concepts and methods of developing the information systems.<br />
The developing organization, in English emerging organizations, are the organizations<br />
whose constant is the continue attempt of adaptation to fluctuant environments but<br />
they never reach the stability for which they are acting.<br />
This type of organization is very different from the stable ones. Because of the<br />
fundamentally different hypothesis regarding the reality and the development of the<br />
information systems, the processes of making the information systems for stable<br />
organizations, respectively emerging ones are different. In fact, the objectives of the<br />
two processes are contradictory.<br />
The development of the information systems for stable organizations takes into<br />
account the following objectives:<br />
• the economic advantages of a detailed analysis;<br />
• the satisfaction of the users;<br />
• abstract requirements;<br />
• complete specifications and without ambiguity.<br />
The proposed objectives for the development of the information systems designed for<br />
the emerging organizations are:<br />
• the dynamic analysis;<br />
• the negotiation of the dynamic requirements;<br />
• useful but ambiguous and incomplete specifications;<br />
• continue redevelopment.<br />
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For emerging organizations, among the methods used within the development of the<br />
information systems we can find: the conceptual modelling and the evaluation of the<br />
utility and usability. The conceptual modelling at the remaking of system’s<br />
modifications and the evaluations of the usability might be seen as an analysis form in<br />
terms of constant analysis which requires to be applied to the emerging organizations.<br />
The analysis published in the special literature and some of the authors’ researches<br />
prove that within the information systems changes is always necessary, aspect that is<br />
taken into account during the audit of the information systems.<br />
There are two results for a product subjected to an audit. The first case, the<br />
unfavourable one, corresponds to the situation in which the audit process leads to the<br />
conclusion that there are essential differences between the real information system<br />
and the one expected by the user; the information system doesn’t integrally execute<br />
the established processing functions; the reports obtained are only a part of the<br />
established ones; the auditors advise the addition of new modules meant to develop<br />
the planned but unmade processing; the differences that appear are caused by the<br />
incomplete results of the report; it is advised to add modules which bring the reports<br />
at the required level of completeness; the differences refers to the way of indicator’s<br />
calculation; it is recommended to make modifications within the sequences of the<br />
program, which either include all the processing elements or modify the filtration<br />
criteria, or modify the evaluation’s expressions; if there are identified causes on the<br />
main levels of the tree associated to the information system the requirements of<br />
modification demanded in the audit report have a greater importance. In all the cases<br />
the differences are specified and it’s established the necessity to cut them out or<br />
reduce them. The audit doesn’t provide any solution. The audit report doesn’t transfer<br />
credibility and it is in fact the report of observation. It’s not reasonable in this context<br />
to make out an audit report because of the fact the developer has available a document<br />
by which, if he presents garbled information, he hints that the information system has<br />
been audited. If the negative result of the audit is presented, it’s understood that the<br />
audit was positive. The developer of the information system won’t be held liable for<br />
not detailing if not requested in advance. After the making of the modifications, in<br />
software and databases, the audit process is resumed and the observation report turns<br />
into an audit one, a certificate is delivered by the auditor by which the qualities of the<br />
information system are recognized and the users have to trust the audited system.<br />
In the second case, the favourable one, the differences between what was expected by<br />
the users and what was made are insignificant or favourable to product’s quality<br />
enhancement. The audit report is a complex work developed by the audit team’s<br />
members. Like a book structured on chapters, it has a tree structure. Every node of the<br />
tree has information with a standard structure:<br />
• objective;<br />
• inputs, outputs,<br />
• content;<br />
• processing;<br />
• recording of the analysis’ result;<br />
• evaluation of process;<br />
• conclusions;<br />
• competence.<br />
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The aggregations are made from the base to the root of the tree structure. The audit<br />
report is a work of maximum detail. The presented approach clearly shows the<br />
difference between other activities and the audit. It’s clearly seen that the audit has an<br />
analysis as result, a series of evaluations and the exact prominence of the differences<br />
between the information system requested by the user and depicted in the agreed<br />
specifications, on the one hand, and the information system ready to be delivered, by<br />
the other hand.<br />
The audit is meant to transfer certitude and trust within the information system by the<br />
positive result established by an auditing team which belongs to a consulting agency<br />
having the authority provided by previously made audits. The management of the<br />
audit has specific particularities mainly related to auditor’s capacity of learning<br />
procedures and especially to unitary applies these procedures.<br />
Any spontaneous or elation display brings about differences of approach which are<br />
turned into contradictions in choosing the patterns, in collecting data. The<br />
comparability of data is so reduced and the data aggregation is reduced up to the<br />
impossibility of operating with datasets which regard components of a same class.<br />
The audit of an information system involves an important amount of work because the<br />
whole process followed by the team is revised and even more, because the<br />
specifications along with the sources on which they are based enter the analysis. If the<br />
audit result is reliable the immediate effect of the information system’s audit is its<br />
trustful use. If it passed the audit test, the information systems development team has<br />
favourable conditions to develop new information systems much more complex.<br />
In case the information system didn’t pass the audit test, serious problem appear in<br />
terms of management of the software company which develops such a system. Major<br />
changes must appear at the level of management and development teams. Technique<br />
of analysis, projection, program testing, implementation, maintenance, efficiency has<br />
to be taken up in order to generate compatibles development flows.<br />
The audit involves an active way of product correction, release versions in current use<br />
if it’s requested. The audit is needed for all the information systems. It’s obvious that<br />
the company covers all the damages when an information system that hasn’t been<br />
audited generates errors. The lack of the audit means assumed risks. The risks means<br />
costs and they have to be covered by the one who assumed them at a level which<br />
exceeds the rational limits.<br />
The audit is an optional process up to a point. In terms of public software in which the<br />
citizen develops processes of treatment in self-interest, the audit is a must, becoming<br />
compulsory. The compulsoriness is a measure of self-preservation of the company<br />
which uses public software to deploy services for citizens with own resources to<br />
satisfy the requirements of the citizens. This kind of organization doesn’t have to take<br />
risks. The audit means transfer of trust and maintenance of risks at bearable levels<br />
ensuring a good level of profitability.<br />
Given the conditions of the information society the connection to a new information<br />
systems architecture of audited information systems is effective if only the systems<br />
~ 700 ~
which connects is audited and the result of the audit allows the connection. Otherwise,<br />
the effects of multiple drives at the level of risks become incontrollable.<br />
CONCLUSIONS<br />
A) The information society develops a new attitude unto the audit. It is considered to<br />
be an essential element for the construction of public utility complex software<br />
architectures in continuous regime and without any assistance. The creation of the<br />
civilization based on information interactively obtained starts from the idea of<br />
completeness and correctness of the information got. In order to have low costs, the<br />
information systems have to use the resources at the lowest levels. Only within the<br />
auditing process results if the way to minimize costs has been followed. There are<br />
arguments, there are measurements and the entire undertaking must be sustained by<br />
efficiency calculations.<br />
B) The audit must be seen as a supplementary investment. The software company that<br />
develops an information system and deploys audit procedures creates the selfprotection<br />
premises against the risks that generates expenses that exceed the<br />
company’s potential.<br />
C) A new attitude unto the information system audit is considered something else<br />
than a required activity or a necessary evil, turning itself into the only way whereby<br />
real warranties are obtained upon the quality of the information system, warranties<br />
that the users perceive in time.<br />
Once implemented, an information system must be regularly audited to make sure it<br />
meets all the requirements at the highest level of efficiency and effectiveness. The<br />
growth of the organization and of the business amount, the changes in business<br />
environment, the changes in technologies and the latest information requirements all<br />
these are placing an increasing requirement upon the existing information system and<br />
they are often requiring the modification or the extension of the information system.<br />
Examples of a running information system’s audit:<br />
• the re-evaluation of the information requirements;<br />
• the verification of the proposed modifications to the existing basic projections;<br />
• the investigation of the latest technologies’ opportunity;<br />
• the enhancement of the operating procedures.<br />
In practice it’s has been observed the need to audit an information system once every<br />
three years or each time the appeared changes require it.<br />
REFERENCES<br />
Ash JS, Sittig DF, Dykstra R, Campbell E, Guappone K.(2009) “The unintended<br />
consequences of computerized provider order entry: findings from a mixed methods<br />
exploration”. Int J Med Inform ./ Apr 2009;78 Suppl 1:S69-76.<br />
Bias RG, Mayhew DJ. (2005) Cost-Justifying Usability: An Update for the Internet Age. San<br />
Francisco, CA: Morgan Kaufman.<br />
Conner J. (2006) Managing at the Speed of Change. New York: Random House<br />
Schaffer E. (2004) Institutionalization of Usability: A Step-By-Step Guide. Boston: Addison-<br />
Wesley<br />
http://www.sfia.org.uk<br />
~ 701 ~
PS15 XBRL<br />
Chairperson<br />
Sorin BRICIU, 1 Decembrie 1918 University,<br />
Alba Iulia, Romania<br />
THE EFFICIENCY OF SMALL AND MEDIUM<br />
ENTERPRISES BY THE IMPLEMENTATION<br />
OF WEB-BASED ACCOUNTING<br />
Sorin BRICIU, Florin MIHAI, Constantin GROZA<br />
13 YEARS AFTER: AN XBRL LITERATURE<br />
REVIEW AND OVERVIEW<br />
Claudia URDARI, Adriana TIRON TUDOR<br />
THE INFLUENCE OF FIRM-SPECIFIC<br />
CHARACTERISTICS ON THE EXTENT<br />
OF VOLUNTARY DISCLOSURE IN XBRL:<br />
AN EMPIRICAL ANALYSIS OF SEC FILINGS<br />
Devrimi KAYA<br />
~ 702 ~
THE EFFICIENCY OF SMALL AND MEDIUM<br />
ENTERPRISES BY THE IMPLEMENTATION<br />
OF WEB-BASED ACCOUNTING<br />
Sorin BRICIU 1<br />
1 Decembrie 1918 University, Alba Iulia, Romania<br />
Florin MIHAI<br />
Bucharest Academy of Economic Studies, Romania<br />
Constantin GROZA<br />
1 Decembrie 1918 University, Alba Iulia, Romania<br />
ABSTRACT<br />
The modernization of small and medium enterprises represents a priority, considering the<br />
role they have in the economic development. A way to achieve this modernization would be<br />
the implementation of an accounting system based on web technology. The present article<br />
presents the main characteristics of a web-based accounting system, how it should work and<br />
which would be the factors that influence the implementation of the web-based accounting<br />
with the SMEs. Web-based accounting by the implementation of XBRL as the method of<br />
reporting the main accounting information could be a way to promote accounting standards<br />
within the SMEs. Through web-based accounting, the SMEs could implement solutions for<br />
cost reduction, increase of efficiency and facile access to accounting information for external<br />
users like suppliers, customers etc. and for internal users: accountants, managers and other<br />
interested users.<br />
KEYWORDS: Web-based Accounting, Small and Medium Enterprises (SMEs), Web<br />
Technology, XML, XBRL.<br />
INTRODUCTION<br />
The accounting software for microcomputers has had a dynamic evolution,<br />
considering its relatively short history (Deshmukh, 2006). From simple accounting<br />
applications (software) based on a single computer (CBAS), which could work<br />
independently, with a reduced consume of hardware (single user, low memory, and a<br />
relatively low capacity processor) the shift was quick to relational database systems<br />
available in the system client-server, with several users and even to object-oriented<br />
databases. These, in their turn, were quickly overtaken by the apparition of other<br />
applications based on complex technologies and informational systems of<br />
communications. In this context, it was considered that the accounting system of an<br />
organization would follow the development trend imposed by the IT technologies at a<br />
certain point (Pushkar et al., 2007).<br />
1<br />
Correspondence address: Sorin BRICIU, „1 Decembrie 1918” University of Alba Iulia;<br />
email: sbriciu@yahoo.com<br />
~ 703 ~
Web-based applications in accounting are considere as one of the most important<br />
innovations brought to this function of the business (Deshmukh, 2006).<br />
For the presentation part at the level of user interface, web-based applications use<br />
simple systems (Internet browsers). The application part and the database require a<br />
complex relational system facilitated by the development of communication<br />
techniques via Internet.<br />
A web-based accounting system, unlike the CBAS, is unitary as a function but<br />
distributed in space, from the point of view of the inclusion area, of database and<br />
hardware support. This is because it is based on the use of communication<br />
technologies and the resources of some servers and less on the resources of the users’<br />
computers. The technology used is based on XML with multiple data (content)<br />
storage and transmittal capacity. What made these systems really strong and<br />
unanimously accepted is their capacity to storage and transmit any type of<br />
information, be it a picture, film, drawing, complex mathematical calculations, but<br />
especially digits.<br />
Accounting is one of the business functions that had developed faster in the area of<br />
web-based informatics systems, as compared to other functions. The capacity of web<br />
technologies to storage and transmit accounting information in real time, this is in the<br />
moment the described event is produced or appears, turns accounting into an active<br />
function, not a “post-active” one, being a function even more integrated into the<br />
operational management (Deshmukh, 2006).<br />
SMEs, as the most dynamic and innovative branch of business, could not remain<br />
expectative to this informational explosion. Because from reasons of financial<br />
restraint they could not always afford the buy or build these systems (in house) like<br />
ERP, which is considered as the most complex accounting application at the time<br />
being, it was the turn of the developers of accounting applications to meet the needs<br />
of the SMEs. The sellers of ERP software like SAP, Oracle and Microsoft, offer now<br />
enterprise software at a low price.<br />
If from the point of view of the cost the problem was more or less solved, from the<br />
point of view of efficiency and use of these software things are still at the beginning.<br />
It is claimed that within SMEs only 10-20% of the capacities of an accounting<br />
software are being used. (Pederiva, 2010). The reasons of this reduced use of capacity<br />
of accounting software within the SMEs are multiple, and we mention as possible<br />
causes: a construction which is too sophisticated and not adapted to the needs of the<br />
SMEs and the lack of education and training of the users of such systems.<br />
There are two main directions for accounting in this sector. On the one side the<br />
facility of collecting and processing accounting information and on the other side the<br />
integration of accounting in the business function and transmittal of accounting<br />
information in due time to the users. In other words this is the development of<br />
accounting itself and on the other side the perfecting of reports and integration of<br />
accounting in business.<br />
Both can be done in real time with the help of web-based technology. In the following<br />
we shall present the main characteristics of web-based accounting as well as the<br />
factors that could influence the adoption of web-based accounting by the SMEs.<br />
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1. LITERATURE REVIEW<br />
1.1. Tendencies in the research and modernization of SME accounting<br />
Regarding the present tendencies of modernization of SME accounting, one may<br />
notice a constant preoccupation of the researchers and responsible factors for policies<br />
in this area, to find ways and means to stimulate the implementation of the accounting<br />
system adapted to the international requirements and practices (Briciu et al., (2009). A<br />
very important help came from the discoveries in the IT. As it is well known, the big<br />
issue SMEs are confronted with comes from the lack or financial and human<br />
resources for the implementation of sophisticated and complex accounting systems<br />
like ERP. This has often led to the outsourcing of accounting by the SMEs. The<br />
solution could come either by creating simple and cheap solutions to satisfy the<br />
implementation requirements of accounting systems, or by sharing the costs of<br />
programs like ERP among several SMEs.<br />
There are few studies focused on the introduction of new informational technologies<br />
within SMEs. This is so because there are few data to be analyzed due to the improper<br />
system of reporting or to the limited resources SMEs have for the implementation of<br />
such technologies, or due to the pioneering character and a very recent history of these<br />
services. It is worth though mentioning the studies in the field of the management of<br />
implementation of IT systems within the SMEs (Suraweera et al., 2006), the use of<br />
the Beta accounting index for risk determination at non-listed enterprises (Pierre et<br />
al., 2006) or the analysis of the relation between SME performance and the adoption<br />
of (Accounting Information System) (Ismail et al., 2005). As we have mentioned<br />
before, the system of web-based accounting accelerated the implementation of some<br />
modern systems of collecting, processing and transmittal of accounting information to<br />
the SMEs as well. This has determined the apparition of some studies in this area. It is<br />
worth mentioning in this respect the work “Digital Accounting –The Effect of Internet<br />
and ERP on Accounting” by Ashutosh Deshmukh as a landmark work in the field of<br />
using web-based technology in accounting.<br />
In the above mentioned work it is claimed that: ”Accounting has evolved together<br />
with information technology. The distinction between the message of accounting and<br />
the environment of information technology is blurring even faster.” (Deshmukh,<br />
2006) paradoxically to the idea of accounting as a science less developed in the sense<br />
that it is reactive and reacts only to the evolutions in business and information<br />
technology. True or not, we notice that the development of accounting information is<br />
accompanied by the rapid development of information technology (Zhou, 2010).<br />
That is exactly why in our days we assist to an explosion of accounting information<br />
and the development of the International Accounting System (AIS) as well as of the<br />
research in this area. Of course, there are quite a few researchers who consider that the<br />
use of accounting software as compared to the manual accounting can only bring<br />
benefits for the SMEs because it would be easy to use (Banzacar, 2010). Considered<br />
from the point of view of the accounting praxis, things do not look that simple. Even<br />
professional accountants complain that the accounting software is too sophisticated<br />
and difficult to apply. It is claimed that in average only 10-20% of the capabilities of<br />
an accounting software are being used in the SMEs (Pederiva, 2010).<br />
~ 705 ~
Some studies have focused on the analysis of the possibilities of integrating<br />
accounting software into business (Schubert, 2005). The author tries to accredit the<br />
idea of creating ERP software for SMEs. At the end of the study the same author<br />
reaches the conclusion that the implementation of ERP systems depends though<br />
largely on the size of the company.<br />
There are many opinions on the subject in the specialized literature and in the<br />
specialized forums: http://www.focus.com/profiles/tom-coyes/public/. It is claimed<br />
this way that integration can not be achieved by the use of a single accounting<br />
software and that other applications are needed to facilitate this integration. In this<br />
respect the so-called MiniERP is proposed as a variant of ERP for SMEs (see<br />
http://www.devantiscapital.com).<br />
We are not against such approaches but we consider that one must take into<br />
consideration the characteristics of this sector of economy which functions with<br />
limited resources. We consider that an approach of this sector from the point of view<br />
of the ERP is not possible, at least at the present stage of interconnectivity of the<br />
SMEs among them and in the relation to the institutions of the state. For these it<br />
would be needed, in our opinion, to have simple systems to cover first that what<br />
businesses require and once interconnectivity, resources and the degree of education<br />
increase, applications should be extended even to the ERP.<br />
Like other authors have already mentioned, the accounting system is moving to an<br />
area where the communication language will be XML. The strong point of this<br />
language is that it can be adapted to understand various forms of the explained object<br />
by using reference standards (Bonsón et al., 2009), (Murthy et al., 2004) mention that<br />
“the future accounting systems are susceptible of being constructed using XML<br />
technologies that incorporate a close (internal) set of XML tags for purposes of<br />
internal reports as well as open tags for extensible languages (XBRL) used for the<br />
external reports of the business.”<br />
The idea is to create a set of accounting principles and reporting methods to allow the<br />
comparison of corporative financial data and reports, even if these come from<br />
different countries, where different accounting principles are being used. How is this<br />
done? By using an adequate language which is similar to the translation from one<br />
language to another. It is practically the same thing as running a laboratory analysis.<br />
In the analysis laboratory one element called standard is introduced and the other<br />
studied elements are compared to it. The languages used in the standards of business<br />
accounting like XBRL and ebXML or UBL (Mihai, et al., 2007) facilitate the<br />
comparison and access of these standards, used by companies to exchange<br />
information (Bergeron, 2003). The problem was easy to solve regarding the access to<br />
the standards by using these languages. In this respect, as we have shown, various<br />
classifications have been created, the so-called taxonomy that can be accessed from<br />
applications, which are a map of the logical structure of information, helps these<br />
standards to be used in a uniform way. A second important point is that these<br />
languages are used to communicate and read information with the help of a computer<br />
or a browser. From this point of view it is worth mentioning that Microsoft was the<br />
first company to issue financial reports in the XBRL format and the most recent<br />
application of XBRL is to simplify the processing of information from the area of<br />
government activity like taxation. Practically, several countries, especially those<br />
~ 706 ~
included in the category of developed countries have started to accept financial<br />
reports to calculate taxes in iXBRL format (extensible business language of line<br />
reporting). We mention here countries like the USA, Canada, and most recently<br />
England, where all companies, starting with 2010, will have to prepare reports in<br />
electronic iXBRL format: (Callaghan and Nehmer, 2009), (Gray et al., 2009). This is<br />
only one area. Let us not forget that numerous bodies for the regulation of the<br />
investment activity requested that reports of listed corporations to be in XBRL format<br />
(SEC). What makes XBRL reports to be attractive is the fact that they are more<br />
accurate and there are smaller chances for them to be wrong. In another respect,<br />
XBRL reports are easier to access and practically they can be accessed at any hour,<br />
day or night. Therefore, it is a reporting method with a reduced consume of paper and<br />
toner, by accessing the data base instead of the paper supported documents. The<br />
challenge now is to use a “web-based accounting system” which can update<br />
automatically accounting data and norms. In other words, using XBRL and other<br />
reporting languages one can practically access directly (in real time) any document<br />
contained by the databases.<br />
There are several ways to describe accounting by using web services or an XMLbased<br />
accounting system. We named here the Web-Based Accounting – a term e<br />
consider to be the most adequate to describe the use of web services in accounting.<br />
We have not found so far an explicit definition of web-based accounting. Relying<br />
though on what other authors have mentioned in this respect and on the definition<br />
given by Wikipedia (Web Dictionary), for web-based services, we have reached to the<br />
conclusion that the most adequate definition of web-based accounting is that of<br />
accounting software that registers, stores and processes accounting transactions, using<br />
XML as a technology for data transmittal and storage, HTTP as primary<br />
communication protocol, and the presentation of information in HTML format.<br />
Web-based accounting systems, destined for the SMEs, could register a new evolution<br />
with the perfecting of the “cloud computing” technologies which are based on<br />
resource sharing via Internet, and the software and information circulated are supplied<br />
by other devices by request. Though, from a conceptual point of view, the basic<br />
concept related to “cloud computing” is not a recent one, as John McCarthy<br />
mentioned in 1961 (in a speech held to celebrate the MIT centenary) that<br />
“computation may someday be organized as a public utility”. From a technical point<br />
of view, the software for the implementation of “cloud computing” technology has<br />
developed slower and at high costs. Of course, the main beneficiaries of this<br />
technology are enterprises and the government. In order to improve the process at the<br />
level of international organizations and states there are resources allocated to develop<br />
these technologies. One of these projects is e-billing and e-public Procurement<br />
launched by the European Commission in 2007. The two main objectives of the<br />
project are “to contribute to the use of electronic billing in the public sector, in<br />
conformity with the objectives from the action plan i2010 e-government and the<br />
action plan e-Procurement. A second objective is to contribute to the creation of a<br />
European frame of electronic billing (IAE), which is under the responsibility of the<br />
experts group concerning e-billing "(www.epractice.eu / cazuri / ePRIOR). The<br />
solutions developed within the European Commission will allow the suppliers who<br />
use web-based services to upload and download XML messages: catalogues, orders,<br />
invoices, disputes, credit notes etc.<br />
~ 707 ~
1.2 The relation between computerized accounting and web-based technology<br />
There are quite a few researchers or software developers who consider that there are<br />
no differences between accounting software and web-based accounting. It is<br />
considered that both systems do the same thing, the difference coming from the<br />
preferred work mode: local or web-based. This because in the specialist literature the<br />
analysis of the evolution of accounting software is done from the perspective of the<br />
evolution in hardware and less regarding the evolution of the programming languages<br />
(Deshmukh, 2006). We do not deny the existence of a correlation between the<br />
development (history) of accounting software and the evolution concerning the<br />
computer world (hardware) but we consider that more attention should be paid to the<br />
studying of accounting software correlated to that of the programming languages<br />
when we analyze the web-based accounting.<br />
If we observe well, there is no great difference between these two terms, both have a<br />
common term, that of program or programming, the difference lying in the fact that<br />
the first expresses calculations that can be done by a computer and the second<br />
supplies instructions and tells a computer what it has to do. In other words, the<br />
language creates the frame and the software populates this frame. The software can be<br />
regarded as a written program, using the programming language, used by the<br />
computer to be able to work. There is a great overlap between these two terms.<br />
Neither can work without the support of the other just as the software can not work<br />
without the hardware. In particularly, the accounting software is “a software which<br />
deals with the accounting functions and the financial part” (Deshmukh, 2006).<br />
One may notice that programming languages destined to be used at the beginning of<br />
the computer era mainly for writing accounting programs like ABLE, Dexterity and<br />
even COBOL, Assembler, FORTRAN, RPG for mainframe or Basic, Pascal or dBase<br />
II for PC are no longer in use today, being gradually replaced by more flexible<br />
languages used mainly to deal with programming in the system Client-Server, Local<br />
Area Networks, Wide Area Networks.<br />
According to some studies it was noticed that the most popular programming<br />
languages used today would be (chart 1): C, Java, C++, JavaScript, Pyton, etc.<br />
Chart 1. The most popular programming languages used today<br />
(Source: http://langpop.com/)<br />
~ 708 ~
It was interesting to discover which are the most recent programming languages used<br />
to write accounting software. We have not found a source like the above mentioned<br />
but we created a table based on what we found on the site:<br />
http://www.sourcecodeonline.com/code/accounting_system.html<br />
The result is reflected in the chart 2.<br />
CFML<br />
Java<br />
CGI/PERL<br />
ASP.net<br />
PHP<br />
C/C++<br />
Delphi<br />
Chart 2. Accounting software<br />
Accounting software<br />
0 5 10 15 20 25 30 35<br />
Users<br />
According to the data gathered we notice that the most used for writing accounting<br />
programs are PHP, Delphi, CGI/PERL, ASP.NET and C/C++. Generally, the<br />
developers of big accounting programs do not use a single programming language but<br />
several ones, according to what they want to develop. Many accounting software<br />
developers do not explicitly mention the programming language used, because they<br />
use several programming languages to write the soft. QuickBooks for instance, a very<br />
popular accounting software in North America could use C++ for the interface, SQL<br />
for the database, and other languages including XML for some reports. The<br />
interesting part of the issue is that all that overlapping between the programming<br />
language used and the developed software could have led to the apparition of a new<br />
information technology that has the capacity to process, store and transmit<br />
information themselves.<br />
Il looks like everything started with the apparition of the Internet and web-based<br />
technologies. Between the client and the system of data storage (server) there is now a<br />
new server, the so-called Web Server which lies between the application, client and<br />
database. From the architecture client-server the accounting software passed rapidly to<br />
the architecture browser-server, or in other words a client server web architecture. In<br />
this architecture the data stored via Internet browser can be accessed and managed<br />
through applications stored in the same browser. It is most interesting that both<br />
accounting applications (software) and the interrogation of the databases can be used<br />
by several users without having to install the application for each client.<br />
For small and medium enterprises the sharing of the cost of accounting applications<br />
and of data base management as well as their accessing from anywhere and at anytime<br />
is a dream largely come true, as applications become more and more developed. Even<br />
the ERP application can be now, thanks to the web-based technology, shared among<br />
several clients which means a lot especially for small businesses.<br />
~ 709 ~
What does that mean for the accounting software? A lot. This is so also because<br />
nowadays there are languages that incorporate both software and technology (XML)<br />
which have changed fundamentally the work and the understanding of the<br />
informational phenomenon.<br />
Customized accounting applications for a single user have become obsolete and many<br />
users orientate themselves already to the web-based technologies. This can be noticed<br />
also from the analysis of the programming languages used for writing accounting<br />
applications (see fig. 1) where languages that are used to write web-based accounting<br />
applications (PHP) have outrun other traditional languages C/C++ or Visual Basic.<br />
The idea is to serve as much as possible the business needs of the served companies,<br />
developing the so-called integrated accounting software. Our opinion is that very soon<br />
even small companies will be able to use ERP type packages by sharing costs in web<br />
system using technologies of the “cloud computing” type.<br />
The novelty for SMEs will be that the automation of many processes of data<br />
gathering, and the introduction only one time of data into the system will be realized<br />
by gathering data from a single source, like those realized through bank accounts, or<br />
the creation of documents that could be read by computers by using a RDDL-type<br />
language (Resource Directory Description Language).<br />
2. WORK METHODOLOGY AND ANALYSYS RESULTS<br />
2.1 The research method and the questions we answer<br />
Like some researchers have already mentioned, accounting systems are susceptible of<br />
being built with the use of XML technologies (Murthy and Groomer, 2004). The<br />
objectives of this study were to answer the following questions: Why was it necessary<br />
for this new technology to be applied for SME accounting? What is the novelty it<br />
brings and how do such systems work? Which are the factors that could influence the<br />
adoption of web-based accounting?<br />
In order to answer the first question we relied on the results of researches conducted<br />
in the field, and especially on the historical analysis and the evolution of accounting<br />
software and web-based technology. We wanted to underline and explain how<br />
accounting software, including the web-based technology, can influence research and,<br />
why not, the development of SME accounting.<br />
For the second question we tried to show how such a system should work within a<br />
SME. Finally, the answer to the third question is based on the result of a study relying<br />
on a questionnaire conducted at 48 SMEs from Canada. This questionnaire was<br />
destined first to the responsible factors for the implementation of accounting systems<br />
(managers, owners and accountants of SMEs) as well as the users of accounting<br />
information (managers, owners, investors). Due to the characteristics and complexity<br />
of such an interview, we do not deny that the answers and cooperation at some of the<br />
questions could be influenced by subjective factors. That is also why the<br />
generalization of the results could have certain limits.<br />
~ 710 ~
2.2 Why are web-based applications and web accounting needed?<br />
An answer to this question, although it seems simple at a first glance, requires actually<br />
a series of other questions we have to answer: what is a web application, what is web<br />
accounting? And finally what is XBRL? We answered part of these questions when<br />
we spoke about theoretical aspects in the modernization of SME accounting by using<br />
web-based technology (Groza et al., 2010). In the present study we shall focus on the<br />
study of web-based accounting as compared to the traditional accounting software.<br />
The popularity of web-based applications is due to their capacity of being maintained<br />
and accessed without having to install them on a computer. We mention here as<br />
applications: online retail sales, online tendering, web-mail, wikis and many others,<br />
and nowadays one can speak also about systems of internet operations and web<br />
applications framework which will determine without any doubt an informational<br />
explosion. In a recent study concerning XBRL, (Haley, 2009) underlined that in the<br />
years to come accountants will have to become more familiarized with accounting<br />
software as well as with the use of taxonomies, tags, web documents (instance<br />
documents) and their validation. This is a surprising statement because not long ago<br />
accountants were considered persons who register accounting events being assisted<br />
only by certain machines to ease their calculation work.<br />
Regarded from the perspective of today, the statement is not surprising at all. Can we<br />
still speak today of accountants who do not know how to use a computer or the<br />
accounting software? Certainly not. The computer has become a commodity, not only<br />
as a new way of working and doing business, but also as a way of life in our homes.<br />
When we speak about computers we also speak about the internet. It is very difficult<br />
to imagine today a computer without a connection to the internet. And if we came to<br />
the internet we certainly think that not only the computer uses the internet. The<br />
telephone, TV set, complex installations in the laboratory or production, robots and<br />
other instruments also use the internet as a way of transmittal and their manipulation.<br />
The accounting information is maybe one of the most sensitive because we are<br />
speaking about information that express first of all money. To transmit and<br />
manipulate it through the internet has become today as popular as any other<br />
technology. Since many business functions like marketing and sales went online,<br />
accounting also had to find its online sense. Like we have already shown on other<br />
occasions, the registration of the accounting event after it has been produced; this is<br />
the post active function, passed to the proactive function, the registration of the<br />
accounting information the moment it is produced and its communication in due time<br />
in order to have an operative management. And what could make it more operative,<br />
efficient and complete than web-based accounting.<br />
Of course, web-based accounting has numerous advantages in financial and<br />
managerial reporting, like the elimination of data reintroduction in order to be<br />
presented in different electronic environments, their easy accessibility by different<br />
users: banks, government, investors, employees, auditors and maybe the relatively<br />
reduces consume of time and resources for the manipulation of accounting<br />
information, this to name only a few examples. And because the great majority of<br />
accounting information circulates already translated into electronic languages, there is<br />
only a small step to have all the accounting system transposed into an electronic<br />
language (Web). This is why we can say that the web-based accounting system<br />
~ 711 ~
appeared as a necessity to modernize accounting evidence and to integrate it as a<br />
business function (Groza et al., 2010). The difficult problem of web-based accounting<br />
that determines also a still reduced rhythm of implementation is the high risk or<br />
vulnerability of the security and data protection systems on the internet (Collins,<br />
2010). And if for the part of reporting this is not a big issue, for the part of data base<br />
there are a lot of reluctance and reserve. For how long? We believe that the problem<br />
will we arranged soon and the security of databases will be solved. Web-based<br />
accounting is looking more and more, as it continues developing, like ERP, meaning<br />
that very soon it might be possible for SMEs to have access to this type of software.<br />
WE shall present some similarities between an ERP system and web-based<br />
accounting. Generally, when speaking about ERP, the specialist literature analyses it<br />
from the perspective of some characteristics like: integration, visibility and control,<br />
centralization, flexibility and standardization of information and processes<br />
(Seethmaraju, 2008).<br />
A first remark to this is that if ERP is considered to be one of the most important<br />
innovations in business (Davenport, 2000), we consider that the web system may be<br />
the most important innovation in informatics for accounting. If ERP focus is in the<br />
integration of activities from different functions and hierarchical levels of an<br />
organization (Markus and Tanis, 2000), web-based accounting focus can be<br />
considered, the integration and accessing of information from anywhere and at<br />
anytime, as location and time. For SMEs, the adoption of ERP is a critical decision<br />
considering the financial restrictions but also for the provocations resulted from the<br />
adoption of this system by other companies (Seethamaraju, 2008). The adoption of<br />
web-based accounting on the other side by the SMEs, just like the ERP is determined<br />
by the necessity of improving operative management by increasing the quantity,<br />
quality and accessibility in real time of accounting information (Raymond et al.,<br />
2004). In an article published in ASA Research, J. Carlton Collins finds at least 10<br />
advantages for the adoption of web-based accounting and only 5 disadvantages of<br />
adopting web-based accounting (htttp://www.asaresearch.com/articles/<br />
web_accounting). And if the great majority of the last is based on operation and<br />
security issues of the databases, we consider that the future will demonstrate that this<br />
system is in itself just like the internet will be for the future. The same author claims<br />
that this system “will change dramatically the face of accounting ... opening the gates<br />
for a wide range of changes.” How long and how far it remains to be seen. It is clear<br />
that the system has started to be implemented by the big producers of ERP software<br />
and it is certain that soon we will see that kind of software implemented in web<br />
technology.<br />
2.3 A schematic presentation of web-based accounting<br />
The case presented here is an academic project of explanation of web-based<br />
accounting. For this study we shall present a schematic diagram of applications of<br />
web-based accounting for small and medium enterprises. We mention that the system<br />
is conceived to take over automatically some data via internet. All communication is<br />
planned to be done via internet using any instrument which can display a web page.<br />
The system can use Internet Explorer, Mozilla, Netscape or other browsers. In figure<br />
1 we present a first work image of web-based accounting.<br />
~ 712 ~
Figure 1. Web based accounting architecture<br />
In this example, the browser is any device that does not host the software of the<br />
accounting system or the database, but can display data by request. The server is the<br />
one that stores all applications (software), of communication and of databases. Using<br />
a PHP language and transporting data in XML format databases are created which are<br />
accessed via internet. This system allows the user to access through the internet all<br />
instruments of accounting and reporting. We presented the accounting web<br />
application for small and medium enterprises in two stages and six modules. We shall<br />
start with the module of data gathering. In this first stage, data are collected from the<br />
source and get to the database through the intermediary of the browser using the<br />
internet. One must mention that under certain circumstances the browser might store<br />
data also offline, and these will enter the system as soon as it will have an internet<br />
connection available. In this case the browser must have the capacity to access a local<br />
server (MySQL platform).<br />
Considering that all operations are transmitted and operated via internet, a series of<br />
information can enter the system automatically like operations done through the bank<br />
or credit card like VISA or MasterCard. One may also consider that the account<br />
statements from the bank to be taken automatically into the system.<br />
Figure 2 presents as a scheme this procedure of automatic overtaken of data.<br />
BANK<br />
DATA<br />
Data<br />
gathering<br />
Figure 2. Automatic data acquisition process<br />
ACCESS<br />
DATA<br />
ACCESS<br />
DATA<br />
Spreadsheet Internal Reports<br />
~ 713 ~<br />
WEB<br />
SERVER<br />
.csv<br />
format<br />
Browser<br />
Data Base<br />
MAP<br />
DATA<br />
AccountingData
The data overtaken from the banking system following the various transactions done<br />
through the intermediary of the account notes cards or with a check and in cash are<br />
accessed and transferred in the system in csv format. The next step is to account<br />
electronically, using the accounting plan and than the data are processed and<br />
electronically registered into the database. As we may notice, the only activity is that<br />
of counting which is also largely automatic, because the system retains an important<br />
part of the history of transactions and each time a transaction repeats itself the system<br />
takes the account from the previous counting.<br />
After the data have been taken into the system there comes the registry into the log<br />
book and general ledger for the editing of accounting reports. The activity of reporting<br />
and accessing the accounting information can be adapted to the management<br />
requirements and to the other users who solicit this kind of information: banks,<br />
shareholders and investors, governmental agencies. Because the editing of accounting<br />
reports and information is in electronic format the transmittal of information to these<br />
can be done also in electronic format being more efficient from the point of view of<br />
the speed of processing and transmitting, not to mention the reduced consume of<br />
paper, toner and time of collecting and processing these information. The system<br />
emphasizes the data collected from banks because they are more reliable, complete<br />
and correct and the possibility of errors is quite reduced. In the same time,<br />
information are not reintroduced into the system, being processed directly from the<br />
source a single time. Figure 3 shows the way this system works using also the XBRL -<br />
GL scheme.<br />
Internal<br />
Reports<br />
Figure 3. The way the system works using the XBRL<br />
Web<br />
Server<br />
Browser<br />
XBRL Document<br />
Report Display :.<br />
pdf,.html,xsl<br />
Internal reports are produced by the accounting software according to the collected<br />
and processed accounting data. We have to mention that not al reports are public and<br />
therefore they do not have to be published. Many of them are used strictly inside to<br />
satisfy the needs of the management.<br />
~ 714 ~<br />
XBRL - GL<br />
Scheme<br />
XML<br />
Document
From this module data are translated and transported to the module XML documents<br />
by the use of software written in PHP, using a browser that can be any instrument able<br />
to display a web page. The conversion of reports into XML and their preparation to be<br />
validated and transported to the system take place here. In this module there is the<br />
first validation operation to see if the instance document is well formed, this is if it is<br />
well written from the point of view of the XML language and if there are no errors. In<br />
the next module, XBRL-GL, documents will be checked with the scheme to see if the<br />
document corresponds to the XBRL-GL standard, where the operation of validation of<br />
the XML document takes place and it is deposited at the web server via internet.<br />
In the second stage we ask for the accounting reports from the module web server,<br />
which will validate the XBRL-GL module, if the data are concordant with the<br />
schemes done according to accounting standards, these are translated using the XBRL<br />
language and are transformed into XBRL reports and then displayed in various<br />
formats by request like pdf, xslt or html. From here user can ask for any published<br />
information, being sure that these correspond to the accounting standards. Each<br />
module will have web services which supply data, by request, about the information<br />
processed and executed in that module. We have to mention that once the data reach<br />
this module, it can be accessed from anywhere and at anytime because it is accessible<br />
via the internet 24 hours a day.<br />
2.4 Factors that could influence the adoption of web-based services by the SMEs<br />
In a recent study in Canada, done on a sample group of 48 SMEs using questionnaires<br />
with predefined questions and answers we noticed the following: We found only one<br />
organization (SME) that uses web-based accounting due to the distrust and the<br />
pioneering character of these services in accounting. This company was not included<br />
into the study but it will be the object of a future case study. The type of scale used to<br />
analyze the answers in this study was nominal – polytomous, in the case when the<br />
respondents had more than two selected options. The study was done in order to find<br />
out which are the key factors that determine the management of the SME to use webbased<br />
services and web accounting. The respondents from this study were managers,<br />
owners, accountants and other persons involved in the process of implementation of<br />
the informational accounting system.<br />
Within this analysis the correlation of each two pairs of variables was investigated.<br />
The first pair of variables analyzed was the user’s behavior and perception for<br />
accounting information and the level of knowledge of the user related to the web<br />
services and the way how the accounting system is organized.<br />
The relation between the behavior of the user and his/her level of knowledge of the<br />
accounting system in force is presented in table 1.<br />
Based on the obtained values, we have reached to the following conclusion:<br />
• Those users (owners of small enterprises, managers, accountants or even<br />
investors), who have knowledge about the accounting system and the internet<br />
are more likely to use web-based services.<br />
• The users of web-based services are increasing. More than 95% of those<br />
questioned use the internet and a browser to do business [(20 +14+ 6 +6) / 48]<br />
* 100 and 70.83% of them have accounting knowledge [(20 +14) / 48] * 100.<br />
~ 715 ~
• We discovered that 54.17% of the respondents [(20 +6) / 48] * 100 used some<br />
web services for accounting purposes: account statement downloaded into<br />
their accounting system, information from clients and suppliers via e-mail that<br />
have to be registered, etc. In the same time more than 68% of the respondents<br />
see web-based services as a new way to do and control business.<br />
• In the second pair of variables considered we analyzed the relation between<br />
the level of knowledge of the user related to the web services and the way the<br />
accounting system is organized. WE summed up the result in table 2.<br />
Table 1. The relation between the behavior of the user and his/her level of knowledge<br />
of the accounting system in force<br />
User’s behaviour and<br />
perception for internet<br />
and web services<br />
No. Caracteristica<br />
1 New way to do<br />
business and control<br />
transactions<br />
2 New way to do<br />
business and<br />
communicating via<br />
internet<br />
3 Improval of<br />
marketing policy an<br />
of the control of the<br />
business<br />
4 Use of the internet to<br />
communicate<br />
User are involved in the registration of accounting<br />
information and use the internetul and browser<br />
for some registrations<br />
The level of knowledge of the user related to the web services<br />
Users understand accounting information produced<br />
by a qualified accountant and use the internetul<br />
or other display devices for running the business<br />
~ 716 ~<br />
Users understand accounting information produced<br />
by a qualified accountant or IT and use the internetul<br />
or other display devices for communicating some<br />
accounting information<br />
Users understand accounting information produced<br />
by a qualified accountant outside the organization<br />
din afara organizatiei and use the internetul<br />
or other display devices for running the business<br />
The questioned do not have knowledge about the<br />
accounting informational system and the internet.<br />
Total<br />
14 11 4 4 0 33<br />
4 2 1 0 0 7<br />
2 1 1 1 0 3<br />
0 0 0 1 1<br />
5 Internet is not used 0 0 0 0 2 2<br />
Total 20 14 6 6 2 48
Table 2. The relation between the level of knowledge of the user related to the web<br />
services and the way the accounting system is organized<br />
Level of knowledge of the user<br />
related to the web-based services<br />
No. Characteristics<br />
1 User are involved in the<br />
registration of accounting<br />
information and use the<br />
internetul and browser<br />
for some registrations<br />
2 Users understand accounting<br />
information produced by a<br />
qualified accountant and use<br />
the internetul<br />
or other display devices for<br />
running the business<br />
3 Users understand accounting<br />
information produced by a<br />
qualified accountant or IT and<br />
use the internetul<br />
or other display devices for<br />
communicating some<br />
accounting<br />
4 Users understand accounting<br />
information produced by a<br />
qualified accountant outside the<br />
organization din afara<br />
organizatiei and use the<br />
internetul<br />
or other display devices for<br />
running the business<br />
The organization of accounting activities<br />
There is an organized accounting<br />
system and accounting software is<br />
being used<br />
There is an organized accounting<br />
system but no accounting software is<br />
being used<br />
~ 717 ~<br />
There is no organized accounting<br />
system or accounting software<br />
There is an organized accounting<br />
system but no accounting software is<br />
being used but outside the organization<br />
There is no organized accounting<br />
system or accounting software<br />
Total<br />
16 0 0 4 0 20<br />
4 7 3 0 0 14<br />
2 1 2 1 0 6<br />
0 0 5 1 6<br />
5 The questioned do not have<br />
knowledge about the<br />
accounting informational<br />
system and the internet.<br />
0 0 0 0 2 2<br />
Total 22 8 10 6 2 48<br />
We noticed that 58.33% of the respondents use accounting software to do and control<br />
business (22 +6) / 48] * 100. This number is close to those who use web-based<br />
services in accounting (54.17%). We consider that there is a vrey close relation<br />
between the use of software for accounting and the use of web-based services. Finally,<br />
we believe that those who use accounting software will migrate to web-based<br />
accounting. Therefore, the increase of the number of accounting software users will<br />
lead eventually to the increase of the number of those who use web-based accounting<br />
services.
CONCLUSIONS<br />
In our opinion web-based accounting will be the new wave for the future of SMEs.<br />
Such a system can bring enormous benefits to those entities considering their<br />
characteristics as well as the characteristics of economy as a whole. This system is<br />
easy accessed, with reduced costs of maintenance and use, requires few technological<br />
knowledge are has wide possibilities of application. It is a system open to a great<br />
number of integrated solutions, internally and for third parties for the extension of<br />
functionality and for fitting the specific needs.<br />
The system has great possibilities of integration with other applications, especially<br />
Excel in the analysis and reporting as well as for importing information into the<br />
system. It has also great chances for the development of business intelligence<br />
especially by accessing accounting information in due time by the company<br />
management. At last but not at least, this system allows the integration and easy<br />
transition to the XBRL reporting system as well as the transition to the EDI<br />
(Electronic Data Interchange) system. Actually, this is one of the great advantages of<br />
the so-called “cloud based accounting”.<br />
The web technology is one of the areas with the widest spread today, and SMEs<br />
cannot stand by and not apply these technologies.<br />
Although security related problems can still occur with these systems, mainly<br />
concerning the transmittal of information and databases, we consider that these will be<br />
solved in the near future. We rely for this on the fact that several banks and companies<br />
started to work exclusively online already, engaging 100% of their activity in this<br />
way.<br />
REFERENCES<br />
Benzacar, K. (2010) “Accounting made easy”, CMA Management, available on-line at<br />
http://www.knowledgeplus.ca/pdfs/CMA%20Magazine_Apr10_Accounting%20Made<br />
%20Easy_English.pdf, April 2010<br />
Bergeron, B. (2003) “Wireless handheld computing”, MedGenMed Medscape General<br />
Medicine 5(1)<br />
Bonsón, E., Cortijo, V., Escobar, T. (2009) “Towards the global adoption of XBRL using<br />
International Financial Reporting Standards (IFRS)", International Journal of<br />
Accounting<br />
Briciu S, Groza C., Gânfalean, I. (2009), “International Financial Reporting Standard (IFRS) will<br />
Support Management Accounting System For Small And Medium Enterprise (SME)?",<br />
Annales Universitatis Apulensis Series Oeconomica, 2009, vol. 1, issue 11, p. 32<br />
Callaghan, J., & Nehmer, R. (2009), “Financial and governance characteristics of voluntary<br />
XBRL adopters in the United States”, International Journal of Disclosure and<br />
Governance, 2009, 6, 4, 321-335<br />
Carlton Collins, J. (2010), “Web-based Accounting”, available on-line at<br />
htttp://www.asaresearch.com/articles/web_accounting<br />
Davenport,T. H., (2000), Mission Critical:Realizing the Premise of Entreprise System,<br />
Boston, MA: Haward Business School Press.<br />
Deshmukh, A. (2006). Digital accounting: The effects of the internet and ERP on accounting,<br />
2006.<br />
Gray, GL, & Miller, DW (2009) “XBRL: Solving real-world problems", International<br />
Journal of Disclosure and Governance<br />
~ 718 ~
Groza C., Briciu S., Cordos A.M, (2010) “Challenges of management accounting of small and<br />
medium enterprises (SMES)”, Revista economic, No. 6(53)/2010 vol I, University<br />
“Lucian Blaga”, Sibiu<br />
Groza,C.,Groza L.,Topor I. D. (2010) “Theoretical aspects about Accounting modernization<br />
of Small and Medium Enterprises Using Web Technology”, International Workshop on<br />
Accounting, Audit and Finance, Alba Iulia, Romania<br />
Haley, K., 2009, Accounting Information Systems- XBRL, Research Paper<br />
Ismail, N. A., & King, M. (2005) “Firm performance and AIS alignment in Malaysian<br />
SMEs", International Journal of Accounting Information<br />
Mihai, F., Aleca, O., Tartavulea, C.V. (2007) “Ubl - An Universal Business Language For<br />
Xml”, Annales Universitas Apulensis, series Oeconomica, Vol. 1, No. 9<br />
Markus,M. L.,Tanis, C., 2000, The Entreprise system experience-from adoption to success. In<br />
Price,M.F.(Ed) Framing thenDomains of IT Management: Projecting the Future<br />
trough the Past, Pinaflex Educational Resources, Cincinnati, OH, pp.173-207.<br />
U. S. Murthy, S.M. Groomer (2004) “A continuous auditing web services model for XMLbased<br />
accounting systems", International Journal of Accounting Information<br />
Pederiva, P. (2010), CMA Management, April 2010<br />
Pierre, J., & Bahri, M. (2006) “The use of the accounting beta as an overall risk indicator for<br />
unlisted companies", Journal of Small Business and Enterprise<br />
Pushkar, M., Rippa, S., Sachenko, S.(2007) Intellectualization of accounting system: 2007 4th<br />
IEEE Workshop on Intelligent Data Acquisition and Advanced Computing Systems:<br />
Technology and Applications, IDAACS, 2007, 536-538<br />
Raymond, L., Rivard, S., Jutras, D. (2004), Small enterprises predisposition to adopt an ERP,<br />
Sixth International Conference on Enterprise Information Systems(ICEIS), Portugal,<br />
10-14 April, 2004, pp 614-618<br />
Schubert, P.,(2005) “Business Software Integration: An Empirical Study in Swiss SMEs",<br />
<strong>Proceedings</strong> of the 18th Bled eConference<br />
Seethamaraju, R., (2008), Enterprise System's characteristics in SMEs context – An Analysis<br />
of Adoption & Implementation, European and Mediterranean Conference on<br />
Information Systems 2008 (EMCIS2008) May 25-26, Al Bustan Rotana Hotel, Dubai<br />
Suraweera, T., Pulakanam, V., Guler, O. (2006), Managing the implementation of IT projects<br />
in SMEs: An exploratory investigation, 2006 1 st International Conference on Digital<br />
Information Management, ICDIM, 381-388<br />
Zhou, L. (2010) “The Research on Issue and Countermeasures of Accounting Information of<br />
SMES”, International Jurnal of Business and Management, Vol. 5, No. 3<br />
~ 719 ~
13 YEARS AFTER: AN XBRL LITERATURE<br />
REVIEW AND OVERVIEW<br />
Claudia URDARI 1 & Adriana TIRON TUDOR<br />
Babes Bolyai University, Romania<br />
ABSTRACT<br />
In 2008, SEC proposed new rules that mandate listed companies from US stock exchange to<br />
prepare their financial statements in accordance with US GAAP or IFRS and to file the<br />
financial statements content in XBRL format beginning with 2009. The purpose of this article<br />
is to review the current state of academic research articles related to XBRL that are<br />
published in ScienceDirect and Springerlink databases, in order to identify the trends and<br />
researchers’ contributions and to assess the XBRL capabilities and its future. Although there<br />
are lots of XBRL calls for papers, after 13 years from XBRL development, the number of<br />
academic articles on XBRL topic are still few, the research questions are increasing, more<br />
and more researchers becoming interested in this topic.<br />
KEYWORDS: XBRL, literature review, Springerlink, ScienceDirect, database<br />
INTRODUCTION<br />
One of the most important principles of corporate governance states that companies<br />
should ensure that timely and accurate disclosure is made on all material matters<br />
regarding the corporation, including the financial situation, performance, ownership,<br />
and governance of the company. (OECD Principles, 2004), making reference to<br />
information transparency and disclosure.<br />
Over the years, the need for more and more data caused the switch from paper<br />
disclosure to online disclosure. After ‘90s, the accounting environment was merged<br />
with the electronic one (Bierstaker et al., 2001; Flowerday et al., 2006). The internet<br />
usage and development of new online systems became the new trend for financial<br />
reporting disclosure. Data analysis went from the use of Html (Hyper Text Markup<br />
Language) to XML (eXtensible Markup Language) and now to XBRL (eXtensible<br />
Business Reporting Language), an electronic language that is specifically used for<br />
financial information disclosure.<br />
All these changes were developed for a simple reason: the more transparent the data<br />
was (for the majority of interested parties meant more data disclosure), the more<br />
difficult data extraction and analysis become. Using the paper format meant to collect<br />
the information, but almost impossible to read it all. More the information was- more<br />
paper we had, but less knowledge about the whole information. So, practitioners had<br />
the idea to use Html. But there was a big disadvantage: Html has the capability to<br />
1 Correspondence address: Claudia URDARI, Babeş-Bolyai University, Faculty of Economics and<br />
Business Administration, Department of Accounting and Audit, Cluj-Napoca, Romania; email:<br />
claudia.urdari@econ.ubbcluj.ro<br />
~ 720 ~
present the information, but is difficult to extract it (Alles et al., 2004). The solution<br />
was the use of XML. This language adds all the information in tags, making easier for<br />
computers to read the data, to search and to extract it in different kind of programs.<br />
XBRL is created based on XML. It has the same proprieties, but it usage refers to just<br />
financial data exchanging. (Srinivas, 2004)<br />
XBRL is an electronic communication reporting language that facilitates disclosure of<br />
financial information over the internet, simplifying disclosure and allowing<br />
companies to communicate financial information more readily (Zambon and<br />
Marzo, 2007).<br />
The communication language is gaining more and more field in financial information<br />
disclosure research. At the present, there are 18 countries with XBRL established<br />
jurisdictions and 5 countries that have provisional jurisdiction . Besides them, there are<br />
5 other independent jurisdictions, including International Accounting Standards<br />
Board. Only in Europe there are 11 established jurisdictions and 3 provisional<br />
jurisdictions.<br />
The history of XBRL begins in 1998, when Charles Hoffman, a certified public<br />
accountant, has the idea to develop an XML version for accounting and audit. But the<br />
fast forward jump was made in 2008, when SEC (Securities and Exchange<br />
Commision) proposed new rules that mandate listed companies from US stock<br />
exchange to prepare their financial statements in accordance with US GAAP or IFRS<br />
and to file the financial statements content in XBRL format beginning with 2009.<br />
Due to SEC’s XBRL adoption and to its fast widespread over the world, we<br />
considered that a research on XBRL is needed. The purpose of this article is to review<br />
the current state of academic research on the XBRL topic between 1998 and 2010,<br />
after 13 year of the communication language’s life.<br />
The discussion focuses on two databases: ScienceDirect and Springerlink database for<br />
scientific Journals, identifying the trends and researchers actively contributions to this<br />
development. Another goal is to assess XBRL capabilities and its future.<br />
The ScienceDirect database search has been motivated by the possibility to access<br />
more than 1,200 of the most commonly-used academic journals, searchable back to<br />
1967 and covering subjects as diverse as the physical and social sciences to business<br />
and management. Furthermore, ScienceDirect's website is comprehensive and easy to<br />
use. The user can perform general topic, author, or title searches among all available<br />
documents, or narrow the search to a specific subject or year (Beth, 2009).<br />
With a platform that offers over 2200 journals, Springerlink database was considered<br />
as the second choice for the XBRL literature review. Among the research domains are<br />
included all the ones related to our topic: economic, informatics and engineering.<br />
Including articles from 1996, the implemented system reduces the search time, being<br />
more efficient for research developments (www.springer.com). The platform also<br />
includes numerous book chapters, but giving the fact that our review was focused just<br />
on article search, the book reviews were excluded from the start. However, the search<br />
has a disadvantage: the search is performed just in the title, abstract, tables of contents<br />
and not in the whole paper as in the case of ScienceDirect.<br />
~ 721 ~
The reminder of the paper is organized as follows: in the first section we emphasize<br />
the importance of performing a literature review. In section two we discuss our<br />
research design. The results of our research are reported in the Section 3, followed by<br />
Section 4 that present our conclusions and, in the same time, discuss the limits and<br />
further developments of this paper.<br />
1. LITERATURE REVIEW DISCUSSION<br />
It was proven that the literature review plays an important role in delimiting the<br />
existing research problem in the field of social sciences. For this reason, many<br />
researchers have chosen to develop a literature review in different fields of research<br />
(Gray et al, 2002). Also, the literature review is considered to be the primordial<br />
method in distinguishing what has been done from what needs to be done, identifying<br />
relationships between ideas and practices, establishing the context of the topic or<br />
problem, understanding the structure of the subject, relating ideas and theory to<br />
applications, identifying the main methodologies and research techniques that have<br />
been used, and placing the research in a historical context to show familiarity with<br />
state-of-the-art developments.<br />
While the majority of researchers consider that the most relevant and complete<br />
literature review can be found in accounting journals, based on journal rankings<br />
and/or impact factors (Gendron, 2008), others think that top articles should also be<br />
searched in non-top journals.<br />
To avoid being one side or the other one, we positioned our research at internet search<br />
and/or availability level, considering that all the databases that are available online are<br />
primordial source for article analysis. Thus, beside ScienceDirect and Springerlin<br />
databases, this review can be continued by studying the literature from at least other<br />
six online databases: Wiley Interscience, Emerald, JSTOR, Highwire, EBSCO<br />
and SSRN.<br />
2. RESEARCH DESIGN<br />
The review was conducted using a search command for the word “XBRL” on a<br />
number of two databases available online: ScienceDirect and SpringerLink. The<br />
search engine performed a quick overlook in the title, abstract or the whole paper,<br />
including references of all journals included in these databases.<br />
After collecting the articled, the first step was to divide them in four categories, as<br />
follows:<br />
• XBRL articles: articles whose content refer at XBRL - descriptive articles,<br />
data extraction, data process and so on;<br />
• XBRL chapter: articles that include a chapter or a significant part about<br />
XBRL;<br />
• XBRL mentioning: articles that mention XBRL existence or make reference<br />
to XBRL usage inside the text;<br />
• XBRL reference: articles that include the word “XBRL” inside the<br />
“References” section.<br />
~ 722 ~
The second step was to establish the information associated with the articles that were<br />
extracted from the databases:<br />
• Author(s);<br />
• Title;<br />
• Journal Name;<br />
• Language: not all the articles were in English, but we preferred to keep a track<br />
on all XBRL related articles, even if we didn’t review the ones in another<br />
foreign language;<br />
• Type of research: Economic, Computer Science and Others. Given the fact<br />
that two of the analyzed articles couldn’t be included in none of the first two<br />
categories, as we initially developed them, we created a new category, called<br />
“Other”. The two articles included here discuss about critical research<br />
literature review in accounting and accounting education.<br />
This information was stored in Excel in order to facilitate a further detailed analysis.<br />
Also, we stored in Word a brief description of the most important points of the paper,<br />
in order to facilitate the comparisons between different articles. This type of<br />
information included: the subject, the procedure, the motivation, the target group, the<br />
results and our subjective point of view regarding the paper. To facilitate the data<br />
storage, search and data examination, we allocated in Excel a number for each paper<br />
(example 148), that was also given to the articles (example 148_a) and to our<br />
comments (example 148_c).<br />
The third step was to analyze the articles keeping in mind some questions that we<br />
considered to be important for our research: What themes emerge and what<br />
conclusions can be drawn? What are the major similarities and differences between<br />
the various writers? Are there any significant questions which emerge and which<br />
could form a basis for further investigation? The answer to all this questions and the<br />
link between the articles were included in the discussion and result section.<br />
3. DISCUSSION AND RESULTS<br />
During 13 years of XBRL existence, 78 articles related to this subject were published<br />
in ScienceDirect and Springerlink databases (Table 1). The first two articles were both<br />
published in the same volume: one was concluding that both XML and XBRL would<br />
improve financial disclosure (Debreceny and Gray, 2001) and the other one was<br />
discussing the problematic of XBRL in the context of continuous auditing (Woodroof<br />
and Searcy, 2001). For early period adoption, there were other articles that focused on<br />
the use of XML in financial reporting, the majority of them also emphasizing the<br />
widespread adoption of Internet for financial reporting usage (Debreceny et al., 2002;<br />
Dull et al., 2003; Beattie and Pratt, 2003; Vasarhelyi and Greenstein, 2003).<br />
As it can be seen in Figure 1, ScienceDirect database journals shown a high interest<br />
for articles related to XBRL topic. During 1998 – 2010, there were 62 articles<br />
published in 25 journals included in ScienceDirect database. On the other hand, the<br />
Springerlink database search lead to 16 articles, included in 3 Journals, all related to<br />
the computer science filed.<br />
~ 723 ~
Table 1. Publications with XBRL included in the title,abstract or in the body<br />
of the paper<br />
Year Number of XBRL related articles<br />
2001 2<br />
2002 1<br />
2003 6<br />
2004 14<br />
2005 7<br />
2006 8<br />
2007 8<br />
2008 9<br />
2009 8<br />
2010 15<br />
Total 78<br />
Figure 1. The number of XBRL related articles in ScienceDirect and Springerlink<br />
databases<br />
As shown in Table 2, we found 29 Journals that published XBRL related articles.<br />
From these ones, 2 seemed to play a key role in XBRL academic research<br />
publications: International Journal of Accounting Information Systems (Srivastava<br />
and Kogan, 2010; Alles and Pietchocki, 2010; Debreceny and Gray, 2010) and<br />
Lecture Notes in Computer Science (Bao et al., 2010; Lara et al., 2006, Hou et al.,<br />
2006). The diversity of academic journals that published articles related to XBRL<br />
suggest that academic community is engaged in the development and implementation<br />
of web-technology for financial reporting disclosure and business data extraction, the<br />
improvement of financial information transparency, real-time disclosure and real-time<br />
audit.<br />
Table 2. XBRL related articles appearing in academics journals<br />
Academic Journals Total<br />
1 Accounting Forum 1<br />
2 Accounting, Organizations and Society 2<br />
3 Advances in Accounting 1<br />
4 Automation in Construction 1<br />
~ 724 ~
Academic Journals Total<br />
5 Computer & Security 1<br />
6 Computer Fraud & Security 1<br />
7 Computer Standards & Interfaces 2<br />
8 Critical Perspectives on Accounting 3<br />
9 Decision Support Systems 2<br />
10 Digital Investigation 1<br />
11 Expert Systems with Applications 1<br />
12 Information & Management 1<br />
13 Information Systems 1<br />
14 Information Systems Frontiers 1<br />
15 International Journal of Accounting Information Systems 24<br />
16 International Journal of Information Management 2<br />
17 Journal of Accounting and Economies 1<br />
18 Journal of Accounting and Public Policy 4<br />
19 Journal of Business Research 2<br />
20 Journal of Retailing and Consumer Services 1<br />
21 Lecture Notes in Computer Science 14<br />
22 Management and Accounting Research 1<br />
23 Public Relations Review 2<br />
24 Research in Accounting Regulation 3<br />
25 Scientific and Technical Information Processing 1<br />
26 Technology in Society 1<br />
27 The British Accounting Review 2<br />
28 The Journals of Systems and Software 1<br />
Total 78<br />
As explain in Section 2, we have divided the XBRL related articles in 4 groups.<br />
Analysis of publication volumes show that XBRL related articles were slightly<br />
increasing from year to year (Table 2), excepting 2002 and 2009, when they had an<br />
insignificantly decrease (1 article) and 2004, when the number of articles doubled.<br />
This fact can be explained by looking at Table 4, were we can see that the number of<br />
articles that mention XBRL tripled during 2004. A more detailed look over these<br />
articles will show that they don’t include short description of XBRL, neither a link<br />
with it. The authors just mention the business language as an example for voluntary<br />
disclose (Xiao et al., 2004), a model of customization for financial reports (Beattie,<br />
2004), organizations increasing surveillance possibilities (Poullaos, 2004), and so on.<br />
Thus, they can’t be considering as articles that argue the importance of XBRL. This<br />
would mean that our first conclusion, of slightly increasingly publication numbers<br />
from year to year, remains valid.<br />
Table 3. XBRL related articles<br />
Year Number of Number of “XBRL Number of “XBRL Number of “XBRL<br />
XBRL articles chapter” articles mention” articles reference”<br />
2001 2 - - -<br />
2002 - - 1 -<br />
2003 1 1 3 1<br />
2004 2 1 10 1<br />
2005 2 1 4 -<br />
2006 4 - 3 1<br />
2007 1 - 6 1<br />
2008 2 2 4 1<br />
2009 2 1 2 3<br />
2010 8 - 5 2<br />
Total 24 6 38 10<br />
~ 725 ~
From the analyzed articles, 31% represent research on XBRL topic (Table 3), 8%<br />
include a chapter on XBRL as tool for financial information disclosure or for<br />
transparency improvement. The rest of 61% of these articles are either mentioning<br />
XBRL, at a higher or a lower level, or just include in the reference part XBRL<br />
articles.<br />
Figure 2 graphs the volume of economic versus computer science XBRL related<br />
articles. Although the figure indicates a general uptrend, this is not a constant one. A<br />
closer look shows as that the big difference appears in 2004, referring to the fact that<br />
we concluded above, in articles content part. As for the type of the articles, economic<br />
and computer science, it can be seen that their lines play together as in a spiral. This<br />
fact happens because each time a practitioner develops a new application model, their<br />
results can be used by the researchers from the economic field as a start for their<br />
research. In the same time, each unanswered question of the economists will bring a<br />
new research question for the practitioners. This way, the financial reporting field,<br />
will be continuous under developing improving data disclosure and extraction term of<br />
time waste.<br />
Figure 2. The number of XBRL related articles in ScienceDirect and Springerlink<br />
databases<br />
The primary interest of this paper was the economic articles related to XBRL topic.<br />
Thus, Table 4 shows the publishing outlet by year for economics articles. As it can be<br />
seen, they represent 62% of analyzed articles. From all 28 analyzed journals, just 16<br />
contain XBRL economic related articles. The majority of the articles were by far<br />
published in International Journal of Accounting Information Systems (21 articles),<br />
followed by Journal of Accounting (4 articles) and Public Policy and Research in<br />
Accounting (3 articles).<br />
~ 726 ~
Table 4. Articles that mention XBRL in their references (“XBRL references”)<br />
Academic Journals<br />
Total<br />
2001<br />
2002<br />
1 Accounting Forum 1 - - - 1 - - - - - -<br />
2 Accounting,<br />
Organizations and<br />
Society<br />
2 - - 1 - - - 1 - - -<br />
3 Computer & Security 1 - - - - - 1 - - - -<br />
4 Computer Fraud &<br />
Security<br />
1 - - - - 1 - - - - -<br />
5 Critical Perspectives on<br />
Accounting<br />
2 - - - - - - 2 - - -<br />
6 International Journal of<br />
Accounting<br />
Information Systems<br />
21 2 - 3 3 2 2 - 4 1 4<br />
7 International Journal of<br />
Information<br />
Management<br />
1 - - - - - 1 - - - -<br />
8 Journal of Accounting<br />
and Economies<br />
1 - - - - - - - - - 1<br />
9 Journal of Accounting<br />
and Public Policy<br />
4 - 1 - 1 1 - - - - 1<br />
10 Journal of Business<br />
Research<br />
2 - - - - - - - - - 2<br />
11 Journal of Retailing<br />
and Consumer Services<br />
1 - - - - - - - - - 1<br />
12 Management and<br />
Accounting Research<br />
1 - - - - - - - - - 1<br />
13 Public Relations<br />
Review<br />
2 - - - 2 - - - - - -<br />
14 Research in<br />
Accounting Regulation<br />
3 - - - - 1 - - 1 - 1<br />
15 Technology in Society 1 - - - 1 - - - - - -<br />
16 The British Accounting<br />
Review<br />
2 - - 1 1 - - - - - -<br />
Total 46 2 1 5 9 5 4 3 5 1 11<br />
Given the fact that XBRL represents a relatively new topic in accounting domain,<br />
most articles in academic journals point out the benefits and that accrue from adoption<br />
of XBRL (Kaya, 2011). The XBRL related articles are divided in two types of<br />
categories: economic articles and computer science articles. The first ones include a<br />
wide variety of areas that interest accounting academics such as corporate<br />
governance, management, IFRS and audit issues. The numbers of articles that were<br />
published by the academic community are relatively small, as also shown in one of<br />
Roohani et al. articles (2010).<br />
One paper that drawn our attention was the one of Srivastava and Kogan (2010),<br />
which discusses the problematic of data assurance. Since June 15, 2009 SEC<br />
(Securities and Exchange Commission) required that the top 500 companies add their<br />
fillings in XBRL format, although they are not requiring a third party assurance on the<br />
information that is in this manner available on the internet. Their paper brings a new<br />
vision on XBRL assurance, developing and discussing assertions on XBRL assurance.<br />
2003<br />
~ 727 ~<br />
2004<br />
2005<br />
2006<br />
2007<br />
2008<br />
2009<br />
2010
Nevertheless, we have to mention that several other authors mention the subject of<br />
auditing XBRL data: Debreceny, who is currently developing a project financed by<br />
IAAER, called “The implications of XBRL for the Financial Statement Audit”,<br />
Flowerday, Bluntell, von Solms, Woodroof, Searcy, Onion, Rezaee and so on.<br />
One aspect that is related to XBRL is the disclosure improvements. Yoon et al. (2010)<br />
analyzed if XBRL reduces the information asymmetry in the case of Korean stock<br />
markets. As we previously mentioned, the majority of the accounting and finance<br />
researchers consider that when the level of financial disclosure increases, the<br />
information asymmetry decreases. However, the authors conclude that XBRL may<br />
lead to the reduction of information asymmetry from the point of view of the<br />
investors. They prove that the information asymmetry reduction is stronger for the<br />
larger companies than for the medium and small sized companies. Yet, for their result<br />
to stand up it would be necessary to analyze a longer sampling window for the<br />
selected companies, for at least two years<br />
One of the studied articles refers to corporate governance (Premuroso and<br />
Bhattacharya, 2008), even if it uses a small sample of companies, sows that corporate<br />
governance is associated with a firm’s decision to be an early filer in XBRL format.<br />
Another study that analyses the XBRL influence on corporate governance is the one<br />
of Alles and Piechocki (2010). They discuss about the decision making process and<br />
state that XBRL has the potential of significantly improving the governance process,<br />
but the full usage of this advantages depend on how the users put it in use. They need<br />
to understand that XBRL is not just a distributor mechanism, but it can also do data<br />
modeling and be linked to analytical software. They emphasize that other programs<br />
can also do that, but it would take a lot of time to do it and it will also imply a higher<br />
cost, which should never be ignored in a business environment.<br />
Bonson et al. (2009) discuss about IFRS adoption at European level in 2005 and the<br />
IFRS decision to use XBRL in order to create a global set of standards. They draw the<br />
conclusion that the idea to use XBRL as a common ground for international<br />
companies is very usefully, but they also stipulate that IFRS-GL taxonomy has some<br />
deficiencies that must be corrected if IASB wants to reach his goal. They are the only<br />
authors that analyze this subject of research from all the analyzed articles.<br />
Nevertheless, in the practitioners’ area, the subjects of the articles are as interesting as<br />
in the economic one. Herein, they were going from XBRL and XML descriptions,<br />
their advantages in comparison with other electronic languages, to data extraction<br />
programming, such as structured and unstructured information from financial<br />
reporting disclosed on the stock exchanges websites. Another issue that has to be<br />
mention is databases development for different types of financial information.<br />
So, as a general conclusion that can be drawn from these articles, XBRL is seen as the<br />
best communication language that can assure a unique accounting standard all over<br />
the world. But the use of XBRL draws over himself the need for a reliable and<br />
accurate audit tool that can assure the interested parties for its precise information.<br />
We can conclude that the XBRL topics cover subject as corporate governance<br />
(Premuroso and Bhattacharya, 2008; Alles and Piechocki, 2010), audit (Srivastava<br />
~ 728 ~
and Kogan, 2010; Debreceny et al., 2010; Flowerday et al., 2006; Flowerday and von<br />
Solms, 2006; Daigle and Lampe, 2004, Murthy and Groomer, 2004), internet<br />
disclosure (Yoo et al., 2010; Mena et al., 2010; Williams et al., 2006, Boritz and No,<br />
2005), IFRS (Bonson et al., 2009), system development for business disclosure<br />
(Spies, 2010), system development for financial data extraction (Maynard et al., 2007)<br />
and financial database development (Mendez Nunez et al., 2008.<br />
As regarding the questions that emerge from the studied articles, the most important<br />
one is: how much the XBRL filling errors could affect the decision made by interested<br />
parties. Other questions that are interesting are the following ones: Are the models of<br />
continuous auditing really viable? The audit programs use continuous audit in the<br />
present? If yes, what are the problems that continuous audit encounter? To all this<br />
questions related to audit, we add one more regarding IFRS: are there any studies<br />
about users’ opinion on IFRS taxonomy?<br />
DISCUSSION AND CONCLUSIONS<br />
This literature review was conducted by searching two online databases, during 1998-<br />
2010. The summary and information regarding the XBRL related articles were kept in<br />
both Microsoft Excel and Word, in order to facilitate detailed analysis. The aim was<br />
to identifying the trends and researchers actively contributions to XBRL development<br />
and to assess XBRL capabilities and its future.<br />
We believe that our results sustain the lack of academic XBRL publication in<br />
accounting: 24 articles with XBRL content, including the ones from the computer<br />
science field. Although during this search we also find lots of call for papers, it seems<br />
that the researches in this field are still at their start-ups and that the topic of XBRL<br />
can be further discussed and new studies can be developed.<br />
The research tendency in this field is to start with describing the communication<br />
language, its advantages and disadvantages and comparison with other online<br />
financial disclosure languages. At this point of the research it can be state that in the<br />
countries with provisional jurisdictions the main research point is what is XBRL, how<br />
can be developed in this countries and always include descriptions of XBRL, it’s<br />
advantages and disadvantages. Also, our results show that after the countries gain an<br />
established jurisdiction, their main research interest tends to be related to continuous<br />
auditing. This fact could be related with the increasingly need of financial information<br />
disclosure assurance.<br />
Although we went through all the articles from ScienceDirect and Springerlink<br />
databases, there are other available databases, books and practitioners’ reports that<br />
weren’t yet reviewed.<br />
This review of the literature will be further developed, intending to include at least<br />
other six online databases: Wiley Interscience, Emerald, JSTOR, Highwire, EBSCO<br />
and SSRN and to perform a broader analyze on XBRL related articles, including the<br />
authors’ origin, research methodology and so on.<br />
~ 729 ~
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THE INFLUENCE OF FIRM-SPECIFIC<br />
CHARACTERISTICS ON THE EXTENT<br />
OF VOLUNTARY DISCLOSURE IN XBRL:<br />
AN EMPIRICAL ANALYSIS OF SEC FILINGS<br />
Devrimi KAYA 1<br />
University of Erlangen-Nuremberg, Germany<br />
ABSTRACT<br />
eXtensible Business Reporting Language (XBRL) is an open standard for the electronic<br />
preparation and exchange of business information. The purpose of this paper is to empirically<br />
investigate the influence of several firm-specific characteristics on the extent of voluntary<br />
disclosure in XBRL. I define voluntary disclosure in XBRL as being an offer of information,<br />
whether financial or non-financial, in a new format via the SEC’s Voluntary Filing Program<br />
(VFP) in addition to official 10-K and 10-Q filings. The extent of voluntary disclosure is<br />
measured by a disclosure index with 54 financial and non-financial items. Based on a sample<br />
of 51 U.S. listed firms, this study states that the extent of overall disclosures is significantly<br />
and positively related to firm size and the firm’s level of innovativeness. Moreover, the results<br />
of the study indicate that different factors are important in explaining the voluntary<br />
disclosures of financial, non-financial, and general information. The findings of this study<br />
should be of interest to firms that prepare, consumers that use and regulators that monitor<br />
financial reporting disclosures.<br />
KEYWORDS: Financial Reporting, Voluntary Disclosure, XBRL, Annual Reports, U.S.<br />
stock exchanges, SEC<br />
INTRODUCTION<br />
In times of an incredible volume of information in annual reports, it is becoming<br />
difficult for users to analyze all the information. A relatively new technology called<br />
eXtensible Business Reporting Language (XBRL), an XML-based data standard, is a<br />
system for tagging information which is exchanged electronically so that it can be<br />
given contextual meaning in the systems of those receiving it, e.g. banks, regulators,<br />
and investors (Wagenhofer 2003). XBRL provides an increase in standardization and<br />
comparability of available financial and non-financial information (Baldwin et al.<br />
2006). The Securities and Exchange Commission (SEC) adopted rule amendments<br />
(33-8529) establishing the XBRL Voluntary Financial Reporting Program (VFP) on<br />
the EDGAR System on March 16, 2005 (SEC 2005). These amendments enable<br />
voluntary filers to furnish XBRL documents on EDGAR additionally to official<br />
filings such as 10-K and 10-Q. In January 2009, the SEC then announced rule 33-<br />
9002, which requires corporations to file their financial statements in XBRL with the<br />
requirement being phased-in over three years (SEC 2009). From quarters ended June<br />
1 Correspondence address: Devrimi KAYA, University of Erlangen-Nuremberg, Department of<br />
Accounting and Auditing; email: devrimi.kaya@wiso.uni-erlangen.de<br />
~ 732 ~
15, 2009 on, the largest companies with public float greater than $5 billion are<br />
required to submit their financial statements and block tagged notes in XBRL format<br />
(SEC 2009; IASCF 2010). All other filers in US-GAAP, as well as all issuers using<br />
IFRS, will phase-in by 2011 (Debreceny et al. 2010). However, in many other<br />
countries all over the world, such as Germany, United Kingdom, and Canada, XBRL<br />
filings are still on a voluntary basis.<br />
Previous literature examined the firm-specific drivers for voluntary filing in XBRL<br />
rather than the extent of information, which was voluntarily disclosed. Research has<br />
shown that factors such as liquidity and firm size influence the decision of firms to<br />
voluntarily adopt XBRL (Premuroso and Bhattacharya 2008; Callaghan and Nehmer<br />
2009). Little attention has been devoted how voluntary adopters use XBRL to<br />
disseminate information. One would also expect that there are potential disparities<br />
between voluntary filers in their disclosure level and the amount of financial and nonfinancial<br />
information disclosed. Some descriptive evidence exists that companies file<br />
predominantly financial tagged information (Boritz and No 2008). Notes<br />
accompanying the financial statements, supporting schedules, and Management<br />
Discussion & Analysis could be excluded in the phase of voluntary filing. However, if<br />
a company decides to include notes in XBRL filings, it has to invest significant time<br />
and effort to prepare these documents in their entirety. Thus, in determining the<br />
optimal level of voluntary disclosure in XBRL, firms have to weigh the specific cost<br />
factors against the potential benefits (Botosan 1997; Wagenhofer 2003). Voluntary<br />
filers may potentially expect to be rewarded by capital markets and financial<br />
statement users for increased transparency, as well as comparability, of their financial<br />
statements, and hence do exhibit a larger extent of disclosed financial and<br />
non-financial information in XBRL. Thus, such disclosures are aimed at reducing<br />
the information asymmetry between managers and investors, and the firm’s costs<br />
of raising capital (Spero 1979; Cooke 1989; Healy & Palepu 2001; Boesso &<br />
Kumar 2007).<br />
The purpose of this paper is to therefore empirically investigate the influence of<br />
several firm-specific characteristics on the extent of voluntary disclosure in XBRL. In<br />
this context, I define voluntary disclosure in XBRL as being an offer of information,<br />
whether financial or non-financial, in a new format via the SEC’s VFP in addition to<br />
official 10-Q and 10-K filings, which are required by law. This definition is in line<br />
with literature that studies voluntary disclosure of financial information on the internet<br />
(e.g., Ausbaugh et al. 1999; Craven and Marston 1999; Trabelsi et al. 2004). Other<br />
studies focused on voluntary disclosures as disclosures beyond the required content in<br />
the financial statements (e.g., Gary et al. 1995; Kumar et al. 2008). The specific<br />
research questions considered in this study are:<br />
1. How widespread is voluntary disclosure in XBRL?<br />
2. What is the nature of XBRL disclosures?<br />
3. To what extent is the variability in voluntary disclosure in XBRL explained by<br />
a number of firm-specific characteristics?<br />
Answers to the research questions provide insights about voluntary disclosure<br />
practices. The focus of this study is on the well-developed U.S. VFP, which was<br />
launched by the SEC. In this program, financial and non-financial data of U.S. and<br />
foreign firms is accessible for every interested person. Furthermore, the U.S. has a<br />
large capital market that exerts a dominant influence on disclosure of financial<br />
~ 733 ~
statements. The study examines the contents of the entire annual report, which was<br />
filed in the last year of the VFP, not just the financial statement part, as has typically<br />
been empirically investigated in previous work on voluntary disclosure. Thus, the<br />
sample of 51 firms includes all voluntarily filed annual reports of 2008. Following<br />
Gray et al. (1995), the entire annual report is seen as a disclosure package. The focus<br />
on the annual report is not the only way by which companies voluntarily provide<br />
information to investors or other interested parties. For example, conference calls and<br />
analyst meetings can provide relevant information to stock market participants<br />
(Debreceny et al. 2002; Healy and Palepu 2001; Frankel et al. 1999). Nevertheless,<br />
the annual report is the most widely disseminated source of information on publicly<br />
and privately held firms (Arnold et al. 1984; Chang et al. 1983; Gray et al. 1995). The<br />
extent of voluntary disclosure is measured by a disclosure index with 54 items.<br />
Moreover, I examine voluntary disclosures by type of information, namely financial,<br />
non-financial, and general information. This procedure is supported by the<br />
expectation that there may be differences in the disclosure behavior of firms<br />
depending on the type of information (Gray et al. 1995). As in recent studies, this<br />
paper considers the hypothesis that certain firm-specific variables may explain the<br />
observed variation in voluntary disclosure. Following Lang and Lundholm (1993),<br />
independent variables were categorized in structure-related variables, performancerelated<br />
variables, and market-related variables.<br />
The study provides several interesting findings. The findings show that voluntary<br />
filers predominantly provide financial tagged information to financial statements<br />
users. However, contrary to earlier research (e.g., Boritz and No 2008), the results<br />
indicate that due to more experience in XBRL filings, firms included notes and<br />
Management Discussion & Analysis (MD&A) in their filings. Thus, the development<br />
of XBRL taxonomies for narrative parts of the annual report is becoming increasingly<br />
important. The results show that firm size and the level of innovativeness of the firm,<br />
measured by the ratio R&D expenditures to sales, to be significantly and positively<br />
related to the extent of voluntary disclosure. Both variables also seem important in<br />
explaining the sub-category financial information disclosures.<br />
The potential contributions of this current study are several. First, examining the<br />
voluntary disclosures of U.S. listed companies should be useful worldwide for<br />
companies that are thinking about adopting XBRL. These companies have a likely<br />
interest in knowing how other firms have followed the complex cost-benefit trade-offs<br />
associated with voluntary disclosures in XBRL format. In addition, voluntary<br />
disclosures often foreshadow trends in worldwide financial reporting and research on<br />
voluntary disclosure will represent an addition to knowledge. Second, the acceptance<br />
and implementation of XBRL around the world has considerably grown during the<br />
last few years. For example, in Europe, a wide range of European countries have<br />
admitted the voluntary submission of financial statements in XBRL format. Still,<br />
several other countries in Europe, such as Lithuania, Czech Republic, and Slovenia, as<br />
well as large parts of Africa and Asia, have not yet dealt with the implementation of<br />
XBRL business reporting at all. Consequently, the results of this study might be<br />
relevant for governments that consider regulating XBRL business reporting for listed<br />
and not listed firms and developing XBRL taxonomies at the national level. However,<br />
only national taxonomies are not able to correspond to the increasing demand for<br />
standardization and comparability on capital markets (Wagenhofer 2003). Therefore,<br />
~ 734 ~
common base taxonomies like an IFRS and US-GAAP taxonomy with additionally<br />
national and firm-specific supplements is an obvious concept for cross-sectional<br />
comparability (Richards et al. 2006). Thus, the results of this study should be of<br />
particular interest for standard setters like IASB and FASB.<br />
The remainder of this paper proceeds in seven additional sections. The following<br />
section examines potential benefits of XBRL business reporting. Section 3 reviews<br />
the literature. In section 4, independent variables are discussed and hypotheses are<br />
developed. Section 5 describes the data, disclosure index, and research methodology,<br />
while section 6 presents the descriptive and empirical results. Section 7 concludes the<br />
study with final comments, limitations of the study, and suggestions for future<br />
research.<br />
1. POTENTIAL BENEFITS OF XBRL BUSINESS REPORTING<br />
XBRL is a language that is used for a standardized exchange and representation of<br />
business information. Based on the eXtensible Markup Language (XML) (Premuroso<br />
and Bhattacharya 2008), XBRL also marks information with unambiguous and<br />
predefined attributes, the so-called “tags” that could be compared to labels or<br />
barcodes on goods (Ramin and Kesselmeyer 2007; Efendi et al. 2009). With the<br />
introduction of tags, the information is not treated as a block of text, as in a printed<br />
document or PDF-file, but is computer readable and enables automatic and efficient<br />
processing by providing an identifying tag for each individual item of data. An XBRL<br />
taxonomy (e.g., U.S.-GAAP Taxonomy) includes and fully structures all elements that<br />
are valid for an XBRL instance document by defining each specific tag (Richards<br />
et al., 2006; Bergeron, 2003; Wagenhofer & Ewert, 2003; Hannon, 2005; Richards<br />
et al., 2006).<br />
Firms’ participation in XBRL business reporting in addition to traditional disclosure<br />
practices is preceded by a careful process of the evaluation of potential benefits and<br />
costs. The major benefit of XBRL is to reduce inefficient processes of information<br />
communication and to act as a standardized interface for the internal and external<br />
reporting of business information. Its support of various languages simplifies the<br />
exchange of information within international organizations. Other potential benefits<br />
that distinguish XBRL business reporting from other voluntary disclosure practices<br />
are as follows. First, disclosure in XBRL format can reduce firms’ disclosure costs.<br />
Costs of the adoption of XBRL include the costs of implementation and preparation of<br />
XBRL filings, which are generally not very high. Stantial (2007) outlines the<br />
relatively affordable prices for tagging software and the significant occurrence of<br />
learning curve effects. As manual processes are reduced due to the adoption of XBRL,<br />
time and cost savings can be realized. According to a survey by Pinsker and<br />
Li (2008), cost savings can result from rising efficiency, i.e. a reduction of data<br />
redundancy, and through declining bookkeeping cost. Second, in today’s financial<br />
reporting it is complex for the users to select “important” information within a<br />
200 pages annual report in a paper- or PDF-format. Most of the users do not have the<br />
time to separate not relevant information from relevant information. In addition, firms<br />
historically have provided aggregated information to the financial statements users<br />
(Wallman 1995; Ausbaugh 1999). Therefore, users drew on the services of databases<br />
like Thomson Financial Datastream or Compustat to have access to disaggregated<br />
data. By engaging in XBRL reporting firms may increase their financial disclosures<br />
~ 735 ~
and lower users’ information costs. For instance, XBRL may improve the ability to<br />
provide more timely data in comparison to voluntary disclosures in periodic reports<br />
(Wallman 1997). The provided disaggregated data can be historical costs, fair values,<br />
and forecasts (e.g., monthly or quarterly sales), as well as values in different<br />
currencies. Third, voluntary disclosures in traditional disclosure formats have<br />
important limitations in accessibility. XBRL disclosure is accessible to all users of<br />
financial statements and is flexible in format (Debreceny 2002). Thus, XBRL<br />
improves the orientation towards users` information needs. Due to the better<br />
accessibility, tagged information can be easily acquired and automatically extracted<br />
from various parts of the financial statements and the footnotes without searching the<br />
annual report manually. Hodge et al. (2004) investigate in their study the potential of<br />
XBRL to improve non-professional investors’ use of financial information in<br />
investment decisions. The authors state that in the context of recognition versus<br />
disclosure of stock option compensation, participants of the study who use XBRL are<br />
more likely to acquire and to integrate the footnote information. In another study,<br />
Arnold et al. (2010) examine the impact of tagging qualitative information on<br />
investors’ decision making. They determine that the presentation of MD&A in a<br />
tagged form information leads to more efficient incorporation of risk information into<br />
decision making of professional and non-professional investors. The empirical results<br />
of both studies suggest that XBRL improves the transparency of financial reporting,<br />
since transparency is associated with the idea that annual reports should be presented<br />
in a manner that is easily understood by financial statement users (Hodge et al. 2004).<br />
Finally, XBRL disclosure is also likely to enhance the comparability of financial<br />
statements across firms. The more firms and countries adopt XBRL, the more<br />
valuable XBRL will become because comparability increases with the size of the<br />
network (Meeks and Swann 2009). Currently, many countries all over the world<br />
require or permit IFRS reporting. A special XBRL taxonomy for IAS/IFRS was<br />
developed, which even allows cross-country comparison between companies in all<br />
nations using this standard.<br />
Higher comparability and improved transparency in financial reporting are linked to<br />
important economic consequences, e.g. market liquidity and the firms’ cost of capital<br />
(Hodge et al. 2004; Christensen 2007). Generally with increasing voluntary disclosure<br />
in XBRL format, investors’ costs of gathering and processing information may<br />
decrease, mitigating information asymmetries on the security markets. Therefore,<br />
adverse selection and insider trading problems can be attenuated, increasing investors’<br />
willingness to participate on the security markets and thus, boosting market liquidity<br />
(Ball 2006). Furthermore, disclosure in XBRL may bring forward the international<br />
integration of capital markets, since it allows companies to approach potential<br />
investors worldwide. If investors are provided with more useful and timely<br />
information for their decision making, information asymmetries and adverse selection<br />
problems further decrease, and thus, market liquidity is expected to increase even<br />
more. If the application of XBRL can increase the liquidity of a company’s shares by<br />
reducing information asymmetries, investors’ liquidity premia might decrease (Hail et<br />
al. 2010a, 2010b).<br />
~ 736 ~
Increasing comparability Improving transparency<br />
Integration of<br />
worldwide<br />
capital markets<br />
Figure 1. Benefits of XBRL Business Reporting<br />
Increasing market liquidity<br />
Decreasing liquidity premia<br />
Economic Benefits of XBRL Business Reporting<br />
Decreasing<br />
information<br />
costs<br />
Decreasing information asymmetries<br />
Decreasing costs of capital<br />
~ 737 ~<br />
Improving information<br />
quality for investors<br />
Decreasing investors’ estimation risks<br />
Decreasing risk premia<br />
It is important to note that a key factor for the success of XBRL worldwide is the data<br />
quality of filings (Debreceny et al. 2010). If financial statements users cannot trust the<br />
data which is submitted to regulatory bodies, such as the SEC, the expected benefits<br />
of XBRL adoption will not occur. Currently, there is limited empirical evidence on<br />
data quality of XBRL filings. For instance, Boritz and No (2008) analyzed filings in<br />
the SEC’s Voluntary Filing Program. They found that two-thirds of the XBRL<br />
instance documents furnished under the VFP contain validation exceptions,<br />
inconsistencies, and errors. The authors came to the conclusion that the quality of<br />
XBRL filings has not improved since the SEC launched the VFP (Boritz and No<br />
2008). One main reason for these results might be that firms that participated in the<br />
VFP were not required to audit their XBRL filings. In a recent study, Debreceny et al.<br />
(2010) stated that one quarter of the filings of 400 large corporations in the first round<br />
of mandatory submissions to the SEC contained errors. Typical errors were missing<br />
fact values in calculation relationship or wrong fact values. Therefore, the authors<br />
suggest several actions, such as better warnings within the SEC’s interactive data<br />
submission program, to prevent and detect the cause for these errors. This early<br />
evidence on data quality can raise an issue about the potential manipulation of<br />
reported financial and non-financial information in XBRL. Another critical point<br />
regarding the comparability of a standardized taxonomy, such as an U.S.-GAAP or<br />
IFRS taxonomy, is that companies are using different types of extensions in their<br />
XBRL filings. These extensions can be firm-, sector- as well as country-specific.<br />
Firms can easily add or modify elements of a taxonomy, which is basically the<br />
innovative idea of XBRL (Boritz and No 2008). But an increase in extensions<br />
worsens the cross-sectional comparability of financial data simultaneously. We might
speculate how standard setters might solve this problem. One solution might be a<br />
limitation of extensions and options provided by accounting standards like IFRS and<br />
U.S.-GAAP because financial statement users find it difficult to follow up individual<br />
specifications.<br />
2. LITERATURE REVIEW<br />
Most of the articles in practitioner journals point out the benefits that accrue from the<br />
adoption of XBRL and give an overview of the technological details of XBRL.<br />
Sinnett (2006) states that the most commonly reported benefits are internal and<br />
external processing efficiencies. Malhotra and Garritt (2004) discuss the implications<br />
of XBRL on accountants, investors, analysts, and the financial services industry.<br />
Furthermore, Debreceny et al. (2005) examine the role of XBRL in financial<br />
reporting, concerns with XBRL taxonomies, and the impact of XBRL on the SEC’s<br />
filing program. Roohani et al. (2010) state in their analysis of XBRL literature that<br />
practitioner journals have published XBRL related articles at significantly higher rate<br />
than academic journals.<br />
However, due to the exceptional accessibility of submitted reports in XBRL format,<br />
several research studies focuses on the SEC’s Voluntary Filing Program. Efendi et al.<br />
(2009) were examining the characteristics of voluntary adopters. The authors state<br />
that the number of submitted files and the number of first-time filers in the VFP were<br />
increasing over time, whereas the reporting lag was decreasing (the reporting lag is<br />
the time difference in days between filing date and the reporting period). In addition,<br />
they compared several characteristics of companies taking part in the VFP to their<br />
industry average finding out that voluntary filers are larger, more profitable, and more<br />
innovative (Efendi et al. 2009). The assumption whether or not the number of<br />
reporting lines will also increase over time could not be verified. Premuroso and<br />
Bhattacharya (2008), as well as the study of Callaghan and Nehmer (2009),<br />
empirically investigate the drivers that motivate companies to file annual reports in<br />
XBRL format. Premuroso and Bhattacharya (2008) found that firm-specific factors<br />
like liquidity and firm size influence the decision of firms to be an early and voluntary<br />
filer in XBRL. In another empirical study Callaghan and Nehmer (2009) analyze a<br />
final sample of thirty-nine companies that had been filing their annual reports under<br />
the VFP. They figured out that XBRL adopters are bigger, less financially leveraged,<br />
and have lower corporate governance ratings than their pair-matched control group.<br />
However, comparisons of liquidity, profitability, and external risk measures provide<br />
no evidence of group differences (Callaghan & Nehmer 2009). These results are<br />
partially consistent with studies that analyzed Internet Financial Reporting (IFR) in<br />
the past. For example, Ashbaugh et al. (1999) examined voluntary IFR practices of<br />
firms as a supplement to their traditional financial reporting. They found that firm size<br />
is an important determinant of IFR practices, whereas equity and profitability do not<br />
affect voluntary IFR practices. Craven and Marston (1999) state that IFR practices of<br />
the largest U.K. firms are positively associated to firm-specific characteristics, such as<br />
firm size. Additionally, Ettredge et al. (2002) examined that firm size explain the<br />
disclosures of the same financial reports through the internet as the one filed with<br />
SEC, and size and reputation of a firm have a positive relationship with voluntary<br />
disclosures of all other information.<br />
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3. INDEPENDENT VARIABLES DISCUSSION AND HYPOTHESES<br />
DEVELOPMENT<br />
Voluntary disclosure in XBRL is the process of providing information to the financial<br />
market and interested parties, although this information is not statutorily required by<br />
the enforcing authorities. Thus, voluntary disclosure represents free choices of a<br />
company’s management to provide information in a new format in addition to official<br />
filings, such as 10-Q and 10-K filings. Different theories have been used in prior<br />
studies to explain voluntary disclosure (e.g., Marston and Shrives 1996; Gray et al.<br />
1995). In particular, agency theory may be relevant in the context of voluntary<br />
disclosure in XBRL. Agency theory models the relationship between the principal and<br />
the agent. In this context, the agent (manager) acts on behalf of the principal<br />
(shareholder) (Jensen and Meckling 1976; Eisenhardt 1989). Managers with better<br />
access to a firm’s specific situation can communicate reliable information in XBRL<br />
format to external owners and investors in order to raise capital on the best available<br />
terms (Gray et al. 1995; Bujaki and McConomy 2002). Additional financial and nonfinancial<br />
disclosures may help voluntary filers in XBRL to attract new shareholders,<br />
thus enabling companies to reduce information asymmetries and to enhance the value<br />
of the firm. In an increasingly globalized world, the demand of accounting<br />
information by capital market participants for valuation and investment decisions is<br />
becoming more important (Broberg et al. 2009). It is assumed that as the worldwide<br />
use of XBRL increases, companies will have more incentives to voluntarily provide<br />
useful and timely disclosures.<br />
Many studies have been carried out on the extent of voluntary disclosure and<br />
empirical literature suggests several firm-specific variables that may explain voluntary<br />
disclosures. In considering relevant firm-specific characteristics as proxies for the<br />
degree of variation of voluntary disclosure in XBRL, this paper follows the approach<br />
of Lang and Lundholm (1993). They found that firms that access the capital markets<br />
are more likely to engage in voluntary disclosure. This paper expects the incentives to<br />
be same for the dissemination of information in XBRL, and categorizes according to<br />
Lang and Lundholm (1993) the independent variables into three categories (Lang and<br />
Lundholm, 1993):<br />
1. Structure-related variables (firm size, leverage ratio, and firm age)<br />
2. Performance-related variables (return on assets, current ratio, and<br />
innovativeness level)<br />
3. Market-related variable (auditor type)<br />
3.1 Structure-related variables<br />
Size. Much evidence from past studies has stated a positive and significant<br />
relationship between firm size and extent of disclosure of annual reports (Wallace et<br />
al. 1994; Ahmed 1995; Meek et al. 1995; Zarzeski 1996). Also, Premuroso and<br />
Bhattacharya (2008), as well as Callaghan and Nehmer (2009), state that the variable<br />
firm size is significantly and positively associated with a firm’s decision to be a<br />
voluntary filer of information in XBRL format. Larger firms may tend to disclose<br />
more information for several reasons:<br />
• Large firms have the resources for collecting, analyzing, and presenting<br />
financial data in new formats like XBRL;<br />
~ 739 ~
• Compared to smaller firms larger firms are in the public spotlight; therefore,<br />
they are more likely to disclose more information;<br />
• Large firms are able to attract highly skilled professionals necessary to<br />
introduce more sophisticated management reporting systems;<br />
• Revealing more information may positively impact a firm’s future cost of<br />
obtaining new funds at lower cost (Botosan 1997).<br />
Furthermore, Chow and Wong-Boren (1987) argue that agency costs increase with<br />
firm size, and thus, large firms voluntarily disclose more information to ease agency<br />
conflicts. Therefore, the following hypothesis is tested:<br />
H1: The extent of voluntary disclosure in XBRL is positively related to the firm’s size.<br />
Leverage ratio. A widely held view is that highly leveraged firms may tend to<br />
disclose more information to reassure their creditors regarding their future debt<br />
requirements than less leveraged firms. Particularly, if a firm raises debt in public<br />
security markets, it has more requirements to satisfy the needs of related creditors<br />
than firms with little or no public debt. Firms with higher debts are prone to higher<br />
agency cost and higher agency cost suggests a positive relationship between voluntary<br />
disclosure level and leverage (Fama and Miller 1972). Various studies stated leverage<br />
as a variable positively affecting the extent of voluntary disclosure (Belkaoui and<br />
Kahl 1978; Malone et al. 1993; Naser 1998). However, other studies did not provide a<br />
significant relationship between leverage and extent of disclosure (Carson and<br />
Simnett 1997; Hossain et al. 1994). The following hypothesis is examined:<br />
H2: The extent of voluntary disclosure in XBRL is positively related to leverage.<br />
Firm age. In recent studies the age of a company as an independent variable is<br />
examined. Older firms might have more experience with their financial reporting and,<br />
hence, improved their financial reporting practices over time. With regard to this<br />
study older firms might be more involved in the recent developments of financial<br />
reporting, such as internet financial reporting practices, than young firms. In the study<br />
of Alsaaed (2006) a significantly positive relationship between the age and the<br />
disclosure level could be stated. In contrary, Al Mamum (2009) does not find any<br />
relationship between the age of the company and Human Resource Disclosure<br />
(HRAD). The study tests the following hypothesis:<br />
H3: The extent of voluntary disclosure in XBRL is positively related to the firm’s age.<br />
3.2 Performance-related variables<br />
Return on assets. A firm’s profitability is often measured by its return on assets (e.g.,<br />
Callaghan and Nehmer 2009). Empirical results provide mixed evidence between<br />
profitability measures and the extent of disclosure. For example, Singhvi and Desai<br />
(1971) found that higher profitability might persuade management to supply more<br />
information to illustrate its ability to maximize the shareholders’ value and to increase<br />
its managerial compensation. Similarly, management of a profitable company may be<br />
more willing to disclose more information to the public to signal positive effects of its<br />
performance. In contrast, low profitability may force the management to disclose less<br />
information (Richard 1992). Lang and Lundholm (1993) stated that the link between<br />
the performance and disclosure is rather unclear and, additionally, McNally et al.<br />
~ 740 ~
(1982) found no link between profitability measures and the extent of voluntary<br />
disclosure. Based on the theoretical framework in section 2, it is more likely that<br />
managers of a profitable firm will voluntarily disclose more information in XBRL to<br />
the market to enhance the value of the firm. Therefore, the following hypothesis is<br />
examined:<br />
H4: The extent of voluntary disclosure in XBRL is positively related to the firm’s<br />
profitability.<br />
Liquidity. Liquidity can be defined as the ability of a company to fulfill its short-term<br />
liabilities. Current ratio can be selected as a proxy for liquidity. It may be assumed<br />
that the sounder the financial condition of the firm, the greater the incentives to<br />
disclose more information in XBRL. Premuroso and Bhattacharya (2008) stated that<br />
liquidity is positively associated with the voluntary XBRL filing decision. An<br />
alternative viewpoint on this subject may be that firms with a weak financial position<br />
have greater incentives to voluntarily disclose more information in order to mitigate<br />
fears in the capital markets (Camfferman and Cooke 2002). Similar to the<br />
performance-related variables like return on assets, the empirical evidence regarding<br />
the relationship between liquidity and the extent of disclosure is not clear. Cooke<br />
(1989) stated that the more liquid the financial condition of the firm, the greater the<br />
incentive for it to disclose and signal its strength to the market. In contrast, Belkaoui<br />
and Kahl (1978), as well as Malone et al. (1993), found no relationship between<br />
liquidity and firm disclosure, while Wallace et al. (1994), as well as Camfferman and<br />
Cooke (2002), found a significantly negative relationship. I believe that filers in the<br />
VFP signal their strong financial condition and therefore disclose more information in<br />
order to meet current obligations to short-term lenders or suppliers (Premuroso and<br />
Bhattacharya 2008). In this study the following hypothesis is tested:<br />
H5: The extent of voluntary disclosure in XBRL is positively related to the firm’s<br />
liquidity.<br />
Innovativeness. Certainly, there is a link between innovation and Research &<br />
Development (R&D) (Staw 1976; Staw and Ross 1978; Fox and Staw 1979). R&D<br />
can be seen as the organizational process most directly involved with innovations.<br />
Firms have incentives to invest in R&D if post-innovation market competition allows<br />
them to profit from their investments. The ratio of R&D expenditures to sales can be<br />
used as a measure for input in innovation. Prior research examined the value<br />
relevance of R&D Expenditures (Lev and Sougiannnis 1996; Chan et al. 2001). To the<br />
best of my knowledge, only one study, done by Efendi et al. (2009), has examined the<br />
effect of innovativeness of a firm on the likeliness of voluntary filing in XBRL<br />
format. They state in their descriptive analysis that adopters are likely to be more<br />
innovative firms as they spent on average 4.5% of sales amount for R&D compared to<br />
only 2.9% the industry average. The innovativeness of a firm seems to be an<br />
important issue for research in XBRL. Since XBRL technology is a new format in<br />
business reporting, R&D intensive companies in science- and knowledge based<br />
industries might have a great interest in innovative trends in business reporting. The<br />
prospects of R&D intensive firms are tied to the success of new technologies (Chan et<br />
al. 2001). Based on their business environment and the experiences of many research<br />
projects, these firms might be willing to disclose more information. In comparison to<br />
their long-term investments in R&D projects that are highly unpredictable, the<br />
implementation of XBRL technology in business reporting is quite short and the<br />
~ 741 ~
usefulness not limited in time (Debreceny et al. 2002; Debreceny et al. 2010).<br />
Therefore, this hypothesis is tested:<br />
H6: The extent of voluntary disclosure in XBRL is positively related to the level of<br />
innovativeness of the firm.<br />
3.3 Market-related variable<br />
Auditor type. Worldwide audit firms are divided into the Big 4 and the non-Big 4. The<br />
Big 4 firms are widely spread and operate globally while non-Big 4 audit firms<br />
operate primarily in their domestic countries. Empirical evidence on the relationship<br />
between audit firm size and the extent of disclosure is rather ambiguous. Craswell and<br />
Taylor (1992), Ahmed (1995), Raffournier (1995), Mahmood (1999), Camfferman<br />
and Cooke (2002), and Naser et al. (2002) all stated a positively significant<br />
relationship. In opposition to these findings, Wallace and Naser (1995) noticed a<br />
significantly negative relationship between the disclosure level and audit firm size.<br />
Presently, all Big 4 audit firms are members of XBRL International. Therefore, I<br />
expect that the Big 4 firms encourage their global clients to report in XBRL format in<br />
order to ensure compliance with international regulations regarding financial<br />
reporting. Also, Owusu-Ansah (1998) argues that audit firms can play a major role in<br />
influencing policies and disclosure practices of their clients.<br />
H7: The extent of voluntary disclosure is larger for companies audited by a Big-4<br />
audit firm.<br />
4. RESEARCH METHODOLOGY AND STATISTICAL DESIGN<br />
4.1. Sample Selection and Data Collection<br />
The study focuses on U.S. listed firms that voluntarily disclosed their annual reports<br />
of 2008 in XBRL format on the well-developed U.S. VFP (http://viewerprototype1.<br />
com/viewer) (Viewer 1). The purpose of the VFP is to encourage firms to voluntarily<br />
file reports using the XBRL format. XBRL filings on the VFP are accessible for every<br />
interested person and, hence, useful for several research questions. This program was<br />
launched by the SEC on the EDGAR System on March 16, 2005. Additionally,<br />
voluntary filings were compared with the Bowne Interactive XBRL Viewer<br />
(https://xbrlviewer.bowne.com/) (Viewer 2) in order to ensure that all data was<br />
collected correctly. Adjustments were made for mutual funds, subsidiaries, and non-<br />
U.S. issuers as well as for U.S. firms from the banking/insurance industry. Financial<br />
data required for the firm-specific characteristics was obtained using the database<br />
Infinancials (www.infinancials.com) or obtained directly from the firm’s latest audited<br />
annual report. Considering there are approximately 4,500 companies listed on NYSE<br />
and NASDAQ (Efendi et al. 2008), the final sample covers only 51 U.S. listed firms<br />
and includes all voluntary filed annual reports of 2008.<br />
~ 742 ~
Table 1. Overview of Sample firms<br />
Nr. CIK Firms Country<br />
~ 743 ~<br />
SIC-<br />
Code<br />
36 INFY Infosys Technologies India 7371<br />
37 IP International Paper USA 2621<br />
38 ITRI Itron Inc USA 3825<br />
39 LBTYA Liberty Global Inc USA 4841<br />
40 MSFT Microsoft Corp USA 7372<br />
Comments<br />
Foreign<br />
Incorporation<br />
1 ABB ABB Ltd Schwitzerland 3613<br />
2 ADBE Adobe Systems Inc USA 7372<br />
3 AES AES Corp USA 4991<br />
4 AGL AGL Resources Inc USA 4924<br />
5 AA Alcoa Inc USA 3350<br />
6 FCL Alpha Naturals Resources Inc USA 1221<br />
7 AMED Amedisys Inc USA 8082<br />
8 AEP American Electric Power Inc USA 4911<br />
9 ASML ASML Holding NV Netherlands 3559<br />
Foreign<br />
Incorporation<br />
10 ADSK Autodesk Inc USA 7372<br />
11 ADP Automatic Data Processing Inc<br />
Broadridge Financial Solutions<br />
USA 7374<br />
12 BR Inc USA 6199<br />
13 CAR Carolina Power & Light Co USA 4911 Subsidiary<br />
14 CVX Chevron Corp USA 2911<br />
Bank, Brokerage<br />
15 CME CME Group USA 6200 etc.<br />
16 CXG CNX Gas Corp USA 1311<br />
17 COCA Coca Cola Enterprises Inc USA 2086<br />
18 CMCSA Comcast Corp USA 4841<br />
19 CMA Comerica USA 6021 Commercial Bank<br />
20 CNX Consol Energy Inc USA 1221<br />
21 CSX CSX Corp USA 4011<br />
22 DD Dupont E I De Nemours & Co USA 2820<br />
23 EDGR Edgar Online Inc USA 7389<br />
24 ENG Englobal Corp USA 8711<br />
25 ERIE Erie Indemnity Co USA 6411<br />
26 FAST Fastenal Co USA 5200<br />
27 FLORIDA Florida Power Corp USA 4911 Subsidiary<br />
28 FLR Fluor Corp USA 1600<br />
29 FORD Ford Motor Credit Corp USA 6159 Subsidiary<br />
30 GE General Electric Co USA 3600<br />
31 GIS General Mills Inc<br />
Hancock John Sovereign Bond<br />
USA 2040<br />
32<br />
Fund USA Fund<br />
33 HCP HCP Inc USA 6798<br />
34 IBM IBM USA 3570<br />
35 ICUI ICU Medical Inc USA 3841<br />
Foreign<br />
Incorporation<br />
41 NDAQ Nasdaq Omx Group, Inc USA 6200<br />
42 NETC Net Servicos De Comunicacao SA Brazil 4841<br />
43 NEM Newmont Mining Corp USA 1040<br />
44 NBL Noble Energy Inc USA 1311<br />
45 NOC Northrop Grumman Corp USA 3812<br />
Bank, Brokerage<br />
etc.<br />
Foreign<br />
Incorporation
Nr. CIK Firms Country<br />
~ 744 ~<br />
SIC-<br />
Code<br />
46 NYSE NYSE Euronext USA 6200<br />
47 OMC Omnicom Group Inc USA 7311<br />
48 ONNN On Semiconductor Corp USA 3674<br />
49 OTEX Open Text Corp Canada 7373<br />
50 PZZA Papa Johns Intl. Corp USA 5812<br />
51 PEP Pepsico Inc USA 2080<br />
52 PCG PG & E Corp USA 4931<br />
53 PBI Pitney Bowes Inc USA 3579<br />
54 PX Praxair USA 2810<br />
55 PGN Progress Energy Inc USA 4911<br />
56 PLD Prologis USA 6798<br />
57 RRD RR Donnelley & Sons Co USA 2750<br />
58 SD Sandridge Energy Inc USA 1311<br />
59 LUV Southwest Airlines Co USA 4512<br />
60 TEVA TEVA Ph. Industires Ltd Israel 2834<br />
61 UPL Ultra Petroleum Corp USA 1311<br />
62 UTX United Technologies Corp USA 3724<br />
63 UNH Unitedhealth Group Inc USA 6324<br />
64 WU Western Union Corp USA 7389<br />
65 XRX Xerox Corp USA 3577<br />
4.2. Disclosure Index Construction<br />
Comments<br />
Bank, Brokerage<br />
etc.<br />
Foreign<br />
Incorporation<br />
Foreign<br />
Incorporation<br />
A disclosure index was constructed to measure the level of disclosure by listed firms.<br />
The literature on the use of indexes is divided between unweighted and weighted<br />
indexes. Regarding the unweighted index, dichotomous scores are used. “0” is given<br />
for non-disclosure and “1” is given for a disclosure item. The unweighted scoring<br />
approach assumes that each item of disclosure is equally important. The weighted<br />
index is based on the rank a user of the annual report attaches to the information<br />
disclosure item. The supporters of weighted indexes believe that such a score reflects<br />
both the extent and importance of each disclosure item (Robbins & Austin 1986). The<br />
criticism of the weighted index is due to the fact that this index is subjectivity based<br />
on the ranking by the researcher(s) or by a number of financial statement user(s)<br />
(Naser and Nuseibeh 2003). The use of an unweighted index has been critized on its<br />
assumption that all disclosed items are equally important (Barako et al. 2006).<br />
However, previous research studies stated support for the notion that there is no<br />
significant difference between weighted and unweighted disclosure indexes (Spero<br />
1979; Chow and Wong-Boren 1987). For the scope of this study, the unweighted<br />
index was chosen. Based on this study’s definition of voluntary disclosure as being an<br />
offer of information via the SEC’s VFP in addition to official 10-Q and 10-K filings,<br />
the contents of all voluntary filings in XBRL format were examined. The unweighted<br />
checklist consists of 54 items. For the purpose of detailed analysis the checklist was<br />
categorized into three main categories as follows: financial, non-financial, and general<br />
information. Financial information that is tagged can be the consolidated balance<br />
sheet. An example for a non-financial item, which is voluntarily filed in the VFP, is<br />
the accounting policies of a firm. Non-financial items predominantly refer to positions<br />
in the balance sheet or income statement, while general information does not have a<br />
concrete reference to the financial parts of an annual report. The category financial
information covers 40 items, non-financial information 10 items, and general<br />
information 4 items. Thus, voluntary U.S. filers in XBRL format predominantly focus<br />
on disclosing tagged financial information. Financial information has obvious<br />
decision relevance to investors in the capital market (Gray et al. 1995). However,<br />
table 2 also shows that 31 firms of my sample filed notes in the VFP and 44 firms<br />
disclosed MD&A in their XBRL filings. Contrary to the study of Boritz and No<br />
(2008) these results show that firms invest significant time and effort to voluntarily<br />
file their notes and MD&A in XBRL (Boritz and No 2008). It is important to note if<br />
notes are included, they must be included in their entirety.<br />
Table 2. Number of Voluntary Disclosure Items by Category<br />
Financial Information<br />
1 (Consolidated) Income Statement 51<br />
• (Consolidated) Income Statement Parenthetical<br />
• (Consolidated) Income Statement (Including Gross Margin)<br />
• (Consolidated) Income Statement (Excluding Gross Margin)<br />
2 (Consolidated) Statement of (other) Comprehensive Income 8<br />
3 (Consolidated) Balance Sheet 15<br />
• (Consolidated) Balance Sheet Parenthetical<br />
4 (Consolidated) Statement of Cash Flows 50<br />
• (Consolidated) Statement of Cash Flows Direct Method<br />
• (Consolidated) Statement of Cash Flows Indirect Method<br />
• Cash Flow Supplemental<br />
5 (Consolidated) Statement of Stockholders Equity 50<br />
• (Consolidated) Statement of Stockholders Equity Parenthetical<br />
6 (Consolidated) Statement of Financial Position 38<br />
7 Schedules 4<br />
8 Statement of Partners' Capital 1<br />
9 Interim Reporting 2<br />
10 Cash and Cash Equivalents 2<br />
11 Receivables, Loans, Notes Receivable, and Others 4<br />
12 Investments, Debt and Equity Securities 5<br />
13 Deferred Costs, Capitalized, Prepaid, and Other Assets 2<br />
14 Property, Plant, and Equipment 5<br />
15 Intangible Assets, Goodwill and Other 4<br />
16 Payables and Accruals 2<br />
17 Exit Or Disposal Cost Obligations 3<br />
18 Deferred Revenue 2<br />
19 Debt 5<br />
20 Other Liabilities 4<br />
21 Equity 5<br />
22 Other Income and Expenses 1<br />
23 Research and Development 1<br />
24 Income Taxes 5<br />
25 Discontinued Operations and Disposal Groups 1<br />
26 (Net) Earnings Per Share 5<br />
27 Segment Reporting 6<br />
28 Statement of Cash Flows, Supplemental Disclosures 3<br />
29 Derivative Instruments and Hedging Activities 4<br />
30 Fair Value Measures and Disclosures 3<br />
31 Foreign Operations and Currency Translation 1<br />
32 Leases, Operating 1<br />
33 Inventory 3<br />
34 SEC Schedule, Article 12-15 1<br />
35 SEC Schedule, Article 12-17 3<br />
36 SEC Schedule, Article 12-18 1<br />
37 Unconsolidated Investees 1<br />
38 Assets Held for Sale and Discontinued Operations 1<br />
39 Long term Compensation 1<br />
40 Selected Quarterly Financial Data 1<br />
Total Disclosures: 305<br />
~ 745 ~
Non-Financial Information<br />
1 Notes to the (consolidated) Financial Statements 31<br />
2 Accounting Changes and Error Corrections 1<br />
3 Accounting Policies 6<br />
4 Commitment and Contingencies 6<br />
5 Compensation Related Costs, General 1<br />
6 Compensation Related Costs, Share Based Payments 3<br />
7 Compensation Related Costs, Retirement Benefits 4<br />
8 Business Combinations 5<br />
9 Minority Interest 1<br />
10 Subsequent Event 1<br />
Total Disclosures: 59<br />
General Information<br />
1 Organization, Consolidation and Presentation of Financial Statements 1<br />
2 Document and Entity Information 2<br />
3 Uncategorized Items 4<br />
4 Management Discussion and Analysis 44<br />
Total Disclosures: 51<br />
The scoring rewards both quantitative and qualitative information. Consistent with<br />
most previous disclosure studies, I use the dichotomous scoring where “1” is assigned<br />
when an item is disclosed and “0” otherwise. The extent of voluntary disclosure over<br />
all 54 items was measured by a disclosure index (DIj) calculated as follows:<br />
DI<br />
j<br />
n j<br />
∑<br />
i=<br />
xij<br />
=<br />
n<br />
1 ,<br />
Where:<br />
nj = 54;<br />
xij = 1 if ith (applicable) item is disclosed and 0 otherwise;<br />
so that 0 ≤ DIj ≤ 1.<br />
Additionally, disclosure indexes based on the categories financial (40 items), nonfinancial<br />
(10 items), and general information (4 items) were calculated. Table 3 shows<br />
the scores over all 54 items as well as the scores of the three subcategories.<br />
No. Firms<br />
Table 3. Index Scores of sample firms<br />
Overall<br />
Disclosures<br />
XBRL<br />
Index-Score<br />
(54 items)<br />
~ 746 ~<br />
j<br />
Financial<br />
Information<br />
Index-Score<br />
(40 items)<br />
Nonfinancial<br />
Information<br />
Index-Score<br />
(10 items)<br />
1 Adobe Systems Inc 0.7778 0.7750 0.70 1.00<br />
2 AES 0.1296 0.1250 0.10 0.25<br />
3 AGL Resources Inc 0.2778 0.2500 0.40 0.25<br />
4 Alcoa Inc 0.1111 0.1000 0.10 0.25<br />
5 Alpha Natural Resources 0.0926 0.1000 0.00 0.25<br />
6 Amedisys 0.1111 0.1000 0.10 0.25<br />
7 American Electric Power 0.1111 0.1000 0.10 0.25<br />
8 Autodesk Inc 0.0741 0.1000 0.00 0.00<br />
9 Automatic Data Processing Inc 0.0741 0.1000 0.00 0.00<br />
10 Broadridge Financial Solutions Inc 0.0926 0.1000 0.10 0.00<br />
11 Chevron Corp 0.1296 0.1250 0.10 0.25<br />
12 CNX Gas Corp 0.1111 0.1000 0.10 0.25<br />
13 Coca Cola Enterprices Inc 0.0926 0.1000 0.00 0.25<br />
General<br />
Information<br />
Index-Score<br />
(4 items)
No. Firms<br />
Overall<br />
Disclosures<br />
XBRL<br />
Index-Score<br />
(54 items)<br />
~ 747 ~<br />
Financial<br />
Information<br />
Index-Score<br />
(40 items)<br />
Nonfinancial<br />
Information<br />
Index-Score<br />
(10 items)<br />
14 Comcast Corp 0.1296 0.1250 0.10 0.25<br />
15 Consol Energy Inc 0.1111 0.1000 0.10 0.25<br />
16 CSX Corp 0.1111 0.1000 0.10 0.25<br />
17 Du Pont E I De Nemours & Co 0.1111 0.1000 0.10 0.25<br />
18 Edgar Online Inc 0.1111 0.1000 0.10 0.25<br />
19 Englobal Corp 0.0370 0.0500 0.00 0.00<br />
20 Erie Indemnity 0.1852 0.1750 0.10 0.50<br />
21 Fastenal Co 0.1111 0.1000 0.10 0.25<br />
22 Fluor Corp 0.1111 0.1000 0.10 0.25<br />
23 General Electric Co 0.0926 0.1000 0.00 0.25<br />
24 General Mills Inc 0.0741 0.1000 0.00 0.00<br />
25 HCP Inc 0.1296 0.1250 0.10 0.25<br />
26 Icu Medical Inc 0.0926 0.1000 0.00 0.25<br />
27 International Paper 0.1111 0.1000 0.10 0.25<br />
28 IBM 0.1481 0.1500 0.10 0.25<br />
29 Itron Inc 0.0926 0.1000 0.00 0.25<br />
30 Liberty Global Inc 0.1296 0.1250 0.10 0.25<br />
31 Microsoft Corp 0.4074 0.4000 0.40 0.50<br />
32 Newmont Mining Corp 0.1296 0.1250 0.10 0.25<br />
33 Noble Energy Inc 0.1111 0.1000 0.10 0.25<br />
34 Northrop Grumman Corp 0.1296 0.1250 0.10 0.25<br />
35 Omnicom Group Inc 0.0926 0.1000 0.00 0.25<br />
36 On Semiconductor Corp 0.1111 0.1000 0.10 0.25<br />
37 Papa Johns Int Co 0.1296 0.1250 0.10 0.25<br />
38 Pepsico Inc 0.0926 0.1000 0.00 0.25<br />
39 PG & E Corp 0.0926 0.1000 0.00 0.25<br />
40 Pitney Bowes Inc 0.1111 0.1000 0.10 0.25<br />
41 Praxair 0.0926 0.1000 0.00 0.25<br />
42 Progress Energy Inc 0.1296 0.1250 0.10 0.25<br />
43 Prologis 0.4815 0.5000 0.50 0.25<br />
44 R.R. Donnelley & Sons Co 0.1111 0.1000 0.10 0.25<br />
45 Sandridge Energy Inc 0.1111 0.1000 0.10 0.25<br />
46 Southwest Airlines Co 0.0926 0.1000 0.00 0.25<br />
47 Ultra Petroleum Corp 0.1296 0.1250 0.10 0.25<br />
48 United Technologies Corp 0.3889 0.4000 0.40 0.25<br />
49 Unitedhealth Group Inc 0.1111 0.1000 0.10 0.25<br />
50 Western Union Co 0.1296 0.1250 0.10 0.25<br />
51 Xerox Corp 0.4259 0.4500 0.40 0.25<br />
4.2. Model Development<br />
General<br />
Information<br />
Index-Score<br />
(4 items)<br />
Earlier discussion has suggested that there is no theoretically correct way to describe<br />
the link between dependent and independent variables (Lang and Lundholm 1993;<br />
Cooke 1998). Therefore, Lang and Lundholm (1993), as well as Wallace et al. (1994),<br />
suggested the use of ranked (OLS) regression as a technique for coping with data sets<br />
with non-linear and monotonic relations between dependent and independent<br />
variables (Lang and Lundholm 1993). Following Camfferman and Cooke (2002) and<br />
Alsaeed (2006), this study uses the unranked OLS approach. It is worth noting that the<br />
essence of the quality of disclosure as the dependent variable is not firmly defined.<br />
Wallace et al. (1994), as well as Camfferman and Cooke (2002), used the term of<br />
comprehensiveness. Following Patton and Zelenka (1997), I use the term of extent as<br />
the dependent variable.
The full specification of the regression is:<br />
Disclosure Index Scores = β + β Size + β Leverage + β Age + β ROE + β Liquidity +<br />
β Innovativeness<br />
+ β Auditor + ε<br />
6<br />
0<br />
1<br />
2<br />
Size = Log of the book value of total assets (in millions of U.S. $)<br />
Leverage = Leverage ratio (total liabilities divided by total assets)<br />
Age = Log of the age of firm (in years)<br />
ROA = net income divided by the average of the last two year’s total<br />
assets<br />
Liquidity = current assets divided by current liabilities<br />
Innovativeness = research & development expenditures divided by net sales<br />
Auditor type = Big 4 audit firm = 1 and non-Big 4 audit firm = 0<br />
β = Slopes of the independent variables while β 0 is a constant or<br />
the value of Y when X values are zero.<br />
ε = The error term, normally distributed about a mean of 0.<br />
i<br />
5. ANALYSIS AND DISCUSSION OF RESULTS<br />
5.1. Descriptive Results<br />
Table 4 presents the descriptive statistics for the dependent and independent variables.<br />
There is a wide range of variation within the disclosure indexes as indicated by the<br />
minimum and maximum values. The disclosure index over all 54 items vary between<br />
sample firms and range from 3.7% to 77.8%. The mean of the overall index is 15.1%.<br />
The low amount of items disclosed in the last year of the VFP could be explained on<br />
the basis that XBRL is still a relatively new technology in business reporting. Thus,<br />
the preparations of XBRL documents are based on very limited guidance and<br />
experience. As assumed, within the information subgroups the mean of the index of<br />
financial information is the highest (14.95%), followed by the subgroups nonfinancial<br />
information (11.57%) and general information (2.5%). Table 4 also shows<br />
the considerable variation in the independent variables, which reflects the diversity of<br />
voluntary filers in XBRL. For example, the youngest firm that files in XBRL format<br />
is three years old. In contrast, the oldest firm is 206 years old. 14 firms in my sample<br />
had R&D activities. The maximum value of the innovativeness level is 24.9%. Not<br />
surprisingly, the majority of voluntary filers use Big 4 firms for their annual audits.<br />
7<br />
~ 748 ~<br />
3<br />
i<br />
4<br />
5
Table 4. Sample Characteristics<br />
Variables<br />
Dependent Variables<br />
N Min Max<br />
Standard<br />
Deviation<br />
Mean Median<br />
INDEX_All 51 0.037 0.778 0.128 0.151 0.111<br />
INDEX_FINANCIAL 51 0.05 0.7750 0.1291 0.1495 0.10<br />
INDEX_NON-<br />
FINANCIAL<br />
51 0.00 0.70 0.1419 0.1157 0.10<br />
INDEX_GENERAL 51 0.00 1.00 0.1414 0.025 0.025<br />
Independent Variables<br />
Size a b 51 13.00<br />
6<br />
797,769.0 112,895.1 39,445.2 14,308.0<br />
Leverage 51 0.107 1.022 0.195 0.670 0.694<br />
Firm Age a 51 3.000 206.000 51.847 65.824 46.000<br />
ROA 51 -<br />
0.400<br />
0.227 0.1084 0.043 0.054<br />
Liquidity 51 0.116 8.169 1.433 1.530 1.120<br />
Innovativeness 51 0.000 0.249 0.056 0.025 0.000<br />
Industry type 51 0.000 1.000 0.476 0.333 0.000<br />
Auditor type 51 0.000 1.000 0.238 0.941 1.000<br />
Notes: a size and firm age are provided only for sample characteristics. In the regression<br />
analysis, log of these values are applied. b total assets figures are in million US-$.<br />
By analyzing the annual reports of 2008, only one company disclosed at least 70% of<br />
54 items contained in the overall disclosure index (Table 5). Fifteen companies<br />
(29.41%) disclosed equal to or less than 10% of items. Thirty companies (58.82%)<br />
reached a disclosure score between 11-20%.<br />
Table 5. Voluntary Corporate Disclosure Scores overall 54 items<br />
Items INDEX_ALL No. of companies %<br />
50 1 1.96%<br />
5.2. Multiple Regression Results<br />
In the next step a check of multicollinearity among the independent variables was<br />
performed. The situation where two or more of the independent variables are highly<br />
correlated can have damaging effects on the results of the multiple regression<br />
analysis. Table 6 reveals a number of significant correlations between several<br />
independent variables. For instance, size has significant correlations with leverage,<br />
age, liquidity, innovativeness, and auditor type. Table 6 also shows a significant<br />
correlation between the dependent variable and innovativeness. This suggests the<br />
potential for at least hypothesis 6 to be supported. A coefficient is considered high if it<br />
exceeds +/- 0.80 (Gujarati 1988; Shannon and Davenport 2001). Based on Table 6 the<br />
independent variables do not suffer from the problem of multicollinearity (However,<br />
multicollinearity can still exist even when none of the coefficients are very high. This<br />
is the case when one independent variable may be an approximate linear function of a<br />
set of several independent variables. Another way to assess multicollinearity is the<br />
~ 749 ~
variance inflation factor (VIF). The variance inflation factor (VIF) quantifies the<br />
severity of multicollinearity in an ordinary least squares regression analysis. The<br />
highest VIF is 2.239. Hence, collinearity did not appear to be a serious problem in<br />
interpreting the regression results.).<br />
Table 6. Correlation Matrix with Overall Disclosure Index<br />
Index<br />
ALL<br />
Size Leverage Age ROA Liquid.<br />
Innovativeness<br />
Index<br />
ALL<br />
1.000<br />
Size 0.127 1.000<br />
Leverage -<br />
0.220<br />
0.334* 1.000<br />
Age -<br />
0.101<br />
0.470** 0.239 1.000<br />
ROA 0.130 0.079 -0.434** 0.208 1.000<br />
Liquid. 0.162 -0.302* -0.587** -0.034 0.220 1.000<br />
Innovativeness<br />
0.366* -0.285* -0.231 -0.187 -0.069 0.115 1.000<br />
~ 750 ~<br />
Auditor<br />
Auditor 0.115 0.471** 0.102 0.272 0.112 0.096 -0.190 1.000<br />
*. Correlation is significant at the 0.05 level (2-tailed).<br />
**. Correlation is significant at the 0.01 level (2-tailed).<br />
Multiple regression analysis was used to answer the question if there is an influence<br />
of several firm-specific characteristics on the extent of voluntary disclosure over all<br />
disclosure items in XBRL (the dependent variable in the analysis). Moreover,<br />
regression analysis was performed for the three information subgroups as dependent<br />
variables in order to assess factors explaining the extent of disclosures within the<br />
subgroups. Thus, the study ran four regressions. Table 7 reports the model summaries<br />
for the overall voluntary disclosures and for each of the three information subgroups.<br />
The results are statistically significant both on an overall basis (10%-level) and by<br />
financial information type (5%-level), whereas the statistical model of the<br />
subcategories non-financial and general information is not significant. Table 7<br />
indicates adjusted R2 of 16.6% (F-ratio 2.426, p=0.035), which shows that a moderate<br />
percentage of the overall disclosure index as the dependent variable can be explained<br />
by variations in the entire set of independent variables. Premuroso and Bhattacharya<br />
(2008) reported in their empirical study about voluntary XBRL filers a higher<br />
adjusted R2 of 0.333, but with a smaller sample of firms and less independent<br />
variables. Compared to the empirical literature in voluntary disclosure, lower adjusted<br />
R2 statistics were reported by Wallace (1988) at 0.07, whereas higher adjusted R2<br />
statistics were reported by Wallace et al. (1994) at 0.6050, Ahmed (1995) at 0.332,<br />
and Camfferman and Cooke (2002) at 0.193 (This value is for the Dutch sample. For<br />
the UK sample an adjusted R 2 of 0.231 was reported.). The amount of explained<br />
variation in disclosure subgroups ranges from 18.3% in the case of financial<br />
information to 7.3% for general information, with non-financial information in<br />
between at 6.7%.
Table 7. Model summaries for overall disclosure items and information subgroups<br />
Items Adjusted R 2 Overall Items<br />
F Sig.<br />
Financial Items<br />
0.166<br />
2.426 0.035**<br />
Non-Financial Items<br />
0.183<br />
2.603 0.025**<br />
General Items<br />
0.067<br />
1.513 0.188<br />
0.073<br />
1.564 0.172<br />
* significant at 10% level.<br />
** significant at 5% level.<br />
~ 751 ~<br />
Durbin-<br />
Watson<br />
The results of the OLS regression for the overall disclosure index show that firm size<br />
and the level of innovativeness are statistically significant, with the hypothesized<br />
direction (table 8). In contrast, leverage, firm age, ROA, liquidity, and auditor type<br />
were found not to be statistically significant. The variable firm size is significant at<br />
the five percent level (p=0.026) with a positive coefficient (0.026). The most<br />
significant variable in the model is the level of innovativeness, which has a p-value of<br />
0.004. The coefficient is positive (0.954). Table 8 indicates that the same independent<br />
variables are not consistently statistically significant across information types. Size is<br />
an important variable explaining the voluntary disclosures of the subcategory<br />
financial information. The variable innovativeness is statistically significant for each<br />
of the three information subgroups, but the level of significance changes. Thus,<br />
different factors are important in explaining the voluntary disclosures of different type<br />
of information.<br />
Model:<br />
Disclosure<br />
Independent<br />
Variables<br />
1.648<br />
1.697<br />
1.655<br />
1.460<br />
Table 8. Regression results for overall disclosures and subgroups<br />
Index Scores<br />
Exp.<br />
Sign<br />
= β + β Size + β Leverage + β Age + β ROE + β Liquidity +<br />
β Innovativeness<br />
+ β Auditor + ε<br />
6<br />
0<br />
1<br />
Overall<br />
Coefficient<br />
(t-statistics)<br />
Constant -0.022<br />
(-0.174)<br />
Size + 0.026<br />
(2.169)**<br />
Leverage + -0.052<br />
(-0.408)<br />
Firm Age + -0.028<br />
(-1.354)<br />
ROA + 0.107<br />
(0.587)<br />
Liquidity + 0.014<br />
(0.877)<br />
Innovativeness + 0.954<br />
(3.023)***<br />
Auditor + 0.029<br />
(0.348)<br />
** significant at 5% level.<br />
*** significant at 1% level.<br />
2<br />
7<br />
Financial<br />
Coefficient<br />
(t-statistics)<br />
-0.035<br />
(-0.282)<br />
0.027<br />
(2.285)**<br />
-0.038<br />
(-0.304)<br />
-0.030<br />
(-1.472)<br />
0.127<br />
(0.694)<br />
0.015<br />
(0.969)<br />
0.991<br />
(3.143)***<br />
0.025<br />
(0.300)<br />
3<br />
i<br />
4<br />
Non-Financial<br />
Coefficient<br />
(t-statistics)<br />
0.005<br />
(0.033)<br />
0.023<br />
(1.647)<br />
-0.097<br />
(-0.650)<br />
-0.026<br />
(-1.086)<br />
0.078<br />
(0.361)<br />
0.004<br />
(0.229)<br />
0.872<br />
(2.353)**<br />
0.035<br />
(0.359)<br />
5<br />
General<br />
Coefficient<br />
(t-statistics)<br />
0.047<br />
(0.324)<br />
0.019<br />
(1.384)<br />
-0.072<br />
(-0.486)<br />
-0.008<br />
(-0.329)<br />
-0.014<br />
(-0.067)<br />
0.023<br />
(1.274)<br />
0.788<br />
(2.141)**<br />
0.054<br />
(0.554)
5.3. Discussion of findings<br />
The findings of this study are supported by the findings of some previous studies of<br />
voluntary disclosure, but are also contrary to the findings of other previous studies.<br />
The significant findings on firm size are consistent with most previous international<br />
studies (e.g., Lang and Lundholm 1993; Raffournier 1995; Craven and Marston 1999;<br />
Debreceny et al. 2002). Similar to Premuroso and Bhattacharya (2008), this study also<br />
states a significant effect on the five percent level (p
(Healy and Palepu 2001). Finally, the empirical findings and conclusions of this study<br />
are limited to one type of corporate communication, namely the annual report. The<br />
annual report is not the only way that information is disseminated to investors,<br />
analysts, and other capital market participants.<br />
Since the spread of XBRL is worldwide, the current stage of development offers<br />
researchers significant opportunities. It might be interesting to replicate this study<br />
based on a larger sample size from another voluntary filing program. Therefore,<br />
extending the study by countries that are openly advocating early XBRL adoption like<br />
Japan, Germany, and the United Kingdom, might help to point out similarities and<br />
differences in voluntary disclosure in XBRL. Future research could assess the extent<br />
of disclosure of privately held and financial firms. In many countries in Europe, such<br />
as Germany, also not-listed firms have the option to file their annual reports in XBRL<br />
format. Furthermore, future research could incorporate other independent variables<br />
that may affect the behaviour of management. Finally, the effect of XBRL on<br />
corporate cost of capital issues is widely unknown.<br />
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Wagenhofer, A. (2003) „Economic consequences of internet financial reporting”,<br />
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~ 757 ~
PS16 SMEs<br />
Chairperson<br />
Jiri STROUHAL, University of Economics Prague,<br />
Czech Republic<br />
OBLIGATION OR OPPORTUNITY FOR DRAWING<br />
THE CASH-FLOW STATEMENT. THE CASE<br />
OF ROMANIAN SMALL AND MEDIUM ENTERPRISES<br />
Adina POPA, Rodica BLIDISEL, Nicoleta FARCANE, Dan STIRBU<br />
ROMANIAN PROFESSIONAL ACCOUNTANTS’<br />
PERCEPTION ON THE DIFFERENTIAL FINANCIAL<br />
REPORTING FOR SMALL AND MEDIUM-SIZED<br />
ENTERPRISES<br />
Stefan BUNEA, Marian SACARIN, Mihaela MINU<br />
ACCOUNTING PRINCIPLES AND BOOK-TAX<br />
(DIS)CONNECTION IN ROMANIA<br />
Costel ISTRATE<br />
~ 758 ~
OBLIGATION OR OPPORTUNITY FOR DRAWING<br />
THE CASH-FLOW STATEMENT. THE CASE<br />
OF ROMANIAN SMALL AND MEDIUM ENTERPRISES<br />
Adina POPA 1<br />
“Eftimie Murgu” University of Resiţa, Romania<br />
Rodica BLIDISEL, Nicoleta FARCANE & Dan STIRBU<br />
West Univesity of Timisoara, Romania<br />
ABSTRACT<br />
This paper aims to assess the extent to which Romanian SMEs are prepared for the transition<br />
to IFRS standards. A quantitative survey addressed to the practitioners and accountants in<br />
the small and medium enterprises from the western area of Romania is made in order to<br />
establish the degree of perception regarding the importance and usefulness of cash flow<br />
statement. The results show that there are differences between the views of staff specialized in<br />
financial and accounting departments who have used this instrument and who did not use,<br />
emphasizing difficulties encountered and illustrates the usefulness of this tool in the financial<br />
information necessary for decision making.<br />
KEYWORDS: SMEs in the western region of Romania, IFRS, cash flow, accountants and<br />
management perception<br />
1. CONCEPTUAL FRAMEWORK AND DEVELOPMENT OF<br />
ASSUMPTIONS<br />
The emergence of International Financial Reporting Standards (IFRS) for Small and<br />
Medium-Sized Enterprises (IFRS for SMEs) determined us to make assessments on<br />
the extent to which Romanian companies in this category are prepared for the<br />
transition to this set of standards. Unlike the case of listed companies, in 2007 the<br />
European Union stated that there is no intention for IFRS to become mandatory for<br />
SMEs (Nolke and Perry, 2007). Before adopting IFRS for SMEs both at national and<br />
at company level, it is very important for all parties involved to be aware of pros and<br />
cons both in the view of users and producers of financial information.<br />
From the perspective of our study, we were interested particularly in aspects related to<br />
cash-flow statements. According to IFRS for SMEs, this statement is a mandatory<br />
reporting, being part of the financial reports. The transition to the application of IFRS<br />
for SMEs involves a different way of thinking and applying of working rules and<br />
procedures at the level of SMEs. Therefore, the role of human resources with financial<br />
and accounting knowledge and specialised studies is essential for SMEs in the context<br />
of the implementation of the new accounting standards.<br />
1<br />
Correspondence address: Adina POPA, “Eftimie Murgu” University of Resiţa, Romania;<br />
email: nicoletafarcane@yahoo.fr<br />
~ 759 ~
2. A NEW PERCEPTION OF THE ROMANIAN ACCOUNTING<br />
PRACTITIONERS’ IDEA ON FINANCIAL STATEMENTS?<br />
The topic of our research is structured around the main question: “How prepared are<br />
Romanian SMEs to transpose cash-flow information into mandatory financial<br />
reporting?”<br />
Information provided by cash-flow statements can be used to increase quality and<br />
level of financial earnings, liquidities and flexibility and they help when forecasting<br />
cash-flows. Information on cash-flows should provide better guidance on the level of<br />
a company’s liquidity, because no other asset is more liquid than cash. According to<br />
Carslaw and Mills (1991:63), a company’s financial strength and weakness is<br />
estimated best by using a set of cash-flow ratios combined with traditional financial<br />
statements – balance sheet and income statement.<br />
The main purpose of this article is to study the opinion of the management of small<br />
and medium-sized enterprises located in the western part of Romania in respect to the<br />
importance and usefulness of cash-flow statements for this category of companies.<br />
This results from the fact that there are no records of the views of practitioners in<br />
finance and accounting departments in respect to this initiative.<br />
The undertaken research focuses on the necessity, usefulness, importance and usage<br />
level of cash-flow statements in the praxis of Romanian small and medium-sized<br />
enterprises. Thus, the following questions are required:<br />
1. How do SMEs perceive the costs and benefits of cash-flow statements included in<br />
the IFRS proposed for SMEs?<br />
2. Are there significant differences between SMEs regarding management<br />
perceptions on cash-flow statements, depending on their size?<br />
3. What are the difficulties of SMEs’ management resulting from non-preparation of<br />
cash-flow statements?<br />
4. How do specialised personnel who prepare financial statements perceive the<br />
usefulness of cash-flow statements?<br />
Currently, there are no defined records of SMEs perceptions and views on adopting<br />
IFRS for SMEs and on the usefulness of cash-flow statements, feasibility and benefits<br />
of its adoption and on the difficulties faced by SMEs in implementing various<br />
accounting standards and regulations. There are significant gaps in professional<br />
literature regarding the adequacy of IFRS proposed for SMEs. Also, there is no<br />
evidence on accounting issues relevant for SMEs and this would have to be covered<br />
by IFRS for SMEs. Moreover, there is a lack of empirical evidence on costs and<br />
benefits of accounting methods based on IFRS for SMEs.<br />
2.1. Reasons for performing an analysis of practitioners’ perceptions<br />
on adopting IFRS for SMEs<br />
According to current Romanian accounting regulations, SMEs prepare simplified<br />
financial statements, where the statement of changes in equity and the cash-flow<br />
statement are not mandatory.<br />
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IFRS for SMEs provides that, besides the company’s financial position, the financial<br />
statements of SMEs have to also present fairly the financial performance and cashflows<br />
of an entity in this category. Before their implementation it is impossible to<br />
examine directly the effects of IFRS for SMEs. Therefore, experience of those<br />
persons with knowledge on IFRS for SMEs is useful for understanding the possible<br />
consequences of its adoption.<br />
In Romania, the new rules on IFRS for SMEs have been submitted to the Body of<br />
Chartered Certified Accountants (CECCAR) in order to be analysed, and its members<br />
will make recommendations and notes on the practical applicability of the new<br />
accounting regulations.<br />
According to a survey conducted by NEXIA International, although the International<br />
Accounting Standards Board headquartered in London (IASB) has issued the<br />
international financial reporting standard (IFRS) for SMEs in July 2009 (it is<br />
considered that SMEs represent over 95% of all companies in the world), it seems that<br />
companies have a poor “appetite” for adopting international financial reporting<br />
standards (IFRS) for SMEs.<br />
Due to recent completion of IFRS for SMEs (since 2009 – the English version and in<br />
2010 – its translation into Romanian), there are only few case studies on the practical<br />
difficulties of SMEs in Romania, and literature addresses this issue more from the<br />
theoretical point of view.<br />
2.2. Literature on the necessity and applicability of IFRS for SMEs<br />
Eierle and Haller (2009) noted that most SMEs in Germany consider that it is<br />
necessary only in a small extent or even unnecessary to provide internationally<br />
comparable financial information. Based on the analysis of Belgian data, Coppens and<br />
others (2007) have shown that adoption of IFRS for SMEs will result in a need of<br />
separate financial reporting to tax authorities by those companies that apply IFRS for<br />
SMEs. Moreover, both studies - Coppens and others (2007) and Haller (2003) – noted<br />
that, according to experts’ opinion, after adoption of IFRS for SMEs, companies’<br />
efforts for data collection and processing will probably increase considerably due to<br />
the standard’s complexity.<br />
According to Coppens and others (2007), SMEs require assistance from external<br />
accounting specialists in order to apply IFRS, which increases implementation costs.<br />
According to Evans and others (2005), the relative value of these costs will be high,<br />
especially for smaller companies, but the size effect is quite rare in terms of<br />
evaluation of costs and benefits of this particular accounting standard (Eierle and<br />
Haller, 2009). Thus, Eierle and Haller (2009) argue that, in comparison to larger<br />
companies, small companies overestimate the benefits of accounting standards and<br />
underestimate their costs, probably due to the lower level of accounting knowledge in<br />
small companies.<br />
Many researchers confirmed the usefulness and importance of operating cash-flows in<br />
comparison with revenues in respect to: Evolution of exchange rates for securities:<br />
Beaver and Dukes (1972), Pattel and Kaplan (1977), Rayburn (1986), Bowen and<br />
others (1987), Wilson (1986, 1987), Bernard and Stöber (1989), Papilor (1995), Wang<br />
~ 761 ~
and others (1998), Saïd and others (2001); - Forecast of future cash-flows: Bowen and<br />
others (1986), Finger (1994), Krishnan and Largay (1997), Barth and others (2001),<br />
Hussain and others, Attar (2004); Enterprise risk management and cash-flow<br />
forecasting, Farcane N., Popa A., Caciuc L., Blidişel R., 2008; Risk management, at<br />
the border between accounting constructions and cash-flow forecasting tools, Solle<br />
G., Farcane N, Saglietto L., Stirbu D., 2010; Assessment of company’s financial<br />
situation, Cristea H, Pirtea M, Enache C, 2000; - Company’s cash-flows under<br />
inflationary circumstances, Pirtea M., 2000.<br />
Both international and national professional literature demonstrates that specialized<br />
finance and accounting personnel, who have encountered various situations in their<br />
professional career, or have even prepared cash-flow statements, are more receptive to<br />
implementing the new accounting standard IFRS for SMEs.<br />
3. ASSUMPTIONS CONCERNING THE ASSESSMENT OF MENTALITY<br />
CHANGE OF ROMANIAN ACCOUNTING PRACTITIONERS<br />
Based on various domestic and foreign studies, which showed that the size of a<br />
company is a factor that influences its behavior in terms of preparation and<br />
dissemination of financial and accounting information (Hermann et. al. (1996),<br />
Ettredge et al.(2002) , Haniffa and Cooke (2002) , Popa (2008) ), we considered that<br />
management of small companies have different perceptions regarding cash-flow<br />
statements in comparison with managers of medium-sized companies. Consequently,<br />
we start from the following assumptions:<br />
Assumption 1: There are significant size differences between SMEs in respect to<br />
management perception on cash-flow statements.<br />
Regardless of whether they have used cash-flows during their career or not,<br />
specialized personnel who prepare financial statements for SMEs are aware of their<br />
importance and of the problems faced by companies, which prepare cash-flow<br />
statements.<br />
Assumption 2: Specialized personnel preparing financial statements are aware of the<br />
problems faced by companies, which prepare cash-flow statements, regardless of<br />
whether they have used cash-flow statements during their career or not.<br />
Moreover, it is presumed that specialised personnel in finance and accounting<br />
departments, who prepare financial statements, consider that cash-flow statements<br />
provide important financial information for improving decision-making at the level of<br />
SMEs. Performance assessment, one of SMEs’ main objectives, caught attention of<br />
many researchers. This led us to a third assumption:<br />
Assumption 3: Specialised personnel in finance and accounting departments, who<br />
have used cash-flow statements during their career, consider that managers face<br />
difficulties in decision-making in the absence of information resulted from the<br />
analysis of cash-flow statements, while non-users have a different perception.<br />
Usefulness of cash-flow statements for decision-making at a company’s management<br />
level is a matter that has to be taken into account by those who prepare the company’s<br />
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financial statements. We assume that those respondents, who have not used or<br />
prepared cash-flow statements during their careers, will have different perceptions<br />
about the usefulness of this statement, in comparison to the group of those who have<br />
used and even prepared it. This is the fourth assumption of our study.<br />
Assumption 4: Specialized personnel (users and non-users of cash-flow statements)<br />
have different perceptions regarding usefulness of cash-flow statements in providing<br />
financial information for decision-making process.<br />
3.1. Ways and means for testing our assumptions<br />
Research methodology is used to obtain information for elucidating the questions<br />
addressed in this study. Research is based on testing assumptions through logical<br />
empiricism, which is a positive approach. Also, in order to analyse experience in<br />
knowledge process, we have used quantitative and qualitative methods, recommended<br />
and used by many researchers, these being the most used research methods at socioeconomical<br />
level.<br />
In our study, quantitative data are collected by means of a questionnaire distributed to<br />
small and medium-sized enterprises in the western part of Romania. Qualitative data<br />
were obtained by means of open questions and direct interviews with some of the<br />
finance managers of SMEs in this region.<br />
The sample represents a group of people to which we apply a study which results in a<br />
conclusion about the entire studied population. Sample methodology is used for<br />
obtaining the opinions of finance and accounting professionals on the necessity and<br />
usefulness of cash-flow statements in management and administration of small and<br />
medium-sized enterprises.<br />
The studied population consists of representatives of small and medium-sized<br />
enterprises (according to the definition of SMEs in Romanian legislation harmonized<br />
with European Directives) located in the western part of Romania, in Timiş,<br />
Caraş-Severin, Arad and Hunedoara Counties. The sample was obtained from the<br />
companies registered in the database of the Trade Register Offices of the 4 counties in<br />
Region V West.<br />
3.2. Results obtained based on statistical treatment of answered questionnaires<br />
We have made a random selection out of the total number of 35,204 SMEs, which<br />
were registered with Trade Register Office in 2007 in the 4 counties in Region V<br />
West. By using a disproportionate stratified sampling technique we selected 400<br />
companies that meet the definition of SMEs in the Romanian legislation and have an<br />
annual turnover of not more than 43 million lei. We used stratification variables for<br />
the companies’ size and headquarters. We chose the disproportionate sampling<br />
technique for ensuring that all important subpopulations were represented in the<br />
sample. We used the following two size groups for selecting the sample: companies<br />
with turnover of less 8.6 million lei and companies with turnover between 8.6 and<br />
43 million lei respectively. The clusters for headquarters were represented by the<br />
4 counties in Region V West: Timiş, Arad, Caraş-Severin and Hunedoara. From each<br />
group we selected randomly a number of 100 entities. We sent questionnaires to these<br />
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companies and only a number of 162 companies have returned them filled out (27%).<br />
Out of the 162 returned questionnaires, 37 were not valid because they were not<br />
complete or the companies have a turnover exceeding 43 million lei for 2009. Thus,<br />
there resulted a sample of 125 valid and usable questionnaires, and a response rate<br />
of 31.25%.<br />
Based on the received responses and validated questionnaires, we determined the<br />
sampling error of +/- 7.28%. The sampling error or the confidence interval represents<br />
the range of values (error) for fitting in the percentage calculated based on the sample<br />
within total population.<br />
One section presents descriptive data on examining the perceptions of respondents<br />
regarding the necessity and importance of using cash-flow statements. Additionally,<br />
we compared opinions of persons who prepared cash-flow statements in their<br />
professional career with opinions of persons who did not use or prepare such<br />
statements, in order to determine significant differences between the two groups<br />
related to choice of preference, difficulties in implementing cash-flow statements and<br />
usefulness of information in cash-flows in the decision-making process.<br />
Out of those who have been using cash-flow statements during their career, 9.6% said<br />
that they have only poor knowledge about its structure. Therefore, we consider that<br />
the group of persons who have used cash-flow before is better informed than the<br />
group of respondents who have not used it. 36.8% of the sample companies prepared<br />
cash-flow statements, while 63.2% of them did not. We appreciate that more than half<br />
of the SMEs do not prepare cash-flow statements.<br />
In Romania, the General Tax Office (DGFP) is considered the main user of cash-flow<br />
statements, followed by banks and other credit institutions, shareholders, creditors and<br />
managers. According to respondents who used cash-flow statements, all these<br />
categories have obtained an average around 2, “partial agreement”. On the other hand,<br />
those who did not use cash-flow statements are of the opinion that banks and other<br />
credit institutions, and shareholders are the main categories of users, while the<br />
General Tax Office and creditors are less interested in them, with an average of<br />
2.74, closer to “not-interested” level. Both groups consider that employees and<br />
suppliers are the least interested in cash-flows.<br />
The using respondents consider that the main purpose served by cash-flow statements<br />
consists in filling out tax returns, while finding and obtaining financing ranks second<br />
in the hierarchy of purposes. Non-using respondents consider that the main purpose<br />
served by cash-flow statements consists in obtaining financing. The same group<br />
considers that cash-flow statements are necessary for transactions with clients and<br />
suppliers. We consider that the average obtained by this statement (average=1.65) is<br />
the result of a misunderstanding of the question. Both groups consider that preparation<br />
and usage of cash-flow statements does not lead to better relationships with<br />
employees.<br />
A comparison between respondents who have prepared and used cash-flow statements<br />
in their professional career and those who did not use them shows that, most of those<br />
who have used such statements (81.6%) consider it is appropriate and useful to<br />
prepare those (76%), and only 5.6% of them chose to give up preparation of such<br />
~ 764 ~
statements. The group of subjects who did not use cash-flow statements represents<br />
24% and all of them consider that it is not necessary to prepare them. The responses<br />
suggest that those who know the cash-flow statements are aware of their importance<br />
and necessity.<br />
The group of those persons who did not use such statements has invoked “costs with<br />
acquisition of appropriate software” and “costs with financial and accounting<br />
consultancy” as the reasons that make them unwilling to use cash-flow statements.<br />
The two statements have an average of 1.35, and 2.04 respectively, for this group.<br />
Respondents have established that the most important problem faced in preparation of<br />
cash-flow statements consists in “a low degree of acceptance from the side of<br />
managers and shareholders in respect to the cost-benefit ratio of preparation<br />
compulsoriness”, with an average of 1.84.<br />
As regards the groups of users and non-users, respondents who used cash-flow<br />
statements consider that the most important problem regarding the use of cash-flow<br />
statements consists in the fact that managers and shareholders do not accept the costbenefit<br />
ratio in terms of compulsoriness in the preparation of such statements (an<br />
average of 1.68). The difficulties related to how cash-flow statements are prepared<br />
and understanding of terminology.<br />
In terms of perception, those respondents who have not used cash-flow statements<br />
share almost the same opinion like those who have used such statements. They invoke<br />
especially the first problem: “low acceptance degree from the side of managers and<br />
shareholders in respect to the cost-benefit ratio of preparation compulsoriness”, with<br />
an average value of 2.57 and the second one “low understanding of terminology”,<br />
with an average value of 2.57.<br />
In order to assess the necessity and usefulness of cash-flow statements in the decisionmaking<br />
process, respondents expressed their opinions on the difficulties faced by<br />
management in the absence of relevant information that might result from the analysis<br />
of cash-flow statements.<br />
3.3. Opinions on the usefulness of cash-flow statements in the decision-making<br />
process<br />
In this study we tested the following assumptions:<br />
Assumption 1: There are significant size differences between SMEs in respect to<br />
management perception in terms of cash-flow statements<br />
Assumption 2: Specialized personnel preparing financial statements are aware of<br />
the problems faced by companies, which prepare cash-flow<br />
statements, regardless of whether they have used the cash-flow<br />
statements during their career or not<br />
Assumption 3: Specialised personnel in finance and accounting, who during their<br />
career have used cash-flow statements, consider that managers<br />
face difficulties in decision-making in the absence of information<br />
resulted from the analysis of cash-flow statements, while non-users<br />
have a different perception<br />
Assumption 4: Specialized personnel (users and non-users of cash-flow<br />
statements) have different perceptions regarding usefulness of<br />
~ 765 ~
cash-flow statements in providing financial information for the<br />
decision-making process<br />
After processing the data, we can say that respondents consider that in the absence of<br />
information provided by cash-flow statements managers will not be able to<br />
“understand the causes of different cash-flow sizes” and they will face the<br />
“impossibility of performing an evaluation of the company’s capacity to generate cash<br />
and cash equivalents from operating, investment and financial activities”.<br />
We concluded that respondents agree that “cash-flow statements are necessary for<br />
planning and management of future financial engagements”, with an average of 1.63.<br />
Also, they agree with following assertions: “cash-flow statements provide additional<br />
information for financial analysis” and “cash-flow statements serve financial<br />
informational needs for assessing performances in a manner more close to reality”,<br />
with averages of 1.83 and 2.25.<br />
Many of the respondents partially disagreed in respect to assertion “cash-flow<br />
statements serve for comparing operating results of various companies, because they<br />
eliminate the effects of applying different accounting criteria for the same types of<br />
transactions and events” (average 3.68), considering that, in the absence of such<br />
statements, operating results of various companies can be compared only based on<br />
information included in the income statement. In the same time, respondents are<br />
showed no interest with respect to usefulness of cash-flow statements for “company’s<br />
evaluation based on forecasts for a wider time horizon” and “assessment of the extent<br />
to which previous assessments correspond to cash-flows determined at a certain<br />
moment in time”, which shows that interviewed respondents did not encounter such<br />
statements, and the two assertions obtained averages close to “not-interested”, of 3.25,<br />
and 3.21 respectively.<br />
We also highlight that respondents of the two groups do not have similar opinions in<br />
respect to most of the assertions. Unlike the respondents who used cash-flow<br />
statements, those who did not use them are not so decided in respect to their<br />
usefulness, the average of the group who did not use cash-flow statements being of<br />
only 3.74 and the standard deviation of 1.514. These respondents have an opinion<br />
close enough to “not-interested” and “strongly disagree”, which makes us to assert<br />
that probably they do not have sufficient knowledge and expertise for issuing resolute<br />
judgments about subtle aspects related to cash-flow statements.<br />
Based on various domestic and foreign researches, which showed that company’s size<br />
is a factor that influences its behavior in respect to preparation and dissemination of<br />
financial information, we considered that small companies’ management have<br />
different perceptions on cash-flow statements in comparison to medium-sized<br />
companies’ managers.<br />
The results of the Kruskal-Wallis test applied to the two groups of companies -<br />
companies with turnover of less 8.6 million lei and companies with turnover between<br />
8.6 million lei and 43 million lei - show that for certain assertions there are<br />
differences between the two groups, and for other assertions the respondents have the<br />
same opinions, regardless of the company’s size. In order to analyse the differences<br />
between the perception of personnel who did and who did not use cash-flow<br />
~ 766 ~
statements before, the questionnaire gave the opportunity to express options within<br />
nine pre-identified advantages.<br />
CONCLUSIONS<br />
This study aimed to test the addressed assumptions by means of statistical parameters,<br />
based on the fundamental theory on the debate regarding application of cash-flow<br />
statements by SMEs. International professional literature presents different opinions<br />
on the feasibility of applying cash-flow statements and relevance of financial<br />
information provided by them for decision-making. A number of studies have<br />
suggested that specialised personnel who applied cash-flow statements are more<br />
responsive to changes implied by their application, than personnel who did not use<br />
such statements.<br />
Thus, we used the quantitative approach (questionnaire) in order to shape viable<br />
research tools for examining the construction of this study. The methodological<br />
research focused on the population in the companies’ finance and accounting<br />
departments, in order to ensure collection of data required for obtaining the main<br />
results of this study.<br />
The results obtained by testing the assumptions are summarised in this table.<br />
Table 1. Assumptions of comparative analysis: users and non-users of cash-flow<br />
statements<br />
Assumption 1:<br />
Assumption 2:<br />
Assumption 3:<br />
Assumption 4:<br />
Assumptions Results<br />
There are significant size differences between SMEs in respect to<br />
management perception in terms of cash-flow statements<br />
Specialized personnel preparing financial statements are aware of the<br />
problems faced by companies, which prepare cash-flow statements,<br />
regardless of whether they have used the cash-flow statements during<br />
their career or not<br />
Specialised personnel in finance and accounting, who during their<br />
career have used cash-flow statements, consider that managers face<br />
difficulties in decision-making in the absence of information resulted<br />
from the analysis of cash-flow statements, while non-users have a<br />
different perception<br />
Specialized personnel (users and non-users of cash-flow statements)<br />
have different perceptions regarding usefulness of cash-flow statements<br />
in providing financial information for the decision-making process<br />
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Partially<br />
confirmed<br />
Partially<br />
confirmed<br />
Confirmed<br />
Confirmed<br />
The results show that there are differences between the opinions of specialised<br />
personnel in finance and accounting departments who have used cash-flow statements<br />
before and those who have not used such statements in respect to the difficulties faced<br />
and the usefulness of financial information provided for the decision-making process.<br />
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Malaysian corporations. ABACUS, 38 (3), pp. 317-350<br />
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statistică psihologică on-line Universitatea A.I.Cuza, Iaşi, pp. 1-4.<br />
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Alexandru I.Cuza, ISBN 978-973-703-299-7<br />
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ROMANIAN PROFESSIONAL ACCOUNTANTS’<br />
PERCEPTION ON THE DIFFERENTIAL FINANCIAL<br />
REPORTING FOR SMALL AND MEDIUM-SIZED<br />
ENTERPRISES<br />
Stefan BUNEA, Marian SACARIN 1 & Mihaela MINU<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
2009 was an important year, internationally, for the financial reporting of small and mediumsized<br />
enterprises. First of all, the International Accounting Standards Board (IASB) published<br />
the international financial reporting standard for the small and medium–sized entities (IFRS<br />
for SMEs). Secondly, the European Commission started the consultations over the amendment<br />
of Directives IV and VII with a view to simplifying them for the small entities. Moreover, the<br />
European Commission launched a consultation over a possible adoption at the level of the<br />
European Union of the IFRS for SMEs.<br />
In this context, through our study, we attempt mainly, to identify the attitude of professional<br />
accountants in our country about the financial reporting of the small and medium-sized<br />
enterprises. Do they want a simplified financial reporting system for the small and mediumsized<br />
enterprises? Should this financial reporting system be designed starting from the<br />
European directives or should the IFRS for SMEs prepared by the IASB be applied as such?<br />
Should this financial reporting system be based on detailed rules or on principles and<br />
professional reasoning? What should be the criteria for the identification of small and<br />
medium-sized enterprises? Which is, the professional accountants’ view, the main user of the<br />
financial statements prepared by the small and medium-sized enterprises?<br />
The analysis of the 190 answers we received revealed that 52.6% of the respondents consider<br />
that the current regulations do not provide for a reasonable level of simplification for the<br />
small and medium-sized enterprises and, consequently, a more simplified reporting system is<br />
needed for the SMEs. 43.2% of the respondents reckon that the accounting of SMEs should be<br />
standardized by simplifying the Order of the Minister of Public Finance no. 3055⁄2009,<br />
whereas only 4.2% of the respondents consider that the IASB standard could be applied as<br />
such and 72.6% of the respondents consider that the accounting regulations for small and<br />
medium-sized enterprises should be based on detailed rules.<br />
87.4% of the respondents believe that the entities bound to apply the simplified financial<br />
reporting system should be established based on quantitative criteria.. Also, 42.6% of the<br />
respondents considered that the main user of accounting information about the small and<br />
medium-sized enterprises is the tax authority, while 22.1% consider the management as the<br />
main user, and 22.1% consider those who provide the funding as the main user.<br />
KEYWORDS: Differential reporting, small and medium-sized enterprises (SMEs),<br />
professional accountants, international financial reporting standard for small and mediumsized<br />
entities (IFRS for SMEs), European directives<br />
1 Correspondence address: Marian SĂCĂRIN, Bucharest Academy of Economic Studies, Faculty of<br />
Accounting and Management Information Systems, Piata Romana Street, No. 6, 010374; email:<br />
sacarinm@gmail.com<br />
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INTRODUCTION<br />
The preparation of a standard for small and medium-sized enterprises is not a new<br />
idea, the differential financial reporting being in the focus of several national<br />
standardization bodies for many years. Thus, before the International Accounting<br />
Standards Board (IASB) released the IFRS for SMEs, in many countries (Great<br />
Britain, Australia, Canada, New Zeeland, Hong Kong, Philippines), there had already<br />
been accounting standards for these companies. Moreover, the differential financial<br />
reporting for individual financial statements is provided for in the European Union<br />
Directive IV as well.<br />
When the need for a differential financial reporting is invoked, the following are<br />
considered amongst other things: the economic and social importance, number and<br />
diversity of users of the financial statements, their information needs and the costbenefit<br />
ratio.<br />
The public’s interest in a company is determined by its economic and social<br />
importance. Thus, the more an entity is economically and socially important for the<br />
different stakeholders, the more is has to prove accountability, transparency and rigor<br />
in its financial reporting.<br />
It is generally agreed in the literature that the users and their information needs vary<br />
depending on the nature of the entities. In its conceptual framework, the IASB<br />
identifies the following categories of users of financial situations: the investors,<br />
creditors, customers, suppliers, employees, government and its agencies and the<br />
public. Conversely, in the international financial reporting standard for small and<br />
medium-sized enterprises, the IASB mentions the following categories of external<br />
users of the general financial statements prepared by the small and medium-sized<br />
enterprises: owners who are not involved in managing the business, existing and<br />
potential creditors and the credit rating agencies (IASB 2009). Moreover, other<br />
categories of users were also been identified for the small and medium-sized<br />
enterprises: tax authorities, administrators etc (UNCTAD, 2003). The financial<br />
statements of public entities are available for an unlimited number and a diversified<br />
category of users. The existing and potential investors are the main users of the<br />
financials statements. These users whose economic decisions depend on the<br />
information published in the financial statements are a heterogeneous category made<br />
up of individuals, mutual and pension funds, insurance companies, banks etc. In the<br />
case of small and medium-sized enterprises, however, the main users are the owners<br />
(who most of the times are also the administrators), banks and commercial creditors.<br />
Various studies have emphasized that in regards to the usefulness of the information<br />
in the decision-making, the larger and diversified the user group, the more likely it is<br />
that the entities would benefit from publishing more detailed information in the<br />
financial statements, which is not the case of the medium-sized enterprises (Canadian<br />
Institute of Chartered Accountants, 2001).<br />
Moreover, one should not only consider the benefits, but also the costs incurred with<br />
the financial reporting, such as:<br />
� costs for the preparation, printing and publication of financial information;<br />
� audit costs;<br />
� potential costs generated by the disclosure of information to a competitor;<br />
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� costs of compliance with the legal requirements;<br />
Many such costs are fixed or do not vary proportional with the size, but in turn, they<br />
are much more significant for the small and medium-sized enterprises.<br />
In addition, the financial reporting is influenced by the information needs of the users<br />
of financial statements. These needs depend, first, on the nature of the decisions. The<br />
users of financial statements of small and medium-sized enterprises are confronted<br />
with different decisions than those of large enterprises. Thus, while the investors of<br />
public (large) enterprises use the financial information to decide whether to "sell or<br />
keep the stock”, for the investors of small and medium-sized enterprises the strategy<br />
of withdrawal from an entity does not represent a realistic option (Canadian Institute<br />
of Chartered Accountants, 2001). In addition, although the profitability and liquidity<br />
remain important indicators, for the owners of small and medium-sized enterprises<br />
other factors are important too, such as the independence and participation in a<br />
business, managing their own business etc. Consequently, for the investors of small<br />
and medium-sized enterprises, unlike those of large companies, it is not so important<br />
to compare the information in the financial statements, and much of the information<br />
requested for the public entities is less relevant for the small and medium-sized<br />
enterprises.<br />
To the same extent, the literature contains opinions opposing a differential accounting.<br />
The main argument against the differential reporting is the need for universality.<br />
Thus, it is believed that the existence of different accounting rules will result in<br />
several identical images (Evans et al., 2005). Moreover, the existence of a differential<br />
financial reporting will diminish the comparability and credibility of accounting<br />
information (Roberts & Sian, 2006). In addition, moving from one reporting system to<br />
another may be perceived as costly and burdensome. The opponents of differential<br />
reporting also argue that the existence of differential standards may result in a lower<br />
quality of some of these and, consequently, those who credit the institutions will levy<br />
a premium to compensate for the lower quality of the financial statements. In addition,<br />
there is even a fear of division of the accounting profession. (Evans et al., 2005).<br />
On the other hand, there seem to be stronger arguments in favor of a differential<br />
reporting. (Roberts & Sian, 2006). In fact, the important aspect is not the existence of<br />
the differential reporting (big GAAP versus little GAAP), but the way in which this<br />
shall be conceived.<br />
If the idea of differential reporting is accepted, criteria must be decided for<br />
establishing the different categories of reporting entities. The qualitative (public<br />
accountability, separation between management and ownership, etc) or quantitative<br />
(number of employees, turnover, total assets) are among the most frequently used<br />
criteria. In practice, however, other criteria may also be used, individually or in<br />
combinations: legal status of the business, branch of activity, listing on a stock<br />
exchange, owners' accountability etc. In addition, it must also be decided on what<br />
should be differential: the accounting and/or audit and/or the form of publication. A<br />
distinction shall also be made between the individual and consolidated financial<br />
statements.<br />
As regards the differential accounting, a decision needs to be made as to whether the<br />
differentiation should be restricted to the information that should be disclosed or<br />
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should also affect the recognition and measurement. In practice, the simplifications on<br />
the disclosure of information are accepted easier than the differentiation of the rules of<br />
recognition and measurement, as the latter has an impact on the reported outcome,<br />
reduces the comparability among enterprises and may lead to an increased risk of<br />
misinterpretation by the users of financial statements. The differential financial<br />
reporting may also target the audit requirements (the obligation to have an annual<br />
statutory audit, requirements on the signature of financial statements by certain<br />
persons, etc), but also the form of publication and preparation of financial statements<br />
(detailed financial statements versus simplified financial situations, the exceptions to<br />
the publication of financial statements, the exceptions to the preparation of financial<br />
statements by the companies with no activity etc).<br />
Our study is structured as follows. The first part comprises a short history of<br />
differential reporting in our country. Then, there is an overview of the studies<br />
published by various authors from our country on the differential reporting for small<br />
and medium enterprises. Further on, there are presented the research methodology, the<br />
results of the research, the conclusions and limits of the research.<br />
We expect this research to raise the interest of the academic environment involved<br />
both in the research and practical activity, but also the interest of those who have<br />
anything to do with the financial reporting of the small and medium-sized enterprises:<br />
the Romanian accounting standard setter (Directorate for accounting regulations<br />
within the Ministry of Public Finance), the preparers, users and, last but not least, the<br />
professional accountants, whose opinion is analyzed.<br />
We believe that the main quality of our paper resides in the fact that, through the<br />
empirical study presented, we go beyond the limits of descriptive research. Moreover,<br />
to our knowledge, this is one of the few papers that test the attitude of a party<br />
involved in the financial reporting of small and medium-sized enterprises, i.e. the<br />
professional accountants in our country.<br />
1. DIFFERENTIAL REPORTING: ROMANIA’S CASE<br />
After 1989, three stages can be identified in the evolution of accounting in our country<br />
(Ionaşcu et. al., 2007):<br />
a) 1990-1998: the stage of creating an accounting system suitable for a market<br />
economy;<br />
b) 1999-2005: the stage of harmonization with the European directives and<br />
international accounting standards;<br />
c) 2006-to date: the stage of compliance with the European directives and<br />
international financial reporting standards.<br />
In all these stages, at individual account level, to a larger or lesser extent, there have<br />
been and still are elements of differential financial reporting. These have been mainly<br />
aimed at the composition of the financial statements and the level of details therein.<br />
The first accounting regulation to include elements of differential financial reporting<br />
is the Methodological norm for the drafting and submission of the accounting balance<br />
sheet, approved through Government Decision no. 704⁄1993. This stated that the legal<br />
entities that carry out economic activities shall prepare annual accounting balance<br />
sheet (balance, profit and loss account and annexes) as follows:<br />
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� simplified system for the small and medium-sized enterprises; and<br />
� basic system, the large enterprises.<br />
However, the small and medium-sized enterprises have had the possibility to opt for<br />
the basic or the simplified system, and in order to move from one category to another<br />
they had to meet the criteria set by law during two consecutive financial exercises.<br />
Form the accounting point of view, the difference was limited to the information<br />
disclosed in the financial statements, without targeting aspects dealing with the<br />
recognition and assessment. In fact, the difference between the two systems of<br />
accounting balance sheet was related to the more detailed structure of the basic system<br />
compared to the simplified one. The accounting balance sheet, however, had the same<br />
components, irrespective of the system: balance, profit and loss account and annexes.<br />
In our view, this situation is explained, first of all, through the French origin of our<br />
regulations and less through the intention of Romanian standard bodies to simplify the<br />
financial reporting for small and medium-sized enterprises, for which there were no<br />
identification criteria in the accounting regulations.<br />
Moreover, the company law 31⁄1990, provided for different regulations over the<br />
existence of the censors. Thus, in case of a joint stock company, the balance sheet and<br />
the profit and loss account had to be accompanied by the censors’ report.<br />
Between 1999 and 2005, the accounting goes through a new stage in its evolution in<br />
Romania, which is the harmonization with the European directives and the<br />
international financial reporting standards. In 1999 and 2001, new accounting<br />
regulations were issued aimed mainly at harmonizing the accounting of large entities<br />
with the European Directive IV and the international accounting standards. The<br />
companies falling into their scope were initially established based on qualitative<br />
criteria (trading on the stock exchange, national interest and operation on the capital<br />
market), and later on based on quantitative criteria (turnover, total assets and average<br />
number of employees). By enforcing these regulations, the companies have been<br />
required to prepare new financial statements as well as a cash flows statement of<br />
changes in equity and also to apply principles of Anglo-Saxon origin as well as the<br />
substance over form principle and the materiality principle. Moreover, by assimilating<br />
the IASB conceptual framework, general criteria have been introduced for the<br />
recognition and evaluation of items in the financial statements. In addition, for the<br />
first time in our country, the companies that applied these regulations were obliged to<br />
audit their financial statements as well.<br />
In 2002, the simplified accounting regulations were approved, harmonized with the<br />
European directives. These have been applied by companies that did not exceed<br />
certain criteria related to size, and by the companies that exceeded the size criteria but<br />
did not fall under the scope of the accounting regulations harmonized with the<br />
European directives and the international accounting standards. Moreover, these<br />
regulations concerned the micro-enterprises as well. Unlike other companies that fell<br />
under the scope of these regulations and were bound to prepare the balance sheet, the<br />
profit and loss account and the explanatory notes, the micro-enterprises were only<br />
bound to prepare the balance sheet and the profit and loss account. Also, in 2000, the<br />
first regulations appeared concerning the experimental preparation of consolidated<br />
financial statements. Although in theory the appearance of these regulations marks the<br />
differentiation between the individual and the consolidated financial statements, the<br />
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consolidated accounting remained in an experimental stage until 2006, when the<br />
obligation to prepare consolidated financial statements was introduced for the first<br />
time in Romania.<br />
Starting with 2006, the accounting in our county has entered the stage of compliance<br />
with the European directives and the international financial reporting standards. Thus,<br />
by Order of the Minister of Public Finance no 907⁄2005, the companies were divided<br />
into those who were to apply the accounting regulations in line with the European<br />
directives and those which, additionally, for the information needs of the users, others<br />
than the state, had to (credit institutions) or could (institutions of public interest other<br />
than credit institutions) apply the international financial reporting standards, starting<br />
with the 2006 financial exercise. Moreover, in order to ensure the compliance of<br />
national accounting regulations with the European Union regulations, the international<br />
financial reporting standards continued to be implemented progressively. Thus,<br />
starting with the 2007 financial exercise, the credit institutions continued to apply the<br />
international financial reporting standards in preparing the consolidated financial<br />
statements. But, besides the credit institutions, the companies with securities traded on<br />
a regulated market have also been obliged to apply the international financial<br />
reporting standards in preparing their consolidated financial statements.<br />
At present, the small and medium-sized enterprises in Romania fall under the scope of<br />
the accounting regulations in line with the European directives. These regulations<br />
include several aspects of differential financial reporting, both in terms of accounting<br />
and audit. Hence, the companies that fail to comply with certain size criteria prepare<br />
simplified annual financial statements including: the abridged balance sheet, the profit<br />
and loss account and the explanatory notes to the annual financial situations.<br />
Optionally, these companies can prepare the statement on the changes in their won<br />
capital and/or the statement of cash flows. Moreover, these companies are not bound<br />
to audit their annual financial statements.<br />
2. LITERATURE REVIEW<br />
In our country, several studies were published, focusing on various aspects of<br />
financial reporting for small and medium enterprises. They were developed both<br />
before and after publication by IASB of the IFRS for SMEs, and most of them offer a<br />
theoretical approach.<br />
As such, the possible benefits of an international financial reporting standard for<br />
enterprises in our country have been analyzed (Păunescu, 2006). From the perspective<br />
of our country’s accession to the European Union, the author believed that a less<br />
complex international financial reporting standard for small and medium enterprises<br />
would be gladly embraced by the small and medium enterprises in our country.<br />
Moreover, the adoption at European level of the international financial reporting<br />
standard for small and medium enterprises developed by IASB would be helpful in<br />
improving comparability of financial reporting.<br />
Furthermore, the difficulties that would be involved in the implementation of an<br />
international financial reporting standard for small and medium enterprises in our<br />
country have also been examined (Gîrbină & Bunea, 2007). The authors invoke the<br />
frequent changes in the international accounting referential and, implicitly, those of a<br />
~ 775 ~
future international financial reporting standard for small and medium enterprises.<br />
Under such circumstances, companies would be forced to bear various costs, on a<br />
regular basis, which conflicts with the motivation of simplified reporting for small and<br />
medium enterprises, namely cost reduction.<br />
Lungu et al. (2007) have conducted a review of the specialized literature on the<br />
possible impact of the IFRS for SMEs issued by IASB on practitioners and<br />
professional organizations. In addition, the content of the exposure draft developed by<br />
IASB has been reviewed.<br />
The pros and cons of an IFRS for SMEs enterprises have also been analyzed (Tiron &<br />
Muţiu, 2008). Furthermore, the authors consider that regulation of accounting for<br />
small and medium enterprises is a national or regional problem, in the case of the<br />
European Union.<br />
The advantages and difficulties of the implementation of international standards by<br />
small and medium enterprises in Romania have moreover been addressed (Feleagă et<br />
al., 2008). The main advantages identified by the authors are the improvement of<br />
financial communication and the enhancement of the quality of information used by<br />
the management of entities. Difficulties would be involved by the translation of the<br />
international financial reporting standards into Romanian and by the training of<br />
professionals on their implementation.<br />
Farcane & Popa (2008) have reviewed the role and objectives of IASB in developing<br />
a standard for small and medium enterprises, but also the reasons and the<br />
disadvantages associated to such standard.<br />
Albu & Albu (2010), in an exploratory study, examines the context of a possible<br />
implementation of the IFRS for SMEs in our country. The authors come to the<br />
conclusion that the implementation of the standard for small and medium enterprises<br />
developed by IASB is inevitable in our country, as long as the national standard setter<br />
does not develop high quality accounting standards.<br />
Marian Săcărin (2010) attempted to identify the attitude of people who had sent<br />
comment letters to the exposure draft to IASB’s initiative of developing the IFRS for<br />
SMEs.<br />
Consequent to examining the 160 comment letters concerning the exposure draft of<br />
the standard, he concluded that most of the respondents (44%) had not expressed an<br />
explicitly favourable position to IASB’s approach of developing the standard, 13%<br />
had not agreed with IASB’s approach, whereas 43% had explicitly supported IASB’s<br />
approach.<br />
In our country, empirical studies on the need for differential financial reporting for<br />
small and medium enterprises are almost nonexistent. However, it is worth<br />
mentioning the study undertaken by Deaconu et al. (2009), where, among other<br />
things, the authors also tested the opportunity in our country of adopting the standard<br />
developed by IASB for small and medium entreprises. After questioning a certain<br />
number of accounting professionals, it has been found that an accounting standard, or<br />
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accounting regulations, for small and medium enterprises is (are) welcome, but the<br />
adoption of the standard developed by IASB has not been accepted.<br />
3. RESEARCH METHODOLOGY<br />
The differential reporting elements existing in the current accounting regulations are<br />
not sufficient in our view, and we moreover believe that, in the case of small and<br />
medium enterprises, financial reporting generates unjustified costs.<br />
The purpose of our study is to identify the attitude of accounting professionals in our<br />
country towards the financial reporting of small and medium enterprises. Do they<br />
want a simplified financial reporting system for small and medium enterprises?<br />
Should this financial reporting system be based on the European directives or on<br />
international financial reporting standard published by IASB? What should be the<br />
identification criteria for small and medium enterprises? Who is, according to<br />
accounting professionals, the main user of the financial statements prepared by small<br />
and medium enterprises? Should this financial reporting system be based on detailed<br />
rules or rather on principles and professional judgment?<br />
In order to achieve our purpose, we have developed a questionnaire consisting of<br />
11 questions. The questionnaire has been sent to the email addresses of a number of<br />
550 members of CECCAR (the Body of Expert and Licensed Accountants of<br />
Romania), randomly selected from the CECCAR Table. We have received<br />
198 responses, but 8 of them have been canceled for being incomplete (consequently,<br />
the response rate has been 36%). The responses were collected during 1-15 March,<br />
2011. The responses have been statistically processed with a sampling error of ±7% at<br />
a confidence level of 95% and a total population of 40,000 chartered accountants. The<br />
sampling method is simple random sampling. The confidence level expresses the<br />
probability that the true value of an indicator should fall within the confidence<br />
interval. The most used confidence level is the value of 95%. It determines the<br />
interval between the highest value and the lowest value and eliminates the percentage<br />
of 2,5% of the extreme outliers in both directions. In other words, the confidence<br />
interval includes 95% of the possible values of the population located at the middle of<br />
the distribution.<br />
The sample, consisting of 190 respondents, has the following structure by sex: women<br />
72.1%, and men 27.9%. This gender representation is consistent with the structure of<br />
the accounting profession in Romania, where seven out of ten individuals exercising<br />
the profession of chartered accountant are women. Among men, most respondents are<br />
aged between 30 and 40 years (39.6%), and over 50 years (34%). There have been<br />
few responses of the male population aged between 20 and 30 years (5.7%).<br />
The majority of female respondents are aged between 30 and 50 years (61.3%). The<br />
20-30 years age group is better represented in the sample (21.2%) than the group of<br />
women aged over 50 years (17.5%).<br />
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Chart 1. Breakdown of sample by age<br />
Out of the total sample surveyed, 37.4% have a professional experience of up to 10<br />
years, 37.4% of 10 to 20 years, while the remaining 25%, of over 20 years. The<br />
opinions have been preponderantly expressed by male respondents having an<br />
experience of 10-20 years (50.9% of the total male population), and by those having<br />
an experience of over 20 years (28.3%). The opinions expressed by women belong to<br />
the group having a professional experience of up to 10 years (43.8% of the total<br />
female population) and to the group having an experience between 10 and 20 years<br />
(32.1% of the total female population).<br />
Chart 2. Breakdown of sample by professional experience<br />
4. RESEARCH RESULTS<br />
In 2009, IASB published the IFRS for SMEs. This standard is the result of a project<br />
that began in 2003, even against the will of some of the members of the international<br />
standardization body, who considered that such a project strayed away from IASB’s<br />
main mission, namely that of developing standards for listed companies (Nobes &<br />
Parker, 2008: 290).<br />
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The standard published by IASB, in July 2009, is intended for entities not having<br />
public accountability, but who publish, for external users, general purpose financial<br />
statements. In order to identify the companies falling within the scope of the standard,<br />
IASB selected qualitative criteria, yet left at the discretion of regulatory authorities<br />
and standard setters in each country to determine the entities required or permitted to<br />
apply the IFRS for SMEs.<br />
Unlike the IASB, the Fourth Directive of the European Economic Community uses<br />
quantitative criteria to determine the companies for which certain simplifications of<br />
financial reporting are stipulated: total assets, turnover, and average number of<br />
employees during the year (Article 27). Similarly, in our country, it is still the<br />
quantitative criteria that are used in order to identify the companies preparing<br />
simplified financial statements.<br />
As such, we have included the following question (Q4) in our questionnaire:<br />
Q4: What would be, in your opinion, the characteristics to be considered when<br />
including a company in the category of small and medium enterprises?<br />
After statistical processing of the responses, we have found that most respondents<br />
(87.4%) consider quantitative criteria as more appropriate than the qualitative criteria<br />
established by the IFRS standard for SMEs (12.6%).<br />
Concerning the reference to quantitative criteria, opinions are divided between the<br />
preference for the criteria under the Order of the Minister of Public Finance (OMFP)<br />
No 3055/2009 (46.3%), and for the criteria established by the European Commission<br />
(41.1%). Women rather prefer the criteria stipulated in the national legislation (52.6%<br />
of the female respondents), while men are in favour of those established by the<br />
European Commission (49.1% of the male respondents).<br />
Chart 3. Q4 Responses<br />
The preference for quantitative criteria is consistent with the existing trend in the<br />
European Union, where most Member States have introduced quantitative criteria in<br />
their national legislations, for identifying small and medium enterprises. Although<br />
qualitative criteria are very easy to apply, their determination is not free of difficulty<br />
(Roberts & Sian, 2006:7). For instance, the average number of employees may be<br />
distorted by an increased number of part-time and occasional employees or by<br />
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outsourcing certain activities, whereas the asset value is influenced by the appraisal<br />
values used. Based on this assumption, our questionnaire included the following<br />
question (Q5):<br />
Q5: Do you believe that it is necessary to determine the size criteria depending on the<br />
particularities of the sector to which the enterprise belongs?<br />
Most respondents consider that is necessary to establish size criteria depending on the<br />
particularities of the sector to which the enterprise belongs (60.5%). With<br />
insignificant variations, this percentage has been found in all age groups, regardless of<br />
gender and professional experience. As mentioned earlier, we believe that the current<br />
regulations in our country do not contain sufficient simplification options for small<br />
and medium enterprises and, consequently, the latter are forced to bear unjustified<br />
costs associated to financial reporting. Therefore, by question number 6 of the<br />
questionnaire (Q6), we have sought to identify the simplification level provided by the<br />
Order of the Minister of Public Finance (OMFP) 3055/2009 for small and medium<br />
enterprises.<br />
Q6: Please rate on a scale of 1 to 5 the simplification level provided by the Order of<br />
the Minister of Public Finance (OMFP) 3055/2009 to small and medium enterprises.<br />
Analyzing the responses, we have found that 52.6% of the individuals surveyed<br />
believe that the simplification level provided by the national regulation is not<br />
reasonable, but low and very low. Out of this percentage, most respondents are aged<br />
between 20 and 30 years (59.5% of the people in this group), and between 40 and 50<br />
years (59.1% of the people in this group). The regulation is deemed appropriate rather<br />
by specialists having an experience of 10-20 years (54.9%).<br />
The responses received show that it is necessary to simplify financial reporting for<br />
small and medium enterprises. This can be achieved by amending the Order of the<br />
Minister of Public Finance 3055/2009 or by implementing, as it is, the IFRS for<br />
SMEs.<br />
By question number 7 (Q7), we have attempted to identify which would be, in the<br />
opinion of accounting professionals in our country, the best standardization solution<br />
for the accounting of small and medium enterprises.<br />
Q7: What would be, in your view, the best standardization solution for the accounting<br />
of small and medium enterprises?<br />
The solution favoured by most accounting professionals is to amend the Order of the<br />
Minister of Public Finance (OMFP) 3055/2009 by introducing several simplifications<br />
for small and medium sized enterprises (43.2% of the respondents have been in favour<br />
of this solution). The stand-out group was aged between 30 and 40 years (54.2%),<br />
having a professional experience of 10 to 20 years (50.7%).<br />
Conversely, very few are those who believe that the implementation of international<br />
financial reporting standard for small and medium sized entities is an appropriate<br />
standardization solution in Romania (4,2%).<br />
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Chart 4. Q7 Responses<br />
Nevertheless, two other standardization solutions have been considered appropriate by<br />
some respondents. One group is represented by those who favour the development of<br />
differential regulations, in accordance with the European directives, depending on the<br />
size of the enterprise (20.5%), and another one believes that the best solution would<br />
be to develop a national accounting standard converged with the IFRS standard for<br />
SMEs, accompanied by a Chart of accounts and an implementation guide (20%).<br />
Q8: Do you believe that, for SMEs, the accounting treatment should, first of all, take<br />
into account the Tax Code rules?<br />
The answer given by most respondents has been in the affirmative (65.8%). On<br />
average, 7 out of 10 respondents, regardless of age, gender, and professional<br />
experience, have responded affirmatively. Such a response rate confirms the<br />
prevalence of a high degree of connection between accounting rules and tax rules. In<br />
the case of SMEs, such connection degree is much stronger than what might be<br />
determined by reading the national regulation. Although OMFP 3055/2009 provides<br />
for the possibility of a reasonable disconnection, accountants of small and medium<br />
enterprises prefer to keep the accounting policies consistent, as far as possible, with<br />
the tax rules. The reasons are multiple: avoiding additional work arising from the<br />
reconciliation between the accounting result and the tax result, the difficulty to<br />
convince administrators and owners of small businesses to bear higher costs<br />
associated with software adjustments for ensuring the implementation of accounting<br />
rules appropriate for the business, but different from tax rules, the education level of<br />
accountants of small businesses concerning the importance of financial reporting, the<br />
poor enforcement of compliance with accounting rules for entities that are not subject<br />
to auditing requirements, etc.<br />
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Chart 5. Q8 Responses<br />
Q9: Who is, in your opinion, the main user of accounting information in the case of<br />
an SME in Romania?<br />
Based on the responses received, the following hierarchy of users of accounting<br />
information provided by SMEs is emerging: tax authority (42.6%), enterprise<br />
management (22.1%), and business funders (17.9%).<br />
Chart 6. Q9 Responses<br />
Q10: Do you think that the accounting regulations applicable to small and medium<br />
enterprises should be based on detailed rules?<br />
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After processing the collected data, we have found that 7 out of 10 respondents<br />
believe that accounting regulations for SMEs should be based on detailed rules.<br />
Chart 7. Q10 Responses<br />
Traditionally, Romanian accountants, and especially the accountants of small and<br />
medium enterprises, are dependent on detailed rules, on regulations that should<br />
provide, through the Chart of accounts, the representation of transactions and events.<br />
Recourse to the conceptual framework and the development of professional<br />
judgments based thereon are very scarcely present.<br />
Q11: Do you believe that accounting regulations applicable to small and medium<br />
enterprises should be based on principles and on the exercise of professional<br />
judgment?<br />
8 out of 10 respondents have answered this question in the affirmative. It is<br />
noteworthy that most respondents, although they feel the need to exercise professional<br />
judgment, do not give up the idea of a regulation based on detailed rules. This<br />
situation is explained by an insufficiency and inconsistency of national regulations, a<br />
context where recourse to professional judgment is essential.<br />
Chart 8. Q11 Responses<br />
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We have found that respondents having an experience of up to 10 years reject more<br />
willingly the idea of detailed rules than the idea concerning professional judgment.<br />
One explanation may be that the new generations of professionals have received<br />
initial training where the study of IFRS and the development of professional judgment<br />
were given an utmost importance.<br />
Most of the respondents who had believed that the accounting treatment of SMEs<br />
should take into account, first of all, the Tax Code rules have identified the tax<br />
authority as the privileged user (37.6%).<br />
Analyzing the answers, we have found that 52.6% of the surveyed people believe that<br />
the degree of simplification provided by the national legislation is not reasonable, but<br />
low and very low. Most of these are aged between 20 and 30 years (59.5% of the<br />
respondents in this group), and between 40 and 50 years (59.1% of the respondents in<br />
this group). The regulation is deemed appropriate for SMEs rather by professionals<br />
having an experience of 10-20 years (54.9%).<br />
44.4% of the respondents who have argued that the current form of the national<br />
regulation is not appropriate for the needs of SMEs have believed that the best<br />
solution of standardization is to amend this regulation by introducing simplified rules<br />
for SMEs. The respondents who expressed this opinion are mostly persons aged<br />
between 30 and 40 years (59.3%), and over 50 years (46.7%). 49% of the women and<br />
34.8% of the men have supported the solution of amending the existing regulation.<br />
Out of the respondents who do not consider the current regulation appropriate, 23.6%<br />
have opted for the solution of developing a national accounting standard converged<br />
with IFRS for SMEs. Proponents of this solution are mostly young people (42.9% of<br />
respondents in this age group), as well as people aged between 40 and 50 years<br />
(37.5%).<br />
Among those who have argued that the current legislation is appropriate for the needs<br />
of SMEs, 59.1% have considered that the quantitative criteria existing in the<br />
regulation are the most appropriate. 78 out of the 190 respondents have considered<br />
that quantitative criteria established at EU level are more appropriate for SMEs. Out<br />
of the latter, 37.2% favour the development of separate SME regulations in<br />
accordance with European Directives, while 16.7% support the development of a<br />
standard converged with IFRS for SMEs.<br />
CONCLUSIONS AND LIMITS<br />
Our research was aimed at identifying the attitude of professional accountants in<br />
Romania about a simplified financial reporting system for small and medium-sized<br />
enterprises. For this purpose, we prepared a questionnaire that was sent by email to<br />
550 expert accountants that had been randomly selected from the CECCAR Table.<br />
The analysis of the 190 answers we received revealed that 52.6% of the respondents<br />
consider that the current regulations do not provide for a reasonable level of<br />
simplification for the small and medium-sized enterprises and, consequently, a more<br />
simplified reporting system is needed for the SMEs.<br />
87.4% of the respondents believe that the entities bound to apply the simplified<br />
financial reporting system should be established based on quantitative criteria<br />
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(turnover, average number of employees, total assets). As regards the size of the<br />
criteria, most of the respondents (46.3%) expressed preference for the values stated in<br />
the OMPF (Order of the Minister of Public Finance) 3055/2009. Moreover, 43.2% of<br />
the respondents reckon that the accounting of SMEs should be standardized by<br />
simplifying the OMPF 3055⁄2009, whereas only 4.2% of the respondents consider that<br />
the IASB standard could be applied as such. In our view, this reluctance over the<br />
IASB standard is mainly because in our country we did not experience a large scale<br />
implementation of the international financial reporting standards, these only being<br />
mandatory for the consolidated financial statements of publicly traded companies.<br />
65.8% of the respondents believe that the accounting treatments for SMEs should take<br />
into account, first of all, the fiscal rules. This indicates that although the premises for<br />
separating the accounting and the taxation have been created in principle, in practice,<br />
the accounting treatment is assimilated to the fiscal one. This situation, in our view, is<br />
no surprise, because 42.6% of the respondents considered that the main user of<br />
accounting information about the small and medium-sized enterprises is the tax<br />
authority, while 22.1% consider the management as the main user, and 22.1%<br />
consider those who provide the funding as the main user. 72.6% of the respondents<br />
consider that the accounting regulations for small and medium-sized enterprises<br />
should be based on detailed rules, which indicates that most of the professional<br />
accountants depend on a regulation to offer them through the chart of accounts the<br />
representation of the transactions and events.<br />
Our study is limited because we only tested the opinion of one of the parties involved<br />
in the financial reporting of small and medium-sized enterprises, the professional<br />
accountants. Moreover, the generalization of the results must be made with<br />
cautiously, one of the limits being the sampling error of ±7% for a level of trust<br />
of 95%. Despite all these limits, we believe that our study may be of interest both for<br />
the academic environment and for those who are involved in the financial reporting of<br />
small and medium-sized enterprises: the accounting standard setter, preparers, users<br />
and last, but not least, the professional accountants. Moreover, we consider that this<br />
study may be used as a reference for further research into the financial reporting for<br />
small and medium-sized enterprises in our country.<br />
REFERENCES<br />
Albu, C.N. & Albu, N. (2010) „The context of the possible IFRS for SMEs implementation in<br />
Romania. An exploratory study”, Accounting and Management Information Systems,<br />
vol. 9, no 1: 45-70<br />
Canadian Institute of Chartered Accountants (2001) „Differential Reporting, Background<br />
Information and Basis for Conclusions, Exposure Draft”, available on-line at<br />
http://www.ica.bc.ca/pdf/BasisforConclusions.pdf<br />
Deaconu, A., Pop, I., Buiga, A., Fulop, M. (2009) „Conceptual and Technical<br />
StudyRegarding Future Accounting Regulation for SMES in Europe”, Theoretical<br />
and Applied Economics, vol. I (January): 19-32<br />
Evans, L., Gebhardt, G., Hoogendoorn, M., Marton, J., Di Pietra, R., Mora, A., Thinggard, F.,<br />
Vehmanen, P., Wagenhofer, A. (2005) „Problems and Opportunities of an International<br />
Financial Reporting Standard for Small and Medium-sized Entities. The EAA FRSC's<br />
Comment on the IASB's Discussion Paper”, Accounting in Europe, vol. 2: 23-45<br />
IASB (2009) „International Financial Reporting Standard for Small and Medium–sized<br />
Entities”, available on-line at http://eifrs.iasb.org/eifrs/sme/en/IFRSforSMEs<br />
2009.pdf<br />
~ 785 ~
Ionaşcu, I, Ionaşcu, M., Olimid, L., Calu, D.A. (2007) „An Empirical Evaluation of the Costs<br />
of Harmonizing Romanian Accounting with International Regulations (EU Directives<br />
and IAS⁄IFRS)”, Accounting in Europe, vol. 4:169-206<br />
Farcane., N, Popa., A. (2008) „Recent evolutions regarding IFRS for SMES”, Accounting and<br />
Management Information Systems, Supplement: 324-333<br />
Feleagă, L., Feleagă, N., Vasile., C (2008) „The Stakes in applying the International Financial<br />
Reporting Standards (IFRS) within the small and medium enterprises”, Accounting<br />
and Management Information Systems, nº. 26:43-54<br />
Gîrbină, M. & Bunea, S. (2007) „Les pieges de l'internationalisation de la comptabilite des<br />
PMES. Enseignements de la reforme comptable roumaine”, The Journal of the<br />
Faculty of Economics, Economic Science Series, vol. 2: 366-370<br />
Government Decision no. 704 ⁄ 1993 on the approval of measures for the enforcement of the<br />
Accounting Law no. 82/1991, published in the Official Journal no. 303 ⁄ 22.12.1993<br />
Lungu, C., Caraiani, C., Dascalu, C. (2007) „New Directions of Financial reporting within<br />
Global Accounting Standards for small and medium-sized entities”, available on-line<br />
at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1013520<br />
Nobes, C. & Parker, R. (2008) Compartive International Accounting, Tenth Edition, Pearson<br />
Education Limited<br />
Order of the Minister of Public Finance no. 3055 ⁄ 2009, with subsequent amendments and<br />
supplementations, for the approval of Accounting Regulations in line with the<br />
European Directives, Official Journal no.766 ⁄ 10.11.2009<br />
Order of the Minister of Public Finance no. 1121 ⁄ 2006 on the enforcement of the<br />
international financial reporting standards, Official Journal no. 602 ⁄ 12.07.2006<br />
Order of the Minister of Public Finance no. 1752 ⁄ 2005 on the approval of Accounting<br />
regulations in line with the European directives, Official Journal no. 1080 bis ⁄<br />
30.11.2005<br />
Order of the Minister of Public Finance no. 907 ⁄ 2005 on the approval of the categories of<br />
legal persons that apply the accounting regulations in line with the International<br />
Financial Reporting Standards, the accounting regulations in line with the European<br />
directives, respectively, Official Journal no. 597 ⁄ 11.07.2005<br />
Order of the Minister of Public Finance no. 306⁄ 2002 on the approval of Simplified<br />
accounting regulations, harmonized with European directives, Official Journal<br />
no. 279 ⁄ 25.04.2002<br />
Order of the Minister of Public Finance no. 94 ⁄ 2001 on the approval of Accounting<br />
regulations harmonized with the European Economic Communities’ Directive IV and<br />
the International Accounting Standards, Official Journal no. 480 ⁄ 04.10.1999<br />
Order of the Minister of Public Finance no. 704 ⁄ 2000 on the approval of Account<br />
consolidation norms, Official Journal no. 374 ⁄ 11.08.200<br />
Order of the Minister of Public Finance no. 403 ⁄ 1999 on the approval of Accounting<br />
regulations harmonized with the European Economic Communities’ Directive IV and<br />
the International Accounting Standards, Official Journal no. 480 ⁄ 4.10.1999<br />
Păunescu, M. (2006) „Good news for Romanian companies: IFRS for Small and Medium –<br />
sized Entreprises (SMES)!”, Accounting and Management Information Systems,<br />
Supplement 2006: 648-656.<br />
Roberts, C., Sian, S. (2006) „Micro-Entity Financial Reporting: Perspectives of Preparers and<br />
Users”, Information Paper, available on-line at http://www.docin.com/p-<br />
53065095.html<br />
Săcărin, M. (2010) „Standardul International de Raportare Financiară pentru întreprinderile<br />
mici şi mijlocii: susţinere şi percepţii”, Contabilitate, Expertiză şi Auditul Afacerilor,<br />
no. 10:36-41<br />
Tiron, A. & Muţiu, A. (2008) „Pro and contra opinions regarding a SME accounting”,<br />
Annales Universitatis Apulensis Series Oeconomica, vol. I: 71-82<br />
United Nations Conference on Trade and Development (2003) „Guidelines for small and<br />
Medium - sized entreprises (SMEGA), Level 3 Guidance”, available on line at<br />
http://www.unctad.org/en/docs/iteteb20036_en.pdf<br />
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ACCOUNTING PRINCIPLES AND BOOK-TAX<br />
(DIS)CONNECTION IN ROMANIA<br />
Costel ISTRATE 1<br />
“Alexandru Ioan CUZA” University of IASI, Romania<br />
ABSTRACT<br />
The difference between accounting and taxation is justified by their different goals. However,<br />
referring to income tax, the starting point in the assessment of the tax base is the accounting<br />
income. To understand the differences between accounting and taxation, an important<br />
milestone is the manner in which accounting principles are recognized for tax purposes. Each<br />
of the nine principles explicitly listed in the Romanian Accounting Standards could be<br />
restricted by the tax rules. In our paper, we identified and described some of these situations:<br />
tax implications of the lack of continuity, tax recognition of a change of the accounting<br />
method (inventoiris and revaluation), tax regime of the provisions, tax vs. accounting timing<br />
of revenues and charges (interests, subsequent costs), lease-back as a finance lease,<br />
recognition of some revenues from sales of goods. The recent evolutions of the book-tax<br />
relationship in Romania confirm the increasing deconnection de jure of the accountig and tax<br />
rules.<br />
KEYWORDS: book-tax differences, accounting principles, accounting recognition, fiscal<br />
recognition<br />
INTRODUCTION<br />
The relation between accounting and taxation is a major topic in specific theory and<br />
practice However, (Lamb and Lymer, 1999). The successive and rapid changes<br />
occurring in accounting and fiscal regulations lead sometimes to spectacular<br />
evolutions in the relation between these two aspects of company business. This<br />
generally applies to the accounting and fiscal systems in all the countries that have a<br />
market economy. And Romania is no exception to the rule. We may even consider<br />
Romania’s case a somewhat exemplary one, just like in all the other former<br />
communist countries, in the sense that it is characterized by an extremely fast<br />
evolution of the tax - accounting relationship, due to the short time elapsed from the<br />
implementation of a set of modern accounting and fiscal systems in these countries.<br />
Over the last 20 years, countries like Romania have gone through successive<br />
development phases that free economies have covered over much longer periods of<br />
time. The scientific papers of the tax – accounting relation frequently refer to income<br />
tax, more specifically to the criteria applied to measure profit/loss from the accounting<br />
and fiscal viewpoints. However, this relation may also influence other taxes, although<br />
less numerous and less spectacular, such as value added tax, nonresident income tax,<br />
building tax, dividend tax…<br />
1<br />
Correspondence address: Costel ISTRATE, Alexandru Ioan Cuza University of Iaşi;<br />
email: istrate@uaic.ro<br />
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Among the numerous matters that we may discuss when approaching the tax -<br />
accounting relation (Mills, 1996; Langli and Saudagaran, 2004, or features such as<br />
export orientation or involvement in activities related to new technologies; Hung and<br />
Mo, 2002; for Romania, Fekete et al. 2009), we will focus on the way in which<br />
accounting principles are fiscally recognized or influence taxable income, without<br />
however aiming at an exhaustive analysis of these topics. In this paper, the term<br />
accounting principles mean the general accounting evaluation rules listed explicitly<br />
by the Romanian regulation and European directives.<br />
1. METHODOLOGY<br />
Accounting and taxation are highly regulated in Romania. The regulations that set<br />
specific rules are numerous and they originate mostly in the same place – the<br />
Romanian Ministry of Public Finance – which makes us believe in a coherent<br />
approach both within each category of rules and between the two sets taken together.<br />
Our approach consists of a document-based analysis of Romanian accounting and tax<br />
regulations, which is designed to underline the manner in which tax regulations<br />
recognize accounting principles, either by fully or partially accepting them, or by<br />
simply rejecting them when calculating profit tax. Our analysis dwells on explicitly<br />
recognized accounting principles. Consequently, we can only examine the accounting<br />
of individual Romanian business entities, since any taxable income refers to<br />
individual corporate bodies and not to groups of companies – we agree on this point<br />
with Lamb et al. (1998).<br />
The rest of the document is organized as follows: we list the explicit accounting<br />
principles imposed by Romanian accounting regulations (section 2), followed by<br />
general fiscal rules that apply to taxable income (section 3), and by several<br />
developments on the tax recognition of each principle (section 4) and, finally, by<br />
conclusions.<br />
2. THE LIST OF ACCOUNTING PRINCIPLES IN THE ROMANIAN<br />
ACCOUNTING STANDARDS<br />
The unceasing adjustment of Romanian accounting to the European and international<br />
developments in this field, as well as to the business requirements, materialized in a<br />
weariless set of amendments to these regulations. The creation and development of<br />
the Romanian accounting standards have been observing all along the European<br />
directives, international standards (IAS/IFRS) and – although to a lesser extent – the<br />
accounting and tax practices imposed by Romanian practitioners. We will only focus<br />
here on the explicitly recognized accounting principles revealed in the current<br />
Romanian accounting regulations. Although the first version of the accounting<br />
regulations drafted after 1990 (Government’s Decision no. 704/1993 – HG 704/1993)<br />
included only the six principles proposed by the 4 th European Directive, the current<br />
regulation - order of the minister of public finance no. 3055/2009 (OMPF 3055/2009)<br />
- lists nine principles. This evolution also brought about significant qualitative<br />
advantages: the explanations and examples given were welcome and facilitated the<br />
work of accounting practitioners.<br />
Romanian regulations do not set an accounting principle hierarchy different than the<br />
principle presentation order. Starting with 2010, the OMPF 3055/2009 renders almost<br />
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literally several provisions of the General Framework for the Preparation and<br />
Presentation of Financial Statements drafted by IASC/IASB. We may assume that the<br />
IASC/IASB hierarchy is also used by the Romanian regulation (IASB and FASB are<br />
working on a major project of improving the General framework... In the new version,<br />
the hierarchy of quality characteristics is even more pronounced). Therefore, these<br />
enacting terms are said to rely on basic concepts (accrual accounting and going<br />
concern), as well as on qualitative characteristics and their components (In this<br />
context, it is to emphasize that the use of IAS/IFRS in Romania, during 2000 - 2005,<br />
had some tax consequences in entities bound by the Order of the Minister of Public<br />
Finance 94/2001 on the approval of accounting regulations harmonized with the<br />
Fourth European Economic Community and the International Accounting Standards<br />
(Official Gazette 94/2001). Table 1 shows the regulations that imposed explicit<br />
accounting principles in Romania.<br />
Although it may not be representative, the principle presentation order suggests a<br />
slight approach alteration. Thus, the principle of prudence, which ranks first in the HG<br />
704/1993, seems to lose its importance with the diversification of the inspiration<br />
sources used by the Romanian regulator that also relies on IAS/IFRS (Albu et al.,<br />
2010). After 1999, for some entities (especially public entities), the regulations added<br />
three principles: separate accounting evaluation of assets and liabilities, substance<br />
over form and materiality. Starting with 2010, the nine principles apply to all entities,<br />
regardless of their size or presence on the financial market.<br />
The accounting principle<br />
Table 1. Accounting principles evolution in Romania<br />
HG<br />
704/1993<br />
OMFP<br />
403/1999,<br />
replaced<br />
by OMFP<br />
94/2001<br />
~ 789 ~<br />
OMFP<br />
306/2002<br />
OMFP<br />
1752/2005<br />
OMFP<br />
3055/2009<br />
Effective date 1.01. 1994 1.01. 1999 1.01. 2003 1.01. 2006 ian. 2010<br />
Date up to which has been<br />
applied<br />
31.12. 2002 31.12. 2005 31.12. 2005 31.12. 2009<br />
Going concern 3 1 1 1 1<br />
Comparability 2 2 2 2 2<br />
Conservatism (evaluation on a<br />
prudent basis)<br />
1 3 3 3 3<br />
Accrual basis 4 4 4 4 4<br />
Separate accounting evaluation<br />
of assets and liabilities<br />
- 5 5 5 5<br />
Individual recognition, without<br />
any off-setting<br />
The opening balance sheet for<br />
6 6 6 6 6<br />
each financial year must<br />
correspond to the closing balance<br />
of the preceding financial year<br />
5 7 7 7 7<br />
Substance over form - 8 - 8 8<br />
Materiality - 9 - 9 9<br />
3. GENERAL TAX RULES, IN THEIRE RELATIONSHIPS<br />
WITH ACCOUNTING STANDARDS<br />
The tax code does not bring about completely new rules when it tries to set the<br />
notional amount of profit tax. Conversely, the starting point is the accounting
(Whitaker 2005 although the latter's proposals go in the opposite direction suggested<br />
by Nobes 2004, Schön 2005, Walker 2007 or Desai and Dharmapala 2009), that is the<br />
book income. The simple reading of the tax return is sufficient to convince us of this<br />
initial recognition by the taxation bodies of the accounting income: it includes all the<br />
accounting expenditure and revenue as such, according to their nature, i.e. the gross<br />
accounting income. Starting from here, taxable income calculation considers several<br />
corrections of the accounting earnings, which corrections may be synthesized as<br />
follows:<br />
a) items assimilated to revenue and items assimilated to expenditure;<br />
b) tax deductions (tax-free income and other deductions);<br />
c) nondeductible expenditure;<br />
d) tax loss carryforward.<br />
Yet, fiscal adjustments do not stop here. When the notional amount of profit tax has<br />
been set and a theoretical value of this tax has been determined, the following are<br />
deducted, if necessary (in this order): foreign tax credit, profit tax exemption, profit<br />
tax reductions, amounts recognized as sponsorship and similar sums.<br />
The enforcement by taxation regulations of recognition criteria different from the<br />
accounting ones is accounted for by the different goals of taxation and accounting<br />
(Raby and Richter, 1975; Viandier and Lauzengheim, 1993, p. 7; Rossignol, 2002;<br />
Plesko, 2004; D’Ascenzo şi England, 2005; Whitaker, 2005; Nobes and Schwenke,<br />
2006 etc.). The former (taxation) mainly focuses on gathering the resources that are<br />
needed to cover public expenditure, while the latter (accounting) is mostly designed to<br />
gather and process data in order to collect and provide information on various entities.<br />
4. TAX IMPLICATIONS OF THE ACCOUNTING PRINCIPLES<br />
Considering the differences that may occur between tax and accounting, it becomes<br />
interesting to see to what extent the effects in terms of revenue and expenditure of<br />
accounting principles are recognized, fiscally speaking. Our approach involves both<br />
tax recognition as such, when the revenue and expenditure are recorded in the books,<br />
and tax timing, if different from accounting timing (Yoon, 2008). We intend to<br />
analyze all the nine principles (Istrate 2010) shown in table 1, although some of them<br />
do not significantly influence the relation between accounting and taxation (King et<br />
al. 2001).<br />
4.1. Going concern<br />
The OMPF 3055/2009 argues that financial statements are normally drafted bearing in<br />
mind the assumption that the business will not be interrupted in the predictable future.<br />
This going concern does not bear special fiscal consequences – the company will<br />
calculate the taxes according to a set of general rules. Specific cases occur when, for<br />
various reasons, the continuity is no longer possible and the company starts the<br />
winding-up procedure. Thus, if after the enforcement of the winding-up procedures<br />
and the payment of the debts, the company still has assets left, these assets will be<br />
distributed to the shareholders or stockholders. In order to be able to identify the<br />
taxation treatment applied to this transfer, we must first analyze the structure of the<br />
equity capital left after debt payment. If one component of the equity capital<br />
originated from different sources, one may have to deal with different taxation<br />
~ 790 ~
treatments. For instance, the share capital may come from the actual contributions of<br />
the shareholder/shareholders, and also from complements consisting of profits made<br />
by the company during its operation years or of fiscally recognized or non-recognized<br />
revaluation surplus. The taxation treatment differs depending on the origin of each<br />
structure. Another comment related to these possible asset reimbursements to the<br />
shareholders focuses on whether such reimbursements should be considered or not<br />
dividend payments. When defining dividends, the tax code explicitly states that any<br />
money or other asset distribution performed in relation to the winding-up of a<br />
corporate body is not assimilated to dividends. This means that the reimbursement is<br />
not subjected to dividend taxation. One should nevertheless make a distinction<br />
between the capacity of the shareholder, who may be either an individual or a<br />
corporate body. If the shareholder is a corporate body, the money transferred on the<br />
winding-up is not subjected to dividend taxation, but it will materialize in taxable<br />
revenue of the shareholder/stakeholder. Conversely, if the shareholder is an<br />
individual, the money that is reimbursed is subjected to 16% tax withheld at source, as<br />
it is considered income from the winding-up of a corporate body.<br />
Bearing in mind these remarks, we are now able to draft a fiscal classification of the<br />
equity capital items left after the winding-up of a company:<br />
a) equity capital coming from the actual contributions of the shareholders/<br />
stakeholders, which is reimbursed as such, without being subjected to any<br />
tax; we refer here to share capital components and share premiums;<br />
b) equity capital coming from gross profits or other sums similar to gross<br />
profits – their reimbursement changes the fiscal destination, and it is hence<br />
subjected to profit taxation (legal reserves, other reserves resulted from tax<br />
facilities, untaxed revaluation reserves); the income resulted from the<br />
winding-up of a company is also subjected to 16% taxation after having<br />
withheld the profit tax, if the shareholders/stakeholders are individuals;<br />
c) the equity capital coming from profits that were already subjected to profit<br />
taxation is reimbursed considering the system of law applying to the<br />
beneficiary of the amounts: if the shareholder /stakeholder is a corporate<br />
body, no tax is withheld; if, on the contrary, the shareholder/stakeholder is<br />
an individual, 16% taxation is applied to the income resulted from the<br />
winding-up of a corporate body.<br />
4.2. Comparability<br />
According to the basic rule proposed by this principle the valuation methods and the<br />
accounting policies must be used coherently. Yet, in special cases, changes to the<br />
accounting policies used by the entity are also acceptable. The tax code does not set a<br />
general rule for method changing, yet we may identify tax recognition in at least two<br />
cases: inventories valuation and positive revaluation of tangible assets.<br />
As concerns inventories, the tax code argues that the stock valuation accounting<br />
methods must not be altered during the fiscal year. This means that the stock valuation<br />
method may only be changed at the beginning of the fiscal year. This rule may very<br />
well coincide with the accounting rule, thus almost becoming one and the same<br />
(Hoffman and McKenzie, 2009) Any change to the stock valuation method leads to<br />
the alteration of the stock value in the opening balance sheet of a financial year as<br />
compared to the same stock value found in the closing balance sheet of the previous<br />
~ 791 ~
financial year. The tax recognition of the change makes the amount under retained<br />
earnings to be fiscally accepted by its assimilation to deductible expenditure or<br />
taxable revenue. Whatever the case, on the following discharge from administration of<br />
the stocks on which the method was changed, that stock expenditure will be fully<br />
deductible.<br />
According to the accounting regulations, subsequent fixed asset valuation is possible<br />
using either the cost model, or the fair value model. Switching from one model to the<br />
other means changing the accounting method. The tax code provides that the tax value<br />
of fixed assets also includes the revaluations performed under the law. This<br />
accounting method change is also accepted from the taxation viewpoint. Revaluation<br />
tax recognition has become rather a formality since, starting with May 2009, the<br />
revaluation adjustment is taxed gradually, as the revaluated assets depreciate, which<br />
makes the actual tax deduction to stay at the level of the depreciation that would have<br />
been calculated if no revaluation had been performed. We should also point out that<br />
tax recognition is limited to positive revaluations: if a depreciation that should be<br />
recorded under expenditure occurs further to the revaluation, then this depreciation is<br />
non-deductible expenditure, which generates deductible temporary differences.<br />
The current version of the principle of the permanence of methods also refers to<br />
accounting estimates, more specifically to accounting estimate changes. These are<br />
explicitly allowed, and the examples provided by the OMPF 3055/2009 refer to<br />
uncertain customers, to the life cycle and depreciation treatment applied to<br />
depreciable fixed assets. Estimates on provisions, prospective cash flows or discount<br />
rates necessary to set particular values etc may also be added to this category. If, from<br />
the accounting viewpoint, the estimate changes are usually recognized and even<br />
encouraged, the fiscal rule set reliable boundaries to accounting estimate drafting and<br />
modification. For instance, the items considered when setting the fixed asset tax<br />
depreciation must under no circumstances exceed the boundaries set by fiscal<br />
regulations (duration, depreciation treatment, null residual value) and once set, these<br />
landmarks are very difficult to alter. Nevertheless, we may dare to assume (without<br />
having any empirical confirmation whatsoever) that many entities include in their<br />
accounting records tax-based estimates, in order to avoid keeping two sets of different<br />
books. However, it is sometimes difficult – or even impossible – (especially in<br />
companies forced to audit their financial statements and/or in Romanian branches of<br />
foreign groups) to make accounting and fiscal estimates coincide.<br />
4.3. Accounting conservatism<br />
Accounting prudence prohibits both revenue and asset overvaluation, and debt and<br />
expenditure undervaluation (Givoly et al., 2007). Thus, in its pure version, accounting<br />
prudence brings about an asymmetric probable revenue and expenditure treatment<br />
(Watts, 2003; Pae, 2007, Iyengar & Zampelli, 2010): while probable expenditure is<br />
always considered, probable revenue is disregarded, as its recording depends on<br />
whether or not an event occurs that turns it into certain revenue. Among the direct<br />
consequences of accounting prudence one may note systematic asset undervaluation<br />
and expenditure overvaluation (Richard, 2005, Huerta de Soto, 2010, pp. 20-21). It<br />
has also been argued that financial statements become more prudent when the<br />
connection between accounting and taxation is more close; this statement needs<br />
~ 792 ~
however to be enlarged upon and also consider the evolution of the taxation levels and<br />
of the tax deduction systems applied in each jurisdiction (Aisbitt, 2002).<br />
Accounting standards try to discourage exaggerations when applying this principle,<br />
stating, for instance, that prudence allows neither the constitution of excessive<br />
provisions, or the deliberate asset or revenue undervaluation, nor the deliberate debt<br />
or expenditure overvaluation, as financial statements would thus no longer be neutral<br />
and hence they would stop being reliable.<br />
Considering the impact of prudence on accounting earnings, the taxation body is<br />
extremely careful to the consequences of prudence in terms of expenditure (Niskanen<br />
and Keloharju 2000). As concerns Romania’s case, if we only take into consideration<br />
the depreciation adjustments and the provisions (Givoly et al. 2007), we will find in<br />
the tax code drastic limitations applied to their tax recognition. If we focus on<br />
business entities other than those with mostly financial activities, we notice that the<br />
list of deductible provisions (Feleaga et al. 2010) is rather short:<br />
a) for performance bonds granted to customers;<br />
b) for accounts receivable depreciation;<br />
c) for the closing and post-closing follow-up of waste deposits;<br />
d) for land restoration, after natural deposit exploitation.<br />
As compared to the tons of adjustments and provisions allowed by accounting rules,<br />
the 4 categories above seem rather few. And the limitations do not stop here: tax<br />
recognition is only achieved if additional specific requirements are met.<br />
Another issue that relies on the principle of prudence is the treatment applied to<br />
subsequent fixed asset-related expenditure. The rule is roughly the same from both the<br />
accounting and fiscal viewpoints: any subsequent expenditure designed to improve<br />
the initial technical parameters of the assets becomes fixed, provided it leads to<br />
additional future economic benefits – the taxation regulation (HG 2139/2004)<br />
illustrates the example of buildings. Although there does not really seem to be clear<br />
differences between the two sets of standards, the estimate according to which one<br />
determines whether additional future economic benefits will be gained is a strongly<br />
subjective one. Therefore, we can assume that this compulsory accounting prudence<br />
could lead to the capitalization of a lower amount of expenditure than expected by the<br />
taxation body.<br />
Intangible assets may also be treated differently from the accounting and fiscal<br />
viewpoints, which also points out the differences between the fiscal and accounting<br />
prudence. Thus, whereas the fiscal rule explicitly recognizes the recording in the<br />
books of patents, trademarks, copyrights or development expenditure, the same rule<br />
stipulates that the accounting depreciation of goodwill (which is compulsory,<br />
according to the OMPF 3055/2009) is not deductible. The opposite example is the<br />
case of computer software: fiscally speaking, its depreciation takes three years,<br />
although it may actually be used longer than that. This is one of the few examples<br />
where the taxation standard is more prudent than the accounting standard.<br />
~ 793 ~
4.4. Accrual basis accounting<br />
After 1990, the Romanian regulations consider accrual accounting as the basic<br />
assumption when obtaining and providing accounting information. Our preference for<br />
the international accounting standards (IAS/IFRS) confirms and supports this<br />
approach, according to which transactions and events generate accounting revenue<br />
and expenditure when they occur and not necessarily when cash flows are generated<br />
(proceeds/payments). This basic concept (provided in the IASC General<br />
Framework…) is described as such in the OMPF 3055/2009. The description of<br />
accrual accounting may seem somewhat ambiguous (Edwards, 2003 proposes (for the<br />
United States) to return to a cash flows tax system; Shaviro,2009). In order to<br />
overcome this difficulty, the standard explicitly provides an important consequence of<br />
this principle – the matching principle.<br />
The general fiscal rule currently acknowledges the same principle, without too many<br />
exceptions – revenue and expenditure are recognized in the same way accounting<br />
does, that is when they are earned/undertaken and not when they are actually<br />
received/paid. One may therefore conclude that, from the principle standpoint, both<br />
the accounting and fiscal standards rely on the same reasoning.<br />
The tax treatment applied to installments sales enjoyed certain specific aspects related<br />
to profit tax. Thus, before April 30, 2005, the revenue and related expenditure became<br />
taxable/deductible (as profit tax) on the date set for installment collection.<br />
Consequently, a clear distinction between accounting and taxation could be revealed,<br />
although, for simplicity reasons, some accountants recorded the accounting revenue<br />
and related expenditure on the same date set for installment collection.<br />
The tax recognition of the accounting independence of financial years is also<br />
supported by the following explicit provision of the tax law: “the taxable profit is<br />
calculated as the difference between the revenue earned from any source and the<br />
expenditure undertaken in order to earn revenue, in a fiscal year…” One may however<br />
notice that there are cases when the financial year of the fiscal recognition of<br />
particular expenditure (and revenue, although less significant) differs from the<br />
financial year when this expenditure achieves accounting recognition. Theoretically<br />
speaking, we may include here all the differences between the taxable income and the<br />
accounting earnings, which the international accounting standards (IAS 12 Profit Tax)<br />
include in taxable or deductible temporary differences (see also Plesko, 2004;<br />
Gallego, 2004; Ristea, 2008). In short, here are the possible sources of such temporary<br />
differences:<br />
� accounting depreciation different from tax depreciation – differences occurred<br />
because of different amounts to be depreciated, different depreciation periods<br />
or systems;<br />
� depreciation adjustments and fiscally nondeductible provisions;<br />
� interests whose deductibility is deferred until all the indebtedness and positive<br />
equity capital requirements are met;<br />
� nontaxable revenue from value differences of long-term equity securities.<br />
~ 794 ~
4.5. Separate evaluation of assets and liabilities<br />
The accounting standard provides that individual assets and liabilities must be<br />
valuated separately. This individual identification of assets and liabilities with a view<br />
to their valuation must be done throughout the accounting valuation process. Here are<br />
some of the advantages of a separate valuation of assets and liabilities:<br />
� better determination of the unit values of the assets and liabilities components<br />
when only the overall value of a set of various assets and liabilities is known;<br />
� avoidance of offsetting between possible favorable and unfavorable<br />
differences occurred on the valuation of different assets and liabilities.<br />
Fiscally speaking, separate valuation may trigger effects, depending on which of the<br />
two cases described above we are confronted with. Thus, if the company acquires a<br />
set of assets (accompanied by possible liabilities) for a unique negotiated price, the<br />
setting of the unit values of the assets and liabilities concerned is nothing but neutral.<br />
For instance, some quickly depreciable components or some components that are<br />
more quickly turned into expenditure in other manner might be assigned higher values<br />
in order to accelerate the tax deduction process. If the valuation is done on inventory<br />
and closing, the block valuation may lead to the failure to observe other accounting<br />
principles, such as prudence, which, as already seen, brings about the asymmetric<br />
treatment of the favorable and unfavorable value differences.<br />
4.6. The opening balance sheet for each financial year must correspond<br />
to the closing balance of the preceding financial year<br />
The most important consequence of this principle is that fact that, once published, a<br />
set of financial statements (balance sheet, profit and loss account, cash flow<br />
statements…) can no longer be altered. The correction of the errors encountered in the<br />
previous financial years or the changing of the accounting methods employed cannot<br />
result into changes to the already published financial statements for those financial<br />
years. The effects of these events are to be seen in the retained earnings of the<br />
financial year affected by adjustment.<br />
Fiscally speaking, the method change treatment was dwelled upon above. If it has<br />
fiscal effects, accounting error correction will generate a possible corrective statement<br />
where the tax is recalculated.<br />
4.7. Individual recognition, without any off-setting<br />
The accounting interdiction related to the offsetting between assets and liabilities, and<br />
especially between revenue and expenditure, is a rule that has significant fiscal<br />
implications. Accounting information would really be distorted if, for instance, a<br />
taxable income were offset by a nondeductible expenditure item, or if a nontaxable<br />
income were offset by a deductible expenditure item. Coming back to the case of<br />
block assets acquisition, which are accompanied by liabilities, the possible offsetting<br />
between an asset and a liability has effects on the tax values employed to records into<br />
books the components of the purchased assembly.<br />
The principle of non-offsetting proposed by the OMPF 3055/2009 brings something<br />
new as compared to the previous standards, namely an accounting solution to assets<br />
~ 795 ~
changes. Until 2009 inclusive, the accounting standard made no reference to such<br />
types of operations. Conversely, the tax standard (when referring to VAT) argued that<br />
any exchange of goods was to be recorded as two concomitant deliveries, meaning<br />
that each of the parties involved issues an invoice and collects VAT. We can only<br />
assume that, when they had to record in the books an exchange of assets, accountants<br />
employed this rather fiscal rule. The OMPF 3055/2009 provides a procedure that is<br />
very close to the fiscal one described above: the sale/discharge from administration<br />
and the purchase/entry in administration are recorded distinctly by the entities<br />
involved in the transaction, which are also supposed to record the entire revenue and<br />
expenditure related to these operations. This solution provides the accounting and<br />
taxation compliance of the asset and service exchange transactions. Nevertheless,<br />
please note that exaggerations are possible, that is unfounded revenue and expenditure<br />
multiplications, when the goods and services exchanged are similar. Fiscally<br />
speaking, such asset exchange is only interesting since it generates revenue and<br />
expenditure (once or several times), as well as profit or loss. Revenue increase may<br />
have some implications since tax is (also) established depending on the overall<br />
revenue level, and profit is taxed somewhat in advance, as long as the goods received<br />
further to the exchange have not yet been recognized as expenditure.<br />
4.8. Substance over form<br />
One of the consequences of Romania’s embracing of the international accounting<br />
standards (IAS/IFRS) was the introduction in the national authoritative accounting<br />
pronouncements of this Anglo-Saxon rule. Before the passing of the OMPF<br />
3055/2009, the application of this principle was limited to marketable entities, to other<br />
public interest entities, as well as to entities that exceeded specific size criteria.<br />
Starting with 2010, the substance over form principle is valid for all entities.<br />
Substance over form is invocated when the legal form of the transaction (provided by<br />
the drafted documents) fails to perfectly match its economic substance. Yet, the<br />
standard suggests that such differences should be “extremely rare”, since, under<br />
normal circumstances, it is the obligation of the business entities to draft documents<br />
that reflect their economic status as accurately as possible. The accounting standard<br />
enumerates some cases when the economic background is different from the legal<br />
status:<br />
� the classification, by the users, of leasing contracts as operational or financial<br />
leasing;<br />
� the categorizing of specific sales as deferred revenue and expenditure<br />
generators;<br />
� the categorizing of securities as long or short-term securities;<br />
� the classificatin of granted and received discounts as commercial or financial<br />
discounts.As concerns leasing contracts, their categorizing as financial or<br />
operational is not necessarily a consequence of the substance over form<br />
prevalence. It is true that in Romanian the distinction between the two<br />
categories of contracts is imposed by legal regulations and not by business<br />
usage or practice. We even find explicitly described separation criteria in both<br />
the fiscal and accounting standards. The difference that may occur here is not<br />
between form and substance, but between the accounting and fiscal standards:<br />
the criteria are not exactly the same, although they are highly similar and the<br />
perfect connection between the two sets of records is possible in practice.<br />
~ 796 ~
Moreover, the legal documents supporting the contracts (especially invoices)<br />
are recorded exactly in the form they have.<br />
There is however a significant source of differentiation between the accounting and<br />
fiscal standards, namely the lease-back contracts. According to the OMPF 3055/2009<br />
(sequel of OMPF 2374/2007), the procedure of recording in the books of lease-back<br />
contracts materialized in financial leasing is limited to the accounting component<br />
where the current account is debited and the corresponding long-term debt account is<br />
credited. If this is the case, its accounting reflection somewhat lacks covering in the<br />
related documents or, to put it differently, the documents drafted lack their<br />
transposition in the books in accordance with their formal content. A lease-back<br />
transaction is a sale followed by the reception of the asset in financial leasing<br />
conditions – it is actually a leasing contract where the user is also the supplier.<br />
Fiscally speaking, the sale is reflected in the invoice, which includes an income equal<br />
to the sale price, as well as the afferent collected VAT (if any). This income is taxable<br />
on the sale date, even when no record of it appears in the company books. Also, if this<br />
income is fiscally recognized, it should be confronted with the expense that generated<br />
it, meaning with the net book value of the sold asset and taken over in leasing. Under<br />
normal circumstances, this expense is deductible. Neither the income, nor the expense<br />
is recorded in the books, but they are both fiscally recognized. After the taking over of<br />
the asset in leasing, its book value remains the same as before, since the fixed assets<br />
and depreciation accounts were not involved at all in the recording of the transaction<br />
in the books. The tax value of the asset, that is the value considered when calculating<br />
deductible depreciation is equal to the contract input value, that is the VAT exclusive<br />
price for which the asset was “sold” to the leasing company.<br />
The rule employed when recording asset sales in company books seems rather clear.<br />
The OMPF 3055/2009 provides as such the recognition criteria of IAS 18, which<br />
apply to such transactions. Let us not forget that IAS 18 was created in a business<br />
environment that often employs rules that we have not yet taken sufficiently in. Thus,<br />
the first provision states that an asset sale income is recognized by the seller if it<br />
complies with several requirements, the first of which is the transfer to the buyer of<br />
significant risks and benefits associated with the ownership right over that asset.<br />
What happens if the sale is paid in installments and the ownership transfer depends on<br />
the payment of the last installment? The accounting solution essentially depends on<br />
the manner in which the requirements imposed by the standard are thought to be met.<br />
If, for instance, the seller has reasons to believe that he will have difficulties in<br />
recovering the entire amount of money, the sale is not certain and the income cannot<br />
be immediately recognized. If this is the case, the accounting treatment could resort to<br />
spacing out or even deferring the income (and, hence, the expense), unlike the tax<br />
treatment, which is limited to the recording in the books of the supporting documents<br />
(invoice). This is the difference between accounting and taxation.<br />
The categorizing of securities as long or short-term securities does not lack fiscal<br />
implications: as concerns long-term securities, any possible income from changes to<br />
their value is not taxable as long as those assets are held by the company (the book<br />
value thus differs from the tax value). Conversely, when they are categorized as shortterm,<br />
their accurate valuation may generate book income that is taxed right away (the<br />
book value remains equal to the tax value).<br />
~ 797 ~
The categorizing of discounts as commercial or financial discounts is important from<br />
the standpoint of their financial reporting, as they influence either the operating, or the<br />
financial profit/loss, which could have specific effects on the indicators that reflect the<br />
company business. From the fiscal point of view, the distinction between financial<br />
and operating discounts is important, at least for two reasons:<br />
� if the discount received is categorized as financial, then it is automatically<br />
recognized under revenue, which is immediately taxed and increases the<br />
overall amount of revenue recorded in the books;<br />
� if the discount received is categorized as commercial, then it either diminishes<br />
a cost of purchase, with fiscal effects when recording the purchased goods<br />
under expenditure, or it is directly recognized as expenditure diminution<br />
(deductible);<br />
� commercial discounts are usually invoiced, which also involves the adjustment<br />
of the value added tax, while as concerns financial discounts the invoicing is<br />
not implicit, which means that the VAT is not always adjusted.<br />
9. Materiality<br />
Rules derived from this principle were also applied before our alignment to the<br />
European directives and to the IAS/IFRS, although this occurred in a somewhat<br />
implicit manner. In its current official wording, the significance threshold principle<br />
refers to information presentation in the balance sheet and in the profit and loss<br />
account. Thus, if the information is significant, then it is presented distinctly; if, on<br />
the contrary, it lacks significance, then it may be presented together with other pieces<br />
of information of the same type, as a single indicator. This version of the principle<br />
does not seem to have too many fiscal consequences, since no reference was made to<br />
any kind of revenue or expenditure. We could nevertheless attempt to extend the<br />
significance threshold, starting also from the text of the OMPF 3055/2009, which<br />
provides the IASC General Framework…, to the qualitative characteristics of annual<br />
financial reports. Relevance is influenced by the nature of the information and by the<br />
significance threshold. The information reference enables us to say that it is not only<br />
the way in which it is presented but also the way in which it is collected that maters.<br />
We thus come to accept significance threshold rules also when processing the data<br />
that lead us to accounting information. Actually, this is not at all new: when recording<br />
a transaction in the books, we sometimes apply the simplest rule, which is not always<br />
the main one, pleading for it precisely since that transaction is insignificant. From this<br />
point of view, fiscal implications are also possible, that the taxation body accepts or<br />
not. For instance, on the reception of assets on which discounts were received, it is<br />
possible to correct the cost of purchase by those discounts, or, for simplicity reasons,<br />
they could be considered expenditure or even revenue diminution. These different<br />
discount treatments may be caused by the difficulties related to the determination of<br />
the reason for which those discounts were granted. To continue this reasoning, the<br />
categorizing of subsequent expenditure related to fixed assets is not always easy to<br />
perform, for which reason we choose the simplest solution, especially if the value of<br />
that expenditure is not significant. All these options may also have fiscal implications,<br />
to the extent they are included, sooner or later, in expenditure and/or revenue<br />
structures.<br />
Compliance with tax obligations brings about costs that tax payers must bear. The<br />
more complex the taxation system, the higher the costs related to tax management<br />
~ 798 ~
(Slemrod and Blumenthal, 1996). In some countries (including Romania), the<br />
limitation of this kind of costs for specific companies and the simplification of the<br />
taxation procedures resulted into the replacement of profit tax by income tax, the<br />
latter being much easier to calculate and follow (for certain companies with revenues<br />
of less than 100,000 euros). We may even rest our argument on a sort of significance<br />
threshold principle with fiscal applications: the profit tax is calculated only for<br />
companies that are large enough.<br />
DISCUSSION AND CONCLUSIONS<br />
The relation between company accounting and company taxation has been is a<br />
perpetual evolution and its implications are to be identified especially in the profit tax<br />
area, and also when calculating and declaring other taxes (value added tax, local taxes<br />
and charges). When trying to detect the difference or superposition between<br />
accounting and taxation, it is useful to examine the manner in which accounting<br />
principles are fiscally recognized. We thus looked at the nine principles explicitly<br />
listed by the OMPF 3055/2009 and we tried to identify some of their fiscal<br />
implications, focusing especially on the instances when tax regulations differ from<br />
accounting regulations. The result was more or less numerous fiscal consequences for<br />
each of the nine principles.<br />
Therefore, as concerns the going concern, the fiscal consequences occur especially<br />
when this continuity is interrupted. Or, a lack of continuity may mean winding-up,<br />
which is the end of the life of an entity. If, after the payment of the debts there is still<br />
some money left, then profit tax and/or income tax is calculated for the winding-up<br />
revenue, that is for the remaining equity capital structures. The taxation of equity<br />
capital does not necessarily result from the differences found between the accounting<br />
and fiscal regulations, but it is rather a natural consequence of the taxation treatments<br />
applied to those equity capital components on their constitution.<br />
As for method permanence, we find fiscal implications and we comment upon the<br />
method change effects. For instance, fiscal regulations accept changes to the stock<br />
valuation method, if these changes occur when passing from one financial year to the<br />
next. Another method change with considerable fiscal implications is the passing from<br />
the depreciated cost model to the fair value model. No differences between the two<br />
sets of records occur to the extent this revaluation is fiscally recognized. As concerns<br />
accounting estimate changes, accounting regulations have become slightly less rigid<br />
than fiscal regulations, which may help distinguish between the two. Accounting<br />
method changes and error corrections are also the object of the principle of balance<br />
sheet intangibility.<br />
Accounting conservatism is one of the principles that have important outcomes for the<br />
accounting-taxation relation. For simplicity reasons, we may even say that the<br />
Romanian taxation body does not fully accept the consequences of the accounting<br />
prudence rule, thus seriously limiting the fiscal recognition of the expenditure<br />
undertaken further to the application of this principle or simply deferring their<br />
recognition. For instance, the tax deduction of expenditure undertaken for provisions<br />
and depreciation adjustments is limited and conditioned rather strictly.<br />
~ 799 ~
The accrual accounting is also a potential source of differences between accounting<br />
and taxation. Generally speaking, fiscal regulations recognize revenue and<br />
expenditure as they were recorded in the books. Nevertheless, in some cases, the<br />
moment of accounting recognition does not coincide with the moment of tax<br />
recognition. In IAS/IFRS terms, some of these inconsistencies are considered<br />
temporary differences. Here are the current difference sources: accounting<br />
depreciation different from tax depreciation; adjustments for depreciation that are not<br />
tax deductible; provisions that are not tax deductible; interests whose deductibility is<br />
deferred; specific revenue from equity securities that is not taxable; differences<br />
between book and tax values occurred further to restructuring and reorganization<br />
operations. Nevertheless, unlike IAS/IFRS, Romanian accounting regulations (no<br />
longer) require the use of the deferred tax mechanism.<br />
Separate asset and liability valuation is important from the fiscal viewpoint, since it<br />
prevents assigning individual values in a neutral manner, which in its turn prevents,<br />
for instance, the offsetting between favorable and unfavorable differences, should the<br />
fiscal treatments applied to these differences be diverging.<br />
Given the obligation of recording all individual revenue and expenditure components,<br />
the accounting principle of non-offsetting also has fiscal effects, since it prevents, for<br />
instance, the offsetting between a taxable income and a non-deductible expense and<br />
vice-versa. Also, starting with the OMPF 3055/2009, another connection between<br />
accounting and taxation is achieved, namely the asset exchange treatment.<br />
As it was to be expected, substance over form may also have considerable fiscal<br />
implications. Taxation regulations focus a great deal on supporting documents (with<br />
few exceptions). Yet, the reflection in the books of the transactions should rather<br />
consider their economic background, which would result in some approach<br />
differences. We identified such a suggestive example, namely lease-back operations,<br />
where accounting regulations propose a bookkeeping method that is totally different<br />
from the one suggested by fiscal regulations. In other cases (sales under various<br />
circumstances), a daring accounting approach may bring about taxation advantages in<br />
terms of deferred tax and charge payment.We agree with the idea according to which<br />
the relation between accounting and taxation, measured by the method employed to<br />
calculate profit/loss from the accounting and fiscal viewpoints, does not have the<br />
same characteristics for all the categories of companies. Company size, funding<br />
method (marketable or not), or affiliation to a group, as well as the nationality of the<br />
major shareholders/stockholders, the interest in terms of resource mobilization from<br />
banks or other crediting institutions are all variables that the application and fiscal<br />
recognition of accounting principles may depend on.<br />
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PS17 Financial analysis II<br />
Chairperson<br />
Sotirios KARATZIMAS, University of Aegean, Greece<br />
FUNDAMENTAL DETERMINANTS OF CAPITAL<br />
STRUCTURE CHOICE:<br />
A SURVEY OF ROMANIAN COMPANIES<br />
Marilen PIRTEA, Cristina NICOLESCU, Claudiu BOTOC<br />
IMPACT OF LONG-TERM INVESTMENT<br />
DECISIONS ON PROFITABILITY AND COMPETITIVE<br />
ADVANTAGE IN BUSINESS. CASE STUDY<br />
IN THE MINING INDUSTRY IN ROMANIA<br />
Claudia Elena SERBAN, Oana-Adelina FLORICIOIU,<br />
Radu-Daniel LOGHIN<br />
INCLUDING BEHAVIOURAL ELEMENTS<br />
IN ASSET ALLOCATION PROCESS<br />
Aurora MURGEA<br />
~ 804 ~
FUNDAMENTAL DETERMINANTS OF CAPITAL<br />
STRUCTURE CHOICE: A SURVEY OF ROMANIAN<br />
COMPANIES<br />
Marilen PIRTEA, Cristina NICOLESCU & Claudiu BOTOC 1<br />
West University of Timisoara, Romania<br />
ABSTRACT<br />
One of the longest-standing questions about capital structure is whether companies have<br />
target debt ratios. The most important arguments for what could determine capital structure<br />
is trade-off theory and the pecking order theory. The goal of this paper is to express the<br />
linkage between financial leverage and characteristics of the company, in an emerging<br />
market such as the Romanian one. To address this problem, we used a simple linear<br />
regression model throughout the analysis in order to put the focus on within-company<br />
changes in financial leverage. We consider factors related to the demand for and the supply<br />
of debt financing. Together, the magnitude of the estimated effects of supply and demand<br />
factors appears large enough to account the most or the entire long-term trend in emerging<br />
market debt ratios. On the demand side, theory suggests, and prior empirical evidence of<br />
companies, that fundamental company-level characteristics influence the degree to which<br />
companies take on debt. In a linear simple regression model, we found a negative correlation<br />
between financial leverage, return on operational income to total assets or growth<br />
opportunities and a positive correlation between financial leverage, the rate of tangible assets<br />
or turnover.<br />
KEYWORDS: Capital structure, Trade-off theory, Pecking order theory, Financial<br />
leverage, Company-level factors<br />
INTRODUCTION<br />
The capital structure of a company is basically described by the two main elements<br />
that characterize its debt: financial leverage and maturity. Optimal leverage represents<br />
a compromise between the “nominal” stream of tax benefits that debt generates, and<br />
the probability of this stream being received.<br />
In recent decades in emerging markets debt financing has played the role of both hero<br />
and villain. As hero, debt financing has been viewed as an engine for growth that<br />
enables companies to undertake profitable investments that otherwise might not have<br />
been financed. As the villain, debt financing has been viewed as a vehicle for<br />
companies to take excessive risks that have led to instability in emerging markets.<br />
Although the relative costs and benefits of debt financing may be in question, it is at<br />
least clear that debt financing has played an increasingly important part in emerging<br />
markets finance over the past quarter century.<br />
1 Correspondence address: Claudiu BOŢOC, West University of Timişoara, Faculty of Economics and<br />
Business Administration, Finance Department, 16 J. H. Pestalozzi Street, 300115, Timişoara,<br />
Romania; tel.: 0757100904; fax: 0256/592500; email: claudiu.botoc@feaa.uvt.ro<br />
~ 805 ~
It is standard in literature to estimate the capital structure by financial leverage. As for<br />
the definition of financial leverage, the ratio of total liabilities to total assets is the<br />
broadest one and used in many empirical studies. However, Rajan and Zingales<br />
(1995) point out that this definition is inappropriate for financial leverage since total<br />
liabilities includes items used for transaction purposes (e.g. account payable) rather<br />
than financing. Also, Rajan and Zingales (1995) suggest that total debt to capital<br />
probably best represents the effects of past financing decisions.<br />
The goal of this paper is to express the linkage between financial leverage and<br />
characteristics of the company, in an emerging market such as the Romanian one. To<br />
address this problem, we used a simple linear regression model throughout the<br />
analysis in order to put the focus on within-company changes in financial leverage.<br />
We consider factors related to the demand for and the supply of debt financing.<br />
Together, the magnitude of the estimated effects of supply and demand factors<br />
appears large enough to account the most or the entire long-term trend in emerging<br />
market debt ratios.<br />
On the demand side, theory suggests, and prior empirical evidence of companies, that<br />
fundamental company-level characteristics influence the degree to which companies<br />
take on debt. Although numerous potential company-level determinants of capital<br />
structure have been tested, the variables that have most consistently survived<br />
empirical tests are company size, profitability, asset tangibility, and growth<br />
opportunities (Rajan & Zingales, 1995).<br />
We find that within-company trends in each of these four variables are significantly<br />
correlated with within-company trends in debt ratios. In each case, the correlation is in<br />
the direction consistent with previous literature: larger size, lower profitability, higher<br />
asset tangibility, and lower growth opportunities are all associated with higher levels<br />
of debt. Moreover, the trend in each of these four variables over the time was in the<br />
direction that would imply an increase in leverage. On average, emerging market<br />
companies experienced increases in size, decreases in profitability, increases in asset<br />
tangibility, and decreases in growth opportunities in last three decades (Mitton, 2008).<br />
Estimates of economic significance suggest that changes in these company-level<br />
fundamentals can explain the majority of the increase in emerging market debt over<br />
this period. Debt ratios have increased in emerging markets in large part because<br />
companies have changed in such a way that their optimal level of debt has increased.<br />
The increase in debt ratios may also depend on supply factors, or in other words, the<br />
ability of companies to obtain external financing in emerging markets. If companies<br />
are financially constrained, then increases in credit market development may lead to<br />
higher debt ratios. Increases in stock market development (which allow companies to<br />
substitute equity for debt) may lead to decreases in debt ratios.<br />
This study complements and adds to Mitton’s (2008) survey of capital structure in 34<br />
emerging markets (Romania was not included in the sample). We complement<br />
Mitton’s work as we analyze company-level factors that affects capital structure for<br />
Romanian companies, also an emerging market with reduced liquidity and imperfect<br />
transactions mechanisms. According to another study realized over Romanian<br />
~ 806 ~
companies, we found a statistical significant negative correlation between financial<br />
leverage and PER ratio. More exactly, one can argue that for an emergent market,<br />
with severe restrictions on financial resources supply side, the choice of the capital<br />
structure implies a tradeoff between external sources represented mainly by banking<br />
credit and limited appeal to the financing opportunities through the capital market<br />
(Pirtea et al., 2010).<br />
The paper is organized as follows. The next section highlights theoretical<br />
considerations regarding the main theories of capital structure, financial leverage and<br />
value of the company. The third section briefly describes the methodological<br />
framework, where for an empirical research we try to search for a relation between<br />
financial leverage and main variables of the company. The data characteristics and the<br />
results are reported in this section, whilst the last section summarizes the conclusions<br />
of the paper.<br />
1. LITERATURE REVIEW<br />
One of the longest-standing questions about capital structure is whether companies<br />
have target debt ratios. The most important arguments for what could determine<br />
capital structure is trade-off theory and the pecking order theory. These two theories<br />
are reviewed, but neither of them provides a complete description of the situation and<br />
why some companies prefer equity and others debt under different circumstances.<br />
These theories are conditional, not general. It is easy to find examples of each theory<br />
at work, but otherwise difficult to distinguish the theories empirically. Large, safe<br />
companies with mostly tangible assets tend to borrow more. Companies with high<br />
profitability and valuable growth opportunities tend to borrow less. Each of these<br />
tendencies is consistent with two or more of the major theories of financing.<br />
Theoretical models developed seem to explain differently if the data is divided into<br />
several generic groups of companies.<br />
The trade-off theory says that companies have optimal debt-equity ratios, which<br />
determine by trading off the benefits of debt with the costs (Graham & Harvey, 2001).<br />
In traditional trade-off models, the chief benefit of debt is the tax advantage of interest<br />
deductibility (Modigliani & Miller, 1963). The primary costs are those associated with<br />
financial distress and the personal tax expense bondholders incur when they receive<br />
interest income (Miller, 1977).<br />
The pecking-order model of financing choice assumes that companies do not target a<br />
specific debt ratio, but instead use external financing only when internal funds are<br />
insufficient. External funds are less desirable because informational asymmetries<br />
between management and investors imply that external funds are undervalued in<br />
relation to the degree of asymmetry (Myers & Majluf, 1984). Therefore, if companies<br />
use external funds, they prefer to use debt, convertible securities, and, as a last resort,<br />
equity.<br />
1.1. The trade-off theory<br />
Jensen argues that debt is an efficient means by which to reduce the agency costs<br />
associated with equity (Jensen, 1986). Klaus and Litzenberger show that with the tax<br />
~ 807 ~
advantages of debt, optimal capital structure includes debt financing. Ross argues that<br />
debt can be valuable as a device for signaling company value (Ross, 1977). The three<br />
main hypotheses that are used to explain differences in capital structure between<br />
companies are the transaction-cost hypothesis, the asymmetric information hypothesis<br />
and the tax hypothesis. According to Harris and Raviv, financial leverage increases<br />
with fixed assets, non-debt tax shields, investment opportunities, and company size<br />
and decreases with volatility, advertising expenditure, the probability of bankruptcy,<br />
profitability and uniqueness of the product (Harris & Raviv, 1991).<br />
This theory claims that a company’s optimal debt constant ratio is determined by a<br />
trade-off between the losses and gains of borrowing, holding the company’s assets<br />
and investment plans. The company substitute’s debt for equity or equity for debt<br />
until the value of the company is maximized. The gain of debt is primarily the taxshelter<br />
effect, which arises when paid interest on debt is deductible on the profit and<br />
loss account. The costs of debt are mainly direct and indirect bankruptcy costs.<br />
The original static trade-off theory is actually a sub theory of the general theory of<br />
capital structure because there are only two assumptions that are broken here, the no<br />
tax incentive assumption and the no bankruptcy cost assumption. In the more general<br />
trade-off theory several other arguments are used for why companies might try to<br />
adjust their capital structure to some target. Financial leverage also depends on<br />
restrictions in the debt-contracts, takeover possibilities and the reputation of<br />
management. Vintage companies with a long history of credits will have relatively<br />
low default probability and lower agency costs using debt financing than newly<br />
established companies. A common factor for all these company characteristics is that<br />
they are proxies meant to measure some form of costs related to a principal-agent<br />
problem. There may simultaneously be several principal-agent problems between the<br />
different classes of securities in the company or between stockholders and managers<br />
in the company. This multiplicity of problems can easily confuse the analyst and lend<br />
an air of incomprehensibility to the field of corporate finance.<br />
A construction of a positive theory of debt financing, builds on arguments on the<br />
advantages and disadvantages of debt. First, debt is a factor of the ownership structure<br />
that disciplines managers. Limiting control to a few agents that control the common<br />
stock, while the rest of the capital is raised through bond sale, can reduce agency cost<br />
of management. Second, debt is a useful signaling device, used to inform investors a<br />
message of the company’s degree of excellence. Third, debt can also reduce excessive<br />
consumption of perquisites because creditors demand annual payments on the<br />
outstanding loans. Debt also has its disadvantages. First, there is the problem of<br />
agency cost of debt that includes risk substitution and under investment. Second, debt<br />
also increases bankruptcy possibility by increasing the financial risk of the company.<br />
Debt creation, without retention of the proceeds of the issue, enables managers to<br />
effectively bond their promise to pay out future cash flows. Thus debt can be an<br />
effective substitute for dividends, something not generally recognized in the corporate<br />
finance literature (Jensen, 1986). Debt reduces management opportunity to spend<br />
excess cash flow in non-profitable investments. Management has less control over the<br />
company’s cash flows since these cash flows have to be used to repay creditors.<br />
Managerial incentives to allocate the company’s resources to their private benefit are<br />
larger when the company is mainly equity financed.<br />
~ 808 ~
The “free cash flow” term is the amount by which a company’s operating cash flow<br />
exceeds what can be profitably reinvested in its basic business and the emphasis is<br />
here on the word profitably. Conflicts of interest between stockholders and managers<br />
over payout policies are especially severe when the organization generates substantial<br />
free cash flow (Frydenberg, 2008).<br />
Profitability affects leverage in at least two directions. First, higher profitability<br />
usually provides more internal financing. More earnings can be kept in the company<br />
and hence a lower level of debt. Less debt is then needed to finance already planned<br />
investments. Secondly, debt introduces an agency cost argument. Management will<br />
refrain from the building of empires and excessive consumption of perquisites, when<br />
large sums of money must be paid to creditors each year. Debt keeps the company<br />
slim and cost efficient. Unnecessary non-profitable investments will be avoided<br />
because creditors demand annual payments and claim any free cash flow. High<br />
profitability should result in higher leverage according to the free cash flow<br />
hypothesis, but a high leverage would result in high profitability on the basis of the<br />
pecking order hypothesis.<br />
1.2. The pecking order theory<br />
Issuing debt minimizes the managers' information advantage. Optimistic managers,<br />
who believe their companies' shares are undervalued, will jump at the chance to issue<br />
debt rather than equity. Only pessimistic managers will want to issue equity. If debt is<br />
an open alternative, then any attempt to sell shares will reveal that the shares are not a<br />
good buy. Therefore investors will spurn equity issues if debt is available on fair<br />
terms, and in equilibrium only debt will be issued. Equity issues will occur only when<br />
debt is costly, for example because the company is already at a dangerously high debt<br />
ratio where managers and investors foresee costs of financial distress. In this case<br />
even optimistic managers may turn to the stock market for financing.<br />
This leads us to the pecking-order theory of capital structure (Myers, 2003).<br />
Companies prefer internal to external finance (Information asymmetries are assumed<br />
relevant only for external financing). Dividends are "sticky", so that dividend cuts are<br />
not used to finance capital expenditure, and changes in cash requirements are not<br />
soaked up in short-run dividend changes. Changes in free cash flow (operating cash<br />
flow less investment) show up as changes in external financing.<br />
If external funds are required for capital investment, companies will issue the safest<br />
security first, that is, debt before equity. As the requirement for external financing<br />
increases, the company will work down the pecking order, from safe to riskier debt<br />
and finally to equity as a last resort, when the company is sufficiently threatened by<br />
financial distress. If internally generated cash flow exceeds capital investment, the<br />
company works up the pecking order. Excess cash is used to pay down debt rather<br />
than repurchasing and retiring equity. The company's debt ratio therefore reflects its<br />
cumulative requirement for external financing.<br />
According to the pecking order theory, the companies will prefer internal financing.<br />
The companies prefers internal to external financing, and debt to equity if the<br />
company issues securities. In the pure pecking order theory, the companies have no<br />
~ 809 ~
well-defined debt-to-value ratio. There is a distinction between internal and external<br />
equity.<br />
The companies prefer internal financing they target dividends given investment<br />
opportunities, then chose debt and finally raise external equity (Myers & Majluf,<br />
1984). The pecking order was traditionally explained by transaction and issuing costs.<br />
Retained earnings involve few transaction costs and issuing debt incurs lower<br />
transaction costs than equity issues. Debt financing also involves a tax - reduction if<br />
the company has a taxable profit. To give a theoretical explanation for the pecking<br />
order phenomena several authors invoked asymmetric information. The signaling<br />
model leads to a pecking order concept of capital structure, where retained earnings<br />
are preferred to debt and debt is preferred to new equity. The signaling model showed<br />
that only low profit type companies would issue equity in a separating equilibrium.<br />
Rational investors foresee this and demand a discount in Initial Public Offerings<br />
(IPO). This discount is a cost of raising equity that will be borne by the internal<br />
stockholders. Debt signals to the capital market that the issuing company is a high<br />
performance company.<br />
Asymmetric information between old and new investors, and managers and investors<br />
incite to signaling games where the amount of debt and the timing of new issues is<br />
viewed as a signal of the performance of the company. The idea underlying the<br />
signaling models is that stockholders or managers signal private information to the<br />
security market in order to correct the market’s perception of excellence.<br />
The pecking-order theory explains why the bulk of external financing comes from<br />
debt. It also explains why more profitable companies borrow less: not because their<br />
target debt ratio is low in the pecking order they don't have a target but because<br />
profitable companies have more internal financing available. Less profitable<br />
companies require more external financing, and consequently accumulate more debt.<br />
The pecking-order theory cannot explain why financing tactics are not developed to<br />
avoid the financing consequences of managers' superior information. For example,<br />
suppose that any special information available to the manager today will reach<br />
investors within the next year. The manager cannot know today whether he or she will<br />
view the future price as too high or too low.<br />
Myers and Majluf consider a very simple setting, where the company's only financing<br />
choice is debt vs. equity. The pecking order does not necessarily hold in more<br />
complicating settings, for example when the company also chooses between straight<br />
and convertible debt.<br />
1.3. Tests of the trade-off and pecking order theories<br />
The trade-off theory implies a target-adjustment model meanwhile pecking-order<br />
theory says that the debt ratio depends on the company's cumulative financial deficit<br />
its cumulative requirement for external financing. Shyam-Sunder and Myers tested<br />
these time-series predictions on a panel of 157 companies from 1971 to 1989. They<br />
found statistically significant support for both the pecking order and a targetadjustment<br />
specification of the trade-off theory. The trade-off theory, expressed as a<br />
target adjustment model, was "consistent with" financing choices driven solely by the<br />
pecking order. The pecking order generates mean-reverting debt ratios when capital<br />
~ 810 ~
investments are "lumpy" and positively serially correlated, and when free cash flow<br />
varies over the business cycle (Shyam-Sunder & Myers, 1999).<br />
Frank and Goyal tested Shyam-Sunder and Myers' time-series specification for the<br />
pecking order on a much larger sample of companies from 1971 to 1998. This<br />
specification worked reasonably well for large companies, particularly in the 1970s<br />
and 1980s. They also find that variables motivated by the trade-off theory help<br />
explain changes in debt financing, even after accounting for changes in companies'<br />
financial deficits. Large companies with tangible assets borrow more, profitable<br />
companies with high market-book ratios borrow less (Frank & Goyal, 2003).<br />
Fama and French test the predictions of both trade-off and pecking-order models on a<br />
large panel of companies from 1965 to 1999. They also consider modified versions of<br />
the pecking order. (Fama & French, 1998) Both theories score some points in Fama<br />
and French's tests, but run into serious difficulties. The trade-off theory struggles to<br />
explain the strong inverse relationship of profitability and leverage. The pecking order<br />
struggles to explain the heavy reliance on equity issues by small growth companies<br />
(Fama & French, 2002).<br />
Baker and Wurgler find that issuing companies seem to "time" the market, issuing<br />
shares when their stock prices are high and turning to internal finance or debt when<br />
prices are low. Consistent pursuit of timing strategies would make debt ratios depend<br />
on paths of past stock prices as well as on requirements for external funds (Baker &<br />
Wurgler, 2002). Ritter calls this the "windows of opportunity" theory. If investors<br />
sometimes overprice issuing companies' shares, so that equity is truly cheap, then<br />
equity can move temporarily to the top of the pecking order. Thus the windows of<br />
opportunity theory could absolve the pecking order of a major empirical shortcoming,<br />
provided that one is willing to assume systematic mispricing of new issues, at least in<br />
"hot" issue periods (Ritter, 2003).<br />
Most research on corporate financing decisions considers the trade-off and peckingorder<br />
theories. There are convincing examples of these theories at work. The<br />
economic problems and incentives that drive the theories taxes, information and costs<br />
of agency and distress show up clearly in financing tactics. Yet none of the theories<br />
gives a general explanation of financing strategy. They are plausible as conditional<br />
theories, but we have only a partial understanding of the conditions under which each<br />
theory, or some combination of the theories, works (Myers, 2003). Zingales says that<br />
we need "new foundations" for corporate finance. The foundations will require a<br />
deeper understanding of the motives and behavior of managers and employees of the<br />
company (Zingales, 2000).<br />
1.4. Confronting theory with practice<br />
How companies make their capital structure decisions has been one of the most<br />
extensively researched areas in corporate finance, yet there is little consensus among<br />
these studies. In a recent paper, Graham and Harvey (2001) examine the theory and<br />
practice of corporate finance by surveying US managers. Bancel and Mittoo (2004) do<br />
the same in the European context, but differ in its scope and focus.<br />
Graham and Harvey (2001) test the implications of different capital structure theories<br />
through a survey of US managers. They find moderate support that companies follow<br />
the tradeoff theory and target their debt ratios. They also find some support for the<br />
~ 811 ~
pecking-order theory. Their results show that companies’ value financial flexibility<br />
but its importance is not related to information asymmetry or growth options in the<br />
manner predicted by the pecking order theory. They find little evidence that other<br />
factors including agency costs, signaling, asset substitution, free cash flow and<br />
product market concerns affect capital structure choice.<br />
They also report that managers use many informal criteria, such as credit rating and<br />
earnings per share dilution, in making their financing decisions. An important issue is<br />
whether US managers' views are influenced largely by the US institutional<br />
environment or are also shared by their peers in other countries.<br />
Overall, company size is positively related to the use of the discounted cash flow<br />
method and the application of the CAPM. Smaller companies and companies less<br />
oriented towards maximizing shareholder value are more likely to evaluate their<br />
investment opportunities by using the payback period criterion and setting their cost<br />
of capital at whatever level their investors tell them. For capital structure, there are<br />
smaller disparities between corporate debt policies for US and European companies.<br />
Financial flexibility is the key factor when determining their debt structure. In<br />
addition, corporate financial management practices are predominantly determined by<br />
company size, to a lesser extent by shareholder orientation, and least by country of<br />
origin (Brounen & Koedijk, 2004).<br />
European managers use factors similar to those used by their US peers for their<br />
financing decisions. However, there are differences across countries on several<br />
dimensions, especially between Scandinavian and non-Scandinavian countries. Also<br />
the quality of the country's legal system explains cross-country variations in the<br />
rankings of several major factors, but so do other country-specific factors such as cost<br />
of capital. In addition, although differences in debt policy factors vary systematically<br />
with the quality of a country's legal system, company-specific factors such as the<br />
company's growth opportunities strongly influence the common stock policy factors<br />
(Bancel & Mittoo, 2004). Most companies determine their optimal capital structure by<br />
trading off factors such as tax advantage of debt, bankruptcy costs, agency costs, and<br />
accessibility to external financing.<br />
2. METHODOLOGICAL FRAMEWORK<br />
2.1. Defining variables and regression model building<br />
A company`s requests for a private loan financing should change with changing its<br />
characteristics, over time. In this respect, we believe that the changes at the<br />
companies` level have an impact on corporate capital structure. Among these changes,<br />
we will consider just four factors of influence to determine the correlation with<br />
financial leverage: the companies` size, profitability, the rate of tangible assets and the<br />
growth opportunities, similar to other studies on financial leverage (Mitton, 2008).<br />
The company`s size is generally positively correlated with the financial leverage,<br />
since large companies are less likely to fail, thus generating a greater debt capacity. In<br />
case of information asymmetry, the more a company is transparent in providing<br />
information, the access to obtain borrowed capital is better. Investors believe that a<br />
big company has more reliable guarantees and a better control risk. Size can be<br />
expressed either by turnover or by the number of employees, but due to the<br />
~ 812 ~
estructuring process of the companies in Romania will take into account the turnover<br />
for expressing dimension.<br />
The econometric models are linear regressions regarding the parameters, but not<br />
compulsory regarding the variables. Logarithms of variables, those dependent or the<br />
explanatory or both categories, allows the performance of classical linear regression<br />
model assumptions. Thus the determination will be made using the logarithm scale<br />
turnover.<br />
Profitability is negatively correlated with the financial leverage, according to the<br />
pecking order theory hypothesis, in which companies turn to borrow capital only<br />
when internal sources are insufficient. According to the information asymmetry<br />
theories, the financing policy is a corporate performance indicator. The higher the<br />
financial leverage, the better the company will be perceived as more performing, and<br />
the confidence regarding the manager will be higher. We use the return on operational<br />
income to total assets rate (ROIA) to express profitability, calculated as follows:<br />
Net operating income<br />
ROIA = (1)<br />
Total assets<br />
Because tangible assets can be used as collateral for obtaining loan resources, a<br />
significant share of them may be associated with a high degree of financial leverage,<br />
reflecting a positive correlation. Rate of tangible assets is determined as follows:<br />
where:<br />
R ta<br />
TA – total assets<br />
IA – intangible assets<br />
FA - financial assets<br />
TA − IA − FA<br />
= ∗100<br />
(2)<br />
TA<br />
Companies with growth opportunities should have a low financial leverage, Myers<br />
arguments that an excessive level of leverage may determine companies to avoid<br />
profitable investment opportunities. Consequently, there is a negative correlation<br />
between growth opportunities and financial leverage. (Fama & French, 2002). To<br />
determine the growth opportunities we will consider the relationship between market<br />
value and accounting value of shares (market-to-book ratio):<br />
Share price<br />
MBR = (3)<br />
NAS<br />
where NAS represents the accounting net asset per share and is calculated as:<br />
Total assets − Total debt<br />
NAS = (4)<br />
Number of shares<br />
Using the above variables we can set a pool type econometric model with the<br />
following equation:<br />
y i, t = αi<br />
+ β1<br />
∗x<br />
i, t + εi,<br />
t<br />
(5)<br />
The reasons for choosing such a model were related to relatively short time span and<br />
presentation of data, where the observations of a variable being grouped together but<br />
presented separately from the observations of the other variables (unstacked data). For<br />
~ 813 ~
a more detailed approach on the influence of the four variables on financial leverage,<br />
we have performed a sequential analysis of the model. In this regard, we have<br />
considered possible combinations of the four variables: we analyzed those grouped<br />
three and finally all four, the explicit form of the model being the following:<br />
where:<br />
FL = α + α ∗log(CA)<br />
+ α ∗R<br />
+ α ∗R<br />
+ α ∗MBR<br />
(6)<br />
i, t<br />
0<br />
1<br />
i, t<br />
2<br />
e i, t<br />
~ 814 ~<br />
3<br />
at i, t<br />
FL – financial leverage = Total debt/Equity capital<br />
i – represents i company<br />
t – represents the t moment<br />
2.2. Description and result interpretation<br />
To achieve a regression model that can explain the financing policy of the companies<br />
listed on BSE, we considered a sample of 46 companies (the 22 from first category<br />
and 24 from second category), for the period 2005-2009.<br />
Next, we consider the analytical models under the influence of 3 of the 4 treated<br />
factors. For the analysis model between the financial leverage (dependent variable),<br />
the return on operational income to total assets, the rate of tangible assets and marketto-book<br />
ratio (independent variables), the results are reflected in the following table:<br />
Table 1. Relationship between FL, ROIA, TAR and MBR<br />
Dependent variable: FL?<br />
Method: Pooled EGLS (Cross-section weights)<br />
Sample: 2005 2009<br />
Number of included observations: 5<br />
Crossed observations: 46<br />
Total observations: 230<br />
Weighted variables matrix as linear estimation in a single step<br />
Variable Coefficient Std. Error t-Statistic Prob.<br />
C 0.554361 0.230297 2.407161 0.0169<br />
ROIA? -2.188050 0.735553 -2.974699 0.0033<br />
TAR? 0.382838 0.227870 1.680071 0.0943<br />
MBR? -0.042326 0.049410 -0.856640 0.3926<br />
Weighted Statistics<br />
R-squared 0.076028 Mean dependent var 3.122705<br />
Adjusted R squared 0.063763 S.D. dependent var 3.385150<br />
S.E. of regression 3.093244 Sum squared resid 2162.403<br />
F-statistic 6.198701 Durbin-Watson stat 0.692769<br />
Prob(F-statistic) 0.000459<br />
Unweighted Statistics<br />
R-squared -0.018004 Mean dependent var 1.345409<br />
Sum squared resid 5308.495 Durbin-Watson stat 2.278699<br />
(Source: authors’ own calculations generated by using the Eviews7 soft)<br />
Since the standard error of the coefficient value is higher, in module, than the<br />
coefficient`s value, the impact analysis model based on return on operational income<br />
to total assets, tangible assets and market-to-book ratio is not valid.<br />
4<br />
i, t
For the analysis model between the financial leverage (dependent variable), rate of<br />
return on operational income to total assets, market-to-book ratios and turnover<br />
(independent variables), the results are reflected in the following table:<br />
Table 2. Relationship between FL, ROIA, MBR and turnover<br />
Dependent variable: FL?<br />
Method: Pooled EGLS (Cross-section weights)<br />
Sample: 2005 2009<br />
Number of included observations: 5<br />
Crossed observations: 46<br />
Total observations: 230<br />
Weighted variables matrix as linear estimation in a single step<br />
Variable Coefficient Std. Error t-Statistic Prob.<br />
C -4.094321 0.785778 -5.210528 0.0000<br />
ROIA? -1.933981 0.735223 -2.630469 0.0091<br />
MBR? -0.066925 0.050419 -1.327371 0.1857<br />
LOGTO? 0.614072 0.101037 6.077688 0.0000<br />
Weighted Statistics<br />
R-squared 0.156063 Mean dependent var 2.685130<br />
Adjusted R squared 0.144860 S.D. dependent var 3.018797<br />
S.E. of regression 2.962386 Sum squared resid 1983.316<br />
F-statistic 13.93081 Durbin-Watson stat 0.571497<br />
Prob(F-statistic) 0.000000<br />
Unweighted Statistics<br />
R-squared 0.014295 Mean dependent var 1.345409<br />
Sum squared resid 5140.067 Durbin-Watson stat 2.350760<br />
(Source: authors’ own calculations generated by using the Eviews7 soft)<br />
Consequently, the following observations can be drawn:<br />
� The standard error values of the regression function coefficients are lower, in<br />
module, than the coefficients` values, which imply that their estimate is<br />
correct, also reasoned by the low values of probabilities.<br />
� The correlation coefficient shows that 15.60% of the changes in ROIA,<br />
turnover and MBR are reflected in financial leverage.<br />
� The model`s coefficients indicate that a 1% change of ER leads to a change of<br />
-1.93% for the financial leverage, a 1% change in the MBR causes a change of<br />
-0.06% for the financial leverage, and an amendment to 1 % of turnover<br />
results in a change of 6.14% of the financial leverage.<br />
� Durbin-Watson test indicates a partial correlation between the residual<br />
variables (0.57).<br />
~ 815 ~
For the analysis model of financial leverage (dependent variable), return on<br />
operational income to total assets, the rate of tangible assets and turnover<br />
(independent variables), the results are reflected in the following table:<br />
Table 3. Relationship between FL, ROIA, TAR and turnover<br />
Dependent Variable: FL?<br />
Method: Pooled EGLS (Cross-section weights)<br />
Sample: 2005 2009<br />
Number of included observations: 5<br />
Crossed observations: 46<br />
Total observations: 230<br />
Weighted variables matrix as linear estimation in a single step<br />
Variable Coefficient Std. Error t-Statistic Prob.<br />
C -4.423280 0.774168 -5.713592 0.0000<br />
ROIA? -2.456691 0.539234 -4.555892 0.0000<br />
TAR? 0.471362 0.216578 2.176411 0.0306<br />
LOGTO? 0.595256 0.093495 6.366696 0.0000<br />
Weighted Statistics<br />
R-squared 0.190355 Mean dependent var 3.323127<br />
Adjusted Rsquared 0.179607 S.D. dependent var 3.434845<br />
S.E. of regression 3.424266 Sum squared resid 2649.986<br />
F-statistic 17.71151 Durbin-Watson stat 0.547392<br />
Prob(F-statistic) 0.000000<br />
Unweighted Statistics<br />
R-squared 0.014572 Mean dependent var 1.345409<br />
Sum squared resid 5138.623 Durbin-Watson stat 2.345460<br />
(Source: authors’ own calculations generated by using the Eviews7 soft)<br />
Consequently, the following observations can be drawn:<br />
� The standard error values of the regression function coefficients are lower, in<br />
module, than the coefficients` values, which imply that their estimate is<br />
correct, also reasoned by the low values of probabilities.<br />
� The correlation coefficient shows that 19.03% of the changes in ER, rate of<br />
tangible assets and turnover are reflected in financial leverage.<br />
� The model`s coefficients indicate that a 1% change of ER leads to a change of<br />
-2.45% for the financial leverage, a 1% change in the Tar causes a change of<br />
0.47% for the financial leverage, and an amendment to 1 % of turnover results<br />
in a change of 0.59% of the financial leverage.<br />
� Durbin-Watson test indicates a partial correlation between the residual<br />
variables (0.54).<br />
For the analysis model of financial leverage (dependent variable), the rate of<br />
tangible assets, market-to-book ratio and turnover (independent variables), the results<br />
are reflected in the following table 4.<br />
~ 816 ~
Table 4. Relationship between FL, TAR, MBR and turnover<br />
Dependent variable: FL?<br />
Method: Pooled EGLS (Cross-section weights)<br />
Sample: 2005 2009<br />
Number of included observations: 5<br />
Crossed observations: 46<br />
Total observations: 230<br />
Weighted variables matrix as linear estimation in a single step<br />
Variable Coefficient Std. Error t-Statistic Prob.<br />
C -4.479768 0.651429 -6.876829 0.0000<br />
TAR? 0.206118 0.181929 1.132958 0.2584<br />
MBR? -0.065353 0.042456 -1.539293 0.1251<br />
LOGTO? 0.615475 0.079661 7.726171 0.0000<br />
Weighted Statistics<br />
R-squared 0.214896 Mean dependent var 3.070773<br />
Adjusted R squared 0.204475 S.D. dependent var 3.204010<br />
S.E. of regression 3.043110 Sum squared resid 2092.877<br />
F-statistic 20.62002 Durbin-Watson stat 0.611174<br />
Prob(F-statistic) 0.000000<br />
Unweighted Statistics<br />
R-squared 0.002681 Mean dependent var 1.345409<br />
Sum squared resid 5200.630 Durbin-Watson stat 2.329926<br />
(Source: authors’ own calculations generated by using the Eviews7 soft)<br />
Consequently, the following observations can be drawn:<br />
� The standard error values of the regression function coefficients are lower, in<br />
module, than the coefficients` values, which imply that their estimate is<br />
correct, also reasoned by the low values of probabilities.<br />
� The correlation coefficient shows that 21.48% of the changes in the rate of<br />
tangible assets, MBR and turnover are reflected in financial leverage.<br />
� The model`s coefficients indicate that a 1% change of TAR leads to a change<br />
of 0.20% for the financial leverage, a 1% change in the MBR causes a change<br />
of -0.06% for the financial leverage, and an amendment to 1 % of turnover<br />
results in a change of 0.61% of the financial leverage.<br />
� Durbin-Watson test indicates a partial correlation between the residual<br />
variables (0.61).<br />
Of all the models with three variables, the greatest influence over financial leverage<br />
belongs to the model based on the influence of tangible assets ratio, the market-tobook<br />
ratio and turnover. However, three of the four possible combinations present a<br />
valid pattern and a positive correlation of financial leverage.<br />
The last model takes into account all four factors as independent variables, the results<br />
being reflected in the following table 5.<br />
~ 817 ~
Table 5. Relationship between LF, turnover, ROIA, TAR and MBR<br />
Dependent variable: FL?<br />
Method: Pooled EGLS (Period weights)<br />
Sample: 2005 2009<br />
Number of included observations: 5<br />
Crossed observations: 46<br />
Total observations: 230<br />
Weighted variables matrix as linear estimation in a single step<br />
Variable Coefficient Std. Error t-Statistic Prob.<br />
C -5.755206 1.741865 -3.304049 0.0011<br />
LOGTO? 0.828612 0.205148 4.039082 0.0001<br />
ROIA? -3.465510 1.748949 -1.981481 0.0488<br />
TAR? 0.640928 0.510407 1.255719 0.2105<br />
MBR? -0.248395 0.128525 -1.932666 0.0545<br />
Weighted Statistics<br />
R-squared 0.117211 Mean dependent var 1.971556<br />
Adjusted R squared 0.101517 S.D. dependent var 4.279617<br />
S.E. of regression 4.047378 Sum squared resid 3685.785<br />
F-statistic 7.468520 Durbin-Watson stat 1.409860<br />
Prob(F-statistic) 0.000012<br />
Unweighted Statistics<br />
R-squared 0.011715 Mean dependent var 1.345409<br />
Sum squared resid 5153.522 Durbin-Watson stat 2.418481<br />
(Source: authors’ own calculations generated by using the Eviews7 soft)<br />
Consequently, the following observations can be drawn:<br />
� The standard error values of the regression function coefficients are lower, in<br />
module, than the coefficients` values, which imply that their estimate is<br />
correct, also reasoned by the low values of probabilities;<br />
� The correlation coefficient shows that 11.72% of the changes in turnover, the<br />
rate of economic return, the rate of tangible assets and MBR are reflected in<br />
financial leverage;<br />
� The model`s coefficients indicate that a 1% change of turnover leads to a<br />
change of 0.82% for the financial leverage, a 1% change in ER causes a<br />
change of -3.46% for the financial leverage, a 1% change of Tar leads to a<br />
change of 0.64% for the financial leverage and a 1% change of the MBR<br />
leads to a change of -0.24% for the financial leverage;<br />
� Durbin-Watson test indicates a partial correlation between the residual<br />
variables (0.61).<br />
Overall, the results of the study on the specified sample are consistent with the results<br />
on companies from USA, Europe and other emerging countries: return on operational<br />
income to total assets and growth opportunities are negatively correlated with the<br />
financial leverage, while the rate of tangible assets and turnover are positively<br />
correlated.<br />
~ 818 ~
CONCLUSIONS<br />
There is no universal theory of capital structure, and no reason to expect one. There<br />
are useful conditional theories, however. The theories differ in their relative emphasis<br />
on the factors that could affect the choice between debt and equity These factors<br />
include agency costs, taxes, differences in information, and the effects of market<br />
imperfections or institutional or regulatory constraints. Each factor could be dominant<br />
for some companies or in some circumstances, yet unimportant elsewhere.<br />
Financing policy for Romanian companies is based on debt financing, with a level of<br />
indebtedness which varies between 60-70%, except companies listed on the first<br />
category at BSE for which the indebtedness varies between 30-40%. The explication<br />
for these differences in results is explained by main criteria for listing at the first<br />
category at BSE: the value of equity must be more than 30 million Euros, Romanian<br />
capital market having a small number of companies with such volume of financial<br />
resources.<br />
However, the results achieved in the case study, did not show that higher borrowing<br />
by companies in Romania was a hazardous activity very risky or undisciplined. The<br />
existence of a high degree of financial leverage is explained by the importance of<br />
using financial resources for the acquisition of current assets, the lack of equity and<br />
fiscal policy.<br />
The purpose of this study was to provide some empirical evidences on the linkage<br />
between company’s capital, as it is this reflected by the financial leverage, companylevel<br />
factors that affect capital structure. In a linear simple regression model, we<br />
found a negative correlation between financial leverage, return on operational income<br />
to total assets or growth opportunities and a positive correlation between financial<br />
leverage, the rate of tangible assets or turnover.<br />
Of course this study have several limits both on conceptual as well as on empirical<br />
level. Among this:<br />
1. The use of return of operating income to total assets ratio instead of EBIT on<br />
total sales ratio. The main reason for such substitution is connected to the real<br />
sectors ‘prices rigidities and slow adjustments mechanism in an inflationary<br />
environment. Thus, we had considered that the total assets reflect better the<br />
output of the company’s operational activities.<br />
2. The short-time span considered, the limited numbers of traded companies<br />
included the absence of split by sectors, the absence of any references to the<br />
inter-correlation between stocks as well as between stocks and global market<br />
dynamic, some robustness of the estimated coefficient problems revealed by<br />
the existence of certain autocorrelations in estimation residuals etc.<br />
Despite the resulted caveats, we are identifying the similar trends between Romanian<br />
companies and companies from other emerging countries, regarding the financial<br />
leverage and company-level factors and further investigation are relevant for a better<br />
understanding of capital structure formation mechanisms.<br />
~ 819 ~
REFERENCES<br />
Baker, M. & Wurgler, J. (2002) „Market Timing and Capital Structure”, Journal of Finance.<br />
Bancel, F. & Mittoo U. (2004) „Cross-Country Determinants of Capital Structure Choice: A<br />
Survey of European Firms”, Journal of Financial Management.<br />
Fama, F. & French, K. (1998) „Taxes, Financing Decisions and Firm Values”, Journal of<br />
Finance.<br />
Fama, F. & French, K. (2002) „Testing trade-off and pecking order predictions about<br />
dividends and debt”, Review of Financial Studies.<br />
Frank, M. & Goyal, V. (2003) „Testing the pecking order theory of capital structure”, Journal<br />
of Financial Economics.<br />
Frydenberg, S. (2008) Theory of Capital Structure – A review, NO-7005 Trondheim: Tapir<br />
Academic Press.<br />
Graham, J. & Harvey C. (2001) „The Theory and Practice of Corporate Finance: Evidence<br />
From The Field”, Journal of Financial Economics.<br />
Harris, M. & Raviv, A. (1991) „The theory of capital structure”, Journal of Finance.<br />
Jensen, M. (1986) “Agency Cost of Free Cash Flow, Corporate Finance, and takeovers”,<br />
American Economic Review, no. 76.<br />
Miller, M. (1977) „Debt and Taxes”, The Journal of Finance.<br />
Mitton, T. (2008) „Why Have Debt Ratios Increased for Firms in Emerging Markets”,<br />
Journal of European Financial Management, vol. 14: 52-57.<br />
Modigliani, F. & Miller, M. (1963) „Corporate income taxes and the cost of capital: a<br />
correction”, The American Economic Review no. 53: 15-25.<br />
Myers, S. C. (2003) „Financing of corporations”, Journal of Financial Economics.<br />
Myers, S. & Majluf, N. (1984) „Corporate financing and investment decisions when firms<br />
have informations that investors do not have”, Journal of Financial Economics.<br />
Pirtea, M. & Dima, B. & Boţoc C. (2010) „Trade Off Theory of Capital Structure Choice and<br />
its relevance for emergent markets: the Romanian case”, 5th WSEAS International<br />
Conference on Economy and Management Transformation, Timişoara.<br />
Rajan, R. & Zingales, L. (1995) „What do we know about capital structure? Some evidence<br />
from International Data”, Journal of Finance, no. 50(5): 34-42.<br />
Ritter, J. (2003) „Investment banking and security issuance”, in: G M Constantinides, M<br />
Harris and R.M Stulz, eds , Handbook of the Economics of Finance, Vol A (Elsevier,<br />
Amsterdam) Chapter 5, this volume.<br />
Ross, A. (1977) „The Determination of Financial Structure: The Incentive-signalling<br />
Approach”, The Bell Journal of Economics, no. 8: 89-95.<br />
Shyam-Sunder, L. & Myers, S. (1999) „Testing static trade off theory against pecking order<br />
theory models of capital structure”, Journal of Financial Economics.<br />
Zingales, L. (2000) „In search of new foundations”, Journal of Finance, vol. 55: 1623-1653.<br />
~ 820 ~
IMPACT OF LONG-TERM INVESTMENT<br />
DECISIONS ON PROFITABILITY AND COMPETITIVE<br />
ADVANTAGE IN BUSINESS. CASE STUDY<br />
IN THE MINING INDUSTRY IN ROMANIA<br />
Claudia Elena SERBAN 1 ,<br />
Oana-Adelina FLORICIOIU & Radu-Daniel LOGHIN<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
Computer applications’ era, contemporary to us, generates the organizations’ management<br />
appetite for long-term investment decision, especially since these investments, made either for<br />
maintenance or for renewal-extension, are shown to be the path to profitability and<br />
competitive advantage. However, are there limits to such investments? What should be the<br />
reasoning when a long-term investment decision is taken? How could the executive identify<br />
any faults that long-term investment decision could generate? In order to get answers to these<br />
questions, we propose a model to reach practitioners, validated by statistical observation in<br />
the mining industry, as organizational success depends not only on the chosen strategy and its<br />
implementation, but on the mastery and application of quick observation techniques failures<br />
as well.<br />
KEYWORDS: investment decision, fixed-asset investment, economic and financial<br />
equilibrium, business profitability, competitive advantage<br />
INTRODUCTION<br />
In the last decade in the U.S. have been rapidly shaped, developed and expanded<br />
worldwide, the germs of “knowledge-based economy” that changes the fundamental<br />
way to address macro and micro processes. For this type of economy “knowledge<br />
becomes a cornerstone of achieving high productivity and competitiveness for firms,<br />
industries, national economies and world economy as a whole”, says O. and L.<br />
Nicolescu in „Economia, firma şi managementul bazate pe cunoştinţe” (Economy,<br />
firm and knowledge based management). The two authors submit a concept with a<br />
content that was developed almost simultaneously with the knowledge-based<br />
economy, namely the concept of competitiveness. Countless international bodies and<br />
experts put in the spotlight, during this period, competitiveness and how to get<br />
competitive advantage at the macro and micro level.<br />
However, as stated by the Lisbon European Council report in March 2000, now it can<br />
be said, “there were no general accepted definitions of the concept and yet has not<br />
been developed a comprehensive model to formalize its content”. Policy Board of<br />
U.S. Competitiveness defines competitiveness as “the ability to produce goods and<br />
1<br />
Correspondence address: Elena Claudia ŞERBAN, Bucharest Academy of Economic Studies;<br />
email: claudiaserbanos@yahoo.com<br />
~ 821 ~
services that meet the requirements of international markets while citizens obtain a<br />
growing and long-term sustainable standard of living”. U.S. Energy Department<br />
defines industrial competitiveness as the ability of a company or industry to meet the<br />
challenges of foreign competitors(Havlik,2001). An interesting approach on<br />
competitiveness is the one conducted by the Ministry of Industries in Denmark<br />
(Nicolescu O, Nicolescu L, Economia, firma şi managementul bazate pe cunoştinţe -<br />
Economy, firm and knowledge based management) who prepares a competitive<br />
pyramid, containing seven factors considered to be relevant, but allowing the<br />
consideration of others as well, and leaving opened the evolution to new factors<br />
(openness is suggested by the top blank quadrilateral). The seven factors are<br />
favourable environmental and social conditions, continuous innovation and<br />
technological competence, building new markets and international profiles, fast<br />
delivery, confidence in the sales, efficient manufacturing and low price.<br />
In our opinion, any approach to measuring competitiveness and competitive<br />
advantages must take into account, on one hand, the level at which the analysis -<br />
micro, mezzo and macro is made - and on the other hand the fact they are the resultant<br />
of many variables which are conditioned directly or indirectly. Among the variables<br />
which determine the competitiveness and competitive advantage, regardless of the<br />
approach, there is reflected the technological competence. This depends, at any<br />
approach level, on the quantity, quality and reliability of the existent technique as well<br />
as on the way the decision factors understand how to develop and conduct an<br />
investment policy. Investment policy was and still represents a concern for all<br />
professionals in the economic field. At a company level, financial and accounting<br />
specialists have investigated the correlation between capital expenditures and the<br />
volume of loans. Thus, G. Nini., D. Smith and A. Sufi showed in a study in the 90<br />
years in Britain that over 30% of loan contracts held by companies under investigation<br />
included limitations on capital expenditures.<br />
The study showed the impact of these loan contracts limitations on the market value<br />
of the business and its operational performance. Another study in Belgium conducted<br />
by Marc Deloof in the period 1992-1996 and published in 2003 in the Journal of<br />
Business Finance & Accounting, shows the relationship between the intensity of the<br />
policy investment in the company, working capital levels and profitability of the<br />
company. Since the 60s, in U.S., concerns are obvious in the investment policy and<br />
starting with the 80s the issue of social responsibility and prudent behaviour of the<br />
management in the investment policy at the microeconomic level has been set. The<br />
concept of social responsibility was standardized in 2010 (ISO_DIS 26 000 -<br />
Guidance of Social Responsibility) and is considered a higher level of sustainable<br />
development approach.<br />
In our approach to identify the competitive advantages of the extractive industry in<br />
Romania in the context of a national funded research, an important step was<br />
conducting a survey of the companies listed on Bucharest Stock Exchange, whose<br />
main activity object is coal mining, in order to identify correlation between the<br />
firm's investment policy and long-term business profitability. In the following, we<br />
present our approach and results of the study.<br />
~ 822 ~
1. PRESENTATION OF THE SCIENTIFIC PROCESS<br />
The contemporary crisis has shifted the management of companies in managerial<br />
practices adapted to environmental turbulence, focused on competitive skills, which<br />
lead to organizational success. Organizational success depends on the chosen strategy<br />
and its implementation, but on the mastery and application of rapid observation<br />
techniques failures as well. The “knowledge” resource is the necessary condition for<br />
the competitiveness of the organization (Sedziuviene N., Vveinhardt J., 2010).<br />
Economic development processes depend on the amount invested in noncurrent<br />
assets. In a research made in China between 1979-2008, whose results are published<br />
in the paper entitled „The analysis of the composite improve models on the<br />
relationship among Shenzen’s economic growth with its fixed-asset investment and<br />
export volum”, Zhang L. et al. show strong positive correlation between the volume of<br />
investments in fixed assets and business economic growth.<br />
In addition, the qualitative level in the economic process depends on the maintenance<br />
of technical and technological equipments. Al-Najjar B., in the paper entitled “The<br />
lack of maintenance and not/maintenance which costs: A model to describe and<br />
quantify the impact of vibration-based maintenance on company’s business” puts<br />
under observation the role of maintenance of technical equipments and technologies<br />
on quality production processes and determines the impact of this maintenance on<br />
business profit and the achievement of competitive advantage desideratum, creating<br />
the concept of “vibration-based maintenance(VBM)”.<br />
I. Chengalur-Smith and all, observed in a study of 149 U.S. organizations, that these<br />
are particularly interested, in the contemporary period, in the Open Source Software<br />
(FLOSS), due to the increase in value that is recorded by the company together with<br />
the acquisition of this technology. The study, published in 2010, entitled “An<br />
empirical analysis of the business value of Open Source Infrastructure Technologies”<br />
shows that about 20% of the business value is due to possession of Open Source<br />
Technologies, such as MySQL.<br />
Computer applications’ era, contemporary to us, generates the organizations’<br />
management appetite for long-term investment decision, especially since these<br />
investments, made either for maintenance or for renewal-extension, are shown to be<br />
the path to profitability and competitive advantage.<br />
However, in an accounting vision, are there limits to such investments? What should<br />
be the reasoning when a long-term investment decision is taken? Do these decisions<br />
have only positive effects? How could the executive identify any faults that long-term<br />
investment decision could generate?<br />
Our proposed model responds to these questions and is one useful for practitioners,<br />
validated by statistical observation in the mining industry.<br />
1.1. The area of the scientific correlation proposed<br />
The correlation has as a starting point the approach of the economic-financial<br />
equilibrium of an economic agent. The relations that arise between funding sources of<br />
~ 823 ~
the business and their uses determine the economic-financial equilibrium in the<br />
business. Sources of financing (equity or liabilities) and uses of financing sources<br />
(assets) are reported in the balance sheet and in the ownership vision; they are<br />
considered material and financial resources for the entity. Exploitation of these<br />
resources gives rise to outgoing or incoming economic flows to / from management,<br />
which, from an accounting point of view are reported in the income statement. In turn,<br />
economic flows, depending on the size, structure, and the degree of liquidity make the<br />
resumption of the mining activity at a certain scale, in other words allow for resource<br />
recovery designated to exploitation at a certain level or dimension. All this<br />
mechanism is coordinated and controlled by the human capital available to business,<br />
management and employees, capital resources that represent another category of<br />
resources.<br />
In this context, the level of individual skills and training of human resource is a<br />
decisive influential factor on economic and financial equilibrium. Schematically, the<br />
function could be presented in the following way:<br />
Table 1. Correlation “management decisions - synthesized financial statements”<br />
Management Assets Economic Flows Equity Management<br />
Long-term<br />
Investment<br />
decisions<br />
Operational<br />
Investment<br />
decisions<br />
Non-current<br />
Assets<br />
Current<br />
Assets<br />
Depreciation and<br />
financial expenses<br />
Operational Revenue<br />
Raw materials, materials,<br />
inventory, external<br />
benefits,<br />
employee benefits, other<br />
expenses<br />
Accordingly, the enterprise has funding sources (equity) which remain at its disposal<br />
for a period of time longer than a year (permanent equity), or a shorter period of time<br />
than a year (permanent assets), or for a period less than an year(current equity). These<br />
funding sources are investment-oriented either towards real estate, securities, or noncurrent<br />
assets, or in values or commodities unique to the operational cycle (current<br />
assets).<br />
The financial balance theory presents us, among others, with working (floating)<br />
capital(WC/FR). Bernard Colasse, in his paper titled “Gestion Financiere”, mentions<br />
that a company is financially-balanced if working capital is positive at best or null at<br />
worst. The formula presented by Colasse for working capital is as it follows:<br />
WC = PE - NCA,<br />
Where: PE – permanent equity (long term financial sources);<br />
NCA -non-current assets<br />
~ 824 ~<br />
Permanent<br />
Equity<br />
Current<br />
Equity<br />
Long-term<br />
Investment<br />
decisions<br />
Operational<br />
Investment<br />
decisions<br />
Management Assets Economic Flows Equity Management
The equation shows that maintaining the financial-economic balance assumes that<br />
purchasing non-current asset, or assets with a longer operational duration than a year<br />
must be done in the limit of available equity for the same period. Why this constraint?<br />
We consider the balance sheet a schematic mirror for the enterprise. According to the<br />
principle of double entry bookkeeping, the balance sheet reflects funding sources and<br />
their uses. The framework for the balance sheet can be presented as it follows.<br />
WC = 0<br />
Table 2. Balance sheet framework, case A<br />
A perfect economic and financial balance assumes perfect<br />
dependency between the balance sheet items, according to<br />
their duration in the enterprise<br />
This state is practically very difficult to be achieved in<br />
practice.<br />
Table 3. Balance sheet framework, case B<br />
WC > 0<br />
This case is considered advantageous to the enterprise.<br />
Investments comprising of long-term equity is carried out<br />
both on non-current assets and operating assets, flow which<br />
allows obtaining revenue or profits.<br />
This can be observed in the asset composition through an<br />
increase in the current assets ratio.<br />
Many profitable companies posses this kind of balance sheet<br />
structure.<br />
WC < 0<br />
Table 4. Balance sheet framework, case C<br />
This situation is considered disadvantageous for the<br />
enterprise. For non-current asset purchases, the long-term<br />
equity was used, but also a part of current assets, those which<br />
economically speaking are destined to the operating cycle. We<br />
can see the altering trend of the asset composition, by<br />
reducing the non-current asset ratio destined for the operating<br />
cycle.<br />
Enterprises in this kind of situation are challenged initially by<br />
diminished returns, due to rescaling previous operating cycles,<br />
after a decision has been made to invest some of the current<br />
assets in non-current assets. Maintaining this situation for a<br />
longer period leads inevitably to real financial losses.<br />
Of course, in practice, financial statements like the ones previously schematically<br />
disclosed are much more complex as there are influenced by factors such as total<br />
receivables, total commercial liabilities, the average collection time for receivables,<br />
~ 825 ~<br />
Non-current<br />
Asset<br />
(duration > 1 year)<br />
Current<br />
Asset<br />
(duration < 1 year)<br />
Non-current<br />
Asset<br />
(duration > 1 year)<br />
Current<br />
Asset<br />
(duration < 1 year)<br />
Non-current<br />
Asset<br />
(time frame > 1<br />
year)<br />
Current<br />
Asset<br />
(time frame < 1<br />
year)<br />
Permanent<br />
Equity<br />
(duration > 1 year)<br />
Current<br />
Equity<br />
(duration< 1 year)<br />
Permanent<br />
Equity<br />
(duration > 1 year)<br />
Current<br />
Equity<br />
(duration< 1 year)<br />
Permanent<br />
Equity<br />
(time frame> 1 year)<br />
Current<br />
Equity<br />
(time frame< 1 year)
the average payment time for liabilities, but we will not delve deeper since these are<br />
out our focus for our paper.<br />
Non-current assets are defined as that kind of asset that serves many operating cycles,<br />
that is why its value is recovered through depreciation. Altering the total non-current<br />
asset (non-current asset) alters economic flows in the (comprehensive) income<br />
statement. Thus, the total depreciation expenses, regardless of method used in<br />
determining the depreciation method (linear, accelerated, regressive) changes with the<br />
total altered non-current asset. Moreover, operating non-current assets generates<br />
income, which varies according to non-current asset type and its degree of use. Every<br />
penny worth of non-current assets’ contribution to income can be determined using an<br />
efficiency rate like (Vălceanu, Gh. &co, 2005):<br />
Revenue<br />
Revenue _ per _ asset _ unit = * ( 100)<br />
or(<br />
1000)<br />
Asset<br />
Used revenue for calculation can be operating revenue, sales revenue or even total<br />
revenue, including extraordinary and financial revenue. The asset unit can be<br />
currency, 100 currency units or 1000 currency units, according to the size of the<br />
revenue or the asset. The frequent formula uses 100 currency units worth of assets,<br />
because the result can be further used in correlation with measures such as return<br />
rates.<br />
The economic correlation, which should govern every enterprise’s activity, is the<br />
following:<br />
I ≤ I<br />
EFFORT<br />
EFFECT<br />
E N<br />
Where I represents the base chain index ( ). In our approach, total assets are the<br />
EN<br />
−1<br />
enterprises’ effort necessary for a normal operation, and the revenue represents the<br />
effect from a normal operation. Naturally, a sharper growth of the revenue relative to<br />
the asset would satisfy the efficiency criteria and this would be tantamount to a<br />
sharper revenue growth per asset unit. However, revenue includes specific expenses<br />
as well as a gross margin or profit, as:<br />
Re venue = expenses+<br />
profit<br />
An activity is efficient when the revenue structure modifies to an increasing profit, or<br />
an equal decrease in expenses. This means:<br />
profit<br />
profit<br />
( * 100)<br />
N > ( * 100)<br />
N −<br />
revenue revenue<br />
equal to I REVENUE <<br />
I PROFIT<br />
1<br />
this is from a mathematical point of view<br />
~ 826 ~
or<br />
expense.<br />
expense.<br />
( * 100)<br />
N < ( * 100)<br />
N −<br />
revenue revenue<br />
equal to I EXPENSE < I REVENUE<br />
1<br />
this is from a mathematical point of view<br />
Where:<br />
profit<br />
• ( * 100)<br />
is the profit margin or profit levels for 100 currency<br />
revenue<br />
units in revenue.<br />
expense<br />
• ( * 100)<br />
is the expense rate or the level of expenses for<br />
revenue<br />
100 currency units in revenue<br />
Thus, an efficient activity is governed by the following relationship:<br />
I < I < I<br />
EXPENSE.<br />
REVENUE<br />
~ 827 ~<br />
PROFIT<br />
Which is equal to an increase in return rates for revenues or a decrease in expenses for<br />
100 currency units in revenue. Disregard for this relation would thus determine a<br />
reduction of revenue return rates, as well as increased expense levels per revenue unit.<br />
Customizing the previous equation would follow that every type of expense should<br />
have an inferior index compared to that of the corresponding revenue. Thus<br />
depreciation expenses should rise slower compared to that of the operating revenue, or<br />
I DEPRECIATION.<br />
EXPENSE < I OPERATING.<br />
REVENUE<br />
This would entail maintaining or increasing business returns, equivalently, reduce, or<br />
maintain in dynamic the level of depreciation expense to 100-currency unit in revenue<br />
depreciation.<br />
expense<br />
(<br />
revenu<br />
* 100)<br />
Our reasoning leads us to believe that, as non-current asset absolute growth<br />
determines a relative increase in depreciation expenses, increases in non-current assets<br />
should be limited to a level, which preserves the correlation:<br />
I DEPRECIATION.<br />
EXPENSES < I OPERATING.<br />
REVENUE<br />
Therefore, the business’ returns would not be diminished over time. In this context,<br />
we have to try preserving the asset structure, to maintain a greater ratio for noncurrent<br />
assets, or experience a diminished relative return. This is the theoretical<br />
hypothesis we would wish to validate through statistical observation.<br />
.
1.2. Research method and scope<br />
To validate these scientific observations we chose the mining industry, or a number of<br />
eight companies, whose main activity is coal mining, listed at the Bucharest Stock<br />
Exchange (BVB). The sample was restricted by the main activity as well as<br />
difficulties in gathering data. For each company we followed, over a three-year<br />
period, the progress for the following measures: non-current assets (X1 variable -<br />
AC), non-current asset (X2 variable - AI), operating revenue (X3 variable -V),<br />
operating margin (X4 variable - PR), depreciation expenses (X5 variable - CA). The<br />
data was partly collected from the BVB website, financial statement section and partly<br />
from each company’ website from the sample. The method employed was statistical<br />
observation. The research stages were the following:<br />
• Gathering the appropriate data;<br />
• Statistical processing for the variable to obtain a statistical average for each<br />
variable;<br />
• According to the average for each variable we determined the average level<br />
for the following revenue per non-current asset currency unit, revenue per 1<br />
currency unit of non-current asset, the sum of depreciation expenses per 1 unit<br />
of non-current assets;<br />
• According to the average level of the measures previously obtained, we<br />
simulated an evolution of revenue, profit and depreciation expenses to identify<br />
their trends according to the relative change of the asset structure. Likewise,<br />
we tried to observe if the scientific hypothesis presented in the next chapter are<br />
validated through the performed simulation.<br />
We used software like Excel and advanced statistical calculator OpenStat.<br />
1.3. Presentation of data and the result of statistical observation<br />
Statistical processing the financial information gathered from the eight companies<br />
subjected to observation generated the following report:<br />
Table 5. Distribution parameter estimates<br />
N=24, date<br />
VARIAB. MEAN VARIANCE STD. DEV. STD. ERROR OF MEAN RANGE<br />
X1 76.600 8640.267 92.953 29.394 242.000<br />
X2 94.800 8011.511 89.507 28.305 236.000<br />
X3 95.700 9287.789 96.373 30.476 298.000<br />
X4 13.700 134.011 11.576 3.661 32.000<br />
X5 7.000 41.778 6.464 2.044 19.000<br />
The matrix of the correlations between the variables is as it follows:<br />
Table 6. Correlation Matrix<br />
VARIAB. X1 X2 X3 X4 X5<br />
X1 12,018 13,956 12,918 11,215 13,635<br />
X2 12,918 7,692 10,298 12,973 10,243<br />
X3 13,956 11,354 7,692 12,592 19,684<br />
X4 11,215 12,240 12,973 12,251 12,188<br />
X5 1,635 19,684 10,243 12,188 13,198<br />
t-test Values for prob. |corr.| > 0 test, with prob. > t = 0.601<br />
~ 828 ~
As we mentioned in the previous subchapter we used the average values of the<br />
variables to determine the revenue per current asset currency unit (V/AC), revenue per<br />
non-current asset (V/AI), profit per revenue unit (PR/V), and total depreciation<br />
expenses per non-current asset (A/AI). The report is the following:<br />
Table 7. Average values of management rates<br />
Measure V/AC V/AI PR/V A/AI<br />
Medium value 1.249347 1.009494 0.143156 0.07384<br />
Next, we simulated the development of the measures: operating revenue, operating<br />
profit, depreciation expenses according to changes in the asset structure. To determine<br />
the mentioned measures we used the rates from table no.6.<br />
Table 8. Simulation of development for revenue, profit and depreciation<br />
AC AI V PR CA<br />
100 100 225.8841 32.33659 7.383966<br />
90 110 223.4856 31.99323 8.122363<br />
80 120 221.087 31.64987 8.860759<br />
70 130 218.6885 31.3065 9.599156<br />
60 140 216.2899 30.96314 10.33755<br />
50 150 213.8914 30.61977 11.07595<br />
40 160 211.4929 30.27641 11.81435<br />
30 170 209.0943 29.93305 12.55274<br />
20 180 206.6958 29.58968 13.29114<br />
10 190 204.2973 29.24632 14.02954<br />
The chart depicting the development of the measures is as it follows:<br />
Graphic1. Simulation of development for revenue, profit and depreciation<br />
250<br />
200<br />
150<br />
100<br />
50<br />
0<br />
1 2 3 4 5 6 7 8 9 10<br />
The graph shows the evolution trends for each of the indicators taken into<br />
consideration. For consistency reasons we also present the relative changes.<br />
~ 829 ~<br />
AC<br />
V<br />
CA<br />
AC<br />
AI<br />
V<br />
PR<br />
CA
Table 9. Simulation of index deviation for revenue, profit and depreciation<br />
Revenue<br />
index<br />
Profit<br />
index<br />
Depreciation<br />
index<br />
~ 830 ~<br />
Revenue<br />
Index<br />
deviation<br />
Profit index<br />
deviation<br />
Depreciation<br />
index<br />
deviation<br />
0.989382 0.989382 1.100000<br />
0.989268 0.989268 1.090909 -0.000114 -0.000114 -0.009091<br />
0.989151 0.989151 1.083333 -0.000116 -0.000116 -0.007576<br />
0.989032 0.989032 1.076923 -0.000119 -0.000119 -0.006410<br />
0.988911 0.988911 1.071429 -0.000122 -0.000119 -0.005495<br />
0.988786 0.989032 1.066667 -0.000124 -0.000122 -0.004762<br />
0.988659 0.988786 1.062500 -0.000127 0.000122 -0.004167<br />
0.988529 0.988659 1.058824 -0.000130 -0.000246 -0.003676<br />
0.988396 0.988396 1.055556 -0.000133 -0.000263 -0.003268<br />
Both the numbers and the chart, show that altering the asset structure, as increasing<br />
non-current asset ratio determines a relative decrease in total revenue, total profit and<br />
relative increases of depreciation expenses.<br />
Practically for every 5% increase in noncurrent assets, revenue and profit register a<br />
1% decrease, while depreciation expenses register a minimum 1% increase, which<br />
causes the relative profit margin to reduce approximately 2%.<br />
I > I > I<br />
DEPRECIATION.<br />
EXPENSE<br />
REVENUE<br />
PROFIT<br />
In conclusion, this correlations’ appearance between the three measures is tantamount<br />
to a reduction in the dynamic of the profit margin. The intensity of reducing relative<br />
revenue return depends on the structural asset variation. According to the simulation,<br />
to a 5% increase in the non-current asset ratio, the revenue return diminishes by 2%.<br />
For the organizations’ management using this method would mean determining asset<br />
structure for two consecutive periods and identifying the dynamic trend. Assuming<br />
the non-current assets grew with x%, the relative change in revenue returns (y %) due<br />
to structural asset alterations will be<br />
x ⎛ 2 ⎞<br />
⋅ ⎜−<br />
⎟<br />
100 ⎝ 100<br />
y =<br />
⎠<br />
5<br />
100<br />
Therefore, we are talking about diminishing relative and absolute returns. The<br />
absolute value of the percentage point of diminished returns will be determined<br />
according to the absolute profit size.<br />
These conclusions ware determined from a simulation, which did not consider internal<br />
or external factors relative to the company. That is why there is a certain probability,<br />
in a certain context, the structural asset alteration that we presented be present in the<br />
financial statements. The management should consider this aspect and follow the<br />
implementation of efficiency principles in management.<br />
DISCUSSION AND CONCLUSION<br />
In conclusion, the management tendency to invest in long-term equipment and<br />
technologies, motivated by the desire to keep up with innovations in the field to
maintain the quality of the operating process, product quality and the differential<br />
competitive advantages, must be limited to respecting the economic-financial balance<br />
correlation<br />
I DEPRECIATION.<br />
EXPENSE.<br />
< I OPERATING.<br />
REVENUE < I OPERATING.<br />
PROFIT<br />
correlation, which is conditioned by the asset structure. This is mentionable as long as<br />
in the asset structure, non-current assets have a greater ratio.<br />
A proactive investment policy determines major financial imbalances. The first<br />
consequence is the reduction of the scale from which the operational cycle resumes,<br />
amid directing financing sources to equipment and technologies, which do not bring<br />
important values immediately, but as an important long-term value in size. This value<br />
divided into financial periods, short-term elaborated, fails to eliminate relative<br />
financial losses. A second consequence would be an improved product quality, which<br />
would contribute to customer appeal. However, even if the customers are drawn<br />
towards the new qualitative standard, the physical volume of production diminishes<br />
relatively due to a lack in cash-flows, consequently the company’ offer diminishes,<br />
with immediate impact in the progress of the operating revenue. A third consequence<br />
is increases depreciation expenses at a higher rate than that of the revenue, with<br />
impact over relative returns. From a bookkeeping point of view, it is arguable that this<br />
kind of expenses does not generate cash flows. Really, cash flows diminished now of<br />
payment in favor of the non-current asset supplier with a higher value then current<br />
depreciation expenses. Moreover increases of these expenses, even as a fictitious<br />
value, affect measures such as profit, return rates, etc. and measures used as<br />
performance and reporting measurement instruments towards shareholders and<br />
stakeholders.<br />
However, our explanation does not imply that we propose reducing the depreciation<br />
expense amounts, or the non-current assets amount, as this would mean diminished, as<br />
this would mean decreasing operations and violating the competitive advantages<br />
principles. Our approach is for rationalization in the long-term investment decision,<br />
meaning the following:<br />
• Preserve the asset structure with an emphasis on a larger current asset ratio;<br />
• Total non-current assets should not surpass permanent equity, and even<br />
maintain a positive offset to finance the operating cycle;<br />
• Maintain the fundamental economic correlation between the expense, revenue<br />
and profit evolution, as means for a relative increase in returns and obtain or<br />
maintain competitive advantages.<br />
REFERENCES<br />
Aleca, O.E. and all (2010) „A research profile for management information systems- case<br />
study based on The AMIS scientific journal and AMIS international conference”,<br />
AMIS 2010 – <strong>Proceedings</strong> of the 5 th international conference, Accounting and<br />
Management Information Systems, 1060-1072<br />
Al-Najjar, B. (2007) „The lack maintenance and not maintenance which costs: A model to<br />
describe and quantify the impact of vibration-based maintenance on company’s<br />
business”, International Journal of Production Economics, vol. 107, no. 1: 260-273<br />
~ 831 ~
Chengalur-Smith, I. and all (2010) „An empirical analysis of the business value of Open<br />
Source Infrastructure Technologies”, Journal of the Association for Information<br />
Systems, vol. 11, no. 11 (SI): 708-729<br />
Colasse, B. (2009) Gestion Financiere, „Analiza financiară a întreprindere”(Company’s<br />
financial analysis), Iaşi, translation done by Neculai Tabără<br />
Evangelista, R. and Vezzani, A. (2010) „The economic impact of technological and<br />
organizational innovation. A firm-level analysis.”, Research Policy , vol. 39, no. 10:<br />
1253-1263<br />
Havlik P., Landesmann M., Stehrer R. (2001) “Competitiveness of CEE Industries: Evidence<br />
from Foreign Trade Specialization and Quality Indicators”, WIIW Research Reports,<br />
No. 278, Vienna<br />
Nicolescu O., Nicolescu L.(2005) Economia, firma şi managementul bazat pe cunoştinţe,<br />
Editura Economică, Bucureşti<br />
Sedziuviene, N. and Vveinhardt, J. (2010) „Competitiveness and Innovations: Role of<br />
Knowledge Management at a Knowledge Organization.”, Inzinerine Ekonomika-<br />
Engineering Economics, vol. 21, no. 5: 525-536<br />
Şerban, C. (2009) Riscul în activitatea agenţilor economici, Bucureşti<br />
Vălceanu, Gh., Robu V., Georgescu N. (2005), Analiză economico-Financiară – Economic<br />
and financial analysis, Ed.Economică, Bucureşti<br />
Zhang, L.Y. and all (2010) „The analysis of the Composite Improved Models on the<br />
relationship among Shenzhe’s Economic Growth with Its Fixed-asset Investment and<br />
Export Volume”, International Conference on Management Science and Engineering,<br />
MSE , vol. 3 : 350-354<br />
Financial data – www.bvb.ro- The Bucharest Stock Exchange website<br />
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INCLUDING BEHAVIOURAL ELEMENTS IN ASSET<br />
ALLOCATION PROCESS<br />
Aurora MURGEA 1<br />
West University of Timisoara<br />
ABSTRACT<br />
Human mind ability in understanding, processing and using large amount of information is<br />
unfortunately limited. Confronted each day with hundreds of decisions, affective, emotional<br />
social and cultural factors often play a more important role that the rational ones, in<br />
contradiction with the assumption of classical finances centred on Efficient Market<br />
Hypothesis. As Platon once said the human mind could be easily compared with a chariot<br />
pulled on the one side by one pony – the ration and on the other by one elephant – the<br />
emotions. The aim of this paper is to combine the classical financial analyses and the<br />
behavioural elements in an allocation model which could be use by the financial consultant in<br />
the relation with their private clients. The proposed study take into consideration both<br />
cognitive and emotional biases, their differential presence in the case of man and women and<br />
their influence on the investors’ decision. A survey on 888 participants was used in order to<br />
be able to formulate the final conclusions.<br />
KEYWORDS: cognitive and emotional biases, asset allocation, investment decision,<br />
capital markets<br />
INTRODUCTION<br />
Despite the late progresses, classical finances still finds hard to explain why people<br />
act apparently irrational, managing their money. The financial markets evolutions in<br />
the last years leaded to a new research field, Behavioural Finance, which includes<br />
some new independent variables, the cognitive and emotional decision’s determinants<br />
into the equation.<br />
The fusion between the classical financial analysis and the one which also considers<br />
psychological, social, affective and emotional elements could help the investors and<br />
financial analysts to broadly understand the market’s mechanisms and the way its<br />
participants fundament and take the financial decisions.<br />
Understanding financial markets starts with understanding investors decisions because<br />
investors drive markets, make them rise and fall. The human capacity to process,<br />
understand and assimilate the huge volume of information and stimulus is limited.<br />
The decisions and reasoning individuals daily assume are constricted by personal<br />
circumstances, time restrictions, psychological and emotional determinants and rarely<br />
based on strict rational economical logic. The new paradigm of behavioural<br />
1 Correspondence address: Aurora MURGEA, West University of Timisoara, Faculty of Economics and<br />
Business Administration; email: auroramurgea@gmail.com<br />
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economics tries to convince that studying the real individuals behaviour it is at least<br />
equal interesting with the classic study of what people are suppose to do.<br />
The investor who succeed to balance the economical rational analysis and the<br />
behavioural analysis have a chance to understand the market and to affect less his<br />
portfolio performance, comparing with a non-rational, hyperactive and over<br />
influenced investor, who refuse to take into consideration the evidences. Adam Smith<br />
(Smith,1976) said in The money game that The first thing you have to know is<br />
yourself. A man who knows himself can step outside himself and watch his own<br />
reactions like an observer. Discussing about investor decision and considering that<br />
people are rational could be a limitation of the human nature which could lead to<br />
important mistakes. This paper tries to adapt the model of asset allocation to account<br />
for the cognitive and emotional biases present in men and women investment<br />
decisions using the findings of the generous field of behavioural finances.<br />
First part presents, as a starting point, the debate between the classic and behavioural<br />
finance regarding the market efficiency and the investor rationality. In the second one<br />
we are discussing how a financial consultant could and should act in the relation with<br />
his partly rational client, what principles he could have in mind. The third and forth<br />
parts are dedicated discussing the main cognitive and emotional biases included in the<br />
study conducted in the fifth part while the next part encloses the gender influence to<br />
the asset allocation model. The last part is dedicated to the main conclusions and<br />
limits of the study and also to the further researches proposed to complete this work.<br />
1. CLASSIC VERSUS BEHAVIORAL FINANCE: CAPITAL MARKET<br />
EFFICIENCY AND INVESTOR’S RATIONALITY ON THE MODERN<br />
CAPITAL MARKETS<br />
The efficient market hypothesis (EMH) has been the central proposition of finance for<br />
nearly forty years. During the 1970s the standard finance theory of market efficiency<br />
became largely accepted by a majority of academics and also by a good numbers of<br />
professionals. The basic theoretical case for EMH (Fama, 1970) rests on three<br />
arguments: the investors are rational and as a result they value securities rationally;<br />
assuming that some of the investors are not rational, their trades are random and<br />
therefore cancel each other out without affecting prices; accepting a certain degree of<br />
irrationality, this kind of investors are met in the market by rational arbitrageurs who<br />
eliminate their influence on prices. Based on these, a series a model based on<br />
efficiency concept have been developed, started from the initial version who defines<br />
the efficient market as a market who rapidly adjust on the latest available information<br />
and continuing with the modern version (Fama 1991) where the financial asset prices<br />
reflects in a holistic manner all the available information. This implies that the<br />
investors and the market are fully rational and the prices level is determined by the<br />
fundamental determinants.<br />
There are three forms of the efficient market hypothesis:<br />
� the weak form – all past market prices are fully reflected in securities prices so<br />
it is impossible to earn superior risk –adjusted profits based on the knowledge<br />
of past prices and return;<br />
� the semistrong form – all publicly available information is fully reflected in<br />
securities prices so the investor cannot gain using this information to predict<br />
returns;<br />
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� the strong form – all information is fully reflected in securities prices or in<br />
other words, insider information is of no value.<br />
There are mixed empirical results regarding the market efficiency but mostly non<br />
supporting the strong form of EMH (Nicholson, 1968, Basu, 1977, Rosenberg et al.,<br />
1985, Bechev, 2003, Moustafa, 2004, Dima et al, 2006,). Researchers have<br />
documented numerous, persistent anomalies that contradict the EMH as the<br />
fundamental anomalies, technical anomalies, calendar and weather anomalies. The<br />
fundamental anomalies appear for instance because investors consistently<br />
overestimate the prospectus of growth companies and underestimate the value of outof-favour<br />
companies Also numerous studies have shown that low price-to-earnings<br />
(P/E) value stocks tend to out-perform both high P/E stocks and the market in general.<br />
The technical anomalies are revealed due to the use of technical analysis which<br />
attempt to forecast securities prices by studying past experiences. Sometimes<br />
technical analysis finds inconsistencies with respect of efficient market hypothesis,<br />
called technical anomalies. In the last categories one could easily include some very<br />
well known anomalies as: January effect, Monday effect, December effect, Turn-ofthe<br />
Month effect, SAD effect.<br />
One alternative solution, acknowledging a lot of anomalies which contest the<br />
efficiency, information symmetry and investors rationality is represented by the<br />
bonded rationality models, firstly promoted by Herbert Simon. He supports the idea of<br />
a partially rational investor who takes just a part of the decisions based on<br />
fundamental criteria and the rest based on emotional irrational factors. Starting from<br />
his work, a series of other studies (March, 1994, Rubinstein, 1998, Gigerenzer and<br />
Selten, 2002, Kahneman,2003, Hirshleifer et al.,2006) are using the bounded<br />
rationality to explain the individuals decision determinants, using fundamental<br />
methods on information analysis and understanding the information, even the<br />
asymmetrical ones. A development of this line is represented by the so called fuzzy<br />
logic, the neural networks and genetic algorithms. (Chiang 1996, Kim and Chum,<br />
1998, Aiken and Bsat, 1999, Romahi and Shen, 2000) formulated decisional models<br />
based on a postulated rational behaviour in imperfect information conditions.<br />
Generally speaking the mentioned studies seems to try to solve two different kinds of<br />
problems: the portfolio optimization (including the efficiency frontier) and the short<br />
term prediction of the asset prices dynamics (Lowe, 1994)<br />
In the last decades there been a lot of works analyzing the investor psychology and the<br />
way it affects his decisions and the market. In their seminal work, Tversky and<br />
Kahneman (Tversky and Kahneman, 1974) investigate heuristics that people often<br />
employ when making decisions under uncertainty (representativeness, availability,<br />
adjustment and anchoring). Despite the usefulness of heuristics (they could make the<br />
probability valuation of the uncertain events much easier) they could also lead to<br />
systematic biases. Kahneman and Riepe (Kahneman and Riepe,2003) focus on biases<br />
in beliefs and preferences of which financial advisors should be aware: judgment<br />
biases: overconfidence, optimism, hindsight, over-reaction to chance events; errors of<br />
preference: non-linear weighting of probabilities, people value changes not states,<br />
value function, the shape and attractiveness of gambles; the purchase price as a<br />
reference point: narrow framing, repeated gambles and risk policies, short and long<br />
views; living with the consequences of decisions: regrets of omission and commission,<br />
regret and risk taking. In his book Shefrin presents a large number of heuristic driven<br />
biases (representativeness bias, gambler’s fallacy, overconfidence, anchoring and<br />
~ 835 ~
adjustment, conservatism, ambiguity aversion, emotion and cognition) and framedependence<br />
driven biases (loss aversion, mental accounting, hedonic editing,<br />
cognitive and emotional aspects, self control, regret, money illusion).<br />
During the last years, a lot of models starting from the predominant theoretic<br />
approach from the quoted papers were proposed. One could notice the behavioural<br />
models based on artificial financial markets -ACE: agent-based computational<br />
economics (Pidd,2000, Boer-Sorban et al.,2005, Tesfatsion and Judd, 2006, LeBaron,<br />
2006, Hommes, 2006, Lovric et.al.,2008), Chan model which validated one of the<br />
most important bias in behavioural finances called representativity (Chan et al.2002),<br />
Mei model which tested the capital market manipulation determined by driven<br />
heuristics biases, for the first time on the American market (Mei, 2004); Lo model<br />
(AMH-Adaptative Markets Hypothesis)where the individual investor adapt their<br />
decision to the environment changes using heuristics (Lo,2005), Baker and Wurgler<br />
model which proposes a way to measure the investors feelings and test it on the main<br />
speculative events in the last 40 years (Baker and Wurgler,2007), SAD model (Kelly<br />
and Meschke) which tests the seasonal effects on the investors attitude.<br />
2. INCLUDING BEHAVIORAL ELEMENTS IN THE ASSET ALLOCATION<br />
PROCESS<br />
There is no doubt that understanding the investor’s mind and emotions could improve<br />
the relation between him and his financial consultant. The result will be a balanced<br />
portfolio constructed for achieving the investor’s long term objectives.<br />
First question raised form here could be: in what circumstances should the consultant<br />
moderate the biased investor and in what circumstances has to adapt. Two main<br />
principles could be formulated regarding to this problem (Pompian, 2006):<br />
• moderate biases in less wealthy clients and adapt to biases in wealthier clients<br />
• moderate cognitive biases- adapt to emotional biases<br />
Why should a consultant adapt if his client is wealthy? The wealthy clients do not care<br />
if they lose money? No doubt they do but the loss has a very different impact on their<br />
general situation. For a less wealthy client an adaptation to his biases could represent<br />
an important threat to his lifestyle but in a wealthier client case only severe market<br />
turmoil could affect the client’s daily financial security<br />
The second principle is easily explained if we consider the potential causes of the two<br />
biases types. The cognitive biases are derived from faulty reasoning and could be<br />
corrected much more easily if the investor is better informed and advised than the<br />
emotional one who is derived from the investor’s personality, from impulse or<br />
intuition.<br />
To combine those two principles one could chose to follow the next path: to adapt if<br />
the client have a high level of wealth and shows emotional biases, to moderate and<br />
adapt if the investor has a low level of wealth and shows emotional biases, to<br />
moderate the cognitive biases for a less wealthy client and finally to moderate and<br />
adapt in the last situation as one can see in the next figure.<br />
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Cognitive<br />
biases<br />
(Moderate)<br />
3. COGNITIVE BIASES<br />
Figure 1. Two axis behaviour model<br />
Moderate and<br />
adapt<br />
Moderate<br />
High level of wealth (Adapt)<br />
(Source: Pompian, 2006:45)<br />
A cognitive bias is a term used to describe many distortions in the human mind that<br />
lead to perceptual distortion or inaccurate judgment. They occur because they lead to<br />
more effective actions in given contexts or enable faster decisions when faster<br />
decisions are of greater value or could result from a lack of appropriate mental<br />
mechanisms, or from the misapplication of a mechanism that is adaptive under<br />
different circumstances<br />
A large amount of cognitive biases are mentioned in the literature. Our study will<br />
focus on 13 of them, listed and described below:<br />
� Overconfidence bias<br />
� Anchoring bias<br />
� Illusion of control<br />
� Framing bias<br />
� Conservatism bias<br />
� Hindsight bias<br />
� Cognitive dissonance bias<br />
� Recency bias<br />
� Representativeness bias<br />
� Availability bias<br />
� Mental accounting bias<br />
� Confirmation bias<br />
� Self-attribution bias<br />
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Adapt<br />
Moderate and<br />
adapt<br />
Low level of wealth (moderate)<br />
Emotional<br />
biases<br />
(Adapt)
3.1. Overconfidence bias<br />
Extensive evidence shows that people are usually overconfident in their judgments.<br />
An overconfident individual overestimates his personal contribution at the successful<br />
events with respect to capacities of other people on average and underestimates the<br />
associated risk (Hoffrage, 2004). A potential reason for that is that people assign too<br />
narrow intervals to their estimates of quantities. Second, people are poorly calibrated<br />
when estimating probabilities (Barberis and Thaler, 2002). The result is an investor<br />
who overtrades in such a way that the difference between stock he buys and those he<br />
sells does not cover transaction costs.<br />
In the behavioural finances overconfidence is one of the most discussed biases<br />
because it can make the market less efficient creating the mispricing in the form of<br />
excess volatility in return prediction (Ko and Huang, 2006). There is a strong<br />
correlation between investors overconfidence, prices, turnover, volatility and market<br />
bubbles because the manipulator’s strategic actions combined with this bias not only<br />
bring profits to the manipulator but also brings about higher volatility, larger trading<br />
volume, short-term price continuation and long-price reversal (Scheinkman and<br />
Xiong, 2003, Mei et al, 2004).<br />
Several scholars analyzed during the time the negative effects overconfidence could<br />
impact the decisional process and how this bias affects the boys and girls (Barber and<br />
Odean, 2001, Chira et.al, 2008).Their study pointed out the fact that due to their<br />
overconfidence excess the boys will overtrade more and will have poorer<br />
performances compared with girls. Girls and boys also in their study would obtain<br />
higher performances if they would be stick at the initial investment portfolio because<br />
the shares they decided to sell would bring higher benefits than the ones they decided<br />
to buy (for instance in Barber and Odean’s study the shares men bought generated<br />
20% smaller returns than the one they have sold from their portfolio. The same<br />
decrease was 17% in the women’s case)<br />
3.2. Anchoring bias<br />
Anchoring is a cognitive heuristic in which decisions are made based on an initial<br />
value: ‘anchor’, adjusted up or down in order to reflect the subsequent information<br />
(Epley and Gilovich, 2006). The main problem regards the fact the adjustment is often<br />
insufficient and the final value will heavily depend on the initial value. In financial<br />
markets is often seen that even the data and forecast that initially appear to be far from<br />
reality can still present an anchoring effect (Goldberg and von Nitzsch, 2001).<br />
Because of the anchoring bias the investor tend to stick too closely to the current level<br />
of the current level or the original estimates about a company or a financial indicator.<br />
Also investor could become anchored in a economic state of a certain countries, sector<br />
or companies which could negatively affect their portfolio (Pompian, 2006)<br />
The existence of anchoring effect is relevant because help us to ask if the individuals<br />
truly have a unique, stable and very well defined preferences or are influenced by<br />
arbitrary anchors (Araña and León, 2004). Trying to answer at this question Araña<br />
and León conducted a field experiment based on double bounded dichotomy choice<br />
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method with the next results: anchoring effect alters the welfare estimation and put<br />
under the question the stability of the preferences; the elicited preferences could be<br />
considered stable or insensitive to scope even under the presence of the anchoring<br />
effect; between the anchoring effect and emotional intensity a U form relationship<br />
could be found.<br />
3.3. Illusion of control bias<br />
Ellen Lager defined the illusion of control al attributing a higher probability to the<br />
subjective success than to the objective one (Langer, 1975). The right to chose, the<br />
results sequence, task familiarity, competition but also active implication could<br />
increase the individual confidence in them self and create the illusion of control.<br />
When a person act intending to obtain certain result and the relation between this<br />
action and the result is obvious, people usually consider that they controlled the<br />
events. As many other heuristics this shortcut could also lead to correct judgments.<br />
For instance when they have the power to influence the outcome the individuals<br />
usually act deliberately to obtain it so there is a relationship between that action and<br />
the outcome. Also people could act for a special result and could consider that there is<br />
a connection between their acts and the outcome even in situations when they cannot<br />
control things (Thompson, 1998).<br />
Illusion of control could determine investors to trade more than is prudent and to<br />
maintain under diversified portfolio because they think they can control and beat the<br />
market. The excessive use of limit orders and other such control techniques could be<br />
also considered a result of this illusion. The institutional investors are also committed<br />
to this error because “the task and environment faced by traders are conducive to the<br />
development of illusions of control and that individual propensity to illusion<br />
of control will be (inversely) related to trader performance” (Fenton-O’Creevy<br />
et. al, 2010)<br />
3.4. Framing bias<br />
Framing refers to the way a problem is poses for the one who has to take a decision.<br />
The first step in making a choice is to frame it but it is also the first place where<br />
people can go wrong because the way a problem is framed influences the choice they<br />
make.<br />
According to the behavioral scholars if the option is presented as sure gain the result<br />
will be a positive framing effects which will generally lead to a less-risky choice<br />
(Twersky and Kahneman, 1981) comparing with a option presented as relative<br />
likelihood of looses where negative framing effects will occur.<br />
Different models have been proposed to explain the framing effect: prospect theory<br />
which explains the framing effect starting from the differential weighting people give<br />
to losses than to equivalent gains (Kahneman and Twersky, 1979), fuzzy-trace theory<br />
based on the determination of the amount of cognitive processing needed to<br />
distinguish between potential losses and gains (Reyna et.al, 2003), motivational<br />
theories which use element as fear and wishes in order to explain what determine our<br />
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decisions (Reiss 2004), cognitive cost-benefit trade-off theory as a compromise<br />
between desires, correct decisions and cognitive efforts (Flyvbjerg et al, 2003).<br />
The development of neuroimaging have linked the framing effect to the neural<br />
activity in the amygdala (responsible for fear) and in the orbital and medial prefrontal<br />
cortex that appears to be the part of our brain responsible for moderating the<br />
emotion’s role on decision. Monitoring brain activity using functional magnetic<br />
resonance imaging a greater activity in the prefrontal cortex of the subjects less<br />
susceptible to framing-effects was noticed (De Martino et al., 2006).<br />
3.5. Conservatism bias<br />
„A conservatism bias means that investors are too slow (too conservative) in updating<br />
their beliefs in response to recent evidence. This means that they might initially under<br />
react to news about a firm, so that prices will fully reflect new information only<br />
gradually. Such a bias would give rise to momentum in stock market returns." (Bodie<br />
et al.2005). In a narrow sense conservatism means that people are not perfect<br />
Bayesian updaters (Massy and Wu, 2005).<br />
Conservatism could cause investors to cling to a initial forecast or opinion, to react<br />
too slow to new information and not in the last place, can be related to an underlying<br />
difficulty in processing new information. One of conservatism’s possible explanations<br />
is that processing new information and updating beliefs is cognitively costly.<br />
Confronted with abstract and statistical information people tends to weight them less<br />
than the information which are easily processed and this form of base rate<br />
underweight could be considered a form of conservatism (Hirshleifer, 2001).<br />
Conservatism bias is present at the individual investor’s level but also at the financial<br />
analyst’s level. James Mortier noticed in 2002 that analysts are exceptionally good at<br />
telling what has just happened but have the tendency to underreact to fundamental<br />
information as dividends, initiations, earnings reports because they invested in their<br />
view and they will change it only when presented with evidences of its falsehood<br />
(Mortier, 2002)<br />
3.6. Hindsight bias<br />
The hindsight bias is a psychological phenomenon which tends to occur when a<br />
person believes that the past events were predictable and completely obvious. Investor<br />
believe that he truly predicted what happened and they new from the beginning the<br />
right answer, the events succession, the price evolution etc (Fischhoff, 2001) In fact,<br />
as Keynes said “the representative investor is assumed to understand the economy and<br />
the process determining asset prices; the individual investor frequently does not” .<br />
Psychologist consider that hindsight is determined by our innate need to find a pattern<br />
an order in the world by creating explanation that allow us believe that we could<br />
predict future events. For investors hindsight bias is a cause for the most dangerous<br />
mindsets that an investor can have: overconfidence. There are strong evidences for the<br />
consequences hindsight bias could have on the investor’s decisions, the portfolio<br />
allocation perception and in the final on the risk exposure (Werth et al, 2002, Monti<br />
and Legrenzi, 2009). If this bias is present the investors will try to rewrite the history<br />
in order to have a reason to believe their prediction was correct.<br />
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3.7. Cognitive dissonance bias<br />
When the newly obtained information does not match what individuals already<br />
understood and accumulated or when a conflict between desires and self-interest and<br />
fairness arises this generates a psychic discomfort called cognitive dissonance.<br />
Cognitive theory proposes that the individuals will try to reduce this tension, to<br />
harmonize what they know either by reducing self-interest behaviour or by engaging<br />
in self-deception or by a combination (Festinger, 1957)<br />
In order to reduce the cognitive dissonance the investor’s brain filters and reduce the<br />
relevance of the negative information and concentrate son the positive information,<br />
consonant with the former opinions. Investors who present this bias would maintain<br />
the losing position despite the logical action just trying to avoid recognizing that he<br />
was wrong; also the investor could continue to buy stocks just to confirm the initial<br />
reasoning even if it is not a good idea and could neglect the new information which is<br />
discordant with their ex ante expectation (Konow, 2000). This will lead to a<br />
systematic overvaluation or undervaluation depending of the new information<br />
combined with an risk assessment error (Eckwert and Dress, 2005)<br />
3.8. Recency bias<br />
The last events and information seem to have more importance for the investor. The<br />
large amount of data available to the investor are not all the time cognitively available<br />
because the investors usually have difficulties in understand, process and assimilate<br />
large amounts of data. The recency bias could be defined as the tendency to remember<br />
and to consider more recent information than historical information. As a result this<br />
could cause the abandon of the long-term strategy and hinder the ability to make<br />
rational investment decision.<br />
In the bull market often investors are suffering by this bias considering that this bull<br />
market will last. In fact the bull market is sooner or later replaced by a bear market. If<br />
the investor extrapolates trends and tries to make predictions on short data series he<br />
could buy the stocks exactly in the pick moment. Also this error could determine the<br />
investor to consider just the last prices evolutions and ignore the fundamental value of<br />
the assets they intend to buy or to overload the portfolio with hot stock which will<br />
unbalance the portfolio and will determine an increase in the taken risk level.<br />
In a paper named Irrational Pessimism and the Road to Revulsion, James Montier<br />
(Montier, 2003) created a model using the recency bias and anchoring bias to proxy<br />
investors’ expectations. Montier presents in parallel the irrational and rational<br />
investors’ model noticing that between the expected return in a rational and irrational<br />
models there is a difference of at least 3%, determined by those two biases.<br />
3.9. Representativeness bias<br />
Confronted with large data flow the investor tries to classify them to look for patterns<br />
which could help him to understand the events and predict the future.<br />
Representativeness heuristic is a judgement based on stereotypes (Shefrin, 2000) and<br />
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it is high when an observation fits the pattern (Goldberg and von Nitzch, 2001). Some<br />
of the most important application of this heuristic could be found in market<br />
prediction, picking stocks, choosing mutual funds, investing in initial public offerings.<br />
The neuronal studies found out that this bias is connected with the left side of our<br />
cortex which is responsible for trends search even if there are no any and the<br />
phenomenon is random. One of the most used financial example of this bias is<br />
winner-loser effect (DBond and Taler, 1985) which could be explained from the way<br />
the investor see the past winners (too optimistic) and past losers (too pessimistic)<br />
which leads to an overvaluation of past winners and undervaluation of past losers.<br />
Base rate neglect (judging the potential outcome probability investors tend to neglect<br />
base period frequencies used to analyse the same phenomenon) and sample rate<br />
neglect (choosing to short intervals in order to perform the needed analysis) are also<br />
very frequent in the case of the investor confronted with this bias.<br />
3.10. Availability bias<br />
Availability is a heuristics in which the probability of an event is assessed on how<br />
easy is to recall its instances- retrievability,to mentally construct its instances -<br />
imaginability or how easy is to associate two instances - illusionary correlation<br />
(Tversky and Kahneman, 1974).The individuals affected by this bias consider more<br />
probable the events they recall and understand better comparing with the one who are<br />
harder to imagine or understand.<br />
What mistakes can cause availability for the investor? The main problem is that the<br />
investor will chose the asset he wants to buy based on the cognitive available<br />
information excluding the disciplined research. Also the investors will usually chose<br />
investments which fit their expertise area and which resonate with their own<br />
personality ignoring some potential good investments. In working paper called : All<br />
that glitters: the effect of attention and news on the buying behaviour of individual<br />
and institutional investors, Odean and Barber (Odean and Barber, 2002) pointed out<br />
that when confronted with the need to take a decision the investor chose usually the<br />
stocks who catch their attention not necessarily the best stocks. These glittering stocks<br />
are signalled according to the authors by: daily abnormal trading volume, daily returns<br />
and daily news.<br />
3.11. Mental accounting bias<br />
Mental accounting bias describes the human tendency to codify, categorize and<br />
valuate the economic results by grouping them on non-fungible and noninterchangeable<br />
mental accounts. Three types of mental accounting were widely<br />
described in the literature (Thaler, 1999). First type regards how the outcomes are<br />
perceived and experienced and how the investments are finally valuated: ex-ante and<br />
ex-post cost-benefit analysis. The second one involves the assignment of activities to<br />
specific accounts. People like to separate gains and integrate losses. For example in<br />
capital markets an investor who experienced capital gains like to separate dividends<br />
payments and in bear markets they can use dividends to buffer capital losses.<br />
Different types of resources and expenses are separately included in different mental<br />
accounts: long term versus short term, incomes versus capital, poverty protection<br />
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versus development potential. The third approach regards the frequency these<br />
accounts are evaluated: daily, monthly, yearly and the way they are defined: narrowly<br />
or broadly, concept called “choice bracketing”.<br />
The mental accounting is a very often bias which could lead to important mistakes.<br />
The most common is that decision makers tend to segregate different types of gambles<br />
into separate accounts and then apply prospect theory to each account neglecting the<br />
potential connections among them. The investors have difficulties in noticing the<br />
interconnections between assets which leads to the pyramidal portfolio construction<br />
where each floor is addressed to a certain investment purpose.<br />
The house money effect (prior gains increase risk seeking for wealthy individuals)<br />
and disposition effect (investors are risk averse over gambles for some stocks and risk<br />
loving in gambles for others) are both determined by the mental accounting bias. The<br />
noticed difference in attitude is driven by weather the stock has generated a paper<br />
capital gain or a paper capital loss (Grinblatt and Han, 2005) explaining the link<br />
between momentum and turnover (Lee and Bhaskaran, 2000)<br />
3.12. Confirmation bias<br />
Confirmation bias is a tendency to search for evidence which could confirm your<br />
preconceptions, rather than for evidence that could disconfirm it (Jones and Sugden,<br />
2000).This bias affects the decisions the investor may take in the relation with the<br />
acquisition of information. For example the investor could search only for the<br />
information which confirms the initial reasoning he has to choose the financial<br />
instrument neglecting all the rest of them. The investor could also concentrate his<br />
portfolio in shares of the company where he works or in other companies because he<br />
emotionally connects and does not want to hear anything negative about them.<br />
Confirmation bias could determine investors to be overconfident ignoring that in this<br />
way they could lose money (Zweig, 2009). Several scholars have determined that the<br />
investor would make more profit if he will resist to this bias and he will try to find<br />
arguments for a contrary viewpoint just for the sake of argument. (Hilton, 2001)<br />
imagining that they investment have collapsed (Krueger and Mann, 2009).<br />
3.13. Self-attribution bias<br />
"Self-attribution bias occurs when people attribute successful outcomes to their own<br />
skill but blame unsuccessful outcomes on bad luck." (Shefrin, 2000).<br />
Investors who experience a run of successful results start to develop an inflated<br />
opinion of their own skill which could determine and exaggerated risk taking. More<br />
than that the investor fails to learn from the mistake and in this way create o good<br />
opportunity to repeat them. Thinking that they are infallible investors starts to<br />
overtrade and to maintain under diversified portfolios.<br />
4. EMOTIONAL BIASES<br />
An emotional bias is a distortion in cognition and decision making due to emotional<br />
factors. Emotions play the role of a pain avoiding/pleasure seeking decision factor.<br />
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This role associated to feelings is often important and maybe more than the part<br />
played by pure cognition.<br />
The study take into consideration 5 of the emotional biases listed below:<br />
� Optimism bias<br />
� Endowment bias<br />
� Self-control bias<br />
� Loss aversion bias<br />
� Regret aversion bias<br />
4.1. Optimism bias<br />
According to the John Maynard Keynes (The general theory of employment, interest<br />
and money, 1936) “even apart from the instability due to speculation, there is the<br />
instability due to the characteristic of human nature that a large proportion of our<br />
positive activities depend on spontaneous optimism rather than a mathematical<br />
expectation, whether moral or hedonistic or economic”<br />
Optimism bias, originally referred to as unrealistic optimism (Weinstein, 1980), could<br />
be defined as the tendency of individuals to be overly optimistic about the outcome of<br />
planned actions. This includes over-estimating the likelihood of positive events and<br />
under-estimating the likelihood of negative events.<br />
Hope and fear are obviously sentimental states characteristic of this form of<br />
unrealistic optimism and they could represent the main motivational factors of a<br />
particular way of action. The entrance of unrealistic optimism into financial world<br />
could potential hurt if it leads to passivity and lack of interest thinking that the<br />
problem will self solve or impulsive behaviour, taking wrong decision based on<br />
illusions.<br />
Kahneman and Lovallo realised a more technical description of this error. They<br />
consider it determined by the investors’ inability to analyse the facts form outside,<br />
non-passionately and comparing the current situation with the previous ones (Lovallo<br />
and Kahneman, 2003)<br />
The financial analysts are not exempt from this bias. Analysts are typically<br />
overoptimistic, slow to revise their forecasts to reflect new economic conditions, and<br />
prone to making increasingly inaccurate forecasts when economic growth declined<br />
4.2. Endowment bias<br />
The endowment bias is a really common feeling among the owners of economic assets<br />
who consider that they worth more than the market because ownership increase value<br />
in the owner’s mind. As a result the investor will ask for more money to sell the asset<br />
than he will give to obtain it. The disparity between the willingness to pay for a<br />
certain good (WTP) and the willingness to accept retribution payments in exchange<br />
for giving up this good (WTA) cold be explained by the “disutility from parting with<br />
one’s endowment and/or by an extra utility from ownership which is not anticipated<br />
by individuals who are not endowed with the good” (Bischoff, 2006).<br />
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This bias could determine the investor to keep the inherited and bought securities even<br />
if they worthless because this could be seen as a lack of loyalty or because they are<br />
afraid that the selling will generate fiscal effects. Plus the investor could be afraid that<br />
he will have to bear high trading cost if he sells those securities but in some cases the<br />
opportunity costs leaded to their keeping is higher that the trading cost. This bias is<br />
more frequent in the case of the investor with small experience. Experienced traders<br />
are less susceptible to endowment bias (List, 2003)<br />
4.3. Self control bias<br />
Many financial decisions involve individual intertemporal choices in trying to find an<br />
answer to the question: spend now or save for tomorrow? How do we decide? There<br />
are two sets or answers. In the first one the answer in rational, logical based on the<br />
careful weighting up the present value against the future, exercising the wisdom of<br />
Solomon. Unfortunately this view does not explain how people actually behave<br />
(Thaler and Shefrin, 1981). Nowadays amongst researchers there's much less<br />
emphasis on people’s rationality - and more on how our self-control and emotions<br />
interact at the actual moment of decision-making (Camerer, Loewenstein & Prelec,<br />
2005).<br />
In the literature there are several factors which are were found as interacting with the<br />
self-control:<br />
� increased cognitive load – based on the fact that distracted people are more<br />
likely to spend money. Commercials, incredible offers are made to confuse the<br />
individual and to make him open his wallet in the detriment of the investments<br />
for tomorrow.<br />
� frequency we had to use the self control: studies show that our self-control is<br />
undermined each time we use it (Baumeister and Vohs, 2003)<br />
� sadness – could determine an increase in our spending desires because those<br />
who are sad are more likely to want to sell at a lower price and buy at a higher<br />
price (Lerner et. al, 2004).<br />
� disgust –determine a decrease in our desires to buy things<br />
� anxiety – makes us to prefer low-risk option in order to reduce uncertainty<br />
(Raghunathan and Pham, 1999)<br />
4.4. Loss aversion bias<br />
The loss aversion bias could be defined as the tendency to find losses twice as painful<br />
as we find gains pleasurable. “People hate losses (and their Automatic Systems can<br />
get pretty emotional about them). Roughly speaking, losing something makes you<br />
twice as miserable as gaining the same thing makes you happy....Consequently loss<br />
aversion produces inertia, meaning a strong desire to stick with your current<br />
holdings,”(Thaler and Sunstein, 2008) Nudge: Improving Decisions About Health,<br />
Wealth and Happiness.<br />
Loss aversion also explains a very common tendency to sell the stocks that have<br />
increased in value and to maintain the depreciating stocks. On the long term this<br />
strategy is exceedingly foolish because in the final the portfolio will be composed<br />
entirely of shares that are losing money. Why does the investor do this? One of the<br />
possible explanations could be that if they would sell their shares that have decreased<br />
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in value this will make the loss tangible and they prefer to postpone the pain for as<br />
long as possible, causing in this way more losses. The things seem to be also<br />
connected with the brains activity because several studies have shown that higher<br />
sensitivity to loss entails emotional processes recruiting structures such as the<br />
amygdala and the anterior insula, which are parts of human cortex associated with a<br />
some mostly negative emotions and behaviors, from the generation of fear to the<br />
memory of painful associations (Tom et al, 2007).<br />
4.5. Regret aversion bias<br />
Sometimes where people are confronted with the results of a bad decision they blame<br />
themselves considering that a different way of action would bring a different outcome.<br />
This unpleasant feeling is the emotion of regret. Regret has serious behavioural<br />
implication determined from the anticipation and also from the experience of this<br />
emotion (Zeelenberg et al, 2001)<br />
Usually individuals experience more regret for the actions they have take than for the<br />
action they have forgone (Gilovich et al.1995, Ordonez and Connolly, 2000)<br />
5. GENDER REALLY MATTERS?<br />
In order to test for the described biases a questionnaire was distributed to 1000<br />
participants, students form West University from Timisoara and Polytechnic<br />
University from Timisoara. 888 questionnaires were declared correctly filled and were<br />
used in the second step to determine if men and women are equally susceptible to<br />
certain cognitive and emotional biases at the debut of their investment period.<br />
The questionnaire encloses 38 multiple choice questions that verify the presence of<br />
the 18th biases already discussed. The respondents were asked to state first their<br />
gender and after to fill the form with the answers they consider correct for them. The<br />
asked questions are presented below .The answers susceptible of the bias are market<br />
with bold characters or/and italic characters; in the case of the biases verified by two<br />
questions each answer susceptible of that bias counts 0.5 point. In the case of<br />
2 answers susceptible for a bias for a question, the second susceptible answer counts<br />
0.25 point –the answer market with italics (the questions were randomly distributed in<br />
the questionnaire)<br />
5.1. Overconfidence<br />
How easy you would consider predicting the price increase for a certain stock on the<br />
stock exchange?<br />
• easy<br />
• pretty easy<br />
• pretty hard<br />
• hard<br />
Do you think you could easily estimate what stocks will outperform the market?<br />
• absolutely not<br />
• in a very small part<br />
• yes<br />
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5.2. Anchoring bias<br />
You bought two years ago A companies’ stocks with 5 RON and now their price is<br />
8 RON. A couple of month ago the price reached a record level of 15 RON caused by<br />
the announcement of high past profits. You thought to sell the stocks but you haven’t<br />
done it. The price dropped at 15 RON after the managers were accused by fraud.<br />
What would you chose from the following choices?<br />
• keep the shares hoping that the price will increase again at the previous level<br />
because now you are feeling that you would lose 7 (15-8) RON if you would<br />
sell them<br />
• sell the shares because this increase had a conjectural reason.<br />
Assume that you would have to sell your current house from the outskirts in order to<br />
buy another one located in the centre of the city. You still hesitate regarding your<br />
selling price. Your agent valuated your property at 200.000 euro. This value amazes<br />
you because you have bought the house 15 years ago with 50.000 euro. You have<br />
posted your selling order on market but you did not receive any offer for a couple of<br />
month. One of the days your agents ask you an urgent meeting. He told you that<br />
company A, that was created 8 years ago have bankrupt and 2.500 people remained<br />
unemployed. Your agent and his co-workers concluded that this bankruptcy made the<br />
real market to drop 10%. Your agent told you that you have to revaluate your selling<br />
price taking into consideration this new information. You are telling him that you will<br />
consider it and you will tell him the results. What is more probable for you to choose?<br />
• decide to keep the initial price<br />
• decide to reduce the price with 5%<br />
• decide to reduce the price with 10%<br />
• decide to reduce the price to 150.000 because you want to be sure that you will<br />
sell it.<br />
5.3. Illusion of control<br />
Do you consider yourself able to better control the game output if you throw the dice<br />
when you play games like Monopoly, dice, etc?<br />
• yes, seems that I am in control<br />
• no, this does not matter for me<br />
If you buy a lottery ticket are you more confident when you are choosing the numbers<br />
comparing with a randomly selected numbers?<br />
• yes, it seems more probable to win if I am choosing the numbers<br />
• no, this does not matter for me.<br />
5.4. Framing bias<br />
(In this case the susceptibility of this error is verified if the respondent chose different<br />
answers to the two parts)<br />
a. Assume that you prepare to retirement. You need 50.000 RON per year to live<br />
comfortably but you could live with 40.000 RON and you could survive in the<br />
extremis with 30.000 RON. In the second step, assume that there is no<br />
inflation. Now you have to choose among two hypothetical investments. First<br />
choice will secure you 40.000 RON/year without risk and the second one will<br />
bring 50.000 (50% chance) or 30.000 (50% chance). What would you chose?<br />
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• first option<br />
• second option.<br />
b. Assume that you prepare to retirement. You need 50.000 RON per year to live<br />
comfortably but you could live with 40.000 RON and you could survive in the<br />
extremis with 30.000 RON. In the second step, assume that there is no<br />
inflation. Now you have to choose among two hypothetical investments.<br />
The first choice will secure you an income able to cover your main living<br />
expenses but you will be never able to have a high living standard. In the<br />
second alternative you have 50% chances to have a high living standard<br />
(50.000 RON) and 50% chance to have to live with 30.000 RON. What would<br />
you chose?<br />
• first option<br />
• second option.<br />
5.5. Conservatism bias<br />
Assume that you live in Covasna and you make a prediction that sound like this: I<br />
believe that in this winter will be a lot of snow. You are realising that you are in the<br />
middle of February and there were no snow. What is your natural reaction to this<br />
information?<br />
• there is still time to snow, so my prediction still can be correct<br />
• there is still time to snow but it is possible to have been mistaken<br />
• my experience tells me that my prediction is probably incorrect. The winter<br />
almost have passed.<br />
What your natural reaction could be when you hear some news that could negatively<br />
affect your investments?<br />
• I am tempted to ignore them because I have already made my investment<br />
• I will revaluate the initial reasons I had but probably I will stick to the initial<br />
decision because usually I am doing this<br />
• I will revaluate the reasons that determined me to initially buy the stock and I<br />
will decide what to do after analysing all the determinants.<br />
5.6. Hindsight bias<br />
Assume you have made a bed investment. What is your natural reaction to that?<br />
• Normally I will not blame myself because it could be a misfortune. I wil sell<br />
the shares and I will move on<br />
• I would want to know why I have failed. Usually I have a pretty good<br />
fundament decision system and I have to realise what motivates the<br />
performances of my investments.<br />
Assume you have thought to include open-end funds units in your portfolio. You<br />
analysing their performances. What is your natural approach when you are evaluating<br />
their performances?<br />
• I am tempted to look at the historical performances comparing them with a<br />
certain referential. I am not interested in the strategy the manager applies. I<br />
am interested just in results. If the results are not satisfying I prefer not to<br />
choose it.<br />
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• I am looking at the returns but I also pay attention to the manager’s strategy<br />
and I am trying to realise what manager did in the analysed period of time. In<br />
my decision coherent strategies represent an important factor.<br />
5.7. Cognitive dissonance bias<br />
Assume that you just have bought a new mobile phone, brand A, model B. You are<br />
very happy with your acquisition. One day your colleague meets you and has the next<br />
statement: This is a very nice mobile. I know this model. Did you know that for the B<br />
brand, model D (model D is almost identical with model B) free internet is included?<br />
You are confused initially. You did not know about it and you would also like to have<br />
this option. Maybe you start questioning your decision and to ask yourself if you have<br />
done the right decision. You returning back home. Which of the next action would<br />
consider more suitable for you?<br />
• Try to find if the information is correct<br />
• You will neglect the information thinking that if you would be in the position<br />
to buy it again you would do the same. Even if mine does not have the free<br />
internet I am still happy with my decision<br />
• You think to further investigate the D model. Still you decide not to and you<br />
decide to listen to your first instinct because you prefer not to discover that<br />
you misjudged. It is better to forget about is and to enjoy it.<br />
Assume that winter came and the entire city is full of snow. You do not have winter<br />
tires and do not intend to buy some because believe that the winter will pass even<br />
without them. In the evening at the news a lot of accidents due to the snow and ice are<br />
announced and all the people are counselled to buy winter tires. What do you decide?<br />
• Even if you are confident in your driving abilities you will go and buy some<br />
adequate tires<br />
• You are going to a tires store but because they are too expensive you abandon<br />
the idea<br />
• You still thinking at the last years experiences and you continue to drive<br />
without winter tires<br />
5.8. Recency bias<br />
Read the next names’ list. Without counting them answer to the next question: the list<br />
contains more male or female names?<br />
Sorin, Andreea, Silvia, Andrei, Ana, Maria, Eugen, Maximilian, Rodica, Octavian<br />
• Male names<br />
• Female names<br />
5.9. Representativeness bias<br />
George was a very good handball player in high school. After graduation George<br />
become sport teacher. George has two sons, both very good athletes. What do you<br />
consider more probable?<br />
• George will become the coach of the local handball small league<br />
• George will coach small league and play at the local team<br />
~ 849 ~
Look carefully the next results from flipping a coin in the air. Which one of the next<br />
outputs seems more probable for you?<br />
Had Tail Tail Had Tail<br />
Had<br />
Tail Tail Tail Had Had Had<br />
• First one<br />
• Second one<br />
5.10. Availability bias<br />
Assume that you have some money to invest and that you get a tip from a neighbour<br />
who is known for his flair. He recommends you to buy shares of A company. What<br />
would you do?<br />
• Probably I will buy those shares because my neighbour is usually right<br />
• Probably I will take his advice into account but I will first go home to analyse<br />
the offer<br />
Which one from the next two determine more deceases in USA<br />
• Lightings<br />
• Tornados<br />
Mental accounting bias (In this case the susceptibility of this error is verified if the<br />
respondent chose different answers to the two parts)<br />
a. Assume that you have bought a ticket to the favourite band. When is about to<br />
start you notice that you have lost your ticket. You have paid 100 RON for<br />
your ticket and you are noticing that there are still available tickets for the<br />
same price. Associate a probability to a new tickets buying.<br />
100% 50% 0<br />
b. Assume that you have not bought a ticket in advance but you thought that you<br />
will buy one with 100 at the entrance. When you are there you panic because<br />
you realise that you lost the 100 for ticket. Notice that there is an ATM near by<br />
so you could use it to get the needed money. Please associate a probability<br />
100% 50% 0<br />
5.11. Confirmation bias<br />
Assume that you bought a security after a close search. You have seen now that the<br />
company have serious difficulties in production. In the second paragraph of the media<br />
communicate you are reading a new product which could start to be created by the<br />
firm, is described. What will you do?<br />
• I will notice the new product launch and I will further investigate it<br />
• I will notice the problems regarding the old products and I will try to further<br />
investigate it<br />
Assume that you have invested in a security. The investment value increases but not<br />
caused by the predicted factors. What would you do?<br />
• Because there is an increase, the reason does not interest me<br />
~ 850 ~
• Even if I am very satisfied with my investment I will check it to see what<br />
happened.<br />
5.12. Self-attribution bias<br />
If the total return of your portfolio increases, what is the cause for this?<br />
• Your investments talents<br />
• A combination between talent and lack<br />
• Lack<br />
After you invested some money you hear news which will negatively impact your<br />
investment. How probable it is that you will look for other information to confirm that<br />
you were wrong?<br />
• Extremely improbable<br />
• Improbable<br />
• Probable<br />
• Very probable<br />
5.13. Optimism bias<br />
If you have to choose between investing on the next exchanges, what would you<br />
chose<br />
Bucuresti Osaka Londra<br />
How large is the probability of something good happening to you today?<br />
very high high moderate reduced<br />
5.14. Endowment bias<br />
Assume that your aunt have died and left you 100 IBM stocks. Your consultant told<br />
you that you already have too many stocks in the same field and he suggested you to<br />
sell them. What is the most probable action you will take?<br />
• Probable I will keep those stocks because I have inherited them from my aunt<br />
• I will do what my counsellor says<br />
Assume that you have bought some pretty profitable corporate bonds. They generated<br />
high yields and you are very happy with them. Your financial consultant analyses<br />
your portfolio and advice you to change them with municipal bonds, unknown for you<br />
until now, with the same return. He explains that after all the taxes your profit will be<br />
higher. How would you react?<br />
• You will prefer the corporate bond because they are familiar to you<br />
• You will sell the corporate bonds and buy the municipal bonds even if I am<br />
not familiar with them<br />
5.15. Self-control bias<br />
How would you characterise yourself from the self-discipline point of view?<br />
• I am always reaching my goals if they are important for me no matter what<br />
sacrifices I have to make<br />
~ 851 ~
• Most of the time I am achieving my goals but sometimes I have difficulties to<br />
continue the battle if it seems to be too difficult<br />
• Respecting the promises to myself represent a real problem. I have very few<br />
self-discipline and I am finding myself asking for help very often<br />
Assume you need a new car. You had this car in the last seven years and it is the right<br />
moment for a change. Which option seems possible for you?<br />
• Usually I do not spend too much money for my car because I am considering it<br />
only a way of transport. I could save the money I would pay for an expensive<br />
car and invest them<br />
• I would buy an average price car with sophisticated options because I like to<br />
have a nice car. I cannot imagine myself buying a very extravagant car<br />
• When is about the car I like to indulge myself. Probably I will choose a special<br />
model with luxury options. Even if buying of this car will affect my long term<br />
saving I think for me is important the present<br />
5.16. Loss aversion bias<br />
Chose between the next two options:<br />
• A sure gain of 475<br />
• 25% chance to gain 475 and 75% chance to gain 2000<br />
Assume that you want to invest 50.000 RON. You have to choose between two<br />
options:<br />
• To be sure that I will recuperate the invested money even if I do not gain<br />
anything<br />
• To have a 50% chance to win 70.000 and 50% chance to gain 35.000<br />
5.17. Regret aversion bias<br />
Assume that you invested in company A and its shares increased with 10% in the<br />
next 12 month. You are thinking to sell your shares to rebalance your portfolio but<br />
you read an articol that states that their prices will increase further. What will you do<br />
considering the new informations and evolutions?<br />
• I think I will keep them and I will sell them later. I would be realy sory if I<br />
would sell them and I will notice a future increase<br />
• Probably I will sell them. But I will be sorry anyway if the price will increase<br />
after I sold them<br />
• Probably I will sell the shares without any regret<br />
The answers have showed some differences among the two genders, which are<br />
described in the next graphs, grouped regarding the prevalence for the two genders<br />
and the type of bias (cognitive or emotional)<br />
~ 852 ~
60<br />
50<br />
40<br />
30<br />
20<br />
10<br />
60<br />
50<br />
40<br />
30<br />
20<br />
10<br />
0<br />
Anchoring bias<br />
0<br />
80<br />
70<br />
60<br />
50<br />
40<br />
30<br />
20<br />
10<br />
0<br />
40<br />
34<br />
23<br />
Figure 2. Questionnaire results<br />
Illusion of control<br />
25<br />
Overconfidence<br />
bias<br />
60<br />
50<br />
40<br />
30<br />
20<br />
10<br />
0<br />
19<br />
50 47<br />
49<br />
Prevalent cognitive biases for women (%)<br />
Framing bias<br />
32<br />
29<br />
Cognitive dissonance bias<br />
25 24<br />
Representativeness bias<br />
29 28<br />
Availability bias<br />
~ 853 ~<br />
43 42<br />
Mental accounting bias<br />
35<br />
28<br />
Prevalent emotional biases for women(%)<br />
43<br />
Endowment bias Regret aversion bias<br />
Prevalent cognitive biases for men(%)<br />
11<br />
12<br />
Conservatism<br />
bias<br />
20<br />
24<br />
29<br />
72<br />
37<br />
50<br />
62<br />
Confirmation bias<br />
13<br />
42 40<br />
14<br />
Hindsight bias Recency bias Self-attribution<br />
bias<br />
Prevalent emotional biases for men (%)<br />
7<br />
Optimism bias Self-control bias Loss aversion bias<br />
As one can see the results shows gender differences regarded to susceptibility to<br />
certain biases, especially in the case of some of them:<br />
• Recency bias – men are more susceptible to be affected by this bias (13%<br />
diference)<br />
• Regret aversion bias – women are more susceptible to be affected by this bias<br />
(10% diference)<br />
• Mental accounting bias- women are more susceptible to be affected by this<br />
bias (7% diference)<br />
Why these differences? Trying to explain the first difference one potential explanation<br />
could be represented by the memory differences between the two genders. According<br />
to some specialists (Knox et al, 2001;Sinha, 2005, Washburn, 2005) women have<br />
better multi-tasking skills than men which involve the use of memory. Women were<br />
8<br />
50<br />
55<br />
women<br />
men<br />
women<br />
men<br />
women<br />
men<br />
women<br />
men
more likely to come up with a creative way to remember the events or values, a better<br />
ability to adapt and respond to uncertainty that could improve their results in recency<br />
bias.<br />
Women are more pessimistic (see the result in optimism bias), realist (see the results<br />
in overconfidence bias), risk adverse and regret adverse that men. The thinks are<br />
connected because the higher proportion of regret aversion is somehow determined of<br />
the general differences between man and women in those aspects (Zeelenberg et<br />
al.,1996; Ben –Ze’ev, 2000; Seiler,j.M., Viccky, l.S., Traub, S., Harrison, D.M.,<br />
2008). The differences between genders could be explained using the knowledge of a<br />
new field of cellular biology called epigenetic. The scientists promote the idea that the<br />
main characteristic of a cell (in our case of our investor, man or woman) could be<br />
better explained by the environment they live (the neighbour cells, their state and<br />
local processes) than by their genetic determinants. The creation of sub-conscious<br />
memory in the first year of life as a basis for 95% of our futures actions could make<br />
us believe that the different environment we create for children, the different approach<br />
in raising them could be a determinant of the differences we are noticing in their adult<br />
life. The permanent encouragement for boys to be courageous, not to fear anything<br />
and not to show their emotions could be seen in the action of the potential men<br />
investors.<br />
As one can see in mental accounting women seem to be again more biased than men.<br />
One could say that it is normal to see this in the financial field too because it is really<br />
common in the real non-financial life. Women are more used and more capable that<br />
men to solve multi-task problems (Sinha, 2005) using the mental acocounting to<br />
separate the career and different fields of the personal life in order to try to reach their<br />
goals in both.<br />
6. GENDER INFLUENCES IN ASSET ALLOCATION MODEL<br />
The classic finance proposes portfolios build on the rule of return/risk optimization. It<br />
is certain from what we have already discuss that men and women investors are not<br />
alike and a common strategy for both could not be appropriate.<br />
More, a portfolio who does not account for the biases the investor could be<br />
susceptible to, based on the idea of investor rationality could not hold if we are aware<br />
of the multiple examples of human irrationality and capital market lack of efficiency.<br />
That is why sometimes the proposed portfolio should depart from the efficiency<br />
frontier incorporating gender differences and the susceptibility to a specific set of<br />
biases. For instance if the general mean-variance output recommendation would be<br />
65% bonds and 35% shares it is more than possible to increase the proportion of riskfree<br />
asset in portfolio for women or to decrease it for a man, after analysing the biases<br />
he is susceptible of. One should see the portfolio as a tailor-made one, specific to each<br />
investor and to accept a departure from the classical optimum because the optimum<br />
portfolio is the one which brings the expected return but also allows the investor to be<br />
able to sleep.<br />
~ 854 ~
DISCUSSION AND CONCLUSIONS<br />
The main conclusion of this paper is that men and women both are susceptible to<br />
different cognitive and emotional biases but in different proportions and that those<br />
biases affect their investment decisions. Constructing a portfolio based on the<br />
assumption of investor’s rationality could be considered a non-realistically approach<br />
as one could easily see from the results obtained from this questionnaire and from the<br />
existing literature in behavioural finance. Including behavioural finance in the asset<br />
allocation and taking into consideration the differences between genders in the<br />
decision processes could be by far a more efficient solution.<br />
One of the possible limitations of this study could be represented by the small number<br />
of respondents and by their representativeness for the investor sample. This limit<br />
could be overwhelmed by increasing the number of participants and by trying to find<br />
a better representative sample.<br />
A future direction is to try to create a neuronal network capable to generate clusters of<br />
individuals who are susceptible to a specific set of biases, on gender criterion or/and<br />
by other. This approach could help a potential consultant to know the investor better,<br />
to create a portfolio that perfectly suits to the investor’s gender and personality.<br />
ACKNOWLEDGEMENTS<br />
This paper received financial support through the project, Post-Doctoral Studies in<br />
Economics: training program for elite researchers - SPODE" No finance contract.<br />
POSDRU/89/1.5/S/61755, European Social Fund project funded by Human Resources<br />
Development Operational Programme 2007-2013<br />
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PS18 Education<br />
Chairperson<br />
Alain BURLAUD, INTEC Paris, France<br />
ACCOUNTING STUDENTS’ ACADEMIC<br />
PERFORMANCE: A BATTLE BETWEEN<br />
PERCEPTIONS? A ROMANIAN RESEARCH NOTE<br />
Carmen Giorgiana BONACI, Razvan V. MUSTATA,<br />
Alexandra MUTIU, Dumitru MATIS<br />
PERCEPTION OF THE ROMANIAN ACCOUNTANTS<br />
REGARDING THE FINANCIAL ACCOUNTING<br />
EDUCATION<br />
Paul DIACONU, Vasile GORGAN, Catalina GORGAN,<br />
Nicoleta COMAN, Codrina Sandru<br />
MANAGEMENT VIEW RELATED TO HIGHER<br />
EDUCATION – AN ANALYSIS OF THE ROMANIAN<br />
BUSINESS PERCEPTIONS<br />
Mihaela STET, Alexandra ROSU<br />
SOCIAL NETWORKING IMPACT ON EDUCATIONAL<br />
PROCESSES IN ROMANIA<br />
Florin MIHAI, Andrei STANCIU, Ofelia Ema ALECA<br />
THE BEGINNINGS OF TRANSYLVANIAN CLUJ<br />
ACCOUNTING SCHOOL<br />
Teodora Viorica FARCAS, Adriana TIRON TUDOR<br />
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ACCOUNTING STUDENTS’ ACADEMIC<br />
PERFORMANCE: A BATTLE BETWEEN<br />
PERCEPTIONS? A ROMANIAN RESEARCH NOTE<br />
Carmen Giorgiana BONACI 1 , Razvan V. MUSTATA,<br />
Alexandra MUTIU & Dumitru MATIS<br />
Babes-Bolyai University, Romania<br />
ABSTRACT<br />
Our paper contributes to the body of literature dealing with accounting students’ academic<br />
performance. Since any method used in measuring students’ academic performance will<br />
generate results that bear the evaluator’s fingerprint, we focus our analysis on examination<br />
performance. We therefore look at students’ self-acknowledged grades and their final grades<br />
as assessed by the educator. The educator in assessing students’ final grades uses bloom’s<br />
taxonomy of educational objectives. We further analyze and discuss students’ ability to<br />
acknowledge their academic performance and the components of their final grade in<br />
accordance to Bloom’s taxonomy. The analysis is performed on a sample of 3 rd year<br />
accounting students and considers the Controlling course. Cluster analysis is also employed.<br />
The findings offer useful insights for accounting educators.<br />
KEYWORDS: accounting students, examination performance, Bloom’s taxonomy, selfacknowledgement<br />
INTRODUCTION<br />
Accounting students’ academic performance represents an important component of<br />
the educational process since it should represent a reflection of students’ knowledge,<br />
but also an indicator of their intellectual abilities and skills. Chia (2005) even<br />
documents that graduate’s academic performance represents a significant indicator of<br />
future initial job interviews. We must also make reference to Vroom’s (1964)<br />
expectancy theory, which provides a useful conceptual framework for understanding a<br />
student's motivation to strive for academic success (Harell, 1985). Furthermore, by<br />
using the within-persons decision modeling approach Stahl and Harrell (1981)<br />
documented that a student's motivation to strive for academic success is positively<br />
correlated with the student's actual behavior (academic performance). The manner in<br />
which educators through the evaluation process are assessing students’ academic<br />
performance is therefore extremely important in motivating their future behavior.<br />
Moreover, we believe that students should also develop the ability to selfacknowledge<br />
their academic performance and make them aware of their actual status.<br />
As a saying goes we almost always get what we measure, the assessment process of<br />
students’ academic performance should be very carefully considered.<br />
1 Correspondence address: Carmen Giorgiana BONACI, Babes-Bolyai University,<br />
Faculty of Economics and Business Administration, Cluj Napoca, Romania;<br />
email: carmen.bonaci@econ.ubbcluj.ro<br />
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As it is also said that beauty lies in the eyes of the beholder it might be a difficult task<br />
to reconcile students’ self-acknowledged academic performance with that assessed by<br />
the educator. Our paper therefore analyzes and compares the two reflections of<br />
students’ academic performance by considering a sample of 3 rd year accounting<br />
students and the Controlling course. Students’ self-acknowledged grades were<br />
obtained with the help of the questionnaire while their final grades as assessed by the<br />
educator were those attributed to them through the final exam for the Controlling<br />
course. Bloom’s taxonomy was used in developing the examination process that<br />
generated students’ final grades as assessed by the educator, after previously being<br />
used within the teaching-learning process during the semester. Other students’<br />
characteristics obtained through the questionnaire were used in order to develop<br />
cluster analysis.<br />
The question therefore being posed by our study is what would be the best manner in<br />
which we could approach the examination process of accounting students’ academic<br />
performance? In order to find a suitable answer we must first think about the outcome<br />
and that would be a true and fair view of students’ academic performance. Correctly<br />
reflecting accounting students’ knowledge, and their intellectual abilities and skills<br />
would represent useful input when considering their future behavior which can<br />
represent better academic performance for the following academic years (when<br />
considering undergraduates) or a suitable career orientation (when considering<br />
graduates). Our paper proposes the use of Bloom’s taxonomy within the evaluation<br />
process based on its role of providing the classification of the goals for the<br />
educational systems, which we think should also be considered when assessing the<br />
output of the educational process in terms of students’ academic performance. We<br />
further analyze how students’ final grades are formed based on the taxonomy’s levels.<br />
Our paper proposes the use of Bloom’s taxonomy in order to asses accounting<br />
students’ academic performance. Since the taxonomy is supposed to provide the<br />
classification of the goals for the educational systems, it would only be natural for us<br />
to also use it when assessing the results of the educational process.<br />
Students’ self-acknowledgement is also a component of their behavior that can be<br />
analyzed and considered within the educational process. Analyzing and comparing<br />
accounting students’ self-acknowledged grades with those assessed by the educator<br />
can bring some insights in this direction. The results of our paper are useful for<br />
accounting educators when considering the evaluation process.<br />
Our paper further develops a review of literature on accounting students’ academic<br />
performance in order to acknowledge the state of the art when it comes to this<br />
significant component of the educational process. A distinctive component of the<br />
paper explains the research design, which was used in its development. Within the<br />
following part of the paper, we perform the proposed research design and interpret the<br />
obtained results. Some concluding remarks, which synthesize our findings, are<br />
presented within the final part of the paper together with some research perspectives.<br />
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1. ACCOUNTING STUDENTS’ ACADEMIC PERFORMANCE:<br />
REVIEW OF LITERATURE<br />
Up-to-date literature considering academic performance in accounting rarely focuses<br />
on the examination performance by itself, while in most of the cases emphasizing its<br />
correlates. If we look at studies being developed few decades ago we can find support<br />
for multiple choice testing as an alternative to the traditional “problem” or essay test<br />
used for evaluation of academic achievement in accounting courses (Collier and<br />
Mehrens, 1985), while also encouraging the development of objective test items for<br />
use in the classroom. We must nowadays mention Guney’s (2009) study discussing<br />
the idea of examination structure, noting that students do care about the way the<br />
examination questions are asked, and pleading for a rigorous and pedagogic<br />
preparation of examination questions in accounting. Guney (2009) documents that<br />
some students show their ability and intellect better in multiple-choice examinations,<br />
while some on essay-type examinations. That is why he argues for the use of various<br />
formats of examinations that should have the role of mitigating the adverse<br />
consequences of a typical exam structure on a specific group of students.<br />
If we are to make a review of how academic performance is being measured within<br />
literature and emphasize the exact term being used we can conclude that it is through<br />
marks (Jones and Wright, 2010; Guney, 2009), grades (Schleifer and Dull, 2009;<br />
Ramburuth and Mladenovic, 2004; Gracia and Jenkins 2003; Lewis et al. 1983),<br />
scores (Fordham and Hayes, 2009; Gardner et al. 2005; Koh and Hoh 1999), points<br />
(Kealy et al., 2005) and examination results (McDuffie and Smith, 2006; Chia, 2005;<br />
Duff, 2004; Paisey and Paisey, 2004; Hartnett et al., 2003; Lane and Porch, 2002;<br />
Lancaster and Strand, 2001; Naser and Peel, 1998; Tho, 1994; Barlett et al, 1993).<br />
Jones and Wright (2010) use marks on two questions on the final examination dealing<br />
with consolidation accounting, Ramburuth and Mladenovic (2004) use aggregate final<br />
grades, Lewis et al. (1983) grade point average and Schleifer and Dull (2009) use a<br />
grade-point average scale (4 for an A, 3 for a B, 2 for a C, 1 for a D, and 0 for an F).<br />
In accordance to the purpose of each study, authors may consider students’ academic<br />
performance for one or more years, while looking at one or more subjects (accounting<br />
or others). Fro example Gracia and Jenkins (2003) use total grade points achieved in<br />
all modules studied by each student in the previous academic year, while Koh and<br />
Koh (1999) use scores obtained in all the subjects for each of the three years of an<br />
accountancy degree programme in order to capture a better assessment of their overall<br />
academic ability than one or two subjects, and to track their performance over time.<br />
Other studies using examination results make reference to the common final exam<br />
(Lancaster and Strand, 2001), module performance (Paisey and Paisey, 2004),<br />
assessment task (Hartnett et al., 2003), assessment test (Barlett et al., 1993) and quiz<br />
scores (Fordham and Hayes, 2009) or percentage of total points earned on three<br />
interim tests and on the final exam (Kealy et al., 2005).<br />
A significant number of studies that were developed over time can be included in the<br />
body of literature considering the determinants of academic success in accounting.<br />
Therefore, academic performance is most of the times analyzed as being the<br />
dependent variable for literature considering correlates of academic performance in<br />
accounting. Once again studies vary in accordance to their main objective, looking at<br />
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a particular accounting subject or more, at academic performance for different periods<br />
and taking into consideration a series of determinant factors (Barlett et al., 1993; Tho,<br />
1994; Phillips ,1998; Naser and Peel, 1998; Koh and Koh, 1999; Lancaster and<br />
Strand, 2001; Gracia and Jenkins, 2003; Hartnett et al., 2003; Duff, 2004; Paisey and<br />
Paisey, 2004; Ramburuth and Mladenovi, 2004; Gardner et al., 2005; Kealey et al.,<br />
2005; McDuffie and Smith, 2006; Watson et al., 2007; Guney, 2009; Schleifer and<br />
Dull, 2009; Fox et al., 2010; Jones and Wright, 2010).<br />
First explanatory variables of accounting students’ academic performance to be<br />
considered in literature comprised educational, demographic and/or financial<br />
characteristics variables (Barlett et al., 1993; Tho, 1994). Primarily developed in the<br />
USA, the substantial literature considering the determinants of academic success in<br />
accounting focused on gender, prior knowledge of accounting, academic aptitude, and<br />
mathematics, producing largely inconclusive results (Duff, 2004). Phillips, 1998 notes<br />
that in accounting education research, cognitive style and ability have received the<br />
greatest attention when assessing performance. A review of accounting education<br />
literature by Watson et al. (2007) includes a discussion of learning styles and<br />
technology (Tho, 1994). For example, McDuffie and Smith (2006) address the<br />
particular use of an audit reporting system as a teaching aid and its impact on<br />
students’ performance. Koh and Koh (1999) investigate the impact of six variables<br />
(namely, gender, prior accounting knowledge, academic aptitude, mathematics<br />
background, previous working experience and age) on the performance of students in<br />
a three-year accountancy degree programme. Lancaster and Strand (2001) investigate<br />
academic performance and student perceptions regarding the cooperative learning<br />
format. Further studies consider a blend of data from demographic, attitudinal and<br />
behavioural sources, effectiveness of accounting students' approaches to learning<br />
being often considered (Gardner et al., 2005; Paisey and Paisey; 2004; Gracia and<br />
Jenkins, 2003; Hartnett et al., 2003, Byrne et al., 2002; Booth et al., 1999; Duff, 1997;<br />
Tan and Choo, 1990).<br />
We will furthermore mention a few particular approaches and factors considered<br />
when analyzing accounting students’ academic performance. Paisey and Paisey<br />
(2004) focus on two aspects of student attendance, namely the reasons why some<br />
students do not attend classes, and the issue of whether attendance improves academic<br />
performance, documenting a clear positive relationship between attendance at classes<br />
and subsequent academic performance. Gardner et al. (2005) look for associations<br />
between levels of communication apprehension and students’ abilities to advance in<br />
their studies or average levels of academic performance, but fail to document it.<br />
As previously mentioned, studies can also be grouped by considering a certain<br />
accounting subject when analyzing academic performance. This is the case for Naser<br />
and Peel (1998) and Kealey et al. (2005), who focused on determinants of student<br />
performance in a Principles of Accounting course. Naser and Peel (1998) examined<br />
the impact of a number of new attitudinal variables on examination performance,<br />
documenting that student perceptions of factors associated with class size, the<br />
attributes of the lecturer, student effort and the complexity of the course are associated<br />
with student performance in a first level principles of accounting course. Meanwhile,<br />
Kealey et al. (2005) document that critical-thinking skills contribute significantly to<br />
explaining the cross-sectional variation in student performance in an accounting<br />
~ 864 ~
principles class. A more particular factor such as paper colour was also considered by<br />
Michael and Jones (1955) and further analyzed by Fordham and Hayes (2009).<br />
Another classification of the significant number determinants of academic<br />
performance in accounting currently being used in literature is done by Guney (2009),<br />
employing student-oriented endogenous factors (e.g. age, gender) as well as studentexogenous<br />
factors (e.g. quality of teaching, examination structure). And finally we<br />
will refer to the latest studies on accounting students’ academic performance.<br />
Schleifer and Dull (2009) consider metacognition as an important aspect of selfregulated<br />
learning and therefore having potential as a learning skill or attribute that<br />
can serve to improve accounting education and performance. Fox et al. (2010)<br />
consider the impact of a student peer-mentoring programme on first-year<br />
undergraduates’ academic performance, while Jones and Wright (2010) extend<br />
previous work by combining the effect of cognitive style and the use or non-use of<br />
two versions of a hypertext learning aid and their interaction on student performance<br />
in advanced financial accounting.<br />
While considering literature on accounting students’ academic performance we must<br />
also mention those cases when academic performance represents an explanatory<br />
variable or a determinant factor for another considered dependent variable. It is<br />
mostly the case of studies in job search, such as Chia (2005) and Lewis et al. (1983).<br />
Chia (2005) investigates the effects of academic performance, extracurricular<br />
activities and emotional intelligence of potential accounting-major graduates on the<br />
outcomes of their respective interviewing activities and the number of final job offers<br />
given by the multinational Big 5 public accounting firms. His results document that<br />
the number of initial job interviews is affected by both a graduate’s academic<br />
performance and level of participation in extracurricular activities.<br />
Overall, the above presented studies approach academic performance even though the<br />
criterion of success being defined differently in each case, as Gammie et al. (2003)<br />
also comment on previous academic performance that was documented to be a<br />
statistically significant indicator of university performance. Therefore, in many cases,<br />
due to the limited information supplied in the studies in relation to the precise<br />
specification of the independent variables, it is difficult to compare the predictor<br />
variables.<br />
Our study proposes the use of Bloom’s taxonomy in assessing accounting students’<br />
academic performance. Bloom’s taxonomy has received considerable international<br />
recognition within the evaluation community (Lewy and Bathory, 1994). This was<br />
mainly due to the fact that the taxonomy was soon after its introduction used within<br />
seminars at the United Nations Educational, Scientific, and Cultural Organization<br />
(UNESCO) and the Organization for Economic Cooperation and Development<br />
(OECD) (Athanassiou et al., 2003, p.535). A review of literature indicates a growing<br />
awareness of the taxonomy’s potential usefulness and richness among college and<br />
university level educators (Athanassiou et al., 2003, p.537). The taxonomy can be<br />
used in developing the curriculum design process, students’ assessment process and<br />
instruction evaluation. Until recently the taxonomy has been largely used within the<br />
teaching process, Stokes (2008) documenting how authors of 24 accounting textbooks<br />
used verbs at the lower levels of the cognitive domain.<br />
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2. RESEARCH DESIGN<br />
Developing the analysis of our research project involves the use of two distinctive<br />
instruments: a questionnaire and the examination process that will further be<br />
described.<br />
In order to develop the analysis that was aimed through our study we implemented a<br />
questionnaire on a sample of accounting students. Choosing the students was done<br />
based on our intention of continuing our research in the area of accounting students’<br />
academic performance by considering the same group of students that were<br />
investigated a year ago when considering a different course (Financial Accounting).<br />
This group comprises students within a three years accounting programme of Babes-<br />
Bolyai University in Cluj-Napoca, Romania. We therefore aimed a group of 389<br />
students in their 3 rd university year, at the end of the first semester. The questionnaire<br />
was only administered to a number of 367 students that took the final exam in<br />
Controlling during the 2009 winter exam session period. We finally ended up in using<br />
a number of 316 questionnaires for this study. We eliminated those questionnaires that<br />
either were missing a significant number of filled questions (which we considered to<br />
be 10 out of a total of 29), either had no response for the last question of the<br />
questionnaire. This last question required students to self-acknowledge their grade for<br />
the Controlling final exam, which they have just been taken.<br />
The questionnaire was implemented after a 14 weeks period of educational activities<br />
comprising courses and seminars. Controlling courses and seminars were structured<br />
during the semester based on Bloom’s taxonomy. Students were required to read the<br />
materials assigned for the classes and to do not more than 3 problems or exercises per<br />
week as homework. The scope of the seminar was to check the comprehension of the<br />
material assigned to be read and to apply the theory to a specific situation. Courses<br />
were designed to exercise students’ abilities to analyze, synthesize and evaluate a<br />
given case study. The courses preceded seminars, the learning process therefore<br />
following the presented order of the taxonomy.<br />
A particularity of our study is that implementing the questionnaire was correlated with<br />
students’ actual examination through written final exam during the exam session<br />
period. Students attending the final exam in Controlling were presented with two sets<br />
of documents. Each set was het-up and comprised A4 format white paper and a cover<br />
page. The cover page presented a series of distinctive elements such as name of the<br />
course, research project, date etc. One set comprised the exam questions and its cover<br />
page included a small red square (20 cm side). The other set comprised the<br />
questionnaire and its cover page included a small blue square (20 cm side). The cover<br />
page for the exam questions required students to fill in their personal information<br />
(name) in a particular designed space, while the cover page for questionnaire did not<br />
ask for students’ name. Moreover, students were instructed that the questionnaires<br />
were anonymous in order to ensure the objectivity of their answers. Students were<br />
allocated separate time required for responding the exam questions and for filling in<br />
the questionnaire. This information was clearly explained to them after handing the<br />
two sets of documents. At the end of the allocated time, students were asked to place<br />
their questionnaires in a distinctive set that was separated from that of the exam<br />
documents.<br />
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As previously mentioned, the questionnaire was formulated in such a manner that did<br />
not allow for the identity of the respondent to be reviled. Still, in order for is to be<br />
able to develop our analysis we needed to correlate each student’s questionnaire with<br />
its corresponding exam documents, which reflected the academic performance. This<br />
had to be initially done without students’ acknowledgement with the purpose of<br />
maintaining their objectivity. That is why we posted a particular code on the cover<br />
page of students’ exam documents in a manner that would not receive students’<br />
attention. The same code was posted on the questionnaire set of documents. When<br />
distributing the two sets of documents to students, each student received the two sets<br />
bearing the same code. This allowed us to match each student’s questionnaire with the<br />
corresponding exam documents. The information obtained through the questionnaire<br />
was not used until the beginning of the next semester when students were told about<br />
the used code system and asked for their written acceptance in order for us to use the<br />
information they therefore provided within our research project. All students within<br />
our sample gave their approval in order for us to use the information they provided<br />
through the questionnaire and also their examination information for Controlling.<br />
Questions within the questionnaire were formulated in relation to a series of<br />
determinants of accounting students’ academic performance as identified through<br />
literature. The questionnaire was structured on two distinctive components. The first<br />
components comprised a number of 11 questions that had a general character. The<br />
second component comprised 18 specific questions asking students to relate to the<br />
particular Controlling course. The final question within the questionnaire asked<br />
students to self-asses their grade for the Controlling final exam they had just taken<br />
and express it in accordance to the Romanian grading system (grades ranging from 0<br />
to 10, where 10 represents the maximum possible grade). Their answers to this final<br />
question actually represented Students’ Self-Acknowledged Grade (SSAG), which we<br />
used in developing our study.<br />
As previously mentioned, Controlling courses and seminars were structured during<br />
the semester based on Bloom’s taxonomy. It was the taxonomy that also helped us<br />
structure the exam questions for the above mentioned Controlling final exam.<br />
Students’ examination process was therefore in deep correlation with the way<br />
students learned during the semester. Our arguments for using Bloom’s taxonomy<br />
refer to its structure that offers a very clear tool of testing students’ knowledge and<br />
abilities on a continuous basis, while generating clear feedback on what they have to<br />
do further in order to develop their learning process. We also consider that grounding<br />
the teaching and evaluation process on Bloom’s taxonomy gives educators a basis of<br />
comparison between the effective level being achieved during the semester and the<br />
goal of the educational system. We will further outline some main aspects related to<br />
Boom’s taxonomy.<br />
In 1956, a committee of College and University examiners published the Classification<br />
of Educational Goals under the name of Taxonomy Educational Objectives: The<br />
Classification of Educational Goals. Handbook 1. Cognitive domain. The editor of the<br />
material was Benjamin S Bloom from University of Chicago. The committee’s scope<br />
was to build a taxonomy of educational objectives, which would provide the<br />
classification of the goals for the educational systems. “It is expected to be of general<br />
help to all teachers, administrators, professional specialists, and research workers who<br />
deal with curricular and evaluation problems. It is especially intended to help them<br />
~ 867 ~
discuss these problems with greater precision” (Bloom, 1956, p.1). This is referred to<br />
as the original taxonomy. 45 years after, the taxonomy was revised. We developed our<br />
research based on the original taxonomy.<br />
The original taxonomy of educational objectives related to cognitive domain is<br />
structured on two levels: Knowledge and Intellectual abilities and skills. The first<br />
level, Knowledge, “involves the recall of specifics and universals, the recall of<br />
methods and processes, or the recall of a pattern, structure, or setting” (Bloom, 1956,<br />
p. 201).<br />
The second level, Intellectual abilities and skills, refer to organized modes of operation<br />
and generalized techniques for dealing with materials and problems (Bloom, 1956,<br />
p. 201). Materials and problems can have different natures: some of them may require<br />
special information and techniques but some may require general information, which<br />
can be assumed to be part of the individual's general fund of knowledge. This level<br />
refers to the mental process of organizing and working with the materials and<br />
problems in order to achieve a purpose. In order to be able to work with information,<br />
this level is based on 5 sub-levels:<br />
• Comprehension of material and problem; comprehension represents the lowest<br />
level of understanding. It is related with the ability of understanding what is<br />
being communicated and conveying the idea further without necessarily<br />
connecting it with other ideas or materials.<br />
• Application; this refers to the ability and skills needed to apply general rules,<br />
procedures, and methods called abstractions to a specific situation. To be<br />
applied, abstractions need to be remembered first.<br />
• Analysis, which implies to break the material and problem into parts and to<br />
analyze them separately and then in correlation with other factors. The scope of<br />
this phase is to understand how the initial material was build.<br />
• Synthesis represents the process of combining the material’s parts using a new<br />
structure, clearer than before.<br />
• Evaluation represents the process of judging the materials for a given purpose.<br />
Usually, this phase requires quantitative and qualitative judgments and very<br />
often the given purpose is not indicated by the material ad has to be identified<br />
by the evaluator.<br />
Our study assesses accounting students’ academic performance by using an evaluation<br />
grid that was structured based on the above presented taxonomy. The content of the<br />
discipline was divided into four main parts: marginal analysis, cost-volume-profit<br />
analysis, budgeting and activity based costing. We tested each part’s content based on<br />
students’ knowledge and their ability to comprehend, apply, analyze and synthesize.<br />
We used closed and open questions and also multiple choice questions therefore<br />
applying various formats of examinations, as advised within literature (Guney, 2009).<br />
Open questions approached theoretical aspects and problems whose calculation<br />
needed to be detailed by students in order to be graded. The last level within Bloom’s<br />
taxonomy was tested by using a case study where students had to reach a certain<br />
conclusion, which also had to be presented in writing and argued. The maximum<br />
grade that could be obtained (10 points) was structured by considering the taxonomy’s<br />
five levels (comprehension – 2.25 points, application – 2.25 points, analysis –<br />
2.25 points, synthesis – 2.25 points, and evaluation – 1 point).<br />
~ 868 ~
After developing the two methodological instruments that were described above we<br />
proceeded with implementing our analysis. Descriptive analysis was performed for<br />
the whole sample of students. Correlation analysis was used when considering the two<br />
reflections of students’ academic performance (students’ final grade as assessed by<br />
the educator and students’ self-acknowledged grade). Both descriptive analysis and<br />
correlation analysis was also performed on clusters in order to obtain more insights on<br />
students’ academic performance. The obtained results are presented within the<br />
following part of our paper.<br />
3. DEVELOPING THE ANALYSIS AND INTERPRETING RESULTS<br />
Based on previous mentioned methodological aspects we have further implemented<br />
the analysis aimed through the development of this study. This analysis is based on<br />
two distinctive dimensions. The first one refers to students’ academic performance<br />
and the other to a series of answers that were offered by students through the<br />
questionnaire that was implemented after their examination process through the final<br />
exam for Controlling. It was based on these answers that we developed cluster<br />
analysis, which allows us to look at students’ academic performance more coherently,<br />
and in a more detailed manner.<br />
Therefore, the answers that were provided by students through the implemented<br />
questionnaire represent the basis for our developing of seven distinctive clusters. The<br />
first cluster actually comprises our entire population of students participating in our<br />
research project that includes 316 cases (students) being observed. The following<br />
clusters are built based on a series of factors that are considered by literature as<br />
determinants of students’ academic performance and therefore were used in<br />
formulating questions within the implemented questionnaire. We will further present<br />
the factor determining each of the considered clusters. The second cluster can be<br />
called the Gender Cluster based on the fact that it groups respondents based on their<br />
gender. Results point the fact that our sample population is mainly formed out of<br />
females, representing 86% of the respondents. Another cluster considers students’<br />
previous high school characteristics, separating students that went to a high school<br />
with economic profile, therefore having previous encounters with accounting<br />
disciplines. We therefore separated students which went to a high school with<br />
economic profile from those who did not based on the answers they provided. The<br />
results being obtained based on this separation show a relative balance between the<br />
two sub-clusters.<br />
40<br />
30<br />
20<br />
10<br />
0<br />
Students' Assessed Final Grade<br />
9,50<br />
9,00<br />
8,50<br />
8,00<br />
7,50<br />
7,00<br />
6,50<br />
6,00<br />
5,50<br />
5,00<br />
4,50<br />
4,00<br />
3,50<br />
3,00<br />
2,50<br />
2,00<br />
1,50<br />
1,00<br />
,50<br />
NREALA<br />
Std. Dev = 2,20<br />
Mean = 4,93<br />
N = 316,00<br />
120<br />
100<br />
80<br />
60<br />
40<br />
~ 869 ~<br />
Students' Self-Acknowledged Grade<br />
20<br />
Std. Dev = 1,30<br />
Mean = 7,5<br />
0<br />
N = 316,00<br />
2,0 4,0 6,0 8,0 10,0<br />
3,0 5,0 7,0 9,0<br />
NSPERATA
Panel<br />
A<br />
Table 1. Students’ Academic Performance Analysis<br />
Values Percentage Cases<br />
Clusters Correlations Min Max Mean Std. Min Max Mean Std. No.<br />
Bloom Comp.<br />
Pearson 0.567** 316<br />
Spearman 0.589** 316<br />
SAFG 0.250 9.450 4.934 2.203 316<br />
SSAG 2.000 10.000 7.487 1.303 316<br />
Comprehension 0.000 2.250 1.084 0.683 0.00 0.63 0.20 0.110 316<br />
Application 0.000 2.250 1.266 0.632 0.00 1.00 0.26 0.122 316<br />
Analysis 0.000 2.250 1.306 0.690 0.00 0.75 0.25 0.113 316<br />
Synthesis 0.000 2.250 1.095 0.580 0.00 1.00 0.23 0.127 316<br />
Evaluation 0.000 1.000 0.181 0.202 0.00 0.32 0.03 0.043 316<br />
Notes: Panel A comprises the whole sample of students being analyzed; SSAG - Students’ Self-<br />
Acknowledged Grade, SAFG - Students’ Assessed Final Grade; ** Correlation is significant<br />
at the 0.01 level (2-tailed)<br />
Table 1. Students’ Academic Performance Analysis (continued)<br />
Values Percentage Cases<br />
Clusters<br />
Bloom Comp.<br />
Correlations Min Max Mean Std. Min Max Mean Std. No.<br />
Panel B<br />
Gender Pearson 0.365* 42<br />
Male Spearman 0.351* 42<br />
SAFG 0.250 8.470 3.953 2.091 42<br />
SSAG 3.000 10.000 7.238 1.494 42<br />
Comprehension 0.000 1.875 0.875 0.552 0.00 0.63 0.21 0.133 42<br />
Application 0.000 2.250 1.019 0.656 0.00 1.00 0.27 0.158 42<br />
Analysis 0.000 2.250 1.047 0.736 0.00 0.50 0.23 0.136 42<br />
Synthesis 0.000 2.070 0.842 0.482 0.00 0.71 0.23 0.153 42<br />
Evaluation 0.000 1.000 0.169 0.212 0.00 0.32 0.04 0.068 42<br />
Gender Pearson 0.608** 262<br />
Female Spearman 0.617** 262<br />
SAFG 0.250 9.450 5.132 2.211 262<br />
SSAG 4.000 10.000 7.561 1.235 262<br />
Comprehension 0.000 2.250 1.120 0.705 0.00 0.59 0.20 0.106 262<br />
Application 0.000 2.250 1.312 0.628 0.00 1.00 0.26 0.114 262<br />
Analysis 0.000 2.250 1.367 0.671 0.00 0.75 0.26 0.109 262<br />
Synthesis 0.000 2.250 1.143 0.589 0.00 1.00 0.23 0.123 262<br />
Evaluation 0.000 1.000 0.188 0.204 0.00 0.23 0.03 0.038 262<br />
Notes: Panel B groups respondents based on their gender; SSAG - Students’ Self-Acknowledged<br />
Grade, SAFG - Students’ Assessed Final Grade;<br />
*,** Correlation is significant at the 0.05, 0.01 level (2-tailed)<br />
~ 870 ~
Table 1. Students’ Academic Performance Analysis (continued)<br />
Values Percentage Cases<br />
Clusters<br />
Bloom Comp.<br />
Correlations Min Max Mean Std. Min Max Mean Std. No.<br />
Panel C<br />
Prior Pearson 0.509** 146<br />
Economic Spearman 0.408** 146<br />
High<br />
School<br />
SAFG 0.250 8.770 4.705 2.156 146<br />
SSAG 2.000 10.000 7.465 1.303 146<br />
Comprehension 0.000 2.250 1.056 0.651 0.00 0.59 0.20 0.108 146<br />
Application 0.000 2.250 1.166 0.628 0.00 1.00 0.26 0.142 146<br />
Analysis 0.000 2.250 1.276 0.709 0.00 0.61 0.26 0.120 146<br />
Synthesis 0.000 2.250 1.050 0.566 0.00 1.00 0.23 0.132 146<br />
Evaluation 0.000 0.900 0.156 0.178 0.00 0.32 0.03 0.045 146<br />
No Prior Pearson 0.616** 170<br />
Economic Spearman 0.635** 170<br />
High<br />
School<br />
SAFG 0.700 9.450 5.131 2.230 170<br />
SSAG 3.000 10.000 7.505 1.306 170<br />
Comprehension 0.000 2.250 1.109 0.710 0.00 0.63 0.20 0.113 170<br />
Application 0.000 2.250 1.351 0.625 0.00 0.67 0.26 0.101 170<br />
Analysis 0.000 2.250 1.332 0.673 0.00 0.75 0.25 0.108 170<br />
Synthesis 0.000 2.250 1.134 0.591 0.00 0.81 0.22 0.123 170<br />
Evaluation 0.000 1.000 0.203 0.219 0.00 0.23 0.04 0.041 170<br />
Panel D<br />
Notes: Panel C divides students into two categories as follows: the first category comprises students that went to<br />
a high school with economic profile previous to university, and the second comprises the other students;<br />
SSAG - Students’ Self-Acknowledged Grade, SAFG - Students’ Assessed Final Grade;<br />
** Correlation is significant at the 0.01 level (2-tailed)<br />
Table 1. Students’ Academic Performance Analysis (continued)<br />
Values Percentage Cases<br />
Clusters Correlations Min Max Mean Std. Min Max Mean Std. No.<br />
Bloom Comp.<br />
Prior Pearson 0.524** 73<br />
Professional Spearman 0.621** 73<br />
Experience SAFG 0.700 9.450 5.274 2.047 73<br />
SSAG 2.000 10.000 7.863 1.283 73<br />
Comprehension 0.000 2.250 1.117 0.605 0.00 0.42 0.20 0.090 73<br />
Application 0.250 2.250 1.379 0.589 0.00 0.62 0.27 0.104 73<br />
Analysis 0.000 2.250 1.408 0.647 0.00 0.50 0.26 0.096 73<br />
Synthesis 0.000 2.250 1.177 0.559 0.00 0.56 0.22 0.091 73<br />
Evaluation 0.000 1.000 0.191 0.217 0.00 0.14 0.03 0.034 73<br />
No Prior Pearson 0.573** 243<br />
Professional Spearman 0.578** 243<br />
Experience SAFG 0.250 9.225 4.832 2.241 243<br />
SSAG 3.000 10.000 7.374 1.290 243<br />
Comprehension 0.000 2.250 1.074 0.705 0.00 0.63 0.20 0.116 243<br />
Application 0.000 2.250 1.231 0.641 0.00 1.00 0.26 0.127 243<br />
Analysis 0.000 2.250 1.276 0.700 0.00 0.75 0.25 0.118 243<br />
Synthesis 0.000 2.250 1.070 0.585 0.00 1.00 0.23 0.136 243<br />
Evaluation 0.000 1.000 0.178 0.198 0.00 0.32 0.03 0.045 243<br />
Notes: Panel D considers weather students have previous working experience in the field of accounting; SSAG -<br />
Students’ Self-Acknowledged Grade, SAFG - Students’ Assessed Final Grade; ** Correlation is<br />
significant at the 0.01 level (2-tailed)<br />
~ 871 ~
Table 1. Students’ Academic Performance Analysis (continued)<br />
Values Percentage Cases<br />
Clusters<br />
Bloom Comp.<br />
Correlations Min Max Mean Std. Min Max Mean Std. No.<br />
Panel E<br />
No Future Pearson -0.030 32<br />
Professional Spearman 0.018 32<br />
Accounting SAFG 0.250 7.970 3.342 1.736 32<br />
Activity SSAG 5.000 10.000 6.906 1.201 32<br />
Comprehension 0.000 1.875 0.712 0.600 0.00 0.63 0.19 0.151 32<br />
Application 0.000 1.950 0.885 0.577 0.00 1.00 0.28 0.188 32<br />
Analysis 0.000 2.075 0.820 0.563 0.00 0.61 0.23 0.141 32<br />
Synthesis 0.000 2.070 0.820 0.493 0.00 0.51 0.25 0.131 32<br />
Evaluation 0.000 0.300 0.103 0.112 0.00 0.14 0.03 0.039 32<br />
Future Pearson 0.600** 284<br />
Professional Spearman 0.616** 284<br />
Accounting SAFG 0.250 9.450 5.114 2.180 284<br />
Activity SSAG 2.000 10.000 7.552 1.299 284<br />
Comprehension 0.000 2.250 1.126 0.680 0.00 0.59 0.20 0.105 284<br />
Application 0.000 2.250 1.308 0.624 0.00 1.00 0.26 0.112 284<br />
Analysis 0.000 2.250 1.361 0.682 0.00 0.75 0.26 0.110 284<br />
Synthesis 0.000 2.250 1.12 0.582 0.00 1.00 0.22 0.127 284<br />
Evaluation 0.000 1.000 0.190 0.209 0.00 0.32 0.03 0.043 284<br />
Notes: Panel E groups students based on their intention of pursuing a future career in the field of<br />
accounting after graduation; SSAG - Students’ Self-Acknowledged Grade, SAFG - Students’<br />
Assessed Final Grade; ** Correlation is significant at the 0.01 level (2-tailed)<br />
Table 1. Students’ Academic Performance Analysis (continued)<br />
Values Percentage Cases<br />
Clusters<br />
Bloom Comp.<br />
Correlations Min Max Mean Std. Min Max Mean Std. No.<br />
Panel F<br />
Personal Pearson 0.544** 257<br />
Option Spearman 0.584** 257<br />
for<br />
SAFG 0.250 9.450 5.157 2.167 257<br />
Accounting<br />
Specialization SSAG 2.000 10.000 7.622 1.253 257<br />
Comprehension 0.000 2.250 1.145 0.670 0.00 0.59 0.21 0.105 257<br />
Application 0.000 2.250 1.312 0.623 0.00 1.00 0.26 0.114 257<br />
Analysis 0.000 2.250 1.388 0.662 0.00 0.75 0.26 0.111 257<br />
Synthesis 0.000 2.250 1.118 0.586 0.00 0.59 0.21 0.108 257<br />
Evaluation 0.000 1.000 0.191 0.213 0.00 0.32 0.03 0.044 257<br />
No Personal Pearson 0.542** 51<br />
Option Spearman 0.584** 51<br />
for<br />
Accounting<br />
SAFG 0.625 8.820 4.122 1.987 51<br />
Specialization SSAG 3.000 10.000 6.862 1.280 51<br />
Comprehension 0.000 2.050 0.864 0.665 0.00 0.63 0.19 0.131 51<br />
Application 0.000 2.250 1.131 0.598 0.00 0.76 0.28 0.151 51<br />
Analysis 0.000 2.250 0.989 0.703 0.00 0.42 0.21 0.109 51<br />
Synthesis 0.000 2.070 1.005 0.546 0.00 0.71 0.26 0.138 51<br />
Evaluation 0.000 0.400 0.131 0.110 0.00 0.11 0.03 0.030 51<br />
Notes: Panel F considers weather students are part of the accounting specialization as a result of their own<br />
choice or as a consequence of other determinant factors (the influence of their environment or the result<br />
of the faculty distribution process); SSAG - Students’ Self-Acknowledged Grade, SAFG - Students’<br />
Assessed Final Grade; ** Correlation is significant at the 0.01 level (2-tailed)<br />
~ 872 ~
Table 1. Students’ Academic Performance Analysis (continued)<br />
Values Percentage Cases<br />
Clusters<br />
Bloom Comp.<br />
Correlations Min Max Mean Std. Min Max Mean Std. No.<br />
Panel G<br />
Negative Pearson 0.035 29<br />
Attitude Spearman 0.044 29<br />
for<br />
SAFG 0.250 6.875 2.965 1.475 29<br />
Accounting<br />
Specialization SSAG 4.000 10.000 6.931 1.412 29<br />
Comprehension 0.000 1.725 0.527 0.519 0.00 0.37 0.15 0.118 29<br />
Application 0.250 1.950 0.793 0.488 0.11 1.00 0.29 0.174 29<br />
Analysis 0.000 2.000 0.822 0.593 0.00 0.67 0.26 0.176 29<br />
Synthesis 0.000 1.525 0.704 0.479 0.00 0.56 0.24 0.165 29<br />
Evaluation 0.000 0.500 0.117 0.158 0.00 0.27 0.04 0.068 29<br />
Positive Pearson 0.599** 287<br />
Attitude Spearman 0.614** 287<br />
for<br />
Accounting<br />
SAFG 0.250 9.450 5.133 2.168 287<br />
Specialization SSAG 2.000 10.000 7.543 1.28 287<br />
Comprehension 0.000 2.250 1.141 0.673 0.00 0.63 0.21 0.108 287<br />
Application 0.000 2.250 1.313 0.626 0.00 1.00 0.26 0.115 287<br />
Analysis 0.000 2.250 1.355 0.681 0.00 0.75 0.25 0.106 287<br />
Synthesis 0.000 2.250 1.135 0.575 0.00 1.00 0.22 0.123 287<br />
Evaluation 0.000 1.000 0.188 0.206 0.00 0.32 0.03 0.040 287<br />
Notes: Panel G considers students’ grouping into two categories based on their satisfaction degree related to the<br />
accounting specialization they are part of;<br />
SSAG - Students’ Self-Acknowledged Grade, SAFG - Students’ Assessed Final Grade;<br />
** Correlation is significant at the 0.01 level (2-tailed)<br />
Another aspect that was analyzed through one of our questionnaire’s components is<br />
weather students already have some previous working experience in the field of<br />
accounting. Two sub-clusters have therefore been created, the first comprising<br />
students with previous working experience in the field of accounting. This time results<br />
show a major unbalance, the number of students having no previous working<br />
experience in the field of accounting being significantly higher. Considering the same<br />
topic of accounting practice, students were also asked weather they intend to develop<br />
a career in the field of accounting after graduating. This time almost 90% of our<br />
respondents declared they have this intention for their future development.<br />
The following two clusters refer to students’ attitude towards the accounting<br />
specialization to which they currently belong. The first cluster looks at how students<br />
became part of the accounting specialization and separates those students who became<br />
accounting students as a result of their own wishing, as opposed to those who were<br />
determined by their close company or even “victims” of the faculty distribution<br />
process. We can notice that 257 students out of the total 316, meaning 83.44% of<br />
them declared to have chosen the accounting specialization based on their own<br />
wishing. Our last cluster looks at students’ satisfaction related to the accounting<br />
specialization at the moment of the questionnaire’s implementation. Results show that<br />
those declaring to be unsatisfied with the accounting specialization they currently<br />
belong to only represent 9.71%. This value is lower than that representing students<br />
who did not initially wish to become accounting students (16.56%), pointing that<br />
some of the students have come to be satisfied with the accounting specialization even<br />
~ 873 ~
if this was not their first option when faced with choosing their future specialization,<br />
as they were in the past.<br />
We should also mention the fact that out of the total 367 questionnaires that were<br />
implemented we only ended up using 316. This was due to some questionnaires being<br />
incompletely filled and eliminated from the analysis, as explained within the research<br />
design part of the paper. Moreover, as Table 1 shows, the number of cases being<br />
analyzed when considering different clusters might also differ from the total number<br />
of questionnaires finally being kept for analysis within the study. We refer here to<br />
clusters comprising less than the 316 students due to eliminating those students who<br />
did not answer the question that actually represented the factor that helped us establish<br />
a certain cluster. For example, 12 students forgot to mention their gender when<br />
answering the questionnaire. As a consequence, Panel B only comprises a number of<br />
304 students.<br />
Moving forward, another aspect that should be discussed is students’ academic<br />
performance. We have appealed within our study to using two distinctive instruments<br />
in order to measure academic success or performance. One on hand we used students’<br />
final grade as assessed by the educator (the SAFG variable) and on the other their<br />
self-acknowledged grade (the SSAG variable). We meanwhile consider that both<br />
instruments being used in measuring students’ academic performance actually<br />
represent two distinctive perceptions upon the same reality. Therefore, the main<br />
objective of our study would be to question and analyze these two perceptions on the<br />
evaluation process while also making use of Bloom’s taxonomy. The obtained results<br />
are interpreted in correlation and based on variables obtained through the<br />
implemented questionnaire.<br />
A first step of our study would be to analyze the correlation degree between the two<br />
grades used in measuring accounting students’ academic performance while also<br />
considering cluster analysis. We furthermore analyzed the manner in which students’<br />
final grades as assessed by the educator were formed when considering the levels of<br />
Bloom’s taxonomy. We therefore calculated the Percentage representing the weight<br />
of each level of Bloom’s taxonomy in generating students’ final grade (SAFG).<br />
We might say that some of the obtained results are unexpected and reflect<br />
particularities of the analyzed environment. First, when referring to the whole group<br />
of students being analyzed (Panel A) we maybe expected a high level of students’<br />
subjectivity in assessing their self-acknowledged grade to make it difficult to establish<br />
a correlation between their assessment (SSAG) and that of the educator (SAFG).<br />
Obtained results document that such a correlation exists and records a medium level.<br />
The analyzed correlation could not be documented for the group of students that were<br />
not planning on pursuing a future career in the field of accounting (Panel E) and also<br />
for the group of students that presented a negative attitude towards the accounting<br />
specialization as being unsatisfied with it (Panel G). When looking at the graph that<br />
reflects grades’ distribution for the two considered measurement instruments of<br />
accounting students’ academic performance (SAFG and SSAG) we can conclude that<br />
students’ expectations for their grades as based on their self-acknowledgement is<br />
higher in comparison to the actual grade being granted by the educator. This for sure<br />
we kind of expected as a result of the comparison. When considering students’ final<br />
grades as assessed by the educator our sample records a mean grade of 4.93, while the<br />
mean for students’ self-acknowledged grades is 7.50. We consider the difference<br />
~ 874 ~
etween the two calculated means to be significant since the evaluation process<br />
measures grades on a scale from 0 to 10. The obtained results therefore identify a<br />
significant need for educators to work on improving students’ ability to acknowledge<br />
their own academic performance.<br />
When analyzing students’ final grades as assessed by the educator we notice that<br />
neither one of the students received the maximum grade (10). Meanwhile, 12 students<br />
responded they were expecting to obtain a 10, as mention through their selfacknowledged<br />
grade. The highest grade being granted by the educator was 9.45 and<br />
belonged to a female student. Cluster analysis points the fact that the highest grade<br />
being granted by the educator to a male student was 8.47, with almost 1 point lower.<br />
As also documented within literature, the presence of gender differences with respect<br />
to performance may have implications on students’ career choices, course enrolment,<br />
and the use of knowledge, etc (Guney, 2009). While accepting the fact that gender can<br />
affect the degree of motivation and thus performance, various studies considering this<br />
variable generated mixed evidence. Some studies cannot detect any meaningful<br />
relation between gender and accounting performance (Gammie et al., 2003a; Jackling<br />
and Anderson, 1998). Tho (1994), reports that female students outperform male<br />
students in accounting, as they are believed to have higher work needs. De Lange and<br />
Mavondo (2004) also show that gender may induce different learning strategies for<br />
female and male students which can affect their academic performance.<br />
One of the results that contradict our expectations refers to the fact that the maximum<br />
grade obtained by students having no previous economic background is higher than<br />
that of students who went to a high school with economic profile. This is also true<br />
when considering the two groups’ mean grade for both SAFG and SSAG. Moreover,<br />
the mean final grade as assessed by the educator when considering the group of<br />
students who went to a high school with economic profile (4.705) is beneath the grade<br />
required for passing an exam in accordance to the Romanian grading system (5). This<br />
once again raises some question marks. Under these circumstances we consider we<br />
should analyze to what extent are the high school and university education systems<br />
correlated and is the first one less efficient than the latter so that it affects students’<br />
academic performance? Of course that another explanation could lay in the fact that<br />
maybe students having no previous economic knowledge work and study harder than<br />
those who already do (Panel C).<br />
Students who already have some working experience in the field of accounting seem<br />
to outperform those who don’t (Panel D). This can be an indicator of the importance<br />
of accounting students’ involvement in practice. This is also the case when analyzing<br />
students’ cluster based on their choosing of the accounting specialization and pursuing<br />
of a future accounting career. Therefore, those becoming accounting students as a<br />
result of their own wish outperform those influenced by other factors (Panel F) and<br />
students’ pursuing a future accounting career outperform those who don’t (Panel E).<br />
Results also document the fact that students that are unsatisfied with them being a part<br />
of the accounting specialization record lower chances of passing the exam (Panel G).<br />
Another dimension of our study focuses on analyzing how students’ final grades as<br />
assessed by the educator are being constructed based on the levels within Bloom’s<br />
taxonomy. When analyzing the whole sample of 316 students, results show that<br />
students obtain higher points based on analysis (Panel A). Students’ seem to receive<br />
few points when it comes to comprehension and evaluation. If we were expecting<br />
students to do worst on the evaluation level questions, them having difficulties on the<br />
~ 875 ~
comprehension level questions was unexpected. As an overall conclusion, students<br />
earn their grade based on the first four levels in Bloom’s taxonomy, evaluation<br />
problems’ solving being less accessible for them.<br />
When considering gender clusters we notice that male students base their grade<br />
mostly on questions belonging to the application level while female students equally<br />
rely on questions belonging to the application and analysis levels (Panel B). These<br />
results proving that female students find it easier to reach the analysis level questions<br />
are consistent with them outperforming male students.<br />
Students who went to high schools with an economic profile seem to rely on<br />
application and analysis also, while students with no economic background prefer the<br />
application level question (Panel C). These is no longer consistent with the later<br />
outperforming the former.<br />
Previous working experience in the field of accounting doesn’t seem to differentiate<br />
students when it comes to forming their grade, questions belonging to the application<br />
level being preferred by both students who have it and those who don’t (Panel D).<br />
This is also the case when considering students’ satisfaction related to the accounting<br />
specialization (Panel G).<br />
Some differences are also found when considering students’ intention of developing<br />
future careers in the field of accounting and their status of accounting students. More<br />
precisely, students planning on pursuing an accounting career and those who became<br />
accounting students as a result of their own desire equally rely on questions belonging<br />
to the application and analysis levels (Panel E and F). Meanwhile, students who do<br />
not plan on pursuing an accounting career and those who became accounting students<br />
due to other factors than their own desire mostly rely on questions belonging to the<br />
application level (Panel E and F).<br />
Overall, the obtained results show that students mostly base their final grade in<br />
Controlling on questions belonging to the application and analysis levels, while<br />
evaluation questions are rarely correctly solved. The mean percentage recorded for the<br />
evaluation level is only 3%, while the maximum points that could be obtained on this<br />
level represent 10% out of the total final grade.<br />
CONCLUDING REMARKS<br />
We will further synthesize the main findings of our study while also identifying some<br />
research perspectives.<br />
Results being obtained when comparing students’ self-acknowledged grades with<br />
those assessed by the educator, even though correlated, represent an indicator showing<br />
that further work could be done in order to enhance students’ ability to better assess<br />
their real academic performance. This of course is based on the consideration that<br />
grades being assessed by the educator, which are not considered to represent the<br />
supreme truth either, should be less biased than those self-acknowledged by students<br />
who for sure tend to be subjective. Developing students’ ability to better assess their<br />
accounting knowledge as well as abilities and skills might be helpful for them when<br />
searching for a job that optimizes their characteristics and expectations.<br />
~ 876 ~
Cluster analysis being performed within the previous part of the paper was also<br />
interpreted by reference to findings of studies dealing with similar aspects. Some<br />
question marks are raised upon the Romanian high school education system in the<br />
case of economic profile high schools since results document that students with no<br />
economic background seem to outperform those who went to a high school with<br />
economic profile.<br />
Our paper proposes the use of Bloom’s taxonomy in order to asses accounting<br />
students’ academic performance. Since the taxonomy is supposed to provide the<br />
classification of the goals for the educational systems it would only be natural for us<br />
to also use it when assessing the results of the educational process. When analyzing<br />
how students’ final grades as assessed by the educator are being constructed based on<br />
the levels within Bloom’s taxonomy an unexpected situation is documented, students’<br />
actually receiving lower points for the comprehension level questions than for the<br />
application, analysis and synthesis level questions. Since comprehension represents<br />
the lowest level of understanding, the determinants of the obtained results should be<br />
further investigated. Overall, questions belonging to the application and analysis<br />
levels seem to be preferred by students when analyzing their percentage within the<br />
final assessed grade in Controlling, while evaluation questions are rarely correctly<br />
solved.<br />
We once again relate to Stahl and Harell’s (1981) within-persons decision modeling<br />
approach, which we consider, emphasizes the importance of students’ examination<br />
process. Examination performance as assessed by the educator is considered to be a<br />
relevant reflection of students’ academic performance and used by the majority of<br />
studies within research literature. This represents an argument for its consideration<br />
and analysis aiming for the improvement of students’ examination process. On the<br />
other hand, students’ self-acknowledged performance may motivate students’<br />
behavior. Considering the fact that there must be a fair representation of students’<br />
academic performance, the relationship between students’ and educators’ perceptions<br />
on academic performance should also be considered.<br />
ACKNOWLEDGEMENTS<br />
Authors would like to acknowledge the participants to the Audit and Accounting<br />
Convergence 2009 Annual Convention for their helpful comments and suggestions.<br />
Special thanks go to our colleague Vasile Cardos for his inspiring ideas that helped us<br />
develop this paper. This work was supported by CNCSIS–UEFISCSU, project<br />
number PNII – IDEI 2476/2008, “Study regarding the development process of the<br />
Romanian educational accounting system toward a global economic environment”.<br />
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~ 879 ~
PERCEPTION OF THE ROMANIAN ACCOUNTANTS<br />
REGARDING THE FINANCIAL ACCOUNTING<br />
EDUCATION<br />
Paul DIACONU 1 , Vasile GORGAN,<br />
Catalina GORGAN & Nicoleta COMAN<br />
Bucharest Academy of Economic Studies, Romania<br />
Codrina SANDRU<br />
University of Transilvania Brasov, Romania<br />
ABSTRACT<br />
In the past twenty years the Romanian economy has undergone profound transformations.<br />
The fall of communism in December 1989 followed by the transition to a market economy has<br />
produced a series of major changes in the economic, political and social environment.<br />
Accounting higher education has faced constant need to adapt to frequent changes in recent<br />
years accounting system and the whole higher education system was reorganized in<br />
accordance with the Treaty of Bologna. On the other hand there are worldwide studies that<br />
confirm the differences between what is expected of a professional accountant and what he<br />
acquired during university studies. Given that, our empirical study aims to outline the<br />
perception of professional accountants on the Romanian accounting educational system. In<br />
this approach, we tried to capture the relationship between theoretical and practical<br />
knowledge in terms of importance assigned to each category by professional accountants, to<br />
establish the role that the accounting professional bodies play in permanent training and<br />
creating a hierarchy of skills required for professional accountants by IES 2 (International<br />
Education Standard -Content of professional accounting education programs) from the<br />
perspective of the accounting professionals from Romania.<br />
.<br />
KEYWORDS: Professional education, higher education accounting, professional<br />
accounting bodies<br />
INTRODUCTION<br />
The fall of communism in December 1989, followed by transition to a market<br />
economy has produced a series of changes in accounting in Romania. The French<br />
accounting model served initially as a model of inspiration for the Romanian<br />
accounting system. Between 1990 and 1993 the French accounting system was taught<br />
in Romanian universities. In this time the Romanian accounting system consists of a<br />
combination of soviet accounting and an accounting system of French inspiration<br />
(Albu, Alexander, & Albu, 2010).<br />
Accounting model applied as of 1 January 2004 was a French-inspired one although<br />
traces of the communist accounting model seemed to continue to manifest (Feleaga,<br />
1999). Analyzing the conditions under which an accounting system can change,<br />
1<br />
Correspondence address: Paul DIACONU, Bucharest Academy of Economic Studies, Romania;<br />
email: pauldiaconu74@yahoo.com<br />
~ 880 ~
Nobes and Parker (2008) argue that neither country has completely broken with the<br />
past and the influences left from the pre-communist and communist period.<br />
Following the conditions imposed by the World Bank in the late 90’s, Romanian<br />
accounting system focuses on international accounting standards while not forgetting<br />
about European Directives. OMFP (Order of the Ministry of Public Finance) no.<br />
94/2001 was issued for the harmonization with the European Directives and<br />
International Accounting Standards. Jermakowicz and Górnik-Tomaszewski (2006)<br />
deemed that the implementation of international accounting standards might affect a<br />
country's reputation, transforming it into a "modern business environment, organized<br />
and well regulated, especially in ex-communist countries that have gone through<br />
several reforms.<br />
Later, as Romania moved towards becoming a member of the European Union OMFP<br />
no. 1752 was issued in 2005 for the enactment of the 4th and 7th European Directives.<br />
This was replaced with OMFP no. 3055 in 2009.<br />
Accounting higher education in Romania has been influenced by the changes of the<br />
Romanian economy, suffering a continuous process of adjusting to economic<br />
conditions, often being a step ahead.<br />
On the other hand, since 1993 Romania has made major steps towards the European<br />
Higher Education Area by reorganizing the entire higher education system (MECT,<br />
2005). The new legislation of June 2004 (law no. 288/2004) stipulates the<br />
reorganization of university studies in three cycles (Bachelor, Master, and Doctoral).<br />
Starting with the academic year 2005-2006, Romanian higher education is structured<br />
as follows:<br />
• First cycle (180-240 ECTS) – Bachelor degree;<br />
• Second cycle (90-120 ECTS, exceptionally 60 ECTS) – Master degree;<br />
• Third cycle (3 years and in special situations 4 or 5 years) - Doctoral degree.<br />
As Romania became member of EU starting with 2007, the transition has brought a<br />
number of important changes in the higher education system, the reform being<br />
accelerated.<br />
Over time there have been signals sent to higher education regarding its capability to<br />
meet the requirements of the accounting labor market.<br />
The Bedford Report of the American Accounting Association states: “there is little<br />
doubt that the current content of professional accounting education, which has<br />
remained substantially the same over the past fifty years, is generally inadequate for<br />
the future accounting professional. A growing gap exists between what accountants<br />
do and what accounting educators teach” (American Accounting Association, 1986).<br />
Cheng Kai-Wen (2007) assess that: under the influence of globalization and the<br />
ongoing expansion of technology, many scholars believe that there is an obvious<br />
discrepancy of expectation between the providers of accounting education (i.e.<br />
teachers and students) and the demanders of that education (i.e. accounting firms and<br />
business enterprises).<br />
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Likewise Tanyel, Mitchell, & McAlum (1999) conducted a quantitative study<br />
involving 129 faculty and 151 potential employers of economic studies graduates.<br />
They investigated the perceptions of the attributes required by an employer from a<br />
fresh graduate at the start of his career.<br />
The most important characteristics nominated by the employers were interpersonal<br />
skills, ethics and graduate accountability. Faculties on the other hand nominated the<br />
following: interpersonal relations at the same level with ethics, the second nominee,<br />
followed by attitude accountability and managerial skills. In turn, Baker & McGregor<br />
(2000) conducted a study on the importance of accounting student characteristics in<br />
the employment process. The report concluded that the most important group of<br />
features is the one that regards candidate's personal honesty.<br />
Lowry & Yap (1997) conducted a study on the usefulness of skills acquired in school<br />
learning process by management accountants. General knowledge skills were<br />
classified as having a very high priority, and in their communication skills were rated<br />
as most important.<br />
Teaching process involves two categories of actors, teachers on one hand and students<br />
on the other, adequate preparation of the latter activity not solely depending on<br />
activity of the first category. Tanner, Totaro şi Wilson (1998) conducted a study on<br />
the perception of students' abilities and motivation. Study results show that teachers<br />
are dissatisfied with students oral and writing communication skills, no sign of<br />
improvement being noticed in the last ten years.<br />
Howieson examines the skills required of professional accountants in the context of<br />
existing trends in business environment at the beginning of the 21 st century, and their<br />
implications for accounting education. One of the conclusions states that the objective<br />
of preparing students for ongoing training cannot be limited to university level.<br />
Predictions concerning the rapid change in knowledge and technology, as well as<br />
practitioners desire to improve their career, suggest that continuous training is another<br />
area where the activity will become more significant than it is now. Universities may<br />
be able to position themselves as high quality training 2.offerer but they will have to<br />
face competition from employers and professional associations.<br />
Our study addressed the majority of financial and accounting professionals of the<br />
accounting professional bodies from Romania: CECCAR (The Body of Expert and<br />
Licensed Accountants of Romania), CAFR (Chamber of Financial Auditors of<br />
Romania), CCF (Chamber of tax consultants) and ANEVAR (National Association of<br />
Romania Evaluators), seeking to capture both their perceptions about the current<br />
system of access to the profession and issues related to learning and lifelong selection.<br />
seeking to capture both their perceptions about the current system of access to the<br />
profession and issues related to training throughout life.<br />
The objectives of our research are the following:<br />
• Establishing the relationship between theoretical and practical knowledge in<br />
terms of importance assigned to each category by professional accountants<br />
• Establishing the role of professional bodies in the financial accounting training<br />
throughout life<br />
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• The creation of a hierarchy of skills required by IES 2 (International Education<br />
Standard-Content of professional accounting. Education programs) for the<br />
accounting professionals, from the perspective of the professional accountant<br />
in Romania.<br />
1. RESEARCH METHODOLOGY<br />
The data gathering process involved an online questionnaire with closed and open<br />
questions. Most of the questions were closed or fixed-choice response. The<br />
questionnaire structure followed the research objectives. The questionnaire was sent<br />
to a number of 1435 members of professional organizations (CFAR, CCF, ANEVAR,<br />
and CAFR) whose email addresses were extracted from the official websites<br />
of the organizations mentioned above. A total of 78 responses were received in<br />
October 2010.<br />
The sample structure by age and by level of academic education is as it follows<br />
Table 1. Sample structure by age<br />
Age Percent<br />
25-35 years 25,64%<br />
35-45 years 34,62%<br />
45-55 years 25,64%<br />
Above 55 years 14,10%<br />
Table 2. Sample structure by education<br />
Academic education level Percent<br />
Bachelor degree 37,18%<br />
Master degree 41,03%<br />
Doctoral degree 21,79%<br />
The questionnaire was organized into four sections which :<br />
a. Statistical positioning of the interviewed<br />
b. The importance assigned by accounting professionals to theoretical and<br />
practical activities<br />
c. The role of the accounting professional bodies (CAFR, CECCAR,<br />
ANEVAR, CCF) in professional training<br />
d. The hierarchy of skill acquired through educational process in universities<br />
The first category of questions allow the positioning of the respondents according to<br />
age and academic training. Given the relatively heterogeneous population covered by<br />
the study, we divide it after the main descriptors of the respective populations: age<br />
and academic education. Depending on this we can establish the level of academic<br />
education and age of respondents and will be able to make our opinion on the level of<br />
awareness of issues by those interviewed.<br />
The second section of questions tries to identify the perception of accounting<br />
professional on the theoretical and practical training in relation to the demands of<br />
employers on the accounting labour market.<br />
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The third category of questions tries to outline the perception of the interviewed on<br />
the transition from academic education to education offered by professional bodies,<br />
the way these two broad categories of professional trainers interact (through the<br />
perception of members of professional bodies), and to assess the need of evaluation<br />
and control of the educational process.<br />
The last category of questions tries to assess importance of discipline recommended<br />
by the IES educational standards issued by IFAC in the activity of accounting<br />
professionals.<br />
A five points semantic differential scale was used for most of the questions to assess<br />
the opinion of those interviewed. Values between 1 and 5 in correspondence with the<br />
importance stated by the respondents were assigned to the responses (5-important,<br />
1-not important).<br />
To determine the hierarchy of skills a weighted average was calculated based on the<br />
scores obtained by each skill, the resulting average being used to rank the skills.<br />
We applied Chi-square procedure to test the significant difference between groups<br />
using as differentiation criteria the age of the interviewed and their level of academic<br />
education. Data processing was performed with Microsoft Excel spreadsheet and<br />
XLSTAT add in.<br />
2. RESEARCH RESULTS<br />
2.1 The importance assigned by accounting professionals to theoretical<br />
and practical activities<br />
.<br />
In order to assess the importance assigned by accounting professionals to theoretical<br />
knowledge acquired during university studies on one hand and solid practical skills<br />
acquired through practical work experience on the other hand, respondents were asked<br />
to give scores on a scale of 1 to 5 according to their importance (1 not important,<br />
5 important). The distribution of responses is shown below:<br />
Table 3 The importance assigned by accounting professionals to theoretical<br />
and practical activities (response distribution)<br />
Theoretical knowledge<br />
acquired during university<br />
studies<br />
Solid practical skills<br />
acquired through practical<br />
work experience<br />
not important important<br />
1 2 3 4 5<br />
2 (2,56%) 8 (10,26%) 15 (19,23%) 19 (24,36%) 34 (43,59%)<br />
0 (0,00%) 0 (0,00%) 5 (6,41%) 15 (19,23%) 58 (74,36%)<br />
By analyzing the frequency series we can conclude that accounting professionals find<br />
theoretical knowledge acquired during university studies important, but to a lesser<br />
extent than solid practical skills acquired through practical work experience. This<br />
could confirm what some of studies cited above, namely that “there is an obvious<br />
discrepancy of expectation between the providers of accounting education and the<br />
~ 884 ~
demanders of that education” (American Accounting Association, 1986) (Cheng,<br />
2007). In what follows we try to detect if there is any link between the age and level<br />
of academic education on one hand and the way they appreciate the theoretical<br />
knowledge acquired during university studies and practical skills acquired through<br />
practical work experience on the other hand. To do that we use chi-square analysis to<br />
test some hypothesis.<br />
Hypothesis 1<br />
There is a link between the age of the interviewed persons and the importance level<br />
they attaches to the theoretical knowledge acquired in school.<br />
H0: There is no association relation.<br />
Ha: There is an association relation<br />
Given the small sample size the recoding of variable was required. To safely use the<br />
Chi-square test based on the Chi-square approximation, a maximum of 20% of the<br />
cells of the contingency table should have values lower than 5 (number of cases). To<br />
overcome this limitation we arbitrarily grouped scores lower than 3 and those greater<br />
than 3. We also regrouped ages categories obtaining two of four: 25-45 years and<br />
45-65 years. The effect of the re-codification is the occurrence of the possibility that<br />
certain correlations existing between subgroups might have been lost.<br />
Table 4. Chi-square results for Hypothesis 1<br />
Chi-square (Observed value) 6,685<br />
Chi-square (Critical value) 5,991<br />
DF 2<br />
p-value 0,035<br />
alpha 0,05<br />
As the computed p-value is lower than the significance level alpha=0,05, one should<br />
reject the null hypothesis H0, and accept the alternative hypothesis Ha.<br />
The risk to reject the null hypothesis H0 while it is true is lower than 3,54%.<br />
Hypothesis 2<br />
There is a link between the academic education level of respondents (bachelor degree,<br />
master degree, doctoral degree) and the importance level they attaches to the<br />
theoretical knowledge acquired in school<br />
H0: There is no association relation.<br />
Ha: There is an association relation<br />
Because of the restrictions imposed by the Chi-square contingency table, scores lower<br />
than 3 and greater than 3 were grouped. The chi-square results are listed below:<br />
~ 885 ~
Table 5. Chi-square results for Hypothesis 2<br />
Chi-square (Observed value) 7,768<br />
Chi-square (Critical value) 9,488<br />
DF 4<br />
p-value 0,100<br />
alpha 0,05<br />
As the computed p-value is greater than the significance level alpha=0,05, one cannot<br />
reject the null hypothesis H0. The conclusion is that there is a link between the<br />
education level of respondents (bachelor, master, doctorate) and the importance level<br />
they attaches to the theoretical knowledge acquired in school.<br />
Hypothesis 3<br />
There is a link between the age of the interviewed and the importance level they<br />
attaches to the solid practical skills acquired through practical work experience<br />
H0: There is no association relation.<br />
Ha: There is an association relation<br />
The results of chi-square test applied on the distribution of responses associated with<br />
scores 3,4 and 5, because the number of responses for scores 1 and 2 is zero, is shown<br />
below:<br />
Table 6. Chi-square results for Hypothesis 3<br />
Chi-square (Observed value) 1,114<br />
Chi-square (Critical value) 5,991<br />
DF 2<br />
p-value 0,573<br />
alpha 0,05<br />
As the computed p-value is greater than the significance level alpha=0,05, one cannot<br />
reject the null hypothesis H0. The conclusion is that there is no link between the age<br />
of the interviewed and the importance level they attaches to the solid practical skills<br />
acquired through practical work experience<br />
Hypothesis 4<br />
There is a link between the academic education level of the interviewed and the<br />
importance level they attaches to the solid practical skills acquired through practical<br />
work experience<br />
H0: There is no association relation.<br />
Ha: There is an association relation<br />
~ 886 ~
The results of chi-square test applied on the response distribution of associated with<br />
scores 3,4 and 5, because the number of responses for scores 1 and 2 is zero, is shown<br />
below:<br />
Table 7. Chi-square results for Hypothesis 4<br />
Chi-square (Observed value) 1,103<br />
Chi-square (Critical value) 5,991<br />
DF 2<br />
p-value 0,576<br />
alpha 0,05<br />
As the computed p-value is greater than the significance level alpha=0,05, one cannot<br />
reject the null hypothesis H0. The conclusion is that there is no link between academic<br />
education level of the interviewed and the importance level they attaches to the solid<br />
practical skills acquired through practical work experience<br />
2.2 The role of the accounting professional bodies (CAFR, CECCAR, ANEVAR,<br />
CCF) in professional training<br />
To assess the opinion of the interviewed on The role of the accounting professional<br />
bodies (CAFR, CECCAR, ANEVAR, CCF) in professional training, we asked them<br />
to give their views on the Romanian university system's ability to meet the needs of<br />
accounting professionals who tries to get access to the Romanian qualified labour<br />
market. Responses to questions are summarized in the table below.<br />
Table 8. The response distribution to questions used to assess the role<br />
of role of the accounting professional bodies<br />
Question<br />
Do you find the current three year bachelor degree<br />
cycle adequate for young graduates to satisfy the<br />
demands of labour market from Romania and<br />
European Union?<br />
Do you find the graduation of a two year master,<br />
which contains the disciplines required to gain access<br />
to profession, adequate to offer access to training<br />
stage for auditor, chartered accountant or tax<br />
consultant?<br />
Do you think that there is a need for a mechanism to<br />
monitor the education process of universities masters<br />
in order to offer access to training stage of<br />
professional bodies without an admission exam?<br />
Do you consider necessary an institutional dialogue<br />
mechanism between existing professional bodies and<br />
the Romanian higher education system for monitoring<br />
educational curricula of faculties ?<br />
Do you find the current training programs conducted<br />
by professional bodies useful?<br />
~ 887 ~<br />
Number of<br />
responses<br />
Yes No<br />
%<br />
Number of<br />
responses<br />
%<br />
25 32% 53 68%<br />
44 56% 34 44%<br />
59 76% 19 24%<br />
75 96% 3 4%<br />
63 81% 15 19%
Most of those interviewed (68%) believe that three years cycle is not sufficient for<br />
training graduates for the labor market requirements, while 32% say that the cycle of<br />
three years is enough. Generally, accounting professionals agree to assimilate a master<br />
program which contains the disciplines required to gain access to profession to an<br />
admission exam that offer access to training stage. Most of them find the current<br />
training programs conducted by professional bodies useful (81%). Likewise, most of<br />
them consider that there is a need for a for a mechanism to monitor the education<br />
process of universities masters and find necessary an institutional dialogue<br />
mechanism between existing professional bodies and the Romanian higher education<br />
system for monitoring educational curricula of faculties (96). These responses outline<br />
the important role the professional bodies play in the ongoing training and educational<br />
curricula and also highlight the need to adapt the educational curricula to market<br />
demands.<br />
Our study has also detect a link between the academic education level (bachelor<br />
degree, master degree, doctoral degree) and how they estimate that three year<br />
bachelor degree cycle is adequate for young graduates to satisfy the demands of<br />
labour market from Romania and European Union?<br />
The response distribution is shown below:<br />
Table 9. The response distribution used the detect the link between academic<br />
education level and accountants opinion on bachelor degree cycle<br />
Academic education level Yes No<br />
Bachelor degree 14 15<br />
Master degree 5 27<br />
Doctoral degree 6 11<br />
Table 10. Results of chi-square test<br />
Chi-square (Observed value) 7,552<br />
Chi-square (Critical value) 5,991<br />
DF 2<br />
p-value 0,023<br />
alpha 0,05<br />
As the computed p-value is lower than the significance level alpha=0,05, one should<br />
reject the null hypothesis H0, and accept the alternative hypothesis Ha according to<br />
which there is no link between the academic education level and the perception of the<br />
bachelor degree cycle.<br />
The study has not found other links between categories of respondents constituted on<br />
the basis of age or academic education level and the response distribution to questions<br />
of this section.<br />
2.3 The hierarchy of skill acquired through educational process in universities<br />
In order to highlight the opinion of accounting professionals on the on the<br />
competences acquired during the current bachelor degree cycle, they were asked to<br />
give scores from scores from 1 to 5 (1 unimportant, 5 important) to competences<br />
~ 888 ~
ecommended by IES 2 (Content Programs of professional accounting education) and<br />
IES 3 (Professional skills and general education) issued by IFAC. To determine the<br />
hierarchy of skills a weighted average was calculated based on the scores obtained by<br />
each skill, the resulting average being used to rank the skills. The resulted hierarchy is<br />
presented below<br />
Figure 1. Hierarchy of competences as seen by accounting professionals<br />
In order to make a comparison we created a hierarchy of competences associated to<br />
disciplines taught during the bachelor degree cycle of the Faculty of Accounting and<br />
Management Information Systems from the Academy of Economic Studies of<br />
Bucharest. To create the hierarchy we used the number of ECTS (European Credit<br />
Transfer and Accumulation System) points allocated to each discipline. The score<br />
final score obtained by a competence is the sum of ECTS points of the disciplines that<br />
make up that competence. Professional judgement of the authors was used to classify<br />
the disciplines.<br />
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The resulted hierarchy is shown below:<br />
Table11. Hierarchy of competences order by ECTS points<br />
Competences ECTS points<br />
Financial accounting and reporting 31<br />
Finance and financial management 24<br />
Quantitative methods 18<br />
Business and commercial law 16<br />
Economics 15<br />
Audit 11<br />
IT control competences 9<br />
Financial markets 9<br />
One of, or a mixture of, the competences of, the roles of manager 9<br />
Management and strategic decision making 8<br />
Management accounting and control 6<br />
General knowledge of IT 5<br />
Taxation 5<br />
IT user competences 4<br />
Marketing 4<br />
Interpersonal and communication skills 2<br />
It may be noted that there is a discrepancy between the importance of skills acquired<br />
through education system and the assessment of professional accountants. These ones<br />
focuses on competences which rather belong to human quality (professional values,<br />
ethics, attitude, intellectual skills). Surprisingly, skills that exclusively belong to<br />
finance and accounting field appear to be less valued by those interviewed.<br />
CONCLUSIONS<br />
Given the changes that the Romanian higher education has to face, our study aims to<br />
highlight the perception of the professionals on the Romanian accounting education.<br />
One of the first conclusions is that accounting professionals find theoretical<br />
knowledge acquired during university studies important, but to a lesser extent than<br />
solid practical skills acquired through practical work experience. This choice may be<br />
explain by the fact that most of them find the current three year cycle inadequate to<br />
fulfill the demands of labour market from Romania and European Union. A two years<br />
master seems to offer an adequate level of education to gain access to profession if<br />
there is monitoring mechanism for those masters.<br />
The study highlights the role that professional bodies play in ongoing training, the<br />
education programs of these ones being appreciated by the respondents. An<br />
institutional dialogue mechanism between existing professional bodies and the<br />
Romanian higher education system for monitoring educational curricula of faculties is<br />
also recommended.<br />
The hierarchy of skills based on responses received highlights the important role<br />
played by practical knowledge, ethical values, intellectual skills in the work of the<br />
professional accountant confirming studies cited in firs part of this paper.<br />
~ 890 ~
REFERENCES<br />
The Academy of Economic Studies Bucharest. (2010). Planuri de invatamant Contabilitate si<br />
Informatica de Gestiune. Available at http://www.ase.ro/site/pentru/Planuriinvatamant/<br />
plan_inv/plan_cig.asp (2011)<br />
Albu, N., Alexander, D., & Albu, C. N. (2010). Accounting change in Romania- A historical<br />
analysis. The 31st Congress of the Association Francophone de Comptabilité, Nice,<br />
France<br />
American Accounting Association. (1986). The Bedford Report- Future Accounting<br />
Education:Preparing For The Expanding Profession. Available at, http://aaahq.org/<br />
aecc/future/prologue.htm (2010)<br />
Baker, W. M., & McGregor, C. C. (2000). “Empirically Assessing the Importance of<br />
Characteristics of Accounting Students”. Journal of Education for Business, 149-157.<br />
Cheng, K.-W. (2007). “The Curriculum Design in Universities from the Perspective of<br />
Providers in Accounting Education”. Education, 581-590.<br />
Feleaga, N. (1999). Comparative accounting [Sisteme contabile comparate]. Bucharest:<br />
Editura Economică.<br />
IFAC. (2008, 8). International Education Standard IES 2 Content of Professional Accounting<br />
Education Programs. Available at http://web.ifac.org/media/publications/d/handbookof-international-e/ies-2-content-of-professi.pdf<br />
IFAC. (2008). INTERNATIONAL EDUCATION STANDARD IES 3 PROFESSIONAL SKILLS<br />
AND GENERAL EDUCATION. Available at: http://web.ifac.org/media/publications/d/<br />
handbook-of-international-e/ies-3-professional-skills-1.pdf<br />
Jermakowicz, E., & Gornik-Tomaszewski, S. (2006). “Implementing IFRS from the<br />
perspective of EU publicly traded companies”. Journal of International Accounting,<br />
Auditiong and Taxation, pp. 170-196<br />
Lowry, J., & Yap, C. (1997). Management Accounting: What Skills? Australian Accountant,<br />
pp. 50-51.<br />
MECT Towards the european higher education area. Bologna process. National Reports<br />
2004-205. Available at: http://www.edu.ro/index.php?module=uploads&func=<br />
download&fileId=6393 (2005)<br />
Nobes, C., & Parker, R. (2008). Comparative International Accounting-Tenth Edition,<br />
Prentice Hall<br />
Tanner, J. R., Totaro, M. W., & Wilson, T. E. (1998). “Accounting Educators' Perceptions of<br />
Accounting Students' Preparation and Skills: A 10-Year Update”. The Journal of<br />
Education for Business, pp. 16-17.<br />
Tanyel, F., Mitchell, M. A., & McAlum, H. G. (1999). “The skill set for success of new<br />
business school graduates: Do prospective employers and university faculty agree?”<br />
Journal of Education for Business.<br />
~ 891 ~
MANAGEMENT VIEW RELATED TO HIGHER<br />
EDUCATION – AN ANALYSIS OF THE ROMANIAN<br />
BUSINESS PERCEPTIONS<br />
Mihaela ŞTEŢ 1 , & Alexandra ROŞU<br />
“Vasile Goldiş”, Western University Arad, Romania<br />
ABSTRACT<br />
The main objective of this paper consists in revealing the business environment expectations<br />
regarding the competences and capabilities offered by the universities. It aims also to give<br />
indications about the strengths and weaknesses of higher education regarding the changing<br />
requirements of business environment. The researches are founded on the surveys on<br />
graduates from different specialties in economics and interviews realized in Romanian<br />
business environment. On the basis of collected information there has been realised analysis,<br />
interpretation and drawing inferences. This methodology puts into evidence some indicators<br />
that can be used to measure the customer satisfaction regarding the higher education, both<br />
from individuals and business environment points of view. Starting from an analysis of<br />
customers’ perceptions, the paper offers indications about how can universities improve their<br />
economics curricula in order to respond at the requirements of our present business<br />
environment.<br />
KEYWORDS: management, business, university, satisfaction, globalization<br />
INTRODUCTION<br />
In those days of crisis that Romania, as most of countries, around the world found on<br />
XXI century's (Breban, L. et al., 2010) scaffold are passing through, we must be<br />
aware that any rational modern enterprise is becoming more oriented towards two<br />
major directions: first to give up a greater share more or less substantial of employees<br />
by reason of the impossibility of paying wages and to employ the graduate students<br />
because of the advantages that the government offers to the employers. But in this<br />
second case, becomes noticeable a neo-trend positioned at the level of management<br />
know-how that a university graduate can inject in an organization, upstream and/or<br />
downstream of its value creation chain.<br />
In fact, from interviews with Romanian managers, one of the indicators that we<br />
wanted to analyze with priority it was the level of satisfaction of both students and<br />
graduates of the Bologna cycles, in parallel with the feed-back existing at the level of<br />
business men. In fact, all these steps follow one thing in common: profit and return on<br />
investment realized. Namely: the profit of university graduates initially confined to<br />
recognized diplomas obtained and thus will absorb the costs of fees for university<br />
studies and in the second phase and not only the material advantages which would<br />
1<br />
Correspondence address: Mihaela STET, “Vasile Goldiş”, Western University Arad, Romania;<br />
email: mihaelastet@yahoo.com<br />
~ 892 ~
naturally succeed on the organizational ladder. From the perspective of managers<br />
(Kotler, P., 2003) it is clear that profit will be strictly linked to the contribution of<br />
knowledge brought by the graduate employee that should be much higher as the<br />
investments in salary, payments to state and/or other benefits that results from its<br />
employee status in accordance with policy organization.<br />
We appreciate that this phenomenon should not and can not be analyzed from an<br />
isolationist perspective, being necessary to create a IQMS (Integrated Quality<br />
Management System) which is existing both in the state and/or private national<br />
universities and in the business area as long as possible to ensure a regular self-control<br />
designed to adjust its own methods, theoretical and practical of both analyzed levels<br />
by this work.<br />
1. METHODS AND MATERIAL RESOURCES<br />
To be able to provide objective monitoring of HE-MB ratio (higher education -<br />
modern organization) we propose another pragmatic and dynamic indicator<br />
generically called OKIE (Object Key Interest in Education), capable to permit a<br />
relevant insurance of quality system in their own HE area (Söderqvist, M., 2001). We<br />
consider that this measure will ensure that costs incurred for the benefit of knowledge<br />
will get quality education, own skills, information and proper management NPE<br />
(needs-preferences-expectations). We also consider that this neo-parameter can be<br />
addressed from the perspective of KPIs (Key Performance Indicator), which explains<br />
the fact that the scope of MUs (modern universities) found under the incidence of<br />
micro-macro directions imposed by the chaotic pace of the third millennium has to<br />
ensure real commissions of intellectual know-how in order to be easily decoded,<br />
implemented and related to the specific management environment of the workplace.<br />
In this context, we also appreciate that we can speak about an IHES (Implicit Higher<br />
Education Sustainability) who actually understand the importance that the<br />
globalization throws on the world micro-macro-global economic stage (Dumitraş, C.,<br />
Roşu, A., 2010): prevention of the lack of educational opportunities for both daily and<br />
distance higher education. This can be accomplished by monitoring, analysis and<br />
interpretation of SSFR (Student Satisfaction Feedback Request). At this level it will<br />
be generate informational windows in the form of a real MDB (modern database),<br />
able to reflect in the management analysis the concrete action of RVHE type<br />
(Rethinking the Values of Higher Education). The proposed indicator can actually<br />
demonstrate the linearity shaken by the environment that changes with steps that are<br />
more harder forecasted (Oliver, HM et al., 2000).<br />
Yet any analysis undertaken at the level of HE - business area ratio needs to<br />
demonstrate clearly whether it exist or not CWF (competing worries and Fears) on the<br />
reference market, especially for the two axes that are analyzing in this work. The<br />
CWF is actually locates at the level of the known collocation "value for money",<br />
which acquires new connotations in the current EFS (economic, financial and social)<br />
crisis that brings on LRI (local-regional-international) stage another paradox:<br />
although high school graduates no longer have the financial resources necessary to<br />
continue studies degree (mainly due to a drastic minimization of income from families<br />
and on the other hand the impossibility to be engaged because of the lack of<br />
~ 893 ~
experience), and are put in a position to accept a job that doesn't requires HE and even<br />
less management skills.<br />
So, we are in situation to ask ourselves if the Romanian society and not only will be<br />
satisfied with a low level of management skills and knowledge, truncated by the sap<br />
of superior knowledge and not with an intelligence certificated through well known<br />
Bologna process that Romania has already aligned as an EU member (Şanta C. et al.,<br />
2010). Actually, obtaining a better grade in business life becomes now just an<br />
approach totally devoid of a fully justification that is necessary and reasonable if we<br />
take into consideration the discrepancy and injuriousness of the salaries of those who<br />
own the HE and those who remain anchored in unknowledge. And since we get here,<br />
what can we say about the basic curriculum that it involves national universities<br />
today? How fast can it be adapted to an unstable market from the dynamic behave<br />
point of view (Blackwell, R., Engel, AM, 2002), to which social challenges must<br />
respond and how its performance can be measured? To all this questions we are trying<br />
to answer further.<br />
National universities and not only should first focus on creating its own internal<br />
structures in order to be in making a proper reorientation of the curriculum in parallel<br />
with the evolution and the specific NPE at the active market level. In other words, it is<br />
necessary that a redefinition and repositioning of its outputs (learning outcomes,<br />
management knowledge, abilities, skills acquired by students and/or graduates), while<br />
keeping the specific and traditional academic fingerprints (Parker, C, Mathews, BP,<br />
2001). The universities contribution should be fully correlated with the state suport in<br />
order to reach the stage for underline QNR (National Qualifications Register) able to<br />
provide a transparent approach on HE quality for to correctly compensate the quantity<br />
of HE anchored to the level of credit awarding, which measured the volume of<br />
students work during the years of study. But in our opinion, all this effort calls for a<br />
neo-cooperation of all forces of responsabile for the entourage specific to HE:<br />
national universities, ARACIS responsible representatives of the Romanian<br />
government.<br />
Further, in our opinion, we must consider that we have to take into consideration with<br />
priority also the effects of the EFS crisis towards the current market, extended from<br />
the end of 2009 until present, if we think to the mutations that are operating in a<br />
century of chain crisis. And we continue to ask: is there an optimal rate of intellectual<br />
adaptation to a globalize present environment?<br />
And if so, then that would be the anti-crisis intellectual ingredients and/or spices that<br />
Romania can afford? In an open dialogue with national entrepreneurs we obtained an<br />
apparently interesting information, located in a nodal point: the potential today's<br />
students represent a niche of HE threatened by declining birth-rates garnished with<br />
increasing lack of revenue needed to cover the costs claimed by the current private<br />
education system and fewer places for the scholarship offered by the public<br />
universities.<br />
2. RESULTS AND DISCUSSIONS<br />
If this seems to be the landscape of our world then it means we can easily associate<br />
the university services with the trade negotiation field, where the partners face at a<br />
~ 894 ~
negotiation table, where they are the common stake. This easily implies that all it is<br />
essentially just a game of will and desire to win. Well, in our case who will have the<br />
advantage of slightly higher: the universities or the future graduates?<br />
And we also ask: what academic entrepreneurship manager is able to analyze and<br />
resolve this issue? On first examination, we appreciate that the neo-business people<br />
optics is directly positioned in the pattern shown in the figure 1.<br />
Figure 1. A business pattern directly concerned to HE<br />
Goal Knowledge Knowing<br />
single<br />
mind<br />
Providing new task/work<br />
exploring<br />
mind<br />
~ 895 ~<br />
improved<br />
mind<br />
Studying this pattern of relationship we are in position to appreciate that we’re<br />
moving increasingly towards an educationcracy (democratic education) able to absorb<br />
with a fantastic speed more varied PIs (Performance Indicators) that constantly focus<br />
on outputs, which is characteristic to HE. And if this complex curriculum researchers<br />
usually resort to various methods more or less adapted to the evolving nature of OKIE<br />
(Likert scale, different methods such as ASSIST, AEQ, LSQ, ETQL), our research<br />
was conducted and configured in two distinct phases.<br />
The first was the interviews realization with graduates of HE as well as<br />
representatives directly responsible for HEOs (Higher Education Organizations)<br />
found at national level. Then, this process was accompanied by the organization of<br />
focus groups from where data were collected and processed both by univariate and<br />
multivariate analysis.<br />
If we refer to the 60 universities currently existing on the Romanian market, then we<br />
can say that high school graduates have provided a solid bunch of alternatives but the<br />
key question appears to follow when evaluating it is made for the quality of<br />
educational services provided by them. The course here will be extended an issue<br />
related to the decision to continue or not the masteral and/or PhD studies under the<br />
umbrella of the same university that granted the bachelor degree in the particular<br />
study. This unknown field could be resolved in a view already expressed that "people<br />
should understand that Frontline They are the ones who bring success to Their<br />
moments of truth, and everyone else should understand Their first job is to support the<br />
people as They Frontline do it"(Carr, C., 1990).<br />
We believe that we can naturally extend this explanation by addressing in terms of<br />
TQM (Total Quality Management) (Ahlberg, M., 1995) in order to understand the fact
that the neo-student (McCulloch, A., 2009) of XXI century has increasingly the regard<br />
such approach HOME (How the Opportunities Must Be Experimented) thinking.<br />
Certainly here we consider including proximity parameter to the centre of HE and<br />
particularly the possibility of replacing students' home or rental pay by own incomes<br />
with personal and/or family home. Here is just a step required to understanding that<br />
CST (Customer Satisfaction Theory) should be incorporated in the circumstances as<br />
the following relational model:<br />
SST<br />
Students<br />
Satisfaction<br />
Theory<br />
Figure 2. Pattern transposed on CST principle<br />
+ SSI<br />
Fig<br />
Students<br />
Satisfaction<br />
Ideas<br />
~ 896 ~<br />
SSI<br />
Students<br />
Satisfaction<br />
Aplications<br />
In such an equation it becomes very simple a refocusing of national universities<br />
positioning, which will claim an obvious reconfigure of placement and the systemic<br />
way of perception by potential and/or current customers (Emery, C. et al., 2001)<br />
found in their academic record book.<br />
For this we found that it is necessary to achieve even a design of what we understand<br />
from the initially discussions in order to obtain a sketching of this scientific material<br />
that should be finally a parameter of SS (Student Satisfaction) type, played in figure 3,<br />
specific to the time we cross on the uncertainties EFS scale imposed by the current<br />
intangible barometer of globalization.<br />
Figure 3. The model of 10 forces with direct incidence on SS management<br />
materialization<br />
University<br />
performance<br />
University<br />
relationships<br />
University<br />
world<br />
perception<br />
University<br />
culture<br />
University<br />
goals<br />
SS<br />
University<br />
mentality<br />
University<br />
world<br />
ranking<br />
University<br />
behaviour<br />
University<br />
promotion<br />
University<br />
access
It is relatively easy to observe that among these 10 distinct channels, own by any<br />
academic entity (Garbarino, E., Johnson, MS, 1999) may not be omitted a proactive<br />
CRM (Customer Relationship Management) template so that it can be outlined as<br />
accurately as possible the opportunities offered by the graduates to managers with<br />
their hiring in the organization and the opportunities that university can provide them<br />
as a corresponding feedback towards school fees directly payable (if private university<br />
entities).<br />
Actually the modern academic environment (Umbach, PD, Porter, SR, 2002) should<br />
be able to provide a customized and personalized educational pattern, watering,<br />
concentrated and focused on increasing the number of students, able to acquire<br />
successful career in duly elected academic training and / or associated and / or<br />
completely separate.<br />
DISCUSSION AND CONCLUSIONS<br />
To compact all the presented elements in a normal way, concerning the academic<br />
intelligence stage, then we should look misplaced idea that instead of wasting of time<br />
in order to identify the corresponding university for the NPE’s high school graduate<br />
parameters (Slater, D., 1998), and so this would certainly be more normal to be<br />
wasted energy in the quality of higher education itself, so throughout higher education<br />
to become a continuous quality summum.<br />
It should be understood that the society has no current practical needs of graduates<br />
and/or bachelor degrees/masters/PhDs graduates over disagreements that have<br />
somehow acquired the same skills and/or theoretical and practical knowledge related<br />
graduate who has a simple high school diploma. Today, Romania and so the other<br />
countries needs elites, which completely reverses the quality training priorities for HE<br />
quality and against HE quantity.<br />
Sure it would be necessary lot of efforts for to create a revival national business<br />
infrastructure to prevent national brain drain but also in parallel to this step should be<br />
based on synergistic pattern of business consulting career that the Romanian state<br />
should be aware and to assume, in order to obtain a desaturation of the educational<br />
guidelines for curriculum areas that can not be absorbed at the present job market<br />
level.<br />
We appreciate also that this approach will be able to extract the country from state<br />
paying the irrational unemployment benefits as a response to a proper undistributed of<br />
the present HE outputs. So we state that Romania currently must understand that<br />
many organizations that have not yet entered into specific stages of insolvency and/or<br />
bankruptcy in particular can increase no longer databases with graduates with higher<br />
education.<br />
It is necessary an orientation more judicious, balanced and rational of eager HE in<br />
relation to a momentary lack of optimal absorptions and we appropriate the existing<br />
jobs integration in the current market as a national priority. In fact, an effective<br />
national CRMs should be able to profitable translate HES (Higher Education<br />
Services) in order to be able to positively and proactively influence perceptions,<br />
satisfaction and HE results in order to obtain in the end reports exclusively focused<br />
~ 897 ~
towards the quality of cost-benefits axe. Thus, new challenges overlap task university<br />
sites, which are able to explain a national opened competitive behaviour.<br />
The strength of the educational act itself on domestic market is actually a correct<br />
democratic struggle (Needham, C., 2003), justified by the competition law so that the<br />
SS currently receives an even broader sense conceptually, as we can see in the next<br />
figure.<br />
SG<br />
student<br />
goals<br />
Figure 4. Materialization of relations found at the SS level<br />
SPQ<br />
(student perception quality)<br />
SH<br />
student<br />
hired<br />
SL<br />
student<br />
life<br />
SS<br />
~ 898 ~<br />
SPV<br />
(student perception value)<br />
SR<br />
student<br />
renoun<br />
SK<br />
student<br />
knowledge<br />
SP<br />
student<br />
performance<br />
Based on the SPE and SPQ the Romanian state should implement sustainable<br />
benchmarking efforts of specific type so that the NPEs with bachelor/master/PhD<br />
graduates to be as realistic and possible to be translated in the near future into reality<br />
of a painful viral SWOT suffocation characteristic to the EDC (contemporary Digital<br />
Economy) pattern, expanded due to widespread ICT interfaces, upstream or<br />
downstream of the national economy.<br />
However, regardless of which option will be pursued at the management study level,<br />
we note that virtually progress is irreversible and the Internet market is very firmly<br />
embedded in a future which overlaps with a hologram seemingly unimaginable at<br />
present so that the universities can no longer afford not to fully digest and absorb the<br />
whole information without transforming it into business advantages and management<br />
durable niches for the entire society.<br />
REFERENCES<br />
Ahlberg, M., (1995) “TQM for University Level Needs Attention to Neglected Processes of<br />
Quality Learning and Quality Research”, <strong>Proceedings</strong> of the Seventh International<br />
Conference on Assessing Quality in Higher Education, July 1995. Indianapolis, Indiana:<br />
Planning and Institutional Improvement, Indiana University/Purdue University<br />
Indianapolis, 1995<br />
Blackwell, R., Engel, P.M., (2002) Consumer Behaviour, Piter, St. Petersburg<br />
Breban, L., Borlea, S., Roşu, A., Şanta, C., (2010) “Management pulse of the XXI century<br />
towards the responsible enterprise”, 5 th International Conference – Accounting<br />
and Management Systems AMIS 2010, Academy of Economic Studies Bucharest,<br />
June 16-18, 2010
Carr, C., (1990) Front-line Customer Service: 15 Keys to Customer Satisfaction, USA:<br />
John Wiley & Sons, Inc.<br />
Dumitraş, C., Roşu A., (2010) Bazele comerţului, Ed. Risoprint, Cluj-Napoca<br />
Emery, C., Kramer, T., Tian R., (2001) “Customer vs. Products adopting an effective<br />
approach to business students”, Quality Assurance in Education, volume 9, number 2,<br />
pp. 110.115<br />
Garbarino, E., Johnson, M.S., (1999) “The diffrent roles of satisfaction, trust, and<br />
commitment in customer relationships”, Journal of Marketing, volume 63, pp. 70-87<br />
Kotler, P., (2003) Marketing Management, Prentice Hall<br />
McCulloch, A., (2009) “The student as co-producer: learning from public administration<br />
about the student university relationship”, Studies in Higher Education, vol. 34, no. 2,<br />
pp. 171-183<br />
Needham, C., (2003), Citizen Consumers: New Labour’s Markeplace Democracy, London:<br />
Catalyst Working Paper<br />
Oliver, H.M. et al., (2000) “Is relationship marketing for everyone?”, European Journal of<br />
Marketing, volume 34, number 9/10, pp. 1111/1127<br />
Parker, C, Mathews, B.P., (2001) “Customer satisfaction: contrasting academic and<br />
consumers’ interpertations”, Marketing Intelligence & Planning, volume 19, number 1,<br />
pp. 38/44<br />
Slater, D., (1998) Consumer Culture and Modernity, Cambridge: Polity Press<br />
Söderqvist, M., (2001) The Internationalization and strategic planning of Higher/Education<br />
Institutions - An analysis of Finnish ERP strategies, Helsinki School of Economics and<br />
Business administration<br />
Şanta C., Roşu A., Breban L., Bochiş L. (2010) “EU Intelligent steps to maintain in the race<br />
of the 3 rd millennium”, Conferinţa internaţională “Integrarea europeană – noi<br />
provocări”, ediţia a-VI–a, Facultatea de Ştiinţe Economicea Universităţii din Oradea,<br />
28-29 mai 2010, TOM XVII, ISSN 1582-5450, steconomice.uoradea.ro/<br />
pdf/sesiune_com/2010/programme.pdf<br />
Umbach, P.D., Porter, S.R., (2002) “How do academic departments impact student<br />
satisfaction? Understanding the Contextual Effects of Departments”, Research in Higher<br />
Education, Volume 43, number 2, pp. 209-234<br />
~ 899 ~
SOCIAL NETWORKING IMPACT ON EDUCATIONAL<br />
PROCESSES IN ROMANIA<br />
Florin MIHAI 1 , Andrei STANCIU & Ofelia Ema ALECA<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
The main purpose of the research is to analyze the impact of social networks on educational<br />
process in Romanian higher education. Considering these aspects, based on a theoretical<br />
frame regarding the educational value of the social networking web sites, a model of<br />
implementing Facebook usage in higher education leaning processes was proposed. The data<br />
required to validate the model were gathered through a survey on students at the Bucharest<br />
Academy of Economic Studies. The survey has revealed that social networking sites have<br />
become very popular among students and could be considered as valuable potential for<br />
education. The study opens a wide perspective on students’ availability to use social<br />
networking sites, but also other web based technologies.<br />
KEYWORDS: On line social network, e-Learning, Educational context, Facebook,<br />
Computer Supported Collaborative Learning<br />
INTRODUCTION<br />
Due to the continuous increase of using new IT&C technologies in everyday life, the<br />
implementation of these technologies in learning activities becomes a necessity.<br />
Though the e-learning platforms are implemented in universities all around the world,<br />
the educational methods, techniques and educational software tools do not have<br />
always keep the pace with the new information technologies, an example being the<br />
social networking sites which are very popular, being accessed regularly by most<br />
students and teachers, but not yet considered an instrument for learning and teaching.<br />
Kleiner at all (2007) conducted a study regarding the development of educational<br />
technologies and found that the reluctance of teachers is the key of non-integration of<br />
new technologies in teaching.<br />
For example, many Romanian teachers still consider social networking sites as a kind<br />
of virtual playground for teenagers. But there evidence that social networking is a<br />
more complex phenomenon and, there are the politicians who prove that<br />
social networks are not just a funny places on the web and are worth to pay attention<br />
(Figure 1).<br />
1 Correspondence address: Florin MIHAI, Academy of Economic Studies, Piata Romana, nr. 6, Sector<br />
1, Bucharest, Romania; email: fmihai@gmail.com
Figure 1. Social networking became a more complex phenomenon<br />
Though some negative aspects could be also emphasized and Flynn (2009); Stansbury<br />
(2009); Young (2009) identified specific issues, there are already several educational<br />
institutions which are using social networking establishing relationships with<br />
students’ accounts. For example University of Cambridge and University of Oxford<br />
are very keen on promoting their Facebook pages (Figure 2).<br />
Figure 2. Several educational institutions are using social networking in order<br />
to establish relationships with students’ accounts<br />
These models could be useful to eliminate teachers’ reluctance and to demonstrate<br />
that social networking sites are basically a solution for teachers to be constantly in<br />
touch with students (Roblyer et all, 2010).<br />
The key of success consists not only in a prompt response regarding the evolution of<br />
support technologies for teaching, but also in reengineering educational processes<br />
~ 901 ~
through developing and implementing new concepts as Computer Supported<br />
Collaborative Learning (CSCL) which encourages collaborative development of<br />
knowledge. From this point of view, modern e-learning platforms have radically<br />
changed students and teacher's role in learning activities and are promoting the<br />
concept of social learning by using social software tools (such as blogs, online<br />
encyclopaedias and virtual worlds). In scientific papers, this tendency to transform<br />
e-learning process and to convergence with social networking is referred by some<br />
authors as Long Tail Learning (Karrer, 2008).<br />
E-Learning 2.0, unlike systems not based on CSCL, involves the accumulation of<br />
knowledge as a social phenomenon which can be socially constructed and is based on<br />
effective learning through conversations and various types of interaction in the virtual<br />
environment (Casquero et al. 2010). In recent years, a massive increase in the number<br />
of virtual classes or delivered live online presentations was recorded in high education<br />
all around the world. Complementary to virtual classes, accessing social networks as<br />
learning environments has become a basic concept for E-learning 2.0 frameworks.<br />
The main role of social networks is to coagulate virtual learning communities within<br />
the scope of discussions on topics such scientific subjects, virtual experiments or other<br />
various themes as exams preparation.<br />
A major impact in promoting these activities focused around the concept of "social<br />
networking" is provided nowadays by the development of client applications for<br />
mobile devices which enhances their accessibility. Moreover, the development of<br />
technologies needed to implement e-learning software on the latest generation<br />
telephone devices and other mobile devices has led to the shaping of new concepts<br />
such as mobile-learning or, in learning foreign languages, Mobile Assisted Language<br />
Learning (MALL).<br />
In the area of social networking, recent surveys highlighted that 30% of Facebook<br />
users and 37% of Twitter are using the networks from mobile devices (Figure 3).<br />
Figure 3. Social networking web sites: Login via mobile devices<br />
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1. LITERATURE REVIEW<br />
Formerly designed on communication purposes and for improving information<br />
exchange among small groups of users, social networking sites have become quickly<br />
very popular, and the number of users from a wide geographical area joined the<br />
groups and became regular clients.<br />
In general, the social networks sites provide users with a private virtual space where<br />
each one could build his own public profile and manage a list of links to other users’<br />
profile (Boyd and Ellison, 2007).<br />
1.1 Facebook (facebook.com)<br />
Founded in 2004 by Mark Zuckerberg, was formerly named thefacebook.com and was<br />
designed as a closed online social network, available only for Harvard University staff<br />
and students. Subsequently, network access has been extended to other universities<br />
and companies like Apple or Microsoft. Since 2006, Facebook provide free access<br />
regardless the membership in a university or company.<br />
The network is based on Web 2.0 technology and is available from any computer with<br />
Internet access, providing support for other several device types, including mobile<br />
devices, benefiting from optimized software interfaces, especially designed.<br />
Users can look up for their friends from around the world and can build their own<br />
profile that can be public or private. The profile could be changed at user will or,<br />
public profiles could be blocked by the administrators if other users are reclaiming the<br />
content. Each user is allowed to post messages or photos which, also, could be public<br />
or could be addressed to a specific group or users. More recently, Facebook also<br />
provide different types of games for the users’ entertainment.<br />
The main controversy which Facebook has been facing since the beginning concerns<br />
about the respect for private life, given that information about user’s privacy can be<br />
gathered for advertising purposes, by placing ads on the each user’s page and several<br />
analyses are made by Facebook for his commercial partners in order to study the<br />
social behaviour of each user. Undoubtedly, at this moment, in Romania<br />
facebook.com is one of the most popular social networks and is estimated that<br />
approximately 1.5 million Romanians are using Facebook (Negrila, 2010). Despite the<br />
worldwide spread of Facebook users, there are still countries in the Middle East (or<br />
even China) where Facebook is banned or limited.<br />
In terms of educational impact on higher education institutions, at the moment, there<br />
are several institutions registered on Facebook, but also students, parents and many<br />
groups specially created for finding school or university colleagues. Practically, on<br />
Facebook, we find all forms of interaction between educational services providers,<br />
direct beneficiaries of education services, and why not, parents of students as<br />
stakeholders. These interactions can take several educational approaches for Facebook<br />
users:<br />
(a) Learning for using Facebook<br />
(b) Using Facebook for learning<br />
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(a) Learning for using Facebook could be consider a strange approach, but is a<br />
concept which emerges from the users’ incontestable interest in own information<br />
security and privacy in order to answer to questions such “What could happen when a<br />
student make public their information on Facebook ?”<br />
On the facebookforparents.org web site tips and good practices are available for<br />
parents, in order to keep safe the children while they are surfing on Facebook pages.<br />
Things have gone further and there are software applications designed for data<br />
security which provide the option to deny access to Facebook to specific users of a<br />
given computer. However, a proper understanding of social networking concept and a<br />
proper evaluation of knowledge spreading potential could be an important step for<br />
decision makers in network security for many institutions.<br />
(b) Regarding from the Using Facebook for learning point of view, teachers<br />
seems to be less convinced than students to use Facebook. The teachers’’ reluctance<br />
on using Facebook to communicate with students is not resulting from their<br />
conviction that using Facebook would not produce beneficial effects on learning, but<br />
from their concerns about security of information conveyed in social networking and<br />
high exposure on the Internet for teachers’ privacy.<br />
There are many possible uses of Facebook in education, some authors<br />
(Onlinecollege.org, 2009) stating about 100 ways to use Facebook in the classroom, in<br />
order to provide value to the educational process.<br />
The main features which recommend Facebook as a valuable tool which could be<br />
used in education are:<br />
� Teachers can create custom list of students and manage groups of students on<br />
custom topics related to courses;<br />
� Exchanging information through links, photos or multimedia content related to<br />
specific subjects;<br />
� Creating surveys and quantifies the feedback.<br />
� Using the on line chat for direct communication between students and<br />
teachers.<br />
� Publishing news on tests, exams or face to face meetings.<br />
� Integrating Facebook with other collaborative services provided by other<br />
application (like Google docs).<br />
� Using Facebook as a complement for an eLearning platform<br />
1.2 Twitter (twitter.com)<br />
Twitter is a micro blogging service based on WEB 2.0 technology. The main<br />
characteristic of Twitter is the feature of transmitting short messages like SMS, up to<br />
140 characters. Formerly, many users considered Twitter an alternative SMS service<br />
in the Internet.<br />
Being two years younger than Facebook, Twitter is online since 2006 at<br />
www.twitter.com. In the online community, the short messages transmitted through<br />
twitter are known as “tweets” and the users of Twitter “tweeters”. In order to transmit<br />
a message, a user could directly access the twitter web site or could use a dedicated<br />
interface such: Twitpic, Digsby, Tweetdeck, etc. Several mobile phone operators from<br />
different countries allow the transmission of messages on Twitter network through<br />
SMS, using your mobile phone.<br />
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The base concept for Twitter is to allow the users to publish their own notes on a<br />
personal Twitter account and, in the same time, to let them read messages posted by<br />
other users on their accounts.<br />
Each person could define a custom list of Twitter users and is allowed to follow notes<br />
posted by these people. Starting from these premises, the virtual space provided by<br />
twitter for micro blogging is used nowadays in many activities:<br />
� Publishing news by newspapers or media agencies. There are several TV<br />
stations (like CNN or PROTV) which publish the latest news on Twitter,<br />
allowing users to be informed in the shortest time via mobile phone<br />
notifications.<br />
� Promoting blogs. Many Twitter users have personal blogs and are using<br />
Twitter in order to promote their activity on a personal blog and to attract new<br />
visitors. Meanwhile on blog pages could be inserted Twitter widgets which<br />
foster the micro blogging.<br />
� Promoting political activities. In recent years Twitter started being used<br />
extensively for political action: elections, protests, etc. There are countries<br />
(Barry, 2009), where large protests were coordinated on Twitter, when local<br />
authorities tried to censor the calls to protests in local media.<br />
� Promotion of projects by institutions<br />
� Promotion of cultural events.<br />
� Launch of book or web sites.<br />
� Set up surveys.<br />
� Marketing.<br />
Although at first glance, using a micro blogging service in the educational process<br />
may seem cumbersome and inefficient and the features that could be used in the<br />
educational process are not as complex as in the case of Facebook, micro blogging<br />
network offers certain advantages that can be emphasized in the educational<br />
processes:<br />
� Tracking news about books, journals or treaties available in the libraries of<br />
educational institutions<br />
� Rapid spread of information about scheduled face to face meetings, exams, or<br />
seminars.<br />
� Rapid spread of solutions to exercises, problems or specific controversies<br />
� Posting bibliographical notes or hyperlinks to scientific references by teachers<br />
and students.<br />
� Facilitate the solving of specific problems which may be easily solved in a<br />
group.<br />
� Teachers can set also up surveys and collect feedback information<br />
� Short messages of 140 characters offer a high degree of conciseness and<br />
develop the ability of teachers and students to communicate in a more efficient<br />
way.<br />
However using a micro blogging platform in the educational process, whether it's<br />
Twitter or other platform, because of the specific environment for conversations,<br />
some controversial situations could arise. Regarding Twitter few negative aspects<br />
could be mentioned:<br />
~ 905 ~
� Twitter does not allow users to define groups in order to design a structure of<br />
courses on topics of interest or to define specific groups of students as targets<br />
for messages. If a teacher coordinates several courses for different groups of<br />
students, spreading messages only on certain groups is difficult and<br />
information could become irrelevant.<br />
� Rapid propagation of rumours (intentionally or not intentionally).<br />
� Because of limited message size to 140 characters, users can get to make gross<br />
errors of expression.<br />
� Messages could become a source of spam.<br />
� Some students could prefer just to take advantage of others' work, posting<br />
notes from time to time just to look like they are working.<br />
We also found interesting, the latest demographic statistics which prove that social<br />
networking is sharing a large segment of users with schools and universities. For<br />
example around 50% percent of Facebook & Twitter users are people under 35 years.<br />
Figure 4. Facebook & Twitter Facts - 2010<br />
(Source: Data provided by Digital Surgeons, www.digitalsurgeons.com)<br />
The same statistics reveal that 49% percent of Facebook users and 55% of twitter are<br />
involved I educational activities in high schools or universities. And another quarter<br />
has already graduated (Figure 5).<br />
Figure 5. Facebook & Twitter Facts - 2010<br />
(Source: Data provided by Digital Surgeons, www.digitalsurgeons.com)<br />
~ 906 ~
2. STUDY METHODOLOGY<br />
Lee and McLoughlin (2008) consider social networking sites as educational tools<br />
because students users can use them for communication and social support as well as<br />
for discovering and sharing knowledge.<br />
Based on previously proposed models in the scientific literature (Mazman & Usluel,<br />
2010) a model for educational use of social networking sites was designed (Figure 6).<br />
In this model the authors proposed to develop the usefulness of social networking<br />
sites for learning and teaching in terms of six components: communication with<br />
teachers or peers, collaboration in a particular group of learning, sharing resources<br />
through interchange of documents and multimedia resources, the usefulness in the<br />
educational process and the frequency of access.<br />
Figure 6. A model for using social networking sites in educational context<br />
(Source: adapted from Mazman & Usluel, 2010)<br />
Communication with teachers<br />
Communication with teachers through social networking could be considered an<br />
extension to “face to face” classroom communication.<br />
H1: Communication has a significant influence on the potential use of social<br />
networking sites for educational purposes<br />
Collaboration<br />
Several scientific papers (Ajjan & Hartshorne, 2008, Lockyer & Patterson, 2008)<br />
emphasize that social networking sites provide support for collaborative learning.<br />
Users of social networking sites can join study groups corresponding to a certain<br />
school, class or group they belong to and can share educational resources and<br />
knowledge in an easier way.<br />
H2: Collaboration has a significant role in using social networking as a support for<br />
educational activities.<br />
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Resources and knowledge sharing<br />
Using social networking sites allows sharing multimedia resources like photos, videos<br />
or hyperlinks to other web resources. One of the main advantages in using social<br />
network sites as a tool for education consist in a unique approach which involves<br />
collaborative group work and sharing of knowledge.<br />
H3: Resource sharing has a significant influence on the use social networking sites in<br />
educational purpose.<br />
Usefulness<br />
The utility factor concerns about the “the degree to which a person believes that using<br />
a particular system would enhance his or her job performance“ (Davis, 1989). The<br />
usefulness of social networking sites is provided by facilities offered to users, such as<br />
communication, interchange of information and resources that could be achieved<br />
through a public or semi-public profile accessible to other users.<br />
H4: The usefulness has a significant influence on the use social networking sites for<br />
educational purpose<br />
Frequency of access<br />
Some authors believe that using social networking sites in everyday life (Mazman &<br />
Usluel, 2010) and the fact that most users spend a lot of their time online provide a<br />
good support in the context of education.<br />
H5: Frequency of hits has a significant influence on the use of social networking sites<br />
in educational purpose<br />
Use of flexible technologies<br />
The technological boom in IT&C technology allows access to web sites anytime,<br />
anywhere through mobile communication devices.<br />
H6: Flexibility of access provided by new technologies has a significant influence on<br />
the frequency of accessing social networking sites<br />
In order to examine how students perceive the use of social networking sites for<br />
educational purposes a questionnaire-based survey was developed (presented in<br />
Annex 1).<br />
3. STUDY RESULTS AND IMPLICATIONS<br />
In the questionnaire-based survey were involved 64 persons, students at the Bucharest<br />
Academy of Economic Studies, the large majority being young people aged between<br />
21 and 31 years.<br />
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Figure 7. Structure of the survey participants by age<br />
Social networking sites<br />
According to the survey we found that Social networking is common among young<br />
people in Romania and only 16% of participants do not have an account on a social<br />
networking site. The most used social network is Facebook with over 87% of<br />
participants at the survey being registered on Facebook. The survey also reveals that<br />
Twitter is not so popular among students from Bucharest Academy of Economic<br />
Studies.<br />
Figure 8. Preferences on social networking sites<br />
Another target of our survey was to find why students are joining social networks.<br />
Nowadays, social networking sites are mainly used for keeping in touch with<br />
colleagues and friends (over 60% of respondents saying that they have registered for<br />
this purpose). Communication for educational purposes has a smaller percentage of<br />
respondents (around 28%).<br />
~ 909 ~
Figure 9. Why are students using social networking?<br />
Frequency of access<br />
In terms of frequency of access, most users (around 67%) are accessing social<br />
networking sites from 1 to 5 times a day and around 6s% could be considered pretty<br />
addicted to social networking. They are doing over 20 logins per day.<br />
Figure 9. Frequency of access (social networking sites)<br />
Another highlighted point in the study is the link between the frequency of hits on<br />
social networking sites accounts and e-mail services as means of communication.<br />
According to the survey results, it seems that the trend of registering on social<br />
networking web sites and email accounts is the same (t = 0.31, p = 0.76). All the<br />
survey participants are using email and 92% access their accounts at least once a day.<br />
~ 910 ~
Figure 10. Frequency of access (email accounts)<br />
Flexibility<br />
Technological flexibility involves use of electronic mobile devices to access the sites<br />
for social networking “anywhere and anytime". Regarding flexibility of access, most<br />
of survey participants are using laptops (62%) while 25% are using mobile phones.<br />
Very few said they have used other devices (like tablet PC or IPad), this kind of<br />
devices tends to become popular in our country but they are still quite expensive for<br />
students.<br />
Figure 11. Devices used to access social networking sites<br />
Prospects for social networking sites as support for educational activities<br />
At a more specific question regarding the prospects for social networking sites as a<br />
support for educational activities, most of the respondents (about 62%) consider using<br />
social networking sites an opportunity for communication between students and<br />
teachers and around 25% consider that online social networking does not fit for<br />
education. (Figure 11).<br />
~ 911 ~
Figure 12. Use of social networking sites for educational purposes<br />
Communication, collaboration and sharing of learning resources and knowledge<br />
In terms of use social networking sites for educational purposes, most of students who<br />
responded to the survey (around 50%) believe that sharing resources, collaborating<br />
through online social networking and communicating with teachers are very important<br />
in using social networking sites for learning and only around 20% of the students<br />
found one of these less important.<br />
Figure 13. Communication, collaboration and sharing of learning resources<br />
and knowledge<br />
DISCUSSION AND CONCLUSIONS<br />
Tools for education provided through social networking sites offer specific<br />
advantages especially for distance learning, using an affordable and popular<br />
environment. Currently, online social networks are used by heterogeneous groups<br />
with different ages which tend to integrate more and more facilities offered by these<br />
networks in their daily lives. There is no doubt that, with the unprecedented expansion<br />
of social networks, personal data security policies must to be improved and users are<br />
~ 912 ~
have to be better trained to protect themselves. In recent years several social<br />
networking users have been victims of hackers, spam, malware or phishing.<br />
One of the most popular social networks in Romania is Facebook, which is gathering<br />
many visitors, especially young people, from different backgrounds and continues to<br />
expand rapidly in all age groups. The rapid development of technology in the field of<br />
mobile devices is opening new opportunities for knowledge transfer and social<br />
networks are the first to benefit. Student are very receptive to the development of<br />
technologies for mobile devices and implementing e-learning software on the<br />
telephone devices or other mobile devices is already leading to the shaping of new<br />
concepts (as M – Learning or mobile-learning )<br />
According Facebook Statistics, there are more than 250 million active users currently<br />
accessing Facebook through their mobile devices and people that use Facebook on<br />
their mobile devices are twice as active on Facebook than non-mobile users. Also,<br />
there are more than 200 mobile operators in 60 countries working to deploy and<br />
promote Facebook mobile products. As regards the support of these networks for<br />
educational processes, as we noted in the above analysis, there are users of social<br />
networking, whether students or teachers who do not realize the benefits of certain<br />
features of these networks educational purposes. The percentage of Romanian<br />
students who show reluctance to communicate on networks like Facebook for<br />
educational purposes is still pretty high. Of course, this could be also interpreted as an<br />
issue of social culture on student- teacher relationship in Romanian universities.<br />
In 2007 Facebook officially published some statistical data regarding users’ activity<br />
on the network. The data revealed that the visitors spend a lot of time interacting with<br />
other integrated applications in Facebook (at that time were estimated 88 million<br />
visits with an average duration of 4 minutes and 30 seconds and not less than 14<br />
millions unique visitors). Facebook applications are custom functionality that works<br />
within the Facebook environment. The code runs on a separate server, but the<br />
applications interface plays back inside Facebook.<br />
A great challenge for e-learning solutions developers is related to the integration of<br />
collaborative tools in education. For social networks web sites, but also for the<br />
educational system, a very important step would be to develop additional features<br />
geared towards the development of social learning concept, and to develop and foster<br />
tutorials on how these networks could be used to socialize at school and home.<br />
REFERENCES<br />
Ajjan, H., & Hartshorne, R. (2008) “Investigating faculty decisions to adopt Web 2.0<br />
technologies: theory and empirical tests”, The Internet and Higher Education, Vol. 11,<br />
No. 2: 71-80<br />
Barry, E. (2009) Protests in Moldova Explode, With Help of Twitter, N. Y. Times, available<br />
on-line at http://www.nytimes.com/2009/04/08/world/europe/08moldova.html?_r=1,<br />
accessed at 07.04.2009.<br />
Boyd, M. D., & Ellison, N. B. (2007) “Social network sites: definition, history, and<br />
scholarship”. Journal of Computer-Mediated Communication, 13(1), 210-230.<br />
Casquero, O., Portillo, J., Ovelar, R., Benito, M., Romo, J. (2010) “iPLE Network: an<br />
integrated eLearning 2.0 architecture from a university's perspective”, Interactive<br />
Learning Environments, Vol. 18, No. 3<br />
~ 913 ~
Davis, F. D. (1989) “Perceived usefulness, perceived ease of use, and user acceptance of<br />
information technology”, MIS Quarterly, Vol.13, No. 3:319-340<br />
Flynn, N. (2009) “Facebook, take 2: Cyberbullying”, Education week, available on-line<br />
at http:// blogs.edweek.org/edweek/LeaderTalk/2009/05/facebook_take_2_<br />
cyberbullying.html?qs=facebook<br />
Karrer, T. (2008) “Corporate Long Tail Learning and Attention Crisis”,<br />
Elearningtech.blogspot.com, available on-line at http://elearningtech.blogspot.com/<br />
2008/02/corporate-learning-long-tail-and.html<br />
Kleiner, B., Thomas, N., & Lewis, L. (2007) Educational technology in teacher education<br />
programs for initial licensure (NCES 2008–040). Washington, DC: National Center for<br />
Education Statistics, Institute of Education Sciences, U.S. Department of Education<br />
Lee, M. J. W., McLoughlin, C. (2008) “Harnessing the affordances of Web 2.0 and social<br />
software tools: can we finally make “student-centered” learning a reality?”, Paper<br />
presented at the World Conference on Educational Multimedia, Hypermedia and<br />
Telecommunications<br />
Lockyer, L., Patterson, J. (2008) “Integrating social networking technologies in education: a<br />
case study of a formal learning environment”, <strong>Proceedings</strong> of 8th IEEE international<br />
conference on advanced learning technologies : 529-533<br />
Mazman, S. G., Usluel, Y. K. (2010) “Modeling educational usage of Facebook”, Computers<br />
& Education, No. 55: 444-453<br />
Negrila, S. (2010) “Cum comunica mall-urile pe Facebook”, wall-street.ro, available on-line<br />
at http://www.wall-street.ro/slideshow/Real-Estate/91365/Cum-comunica-mall-urilepe-Facebook.html,<br />
accesat la 25.08.2010.<br />
Onlinecollege.org (2009) 100 Ways You Should Be Using Facebook in Your Classroom,<br />
http://www.onlinecollege.org/2009/10/20/100-ways-you-should-be-using-facebook-inyour-classroom/,<br />
accessed at 10.01.2011.<br />
Roblyer, MD, McDaniel, M., Webb, M., Herman, J, Witty, J.V. (2010) “Findings on<br />
Facebook in higher education: A comparison of college faculty and student uses and<br />
perceptions of social networking sites”, Internet and Higher Education, No. 13:<br />
134–140<br />
Stansbury, M. (2009) “Coach sued for requesting Facebook logins. eSchool News:<br />
Technology news for today's K-20 educator”, eSchool 20News, Vol 19, No. 9 :4<br />
Young, J. R. (2009) “How not to lose face on Facebook, for professors”, The Chronicle of<br />
Higher Education, Vol.55, No. 22, A1<br />
~ 914 ~
ANNEX 1<br />
Questionnaire on the impact of social networks on educational process in Romania<br />
1. What social networking sites do you use?<br />
FaceBook MySpace Twitter Hi5 Others I do not<br />
access social<br />
networks<br />
2. How often do you visit social networking sites?<br />
I do not access websites<br />
for social networking<br />
Less than 1<br />
time per day<br />
Between 1 and 5<br />
logins per day<br />
Between 6 and 20<br />
logins per day<br />
3. How often do you access other online communication technologies (email)?<br />
I do not have an<br />
email account<br />
Less than 1 time<br />
per day<br />
4. Do you use social networking sites to:<br />
Between 1 and 5<br />
logins per day<br />
I’m not using social networks<br />
Communicating with people whom I've not seen recently<br />
Keep in touch with colleagues<br />
Communication in educational purposes<br />
Personal presentation<br />
Others (please specify)<br />
Between 6 and 20<br />
logins per day<br />
Very<br />
much<br />
A lot A<br />
little<br />
More than 20 times<br />
daily<br />
More than 20 times<br />
daily<br />
Not at<br />
all<br />
5. If you are a member of one or more social networks *:<br />
desktop pc laptop Mobile phone Other devices ( Ipad, tablet pc,<br />
etc)<br />
Access social networks using:<br />
* You can specify multiple variants<br />
6. To what extent do you consider the following elements in the use of social networking sites for teaching and<br />
learning?<br />
Very important Important Less Not at all<br />
important important<br />
Communication with teachers or colleagues, links<br />
to topics, resources or training<br />
Collaboration (within a particular group based on<br />
the sharing of educational topics, resources,<br />
projects, ideas, etc.).<br />
Resource sharing (interchange of documents and<br />
multimedia resources)<br />
Others (please specify)<br />
7. What do you think about the prospects of using social networking sites as a support for classroom activities?<br />
An opportunity for communication<br />
between students and teachers<br />
8. You are:<br />
Male Women<br />
9. Your age:<br />
Less than<br />
20 years old<br />
Between 20 and<br />
30 years old<br />
Online social networks are not<br />
for education<br />
Between 30 and<br />
40 years old<br />
Between 40 and<br />
50 years old<br />
Others (please<br />
specify)<br />
Between 50<br />
and 60 years old<br />
I don’t<br />
know<br />
Over 60 years<br />
old
THE BEGINNINGS OF TRANSYLVANIAN CLUJ<br />
ACCOUNTING SCHOOL<br />
Teodora Viorica FARCAS 1 & Adriana TIRON TUDOR<br />
Babes-Bolyai University, Romania<br />
ABSTRACT<br />
Our contribution in this paper is to identify the main influences that have an effect on the<br />
beginnings of school of accounting from Cluj Transylvania, in XIX century and first part of<br />
the XX century, connected with the political and socio economical changing contexts of that<br />
historical period. We focus our attention mainly on the accounting school created in the<br />
institutional environment of the Academy of High Commercial and Industrial Studies. This is<br />
due to the excellence of this school of accounting, taking into considerations the follows<br />
arguments: the ancientness of the school, the school reputation, professors' fame, the ideas<br />
presented in school research journals, the activity of professors association, the excellence of<br />
this school of accounting.<br />
KEYWORDS: Accounting School, The Academy of High Commercial an Industrial<br />
Studies, Transylvania, Cluj, history, educations<br />
INTRODUCTION<br />
The history of accountancy is, in a large measure, the history of civilization.(Woolf<br />
(1986) .There is a strong emphasis on attempting to study accounting in the contexts<br />
in which it operates (Hopwood, 1983;Napier, 1989).<br />
Our aim is to demonstrate the strong connections between the history of the<br />
foundation of the main schools of accounting from Romania and the social<br />
economical and political context in which was created.<br />
The accounting education started in her incipient form in XIX century in Romanian<br />
territories.<br />
The evolution of economy and merchandise commerce required the appearance of<br />
education forms, which developed in various ways on the territories inhabited by<br />
Romanians.<br />
From all the Romanian territories, Transylvania was the first territory where the<br />
institutions of economic and accounting sciences appeared, having Germanic and later<br />
on Austro-Hungarian influences. Tiron-Tudor A and Matiş D (2010) emphasize that<br />
the accounting system in 19 th century in Transylvania was influenced by German<br />
models.<br />
1<br />
Correspondence address: Teodora Viorica FARCAS, Babes-Bolyai University, Romania;<br />
email: teodorafarcas@yahoo.com<br />
~ 916 ~
The first works in Romanian, in the field of accounting, appeared on the<br />
Transylvanian territory, as here there was an education form intended for the training<br />
of the population in the field of commerce.<br />
The organization of the higher education in Romanian language, in Transylvania,<br />
more exactly in Cluj – Napoca, had several attempts and restraints, but eventually,<br />
they succeeded in setting here a higher education institution, with a major in<br />
economy, which represents today the precursor of the greatest Faculty of Economic<br />
Sciences from Romania.<br />
One of the first higher education Institution in the field of economy, and particularly<br />
in the field of accounting in Romanian language, was settled in Cluj, in 1919, after the<br />
Great Unification. This was called the Academy of High Commercial and Industrial<br />
Studies from Cluj and it can be considered the first form of higher education in the<br />
accountancy field from Transylvania. The institution carried out its activity for 20<br />
years in the town of Cluj, and then it was entirely moved to Brasov due to political<br />
changes.<br />
Our attention will be focused on Cluj first form of higher education in the<br />
accountancy field. There are some reasons for taking a particular institutional focus,<br />
as well as for selecting specifically the Cluj Accounting School as the purview of<br />
interest. Firstly, the specific choice of the Cluj Accounting School for an exploration<br />
of the interrelations between its beginning and the social, economical and political<br />
context at that period is because it is an institution with a rich cultural and social<br />
history, which has and continues to have, a marked influence on the accounting<br />
research and opinions at national level. Secondly, the specific of the period in which<br />
the First Romanian accounting school was set up in Transylvania. Thirdly, as on of<br />
the oldest accounting educational institution in Romania, with over 90 years of<br />
activity deserve an institutional history. Institutional history works commonly appear<br />
in celebration of a key anniversary, as part of accounting history’s role in enhancing<br />
the status of accounting and those who practice it (Carnegie, Napier 1996).<br />
The article is divided into three major parts. The first briefly introduces the reader into<br />
the subject of research by presenting the subject importance and the reasons for<br />
choosing this subject. The methodology used is presented in the second part, the third<br />
part provides the heart of analysis and is structured in three sections one for each<br />
period of time. For each period, the social economical and political context is<br />
explored in the beginning and we continue with capturing the determinant elements of<br />
the evolution of Transylvanian accounting school.<br />
Finally, the concluding section summaries the article as well as presents some wider<br />
implication of the analysis.<br />
1. RESEARCH METHODOLOGY<br />
We develop a qualitative, explanatory study involving a contextual analysis with the<br />
intention to elucidate the contingent nature of the Transylvanian accounting school<br />
evolution by describing events as they occur, with the goal of capturing all of the<br />
richness of everyday behaviour and with the hope of discovering and understanding<br />
~ 917 ~
phenomena that might have been missed if only more cursory examinations have been<br />
made.<br />
The purpose of our historical writing is:<br />
� to tell the story in the present of something happened in the past (Munslow,<br />
2001)<br />
� to explain why certain things in the past happened as they did (Rampolla, 2004)<br />
� to became aware of, appreciate and judge perspectives others than one’s own<br />
both through historical data and through interpretation of what other historians<br />
have said (Marius & Page, 2009)<br />
Under Parker (1993) criteria, our study should be classified as being written “from the<br />
inside” due to the authors affiliation at this school. We follow in our research the<br />
model of historical works on accounting bodies used by Brown (1905), Garrett<br />
(1961), Institute of Chartered Accountants of Scotland (1954), Institute of Chartered<br />
Accountants in England and Wales (1966) and Carey (1969) as examples of works<br />
which had been written “from the inside”.<br />
From a methodological point of view, it was conducted a thorough study of relevant<br />
(mainly Romanian) literature available (textual analysis). We have studied primary<br />
and secondary data of information about the Transylvania history, accounting<br />
education in Romania, and about the Academy of High Commercial and Industrial<br />
Studies written in Romanian language, English and French in order to become<br />
familiarized with the process of accounting education in Transylvania changes<br />
through time.<br />
Furthermore, in order to get an understanding of accounting literature in different<br />
periods of time, and of the development of an accounting literature (and thought) in<br />
Romania, there were been studied older (beginning of the 20th century) and newer<br />
Romanian accounting books.<br />
The analyzed period was split into three distinct periods with the reason of capturing<br />
the events chronology:<br />
� the development phase - before the 1918, when modern Romania was formed<br />
� the mature phase of Transylvanian Accounting School in Cluj - between 1918<br />
and 1940<br />
� the decline phase of Transylvanian Accounting School in Brasov – between<br />
1940-1950<br />
We analyzed individually each of the three periods because accordingly with the<br />
Punctuated equilibrium theory, there were three stasis (- long period of relatively<br />
unchanged form) and three punctuation (radical change over a short duration):<br />
� 1918 the year when all Romanian territory were unified, and the modern<br />
Romania was formed<br />
� 1940 the year when the Academy of High Commercial and Industrial Studies<br />
was refugee in Brasov, due to the Vienna Diktat 30 august 1940,<br />
� 1950 the year when the Institute of Economic sciences and forecasting (the<br />
transformed name of the Academy) was dissolved.<br />
~ 918 ~
However, after 10 years, the Transylvanian accounting school was reborn like<br />
Phoenix bird. In 1961 was founded in Cluj, The Faculty of Economic Sciences in the<br />
framework of Babes Bolyai University who continued the tradition of Academy of<br />
High Commercial and Industrial Studies.<br />
The punctuated equilibrium theory was used for the first time in accounting research<br />
by Alexander and Servalli (2010), to investigate the complex process of accounting<br />
change. The model of Alexander and Servalli was used by Albu, Albu and David<br />
(2010) to analyses the processes and causes of change in history of Romanian<br />
accounting. The main objective of the study was to explore the Romanian accounting<br />
histories in the context of the model as proposed by Alexander and Servalli (2010), in<br />
order to critically examine Romanian attitudes and perceptions today and suggest a<br />
number of rational predictions of likely future developments in an EU/IFRS<br />
environment, in a world where accounting seeks to serve organizations of vastly<br />
different sizes, with vastly different user needs, in vastly different attitudinal contexts.<br />
Tosh (1991:12-13) explained the fundamental premises of historicism as follows:<br />
,,Each age is a unique manifestation of the human spirit, with its own culture<br />
and values. For one age to understand another there must be recognition that<br />
the passage of time has profoundly altered both the conditions of life and the<br />
mentality of men and women – even perhaps human nature itself – and that an<br />
effort of the imagination must be made to relinquish present-day values and to<br />
see an earlier age from the inside.”<br />
For this reason, in our research we consider important to analyze the coordinates of<br />
the Transylvanian accounting school evolution linked with the economic<br />
environment, the historical context at the national level. In this respect we’ll try to<br />
look at the main defining moments of the accounting history marked by the evolution<br />
of capitalism and implicitly the development of Transylvanian accounting school.<br />
We apply the contextual analysis, that helps us to assess the text within the context of<br />
its historical and cultural setting. A contextual analysis combines features of formal<br />
analysis with features of “cultural archaeology,” or the systematic study of social,<br />
political, economic, philosophical, religious, and aesthetic conditions that were (or<br />
can be assumed to have been) in place at the time and place when the text was<br />
created. While this may sound complicated, it is in reality deceptively simple: it<br />
means “situating” the text within the milieu of its times and assessing the roles of<br />
author, readers (intended and actual), and “commentators” (critics, both professional<br />
and otherwise) in the reception of the text.<br />
Our contribution in this paper is to identify the main influences that have an effect on<br />
the beginnings of school of accounting from Cluj Transylvania in XIX century and<br />
first part of the XX century connected with the political and socio economical<br />
changing contexts of that historical period. We focus our attention mainly on the<br />
accounting school created in the institutional environment of the Academy of High<br />
Commercial and Industrial Studies. This is due to the excellence of this school of<br />
accounting, taking into considerations the follows arguments: the ancientness of the<br />
school, the school reputation, professors' fame, the ideas presented in school research<br />
~ 919 ~
journals, the activity of professors association, the professors' role in national<br />
accounting profession organisation.<br />
2. TRANSYLVANIAN ACCOUNTING SCHOOL-THE DEVELOPMENT<br />
PHAS – BEFORE 1918<br />
2.1. The Romanian territories social, historical and economic context before 1918<br />
Before 1918 the Romanian territories were considered individual countries. In history,<br />
Romanian principalities existed mainly independently of one another (at least in a<br />
formal manner), due to mainly external pressures.<br />
Transylvania is one of the Romanian historical territories situated in the North West<br />
part of Romania. In ancient times it was part of the Dacia Kingdom and Roman Dacia.<br />
Since the 10th century, Transylvania became a province of the Kingdom of Hungary.<br />
After the Battle of Mohacs in 1526, it was part of the Eastern Hungarian Kingdom,<br />
out of which the Principality of Transylvania emerged. Most of the time, in the 16th<br />
and 17th century, this Principality was vassal to the Ottoman Empire, and in some<br />
periods to the Habsburg Empire. At the end of the 17th century, Transylvania came<br />
under the control of the Habsburg Empire.<br />
From 1437 to 1848, medieval political power in Transylvania was shared between the<br />
mostly Hungarian nobility, German burghers, and the seats of the Székely people (a<br />
Hungarian ethnic group), while the population was made up by Hungarians, Szeklers<br />
and Germans and Romanians) Starting then, Transylvania was in name attached to<br />
Habsburg-controlled Hungary, though it had a separate status, being subjected to the<br />
direct rule of the emperor’s governors. In practice Transylvania was severed from<br />
Hungary until 1867 when, after the Austro-Hungarian Compromise, the separate<br />
status of Transylvania ceased and it was incorporated into the Kingdom of Hungary as<br />
part of Austrian-Hungarian Empire.<br />
Transylvania became part of Romania only after the First World War, and at that time<br />
the country was represented by Moldavia and Wallachia, other two Romanian<br />
territories, unified in 1859, and gained their independence in 1878 (recognized at the<br />
international level).<br />
Because all of these historical conditions, in Romania capitalism imposed rather late<br />
in comparison with West European countries, which generated a slower development<br />
of accounting in our country. If in the western countries the industrial revolution<br />
started at the beginning of the 17th century, Romania had been until the beginning of<br />
the 19th century a country still in late Middle Ages.<br />
Romania’s economy was still based on a feudal agriculture, the industry almost didn’t<br />
exist, the manufacturers, in classical view, appearing only in the middle of 18th<br />
century. The trade, which was the main economic factor contributing to the<br />
development of capitalism had a lot to suffer in the Romanian historical provinces,<br />
being strongly influenced in the second half of the 16th century by the instauration of<br />
Turkish and Austro Habsburg Empires monopoly (Muresan, 2007). Consequently,<br />
due to the change in international context (in our influence sphere the Turkish Empire<br />
starts losing ground in favour of the Russian empire), until the beginning of the 19th<br />
~ 920 ~
century when the economic life starts developing, accounting hadn’t been a necessity<br />
in the Romanian economic life (Dobroteanu, 2004). The main factors which<br />
influenced directly the economy of Romanian provinces in the 19th century are: the<br />
degree of industrial development, the trade development, the degree of economic<br />
autonomy, capital availability, national independence, etc. (Ionascu, 1997).<br />
2.2. The early beginning of Transylvanian trade and accounting school<br />
Prior to the late 1800s, the terms bookkeeping and accounting were often used<br />
interchangeably because the recording/posting process was central to both activities.<br />
There was little need for financial statements (e.g., income statements) because most<br />
owners had direct knowledge of their businesses and, therefore, could rely on<br />
elementary bookkeeping procedures for information.<br />
For example, in 14th century during the time of crafting organizations, we can find<br />
proof that incomes and expenses accounts were kept, registers and exchanges<br />
document were used, different „stories” of economic activities ( Hrisoave) were found<br />
in towns like Sibiu, Brasov, Rasnov, giving evidence that accounting in its primary<br />
form was quite developed (CECCAR).<br />
Double-entry accounting manifested certainly in the 17th century, in factories in<br />
Sibiu, Brasov and Bucharest (Demetrescu et al., 1979, cited in Ionascu, 1997: 176).<br />
Althought there were proofs that forms of accounting were used in the Romanian<br />
territories long before, considering the registers and accounting books found for<br />
several very old estates of the time, but a significant development was only visible<br />
starting the second half of the 18th century, when commerce began developing.<br />
There were some towns from Transylvania: Sibiu, Brasov and Rasnov, that were<br />
situated in the eastern border of Habsburgic Empire, and had the majority of the<br />
citizens Saxons. These people were brought in by the Hungarian king to repel the<br />
Turks and they came in the area with their habits, traditions, knowledge and<br />
mentalities. The cities flourished with trade, being coveted by its neighbors. These<br />
towns were important trading centers, acting as intermediaries in the long-distance<br />
trade between Western and Central Europe and the Ottoman Empire.<br />
For this reason at the beginning of XIX century Transylvania, the eastern part of<br />
Habsburgic Empire had an economy more developed if we compare with other parts<br />
of Romanian territories (Moldavia and Wallachia).<br />
The Transylvania economy was characterized by a developed structure of trade and<br />
industry, and have bequeathed to us accounting records.<br />
The fact that accounting has invariably been associated with societies where business<br />
has flourished was to Hatfield "so obvious that I offend by explanation. Wherever<br />
trade flourished, the practice of double-entry could be found, lending color to the<br />
views that trade followed double entry, or that double-entry followed trade.”<br />
(Hatfield, 1950)<br />
~ 921 ~
As Bedford (1970) explains “historically the process by which accounting procedures<br />
and thought has been transmitted from one country to another has been by the<br />
physical transfer of accountants.”<br />
The invention of accounting was vital to the development of the capitalistic enterprise.<br />
In particular, double-entry bookkeeping permitted the full representation of the flow<br />
of capital through a business.<br />
However, in the late 1820s the numbers of corporations rapidly increased and to<br />
operate successfully, were needed cost reports, production reports, financial<br />
statements, and operating ratios that were more complex than simple recording<br />
procedures could provide.<br />
Referring again to Transylvania and trade, we can give as an example the spices, that<br />
were a major element in the transit tradeoff oriental goods. Pakucs studied the subject<br />
using data available from the beginning and from the fifth decade of the sixteenth<br />
century: the customs registers as primary sources for reconstructing commercial<br />
traffic. Using a comparative approach the author presents the amounts of different<br />
spices that reached Transylvania through the customs of Brasov and Sibiu. Although<br />
Brasov attracted a far larger amount of goods and number of traders than Sibiu, the<br />
latter surpassed Brasov in the trade with saffron and other spices. Apart from pepper,<br />
the quantities of spices brought to the Saxon towns via Wallachia are not very<br />
impressive.(Pakucs 2002)<br />
For centuries, the city of Brasov was (and still is) Transylvania's gateway towards the<br />
South and East. As the renowned Harvard professor Samuel Huntington shows in his<br />
work "The Clash of Civilizations", this is where (ideologically) Europe ends. The<br />
fault line between the western and the eastern civilization runs indeed through Brasov,<br />
separating Transylvania from the rest of Romania (Huntington, 2003).<br />
Due to its geographical position, at the crossroads of Moldavia and Wallachia, Brasov<br />
has had a fast economic growth, becoming one of the most important markets in<br />
Transylvania. On the 14th century Brasov became one of the most economical and<br />
political strongholds in the Southeast of Europe and on the 16th century also a cultural<br />
center. Johannes Honterus, a great German humanist, worked most of the time in<br />
Brasov and Deaconu Coresi printed the first Romanian book also in Brasov.<br />
2.2.1. Books<br />
The first trade book, who precede the Romanian accounting literature is considered to<br />
be the paper "Izvod pentru lucrurile de obste si dechilin în scrisori de multe chipuri"<br />
(Sibiu, Petre Bart printing house), a translation from Slavonic language made in 1792<br />
by Dimitrie Evstatievici, who was a school director. The book contents models for<br />
contracts, receipts, accounts, trade bills etc.<br />
In 1837, in Brasov, is published the first double entry bookkeeping in Romanian<br />
language, “Pravila comerciala” under the signature of the well known teacher from<br />
Brasov Emanoil Ioan Nechifor that offers in this way a good example for other<br />
accounting teachers and practitioners. It is worth saying that Nechifor creates his own<br />
terms, in Romanian, which was very important and hard to do at that moment. The<br />
~ 922 ~
first accounting manual written in Romanian includes procedures and economic<br />
calculus, principles of commercial moral and ethics, notions of administration and<br />
commercial law. The Nechifor accounting book was a translation from the German<br />
language Practical usage of double entry accounting. Some other translations of that<br />
period, published in the 1830s and 1840s were adapted from French - J. J. Jaclot, La<br />
tenue des livres enseignée en vingt et une leçons - and German (CECCAR, 2006;<br />
Drăgănescu-Brateş, 1941). Some time later, in 1844, in Bucharest was published by<br />
Dimitrie Jarcu the paper „Scriptura Doppia or the bookkeeping”.<br />
Allowing for the difference in context, Rusu et al. (1991: 52) compare the<br />
contribution of Nichifor for Romania with that of Luca Pacioli at the international<br />
level, as they consider fundamental Nichifor’s work of disseminating in Romanian a<br />
first treatise of accounting and commerce, using mathematics and economic<br />
philosophy, religious and laic literature in order to influence merchants and<br />
accountants.<br />
Due to the economic growth, accountancy also has a significant rise: there appeared a<br />
series of works about accountancy, such as those belonging to Honoriu Warta<br />
(“Tinerea registrelor în partida simpla si în partida dubla” – Single and double entry<br />
bookkeeping in 1873), Ion Ionescu de la Brad (“Mic tratat de contabilitate”<br />
Accounting small book in 1870), Dimitrie Iarcu (“Contabilitatea casnica” House<br />
Accounting in 1863 and “Contabilitatea agricola” Agricultural accounting in 1870),<br />
Theodor Stefanescu (“Contabilitate în partida dubla” Double entry accounting in<br />
1873) and other.<br />
Only in the second part of XIX century we can speak about the beginning of<br />
Romanian accounting thinking. The writings of the time prove that until 1888 there<br />
hadn’t been an official organization of a guild of accountants in Romania. Until that<br />
moment there had been only the distinction between an accountant and a bookkeeper.<br />
In this sense, Stefanescu (1874: 93) believes that an accountant needs economics,<br />
finance, math knowledge, the difference between the two professional categories<br />
being like the one between an architect and a mason (Zelinschi).<br />
In 1874 Professor Theodor Stefanescu published „The course of double entry<br />
accounting”. Even if his source of inspiration were mainly French authors, we must<br />
say that his study can be considered the first study that was no longer a simple<br />
translation of compilation. It opened a new way for the Romanian accounting thinking<br />
and practice.<br />
Up to the end of XIX century we can observe that a great number of translations and<br />
original works regarding accounting are published in the important centers of culture<br />
and economy such as Brasov and Cluj in Transylvania, Bucharest, Iasi and Galati in<br />
other Romanian territories.<br />
2.2.2. Influence of European practices<br />
Transylvanians movements derived their inspiration from the eighteenth-century<br />
European Enlightenment. Younger were students of the French Enlightenment and<br />
of German classicism. Samuil Micu, the founder of modern Romania, was deeply<br />
influenced by the contemporary Austrian Enlightenment as a student at the<br />
~ 923 ~
University of Vienna. Other examples abound. It is conclusive that the common<br />
heritage of movements included a keen assimilation of the Enlightenment and a<br />
strong desire to improve Transylvanian society.<br />
XIX century in Romanian accounting is a period that may be characterized by the<br />
adoption of the best European accounting practices. (Tiron, Mutiu) In the context of<br />
the advanteges of the Romanian territories position (“a bridge between Central Europe<br />
and the Far East”), Rusu et al. (1991: 50-51) show the possitive infuence of tranzit<br />
commerce on accounting development.<br />
In XIX century, the numerous theories of „accounts” aimed at finding the basic rules<br />
of keeping books, sough to disentangle the „mystery” of double-entry. Among the<br />
most frequently mentioned authors dealing with two and four series theories were<br />
several Italian scholars: Cerboni Giuseppe (1827-1917 and Tuscan school with his<br />
„logismografi”, Francesco Villa and the lombardian school and Fabio Besta and the<br />
Venetian school with their materialistic theory of accounts. These theories was<br />
developed in time by Edmond Degranges- the father.<br />
Given the presence of Venetian or Genovese merchants (starting 1200) on Romanian<br />
territories, there can be no doubt that Romanians learned accounting and bookkeeping<br />
principles from them.<br />
At the beginning of the nineteenth century the former glory of Italian accounting was<br />
overshadowed by its decline during the eighteenth century, and accounting literature<br />
from France, England, and Germany took centre-stage.<br />
Concerning the influence of foreign literature, Demetrescu underline that the French<br />
literature was used in the south part of Romanian territories ( Muntenia), while the<br />
Italian literature was used in Moldavia and the German literature in Transylvania.<br />
There were also some theories in the accountancy field at that time. “Theories of<br />
accounts” (rather than “accounting theories”) dominated not merely the early but also<br />
the later part of this century when Italian accounting had regained a prominent<br />
position beside other countries. The relation of those theories to the “charts of<br />
accounts”-which later became so prominent in Continental Europe is historically<br />
important.<br />
Different authors of XIX century support theories based on individual study or<br />
materialistic theories. The former (theories based on individual study) tried to<br />
identify every account with a person responsible for it, while the materialistic<br />
theories derided such an attempt. Another dispute was how many classes of accounts<br />
were used. Their numbers originally ranged from one to about five. Many<br />
combinations of these criteria existed. In XIX century another scientific dispute was<br />
between entity versus proprietary theories, as well as the emergence of other<br />
theories. (Mattessich, 2003)<br />
Schar developed materialistic theories with two classes of accounts, the most<br />
successful category. He was the father of one version of the basic equations (A-L) =<br />
OE which was to indicate that the accounts of assets and liabilities form one single<br />
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category, and those of owners equity form the other. This theory was advanced by<br />
Hugli and above all Schar.<br />
In XIX century in Transylvania was used the most successful theory of that times, a<br />
developed theory of Venetian school. Hugli’s materialistic theory of two accounts<br />
classes. This was further developed by another Swiss Schar whose „closed accounts<br />
system” was regarded by Scherpf (1955:8) as the fist chart of accounts in the proper<br />
sense.<br />
2.2.3. Accounting personalities<br />
Accounting is a human construction. Contemporary accounting cannot be<br />
understood without reference to the key personalities who have contributed to<br />
accounting development (Millerson, 1964, p. 50; Parker, 1993). Recent studies on<br />
the formation of the accounting profession may present pitfalls to historians who<br />
choose to undertake explanatory biographical investigations of accounting’s past. In<br />
an article Napier (1989) refers to these studies and their authors. These studies<br />
propose different factors such as social class (Macdonald, 1984), gender (Kirkham<br />
and Loft, 1993; Roberts and Coutts, 1992), political acuity (Willmott, 1986),<br />
relations with the State (Chua and Poullaos, 1993; Chua and Sinclair, 1994;<br />
Poullaos, 1993) and links with other professions (Kedslie, 1990a; Macdonald, 1984)<br />
as determinants of the professionalization of accounting.<br />
Emanoil Ion Nikifor the first author of an accounting book in Romanian language<br />
was teacher at Trade School in Brasov. His book printing cost was sponsored by<br />
Gheorghe Nica, a great trader who was in the sale tile the supervisor of Trade<br />
School, founded by Gheorghe Baritiu, in 1837 in Brasov. In introduction, Nichifor<br />
present his good intention to help his colleagues with a book wrote in Romanian<br />
language following the Austrian model of accounting. Also in the book were used as<br />
well a lot of Germans words: Weksselgeschaft, Gericht, Kommission-Buch., etc.<br />
Another important personality for the Romania and Transylvania was I. C. Pantu. He<br />
was born in Brasov in 1860, and after the high school, in 1879 he went to Vienna to<br />
continue his studies at Trade Academy. In parallel he was student at Philosophy and<br />
Polytechnic University. At his return in Brasov in 1882 he start to teach accounting<br />
and business correspondence at Commercial school Andrei Birseanu till his<br />
retirement in 1921. In 1898 Pantu published his firs double entry accounting book<br />
and some others after 1900. In his books introduction Pantu mentioned that he was<br />
inspired by German literature of Kurtzbauer, Augspurg, Ziegler,Schar, Hugli, Reisch<br />
, Kreibig and French literature of Leautey, Guilbaut, Granges, Andoyer and Mertens.<br />
He declared himself to be pro for the materialistic theory with three series of<br />
accounts and a supporter of mathematical concept of accounting.<br />
2.2.4. Accounting vocational schools<br />
C. G. Demetrescu considers that including accounting as a study object in the<br />
teaching system had an important impact in the development of the accounting used<br />
in the Romanian states. In this respect, after 1831, the teaching curricula for the<br />
secondary schools, included subjects with a profound commercial character,<br />
accounting included.<br />
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In Transylvania, the roots of accounting schools start up in Cluj and Brasov. In 1837<br />
the Trade School from Brasov curricula contents accounting discipline, and the<br />
course book was Pravila Comerciala writed by Emanoil Ioan Nichifor.<br />
Also, in other Romanian territory, like Iasi in 1838, Braila in 1843 and Bucharest in<br />
1844, accounting discipline was included in trade schools curricula.<br />
In XIX century the economic development requests qualified employees in<br />
industrial, agricultural and trade activities. For this reason, Trade and Industry<br />
Chambers from Transylvania (founded by law in 1850) supported the foundation of<br />
commercial schools for trade and other business activities. In Transylvania were<br />
14 commercial schools with a three years study curricula including discipline like:<br />
trade history, accounting, business correspondence, commercial mathematics,<br />
economics principles, and commercial law. In parallel, there were some projects<br />
concerning the foundation of higher studies in economics.<br />
In 1835, in Cluj was founded the Normal Trade School and in the second part of XIX<br />
century was founded the High School of Trade and in 1902, at the Trade and industry<br />
Chamber of Cluj, was founded the Trade Academy of Cluj. The two years curricula of<br />
the Academy consist theoretical and practical knowledge combined with economic<br />
legal framework. The management, the pedagogical activities and the curricula were<br />
influenced by that time models from Vienna, Budapest, Prague and Bratislava, but<br />
taking into consideration the Transylvanian economies needs.<br />
The elementary schools of commerce, where courses lasted three years, accepted<br />
candidates with a primary education diploma, while the high schools provided four<br />
year courses and accepted graduates from lower secondary schools or elementary<br />
schools of commerce. The courses taught in the schools of commerce were primarily<br />
practical and accounting was concerning only the facts of commerce. The graduates<br />
enjoyed good career opportunities, especially in accountancy, banking, education<br />
and public administration. They predominantly filled positions as accountants in the<br />
private or public sectors (Zelinschi).<br />
In our opinion the educational institutions (trade schools) which create, transmit and<br />
legitimize the body of knowledge, are a key part of the accounting history in any<br />
country. These institutions also play another role in that they establish a social<br />
network and a community which share the same formal education and professional<br />
interests in the early 20th century. The schools of commerce in Romania were the<br />
primary institutions which diffused accounting knowledge, in addition, the alumni of<br />
these schools formed a well developed network that provided a basis for building the<br />
accounting profession (Zelinski).<br />
2.2.5. Accounting academic school<br />
As professor Walker says in his work, the national contexts set the conditions for the<br />
development of accounting in universities (Anderson-Goughin, Edwards and Walker,<br />
2009). The first academic studies in Cluj were started in the mid of XVI century. In<br />
1565, it was established to set-up a Calvin College in Cluj – Napoca; but this was<br />
achieved only in 1581, once Prince Stefan Batory started to reign the territory; so on<br />
12 May 1581, a University with the office in this town was set-up. The University of<br />
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Cluj, also called College, was organized and managed by the Jesuit monks sent from<br />
Poland, and this University raised at the level of the Western Universities.<br />
The first University of Cluj had a religious background; its main purpose being that of<br />
drawing young people to Catholicism. In 1603, because of denominational debates,<br />
the University was dissolved.<br />
In 1698, a new University was set-up in Cluj, this time by the Habsburgs, but its<br />
purpose was also religious. At this moment, the teaching language at Universities was<br />
Latin. Although they tried to draw young people to Catholicism, this did not happen;<br />
instead, young people had access to learning, which was very difficult to get at that<br />
time.<br />
Because State intervention was stronger and stronger, in 1776, the Emperors in<br />
Vienna agreed that the Catholic University of Cluj would become interdenominational.<br />
On this occasion, the Piarists, who were more permissive, replaced<br />
the Jesuits. This may be noticed in the increased number of students from that period.<br />
In 1784, the number of Universities from the Empire was reduced to only three, in<br />
Vienna, Lowen and Buda, the rest of the education institutions being transformed into<br />
high shcools. The University of Cluj was transformed in the „Academic Royal High<br />
School” (Dana Pop, 2005).<br />
The teaching languages in these schools were Latin, German, Hungarian, but not<br />
Romanian. The attempts of the Romanians from Transylvania were countless, they<br />
wrote many appeals and sent them to Vienna, requesting to set-up a University for<br />
Romanians, where the teaching language would be Romanian and the teachers would<br />
be Romanians.<br />
Thus, following the Gathering of Blaj, in the 19 th century, a Juridical Faculty was setup<br />
in Sibiu, but the teaching language was German. The Romanians wished to set-up<br />
a University in Cluj, where the teaching language would be Romanian. The<br />
publications of that period, Gazeta Transilvaniei [The Gazette of Transylvania], as<br />
well as the Romanians from the other territories supported the cause of the Romanians<br />
from Transylvania.<br />
After the annexation of Transylvania to Hungary in 1867, in 1872 it was decided to<br />
set-up a University in Cluj, where the teaching language was Hungarian. The<br />
University had four Faculties: Law; Medicine; Philosophy, Literature and History;<br />
Mathematics and Natural Sciences. At that time, the University had several<br />
shortcomings, beginning with the teachers and continuing with the material resources.<br />
At the same time, the access of the Romanians to education was modest, and the fact<br />
that the Romanian language and literature were taught in Hungarian was very difficult<br />
to accept for the Romanian population.<br />
Economics disciplines were included in Law Faculty curricula (economy, public<br />
finances and corporate finances, statistics, commercial law, commercial<br />
correspondence, and accounting) but also in the curricula of other faculties<br />
(economic history, economic geography, statistics and mathematics of economics).<br />
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2.3. Conclusion about the before 1918 period<br />
In Europe, once with the increase in the number of corporations, there arose as well<br />
a demand for additional financial information. With no direct knowledge of a<br />
business, investors had to rely on financial statements for information, and, to create<br />
those statements there were required more complex accounting methods. Therefore<br />
the accountant’s responsibility expanded beyond simply recording entries to include<br />
the preparation, classification, and analysis of financial statements.<br />
As John L. Carey (1969) wrote in The Rise of the Accounting Profession, ‘‘the<br />
nineteenth century saw bookkeeping expanded into accounting’’. Additionally, as<br />
the development of the corporation created a greater need for the services of<br />
accountants, the study of commerce and accounting became more important.<br />
Although there had been trade business schools and published texts on<br />
accounting/bookkeeping, traditional colleges had largely ignored the study of<br />
business and accounting. When a lot of major universities decided to create schools<br />
of commerce, the accounting started to secure a significant place in the curriculum.<br />
Once with the separation between management and ownership in corporations, there<br />
arose as well a need for an independent party to review the financial statements.<br />
Someone was needed to represent the owners’ interest and to verify that the<br />
statements accurately presented the financial conditions of the company. Moreover,<br />
there was often an expectation that an independent review would discover whether<br />
managers were violating their fiduciary duties to the owners. Additionally, because<br />
the late nineteenth century was a period of major industrial mergers, someone was<br />
needed to verify the reported values of the companies. The independent public<br />
accountant, a person whose obligation was not to the managers of a company but to<br />
its shareholders and potential investors, provided the knowledge and skills to meet<br />
these needs.<br />
Even though Romanian society developed a lot during the 19th century, this is more<br />
an appearance than a reality. The development of western nations was more<br />
significant for the same period, because a strong obstacle in the development of the<br />
capitalist society was in the Romanian countries the suzerainty, even formal,<br />
towards the Turkish Empire. Only after the War of Independence from 1877-1878,<br />
the basis of a modern economy could be establish in the real sense of the word,<br />
because of the political and legal freedom that was obtained. This moment marks the<br />
beginning of the Romanian accounting thinking.<br />
Certainly, in Romania, the development of accounting depended to a large extent on<br />
economic development, on the concrete conditions in which both the social and the<br />
economic field evolved.<br />
After reviewing the accounting and history literature, we could identify the different<br />
impact of the foreign influence. Major factors which are contributing to the way of<br />
Romanian accounting evolutions are as follows:<br />
� the influence of economics, characterized by: the industrial development rate,<br />
the trade evolution, the economical autonomy rate, the available capital, the<br />
financing system, the management system of enterprises.<br />
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� the political influence and the domination of Austro Hapsburg Empire in<br />
Transylvania and Ottoman Empire in other Romanian regions.<br />
� Cultural influences: the Austro Hungarian Empire has left on the Transylvania<br />
a large number of habits regarding the administrative organization as well the<br />
German influence of the accounting school can be found in the accounting<br />
theory. In the same period, in others Romanian territories, not part of the<br />
Austro Hapsburg Empire, the Latin origins of the Romanian people and the<br />
similarities with the French culture have influenced the legal system – based<br />
on laws and the accounting.<br />
Historians of accounting will of course have disparate interests and agendas, and<br />
their research may well be used by others of different standpoints. Through all of<br />
this, the words of Haskins, asserting that accounting history helps us to “understand<br />
our present and…forecast or control our future” (Haskins, 1904:141), return as a<br />
challenge to current accounting historians.<br />
3. THE MATURE PHASE OF TRANSYLVANIAN ACCOUNTING SCHOOL<br />
IN CLUJ – BETWEEN 1918 AND 1940<br />
3.1. The Romanian territories social, historical and economic context after 1918<br />
Internationally, this period was marked by two important events: the Second World<br />
War (1939-1940) and the Great Depression (1929-1933). These events have had<br />
negative economic consequences, but subsequently led to the formation of the<br />
Common Market.<br />
The 1918 is for Romanians the “Unification year”, the year of the formation of<br />
Greater Romania, when Moldavia and Wallachia were joined by Transylvania,<br />
Bukovina and Bessarabia. This unification and the end of the First World War had<br />
brought lots of changes in the economic, politic and cultural context.<br />
First World War ended on 11 November 1918 by the defeat and capitulation of<br />
Germany and the signing of the armistice from Retondes. On December 1, 1918 in<br />
Alba Iulia proclaimed the Grand Union of all the Romanian. This Union was all that<br />
the Romanian wanted for ages.<br />
In the interwar period - 1918-1938 - Romania has undergone several phases:<br />
a) 1919-1922 – the stage characterized by the destructions of the First World<br />
War,<br />
b) 1922-1928 – period of relative development, when Romania restore the<br />
economic, industrial and agrarian production and completed its political and<br />
economic unification;<br />
c) 1929-1933 – economic crisis, characterized by: high inflation, unemployment,<br />
poverty;<br />
d) 1934-1938 – Romania's economic boom period due to the protectionist<br />
policies and intervention state in the economy.<br />
Romania between Wars is an agricultural-industrial country. Peasants are now the<br />
subject of the biggest land reform in postwar Europe and the industry knows an<br />
accelerated growth. Romania, in terms of energy is independent and manufactures<br />
~ 929 ~
locomotives, buses, airplanes, various electro-technical articles, features and<br />
important chemical industries, food, textiles. Oil production situates Romania first in<br />
Europe, gas and gold Romania ranking second in the same tables. National income of<br />
110 dollars per capita was higher than the Balkan states.<br />
In the accounting plan, this period is marked by existing global concerns to create a<br />
chart of accounts (in Western countries especially Germany) and those on Improved<br />
financial communication. Romania was sharing the ideas existing at the European<br />
level.<br />
3.2. Romanian Academy of Higher Commercial and Industrial Studies, Cluj<br />
After the Great Union of 1918, the new Romanian University of Cluj was organized.<br />
For this organization, there was taken into consideration the opinion of the Bucharest<br />
University and the Iasi University. In the mean time, for the beginning, teachers from<br />
the Old Kingdom were brought to this University, and only 8 out of 20 teachers were<br />
from Transylvania. The University had four Faculties, namely Letters and Philosophy,<br />
Sciences, Law and Medicine.<br />
The need of having a higher economy education was felt even at the beginning of the<br />
19 th century. Thus, once with the setting up of the University teaching in Romanian in<br />
1919, only after an year, in 1920, there was set up the first form of higher economy<br />
education, namely the Commercial Academy (which in 1922 was called the<br />
“Academy of High Commercial and Industrial Studies”).<br />
3.2.1. Books<br />
During the First World War there were no writings in the accountancy field in<br />
Romania, the war interrupted all the work that was made before in the second part of<br />
the 19 th century. However, after 1921, the accounting literature begins to develop<br />
a lot.<br />
Between 1925-1927 the accounting courses appear in three volumes compiled by<br />
professor C. G. Demetrescu, who was teaching at the Higher Commercial School in<br />
Iasi. They have been used for three decades by all business schools in the country,<br />
including students of the Academy of Higher Commercial and Industrial Studies<br />
from Cluj.<br />
In 1932, D. Voina, Professor at the Academy of Higher Commercial and Industrial<br />
Studies from Cluj, has published his PhD paper: “Phases in the evolution of<br />
accounting”. In this paper, the author has study the evolution of the accountancy in<br />
Italy, France and Germany.<br />
The period of the Academy of Higher Commercial and Industrial Studies from Cluj is<br />
characterized by a large number of writings, articles in the accountancy field, that<br />
were written and published by the professors of the Academy.<br />
For this reason, in 1930, there was founded an important economic magazine -<br />
“Observatorul Social – Economic”, which became “the most important and wellknown<br />
in our part of the country and one of the best in the whole country”. (Victor<br />
~ 930 ~
Jinga, 1943:1). During its 14 years of existence, all the important writings – including<br />
a large part of the professors and students works - were published in this magazine<br />
(222 articles and studies, and many notes, book presentations and reviews).<br />
In the period when the Academy functioned at Cluj, (for 10 years, until 1940), in<br />
“Observatorul Social-Economic” there were published two papers in the accountancy<br />
field, both written by Iosif Gârbacea. One of this was referring to the control<br />
problematic in the companies, and the other one was about the Romanian currency<br />
(this is more an economic paper).<br />
In addition to published works by teachers, the accounting literature in Romania in the<br />
period after 1918, was enriched by the published works of the ones who were working<br />
in the field of accounting. For example Aug. Dorwagen has published the works:<br />
“Agricultural Accounting” (1921) and “Analytical studies related to agricultural<br />
technical accounting, economics and agricultural policy, as well as livestock and<br />
zooeconomics” (1913).<br />
3.2.2. Accounting personalities<br />
In the first year of Academy activity, its courses were taken by 35 students, followed<br />
by a group of professors made of six personalities of the Cluj academic environment:<br />
Gheorghe Moroianu (Political Economy), Ion Mateiu, Octavian Prie (Romanian<br />
Language), Aurel Ciortea (Commercial Mathematics), Constantin Leca (German<br />
Language) and Ion I. Lapedatu (Financial Science and Legislation).<br />
The founding professors, besides the above-named ones, were Gheorghe Bratu<br />
(Commercial Arythmetics), Silviu Dragomir (History of Commerce); Ion Evian and<br />
Dumitru Voinea (Accounting), Dumitru B. Ionescu, Victor Jinga (Political Economy).<br />
Some of them worked as professors at the Cluj University, others came from the preuniversity<br />
environment and from the business environment from Transylvania.<br />
At the same time, personalities of the accounting history, well-known people, who left<br />
important works in the field of the Romanian accounting, worked as professors at the<br />
Academy. In the table below, the most important experts of those times are identified:<br />
Table 1. Accounting professors of the Academy of High Commercial and Industrial<br />
Studies<br />
Ion Evian Accounting<br />
Dumitru Voina General Accounting<br />
Iosif Ioan Gârbacea General Accounting<br />
Ioan Tarţa Financial Accounting<br />
Dumitru Haşiegan Statistical Accounting<br />
Octavian Lungu Accounting<br />
3.2.3. Accounting vocational schools<br />
As we said in the first chapter the number of commercial schools was hight since the<br />
19 th century, and the tradition will continue in the next century too. So on 1<br />
September 1918 has been founded in Brasov the State Higher School of Commerce.<br />
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During the school year 1921-1922 the School of Commerce was reorganized after the<br />
similar model of schools of those times, turning into commercial school for 4 years.<br />
At the end of the 1928 the number of medium comercial schools has increased in<br />
Transylvania at the number of 54.<br />
After the 1918 in Transylvania and Cluj, there was an important number of schools<br />
that were teaching commerce. Here are few of those: The Commercial Academy in<br />
Cluj (1878-1923), Apprenticeship commercial school in Cluj (1882-1961), The<br />
Commercial High School for girls ,,Marianum” (1896-1948), Commercial practice<br />
school Cluj (1924-1931), Turda middle commercial technique school (1928-1955),<br />
The Superior commerce School from Dej(1929-1931), The Superior Commerce<br />
School for boys ,,Great Prince Mihai” from Cluj (1931-1954) .<br />
3.2.4. Accounting academic school<br />
As we have already mentioned, the Academy of High Commercial and Industrial<br />
Studies was set up in Cluj in 1920. In 1922, the Academy was structured in two<br />
sections:<br />
� Commerce, Bank, Insurance Section<br />
� Industrial Section<br />
After a while, a new re-structuring of the sections took place, this time in three<br />
specialization groups:<br />
� Economic Sciences<br />
� Financial Sciences<br />
� Social Sciences<br />
Based on the above, it can be noticed that at the Academy was no Accountancy<br />
section, in spite of this in the university environment, it is very important to<br />
understand the relationship of the accountancy with economics and also the<br />
accounting itself through educational practices. However, accounting itself was to<br />
become increasingly distanced from a very theoretical mathematically oriented<br />
economics (Sanderson 1972: 202). Solomons (1974) identifies the McNair Report<br />
(which instigated the Universities Scheme) as the source of a problematic relationship<br />
with economics. In Solomons’ view this scheme maintained accounting in a<br />
subordinate position within universities. (Anderson Goughin J.R., Edwards and<br />
Walker, 2009)<br />
In the first ten years of existence, approximately 2000 students attended the academic<br />
courses, then until 1948, the number of students exceeded 10.000. As of 1 January<br />
1930, the academic and research activity of the higher economic education institution<br />
from Cluj was organized through a special law, namely the Law of the Academy of<br />
High Commercial and Industrial Studies.<br />
3.2.5. Conclusion about the period<br />
This period was one of a new beginning. The Unification contributed to a high<br />
development of the superior economic education. In this context it was founded the<br />
first form of higher education in Romanian language in Transylvania, the Academy of<br />
High Commercial and Industrial Studies from Cluj.<br />
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The accounting literature is rich after 1918, a large number of professors and students<br />
from Transylvania and from the other Academies from Romania published important<br />
papers in the accountancy field. Also there were few accountants that were not<br />
professors who published some works in the accounting field.<br />
There was an important review of the Academy, were all the works of the professors<br />
and students were published. The name of this review was ,,Observatorul socialeconomic”.<br />
The period of the Academy in Cluj was one of organization and beginning<br />
of academic work in all the economic fields including accountancy.<br />
4. THE DECLINE PHASE OF TRANSYLVANIAN ACCOUNTING SCHOOL<br />
IN BRASOV – BETWEEN 1940-1950<br />
4.1. The Romanian territories social, historical and economic context after 1940<br />
The Second World War broke out on 1 September 1939 in the contradictions between<br />
the imperialist powers because of the desire for territorial expansion and domination<br />
of Nazi Germany.<br />
In the spring begins the great German offensive in the West, which leads on the one<br />
hand, to the occupation of Denmark and Norway, and on the other to the dissolution<br />
of French military power. Marshal Petain called a truce (17 June 1940), and not only<br />
the France collapsed, but the entire European political system including Romania. On<br />
26 June, after the Romanian government's ultimatum presented by the Soviet<br />
government, the territory between the Prut and Dniester, and northern Bukovina came<br />
into the Soviet Union.<br />
Romania had been part of the beneficiaries of peace of the World War, Germany<br />
claimed the former losers, who, encouraged by her great military successes, now<br />
openly calling for the revision of borders. Romania was forced to accept so-called<br />
"arbitration", in fact the Vienna Dictate (30 August), decided before the two foreign<br />
ministers, the Germany and Fascist Italy, and to give an area of 42,243 km square in<br />
Transylvania, including Maramures, Crisana and northern Transylvania, including<br />
Cluj. In this context the Academy of High Commercial and Industrial Studies will<br />
move to Brasov.<br />
After a short period of neutrality, Romania joined the Axis Powers in June 1941<br />
during the government of Ion Antonescu. In 1944, after Antonescu was removed,<br />
Romania joined the Allies powers. Romania's participation in the Second World War<br />
was characterized by the two campaigns: one in the East for the liberation of<br />
Bessarabia and Bukovina, and Western for the liberation of Transylvania.<br />
4.2. Transylvanian Accounting school decline<br />
After the Vienna Dictate, more precisely in September 1940, as we said before, the<br />
Academy of High Commercial and Industrial Studies of Cluj had to find a new<br />
location in Transylvania. The University of Cluj was moved to Sibiu and Timisoara,<br />
and the Academy of High Commercial and Industrial Studies was moved to Brasov, a<br />
town with tradition for the Romanian economic and accounting education.<br />
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During the first years of activity in Brasov, conditions were quite harsh, because<br />
nothing was prepared for the receiving of the new University in town. First of all there<br />
was not a building of the Academy; the courses were held at a high school and even at<br />
cinema Astra. Thus, the professors and the students from Cluj needed to rebuild the<br />
Academy in Brasov.<br />
4.2.1. Books and accounting personalities<br />
During over 25 years, a significant series of papers with a didactic character were<br />
published. Some of them included important historical references and dealt with the<br />
fundamental topics of a discipline.<br />
The professors I. N. Evian and Dumitru Voina with their writings broght into the<br />
heritage of accounting new elements of thinking. The first one developed the<br />
economic conception above the accountancy in two fundamental books, and the other<br />
one has created the economic and legal theory.<br />
Although the prevalence of substance over form was set out as a principal relatively<br />
late in Romania, there were "voices" to refer to an "economic outlook" of accounting<br />
in contrast to a "legal concept". Thus I. Evian in "Industrial Accounting" published in<br />
1947, makes clear that the accounting technique would have the objective to follow<br />
the economic phenomena that occur in companies, not the registration of their<br />
patrimony.<br />
Between the two opposite approaches of accounting, the patrimonial one, sustained by<br />
professor Spiridon Iacobescu, and the economic one, sustained by Ion Evian, has<br />
made its way the economic and legal thinking of Dumitru Voina. The economic and<br />
legal conception of Voina brings new elements in the judgment of fundamental<br />
problems of the accountancy. In his writing, "General Accounting", Voina, presents<br />
the following definition of accounting: "Accounting observe the movements of values<br />
that are causing economic phenomena and legal relationships, describe them and<br />
represent their numerical , groups them into categories and then reconstituted by the<br />
synthesis calculations, the entire life of the organism that falls within its research<br />
area” (Voina, 1947).<br />
The professor Ion Evian, also wrote "Theories of accounts", in which will try to<br />
remove legal elements from accounting, the author being an adept of German<br />
literature. His belief consisted in the fact that accounting is only an arithmetic<br />
supplement of economic science.<br />
Accounting professors and specialist were at that time at the Academy, also: Garbacea<br />
Iosif, Hasiegan Dumitru, Lungu Octavian, Lupas Semproniu, Manolache Mihai, Tarta<br />
Ion V., Rusu Dumitru, Turdeanu Lucian. They also published their work in the<br />
Academy review ,”Observatorul social-economic”.<br />
Beside the publication of the Academy from Cluj-Brasov, in Romania there were<br />
other few reviews with accounting specific. The most important was “The General<br />
Review for Commerce and Accountancy” (1908-1916 and 1921-1946), replaced from<br />
1937-1955 with “The Accounting Newsletter”.<br />
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4.2.2. Influence of European practices<br />
The influences from the outside in the period of the Academy in Brasov were the one<br />
that influenced from the beginning the writing in the accountancy field in this part of<br />
the country. Thus first of all there was the German influence, very well ilustrated by<br />
Iosif Garbacea, who published in the review of the Academy two papers having a<br />
German example: “Hans Scherpf: Handelsbilanz-Steuerbilanz” and “Dr. W<br />
Shroder:Bilanzverglich mittels Bewegungs-Bilanz und Kennziffern”, Hamburg, 1942.<br />
The French influence was expressed by Ioan Tarta, the professor that wrote about<br />
Henry Fayol in a paper, published in the review of the Academy.<br />
Concerning the Italian influence, Iosif Garbacea wrote three papers about this<br />
influence in the accountancy field: “Nello celio la contabilita nel nuevo codice…berna<br />
1939”, “Gino Zappa: Le volutazioni di Bilancio con particolare reguavdo ai bilanci<br />
delle sicieta per azinoni. Milano” and “The Italian influence in the accountancy field”.<br />
This influence can be seen very important because in Italy the accountancy was taught<br />
in the Universities since the nineteenth century, so that it was a very strong tradition<br />
already there (Anderson Goughin J.R., Edwards and Walker, 2009).<br />
4.2.3. Accounting vocational school and accounting academic school<br />
As well as in the other two periods, there can be identify some schools of accounting<br />
and commerce in Transylvania area: The Commercial High School for girls<br />
(1940-1953), The Economic High School from Odorheiul Secuiesc (1943-1975),<br />
Trading technique middle school for boys Cluj (1945-1955), Hungarian trade school<br />
(1945-1948).<br />
There will be identified a growth of university accounting education in this period,<br />
that can be seen as the continuing story of the dynamic of the credentialing and<br />
licensing practice. The initial exporting of the practice of credentialing and licensing<br />
(as in accounting) beyond the university was one thing. People recognised the<br />
universities as the experts in expertise in general and were willing to see the<br />
qualification in general as a sign of expertise. However, trying to use this new<br />
knowledge identity to establish a different set of rules about the nature of expertise<br />
(one dominated by technique, by teaching not research) within the university was<br />
quite a different matter (Anderson Goughin J.R., Edwards and Walker, 2009).<br />
Given the conditions, the Academy carried out its activity in Brasov till 1948, and was<br />
a real form of higher education in which the accountancy was an important subject of<br />
study. The professors and the students that were learning here wrote important papers<br />
that influenced the way of thinking in the accountancy field in Romania.<br />
The relocation of the Institute to Iasi was made under the pressure of political factors<br />
and it was the result of a debatable decision, taking into consideration that, afterwards,<br />
Brasov asked that a higher education economic establishment be restored to this<br />
centre of rapid industrial and commercial growth. This request was accomplished<br />
after exactly 40 years by the foundation, in 1990, of the Faculty of Economic Sciences<br />
within TRANSYLVANIA University of Brasov.<br />
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4.2.4. Conclusions about the period<br />
Due to the existence and activity of the Academy of Higher Commercial and<br />
Industrial Studies in Brasov for a decade, the city became a real university centre.<br />
Nevertheless, the city’s academic claims can be traced back much earlier: “The idea<br />
of a Romanian university in Ardeal preoccupied our predecessors as well. When the<br />
dwellers of Brasov started building the secondary school from Groaveri, they made a<br />
strong foundation for sturdy walls which could support other floors. These would later<br />
be the home of the university” (Puscariu, 1978).<br />
The Commercial Academy in Brasov imparted an academic flavour to the city due to<br />
an increasing number of scientific and artistic activities, public conferences, research<br />
institutes, journals and other publications and intense activities carried out by<br />
students.<br />
This phase of the Academy of High Commercial and Industrial Studies was<br />
characterized by the efforts to maintain the scientific and didactic requirements, the<br />
requirements for the extension of the social and education spaces, the requirements for<br />
didactic works, specialty magazines and books for the library, the requirements to<br />
organize the student life in the best conditions.<br />
CONCLUSIONS<br />
The development of the economic education as a whole, and specifically in Romania,<br />
followed the evolution of the economy. Thus, because of the development of the<br />
commerce with merchandise, at the end of the 19 th century, and the beginning of the<br />
20 th century, in the territories inhabited by Romanians, the effort to disseminate<br />
economic knowledge through commercial schools, was intensified.<br />
There were a series of factors which contributed to the way Romanian accounting<br />
evolved, as folows:<br />
� the influence of economics, characterized by: the industrial development rate,<br />
the trade evolution, the economical autonomy rate, the available capital, the<br />
financing system, the management system of enterprises.<br />
� the political influence and the domination of Austro Hapsburg Empire in<br />
Transylvania and Ottoman Empire in other Romanian regions.<br />
� cultural influences: the Austro Hungarian Empire, the German influence of the<br />
accounting school can be found in the accounting theory, the French culture<br />
have influenced the legal system – based on laws and the accounting, and the<br />
Italian influence.<br />
The Transylvanian territory lived a different historical experience than the other<br />
Romanian territories, this is the reason why their wish to create a Romanian higher<br />
education could be reached only after the Great Union.<br />
In 1919, the University of Cluj was founded, and in 1920 the first form of higher<br />
economic education was set up, namely the Academy of High Commercial and<br />
Industrial Studies of Cluj. This Academy is considered the first form of higher<br />
education in the accountancy field in Cluj and in Transylvania.<br />
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Due to the foundation of the Academy, the accounting literature is rich after the 1918,<br />
a large number of professors and students from Transylvania and from the other<br />
Academies from Romania published important papers in the accountancy field.<br />
Through the study of the papers written by the professors of the Cluj Academy<br />
(moved to Brasov in 1940) we could identified the special interest for the scientific<br />
research in the field of accounting. The most part of their works, made of articles,<br />
chronicles and reviews, were published in the magazine of the Academy of High<br />
Commercial and Industrial Studies, called “Observatorul social-economic”, which<br />
was founded in 1930 and functioned until 1947.<br />
The period of the Academy in Cluj was one of organization and beginning of<br />
academic work in all the economic fields including accountancy. During the period<br />
when the Academy carried out its activity in Brasov, an important number of works in<br />
the field of accounting was written, especially in the field of financial accounting.<br />
These works represent the manifestation of accounting maturity in the evolution of<br />
accounting on the territory of our country. These are basic works, which present the<br />
principles used today in the field of accounting.<br />
The Academy of High Commercial and Industrial Studies of Cluj is one of the most<br />
important period of the accounting school in Transylvania and it represents the<br />
evolution of the accounting thinking in Romania and accounting higher education.<br />
This is not an exhaustive paper, some more arguments for the accounting education<br />
and accounting school can be found and we will try to found.<br />
REFERENCES<br />
Anderson-Goughin, F., Edwards, J.R., Walker, S.P., (2009) The routledge companion to<br />
accounting history, Routledge Press, London<br />
Bedford, N. M. (1970) The future of accounting in a changing society, Stipes Pub Llc<br />
Calu, D.A. (2005) Istorie si dezvoltare a privind contabilitatea din România, Ed. Economica,<br />
Bucuresti<br />
Carey, J. L. (1969) The Rise of Accounting Profession, American Institute of Certified Public<br />
Accountants, New York<br />
Carnegie, G.D. and Napier, C.J. (1996) ,,Critical and Interpretive Histories: Insights into<br />
Accounting's Present and Future Through its Past”, Accounting, Auditing &<br />
Accountability Journal, Vol.9, No.3:7-39.<br />
Demetrescu, C. G. (1930) Istoria contabilitatii. Antichitatea, Bucuresti<br />
Demetrescu, C. G. (1947) Istoria critica a literaturii contabile din România, Ed. Socec,<br />
Bucuresti<br />
Dobroteanu, L. and Dobroteanu, C. (2002) Audit, Concepte si practici. Abordare nationala si<br />
internationala, Ed. Economica, Bucuresti<br />
Draganecu Brates, P. (1941) Precursori români în contabilitate, Bucuresti<br />
Dumitrescu, St. (1947) Elemente si principii de stiinta contabila, Bucuresti<br />
Dumitrescu, St. and Toma, D. (1973) Principii ale contabilitatii, Ed. Didactica si Pedagogica,<br />
Bucuresti<br />
Evian, I.N. (1946) Contabilitatea dubla, Bucuresti<br />
Haskins, C. W. (1904) Business education and accountancy, Harper & brothers<br />
Hatfield, H.R. (1950) A Historic Defence of Bookkeeping, WT Baxter Press, London<br />
Hopwood, A. G.(1983) ,,On trying to study accounting in the contexts in wich it operates”,<br />
Accounting, Organizations and Society, Vol.8, No. 2-3:287-305<br />
~ 937 ~
Huntington, S. (2003) The clash of civilizations and the remaking of world order, Simon<br />
&Schuster Ed., New York<br />
Ionascu, I. (1997) Epistemologia contabilitatii, Ed.Economica, Bucuresti<br />
Marius, R. A., Page, M. (2009) A short guide to writing about history (7 th ed), Longman<br />
Press, New York<br />
Mattessich, R. (2003),, Accounting research and researchers of the nineteenth century and the<br />
beginning of the twentieth century: an international survey of authors, ideas and<br />
publications Accounting”, Business & Financial History, Volume 13:125 - 170<br />
Munslow, A. (2001) ,,What history is”, Institute of Historical Research, London<br />
Muresan, O (2007) De la antichitatea tarzie la amurgul evului mediu sec. IV-XIII ed. a 3-a,<br />
Ed. Todesco, Cluj-Napoca<br />
Napier, C. J. (1989) ,,Research directions in accounting history”, The British Accounting<br />
Review, Vol. 21, No. 3:237-254<br />
Parker, R. H. (1993) ,,The scope of Accounting History: A note”, ABACUS, Vol. 29,<br />
No.1:106-110<br />
Petrescu, C. (1901) Curs de contabilitate si administratie, Iasi.<br />
Puscariu, S. (1978) Memorii, Ed. Minerva, Bucuresti<br />
Rampolla, M. L. (2004) A Pocket Guide to Writing in History, St. Martin’s Press, Boston<br />
Richard, J. (1998) Accounting in Eastern Europe: from Communism to Capitalism,<br />
International Accounting, International Thompson Bussiness Press, London<br />
Pakucs, M. (2002) The Trade in Spices of Brasov and Sibiu in the First Half of the XVIth<br />
century, Studies and Materials of Medium History, Ed. Istros Muzeul Brailei<br />
Ristea, M. (1994) Noul sistem contabil din România, Ed. Cartimex, Bucuresti<br />
Rusu, D. et all (1991) Fra Luca di Borgo şi doctrinele contabilităţii în cultura economică<br />
românească, Ed. Junimea, Iaşi<br />
Scherpf, P. (1955) Der Kontenrehmen:Entstehung, Vebreitung, Moglichkeiten, Max Hueber,<br />
Munchen<br />
Tiron Tudor A , Mutiu A (2007) ,,Important stages in the development of Romanian<br />
accounting profession (from 1800 up to now)”, Spanish Journal of Accounting<br />
History, No. 6<br />
Tosh, J. (1991) The Pursuit of History: Aims, Methods and New Directions in the Study of<br />
Modern History, Longman Press, New York<br />
Voina, D. (1932) ,,Faze în evolutia contabilitatii”, Cluj<br />
Voina, D. (1947) Contabilitate generala, Ed. Academiei, Brasov<br />
Woolf, A. H. (1986) A short history of accountants and accountancy, Garland Pub., New<br />
York<br />
Zelinschi D. (2009) ,,Legitimacy, expertise and closure in the Romanian accountants’<br />
professional project, 1900-16”, Accounting History Review, Vol. 14, No. 4:381-403<br />
JOURNALS:<br />
Buletinul contabililor, 1937-1955.<br />
Colectia Revista Finante, Credit, Contabilitate<br />
Colectia Revista Generala de Comert si Contabilitate, 1908-1916.<br />
Contabilitate si expertiza, 1998-1999.<br />
Evidenta contabila, 1956-1969.<br />
Expertiza contabila, 1993-1995.<br />
Revista Generala de Contabilitate si Expertiza, 1996-1997<br />
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PS19 Financial markets<br />
Chairperson<br />
Andrei FILIP, ESSEC Paris, France<br />
FINANCIAL MARKET EFFICIENCY<br />
AND PERSPECTIVES ON IFRS ADOPTION.<br />
CASE STUDY FOR THE UNITED KINGDOM,<br />
THE UNITED STATES OF AMERICA AND JAPAN<br />
Stefana DIMA (CRISTEA), Bogdan DIMA, Otilia ŞĂRĂMĂT<br />
PROPERTIES OF ANALYSTS’ FORECASTS<br />
FOR ROMANIAN LISTED COMPANIES:<br />
HOW MUCH DO FIRM-SPECIFIC FACTORS MATTER?<br />
Mihaela IONASCU<br />
NET INCOME VERSUS COMPREHENSIVE INCOME<br />
FOR PROFESSIONAL INVESTORS<br />
Iulia JIANU, Ionel JIANU, Ionela GUSATU<br />
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FINANCIAL MARKET EFFICIENCY<br />
AND PERSPECTIVES ON IFRS ADOPTION.<br />
CASE STUDY FOR THE UNITED KINGDOM,<br />
THE UNITED STATES OF AMERICA AND JAPAN<br />
Ştefana DIMA (CRISTEA) 1<br />
Vasile Goldis Western University of Arad, Romania<br />
Bogdan DIMA & Otilia ŞĂRĂMĂT<br />
West University of Timişoara, Romania<br />
ABSTRACT<br />
This paper examines the random walk behavior of three major capital markets, namely<br />
United Kingdom, United States of America and Japan. Results are obtained for DJI, FTSE<br />
100 and NIKKEI 225 indexes, over a time span from 1995 to 2010. Our analysis uses the so<br />
called Lo-MacKinlay (1988) Variance Ratio Tests and some unit root tests in order to<br />
estimate if the corresponding Hurst exponents of these indexes evolve as random walk<br />
processes. The results suggest that the Hurst exponents for the prices series can not be<br />
described as random walk processes. The unit root analysis suggest that overall, the trend<br />
stationarity hypothesis can be rejected in the favor of unit root with drift processes. We are<br />
viewing such outcome as an empirical proof for the difficulty of validating the weak form of<br />
markets informational efficiency. However, we are considering that the intensification of<br />
IFRS adoption can contribute to further improvement of this efficiency.<br />
KEYWORDS: informational efficiency, random walk, IFRS adoption, financial market<br />
INTRODUCTION<br />
Efficiency of capital markets has important implications for the investors’ policy of<br />
investment. In efficient markets, all fundamental information about the intrinsic value<br />
of traded assets and information related to market characteristics should be reflected<br />
in prices, without any distortions or omissions. So, prices of the assets will reflect<br />
markets’ best estimate for the risk and expected return of the asset, taking into account<br />
what is known about the asset at the time. Therefore, there will be no undervalued<br />
assets offering higher than expected return or overvalued assets offering lower than<br />
the expected return. All assets will be appropriately priced in the market offering<br />
optimal reward to risk.<br />
In general terms, market efficiency means that prices “fully reflect all the available<br />
information” (Fama, 1970: 383). The accepted view was that when information arises,<br />
the news spreads very quickly and is incorporated into the prices of securities without<br />
delay. Thus, neither technical analysis, which is the study of past stock prices in an<br />
1 Correspondence address: Ştefana DIMA (CRISTEA), Vasile Goldiş Western University of Arad,<br />
Faculty of Economic Sciences, Address: 15, Mihai Eminescu St., Arad, Romania ; email:<br />
stefana_cristea@yahoo.it<br />
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attempt to predict future prices, nor even fundamental analysis, which is the analysis<br />
of financial information such as company earnings, asset values, etc., to help investors<br />
select “undervalued” stocks, would enable an investor to achieve returns greater than<br />
those that could be obtained by holding a randomly selected portfolio of individual<br />
stocks with comparable risk (Malkiel, 2003).<br />
Based on such views, the goals of this paper are: 1) to empirical evaluate the<br />
informational efficiency for three major financial markets – the United States of<br />
America, Japan and the United Kingdom – in the context of current real and financial<br />
turbulence; 2) to debate over the implications of IFRS adoption on the respective<br />
market informational efficiency.<br />
The paper is structured as follows: the next section review the conceptual framework<br />
of Efficient Market Hypothesis, discussing some recent critics as this are synthesized<br />
by so called Adaptive Market Hypothesis. Section 2 debates the implications that<br />
IFRS adoption might have on market efficiency. Section 3 describes the data and the<br />
methodology. Section 4 reports the results. Some conclusions are drawn and some<br />
further research directions are suggested in section 5.<br />
1. A CRITICAL ASSESSMENT OF THE EFFICIENT MARKET<br />
HYPOTHESIS<br />
In regard to the assessment of market efficiency there are two main approaches: the<br />
first is represented by the “efficient market hypothesis” (EMH) as it was initially<br />
defined by Fama (1965; 1970; 1991): information is “perfect” and the “rational”<br />
economic subjects collect and use in a systematic and logic manner this information,<br />
the prices of the financial assets are based on fundamentally efficient mechanisms.<br />
The second one refers to the “adaptive market hypothesis” (AMH) when information<br />
is “imperfect” and the economic subjects make portfolio management decisions in a<br />
“partially rational” manner (Lo [2004; 2005]).<br />
For a long time EMH has represented a dominant model in explaining the asset price<br />
formation (Beechey et. al., 2000), among others because until AMH emerged there<br />
was no viable alternative (Zhang, 1999). According to EMH since the information is<br />
“perfect”, it is assumed that there are no significant cases of informational asymmetry,<br />
non-uniformly distributed, costly and partially relevant information. Grossman (1976)<br />
and Grossman and Stiglitz (1980) argue that perfectly informational efficient markets<br />
are an impossibility, because if markets are perfectly efficient, the return to gathering<br />
information is nil, in which case there would be little reason to trade and markets<br />
would eventually collapse.<br />
The EMH for common stocks has received significant empirical support in the past,<br />
and as noted by Jensen (1978: 95), “there is no other proposition in economics which<br />
has more solid empirical evidence supporting it than the Efficient Market<br />
Hypothesis”.<br />
Lo and McKinlay (2001) argue that EMH by itself is not a well-defined and<br />
empirically irrefutable hypothesis. To make it operational, one must specify additional<br />
structure, e.g. investors preferences, information structure, business conditions, etc.<br />
But then a test of EMH becomes a test of several auxiliary hypotheses as well, and a<br />
~ 941 ~
ejection of such a joint hypothesis tells little about which aspect of the joint<br />
hypothesis is inconsistent with the data.<br />
Hence, when EMH is not empirically validated, an alternative solution is the<br />
“adaptive market hypothesis” (Lo and MacKinlay, 1988; Lo, 2004). This approach is<br />
consistent with the concept of bounded rationality as understood by Simon (1955).<br />
According to Simon, the decision making people have a limited analytical ability and<br />
the information analysis algorithms are inherently imperfect. Thus, instead of<br />
pursuing an optimal solution, the economic subjects are frequently preferring to select<br />
a solution which can be seen as satisfactory, whether this is optimal or not.<br />
Thus, the market is seen as a diversified ecology populated with various species of<br />
investors (investment funds, retirement funds, individual investors and so on)<br />
unequally adapted to the decisional environment. When a diversified number of such<br />
species of investors compete on the market in attracting high quality financial assets,<br />
the market is highly efficient. However, if a reduced number of investor species<br />
attempt to incorporate in their portfolios low quality financial assets, the informational<br />
efficiency of the market decreases.<br />
In consequence, the market evolution is characterized by an alternation of the areas in<br />
which a significant fraction of the investors has the adequate decisional methods and<br />
the informational efficiency of the market is maximal, with areas in which an<br />
important number of the market participants use decisional methods insufficiently<br />
adequate and the market presents a reduced informational efficiency. From this<br />
perspective AMH does not necessarily excludes the possibility of EMH being locally<br />
feasible, however it represents a significant generalization of this by taking into<br />
account of certain evolving mechanisms which set new trajectories to the market<br />
dynamics.<br />
In regard to the forms of market efficiency, Fama (1965) identifies:<br />
� weak form efficiency: financial assets’ prices instantly and completely reflect<br />
any information from the past. This means future prices cannot be predicted by<br />
analyzing past prices.<br />
� semi-strong form efficiency: financial assets’ prices adjust to publicly available<br />
new information very rapidly and in an unbiased fashion, such that no excess<br />
returns can be earned by trading on that information. Thus, any information<br />
will be automatically reflected in prices, in the shortest time possible. So, the<br />
semi-strong form has a more general nature than the weak form.<br />
� strong form efficiency: financial assets’ prices fully reflect all public and<br />
private information available. Therefore, no one c can earn excess returns<br />
since there is no piece of information that would provide additional value to<br />
the investors.<br />
These forms of efficiency are included in one another, thus the semi-strong form<br />
includes the weak one, while the strong form includes both.<br />
Out of these three forms of informational efficiency we consider that the most capable<br />
of influencing the IFRS adoption is the weak form, given that in this case, the<br />
financial assets’ prices reflect any information from the past (Fama, 1970, p. 383).<br />
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In the context of IFRS adoption, the empirical evidences which can support this<br />
hypothesis are obtained by testing the weak form using two sets of methods:<br />
a) in a direct manner by determining the degree in which the financial assets’<br />
prices evolution can be described as martingale and respectively, as randomwalk;<br />
b) in an indirect manner, by analyzing the statistical characteristics of the<br />
temporal series formed by the efficiency of owning and trading financial<br />
assets.<br />
In regard to the tests for market efficiency, there is voluminous literature on the topic<br />
(Bollerslev and Hodrick, 1992). The ideas discussed include standard auto-correlation<br />
tests, multi-period regression tests and volatility tests. Due to the extensive literature,<br />
we will make reference to those sources related in some extend to the tree countries<br />
we are addressing in this paper – Japan, the USA and the UK.<br />
Thus, the weak form market efficiency of Asian capital markets was studied by<br />
Whorthingthon and Higgs (2006). They examined for random walks daily returns for<br />
ten emerging (China, India, Indonesia, Korea, Malaysia, Pakistan, the Philippines, Sri<br />
Lanka, Taiwan and Thailand) and five developed markets (Australia, Hong Kong,<br />
Japan, New Zealand and Singapore), using serial correlation coefficient and runs tests,<br />
augmented Dickey-Fuller, unit root tests and multiple variance ratio tests. The results<br />
for the tests of serial correlation were in broad agreement, conclusively rejecting the<br />
random walks in the daily returns of all the markets studied. The results from the<br />
more stringent variance ratio tests indicated that the developed markets in Hong<br />
Kong, New Zealand and Japan were consistent with the most stringent random walk<br />
criteria.<br />
Cooray (2003) tested the random walk hypothesis for the stock markets of the USA,<br />
Japan, Germany, the UK, Hong Kong and Australia, using unit root tests and spectral<br />
analysis, which is a method of testing for oscillatory movements in a time series and<br />
enables identifying any cyclical or seasonal patterns in stock prices. For this study<br />
were used monthly data of stock market indices of these six countries mentioned<br />
above, during April 1991 to March 2003. The results based upon the augmented<br />
Dicky-Fuller (1979) and Phillips-Perron (1988) tests and spectral analysis find that all<br />
markets exhibit a random walk. While the multivariate cointegration tests based upon<br />
the Johansen Juselius (1988, 1990) methodology indicates that all six markets share a<br />
common long run stochastic trend, the vector error correction models suggest a short<br />
run relationship between the US, Germany, Australia and the rest of the markets<br />
implying that these countries can gain in the short run by diversifying their portfolios.<br />
Taylor (2000) investigated the predictability of long time series of stock index levels<br />
and stock prices, by using both statistical and trading rule methodologies. The trading<br />
rule analysis used a double moving-average rule and the methods of Brock,<br />
Lakonishok and Le Baron (1992). Thus, he studied the FTA, FTSE-100, DJIA and<br />
S&P-500 indices, prices for twelve UK stocks and indices derived from these stock<br />
prices. From the statistical analysis resulted that the index and price series were not<br />
random walks, and the trading rule analysis generally confirmed this conclusion.<br />
Borges (2008) studied the weak-form market efficiency applied to stock market<br />
indexes of France, Germany, UK, Greece and Spain. The used data were daily closing<br />
values of stock markets, chosen as representative for each of those markets. The<br />
~ 943 ~
period observed was between 1 January 1993 and 31 December 2007, during which<br />
the markets were very volatile, especially in the case of Greece. Overall, it found<br />
convincing evidence that monthly prices and returns follow random walks in all six<br />
countries. It concluded that France, Germany, UK and Spain meet most of the criteria<br />
for a random walk behavior with daily data, but that hypothesis is rejected for Greece<br />
and Portugal, due to serial positive correlation.<br />
Chan et al. (1992) studied the relationships among the stock markets in Hong Kong,<br />
South Korea, Singapore, Taiwan, Japan and the United States, by using unit root and<br />
co-integration tests. In this study, all the stock prices were analyzed both individually<br />
and collectively to test for international market efficiency. They found unit roots in<br />
stock prices and the higher-order co-integration tests indicated that there is no<br />
evidence of co-integration among the stock prices. Their finding suggested that the<br />
stock prices in major Asian markets and United States were weak-form efficient<br />
individually and collectively in the long run.<br />
Worthington and Higs (2003) have tested random walks and weak-form efficiency in<br />
European equity markets. They have studied the daily returns for sixteen developed<br />
markets (including the UK) and four emerging markets (Czech Republic, Hungary,<br />
Poland and Russia). Their results shown that among the developed markets, only<br />
Germany, Ireland, Portugal, Sweden and the UK satisfy the most stringent random<br />
walk criteria with France, Finland, the Netherlands, Norway and Spain meeting at<br />
least some of the requirements of a strict random walk. Among the emerging markets,<br />
only Hungary satisfies the strictest requirements for a random walk in daily stock<br />
returns. The results of their analysis are consistent with the generalization that<br />
emerging markets are unlikely to be associated with the random walks required for the<br />
assumption of weak-form market efficiency. The evidence regarding developed<br />
markets is less conclusive with some markets following random walks while others<br />
do not.<br />
Overall, this literature depicts a non-conclusive picture of the current status of various<br />
markets’ informational efficiency. Supplementary, the current financial and economic<br />
turbulence has affected markets’ mechanisms and, presumably, has increased the<br />
heterogeneity of markets’ evolutions.<br />
2. PERSPECTIVES FOR IFRS ADOPTION<br />
Due to the growing interdependence of economies around the world, the global<br />
economic and financial crisis had influenced greatly the general public’s perception<br />
on financial sector issues. The role that financial reporting plays in the contemporary<br />
society has been largely debated over the last three years as a wide range of key<br />
organizations such as UNCTAD, G-8 Finance Ministers, G-20 Summit, the European<br />
Council of Ministers and the United States Congress paid more attention to the need<br />
for a sound accounting language able to ensure financial and economic stability.<br />
The main purpose of the accounting convergence process is to provide reliable,<br />
transparent and comparable financial information required by the globalized financial<br />
markets. The core element of this process is represented by the standards issued by<br />
IASB (International Accounting Standard Board). In order to respond to the needs of<br />
these markets, IASB and US FASB have established in 2009 a Financial Crisis<br />
~ 944 ~
Advisory Group (FCAG) which comprises around 20 senior leaders experienced in<br />
international financial markets’ related aspects. The role of FCAG is to advise the two<br />
Boards in regard to the implications that the financial crisis alongside the possible<br />
changes in the global regulatory environment might have on standard-setting. In<br />
relation to this, IASB has launched a number of projects (such as fair value<br />
measurement and financial instruments). Moreover, IASB: had amended requirements<br />
on the reclassification of some financial assets from fair value categories to amortized<br />
cost categories; issued additional technical guidance on the determination of fair<br />
values of financial assets in illiquid / inactive markets.<br />
The literature seldom considers that IFRS adoption lead to an increase in the<br />
understandability of financial statements for investors, financial analysts and other<br />
users, these standards already representing the financial reporting framework<br />
accepted for the issuers admittance on the main stock exchanges in the world (Mueller<br />
et al., 1997).<br />
In this context, the question that arises is the following:<br />
Does the adoption of IFRS contribute to an increase in the informational efficiency of<br />
the financial markets?<br />
There are certain advantages of IFRS adoption – such as greater comparability of the<br />
financial information and better disclosure to stakeholders – which may lead to a<br />
decrease in the investors risks and uncertainty, leading to an increase in the<br />
informational efficiency of the market and eventually minimizing the cost of capital<br />
(Prather-Kinsey et al., 2008; Fogarty, 2008; Bova and Pereira, 2010). Comparability<br />
contributes to the general objective of trust in the information given (Epstein and<br />
Mirza, 2005). Thus, the IFRS intrinsically attempt to comprehensively respond to<br />
investors’ needs in terms of information and economic guidance based on accounting<br />
information (Rosenfield, 2005).<br />
The literature review reveals that there are a few studies addressing directly the link<br />
between the financial information provided by IFRS-based financial reports and<br />
informational efficiency as defined by the “Efficient Market Hypothesis” - Fama<br />
(1970; 1991) or the “Adaptive Market Hypothesis” - Lo (2004; 2005). Such an<br />
example is represented by Lambert et al. (2006) which investigated the way in which<br />
the voluntary adoption of IFRS before 2005 has contributed to the semi-strong form<br />
of the European financial markets’ informational efficiency; and provided interesting<br />
evidences regarding the potential use of IFRS in the investment decision making<br />
process. However, we consider that the respective paper does not provide sufficient<br />
empirical evidences which validate the semi-strong form on those markets. Thus, the<br />
respective research direction remains open for further development.<br />
With the aim of responding to our question it is essential to have first a complete and<br />
stable set of financial reporting standards, condition which will probable be met not<br />
prior to 2012. However, the issuance of a coherent set of standards is not the only<br />
condition, another one may reside in extensive adoption of these standards on the<br />
global financial markets. At the moment, more than 120 jurisdictions from around the<br />
world permit or require IFRSs for domestic listed companies. Besides, the IFRS<br />
adoption depends greatly on the status of the convergence process between IASB and<br />
US FASB and on the standpoints of the US Securities and Exchange Commission<br />
~ 945 ~
(SEC) and of the European Union; since these are the “trend setters” for companies<br />
planning to get listed on the most developed financial markets in the world.<br />
Consequently, in this paragraph we shall address the issue of IFRS adoption in the<br />
UK, USA and Japan focusing on the time span 1995-2010, whereas in the following<br />
paragraph we will be testing the weak-form market efficiency of these financial<br />
markets; a discussion regarding the perspectives of the influence of IFRS adoption on<br />
market efficiency being included in the last paragraph of the paper.<br />
2.1. IFRS adoption in the USA<br />
The United States of America started to show interest in the elaboration of the<br />
international accounting standards in a 1980’s series of joint meetings between the<br />
International Accounting Standards Committee (IASB’s predecessor), the US<br />
Securities and Exchange Commission, New York Stock Exchange and International<br />
Bar Association. Soon after, the US FASB (Financial Accounting Standard Board)<br />
has joined IASC as an observer.<br />
However, through the Norwalk Agreement in October 2002, FASB and IASB<br />
committed for the first time to eliminate the differences in the accounting treatments<br />
stipulated by international accounting standards and US GAAP. In addition, the two<br />
Boards decided to co-ordinate their future activities in order to ensure that, once<br />
achieved, compatibility is maintained. Moreover, in February 2006 (and updated in<br />
2008), the Boards released a new Memorandum of Understanding (MOU) identifying<br />
short-term and long-term convergence projects and setting the steps and milestones<br />
towards achieving convergence. Recently, as reaction to the pressure exercised by<br />
international groups and organizations, IASB and FASB reaffirmed their commitment<br />
to convergence by issuing a statement outlining steps for completing the major joint<br />
projects by 2011.<br />
To this decision contributed in certain extend the standpoint of US SEC in regard to<br />
IASB-FASB convergence process, since right at the beginning of the economic and<br />
financial crisis, the SEC’s decision to drop the reconciliation requirements for foreign<br />
registrants that adopt IFRSs came as a surprise. Till November 2007, the foreign<br />
companies had two choices: either to prepare US GAAP based financial statements or<br />
to fill a reconciliation form of net income and net assets to US GAAP (Form 20-F).<br />
Thus, this was the case for more than 1.100 non-US companies of the approximately<br />
15,000 companies registered with SEC. The cost of such reconciliation for European<br />
companies was between 1 and 10 million Euros annually depending on their size and<br />
field of activity (McCreevy, 2005).<br />
However, due to the progress of the convergence process, SEC dropped these<br />
requirements and allowed the use of IFRSs as issued by the IASB; by this, meaning<br />
the full set of standards including the carve-out made by the European Union and the<br />
continuous amendments to IFRSs.<br />
Moreover, in August 2007, SEC launched a public debate on whether or not to allow<br />
US domestic issuers to prepare IFRS financial statements for the purpose of<br />
complying with the rules and regulations of the SEC. To show its clear intentions, in<br />
November 2008, SEC published for a proposed “IFRS roadmap”, which outlines the<br />
~ 946 ~
milestones that, if achieved, may lead to mandatory transition to IFRS starting<br />
December 2014; certain entities are allowed to adopt IFRS in advance.<br />
SEC and IASC<br />
joint<br />
conference<br />
‘80s<br />
FASB becomes<br />
an observer at<br />
IASC meetings<br />
2002<br />
MoU1<br />
Figure 1. Timeline of IFRS adoption in the USA<br />
MoU2<br />
2006<br />
Launched<br />
debate over the<br />
use of IFRS by<br />
US issuers<br />
2007<br />
!!! SEC drops<br />
reconciliation<br />
requirements<br />
In addition, in February 2010, the SEC published a Statement in Support of<br />
Convergence and Global Accounting Standards aiming at facilitating the development<br />
and execution of a “Work Plan” that will enable SEC to reach a decision regarding the<br />
use of IFRSs by US issuers by 2015 /2016.<br />
2.2 IFRS adoption in the United Kingdom<br />
The financial reporting principles of the United Kingdom influenced in a great extend<br />
the development of the international accounting standards and the financial reporting<br />
within the European Economic Community and, implicitly, the European Directives.<br />
In fact, the euro-harmonization process coincided with UK’s joining the EEC.<br />
Meanwhile, at London, IASC was being founded, with UK being one of the nine<br />
accounting organizations supporting the initiative.<br />
As member of the EEC, UK was part of the European Union’s decision to sign the<br />
1995 protocol, EU offered guidance to the Member States in adopting IAS, whereas<br />
these standards were compatible with the European Directives. “The Directives do<br />
not, however, provide answers to all the problems facing the preparers and users of<br />
accounts and accounting standard setters in the 1990s. Some issues are not addressed<br />
at all in the Directives”.<br />
Also, in 2000, Commission announced the plan to require IAS for group accounts of<br />
listed companies by 2005. A year later, the Commission adopted a fair value directive,<br />
which requires/allows fair value measurement of certain financial instruments.<br />
Financial reporting standards in the UK are set by the Accounting Standard Board<br />
(ASB) of the Financial Reporting Council (FRC). Since the end of 2000 and<br />
beginning of 2001, ASB addressed the issue of convergence between the UK GAAP<br />
and IAS. The publication of The Convergence Handbook was expected to help the<br />
ASB to identify and prioritize the areas where national standards should be changed.<br />
Moreover, on 15 May 2002, the Accounting Standards Board (ASB) published seven<br />
Financial Reporting Exposure Drafts (FREDs) as part of the first stage of a three<br />
phase programme to align UK GAAP with IFRS.<br />
~ 947 ~<br />
SEC<br />
proposes<br />
IFRS<br />
roadmap<br />
2008<br />
Update<br />
MoU2<br />
Workplan<br />
regarding<br />
the decision<br />
over the use<br />
of IFRS by<br />
US issuers<br />
2010<br />
???<br />
2015/2016<br />
Prospective<br />
mandatory<br />
use of IFRS<br />
by US<br />
issuers
In response to the issuance of the IAS Regulation by the European Union, on July<br />
2003 UK Department of Trade and Industry (DTI) has approved a regulation that<br />
permits, starting January 2005, all UK companies to use IFRS as an alternative to UK<br />
GAAP, in addition to the European law requirement for listed companies to use IFRS<br />
from 2005 in preparing their consolidated statements.<br />
UK<br />
joined<br />
EEC<br />
‘70s<br />
IASC<br />
founded<br />
at<br />
London<br />
1995<br />
EU<br />
protocol -<br />
guidance<br />
to IAS<br />
adoption<br />
Figure 2. Timeline of IFRS adoption in the UK<br />
EU<br />
announces<br />
plan to<br />
require IAS<br />
for listed<br />
2000<br />
The status of the UK convergence process with IFRS had been reconsidered on March<br />
2004 in a Discussion Paper “UK Accounting Standards: A Strategy for Convergence<br />
with IFRS”. The starting point was the impossibility to maintain on long run the use<br />
of two sets of different accounting standards in the UK (UK GAAP and IFRS) so<br />
alignment in necessary.<br />
In addition, at the end of 2008, the ASB issued a UK standard on Improvements to<br />
Financial Reporting Standards in order to maintain the convergence between UK<br />
GAAP and IFRS. Overall, as indicated in the 2008/2009 Financial Reporting Council<br />
Annual Report, the ASB remains committed to convergence; however, “the strategy<br />
for achieving this remains under consideration. The ASB continued its efforts to<br />
ensure that UK converged standards remain in line with their IFRS equivalents,<br />
responding to circumstances arising from the current crisis as appropriate”. (FRC,<br />
2009: 5). Also, late last year, ASB issued Improvements to Financial Reporting<br />
Standards 2010 in order to maintain converge with IFRS.<br />
However from 2012, UK GAAP is expected to be replaced with the IFRS for SMEs<br />
and the Financial Reporting Standard for Smaller Entities (FRSSE) will remain in<br />
place for those entities choosing to do so and subject to threshold criteria.<br />
2.3 IFRS adoption in Japan<br />
ASB<br />
launched<br />
convergence<br />
with IAS<br />
2001<br />
For almost 30 years, Japanese entities prepared consolidated financial statements<br />
according to Japanese GAAP and submitted those to the Japanese securities<br />
commission. Until the foundation of Accounting Standards Board of Japan (ASBJ), a<br />
governmental council was setting accounting standards. The use of US GAAP in<br />
consolidated accounts, instead of Japanese GAAP is allowed for domestic companies<br />
registered with the US SEC. US GAAP consolidated financial statements of the<br />
current 35 companies can be used for Japanese reporting as well. Around<br />
2005<br />
All UK<br />
companies<br />
permitted<br />
to use<br />
IFRS<br />
~ 948 ~<br />
UK<br />
government<br />
uses IFRS<br />
2008<br />
Standard on<br />
convergence<br />
Standard on<br />
convergence<br />
2010<br />
???<br />
2012<br />
UK GAAP is<br />
expected to<br />
be replaced<br />
by IFRS for<br />
SMEs
250 Japanese companies are listed on EU exchanges, using Japanese GAAP, whereas<br />
approximately 10 companies from IFRS countries are listed in Japan.<br />
The road towards the adoption of IFRS has started in October 2000 when an advisory<br />
body of the Ministry of Finance (Business Accounting Deliberation Council - BADC)<br />
decided to make Japanese GAAP more compatible with IAS. However, in 2001, a<br />
newly created organization was entrusted with the accounting standard setting<br />
function - ASBJ - and an oversight foundation similar to IASB Foundation was<br />
created as well - Financial Accounting Standards Foundation (FASF).<br />
Four years later, ASBJ and IASB launched a joint convergence project between<br />
Japanese GAAP and IFRS. In addition, the Committee of European Securities<br />
Regulators (CESR) completed its review on the equivalence of Japanese, American<br />
and Canadian GAAPs with IFRS and recommended the European Commission to<br />
declare the three sets of GAAP equivalent to IFRS, subject to limited changes, which<br />
were considered significant by CESR. As a response to the CESR report, in October<br />
2006, the ASBJ released its “Project Plan Concerning the Development of Japanese<br />
Accounting Standards”, which identified 26 accounting issues to address in order for<br />
the EU to permit Japanese companies to trade on European securities markets.<br />
In 2007, with the signing of the "Tokyo Agreement", ASBJ and the IASB laid out<br />
short term convergence projects to be completed by 2011. As part of the agreement<br />
the two boards will seek to eliminate by 2008 major differences between Japanese<br />
GAAP and IFRS (as defined by the July 2005 CESR assessment of equivalence), with<br />
the remaining differences being removed on or before 30 June 2011. As a<br />
consequence, revisions were made to Japanese GAAP and at the end of 2008; the EC<br />
established that Japanese GAAP are “equivalent” to IFRS.<br />
BADC<br />
decides on<br />
compatibility<br />
with IAS<br />
2000<br />
2001<br />
ASBJ is<br />
founded<br />
Figure 3. Timeline of IFRS adoption in Japan<br />
ASBJ +<br />
IASB<br />
launched<br />
joint<br />
convergence<br />
project (CP)<br />
2005<br />
2006<br />
ASBJ<br />
released<br />
JGAAP<br />
development<br />
plan with IAS<br />
Tokyo<br />
Agreement<br />
2007<br />
On 11 December 2009, the Financial Services Authority of Japan (FSA) issued an<br />
order allowing certain listed domestic companies voluntarily to start using<br />
“designated IFRSs” in their consolidated financial statements starting from the fiscal<br />
year ending 31 March 2010. The “designated IFRSs” are all approved by the FSA and<br />
the list includes all IFRS and Interpretations issued before 30 June 2009. Those<br />
companies not choosing to adopt “designated IFRSs”, must use Japanese GAAP. The<br />
domestic companies using US GAAP must cease to do so after 31 March 2016.<br />
~ 949 ~<br />
2008<br />
EU announces<br />
JGAAP<br />
equivalence<br />
FSA allows<br />
voluntarily<br />
use of<br />
“designate<br />
d IFRSs”<br />
2009<br />
CPs<br />
2010<br />
2011<br />
CPs<br />
???<br />
2012<br />
FSA decision<br />
on the<br />
mandatory<br />
adoption of<br />
IFRS
An updated Project Plan aligned with the IASB’s work plan was released by ASBJ in<br />
April 2010, focusing on eliminating the remaining differences between Japanese<br />
GAAP and IFRS by June 2011.<br />
In this context, the decision of the mandatory adoption of IFRS for Japanese listed<br />
entities in 2015 or 2016 is still subject to the FSA’s final decision expected in 2012.<br />
In March 2011, ASBJ has released its latest summary of standards development and<br />
its project plan, discussing issues related to the projects of IASB and FASB. The<br />
project plan states: "2011 is the year for significant change in the IASB's leadership.<br />
Accordingly, the IASB's Work Plan does not show the timetable for 2012 and beyond.<br />
In Japan, market participants expect that within this year the uncertainty about the use<br />
of IFRSs would be eliminated. The Business Council of Financial Services Agency<br />
will also resume its deliberation. The convergence efforts by the ASBJ including the<br />
MoU projects need to be carried on taking account of the direction of the discussions<br />
at the Council. Consideration is needed about the pace and the expected effective<br />
dates for the development of standards and we need to extensively listen to views<br />
from market participants."<br />
Also, in the latest meetings between the ASBJ and the FASB in February 2011, the<br />
two boards discussed the future of global convergence of accounting standards. Since<br />
the final decisions regarding the mandatory use of IFRS are expected to be made<br />
during 2011 for the USA and in or around 2012 for Japan, the ASBJ and the FASB<br />
updated each other with the recent developments in their respective convergence<br />
projects with the IASB and exchanged views on the a number of IASB projects.<br />
3. DATA AND RESEARCH DESIGN<br />
For drawing the sample study, we obtained data from three developed capital markets,<br />
namely the United Kingdom, the United States and Japan, on the DJI indexes, the<br />
FTSE 100 and NIKKEI 225 over the period 1995-2010.<br />
The main statistic characteristics of the indexes are reported in Table 1. It can be<br />
noticed that the indexes display a non-normal distribution with clear fat-tails effects.<br />
More exactly, the distribution of DJI and FTSE 100 indexes is left tailed while Nikkei<br />
225 is right tailed. In the meantime, DJI have a peaked distribution (leptokurtic)<br />
relative to the normal one, while for FTSE 100 and Nikkei 225 this is flat (platykurtic)<br />
relative to the normal.<br />
Table 1. Main statistic characteristics of major indexes<br />
DJI FTSE100 NIKKEI225<br />
Mean 9486.69 5103.81 14154.51<br />
Median 10110.02 5203.75 14156.87<br />
Maximum 14093.08 6930.20 22667.00<br />
Minimum 3832.08 2954.20 7054.98<br />
Std. Dev. 2219.10 967.71 3799.44<br />
Skewness -0.65 -0.22 0.15<br />
Kurtosis 3.05 1.94 1.92<br />
Jarque-Bera 265.02 204.63 196.88<br />
Probability 0.00 0.00 0.00<br />
Observations 3732 3732 3732<br />
~ 950 ~
Graphic 1. Recent evolutions of DJI, FTSE 100 and NIKKEI 225 markets<br />
16,000<br />
12,000<br />
8,000<br />
4,000<br />
0<br />
500 1000 1500 2000 2500 3000 3500<br />
DJI FTSE 100 NIKKEI 225<br />
~ 951 ~<br />
24,000<br />
20,000<br />
16,000<br />
12,000<br />
A series is said to be (weakly or covariance) stationary if the mean and autocovariances<br />
of the series do not depend on time. Any series that is not stationary is<br />
said to be non-stationary.<br />
A common example of a non-stationary series is the random walk:<br />
y ε<br />
8,000<br />
4,000<br />
t = yt<br />
−1 + t<br />
(1)<br />
Where ε is a stationary random disturbance term. The series y has a constant forecast<br />
value, conditional on t, and the variance is increasing over time. The random walk is a<br />
difference stationary series since the first difference of y is stationary:<br />
t<br />
( − L)<br />
yt<br />
= t<br />
y − y − = 1 ε<br />
t 1 (2)<br />
A difference stationary series is said to be integrated and is denoted as I(d ) where d is<br />
the order of integration. The order of integration is the number of unit roots contained<br />
in the series, or the number of differencing operations it takes to make the series<br />
stationary. For the random walk above, there is one unit root, so it is an I(1) series.<br />
Similarly, a stationary series is I(0).<br />
Standard inference procedures do not apply to regressions which contain an integrated<br />
dependent variable or integrated regressors. Therefore, it is important to check<br />
whether a series is stationary or not before using it in a regression. The formal method<br />
to test the stationarity of a series is the unit root test.<br />
Unit root tests can be used to determine if trending data should be first differenced or<br />
regressed on deterministic functions of time to render the data stationary. Moreover,<br />
economic and finance theory often suggests the existence of long-run equilibrium<br />
relationships among non-stationary time series variables.<br />
Various unit root tests suggests that overall the evolutions of the considered<br />
developed markets indexes can be fairly described as unit root with drift processes
(Table 2). Among these, Kwiatkowski et al. (1992) and Bierens and Guo (1993) imply<br />
as null trend stationarity against unit root with drift, while Bierens (1993) and<br />
Breitung (2002) assume that the series are unit roots with drifts.<br />
With some notable exceptions, especially for Bierens-Guo tests (Type 6) and, in a<br />
certain measure for Nikkei 225, these are converging to depict the image of all the<br />
markets’ indexes being I(1) variables.<br />
Table 2. Unit roots tests (trend stationarity against unit root with drift)<br />
KPSS<br />
Null:Trend<br />
stationarity<br />
against unit root<br />
with drift<br />
DJI 0.97<br />
(reject / reject)<br />
FTSE 100 0.68<br />
(reject / reject)<br />
NIKKEI<br />
225<br />
0.76<br />
(reject / reject)<br />
BIERENS-GUO<br />
(Type 5)<br />
Null:Trend<br />
stationarity<br />
against unit root<br />
with drift<br />
1560.49<br />
(reject / reject)<br />
1882.12<br />
(reject / reject)<br />
181.67<br />
(reject / reject)<br />
BIERENS-GUO<br />
(TYPE 6)<br />
Null:Trend<br />
stationarity<br />
against unit root<br />
with drift<br />
24.05<br />
(reject / reject)<br />
27.74<br />
(reject / reject)<br />
10.65<br />
(accept / reject)<br />
~ 952 ~<br />
BIERENS DHOAC<br />
Null:<br />
Unit root with drift<br />
against trend stationarity<br />
DHOAC(1,1)=0.42<br />
DHOAC(2,2)=0.45<br />
(accept/accept)<br />
DHOAC(1,1)=0.39<br />
DHOAC(2,2)=0.56<br />
(accept/accept)<br />
DHOAC(1,1)=0.58<br />
DHOAC(2,2)=0.68<br />
(accept/accept)<br />
BREITUNG<br />
NULL:<br />
Unit root with<br />
drift against trend<br />
stationarity<br />
0.42<br />
(accept/accept)<br />
0.26<br />
(accept/accept)<br />
0.31<br />
(accept/accept)<br />
Notes: Bierens DHOAC and Breitung tests computed based on 100 replications with the<br />
errors draw from the normal distribution with zero mean and variances the squared<br />
OLS residuals (bootstrapping); The conclusions are drawn for 5% and 10% critical<br />
regions.<br />
3. RESULTS AND COMMENTS<br />
Our evaluation of the Efficient Market Hypothesis for the considered markets consists<br />
in testing the indexes in order to estimate the possibility to describe them as random<br />
walk processes. This involves the appliance of the so-called Lo and MacKinlay (1988;<br />
1989) overlapping Variance Ratio Test. This test examines the predictability of the<br />
time series by comparing variances of differences of data computed over different<br />
intervals. If the data are assumed to follow a random walk, the variance of a –q period<br />
difference should be q times the variance of the one-period difference. Evaluating the<br />
empirical evidence for or against this restriction is the basis of the variance ratio test.<br />
More exactly, if there is a time series {Yt}= {Y1, Y2,…,Yt} satisfying:<br />
ΔY<br />
= μ + ε<br />
t<br />
where μ is an arbitrary drift parameter then the key properties of a random walk that<br />
are of interest for the test can be described as E(εt)=0 for all t and E(εtεt-j)=0 for any<br />
positive j.<br />
The estimators for the mean of first difference and the scaled variance of the q-th<br />
difference are defined as:<br />
t<br />
(3)
1<br />
ˆ μ =<br />
T<br />
T<br />
∑<br />
i=<br />
1<br />
2<br />
σ<br />
Tq<br />
and the corresponding variance ratio:<br />
2<br />
ˆ σ q<br />
VR ( q)<br />
= 2<br />
ˆ σ 1<br />
( Y −Y<br />
)<br />
t<br />
T 1<br />
( q)<br />
= ∑(<br />
Yt<br />
− Yt<br />
−q<br />
− q ˆ μ)<br />
t=<br />
1<br />
( )<br />
()<br />
t−1<br />
The variance estimators may be adjusted for bias, as suggested by Lo and MacKinlay,<br />
by replacing T in equation (4) with (T-q+1) in the no-drift case, or with (T-q+1)(1q/T)<br />
in the drift case.<br />
Lo and MacKinlay (1988) show that the variance ratio z-statistic:<br />
[ ] −1/<br />
2<br />
2<br />
( q)<br />
= ( VR(<br />
q)<br />
− 1)<br />
⋅ sˆ<br />
( q)<br />
z (6)<br />
is asymptotically N(0,1) if the estimator s 2 is properly chosen.<br />
Under the i.i.d. (independent identically distribution) hypothesis we have the<br />
estimator,<br />
ˆ 2<br />
s<br />
=<br />
2<br />
( 2q<br />
− 1)(<br />
q − 1)<br />
3qT<br />
while under the m.d.s. assumption we may use the kernel estimator,<br />
where:<br />
( q j)<br />
( ) ∑ − q 1<br />
2<br />
2 ⎛ 2 − ⎞<br />
q = ⎜ ⎟ ⋅ ˆ<br />
j<br />
j=<br />
1 q<br />
sˆ δ<br />
⎝ ⎠<br />
ˆ<br />
⎧<br />
⎫ ⎧<br />
δ j = ⎨<br />
∑<br />
⎩t<br />
= j+<br />
1<br />
⎭ ⎩<br />
T<br />
T<br />
2<br />
2<br />
∑ ( y − ˆ ) ( − ˆ ) ⎬ / ⎨ ( − ˆ<br />
t − j μ yt<br />
μ yt<br />
− j μ )<br />
~ 953 ~<br />
t = j+<br />
1<br />
The test is first performed for homoskedastic random walks using the wild bootstraps<br />
distribution to evaluate statistical significance. Such an approach is based on the<br />
strong assumption that εt is i.i.d. Gaussian but the normality assumption is not strictly<br />
necessary. Three different alternatives are considered:<br />
1) The Hurst exponent series are random walks so that variances are computed<br />
for differences of the data;<br />
2) These series are assumed to follow an exponential random walk so that the<br />
innovations are obtained by taking log differences or, alternatively,<br />
3) The series contains the random walk innovations themselves.<br />
2<br />
2<br />
⎫<br />
⎬<br />
⎭<br />
2<br />
(7)<br />
(8)<br />
(9)<br />
(4)<br />
(5)
A) Random walk<br />
DJI<br />
Table 3. Lo and MacKinlay Variance Ratio Tests<br />
JOINT TESTS VALUE DEGREE OF<br />
FREEDOM<br />
~ 954 ~<br />
PROBABILITY<br />
Max |z| (at period 8) 3.35 3731 0.00<br />
Wald (Chi-Square) 29.84 15 0.01<br />
Max |z| (at period 9) 4.14 3731 0.00<br />
FTSE 100 Wald (Chi-Square) 35.14 15 0.00<br />
Max |z| (at period 3) 2.74 3731 0.02<br />
Nikkei 225 Wald (Chi-Square) 15.95 15 0.39<br />
B) Exponential random walk<br />
DJI<br />
JOINT TESTS VALUE DEGREE OF<br />
FREEDOM<br />
Max |z| (at period 4) 3.02 3731 0.00<br />
Wald (Chi-Square) 31.15 15 0.01<br />
Max |z| (at period 9) 4.00 3731 0.00<br />
FTSE 100 Wald (Chi-Square) 37.90 15 0.00<br />
Max |z| (at period 3) 2.62 3731 0.03<br />
Nikkei 225 Wald (Chi-Square) 15.34 15 0.43<br />
C) Random walk innovations<br />
DJI<br />
JOINT TESTS VALUE DEGREE OF<br />
FREEDOM<br />
Max |z| (at period 16) 200.99 3732 0.00<br />
Wald (Chi-Square) 50787.63 15 0.00<br />
Max |z| (at period 16) 200.84 3732 0.00<br />
FTSE 100 Wald (Chi-Square) 50617.52 15 0.00<br />
PROBABILITY<br />
PROBABILITY<br />
Max |z| (at period 16) 203.79 3732 0.00<br />
Nikkei 225 Wald (Chi-Square) 52794.16 15 0.00<br />
Notes: Null Hypothesis: A) The index is a random walk; B) The (log) index is a random<br />
walk; C) The cumulated index is a random walk; Computed using: Rank scores;<br />
Included observations: 3731 (after adjustments); Standard error estimates assume<br />
no heteroskedasticity; Lags specified as grid: min=2, max=16, step=1; Test<br />
probabilities computed using permutation bootstrap: 10000; Random generator:<br />
Knuth; Tie handling: Random<br />
Kim (2006) offers a wild bootstrap approach to improving the small sample properties<br />
of variance ratio tests, as it was found that the wild bootstrap tests have desirable size<br />
properties and exhibit higher power than their alternatives in most cases. The<br />
approach involves computing the individual (Lo and MacKinlay, 1988) and joint<br />
(Chow and Denning, 1993) variance ratio test statistics on samples of observations<br />
formed by weighting the original data by mean 0 and variance 1 random variables,<br />
and using the results to form bootstrap distributions of the test statistics. The bootstrap
p values are computed directly from the fraction of replications falling outside the<br />
bounds defined by the estimated statistic. Kim’s simulations indicate that the test<br />
results are generally insensitive to the choice of wild bootstrap distribution.<br />
Wright (2000) proposes modifying the usual variance ratio tests using standardized<br />
ranks of the increments, ΔYt. Letting r(ΔYt) be the rank of the ΔYt among all T values,<br />
he defines the standardized rank (r1t) and van der Waerden rank scores (r2t):<br />
⎛ T + 1⎞<br />
= ⎜ r(<br />
ΔY<br />
) − ⎟ /<br />
⎝ 2 ⎠<br />
r1t t<br />
−1<br />
r2 = Φ<br />
t<br />
( r(<br />
ΔY<br />
) / ( T + 1)<br />
)<br />
~ 955 ~<br />
( T −1)(<br />
T + 1)<br />
12<br />
(10)<br />
t (11)<br />
In cases where there are tied ranks, the denominator in r1t may be modified slightly to<br />
account for the tie handling.<br />
The Wright variance ratio test statistics are obtained by computing the Lo and<br />
MacKinlay (1988) homoskedastic test statistic using the ranks or rank scores in place<br />
of the original data.<br />
Under the i.i.d. null hypothesis, the exact sampling distribution of the statistics may be<br />
approximated using a permutation bootstrap.<br />
Wright (2000) also proposes a modification of the homoskedastic Lo and MacKinlay<br />
(1988) statistic in which each ΔYt is replaced by its sign. This statistic is valid under<br />
the m.d.s. null hypothesis, and under the assumption that μ = 0, the exact sampling<br />
distribution may also be approximated using a permutation bootstrap.<br />
The unit root analysis suggests that, overall, the trend stationarity hypothesis can be<br />
rejected in the favor of unit root with drift processes. In the mean time, the failure of<br />
describing the Hurst exponent as a random walk, suggests that the indexes are<br />
imperfectly adjusted under the impact of informational shocks and displays some<br />
rigidities in their formation mechanisms.<br />
CONCLUSIONS AND FURTHER RESEARCH<br />
One of the primary goals of this study is to evaluate the weak-form of three major<br />
financial markets’ informational efficiency. Our results suggest that the Hurst<br />
exponent for the prices series can not be described as random walk (with different<br />
versions) processes.<br />
We interpret such results as rejecting the Efficient Market Hypothesis for the<br />
considered markets. Of course, there can be identified some limitations of our<br />
proposed analysis. Among these, the estimated levels of the Hurst exponent are<br />
sensitive to the choice in methodology; the Lo and MacKinlay approach is a test of<br />
the long run variance and so it allows the treatment of the short run adjustments in the<br />
series. The data set is limited and no structural break-points are identified in the<br />
behavior of indexes during different sub-periods of the observed time span; the<br />
interactions between indexes are ignored; the Adaptive Market Hypothesis is just
mentioned, but no analytical developments are considered. Thus, some possible<br />
further research directions can be developed by: evaluating the results robustness to<br />
the changes of the methodology evaluating the Hurst exponent; considering a longer<br />
data set and performing sub-periods evaluations; developing a sounder framework,<br />
able to explain in greater details the mechanisms of market’s partial informational<br />
inefficiency.<br />
Meanwhile, it is necessary to provide a description for the underlying mechanisms of<br />
the potential impact that extending the IFRS adoption might have on the informational<br />
efficiency of the considered markets; by taking into account both the effects on<br />
information’ quality as well as the induced changes in investors’ behavior.<br />
Despite this caveats, we consider that such results can better highlight the intrinsic<br />
markets adjustment’s mechanisms to the various informational shocks and allows a<br />
better understanding of transactional decisions in the context of an uncertain business<br />
environment.<br />
ACKNOWLEDGEMENT<br />
This article has benefited by financial support through the project ,,Studii Post-<br />
Doctorale în Economie: program de formare continuă a cercetătorilor de elită –<br />
SPODE”, financing contract no. POSDRU/89/1.5/S/61755, project financed by the<br />
European Social Fund Sectoral Operational Programme Human Resources<br />
Development 2007-2013.<br />
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~ 958 ~
PROPERTIES OF ANALYSTS’ FORECASTS<br />
FOR ROMANIAN LISTED COMPANIES:<br />
HOW MUCH DO FIRM-SPECIFIC FACTORS MATTER?<br />
Mihaela IONASCU 1<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
This paper seeks to explore the properties of analysts’ forecast accuracy for companies listed<br />
on Bucharest Stock Exchange (BSE). Based on a sample of 266 firm-month observations<br />
(predictions made in 2008 for 2009 and 2010), the paper investigates several firm-specific<br />
factors documented by the literature to have a significant impact on forecast accuracy, and<br />
shows that for Romanian listed companies, forecast errors for earnings per share reported<br />
under local GAAP are negatively correlated with the size of the firm and the corporate<br />
governance policies. The results are convergent with those documented in international<br />
contexts, showing that larger firms as well as those which are better governed are more likely<br />
to provide additional disclosures, and thus increase forecast accuracy.<br />
KEYWORDS: properties of analysts’ forecast, corporate governance, information<br />
environment<br />
INTRODUCTION<br />
There is a large amount of literature investigating various factors affecting analysts’<br />
forecast accuracy. The drivers of forecast accuracy can be both analyst-specific (such<br />
as analysts skills and behavior), and firm-specific (such as firm characteristics and<br />
actions) (Ernstberger, Krotter and Stadler, 2008). Among the firm-specific factors, the<br />
information environment of a company is a key driver of forecasts’ accuracy, as more<br />
information reduce uncertainty about a company’s future prospects and thus leads to<br />
smaller forecast errors. And the literature documents factors such as corporate<br />
governance policies and financial reporting standards and disclosure to lead to a better<br />
information environment, and consequently to increase analysts forecast accuracy.<br />
In Romania, several steps were taken in order to improve the quality of financial<br />
disclosure and that of corporate governance polices of listed Romanian companies. In<br />
2006 Companies Law was amended to improve board composition by including<br />
independent directors and to allow for a dualist governance system comprising a<br />
Supervisory Board and a Management Board (Olimid et al. 2009). And starting in<br />
2001, several requirements were gradually issued to ensure companies’ adherence to a<br />
Corporate Governance Code. At the same time, there were gradual requirements<br />
aimed at improving the financial disclosures of firms listed on BSE, and starting with<br />
1<br />
Correspondence address: Mihaela IONASCU, Bucharest Academy of Economic Studies;<br />
emal: mihaela.ionascu@gmail.com<br />
~ 959 ~
2005, listed Romanian companies prepare mandatorily financial statements in<br />
compliance with IFRS, while others apply IFRS for internal information needs.<br />
In this context, the purpose of this paper is to investigate the properties of analysts’<br />
forecasts for listed Romanian companies, trying to expose the effect of firm-specific<br />
factors, especially those that are reasonably expected to affect the quality of the<br />
information environment, and thus enhance or decrease forecast accuracy.<br />
1. LITERATURE REVIEW<br />
There is a large amount of literature showing that both analyst-specific and firmspecific<br />
factors are driving forecasts accuracy. For instance, rather optimistic analysts<br />
tend to have upward biased forecasts (Easterwood and Nutt 1999), while more<br />
experienced analysts tend to have more accurate forecasts (Clement, 1999). Among,<br />
the firm-specific factors, the literature documents company size, industry, corporate<br />
governance policies or financial reporting standards and disclosure as drivers of<br />
forecasts accuracy.<br />
For instance, larger firms are expected to provide additional disclosure than smaller<br />
firms, which may lead to a decrease in forecast errors. However, larger firms may also<br />
have more complex activities which may decrease forecast accuracy. (Brown, Preiato<br />
and Tarca, 2009).<br />
There is also a recent stream of research showing that better quality corporate<br />
governance is associated with an increase in the overall quality of information<br />
possessed by financial analysts, which can reasonably be expected to lead to more<br />
accurate analysts forecasts. Bhat, Hope and King (2006), using country level proxies<br />
for corporate governance transparency, showed that differences in transparency across<br />
21 countries affect forecasts accuracy, when controlling for financial transparency. In<br />
addition, their results showed that the effect of corporate governance transparency on<br />
analyst forecast accuracy is larger when financial disclosures are less transparent. The<br />
argument supporting these findings is that governance-related disclosure plays a role<br />
in improving the information environment of companies which leads to smaller errors<br />
in analyst forecast.<br />
This rationale is backed by other research results, such as the ones provided by<br />
Karamanou and Vafeas (2005), who documented that effective corporate governance<br />
is associated with higher financial disclosure quality. Karamanou and Vafeas (2005)<br />
showed that more effective corporate boards and audit committees structures lead to<br />
more accurate management earnings forecasts, which can reasonably lead to a<br />
decrease in analysts’ forecast errors.<br />
Byard and Weintrop (2006) have also discussed the association between corporate<br />
governance and the quality of information available to financial analysts. Their<br />
findings proved that the quality of corporate governance increases the quality of<br />
financial analysts’ information about upcoming earnings.<br />
~ 960 ~
Several recent papers have showed that financial reporting is an important source of<br />
information used by financial analysts for predictive purposes (Peek, 2005).<br />
Consequently, there was an increase in the body of research investigating the<br />
relationship between financial disclosure and analysts’ forecast accuracy. Authors<br />
such as Vanstraelen, Zarzeski and Robb (2003) or Hope (2004) proved that increased<br />
disclosure leads to increased analysts’ forecast accuracy. Hope (2002), for instance,<br />
relates the CIFAR index of the level of annual report disclosure to forecast accuracy<br />
for a sample of 1,553 firm-years from 22 countries, showing that a high volume of<br />
financial information made available to financial analysts enhances their forecast<br />
accuracy.<br />
IFRSs are allegedly high-quality financial reporting standards, with extensive<br />
disclosure requirements and evolved recognition and valuation procedures, expected<br />
to increase transparency, diminish information asymmetry, and, consequently,<br />
facilitate predictions in order to support investment decisions on capital markets.<br />
Starting with the adoption of IFRS in the EU, several papers tried to investigate the<br />
impact of IFRS adoption on the analysts’ forecast accuracy. For instance, Brown,<br />
Preiato and Tarca (2009) showed on a sample of 40.123 monthly observations for<br />
companies operating in 13 European countries during 2002-2007 that forecast errors<br />
were significantly lower after the IFRS mandatory implementation. Ernstberger<br />
(2008) has also showed that on the German capital market analysts’ forecast accuracy<br />
improved after the IFRS adoption. Tan, Wang and Welker (2009) obtained similar<br />
results on a sample of 38 countries, several European countries included.<br />
Furthermore, Tan, Wang and Welker (2009) documented empirically, that the IFRS<br />
adoption attracts foreign analysts, especially those with experience in IFRS, or whose<br />
countries make IFRS implementation compulsory at the same time.<br />
However, the literature has not yet reached common grounds on the role plaid by the<br />
quantity of financial disclosure in enhancing analysts’ forecast accuracy, authors such<br />
as Pope (2003) arguing that it is not clear whether financial disclosure is a<br />
fundamental determinant or just a complement of the recognition rules operating in<br />
different accounting regimes. At the same, a higher volume of financial disclosure due<br />
to preparing two sets of financial statements under two types of standards (usually<br />
local GAAP and IFRS) might have a negative impact on the information environment<br />
of a company which may lead to a decrease in analysts’ forecasts accuracy.<br />
This paper investigates the effect of firm-specific factors on analysts’ forecasts<br />
accuracy for Bucharest Stock Exchange, trying to expose those that are reasonably<br />
expected to affect the quality of the information environment, and thus enhance or<br />
decrease forecast accuracy.<br />
2. METHODOLOGY<br />
The sample was comprised of 19 companies listed on the Bucharest Stock Exchange<br />
followed by financial analysts according to Thomson Reuters’ I/B/E/S data base. We<br />
used monthly predictions made in 2008 for 2009 and 2010. The sample was reduced<br />
to 266 firm-month observations by the following: lack of actual earnings for 2010,<br />
absolute analyst forecast error in the corresponding month of the previous year cannot<br />
be calculated due to missing consensus forecast, eliminating financial entities.<br />
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The following regression model (firm, month and year subscripts omitted for<br />
convenience) are used to investigate the properties of analysts’ forecasts:<br />
ERROR = α 0<br />
+ α1IndGOV<br />
+ α 2LOG<br />
_ SIZE + α 3IFRS<br />
+ α 4FOLLOWING<br />
+<br />
α HORIZON + α PREV _ ERROR + ε<br />
Where:<br />
5<br />
ERROR The absolute difference between actual EPS computed under local<br />
GAAP and the monthly median consensus forecast scaled by stock<br />
price at the middle of the month.<br />
IndGOV An aggregate index for corporate governance computed by Olimid<br />
et al. (2009) for listed Romanian companies based on three<br />
characteristics of the board of administrators (board size, proportion<br />
of non-executive directors, duality for the Chairman and Director<br />
General).<br />
LOG_SIZE Natural log of the market value of equity at the middle of the<br />
month.<br />
IFRS An indicator variable equal to 1 for companies with double reporting<br />
(both IFRS and local GAAP), and 0 otherwise.<br />
FOLLOWING The number of analyst earnings forecasts included in the<br />
median consensus forecast.<br />
HORIZON The number of months between the announcement of the median<br />
consensus forecast and the earnings announcement date.<br />
PREV_EPS The absolute value of last year’s forecast error scaled by price,<br />
measured at the corresponding month in the previous year.<br />
We expect the coefficient on IndGOV and LOG_SIZE to be negative, consistent with<br />
a reduction in analysts’ forecast errors, and the coefficient on IFRS to be positive, as<br />
double reporting may lead to confusion and a decrease in forecast accuracy.<br />
The model used three control variables: FOLLOWING was used, as the literature<br />
documents that more competition between analysts makes them forecast future<br />
earnings more accurately (Hodgdon et al. 2008). We also controlled for the number of<br />
months between the announcement of the consensus forecast and the announcement<br />
of actual earnings (HORIZON) to control for the fact that earnings forecasts tend to<br />
become more accurate near the announcement of actual earnings date (Clement 1999;<br />
Brown et al. 1999). And we also controlled for the previous errors effect<br />
(PREV_ERROR), as the current period’s forecast error is expected to be positively<br />
correlated with the previous period’s forecast error (Brown et al. 1999).<br />
3. RESEARCH RESULTS<br />
6<br />
The values obtained after the operationalization of the variables are presented in Table<br />
1 below.<br />
Table 1. Descriptive statistics<br />
Observations Minimum Maximum Mean Std. Deviation<br />
ERROR 266 ,0088 15,0796 ,502168 1,5841630<br />
IndGOV 266 ,2222 1,0000 ,661785 ,2695070<br />
SIZE 266 15,6529 24,0965 19,364842 1,8554278<br />
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Observations Minimum Maximum Mean Std. Deviation<br />
IFRS 266 0 1 ,47 ,500<br />
FOLLOWING 266 1 7 1,73 1,341<br />
HORIZON 266 13 41 24,91 6,760<br />
PrevERROR 266 -,9625 19,7236 1,736109 4,8418358<br />
We used stepwise regression analysis to avoid eventual collinearity problems and to<br />
find the best fitted model to explain forecasts errors.<br />
Regression results are summarized in Table 2 below.<br />
Table 2. Regression results<br />
Model 1 Model 2 Model 3<br />
Variables Coefficients t Sig. Coefficients t Sig. Coefficients t Sig.<br />
(Constant) 6,989 7,433 ,000 10,518 11,425 ,000 9,818 10,776 ,000<br />
LOG_SIZE (-) -,335 -6,930 ,000 -,556 -11,244 ,000 -,528 -10,872 ,000<br />
IFRS (+) 1,613 8,785 ,000 1,695 9,440 ,000<br />
PREV_ERROR (+) ,067 4,061 ,000<br />
Observations 266 266 266<br />
Adjusted R square ,151 ,341 ,378<br />
F statistic 48,024 (sig. ,000) 69,534 (sig. ,000) 54,583 (sig. ,000)<br />
As expected, company size is negatively correlated with forecasts errors, as larger<br />
firms are more likely to disclose more information and thus reduce forecasts errors.<br />
Contrariwise, companies preparing financial statements in compliance with both local<br />
GAAP and IFRS tend to have lower forecast accuracy. We were only able to control<br />
for previous errors effect, which are positively correlated with current period forecasts<br />
errors. Overall, the model accounts for 37,8% of the analysts’ forecast errors<br />
variations.<br />
The other control variables, FOLLOWING and HORRIZON, were not significantly<br />
associated with forecast errors. However, IndGOV was found to be negatively<br />
associated with forecasts errors, when analyzed as a single independent variable (see<br />
Table 3 below):<br />
Table 3. Regression results<br />
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Model 4<br />
Variables Coefficients t Sig.<br />
(Constant) 1,900 7,877 ,000<br />
IndGOV (-) -2,112 -6,255 ,000<br />
Observations 266<br />
R square ,129<br />
F statistic 39,123 (sig. ,000)
CONCLUSIONS, LIMITATIONS AND FURTHER RESEARCH<br />
The paper investigated several firm-specific factors expected to affect analyst forecast<br />
accuracy for listed Romanian companies. The results confirmed the international<br />
trends, as larger Romanian listed companies and those that are better governed tend to<br />
have more accurate forecasts. However, companies preparing two sets of financial<br />
statements incur bigger forecast errors, as double reporting seems to have a negative<br />
impact on the information environment of a company.<br />
The main limitation of the paper comes from the small number of listed companies<br />
followed by financial analysts and the limited period covered. Furthermore, there was<br />
no data available on forecasted earnings per share reported under IFRS to compare<br />
their properties with those for earnings per share reported under local GAAP.<br />
Consequently, research is needed in order to further clarify the effect of the<br />
information environment on analysts’ forecast accuracy for Romanian listed<br />
companies with an emphasis on the role plaid by financial reporting.<br />
ACKNOWLEDGEMENT<br />
The authors gratefully acknowledge the financial and logistic support offered by the<br />
Project Performance and Excellence in Postdoctoral Research in the Field of<br />
Economic Sciences in Romania, grant POSDRU/89/1.5/S/59184.<br />
REFERENCES<br />
Bhat, G., Hope, O.-K. and Kang, T. (2006), “Does corporate governance transparency affect<br />
the accuracy of analyst forecasts?”. Accounting & Finance, 46: 715–732<br />
Brown, P. R., Preiato, J. P., Tarca, A. (2009). “Mandatory IFRS and Properties of Analysts’<br />
Forecasts: How Much Does Enforcement Matter?” UNSW Australian School of<br />
Business Research Paper No. 2009 ACCT 01<br />
Byard, D., Li, Y. & Weintrop, J. (2006). “Corporate Governance and the Quality of Financial<br />
Analyst’s Information”. Journal of Accounting and Public Policy, 25, 609-625.<br />
Clement, Michael B. (1999): “Analyst Forecast Accuracy: Do Ability, Resources and<br />
Portfolio Complexity Matter?”, Journal of Accounting & Economics, 27 (3): 285–303.<br />
Easterwood, John C. and Stacey R. Nutt (1999): “Inefficiency in Analysts’ Earnings<br />
Forecasts: Systematic Misreaction or Systematic Optimism?”, Journal of Finance, 54<br />
(5): 1777–1797.<br />
Ernstberger, J, Kroter, S., Stadler, C. (2008) ”Analysts’ Forecast Accuracy in Germany: The<br />
Effect of Different Accounting Principles and Changes of Accounting Principles”,<br />
Business Research, 1(1):26-53<br />
Hope, Ole K. (2004): “Variations in the Financial Reporting Environment and Earnings<br />
Forecasting,” Journal of International Financial Management and Accounting, 15<br />
(1):21–43<br />
Hope, O-K. (2002). “Disclosure Practices, Enforcement of Accounting Standards and<br />
Analysts' Forecast Accuracy: An International Study”, Available at SSRN:<br />
http://ssrn.com/abstract=353160 or doi:10.2139/ssrn.353160<br />
Karamanou I., Vafeas N. (2005) “The Association between Corporate Boards, Audit<br />
Committees, and Management Earnings Forecasts: An Empirical Analysis”, Journal of<br />
Accounting Research, 43(3): 453-486<br />
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Olimid. L., Ionaşcu M., Popescu L., Popescu V. D. (2009), “Corporate Governance in<br />
Romania. A Fragile Start, <strong>Proceedings</strong> of ECMLG 2009, the 5th European Conference<br />
on Management, Leadership and Governance, held at the ATExcelixi Training and<br />
Conference Centre”, Athens, Greece, 5-6 November 2009, 151-156.<br />
Pope P. (2003). “Discussion of Disclosure Practices, Enforcement of Accounting Standards,<br />
and Analysts' Forecast Accuracy: An International Study”, Journal of Accounting<br />
Research, 41(2), 273-283.<br />
Peek, Erik (2005): “The Influence of Accounting Changes on Financial Analysts’ Forecast<br />
Accuracy and Forecasting Superiority: Evidence from the Netherlands”, European<br />
Accounting Review, 14 (2): 261–295.<br />
Tan, H., S. Wang, S., Welker, M. (2009). „Foreign Analysts Following and Forecast<br />
Accuracy around Mandatory IFRS Adoptions”, in progress, http://www.bus.wisc.edu/<br />
accounting/faculty/ documents/PaperMikeWelker4-17-09.pdf<br />
Vanstraelen, Ann, Marilyn T. Zarzeski, and Sean W.G. Robb (2003): “Corporate<br />
Nonfinancial Disclosure Practices and Financial Analyst Forecast Ability across Three<br />
European Countries”, Journal of International Financial Management and Accounting,<br />
14 (3): 249–278.<br />
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NET INCOME VERSUS COMPREHENSIVE INCOME<br />
FOR PROFESSIONAL INVESTORS<br />
Iulia JIANU 1 & Ionel JIANU<br />
Bucharest Academy of Economic Studies, Romania<br />
Ionela GUSATU<br />
University of Medicine and Pharmacy "Carol Davila", Romania<br />
ABSTRACT<br />
This paper tries to grasp the importance given by professional investors to comprehensive<br />
income in relation to net income. The question around which this study circumscribes is the<br />
following: Which of the indicators: the net income or comprehensive income is more relevant<br />
to professional investors in making investment decisions? To answer to this question, based<br />
on data collected from financial statements of 62 companies listed on the London Stock<br />
Exchange, we calculated on the one hand, Pearson correlation coefficient, between the basic<br />
earning per share and price per share, and on the other hand, between the comprehensive<br />
income per share and price per share. The results reflected similar values of the Pearson<br />
coefficient in both cases, suggesting that in making investment decisions, professional<br />
investors give almost equal importance to both net income and comprehensive income. The<br />
results were supported also by simple regression functions constructed which showed very<br />
similar changes in size of the price per share due to the influence of the net income or of the<br />
comprehensive income.<br />
KEYWORDS: comprehensive income, net income, price per share, professional investors<br />
INTRODUCTION<br />
The net income is considered the main indicator for measuring the financial<br />
performance of an economic entity. By the method of its calculation, the net income is<br />
oriented towards the past, serving as a measure of the progress of an economic entity<br />
during a past period of time. According to Olimid (1998), the net income may have<br />
other uses: a guide of dividend policy and of entity acquiring; a means of predicting<br />
future results to make investment or disinvestment decisions; a means of evaluating<br />
the capacity of management to lead the economic entity; a means of estimating the<br />
value of other groups’ decisions related to the entity; a management tool in a number<br />
of areas within and outside the company (pricing policy, wage negotiations, credibility<br />
in front of credit agencies, price regulation in monopoly conditions.<br />
The net income is the difference between revenue realized in transactions and related<br />
historical cost occurred in a designated period of time, based on the accrual basis,<br />
realization principle and matching principle. The calculation of the net income, taking<br />
into account the mentioned principles, involves two stages:<br />
� recognizing revenue when it is realized;<br />
1 Correspondence address: Iulia JIANU, Faculty of Accounting and Management Information<br />
Systems, Bucharest Academy of Economis Studies, Romania, email : jianu.iulia@cig.ase.ro<br />
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� recognizing expenses in three possible ways:<br />
o associating cause with the effect, as it is the case of different components<br />
that make up the cost of sold goods which are recorded as expenses along<br />
with recording revenue from the sale of those goods;<br />
o a systematic and rational allocation when it is required to obtain economic<br />
benefits over several financial years and the correlation with income can<br />
be made generally or indirectly, as the case of property depreciation;<br />
o an immediate recognition when they do not produce future economic<br />
benefits or when such benefits do not have the necessary characteristics to<br />
be recorded as assets on the balance sheet. It is the case of administrative<br />
or sales expenses, as well as research expenses.<br />
Lately, due to the evaluation of a growing number of items at fair value, the principle<br />
of revenue recognition when it is realization is more often violated by the recognition<br />
of unrealized gains (for investment property, biological assets, financial instruments<br />
measured at fair value through profit and loss account, derivatives). Thus, the net<br />
income in the profit and loss account tends to reflect not only the current income and<br />
expenditure but also those expected to occur in the future.<br />
An economic entity gains profit by carrying out two types of activities: those that<br />
combine or transform inputs into goods whose sales value is greater than the value of<br />
factors and activities that lead to achieving growth in earnings due to factors of<br />
production that are in entity’s possession. Since 1961, Edwards & Bell have claimed<br />
that the decisions involved by the two activities are so different that their separation is<br />
inevitable for assessing the fairness of management decisions and that there must be a<br />
clear distinction between the change in value resulting from the production and the<br />
change in value resulting from over time. Currently, this distinction is less obvious.<br />
More and more elements are measured at fair value, and the gains obtained from asset<br />
appreciation, as the case of real estate investments and biological assets, are presented<br />
in the income from ordinary activities, thus violating the principle of achieving<br />
revenues. Instead, the fair value measurement for other types of assets (revalued<br />
tangible and intangible assets, assets held for sale) requires recognition of gains by<br />
directly affecting the equity.<br />
Chambers (1994) stated that only the comprehensive income can be used to assess the<br />
performance of the company and of its managers. In his view, the acquisition of any<br />
asset is considered a good investment as long as the present value of future cash flows<br />
generated by its use exceeds the present value of future earnings generated by<br />
alternative use of the amount that would currently be obtained from the sale of the<br />
asset. No matter how fixed would be the intention to use an asset over a long period of<br />
time, it is wise that when a superior profitability opportunity is found, the asset should<br />
be sold and we should invest in another one. Thus, goods are not purchased solely for<br />
the gross profit, but also to benefit from the expected price changes, the general or<br />
relative ones.<br />
In France, in 1998, Bernheim predicted a two-pronged approach of the outcome:<br />
addressing the economic entity's performance based on transactions that it achieved<br />
during the period, translated by the difference between its revenues and expenses and<br />
addressing its patrimonial enrichment measured by the difference between its net<br />
assets at the beginning and at the end of the period. This dual approach aims to answer<br />
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two types of different needs of users, to measure the performance of activities, current<br />
operating concept, and to measure enrichment, in a patrimonial conception of the<br />
economic entity, all inclusive concept. According to current operating concept, in<br />
profit and loss account are included only the consequences of operational, normal<br />
activities of the period, and there are reported on equity, the activities that do not<br />
affect the operational activities. These activities are considered as normal, recurring<br />
and allowing to provide the economic entity's future performance. Proponents of<br />
performance assessment based on the result of current operating concept, tend to<br />
measure the managers’s performance, retaining in a restrictive manner, only the<br />
elements controlled by them. According to all inclusive concept, all elements that<br />
affect the increase or decrease in equity during the period, except for the distributions<br />
of dividends or capital decrease through distribution to shareholders or partners, from<br />
their respective contributions, enter in the field of financial performance<br />
measurement. The indicator which allows the calculation of the financial performance<br />
in terms of all inclusive concept is the comprehensive income.<br />
The comprehensive income takes into account both realized gains and losses and<br />
unrealized gains and losses that are directly recognized in equity as being the<br />
consequence not only of factors that can be controlled by the entity through its<br />
management team but also of market factors such as the evolution of market prices, of<br />
the interest rate, of the exchange rate or of the stock market of shares. The category of<br />
gains and losses recorded directly in the equity under IFRS includes: gains and losses<br />
from the revaluation of tangible and intangible fixed assets, gains and losses from the<br />
evaluation of financial instruments that are available for sale, gains and losses from<br />
the risk hedging associated with cash flows and investment in a foreign entity,<br />
exchange differences from the conversion of foreign operations, gains and losses<br />
relating to defined benefit plans, deferred tax relating to items recorded directly in<br />
equity.<br />
The financial statements of an economic entity are important for a wide range of<br />
users: investors, financial lenders, suppliers, customers, employees, the state, and the<br />
general public. We must admit the truth:that the vast majority of information is used<br />
by investors to predict financial statement and the future performance of the<br />
economic entity. This is the reason why investors are first appointed by the IASB as<br />
users of accounting information. In other accounting referentials, such as U.S. GAAP,<br />
investors are the only users, the others being considered auxiliary users who use the<br />
information provided to investors to meet their own needs. Investors who "play" on<br />
the stock exchange by speculating the price variation are considered professional<br />
investors.<br />
Longevitaty of the net income, as main indicator for measuring the financial<br />
performance of an economic entity on the one hand, and the "novelty" of the concept<br />
of comprehensive income that tends to take the place of the net income in measuring<br />
the financial performance of an economic entity, on the other hand, were the<br />
prerequisites for testing the relevance of the two indicators in making decisions on the<br />
sale or on the purchase of shares by professional investors. Consequently, the question<br />
around which this study circumscribe is the following: Which of the indicators: the<br />
net income or the comprehensive income is more relevant to professional investors in<br />
making investment decisions?<br />
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This study is structured in the following way: the first part carries aut a brief history<br />
on the comprehensive income since the emergence of the concept up to present, the<br />
second part summarizes the literature review focused on the statement of<br />
comprehensive income, the third part explains the research methodology, and the<br />
fourth part focuses on presenting the results obtained from the data collected and the<br />
discussions that are appropriate. The paper concludes with the authors' conclusions<br />
regarding the importance given by professional investors to net income versus<br />
comprehensive income.<br />
1. BRIEF HISTORY CONCERNING THE STATEMENT<br />
OF COMPREHENSIVE INCOME<br />
The term comprehensive income appeared for the first time in 1980 in the American<br />
legal texts (SFAC 3). Five years were necessary so that the term ‘comprehensive<br />
income’ should be defined for the first time in 1985 in Concepts Statement 6 Elements<br />
of Financial Statements as:<br />
"the change in equity of a business enterprise during a period from transactions<br />
and other events and circumstances from nonowners sources. It includes all<br />
changes in equity during a period except those resulting from investments by<br />
owners and distributiond from owners”.<br />
If the definition of this concept required five years, its implementation required 12<br />
years, SFAS 130 Reporting Comprehensive Income applied to financial years<br />
beginning after December 15, 1997.<br />
In the U.S., SFAS 130, requires companies to disclose the comprehensive income in a<br />
primary financial statement, but allows the disclosure of the comprehensive income<br />
either in a performance or nonperformance statement. The comprehensive income<br />
includes the effects of all performed operations and of all acts that occurred during the<br />
year, relating themselves to the current operation or not and having contributed to the<br />
increase or decrease in equity (excluding the shareholders’ contributions or their<br />
associates’ contributions and the distributions to them). Any gains or losses recorded<br />
in the year, realized or not, exceptional or extraordinary, contribute to the economic<br />
entity's performance and should be included in the statement of comprehensive<br />
income. By adopting the comprehensive income, the FASB abandons the concept of<br />
profit and loss account and directs its attention to the balance sheet. This does not<br />
mean that the American standards give a greater importance to the balance sheet (it<br />
belongs to users and not to regulators) but that translates a conceptual shift with such<br />
important consequences that FASB felt obliged to foresee compromises and steps to<br />
ensure the transition.<br />
The U.S. format of comprehensive income statement was the consequence of heated<br />
debates between two different points of view: on the one hand, the FASB that<br />
supported the disclosure of the comprehensive income statement as reflecting the<br />
performance of the entity and on the other hand, board members who indicated that<br />
the presentation of comprehensive income in a performance statement would enhance<br />
its visibility, thereby increasing investors' use of this information, which is why they<br />
supported the disclosure of comprehensive income statement as a change in equity. As<br />
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a result of diverging views between the two representatives, FASB and board<br />
members, the solution found was to choose the option between the two preferences:<br />
� the presentation of comprehensive income as a statement of performance, in<br />
two possible options: either as a financial statement that is different from<br />
profit and loss account that includes two items: the net income shown in the<br />
income statement and other comprehensive income. The category of other<br />
gains and losses includes changes in fair values of financial instruments<br />
available for sale, the gain or loss from derivatives, adjustments to the pension<br />
plans, the differences arising from translating the financial statements of<br />
foreign entities, or drawing a single statement of financial performance that<br />
includes both the evidence presented in the profit and loss and other gains and<br />
losses component.<br />
� presentation of comprehensive income as part of the statement of changes in<br />
equity.<br />
ASB in the UK was the first regulator that in 1992 adopted the concept of<br />
comprehensive income by FRS Rule 3 Statement of Total Recognised gains and<br />
losses. The publication of the Statement of total recognised gains and losses is<br />
justified by the ASB in that British accounting rules or statutory provisions allow the<br />
direct observation in equity of gains and losses as well as the revaluation of property,<br />
differences in conversion, latent gains or losses on financial instruments, gains and<br />
losses arising from pension funds. Statement of total recognised gains and losses is<br />
specific to British accounting being seen as a situation that facilitates forecasting,<br />
ASB arguing this:<br />
„The disclosure of these components is designed to facilitate understanding of<br />
the performance achieved in a period and to assist users in deciding on the<br />
extent to which past results are useful in helping to assess potential future<br />
results.” (ASB, 1992, FRS 3)<br />
FRS 3 also states the preparation of a statement reconciliation of the net income<br />
obtained under conditions in which the economic entity has revalued the tangible<br />
outcome with the net income that would have been obtained in historical costs. The<br />
role of this statement is to allow comparability between the financial statements of<br />
entities which have opted for the revaluation of tangible and financial statements of<br />
entities which have remained at historical cost. This must be presented in the notes to<br />
financial statements and it has no equivalent in international practice. Information<br />
should be presented only if the differences between the two results are<br />
significant. Differences may be due to:<br />
� if assets are revalued, depreciation is based on the revalued amount, if assets<br />
had not been revalued, the depreciation would have been based on historical<br />
cost;<br />
� if assets are sold, profit is the difference between the selling price and the<br />
revalued carrying amount, while for the assets valued at cost, the profit is<br />
higher because it represents the difference between the sale price (the same)<br />
and the historical book value (lower).<br />
Introducing this reconciliation statement between the historical costs and the net<br />
income in fair values provides very relevant information, especially for users of<br />
accounting information who are skeptical on the fair value determined after<br />
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eassessment, it is easily to make it, thus respecting the qualitative cost-benefit<br />
constraint. We recommend this statement to be part of a set of financial statements<br />
and not to be just a certain note in the annexes.<br />
IASC revised the IAS 1 standard in 1997, to introduce a second statement of the<br />
results regarding the changes in equity which may reflect either all changes in equity<br />
or changes in equity other than transactions with owners. We believe that the<br />
objective of the two statements is so different that the IASB would not have asked the<br />
economic entities to make a choice. The statement of comprehensive income, called<br />
by the IASB –The statement of gains and losses, was a statement that reflects the<br />
overall performance of the economic entity, while the situation of changes in equity,<br />
as the title suggests, was a statement that presented changes in equity and was quite<br />
complex to present relevant information.<br />
In 1998, ASB in Australia published an exposé-survey (ED 93), which proposed a<br />
unique statement to reflect performance, with an overview presentation in a separate<br />
statement of changes in equity which are not attributed to owners. The need for a<br />
unique statement to reflect the performance has become increasingly evident<br />
worldwide. In this regard, in 1998, the representatives of the Council of Accounting<br />
Rules in Canada belonging to ICCA attended, with the representatives from the U.S.<br />
standardization bodies, New Zealand, Australia and Britain, as well as with the<br />
representatives of the IASB (this group of regulators is known as the G4 +1) the<br />
publishing of a special report on a new presentation of the performance<br />
statement. The G4 +1 proposals have focused mostly on presenting the performance<br />
components and not on establishing and measuring the performance. In other words, it<br />
was about the way in which specific performance items were grouped and presented<br />
in such a way as to serve the objectives of financial statements. The unique statement<br />
of the performance proposed by the G4+1 distinguished the elements specific to<br />
operating activities from other elements specific to other gains and losses, according<br />
to four basic criteria: operating activities/activities outside operation, recurring/nonrecurring<br />
items, items that are not owned/held items, internal/external events.<br />
Currently, the IASB calls that both net income and unrealized holdings gains or losses<br />
(other comprehensive income) will be included in a single comprehensive income<br />
statement. In this sense, art. 81 of IAS 1 Presentation of Financial Statement allows<br />
economic entities to choose between two ways to present all items of income and<br />
expense recognised in a period:<br />
(a) a single statement of comprehensive income, or<br />
(b) two statements: a statement displaying components of profit or loss<br />
(separate income statement) and a second statement beginning with profit or<br />
loss and displaying components of other comprehensive income (statement of<br />
comprehensive income).<br />
IAS 1 defines the notion of „other comprehensive income” as:<br />
„income comprises items of income and expense (including reclassification<br />
adjustments) that are not recognised in profit or loss as required or permitted<br />
by other IFRSs”.<br />
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The components of other comprehensive income include: changes in revaluation<br />
surplus; actuarial gains and losses on defined benefit plans; gains and losses arising<br />
from translating the financial statements of a foreign operation; gains and losses on<br />
remeasuring available-for-sale financial assets; the effective portion of gains and<br />
losses on hedging instruments in a cash flow hedge.<br />
2. LITERATURE REVIEW<br />
Smith & Reither (1996) consider that the comprehensive income is higher than the net<br />
income because, by its components (other comprehensive income) there can be made<br />
easier comparisons between entities in the same sector and moreover, these elements<br />
must be known for evaluating overall performance because they result from a<br />
company’s economic decisions and activities.<br />
Based on prior research in accounting and psychology, Laureen & McDaniel (2000)<br />
developped a psychology-based framework that evaluates how presentation format of<br />
comprehensive income affects nonprofessional investors' information acquisition,<br />
evaluation, and weighting processes. In order to test these predictions, ninety-five<br />
M.B.A. students participated in an experiment by analysing the insurance company's<br />
financial statement. The results of the study showed that the financial-statement<br />
format for presenting comprehensive income did not significantly affect<br />
nonprofessional investors' acquisition and evaluation of that information, but<br />
generally did significantly influence their information weighting and resulting<br />
performance judgments. Moreover, the authors showed that the nonprofessional<br />
investors' judgments of corporate and management performance reflect the volatility<br />
of comprehensive income only when it is presented in a statement of comprehensive<br />
income.<br />
Gordon & Niles (2005) on a case study for students, inspired by the practical reality<br />
of two technology firms: Lucent Technologies and Microsoft, in order to reflect the<br />
effect of timing on accounting reporting decisions and the role of auditors in<br />
deternining fair financial reporting, demonstrates that the comprehensive income<br />
statements, unlike net income, are relatively stable and difficult to manipulate.<br />
In a survey of 202 U.S. commercial banks in 1996-2004, Hodder et al (2006) have<br />
pointed out that result volatility in an accounting that would allow evaluation of all<br />
financial instruments at fair value, is 90 % higher than the volatility of net income and<br />
77% higher than the volatility of comprehensive income which would result in a<br />
higher stability of comprehensive income in relation to net income. Hunton et al<br />
(2006) in an experiment involving 59 financial executives and 3 chief executive<br />
officers shows that a greater transparency of comprehensive income statement reduces<br />
the likelihood for the managers to recommend selling available-fot-sale securities that<br />
increase/decrease current income when projected earnings are below/above consensus<br />
forecast. Liu & Liu (2006) consider that the comprehensive income reporting will<br />
provide more useful and related information, and satisfy the users with comprehensive<br />
financial information in future, recommending that other comprehensive income<br />
should be reported separately from other equity items.<br />
Following the analysis of 46 annual reports of the 2008 financial year published by<br />
European industrial companies which apply IFRS, Dumitrana et al (2010) noticed that<br />
~ 972 ~
only 9 companies have written out the statement of comprehensive income (the<br />
standard IAS 1 provided for the year 2008 the option to choose between the<br />
preparation of the statement of losses and gains and the statement of changes in<br />
equity). For the analysed entities other comprehensive income recognised directly in<br />
the equity represent on an average, 27,8% of the total comprehensive income. Within<br />
other comprehensive income, the most considerable items are owned by gains and<br />
losses arising from translating the financial statements of a foreign operation.<br />
Although most investors prefer reporting comprehensive income as a separate<br />
statement of performance due to the more transparent provided information, in a study<br />
of 440 companies, Bamber et al (2010) showed that 81 percent of the sample S&P<br />
500 firms do not follow policymakers’ preference, and instead report comprehensive<br />
income in the statement of equity. Only 19 percent the sample (85 firms) reports<br />
comprehensive income in a performance statement. The absolute value of other<br />
comprehensive income is 12.7 percent of the absolute value of net income. The most<br />
important component of the other comprehensive income is unrealized gains and<br />
losses on foreign currency translation reported by 81 percent of the sample firms (this<br />
component represents 55,4 percent of other comprehensive income). The next<br />
component of other comprehensive income are: unrealized gains and losses on AFS<br />
securities reported by 60 percent of the sample firms (this component represents 30,9<br />
percent of other comprehensive income); a pension component reported by 39 percent<br />
of the sample firms (this component represents 11,3 percent of other comprehensive<br />
income); and a derivatives component reported by 4 percent of the sample firms (this<br />
component represents 2,2 percent of other comprehensive income). However, based<br />
on this survey, the authors have shown the comprehensive income is 32 percent more<br />
volatile than net income. It is also important to highlight the assumptions that have<br />
been validated by the authors following the survey they conducted: managers with<br />
more powerful equity-based incentives are more likely to avoid performance<br />
reporting, and CEOs whose jobs are less secure are more likely to avoid performance<br />
reporting.<br />
Barton et al. (2010) estimated and compared the value relevance of a comprehensive<br />
set of performance measures commonly disclosed in the financial statements of<br />
almost 20,000 firms from 46 countries during 1996–2005. The performance measures<br />
analysed were operating cash flows, sales, EBITDA, operating income, income before<br />
taxes, income before extraordinary items and discontinued operations, net income,<br />
and total comprehensive income. The autors find that the value relevance of the<br />
performance measures varies substantially across line items on the income statement<br />
as well as across countries. The results of the survey have shown that, subtotals near<br />
the center of the income statement, such as operating income, have the strongest<br />
association with contemporaneous stock returns than subtotals at the top or bottom of<br />
the income statement, such as sales and total comprehensive income, which have the<br />
weakest association with stock returns. Also, the survey has shown the weak value<br />
relevance of net income and comprehensive income mostly in common-law countries.<br />
Taking into account the results of the survey, we could see the superiority of the net<br />
income towards the comprehensive income from the value relevance point of view,<br />
both in common-law countries and in code-law countries.<br />
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3. RESEARCH METHODOLOGY<br />
For data collection we have chosen as a sample of 100 economic entities listed on<br />
London Stock Exchange (FTSE 100) those which had submitted the annual report on<br />
www.orderannualreports.com site, thus obtaining a total of 71 annual reports. Out of<br />
the 71 economic entities, we have removed 9 because: an entity did not present the<br />
financial statements in the annual report, 4 entities presented financial statements<br />
prior to 2009 in their annual report, an entity applied the U.S. GAAP referential in its<br />
financial reporting, an entity did not apply the amendments to IAS 1 for the financial<br />
year 2009 regarding the statement of comprehensive income, and for two entities the<br />
data on the price per share was not available. Therefore 62 entities were surveyed.<br />
Regarding the analyzed entities, the balance-sheet date was the end of 2009 for 42<br />
entities and 06/30/2009 for two entities. The remaining 18 entities had the closing<br />
date of the balance sheet in 2010 as follows: in January, 4 entities; in February 1<br />
entity; in March 12 entities; in April 1 entity. Therefore, in order to show to what<br />
extent net income and comprehensive income influence the price per share, we took<br />
for analysis the price per share of closing balance. Since 15 economic entities had<br />
financial statements which was different from GBP (14 entities in USD and one entity<br />
in EUR ), in order to achieve the price correlations of these entities, we converted the<br />
GBP in USD then in EUR taking into account the rates in effect of the stock market.<br />
To convert, we used the converter on the XE website (http://www.xe.com/<br />
currencycharts/?from=GBP&to=USD). The entities participating in the study, the<br />
reporting currency of the financial statements, the date for balance sheet and the price<br />
per share for the analysed entities are presented in Annex 1.<br />
In order to determine which of the indicators between net income and comprehensive<br />
income influences more the price per share, we calculated the correlation degree<br />
between basic earning per share and price per share, on the one hand, and<br />
comprehensive income per share and price per share, on the other hand. In order to<br />
calculate the correlation degree, the Pearson correlation coefficient was used. This<br />
coefficient serves three function (Smith, 2005, p. 69):<br />
„• it establishes the direction of any relationship which should be intuitively<br />
correct and which must correspond whith the sign if this variable in any<br />
regression equation;<br />
• it suggests those varables which are likely to be useful explanatory variables<br />
because they are highly correlated with the dependent variable;<br />
• it highlights potential multicollinearity problems by quantifying the strenght<br />
of association between competing explanatory variables”<br />
Pearson correlation coefficient may take values between -1 (for a perfect inverse<br />
relationship) and +1 (for a perfect positive correlation). In the present study, the<br />
calculation of the coeficient was automatically done by Pearson function in EXCEL.<br />
To this purpose, two data were used:<br />
• for calculation correlation degree between net income and price per share, the<br />
independent variable is the basic earning per share and the dependent variable<br />
is the price per share (Annex 2).<br />
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• for calculation correlation degree between comprehensive income and price<br />
per share, the independent variable is the comprehensive income per share<br />
and the dependent variable is the price per share (Annex 3).<br />
The price per shares for the entities under study was taken from the site of the London<br />
Stock Exchange (www.londonstockexchange.com). Basic earning per share for the<br />
2009 financial year was taken from income statement. Total comprehensive income<br />
per share was calculated by relating total comprehensive income to the number of<br />
shares. The values for total comprehensive income, net income, total other<br />
comprehensive income and for each element of other comprehensive income (changes<br />
in revaluation surplus, actuarial gains and losses on defined benefit plans, gains and<br />
losses arising from translating the financial statements of a foreign operation, gains<br />
and losses on remeasuring available-for-sale financial assets, the effective portion of<br />
gains and losses on hedging instruments in a cash flow hedge, tax relating to<br />
components of other comprehensive income) were taken from the statement of<br />
comprehensive income.<br />
In order to show how much the change of the basic earning per share or the<br />
comprehensive income per share influences the stock market we used the simple<br />
regression model. The simple regression analysis which assesses the possibility of a<br />
link between two variables, we make by Regression fonction in EXCEL.<br />
In order to show to what extent the change of the basic earning per share influences<br />
the price per share we named the function:<br />
YNI= a + bXNI<br />
where:<br />
YNI – price per share (dependent variable)<br />
XNI – basic earning per share (independent variable)<br />
a, b – parameters for the simple regresion between market stock and basic<br />
earning per share<br />
In order to show to what extent the change of the comprehensive income per share<br />
influences the price per share we named the function:<br />
YCI = α + βXCI<br />
where:<br />
YCI – price per share (dependent variable)<br />
XCI – comprehensive income per share (independent variable)<br />
α,β – parameters for the simple regresion between market stock and<br />
comprehensive income per share<br />
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4. RESULTS AND DISCUSSIONS<br />
4.1. Correlation analyse between basic earning per share or comprehensive<br />
income per share, on the one hand, and the price per share, on the other<br />
hand<br />
The way in which each of the performance indicators, net income and comprehensive<br />
income, affect the decisions of professional investors, to keep or sell the shares they<br />
hold or to acquire new ones, is reflected through price per shares. To show which of<br />
the two indicators gives better information to professional investors, by a comparative<br />
way, we calculated the degree of correlation between, on the one hand, the basic<br />
earning per share and price per share, and on the other hand, comprehensive income<br />
per share and price per share. For the analysis of the correlation, Pearson index was<br />
calculated through EXCEL.<br />
The degree of correlation between the basic earning per share and price per share<br />
(Person's correlation coefficient) based on data presented in Annex 2 is 0.56. The<br />
degree of correlation between comprehensive income per share and price per share<br />
(Person's correlation coefficient) based on data from Annex 3 is 0.47. The results<br />
obtained show that the degree of correlation is stronger between net income and price<br />
per share than between the comprehensive income and the price per share. One reason<br />
for this result may be that the comprehensive income is a new concept which is not<br />
given due importance by the bodies that should promote it among the main indicators<br />
in assessing the economic entity's financial performance. We refer here to the<br />
supervisory body of the London Stock Exchange, which among the basic indicators<br />
under the heading "summary" in the presentation of companies, does not have the<br />
comprehensive income. In addition, under the heading "fundamentals" is presented<br />
only the balance sheet and profit and loss account, the comprehensive income is not<br />
presented.<br />
The financial year 2009 was the first year in which entities that apply IFRS can<br />
choose to present the economic entity's financial performance in a single statement of<br />
comprehensive income (here, it will be presented the income and expenses which are<br />
now reflected in the profit and loss account, as well as gains and losses recognized<br />
directly in equity), or in two situations: first, the profit and loss account, and then, the<br />
statement of comprehensive income (here, it will be presented only the total of the<br />
accounting income that is calculated in profit and loss account , as well as gains and<br />
losses recognized directly in equity). As seen in Figure 1, regarding the economic<br />
entities under study, we found that only 5 entities present a single statement of<br />
performance, while the remaining 57 entities prepare two statements of reporting<br />
performance: profit and loss account and the statement of comprehensive income.<br />
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Figure 1.The distribution of financial statements reporting the number<br />
of performance<br />
Thus the traditional in reporting financial performance seems to take priority over the<br />
new changes that tend to present an unique performance reporting. However, the<br />
values that are high and near the Pearson coefficient for both the analysis of net<br />
income correlation with the price per share (0.56), and for the analysis of the<br />
comprehensive income correlation with the price per share (0.47) suggests that<br />
professional investors take into account in making investment decisions both the net<br />
income and the comprehensive income. To validate this hypothesis we considered<br />
important to show to what extent the modification of basic earning per share and<br />
comprehensive income per share influence the price per share. For this, we used the<br />
simple regression model, having already shown that the basic earning per share or<br />
comprehensive income per share, and the price per share, are linked.<br />
4.2 The simple regression model to calculate the price per share in relation<br />
to earning per share<br />
Based on data from Annex 2 and on the results obtained by applying the Regression<br />
function presented in Table 1, we defined the following simple regression function to<br />
express the price per share in relation to basic earning per share:<br />
YNI = 512,22 + 8,91 XNI (Formula 1)<br />
The b coefficient in Formula 1 shows that in the case of a change with a pound/cent of<br />
basic earning per share, the price per share changes by 8.91 pounds/centimes.<br />
Table 1. Summary output for simple regression between price per share<br />
and comprehensive income per share<br />
Regression Statistics<br />
Multiple R 0,56005749<br />
R Square<br />
Adjusted R<br />
0,313664392<br />
Square<br />
Standard<br />
0,302225466<br />
Error 1180,733454<br />
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Observations 62<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 38228184,72 38228184,72 27,42079 0,00000221166<br />
Residual 60 83647889,32 1394131,489<br />
Total 61 121876074<br />
Coefficients<br />
Standard<br />
Error t Stat P-value<br />
~ 978 ~<br />
Lower<br />
95%<br />
Upper<br />
95%<br />
Lower<br />
95,0%<br />
Upper<br />
95,0%<br />
Intercept 512,2206 190,3024 2,6916 0,0092 131,5590 892,8821 131,5590 892,8821<br />
X Variable 1 8,9158 1,7026 5,2365 0,0000 5,5100 12,3216 5,5100 12,3216<br />
Since Multiple R has a positive value which is greater than 0.5, shows that between<br />
basic earning per share and price per share there is a direct correlation of medium<br />
intensity. R Square shows that 31.36% of the variation of the price per share is<br />
explained by the basic earning per share. Since Significance F has a very small, far<br />
below the threshold limit of 0.05, and F has a high value (27.42), we can accept the<br />
simple regression model presented in Formula 1, and validated by Figure 2.<br />
Figure 2. X Variable 1 Line Fit Plot<br />
4.3 The simple regression model to calculate the price per share in relation<br />
to comprehensive income per share<br />
Based on data from Annex 3 and on the results obtained by applying th Regression<br />
function in Table 2, we defined the following simple regression function to express<br />
the price per share in relation to basic earning per share:<br />
YCI = 729,47 + 5,37 XCI (Formula 2)
The 2 β coefficient in the formula 2 shows that in the case of a change with a<br />
pound/centime of comprehensive income per share, the price per share changes by<br />
5.37 pounds/centimes.<br />
Table 2. Summary output for simple regression between price per share and basic<br />
earning per share<br />
Regression Statistics<br />
Multiple R 0,472184425<br />
R Square<br />
Adjusted R<br />
0,222958131<br />
Square<br />
Standard<br />
0,210007433<br />
Error 1256,336024<br />
Observations 62<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 27173261,72 27173262 17,215916 0,00010679<br />
Residual 60 94702812,33 1578380<br />
Total 61 121876074<br />
Coefficients<br />
Standard<br />
Error t Stat P-value<br />
~ 979 ~<br />
Lower<br />
95%<br />
Upper<br />
95%<br />
Lower<br />
95,0%<br />
Upper<br />
95,0%<br />
Intercept 729,4754 185,9590 3,922776 0,0002278 357,5021 1101,4488 357,5021 1101,4488<br />
X Variable 1 5,3719 1,2946 4,149207 0,0001068 2,7821 7,9616 2,7821 7,9616<br />
Since Multiple R has a positive value close to 0.5, this shows that between<br />
comprehensive income and price per share there is a direct correlation of medium<br />
intensity. R Square shows us that only 22.29% of the variation of the price per share is<br />
explained by the comprehensive income. Since Significance F has a low value,below<br />
the threshold limit of 0.05, and F is a high value (17.21), we can accept the simple<br />
regression model presented in Formula 2 and validated by Figure 3.
Figure 3. X Variable 1 Line Fit Plot<br />
4.4. Discussion concerning the power of net income and comprehensive income<br />
for profesional investors<br />
From the comparative analysis of the two simple regression models, it is noted that<br />
the price per share is influenced to a greater extent by the net income than by the<br />
comprehensive income. Thus, in the case of a change with a pound/centime of basic<br />
earning per share, the price per share changes by 8.91 pounds/centimes, while in the<br />
case of a change with a pound/centime of comprehensive income per share, the price<br />
per share changes by 5,37 pounds/centimes. However, we consider that the difference<br />
between the b coefficient in Formula 1 (8.91) and the β coefficient in Formula 2<br />
(5.37) is insignificant since the amounts are expressed in pounds/centimes. This close<br />
relationship that is, on the one hand, between basic earning per share and price per<br />
share, and on the other hand, between comprehensive income per share and price per<br />
share, was confirmed by the analysis using Pearson coefficient which showed the<br />
correlation values of 0.56 for net income and 0.47 for comprehensive income.<br />
Therefore, we consider validated the assumption that in making investment decisions,<br />
professional investors take into account both the net income and the comprehensive<br />
income. To support this idea, we present the interpretation of the results obtained by<br />
collecting data from the 2009's financial statements for entities under study.<br />
As seen in Table 3, most economic entities obtain a positive result, for both net<br />
income and comprehensive income. Four out of the eight entities for which<br />
comprehensive income registered a negative value, was generated by other<br />
comprehensive income (net income for these entities being positive) while for the<br />
remaining four entities, the negative value of comprehensive income was generated<br />
both by the negative net income and by the negative value of other comprehensive<br />
income. The remaining two entities had a negative result, in the end they had a<br />
positive comprehensive income as other comprehensive income were higher than net<br />
income. We can note that for 60% of entities surveyed, total comprehensive income<br />
has a negative value.<br />
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Entities<br />
nomber<br />
Table 3. Differences between net income and comprehensive income<br />
Total comprehensive<br />
income<br />
positive<br />
value<br />
negative<br />
value<br />
positive<br />
value<br />
Net income<br />
~ 981 ~<br />
negative<br />
value<br />
Total other comprehensive<br />
income<br />
positive value negative value<br />
62 54 8 56 6 25 37<br />
Therefore, only for six of the entities reviewed, other comprehensive income was at<br />
the basis of changing the sign of the obtained result (positive net income and negative<br />
comprehensive income, or, negative net income and positive comprehensive income), which<br />
represents less than 10% of the total number of entities reviewed. An argument to<br />
support the importance of comprehensive income in making investment decisions is<br />
the significant amount of total other comprehensive income related to the value of the<br />
net income.<br />
Figure 4. Proportion of value of total other comprehensive income in value of net<br />
income<br />
As seen in Figure 4, less than 10% of the total number of entities present values that<br />
are insignificant for total other comprehensive income ( 5% of net income to levels > 100% of the net<br />
income.<br />
According to IAS 1, the components of other comprehensive income include:<br />
(a) changes in revaluation surplus (IAS 16 Property, Plant and Equipment and<br />
IAS 38 Intangible Assets);<br />
(b) actuarial gains and losses on defined benefit plans recognised in accordance<br />
with paragraph 93A of IAS 19 Employee Benefits;<br />
(c) gains and losses arising from translating the financial statements of a foreign<br />
operation (IAS 21 The Effects of Changes in Foreign Exchange Rates);
(d) gains and losses on remeasuring available-for-sale financial assets (see IAS<br />
39 Financial Instruments: Recognition and Measurement);<br />
(e) the effective portion of gains and losses on hedging instruments in a cash<br />
flow hedge (see IAS 39).<br />
As seen in Figure 5, gains and losses arising from translating the financial statements<br />
of a foreign operation is the element that is found in 85% of the reviewed entities,<br />
followed by, the effective portion of gains and losses on hedging instruments in a cash<br />
flow hedge (77%), gains and losses arising from translating the financial statements of<br />
a foreign operation (73%), actuarial gains and losses on defined benefit plans (71%).<br />
The element with the lowest weight represents changes in revaluation surplus which is<br />
only represented at the level 3 of the economic entity, which suggests the trend of<br />
economic entities to be evaluated at historical cost, avoiding the fair value<br />
measurement when it is not required by regulations (IAS 16 provides only the option<br />
of revaluation of tangible and intangible assets at fair value).<br />
Figure 3. The number of companies that present other comprehensive income<br />
Along with the 5 components of the other comprehensive income, the amount of<br />
income tax relating to each component of other comprehensive income, including<br />
reclassification adjustments shall be disclosed, either in the statement of<br />
comprehensive income or in the notes. According to IAS 1, the economic entities may<br />
present components of other comprehensive income either: net of related tax effects,<br />
or before related tax effects with one amount shown for the aggregate amount of<br />
income tax relating to those components. In the case of the reviewed entities, 40% of<br />
them, representing 25 entities, presented in statement of comprehensive income<br />
components of other comprehensive income net of related tax effects.<br />
CONCLUSION<br />
For a long time and even today net income continues to be considered the main<br />
indicator for measuring economic performance of an entity. Along with the net<br />
income, the comprehensive income starts to gain the status of leading indicator in<br />
reflecting the entity's financial performance. The close values of the Pearson<br />
~ 982 ~
coefficient, for both the correlation of the net income with the price per share and for<br />
the correlation of the comprehensive income with the price per share, suggests that<br />
professional investors take into account in making investment decisions both the net<br />
income and comprehensive income. By analysing the regression function on the one<br />
hand between the basic earning per share and the stock market of the share, and on the<br />
other hand between comprehensive income per share and the stock market of the<br />
share, it came out that both net income and comprehensive income influence in the<br />
same way and with almost equal intensity the stock market of the share.<br />
By analyzing the financial statements of entities under study, we could fiind that most<br />
entities present two financial statements to report performance (income statement and<br />
statement of comprehensive income) although IAS 1 recommends as basic treatment<br />
the submission of a single statement of performance reporting. The appeal, however,<br />
to two cases involving financial reporting of performance, has an inconvenient, at all<br />
insignificant: a greater importance can be given to a statement over the other. The fact<br />
that professional investors give the same importance to both comprehensive income as<br />
well as net income, this represents a prerequisite for supporting the need for unique<br />
statements in performance reporting.<br />
Although it is stated that the net income includes only revenues and expenses, in<br />
recent years, due to the use of fair value in evaluating a large number of items in the<br />
financial statements, the difference between net income and comprehensive income<br />
tends to diminish. What distinguishes the comprehensive income from the net income<br />
is other comprehensive income, which includes five components: changes in<br />
revaluation surplus, actuarial gains and losses on defined benefit plans, gains and<br />
losses arising from translating the financial statements of a foreign operation, gains<br />
and losses on remeasuring available-for-sale financial assets, the effective portion of<br />
gains and losses on hedging instruments in cash flow hedge. But, although in small<br />
numbers, these five components together, have presented significant value for the<br />
analyzed entities; more than 45% of the entities had the value for other comprehensive<br />
income over 50% of net income. Of the five components, gains and losses arising<br />
from translating the financial statements of a foreign operation, were found in most<br />
organizations. This is normal, given that the analyzed entities are multinational and<br />
the exchange differences arise inherently from the consolidated financial statements.<br />
It should be noted, however, the low number of entities which have opted for the<br />
revaluation of property, (3 entities). It is a definite proof of the superiority of<br />
historical cost over fair value.<br />
The results of this study represent a balance between the conflicting results of<br />
researches that have been done so far in terms of comparison of the comprehensive<br />
income and the net income. We state that they are contradictory because, as seen in<br />
the literature review, some studies have reflected the superiority of the net<br />
income,while others reflected the superiority of the comprehensive income. This<br />
study represents only a link in the multitude of researches that will probably be made<br />
in the future in thisarea; and this because only in 2009, the statement ofcomprehensive<br />
income became a single reporting statement of performance for entities that apply<br />
IFRS.<br />
~ 983 ~
This study is not without limits, among which we may include: the small number of<br />
entities under study, limiting the analysis solely to information collected from a single<br />
stock exchange, the authors' subjectivity in interpreting the results.<br />
ACKNOWLEDGEMENTS<br />
This work was supported from the European Social Fund through Sectoral Operational<br />
Programme Human Resources Development 2007-2013, project number<br />
POSDRU/89/1.5/S/59184 „Performance and excellence in postdoctoral research in<br />
Romanian economics science domain”<br />
REFERENCES<br />
ASB (1992). Financial Reporting Standard 3. Reporting Financial Performance<br />
Chambers R. J. (1994) Accounting, Evaluation and Econumic Behavior. New Jersey:<br />
Prentice Halol, Englewood Cliffs<br />
Bamber L.S., (Xuefeng) Jiang J., Petroni K.R., Wang I.Y. (2010). “Comprehensive Income:<br />
Who’s Afraid of Performance Reporting?”. The Accounting Review 85 (1): 97–126<br />
Barton J., Hansen T.B., Pownall G. (2010). “Which Performance Measures Do Investors<br />
Around theWorldValue the Most—andWhy?”. The accounting Review 85 (3): 753–789<br />
Bernheim Y. (1998). “Les mesures de la performance des enterprises”, Revue Francaise de<br />
Comptabilité. mars 1998<br />
Dumitrana M., Jianu I. & Jinga G. (2010). “Comprehensive income – past, present and<br />
future”. Analele stiintifice ale universitatii „Alexandru Ioan Cuza” din Iasi, - Stiinte<br />
Economice. Special number<br />
Edwards E. O., Bell P. W. (1961). The Theory and Measurement of Businesse Income. SUA:<br />
University of California Press<br />
G4+1, Project „Financial Performance Reporting”<br />
Gordon T.P. & Niles M.S. (2005).” Lucent Loses Its Luster: Accounting for Investment<br />
Turned Bad”. Issues In Accounting Education 20(2): 183-193<br />
Hodder L.D., Hopkins P.E., Wahlen J.M. (2006). “Risk-Relevance of Fair-Value Income<br />
Measures for Commercial Banks”. The Accounting Review 81(2): 337-375<br />
Hunton J.E., Libby R. and Mazza C.L. (2006). “Fianacial Reporting Transparency and<br />
Earnings Managemen”t. The Accounting Review 81 (1): 135-157<br />
Laureen A. Maines and Linda S. McDaniel (2000). “Effects of Comprehensive-Income<br />
Characteristics on Nonprofessional Investors' Judgments: The Role of Financial-<br />
Statement”. The Accounting Review 75(2): 179-207<br />
Liu X & Liu Y (2009). “Applying Reporting of Comprehensive Income in China”.<br />
International Journal of Marketing Studies 1(2): 74-78<br />
Olinid L. (1998). Măsurarea rezultatului contabil. Bucureşti: Ed. Economică<br />
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Smith P.A. & Reither C.L. (1996). “Comprehensive Income and the Effect of Reporting It”.<br />
Financial Analysts Journal 52(6): 14-19<br />
~ 984 ~
COMPANY NAME<br />
Balance<br />
sheet date<br />
Stock<br />
market data<br />
ANNEX 1<br />
Reporting<br />
currency of<br />
COMPANY NAME<br />
Balance<br />
sheet date<br />
Stock<br />
market data<br />
Reporting<br />
currency of<br />
1. 3I GROUP PLC 31.03.2010 01.04.2010 Million £ 32. KINGFISHER PLC 30.01.2010 01.02.2010 Million £<br />
2. AMEC PLC 31.12.2009 04.01.2010 Million £<br />
3. ADMIRAL GROUP PLC 31.12.2009 04.01.2010 Million £<br />
4. AGGREKO PLC 31.12.2009 04.01.2010 Million £<br />
5. ALLIANCE TRUST PLC 31.01.2010 01.02.2010 Million £<br />
6. ASSOCIATED BRITISH<br />
FOODS PLC<br />
12.09.2009 14.09.2009 Million £<br />
33. LLOYDS BANKING<br />
GROUP PLC<br />
34. LONDON STOCK<br />
EXCHANGE PLC<br />
35. MARKS AND<br />
SPENCER PLC<br />
36. MORRISON (W M)<br />
SUPERMARKETS PLC<br />
37. NATIONAL GRID<br />
PLC<br />
31.12.2009 04.01.2010 Million £<br />
31.03.2010 04.01.2010 Million £<br />
03.04.2010 06.04.2010 Million £<br />
31.01.2010 01.02.2010 Million £<br />
31.03.2010 04.01.2010 Million £<br />
7. ASTRAZENECA PLC 31.12.2009 04.01.2010 Million $ 38. NEXT PLC 30.01.2010 01.02.2010 Million £<br />
8. AVIVA PLC 31.12.2009 04.01.2010 Million £ 39. OLD MUTUAL PLC 31.12.2009 04.01.2010 Million £<br />
9. BG GROUP PLC 31.12.2009 04.01.2010 Million £<br />
10. BP PLC 31.12.2009 04.01.2010 Million $<br />
40. PETROFAC<br />
LIMITED<br />
41. RANDGOLD<br />
RESOURCES PLC<br />
31.12.2009 04.01.2010 Million $<br />
31.12.2009 04.01.2010 Million $<br />
11. BARCLAYS PLC 31.12.2009 04.01.2010 Million £ 42. REXAM PLC 31.12.2009 04.01.2010 Million £<br />
12. BRITISH AIRWAYS<br />
PLC<br />
13. BRITISH SKY<br />
BROADCASTING PLC<br />
31.03.2010 06.04.2010 Million £<br />
30.06.2009 02.07.2009 Million £<br />
14. BUNZI PLC 31.12.2009 04.01.2010 Million £<br />
15. BURBERRY GROUL<br />
PLC<br />
43. RSA INSURANCE<br />
GROUP PLC<br />
44. RECKITT<br />
BENCKISER PLC<br />
45. REED ELSEVIER<br />
PLC<br />
31.12.2009 04.01.2010 Million £<br />
31.12.2009 04.01.2010 Million £<br />
31.12.2009 04.01.2010 Million £<br />
31.03.2010 06.04.2010 Million £ 46. RIO TINTO PLC 31.12.2009 04.01.2010 Million $<br />
16. CENTRICA PLC 31.12.2009 04.01.2010 Million £<br />
47. ROYAL DUTCH<br />
SHELL PLC<br />
31.12.2009 04.01.2010 Million $<br />
17. COMPASS GROUP PLC 30.09.2009 02.10.2009 Million £ 48. SABMILLER PLC 31.03.2010 01.04.2010 Million $<br />
18. DIAGEO PLC 30.06.2009 01.07.2009 Million £<br />
19. EURASIAN NATURAL<br />
RESOURCES PLC<br />
20. FRESNILLO<br />
MANAGEMENT SERVICE<br />
31.12.2009 04.01.2010 Million $<br />
31.12.2009 04.01.2010 Million $<br />
49. SMITH & NEPHEW<br />
PLC<br />
50. SMITHS GROUP<br />
PLC<br />
51. STANDARD<br />
CHARTERED PLC<br />
31.12.2009 04.01.2010 Million $<br />
31.07.2009 03.08.2009 Million £<br />
31.12.2009 04.01.2010 Million $<br />
21. G4S PLC 31.12.2009 04.01.2010 Million £ 52. TUI TRAVEL PLC 30.09.2009 04.01.2010 Million £<br />
22. GLAXOSMITHKLINE<br />
PLC<br />
23. HAMMERSON GROUP<br />
PLC<br />
24. IMPERIAL TOBACCO<br />
GROUP PLC<br />
25.<br />
INTERCONTINENTAL<br />
26. INTERNATIONAL<br />
POWER PLC<br />
31.12.2009 04.01.2010 Million £ 53. TESCO PLC 27.02.2010 01.03.2010 Million £<br />
31.12.2009 04.01.2010 Million £<br />
30.09.2009 02.10.2009 Million £<br />
31.12.2009 04.01.2010 Million £<br />
31.12.2009 04.01.2010 Million £<br />
54. THE CAPITA<br />
GROUP PLC<br />
55. THE ROYAL BANK<br />
OF SCOTLAND GROUP<br />
56. THE SAGE GROUP<br />
PLC<br />
57. TULLOW GROUP<br />
SERVICES LTD<br />
31.12.2009 04.01.2010 Million £<br />
31.12.2009 04.01.2010 Million £<br />
30.09.2009 02.10.2010 Million £<br />
31.12.2009 04.01.2010 Million £<br />
27. INVENSYS PLC 31.03.2010 01.04.2010 Million £ 58. UNILEVER PLC 31.12.2009 04.01.2010 Million €<br />
28. INVESTEC PLC 31.03.2010 01.04.2010 Million £<br />
59. VODAFONE<br />
GROUP PLC<br />
31.03.2010 04.01.2010 Million $<br />
29. J SAINSBURY PLC 20.03.2010 22.03.2010 Million £ 60. WPP GROUP PLC 31.12.2009 04.01.2010 Million £<br />
30. JOHNSON MATTHEY<br />
PLC<br />
31.03.2010 01.04.2010 Million £ 61. WHITBREAD PLC 04.03.2010 04.01.2010 Million £<br />
31. KAZAKHMYS PLC 31.12.2009 04.01.2010 Million $ 62. XSTRATA PLC 31.12.2009 04.01.2010 Million $
ANNEX 2 (amounts in pounds or centimes)<br />
COMPANY NAME COMPANY NAME<br />
1. 3I GROUP PLC 17,20 293,00 32. KINGFISHER PLC 16,50 216,60<br />
2. AMEC PLC 52,42 805,00 33. LLOYDS BANKING GROUP PLC 7,50 52,26<br />
3. ADMIRAL GROUP PLC 59,00 1.174,00 34. LONDON STOCK EXCHANGE PLC 33,80 733,50<br />
4. AGGREKO PLC 62,67 938,00 35. MARKS AND SPENCER PLC 33,50 377,90<br />
5. ALLIANCE TRUST PLC 9,14 314,00<br />
36. MORRISON (W M) SUPERMARKETS<br />
PLC<br />
22,80 291,30<br />
6. ASSOCIATED BRITISH FOODS PLC 45,50 850,00 37. NATIONAL GRID PLC 152,38 647,50<br />
7. ASTRAZENECA PLC 519,00 4.744,83 38. NEXT PLC 188,50 1.984,00<br />
8. AVIVA PLC 37,80 394,50 39. OLD MUTUAL PLC -7,80 111,40<br />
9. BG GROUP PLC 64,50 1.161,00 40. PETROFAC LIMITED 104,78 1.671,42<br />
10. BP PLC 88,49 989,95 41. RANDGOLD RESOURCES PLC 86,00 8.271,59<br />
11. BARCLAYS PLC 86,20 280,60 42. REXAM PLC -3,70 288,30<br />
12. BRITISH AIRWAYS PLC -38,50 243,30 43. RSA INSURANCE GROUP PLC 12,20 119,70<br />
13. BRITISH SKY BROADCASTING PLC 14,90 454,80 44. RECKITT BENCKISER PLC 198,90 3.351,00<br />
14. BUNZI PLC 46,40 672,50 45. REED ELSEVIER PLC 17,20 512,50<br />
15. BURBERRY GROUL PLC 18,80 724,00 46. RIO TINTO PLC 276,20 5.598,29<br />
16. CENTRICA PLC 16,50 281,30 47. ROYAL DUTCH SHELL PLC 204,00 45,48<br />
17. COMPASS GROUP PLC 31,70 377,60 48. SABMILLER PLC 122,60 2.986,65<br />
18. DIAGEO PLC 64,60 897,00 49. SMITH & NEPHEW PLC 53,40 1.051,90<br />
19. EURASIAN NATURAL RESOURCES<br />
PLC<br />
20. FRESNILLO MANAGEMENT<br />
SERVICE LTD<br />
81,00 1.533,96 50. SMITHS GROUP PLC 72,40 735,50<br />
44,90 1.284,54 51. STANDARD CHARTERED PLC 167,90 2.603,93<br />
21. G4S PLC 14,40 267,20 52. TUI TRAVEL PLC -2,30 253,40<br />
22. GLAXOSMITHKLINE PLC 109,10 1.340,00 53. TESCO PLC 27,50 433,00<br />
23. HAMMERSON GROUP PLC -54,10 412,20 54. THE CAPITA GROUP PLC 30,76 751,00<br />
24. IMPERIAL TOBACCO GROUP PLC 65,50 1.809,00<br />
25. INTERCONTINENTAL HOTELS<br />
GROUP PLC<br />
55. THE ROYAL BANK OF SCOTLAND<br />
GROUP PLC<br />
-6,40 32,10<br />
74,70 904,50 56. THE SAGE GROUP PLC 14,46 224,00<br />
26. INTERNATIONAL POWER PLC 65,50 309,90 57. TULLOW GROUP SERVICES LTD 1,87 1.331,00<br />
27. INVENSYS PLC 296,00 345,90 58. UNILEVER PLC 121,00 2.246,32<br />
28. INVESTEC PLC 44,00 539,50 59. VODAFONE GROUP PLC 16,44 244,74<br />
29. J SAINSBURY PLC 32,10 329,20 60. WPP GROUP PLC 35,90 617,00<br />
30. JOHNSON MATTHEY PLC 77,60 1.786,00 61. WHITBREAD PLC 92,37 1.486,00<br />
31. KAZAKHMYS PLC 104,00 2.210,28 62. XSTRATA PLC 25,00 1.861,79<br />
TOTAL 4.266,68 69.798,64
ANNEX 3 (amounts in pounds or centimes)<br />
COMPANY NAME COMPANY NAME<br />
1. 3I GROUP PLC 45,46 293,00 32. KINGFISHER PLC 11,40 216,60<br />
2. AMEC PLC 21,96 805,00 33. LLOYDS BANKING GROUP PLC 11,92 52,26<br />
3. ADMIRAL GROUP PLC 57,01 1.174,00 34. LONDON STOCK EXCHANGE PLC 8,77 733,50<br />
4. AGGREKO PLC 58,46 938,00 35. MARKS AND SPENCER PLC 18,49 377,90<br />
5. ALLIANCE TRUST PLC 9,14 314,00<br />
36. MORRISON (W M)<br />
SUPERMARKETS PLC<br />
20,47 291,30<br />
6. ASSOCIATED BRITISH FOODS PLC 47,99 850,00 37. NATIONAL GRID PLC 140,21 647,50<br />
7. ASTRAZENECA PLC 515,28 4.744,83 38. NEXT PLC 155,82 1.984,00<br />
8. AVIVA PLC 9,54 394,50 39. OLD MUTUAL PLC 73,37 111,40<br />
9. BG GROUP PLC 51,99 1.161,00 40. PETROFAC LIMITED 116,33 1.671,42<br />
10. BP PLC 106,99 989,95 41. RANDGOLD RESOURCES PLC 123,50 8.271,59<br />
11. BARCLAYS PLC 86,20 280,60 42. REXAM PLC -14,67 288,30<br />
12. BRITISH AIRWAYS PLC 18,12 243,30 43. RSA INSURANCE GROUP PLC -5,71 119,70<br />
13. BRITISH SKY BROADCASTING PLC 22,61 454,80 44. RECKITT BENCKISER PLC 161,59 3.351,00<br />
14. BUNZI PLC 46,40 672,50 45. REED ELSEVIER PLC 17,02 512,50<br />
15. BURBERRY GROUL PLC 18,53 724,00 46. RIO TINTO PLC 487,43 5.598,29<br />
16. CENTRICA PLC 5,98 281,30 47. ROYAL DUTCH SHELL PLC 311,07 45,48<br />
17. COMPASS GROUP PLC 29,13 377,60 48. SABMILLER PLC 249,21 2.986,65<br />
18. DIAGEO PLC 42,90 897,00 49. SMITH & NEPHEW PLC 63,70 1.051,90<br />
19. EURASIAN NATURAL RESOURCES PLC -11,59 1.533,96 50. SMITHS GROUP PLC 17,54 735,50<br />
20. FRESNILLO MANAGEMENT SERVICE LTD 50,42 1.284,54 51. STANDARD CHARTERED PLC 193,30 2.603,93<br />
21. G4S PLC 5,96 267,20 52. TUI TRAVEL PLC -19,45 253,40<br />
22. GLAXOSMITHKLINE PLC 96,15 1.340,00 53. TESCO PLC 23,75 433,00<br />
23. HAMMERSON GROUP PLC -62,58 412,20 54. THE CAPITA GROUP PLC 21,82 751,00<br />
24. IMPERIAL TOBACCO GROUP PLC 83,01 1.809,00<br />
55. THE ROYAL BANK OF SCOTLAND<br />
GROUP PLC<br />
-16,97 32,10<br />
25. INTERCONTINENTAL HOTELS GROUP PLC 83,78 904,50 56. THE SAGE GROUP PLC 25,45 224,00<br />
26. INTERNATIONAL POWER PLC 60,69 309,90 57. TULLOW GROUP SERVICES LTD -14,38 1.331,00<br />
27. INVENSYS PLC 560,84 345,90 58. UNILEVER PLC 138,16 2.246,32<br />
28. INVESTEC PLC 78,59 539,50 59. VODAFONE GROUP PLC 16,30 244,74<br />
29. J SAINSBURY PLC 28,15 329,20 60. WPP GROUP PLC 24,05 617,00<br />
30. JOHNSON MATTHEY PLC 60,49 1.786,00 61. WHITBREAD PLC 12,24 1.486,00<br />
31. KAZAKHMYS PLC 168,51 2.210,28 62. XSTRATA PLC 143,18 1.861,79<br />
TOTAL 4.574,00 69.798,64
PS20 Environmental accounting<br />
Chairperson<br />
Massimo POLLIFRONI, University of Turin, Italy<br />
EXPLORATORY STUDY ON SOCIAL<br />
AND ENVIRONMENTAL REPORTING OF EUROPEAN<br />
COMPANIES IN CRISES PERIOD<br />
Camelia Iuliana LUNGU, Chirata CARAIANI,<br />
Cornelia DASCALU, Raluca Gina GUŞE<br />
A COMPLEX APPROACH TO CLIMATE CHANGE<br />
EXTERNALITIES<br />
Florian COLCEAG, Cornelia DASCALU, Chirata CARAIANI,<br />
Camelia Iuliana LUNGU, Raluca Gina GUŞE<br />
DIFFERENCES REGARDING ENVIRONMENTAL<br />
REPORTING: THE CASE OF ROMANIAN<br />
ORGANIZATIONS<br />
Ionel-Alin IENCIU<br />
ENVIRONMENTAL SUSTAINABILITY AND SOCIAL<br />
RESPONSIBILITY: A THEORETICAL PROPOSAL<br />
FOR AN ACCOUNTING EVALUATION<br />
Massimo POLLIFRONI<br />
THE IMPACT OF THE SUSTAINABLE DEVELOPMENT<br />
ON THE FINANCIAL STATE OF THE COMPANY –<br />
SECTOR STUDY<br />
Petru STEFEA, Cristina CIRCA<br />
EMPIRICAL STUDY REGARDING KEY INDICATORS<br />
CORRELATIONS FOR SUSTAINABLE PERFORMANCE<br />
BUDGETING<br />
Violeta CIMPOERU, Maria RADU, Valentin CIMPOERU<br />
~ 988 ~
EXPLORATORY STUDY ON SOCIAL<br />
AND ENVIRONMENTAL REPORTING OF EUROPEAN<br />
COMPANIES IN CRISES PERIOD<br />
Camelia Iuliana LUNGU 1 , Chirata CARAIANI,<br />
Cornelia DASCALU & Raluca Gina GUŞE<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
The present study promotes arguments for reporting improvement to support stakeholders’<br />
confidence and proposes possible policies and strategies for social and environmental<br />
reporting, resulting from European companies’ activity. We examined the information<br />
disclosed in annual reports and corporate social responsibility reports from a sample of the<br />
companies listed on the Euronext Stock Exchange over a three-year period. The purpose of<br />
the research is to support the idea that the quality of social and environmental information<br />
provided by companies is increasing as time passes and in relation to the present economic<br />
conditions. We conducted an exploratory study whose results are analysed and discussed in<br />
terms of financial and economic evolution within the present world crisis. They give us the<br />
possibility to design a new facet of the overall framework for reporting social and<br />
environmental information by combining theoretical requirements of the Global Reporting<br />
Initiative (GRI) standards with their implementation in the reporting practice of European<br />
companies.<br />
KEYWORDS: social, environmental, reporting, corporate responsibility, companies’<br />
practice.<br />
INTRODUCTION<br />
Concerns with the current state of knowledge in the area of corporate social and<br />
environmental reporting have moved beyond their initial stage in the research<br />
community and most certainly needs further encouragement (Milne and Gray, 2007).<br />
There are genuinely complex and difficult issues to be confronted in reporting on<br />
corporate actions in regard to the society and the environment (Hopwood, 2009). The<br />
challenges resulting from this, both financially and related to sustainability issues<br />
have been reported by an increasing number of businesses. Many companies have<br />
board committees that take responsibility for and oversee sustainability, supporting<br />
compliance with a voluntary social and environmental reporting framework and<br />
disclosing adequate adherence to sustainable development principles.<br />
Corporate social responsibility (CSR) is gaining more importance in today’s business<br />
life, and its different approaches emphasise its contribution to sustainability. The core<br />
idea sustains that the business sector should play a proactive role in society, in<br />
addition to its economic purpose of making profits. These issues have led the industry<br />
1<br />
Correspondence address: Camelia Iuliana LUNGU, Academy of Economic Studies, Bucharest;<br />
email: camelia.lungu@cig.ase.ro<br />
~ 989 ~
to engage in a sustainability debate and initiate strategies for responding to the<br />
challenges of sustainable development, in the spirit of Brundtland Commission Report<br />
(UN, 1987). More and more companies provide concise and focused sustainability<br />
information in their annual report, as proof of reliable disclosure, accompanied by full<br />
sustainability reports on their websites, reflecting a growing maturity on CSR<br />
disclosures (Lungu et al., 2010).<br />
The development of social and environmental accounting and reporting over the last<br />
40 years has resulted in a wide range of actual and potential accounts of (typically)<br />
organisational interactions with society and the natural environment (Gray, 2010).<br />
Since the mid 1970s, a number of studies (most of them of qualitative in nature) have<br />
investigated the nature and frequency of social and environmental disclosures, their<br />
patterns and trends, and their general relationships to corporate size and profitability.<br />
Nevertheless, the voluntary nature of sustainability reporting explains the variations in<br />
content and the lack of expected assurance for the disclosed social and environmental<br />
information. This gap raises concerns regarding accuracy and reliability and has to be<br />
considered by companies for their future reports.<br />
In this study we examine the Corporate Social Reports, but also Annual Reports in<br />
terms of social and environmental information disclosed by European companies. The<br />
main objective of this study is to determine the degree to which social and<br />
environmental reporting requirements included in Global Reporting Initiative (GRI)<br />
standards are considered for publication by European companies, as proof of reliable<br />
and high quality disclosure. The target period for our study is 2007-2009, as it is the<br />
most recent period for which companies have published information for stakeholders.<br />
It is also the period during which companies have struggled through the deepest<br />
global crisis. The study population in this article consists of European companies<br />
listed on Euronext Stock Exchange. We seek to design a pattern for reporting social<br />
and environmental information and for highlighting a trend in the evolution of the<br />
content of financial and non-financial published reports during the crisis period.<br />
The central research proposition of the study is: The quality of social and<br />
environmental information provided by companies is increasing in relation to the<br />
amount of time passing and the present economic conditions. Based on our previous<br />
research, both theoretical and practical, we analyse the content of reports published by<br />
the companies in our sample, in terms of implementation of GRI requirements. As we<br />
argue in the following paragraph, GRI standards may be considered the most relevant<br />
because they are applied by a considerable number of companies interested in<br />
extending reporting for stakeholders. We support the idea that providing qualitative<br />
disclosures is increasingly necessary once the users upgrade from shareholder to<br />
stakeholders. Thus, information needs have become increasingly complex, and they<br />
now rank at a more complex level of analysis. In order to put up with the current<br />
economic context, entities must overcome the simple reporting of financial<br />
information and extend the reports to include integrated value and descriptive<br />
presentations to give confidence in their activity.<br />
We conducted an exploratory study whose results are analysed and discussed in terms<br />
of financial and economic evolution within the context of the present world crisis.<br />
This analysis give us the possibility to design a new facet for the overall framework of<br />
reporting social and environmental information, by combining theoretical<br />
~ 990 ~
equirements with their implementation in the practices of European companies.<br />
Therefore, it will be an important contribution not only for interested companies, but<br />
also for national standard setters. The study’s originality also rests on the conclusions<br />
and debates discussed, based on the obtained results that refer to connecting the<br />
disclosure patterns to policies and strategies for social and environmental reporting in<br />
time and space.<br />
1. REPORTING SOCIAL AND ENVIRONMENTAL ISSUES IN EUROPEAN<br />
COMPANIES - RESEARCHERS' AND PRACTITIONERS' VIEWS<br />
Integrating principles of sustainable development into general business accountability<br />
structures opens up new business opportunities and helps companies create value, not<br />
just avoid destroying it (WBCSD, 2006). At the company level, discussions of<br />
sustainability reporting (SR) are focused on the idea that environmental or social<br />
concerns may affect the ability to expand operations or may damage the reputation<br />
and brand value. New codes of corporate governance have increasingly begun to<br />
highlight the attention they must pay to risks associated with sustainability concerns<br />
on the management agenda. Thus, organisations must redefine their essential business<br />
objectives by aligning them with the sustainability strategy of the company.<br />
Additionally, they must be coherent with the changes in organisational culture implied<br />
by corporate responsibility.<br />
Reporting is an important communication tool which can ensure greater corporate<br />
transparency and enable better engagement with stakeholders. Moreover,<br />
sustainability reporting is largely voluntary and appears to be driven by market<br />
pressures (Golob and Bartlett, 2007). Since the beginning of the 2000s, the demand<br />
for disclosure from the most important listed companies has dramatically increased.<br />
The failures of large companies listed on the most important stock exchanges have<br />
placed extra pressure on them and standards setters for the increase in the quality of<br />
corporate reporting (Beretta and Bozzolan, 2004). A study by Mammat et al. (2010)<br />
shows that as of 2008 there has been an increase in the quality and effectiveness of the<br />
social and environmental information reported. However, debates still continue on the<br />
quality of information presented, based on the fact that some companies report large<br />
volumes of data that is difficult for the reader to digest. Even more so, other<br />
companies report so little that it merely raises questions regarding their commitment<br />
to sustainability and stakeholder reporting overall.<br />
The stakeholder approach to strategic management, first proposed by R. Edward<br />
Freeman in 1984, is used today in an extensive body of research, including social and<br />
environmental disclosure. Investors and stakeholders in continental Europe are<br />
becoming increasingly concerned about corporate social and environmental policies.<br />
As a result, many companies are voluntarily increasing the extent of social and<br />
environmental disclosures in their annual report. Cormier et al. (2005) identified<br />
determinants of corporate disclosure using multi-theoretical lenses that rely on<br />
economic incentives, public pressures and institutional theory. Results show that risk,<br />
ownership, fixed assets age, and company’s size, as well as routine, determine the<br />
level of environmental disclosure by German companies for a given one year period.<br />
Although determinants have been identified, mixed findings are presented in prior<br />
studies for some commonly examined variables such as size, industry classification<br />
and ownership structure. Gray et al. (2001) suggest that larger, more profitable<br />
~ 991 ~
companies and those in more socially and environmentally sensitive industries can be<br />
expected to make greater use of the (typically voluntary) disclosure of information<br />
about their social and environmental. Lynn (1992) found no relationship between<br />
company size and the level of social and environmental disclosures, while Hackston<br />
and Milne (1996) show that there is no relationship between profit measures and<br />
social and environmental disclosures. Brammer and Pavelin (2006) found that larger,<br />
less indebted companies with dispersed ownership characteristics are significantly<br />
more likely to make voluntary environmental disclosures, and that the quality of<br />
disclosures is positively associated with company’s size and corporate environmental<br />
impact. Some studies suggest that, in addition to company’s size, proprietary costs,<br />
information costs and media visibility determine corporate environmental reporting<br />
(Cormier and Magnan, 2003).<br />
Surveys of social and environmental reporting practice tend to show that both the<br />
quantity and the overall quality of reporting are increasing (WBCSD, 2003; Holland<br />
and Foo, 2003; Gray and Milne, 2002). We support the idea that, in areas such as<br />
scope of reporting, consistency of methodological approaches to recognition and<br />
measurement policies, and timeliness of reporting, improvements in quality are<br />
required. Similarly, we see the need for better focused stakeholder related reporting.<br />
Preparers of social and environmental reports, in particular, would like confirmation<br />
that their reports are effective. Additionally, users of such reports, especially the<br />
increasingly environmentally aware financial community, are demanding more<br />
consistency in the ways in which social and environmental issues are measured and<br />
reported.<br />
The latest studies refer to the recent accounting scandals that appear differently when<br />
viewed from the perspectives of the political/regulatory process and of the market for<br />
corporate governance and financial reporting (Ball, 2009). For the most part,<br />
governments have maintained a distance from the reporting and CSR movements,<br />
considering them voluntary private initiatives (Brown et al., 2009). There have<br />
recently been several professional associations and other initiatives that have<br />
responded to these concerns; therefore, a range of tools and guidelines for social and<br />
environmental reporting are available (see www.enviroreporting.com).<br />
Corporate Social Responsibility is part of the Europe 2020 strategy for smart,<br />
sustainable and inclusive growth. In March 2010 the European Commission made a<br />
commitment to “renew the EU strategy to promote Corporate Social Responsibility<br />
(CSR) as a key element in ensuring long term employee and consumer trust”. More<br />
and more issues concerning voluntary social and environmental standards as<br />
introduced by the Global Reporting Initiative are included in today’s compulsory<br />
reporting. Thus, in addition to existing International Financial Reporting Standards<br />
(IFRS) regarding accounting and reporting of social and environmental aspects, the<br />
International Accounting Standards Board (IASB) has published a proposed nonmandatory<br />
framework to help entities prepare and present a narrative report. This<br />
publication is referred to as the Management Commentary (IASB, 2010) and helps<br />
users of the annual reports, among others, to understand how non-financial factors<br />
have influenced the information presented in the financial statements.<br />
In EU countries there are government initiatives and requirements to enlarge the<br />
scope of conventional reporting to include non-financial information. Some actions<br />
~ 992 ~
are motivated by national environmental and social policy goals, others by external<br />
users’ pressures to obtain a reliable view on companies’ actions. All indications point<br />
to continuing expansion of governmental reporting initiatives to new countries and<br />
regions over the next few years. The European requirements on sustainability<br />
reporting, included in the EU Accounts Modernisation Directives, define and describe<br />
Key Performance Indicators (KPIs) that provide businesses with a tool for<br />
measurement. They are quantifiable metrics that reflect the environmental<br />
performance of a business in the context of achieving its wider goals and objectives.<br />
KPIs help businesses to implement strategies by linking various levels of an<br />
organisation (business units, departments and individuals) with clearly defined targets<br />
and benchmarks (DEFRA, 2006). The EU Accounts Modernisation Directives also<br />
introduce requirements for companies to include a balanced and comprehensive<br />
analysis of the development and performance of the business in their Directors’<br />
Report. The requirement for an expanded Directors’ Report, which came into effect<br />
for EU companies in January 2005, is not a completely new idea. The concept of nonfinancial<br />
reporting and in particular, the recognition, measurement and disclosure of<br />
environmental issues in the annual accounts and annual reports of companies, was<br />
recommended by the European Commission. The analysis should “include both<br />
financial and, where appropriate, non-financial key performance indicators relevant to<br />
the particular business, including information relating to environmental and employee<br />
matters” (EU, 2003).<br />
Complementary to European Union specific requirements, there is evidence that the<br />
majority of European companies use the Global Reporting Initiative Guidelines for<br />
reporting social, environmental and economic aspects of their activity. Social and<br />
environmental reports based on the GRI Reporting Framework, disclose outcomes and<br />
results that occurred within the reporting period in the context of the organisation’s<br />
commitments, strategy and management approach. Its purpose is to communicate<br />
clearly and openly about sustainability and to be used by organisations of any size,<br />
sector, or location (GRI, 2006). GRI Framework defines the principles of preparing a<br />
sustainability report (materiality, stakeholder inclusiveness, sustainability context, and<br />
completeness) and underlines a number of principles for qualitative disclosure<br />
(balance, comparability, accuracy, timeliness, clarity, and reliability). Report makers<br />
choose the guidance and indicators contained in the various Framework components<br />
to suit their needs and their stakeholders’ interests. GRI framework emphasises the<br />
importance of extensive interaction with stakeholders to determine appropriate<br />
reporting boundaries. Reporting organisations are encouraged to follow GRI structure<br />
in compiling their reports, however, other formats may be chosen. A content index is<br />
provided for entities reporting on GRI Framework in order to identify information by<br />
referring to page numbers the standard disclosure can be found.<br />
According to Brown et al. (2009), GRI’s major contribution to the field of reporting,<br />
and its own source of legitimacy, has been to popularise a multi-stakeholder process.<br />
This allows participants to articulate their principal concerns with regard to<br />
sustainability performance and incorporate emerging issues, facilitating a broadly<br />
based societal dialogue and indirectly contributes to the policy agenda. Lozano and<br />
Huisingh (2011), in their analysis on various sustainability reporting frameworks,<br />
concluded that GRI guidelines have the broadest scope, and it tends to be the most<br />
frequently used set of guidelines for SR reporting.<br />
~ 993 ~
There are also critical approaches to social and environmental reporting, considered<br />
just an increment of corporate social responsibility, with limited amount of<br />
disclosures (Solomon and Lewis, 2002). The idea that some organisations label<br />
themselves as corporate social reporters but do not behave in a responsible way<br />
concerning sustainability matters is also discussed (Moneva et al., 2006). At the same<br />
time there are organisations that often have good intentions in sustainability matters,<br />
but they cannot transform those intentions into actions and results. Reporting<br />
corporate social and environmental information has matured over the past decades,<br />
but there still remains a lack of adequate standardisation. Equally significant is the<br />
growing movement by the major accounting organisations to become involved in the<br />
development of standards for corporate social reporting, auditing and verification.<br />
Triggered by the financial crisis, issues of comprehensive risk management, long-term<br />
performance and ethics are rapidly gaining relevance and consideration. Restoring<br />
confidence and trust in markets will require a shift to long-term sustainable value<br />
creation, and corporate responsibility must be an instrument towards this end.<br />
2. RESEARCH METHODOLOGY<br />
2.1. Sample and data collection<br />
Our focus on the reporting practices of European companies led us to construct our<br />
sample based on companies listed on the European stock exchange. There are the two<br />
pan-European stock exchanges: OMX Exchanges, which operates eight stock<br />
exchanges in the Nordic and Baltic countries, and Euronext, based in Amsterdam and<br />
with subsidiaries in Belgium, France, Netherlands, Portugal and the United Kingdom.<br />
For this study, the Euronext stock exchange is the most suited because it is highly<br />
representative for the practices of European companies, due to its declared objective:<br />
to take advantage of the harmonisation of the European Union financial markets.<br />
According to their website presentation, Euronext has successfully integrated local<br />
markets across Europe to provide users with a unified market that is broad, liquid and<br />
cost effective. Euronext is the largest central order book cash market in Europe and<br />
the second largest derivatives exchange in the world, by value of business traded.<br />
Following the initial three-way merger of the local exchanges of Amsterdam, Brussels<br />
and Paris, Euronext acquired the London-based derivatives market LIFFE and merged<br />
with the Portuguese exchange in 2002.<br />
The evidence from prior studies (Hackston and Milne, 1996; Gray et al., 2001)<br />
supports the argument that larger companies are subject to stronger pressure from<br />
stakeholders and consequently, they are expected to find more persuasive arguments<br />
to disclose social and environmental information. These assertions led us to determine<br />
our sample structure. Thus, we included companies from 16 different industries as<br />
follows: one company per industry having the highest market capitalisation on 31 st of<br />
July 2010 and one company per industry having the smallest capitalisation, all<br />
extracted from compartment A (includes Issuers with a market capitalisation of which<br />
is superior to 1 billion Euro) of Euronext Stock Exchange. Thus, we arrived at a<br />
sample of 32 entities. For the companies included in our study, we searched their<br />
websites and analysed their annual reports and corporate social responsibility reports<br />
in accordance with the research objective, formerly described, over a period of three<br />
years, between 2007 and 2009.<br />
~ 994 ~
We created a database containing information related to the importance attributed by<br />
each company to environmental and social aspects, measured by existence or absence<br />
of elements such as: distinctive corporate responsibility links disclosed on a<br />
company’s website; existence of a published CSR report and its volume; compliance<br />
with GRI Guidelines; appliance of G3 requirements; key performance indicators<br />
(KPI) disclosure; social and environmental external certification supported by an<br />
assurance statement; existence of a CSR section on published annual reports and its<br />
volume; presentation of GRI compliance in annual reports; and disclosure of social<br />
and environmental elements in financial statements. The volume of CSR reports, CSR<br />
section in annual reports and of the annual reports are measured in number of pages.<br />
This information was gathered using the Euronext database. In order to achieve our<br />
objectives, the information included in the database was sorted and filtered using MS<br />
Excel and we created sub-databases with companies classified on size (large/small<br />
capitalisation) and according to European market affiliation established by the<br />
Euronext Stock Exchange (presently there are functional markets in Paris,<br />
Amsterdam, Brussels and Lisbon).<br />
2.2. Research method: Content analysis and it’s appliance for the study<br />
In order to develop patterns of social and environmental disclosure, we carried out a<br />
thorough content analysis of the corporate social responsibility (CSR) reports<br />
published by the companies in our sample. Content analysis is defined as a method of<br />
codifying text into different groups depending on selected criteria (Weber, 1990). This<br />
research method has been used extensively to investigate CSR reporting, and is<br />
considered a technique for gathering data that consists of codifying qualitative<br />
information in anecdotal and literary form into categories in order to derive<br />
quantitative scales of varying levels of complexity (Abbot and Monsen, 1979). By<br />
definition, content analysis is both a qualitative and quantitative technique, employing<br />
qualitative data which are subsequently quantified, and concentration on either<br />
approach may lead researchers to overlook the challenges arising from the method’s<br />
multifaceted nature (Gephart, 2004).<br />
The extent of disclosure can be taken as an indication of the importance of a CSR<br />
topic to the reporting entity (Krippendorf, 1980). In content analysis, several<br />
alternatives have been proposed in order to measure the amount of CSR reporting<br />
(Unerman, 2000). Gray et al. (1995) suggest that the amount of disclosures (number<br />
of words, sentences or pages) provides richer data and automatically encompasses the<br />
number of disclosures. Generally, studies measure the number of words (Deegan and<br />
Gordon, 1996; Zéghal and Ahmed, 1990), sentences (Hackston and Milne, 1996) or<br />
pages (Gray et al., 1995; Patten, 1992) used to address the different CSR topics.<br />
Advocates of the number of words, such as Deegan and Gordon (1996), have argued<br />
that this method can record the level of disclosure in greater detail, while, those of the<br />
number of sentences (Hackston and Milne, 1996; Milne and Adler, 1999) argue that<br />
these units, rather than words, convey meaning. It seems now widely accepted that the<br />
number of pages is the preferred method for computing the amount of disclosure.<br />
Because the number of pages reflects the total space given to corporate issues, the<br />
importance attached to that theme can be contingent.<br />
Considering all this information and correlating them with our study objective, we<br />
established the research unit to be CSR and annual reports published by the European<br />
~ 995 ~
companies, listen on compartment A of Euronext Stock Exchange and the unit for<br />
measuring the extent of social and environmental disclosure to be the number of<br />
pages. Elements tracked in the content analysis of company reports are chosen in<br />
order to assess the quality of information presented and are expressed as research<br />
questions, such as:<br />
• Does the company publish the social and environmental disclosure through<br />
distinguished corporate social reports, other than information offered on the<br />
company website?<br />
• Does the company provide a web link to particular areas designed to inform the<br />
stakeholders of the company's corporate responsibility?<br />
• Does the company report in either the CSR report or annual report the<br />
compliance with the GRI requirements in general, and with GRI G3 Guidelines,<br />
in particular?<br />
• Does the company include special presentations on Key Performance Indicators<br />
(KPIs), which would increase the quality level of non-financial information?<br />
• Is auditing of social and environmental information presented in corporate<br />
social reports, which provides presentations’ assurance?<br />
• What social and environmental information is presented within financial<br />
statements?<br />
3. RESULTS AND DEBATES OF THE EXPLORATORY STUDY<br />
This exploratory study based on the content analysis of reports published by European<br />
companies concerns the evolution of social and environmental information volume<br />
and quality provided by reference to GRI requirements, during the global crisis period<br />
of 2007-2009. For this research, we defined the quality of corporate information in<br />
compliance with GRI standards by inclusion of measurable information along with the<br />
descriptive one. This is illustrated by presenting the key indicators of global<br />
performance (KPIs) but also by ensuring external credibility, relevance and assurance<br />
of the information presented in corporate social and financial reporting. We also<br />
consider that using new tools available on a company’s website is one aspect defining<br />
the increasing quality of information provided to the interested stakeholders.<br />
3.1. Social and environmental information’s evolution in time (three years)<br />
provided by category of market capitalisation<br />
Through analysing the websites of the companies included in the sample, we noticed<br />
that all top European companies (classified by mid-2010 capitalisation level) provide<br />
information on corporate responsibility and on the effort to support the principles of<br />
sustainable development. This information is either classified by category,<br />
summarised in correlative tables, or detailed using descriptions of social and<br />
environmental issues overviewed throughout the business activity. Among companies<br />
with smaller capitalisation, 63% provide such information on their websites, a rather<br />
high percentage, in our opinion.<br />
The awareness process of environmental and social responsibility by economic<br />
entities can be monitored by analysing corporate social reports published by these<br />
companies. The voluntary presentations in these reports provide identification of the<br />
degree of awareness that economic and financial society has now come to. The data<br />
resulting from the content analysis of reports of European companies in our sample<br />
show that publishing independent rather than compulsory reports is still a difficult<br />
~ 996 ~
process to implement at an extended level. Companies with a market capitalisation of<br />
less than 3,500 million Euros publish such reports in a very small proportion and with<br />
an insignificant extent and details. However, we find it encouraging that there is a<br />
significant percentage of the above mentioned companies which give a great<br />
importance to informing the stakeholders by using their websites and creating<br />
designated areas for social responsibility. These are companies that in the future may<br />
publish more and more complex corporate social reports.<br />
The percentages of corporate social reports published, shown in Table 1 should be<br />
debated so as not to leave a false impression on the reader. It is true that at first sight<br />
the social and environmental information disclosure through CSR reports are<br />
characterised by decreasing during the period under review, but we did not jump to<br />
the conclusion that companies have lost their interest in such reporting. We detailed<br />
our analysis and noted that some companies, such as Faurecia, in the manufacture of<br />
automobiles, or Vinci, in the construction industry, went from ignoring social and<br />
environmental information in 2007 to providing the data in distinct sections in their<br />
annual reports or in their reference documents (as required by French law) by 2009.<br />
While others, like Air Liquide, in the chemical industry, Renault, in the vehicle<br />
constructions, or Societe Generale, in banking, waived the presentation of CSR<br />
reports, choosing to integrate them into the reference documents or presenting them<br />
interactively on their website. From the above discussion we see that large European<br />
companies show an important interest in providing complex information that includes<br />
environmental and social aspects, in addition to financial ones.<br />
The current economic environment, determined by the global crisis that companies<br />
are now experiencing, led us to analyse and discuss the quality of information<br />
provided by companies, referred to in terms of GRI compliance, KPI disclosure and<br />
assurance statements. The data collected for our sample indicates that the GRI<br />
standards are a reference point for corporate social reporting especially for large<br />
companies, and the percentage of GRI reporting was 88% in 2009, up from 2007,<br />
after a decrease recorded in 2008.<br />
Table 1. Social and environmental information in CSR reports – size classification<br />
Grouped sampled<br />
companies<br />
SEI* on<br />
web site<br />
Existence<br />
CSR Report<br />
ANoP**<br />
mNoP***<br />
~ 997 ~<br />
MNoP****<br />
GRI Com-pliance<br />
G3 Guide-lines<br />
KPI<br />
Assu-rance in<br />
CSR Report<br />
High capitalisation<br />
companies 2009<br />
100% 75% 91 26 229 88% 44% 50% 81%<br />
High capitalisation<br />
companies 2008<br />
100% 81% 64 26 116 69% 50% 44% 63%<br />
High capitalisation<br />
companies 2007<br />
100% 88% 68 34 94 75% 63% 56% 50%<br />
Small capitalisation<br />
companies 2009<br />
63% 13% 62 16 68 13% 13% 19% 13%<br />
Small capitalisation<br />
companies 2008<br />
63% 13% 44 28 57 13% 6% 6% 13%<br />
Small capitalisation<br />
companies 2007<br />
63% 19% 48 41 56 19% 19% 6% 13%<br />
*SEI – social and environmental information<br />
**ANoP – average number of pages
***mNoP – minimum number of pages<br />
****MNoP – maximum number of pages<br />
In 2009, Sodexo was the only company that declined to show compliance with GRI.<br />
In an attempt to find a plausible explanation, we also analysed the 2010 Corporate<br />
Citizenship Review Progress and noticed that the company specified the compliance<br />
with GRI guidelines, presenting social, environmental and economic indicators<br />
required by the standards. Also, the presentation of key indicators of global<br />
performance declined in 2008 (Societe Generale, Sodexo and AbInBev) and had a<br />
return in 2009. Although we have no other information, the decline of details<br />
presented in 2008 and the return to detailed presentation in 2009 may also be<br />
explained by the critical moment of the economic and financial crisis, believed to be<br />
in 2008. Companies had to face this period with a negative impact on financial results<br />
that affected the interest of companies in providing detailed information on social<br />
responsibility.<br />
Contrary to the volume and details characterising the social and environmental issues<br />
reporting, external assurance by one of the Big Four was on an upward trend. In this<br />
case we consider that the economic and financial crisis had a strong impact. To find<br />
resources to overcome the negative effects of the crisis, European companies have<br />
turned to external assurance for corporate reports to increase stakeholders’<br />
confidence.<br />
The companies whose capitalisation is less than 3,500 million Euros are not yet<br />
interested in reporting social and environmental information. In our view, they are in<br />
an intermediate stage of the implementation of integrated economic, social and<br />
environmental reporting as a response to stakeholders’ requirements. These<br />
companies have a low interest in providing information to comply with certain<br />
reporting standards. By complying, they would have an impact on stakeholders by<br />
providing valuable data on global performance or external assurance of such<br />
information. However, the trend is still not exponentially increasing as we had<br />
expected.<br />
We also analysed the trend of companies which incorporated social and<br />
environmental information in annual reports (results in Table 2).<br />
Table 2. Social and environmental information in annual reports – size classification<br />
Grouped sampled<br />
companies<br />
Annual<br />
report (AR)<br />
CSR section<br />
in AR<br />
ANoP* in<br />
CSR section<br />
~ 998 ~<br />
GRI reference<br />
in AR<br />
Environmental<br />
aspects in Financial<br />
Statements<br />
High capitalisation<br />
companies 2009<br />
100% 88% 12 13% 50%<br />
High capitalisation<br />
companies 2008<br />
100% 88% 10 13% 44%<br />
High capitalisation<br />
companies 2007<br />
100% 88% 9 13% 31%<br />
Small capitalisation<br />
companies 2009<br />
100% 88% 7 0% 19%<br />
Small capitalisation<br />
companies 2008<br />
100% 88% 7 6% 19%<br />
Small capitalisation<br />
companies 2007<br />
100% 88% 7 0% 13%<br />
*ANoP – average number of pages
We noticed that an important percentage of companies developed a separate section in<br />
their annual reports, incorporating information on corporate social responsibility.<br />
While it is an important step in the direction of company responsibility to ensure a<br />
high quality of life, it is just the beginning. We are witnessing an increasing number<br />
of entities which agree to assume social responsibility and begin to act according to its<br />
principles. However, the information in the annual reports considered as reference<br />
documents for the company’s relationship with the stakeholders is minimal.<br />
The data included in Table 2 shows that the companies in our sample still offer a<br />
small space in annual reports to sections detailing social and environmental<br />
information. Thus, large capitalisation companies have an average of 10 pages<br />
describing social and environmental issues, from a total average of 215 pages of the<br />
annual report, (5% of all information provided). References to GRI reporting<br />
standards are very rare in the annual reports (13% of large companies, insignificant<br />
for small capitalisation companies). The most common details presented in the Notes<br />
to financial statements are related to environmental provisions, the references to<br />
environmental costs and social costs. Information on employee benefits, other than<br />
mandatory social contributions is presented in a descriptive form rather than as<br />
measurable indicator.<br />
The volume of social and environmental information provided by European<br />
companies through annual reports differs according to their market capitalisation.<br />
Thus, whether corporate social reports for large capitalisation companies are<br />
comprehensive, including up to 229 pages, with an average of 91 pages in 2009,<br />
corporate social reports of companies with capitalisation up to 3,500 million Euros, do<br />
not exceed a volume of 68 pages. Analysing the evolution over three years, we<br />
identified an upward trend for both types of companies, supporting our research<br />
proposition that the quality of social and environmental information reported by<br />
European companies is increasing over time.<br />
3.2. The evolution of social and environmental information presentation by<br />
financial market between 2007 and 2009<br />
The second aspect of the content analysis of the reports included in our sample refers<br />
to the trend in social and environmental reporting that could be influenced by the<br />
financial markets within Euronext Stock Exchange. Results are presented in Table 3.<br />
Due to a highly different number of companies on each market covered by our sample<br />
(Paris 21, Brussels 4, Amsterdam 5, and Lisbon 2), we could not extrapolate proposals<br />
to improve social and environmental reporting for other countries in the European<br />
Union.<br />
We limited our debate regarding the changes over time to each listed market.<br />
Companies listed on Euronext Paris and Amsterdam markets give the highest<br />
importance to providing social and environmental information through their website.<br />
On a large proportion, (about 60%) companies develop and publish reports on<br />
corporate social responsibility. If the number of companies publishing corporate<br />
social reports did not varied significantly during the period 2007-2009, representing<br />
the first part of the global crisis, in terms of average volume (measured in number of<br />
pages) of such reports we noticed interesting developments. Thus, European<br />
~ 999 ~
companies from all four Euronext markets have diminished interest in the qualitative<br />
social and environmental information reporting in 2008 compared to 2007, suddenly<br />
rethinking corporate reporting aspects in 2009. A more nuanced situation occurred for<br />
the companies listed on the Lisbon market: although they reported social and<br />
environmental issues in 2007, they completely abandoned them in 2008 and did not<br />
reconsider them in 2009.<br />
Table 3. Social and environmental information in CSR reports – Euronext market<br />
classification<br />
Financial markets of<br />
Euronext by year<br />
SEI* on<br />
web site<br />
Existence<br />
CSR Report:<br />
ANoP**<br />
mNoP***<br />
MNoP****<br />
~ 1000 ~<br />
GRI Com-pliance<br />
G3 Guide-lines<br />
KPI<br />
Assu-rance in CSR<br />
Report<br />
PARIS 2009 81% 57% 93 26 229 57% 29% 38% 57%<br />
PARIS 2008 81% 52% 65 26 116 43% 29% 19% 48%<br />
PARIS 2007 81% 57% 72 48 94 48% 38% 29% 43%<br />
BRUSSELS 2009 75% 25% 99 99 99 25% 0% 0% 0%<br />
BRUSSELS 2008 75% 25% 40 40 40 25% 25% 25% 0%<br />
BRUSSELS 2007 75% 25% 40 40 40 25% 25% 25% 0%<br />
AMSTERDAM 2009 100% 60% 57 50 68 60% 60% 60% 60%<br />
AMSTERDAM 2008 100% 60% 47 44 50 60% 60% 60% 40%<br />
AMSTERDAM 2007 100% 60% 49 34 71 60% 60% 60% 20%<br />
LISBON 2009 50% 0% 0 0 0 0% 0% 0% 0%<br />
LISBON 2008 50% 0% 0 0 0 0% 0% 0% 0%<br />
LISBON 2007 50% 50% 47 47 47 50% 50% 0% 50%<br />
*SEI – social and environmental information<br />
**ANoP – average number of pages<br />
***mNoP – minimum number of pages<br />
****MNoP – maximum number of pages<br />
Entities listed on the Lisbon market have dropped for the time, the presentation of<br />
social and environmental aspects and entities listed on the Amsterdam market<br />
maintained their high level of quality for social and environmental information.<br />
Moreover, the entities listed on the Brussels market registered a regression in<br />
presentation beginning with the financial year ending on December 31, 2008, while<br />
those listed on the Paris market followed the global economic and financial trend: a<br />
decline in 2008 and a return on an upward trend in 2009. The declarations of external<br />
assurance for social and environmental information provided by corporate social<br />
reports are still growing and becoming more prominent from 2007 to 2009. The<br />
number of companies addressing external assurance aspects increased by 5% in 2008,<br />
and by 10% in 2009, compared to the year 2007.<br />
Formalising the presentation of expanded economic, social and environmental<br />
information in the annual report as the main credible and transparent instrument of<br />
economic entities’ activity is gaining ground slowly but surely. Thus, the volume of
CSR sections in the annual report increased from year to year, as well as the various<br />
presentations of social and environmental factors in the financial statements.<br />
Table 4. Social and environmental information in Annual Reports (AR) – Euronext<br />
markets<br />
Financial markets of<br />
Euronext by year<br />
AR -<br />
ANoP*<br />
in AR<br />
CSR section<br />
ANoP*<br />
~ 1001 ~<br />
mNoP**<br />
MNoP***<br />
GRI<br />
reference in<br />
AR<br />
Environ-mental<br />
aspects in<br />
Financial<br />
Statements<br />
2009 PARIS 216 90% 12 1 38 10% 38%<br />
2008 PARIS 221 90% 10 1 28 10% 33%<br />
2007 PARIS 204 95% 10 1 32 10% 29%<br />
2009 BRUSSELS 120 75% 10 2 23 0% 25%<br />
2008 BRUSSELS 108 75% 11 2 22 0% 0%<br />
2007 BRUSSELS 98 75% 9 2 14 0% 0%<br />
2009 AMSTERDAM 131 80% 4 2 7 0% 40%<br />
2008 AMSTERDAM 136 80% 6 2 10 0% 40%<br />
2007 AMSTERDAM 133 60% 6 2 13 0% 20%<br />
2009 LISBON 215 100% 10 5 14 0% 0%<br />
2008 LISBON 172 100% 10 2 14 50% 50%<br />
2007 LISBON 179 100% 8 1 15 0% 0%<br />
*ANoP – average number of pages<br />
**mNoP – minimum number of pages<br />
***MNoP – maximum number of pages<br />
The figures summarised in Table 4 demonstrate a poor representation of social and<br />
environmental information included in the annual reports and an even lower one in<br />
financial statements. These results correspond to the reality that we are presently<br />
facing today: climate changes, reaching the margin in natural resources, the ecological<br />
footprint of companies, waste management, human rights, improving labour relations,<br />
and ensuring reasonable social protection.<br />
4. DISCUSSIONS AND RECOMMENDATIONS<br />
Based on the exploratory study debated in this research, and also from our previous<br />
research experience, we support the implementation of corporate social reporting in a<br />
company through a series of steps:<br />
• Provide additional social and environmental information for a competitive<br />
advantage;<br />
• Redesign the company’s website in order to present descriptive information on<br />
corporate responsibility;<br />
• Redesign the company’s organisational structure by creating a department or<br />
appoint a manager responsible for corporate social reporting;<br />
• Prepare and publish corporate social reports complying to a set of standards;<br />
• Obtain an external audit of social and environmental information presented in<br />
the corporate report;
• Include social and environmental information in separate sections of the<br />
annual report;<br />
• Integrate social, environmental and economic indicators in the financial<br />
statements.<br />
To develop their social and environmental reporting practices, European companies<br />
should consider focusing on key issues of the sustainable development agenda,<br />
demonstrating relevance and transparency in reporting. The increasing pressure from<br />
stakeholders in relation to the corporate accountability disclaimer offers incentives for<br />
understanding corporate responsibility as “the right thing to do”. Additionally, this<br />
pressure guides companies to adopt strategic management and global information<br />
reporting collaboration in order to develop sustainable, healthy and stable products<br />
and services.<br />
Issues that support our recommendations for increasing European companies’<br />
interests in the preparation of social and environmental reports complying with<br />
European and internationally applicable standards are: the global trends of moving<br />
from efficiency to cleaner and more sustainable activity; improving stakeholders’<br />
evaluation, risk management, engagement and research; the leadership among large<br />
companies in science and innovation; greater risks for those with a global footprint,<br />
that depend on natural resources; a better collaboration among industries for finding<br />
the best solutions to ensure sustainability; the transfer of power back to the hands of<br />
customers who ask for environmentally friendly products and services; and the need<br />
for governments to take action and not ignore social and environmental policies and<br />
taxes.<br />
The financial and economic crisis of 2007 to the present contributed to the failure of<br />
key businesses, declines in consumer wealth, substantial financial commitments<br />
incurred by governments, and a significant decline in economic activity. Even if both<br />
market-based and regulatory solutions have been implemented or are under<br />
consideration, significant risks remain for the world economy over the next periods.<br />
The global financial crisis started to show its effects in the middle of 2007 and into<br />
2008. Around the world, stock markets have fallen, large financial institutions have<br />
collapsed or been bought out, and governments in even the wealthiest nations have<br />
had to come up with rescue packages to restore their financial systems. During<br />
periods of crisis economics are rethinking.<br />
The results and discussions presented in this study lead us to conclude that the impact<br />
of economic and financial crisis on reporting social and environmental information is<br />
extremely powerful, both in voluntary non-financial reports and annual reports. The<br />
use of corporate social reporting as a tool for providing social and environmental<br />
information is still limited. Even though, the references in the annual reports on the<br />
description and presentation of measurable social and environmental aspects gains<br />
more and more importance and a higher percentage of companies consider necessary<br />
to provide details on the social responsibility they assume and created special links on<br />
their web pages. The evolution of corporate social reporting has been modelled<br />
according to the development of the economic crisis, and signals an upward trend of<br />
pushing companies to provide comprehensive, integrated, and certified information on<br />
their activity.<br />
~ 1002 ~
CONCLUSIONS<br />
The qualitative aspects of the information presented in our analysis, including the<br />
compliance with GRI Guidelines, the new generation of GRI G3 standards, key<br />
performance indicators of global performance and external assurance by publishing an<br />
assurance statement, are those that differentiate companies in European Union<br />
countries. The findings presented in our article give us hope that in the future the<br />
quality of information provided by entities will be presented in terms of the impact of<br />
their actions on the environment and society, and given an equal role in the financial<br />
impact. This approach will help companies to overcome the negative effects of the<br />
global crisis but also the disadvantages in the very near future: natural resources<br />
reaching the limit. Therefore, saving through recycling efforts, environmental<br />
protection, environmental-friendly products and the awareness of necessity for their<br />
presentation in the annual reports are mandatory actions for economic recovery on an<br />
upward trend.<br />
Thus, we assert once more that a formal set of recognised reporting principles and a<br />
standardised reporting framework, not dissimilar in principle to those adopted in the<br />
EC 4th Directive on Company law or to IASB framework, should help overcome any<br />
perception that reporting of social and environmental information lacks credibility.<br />
All these issues lead us to the conclusion that a base for discussion on corporate<br />
economic, social and environmental reporting is necessary for European entities. In<br />
our future research we intend to enlarge the present study in order to propose<br />
guidelines for an integrated reporting.<br />
Our research is aimed through its scope to encourage companies to expand their<br />
financial reporting on corporate social and environmental information. The findings of<br />
this paper will help formulate government policy decisions that promote corporate<br />
social and environmental reporting and thereby make entities more responsive to<br />
changes in the natural and social environments. We consider this a useful contribution<br />
in entities efforts to integrate quality information in their annual reports.<br />
ACKNOWLEDGEMENTS<br />
This work was supported by CNCSIS - UEFISCDI, project number PNII - IDEI ID<br />
1819/2008, titled Research regarding reassessment of financial reporting in the light<br />
of risks and uncertainties generated by contingent social and environmental factors.<br />
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~ 1005 ~
A COMPLEX APPROACH TO CLIMATE CHANGE<br />
EXTERNALITIES<br />
Florian COLCEAG 1<br />
IRSCA Gifted Education, Romania<br />
Cornelia DASCALU, Chirata CARAIANI,<br />
Camelia Iuliana LUNGU & Raluca Gina GUŞE<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
This paper analyzes the current state of the externalities in the field of climate change. The<br />
objective of our scientific study is to provide a conceptual framework for the complex analysis<br />
of phenomena with a destructive environmental impact, offering emerging economies a<br />
decision alternative. Through qualitative-correlative research, based on complexity sciences,<br />
this paper approaches the issue of climate change externalities from the perspective of<br />
environmental feedback controlled by triangulated Source – Sensor – Decision-maker<br />
structures. The main result of the research is the complex analysis model of externalities,<br />
adapted to Triple Bottom Line reporting, convergent with the requirements of corporate<br />
social responsibility.<br />
KEYWORDS: climate change, externalities, Source – Sensor – Decision-maker,<br />
performance, sustainability<br />
INTRODUCTION<br />
Interactions between human factors and the natural environment are pervasive and<br />
manifest in various forms, without any possibility for direct communication of<br />
accurate and coherent reporting of causes, actions and effects. Due to environmental<br />
phenomena, which can directly and implicitly affect the economy, the need to<br />
understand the rules of the “game” is becoming increasingly important. At the<br />
present, the global crisis is intensified by global climate change, with deep<br />
implications for the environment, society and economy. The expression "climate<br />
change" is increasingly used instead of global warming to describe the materialization<br />
of cumulative environmental changes and not only the rising temperatures (Staudt et<br />
al., 2008). The general term of climate change means any form of climate deviation<br />
that has no physical cause or statistical nature. The reasons for this complex<br />
phenomenon are natural (changes in solar activity, long-term changes related to the<br />
Earth’s orbit, and natural internal climate system processes) and anthropogenic<br />
(increasing atmospheric concentration of carbon dioxide and other greenhouse gases).<br />
In a narrow sense, climate change shows significant adjustments of climate elements<br />
during a given period, within economic, social and environmental effects. Climate<br />
change is an environmental issue, which creates risks in the development process<br />
(European Commission, 2009). Food crises, water shortages, the spread of diseases<br />
1<br />
Correspondence address: Florian COLCEAG, IRSCA Gifted Education, Bucharest, Romania;<br />
email: florin.colceag@gmail.com<br />
~ 1006 ~
into new territories, destruction caused by floods, forced migration of populations<br />
caused by land desertification, and rising levels of seas and oceans are only a few<br />
effects of climate change that all countries must recognize.<br />
While studies are underway on the main cause of global warming (Le Treut et al.,<br />
2007; Solomon et al., 2009), there is a scientific consensus that the greenhouse effect<br />
is the main item in the hierarchy of causal factors. Although it is a natural<br />
phenomenon consisting of a partial retention of the Earth’s radiation in the<br />
atmosphere, the greenhouse effect is caused by greenhouse gases, which reflect<br />
radiation. Greenhouse gases are the effect of human activities, currently supported by<br />
objects, equipment, machinery, etc., all generating major environmental impact.<br />
The lack of complex tools to address this issue, as well as linear-thinking trained to<br />
operate without a complex understanding of the dynamics and the evolutive structure<br />
of the environment, are problems which may jeopardize humanity in the future.<br />
Despite warnings from climatologists, economists and other specialists, the world is<br />
not yet sufficiently aware of the dangers of climate change. Wright and Erickson<br />
(2003) are concerned about the incorporation of possible catastrophic consequences in<br />
the integrated models developed to assess global climate changes. Studies by<br />
Rokityanskiy (2007) discuss the regulatory aspects concerning greenhouse gases<br />
(carbon and methane) which have a potential to destroy the Earth’s energetic balance<br />
and trigger a catastrophic event. Le Kama et al. (2010) agree that environmental<br />
destruction caused by economic activities may be irreversible and that the level when<br />
environmental degradation becomes irreversible is unknown. There is no perception<br />
of complexity, dynamics, exponential growth, or the momentum of changes in climate<br />
change. This leads to the preservation of traditional social structures, and a slow<br />
response to current problems, that are still assessed using a quantitative approach,<br />
with similarly low efficiency, precision and adequacy. Although catastrophic and very<br />
uncertain, variations in climate changes may generate a butterfly effect starting from<br />
insignificant quantitative data, with qualitative changes in information, relationships,<br />
direction, data structure etc. (Olmstead, 2011).<br />
The perception of ecological crises is directly correlated with social and cultural<br />
values. The currently enforced “polluter pays” principle is bound to the culture of<br />
using financial values as an assessment tool for any product, although the amount paid<br />
does not often compensate the damages done to biodiversity. Additionally, the ethical<br />
approach in regard to the environment is the total prohibition of pollution. Otherwise,<br />
it becomes obvious that manufacturers are allowed to pollute, provided they pay ecotaxes.<br />
The tendency of the political and economic environment to approach<br />
environmental problems in economic terms is clear. The issue of externalities is<br />
broader than the assessment and measurement for the prevention of pollution. It is<br />
bound to the environmental impact of a corporate activity, and where regulations are<br />
consistent with sustainability principles, the company’s ability to generate profits is<br />
severely affected. The mechanisms of taxes that will ultimately benefit stakeholders<br />
through specific policies fail to simultaneously cover the social and sustainability<br />
needs. Therefore, there is a pressing need for an initial assessment of the complex<br />
relationships between the environment and humanity, as well as the relationships<br />
between the economic and financial mechanisms, before designing political decisions<br />
and fund allocations.<br />
~ 1007 ~
This research endorses the idea from Tol (2009) that climate change, more<br />
comprehensive, more complex and more uncertain than any other environmental<br />
issue, is the origin of all externalities. The research hypothesis is:<br />
With climate change, sustainability may be achieved through a qualitative-correlative<br />
approach, characteristic to complexity science.<br />
To support the research hypothesis and to create a real image of the knowledge limits,<br />
the first section of the paper presents representative models developed thus far for<br />
recognition and analysis of externalities in the context of severe global climate<br />
change. The second section presents the qualitative-correlative modeling in terms of<br />
global climate change events. Qualitative analysis can be balanced by classical<br />
quantitative analysis methods incorporated into the accounting models, in order to<br />
establish the extent of information flow, with directions determined by commutative<br />
circuits and diagrams. The resulting reference scheme represents the sustainability<br />
model in the context of global climate change.<br />
1. THE ANALYSIS OF CLIMATE CHANGE EXTERNALITIES<br />
The manufacture and consummation have effects that ascribe costs and benefits to<br />
third parties, without affecting the prices of goods or services; these are externalities.<br />
The externality arises when the manufacturing cost of a good or the benefits<br />
associated with its consumption are allocated to someone other than the manufacturer<br />
or the consumer, respectively. Environmental externalities represent the negative<br />
(cost) or positive (benefit) impacts of manufacturing and consumption on the<br />
environment, which are not recognized, but affect consumer satisfaction and entity<br />
value, avoiding the market mechanisms.<br />
Neoclassical economics failed to provide a consensus regarding solutions to remedy<br />
external effects. Pigou (1920) finds that taxes and regulations can spontaneously<br />
correct the prices of ecosystem-generated services. Coase (1960) believes that a<br />
market response generated during the development process leads to a spontaneous<br />
reaction, associated with externalities. In Coase’s approach, the monetary<br />
measurement is the result of demand and supply of environmental services,<br />
constituting an active economic factor. Costanza et al. (1997) support the necessity of<br />
a financial measurement of services created by the natural environment, as well as the<br />
measurement of collateral damages created by affecting these environmental services.<br />
They believe that in the case of externalities, any evaluation is better than no<br />
evaluation at all.<br />
Externalities causing damages to the environment and community generate costs that<br />
appear, for example, when a company releases a pollutant into the natural<br />
environment without an economic transaction taking place (Antheaume, 2003). An<br />
entity involved in the monetary measurement of costs for goods and services may take<br />
into account clean air and unpolluted water, or raw materials, but it does not take into<br />
account the multiple effects of its economic activity on biodiversity. Therefore, an<br />
inadequate understanding of environmental mechanisms prevents a correct financial<br />
assessment of environmental impacts and of the way they subsequently affect the<br />
economic environment and health.<br />
~ 1008 ~
Attempts by economists to describe the relationship between the economy and the<br />
natural environment in terms of costs have resulted in a number of modeling theories<br />
(Azar and Schneider, 2002; Nordhaus, 2007; Faber and Frenken, 2008). These<br />
theories currently allow a quantitative assessment, covering the stability interval of<br />
the relationship, but are unable to characterize its internal structure. The global<br />
warming phenomenon, caused not only by industrial and domestic pollution, but also<br />
by the discretionary intervention of economic society on the balance of biodiversity,<br />
has intensified and diversified the relationship between the economic and natural<br />
environment, emphasizing externalities of an exhaustive nature.<br />
A considerable amount of economic literature has approached the issue of climate<br />
changes, their causes and potential impact, and also the costs to mitigate the process<br />
(Edmonds and Reilly, 1983; Nordhaus, 1991; Pearce, 1991; Cline, 1992;<br />
Schmalensee, 1993; Weyant, 1994). From the perspective of economic analysis,<br />
recognizing the irreversible nature of pollution caused by economic activities induces<br />
the hypothesis that the natural environment has the capacity to absorb pollutants at a<br />
constant rate (Keeler et al., 1972; Gradus and Smulders 1993). Other researchers<br />
(Forster, 1975; Dasgupta 1982) have formalized the assimilation function of nature,<br />
correlating the level of pollution and the absorption capacity of the environment: the<br />
more intense the pollution, the lesser the level of environmental assimilation. These<br />
works are deterministic in nature. Attempts to optimize the balance between the wellknown<br />
business interests and the not yet fully configured or understood environmental<br />
interests, have created compromise models hoped to generate valid solutions.<br />
Reductionist approaches specific to the twentieth century have permitted the<br />
accumulation of a massive amount of information, multifaceted and in all areas. This<br />
information must be integrated through the vision of complexity sciences into<br />
aggregated models, holistic, dynamic and on multiple layers of complexity to<br />
understand the nature of complex crises generated by climate change.<br />
At the end of the twentieth century, policies to reduce the destructive effects on the<br />
environment were shaped to reflect sustainable development and economic growth;<br />
the optimal emissions policy leads to uncertainty about the occurrence of<br />
environmental events, which may lead to a continuous decline in wealth. The resource<br />
of “air purity” is renewable due to the natural process of eliminating carbon dioxide<br />
and other gases form the atmosphere through, for example, photosynthesis or the<br />
dissolution of pollutants into the ocean, in conditions we hope to be stable, but have<br />
an unclear dynamic because of the disappearance of species. Similar processes have<br />
been considered by Clarke and Reed (1994).<br />
The description and recognition of these change processes allows managers to decide<br />
at any time if it is desirable to keep emissions below the natural rate of purification.<br />
Additionally, it is important to see if it is possible to maintain the probability of<br />
occurrence or restriction of emissions at or below the purification rate, avoiding the<br />
risk for the occurrence of severe environmental events. These decisions are currently<br />
ignoring the issue of alleged stability of the natural environment and primarily<br />
consider the economic factor in terms of profitability. The possibility to avoid risks,<br />
originating in the nature of environmental events considered here is unique for our<br />
research and has important consequences. On the other hand, the policy of pollution<br />
allowances does not solve the problem of nature’s ability to intervene, but gives way<br />
to risks for unpredictable biological and ecosystem catastrophes.<br />
~ 1009 ~
Clarke and Reed (1994) emphasized the importance of continuous and discontinuous<br />
damage effects on accumulated pollution. Similarly, we explain the recognition of<br />
direct costs associated with air pollution, caused by the hazardous effects of pollutants<br />
(other than greenhouse gases). These direct costs manifest themselves in the form of<br />
increasing healthcare costs, reducing agricultural crops, degraded values of<br />
recreational areas and advanced corrosion of materials and buildings; examples of<br />
such costs are identified in the works of other authors like Hohmeyer (1988),<br />
Nordhaus (1991), Ottinger et al. (1991), Cline (1992) and Curtiss et al. (1995). The<br />
main characteristic of such procedures is the recognition of the external effects of<br />
pollution. Typically, profit-based economic and financial effects do not take into<br />
account the irreversible degradation of the balance of biodiversity. We consider that<br />
these events are not necessarily irreversible: there is life after the event. Therefore, we<br />
assume, for any event, that it is partially reversible and that there is a possibility to<br />
recover from the impact with the help of remediation activities. The cost of such<br />
remediation activities, once it is identified, may have a profound effect on the<br />
optimization of policies regarding pollution. Furthermore, the remediation of natural<br />
balances is uncertain as long as the biodiversity equilibrium – which currently allows<br />
an efficient intervention to reduce pollution through specialization of species – is<br />
destroyed.<br />
The catastrophic environmental effects covered by the Cropper model (1976), and the<br />
effects of catastrophic environmental collapse risks on the optimal and equitable<br />
consumption/pollution tradeoffs presented by Clarke and Reed (1994), are generated<br />
by random environmental processes whose probability of occurrence depends on the<br />
concentration of pollutants. Therefore, the risk of occurrence of such events depends<br />
exclusively on the current level of pollution, and not on the history of pollution or the<br />
actual trends. In this case, uncertainty results from the lack of information regarding<br />
the critical point of pollution, which triggers these events, rather than the real<br />
stochastic environmental processes. In our opinion, the profound lack of knowledge<br />
regarding the pollution phenomenon and the pollution levels are endogenous risks.<br />
This includes internal causes which may be manipulated if there is a coherent global<br />
framework to reduce uncertainty and the hazard of destructive effects on the natural<br />
environment. The hypothesis of Cropper (1976) and Clarke and Reed (1994)<br />
determine that the pollution levels and the hazard of environmental effects are<br />
external to the system (exogenous). This different approach leads to specific actions<br />
with important implications for optimal policy formulation and analysis. Stochastic<br />
analyses ignore qualitative relationships, treating dynamic and complex structures in<br />
numerical terms, which make it unsuitable for understanding relationships that<br />
maintain the equilibrium of the planet.<br />
When viewed through the lens of history, this reality is revealed in the form of<br />
endogenous uncertainties – the critical conditions must be kept below the pollution<br />
levels achieved in the past (if such an event has taken place before). For example, in<br />
the case of endogenous uncertainties, the probability of hazard occurrence is<br />
diminished by applying a policy to not increase pollution, in which case the planner<br />
can avoid the risk of occurrence by prohibiting emissions exceeding the natural<br />
purification rate. Returning to a pollution level below a certain threshold value,<br />
however, cannot recreate extinct species or lost balances. Therefore, the objective is<br />
sensitive to the upward or downward trend of pollution and to the natural mechanisms<br />
to reduce pollution, which are generally ignored or unknown. For this reason, it is<br />
~ 1010 ~
essential to establish a monotony property of the state of the variable – pollution must<br />
neither be increasing nor decreasing along the optimal plan – before the problem is<br />
correctly formulated. The equilibrium implies that the optimal emissions form an<br />
interval whose limits attract the pollution process outside the interval, from any initial<br />
level. This is an optimistic point of view if the process is regarded from the<br />
perspective of increasing variability of responses from the natural environment,<br />
caused by the degradation of biodiversity. Considering the response of the natural<br />
environment as a constant, induces an unjustified optimism underlying the economic<br />
policies regarding the emissions of pollutants. In comparison, the exogenous events in<br />
the Clarke and Reed (1994) study generated isolated equilibriums.<br />
A similar structure was determined by Tsur and Zemel (1995) in the context of<br />
renewable groundwater in aquifers under threat of salt water intrusion. The event of<br />
salt water intrusion occurs when the state of the aquifer – a body of underground<br />
water filtered through a water-permeable rock, but not salt water – reaches an<br />
unknown threshold. In the aquifer, salt water intrusion is irreversible and terminal (the<br />
damages cannot be repaired). The initiative of reversible events analysis provides an<br />
opportunity for participative attitudes (Tsur and Zemel, 1995). Considering, for<br />
example, the probability of polar glaciers to disappear and change the state of the<br />
water, we find that the aquifer and water purity are dependent variables which are not<br />
yet accounted for, and that conventional reporting does not reflect the complexity of<br />
processes. The analysis takes place in terms of comparing decision problems where<br />
the hazardous events cannot be ignored. For this type of problem, there is a single<br />
point of equilibrium in which the optimal condition (concentration of air pollution)<br />
converges from any initial level. When the environmental protection costs are high,<br />
the equilibrium interval extends beyond the relevant levels of state variations,<br />
implying that “it is never optimal to keep emissions over the level of natural<br />
purification rates” (Tsur and Zemel, 1996).<br />
Even if the severity of global warming is a threat to the existence of humanity, the<br />
problem is still approached from the carbon variable. The carbon in the carbon<br />
dioxide implicitly affects the oxygen equilibrium of the planet, with similarly<br />
irreversible effects. According to Lovelock (2009), a 2% increase or decrease could<br />
result in burning the entire vegetation through auto-combustion or the impossibility of<br />
respiratory processes. For this reason, there is a need for complex and correlative<br />
approaches, of a metabolic type, which consider the effects of economic activities in<br />
the phenomenon of global warming.<br />
The indicator currently used to assess the environmental component in Triple Bottom<br />
Line evaluations is the Global Reporting Initiative (GRI) system. It includes reporting<br />
indicators structured in accordance with the information requirements of stakeholders:<br />
• Core indicators, which are relevant to most reporting entities and of interest to<br />
the majority of stakeholders;<br />
• Additional indicators, which are the result of emerging practices or show<br />
interest to some organizations. These are currently tested and may become<br />
core indicators.<br />
The GRI reporting framework for environmental issues is presented in Table 1.<br />
~ 1011 ~
Table 1. Environmental Performance Indicators<br />
Environmental<br />
aspects<br />
Core indicators<br />
EN1 Materials used by weight or volume.<br />
Additional indicators<br />
Materials EN2 Percentage of materials used that are<br />
recycled input materials.<br />
EN3 Direct energy consumption by primary EN5 Energy saved due to conservation and efficiency<br />
Energy<br />
Water<br />
Biodiversity<br />
Emissions,<br />
effluents, and<br />
waste<br />
Products and<br />
energy source.<br />
EN4 Indirect energy consumption by primary<br />
source.<br />
~ 1012 ~<br />
improvements.<br />
EN6 Initiatives to provide energy-efficient or<br />
renewable energy based products and services, and<br />
reductions in energy requirements as a result of these<br />
initiatives.<br />
EN7 Water sources significantly affected by<br />
withdrawal of water.<br />
EN8 Total water withdrawal by source. EN9 Water sources significantly affected by<br />
withdrawal of water.<br />
EN10 Percentage and total volume of water recycled<br />
EN11 Location and size of land owned, leased,<br />
managed in, or adjacent to, protected areas and<br />
areas of high biodiversity value outside protected<br />
areas.<br />
EN12 Description of significant impacts of<br />
activities, products, and services on biodiversity<br />
in protected areas and areas of high biodiversity<br />
value outside protected areas.<br />
EN16 Total direct and indirect greenhouse gas<br />
emissions by weight.<br />
EN17 Other relevant indirect greenhouse gas<br />
emissions by weight.<br />
EN19 Emissions of ozone-depleting substances<br />
by weight.<br />
EN20 NO, SO, and other significant air<br />
emissions by type and weight<br />
EN21 Total water discharge by quality and<br />
destination.<br />
EN22 Total weight of waste by type and disposal<br />
method.<br />
EN23 Total number and volume of significant<br />
spills.<br />
EN26 Initiatives to mitigate environmental<br />
impacts of products and services, and extent of<br />
impact mitigation.<br />
and reused.<br />
EN13 Habitats protected or restored<br />
EN14 Strategies, current actions, and future plans for<br />
managing impacts on biodiversity.<br />
EN15 Number of IUCN Red List species and national<br />
conservation list species with habitats in areas affected<br />
by operations, by level of extinction risk.<br />
EN18 Initiatives to reduce greenhouse gas emissions<br />
and reductions achieved.<br />
EN24 Weight of transported, imported, exported, or<br />
treated waste deemed hazardous under the terms of the<br />
Basel Convention Annex I, II, III, and VIII, and<br />
percentage of transported waste shipped internationally.<br />
EN25 Identity, size, protected status, and biodiversity<br />
value of water bodies and related habitats significantly<br />
affected by the reporting organization’s discharges of<br />
water and runoff.<br />
services EN27 Percentage of products sold and their<br />
packaging materials that are reclaimed by<br />
category.<br />
Compliance EN28 Monetary value of significant fines and<br />
total number of non-monetary sanctions for<br />
noncompliance with environmental laws and<br />
regulations.<br />
Transport EN29 Significant environmental impacts of<br />
transporting products and other goods and materials<br />
used for the organization’s operations, and transporting<br />
members of the workforce.<br />
Overall EN30 Total environmental protection expenditures and<br />
investments by type.<br />
(Source: Global Reporting Initiative, 2006)
There is an observable prevalence of quantitative reporting, while qualitative aspects<br />
such as the direct influence of the individual human factor or behavioral issues are<br />
summarily reported. However, these issues are studied by economic sciences and<br />
allow the use of other reporting practices, present in quantitative approaches, even if<br />
they reflect qualitative processes.<br />
Sustainable development encompasses a wide range of social, environmental and<br />
cultural dimensions complementary to economic issues. Issues are multidisciplinary<br />
in nature, and complexity and uncertainty are the norm. Sustainable development is<br />
also an ideologically laden concept. The conflicts of interests dissipate from the usual<br />
business approach to adapting to the current system and making radical changes. The<br />
conventional cost-benefit considerations solve many of the sustainability problems.<br />
Sustainability assessment models are used to demonstrate the features and potential of<br />
participative environmental protection alternatives.<br />
Discussions on global warming have led to the emergence of the carbon market,<br />
where the negotiation of the trading price for atmospheric carbon is essential. In the<br />
carbon market, the benefits of pollution remediation generated by abandoning<br />
polluting industries are translated into degrowth programs, according to the economic<br />
vision for financial benefits. This pseudo-technique to reduce the effects of global<br />
warming emphasizes the possibility to increase carbon emissions in one country,<br />
caused by industrial pollution in another country. Therefore, there is still a tendency to<br />
provide a reductionist approach to a complex problem, with catastrophic-type<br />
behavior. The measures taken to reduce energy and materials consumption, decrease<br />
industrial pollution, and enforce taxes on polluters, do not address the issue of<br />
restoring biodiversity, which would be the only guarantee that nature can eliminate<br />
pollution through its own means and reinstate the natural balance. These types of<br />
studies and measures require complex approaches to biodiversity and systemic<br />
equilibriums, as well as complex analysis instruments.<br />
The recognition and measurement of global climate change effects is a new challenge.<br />
The biggest issue is the shift from a model with a small number of quantitative and<br />
measurable variables to more complex models, qualitative and/or correlative in<br />
nature. However, the current models allow estimations for short-term or long-term<br />
financial effects on companies. These companies are permitted a certain allowance of<br />
carbon dioxide emissions annually, but those which exceed the established levels of<br />
pollution are fined. From this point of view, the ecological solution would be to<br />
discontinue the emissions of carbon dioxide and other pollutants creating a<br />
greenhouse effect and, implicitly, global warming. In the current technological<br />
conditions, this solution means discontinuing the activity of all oil and coalconsuming<br />
organizations and generating social and economic crises associated with<br />
this decision. The carbon problem is still approached in a business to business manner<br />
and without sufficient consideration for the possibility to support nature in<br />
remediating pollution, or to create non-invasive technologies using the reporting and<br />
analysis methodologies based on complexity sciences. Changes in seasons affect the<br />
life-cycle of all living organisms, with direct effects on the survival of species.<br />
Among others, destroying the species cooperation chains by their extinction occur a<br />
reduced capacity to produce food and, profound economic crises that directly affect<br />
the social and environmental environments. An incomplete understanding of these<br />
~ 1013 ~
causal chains (which may only be fully comprehended through complexity sciences)<br />
results in insufficient reporting of relevant data. Moreover, inefficient policies are<br />
employed to solve climate change related problems.<br />
Managerial accounting approaches are encumbered by the inherent subjectivity of<br />
political and cultural influences, the limits of understanding, and social mechanisms<br />
of decision-making. The measurement of environmental externalities based on the<br />
theory of economic welfare is built on restrictive behavioral foundations. This can<br />
only model moral values to some extent, although such values are an essential part of<br />
people’s preferences towards the environment. In addition, many externalities are new<br />
and complex. In these cases, the initial challenge lies not in “discovering” private<br />
preferences, but in specifying the conditions for public discourse over common ways<br />
of understanding the pertinent issues. This implies that research on the environmental<br />
externalities, in addition to refining the theory and the applications of existing nonmarket<br />
valuation techniques, must also address the instruments and content of<br />
political and moral debate (Frame and Cavanagh, 2008).<br />
2. RESEARCH METHODOLOGY AND RESULTS<br />
Due to complexity sciences, explorations that generate accounting analyses and<br />
reports benefit from the presence of a component which analyzes the structure and<br />
equilibrium of information flows. The equilibrium is given by the number and<br />
structure of cycles and commutative diagrams. This is relevant to not only<br />
understanding the information dynamics and identifying the control or accumulation<br />
centers, but also in understanding the command circuits or control mechanisms.<br />
The cybernetic approach given by sustainability or chaos schemes allows for an<br />
understanding of relationships, generating factors, and information structures that may<br />
lead to changes, regardless of the size or direction of information flows. Therefore,<br />
the qualitative approach becomes useful in understanding the mechanisms of<br />
informational relationships between the human structure, social and economic<br />
structure, technological structure and natural environment structure. This cybernetic<br />
approach is specific to the analysis models that result from complexity sciences,<br />
allowing an intimate understanding of the complex and dynamic structures and<br />
mechanisms for interrelationship. In terms of economy and accounting business<br />
processes, this approach allows both the analysis of organization schemes and<br />
organization efficiency, and the analysis of complex human relations or relations with<br />
the components of the social and natural environment, technological impact or<br />
organizational policies, regardless of the complexity of the studied processes and<br />
structures.<br />
2.1 Description of research method<br />
To address complex modeling of climate change externalities, this research focuses on<br />
commutative cycles and diagrams. At the base of the primary structure lies a<br />
triangulated feedback structure containing a Source, a Sensor and a Decision-maker,<br />
and a portfolio of possible relationships between the three components. In terms of<br />
externalities, the cost is the main instrument for decisions on resource allocations,<br />
production volume and structure, supply side, and technological innovations. The<br />
cost is also the most important feedback realized through variations that identify the<br />
~ 1014 ~
source and detect the sensor, giving the decision-maker the possibility to describe<br />
future self-stimulating (increasing the amplitude of variations) or self-inhibition<br />
(decreasing the amplitude of variations) behaviors. The unlimited manifestation of the<br />
two behaviors can lead to the destruction of the system equilibrium or to the evolution<br />
to another level of existence (Dascălu et al., 2010). Through the triangulated feedback<br />
structure, the decision-maker can act through successive iterations until the objective<br />
is met.<br />
Figure 1. Triangulated structure for the complex analysis of externalities<br />
Source S<br />
Sensor &<br />
Decision-maker D<br />
Consumer<br />
behavior<br />
Decision<br />
making<br />
Audit<br />
Commitmen<br />
Decision<br />
efficiency<br />
Conformity<br />
assurance<br />
(Source: Adaptation from Colceag et al., 2010)<br />
Primary behaviors given by the sense of the arrows that establish the relationships<br />
between the Source, Sensor and Decision-maker are refined by the time factor, with<br />
the possibility of self-stimulation or self-inhibition for each behavior. In the cycles of<br />
complex analysis of climate change externalities, the game of triangulated structures<br />
leads to behaviors that describe and offer a potential decision portfolio.<br />
These fractal patterns generate simple schemes, corresponding to cycles, and contain a<br />
minimum of three items A, B, and C, integrated in a perpetual relationship of<br />
transmitting information, such as:<br />
A → B → C → A → B......<br />
If between A, B, and C there is a Source, Sensor, Decision-maker relationship or<br />
function attached, we can identify:<br />
• A growth cycle: Source → Sensor → Decision-maker → Source...<br />
• A degrowth cycle Source → Decision-maker → Sensor → Source…<br />
Therefore it can generate behaviors that modify the overall entropy of the system or<br />
its components.<br />
~ 1015 ~<br />
What If<br />
Analysis<br />
Cause<br />
determinatio<br />
Effects<br />
determinatio
Considering A as the starting point, the resource base, and C, as the accumulation<br />
base, we obtain a commutative diagram with B as an intermediate point, and the<br />
following relationship between the three:<br />
A → B and B → C ⇒ A → C<br />
The model is specific to the command – control structures and allows quantitative<br />
measurements in point C, validated by B as an intermediate point.<br />
This study is based on qualitative-correlative approaches to self-stimulating and selfinhibiting<br />
cycles as described by Prigogine (1976) in dissipative systems. Therefore,<br />
this study uses the notions Source (S), Sensor (&), Decision-maker (D) and the<br />
relationships between two triangulated structures that are interfering. Using this<br />
research method, we assess the qualitative characteristics of interrelations specific to<br />
the composite structure Source – Sensor – Decision-maker, generating costs that<br />
entities are (internal or conventional costs) or are not (external costs or negative<br />
externalities) responsible for and committed to.<br />
Designing this model of complex analysis for climate change externalities can be<br />
represented by attributing financial and non-financial information to the Decisionmaker<br />
element of the model. Here the Sensor is represented successively or integrated<br />
through social and environmental factors that influence the measurement and<br />
recognition of environmental externalities. In both cases, the behavior of cycles can<br />
be self-stimulating or self-inhibiting. Self-stimulating behaviors increase the<br />
amplitude, while self-inhibiting behaviors decrease the amplitude, in both growth and<br />
degrowth cycles. There may be polygonal commutative diagrams, some having two<br />
accumulation points and two starting points for the arrows representing the flows. The<br />
research has revealed a vast array of dynamic life phenomena: individual and<br />
organizational behavior, team work, and even social, economic and environmental<br />
behavior, showing a fractal evolution (Malik, 2004).<br />
Our previous work (Dascălu et al., 2008; Gu e et al., 2010), as well as numerous<br />
research papers on environmental externalities (Little, 2000; Herbohn, 2005;<br />
Vogtländer, 2010), show that quantitative measurements on the product life cycle<br />
made for environmental accounting systems involve assigning a value (quantitative,<br />
measurable) to the environmental impact while achieving a certain objective. This<br />
approach involves self-regulating cycles and commutative diagrams built on the<br />
composite structure Source – Sensor – Decision-maker:<br />
• Drawing up a list of relevant energy and material consumption and discharges<br />
in the natural environment (Source);<br />
• Estimating the potential social and environmental impact, in correlation with<br />
the identified inputs and discharges (Sensor);<br />
• Interpreting results in terms of adopting a correct and well-documented<br />
decision (Decision-maker).<br />
2.2. Discussions and results<br />
The theory of dissipative structures finds its place in the complex analysis of climate<br />
change externalities through a complex model of open systems with the ability to<br />
continuously generate changes or innovative transformations. A dissipative system is<br />
formed when there are three minimal components: a Source (e.g. a source of heat), a<br />
Sensor (e.g. a thermometer), and a Decision-maker (e.g. a thermostat). A self-<br />
~ 1016 ~
stimulating system is manifesting, for example, when the temperature rises, and the<br />
Decision-maker gives the order to continue increasing the temperature. The selfinhibiting<br />
system is present when, in the case of a drop in temperature, the Decisionmaker<br />
gives the order to continue decreasing the temperature. In all the other cases,<br />
we find a self-regulatory system (Gregor, 2005).<br />
Projecting the principles of dissipative systems onto sustainable economy reveals,<br />
through parallelism, the following essential points:<br />
• The Earth is a complex dissipative structure made up of other dissipative<br />
systems linked by complex interdependencies;<br />
• The lack of knowledge and compliance with dissipative structures can be<br />
observed as the increased entropy of the natural, economic and social<br />
environment;<br />
• The lack of knowledge and compliance with dissipative structures can be<br />
observed as the destruction of species caused by global warming;<br />
• The lack of knowledge and compliance with dissipative structures can be<br />
observed as financial, economic and productivity crises;<br />
• The lack of knowledge and compliance with dissipative structures can be<br />
observed as the decline of public confidence in governmental structures<br />
followed by manipulative and centralizing attempts by the state to monitor and<br />
insure control; and the violation of basic human rights;<br />
• The dissipative approach of complex relationships that allows the<br />
identification of energy and financial flows, or other types of flows, depends<br />
on the scope of the theory;<br />
• Sustainable management decisions require an understanding of systemic<br />
complexity and dynamics;<br />
• There is a possibility to transfer the behavioral patterns between various<br />
dissipative systems, for example, between the cycles from the economy of the<br />
living cell to the global economy.<br />
Dissipative systems, characterized by entropy and synergy, stimulation and inhibition,<br />
commutative circuits or diagrams, flows or accumulations, information or functional<br />
structure, behaviors or adapting portfolio, are adequate instruments for the qualitative<br />
approach of various phenomena generated by internal structuring rules and<br />
interactions with the environment.<br />
Physical considerations from the theory of dissipative systems are perfectly adaptable<br />
to the unbalanced and crises-generating social, economic and environmental<br />
phenomena, which must be controlled in the context of a real sustainable<br />
development. Adaptation involves a quantitative analysis of the phenomenon,<br />
according to the changes in entropy. Additionally, a qualitative-structural analysis and<br />
a complex, dynamic analysis of internal mechanisms generated by the interferences<br />
and interactions of dissipative systems is needed. This is achieved not only through<br />
geometric homological or algebraic modeling (triangulated structures), but also<br />
through quantitative vector models.<br />
The involvement of civil society in environmental and social issues is considered and<br />
characterized by two dissipative systems, the natural/social environment and civil<br />
society. A triangulated approach to the two dissipative systems identifies each<br />
benchmark composite structure, with real correspondents presented in Table 2.<br />
~ 1017 ~
Table 2. Dissipative systems involved in environmental issues<br />
Dissipative systems Composite structure Real possible correspondents<br />
Natural/social Source Stability of the social and natural environment<br />
environment Sensor Temperature/degree of agitation and tension<br />
Decision-maker Pollution/loss of cultural, economic, political equilibrium<br />
Civil society<br />
Source Public policy crises management/ response to abuses<br />
Sensor Reactivity/response to imbalances<br />
Decision-maker Organized action/response to emergencies<br />
The interaction between the two systems generates eight other systems which are<br />
structured according to the characteristics and functions in growth and degrowth<br />
cycles and commutative diagrams.<br />
In Table 3, we summarize the eight triangulated structures as a result of complex<br />
analysis of climate change externalities, identifying the action on the emitting system,<br />
with results captured by the receiver.<br />
Table 3. Complex approach for climate change externalities by cycles and diagrams<br />
A. Growth cycles<br />
Interfering structures Emitting system Action Result Receiving system<br />
Source = Stability of Natural/ social Volunteer work Response reactivity to Civil society<br />
natural and social<br />
environment<br />
environment<br />
imbalances = Sensor<br />
Sensor = Response Civil society Maintaining Reactions against pollution, Natural/ social<br />
reactivity to imbalances<br />
values<br />
loss of cultural, economic, environment<br />
1<br />
political balance = Decisionmaker<br />
3<br />
4<br />
2<br />
Decision-maker =<br />
Pollution, loss of<br />
cultural, economic,<br />
political balance<br />
Source = Crises<br />
management/ response to<br />
abuse<br />
Sensor = Response<br />
reactivity to imbalances<br />
Decision-maker =<br />
Organized actions/<br />
response to emergencies<br />
B. Degrowth cycles<br />
Source = Stability of<br />
natural and social<br />
environment<br />
Actions organized<br />
according to the<br />
emergencies = Decision-<br />
maker<br />
Sensor = Temperature/<br />
degree of agitation and<br />
tension<br />
Sensor = Temperature/<br />
degree of agitation and<br />
tension<br />
Source = Crises<br />
management/response to<br />
abuse<br />
Natural/ social<br />
environment<br />
Civil society Alternative<br />
planning<br />
Penalty Stability of the natural and<br />
social environment = Source<br />
~ 1018 ~<br />
Response reactivity to<br />
imbalances = Sensor<br />
Civil society Urgent actions Actions organized according<br />
to the emergencies =<br />
Decision-maker<br />
Civil society Cooperation Crises management/ response<br />
to abuse = Source<br />
Natural/social<br />
environment<br />
Civil society Transparent<br />
cooperation<br />
Natural/social<br />
environment<br />
Natural/social<br />
environment<br />
Organization Actions organized according<br />
to the emergencies =<br />
Decision-maker<br />
Natural/ social<br />
environment<br />
Civil society<br />
Civil society<br />
Civil society<br />
Civil society<br />
Control of temperature and Natural/ social<br />
degree of agitation and tension environment<br />
= Sensor<br />
Warning Stability of natural and social<br />
environment = Source<br />
Responsibility Crises management/response<br />
to abuse = Source<br />
Civil society Cooperation Organized actions in response<br />
to emergencies = Decisionmaker<br />
Natural/ social<br />
environment<br />
Civil society<br />
Civil society
Decision-maker =<br />
Organized<br />
actions/response to<br />
emergencies<br />
Civil society Transparent<br />
cooperation<br />
~ 1019 ~<br />
Control of temperature and Natural/ social<br />
degree of agitation and tension environment<br />
= Sensor<br />
C. Commutative diagrams starting from Decision-maker<br />
Source = Crises Civil society Involvement Stopping pollution,<br />
management/ response to<br />
cultural, economic and<br />
abuse<br />
political imbalances =<br />
Decision-maker<br />
5<br />
6<br />
7<br />
8<br />
Sensor = Response<br />
reactivity to imbalances<br />
Source = Stability of the<br />
natural and social<br />
environment<br />
Sensor = Reactivity of<br />
response to imbalances<br />
Alternative<br />
planning<br />
Response reactivity to<br />
imbalances = Sensor<br />
Civil society Maintaining values Stopping pollution,<br />
cultural, economic and<br />
political imbalances =<br />
Decision-maker<br />
Natural/social<br />
environment<br />
D. Commutative diagrams starting from Source<br />
Decision-maker = Natural/social<br />
Pollution, loss of cultural, environment<br />
economic, political<br />
balance<br />
Sensor = Temperature/<br />
degree of agitation and<br />
tension<br />
Decision-maker =<br />
Organized<br />
actions/response to<br />
emergencies<br />
Sensor = Temperature/<br />
degree of agitation and<br />
tension<br />
Decision-maker =<br />
Organized actions/<br />
response to emergencies<br />
Natural/social<br />
environment<br />
Civil society Transparent<br />
cooperation<br />
Natural/social<br />
environment<br />
Organization Organized actions in<br />
response to emergencies<br />
= Decision-maker<br />
Volunteer work Response reactivity to<br />
imbalances = Sensor<br />
Urgent actions Organized actions in<br />
response to emergencies<br />
= Decision-maker<br />
Previsions Control of temperature<br />
and degree of agitation<br />
and tension = Sensor<br />
Natural/ social<br />
environment<br />
Civil society<br />
Natural/social<br />
environment<br />
Civil society<br />
Civil society<br />
Civil society<br />
Natural/social<br />
environment<br />
Maintaining values Stability of the natural Natural/social<br />
and social environment = environment<br />
Source<br />
Warning Stability of the natural Natural/social<br />
and social environment = environment<br />
Source<br />
Control of temperature<br />
and degree of agitation<br />
and tension = Sensor<br />
Responsibility Crises management/<br />
response to abuse =<br />
Source<br />
Civil society Cooperation Crises management/<br />
response to abuse =<br />
Source<br />
Natural/social<br />
environment<br />
Civil society<br />
Civil society<br />
This complex approach provides flexibility to the decision-making process and it is<br />
consistent with the Triple Bottom Line reporting model, in the context of social<br />
corporate responsibility. Our future research proposes a component designed to<br />
correct errors through systems with four points of support.
CONCLUSIONS<br />
Complex and dynamic approaches have the potential to cover the gaps generated by<br />
the traditional linear quantitative approaches by introducing new instruments to<br />
approach issues and design solutions. These approaches cannot always be translated<br />
into financial or quantitative terms. Translation in financial terms is possible in the<br />
case of interference between the economic factor and another factor, but it is not<br />
feasible for phenomena connected with the economic environment. Biodiversity has<br />
emerged independently from the economic human factor, and therefore it cannot be<br />
assessed either in financial terms, or through economic, financial or political measures<br />
of intervention. In the case of biodiversity, the influence of the economic factor is<br />
invasive. The social and economic environment consumes the same resources as<br />
biodiversity and generates entropy, as opposed to biodiversity which generates<br />
synergy.<br />
Understanding how best to relate the organization performance and the<br />
macroeconomic issues is an evolving process. Global Reporting Initiative<br />
recommends reporting entities to explore ways in which to include these aspects in<br />
their sustainability reports directly; doing so would accelerate the process of<br />
understanding these links, both by themselves and with their users (GRI, 2006).<br />
To create projections of reality that can be studied by integrated analysis, the complex<br />
approach to global climate change externalities provides a solution. It validates the<br />
need to create an integrated framework to "reduce complexity" so that it becomes<br />
predictable, controllable and responsive to the actions of correcting the destructive<br />
effects caused by natural or human forces. This framework should allow integrating a<br />
variety of areas relevant to sustainability, including both natural and social sciences<br />
and using a system of values that are recognizable, identifiable and quantifiable. The<br />
framework should be accessible to decision-makers, combining different effects of<br />
options in various areas. Lastly, it calls for the development of human abilities, which<br />
are now limited to monitoring a small number of dimensions of reality (Huppes and<br />
Ishikawa, 2009).<br />
ACKNOWLEDGMENT<br />
This work was supported by The National Council for Higher Education Research –<br />
Executive Board for Financing Higher Education and University Research (CNCSIS –<br />
UEFISCSU), project PN II – IDEI 1825/2009: Researches, developments and<br />
innovations in social environmental accounting from the policies and procedures<br />
perspective for global warming eco-costs recognition in Romania.<br />
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~ 1023 ~
DIFFERENCES REGARDING ENVIRONMENTAL<br />
REPORTING: THE CASE OF ROMANIAN<br />
ORGANIZATIONS<br />
Ionel-Alin IENCIU 1<br />
Babes-Bolyai University, Romania<br />
ABSTRACT<br />
Since environmental reporting remains voluntary at international level, there are major<br />
differences in terms of the quality and quantity of the environmental information reported by<br />
organizations in different sectors and countries. The main objective of the study is to analyze<br />
the corporate environmental behavior and to suggest factors that explain the quality and<br />
quantity of environmental disclosure within Romanian organizations. The results show that<br />
the environmental information provided by the Romanian organizations is incomplete and<br />
irrelevant for stakeholders. The statistical analysis has demonstrated that environmental<br />
reporting in the case of Romanian organizations is influenced by the size of the entity, by<br />
public exposure and by the structure of the shareholders.<br />
KEYWORDS: environmental reporting, Romanian organizations, performance, public<br />
exposure, size<br />
INTRODUCTION<br />
Since the environmental reporting is a voluntary fact at international level, there are<br />
major differences in terms of the quality and quantity of the environmental<br />
information reported by entities in different sectors and countries. Many studies have<br />
investigated various determinants of companies voluntary disclose practices, but most<br />
of all have been inducted in developed countries such as Germany (Cormier et al.,<br />
2005), UK and US (Holland and Foo, 2003); Australia (Frost, 2007; Deegan and<br />
Rankin, 1996), Spain (Larrinaga et al., 2002; Criado-Jimenez et al., 2007), Canada<br />
(Buhr and Freedman, 2001), Nordic Counties (Nyquist, 2003). Only a few studies<br />
have analyzed environmental reporting within developing countries: Malaysia<br />
(Sumiani et al., 2007), India (Chatterjee and Mir, 2008), Kenya (Dulacha, 2006),<br />
Zimbabwe (Owusu-Ansah, 1998).<br />
The study adds to the literature that analyzes factors that influences voluntary<br />
disclosure in developing countries such as Romania. In the absence of a regulatory<br />
framework regarding environmental reporting the paper analyze the quality of<br />
environmental information disclosed by Romanian organizations and suggest factors<br />
that determine companies from a developing country such Romania to report<br />
environmental information.<br />
1 Correspondence address: Ionel-Alin IENCIU, Babeş-Bolyai University, Faculty of Economics and<br />
Business Administration, Cluj-Napoca, Romania; email: alinienciu@yahoo.co.uk<br />
~ 1024 ~
1. ENVIRONMENTAL REGULATION IN ROMANIA<br />
As many other countries from Central and Eastern Europe, Romania inherited heavy<br />
environmental problems from the communist period. These problems were caused by<br />
the industrial policy based on high productivity that did not take into account the<br />
impact on environment and public health. The biggest issues concern sectors like:<br />
water quality, waste disposal, and air and soil pollution. In Romania the<br />
environmental policies were born during the 90s once with the former Ministry of the<br />
Environment. The national objectives regarding the environmental field were<br />
elaborated in 1992, “The National Strategy for Environmental Protection” being<br />
revised in 1996 and 2002. Starting from 1999, Romania has adopted a National<br />
Strategy for Sustainable Development, in accordance with the area regulations in<br />
Europe and worldwide. Since 2000 the national environmental policies try to assess<br />
the European standards and objectives, the environmental aspects becoming an<br />
important component for Romania’s general policy. The year 2007 marks the<br />
integration of Romania into the European Union, the implementation of European<br />
environmental policies and the introduction of new European funding programs for<br />
environmental protection activities (structural funds). Since 2008, Romania has a new<br />
National Strategy for Sustainable Development, characterized by a new philosophy of<br />
development of the European Union and worldwide shared. The strategy sets actual<br />
targets for the transition to a generating value added development model, aimed at a<br />
continuous improvement of the quality of people life and their relations in harmony<br />
with the natural environment.<br />
However, there is, so far, no legislation in this area, requiring organizations from<br />
Romania, listed or not at the capital market to provide stakeholders separate reports or<br />
specific information relating to the environmental impact. Providing such information<br />
would be useful, especially for listed companies and for those operating in industries<br />
considered highly polluting. In other words, the entity’s commitment regarding the<br />
environmental impact or environmental issues remains voluntary in the case of<br />
Romanian companies.<br />
2. LITERATURE REVIEW<br />
The study accomplished by Lee and Hutchison in 2005 (Lee and Hutchison, 2005: 86)<br />
provides a current state of the factors that could influence environmental reporting<br />
and categories them in three types: external factors (laws and regulations, the<br />
legitimacy of the entity, rising public, public exposure); factors related to the entity<br />
(features, the cost/benefit report, other tests); Individual factors (culture, attitude). In<br />
this study we take into consideration:<br />
1 External factors such as public exposure (expressed by section or category on<br />
the stock exchange or the share of sales for export);<br />
2 Factors related to the entity such as the entity’s characteristics (size expressed<br />
by the turnover and by the number of employees);<br />
3 Individual factors related to the capital structure (the origin of capital, the type<br />
of capital, the number of shareholders);<br />
4 Factors related to environmental performance (fines from Environmental<br />
Guard; if the entity pollutes the environment as stated in negative press<br />
articles, environmental performance indicators);<br />
~ 1025 ~
5 Factors related to the entity’s financial performance (financial performance);<br />
6 Factors related to the entity’s membership in various environmental programs<br />
(PANP membership – carbon emission, the coming out in the Register of the<br />
Romanian Polluters appeared in 2007).<br />
In order to check the existence of these links, I formulate the following assumptions<br />
that I tried to validate through statistical analysis:<br />
H1: The level of environmental reporting for a publicly traded organization from<br />
Romania depends on the entity’s public exposure. In formulating this hypothesis was<br />
started from the following consideration: the more an organization is exposed to the<br />
public (investors, users, media, etc.), the more it would be willing to provide all<br />
possible information on various aspects, including environmental information. This<br />
hypothesis was tested in studies such as those of Brown and Deegan (1998), Patten<br />
(2002) etc. The public exposure of an entity was quantified by turn by three variables:<br />
the section on the Stock Exchange (the organization may be traded on capital markets<br />
BVB or RASDAQ), the category at the Stock Exchange (the organization may be<br />
listed in Category I, II or III) and the sales percentage intended for export (here was<br />
analyzed especially the opening of the organization outdoors).<br />
H2: The size of the entity determines the level of environmental reporting. The size of<br />
the entity, in particular the intensity of the work carried out, would represent, from our<br />
point of view, an essential factor of environmental reporting. Pattern (1991) and<br />
Milne and Hackston (1996), Cormier and Magnan (2003), Cormier et al. (2005),<br />
Belkaoui-Riahi (2001), Watson et al. (2002) are some of the researchers that have<br />
demonstrated over time the correlations between the size of the entity and the level of<br />
environmental reporting. Ahmed and Courtis (1999) found that size, listing status and<br />
financial leverage influence voluntary disclosure. The size of the entity is expressed<br />
by two variables: turnover and the number of employees.<br />
H3: The capital structure determines the level of environmental reporting for the<br />
Romanian entities. Cormier and Gordon (2001) showed that the status of the capital<br />
(public or private) influences environmental reporting. Cormier and Magnan (2003)<br />
showed that the dispersion of the capital (national/foreign) positively affects<br />
environmental reporting in the annual report. The following variables were examined:<br />
the status of the capital (public or private), its dispersion (Romanian or foreign) and<br />
the number of the shareholders.<br />
H4: The level of environmental reporting is closely linked to the environmental<br />
performance for the Romanian entities, environmental performance of an organization<br />
being expressed by three indicators: whether or not appeared press articles related to<br />
the negative environmental performance for a particular entity; whether an entity has<br />
been fined or not by the Environmental Guard for not complying with the related<br />
legislation; environmental performance expressed in financial terms as being equal to<br />
the total number of emissions in the environment related to turnover (we considered<br />
the polluting level reported to the intensity of the work performed). In the study<br />
conducted in 2002, Dennis Patten (2002) demonstrates, using as indicators for<br />
environmental performance the level of emissions in the environment related to the<br />
turnover, the existence of a negative link between the environmental performance and<br />
the level of environmental reporting.<br />
~ 1026 ~
H5: The financial performance of en entity determines the quality level of<br />
environmental reporting. In formulating this hypothesis, we assumed that an<br />
organization with positive financial performance (profit) gives greater importance to<br />
environmental issues. There have been previous studies that sustain this hypothesis<br />
(Wallance and Naser, 1995; Belkaoui-Riahi and Karl, 1978; Cooke, 1989), but also<br />
there are some studies that argue that organizations with low profitability might<br />
disclose more voluntary information to justify their status (Wallace et al., 1994).<br />
H6: Belonging to different environmental programs, determines the level of<br />
environmental reporting. Since 2007 Romania is part of the EU ETS European<br />
Program regarding the trading of CO2 emissions to European level. There are a<br />
number of entities in Romania taking part to this program in order to reduce<br />
emissions. This program membership was considered to be a factor that would<br />
determine organizations to give greater importance to environmental protection and<br />
also to report more information on environmental impact. Also, in 2007, was<br />
published The Registry of Polluters in Romania, where a series of organizations and<br />
the amount of emissions into the environment for 2005 are present. Thus, we<br />
considered that the entities that are present in this registry are determined in the future<br />
to provide more conclusive information on the environmental impact.<br />
3. RESEARCH METHODOLOGY<br />
I selected only organizations listed at Bucharest Stock Exchange, because they<br />
provide annual reports, financial statements and other categories of reports (The<br />
Manager’s Report, environmental reports, sustainable reports) which are publicly<br />
available, while for unlisted organizations, the access to information is restricted. As<br />
indicated in the previous subsection, there is a variety of studies that analyses the level<br />
of environmental reporting in different countries, taking as a sample, particularly<br />
listed entities (Gamble et al., 1995; Deegan and Rankin, 1996; Walden and Schwartz,<br />
1997; Cormier and Magnan, 1997; Brown and Deegan, 1998; Larrinaga et al., 2002;<br />
Deegan et al., 2002; O’Donovan, 2002; Burritt, 2002; Al-Tuwaijri et al., 2003;<br />
Comier et al., 2005; Frost, 2007; Taylor, 2007; Sumiani et al., 2007). Thus, were<br />
taken into account 101 organizations from 22 areas of activity that may impact the<br />
environment (Table 1).<br />
Table 1. Areas of activity included in the study<br />
No. Area of activity Symbol<br />
~ 1027 ~<br />
Number of<br />
entities<br />
1 Agriculture, forestry and fishing Ag 5<br />
2 Mining industry IE 5<br />
3 Production and supply of electricity, thermal energy, gas, water EE 2<br />
4 Water distribution, sanitation, managing waste, recyclable materials D 1<br />
5 Construction<br />
ti iti<br />
C 14<br />
6 Transport and storage Tr 6<br />
7 Food industry IA 10<br />
8 The manufacture of beverages FB 3<br />
9 The manufacture of textiles FT 2<br />
10 Wood processing, the manufacture of wood and cork products, except<br />
f it<br />
PL 3
No. Area of activity Symbol<br />
~ 1028 ~<br />
Number of<br />
entities<br />
12 The manufacture of coke products and of products resulted from PC 1<br />
13 The<br />
t<br />
manufacture<br />
l<br />
of<br />
i<br />
substances and chemical products IC 5<br />
14 The manufacture of basic pharmaceutical products and pharmaceutical PF 4<br />
15 The manufacture<br />
ti<br />
of rubber and plastic products FPC 3<br />
16 The manufacture of other non-metallic mineral products PNM 5<br />
17 Metallurgy industry IM 5<br />
18 Metallic construction industry CM 4<br />
19 The manufacture of electrical equipment FEE 3<br />
20 The manufacture of vehicles FMT 18<br />
21 The repair, maintenance and installation of machinery and equipment RIIME 1<br />
22 Printing and reproduction of recorded media TRSI 1<br />
Total number of entities 101<br />
(Source: accomplished by the author)<br />
For all the organizations selected I conduct a content analysis regarding the<br />
environmental information provided in various types of reports and published<br />
statements for the year 2007. Se I create a reporting model (Table 2) comprising four<br />
categories of environmental information that an organizations should provide to give<br />
users a clear and comprehensive picture of the environmental impact. This model<br />
includes categories of environmental information that GRI Guidelines 2006 suggests.<br />
Moreover, such models on different categories of environmental information are used<br />
for content analysis of environmental reporting in countries such as Germany (Comier<br />
et all, 2005), Spain (Larrinaga et al., 2002; Criado-Jimenez et al., 2007), Canada (Neu<br />
et al., 1998), Ireland (O’Dwyer, 2001), Great Britain (Stray, 2007), USA (Holland and<br />
Foo, 2003), India (Chatterjee and Mir, 2008) or in the entities listed on major<br />
international exchanges (Davis-Walling and Batterman, 1997; Jose and Lee, 2006).<br />
Table 2. Reporting model of environmental informational<br />
No. Environmental information detailed on categories and subcategories<br />
1 Information regarding general aspects of environmental management /corporate policies<br />
1.1 Environmental policies (information on environmental activities, the undertaken products and processes,<br />
management’s commitment to environmental issues, the responsibility to the environment, sustainability,<br />
sustainable development)<br />
1.2 The structure and organization of environmental management (monitoring of the environmental issues,<br />
environmental management system, the existence of pollution control departments, ISO 14001/EMAS<br />
certification, training and employee involvement, investments, awards)<br />
1.3 Targets and objectives for environmental management (future investments, targets, objectives, purpose)<br />
1.4 External initiatives regarding environmental protection (the participation in the development of<br />
environmental standards, awards, research and development on environmental management, local<br />
community initiatives, joint projects with other entities on environmental management, support for<br />
environmental organizations, environmental investments)<br />
1.5 Information regarding Environmental Audit<br />
2 Information regarding environmental regulations and legislations<br />
2.1 Actual or potential litigation for breaching environmental legislation<br />
2.2 Fines received for violations of environmental legislation<br />
2.3 Environmental pollution (water pollution, air, soil, noise, waste discharge)<br />
2.4 Corrective, remedial or improvement actions, undertaken or to be taken<br />
2.5 Present or future environmental legislation<br />
3 Information on environmental pollution and resource consumption, water and energy<br />
3.1 Carried pollution (emissions in air, discharge to waters, soil emissions – the level of emissions,<br />
discharges, information on initiatives to prevent and reduce emissions and discharges)
No. Environmental information detailed on categories and subcategories<br />
3.2 Information on material consumption (used materials, material recycling, material recycling efforts)<br />
3.3 Information on energy consumption (energy used, reducing energy consumption, investments and<br />
initiatives to reduce energy consumption)<br />
3.4 Information on water consumption (amount of water used, water recycling activities)<br />
3.5 Information on the produced pollution on products and activities (product life cycle analysis, products or<br />
processes impact on the environment , on the local community, on biodiversity, current or future actions<br />
regarding the improving of the environmental performance for products or processes)<br />
4 Information on environmental risk/ environmental costs/environmental obligations<br />
4.1 Past, present or future environmental investments (details of investments, the way they contribute to<br />
improving environmental performance)<br />
4.2 Past, present or future operating environmental expenses (details of investments, the way they contribute<br />
to improving environmental performance)<br />
4.3 Environmental savings and avoided costs (cost reductions of emissions, waste, gains on recycling,<br />
savings on energy consumption)<br />
4.4 Environmental externalities (information on environmental externalities, the way the entity recognizes<br />
environmental externalities in the category of environmental costs, measures to reduce environmental<br />
externalities)<br />
4.5 Environmental obligations (environmental liabilities, environmental provisions, environmental contingent<br />
liabilities, accounting treatment of environmental obligations, assessment, estimation, the probability of<br />
the resources outflow , detailing of obligations)<br />
(Source: accomplished by the author)<br />
In order to achieve a qualitative analysis of environmental information reported by the<br />
organizations in the study, for each subset of environmental information contained in<br />
Table 2 it was used a scale of 0 to3 as follows:<br />
1. If the organization does not provide information.<br />
2. If the organization provides general information. General information refers to<br />
information that is not specific to an activity conducted by the entity. This<br />
information is usually standard sentences or phrases used by different entities,<br />
not being specific to the carried activities.<br />
3. If the organization provides information specifically described. Specific<br />
information represent non-financial information that are specific to some<br />
activities, industries and entities;<br />
4. If the organization report quantitative information regarding environmental<br />
issues. If specific issues are presented in monetary or quantitative terms, the<br />
entity will receive the maximum score because it provides comprehensive<br />
environmental information.<br />
This way of coding was used in the studies conducted by Wiseman (1982), Cormier<br />
and Magnan (2003), Comier et al. (2005) and offers the following advantages<br />
(Comier et al, 2005:15):<br />
• allows integration of various types of information in a single figure<br />
comparable between entities in terms of relevance;<br />
• allows the implementation of a qualitative scoring of environmental<br />
information provided by each entity;<br />
• Although this process has its subjectivity, it eliminates irrelevant information,<br />
taking into account only relevant information.<br />
5. ANALYSES AND RESULTS<br />
On a first analysis of the environmental information provided by the 101 surveyed<br />
organizations, I select only entities providing certain environmental information<br />
which have impact on the environment through their work. It was found significant<br />
~ 1029 ~
the reduction of the sample to the 46 entities because it would be relevant to quantify<br />
the environmental reporting for the entities that have environmental impact. It was<br />
found that there are two entities (SC Albalact SA and SC Romimplent SA) who have<br />
claimed to have no significant impact on the environment and have not provided<br />
relevant information on the environmental impact, being thus fined by The<br />
Environmental Guard because of the violation of the laws of the environment. This<br />
trend highlights that the entities avoid the presentation of negative aspects (such as<br />
fines, penalties), being thus violated the principle of true image on environmental<br />
impact, trying to maintain its legitimacy by not providing information that could strike<br />
its reputation. Appendix 1 (at the end of the paper) presents the descriptions of the<br />
variable and appendix 2 (at the end of the paper) reflects the values of variables for<br />
the 46 entities included in the sample.<br />
Checking the first assumption I analyzed the variation of environmental reporting<br />
related to the public exposure of the organization. As stated earlier, the public<br />
exposure of an organization was quantified by the following variables:<br />
1 The Stock Exchange section<br />
2 The Stock Exchange category<br />
3 The percentage of export sales<br />
Table 3. The coefficient of the correlation between variables<br />
The level<br />
of environmental<br />
reporting<br />
The Stock<br />
Exchange<br />
section<br />
~ 1030 ~<br />
The Stock<br />
Exchange<br />
category<br />
The percentage<br />
of sales export<br />
Pearson Correlation 1 -.581(**) -.623(**) .488(**)<br />
Sig. (2-tailed) .000 .000 .001<br />
N 46 45 45 45<br />
Kendall's tau_b 1 -.549(**) -.546(**) .428(**)<br />
Sig. (2-tailed) .000 .000 .000<br />
N 46 45 45 45<br />
Spearman's rho 1 -.656(**) -.654(**) .593(**)<br />
Sig. (2-tailed) .000 .000 .000<br />
N 46 45 45 45<br />
** The correlation is significant for a level of the coefficient equal to 0.01.<br />
(Source: calculations made by the author in SPSS)<br />
The correlation between the dependent variable and the three independent variables is<br />
reflected in table 3:<br />
1 Pearson’s coefficient (ranging between -1 and 1), for the first independent<br />
variable (the Stock Exchange variable) is negative (-0.581 different from 0),<br />
which demonstrates a link inversely proportional, of average intensity,<br />
between the level of environmental reporting and the Stock Exchange section.<br />
In other words, the entities traded on BVB have a higher level of<br />
environmental reporting than the RASDAQ traded entities;<br />
2 For the second independent variable (the Stock Exchange category) the<br />
Pearson’s coefficient is negative (-0.623 different from 0), which demonstrates<br />
a link inversely proportional, of average intensity, between the level of<br />
environmental reporting and the Stock Exchange category. In other words, the<br />
entities that are traded in the first category present a higher level of
environmental reporting than the entities traded in the second category,<br />
respectively the entities traded in the third category which present the lowest<br />
level of environmental reporting;<br />
3 Pearson’s coefficient for the percentage of export sales is positive (0.488<br />
different from 0) which demonstrates a link directly proportional, of average<br />
intensity, between the environmental reporting and the percentage of export<br />
sales. In other words, the entities that export more, are publicly exposed both<br />
in the national country and abroad, are entities more opened to the<br />
international level ( must provide a good image both in the national country<br />
and abroad), thus being tempted to report more information.<br />
From the statistical analysis conducted it can be concluded that the public exposure of<br />
the Romanian entities has a significant influence on the level of environmental<br />
reporting, which allows us to accept the first assumption and to bring publicly<br />
exposed as a factor that determine the quality of environmental information.<br />
Checking the second assumption: the variation of environmental reporting depending<br />
on the entity’s size, expressed in turn by two variables: turnover and number of<br />
employees.<br />
Table 4. The correlation coefficient between variables<br />
The level<br />
of environmental<br />
reporting<br />
~ 1031 ~<br />
Turnover<br />
Number<br />
of employees<br />
The level of<br />
environmental reporting<br />
Pearson Correlation<br />
1 .623(**) .535(**)<br />
Sig. (2-tailed) .000 .000<br />
N 46 45 45<br />
Kendall's tau_b 1 .362(**) .383(**)<br />
Sig. (2-tailed) .001 .000<br />
N 46 45 45<br />
Spearman's rho 1 .477(**) .530(**)<br />
Sig. (2-tailed) .001 .000<br />
N 46 45 45<br />
** The correlation is significant for a level of the coefficient equal to 0.01.<br />
(Source: calculations made by the author in SPSS)<br />
Pearson’s coefficient reflects in both cases a direct link, of high intensity between the<br />
level of environmental reporting and the turnover (0.623**), respectively between the<br />
level of environmental reporting and the number of employees (0,535**). R Square<br />
Coefficient shows that between the two independent variables (turnover and number<br />
of employees) turnover best explains the variations of environmental reporting<br />
(0.388%). The value of Sig. coefficient is 0, if the link is there in all three cases with a<br />
probability of 99% (Sig.
To see if capital structure determines the level of environmental reporting we analyze<br />
the existence of statistical correlations between the level of environmental reporting<br />
and the type of the capital (private capital/state capital), the origin of the capital<br />
(Romanian capital/foreign capital) and the dispersion of shareholders (the number of<br />
shareholders).<br />
Table 5. The correlation coefficient between variables<br />
The level of<br />
environmental<br />
reporting<br />
Private capital/<br />
state capital<br />
~ 1032 ~<br />
Romanian/fo<br />
reign capital<br />
Number of<br />
shareholders<br />
Pearson<br />
Correlation<br />
1 .337(*) .435(**) .184<br />
Sig. (2-tailed) .022 .003 .226<br />
N 46 46 46 45<br />
Kendall's tau_b 1 .242 .353(**) .134<br />
Sig. (2-tailed) .052 .005 .245<br />
N 46 46 46 45<br />
Spearman's rho 1 .289 .421(**) .175<br />
Sig. (2-tailed) .051 .004 .250<br />
N 46 46 46 45<br />
* The correlation is significant for a level of the coefficient of 0.05.<br />
** The correlation is significant for a level of the coefficient of 0.01.<br />
(Source: calculations made by the author in SPSS)<br />
The correlation between the dependent variable and the three independent variables<br />
which expresses the entity’s capital structure is reflected in Table 5:<br />
1 The Pearson’s coefficient (can range between -1 and 1) for the first<br />
independent variable (private/state capital) is different from 0, and Si. Is<br />
It can be thus concluded, that the only variable regarding the capital structure, which<br />
would explain the quality level of environmental reporting for listed entities in<br />
Romania, is the origin of the capital, the foreign owned entities representing a higher<br />
level on environmental reporting.<br />
Checking the fourth hypothesis: the level of environmental reporting varies according<br />
to the environmental performance in the entities, environmental performance that we<br />
tried to express in different forms, namely:<br />
1 environmental performance through the media (press negative information);<br />
2 environmental performance through the Environmental Guard (fines from the<br />
Environmental Guard)<br />
3 Environmental performance based on the emissions released into the<br />
environment (total emission in the air, water, soil in 2005/turnover in 2005),<br />
published in the Register of Polluters in Romania in 2007.<br />
Table 6. The Correlation Coefficient between Variables<br />
The level of<br />
environmental<br />
reporting<br />
Negative<br />
aspects<br />
appeared in<br />
press<br />
~ 1033 ~<br />
Fines from<br />
the<br />
Environme<br />
ntal Guard<br />
Environmental<br />
performance<br />
(emissions/turnover)<br />
Pearson Correlation 1 -.023 -.170 .112<br />
Sig. (2-tailed) .879 .260 .742<br />
N 46 46 46 11<br />
Kendall's tau_b 1 -.004 -.122 .278<br />
Sig. (2-tailed) .973 .329 .240<br />
N 46 46 46 11<br />
Spearman's rho 1 -.005 -.146 .479<br />
Sig. (2-tailed) .973 .334 .136<br />
N 46 46 46 11<br />
(Source: calculations made by the author in SPSS)<br />
If we analyze the coefficients in Table 6 it can be noted that there is no correlation in<br />
any of the three cases, implying that the environmental performance does not affect<br />
the level of environmental reporting. A number of factors such as the negative image<br />
as a result of newspaper articles or receiving fines from the Environmental Guard<br />
have not determined entities to increase environmental reporting, most of these<br />
unfavorable issues being raised in annual reports, other documents or summary<br />
reports. It can thus be affirmed that this hypothesis cannot be validated.<br />
Table 7 is analyzing the variation of environment reporting depending on the financial<br />
performance (profit/loss).
Table 7. The Correlation Coefficient between Variables<br />
~ 1034 ~<br />
The level of<br />
environmental<br />
reporting<br />
Financial<br />
performance<br />
The level of environmental<br />
reporting<br />
Pearson Correlation<br />
1 .232<br />
Sig. (2-tailed) .125<br />
N 46 45<br />
Kendall's tau_b 1 .190<br />
Sig. (2-tailed) .132<br />
N 46 45<br />
Spearman's rho 1 .227<br />
Sig. (2-tailed) .134<br />
N 46 45<br />
(Source: calculations made by the author in SPSS)<br />
Following the statistical analysis, it can be concluded that there is no link between<br />
financial performance and the level of environmental reporting, the fifth hypothesis<br />
being rejected.<br />
The entity’s membership in various environmental programs determines the level of<br />
environmental reporting for the entities in Romania. Thus it will be analyzed the<br />
variation of environmental reporting depending on:<br />
1 Membership of PNAP – carbon emissions;<br />
2 The presence in The Registry of Romanian Polluters from 2005 issued in<br />
2007.<br />
Table 8. The Correlation Coefficient between Variables<br />
The level of<br />
environmental<br />
reporting<br />
The entity is part of<br />
PNAP – carbon<br />
emissions<br />
The entity is present in<br />
the Registry of<br />
Romanian Polluters<br />
Pearson Correlation 1 -.143 -.242<br />
Sig. (2-tailed) .344 .105<br />
N 46 46 46<br />
Kendall's tau_b 1 -.086 -.150<br />
Sig. (2-tailed) .489 .230<br />
N 46 46 46<br />
Spearman's rho 1 -.103 -.179<br />
Sig. (2-tailed) .495 .235<br />
N 46 46 46<br />
** The correlation is significant for a level of the coefficient of 0.01.<br />
(Source: calculations made by the author in SPSS)<br />
Following the statistical analysis, it can be concluded that the entity’s belonging to<br />
various environmental programs (PANA, The Registry of Romanian Polluters) does<br />
not determine them to provide more information on the environmental impact.
CONCLUSIONS<br />
The level of environmental reporting in the case of Romanian entities is very low. The<br />
average report in 2008, the highest of the three periods analyzed is 0,78 thus resulting<br />
a low interest manifested by the Romanian entities towards these aspects. Because<br />
0,78 comes close to the qualitative level 1, which shows that an entity offers general<br />
information about a certain category of environmental information, we could say that<br />
the entities of Romania offer only general information regarding their impact on the<br />
environment, incomplete and irrelevant information for its users;<br />
The environmental information category which got the highest score or the<br />
environmental aspects most often offered by the Romanian entities is the information<br />
regarding general aspects of environment management / corporative politics, and the<br />
less tackled aspects consist of the information regarding the environmental risks /<br />
costs / obligations. Although the latter is the most relevant information for a detailed<br />
analysis of the entities' impact on the environment, these aspects are neglected or<br />
hidden by the Romanian entities. They stick to general aspects regarding the<br />
environmental management, politics, targets and objectives, without mentioning any<br />
details.<br />
The main source of environmental information is represented by annual reports. 44<br />
environmental informational cases were presented in the annual reports of the entities<br />
(generally in section 1.1.6), which shows that annual reports are the main sources of<br />
information of the entities of Romania. Also, the entities' sites (for those that have<br />
one) and the explaining notes to the financial situations represent relevant sources of<br />
information regarding the environmental impact. We could also see that no entity of<br />
Romania listed on the BVB emits a separate environmental reporting or sustainable<br />
reporting, which have become a regular aspect for numerous entities of European<br />
countries, both developed and in course of development.<br />
The factors best explaining the variation of environmental reporting in the case of<br />
Romanian listed companies are the public exposure of the company (by means of<br />
variables like stock exchange tier and the export sales percentage), the size of the<br />
company (by means of turnover variable), respectively the type of capital (by means<br />
of the Romanian / foreign capital variable), explaining 64,7% of the environmental<br />
reporting variation in the case of Romanian listed companies. The exposed<br />
environmental information are positive information fact representing an advantage for<br />
companies in their relations with users, and environmental reporting is not correlated<br />
with environmental performance, which raises again the issue of objectivity regarding<br />
these information.<br />
ACKNOWLEDGEMENTS<br />
This paper is part of the research project POSDRU/89/1.5/S/59184 ‘Performance and<br />
excellence in postdoctoral research within the field of economic sciences in<br />
Romania’, Babeş-Bolyai University, Cluj-Napoca being a partner within the project.<br />
~ 1035 ~
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~ 1038 ~
APPENDIX 1<br />
Description of the variables used<br />
Variable Symbol Source Coding Type<br />
Company Company www.bvb.ro Name of the company<br />
Can bring value<br />
dependent<br />
Environmental reporting<br />
between 0 (minimum)<br />
level ER_level Determine by the authors to 3 (maximum) independent<br />
The Stock Exchange section SB_E www.bvb.ro 1 - BVB; 2 - RASDAQ<br />
1 – first category; 2 –<br />
independent<br />
The Stock Exchange<br />
second category; 3 –<br />
category CB_E www.bvb.ro<br />
third category independent<br />
The percentage of sales<br />
Annual report 2007 Total exports / Total<br />
export PExp_E<br />
sales independent<br />
Annual report 2007 Turnover (RON-<br />
Turnover Turnover<br />
national currency) independent<br />
Number of employees Emp Annual report 2007 Number of employees independent<br />
Financial performance PF_E Annual report 2007 1 - profit; 2 - loss independent<br />
Negative aspects appeared<br />
1 - appear; 2 – not<br />
in press Pres_Neg_E www.google.com appear independent<br />
Fines from the<br />
1 – were amended; 2 –<br />
Environmental Guard Amz_E www.gnm.ro<br />
were not amended independent<br />
The entity is part of PNAP –<br />
National plan of 1 – part of; 2 – not part<br />
carbon emissions<br />
The entity is present in the<br />
PNAP_E emissions allocations of independent<br />
Registry of Romanian<br />
Romanian Pollution 1 – part of; 2 – not part<br />
Polluters RegPol_E Register 2005<br />
of independent<br />
Environmental performance<br />
Romanian Pollution<br />
(emissions/turnover) Perf_mediu_E Register (RPR 2005) Emissions /Turnover independent<br />
Annual report 2007 1 – private capital ; 2 –<br />
Private capital/ state capital TC_E<br />
state capital independent<br />
Annual report 2007 1 – Romanian capital;<br />
Romanian/foreign capital CRS_E<br />
2 – foreign capital<br />
Number of<br />
independent<br />
Number of shareholders Nr.Act_E Annual report 2007 shareholders independent<br />
(Source: accomplished by the author)<br />
~ 1039 ~
Company<br />
ER_<br />
level<br />
SB<br />
_E<br />
CB_<br />
E<br />
PExp_<br />
E<br />
APENDIX 2<br />
Values of the variables used<br />
Turnover Emp<br />
PF<br />
_E<br />
~ 1040 ~<br />
Pres<br />
_N_<br />
E<br />
Amz<br />
_E<br />
PNAP_<br />
E<br />
RegPol<br />
_E<br />
Perf_<br />
mediu_<br />
E<br />
Petrom 2,35 1 1 54 12284378408 26397 1 1 1 1 1 0,177 1 2 5<br />
Dafora 0,25 1 2 0 294954903 1269 1 2 2 2 2 . 1 1 2<br />
Rompetrol Well<br />
Services<br />
0,45 1 2 0 87354241 320 1 2 2 2 2 . 1 1 2<br />
Foraj Sonde 0,25 2 3 0 102475892 625 1 1 1 2 2 . 1 1 2<br />
Transelectrica 1,9 1 1 50 2314303549 2184 1 2 2 2 2 . 2 1 3<br />
Vest Energo 0,15 2 3 0 26167224 75 1 2 2 1 2 . 1 1 3<br />
Impact<br />
Developer&Cont<br />
0,25 1 1 0 108645733 166 1 2 2 2 2 . 1 1 4<br />
Pentaco 0 2 3 0 20029345 176 1 2 2 2 2 . 1 1 2<br />
Condmag 0,45 1 2 0 214701853 907 1 2 2 2 2 . 1 1 3<br />
Transgaz 1,4 1 1 0 1038866794 4869 1 2 2 2 2 . 2 1 4<br />
Alro 0,85 1 1 79,93 2045525398 4306 1 1 1 1 1 0,253 1 1 3<br />
Mechel 1 1 2 9,33 809910584 4012 1 1 1 1 1 0,19 1 2 3<br />
T.M.K. Artrom 0,9 1 2 72 522572481 1325 1 2 2 1 2 . 1 2 3<br />
Nutricom 0,3 2 3 0 98957828 556 1 2 2 2 2 . 1 1 2<br />
MNP 0,95 1 2 0,2 238925170 920 1 2 2 2 2 . 1 1 2<br />
Ves 0,85 1 2 0 43169285 727 1 2 2 2 2 . 1 1 2<br />
Amonil 0,95 1 2 80 87082133 406 1 1 1 1 1 0,666 1 1 4<br />
Azomures 1,25 1 1 69,48 820607363 2659 1 1 1 1 1 10,732 1 2 3<br />
Oltchim 1,5 1 1 74 1749871975 4836 2 1 1 1 1 0,099 1 1 5<br />
Sinteza 0,8 1 2 0 13753903 182 1 2 2 2 2 . 1 1 3<br />
Victoria 0,35 2 3 0 25189238 158 1 2 2 1 2 . 1 1 2<br />
Siretul Pascani 0,9 1 2 38 15979583 445 1 2 2 2 2 . 1 1 5<br />
Sef Petroforest 0,3 2 3 44,94 16954411 378 1 1 2 2 2 . 1 1 4<br />
Rompetrol<br />
Rafinare<br />
2,05 1 2 35 5429312435 879 2 2 2 1 1 0,056 1 2 4<br />
Antibiotice 0,85 1 1 61 229415602 1565 1 2 2 2 1 0,004 1 1 4<br />
Biofarm 0,8 1 2 64,87 62344059 317 1 2 2 2 2 . 1 1 5<br />
Zentiva 0,95 1 1 5 193996640 821 1 2 2 2 2 . 1 2 4<br />
Romcarbon 0,55 1 2 6,86 90588846 761 2 1 1 2 2 . 1 1 5<br />
Teraplast 0,4 . . . . . . 1 2 1 2 . 1 1 .<br />
Carbochim 0,6 1 2 1 32225111 386 1 1 2 1 2 . 1 1 8<br />
Helios 0,25 2 3 0,6 26500787 282 1 2 2 1 2 . 1 1 2<br />
Vulturul 0 2 3 0 6316451 168 1 2 2 1 2 . 1 1 3<br />
Electroputere 1,3 1 2 47,83 142819099 2550 2 2 2 2 2 . 1 2 2<br />
Grupul Industrial<br />
Electrocontact<br />
1,55 1 2 1,7 14241340 197 1 2 2 2 2 . 1 1 4<br />
Armatura 0,4 1 2 31,47 30573774 402 2 2 2 2 2 . 1 1 4<br />
Comexip 0,8 2 3 0 6654754 147 1 2 2 2 2 . 1 1 3<br />
Comelf 0,6 1 2 87,29 108922175 1113 1 2 2 2 2 . 1 1 2<br />
Titan<br />
Echipamente<br />
Nucleare<br />
0,9 2 3 0 5186698 114 2 1 2 2 2 . 1 2 2<br />
TC_<br />
E<br />
CRS<br />
_E<br />
Nr.Act<br />
_E
Compa 1 1 2 77 301563792 1860 1 2 2 2 2 . 1 1 2<br />
Uamt 0,4 1 2 0,7 70416635 572 1 2 2 2 2 . 1 1 3<br />
Aerostar 0,8 1 2 37 139190732 1679 1 1 1 1 2 . 1 1 3<br />
Santierul Naval<br />
Orsova<br />
1,45 1 2 100 87376230 723 1 1 1 2 2 . 1 1 4<br />
Vae Apcarom 1,5 1 2 38,59 77972560 237 1 2 2 2 2 . 1 2 2<br />
Avicola Iasi 0,1 2 3 0 32072516 409 1 1 2 2 1 0,052 1 1 5<br />
Protan 0,15 2 3 0 42911182 356 1 1 1 2 1 0,018 1 1 3<br />
Agrana Romania 0,15 2 3 1 441474213 679 1 1 1 2 1 0,001 1 2 4<br />
(Source: accomplished by the author)<br />
~ 1041 ~
ENVIRONMENTAL SUSTAINABILITY AND SOCIAL<br />
RESPONSIBILITY: A THEORETICAL PROPOSAL<br />
FOR AN ACCOUNTING EVALUATION<br />
Massimo POLLIFRONI 1<br />
University of Turin, Italy<br />
ABSTRACT<br />
The aim and topic of the paper is to formulate a theoretical accounting model for the<br />
measurement and the inclusion of a new intangible asset in the financial statements related to<br />
environmental sustainability and social responsibility. To achieve this goal the central part of<br />
the paper presents an accounting approach that follows an Italian research project entitled<br />
POLIED(RO) (POL Pollenzo, I index, E environmental and economics Design). The<br />
accounting model proposed in the study tries to accommodate the main suggestions of the<br />
International Accounting Standards and the final result tries to propose an accounting model<br />
oriented towards the overcoming of the current neutrality between the results of the<br />
traditional accounting models and those derivable from social and environmental reports<br />
realised by companies, in which is possible to assume an ideal bidirectional connection<br />
between the different accounting approaches.<br />
KEYWORDS: Accounting Methodology, Environmental Sustainability, Financial<br />
Accounting, Green Accounting, International Accounting Standards, Corporate Social<br />
Responsibility.<br />
INTRODUCTION<br />
The scientific objective of the project is to create an index based on a range of<br />
different criteria, combining the various aspects of sustainability with current market<br />
demands. The index, entitled POLIED(RO) (transl. POLYHEDRON)[POL Pollenzo<br />
(note: Pollenzo is the town which houses the headquarters of the unit research leader,<br />
the University of Gastronomic Sciences; for more information see at www.unisg.it;<br />
the project period was started in December 2009 and will end in December 2011), I index, E<br />
environmental and economics Design] is based on a variety of different aspects, all of<br />
which possess the same scientific weight in the index, and all of which have at least<br />
one thing in common with the others (Piedmont Region, 2009). The general aim of<br />
the index is based on three observations:<br />
1. the fact that existing standards can be difficult to interpret, and the presence of<br />
an increasing range of certification without adequate consumer knowledge,<br />
has generated confusion for consumers;<br />
2. the demand for a “return to the past”, namely consumers’ desire to rediscover<br />
historic products connected to the traditional cuisine of a given area,<br />
representing an innate tourist attraction for the area, but also a cause for<br />
1<br />
Correspondence address: Massimo POLLIFRONI, University of Turin;<br />
email: pollifroni@econ.unito.it
greater attachment to the area among those who live there and exhibit an<br />
increasing desire to rediscover time-honoured traditions and products;<br />
3. safeguarding the environment and landscape. With reference to the most<br />
widely used voluntary certification systems, and product standards in<br />
particular, often these are only relatively successful, due to bureaucratic<br />
problems and a poor market response.<br />
In order to tackle these demands, which can become pressing in view of the fact that<br />
in some cases they prevent the certification mechanism from being effective, and in<br />
order to forge a closer bond with the local area by means of feedback, we underline<br />
various aspects (Piedmont Region, 2009):<br />
• the culinary and historic traditions of the product’s area of origin. As the work<br />
programme shows, using the Piedmont region as an example, this unit will be<br />
responsible for supplying “basic tools for studying Regional gastronomyeconomic<br />
aspects and sociological aspects: these aspects will be analysed by<br />
means of two sets of indicators, that will form one side of our ‘polyhedron’.<br />
The first set is based on the relationship between production/distribution and<br />
the local community (acceptance, sharing, participation, collective decisionmaking),<br />
while the second refers to the final consumer’s expectations and<br />
frames of reference;<br />
• the environmental sustainability of the product in according to the LCA (life<br />
cycle analysis) approach, throughout the entire production chain, and by<br />
means of the flexible environmental management system specially designed to<br />
take into account the various areas that the index intends to include;<br />
• the environmental sustainability connected to design and packaging, which<br />
strongly influences the image and eco-efficiency of the entire production<br />
chain, even more so in the case of food products;<br />
• the aspects regarding the interaction between business activities and the local<br />
area, analysing the environmental/landscape-related sustainability of strategies<br />
adopted by the farming and food processing industries.<br />
The methodology applied is the system of environmental/landscape management that<br />
was created in the context of a three year project funded by the Environment<br />
Department of the Piedmont Regional Council. This system combines the classic<br />
priorities of an environmental management system with the landscape issues<br />
championed by the European Landscape Convention. This methodology will enable<br />
us to start out from the local area and its products, identify the tasks of each partner in<br />
the project, and construct an index capable of leading the surrounding area towards a<br />
wide-ranging concept of sustainability first introduced in 1987 by the World<br />
Commission on Environment and Development (WCED) as “(…) the economic and<br />
social development that doesn’t compromise the environment and the natural<br />
resources the continuation of human species and the future development depend on<br />
(…)” (WCED, 1987). The potential impact of the project consists in fostering<br />
increasing attention to product and local area sustainability among the institutions and<br />
the population (Piedmont Region, 2009). The aforementioned bureaucratic problems<br />
that standards encounter have often prevented them from being adopted by producers,<br />
and even when a certification process is initiated and completed, the widespread lack<br />
of knowledge, and sometimes also the costs involved, have prevented the general<br />
spread of these standards. The idea is to connect these virtuous, often isolated<br />
examples to the local area, by means of a mechanism based on a system to manage the<br />
~ 1043 ~
organization of research and resources (which are complementary yet diversified) to<br />
arrive at the creation of the index in question (Piedmont Region, 2009).<br />
This will then be returned to the local area, with the application of at least some of the<br />
aspects of the environmental/landscape management system. The joint use of these<br />
tools, the high degree of flexibility planned for the index, and the multidisciplinary<br />
nature of the project from its outset should represent a sort of guarantee of results, in<br />
view of the fact that in the organizational process and at the various stages of the<br />
project, nothing is left to chance. Moreover, the planned trial of the index in the<br />
Piedmont region could come to represent an exemplary point of departure, and a<br />
model for other regional areas, in Italy and elsewhere, interested in the index. The<br />
accounting approach followed in the research is explained in the following paragraph.<br />
1. THE ACCOUNTING APPROACH FOLLOWED IN THE POLIED(RO)<br />
RESEARCH PROJECT<br />
During the last years, the topics of innovation and measurement of the results is<br />
assuming a progressively higher relevance with perspectives of sustainable promotion<br />
of the local and regional development and the updated approach oriented toward a<br />
sustainable system has produced many world-wide experimentations, starting working<br />
on a deep reflection on how to incorporate macroeconomics by environmental and<br />
social parameters (Stiglitz et al., 2009; European Commission, 2009). The increasing<br />
debate over the process of globalization (and of glocalization) (McLuhan, 1989;<br />
Nederveen, 2004; Robertson et al., 2003) and, at the same time some others drivers,<br />
like as the awareness of the important role that the innovation can assume in the<br />
economic and social development of Italy and the new demands shown by<br />
stakeholders (Freeman, 1984; Jones, 1995), have stressed the need, for what pertains<br />
the activities related to the food and agricultural compartment, to develop and to use<br />
evaluating tools more precise and shared. In this way, the experience of other<br />
Countries and the related literature on the aforesaid issues underline that the<br />
substantial activation of both evaluating and innovative tools generally bring<br />
interesting benefits. Nevertheless it is to underline that such processes, when not<br />
properly developed, addressed and understood, can bred distortions on the same<br />
assessment activities. Moreover these evaluating activities can shape interesting<br />
opportunity to stimulate both the link with the paradigms coming from other<br />
disciplines and the process of internationalization of the business studies related with<br />
the issue of food and agricultural compartment. In the light of the general objectives<br />
of the project, the contribution priority focuses on the economic evaluation<br />
sustainability – in general sense – applied on food and agricultural compartment<br />
through the work out of a “cause-effect” analysis model of the processes of<br />
production, distribution, sale and consumption of the food and agriculture<br />
commodities, directed on two profiles of analysis (Piedmont Region, 2009):<br />
1. the sustainability of the process, in different configurations that characterize it:<br />
social, environmental, etc.;<br />
2. the responsibility for the action of players (accountability) and the results<br />
policy asseveration related (assurance engagement policy).<br />
Under the first profile of research, in an wider and above all in a much more<br />
“sustainable” vision of the food and agricultural compartment, the main purpose of<br />
the present contribution is, therefore, to identify, systematize and implement into the<br />
~ 1044 ~
process of the compartment the informative tools pertaining the model of the<br />
Corporate Social Responsibility (CSR) (Carroll, 1979; Sethi, 1975). Under the second<br />
aspect of research the main purpose of the model is to define a matrix of common<br />
valuing elements, related to the accountability and assurance engagement policies,<br />
that can be taken as reference in the sector of the integrated food and agricultural<br />
compartment.<br />
Therefore the present model wants to represent one aspect (the one purely business<br />
economics oriented), of the wider scientific objective of the whole project, that is to<br />
create a multi-criteria index that gathers in its own lay-out the aspects of the<br />
sustainability applied to the processes of production, distribution, sale and<br />
consumption of the food and agricultural commodities (Piedmont Region, 2009).<br />
The POLIED(RO) index results in fact constituted by manifold field of study, all<br />
pertaining to the index with the same scientific weight, all interconnected and having<br />
at least one side in common. The aim of the present theoretical study is related to a<br />
theory concerning accounting model that can farther reinforce the connection between<br />
the different accounting models defined by a mutual exchange process of information<br />
flow in which:<br />
• the environmental and social reports can, on one hand, acquire the economic<br />
information they need to edit their own documents from the traditional reports;<br />
• on the other hand they can be in a position to reallocate the environmental and<br />
social performance previously got in the traditional final statement,<br />
influencing – in a direct way – the accounting results.<br />
In this case the financial statement should become an independent governance<br />
instrument used by the company (public or private) to be accountable to its<br />
stakeholders of the results of its environmental and social policies realized in a<br />
sustainable development perspective: at the present moment several companies use<br />
dedicated documents regarding the environmental and social communications, such as<br />
e.g., social reports, environmental reports and sustainability reports.<br />
The International Accounting Standards – mentioned above – present an accounting<br />
model where the financial, economic and patrimonial information enclosed with the<br />
traditional final statement isn’t directly influenced by the one enclosed with the<br />
environmental and social reports: the main link is that the environmental and social<br />
reports use the data produced by the traditional reports. In the environmental report<br />
models applied to the private companies (Mathews, 1997; Lehman, 1999) or to the<br />
public institutions (CLEAR, 2003; ISPRA, 2009), two different cluster of accounts<br />
are expected to be used (Giovanelli et al., 2000):<br />
• the first cluster is called Physical Accounts: e.g. the set of 10 European<br />
Common Indicators (ECI) (European Commission, 2001) is the most common<br />
cluster used at European level and it has the focus of having indicators capable<br />
of measuring not a specific phenomenon, but the overall sustainability at a<br />
local level;<br />
• the second cluster is called Monetary Accounts: it concerns the money that a<br />
company has to invest in the environmental protection.<br />
Only the Monetary Accounts have an accounting derivation because the company<br />
fixes them toward a reprocessing of balance (budget plan and/or final balance): this<br />
reprocessing is the only one-way link between the two types of reports; equally it is<br />
~ 1045 ~
not possible to have a parallel (and opposite) process where the final statement results<br />
could be – directly – conditioned by the performance got from the environmental<br />
report in a positive way (eco-efficiency) or negative trend (eco-inefficiency).<br />
Similar consideration can be made with reference to the traditional social report<br />
models related to the public company (G.B.S., 2005) or to the private sector (G.B.S.,<br />
2001): during the last years the Italian Accounting Standards have used the Added<br />
Value as a referential quantitative indicator.<br />
For the Italian Accounting Model the Added Value is considered very important in the<br />
social report field (Gabrovec Mei, 2002): the Added Value measures the wealth<br />
produced by the company with reference its shareholders that participate to the<br />
distribution of the wealth itself. Added Value is represented in two different tables<br />
(G.B.S., 2001): the table for the calculation of Added Value, identified by comparing<br />
interim revenues and costs (see Figure 1.); the table for the allocation of Added Value<br />
being the summation of the remuneration received by stakeholders within the<br />
company and the donations (see Figure 2.).<br />
Figure 1. Schema for the calculation of Added Value<br />
(Source: G.B.S., 2001: 21)<br />
~ 1046 ~
Figure 2. Table of the allocation of Added Value<br />
(Source: G.B.S., 2001: 24)<br />
In the document of the G.B.S., mentioned above, the table for the calculation of<br />
Added Value the articulated opposition between the positive and the negative<br />
elements involved in the working capital that come directly from the economic –<br />
financial accounting system of the company. In both examined cases – the assessment<br />
of the Monetary Accounts in the environmental report and the Added Value<br />
determination in the social report – a common accounting derivation of the values is<br />
recorded: both of them are determined by a data reprocessing of the final statement of<br />
the company, but they can not able to reallocate the environmental and social<br />
performance previously found in the final statement of the company.
The central part of the study has the aim of suggesting a theoretical accounting model<br />
able to go beyond the informative limit (definable now as one-way informative flows)<br />
and where it can be possible to create a bi-directional link between the report models<br />
(an environmental and social one on one hand and a traditional one on the other<br />
hand): this model should have a reciprocal exchange of the informative flow where<br />
the environmental and social reports can acquire the economic information they need<br />
from the traditional report, and – then – they can reallocate the environmental and<br />
social performance they got in the final balance, directly influencing the accounting<br />
results. The most virtuous companies from the point of view of environmental<br />
sustainability and social responsibility should deserve an award: a new intangible<br />
asset, a new “social-green goodwill” (André et al., 2009; Johnson, E.R., 2010) having<br />
in return a net equity increase of the company (Kriström et al., 2003).<br />
The present accounting model, that introduces a new intangible asset in the balance<br />
sheet as a reward to the most virtuous companies from the point of view of<br />
environmental sustainability and social responsibility (Laufer, 2003), presents the<br />
following issues:<br />
1) determining the composition of the board responsible for evaluating;<br />
2) defining the evaluation process phases;<br />
3) evaluating of environmental and social performances.<br />
The aspects mentioned above are outlined below.<br />
1) Determining the composition of the board responsible for evaluating.<br />
About the first point, determining the composition of the board responsible for<br />
evaluating, the board may be: a) an internal board; or b) an external board<br />
(recommended choice). In the case of an internal board the components are<br />
represented by internal employees (or consultants) of the company subject, while in<br />
the second case (external board), the model would require:<br />
• to chose an external and independent board in order to avoid the self –<br />
reference risk of the process realised by the company;<br />
• to find the auditors in the professional categories having more ability both in<br />
the field related to the accounting profession [accountants have to have the<br />
Certification (or Asseveration) of the accounts], or in the field related to the<br />
environmental audits, that is “(…) activities intended to quantify<br />
environmental performance and environmental position (…)” (CLEAR,<br />
2003) [auditors have to check the Environmental Management System (EMS)<br />
of a company (public or private) to see if it has the mandatory requirements<br />
asked according to the international standards EMAS or ISO 14001].<br />
The auditor’s opinion should be independent, according to two aspect of the problem.<br />
The first aspect concerns the choice of the target in charge of the evaluation, that<br />
shouldn’t be the responsibility of the company, but – in order to limit the discretion –<br />
should be the responsibility of the central administration (such as the Ministry of<br />
Economy or the Ministry of Environment) or of a local administration (such as, e.g.,<br />
the Court that has territorial jurisdiction, or the local office of the Court of Auditors,<br />
etc.). The second aspect regards the ways of payments of the auditors: instead of a<br />
direct payment between the company and the auditor, it should be used an indirect<br />
way between the central (or local) administration and the auditor (in this case the<br />
environmental fiscal system adopted by the single nation should provide for a correct<br />
~ 1048 ~
eallocation of the resources needed to assure the correct payments of the auditor’s<br />
activities). In both cases mentioned above (evaluation by an internal board or an<br />
external board), the model would require a national or regional coordination achieved<br />
by a public institution (a central or local administration).<br />
2) Defining the evaluation process phases.<br />
This point concerns the freedom of joining the evaluation process in the early on: the<br />
freedom of choice should be limited to the years after the first evaluation accession in<br />
order not to enforce the “budget policies” of the environmental and social<br />
performances (see Figure 3.).<br />
Figure 3. Theoretical framework of the evaluation process phases<br />
~ 1049 ~
The adhesion to the evaluation process should be guaranteed by pre-emptively<br />
definite cycles (for example three-year cycles or five-year cycles) and the choice of<br />
exiting the evaluation process after a cycle should be at least as long as the length of<br />
the attended cycle in order to avoid a periodicity adhesion which is convenient to the<br />
evaluation process: once the minimum exclusion period is over, the company should<br />
be able to join the next evaluation processes of its environmental and social<br />
performance, following the same rules above described.<br />
3) Evaluating of environmental and social performances.<br />
The final point – Evaluating of environmental and social performances – can produce,<br />
respectively, two kinds of outcomes: a qualitative result or a quantitative result.<br />
A qualitative result – as a qualitative assessment of the company – may be achieved<br />
by administering a questionnaire: it is the case realised by an internal board above<br />
mentioned (this part of the research is in working progress and is not available at the<br />
present moment).<br />
The second case concerns the analysis of the companies from the point of view of<br />
environmental sustainability and social responsibility that should deserve an award, a<br />
new intangible value, above mentioned as “social-green goodwill”. This quantitative<br />
value can be analysed alternatively as:<br />
• a non-accounting value (to say not included in the annual balance sheet);<br />
• or an accounting value, a new accounting asset included in the annual balance<br />
sheet.<br />
The methodological path to evaluate this new value (like a non-accounting value not<br />
included in the annual balance sheet, or like an accounting value included in the<br />
annual balance sheet) is shown in the following two paragraphs.<br />
2. THE METHODOLOGICAL PATH FOR EVALUATING THE SOCIAL<br />
PERFORMANCE<br />
Looking for a precise methodological path for evaluating the social performance, the<br />
model has selected the Value added distribution plan mentioned before, created by the<br />
G.B.S., an Italian scientific no profit organisation “(…) having the aim of developing<br />
and promoting the scientific research on social balance and the topics related to the<br />
stewardship of the companies in order to advance the social responsibility of the<br />
company and its use in national and international spheres (...)”.<br />
The plan suggested by the G.B.S. divides the value added remuneration in:<br />
a) human resources remuneration;<br />
b) civil service remuneration;<br />
c) payment of loan capital;<br />
d) non distributable value assigned to the preservation and the increase of the<br />
asset.<br />
What needs to be rewarded “more” could be found as a real social dynamic<br />
charactering the company that has to be evaluated only in point a) called human<br />
resources remuneration. This happens because:<br />
• point b), civil service remuneration,<br />
• point c), Payment of loan capital, expresses the outcome of certain fulfilments<br />
to contract regulations that connect the company to its financiers;<br />
~ 1050 ~
• point d), Non distributable value assigned to the preservation and the increase<br />
of the asset, ultimately, relates to the observance of particular statutory or law<br />
obligations.<br />
So the only winning factor (in case of socially virtuous behaviours) could be<br />
represented by destining the value added to the employees that – according to the<br />
model proposed by G.B.S. – are subdivided into: Members of the Administrative<br />
Institutions (politically or administrative eligible); subordinate employees (with short<br />
term or long term contracts) and non-subordinate employees and co-workers, whereas<br />
the relative salaries are included in two classes:<br />
• Direct salaries: they include all those financial and natural components that<br />
contribute to quantify the immediate or delayed economic benefit, that the<br />
employee excerpts from the relation with the company. Examples of direct<br />
salaries of the employees are: direct payment (including natural payments and<br />
excluding refunds); severance pay or other types of funds; company provisions<br />
(food, crèche, scholarship, etc.);<br />
• Indirect salaries: they include social contributions at expense of the company<br />
(costs defrayed for the employees are not part of the salary of the interlocutor,<br />
because they convert in benefits obtained in a indirect way for the company<br />
that manage the social service) (G.B.S., 2005).<br />
That being stated, in continuing the discussion, the components we need to isolate in<br />
order to quantify social policies (Carroll 1991; Levitt, 1958) that are actually virtuous,<br />
and therefore winning from the social point of view, should be referable to direct and<br />
indirect salaries of the subordinate employees with a long term contract: in the other<br />
circumstances, particularly in short term jobs, flexible jobs, etc., the nature of contract<br />
relations includes a priori that medium-long term planning so much wished – most of<br />
all for new generations – in the contemporary debate about the optimization of<br />
welfare models (Carter, 2006). This argument finds solace in the definition made by<br />
the European Commission of social responsibility, as: “(…) the voluntary decision of<br />
contributing to the progress of society and to the protection of the environment,<br />
combining social and ecological concerns in company dealing and in interactions<br />
with stakeholders (…)” (European Commission, 2000): the increasing appeal to<br />
flexible job instruments, also in Public Administration and in our specific area of<br />
interest, the university, unfortunately doesn’t embody that spirit of cohesion and<br />
social welfare mentioned several times in the Community document cited before. The<br />
reflections done before have the purpose of bringing the attention to a delicate and<br />
complex theme, the flexibility in job market, that in our model depicts itself more and<br />
more like a physiological board towards a system structurally oriented on<br />
precariousness. A thorough reflection about the phenomenon – and about related<br />
corrective actions – is therefore appropriate, but is beyond the aim and the contents of<br />
this contribution: parallel reflections concern the coupling of these reflections to a<br />
model of management control oriented on the fundamental principles of efficiency,<br />
efficacy and company inexpensiveness: so the values of the social actions are to be<br />
isolated from those made voluntarily, in adherence to the definition of social<br />
responsibility realised by the European Commission and above mentioned (E.C.,<br />
2000; McWilliams et al., 2001).<br />
After having indentified the voluntary social expenditures from those required by law<br />
(note: in the model are relevant only the voluntary expenses), it is necessary to share<br />
~ 1051 ~
the voluntary social expenses between current management and asset management:<br />
this process is explained in the following points.<br />
1) Assessment of Intangible Value Created by the Relevant Social Performance<br />
for Current Management (IVCRSPcm(t;s)).<br />
Taking up our approach, the formula related to the quantification in the year (t) of the<br />
reward acknowledged for a social relevant behaviour, defined as Intangible Value<br />
Created by the Relevant Social Performance for Current Management (IVCRSPcm(t;s))<br />
– placed under the assets of Immaterial Immobilizations with counterpart a net equity<br />
revaluation (in the case of an accounting asset included in the annual balance sheet) –<br />
could be written as:<br />
n n<br />
IVCRSPcm(t;s) = ∑ (SCi(s) * r(t – s)) – ∑ (SBi(s) * r(t – s)) (1)<br />
i=1 i=1<br />
where:<br />
• IVCRSPcm(t;s) = Intangible Value Created by the Relevant Social Performance<br />
for Current Management (IVCRSPcm(t;s)), quantified in the year (t) (year when<br />
the evaluation of social performances is realized) and related to the accounting<br />
year (s) (year when the Social Costs are paid and the Social Benefits are<br />
obtained);<br />
• ∑ SCi(s) = Sum of Social Costs (i) concerning the year (s);<br />
• ∑ SBi(s) = Sum of Social Benefits (i) concerning the year (s);<br />
• r(t-s) = monetary revaluation rate (r) concerning the period between the<br />
accounting year (s) (year when the Social Costs are paid and the Social<br />
Benefits are obtained) and the year (t) (year when the evaluation of social<br />
performances is realized).<br />
The monetary revaluation rate (r) used in the model, should be defined directly by the<br />
related set of rules, or indirectly referring to specific Prices Indexes for monetary<br />
revaluation produced by official national institutions (e.g. in Italy the Italian National<br />
Institute of Statistics – Istat) or by official international’ones (e.g. in Europe Eurostat).<br />
2) Assessment of Intangible Value Created by the Relevant Social Performance<br />
for Asset Management (IVCRSPam(t;s)).<br />
The same reflection concerns the social investments (Burke et al., 1996) to isolate in<br />
order to quantify social policies actually virtuous, always referable to subordinate<br />
employees (like, for example, the capitalization of the costs of education and research,<br />
the construction of kindergartens and company refectories, etc.): also in this case,<br />
these accounts should be purified from possible subsidies collected in capital accounts<br />
for this purpose. In this last case the formula of the quantification in the year (t) of the<br />
reward acknowledged for a social relevant company behaviour, definable as<br />
Intangible Value Created by the Relevant Social Performance for Asset Management<br />
(IVCRSPam(t;s)) could be written as:<br />
n n<br />
IVCRSPam(t;s) = ∑ (SAi(s) * r(t – s)) – ∑ (SCBi(s) * r(t – s)) (2)<br />
i=1 i=1<br />
~ 1052 ~
where:<br />
• IVCRSPam(t;s) = Intangible Value Created by the Relevant Social Performance<br />
for Asset Management (IVCRSPam(t;s)), quantified in the year (t) (year when<br />
the evaluation of social performances is realized) and related to the accounting<br />
year (s) (year when the Social Assets are paid and the Social Capital Benefits<br />
are obtained);<br />
• ∑ SAi(s) = Sum of Social Assets (i) concerning the year (s);<br />
• ∑ SCBi(s) = Sum of Social Capital Benefits (i) concerning the year (s);<br />
• r(t-s) = monetary revaluation rate (r) concerning the period between the<br />
accounting year (s) (year when the Social Assets are paid and the Social<br />
Capital Benefits are obtained) and the year (t) (year when the evaluation of<br />
social performances is realized).<br />
In conclusion, the quantification of the Total Intangible Value Created by the<br />
Relevant Social Performance (IVCRSPT(t;s)) in the year (t), is determined by the<br />
following formula:<br />
IVCRSPT(t;s) = IVCRSPcm(t;s) + IVCRSPam(t;s) (3)<br />
where:<br />
• IVCRSPT(t;s) = Total Intangible Value Created by the Relevant Social<br />
Performance (IVCRSPT(t;s)), quantified in the year (t) (year when the<br />
evaluation of social performances is realized) and related to the accounting<br />
year (s);<br />
• IVCRSPcm(t;s) = Intangible Value Created by the Relevant Social Performance<br />
for Current Management (VCRSPcm(t;s)), quantified in the year (t) and related<br />
to the accounting year (s) (year when the Social Costs are paid and the Social<br />
Benefits are obtained);<br />
• IVCRSPam(t;s) = Intangible Value Created by the Relevant Social Performance<br />
for Asset Management (VCRSPam(t;s)), quantified in the year (t) and related to<br />
the accounting year (s) (year when the Social Assets are paid and the Social<br />
Capital Benefits are obtained).<br />
3. THE METHODOLOGICAL PATH FOR EVALUATING<br />
THE ENVIRONMENTAL PERFORMANCE<br />
Even in this case the values of the environmental actions are to be isolated from those<br />
made voluntarily, in adherence to the above definition of social responsibility realised<br />
by the European Commission (E.C., 2000): for individualizing the areas of analysis it<br />
is possible to follow national standards [e.g. an Italian standard is the framework<br />
realised by ISPRA (ISPRA, 2009)] or international standards [e.g. an international<br />
standard is the COFOG (Classification of the Functions of Government) classification<br />
realised by United Nations (Eurostat, 2007)].<br />
With reference to the last classification, COFOG classification, it includes for<br />
environmental analysis these functions: 01 - General public services, 02 – Defence,<br />
03 - Public order and safety, 04 - Economic affairs, 05 - Environmental protection,<br />
06 - Housing and community amenities, 07 - Health, 08 - Recreation, culture and<br />
religion, 09 - Education, 10 - Social protection; then for the function n. 05 -<br />
Environmental protection - there are included the following sub-sectors of financial<br />
~ 1053 ~
analysis: 05.1 - Waste management, 05.2 - Waste water management, 05.3 - Pollution<br />
abatement, 05.4 - Protection of biodiversity and landscape, 05.5 - R&D<br />
Environmental protection, 05.6 - Environmental protection n.e.c. (residual division).<br />
Our research suggests to use COFOG classification, because the fixed structure<br />
proposed by United Nations is more preferable to the IAS’one and defines clearly (not<br />
discretionary) the areas of environmental analysis making it easier to compare several<br />
results across different cases studies: this represents a competitive advantage for<br />
applied environmental research (Rouse et al., 1999).<br />
Also in this case the next steps are:<br />
• identifying the voluntary environmental expenditures from those required by<br />
law (note: in the model are relevant only the voluntary expenses);<br />
• sharing the voluntary environmental expenses between current management<br />
and asset management: this process is explained in the following points.<br />
1) Assessment of Intangible Value Created by the Relevant Environmental<br />
Performance for Current Management (IVCREPcm(t;s)).<br />
After we having individualized the environmental values on which we can apply the<br />
model, the formula of quantification in the year (t) of the reward to acknowledge, in<br />
these case, for an environmental relevant behaviour, defined as Intangible Value<br />
Created by the Relevant Environmental Performance for Current Management<br />
(IVCREPcm(t;s)) – placed under the assets of Immaterial Immobilizations with<br />
counterpart a net equity revaluation (in the case of an accounting asset included in the<br />
annual balance sheet) – could be written as:<br />
n n<br />
IVCREPcm(t;s) = ∑ (ECi(s) * r(t – s)) – ∑ (EBi(s) * r(t – s)) (4)<br />
i=1 i=1<br />
where:<br />
• IVCREPcm(t;s) = Intangible Value Created by the Relevant Environmental<br />
Performance for Current Management (IVCREPcm(t;s)), quantified in the year<br />
(t) (year when the evaluation of environmental performances is realized) and<br />
related to the accounting year (s) (year when the Environmental Costs are paid<br />
and the Environmental Benefits are obtained);<br />
• ∑ ECi(s) = Sum of Environmental Costs (i) concerning the year (s);<br />
• ∑ EBi(s) = Sum of Environmental Benefits (i) concerning the year (s);<br />
• r(t-s) = monetary revaluation rate (r) concerning the period between the<br />
accounting year (s) (year when the Environmental Costs are paid and the<br />
Environmental Benefits are obtained) and the year (t) (year when the<br />
evaluation of environmental performances is realized).<br />
Also in this case the monetary revaluation rate (r) used in the model, should be<br />
defined directly by the related set of rules, or indirectly referring to specific Prices<br />
Indexes for monetary revaluation produced by official national or international<br />
institutions.<br />
2) Assessment of Intangible Value Created by the Relevant Environmental<br />
Performance for Asset Management (IVCREPam(t;s)).<br />
~ 1054 ~
The same reflection concerns the environmental investments (Nehrt, 1996) to isolate<br />
in order to quantify environmental policies actually virtuous: these accounts should be<br />
purified from possible subsidies collected in capital accounts for this purpose.<br />
In this last case the formula of the quantification in the year (t) of the reward<br />
acknowledged for a environmental relevant company behaviour, definable as<br />
Intangible Value Created by the Relevant Environmental Performance for Asset<br />
Management (IVCREPam(t;s)) could be written as:<br />
n n<br />
IVCREPam(t;s) = ∑ (EAi(s) * r(t – s)) – ∑ (ECBi(s) * r(t – s)) (5)<br />
i=1 i=1<br />
where:<br />
• IVCREPam(t;s) = Intangible Value Created by the Relevant Environmental<br />
Performance for Asset Management (IVCREPam(t;s)), quantified in the year (t)<br />
(year when the evaluation of environmental performances is realized) and<br />
related to the accounting year (s) (year when the Environmental Assets are<br />
paid and the Environmental Capital Benefits are obtained);<br />
• ∑ EAi(s) = Sum of Environmental Assets (i) concerning the year (s);<br />
• ∑ ECBi(s) = Sum of Environmental Capital Benefits (i) concerning the year (s);<br />
• r(t-s) = monetary revaluation rate (r) concerning the period between the<br />
accounting year (s) (year when the Environmental Assets are paid and the<br />
Environmental Capital Benefits are obtained) and the year (t) (year when the<br />
evaluation of environmental performances is realized).<br />
The quantification of the Total Intangible Value Created by the Relevant<br />
Environmental Performance (IVCREPT(t;s)) in the year (t), is determined by the<br />
following formula:<br />
IVCREPT(t;s) = IVCREPcm(t;s) + IVCREPam(t;s) (6)<br />
where:<br />
• IVCREPT(t;s) = Total Intangible Value Created by the Relevant Environmental<br />
Performance (IVCREPT(t;s)), quantified in the year (t), year when the<br />
evaluation of environmental performances is realized;<br />
• IVCREPcm(t;s) = Intangible Value Created by the Relevant Environmental<br />
Performance for Current Management (VCRSPcm(t;s)), quantified in the year<br />
(t);<br />
• IVCREPam(t;s) = Intangible Value Created by the Relevant Environmental<br />
Performance for Asset Management (VCRSPam(t;s)), quantified in the year (t).<br />
In conclusion the new immaterial asset can be defined as Global Intangible Value<br />
Created by the Relevant Social and Environmental Performance (IVCRSEPG(t;s)) and<br />
can be determined by the following formula:<br />
IVCRSEPG(t;s) = IVCRSPT(t;s) + IVCREPT(t;s) (7)<br />
~ 1055 ~
where:<br />
• IVCRSEPG(t;s) = Global Intangible Value Created by the Relevant Social and<br />
Environmental Performance (IVCRSEPG(t)): the value is determined in year (t)<br />
and refers to the activities supported in year (s);<br />
• IVCRSPT(t;s) = Total Intangible Value Created by the Relevant Social<br />
Performance (IVCRSPT(t;s)), quantified in the year (t);<br />
• IVCREPT(t;s) = Total Intangible Value Created by the Relevant Environmental<br />
Performance (IVCREPT(t;s)), quantified in the year (t).<br />
The last formula concerns the Global Intangible Value Created by the Relevant Social<br />
and Environmental Performance (IVCRSEPG(t;s)) determined in year (t) and refers to<br />
the activities supported in year (s). At this point it is possible to extend the formula for<br />
social and environmental activities supported in a defined year cycle (w) (e.g. a three<br />
years cycle or a five years cycle, etc.), with w = 1 … (s) … m. In this case the Global<br />
Intangible Value Created by the Relevant Social and Environmental Performance<br />
(IVCRSEPG(t;w)) – determined in year (t) and referred in a defined year cycle (w) –<br />
can be determined by the following equation:<br />
m m<br />
IVCRSEPG(t;w) = ∑IVCRSPT(t;s) + = ∑IVCREPT(t;s) (8)<br />
s=1 s=1<br />
where:<br />
• IVCRSEPG(t;w) = Global Intangible Value Created by the Relevant Social and<br />
Environmental Performance (IVCRSEPG(t;w)) determined in the year (t) and<br />
referred to the activities supported in a defined year cycle (w), with w = 1 …<br />
(s) … m;<br />
• ∑IVCRSPT(t;s) = Sum of Intangible Values Created by the Relevant Social<br />
Performance (IVCRSPT(t;s)), quantified in the year (t) and referred to the social<br />
activities supported in a defined year cycle (w);<br />
• ∑IVCREPT(t;s) = Sum of Intangible Values Created by the Relevant<br />
Environmental Performance (IVCREPT(t;s)), quantified in the year (t) and<br />
referred to the environmental activities supported in a defined year cycle (w).<br />
DISCUSSION AND CONCLUSIONS<br />
In the central part of the study we tried to prove theoretically the determination of the<br />
new intangible asset attributable to companies virtuous from the standpoint of<br />
environmental sustainability and social responsibility (Orlitzky et al., 2011): this new<br />
intangible asset can be considered as a new “social-green goodwill” having in return a<br />
net equity increase of the company that would work as a “revaluation reserve” (or<br />
“revaluation surplus reserve”) that is created when the value of an asset becomes<br />
greater than the value at which it was previously carried on the balance sheet,<br />
increasing shareholders funds.<br />
Adhering to the evaluation process, taking up what we said before, should be<br />
guaranteed for defined year cycles (for example three years cycles or five years<br />
cycles), and the possible choice of leaving at the end of the cycle should be confirmed<br />
for a period at least of the same duration of the one expected for the adhesion, in order<br />
to avoid an adhesion in alternation and for the convenience of the evaluation process.<br />
Consequently the counterpart created as a revaluation reserve (net equity value) has<br />
~ 1056 ~
the function to compensate possible future company losses and it should be used for<br />
this aim only just for the part that corresponds to the revaluation related to the current<br />
management. All this in order to avoid the creation of potential negative values of this<br />
net equity fund showed previously (that, for example, in the case of asset divestment):<br />
the potential connection between the new intangible asset [Global Intangible Value<br />
Created by the Relevant Social and Environmental Performance (IVCRSEPG(t;w))] and<br />
the related reserve is explained in Table 1.<br />
Moreover the Global Intangible Value Created by the Relevant Social and<br />
Environmental Performance (IVCRSEPG(t;w)) is not subject to problems of<br />
amortization because the conditions are lacking (like, for example, the use of the<br />
economic good, the useful duration defined of new tangibility, etc.), whereas in<br />
adherence to the following International Accounting Standards: a) for the Private<br />
Sector the main IAS/IFRS documents are:<br />
• IAS 36 Impairment of Assets (it deals with impairment testing for all tangible<br />
and intangible assets, except for assets that are covered by other IFRS) (IASB,<br />
2010);<br />
• IAS 38 Intangible Assets (IASB) (IASB, 2009) [for the Public Sector the<br />
similar standards are: IPSAS 21 Impairment of Non-Cash-Generating Assets<br />
(IPSASB, 2004); IPSAS 31 Intangible Assets (IPSASB, 2010)].<br />
The present contribution – in its essential parts – proposed a purely theoretical model<br />
oriented towards the overcoming of the current neutrality, previously defined, in the<br />
connection-conditioning (reciprocal or bidirectional) between the results of the<br />
traditional accounting and those derivable from social and environmental accounting<br />
of the company, in which is possible to assume an ideal bidirectional connection<br />
between the different accounting models (Griffin et al., 1997).<br />
Table 1. Connection between the new intangible asset and the related reserve<br />
New intangible asset<br />
Level 1 Level 2 Level 2<br />
(IVCRSEPG(t;w)) =<br />
Global Intangible Value<br />
Created by the Relevant<br />
Social and<br />
Environmental<br />
Performance<br />
∑IVCRSPT(t;s) =<br />
Sum of Intangible<br />
Values Created by<br />
the Relevant Social<br />
Performance<br />
IVCRSPcm(t;s) = Intangible Value<br />
Created by the Relevant Social<br />
Performance for Current Management<br />
~ 1057 ~<br />
+<br />
IVCRSPam(t;s) = Intangible Value<br />
Created by the Relevant Social<br />
Performance for Asset Management<br />
+ +<br />
IVCREPcm(t;s) = Intangible Value<br />
∑IVCREPT(t;s) =<br />
Sum of Intangible<br />
Values Created by<br />
the Relevant<br />
Environmental<br />
Performance<br />
Created by the Relevant<br />
Environmental Performance for<br />
Current Management<br />
+<br />
IVCREPam(t;s) = Intangible Value<br />
Created by the Relevant<br />
Environmental Performance for Asset<br />
Management<br />
Related Revaluation<br />
Reserve<br />
Potential use for<br />
future coverage of net<br />
equity losses<br />
Yes<br />
No<br />
Yes<br />
No
Therefore is evident that the aspects analyzed and the consequent solutions, need a<br />
natural consolidation obtainable through the realization of a comparative<br />
benchmarking between the actors of the system (scientific community, public<br />
companies, interested professional orders, guarantee institutions of the process, etc.),<br />
oriented towards the determination of a scientific method to evaluate a model that is<br />
commonly shared by all the subject interested in the process (De Moor et al., 2005).<br />
In conclusion it is meaningful to obtain that if the debate about how to individualize a<br />
model of accounting that combines more the traditional accounting evaluations with<br />
social and environmental ones, is quick, it is also – nowadays – a far off target: the<br />
final wish is that this contribution can, in some ways, stimulate the common interest<br />
towards the definition of an accounting system in which the traditional accounting<br />
analysis are more integrated with the complementary ones (social and environmental<br />
analysis) (Hooghiemstra, 2000; Laufer, 2003).<br />
Further arguments and widening, combined with an experimentation on the field, will<br />
be able, therefore, to allow a useful consolidation of this proposal and favour at the<br />
same time a formation process of a new vision of the concept of sustainable<br />
development referred to the accounting disciplines.<br />
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THE IMPACT OF THE SUSTAINABLE DEVELOPMENT<br />
ON THE FINANCIAL STATE OF THE COMPANY –<br />
SECTOR STUDY<br />
Petru STEFEA 1 & Cristina CIRCA<br />
West University of Timisoara, Romania<br />
ABSTRACT<br />
The present article approaches the relationship between the financial objectives and the<br />
environmental sustainability restrictions in three industrial sectors with major environmental<br />
impact: the water and wastewater sector, the production of heating and electricity from<br />
conventional sources and the production of electricity from wind energy. Starting from the<br />
specific features of each sector, we shall debate the impact of the current and long-termed<br />
financing needs on the companies’ performance and consistency of operations.<br />
KEYWORDS: sustainable development, financing needs, performance, energy supply,<br />
water supply<br />
INTRODUCTION<br />
The integration of the sustainability principles into the economical development has<br />
lately turned into a strongly promoted challenge. Nevertheless, its accomplishment<br />
requires a common effort of all the actors performing on the market: the producers of<br />
goods and services are often bound to redefine their technological process, according<br />
to the environmental restrictions, while the consumers of goods and services may<br />
accept or refuse price increases generated by the improvement of the companies’<br />
ecological performance.<br />
In the present article, we decided to illustrate this assumption, by analyzing the<br />
specific features of three sectors with a major environmental impact: the water and<br />
wastewater sector, the production of heating and electricity from conventional sources<br />
and the production of electricity from wind energy. Talking about sustainable<br />
economic development, all of them are currently in the public spot-light. The two<br />
traditional ones – the water supply and the energy supply from fossil fuels – are<br />
associated to environmental risks, mostly generated by still unsolved pollution<br />
problems, especially in countries where the environmental protection policies are in<br />
an inception stage. On the other hand, the use of renewable resources in the supply of<br />
electricity represents a business opportunity per se, born from the environmental<br />
concerns.<br />
1 Correspondence address: Petru Stefea, West University of Timisoara, Romania;<br />
email:petru.stefea@rectorat.uvt.ro<br />
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Besides their relevance in the context of sustainability, we chose the three sectors due<br />
to the size and diversity of their markets. Water and energy are basic products,<br />
procured by any individual. As common topics, we chose to debate the financing<br />
sources of the investment and operating process, as well as the influencing factors of<br />
the performance in each sector. As for the format of the paper, we shall start by<br />
shortly describing the specific features of the debated fields, as well as the common<br />
sustainability restrictions; finally, after drawing the general picture, we shall conclude<br />
the article by detailing their impact on the companies’ financial indicators. In our<br />
research, the theoretical premises were supported and confirmed in the financial<br />
statements analysis of several sample companies.<br />
1. THE WATER AND WASTEWATER SECTOR<br />
1.1 The state of affairs<br />
According to the World Commission on Water, the world population tripled in the last<br />
century, whereas the world water consumption increased six times. 70% of the total<br />
amount of water extracted in this period was used in the agriculture, 20% was used in<br />
the industry and 10% was consumed by households. For the next 30 years, the water<br />
consumption is estimated to increase with about 50%.<br />
Many of the present water allocations proved to be inefficient, as a consequence of the<br />
centralized control over the water companies, imposed by the current legislation, of<br />
the lack of cost control and of the incomplete evaluation of the benefits. This is the<br />
reason why, according to the current trends, the allocation of the water should be<br />
governed to a greater extent by market rules.<br />
As for Romania, only 52% of the total population is connected both to water and<br />
sewage services, while 71% of the wastewater is untreated or insufficiently treated.<br />
Until now, most of the water and wastewater companies have been operated often<br />
inefficiently by city companies, with little access to additional financial resources.<br />
1.2 Financing the investments<br />
Considering the fact that the water operators use to be state controlled companies,<br />
investments are frequently financed by means of subsidies granted by local, national<br />
or European public authorities, as well as by loans granted rather by financial<br />
institutions like the European Investment Bank, the European Bank for<br />
Reconstruction and Development, or the World Bank. Given the current concerns<br />
regarding the EU grants, we shall further on detail several of their potential additional<br />
problems.<br />
The amount of such a subsidy equals that part of the investment which cannot be<br />
covered by the company from the net revenues generated by the investment. The<br />
future net revenues are forecasted at their present value, in order to take into account<br />
the time value of the money, whereas the discount rate is set by the European<br />
Commission and adjusted, if necessary, by the beneficiary state. This mechanism may<br />
generate problems in times of economical insecurity, like the crisis we are<br />
experiencing nowadays, when the given discount rate – seen as an opportunity cost of<br />
the capital – may be not realistic. In this context, if the rate proves to be too high or<br />
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too small, the revenues and, as a consequence, the subsidy may be over- or<br />
underestimated.<br />
Further on, an extremely important, but seldom analyzed implicit cost, imposed to<br />
subsidized companies, is the obligation of the beneficiary company to reach certain<br />
performance standards, which means to continue the investment process and finance it<br />
from own resources.<br />
The performance indicators imposed to the company can be reached if the forecasts<br />
included in the cost benefit analysis were realistic. These are influenced both by the<br />
level of the discount rate and by the precision of the tariffs fixed for the services<br />
rendered. In this context, water operators must also consider two antagonistic<br />
principles, detailed in the next paragraph: the polluter pays principle and the<br />
affordability principle. A high level of the tariff, according to the polluter pays<br />
principle, will apparently increase the forecasted profitability of the company, i.e. its<br />
net revenues, whereas the direct consequence will be the decrease of the subsidy<br />
granted. In fact, it is possible that the predicted income, given by the amount invoiced,<br />
is reduced by a high level of accounts receivable which remain unsettled. In the eyes<br />
of the financer, the incapacity of the company to collect its receivables is considered a<br />
sign of bad financial management.<br />
In order to respect its future investment commitments, a good solution could be the<br />
acceptance of private companies in the water and wastewater sector, in order to grant<br />
the access to more financing sources.<br />
1.3 Financing the operations<br />
For the operations of companies in the water and wastewater sector, significant<br />
balance sheet and income statement positions are the following:<br />
� in the balance sheet, the most important current assets are the accounts<br />
receivable, as the activity of such companies doesn’t need important<br />
inventory; the most significant current obligations recorded regard the energy<br />
suppliers and the personnel;<br />
� in the income statement, the most important revenues are given by the services<br />
rendered, while the most significant expenses come from the energy<br />
consumption and the personnel costs – paid usually with constant (fixed)<br />
monthly wages.<br />
Based on these circumstances, we shall mainly discuss further on the premises and<br />
conditions governing the collection of the accounts receivable, depending on the<br />
number of customers (or the amount of billed services) and the level of the tariff.<br />
Considering the monopoly position and the certain and constant demand for water and<br />
sewage services, the number of customers is high and constant. The possible<br />
difficulties to overcome do not regard the number of the customers, but their structure<br />
on income levels.<br />
The water demand is mainly determined by two elements:<br />
� the number of households, the areas to be irrigated and the number of<br />
industrial entities to be supplied by one water company and<br />
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� the amount of water which is supplied or needs to be supplied in a certain<br />
period of time.<br />
With regard to the amount of supplied water, an important parameter to be considered<br />
is the elasticity of the water demand to the water price, calculated firstly for certain<br />
geographical areas and then in each area for several income stages, respectively for<br />
small and big consumers. Moreover, the demand must be estimated for a defined<br />
period of time, within which one has to consider the demographic forecasts, as well as<br />
the agricultural and industrial development on the considered territory.<br />
The most important factor in assuring the current financial resources is the collected<br />
tariff. Fixing the tariff for water supply and sewage is a delicate matter, as its level<br />
should fulfill at the same time several antagonistic conditions:<br />
� from the standpoint of the customers, the price of the supplied water should be<br />
sufficiently low, so that it doesn’t raise any affordability problems, as water is<br />
a primary good and the access to it should be granted to anyone;<br />
� from the standpoint of the environmental authorities, the price of the supplied<br />
water should be sufficiently high to cover the environmental costs of the water<br />
use, according to the polluter pays principle;<br />
� from the standpoint of the water company, the price of the supplied water<br />
should be sufficiently high to cover the supplier’s current obligations (given<br />
by operational costs, the share of the investment cost to be paid in the current<br />
year, as well as a share of the investments’ replacement cost at the end of their<br />
useful life) and to grant a certain profit, but in the same time sufficiently low<br />
to assure a satisfactory collection of the accounts receivable.<br />
In the context of the above described matters, the level of the tariff must be set<br />
considering three main restrictions:<br />
The polluter pays principle<br />
According to one of the basic premises of the sustainable economic development - the<br />
polluter pays principle – the level of the tariff should be sufficiently high to cover the<br />
cost of the already produced pollution, as well as the prevention cost of the future<br />
pollution. The water companies usually have a monopoly status, nevertheless the tariff<br />
increase as a consequence of the lack of competition will not necessarily lead to the<br />
turnover increase. Though the elasticity of the water demand to the price is small, it<br />
increases with the decrease of the consumers’ income. As a consequence, the<br />
principles of the sustainable development will be observed if the water consumption<br />
decreases, but the company will face the risk of reducing the profitability of its<br />
operations, as the most operational costs are fixed costs.<br />
The willingness to pay<br />
The willingness to pay is a second essential factor to be considered when fixing the<br />
water and sewage tariff, especially when the tariff is about to increase in order to<br />
cover the cost of recent investments in specific assets. The upgrade or the extension of<br />
the existing water infrastructure of a city doesn’t necessarily change the quality of the<br />
supplied water, as perceived by the consumer. Such investments usually lead to the<br />
decrease of the company’s operational costs, the decrease of the pollution or a certain<br />
improvement of the services rendered, like the elimination of the water supply<br />
breakdowns. In any of these situations, the consumer will not perceive an<br />
improvement of the water quality, able to justify a tariff increase; as a consequence,<br />
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the customers might refuse to pay or might delay the payment of the bills, thus<br />
affecting the collection of the company’s accounts receivable.<br />
Remark. An average collection period in the water and wastewater sector covers 70<br />
days.<br />
The affordability level<br />
In order to be affordable, the water and wastewater tariff should not exceed certain<br />
generally accepted levels. In order to make sure that the tariff remains affordable on<br />
the target market, the company shall take into account the capacity to pay of the<br />
households with the lowest incomes, i.e.:<br />
� it shall estimate the average household income for all tariff paying households;<br />
� it shall estimate the number and the income of all low income households,<br />
based on the lowest income decile;<br />
� the general affordability will be assured, if the total amount billed monthly to<br />
the lowest income households, for water and wastewater services, including<br />
direct taxes, does not exceed 4% of the household’s available income<br />
(generally accepted level, for an average consumption of 75 l per capita),<br />
respectively 1,2-2,5% for average income households (for an average<br />
consumption of 110 l per capita).<br />
In this context, there are voices saying that conditioning the tariff level by the<br />
affordability of the consumers breaks the rules of the market economy, as the tariff<br />
may no longer reflect the real value of the service rendered. As a consequence, the<br />
water operator should not be concerned with the affordability matter when fixing the<br />
tariff, while the water and sewage availability to the lowest income households should<br />
be approached by the social protection authorities.<br />
1.4 The performance<br />
In the water and wastewater sector, investments are made in long-term assets, with<br />
high procurement/construction and maintenance costs. Though the water industry is<br />
not affected by fashion or trends, it is influenced by following variables:<br />
� the expectations of the consumers with regard to the quality of the services<br />
rendered;<br />
� the technological progress, recorded both inside and outside the water sector<br />
(devices meant to reduce the water consumption, used both by industrial<br />
entities and by households);<br />
� the increase of the demand, based on the demographic increase, the<br />
improvement of the life quality and the industrial development;<br />
� the environmental protection restrictions: the water industry has a major<br />
environmental impact, both in the management of the water reserves and in the<br />
treatment and disposal of the wastewater.<br />
Considering the need to fulfill both the economic performance and the social<br />
performance criteria, the profitability of the water companies is usually moderate or<br />
small.<br />
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2. THE PRODUCTION OF HEATING AND ELECTRICITY<br />
FROM CONVENTIONAL SOURCES<br />
2.1 The state of affairs<br />
One of the major causes of the air pollution in the urban area is given by the steam<br />
power plants, responsible for most urban SO2 and NOx emissions, especially when the<br />
applied technology is old. The impact of the firing plants on the environment is<br />
significant: climate changes induced by the greenhouse gas emissions, wide<br />
dispersion of the polluting substances, as well as alterations of the air quality.<br />
As chemical sources of energy, steam plants usually burn energetic coal (pit and<br />
brown coal), pit gas, or oil fuel. Considering the outcome, steam power plants can be<br />
either electricity suppliers - with an additional production of heating for internal<br />
(own) use, or electricity and heating suppliers, operating as an urban heating plant.<br />
According to the National Strategy for Energy, the supply of heating and electricity in<br />
Romania is still highly dependent on the use of fossil fuels, among which the most<br />
important are the coal and oil fuel (46%), followed by natural gas (39%). Natural gas<br />
is a source of energy with a higher energetic performance and a lower pollution level.<br />
Nevertheless, due to its high procurement price, all recent economical forecasts in the<br />
European energy sector point out to coal as a base fuel for the next period.<br />
In Romania, the energy sector is characterized by:<br />
� low efficiency in the use of the energy sources;<br />
� ageing equipment and facilities, leading to important energy losses, ultimately<br />
paid for by the final consumers;<br />
� poor technical and economical performance;<br />
� high operating and maintenance costs.<br />
Under these circumstances, complying with the Kyoto Protocol requires the<br />
implementation of important investment projects in firing plant technology, aimed at<br />
the decrease and sweetening of the emissions. Other major goals are the partial use of<br />
renewable fuel in the firing process (biomass), as well as the cogeneration of heating<br />
and electricity, raising the efficiency in the consumption of basic resources.<br />
We find here the problems already pointed out in the water sector: the centralized<br />
(urban) heating systems have a three-sided social-economical impact, reaching the<br />
energy, the environmental and the public services sector. On the one hand, they need<br />
to satisfy the energy demand, without harming the environment and the health of the<br />
population; on the other hand, the tariff of the services rendered must remain<br />
affordable.<br />
2.2 Financing the investments<br />
Investments in the technology of urban firing plants are financed mostly from loans or<br />
subsidies, given the prevailing state ownership of such companies and subsequently<br />
their low profitability. Loans are usually granted by financial institutions supporting<br />
the development, like regional development banks, multilateral development<br />
institutions and development agencies.<br />
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Among other financing sources, we can mention international funds aiming the<br />
development of the energetic sector and the decrease of its impact upon the<br />
environment, like:<br />
� structural instruments, supporting the investment without explicit financial<br />
costs, though inducing the obligation that the investment is efficiently<br />
operated, in order to assure not the reimbursement of the funds, but the<br />
steadiness of the investment’s operation;<br />
� financing mechanisms promoted by the Kyoto Protocol: the Joint<br />
Implementation Mechanism – JTI, , the Clean Development Mechanism –<br />
CDM and the International Emission Trading – IET.<br />
Similar national sources are the following:<br />
� the Romanian Fund for Energetic Efficiency, administering funds grated by<br />
the Global Environmental Fund and the International Bank for Reconstruction<br />
and Development, allocated to the projects of energetic efficiency;<br />
� the Environmental Fund, administered by the Ministry of Environment and<br />
allocated to projects aiming the control and decrease of the air, water and soil<br />
pollution (including the implementation of clean technologies), the waste<br />
recycling and the treatment and disposal of hazardous waste;<br />
� funds of the Romanian Agency for Energy Conservation, allocated to<br />
investment projects in the production, transport and distribution of heat<br />
energy.<br />
The declared non reimbursable funds also carry implicit costs – with regard to the cofinancing,<br />
later investments or operations – detailed in the next paragraph.<br />
2.3 Financing the operations<br />
Just like in the water sector, the tariff collected for the rendered services is the point<br />
where the economical, the social and the environmental concerns come together, as it<br />
has to fulfill at the same time several conditions:<br />
� it has to cover the operating and maintenance costs of the equipment (existent<br />
and new);<br />
� it has to be affordable;<br />
� it has to be an incentive for the decrease of energy consumption.<br />
The synchronic fulfillment of the three conditions is currently assured by a subsidy<br />
system, assigned both to the producer and to the consumer. Out of social reasons, the<br />
tariff is fixed by public authorities as an exogenous variable, independent of the<br />
production cost, while the liquidity of the supplier is assured by subsidizing the<br />
difference between the tariff and the cost. At times, the production cost is seen as a<br />
net cost, computed as the difference between the production cost of the heating and<br />
electrical energy and the selling price of the electricity, where the produced electricity<br />
exceeds the own needs. The consumer subsidies are added up to the producer<br />
subsidies and address only households.<br />
The fixing of the tariff in connection with the average household income allows tariff<br />
increases with the increase of the standard of living. Nevertheless, the positive impact<br />
of the tariff increase upon the producer’s cashflow may be cancelled by another trend<br />
accompanying a better standard of living and promoted by the public authorities: the<br />
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improvement of the buildings’ energetic efficiency, which reduces the necessary<br />
heating to be supplied.<br />
Besides assuring the affordability, subsidies are meant to encourage a more efficient<br />
fuel consumption and reduce the impact on the environment, whereas one of the ways<br />
to reach these goals is the promotion of heat and electric energy in co-generation. The<br />
effects of the co-generation are well known in Romania, as the national energetic<br />
system includes several co-generation plants with high-duty steam turbines, covering<br />
ca. 40% of the annually produced energy. To keep this trend, the producer subsidy is<br />
thought to be replaced with a bonus for efficient co-generation, based on the sold<br />
electricity, for which the market and the price will be guaranteed by the public<br />
authorities. Other bonuses could be granted for the use of renewable fuel in the<br />
burning process.<br />
2.4 The performance<br />
The forecasts regarding the future demand of heating energy are based on following<br />
parameters:<br />
� the trends of the energy consumption in households, public institutions,<br />
industry etc;<br />
� the development of the market, with regard to the surface to be heated;<br />
� the heat losses from the networks.<br />
The last parameter is the only one that can be controlled by the producer, as the heat<br />
losses from the networks can be diminished by means of investments, meant to renew<br />
the infrastructure; the first two parameters are exogenous, i.e:<br />
The development of the market, with regard to the surface to be heated, depends on<br />
the general economic conditions, as they determine both the development of the<br />
building market and the connection/disconnection rate of the consumers. The<br />
voluntary disconnection of the consumers from the central heating system, out of<br />
affordability reasons, is a specific problem of the sector. In the water sector,<br />
disconnections from the public network are extremely rare, as consumers usually do<br />
not have an alternative source of water. In the heating sector, the affordability must be<br />
accompanied by the willingness to pay, defined as the part of the income that an<br />
individual is willing to allocate to a certain service rendered. The willingness to pay is<br />
reflected in the collection rate of the accounts receivable, as well as in the<br />
disconnection rate of the consumers from the public heating network. The latter is<br />
usually induced by two main reasons:<br />
� the wish to pay less for the heating – characterizing low income households;<br />
� the capacity to use individual heating sources, of a better quality –<br />
characterizing high income households.<br />
The consumption depends on the price of the heating (starting from the premise that<br />
the consumption is metered and the customer always pays for exactly what he has<br />
consumed), as well as on the efforts to save heat energy. This is the point where the<br />
elasticity of the demand to the price should be debated. A rising fuel price will lead to<br />
rising costs of the individual heating systems and these will become more expensive<br />
than the centralized (urban) heating system. It means that the elasticity of the heated<br />
surface to the price of the fuel is positive, leading to the extension of the market for<br />
the centralized heating systems, due to the increase of the heated surface. In the same<br />
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time, a rising fuel price will also increase the cost of the centralized heating,<br />
encouraging the individuals to cut back their consumption. In this case, the elasticity<br />
of the demand to the price is negative, leading to the decrease of the market due to the<br />
decrease of the consumption. As a consequence, the effects of a rising fuel price on<br />
the size of the market depend on which one of the above described effects is<br />
prevailing.<br />
With regard to the costs, the most important financial effort goes to the fuel<br />
procurement, as the main variable cost. For the plants working on natural gas, the fuel<br />
cost requires future efforts to decrease the consumption, given the high price of the<br />
imported gas. Moreover, the price of the inland procured gas is also on the rise, as the<br />
intention of the governing authorities is to level out the price differences between the<br />
inland and the imported fuel.<br />
As important fixed costs, worth mentioning are the personnel and the maintenance<br />
costs. Similar to any other enterprise, personnel costs are given by the number of<br />
employees and their competence. A specific feature of the heating sector is the fact<br />
that the number and the features of the personnel also depend on the type of fuel<br />
powering the plant, which prescribes the complexity of the equipment to be operated.<br />
As an example, gas plants need relatively few but highly qualified employees, while<br />
coal and oil plants are operated by more, though less qualified employees. Also worth<br />
mentioning is the fact that the operating costs can be significantly decreased if the<br />
plant equipment is operated at the working capacity it was designed for, whereas the<br />
working capacity can be affected by the occasional heat losses in the installation.<br />
3. THE PRODUCTION OF ELECTRICITY FROM WIND ENERGY<br />
3.1 The state of affairs<br />
The production of clean energy is not the object of one, but of several industry<br />
sectors: wind energy, solar energy, geothermal energy, wave energy, biomass energy<br />
etc, different with regard to the growth factors, technology, competition and<br />
profitability. None of these sectors is currently able to produce enough clean energy<br />
as to satisfy the global demand, at a convenient price. Nevertheless, their parallel<br />
existence and development balance the shortcomings of the conventional energy<br />
production with fossil fuels.<br />
The development of the renewable energy sectors is supported by extremely<br />
convincing reasons, given in fact by the faults and current trends of the global<br />
economy: the negative side effects of the fossil fuel consumption (the soil, air and<br />
water pollution, the pools built in the oil sector, the rising fuel prices), the increase of<br />
the global energy demand, the development of the clean energy production<br />
technology, the need to diversify the current energy sources, as a result of the<br />
overload of the existing networks, the rising electricity prices etc.<br />
The global production of wind turbines has important annual growth rates, as the wind<br />
energy is an important electricity source in several European countries, like Denmark,<br />
Spain, Portugal and Germany. As a matter of fact, most important wind energy<br />
companies are European.<br />
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The most significant advantage of this energy source is given by the fact that it allows<br />
the production of electricity with absolutely no greenhouse gas emissions, while the<br />
main resource used is inexhaustible, the operating and maintenance costs are low (as a<br />
no fuel is burnt), the turbines can be built both by land and by sea and the<br />
surroundings of the wind farm can also be used to other purposes. On the other hand,<br />
the main disadvantage consists in the fact that the production is discontinuous,<br />
depending on the wind intensity. Moreover, the operation of the wind farms is highly<br />
dependent on public subsidies, the installation costs of the turbines are high, the<br />
turbines can be installed only on certain regions, where they will also produce noise<br />
and alter the landscape.<br />
In this context, the wind power sector is operated by three types of companies:<br />
a. wind turbine producers, whose profitability has been continuously increasing<br />
during the last years, as a consequence of the increasing demand for wind energy.<br />
A recent trend among the turbine producers is the high number of mergers, in<br />
order partly to increase the market shares, partly to take control over the turbine<br />
subsystem suppliers;<br />
b. wind turbine subsystem suppliers – usually including companies producing<br />
turbine subsystems as a part of their current activity;<br />
c. wind turbine operators – consisting partly in electricity producers from different<br />
sources and partly in independent operators, selling their production to local<br />
distributors.<br />
The activity of the three is strongly interdependent, as they all contribute to the final<br />
production price of the wind electricity.<br />
3.2 Financing the investments<br />
Investments in the production technology of clean energy are financed both from<br />
public and from private funds. The public financing generally comes as:<br />
� loans granted by the World Bank, the United Nations Development Program,<br />
the United Nations Environment Program, the European Bank for<br />
Reconstruction and Development, the Inter-American Development Bank;<br />
� public underwriting of loans granted by commercial banks;<br />
� subsidies;<br />
� tax abatements.<br />
Private capital is brought into listed companies either as direct investments, or as<br />
investments in specific funds: mutual funds interested in environmentally sustainable<br />
companies, as well as listed energy investment funds.<br />
3.3 Financing the operations. The performance<br />
The financial sustainability and the performance of the operations are influenced by<br />
different factors, depending on the profile of the company: wind turbine producer or<br />
operator. The main difference between the two is given by the dependence on public<br />
subsidies, whereas the operators are directly and the produces indirectly dependent on<br />
the public support.<br />
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Subsidies are granted in order to promote the sustainable economical development, as<br />
the connection key between the ecological and the economical development. Unlike<br />
the support granted to public water and heat suppliers, the wind energy is subsidized<br />
not in the investment, but in the operating process, assuring the latter’s continuity.<br />
The clean energy is produced by means of new technology, whose research and<br />
development process is far from being completed; as a consequence, the cost-<br />
efficiency ratio is still not optimal. The cost of the competition, i. e. of the fossil fuel<br />
energy producers, is generally lower than the production cost of the clean energy.<br />
Therefore, public authorities try to balance the relationship between the ecological<br />
and the financial performance, by taking specific measures:<br />
� the taxing of the greenhouse gas emissions, which increases the production<br />
cost of the fossil fuel energy producers, in order to cut their cost advantage;<br />
� the coercion of the electricity suppliers to procure a part of the necessary<br />
energy from renewable sources;<br />
� the fixing of a minimum selling price for the clean energy producers (an<br />
important condition when investments are financed from loans granted by<br />
commercial banks, as a certain selling price guarantees a certain profitability<br />
and return on the investment).<br />
The production cost of the wind electricity includes all costs of the project<br />
(investment costs - land procurement, turbine procurement and assemblage, as well as<br />
operating costs); further, the costs are returned on the electricity amount estimated to<br />
be produced during the equipments’ useful life. As a consequence, the economical<br />
sustainability of the sector depends on the economical efficiency both of the turbine<br />
producers and of the turbine operators. As a general premise, the wind electricity<br />
involves high investment costs, balanced by low operating and maintenance costs.<br />
The wind turbine producers are generally governed by market rules, whereas the<br />
public financing has an indirect influence upon their activity, by means of its impact<br />
on the demand for clean energy. The (unlikely) abandonment of the support granted to<br />
the turbine operators will lead to the decrease of the demand for turbines.<br />
Nevertheless, the turbine production is currently experiencing such a spectacular<br />
growth, that its main problem has become the insufficient working capacity of the<br />
turbine subsystem suppliers. This potential blocking is determined by three main<br />
types of factors: political, technological and economical factors. Politically seen, the<br />
problem consists in the irregularity of the granted investment subsidies. The<br />
subsystem producers need to increase their working capacity in order to be able to<br />
satisfy the demand, whereas the necessary investments are usually financed from<br />
public funds. The funds are not granted with a regular frequency, which means that<br />
the producers delay the investment process, in order not to spend their own funds. The<br />
technological factors involve the constant demand for better technological<br />
performance, whereas not all the suppliers are able to keep the rhythm. The<br />
economical factors regard the constantly rising prices of the raw materials (steel,<br />
copper and carbon), affecting both the planning of the production and the subsystem<br />
selling prices.<br />
As already mentioned, the market of the wind turbine producers is dominated by<br />
relatively few companies (mostly European), while the current market trend is given<br />
by the vertical and horizontal integration of the activity, justified by the need to get<br />
the subsystem supply problem solved.<br />
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DISCUSSION AND CONCLUSIONS<br />
As anticipated, we shall conclude the present paper by shortly summarizing, in the<br />
three sectors described, the impact of the general state of affairs, as well as of the<br />
financing characteristics of the investment and operating process, upon their main<br />
financial analysis indicators.<br />
It is firstly obvious that the environmental sustainability efforts are generally<br />
supported by means of public funds, oriented either towards the investment, or<br />
towards the operating process. Without the public support, the sustainable<br />
administration of the conventional resources would not be affordable for the<br />
consumers, while the renewable resources could not represent a competitive<br />
alternative.<br />
As subsidies are recorded as a part of the capital, they will have a direct positive<br />
impact on the financial sustainability and autonomy indicators and an indirect positive<br />
impact on the solvability indicators, as they allow the completion of the total assets<br />
with no debt costs. Nevertheless, subsidies are usually accompanied by several<br />
implicit costs, given by restrictions regarding the future performance of the subsidized<br />
activity; such restrictions can increase the working capital needed and create shortterm<br />
liquidity problems. We talk mainly about the tariff setting restrictions, where the<br />
environmental component (the polluter pays principle) conflicts with the social<br />
component (the affordability principle), possibly leading to delays in the collection of<br />
the accounts receivable. A further threat on the short-term financial equilibrium is<br />
generated in the subsidy granting period, if the financing principle is the<br />
reimbursement of already paid expenses. The time lag between the own cash outflows<br />
and the subsidy cash inflows can be financed by means of short-term bank loans,<br />
whereas the cost of the debt can be considered a collateral cost of the subsidy.<br />
If the subsidy is oriented towards investment costs, it rarely covers all investment<br />
needs of the company. The public funds are granted either for a part of the initial<br />
investment need, either for the entire initial investment, though conditioning the<br />
company to continue the renewal of the technology in future, from own sources. If the<br />
water or heating supplier is a public company, then its low profitability limits its<br />
access to regular, unsubsidized loans, meaning that a public support granted today<br />
might affect the performance and solvability of the company in the future.<br />
The ecological and economical principles are rarely complementary, at least in the<br />
described sectors. The profitability of the operations (with effects on the return on the<br />
investment) increases when the renewal of the technology leads to the decrease of the<br />
resource losses, out of technical reasons. In the same time, the decrease of the billed<br />
water or energy, as a consequence of the tariff increase required by the polluter pays<br />
principle, will increase the ecological performance of the population, but decrease the<br />
financial performance of the water or energy supplier. In this context, water suppliers<br />
will be quite strongly affected, as most operating costs they record are fixed costs.<br />
With regard to the energy suppliers, the principles of the sustainable economical<br />
development will be respected if the conventional and alternative energy sources will<br />
become real competitors. For the moment, as both are strongly subsidized, the clean<br />
~ 1072 ~
energy comes to complete the conventional one, representing an option either for the<br />
middle and high income consumers.<br />
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Bartelmus, P. (2008) Quantitative Eco-nomics. How Sustainable Are Our Economies?<br />
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Bennet, M., James, P. (1998) Environment under the Spotlight – Current Practice and Future<br />
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Caldelli A., Parmigiani M.L. (2004) “Management Information System – A Tool for<br />
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Ciobanu, Anamaria (2006) Analiza performanţei întreprinderii, Bucureşti: ASE<br />
Esti C.D., Winston A.S. (2006) Green to Gold, New Haven and London: Yale University<br />
Press<br />
European Union of National Associations of Water Suppliers and Wastewater Services (2004)<br />
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Helfert E.A. (2006) Tehnici de analiză financiară, Bucureşti: BMT Publishing House<br />
International Water Association (2000) Losses from Water Supply Systems: Standard<br />
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Ministerul Mediului şi Dezvoltării Durabile (2007) Programul Operaţional Sectorial de<br />
Mediu 2007-2013, available online at http://www.mmediu.ro/proiecte_europene/<br />
01_integrare_europeana/02_POS_mediu/00_Pos_Mediu/POS_Mediu_RO.pdf<br />
Quentin-Grafton R. et al. (2004) The Economics of the Environment and Natural Resources,<br />
Malden USA: Blackwell Publishing Ltd<br />
Palepu K.G. et al. (2007) Business Analysis and Valuation, London : Thomson Learning<br />
Popescu, C. (2005) Creşterea economică şi echilibrul ecologic, Timişoara : Mirton<br />
Renewable Energy Policy Network für das 21. Jahrhundert – REN 21 (2007) Globaler<br />
Statusbericht 2007. Erneuerbare Energien, available online at<br />
http://www.wupperinst.org/uploads/tx_wiprojekt/RE2007_Global_Status_Report.pdf<br />
Rubin S.E. et al. (2007) Cost and performance of Fossil Fuel Power Plants with CO2 capture<br />
and Storage, available online at http://www.iecm-online.com/PDF%20files/2007/<br />
2007b%20Rubin%20et%20al,%20Energy%20Policy%20(Mar).pdf<br />
Sannen A. et al (2009) Manualul Naţional al operatorilor de apă şi canalizare, available<br />
online at http://www.ara.ro/documentare/Manualulu%20operatorului%20de%<br />
20alimentare%20cu%20apa%20si%20canalizare/Manualul%20operatorului%20de%20<br />
alimentare%20cu%20apa%20si%20canalizare.pdf<br />
Săcui, Violeta (2002) Decizii de selecţie şi finanţare a investiţiilor întreprinderii, Timişoara:<br />
Eurobit<br />
Siegel J. et al. (2008) Investing in Renewable Energy, J New Jersey: John Wiley and Sons Inc.<br />
Ştefea, P. (2002) Analiza rezultatelor întreprinderii, Timişoara : Mirton<br />
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www.acciona.es<br />
www.fin-apa.ablog.ro<br />
www.gamesacorp.com/es<br />
www.repower.de<br />
www.vestas.com<br />
www.wassernet.at<br />
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EMPIRICAL STUDY REGARDING KEY INDICATORS<br />
CORRELATIONS FOR SUSTAINABLE PERFORMANCE<br />
BUDGETING<br />
Violeta CIMPOERU 1 & Maria RADU<br />
Bucharest Academy of Economic Studies, Romania<br />
Valentin CIMPOERU<br />
University Politechnica Bucharest, Romania<br />
ABSTRACT<br />
The purpose of this paper is to emphasize that there is no economic growth without<br />
sustainable performance, leading to medium and long term improvement of the public and<br />
private sector management, while maintaining environmental quality and sustainable use of<br />
natural resources. Green strategies for economic development bring up the concerns about<br />
social and environmental issues as a source of economic recovery and long-term growth. The<br />
study is based on the deepening of quantitative analysis tools, using a model of simple linear<br />
regression, being an useful tool for a specialist to help explain economic phenomena, while<br />
putting forward work hypotheses and quantitative relations between the two variables used in<br />
our investigation: Environmental Performance Index (EPI) and Gross Domestic Product<br />
(GDP) per capita, calculated for the year 2008. This paper evaluates the recorded ecological<br />
progress, measured by the environmental performance indicator, dependent variable, related<br />
to economic growth measured by GDP per capita, independent variable, and seeks to present<br />
the strategic planning and sustainable performance as a source of inspiration for managers,<br />
leading them to change their practices and to experiment with new devices.<br />
KEYWORDS: sustainable performance, budgeting, social and environmental reporting,<br />
environmental performance indicator, simple linear regression.<br />
INTRODUCTION<br />
Sustainable development policies and practices have generated numerous violations in<br />
the past 20 years, and the approach and the involvement of specialists in this field<br />
have evolved exponentially over the years. Practice suggests that drawing attention to<br />
the reporting of economic, social and environmental information provides<br />
considerable advantages in various fields such as finance, insurance, marketing,<br />
normalization etc. The rapid evolution of global market requires the existence of<br />
common rules to facilitate trade. Competition created by global market entails<br />
streamlining and improving the resources and processes within the entities (Caraiani<br />
et al., 2010). As the economic and financial crisis is being generated by the current<br />
market model, the global economy requires a perspective change in the business and<br />
government area. The solution could come from a sustainable model, oriented towards<br />
the long-term progress of human society. Expedient and necessary, the sustainable<br />
development measures are being applied by more and more worldwide entities. The<br />
1 Correspondence address: Maria Violeta CIMPOERU, Bucharest Academy of Economic Studies,<br />
Romania, email: violetacimpoeeru@yahoo.com<br />
~ 1075 ~
sustainable performance can represent a “3 in 1” solution for the economic, social and<br />
environmental issues. The entities oriented towards green strategies must comply in<br />
the future with mandatory regulations for each activity, and managers’ plans will be<br />
targeted to sustainable budgets models. This reflects that the budgetary annual<br />
approach may undermine the budgetary performance, leading to incorrect allocation<br />
and inefficient use of resources and also to fiscal instability. In the late 1980s and the<br />
beginning of 1990, many countries of the Organisation for Economic Co-operation<br />
and Development (OECD) have launched reforms in the public sector which included<br />
new budgetary approaches to significantly reduce large fiscal deficits. Gradually, they<br />
abandoned the traditional budgeting, line - element, and applied a sustainable topdown<br />
(vertical) budgetary model. This modern approach of public finance<br />
management seeks to structure the budget around large programs, which are defined<br />
along the goals of governmental policy and they are linked to specific outcomes in<br />
order to integrate policy, planning and annual budgets. (Petkova, 2009). The<br />
transition, from initiation to performance-oriented budgeting, is extremely difficult<br />
because appropriate approaches are needed for the political and institutional contexts<br />
within the Ministry of Finance and the sectoral ministries. It also means that the<br />
budgets are structured on a program with very stable allocations from one year to<br />
another, replacing the budgets based on a traditional line, where the sectors used to<br />
forecast the current budget on the one of the previous year, plus a small increase. In<br />
other words: "the priorities of the policy determine the funding and not vice versa"<br />
(Holmes & Evans, 2003). By planning their activities, managers learn to anticipate<br />
potential problems and how they can be avoided. Therefore, representatives of<br />
environmental ministries and other relevant governmental agencies having<br />
responsibilities for managing environmental and natural resources, struggle to<br />
introduce into the medium-term budgets this useful analysis for green strategies.<br />
However, the cross - sectoral nature of many environmental problems requires a<br />
specific action, coordinated by a wide range of public sector institutions and<br />
represents a major challenge. It is remarkable that countries that have successfully<br />
introduced such budgeting models, which also included social and environmental<br />
programs, have started from a strong base in terms of public sector capacity and<br />
public finance management, and have done so for a certain number of years.<br />
Exploring a wider area of decision making situations of public and private entities in<br />
the developed countries involves a special focus on accounting informing needs of<br />
stakeholders (Bebbington et al., 2007). Recent research refer to numerous motivations<br />
regarding the social and environmental reporting (O'Dwyer et al., 2005, Cormier et<br />
al., 2005, Solomon & Lewis, 2002). Cormier et al. (2005) propose that sustainable<br />
reporting of potential costs should be understood in the context of benefits for the<br />
humankind. Hassel et al. (2005) examined the relevance of environmental<br />
performance and finds that investors do not appreciate the true value of this<br />
performance increase as a result of environmental protection activities in terms of<br />
overall green performance. Sustainable reporting is often known as the Triple Bottom<br />
Line Reporting (TBL) and forms the basis of shares within companies that lead to<br />
environmental performance and technological development together with social<br />
contribution. In practice, public and private agencies of environmental management<br />
use environmental indicators to summarize and assess the ecological processes<br />
(environmental performance, the allocation of restoration efforts and to establish the<br />
benchmarks of social and environmental criteria). Yale Center for Environmental Law<br />
and Policy (YCELP) and the Center for International Earth Science Information<br />
Network (CIESIN) at Columbia University in collaboration with the World Economic<br />
~ 1076 ~
Forum and Joint Research Centre of the European Commission have elaborated and<br />
calculated the Environmental Performance Index as a response to information<br />
technology developments and data-driven decisions that have transformed every<br />
corner of society, from business to the green environment. EPI includes a set of<br />
environmental indicators, which are calculated for areas with problems and which<br />
should become factors of great interest in political decisions in every country.<br />
Since everybody is talking about the economic crisis in negative terms only, we<br />
believe that there can be some positive aspects, and one of them may be a greater<br />
attention of the public, for the community in which they live, regarding to exacerbate<br />
consumption of resources, which can also represent a starting point to sustainable<br />
programs. Our study emphasizes that, although growth represents "the right hand" and<br />
the ecological growth "the left hand", the right cannot work without the left and vice<br />
versa. Thus, we made a comparative analysis between the environmental performance<br />
indicator, calculated for the year 2008 for 149 countries, with GDP per capita,<br />
calculated for 2008 using a statistical-econometric methodology.<br />
1. BUDGETING FOR SUSTAINABLE PERFORMANCE -<br />
THE CONNECTION BETWEEN ENVIRONMENTAL PROGRAMS<br />
AND ECONOMIC AND POLITICAL PROGRAMS<br />
Most countries are moving towards a form of sustainable performance-based budget,<br />
where the medium-term expenditures with a focus on politics are included in program<br />
budgeting. The translation of political priorities in results for the citizens requires that<br />
the budget structure be supported by a programmatic approach. At the same time it is<br />
important for the budgetary structures to not be so restrictive, as they may limit the<br />
ability of administrative agencies to mobilize available resources to maximize<br />
efficiency and effectiveness.<br />
Australia has the most sophisticated performance-based budgeting system, but studies<br />
have pointed out that this is not a criterion for cost-effectiveness (Petroka, 2009).<br />
A gradual process would be more cost-effective because it combines expenditures<br />
regarding policy development and program objectives, but also performance<br />
indicators, establishing monitoring and evaluation systems. Most studies suggest that<br />
monitoring and evaluation are the weak links in the chain for a sustainable budgeting,<br />
because very often, there is a direct link between indicators, results and resource<br />
allocation. From these essential parts of the process of understanding of what actually<br />
works and what doesn’t, we will enrich the analysis basis which should support not<br />
only the decisions regarding the fiscal space, but also the decisions regarding the<br />
reallocation within the existing base, so going from underperforming to the green<br />
performance through the implementation of environmental budgeting programs.<br />
In the Netherlands, promises made by politicians during the electoral campaign,<br />
represents the basis for assessing the government at the end of his four-year term. As<br />
a consequence, the Dutch politicians are very careful in preparing the political<br />
programs and therefore seek the help of the technocrats or the economic research<br />
institutes, to prepare macro-economic projections and the estimated cost of electoral<br />
programs they are proposing. The aggregated results are published before the<br />
elections and environmental agencies make assessments regarding the impact of the<br />
~ 1077 ~
economic activities on the environment, but also the environmental investments. Such<br />
a situation gives great credibility to budgeting for sustainable performance and is fully<br />
supported by politicians and then is internalized to the sectoral ministries. There are<br />
some similarities also in Australia, where, under the state budget honesty, Finance and<br />
Treasury are required to disclose the estimated cost of electoral programs of the<br />
government and the opposition before the elections (Van Helden, 2008). Experiences<br />
from developing countries showed that the sectoral strategies for environmental<br />
programs, if they do exist, are usually prepared without much consideration to the<br />
actual costs and budgetary implications of planned policies. There is an abundance of<br />
documents related to policies and strategies, but they often remain on paper. The<br />
problem of these countries is the lack of reliable data that could support credible<br />
monitoring systems. Thus, environment ministries need information and<br />
methodologies for setting targets and measures for evaluating the results of<br />
environmental programs both financially and socially. However, this is a good<br />
practice, because these documents regarding the policies and strategies are available<br />
to the general public, making the first step in improving transparency and reporting<br />
Triple Bottom Line (TBL).<br />
2. SUSTAINABLE PERFORMANCE - THE NEED FOR TBL REPORTING<br />
On an international scale, there is growing number of entities reporting on<br />
environmental and social impact of organizational activities. However, traditional<br />
financial and reporting accounting do not provide adequately data for measuring<br />
environmental and social impacts and, therefore, require a more detailed reporting<br />
within organizations (Yongvanich & Guthrie, 2006). Recent years have experienced a<br />
substantial increase in reporting on environmental and social problems by big<br />
corporations (Gray, 2006).<br />
According to a survey by Deloitte and Touche, 90% of the respondents believe that<br />
the economic, social and environmental reporting is an important element in the<br />
listing entity in terms of reputation and brand value. The survey also shows that 42%<br />
of financial managers consider that companies with a good social and environmental<br />
performance can successfully overcome weaknesses (Deloitte & Touche, 2002).<br />
Depending on specific circumstances such as industry, location or business model,<br />
environmental issues found in most corporate reports of entities relate to: climate<br />
change, energy, water, biodiversity and land use, chemicals, heavy metals and toxic<br />
air pollution, management loss, rarefaction of the ozone layer, the situation of the<br />
oceans, fishing and deforestation (Esty & Winston, 2006). Cormier et al., (2005)<br />
proposed an understanding of environmental reporting for the potential costs based on<br />
the benefits to mankind. Hassel et al. (2005) examined the relevance of the<br />
environmental performance and found that investors do not appreciate a performance<br />
increase, as a consequence of environmental protection activities. The supporters of<br />
the phrase:”one must pay to be green" say that there is a causal link between<br />
environmental performance and financial performance (Hassel et al., 2005). The<br />
attempts - to isolate the effects of pollution control in the process of determining the<br />
net cash flow, and to assess the environmental impact that their environmental efforts<br />
have on the entity, - proved to be challenges for the accounting research. Based on<br />
studies conducted in order to examine the evolution of investment funds, sustainable<br />
methods of investment, sustainable development indicators, the accounting regulators<br />
~ 1078 ~
institutions show that investors tend to give increasing importance to the green<br />
reporting (Koellner et al., 2005). Thus, social and environmental reporting provide<br />
complete reasoning for incorporating environmental and health issues in the decision<br />
making process.<br />
3. RESEARCH METHODOLOGY<br />
In order to achieve the objectives, the team used a fundamental research based on<br />
specialized literature and a quantitative method of data collection, based on an<br />
econometric regression model. In presenting a linear regression model are important<br />
aspects related to identification of the two variables and specification of regression<br />
model parameters. The simple linear regression model is defined by its linear<br />
relationship between the two economic variables and through a set of assumptions<br />
made on the data series, on the residual variable and two variables of the model and<br />
also on the linear relationship between them.<br />
In 2008, EPI was calculated for 149 countries and 146 countries used the model<br />
because for the three of them the GDP per capita for 2008 was not found, and they<br />
were eliminated. The endogenous or explained variable within the EPI model is the,<br />
and the exogenous or independent variable is GDP per capita.<br />
First, we created a database with two variables in MS Excel, by analyzing the data<br />
using EViews 7, and second, we tested their linear dependence and obtained a<br />
stochastic dependence, because the endogenous variable is auctioned by a series of<br />
factors, which are not specified within the regression model. This opens up<br />
opportunities for new approaches regarding the analysis of a multiple regression<br />
model, taking into account other factors approaching in a new way the economic,<br />
political and environmental context.<br />
4. GREEN INDEX - EPI 2008<br />
4.1. A brief overview<br />
EPI 2008 based itself on a team of researchers and experts to identify the most<br />
suitable indicators in each policy category and, in some cases, to assist the data<br />
processing activity, making a truly collaborative effort with the world of science.<br />
EPI focuses on two important environmental objectives:<br />
• reducing stressors for environmental health;<br />
• promote the strengthening of the ecosystems and the healthy management of<br />
natural resources.<br />
These broad objectives reflect the priority policy of the environmental authorities<br />
around the world and of the international community, which aims to ensure<br />
environmental sustainability.<br />
The two goals were analyzed using 25 performance indicators in six well-established<br />
policy categories that have then been combined to create the final result. In order to<br />
make the 25 indicators comparable, each measure was converted to a measure of<br />
proximity-to-target with a range from 0 to 100. Initially, they examined the<br />
~ 1079 ~
distribution of each indicator to identify whether the extreme values reach the<br />
aggregations of some indicators. Consequently, outliers were removed using a<br />
statistical technique called winsorization which selected 95% of the distribution for<br />
the analysis, and, by using a simple arithmetic transformation, EPI 2008 was<br />
determined for 149 countries and the observed values were placed on a scale from 0 to<br />
100. EPI is a work in progress, and thus EPI 2010 was also determined. Given the fact<br />
that the GDP values per capita for 2010 have not been made public yet, the<br />
econometric model was developed by using the indicators calculated for 2008.<br />
4.2. Econometric Model<br />
Research focused on a comparative analysis using a statistical-econometric<br />
methodology used by a wide range of authors of specialized literature. The statistical<br />
parameters – measuring the symmetry, the normality of distribution and the<br />
correlation between various statistical data, - are obtained by the regression function.<br />
Data processing for the analyzed indicators was performed with the help of EViews 7<br />
application. The quantitative data allowed the drawing up of a simple regression<br />
model showing the dependence between the EPI indicator and the analysis factor,<br />
GDP per capita.<br />
The linear regression model is as follows:<br />
yi = b + a ⋅ xi<br />
+ ε i , i = 1,...,<br />
n<br />
where:<br />
y i represents the EPI SCORE, calculated for the year 2008<br />
x i represents GDP per capita, calculated for the year 2008<br />
n represents the number of countries taken into account for the analysis<br />
We will consider next the GDP per capita influences the EPI indicator for a number of<br />
146 countries, alphabetically grouped.<br />
The necessary series of data, necessary to estimate the values of the model, are crosssectional<br />
data (collected for a set of statistical units):<br />
Index EPI (2008) – marked as EPI / Source: Environmental Performance Index<br />
2008- www.yale.edu.epi<br />
GDP per capita (current U.S. $) (2008) - marked as GDPC / Source: World<br />
Bank and OECD national accounts on National Accounts data files<br />
http://data.worldbank.org/index/NY.GDP.PCAP.CD<br />
Units of measurement and transformations on data series:<br />
The EPI: values between 0 and 100 (100 - the country with the highest score EPI)<br />
GDP per capita: GDP per capita is gross domestic product divided by midyear<br />
population. GDP is the sum of gross value added by all resident producers in the<br />
economy plus any product taxes and minus any subsidies not included in the value of<br />
the products. It is calculated without making deductions for depreciation of fabricated<br />
assets or for depletion and degradation of natural resources. Data are in thousand<br />
current U.S. dollars for comparability.<br />
We study, in a comparative manner, the data series related to this model. In this case,<br />
the series of the EPI indicator has a Mean of 71.87, the values ranging from a<br />
~ 1080 ~
Minimum of 39.1 to a Maximum of 95.5. Standard Deviation of 12.83, shows that the<br />
data are relatively homogeneous. Skewness is -0.59, Kurtosis 2.61, Jarque-Bera 9.63,<br />
which are values close to those of a normal distribution (0 and 3, respectively) (Figure<br />
1). For data series describing the GDP per capita Mean is 13.22, the values ranging<br />
from a Minimum of 0.14 and a Maximum of 117.95. Standard Deviation of 20.06,<br />
suggests a wider range of values for this series of data. Skewness is 2.29, Kurtosis<br />
9.05, Jarque-Bera 351.83 (Figure 2), indicating that the normal distribution of data<br />
series is missing.<br />
The Skewness indicator is a statistical parameter measuring the lack of symmetry (the<br />
symmetry of a distribution requires that this latter has be symmetrical to the central<br />
point). The value of this indicator close to 0 indicates the existence of a normal<br />
distribution of the analyzed data series. Values significantly different from 0 (positive<br />
or negative) reflect the degree of remoteness from the normal distribution.<br />
The Kurtosis indicator measures to see if the elements of a series are close or far from<br />
the normal distribution. A high value of this indicator (in our case for our series GDP<br />
per capita) indicates that the data series has a distinct peak from the average.<br />
A "link" between these two indicators is shown by the Jarque-Bera statistics test,<br />
which measures the degree of closeness to normality. The normal distribution<br />
measures the extent to which a statistical model fits with the observed data series.<br />
Testing the null hypothesis with the help of the Jarque-Bera test indicates null values<br />
of the Skewness and Kurtosis parameters.<br />
90<br />
80<br />
70<br />
60<br />
50<br />
40<br />
30<br />
20<br />
10<br />
20<br />
16<br />
12<br />
8<br />
4<br />
0<br />
Figure 1. Data analysis for EPI series (Histogram and stats)<br />
40 50 60 70 80 90<br />
~ 1081 ~<br />
Series: EPI<br />
Sample 1 146<br />
Observations 146<br />
Mean 71.87466<br />
Median 74.60000<br />
Maximum 95.50000<br />
Minimum 39.10000<br />
Std. Dev. 12.83647<br />
Skewness -0.599122<br />
Kurtosis 2.615645<br />
Jarque-Bera 9.633055<br />
Probability 0.008095<br />
Figure 2. Data analysis for GDPC series (Histogram and stats)<br />
0<br />
0 20 40 60 80 100 120<br />
Series: GDPC<br />
Sample 1 146<br />
Observations 146<br />
Mean 13.22144<br />
Median 4.215000<br />
Maximum 117.9500<br />
Minimum 0.140000<br />
Std. Dev. 20.06073<br />
Skewness 2.298092<br />
Kurtosis 9.058982<br />
Jarque-Bera 351.8367<br />
Probability 0.000000<br />
The deterministic relationship between the two data series expresses the dependency<br />
between the dependent variable – EPI - at the macroeconomic level and the<br />
independent variable - GDP per capita (Figures 3 and 4).
120<br />
100<br />
80<br />
60<br />
40<br />
20<br />
0<br />
Figure 3. The importance of GDPC for EPI determination (Excel)<br />
Figure 4. The importance of GDPC for EPI determination (EViews)<br />
25 50 75 100 125<br />
GDP PER CAPITA (THOUSAND US $)<br />
EPI<br />
The graph "cloud points" includes both coordinate points (EPIi, GDPCi) i = 1.146 and<br />
the GDPC regression line used to quantify the GDPC effect on EPI (Figure 5). From<br />
this graph we can notice a positive linear dependence between two variables: the<br />
higher the GDPC level gets, the higher EPI is.<br />
~ 1082 ~
EPI<br />
100<br />
90<br />
80<br />
70<br />
60<br />
50<br />
40<br />
30<br />
Figure 5. Scatter with regression<br />
0 20 40 60 80 100 120<br />
GDP PER CAPITA (THOUSAND US $)<br />
As, in reality, the dependence between the dependent variable Environmental<br />
Performance Index at a macroeconomic level and the independent variable GDP per<br />
capita is a stochastic one, and in determining the EPI was taken into account only one<br />
factor (although the dependencies are more numerous), the econometric model is<br />
given by:<br />
yi = b + a ⋅ xi<br />
+ ε i , i = 1,...,<br />
n<br />
where ε is the error of meaning (specification), which is a random variable<br />
(stochastic) that has some probabilistic properties, being given by the inexact<br />
relationships between the variables.The variance of the two data series as a group is<br />
shown in Tabel 1, by applying the test for Equality of Variances.<br />
Table 1. Comparison of variances for the two series as a group<br />
Test for Equality of Variances Between<br />
Series<br />
Date: 03/27/11 Time: 11:26<br />
Sample: 1 146<br />
Included observations: 146<br />
Method df Value Probability<br />
F-test (145, 145) 2.442319 0.0000<br />
Siegel-Tukey 0.879505 0.3791<br />
Bartlett 1 27.89582 0.0000<br />
Levene (1, 290) 8.866492 0.0031<br />
Brown-Forsythe (1, 290) 0.485026 0.4867<br />
Category Statistics<br />
Mean Abs. Mean Abs. Mean Tukey-<br />
Variable Count Std. Dev. Mean Diff. Median Diff. Siegel Rank<br />
EPI 146 12.83647 10.57504 10.46644 150.8493<br />
GDPC 146 20.06073 14.43154 11.63322 142.1507<br />
All 292 33.84723 12.50329 11.04983 146.5000<br />
Bartlett weighted standard deviation: 16.84054<br />
~ 1083 ~
Estimating the parameters for the proposed model, the relationship between the<br />
dependent variable Environmental Performance Index (marked as EPI) and<br />
independent variable GDP per capita (marked as GDPC), we obtain the following<br />
form for the regression equation (Table 2):<br />
EPI = 67.51565+ 0.329693* GDPC<br />
Table 2. The estimation results for the regression model parameters<br />
Dependent Variable: EPI<br />
Method: Least Squares<br />
Date: 03/26/11 Time: 22:30<br />
Sample: 1 146<br />
Included observations: 146<br />
EPI=C(1)+C(2)*GDPC<br />
Coefficient Std. Error t-Statistic Prob.<br />
C(1) 67.51565 1.095368 61.63743 0.0000<br />
C(2) 0.329693 0.045701 7.214194 0.0000<br />
R-squared 0.265473 Mean dependent var 71.87466<br />
Adjusted R-squared 0.260372 S.D. dependent var 12.83647<br />
S.E. of regression 11.03957 Akaike info criterion 7.654453<br />
Sum squared resid 17549.58 Schwarz criterion 7.695324<br />
Log likelihood -556.7750 Hannan-Quinn criter. 7.671060<br />
F-statistic 52.04459 Durbin-Watson stat 2.102390<br />
Prob(F-statistic) 0.000000<br />
Testing some assumptions made on the parameters of the regression model<br />
We are testing to see whether the variable GDP per capita coefficient is significantly<br />
different from 1.<br />
We define the hypotheses of the statistical test:<br />
H0 : a = 1<br />
H1 : a ≠ 1<br />
We calculate the test statistics using the formula:<br />
a −1<br />
t =<br />
σa<br />
Obtaining: t = -14.68 .<br />
The tabulated value for this test, with 145 degrees of freedom and significance level of<br />
0.001, is 3.291. The calculated value is less than the tabulated value, so we accept null<br />
hypothesis and the GDP per capita coefficient is not significantly different from 1.<br />
Econometric Interpretation<br />
For this model, GDP per capita increase by $ 1,000 (for this data series were divided<br />
by 1000), leads to an improvement in the 0,329 Environmental Performance Index.<br />
~ 1084 ~
The determination rapport (R-squared) has a small value, almost 26.54% of the<br />
variance of EPI and is explained by the variance of the GDP per capita factor.<br />
Statistical relationship between the endogenous variable and exogenous variable is<br />
weak, which shows that besides the GDPC variable, used to test a causal relationship<br />
between the EPI and GDPC, we also include other variables as the composition of this<br />
indicator includes a number of 25 other influential factors.<br />
The validity of this model can be sustained on the account of low values of probability<br />
and standard error values. The probabilities associated with the t-Student test for<br />
independent variable coefficient is below 5% (0%), thus rejecting the null hypothesis<br />
that the slope of the regression line is insignificantly different from zero, thus<br />
obtaining a properly specified model. Similar results for free term (free term is<br />
significantly different from zero). Between the value of t and F statistics, which<br />
corresponds to the regression slope, we can verify the relationship t ² = F. Durbin-<br />
Watson test, with a value of 2.10, indicating that the residual variables are not auto<br />
related.<br />
Forecast<br />
In order to make a forecast of the EPI variable we have resized the data series by<br />
using a sample of observations from 1 to 120, and starting with the observation 121,<br />
we considered the prediction (Figure 6). The forecast is accurate enough because<br />
RMSE is low (11.33) taking into account that the sample taken into consideration is<br />
quite high, and the Theil coefficient is less than 1 (0.078).<br />
130<br />
120<br />
110<br />
100<br />
90<br />
80<br />
70<br />
60<br />
50<br />
40<br />
Figure 6. Forecast for EPI variable based on current values<br />
10 20 30 40 50 60 70 80 90 100 110 120<br />
PREVIZIUNI_EPI ± 2 S.E.<br />
~ 1085 ~<br />
Forecast: PREVIZIUNI_EPI<br />
Actual: EPI<br />
Forecast sample: 1 120<br />
Included observations: 120<br />
Root Mean Squared Error 11.33958<br />
Mean Absolute Error 9.242842<br />
Mean Abs. Percent Error 14.55307<br />
Theil Inequality Coefficient 0.078198<br />
Bias Proportion 0.000001<br />
Variance Proportion 0.333530<br />
Covariance Proportion 0.666469<br />
Economic Interpretation<br />
The regression model results obtained by using the application EViews, showed that<br />
GDP per capita influences to a large extent the EPI indicator. By analyzing the<br />
determination ratio (R-squared = 26.54%) we can observe that its amount is quite high<br />
considering the fact that 25 variables are included into the composition of EPI. Given<br />
that developed countries have a very high GDP per capita, an increase of $ 1,000<br />
means (by refering to our average) an increase of the EPI Score by 0.329.<br />
Extensions of the above- used regression model Environmental Performance Index is<br />
a variable depending not only on the classical indicators such as GDP per capita, as
shown above, but also by sizes which approach in a new way the economic and<br />
political context such as Government Effectiveness.<br />
The form-model is defined as follows:<br />
Where<br />
y i is EPI, for 2010<br />
x GDP per capita, for 2010<br />
i<br />
yi i i i<br />
= b + a ⋅ x + c ⋅ z + ε , i = 1,...,<br />
n<br />
z i is the Government Effectiveness<br />
n represents the number of countries taken into analysis<br />
The econometric model is a multiple regression model and opens another path for<br />
future research.<br />
CONCLUSIONS<br />
Environmental issues and over-exploitation of natural resources can be largely<br />
explained by the lack of clearly defined property rights and other causes of market<br />
failure in combination with inadequate policies and weak institutions. Linking<br />
environmental concerns with economic arguments in decision-making process can be<br />
an important step towards better achieving the Millennium development policies.<br />
Thus, technical and economic arguments for policy reform argue that the allocation of<br />
budgetary resources based on well-designed programs can contribute to sustainable<br />
development. Environmental programs are more credible if they are developed and<br />
budgeted for professional entities (eg. Australia and the Netherlands). The<br />
introduction of medium-term budgeting is particularly favorable for environmental<br />
ministries and agencies with responsibility for environmental management, because<br />
the programs are long-term and investment in infrastructure is also for long periods.<br />
Budgeting for sustainable performance force weaker ministries such as environment<br />
to think strategically and to develop policies and financial planning in order to obtain<br />
a convenient budget compared to other budgets of the stronger ministries. If they are<br />
well-conceived, the environmental programs can provide a strong link between<br />
policies, strategic budgeting and TBL reporting.<br />
Based on specialization literature review, we can affirm that more and more<br />
companies conduct a reporting of the sustainability, by including the social,<br />
environmental and economic impact, not only as an accounting tool, but also a<br />
strategic one, in order to highlight the new sources of income and economic growth.<br />
Our research argues that countries that take environmental issues into the economic<br />
and governmental policies are more competitive and more innovative than others.<br />
They have access to a range of information before others and are better prepared to<br />
deal with unpredicted issues that may adversely affect people's lives. By rethinking<br />
products and services to meet market-oriented needs, the environment–oriented<br />
countries ensure themselves environmental and ecological growth. This hypothesis<br />
results from the empirical model presented, showing that the environment results can<br />
be quantitatively determined, facilitating a detailed analysis of environmental policy.<br />
In order to improve these goals, politicians should invest in collecting more data and<br />
monitoring a set of key indicators over time.<br />
~ 1086 ~
Environmental challenges come in many forms, which vary with material wealth and<br />
development. Developed countries and developing countries raise the question of<br />
pollution impacts and undeveloped countries are threatened by the lack of basic<br />
environmental facilities, such as access to potable water and sanitary facilities.<br />
AKNOWLEDGEMENTS<br />
This work represents the partial results of doctoral research, which was realized with<br />
the support of the doctoral scholarship, within the project Doctorate in economy at the<br />
Europe’s knowledge standards (DoEsEc), POSDRU/88/1.5/S/55287 contract,<br />
financed from European Social Fund and from the European Social Fund through<br />
Sectoral Operational Programme Human Resources Development 2007-2013, project<br />
number POSDRU/107/1.5/S/77213 „Ph.D. for a career in interdisciplinary economic<br />
research at the European standards” and with the support of the doctoral scholarship<br />
within the project Doctoral and post doctoral programs supporting research contract<br />
no POSDRU/107/1.5/S/76813.<br />
REFERENCES<br />
Andrei, T., Bourbonnais, R. (2008) Econometrie, Ed. Economica, ISBN 978 – 973 - 709 –<br />
353 – 0<br />
Bebbington, J., Brown, J., Frame, B. (2007) „Accounting technologies and sustainability<br />
assessment models”, Ecological Economics, vol. 61, no. 2-3: 224-236<br />
Beer P. & Friend F., (2006), „Environmental accounting: A management tool for enhancing<br />
corporate environmental and economic performance”, Ecological Economics, vol. 58,<br />
no. 3: 548-560<br />
Caraiani C., Lungu C., Dascălu C., Guşe R., Cimpoeru M., (2010) „Verde pentru practici de<br />
aur - Eco-eficienţa în contabilitatea socială şi de mediu”, Congresul al 18-lea al<br />
Profesiei Contabile din România, Ed. CECCAR, Bucureşti, ISBN 1844-7767:. 95-107<br />
Caraiani, C., Lungu C.I., Dascălu, C., Colceag, F., Guse, R.G. (2010) Contabilitatea verde –<br />
strategii transdisciplinare către contabilitatea socială şi de mediu, Ed. ASE Bucureşti,<br />
ISBN: 978 – 606 – 505 – 344 – 1<br />
Carol A., Geoffrey R. Frost (2008) „Integrating sustainability reporting into management<br />
practices”, Accounting Forum no. 32: 288 – 302<br />
Cormier, D.M., Magnan, M., Van Velthoven, B. (2005) „Environmental disclosure quality in<br />
large German companies: Economic incentives, public pressures or institutional<br />
conditions?”, European Accounting Review, vol. 14, no. 1: 3-39<br />
Deloitte & Touche (2002) „Socially Responsible Investment Survey”, London<br />
Diamond, J. (2003) “Performance Budgeting: Managing the Reform Process”, IMF Working<br />
Paper WP 03/33, International Monetary Fund, Washington DC<br />
Esty, D.C. & Winston, A. (2006) „Green to Gold: how smart companies use environmental<br />
strategy to innovate and create value and competitive advantage”, Yale University<br />
Press EU (European Commission) (2007), Public Finances in EMU – 2007, EC's<br />
European Economy, no.3, EC, Brussels<br />
Farneti F., Guthrie J. (2009) “Sustenability reporting by Australian public sector<br />
organisations: Why they report”, Accounting Forum no. 33: 89-98<br />
Gray, R.H. (2006) „Social, Environmental and Sustainability Reporting and Organizational<br />
Value Creation? Whose value? Whose creation?”, Accounting, Auditing and<br />
Accountability Journal, vol. 19, no. 6<br />
Hassel, L., Nilsson, H., Nyquist, S. (2005) “The Value Relevance of Environmental<br />
Performance”, European Accounting Review, vol. 14, no. 1: 41-61<br />
~ 1087 ~
Holmes, M. & Evans, A. (2003) A Review of Experience in Implementing Medium Term<br />
Expenditure Frameworks in a PRSP Context: A Synthesis of Eight Country Studies,<br />
Oversees Development Institute, London<br />
Koellner, T., Weber, O., Fenchel, M. and Scholz, R. (2005) “Principle for sustainability rating<br />
of investment funds”, Business Strategy and the Environment, vol 14, no.1: 54-70<br />
O’Dwyer, B., Unerman, J. and Bradley, J. (2005) “Perception on the emergence and future<br />
development of corporate social disclosure in Ireland”, Accounting, Auditing &<br />
Accountability Journal, vol 18, no.1: 14-43<br />
Petkova, N. (2009) “Integrating Public Environmental Expenditure within Multi-year<br />
Budgetary Frameworks”, OECD Environment Working Papers, no. 7, OECD,<br />
Publishing doi: 10.1787/224138120533<br />
Solomon, A. and Lewis, L. (2002) “Incentives and discentives for corporate environmental<br />
disclosure”, Business Strategy and the Environment, vol 11, no.3: 154-169<br />
Van Helden, F. (2008) “Medium term expenditure frameworks and environmental spending:<br />
the case of the Netherlands”, OECD background case studies<br />
Yongvanich, K. & Guthrie, J. (2006) “An extended performance reporting framework for<br />
social and environmental accounting”, Business Strategy and the Environment, vol. 15,<br />
no.5:309-321<br />
Environmental Performance Index (2008) Yale Center for Environmental Law & Policy<br />
available on-line at http:// www.yale.edu.epi<br />
Gross Domestic Product (2008) available on-line at http://data.worldbank.org/indicator/<br />
NY.GDP.PCAP.CD<br />
~ 1088 ~
PS21 Management information systems IV<br />
Chairperson<br />
Felicia ALBESCU, Bucharest Academy of Economic Studies,<br />
Romania<br />
MANAGEMENT INFORMATION SYSTEMS –<br />
AN APPROACH INSIDE AND OUTSIDE<br />
THE ORGANIZATIONAL<br />
Georgiana Andreea CIOANĂ, Ilinca HOTARAN<br />
BEYOND REPORTING IN BUSINESS INTELLIGENCE:<br />
INTELLIGENCE THROUGH ANALYTICS<br />
Irina Bogdana PUGNA, Felicia ALBESCU, Robert SOVA<br />
~ 1089 ~
MANAGEMENT INFORMATION SYSTEMS –<br />
AN APPROACH INSIDE AND OUTSIDE<br />
THE ORGANIZATIONAL<br />
Georgiana Andreea CIOANĂ 1 & Ilinca HOTARAN<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
The management information system can be a powerful weapon for the business environment,<br />
if it is well managed and if we have acknowledgments about its hidden aspects. For this, we<br />
must understand how we can collect appropriate data, what are the methods used for<br />
managing the databases and how we can combine traditional with modern methods for<br />
developing the picture of a “whole”. This is essential because only in an integrated business<br />
environment we can act as change and improvement agents, we can see the priorities, the<br />
restrictions and we can establish an order in what first seems to be “chaos”. We chose a<br />
double approach because one of the key for success is manager’s ability to see the trees as<br />
much as the forest.<br />
KEYWORDS: information system, organization, priorities, extended supply chain,<br />
integration, performance<br />
INTRODUCTION<br />
In the representation of reality, the concept of system highlights the interaction,<br />
correlation, relationship between all elements. In some sense, the concept of system is<br />
the opposite of the term “chaos”. The intention of the general theory of systems is to<br />
disclose property, principles and laws that are characteristic of systems in general,<br />
regardless of their variety or type of their components. The extended supply chain is a<br />
system, and its main objective is to reach out to the highest goals trough collaboration.<br />
In a collaborative relationship, we must understand that the information flow is a<br />
necessity, an opportunity, a chance for development but also it can be a great<br />
disadvantage if the companies miss the essential elements of its integration.<br />
The organization is an open and adaptive system if we take into account the fact that it<br />
is a component of larger systems with which it has harmonized links, trough the<br />
management process. An organization can be understood, only if you research it as an<br />
open system, whose internal processes are in relation to the environment, and also are<br />
depending to the quality of information systems.<br />
Systemic analysis of organizations offers a new perspective on the information<br />
exchange between humans and between humans and the environment. We consider<br />
that is essential to analyze the management of information systems situated inside an<br />
organization and also the information system that reveals the extended supply chain,<br />
taking it from the “chaos” to the next step, to the “whole future”.<br />
1 Correspondence address: Georgiana Andreea CIOANĂ, Management Faculty, Bucharest Academy<br />
of Economic Studies, Bucharest; email: georgianacioana@yahoo.com<br />
~ 1090 ~
1. INFORMATION<br />
The information assures an interface between companies trough the implementation<br />
of different information software. A barrier difficult to overcome over the time was<br />
the lack of integrated applications. The use of information resources brought<br />
extraordinary improvements<br />
1.1. Cooperation at the information flows level<br />
It is linked to a shift from transaction marketing to relationship marketing, in which<br />
complete and reliable information exchange between actors in the distribution channel<br />
is essential. This has proved to be the key to the success of a partnership. Indeed, a<br />
successful partnership depends on the quality of communication, on the information<br />
exchange, on the register of shared information and also on the active participation of<br />
partners in the process. The interchange of electronic data (EDI) is both quantitative<br />
(helping to sales forecasting and also to production management and physical<br />
distribution) and qualitative (as a valuable support in launching new product or<br />
supporting marketing activities). Cooperation at the level of products flow has led to<br />
developments in terms of "supply chain management (SCM)".<br />
1.2. The role of information<br />
There are four major fundamental mistakes when we delineate the need for<br />
information:<br />
• We consider systems as individual features and not cross-functional elements<br />
• We interview managers individually and not jointly<br />
• We are not allowing trial and error in the detailed design process<br />
• We ask the wrong questions during the interview<br />
2. THE FIRST APPROACH - THE ROLE OF INFORMATION<br />
AND THE COMMUNICATION PROCESS INSIDE ORGANIZATIONS<br />
In order to do their work effectively, the personnel inside organizations need to have<br />
access to information in a timely manner and accurately. Business functions are better<br />
integrated, the link between organization and its suppliers and stakeholders is<br />
stronger, internal processes are more efficient if organizations have information<br />
systems that can provide this type of information. In nowadays business environment<br />
there is a higher need for managers to focus on the quality of the information systems<br />
they implement in their companies. One should not jump to the conclusion that it is<br />
the IT experts’ duty to make sure that the clearness of information is ensured. They<br />
are only responsible for designing the systems. It is management’s task to ensure that<br />
the systems developed serve the needs of people and of the business (Boddy et al.,<br />
2004). As information systems have become more and more crucial in the process of<br />
organizational development, moving from behind the curtains directly on stage,<br />
managers should seek to actively involve in the their customization which will have<br />
great impact on firm’s performance.<br />
Organizations are mainly constituted as open environments, where information flows<br />
between all the interested parties. People select the data they need, make changes on<br />
~ 1091 ~
it, transform it in order to get the necessary results, or as the literature states, the<br />
resources (inputs) are worked upon and transformed into outputs which affect<br />
organization’s environment and which, at their turn, generate new sources of inputs<br />
and information. If we analyze a production process for instance, one good example<br />
for the flow of information inside the process would be that of the shop-floor<br />
supervisors and operators who use information about the raw materials available,<br />
inventory, warehouses, machinery in order to help them in planning production;<br />
furthermore, they transform this information with the use of other pieces of<br />
information regarding the degree of capacity utilization, efficiency and process<br />
quality, delivery schedules and deliver orders to the final customers, generate<br />
information about customer satisfaction to the marketing department, prices, sales and<br />
other incoming orders to the financial department, thus creating a continuous<br />
information flow, adding value to all the processes.<br />
Firms nowadays operate by combining two types of activities: physical - the transport<br />
of materials from suppliers, the actual production, the handling of work-in-process<br />
throughout the facilities, the delivery to the customer etc. and electronic - online<br />
orders, products catalogue and offers, payment systems, scheduling of operations,<br />
online meetings, the communication in the supply chain and many more (Boddy et al.,<br />
2004). Even if the IS are well development and wide-spread, there is still the need for<br />
direct human contact - face-to-face reunions, telephone calls, brainstorming, which<br />
usually are most efficient when unusual problems arise or solutions are unclear.<br />
However, in situations or cases where the exchange of information has become a<br />
routine, IS enable the communication to be done almost only electronically, through<br />
the means of company-wide databases, interrelating different parts of the organization<br />
to have access to updated information. It is not only a consequence of the fact that<br />
technology rushes to provide new and non-conformist means of communication in the<br />
competition for growing progress. It is a solution for the necessities of businesses that<br />
have developed and operate globally, in different environments. As a consequence of<br />
globalization and instant access to information, new products and services have<br />
transformed the way customers influence businesses (Petcu & Drăghici, 2010).<br />
Corporations transfer their knowledge and their operational functions worldwide,<br />
creating a network of information sharing that has to be accessible from every corner<br />
of the international business arena; emerging firms want to promote themselves and to<br />
enter the market with a modern approach of doing business, going online and getting<br />
in contact with their clients and partners by all means.<br />
Figure 1. Increase of information intensity in manufacturing<br />
Dynamic business<br />
environment<br />
cement<br />
food<br />
~ 1092 ~<br />
aero<br />
(Source: Coronado Mondragon et al, 2004:1223)<br />
elec-s<br />
auto<br />
Information intensity
2.1. The benefits of information<br />
• Information is tradable - it may be considered as a resource, the issuer of the<br />
message can sell it many times and transferring it to the buyer may give birth to<br />
another ‘sale’. The latter could sell it for a higher price, sometimes increasing its<br />
value through the knowledge that comes with it. (Fattahi & Afshar, 2006: 134)<br />
• Information can be used and reused - we can state that information is<br />
something that can be ‘recycled’.<br />
• Information can be shared - it can be used by several users at the same time<br />
without being depreciated, especially if it is in electronic format. Thus it allows the<br />
creation of databases and their continuous expansion.<br />
• Information can be transferred - in the physical form, for example written<br />
documents, reports, files; it is hard to transfer information from one user to another,<br />
sometimes involving time delays and loss of some of its value. Thus, technological<br />
innovation provides solutions to make the transport of information easier through<br />
electronic means, which involve lower costs and less effort. E-databases, e-mail, ebooks,<br />
intranets, the Internet and other products of the great IT progress allow<br />
information to be accessible in all parts of the world, with minimum efforts. (Fattahi<br />
& Afshar, 2006: 135)<br />
• Information can be processed - since technology made it possible in the first<br />
place, it also provided ways of managing information, designing in this way new<br />
sources of information which add value to the communication process and require<br />
very few investments, as compared to the benefits resulted.<br />
• Information can be reproduced - information from databases can be copied on<br />
legal conditions, electronic sources on the Internet can be translated and shared with<br />
different other users, online documents can be compiled and reused.<br />
• Information can be refined - as they use several pieces of information and they<br />
come in contact with widely spread resources, users reach to the conclusion that<br />
information needs revising because sometimes it is loaded with useless items. This<br />
characteristic permits adding value to information and making it more useful to the<br />
persons accessing it. By deleting unnecessary data, information becomes more useful<br />
and hence users spend less time in analyzing it and retrieving what they need.<br />
• Information can be interpreted, inferred and adapted - users have the<br />
opportunity to give different interpretations to information, creating and delivering<br />
new sources and adding value through their work. (Fattahi & Afshar, 2006: 136)<br />
• Information can be synthesized and converted into knowledge - new<br />
information is generated through analyzing, synthesizing and extracting what’s most<br />
valuable out of it. (Fattahi & Afshar, 2006: 137)<br />
2.2. The relationship between information systems and company’s priorities<br />
In the current business context, companies are striving more and more for continuous<br />
improvement and more integrated processes. Globalization, increased competition,<br />
increased customer demands, fast changing wants (Cioană & Ohotă, 2010: 613) and<br />
the recent economic crisis impact a lot the business environment. In this context, the<br />
advanced information technology solutions and ERP implementation have become a<br />
major strategic issue. The relationship between implementing ERP systems and<br />
establishing their organizational strategies is critical, therefore the management of<br />
companies has a decisive role in this process. The success of this resides mainly in the<br />
~ 1093 ~
efforts of the top management, in providing training to employees and to all the<br />
personnel involved, a very good communication of the objectives, a fully supervised<br />
project management as well as an adaptation to the resistance to change and an<br />
employment of results measures.<br />
Another key aspect in this respect, and one that turned into an impediment when<br />
different firms enrolled in adopting such kind of IT tool, is the good understanding of<br />
the business, the organizational goals and needs, the relationships inside the firm and<br />
firm’s connections with the business environment. Under these circumstances, due to<br />
its integrative approach of managing businesses, ERP has become lately more like a<br />
new style of management (Yen & Sheu, 2004). At the same time, in order to produce<br />
the discounted results, the ERP systems should be customized according to the<br />
company’s necessities and to its processes.<br />
It is more that obvious that the implementation of ERP systems engages an effect on<br />
the company’s position as compared to its competitors. Unfortunately, until now a<br />
procedure to guide the implementation of ERP in straight connection with company’s<br />
competitive strategy is yet to be developed. Therefore this chapter investigates the<br />
strategic issues of ERP systems and of their customization for firm’s requirements.<br />
Different studies throughout the years have discussed the competitive priorities of<br />
companies and refined them according to changes in the evolution of the business<br />
environment. Some included differentiation, competitive costs, response to customers’<br />
needs, and as competition rose, other priorities where emphasized like quality,<br />
delivery, flexibility, service, innovation. The further step in the enforcement of<br />
company’s strategy is the segmentation of priorities at lower levels in the organization<br />
into structural and infrastructural plans (Yen & Sheu, 2004). These decisions refer to<br />
long-term concerns such as processes, facility location and capacity and their<br />
interaction with the organizational structure, the planning and control systems, the<br />
quality issues and employees’ skills and leadership.<br />
ERP implementation has a very significant impact on the business functions and<br />
company’s performance, affecting numerous elements like planning, scheduling and<br />
control systems (Yen & Sheu, 2004) at the operational level, and tactical and strategic<br />
decisions in terms of integrated business plans. According to this assumption, we can<br />
state that it is an integrative solution that puts together firm’s resources and delivers<br />
the most effective results out of their most efficient utilization. It acts on a horizontal<br />
basis, at the level of operations, employing at the same time the entire organization’s<br />
plans and strategies in a global perspective, gradually attracting all the organizational<br />
structures as we move along the vertical scale and reach the top management level.<br />
It is the characteristics of firm’s operations that influence the ERP implementation<br />
steps the management should approach. The most influential steps in this process are<br />
those related to management’s actions (process analysis and diagnose, process<br />
standardization, package customization, information sharing and accessibility,<br />
centralization, team selection, training) even though technology related actions should<br />
not be overlooked (software acquisition, adaptation, tests). Therefore management’s<br />
role in the implementation process is crucial: it is the decision making structure on<br />
which the success and the effectiveness of the implementation steps reside. Further in<br />
this article we will discuss in detail the ERP systems as a method.<br />
~ 1094 ~
2.3. How line managers use information systems to increase the efficiency<br />
of processes<br />
The are a lot of definitions of the concept of line manager in the literature, but the<br />
most appropriate one to the scope of the research would be ‘the person who is<br />
responsible for the day-to-day tasks and for the people under his supervision,<br />
mediating the communication of company’s objectives from the upper levels down to<br />
the employees, being at his turn under the guidance of a middle manager’. Mainly,<br />
their role is that of linking top management with workers and operators, by taking the<br />
overall strategies and figuring them out into operational activities, performing the<br />
functions of planning, organizing, leading and controlling. None of these functions<br />
could be performed efficiently without putting all the resources of the company<br />
together (human and physical) and no results could be obtained effectively without<br />
the support of the sharing of information, communication, motivation and coaching.<br />
In this respect, line managers rely very much on the benefits provided by different<br />
information systems to undergo activities in a timely, qualitative and cost-effective<br />
manner.<br />
We will furthermore analyze the way in which line managers contribute to<br />
performance improvement through the means of information systems by resuming the<br />
results of a study (Malmqvist, 2008) undertaken by Chalmers University of<br />
Technology, Gothenburg, Sweden. The study had in view Volvo Information<br />
Technology AB, a global company owned by Volvo AB, which offers support and IT<br />
solutions for all activities at Volvo AB. It is one of the six business units that sustain<br />
the eight business areas which constitute Volvo Group (Volvo Group, 2010). As it is a<br />
very large business area and the view upon the big picture could hinder more specific<br />
results that actually represented the aim of the analysis, the focus was centered upon<br />
Volvo Infrastructure and Operations (I&O) Site Göteborg, the managerial issues faced<br />
by line managers and the relationship with the information systems they have<br />
enforced.<br />
In order to gather data regarding the position and the tasks of I&O inside the<br />
organization, the work and the role of line managers in I&O, the problems they incur<br />
in their day-to-day work, the way they handle the large panel of responsibilities they<br />
have and whether or not they have to leave aside some of them because of the lack of<br />
time, three preliminary semi-structured interviews were conducted where interviewees<br />
expressed their ideas and points of view on the specified issues. In the second part of<br />
the study, six final interviews provided information on the way line managers<br />
prioritized their tasks and on the conflicts that arose when trying to rank these<br />
priorities. The managers were also enquired about the way in which information<br />
systems enhanced the ease of doing their work more accurately and having access to<br />
necessary information. Other important aspects were the ways in which information<br />
systems could be better designed, implemented and improved to help people use<br />
resources at full potential and provide the best results.<br />
The observations were made according to the principles of Soft Systems Methodology<br />
which focuses on the study of phenomena and on treating systems as flexible entities,<br />
taking into account the fact that reality is built by humans in a continuous way. It<br />
assumes that organizational systems are changing on a permanent basis, thus all the<br />
~ 1095 ~
norms, roles and values residing in it should be looked at from a subjective point of<br />
view (Jacobs, 2004: 140). It all stands in analyzing the organizational environment<br />
from the “soft” perspective and applying it to the “hard” procedures, understanding<br />
the change-related issues rather than seeing it as a collection of static processes, tools<br />
and people. Checkland and Pouter (2006: 196), referring to this method of<br />
observation, say that it can be used in human situations when there is a feeling “that<br />
this could/should be improved”, or when “something needs to be done about this.”<br />
In figure 2 we presented a visualization of the mnemonic CATWOE (the abbreviation<br />
stands for Customer, Actors, Transformation process, Worldview, Owner and<br />
Environmental constraints) (Malmqvist, 2008) adapted to the information flow and<br />
processes at Volvo I&O Site Gothenburg, which better illustrates the relationship with<br />
all departments involved in the decision making and with all interested parties<br />
(stakeholders), as well as their interaction with company’s information systems.<br />
There were seven semi-structure interviews and discussions with some of the most<br />
influential people in the process at the I&O Site, among which the Site Manager, a<br />
Manager for Managers, a line manager, two employees and two process owners - one<br />
representing the HR department and another from the Finance department<br />
(Malmqvist, 2008). As a brief presentation, we are going to describe in short the main<br />
responsibility of the interviewees: the Functional Manager controls the process in<br />
terms of efficiency, quality of the products, establishing goals or more specifically,<br />
performing the long-term planning, being a customer of the site’s resources; the Site<br />
Manager is concerned with daily activities; the HR department is responsible for all<br />
employees working at the site; the line manager is in charge of the daily activities,<br />
who and what task performs each employee, in other words he is making sure that his<br />
team meets the objectives set by the Functional Manager, as well as of product<br />
economy, quality, and it also has economic and HR responsibility, which refers to<br />
planning the budget and forecasting the needs in terms of resources, and also<br />
supervising the work of the employees, their performance and development. Some of<br />
the interviewed people underlined the fact that at Volvo there is a great highlight on<br />
employees, it is the idea of knowledge-based company who cares for its people<br />
mostly because it’s them who carry out most of the tasks and commit to the actual<br />
realization of strategic goals.<br />
From the opinions of some of the people interviewed we could agree upon the fact<br />
that most of the time, economic issues and daily activities get more priority due to<br />
their apparent urgency and tactical impact, hence the focus on employees is hindered<br />
and it comes off second best. The general point made refers to the need of line<br />
managers to be responsible for HR activities also, as they are more long-term issues.<br />
There is also the impression and it may at the same time be not just that, that line<br />
managers are facing a lot of pressure from all directions, making it very difficult to<br />
prioritize between what the function requires from a line manager and how he deals<br />
with daily activities. Therefore the exact and fair description of the role of a line<br />
manager would solve all ambiguities, as well as a better planning of his duties and a<br />
good structure of his work<br />
~ 1096 ~
Figure 2. CATWOE illustration of information flow between parties impacting<br />
the manufacturing process at Volvo I&O Site Gothenburg<br />
$<br />
$<br />
Finance<br />
Department<br />
HR<br />
Department<br />
SUPPORT,<br />
CONTROL<br />
Functional<br />
manager<br />
RESULTS,<br />
REPORTS,<br />
QUESTIONS<br />
Manager<br />
for managers<br />
DEMANDS<br />
FOR<br />
RESOURCES<br />
DEMANDS FOR<br />
RESOURCES AND<br />
COMPETENCE<br />
QUESTIONS,<br />
RESULTS<br />
OBJECTIVES,<br />
SUPPORT,<br />
CONTROL<br />
OBJECTIVES<br />
RESULTS<br />
OBJECTIVES<br />
TRAINING<br />
GUIDANCE<br />
CONTROL<br />
ASSESMENT<br />
Sales<br />
Department<br />
RESOURCES<br />
Line<br />
manager<br />
Operators/employees<br />
RESULTS<br />
APPRAISAL<br />
EMPOWERMENT<br />
QUESTIONS<br />
PAYMENT<br />
In their position, having to deal with a lot of activities and coming in contact with a<br />
lot of people, whether they are employees or site, finance or marketing manager, line<br />
managers must handle a lot of information that they must look for in a lot of different<br />
places. For financial facts and figures, as well as other data regarding the daily work,<br />
the planning of employees’ time or budgeting, they can get a great deal of reports<br />
from the SAP they have implemented. For HR activities there are some modules of<br />
the SAP that provide useful information on how to better manage the workforce and<br />
to value it accordingly. To serve this purpose, a handbook is available on the intranet,<br />
there is a service center that can provide help for many types of problems regarding<br />
the HR policy, and another level is designed for HR policies. There are also other<br />
means of transmitting information like Outlook, where managers can plan their time<br />
and employees’ time if they want, or getting information from, like Faros, through<br />
which someone can order programs or other services he/she needs to do their work.<br />
And last but not least, there is an IT solution that Volvo IT offers to enable a more<br />
“lean” flow of information and communication, a virtual workplace presented as a<br />
website that provides open or secure access, where collaboration is made possible<br />
through forums, news, lists of contacts or tasks - TeamPlace (Volvo IT AB, 2011).<br />
In addition to these computerized means of communication, some interviewees<br />
stressed out that there are pieces of information they normally get in traditional ways,<br />
like discussing with their colleagues, receiving feedback from coaches or mentors,<br />
sometimes in informal situations, not necessarily during meetings or reunions. This<br />
has, needless to say, its advantages and disadvantages, like for instance the fact that<br />
the novice gets the information easier and in a facile manner, but he/she can actually<br />
not get it the right way, he/she cannot learn how to deal with a new method the way it<br />
~ 1097 ~<br />
Site<br />
Manager<br />
Information Systems<br />
GOALS<br />
PERFORMANCE<br />
APPRAISAL,<br />
RESULTS<br />
PERFORMANCE<br />
RESULTS<br />
I&O<br />
Manager<br />
Top management<br />
CUSTOMER<br />
SUPPORT<br />
Marketing<br />
Department<br />
Customers<br />
ORDERS
is designed. But not all issues are solved in the traditional way. Line managers use<br />
their computers depending on the activity they need to undertake, if it is either to<br />
create reports, to analyze results of different projects or tasks. Some of them have<br />
assistants who perform this work for them, but it depends again on what kind of<br />
information is needed or what kind of analysis has to be done.<br />
Even though they benefit of a lot of IT support, there is still the feeling that<br />
information is spread all over the place (Malmqvist, 2008: 25). This may lead to<br />
creating difficulties in finding information in a timely manner, and also having access<br />
to the right kind of information mainly because there seems to be a lack of<br />
effectiveness in the structuring process. The company has tried to adapt all other<br />
information systems they introduced which were basically created for the general<br />
management purpose, like SAP, sometimes even to the needs of the line managers, in<br />
order to make available the right information to certain categories of users.<br />
Interviewees agreed that they had problems using all the applications and in getting<br />
the requested information from the systems, partly because these applications were<br />
very difficult to work with and it took a long time to learn it, but they pursued because<br />
they acknowledged that in this way their effectiveness will increase considerably.<br />
The challenge for line managers is and will continue to be the overall picture and how<br />
to get a general overview of the situation in your area of interest with so much<br />
information that one has access to. Putting together data from the financial reports,<br />
inventory systems, HR system, demand forecasts etc. is not enough. Learning how to<br />
manage information and how to make better use of information systems helps only in<br />
theory; in practice, we all have the same behavior and instead of reading the<br />
instructions manual, we simply try to see how a device works. In reality, the<br />
advantages of these systems are far beyond one’s acknowledgement. They have a lot<br />
of functions that could make easier a line manager’s work, but they cannot spend too<br />
much time in seeing how all these things work, they are trying to prioritize and time is<br />
not really their best friend. The systems are not by far used at their full extent, a lot<br />
more could be done with them, but it is user’s choice to how much he/she can<br />
dedicate to learning all the functionalities and relationships beyond the interface and<br />
his/her background that support or impedes the learning process.<br />
Another gap in implementing information systems and making them accessible to<br />
employees is the approach of the training that needs to be done. This is the case for<br />
many companies worldwide, when the experts provide the users with some basic<br />
training, but as things get more and more complicated, there are still questions left<br />
without answer. It’s the “now you have the application, here is your password, ask if<br />
there is anything you need to know” (Malmqvist, 2008: 28) type of approach, as one<br />
of the interviewed line managers states. Since line managers have a lot of crossfunctional<br />
responsibilities, they should probably receive a more in-depth training<br />
which should be done on a continuous basis. With all the many tasks they are<br />
requested to perform, they are entitled to have the necessary conditions to do that.<br />
And as previously mentioned, the solution to this issue would be to develop training<br />
for general purpose and then to allocate each line manager and each decisional staff a<br />
training that is focused on the particularities of his/her work, to adapt it to the needs of<br />
the user.<br />
~ 1098 ~
We can assume that the problems enumerated here are probably not only the case of<br />
Volvo, other companies who have embraced the challenges of information systems<br />
are facing the same situation: systems are not exploited at their maximum,<br />
information is not appropriately put at disposal, there are too many tools and functions<br />
the users are trying to make themselves familiar with but which they never actually<br />
implement in their work and thus become more of a counterproductive mean.<br />
Other surveys, some of which presented in the research of Coronado Mondragon et al.<br />
(2004), have revealed the limited advantages that investment in information systems<br />
can provide, underlining the fact that despite the great amount of support software and<br />
techniques developed, productivity and effectiveness have seldom increased, in most<br />
cases stagnating.<br />
3. SECOND APPROACH – THE ROLE OF INFORMATION<br />
AND COMMUNICATION SYSTEM OUTSIDE THE ORGANIZATIONAL<br />
BOUNDARIES<br />
3.1. Methods for data collection in the extended supply chain<br />
Data collection involves the use of several methods. Business system planning (BSP)<br />
is a structured interview technique developed by IBM. It focuses on identifying<br />
problems and decisions related to an organizational process and it determines what<br />
information is required for a correct approach.<br />
Table 1. Business System Planning<br />
BSP- PROBLEMS/ SOLUTIONS/ INFORMATION<br />
Problems Solutions Information<br />
Reducing the order processing cycle The need to understand the lead • Performance to fulfill orders for<br />
among members of supply chain time cycles between the chain each organization<br />
while maintaining or even reducing members and logistics costs vs. • The total cost of supply chain<br />
overall costs.<br />
total performance.<br />
logistics<br />
• Historical data on orders from<br />
chain members<br />
• Travel<br />
times<br />
costs and processing<br />
BSP - Decision BSP - Information<br />
How to transport the X product. • Comisionarul şi modalitatea folosite de competiţie<br />
• Costurile de transport şi performanţele comisionarului şi a modalităţilor<br />
• Commissioner and the method used by competition<br />
• Transportation cost and the performance and the methods used by the<br />
commissioner<br />
Critical Success Factors (CSF) focuses on areas of high performance that must<br />
function effectively for the organization to succeed and meet the information<br />
requirements.<br />
CSF Information<br />
The performance measurement<br />
system of integrated supply<br />
chain<br />
Table 2. Critical Success Factors<br />
• Measurement for the integrated supply chain performance<br />
• Performance measurements for individual members of the organization<br />
• Effective performance of supply chain and of organizational measurement<br />
• Goals to measure<br />
• Performance over time<br />
~ 1099 ~
Traditional systems do not allow trials and errors regarding information systems.<br />
Following these methods have resulted systems that must be changed every time and<br />
because of this they become completely unnecessary. To meet this great challenge, a<br />
new prototype was built. The prototype was introduced to overcome these obstacles<br />
through the validation of the system’s requirements due to experimentation, refining<br />
and testing. To achieve the performance standards, certain information must be<br />
automated. There are three interrelated streams: value stream, informational stream<br />
and material stream. To the extent that they can be automated, they can be included in<br />
the ERP. It is a process that can be a standard, but also a freeze of the factors included<br />
in the ERP.<br />
3.2. Information systems and supply chain management<br />
When computers first appeared in 1960, those displays filled an entire room with<br />
tubes and wires. With the development and evolution of the integrated circuit, the cost<br />
of a computer decreased significantly and its power increased exponentially. With the<br />
emergence of personal computer, fiber optic networks and the explosion of Internet<br />
and World Wide Web, the cost and availability of the information, all that led to the<br />
elimination of delays caused by the information’s transmission in any supply chain<br />
network. Computer and telecommunications technology have led to simulation of<br />
work in real time and on-line communication throughout the entire chain.<br />
Managers that create information systems should not view them as a set of repetitive<br />
transactions between different entities, customers and suppliers, or distributors or<br />
retailers. An ideal system should include all functions and all organizations that go<br />
through the chain. Given the explosion of Internet, of intranet systems inside the<br />
companies, future systems will have the following characteristics:<br />
• A centralized coordination of information flow<br />
• Total logistics management - the integration of all transport systems, control<br />
and production systems<br />
• Signs of change orders that triggered a series of changes in the program of<br />
production, logistical or planning storage operations<br />
• Global visibility in terms of resource’s transport across business units within the<br />
boundaries<br />
• Overall management of stocks - the ability to locate and track the movement of<br />
each element<br />
• Global procurement - Strengthening procurement functions across<br />
organizations, facilitating the rigging components for purchasing and also the<br />
standardization<br />
• Inter-company access of information - clarity of information on production and<br />
demand is identified at the top and also at the bottom of the value chain<br />
• Data capture - the ability to capture data on a command from its point of<br />
departure, and to track products throughout their road, when their properties are<br />
modified.<br />
• Transform the image from the inside - managers can see the "big picture"<br />
In the ideal informational supply chain, the information is available to any party in the<br />
chain and also the number of feedback loops that characterize a fully integrated<br />
supply chain. These links are critical because they allow the appearance of just-in-<br />
~ 1100 ~
time deliveries between each link of the chain. They also assure that the inventories<br />
can be minimized and entities may respond to fluctuations in an appropriate manner in<br />
terms of time and quality.<br />
4. SOLUTION FOR INTEGRATING THE INFORMATION FLOW<br />
4.1. Computer system for the optimization of an extended supply chain using<br />
electronic commerce<br />
E-commerce means, in “traditional” way, the use of applications such as electronic<br />
transfer of documents (EDI), fax communications, bar code, file transfer and email in<br />
networks, along with adding value. The extraordinary development of the<br />
interconnectivity of computers through the Internet, in all segments of society, led to<br />
an obvious increasing trend for companies to use these networks in the area of a new<br />
type of commerce, electronic commerce. Besides the old services mentioned, this type<br />
of commerce, also uses new ones. It is, for example, the ability to make purchases<br />
over the network, electronic "on" web catalogs consultation or “off” web catalogs<br />
consultation on a CD-ROM and the possibility of paying via credit card or some<br />
electronic purses. For others, trade business on the Internet is the business network<br />
that runs between suppliers and customers as an alternative option for "traditional"<br />
communication by fax, dedicated communication lines or EDI on value-added<br />
networks. Finally, another form of Internet commerce involves the transfer of<br />
documents - from contracts and orders pro forma, to photos or voice recordings.<br />
4.1.1. E-commerce system architecture<br />
To build an e-commerce system, the architectural need is to collaborate with four<br />
components (electronics / computer subsystems) for the following roles:<br />
(a) Client. The first component is a classic equipment, a PC connected directly (via<br />
an ISP) or indirectly (a corporate network) to the Internet. The buyer uses this<br />
equipment to browse and shop.<br />
(b) Trader. The second component is a computer system (hardware & software),<br />
usually located at the dealer, which also hosts updated electronic catalog of products,<br />
available to be ordered online on the Internet.<br />
(c) Transactional system. The computer system (hardware & software) responsible<br />
for processing orders, taking payment, records and other business aspects involved in<br />
trading.<br />
(d) Payment Gateway. A computer system which is responsible for the routing of<br />
payment instructions within the financial and banking networks, including credit card<br />
verification and authorization of payments. This system acts as a gate linking the<br />
global network and Internet-banking financial subnet, it is the gate through which<br />
access is controlled by a gatekeeper, based on specific credit card information (card<br />
type, card no.). From the payment instructions, the "goalkeeper" redirects the<br />
information to central card information (CC - a server certificate to this purpose and<br />
approved by the issuing bank). In this place the card issuing bank is identified and the<br />
payment instructions are forwarded to the bank server that connects networks interbank.<br />
Once the information reached the bank network which is working with the<br />
buyer, a series of checks regarding the authenticity of the card and available credit are<br />
made (automatically). Depending on the outcome of these checks, the bank decides<br />
either payment (bank transfer - the trader's account can be opened in any bank), or<br />
~ 1101 ~
efuses this payment. In both cases, the outcome of the decision (payment<br />
confirmation or refusal) is sent in real time, following the chain of servers in reverse<br />
to the customer (Jacobs & Whybark, 2000).<br />
4.1.2. Models of e-trade<br />
The most widely implemented models for e-trade are:<br />
B2B transactions. B2B is an e-trade model in which all participants are companies or<br />
other organizations. B2B field is a very promising, due to Internet involvement at the<br />
corporate level. Recent studies show that there are more than 1.1 million Internet<br />
users from their work place (including schools and universities) and over 42,000 toplevel<br />
domains registered.<br />
B2C transactions. This type of transaction is made between individual buyers and<br />
sellers from the large companies. In this case, the human factor is more important and<br />
the interactivity is the basic characteristic of the purchasing decision. Customers buy<br />
from people they know and they trust. Clients trust the brand firstly because they trust<br />
the managers of the company, its specialists and / or its employees. That is why the<br />
companies should treat very carefully the public image of its employees. An online<br />
community has as main objective to get into contact persons with common concerns.<br />
(Canda et al., 2010)<br />
B2G transactions. Governments use the channels of e-trade to increase efficiency of<br />
operations and to improve customer service. One area of concern for governments in<br />
the area of business is wide-scale use of the Internet and WAN networks, to<br />
disseminate information, opportunities, quotations received from vendors/suppliers of<br />
goods and services. Government involvement in e-trade has a catalytic effect on local<br />
business, in a particular country. Governments are the biggest purchasers of goods<br />
and services from the private sector. Building a critical mass of online shoppers to<br />
assist the emergence of an e-trade business community, requires the active<br />
involvement of governments, not only from a legal perspective but also as a<br />
participant in electronic trade as an ideal source of training and technical assistance to<br />
new firms, just born in e-trade. (Jacobs, 2004)<br />
4.1.3. The benefits of electronic commerce<br />
With the support of the Internet and the use of specific software packages, electronic<br />
commerce had and still has advantages and benefits for firms, individual consumers<br />
and society.<br />
Benefits for business:<br />
• Extension to international markets by providing services and performance;<br />
• Decrease of the costs for design, processing, distribution, storing and finding<br />
paper-based information, by creating an attractive web page for a virtual shop.<br />
The customized web sites, purchase suggestions and tailored special offers can<br />
substitute for face to face interaction;<br />
• Lower communication cost;<br />
~ 1102 ~
• Reliability and safety. Parallel servers, hardware redundancy, fail-safe<br />
technology, information encryption and firewalls sites can meet this<br />
requirement;<br />
• Construction of an electronic value chain in which to focus on a limited<br />
number of core competencies - the opposite of a one stop shop (electronic<br />
stores can be specific or general, if properly programmed).<br />
Benefits for consumers:<br />
• The possibility for consumers to purchase or make transactions 24 hours a day,<br />
all year round, from almost any location;<br />
• Give consumers more choices of products and prices;<br />
• Consumers have certainty about the value. Vendors can achieve this by<br />
offering a product or a product line that attracts potential customers through<br />
competitive prices;<br />
• Consumers can receive relevant information in seconds, not days or weeks;<br />
• Makes it possible to participate in virtual auctions;<br />
• Urging consumers to buy. Traders on the internet can provide such help<br />
through ample comparative information and good search facilities;<br />
• Allows consumers to interact with other buyers in electronic communities and<br />
to compare experiences;<br />
Benefits for society:<br />
• Providing a sense of community through chat, forums that require the<br />
involvement of customer, loyalty schemes and affinity programs;<br />
• Allows more people to work from home and buy from home and hence less<br />
traffic on the streets and low air pollution;<br />
• Allow certain goods to be sold at lower prices, with advantages for those with<br />
lower incomes;<br />
• Increase efficiency and/or improve quality;<br />
• Provides an organization careful and agile enough to respond quickly to any<br />
changes in the economic, social and physical environment. (Jacobs & Whybark,<br />
2000)<br />
4.2. ERP: Enterprise Resource Planning<br />
Systems for enterprise resource planning (ERP) have emerged as a way to keep track<br />
of company’s inventory and developed trough the integration of traditional<br />
management functions, such as the financial, payroll and human resources, with other<br />
functions, including production and distribution. Currently, ERP systems continue to<br />
evolve and already we can observe acronyms, such as extended ERP, ERP II,<br />
enterprise business applications EBA, enterprise commerce management ECM, or<br />
comprehensive enterprise applications EBA. (Hotăran & Horga, 2010). In 1960, the<br />
main objective of an ERP was the inventory control systems. In the '70s, the midsized<br />
companies could afford to buy computers, leading to the revision of the<br />
traditional cycle of production and resource allocation. We have developed systems<br />
for material requirements planning (MRP) to ensure that the company has in stock the<br />
required quantity of material. Determining the amount of components needed,<br />
however, was not sufficient. To improve efficiency, companies have to plan their<br />
production based on materials, equipment and priorities. Thus, we have implemented<br />
~ 1103 ~
capacity requirements planning (CPR). But computers with reduced capacities didn’t<br />
allow adding in the calculation of CRP equation, variables such as downtime or<br />
maintenance. As a result, each work station was modeled as having infinite capacity<br />
and the planning still remained unclear. The next step was the development of<br />
manufacturing resource planning (MRPII), which integrated business planning, sales,<br />
support activities and other functions, so that they can be coordinated.<br />
In the '90s, each functional department of the company benefited from computer<br />
support. Programs and departments' databases were not connected, repeated<br />
introduction of the same data meant loss of time, data arising from individual<br />
applications were inconsistent and attempts to analyze them only lead to chaos at the<br />
decisions level. In addition, consumers increasingly required reduced delivery times.<br />
All this, combined with the Japanese philosophy of the production process, have led<br />
Western businesses to reassess the production process. "Just in time" (JIT), which was<br />
aimed at eliminating wastage and unproductive time, required the development of<br />
much closer relationships between suppliers and manufacturers. On the one hand,<br />
producers had to know the cost of materials when an order was settle. On the other<br />
hand, those who dealt with the supply had to know the sales plan in advance. There<br />
was the need to develop a common database and this is the moment that can be<br />
considered the birth of ERP systems.<br />
When we talk about ERP, we rarely think about planning how to spend resources.<br />
Rather we think of a company's vision on business, in other words, the company and<br />
all the components seen as a unified whole, rather than isolated segment of activity.<br />
On the one hand, ERP refers to software infrastructure that provides internal cohesion<br />
in a company, and on the other hand, it supports external business processes in which<br />
the company is involved.<br />
4.2.1. How can ERP improve business performance?<br />
An ERP system enables decision makers to achieve full analysis of a business plan, to<br />
achieve better communication within the company, to improve cooperation and<br />
interaction between various departments. Through the option of simulation and trough<br />
the flexible and dynamic nature of applications, we can make forecasting plans,<br />
assessments, pre-definitions of the evolving trends for the industry which includes the<br />
company, qualitative analysis, all this integrated with e-business technologies and<br />
communication on-line.<br />
C<br />
L<br />
I<br />
E<br />
N<br />
T<br />
S<br />
Figure 4. Conceptual diagram of an ERP system<br />
Sales and<br />
distribution<br />
After-selling<br />
Services<br />
“Front-office”<br />
Applications<br />
Reports for<br />
management<br />
Unic data<br />
base<br />
Staff<br />
payroll<br />
~ 1104 ~<br />
Financial<br />
Accounting<br />
Production<br />
Stocks<br />
“Back-office” Applications<br />
S<br />
U<br />
P<br />
P<br />
L<br />
I<br />
E<br />
R<br />
S
From the customer perspective an ERP can facilitate management of current<br />
operations, improve order fulfillment, improve cash flow, integrate financial<br />
information, improve customer services, improve production control, raise the<br />
efficiency in production scheduling and can adapt quickly to changing market<br />
conditions. Also, an ERP ensures the compliance with reporting requirements<br />
imposed by law, and documents provided by internal procedures, eliminating<br />
inconsistencies and redundancies in companies. (Hotăran & Horga, 2011)<br />
4.2.2. Disadvantages of an ERP system<br />
Many of the problems that organizations have with ERP systems are due to<br />
inadequate investment in training of personnel, including those implementing and<br />
testing changes, and the lack of a policy of protecting the integrity of data in ERP<br />
systems and also its use.<br />
Limitations of an ERP system include:<br />
• Success depends on the skills and employment experience, including training<br />
on how to use the system correctly.<br />
• Customizing the ERP software is limited.<br />
• Redesigning business processes to fit the industry standards set by the ERP<br />
system, may lead to a loss of competitiveness.<br />
• ERP vendors can charge sums of money for annual license renewal, which is<br />
not related to the size or profitability of the company which uses ERP software.<br />
• ERP systems are seen often too rigid and too difficult to adapt to specific<br />
production flows of companies - this is one of the main causes of their failure.<br />
• Refusal to provide internal confidential information between departments can<br />
reduce the efficiency of the software.<br />
• There are often compatibility issues with older systems used by different<br />
partners.<br />
4.2.3. ERP costs<br />
Many companies classify the ERP solutions as expensive. The costs of an ERP<br />
solution may vary depending on many factors and are, in fact, a plurality of other<br />
costs. So, in the price cost of an ERP, we include the software licenses, the cost of<br />
implementing the solution, maintenance costs, costs of integration with external<br />
applications and the maintenance of those interfaces and also hardware and<br />
telecommunications infrastructure costs. All these elements depend on the specifics of<br />
the solution in a particular company: the processes that need to be implemented, the<br />
number of users, duration and purpose of implementation.<br />
Many users complain about the cost overruns from the initial budget approved for<br />
purchasing an ERP system. The emergence of these hidden costs is caused by lack of<br />
consistency between the position during the negotiation and implementation. In other<br />
words, at the negotiation level, the customer requirements are at the minimum level<br />
because they want to decline the purchase price, but during implementation, there<br />
requests go to a maximal level, in disagreement with the initial negotiation. Secondly,<br />
it is the cost of licenses, and this means also the cost of service configuration that<br />
requires additional software (network, database, etc.) and also the need for<br />
modernization of hardware that ERP providers believe that there are included in the<br />
ERP price. Third, during implementation, with deeper understanding of the<br />
~ 1105 ~
application for the beneficiary, it reveals other solutions or necessities that attract<br />
additional costs.<br />
Underestimated costs:<br />
• Training represents, on the unanimous opinion of those who have implemented<br />
ERP systems, one of the most underrated aspects of the budget.<br />
• Integration and testing of ERP package with other software tools used by the<br />
company is often an activity whose cost is underestimated.<br />
• Conversion of data from the format required by the old applications to the<br />
format required by the ERP systems is an activity that proves to be very costly<br />
and difficult to estimate quantitatively.<br />
• Maintenance. Developing such a solution actually does not stop, ever.<br />
Customers always have special requirements to change, but there are also<br />
requirements that arise from changes in the law.<br />
4.2.4. ERP II<br />
The evolution of technology is subject to the laws of nature, and is subject to "natural<br />
selection" and "adaptation to environment." These laws express a simple principle: the<br />
things that do not adapt do not survive environmental change. Business is business<br />
and that information systems that support them, are no exception to the law of<br />
evolution. ERP II represents the next stage of development of enterprise resource<br />
planning systems. Technology has entered into the communication era, particularly<br />
with the growth of the Internet. ERP II is actually an ERP adapted to the reality of the<br />
Internet, through changes in functionality, technology and architecture. The most<br />
obvious change is the shift in emphasis from activities focused on the internal<br />
workings of the company, to the integration and external collaboration.<br />
Table 4. ERP applications versus ERP II applications<br />
ERP ERP II<br />
ROLE Optimizing enterprise Integrating the value chain,<br />
FUNCTION Production, sales and distribution, financial<br />
processes<br />
~ 1106 ~<br />
collaborative-commerce opportunities<br />
Vertical processes, horizontal<br />
processes, custom industrial<br />
applications<br />
PROCESSES Internal, hidden External connection including suppliers<br />
and customers<br />
ARCHITECTURE Web-aware, closed, monolithic Web-based, open, modular<br />
DATE Internally generated and consumed Published and shared internally and<br />
externally<br />
(Source: Gartner Research)<br />
4.2.5. ERP solution - Microsoft Dynamics Nav<br />
This software was purchased in 2002 by Microsoft. It passed successive stages of<br />
integration into Microsoft's Navision portfolio of solutions – from “The way to grow”,<br />
to “Microsoft Business Solutions Navision” and then to its current name “Microsoft<br />
Dynamics Nav”. Microsoft Dynamics NAV is an application on two or three layers.<br />
The two layer architecture is the most used. The three layer architecture means that<br />
between the client and server, business logic is taken by Navision Application Server,<br />
which performs operations without user interface (eg. barcode reader).
There are two methodologies for implementation:<br />
• standard methodology<br />
Sales Diagnosis Analysis Design Development<br />
• rapid implementation methodology<br />
A reliable platform for development. Microsoft Dynamics NAV provides the<br />
functionalities needed to run a business. Thus, the open architecture of Microsoft<br />
Dynamics NAV, allows to Microsoft certified partners to transform the standard<br />
technological platform, into a solution adapted to the specific way of doing business.<br />
They are the only global software provider from the middle market sector which<br />
offers complete freedom to local partners searching to meet specific needs. Their<br />
partners have access to the entire source code for business logic.<br />
Open and secure platform. Object-oriented development environment of Microsoft<br />
Dynamics NAV and compact source code, make this solution easy to customize,<br />
maintain and connect to other systems.<br />
Reliable database. Whether it chose Microsoft SQL Server or Database Server for<br />
Microsoft Dynamics NAV, you can count on a reliable way of storing data. The<br />
security system controls not only the users and applications accessed, but also ensures<br />
that there will never be inconsistencies. Even if, during a post process, the computer<br />
stops, the recorded transactions will not be un-synchronized.<br />
Easy to learn. Familiar look of Microsoft Outlook makes the employee training<br />
quicker. For example, in the general accounting section, the screen will show the<br />
same interface whether it is viewed a balance, created a new account or something it<br />
is posted on a journal to an existing account. Surfing is more familiar because the<br />
interface is based on Microsoft Windows standards. Complete online support is<br />
available, on which you can even add your own suggestions.<br />
Accessing information in any language. This software provides better service to<br />
customers and suppliers. It offers them the inventory’s descriptions, printed reports<br />
and invoices, in their own language and currency.<br />
DISCUSSION AND CONCLUSIONS<br />
In our opinion, a supply chain of the future will be more:<br />
• Instrumented: the information that was created before by human resource<br />
will be increasingly more handled by computers. Stocks will self-count. Containers<br />
will detect their own content. Pallets will report if they have reached the wrong<br />
location.<br />
• Interconnected: the whole chain will be connected - not only the customers,<br />
suppliers and IT systems, but also the elements, the products and other small objects<br />
~ 1107 ~
used to monitor the supply chain. Extensive connectivity will enable supply chain<br />
networks worldwide to plan and make decisions together. The quality and<br />
performance management of companies to manage economic risk, social and<br />
environment can be measured today and the information can be sent to investors so<br />
they can track and choose the top companies. (Ciora, 2010)<br />
• Intelligent: decisions taken within the supply chain will also be more<br />
intelligent. Advanced modeling will help decision makers to revue their options<br />
before heading to a dynamic set of risks and restrictions. Intelligent systems will be<br />
capable to automatically make decisions, increasing response and reducing the need<br />
for human intervention.<br />
Thus, we can say that the future supply chain will be eager for change, will have a<br />
capacity for innovation beyond customer imagination, will be integrated globally, will<br />
withstand environmental perturbations and will be authentic. In all this characteristics<br />
we can see clearly the involvement of evolved information flows at different level.<br />
Regarding the trend companies are following to adopt information systems, we would<br />
recommend first an in-depth analysis of strategies and business plans, an alignment<br />
with short-term priorities and only afterwards should the actual implementation be<br />
considered. Otherwise, the investment could not lead to the desired benefits.<br />
Management information systems can be seen also as an offensive and defensive<br />
weapon in a changing environment. In our opinion, the perfect integration can be<br />
made if you look closely at both approaches. It is important to stay with one eye at the<br />
detail and one eye at the system, explaining in this way why some managers from the<br />
biggest companies are not able to see the forest for the trees.<br />
REFERENCES<br />
Boddy, D., Boonstra, A. & Kennedy, G. (2004) Managing information systems: an<br />
organisational perspective - second edition, London: Prentice Hall/Financial Times.<br />
Canda, A., Rusescu, M. & Pantea, C. (2010) “Revealing the people who empower the social<br />
networks – an exploratory research of the Romanian market”, 17th International<br />
Economic Conference – IECS 2010, Sibiu: 30-36, ISBN 9789737399878<br />
Checkland, P. & Poulter, J. (2006) Learning for Action: A Short Definitive Account of Soft<br />
Systems Methodology and its use for Practitioners, Teachers and Students, Chichester:<br />
John Wiley & Sons, Ltd.<br />
Cioană, G. & Ohotă, A.A. (2010) “Romanian Quality Seen by an American Group”, 5th<br />
WSEAS International Conference on Economy and Management Transformation,<br />
24-26 October, 2010, Timişoara, Selected Topics in Economy and Management<br />
Transformation, vol. 2: 610-614<br />
Ciora, C. (2010) “Value creation through sustainable development”, Suplimentul revistei<br />
Calitatea - Acces la succes, year 11, no.111, ISSN 1582-2559<br />
Coronado Mondragon, A.E., Lyons, A.C. & Kehoe, D.F. (2004) “Assessing the value of<br />
information systems in supporting agility in high-tech manufacturing enterprises”,<br />
International Journal of Operations and Production Management, vol .24, no. 12:<br />
1219-1246<br />
Fattahi, R. & Afshar, E. (2006) “Added value of information and information systems: a<br />
conceptual approach”, Library Review, vol.55, no.2: 132-147<br />
Hotăran, I. & Horga, G. (2011) “ERP Software – The Opportunity to Bypass the Time of<br />
Crisis”, International Journal of Education and Information Technologies, issue 2,<br />
vol. 5: 242-249<br />
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Hotăran, I. & Horga, G. (2010) “Leadership - crucial element in implementing ERP systems”,<br />
WSEAS International Conference on Economy and Management Transformation, West<br />
University of Timisoara, October 24-26, vol 2: 388-393<br />
Jacobs, B. (2004) “Using soft systems methodology for performance improvement and<br />
organisational change in the English National Health Service”, The Journal of<br />
Contingencies and Crisis Management, vol.12, no.4: 138 – 149<br />
Jacobs, F.R. & Whybark, D.C. (2000) Why ERP A Primer on SAP Implementation, New<br />
York: Irwin/McGraw-Hill<br />
Malmqvist, M. (2008) First Line Manager Role and Information Systems: A Case Study at<br />
Volvo IT of how Information Systems Can Help the First Line Manager Better Balance<br />
the ‘Soft’ and ‘Hard’ Tasks They Face, thesis work in Informatics, report no.2008:019,<br />
Gothenburg: Library of Chalmers University of Technology<br />
Petcu, A.J. & Drăghici, M. (2010) “Confluences and interferences between TQM and Lean<br />
Six Sigma”, 17th IGWT Symposium and 2010 International Conference on Commerce,<br />
Facing the Challenges of the Future: Excellence in Business and Commodity Science,<br />
21 – 25 September 2010<br />
Yen, H.R. & Sheu, C. (2004) “Aligning ERP implementation with competitive priorities of<br />
manufacturing firms: an exploratory study”, International Journal of Production<br />
Economics, no.92: 207-220<br />
Volvo Group (2010) “Volvo IT Company Presentation”, available at<br />
http://www.volvoit.com/SiteCollectionDocuments/Volvo%20IT/documents/other/Volv<br />
o%20IT%20company%20presentation%202010%20en.pdf (accessed 19.03.2011)<br />
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BEYOND REPORTING IN BUSINESS INTELLIGENCE:<br />
INTELLIGENCE THROUGH ANALYTICS<br />
Irina Bogdana PUGNA 1 , Felicia ALBESCU & Robert SOVA<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
We are witnessing a new shift in business intelligence: the move from traditional analytics to<br />
predictive analytics, as a distinct new software sector. In this paper, we try to present some<br />
aspects regarding predictive analytics and their role in providing a deeper insight of data, in<br />
“adding” intelligence to BI applications. After presenting some notions about predictive<br />
analytics – what it means and how it differs from terms like data mining or business<br />
intelligence itself, we discuss about the process of predictive modeling, about different types<br />
of business users and analytical tools that we can integrate in the BI platform of an<br />
organization. At the end, we propose a BI cycle that should be extended to cover all the<br />
decision making process, including the decision itself, the action generated by it and to<br />
provide feedbacks in order to update it accordingly with the changes of business environment<br />
– as both as a way and as a mean to a predictive performance management.<br />
KEYWORDS: predictive analytics, business analytics, data mining, analytical modeling,<br />
analytical tools<br />
INTRODUCTION<br />
Companies are increasingly turning to a new management discipline called predictive<br />
analytics to compete and thrive. Rather than relying on intuition when pricing<br />
products, maintaining inventory or hiring talent, managers are using data, analysis and<br />
systematic reasoning to improve efficiency, reduce risk and increase profits.<br />
In simple terms analytics means using quantitative methods to derive insights from<br />
data, and then drawing on those insights to shape business decisions and, ultimately,<br />
improve business performance. Thus predictive analytics is emerging as a gamechanger.<br />
Instead of looking backward to analyze "what happened?" predictive<br />
analytics help executives answer "What's next?" and "What should we do about it?”.<br />
Business analytics are accessible for managers only through business intelligence. But<br />
is there a difference and, if so, which is it, between business intelligence and business<br />
analytics?<br />
Business intelligence (term coined in 1989 by Howard Dresner, researcher at the<br />
Gartner Group) is considered more and more as being an “umbrella term” to cover a<br />
number of methodologies and ideas designed for the increase of efficiency and<br />
profitability in the corporate workplace. Some consider it as being primarily data<br />
reporting and visualization, others include business performance management. For<br />
1 Correspondence address: Irina – Bogdana PUGNA, PH.D, Academy of Economic Studies,<br />
Bucharest; email: irina.bogdana@yahoo.com<br />
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database vendors, is mainly about data extraction, transformation and integration,<br />
while for the analytics vendors is mainly about statistical analysis and data mining.<br />
C<br />
o<br />
m<br />
p<br />
e<br />
t<br />
i<br />
t<br />
i<br />
v<br />
e<br />
A<br />
d<br />
v<br />
a<br />
n<br />
t<br />
a<br />
g<br />
e<br />
Standard<br />
reports<br />
Query drilldown<br />
Ad hoc reports<br />
Figure 1. Intelligence through analytics<br />
Statistical analysis<br />
Alerts<br />
What happened?<br />
Forecasting<br />
Degree of intelligence<br />
~ 1111 ~<br />
Predictive<br />
modeling<br />
Where exactly is the problem?<br />
How many, how often, where?<br />
(Source : SAS, 2008:5)<br />
Optimization<br />
Why is these happening?<br />
What actions are needed?<br />
What’s the best<br />
that can happen?<br />
What will happen next?<br />
What if these trends continue?<br />
For many years, BI was limited to assist and support the process of extracting<br />
valuable information and knowledge from large collections of data via sophisticated<br />
analytic and statistical tools. Traditionally, BI could be broken in three components:<br />
• information sources, or the database and software applications where data<br />
resides;<br />
• integration – the act of compiling data from various and heterogeneous sources<br />
before it was analyzed;<br />
• analysis and reporting of the data itself.<br />
In other words, it is all about collection, integration, analysis and presentation of<br />
business information using analytic applications.<br />
Business analytics is the analytical process of reasoning, forecasting and measuring<br />
business actions and processes based on extracted patterns in collected business data<br />
and business plans. The analytic applications offer feedback about the “status” of the<br />
organization; they adapt to the business model, answer questions about the business<br />
and are optimized to answer to the user questions.<br />
Lately, business analytics is the new term embraced on the market. The term business<br />
intelligence has been watered down so much that seems to be less attractive to<br />
business users. It’s enough to compare the interest on those two terms in the last years<br />
as it is shown by the volume search relatively to each of them on the Google.
Figure 2. Google Trends on “business intelligence” – slow decline<br />
Figure 3. Google Trends on “business analytics” – rising sharply<br />
(Source Google st, 2011: 16)<br />
But, in the end, which is the difference between business intelligence and business<br />
analytics? For example, one of the most important vendor on BI market consider that<br />
business analytics is an umbrella term including data warehousing, business<br />
intelligence, enterprise information management, enterprise performance<br />
management, analytic applications, and governance, risk, and compliance. But other<br />
vendors use “business analytics” to indicate some level of vertical/horizontal domain<br />
knowledge tied with statistical or predictive analytics.<br />
Generally, when a new term is introduced (at least in information technologies field),<br />
people are tempted to dismiss the old one as “just technology driven” and “backward<br />
looking” while the new term is “business oriented” and “actionable”.<br />
There are two things worth differentiating:<br />
~ 1112 ~
• The first is the business aspect of BI — the need to get the most value out<br />
of information. This need hasn’t really changed in over fifty years<br />
(although the increasing complexity of the world economy means it’s ever<br />
harder to deliver). And the majority of real issues that stop us from getting<br />
value out of information (information culture, politics, lack of analytic<br />
competence, etc.) haven’t changed in decades either.<br />
• The second is the IT aspect of BI — what technology is used to help<br />
provide the business need. This obviously does change over time —<br />
sometimes radically.<br />
There are still some BI professionals that equate “reporting” or “monitoring” with<br />
analytics, and may be is not entirely inaccurate to do so. Business people can use<br />
reports to understand the business, analyze root causes and guide future activities. For<br />
some users, such as executives and managers, reports and dashboards are optimal<br />
analytical tools; for others, such as business analysts or analytical modelers there is a<br />
need to move beyond reporting to analytical and predictive technologies with richer<br />
functionality.<br />
Still, at the end of the date, nobody important cares how we call it. If we are in charge<br />
of a project, what really matters is working out the best way to leverage the<br />
information opportunity in the organization, and putting in place appropriate<br />
technology to meet that business need.<br />
Nevertheless, it’s true that we are witnessing an unprecedented shift in business<br />
intelligence (BI), largely because of technological innovation and increasing business<br />
needs. The latest shift in the BI market is the move from traditional analytics to<br />
predictive analytics. Although predictive analytics belongs to the BI family, it is<br />
emerging as a distinct new software sector.<br />
1. PREDICTIVE ANALYTICS - the science that makes decision smarter<br />
How we can define predictive analytics? Analytics is defined as being “the science of<br />
analysis” and analysis “the tracing of things to their source, and the resolving of<br />
knowledge into its original principles”. From a business perspective, analytics is about<br />
understanding the root causes of business events and conditions. Typically, business<br />
people identify root causes by asking a series of questions in a heuristic fashion (the<br />
answer to each question sheds new insights and generates new questions, and the<br />
process continues until one discovers desired insights).<br />
Predictive analytics is a broad term describing a variety of statistical and analytical<br />
techniques used to develop models that can be used to predict future behavior and<br />
events. The form of those predictive models varies, depending on the behavior or<br />
event that they are predicting. The core element of predictive analytics is the<br />
predictor, a variable that can be measured for an individual or entity to predict future<br />
behavior. Multiple predictors are combined into a predictive model, which, when<br />
subjected to analysis, can be used to forecast future probabilities with an acceptable<br />
level of reliability. In predictive modeling, data is collected, a statistical model is<br />
formulated, predictions are made, and the model is validated (or revised) as additional<br />
data become available.<br />
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Predictive analytics combine business knowledge and statistical analytical techniques<br />
to apply with business data to achieve insights. These insights help organizations<br />
understand how people behave as customers, buyers, sellers, distributors and so on.<br />
Multiple related predictive models can produce good insights to make strategic<br />
company decisions, like where to explore new markets, acquisitions, and retentions;<br />
find up-selling and cross-selling opportunities; and discovering areas that can improve<br />
security and fraud detection. Predictive analytics indicates not only what to do, but<br />
also how and when to do it, and to explain what-if scenarios.<br />
1.1 Predictive analytics versus business intelligence and data mining<br />
BI tools fall into the following categories:<br />
• Report and visualize what has happened – most of the currently available tools<br />
fall into this category<br />
• Understand why it has happened – some tools are available at the moment,<br />
while more and more tools will be available in the next years<br />
• Predict what will happen – few tools available today, more will start to appear<br />
in the next years<br />
HIGH<br />
LOW<br />
COMLEXITY<br />
What<br />
happened?<br />
Why did it<br />
happened?<br />
Figure 4. BI technologies<br />
What’s<br />
happening<br />
now?<br />
Reporting Analysis Monitoring<br />
BUSINESS VALUE<br />
What might<br />
happen?<br />
(Source: W.Ekerson, 2007: 5)<br />
~ 1114 ~<br />
BI technologies<br />
Prediction<br />
HIGH<br />
Predictive analytics<br />
Dashboards, scorecards<br />
OLAP and<br />
visualization tools<br />
Query,<br />
reporting<br />
and search<br />
tools<br />
The other BI technologies – query and reporting tools, online analytical processing<br />
(OLAP), dashboards and scorecards are deductive in nature, as they examine what<br />
happened in the past. Business users must have some sense of the patterns and<br />
relationships that exists within the data based on their personal experience. They use<br />
query, reporting, and OLAP tools to explore the data and validate their hypotheses. As<br />
for dashboards and scorecards, they take deductive reasoning to a step further by<br />
presenting to the users a de facto set of hypotheses in the form of metrics and key<br />
performance indicators (KPIs) that users examine on a regular basis.<br />
Predictive analytics works the opposite way: it is inductive. It doesn’t presume<br />
anything about the data; it rather lets data lead the way. Predictive analytics employs<br />
statistics, machine learning, neural computing, computational mathematics and<br />
artificial intelligence techniques to explore all the data, and not only a narrow subset
of it, to dig out meaningful relationships and patterns. It is important to note that<br />
predictive analytics is more than statistics – some call it “statistics on steroids” (W.<br />
Eckerson, 2007). It’s true that nearly all analytical modelers use descriptive statistics<br />
to understand the nature of data that has to be analyzed, but there are a lot of<br />
predictive techniques (neural networks, decision trees, genetic algorithms) that take<br />
advantage of increased computer processing power to perform complex calculations<br />
that often require multiple passes through extremely large volumes of data.<br />
At that point, we can ask: what’s the difference than between predictive analytics and<br />
data mining? Because the term data mining has been used - especially by the software<br />
companies, while academics and researchers have used the term “knowledge<br />
discovery” instead - to describe the techniques and processes involved in creating<br />
predictive models. Both data mining and predictive analytics apply sophisticated<br />
mathematics to data in order to solve business problems. But when we talk about data<br />
mining, we are usually referring to an analytical toolset that automatically searches for<br />
useful patterns in large data sets. On the other side, predictive analytics is an analyst –<br />
guided (not automatic) discipline that uses data patterns to make forward –looking<br />
predictions by evaluating multiple data patterns. Data mining searches for clues, while<br />
predictive analytics delivers answers that can guide to a “what next” action.<br />
Figure 5. Data mining versus predictive analytics<br />
Data<br />
mining<br />
Explore<br />
~ 1115 ~<br />
Predictive<br />
analitics<br />
Answers<br />
What next?<br />
Data mining is often one stage in developing a predictive model; it’s automated<br />
techniques are used to isolate the most data variables within a vast field of<br />
possibilities. These variables are used to build a mathematical model that predicts the<br />
future behavior consistently.<br />
The term data mining it‘s so “out of fashion” that vendors and consultants now<br />
embrace the term “predictive analytics” or “advanced analytics” or just “analytics” to<br />
describe the nature of tools they offer. But not all the analytics are predictive! In fact,<br />
there are only two major types of predictive analytics: supervised learning (the<br />
process of creating predictive models using a set of historical data that contains the<br />
results we want to predict) and unsupervised learning (previously known results are<br />
not used to train its models).
Figure 6. Types of predictive analytics<br />
Supervised<br />
learning<br />
Classification<br />
Regression<br />
Time series analysis<br />
Analytic model<br />
~ 1116 ~<br />
Clustering<br />
Association<br />
Unsupervised<br />
learning<br />
We can “predict” that the future of data mining lies in predictive analytics. Although<br />
the terms data mining and data extraction are often confused with each other, data<br />
mining is more than data extraction It is the extraction of hidden predictive<br />
information from large databases or data warehouses. Data mining, also known as<br />
knowledge-discovery in databases, is the practice of automatically searching large<br />
stores of data for patterns. A predictive analytical model is built by data mining tools<br />
and techniques.<br />
Traditional business intelligence (BI) tools extract relevant data in a structured way,<br />
aggregate it and present it in formats such as dashboards and reports. Like data<br />
mining, BI tools are more exploratory than action-oriented, but the exploration is<br />
more likely driven by a business user than an analyst. BI helps businesses understand<br />
business performance and trends. It focuses on past performance, while predictive<br />
analytics forecasts behavior and results in order to guide specific decisions.<br />
Predictive analytics also focuses on distilling insight from data, but its main purpose<br />
is to explicitly direct individual decisions. Many BI suites now include some<br />
analytics, ranging from report-driven analytics that synthesize past performance data<br />
to predictive analytics used in forecasting.<br />
Figure 7. Business intelligence versus predictive analytics<br />
Business<br />
intelligence<br />
INSIGHT<br />
Predictive<br />
analytics<br />
What’s happened? What to do?<br />
ACTION
Traditional analytical tools claim to have a total integrated view of the enterprise or<br />
business, but they analyze only historical data—data about what has already<br />
happened. Traditional analytics help gain insight for what was right and what went<br />
wrong in decision-making. Today’s tools merely provide rear view analysis.<br />
However, one cannot change the past, but can prepare better for the future and<br />
decision makers want to see the predictable future, control it, and take actions today to<br />
attain tomorrow’s goals.<br />
Predictive analytics employs both a microscopic and telescopic view of data allowing<br />
organizations to see and analyze the minute details of a business, and to peer into the<br />
future. Traditional BI tools cannot accomplish this functionality. Traditional BI tools<br />
work with the assumptions one creates, and then will find if the statistical patterns<br />
match those assumptions. Predictive analytics go beyond those assumptions to<br />
discover previously unknown data; it then looks for patterns and associations<br />
anywhere and everywhere between seemingly disparate information.<br />
1.2 The business value of predictive analytics<br />
Predictive analytics can help companies optimize existing processes, better<br />
understand customer behavior, identify unexpected opportunities and anticipate<br />
problems before they appear. There is no doubt that predictive analytics can yield a<br />
substantial ROI. Nevertheless, there are many organizations that have yet to employ it<br />
- according to a survey conducted in august 2010 by TDWI (The Data Warehousing<br />
Institute) only 30% of organizations have fully or partially implemented predictive<br />
analytics, while more than 50% were still exploring or have no plans about it.<br />
We can list a lot of reasons to justify that a company needs predictive analytics; these<br />
are only some of them:<br />
• Get a higher return on data investment<br />
• Find hidden meaning in data<br />
• Look forward, not backward<br />
• Deliver intelligence in real time<br />
• Discover unexpected opportunities<br />
• See assumptions in action<br />
• Empower data-driven decision making<br />
If that’s so, why we don’t find predictive analytics wide spread in most of the<br />
organizations? Many IT managers and some business managers understand the value<br />
that predictive analytics can bring, but most are still wondering where to begin.<br />
Analyzing data is not easy. Finding people who have sufficient knowledge of the<br />
business processes, underlying data structures, and data access and analysis tools is<br />
challenging. Also, preparing organizational data so that business people can access<br />
and trust it is difficult, time-consuming and expensive. The analytical tools – like<br />
spreadsheets, desktop databases, reporting tools – are not so evolved and haven’t<br />
changed much in the past years. But there are many new analytical tools (like visual<br />
discovery and workgroup BI tools) and technologies designed to improve the<br />
productivity of business analysts and preserve information consistency throughout an<br />
organization.<br />
~ 1117 ~
2. THE PROCESS OF PREDICTIVE MODELING<br />
The process of predictive modeling requires great skill and is so important that it must<br />
be integrated in a clear methodology ( in fact, in 1996 was created the first industry<br />
standard methodology called CRISP – Cross Industry Standard Process for Data<br />
Mining). So most analytic modelers adhere to a methodology to create predictive<br />
models. But, whatever which methodology, explicit or implicit, is followed, the<br />
processes of creating predictive models integrate the following steps:<br />
� Project definition – define the business objectives and desired outcomes and<br />
translate them into predictive analytic objectives and tasks. That requires a<br />
close interaction between the business and analytic modeler.<br />
� Exploring the data – analyze source data to determine the most appropriate<br />
data and model building approach.<br />
� Data preparation – select, extract and transform data upon which to create<br />
models.<br />
� Model building – create, test and validate models and evaluate whether they<br />
will meet project goals.<br />
� Deployment – apply model results to business decisions or processes.<br />
Deploying analytical models can be achieved in more than one way : share the<br />
model (share insights with business users via a presentation), score the model (<br />
transform the model in a SQL statement or programming code and then apply<br />
it to every record in the database ), embed the model in a business intelligence<br />
report or in an application (so it drives business actions automatically).<br />
� Model management – manage models to improve performance, control access,<br />
promote reuse and minimize overhead. Even if now few organizations are<br />
concerned about model management, the demand for that particular activity<br />
will increase to comply with new compliance regulations.<br />
Figure 8. The process of predictive modeling<br />
Data cleaning and organizing<br />
Data<br />
Mining<br />
Predictive<br />
model<br />
development<br />
Predictive model<br />
Operational data<br />
External data<br />
Deployment : SHARE / SCORE /EMBED IN APPLICATIONS<br />
Model Management<br />
~ 1118 ~
2.1 Analytics get more embedded into business applications<br />
Business intelligence traditional tools are not an ideal environment for creating<br />
sophisticated models with complex algorithms. But there is sometimes a fine line<br />
between BI tools - that can create reports and support any department or domain - and<br />
analytic applications, which are solutions that consist of a set of predefined reports<br />
that enable business users to manage a variety of integrated processes within a single<br />
domain. Many BI and application vendors are delivering packaged analytic<br />
applications that embed predictive models, which are easy to use as the user is not<br />
required to create analytical models - he needs only to know how to interpret the<br />
results.<br />
According to a research conducted by TDWI (The Data Warehousing Institute) in<br />
2009 the MAD (Monitor, Analyze and Drill to detail) framework represents the<br />
optimal way to design a BI environment to meet the analytical needs of casual<br />
business users.<br />
Analyze<br />
Drill<br />
Monitor<br />
Figure 9. MAD framework<br />
Graphical<br />
KPIs<br />
Dimensional views and<br />
filters<br />
Operational queries and reports<br />
Executives/<br />
Managers<br />
(Source: W. Eckerson, 2009:9)<br />
~ 1119 ~<br />
Managers/<br />
Analysts<br />
Analysts/<br />
Workers<br />
The monitoring layer consists of graphical KPIs (Key Performance Indicators) that<br />
enable business users to asses the status and trend of KPIs at a glance. If a KPI value<br />
is out of order, they can drill down to the analysis layer to explore the KPI from<br />
multiple perspectives or dimensions using filters. Once they discover the root cause of<br />
the problem, they can drill to atomic-level data in the data warehouse or source<br />
system to identify the customers or products affected by the problem and take action.<br />
The monitoring layer is usually supported by a portal or dashboard interface, the<br />
analysis layer by an OLAP tool, and the drill-to-detail layer by dynamically generated<br />
queries into a data warehouse or source application. BI applications based on MAD<br />
framework address 60 to 80% of the questions asked by casual users (according to the<br />
study quoted before).<br />
Vendors are starting to expand the MAD framework to extend the analytical reach of<br />
casual users. Rather than giving casual users separate analytical tools that they likely
won’t use, a MAD solution embeds analytical capabilities into the application so that<br />
users hardly recognize that they’re crossing the boundary from casual user to<br />
analytical modeler.<br />
Analyze<br />
Drill<br />
Figure 10. The double MAD framework<br />
Current Future<br />
Monitor<br />
Graphical<br />
KPIs<br />
Dimensional views and<br />
filters<br />
Operational queries and reports<br />
~ 1120 ~<br />
Modeling<br />
WHAT-IF<br />
Advanced<br />
Analytics<br />
(Source: W. Eckerson, 2009:10)<br />
Do<br />
Collaborate and<br />
Act<br />
The monitoring layer of a double MAD application enables users to perform “what-if”<br />
analysis. They can change variables in their KPIs (by moving interactive slides) and<br />
view the impact on current and forecasted results. The analysis layer embeds more<br />
sophisticated visualization and analytical functions that make it easy to spot patterns<br />
and relationships in data. The bottom layer incorporates collaboration and closed-loop<br />
capabilities so users can share ideas about data trends and issues, update or interact<br />
with operational applications.<br />
2.2 Analytical tools<br />
With the new “analytical” trend in BI, there are a lot of analytical tools now on the<br />
market – from the “traditional” ones like spreadsheets and reporting tools to the<br />
modern ones like visual discovery or graphical modeling. The problem is how those<br />
tools can be implemented – in which BI framework – and, even more important, who<br />
are their users. First of all, we have to identify and classify different kinds of users;<br />
and there are at least two types of users that we can distinguish: the casual users<br />
(executives, managers, some business analysts) and power users (IT developers,<br />
business analysts, analytical modelers). It’s very important to understand their roles,<br />
capabilities and information requirements when it comes to business analytics (or to<br />
business intelligence). Usually, we find in organizations BI tools that are too complex<br />
for casual users but not sophisticated enough for power users. That’s why there are<br />
different types of analytical tools on the market: analytical tools for casual users and<br />
analytical tools for power users (the newest ones).
The most spread analytical tools for casual users are BI platforms and search and<br />
exploration tools. A BI platform is an integrated suite of BI modules built on a<br />
unified, services-based architecture.<br />
DELIVERY<br />
CHANNELS<br />
BI<br />
MODULES<br />
SERVICES<br />
SOURCES<br />
Figure 11. A BI platform<br />
WEB DESKTOP MOBILE PORTAL PRINTER SOCIAL<br />
MEDIA<br />
Production<br />
Reporting<br />
Security<br />
OLTP and<br />
Operational<br />
systems<br />
Ad-hoc<br />
queries<br />
Data<br />
access<br />
Data warehouse /<br />
Data mart<br />
Dashboards<br />
Scorecards<br />
~ 1121 ~<br />
OLAP End user<br />
reporting<br />
COMMON SEMANTIC LAYER<br />
Metadata Query<br />
engine<br />
Calculation<br />
engine<br />
OLAP Packaged and<br />
custom apps<br />
(Source: W. Eckerson, 2009:16)<br />
Proactive<br />
detection and<br />
alerts<br />
User<br />
access<br />
Files/<br />
Excel/XML<br />
Disconnected<br />
and mobile<br />
analytics<br />
Caching<br />
Business<br />
Processes<br />
From a casual user perspective, a BI platform should only expose the BI capabilities<br />
they need using role-based access control; from there, BI platforms should parcel<br />
information on demand using the MAD framework.<br />
The analytical tools for business analysts – a category of super users – are OLAP tools<br />
and visual discovery tools that provide “speed of thought” analysis, conforming to the<br />
way the user wants to interact with data.<br />
There are also other new types of analytic tools, for more specialized super users –<br />
like IT developers and analytical modelers. Among them: workgroup BI, analytical<br />
workbenches and functions (text analytics, graphical modeling), in-database analytics<br />
(user-defined functions, sandboxes), high performance analytical platforms.<br />
So, we have different kind of users - from manager to IT developer – of business<br />
analytics and it’s important to provide to each type the user the right analytic tool for<br />
his information and analysis needs and competencies. Business intelligence must be<br />
customized to user’s roles and personalized to their individual tastes.
3. ANALYTICS FOR ADAPTIVE BUSINESS INTELLIGENCE<br />
AND AGILE ENTERPRISE<br />
“2011 is the year of breakthrough analytics…Acceleration of analytics will support<br />
the agile enterprise. Agility is a concept that incorporates the ideas of flexibility,<br />
balance, adaptability and coordination under one umbrella in business. Analytics<br />
technologies will help businesses be more agile and will become a key business<br />
differentiator in 2011 and beyond …” (Maria Ketan, CMO and vice president, Ingres<br />
Corporation, 2011).<br />
The future of business intelligence lies in the development of systems that can<br />
autonomously and continuously improve decision making within a changing business<br />
environment, rather than tools that just produce more detailed reports based on current<br />
static standards of quality and performance. It must incorporate techniques that build<br />
autonomous learning, with feedback loops that generate prediction and optimization<br />
scenarios to recommend high-quality decision outcomes; but also with an in-built<br />
capacity to continuously improve future recommendations. To answer to that demand,<br />
developers are focusing on new-generation information infrastructures that will be<br />
more “intelligent”.<br />
In our vision, the BI cycle should be extended to cover all the decision making<br />
process, including the decision itself, the action generated by it and to provide<br />
feedbacks in order to update it accordingly with the changes of business environment<br />
(figure 12).<br />
DATA<br />
Collect<br />
Integrate<br />
Data<br />
warehouse<br />
OLAP<br />
Synthesis<br />
Aggregate<br />
INFORMATION<br />
(transformed data)<br />
Figure 12. BI cycle<br />
DM<br />
Analyze<br />
MODELS<br />
(output<br />
patterns)<br />
AI<br />
Interpret<br />
~ 1122 ~<br />
Actionable<br />
KNOWLEDGE<br />
Distribute<br />
Business<br />
analytics<br />
AI<br />
ADAPT<br />
GOALS and METRICS<br />
Act<br />
!<br />
Measure<br />
Environment<br />
These feedbacks should be covered by adaptive modules, that can automatically<br />
“adjust” the action to the new reality in order to optimize it’s result. Those adaptive<br />
modules use business analytics (measuring, forecasting and optimizing if it’s the case<br />
business actions and processes based on available knowledge and on goals and<br />
metrics established in business plans) and AI technologies. They are supposed not<br />
only to change the action (or at least to offer new actionable knowledge for that) but<br />
also to detect the change itself. This involves a shift towards predictive performance<br />
management – moving beyond simple metrics to a form of artificial intelligence based<br />
software analysis and learning.<br />
Business<br />
plan<br />
Changes<br />
impact
DISCUSSION AND CONCLUSIONS<br />
Data continues to grow, and it seems that is happening somehow out of control. But<br />
all this impressive amount of data (even if we assume that we can access and trust it,<br />
so it’s already structured an d organized in data warehouses or even analytical data<br />
marts, which is usually difficult, time-consuming and expensive) that doesn’t<br />
necessarily mean bigger or deeper insights for business. The only way for that is<br />
through powerful analytics and interactive reporting tools that deliver high<br />
performance results.<br />
Analytical tools enable greater transparency, and can find and analyze past and<br />
present trends, as well as the hidden nature of data. However, past and present insight<br />
and trend information are not enough to be competitive in business. Business<br />
organizations need to know more about the future, and in particular, about future<br />
trends, patterns, and customer behavior in order to understand the market better. To<br />
meet this demand, many BI vendors developed predictive analytics to forecast future<br />
trends in customer behavior, buying patterns, and who is coming into and leaving the<br />
market and why.<br />
As Nigel Rayner noted in his speech at the annual Gartner Business Intelligence<br />
Summit in 2009: “The business intelligence market is a perennial evergreen. While it<br />
has seen ups and downs in the past decade, its growth vector remains strong, and<br />
aggregate revenues should exceed $ 12 billion by 2014. New categories continue to<br />
emerge and be absorbed into core BI. The current crop includes business<br />
performance solutions, text analytics, predictive analytics and data mining and<br />
complex event processing. …By 2012, 33% of analytic applications applied to<br />
business processes will be delivered through course –grained application mashups.”<br />
In our opinion, business analytics, operational business intelligence, the agile<br />
enterprise, the need for powerful insight tools are the most important trends connected<br />
to business intelligence today. It’s future lies in systems that can guide and deliver<br />
increasingly smart decisions in a volatile and uncertain environment. In this context,<br />
it’s extremely important both for business managers and BI professionals to cooperate<br />
in order to implement in organizations the right analytical tools, that respond to each<br />
particular user needs: from ad-hoc report navigation to ad-hoc report creation and<br />
develop of predictive models. An information and intelligence insights partnership<br />
should function between business people of different competencies and roles<br />
regarding business intelligence. And that is where the future research must be focus<br />
on (together with attempts to define a more widely accepted methodology for the<br />
process of predictive modeling itself), as we have the tools for predictive analytics, we<br />
recognize the need and it’s business value but still “we are sitting on a mountain of<br />
gold but we’re not mining it as effectively as we could” (M. Masciandro, director of<br />
BI at Rohm & Haas: 2011).<br />
REFERENCES<br />
Albescu F., Pugna I. and Paraschiv D (2008)., “Business Competitive Intelligence – the<br />
ultimate use of information technology in strategic management”, 4 th International<br />
Conference of ASECU – Development, Cooperation and Competitiveness, Bucharest<br />
Azvine B., Cui Z., Majeed B and Spot M (2007) “Operational risk management with real time<br />
business intelligence”. BT Technology Journal vol. 25, nr. 1 :154-167<br />
~ 1123 ~
Azvine B.Cui Z.Majeed B and Nauck D.D. (2006) “Real time business intelligence for the<br />
adaptive enterprise” in <strong>Proceedings</strong> of the IEEE Joint Conference on E-Commerce<br />
Technology (CEC ’06) and Enterprise ComputingE-Commerce and E-services<br />
(EEE’06) San Francisco :222-229<br />
Blasum R. (2006) “Operational BI” available on line at www.business-code.de<br />
Davis J. (2006) “Right-time business intelligence: optimizing the business decision ycle”<br />
available on line at www.B-EYE-network.com<br />
Economist Intelligence Unit (2006) “Business Intelligence: Putting information to work”<br />
available on line at www<br />
Ekerson W.W.(2007) “Best practices in operational BI – Converging analytical and<br />
operational processes” available on line at www.tdwi.org/<br />
Ekerson W.W.(2007) “Predictive Analytics: Extending the value of your data warehouse<br />
environment” on line at www.tdi.org<br />
Ekerson W.W.(2009) “Beyond reporting: delivering insights with next generation analytics”<br />
on line at www.tdi.org<br />
FICO (2010) “Understanding predictive analytics” available on line at www.fico.com<br />
Gartner Group (2009) Business intelligence summit, interviews available at<br />
www.gartnergroup.com<br />
Heizenberg J. (2009) “BI predictions 2009: The paradox between demand and supply”<br />
available on line at www.bi-guru-nhm.com<br />
IBM (2009) “Get more from BI by understanding your analysis needs”, available online at<br />
www.informationmanagement.com<br />
Imhoff C. (2007) “Faster must go faster” available on line at www.paraccel.com<br />
Ketan M., (2011) “11 Big-data analytics predictions for 2011”, available online at<br />
http://tdwi.org/Articles/2011/03/16/Big-Data-Analytics-Predictions.aspx?Page=1<br />
Michalewicz M., Schmidt M. and Chiriac C. (2006) Adaptive Business Intelligence, Springer<br />
Books<br />
Pugna I., Albescu F. and Paraschiv D.(2009) “Adaptive and right-time business intelligence”,<br />
AMIS International Conference, Bucharest<br />
Pugna I., Albescu F. and Zaharie D.(2008) “ Business Intelligence for strategic performance<br />
measurement –BPM”, 4 th International Conference of ASECU – Development,<br />
Cooperation and Competitiveness, Bucharest<br />
Sandu D.I. (2008) “Operational and real–time Business Intelligence”, Revista Informatica<br />
Economica nr. 3 (47):33-36<br />
Tapscott D.(2008) “Business Intelligence: Actionable insights for business decision makers:<br />
available on line at www.newparadigm.com<br />
White C. (2007) “Become more agile: put operational BI to work” available on line at<br />
www.bi-research.com<br />
~ 1124 ~
PS22 Management accounting<br />
Chairperson<br />
Mathew TSAMENYI, University of Birmingham, UK<br />
SURVEY OF THE PRODUCT COSTING METHODS<br />
USED IN CZECH REPUBLIC<br />
Boris POPESKO, Petr NOVAK<br />
THE ROLE OF COSTS AND CONTROL IN ENSURING<br />
A SUCCESSFUL MANAGEMENT IN THE DECISIONAL<br />
PROCESS<br />
Stefania-Eliza BANA (PANCIU), Florinel Marian SGARDEA<br />
THE CHANGE IN MANAGEMENT ACCOUNTING<br />
IN ROMANIA<br />
Madalina DUMITRU, Daniela CALU, Gorgan CATALINA,<br />
Adriana CALU, Georgiana TOADER<br />
~ 1125 ~
SURVEY OF THE PRODUCT COSTING METHODS<br />
USED IN CZECH REPUBLIC<br />
Boris POPESKO 1 & Petr NOVAK<br />
Tomas Bata Univerzity in Zlin, Czech Republic<br />
ABSTRACT<br />
This paper presents the results of the survey focused on the usage of the different types of<br />
product costing methods in Czech enterprises performed in the years of 2004, 2007 and 2009.<br />
Results of individual surveys are compared with one another, in order to prove the expected<br />
tendencies of higher usage of modern costing methods such as Activity-Based Costing, in<br />
recent years. First part of the paper refers to previous studies of the enterprise cost structure<br />
presented by other authors and illustrates the most important reasons of the individual<br />
costing system utilization. Following part of the paper defines the basic research<br />
methodology and expected limitation of the study. In final part of the paper, results of the<br />
survey are introduced and properly discussed.<br />
KEYWORDS: cost management, costing system, overhead cost, Activity-based costing<br />
INTRODUCTION<br />
Field of the product costing techniques is one of the important features of cost<br />
management and management accounting. While the method used for product costing<br />
purposes are usually not an object of the any regulations, companies could use any<br />
method of product costing and any tape of cost allocation technique. This fact causes<br />
a high variety of used costing methods. According to traditional management<br />
accounting (Drury 2003, Garrison et al. 2010, Weygandt et al. 2010, Shim and Siegel<br />
2009) product costing methods could be divided in two major categories: job order<br />
costing and process costing. These systems differ in the object of the cost assignment.<br />
While in job order cost system, the company assigns costs to each job or to batch of<br />
goods, in process cost system companies apply costs to similar products that are massproduced<br />
in similar fashion (Weygandt et al. 2010). It is therefore unnecessary to<br />
assign costs to individual units of output (Drury 2001). Based on this definition we<br />
can expect, that choice to use either job order costing system or process costing<br />
system will be more determined by the characteristics of the company production<br />
process than by desired way of cost assignment.<br />
Objective of the study was to identify the product costing method according to used<br />
method of cost allocation. Traditionally, two different product costing systems are<br />
defined, the traditional absorption costing and alternative variable costing (Drury<br />
2001). These two major costing approaches differs from one another, by the degree of<br />
costs assigned to the cost driver. Many other methods of product costing are defined<br />
1 Correspondence address: Boris POPESKO, Tomas Bata University in Zlín, nám. T. G. Masaryka<br />
5555760 01 Zlín Czech Republic; email: popesko@fame.utb.cz<br />
~ 1126 ~
in traditional management accounting. Special category of product costing method is<br />
the Activity-Based Costing, which was designed in 1980´s and became more natural<br />
part of enterprise’s costing system in recent years. One of the objectives of the study<br />
was to identify the level of Activity-Based Costing utilization in Czech Republic.<br />
1. PRODUCT COSTING METHODS<br />
Various types of the product costing systems are defined by the academics and<br />
practitioners. As mentioned above, product costing methods are not object of any<br />
regulation which lead in situation, where users of these systems are free in design,<br />
construction and use of the product costing system. Shields (1998) has speculated that<br />
there will be an increasing divergence in management accounting practices across<br />
industries. Classification of the product costing methods is not general. Product<br />
costing methods could be classified in different ways. As mentioned above the costing<br />
methods could be classified into job order costing and process costing based on the<br />
type of production process. More important classification of the product costing<br />
systems is based on cost allocation principles. In this field we can distinguish the<br />
traditional absorption costing, variable costing and Activity-Based Costing.<br />
Product costing methods used in organizations went through the relatively important<br />
changes in last decades. Al Omiri and Drury (2007) suggests that a need to improve<br />
the sophistication of product costing systems has been driven by changes in<br />
manufacturing technology, global competition, information costs and customers’<br />
demands for greater product diversity. These changes prompted criticisms of the<br />
ability of traditional management accounting systems to report sufficiently accurate<br />
product costs and ABC systems were promoted as the solution to overcome the<br />
distortions in the product costs reported by traditional costing systems (Cooper, 1988;<br />
Kaplan, 1994).<br />
Many studies had been performed in order to analyse the level of utilization of<br />
individual costing methods. Most of these studies are focused on the individual<br />
segments of the business (Brierley et al, 2007). Many surveys into product costing<br />
practice identify the industries making up their sample (e.g. Bright et al., 1992; Drury<br />
et al., 1993; Lamminmaki and Drury, 2001) and others have identified industries<br />
making up their samples in Activity-Based Costing (ABC) research (e.g. Cobb et al.,<br />
1993; Gosselin, 1997).<br />
Performed studies had the focus on different industry segments and used different<br />
structure of questions, which make even more difficult to declare any common results.<br />
Brierley´s (2007) study performed in England shows that 20.7% of companies do not<br />
include overhead costs in product costs, while 33.6% of companies uses or is open to<br />
use ABC. Similar study made by Al Omiri and Drury (2007) in 1000 UK companies<br />
showed very similar result: 35% of companies use traditional absorption costing<br />
system, 23% of companies use variable (direct) costing system and 29% of the<br />
companies use ABC system.<br />
Many studies have been reported in field of ABC extent. Cokins (2003) suggest that<br />
significant variations in usage of ABC both within the same country and across<br />
different countries have been reported. These differences may arise from the difficulty<br />
to define precisely the difference between traditional costing systems and ABC<br />
~ 1127 ~
systems and the specific time period when the surveys were actually undertaken. The<br />
same limitations could play role in distinguishing other types of costing systems such<br />
as absorption and direct costing.<br />
Drury (2003) suggests that performed survey evidence points at an increasing interest<br />
in ABC over the last two decades. In the UK, surveys in the early 1990s reported<br />
adoption rates around 10% (Innes and Mitchell, 1991), similar adoption rates of 10%<br />
were found in Ireland (Clarke, 1992) and 14% in Canada (Armitage and Nicholson,<br />
1993). In the USA Green and Amenkhienan (1992) claimed that 45% of firms used<br />
ABC to some extent. More recent studies suggest higher ABC adoption rates. In the<br />
UK reported usage was 29% (Al Omiri and Drury, 2007). In the USA Shim and<br />
Stagliano (1997) was reported usage rate 27%.<br />
Large surveys related to the ABC adoption had been performed in mid 1990s. Report<br />
usage rates from mainland Europe are 19% in Belgium (Brugemann et al, 1996), and<br />
6% in Finland in 1992, 11% in 1993 and 24% in 1995 (Viertanen et al, 1996). Low<br />
usage rates have been reported in Denmark (Israelsen et al, 1996) in Sweden (Ask et<br />
al, 1996) and Germany (Scherrer, 1996). Activity-based techniques do not appear to<br />
be adopted in Greece (Ballas and Venieris, 1996), Italy (Barbato et al., 1996) or Spain<br />
(Saez-Torrecilla, 1996).<br />
Along with the relatively strong differences between used product costing methods in<br />
different surveys, many authors points at the dependence of the used method of<br />
product costing on the type of the organization and organization cost structure. Study<br />
performed by Lawson et al. (2009) showed very strong relation between indirect cost<br />
portion and cost management methods used. Study proves the fact, that best-practice<br />
organizations have a much higher level of indirect costs, requiring them to have a<br />
costing system that can more accurately allocate these costs in a relevant, reliable, and<br />
reasonable manner. The greater use and appreciation of Activity-Based Costing by the<br />
best practice companies can be attributed to their greater need for better costing<br />
system. Strumactickas and Valanciene (2009) proved that the applicable instruments<br />
of management accounting depend on an organization type. Their study indicates that<br />
Market Creators use the least tools and Value Creators have most of them on an<br />
average. Market creators are strategically oriented young companies, which reach<br />
their “blossom” phase and start to stabilize, while value creator is mainly related to<br />
the getting out of stabilization phase.<br />
Another reason which drives the selection of the product costing system is the<br />
structure of the products, customers and performed activities. Many authors (Cokins,<br />
2001; Stanek 2003) refer that application of more sophisticated product costing<br />
method, such as Activity-based costing, is most effective in enterprises with complex<br />
structure of the products, customers and activities. Abernethy et al.(2009) shows how<br />
product diversity and cost structure influence the design of costing systems.<br />
1.1. Specifics of the product costing in Czech perspective<br />
Use of the management accounting techniques in Czech Republic in the second half<br />
of 20 th century had several specifics caused by political environment. Orientation on<br />
central planned economy led to the establishment of integral system for company<br />
management. Methodology of the product costing was regulated by the statutory rules<br />
~ 1128 ~
in order to fulfil the needs of central planned economy. This costing technique was<br />
based on traditional absorptions costing principles and used three different types of<br />
overheads (production, administrative and sales). In 1966, the regulations of the<br />
unified costing rules were accepted and in 1971 act of unified social-economic<br />
information system finished the complex regulation of the management accounting<br />
techniques in state owned enterprises (Lanča and Sedláček, 2005).<br />
Change of the politic system in 1989 caused the transformation from central planned<br />
economy into free market economy. In this situation no regulations related to the<br />
system of the management accounting were furthermore demanded. The change of the<br />
political system doesn’t mean radical change in the management accounting practices.<br />
Companies started very slow process of adoption of diverse costing techniques.<br />
Anyway, many companies keep in use the traditional techniques known from 1970s.<br />
2. RESEARCH OBJECTIVES AND USED METHODOLOGY<br />
Research focused on the product costing method application in Czech enterprises had<br />
been performed in years 2004-2009. Three individual surveys had been performed:<br />
first in 2004, second in 2007 and last in 2009. The performed researches has been<br />
focused on the more aspects of the management accounting practices such as cost<br />
structure, used methods of product costing, budgeting practices etc. This paper reports<br />
the results of the research focusing on used product costing techniques. Performance<br />
of the similar researches in different periods of time allows the analysis of the product<br />
costing method utilization trends. The expectations, based on the foreign studies, were<br />
in increasing usage of the sophisticated costing methods such as Activity-based<br />
costing and decreasing use of traditional absorption costing methods. Foreign<br />
experience shows, that relative use of modern costing systems is gradually increasing<br />
in long term period. Expectation about absolute portion of use of different costing<br />
methods was different than in foreign studies. Because of the above mentioned<br />
specifics of the costing process before 1989 and slower adoption of progressive<br />
managerial techniques, considerably lower usage of ABC was expected in the study.<br />
The hypothesis about the low usage of ABC techniques and about their increasing use<br />
in Czech enterprises was tested by the questionnaire survey and by the statistical<br />
comparison of the data gathered from different time periods.<br />
Data from three questionnaire surveys has been analyzed in the research in order to<br />
get better and more accurate results and also because of a need to compare the<br />
evolution of the researched indicators. First questionnaire survey was made in 2004,<br />
when 116 questionnaires had been evaluated (Popesko 2005). Similar research was<br />
made in 2007. The structure of the questionnaire was focused on the same objectives<br />
as in 2004. 96 questionnaires have been gathered and analyzed (Popesko & Novak<br />
2008). Final questionnaire survey was performed in 2009 as a part of extended<br />
research focused on costing methods use in Czech enterprises (Novak 2009). Finally<br />
77 questionnaires have been processed. Enterprises of different sizes have been<br />
researched within the individual surveys. Table 1 shows the structure of statistic file.<br />
~ 1129 ~
3. RESULTS<br />
Table 1. Structure of the researched enterprises<br />
YEAR/ENTERPRISE CATEGORY TOTAL RELATIVE<br />
2004<br />
2007<br />
2009<br />
Small 9 7,76%<br />
Medium 55 47,41%<br />
Large 52 44,83%<br />
Small 38 39,58%<br />
Medium 32 33,33%<br />
Large 26 27,08%<br />
Small 8 10,39%<br />
Medium 42 54,55%<br />
Large 27 35,06%<br />
As mentioned above, first research survey has been made in 2004 where 116<br />
manufacturing enterprises have been investigated. The objective of the survey was an<br />
identification of the used product costing methods in Czech enterprises. Results of the<br />
survey are depicted in table 2. Total sum of answers doesn’t give the number of<br />
surveyed enterprises, because some of the respondents use more than one method.<br />
Table 2. Product costing methods used in 2004<br />
USED PRODUCT COSTING METHOD TOTAL RELATIVE<br />
Do not use any product costing method 7 5.98%<br />
Division costing 5 4.27%<br />
Traditional absorption costing 36 30.77%<br />
Joint and by-product costing 2 1.71%<br />
Standard costing 50 42.74%<br />
Variable costing 35 29.91%<br />
ABC/M 6 5.13%<br />
Other 11 9.40%<br />
(Source: Popesko, 2005)<br />
The survey proved relatively high use of traditional absorption costing (over 30%)<br />
and high use of variable (direct) costing method (30%). Relatively surprising was the<br />
use of the standard costing method. Because this method in not pure allocation<br />
method, but rather cost control method, it was mostly marked along with the other<br />
costing methods. Use of the Activity-based costing and management techniques were<br />
identified by 5.1% enterprises.<br />
~ 1130 ~
Very similar research had been performed in 2007. The performed research, which<br />
was primarily oriented on the complex management accounting techniques used by<br />
Czech enterprises, contained the same questions related to the used product costing<br />
methods as research performed in 2004, in order to allow the comparison with 2004<br />
research. Results of the survey are depicted in table 3.<br />
Table 3. Product costing methods used in 2007<br />
USED PRODUCT COSTING METHOD TOTAL RELATIVE<br />
Do not use any product costing method 5 5.21%<br />
Division costing 9 9.38%<br />
Traditional absorption costing 30 31.25%<br />
Joint and by-product costing 4 4.17%<br />
Standard costing 39 40.63%<br />
Variable costing 23 23.96%<br />
ABC/M 5 5.2%<br />
Other 2 2.1%<br />
(Source: Popesko and Novak, 2008)<br />
Despite relatively different structure of the researched enterprises (table 1), survey<br />
performed in 2007 showed very similar results as the study performed in 2004. This<br />
similarity could support the relevance of the performed studies based on the relatively<br />
low number of respondents. Two major product cost techniques showed similar<br />
utilization as in 2004, the traditional absorption costing (31.5%) and variable costing<br />
little lower volume (24%). The study showed again relatively high usage of the<br />
standard costing method very often used along with other costing methods. Utilization<br />
of ABC is almost the same (5.2%).<br />
Similar data were gathered in questionnaire survey performed in 2009. Results of the<br />
survey are depicted in table 4.<br />
Table 4. Product costing methods used in 2009<br />
USED PRODUCT COSTING METHOD TOTAL RELATIVE<br />
Do not use any product costing method 3 3,90%<br />
Division costing 2 2,60%<br />
Traditional absorption costing 31 40,26%<br />
Joint and by-product costing 0 0,00%<br />
Standard costing 8 10,39%<br />
Variable costing 4 5,19%<br />
ABC/M 6 7,79%<br />
Other 30 38,96%<br />
(Source: Novak, 2009)<br />
Result of the survey is relatively different form previous studies. Most common<br />
product costing method is again the traditional absorption costing. Survey showed<br />
relatively low use of variable costing. Some of the users of variable (direct costing)<br />
could be in the category “other” because of various description of this type of product<br />
~ 1131 ~
costing method in practice. The use of ABC/M was very similar to the expectations.<br />
Result showed that use of this method is slightly increasing.<br />
DISCUSSION AND CONCLUSIONS<br />
Above described results qualify the authors to several statements. Most used type of<br />
product costing method in Czech manufacturing enterprises is traditional absorption<br />
costing. Surprising result was the relatively increasing use of this type of product<br />
costing, together with the relative lower use of variable (direct) costing. Explanation<br />
of this could be tendencies of manufacturing companies to adopt the full costing<br />
method in order to better support of pricing decisions. The variable costing method<br />
seems to be relatively popular in Czech enterprises in 1990´s. Temporary adoption of<br />
the absorption costing method could be accepted as the interpretation of the survey<br />
results.<br />
Expected results have been indicated in the Activity-based methods utilization.<br />
Survey showed relatively low use of these methods with comparison to other<br />
European countries. The study also proved increasing use of ABC/M in Czech<br />
manufacturing enterprises. The study also showed that the utilization of Activitybased<br />
techniques is relatively more frequent in large enterprises, than in small and<br />
medium enterprises. The large companies were ABC users in 5 out of the 6 cases in<br />
2004, in 4 out of the 5 cases and in 2 out of the 6 cases in 2009.<br />
The study could have limitations in number of researched enterprises, in<br />
understanding of question by the respondents or in ability of respondents to provide<br />
undistorted answers in the survey. Despite that fact it provides the actual overview of<br />
the used product costing methods in Czech manufacturing enterprises during 2000´s.<br />
The comparison of the individual survey results could also depict the tendencies in<br />
product costing method utilization.<br />
REFERENCES<br />
Abernethy, M. A., Lillis, A.M., Brownell P., Carter, P. (2001) „Product diversity and costing<br />
system design choice: field study evidence”, Management Accounting Research,<br />
vol. 12, no. 3, 2001, 261–279, ISSN: 1044-5005<br />
Al Omiri, M., Drury, C. (2007) „A survey of factors influencing the choice of product costing<br />
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Barbato, M.B., Collini, P, Quagli (1996) „Management accounting in Italy”, in Bhimani, A.<br />
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~ 1132 ~
Brierley, J.A., Cowton, C.J., Drury, C. (2007) „Product Costing Practices in Different<br />
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Manufacturing Firms”, The 15 th Annual Congress of the European Accounting<br />
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Cooper, R. (1988) „The rise of activity-based costing-part three: how many cost drivers do<br />
you need, and how do you select them?” Journal of Cost Management in<br />
Manufacturing Industry, 34–46. ISSN: 0899-5141<br />
Drury, C, Braund, S., Osborne, P. and Tayles, M. (1993) „A Survey of Management<br />
Accounting Practices in UK Manufacturing Companies”, London, Chartered<br />
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Drury, C., Management and Cost Accounting, Fifth Edition, Thomson Learning 2001,<br />
ISBN 1-86152-536-2<br />
Garrisin, R.H., Noreen, E.W., Brewer, P.C., Managerial Accounting, McGraw/Irwin New<br />
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and Implementation of Activity-based Costing, Accounting”, Organizations and<br />
Society, pp. 105-122<br />
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manufacturing firms”, Journal of Cost Management of the manufacturing industries,<br />
Spring 58-64.<br />
Innes, J., Mitchell, F. (1991) „ABC: A survey of CIMA members”, Management Accounting,<br />
October, 28-30<br />
Israelsen, P., Anderson, M., Rohde, C., Ssorensen, P.E. (1996) „Management Accounting in<br />
Denmark: theory and practice", in Bhimani, A. (ed), Management Accounting:<br />
European Perspectives, Oxford, Oxford University Press, pp. 31-53<br />
Kaplan, R.S. (1994) „Management accounting (1984–1994): development of new practice<br />
and theory.”, Management Accounting Research, Vol. 5, no. 3-4, 247–260.<br />
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Costing Practices”, The International Journal of Accounting, pp. 329-347,<br />
ISSN: 0020-7063<br />
Lanca, J., Sedlacek, J. (2005) Managerial Accounting, Brno: Masaryk University. 172 pgs,<br />
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Lawson, R., Stratton, W., Desroches, D., Hatch, T. (2009) „Best practices in cost and<br />
profitability systems”, Cost Management, Sep/Oct 2009, Vol. 23, no. 5, p. 13<br />
Novak, P. (2009) The Problems of Overhead Costs Controll and Allocation in Manufacturing<br />
Companies` Conditions, Disertation thesis, Tomas Bata Univerzity in Zlin<br />
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Czech enterprises, Dissertation thesis, Tomas Bata Univerzity in Zlin, ISBN 80-80-<br />
7318-280-7<br />
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Lex et Scientia International Journal, Vol. 1, no. XV, Nicolaue Tulescu University<br />
from Bucharest, ISSN 1583-039X<br />
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Saez-Torrecilla, A., Fernandez-Fernandez, A., Texeira-Quiros, J., Vaquera-Mosquero, M.,<br />
(1996), „Management accounting in Spain: trends in thought and practice”, in Bhimani,<br />
A. (ed), Management Accounting: European Perspectives, Oxford, Oxford University<br />
Press, pp. 180-190<br />
Scherrer, G. (1996), „Management Accounting: a German perspective”, in Bhimani, A. (ed),<br />
Management Accounting: European Perspectives, Oxford, Oxford University Press,<br />
pp. 100-122<br />
Shields, M.D. (1998) „Management Accounting Practices in Europe: A Perspective from the<br />
States”, Management Accounting Research, Vol. 9, no. 4, pp. 501-513<br />
Shim, E., Stagliano, A. (1997) „A survey of US manufacturers on implementation of ABC”,<br />
Journal of Cost Management, March/April, 39-41<br />
Shim, J.K., Siegel, J.G. (2009) Modern Cost Management & Analysis, Barron´s Business<br />
Library 2009, ISBN 978-0-7641-4103-4<br />
Viertanen, K., Malmi, T., Vaivio, J., Kasanen, E., (1996), „Drivers of management<br />
Accounting in Finland”, in Bhimani, A. (ed), Management Accounting: European<br />
Perspectives, Oxford, Oxford University Press, pp. 218-241<br />
Weigandt, J.J., Kimmel, P.D., Donald, E.K. (2010) Managerial Accounting, John Wiley &<br />
Sons, ISBN-13 978-0-470-47714-4<br />
~ 1134 ~
THE ROLE OF COSTS AND CONTROL IN ENSURING<br />
A SUCCESSFUL MANAGEMENT IN THE DECISIONAL<br />
PROCESS<br />
Stefania-Eliza BANA (PANCIU) 1 & Florinel Marian SGARDEA<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
Knowing the costs represents an important factor when taking decisions or planning future<br />
activities. The analysis and registration of data regarding the costs of past activities is only<br />
part of the cost accounting. Managers are preoccupied both by the future costs - their level<br />
influences production and supply decisions – and by price politics. Considering that all firms<br />
are preoccupied with continuous cost reduction, in this material we want to debate on this<br />
subject that is of major importance for any manager, regardless of his or her field of activity.<br />
We will try to answer to the following questions:<br />
How can we effectively reduce business costs?<br />
What should be the priorities of the management of companies in 2011?<br />
“The strategy of an enterprise is the art of selecting and optimizing the resources and the<br />
means of all type that are available, in order to reach one or more goals of progress,<br />
imposing to the competition the place, time and conditions of the competitive struggle” –<br />
Maria Niculescu (2003). From here we can understand the important role that the resources<br />
consumption analysis has, the analysis of costs when evaluating the results obtained. Between<br />
cost analysis and the enterprise strategy is a double connection. On the first hand the results<br />
obtained from cost analysis and accounting are important for strategic decisions of the<br />
enterprise, and on the second hand management accounting provides us information<br />
regarding the costs of products, services and activities. By comparing them with the turnover<br />
obtained by a product or service, we can calculate the margins and profitability for every<br />
level of analysis. Comparative analysis of the profitability of products is important when<br />
deciding the product portofolio of the firm. Choosing a method for calculating the costs is<br />
determined by the tight relationship between the type of production and the type of<br />
corresponding evidence of the consumption. In general, the specific of the manufacturing<br />
technique determines the method of calculating the cost which suits it best. The principles of<br />
organizing [Călin O., Cârstea Gh., 2002, p.76-80] modeled the structure, management and<br />
results of the enterprises along the XIXth and XXth century. It is time to renounce to these<br />
principles in order to adopt new ones. Contemporary enterprises must engage themselves in a<br />
radical mission of reinventing the working arrangements.<br />
KEYWORDS: support costs, strategic management, Target Cost, fixed costs, variable<br />
costs<br />
1<br />
Correspondence address: Stefania-Eliza BANA (PANCIU), Bucharest Academy of Economic<br />
Studies, Romania; email: elizabana@yahoo.com<br />
~ 1135 ~
INTRODUCTION<br />
To calculate, monitor and control the costs represents just one of the aspects of the<br />
performance of which we will consider in this study. To manage costs implies<br />
organizing a managerial accounting which will allow the calculation, analysis and<br />
reporting according to the needs of the management. The economists from transitional<br />
countries try to introduce modern approaches in the calculation of costs with strategic<br />
management purposes, known and utilized in the countries with well developed<br />
economies. Unfortunately they paid little attention to the modalities of applying the<br />
new international approach to cost management in a new competitive environment.<br />
This practice raises interest both in theory and in application and it necessitates a<br />
more ample research, which determined the actuality, objective and purpose of the<br />
present paper.<br />
1. THE UTILIZATION OF THE MODERN METHODS AND TECHNIQUES<br />
OF COST CALCULATION. A PLEAD FOR THE TARGET COSTING<br />
METHOD<br />
The cost of production represents an economic indicator, which expresses the value of<br />
the utilized resources in order to complete a concrete process which is finalized with a<br />
product or service.<br />
The calculation method is the path to be followed by using some specific calculation<br />
processes with the purpose of achieving the mail objective of the managerial<br />
accounting, and the determination of the product unit cost.<br />
The classical methods of production cost calculation belong to the integral or<br />
absorbent cost concept, bringing together within the price of fabricated products,<br />
portfolios and services provided the sum of the production expenses usually grouped<br />
in direct, indirect expenses and calculation articles.<br />
These methods involve making two rows of calculation regarding the costs of<br />
production, namely pre-calculation and post-calculation. Through these calculations<br />
two rows of indicators are elaborated, pre-calculated and effective, with their help the<br />
periodic control over framing the effective cost in the level pre-calculated is done.<br />
Through the comparison between the two rows of indicators the deviation from the<br />
pre-calculated costs can be determined.<br />
The utilization of the traditional cost calculation methods have the following limits:<br />
� Calculates the periodic cost and compares the products that are not in the same<br />
stage of the life cycle;<br />
� Traditional methods measure the cost as it is created, at which point he can no<br />
longer act on it;<br />
� Traditional methods correspond to an optics of fixing the selling price<br />
according to the cost; this logic is not valid in the sectors in which the<br />
competition is high and where the price is market oriented.<br />
In order to respond to these criticisms, we need calculation methods that take into<br />
account the product life cycle, the market-driven price and that allow cost<br />
management from the design of the product is needed.<br />
~ 1136 ~
Performance optimization is translated through optimization of the life cycle that<br />
becomes a management object. The cost is obtained as a “measure of value”, or what<br />
the client is willing to pay for the product. As a result, the enterprise doesn’t have to<br />
manage the cost reduction, but the optimization between cost and value. The switch<br />
from cost management to strategic cost management represents the actual step in the<br />
concept development. In the product life cycle there are three important phases:<br />
planning phase, production phase and abandon phase.<br />
Cost<br />
Abandon<br />
80%<br />
Figure1. LIFE CYCLE<br />
Decided cost<br />
20%<br />
20% of the carried out cost is similar with 80% of the decided cost<br />
~ 1137 ~<br />
Cost carried out<br />
In the ’70`s, following the methods previously used in the USA, a new cost<br />
calculation method is developed in Japan which meets the following requirements:<br />
• Target-Costing (TC) developed at Toyota<br />
The target cost represents a negotiation basis between the different functions of the<br />
enterprise in order to assure the long term viability of the new product and also it<br />
represents the product’s competitiveness. The target-costing method is part of a global<br />
approach, which targets cost reduction along the process of continuous improvement<br />
of technology and fabrication process implying, in the same time, a new human<br />
resources management and better competencies. Specifically, we are talking about the<br />
following issues:<br />
� mastering different phases of the product life cycle;<br />
� cost analysis starting with the birth of the products, according to the<br />
characteristics and the selling price;<br />
� assuring, progressively that the new products will be profitable during their<br />
life cycle;<br />
� reducing the time it takes to conceive products;<br />
� diminishing the development costs and assuring a faster depreciation;<br />
� assuring a better relationship organization between the company and the<br />
suppliers and collaborators;<br />
� mobilizing and motivating all competencies from within the enterprise through<br />
an transversal approach which favors an enhanced competitiveness.
The TC method allows the design of new products according to the market<br />
expectation (price) and of the shareholders (profit margin) resulting the target cost<br />
also according to the firm’s competencies and technical options (estimate cost).<br />
The general calculation formula is:<br />
Target Cost = Competition’s selling price – Expected margin<br />
In the case of the TC method, the market price represents the independent variable<br />
and the costs for design, manufacturing, marketing and other functions are depending<br />
on it.<br />
The variable that the enterprise can’t control is the selling price. It results from the<br />
actual or predicted state of the competition forces that are pressuring the targeted<br />
market segment.<br />
This price is the result of a compromise of examining the different restrictions: needs<br />
and income of the potential client, particularities of the product, long term production<br />
capacity, competitor’s prices. Analyzed as a closed unitary concept of cost<br />
management, TC is characterized through the estimation of values as functions of the<br />
selling price, the complete costs and of the beneficiary on the whole life cycle of the<br />
product.<br />
Such a management is characterized by the following:<br />
� It is maintained on the whole life cycle of the product;<br />
� It focuses on costs even from the developing phase of the product;<br />
� It is based and uses the price information from the target and starts from the<br />
market-orientated cost information;<br />
� It is based on the budgeting of the products functions;<br />
� The evaluation basis is represented by the complete costs.<br />
The objective that TC has represents the improvement of the situation for the results<br />
related to the product through a reduction of standard costs in the direction of some<br />
targets costs according with the competition.<br />
Theoretically, the objective of TC is based on the following six principles:<br />
1. The costs of future products to evaluate the mass production of internal<br />
marketing projected revenue;<br />
2. The necessary target costs, based on the complete costs formula are evaluated<br />
through cutting out from the selling price the profit margin desired, taking into<br />
account a certain degree of risk (cost component);<br />
3. Overall costs are determined by the relationship between the selling price –<br />
desired margin + risk rate and it is distributed on the different components of<br />
the product corresponding to the utility function needed by the clients;<br />
4. Costs of product components serve as the task for the entire value creation<br />
chain, starting from research & development and continuing with supplying,<br />
production and selling;<br />
5. Through the analysis of the difference between target costs and standard costs<br />
and through benchmarking we can identify, on a product component level, the<br />
optimization potential;<br />
~ 1138 ~
6. The value adding chain must assure, through plans of selling the product,<br />
terms of sales by optimizing both material and processing costs, and by value<br />
analysis, to determine measures to be taken and implemented to achieve the<br />
objectives required for each product.<br />
I. Stages of TC method are the following:<br />
Stage I. Setting the target price<br />
Usually, target price is set by market research techniques and concerns the life of the<br />
product. Therefore, it has a strategic determination, a dynamic character and assumes<br />
many forms and levels in relation to market segments and over time supply and<br />
demand.<br />
Market research for the design product resulted in determining a sale price and the<br />
forecast sales volume. It forecast price that will evolve throughout the product<br />
lifecycle.<br />
The steps of the target setting strategy:<br />
For what target markets or market segments should be aimed?<br />
� Target markets (national, international, global);<br />
� Target market segments (price, depending on use);<br />
� The attractiveness of those target markets and market segments.<br />
How does the competition develop?<br />
� The structure of competition (market volume, market share, scope of interest<br />
of competition);<br />
� Structure of cost and quality standards;<br />
� Prices and future pricing policy.<br />
How do the target client groups evolve and what claims will them have regarding the<br />
products?<br />
� Development of target customer groups (segments developments);<br />
� Future claims from customers, for example with regard to price;<br />
� Characteristics of products which highlight the performance;<br />
� Operating characteristics;<br />
� Delivery, service, etc.<br />
� Which is the client’s opinion regarding the prices of the future products.<br />
What is the strategy that the product manufacturer seeks?<br />
� Strategic projects on markets and customers (products, markets, product life);<br />
� Strategies in terms of timing and choice of product depending on which will<br />
calculate the cost and price target.<br />
What purposes related to domestic policies seeks the producer?<br />
� What is expected in terms of return on capital?<br />
� Cash flow;<br />
� Operational results.<br />
~ 1139 ~
Which are the final purposes of the producer?<br />
� Future prices;<br />
� What does the produces want to achieve taking into consideration the quantity<br />
of products that reached the market, the life of these products and market<br />
share;<br />
� The necessary time in order to enter on the market with a new product.<br />
This presentation of strategy, on steps, shows that the process of determining the<br />
target cost should be included in the strategic plan of the producer over several years.<br />
Target pricing is always uncertain, considering how the market evolves, how does the<br />
competition react and the monetary relations. In the event that the assumptions about<br />
the planning are changed, this can have a high impact and effects over future market<br />
prices.<br />
Example 1:<br />
ALFA enterprise studies the project of a new microwaves oven. The sales for this<br />
product were predicted for a period of five years; after this period the pressure from<br />
the competition and the technical innovations will force the enterprise to change this<br />
product with a modern one.<br />
A study made by the enterprise shows that the price could be set at 1500 ron for the<br />
first three years. This price is relatively high, but the device will have a modern<br />
design, which proposes advantage over competitors who have older models. Starting<br />
with the forth year, the price will be adjusted to 1300 ron in order to resist to the<br />
competitor’s new products. Sales forecast are as follows: 4000 units in the first three<br />
years, 2000 units for year four and five.<br />
Table 1. Turnover forecast for five years<br />
Explanations Year 1 Year 2 Year 3 Year 4 Year 5 Total<br />
Quantity 4,000 4,000 4,000 2,000 2,000 16,000<br />
Price of 1,500 1,500 1,500 1,300 1,300<br />
Turnover 6,000 6,000 6,000 2,600 2,600 23,200<br />
Average selling price target is = 23,200,000 = 1,450 lei/unit<br />
16,000<br />
The latest concern to management is to determine the level and the structure of the<br />
cost of a product that it can afford. Often it has to give up the previous fabrication<br />
prescriptions in order to reach the new cost structures and level. Global target prices,<br />
along with the others predictions, must be included both in the planning of the current<br />
and future years in order to:<br />
� offer security to the product profitability,<br />
� establish the maximum value that the price of the product can reach<br />
� motivate this maximum value<br />
Stage II. Estimated profit margin target<br />
This stage results from the strategic middle-term planning of the firm and from its<br />
portfolio of products.<br />
~ 1140 ~
This is why the size of the target price is not a fix sum, but a profit curve which<br />
stimulates, with the help of the financial analysis, the expected profitability of the<br />
product, taking into account the assumptions on the volume of business. Together<br />
with the planning and the presentation of the allowed market prices, it is important to<br />
study the costs and its structure, this being done by the project managers and internal<br />
control.<br />
For different rates which are estimated for five years, the gross profit margin is<br />
calculated in Table 2.<br />
Tabele 2. The calculation of profit margins<br />
Explications Year 1 Year 2 Year 3 Year 4 Year 5 Total<br />
Turnover<br />
Profit rate<br />
6,000 6,000 6,000 2,600 2,600 23,200<br />
la C<br />
Margin<br />
11% 10% 8% 6% 6% 8.84 %<br />
Profit (mii lei) 660 600 480 156 156 2,052<br />
ALFA enterprises has as objective a profit rate calculated using the turnover.<br />
(a) is the average target profit 2.052.000 = 8.84 %,<br />
23.200.000<br />
from here results that the share of the cost in the price is of 100% - 8.84% = 91.16%.<br />
The objective margin for a washing machine is equal to the average price multiplied<br />
by the average profit margin, meaning: 1.450 X 8.84% = 128.18 lei /unit.<br />
Stage III. Determining the target cost<br />
The target cost is derived from the previous calculations by a simple substraction. The<br />
evaluation is not made globally, but in an analytical way, using partial target costs,<br />
depending on the product components and subassemblies. In our case, the objective<br />
cost of a product is equal to the difference between the selling price and the objective<br />
margin. The two terms (price and margin) cover all product life cycle. The objective<br />
cost is then broken down in parts cost objective in each product.<br />
Example: The objective cost of the washing machine is 1.450 lei – 128.18 lei =<br />
1.321,82 lei. The global objective cost is broken down by the relative importance of<br />
the sub-assemblies, as we can see in the following table:<br />
Table 3. Target costing benchmarks<br />
Name of benchmark Share on cost Target costs on parts<br />
Magnetron 30% 396.54 lei<br />
Metal case 20% 264.36 lei<br />
Electric lamp 10% 132.18 lei<br />
Programmer 25% 330.46 lei<br />
Command system 15% 198.27 lei<br />
Total 100% 1.321,82 lei<br />
~ 1141 ~
The evaluation is not done global, but analytical, on different types of partial target<br />
costs, depending on the product components and subassemblies. The breaking down<br />
can be done using:<br />
Organic break down: of the product in subassemblies, taking into account its physical<br />
structure. This method is based on the knowledge of the current costs of the<br />
components and the ability of the enterprise to produce them. It implies a continuity in<br />
the preservation of existing techniques, but also an adaptation through innovation,<br />
considering the product features.<br />
Functional break down: is based on the analysis of the product, taking into<br />
consideration the client’s needs: each function is a customer need that a product must<br />
meet. This method is based on customer and market needs; by target cost we<br />
understand what customers are willing to pay for all services expected from their<br />
product.<br />
The estimated cost is a cost built the whole lifecycle of the product.<br />
Target cost method is part of a global approach, which aims at reducing costs along<br />
the continuous process of improving the technologies and manufacturing processes,<br />
assuming in the same time a new style of human resources management and greater<br />
powers.<br />
Continuous cost reduction has to concern all the enterprise, which requires an adapted<br />
management style. We take into consideration the following:<br />
� Overcoming different stages of product life;<br />
� Cost analysis starting from the product concept, depending on their<br />
characteristics and possible selling prices;<br />
� Ensure progressively, that the new products will be profitable during their life<br />
cycle;<br />
� Reducing the time of conception of products;<br />
� Minimize development costs and ensure faster depreciation;<br />
Example 2:<br />
Gama enterprise studies the launch of a new type of metering and protection for niche<br />
block (BMPT) with two counters, used in low voltage networks to supply electricity<br />
to small consumers, which should provide increased tolerance to gauge and mounting<br />
shares. The forecast amount to be produced is 10,000 units/month. After a market<br />
analysis it has been determined that for the target segment the acceptable sale price is<br />
of 60,000ron/box. The accepted margin by shareholders is 10% of the selling price.<br />
From the production activity we known these costs:<br />
� direct costs for a carton: 2,000 RON / niche by niche, niches in block 24;<br />
� direct costs per carton: 20,000 lei;<br />
� costs for customers (advertising): 10,000,000/month<br />
After interviewing distributor clients to final consumers is seems that it is not very<br />
important that these blocks have this specific gauge (meaning 24 niches / block),<br />
reason why the firm will reduce them to 20. In this way the acquisition cost will be<br />
reduces with 3,000 lei/unit. From the direct costs, 1700 represents the raw material<br />
which gives the product its quality. This represents 50% of the client value.<br />
~ 1142 ~
To establish:<br />
1. target cost and estimated cost<br />
2. 2. new estimated cost. Can you manufacture the product?<br />
Solution:<br />
1. CT/BMPT = Price – Profitability = 60,000 – 60,000*10% = 54,000 lei/box<br />
CE/BMPT = 24*2,000 + 20,000 + 10,000,000/10,000 = 69,000 lei<br />
Deviation from the target cost (CT) = 69,000-54,000 = 15,000 lei<br />
Optimal cost for raw material = 50%*54,000 = 27,000 lei/box<br />
2. Optimal cost for raw material /BMPT = 27,000/20 = 1,350 lei<br />
Initial cost for raw material/BMPT = 1,700<br />
From here it results that we have to lower raw material cost for one unit with<br />
350 lei.<br />
CE/BMPT = 20*(2,000-350) + (20,000-3,000) + 1,000 = 51,000 lei<br />
Deviation from the target cost = 54,000 – 51,000 = 3,000 lei<br />
Conclusion: Considering that the deviation is relatively large from the target cost, is<br />
not recommended to start manufacturing the product.<br />
II. Steps and implications to ensure cost objectives in the TC<br />
Orienting the costs toward the market and planning target costs in relation to the<br />
product functions require some changes in the company structure and technology,<br />
starting from the market.<br />
In this way production leans on interoperable sales plans which ensure the<br />
conjunction between potential improvements on products, production costs by product<br />
and functional requirements. The estimated cost is a cost built on the whole lifecycle<br />
of the product. The estimated cost is based on the following formula:<br />
• production cost<br />
+ research and development cost<br />
+ distribution cost<br />
+ overall cost of administration<br />
= Complete estimated cost<br />
From the client point of view, the estimated cost of possession is based on the<br />
following formula:<br />
• purchase price<br />
+ ancillary costs of acquisition<br />
+ cost of use (operating)<br />
+ maintenance costs<br />
+ residual cost<br />
= Possession cost of the user<br />
By summing the two costs, the producer and the user, we get the overall cost of the<br />
product life cycle. The rapid pace of competition obliges the enterprise to have an<br />
appropriate approach based on a forestall thinking for production lines. The whole<br />
issue regarding the chain of value creation and related service functions have to be<br />
resolved at latest until the beginning of series manufacture.<br />
To achieve or obtain a transparency of costs and outcomes is necessary to provide a<br />
procedure for combining, oriented towards the responsibility sectors. This allows a<br />
~ 1143 ~
cost management oriented towards sectors and thereby a clear delineation of<br />
performance at this level. Goals and deviations are structured as follows:<br />
� Change in design - Technical development<br />
� Changing prices – Purchasing<br />
� Changing Purchasing - Purchasing / Production<br />
� Change in Technology – Production<br />
� Volume mix - Price - Quantity disposed - Sales<br />
The core of this new organization is delegating responsibility concerning results,<br />
down, to the professional levels; using design teams are separated the bearers of skills.<br />
The results are not driven by the controlling, but by team members in those sectors,<br />
occasion on which controlling collaborators offer support in the decisions field.<br />
Benefits of the controlling new conception must be seen in:<br />
� Clear demarcation of responsibility by sector;<br />
� Support operational decision-making processes in areas of product design;<br />
� Increasing efficiency of the management corporation and the divisions;<br />
� Increased capacity to adapt to environmental changes;<br />
� Avoiding the loss of the lack of correlation, by organizing the projects for<br />
sectors and clear delegation of liability for each man;<br />
� Shortening the time of design and development, and avoid modification costs<br />
by an early engineering knowledge of design teams.<br />
To apply a consistent cost management, target oriented, considering the current<br />
market situation and environment, there is no rational alternative. By the new<br />
organizational structuring of the information systems which are oriented towards the<br />
procedural chain which has to be created and by orientation towards the market<br />
determined objectives, we will be able to better adapt in the future to strategic needs.<br />
2. HOW CAN WE EFFECTIVELY REDUCE BUSINESS COSTS?<br />
In order to answer to this question it is necessary to know some useful information, as<br />
follows:<br />
Fix costs (FC) are those whose size remains relatively unchanged, or changes<br />
depending on the increase or decrease of the production obtained in insignificant size.<br />
For example: depreciation costs, costs with rent, costs with salaries. Fix costs are<br />
generated from consumption of material, human, informational, financial resources,<br />
resources used in various activities of the firm with the purpose of obtaining income<br />
and benefits, in accordance with the objectives, strategies and company policies.<br />
Variable costs (VC) are those which modify their volume according to the<br />
modification of the volume of production. For example: consumption with raw<br />
materials, consumables, energy and water.<br />
When the economy is rising, the companies are concerned with reaching objectives<br />
that refer especially to the growth of the market share and income and use<br />
development strategies by further investments in upgrading or acquisition of new<br />
storage, sale and production capacities. This expansion of company activities<br />
automatically generates an increase in fixed costs related to the use of new resources.<br />
~ 1144 ~
When the business opportunities are stagnating or decreasing, companies give more<br />
attention to reducing fixed and variable costs of the company, taking in consideration<br />
the objectives of maintaining the profitability and financial stability in an unstable and<br />
unpredictable business environment.<br />
Identification, classification, calculation and control of fixed costs become a priority<br />
for managers of any company daily. The analysis and control of costs requires<br />
awareness and understanding of general characteristics of the company's activity and<br />
understanding the interdependencies relation between business and the environment in<br />
which it operates (economic, politic, technologic, social etc.).<br />
Cost managerial accounting is the main source of information for the analysis and<br />
control of fixed costs. For the analysis and efficient reduction of fix costs we can take<br />
into consideration the following:<br />
� cost approach must begin first at the company level (global approach) and then<br />
by components (types of activities and cost centers, types of expenses);<br />
� identify the activities which generate fix costs and analyze then the two basic<br />
options: the activities will be decreased and reorganized or the activities will<br />
be eliminated;<br />
� identify resources that generate the highest consumption within each cost<br />
center;<br />
� approaches to reduce fixed costs are determined by each category of fixed<br />
costs;<br />
� benefits of cost reduction measures must be maintained on long term in order<br />
to ensure business competitiveness on the short, medium and long term.<br />
The best way to reduce costs is to change the way of thinking on the use of resources.<br />
Conventional methods of cost reduction focus on reducing staff. They give short term<br />
results but fail in the long term because staff reduction does not necessarily mean<br />
reduction of the related activities.<br />
Turney has five basic ideas related to cost reduction by administrating the activities,<br />
as follows:<br />
a) reducing the time and effort required to perform a task. This is usually done by<br />
improving the process or product;<br />
b) eliminating the activities that are unnecessary, not appreciated by clients and<br />
not essential for the well-functioning of the firm;<br />
c) where is possible the choosing and selecting the activities with low cost since<br />
the design phase;<br />
d) business must meet several requirements, unless it is necessary only in one<br />
purpose;<br />
e) elimination of unused resources. Costs can be reduced only if resources that<br />
can be saved are spread in another place of the firm or eliminated. Cost<br />
savings based on these data become re-allocation bases.<br />
~ 1145 ~
3. WHICH SHOULD BE THE PRIORITIES OF THE ENTERPRISES<br />
MANAGEMENT IN THE YEAR 2011?<br />
Enterprises will focus their attention especially on:<br />
� restructuring the product and service portfolios towards the actual target client<br />
needs;<br />
� revising selling price policies, promotion and distribution of products, in a way<br />
in which clients may understand the characteristics, advantages and benefits of<br />
each product and by doing this stimulating the demand for consumption;<br />
� implementing a system of measuring performances on a company level and<br />
based on activity types;<br />
� resuming investments that sustain the re-launch of the firms activities;<br />
Sales priorities: more or better?<br />
Most of the businesses recorded declines in sales in 2009 and 2010 compared to 2007-<br />
2008. And still, some businesses are also doing well in 2011. Why is that?<br />
Because in these businesses, managers and specialists have acted with priority in the<br />
following directions:<br />
� they re-evaluated the opportunities and risks of the market;<br />
� they restructured and diversified the product and services based on the needs<br />
and the power of paying customers portfolio ;<br />
� they monitored the financial efficiency of each sale and focused on cashing and<br />
commercial profit.<br />
Changing the strategic position of enterprises<br />
This is due to changes in the environment of the enterprise. These changes occurred<br />
due to the essential contributions of developments in computer technology. Along<br />
with the introduction of CIM systems (Computer Integrate Manufacturing) came<br />
important modification in all fields and sectors of the enterprise.<br />
Within decision-making of the enterprise we find new aspects on a high level such as:<br />
� Preparing information about costs referring to a multitude of objects of cost<br />
calculation.<br />
� Reduction of the size of the fabrication lots;<br />
� Determining an optimal number of production variances;<br />
� Determining costs for specific orders;<br />
� The economic efficiency control in the ever-growing and important sectors of<br />
common indirect costs.<br />
The necessary information is referring to the whole value adding chain within a<br />
company, including production sectors and auxiliary activities that help indirectly.<br />
Knowing the mode of action of each of the factors of profit optimization<br />
It is necessary the knowledge about the mutual influences of those factors (sales price,<br />
volume of production and distribution, variable costs, fixed costs, production structure<br />
and dissolution), because only in this way we can take rational decisions to optimize<br />
profit:<br />
� modification of the production and sale structure of the products and<br />
assortments, stimulating the product with the highest coverage factor,<br />
promoting the sale of differentiated products and assortments which will lead to<br />
~ 1146 ~
an increase in profit equal to the difference between the amount by which the<br />
production and sale of certain types has increased (with high coverage factor)<br />
multiplied with the gross contribution per unit and the reduced amount of<br />
production and sale of certain products and assortments (with lower coverage<br />
factor) multiplied by the gross contribution per unit.<br />
� reducing variable costs as a result of actions to redesign the products, to use<br />
substitutes, to streamline work etc. with a certain percentage or amount to each<br />
individual product, which will result in an additional profit equal to the product<br />
between the quantity sold and the reduction of variable costs.<br />
� finally, reducing fixed costs, either by dissolution of a retail store, of a<br />
warehouse, downsizing staff, with a certain percentage or amount, leading to<br />
the obtaining of additional profit equal to the reduction of fixed costs.<br />
CONCLUSIONS<br />
By monitoring movements of the market share for most products, a company can see<br />
if she gains or loses its market position, and the examination of relative market shares<br />
will indicate the strength of different competitors. Cost management has to be well<br />
informed in order to determine the strategic positioning in the market. Depending on<br />
the chosen strategic position, firms put more emphasis on particular techniques of cost<br />
management.<br />
Conceptual conditions that must be met by current methods of calculation of the costs<br />
in terms of future company engineering, are:<br />
� Technology costs should be allocated directly to products<br />
� Significant costs should be entered directly in the objectives of management<br />
reporting<br />
� Costs of activities that bring or don’t bring added value should be separately<br />
identified<br />
� Support costs will be recognize as costs that don’t bring added value and that<br />
should be to be oriented directly to the product<br />
� Each homogeneous group of activities, products, etc.. should be organized in<br />
the centers of responsibility<br />
� Calculating the cost of activities will enhance the efficiency of storage and<br />
operational control<br />
� To determine the cause - effect relationships between the costs of activities<br />
and objectives of management reporting separate criteria for allocating should<br />
be developed<br />
� The costs must be aligned to support the requirements of the product life cycle<br />
The cost of production is an economic quality and quantity indicator, which occupies<br />
a central position in the indicator system of a company and it is used for the<br />
measurement and assessment of economic growth. The cost of production expresses<br />
the value of the resources used for realising a process, which ends with the creation of<br />
a product or service and is meant to assist the efficiency evaluation of the production<br />
activity conditioned by the production technology and organization, and to assist the<br />
process of managerial decision making with the purpose of selecting the best and the<br />
most rational way of business development.<br />
The concept according to which traditional accounting-based systems are useful tools<br />
for strategic analysis of costs is wrong; companies must implement new systems of<br />
~ 1147 ~
modern strategic management of costs. Today, the competitive environment requires a<br />
modern architecture of the cost system, which should be based on the conceptual<br />
principles of strategic management: to allow multidimensional cost management and<br />
performance measurement of the company.<br />
Knowing the production cost structure, knowing its change in time and space, is<br />
particularly important in guiding actions to reduce costs, acting preferably on costs<br />
with the largest share of expenditure.<br />
REFERENCES<br />
Briciu Sorin, Burja Vasile, 2004, Contabilitate de gestiune. Calculaţia şi analiza costurilor,<br />
Editura Ulise, Alba Iulia;<br />
Dumitru Corina Graziella, Ioanăş Corina, 2005; Contabilitatea de gestiune şi evaluarea<br />
performanţelor, Editura Universitară, Bucureşti;<br />
Ebbeken Klaus, Possler Ladislau, Ristea Mihai, 2000, Calculaţia şi managementul costurilor,<br />
Editura Teora, Bucureşti;<br />
Epuran Mihail, Băbăiţă Valeria, Grosu Corina,1999, Contabilitate şi control de gestiune,<br />
Editura Economică, Bucureşti;<br />
Ion Cucui, Vasile Horga, Mariana Radu (2003) Control de gestiune, Editura Niculescu,<br />
Bucuresti<br />
Ionaşcu Ion, Filip Andrei Tiberiu, Stere Mihai, (2003), Control de gestiune, Editura<br />
Economică, Bucureşti.<br />
Yoram Eden, Boaz Ronen, “Activity Based Costing (ABC) and Activity Based Management<br />
(ABM)”, Financial and Management Accounting Committee, Articles of Merit<br />
2002,(http://www.ifac.org./bookstore/Professional Accountants in Business)<br />
Oprea Calin (2000). “Contabilitatea de gestiune”, Tribuna Economică, colecţia “Metode,<br />
tehnici, instrumente” nr. 145, Bucureşti<br />
Sorin Briciu, Vasile Burja (2004), Contabilitate de gestiune. Calculaţia şi analiza costurilor,<br />
Editura Ulise, Alba Iulia, p. 199<br />
Sgardea Florin, Sendroiu Cleopatra (2007),”Contabilitatea de gestiune-sursa de informatii<br />
pentru adaptarea deciziilor”, Gestiunea si contabilitatea firmei, vol. 10, nr. 4, pp. 28-41<br />
~ 1148 ~
THE CHANGE IN MANAGEMENT ACCOUNTING<br />
IN ROMANIA<br />
Madalina DUMITRU 1 , Daniela CALU, Gorgan CATALINA,<br />
Adriana CALU & Georgiana TOADER<br />
Bucharest Academy of Economic Studies, Romania<br />
ABSTRACT<br />
The change in management accounting is a topical issue in international research in<br />
management accounting. We want to see which the situation in Romania is. In order to<br />
analyse it, we followed two approaches. First, we made a brief presentation of the situation of<br />
management accounting in Romanian companies, relying on a few empirical researches<br />
published previously. Secondly, we studied the articles published in four top journals in<br />
Romania and classified them according to the issues studied.<br />
KEYWORDS: management accounting, change, journals<br />
INTRODUCTION<br />
One way to study the nature of change is exploring the stability and continuity of the<br />
inherent continuous processes of life. Veblen was the first to build a parallel with<br />
biology, emphasizing the pass of the relevant information in time (Veblen, 1898,<br />
1919). The same parallel was used by Hodgson (1993) and Calu (2005) in their<br />
studies. Stability and change are not independent: even though the biggest part of life<br />
is stable, people are characterized by a curiosity searching for alternatives to the<br />
present situation. So, there is always potential for change. The change in this area is a<br />
continuous process, of interest in the international research (Scapens, 2006). The<br />
recent social, economical and juridical changes forced the appearance of innovations<br />
in the management accounting. These changes sent the old theories into the shadow,<br />
questioning their opportunity, but also the capacity of the new ones to succeed in<br />
difficult moments. The analysis of the change in management accounting supposes<br />
the analysis of the way in which a theory is chosen instead of another.<br />
We ask ourselves which the factors are determining the change in the management<br />
accounting of the entities in the public and private area, at international level, but<br />
especially in Romania, where taxes frequently prevents the decision making persons<br />
to focus on other aspects of the entity they work in. Even more, in Romania the<br />
application of the management accounting was poorly understood in 1990 (as being<br />
optional), which stopped its progress.<br />
The social and economical environment, including culture, have a collateral impact in<br />
the change appearance in the financial accounting, the immediate impact being<br />
1<br />
Correspondence address: Mădălina DUMITRU, Academy of Economic Studies of Bucharest;<br />
email: madidumitru2007@gmail.com<br />
~ 1149 ~
managed by the financing system of the firms, to which the political factor is added.<br />
By observing through time the political-economical-accounting correlation in<br />
Romania, we can distinguish the following general ideas: the enforcement of<br />
socialism has generated the incitement of an accounting which uses adequate<br />
mechanisms, and the globalization is currently generating the aggregation of standards<br />
regarding the convergence, concluded between IASB and FASB (Baker and Barbu,<br />
2007). In the management accounting, the elements which determine the changing are<br />
represented by external factors (such as, normalized factors in the case of Romania, in<br />
the nineties) but mostly by the internal factors – the culture of the firm, the<br />
management, the size of the firm, the activity area, the form of ownership of the<br />
capital etc. (Burns, 2000; Scapens, 2009).<br />
“We live in a changing world!” But do we live in a changing country? At least from<br />
the point of view of the management accounting. Let’s see an example. A study<br />
published in 2010 (Jinga et al., 2010) showed that as far as the cost methods employed<br />
by surveyed managers, 20.51% apply the global absorption method, 25.64% apply the<br />
job costing, 7.69% apply direct-costing, 12.82% use ABC costing, 5.13% use targetcosting<br />
and 17.95% do not know the name of the method or they do not use any<br />
method for cost computation.<br />
However, global absorption and job costing methods (the two most used costing<br />
methods in Romania according to the previous study in 2009) were the ones used<br />
more than thirty years ago. That is, before the Relevance lost of the management<br />
accounting.<br />
Nowadays, the continuous change has become a constant, the organizational<br />
environment being constrained to align to the new trends and technologies, and even<br />
to a whole redefining as an organization. In order to survive, the entities must change,<br />
must reinvent their operation of dependence towards the movements and trends of the<br />
market. For a considerable period of time, the management was regarded as true art,<br />
an acquired talent through the practice of attempts and errors. A variety of individual<br />
techniques, often based on creativity, human reasoning, intuition and experience were<br />
used for solving problems of the same type and this against the quantitative methods<br />
and the scientific approaches. The complexity of businesses and their activity<br />
environment has increased considerably in the last decades (Quattrone and Hopper,<br />
2001).<br />
The international researchers admitted the need for a change in management<br />
accounting. In this article we try to assess the situation in Romania. In order to do this,<br />
we organize the rest of this research paper as it follows:<br />
� We analyze the change in the management accounting from the international<br />
perspective;<br />
� We analyze the change in the management accounting in Romania identified<br />
at the level of the companies;<br />
� We analyze the change in the management accounting in Romania from the<br />
point of view of the research works published;<br />
� We analyze the change in the management accounting in a future perspective.<br />
~ 1150 ~
1. THE ANALYSIS OF CHANGE IN THE MANAGEMENT ACCOUNTING<br />
– THE INTERNATIONAL PERSPECTIVE<br />
Management accounting change in organizations has to be seen as an evolutionary,<br />
path dependent process in which existing ways of thinking (institutions), circuits of<br />
power and trust in accountants can all have an impact on the way in which the actors<br />
within the organization respond to external institutional and economic pressures. It is<br />
this complex process of inter-related influences which shapes management accounting<br />
practices and explains the diversity we see in the practices of individual companies.<br />
Understanding management accounting change requires an understanding of various<br />
organisational and historical contingencies (Scapens and Roberts, 1993; Hopper et al.,<br />
2004). In the last thirty years there has been a change in the management accounting<br />
research topics: from explaining the diversity of practices in a population, to making<br />
sense of the practices in individual companies. In management accounting research<br />
the 1970s was an era of economic oriented mathematical models. Going into the<br />
1980s, management accounting researchers began to recognise that there was a gap<br />
between theory and practice, and that research to describe practice was urgently<br />
needed. Into the 1990s a variety of theories and a number of different methodological<br />
approaches started to be used to study management accounting practices. This change<br />
is reflected in the shift in the research methods – from quantitative survey work to<br />
qualitative case studies (Scapens, 2006). But the challenge for current (and future)<br />
work is to use the theoretical perspectives which the researchers have developed to<br />
provide insights that are relevant and helpful for practitioners. This is the case<br />
especially when academic works theorise issues closer to managers’ daily lives such<br />
as accounting change (e.g. Burns and Scapens, 2000), and accounting in interorganizational<br />
relationship (e.g. Mouritsen and Thrane, 2006).<br />
The success of the changes in the accounting system depends on the manner in which<br />
the behavioural and organizational implications are managed (Shields, 1995). The<br />
appropriate implementation of these changes is less successful if they are seen as<br />
simple technical innovation. Most of the studies are focused especially on the users’<br />
perceptions (managers), while the perceptions of information providers were often<br />
ignored (Pierce and O’Dea, 2003).<br />
The recent financial crisis and corporative scandals without precedent, the markets’<br />
globalization and the competitiveness without precedent, the continuous change of the<br />
national and international regulations together with the opportunities offered by the<br />
informational advanced technologies have forced the appearance of innovations in the<br />
management accounting. In the specialized literature, we can find many<br />
understandings of the term “innovation” (Alter, 2000; Rogers, 1995; Moisdon, 1997).<br />
This problem was studied also in the past by the specialty authors for the entities from<br />
the public sector (Lapsley and Wright, 2004; ter Bogt and van Helden, 2000) and the<br />
private sector (Albu, 2008; Alcouffe, 2002; Alcouffe s.s.,2003; Wolfe, 1994). A<br />
relevant feature is that when a product which solves a practical problem with a<br />
theoretical interest is obtained and that product works, that means we have<br />
constructed a theory in the management accounting (Malmi s.a., 2004). When it<br />
comes to innovations, the following have to be described: the theoretical framework<br />
of the research, the methodology used, the causes of implementing the innovation, the<br />
elements which have influenced the implementation and further on the process of<br />
~ 1151 ~
implementation for different innovations will be analyzed by comparison, the degree<br />
of spreading for these innovations in Romania will be discussed, the results obtained<br />
will be synthesized and proposals will be interpreted and defined for running the<br />
innovations in the management accounting.<br />
After the seventies, the research in the international management accounting has been<br />
characterized through an obvious disciplinary opening (Bollecker & Azan, 2009). It is<br />
known that the theoretical borrowings are meant to diversify the analysis and enlarge<br />
the research. From this point of view, Rojot (2005) was highlighting that in the<br />
current status of the management sciences, the capacity of conservation of the<br />
plurality of approaches must be supported, in an independent manner from the<br />
disciplinary frontier and to be chosen depending on the needs. A researcher has great<br />
chances to innovate, by moving away from the traditional cores of its discipline, in<br />
order to advance towards the frontier areas, because the progress appears in a greater<br />
degree at the meeting point of the disciplines (Dogan and Pahre, 1991). By studying<br />
the international specialized literature, we can see that the articles are influenced more<br />
by the management sciences (43.39% from citations) than by sociology (33.96%).<br />
The management accounting system, as a way of organizational control being at the<br />
disposal of managers, is by its nature dependent of the organization (Bouquin, 2004).<br />
By analyzing the specialized literature, we have identified features of the entities from<br />
the private sector which operate in production, services, distribution, constructions,<br />
agriculture (Bavita et al., 2008; Maurel, 2008) etc. In the last years, with the advent of<br />
the philosophy New Public Management, the research of the entities from the public<br />
sector grew considerably. Concerning the public sector, in the specialized literature,<br />
we have identified organizational features for education, health, public administration<br />
etc. (Nor-Aziah and Scapens, 2007; Brignall and Modell, 2000; Lapsley and Pllot,<br />
2000). As well, we may identify the features of those who activate as freelancers<br />
(notary – Cappellatti and Kouthra, 2008, individual offices of accounting etc.).<br />
Nowadays, the accounting activity is automated. The main issues of the accounting<br />
system from the point of view of the management are not technical or structural but<br />
refer to the need of an efficient management accounting from the management’s point<br />
of view. The IT system is at the basis of this process, supplying the information.<br />
Caglio (2003) was stating that usually the external factors are significant for those<br />
who work in the domain of management accounting. Other studies cannot provide<br />
such an assurance and state that the impact is collateral, through control (Scapens and<br />
Jazayeri, 2003; Granlund and Malmi, 2002). As influences of the informational<br />
technologies upon the management accounting, we mention the following: the joint of<br />
the management accounting systems to strategy and action (Boitier, 2007); the<br />
transition from the management accounting system based on numbers generated by<br />
accounting to a system based on nonfinancial, operational numbers (Dechow and<br />
Mouritsen, 2005); the remodelling of the mission of the management accountants,<br />
which focus mostly on analytical duties (Davis and Albright, 2000); the remodelling<br />
of the knowledge which the management accountants must acquire (Azan, 2009); the<br />
increase of the flexibility of the information processing, in this way integrating the<br />
accounting information. In the last three decades the role of the management<br />
accountant was to improve the competitiveness and the profitability of the firm<br />
through a speech of logical analysis and a rational decision-taking process. Still, the<br />
~ 1152 ~
manner in which the speech is designed has been modified through time – from the<br />
presentation of the relevant information in the 1980’s, to the working with the<br />
managers for finding the information needed in the 1990’s, to disciplining the<br />
organization through the measurement systems of performance in 2000 (Balvinsdottir<br />
et al., 2009).<br />
2. THE ANALYSIS OF CHANGE IN THE MANAGEMENT ACCOUNTING<br />
– THE NATIONAL PERSPECTIVE<br />
In Romania the concerns are still early. Glavan et al. (2007) conducted a research on<br />
the relevance and quality of accounting information in management decisions. The<br />
conclusion of their study was that accounting information is used in management<br />
decisions (83% of managers consider it significant and 67% deemed necessary). Yet,<br />
the most important elements are taken from the financial accounting (66%). This<br />
answer can be explained by the fact that 83% of the entities surveyed organize<br />
financial accounting and only 17% management accounting. 17% of the responding<br />
managers cannot assess the role of the accounting information in the decision-making<br />
process. 17% of the managers consider that the support for the managerial decision is<br />
the information offered by the market and mass-media. In the same time, most of the<br />
accountants fully trust the accounting information (67%), which they consider it is<br />
available in time (67%).<br />
One reason for lack of relevance of information provided by management accounting<br />
is that despite changes in economic environment accountants continue to use the same<br />
tools and traditional techniques (Almasan and Grosu, 2008; Dumitru, 2007).<br />
Albu managed in 2007-2008 a research contract based on the contingency theory. The<br />
team studied the influence of the cultural factors, contingency factors on types of<br />
instruments, innovations in management accounting in Romania and the process of<br />
hybridization in the accounting profession and the identification of the contingency<br />
factors for this phenomenon.<br />
In a study analysing the job advertisements for the management controllers, Albu and<br />
Albu (2007) notice that: the instruments focusing the actions and behaviours of the<br />
actors are mostly represented by the budgets and are used mostly in the subsidiaries<br />
and the foreign capital companies; the modelling of the relationships between the<br />
resources and the aims of the decision making processes; there is a bond between the<br />
strategy and the daily issues.<br />
Jinga et al. (2010) analysed in an empirical survey the situation of the management<br />
accounting in Romania in this moment in different activity domains. The conclusion<br />
is that there would be a gain in the modernization of the management accounting if<br />
the registration of the expenses according to their destination and evolution would be<br />
ruled. The use of the three criteria offers unlimited informing opportunities. The legal<br />
change would determine the entities to form a database with multiple uses.<br />
~ 1153 ~
3. THE ANALYSIS OF THE RESEARCH IN MANAGEMENT<br />
ACCOUNTING IN ROMANIA<br />
Many studies have chosen to investigate the role of academic journals in the<br />
dissemination of accounting knowledge because they have proven to be the primary<br />
means for the diffusion of research knowledge in the social sciences (Nederhof, 1985;<br />
Nederhof and van Raan, 1993; Gray et al., 2002, quoted by van Campenhout and Van<br />
Caneghem, 2010, pag. 837). Even though Schneider (1995) argues that it is not only<br />
the publication of a piece of research that matters, but also its ability to boost further<br />
research, current evaluation methods still mainly focus on the former.<br />
For individuals, publications are crucial because their number and quality are<br />
generally the main criteria for hiring, tenure and promotion decisions (Brinn et al.,<br />
1996; Stone, 1996; Mathieu and McConomy, 2003), even in institutions which have<br />
little interest in research (Hopwood, 2008, p. 89). For universities, recognition as a<br />
research-intensive institution creates a favourable image that may attract the best<br />
postgraduate students and provide financial resources, especially since several<br />
governments have undertaken research assessment exercises to guide the allocation of<br />
public funds Raffournier and Schatt, 2010, pag. 2).<br />
In Romania, the term of quality ratio was introduced to include in the universities<br />
financing methodology a stimulating and corrective component. The National Council<br />
of Research in Higher Education (CNCSIS) computes IC6 since 2006, using the data<br />
from 2005 (previously, IC8 was computed). This quality ratio, involved in the<br />
assessment of the performances level in the university scientific research, has a<br />
complex structure and a distinct computation formula as to other quality ratios. It<br />
allows the budgetary allocations covering the basic needs of the universities in<br />
students’ preparation (wages and materials) to be correlated with the way in which<br />
they are satisfied, both from funds allocated from the state and from other revenues<br />
(http://www.cncsis.ro/Public/cat/25/Prezentare.html).<br />
The criteria imposed on the universities by this quality ratio have as effect requests<br />
regarding the research results of the academics. The relevance and visibility of the<br />
results of the scientific research activities is measured according to:<br />
1. a) Articles, proceedings paper, review published in ISI indexed journals;<br />
b) Scientific papers published in foreign journals in the main journals stream,<br />
indexed in international databases;<br />
c) Scientific papers published in the volumes of the international conferences<br />
ISI indexed and/or the ones organised by international professional bodies<br />
2. Articles published in journals recognised at a national level, by CNCSIS – B<br />
and B+ categories<br />
3. Books published by national printing houses recognised by CNCSIS or<br />
prestigious international printing houses (on paper or electronic).<br />
Raffournier and Schaff (2010) study the content of 18 major academic journals in<br />
accounting over five years (2000–2004) and the set of papers presented at the EAA<br />
congress in 2003, 2004 and 2005. We notice in their study that no paper of a<br />
Romanian author appears in any of the journals and only 2 papers are presented at<br />
EAA congresses. However, these papers are not part of the evaluation process in<br />
Romania. Thus, we consider that the researches of the Romanian authors are mainly<br />
~ 1154 ~
published in Romanian journals. The result is convergent with the one of Popa et al.<br />
(2009).<br />
We base our research on the study of the articles published in Romania on this topic.<br />
In order to analyze the research in management accounting in Romania, we establish<br />
four periods in time:<br />
� 1908-1948: in 1908 the first accounting journal was published in Romania,<br />
Revista generală de comerţ şi contabilitate (RGCC). In this time range the first<br />
articles on management accounting issues appear;<br />
� 1949-1989: in 1949 Romania switched to a soviet accounting system. As this<br />
domain is less affected by the new rules of the economic doctrine, the number<br />
of articles on this topic is increasing;<br />
� 1990-2004: it is the period in which Romania started to implemented a new<br />
accounting system;<br />
� 2005 – nowadays: important changes occurred in the methodology of<br />
classification of the research journals and in the performance measurement<br />
systems within the universities.<br />
Our research has as information source the identified journals existing in the four<br />
periods of time, as it follows:<br />
Period<br />
analyzed<br />
Historical period: 1908-1948<br />
1908-1948 The Journal of Commerce and<br />
Accountancy<br />
Table 1. Journals analysed<br />
Journal Specific features<br />
Existing journals<br />
RGCC The idea of founding the journal was launched<br />
during the first National Congress of Schools of<br />
Commerce Alumni that took place on October<br />
29 th 1906. It materialized through the<br />
publication of the first issue of the journal in<br />
January 1908. When Romania entered the war in<br />
August 1916 the publication was discontinued<br />
for a period of four years (July 1916 –<br />
December 1920). Subsequently, the journal<br />
continued to be published until March 1947. The<br />
area of interest is very broad, including<br />
management accounting.<br />
Historical period: 1949-1989<br />
1937-1955 Accounting Bulletin BC The Accounting Bulletin, as an official<br />
publication of the Body of Accountants – Ilfov<br />
Sector, was only an “instrument” of<br />
communication between the professional<br />
organization and its members. Starting in June<br />
1939, papers are published as well, addressing a<br />
variety of issues.<br />
1956-1969 Accounting and Bookkeeping EC The renaming of the Accounting Bulletin as<br />
Accounting and Bookkeeping brought a certain<br />
change in the contents of the journal. Therefore,<br />
a diversification and a specialization of the<br />
structure of the journal can be observed, and<br />
also a certain “detachment” from the generalized<br />
Soviet model, in the sense that some discussions<br />
on important matters occur. An important<br />
number of management accounting articles is<br />
published.<br />
~ 1155 ~
Period<br />
analyzed<br />
Journal<br />
Existing journals<br />
Specific features<br />
1970-1989 The Accounting Journal RC The trend of de-sovietisation in the ’70 was<br />
supported by important changes in the<br />
accounting field, such as the renaming of the<br />
only accounting journal in Romania. Accounting<br />
and Bookkeeping became The Accounting<br />
Journal.<br />
Historical period: 1990-2004<br />
1990-2001 The Journal of Finance, Credit, and<br />
Accounting<br />
2002-2004 The Journal of Public Finance and<br />
Accounting<br />
RFCC<br />
RFPC<br />
1993-1995 Accounting expertise EXC<br />
1996-1997 The General Journal of<br />
Accounting and Expertise<br />
RGCE<br />
1998-1999 Accounting and Expertise CE<br />
2000-2004 Accounting, Expertise and<br />
Business Auditing<br />
CEAA<br />
1998-2004 Business Management and<br />
Accounting<br />
2002- 2004 Accounting and Management<br />
Information Systems/Contabilitate<br />
şi informatică de gestiune<br />
Journals according to the CNCSIS quotations<br />
2005-<br />
nowadays<br />
2005-<br />
nowadays<br />
2005-<br />
nowadays<br />
Accounting and Management<br />
Information Systems/Contabilitate şi<br />
informatică de gestiune<br />
http://www.cig.ase.ro/revista_cig/<br />
Scientific Annals of the Alexandru<br />
Ioan Cuza University in Ia i.<br />
Section Economic Sciences/<br />
Analele Ştiinţifice ale Universităţii<br />
Alexandru Ioan Cuza din Iaşi –<br />
Secţiunea Ştiinţe Economice<br />
http://anale.feaa.uaic.ro/anale/en/<br />
Virgil Madgearu Review of<br />
Economic Studies and Research/<br />
Revista de Studii şi Cercetări<br />
Economice Virgil Madgearu/<br />
http://www.econ.ubbcluj.ro/rvm/en/<br />
2008-prezent Studia Universitatis Babeş Bolyai.<br />
Oeconomica<br />
http://studiaoeconomica.ubbcluj.ro/<br />
~ 1156 ~<br />
Changes in the political and economic doctrine<br />
(the transition to a free-market economy)<br />
generated important changes in the publishing<br />
field. Therefore, The Accounting Journal<br />
changes its name and content to The Journal of<br />
Finance, Credit, and Accounting and later to<br />
The Journal of Public Finance and Accounting.<br />
One of the topics studied is the management<br />
accounting.<br />
A competing journal is founded in 1993,<br />
Accounting Expertise, edited by the Body of<br />
Expert and Licensed Accountants of Romania<br />
(CECCAR).<br />
The thread interrupted in 1947 (when the<br />
General Journal of Commerce and Accountancy<br />
– RGCC, founded in 1908, ceased to appear) is<br />
therefore resumed. Subsequently, the journal<br />
changed names several times, but management<br />
accounting articles were published all along the<br />
period.<br />
GCF It is a new competing journal with a very broad<br />
area of interests, including management<br />
accounting.<br />
AMIS As well as the previous journals, AMIS<br />
publishes articles on management accounting<br />
topics. Even more than other journals in the<br />
field, AMIS emphasizes the scientific character<br />
of the published papers.<br />
AMIS<br />
FEAA<br />
VM<br />
SUBB<br />
These journals have as a common denominator a<br />
good CNCSIS classification based on<br />
performance criteria, which attracts some of the<br />
most relevant scientific papers in the field.<br />
a) Publishing the research results in management accounting in 1908 – 1949<br />
According to the research conducted by Calu (2005), management accounting<br />
(costing) issues began to attract the interest of accounting specialists; many articles<br />
were published in the RGCC, in 1908-1948. Accordingly, specialized articles were
published on a particular segment, such as the division of general administrative<br />
expenses or an overview of the calculation of costs in different economic sectors:<br />
industry, trade. The problem of distribution methods of the expenses was also<br />
presented in the pages of journals; in this regard, the appearance of procedures<br />
(methods) in the Romanian literature is noticed: the division method, the additional<br />
method, equivalent figures method, coupling method etc.<br />
Issues related to budgeting cost were also if interest; in this respect we recall a chapter<br />
in Evian’s book “Accounting Industry” (The budget is “a projection into the future of<br />
the enterprise’s activity”) and an article published by Donoaica in BC (1948).<br />
The period under review is characterized by the concerns displayed by the academics<br />
for choosing, defining and clarifying specific terms for cost calculation. Accordingly,<br />
there were discussed and defined the following terms: price cost, the recovery price:<br />
“price cost, meaning the purchase (procurement) price, the recovery price – a<br />
minimum sale price”, general administration overheads – “all the expenses connected<br />
with rent, salaries, light and heating, various taxes etc.”, procurement costs for sale –<br />
“all the general expenses made with the purchasing of goods and not included in<br />
paragraph a) [the cost price], selling expenses – “all the expenses incurred in the sale<br />
such as advertisement, displays, placement agencies etc.” These concepts were<br />
debated in CECCAR and were published in RGCC (1936).<br />
At the same time, different aspects of industry experience in other countries are<br />
presented as examples, such as standardization and cost calculation in Germany<br />
(RGCC, 1937). Another idea found in the pages of the publications of that time is the<br />
computation of the industrial recovery cost using extra accounting techniques.<br />
Therefore, “... technical or extra accounting recovery costs are established using<br />
sheets prepared for each item produced and columns containing the quantity and the<br />
cost of the raw materials employed, wages and manufacturing overheads reported<br />
percent” (RGCC, 1940).<br />
b) Publishing the research results in management accounting in 1949 – 1989<br />
Post calculation was the part of the management accounting on which no substantial<br />
changes were generated by the new economic doctrine. Given the possibility of a<br />
wider exercise of the professional judgment, the cost calculation is one of the topics<br />
covered in the pages of the journals EC and BC.<br />
According to Calu (2005) the first research subjects that made reappearance in BC<br />
(after the June 11 th 1948 moment) were those addressing the issue of costing. The<br />
main topics were: costing in coal mines; cost calculation in the manufacturing<br />
industry; post calculation in publishing houses; post calculation in cotton mills. Given<br />
that the accounting standard-setting process was developed at the industry level, there<br />
can be noticed that most authors attempted to point out various features in the field of<br />
management accounting as well.<br />
Changing the name of the journal from Buletinul contabililor (BC) to Eviden a<br />
contabilă (EC) in 1956 only brought formal changes. Costing is as in the previous<br />
period, one of the main subjects addressed in the pages of this journal. According to<br />
Calu (2005), the subjects addressed in EC can be divided into two categories: (1) the<br />
~ 1157 ~
presentation of classical costing methods, using different companies as examples and<br />
providing suggestions for improvement and (2) suggestions regarding the use of new<br />
methods (direct-costing), from the “industrialized countries”. In the first category of<br />
methods, full-costing, process costing and job order costing were discussed, as<br />
methods used assess costs in various industries. The second category, of modern<br />
methods, began to be presented in the literature in the late ‘60s, initially in the form of<br />
a book review, and subsequently in some articles addressing the issues of: recording<br />
and calculation of production costs using THM method (machine-hour rate), the cost<br />
calculation concepts under standard costing method, GP (George Perrin) cost<br />
calculation method, direct-costing method.<br />
Together with the “object” of accounting, the cost calculation was the subject of<br />
articles published in RC in the period 1970-1972. It was defined as it follows: “the<br />
object of the cost calculation is, on one hand, the production and selling expenses of<br />
the enterprise, and on the other hand, the production of material goods, works and<br />
services conducted in a given organizational framework and expressed quantitatively<br />
by certain units of measurement” (RC, 1971).<br />
In the late socialist period, in an article published in RC (1988), Ristea discussed the<br />
need to organize “the management accounting as an autonomous function”. This<br />
article expressed the view that “accounting cannot be limited to costing and the<br />
computation of the results only through the carriers of value”, requiring “a separate<br />
accounting information structure ... called «management accounting», the central<br />
problem of which is to calculate the production costs and results” and using “the<br />
specific instruments ... costing, internal budgets and internal financial control”.<br />
c) Publishing the research results in management accounting in 1990 – 2004<br />
Following the Revolution of 1989, which resulted in the fall of communism and the<br />
transition to a free market economy, the publishing environment has undergone a<br />
significant transformation. Therefore, a transition occurred, from the existence of a<br />
monopoly on specific accounting journals to a plurality of options. An analysis was<br />
performed of articles published during this period in the field of management<br />
accounting according to topic.<br />
The duality in the post-revolutionary Romanian accounting system involves distinct<br />
approaches regarding the problems of management accounting and costing. In the<br />
early ‘90s, “the benchmark treatment” was represented by full costing, matched by the<br />
accounting technique of using the Class 9 accounts form the Chart of accounts to<br />
record costing activities. These accounts were called Management Accounts and<br />
provided under the regulations issued by the Ministry of Finance.<br />
Switching from a monistic accounting to a dualistic accounting system resulted in the<br />
appearance of original articles presenting the appropriate technical solutions for the<br />
new realities, such as introducing a practical choice for the organization of<br />
management accounting (EXC, 1993). The issues raised were not only technical, but<br />
they also raised questions: is there a boundary between financial and management<br />
accounting? (EXC, 1996). Subsequently, management accounting began to be more<br />
and more the subject of articles that relate to a modern approach. In this respect we<br />
mention the following: activity-based costing (RFCC, 1999; CEAA, 2003; RFPC,<br />
~ 1158 ~
2003; GCF, 2003; AMIS), target costing (AMIS), the relevance of accounting<br />
information in making decisions on cost management within a company (GCF, 1999;<br />
AMIS, 2004), approaches concerning the limits of the management accounting system<br />
(GCF, 2000), the conceptual boundaries of the management accounting in the<br />
development worldwide (RFCC, 2001), considerations of influence of the cost<br />
calculation on the profit or loss (RFCC, 2001), comparative management accounting<br />
(CEAA, 2002), management accounting using marginal costs (AMIS, 2004), cultural<br />
aspects (AMIS, 2003) etc.<br />
Linked to the management accounting issue is the management control, defined as<br />
“the process by which managers ensure that resources are obtained and used with<br />
efficiency, effectiveness and relevance for the objectives of the organization” (Ionaşcu<br />
et al., 2001). Some particular aspects of management control began to be addressed in<br />
specialized journals. In this respect, we note the overall approach of this domain:<br />
restructuring the company and management control (RFCC, 1999), management<br />
control for activities generating fixed overheads (GCF, 2003), internal transfer pricing<br />
practices (CEAA, 2001, 2002), inventory management models, the concept of<br />
management control (AMIS, 2004), budgets (AMIS, 2004), concept of performance<br />
(AMIS, 2002, 2004), project management (AMIS, 2003), quality control and quality<br />
costs (AMIS, 2004).<br />
d) Publishing the research results in management accounting in 2005 – 2011<br />
In 2005 the Ministry of Education established new criteria for holding teaching<br />
positions in higher education and for achieving academic titles. Consequently, some<br />
mutations occurred regarding the publication of scientific papers. According to the<br />
new regulations, the most relevant criteria for holding teaching positions in higher<br />
education and for achieving academic titles are: the number of ISI articles (A journals<br />
in CNCSIS classification), the number of international databases indexed articles (B+<br />
journals in CNCSIS classification), holding the position of director or member of a<br />
research team working on a research project financed through a national competition.<br />
Thus, the most relevant papers were published in journals classified by CNCSIS as A<br />
(ISI) and B + (indexed in international databases).<br />
In the same year, CNCSIS established new criteria for the evaluation of journals (A,<br />
B, C, and D). In 2007, the B+ subcategory was introduced to stimulate the visibility of<br />
Romanian journals on the Web. In 2008 the B+ subcategory became the category of<br />
Romanian journals indexed in international databases, and complying with all the<br />
conditions of the B category journals (http://www.cncsis.ro/articole/1901/Arhiva-<br />
2005-2010.html).<br />
To classify the articles published in the four journals we did as it follows: we<br />
identified the articles with other topics than accounting, articles with financial<br />
accounting topics, management accounting articles and other types of accounting. To<br />
classify the management accounting articles we adapted a classification published by<br />
Management Accounting Review (MAR) to analyze the articles published in the last<br />
two decades (Management Accounting Research, 21 (2010) 278–284). However, the<br />
classification of these articles is the result of our work and is inevitably subjective.<br />
Thus, the articles were classified according to two criteria: topic studied and research<br />
~ 1159 ~
settings. After analyzing the abstracts of the articles published, the criteria were<br />
detailed as it follows:<br />
Criteria<br />
Topic studied<br />
Research settings<br />
Table 2. Criteria used<br />
Traditional costing techniques<br />
Advanced costing techniques<br />
Pricing; including transfer pricing<br />
Management accounting practices<br />
Management accounting change<br />
Management and organisational control<br />
Performance measurement<br />
Strategic management<br />
Risk management<br />
Inter-organisational management control<br />
Others<br />
Generic<br />
Manufacturing<br />
Specific industries<br />
Services<br />
Specific countries<br />
Other<br />
The results obtained are the following:<br />
Table 3. Classification of articles<br />
Items<br />
Total AMIS FEAA VM SUBB<br />
u % u % u % u % u %<br />
Total number of articles, of which: 731 100 531 100 49 100 61 100 90 100<br />
Number of articles in other domains 391 53.49 251 47.27 11 22.45 53 86.89 76 84.44<br />
Number of articles in accounting, of<br />
which:<br />
340 46.51 280 52.73 38 77.55 8 13.11 14 15.56<br />
Number of articles in financial accounting 138 40.59 115 41.07 18 47.37 1 12.5 4 28.57<br />
Number of articles in management<br />
accounting<br />
70 20.59 55 19.64 8 21.05 3 37.5 4 28.57<br />
Number of articles in other types of<br />
accounting<br />
132 38.82 110 39.29 12 31.58 4 50 6 42.86<br />
We notice that the average percentage of papers in management accounting is 20.59%<br />
in these journals (from 19.64% in AMIS to 37.5% in VM).<br />
Table 4. First criteria: topics studied<br />
Items MAR 2000- Total AMIS FEAA VM SUBB<br />
2009 (%) Romania<br />
u % u % u % u % u %<br />
Traditional costing techniques 9 12.86 7 12.73 2 25<br />
Advanced costing techniques 15 16 22.86 12 21.82 2 25 1 33.33 1 25<br />
Pricing; including transfer<br />
pricing<br />
2 4 5.71 4 7.27<br />
Management accounting<br />
practices<br />
8 6 8.57 4 7.27 1 12.5 1 33.33<br />
Management accounting<br />
change<br />
15 5 7.14 5 9.09<br />
Management and<br />
17 5 7.14 3 5.45 2 50<br />
organisational control<br />
Performance measurement 14 2 2.86 2 3.64<br />
Strategic management 3 5 7.14 3 5.45 1 33.33 1 25<br />
~ 1160 ~
Risk management 3 2 2.86 2 25<br />
Inter-organisational<br />
management control<br />
6 1 1.43 1 1.82<br />
Others 17 15 21.43 14 25.45 1 12.5<br />
Total 100 (205 papers) 70 100 55 100 8 100 3 100 4 100<br />
We notice that in Romania there are still a number of papers published regarding the<br />
traditional costing systems. In the same time, the percentage of the papers dealing<br />
with costing techniques (both traditional and advanced) is very big as compared with<br />
MAR. Management accounting change, Management and organisational control,<br />
Performance measurement, Inter-organisational management control are poorly<br />
represented in the Romanian literature (for the first two the percentage is almost a half<br />
of the one in MAR, while for the second two the percentage is almost five times<br />
smaller than the one in MAR). In the same time, the percentage for strategic<br />
management is two times bigger in Romania than in international literature (MAR).<br />
Table 5. The second criteria: research settings<br />
Items MAR 2000- Total AMIS FEAA VM SUBB<br />
2009 (%) u % u % u % u % u %<br />
Generic 14 33 47.14 26 47.27 5 62.5 1 33.33 1 25<br />
Manufacturing 9 1 1.43 1 33.33<br />
Specific industries 18 9 12.86 7 12.73 2 50<br />
Services 14 4 5.71 4 7.27<br />
Specific countries 25 2 2.86 1 1.82 1 25<br />
Other 20 21 30 17 30.90 3 37.5 1 33.33<br />
Total 100 (196 papers) 70 100 55 100 8 100 3 100 4 100<br />
We notice that most of the articles in Romania offer generic “recipes”, while the<br />
number of articles dealing with a certain matter is small. We notice that at MAR the<br />
services became an important research setting (trend which is not yet adopted by the<br />
Romanian researchers). A cause may be that the most used research method at MAR<br />
in the last 10 years was the case study (40%), while in Romania we could not<br />
encounter this method. There is also an important difference in the Specific countries<br />
setting, as in Romania, dealing with Generic setting we do not take into account the<br />
characteristics of the country (especially our own country).<br />
4. THE ANALYSIS OF CHANGE IN THE MANAGEMENT ACCOUNTING<br />
– THE FUTURE PERSPECTIVE<br />
The management accounting is a deregulated domain. The absence of legal<br />
constraints has resulted in a diversity of methods of organization of the management<br />
accounting, many of these organization methods presenting gaps from the<br />
informational potential point of view. An analysis of the politics regarding the<br />
selection of these methods, in the economical and cultural context of our country, is<br />
able to highlight new valences of the accounting research in the management<br />
accounting domain. By analyzing the international and national literature (Albu, 2007;<br />
Baker, 2007, Scapens, 2006; Levant, 2006; Calu, 2005; Boyns, 1997; Nikitin, 1996)<br />
we notice the obvious discrepancy between theory and practice, among the studies<br />
undertaken in diverse geographical areas but also among the addressed research<br />
methods.<br />
~ 1161 ~
The research in the change in the management accounting in Romania may be based<br />
on the evolution theory, whose potential was not fully described or used in the<br />
accounting research (Johansson and Siverbo, 2009; Coad and Cullen, 2006). The<br />
analysis of change in management accounting should follow two axes: the trend at the<br />
conceptual level and the methodological one.<br />
Form the conceptual point of view, theories in a social sciences field such as<br />
management accounting research should provide explanations that are useful for those<br />
we study – managers, organizations and society (Malmi and Granlund, 2009). The<br />
ultimate reason for developing a theory is to be able to use this understanding, or<br />
theory, in creating better management accounting practices, both in terms of content<br />
and use (Chenhall, 2003; Ittner and Larcker, 2001). An important criterion for a<br />
theory’s success is the value of the theory to users (Demski et al., 1991). As well,<br />
there is a need for management accounting theories addressing what systems or<br />
techniques to use, how and in which circumstances (Kaplan, 1998). Not in the last<br />
time, we need theories explaining how to change management accounting practices<br />
(Malmi and Granlund, 2009). Studies should address the performance implications of<br />
various practices. Another avenue is to develop existing practice theories to more<br />
complete theories by specifying constructs, relationships and underlying mechanisms<br />
more clearly and addressing their limitations (Malmi and Granlund, 2009). One of the<br />
most used theories in the management accounting change is the framework suggested<br />
by Burns and Scapens (2000).<br />
In terms of methodology there has been a change from the use of mathematical<br />
models to prescribe optimal practices, through statistical generalisation to explain the<br />
diversity of observed practices, using a combination of economic reasoning and<br />
contingency theory to do the explaining, to an approach which focuses on<br />
understanding the specific practices of individual organizations. According to Scapens<br />
(2006), the evolution of the twin theory – methodology in the management accounting<br />
is presented, in time, as it follows:<br />
Table 6. The evolution of the management accounting research<br />
Year Methodology Theory Practical dimensions Research tool used<br />
1970s Modelling Economic What managers should do? Mathematical models<br />
1980s Positivism Contingency What do managers do? Empirical surveys<br />
1990s Interpretivism Structuration Making sense of practice Interviews<br />
2000s Pluralism/Pragmatism Institutional Helping practitioners Case studies<br />
(Source: Scapens, 2006)<br />
As a conclusion, the new trend in the research in management accounting at<br />
international level is the institutional theory (most of the papers – 19% – published by<br />
MAR in 2000 – 2009 used this theory). Institutional theory seeks to explain the<br />
development of institutions and organizations and the way that organizations compete<br />
for political and social power and institutional legitimacy. DiMaggio and Powell<br />
(1983) label the process through which institutions and organizations tend to adopt<br />
similar structures and practices, as institutional isomorphism. Institutional<br />
isomorphism is a process that causes a particular organizational unit within a<br />
population to resemble other units in the population facing similar sets of<br />
environmental conditions and it can be coercive, normative and mimetic.<br />
~ 1162 ~
From the research methodology point of view the newest existing trend at<br />
international level is the pluralism/pragmatism, which supposes using a mixing of<br />
methods, both qualitative and quantitative. The latest method is the triangulation.<br />
Triangulation represents an original abstract of different research methods (e.g. case<br />
studies and survey methods). Within the survey methods the questionnaires and the<br />
interviews may be used. The triangulation between the case studies and the empirical<br />
investigation methods (Modell, 2005) offers the means for assessing the degree of<br />
convergence and, in the same time, offers the means for the presentation of<br />
differences between the results obtained (Brewer and Hunter, 1989; Jick, 1979;<br />
Sieber, 1973). The empirical surveys can improve the level of understanding the<br />
impact of a certain phenomenon and/or the form and intensity of the conceptual<br />
relationships noticed in the case studies. On the other hand, the case studies increase<br />
the understanding level offered by the results of the empirical investigations, offering<br />
a holistic vision and, in the same time, help explaining the obvious problems or the<br />
problems that can appear in the future.<br />
CONCLUSIONS<br />
We started form the idea of comparing the research published in four Romanian<br />
academic journals on management accounting topics. The small number of articles<br />
published made us believe that this was not relevant. So, we compared the total<br />
number of articles published in these journals with the articles published in MAR.<br />
A limit of our research is that due to the lack of tradition in publishing management<br />
accounting papers in academic journals, we could not make a comparison in time of<br />
the results obtained. Another limit is that we only selected 4 journals, while there are<br />
lots of other economic journals in Romania classified B+ by CNCSIS which publish<br />
articles on this topic. Another limit is that in some journals the number of articles<br />
published on management accounting topics is very small. Another limit is that we<br />
could not use the entire classification presented in MAR, namely the theory used, as<br />
many articles had only a literature review part. We also didn’t present the regions of<br />
origin of these papers, as in more than 90% of the cases (100% for the journals except<br />
AMIS) this is Romania.<br />
The differences in percentages show us that there is a need for a change in the<br />
management accounting research in Romania. We notice that in Romania the<br />
researchers are more concerned with the costing techniques than with the management<br />
control. In the same time, the target of management accounting is to help managers in<br />
their decision making process. This cannot be achieved since our research focuses on<br />
generic settings and not on specific industries or services. We must pay more attention<br />
to the accounting and management practices in the successful organizations (Malmi<br />
and Granlund, 2009). For our country the researchers are also the professors. Since<br />
their concerns are related to the costing techniques mostly, this is what they transmit<br />
to their students, and their students will implement in their companies. This is why we<br />
believe that that a change in the management accounting research topics will also lead<br />
to a change in the management accounting practice. The target is to find the way in<br />
which the challenges of the economical, social and legal environment are transformed<br />
in opportunities through the changes from the management accounting.<br />
~ 1163 ~
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Revista de contabilitate, 1970-1989 [RC]<br />
Expertiză contabilă, 1993-1995 [EXC]<br />
Contabilitatea, expertiza şi auditul afacerilor 2000-2003 [CEAA]<br />
Gestiunea şi contabilitata firmei [GCF]<br />
Revista Finanţe, Credit, Contabilitate [RFCC]<br />
Revista Finanţe publice şi contabilitate [RFPC]<br />
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