Volume 28 Number 3 December 2003
Editor - Robert Marks
|C onsider the pencil. A simple implement, you might quickly conclude, with no lessons for today's manager. And yet the pencil is mute testimony to a process of discovery, invention, and refinement that has culminated in an object beautifully adapted to its purpose. If our civilisation were wiped out, and with it all knowledge of how to manufacture pencils - indeed, given the lack of written information about pencil making, wiping out the pencil-making companies and their employees' memories would suffice - it would be very difficult for future intelligences, lacking pencils of their own, but possessing some surviving pencils of ours, to figure out how to make pencils. Their function, however, would be clear, after a few moments' play.|
|That, at any rate, is the convincing conclusion of Henry Petroski, who has written a fascinating book, The Pencil: A History of Design and Circumstance, on the (undocumented) evolution of the pencil, as a captivating history of a designed artefact. Captivating, for me, as a lapsed engineer, and, although I was driven to economics by my urge to better understand the econosphere, to use Boulding's coinage, I was also aware that both engineers and economists design. And, in order to design - to change the world, in Marx's phrase - it is also necessary to analyse - to understand the world. The history of the pencil is a story of better design following better understanding.|
|Graphite is a modern word, but graphite deposits have been known of for centuries, and the deposit of 'wadd,' or 'black lead' near Borrowdale in the English Lakes District became the first source of the main ingredient for making pencils. Indeed, the English monopoly on graphite was the mother of a French invention at the time of the Napoleonic wars when a Frenchman, N.-J. Conde, cut off from new English pencil lead found how to bake a mixture of clay and ground graphite to eke out French supplies, and incidentally to create different grades of pencil lead. When the Borrowdale deposit became exhausted in the 1850s, the English had no fall-back. Instead, the French, the Germans, and the Americans (including the young Henry Thoreau) took over the industry, refining the process of choosing the wood, of inserting the pencil lead into the envelop of wood, and meeting the demands for a convenient writing implement that is the modern pencil.|
|The design of the modern pencil has been the result of many hands, eyes, and minds, working not together, but generally in isolation, the pencils they produced embodying the improvements they made. Communication of the design improvements has thus been implicit in their pencils, evidence of their solutions to design problems that has spurred later pencil engineers on to better designs. Pencil making must be profitable for the pencil-manufacturing firm to survive, of course, so one dimension of better pencil design must be the cost of production. The challenges are not only technical - how to centre the lead so a pencil sharpener will sharpen, for instance - but also cost-related - to do so at low cost.|
|Can we draw an analogy between making pencils and managing firms? The technical issues for the manager might be managing people, including any engineers in the firm; the financial elements are similar to the pencil engineer's, with the added aspect of stimulating demand, as well as keeping costs under control to maximise the value added of the firm's produced goods and services.|
|Perhaps the analogy is farfetched: I doubt that my O.B. colleagues would see the parallels. Yes, it is true that the firm embodies the design decisions of the manager - think of Jack Welch's General Electric - but there's nothing mute about it, and of course managing people is quite different from combining inanimate graphite, wood, glue, paint, metal, and rubber into a pencil, however well adapted it is. People must be encouraged (using, crudely, carrots or sticks) to do their jobs well, and these jobs must mesh in order to enable the firm to satisfy demand at low cost, and indeed ideally to stimulate demand.|
|Engineers are well aware of the evolution of their discipline, partly from relevant scientific advances, but also partly from the accretion of design decisions embodied in artefacts such as the pencil.|
|Managers, however, despite the growth of scientific management over the past century, must wonder sometimes whether their discipline is cyclical, without the benefit of progress, except at the most mundane level, such as the use of modern communications and machines. Where is the artefact that testifies to management's progress, where is the pencil of management?|
|And yet, as an academic at a management school, I deplore such equivocation. The modern organisation - the modern firm - is the manager's pencil: it embodies the advances in management over the twentieth century. If these improvements in management are not so obvious, this might be because all surviving firms in any industry have also improved, so that the old benchmarks have gone as competition has intensified, not least with globalisation, and the profits of firms in the industry have not risen with improvements in management.|
|Steven Jay Gould provides an analogy in his book, Life's Grandeur, where he argues, convincingly I believe, that although the skill of the batter, in twentieth century professional baseball has improved progressively, so have the skill of the pitcher and fielder, so that while hitting averages have actually risen, peak hitting averages have fallen: the distribution of hitting averages has become compressed.|
|Thorstein Veblen, particularly in The Engineers and Price System and The Theory of Business Enterprise, argues that 'there is a class struggle under capitalism, not between the bourgeoisie and the proletariat, but between businessmen (sic) and engineers'. (Blaug 1986). But although he critiques the market mechanism and hankers for something like a technological revolution, Veblen 'warns us specifically against the belief that the engineers are capable of taking over and running the system'. I agree.|
|We can teach managers how to produce better pencils, as it were, and we all benefit from the rising levels of productivity which are partly a function of better management, and partly a function of better engineering of processes. Which is where we came in.|
This Issue's Papers
Cognitive dissonance, possibly one of social psychology's greatest theories? As I understand it, cognitive dissonance is a psychological state that may result when, as it were, heart and mind - opinions and cognition - pull us in different directions. Pop psychologists use the concept to explain, for example, why graduates who were disappointed at the time might remember their student days with fondness. Soutar and Sweeney are interested in the impact of the phenomenon on consumer choice. Using a multidimensional measure of 'consumer dissonance' of theirs, they postulate that a buyer's response to a purchase can be measured in three dimensions, one emotional, and two cognitive - 'wisdom of purchase' and 'concern over the deal.' The paper describes these three dimensions in more detail. In the reported study, customers were surveyed after purchase but before first use, at a furniture store and a car stereo centre. Although, on average, the authors found relatively little dissonance across the customers, closer examination found three clusters of customers (classified using the three dimensions) at both the furniture store and the car stereo centre.
|The largest cluster in each case was low in dissonance; the second largest (between 20 and 30%) was 'concerned about needing the purchase;' and the smallest groups (at 10%) had high dissonance scores in all three dimensions. After further analysis, the authors recommend that retail managers spend more time and resources (not least in recruitment and training of staff) to reduce customers' perceived risk associated with the purchase, to reduce consequent dissonance. Whether this would result in more sales in the future is a moot point.|
|I know of no studies of 'consumer dissonance' among participants in financial markets. In this case there are buyers, as in retail, but buyers could just as easily be sellers, since buyers will later sell, and there is no use - both sides might suffer regret after the transaction. The more so when the main purpose of trading financial investments is to obtain a portfolio whose risk-return profile matches the trader's risk preference. This profile is prospective, but information arrives ex post, not ex ante. And information can affect the volatility (or risk) of the assets' prices.|
|Fleischer's paper studies the impacts of information on volatility across six markets: Australian equity, money, and bond markets, and their U.S. counterparts. The main link among the markets is cross-market hedging, and the two sources of volatility linkages are common information and information spillovers. Common information (such as government policy) will be significant within-country, and, because of cross hedging, so will information spillovers (when information of an event affects one market directly, and investors' rebalancing their portfolios influences the trades in other markets). Using the General Method of Moments (GMM), Fleischer finds much stronger linkages across the Australian markets and across the two countries' markets than previous researchers have reported.|
|Information is also the focus of the third paper in the issue. Kent and Ung explore the extent to which Australian listed companies volunteer information about future earnings in their annual reports. They find that few companies volunteer quantitative earnings forecasts, although over half do make some forecasts about earnings, without clear numbers. Not surprisingly, most of these forecasts predict good outcomes - perhaps on the principle that if you can't say something nice, better to say nothing at all. The authors find that larger companies with earnings of lower volatility are more likely to report predictions of future earnings - whether quantitative or not - than are smaller companies whose earnings are more volatile.|
|Australian listed companies are also the subject of Welch's paper, which examines whether a firm's ownership structure - not only the diversity of ownership, but also the proportion of shares held by top management and the company's directors, and the proportion of shares owned by others - is related to its performance, Of course, a more successful company might attract a wider ownership, but there might also be a benefit from a diverse ownership when the firm needs capital to grow quickly: there might well be endogeneity of ownership structure. On the other hand, greater diversity of ownership leads to higher costs of monitoring by outsider shareholders. Welch finds that, while ignoring endogeneity, firm performance in Australia is statistically dependent on the degree of managerial ownership, when ownership is modelled as multidimensional and endogenously determined, firm performance exhibits no statistically significant dependence on either ownership measure - proportion of managerial owners or proportion of outside owners.|
|In 2002 we published a paper by Nguyen and Faff (2002), which considered the use of financial derivatives by Australian firms. The authors found that, not surprisingly, Australian managers use derivatives to maximise their firm's value. Now Nguyen and Faff are back, this time - and with the same sample of firms - exploring the use of foreign-currency and interest-rate derivatives. The results they report are relatively consistent with hedging theories, at least for interest-rate derivatives: the larger the firm and the more leveraged, the more liquid, and the higher its dividends, then the greater the likelihood that it uses interest-rate derivatives. That is, firms appear to use interest-rate derivatives to reduce the risk of financial distress and to secure internal capital for future growth; use of these derivatives reduces the cost of under-investment. They also find that the larger the firm and the greater its level of debt, then the greater the likelihood that it uses foreign-currency derivatives. Firms appear to use foreign-currency derivatives to minimise cost, especially when there is foreign-currency-denominated debt. The authors conclude that, as with their earlier work, managerial discretion in the use of derivatives seems to take a backseat to maximising firm value.|
|The business cycle is reflected on the cycle of the underpricing of floats, of initial public offerings (IPOs). But underpricing has also been related to the proportion of resource-based IPOs. Why so? Well, as Suchard and Woo explain in the next paper, resource firms are generally more speculative in nature, often more difficult to value, and their cashflows are influenced by changes in commodity prices (and changes in exchange notes, I add), which are not usually considered in most IPOs. Using a 17-year database they establish the significance of resource-specific influences, along with traditional risk factors, in the average level of underpricing of IPOs, especially during periods of 'hot' markets, when the traditional risk characteristics - firm size, ex-ante uncertainty, and period of subscription - do not appear to affect the level of underpricing significantly. They characterise as 'hot' markets associated with large numbers of highly speculative resource-based IPOs over a short period. Although they expected otherwise, they did not find any systematic impact on the level of underpricing from the level of the resource firm diversification or the nature of resource activity (producer versus explorer).|
|Economists have worried about the apparently persistent issues of over- or under-pricing of IPOs.|
|Underpricing of, say, privatised government assets means that the community (of taxpayers) lose, while overpricing can result in reluctance of later investors to buy in, after the share price has fallen. Share prices fluctuate, as Bernard Baruch is reputed to have said when asked what the market would do, but systemic over- or under-pricing could be reduced with the greater use of the auction mechanism, the most efficient means we have of pricing newly created financial instruments.|
|The final paper in this issue is a survey of tenders and auctions by Menezes, Pitchford, and Wait. You have an item (or items) to sell (or wish to buy a service, perhaps). How should you design the auction (or sealed- bid tender) you plan to use to achieve you end? This question is one that has prompted much research using mathematics and game theory over the past twenty-five years, and one which is of great interest to regulators, as the privatisation of government activities and assets proceeds in such areas as airports, ports, and telecommunications, to name a few.|
|The principal lesson, the authors say of their review, is that the format of the auction can affect the expected revenue and the allocative efficiency, but unfortunately, there is no general rule to obtain the highest revenue (or lowest cost). Depending on the desired objectives, the auction format will vary, as the paper explains. I leave it to the interested reader to discover how.|
Every year the Associate Editors of the Journal vote for the best paper in the previous year's volume, the authors of which receive the E.Yetton Award. For 2002 the Best Paper was 'Bayesian Cross Hedging: An Example from the Soybean Market', by Doug Foster and Charles Whiteman, of UNSW and the University of Iowa, respectively. The votes for Runner-Up were cast wide, including three papers from the Special Issue on Organizational Behaviour, and five papers from the two regular issues, but the choice was clear: Garry Twite's 'Gold Prices, Exchange Rates, Gold Stocks and the Gold Premium'. Congratulations to all three authors. Although both Doug and Garry could vote for the award, neither voted for himself, and Doug declined to vote at all.
|Congratulations are also in order for Professor Sharon Parker, Area Editor in Organisational Behaviour, for her recent promotion.|
Blaug, M. 1986, Great Economist Before Keynes: An Introduction to the Lives and Works of One Hundred Great Economists of the Past, Wheatsheaf, Brighton.
Boulding, K. 1966, 'The economics of the coming Spaceship Earth,' in Environmental Quality in a Growing Economy, ed. Henry Jarrett, Johns Hopkins Press, Baltimore.
Gould, S.J. 1996, Life's Grandeur: The Spread of Excellence from Pluto to Darwin, Jonathan Cape, London. (This book was published in the U.S. under the title Full House.)
Graney, B. 2001 'Taking advantage of market fluctuations', Fool on the Hill, The Motley Fool, March 23. http://www.fool.com/news/foth/2001/foth010323.htm
Marx, K. 1886, 'Theses of Feuerbach,' Appendix to F. Engels' Ludwig Feuerbach and the End of Classical German Philosophy, in Die Neue Zeit. http://csf.colorado.edu/psn/marx/Archive/1845-Theses/
Nguyen, H. & Faff, R. 2001, 'On the determinants of derivatives usage by Australian companies,' Australian Journal of Management, vol. 27, pp. 1-24.
Petroski, H. 1998, The Pencil: A History of Design and Circumstance, Alfred A. Knopf, New York.
Veblen, T.B. 1904, The Theory of Business Enterprise, Scribner's Sons, New York.
Veblen, T.B. 1921, The Engineers and the Price System, Viking, New York.
A Note from the Editors
The editors of the Australian Journal of Management would like to thank the following researchers and practitioners who reviewed articles for the Journal during the period from 2000 through 2003. Thank you.
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