Volume 26 Number 2 December 2001

Editor - Robert Marks

The Anti-Terrorist's Dilemma

S ince September 11, the world has changed. That is what was being said as we tried to absorb the enormity of the acts of terrorism (a word first coined to describe aspects of the French Revolution), the images of which had been transmitted around the world from New York and Washington D.C. In the face of the barbarity of the attacks, it is difficult to know what more can be said. In the aftermath of the mowing down of the twin towers and the deaths of thousands of innocent people, civilised people the world over are asking how we might prevent or at least reduce the likelihood of such terrorist attacks in the future.

An article which appeared thirteen years ago (Lee 1988) uses techniques of game theory to argue, first, that the fight by nations (as players) against terrorists has elements of the Prisoner's Dilemma: although all countries would be better off if every country targeted terrorists, there is some incentive to free ride and let other countries do the dirty work. Lee, however, points out that nonetheless cooperation to fight terrorists does occur, perhaps owing to the indirect ramifications of not retaliating. Retaliation by one state generates both positive and negative externalities for others: positive in the free-riding sense, negative in that non-retaliators might be easier targets for future terrorist attacks.

Second, a country might find it beneficial to allow a terrorist group to operate on its territory (while attacking beyond its borders) in return for assurances that the country would be spared future terrorist attacks. Lee calls this 'paid riding', although it might also be called a form of blackmail. Such hospitality, of course, reduces the effectiveness of another country's retaliation against the terrorists. The existence of the option of paid ridership means that it is not always in a country's best interests to retaliate, even if it stands to benefit from reduced terrorist activity.

Lee's solution? He argues for a 'transnational commando force', which would reduce nations' flexibility to opt for the paid-rider strategy. On a broader scale, a common anti-terrorist policy would, if adhered to by all nations, achieve the same end, of eliminating or reducing the existence of national safe havens for terrorists. One difficulty might be to establish a mechanism for joint decision making about whether a group is a terrorist group, or rather a group with a legitimate grievance towards an aggressive neighbour. In the world as we find it today, consensus on these issues is ever more desirable, even if not much closer to fruition.*

* I have found the executive summaries of leading research in the Canadian publication, Economic Intuition, to be valuable in alerting me to Lee's article.

This Issue's Papers

Gong and Shekhar tackle the concern that governments, perhaps for political purposes, have been offering shares in previously government-owed enterprises at prices which have been too low, thus allowing the initial owners to reap an abnormal capital growth as the price of the newly privatised firm rises after the float. The first (but not the second) tranche of Telstra shares exemplifies these concerns. The authors consider eleven privatised initial public offerings (IPOs), from 1989 to 1999, of both federal- and state-owned companies, and find that they were, on average, underpriced by about 11%. This does not, however, prove that the concerns have been warranted, since this amount is not significantly above the magnitude of underpricing of privately owned IPOs in Australia or of privatised IPOs in other OECD countries, although they do find that privatised IPO prices have been relatively lower under conservative governments then under Australian Labor Party governments.

One of the most pervasive principal-agent issues is that of the employer-employee relationship, where the employment contract can be seen as a means of providing incentives to induce employees' behaviour to more closely approach that desired by employers. Ed Lazear (1995) has developed the new field of 'personnel economics' in applying the tools of game theory to the design of the 'rules of the game,' or the employment contract, but there is a large literature in organisational behaviour which examines this issues.

Kent, Siu and Walker use data from Australian mining companies to investigate the relationship between mine managers' remuneration contracts and firm-specific variables, such as the riskiness of the firm, as revealed in both its exploration risk and its project-specific finance. They find that higher-risk firms reward their mine managers with a higher proportion of variable remuneration and market/and/or accounting-based remuneration than do lower-risk firms, at least when risk is measured by the firm's project-specific risk. When they measure risk by the firm's exploration risk, this relationship is not proved. The value of this study is that the position of mine manager is clearly defined and regulated by legislation, and so the contracts of this middle-management position will be less affected by the firm's organisational structure, unlike other middle-management positions that are not statutorily defined.

The benefits of diversification across national frontiers have been known for at least three centuries. A document dating back to 1774 instructs the manager of a Dutch mutual fund to hold an equal-weighted portfolio of Russian government bonds, Bank of Vienna bonds, English colonial securities, government loans from Mecklenburg and Saxony, and Spanish Canal loans (Goetzmann et al. 2000). Indeed, even the theoretical and quantitative analysis of portfolio theory is almost a century old: in 1909 Henry Lowenfeld described international diversification strategies that revolved around industry-neutrality, risk-adjustment, and portfolio rebalancing. Such diversification is more effective if the returns across national stock markets are independent, but recent work casts doubt on such independence.

Durand, Kee and Watson investigate the relationships among seven Pacific-Rim stock markets (in Australia, Hong Kong, South Korea, Malaysia, Singapore, Taiwan, and Thailand) to changes in financial variables in the US and Japan. They find that, over the eleven years from 1985 through 1996, these seven markets were, on average, led by the US market, with half of them also exhibiting a significant relationship with the Japanese market. To the extent that increasing globalisation will strengthen these relationships, the possibilities for such cross-frontier diversification strategies will dwindle.

The 'glass ceiling' is evidently a real phenomenon in Australia, with only a single woman as C.E.O. of a top-100 Australian company. Yet at least a third of recent MBA graduates at the AGSM are women, and women's numbers in middle management have been increasing over the past twenty five years. Many possible reasons have been advanced for their state of affairs, and the paper by Janne Chung provides another, with experimental data.

Chung hypothesises that performance of female managers is more harshly judged than is comparable performance by male managers, whether or not the evaluation is done by male or female observers. She has 57 observers (33 male and 24 female) evaluate and rate the performance of two managers of (one male, one female) who had made decisions based on common data. Her results on this experiment support the hypothesis, although a second hypothesis (that the perceived benefits from a woman-initiated decision will be lower than those from a male-initiated decision) is not supported. As it stands, these results are apparently consistent with the relatively small number of woman advancing to higher levels of corporate management in Australia, although further experimental data would strengthen this conclusion.

Issues of insider trading (where traders with access to non-public knowledge have apparently made profits at the expense of traders without this knowledge) are of continuing concern, most recently after the events of September 11, 2001, when it proved impossible to prove that trading by the terrorists was responsible for some anomalous price behaviour in the days before the attacks, presumably in order to profit from their knowledge that successful attacks would cause slumps in the prices of airline stocks and insurance stocks.

To what extent could public knowledge about the intrinsic values of the firms comprising a portfolio be used to predict the future returns on the portfolio? If such intrinsic-value measurement of portfolio values is effective, it suggests a violation of capital-market efficiency, in which the market has already arbitraged away any possible gains from publicly available information.

Using local data, Guido and Walsh test the robustness of recent work in the US which developed such intrinsic-value measures. Their findings should give heart to much of finance theory which assumes capital-market efficiency, since they are not able to support the US results.


The E. Yetton Awards are made to the best paper of the previous volume of the Journal and its runner-up, as voted on by the Area Editors of the Journal. Competition for Volume 25 (which included these issues, two general issues, and one special issue on Market Orientation, guest edited by Mark Uncles) was fierce, which is to say that distinguishing, the best two papers was not easy. The winning paper is 'Beta and Return: Implications of Australia's Dividend Imputation Tax System', by Robert Faff, David Hillier, and Justin Wood. The runner-up was 'The Impact of Regional Variables on Export Performance: An Empirical Investigation in Australia and the UK' by Chris Styles and Tim Ambler. Congratulation to all concerned! A list of previous winners can be seen on the Web, at http://www.agsm.edu.au/eajm/yettonaward.html. I note that this is the second time for Robert Faff, who was co-author at the paper that won in 1998 (Brooks, Faff & McKenzie 1998).

On the editorial front, I wish to welcome Chris Kirby, of the AGSM, who has agreed to take over the Finance Area Editorship from Stephen Gray, who had been in the position for several years. Thank you, Stephen, and welcome, Chris.


Brooks, R.D., Faff, R.W. & McKenzie, M.D. 1998, 'The varying beta risk of Australian industry portfolios: A comparison of modelling techniques', Australian Journal of Management, vol. 23, no. 1, pp. 1-22.

Economic Intuition, www.economicintuition.com

Faff, R., Hillier, D. & Wood, J. 2000, 'Beta and return: Implications of Australia's dividend imputation tax system', Australian Journal of Management, vol. 25, no. 3, pp. 245-60.

Goetzmann, W.N., Li, L. &. Rouwnhorst. K.G. 2000, 'Long-term global market correlations', Yale International Centre for Finance, Working Paper no. 00-60.

Lazer, E 1995, Personnel Economics, Cambridge: MIT Press.

Lee, D.R. 1988, 'Free riding and paid riding in the fight against terrorism', American Economic Review, vol. 78, no. 2, May, pp. 22-6.

Styles, C. & Ambler, T. 2000, 'The impact of regional variables on export performance: An empirical investigation in Australia and the UK', Australian Journal of Management, vol. 23, no. 3, pp. 261-85.

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