Volume 27 Number 2 December 2002

Editor - Robert Marks

Corporate Governance or Where Does Ownership Lie?

C orporate collapses over the past twelve months or so, in Australia and overseas, have raised the issue of deterring unethical behaviour among executives. Re-regulation or strengthening of existing regulation (either industry-specific, or more broadly based) may not be effective when the actions of an individual or a small self-interested clique can undo the corporation -- and have done so recently. Internal control of such behaviour has raised the further issue of corporate governance.

Closer to home, universities are asking whether their changed financial arrangements spell change for their governance structures. When - especially in such countries as the U.K., Canada, Australia, and New Zealand - almost the entire budget of the university was paid for by government, it was appropriate that the government have a large say in the financial affairs of the university, through the membership of its governing body, while maintaining an arm's-length distance from academic matters. But as direct government financial support has dwindled, and free university study has disappeared - which has meant a larger reliance on fees and other forms of income - universities have wished to have more control over their governance than in the past.

In New South Wales, where, as in other states and provinces, universities are established under state-government statute, state-government financial support for universities has been negligible for over twenty-five years, since the Whitlam ALP federal government took over university funding. Nonetheless, the state government has reserved several places on each university's governing body, which are filled by serving state politicians. This seems anomalous, if not anachronistic. All power and no responsibility. Rather, let him who pays the piper call the tune, or at least allow a greater degree of self-government. If the concern is that universities might prostitute themselves to the highest bidder, then reduce the incentive for universities to have to beg, in effect, by providing more financial support - and retain equivalent representation on their governing bodies, to boot.

As government support has dwindled for universities in general, so it has for the Australian Graduate School of Management - publisher of the Journal - in particular. Originally founded by the federal government to provide a viable Australian alternative to the top overseas management schools, with ear-marked funding and student scholarships (well, we're talking almost thirty years ago), government funding through the two parent universities is now low and set to fall to zero within three or four years. In general, through its educational programs (both degree and non-degree), the AGSM has been able to replace the vanishing government/university support and even grow in scale and revenue, a worthy outcome, which has meant growing numbers of students and managers being exposed to the ideas and tools of modern management education. But the membership of the governing body does not reflect this hard-earned financial independence.

This is an issue for universities in general and business management schools in particular. And there are further constituencies: as well as the parent universities and the students, there are the faculty and the alumni and the firms and organisations that hire or employ the students. Perhaps we can deal with potential employers by observing that the need to produce graduates who are attractive to such stakeholders will focus the school's mind as it crafts its curriculum and hires its faculty. Companies and alumni too have the possibility of providing support for research centres and named chairs in disciplines and areas of their choice, which in turn provides a means for them to guide research as well as teaching in directions they favour, subject to academic oversight to preclude undue influence.

This leaves the faculty: the academics who teach and research. The university's top administrators are by and large academics-turned-administrators, who may have professional managers reporting to them, but who implement policy and manage the affairs of the university. Of course, not every academic is cut out to be an administrator, but even at those epitomes of the ivory tower, the Oxbridge colleges, the dons collectively decide policy for their college, sometimes even quickly. (I recently read how the dons of Pembroke College, Cambridge, had deliberated at length on how to enlarge their historic college library building: all had their say - many amazingly would have had gifted careers in architecture but for a missed bus or a late letter - and eventually the decision was made.) This model - in effect a partnership of faculty - may well be appropriate for business schools which have financial autonomy from their parent universities, but not yet governance autonomy.

The governing body of the business school would resemble the governing body of a professional partnership, such as a law firm or an accounting partnership. There would still be need for the parent university to be represented, and for various outside stakeholders as well, such as significant supporters of the school, but the main representation on the governing body would be the representatives from the faculty.

By now it should be becoming clear that I have an answer to the rhetorical question in the editorial's header: ownership of a financially autonomous business school should lie with the faculty, who of all stakeholders have most invested in the school, in terms of career, forgone opportunities, and their patterns of teaching and researching. I would take the model of a professional partnership, with suitable amendments, and feel confident that ownership, governance, and incentives to stimulate the growth and improvement of the school were suitably aligned. Floreat domus!

This Issue's Papers

A farmer wishes to reduce the risk of price movements by hedging his soybean harvest using futures contracts. The issue explored by the authors of the first paper in this issue of the Journal, Foster and Whiteman, is the 'hedge ratio', the proportional relation between changes in the spot price of a commodity and the changes in the price of an associated derivative producer, here the futures prices of soybeans. To do this requires predicting the spot and future prices of soybeans over the life of the futures contract.

If you know your harvest will be ready for sale in January, say, but you don't of course know what the price will be then, you can hedge by 'shorting' the soybean futures contract to lock in the current spot price, suitably adjusted for the cost of carrying stock. But how many futures contracts should you sell? One simple criterion is to choose a futures position that will minimise the variance of cash flows; the hedger attempts to offset possible gains or losses from price changes in the spot market with equivalent gains or losses in the futures market. But, as the authors point out, there are several drawbacks to this approach, not least that it ignores any relationship between choices in the hedging strategy and real resource allocation by the farmer hedger. They introduce a numerical technique for estimating Bayesian hedge rates that extends earlier analytical work and can easily accommodate different specifications (levels or logarithms, trends or no trends, etc.), uncertainties about the risk that arises when the hedger does not know the probabilistic relationship between spot and futures prices (the so-called estimation risk), and other factors.

Using Monte Carlo simulations, the authors computed Bayesian hedge ratios for a number of horizons and expiration dates, as well as 'naive' and 'certainty equivalent' hedge ratios. They draw eight qualitative lessons from their analysis, comparing the three types of estimating the hedge ratios. They conclude that their Bayesian hedging can be more valuable than a 'naive' procedure, and permit more complex and realistic representations of the data, while taking into account the estimation risk that they entail. As author of the editorial in the June 2002 issue of the Journal (Marks 2002), I was gratified to see that numerical techniques continue to shed light on finance issues.

The use of Discounted Cash Flow (DCF) techniques verged on revolutionary as a management tool in the 1970s. It took some time to become widely understood and used - indeed, in the mid-1980s I found myself advising the treasurer of a large public institution who had an intuitive feel for the opportunity cost of capital, but wasn't sure how to factor it into his investment decisions. A few years later the idea of using option theory to model the flexibility that management retains to vary their activities in response to changed future conditions was being developed by Dixit and Pindyck (1994). In the past eight years, the application of real-option theory has burgeoned. The second paper is a study of the relationship between gold prices and the valuation of Australian gold-mining firms. Twite finds that, by ignoring managerial flexibility, DCF models systemically undervalue the market price of gold-mining companies, although he feels that this is partly because of misuse of DCF techniques. The upshot of his research is that gold-mining companies can be represented as a portfolio of gold assets (whose value reflects the gold price) and embedded real options. Because they are specialised and price takers, gold-mining companies lend themselves to the kind of analysis Twite has undertaken. His work suggests that DCF techniques would also underestimate the value of firms with market power, or of more diversified corporations.

Service organisations, such as graduate schools of management or hospitals, are facing increased cost pressures when they use labour-intensive technology, as Baumol (1965) argued. Although investment in high-tech equipment has risen in response to technical breakthroughs, such as CT and MRI scanners, the number of carers per patient has probably risen over the past fifty years - capital is not substituting for labour, the two are probably complementary. Meanwhile, an aging population with higher expectations and wealth has resulted in greater pressure on the supply of hospital services, especially where - as in Australia and Canada - there is a high degree of tax-payer support for hospitals.

Squeezed between rising costs and higher demand, hospitals have attempted to enlist the latest incarnation of W. Edwards Deming's Total Quality Management (1981), first developed for assembly-line production, in order to increase carer productivity and the quality of service. LeBrasseur, Whissell and Ojiha examine the implementation of continuous quality improvement (CQI) in acute-care general hospitals in Ontario, Canada. They argue that its implementation was both a paradigm shift and an occurrence of organisational learning. Their two case studies, as well as a survey of Ontario hospitals, support the prescription of a top-down approach, in which the hospital's top administrator leads the transformation and aligns the hospital's strategy, structure, and culture to CQI. To a great extent, this reduces the trade-off between quality and cost of care. They find that members of the organisation - especially the professionals and administrative groups - undergo both a cognitive and a behavioural adjustment that is centred on teamwork, and facilitated by training and education. Teamwork and involvement of physicians, however, remains a long-term challenge, in their words.

As the Australian government considers paying out all its Australian-dollar creditors and so closing Australian bond markets - with some concern among bond traders and others - along comes reported research into the relative performance of active Australian bond funds. It is a truth universally acknowledged that active funds do not often outperform market indices (that is, the earnings associated with a fictional bundle of assets). But these results have almost entirely been verified for equity funds or diversified portfolios (of equity and non-equity securities) alone. In Australia - at least until Peter Costello acts - managed bonds represent about a fifth of total assets under management, the second largest class of managed assets. Gallagher and Jarnecic attempt to remedy the analysis gap by examining the investment performance of active Australian bond funds, using both unconditional and conditional performance evaluation (which incorporates information variables to obtain more accurate measurement of abnormal returns, those earned beyond publicly available information). Their results resoundingly support the earlier findings: the average active bond fund does not outperform the market index (whether or not management fees are accounted for). The results hold whether a conditional or an unconditional performance model is employed: performance is equivalent to an index fund before costs, which is of course consistent with an efficient market: all arbitrage opportunities have been exhausted.

The four papers introduced above have this in common: they examine the means and ends of individual or managerial decisions: hedging, valuation of a gold-mining company, implementation of change in hospitals, and whether to pay for the services of a managed bond fund. The final paper is focussed on modelling the policy implications of tax, a policy issue. Following earlier work on proxies for the marginal tax rate, Pattenden examines two factors: the impact of tax regulations on proxy performance, and the presence of bias in proxy construction, using a simulated tax world with a known (because constructed) 'true' marginal tax rate. She uses two proxies (estimates of the marginal and average tax rates) and ranks them against the 'true' rate using regression diagnostics. She finds that the best performance proxy is also an unbiased estimate of the underlying tax process, although proxies differ in performance across different tax-loss treatments. Specialist work, this research will be of especial interest to researchers constructing and using tax proxies.


Congratulations to Sharon Parker, Area Editor for Organisation Behaviour (O.B.), and her co-editor, Robert Wood, on the recent Special Issue on O.B. in Australia and New Zealand. When she became Area Editor, Sharon suggested that to kick-start an association between the Journal and academic researchers in O.B. it might be useful to publish a special issue on the area, with shorter papers from more people. In the event, there are fifteen papers from twenty-one authors, in an issue of 159 pages plus a seven-page introduction - the largest issue for several years. We hope that it results in more O.B. submissions to the Journal, and so more published papers.

While John Lyon was overseas, Baljit Sidhu has been the second Area Editor in Accounting: thank you, Baljit.


Baumol, W. 1965, 'On the performing arts: the anatomy of their economic problem', American Economic Review, vol. 55, May, pp. 495-502.

Deming, W.E. 1981, On the Management of Statistical Techniques for Quality and Productivity, W. Edwards Deming, Washington, D.C.

Dixit, A.K. & Pindyck, R.S. 1994, Investment Under Uncertainty, Princeton University Press, Princeton, N.J.

Marks, R.E. 2002, 'Simulating economics', Australian Journal of Management, vol. 27, no. 1, pp. i-v.

Pembroke College Society Annual Gazette, September 2002, Cambridge.

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