Volume 31 Number 1, June 2006

Robert E. Marks
General Editor

The Threesome: TLA, BCP, and AFP

I had entitled this piece 'BCP for AFP' when I realised, after reading Stern's recent Financial Times column (Stern 2006), that I was focussing on the latest fad in management-speak: the TLA, or three-letter acronym. After one's become aware of them, one finds them everywhere: TQM, BCP, CSR, AFP, BPR, etc; QED. Stern argues that emergence of the TLA often indicates that the concept is on the way to obsolescence: DOA, as it were. Unfortunately, I fear that's not true for Avian Flu Pandemic, and the best way, the prudent way, for firms to approach the threat of AFP is with Business Continuity Planning.

Y2K, AFP: what's the difference? Well, it's true that the fearful predictions of chaos didn't occur as the world's clocks ticked over to 12:01 am on Saturday, January 1, 2000, and it might be difficult to remember the efforts that went into preventing disruption or worse in the months and years leading up to the new millennium, now, six and a half years later. But don't assume that another flu pandemic won't occur, or when it does come that it will be a minor inconvenience, as the 1968 pandemic--the last to arrive--turned out to be. The fable of the boy who cried 'Wolf!' illustrates two pertinent morals: first, don't sound the alarm too often, and, second, just because warnings become monotonous doesn't mean that there is no threat. Perhaps not immediately from a flu pandemic, but what about a cyclone? or a power outage? or a new form of computer virus? or an escalating conflict near the oil wells? Or a terrorist attack in the CBD? None is likely; any is possible.

BCP is a form of self-insurance when the firm takes action to mitigate the impacts on its activities from disruption, usually from external events. Just as corporate strategy argues that successful firms are matched to their market environment at both ends of the value chain, BCP suggests that they should make some contingency plans against the time when that environment changes significantly, often without warning.

At this point, use of an extended value chain can illuminate. As well as Customers at the top and Suppliers at the bottom, envisage other inputs (Services and Utilities-banking, auditing, legal, insurance, training, security, travel, communications, water, electricity, other energy, sewerage, public health, etc.) on the left, and Employees (up to and including the CEO and the Board) on the right. Disruption to any of these can potentially cripple the firm. Some firms try to list all possible shocks or contingencies, from any or several of the four quadrants. But this task has no end: an imaginative committee can always come up with another, and then disagree at length about the likelihood of its happening.

A better way, I argue, is to undertake a form of triage: decide which of the firm's activities are core, to be abandoned only in extremis; which are postponable, until full operations are resumed, to be cannibalised to maintain the core; and which are desirable, but not quite core. Then the BCP committee can more readily see what needs to be done to maintain the core and if possible the desirables, under several possible disruptions.

Customers and suppliers should be kept informed, both prospectively, and as events unfold, to manage their expectations, and to help them coordinate their own BCPs. Indeed, some customers demand that their suppliers have a BCP.

In several classes on this, I have found that many firms (often in financial services) have made serious provision against their computers being unavailable (because of a power outage, a terrorist hit, or perhaps a virulent computer virus), but seldom do firms plan against the impact of a highly infectious disease on their workforce, and especially not on the BCP team. Yet this is the immediate impact of a serious flu epidemic-significant absenteeism because of illness, or fear of infection.

Experts agree that it is a question of when, not whether, another flu pandemic will come. All the current bird flu lacks is easy human-to-human transmission, and as it spreads to become endemic in flocks around the planet the mutations necessary become more likely.

But whether it will be A(H5N1) or some other flu virus, and how severe the pandemic will be we cannot yet know, nor can public health authorities comprehensively plan for it. Nonetheless, firms and other organisations can develop the contingency plans for such possibilities known as BCP. I argue that BCP, although not a panacea, is a prudent response to the risk of disruption.

The Papers

Designing markets? Isn't that a little like designing animals? That is, haven't markets just evolved, along with civilisation? While it's true that markets are always associated with towns and cities and reflect the specialisation of labour that must accompany or cause the growth of places of densities of human population greater than those of hunter-gatherer societies or of agricultural societies, as the late Jane Jacobs (1984) argued in her significant work on cities as civilisations, not all markets are ancient. In recent years new markets have been designed for trading risk (via financial derivatives, indices, and synthetic instruments), for trading electricity, for trading pollution emission permits, for trading on the Internet (whether business-to-business or eBay and its emulators). All of these have been designed, often through a process of trial and error, but sometimes based on our understanding of theories of how markets work. Often, in these cases, trying to understand how to design a market to achieve specific aims-of efficiency, of cost, of speed, of highest revenue etc-has provided a fillip to theory.

In the first paper in this issue, Byde uses the machine-learning technique known as the Genetic Algorithm to develop a form of sealed-bid auction between the standard first-price auction, in which the highest bidder (when the auctioneer is selling) pays his bid for the item, and the Vickrey, second-price auction, in which the highest bidder pays the second-highest bid for the item. In Byde's synthesis he designs auctions in which the price paid is a weighted average of the highest and second-highest bids and in which under certain robust circumstances the average revenues exceed the revenues for both first- and second-price auctions.

Trade credit is the deferred payment of commercial debt to sellers. When firms are constrained by institutional lenders, it is an important short-term financing mechanism, as well as an important tool for building business relationships. Consequently, trade credit can be an important strategic tool for a firm's operations, and has become the predominant method of transaction for international trading. A boon for importers, use of trade credits has, however, increased the operational risks faced by exporters, with higher bad debts, lower profits from de facto discounting, and greater exposure to exchange rate fluctuations. Exporters have responded with increased assessment of their credit risks.

Despite much theory on credit risk assessment, there has been little empirical research on the assessment and prediction of credit risk in international trade. Chi and Tang construct and test a model of prediction of trade credit risk, using data of financial ratios and firm-specific characteristics of 60 listed firms that filed for bankruptcy between 2001 and 2003 in the seven Pacific-Asian countries of Hong Kong, Japan, Korea, Malaysia, Singapore, Thailand, and the Philippines. They claim their model's ability to predict was approximately equal to its ability to classify and that its accuracy is decreasing in time from the event.

The principal-agent problem as applied within the firm has resulted in attempts to provide incentives for managers that are positively correlated with the firm's success. Concerns about corporate governance have led to changes in the use and accounting for stock options; see Pitt (2006). The standard stock option grants a call option on the firm's shares at a fixed strike price. Is this too generous to the executive? Does it unfairly reward the executive for broad rises in the market that therefore are not a consequence of the executive's efforts to improve the value of the employing firm? Recently, firms have begun to offer executive stock options with a strike price that, first, rises over time at a hurdle rate usually set with respect to the (varying) cost of capital, and, second, is adjusted down by the amount of any dividends paid. These two features should tie the incentive more closely to the firm's performance and so reduce any incentive for the firm to reduce its dividends payments.

There are several questions that could be asked about such stock options. The most pressing one, given recent concerns about corporate governance, is how to value them, a task made difficult by the path-dependence of the link to dividend payments.

Cheung and his co-authors use a new approach to this valuation and compare their results with the usual method of the Black-Scholes-Merton (BSM) formula for constant strike-price options. They find that the new options are consistently and significantly overvalued by the BSM formula, a lesson for corporate accountants. Just how effective the new options are at providing the correct incentives for executives, with a lower incidence of manipulation, remains to be seen.

It was Ben Franklin who noted the two certainties of life: death and taxes. The second of these is addressed in Pattenden's paper, while the first, or at least life insurance, is address in the next paper. Despite the introduction of compulsory superannuation payments in Australia, the relative importance of life insurers in capital markets has risen, to 7% of total assets. And, in many families, an offspring's first life policy is his or her introduction to financial planning, after the childhood money box. But what drives demand for life policies?

Lenten and Rulli have found that the strong growth in demand for such policies in the mid-1980s was probably affected by various changes to the supply side of the industry. At the same time there was a higher demand in summer. They also found correlations between the demand for polices and prices, incomes, unemployment levels, and population levels, as theory would predict.

Taxes, pace Mark Twain, might be certain, but not their form and hence the incentives they provide. Public finance students never forget the ill-fated revenue-raiser of the English tax on windows, that resulted in many a dark day for the dwellers of the now windowless houses. In more recent times in Australia, the 1986 change in the corporate tax regime from the so-called classical regime (similar to the current US regime) to the dividend-imputation regime that exits now has changed firms' incentives. In the classical regime, interest was tax-deductible while dividends were not and profits were taxed, which led to an incentive for firms to finance with debt; in the dividend-imputation (or integrated) regime, shareholders receive a tax credit for taxes paid by the firm, which eliminates any tax benefit of debt by treating dividends and interests payments equally from the firm's perspective.

Pattenden's Bayesian econometric analysis of a panel of Australian firms both before 1986 and after the imputation regime was introduced confirms this prediction, and goes some way towards helping explain why, with imperfections such as asymmetrical taxes in the capital market, the debt: equity capital structure is relevant. The 'natural experiment' of the change in Australia's corporate tax regime allows for this analysis.

A premium is positive, right? Especially if the premium is associated with higher risk to equity holders. Indeed, the Capital Asset Pricing Model makes the implicit assumption that the ex ante equity risk premium is always positive. But at least two non-Australian studies had found otherwise when Walsh undertook research to examine the sign of the equity risk premium in Australian markets. She found that here, too, the ex ante risk premium can be negative, although by itself this does not invalidate use of the conditional CAPM. In the course of the research she used the concept of two regimes, the normal regime of positive risk premia, and an uncommon regime with negative premia.

As an economist tracking applied economics and game theory in a graduate school of business, I hew pretty much to a 'rational decision maker' model, with some hedging around the edges. (My recent research has included boundedly rational decision making.) So I find the concepts in Janczak's paper-the logics of collective action-rather remote. Janczak included bounded rationality in the first of his four approaches to decision making: rational choice. The other three are: political, intuitive, and garbage can. Underlying all of these, Janczak argues, are three possible logics: authoritarian, emotional, and conciliatory. After analysing a survey of 59 projects undertaken by 39 middle managers, Janczak concludes with three recommendations for top managers trying to develop better decision making within the organisation.

The final paper in this issue is really an indulgence. It is now thirty years since the Foundation Editor, Ray Ball, brought out the first issue of the Journal. For those interested, all back issues are available for purchase, paper by paper, from EBSCO. As well, about half of the Journal's articles are available on the Journal's web site. With the first issue of the thirty-first volume, David Gallagher, the in-coming Finance Area Editor, has written a review article of the Journal's first thirty years, focussing on issue citation rates, authors, institutional affiliations of authors, most highly cited papers, and the patterns of papers by discipline area. David ends by asking what the future might hold, as specialist journals arise, and as the stigma associated with on-line publishing fades. What will the future bring to the Journal? Watch this space.


In June 1991, the Journal published a Special Issue, on 'Internationalising Australia's Economy,' edited by Ian Marsh. Ian went on to become the Journal's Area Editor in Government Policy and Regulation, and also edited another Special Issue, on 'Economic Strategies for a Prosperous and Fair Society,' in 2001. Even earlier, in 1988, the Journal published a Supplement, 'The Public Policy Forum presents the Campaign Managers,' which Ian had been instrumental in organising and having transcribed for publication. For almost twenty years, then, Ian has remained an Area Editor while at the AGSM, at ANU, and most recently at the Australian and New Zealand School of Government at the University of Sydney. For almost twenty years the Journal has benefited from Ian's imagination and energy. This issue marks the end of Ian's long association as an Area Editor with the Journal. Thank you, Ian.

Peter Lok was one of the group of Organisational Behaviour academics at the AGSM who volunteered to assist the General Editor in processing O.B. submissions to the Journal, in the absence of a dedicated Area Editor. With his recent departure from the AGSM, Peter has ended this relationship with the Journal. Thank you, Peter. Finally, Farid Khoury, the maintainer of the eAJM, has moved on to pastures greener, and I'd like to welcome James Murty, who will continue in this role. Thank you, Farid, and welcome, James.

Robert E. Marks
General Editor


Jacobs, J. 1984, Cities and the Wealth of Nations, Vintage, New York.

Marks, R.E. 2006, 'Market design using agent-based models', chapter 27, in the Handbook of Computational Economics, Volume 2: Agent-Based Modeling, edited by L. Tesfatsion & K.L. Judd, in the series Handbooks in Economics, (general editors K. Arrow & M.D. Intriligator), Elsevier Science, Amsterdam, pp. 1339-80.

Marsh, I. (ed.), 1991, 'Internationalising Australia's Economy: Vision and Means in the Garnaut and Australian Manufacturing Council Reports', Australian Journal of Management, vol. 16, Special Issue.

Marsh, I. (ed.), 2001, 'Economic Strategies for a Prosperous and Fair Society', Australian Journal of Management, vol. 26, Special Issue.

Stern, S. 2006, 'Curse of the three-letter acronym', Financial Times, May 29.

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