Volume 23 Number 2 December 1998

Editor - Robert Marks

In Search of Efficiency

T he six papers in this issue of the Journal are focused on efficiency, across three disciplines. All six papers include empirical sections. There are four finance papers, one economics paper, and one accounting paper. In three of the four finance papers, price data from the Australian Stock Exchange (ASX) or the Sydney Futures Exchange (SFE) are analysed, and ASX data also play a part in the accounting paper (Abrahams and Sidhu). (Abrahams and Sidhu). The fourth finance paper (Brailsford and Mahaswaran) looks at determinants of short-term interest rates, while the sixth paper (Hutcheson and Sharpe) is not directly concerned with market data, relying instead on accounting data in examining the effect of the firm's ownership on its efficiency.

Indeed, implicitly or explicitly, questions of efficiency underly all the papers - explicitly in the cases of Hutcheson and Sharpe, Abrahams and Sidhu, Frino, Stevenson and Duffy, and Easton and Pinder; implicitly in the case of the two remaining, which should remind us of the role of the Bourse in allowing the exchange of risk to overcome the absence of a full set of Arrow-Debreu contingent markets (Arrow 1953).

The now-standard Capital Asset Pricing Model (Brennan 1989) is predicated on certain assumptions which are required for rational agents to hold mean-variance efficient portfolios. One sufficient assumption is that asset returns are distributed multivariate normal, and so are completely described by the first two moments of the distribution: the mean and variance. Finding univariate normality is not sufficient for multivariate normality however, so Gray, Kalotay and McIvor examined 24 years of ASX data for multivariate normality. They found strong evidence that asset returns on the ASX were not multivariate normal. As well as having implications for asset pricing, this result may require adjustments in the models used to describe stock-market returns.

The move towards privatisation in many countries in recent years has been partly motivated by the belief that managers manage better when the firm's owners have incentives and opportunities to monitor managers' actions more thoroughly than occurs with government ownership. That is, private ownership alleviates the principal-agent problem (Ross 1973) exhibited by state-owned enterprises. Over the same period there have been many examples of demutualisation, in Australia most prominently by the life office, AMP Ltd.

Hutcheson and Sharpe use data from 31 Victorian building societies (17 mutuals, 6 share-owned, and 8 that converted from mutuals to share-owned in the 23 years examined) to see, by examining the X-efficiency of these, whether the agency problem - as reflected by different cost structures - was reduced in the share-owned societies. Against expectations, they found that mutuals provided a more efficient mix of services than did the share-owned societies, including the notorious Pyramid Building Society. They discuss possible reasons for the relative poor performance of the share-owned societies, which the interested reader may find at the end of their paper.

Abrahams and Sidhu are concerned with proposals to reduce the discretion of the managers of Australian firms to capitalise their annual R&D (research and development) expenditures. They attempt to answer two questions: first, is the unamortised balance of R&D on the balance sheet value-relevant? That is, does the market 'believe' capitalised R&D to be an asset of the firm? Second, do R&D accruals lead to improvements in accounting-based measures of firm performance relevant to investors? That is, do R&D accruals improve the association of accounting measures of performance with stock returns? In both cases, their tentative findings are yes. These results are consistent with arguments against the proposals to limit managerial discretion to defer and amortise R&D costs if specific criteria are satisfied.

Intraday trades on futures markets have previously been seen to exhibit a U-shaped spread between bids and asks: larger at the opening and closing of daily trading than during the day, whereas competition-dealer markets that trade options and equities have exhibited a larger spread at the opening but a narrowing at the close of trading. Using data from the SFE on quoted bid-ask spreads, Frino, Stevenson and Duffy found that here the intraday pattern of bid-ask spreads reflected the previous options and equities markets, rather than the previous futures markets. The main determinants of bid-ask spreads are volume and volatility, which are both elevated at the start and close of trading, leading the authors to conclude that the cost of holding inventories overnight drove the narrowing at the close. This study is the latest in the literature of the microstructure of markets - in this case, competitive-dealer markets, compared to specialist-dealer markets - which will aid in the design of markets now and the future, such as electricity auctions and the new markets in environmental instruments (Spulber 1996).

In the past 20 years observers have seen the emergence of large trades in financial derivatives (Hull 1997) - financial entities devised to provide, through their trading, a means of improving the efficiency of the economic system. In Australia, the opening of the SFE provided trades which complemented the trades on the ASX. One recently devised derivative is the Low Exercise Price Option (LEPO), initially authorised for trading in ten companies on the ASX. Following Black, Scholes and Merton (Black 1989), it is possible to derive the correct prices of LEPOs, and so to test whether the markets are pricing them correctly or not. Easton and Pinder examined the first twelve months of trading to find that LEPOs had been systematically underpriced (favouring the taker) for six of the eight companies examined, or overpriced (favouring the writer) when the LEPOs were affected by dividends. Just why provides a question for future research.

Interest rates in general, and short-term interest rates in particular, are of increasing importance not just to government and central banks as they revise economic policy, but also to risk managers. Indeed, understanding interest-rate volatility is important to banks, to portfolio managers, and to corporate treasurers as they seek to hedge interest-rate risk, to employ optimal hedging strategies, to establish bond-trading strategies, and to make portfolio allocation decisions.

Brailsford and Maheswaran take a step in furthering our understanding of the dynamics of short-term interest rates by using Australian data (20 years of the 30-day 'bank acceptance bill', or BAB, rate) to compare three classes of models: one in which variance may be a function of interest rate levels, one which incorporates time-varying volatility, and one which incorporates both of these. They find that the first model is not as good as the second or third at estimating short-term interest rates.

Finally, Waring reviews a new book, The Essence of Corporate Strategy, by Davis and Devinney, which demonstrates that accessible books on management need not be theory-free zones, with no basis in rigorous empirical research.


The Journal's home, The Australian Graduate School of Management, has become the first business school in Australia and perhaps the world to belong jointly to two universities - from the first of January 1999, the AGSM is a School of both The University of Sydney (previously the Graduate School of Business) and The University of New South Wales (previously the AGSM). For the Journal, this means that to a 23-year association with The University of New South Wales is added a new association with The University of Sydney. Subscribers and readers will continue to see improvements in the Journal's content, but otherwise no great changes.

Through the eight area editors and the more than sixty regular reviewers, the Journal has long had strong links with other institutions, both at home and abroad, not least The University of Melbourne, where two of the area editors, Rob Widing in marketing and Joshua Gans in economics, are employed. Unfortunately, owing to a new administrative position, Rob Widing has indicated that he will stand down as the marketing editor, a resignation we have sadly accepted. Rob has provided intelligent and energetic input to the Journal over the past five issues, and we thank him.

That this issue appears slightly behind schedule is due to an early arrival - Ayla Louise Barratt, first child of Ian and Fiona Barratt, our Manager, was born on 14 September 1998, six weeks early. On the same day, however, my loving wife, Hazel Church, finally succumbed to advanced breast cancer. Hazel provided me with indispensable support and encouragement over the years, not least during my 15 years' association with the Journal. Vale, Hazel.


Arrow, K.J. 1953, 'Le role des valeurs boursieres pour la repartition la meilleure des risques, Econometrie, Centre National de la Recherche Scientifique, Paris, pp. 41-48.

Black, F. 1989, 'How we came up with the option formula', The Journal of Portfolio Management, vol. 15, pp. 4-8.

Brennan, M.J. 1989, 'Capital asset pricing model', in Finance, eds J. Eatwell, M. Milgate & P. Newman, Norton, New York, pp. 91-102.

Hull, J.C. 1997, Options, Futures and Other Derivatives, 3rd edn, Prentice Hall, Englewood Cliffs.

Ross, S. 1973, 'The economic theory of agency: The principal's problem', American Economic Review, vol. 63, pp. 134-39.

Spulber, D.F. 1996, 'Market microstructure and intermediation', The Journal of Economic Perspectives, vol. 10, no. 3, pp. 135-52.

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